Asia's petrochemical sector still reeling from economic collapse

The Chandra Asri complex, Indonesia's sole ethylene producer, has racked up huge losses recently because of the continuing economic crisis in Indonesia and elsewhere in Asia. Japan's Marubeni Corp., a principal investor in the complex, has seen its credit rating downgraded because of its exposure to Indonesia's troubled petrochemical sector. Photo courtesy of Marubeni.

Mitsubishi Chemical Corp. has cut back its ethylene output by 10% in response to the economic and petrochemical industry downturns in Japan. Shown here is Mitsubishi's Mizushima ethylene complex in Japan. Photo courtesy of Mitsubishi [40,239 bytes].
Mitsui Chemicals Inc.'s Ichihara complex in Japan's Chiba Prefecture is another Japanese olefins facility that has seen reduced output as a result of the petrochemical industry doldrums in Asia. Photo courtesy of Mitsui [39,225 bytes].

As the economic crisis in Asia deepens, the petrochemical sector remains one of the hardest hit sectors in the region.

Moreover, cautious forecasts of recovery in Asia suggest that it will be several years before demand rebounds to the levels of mid-1997, just before the Asian "flu" broke out. Even the optimists are not anticipating a return to normal market conditions before 2000.

Central to everyone's concerns regarding the economic doldrums is the state of Indonesia. An Indonesian economic and political collapse would plunge the whole of Asia into a further spiral of devaluing currencies and renewed economic crisis, and would have global implications.

So would a further decline of the Japanese economy. The demise of the yen in recent months has followed the confirmation that the country has technically entered into recession. That development, together with the ensuing market intervention-of about $2 billion in a single day by the U.S. Federal Reserve Bank-to prop up the Japanese currency, reflects just how deep concerns are over the state of Asia's largest economy.

Also desperately worried is China, which continues to reiterate its promise not to devalue the renminbi (yuan). However, many believe that Beijing has extracted a promise from both Japan and the U.S. to ensure that the value of the yen will not be allowed to fall any further. Should the money markets take up the challenge and put further pressure on the yen-as seems likely, unless the Japanese government takes decisive action soon to stimulate the domestic economy-the Chinese might feel forced to devalue their currency, a move that would have far-reaching consequences.

Nevertheless, the strength of the dollar against Asian currencies has, ironically, become a straw to gRasp for survival. Any decision by the U.S. to allow the dollar to weaken against global economies could undermine the strategy now in place and endorsed by the International Monetary Fund for stricken nations to export their way out of the present crisis.

Asian petrochem woes

For Asian petrochemical producers, market activity has become a matter of day-to-day survival during the past year, and there are few signs that margins or profits will improve in the months to come.

With plunging petrochemical prices, cracker cutbacks will inevitably have to be made to reduce operating costs. At the same time, there is little hope of increased margins further down the line: polypropylene (PP) and polyethylene (PE) prices are hitting historic lows, and high-density polyethylene (HDPE) prices are down to their lowest levels in 4 years and, in real terms, possibly their lowest in decades.

"There is increasing pressure for producers to reduce operating rates due to overcapacity as a result of the collapse in downstream petrochemical demand," said Philip Hall, chemicals analyst with Schroders in Tokyo.

Indonesia critical

Nowhere in Asia is the crisis as critical as it is in Indonesia, principally due to the complete collapse of the rupiah, which has fallen in the space of a year from 2,500:$1 to about 14,000:$1.

The result is that there is hardly a single chemical concern capable of meeting its debt payments, and, indeed, many of them are technically bankrupt.

Indonesian domestic chemical demand has virtually dried up, while on the international market, product prices have slumped because of a glutted market. The result is that companies are constantly having to revise their strategies to survive this crisis. Major Indonesian PP producer Tripolyta, for example, recently obtained permission from its creditors to use about 124 billion rupiah in funds originally earmarked as cash flow for new projects. However, because the funds are still in rupiah, unless the currency sharply increases in value, the company will still have to accept huge foreign-exchange losses on these borrowings. The company's debts total almost 250 billion rupiah.

The situation at rival Polytama is, if anything, even worse. It is holding extensive talks with creditors to restructure its debt repayments following its failure to meet an 11.5% interest payment on its $200 million in U.S. bonds. Moreover, its outlook is further clouded by the fact that it sells entirely into the domestic market.

Indonesian PE demand, meanwhile, has slumped from 550,000 metric tons in 1997 to an estimated 150,000 tons this year. As a result, many operators have been forced to cut back production. Petrokima Nusantara Interindo (PENI), for example, is running its Merak plant at 50-60% of its 450,000 ton/year linear low-density (Lldpe)/ HDPE capacity and has mothballed plans to add a third 200,000 ton/year line.

