Petrochemicals: The Future of Saudi Petrochemical Industry

Interview with Jamal J. Malaikah, President and COO of NATPET

The continued uncertainty over the health of the global economy is clouding the outlook on the global recovery. We have seen some recovery but it is a tenuous recovery, U shaped rather than V Shaped. For the emerging markets it’s been mostly V shaped, they’ve recovered quite well. Given all the uncertainties, what is the outlook for the petrochemical industry in 2015 and 2016?

The petrochemical industry is like any other industry. If the world economy is in good health, the petrochemical industry is in good health. If there is growth, if there is demand, it will be business as usual in the petrochemical industry. When do we see a problem with petrochemicals? When there is an economic problem, like in the aftermath of the financial crisis of 2008. Then there was a problem. The world was in trouble.

The demand was lower. Many countries faced economic problems. Today things have normalized and the petrochemical industry is following the world’s path towards recovery. Demand is strong. Economies have improved. The economies are different from what they were in 2009 or 2010. So, in the petrochemical industry it is business as usual. There shouldn’t be any problems unless the world faces another economic crisis.

We are currently seeing a drop in oil prices. Projects in the petrochemical industry are usually long term projects and can take up to 10 years to complete and produce cash flows. How does global economic uncertainty affect your investment plans?

If you talk about a basic commodity like oil, its price fluctuations affect the market. But the window of effect is limited, maybe 2 to 3 months. Businesses that are dependent on oil adjust to this change. But it is not a long term effect. If the price of oil drops, it does not mean the petrochemical industry will decline. The petrochemical industry will be affected, but within a short period of time, the prices of the end product adjust.

I wouldn’t say the drop in oil prices has caused a decline in the prices of petrochemical products, affecting the financial viability of petrochemicals.

Where do you see investment opportunity for the petrochemical industry?

Today, at least in our country, we are seeing a drive to go downstream. If you look at mainstream projects you will see mostly ARAMCO joint ventures like in Sadara in Jubail in the eastern province and Petro Rabigh on the west coast. There are some other projects too. It is not quite the bonanza it was several years ago, when the country was flourishing, with lots of investment in petrochemical projects because of the advantages we have in Saudi Arabia.

Today, the focus of the government and the private sector is on downstream projects. To be frank, going downstream is a must. Once a lot of projects have been established in the mainstream, going downstream is the next step. Why? Because it helps us diversify our income, as a country and as a company. It helps create employment, which is very important for the country. You also enable the transfer of technology. Usually when a company goes downstream, it partners with large, world players. This is what we have done in our company. I think, more and more of the investments in this country will be going downstream.  Investments in upstream projects will continue, but not at the same pace as it was years ago.

How would you characterize your short, medium and long term strategies?

I think the answer would be consistent with my previous answer. We want to diversify and build more downstream. We have already started with one project that is already on stream. We have another project coming up. Both are with international partners the latter one  will be on stream in the second half of 2016.

Our strategy is diversifying through downstream projects. However, that does not mean we are closed to investing in the mainstream, whether in Saudi Arabia or outside, if the financial conditions are right.

While you are not obliged to disclose your financial details, how would you describe your financial performance?

Thank God, 2014 was a banner year for the company.

Our profits were up 50% from 2013.

That is significant. I haven’t seen a lot of data about any companies, in Saudi Arabia or outside, who made that kind of profit growth. This was due to God’s grace and our efforts in the market. We follow a very unique marketing strategy, with diversification in several countries and the way we sell. Our ratios and our financial performance are very good, Alhamdulillah. We expect this to continue due to our strategy.

What is this unique marketing strategy?

That’s our secret. I have seen that we have a very different method, be it in in Saudi Arabia or other countries. Just the way we go about selling our product is different. That is our uniqueness and we will continue on this path.

What is your personal opinion about the diversification efforts? And how are things looking for the long term future of the kingdom?

Diversification has always been on the table in Saudi Arabia. To be frank, in spite of the government’s efforts at diversification, to date, oil still plays the major role in the economy. We have seen the private sector move into electricity generation, telecommunications and transport. We see a lot of effort, and the government is playing a big part in it. However, in my opinion, it’s going to be a long road. It will take a while.

