Analysis
Energy

Saudi Arabia’s markets to feel petrochemicals slump

August 17, 2023

Saudi petrochemicals — Saudi Basic Industries Corp (Sabic) warns that margins will “be continuously under pressure” in the third quarter

Sabic reported 85% decline in net profit
Gloomy outlook weighs on stock market
Ongoing struggle due to global uncertainty

Saudi Arabia’s petrochemicals producers reported plunging profits in the second quarter, and are likely to face further struggles due to weak demand, oversupply and high costs.

There seems little scope for the industry to rebound until at least 2024, analysts now predict, as a hoped-for turnaround failed to materialise.

This gloomy outlook will weigh on the kingdom’s stock market, in which petrochemicals are a heavyweight sector along with oil and banking.

“Q2 earnings were generally in line with, or slightly worse than, expectations,” said Yousef Husseini, director of chemical equity research at EFG Hermes in Cairo.

“The market reaction post-results showed some investors were disappointed, with costs higher than anticipated.

“In early Q3, petrochemicals prices have fallen even further, so the outlook isn’t great although it’s not uniform.”

Saudi Basic Industries Corp (Sabic), the kingdom’s top petrochemicals maker and majority-owned by state oil company Saudi Aramco, reported an 85 percent year-on-year decline in second-quarter net profit.

In an investor presentation, Sabic warns that margins will “be continuously under pressure” in the third quarter.

Other Saudi producers are also struggling. Second-quarter net profit at Sahara International Petrochemical Co’s (Sipchem) and Yanbu National Petrochemical Co (Yansab) fell 75 and 90 percent respectively.

Industry-wide, petrochemical margins have tumbled to two-decade lows.

“Saudi operations are under pressure and the cost advantage that Saudi companies have now is much less than what it was 15 years ago due to changes in the feedstock mix,” Husseini said.

Historically, Saudi producers’ gas-based feedstock was a by-product of oil production and its supply was limited by crude output.

As petrochemical production expanded, a growing percentage of feedstock came from oil itself.

In a high oil price era, that has increased manufacturing costs despite state subsidies.

“The question is how steep the margin recovery will be and perhaps it will be shallower than we previously thought,” said Oliver Connor, vice president of energy equity research at Citi in London.

As low-cost producers versus rivals in Asia and Europe, Saudi manufacturers usually operate at full production capacity.

Producers worldwide have cut aggregate output of polyethylene – a major petrochemical product – to less than 80 percent of capacity from 90 percent in early 2022, according to EFG Hermes.

Such reductions have failed to arrest declining margins and further cuts are likely, Husseini said.

That is in part because of the stuttering global economy, which has seen different sectors fall into recession, or at least a prolonged slowdown, at different times.

Such mixed signals are causing uncertainty among petrochemicals companies as to when to lower production, by how much and for how long.

“It’s hard to plan,” Husseini said. “Also, a company might reduce output, only for new supply to enter the market that’s more efficient and usually debt-heavy and so needs to be operational.

“That’s partly why capacity cuts haven’t moved the needle much in terms of margins.”

Petrochemicals is a cyclical industry. In previous downturns, it was Chinese demand that sparked the recovery, with all non-Chinese producers net exporters to China.

Now though, “demand growth in China is pretty weak”, said Citi’s Connor, noting Chinese petrochemical imports were lower than 12 months ago – partly because of the country’s push to become less dependent on foreign suppliers.

“From a 20–30-year viewpoint, it will be interesting to see how that dynamic plays out because China wants to rely less on petrochemical imports, regardless of whether it costs more to produce the same products domestically,” Connor said.

Huge oversupply in China’s once-buoyant real estate sector, which was a major consumer of petrochemicals, suggests demand for petrochemicals from the world’s No 2 economy will remain subdued.

The correlation between China’s GDP expansion and petrochemicals demand growth has been strong over time, according to EFG Hermes.

“There’s no question there’s a slowdown in petrochemicals, the question is how big and how long of a slowdown it will be,” Husseini said.

“I doubt we’ll see any improvement until 2024. We’re still seeing de-stocking of petrochemicals by buyers, which tells you they’re uncertain. They’re not willing to build any inventory yet.”

China began increasing its own petrochemicals capacity significantly from 2021, with 2023 likely to be the peak in terms of its annual capacity expansion.

Worldwide, supply will increase by around 8 percent this year, while demand will increase by “sub-3 percent”, Husseini said. “There is a massive surplus of capacity.”

The last time the industry faced such an imbalance was from 1998-2003 when the tech bubble burst.

“This one will be similar,” Husseini added. “I expect a recovery to begin next year, but the industry won’t return to a normal situation until 2026 at least.”