SAUDI ARABIA - Risks.

The Gulf's product diversification may come as the market contracts. Data suggest there will be a surplus of over 3m t/y PE and 4m t/y of PP from 2008. Demand growth for ethylene will decrease from 5% to slightly more than 4% by 2009 as the global economy cools and more capacity comes on stream. Ethylene demand growth in China is set to fall from 13% to 7.5% over the same period. Trautz said: "We all know that new capacity builds have been made based on Chinese growth. This...dependency is, of course, dangerous. Looking more closely at the Chinese supply/demand pattern, you will see that the imports into China over the coming years will stabilise if the demand in China remains as high as it is at present...Middle East products will have to find another home beyond the Chinese market".

Increasing EPC costs may alleviate the problem as project development concerns delay new capacity. Costs on some projects have risen by 35-80%. The use of the cost-reimbursable contracting model for major EPC work is now common, but it is hardly the panacea it was hoped it would be when it was introduced two to three years ago. Contractors are being replaced when cost estimates during the engineering stages exceed their clients' budgets. It is not uncommon to find projects temporarily - or even permanently - shelved because of the capital cost. The situation is unlikely to change soon.

A MEED poll of major EPC contractors shows the next two years are to be just as tight. As costs increase, feedstock dries up and products diversify, investors are starting to look outside the Gulf. More attention is being paid to Algeria and Libya as they aim to open up their economies. Both have ample amounts of cheap gas, a large resource of skilled and cheap labour, a ready market in nearby Europe, and for now are willing to stick to bulk chemical commodities. MEED quoted an investor as saying: "It is going to be an interesting future. The Gulf is not going to lose its dominance anytime soon, but it may well find itself with a considerable fight on its hands".

The French petrochemical industry association expects the Middle East to overtake Europe by 2015 when it will account for 20% of world ethylene capacity, against 17% for Europe. Saudi Arabia is investing $80-85 bn in this sector over the next five years. But as the Chinese raise their domestic capacity, Middle East producers are likely to turn to Europe to dispose of future surplus capacity. Russia too is expected to start investing heavily in petrochemicals in the next few years. But pressures are likely to be particularly acute for European manufacturers, who are now coming under far more stringent regulatory constraints than their competitors in emerging markets and oil-producing countries.

European producers have to deal with the EU's Reach directive on chemicals, the Kyoto protocol and moves by individual states to step up environmental campaigns. The debate over the economic damages or benefits of the Reach directive has been rumbling for years.

The current predicament of the European petrochemicals industry simply highlights once again the dilemma facing EU regulators and policy makers. How does one reconcile the pursuit of free and fair competition with regulations which inhibit the ability of European companies to compete in world markets? One of the key answers is the role of the World Trade Organisation (WTO) against resource-rich countries subsidising feedstock prices, such as Saudi Arabia whose ethane is sold way below world market rates - an issue Riyadh will have to tackle in the coming years.