The path to real diversification will take a lot of time and a great deal of effort on the part of the government and the private sector. But it will happen. I wish I had an easy answer to this question. But I think it will take time. It needs a dialog between the government and the private sector. But we also need more of what I call ‘workshops’, involving all the stakeholders, government officials, private sector, academia and consultants. Together they can come up with the right formula for diversification. I don’t think any of these stakeholders can do it alone. That’s my opinion.

How do you see the role of the petrochemical industry in the economy? Will it stay the same or will it increase?

One has to understand that the petrochemical industry is a key industry in our country. This is because petrochemicals go into many end products. These end products touch all of our lives in many ways and in many places, in the car, in the home, in the office, in buildings, in medicine. Petrochemicals are everywhere.

Plastics are everywhere. Therefore the petrochemical industry will always play a big role everywhere. However, because of our oil and gas resources in Saudi Arabia, it plays a greater role in our country. For example, as an indication of the importance of the industry, petrochemical companies make up about 30% of our stock market. That’s a very significant portion. So keeping this industry healthy is very important.

Both government and business should approach the industry in a very balanced and careful way, because this is a very important resource for the country. I believe petrochemicals will always play a very significant role in the country. Again I repeat, we need more dialog between the different stakeholders, definitely between the policy makers and business. When I say dialog, I do not mean discussions. I mean real, structured dialog, so that we can come up with the best solutions to any challenges, whether they are external threats or internal issues.

How do you view the progress and the implementation of the national petrochemical strategy?

I wouldn’t call it a national strategy. We see a lot of effort in the country to promote downstream projects. That’s very clear, with the clusters program and the downstream projects that ARAMCO does. The private sector still seems shy. As of today, I couldn’t say that we do have a ‘national’ petrochemical strategy. That wouldn’t be the right answer. If we want to have a structured strategy, we first need to have all the involved parties talking with each other, to come up with a ‘national’ strategy. Without that, there will be many different efforts, and each party will move believing they are doing the right thing. Everybody needs to be involved.

One of the main challenges Saudi Arabia faces is that it is using up its gas reserves and oil for electricity generation. There is more demand for electricity as the population grows. SABIC (Saudi Basic Industries Corporation) is now considering setting up a petrochemical plant in the US, to take advantage of the shale gas revolution. With so many challenges on the horizon, what do you expect to be your main challenge?

That is a very good question. Most people don’t know that our oil and gas are being used up in electricity power generation, water desalination and automobiles. There needs to be a proper rationalization of the issue. We see some signals. The government is making some effort to regulate the consumption of energy in industry. Specifications have been issued to the air conditioning business. In the automotive sector, the Ministry of Trade has introduced specific mileage per liter requirements. But these are still in the infancy stage. We believe these steps should be taken further.

However, there is a very serious matter here. People have different opinions on this. The government can’t simply decide to target the petrochemical industry because oil consumption is very high. It should be the other way round. The government should target that consumption which doesn’t generate income or employment, like electricity consumption and car fuel consumption. This can be done in several good ways, like changes in pricing structure and encouraging conservation efforts.

When it comes to petrochemicals, they must be very careful. Here is an industry that contributes significantly to the GDP of the country, contributes significantly in employment generation. Many of us, but not all of us, within this industry are going downstream to create more jobs. To tie the consumption of oil and gas to our industry would be wrong. The regulation of the consumption of oil and gas in unproductive areas is necessary. I agree with you on that. But when it comes to industry, more oil and more gas should be allocated to industry, to enable more projects and create more jobs.

Given the shale oil revolution in the US, can Saudi Arabia still be competitive?

That’s another good question. We believe this is another challenge we will face very soon. By our very solid information, we will see about 13 million tons of petrochemical products based on shale gas in the US by 2017. Where will these products go? They will go to our markets. So there will be huge competition to our products worldwide. This is a big challenge. We’ve been talking about it for the last few years, now it’s going to happen. We also see a global trend towards more protectionism since the financial crisis of 2008. There are higher tariffs, unfair anti-dumping laws etc. These are new challenges. These two factors are alarming and threatening. A third threat that is not getting much attention in the industry is the new technology that allows petrochemicals to be produced from coal. The Chinese are making big progress in that area. We are cautioning everyone now to look into these problems. The Chinese are not only building conventional petrochemical plants, they are building coal-to-gas plants. They have abundant coal resources. These are big challenges. That’s why anybody thinking of changing the structure and privileges of our industry must be very careful.

