Saudi Petrochemical. Saudi Petrochemical Sector. Global Research Sector Petrochemicals Equities Saudi Arabia June 20, 2012

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1 Saudi Petrochemical Global Research Sector Petrochemicals Equities Saudi Arabia June 20, 2012 Saudi Augmentation in feedstock prices ruled out for the time being; not too last long Shift to alternate feedstock a double edged sword Plunging oil price dragging the share price of petrochemicals companies Strong Buy: SABIC, YANSAB & SIPCHEM Augmentation in feedstock price ruled out for the time being; not too last long Price of feedstock have been steady and unchanged over a decade. Ethane prices which currently stand at USD0.75/mmbtu were expected to rise last year and the news regarding it made huge rounds, however, in early 2012 the price increase was ruled out. We are of the view that this rise has not resulted because of drop in international gas price which are expected to make the prices of petrochemicals in North America very competitive. Although we do not rule out rise in feedstock prices in the coming years, however, we have not yet incorporated the increased prices in our models. Saudi Arabia shifting to alternate feedstock Scarcity of gas, coupled with inapplicability of ethane to yield higher-value products, is however driving petrochemicals producers of Saudi Arabia away from it. In view of the aforesaid restrictions, the petrochemicals producers are shifting toward alternative feedstock such as naphtha. The trend of shifting away from ethane for diversification of the product is encouraging, as it is in line with the government s efforts to promote production of higher value chemicals and plastics essential for broader-based industrial and economic development in the region. Outlook; not too rosy in the long term for Saudi Arabia Petrochemical producers in the Saudi Arabia are currently at a quite defining moment that in the long term will affect their business. Following years of development and significant growth, the industry is now experiencing a shortage of natural gas. This is leading petrochemical players to use liquid feedstocks, which do not offer the same cost advantages as natural gas. At the same time, feedstock supplies are undergoing major changes worldwide. Production from Shale gas is increasing at a higher pace which will make US petrochemical more competitive, China has ambitious plans to convert coal to olefins, new exploration of oil and gas in Iraq can result in an increase in low cost feedstock from Iraq. Collectively all these developments can present a material threat to the Saudi petrochemical players. Faisal Hasan, CFA Head of Research fhasan@global.com.kw Tel: (965) Hettish Karmani Senior Financial Analyst hkumar@global.com.kw Tel: (965) Global Investment House Plunging oil price dragging the price of petrochemicals Oil price has received severe battering in the last couple of months. Number of factors have contributed to the tumult, economic slowdown in Europe, particularly in Spain, Italy and Greece has dampened the demand, higher than expected increase in production from Iraq and Libya and increase in Non-OPEC supply to 0.52mnbpd in 2012 compared to 0.09mnbpd in Since the price of petrochemicals generally track the price of oil, the companies have witnessed double beating: falling share prices and drop in product prices and hence revenue. Same has been the case with Saudi Petrochemical companies as the Tadawul petrochemical index witnessed a fall of 14.6% in the last three months. Prices of SABIC, YANSAB & SIPCHEM also registered significant decline of 13.4%, 13.7% and 22.6% respectively in last 3months, which is the reason of Strong Buy recommendation despite expected drop in profitability and margins. Global Research - Saudi Petrochemical Universe Company CMP (SAR) Mkt. Cap (USD mn) SABIC , % Strong Buy YANSAB , % Strong Buy SIPCHEM , % Strong Buy Source: Bloomberg & Global Research P/Bv 2012e P/E 2012e Target Price (SAR) Upside / (Downside) Recommen dation

2 Global Research Saudi Arabia Valuation Methodology For arriving at the fair value, we have used a blend of two valuation methods: Cash flow approach represented by the Discounted Cash Flow method. Relative valuation using peer group P/E multiple. Valutions DCF SABIC YANSAB SIPCHEM (SAR mn) (SAR mn) (SAR mn) PV of Cash Flows & Terminal Value Yr 1 42,795 2,822 1,053 Yr 2 35,502 2,446 1,121 Yr 3 36,374 2, Yr 4 21,486 2, Terminal 256,047 31,656 8,519 Assumptions Growth Rate 3% 3% 3% Risk Free Rate 1.7% 1.7% 1.7% Risk Premium 11.1% 11.1% 11.1% COE 12.8% 12.8% 12.8% WACC 11.6% 11.1% 11.8% Equity Value 374,248 32,751 10,233 DCF based Fair Value per Share Relative Valuation Peer Group Multiple Price based on Relative Valuation Method Fair Value Fair Value - DCF (80%) Fair Value - Relative Valuation (20%) Fair Value Source: Global Research June

3 Global Research Saudi Arabia Peer Group Analysis Name Country Mkt Cap Stock Performance P/E P/BV USD mn 1m 3m 12m Saudi Basic Industries Corp KSA 73,396 (2.1) (13.4) (8.3) Saudi Kayan Petrochemical Co KSA 6,080 (6.7) (22.8) (15.6) Yanbu National Petrochemical KSA 6,735 (4.1) (13.7) (1.3) Saudi International Petrochemical Co KSA 1,775 (8.6) (22.6) (11.3) Sahara Petrochemical Co KSA 1,638 (7.0) (24.9) (31.6) Advanced Petrochemicals Co KSA 1,106 (1.6) (12.8) (4.2) Methanol Chemicals Co KSA 487 (9.3) (20.3) Alujain Corporation (Alco) KSA 285 (12.2) (29.1) (23.9) Nama Chemicals Co KSA 552 (6.4) NA 1.5 National Industrialization Co KSA 5,654 (3.1) (11.6) (1.4) Rabigh Refining And Petrochemical Co KSA 4,590 (6.7) (22.9) (23.2) National Petrochemical Co KSA 2,720 (11.5) (16.3) (0.7) Basf Se GERMANY 66, (12.2) (6.2) Mitsubishi Chemical Holdings JAPAN 6,684 (2.8) (21.7) (34.8) Petrochina Co Ltd-H CHINA 264, (2.9) Exxon Mobil Corp US 395, (1.8) China Petroleum & Chemical-H CHINA 86,029 (2.1) (16.5) Sinopec Shanghai Petrochem-H CHINA 5, (18.2) (22.6) Sumitomo Chemical Co Ltd JAPAN 5,311 (7.7) (31.2) (32.2) Lyondellbasell Indu-Cl A NETHERLANDS 23, (2.2) Petronas Chemicals Group Bhd MALAYSIA 16, (0.7) (1.2) Reliance Industries Ltd INDIA 42, (2.1) (10.7) Source: Bloomberg & Global Research As of 19 June 2012 June

