1

A P R I L 2 0 14

When gas gets tight: Next steps for

the Middle East petrochemical industry
The region’s producers are entering a world of limited new gas supply. To continue to
grow at home and remain competitive, big changes will be required.

Florian Budde, The Middle East petrochemical industry has seen build the managerial and technical capa-
Christian Günther, spectacular growth over the past 30 years based bilities needed to develop and further grow
and Mihin Shah
on the availability of low-price gas feedstocks. their businesses.
But with advantaged new gas supply expected to
end in most countries in the region over the next Petrochemicals’ child prodigy grows up
few years, petrochemical producers that want to The Middle East petrochemical industry has come
expand domestically face major challenges. They very far, very fast. From the first joint-venture
can continue to build up their export industry plant in 1981, the industry has expanded to a total
using naphtha feedstock instead, but companies annual petrochemical production of 121 million
will have to find new ways to offset the handi- tons in 2012. Capturing the gas flows associated
cap of their geographical location far from major with oil production that were previously flared
growth markets. While obtaining naphtha at and instead channeling those flows as very low-
advantaged prices would help their position, the priced feedstock for chemical production has
region’s petrochemical producers should become made it possible to build an immense and highly
leaders in operating and functional efficiency. profitable industry. The Gulf Cooperation
This will in turn require a broad mobilization to Council (GCC) countries contributed 11 percent
2

MoChemicals 2014
of global petrochemical-capacity growth over the The expansion in petrochemicals has made an
Mid East
past ten years and are now a leading global important contribution to the region’s economies,
Exhibit
producer1andof supplier
5 to world markets of ethylene diversifying them away from their dependence
and derivatives and methanol (Exhibit 1). on oil production. The region’s chemical industry

Exhibit 1 The GCC’s petrochemicals output has grown 11% a year since 2000,
capturing significant global share.

Global petrochemicals capacity 1 GCC capacity: top 10 petrochemicals, 20121

Million metric tons per annum (Mtpa) CAGR,3 Mtpa GCC share of
% global capacity,
>10% share of global capacity %

1,884
4% p.a.
Ethylene 21 14
231 3.8
Urea 14 6
121 11.1
Ammonia 12 6
1,175
476 Methanol 11 12
3.2
Rest of world 148
GCC 2 Ethylene glycols 7 27
34
Rest of Asia 327 513 13.3 Propylene 7 7

China 114 Polypropylene 6 10

Europe 246 HDPE4 6 14

260 0.5
Ethylene oxide 6 20
North America 305 283 –0.6 LLDPE5 5 18

2000 2012 Others 25 3

GCC 2 share of 3 6 Total 121 6

capacity, %

1 Figures may not sum to total, because of rounding.

2 GulfCooperation Council.
3 Compound annual growth rate.
4 High-density polyethylene.
5 Linear low-density polyethylene.

Source: ICIS; IHS; International Fertilizer Development Center; Italia ATEC; McKinsey analysis
 3

As job creation and economic diversification has become a more

pressing issue in the past decade, the industry’s contribution has
increasingly been recognized by national governments.

currently supports an estimated 840,000 jobs: As the Middle East’s petrochemical industry
110,000 in chemical production, and, indirectly, has grown, a number of companies have emerged
a further 730,000 jobs, including suppliers as leading global players. Sabic has acquired a
and contractors involved in areas such as gas petrochemical base in Europe, bought GE Plastics,
production, outsourced maintenance, and made production investments in China
transportation services, and other logistics that it continues to expand. The portfolio of Abu
services. In Saudi Arabia, chemicals represented Dhabi’s International Petroleum Investment
4.5 percent of non–oil and gas GDP in 2011— Company includes Nova Chemicals and Cepsa as
a share that increases to 11 percent if indirect well as majority ownership of Borealis.
and induced contributions are included.
This internationalization trend has gained a
As job creation and economic diversification has further dimension over the past decade as Middle
become a more pressing issue in the past decade, East oil producers have increasingly invested
the industry’s contribution has increasingly directly in emerging markets; some of these
been recognized by national governments. Of investments include petrochemicals as well as
course, 840,000 jobs can only go so far in refinery units. Such moves clearly help to
meeting the employment needs of a working-age assure outlets for these Middle Eastern countries’
population of around 20 million across the hydrocarbons in the markets that are the key
GCC countries, but it represents an important step drivers of oil-consumption growth. But to further
toward diversification. the economic diversification and employment
growth that most Middle Eastern countries are
While progress to date in building up industries looking for at home, expansion of the domestic
such as plastics processing that could consume petrochemical sector would remain an important
some of the region’s petrochemicals has instrument. Superficially, the Middle East
so far lagged behind expectations, this largely petrochemical industry is still in a good position:
untapped opportunity offers promise for petrochemical production requires feedstocks,
the future. Chemical production more than three and the region sits on immense reserves of oil and
or four processing steps beyond the cracker gas, which could potentially feed continued
or aromatics plant—“downstream activities” in global growth in petrochemical demand.
chemical-industry parlance—accounted
for 3 percent of capacity and 4 percent of New hurdles on the development path
chemical revenues in the region in 2010, com- However, producers in the GCC face a number
pared with 15 percent of capacity on of challenges, and perhaps surprisingly, the
average worldwide. most significant of these is in feedstocks. The scale
4

