Chemical producers in Saudi Arabia are bracing themselves for a possible hike in feedstock prices. Media reports of a hike from as early as the fourth quarter of 2023 have been circulating since at least June 2022. Feedstocks such as ethane and propane form the bulk of Saudi chemical producers' operating expenses, making them sensitive to price hikes despite their advantageous position over global peers. However, S&P Global Ratings believes that publicly listed rated and unrated Saudi chemical producers would be able to withstand a potential price hike, with their reported EBITDA margins remaining above 17% and adjusted debt to EBITDA below 1.5x on average. All else being equal, we estimate that these companies, including Saudi Basic Industries Corp. (SABIC; A/Stable/A-1), could withstand up to a 25% decrease in EBITDA due to higher feedstock costs, among other causes, in 2024.

Saudi chemical producers are in a more favorable position than their global peers because domestic feedstock prices are significantly lower than global benchmarks, and will likely remain so, even in the event of a price hike in the next few months. Saudi ethane and methane cost less than $2 per metric million British thermal unit (/mmbtu), compared with average Title Transfer Facility prices of $42/mmbtu in 2022 and $7.8/mmbtu in late May 2023. Historically, these competitive prices have helped listed Saudi chemical producers' EBITDA margins remain above 17%, our threshold for above-average profitability, even in periods of volatile prices and macroeconomic uncertainty (see chart 1).

Chart 1

Chart 2

The gap between feedstock prices for Saudi and global players widened following the Russia/Ukraine conflict because of the uncertainty over gas supply to Europe and the volatility in commodity prices (see chart 2). However, we expect the gap between domestic ethane and methane prices and global benchmarks to narrow over the next few years, with Henry Hub averaging $3.25/mmbtu in the remainder of 2023 and in 2024, and $3.50/mmbtu in 2025 (see: "S&P Global Ratings Revises Approach To Determining Its Hydrocarbon Price Decks; Changes Definition Of Long-Term Price," published April 20, 2023).

Raw materials account for about 80%-85% of listed Saudi chemical producers' cost of goods sold on average, excluding depreciation and amortization expenses (see chart 3). Ethane and propane generally make up between 65% and 70% of all feedstocks used in Saudi Arabia (see chart 4).

Chart 3

Chart 4

The Last Feedstock Price Hike Only Dented EBITDA Margins Moderately

The last feedstock price hike was in January 2016, when the Saudi government increased the prices of ethane and methane to $1.75/mmbtu and $1.25/mmbtu, respectively, from $0.75/mmbtu, and reduced the price discount for propane, butane, and naphtha to 20% from 28%. These price adjustments led to a 300 basis-point reduction in listed chemical producers' EBITDA margins on average over 2016. Revenue declined by 11%-12% on a weighted-average basis due to lower selling prices, with Brent oil prices falling 17% year on year and average polyethylene prices falling 5%-10%. EBITDA dropped by 9%. Some companies with higher exposure to methane, including fertilizers, were more sensitive to the price adjustments and their EBITDA margins declined more markedly, by 18% in one case (see table).

While feedstock price increases are key drivers of profitability, the ability to pass on price increases to customers is equally important in mitigating the pressure on profitability. In our view, this will be challenging for petrochemical companies in the near nerm, because of capacity additions in the sector and the link between demand and macroeconomic conditions in several end markets. However, for fertilizer companies, the profitability drivers are very different, because demand is linked to the fundamental need for food in light of the growing population, limited arable land, and challenges due to climate change, all of which are independent of macroeconomic conditions. For instance, in 2022, nitrogen fertilizer producers reported record-high margins, notwithstanding record-high gas prices in Europe, because they were able to pass on feedstock costs to farmers amid supply shortages due to export restrictions in China and disruptions in supply from Russia.