I want to elaborate a little on this. There is nothing called a subsidy to the petrochemical industry. That is a wrong perception. The price of feedstock in Saudi Arabia reflects the true cost of production. Cost of production should be the benchmark in the pricing of a product. There is no such thing as an international price in our industry. The price in the US is very different from the price in Europe, Japan or China. They are very different from the price in Saudi Arabia with its abundant oil and gas resources. The government rightly put in a structure to use it for industry. It is a myth that there is a subsidy or an international price. The price of feedstock should reflect the true cost of production, including transportation, processing and selling it to the customer. That’s our opinion.

In the face of all these challenges, shale gas, the Chinese transformation technology etc., is the Saudi petrochemical sector still competitive? And will it remain so?

I think we face very serious challenges. Some people will downplay that. I am afraid we are all in for a big surprise. Once there is an influx of these competing products in the market, or when we clearly see the protectionist measures already being practiced by many countries which deprives us of fair entrance into those markets, and we face the new technologies, we will have to face them as serious challenges. Are we prepared? I don’t think so.

Speaking for yourself and your company, how are you preparing for these challenges?

It’s not easy. The local market for downstream is limited. Today there is about 2.5 million tons of downstream consumption in Saudi Arabia. The production of petrochemicals is about 55 million tons of end products. This is before Sadara or Petro Rabigh come on stream.  In this country, we will always have to export. Always. Even if we grow our downstream consumption by 10% it is not enough. It will take 50 to 80 years for us to consume the product of our petrochemical industry. The government is encouraging everyone to invest downstream. But a big volume of our product has to be exported. These challenges will not disappear. We are doing our part. As I explained, we are doing 2 projects but there is a limit to how many projects we can do. It’s not easy. If you have 400,000 tons, to transform it all to petrochemicals downstream, it’s not easy. It’s very difficult. You need foreign partners, you need proximity to the market, you need proper research shelters. There is no easy answer to this unfortunately.

Can you use hedging strategies?

Hedging is a short term strategy. The firm that you hedge with understands all these things. Hedging can work for a very short time. You cannot hedge your production or sales for 20 years. That’s impossible. That will not happen.

How much petrochemicals is Saudi Arabia currently producing?

About 55 million tons. That’s a significant amount. The consumption in Saudi Arabia is 2.5 million tons. You can see the ratio there.

There are a lot of people entering the middle class in India and China. Are you sure the petrochemical industry will face challenges in the future?

I am a 100% sure. It’s not just something we are imagining. China has mega projects of its own in the petrochemical sector, both from coal and conventional sources like oil and gas. I’m not sure about the Indian situation, but there is significant petrochemical business in India. It’s not just Saudi Arabia that is affected. It’s the whole GCC region. And we have the added challenge of shale gas from the US. Even Brazil has petrochemical projects. Where are all these products headed? Our markets. Whatever the growth, ultimately the market is ‘x’ and production is ‘y’, there will be a gap between the 2 and prices will surely go down. It’s no use trying to say that no challenges exist or that things won’t change.

Do you know what the current global production figures are?

I can tell you about our business. In Polypropylene, we are talking about 55 million tons of demand. The supply is a bit higher but that depends on the operating condition of the plants. Supply is higher than demand though. Of course it will be higher with the shale gas products, Chinese products, Brazilian products, GCC products etc. Supply will always be higher than demand. There are a lot of threats, including shale gas, protectionism, new technologies and our distance from the markets. People don’t understand that transporting our products from here to Latin America, the US, Europe etc. is very expensive. The logistics of the supply chain are complex. It is not as simple as people think, they think we just make a lot of money. It’s going to be very tough in the future.

Can you speak about your plants and the technologies that you utilize? And is there such a thing as quality in polypropylene production?

We have a 400,000 ton plant for polypropylene. We use a state of the art technology called Spheripol by LyondellBasell, one of the best companies in the world. Quality is key to any business. Our product is of a very good quality. We are very careful of how we produce. Quality is one of our advantages in the business. However, it’s not our only advantage. Even with the best quality product, you cannot succeed if you cannot sell properly – at the right price, with innovative strategies for sales, stocking and processing. These are important factors to in getting a business edge. But quality is key.

