October 2019

Trends & Resources

Business Trends: One downstream—Strategic imperatives for the evolving refining and chemical sectors

Downstream executives will remember the present decade as a golden age for the industry, driven by low feedstock prices and healthy end-use demand.

Dickson, D., Slaughter, A., Deloitte Services; Mittal, A., Deloitte Services LP

HPDownstream executives will remember the present decade as a golden age for the industry, driven by low feedstock prices and healthy end-use demand. Whether it is a U.S. simple refiner processing discounted tight oil, an integrated player with unified refining and chemical operations, or a pure-play chemical company operating in a niche market, organizations seem to have created more wealth over the past 10 yr. However, this golden era is coming to an end.

Business risks and/or market forces that have been on the horizon, but were perhaps masked by high growth and margins, have started to strengthen. Forces that have positively supported the sector (e.g., lower feedstock prices) or posed only minimal obstacles (e.g., sustainability goals) may not support profitability in the next decade. Indeed, our text mining and sentiment analysis on the annual SEC filings of more than 80 U.S. refining and chemical companies highlight five rising risks (or forces) for the downstream sector (FIG. 1). These risks include:

  • Feedstock changes and choices
  • The state of globalization
  • End-market disruption
  • Circular economy and long-term sustainability
  • Large-scale operational technology transformation.
FIG. 1. Growing risks in the downstream sector. Source: Deloitte Analysis.
FIG. 1. Growing risks in the downstream sector. Source: Deloitte Analysis.

Among the five forces, volatility and uncertainty in the feedstock market are highlighted as the biggest risks, while the state of globalization has weakened the most for downstream companies—down 80% since 2016. Many companies are not sufficiently acknowledging the deteriorating risk profile, either for their firm, their sector or for the downstream industry. By ignoring these emerging risks, are downstream companies ill-prepared to face them as they strengthen?

The answer is, quite possibly. In fact, analysis of more than 1,350 downstream companies worldwide suggests that these five forces have already begun to alter the balance across the downstream value chain. In 2010, the operating margin spread between the least and most profitable business in the downstream value chain was close to 13%. By 2018, the spread had narrowed to 8%. Similarly, within the three pure-play chemical subsegments (commodity, diversified and specialty), the differentiation has narrowed, and the margin spread is now less than 1%. This period of convergence has been most challenging for incumbent players, especially those who were slow in dealing with new market forces because of their conventional strategies and legacy processes.

In the downstream universe, simple and complex refiners and specialty chemicals segments are most affected by feedstock changes and/or end market. Although the established position of companies in the integrated refinery-petrochemical and commodity and diversified chemicals segments have shielded them against these forces, the landscape is becoming more competitive due to the growing strength of regional players and the entry of many small and new chemical companies.

Confluence of five market forces

Margin convergence and performance disparity among segments suggest that disruption is already underway in the industry. Until now, the five forces have largely played out linearly and individually. Imagine the disruption when all five forces start playing out together and, most importantly, influence each other and cut across the value chain. How and where is the confluence of five forces happening? What does this mean for the future of downstream?

Feedstock changes and choices. Downstream companies are “expected” to be fully familiar with new feedstock choices in the market, especially the availability of light feedstocks such as tight oil and natural gas liquids at a discounted price. Although this “light” ride itself will not be smooth, a bigger opportunity and challenge are in waiting when forces such as sustainability and end-market disruption start altering the entire feedstock landscape of the industry.

For example, sustainability will likely demand higher mechanical, chemical and thermal recycling of plastics, where both the hydrocarbon and energy content is fed into polymerization units. Similarly, end-market disruptions will call for using “renewable” feedstocks for petroleum products and chemicals, vs. fossil fuels. Essentially, the industry’s future feedstock mix will not be limited to primarily fossil fuels, as higher recycling of end products would lead to disintermediation of intermediate feedstocks, and a combination of “good” regulations and “proactive” use of renewables may displace a portion of primary fuels.