Further Feedstock Price Hikes Would Not Harm Profitability And Leverage Unduly

A hypothetical EBITDA decline due to further feedstock price hikes would not affect Saudi chemical producers' profitability and leverage greatly, according to our two stress scenarios. Although the industry dynamics look weaker in 2023 due to macroeconomic uncertainty and overall price volatility adding to pressure on margins, we applied the stresses in 2024, assuming the announcement of a feedstock price hike in the fourth quarter of 2023. Our two scenarios measure the effect of a deterioration in EBITDA on chemical producers' EBITDA margins and debt to EBITDA:

Scenario A

The EBITDA margin decline is similar to that in 2016, at about 300 basis points (bps). We assume that most of the decline in 2016 related to the increase in feedstock prices.

Scenario B

The EBITDA margin decline is more pronounced than in 2016, at 700 bps, mainly to factor in additional cost pressures. These include inflation; weaker topline growth due to the macroeconomic slowdown, which could reduce demand; and an oversupply of commodities, which could prolong the pressure on selling prices.

All else being equal, and assuming no price pass-through or management actions to mitigate margin pressure, the impact on EBITDA is substantial, with an average 25% decline in U.S. dollar terms under scenario B, and an average 11% decline under scenario A. However, we still expect the listed companies' average profitability to remain above 17% in 2024 under both scenarios (see chart 5). This is testament to the strong operating efficiency, scale, and shock-absorption capacity of most players. Both scenarios result in less than a 1x increase in debt to EBITDA, on average (see chart 6). This is because most listed chemical producers in Saudi Arabia have strong balance sheets, with some having no gross debt at all. We expect companies with more exposure to fertilizers to be more sensitive to higher costs, but still maintain relatively resilient credit metrics.

Chart 5

Chart 6

The likelihood of the rumored feedstock price adjustments materializing could fall if Brent oil prices look set to hit $90 per barrel (/bbl) in 2023 and $85/bbl in 2024, coupled with fiscal surpluses in the same period (see "Saudi Arabia Upgraded To 'A/A-1' On Significant Reform Momentum And Economic Growth Prospects; Outlook Stable," published March 17, 2023).

SABIC In Focus

We expect that Saudi chemical manufacturing company SABIC will maintain industry-leading profitability and modest leverage. We anticipate funds from operations to debt of above 60% and debt to EBITDA of below 2x in 2023. These ratios were above 100% and below 1x, respectively, on Dec. 31, 2022. In our base case for SABIC, we do not factor in additional feedstock price hikes. However, under the two hypothetical stress scenarios above, we anticipate that SABIC's adjusted debt to EBITDA would remain well below the 2x threshold for the 'A' rating, all else being equal.

The adjustments to feedstock prices in 2016 did not have a meaningfully negative impact on SABIC's margins on a consolidated basis. However, the fertilizers segment (6% of first-quarter 2023 revenue) saw a more negative impact than the petrochemicals and specialty chemicals segment (86% of first-quarter 2023 revenue) (see chart 7).

Chart 7

While SABIC gets some of its feedstocks from Europe and the U.S., most of its assets are in Saudi Arabia, where it benefits from the competitive prices. At the end of first-quarter 2023, 71% of SABIC's noncurrent assets (excluding financial assets and deferred tax assets) were in Saudi Arabia, compared with 87% as of end-2016.

Interest Rates Are More Influential Than EBITDA Margin Declines

In general, we believe that chemical companies in Saudi Arabia are more sensitive to rising interest rates than declining EBITDA margins. As a result, we keep a close eye on their refinancing risk and liquidity, in addition to their financial policy decisions and the actions they take to preserve their liquidity positions (for more details, see "Stressing Accessibility, Affordability, and Availability: Can GCC Chemical Companies Stand The Heat?," published Oct. 10, 2022). The cash flow visibility that chemical players enjoy is also essential for mitigating price volatility and preserving credit metrics.

Related Research

• S&P Global Ratings Revises Approach To Determining Its Hydrocarbon Price Decks; Changes Definition Of Long-Term Price, April 20, 2023
• Saudi Arabia Upgraded To 'A/A-1' On Significant Reform Momentum And Economic Growth Prospects; Outlook Stable, March 17, 2023
• Stressing Accessibility, Affordability, and Availability: Can GCC Chemical Companies Stand The Heat?, Oct. 10, 2022