Corporate Strategy Case: Haldia Petro Chemicals

Competition & StrategyIndustry: PetrochemicalsCompany: Haldia Petrochemicals Author(s)-Group 13 Roll No.Govindji Nigam 1014017Lokesh Kumar 1014024Narayanan Venkataraman 1014027Utsav Pandey1014064Ramamurthy Bhamidipati Prakash1014071 August 09, 2010 Table of Contents TOC quot;
MT_Chapter Name,1,MT_Heading 1,2,MT_Heading 2,3,MT_Subheading 1,5,MT_Heading 3,4quot;
Definitions, Abbreviation and Acronyms PAGEREF _Toc269138568 2 Executive Summary PAGEREF _Toc269138569 2 Introduction PAGEREF _Toc269138570 2 2.1.Objectives PAGEREF _Toc269138571 2 2.2.Scope of Study PAGEREF _Toc269138572 2 2.3.Assumptions PAGEREF _Toc269138573 2 2.4.Out of Scope PAGEREF _Toc269138574 2 Indian Petrochemical Industry PAGEREF _Toc269138575 2 3.1.Industry Overview PAGEREF _Toc269138576 2 3.2.The Characteristics of Indian Petrochemical Industry PAGEREF _Toc269138577 2 3.3.Market Structure and Snapshot PAGEREF _Toc269138578 2 3.4.Market Forecast PAGEREF _Toc269138579 2 3.5.Industry Structure and Leading Players PAGEREF _Toc269138580 2 3.6.Key Industry Characteristics PAGEREF _Toc269138581 2 3.7.The Growth PAGEREF _Toc269138582 2 Haldia Petrochemicals PAGEREF _Toc269138583 2 4.1.Company Overview PAGEREF _Toc269138584 2 4.2.Business Overview PAGEREF _Toc269138585 2 4.3.Key Financial PAGEREF _Toc269138586 2 Strategy Analysis PAGEREF _Toc269138587 2 5.1.Current State - Our Understanding PAGEREF _Toc269138588 2 5.2.Problem Statement PAGEREF _Toc269138589 2 5.3.Industry Analysis - Porter's Five Forces Analysis PAGEREF _Toc269138590 2 5.4.Comparative Financial Analysis PAGEREF _Toc269138591 2 5.1.Product Mix PAGEREF _Toc269138592 2 5.2.Strength and Weaknesses - SWOT Analysis PAGEREF _Toc269138593 2 5.3.Propose Alternatives & Evaluations PAGEREF _Toc269138594 2 5.3.1.Alternative 1 : Backward Integration PAGEREF _Toc269138595 2 5.3.2.Alternative 2 : Disinvest PAGEREF _Toc269138596 2 5.3.3.Alternative 3 : Tie up with Oil refineries in Eastern region for Supply of naphtha PAGEREF _Toc269138597 2 5.3.4.Alternative 4 : Forward Integration PAGEREF _Toc269138598 2 5.3.5.Alternative 5 : Setup/Alter the plant to be gas-based PAGEREF _Toc269138599 2 5.3.6.Alternative 6 : Increase capacity for polymers PAGEREF _Toc269138600 2 Recommendation and Implementation Plan PAGEREF _Toc269138601 2 6.1.Recommended Strategy PAGEREF _Toc269138602 2 6.2.Timelines and Cost Implications PAGEREF _Toc269138603 2 6.2.1.Assumptions PAGEREF _Toc269138604 2 6.3.Contingency Plan PAGEREF _Toc269138605 2 References PAGEREF _Toc269138606 2 Appendix A PAGEREF _Toc269138607 2 Definitions, Abbreviation and Acronyms The terms in use in the document are explained below. AcronymDescriptionB2CBusiness to CustomerBCGBoston Consulting GroupBdButadieneBzBenzene CAGRCompounded Annual Growth RateFYFinancial YearhdPEHigh Density PolyethylenelldPELinear Low Density PolyethylenePPPolypropyleneLPGLiquefied Petroleum GasMMTMetric Million TonnesPSPoly StyrenePATProfit After TaxROSReturn On SalesROAReturn On AssetROCEReturn On Capital EmployedTPATonnes Per Annum Executive Summary Haldia Petrochemicals has been able to consolidate its position in the petrochemical industry with an established customer base and market position in the domestic industry. The company has a strong market position in Eastern India and Northern India and sells most of its products in the high netback regions of North and East. Further, the company has also developed niche grades of polymers that command a higher premium in the market. HPL sells polymers both directly to large consumers such as Jindal Poly Films Limited, Supreme Industries Limited and Jain Irrigation Systems Limited, and indirectly to numerous small and medium-scale processors through dealers. However, being a standalone player in the petrochemicals industry, HPL remains vulnerable to volatility in naphtha prices. For example, during 2008-09 the rise in naphtha price beyond $1100/MT and decline by more than 80% to nearly $200/MT and partial pass-through to downstream producers resulted in contraction in the tolling margins of the company. The average tolling margin in 2008-09 declined to around $247/MT as against $ 285/MT in 2007-08. The fall in naphtha prices, which could have resulted in better margins, were constrained by inventory devaluation in Q3 2008-09. Despite some production cutbacks, the company also experienced production-sales gap because of postponement of purchase decisions by end users in a falling price scenario. The imposition of 5% import duty on naphtha (as per Union Budget 2008-09) also adversely affected the profitability of the company. In order to protect its bottom line, HPL has been using advance license for duty-free naphtha imports, which would translate into additional export obligations that may be required to be fulfilled within 36 months. In case the duty was to persist, HPL could have sizeable export obligations associated with duty-free naphtha imports. The company witnessed decline in sales during 2008-09 on account of weak demand and price volatility. The company also witnessed deferred procurement plans by its customers on account of poor performance of downstream units in South-east