The downstream oil industry in the Middle East is at a crossroads. No doubt that 2020 will be remembered as a pivotal year but there were trends in place before Covid that were going to reshape the industry in all cases. When the impact of Covid will be analysed retrospectively, let say in 2030, perhaps it will be seen more as a catalyst that accelerated change that would have happened anyway. Lower oil prices had already brought new fiscal frameworks and stronger investment discipline. The reckoning that global carbon policies would eventually cause “peak demand” was an ever-present undercurrent. Concerns related to long-term demand for fuels were key to the focus on petrochemicals integration that has characterized the investment strategies of Middle Eastern NOCs in recent years.
OVERVIEW OF THE INDUSTRY
In petrochemicals, a wave of new projects are springing up. Even with conventional refineries, many new builds are targeting at least 25-30% petrochemical yields, compared to 5-15% historically, with global plastics demand set to increase three to four times faster than gasoline demand. Refiners have started reconfiguring their output to change fluid catalytic cracker yields to maximize distillate production for low sulfur bunker fuels ahead of IMO’s 2020 regulation, resulting in less feedstock into the cracker units that will mean tighter feedstock naphtha market. The automotive industry faced challenging years in 2019 and 2020, with European and Asian demand for new autos dropping significantly.
The first and perhaps most significant implication would be that with growth rates only a little above annual capacity creep, there will be less need for new builds. Most new investments will either replace existing assets or need to displace others. For example, the new crackers in North America will target Asian markets and compete with exports from Middle East producers. The latter’s exports to Europe may increase as a result, increasing pressure on European petrochemical players in the medium term. More broadly across the industry, companies could be forced to restructure in almost all parts of the world, and we foresee players trying to attain greater economies of scale through new waves of M&A. The only major exceptions might be India—where all indicators suggest that the local growth is going to continue, albeit from a low base—and China.
The Middle East is the largest PP exporter in the world globally, with over 40% of its volumes coming into Asia. Middle East PP producers face a difficult time as Asia ramps up supply China’s growing self-sufficiency for PP which presently stands at over 80%, will lead to the country’s reduced import requirement for the material.
Middle East PE producers are facing a challenging year ahead with more US and Chinese capacity coming online amid slowing global demand. The global supply surplus is likely to extend its influence over PE prices everywhere, including in the Middle East. The growing use of discounting as a means of attracting business has become increasingly prevalent, suggesting that 2020 may remain a buyer’s market. The population in the GCC is not generally growing, so the demand for finished consumer goods within the region remains on the same level.
Processors who used to hold stocks for a month are today not keen to hold inventories for more than 15-20 days fearing future price reductions, which means purchased volumes are almost cut by half. Middle Eastern sellers may be prompted to divert volumes to markets such as Europe.
Integrated refining and petrochemical plants in Asia are therefore a key plank in Middle Eastern NOCs’ strategies to secure long-term offtake opportunities for their crude. For Asian NOC partners, a refining deal with a Middle Eastern NOC helps fund new capacity and guarantees access to crude as countries ramp up efforts to go green. As well as the quest for sustainability, dealing with plastic waste is also high up on the GCC’s priority list. A number of renewable energy projects are expected, with many countries in the region embracing ambitious clean energy targets to free up more hydrocarbons for export and stay ahead of market shifts in response to climate change concerns. The increased focus on sustainability is also expected to impact on PE demand and trade in the region.
What's next?
Covid has brought a new collapse of oil prices. It has also added momentum to the global effort towards the energy transition because the economic stimuli of developed countries are being directed towards “Green New Deals”. The rationale of vertical integration into petrochemicals is now stronger for oil producers, or perhaps more urgent given market uncertainty. The key issue is the funding of projects at lower oil prices. This should bring more discipline and sharper prioritization of projects. Expect more emphasis on brownfield projects, less on the expansion of refining capacity and much less “greenfield” activity. We think this is something that would have happened also without Covid, even though some forecasts were perhaps anchored to historical trends. Stronger adherence to rational planning should bring a smaller pipeline of higher quality projects, perhaps more likely to get to fruition. As companies focus more on shareholders’ return, a moderate amount of rationalization would not be impossible. However, governments remain shareholders and stakeholders of primary importance. Some divestments are also possible. An example of this is the recent announcements of infrastructure carve-outs.
The issue of competitive advantage
The implementation of investment strategies based on refinery-petrochemicals integration will face the usual problem of defining projects with a competitive advantage. As liquid feedstocks can be moved to global markets at low cost, Middle Eastern sites do not find it easy to out-compete equivalent plants in Asia that operate closer to demand centres. The Middle East has historically enjoyed low energy costs, but this advantage has been eroded by a combination of lower subsidies at home and lower energy prices in international markets.
