Friday, April 10, 2020
Petrochemical Companies Pushing for Business Diversification
Sluggish Demand Cutting into Profitability
Petrochemical Companies Pushing for Business Diversification
  • By Jung Min-hee
  • May 27, 2019, 12:30
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The profitability of Korean oil refining and chemical companies is expected to worsen in the second quarter due to China's economic downturn and the U.S.-China trade war.

Sluggish demand due to China's economic downturn and the U.S.-China trade war is cutting into the profitability of Korean oil refining and chemical industries.

Industry sources forecast on May 26 that the operating profit of major oil refiners and chemical companies such as SK Innovation, LG Chemical, S-Oil, Lotte Chemical and Hanwha Chemical would drop 30 percent to 40 percent in the second quarter compared with last year.

In particular, analysts say that second quarter earnings will be lower than those forecast at the beginning of the second quarter as margins for major petrochemicals and chemicals will plunge due to sluggish demand. "Refining margins rebounded but slowed down and is now staying below the break-even point," said a researcher at Mirae Asset Daewoo. "China's domestic demand is weak. Under these circumstances, growing uncertainties stemming from trade disputes has dampened export demand."

In fact, the Singapore gross refining margin (GRM), an important benchmark of profitability for refining companies, sank below US$3.1 per barrel this month. Last week, it fell to the US$2 level. It rose from US$2.50 to US$4 a barrel earlier this year, boosting anticipation for a recovery in demand, but it has been trending downwards since last month. Refining companies say that margins must exceed US$4 per barrel to generate a profit in the refining business. If this situation holds, oil refineries will be forced to sell petroleum products such as gasoline at a loss.

Margins of petrochemical products such as naphtha have been on the decline recently. Paraxylene (PX) had been a cash cow for petrochemical companies in recent several years but its price has been falling recently. Although the International Maritime Organization (IMO)’s IMO 2020 regulations on sulfur content in vessel fuel are expected to set off an uptake in demand for environment-friendly fuel oil for vessels in the second half of this year, its impact on margins is expected to gradually decrease after 2021.

Industry experts forecast that the Korean oil refining and chemical industries will face some difficulties for the time being due to protectionism and Middle East countries’ moves to expand their oil refining and chemical business. In fact, Aramco of Saudi Arabia has been accelerating vertical integration from crude oil supply to processing.

These developments are compelling the Korean refining and chemical industries to accelerate the diversification of their business areas. For instance, LG Chem lowered the proportion of basic materials sales from 67.1 percent in 2017 to 59.4 percent in the first quarter of this year. On the contrary, the proportion of battery sales increased from 17.8 percent to 24.9 percent during the same span.

SK Innovation is also turning its eyes to batteries after chemical products. The company will invest more than 3 trillion won in its battery business this year with the goal of generating a profit in 2021. Hanwha Chemical is pinning its hopes on reviving the solar energy business which accounts for half of its total sales.

On the other hand, Lotte Chemical, which has adopted a strategy to pursue economies of scale rather than diversify into new areas, is suffering more from market deterioration. Financial information company WiseFn projected that Lotte Chemical’s operating profit would plunge by 46.4 percent in the second quarter, worse than LG Chem’s 29.6 percent and SK Innovation’s 33.1 percent drop. "As Lotte Group Chairman Shin Dong-bin is seeking to make Lotte Chemical as the group’s key exporting company, Kim Kyo-hyun, head of the group’s chemical business unit, will spend more sleepless nights," an industry official said.