Asia. At this juncture, HPL badly needs a solid business & operational strategy to sustain its market share in the domestic market. The recommended strategy for Haldia Petrochemical hence is to continue with the *Cost Leadership* in order to achieve growth in the polymer segment by augmenting its capacity. The forecasts present promising growth numbers for both basic petrochemicals and polymers. Since our study is focused on polymers, the reasons are in context of polymers. Approximately 3,00,000 tonnes of domestic polymer demand and approximately 6,00,000 of deficit capacity exists in industry. To tap this growth, Haldia needs to expand its capacity. This would help to attain the required sustainability and competitive advantage. The alternatives proposed are Capacity Expansion in medium term strategy and Backward Integration as long term plan.. Introduction Objectives The objective of this study is to analyze one Indian firm from one of the suggested industries (Aluminum, Petrochemicals, Auto-components, Consumer electrical, Paper and paperboard, Electronic media (including Internet and Television) and Pharmaceuticals) and examine its strategy in the context of its industry. Based on the outcome of the study of firm’s strategy, the group is expected to identify alternate strategies with their evaluation and eventually submit the strategy recommendations along with contingency plan. Scope of Study This study focuses on the analysis of the firm’s business level strategy and challenges with its strategy. Assumptions The following are the assumption for this study – The company is unlisted. The financial data might be unaudited. The financial data for the available period up to FY2009. We therefore assume that this data is correct. The impact of basic petrochemicals demand forecast and growth (such as ethylene) is assumed to be negligible because it is out of the scope of study. The overall strategy might have some deviation should be consider the basic petrochemicals as well in the overall portfolio. Out of Scope As the part of this study we have analyzed only the polymers product segment. The basic petrochemical product segment is not analyzed. Indian Petrochemical Industry This chapter presents the Indian petrochemical industry overview, key players and Porter’s analysis. Industry Overview Petrochemicals are derived from natural gas, natural liquids, or refinery products like naphtha (derived from the distillation of crude oil). These compounds are made up of hydrocarbons, which are converted into primary petrochemicals, such as methanol, olefins and aromatics. Primary petrochemicals are obtained through the application of heat and pressure in the presence of catalyst or by reaction with other chemicals, after which primary petrochemicals are separated from compounds by distillation and extraction. Primary petrochemicals are further processed into intermediates such as vinyl chloride and styrene and its derivatives, the most important of which are polymers. During polymerization, ethylene, propylene, vinyl chloride and styrene react in the presence of a catalyst. The process involves the breaking up their double bonds and the formation of a long chain compound known as 'polymer'. The Characteristics of Indian Petrochemical Industry The Indian petrochemical industry is a highly concentrated one and is oligopolistic in nature. Four major companies viz. Reliance Industries Ltd (RIL), Indian Petrochemicals Corporation Ltd. (IPCL), Gas Authority of India Ltd. (GAIL) and Haldia Petrochemicals Ltd. (HPL) used to dominate the industry at a large extent. With the amalgamation of IPCL with RIL, RIL accounts for over 70% of country's total petrochemical capacity. However, the scene is a bit different for the downstream petrochemical sector, which is highly fragmented in nature with over 40 companies exist in the market. Petrochemical Industry in India is a cyclical industry. This industry, not only in India but also across the world, is dominated by volatile feedstock prices and sulky demand. India has one of the lowest per capita consumptions of petrochemical products in the world. For example, the per capita consumption of polyester in India lies at 1.4 kg only comparing to 6.6 kg for China and 3.3 kg for the whole world. Similarly, the per capita consumption of polymers is 4 kg in India, whereas the per capita consumption is around 20 kg for the whole world. Market Structure and Snapshot The Petrochemical industry is segmented based on the final products. The two main categories are - Basic Petrochemicals - The basic petrochemicals include - Olefins (ethylene, propylene and butadiene) Aromatics (benzene, toluene etc.) Among basic petrochemicals, ethylene is the most important due to its various end uses. The size of a petrochemical industry is judged by its ethylene capacity. The basic petrochemicals are largely produced by cracking feedstock - naphtha or natural gas. The proportion if various basic petrochemicals produced depends on the quality and type of the feedstock used. The domestic consumption during 2007-08 and 2008-09 is presented below. Basic Petrochemical – Domestic Consumption Summary Polymers - They