Chemical companies in the Gulf are likely to cope relatively well with the current stresses of rising interest rates and higher energy costs. Here, S&P Global Ratings stresses the sensitivities of credit metrics of chemical companies based in the Gulf Cooperation Council (GCC) countries to both rising interest rates and higher energy costs, and finds that they come out stronger compared with other larger European peers. Besides overall healthy balance sheet positions, the larger regional chemical companies generally benefit from competitively low feedstock prices in the region, which are priced at significant discounts to the European benchmark, the Dutch TTF, which temporarily exceeded the $70 per million British thermal units (mmbtu) in mid-August 2022, compared with $25/mmbtu at the beginning of June 2022 and $18/mmbtu at the end of 2021. Cost competitiveness, plus long-term supply agreements with the region's national oil companies, which in turn have access to large and abundant reserves, should provide further cash flow visibility amid energy supply concerns in other regions.

That said, the pressures on the GCC's chemical companies are similar to the rest of the world. Increased geopolitical fallout in Europe (such as the Russia-Ukraine conflict, for example) and prolonged COVID-19 restrictions in China have strained supply chains and translated into a weaker global macroeconomic picture, with expectations of increasing interest rates in many jurisdictions, including the GCC. As such, S&P Global Ratings expects global real GDP to grow 3.1% and 2.4% in 2022 and 2023, compared with 6.1% in 2021. Additionally, given the recent increase in natural gas prices--the main feedstock for chemical companies in Europe and the Middle East--this has raised questions about the resilience of chemical companies.

We see European chemicals companies as more exposed to such risks than their GCC peers. For that reason, we took various rating actions on several European chemicals companies in August 2022, including on leading players such as BASF (A/Negative/A-1) because of the increased business risk. The higher prices and threats to supply of natural gas, which is not only used to generate electricity and steam, but also serves as raw material in chemical value chains, introduced grave operational supply chain challenges (see "Various Rating Actions Taken On Several European Chemicals Companies On Gas Supply Risks," Aug. 1, 2022).

On the other hand, higher prices for commodities (including natural gas), benefits commodity players in the GCC, including our rated universe and publicly listed chemical companies. This is evident in their relatively strong performance in 2021 and relatively resilient first-half 2022. For full-year 2022, overall market expectations are for publicly listed chemical companies to, on average, post continued healthy reported unadjusted EBITDA margins of about 30%, compared with 34%-35% in 2021, despite expectations of some margin softening this year from global capacity additions outpacing demand in some segments and high inventory levels (market consensus based on S&P Capital IQ data as of September 2022). This is in line with our base case for EBITDA margins of rated GCC chemical companies, which we see at about 30% in 2022 on a weighted average S&P Global Ratings-adjusted basis. This roughly translates into very healthy EBITDA interest coverage ratios comfortably above 15x, commensurate with a financial risk profile of at least intermediate risk, according to our ratio thresholds. In particular, all of our rated GCC chemical entities carry investment-grade ratings, meaning 'BBB-' or higher, with EBITDA interest coverage median of 35x-40x for 2022 and 2023.

Notably, our analysis shows that generally for our rated universe of GCC chemical companies, increases in interest rates place more downside pressure on credit metrics than rising energy costs, mainly because most debt carries floating interest rates, and feedstock is significantly discounted to market prices (fixed in Saudi Arabia, for example). We estimate that a hypothetical 500 basis points (bps) increase in interest rates, which is an extreme case scenario and not in our base case, each year over the next two years, would all else being equal not move weighted-average EBITDA interest coverage metrics enough to breach financial risk thresholds. That's mainly because of their staggered refinancing needs and adequate liquidity position. Similarly, we estimate that the chemical companies can withstand up to a 20% decline in profitability (EBITDA), which could be a result of increased raw material prices and inflationary pressure on costs, for example, with no material deterioration in overall credit metrics.

