asia pacific petrochemical industry v1

8/9/2019 Asia Pacific Petrochemical Industry v1

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Asia PacicsPetrochemical

Industry:A Tale of Contrasting

Regions

kpmg.com/energyaspac

KPMG GLOBAL ENERGY INSTITUTE


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Executive Summary

Asia Pacics Petrochemical Industry:Exposed to Shifting Dynamics

Interview: Paul Harnick

Intra-regional Focus: China

Intra-regional Focus: North Asia

Intra-regional Focus: ASEAN

ConclusionContact Us

CONTENTS

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2014 KPMG International Cooperative (KPMG International), a Swiss entity. Member rms of the KPMG network of independent rms are afliated with KPMG International. KPMG International provides no client services. Nomember rm has any authority to obligate or bind KPMG International or any other member rm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member rm. All rights reserved.

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EXECUTIVE SUMMARY

2014 KPMG International Cooperative (KPMG International), a Swiss entity. Member rms of the KPMG network of independent rms are afliated with KPMG International. KPMG International provides no client services. Nomember rm has any authority to obligate or bind KPMG International or any other member rm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member rm. All rights reserved.

With its robust economic growth anddomestic consumption, Asia Pacic(ASPAC) has spearheaded the revivalof the global petrochemical sector,which found itself subdued as aresult of the 2008 nancial downturn.Over the next decade, Asia Pacic isexpected to drive two-thirds of global

petrochemical demand.1

To mitigate an expanding energysecurity dilema and capitalise onrising forecasted demand, Chinasgovernment has pursued a policyof petrochemical self-sufciency.Today, China is the worlds largestchemicals producer.2

Chinas ascendance as apetrochemicals producing andconsuming powerhouse has amplied

intra-regional competition. To competein this overpopulated industry, North

Asian and Association of SoutheastAsian Nations (ASEAN) petrochemicalproducers will have to executestrategies that are both innovativeand sustainable.

With China and ASEANs rapidmodernisation, large demographic

size and escalating domesticconsumption, it appears the energydemand has gravitated to the east.Scrutinise the supply of feedstocktrends however, and the shift of thepetrochemical industry towards Asiais not wholly accurate.

In recent years, the industryhas experienced a technologicalrenaissance, shaking up globalsupply dynamics. Fast evolvingtrends in the petrochemical sector

are promoting the industrysadoption of cost effective, non-

oil feedstocks such as natural gasliquids (NGLs) and associated gases.The Middle East and US are nowestablished petrochemical powers,with comparatively favourable costpositions because of this feedstockdiversication. It could be argued thatthe competitive advantage is shifting

to producers outside of Asia Pacic.

This report reviews the prevalentmegatrends in the petrochemicalindustry, with specic emphasis onthe main intra-regional componentsof ASPAC: China, North Asia andASEAN. It provides insight into thenuanced challenges these regionsface over the next decade. Thisreport aims to provide strategicsolutions to ASPAC companies onhow they can adapt their portfolio

strategy to respond to rising regionaland global competition.

1 Interview, ExxonMobil, Singapore, March 2013, accessed via www.energyboardroom.com

2 China identies 58 chemicals to act on, International Chemicals Secretariat, accessed viahttp://www.chemsec.org/what-we-do/inuencing-public-policy/news-updates/1136-china-identies-58-chemicals-to-act-on


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2014 KPMG Services Pte. Ltd. (Registration No: 200003956G), a Singapore incorporated company and a member rm of the KPMG network of independent member rms afliated with KPMG International Cooperative

("KPMG International"), a Swiss entity. All rights reserved.

4 | Asia Pacic's Petrochemical Industry: A Tale of Contrasting Regions

Asia Pacics Petrochemical Industry: Exposed toShifting Dynamics

3 Interview, ExxonMobil, Singapore,March 2013, accessed via www.energyboardroom.com

ASPACs petrochemical industry faces erce competitionfrom regional counterparts that have embraced feedstock diversication as a

means to compete in an increasingly cost sensitive industry

Figure 1: GDP Growth

Source: World Economic Outlook Database October 2013, IMF; Statistics Department of Singapore

ASPAC: The Global DemandEngine

Since the 2008 nancial crisis, AsiaPacic (ASPAC) has been the poster-child of the global petrochemicalindustry. A combination offavourable economic anddemographic trends has stimulateda growing appetite for petrochemicalproducts. Over the next decade,it is anticipated that two thirds ofglobal petrochemical demand will

originate from Asia Pacic.3Suchunderlying demand and growthfundamentals have catalysedsubstantial investment into ASPACspetrochemical industry.

Although macro-economic indicatorssuch as GDP growth (Figure 1) anddemand fundamentals such asGDP Per Capita (Figure 8) remainrelatively attractive for a signicantpart of ASPAC, the availability oftraditional feedstock and adoption

of non-traditional feedstock has

shaken up global petrochemical supplydynamics. In order to participate in the

industry, petrochemical companies

in ASPAC, will need to assess whatoptions are available for them to

become more competitive.

2005

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2013p

2014p

2015p

2016p

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2018p

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2014 KPMG Services Pte. Ltd. (Registration No: 200003956G), a Singapore incorporated company and a member rm of the KPMG network of independent member rms afliated with KPMG International Cooperative ("KPMG

International"), a Swiss entity. All rights reserved.

Asia Pacic's Petrochemical Industry: A Tale of Contrasting Regions | 5

4 European chemical companies adapt to changing times,Reaction Magazine, July 2014, accessed viahttp://www.kpmg.com/global/en/issuesandinsights/articlespublications/reaction/pages/european-chemical-companies.aspx

Figure 2: Petrochemical Feedstock Prices

Source: KPMG Analysis, UN Data, EIA

Lighter is Brighter

The petrochemical industrys growingpreference towards lighter feedstocksas an alternative to naphtha hastriggered a competitive edge forNorth American and Middle Easternproducers. The North American shale gale has revolutionised thesector and its impact on productiongrowth is likely to fundamentallytransform trade ows. Indeed, theshale boom has dramatically loweredprices of natural gas liquids (NGLs)such as ethane, the dominant

petrochemical feedstock in the US.In 2013, ethane price hovered around(USD185.50/mt),4 while the price ofthe overriding Asian petrochemicalfeedstock - Japanese naphtha -averaged approximately USD850/mt(Figure 2).