are the building blocks for a variety of products such as polymers, fiber intermediates and elastomers. The domestic consumption during 2007-08 and 2008-09 is presented below. Polymers – Domestic Consumption Summary Market Forecast As per the CRISIL projections, the domestic petrochemicals demand is likely to show healthy growth in spite of weak growth expected all over the globe. The key growth highlights are – The domestic demand is expected to grow at a CAGR is 10-11% during 2008-2009 to 2013-14. The global demand is expected to grow at a CAGR of 3-3.5% during the same period Basic Petrochemicals – Domestic Demand Summary Polymer – Domestic Demand Summary Industry Structure and Leading Players The domestic petrochemical industry is oligopolistic in nature with four to five large producers. However, competition has been increasing gradually, with existing producers expanding capacities and thus trying to eat each other's market. Moreover, with the entry of new players like India Oil Corporation and ONGC Petro - additions Limited (OPaL), competition is expected to increase further. Though the Indian petrochemical industry is highly dominated by only a few players, however, there are a number of key petrochemical companies in India, doing their share of business. Some of the top companies are listed as below: Reliance Industries Limited. Haldia Petrochemicals Limited. Indian Oil Corporation Limited Gas Authority of India Limited The capacity share of various Indian players in the ethylene and polymers segment is presented below. Domestic Ethylene - Capacity Share ( 2008-2009) Polymer - Capacity Share ( 2008-2009) Key Industry Characteristics This sub- section describes some of the key characteristics of the petrochemical industry that are critical to the growth. Crude Oil Linkages - Naphtha is derived on crude oil. Approximately 51% of global cracking capacity is based on the naphtha. Hence, price and availability of crude oil affects the industry. Crude oil prices are highly volatile, thus making the prices of petrochemicals also volatile. Volatility is higher in the case of basic petrochemicals and intermediates, as against polymer and downstream organic chemicals due to their close linkages with crude oil and lower trade of these products. Hence the recent trend in the industry is acquiring or merging with refining and oil exploration companies and vice versa is attributed to strong linkages of petrochemicals with crude oils. For instance - Reliance Industries has backward integrated from petrochemicals to refining and oil exploration. Economies of Scale - The investment required per tonne of capacity decreases as capacity increases. In addition, other costs (per tonne of capacity) such as administration, logistics and marketing also decrease with increasing capacity. Higher capacity also gives the producer more bargaining power in the purchase of feedstock. As a result the large players in this industry are more cost competitive than smaller players. Plant Operating Rates – Critical to Profitability - The petrochemical industry is capital intensive, resulting in high interest and depreciation costs. Hence, plants need to operate at high rates, in order to reduce the fixed cost per unit of production. Higher operating rates reflect the demand for products and hence, the bargaining power of producers increases over that of the consumer. During price negotiations, besides inventory levels, plant operating rates also determine the relative bargaining power of the producer and the consumer. Feedstock and Product Prices - The naphtha prices are highly depended on the crude oil prices. These in turn (feedstock) influences the establishment of a plant. The diversity of feedstock could result in the price difference. Natural gas based products are relatively cheaper than Naphtha based products. Hence countries producing natural gas could affect the competitiveness of countries facing the shortage of natural gas. The product pricing is complex as single feedstock yields many co-products, prices of which are correlated. Moreover, different feedstock can be used to produce the same product. The Consumer's willingness or ability to pay drives the prices of the petrochemical products. Cyclicality - The demand for petrochemicals is linked to economic growth. Demand increases when economy is strong; consequently, profitability of players increases, leading to capacity additions by existing players and entry of new players. Fragmented and Competitive Industry - The global petrochemical business is very competitive with large number of petrochemical companies having small market share. Top 10% producers account for less than 45% of total capacity. It is highly capital intensive business; acts as entry barrier to new and small companies. The competition is based on cheap availability of feedstock, prices and ability to offer new and improved products and proximity to markets. The Growth The petrochemical industry in India came into existence during 1970s. The 1980s and 1990s saw some rapid growths for Indian petrochemical industry. The biggest reason for this growth was the high demand for petrochemicals in India, which grew