Petrochemical Awakens the Sleeping Giant
Leveling up the consumer boom
Indonesia’s continuously robust economic growth with strong structural platform has translated to strong GDP growth and rising income levels that boosted demand for consumer product. Petrochemical industry that supplies chemicals products for packaging, construction, agriculture, textiles, electronics as well as consumer goods would be definitely a key beneficiary of the economic growth and would serve as an interesting proxy for exposure in the ever-striking consumer sector.
Solid macroeconomics performance
With expected GDP growth of 6.3% and modest inflation rate of 5.8% in 2011, we believe Indonesia’s economic is poised for better performance. This has translated to more interest from foreign investors to invest in Indonesia’s real sector. World Bank stated that net FDI in 2010, totaling USD26bn were three-times higher than pre-crisis 2008 level. Strong foreign investment numbers as, posted by the investment agency (BKPM), shows a 52% y-o-y increase in 2010 and expected to register another 22% growth in 2011.
The rise of middle class in Indonesia
Strong domestic demand, expanding by 4.6% in 2010 has been the main engine of recent economic growth. This also highlighted by the rising of middle class in Indonesia which will continue to accelerate the growth of consumer sector. The middle class has a population share of 56.5% in 2010 compared to only 37.7% in 2003 according to World Bank. Rising consumer sector will demand for more consumer products which in turn will positively impacted the petrochemical industry as well.
Attractive playing field
Based on the aforementioned catalyst, the petrochemical field has become an intriguing prospect evidenced by recent interest from foreign companies to invest in this highly capitalized industry. Surrounding media talks are centered to news regarding Lotte Group, through Honam Petrochemical, planning to invest USD5bn in Indonesia. There have also been talks regarding Pertamina’s joint venture plan with Chandra Asri Petrochemical (TPIA) to build an oil refinery.
The lucrative prospect of Indonesia’s petrochemical industry
With rising economic growth ample with huge population (approaching 240m) potential demand growth for basic chemicals and polymers in Indonesia remains very promising in medium and longer term as current levels of consumption per capita still low compared to its Asian peers. At present, Indonesia is structurally deficient in many petrochemicals and polymers relying in import thus providing room for production capacity expansion in the coming years.
Having said that, we believe current companies that operates in this industry, both up-stream and down-stream player will benefit with positive dynamics of supply and demand. Given the highly cyclical nature of the industry, opportunity of expansion is imminent as to prepare for capturing the up cycle moment which is expected to reach industry’s peak in 2015.
Identifying the players
As a general concept, petrochemical related listed companies could be grouped into upstream player, polyester producers (mid stream to downstream) and plastic packaging producers (downstream). Currently, there is only a single upstream player, Chandra Asri Petrochemical (TPIA) and is the only single Indonesia chemical player that provides naphtha cracker. TPIA holds a very important position in Indonesia given its hopes to go further upstream to oil refineries which may decapitate bottlenecks from downstream players importing raw materials.
Leveling up the consumer boom
Consumer demand boom
Indonesian domestic consumption has been growing by 15% CAGR in the last five years; the trend was in tandem with increasing middle class proportion that grew along with GDP/ capita. Population growth and relatively young age concentration also helps the consumer demands to grow further. The growing demand combined with cheap labor and near distance to lines of natural resources attracts foreign direct investment into Indonesia, FDI already growing by 28% CAGR in the last 5 years.
INDONESIA PETROCHEMICAL INDUSTRY – Strong Demand in the Emerging Market
There are many chemical components which could be possibly discussed in this report. However, this report only focuses on the olefin (mainly ethylene and propylene) industry including its derivatives, polyolefin (mainly polyethylene and polypropylene, both are commonly known as plastics), as we believe these olefin base chemicals holds an important position in the petrochemical industry given: 1.) Strong exposure to growing emerging markets, 2.) low consumption per capita for polyolefin in countries such as China, India and Indonesia, which provides growth opportunity, 3.) production expansions in the petrochemical industry.
We believe Indonesia provides abundance of opportunity in the petrochemical industry given its low consumption per capita for polyolefins compared to developed markets. The government recently proposed Indonesia’s 2012 GDP growth to be 7%, hence will provide ample opportunity for higher consumption given that economic conditions are the key driver in the petrochemical industry. Also, substitute products pressure in general is lesser in emerging markets compared to developed ones, giving an easier access to penetrate to the Indonesian market. The specific drivers to olefin consumption are tied to further growth in packaging, automotive, textiles and construction sectors.
THE FLOW FROM UPSTREAM to MIDSTREAM – Deficiencies in Supply Provides An Opportunity
Polyolefin producers are mostly regional based players
Polyolefins supply in Southeast Asia mainly consists of regional players. The top 3 players are PTT Group (Thailand), Titan Chemicals (Malaysia) and Siam Cement Group (Thailand). Chandra Asri Petrochemical (TPIA) is positioned as the 6th largest polyolefin producer in Southeast Asia in terms of capacity.
It is worth noting that the competitive advantage of polyolefin’s production lies on the cost determination of olefin supply. Indonesia’s naphtha based cash cost for high density polyethylene (HDPE) and linear low density polyethylene (LLDPE) is the second lowest after Thailand, while Indonesia’s naphtha based cash cost excluding TPIA has the largest cash cost in the regional market given. This indicates the important presence of naphtha cracker in Indonesia.