4 WACC COD WACC COD WACC COD Global Research Saudi Arabia Sensitivity Analysis SABIC Terminal Growth Rate COE ##### 1.0% 2.0% 3.0% 4.0% 5.0% ##### 10.8% 11.8% 12.8% 13.8% 14.8% 9.6% % % % % % % % % % YANSAB Terminal Growth Rate COE % 2.0% 3.0% 4.0% 5.0% % 11.8% 12.8% 13.8% 14.8% 9.1% % % % % % % % % % SIPCHEM Terminal Growth Rate COE % 2.0% 3.0% 4.0% 5.0% % 11.8% 12.8% 13.8% 14.8% 9.8% % % % % % % % % % June

5 Global Research Saudi Arabia Petrochemicals Themes World output to drop in 2012 when compared to 2011 The Global economy has witnessed various ups and downs in the last couple of years. Rising sovereign debts, increasing inflation and rise in unemployment have continued to make the situation worse. These situations have given rise to subdued demand for the petrochemical products. Situation has also worsened because of the global credit crunch which has created difficulties in getting the required funding for the projects which in the case of petrochemicals are not very small. World Economic Outlook Projections (%) e 2013e World Output 5.3% 3.9% 3.5% 4.1% Advanced Economies 3.2% 1.6% 1.4% 2.0% US 3.0% 1.7% 2.1% 2.4% Euro Area 1.9% 1.4% -0.3% 0.9% Japan 4.4% -0.7% 2.0% 1.7% UK 2.1% 0.7% 0.8% 2.0% Canada 3.2% 2.5% 2.1% 2.2% Developing Asia 9.7% 7.8% 7.3% 7.9% China 10.4% 9.2% 8.2% 8.8% India 10.6% 7.2% 6.9% 7.3% MENA 4.9% 3.5% 4.2% 3.7% GCC 5.2% 8.0% 5.3% 3.7% Source: IMF Passive demand affected various petrochemicals projects globally which lead to project delays or outright cancellations. The majority of those project which were shelved were in Western Europe and North America. Europe continues to remain the biggest market for petrochemical products Petrochemicals consumption is generally a function of GDP and the economies in the developed regions of the world have weakened in the recent past. Many industries, such as the construction industry and automotive industry, have suffered a significant downturn in such scenario. Overall consumer spending has also affected. As a result, the demand for petrochemicals in major end-use markets declined. The collapse in petrochemical demand and a loss of business confidence also triggered industry wide de-stocking, and drastic cutbacks in petrochemical production. The impact of economic downturn has been the greatest in the US and Western Europe. Basic & Diversified Chemicals Sales by Region (%) Asia Pacific 43.5% 37.8% 34.1% 29.3% Europe 43.0% 38.0% 31.7% 40.5% North America 21.3% 19.9% 28.3% 27.0% South America, Africa & Middle East 10.5% 10.4% 11.1% 8.1% Adjustment -18.3% -6.1% -5.2% -4.9% Source: Bloomberg Despite that Europe is still the biggest market for the basic and diversified chemicals. On an average sales exposure of petrochemical companies towards Europe as of 2011 is 40.5% followed by 29.3% in Asia Pacific. Within Asia Pacific majority of the chunk is being acquired by China as the country is 50% producer of various industrial commodities. Petrochemicals demand to be led by China going forward China has emerged as the biggest petrochemical market in the world. Petrochemical demand growth is closely associated with the economic growth of a country, and China is the fastest growing economy in the world. The GDP of China is growing at a rate much higher than that of most other economies of the world. The country successfully posted 9.2% growth in 2011 June

6 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Global Research Saudi Arabia CHINA PMI despite the impact of the global financial slowdown, while most large economies in the world witnessed a downturn. Demand for petrochemicals in China is also rising, with growth in the infrastructure and construction industry, packaging industry, textile industry, automotive industry, the consumer goods and electronics markets, and many other industries which are major markets for petrochemicals. 35 Source: Bloomberg Packaging segment to evolve as main driver of Petrochemicals With the growing emphasis on the look and appeal of the products, the packaging industry has grown rapidly in the last decade. Producers across different industries have grown keen on enhancing the packaging of their products. The packaging industry is scaling new heights, not only in terms of revenue growth, but also in devising new technologies, designs and aesthetically enhanced packaging solutions. The plastic packaging industry is the leading enduse market for many petrochemicals in the world. Basic & Diversified Chemicals Sales by Region (%) Paper & Packaging 7.0% 17.5% 16.0% 14.0% Chemicals 15.0% 15.0% 13.0% 15.0% Consumer & Institutional 23.0% 28.0% 30.0% 25.0% Construction 12.5% 11.8% 15.0% 15.0% Automotive 10.7% 8.0% 10.0% 13.7% Healthcare & Medical 16.5% 5.0% 9.0% 11.0% Glass 6.0% 5.0% 6.0% 4.0% Electronics 5.0% 4.5% 5.0% 3.0% Utilities 4.0% 2.0% 5.0% 4.0% Adjustments 0.3% 3.2% -9.0% 4.7% Source: Bloomberg The global plastics packaging industry is large and growing strongly. The major force driving the consistent growth of the plastics packaging industry is the simultaneous growth in the industries which consumes plastic packaging products. As the need of different markets, the packaging needs of their products grow as well. Of these packaging needs, a few have been particularly popular, such as improved barrier properties. This growth trend, combined with current consumer life-styles and a growing demand for ready-to-eat packaged products, have resulted in a surge of demand in the packaging industry. Prices of various commodities track oil Like any other commodity, the price of oil is primarily driven by two factors: supply and demand, and investor speculation. In times of economic expansion countries typically consume more oil, which increases the demand for it. During recession, oil usually declines in value as countries use less of it. The commodity is also affected by geopolitics as majority of the world s supply comes from the Middle East and when there is unrest, the supply of oil is threatened, which causes its price to rise. When there is no fundamental reason for a steep change in oil s price (i.e. supply and demand) it can usually be attributed to investor speculation. Oil price is pervasive in many aspects of daily life, from energy production to clothing, cars, computers and June