at an annual rate of 13 to 14% since late 90s. It also called for rapid expansion of capacity. The BMI forecast of average annual growth in India over 2007-2011 is 14 to 16%. However, the industry suffered setbacks during 2008 due to surge in the price of crude oil. It will be tough for Indian petrochemical industry to plug the deficit of 5mn TPA of ethylene and 4mn TPA of polymer by 2012 (according to the predictions of the government). In present scenario India has three gas-based and three naphtha-based cracker complexes with a combined annual capacity of 2.9 MMT of ethylene. Besides this, there are also 4 aromatic complexes with a capacity of 2.9 MMT of Xylenes. The production of 5.06 MMT polymers during FY09 accounted for around 62% of the total production of key petrochemicals. It also achieved 88.5% capacity utilization. The industry also produced 2.52 MMT of synthetic fibers during FY09 with a 73% of capacity utilization. Some of the advantages of manufacturing high-class petrochemical products in India are - Friendly government of India policies Low cost labor Low and world class infrastructure Strong technical education Large number of science and engineering graduates Quality output Highly skilled workforce Usage of innovative process Good client relationships Huge scope for innovation Expansion of existing relationships Huge demand in overseas markets Availability of more technical work force Increased number and quality of training facilities The key reasons for the growth are presented below – As the general trend in the global arena of the petrochemical market has shifted to the Middle East and Asia from the West, India stands a good chance in providing a lucrative market to the world. In the present scenario, the scope of India petrochemical industry is very good as the government regulations are aligned with the industry and is playing an important part. The regulations have opened the market which is full of scope for the rapid growth of the industry and in turn, the growth of the economy. The supply and demand situations and the pricing views in the industry are also among the factors for growth. With fierce competition in this sector, there is every chance that superb quality products will be produced in order to stay ahead of competitors. The encouragement for investment has been another growth factor for the India petrochemical industry. Haldia Petrochemicals Company Overview Haldia Petrochemicals Ltd (HPL) is the medium sized petrochemical company in the eastern zone of India concentrating on is naphtha based petrochemical products. It is located at the port city of Haldia in West Bengal, India. It is a Joint Venture project having the Government of West Bengal, The Chatterjee Group, and the TATAs with the Indian Oil Corporation, etc. as major stakeholders with an investment of Rs 5,864 crores. HPL is the second largest petrochemical company in India with a total capacity equivalent to 7,00,000 TPA of ethylene. Process technologies for various manufacturing plants have been selected from internationally renowned vendors from Japan, United States of America, Germany, Italy and South Korea. Business Overview The main products produced are- High Density Polyethylene Linear Low Density Polyethylene Polypropylene Chemicals like Benzene, Butadiene, Cyclopentane, C4 Hydrogenated LPG, Pyrolysis Gasoline and Carbon Black Feedstock . Key Financial The key financial data as per the company’s annual report is presented below. Financial data only up to FY2009 is available. Ratios2006-072007-082008-09AverageNet Sales70873.773638.672771.8372428.043Operating Profit135068516.22967.798329.9967PAT58132786-2813.481928.5067Fixed Assets50624.07NANA50624.07RoS0.030.04-0.040.01RoA1.4NANA1.4RoCE21.83NANA21.83 Strategy Analysis This chapter presents the strategy analysis based on our understanding, alternatives, assumptions and their evaluations and key recommendations for the Haldia Petrochemicals. Current State - Our Understanding The petrochemicals industry is expected to witness a massive expansion in capacity over the next 5 years, with nearly 26-27 million tonnes ethylene likely to be added globally. The Middle East will account for a major share (51 percent) of the planned additions. It is expected that low cost ethylene capacities in this region will commence operations by 2010. North America and Western Europe, conversely, are expected to lose their share in global capacity, primarily due to higher feedstock costs. Consequently, these regions are likely to witness plant shutdowns (old and inefficient units) of around 10 million tonnes. As a result, the Middle East will emerge as a supply hub by 2010 or 2011, replacing the dominance of North America and Western Europe over the petrochemicals export market. Consequently, operating rates of petrochemical players are expected to come down to 80% in 2009 and 2010 from an average 87% in 2008. The trough is expected to prevail throughout the year, as most planned capacities will come on stream in 2010. Capacity additions of around 13 million tonnes are expected to come on stream in Middle East during 2009 to 2013. Abundant availability of low cost natural gas