New feedstock prices to drive positive shift in fuel use, boost operational efficiency: Analysts

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The recent adjustments to fuel prices by Saudi Arabian Oil Co. (Saudi Aramco) were not surprising, as they were in line with the goals announced since 2017 as part of the government’s plans to adjust fuel prices and link them to global reference prices by 2025, analysts told Argaam.

 

They added that despite the variant cost hikes in sectors, there are positive shifts in the use of fuel and inputs, as well as enhancements in operational efficiency.

 

The food industry, transportation, utilities, and most other sectors will witness a limited impact from the recent fuel hikes, while the cement and petrochemical sectors will be most affected, the analysts said.

 

In addition, they expected a number of mergers in some sectors to create larger entities that would result in synergies aimed at creating added value, reducing costs, and boosting the ability to compete healthily.

 

Through fuel price adjustments, the Saudi government aims to enhance revenues in a structural and continuous manner as a main and sustainable source of financing expenditures, especially those related to social aspects.

 

Moreover, the Kingdom seeks to reduce the budget deficit and encourage the establishment of investments with a competitive advantage in the industrial sector.

 

Performance of cement and petrochemical sectors after recent feedstock price hike

 

Jassim Al-Jubran, Head of Sell-Side Research at AlJazira Capital, said despite the variant cost hikes in sectors, there are positive shifts to the use of fuel and inputs as well as enhancements to operational efficiency.

 

Jassim Al-Jubran, Head of Sell-Side Research at AlJazira Capital

 

He added that the impact of the feedstock price hike on sectors will vary depending on the type of fuel and feedstock used, as well as the percentage of the price hike.

 

Cement and petrochemicals may be the most affected sectors, as cement companies are currently facing the effects of low demand and high inventories, Al-Jubran said.

 

Al-Jubran also expects a number of mergers in certain sectors, resulting in synergies aimed at creating added value, reducing costs, and boosting the ability to compete healthily for the benefit of shareholders, the economy, and society.

 

Haggag Hassan, Head of Argaam Plus, had the same view, stating that companies will seek to accelerate discussions on mergers and acquisitions during the coming period as one of the solutions to confront higher costs, in addition to improving operational efficiency and exploring other markets, as was the case with Northern Region Cement Co., which recently built a factory in Iraq.

 

Haggag Hassan, Head of Argaam Plus

 

Haggag expected that cement companies would face a challenge during the coming period due to the existing gap between supply and demand, as the supply reaches nearly 100 million tons, of which 40 million tons are accumulated stocks, while demand amounts to around 50 million tons annually.

 

Demand for cement comes from three sources, mainly the giant under-development projects that are expected to witness an increase in demand. The second source is the housing sector, which witnesses a slowdown in mortgages due to interest rate hikes, while the third source is exports, Haggag said.

 

Feedstock prices and investment attractiveness

 

The cement industry is facing challenges in the short term, he indicated, as initiatives should be launched to alleviate the related impact on profit margins as well as profitability. Prices of heavy fuel oil (HFO), the most used feedstock by companies operating in the industry, surged by 120%.

 

Petrochemicals is the second industry to be affected by the slowdown in demand worldwide, as Europe is suffering a recession while China sees a slow economic recovery in light of increased capacities for some products in 2023. This requires significant cost-efficiency strategies to alleviate the impact over the coming period.

 

Other sectors related to manufacturing, utilities, food industries, and transport are the least affected by the recent hikes in energy products.

 

Since its inception in 1955, the cement industry in Saudi Arabia has been significantly backed by the government in terms of the availability of limestone used as a feedstock, in addition to providing Saudi Aramco-backed fuel. This gave the sector a competitive advantage, and it became one of the most attractive sectors for investors, said Hajjaj.

 

Amid the recent increase in fuel prices -expectedly at 50-100%- the cost of production may rise 10-20% as the cost of fuel represents 20% of the total production costs, which may impact the companies’ margins.

 

Are there upcoming increases in feedstock prices?

 

Al-Jubran said that the Saudi Fiscal Balance Program announced in 2018 includes linking energy prices to global price levels gradually until 2025 to increase energy efficiency in the Kingdom and reduce energy waste in many sectors.

 

He added that the program is working on a gradual shift towards gradually raising reliance on renewable energy for some types of low-carbon and high-efficiency energy, such as natural gas.

 

Al-Jubran believes that some energy products will have a higher ceiling for increase and will not be fully raised, while others, such as ethane and methane, have reached levels close to global prices after raising their prices recently, starting in January 2024.

 

He pointed out that the prices of liquefied fuel gas for the petrochemical sector, represented by propane and butane, are still higher than the current price levels in the United States.

 

On the other hand, Hajjaj predicted that fuel prices will witness other increases, particularly with the government's move to correct energy prices and link them to the global reference price by 2025 in accordance with the Fiscal Balance Program of Vision 2030.

 

Determining sectors

 

With the high cost of cement, some companies may record losses in the first quarters of 2024, especially those operating in areas witnessing price competition and a price war, Hajjaj noted.

 

He also pointed out that there will be a rise in transportation costs, mainly for companies that were trying to sell outside their geographical areas, and that the increase in costs will affect the competitive advantage that the cement industry enjoyed at the regional level and thus export.

 

Meanwhile, Al-Jubran expects companies to work to mitigate the impact of the increase in their inputs to reduce the impact on financial performance and continue to provide the best return to their shareholders.

 

He added that there are several options, including switching to some less expensive and more effective alternative energy products using some modern technologies to reuse wasted energy in factories, as well as identifying everything that can reduce costs, provided that sustainability is maintained for the environment and society.

 

Al-Jubran also pointed out that some cement companies can find appropriate solutions, such as switching to gas, which is less expensive compared to heavy fuel oil, that may have effective results in the long term in light of the huge gas exploration in the Kingdom. However, this requires preparing production lines and high capital expenditures to achieve this result.

 

He noted that it is possible to address the impact at the lowest cost and in the quickest time by focusing on not entering into the recent price war and reducing the burden on company shareholders.

 

This will improve performance in the medium term in light of the upcoming huge projects in various regions, in addition to the expected role of petrochemical companies in making greater efforts to reduce costs and increase production efficiency.

 

He stated that petrochemical companies should focus on exporting to regions with the highest prices in order to be able to maintain their margins and maximize the role of marketing in various countries worldwide.

 

Export and competitive position of the cement and petrochemical sectors

 

Hajjaj affirmed that exports will be impacted due to rising production costs, leading companies to gradually lose the competitive advantage they once had. This is particularly due to the export duties imposed by the government on these companies. The duties were slashed by around 50% to support the companies amidst the challenging conditions facing the sector.

 

On the other hand, Al-Jubran said that the situation depends on the nature of the industry. For instance, the petrochemicals sector still partially enjoys some competitive advantages due to its production efficiency and high capacity to compete with major producers globally.

 

He pointed out that, at present, efforts from the sector companies will be focused on maintaining competitive advantages by reducing costs, improving product quality, exploring growth areas, along with the government role in negotiating free trade agreements with economically advanced countries.

 

These agreements aim to open opportunities for local companies to enhance their competitiveness in those countries.

 

He clarified that despite the decrease in local cement production costs compared to many countries worldwide, cement producers need to reconsider the feasibility of exporting their clinker stocks at low prices.

 

This will not be acceptable in the upcoming phase due to its impact on financial performance. Companies should leverage these stocks to support the strong demand expected in the medium term for mega projects at better prices than export prices.