CHIMEA: A Global Trading Force and Petrochemicals Hub

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1 : A Global Trading Force and Petrochemicals Hub

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3 The shores that border the Indian Ocean form one of the world s most significant trading blocks. Encompassing the global growth engines of and India, the wealth of the Middle East and the emerging potential of Africa, this region is called (, India, Middle East and Africa). Fueled by higher than average growth in the Middle East and Africa and supported by India, its future potential economic power cannot be denied. Currently holding more than half of the world s population, this share of consumers is expected to continue to increase: Estimates indicate that two out of every three people in the world could live in this region by 050. Although the region still represents a lower share of global gross domestic product (GDP), it is anticipated to grow as and India continue to develop and wealth increases in Africa. Its resilience was evident in the recent global financial crisis, with and India remaining the powerhouses of global growth and the Middle East recovering faster than the United States or Europe as it benefited from rising oil prices. s share of global GDP is expected to jump from 1 percent in 005 to around 15 percent in 010 and to more than 0 percent in 00. Growth over the next 10 years is estimated to be twice the global average (see figure 1). is not a new construct the links between the member states are strong and history has wedded them through trade across the Indian Figure 1 s growth is expected to be twice the global average GDP in 009 by region (005 prices, US$ trillion) Canada $1.1 U.S. $13.0 Mexico $0.8 Europe 1 $15.5 Africa $1.1 Middle East $1.3 India $1.1 $3.5 Russia $0.9 Japan $4.5 GDP growth by region (US$ trillion) MENA Sub-Saharan Africa India ROW CAGR ( ) % % 4%.4 7% 7.5 9% 3% 7% (avg.) CAGR (016-00) % 5% 4% 7% 6% 3% 6% (avg.) Brazil $1.1 Australia $ e 00e Notes: All estimates are A.T. Kearney estimates; ROW is rest of the world; CAGR is compound annual growth rate Sources: EIU; A.T. Kearney analysis : A Global Trading Force and Petrochemicals Hub 1

4 Ocean. Historic trade flows from the Middle East s Arab culture into Africa and pearls and gold to India and, and tea and porcelain from back to the Middle East have been replaced with more contemporary goods. Northern Africa and the Levant are feeding the hungry, growing populations of India and with their rich agricultural land; the Middle East and Africa are providing valuable oil and raw materials. and India are playing the role of the financiers along with the mounting investments of the Gulf States. This latest trend toward the flow of money and investments is tying the region tighter together across a range of sectors, from banking and telecommunications to petrochemicals. For example, s major bank, the Industrial and Commercial Bank of (ICBC), recently acquired a 0 percent stake in Standard Bank, South Africa s largest bank by assets and earnings, for $5.5 billion. The Kuwaiti Zain Group invested around $1. billion in Iraq s company for mobile phone services IRAQNA, while Saudi Arabia s SABIC group and s Sinopec decided to work together, investing $.7 billion in a petrochemical plant in Tianjin. In addition, this region is continuing to increase its share of foreign direct investment (FDI) inflows, comprising nearly 0 percent of the global total in 008, up from only 4 percent in 000 (see figure ). The future looks equally bright with strong investor sentiment. is not only a region of FDI inflows and intra-investments but also of investment power beyond the region. Recent examples include Petroleum & Chemical Corp s $4.6 billion investment in one of Canada s oil sand companies, Syncrude, India s Reliance Industries $1.7 billion investment in America s Atlas Energy company, and SABIC s acquisition of GE Plastics. Figure is capturing a larger share of foreign direct investments Share of global FDI inflows (US$ billion) Middle East India Africa Other Latin America Other Asia North America 0.% $1,38 0.3% $735.4% $1, % 0.8% = 4% 7.1% 8.3% 3.0% = 14% 7.3% 7.6%.9%.% 7.4% 1.9% 11.7% 5.% 6.4% 6.0% 8.5% 8.7% 4.%.4% = 18% 18.4% 1.3% Europe 51.7% 35.1% 37.3% Sources: World Investment Report, 009; A.T. Kearney analysis : A Global Trading Force and Petrochemicals Hub