has played a pivotal role in the petrochemical industry’s speedy development in the Middle East. Moreover, the Middle East government is offering incentives in the form of subsidized ethane, low-priced land and low cost power and utilities, there by, giving advantage to the players. Asia will register the second largest addition of capacity (46%) between 2009 & 2014. Of this, China alone is expected to add 32%. A rapidly expanding economy and growing exports of finished goods have resulted in an extremely strong derivative market for ethylene in China. As a result, China’s ethylene demand is expected to grow at a CAGR of around 12% between 2008 and 2013. Petrochemical industry is a globally integrated industry now. Demand and supply fluctuations in one part of the world have far reaching impact on prices across the globe. New capacities coming up in Asia and Middle East are expected to increase global petrochemical supply. With competition poised to increase from global suppliers, especially the Middle East, it is important to evaluate the competitiveness of Indian petrochemical industry. Factors like availability of feedstock, economies of scale, government policies and size of domestic market impact the competitiveness of Indian petrochemical industry. On most counts Indian petrochemical companies are at a disadvantage as compared to companies from Middle East. However Indian companies enjoy the advantage of huge domestic demand and high demand growth rate. The strategy of Haldia petrochemicals needs to be in sync with these ground realities. Problem Statement ,[object Object],Industry Analysis - Porter's Five Forces Analysis The consolidated industry attractiveness of the polymer segment industry is presented below. The detailed analysis can be referred in the Appendix A. lldPEhdPEPPBdBzWeightRivalry among competitors5443230%Barriers to exit222225%Barriers to entry444445%Threat of substitutes432535%Existence of complementsNANANANANANAPower of buyers4444410%Power of suppliers4444425%Government action2222220% Overall Attractiveness3.83.453.43.252.85 Comparative Financial Analysis The comparative analysis of financial performance of Haldia Petrochemicals with key domestic competitors is presented below. The two key competitors are- Reliance Petroleum GAIL Petrochemicals The above figure shows that there is a dip in the operating profit, unusual compared to the other players who are comparatively stable. This could be attributed to the cost overruns that Haldia is going through due to its Supermax project, their internal problems leading to shutdown of work for sometime during the year. Adding to this, the imposition of import duty on Naphtha has reduced the import duty protection available to the company. The above figure shows that HPL operates with the least operating margin. The figure shows the three year average values of RoS of the three players. The above figure shows that HPL has the best technology strategy as shown by their highest RoA ratio. The figure shows the three year average values of RoA of the three players. The figure shows the three year average values of RoCE of the three players. The figure shows the three year values of RoS of the three players. The figure shows the three year values of RoA of the three players. The above figure depicts the RoE versus market share positions of Haldia petrochemicals (HPL) and the petrochemical divisions of GAIL and RIL. We have assumed market risk (beta) equal to 1. Considering the number of players and the size of the share each of these players have, all of these three players could be classified as broad players. Thus the curve which usually accompanies this graph also depicts the ‘focus’ ed players are not shown. None of these players are stuck in the middle and over the years, on an average, they seem to be delivering returns (RoE) more than the cost of equity capital. Product Mix Product nameBdBzhdPElldPEPPIndustry(2007)Demand98,8715,19,31012,08,0548,30,77618,03,913Supply2,47,7509,05,33411,08,1006,77,15817,80,000capacity2,95,00011,72,54012,35,0006,45,00020,00,000Demand/ Supply0.390.571.091.221.01Haldia(2007)capacity (MT)82,00085,0003,00,0002,60,0003,00,000Production(MT)68,2471,02,6512,39,3683,11,9012,75,875Capacity share0.280.070.240.400.15Production share0.280.110.220.460.15 The BCG Product portfolio analysis using is presented below. The Polymer segment (lldPE and hdPE) are the *star* performers with high growth products and high market share. The basic petrochemical product Butadiene is a *cash cow* for Haldia with high market share but low growth. Market shareMarket growthLinear Low Density Polyethylene (lldPE)High Density Polyethylene (hdPE)Polypropylene (PP)Butadiene (Bd)Benzene (Bz) Strength and Weaknesses - SWOT Analysis The SWOT analysis for Haldia Petrochemicals is presented below. Propose Alternatives & Evaluations Alternative 1 : Backward Integration HPL is the only major petrochemical plant that does not produce its own feedstock (naphtha). This has resulted in HPL being forced to import naphtha from Middle East. The fact that competitors are co-located with refineries and hence are able to avoid the transportation cost results in HPL