Michael R. Krenek
Wright Killen & Co.
Houston
An analysis of the economic and political factors affecting the petrochemical br in Latin America indicates that the region still holds excellent prospects for petrochemical companies.
THE NEXT ASIA?
The opportunity in Asia for petrochemical companies generally is well known among global players in the industry. Industry publications have thoroughly explored and documented the details of these opportunities.
Conventional wisdom dictates that most companies at least consider investing in Asia, and for good reason, in most cases. The more aggressive, growth-oriented companies, however, already are attempting to discover the "next Asia," if there is such a thing.
Latin America has been nominated as one of the less developed regions that might inherit the Asia/Pacific region's enviable position. This nomination, however, was made before the Mexican financial crisis and the burgeoning pressure on the currencies of Brazil and Argentina.
In light of current events, can Latin America still be considered the next Asia, and, if so, what opportunities will follow the devaluation of the Mexican peso?
GLOBAL SHIFT
Wright Killen believes the shifting patterns of global economics and petrochemicals are creating opportunities in Latin America on a fundamental level for companies within and outside the region. The Mexican financial crisis certainly has affected the near-term outlook, however, and Wright Killen advises potential investors to act prudently until the political and economic situation becomes clearer.
Wright Killen also believes that the many positive economic and political advancements made by Latin American countries in the past 5 years remain viable. In addition, it would be an overreaction to no longer consider Latin America a region for petrochemical investment during the next 5-10 years.
To accurately predict that Latin America, or any other region, will be the next Asia is impractical. The underlying economic and political fundamentals of some countries in this region still appear encouraging, as do the growth prospects for many key petrochemicals.
Analyzing the variables that are driving the opportunities in Latin America is a complex exercise. Shifts in global economic growth away from industrialized nations toward rapidly developing regions such as Asia and Latin America are creating notable changes in the petrochemical industry.
These changes will lead to significant shifts in the regional allocation of new investments, which is an important factor for Latin America. A profile of economic and petrochemical growth in the most industrialized regions will provide insight into the drivers for some of these global shifts.
INDUSTRIALIZED WORLD
For the past 25 years, the change in U.S. gross domestic product (GDP) varied sharply with economic cycles from year to year. An analysis of this data shows that the trend line is flat at best. This is no surprise, of course, because the U.S. economy is very mature and growth is expected to average an unexciting 2.5-3%/year.
Focusing on the U.S. petrochemical industry, Fig. 1 (32836 bytes) provides a long-term view by detailing the growth of ethylene production and capacity since the industry began in 1945, near the end of World War II. Fig. 1 (32836 bytes) indicates a "golden era" for petrochemicals in the U.S. between about 1960 and 1980. The industry experienced very high growth, led by the development of the polymers industry.
Since that time, the rate of growth has decreased. The current outlook for U.S. ethylene growth is only about 3%/year.
This same reduced-growth trend can be seen in the U.S. for almost every major petrochemical product. The long-term average growth rate falls between 2 and 4%/year for almost all petrochemical products.
These reduced expectations for growth rate represent a significant change from the 1960s and 1970s. Today's leaders of U.S. chemical companies, in sharp contrast to their predecessors during the golden era, cannot depend on U.S. growth to drive earnings and produce the strong financial performance still expected by shareholders. They must adapt to an environment of moderate growth and tailor their strategies accordingly.
In addition, events occurring in the U.S. refining industry may result in additional pressure on petrochemical businesses.
Growth prospects for refined products demand are only 1-1.5%/year, and refining margins are not attractive in many areas of the U.S. Many refining companies are responding to this situation by placing more emphasis on downstream chemicals. This will lead to new entrants in some markets and an even more competitive petrochemicals business as the struggle for market share intensifies.
A third factor driving U.S. companies' interest in developing regions is the loss of export market share.