Ultimately, the promotion of non-oil

feedstocks such as natural gas liquids(NGLs) has sharpened inter-regionalrivalries. With naphtha trading overthree times the price of NGLs, thepetrochemical industry is characterisedby regional cost differentials anddiversifying petrochemical ows.Presently, these traits are notbalanced in the favour of ASPACproducers. US-produced ethane-based product will likely be channelledtowards Asia over the next few years,undercutting the competitive standing

of local Asian producers.

Diverse Regional Cost CurvesASPACs petrochemical industry isoperating in a competitive and globalenvironment in which the volumesof output generated by counterparts

in distant shores signicantly impact

local competition in North Asia andASEAN. North Asian and ASEANproducers are grappling with volatileand high naphtha prices and uncertainfeedstock supplies that are vulnerableto globally changing geopoliticalforces, such as conict in the MiddleEast. This results in higher inputcosts, leading to narrowing margins.

To compound the difcultiesexperienced by ASPAC producers,the three intra-regional environments

are competing against one another.The ascendance of China as apetrochemical producing juggernaut,embracing nascent coal-to-olens andcoal-to-methanol production, presentsfurther challenges for North Asian andASEAN producers.

$MillionMetricTons(mt)

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Coal Naptha LPG


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Considerable base petrochemicalcapacity is due to come-online inASPAC over the next three years.Investors are likely to face differentinvestment risk-return scenariosthan when their investments wereoriginally sanctioned. The industryenvironment is constantly changing,rendering the projection of future

cash ows, prot margins and yieldsmore complex and difcult to forcast,model, or participate. This hasresulted in a number of companiesreviewing future investment fromtheir capital programme.

These market fundamentals arecausing many oil and gas companies

to re-assess the relative valueand contribution of their ASPACpetrochemical assets. In particular,integrated oil and gas companies whoassess the relative contribution oftheir portfolio of business will notethe comparatively lower return of thepetrochemicals division.

ASPAC petrochemical producers must be cognizant of the marketconditions and broader global context that they operate in.


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, . . I I , .

. . . . , I . I

Decline

Align to growth

markets

Optimize

portfolio

Operational

excellence

Innovation to

drive pricing

Financial

strength

Growth

Shareholdersin

control

Debtholdersin

contr

ol

Life-cycle

progress

Closures

Strong revenuegrowth /Growing order book

Profitable

Cash generative

Acquisitive

Growth: Increaseasset acquisition

Failure

Transformationalgrowth strategy

Refinance

Capital raising

Acquisitions

Non-core disposals

Refocused Growth

Recovery &Transformation

Market tipping point

Revenue static /declining,Order book flattens

Need to align cost baseto declining revenues

Customer churn

Covenant breach

Increasing creditors pressure

Rapid cost reduction

Rapid cash generation

Accelerated disposals

Preparation for insolvency

Contraction: Sellingof Assets

Attracting talent

New customers

Attracting & retaining talentbecomes harder

Staff consultation

Financing optionsDifferentiation in the market

Growth

Regional Competitive StatusFigure 3 illustrates differentmarket conditions within whichpetrochemical companies operate.Each region faces contrastingchallenges in their economies andtheir respective markets that theymust contend with. Currently, theglobal situation can be looselycharacterised by three conditions:

1. Growing demand accompaniedby growing investment and

fragmentation.2. Stagnant demand accompanied by

portfolio rationalisation and marketconsolidation.

3. Technological innovation hasprovided access to low costfeedstock, contributing to thegrowth of the industry.

Based on projected economic growthand rising domestic consumption inASEAN, investors and companiesmay nd strong growth opportunities,

and therefore the region is arepresentation of the rst conditionoutlined above. However, as with

the other regions, ASEAN is notimmune to the fast changing trade,supply and capital ows shaping theindustry. With these changing ows,petrochemical producers in ASEANhave to decide if they are to "buildinternally or buy externally." That is, tobuild their own petrochemical plantsand serve the intra-ASEAN region, orimport nished products from abroad.

As Figure 3 conveys, there aremany parallels between the state

of the European and North Asianpetrochemical industries. Bothregions have reached a market tippingpoint and therefore represent theoutlined second condition. In bothregions aging assets are ill-equippedto compete in a changing globalenvironment. Despite steps towardsportfolio rationalisation, there remainsan imbalance in supply and demand,caused by attening economic growthand overcapacity.

The success of both of theirpetrochemical industries will dependon a carefully calibrated set of

strategies that involve innovation,geographical expansion into emergingmarkets and a rigorous focus on cost,efciency and ongoing innovation.

By contrast, the US petrochemicalindustry is experiencing the thirdcondition outlined: growth. Domesticproducers have capitalised on anincrease in feedstock made availablethrough hydraulic fracturing. Accessto cheaper feedstock has in turnattracted larger volumes of investors,

keen to exploit the increasing margins.

Due to a considerable capacity growthsurge in commodity petrochemicals,China was on route to reach themarket tipping point. Nonetheless,targeted policies to cool overcapacityconcerns, and the gradual redirectionof the industry towards high-valueproducts, are long term correctivemeasures. The big question forChinas petrochemical industry will bethe role of coal as a core feedstock.

The ramications of large scale coaladoption will markedly change Chinascompetitive stature.

ASEAN China Europe North Asia Middle East US

Figure 3: Regional Petrochemical Competition and Life Cycle

Source: KPMG Analysis


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Interview with Paul Harnick, KPMG, Global COO,Chemicals and Performance Technologies

Paul Harnick is the Chief Operating Ofcer of KPMGs Global

Chemicals and Performance Technologies practice. He specialisesin emerging market strategy development and complex, cross-border mergers and acquisitions in the chemical industry.

With their vast supplies of non-oil

based feedstocks and technological

ingenuity, the US and Middle Eastare well-established and powerful

petrochemical regions. How would

Asian producers compete?