"We are going to have to accept significant losses, maybe for several years, before the potential of Indonesia's huge market again begins to be realized," admitted a source at Mitsui & Co., which has a 12.5% stake in PENI.

Japanese in Indonesia

Japanese companies collectively represent the biggest multinational presence in Indonesia. Their financial support is vital to many chemical and petrochemical projects that would otherwise be having serious trouble keeping afloat.

However, Japanese companies' exposure to Indonesia has led Moody's Investor Service to revise their credit ratings. It recently downgraded Marubeni Corp., for example, partly because of its 23.8% stake in the Chandra Asri complex, Indonesia's sole ethylene producer. The $1.88 billion venture has been producing 510,000 tons/ year of ethylene, 300,000 tons/year of PE, and 240,000 tons/year of PP, as well as 240,000 tons/year of pyrolsis gas/year since 1995. Marubeni has loans and investments related to the complex totaling about ¥80 billion to date, boosted by an advance payment in February of about $150 million for monomer and polymer supplies.

The venture initially expected to begin turning a profit in 1997. But it racked up a loss of $84 million last year under the weight of huge interest-bearing debts and slumping demand for petrochemical products in Indonesia. As a result, Japanese banks have been forced to agree to the deferral of $180 million (¥25 billion yen ) of loans to Japanese investors, including Maru- beni and Showa Denko KK. The $180 million is the principal of the project's capital, and was originally to be paid off in six tranches during the first 3 years of project operations.

Now the Export-Import Bank of Japan, Fuji Bank, and Bank of Tokyo-Mitsubishi have agreed with Japan Indonesia Petrochemical Investment Corp., the investment firm set up by Marubeni (with an 89% stake) and other Japanese investors in Chandra Asri, to suspend debt payments until August 2001. Chandra Asri has borrowings totaling $472 million from the three banks.

At the same time, the twice yearly interest payments on the remaining capital will also be put off by a further 3 years, meaning that completion of payments will be postponed to February 2009 from the originally scheduled 2006.

Five Indonesian banks have also reached agreement in principle to reschedule debt with Indonesian investors in Chandra Asri, including the Bimantara and Barito business groups.

Meanwhile, Chandra Asri's cash flow will remain very tight, especially after its decision to suspend export sales of ethylene and propylene in July and August because of poor prices. This will make it solely dependent on a domestic market where demand for polymers has dropped by as much as 70% from 1997 levels.

However, the company still maintains that its long-term aim is to broaden its product range by adding a third PE line and a PP plant, as well as aromatics and solvent facilities. However, analysts point out that it will have trouble finding a strategic partner to help meet the costs of such a plan under current economic conditions.

"The problem Japanese investors are facing is that the economic collapse came just as many of these new projects had recently come on stream or were just about to come on stream. The result is that they are now burdened by huge start-up costs and no way to turn the profit needed to pay off those costs," explained Tommy Tang, chemicals analyst at Merrill Lynch in Tokyo.

"Nevertheless, in the longer term, the Indonesian market is simply too big for these companies to ignore, and I wouldn't be surprised to see Japanese investors prop up their joint ventures with further cash infusions," Tang added.

Japan's problems

Meanwhile, domestic Japanese producers are facing serious problems of their own. Japan's petrochemical demand is by far the biggest in the region and therefore the key to any real improvement in the sector's economic health.

But all the signs are that Japan's economy is mired deeply in recession, with domestic consumer spending falling rapidly.

Schroders' Hall pointed out: "Japan is in a Catch-22 situation: The collapse of the bubble economy exposed the huge debts the banks and companies were holding. The need for the banks and companies to restructure their operations by cutting costs-especially labor costs-is vital.

"Also vital is the stimulation in consumer demand. But as long as the general public perceives a threat of unemployment, they will save every penny they can. This will put additional pressure on companies to cut costs and lay off workers, which leads to people being even less reluctant to spend," Hall said.

There is also doubt among Japan's petrochemical players whether the country's new prime minister will achieve a turnaround sufficient to revive the economy and to boost their flagging performances.

Faced with a slowdown of 5% in second quarter industrial growth, and a seemingly unstoppable slide in the value of the yen and in petrochemical prices, the country's chemical players and industry analysts are viewing the new regime in Tokyo with skepticism: "Even with the new corporate tax rate cuts, we're still going to be burdened with the highest (corporate tax) rates in the developed world. As for the cut in consumer tax rates, the amount an individual family will save is simply not enough to convince them to go out and start spending again-they'll simply put it into their savings account," argued one industry source.

