UAE Chemical Report

United Arab Emirates

©

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United Arab EmiratesChemicalsReport Q2 2006Including 4-year industry forecasts by BMI

Part of BMI's Industry Survey & Forecasts Series

Published by: Business Monitor International

Publication Date: May 2006

United Arab Emirates Chemicals Report Q2 2006

© Business Monitor International Ltd Page 2



Contents

Executive Summary .........................................................................................................................................5

Market Overview ................................................................................................................................................................................................... 5

Industry Developments .......................................................................................................................................................................................... 5

Regulatory Developments ...................................................................................................................................................................................... 5

UAE’s Plastics Sector............................................................................................................................................................................................ 5

UAE Chemicals Industry SWOT ............................................................................................................................................................................ 6

UAE Economic SWOT ........................................................................................................................................................................................... 7

UAE Business Environment SWOT........................................................................................................................................................................ 8

Market Overview...............................................................................................................................................9

Table: Investment in UAE Chemicals Industry (US$mn) ....................................................................................................................................... 9

Table: Fertiliser Production Plants in UAE ........................................................................................................................................................ 10

Industry Forecast Scenario...........................................................................................................................11

Table: Urea Capacity in Arab/Persian Gulf Region (in thousand tonnes)........................................................................................................... 12

Plastics Industry .................................................................................................................................................................................................. 12

Table: UAE Polymers Capacity (000 tonnes annual average)............................................................................................................................. 13

Plastic Imports, Exports And Re-exports ............................................................................................................................................................. 13

Plastics Growth And Outlook .............................................................................................................................................................................. 13

Industry Trends And Developments ............................................................................................................15

Business Environment.......................................................................................................................................................................................... 15

Regulatory Developments .................................................................................................................................................................................... 15

Industry Developments ........................................................................................................................................................................................ 16

Macroeconomic Forecast ..............................................................................................................................19

Success Confirmed............................................................................................................................................................................................... 19

Doors Still Open For Expat Workers................................................................................................................................................................... 19

Hydrocarbons: Going For Growth ...................................................................................................................................................................... 20

Table: Macroeconomic Data & Forecasts........................................................................................................................................................... 21

Company Monitor...........................................................................................................................................22

Ruwais Fertiliser Industries................................................................................................................................................................................. 22

Abu Dhabi Polymers Company (Borouge)........................................................................................................................................................... 24

BMI Forecast Modelling.................................................................................................................................25

How we generate our industry forecasts................................................................................................................................................................... 25

Chemicals Industry ................................................................................................................................................................................................... 26

Cross checks ............................................................................................................................................................................................................. 27

Appendix A: Global Economic Assumptions..............................................................................................28

Introduction ......................................................................................................................................................................................................... 28

The World Economy ............................................................................................................................................................................................ 28

Global Assumptions ............................................................................................................................................................................................. 29

United States............................................................................................................................................................................................................. 30

Eurozone................................................................................................................................................................................................................... 31

Japan ........................................................................................................................................................................................................................ 32



China ........................................................................................................................................................................................................................ 33

Commodities ............................................................................................................................................................................................................. 34



Executive Summary

Market Overview

The United Arab Emirates (UAE) chemicals industry comprises chemicals, plastics and fertilisers. The

industry has seen rapid growth, especially on account of growth in the region’s construction industry,

which has been driving demand. Chemical fertiliser production began in the UAE with the establishment

of Ruwais Fertiliser Industries (Fertil). The complex, situated in the industrial zone at Ruwais in

western Abu Dhabi, comprises an integrated production unit, storage, packing and cargo units.

Industry Developments

Fertil outlined plans to expand its urea production in association with France-based Total. Total is

carrying out a detailed feasibility study for Fertil, which envisages additional urea production of 1.2mn

tonnes per annum (tpa). As reported in April 2006, UAE-based Abu Dhabi National Oil Company

(ADNOC) signed an agreement with Austria’s Agrolinz Melamine International (AMI) for the

construction of a new melamine plant in Ruwais. UAE-based Gulf Energy Maritime (GEM) inked a

US$90mn loan deal with UAE-based First Gulf Bank for purchase of high-specification, double-hulled

product/chemical tankers being built at the Hyundai Mipo Dockyard.

Regulatory Developments

Abu Dhabi Environmental Research and Wildlife Development Agency, along with the Federal

Environmental Agency and other concerned authorities, has laid down rules to prevent chemicals from

arriving in the country without a proper licence, and against the dumping of hazardous materials. It will

also now be mandatory for UAE-based chemical dealers to register with and report their activities to the

government.

UAE’s Plastics Sector

The Middle East is witnessing an expansion, both in production capacities as well as in consumption

levels of rubber, plastics and processed plastic products. In 2004, the plastic industry in the UAE had a

production capacity of 150,000 tonnes and employed more than 13,000 people. Over January-August

2005, the UAE imported about US$240.59mn worth of plastics and rubber products from China.



UAE Chemicals Industry SWOT

Strengths Strategic location provides access to new and emerging Asian markets,such as India and China

Availability of high-quality raw material helps in the production of basicchemicals

Weaknesses Logistics comprises one of the largest costs to the industry, with theaverage cost from plant to customer being 12% of the sales price

An extreme climate and a highly saline Arabian Gulf lead to highinvestments to offset the corrosion caused in the oil, gas, process andconstruction sectors

Opportunities Value of the cosmetics market in Dubai is over AED2bn (US$544.5mn) perannum and is expected to grow further due to rising demand

Increasing international urea prices are encouraging UAE to build new,world-scale plants

Threats Increases in oil and gas prices have affected stability in the chemicalsindustry and could lead to pressure on margins

Increasing competition from Russian industrial chemical industry



UAE Economic SWOT

Strengths The UAE is a member of the Gulf Cooperation Council (GCC), which is afree trade zone, and is targeting a common currency by 2010

The UAE has one of the most liberal trade regimes in the region, andattracts strong capital inflows from across the globe

In common with most Gulf states, there are a high number of expatriateworkers at all levels of the economy

The UAE has successfully diversified its economy, minimising itsvulnerability to oil price movements

The International Monetary Fund (IMF) ranked the UAE economy as thethird largest in the Middle East and Central Asian region, after Saudi Arabiaand Iran

Weaknesses The UAE’s main trading partners are other Gulf states, which increases thevulnerability of the non-oil sectors to oil price volatility

The state’s location in a volatile region means that its risk profile is, to someextent, affected by events elsewhere; US concerns about Iranian Weaponsof Mass Destruction (WMD) and Islamic terrorism could affect investorperceptions

