Strong Growth Expected for Russia's Chemical Sector
Although Russia's chemical sector has been hit by global economics and oil prices, in the longer term, its advantaged feedstock position should ensure healthy growth prospects
Consultant's corner
Bulat Zarifullin/Nexant
THE PERFORMANCE of the Russian economy since the 1998 financial crisis has been impressive. Russia ended 2008 with its 10th straight year of growth, averaging 7%/year since 1998.
Until recently, Russian petrochemical producers have benefited from strong international chemical prices, as well as growing demand for their products in both domestic and foreign markets.
The petchem industry has undergone a period of consolidation. Major integrated enterprises, such as Lukoil-Neftekhim, Sibur, Eurochem, PhosAgro and others, have driven a dramatic transformation.
However, there is a concern that the forces supporting recent successes were favorable external factors, rather than internally generated economic development.
Russia is highly dependent on revenues from its oil and gas sector, which makes up nearly half the national income. High oil prices in recent years have played a major role in Russian GDP growth. The country is the world's largest exporter of natural gas and the second-largest oil exporter. However, these sources of income can be volatile and provide an uncertain foundation for Russia's sustained economic development.
Russia faces a problem common to almost all resource-rich countries: how to diversify industrial production and exports in order to add value at home and reduce dependency on natural resources.
ECONOMIC SLOWDOWN
Russia is not alone in experiencing an economic slowdown triggered by the international financial crisis and tightening credit conditions, but the impact is made worse by the fall in oil prices - and thus in national income.
Growth in retail sales has slowed to around 5% in the year to December 2008 from over 17% in the previous year. Purchases of new cars have declined sharply, and some steelworks have reduced output and laid off staff. Evidence of the slowdown is supported by recent data, which show rising unemployment in Russia, possibly reaching 7m by the end of 2009, and a slowing of industrial productivity.
With reduced activity across the economy, including construction and housing, the domestic demand for products of the chemical industry in Russia has softened, and this is reflected to a significant extent in possible export markets. With doubtful prospects in the short to medium term, producers are in the process of reducing output and focusing on cost-cutting measures to offset the negative trading environment.
Some producers, such as petrochemical major Kazanorgsintez are reported to be having serious financial problems.
While unpleasant, an economic slowdown can at least have the benefit of encouraging companies to rationalize their businesses and improve efficiency in preparation for the next upturn.
However, the global economic downturn is also beginning to affect the future of Russia's petrochemical industry. Several Russian petchem majors have shelved their new projects. These reportedly include Lukoil's gas-chemical complex in southern Russia and Sibur's polyolefins plants at Astrakhan and Orenburg. The proposed polyvinyl chloride (PVC) plant in Kstovo, for which the sponsor is the Sibur/Solvin joint venture RusVinyl, is also possibly stalled.
Some of these moves are related to short-term uncertainty, rather than a perception of long-term structural changes in prospects for the industry. So, are the basic conditions in place for growth in the Russian petrochemical industry?
FEEDSTOCK OUTLOOK
The feedstock position is the main driver for sustainable competitive advantage. Russia has access to a broad petrochemical feedstock base. Today, naphtha - produced at oil refineries- is the main feedstock for petrochemicals in Russia. Naphtha prices in Russia are linked to the domestic market for crude oil and refined products. Historically, Russia's domestic price for naphtha has lagged international pricing with a discount. This discount fluctuates and is often more strongly influenced by local demand than international pricing.
In general, Russian companies have lower-cost feedstock than neighboring producers, and thus are able to export some derivatives both westwards and into Asia.
Availability of naphtha as petrochemical feedstock for the domestic industry will be determined by attractiveness of the alternative export value of naphtha. In conditions of low crude oil pricing, the availability of naphtha in Russia may even be increased, but subject to refinery activity.
Another important feedstock is associated petroleum gas (APG) from oil production. Geography and market economics force oil companies either to use it for power generation, flare it, reinject it, or sell it at relatively low prices. These low prices have been mainly enjoyed by Sibur so far, which owns almost all available Russian processing capacity.
Approximately 20bn m3/year of APG that Russia currently produces from crude oil extraction is flared. A new government initiative regulating APG usage mandates that only 5% of Russia's APG throughput can be flared. The other 95% must be consumed by 2014.
This is expected to help reduce the country's emissions of greenhouse gases and is likely to stimulate petrochemical investments. A move toward market pricing of APG is expected to incentivize both producers of APG and operators of processing plants.