The state of globalization. With energy trade and investment becoming more regionally concentrated, the downstream industry cannot afford to stand aside nor adopt a defensive approach to globalization. Uncertainty and risks will expand as technology-led disruptions on feedstock, processes and the end market start to demand higher agility and dynamism from companies. Near-term trade tensions and rising tariffs also pose an immediate risk to markets and established global supply chains.

Large, export-oriented projects using new technologies (e.g., new projects in the Middle East that are directly converting crude oil into chemicals and are estimated to produce about five times the volume of the largest naphtha-based ethylene cracker in the world) will most likely keep the globalization topic relevant into the next decade. Similarly, higher emphasis on the carbon footprint of imported products will most likely challenge the fundamental origin of virgin plastics, which enabled the rise of global mass-market products and facilitated the globalization of the food and packaging industry.

End-market disruption. Automotive, building and construction, and packing industries—key end-markets of the downstream industry—have been undergoing a transformation for some time, but the pace and degree of change have now accelerated. These end users are increasingly driving systemic change at an industry level. In 2018, 13 leading retailers and packaging companies—together representing more than 6 MMtpy of plastic packaging—joined together to move toward 100% reusable, recyclable or compostable packaging by 2025.

End markets/end users impacting intermediates demand through higher recycling is one thing; end products becoming primary fuels or raw materials for manufacturing is another. For example, BASF’s ChemCycling project converts unrecyclable plastic waste, such as mixed or uncleaned plastics, into primary feedstock or fossil fuels (syngas or oils).

Large-scale operational technology transformation. A changing feedstock mix (e.g., single to diversified), stricter and proactive green mandates (e.g., carbon emissions, recycling of plastics), and end-market disruption (peak oil demand by the 2030s) will challenge the functionality and economics of many off-the-shelf technologies and commoditized processes that have been in operation for decades.

Further, the rise of many new technologies focused on reducing intermediate processes (e.g., crude-to-chemicals), lowering feedstock cost and greenhouse gas intensity (e.g., direct oxidative coupling of methane) or having a superior catalyst and reactor process (e.g., integrated coal-to-liquids development in China) will challenge many incumbents with a depreciated asset base and force the industry to shed its “arm’s-length” relationship between segments.

Circular economy and long-term sustainability. Self-regulation by companies and growing expectations from stakeholders will rise to a level where sustainability starts encompassing all other internal and external forces (feedstock, technology, end-markets and globalization) and feature prominently on the boardroom agenda of companies.

Sustainability will throw open many new and innovative business models. The question is how each company sees and evaluates available routes to sustainability—an essential cost, a branding exercise or an opportunity to uncover hidden value.

Combating the confluence of risk factors on the horizon

The future of refining and chemicals will be shaped by a complex convergence of the five market forces. Although the overall balance of the downstream industry is likely to pivot more to the chemicals side and undergo significant consolidation, it is imperative that companies prepare themselves by:

  • Reassessing roles and ownership across the value chain to replace the linear product- and efficiency-centric supply chain model with an ecosystem-linked, platform-based and value-centric mindset.
  • Prioritizing speed-to-market strategies that favor modular workflows, facilitate debottlenecking opportunities, complement chemistry and engineering with data analytics, and drive aggressive sustainability goals.
  • Building a strong alliance capability that focuses on open innovation of molecules and materials, shares environmental footprint across a product supply chain and sponsors end-market innovations.
  • Elevating the manufacturer–distributor relationship to tap into unique insights in a specific region, market and product stream.
  • Speaking the language of jobs, investment and sustainability standards, and exploring new win-win trade strategies that go beyond securing supply-and-demand centers.
  • Preserving and advancing the core by rationalizing cost, extending scale advantage in specific end-markets and integrating assets and operations through advanced analytics. HP

NOTES

This article is an excerpt summary of Deloitte’s report, “One Downstream: Strategic imperatives for the evolving refining and chemical sectors.”

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