Factors Affecting the Global and Domestic Petrochemical Industries

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As the petrochemicals industry is globally integrated, regional imbalances impact international prices. The Asian region has greater number of naphtha-based crackers, while the Middle East and North American regions have a larger number of gas-based crackers. Thus, the feedstock demand-supply situation impacts the demand-supply scenario in these regions. Other factors affecting the petrochemicals industry are economies of scale, operating rates, cyclicality of the industry etc.

Key issues answered through this analysis:

1.How is the petrochemicals industry integrated globally?

2.What are the factors that affect the global and domestic petrochemicals industries?

3.Who are the key players in the global and domestic petrochemicals industries?

Industry characteristics

Global integration

Basic petrochemicals are largely in liquid or gaseous form. However, intermediates and derivatives are mostly in solid or liquid form. Hence, they can be easily transported over long distances. The increasing use of specialised ships (cryogenic tankers, which can carry liquids at low temperature and high pressure), has improved the transportability of basic petrochemicals. As a result, competition has become global without being restricted to specific geographical markets.

Large capacities have also influenced the globalisation of the petrochemicals industry. In addition, hydrocarbon feedstock is widely traded. While trade in ethylene and propylene remains low due to difficulties in transportation, trade in polymers has been increasing. The international trade in polymers is continuously increasing with the commencement of new capacities in the Middle East. Growth in consumption of petrochemicals is expected to be the highest in Asia with both China and India being the major growth drivers.

Given the petrochemicals industry's global integration, regional demand-supply imbalances have an impact on international prices. Hence, plant shutdowns, commencement of production at new capacities and the seasonal demand in a region affect international prices. For instance, in China, which is a large consumer of petrochemicals, the demand for polymers is low during the Lunar New Year holidays (around February). As a result, international prices tend to drop in February owing to the decline in demand. Similarly, the level of economic activity in developed countries such as the US and Japan affect global demand and prices of petrochemicals. Slowdown in the developed economies in 2001 resulted in a slump in global prices of petrochemicals. In 2006, prices and margins increased due to large maintenance turnarounds and strong demand from China and the US. Moreover, the economic crisis in the US in 2008 adversely affected global demand and prices of petrochemicals. Demand for all petrochemical products declined, while prices went to the 2005-06 levels. However, demand bounced back post the second half of 2009 on account of a recovery in economic scenario in the global markets due to which prices of  petrochemicals also registered an increase.

Meanwhile, domestic prices remained highly volatile and cyclical as they are linked to landed costs.

Crude oil linkages

Around 50 per cent of the global cracking capacity is based on naphtha, which is derived from crude oil. Hence, the price and availability of crude oil affects the petrochemicals industry. Crude oil prices are highly volatile, thereby imparting volatility to prices of petrochemical products. Volatility is higher in the case of basic petrochemicals and intermediates, as against polymers and downstream organic chemicals given their close linkages with crude oil and lower trade of these products.

Volatility in crude oil prices affects the Asian petrochemicals industry significantly, as over 70 per cent of the cracking capacity in this region is based on naphtha. However, in North America, nearly 65 per cent of the total cracking capacity is based on natural gas. Prices of natural gas are less volatile, relatively, as compared to those of crude oil and naphtha. As a result, when naphtha prices increase, profitability of natural gas-based producers increases as their feedstock cost remains relatively stable and product prices increase. Similarly, profitability of natural gas-based producers decreases with a drop in naphtha prices, as their feedstock cost remains relatively stable and product prices fall (as naphtha is a by-product of refineries, prices of naphtha are also linked to the operating rate of refineries). In late 2004, the naphtha cracker economics turned favourable vis-a-vis gas cracker economics owing to strong prices of by-products. Among the by-products, prices of propylene, benzene and butadiene increased sharply.

The trend of petrochemicals companies acquiring or merging with refining and oil exploration companies and vice versa is attributed to the strong linkage of petrochemicals with crude oil. In India, Reliance Industries has backward integrated from petrochemicals to refining and oil exploration. Similarly,the Indian Oil Corporation (IOC), which is into crude oil exploration and refining, has entered the petrochemical sector by building greenfield projects. IOC's naphtha cracker and a petrochemical complex was commissioned in May 2010.