5 : An Emerging Petrochemicals Hub With the growth in economic power of, the region has also focused on developing a strong position in the petrochemicals industry. The large and growing population and rapid wealth creation have increased consumption power across key petrochemical consumer industries. Buyers of petrochemicals such as the automotive, construction, textiles, and food and food-packaging industries are expanding rapidly. s automotive industry is a case in point. The industry has grown percent per year over the past five years (see figure 3). In 010 will become the largest car-buying nation in the world, snatching the top position from the United States. Local manufacturers are increasing output to meet this demand. India has also ramped up demand from the automobile industry in recent years with local production doubling from around 5 million units in to 10 to 11 million units in Regional demand for petrochemical products combined with strong state support for economic diversification, job creation, industrial independence, and oil and gas reserves has provided a platform for growth of the petrochemicals industry. Over the past two decades, s industry, specifically in the Middle East and, has dramatically altered the footprint and dynamics of the global market. In the Middle East, for example, growth in the petrochemicals industry is attributed to government economic diversification strategies, and the desire to monetize natural gas resources and create employment opportunities, particularly in Saudi Arabia. The feedstock price and proximity to the booming Chinese market provide Middle East players with the necessary competitive advantage to break into the global export market traditionally dominated by European and U.S. suppliers. For and India the rationale for expanding local petrochemicals production is more closely Figure 3 s automotive industry is experiencing a growth spurt (Units in millions) +% % Key growth drivers Government continues to provide financial support to auto sector Local manufacturers increase new model launches Middle-class has more disposable income Consumers have easier access to auto financing e 011e 01e 013e 014e 015e Sources: Automotive Stats, CAAM, J.D. Power and Associates; A.T. Kearney analysis : A Global Trading Force and Petrochemicals Hub 3

6 tied to a desire for self-sufficiency and continued growth in end-use industries, rather than the petrochemicals export market. and India are both striving to reduce reliance on imported raw materials and actively restructuring the industry and key state-owned players in the process. In the largest players, such as Sinopec, SinoChem and Chem, are vertically integrating to strengthen their value chains and drive industry consolidation. In India, recent government initiatives include the establishment of a series of special economic zones and a number of petroleum, chemical, and petrochemical investment regions (PCPIRs), and the industry in has enjoyed key benefits derived from the Chinese government s RMB4 trillion economic stimulus package. In addition, major global players are also supporting this growth by actively investing in partnerships with the local leaders to gain a foothold in these hungry markets. As a result, is increasingly becoming a global petrochemicals hub. With planned ethylene capacity expected to continue growth, it is forecasted that the region will account for around 45 percent of global ethylene capacity in 00 almost double its 3 percent share in 007 (see figure 4). Of total global capacity added to 00, the Middle East will account for around 50 percent. For polymers, the story is similar, with s total share of capacity expected to grow from approximately 0 percent to 40 or 45 percent by 00 (see figure 5). 1 Across the region, Saudi Arabia and are leading in terms of planned capacity installations, which are often Figure 4 Global ethylene capacity by region 1 Ethylene (tons-million) Africa India Middle East ROW Western Europe % 1% 8 4% % share of global capacity 00e 6% 15% 7% 1% 46% CAGR 4 (010-00) 3% 1% 8% 7% 6% 1% -1% 6% (avg.) North America % -1% Asia % % e 1 Capacity is total available capacity, including estimated additions or reduction in nameplate capacity Rest of the world includes Latin America, Eastern and Central Europe 3 Asia excludes and India 4 CAGR is compound annual growth rate; all estimates are A.T. Kearney estimates 1 Based on polyethylene, polypropylene, PVC and polystyrene capacity estimates 00e Sources: Chemical Market Associates, Inc., Shell, Chemical Week; A.T. Kearney analysis 4 : A Global Trading Force and Petrochemicals Hub

7 a combination of fully -owned investments and partnerships with established global players trying to gain market access or secure supply of cheap feedstocks. Iran also has a substantial program, however, its execution could still be hampered by the current political climate, challenges in securing foreign investment partners and international trade relations. Africa will also grow, but modestly compared to others in the region. Its overall combined capacity is forecast to remain minor on the world stage, at 1 to percent of the global total in 00. Should additional international funding and investment be secured, this could potentially increase, given the availability of feedstock. The expansion will exacerbate the recent pressure endured by players in established markets. The financial crisis was particularly hard on the major players in Europe and the United States, as they were forced to temporarily idle plants and reduce capacity. Despite these measures, which enabled key players to weather the financial storm, further reductions in capacity may be necessary to rebalance the new supply market in the coming decade. New capacity scheduled for 009 and 010 has caused excess capacity in the system (see figure 6 on page 6). This has been made worse by lower demand in the developed European and U.S. markets since the financial crisis. Although there are indications that demand is picking up again in Europe and the United States, aging facilities in these markets will continue to come under pressure from lower-cost producers and those with improved proximity to key Chinese markets. Expected capacity reduction Figure 5 will increase polymers capacity by 00 1 Polymers capacity (tons-million) Africa India Middle East ROW 3 Western Europe North America % 5 % 17 6% % share of global capacity 00e 13% 1% 8% 10% 13% 4% CAGR 5 (010-00) 3% 4% 9% 5% 7% % -1% <1% 6% (avg.) Asia % % e 1 Polymers include polyethylene, polypropylene, PVC and polystyrene Capacity is total available capacity, including estimated additions or reductions in nameplate capacity 3 Rest of the world includes Latin America, Eastern and Central Europe 4 Asia excludes and India 5 CAGR is compound annual growth rate; all estimates are A.T. Kearney estimates 00e Sources: Chemical Market Associates, Inc., Shell, Chemical Week; A.T. Kearney analysis : A Global Trading Force and Petrochemicals Hub 5

