Russia is stepping up the development of its petrochemical industry as one of the future drivers for its hydrocarbon sector. In an interview with Energy Intelligence, Alexander Petrov, CFO of Russia’s largest petrochemical company, Sibur, discusses the impact that coronavirus might have on demand and what lies ahead for the world’s petrochemical industry.
Q: 2019 was not an easy year for the petrochemical industry. Do you expect 2020 to be similar?
A: Petrochemicals" performance depends on two factors: It depends on the cost of creating polymers, which is the price of feedstock or oil products; and on the sales price for petrochemicals or polymers and chemicals consumption.
Talking about petrochemicals, we saw the decline, which started at the end of 2018 and the beginning of 2019 and for most products accelerated in the second half of 2019. This decline was caused by overproduction and new capacities being introduced all over the globe. Of course, the situation with the spread of Covid19 across the globe has accelerated that decline, since a lot of consumption dropped radically – halting construction and cars/tires manufacturing for instance. In the current environment of low oil prices and collapsing demand, naphtha producers have become much more competitive versus NGLbased producers, resulting in lower average petrochemical prices and spreads. And when people talk of low oil demand, they usually think about gasoline and diesel, but a huge chunk of oil products goes into crackers and thus lower petchem demand and prices create additional pressure on oil demand and prices.
The other issue is the feedstock situation, which is rooted in the energy sector.
I would not comment on the situation on the oil market as it’s driven by a number of factors, most of which are of a complex nature and very hard to anticipate. Let’s talk about the situation with oil derivatives like naphtha and liquefied petroleum gas (LPG), which are the main petchem feedstocks. Though these products have a high correlation with crude oil, they still have their own market factors like supply and demand. We see that pressure on those products will continue, mostly driven by extra supplies from the US market. US shale oil producers generate a lot of byproducts NGLs comprising of ethane, LPG and naphtha. Why is it important? Because in 2019 alone, the US added approximately 7 million [metric] tons of LPG to the export markets. To get a sense of how much it is, Russia’s whole annual LPG exports stand at 6 million tons. That was the key factor depressing LPG prices in 2019. While the oil price dropped by almost 10% yearonyear in 2019, LPG prices weakened from 16%22% depending on the region. We expect that US additional volumes will stay on the market if shale oil production continues in the current manner, hence the additional discount on LPG prices compared to oil are likely to continue. That’s been what we expected in terms of the feedstock performance, the midstream segment. Sibur has both a midstream segment and a petrochemical segment.
Q: So what is on for 2020?
A: We don't see any reasons why the market for all products in our portfolio should recover in the short term. I would even expect more pressure on polyethylene because of new volumes coming to the market. This year we might also see what the demand will be around the globe amid the spread of Covid19.
Q: Are there any early indications of what impact coronavirus is having on demand?
A: We haven’t seen significant limitations on deliveries of petrochemical products to China at the beginning of the year though a high stock balance in China may indicate a prolonged imbalance on the market through the whole of 2020. We had certain warnings, but we didn't reroute our deliveries. No one can give a clear picture on what we may see in the next months, but even without a coronavirus effect we didn't anticipate a quick recovery on the market in 2020. The spread of Covid19 across the globe leads to a decline in demand in the developed countries that are key markets for Chinese producers. Therefore it’s sensible to anticipate declining exports from China and an overall slowdown in production. If you look at the financial results of petrochemical companies, you will see a steep decline. This explains why the industry is no longer keenly interested in new investments. In 2017, 2018 there was a lot of rhetoric around petrochemicals as a good industry to invest in. And even oil and gas majors considered the petchem industry as a new opportunity. Today, the industry is no longer that attractive. We should probably expect less investments, less final investment decisions (FIDs), less construction of new capacities. Depending on how quickly all countries will be able to come out of this crisis, our key markets should find new balancing levels that may eventually reshape the petrochemicals universe. I mean we may see more capacities to come out in Asia simply because their economics will be better. Asia will enjoy the same lower oil prices, say for naphtha, that everyone has globally and it’s cheaper to build new capacities there, whereas more expensive US expansion may be put on hold as companies wait to see what happens with shale production. Though you may see new capacities being launched in the next several years simply because FIDs have already been taken some time ago and companies can not put on hold their construction in progress. But such an environment would put a certain limitation on those who were ready to invest but have not started the construction yet. However, in the long run, when a future shortage of new capacities happens, it should bring the margins back. And if you look at the industry's expert opinions, for instance, IHS, they predict the restoration of margins when demand catches up with supply levels.