being at a disadvantage. So, HPL should enter the refinery segment to secure their naphtha supply. Pros: Gives HPL competitive parity with other players in India. Removes dependency on external sources of supplies and as a result avoid fluctuations in their production and in turn are better able to meet their customer commitments Helps achieve economies of scale and compete more effectively with RIL and more importantly with companies from Middle East. Govt. provides incentives to companies that are in backward regions. Eastern region and WB fits into this category and as a result they will be able to get substantial incentives from the govt. Located near a port and as a result they have a huge location advantage. Cons: HPL has over 3000 Cr of debt and as a result there is no cash to fund the project that required Over 4000 Cr. The Chatterjee group and Govt. of WB is involved in a bitter battle for control of the board and as a result such a big decision will be difficult to get through Government of WB has a bad Image with investors and going the Equity way can be a challenge. Other players are adding substantial capacity in oil refinery. Verdict: HPL needs to give this option a serious thought given the current and future naphtha availability. This seems to be a required strategy to sustain the competitive advantage. Alternative 2 : Disinvest Sell the stakes to a player who will be in a better position to source naphtha. Pros: IOC has a refinery near HPL plant but does not have an associated Petrochemical plant. IOC might be genuinely interested in increasing its stake from existing 9% to majority stake. Reliance has no presence in eastern India and this can be a good target for acquisition to serve the eastern markets. Chatterjee group and/or Government of Bengal can see this as an opportunity to move out of the nasty battle for control of HPL. Govt of WB will generate around 4000 corers from disinvesting its stake and the money can be used for other development projects. Cons: The market for petrochemical products is limited in eastern India and this might deter investors. Gas based petrochemical are more cost effective and efficient and this can go against HPL. HPL has been showing losses for 2 years now and situation will not change for next 2 years. This might result in a bad deal for HPL if it is disinvested now. Verdict: This seems to be a viable option but given the current political will in West Bengal this option will see the light of the day and hence is not being considered. Alternative 3 : Tie up with Oil refineries in Eastern region for Supply of naphtha HPL sources most of its naphtha via Imports as there is limited availability of naphtha in the eastern region of India. The cost of transporting naphtha via land from far flung areas is not cost effective. It is actually cheaper to import naphtha via sea than to source it from far flung areas of India. There is an IOC refinery near the Haldia petrochemical plant but it is only able to supply a part of the naphtha requirement of HPL. There is another IOC refinery coming up in Paradip(Orissa, India) The only issue being that IOC Paradip refinery is also setting up an Integrated petrochemical plant collocated with the Paradip refinery. Pros: The imports are subject to changing Govt. excise duty from time to time. Having a local source of naphtha will help to maintain more stable margins. There is a planned capacity expansion of petrochemical plants in Middle East and this might impact the supply of naphtha from middle east in Long term. Or naphtha may be available at higher prices. So it’s more logical to source naphtha from reliable domestic sources. Cons: Local refineries are dependent on imported oil. Any disruption to supply of oil will impact naphtha supply to HPL. In absence of Govt. duty importing naphtha will be at least 10 % cheaper than sourcing naphtha from domestic sources. Signing long term contract with domestic firms might delay the realization of the benefits coming from importing naphtha. Verdict: Again this is a viable option that will help HPL tide over the problem of naphtha supply. But this option is not the preferred option as compared to backward integration. IOC is the only refinery in the eastern region and they are setting up their own petrochemical plants. This will bring tem In direct competition with HPL and conflict of interest can cast shadow On long term supply of naphtha. Alternative 4 : Forward Integration Pros: It is relatively easy to set up forward integration in for petrochemical industries. (Also there are number of options to choose from). Will shield HPL from a scenario where Excise duty on Import of Petrochemical will be lifted Will be able to achieve greater profit margins and be less venerable to price fluctuations of naphtha. Cons: HPL has no funds to invest in such a venture. Being in an oligopolistic market they are as of now not facing an issue of severe competition. In absence of backward integration HPL will potentially keep on sourcing naphtha at a higher price and the end product generated from forward integration might not be cost effective. Verdict: If HPL forward integrates it will enter into a