Saudi Arabia's petrochemicals sector facing greater competition

Rising competition and the threat of higher costs at home could see Saudi Arabia’s petrochemicals industry come under increased pressure. However, these impending challenges have so far failed to slow the progress of new projects being rolled out across the Kingdom.

A report issued by National Commercial Bank (NCB) in mid-July said that while Saudi petrochemicals producers benefited from low costs thanks to subsidised feedstock, some of this advantage could be eroded in the coming years as vast new shale gas reserves come on-line in the US and elsewhere. With international natural gas prices likely to come down, local producers could find their comparative advantage challenged and profit margins reduced, the report said.

In the shorter term, the slowing global economy is also set to squeeze earnings, as will increased petrochemical production capacity in Asia and elsewhere in the Middle East. On July 23, Oman announced it would be developing a $3.6bn polyethylene and polypropylene plant, which will raise the Sultanate’s petrochemicals production capacity to 1.4m tonnes per year. While nowhere near the output of some of Saudi Arabia’s leading producers, the Omani move is indicative of a rise in regional competition.

Some of this forecast pressure was reflected in the recent financial results of a number of the Kingdom’s leading petrochemicals firms. On July 21, Saudi Arabia Basic Industries Corporation (SABIC) announced its second quarter net profits of $1.6bn that, while up by 12%, were below market expectations. SABIC, the world’s largest petrochemicals group in terms of market value, saw Q2 sales fall 3.2% year-on-year to $12bn, a result it said was due to lower demand in key markets in Europe and China, with sales of some main line products such as petrochemicals, metals and fertilisers, down. The corporation said its improved profits were due in part to lower costs.

Another company with lower-than-expected results was Saudi Kayan, an affiliate of SABIC, which posted losses of $63.5m for the second quarter. Although an improvement on the same period of 2012, when the company booked losses of $87.5m, the result for the Jubail Industrial City-based firm was still worse than analyst predictions.

Pressure on industry players is likely to come from a different direction as well, with calls for the Saudi government to lift its base rate for gas, a move that would raise costs for petrochemical companies but which would act as an incentive for gas producers to boost production and develop new reserves. The official rate for gas paid by the state is set at $0.75 per million British thermal units (Btu), among the lowest in the world. By comparison, 1m Btu costs close to $4 in the US and up to $12 in Japan, though these rates could fall, especially in the US, as shale gas deposits are developed commercially.

While Saudi Arabia has considerable gas reserves, most of those being exploited are linked to oil fields. These supplies may not be sufficient in the long term to both feed the expanding petrochemicals industry and meet growing domestic demand, which is projected to climb sharply with electricity usage rising by 8% annually. Saudi Arabia uses oil to fire most of its power stations, though this drains off reserves that could otherwise be used for export. Riyadh would like to use more of its gas for power generation, but this would further limit supplies to the petrochemicals industry.

Though some estimates put Saudi Arabia’s gas reserves at 287tr cu feet – a figure that is likely to be very much on the low side, as surveying for the entire country has not yet been completed –- many of the identified gas fields are in remote regions, where extraction costs would be high. With the low buying rate set by the state, there is little incentive for energy majors to make the sizeable investments needed to bring these fields on-line and develop the infrastructure necessary to process the gas and transport it to market.

There have been calls to increase the domestic gas price to stimulate further exploration and development of new fields, but the NCB report predicted that any hike would be held off until next year at the earliest. The report said that, while a price increase had been expected in the second quarter, it was now unlikely that the Ministry of Petroleum and Mineral Resources would implement the price rise this year.

These potential problems do not appear to have deterred investors. In July alone, plans have been announced for a $517m butanol plant at Jubail Industrial City, a joint venture between Saudi Kayan, Sadara Chemical and the Saudi Acrylic Acid Company, and SABIC awarded a $387m design-and-build contract to Spanish firm Dragados for a new 50,000 tonne-per-year polyacetal plant that will product plastics for the automotive industry.

As long as Saudi Arabia’s petrochemicals sector can maintain its competitive pricing edge, it will continue to be one of the driving forces of the economy. However, it is expected that earnings margins will be tightened in the medium term, as more rivals enter the market and cheaper feedstock becomes more widely available.