The Middle East has been a globalpowerhouse of petrochemicalproduction for many years and the vastmajority of Middle Eastern productsalready nd their way to Asianmarkets. The game changer for globalpetrochemical production has been theshale gas revolution in the US which,

over the course of the next ve years,will fundamentally transform globalpetrochemical trade ows. The scale ofcapacity expansion is vast and despitethe recent return to growth, the USeconomy is mature and will not be ableto absorb all of the new capacity. As aresult, much of the product will enterglobal markets and the majority of thisis likely to nd its way to Asia, whereit will compete with local productionand existing imports from the MiddleEast. For local Asian producers, this

inux of cheap, ethane-based productis likely to have a negative impact ontheir ability to successfully compete.For downstream consumers of basicchemical product in Asia, however,there may be a margin benetfrom the ability to access lower pricedraw materials.

Global competitors, operating

on different cost structures, are

worrying Asian petrochemical

producers. To sustainably compete

in a fast evolving sector, how can

Asian producers enhance their

operational excellence and improvetheir cost-efciency?

Operational excellence is a corecompetency within the global chemicalcompany and it is no surprise thatthe companies at the forefront ofthe industry are those who trulyexcel in this area. The challenge forAsian producers is to embed a morerigorous cost culture throughout theirorganisations and to focus on drivingexcellence through all areas of the

organisation from supply chain tooperations, to channel management tosales and marketing, R&D and nance.

Over the next ve years, what will

be the key supply and demand

trends shaping Asias petrochemical

industry?

In addition to the impact from USshale dynamics, other key supplyside dynamics will include therationalisation of the petrochemicalindustry in China (as the government

drives further focus on innovation andquality of growth) as well as ongoingrationalisation and restructuring inJapan. On the demand side, Chinawill continue to be a huge consumerof chemical product there is muchtalk in the world about the slowdownof China, but 6-7 percent is still greaterthan almost anywhere else and thegrowth is on a much larger base thanever before, so the absolute scaleof demand growth remains huge.

Elsewhere, the next growth engine,

not just for Asia, but for the globalchemical industry, is likely to be the

ASEAN region. While challengesremain in some countries aroundlogistics, infrastructure and the easeof doing business, many of the keycriteria for chemical industry growthare in place including populationgrowth, urbanisation and growth of themiddle classes driving consumerism.

Over the next ve years, what

investment opportunities and M&A

trends do you see arising in Asias

petrochemical industry?Overall, there is likely to be an increaseof M&A activity in Asias chemicalindustry over the next ve years.Ongoing petrochemical rationalisationin China and Japan may drive mergeractivity. Chinese chemical companiesare also increasingly looking toexternalise so I expect to see thempurchasing assets outside of China both in Asia and elsewhere around theworld. Over the last twelve months,Japanese chemical companies have

been hugely active in M&A processesin the US a trend I expect to continue while they have also achieved ahead start on the competition withsome of the investments they havealready made in the ASEAN region andthey are likely to continue investinghere. FDI ows from outside Asiawill continue to be focused on Chinabut with a gradually changing mix asnon-Asian investors increasingly look tocapitalise on the growth opportunities

in ASEAN.


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Intra-Regional Focus China

Chinas petrochemical expansion is entering a phase of slower but targetedgrowth. Domestic policy will seek to strike a balance between innovation, self-

sufciency and environmental sustainability.

5 A New World Order Evolving in Long Term Ethylene Markets,Wood Mackenzie, February 20136 China's ethylene self-sufciency to peak at 2018, Wood Mackenzie, May 2014, accessed via

http://public.woodmac.com/public/media-centre/content/120889797 Asian Paraxylene, End of Golden Years,Platts, May 2013 accessed via http://www.platts.com/

news-feature/2013/petrochemicals/asia-paraxylene/index

China continues to be the primearchitect shaping global petrochemicaldemand. Despite well-documentedeconomic and regulatory pressuresamplifying investor anxiety - inparticular stresses in the housingmarket - Chinas GDP is anticipated

to grow by 7.3 percent in 2014.High domestic consumption, exportexpansion and an agile monetarypolicy are forming the backbone ofthe Chinese economy. Our basketof forecasts anticipates Chinaseconomic growth to moderate toan average GDP growth rate of 6percent through 2020. To OECDcountries such healthy growth froman increasingly expanding baserate would be considered a robusteconomic achievement not a cause

for investor ight. It is important tomake the distinction that Chinaseconomic growth will be slower,not lower.

Drivers of DemandAs a consequence of unprecedentedmodernisation, demand forecastsshow that China is and will remainthe overwhelming engine of ethylenedemand growth. Symbolically, this

demand trend is important. In volume,scope and global impact, ethyleneis the largest and most importantpetrochemical commodity, providing aremarkable range of derivatives withcritical feedstock.5

Chinas demand translates into twomillion tonnes per annum (mtpa)of ethylene equivalent growth,contributing to 50 percent of the90mmt world growth in ethyleneequivalent demand from 2014-2030.6In addition, as standard s of livin gimprove and urbanisation expands,high-end engineered plastics, such asthose used in domestic appliances, orsophisticated products such as liquidcrystal alignment lm resin, used inLCD televisions, are experiencing

rising demand in China.

A Balancing Act

Chinas petrochemical industry is inthe midst of transition. Building onChinas 12th Five Year Plan (5YP - 2011-2015), which sought to improve energysecurity and environmental standards,the Xi Jinping administration hasbeen quick to build on and tweakChinas petrochemical strategy. Indeed

in the face of overcapacity, state-owned enterprise (SOE) dominanceand environmental degradation,reforms focusing on sustainability,modernisation and competition werethe focal point of the 2013 thirdplenary session.

Chinas quest for petrochemical self-sufciency has reshaped ASPACsolen trade and undercut North Asianproducers. Due to Chinas capacityexpansion, domestic ethylene andpropylene supply has lengthened,while imports requirements for thetwo petrochemical products havedeclined. North Asian olen exporterstraditionally supplying the countryhave had to seek alternative markets.A similar story is gathering pace a

step up the value-chain. Chinasparaxylene (PX) expansion drive isexpected to increase by 41 percentfrom 2013-2017,7 contributing tonarrowing PTA-PX spreads andis indicative of the over-capacityissues plaguing the wider ASPACpetrochemical industry. As a resultof capacity growth, the regionaloutlook for olens, aromaticsand a number of petrochemical


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Figure 4: ASPAC's Ethylene Capacity Growth

Source: ICIS 2014

intermediate feedstocks such aspuried terephthalic acid (PTA),monoetheylene glycol (MEG), PE/PPresin, has been bearish for some time.