In the meantime, petrochemical producers will have to find ways to cope with rising inventories, many of which are close to record high levels. Japanese PE inventories in May, for example, were up over 28% year-to-year, while PP inventories were up almost 19%. The result is that olefins producers such as Mitsubishi Chemical Corp. and Mitsui Chemicals Inc. have announced 10% cutbacks in their ethylene output in response to the collapse in demand, which is likely to produce cuts in production of other petrochemical products. This comes at a time when most operating rates are already at only 85%. The Ministry of International Trade and Industry, meanwhile, has warned that ethylene output will be sharply down this year.

"The outlook is gloomy; we are unlikely to see a significant pick-up in domestic demand this year, and exports are going to be hard hit by a slowdown in demand from China and the start up of the new Formosa (Plastics Corp.) cracker in Taiwan," said Hall. Indeed, three of the country's principal petrochemical producers-Mitsubishi Chemical, Tosoh Corp., and Sumitomo Chemical Co. Ltd.-have all recently warned that their pre-tax profits for this fiscal year will be down by 12-40%.

All this is putting increasing pressure on Japanese petrochemical producers to boost efficiency through restructuring and tie-ups. In its first medium-range management plan since Mitsui Toatsu and Mitsui Petrochemical Industries Ltd. merged last October, Mitsui Chemicals says that it will pull out of unprofitable businesses and focus on other business areas with high-growth potential in an attempt to boost sales and pretax profits from ¥532 billion and ¥26 billion, respectively, in 1997 to ¥780 billion and ¥48 billion by 2000.

Areas targeted for growth include urethane materials, electronic materials, health care products, and precision chemicals. At the same time, the company will either pull out of resin production or tie up with other companies in the low-profit business. The likely targets include styrenes and vinyl chloride products such as acrylonitrile butadiene styrene, vinyl chloride mon- omer, polyvinyl chloride, and polystyrene (PS).

However, the company will still retain some petrochemicals as part of its core operations. These include ethylene, propylene, polyethylene terephthalate, purified terephthalic acid (PTA), phenol, elastomers, and PE. As a Mitsui Chemicals source pointed out, "We have just spent ¥10 billion in developing our metallocene PE operations, and our new Lldpe plant has come on line, so it's unlikely that we will be selling that business off."

But Tang points out that details remain vague on exactly how and when Mitsui Chemicals is going to implement this plan: "Equally importantly for the long-term health of the company, they have given no details on cost-cutting measures, such as reducing their work force, or how they are going to consolidate their production and R&D operations-both of which are vital if they are to seriously reduce their operating costs."

There are also rumors of a merger involving the PS operations of Denki Kagaku Kabushiki Kogyo (Denka), Japan Steel, and possibly Daicel Chemical Industries Ltd. If these three producers do merge their PS businesses, they will have a total capacity exceeding 400,000 tons/year, forming the second largest PS group in Japan.

The move would follow the merger of Mitsui Toatsu and Sumitomo Chemical's PS operations in October 1997 and Asahi Chemical Industry Co. Ltd. and Mitsubishi Chemical's PS businesses this May. The latter will eventually become the largest PS producer in Japan, with a capacity of 543,000 tons/year, or almost 37% of the domestic market.

On the other hand, Tosoh Corp. recently announced that it will pull out of the styrene monomer (SM) business "due to excessive competition, which has lead to a collapse in global (SM) markets." The company closed its 130,000 ton/year plant at Yokkaichi, Mie Prefecture, in September.

Mitsubishi Chemical and Tonen Corp., meanwhile, are to sell off their PP and PE manufacturing operations to Japan Polychem in a deal worth "over ¥50 billion." Japan Polychem is a 50-50 joint venture of Mitsubishi Chemical and Tonen set up to market PP and PE.

"The move will enable the two companies to integrate their PP and PE manufacturing operations under one umbrella company (which already acts as the sales agent for these chemicals), thus allowing for big savings to be made in production costs," said a Mitsubishi Chemicals official. The deal, which took effect Sept. 1, will give Japan Polychem a total production capacity of 524,000 tons/year of Lldpe, 199,000 tons/year of HDPE, and 738,000 tons/year of PE, generating annual sales revenue of about ¥100 billion.

"The move is sort of good," said an analyst, "as it will allow Mitsubishi Chemical to at least partially pull out of the PP and PE businesses.

"However, given their poor performance and ever-increasing overcapacity in the Asian region as a whole, it would have been far better for them if they'd been able to sell off their stake in Japan Polychem altogether."

"Nevertheless," Merrill Lynch's Tang, argued, "fully integrating its PP and PE operations into Japan Polychem allows Mitsubishi Chemical to reap some savings and marks yet another step towards the much-needed consolidation among the various sectors of the basic chemicals industry in Japan."