Your facilities are situated in Yanbu City. What are the advantages of operating these cities like Yanbu and Jubail?

When the government built Yanbu and Jubail in the mid-1970s, it was a dream. When I first went there, it was just open land, nothing there. There were big machines excavating and building. The government built these cities to provide the proper infrastructure. There was enough land, the utilities were built, water cooling facilities, ports, roads, housing were built. This is a major achievement of the Saudi government. I don’t think we would have had such a strong petrochemical industry without these 2 cities. Good infrastructure is very important to any investor. The government and the private sector are keen to build other planned, industrial cities. These are not for petrochemicals but other industry, with ports, like King Abdullah port.

Yanbu is an important city on the west coast. It has great infrastructure but it is also very strategic. We are in the middle with access to Europe, Asia and the Middle East. The investment in Yanbu is very important. Jubail is also very important. It is very close to the raw material but it is far from the western hemisphere. Yanbu is strategic.

Is it different doing business in Jeddah, as compared to other parts of Saudi Arabia?

Historically, Jeddah is a city of business and merchants. It has a strong business culture due to its proximity to the sea and the holy cities of Mecca and Medina, for the pilgrimage. It has a diverse population who have knowledge about how the world works. Jeddah is great for doing business in. People are educated and great thinkers. We are very happy to be in Jeddah. You can do business anywhere in Saudi Arabia but Jeddah has these added bonuses.

How difficult is it to do business in Saudi Arabia? Or, how easy?

I don’t think there’s such a thing as ease or difficulty of doing business anywhere. Every country has its advantages and disadvantages. Even if you go to the best economy in the world you will find some issues, like taxes, unions etc. We definitely have our own set of issues here. Mainly it is the education question. Does it match the business requirements? That’s certainly an important issue. The government is making big strides in that direction. The government sponsors a lot of students to get their higher education degrees overseas. That’s very important. Still there is a lack of equilibrium. No company has 100% Saudi employees. That is a problem.

Then we have unemployment. It makes no sense because we also have 10 million foreigners in the country. There is a problem. The government and the private sector are aware of this. The education system itself needs overhaul and the government is trying to do something. The generation that have graduated after 2000 looks good. I have hope in these young men and women. They seem better than the earlier generations. The oil boom of the mid 1970s brought great wealth but it also made the young think that money was easy and you can get everything easily. This changed their work ethic. Now, things are different. The country is facing challenges and the new generation are innovative, enthusiastic and optimistic. Still we have 10 million foreign workers. While we’ll always need guest workers, that is a huge figure, about 25 to 30% of the population. The young generation must work very hard to lessen this dependence.

Saudi Arabia has about 200,000 students in foreign universities in Europe, Japan, and the US. They will come back but will they fit back into local culture? Or will they become disillusioned and go back abroad?

I don’t think so. I don’t see that as a trend at all. We did the same thing in the mid-70s. We sent tens of thousands of students overseas. They all came back. Very few people stay outside. In fact, since they were educated in the country till high school, they know the culture. In their time outside, they are exposed to how the world works and the work ethic there, and how to go about earning a living. I think it’s a good combination. I don’t have any of them working in my company. But I have seen them. When they return they look for work. Some who don’t find work, set up small companies of their own and they succeed. Some of them don’t of course. They just have to work harder. I see a positive trend. The young generation now is definitely different than the ones who came after the oil boom.

We notice a big gap though between executives such as yourself who were educated abroad and others. They often complain about Saudisation and the Saudi work ethic. There’s a big gap between the managerial layer and the working layer.

Rather than label it a problem, I think the leadership of a company should establish a proper culture. The working environment of a company and HR policies should attract good people. The only thing I say is that the private sector should be allowed to let go of people who don’t work properly. It’s not fair. It’s not a question of letting Saudis go, but a question of having the right Saudis in the company. That’s something the government should consider. They shouldn’t tie the hands of the private sector and say you cannot let go of workers just because they are Saudis. That is not proper. Especially if you already have a very high Saudisation rate in your company. We call upon the government to look into this. If people don’t work properly even after being given many chances, then this is not the right place for them. We can hire other Saudis who want to work and do things better.