Q: What about US and Middle Eastern projects? How are they going to affect your market in the longer term?
A: These regions are often mentioned as territories of new capacities because they have a lot of easilyavailable ethane. If you take the petchem industry specifics, you have naphtha as a typical feedstock for the chemicals, you have LPG and you have ethane as a feedstock for chemicals. Ethane is a more attractive type of feedstock for ethylene production, which is a major monomer in the chemical industry. The Middle East simply utilized almost all ethane they have in the region, which is not the case for the US as it has abundant ethane reserves. The socalled first wave of chemical projects already started to operate or are at the commissioning stage right now. There is a separate discussion if we see the second wave of projects in the US as they still have nonutilized ethane. LPG is not that attractive for US crackers as the alternative cost of ethane is much lower (mostly because of cheap gas and high cost of ethane transportation by water) therefore it is easier to monetize LPG by exporting it. An alternative way to monetize ethane is to leave it as part of natural gas to increase its calorific value, and get an additional premium for gas. So US companies are balancing between utilizing ethane in petrochemicals or leaving it as part of natural gas. The key factor here is pricing – if the gas price is high it’s sensible to keep ethane in the gas; if the ethylene or polyethylene price is high it makes sense to build a cracker and use ethane in petrochemistry. Nowadays we have low prices on both gas and petrochemicals which place limits on further investments as it’s economically inefficient to develop new projects. So the bottom line here is that I would not expect any new capacities out of the US in the short to midterm. The prospects for Middle Eastern projects are limited by scarce ethane resources and high construction costs. However, when demand catches up with supply levels, we may see much more attractive prices on the market that may trigger another wave of new projects globally.
Q: So, it's a question about the numbers, right?
A: The US market is good in terms of prices for feedstock, but it is not so good in terms of capital expenditures. It is not so cheap to build capacities in the US relative to Asia for example. And of course, as an investor, you always compare the money you need to invest and the payback you can get. So, the attractiveness of the feedstock allows you to generate good earnings, but you need to spend more on construction and operating. That's why it is a question mark.
Q: What kind of return on capital employed would you get in Russia compared to, let’s say, the US?
A: We see Russia as a good region for chemical investment because we have a similar advantage for feedstock as the US does but we are closer to the Chinese market, hence we can benefit from lower delivery costs. The latter thing is very important because during this turbulent period caused by Covid19 it becomes crucial to be closer to your target markets and be wellconnected to your customers in China. Sibur, being a lowcost producer of petrochemicals located in the heart of Russia, has a unique edge in access to Chinese and EU markets. On top of that we’ve established and continue to develop our relations with Sinopec, one of our shareholders and the largest petrochemical company in China.
Q: Sibur is building the Amur gas chemical complex. We understand the plant is going to be operational by 2024. Is that correct?
A: Mechanical completion is scheduled for 2024, not earlier. We separate these two definitions. Like with ZapSib [Zapsibneftekhim petrochemicals plant], we had two major stages. One is mechanical construction completion. Then what we call a rampup period, a separate project to reach a high level of capacity utilization. It takes up to 11⁄2 years. The same for the Amur complex. 2024 is the date for mechanical construction completion. We usually try to avoid mentioning exact dates for reaching target capacity utilization, because it's really an open question and can take from six to 18 months.
Q: So it could take up to 18 months before it could actually start fullscale production after mechanical completion.
A: Right, before we produce physical volumes. With ZapSib, we mechanically completed it in the middle of 2019, and we started to produce reasonably large volumes in the fourth quarter. We managed to rampup to a 30% utilization rate by the fourth quarter, which is half a year after mechanical completion. And then we still need some time to ramp it up to reasonably good levels. I mean, 90%plus.
Q: What are the plans for reducing the company's impacts on the environment?
A: I would say that this subject became a serious part of our internal agenda a few years ago. It is difficult to specify the exact year, but what is important for us is the approval of the 2025 strategy, the ESG [environmental, social and governance] strategy, by the board last year. This was the indication how seriously we consider ESG factors. It is not just rhetoric for us, there are a lot of targets. We don't disclose certain details, but we took an internal decision to reconstruct of one of our chemical facilities in order to use recycled plastics as a feedstock for polyethylene terephthalate (PET) production. The idea was to not just use plastic, but utilize certain volumes of collected and recycled plastic bottles. This is another illustration that we not just care about the footprint of our production, but we also care about the ecological friendliness of our products, which is a separate section of ESG strategy. Our strategy is saying that we are going to produce at least 40% of PET from recycled PET granules.
