Memo January 14, 2015

Gulf Petrochemical Intelligence Service

Where  Market  Insights  and  Local  Knowledge  Drive  the  Bottom  Line    www.eieadvisory.com  

Qatar:  Petrochemical  Sector  Set  for  Radical  Shift  

A  tectonic  shift  is  occurring  among  Gulf  petrochemical  producers,  with  Qatar  now  shelving  petrochemical  expansion  plans.  This  will  come  as   a   surprise   to  many,   including   industry   insiders   and  key  stakeholders   in   the   hydrocarbon   sector.   Economic   Impact   &  Energy   Advisory   (EIEA)   LLC   foresees   this   will   influence   decision-­‐makers   elsewhere   in   the   region   as   they   refocus   their   strategies  due   to   fundamental   changes   emanating   from   international  markets.    EIEA  estimates   that  GCC-­‐based  planners  will   focus  on   improving  overall  yields  by  producing  higher-­‐value  chemicals,  implementing  enhanced  marketing  plans  and  establishing  unique  ties  with  their  principal  consumers.    Investors  who  have  priced   in   the  continued  expansion  of  traded  entities  such  as  Mesaieed  Petrochemical  Holding  Co.  may  want  to  reconsider   their   price  position   in   the   short   run.   In   the   long   run,  however,  Qatar’s  petrochemical  industry  has  a  positive  outlook.        

Takeaways    • Further   petrochemical   developments   in   Qatar  

have  been  suspended  or  put  on  hold.    • Less  attractive  plant  economics,  new  high-­‐level  

priorities   and   an   enlightened   environmental  policy   have   led   investors   to   reexamine  expansion  of  local  production  capacity.  

 • The   gas   and   ethane   rich   state   is   seeking   to  

profoundly   refine   its   downstream   strategy,  which  is  a  first  for  the  GCC.    

 Nour  Halabi  Manager,  Gulf  Petrochemical  Intelligence  Service  Economic  Impact  &  Energy  Advisory  (EIEA  LLC)  nour.halabi@eieadvisory.com  Mobile:  (+971)  52  680  0393  

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Page 2 І January 14, 2015 Gulf Petrochemical Intelligence Service

Where Market Insights and Local Knowledge Drive the Bottom Line | Dubai (971) 4432-4380 Doha (974) 6608-1468 | eieadvisory.com | meesinfo@eieadvisory.com

© EIEA, LLC. | License restrictions apply. Distribution to third parties requires prior written consent from EIEA LLC

Qatar:  Petrochemical  Sector  Set  for  Radical  Shift    Despite  recent  industry  pronouncements  and  the  affirmative  consensus  view,  Qatar  will  not  proceed  apace  with  downstream  diversification.   Instead,   Qatar’s   petrochemical   expansion   plans   have   been   either   suspended   or   put   on   hold   until   further  notice.   Three   primary   factors   have   led   Qatar   Petroleum   and   its   partners   to   reconsider   the   viability   of   future   projects  including:   revised   project   economics,   refined   strategic   direction   and   reinforced   environmental   concerns.   As   a   result,   local  petrochemical  production  capacity  has  reached  a  self-­‐imposed  plateau.  Ultimately,  Qatar’s  strategic  planners  will  be  studying  how  to  add  yet  more  value  in  this  industry  going  forward.  

The  Economics  Project   economics   have   taken   a   severe  hit   over   the   last   year   due   to   a   variety   of   domestic,   regional   and   international  developments.  Domestically,  infrastructure  constraints  have  led  to  rising  fixed  costs  in  petrochemical  plants.  Regionally,  recent  (now  abated)  tensions  in  the  region  are  no  longer  exacerbating  inflation  pressures  and  fuelling  delays−although  it  may  be  too  early  to  rule  them  out  entirely.  Internationally,  the  turmoil  in  commodity  markets  led  to  a  drop  in  final  sales  prices;  and  a  key  trading  bloc’s  altered  tariff  policy  reduced  margins.  When  compared  to  close  competitors,  costs  rose  sharply  while  revenues  declined.  In  a  downward  market,  decision  makers  are  revisiting  plans.  

