2Natural Resources and EnergyMiddle East ChemicalsJanuary 2011
In terms of margins, the rule of thumb is that companies with the biggest cost advantages and the highestmargins (eg SAFCO) are impacted more by an increase in feedstock prices than companies with lowercost advantages and margins (eg SABIC). Our oil and gas team has increased its energy price forecastsfor 2011-15 by around 10% which has resulted in an increase in our product pricing estimates. In mostcases, the impact from higher product pricing outweighs the impact of higher feedstock costs.
Sector investment thesis
Peak conditions to return by 2013/14, market likely to remain balanced in 2011
Rising emerging market demand and limited supply growth will create an environment of higher capacityutilisation rates. Based on our supply assumptions and HSBC Economics global economic growthforecasts, we expect to see a return to peak conditions (utilisation rates of over 90%) within thecommodity chemical sector by 2013/14.However, while we are bullish on the sector in the medium term, we believe that in the near term supply growth in2011 could potentially come in above expectations. We expect incremental supply from existing plants to matchdemand growth for the year as improving macroeconomic conditions ease some of the bottlenecks (in terms of feedstock supply) that resulted in a tight market in 2010. This should be particularly true for European crackeroperating rates, which are tied to operating rates at refineries in the region. An improving macro environment inEurope should lead to higher ethylene supply on greater naphtha availability from refineries.Furthermore, higher oil-product demand and higher oil prices could lead to an increase in OPECproduction quotas which would make more associated gas available, particularly in Saudi Arabia, andresult in an incremental increase in operating rates at newer crackers – which we estimate are currentlyrunning on average at 80% – owing to feedstock supply constraints. In both these cases, incrementalsupply would materialise from existing capacity only if demand growth continued to be strong and henceshould not result in a big dip in utilisation rates due to an oversupply situation. However, this incrementalsupply would, in the short term, prevent a sharp rise in utilisation rates. We forecast ethylene utilisationrates to improve by only 70bps in 2011 over 2010 levels.
Cautious on sector performance in 2011
We believe that after two years of exceptional stock market performance from the Middle East chemicalsector with stocks on average up 47% in 2009 and 24% in 2010, it is time to take a more cautious view onthe sector in 2011. Our cautious stance on performance is based on by high valuations and elevatedconsensus expectations. Middle East chemical sector valuations are now above mid-cycle levels, withstocks trading on average on a 15.6x forward PE versus the historical sector median forward multiple of 14x. While fundamentals are healthy, these appear to be already factored into share prices and we think itit is unlikely that in 2011 the sector will generate the same level of returns seen in 2009/10.
HSBC Saudi feedstock pricing assumptions2011e2012e2013e2014e2015eGas price (USD/mmbtu), New 0.751.251.502.002.00
Gas price (USD/mmbtu), Old 0.750.750.750.750.75
% Propane Discount, New 28%27%26%25%25%
% Propane Discount, Old 28%28%28%28%28%
Source: HSBC estimates