Global Insight Perspective
The unilateral last-minute withdrawal by the Kuwaitis from the K-Dow joint venture (JV) signals a new phase in the tug-of-war between the Kuwaiti parliament and the government about who has the power over the hydrocarbon sector, as parliament has managed to scupper the deal.
K-Dow would have given Dow Chemical increased access to cheap feedstock, while offering PIC access to advanced technology and growth potential. While market fundamentals underpinning the deal had changed with the global crisis, the fear that parliamentary criticism against the deal could delay or hinder the formation of a new Kuwaiti cabinet is the main reason why the government retracted its support.
The way in which the deal has been broken is likely to exacerbate financial costs and problems for Dow Chemical in the current climate and raise its determination to seek legal compensation, while Kuwait's downstream sector is likely to be seen as completely politicised going forward, causing it to lose out on the thick stream of long-term foreign investment in the petrochemical sector.
Left at the Altar
The decision to break off Petrochemical Industries Company (PIC)'s involvement in the K-Dow joint venture (JV) with U.S. petrochemical giant Dow Chemical in the middle of the recent holiday season struck the U.S. player like a bolt from the blue. Kuwait's Supreme Petroleum Council (SPC) on 28 December decided to cancel the US$17.4-billion deal (see Kuwait: 30 December 2008: Kuwait Scraps Planned US$17.4-bil. Petrochemical JV with Dow Chemical). Indeed, the deal seems to have fallen victim to internal political dealmaking in Kuwait, as the SPC—nominally a technocratic body under government control that sets oil policies—has usually been kept free of parliamentary influence in the tug-of-war between parliament and the royal-family-controlled government over the control of the country's hydrocarbons sector. Signs that parliamentarians were ready to use criticism against alleged overpricing and the taking-over of indebted assets as a way to frustrate the formation of a new cabinet seem to have convinced the royal family to tell SPC to drop the deal in order to remove an obstacle from the political process, in the course setting a dangerous precedent of parliamentary competence to decide on individual investment deals involving foreign partners.
K-Dow was expected to get off to a flying start, taking over several assets from Dow Chemical and PIC that would immediately give it annual sales of around US$11 billion, rising to a yearly revenue of around US$15 billion after the inclusion of the two existing Dow–PIC JVs: ethylene glycol producer MEGlobal; and PET resin supplier Equipolymers. In total, K-Dow was expected to become one of the largest actors in the petrochemicals and plastics fields globally, as soon as it was launched, with production mainly of polyethylene, ethanolamines, polypropylene, and polycarbonate. The 50:50 JV would have given Dow Chemical access to cheap domestic Kuwaiti feedstock prices, while allowing PIC to access growth and advanced technologies, as well as new markets, by pitching US$7.5 billion into the new company.
With the K-Dow deal having been presented as early as December 2007, the mega-project was long in the planning, and the launch of the JV company was set for 2 January this year. The advanced state of the planning means that Dow Chemical has already sunk significant amounts of money into the venture, while also basing other strategic actions on it—including the US$15.3-billion acquisition of U.S. specialist chemical materials manufacturer Rohm and Haas in July, which was to a large extent supposed to be financed by the PIC's injection of funds and asset takeovers through the K-Dow deal.
Dow's position is further complicated by the twofold impact of a harsher economic climate: they are going to have greater difficulty in attempting to refinance the acquisition, while large parts of the company's production have lost the access to cheap Kuwaiti feedstock they were expecting in the immediate future. In addition, the suspension of the deal had almost immediate negative financial consequences, as several international rating agencies downgraded the company's credit rating in the early days of January and flagged the company for further possible downward revisions going forward.
Return the Ring, Please
Dow Chemical last week reacted to the break-off by saying that it was preparing legal action, accusing PIC of being in breach of contract. The U.S. player maintains that the JV agreement provides for a break-up fee of US$2.5 billion, with Dow Chemical chief executive Andrew Liveris telling Reuters that his company would seek compensation for "damages over and above that amount". The threat immediately provoked a retort from Kuwait's Commerce and Industry Minister Ahmad Bagar, saying that his country will take all necessary measures to defend itself and counter Dow's claims (see Kuwait: 8 January 2009: Kuwait Prepares to Defend Pullout from Dow Chemical Venture). Aside from the expected investment by PIC into the JV in exchange for the superior technology of the Dow Chemical operations, a US$1-billion investment by Kuwait's Investment Authority (KIA) was also expected into Dow Chemical itself, supporting its Rohm and Haas acquisition.
While not lethal to Dow's long-term Middle East and North Africa (MENA) strategy, the loss of faith—as a consequence of the last-minute jilt—between the partners is likely to make Dow Chemical shun further co-operation with PIC and instead focus on what can be salvaged through legal proceedings or an out-of-court settlement.
Caught on the Rebound?
Being involved in several other MENA-region projects, Liveris said last week that "We have already been contacted by other interested parties and have begun discussions", according to Greenwire, adding that a new deal "can be done in an accelerated timeline due to the considerable groundwork that has already been established in anticipation of the K-Dow joint venture". Nevertheless, even if new talks are entered into relatively soon, it is hard to see a deal of such scale close without a large part of the year passing by, with all the negative financial consequences of the break-up having to be borne by Dow Chemical alone in the meantime.
Outlook and Implications
The criticism against the K-Dow JV from Kuwaiti parliamentarians was initially centred on the falling world demand for its products and the fact that the assets that were part of the deal had been valued during the first half of 2008, at the peak of a long boom-and-bust cycle. Dow Chemical, however, swiftly agreed to a revaluation of the assets, lowering the value of the deal from the initial US$19 billion by about 8% to US$17.4 billion. Nevertheless criticism persisted against what was seen as a state-owned company's requirement to take on assets at an inflated price, including some debt, Kuwaiti media reported. Under the deal, PIC was required to raise US$7.5 billion—US$4.5 billion through a capital increase and US$3 billion from international banks—while KIA also was expected to invest straight into Dow Chemical to underpin the deal.
The fact that Dow Chemical would have been allowed to lift significant amounts of funding from the deal itself—in order to pay down its debt and finance the Rohm and Haas acquisition—was also suggested by some to be akin to a Kuwaiti acquisition at the height of the market. At the core of the problem, however, is likely to be some parliamentarians' decision to use this issue to press the future cabinet and possibly even frustrate its formation, no doubt egged on by certain factions of the fractured al-Sabah ruling family, which feel they have lost out on their access to government influence over the past decade (see Kuwait: 24 December 2008: Kuwait's Oil Industry Development Approaches Standstill as Political Paralysis Deepens).Whatever the domestic gain for some factions from this, Kuwait's economy is bound to suffer further. Dow Chemical could even, over the long term, mull a divestment of its existing Kuwaiti JVs, while other potential investors—especially in the downstream sector—are likely to also shun Kuwait because of the perceived spiralling politicisation of individual deals. Western and Asian petrochemical companies will continue to seek access to cheap feedstock in the MENA region, in order both to strengthen their margins and match the competitive advantage of the region's state-owned companies, but after this tough break-up, Kuwait has squarely placed itself outside of the thick stream of investment into petrochemicals in the wider region.