7 Global Research Saudi Arabia household appliances. Petrol (for vehicles), polyester (for clothes) and plastic (more than 50% in household and industries) are each derived from petroleum, or crude oil. When oil prices rise, these products become more expensive to produce and vice versa. Commodity Prices Unit Energy Coal, Australia (USD/ton) 93.4% -43.6% 37.6% 22.6% -7.4% Crude Oil, Brent (USD/bbl) 34.3% -36.6% 28.7% 38.5% 7.5% Crude Oil, WTI (USD/bbl) 37.7% -38.1% 28.8% 19.3% 8.5% Coal, SA Richards Bay (USD/ton) 84.8% -46.4% 46.7% 24.2% -10.8% Natural Gas, US (USD/mmbtu) 26.9% -55.4% 11.0% -8.8% -38.6% Fertilizers DAP (USD/Ton) 123.6% -66.6% 54.8% 23.7% -16.5% Ammonia (USD/Ton) 66.5% -46.4% 39.5% 43.5% % Urea (USD/Ton) 59.3% -49.3% 15.8% 45.7% -8.0% Metals and Minerals Aluminum (USD/Ton) -2.5% -35.3% 30.5% 10.5% -9.3% Copper (USD/Ton) -2.3% -26.0% 46.3% 17.2% -5.8% Gold (USD/toz) 25.1% 11.6% 25.9% 28.1% 7.7% NEW World Bank Commodity Price Indices ( 2000 = 100) Energy (x) 39.7% -66.5% 26.4% 29.9% 6.7% Non Energy Commodities (x) 21.0% -47.8% 22.4% 20.7% -8.2% Agriculture (x) 27.2% -35.0% 14.2% 22.7% -7.9% Food (x) 33.9% -37.1% 8.9% 23.9% -3.2% Grains (x) 49.1% -39.9% 1.5% 38.9% -4.9% Raw Materials (x) 11.9% -34.1% 28.8% 24.4% -14.8% Fertilizers (x) 136.0% -64.0% -8.2% 42.6% -2.6% Metals and Minerals (x) 3.7% -63.1% 49.3% 14.4% -9.6% Source: World Bank Pink Sheets & Bloomberg * 2012 till March Falling crude oil prices to drop the prices of petrochemicals Typically, petrochemical prices are determined by adding the production costs of producers to the margin sustained by them. Production costs are heavily influenced by the raw material costs and the prices of the majority of petrochemical feedstock directly track the crude oil price trend. As a result, the price of crude oil is of critical importance to petrochemical producers. With the expectation of crude oil prices remaining in the range of USD per barrel or lower in 2012 and 2013 because of increase in supply from Libya, Iraq and Saudi Arabia and dampening demand in Europe and North America we believe the petrochemical prices would remain depressed in 2012 and 2013 and then gradually would pick up. With the GCC petrochemical producers particularly Saudi enjoy feedstock at fix price, the margins would tend to decline which will drop the profitability unless aided by volumetric growth. Cheaper feedstock highly important for the sustainability of the sector A variety of feedstocks are used for petrochemicals production. Petrochemical feedstocks are generally produced from the refining of crude oil or the processing of natural gas. Recently, alternative process routes utilizing coal, biological hydrocarbons and unconventional natural gas, particularly shale gas, have gained more attention as potential feedstock sources. Other emerging sources include unconventional natural gas, coal and other bio-based commodity feedstocks. June

8 (USD/ton) (USD/ton) (USD/ton) (USD/ton) (USD/ton) (USD/ton) Global Research Saudi Arabia Petrochemical Product Prices 1,000 1, e e Propane Butane 1,000 1, e e Naptha Ethylene 1, , , , , , e e LDPE Ammonia Source: Bloomberg & Global Research GCC low cost advantage not to last long GCC petrochemical producers have long enjoyed the advantage of cheap feedstocks as they tap into the abundant supplies of ethane, propane and butane feedstocks that also can yield more ethylene and propylene compared to the traditional naphtha. But this advantage may not last forever. With fewer new gas fields coming on stream in the Middle East, and those that do come up from exploration being used to replace older fields, it is expected that more of these gas feedstocks will be diverted to domestic use. June

9 China United States Argentina Mexico South Africa Australia Canada Libya Algeria Brazil Others Total Global Research Saudi Arabia Rising Shale gas production is dropping the price of gas and is increasing the cash margins of Northern American companies And with scarcity of gas, coupled with inapplicability of ethane to yield higher-value products, is however driving petrochemicals producers away from it to Naptha. Plants based on naphtha and other Natural Gas Liquids as feedstock are costlier to build and maintain. In addition, the labor cost is comparatively higher in production using liquid feedstock. The prime cost disadvantage, though, is that product margins are highly linked to swings in global oil prices. Nevertheless, the Gulf still has many cost advantages over global players in liquid-based projects as well. This, in our view, will continue to garner investment inflow into the region as evident from the recent JVs between regional players and global energy firms. However on the other hand, majority of steam crackers in Northern America utilize gas feedstock, primarily ethane, which is a by-product of natural gas, typically extracted in the form of NGLs. In comparison, steam crackers in the other regions, with the exception of the Middle east, use more oil based feedstock, such as naptha and gas oil. With fall in natural gas prices (50% lesser than last year) and increase in gas liquid production which comes along with increasing shale gas production, gas based feedstock cost of the US petrochemical industry is dropping significantly and has been the primary driver for renewed profitability and growth in Northern America. Technically Recoverable Shale Gas Resources by Country (tn cubic feet) 1,400 1,200 1, ,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Source: Geology.com While China on the other hand is using coal to produce the chemicals as it produces almost 50% of the world s coal. That country is building a large number of plants that are producing various petrochemicals from coal. Using coal as a feedstock is an expensive way to go. First, there is a large infrastructure for coal handling. Then, the coal must be pulverized and fed into large gasifiers, using oxygen, where so-called synthesis gas, a mixture of carbon monoxide and hydrogen is eventually produced, with carbon dioxide and water as a co-product. The gas is then passed over different catalysts to produce various types of chemicals. Although at current point of time it is an expensive production method but with newer technologies and economies of scale China will either become a low cost petroleum producer or will be self sufficient enough to drop the imports of petrochemical products from Middle east. Outlook; not too rosy in the long term for GCC Petrochemical producers in the GCC are currently at a quite defining moment that in the long term will affect their business. Following years of development and significant growth, the industry is now experiencing a shortage of natural gas. This is leading petrochemical players to use liquid feedstocks, which do not offer the same cost advantages as natural gas. At the same time, feedstock supplies are undergoing major changes worldwide. Production from Shale gas is increasing at a higher pace which will make US petrochemical more competitive, China has ambitious plans to convert coal to olefins, new exploration of oil and gas in Iraq can result in an increase in low cost feedstock from Iraq. On a standalone basis these development would not affect the financially strong petrochemical market of GCC but collectively they can present a material threat to the GCC petrochemical players. June