Responding to overcapacity issues,the Chinese Communist Party (CCP)is implementing supply coolingmeasures, particularly for low-gradespecialty products. The governmentis actively reducing its supportfor international petrochemicalinvestments. International companies

that cannot offer access to specialist

feedstocks or to proprietarytechnology will likely struggle topenetrate the Chinese petrochemicalsmarket.

Chinas petrochemical expansionis entering a phase of slower buttargeted growth. Domestic policywill seek to strike a balance betweeninnovation, self-sufciency andenvironmental sustainability.

Battle of the Feedstocks

An apt example of the innovation

and expansion occurring in Chinaspetrochemical industry is in ethyleneproduction. Over the next three years,Chinas ethylene capacity willincrease by 36 percent and itscontribution to Asias total ethylenecapacity will rise from 45 to 51percent (Figure 4). Respondingto escalating global competitionand operational costs, Chinaspetrochemical industry is graduallymigrating from naphtha as the corefeedstock, towards coal - a resource it

has in abundance.

2012 2013 2014 2015 2016 2017

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thyleneCapacity

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China has in-house technology withthe capability to turn coal to liquidsin a cost-effective manner. By 2020,three dozen coal-to-olens (CTO)

and methanol-to-olens (MTO)projects in China are anticipatedto come on-stream.8As gure 5depicts, if coal based crackers comeon-stream as planned, coal basedcapacity will contribute 39 percent toethylene capacity, up from a presentday 16 percent.

According to the U.S. EnergyInformation Administration, Chinahas claimed the largest shale gasreserves in the world (1,115 trillion

cubic feet).9

Despite considerablereserves and investment plans,China has not started commercialproduction. To drive gas productionon a commercial scale, Chinamust overcome environmental -specically water shortages - andtechnical challenges. Unless Chinacan commercialise its shale reserves,shale gas is not expected to impactChinas energy mix before 2020.

Environmental Reform

Despite investment enthusiasmsurrounding coal-based ethyleneprojects in China, limitations onwater resources and environmentalpollution concerns could limit thepotential of CTO. Facing criticalenvironmental and pollution troubles,the CCP has recently introduced acouple of stringent energy policies,in an effort to curb the consumptionand importation of low qualityinternationally sourced thermal coal.

In September 2014, the National

8 Coal-to-Olens Technology in China Could Soon Flood Global Polyethylene Markets, Platts, March 2014, accessed viahttp://www.platts.com/pressreleases/2014/032414b

9 Water Shortages Will Limit Global Shale Gas Development, Especially in China, Business Week, accessed viahttp://www.businessweek.com/articles/2014-09-02/water-shortages-will-limit-global-shale-gas-development-especially-in-china

10 China ban on low-grade coal set to hit global miners, Financial Times, September 2014, accessed viahttp://www.ft.com/cms/s/0/7b025356-3d3d-11e4-a2ab-00144feabdc0.html

Coal chemicals may yet prove revolutionary and help reassert Chinascompetitive stature vis-a-vis the US and Middle East.

Development and Reform Commissionstated it plans to ban the use of lowquality coal from 2015 in populousand prosperous eastern cities that arethe focus of national efforts to ghtair pollution.10Moreover, in Octoberthe Chinese nance ministry stated itwas reintroducing tariffs of 3 percent

on anthracite and coking coal, 5percent on briquettes and 6 per centon other coals, imposing duties thatwere scrapped in 2007 when coalconsumption was soaring. The tariffsare also aimed at supporting Chinasdomestic coal industry, which hassuffered from tumbling prices, heavydebts and new domestic capacity. Theramications of these policy measureswill likely be an increase in domesticcoal prices. Whether the price hike willhinder CTO investment remains to be

seen, but it is unlikely.

China is trying to craft a delicatebalance between meetingenvironment targets and energysustainability. If successful, thecontribution derived as an advantagedfeedstock, could be revolutionaryand would help reassert Chinascompetitive stature vis-a-vis the US

and Middle East.

Nonetheless, for many commoditypetrochemical products, Chinasdemand picture is expected to outstripsupply by 2020. Capitalising on thispotential supply gap, advantagedsuppliers in the US and Middle Eastwill seek to export excess capacityand target opportunities within Chinaand ASPAC holistically. This arrivalof cheap, ethane-based productwill continue to translate into stiffer

competition for local Asian producers.

Figure 5: China's Ethylene Capacity Growth & Coal Contribution

Source: ICIS 2014

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Percent(%)

MillionMetricTonnes(mmt)


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Intra-Regional Focus North Asia

North Asia's petrochemical is beset by overcapacity, high priced inputand low growth. The developing global industry trends demand

innovation and adaptability.

North Asian Producers: Feeling

the Pinch

Out of the three intra-regions ofASPAC, North Asias petrochemicalindustry is facing the sharpest uphillclimb. Sedate economic growth in thethree major markets: Japan, South

Korea and Taiwan has contributed toattening internal product demand.With market developments in NorthAmerica and Middle East, NorthAsian producers have fallen behindon the cost curve, impacting theircompetiveness (Table 2). Combined

with high priced feedstock values,uncertain demand proles anddeteriorating supply/demandbalances, Asian petrochemicalcompanies are being forced todevelop strategies to cope with thechallenging commercial environment.

Table 2: North Asian Petrochemical Country Snapshot

With its nuclear power programme on pause and lacking natural energy resources, Japan is facing a sharpeningenergy-security dilema.

Increasing reliance on LNG and naptha imports have contributed to an escalation of feedstock, transport andutility costs. As a result, the competitiveness of Japan's petrochemical industry is eroding.

No net capacity growth is planned for olens and aromatics through 2020. Japanese petrochemical companies are actively adapting their strategy through either portfolio rationalisation,

technological enhancement or both.

High feedstock and utility costs, in addition to regional & domestic commodity petrochemical expansion, are allforces suppressing South Korean petrochemical prot margins.

Polyester feedstock supply chains, such as PTA and Monoethylene Glycol (MEG) are facing oversupply concerns.