Meanwhile, Oil and Natural Gas Corporation (ONGC), engaged in the business of oil exploration, development of oil fields, production of crude oil, and natural gas, has announced plans of setting up an aromatics complex in Mangalore. Moreover, considering the higher value addition from the secondary processing units (which yield propylene and benzene), domestic refiners are also enhancing the yields of secondary processing units.

Economies of scale

The investment required per tonne of capacity decreases as capacity increases. In addition, other costs (per tonne of capacity) such as administration, logistics and marketing also decrease with increasing capacity. Higher capacity also gives the producer more bargaining power in the purchase of feedstock. As a result, larger players in the petrochemical industry are more cost competitive than smaller players. In the past, several small players either closed down or were acquired by larger players due to lack of economies of scale. This trend is likely to continue, as smaller players will find it increasingly difficult to compete with cost competitive larger players. In India, Reliance Industries Limited (RIL) acquired IPCL and consolidated its petrochemical operations.

Over the past 3 decades, capacity sizes have increased on account of increasing demand and the resolution of technical problems that had restricted large capacities. The capacities of newly commissioned crackers have increased to over 1.2 million tpa.Plant operating rates critical to profitability

The petrochemical industry is capital intensive, resulting in high interest and depreciation costs. Hence, plants need to operate at high rates, in order to reduce the fixed cost per unit of production. Higher operating rates reflect the demand for products and hence, the bargaining power of producers increases over that of the consumer. In case of petrochemicals, when the demand is adequate, the industry tends to operate at a capacity utilisation rate of around 90-95 per cent. In such a situation, the pricing power shifts from the consumer to the producer. In 2006, the global operating rate for most petrochemicals was high and in the range of 90-95 per cent due to the tight demand-supply situation. However, in 2008 due to weak demand on account of weak economic scenario in the global markets operating rates fell to around 84-85 per cent thereby cracker margins also declined sharply.

Operating rates for ethylene vary across regions. In Eastern and Central Europe, operating rates are estimated to have been lower in the past few years due to low demand growth, small and inefficient capacities and significant competition from the Middle East and Asia. In North America, operating rates were estimated to have decreased  in 2011 to around 84 per cent on account of slowdown in demand coupled with increase in capacities. Operating rates in the Middle East remained at around 80 per cent on account of new capacity additions. The Middle East capacity additions are expected to continue going ahead, hence, Middle East exports to Asia and Europe are expected to increase. Despite the global slowdown, operating rates in Asia remained higher when compared to other regions largely on account of demand from key markets of China and India.

Feedstock and product prices

Naphtha prices have become highly volatile over the last few years, owing to increased volatility in crude oil prices. Naphtha prices (c&f Japan) increased from $273 per tonne in 2000 to around $724 per tonne in 2010; they increase by 30 per cent y-o-y to $930-940 per tonne in 2011 mainly on account of an increase in crude oil prices during the year.

In many regions, availability of feedstock (besides the relative economics of different feedstock) influences the establishment of a plant. Some new crackers being planned have the flexibility to use different feedstock. Diversity of feedstock could result in price differences. Pricing policies of natural gas producing countries such as the Middle East, Malaysia and Indonesia, could affect the competitiveness of countries facing a shortage of natural gas, for example India.

Product pricing is complex, as a single feedstock yields many co-products, prices of which are correlated. Moreover, different feedstock can be used to produce the same product. In general, during periods of low supply (in relation to demand), prices of petrochemical products are based on the consumer's willingness or ability to pay. During periods of oversupply, prices are based on the marginal cost of production.

Cyclicality

The petrochemical industry, like most capital-intensive commodity industries, is cyclical in nature. Demand for petrochemicals is linked to economic growth. Demand increases when economy is strong; consequently, profitability of players increases, leading to capacity additions by existing players and entry of new players. However, as it takes 3-4 years to build petrochemical plants, demand could decrease or stagnate before completion of these capacities or capacity additions could exceed demand. This could lead to a decrease in petrochemical prices causing the industry to face a downturn and players reducing operating rates or shutting down their plants.