10 Global Research Saudi Arabia Saudi Arabia Hydrocarbon Sector Saudi Arabia s hydrocarbon sector operations are dominated by the state-owned oil company, Saudi Aramco. Saudi Aramco is the world s largest oil company in terms of proven reserves and production of hydrocarbons. Saudi Arabia s Ministry of Petroleum and Mineral Resources and the Supreme Council for Petroleum and Minerals have oversight of the sector and Saudi Aramco directly. Basic Structure of Saudi Arabia Hydrocarbon Sector Government of Saudi Arabia Supervising Authority > Ministry of Petroleum & Natural Resources 100% Saudi Arabian Oil Company - (Saudi Aramco) E&P Activities 100% Aramco Gulf 62.5% Operation Company 50% Al Khafji Joint 37.5% Operations Refining Petrochemicals Saudi Aramco Total Refining and Petrochemical Company Rabigh Refining and Petrochemical Company Transportation 100% Vela International Marine Power, Water, Lubricants etc 50% South Rub Al-Khali 50.0% Company Limited Saudi Aramco Mobil Refinery Company Sadara Chemical Company Various Subsidairies & Associated Co's Various Subsidairies & Associated Co's 50.0% 62.5% Saudi Aramco Shell Refinery Company Yanbu Aramco Sinopec Refining Co. Various Subsidairies & Associated Co's 70.0% 50.0% Saudi Basic Industries Corporation Saudi Arabian Mining Company Various Subsidairies & Associated Co's Source: Zawya & Global Research Saudi Aramco is the world s second largest producer and top exporter of crude oil, and is the only major producer that supplies to all three major market regions North America, Europe and Asia and the leading supplier of crude to Asia. As per 2010 report of Aramco, the company maintained its world-leading conventional crude-oil reserves at 260.1bn barrels, replacing 2010 production with oil from new field discoveries, expansions of existing fields and production optimization. Four new oil fields and one new gas field were discovered during the year, and six new oil reservoirs and three gas reservoirs were added to existing fields. Saudi Arabia - GDP breakup 100% 80% 60% 40% 20% 48% 47% 46% 40% 52% 53% 54% 60% 54% 49% 44% 46% 51% 56% 0% p GDP Oil sector GDP Non-oil sector Source: Source: Ministry of Economy & Planning, SAMA June

11 Global Research Saudi Arabia In 2010, Saudi Aramco produced 7.9mn barrels per day (bpd) of crude oil and 9.4bn standard cubic feet per day (scfd) of natural gas, and exported over 2bn barrels of oil and 316.4mn barrels of natural gas liquids (NGL). Aramco has a refining capacity of around 1.47mn b/d (70% of the total). Aramco owns four refineries outright (Ras Tanura, Jeddah, Riyadh and Yanbu) and owns equity shares in a further three (Rabigh, Sasref and Samref). Two new JV refineries are currently under construction at Jubail (SATORP) and Yanbu, which are predicted to come onstream in 2013 and 2014 respectively. In addition, Aramco hopes to increase its own capacity through three additional refinery projects underway. Aramco has five foreign partners in JVs, three of which are in existing refineries. The IOC with the greatest involvement in Saudi Arabian refining is ExxonMobil, which operates the 400,000b/d Samref refinery in Yanbu through a 50:50 partnership with Aramco. Lubricating base oils are produced at the Lubref facilities in Jeddah and Yanbu, which is a 30:70 JV between ExxonMobil and Aramco. The company increased the pace of its Kingdom-wide exploration program in 2010 to prepare for future hydrocarbon demand. These efforts yielded success, with the discovery of four new oil fields and one new gas field, increasing the total number of Saudi Aramco discovered fields to 112, plus the addition to existing fields of six new oil reservoirs and three new gas reservoirs. Saudi Aramco, in 2010, put finishing touches on major parts of the biggest capital program in its history that began in 2009, raising maximum sustainable oil production by 1.7mn bpd to 12mn bpd. Significant progress was made on another giant oil increment i.e. 900,000 bpd Manifa, an Arabian Heavy crude oil field; added more than 200,000 bpd in maintain potential program; and launched an upgrade of Safaniya, the world s largest offshore oil field. June