China's drive towards petrochemical and plastics self-sufciency (China may become a PTA exporter by 2015),has caused import demand from China to plummet.

From 2013 - 2017, South Korea's PX capacity is expected to grow by 94 percent. The scale of such growth isunsettling market equilibrium, lowering utilization rates and driving down margins.

Considering the changing competitive landscape, South Korean producers need to adapt to the evolvingpetrochemical supply and demand trends and consciously tap into emerging markets.

Previously Taiwan was a petrochemical powerhouse, exporting to China approximately 10 million mmt annually. In the last few years, domestic producers have seen exports to China plunge by over 90 percent. With the

signing of the Economic Cooperation Framework Agreement in 2013, bi-lateral economic arrangements withChina are improving.

With tariff barriers expected to fall, Taiwan's export competitve advantage over North Asia rivals will improve; yetquestions will likely remain over their competitiveness vis--vis Chinese domestic players.

Experiencing declining Chinese demand, expansion plans have stalled and sales focus has shifted towards thedomestic market; however, the domestic petrochemicals market was subdued in 2013 and economic trends for2014 have remained unsupportive.

Expect industry-wide capacity utilisation rate cuts for a number of petrochemical products.

JAPAN

SOUTH

KOREA

TAIWAN


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14 Asian Paraxylene, End of Golden Years, Platts, May 2013, accessed viahttp://www.platts.com/news-feature/2013/petrochemicals/asia-paraxylene/index

15 A New World Order Evolving in Long-Term Ethylene Markets, Wood Mackenzie, February 201416 Japan: Heading for Higher Ground, IHS Chemical Week, April 2014, accessed via http://www.chemweek.com/

Over-Capacity ConcernsThe diminishing margins in AsiaPacics PX industry, illustrates thenarrative of decline for North Asiancommodity petrochemical producers.

Total ASPAC PX capacity-basedprojects coming on-stream from2013-2017 is expected to grow by 40

percent, reaching over 40 million mt/year. In that time, South Korea's PXcapacity growth is anticipated to riseby 94 percent from its current 5.4million mt/year. Chinas PX capacityis expected to rise by 41 percentin the same period. In the MiddleEast, PX capacity during the sameperiod is expected to surge by 200percent, reaching 10.85 million mt/year by 2017, from the current 3.4million mt/year.14While upwarddemand trajectory spurred such

capacity investment, PX producersare operating in a market thathas changed signicantly duringthe long lead time between thecommissioning of these projects andthem coming on-stream. Ultimately,the ood of new PX facilities has ledto a regional over-capacity crisis.

With China also increasing its PTAcapacity growth for self-sufciencypurposes, the North Asian PX marketis quickly losing a core demand

market. The net-result for North Asiansuppliers has been an imbalancebetween supply and demand,contributing to three years ofnarrowing PTA-PX spreads. The PTA-PX spread narrowed 83 percent froma quarterly average peak of USD 354/mt in 1Q11 to USD 70/mt in 3Q13,considerably below the industrys

breakeven point of USD 150/mt(Figure 6).

North Asian producers are respondingto tepid market conditions byoptimising asset utilisation or insome cases, halting PX productionaltogether. In February 2014, SouthKoreas Hyundai Cosmo (HC)Petrochemical cut operating rates atits 800,000 tonne/year PX unit to 75percent from 80 - 85 percent. LotteChemicals 250,000 tonne/year No 1

PX unit shut on squeezed margins.

Japan: Adapting to a NewWorld Order

In Japan, the scal policies of PrimeMinister Shinzo Abe, who took ofcein December 2012, have arresteddeation and helped producemoderate GDP growth.

A central feature of Abenomics hasbeen aggressive scal stimulus,which has depreciated the value of

the yen and helped bolster chemicalexports. However, despite a smallrise in exports, imported raw materialcosts which contribute the bulkof a base petrochemical producersbottom line have increased.

In 2018-2020, signicant newethylene production capacity will

occur in North America, the MiddleEast and China, putting furtherdownward pressure on operatingrates.15The mature economies ofEurope and North Asia have anaging asset base with a feedstockchoice limited mostly to naphthaand as such face adjustment. NorthAsian producers have two options:implement portfolio rationalisation orproduct specialisation.

Japans ethylene consumption has

trended down to around 5 millionmt/year, while annual capacityremains around 7.6 million mt/year.16Domestic overcapacity andreduced Chinese imports have led tocompanies Asahi Kasei, MitsubishiChemical, and Sumitomo Chemicalannouncing plans to shut or adjustethylene units. Although it is a stepin the right direction for Japansolens industry, capacity will still be6.4 million mt/year and therefore anovercapacity gap will remain.

Figure 6: Asia PTA-PX spreads (quarterly average)

Source: Standard Chartered, KPMG Analysis

(USD/mt)

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Depicted below are some examples of the activities that North Asian petrochemical companies have adopted in orderto ensure their survival in the petrochemical industry.

Case Studies

Case Study 1: Oil and Gas major

seeks Cost Optimisation andOperational Excellence support:An assessment was made of aJoint Venture (JV) between a globaloil and gas major and a Taiwaneseoil company. The client was a PTAmanufacturer, facing the challenge ofhaving excessive production capacityin a highly competitive domestic andregional market. Their challengeswere compounded as exportsales dramatically fell due to bothincreasing PTA production in Chinaand a subsequent loss of intra-regional

market share to those players.

The client was looking for supportto reduce cost, improve operationalexcellence and cut losses in order to

re-stabilise and establish a platform

for renewed growth. Opportunitieswith a Replacement Cost OperatingProt (RCOP) benet range betweenUSD 8.3, and 18.3m and workingcapital benets between USD 2.8mand USD 5.8m were identied andstrongly supported by the client.

Efciencies were identied anddelivered by: The application of an External

Investor Lens methodologytobring an independent perspectiveto the JV. The estimated baseline

costs were calculated, and useda hypothesis-driven approachto identify potential areas ofimprovement. Hypotheseswere tested through the use of

comparator insights, analysis of

the JV's performance data, andclient interviews and workshops.Hypotheses covered the fullrange of activity in the business:direct production, maintenance,procurement, support functions,logistics and sales.