Opportunities Oil prices are expected to stay high over the forecast period; economicdiversification into gas, tourism, financial services and high-tech industryoffers some protection against volatile oil prices

Driven by domestic and foreign investment, the construction, tourism andfinancial sectors are growing rapidly

Threats Heavy subsidies on utilities and agriculture, along with an outdated taxsystem, contribute to persistent fiscal deficits

There are fears that bubbles could be forming in the construction sector, andalso in the stock market



UAE Business Environment SWOT

Strengths The UAE, besides being a member of the GCC, a six-member free tradezone, has also been a member of the World Trade Organisation (WTO)since 1996

The State has invested large amounts in infrastructure The UAE’s diversified economy reduces risks

Weaknesses Due to the state’s federal nature, regulations are not identical across theEmirates

The regional economy is oil-dependent; this has historically been verycyclical which increases risks for long-term projects

Opportunities Large number of free trade zones offering tax holidays and full foreignownership

Comparatively relaxed rules on expatriate employment The UAE’s social stability and relative prosperity mean that there is far less

concern for security than in some other Gulf states

Threats The State is comparatively bureaucratic compared to its regional peers;strong oil prices have massively increased liquidity in the region and this hasresulted in strong financial flows – increasing risks that projects of lowerinvestment potential are currently being funded



Market Overview

The UAE chemicals industry comprises chemicals, petrochemicals, fertilisers, plastics and

pharmaceuticals segments. The chemicals industry in the UAE has seen rapid growth in the past few

years, especially on account of growth in the region’s construction industry, which has been driving

demand. Investment in the region's US$33bn petrochemical and chemical sectors is growing at 10-15%

annually. Main domestic chemicals suppliers/producers in the UAE are: Al Futaisi Group, Emirates

National Chemicals, Falcon Chemicals, Geco Chemical, Golden Emirates Industrial Services &

Trade, Oasis Chemicals, Kanoo Group, Lootah General Trading, M.H. Enterprises, House of

Chemicals, Nav Sachi International, Petrochem Middle East, Al Khowahir Chemicals Trading and

Fujairah Polymer.

Registered chemical manufacturing enterprises in the UAE totalled 589 by the end of 2005, which adds

up to 17% of the overall industrial enterprises in the UAE. The number of chemical facilities in operation

in 2004 was about 542.

Table: Investment in UAE Chemicals Industry (US$mn)

2000 2001 2002 2003

Manufacture of Chemicals & ChemicalsProducts 374 1276 1315 1401

Manufacture of Rubber and PlasticProducts 314 351 379 421

Source: Ministry of Finance, UAE

Abu Dhabi Fertiliser Industries’ AED5mn (US$1.36mn) chemicals fertiliser plant, having an annual

capacity of 200,000 tonnes, was built as a joint venture in June 1998 between the UAE-based

International Technical Trading Company (64% stake) and SQM of Chile (36% stake). The plant

produces 40,000tpa of fertiliser, mainly water soluble and granular compound products. The company has

a capacity of 200,000tpa and also produces liquid and suspension fertilisers.



Table: Fertiliser Production Plants in UAE

Company Name Products Capacity (tpa)

Ruwais FertilizerIndustries Ammonia

Urea Ammonia- 1,340

Urea-1,850

Union Kemira Water soluble compounds 20,000



UAE: Urea Exports by Destination 2003 (in 000

tonnes)95.9

34.3 33.4 31.7 26.8 27.3 24.1

0

20

40

60

80

100

120

US

A

Vie

tnam

Indi

a

Oth

ers

Sri

Lank

a

Afr

ica

Iran

Source: BMI research

Industry Forecast Scenario

In 1985, the chemicals sector in the UAE started with a small acetylene and calcium carbide plant at Jebel

Ali Free Zone Authority (JAFZA). Since then, Jebel Ali Free Zone (JAFZ) has become the centre for

UAE’s chemicals and petrochemicals industries. Today, plants in this free zone also produce polymer

resins, liquid industrial chemicals and polystyrene. The first phase of a liquid industrial chemicals storage

facility was completed in the second-half of 1995 by All Industrial Chemicals Group of Canada.

Chemicals fertiliser production began in the UAE with the establishment of Fertil. The complex, situated

in the industrial zone at Ruwais in western Abu Dhabi, comprises an integrated production unit, storage,

packing and cargo units.

There are many fertiliser manufacturing projects located in JAFZA. Dubai’s first fertiliser plant has been

onstream since 1990, and produces 6,000tpa of water-soluble compound fertilisers. It was built by Union

Kemira, a joint venture of the UAE’s Union Agricultural and the Finnish chemicals and fertiliser group

Kemira.



Table: Urea Capacity in Arab/Persian Gulf Region (in thousand tonnes)

Country 2000 2001 2002 2003 2004 2005e 2006f 2007f 2008f 2009f

UAE 227 227 227 227 227 227 410 410 410 410

Bahrain 258 258 258 258 258 258 258 258 258 258

Iran 812 812 812 812 812 1,350 1,350 1,350 1,350 1,350

Iraq 718 718 718 718 718 718 718 718 718 718

Kuwait 364 385 466 486 486 486 486 486 486 486

Oman - - - - - 380 1,294 1,294 1,294 1,294

Qatar 642 642 642 642 1,135 1,135 1,135 1,135 1,135 1,135

Saudi Arabia 1,203 1,203 1,203 1,203 1,203 1,203 1,749 1,749 1,749 1,749

Total 4,224 4,245 4,326 4,326 4,839 5,757 7,400 7,400 7,400 7,400

Source: IFA Survey of Urea Capacities and BMI Research

Plastics Industry

The Middle East is witnessing an expansion, both in production capacities as well as in consumption

levels of rubber, plastics and plastic processing. Substantial growth in the UAE's construction industry is

driving the demand for plastic products, especially pipes and fittings, which in turn, is driving the growth

of the plastics industry. The population growth has considerably increased the demand for houseware,

industrial and commercial containers made of plastics. Along with this, other industries, including

refrigeration, furniture and pharmaceutical industries, have also increased the use of various plastic

products as substitutes for metallic products.

The expansion of the non-oil economy has also increased the demand for plastic products. This has also

led to a growth in plastic production, which over time has reduced dependence on imports. The industry

expanded rapidly in the 1990s and continues to grow, slowly making inroads into the export sector,

particularly in the packaging segment.



Table: UAE Polymers Capacity (000 tonnes annual average)

2003 2004Additional Capacity (up to

2009)

HDPE 225 265 545

LLDPE 220 220 530

Ethylene 600 600 1050

Source: CIMA

Plastic Imports, Exports And Re-exports

Imported plastic products meet less than half of the demand for plastic products in the UAE. Imports of

pipes, tubes and related accessories for the construction industry are in particularly small quantities.