12 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 Global Research Saudi Arabia Saudi Arabia Output of chemicals and petrochemicals in the GCC region is expected to rise by 6-7% per annum to reach around 135mn tons, according to the Gulf Petrochemicals and Chemicals Association Petrochemical capacity in the GCC GCC has seen a significant increase in petrochemicals capacities, the main reason being the cheaper feedstock availability. Such that the Middle East s share of petrochemicals production is expected to rise to 22% in 2016, up from 20% in 2011, largely as a result of investment in the Arabian Gulf region. Output of chemicals and petrochemicals in the GCC region is expected to rise by 6-7% per annum to reach around 135mn tons, according to the Gulf Petrochemicals and Chemicals Association. Ethane availability and feedstock pricing will remain key to the future growth of the region s petrochemicals industry. The GCC has gas reserves totaling 42,860bncm. Production of an estimated 455bncm in 2010 should reach 642bcm in 2015, up 41%. However, surging domestic demand for gas has effectively led to a cap on further LNG projects, with no announced plans for new capacity after Announced Ethylene Crackers In The Gulf Region (tpa) Country Capacity Abu Dhabi Polymers (Borouge) UAE 600,000 Al-Jubail Petrochemical (Kemya) KSA 810,000 Arabian Petrochemical (Petrokemya) KSA 800,000 Arabian Petrochemical (Petrokemya) KSA 800,000 Arabian Petrochemical (Petrokemya) KSA 830,000 Equate Petrochemical Kuwait 850,000 Jubail Chevron Phillips (JCP) KSA 300,000 Jubail United Petrochemical Company (JUPC) KSA 1,450,000 Qatar Chemical (Q-Chem) Qatar 500,000 Qatar Petrochemical Company (QAPCO) Qatar 720,000 Rabigh Refining and Petrochemical (Petro-Rabigh) KSA 1,300,000 Saudi Ethylene and Polyethylene Company (SEPC) KSA 1,000,000 Saudi Petrochemical (Sadaf) KSA 1,300,000 Saudi Yanbu Petrochemical (Yanpet) KSA 860,000 Saudi Yanbu Petrochemical (Yanpet) KSA 920,000 The Kuwait Olefins Company (TKOC) Kuwait 850,000 Total GCC 13,890,000 Source: Chemical Week & GPCA Drive towards alternate feedstock Scarcity of gas, coupled with inapplicability of ethane to yield higher-value products, is however driving petrochemicals producers away from it. In view of the aforesaid restrictions, the petrochemicals producers are shifting toward alternative feedstock such as naphtha, propane and butane. However, Use of non-ethane feedstock, in the Gulf petrochemicals sector will require proper due diligence. Plants based on naphtha and other NGL as feedstock are costlier to build and maintain. In addition, the labor cost is comparatively higher in production using liquid feedstock. The prime cost disadvantage, though, is that product margins are highly linked to swings in global oil prices. Movement in Prices of Naptha with the change in Oil Prices 60.0% 40.0% 20.0% 0.0% -20.0% -40.0% -60.0% -80.0% Oil Naptha Source: World Bank Pink Sheets & Bloomberg June

13 Global Research Saudi Arabia The trend of shifting away from ethane for diversification of the product slate is encouraging, as it is in line with the government s endeavors to promote production of higher value chemicals and plastics essential for broader-based industrial and economic development in the region. It is gaining momentum in Saudi Arabia, where heavier feedstock such as propane and butane are used along with a small proportion of ethane, to produce new products. Saudi Arabia petrochemical sector Saudi Arabian petrochemicals business environment is by far the most attractive in the Middle East region, owing to substantial reserves of cheaply extractable feedstock including the largest oil reserves in the world. The petrochemicals sector accounts for about 7% of the global supply for basic and intermediary petrochemical products. From being a net importer, the country has emerged as a leading exporter in the petrochemicals sector, supplying to over 100 countries. Primary drivers for this turnaround have been strong infrastructure, significant cost advantage due to lower average variable and fixed costs, and competitive and fixed natural gas prices. These factors have also resulted in substantial investment inflows into the sector. SWOT Analysis Strengths Weakness - Subsidy on natural gas - Foreign firms can enter only through JV's, none of - Substantial rise in refining capacity in coming years their investment would be completely owned. will ensure adequate, costeffective feedstock supplies for new petrochemical projects - Centrally located to export worldwide Opportunities Threats - Deregulation of the sector because of which foreign - Shift towards naptha as a feedstock can expose them companies can partner with local ones and invest to oil price vulnerability. through JV's. - Political and security situation can deter foreign - Government offers grants & exemption to investment. industrialists investing in plastics industry. - Slowing Asian growth will hurt exports - Drop in price of natural gas in US can increase their margins and make them more competitive. Source: Global Research Ethane availability and feedstock pricing will remain key to the future growth of the Saudi petrochemical industry. Saudi Arabia's rapid and continuing expansion of its petrochemicals industry has been based on the accessibility of cheap feedstock. Sabic, which was established in 1976, is the leading player in the industry, and now ranks at second in terms of revenue worldwide. Over the past five years the company has nearly doubled its output of petrochemicals and its topline has grown from USD19.7mn in 2006 to USD58.3mn in The Company now accounts for over 15% of the sales of the world s top ten firms. Lately the government has introduced deregulation by virtue of which a lot private firms have entered the sector or are in the process of it. One such example is Petro Rabigh, a joint venture between Saudi Aramco and Sumitomo Chemical, Japan. Other examples are: Sabic s Ibn Zahr affiliate will host a previously announced 220,000tpa acrylonitrile JV for the performance chemicals business. Sabic will have a 50% stake in the JV, with Japan s Asahi Kasei and Mitsubishi Corporation each holding 25%. Completion is expected in Sabic subsidiary Ibn Sina will operate a planned 250,000tpa methyl methacrylate (MMA) and 40,000tpa polymethyl methacrylate (PMMA) joint venture with Mitsubishi Rayon using Mitsubishi Rayon s Lucite MMA technology and be on-stream in June