MoChemicals 2014
Mid East
Exhibit 2 of 5

Exhibit 2 GCC petrochemicals growth will be gas-supply constrained

by around 2015.
Domestic demand and export commitments Domestic demand

Gas supply and demand in GCC,1

billion cubic meters per year

500

450
Imports2
400 Unconventional
350 Nonassociated

300

250
Condensate
200

150

100
Associated
50

0
2000 2005 2010 2015 2020

1 Gulf Cooperation Council; demand includes long-term gas export agreements of Oman, Qatar, and United Arab Emirates.
2 Includes liquefied natural gas imports of Dubai and Kuwait.
Source: Company websites; Rystaad; McKinsey analysis

of expansion in the GCC region in petrochemicals, under way. Projects under construction or at
energy-intensive industries, and in gas-fired power the planning stage in Saudi Arabia, Kuwait,
generation has been such that the region will Abu Dhabi, and Oman would add a further 34
move from a gas surplus to a shortage around 2015, million tons of annual capacity by 2018 and
according to current estimates. The expectation would increase the GCC’s share of global ethylene
is that there will simply not be enough gas available capacity from 14 percent to 16 percent. Because
to sustain further petrochemical expansion of a lack of ethane, some of the recent projects have
across the region beyond 2015 (Exhibit 2). Should had to use a different feedstock slate. For example,
any new gas become available, allocations are Saudi Kayan uses butane for 65 percent of
likely to be supplied at a higher price. its feedstock (with the balance ethane), and the
Sadara JV of Saudi Aramco and Dow Chemical
This is already presenting a challenge to the large will use naphtha for approximately half its
wave of new capacity that is currently getting feedstock, with the balance again ethane. Butane
 5

and propane are seeing the same supply limita- petrochemical makers face a gas-supply squeeze
tions as ethane, however. These constraints for at least the next several years.
are likely to force the industry to increasingly
look at naphtha from local refineries for On top of this, Middle East producers have his-
additional feedstock. torically tended to depend on their joint-venture
partners for technology and for marketing;
Shifting to naphtha from low-priced ethane joint ventures account for 60 percent of today’s
represents a major challenge to the cost position capacity. At this point, it is unclear to what
and competitiveness of the Middle East extent international partners will be interested in
petrochemical industry, which has grown accus- participating in ventures that do not have
tomed to operating at the favorable end of an advantaged feedstock position.
the cost curve. Most national oil companies
will want to transfer their naphtha at international The prospect of having to fend for themselves
market prices. Our analysis suggests, however, would take many Middle East–based companies
that crackers in the Middle East getting naphtha at into new territory. Put simply, while the com-
market price will be among the highest cost panies have built up their capacity over the past 30
producers in the world. years, many have not built up their functional
capabilities in parallel. Companies across the
Our modeling identifies two main factors region also confront a gap in the area of manage-
underlying this cost disadvantage. First, the ment and technical capabilities. Moreover,
transportation costs of shipping GCC companies must cope with a severe shortage of
petrochemicals to market—typically in Asia— both qualified graduates and of experienced
put them at a disadvantage not only to naphtha candidates for promotion in the workforce that
crackers in those Asian markets but also to could constrain the industry’s ability to grow.
traditionally high-cost producers such as Europe
and Japan, which have large domestic markets Take the example of chemical engineers: Saudi
to serve. GCC naphtha-based production would Arabia is currently expected to train at most
also be at a significant disadvantage to planned around 3,000 chemical engineers in the next seven
new North American capacity based on new years, while Germany will train around 10,000.
shale-gas supply. Second, by-product streams at This is mismatched with Saudi Arabia’s ambition
GCC petrochemical plants that are used for to build around 15 million tons of new capacity,
fuel have low value given the low price of gas in while Germany expects to build 1.5 million tons
the GCC countries, thus increasing the over the same time period.
plants’ costs.
Adapting to the new feedstocks landscape
Clearly, given the region’s hydrocarbon wealth, The Middle East petrochemical industry faces
there is potential to develop new gas production. some important choices under these new
Initiatives are already under way to develop circumstances. If the only feedstock available is
nonassociated gas production in the region, market-priced naphtha, the only new produc-
notably in Saudi Arabia. But the typically long lead tion that could compete on costs with other
times on such projects mean that Middle East regions would be plants that supply the immediate
6