Petrochemical prices reached a high in 1995. As a result, large capacity expansions were undertaken in the Asia-Pacific region. Despite the Asian economic crisis of 1997, there was a 70 per cent increase in Asian ethylene capacity during the period between 1998 and 2005, as a result of deployment by international companies attempting to secure a production platform in Asia. These companies included oil majors (ExxonMobil and Shell) and chemical majors (Dow), all of which opted for greenfield developments, rather than acquiring existing Asian plants. In 2004, petrochemical prices and margins breached all time highs. Improvement in demand for petrochemicals led to spurt in capacity expansion plans announced in the Middle East, China and other parts of the world.  It is estimated that about 45-50 per cent of the new capacity (in ethylene) is likely to come from the Middle East; remaining capacity expansion will come mainly from the other Asian region.

Fragmented and competitive industry

The global petrochemicals business is very competitive with a large number of petrochemical companies having small market shares. In the case of most petrochemicals, the top 10 producers account for around 45 per cent of the total capacity. In addition, the petrochemicals business is highly capital intensive, which acts as an entry barrier for new players and small companies. Global petrochemical companies compete largely in terms of cheap availability of feedstock, prices and the ability to offer new and improved products (through innovations in product applications), and on proximity to markets.

Industry structure

International market

The petrochemical industry is devoid of any players dominating the market. Production capacities are distributed across regions, no single region has a dominant position in the market.

In 2011, of the total ethylene capacity of around 148 million tpa, the top 10 ethylene producers accounted for over 45 per cent. Most of the ethylene capacity is concentrated in North America, Western Europe and Asia. With the Middle East emerging as the lowest cost producer of ethylene, the industry structure is changing in terms of the regional distribution of capacity. In 2011, the total capacity for propylene was estimated to be around 92-93 million tpa. Propylene production through the refinery route accounts for a significant share of total propylene production. Refining is the major source of aromatics, benzene-toluene-xylenes (BTX). The change is likely to affect the structure of the aromatics industry. North America and Western Europe are expected to emerge as net importers of benzene, while Asia, largely the Middle East, is expected to emerge as the largest net exporter of aromatics.

The industry is undergoing consolidation, with polyolefin players merging due to increasing competition from new integrated capacities being set up in the Middle East. In the polymer industry, capacities for production are distributed across regions. The industry is characterised by the absence of market dominance by any one producer or a group of producers. The capacity share of top 10-polyolefin producers is around 40-45 per cent of the global capacity. The industry is moving towards consolidation. In polyolefins, Lyondell-Basell continues to be the market leader with a production capacity of over 10 million tonnes, mostly for PP. Dow/Union Carbide Union and Exxon Mobil are other big players in the petrochemicals space, but with more balanced portfolios across all polyolefins. The next tier of players has less than half the capacity of leading companies, including companies as Ineos, Sinopec and SABIC.

Similar to most petrochemicals, no player has a very significant market share in PE. Dow Chemicals (along with Union Carbide) and Exxon Mobil Corporation have the world's largest PE capacities. In 2011, global PE capacity is estimated to be around 90-91 million tpa.

World polyolefin capacity share by regions

Source-CRISIL Research

Note: Polyolefins include PE, PP, PS and PVC

Source: Industry and CRIS INFACAsia and North America are the largest producers of Polyolefins, accounting for 45 per cent and 16 per cent of global polyolefins capacity in 2011,respectively.The share of Asia and middle east has continuously been increasing over the past five years on account of huge capacity additions while that of North America and Western Europe is decreasing mainly due to less capacity additions coupled with closing of inefficient capacities.

Competition

The emergence of low-cost producing regions for olefins, primarily in the Middle East, is expected to result in a pressure on margins of other players in the industry. Prices of ethylene depend largely on operating rates in high-cost regions and on cost of incremental ethylene supply.

In the case of propylene and BTX, competition comes from alternate methods of producing chemicals, primarily the refinery route. The Middle East is expected to emerge as the most competitive producer of most petrochemicals. As a result, a shift is likely in the regional trading pattern with the Middle East emerging as the largest producer of ethylene and ethylene-based derivatives. However, in the case of feedstock like propylene, Asia is expected to remain a major player (in the medium term).