Meanwhile, imports of bags, sacks and films have also declined due to steadily increasing domestic

production. Import dependence is highest in the case of bottles, containers and miscellaneous products

such as toys and household goods. Demand volumes for such items are too small in the UAE to justify

domestic production. Over January-August 2005, the UAE imported about US$240.59mn worth of

plastics and rubber products from China.

While production is mostly for the domestic market, the UAE’s plastic industry also exports a significant

portion of its output, focusing on the Middle East region. Packaging products such as bags and containers

occupy a major portion of the plastic export basket. The UAE has also started manufacturing and

exporting some high-quality retail shopping bags, produced and printed locally, for the European markets.

There is a successful re-export trade in plastic products, and about 25% of the imports are re-exported.

The re-exports are spread over all categories; except for fibreglass products which have negligible re-

export value. Re-export is mainly concentrated on consumer plastic goods which are used in households,

such as bottles and containers. Meanwhile, virtually the entire imports of plastic bags and sacks (90%) are

meant for re-export.

Plastics Growth And Outlook

First initiated by the plastic building materials segment, growth in manufacturing is now led by the

packaging segment. Production and exports in the plastic industry have outpaced domestic demand as the



industry has grown on the strength of import substitution. Growth in the plastic industry has been led by

packaging related products, along with a noticeable decline in the net imports of plastic products and

materials.

The nation has a considerable potential for growth in the plastic industry due to the abundant availability

of feedstock. Development of a domestic petrochemicals industry is now gathering pace, which could

considerably enhance the growth of small and medium plastics enterprises.

A major growth opportunity for the plastic industry is expected to flow in from the export market. Large

volume plastic products, such as plastic pipes used in construction, are unlikely to grow beyond domestic

demand. However, packing products such as plasma bags, sheets, covers and strips have considerable

potential for being exported to several major world markets.



Industry Trends And Developments

Business Environment

Before 1984, the Emirates of Dubai, Abu Dhabi, Sharjah, Ajman, Ras Al Khaimah, Umm Al Quwain and

Fujairah followed their own individual procedures governing the operations of foreign business interests.

In 1984, the ‘Commercial Companies Law’ and its by-laws were issued. The law made it conditional that

nationals must wholly own the companies or that nationals must own at least 51% of the share capital,

while the remaining 49% may belong to foreigners. The government of UAE plays a supervisory role in

legislation and organises the functioning of the various economic sectors.

The first free-zone area, Jebel Ali in Dubai, was established in 1985. The success of this free zone led to

the development of ‘Free Zones’ in other Emirates. There are now more than 10 free zones in the UAE,

each governed by its own regulatory authority.

The UAE follows a liberal immigration policy reflecting the need for an expatriate workforce to operate

and develop a fast-growing economy. The majority of the resident UAE population is expatriate, and in

general, employers, particularly those located in a free zone, have minimal difficulty in sourcing labour

from the resident population.

Regulatory Developments

Abu Dhabi Environmental Research and Wildlife Development Agency, along with the Federal

Environmental Agency and other concerned authorities, has laid down rules to prevent chemicals from

arriving in the country without a proper licence, and against dumping of hazardous materials. The UAE

authorities have also decided to make it mandatory for UAE-based chemicals dealers to register and

report their activities to the government.

From 2005 onwards, under the provisions of the Trade Related Intellectual Property Rights (TRIPS)

agreement, the UAE is required to grant patent protection for agricultural chemicals and pharmaceutical

products.

The Abu Dhabi Industrial City (ADIC) was built by the UAE government to streamline industrial

development and to provide the necessary infrastructure. It covers an area of about 14km2 and is about

30km outside Abu Dhabi city. It has been designed to feature different types of industrial activities,

including food processing, textiles, wood furniture, engineering, plastics, chemicals and building

materials.



In March 2005, UAE and Australia concluded the first round of the free trade negotiations that are

expected to culminate in a free trade agreement (FTA) by the year 2006. In May 2005, it was reported

that UAE was also expected to sign a FTA with Singapore. An economic pact was inked between the two

nations earlier in 2005. The UAE was expected to offer investment opportunities for Singaporean

companies in JAFZA in various industries such as oil and gas, petrochemicals and construction.

In February 2005, JAFZA moved into the next level of diversification with the launch of South Zone, a

project for developing specific industry sectors through eight different clusters at an estimated cost of

about AED2bn (US$0.54bn). Facilities at this field are to include hazardous and non-hazardous waste

disposal and special water treatment covering 1mn m2.

Industry Developments

In April 2006, Fertil outlined plans to expand its urea production in association with Total. Total is

carrying out a detailed feasibility study for Fertil’s planned additional urea production of 1.2mn tpa. A

granulation plant is also to be built to supply the UAE market with granulated urea. Currently, Fertil has a

production capacity of 625,000tpa of urea and 450,000tpa of ammonia. The granulation plant is to be

completed by Q408 and the additional urea production of about 1.2mntpa is to come onstream in mid-

2010.

As reported in April 2006, GEM signed a US$90mn loan agreement with First Gulf Bank for high-

specification, double-hulled product/chemical tankers, being built at the Hyundai Mipo Dockyard. The

four 47,000 tonne double-hulled oil product and chemical tankers are likely to be delivered in 2008-2009.

On March 1 2006, the Gulf Petrochemicals and Chemicals Association (GPCA), a voluntary, Dubai-

based non-profit organisation, was launched. The association aims to encourage fair and free trade and

competition. GPCA is to primarily focus on plastics and intends to promote plastic products by

supporting industry innovations. Eight petrochemical makers, including Saudi Basic Industries

Corporation (Sabic), UAE-based Abu Dhabi Polymers Company (Borouge), Kuwait-based Equate,

Bahrain-based Gulf Petrochemical Industries, Kuwait’s Petrochemical Industries, Qatar

Petrochemical, Qatar Vinyls and Saudi Arabia’s National Industrialization Company (Tasnee) signed

a memorandum of understanding (MoU) at the launch of the association.

In February 2006, Chemstore FZCO, a joint venture between UAE-based Modern Freight Company

(MFC) and Horizon Terminals Limited (HTL), a wholly-owned subsidiary of Emirates National Oil

Company (ENOC), opened phase III of its JAFZ facility. Chemstore is a centre for hazardous chemicals,

with 8,000m2 of storage space, capacity for 36,000 drums, and with loading bays capable of handling up

to 30 trucks at any one time. Chemstore also accommodates various hazardous chemicals, drummed or



bagged and palletised or non-palletised, falling under the National Fire Protection Association (NFPA) 30

classifications IB, IC, II, IIIA and IIIB.