region—a very limited opportunity. But if The demand is there: total worldwide ethylene
the region’s governments decide that they want to demand is projected to increase by more than 40
expand petrochemical production in order to million tons per year to around 175 million
continue to diversify and grow their economies, tons by 2020, and to nearly 210 million tons by
then one option could be to make naphtha 2025, with most of the end-use demand
MoChemicals
available at a cost2014
advantage relative to global growth coming from China and other emerging
Mid East
prices. This could make Middle East produc- economies. New North American capacity
Exhibit 3 of 5 again, and large-scale expansion
tion competitive and other advantaged feedstock-based producers
could continue. will cover only around half of new demand,

Exhibit 3 Global petrochemical demand growth will exceed new capacity based
on advantaged feedstocks.
Million metric tons per annum, ethylene, estimated, 2013–25

Expected mix of new ethylene capacity to meet demand growth

84

Demand growth is projected to be

18 sufficient to absorb new supply based
on advantaged feedstocks and still
require high-cost crackers

24

42

Capacity needed North America Other advantaged High-cost crackers

to meet global shale-gas feedstock feedstock 2 to balance demand 3
demand growth1
Expected types and locations of new capacity

1 Assumes annual demand will grow by about 75 million tons by 2025, with capacity added to get to long-term average
industry utilization of about 88%.
2 Includes advantaged ethane in former Soviet Union countries and North Africa, as well as methanol to olefins in China.
Limited by amount of low-cost feedstock supply and other resources (eg, water), and expected gradual pace of building
new capacity based on new technologies.
3 Includes naphtha crackers in China, India, Southeast Asian countries, and the Middle East.

Source: Tecnon; McKinsey analysis

 7

leaving extensive scope for companies in other producers have been so high that producers have
regions (Exhibit 3). not taken the time to ask, “What opportunities
do we have to increase our profits further?” Given
However this plays out, there is one clear the anticipated squeeze on margins as “easy”
no-regrets move for Middle East producers to gas supply dries up, now is the time for producers
make: since margins are likely to be lower to ask a different question: “How much margin
than companies have enjoyed in the past, they will could we make if we optimized all our costs
want to embrace functional-excellence initiatives and operations?”
that can help boost returns. In addition, producers
in the region will want to build up their organi- A range of opportunities under the heading of
zational strengths in order to sustain growth. It is “functional excellence” can be exploited to build a
also important that downstream investment new kind of cost advantage. Manufacturing,
be prioritized. capital projects, and pricing are especially impor-
MoChemicals 2014 tant. The largest gains in return on invested capital
Mid
1. East
Drive functional excellence. (ROIC) tend to occur through manufacturing-
Exhibit
Consider 4 ofthe
first 5 no-regrets move. Historically, excellence efforts; in Europe and North America,
profit levels for Middle East petrochemical gains of three to four percentage points are

Exhibit 4 Functional excellence can significantly improve ROIC performance.