Large PE manufacturers operate mainly in mature markets. Therefore, competition is high and demand for their products is low. Most players are setting up joint ventures in growing markets of Asia and South America. Competition is in terms of product differentiation, through the manufacture of specialty grades, use of better product and process technology (such as metallocene catalysts) and price.

Domestic market

Currently, the domestic petrochemical industry is oligopolistic in nature with four to five large producers. However, competition has been increasing gradually, with existing producers expanding capacities and thus trying to eat into each others market share. Earlier in 1980s and 1990s, domestic production of hydrocarbons increased significantly, resulting in excess availability of naphtha. Many derivatives of petrochemicals such as plastics were perceived as cost effective and superior alternatives for conventional materials such as glass, wood and metals. Synthetic fibers, which were perceived to be a luxury, became critical to supplement cotton production. Low crude oil prices resulted in a decrease in price of imported petrochemicals. As a result, demand for petrochemicals rose significantly, many capacities were set up to meet increasing domestic demand. These trends have defined the existing structure of the domestic petrochemicals industry.

At present, Reliance Industries dominate the industry. In the early 1990s, Reliance Industries commissioned three downstream plants in the first phase of its cracker complex. It commissioned its 750,000 tpa mother cracker and other downstream units in 1997 at Hazira, Gujarat. IPCL started three cracker complexes - Baroda, Gujarat (set up in 1978, having an ethylene capacity of 130,000 tpa, subsequently increased to 175,000 tpa); Maharashtra Gas Cracker Complex (MGCC) at Nagothane (set up in 1990, having an ethylene capacity of 300,000 tpa, subsequently increased to 400,000 tpa); and Gandhar, Gujarat (set up in early 2000, having an ethylene capacity of 300,000 tpa, subsequently increased to 400,000 tpa). Competition has increased with the commissioning of new capacities by Gas Authority of India Limited (GAIL) and Haldia Petrochemicals. In April 1999, GAIL set up a 300,000 tpa cracker at Auriya, Uttar Pradesh, as a part of its forward integration plan. The capacity has been subsequently increased to 440,000 tpa. In April 2000, Haldia Petrochemicals set up its 420,000 tpa cracker at Mednipur, West Bengal (the capacity was subsequently increased to 520,000 tpa). Recently, in May 2010 Indian Oil Corporation Limited (IOCL) commenced operations of its 800,000 tpa ethylene capacity, thus further intensifying competition in the domestic market. Moreover, with entry of new players like Indian Oil Corporation (IOC) (which has already entered in 2010) and ONGC Petro-additions Ltd (OPaL) (which is expected to come on stream in 2014-15), competition is slated to increase further.

Domestic ethylene capacity share

    

Source-CRISIL Research

Domestic polyolefin capacity share (2011-12)

 

Reliance Petroleum has merged with RIL, making the latter an integrated player in the petrochemical industry. RIL has strengthened its position as a dominant player in the domestic petrochemicals market (especially in PP) with the takeover of IPCL (in 2006-07). Further with the commencement of a 900 kt PP unit in Jamnagar in 2009-10, share of RIL in the total domestic PP market  further increased .

In India, RIL dominates the polyolefin industry; it became the dominant player in the domestic market after the takeover of IPCL. Together they have a production share of around 67 per cent. RIL's total  polyolefin capacity is 4.37 million tpa as of March 2012. Another major player in the polymer market is Haldia Petrochemicals with a current capacity of 1.04 million tpa. However, Haldia Petrochemicals faces locational disadvantages since its complex is situated in East India, which along with South India accounts for smaller portion of the total polymer demand.

Competition

Until the early 1990s, domestic competition was limited due to high tariffs, a favourable demand-supply situation and a high concentration ratio. In the late 1990s, competition increased due to the gradual lowering of tariff barriers. Competition also increased significantly with the commissioning of cracker complexes by RIL (1997), GAIL (1999), IPCL (1999), and Haldia Petrochemicals (2000).

In the 1990s, competition in the domestic market increased due to a rise in imports. In recent years, competition has grown significantly due to new capacities set up in the Middle East and Singapore. Earlier, high customs duties effectively protected most domestic producers. Tariff levels have gradually fallen over the past decade. At present, domestic prices are closely linked to global prices (landed costs). As a result, domestic producers have limited flexibility in pricing their products.

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