In January 2006, US-based Foster Wheeler signed a management services contract with Abu Dhabi Gas

Industries (Gasco) for the engineering, procurement and construction (EPC) phase of its Habshan Gas

Complex Expansion Project in Habshan, UAE. Foster Wheeler has completed front-end engineering

design and ECP contractor selection.

India-based JBF Industries outlined plans to build a US$84mn polyester polyethylene terephthalate

(PET) resin packaging chips plant in the UAE in a joint venture with UAE’s Ras Al Khaimah

Investment Authority, as reported in January 2006. The plans include the establishment of a complex

with a total installed polymerisation production capacity of 900tpa. The output will consist of 600tpa

single-stream processor (SSP) chips and 300tpa of polyester film. The produced material is to cater to the

large markets of the US, the EU and China.

As reported in December 2005, Emirates Float Glass (EFG), founded by Dubai Investments, signed

licence and construction agreements to establish a 600 tonne per day (tpd) float glass plant in the UAE.

US-based PPG Industries is expected to provide EFG with the technology services, process assessment

and product licensing rights. The float glass facility is likely to begin production in 2007.

Fertil outlined plans to double production at its existing urea plant. The expansion is expected to increase

the capacity to 2,700tpd from 1,500tpd. Of the total output, 800tpd is to be supplied to the Abu Dhabi

National Oil melamine plant, while 1,900tpd of granular urea is likely to be produced. The front end

engineering and design is likely to be completed by April 2006, while the EPC contract is expected to be

awarded by Q306. Project completion is scheduled by the end of 2008. However, the investment outlay

was not disclosed. Further, Fertil also plans to establish new ammonia and urea plants that are likely to be

operational by the beginning of 2009.

As reported in April 2006, ADNOC signed an agreement with Austria’s AMI for the construction of a

new melamine plant in Ruwais. The plant is to produce 80,000tpa of the petrochemical, which is to be

used to produce surface laminates and adhesives as well as other industrial and commercial products. The

project is likely to cost US$200mn and to be operational in Q109.

In October 2005, Ras Al Khaimah Ceramics reportedly formed a joint venture with Italy-based Smal

Tu Chemica. The joint venture, Chemica, is expected to be engaged in production, marketing and

distribution of chemicals used in ceramic production. Ras Al Khaimah Ceramics holds 55% of the joint

venture, with Smal Tu Chemica holding the balance.



Also in October 2005, Desmet Ballestra reported the installation of the first MiniLAB plant based on

UOP detal linear alkyl benzene (LAB) alkylation technology. The plant has reportedly started

commercial operations. The plant has been supplied by Desmet Ballestra to Emalab and has been

installed in JAFZ. It forms a part of the UOP and Desmet Ballestra’s joint development, focused on

making the installation of medium capacity LAB plants economically viable by serving regional markets

having insufficient LAB production.

In September 2005, US-based Nalco outlined plans to establish a US$2.5bn worth smelter at Abu Dhabi,

UAE. Earlier, in August 2005, it had outlined plans to build a 250,000-300,000tpa aluminium smelter in a

Gulf country by 2009-2010.

In September 2005, India-based Karnataka Agro Chemicals, a leading Indian organic fertiliser

manufacturer, outlined plans to expand operations in markets outside India. The plans include

establishment of a bio-fertiliser manufacturing plant in Dubai through a joint venture with the

Government of Dubai. The plant is expected to produce organic manure based on coir pith and is likely to

start operations in 2006. The Dubai government is expected to provide financial assistance to the project,

while Karnataka Agro Chemicals is likely to provide the ‘know-how’.

In September 2005, Oman Chemicals and Pharmaceuticals (OCP) outlined plans to establish a

US$200mn ammonia plant in the Hamriyah Free Zone Authority in Sharjah. The plant is expected to have

an annual production capacity of 400,000 tonnes and is likely to start operations by April 2007. OCP has

reportedly entered into a 25-year agreement with UAE-based Crescent Petroleum for the supply of

natural gas. It is likely to be charged US$1.50 per million British thermal units (btu) for the supply of

natural gas and is expected to export about 75% of the output. The plant is also expected to start

production of urea and other products including nitric acid, ammonium nitrate and ammonium phosphate

in 2008.

Also in September 2005, Dubai Aluminium (Dubal) and Indian engineering and construction major,

Larsen & Toubro (L&T) reportedly entered into a US$3.6bn joint venture deal for a two-phased bauxite

mining and alumina refinery project and smelter in Orissa, India. The agreement is being considered as

UAE’s largest foreign direct investment (FDI) in the industrial sector in India. The first phase is expected

to include a capacity of 1.5mn tonnes and is likely to cost US$1.1bn. The construction is expected to start

in 2007. The Gulf has been a major market for L&T’s engineering and construction expertise and has

been granted various orders for projects in the UAE.

In August 2005, Fertil reportedly granted a US$3mn project management contract to Australia-based

Worley Parsons. The contract includes a project to debottleneck Fertil’s 690,000tpa urea unit by

90,000tpa and to revamp its 350tpd carbon dioxide recovery unit in Abu Dhabi. Both the projects are

expected to be complete by the end of 2008.



Macroeconomic Forecast

Success Confirmed

Recent reports by the UAE Central Bank and the International Monetary Fund (IMF) confirm the strong

economic performance seen in the past year, and generally point towards a healthy future. Importantly,

attempts to diversify the economy are paying off and growth in the non-oil sector is looking good.

Meanwhile, ambitious plans have been unveiled boost oil output.

Though the weak dollar has taken some of the shine off the UAE’s economic performance, particularly in

the oil sector (the currency in which oil barrels are denominated), the depreciation of the dirham in real

terms is proving a boon for the other export-oriented sectors of the economy. The liberalisation of the

property market will also boost growth, by attracting FDI that will help to sustain the construction boom.

We estimate that GDP growth was 6.2% in 2005, and will be 4.3% this year, with an upside given the

evidence of the non-hydrocarbons sector’s robust performance.

Our GDP forecast assumes 5.5% non-oil growth in 2005, but risks are weighted to the upside owing to

the strong performance of manufacturing exports. The construction boom is also boosting non-oil growth,

and is likely to continue given the recent changes to property ownership laws. With no sign of a

slowdown to the construction boom, the non-oil sector’s growth is likely to match the prodigious

hydrocarbons sector this year, particularly if heightened flows of FDI can be maintained. Meanwhile, the

impressive export and re-export performance will be buttressed by continued strength of demand in

UAE’s main export markets.