Table 1

Chart 1

Future Refinancing Needs And Rising Borrowing Costs Could Slightly Weaken The Credit Picture

In line with expectations of a higher trajectory for lending rates in the GCC, following a series of U.S. rate hikes, we see an upward trend, but with a slight lag. Here, we stress the sensitivity of additional interest rate increases and their impact on the credit metrics of publicly listed, unrated GCC chemical companies, and rated GCC and international chemical companies. Specifically, we look at the impact of higher funding rates on EBITDA interest rate coverage ratios, given the high contribution of floating-rate debt (60%-65% of gross debt, on average) and sizable upcoming maturities (bonds and bank borrowings) of about $3.5-$4.0 billion in 2022 and $4.5billion - $5.0 billion in 2023 annually, mostly in Saudi Arabia, given large downstream investments and projects.

More specifically, we stress that the impact of a hypothetical 500 bps increase in interest rates, over each of 2022 and 2023, on the floating-rate portion of each company's debt, is even more conservative than S&P Global Ratings' assumptions for average U.S. policy rates of 3.70% for 2023 and 2024. Our sensitivity analysis looks at implied EBITDA interest coverage ratios and the impact of a 5% average increase in interest rates, and we calculate that a 500 bps interest rate increase would keep EBITDA interest coverage ratios above 15x on a weighted average basis. Our analysis implies that this would not impact financial triggers for our rated entities.

By looking at the wider portfolio of listed chemical companies in the region, our analysis shows that a similar increase in interest rates could result in EBITDA interest coverage ratios resulting in different financial risk profile categories, based on our defined thresholds, particularly for the smaller players in Saudi Arabia. Based on our hypothetical stressed scenario, we see minimal pressure on EBITDA interest coverage ratios for the rated GCC entities in our portfolio, except for potential pressure on Equate Petrochemical Co. KSCC's (BBB/Positive/A-2) EBITDA interest coverage ratio in 2022. However, we do not see this ratio as the main credit metric for the rating, especially given the cost-competitive advantage that supports above-average profitability and mitigates volatility. The financial risk profile for EQUATE already captures a buffer of volatility weaker than the core ratios, which are in the significant category. For chemical companies, we primarily look at core ratios such as FFO to debt and debt to EBITDA, in addition to free cash flow generation, rather than payback ratios, and this is purely for illustrative purposes in this report. We expect smaller and undiversified players (typically with weaker cashflow or EBITDA generation) to be on average more exposed to these sensitivities.

Chart 2

Chart 3

Even though most of the gross debt of the region's chemical companies comprises floating debt or has a component of variable interest rate movements, we estimate that on a weighted average basis, overall financial thresholds would remain largely unchanged, at least for the bigger players. This is because we see benefits of a relatively good starting point after 2021, staggered refinancing needs, and adequate liquidity position. Moreover, we think the competitively low and stable feedstock prices have supported margins historically, and subsequently played a role in EBITDA interest coverage metrics.

Chart 4

Chart 5

Additionally, the average borrowing cost for GCC chemical companies is still more favorable than for European peers, which in addition to relatively healthy liquidity positions, should help provide additional buffer for further interest rate increases.

Chart 6

Chart 7

How GCC Chemical Companies Compare With European Peers

Market conditions for commodity chemical companies have improved notably over the past 15-18 months on the back of rising oil prices, strong demand, tight supply (amid the Russia-Ukraine conflict and China's export ban), and rising feedstock prices, which pushed up selling prices. Fertilizer prices, for example, are at their highest levels since at least 2008. However, we see potential demand disruption in the medium term for the overall commodity chemicals sector, given the weaker macroeconomic picture from COVID-19 supply chain disruptions (particularly from prolonged lockdowns in China and its zero infections policy), reduced manufacturing activity in China due to power rationing, inflationary pressures in Europe particularly, and geopolitical tensions, which, coupled with high inventories and new capacities could pressure overall profitability and margins.