14 Global Research Saudi Arabia A 400,000tpa elastomers complex, a JV between Sabic and ExxonMobil, is planned for Kemya s site at Jubail with units producing butyl rubber (BR), carbon black, polybutadiene rubber (PBR), and ethylenepropylene diene monomer (EPDM) rubber. The partners are committed to bringing it on-stream in 2015, with an EPC contract expected to be awarded in Saudi Arabia Petrochemical Capacity ('000 tpa) e 2012e 2013e 2014e Ammonia 3,110 4,260 4,860 4,860 4,860 Benzene 1,070 1,180 1,180 1,180 1,330 Ethylbenzene Ethylene dichloride ,200 1,200 1,200 Ethylene glycol 4,300 4,300 4,300 4,300 4,300 Ethylene oxide 2,405 2,830 3,300 3,300 3,300 Ethylene 12,670 15,220 16,520 16,520 16,520 HDPE 2,810 3,210 3,210 3,210 3,210 LDPE LLDPE 3,950 4,250 4,700 4,700 4,700 PE 7,380 8,405 8,855 8,855 8,855 Methanol 7,235 7,235 7,235 8,885 8,885 Polyethylene terephthalate PP 5,070 5,070 5,595 5,595 5,595 Propylene 4,695 5,245 6,345 6,545 6,545 PS PVC Styrene 1,825 1,825 1,825 2,525 2,525 Urea 3,420 3,420 3,420 3,420 3,420 Vinyl acetate Vinyl chloride monomer 1,550 1,550 1,550 1,550 1,550 Xylenes ,085 1,085 Total 66,385 73,220 78,415 81,665 81,815 Source: SABIC & BMI The main reason for the entrance of various private companies to the region is the availability of cheap and abundant feedstock. With the availability of such the petrochemical capacity of the country is expected to increase from 66.3mtpa in 2010 to 81.8mtpa by 2015, growth of 23.2%. Ammonia, LDPE, propylene and styrene will witness a rise of 56.3%, 52.4%, 39.4% and 38.4% respectively. Increasing number of petrochemical projects in Saudi Arabia Petrochemical projects worth USD19bn are under execution in the GCC. Apart from this, projects with an estimated value of USD81bn are in different stages of planning. Saudi Arabia tops the list with USD12bn of projects under execution and another USD41bn of future projects. Gulf Petrochemicals & Chemicals Association has estimated GCC Petrochemical Capacity to increase from 77.3mtpa to 113mtpa at the end of Saudi Arabia is expected to see largest capacity addition by volume and UAE will see largest growth in percentage terms. Refineries and Petrochemicals in KSA moving towards integration Integration of refineries and petrochemicals allows improved risk management, reprocessing of off-gas streams, greater feedstock flexibility and a platform which gives a further room for derivatives production. Its particularly true in various parts of the world where majority of the refineries are integrated with chemical facilities. However, things have begun to change and there is a growing consensus that the key to the feedstock issue is the integration of existing refineries with naphtha and NGL-fed petrochemical complexes. Some of the examples of such integration are: Saudi Aramco and its joint venture partner Dow Chemical of the US will use mainly naphtha feedstock from an Aramco-operated refinery for their Ras Tanura complex (one of the largest single phase petrochemical projects in history), as well as gas from a nearby processing unit. The plant will produce a broad range of basic and derivative products, including ethylene, propylene, aromatics, chlorine derivatives, and polymers. June

15 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 Global Research Saudi Arabia Saudi Aramco and Sumitomo Chemical are carrying out a feasibility study on the second phase of Petro Rabigh in Saudi Arabia, and they aim to start production at the new complex in Rabigh Phase II is set to be built alongside the existing Petro Rabigh refinery and petrochemical complex at Rabigh. The cost is estimated in the region of USD6-8bn and involves adding 300,000tpa of ethylene capacity at the Petro Rabigh complex's 1.3mtpa ethane cracker and building 17 production units making aromatics and a range of intermediates and derivative products. Saudi Aramco Total Refining and Petrochemical Company (SATORP), a JV (62.5% Saudi Aramco, 37.5% Total Petrochemicals are building a USD9.6bn export refinery in Jubail. The project includes a 400,000b/d full conversion refinery, which is scheduled to begin operations in the second half of The refinery will also produce 700,000tpa PX, 140,000tpa benzene and 200,000tpa of polymer-grade propylene. Outlook of KSA petrochemical sector Petrochemical companies of Saudi Arabia have witnessed tremendous recovery in income since losses in 4Q08 & 1Q09. The profits continued to climb reaching the high in 3Q11. However, 4Q11 witnessed the most depressed volumes and pricing. Nevertheless, demand was reportedly much better in 1Q12, which witnessed a growth in income of over 18% in 1Q12 on a QoQ basis. Saudi Listed Petrochemical Companies Profitability (USD mn) 3, , , , (500.0) Source: Bloomberg Going forward we expect things a bit jittery for the overall outlook of petrochemical segment. First of all, we believe that some of demand in last couple of years resulted from the positive impact of government-led measures. As these measures have now expired or are on the verge of it, we suspect some sort of demand might fade with potential negative implications for petrochemical producers, mainly being the shift towards naptha feedstock which is exposed to oil price volatility. Secondly, we believe Europe which on an average account for roughly 20% of the turnover of the companies of Saudi Arabia is not yet out of problems. Countries like Greece, Spain, Italy and Portugal are expected to drag the demand down for petrochemicals. Last but not the least, oil prices are expected to remain in the range of USD per barrel which will keep the upside potential in product prices low. While on the other hand we also believe, demand from Asia and production of high quality petrochemicals because of shift towards Naptha would open new industries and markets for the local producers. June