For the 1981-90 period, the U.S. chemical industry's share of global exports declined 26%. The petrochemical industries of other industrialized countries, such as Germany, France, and Japan, held about even. But Asia, excluding Japan, increased its share several times over (Fig. 2)(30847 bytes).
This loss of market share by the U.S. was difficult to accept for an industry that had always relied on the export market to fill incremental production capacity. The author believes the recognition and acceptance of this reality has been an important part of the driving force for U.S. petrochemical companies to reclaim the lead in global competitiveness.
Low U.S. growth prospects, increasing domestic competition, and loss of export market share all are driving an increasing interest in global diversification among U.S. companies in the struggle to gain added value for their shareholders.
In Western Europe, the story is similar. Germany, France, the U.K., and most other countries in the region, have seen slowing GDP growth rates and recessions over the course of the last 9 years.
Looking ahead, the outlook is for slower GDP growth, perhaps in the range of 2-3%/year. Likewise, in the European ethylene market, growth has slowed and expectations are modest.
Wright Killen sees Western Europe as a large, industrialized region facing a slow growth future. As a result, Europe's large petrochemical companies, like those in the U.S., are seeking opportunities in the more rapidly growing regions. Europe, however, generally is behind the U.S. in restructuring its petrochemical industry and addressing competitiveness.
ASIAN GROWTH
Fig. 3 (26906 bytes) illustrates the sharp contrast in economic growth in Asia. Not surprisingly, the GDP growth rates in China and Thailand are very high. It is this type of strong economic performance by a number of countries in the region that is driving the many opportunities in petrochemicals.
In Japan, however, one can see the same trend that is evident in Europe and the U.S.: economic growth is slowing and harder to maintain. Japanese petrochemical companies, like those in the U.S. and Western Europe, are looking for growth opportunities outside their borders.
LATIN AMERICA
To assess the petrochemical prospects in Latin America, one must consider the state of both economic and political reform in the six countries that account for almost 100% of Latin American petrochemical capacity: Brazil, Mexico, Argentina, Venezuela, Colombia, and Chile. The economic climates and petrochemical market prospects vary significantly between these countries.
Fig. 4 (28870 bytes) characterizes the Latin American petrochemical market by showing the demand for five key products: ethylene, benzene, high-density polyethylene, low-density polyethylene, and polyvinyl chloride.
Brazil and Mexico account for 75% of total demand for these chemicals. Argentina is a mid-sized market. And Venezuela, Colombia, and Chile all are much smaller markets.
The GDP growth rates shown in Fig. 5 (33403 bytes) indicate a relatively broad range of economic performance in the region over the past 3 years. This is largely a reflection of the fact that economic reforms are in different stages of maturity and development in the different countries of the region.
Note that Chile and Argentina averaged more than 6% economic growth between 1991 and 1993, which is a strong performance by any standard.
Success in reducing inflation is further evidence of successful economic reforms. Most countries in this region have tamed the hyperinflation that has been associated with Latin America by the rest of the world (Fig. 6)(27911 bytes).
Fig. 6 (27911 bytes) indicates that Brazil still is experiencing hyperinflation because the data that were used document 1993 performance. The economic situation in that country has changed, however, as will be described.
Given these factors, it is not surprising that Latin America has captured the world's attention, including that of the global petrochemical industry. A more detailed look at Mexico and Brazil will provide additional insight and address the recent economic and political turmoil that began in Mexico and is pressuring other Latin American countries.
MEXICO
The recent political and economic turmoil in Mexico reinforces the fact that Latin America is a developing region and that investment risks there include more political uncertainty than exists in most industrialized countries.
The events of the last year also suggest two key points that should be kept in mind when considering Mexico's future:
- The Mexican people's desire for political and economic reform is very strong
- At least some of those Mexican citizens opposed to fundamental change apparently believe that the prospects for significant reform are very real this time, and are resisting strongly in an effort to stop, or at least slow, the pace of political and economic reform.
