Friday, April 13, 2018

PETROCHEMICALS SPECIAL..... Reinventing growth strategies to stay profitable in petrochemicals


Reinventing growth strategies to stay profitable in petrochemicals

Winning in the petrochemicals business has hitherto hinged on two strategies: accessing low cost hydrocarbons in abundant quantities to make products that are largely undifferentiated from one another; and accessing growth markets in emerging economies. But, as a recent McKinsey study points out, this approach may not work for long. Growth in several emerging markets is slowing and pressure to create circular value chains, incorporating more and more of recycled polymers, will dent markets for virgin resins, and pose immense challenges for businesses. Companies will need to work harder on their core capabilities and strategy, including digital and advanced analytics, to improve productivity and ensure profitable growth.
Strong growth
The global petrochemical industry has seen more than 15 years of strong growth. Production of ethylene – the olefin that has come to be a barometer for the industry – rose from 100-mt in 2000 to nearly 150-mt in 2016, and stocks of petrochemical companies have outperformed other chemical sectors and the market as a whole. The traditional approach to growth in the industry has been to build large plants using cheap feedstock – particularly natural gas – and ship the polymers and chemicals so produced to growth markets, such as China. In parallel, producers in growth markets (including India) stepped up investments to cater to their booming domestic markets.
Since 2000, over half of all petrochemical industry investments – especially in the C1 and C2 value chains – have been based on advantaged feedstock. Producers with access to low cost gas, accounting for around 20% of the industry’s output, captured well over 80% of all value created between 2000 and 2014. For the others – including players in Western Europe, Japan, Latin America and North East Asia – the business environment was very challenging to put it mildly.
But the situation has changed in the last three years. Asian players cracking naphtha – an oil derived feedstock – have benefitted from the low oil price and, importantly, been able to retain a significant portion of the cost advantage that has come their way.
The global petrochemical industry has also witnessed a structural shift that has resulted in the creation of a four-tier structure comprising: national oil companies (NOCs) and other emerging-market players; international oil companies; pure-play petrochemical producers; and diversified chemical companies with large petrochemical-production assets. The NOCs and the emerging market players have accounted for a major chunk of the new capacity been created in the industry, and several of them, including India’s Reliance, now count as industry leading companies.
Diminishing feedstock advantage
McKinsey believes the advantage posed by advantaged feedstock is diminishing. In the Middle East most new petrochemical projects are increasingly based on liquid feedstock such as naphtha and gasoil, or a combination of gas and liquids. These do not have the price advantage that gas-based crackers enjoyed vis-à-vis the competition elsewhere in the world. In North America, where an aggressive ethylene capacity build-up is currently underway, prices for ethane and propane could be driven up both by increased demand from domestic companies and by petrochemical producers elsewhere seeking to import this resource. Reliance and INEOS, for instance, have contracted imports of significant volumes of ethane to feed their crackers.
By 2020, most of the world’s advantaged feedstock projects will have come on-stream, and further investments will be based on heavier feeds and will generate returns that are close to the cost of capital across the cycle and significantly below that in the past.
Slowing markets and margin erosion
The fastest growing market for much of the last 15 years has been China, but it may no longer be the engine of growth. As the country’s economy transitions from infrastructure- and manufacturing-driven development to one focussed on services and upgrade-type purchase, incremental demand for chemicals will slow. McKinsey estimates the slowing down in China will curb global demand growth for chemicals to 2.0-3.0% per annum through 2030, compared to the 3.6% growth seen annually in the last decade. Other emerging economies, including India, will be not be able to make up for the slack in China at least till 2030.
Overall, tighter investment discipline will translate to better operating rates and margins, though at the risk of greater volatility. But in several value chains (e.g. phenol, polyamides, para-xylene and purified terephthalic acid) that have seen significant value erosion in the last decade, the supply overhang will not go away for some time.
Deeper integration
The petrochemical industry will also see deeper integration with the refining industry that goes far beyond just co-location. Oil companies are eyeing faster growth than their traditional fuels business affords and will seek opportunities in petrochemicals. This is abundantly evident in India today, but will require refining operations of sufficient scale. Where possible, such integration will afford several benefits including lower capital and cash costs thanks to synergies in raw materials, energy and shared infrastructure. NOCs, especially in emerging economies, with deep pockets and access to large markets for energy and petrochemicals, are well placed to leverage such opportunities.
Leveraging digital technologies and advanced analytics
The petrochemical industry’s complex and integrated operations, where variable costs make up for a significant portion of total costs, make it well suited to benefit from digital technologies and advanced analytics. Benefits include optimisation of product portfolios to better reflect, predict and respond to market realities; reduction in energy & water consumption norms; predictive maintenance leading to reduced downtime of operations etc.
Strategic approach to growth
To offset the anticipated slowdown in demand, the industry will need to rediscover one of the roots of its growth – its ability to substitute other materials. But the easy pickings to replace paper, wood and metal are done, and further inroads will require a much larger focus on innovation. There could be opportunities for substitution of one polymer with another, and this will create winners and losers.
There is now intense pressure on the industry to adopt closed loops of manufacturing, use, reuse and recycle. This is coming not just from governments and regulators, but also from consumers and retailers. Several approaches are being taken up as part of the solution: use of bio-based and biodegradable materials; mechanical recycling; and recycling to recover chemical or energy values. While these are not yet done at scale, there is considerable pressure on the industry to step-up the scale of such operations. Europe, for example, has recently outlined an ambitious scheme to significantly enhance the share of plastics that go into closed loops and minimise the amount ending up in landfills. In India too, several restrictive measures are being put in place – including outright bans on single-use plastics that have little economic value at end-of-life to incentivise recycling.
Forward-looking companies will divert significant budgets and human resources to rise up to the challenge and develop a credible portfolio of options to transition the industry from its current linear growth model to a more sustainable circular one. One consequence of this will be lower growth rates for virgin products.
The petrochemicals industry of the future will need to reinvent to stay relevant in a changing world. Being in the right place simply may not be enough

Ravi Raghavan
CHWKLY 130318

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