Emerging rivalry in polymer space

The polymer industry is set to become bigger and more competitive over next two-three years as new players like ONGC and IOC enter the business with capacities huge enough to change the domestic market scenario. With a marketshare of 20%, GAIL India is a key player in the polymer business. But the company has been rather slow in expanding its manufacturing capacity because of the domestic gas shortage. Can it face the emerging competition in the market?

GAIL has installed capacity to manufacture 0.41 million tonne per annum (mmtpa) of polymers at its Pata plant in Uttar Pradesh. In comparison, new plants that are coming up have a minimum capacity of 1 mmtpa. Besides, GAIL’s plants are not strategically located to tap the export market. So it has only the domestic market to bank on for its products.

However, GAIL’s strength lies in the fact that it uses natural gas as feedstock to produce polymers. Natural gas is more economical than naphtha. Even though the company uses the costliest gas supplies from the Panna-Mukta-Tapti (PMT) line and imported LNG, cost economics of its polymer plant is still superior to naphtha-based crackers.

For example, the cost of naphtha at current market prices works out to $12-15 per mmbtu while the delivered cost of gas supplies for GAIL’s plant is a little above $6 per mmbtu. The use of gas, thus, more than offsets its disadvantage of sub-optimum economies of scale.

GAIL’s petrochemical business accounts for about 33% of its profit, though revenue share is proportionately lower. That shows relative profitability of the company’s petrochemical business vis-a-vis other business streams like gas transportation & marketing and LPG.

Back-of-the envelope calculations show, in recent years, the company’s net profit margin from the petrochemical business has been above 30%, compared to 18-20% from gas transportation & marketing.

GAIL’s superior marketing strength also puts it at an advantage; it has zonal offices in all parts of the country.

The polymer business is purely market-driven, a play of demand and supply, as there are no government regulations on the sector. The world polymer market is well integrated. That means a country can export and import polymers simultaneously, depending on locational factors. Meanwhile, the government has slashed import duties on polymers to 5%, levelling the play field for imports. Currently, about 16% of the domestic polymer requirement is met through imports. New polymer capacities are also coming up in the Middle East.

Because of the easy availability of cheaper natural gas as feedstock for petrochemical plants in the region, imports from the Middle East are quite competitive in the Indian market. So the share of import is expected to rise further in the coming years. So far, GAIL has maintained its market competitiveness against imports by pricing its products on an import parity basis.

If import competition intensifies in future, GAIL will feel the pressure, but so will other Indian players, since the global petrochemical market is integrated and price competition is strong.

Though belatedly, GAIL is expanding its Pata capacity from 0.41 mmtpa to 1 mmtpa . It is also setting up a new cracker in Assam under joint venture. The new capacities would be commissioned in four years.

By expanding its Pata capacity, GAIL should be able to significantly improve the plant’s economies of scale.

The Assam project is a dual-feedstock project and will benefit from cheaper gas prices for the North East, administered by the Centre.

While there is a huge demand for polymers in north India, where downstream plastic industry is well developed and can easily absorb additional production from the company’s Pata plant, GAIL might not be able to sell its entire production from the Assam project locally given the lack of downstream industry in the region. It would have to develop the local market if it has to make the project commercially viable.

But what might well prove a game-changer for GAIL is its equity participation in ONGC’s upcoming 1.1-mmtpa petrochem complex at Dahej. GAIL has 19% equity in the project, which is being developed through the joint venture, ONGC Petro Additions Ltd. The dual feedstock plant will source naphtha from ONGC’s Hazira and Uran gas processing units while getting ethane and propane from its nearby C2/ C3 extraction units. It will have a capacity to manufacture 1.1 mmtpa ethylene, 340,000 tonne propylene, 135,000 tonne benzene and 95,000 tonne butadiene.

Given GAIL’s relative strength in polymer business, it might be granted the right to market products from the project, to be commissioned by end-2012.

Like refining, petrochemical business is also of cyclical nature since the price of naphtha, a widely used feedstock for petrochemical plants, closely follows international crude oil prices, which is hihgly volatile. This is a major downside risk for standalone petrochemical plants. In contrast, gas prices are less volatile because of the difficulty of transporting gas over long distances that makes it less tradable. Since GAIL’s crackers are based on gas, they are insulated from feedstock price risks.