Jaivime Evaristo, consultant of business advisory at Contax Partners says the petrochemicals industry in the GCC is set to be challenged and shaped by the emerging trends affecting the global petrochemical sector value chain.
Global demand for petrochemicals and their derivatives has historically tracked global economic trends due to the nature of their end uses.
So much so that during the onset of the recent global economic crisis, demand and, therefore, prices of petrochemical products have plummeted to historic lows.
Although prices have since recovered, the long-term outlook for petrochemical products appears set to be challenged and shaped by the emerging trends affecting the global petrochemical sector value chain. Major trends and drivers include:
1- Demand/Supply Imbalance
By 2015, the Middle East is forecast to supply 20% of the global output of petrochemicals, an increase from its 2009 level of 16%. The resultant overcapacity and oversupply will likely affect utilisation rates especially amongst producers in the developed world where the cost of feedstock is relatively less competitive than their Middle Eastern counterparts.
In perspective, ethane in Saudi Arabia – heavily subsidised by the government – is being sold to Saudi producers at US$0.75/mmBtu compared to global spot prices of natural gas at US$4.46/mmBtu as of December 8 2010.
This leads to an ethylene production cost of US$160/mt in Saudi versus US$380/mt for producers in the West which use naphtha-feed crackers.
In anticipation of the lingering oversupply trend, global producers will continue to inevitably suffer lower utilisation rates, thereby depicting a downward pressure on prices.
This outlook stands in stark contrast to the years before the economic crisis when global utilisation rates were higher than 85%. Fortunately for producers in the GCC – thanks to lower raw material and utilities costs – utilisation rates have improved in 2010 together with volumetric sales growth.
2- Shift in Feedstock
The GCC is currently experiencing a shortage of ethane, historically the prime feedstock for its petrochemical plants, due to the increased domestic demand to fuel other industries, primarily power, steel, and aluminium.
Moreover, the region is developing policies to give priority to domestic gas use over export, phase out price subsidies, and align domestic natural gas prices with export prices.
As a result, some project owners such as ChemaWeyaat in the UAE, Saudi Kayan and owners of future downstream petrochemical clusters in Saudi Arabia are moving away from ethane-based, export orientated petrochemical production and are now developing plans to produce a wider slate of high-value specialty chemicals for the automotive, textile, electronic, construction, agricultural, and pharmaceutical industries.
While this shift provides significant socio-economic advantages, like the creation of employment opportunities and gradual technology transfer that will further reinforce a growing petrochemical sector in the GCC, it also means lower margins for GCC producers since liquid-based (propane and butane) and naphtha feedstock have a higher associated cost than the traditional subsidised ethane.
3-Margin vs. Competitive Advantage
As a result of the limited ethane supply and, therefore, increasing utilisation of liquid-based and naphtha feedstock, the future cost advantage of GCC producers will be less than their present ethane-based cost advantage albeit still more competitive than the producers in the West.
For example, producers in Saudi buy propane at a discounted rate to naphtha prices, which in turn are linked to oil prices, such that while propane is more expensive than ethane, the discounted rates ensure that Saudi producers still come out more competitive than their counterparts elsewhere in the West and in Asian region.
GCC Energy & Petrochemical Project Outlook
Having expounded on the three major trends that shape, and will likely continue to define the contour of the petrochemical industry in the GCC, it may be of interest to investigate what will be the likely scenario on the GCC energy and petrochemical project Capex market.
As of Q3 2010, Contax Partners estimates show that over US$440bn worth of energy projects have been awarded over the past five years and that the future opportunity pipeline continues to look positive with US$570bn planned for award between Q4 2010 and 2013.
Despite this optimistic scenario, the project postponement and cancellation trend continues to plague the market and thus begs the question “is this projection realistic, considering the past trends and the current market scenario?”
To develop a more realistic view of the future landscape, Contax Partners regularly assesses and segregates all planned projects into 3 ‘likelihood of proceeding’ tiers: Tier 1, i.e. those projects with greater than 70% likelihood of proceeding in the current market; Tier 2, i.e. those projects with between 40% and 70% likelihood of proceeding in the current market; and, Tier 3, i.e. those projects with lower than 40% likelihood of proceeding in the current market.