Doors Still Open For Expat Workers

The rising UAE national unemployment rate has precipitated measures that have raised the costs

associated with hiring expatriate workers – whose value to the UAE’s economic competitiveness is

widely acknowledged. However, in a positive move, the UAE, unlike some other Gulf states, has avoided

the imposition of employment quotas. The authorities are as aware as anyone that the ‘open doors’ policy

is a critical component of the UAE’s competitive advantage.

In order to address the unemployment issue, the federal government has instituted a number of training

and job placement programmes targeted at the private sector – but these are unlikely to impose a

significant burden on businesses.

While the government has hiked up public sector wages for UAE nationals in recent months, the UAE’s

open-border foreign labour policy should continue to allow the private sector to recruit expatriate workers



at relatively low wages. Future reforms should aim at equalising benefits for nationals in the private and

public sectors.

Hydrocarbons: Going For Growth

With global oil markets unsated by recent OPEC quota increases, the UAE is moving ahead with plans to

raise crude production levels. Oil Minister Mohamed Dhaen al-Hamli told the September OPEC meeting

in Vienna that crude production would increase by 8% by Q106, to 2.7mn b/d. The 200,000b/d increase

would come in two increments – a 100,000b/d jump in Q405 and another hike in the succeeding quarter.

This will help to maintain the UAE’s spare capacity buffer, which stands at around 250,000b/d – one of

the highest in the cartel.

The increases will be sourced from production boosts at onshore fields. ADNOC says the development of

the New Dhabiya field will account for 100,000b/d of the planned increase, with 90,000 extra barrels

resulting from ongoing upgrades at the mature Bab field. Flushed with new investment funding as a result

of the rocketing oil revenues, which BMI expects to exceed US$40bn in 2005, ADNOC is in an

expansive mood. It is planning to increase output capacity from onshore fields to 1.8mn b/d, as part of an

effort to step up long-term production capacity to 3.5mn b/d. Offshore expansion plans envisage boosts to

the Umm Shaif and Lower Zakum fields by 130,000 b/d to a total of 600,000 b/d by end-2008. Another

200,000 b/d of increased production will come as a result of the increase in capacity at the Upper Zakum

field, which is jointly operated with US supermajor Exxon Mobil, taking production there to 750,000b/d.

ADNOC is spending more than US$2bn in order to maintain or increase production levels. A number of

projects to upgrade oilfield infrastructure are underway. Increases in the capacity of the onshore Bu Hasa

field will involve the construction of gas separation units, drilling of gas reinjection wells, and water

injection. One of the major focuses is to deal with a rising water cut in the oilfields, along with the

increased demand for gas reinjection. Many new projects aim at reinjecting gas and water into the

reservoir in an effort to maintain production.

The positive side-effect for the UAE is that these efforts will also help to boost production of gas, whether

in condensate or natural gas liquid form. There is a growing gas focus in the UAE, which is attempting to

make money from reserves estimated at 212 trillion cubic feet (tcf) – the world’s fifth largest. The

ongoing onshore gas development (OGD-3) and second phase expansion of the Asab Gas Development

(AGD-2) are the two major projects absorbing attention at the moment. The Asab expansion will result in

800mn cf/d production, while the OGD-3 project will see a two-train 1.3bn cf/d gas plant. New spend of

US$1bn is earmarked for two big gas projects, building a 200km pipeline to transport some 470mn cf/d of

gas from offshore fields to a processing plant at Habshan. Much of this gas is designed to feed into

domestic downstream projects.



Abu Dhabi is also preparing to sell gas to neighbouring Oman via the Dolphin gas export scheme. A gas

sales agreement with Muscat will deliver 200mn cf/d to Oman Oil Company from early 2008. The gas is

originally sourced from Qatar’s North Field and transported via subsea pipeline to Abu Dhabi.

The UAE is also looking to inject private sector dynamism into the gas sector, with the initial public

offering (IPO) in Dana Gas launched in late September 2005 expected to be the largest in the UAE to

date, and the first in a private gas company in the Gulf. The US$560mn IPO, launched on September 20,

envisaged sale of 34% of the capital. Originally set up by local energy groups Crescent Petroleum, Sajaa

Gas and United Gas Transmissions Company as a gas supplier, the aim is to now expand its Gulf

operations upstream. It is also expected to source gas from Iran.

The net effect of these expansion efforts in the oil and gas sectors will lend an upside risk to our 2006

hydrocarbons sector forecasts. If the UAE meets its crude expansion targets as early as Q106, exports

could exceed the envisaged 2.38mm b/d for the full-year. In light of the continuation of tight

supply/demand conditions, on top of increased production levels, oil export revenues may yet match this

year’s expected peak of US$41bn. The UAE’s slow emergence as a gas exporter will also add ballast to

its hydrocarbon prowess. ADNOC’s money appears to be well spent, and the thirsty global oil markets

will doubtless be thankful for the new supply.

Table: Macroeconomic Data & Forecasts

2003 2004 2005e 2006f 2007f 2008f

Nominal GDP (US$bn) 79.8 85.1 92.7 99 105.5 113

Real GDP growth (%) 7 4.8 6.2 4.3 3.9 4.5

Population (mn) 4 4.3 4.6 5 5.3 5.7

Consumer price inflation (an. avg %) 3.1 3 2.5 2.5 2.5 2.5

AED/US$ (eop) 3.7 3.7 3.7 3.7 3.7 3.7

Merchandise exports (US$bn) 65.9 80 100.8 102.2 103.8 113.5

Merchandise imports (cif, US$bn) 45.7 48.9 52.9 56.2 59.5 63.4

Trade balance (customs, US$bn) 20.1 31.1 47.9 45.9 44.3 50.1

Current account (US$bn) 6.3 18.3 34.7 32.9 31.1 37

Current account (% GDP) 7.9 21.5 37.5 33.2 29.5 32.8

External debt (% of GDP) 16.5 15.8 15 14 13 12

Sources: Ministry of Economy and Commerce, Central Bank of the UAE e/f = BMI estimates/forecast



Company Monitor

Ruwais Fertiliser Industries

Fertil was established in 1980 as a joint venture between ADNOC and

Total. ADNOC holds a two-thirds stake, with the remainder held by

Total. The Fertil plant was commissioned in December 1983 and is

the leading producer of ammonia and urea in the UAE. Located in the

Ruwais Industrial Zone, close to ADNOC's Jebel Dhanna Oil

Terminal, Fertil was established to produce fertilisers for local use and

export, using onshore associated lean gas from the Bah and Asab oil

fields, as well as non-associated gas from the Thammama field.

