War of attrition in petrochemicals: Overcapacity is bringing a vital European industry to crisis point. Neil Thapar reports

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EUROPE'S petrochemicals industry is in trouble. The sector is of strategic importance to the region but is facing a structural crisis that has cost producers billions of pounds in the past five years.

There are many reasons for the predicament but high on the list is chronic overcapacity, particularly in ethylene, the industry's most important basic product and used in plastics and synthetic fibres.

Last month the Association of Petrochemicals Producers in Europe - which includes BASF, BP Chemicals, ICI and Shell - floated a radical proposal aimed at cutting ethylene capacity.

The plan was to create a DM550m (pounds 214m) compensation fund based on a contribution of DM30 per tonne of each producer's installed capacity. The APPE's 32 members would then make 'bids' to shut down plants in return for cash from the fund to offset some of their closure costs. The overall objective was to reduce capacity by 1.5 million to about 17 million tonnes a year.

But the plan failed to attract unanimous support. Some companies were sceptical of its effectiveness. Others, like ICI, felt they did not contribute to the overcapacity.

With no solution in sight most industry experts predict a long war of attrition that could threaten key segments of the industry.

Petrochemicals is one of Europe's vital sectors, providing direct employment to 600,000 and indirectly employing another 3 million people.

The lack of progress was due partly to political factors. Many of Europe's producers are state or quasi-state controlled. Consequently, they have been reluctant to close plants because of the impact on jobs. They have also baulked at making the first move through fears of surrendering market share to rivals.

Although this could have helped narrow the supply and demand gap, most experts say it was not a panacea for the industry's long-term structural problems. These include cheaper imports from Eastern Europe and the Middle East. Competition is also growing in important export markets such as the Far East, which is rapidly expanding its own petrochemical industry.

Another problem is that European plants are highly integrated - with an extensive pipeline network - and so harder to rationalise. Many also use less efficient technology, which means they are too dependent on costly feedstocks such as naphtha, rather than gas.

Here, Middle East producers have a substantial cost advantage. At present, gas from many of their oil fields is simply burnt off. Increasingly, however, they plan to exploit it for petrochemicals.

Other factors include high labour and energy costs and tightening environmental regulations.

At best, the experts say, the plan could help to stabilise ethylene prices and give the industry time to adjust to the structural changes.

The industry also has itself to blame for poor forward-planning, which has contributed to overcapacity. Despite the problems, capacity is still rising and will jump from 18.4 to 19.3 million tonnes this year, represented by 53 ethylene plants.

The reasons go back to the late 1980s, when many petrochemical companies began a huge expansion in the belief that economic growth would continue to push up profits. In fact, the reverse occurred. Severe recession reduced demand just as new plants were coming on stream.

Meanwhile, old, inefficient crackers, particularly in Spain and Italy, have yet to be taken out of service. The collapse of the former communist bloc also led to falling demand in the region with the result that unsold petrochemical products have been diverted into the West.

Few experts are brave enough to predict how and when the industry will resolve these difficulties. A robust economic recovery will help reduce overcapacity. Ethylene prices have firmed over the past quarter but are still woefully short of providing an adequate return.

In short, the industry is likely to struggle with losses for at least another year. A recent study by the APPE concluded: 'The potential of western European petrochemicals producers to export derivative products will be constrained both by the creation of new production capacity in other regions of the world and by the relatively high cost of production in Western Europe.'

But some glimmers of hope remain. Although the APPE's proposal failed, there is a growing sense of realism among Europe's producers to take action. The big three German companies - BASF, Hoechst and Veba - are in the throes of massive restructurings that will cost thousands of jobs.

The extent of the losses - and the consequent cost to taxpayers - is also forcing state-controlled companies to rationalise.

BP Chemicals, which played a key part in devising the fund, said: 'We will continue to develop support for other initiatives. But Europe's producers must look at individual proposals to rationalise.'

Many believe that the sector's restructuring now depends on joint ventures and asset swaps between producers. Last week Shell and Montedison, part of the troubled Italian industrial group Ferruzzi, agreed to a pounds 4.5bn merger of their global polypropylene and polyethylene businesses.

The combined business will have annual capacity of about 3.3 million and 700,000 tonnes - representing market shares of 18 per cent and 5 per cent in polypropylene and polyethylene. Much of their combined capacity is located in Europe where prices of both products have dropped by at least half in the past three years.

The merger, which was first mooted a year ago and requires regulatory approval, is one of several planned link-ups between producers. Another is a proposal by BP Chemicals and Enichem of Italy to merge their styrene businesses - although after protracted talks they have yet to agree terms.

There has also been persistent speculation that ICI could dispose of its 50 per cent stake in the UK ethylene cracker at Teesside to cut its involvement still further in basic petrochemicals.

Long term, though, Europe's producers may have to move away from low-margin commodity products and higher-value segments.

Whatever the future, the next few years look grim for many in the industry. Virtually everyone agrees that tens of thousands of jobs are likely to be lost. (Photograph and graphic omitted)