Fixed   costs   for  Qatari   plants   have   ratcheted  up,   due   to   infrastructure  bottlenecks   and   construction-­‐related  woes.   The  existing  port  is  overstretched,  operating  at  full  capacity  but  still  well  below  the  needs  placed  on  it  by  a  range  of  domestic  users.   Due   to   plans   of   replacing   it  with   a  world-­‐class   facility   of   enormous   size,   there   is   not   likely   to   be   a   reprieve   of  pressure  until  2017  at  the  earliest.  In  the  meantime,  import  costs  are  rising  in  Qatar.  While  the  Supreme  Committee  for  Delivery   and   Legacy   and   the   Ministry   of   Municipality’s   Central   Planning   Office   are   planning   to   slim   down   aggregate  priority  project  lists,  the  number  of  domestic  investments  remains  extensive.    This  has  led  to  port  pressures  and  an  uptick  in   the   cost   of   construction  materials,   including   those   for   petrochemical   complexes.     In   addition,   recent   tensions  with  Saudi  Arabia  and  the  UAE  have  seemingly  led  to  issues  with  imports  as  well.  Given  that  Qatar’s  only  shared  land  border  is  with  Saudi  Arabia   (which   is   the  origin  of  much  of   its   construction   inputs)  and  Dubai’s   Jebel  Ali  acts  as   the   region’s   re-­‐export   hub,   the   cumulative   effect   of   problems   with   these   trading   partners   has   been   impacting   (and   increasing)  construction  costs.    Higher  fixed  costs  have  translated  directly  into  lower  projected  yields.    

Moreover,  Qatari  petrochemical  producers  have   seen   their  margins  decline   in  a   key  market  at   the  beginning  of  2014,  with  the  EU  change  in  trade  policy.  As  of  January  1,  2014  the  bloc  commenced  to  implement  a  new  Generalized  Scheme  of  Preferences  (GSP),  under  which  GCC  petrochemical  exporters  were  no  longer  granted  preferential  access  with  reduced  tariffs.   Instead,   normal   custom  duties   started   to   be   applied   that   reduced  net  margins   by   approximately   3%.  Although  Europe   is   not   Qatar’s   largest   export   market,   this   was   a   key   competitive   advantage   that   was   lost   in   a  major  market.  Despite  public   speculation,   it   is   unlikely   that   a   free   trade  deal   between   the   EU  and   the  GCC   is   nearing   a   close.   These  negotiations  have  been  ongoing  for  20  years,  and  will  likely  continue  for  some  time  as  more  pre-­‐conditions  are  added.  A  major   stumbling  block  pertains   to   the  petrochemical   realm,  with   certain  GCC  members   insisting   that  export  duties  be  waived  on  petrochemicals.    Given   the   slow  pace  of   talks   regarding   the  proposed   free   trade  agreement,   the  prevailing  major   stumbling   blocks   and   the   advent   of   the   GSP,   no   significant   change   is   foreseen   in   this   area:   Qatari   and   Gulf  producer  competitiveness  in  Europe  will  not  change  significantly  in  the  years  ahead.  

Most  significantly,   the  competitive  advantage  of  Qatari  plants  has  deteriorated  throughout  2014  due  to  the  significant  slide  in  commodity,  hydrocarbon  and  petrochemical  prices.  Whereas  feedstock  prices  have  fallen  considerably  in  the  US  (and  elsewhere)  where  they  are  priced  in  the  open  market,  Qatari  feedstock  prices  are  fixed  over  time  on  a  per  project  level  basis.  Given  that  feedstock  prices  account  for  the  vast  majority  of  variable  costs,  this  has  led  to  Qatari  projects  no  longer   enjoying   the   same   cost   advantage   in   relation   to   competitors   from   the   US   and   elsewhere.   Revised   GCC   plant  margins  in  this  new  pricing  environment  will  be  the  subject  of  an  upcoming  landmark  GPIS  memo.  Prior  to  EIEA  disclosing  

Page 3 І January 14, 2015 Gulf Petrochemical Intelligence Service

Where Market Insights and Local Knowledge Drive the Bottom Line | Dubai (971) 4432-4380 Doha (974) 6608-1468 | eieadvisory.com | meesinfo@eieadvisory.com

© EIEA, LLC. | License restrictions apply. Distribution to third parties requires prior written consent from EIEA LLC

its  estimates  on  how  Gulf  producers  have  experienced  comparative  competitive  pressures  across  different  product  lines,  a  general  conclusion  can  be  reached  that  they  are  now  in  a  worse  position.  When  considering  a  final  investment  decision  for   a   multi-­‐billion   dollar   petrochemical   complex   that   will   be   in   operation   over   the   medium   term,   this   new   pricing  environment  must  be  held  in  account.    

