Middle East Petrochemical Producers Have Opportunity In India

John W. King
Chem Systems India
Chennai, India

• Shifts in Indian Petrochemical Industry [32,935 bytes]

International petrochemical producers view India as a major potential market. Middle East producers in particular have the combined advantages, relative to other regional producers, of very favorable feedstock costs and good logistics to serve the Indian market.

This article reviews the opportunities within the Indian petrochemical industry and suggests measures for industry evolution based on core competencies of those foreign producers interested in carving out a position in the Indian petrochemical industry.

Active participation in the historically high-growth markets of East Asia has been sought after and achieved by many global petrochemical producers. They focused on such Asian countries as China, Thailand, Malaysia, Indonesia, and others for growth.

Although the strong fundamentals which led to the historic growth of East Asia will, in the opinion of Chem Systems, re-emerge in the medium-to-longer term, many international organizations are more seriously evaluating opportunities in India. Global players have historically focused on East Asia with India being widely neglected. As growth in demand for many sectors of the chemical industry within India becomes more visible and understood, strategies of indigenous organizations will evolve, especially in light of the entry of more global players with various initiatives to capture a piece of the action.

This, obviously, has not been by accident. Aside from the high growth experienced by East Asian countries prior to the current crisis, significant barriers, historically, have existed in India that have hindered progressive market evolution and discouraged growth in demand.

The Indian situation has changed in a massive way in a very short time. India will, in the short, medium, and longer term, become more prominent.

Opening of opportunity

India has emerged as a strategic target for many global corporations. The country has long been recognized as one of the world's largest potential markets, and has the added attraction of a well-established, western-orientated legal system and business framework to which many multinational organizations can relate. However, barriers have historically existed that restrict the realization of this potential.

Andy Grove, chief executive officer of Intel Corp. (the world's largest manufacturer of microprocessors), refers in his book to a "strategic inflection point" as a point, or a period in the life of a company (or an industry, or indeed a nation) when a major change or changes occur that create a completely new business environment. Such a strategic inflection point occurred in India 1991 with the precipitation of the balance of payments crisis.

Without the historical support of the Soviet Union and with the strong encouragement by the World Bank, the future became clear for the Indian government. In order to develop a sustainable invigorating economy for the future, profound structural changes had to be made.

In 1991, the Indian government began major and irreversible structural changes aimed at radically reforming the economy. These efforts have continued and have already resulted in massive deregulation and a significant opening of the Indian economy, which previously had discouraged foreign direct investment and restricted the role of private enterprise in many industries

. Specifically, some of the key liberalization initiatives in moving from a regulated to a free market economy are:

• Pervasive delicensing of the industrial sector
• Partial privatization of state enterprises
• Financial sector and market reform
• Liberalization of foreign trade
• Exchange rate unification and rupee convertibility on current transactions
• Liberalization of foreign investment regulations.

Trade barriers are easing, with tariff rates moving towards regional comparability (Table 1 [26,722 bytes]) Import tariffs will approach the Association of South East Asian Nations (ASEAN) levels averaging 10-15% by 2001.

Corporate tax rates have declined from a recent high of 57.5% in 1990 to 35% in 1997. Corporate tax rates are directionally more in line with other ASEAN countries (Figs. 1[40,055 bytes]) and (Fig. 2 [41, 304 bytes]).

The future direction of the Indian Petrochemical Industry is clear in the accompanying box.

Demand drivers

India has become a country that global corporations cannot ignore. The driver for proactive initiatives is the tremendous market demand. The key issue for each current and prospective participant is how best to take advantage of its core competencies and combine that with the dynamics of the Indian market.

During the past several years, Indian industry has demonstrated vibrant growth. Industrial growth has averaged over 8%/year and manufacturing growth over 9%. The chemical sector has exceeded these averages, growing on average at 10%, while the petrochemical sector grew even faster at between 15 and 20%. The key factors behind the growth in demand for petrochemicals and polymers include:

• The growing middle class which aspires to a higher standard of living and creates new demand in many sectors of the economy
• Increasing use of petrochemical materials in the agricultural sector
• Increasing demand from industry

Middle class

The emergence of a middle class in India, estimated at nearly 300 million people, has contributed strongly to the rise in demand. This socio-economic group's spending has greatly contributed to the growth in demand for fibers and plastics. Having said this, it is very instructive to see India's position on per capita consumption benchmarks as demonstrated in Fig. 3 (37,731 bytes) and Table 2 (15,436 bytes).

The Indian levels for per capita plastic consumption are vastly below the global average. The Indian govern ment's estimate of per capita plastic consumption of 7.1 kg for the year 2006 is still below the current level in China. For a nation whose population increases by 1.9% per annum and currently stands at over 900 million people, this represents an enormous potential market. With an increase of per capita plastic consumption to 7.1 kg, the demand increase amounts to over 30 world scale polymer plants.