With this reality check and the hypothetical Capex award ceilings – conjectured around the past trends and various other market factors – it is anticipated that the GCC Capex market will not be able to realise all of its annual plans and that a significant proportion of projects will be postponed to future years.
At present, Tier 1 and Tier 2 energy projects together represent c.65% of the total planned energy project Capex between Q4 2010 and 2013.
From a sector perspective, the Power and Petrochemical sectors are the key markets going forward, together accounting for c.50% of the combined planned Tier 1 and 2 Capex.
Under an optimistic scenario where all the projects are awarded as planned, GCC energy workload is forecast to peak in mid-2012, representing a 105% increase from the current level.
However, should only Tiers 1 and 2 projects go ahead as planned, GCC energy workload is likely to plateau for the remainder of 2010 and increase in 2011. Of the total planned petrochemical spend between Q4 2010 and 2013; Tier 1 and 2 projects represent 70%.
Should these Tier 1 and 2 Petrochemical projects go ahead as planned, workload is expected to increase in 2011 and peak in 2013. This paints a picture whereby GCC energy project workload may be on the rise again with a peak forecast for 2012, at a level that could be higher than the last workload peak seen in 2007-2008.
With this workload forecast, while it may be tempting to assume that a resurgence of the ‘tight’ resource scenario in the energy project Capex market is a logical supposition, it is conversely compelling to surmise that due to the changing economic landscape, some pre-award and post-award project risks may have evolved.
Therefore, it is imperative to see how these evolving project risks could impact stakeholders and, as a result, what Project Owners and Contractors can do to mitigate risks early on in the planning cycle and maximise gains.
Considerations for Project Owners
For upcoming projects, Project Owners will need to choose the right ‘sweet spot’ for project awards to maximise the potential upside.
In early 2008, energy-related project workload reached a peak resulting in over-stretched market conditions, EPC price escalation, contractor capacity issues, delays and overruns, etc.
Following the decrease in workload due to the impact of the global economic crisis, workload has ramped up once again in 2010 to levels matching that of the boom period due to the high levels of award activity in 2009.
As mentioned, should projects continue to be awarded as planned, it is expected that the market situation will not only mirror that of 2007-2008 but also could become even more stretched; thereby, underlining the critical importance of having the foresight that will guide the decision on when is the optimal time for project award.
For awarded projects, Project Owners will need to continue to have visibility over and mitigate the risks that may arise from the ailing financial health of many contractors.
For example, while it has been widely reported in the media that commercial banks have sufficient liquidity, many contractors continue to complain that the banks remain reluctant to resume lending activity.
Project Owners who are well-informed about the financial health of suppliers and contractors may prove more empowered to mitigate potential risks throughout project execution.
In addition, Project Owners may also need to consider introducing some enhancements into the traditionally preferred contracting strategies to be able to increase the appeal of the project to Contractors while being able to mitigate project risks and enhance the overall effectiveness of a chosen contracting strategy.
Considerations for Contractors
One of the biggest challenges being faced by Contractors today is choosing the right opportunities to target.
Contax Partners has developed a robust opportunity pipeline methodology to support contractors in this process and in their overall opportunity pipeline management.
Once the right opportunities are identified, Contractors will need to understand their capabilities, how they compare to their competitors, and in which areas they should up-skill.
In addition, Contractors should also consider the following questions:
• What contracting strategies best reflect the risks that are better shared with project owners?
• How can long-term partnerships with project owners, subcontractors and suppliers be developed?
•What behaviours will the current market conditions drive from project owners, subcontractors and suppliers?
• What efforts are being made internally to improve our trusted advisor status levels with key individuals for the future?
The high correlation of petrochemical demand to global economic activity suggests that stakeholders across the entire petrochemical sector value chain will need to remain vigilant of the forces, trends, and drivers that will continue to shape and define their respective desired value and competitive advantage.
It appears likely that those Project Owners and Contractors that have visibility over the risks affecting each one’s turf are better equipped to mitigate, if not eliminate, the unfolding and constantly evolving risks in capital project development.
