Petchems sector shows signs of recovery after torrid Q1

Sabic

• Saudi petrochemicals hit by concerns about global economy
• Kingdom’s most important sector after oil
• Hope for revenue increase through sales rather than price rise

Saudi Arabia’s petrochemicals industry is showing tentative signs of recovery, although product prices are likely to remain under pressure despite the re-opening of the major market of China, analysts say.

The sector is the kingdom’s most important earner after oil. Saudi has become a global petrochemicals player thanks to an abundant supply of feedstock gas and astute investments over several decades. But prolonged over-supply globally has hit earnings.

Saudi Basic Industries Corp (Sabic), which is 70 percent owned by Saudi Aramco and is the country’s third largest listed company with a market capitalisation of SAR273 billion ($72.8 billion). It reported a 90 percent drop in first-quarter net profit as revenue plunged by nearly a quarter and sales costs by about a fifth.

Domestic rivals Petrochemicals Rabigh and Yanbu National Petrochemicals Co (Yansab) also reported first-quarter losses while Sipchem toiled. 

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Sabic derives around 90 percent of its revenue from its petrochemicals business and the remainder mostly from fertilisers.

Sabic’s petrochemical first-quarter product prices fell 23 percent year-on-year and 2 percent versus the preceding three months. Volumes declined 3 and 6 percent respectively over these two time frames.

“It feels like Q4 was the bottom, with petrochemical prices little changed in Q1,” said Oliver Connor, vice president of energy equity research at Citi in London.

Saudi petrochemical producers’ margins began to plunge from mid-2022, slumping to levels unseen for about 20 years as product price increases failed to match those in crude oil. 

Usually, the two are closely correlated. But oversupply and a lack of demand from China weighed on petrochemical prices. In 2022 Sabic derived 35 percent of its revenue from sales to Asia.

Sabic

Brent crude prices averaged $81 per barrel in the first quarter. That compares with $80 in the prior year period and $89 in the last three months of 2022.

“End user demand was down, while feedstock prices were high – petrochemicals producers were getting hit from all directions,” said Yousef Husseini, director of chemical equity research at EFG Hermes in Cairo.

Soaring logistics expenses squeezed margins further.

“Usually, such costs are a minor consideration but they became so meaningful our analyst models weren’t working as well anymore,” said Husseini. “Costs were coming in consistently higher than we expected.”

Cost pressures eased in the first quarter of 2023, enabling Sabic “to do better in some of their assets, but worse in others so overall it ended up about the same” as the fourth quarter of 2022, according to Husseini.

Sabic’s petrochemicals Ebitda (earnings before interest, taxation, depreciation and amortisation) margin was 12 percent in the first quarter, up from just 8 percent in the fourth quarter, according to investment bank Citi.

Historically, Sabic’s petrochemicals Ebitda margin has usually been in the low 20s and should recover to the mid-to-high teens by the fourth quarter, Connor said.  

Outlook

Within the petrochemicals industry, the global consensus is for a turnaround in the second half of 2023. Yet Husseini is uncertain this will happen, citing sluggish demand growth.

“People are trying to time buying at the bottom of the market so that they don’t have higher cost inventory – there’s all sorts of these games going on,” he said.

Citi’s Connor said that although Sabic’s earnings were disappointing, they show signs of stabilising.

Reuters/Faisal Al Nasser

“The question is when will be the inflection point,” said Connor. Unlike some investment banks, Citi is not “especially bullish” on oil prices.

As such, Sabic’s best hope for increasing revenue is through higher volume sales of chemicals rather than significant price rises.

“As Covid restrictions are eased in China and industrial activity increases, that should lessen some of the inventory and oversupply in specific chemical products,” Connor said.

Yet recession in the US and Europe, which Citi believes is possible into 2024, will weigh on petrochemical demand, he warned.

Pritish Devassy, head of sell-side research at GIB Capital in Riyadh, is more bullish. He described demand as “recovering well” thanks to China’s reopening, although he too said prices are unlikely to increase significantly in the near term.

Meanwhile, Saudi petrochemical production capacity will expand further.

“The supply-demand situation should start improving next year, although not by much,” Husseini said. “It’ll be 2025 or 2026 before things start returning to normal given the imbalance currently – we’ve not seen anything like this for at least 15 years.”

Such an outlook does not prohibit prices rising substantially over the next 12-18 months, he explained, because the market tends to overshoot in both directions.

“Producers run down their inventories and cut output. Then when demand rebounds, suddenly there’s insufficient supply and it takes a few months to up production,” Husseini added.

Sabic’s shares ended Thursday at SAR91.20. EFG Hermes has a price target of SAR100 on Sabic and a neutral rating. That contrasts with Citi, which has a target of 111 riyals and a buy recommendation.

“From a financial viewpoint, Saudi producers have resilient balance sheets and can weather these storms,” added Citi’s Connor. “But there’s uncertainty as to when we’ll start to see significant earnings growth again.”