Cost of inputs: Finding the best ways to restructure a sector mainstay

Petrochemicals are a central feature of Egypt’s industrial strategy, making up about 3% of GDP. The sector first began to grow in the early 1950s, when ammonia was generated from surplus fuel from the country’s refineries. By 2010 the industry had grown to 86 companies, 15 of which operate in one of Egypt’s export-oriented free zones. Both the public and private sectors have interests in the petrochemicals segment, as do a number of foreign investors.

TRIBULATIONS: Since the start of political turmoil in January 2011, however, the pace of progress has slowed. The appetite for fresh investment has declined as political instability and other risks disillusion some potential investors, particularly foreign ones. There are also questions about the viability of Egypt’s foremost comparative advantage in petrochemicals production – cheap natural gas to use as a basic input. “The need for security and stability is crucial if upstream investment is to return in any sizeable volume to Egypt,” said Hussein Khattab, former CEO of EM ethanex, an Egyptian joint venture with global methanol industry supplier and distributor Methanex.

The prime mover in petrochemicals in the country is Egyptian Petrochemicals Holding, known as ECHEM, a state-owned enterprise under the supervision of the Ministry of Petroleum. ECHEM is one of Egypt’s five state-owned companies in the energy sector. The company was created in 2002 by former Prime Minister Ahmed Nazif during a period of economic reform and modernisation, and has multiple mandates as an investor and participant in the sector. ECHEM has minority stakes in some of the country’s main production facilities. It is also in charge of marketing the sector abroad and long-term planning.

STRENGTH IN NUMBERS: ECHEM’s pre-tax income reached LE204m ($34.1m) in fiscal year 2009/10, according to the company’s annual report, the most recent available at time of printing. This figure represents an 8.5% increase from LE188m ($31.5m) achieved in the previous reporting period. Revenue reached LE360m ($60.25m), up 13.2% from LE318m ($53.2m) in that same period. The country’s products are further at an advantage in the domestic polyethylene market because of a current 5% tariff on imports.

The growth in production and use of petrochemicals in recent years is in line with a wider regional narrative. Average consumption of petrochemicals in the Middle East and North Africa (MENA) region between 2000 and 2010 increased at a compound annual growth rate of 6.9%, faster than any other part of the world, according to a report by Lebanon’s Blom Bank. The surge in usage has come from the organic regional economic growth, but has also benefitted from a top-down strategy to push increased petrochemicals usage in gas-rich countries.

Natural gas is the cheapest basic input that can be used to create the semi-finished materials that serve as the building blocks for petrochemicals products, such as ethane or propane. The alternative resource, crude oil refined into naphtha, is the primary input used outside the region.

SUBSIDISED ADVANTAGE: The strategy among MENA gas-producing countries has been to subsidise natural gas used by petrochemicals plants or sell it at cost, in part as a bid to industrialise by diversifying and reducing their economies’ reliance on producing and exporting crude oil and natural gas.

For Egypt, this has resulted in a national petrochemicals industry where the cost of production is a significant advantage when compared to regions outside of MENA as well as to other domestic industries. Although the sale price of gas from the state varies by company, and individual arrangements are not as a rule made public, it is generally considered cheaper than other countries, with the exception of Saudi Arabia, Bahrain, Qatar and a few others.

Egypt’s state gas company, Egyptian Gas Holding (EGAS), buys from upstream producers at approximately $2.65 per million British thermal units ( mmBtu), a rate that varies depending on the expenses of production for different gas deposits. EGAS had until early 2012 subsidised most industrial customers by selling at $3/mmBtu, but energy-intensive industries outside the petrochemicals sector, such as cement and steel manufacturing, recently saw prices bumped up to $4/mmBtu, as the government has made it a priority to reduce its own energy bill incurred through the subsidy regime. However, there has been no mention of raising rates for the petrochemicals sector. In comparison, natural gas prices were at $0.75/ mmBtu for petrochemicals producers in Saudi Arabia, $2.25 in Bahrain, and between $0.95 and $2.35 in Qatar, according to market research from Rasmala, a MENA-focused investment bank. That compares with approximately $10 paid in Europe, where contracts are linked by formulas to crude-oil prices. According to Blom Bank’s research, the cost of production of ethylene in Egypt is $300 per tonne, compared with $750 in the US and $150 in Saudi Arabia.

NEW SITES: Egypt outlined an aggressive expansion strategy for the petrochemicals sector in 2002 with the creation of ECHEM and the unveiling of a 20-year master plan to carry the sector through 2022. It pledged $20bn over a 20-year period, and split the plans into three phases. It is now in the second of those stages, which runs from 2009 to 2015 and calls for an investment of $6bn of the overall total.

The pace of investment has slowed since the uprisings began, however, with several projects cancelled or put on hold. In November 2011 ECHEM said that a group of GCC investors had rescinded their offers to invest $5bn in petrochemicals plants in Port Said and in Suez following the protests against a planned petrochemicals facility at the Damietta port, which succeeded in shutting down the hub for 11 days. Another example came in May 2012, when French oil company Total cited political unrest as its reason for halting progress on a proposed $6bn complex for propylene and polypropylene. However, foreign investors have not been unified in avoiding Egypt, and the Saudi Basic Industries Corporation (SABIC), Saudi Arabia’s dominant petrochemicals company, is reportedly talking to Egypt’s Industrial Development Authority about a proposed plant, according to Bloomberg.

In August 2012 Ismail El Nagdy, chairman of Egypt’s Industrial Development Authority, announced the government’s plan to establish a petrochemicals industrial trade zone, the first of its kind, that will be home to foreign and domestic investments of $15bn-20bn. The authority expects the zone to have a number of benefits, including the creation of new businesses.

CHALLENGES: In 2011 and the first half of 2012, it was unclear if Egypt would pursue expansion in its petrochemicals sector to the extent that it has in the past. Expansion plans like those set for 2022 were formulated in a time of greater expectation for Egypt to fully leverage its natural gas deposits. Planned development schemes have been made all the more difficult given the volatile environment. For example, strategies for reaching and sourcing the country’s gas reserves, most of which are located offshore in deepwater blocks, will likely take a back seat, as they are both riskier and more expensive to finance. The inability to effectively source this gas has affected Egypt’s capacity to advance in oil extraction as well.

In the past, Egypt budgeted one-third of its gas for domestic use, and a third for exports, leaving a third for future generations to mine. But growing demand for energy combined with the greater difficulty in reaching deepwater gas has led some industry experts to rethink the approach in favour of allocating a greater proportion of the supply to domestic use, particularly for consumers.

The attempt to create jobs by supplying gas cheaply to energy-intensive industries has not born fruit, said Magdi Nasrallah, chairman of the department of petroleum and energy engineering at the American University in Cairo. “We have not seen the jobs promised,” Nasrallah said, saying that gas was allocated to industries that are not labour-intensive, such as cement. The alternative destination for Egypt’s gas could be a greater allocation to electricity generation, which is already the largest user of the resource.