Driving around Sasol’s Lake Charles Chemicals Project (LCCP) site in Lake Charles, about 225km east of Houston, it is easier to swallow the massive cost overruns and delays on the project, which have led to much criticism from analysts and fund managers.
The scale and complexity of the complex, which will include a 1.5m-ton-per-year ethane cracker (used to produce ethylene, the key building block to produce a range of chemicals), and six downstream chemical production facilities, is simply mind-boggling. About 4 400 construction workers are currently on site, and as of September more than 17 250 piles had been installed, nearly 70% of the total required.
At the time of the visit early in October, construction was about 15% complete, although the project overall (including engineering work and the purchase of equipment) stood at just over 50% completion. To date, about $5bn has been spent.
Originally estimated to cost between $7bn and $9bn when the project was first announced in 2012, the final cost estimate on which the investment decision was made in 2014 was $8.9bn. The estimated cost has since ballooned by another 24% to $11bn (Sasol’s current market capitalisation is $18.4bn), partly due to higher-than-expected site and civil costs, increasing contractor and labour costs and an exceptionally wet rainy season. Sasol’s executives are confident that there will be no further delays or cost overruns, and the first unit is expected to be operational in the second half of 2018.
Not everyone is convinced, however. “Further cost overruns remain a concern, given the scale of the project and the fact that they’re only 50% complete,” says one Johannesburg-based analyst who wished to remain anonymous. “If you’ve ever built a house, you’ll know how hard it is to stick to a budget.”
A second analyst, from an international investment bank, says questions remain as to how wise it was for Sasol to undertake such a large-scale project, rather than for example adding capacity to produce value-added chemicals from its existing cracker at Lake Charles.
“The thing with Sasol is – they are the smartest guys in the room. Are they trying to overcomplicate things, or maybe trying to do too much?”
For analysts and investors, the concern is the expected returns shareholders will earn from the project. With the latest cost increase, the expected return still beats Sasol’s weighted average cost of capital of 8% in the US, but is below its target for new investments of 10.4% returns in dollar terms.
The estimated returns, of course, depend on a number of factors, including the final cost of the project, the cost of feedstock, and the prices it can command for its products once supply comes online. While the US is sitting with a glut of natural gas and natural gas liquids at the moment, leading to depressed prices, Sasol has not been the only chemicals company to spot the opportunity to benefit from cheap feedstock.
“As projects ramp up, the excess natural gas will disappear and things will normalise,” the second analyst says.
Sasol has made provision for this in its financial models, saying it expects ethane demand to increase significantly in the next five years due to increased domestic demand and exports. Initially it also expects a glut of ethylene in the US market from the 2019 to 2021 financial years, which will weigh on prices from the 2019 to 2022 financial years. Polyethylene, another product and key input in the production of plastics, is also expected to be in oversupply in the short term, though prices are expected to rebound by 2020, it said.
Sasol sees its competitive advantage on the performance chemicals side, where it will produce a much wider range of specialty products than its competitors – in part thanks to its unique Ziegler and Guerbet alcohol technologies – and where it believes it can command higher margins.
But this market is “quite opaque”, making it very difficult to do price estimates, the first analyst says. “We won’t know [how accurate Sasol’s predictions are] until we get there.”
Milking the cash cow
As Sasol has taken on some $4bn of debt to fund the LCCP, analysts will also keep a close eye on production levels at its main cash cow – its Synfuels operations in Secunda, which recorded record production volumes in the year to end June – and the rand oil price. A substantial deterioration in either, which seems unlikely at the moment, could lead the group to breach its debt covenants, or force cuts in the dividend.
“In terms of our plans for Secunda – it’s really the heart of our company, and we’ll continue to try to find ways to make it as beneficial for all the stakeholders – shareholders, employees, communities, government – as we can,” says Steve Cornell, joint CEO of Sasol.
“Secunda is operating very well, but any difficulties there will weigh on the group’s financial performance,” the second analyst said. “The concern is where are the key skills: are they in SA, looking after Secunda, or are they in the US building Lake Charles?”
Another question is whether Sasol’s restructuring – Project Phoenix, which led to substantial job cuts – and cost savings plans to deal with the lower oil price environment, “has cut skills too close to the bone or not”, the first analyst says. Cash savings to the end of June total R37.1bn, and Sasol is targeting total sustainable cost savings of R7.9bn from the 2019 financial year.
If the analysts can be believed, it’s worth taking the gamble: of eight analysts polled by INET BFA, five rate the stock a buy, one a hold and two a sell.
The writer visited the LCCP as a guest of Sasol.
This is a shortened version of an article that originally appeared in the 27 October edition of finweek. Buy and download the magazine here.