Strategy Realignment:Potentialopportunities to increase exportsales and to reduce the number ofactive production lines to resize thebusiness for the declining exportmarket were reviewed.

Developed a supplier assessmenttoolraise efciency in thefeedstock procurement process inan effort to reduce costs.


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Case Studies

Case-Study 2: Mitsubishi Chemical Road to RecoveryHigh energy and feedstock costsremain the most intractable problemfor petrochemical producers. Asa result, chemical manufacturersare switching their portfolios frompetrochemicals to high-value-added,specialty products such as thelife sciences, where technologydetermines the competitiveness,not raw material costs. MitsubishiChemicals is one Japanese companythat has adapted its operations andstrategic approach to ground realities.

Portfolio Rationalization:InMay 2014, Mitsubishi Chemical

announced the shutdown ofthe companys number-onenaphtha cracker and benzene unit atKashima, Japan. Mitsubishis 2014ethylene output for the rst quarterdecreased by about 20.8 percentcompared with the AprilJune2013 quarter.17

Operational Restructuring:Developing solutions to establishmore efcient productioncongurations, as evidencedby efforts by Asahi Kasei andMitsubishi Chemical to unify theirnaphtha crackers, aiming to achievemore efcient conguration.Operations will be consolidated at

the Mitsubishi facility at Mizushima,and Asahi Kaseis facility will beclosed. The shared operation of anaphtha cracker will be managedunder a 50-50 joint venture.

Value-add Products:The companyis divesting from general purposepetrochemical products andfocusing on two growth areaswhere it holds an advantage, suchas in high-performance industrialpolymers (Figure 8). In refocusingits product strategy, Mitsubishi'spolymers business, which is part ofthe company's industrial materialssegment, reported a 12.6 percentrise in 1Q14 sales. 18

Regional Case Study

Summary

North Asias petrochemical producersare at a crossroads. Faced with the riseof low cost competition and access tonished products from the US, MiddleEast and China and operating in acyclical sector, North Asian producersneed to drive a renewed focus on core

competencies. The industry is besetby overcapacity and low growth andthe developing industry trends demandinnovation and adaptability.

To regain competitiveness, NorthAsian producers will need to reassesstheir business strategies to optimize

operational structures and assetportfolios and redene their productand customer strategies. In theabsence of market consolidation,i.e. the overall trend of marketconguration, companies can only lookinternally at what they do to ensuretheir survival.

17 Japan: Heading for Higher Ground, IHS Chemical Week, April 2014, accessed via http://www.chemweek.com/18 Japan: Heading for Higher Ground, IHS Chemical Week, April 2014, accessed via http://www.chemweek.com/

Source: IHS Chemical Week


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Intra-Regional Focus ASEAN

With a population of 626 million twice as large as the United States - and forminga combined GDP of US$2.4 trillion, larger than Brazil, India or Russia, ASEAN

stands out as a potentially huge market of untapped resources and opportunities.

Notes: GDP values are real GDP adjusted with 2005 prices and exchange rates (base); 2. FDI range determined on 2011 data with a 15% adjustment

Source(s): BMI; KPMG analysisSource(s): BMI; BP Data, KPMG analysis

Figure 7: GDP (USD bn), Real GDP Growth CAGR (2013 - 2018, %)

2013

2018

Indonesia ThailandMalaysia Philippines VietnamSingaporeMyanmar

$899

$1508

6.2%

$313

$483

4.2%

$63$109

7.4%

5.4%$267

$450

$195

$229

3.3%

$387

$570

4.1%

$170$281

6.3%


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from a low base, the rate of GDPper capita growth in ASEAN is eighttimes that of North Asia. With sucha development in consumer income,domestic consumption levels ofcommodity petrochemicals andplastics increase markedly. Thistransition has taken place in ASEAN

and presents petrochemical investorswith signicant opportunities,particularly as capacity output,although growing, remains behind theintra-regional demand.

As Figure 9 and 10 depict, theASEAN region faces an alarmingoil and gas security dilemma. Thedeclining productivity and increasingconsumption of the regions traditionaloil and gas export leaders, Indonesiaand Malaysia, has resulted in these

countries becoming net-energyimporters. Consequently, ASEANpetrochemical companies are highlyvulnerable to supply disruption,geopolitical volatility and regionally highoil and gas feedstock prices. Theseexposures drive up delivered feedstockand utility costs and push down

petrochemical margins (Figure 11).

Table 4 illustrates a country snapshotof the diverse petrochemical activityin ASEAN. If ASEAN producersare to serve the nascent demandpotential, they must drive downfeedstock costs and adapt to thesurrounding competitive environment,or downstream petrochemicalconsumers will look to China, US andMiddle East to access lower pricedraw materials.

ASEAN: Moving as OneGlobal energy demand is heavilyfocused on Asia. Asias importswill account for nearly 80 percentof inter-regional net imports by2035, up from 57 percent today.19 Inparticular, ASEAN is poised to playa central role in this growth story. InDecember 2015, ASEAN willachieve its long held ambition toestablish the ASEAN EconomicCommunity, consolidating the tenmember states into a single marketand production base.

With a population of 626 million twice as large as the UnitedStates and forming a combinedGDP of US$2.4 trillion, larger thanBrazil, India or Russia, ASEANstands out as a potentially hugemarket of untapped resourcesand opportunities. While globalGDP growth is anticipated to be3.8 percent for 2015, ASEAN-5 isforecast to be 5.3 percent.20 Theintention of the ASEAN EconomicCommunity is to not only be anintegrated market but a singleinvestment destination, facilitatingintra-regional trade, foreign directinvestment and energy connectivity.Indeed, large economic powers suchas China, Japan, India, South Korea,and Australia-New Zealand havealready reached out to ASEAN toestablish Free Trade Agreementswith (FTAs).21

With ASEANs modernisation,the regions GDP per capita grewapproximately 150 percent from2005-2013 (Figure 8). Admittedly