business Line that will potentially require it to deal with non business customers directly. B2C marketing and dealing has not been an area of expertise of HPL. HPL has been primarily a B2B player. Also learning curve required is pretty steep thereby increasing the risk. Alternative 5 : Setup/Alter the plant to be gas-based HPL bought the stake of L&T in HPLCL for Rs. 1.80 billion in April 2008. With this buyout, HPL acquired full ownership of the power utility arm. The residual fuel gas which is a by-product of Naphtha cracker of HPLCL’s power plant can be used as the raw material in petrochemical plants. HPL has to incur some capital expenditure to modify its plant to use the residual fuel gas in lieu of Naphtha. Pros: This would result in savings on account of reduced naphtha purchase as well as enhanced operational efficiency estimated at Rs. 1.50 billion per annum on account of the project. Cons: Initial capital expenditure of Rs. 0.25 billion towards the conversion of the power plant. There are no gas resources in eastern India and gas is more expensive and difficult to transport. It is kind of an industry norm to set up gas based plant closed to the source of gas. Verdict: After weighing the Pros and cons This option Does not offer cost advantage and hence should not be considered. Alternative 6 : Increase capacity for polymers As per the Porter’s analysis for market attractiveness polymers, especially lldPE and hdPE, are scoring high. There is also a deficit of supply of these polymers in India as per the demand and capacity forecast. It is definitely an opportunity for Petrochemical firms to spike up production capability for this segment. There is a total industry deficit of around 3,00,000 tonnes of polymers and 6,00,000 tonnes of production capacity. The recommendation is to add approximately 2,00,000 tonnes of capacity for these items. Pros: HPL is already a strong player in the production of these polymers so its just a matter of increasing the capacity. Naphtha based processes produce larger quantities of basic petrochemicals required for production of these polymers. HPL being one of the three major naphtha based petrochemical is ideally suited to increase the p[production of these polymers. There is a strong domestic demand for these polymers. Cons: If Reliance and GAIL also add capacity then there will be a situation of surplus in the market and the price of polymers will fall down thereby impacting the margins. Verdict: This is the most straight forward and least risky option to pursue. Given The existing deficit in the market and the strong position of HPL in those products this is the preferred choice. Recommendation and Implementation Plan This chapter presents the recommendation and the implementation plan for the same. Recommended Strategy The recommended strategy for Haldia Petrochemical is to continue with the *Cost Leadership*. This is recommended considering the following reasons - Growth - Polymer and Capacity: The forecasts present promising growth numbers for both basic petrochemicals and polymers. Since our study is focused on polymers, the reasons are in context of polymers. Approximately 3,00,000 tonnes of domestic polymer demand and approximately 6,00,000 of deficit capacity exists in industry. To tap this growth, Haldia needs to expand its capacity. Sustainability and Competitive Advantage: HPL has is the only major Petrochemical Company ion India that is not backward integrated. There have been numerous instances where HPL management has been quoted as saying that HPL has been forced to Import naphtha as they are not been able to source naphtha from India. This is also resulting in irregular supplies and also HPL ends up paying more for naphtha as compared to other backward Integrated Companies in India. Fortunately for Haldia the oil industry has been deregulated in India and as a result the prices in India are following the global prices more or less. Also the naphtha prices are 10 to 15 % cheaper internationally as compared to India. After the customs and excise duty there is not much difference. But this is the situation today. Govt recently imposed a 5% customs on Naphtha and thus has a direct impact on HPL margins. This is reflected in their operating margins as we saw earlier in the report. Also HPLS suppliers in Middle East are also planning to set up Petrochemical units in Middle East. This will potentially result in HPL getting the second priority for the Naphtha and might end up paying substantially higher for it or end up sourcing it from Latin America or Africa and thereby incurring huge transportation cost. If this happens HPL will no longer remain competitive in most of the products and might be forced to limit itself to niche markets. Clearly they need to get self reliant if they dont want their market share to shrink drastically. The capital expenditure for setting up a refinery of medium size will be around a billion Dollar. The current debt situation Does not allow HPL to go to banks and seek money (even Though Their rating is A1). The option left to them is to either float debentures or raise money via equity. They can take a mixed approach for funding by striking a balance between debentures and Equity. The existing size of HPL will easily allow it to raise over a billion USD from the market Out of the various alternatives proposed and analyzed from the feasibility perspective, we propose the following plan for Haldia Petrochemicals – Medium Term - Capacity Expansion (Refer chapter 5, section 5.3.6) Long Term – Backward Integration (Refer chapter 5, section 5.3.1) Timelines and Cost Implications The timelines and the cost implication for implementing the recommended alternatives are mentioned below. #AlternativeTimelinesCost/Budget1Medium Term – Capacity ExpansionAprox. 