South Korean dilemma

But if restructuring is needed in Japan, it is even more needed in the neighboring South Korean petrochemical industry.

Overcapacity has forced producers in South Korea to export their way out of trouble as domestic demand dries up. However, a potentially far more serious long-term problem facing the industry is the huge level of debt stemming from rapid production expansion in the late 1980s and early 1990s. It is estimated that the chemical sector and other industries are weighed down by a total domestic debt burden of $400-600 billion.

Hanwha Chemical Corp. and Hyundai Petrochemical Co., for example, are expected to end the year with debt-to-equity ratios exceeding 600%, while Samsung General Chemicals Co. Ltd., LG Chemical, Ssangyong Oil Refining Co., Daelim Industrial Co. Ltd., and Korea Kumho Petrochemical Co. all have debt-to-equity ratios of well above 300%.

This has made banks reluctant to allow many petrochemical companies to open letters of credit over fears that they might go bankrupt. This, in turn, has made it difficult for companies to acquire the funds necessary for raw material purchases.

Moreover, the problem will be made worse by government reforms to the banking sector that will impose strict limits on the percentage of loans that are nonperforming, leading to a new credit crunch. Chemical industry sources are predicting a resulting slowdown in the country's chemical exports and, consequently, in operating rates in second half 1998: "This, combined with signs of a slowdown in the U.S. economy and a continued slump in Japanese domestic demand, will leave many companies unable to meet domestic loan repayments that have not been rolled over," an industry official said. "It has become a vicious cycle."

In an attempt to increase the efficiency and competitiveness of its petrochemical industry, the South Korean government has instigated the "Big Deal" program, an initiative whereby chaebols (South Korea's huge diversified industrial conglomerates) with chemical and other concerns would swap those concerns for the activities of other conglomerates. If successful, the swaps could lead to a radical change in the structure and ownership of South Korea's chemical industry.

Samsung and Hyundai, for example, plan to shift their operations at Daisan to a jointly run company that will manage Samsung's 500,000 ton/ year cracker and Hyundai's 1 million ton/year cracker. Both companies also produce significant quantities of benzene/toluene/xylenes, propylene, PE, PP, and SM, while Samsung also has a PTA JV with Amoco Chemical Co. at the site.

"By combining the two, the government clearly hopes that synergies will be created that will significantly cut running-particularly administrative and marketing-costs," said chemicals analyst George Goundry at HGAsia in Seoul. "On the surface, relations between the two companies look amicable-they have a long history of product cross-supply, for example-but behind the scenes, there are a lot of political issues that might well rear their ugly heads. If they do, then many of the intended benefits might well fail to materialize.

"At the core is the highly sensitive issue of who is going to run the show. Samsung has indicated that it is prepared to back off the petrochemical sector. If it does so, then the JV could be a success. But if it doesn't, then the ensuing fight for control might negate the benefits of the tie-up."

The problem of control is likely to be even more acute with two other proposed mergers (a date for either of which has yet to be set). These involve merging LG Chemical's and Hanwha's petrochemical production (principally PVC, PE, PP, and styrenics) at Yeachon, and SK Corp. (formerly Yukong Ltd.) with Korea Petrochemical Industries (KPI) at Ulsan.

"Regarding SK and KPI, the latter will provide little benefit to the former given that it produces a little of everything and a lot of nothing," Goundry said. "At the same time, SK will have to put up with potential government interference, given that KPI is still state-controlled. As for LG and Hanwha, LG is likely to put up stiff resistance to merging with Hanwha, given the latter's acute financial problems."

But, as another Seoul analyst pointed out, "Any swap arrangement is fraught with difficulties, not least the problem of asset evaluation and debt takeover, especially given the cross-assuming of debts within the chaebols. It is very unlikely that the companies are going to readily agree on how much each is worth, let alone agree on who is going to assume whose debts."

For example, Hanwha Group's financial problems will also have to be sorted out if Hyundai Oil Refinery Co. acquires Hanwha Energy as planned. This issue will prove vital, Goundry believes, if the takeover is to be a success, especially given the fact that the two companies' refineries are at opposite ends of the country. Hyundai's refinery is at Yaechon; Hanwha Energy's is at Pusan.

A merger of the two would create the country's third-largest oil company, with an asset base of about $6 billion and a 20% share of the market. Perhaps more importantly, it would give Hyundai easier access to the lucrative Seoul market.

But Goundry remains skeptical of the benefits of these various alliances: "These companies are all fairly competitive as they stand. By shifting the emphasis to cooperation, the government might well find the exact opposite happening to what is intended."