Other benchmarks

On a global basis, synthetic rubber per capita consumption is 20 times higher than in India; global per capita textile consumption is 2.5 times higher, and global per capita paint consumption is 14 times higher.

The key to how strongly demand rises in India is economic growth of the country, which in turn is influenced significantly by the pace of reform. The preliberalization and postliberalization growth trends of key petrochemical sectors are shown in (Table 3 [32,288 bytes]).

Since 1991, demand, as well as domestic supply, has grown, but in key basic polymer materials, such as low and high-density polyethylene and polypropylene, India is still a net importer (Table 5 [20,491 bytes]).

Based on Chem Systems' demand projections, India is expected to show the highest growth in some of the key commodity polymer sectors relative to China and the ASEAN countries (Fig. 4 [39,836 bytes]).

The issue is how is this demand going to be supplied?

The supply deficit

In order to supply future demand, the clear consensus is that domestic capacity will increase. A recent Indian government release nicely puts this deficit issue in context (Table 4 [25,785 bytes]). Here the supply deficit is equated to the number of additional worldscale plants needed by the year 2006. In this regard, we are talking about the need for 10 new worldscale cracker complexes, 5 worldscale aromatic complexes, 30 worldscale polymer complexes, and so on.

The reality of how this petrochemical supply deficit is actually going to be dealt with remains to be seen, but will no doubt be a combination of capacity and Indian competitiveness.

Capacity

The race for capacity buildup is already moving ahead in India (Fig. 5 [60,034 bytes]).

Currently, there are four complexes in India with a total capacity of 1.2 million tons/year. There have been announcements of eight additional crackers with a total additional capacity of 3.2 million tons/year.

Many of the proposed projects are speculative, but the shear number is indicative that at least part of the supply deficit will be met by domestic capacity buildup. For multinationals, the opportunity lies in some form of participation in this capacity increase in addition to the traditional method of importing into India and investing in marketing infrastructure.

For the domestic players, the challenge will be to develop sustainable competitive positions in the areas of focus.

Before going into implications for the Middle East, however, let us review the competitiveness issue as it relates to petrochemical manufacturing in India.

Indian competitiveness

Ethylene can be used to illustrate the competitiveness issue of India vs. the Middle East.

Tables 6 (25, 071 bytes), Table 7 (17,308 bytes), Table 8 (16,617 bytes), Table 9 (16,563 bytes) compare key cost drivers for ethylene production in the two regions.

They are:

• Capita cost and fixed cost factors
• Manpower
• Feedstock costs
• Ethylene cracker coproduct credits.

As these tables demonstrate, India has key advantages that make domestic manufacturing interesting.

An examination of the impact of the various cost drivers on ethylene production costs shows the enormous feedstock advantage that exists within the Middle East. There is a significant advantage at the cash cost and full production cost (cash cost plus depreciation) levels, for both the Middle Eastern propane and ethane crackers. However, after considering freight costs and current import duties, the Indian cracker becomes more competitive than the Middle East propane cracker for serving the Indian market (Fig. 6 [55,376 bytes]). At average 1996 market prices (Maharashtra), return on replacement capita would have been as follows:

• Middle East ethane cracker, 24%
• Middle East propane cracker, 6.5%
• Indian cracker, 8.5%.

Assuming a reduction of tariffs to half of current levels for ethylene, the landed cost from the Middle East propane cracker would become slightly less than the Indian naphtha cracker (Fig. 6 ).

Implications for the Middle East

The implications for the Middle East are clear:

• The Middle East has vast resources and limited markets.
• India represents a vast and growing market.

However, the strategy of "arms-length" exportation of such final product as commodity resins to India is not what would be recommended as a viable and sustainable long-term approach for India. No doubt this approach has viability for the short and perhaps medium term. However, in the longer term, India will gradually become less dependent on such "arms-length" imports as indigenous and global players start carving out positions in the country.

India can represent much more to the Middle East than a location to export resins. Indeed, there are definite opportunities for the Middle East in the entire petrochemical chain (Fig. 7 [31,513 bytes]).

The historic focus has been on exporting final product and to a more limited degree, exporting feedstocks.

The key issue for each prospective Middle East participant is how to best take advantage of its core competencies and synergistically focus this on the dynamics of doing business in India. To develop a longer term position in the Indian market, some form of local manufacturing will be necessary. This could be done in a variety of different ways, including direct investment, joint venture, and strategic alliances.

Using this petrochemical chain exhibit as a framework, there will be opportunities for Middle East participants in:

• Feedstock supply-By forming long-term strategic alliances with a downstream Indian producer; or as a feedstock supplier by making an active investment in downstream units in India.
• Petrochemical building blocks-By a producer such as the Middle East ethane cracker conceivably investing in downstream units in India and sourcing the required ethylene from its Middle East operations.
• Intermediates-By, as a result of economics as the driver, Indian joint investment in the Middle East for the use of the intermediate in India, or perhaps by the Middle East intermediate producer investing in downstream units in India.

The Author