In broad terms, business strategies can be classified between those that focus on differentiated products and those that focus on being a low-cost producer. The first option does not exist for commodity-type products. In the absence of feed or energy cost advantages, scale is the key factor for Middle East producers to achieve low unit costs. Help here comes in the form of technology developments, which have enabled single-train ethylene crackers in excess of 1,500kta of capacity and single-train paraxylene plants in excess of 2,000kta, making it possible for new plants to have a larger scale than the incumbents. New plants are also more energy-efficient. The other strategic issue for the Middle Eastern downstream is that its Asian competitors enjoy lower operating costs and lower construction costs for comparable facilities. Some of the gaps are due to differences in labour rates and is difficult to address. However, to the extent gaps can be attributed to operating practices, they should be addressed.
Synergies and Integration
Synergies between refineries and petrochemicals are important, particularly for refineries that produce large amounts of off-gases rich in ethane and ethylene. The scale here matters a lot, as demonstrated by the Reliance refinery, which has enough off-gases to supply a world-scale ethylene unit. Only very large refineries have enough off-gases to replicate this concept. Concepts referred to as “crude-to-chemicals” seek to achieve stronger synergies through deeper integration. Configurations that achieve deeper integration by cracking Gasoil are not truly innovative, as they represent a different way for a refinery to feed a petrochemical complex using existing technology. Real innovation would be the creation of concepts, technology or levels of integration that are possible by seeing the integrated refinery-petrochemicals complex as a single entity. A notable example of this is the development of very high severity FCCs, where the main products are olefins and not gasoline.
We especially support the idea of driving towards the circular economy concept (CEE). The CCE cycle has four main pillars: Reduce (energy efficiency, low-carbon fuels); Reuse (inlc. CO2-EOR); Recycle (we mentioned the use of secondary plastics, use of carbon in synthetic fuels, fertilizers/urea, methanol, polymers and other chemicals); Remove (carbon capture utilization and storage). A good example is Ras Tanura Saudi Aramco Refinery Margin Enhancement, the plant is being gradually developed: 2021 – Clean Fuel project (+50% margin improvement), going forward – full conversion refinery (60-90% margin increase). Advanced companies aim to create a portfolio of hydrocarbon sources will combine traditional fuels with recycling – utilizing available options along the value chain i.e. mechanical, chemical and thermal recycling, renewables.
TRENDS
The downstream industry continues to be impacted by the globalization and integration of the world economy. Several factors influencing world petrochemicals are the following:
- Economies of scale. World-scale plants built in recent years are substantially larger than those built over two decades ago. As a result, smaller, older, and less efficient units are being shut down, expanded, or, in some cases, retrofitted to produce different chemical products.
- Price of crude oil. Petrochemical markets are impacted during sharp price fluctuations, creating a cloud of uncertainty in upstream and downstream investments.
- Environment. Increasing concerns over fossil fuel supply and consumption, with respect to their impact on health and the environment, have led to the passage of legislation globally that will affect chemical and energy production and processing for the foreseeable future.
- Technology. Manufacturing processes introduced in recent years have resulted in raw material replacement, shifts in the ratio of coproduct(s) produced, and cost. This has led to a supply/demand imbalance, particularly for smaller downstream petrochemical derivatives. In addition, growing environmental concerns have expedited the development and commercialization of renewably derived chemical products.
- Shale gas development - especially in the US.
- Economic growth and demand. The overall expansion of the population and an increase in individual purchasing power has resulted in an increase in demand for finished goods and greater consumption of energy in China, India, and Latin America.
As a general statement, strategies for chemical companies may become simultaneously simpler and more challenging. They may become simpler because the imperatives of productivity improvement and functional excellence—in other words, executing a chemical-business model better than most competitors in the field—will be even more obvious than today. Without this excellence, companies will lack the financial strength and the credibility to lead in a game that will include a lot of M&A. Strategy development, however, will also become much more difficult: it will be much more challenging to identify the remaining opportunities for growth that exceeds GDP and to develop approaches to capture those opportunities in a value-generating way.
Finally, recycled polymers are expected to gain an increasing foothold, especially in more developed economies, as global brands embrace sustainability under growing pressure from consumers, the media and environmental policy. Even though unfavourable economics in the recycled plastics markets are expected to continue in the first half of 2020, but media and consumer pressure should boost demand globally. Forecasts say global recycled plastics volumes reaching nearly 20 million mt in 2020 or 8% of total virgin demand. This is up from just under 18 million mt in 2019, or 7% of total virgin demand.
New demand outlets emerging In Southeast Asia, methanol demand is expected to be steady to firm in 2020 as Thailand targets a 10% blend of biodiesel into its Gasoil pool in its transport sector from 7% currently mandated, also known as B7. Indonesia and Malaysia also aim to increase their biodiesel blending in their transport sector by 10% next year.
Ultimately, most sellers prefer to send methanol to the more lucrative Chinese market where import volumes are 8 million mt/year.
Specialty chemicals may play an even larger role in sustainable development in the future. Specialty chemicals are sold on the basis of performance or function, not a chemical composition. Products that include "green" specialty chemicals can tap into consumer interest in the environment and bio-based ingredients.
Euro Petroleum Consultants is a technical oil and gas consultancy with offices in Dubai, London, Moscow, Sofia and Kuala Lumpur. Euro Petroleum Consultants also organises leading conferences worldwide.
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