The plants have fully integrated utility units with storage facilities. At

present, ammonia production has reached 1,340tpd and urea 1,850tpd.

The company had granted a project management contract worth

US$3mn to Worley Parsons to debottleneck the company’s

690,000tpa urea unit by 90,000tpa, and to revamp its 350tpd carbon

dioxide recovery unit in Abu Dhabi. The projects are likely to be

completed by the end of 2008.

The company exports about 600,000 tonnes of urea annually,

including surplus ammonia. Fertil’s export markets change from year

to year as many buyers look for short-term contracts or spot

deliveries.

The company sells through traders, including US-based ConAgra and

Germany’s Toepfer, to customers in most countries, while India and

Sri Lanka use tenders to purchase urea. India is expected to become

an important market for Fertil in the future, as insufficient gas

supplies are likely to necessitate India to import more urea. Further,

the domestic UAE agricultural market reportedly purchases about 12-

15% of Fertil’s annual urea production.

In April 2006, the company reported sourcing of carbon dioxide

recovery technology from Mitsubishi Heavy Industries. Fertil is to

use the technology at its urea fertiliser production plant in the Ruwais

Address

PO Box 2288, Abu Dhabi, UnitedArab Emirates

Tel: +971-2-602 1111

Fax: +971-2-602 6800

Web: www.fertil.co.ae

Key Statistics

Number of Employees: 360(2004)

Key Personnel

Chairman: Yousef Omair BinYousef

Managing Director and GeneralManager: Saif Ahmed Al Ghafly

Deputy General Manager andProduction Manager: AndreCadet

Finance and Information SystemsManager: Ayoub Moh'd Saleh

Head of Urea Export Sales:Mohamed Al Anazi

Head of Ammonia Sales: Adil AlHameedi



Industrial Zone. The recovery unit is to be completed towards the end

of 2008 and is to capture up to 400 tonnes of carbon dioxide per day.

The technology recovers carbon dioxide from flue gas emitted during

the urea fertiliser production process.



Abu Dhabi Polymers Company (Borouge)

Borouge was established in 1998 to manufacture and sell polyethylene

(PE) for use in technically demanding applications, primarily in the

flexible and rigid packaging and construction industries. Borouge is a

joint venture owned by ADNOC and the European polyolefins

producer Borealis.

Borouge invested US$40mn to expand the PE capacity at its

US$1.2bn petrochemicals complex in Abu Dhabi so as to produce

580,000tpa. Borouge is fully converting its ethylene production into

PE products, which helps meet the needs of the packaging and pipe

industries in regions such as East Africa, Middle East and Pacific

along with the North East and South East Asia. The facility comprises

a 600,000 tonne ethane-based ethylene cracker and two PE plants,

each with an annual production capacity of 225,000 tonnes of linear

high, medium and low-density PE.

Borouge’s products are used for the manufacture of plastic film and

moulding packaging for the pharmaceuticals, food and beverages,

cosmetics and chemicals industries. The products are also used for the

manufacture of high-pressure pipes, agriculture, mining, water, gas

and sewage distribution, as well as for coating steel pipelines. In

addition to promoting its own PE products, Borouge also oversees the

distribution and marketing of Borealis’ speciality polyolefins in the

Middle East and Asia Pacific.

In March 2006, the company became an official member of the

PE100+ Association, an industry organisation comprising PE

manufacturers. Also in March 2006, the company proposed expansion

of its petrochemical complex in Ruwais, Abu Dhabi.

In July 2005, it was reported that Borouge is planning to expand its

petrochemical manufacturing capacity from 600,000tpa to 2mntpa of

enhanced polyolefins, consisting of PE and PP in Ruwais. The cost of

the project – expected to be completed by 2010 – is expected to be

around US$2.5bn.

Address

PO Box 6925, Abu Dhabi, UAE

Tel: +971-2-6312333

Fax: +971-2-6312999

Website: www.borouge.com

Key Personnel

Chief Executive Officer: HarriBucht

Vice President, Common Support:Jamal Al Ramahi

Vice President, Supply ChainManagement: Mohamed AlRayyes



BMI Forecast Modelling

How we generate our industry forecasts

BMI's industry forecasts are generated using the best-practice techniques of time-series modelling. The

precise form of time-series model BMI uses varies from industry to industry, in each case being

determined, as per standard practice, by the prevailing features of the industry data being examined. For

example, data for some industries may be particularly prone to seasonality, meaning seasonal trends. In

other industries, there may be pronounced non-linearity, whereby large recessions, for example, may

occur more frequently than cyclical booms.

Our approach varies from industry to industry. Common to our analysis of every industry, however, is the

use of vector auto regressions. Vector autoregressions allow us to forecast a variable using more than the

variable's own history as explanatory information. For example, when forecasting oil prices, BMI can

include information about oil consumption, supply and capacity.

When forecasting for some of our industry sub-component variables, however, using a variable's own

history is often the most desirable method of analysis. Such single-variable analysis is called univariate

modelling. BMI uses the most common and versatile form of univariate models: the autoregressive

moving average model (ARMA).

In some cases, ARMA techniques are inappropriate because there is insufficient historic data or data

quality is poor. In such cases, BMI uses either traditional decomposition methods or smoothing methods

as a basis for analysis and forecasting.

It must be remembered that human intervention plays a necessary and desirable part of all our industry

forecasting techniques. Intimate knowledge of the data and industry ensures BMI spots structural breaks,

anomalous data, turning points and seasonal features where a purely mechanical forecasting process

would not.



Chemicals Industry

Plant capacity

The ability of a country to produce basic chemicals products depends on domestic plant capacity. The

number and size of ethylene crackers determines both a country’s likely output, but also its relative

efficiency as a producer. We therefore examine:

Stated year-end capacity for key petrochemicals products, mainly ethylene but also propylene, PP,

PE and so forth. Government, company and third-party sources are used;

Specific company and/or government capacity expansion projects aimed at increasing the number

and/or size of crackers and downstream processing facilities.

Chemicals supply

A mixture of methods is used to generate supply forecasts, applied as appropriate to each individual

country:

Basic plant capacity and historic utilisation rates. Unless a company imports chemicals products for

domestic re-sale, supply is likely to be governed by production capacity;

Underlying economic growth trends. The chemicals industry is highly cyclical. Strong domestic or

regional demand is expected to be met by increased supply and higher plant utilisation rates;

Third party projections from national and international industry trade associations.