4 -5 yearINR. 800 crores2Long Term – Backward IntegrationApprox. 5 – 10 years in stagesINR. 4K-6Kcrores Assumptions The timelines and cost budget are based on the estimated presented in the CRISIL report. Contingency Plan Alternative 3 “Tie up with Oil refineries in Eastern region for supply of naphtha” is a viable alternative to fall to If the proposed alternatives do not work out. The big advantage with this is that IOC already has 9% stake in HPL and hence exercising this option will not be a great challenge. References The source of the data (current and forecast) and other relevant information in this study has been selectively taken from the following public websites and databases. http://www.marketresearch.com/ http://business.mapsofindia.com/petrochemical/ CRISIL : www.crisil.com Capitaline database: www.capitalline.com ICRA : www.icra.in Haldia Petrochemicals website : www.haldiapetrochemicals.com Appendix A The Porter’s five forces analysis for the Polymer’s segment is presented below. AttributesProductAttractivenessRatingRemarksRivalry among competitorslldPE5ProsOnly three domestic players – GAIL, Reliance & HaldiaDemand is increasing very rapidlyCapacity not able to catch up with demandZero or negative excess capacityGrowing usage is extrusion CAGR more than 15%ConshdPE4ProsOnly three domestic players – GAIL, Reliance & HaldiaDemand is increasing rapidlyCapacity not able to catch up with demandZero or negative excess capacityConsPP4ProsHaldia & Reliance are the only producersPolypropylene is increasingly adopted as a substitute to Polystyrene.ConsDemand is not increasing at the same speed as capacity Bd3ProsReliance & Haldia are the only producersDemand expected to go up at CAGR 15% due to the SBR plant being setup by Reliance & Bhansali engineeringInternational cracker operators have not set up butadiene extraction units owing to the lack of adequate demand for butadiene derivatives. As a result, the existing supply is limited.ConsThere is twice as much capacity as the current demand.Reliance is setting up a new butadiene plant for its consumption.Bz2Pros4 firm concentration ratio is close to 80%ConsDemand is stagnant. High excess capacity in the industry.Barriers to ExitlldPE2ConsHigh asset specializationHigh cost of exitStringent labor restrictions for closing down plants.hdPEPPBdBzBarriers to EntrylldPE4ProsVery high economies of scaleLow product differentiationVery high capital requirementSuperior technologyHigh government protectionConsNaphtha – the main raw material required is being imported. Thus it exposes Haldia to global price fluctuations.hdPEPPBdBzThreat of substituteslldPE4ProsThere are no economic substitutes for llDPE in the vast majority of applications in which it is used.hdPE3ProsThe substitutes are not economical.Industry profitability of the substitutes are very low.ConsIn water ducts, substitutes are concrete and steel.PP2 ProsPolystyrene is a reasonable substitute of PP.ConsJute and sisal are close substitutes of PP.The natural fiber substitutes are cheaper.Speed of adjustment to new equilibrium price level is high for PP vis-à-vis the natural substitutes.Bd5 ProsNo substitutes known.Bz3ConsToluene which is a substitute is less toxic and has a wider liquid range.Existence of complementslldPENAInformation not available.hdPENAInformation not available.PPNAInformation not available.BdNAInformation not available.BzNAInformation not available.Power of buyerslldPE4 ProsDue to high land transportation costs buyers have to rely on the regional producers.The demand is much higher than supply or capacity for lldpe and hdpe.Globally many petrochemical companies are closing down due to obsolete technology.ConsThe landed costs for exporters such as Exxon Mobil and Shell have been close to 5% less than the domestic prices.hdPEPPBdBzPower of supplierslldPE4 ProsThere is a huge oversupply of Naphtha.The price of crude has slipped and consequently the Naphtha prices too have come down.India itself is a Naphtha-surplus country.ConsIncreased consumption coming from China may increase the Naphtha prices in the long run.hdPEPPBdBzGovernment actionlldPE2 Pros ConsGovernment imposed 5% import duty on Naphtha.HPL is totally dependent on Naphtha when compared to other refineries which are gas based.Government signed a comprehensive economic co-operation agreement with Singapore which attracts zero-duty tariff on polymer imports. This facilitates international majors penetrating into Haldia’s share of the market.hdPEPPBdBzhdPEPPBdBz

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