Asset management

Despite the massive decline in crude oil prices that the markets have seen this quarter, we have a positive stance for the petrochemical sector of the Middle East and North Africa region.

Based on our expectations, regional production capacity is expected to increase by 7.3% in 2009, and is expected to continue to increase at a compound annual growth rate (CAGR) of 7.6% to reach 113.5 million tonnes by 2011.

Moreover, major expansion in production capacity of Saudi Arabia is expected, where we anticipate capacity to reach 60.3 million tonnes from the production capacity of 44.7 million tonnes in 2007.

It is worth mentioning that most of the big projects in the region are scheduled for completion by 2009, so regional capacity is expected to show an increase of 11.7% in 2009.

This implies that the probability of a delay to these projects is reduced since the necessary investment has largely been made already for the bulk of these projects. However, the status of projects after 2010 is still unclear.

The price of polymers and PET has collapsed this month. Is this something the sector should be alarmed at?

We believe that the recent tumble in the prices of PET and polymers is short-term and mainly due to the decline in raw material prices. This suggests that, regionally, there will be no major impact on the margins.

However, instead of looking at the prices of PET and polymers we should look at the demand for these products. We are still forecasting a continuity of increase in the demand from Chinese and Indian markets.

Moreover, we expect that the regional players will easily tackle this scenario, especially compared with the other international players because of several key factors. Firstly, existing synergies which reduce the cost of making raw material for polymers and PET products remain strong in the MENA region.

This will help maintain operating and profit margins for regional players. Additionally, the recent acquisition of a GE plastic plant by SABIC will help the region’s largest operator fully utilise that synergy and improve its margins on plastic products.
 

Saudi International Petroleum Company (SIPCHEM) has also bid for the acquisition of Lucite International, a British-based acrylic products manufacturing company. Lucite International requires acetate acid as a raw material and SIPCHEM is the currently the only producer in the region.

If this is successful, the acquisition of Lucite International will give the company a huge benefit of synergy.

What is likely to happen to demand for regional petrochemicals products?

The declining prices and global demand, combined with an expected increase in production capacities will lead the regional sales revenue of the sector to remain fairly flat.

However, going forward, the regional sales revenue is expected to show a growth of 7.5% and 4.1%, during 2010 and 2011. The expected increase in sales volume is based on the strategy of the region’s leading player, namely Saudi Basic Industries Corporation (SABIC).

The company has adopted the strategy to acquire the marketing and distribution centre in European and American markets. This will help SABIC to further strengthen its presence in these markets.

However, SABIC is also under negotiation with Saudi Aramco to convince SINOPEC, a leading Chinese petrochemical company, to grant permission to use its distribution network in China, which is a major consumer of petrochemicals and related products.

Furthermore, the sales revenue of Industries Qatar (IQ) is concentrated on the revenues generated from its steel and fertilisers. We think high demand for steel products from the country and ample fertiliser demand in South Asia will help to maintain stability in Qatar’s petrochemical sector.

Is now a good time for people to be investing in downstream companies?

Contrary to the international downstream sector, the region has the huge advantage of an undisrupted supply of feedstock at highly subsidised rates. This implies that downstream companies in the region are able to run with higher margins compared to non-MENA producers.

However a contraction in regional margins cannot be ruled out. Global Investment House is considering the investment in the downstream sector a big bet, since declining retail prices for petrochemical products is alarming, and will no doubt squeeze gross margins.

Based on the low cost feedstock prices, within the region, we recommend investors to make investment in the regional downstream sector based on a number of parameters.

Firstly, asses the production portfolio of the downstream company carefully. A wider production portfolio will give a cushion to producers, and potentially allow them to offset any decline in one product line with another.

As an example, a decline in the sales of refined petrochemiclas could be offset by an increase in sales from fertiliser products.

This is a particularly secure strategy because we know South Asian countries are still running out of ample fertiliser production. Look for companies whose expansion plans are expected to be completed shortly. This will help insulate the investor from risks associated with dropouts or delays in expansion plans.

Secondly, pick a company that has a clearly defined strategy to address declining prices and the slowdown in demand of petrochemical products.

Finally, examine the composition of the company’s overall sales forecast, and consider its exposure in major international markets. By examining the substitute or local markets for its major product the investor should be able to see that in case of a decline in international demand, just how much of that product could be consumed by the substitute or local market.