Chemicals demand

Various methods are used to generate demand forecasts, applied as appropriate to each individual

country:

Underlying economic growth trends. Strong domestic or regional demand is expected to require

larger volumes of either domestically-produced or imported olefins (ethylene, propylene), polyolefins

(PE, PP) or downstream products;

Trends in end-user industries. Strong demand for motor vehicles, construction materials, packaging

products and pharmaceuticals imply rising demand for basic chemicals;

government/industry projections;



third party forecasts from national and international industry trade associations, etc.

Cross checks

Whenever possible, BMI compares government and/or third party agency projections with the reported

spending and capacity expansion plans of the companies operating in each individual country. Where

there are discrepancies, BMI uses company-specific data as physical spending patterns ultimately

determine capacity and supply capability. Similarly, BMI compares capacity expansion plans and

demand projections to check the chemicals balance of each country. Where the data suggest imports or

exports, BMI checks that necessary capacity exists or that the required investment in infrastructure is

taking place.



Appendix A: Global Economic Assumptions

Introduction

Here, BMI analysts give their view of the state of the world economy and the main challenges faced. In

this context, they outline their forecasts for growth, inflation, interest rates and the exchange rate in the

US, the eurozone, Japan and China over the forecast period of the report (2006-2010). There are also

separate sections on the oil price and commodities markets. The forecasts contained in these sections

represent the basic assumptions which underpin the analysis in BMI's country reports.

The World Economy

Downside Risks To Growth Pick-Up

Our baseline forecast is for real growth in the global economy to accelerate in 2006 to 3.8%, from 3.6%

last year. The US will remain the key driver of growth, maintaining its impressive rate of 3.5%, as its

consumers continue their spending binge. Recovery in the eurozone is another important factor, as will be

Japan’s ongoing re-emergence from economic stagnation. Nevertheless, the world’s fastest growing

region will remain Asia (excluding Japan), which we forecast to grow by 7.0% in the year ahead. Looking

to the medium term, we expect global growth to stabilise at a trend rate of around 3.4%, as China’s

blistering rate of expansion eases and the US consumer begins to feel the pressure of increasing debt

levels.

Higher global inflation, in an environment of surging oil prices, will be a key risk to global growth in

2006. The effects of last year’s rise in oil prices will continue to flow through into overall prices,

particularly in emerging economies where governments are still withdrawing fuel price subsidies.

Furthermore, oil prices are expected to climb even higher this year (see page viii). Rapid global growth

also means that many countries may be pushing against capacity constraints, further contributing to

inflation. If inflation does creep higher in 2006, consumer and business confidence will falter as real

wages and profit margins are squeezed. The result would be slower global growth.

A further downside risk to our forecasts is the exacerbation of global imbalances. The US current account

deficit remains alarmingly wide, reaching an unprecedented 6.5% of GDP in 2005, and looks set to

deteriorate even further in 2006. We are particularly concerned by protectionist sentiment developing in

the US. China looks unlikely to allow a significant appreciation of the yuan, which will give

encouragement to those in Washington seeking tariffs on Chinese goods. Whereas a yuan appreciation

has little chance of addressing imbalances, protectionist measures threaten to thoroughly disrupt global

growth. A large proportion of US imports from China are intermediate goods used in manufacturing, and

placing tariffs on them will only serve to raise costs for US firms. Furthermore, imposing greater barriers



to the US market is likely to provoke retaliatory measures from China, undermining the potential of US

exporters. The resulting fall in business confidence could significantly impact on the US economy and the

global economy with it.

Global Assumptions

2003 2004 2005e 2006f 2007f 2008f 2009f 2010f

Real GDP growth(%) US 2.7 4.2 3.5 3.5 3.3 3.3 3.3 3.4

Eurozone 0.7 1.8 1.4 2.1 1.7 1.7 1.7 1.7

Japan 1.8 2.3 2.8 2.8 2.1 1.8 1.5 1.4

China 10 10.1 9.9 9.3 9.4 9.5 8 7.4

World 2.7 4.1 3.6 3.8 3.5 3.5 3.4 3.4

Consumer inflation(year-end) US 2.3 2.7 3.4 2.8 1.9 2 2.1 2.4

Eurozone 2.1 2.1 2.2 2 2.2 2.2 2.2 2.2

Japan* -0.3 0 -0.3 0.3 0.4 0.6 0.6 0.6

Interest rates(average)

Fed fundsrate 1.13 1.35 3.21 4.83 5 4.69 4.5 4.5

ECBrefinancingrate 2.34 2.11 2.19 2.6 3.06 3.06 3.06 3.06

Exchange rates(year-end) US$/EUR 1.26 1.36 1.19 1.3 1.28 1.26 1.25 1.24

EUR/US$ 0.79 0.74 0.84 0.77 0.78 0.79 0.8 0.81

JPY/US$ 108.8 112.04 109.15 108.49 101.85 95.19 92.16 89.58

Commodity Index(2000 = 100) Metals 98.43 133.98 169.33 230.18 192.5 155.74 147.47 140.5

Agriculture 100.38 105.88 108.43 110.16 112.89 115.7 118.51 121.35

Oil prices (average)

Oil - OPECbasketUS$/b 28.09 35.7 50.64 55.75 50 45 45 45

*Calendar-year basis, year-end inflation is average of fourth quarter compared with average of same period a yearearlier; Source: BMI.



Another possible catalyst for a disorderly unwinding of global imbalances would be a collapse in US

house prices. US consumers have undoubtedly raised housing outlays beyond what would be warranted

by fundamental factors, such as income growth. An expectation of continually higher returns is

supporting their confidence in property assets; this confidence would be shattered by a collapse in

housing prices. Without the US consumer to drive the global economy, growth could slow considerably.

Furthermore, excess liquidity has created bubbles in a number of asset markets around the world, and

there is a risk that a US house price adjustment will culminate in these eventually bursting as well.

Clearly, a global collapse in property prices could have severe effects on growth.

United States

The US In 2006 & 2007

The US economy grew strongly in Q106, with annualised quarterly GDP growth at around 5.0%. While

the recovery can be partially attributed to Q405’s low base of comparison (due to the effects of Hurricane

Katrina), the fundamental strength of the US economy is the driving factor. In particular, private

consumption was up 6.7% year-on-year (y-o-y) in January and 6.2% y-o-y in February. While housing

prices may ease gradually towards the end of 2006, we do not expect the bubble to burst – though this

remains a key risk, and our latest scenario test in chapter 3 explores this eventuality in more detail. We

expect growth of 3.5% in 2006, and 3.3% in 2007.