Q: You obviously will get pressure from investors and, of course, potential investors in the future, once you eventually get to an initial public offering (IPO), to get improved financial results. Are you getting pressure from the nonfinancial community to sort of clean up your activities, become greener?
A: I would say that we see rising interest, increasing attention. At the same time, I don't see any of the limitations that, for instance, the tobacco industry is facing, or even oil and gas is facing. We see increasing attention and we need to provide additional details on what we are doing and who our clients are. It is one aspect. In another aspect, it used to be the case some time ago when we convinced our creditors that all our new investments are made in full accordance with modern requirements, I mean, current requirements for ecological footprint of the new plants. We do a pretty detailed, pretty thorough ecological audit for every new plant we build. We show those documents to the lenders. Before we do that, we just don't close the deals. And for instance, all the money that was raised for ZapSib was raised with these components with this thorough, ecological audit of the new plant. We see that it will be the case for the Amur plant.
Q: You have got this butyl rubber plant in India that you have built with Reliance. Do you have other plans to build plants abroad?
A: I wouldn't expect us to be super active out of Russia. Before I directly answer this question, I would comment on the business rationale we saw there, and it explains a lot. This story is pretty simple. In the chemical industry, sometimes to produce certain things you need to buy a license, you need to buy a technology. We had technologies developed by Sibur some time ago. And we just were able to monetize that unique technology in synthetic rubber production. The rationale was to sell the technology and we decided not just sell technology but to contribute that technology as part of our contribution to the joint venture with Reliance. They didn't have a lot of alternatives and that created a business case. We are humble enough to keep our development focused on Russian market. I mean, we see certain conditions that make it possible to develop this basic polymer business in Russia our access to feedstock, our ability to execute capital projects and our market position in Russia. That's why we will focus on the Russian market not only in terms of demand, but also in terms of production because there are a lot of opportunities here. At the same time, we understand that in order to become better on a global scale, you need to have some unique features, competitive advantages. And we don't see those competitive advantages out of Russia, rather than those unique opportunities that are available for us in the case with this technology. That is why I wouldn't expect us to be super active out of Russia. The only exception could be the story like we have in India, where we again may sell our technology and discuss a potential venture in other regions.
Q: The final question is on the IPO. Could it happen this year and is Moscow going to be the main market for the company's shares?
A: Our CEO Dmitry Konov said earlier that it doesn't make sense now. It is our kind of view, but it is up to shareholders to decide. Things may change quickly.
Q: 2019 was not an easy year for the petrochemical industry. Do you expect 2020 to be similar?
A: Petrochemicals" performance depends on two factors: It depends on the cost of creating polymers, which is the price of feedstock or oil products; and on the sales price for petrochemicals or polymers and chemicals consumption.
Talking about petrochemicals, we saw the decline, which started at the end of 2018 and the beginning of 2019 and for most products accelerated in the second half of 2019. This decline was caused by overproduction and new capacities being introduced all over the globe. Of course, the situation with the spread of Covid19 across the globe has accelerated that decline, since a lot of consumption dropped radically – halting construction and cars/tires manufacturing for instance. In the current environment of low oil prices and collapsing demand, naphtha producers have become much more competitive versus NGLbased producers, resulting in lower average petrochemical prices and spreads. And when people talk of low oil demand, they usually think about gasoline and diesel, but a huge chunk of oil products goes into crackers and thus lower petchem demand and prices create additional pressure on oil demand and prices.
The other issue is the feedstock situation, which is rooted in the energy sector.
I would not comment on the situation on the oil market as it’s driven by a number of factors, most of which are of a complex nature and very hard to anticipate. Let’s talk about the situation with oil derivatives like naphtha and liquefied petroleum gas (LPG), which are the main petchem feedstocks. Though these products have a high correlation with crude oil, they still have their own market factors like supply and demand. We see that pressure on those products will continue, mostly driven by extra supplies from the US market. US shale oil producers generate a lot of byproducts NGLs comprising of ethane, LPG and naphtha. Why is it important? Because in 2019 alone, the US added approximately 7 million [metric] tons of LPG to the export markets. To get a sense of how much it is, Russia’s whole annual LPG exports stand at 6 million tons. That was the key factor depressing LPG prices in 2019. While the oil price dropped by almost 10% yearonyear in 2019, LPG prices weakened from 16%22% depending on the region. We expect that US additional volumes will stay on the market if shale oil production continues in the current manner, hence the additional discount on LPG prices compared to oil are likely to continue. That’s been what we expected in terms of the feedstock performance, the midstream segment. Sibur has both a midstream segment and a petrochemical segment.
