Big Is Beautiful

Reliance Industries Limited (RIL) has just commissioned its Rs 9,000 crore petrochemical complex at Hazira. The complex has a capacity to produce 7.5 lakh tonne of the building block, ethylene, two lakh tonne of polyethylene, 3.5 lakh tonne of polypropylene, 2.65 lakh tonne of propylene and 3.5 lakh tonne of purified terephthalic acid (PTA). This will take RILs total production of petrochemical products from 1.5 million tonne to six million tonne.

On the other hand, the other big player of the industry, the Indian Petrochemicals Corporation Limited (IPCL) is building a Rs 3,631 crore complex at Gandhar. When it is fully operational by December 1998, it will produce three lakh tonne of ethylene, 2.7 lakh tonne of polyethylene and one lakh tonne of ethylene oxide. The first phase plant producing 1.5 lakh tonne of polyvinyl chloride (PVC) and 1.3 to 1.5 lakh tonne of caustic soda chlorine went on stream in April.

Both RIL and IPCL are gearing up for the next upcycle in the industry, expected around 2000. For the moment, however, the industry is hampered by low international petrochemical and polyester prices coupled with import duty cuts, which means threats from cheaper imports for domestic players. This is squeezing margins. Even players like RIL saw net profits rising by just one per cent last year.

This lacklustre performance has been in spite of fairly high demand levels. The petrochemicals industry is crucial as it has dominant linkages with other sectors. In fact, it provides the basic raw materials for industries ranging from plastics, synthetic fibres and synthetic rubber to detergents,

pharmaceuticals and dyes.

The annual demand for petrochemicals has been between 12 and 17 per cent for the last few years. This is higher than the industrial growth. But the problem is that capacities, especially in products like polyester filament yarn (PFY) and polyester staple fibre (PSF), is doubling, leading to overcapacities.

Moreover, the capacity expansions at RIL and IPCL point to another trend in the industry. While large integrated players are able to both bear the current downswing and capitalise on future opportunities, the smaller players are getting marginalised.

Says Reena Ramachandran, CMD, Hindustan Organics (HOC), which produces organic chemicals based on petrochemicals, Small players will only survive in niche segments, and if they have developed their own technology. Mergers, swaps and plant shut-downs will become a common phenomenon.

Yet, the future outlook is optimistic. In 1996-97, the total consumption of petrochemical products including polymers, elastomers, synthetic fibres and surfactants was pegged at around 3.5 million tonne. The ministry of chemicals and petrochemicals predicts that demand will touch seven million tonne by 2001. This means a compound annual growth rate of 15 per cent.

Thats not hard to visualise. After all, in the post-liberalisation period, the industry registered significant growth (see BS Reader, May 10, 1995). Also, import duty cuts on petrochemical products -- in the 1991 budget, the duty was slashed from 65 per cent to 40 per cent and in the last budget, it has come down further to 30 per cent -- have not spelt the deathknell for the industry, despite misgivings.

Domestic capacity expansion from 4.28 lakh tonne to 13 lakh tonne during this period has actually lowered dependence on polymer imports. According to the ministry of chemicals and petrochemicals, the share of imports in polymer consumption has declined from 58.2 per cent in 1990-91 to 18 per cent in 1997.

The industrys aggregate profitability in the period went up from 18.5 per cent in 1991 to 31.5 per cent in 1996. For players like RIL and IPCL, net profits have zoomed from Rs 112.9 crore and Rs 57.25 crore in 1990-91 respectively to Rs 1,323 crore and Rs 510 crore in 1996-97 respectively.

Says Suresh Iyer, an analyst with the equity research firm, P R Subramanyam & Sons, The Indian industry benefitted from the depreciation of the rupee and high international prices along with a buoyant demand.

For the large players, integration levels have played a key role. For instance, RILs operations extend from cracking naptha to downstream units producing high density polyethylene (HDPE) and low density polyethylene (LDPE) to units producing yarn and textiles. Now, group company Reliance Petroleum is setting up a refinery. It has also entered the field of oil exploration.

With these projects, RIL plans to be the only company in the world to integrate operations from crude oil production to synthetic fabrics. According to the weekly, Asian Chemical, this will result in a value addition of over 8,000 per cent over the price of crude oil and gas. Similarly, IPCL has integrated operations to include cracking naptha to producing downstream polymers.

But in spite of these achievements, how globally competitive is the Indian industry (see page 4)? This needs to be assessed in the context of petrochemicals majors in the Asia-Pacific region, as capacity creation in the area has major implications on prices.

This is a capital intensive industry. According to a government study, a petrochemical complex with a capacity to manufacture 2.2 lakh tpa LLDPE/HDPE, 1.5 lakh tpa polypropylene and one lakh tpa PVC costs Rs 3,500 crore. Apart from RIL and IPCL, the industry has a host of smaller players like Bindal Agro and Oswal Chemicals.