LOW PRICE ENVIRONMENT
When crude oil prices were very high, Russian petrochemical producers enjoyed the benefits of relatively low domestic feedstock and energy prices, as well as petrochemical product prices, which would justify freight costs for exporting to markets such as Western Europe or China.
In an environment of low crude oil prices, circumstances could change. Not only do the price levels of feedstocks and products change with oil prices but, to a lesser extent, so do unit prices of utilities and freight.
DEPRECIATION APPRECIATION
In addition, in response to slumping oil prices and a deteriorating economy, Russia's central bank began a gradual depreciation of the rouble in November. The expected systematic difference in rouble exchange rates between high and low oil prices also affects international competitiveness.
The table (see above) shows the relative delivered costs of high density polyethylene (HDPE) to Western Europe on an integrated cash cost basis in 2008 (average) and with a low oil price of $35/bbl. Producer types are a Western European naphtha-based producer, a Russian naphtha-based producer, and a Russian producer using natural gas liquids.
In fact, the table shows that the cost-competitive position of the Russian plants is relatively unchanged in the low oil-price scenario, on the basis of the assumptions used in this analysis.
The cost-competitive position does not relate to demand, of course, and a key question is how economic activities in Russia will develop, even if oil prices do not recover to previous levels.
The position of the Russian petrochemical industry is affected by tariffs on imports and exports, like in any other country. Accession to the World Trade Organization would be a significant factor in this respect, and would tend to open up competition.
In the short term, however, the difficulties faced by the industry have led to calls for increased Russian import duties on polymers, a policy with international implications, but which other countries have occasionally used as a temporary measure.
With the credit crunch affecting many parties, some producers also hope for government support in obtaining finance for new investments, or indeed for operational purposes. Whether the federal government is in a position to answer such calls is not clear.
IN THE LONGER TERM
Despite the current problems, the long-term macroeconomic outlook for the Russian petrochemical industry is still positive. Feedstocks are advantaged, and domestic and export demand should drive revenue growth.
On the micro level, the winners are likely to be companies with a long-term strategic focus and a commitment to restructuring their aging assets and investing in value-enhancing projects.
Gaining investment exposure to these companies can be challenging for international strategic investors, as they are mostly majority-owned by the state and not completely open to foreign investors. Once the global economic recovery is underway, development of the petrochemical business by Russian companies is expected to resume.
Consultant's corner
Bulat Zarifullin/Nexant
THE PERFORMANCE of the Russian economy since the 1998 financial crisis has been impressive. Russia ended 2008 with its 10th straight year of growth, averaging 7%/year since 1998.
Until recently, Russian petrochemical producers have benefited from strong international chemical prices, as well as growing demand for their products in both domestic and foreign markets.
The petchem industry has undergone a period of consolidation. Major integrated enterprises, such as Lukoil-Neftekhim, Sibur, Eurochem, PhosAgro and others, have driven a dramatic transformation.
However, there is a concern that the forces supporting recent successes were favorable external factors, rather than internally generated economic development.
Russia is highly dependent on revenues from its oil and gas sector, which makes up nearly half the national income. High oil prices in recent years have played a major role in Russian GDP growth. The country is the world's largest exporter of natural gas and the second-largest oil exporter. However, these sources of income can be volatile and provide an uncertain foundation for Russia's sustained economic development.
Russia faces a problem common to almost all resource-rich countries: how to diversify industrial production and exports in order to add value at home and reduce dependency on natural resources.
ECONOMIC SLOWDOWN
Russia is not alone in experiencing an economic slowdown triggered by the international financial crisis and tightening credit conditions, but the impact is made worse by the fall in oil prices - and thus in national income.
Growth in retail sales has slowed to around 5% in the year to December 2008 from over 17% in the previous year. Purchases of new cars have declined sharply, and some steelworks have reduced output and laid off staff. Evidence of the slowdown is supported by recent data, which show rising unemployment in Russia, possibly reaching 7m by the end of 2009, and a slowing of industrial productivity.
With reduced activity across the economy, including construction and housing, the domestic demand for products of the chemical industry in Russia has softened, and this is reflected to a significant extent in possible export markets. With doubtful prospects in the short to medium term, producers are in the process of reducing output and focusing on cost-cutting measures to offset the negative trading environment.
Some producers, such as petrochemical major Kazanorgsintez are reported to be having serious financial problems.
While unpleasant, an economic slowdown can at least have the benefit of encouraging companies to rationalize their businesses and improve efficiency in preparation for the next upturn.