We expect (mostly price-led) demand destruction to already have taken place this year and that will likely continue into 2023, as inflationary and potential new regulatory pressure in some markets would likely shift consumer spending to more affordable products, less demand for packaging, and potential changes in crop mixes, which in turn could reduce crop yields. We expect the diversified product mix, long-term feedstock agreements, and sizable scale of the large GCC chemical players to support cash flow visibility and mitigate volatility from these risks. This was evident in first-half 2022 results, when we saw some pressure on profitability margins, though they remained relatively healthy. For example, Saudi Basic Industries Corp.'s (SABIC's) reported consolidated EBITDA increased 9% year on year in first-half 2022 to $7 billion, with agri-nutrients (fertilizers) and steel performance offsetting the 12% year-on-year decline of the specialties and petrochemical segment, which suffered from higher feedstock costs (propane and butane) and freight costs (72% of first-half consolidated reported EBITDA).

This is also because our ratings on commodity chemical companies factor in the cyclicality of commodity prices and their sensitivity to supply-demand patterns, which is reflected in the financial risk profile assessments. More specifically, in the GCC, Fertiglobe (BBB-/Stable/--) is the only pure-play fertilizer company we rate, and while we consider industry conditions to be at top of the cycle, we believe Fertiglobe's long-term cost competitive agreements with the national oil companies (ADNOC in the United Arab Emirates, for example) have helped sustain its margins, even in the first-half 2022. As a result, top-of-the-cycle conditions that lead to improvements in profitability and cash flows do not, in isolation of other considerations such as financial policies and liquidity management, translate into an upgrade.

Chart 8

Chart 9

Table 2

As a result, we continue to see the GCC chemical companies emerging as better positioned, with an even more notable widening gap, compared with the largest European players, given the region's:

• Visibility of long-term feedstock supply from the national oil companies; and
• Competitive feedstock pricing in lowest cost quartile, which provides margin support and mitigates volatility amid higher input costs globally.

Feedstock supply.   As gas supply concerns increase in Europe, following the indefinite closure of the Nord Stream 1 pipeline, so does pressure on gas prices in Europe. This highlights the importance of the long-term visibility of feedstock supply for chemical companies as a ratings driver (see "Various Rating Actions Taken On Several European Chemicals Companies On Gas Supply Risks," published Aug. 1, 2022). In the GCC, most of the chemical producers benefit from long-term supply agreements with the national oil companies, which benefit from large and abundant supplies, further adding visibility to feedstock gas supply. Additionally, the national oil companies are investing in the development of gas fields to increase gas production, which help with providing raw materials for electricity and petrochemical production.

In particular, as part of its long-term strategy, Saudi Aramco (not rated) announced in March 2022 that is considering potentially increasing gas production 50% by 2030 and is investing to increase gas production for electricity and petrochemical production by developing gas fields not associated with oil production. In November 2021, Aramco commenced development of the Jafurah unconventional gas field, the largest nonassociated gas field in Saudi Arabia. By 2030, it is expected to reach a sustainable gas rate of 2 billion standard cubic feet per day (bscfd) of natural gas, which further supports feedstock visibility for the country. Similarly in the UAE, ADNOC is developing the Hail, Ghasha, Delma, Nasr, and Shuwaihat fields, which could produce 1.2 bscfd of gas. Moreover, the ratings on the national oil companies in the region are closely aligned (or in certain cases capped) with their respective (mostly highly rated) sovereigns, given ownership structures, oversight on the board, and overall alignment and contribution to the overall economic growth of the country. This is the case with Qatar Energy (AA-/Stable/--) and Energy Development Oman (BB-/Stable/--), for example.

Feedstock pricing.  Compared with European chemical players, GCC chemical producers benefit from a feedstock pricing advantage, with some in countries such as Saudi Arabia, for example, maintained at fixed levels of $1.25 and $1.75/mmbtu for methane and ethane. Combined with a solid customers and shareholder base, the GCC players' profitability has an edge over their European peers.

