September 19, 2010

Adapting and Developing Middle East Companies Toward Chemicals Diversification

Middle East-based chemical companies have capitalised on their advantages in low cost gas-based feedstock to build a strong competitive base—going forward, however, Middle East chemical companies need to diversify which will require adapting to a different competitive landscape and develop complex product management capabilities.

Building on their cost-advantaged feedstock position, Middle East-based chemical companies have built a formidable competitive position in basic petrochemicals. In response to a lack of gas-based feedstock and government policies to create jobs, companies are seeking diversify into new chemicals where their cost advantage diminishes presenting themselves with new challenges. Middle East chemicals companies will now have to adapt to a different competitive landscapes and develop capabilities to manage a more complex product slate to continue to grow and shape the chemical industry.


Today

The chemicals industry worldwide is just beginning to recover from the worst crisis in decades, and finding that the post-crisis landscape is significantly different. Middle East companies have capitalised on a cost advantage of 30 to 90 per cent in natural gas-based feedstock. As a result, these companies will nearly double their share of global capacity from 2008 to 2013.

“To date, companies in the region have focused on the basic, commodity chemicals that are based on natural gas feedstocks, such as fertilizers and plastics which are relatively straightforward to manage and highly profitable. Indeed, Middle East companies have such a strong cost advantage in manufacturing such products that Western giants including Borealis, ExxonMobil Chemicals, and Dow have partnered with regional companies in order to benefit from these advantages,” commented Andrew Horncastle, Head of the Booz & Company Chemicals Practice in the Middle East and North Africa.

Today, Middle East chemicals companies continue to build on their cost advantage in basic petrochemicals, which has made them formidable challengers in the global industry. However, they are now also beginning to invest in more specialised chemicals to further strengthen their overall position as well as create more industrialised, diversified economies in their countries.


Need to Diversify

There are two overarching trends in the region driving these new investments into specialized chemicals.

  • Gas shortage: Gas-based feedstock is becoming scarce in most of the GCC countries including Saudi Arabia and, as a result, there will be an increasing trend to use naphtha as a feedstock.

  • Government policies: Many GCC governments are seeking economic diversification to drive job growth and add economic value and are basing future feedstock allocations in addition to other types of incentives to ensure that companies produce a more diversified portfolio that will support downstream industrial development.


Addressing the Challenges

“Diversification brings numerous challenges for Middle East companies. As they move away from gas-based feedstock, the cost advantage that Middle East companies enjoyed with natural gas will significantly reduce,” commented Ibrahim El-Husseini, Partner at Booz & Company. “In addition, complexity increases rapidly as these chemicals are more difficult to manufacture and require more customer intimacy and applications support as well as stronger capabilities in portfolio management and supply chain,” he added. Going forward, Middle East companies need to address two crucial elements.

  • Competitive landscape: Middle East companies will find a different set of competitors when diversifying into new chemicals and will need to compete on a different basis. For instance, since their cost advantage is diminished, Middle East companies will need to consider other factors besides price and cost where they can build a competitive position requiring a more focused approach to which products and value chains they should target.

    “North American and European companies are likely to be more aggressive in defending their territory in specialty chemicals, where their innovation capacity is a strong source of competitive advantage, than in basic chemicals. However, a lot of specialty segments are commoditizing rapidly and Middle East companies are finding opportunities to put down stakes—particularly as Western companies divest businesses to clean up their balance sheet or adjust to their growth strategies and, in doing so, seek to sell or establish joint ventures for their businesses that could significantly benefit from integration with Middle East players,” commented Horncastle.

    In these cases, it will fall to the Middle East companies to make sure that they truly capture knowledge from these partnerships in order to build their own capacity to develop a high-value and diversified product portfolio, rather than simply acting as the purveyors of inexpensive feedstock. In particular, Middle East companies should consider where else they might be able to build a competitive advantage such as using their regional proximity to Asia and Europe to better serve those markets. Indeed, Middle East chemical companies are well positioned logistically to serve Asian markets, which are currently growing faster than those in North America and Europe.
  • Developing capabilities: It is critical for Middle East companies to develop the necessary capabilities to manage a more complex product slate. This will likely require companies to continue to use JVs and acquisitions as a way to acquire capabilities but more importantly, will require careful planning to integrate those capabilities so that technology and know-how is transferred.


Diversification Has Begun

Saudi Arabia and the UAE have both started to move into new chemical products and are making significant investments in integrated petrochemical and specialty chemical projects. But the move is not without challenges. They must carefully choose those products that meet their profitability targets yet at the same time balance government requirements for diversification and job creation in order to receive the feedstock they need. In addition, they need to further develop their technology and management capabilities to handle the diverse array of products. Marketing these products is more complex as companies need to work much more closely with customers to meet their needs which will require them to put supporting infrastructure directly in Asia and Europe, where there is demand for these products.


Solutions

“In order to overcome these challenges, Middle East companies should focus first on just a few new products to allow for a learning curve and build a sustainable, competitive position. They should continue to use acquisitions and joint ventures with Western and Asian companies to make use of existing technology, market access, and management experience, as well as other capabilities, in order to be competitive. In doing so, it is important for Middle East companies to have a clear strategic intent for acquisitions or joint ventures in order to ensure that they capture the integration benefits of such arrangements,” said El-Husseini.

As the crisis recedes, Middle East companies will continue to shape the chemical industry by further increasing their footprint across products and regions, building on their relative advantages. As a result, they will be continue to be a driver in the transformation of the chemicals industry by actively pursuing acquisitions and forging new alliances.