However, the global economic downturn is also beginning to affect the future of Russia's petrochemical industry. Several Russian petchem majors have shelved their new projects. These reportedly include Lukoil's gas-chemical complex in southern Russia and Sibur's polyolefins plants at Astrakhan and Orenburg. The proposed polyvinyl chloride (PVC) plant in Kstovo, for which the sponsor is the Sibur/Solvin joint venture RusVinyl, is also possibly stalled.
Some of these moves are related to short-term uncertainty, rather than a perception of long-term structural changes in prospects for the industry. So, are the basic conditions in place for growth in the Russian petrochemical industry?
FEEDSTOCK OUTLOOK
The feedstock position is the main driver for sustainable competitive advantage. Russia has access to a broad petrochemical feedstock base. Today, naphtha - produced at oil refineries- is the main feedstock for petrochemicals in Russia. Naphtha prices in Russia are linked to the domestic market for crude oil and refined products. Historically, Russia's domestic price for naphtha has lagged international pricing with a discount. This discount fluctuates and is often more strongly influenced by local demand than international pricing.
In general, Russian companies have lower-cost feedstock than neighboring producers, and thus are able to export some derivatives both westwards and into Asia.
Availability of naphtha as petrochemical feedstock for the domestic industry will be determined by attractiveness of the alternative export value of naphtha. In conditions of low crude oil pricing, the availability of naphtha in Russia may even be increased, but subject to refinery activity.
Another important feedstock is associated petroleum gas (APG) from oil production. Geography and market economics force oil companies either to use it for power generation, flare it, reinject it, or sell it at relatively low prices. These low prices have been mainly enjoyed by Sibur so far, which owns almost all available Russian processing capacity.
Approximately 20bn m3/year of APG that Russia currently produces from crude oil extraction is flared. A new government initiative regulating APG usage mandates that only 5% of Russia's APG throughput can be flared. The other 95% must be consumed by 2014.
This is expected to help reduce the country's emissions of greenhouse gases and is likely to stimulate petrochemical investments. A move toward market pricing of APG is expected to incentivize both producers of APG and operators of processing plants.
LOW PRICE ENVIRONMENT
When crude oil prices were very high, Russian petrochemical producers enjoyed the benefits of relatively low domestic feedstock and energy prices, as well as petrochemical product prices, which would justify freight costs for exporting to markets such as Western Europe or China.
In an environment of low crude oil prices, circumstances could change. Not only do the price levels of feedstocks and products change with oil prices but, to a lesser extent, so do unit prices of utilities and freight.
DEPRECIATION APPRECIATION
In addition, in response to slumping oil prices and a deteriorating economy, Russia's central bank began a gradual depreciation of the rouble in November. The expected systematic difference in rouble exchange rates between high and low oil prices also affects international competitiveness.
The table (see above) shows the relative delivered costs of high density polyethylene (HDPE) to Western Europe on an integrated cash cost basis in 2008 (average) and with a low oil price of $35/bbl. Producer types are a Western European naphtha-based producer, a Russian naphtha-based producer, and a Russian producer using natural gas liquids.
In fact, the table shows that the cost-competitive position of the Russian plants is relatively unchanged in the low oil-price scenario, on the basis of the assumptions used in this analysis.
The cost-competitive position does not relate to demand, of course, and a key question is how economic activities in Russia will develop, even if oil prices do not recover to previous levels.
The position of the Russian petrochemical industry is affected by tariffs on imports and exports, like in any other country. Accession to the World Trade Organization would be a significant factor in this respect, and would tend to open up competition.
In the short term, however, the difficulties faced by the industry have led to calls for increased Russian import duties on polymers, a policy with international implications, but which other countries have occasionally used as a temporary measure.
With the credit crunch affecting many parties, some producers also hope for government support in obtaining finance for new investments, or indeed for operational purposes. Whether the federal government is in a position to answer such calls is not clear.
IN THE LONGER TERM
Despite the current problems, the long-term macroeconomic outlook for the Russian petrochemical industry is still positive. Feedstocks are advantaged, and domestic and export demand should drive revenue growth.
On the micro level, the winners are likely to be companies with a long-term strategic focus and a commitment to restructuring their aging assets and investing in value-enhancing projects.
Gaining investment exposure to these companies can be challenging for international strategic investors, as they are mostly majority-owned by the state and not completely open to foreign investors. Once the global economic recovery is underway, development of the petrochemical business by Russian companies is expected to resume.
source: www.ICIS.com