Q: So what is on for 2020?
A: We don't see any reasons why the market for all products in our portfolio should recover in the short term. I would even expect more pressure on polyethylene because of new volumes coming to the market. This year we might also see what the demand will be around the globe amid the spread of Covid19.
Q: Are there any early indications of what impact coronavirus is having on demand?
A: We haven’t seen significant limitations on deliveries of petrochemical products to China at the beginning of the year though a high stock balance in China may indicate a prolonged imbalance on the market through the whole of 2020. We had certain warnings, but we didn't reroute our deliveries. No one can give a clear picture on what we may see in the next months, but even without a coronavirus effect we didn't anticipate a quick recovery on the market in 2020. The spread of Covid19 across the globe leads to a decline in demand in the developed countries that are key markets for Chinese producers. Therefore it’s sensible to anticipate declining exports from China and an overall slowdown in production. If you look at the financial results of petrochemical companies, you will see a steep decline. This explains why the industry is no longer keenly interested in new investments. In 2017, 2018 there was a lot of rhetoric around petrochemicals as a good industry to invest in. And even oil and gas majors considered the petchem industry as a new opportunity. Today, the industry is no longer that attractive. We should probably expect less investments, less final investment decisions (FIDs), less construction of new capacities. Depending on how quickly all countries will be able to come out of this crisis, our key markets should find new balancing levels that may eventually reshape the petrochemicals universe. I mean we may see more capacities to come out in Asia simply because their economics will be better. Asia will enjoy the same lower oil prices, say for naphtha, that everyone has globally and it’s cheaper to build new capacities there, whereas more expensive US expansion may be put on hold as companies wait to see what happens with shale production. Though you may see new capacities being launched in the next several years simply because FIDs have already been taken some time ago and companies can not put on hold their construction in progress. But such an environment would put a certain limitation on those who were ready to invest but have not started the construction yet. However, in the long run, when a future shortage of new capacities happens, it should bring the margins back. And if you look at the industry's expert opinions, for instance, IHS, they predict the restoration of margins when demand catches up with supply levels.
Q: What about US and Middle Eastern projects? How are they going to affect your market in the longer term?
A: These regions are often mentioned as territories of new capacities because they have a lot of easilyavailable ethane. If you take the petchem industry specifics, you have naphtha as a typical feedstock for the chemicals, you have LPG and you have ethane as a feedstock for chemicals. Ethane is a more attractive type of feedstock for ethylene production, which is a major monomer in the chemical industry. The Middle East simply utilized almost all ethane they have in the region, which is not the case for the US as it has abundant ethane reserves. The socalled first wave of chemical projects already started to operate or are at the commissioning stage right now. There is a separate discussion if we see the second wave of projects in the US as they still have nonutilized ethane. LPG is not that attractive for US crackers as the alternative cost of ethane is much lower (mostly because of cheap gas and high cost of ethane transportation by water) therefore it is easier to monetize LPG by exporting it. An alternative way to monetize ethane is to leave it as part of natural gas to increase its calorific value, and get an additional premium for gas. So US companies are balancing between utilizing ethane in petrochemicals or leaving it as part of natural gas. The key factor here is pricing – if the gas price is high it’s sensible to keep ethane in the gas; if the ethylene or polyethylene price is high it makes sense to build a cracker and use ethane in petrochemistry. Nowadays we have low prices on both gas and petrochemicals which place limits on further investments as it’s economically inefficient to develop new projects. So the bottom line here is that I would not expect any new capacities out of the US in the short to midterm. The prospects for Middle Eastern projects are limited by scarce ethane resources and high construction costs. However, when demand catches up with supply levels, we may see much more attractive prices on the market that may trigger another wave of new projects globally.
Q: So, it's a question about the numbers, right?
A: The US market is good in terms of prices for feedstock, but it is not so good in terms of capital expenditures. It is not so cheap to build capacities in the US relative to Asia for example. And of course, as an investor, you always compare the money you need to invest and the payback you can get. So, the attractiveness of the feedstock allows you to generate good earnings, but you need to spend more on construction and operating. That's why it is a question mark.
Q: What kind of return on capital employed would you get in Russia compared to, let’s say, the US?
A: We see Russia as a good region for chemical investment because we have a similar advantage for feedstock as the US does but we are closer to the Chinese market, hence we can benefit from lower delivery costs. The latter thing is very important because during this turbulent period caused by Covid19 it becomes crucial to be closer to your target markets and be wellconnected to your customers in China. Sibur, being a lowcost producer of petrochemicals located in the heart of Russia, has a unique edge in access to Chinese and EU markets. On top of that we’ve established and continue to develop our relations with Sinopec, one of our shareholders and the largest petrochemical company in China.