Chandra Asri holding a predominant position in Indonesia
Chandra Asri Petrochemical (TPIA) is positioned as an integrated up-stream to down-stream petrochemical business in the full picture of the chain analysis (exhibit 14). Given its exposure to the downstream level, TPIA is Indonesia’s leading petrochemical producer. TPIA’s exposure in the petrochemical industry is distinctive among other players listed in JCI given its recognition as the largest integrated olefin and polyolefin producer in Indonesia and is the only naphtha cracker in Indonesia.
TPIA is currently the market leader in the domestic petrochemical industry with 55% market supply share of ethylene, 40% for polypropylene and 40% for polyethylene, translating to a 55% market share in terms of capacity.
Raw material imports are currently the tough situation faced by the players
Indonesia is structurally deficient as it relies heavily on products imported from other countries such as from Malaysia, Thailand and Singapore. Large major olefins producing companies have forward integration into polyolefins, which we believe is a strategy worth to be plagiarized by Indonesia as it provides better margins. It is worth noting that 48% of ethylene domestic market share is still imports while the remaining 55% is TPIA. As to cope with further demand, several companies has taken expansion moves, which would increase production capacities enabling to meet rising olefin base demands, although in the long-term likely to still be in a net import position.
Ethylene to meet exceeds demand while propylene as the strong future demand
Year 2010 ethylene demand of 1,038k tonnes exceeds Indonesia’s production capacity to fulfill given demands, making Indonesia as a net importer amounting to 538k tonnes. According to Nexant source, ethylene demand will only book 0.6% 2011-17 CAGR, translating to a slow down growth in the long-term. TPIA, as the current single player in the ethylene stream, anticipates the excess ethylene demand by increasing its current ethylene production capacity (600k tonnes/yr) to increase to 1,000k/yr tonnes by end of 2014 and Pertamina is also planning to create an ethylene stream line business with production capacity of 80k tonnes/yr.
In the olefin stream, propylene demand is set to book 7.3% 2011-17F CAGR from its 2010 base of 1,038k tonnes according to Nexant source. The market is supplied by Chandra Asri Petrochemical (TPIA) and Pertamina. Current largest supply market share is TPIA (53%) and second is Pertamina (47%), however in the long-term, Pertamina will outstrip TPIA’s market share to 54%.
PREPARING FOR THE CYCLICAL PEAK
Preparing for the petrochemical up cycle boom
The petrochemical industry is bound to be cyclical proven by its historical records patterns. However, we believe that this is a good momentum to take opportunities from the current down-cycle phase. We believe TPIA is set to capture the up-cycle momentum in 2015 with a gradual improvement from 2011. Based on historical cycle (exhibit 17), it takes 6 to 11 years for the petrochemical industry to reach its peak cycle.
AN ATTRACTIVE PLAYING FIELD
Indonesia is an attractive playing field for investors
One of the missing links in Indonesia’s big picture of the petrochemical industry is the upper stream from the naphtha cracker, which is the oil refinery stream. Chandra Asri Petrochemical (TPIA) is currently the only naphtha cracker in Indonesia, thus it is important for TPIA to secure its naphtha supply since TPIA have been obtaining its entire naphtha from import. If TPIA is able to build its own oil refinery and secure supply, this would help the downstream players’ operations and expansions.
Possible plans going forward will be through joint-venture programs with refinery projects. According to Reuters, Pertamina needs USD2.5bn for refinery development in 2011-2017. TPIA is also in talks to invite Pertamina to build oil refinery in Bojonegoro, Banten with total investment of USD7bn. TPIA will take 25% interest on this project, translating to investment worth USD1.75bn.
Foreigners have also been attracted to invest in the petrochemical industry in Indonesia
Medias highlighted that Lotte Group, a conglomerate company based in South Korea, plans to invest USD5bn in Indonesia through its subsidiary Honam Petrochemical Group. Honam Petrochemical group acquired Titan Chemicals in 2010 (Malaysia based). On 22 February 2011, Lotte Group top management levels has even meet with President SBY to discuss about its petrochemical investment in Indonesia according to medias.
INDONESIAN LISTED PETROCHEMICAL RELATED COMPANIES
As petrochemicals end products widely used in wide arrays of consumption and production goods, we believe petrochemicals industry will be a direct beneficiary of rising Indonesian domestic demand and general economic activity. Below are the simple structure of petrochemicals industry and general exposure of the Indonesian based players. We have added several companies including its profiles and financial performances.
Basically, petrochemical related companies that listed in JSX could be grouped into upstream player, polyester producer (mid stream to end product), and plastic packaging producer. Historically, upstream player like Chandra Asri (pre merger) enjoys a quite good profitability with ~30% ROE. 1Q11 is the exception to this group as cotton price increased, the polyester price as substitution also increase, hence created a wider margin.
Barito Pacific as TPIA’s major shareholder. The founder of Barito Pacific (BRPT), Prajogo Pangestu, established BRPT on 1979 and initially started out as a wood based company. BRPT, which is currently TPIA’s largest shareholder with 72% of shares in possession, engages in the forestry, petrochemicals and property and plantation industry sectors and ultimately evolved into a fully diversified resource-based enterprise.