8 Figure 6 The global petrochemicals supply and demand imbalance Global ethylene capacity-demand gap (tons-million) Capacity Demand Global polymers capacity-demand gap (tons-million) Excess capacity e 00e e 00e (5) <1 Notes: Polymers include polyethylene, polypropylene, PVC and polystyrene; capacity is total available capacity, including estimated additions or reductions in nameplate capacity; all estimates are A.T. Kearney estimates Sources: Chemical Market Associates, Inc., Alpen Capital; A.T. Kearney analysis Figure 7 The petrochemicals supply and demand imbalance Ethylene demand versus capacity 1 (tons-million) Capacity Africa 9 India Middle 6 East Demand Polymers demand versus capacity (tons-million) Excess capacity e 00e e 00e <1 (6) (4) (4) 7 4 (1) 1 Capacity is total available capacity, including estimated additions or reductions in nameplate capacity Polymers include polyethylene, polypropylene, PVC and polystyrene Note: All estimates are A.T. Kearney estimates Sources: Chemical Market Associates, Inc., Shell, Chemical Week; A.T. Kearney analysis between 010 and 015 in these markets is between to 3 million tons with the trend to continue in the following five years as production increases in and the Middle East. While there is a current imbalance globally, the picture within is different. New capacity is evident in both ethylene and major polymers products, but the disparity in supply and demand is much less than that seen globally. In addition, if operating rates are taken into account, then still requires further capacity to be fully self-sufficient (see figure 7). 6 : A Global Trading Force and Petrochemicals Hub

9 This is the picture on an aggregate level. However, if you dig into the sub-regional specifics, a slightly different view emerges., although chasing self-sufficiency, is unlikely to reach it in the next decade. The strength of the economy is expected to drive demand higher than can be accommodated with the current investment trend. In addition, stricter government regulations are expected to put more pressure on smaller, less competitive players and impose tighter requirements on investment in energy-intensive industries such as petrochemicals. With the combination of increased demand and more onerous regulations influencing expansion, estimates put the range of selfsufficiency of total demand between 55 to 75 percent by 015, depending on actual installed capacity and operating rates, but all fall short of the target 100 percent. Based on a sample of key polymers, reliance on imports as a proportion of polymer demand will decrease from around 50 percent in 000 to below 30 percent in 014; net imports will increase in absolute terms to over 13 million tons by 014. India will similarly increase its net imports over the next 4 to 5 years as local capacity installation falls short of growing demand. Africa also will grow imports as demand increases in line with GDP recovery and additional capacity is constrained by regional instability and the need for additional foreign expertise and funding. In addition to the shift in the center of production, demand dynamics are changing too. The strength of demand from and India is well known. For developed nations (predominantly Europe and the United States) demand growth will slow in line with comparatively lower GDP growth rates and population growth. As manufacturing of cars and other finished goods continues a migration to lowercost emerging countries close to major population centers, petrochemical producers in developed nations must find a way to secure access to key customer bases. This redistribution of demand and manufacturing is already altering global trade flows and will continue to do so over the next decade. Over the past two decades, has dramatically altered the footprint and dynamics of the global petrochemicals market. The most dramatic changes will occur in Europe and the Middle East, followed by the United States (see figure 8 on page 8). For Europe, the region is likely to move from being an historical net exporter to become a net importer in the next five years. Contrary to this, the Middle East will experience the biggest growth in capacity focused on the export market. Potential exports are forecast to grow by more than six times over the next five years. For North America, the change will be slower as the region remains a net exporter for the next five years. However, if the recent trends continue, the United States could also change to become a net importing region toward 00. : A Global Trading Force and Petrochemicals Hub 7