Reducing  Emissions  New  Qatari  petrochemical  plants  will  have  to  meet  exacting  environmental  standards,  which  will  raise  operational  costs.    Qatar  takes  the  Kyoto  Protocol  and  its  eventual  successor  very  seriously  and  is  planning  accordingly.    When  evaluating  any   large   domestic   industrial   investment,   the   effect   on   carbon   emissions   is   considered.   QP   has   taken   the   lead   in  upgrading   its   existing   infrastructure   to   be   more   environmentally   friendly   across   its   business   lines,   even   if   this   has  negatively  affected  their  earnings  potential.    This  environmental  trend  has  also  been  extended  to  petrochemical  plants.  Should   any  new  petrochemical   complex  be  built   in  Qatar,   it  will   have   to  meet   stringent   standards;   consequently,   this  focus  has  raised  both  fixed  and  variable  cost  assumptions.  

In   order   to   mitigate   this   environmental   consideration,   QP   has   opted   to   redirect   its   strategy   for   petrochemical  investments  abroad.  Branded  as  Qatar  Petroleum  International  (QPI),  petrochemical  investments  are  being  implemented  in  key  consuming  countries  across  Asia.    This  represents  a  sea  change  in  QPI’s  investment  strategy,  which  was  previously  focused   on   acquiring   operational   stakes   in   upstream   oil   and   gas   investments   abroad.   While   some   petrochemical  investments  are  made   in  places   like  Vietnam  and  China,  QPI   is   increasingly   looking  at  opportunities   in   the  utilities  and  renewables  space  through  Nebras  Power.  

Innovative  Muntajat  The  Qatari  petrochemical  space  has  seen  a  significant  and  new  player  added  to  the  ranks,  which  is  increasingly  vocal  in  making  better  use  of   the  country’s  downstream  infrastructure.  Established   in  2012,  Qatar  Chemical  and  Petrochemical  Marketing  and  Distribution  Company  (Muntajat)  has   lent  a  voice  of  reason.  Responsible   for  marketing  and  distributing  Qatari  chemical  products  to  the  global  market,  they  have  sought  a  reconsideration  of  options  as  they  continue  to  witness  a  downturn  in  international  prices.  Instead  of  increasing  investment  in  the  local  petrochemical  sector,  they  are  focused  on  how  to  achieve  the  highest  returns  possible  for  the  sector  through  innovative  means.  

Financial  returns  matter.    As  EIEA  has  outlined,  real  and  projected  costs  for  Qatari  plants  have  risen  across  the  board.    In  March/April   2014   when   the   decision   was   made   to   put   Al   Sejeel   on   hold,   Al-­‐Karaana   was   thought   to   reach   a   final  investment  decision  and  move  from  the  FEED  phase  to  EPC.    In  early  November  2014,  JP  Morgan  speculated  that  the  Al  Sejeel  complex  was  postponed  because  the  cracker  was  slated  to  run  on  costlier  mixed  feedstock  and  not  pure  ethane,  which  was   only   partially   the   case.   Although   EPC   bids  were   submitted   in  November   2014,   to   date   Al-­‐Karaana   has   not  reached   a   final   investment   decision.   During   this   time  Muntajat   has   been   attempting   to   craft   an   effective   strategy   to  combat  the  issue  of  increased  profitability  under  current  market  conditions.    

Qatar  as  Leader  Qatar  is  set  to  lead  Gulf  petrochemical  producers  in  a  new  direction  as  it  adjusts  its  own  investment  strategy.  Although  Saudi  Arabia  has  announced  a  total  of  $91  billion  of  investments  in  its  petrochemical  sector,  these  will  not  all  necessarily  come  to  fruition.  Gulf  producers  should  focus  on  making  astute  investment  adjustments  in  the  space,  especially  in  light  of   the   disappearing   cost   differential   in   feedstock   prices.     Qatar’s   move   has   been   especially   prescient,   at   least   when  addressing  the  current  market.  Given  its  unique  position  as  the  only  inexpensive  and  plentiful  gas/ethane  producer  in  the  Gulf,   its  decision  to  place  petrochemical   investments  on  hold  may  come  as  a  surprise.  This  may  lead  to  the  Barzan  gas  project  not  producing  as  much  gas  as  forecasted  or  to  a  reevaluation  of  its  intended  customer  base.    EIEA  believes  other  Gulf   producers   will   follow   suit   and   introduce   a   variety   of   new   intermediate/complex   products,   bring   forth   new  producer−client  relationships  and  innovative  selling  techniques.