In evaluating a commodity chemical company's cost position compared with that of its peers, we primarily consider its EBITDA margin, as well as other indicators of cost efficiency and capital intensity, such as margin over raw material costs, capacity utilization rate, and capital spending to sales. Cost position relative to peers is particularly important for many commodity chemical companies. Because the cost of raw materials and production can vary by region, the relative costs and availability of raw materials, energy, and labor can significantly affect a company's cost of production and, thus, its profitability. In addition, proximity to key end markets can have a considerable impact on transportation costs for bulky or hard-to-ship chemicals. Companies that can reduce or use different inputs--whether entirely different inputs or different grades of the same material--can enhance profitability and improve their competitive positions relative to peers that do not benefit from the same flexibility.

In this section, we look at key downside risks for the overall profitability of GCC chemical companies and their impact on credit metrics. Given that the operations of commodity chemicals are largely dependent on the flexibility of the cost structure and the competitiveness of feedstock, the largest component of cost of goods sold (about 80%-85%, on average), we look at impact of higher costs on overall profitability, all things being equal. Our analysis shows that under a stressed scenario environment, which considers EBITDA declines of 20% from the current base case, based on historical EBITDA fluctuations, we could see 20%-30% of companies' EBITDA interest coverage financial risk category (based on our thresholds definitions) weaken in 2022 and 2023. We calculate that at least 70%-80% of chemical companies in the region can withstand up to 20% decline in EBITDA, through higher energy costs and feedstock prices, before material deterioration in credit metrics. Even with lower profitability, our analysis shows that EBITDA interest coverage, on a weighted average basis, will not meaningfully deteriorate.

Chart 10

Chart 11

Ratings For GCC Chemicals Factor In Top-Of-The-Cycle Conditions

Our ratings on chemical companies factor in the inherent cyclicality of commodity prices and their sensitivity to supply-demand patterns, inventory levels, energy prices, and macroeconomic conditions. In the GCC, our rated portfolio is investment-grade level, and two out of the four rated entities carry a positive outlook.

For SABIC, the positive outlook is in line with the outlook on Saudi Arabia, because we view chemicals company as a government-related entity (GRE) with very strong ties with the sovereign. As for EQUATE, the assignment of a positive outlook in November 2021 was supported by improving credit metrics on the back of higher commodity prices. Important to note, that even with elevated pricing conditions, positive outlooks and higher prices would not necessarily translate into immediate upgrades, in our view. In line with the stresses above, monitoring company-specific factors such as financial policies and the use of windfall profits are also important considerations.

Given higher sensitivities of rising interest rate fluctuations, refinancing risk and liquidity profiles would be key aspects we monitor, in addition to financial policy decisions and what actions these companies would take to preserve liquidity positions. Additionally, the cash flow visibility, which GCC chemical players enjoy, and its sustainability are key to mitigating price volatility and preserving credit metrics.

Notably, the GCC's national oil companies, whose credit quality is largely closely aligned with the respective (highly rated) sovereigns and that provide the competitively low priced feedstocks, are major shareholders of our rated GCC chemical entities. More specifically for SABIC and Industries Qatar, the final rating, and ultimately the outlook, is closely driven by the rating on the respective sovereign, because we consider them as GREs with very strong links with the government. For EQUATE, because we view the company as strategically important to Kuwait Petroleum Corp. (unrated), the national oil company in Kuwait, the final rating benefits from a three-notch uplift from the stand-alone credit profile (SACP).

Chart 12

Appendix

Table 3

Related Research

• Various Rating Actions Taken On Several European Chemicals Companies On Gas Supply Risks, published August 1, 2022
• GCC Banks Return To Form, Can It Last? (published Sep 22, 2022)
• GCC Sustainability Targets Are Unlikely To Shake Up Local Energy Markets (published April 11,2022)