10 Figure 8 Redistribution of demand and manufacturing is altering global trade flows Polymers net exports by region (tons-million) Western Europe Central and Eastern Europe (including Russia) North America Middle East Africa 0.0 India e Net consuming regions (net import) Net producing regions (net export) South America Other Indian subcontinent Other Asia Note: Polymers include polyethylene, polypropylene, PVC and polystyrene Sources: Chemical Market Associates, Inc., United Nations Comtrade; A.T. Kearney analysis Based on these trends, will remain a marginal net importer, despite the significant growth in Middle Eastern exports. These exports will be offset by growing absolute demand in, Africa and India. However, the import requirements will have dropped substantially by 014 when compared to needs in 007. For the United States, this poses key questions around the direction of its trade. The most probable outcome will be redirection to focus on the South American market, where proximity would deliver significant advantages and the impact of cheaper Middle Eastern products will be lower given logistics challenges. However, to understand the impact on global trade flows, the picture must be expanded beyond the strict boundaries of to encompass other key Asian producing countries, including Japan, South Korea and Taiwan. When the production of these countries, and demand from the rest of the Indian subcontinent, is combined with, the expanded Middle East, Africa and Asia picture moves to a net export position. As a result, the key question is: Who will succeed in securing share of the key Chinese market? Will it be their compatriots from the Middle East, or their neighbors from Asia? Based on the cost advantage of the Middle East providers, they are expected to maintain a strong competitive positioning compared to all other regions, including the Asian and ethanebased U.S. producers. However, the players from the Middle East are unlikely to focus solely on but rather remain diversified in their focus, 8 : A Global Trading Force and Petrochemicals Hub

11 which includes maintaining strong trade relationships with Europe and potentially selectively expanding into the U.S. market. Many of the key players have already launched strategic expansion strategies, including acquisitions in these developed markets to acquire technology, strategic locations and market position to expand and improve their supply chains. In addition, the Middle East will continue to serve the growing African market, in conjunction with local production. As the Middle Eastern producers maintain a diversified portfolio of export markets, the opportunity to serve the Chinese market will remain for Asian and U.S. producers, although certainly diminished (see figure 9). Figure 9 The Middle East will retain its competitive advantage Delivered costs to SE Asia (US$/ton) 1,00 1, Freight to SE Asia Overhead Fixed costs 16% Middle East 18% 15% U.S. Gulf Coast Utilities Raw materials Sources: ChemSystems, 009; A.T. Kearney analysis 10% 36% 63% 6% 1% 10% 7% 59% % 16% 7% South Korea 4% 1% 5% 15% 5% 6% Northwest Europe The Next Wave? In the past decade the global petrochemicals industry has undergone tremendous change due to the rise of new major producing countries. The leaders have been Saudi Arabia and, followed closely by other Middle Eastern countries, including Iran, Qatar and the UAE, with India also growing its internal production capacity. As the balance of supply and demand changes, several questions arise. Figure 10 on page 10 offers some possibilities and discusses each country in more detail. Within there are a number of contenders that could alter the supply balance through rapid scaling up of production. Iran, Iraq and Nigeria are all worthy contenders due to their natural resource bases and potential government support. Iran already has a significant investment program planned and underway. Currently hampered by international investment flows and political tensions, the change would occur if the political situation were to suddenly stabilize. In this case, how fast could Iran expand to monetize its substantial natural gas reserves? should also be considered. Indeed, could pull further away from the pack with increased government support, and as foreign investment allows it to become truly self-sufficient, eliminate a major area of demand. External to, Canada, Russia and Brazil could all enter the market and change the game. For Canada, the rationale for consideration is further downstream evolution to leverage the potential of its vast oil sands reserves. For Russia, immense natural gas reserves and a substantial oil and gas industry make a further move into petrochemicals a distinct possibility. Brazil, although comparatively small in terms of oil and gas reserves, has ready market access and growing investment in the sector could drive accelerated petrochemicals development. : A Global Trading Force and Petrochemicals Hub 9

