SRIC: Southeast Asia petrochemicals recovery likely by 2002

Oct. 12, 1998
Construction cost location factors [80,938 bytes] Despite a hard hit from recent economic woes in the region, Southeast Asia's petrochemical industry should return to dynamic growth in 2-3 years. That conclusion can be drawn from two recent and related multiclient studies by SRI Consulting (SRIC), Menlo Park, Calif.
Despite a hard hit from recent economic woes in the region, Southeast Asia's petrochemical industry should return to dynamic growth in 2-3 years.

That conclusion can be drawn from two recent and related multiclient studies by SRI Consulting (SRIC), Menlo Park, Calif.

The aim of one study was to develop improved procedures for assessing production economics on a continuing basis, said Walter Sedriks, technical director of SRIC's chemicals and energy practice. This study examined the two main factors affecting petrochemical production costs: relative investment costs and feedstock and product prices.

"By introducing a historical dimension and emphasizing mechanisms, trends, and relativities, rather than absolute values at a particular point in time, the study provides an improved perspective and a good starting point for assessing the outlook for a diverse region undergoing very rapid changes," said Sedriks.

The other SRIC study focused specifically on plausible scenarios for the timing of the petrochemical profitability cycle.

Investment costs

SRIC evaluated the effect of the current Asian economic crisis on investment costs with a relative index called location factor (LF).

LF is heavily dependent on the level of infrastructure at a given location. "As petrochemical production in a location develops and infrastructure is built up," said Sedriks, "the trend will be for differences between the LFs at the various scope levels (e.g., battery limits vs. overall project) to disappear."

In addition, movements in currency exchange rates can have a substantial effect on LFs in the shorter term.

For most countries in Southeast Asia, LFs are considerably lower this year than in 1995, primarily due to the devaluation of local currencies. But they are expected to return to near pre-crisis levels in 2001 (see graph, p. 27).

"Typically, the effects of currency devaluation on costs and on location factors are transient rather than permanent," said Sedriks. "SRIC's assessment is that the recent devaluations will work themselves through over a period of about 2-3 years, and that, by the end of 2001, LF values will mostly have returned to longer-term trend levels."

Feed, product prices

Prices and tariffs are closely related, says SRIC; therefore, Asian producers are often protected by high tariff barriers.

"The trend is towards progressive reduction of tariffs, but tariffs are likely to remain a significant influence on pricing in the region for at least the next 10 years," said Sedriks.

Another important factor in price determination is the extent to which a given market is autonomous.

"The prices in 'developing' petrochemical markets-for practical purposes, all markets other than the U.S. and Europe-have typically been set by a combination of government or quasi-government edict and some form of market mechanism (negotiation between buyer and seller). The global trend is toward the latter.

"However, because the developing markets have tended to be either small or fragmented, one party or player has often had a dominant influence. The overall result has been that, for Asia, the price swings over the cycle have been substantially amplified over those seen in the developed markets."

For ethylene, the region appears to have reached a stage in which contract prices are typically set by some market-responsive formula, usually mirroring U.S. Gulf Coast (USGC) prices. As Asian markets move towards the next, and final, stage-full autonomy-prices will continue to reflect global trends but, in the shorter term, will also be influenced by regional supply/demand balances, says SRIC.

The good news, says Sedriks, lies in the areas of petrochemical intermediates (ethylene glycol, for example) and commodity polymers (polyolefins). Here, Southeast Asia appears to be on the verge of a shift from a developing market to an autonomous free market.

"This does not mean that all linkages between the Asian prices and USGC prices will disappear, but rather that the linkages become indirect rather than direct. Further, and somewhat paradoxically perhapsellipsefor longer-term projection purposes, the best default approximation of Asian prices in some instances may be a straight equivalence to USGC prices," said Sedriks.

In the area of feedstocks, SRIC expects naphtha to remain the dominant ethylene feed in Southeast Asia. Regional naphtha prices are set largely by market forces, so Asian producers have had no advantage in naphtha prices.

"The trends we observe further suggest that, in future, the competitiveness of the Asian arena, in terms of naphtha costs, is likely to become, if anything, even less favorable," said Sedriks.

Outlook

The effects of regional currency devaluations on prices will be mixed in the short term, says SRIC.

Prices of fuel, feedstocks, and commodity petrochemicals tend to be set in U.S. dollars, and thus will show rapid increases, in local currency terms, during periods of devaluation. In contrast, prices of products further downstream tend to be more fixed, in terms of local currencies, and therefore will show an initial and substantial fall, in dollar terms.

This means that, in the short term, margins may increase upstream while becoming progressively squeezed further down the production chain. This can have a disruptive effect on the industry.

"The interlinked financial crises in the region have caused extended (economic) disruptionsellipsethat lower growth, contribute to petrochemical industry overcapacity, and lead to falling profitability across the board," said Sedriks. "Further, as East Asia's surging growth catalyzed and reinforced a global cyclical petrochemical industry upturn in 1987, the region's radical slowdown now appears set to catalyze and reinforce a global cyclical petrochemical downturn starting in 1998.

"That should ensure that the type of petrochemical cycle evidenced over the last 2 decades will continue for at least one more swing."

A corollary, says Sedriks, is that right now may be the optimal time for initiating contracyclical capacity expansion projects. However, to ensure their success, grassroots expansions should typically go hand in hand with a build-and-scrap policy.

SRIC's broad conclusion is that naphtha cracking, per se, is likely to be a "very marginal" business in the region, and will be viable only for well-integrated, pacesetter production facilities.

"True competitive advantage," said Sedriks, "derives from inherent advantages in core elements such as low-cost feedstocks, superior technology and infrastructure, proximity to major markets, or a market/customer responsive culture."

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