Area of functional Improvement in return on invested Enablers

excellence capital (ROIC), %

Manufacturing 3–4

Marketing (pricing) 2–4

Capital projects 2–3

Supply chain 1–2

Sourcing 1–2

Service functions ~1

Innovation ~5–10% top-line growth through innovation

Talent Enabler to all other areas of excellence

8

often achieved (Exhibit 4). Other areas are In manufacturing, many top-performing
nearly as rich with potential, though there is some companies are increasingly shifting their focus
overlap among them. In our experience, these from fixed costs (such as labor) to variable
improvements in ROIC tend to be even higher costs, the much larger portion of their cost base.
MoChemicals 2014 An essential
in Middle East companies. Improvements achieved in energy, yield, and
Mid East
ingredient in all functional-improvement efforts throughput have been substantial—especially
Exhibit 5 of 5
is talent management, which we will since, in petrochemicals, these not only
discuss below. reduce cost but also increase production volumes

Exhibit 5 The competitive position of Middle East ethylene production would

vary sharply depending on feedstock.
Global ethylene cost curve (plant gate): 2020 capacities, 2012 prices, and cash costs1

Cash cost
$ per metric ton

2,000

ME cracker with discounted ME naphtha cracker with

naphtha feed 2,3 naphtha feed at market price 4
1,500
ME cracker with feedstock
divided equally between ethane 2
Middle East (ME) ethane cracker 2 and market-priced naphtha

1,000

500

0
50,000 100,000 150,000

Effective capacity,5
kilotons per annum

1 Plant-gate costs; based on prices in United States, Western Europe, Northeast Asia, Southeast Asia, and Middle East
netbacks (South America costs based primarily on US prices); each cracker’s cost based on estimated feed mix, scale,
and estimated yield-efficiency estimate.
2 Middle East ethane is valued at fuel value with gas at 75 cents per million British thermal units; discounts on naphtha are
assumed at 25% for the curve.
3 Assumes the naphtha cracker has discounted feedstock and integrated operations.
4 Assumes naphtha, butadiene, propylene, and other by-products are at export netback.
5 Effective capacity assumes 93% of nameplate capacity.

Source: CMAI; ICIS; Tecnon; McKinsey analysis

 9

A broad mobilization is going to be needed to

build the functional capabilities that will be
required to run operations more efficiently and
to grow the business.

without consuming more feedstock. This latter international joint-venture partners that
consideration is clearly important in the tight frequently own the process technology needed
feedstock environment that Middle East producers to make higher-margin products.
are now entering.
Middle East hydrocarbon producers are likely to
Companies pursuing this route often set targets continue to invest in refining and in petrochemical
based on a “theoretical limit”—that is, the plants in emerging markets that will also help
minimum amount of energy or feedstock that the capture a greater share of global demand growth.
thermodynamics or stoichiometry requires— But clearly for domestic economic development,
and then analyze losses based on a profit/hour investments in petrochemical production at home
equation. They employ a range of tools, from will be the priority.
load curves to advanced analytics, to identify
improvement opportunities and relentlessly The “economically rational” minimal growth path.
go after them. By focusing on manufacturing in At the opposite extreme is a scenario where
this new way, leading operators can achieve naphtha would only be available at market price.
an additional impact of 3 to 5 percent on As discussed above, this would put Middle
the overall cost baseline, and it is not unusual to East ethylene derivatives production in an
achieve energy-cost savings of as much as uncompetitive position for export. The only hope
15 percent. for new petrochemical production earning a
respectable return based on this feedstock position
2. Tailor the growth path. will be a very limited number—perhaps only
We see three development scenarios that could one or two—of petrochemical complexes that make
play out. a range of more targeted products that can
displace imports in the Middle East region.
Restoring a cost advantage to capture a share of
worldwide demand growth. Our modeling Our analysis suggests that such a plant—one that
suggests that ethylene producers that receive uses market-priced naphtha but is able to optimize
a discount of around 25 percent on their operations, use all its by-products and off-gases,
naphtha supply would have an attractive cost and sell its production in the region—would
position that would enable them to profitably move its position enough down the cost curve to
export into Asian growth markets (Exhibit 5). This where it could expect to make acceptable returns.
advantaged position could also be attractive to If it developed the required derivatives slate,
10