Nevertheless, all companies are seriously studying the proposed swaps, arguing that there are synergies and real cost savings to be made, such as increased bargaining power in feedstock supply negotiations and the ability to strengthen product prices through closer adjustment of operating rates.

"Still, at the end of the day, the government lacks sufficient economic or political clout to force these companies into swapping their assets. If any swapping does take place, it will be because the companies want it," pointed out the Seoul analyst.

Malaysian exception

One country that has successfully managed to keep the problem of overcapacity within manageable levels is Malaysia.

The reasons for this stem from the huge influence and control that the state-owned oil and gas giant Petronas has over the industry. Not only is it the core investor at the upstream end of the industry, but virtually all downstream investments are either Petronas-led or involve foreign partners in ventures with Petronas. Outside of this core, relatively few chemical players have emerged in a market of just 18 million people, and those that have developed independently are almost exclusively foreign-owned. This strategy has meant the avoidance of the damage seen in the chemical industries in countries such as Japan, Thailand, and South Korea due to excessive competition.

As a result, foreign investment in the Malaysian petrochemical industry continues apace. Last August, Petronas signed a memorandum of understanding (MOU) with Germany's BASF AG to boost gas-cracking capacity to provide PP for the C3 derivatives complex at Gebeng in Pahang State.

This March, Petronas also reached an agreement with Union Carbide Corp. for the construction of a 70:30 Petronas-led gas cracker at Kerteh in Terengganu state at a cost of $1.5-2 billion. The complex will produce 600,000 tons/year of ethylene and 100,000 tons/year of PE, with start-up slated for mid-2001. The move will double Petronas's participation in ethylene production by 2002 as the company already owns a 72.5% stake in the Ethylene Malaysia joint-venture cracker with BP Chemicals Ltd. and Idemitsu Corp.

The two core petrochemical plants will spawn a range of related downstream investments and considerably enhance the extent of integration and cost-savings through shared infrastructure at the two neighboring complexes.

China slowdown looming?

So far, many chemical companies in the region have been kept afloat largely by strong demand from China.

However, not only are there signs of a slowdown in the Chinese economy and dampening demand due to a high build-up of inventories in 1997, but China has now also scrapped preferential tariffs on petrochemicals for the first time, in an attempt to help domestic producers fight the flood of low-priced imports.

The removal of preferential tariffs for selected chemicals-some as low as 4%-will mean a return to normal tariff rates for polymers, PTA, ethylene glycol (EG), and other chemicals of 10-16%. In the first 5 months of this year, China imported about 150,000 tons of PTA-almost the entire amount imported for all of 1996.

The move is expected to help domestic PTA producers such as Yangzi Petrochemical, which came close to filing an antidumping application with the government against several other Asian producers. However, it backed away from the threat at the last minute because of difficulties in ascertaining its rivals' production costs.

The government has also stepped up efforts to counter the growing problem of smuggling. It has set up a special police force and has ordered stricter customs checks at ports targeting shipments of chemical fibers, petrochemicals, and refined products. Penalties have also been toughened. The government estimates that up to 3.5 million tons of plastic resins were smuggled into China during 1997, compared with 7 million tons imported legally.

"While China will continue to be a major importer of chemicals, even a relatively small decline in imports will have a serious knock-on effect on regional producers, given their very high levels of dependence on the Chinese market," pointed out Merrill Lynch's Tommy Tang.

Meanwhile, a longer-term threat to other producers in the Asia-Pacific region are plans by China to rationalize its petroleum and petrochemical industries, and already international industry consultants are viewing the impending changes as a warning signal to foreign producers used to regarding China as an easy export market.

China has in the past made clear its intentions to create conglomerates capable of pitting themselves against multinational giants such as BP, Exxon Corp., and Royal Dutch/Shell. Also clear is the desire to increase self-sufficiency and to lower the country's dependency on imports.

Now, China plans to vertically integrate companies involved in oil extraction and chemical production prior to the establishment of two petroleum and petrochemical mega-enterprises, with each entity controlling its own existing oil production, refineries, and petrochemical plants.

Although a recent report by ING Barings argues that it will be difficult for two such conglomerates to easily merge-at least in the near-to-medium-term-with such a wide diversity of upstream and downstream activities, industry watchers warn that, in the longer term, China's plans could create serious problems for regional producers that are very heavily dependent on exports to the Chinese market.

One analyst noted: "While demand will continue to far outpace local production, many regional producers-particularly the South Koreans-devised ambitious chemical and petrochemical expansion programs with the Chinese market specifically in mind. If and when China becomes relatively self-sufficient for its chemical needs, those producers will find themselves in serious trouble."