16 Global Research Saudi Arabia GCC Companies Profitability Petrochemical Companies Financial Performance GCC petrochemical companies 1Q12 earnings declined by 10.2% YoY to USD3.1bn as compared to USD3.5bn in the same period last year. While on a QoQ basis the earning improved by 23.9% added majorly by SABIC profit growth of 39% QoQ (Contributing 61.5% in 1Q12 compared to 58.4% in 1Q11 and 54.9% in 4Q11). First quarter performances of various petrochemical companies witnessed improvement on a QoQ basis mainly due to advancement in the product prices. (USD mn) 1Q11 4Q11 1Q12 YoY Chg (%) QoQ Chg (%) SABIC 2, , , % 38.8% IQ % 13.1% SAFCO % -38.4% KAYAN (2.2) (50.9) (19.0) n/m n/m YANSAB % 8.3% TASNEE % -3.3% RABIGH % 130.2% PETROCHEM (2.8) (7.6) (5.8) n/m n/m SIPCHEM % -28.2% SAHARA % 737.5% APC % -37.0% CHEMANOL % 8.3% ALUJAIN 3.0 (6.6) 2.6 n/m n/m NAMA (1.2) (61.3) (1.2) n/m n/m DANA % 40.1% SHELL OMAN % 65.9% GCC 3, , , % 23.9% Profitability 1Q11 4Q11 1Q12 YoY Chg (%) QoQ Chg (%) Saudi Arabia 2, , , % 25.9% Qatar % 13.1% Oman % 65.9% UAE % 40.1% Sector 3, , , % 23.9% Composition 1Q11 4Q11 1Q12 YoY Chg (%) QoQ Chg (%) Saudi Arabia 82.6% 80.0% 81.3% - - Qatar 16.4% 18.2% 16.6% - - Oman 0.3% 0.2% 0.3% - - UAE 0.7% 1.6% 1.8% - - Sector 100.0% 100.0% 100.0% - - Source: Company Reports & Zawya Overall, the performance of regional petrochemical companies was mixed on a QoQ basis with SABIC (Saudi Basic Industries Corp.), IQ (Industries Qatar), YANSAB (Yanbu National Petrochemical Company), Sahara Petrochemical, Shell Oman, Petro Rabigh and Dana Gas reporting better than expected earnings while other stocks such as Saudi Kayan Petrochemical Co., SAFCO (Saudi Arabia Fertilizers Co.), TASNEE (National Industrialization Co.), Sipchem (Saudi International Petrochemical Co.) and Nama Chemicals Co. reported drop in earnings or extended their losses. June

17 Ratio Analysis Financial Performance Global Research Saudi Arabia Global Research Petrochemical Universe Financial Performance Within the GCC petrochemical companies, Global Research Petrochemical Universe witnessed a decline in profitability during 1Q12 on a YoY basis. Drop in profitability was majorly due to increase in cost of sales which dropped the gross margins of the sector. Cost of sales rose during the period by more than 16% which dropped the gross margins of the sector to an average of 33.1% in 1Q12 compared to 37.4% in the same period last year. Among Global s universe, SIPCHEM margins dropped the most by 6.9pps followed by 5.7pps drop reported by Industries Qatar. Only company registering growth in gross margins was Dana gas by 9.7pps. Internationally, gas prices continued to drop. Price of natural gas (Henry Hub); feedstock used in the petrochemical industry fell by 26.2% QoQ and down 41.3% YoY. Drop in average prices of benchmark was mainly because of discovery of considerable amount of natural gas reserves in western countries coupled with high storage levels and fragile demand. On an average price of petrochemical products rose by 2.2% QoQ during 1Q12. Price of Ethylene witnessed an increase of 17.8% QoQ during 1Q12. While price of LDPE and LLDPE dropped on a QoQ basis by 6.9% and 0.1% respectively. Global Research Universe - GCC Consolidated Financials (USD mn) 1Q11 1Q12 Chg (%) Sales Revenue 14,249 15, % Cost of Sales 8,921 10, % Gross Profit 5,328 5, % Operating Expense % Operating Profit 4,449 4, % Financial Charges % Net Profit 3,097 2, % Assets 113, , % Equity 47,890 54, % Debt 33,936 35, % Cash & Bank Balance 14,606 19, % Liabilities 65,290 63, % 1Q11 1Q12 Chg Gross Margins (%) 37.4% 33.1% bps Operating Expense as % of Assets (%) 0.8% 0.8% 1.0bps Operating Margins (%) 31.2% 27.1% bps Net Margins (%) 21.7% 19.1% bps Financial Charges as % of Debt (%) 0.8% 0.7% -14.6bps Debt as % of Assets (%) 30.0% 30.0% 0.6bps Liabilities as % of Assets (%) 57.7% 53.9% bps Cash as % of Assets (%) 12.9% 16.6% 373.5bps Equity as % of Assets (%) 42.3% 46.1% 379.0bps Return on Equity (%) 6.5% 5.4% bps Return on Assets (%) 2.7% 2.5% -23.1bps Source: Company Report * Consolidated Financials of 6 Listed Companies The sector top-line witnessed a YoY increase of 8.8% in1q12, which was due to the combined effect of increase in price of petrochemical products along with commencement of commercial production from the newly expanded facilities. Most topline growth was registered by SIPCHEM at 52.7% followed by 17.7% increase in the topline of YANSAB. Lowest growth was registered by SAFCO on the backdrop of fall in the prices of Ammonia and Urea by 32.3% and 11.4% QoQ during 1Q12. June

18 Global Research Saudi Arabia Overall net income registered by the companies under our coverage was USD2.96bn in 1Q12 as compared to USD3.09bn in the comparable period last year. SABIC continued to remain the lead contributor to the sector profitability at 65.5% followed by Industries Qatar and SAFCO at 17.7% and 7.1% respectively. During 1Q12, the companies were able to reduce the cost of funding which dropped the interest expense by 13.5% YoY. Overall interest expense during 1Q12 dropped to USD249mn as compared to USD288mn in 1Q11. Drop in the interest expense was on the back of cheaper refinancing rates available worldwide and easier fund raising for these companies because of backing of their oil rich governments. Cash and bank balances of the sector continued to rise, reaching USD19.6bn in 1Q12 compared to USD14.6bn in 1Q11, growth of 34.7%. June