Q: Sibur is building the Amur gas chemical complex. We understand the plant is going to be operational by 2024. Is that correct?
A: Mechanical completion is scheduled for 2024, not earlier. We separate these two definitions. Like with ZapSib [Zapsibneftekhim petrochemicals plant], we had two major stages. One is mechanical construction completion. Then what we call a rampup period, a separate project to reach a high level of capacity utilization. It takes up to 11⁄2 years. The same for the Amur complex. 2024 is the date for mechanical construction completion. We usually try to avoid mentioning exact dates for reaching target capacity utilization, because it's really an open question and can take from six to 18 months.
Q: So it could take up to 18 months before it could actually start fullscale production after mechanical completion.
A: Right, before we produce physical volumes. With ZapSib, we mechanically completed it in the middle of 2019, and we started to produce reasonably large volumes in the fourth quarter. We managed to rampup to a 30% utilization rate by the fourth quarter, which is half a year after mechanical completion. And then we still need some time to ramp it up to reasonably good levels. I mean, 90%plus.
Q: What are the plans for reducing the company's impacts on the environment?
A: I would say that this subject became a serious part of our internal agenda a few years ago. It is difficult to specify the exact year, but what is important for us is the approval of the 2025 strategy, the ESG [environmental, social and governance] strategy, by the board last year. This was the indication how seriously we consider ESG factors. It is not just rhetoric for us, there are a lot of targets. We don't disclose certain details, but we took an internal decision to reconstruct of one of our chemical facilities in order to use recycled plastics as a feedstock for polyethylene terephthalate (PET) production. The idea was to not just use plastic, but utilize certain volumes of collected and recycled plastic bottles. This is another illustration that we not just care about the footprint of our production, but we also care about the ecological friendliness of our products, which is a separate section of ESG strategy. Our strategy is saying that we are going to produce at least 40% of PET from recycled PET granules.
Q: You obviously will get pressure from investors and, of course, potential investors in the future, once you eventually get to an initial public offering (IPO), to get improved financial results. Are you getting pressure from the nonfinancial community to sort of clean up your activities, become greener?
A: I would say that we see rising interest, increasing attention. At the same time, I don't see any of the limitations that, for instance, the tobacco industry is facing, or even oil and gas is facing. We see increasing attention and we need to provide additional details on what we are doing and who our clients are. It is one aspect. In another aspect, it used to be the case some time ago when we convinced our creditors that all our new investments are made in full accordance with modern requirements, I mean, current requirements for ecological footprint of the new plants. We do a pretty detailed, pretty thorough ecological audit for every new plant we build. We show those documents to the lenders. Before we do that, we just don't close the deals. And for instance, all the money that was raised for ZapSib was raised with these components with this thorough, ecological audit of the new plant. We see that it will be the case for the Amur plant.
Q: You have got this butyl rubber plant in India that you have built with Reliance. Do you have other plans to build plants abroad?
A: I wouldn't expect us to be super active out of Russia. Before I directly answer this question, I would comment on the business rationale we saw there, and it explains a lot. This story is pretty simple. In the chemical industry, sometimes to produce certain things you need to buy a license, you need to buy a technology. We had technologies developed by Sibur some time ago. And we just were able to monetize that unique technology in synthetic rubber production. The rationale was to sell the technology and we decided not just sell technology but to contribute that technology as part of our contribution to the joint venture with Reliance. They didn't have a lot of alternatives and that created a business case. We are humble enough to keep our development focused on Russian market. I mean, we see certain conditions that make it possible to develop this basic polymer business in Russia our access to feedstock, our ability to execute capital projects and our market position in Russia. That's why we will focus on the Russian market not only in terms of demand, but also in terms of production because there are a lot of opportunities here. At the same time, we understand that in order to become better on a global scale, you need to have some unique features, competitive advantages. And we don't see those competitive advantages out of Russia, rather than those unique opportunities that are available for us in the case with this technology. That is why I wouldn't expect us to be super active out of Russia. The only exception could be the story like we have in India, where we again may sell our technology and discuss a potential venture in other regions.
Q: The final question is on the IPO. Could it happen this year and is Moscow going to be the main market for the company's shares?
A: Our CEO Dmitry Konov said earlier that it doesn't make sense now. It is our kind of view, but it is up to shareholders to decide. Things may change quickly.