If these points are correct, the current troubles can be seen as part of Mexico's change process and are not really surprising in a historical context. These points also suggest that the reforms that have been instituted in recent years will continue.
While Mexico's GDP growth has been only moderate in recent years, inflation has been controlled. Inflation may increase, however, under the financial austerity plan being implemented by President Zedillo's government.
Perhaps more important, Mexico has established several years of sustained economic reform and growth. It is this consistent progress, although slower than many would desire, that provides the best evidence to support a long-term outlook that is more optimistic than the recent events in global financial markets would suggest.
Other fundamentals also support this optimism. Mexico has the second largest domestic market in Latin America, and a middle class is rapidly developing. These factors indicate rising consumer spending and demand for petrochemicals.
Mexico also is moving toward a stronger free-market business environment. The country is extensively making trade agreements, privatizing industry, and lowering barriers to foreign investment. In addition, the Mexican petrochemical industry can build on national strengths in heavy crude oil, geography, and low labor costs.
Despite the current uncertainties, Mexico will continue to attract foreign investment. And the rate of new investment undoubtedly will increase once the political turmoil subsides.
BRAZIL
Brazil is the largest petrochemical market in Latin America. Because of its geographical size and population (about 160 million), it always has attracted global attention.
Looking back over the past 5 years, Brazil's economic picture has not been encouraging. GDP growth has been erratic, efforts to reduce hyperinflation have failed, and petrochemicals demand has been flat. However, this may be changing.
Today there is increased optimism that Brazil's "great potential" will be realized to a greater degree than in the past. The implementation of the June 1994 economic stabilization program, the "Plan Real," and the election of President Cardosa have generated greater faith and hope that economic reforms will be pursued vigorously, and that inflation will be brought under control for the long term.
Rising consumer confidence already is evident. This confidence, coupled with sound economic policies, if continued, can fuel strong sustainable growth in the economy and in petrochemicals.
Fig. 7 (25075 bytes) illustrates the initial success of the Plan Real. In the first 4 months following the plan's implementation, inflation averaged 1.5-2.0%/month, compared to an average of almost 40% /month in the first half of 1994.
Even before the Mexican financial crisis, however, strong pressures already were building against continued success in Brazil. And maintaining low inflation and stable prices will not be easy.
Almost paradoxically, consumers are increasing their spending sharply and encouraging inflation. And debt loads on state banks are high. The government apparently has taken a lesson from the Mexican situation, however, and has modestly devalued the real in recent days. This should help relieve some of the additional financial pressure on Brazil's currency that followed devaluation of the Mexican peso.
Continued progress will require a strong commitment from the government and the Brazilian people. The author believes several years of sustained performance will be required to turn today's international faith and hope into proven confidence in Brazil. If earned, this firm, international confidence, will lead to the higher levels of foreign investment that can help Brazil increase the growth rate of its petrochemical industry.
ARGENTINA
Argentina is another country and petrochemical market that is attracting attention in Latin America because of sustained success in economic and political reform. Like Brazil, however, its currency has come under pressure in recent weeks because of the fallout from Mexico.
Argentina's economic reform program is younger than Mexico's, but GDP is growing, inflation is at or near single digits, and petrochemical demand is increasing significantly. Although Argentina is much smaller than Mexico and Brazil, it has achieved a good balance of economic and political reform, favorable business climate, and petrochemical market size.
The progress in Argentina and other Latin American countries indicates that, despite the uncertainties caused by the situation in Mexico, the fundamental opportunities in Latin America still appear to be intact. Political and economic reform are progressing, and the two are required together to help ensure mutual success.
A middle class that can support the sustainable consumer spending that drives petrochemical demand is developing.
Additionally, the prospects for the region look even better when compared with the growth outlook in the industrialized world and in mature petrochemical markets.
Wright Killen believes Latin America ranks second only to Asia as the developing region with the best prospects for petrochemicals in the next 5-10 years.