19 BP Energy Outlook, 2035, BP, accessed via http://www.bp.com/content/dam/bp/pdf/Energy-economics/Energy-Outlook/Energy_Outlook_2035_booklet.pdf20 World Economic Outlook, 2014, IMF, accessed via, http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/c2.pdf21 Kishore Mahbubani, Lee Kuan Yew School of Public Policy, Singapore, accessed via: http://www.energyboardroom.com/interviews/interview-kishore-

mahbubani-lee-kuan-yew-school-of-public-policy-singapore

Figure 8: Asia: GDP Per Capita Growth

Source: IMF World Outlook Database 2013, 2014

ASEAN

%Change

USD

35,000

40,000

25,000

20,000

15,000

0

5,000

10,000

30,000

250

300

150

100

50

0

200

China North Asia India

2005 - 2013 % Change2005 2013 2018


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Figure 9: ASEAN Crude: Supply & Demand Dynamics

Source: BP Statistical Review, 2014

Figure 10: ASEAN Gas: Supply & Demand Dynamics

Source: BP Statistical Review, 2014

DailyProduction(Thousands)

ProvenReserves(BillionBOE

)

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

15.5

16.0

14.5

14.0

13.5

11.5

12.0

13.0

15.0

12.5

5000

6000

3000

2000

1000

4000

ConsumptionProven Reserves Production

31%Increasein

CrudeDeman

d

9%DecreaseinSupply

DailyProd

uction(Thousands)

ProvenReserves(BillionBOE)

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

6.5

7.0

5.5

5.0

4.5

3.0

4.0

6.0

3.5

200.0

250.0

100.0

50.0

150.0

Figure 11: Petrochemical Margin Calculation

ConsumptionProven Reserves Production

Feedstock Cost

Fixed Cost

Variable/Utility Costs

Net Margin

Final Petrochemical Price

In ASPAC, there is great potential to reduce operating cost exposure. To

maximize prot, petrochemical companies should target reducing these twocosts: Feedstock and Utility Costs.


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Table 3: ASEAN Petrochemical Country Snapshot

Source: KPMG Analysis, SCBEIC, Oil & Gas Journal, BP Statistics

Approximately 90 percent of Indonesia's cracker feedstock is naphtha.

One of the petrochemical business is the lack of production integration. Due to regulatory policy, petrochemical players inIndonesia lack value chain integration. Foreign companies can only operate in either the upstream or downstream sector,

not both. Crude oil production declined to 826,000 b/d in 2013. This is approximately 50 percent of oil produced in 1995. As such,

security of feedstock is a concern. Indonesia is now a net-oil importer, contributing to a rising scal decit.

Vast and economically growing demand market of over 300 million people, presents a huge opportunity to investors.Demand for petrochemical products far outweighs domestic supply.

There is particular need for commodity petrochemical investment such as in PE, which has import portions ranging from 20- 100 percent and PP, which has an import share of 30 percent.

To penetrate the Indonesian market, a joint venture with local partners is one solution that will facilitate market entry andoperations.

Fiscal reform has catalysed deepwater & EOR investment. In 2012, Malaysia discovered the fourth largest amount of hydrocarbons in the world - the rst time in many years a Southeast Asian state has been in the top ten.

Petronas's renery and petrochemical integrated development (RAPID) project has been postponed to 2018, putting back 3mtpa of new petrochemical capacity and a renery with a processing capacity of 300,000 b/d.

The facility will feature SRT VII cracking heaters, which are designed for cracking gas and liquid feedstock to produce 1.1million tonnes of ethylene each year.

RAPID has potential to be a world-class and competitive project, rivalling the petrochemical plants of Singapore. Malalysia'sJohor belt has the potential to meet its ambition to become a leading integrated renery, petrochemical & stoage hub inASPAC; but to sustainably compete, domestic petrochemical plants must tap into gas sources.

Growth in the domestic resins market is prompting petrochemical producers in the Philippines to consider investment indownstream industries. Despite attracting international players, the domestic petrochemical industry is still in its infancycompared to that in North Asia and Singapore.

With lackluster upstream activity, the Philippines is highly reliant on import oil and gas.

A factor affecting the viability of the industry is the subject of incentives, scal and non-scal, which will be made availableto future plants. The ultimate objective is for naphtha to have a zero tariff, being the primary raw material of the cracker.Capital incentives and tax holidays are also expected to boost the otherwise marginal returns of the cracker plant.

The Philippines economy is forcasted to grow at a real GDP growth rate of 6.3 percent in 2014. With GDP per capitaincreasing markedly, there is a growing domestic demand for petrochemical products and plastics.

The Singapore government has proactively fostered a competitive and modern rening and petrochemical industry. JurongIsland remains a magnet for petrochemical investment.

Gradually turnining away from commodity petrochemicals and towards high-value specialties. ExxonMobil, Shell andLanxess have all channeled huge investment into expanding the technological prowess and energy efciency capabilities oftheir petrochemical complexes.

Despite no natural energy resources, Singapore has sought to reduce feedstock exposure by supporting technologicaladvancement and energy efciency through establishing various R&D science parks.

First LNG terminal opened in 2013, there are plans for a second one. The diversication of Singapore's gas supplies willreduce gas feedstock supply concerns.

Supported by offshore gas elds in the Gulf of Thailand, the Map Ta Phut industrial complex, has grown into one of theworld's biggest petrochemicals hubs.

Thailand's petrochemicals outlook however has been overshadowed by domestic political unrest. Thailand has cut natural

gas imports after demand growth in Asia's fourth-largest user of the fuel plummeted to two-decade lows. The economy has experienced a slowdown. Hopes for export-oriented growth to offset domestic sales have not come to

fruition. This is partly because China has become increasingly self-sufcient in petrochemicals.

Due to internal country risk, Thailand's petrochemical players PTTGC and SGC have looked to other markets in ASEAN, inparticular Indonesia. In late 2013, PTTGC signed a Memorandum of Understanding with Pertamina to form a JV to establisha fully integrated petrochemical plant. The plant will produce products such as ethylene and propylene and commenceoperations during 2018, and it is hoped that it will eventually enjoy a 30 percent market share.

Self-sufciency in oil production gives a feedstock advantage, which has supported the development of the petrochemicalsindustry. Margins however, are dictated by crude oil prices and as such are subject to cost volatili ty.

Has attrated some foreign investment for polyvinyl chloride (PVC) production.

A lack of rening capacity has hamstrung the domestic petrochemical industry for years. With a desire for value-chainintegration, rening expansion plans - tripling capacity by 2017 - will improve margins.

