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Wed 16 Feb 2011 12:00 AM

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Petrochemicals outlook in the GCC

Jaivime Evaristo, consultant of business advisory at Contax Partners says petrochemicals industry in the GCC is set to be challenged and shaped by the emerging trends affecting the global petrochemical sector value chain.

Petrochemicals outlook in the GCC
Jaivime Evaristo, consultant of business advisory at Contax Partners.

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 includes:

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 utilization 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 subsidized
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 utilization rates, thereby
depicting a downward pressure on prices. This outlook stands in stark contrast
to the years before the economic crisis when global utilization rates were
higher than 85%. Fortunately for producers in the GCC – thanks to lower raw
material and utilities costs – utilization 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 subsidized ethane.

3- Margin vs. Competitive Advantage

As a result of the limited ethane supply and, therefore,
increasing utilization 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 realize 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 maximize gains.

Considerations for Project Owners

For upcoming projects, Project Owners will need to choose
the right ‘sweet spot’ for project awards to maximize 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.

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