Plant size is a major indicator of competitiveness as the resultant economies of scale determine profitability. For instance, an increase in plant size from five lakh tonne to 7.7 lakh tonne could cut ethylene production costs by 20 per cent. Or take a naptha cracker. While the world average economic plant size is 7.7 lakh tonne, the average size planned in India is four lakh tonne. RILs 7.5 lakh tonne is the only global sized plant.

Both the non-availability of funds and their high cost have deterred players in India from setting up world-class capacities. The installation factor plays a crucial role here. This is defined as the ratio of the investment required to set up a plant at a given location to the cost of installing a plant on the east coast in USA. This installation factor influences the capital costs and so, annual capital charges.

According to experts, a petrochemical plant in India costs 1.25 to 1.4 times the cost of a plant on the US east coast and is 1.5 to 1.75 times the cost of a plant in, say, Korea. High fund costs and long gestation periods are responsible for the high costs in India.

But things are changing. According to a government study, capital costs have fallen by over Rs 500 crore in the last few years. Thats because duties on capital goods imports have come down from 85 per cent in the late eighties to 25 per cent last year. Further, the Modvat benefit is now available for excise duty on capital goods. This component of taxes and duties, which comprised 40 per cent of capital costs, has halved to 20 per cent. And it could further decline to 10 per cent -- the international norm -- in a few years.

Companies too are tapping overseas markets to reduce fund costs. RIL issued Yankee bonds aggregating $916 million of varying maturity periods. This has increased its debt maturity period from seven to nine years to 20 years, equivalent to that of the global players.

Now, new entrants particularly oil and gas companies like the Oil and Natural Gas Corporation (ONGC) and Gas Authority of India Limited (Gail) are entering the sector. Gail is setting up a Rs 2,400 crore three lakh tonne gas cracker plant and two downstream plants at Pata in Uttar Pradesh, which will go onstream by the year-end. The downstream units include a 2.6 lakh tpa swing plant capable of producing either HDPE or LLDPE and another one lakh tpa HDPE plant with technological support from Japanese major, Mitsui. It will use natural gas as feedstock. This will be transmitted through

Gails Hazira-Bijapur-Jagdishpur pipeline.

This and Haldia Petrochemicals 4.2 lakh tonne ethylene plant are the only two units likely to be commissioned in the country by 2000. Other players like National Organic Chemical Industries Ltd (Nocil) and Spic Petrochemicals have announced expansion plans but they have run into trouble.

The small players have also been unable to expand capacity. High fund costs have resulted in stagnation of the capacities of players like Bombay Dyeing and Bindal Agro. The gross block or asset base of Nocil was Rs 423.3 crore in 1994. In 1996, it came down to Rs 419.4 crore. Similarly, for Bombay Dyeing, it was Rs 610.7 crore in 1994 and now stands at Rs 795.3 crore, indicating only a marginal increase in the assets or production capacities. On the other hand, for the same period, the gross block of RIL increased from Rs 4,737.7 crore to Rs 6,885.5 crore.

Stifled by poor economies of scale and increasing competition from cheaper imports, the small players are finding it difficult to survive. For instance, Nocil supplies butadiene at Rs 23,000 or $642 per MT while imports cost between $340 and $380 a MT.

As a result, many of these players are looking for a way out. In the last quarter of calendar 1996, two plants were sold. Orkay Industries sold its polyester unit at Patalganga to JVG Industries of the Delhi-based JVG group for Rs 228 crore.

And the UB group's flagship, McDowell & Co, sold its polymers division at Vishakhapatnam to the South Korean LG Chemicals for over Rs 100 crore. The division manufactured styrene, polystyrene and other polymer products. The unit had become unviable both because of its size and competition from imports. It had a capacity of 46,000 tpa of polystyrene compared to the internationally competitive size of one lakh tpa.

Now, Nocil is said to be considering diluting its stake while Polychem is also reportedly looking for a buyer.

Globally too, the industry is witnessing strategic alliances and swaps. In 1993-94, ICI and DuPont swapped their acrylic and nylon businesses. In 1994, Shell swapped its polyethylene business with Himonts polypropylene business. If the trend continues, it will result in large players having ten times the scale of operations of Indian players. This could undermine the competitiveness of domestic players and partially explains the frenetic expansions of RIL and IPCL. RIL is already working on another 4,500 crore petrochemical complex at Jamnagar, Gujarat.

For the moment, the industry is looking forward to the next upswing in the petrochemicals cycle. Domestic opportunities for growth are also increasing (see page 3). For instance, at two kg, India has one of the lowest per capita consumption level of plastic. If this goes up by just one kg, it will result in an additional annualised polymers demand of one million tonne.

Compare this with China, among the largest users of plastics with an estimated capacity of 10 million tonne by 2000. So, can India be as big a player as China? Most industry observers feel this is not possible. Capacity growth in India has more or less kept pace with demand. Besides, the small plant sizes weaken the countrys ability to influence global supply. And high financing and input costs hamper export competitiveness. Also, unlike China, which accounts for 28 per cent of petrochemicals consumption, India will not emerge as a major net importer.