INDONESIA

PHILIPPINES

MALAYSIA

SINGAPORE

THAILAND

VIETNAM


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Singapore Innovation &Integration

Singapore through its well-integratedand modern rening, petrochemical,storage and trading infrastructurecan act as a role model for the widerregion. Jurong Island illustratesthe proactive role of the Singaporegovernment in developing acompetitive and modern rening and

petrochemical industry.

For decades petrochemical companieshave been drawn to Singaporebecause of its efcient infrastructure,protection of intellectual property andattractive scal regime.

The emerging economies with fastgrowing populations (in particular:Vietnam and Indonesia) have thepotential to become major demand

centers for nished products in Asia.Petronas Renery and PetrochemicalIntegrated Development (RAPID)project is an example of risingcompetition in ASEAN. The complexincludes a naphtha cracker which willproduce 3mmt of ethylene, propylene,C4 and C5 olens annually. It alsoincludes a petrochemical and polymercomplex which will produce C4 and

C5 derivates. With such development,Malaysias Johor belt has the potentialto become a leading integratedrenery, petrochemical & storagehub in ASPAC, following Singaporesjourney. Such competition indicatesthe intensifying competition withinASEAN, particularly at the lower endof the value chain.

In response to rising global andregional competition, Singapore has

adapted by shifting its petrochemicalfocus towards value-add chemicals.

The governments long-standingpromotion of energy efciency andspecialty products has generatedfurther international investment.Various R&D science parks areused to support technologicaldevelopments. Mitsui Chemical

established its rst overseas R&DCentre in Singapore R&D Centrein 2006. Mitsui Chemical teamedup with the governments A*Starresearch agency to conduct researchon catalysis science and technology.In 2006 BASF SE established itsR&D Lab. With ASEAN and Asianbasic chemical overcapacity issues,Singapore has been proactive instaying ahead of the technologicalcurve to remain competitive.

If ASEAN producers are to serve the nascent demand potential, they must drivedown feedstock costs and adapt to the surrounding competitive environment, ordownstream petrochemical consumers will look to China, US and Middle East to

access lower priced raw materials.

Keeping Ahead of the CurveIn Singapore, major IOCs haverecently pursued innovation initiativesto enhance their petrochemicalcapabilities in ASPAC. ExxonMobilspetrochemical expansion in 2013was the single largest investment inits chemicals business, contributinga quarter of the companys globalchemicals capacity. The plantdevelops a number of highperformance polymers and specialtyproducts, including proprietary

specialty elastomers.22

An example of the high performancepolymers can be seen in thepolypropylene chemical plant. Theplant is among the worlds highestin capacity, using the ExxonMobilPolypropylene Technology for producinghomo-polymer and impact co-polymerresins. ExxonMobil also licenses thisproprietary innovation, which is apioneering integration of polypropyleneslurry and gas phase technologies.

Illustrating the sectors continuedpush towards innovation, the newcracker gives ExxonMobil the capabilityto bypass the rening processingsteps and process crude directlyinto petrochemical products.23Suchtechnological advancement is indicativeof the competitive forces in theindustry, helping ExxonMobil enhanceits operational and technologicalexcellence, while simultaneouslyimproving its energy efciency andlowering emissions.

22 ExxonMobil, Singapore Country Website, http://www.exxonmobil.com.sg/AP-English/about_who_prole_chemical.aspx23 Interview, ExxonMobil, Singapore,March 2013, accessed via www.energyboardroom.com


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Conclusion:

The petrochemical industry inASPAC must be regarded as a multi-faceted, cross-regional systemwith many moving parts. There arealso intra-regional dependencies whichimpact competitive positioning andrelative success in the short and

longer term.

There are certain parameters that

dene how regions interact. Globaland regional supply and demandforces are reshaping ASPACspetrochemical industry, with inuencefrom as far as the US and China. Noregion or country is immune to thefast changing trade, supply and capitalows shaping the industry. Chinas self-

sufciency drive and its subsequenterosion of North Asias petrochemicalstanding, demonstrates how one

region can impact another.

To compete sustainably in thisevolving ecosystem, investors andproducers must adapt to their regionalenvironments. Through introspection,ASPAC based petrochemical producersmust rationalise their portfolios,

enhance their operational excellenceand ensure that they strategically adaptto macro trends and market realities.

Table 4: ASEAN PETROCHEMICAL CHALLENGES & SOLUTIONS

Dwindling Feedstock Supplies: Similar to North Asianproducers, ASEAN producers are exposed to highoperational (feedstock and utility) costs. It is not so muchthe absolute feedstock cost, but the relative differencecompared to other regions such as the US, Middle Eastand increasingly China. For now, the cost structure they areoperating on is signicantly higher than these rival regions.

Challenges Three Step Success Strategy

Diversify Feedstock:On the back of voracious domesticdemand, a number of ASEAN countries have bold plans fortheir petrochemicals industry. New capacity builds need toachieve feedstock exibility, particularly NGLs.

Talent Crisis:NOCs in particular face a tremendouschallenge is procuring the talent with the right skill-set. InASEAN, nding talent with technical expertise, particularly inengineering, is a difcult task.

Going for Specialty:Singaporean producers with nofeedstock cost advantage should aim to reduce raw materialvulnerability by shifting away from commodity petrochemicalproducts and towards speciality products. Producers thatfocus on specialty chemicals such as life sciences are moreexposed to technological prowess, than raw material costs.

Change Management:NOCs should seek third party changemanagement services. People and change managementis designed to facilitate the effective transition of anorganization and its people from current to future state and indoing so support the realization of business benets.

Competitiveness:ASEAN countries, in particular

Vietnam, Indonesia and Malaysia, have embarked on basicpetrochemical product expansion. As a result of capacityexcesses in ASPAC, overcapacity in the olens and aromaticsmarkets are suppressing market potential.

Operational Restructuring:In light of the changing market

dynamics, ASEAN producers need to scrutinise theiroperational structures. A successful strategy will focus onquality business units, successfully divest non-performingassets and ruthlessly restructure the operational cost base inan effort to prepare for the next stage in the business cycle.

Singapore through its well-integrated and modern rening, petrochemical, storageand trading infrastructure can act as a role model for the wider region.


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