12 Figure 10 Potential new mega producers Iraq 13th largest oil producer in 008 3rd largest proven petroleum reserves Proven oil reserves of 115 billion barrels Focus currently on upstream industries, longer term petrochemical opportunities Iran A top 3 player in both proven oil and natural gas reserves Proven natural gas reserves at 1,045 Tcf 1 Strong investment in expansion, but hampered by internal delays and international political situation Russia World s largest natural gas reserves at 1,680 Tcf Oil reserves of 60 billion barrels Comparatively limited petrochemicals industry to date Canada 179 billion barrels of oil reserves 57 Tcf of natural gas reserves Among the world s largest producer and exporter of energy Large potential oil sands reserves Brazil 13 billion barrels of oil reserves 13 Tcf of natural gas reserves Investing in biomass and biofuel Nigeria Heavily oil-dependent economy (~85% of government revenues) 7th largest natural gas producer 36 billion barrels of proven oil reserves 184 Tcf natural gas reserves Establishing gas-to-liquid (GTL) plants Development hampered by instability 80 Tcf natural gas reserves 16 billion barrels of proven oil reserves Massive investments to increase selfsufficiency in petrochemicals Strong government backing and stateowned firms Technology importing via joint ventures Country Brazil Canada Iran Iraq Nigeria Russia Description Brazil has ready access to the growing South and Central American markets and investments in alternative feedstocks such as biomass are underway. Any new players will likely focus on serving the local market, with the major competitive impact hitting North American suppliers. Development of its petrochemicals industry is a longer-term play for Canada. Although it has vast resources of oil sands, extraction is an expensive process and could lead to reduced competitiveness of feedstock and higher production costs. has an extensive development campaign in place to increase installed capacity. Capacity growth post 010 is expected to slow to around 5 to 7 percent per annum compared to about 15 percent from 005 to 010; this slower expansion is expected to continue to 00. Maintaining a certain level of imports also gives flexibility to access lower cost products as required and mitigate the risk of over capacity. Although Iran has both the natural resources and a state government agenda to dramatically grow its petrochemicals industry, an inability to secure the required foreign support is expected to continue. The political outlook must be considered. This, together with tight start-up timeframes, will push any significant additional capacity to beyond 00. The current political instability in Iraq is expected to hamper expansion in the medium term. In addition, prior to establishing downstream petrochemicals operations, Iraq is expected to first focus on developing upstream oil operations. Given the necessary lead time for the construction of new facilities, it is unlikely Iraq will emerge as a significant petrochemicals player before 00. Nigeria has strong incentives to develop the petrochemicals industry adjacent to the current upstream oil business. With government sponsorship, evident in and the Middle East, a successful petrochemicals industry could provide valuable diversification for a country that earns about 85 percent of government revenues from oil. However, local political instability and security concerns are likely to hamper development in the next five years pushing out the expansion timeframe to 00 and beyond. The rich availability of feedstocks positions Russia well for petrochemical expansion. However, the Russian petrochemical industry has been particularly hard hit by the recent economic downturn with key consumer industries experiencing downturns of 10 to 60 percent in 009. With major players struggling to recover profitability, expansion plans over the next five years have been downscaled. As a result, increased capacity is not expected until 018 or 019. Global impact Low to medium Low Low to medium Medium Low Low to medium Medium Sources: U.S. Energy Information Administration, EIU; A.T. Kearney analysis 1 Tcf is Trillion cubic feet 10 : A Global Trading Force and Petrochemicals Hub

13 Based on this analysis, the likelihood of new producers entering and dramatically altering the petrochemicals industry is considered low to medium. Although the emergence of a new super-producer would have immense impact on industry dynamics, the timeframe is likely to be beyond this decade due to a current focus on economic recovery and long lead times for capacity installation. These questions of future production centers are not the only ones facing the petrochemicals industry. The industry is also experiencing change driven by the trend toward sustainability both on the cost and demand sides. Potential environmental taxes or levies and changes to production processes are likely to increase overall cost bases. On the flip side, trends toward new products that have higher recyclability and biodegradability are fueling demand. Demand is also rising for plastics in the automotive industry, for example, which is striving to increase its plastics composition to put lighter and more fuel-efficient vehicles on the road. In addition, alternative feedstocks such as coal to liquid, gas to liquid and biomass to liquid may also change the landscape in terms of feedstock independence and cost. Although this will most likely be a regionalized trend in line with natural resource availability, and unlikely to rival traditional feedstock bases in the short term, it is a trend to watch nonetheless. The potential of shale gas in the United States could push down input prices for ethane-based producers and once again alter industry competitive dynamics. These are only some of the many potential game changers that face the current petrochemical producers in these already dynamic times. It is essential for chemical players across the world to consider the strategic impact of s increasing importance for supply and demand. As the status quo continues to evolve, agility and forward thinking become more critical, and separate the leaders from the rest of the pack. Authors Dan Starta is head of the firm s Middle East operations. Based in the Middle East, he can be reached at dan.starta@atkearney.com. Louis Besland is a partner in the Middle East. He can be reached at louis.besland@atkearney.com. Rebecca Hall is a consultant in the Middle East. She can be reached at rebecca.hall@atkearney.com. : A Global Trading Force and Petrochemicals Hub 11

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