Friday 29 Mar 2024
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This article first appeared in Corporate, The Edge Malaysia Weekly, on May 16 - 22, 2016.

PETRONAS Chemicals Group Bhd (PetChem), which had a weak start to the year as first-quarter net profit slipped 2% from a year earlier, has no plans to slow down anytime soon.

After putting its house in order over the last two years, the group is all set to ramp up capacity and feedstock supply reliability in order to increase its share of the market and fend off incoming competition, especially from the Middle East.

Besides the Sabah Ammonia and Urea (Samur) plant in Sipitang, Sabah, which will provide an additional 1.2 million tonnes per year of granulated urea once commissioned by year-end, PetChem is spending US$2.7 billion (RM10.8 billion) to build four petrochemical plants in Pengerang, Johor. It currently produces 1.4 million tonnes of granulated urea a year.

So far, the group has awarded four contracts worth a combined US$1.36 billion to two consortia to build the four polyethylene and glycol processing plants in the US$27 billion Refinery and Petrochemical Integrated Development (RAPID) project.

But, considering the adverse conditions in the oil and gas (O&G) market, is it a good time to make such huge investment now?

PetChem managing director and CEO Datuk Sazali Hamzah tells The Edge in an interview last Monday that the group’s investment in RAPID is not just another capacity expansion decision by the group.

The project will not only make PetChem the largest producer of polyethylene and glycol in the region, but will also pave the way for a future without natural gas — a commodity that is in critical shortage in the country.

“Why is RAPID a good project for us? First, our gas capacity is already at its peak. Gas supply [from Petronas] can only be sustained at our current capacity for the next 20 years. To grow our gas-based petrochemical productions, the supply would not be enough,” Sazali says.

“We can grow a little bit here and there, but not in a big way. Thus, we have to start using naphtha [as feedstock].

Naphtha is usually a by-product of oil refining. It can also be refined from coal, tar and shale oil.

“And now is the best time for us to compete in the naphtha area as we still have the advantage of having big margins in our gas-based business.” 

According to Sazali, about 30% of petrochemical players in the world are gas-based producers, with PetChem being one of the largest. It is worth noting that gas-based players, especially those subsidised by governments or quasi-government entities such as Petroliam Nasional Bhd (Petronas), enjoy better margins than naphtha-based producers.

While Malaysia is blessed with abundant natural gas reserves, most of the proven reserves have been “pledged” to North Asian countries on long-term contracts. Petronas has even ventured into British Columbia in Canada to secure gas supply for future requirements.

Despite the depleting gas reserves, Petronas is still committed to supporting PetChem’s growth as a gas-based petrochemical producer. Sazali says the group recently finalised a new gas supply agreement with its parent company, Petronas, before the current 20-year contract expires this September.

Apart from the ability to start a naphtha-based petrochemical plant, the investment in four plants in RAPID will increase PetChem’s capacity by half once they are up and running by late 2019 or early 2020, says Sazali.

“With the projects in RAPID, naphtha-based petrochemicals will constitute 30% of our production capacity. We would be much more robust than those players that are 100% naphtha-based producers, while on the gas-based side, nobody can be as big as us in this region,” says Sazali.

The O&G industry has been facing one of the worst downward cycles in history over the last 2½ years, with crude oil prices plunging from above US$110 per barrel in June 2014 to US$28 per barrel in January this year. Last Friday, international Brent crude futures were trading at US$47.66 per barrel.

While acknowledging that nobody can tell what the demand for petroleum and petrochemical products is going to be like over the next five years, Sazali says that, based on his past experience, there should be at least two upward cycles in the O&G industry over a 20-year period.

For a petrochemical project, one upward cycle is enough to recover the initial capital outlay, says Sazali, speaking from his experience during the construction of the Kerteh Integrated Petrochemical Complex (KIPC) in Terengganu in the early 1990s.

“It was the same scenario during that time. I was involved in the development of the aromatics complex in KIPC. People were asking why we were spending RM2 billion — a huge amount at that time — on these two plants.

“When we first ran the aromatics operation, the price was at the lowest margin. We built big plants with low margins but two years after that, the market picked up quickly. So, if we had not followed our discipline along the way back then, we would not be able to enjoy the benefits now,” says Sazali.

He adds that demand for petrochemical products is growing, especially in a region where 50% of the population is forecast to reach middle income level by 2030. Today, Southeast Asia has a population of 620 million. To fulfil the growing demand for petroleum and petrochemical products, Sazali estimates that there is a need for eight integrated refinery and petrochemical complexes the size of RAPID in the region.

To illustrate the high demand for petrochemical products in this region, Sazali says up to 70% of Samur’s capacity has been committed to customers so far, although demand for the products could take up the entire annual capacity of the plant.

PetChem’s balance sheet is still healthy, with cash and cash equivalents of RM8.57 billion and only RM15 million in borrowings as at March 31 this year. The group generated RM891 million in cash from operations in the first quarter ended March 31 (1QFY2016).

While the investments in RAPID will require PetChem to utilise its cash hoard and take up borrowings, Sazali assures that the group’s dividend payout policy of 50% of earnings will not be affected.

In 1QFY2016, PetChem posted a lower net profit of RM592 million compared with RM605 million a year ago, while revenue slipped 0.2% to RM3.15 billion from RM3.14 billion previously. However, during the quarter, PetChem’s plant utilisation across the group reached its highest level since listing, at 92%, compared with 90% in 1QFY2015. Its olefins and derivatives business recorded plant utilisation of 97% during the period, while fertilisers and methanol was 89%.

PetChem’s share price has been on a steady increase over the last one year, adding 7.7% over the period to RM6.45 last Thursday. Between Aug 24, 2015, and Jan 8, 2016, PetChem’s share price rose 40.3% to RM7.74.  Last Friday, the counter closed at RM6.20, 16.7% off its 52-week peak.

Analysts are quite bullish about the group’s prospects. Maybank Investment Bank Research has a target price of RM7.80 on PetChem over the next 12 months with a “buy” call, while Kenanga Research has placed a fair value of RM7.30 per share on the stock.

 

 

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