SAUDI ARABIA - Profit.

Helped by soaring demand and the region's advantage in low feedstock cost, Gulf petrochemical firms' profits have been exceptional. In 2006, base chemical producer Qatar Petrochemical Co. (QAPCO) made a net income of $438m from sales of $598m - a profit/sales ratio of more than 70%. For SABIC's mega-JVs in Saudi Arabia, economies of scale and marketing reach often result in this figure exceeding 80%. In Saudi Arabia, by far the region's biggest player, ethylene is produced at about $150/ton, compared with an average of about $400/ton in Asia, $520/ton in Europe and $605/ton in North America. As oil prices have increased, so the difference has widened.

The Gulf feedstock advantage is not the only factor to high profit. Producers benefit from world-class infrastructure where the needed pipelines, utilities and logistics are in place. Land is cheap and the tax is low. Power, accounting for up to 30% of a venture's costs, is heavily subsidised. While most producers outside the Gulf are subject to market rates, GCC producers get their electricity at low prices. Economies of scale are another factor. The average capacity of an ethylene cracker in Saudi Arabia is over 1m t/y, compared with 740,000 t/y for Dow Chemical, its nearest private competitor.

It is no surprise that just about everyone involved in the petrochemicals business is flocking to the region. Dow, the world's largest chemicals producer, signed a JV deal with Libya's NOC in April and a much bigger one with Saudi Aramco in May to add to its existing plants in Kuwait and a planned JV in Oman. The Netherlands-based Basell has long held equity in JVs in Saudi Arabia. Total, ExxonMobil and Shell have interests in chemical JVs throughout the Gulf and are planning further ramp-ups in Qatar.

All this local and international investment has turned the Middle East into the world's fastest-growing petrochemicals region. Its share of world ethylene output is to rise to almost 20% by 2020. The annual growth rate for the industry in the region is about 15% - compared to 9% in China, the next fastest growing region.

For the first time, investment is flowing out as cash-rich Middle East producers try to gain footholds closer to the end-user and get a better grip on the West's technological expertise. SABIC has bought production facilities in the UK and the Netherlands, and recently acquired the US-based GE Plastics. Abu Dhabi's International Petroleum Investment Co. (IPIC) has a majority stake in Vienna-based Borealis and Kuwait's Petrochemical Industries Co. (PIC) has a share in Canada's MEGlobal and Europe's Equipolymers.

Basell's Trautz said: "In a mature industry, growth occurs through mergers and acquisitions, and new industry leaders emerge. In...our mature industry, we are witnessing a shift of the growth engine from the developed countries and regions to the developing parts of the world. The trend is eastwards - and the pace of change is likely to accelerate with more new players coming forward. These players will be seeking access to the mature markets of Europe and North America. They will be looking to gain access to technology and marketing expertise".

Despite this, however, firms in the sector are at a crossroads. While still raking in cash, there is considerable trepidation over its future direction. The biggest concern is that there is not enough gas feedstock to go around. In Kuwait and Bahrain, there has never been enough gas in the first place. In others, such as Qatar, a lot of the gas production is dry, with only small amounts of ethane and NGL to be extracted; and what gas is available is exported in LNG form to maintain its high calorific content.

In Saudi Arabia, the UAE and Oman, the shortage has been caused by soaring demand for gas, especially for power generation, with little or no gas available for industrial needs. This means potential investors can no longer rely on cheap ethane to form the commercial basis of investing in new production facilities. Increasingly, therefore, producers are having to use mixed feedstock of ethane/propane or ethane/butane, or heavier feedstocks like naphtha, based on integrations with existing refineries. Non-ethane-based production is more expensive. NGLs, while discounted, in most GCC states do not enjoy the same cost advantages as ethane. In Qatar, NGLs are supplied at near market rates.

Abdul-Wahhab al-Sa'doun, head of energy at Saudi Arabian General Investment Authority (Sagia), says: "Throughout its evolution, the [regional] industry could be described as being supply-driven, with the feedstock influencing the pace of the capacity addition and the products portfolio. We are entering a third phase, moving away from the era of mixed feedstocks to that of complexes based on refinery integration. This, in turn, influences the volume and type of basic petrochemicals produced and subsequently determines the industry's products portfolio".

States with few, if any, supplies of ethane to allocate are forcing prospective producers to go for a feedstock mix to obtain a production licence. But investors are reluctant to go for projects where the returns are smaller. This is the root cause of the slowdown in project activity in the Gulf. But it is not the only reason.

Besides being more expensive, heavier feedstocks impose a different product mix. As the region's sector develops, governments are encouraging producers to go down the value chain and introduce new products such as processed and engineering plastics, plastic additives and stabilisers, lubricants and solvents. Whatever feedstock advantage there is initially will be diluted by each subsequent production process.

Downstream manufacturing must be close to customers as they are difficult to market and costly to transport. Many people inside and outside the region say plastics manufacturing is doomed to fail. MEED has recently quoted a "senior executive at a major international petrochemicals producer" as saying: "It just does not make sense from a commercial perspective. You lose the feedstock advantage and the risk is more palpable as you are more exposed to the market. I can see the rationale, but by diversifying your portfolio, you are clearly losing the point of investing in the region in the first place".

This is contested, however. Fayez al-Sharef, head of the $22-26 bn Ras Tanura refinery upgrade and petrochemicals JV for Saudi Aramco and Dow, which will introduce more than 300 new downstream products to the region, says: "The same people said 30 years ago that there was no point in the Middle East developing its gas resources, yet look where we are now. It might take a while, but there is no reason we cannot make it work".