A broader offering: Diversification into a range of petrochemical products and feedstocks

Petrochemicals and plastics remain at the vanguard of Saudi Arabia’s push to diversify its economy away from reliance on oil. Products in these segments make up the bulk of the Kingdom’s non-oil exports, with petrochemicals accounting for nearly 37% and plastics around 30%, according to figures from the Central Department for Statistics in June 2012. Despite worries amongst some in the industry over the health of the global petrochemicals market and new competition from American shale gas, Saudi Arabia remains firm in the belief that the sector can grow further.

Petrochemical Base

The Kingdom accounts for around 7% of the world’s supply of basic and intermediary petrochemical products, but it hopes to increase this to 10%, according to a statement by the National Commercial Bank in August 2012. The country is not only the largest petrochemicals producer in the region, but also the fastest growing in terms of output capacity. Between 2010 and 2015, total output capacity is expected to increase 23.2% to 77.3m tonnes per year out of the region’s total of 113m tonnes, according to the Gulf Petrochemicals and Chemicals Association (GPCA). As well as boasting the largest capacity additions, the Kingdom can also claim to have taken in the highest levels of investment: $12bn worth of projects in the execution phase and a $41bn worth of future projects, according to the Kuwait Financial Centre.

Global Markets

These are uncertain times for the world’s petrochemicals exporters, whose health is closely correlated to that of the global economy and oil market. Despite high oil prices in recent years, there was significant volatility between 2011 and 2012. Worries over an economic crisis in Europe and a manufacturing slowdown in Asia led to significant price drops, taking a toll on sales revenue and company share prices.

Many still take a more positive stance on the longer-term outlook. A June 2012 report by Al Rajhi Capital, for example, “remains positive on the Saudi petrochemical sector as a whole”; it concludes that while the short-term outlook for the petrochemicals market is subdued, as the low-cost feedstock still enjoyed in the Kingdom means that producers can continue with healthy operating rates at a time when weak prices for most products are forcing competitors in other countries to scale down operations.

This means that local producers could secure a greater market share in the years ahead. According to Contax Partners, an oil and gas consultancy, the Middle East will supply 20% of the world’s petrochemicals output by 2015, up from 16% in 2009. Given that Saudi Arabia is adding more capacity than its regional competitors, it looks set to gain the most in this regard.

Gas Supplies

Others point to potential challenges closer to home. As the country’s utilities and industrial sectors eat through the limited amounts of natural gas currently under production, petrochemicals players fear that gas-derived feedstock, such as ethane, will be in increasingly short supply. A related but perhaps more fundamental issue, say some, is the emergence of cheaper shale gas in the US, which could increase the competitiveness of American ethane-fed operations. “Falling gas prices in America are already affecting perceptions of the Kingdom’s competitiveness,” Khalid Zagzoog, the managing director of Safra Petrochemicals, told OBG. “We expect the American prices to continue to decrease in the years ahead.” Such sentiment is echoed in a June 2012 report by the Kuwait-based Global Investment House, which states that US gas, combined with China’s plans to use coal-based feedstock and the potential for new exploration in Iraq to lower its feedstock prices, “could present a material threat to the Saudi petrochemical players”.

Other commentators remain optimistic. First, the American shale-gas revolution is unlikely to have an immediate effect on the market, said a May 2012 report by Al Rajihi Capital: although some US firms are switching to ethane feedstock, the US is expected to remain an importer of petrochemicals over the next five or six years. For the long-term outlook too, the optimists can still be clearly heard. Bank of America Merrill Lynch stated in a July 2012 report that “the impact [of North American shale gas] on the GCC’s competitiveness over the long term is likely to be minimal,” adding that even when US petrochemicals players begin to export to the global market, ethane produced in Saudi Arabia and other GCC countries should remain cheaper.

Feedstock pricing and policy will likely remain a hotly debated topic in the years ahead. “Given that the gap between the prices of naphtha and propane has narrowed, it is no longer a significant advantage that our firms are supplied with propane at a 30% discount from Japanese naphtha prices. The government needs to find a new way to provide petrochemicals producers with feedstock at a competitive price,” Zagzoog told OBG.

While the government attempts to cater to the needs of petrochemicals players, it will also be keeping an eye on the natural gas industry. “The marginal cost for extracting gas is increasing. This can become problematic if the sales price of gas, along with that of gas-derived feedstock such as ethane, does not increase in tandem,” said Jarmo Kotilaine, the chief economist at NCB Capital. “Ensuring that private capital continues to come into the gas sector could prove a challenge.” Nevertheless, as things stand, Saudi Aramco continues to supply feedstock at some of the lowest prices in the world, at $0.75 per million British thermal units, allowing petrochemicals producers to enjoy extremely high profit margins. Statements by Saudi government officials in 2009, suggesting that they would increase the current rate, have not yet been acted upon. In fact, Al Rajhi Capital declared in early 2012 that, in view of low global gas prices, it did not expect ethane prices to be increased in 2013. Furthermore, the additional gas production that is due to come on-line in 2012 is hoped to provide some relief to the supply situation.

Shifting Feedstock

For new investments, industrialists are expecting to make greater use of heavier feedstock, such as naphtha. While it is true that naphtha-fed facilities tend to have smaller profit margins and are more exposed to volatility in oil prices and that global production is shifting in favour of ethane, naphtha feedstock will account for 46% of total ethylene production in 2016, according IHS Chemicals. Naphtha also permits the production of a broader and higher-value range of products, which can be used in agriculture, pharmaceuticals, electronics and other sectors. Such a shift is, therefore, good news during the push for diversification. Recent figures bear witness to the scale of such efforts to diversify. In May 2012 the Samba Financial Group estimated that $50bn of petrochemicals projects in Saudi Arabia – planned or under development – are looking to supply domestic processing or manufacturing, rather than export base chemicals. The Saudi Arabian Basic Industries Corporation (SABIC) – the Kingdom’s leading petrochemicals player and the second largest in the world by revenue – is at the forefront of such efforts. The majority of its headline ventures are partnerships with international firms which will likely help add both capacity and variety to the national petrochemicals offering by 2016. In 2013 two new plants under construction at Jubail by a SABIC-Mitsubishi venture are expected to be completed, and their output will likely be of interest to manufacturers in the electronics, automotive and medical sectors. In 2014, Spain’s Tecnicas Reunidas is due to complete construction of an acrylonitrile butadiene styrene (ABS) plant, under development by Petrokemya, a SABIC subsidiary. In 2015 a joint venture between SABIC and ExxonMobil is looking to start operations at a planned synthetic rubber facility. Finally, following an agreement with Italy’s Montefibre, SABIC will build the first carbon fibre plant in the country, paving the way for a local carbon-composites industry.

Perhaps the most significant addition will come in 2016. Construction work on the $20bn Sadara Chemicals Complex, under development by Dow Chemicals and Saudi Aramco, began in late 2012. Cracking both ethane and naphtha, this complex will add 8m tonnes in annual output – including 1.2m tonnes of ethylene and 400,000 tonnes of propylene – and introduce high-value chemicals to the petrochemicals mix. The government hopes higher-value projects will provide a base to support more processing and manufacturing.