it could also possibly form the basis for a cluster of assess how many people they will need at all levels,
more elaborate, smaller-scale specialty polymers and with what skills, as the industry expands.
and specialty-chemical production plants. They should then liaise with education providers—
governments and training institutions—to
However, it is important to underline that there ensure the provision of vocational training that
is only a limited opportunity here given the will create the skilled manpower needed.
small size of the Middle East market, and such
a plant could be facing competition from the Here, industry can play an important role in
“hybrid” plants described below. defining the standards of occupational skills for
apprentices, on which technical- and vocational-
Hybrid route: Building on past cost advantages. training providers can base their programs.
A third scenario would comprise companies In some countries, such as Saudi Arabia, progress
with grandfathered low-price supplies combining has already been made in piloting such initia-
that profitable base business with expansion tives, but programs will have to be scaled quickly
into naphtha feedstock-based plants. to prevent a talent shortage from blocking
growth. In addition, larger companies should
The combination of low-priced ethane and market- expand their own on-the-job training
priced naphtha could still add up to a competitive curricula for fresh graduates. In time, this will
position, particularly if these plants embraced generate a cadre of skilled employees.
functional-excellence programs. Such programs
would improve the already high profitability Build management and technical capabilities.
of their cheap-gas plants and could help establish Most Middle East petrochemical companies do not
well-run operations at new market-priced have world-class organizational and continuous-
feedstock plants, to compete against similar plants performance-improvement capabilities. Internal
in the West that can look back over decades capability-building initiatives and functional-
of continuous optimization efforts. This approach, excellence programs can help to move them to the
which combines low-priced and market-priced top rank.
feedstocks, is already starting to take shape at
some projects in the region. There are a number of proven approaches that
companies can embrace. These include programs
3. Develop new models to build based on adult-learning principles that combine
organizational strength. conceptual training with on-the-job learning and
A broad mobilization is going to be needed to the creation of continuous-improvement
build the functional capabilities that will be training teams to enable a company to constantly
required to run operations more efficiently and to upgrade its capabilities.
grow the business. The following three areas
represent the top priorities. In addition, a number of successful companies
have invested in corporate academies to help build
Focus on workforce development and talent up a cadre of management trainees. Such
management. The industry must assure academies often include the use of model factories,
a sufficient supply of qualified recruits to meet its where management trainees along with all
growing requirements. Companies should company employees—from top managers to plant
 11

operators—can learn better ways to operate and energy-cost advantages make an impor-
based on actual in-factory experience. tant contribution to final-product profitability.
In a number of product areas, such as con-
Develop new models for growth partnerships. struction chemicals, demand across the region is
As noted, most Middle East companies have already substantial. Related to this is the
formed close partnerships with Western players processing of chemical end products such as
(in some cases including equity investments); polymers to meet local demand. Significant
some of these partnerships aim not only to develop opportunities might be found in plastics pro-
and execute joint projects in the region but also cessing to make articles such as plastic bags.
to transfer capabilities. Employee exchange and
secondment programs, consulting agreements, The second stage consists of further expansion
and knowledge transfer on functional-excellence where a company can identify a viable venture
topics are all a part of the mix. We have observed or where regional governments create conditions
that cultural differences and a lack of defined that could make new ventures viable. Plastics
common objectives can handicap such initiatives, processing (to make products such as vinyl siding
but if the transference of skills can be made or automobile components) has the potential
an explicit part of the partnership agreement, to create a substantial number of jobs, and thus
these initiatives can be successful. a case could be made for government backing
in this area. Both stages of downstream invest-
4. Make downstream investment a priority— ment could help assure the success of expanded
and a strength. petrochemical production in the region.
Most Middle East producers have so far been
hesitant in pushing downstream investment, as
we discussed above. Downstream chemical
production and processing is on track to reach The petrochemical industry in the Middle East is
5 percent of capacity and 8 percent of reve- approaching a watershed. The changes under
nues in 2015, far behind international averages. way in feedstock availability are creating a much
more challenging environment. To continue to
We see the scope for downstream investment grow profitably at home, Middle East companies
growth comprising two stages. The first is in will need to become leaders in operating
capturing existing opportunities, such as replacing and functional excellence. They will also need
imports, and represents a no-regrets move. to build up managerial and technical
For example, companies should identify niches capabilities across their workforces to underpin
for derivatives production that can meet local that performance.
demand, in particular, derivatives where feedstock

The authors would like to thank Scott Andre, Jens-Christian Blad, Maureen Gaj, David Hunter, Asif Lakdawala,
Yasser Salem, and Sari Varpa for their contributions to our research efforts and to this article.

Florian Budde is a director in McKinsey’s Frankfurt office; Christian Günther is a principal in the Dubai office, of
which Mihin Shah is an alumnus. Copyright © 2014 McKinsey & Company. All rights reserved.