Energy prices accelerate the move to the Middle East
The longer natural gas and oil prices remain at record-highs domestically, the faster the chemicals supply base is moving to the Middle East.
By David Hannon -- Purchasing, 8/14/2008 2:00:00 AM
Some buyers were taken by surprise in June when Dow Chemical announced its second major across the board price increase of 25%. But what may have been overshadowed in that announcement was Dow's news that it was cutting North American production of ethylene oxide and acrylic acid as well as materials in Europe due to escalating costs. Only a week later, it was reported that Dow and Saudi Aramco plan to build a $26 billion petrochemicals complex in Saudi Arabia.
It's just one example of a growing trend in which chemical suppliers are reducing the level or shifting the location of production in an effort to reduce their exposure to soaring energy and production costs. The challenge for chemical buyers is to gauge how much and how quickly their supply base may shift.
Go East, young buyer
"There is a flood of new capacity coming on-stream in the Middle East," says Kevin Swift, chief economist for the American Chemistry Council in Arlington, Va. "That region has a distinct advantage of lower energy costs. Natural gas is not a globally traded commodity like oil so the high natural gas prices here in the U.S. reflect our demand and supply of natural gas as well as the price of oil. Those trends aren't prevalent in other regions such as the Middle East."
As an example, Swift points out that by government decree natural gas prices are fixed at 75¢/million BTUs in Saudi Arabia and at $1.25 in Iran. In the U.S. the natural gas price is close to $12/million BTUs. "And that's a 500% increase over the price in 2000," Swift says. "So there's very little investment going into North America and a lot of investment going into the Middle East."
Just how much is that investment going to shift supply? Recently SABIC CEO Mohamed al-Mady said petrochemical output from the Middle East will account for 17% of global output by the end of 2010 vs. 10% at the beginning of 2000. In April, Howard Rappaport, global business director for plastics at Chemical Market Associates Inc. told Purchasing over the next four to five years, 10 million metric tons of polyethylene capacity will start up in the Middle East, while another five to six million tons will come online in the Far East, flooding the export market and forcing North American producers to focus on domestic markets and exports to Latin America.
Another company taking dramatic steps to shift its production footprint is Houston-based LyondellBassell. In June its Equistar Chemicals joint venture closed its Pasadena, Texas low density polyethylene facility because "high operating costs at the site and unfavorable market economics have provided inadequate financial returns," according to Jerry Parker, vice president of polyethylene Americas at Equistar.
Earlier in the month, LyondellBassell announced it would increase polypropylene capacity with a new plant in Guangzhou, China while its Saudi Polyolefins joint venture is also building a new compounding plant in Damman, Saudi Arabia. "We are also considering additional plant investment options for Russia and India," the company said in a statement. And in May, LyondellBassell announced it would stop producing polypropylene at its Morris, Ill. plant and the plant's annual production would shift in part to a new plant coming online in Mexico.
And while buyers may think U.S. chemical suppliers are in a quiet crisis, Nando Galazzo, vice president of procurement at European plastics firm Borealis Group, tells Purchasing that European chemical manufacturers and suppliers are even more exposed to energy costs. "The price of electricity for instance has doubled in the last three years," Galazzo says. "Most of our suppliers have already delocalized or will in the near future."
Because of this Austria-based Borealis has implemented a program called European Asset Competitiveness which analyzes the customer base, supply base and manufacturing for a given product to determine if there is a supply chain disadvantage or the manufacturing costs are not "viable" in a given geography.
Galazzo says Borealis has "major expansion plans" in the United Arab Emirates through its Borouge joint venture with Abu Dhabi National Oil Co. (ADNOC). "Many of our suppliers have established a footprint in the Middle East and this will help us to be competitive in the long run," he says. "We have also divested in recent years our Portuguese and Norwegian operations."
And as if that wasn't enough globalization for one industry, more recently Chinese and Indian firms have been teaming up with Middle East firms for energy and petrochemicals. In April, PetroChina agreed to buy from Qatar 3 million metric tons of liquified natural gas a year for 25 years from 2011. China's number three oil and gas firm, CNOOC, also signed a deal to buy from Qatar 2 million metric tons per year starting in 2009. In July, Reliance Industries, India's biggest company, and state-run GAIL India were finalizing a pitch to Qatar to jointly set up a $1.3 billion petrochemical plant.
Distributors in the middle
Shondra Garrigus, vice president of purchasing at chemicals distributor TRI in Seattle, says with energy costs cutting into their margins, more chemical producers are making short-term production decisions based on production costs vs. demand and market pricing.
"We have one supplier in Korea that uses a single raw material to produce three products and they're constantly weighing their costs against the differentials in their products when they determine their production levels," she says. "If there's not enough return on a certain product in a given month, they will likely produce less of that one and more of the others that month. So that means we may not be able to get as much of that product to supply to our customers."
But overall, chemical manufacturers are more exposed to energy costs than distributors, Garrigus says, and there is a much greater concern for suppliers' health among distributors today. "We want our suppliers to be healthy and we're always in regular contract with our suppliers, but the repercussions of not being in touch with our suppliers today for a few days could be huge."
Garrigus says TRI is looking at new global sources of supply, specifically the Middle East, mostly because "the growth there is massive and I would be surprised if someone in the chemicals industry is not looking there right now," she says. "Suppliers and producers can get better returns on their product by moving their plants to the Middle East region."
Logistics concerns
But while more chemicals suppliers shift production to regions with lower cost energy, the cost of transportation and fuel has gone up enough that some buyers are unsure of the benefits vs. the complications of moving more to overseas sourcing and, at least for the time being, keeping supply lines short where possible in the domestic market.
"In the current market, we are trying to source more from suppliers closer to our plants," says Sheldon Martinez, purchasing agent at KMG Chemicals in Houston. "Right now transportation is a big factor in how suppliers are chosen. We are beginning to source from other countries but the problem we are seeing is that a lot of these companies do not carry registration to import."
Garrigus is also concerned with logistics costs and says her company is trying to ship as much domestic supply by rail or intermodal today due to high fuel and trucking costs, an analysis that could affect which material suppliers are used. In fact, she says many chemical suppliers are thinking twice before accepting a rush order that would have to be shipped by truck.
"The cost will just be prohibitive to the supplier and the price to the customer will have to reflect that," she says.
Consolidation continues
With increased energy costs and varying demand by market segment and geography, the chemicals industry globally has seen a growing consolidation trend. One of Dow Chemical's stated reasons for diversifying away from commodity chemicals and towards specialty chemicals (including its recent deal to buy Rohm & Haas) is reducing exposure to energy costs. And the day after Dow announced its buy of Rohm & Haas, Ashland announced a plan to buy specialty chemicals maker Hercules.
To put the consolidation trend in a long-term perspective, the American Chemistry Council's Swift says in 1980 there were 14 ABS producers in the U.S., today there are four. More recently, according to data compiled by Bloomberg, there have been $40.5 billion of chemical related mergers and acquisitions through mid-July in 2008 after a record $92.5 billion of transactions in the same period last year.
And it's likely not done yet. "Further consolidation is still needed in my view, especially given the pressure on costs and margins in the industry," Philip Keevil, a senior partner at Compass Advisers in London recently told Bloomberg.
Also see: For tips on doing business in the Middle East, but sure to ready
Buyers follow pipeline back to the Middle East
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