19 Global Research Saudi Arabia COMPANY PROFILES June

20 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Global Research Saudi Arabia Saudi Basic Industries Corporation Strong Buy Target Price SAR116.1 Market Data Bloomberg Code: SABIC AB Reuters Code: 2010.SE CMP (19 June 2012): SAR91.75 O/S (mn) 3,000 Market Cap (SAR mn): 275,250 Market Cap (USD mn): 73,396 P/E 2012e (x): 10.1 P/Bv 2012e (x): 1.8 Price Performance 1-Yr High (SAR): Low (SAR): Average Volume: (000) 5,960 1m 3m 12m Absolute (%) Relative (%) Price Volume Performance Limited QoQ growth expected in 2Q12; volumes to drive income Profits from its fertilizer affiliates to keep the bottom line growing Saudi Kayan to report profit in 2012 Recommendation maintained at Strong Buy 1Q12 results higher than expectation Saudi Basic Industries Corporation (SABIC) reported 1Q12 net income of SAR7.27bn compared to SAR7.69bn for the same quarter last year, representing a decrease of 5.5%, and compared to the net income for the fourth quarter of 2011 of SAR5.24bn, representing an increase of 38.8%. The decline on YoY basis resulted because of lower product pricing which was to some extent softened by higher sales volumes. However the results were higher on a QoQ basis mainly driven by higher pricing for certain products and reduction in general and administrative costs. The results came higher despite low income reported by SAFCO and Saudi Kayan and increase in feedstock costs for certain products during the quarter. SABIC Quarterly Performance (SAR mn) 1Q11 2Q11 3Q11 4Q11 1Q12 Sales Revenue 44,873 49,086 48,930 47,033 48,346 Cost of Sales 29,448 32,591 32,117 33,658 33,816 Gross Profit 15,425 16,494 16,813 13,375 14,530 Operating Expense 2,917 3,218 3,312 3,861 3,080 Operating Profit 12,508 13,276 13,500 9,514 11,450 Financial Charges Net Profit 7,689 8,101 8,185 5,237 7, Volume (mn) Price (SAR) - RHS Gross Margins 34.4% 33.6% 34.4% 28.4% 30.1% Operating Margin 27.9% 27.0% 27.6% 20.2% 23.7% Net Margin 17.1% 16.5% 16.7% 11.1% 15.0% ROA 2.3% 2.4% 2.4% 1.6% 2.1% ROE 6.0% 6.2% 6.2% 3.8% 5.0% Debt as % of Assets 28.9% 33.0% 31.9% 30.8% 30.4% Source: Tadawul & Zawya Limited QoQ growth expected in 2Q12; volumes to drive the earnings With oil prices dropping significantly over the last few months in the backdrop of increase in supply from Iraq, Saudi Arabia and Libya, the petrochemical prices which are generally related with the price of oil are expected to drop in unison to it. We, therefore, believe average prices of petrochemicals will show a drop in the range of 3-5% in 2Q12. Hence, we expect the 2Q12 results to be driven by rolling out higher number of products specially in the Asian markets. Hettish Karmani Senior Financial Analyst hkumar@global.com.kw Tel.: (965) SABIC continues to focus on China; the key for Asian growth SABIC announced various growth commitment in China by moving forward on its plans to expand its manufacturing operations in the country. Recently, SINOPEC & SABIC Tianjin Petrochemical Company (SSTPC) laid the foundation for a polycarbonate production complex with 260 tons per annum capacity. Established in October 2009, SSTPC is a joint venture with SINOPEC and SABIC each holding 50% equity. The Phase One project, with annual capacity of one million tons of ethylene, began production in January With a total investment of RMB11 billion (USD1.7bn) and covering a ground area of 67 hectares, this polycarbonate production complex with an annual capacity of 260,000 tons is the Phase Two project and was approved by China's National Development and Reform Commission. Based on initial estimation, demand for polycarbonate in China will reach 1.78mn metric tons by 2015, an average annual increase of nearly 10%. June

21 (SAR 000) Global Research Saudi Arabia IBN AL-BAYTAR Net Income 1,800,000 1,500,000 1,200, , , ,000 Sabic to build carbon fiber plant in Saudi Arabia Following a technology licensing agreement with acrylic Montefibre SpA in 2011, Sabic plans to build a polyacrylonitrile (PAN) precursor and carbon fiber manufacturing plant in the Kingdom. The company plans to produce at least 3,000 tons annually to start. Company said Montefibre's technology will be the basis for a new acrylic manufacturing facility. The acrylic will feed a new polyacrylonitrile (PAN) precursor facility, also to be built by Sabic in Saudi Arabia. The PAN, in turn, will feed a new Sabic carbon fiber manufacturing plant in Saudi Arabia. Company plans to sell most of the produce outside the country while some of it will be consumed in the country as well. Global Research has not incorporated the carbon fiber plant in its estimates. Saudi Kayan; profits expected in the full year Saudi Kayan, an affiliate of Saudi Basic Industries Corporation started commercial production in October Once fully operational, the Kayan complex is expected to have an annual production capacity of more than 4mn tons of petrochemical and chemical products, making SABIC world s largest producer of ethylene glycol. Company is also planning to open a Polyethylene Factory At Jubail. The factory, would use raw material from Sabic's ethylene olefins plant, in an effort to increase operational efficiency and maximize use of internal resources. During 1Q12, Company reported a loss of SAR71mn, mainly due to hike in cost and higher interest expense. However, losses were reportedly lower than the previous quarter on account of better cost control measures adopted by the Company. Company faced technical issues during the second quarter which halted production at all its factories for couple of days. Going forward, with expectation of lower petrochemical prices and being a startup company we expect Saudi Kayan to be in profit for the full year Profits from its fertilizer affiliates to keep the bottom line growing SABIC is one of the leading global fertilizer producers with over 6.7mtpa of gross production capacity from Saudi Arabian Fertilizers Company (SAFCO), the Al-Jubail Fertilizer Company (AL-BAYRONI) and National Chemical Fertilizer Company (IBN AL-BAYTAR). In 2011, SABIC also entered into a joint venture - Maaden Phosphate Company. SABIC and Ma aden holding has stakes of 30% & 70% respectively. The integrated plant is capable of producing 2.9mn tons of phosphate fertilizers and 1.1mn tons of ammonia. SAFCO one of SABIC s affiliated will carry out feasibility studies for the construction of a new plant (SAFCO V), in its complex in Jubail, for the production of urea with annual capacity of 1.4mtpa along with ammonia at 1.2mtpa. The expansion will increase the total Ammonia and Urea capacity to 3.3mtpa and 3.7mtpa respectively. The expansion is to conclude by mid 2014 and is expected to start commercial production in the third quarter of Company is expected to report a net profit CAGR of 12% during e 2013e 2014e 2015e Source: SAFCO & Global Research On the other hand income from IBN AL-BAYTAR is expected to report a CAGR of 2.8% during SABIC s share of earnings are expected to increase to SAR1.0bn in June