GCC petrochemical producers' competitive edge is at risk amid massive market disruptions, a new study by The Boston Consulting Group (BCG) revealed Tuesday. The survey pointed out that in order to maintain their leadership position, petrochemical companies in the region will have to take drastic action – imminently and imperatively. A major paradigm shift is currently sweeping across the Middle East's petrochemical industry, radically redefining the balance of power amongst key regional players. According to the study, this has occurred as a result of a whirlwind of global forces – some expected, others not – that include the domino effect of the US shale gas renaissance, oil prices' relentless dive, Saudi Arabia losing its access to cheap gas feedstock, China's capacity build-up, and the lifting of Iranian sanctions. "Together, these game-changers have altered and reshaped the region's petrochemical landscape – giving rise to a plethora of new challenges and opportunities," said Marcin Jedrzejewski, Principal at the Boston Consulting Group Middle East. "The fact is, today, external political and economic factors paint a less rosy picture of the future of the GCC's petrochemical industry. And while there is still time to reverse the damage done and even turn these setbacks into moments of growth, GCC petrochemical producers must do so fast – or risk losing their long-held competitive streak." First and foremost, the US' much-talked about shale oil renaissance has flooded the US market with abundant supplies of cheap feedstock (ethane). This in turn has armed US petrochemical producers with a hefty cost advantage over their European and Asian rivals – most of whom rely heavily on high-priced naphtha as feedstock. Although this advantage has been eroded by the current drop in the oil prices, in the long run, the US is still positioned to strongly benefit from the abundance of low-cost ethane. In short, while the GCC's ethane-based producers are still the most competitive in the world, North American producers are, without a doubt, trailing closely behind. All in all, this low-cost feedstock environment has spurred a massive expansion of the US petrochemical industry – in fact, ethylene capacity is expected to rise by a staggering 7.5 million tons over the next five years. "North American petrochemical producers will therefore be increasingly better placed to go head-to-head with GCC exporters when it comes to exporting to regions such as North-Western Europe and Asia," said Jedrzejewski. "Of course, with falling oil prices showing no sign of abating, the full impact of the shale gas revolution will most likely be delayed. Still, its inevitable ripple effect will eventually be felt." The drop in oil prices is undeniably a major contributor to the current trends punctuating the GCC's petrochemical industry. After all, Brent oil prices have sharply collapsed from a high of more than $110 in June of 2014 to below $30 early this year. Subsequently, the price of naphtha has fallen steeply. And, in parallel, the price differential with gas has narrowed. The reason why the topic of plummeting oil prices is critical is because naphtha-based producers tend to be marginal producers of ethylene – and their cost of ethylene production sets the fundamentals for the product price globally and regionally. Since the prices of petrochemical products are directly correlated with oil prices – sinking oil prices translate into immediate margin erosion for historically feedstock-advantaged producers, which means most Middle East players. A high oil-gas spread favors ethane-based GCC crackers as the price is typically set by marginal producers in Northeast Asia and Europe who use naphtha as feedstock. Based on this, sustained weakness in oil prices will continue to undermine the profitability of GCC petrochemical producers, especially those fully integrated with upstream or taking advantage of preferentially priced feedstock allocations. Moreover, the Middle East is running out of cheap gas feedstock. Recent petrochemical expansions in Saudi Arabia have shown that feedstock is gradually getting heavier and closer to naphtha economics in the absence of price support from the government. In addition, as demonstrated by Saudi Arabia's recent price adjustments, feedstock costs have also significantly increased. In December 2015, Saudi Arabia more than doubled its ethane price from $0.75 MMBtu to $1.75 MMBtu. This seriously affects the competitive power of petrochemical producers in the region and puts additional pressure on their margin. In yet another development, China, which has long been the largest importer of basic chemicals – comprising polyethylene (PE) and polypropylene (PP) – is undergoing a colossal capacity expansion. Once the country's ambitious plan to develop coal-to-olefins (CTO) technology is brought to life, it will naturally reduce its reliance on imports. While low oil prices may influence the development of China's CTO technology, the slowdown in the nation's economic growth and its build-up of local capacity should be a cause of concern for all GCC producers. Similarly, the lifting of Iran's oil sanctions, and the country's mission to double its petrochemical capacity in the next 10 years, also poses an alarming threat to GCC producers. With all this in mind, it is clear that the GCC's petrochemical landscape is riddled with a number of severe challenges. To effectively overcome these obstacles and minimize any resulting damage, GCC producers will need to act soon. Instead of simply bracing themselves for the impact, they must view this particular situation as an opportunity to refine the petrochemical industry – and in the process not only improve their bottom line but also add some much-needed high-skill jobs to the market. More specifically, GCC producers should focus on the areas of commercial excellence, operational excellence, and product specialization. In terms of commercial excellence, historically, GCC producers have invested very little in sales, marketing and supply chain. In lieu, they greatly rely on off-takers and traders to carry and sell their products in core markets. This arrangement basically means that producers can lose anywhere between 3-10% of their product value to a ‘middle man'. Moving forward, GCC producers should invest in building robust marketing and supply chain capabilities – so they can win back this ‘lost value' from off-takers. From an operational front, there is also ample room for progress. Today, several GCC producers face low operating rates because of unplanned shutdowns or inferior feedstock conversion rates. But in actuality, operational excellence activities such as energy efficiency, raw material usage efficiency, and asset maintenance management can add up to 10-30% to the bottom line. These are indispensable tools to use when the feedstock advantage goes away. That is precisely why this is now standard practice in various regions. In Europe, for example, petrochemical producers that survived the financial crisis of 2008-9 had to learn to adjust quickly and operate in a low-margin, high energy cost, and no-growth environment. The time has come for GCC producers to follow in those very footsteps. Product specialization is another pivotal point to address. Traditionally, GCC producers sell basic chemical products (immediate derivatives from crackers) that are commodities. However, the profits derived from these products are inherently determined by external market conditions – such as feedstock prices, the local supply-demand context and the like. By going further downstream and increasing the specialization of their products, GCC producers can reap more stable and higher earnings. That's not to say that the road to specialization is an easy one. It requires vast experience and fine-tuned capabilities. Often, the best way to successfully spearhead product specialization efforts is by forming a joint venture (JV) with a strategic partner (for instance, Sadara, a JV forged by The Dow Chemical Company and Saudi Aramco). "At present, the GCC's petrochemical industry is caught in the throes of fundamental change," Jedrzejewski noted. "To thrive and survive despite these evolving circumstances, GCC players will have to rethink and revise their business plans – urgently. Because stagnation is no longer an option."
