Petrochem powerhouse: Brazil's Braskem is set to grow, but its clients--and the government--want competition.

Braskem, Brazil's largest petrochemical group, was formed in August 2002, part of a long-delayed government privatization plan heralded then as the restructuring of Brazil's petrochemical sector to face increasing global competition.

Now the Brazilian government is pushing for more mergers so that there will be a second big group to compete with Braskem, which reported US$158 million in net profits on $1.49 billion in net revenues in the first half of 2003. Ironically, the government expects state oil giant Petrobras to drive new mergers by buying back into the sector, even though Petrobras created conditions for the original set of mergers that led to Braskem--mergers still facing antitrust review--by selling off some of its own petrochemical assets.

"We want a restructuring that will have at most two, not three, large petrochemical groups," says Mauricio Lemos, industrial director of Banco Nacional de Desenvolvimento Economico e Social (BNDES), the national development bank in charge of coordinating and financing the restructuring of Brazil's petrochemical sector. "Petrobras will be a very important player, perhaps the key player, in this restructuring?

In the early 1990s, Petrobras sold its minority stakes in a myriad of downstream petrochemical firms. By 2001, the Odebrecht and Mariani petrochemical groups bought control for $314 million of Copene, the country's biggest cracker, which converts naphtha into intermediary products which later become constoner goods like plastic bags. Odebrecht and Mariani put under Copene all of their own downstream assets at the Camacari petrochemical complex in northeastern Bahia state, where Copene is located.

Odebrecht and Mariani then created Braskem, a holding company of their stakes in Copene and Camacari downstream producers, hoping to reduce costs. Since then, Braskem officials say, the company has saved $80 million and expects to save another $110 million by the end of 2004.

Brazil's petrochemical sector needs another large participant to make the sector more competitive, analysts say, How that will happen is another issue. Foreign petrochemical importers are hampered in the market because Brazil's inefficient import infrastructure--customs red tape, import taxes and clogged ports--boosts their costs and makes it hard to compete. Dow Chemical in Argentina, a low-cost polyethylene producer which can easily and cheaply import product into neighboring Brazil thanks to trade agreements, has been able to compete with Braskem.

But Dow Argentina alone won't suffice. So Petrobras reentered the petrochemicals business with its $1 billion acquisition of Argentine oil producer Perez Companc (Pecom), completed in May. Among Pecom's petrochemical assets is Innova, one of Brazil's biggest styrene and polystyrene producers. Petrobras, which still holds a minority stake in all three of the country's crackers, plans to resume investing in petrochemicals, which Petrobras CEO Jose Eduardo Dutra calls a strategic investment. "Our core business will extend from the well to the gas station and from the well to plastics" Dutra says. "But we still don't have a model structured for how this [extension] will work."

Conflict of interest. Braskem CEO Jose Carlos Grubisich also sees "two, or at most three, petrochemical groups emerging as part of a consolidated and restructured petrochemical sector, as is the case in the United States." But, he says. "I don't see Petrobras as being one of those groups."

Since Petrobras supplies naphtha to Brazil's three crackers, "being a big player in, say, one cracker, would create a conflict of interest," Grubisich says. "I see Petrobras as simply making investments that encourage the consolidation of the petrochemical sector here, via, for example, minority stakes purchases, such as its 16.75% stake in a Rio de Janeiro petrochemical complex," scheduled to open at the end of 2004.

Grubisich does expect the Unipar and Suzano groups, which have co-control of the Rio plant, to be candidates for industry consolidation. Suzano is co-owner of Polibrasil, Brazil's biggest polypropylene producer, in Sao Paulo. Unipar has the largest, stake, at 37,5%, in Petroquimica Uniao (PQU), Brazil's No. 3 cracker, also in Sao Paulo state, and controls Polietilenos Uniao, a major Silo Paulo polyethylene producer.

Armando Guedes Coelho, CEO of Suzano Petroquimica, the group's petrochemical arm, says a merger of assets by Suzano, Unipar and Petrobras could create a competitor for Braskem. The assets of such a consolidation would all be located in southeastern Sao Paulo and Rio de Janeiro states, where 70% of the Brazilian petrochemical market is located, says Coelho.

Petrobras would be an important partner in such a merger, not only because of the stakes it holds in the Rio complex and in PQU, but because it is the supplier of natural gas for the Rio complex and for part of the raw materials used by Polibrasil, Coelho says. "Having a feedstock supplier that can guarantee supply is one reason it is important to have Petrobras in the consolidation. Such a consolidation into a big producer would give us the size and economy of scale to make us more competitive, both domestically and internationally," says Coelho. Suzano has held formal talks with BNDES and with Petrobras about such an asset merger, as well as informal talks with Unipar about doing so, he says.

Unipar is more cautious. "Unipar believes that the reorganization of the petrochemical sector is fundamental for its competitiveness mad should involve a conglomeration of possible assets at Brazil's three petrochemical complexes," says Unipar President Roberto Garcia. "Unipar has opted to concentrate its conglomeration activities in the southeastern region."

Competition is overdue, according to some of Braskem's clients. Brazilian polyethylene producer Politeno tried to stop the merger in December 2002, filing a complaint with the Economic Rights Agency of the Justice Ministry against the deal because it feared Braskem's creation would lead to price abuses. In January, 2003, Politeno filed again, arguing that Braskem had artificially raised prices of its raw materials, charges Grubisich calls "unfounded."

The Justice Ministry rejected Politeno's claims and in May recommended approval of the creation of Braskem to CADE, the government's anti-trust agency. Grubisich says he is certain that CADE will approve the deal.

Export power. Braskem is already using its size and efficiency to cement relationships with top clients. Last year, the company built a $100 million research and development facility, in part to supply custom-made products. That research facility, for example, helped Braskem develop a polypropylene resin that one of its clients, Fitesa, now uses to make non-woven fabric for surgical and sanitary masks, replacing a more-expensive imported fabric. Fitesa was just in time to supply masks to Asia during the panic over severe acute respiratory syndrome, known as SARS, says Fitesa's general director, Herminio Freitas.

Braskem also plans to use it expertise and access to credit to help some clients export. Through Braskem, Sol Embalagens, Brazil's largest supermarket bag producer, increased its exports to the United States and Europe in 2003 by five times to 1,000 metric tons, raising its export revenue to $1.2 million from just under a quarter million dollars before. Sol Embalagens bought 5% more polyethylene resin from Braskem this year and expects to buy 15% more resin from Braskem in the year ahead. "We make considerably more money transforming a greater amount of plastic bags for Braskem to export than we did transforming and exporting a smaller volume of bags ourselves," says Rogerio Maul, Sol Embalagens' commercial director. "And Braskem boosts resin sales to us. So we both win."

Braskem plans to export for 10 of its clients this year and up to 40 next year. "If we can help our clients export more, this will increase our clients' need for Braskem's thermoplastic resins," Grubisich says. "That means our sales will grow:' Just what Braskem competitors fear most.