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Petrochemical uptrend: Why and how long? - Views on News from Equitymaster
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  • Sep 13, 2004

    Petrochemical uptrend: Why and how long?

    The recent hike in petrochemical product prices by the major manufacturers has just confirmed that the uptrend in the pricing cycle is far from over. In fact, the two major petrochemicals majors' - Reliance and IPCL have posted robust 1QFY05 results. We believe this trend is likely to continue, atleast till end of FY05.

    Let us analyze the various factors, which have resulted in the uptrend in the petrochemicals cycle:

    • Strong demand: Demand for petrochemical products such as polymers and polyesters has been on the rise. Economic recovery in developed nations and developing nations coupled with strong demand from China has been a major factor in contributing to increasing prices. As for the domestic markets, infrastructure projects such as telecom, road development and construction coupled with government policies tilted towards agriculture and rural construction has buoyed the markets for petrochemicals.

    • No significant capacity addition: It is said that the petrochemicals cycle peaks every 7 years. This is largely due to the fact that as product prices increase, the manufacturers indulge in capacity addition. Once the capacity becomes operational and supply outpaces demand, producers feel the pressure on margins as competition disallows increase in prices. As a result, prices decline and this continues until there is further recovery in economic performance. However, this time round, there has been no such significant capacity expansion and as a result, the demand and supply situation continues to remain tight.

    • Skewness in production: Globally, Asia is fast becoming the production hub for petrochemical products. Rising crude oil prices have rendered many petrochemical complexes in the west as unviable. It is to be noted that the feedstock for petrochemical plants are mainly refinery by-products such as naphtha and ethylene and propylene. Further, even natural gas prices have soared in line with crude oil prices. To put things in perspective, natural gas is currently hovering at nearly Rs 6,000 per thousand standard cubic meters. On the other hand, operational costs in Asian countries are far below the Western regions resulting in economies of scale. Since petrochemicals prices are determined internationally and major demand comes from the Western regions, product prices have shot up significantly.

    Although these factors have been triggering a hike in prices, it is to be noted that currently, Indian manufacturers have started capacity addition and with IOC and ONGC (two major cash rich oil companies) entering the arena, the sector is likely to witness some pressure on margins on account of competition from FY06 onwards. Also, a hike in crude oil prices has affected the performance of the petrochemical sector during the last few quarters. Further, in the global scenario, factors such as rising interest rates and slowing down in the Chinese demand could possibly affect the uptrend.



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