Ben Bernanke’s first move as US Federal Reserve chairman was to boost the Fed funds rate for the 15th

straight time to 4.75%. Stronger-than-anticipated employment figures and upside risks to energy prices

will keep the Fed vigilant. We expect a further 25 basis point (bps) hike to take the rate to 5.00% over the

next quarter – where it should stabilise (though greater tightening is an outside possibility). This view

assumes that growth will moderate over H206, calming inflationary pressures and allowing the Fed to

move to a more neutral policy stance. Should growth and inflation stabilise at sustainable levels, the rate

could peak at 5.50% over the next few quarters. Inflation should continue to abate over 2006 and 2007, to

2.8% and 1.9% respectively.

The big question mark hanging over the economy remains the massive current account deficit. Figures

from early 2006 point to a growing trade deficit. There may be, however, some relief in sight. The

eurozone and Japan are showing signs of economic strength, while mounting international pressure on the

Chinese to revalue the yuan could pay dividends.

Eurozone strength and the prospect of an end to the Fed’s tightening cycle in H206 may cause dollar

depreciation as eurozone interest rates climb higher. However, when seen in the context of a 5.00% Fed

funds rate, US assets will remain attractive vis-à-vis their Japanese and European equivalents. As such,

while some dollar weakness is to be expected, it will not fall beyond US$1.30/EUR in 2006. We see this



recovering to US$1.28/EUR in 2007. With the Japanese economy’s renewed strength, we expect the yen

to appreciate against the dollar (reaching JPY108.5/US$ in 2006, and JPY101.9/US$ in 2007).

The US’s Medium-Term Prospects

While the spectre of a housing market collapse could threaten our forecasts, there is reason to believe that

economic prospects are solid looking forward. According to the results of our latest scenario test, an

adjustment of US property prices would not cause a recession. Moreover, if the property market avoids

such a correction, we think growth will average at about 3.3% through to the end of 2010.

Meanwhile, the current account deficit may not be the monster that many fear it to be. In fact, we feel that

trends in the eurozone, Japan and, hopefully, China will help the current account deficit to improve over

the forecast period – from 6.6% of GDP in 2006 to approximately 5.0% of GDP in 2009 and 2010. Stable

growth, low inflation and a Fed funds rate of around 4.50% through the end of the forecast period will

help the greenback against the euro, even as the ECB refinancing rate climbs to 3.06% in 2009 – bringing

the dollar back to US$1.24/EUR by 2010.

Eurozone

The Eurozone In 2006 & 2007

The macroeconomic outlook for the eurozone is characterised by the upbeat indicators of regional

confidence, on the one hand, and persistently weak real data, on the other. This is particularly the case in

the eurozone’s largest economy, Germany. In March this year, the benchmark Ifo index of confidence in

the business climate rose to a 15-year high. However, despite this apparent boost, national accounts data

have not yet supported hopes of an unmistakeable economic recovery. In Q405, German GDP increased

by just 1.6% y-o-y, and was unchanged on a q-o-q basis. While q-o-q growth is expected to have

improved slightly in Q106, bad weather appears to have constrained the output of vulnerable sectors, such

as construction. Those anticipating firm evidence of a turnaround in Germany will have to wait a bit

longer.

Against a background of fragile consumer spending, we continue to expect that eurozone growth will stay

at around 2.0% in 2006 and 2007. Of the region’s three largest economies (France, Italy and Germany),

only France will outperform this trend. The interest rate policy of the European Central Bank (ECB) is

unlikely to have a significant effect on growth. However, gradual rate rises, to around 3.25% by end-

2007, should allow the ECB to keep annual inflation below its upper ceiling of 2% in the coming years.

Given that the bank’s charter establishes the achievement of price stability as its primary objective, this

should help restore some credibility in an organisation that has been much maligned for its failure to

achieve policy targets since its inception.



The exchange rate channel is unlikely to impart any stimulus to the eurozone economy in 2006 and 2007,

especially given our expectation for a steady strengthening of the euro against the US dollar. Still, given

the strong macroeconomic rationale for the dollar to fall against a range of (mostly Asian) currencies to

correct global imbalance, the euro-US dollar exchange rate should avoid a destabilising adjustment.

Currency strength against the US dollar will restrict the competitiveness of eurozone exports, and ensure

that the current account surplus is fairly constant in nominal terms, and declining as a percentage of GDP.

Nevertheless, in view of the imperfect nature of integration in the single European market, and persistent

labour market inefficiencies, it would be imprudent to ascribe any underperformance of the external

sector to exchange rate issues alone.

The Eurozone’s Medium-Term Prospects

The current structure of the eurozone economy, in addition to the long lead time between reform and

results, lead us to conclude that the region will fail to permanently raise GDP growth from a level of

around 2% over the remainder of the forecast period. Although we expect the eurozone to make some

progress in reducing unemployment, it will still have over 2% more of its workforce unemployed than the

US by 2010 (eurozone unemployment should fall to around 7%, in comparison to a stable rate of 5% in

the US). In this light, it is difficult to see the eurozone bridging the GDP growth differential with the US

without an improbable surge in productivity.

Japan

Japan In 2006 & 2007

There are growing signs that Japan’s economy is finally emerging from the economic doldrums which it

has been in for most of the past 15 years. The economy grew by 2.8% in 2005, including an impressive

4.5% y-o-y expansion in the final quarter, which made Japan one of the world’s fastest growing

developed economies. The recovery, supported by strong export demand (especially from China and the

US), higher consumption, and improving business confidence, is looking more durable than it has for a

long time, and as a result, we have raised our economic growth forecasts for 2006 to 2.8%, and 2.1% in

2007.

In an important development, in March the Bank of Japan (BOJ) announced the end of its policy of

quantitative easing. The central bank will now start to drain excess liquidity from the system as part of its

strategy to normalise monetary policy. The announcement followed more signs that deflation had finally

come to an end, after consumer price inflation reached 0.5% y-o-y in January. The monetary authority’s

decision to abandon its policy of quantitative easing should see the return of positive interest rates,

possibly by as early as the end of the year. While there is concern that such a policy change may be

premature as it could lead to the return of deflation, it is a sign that the authorities are more confident

about the durability of the current economic recovery than in previous upturns.



The Japanese yen is forecast to appreciate against the US dollar over the next two years, reaching

JPY101.9/US$ by the end of 2007. The appreciation is the result of two main factors. The first is the

general weakness of the US dollar, reflecting ongoing concerns over the size of the US current account

deficit; the second is the forecast narrowing of the interest rate differential between the US and Japan,

amid signs that US monetary tightening is coming to an end, and the expectation that interest rates in

Japan will soon begin to rise.

Japan’s current-account surplus is forecast to widen over the next two years from 3.6% of GDP in 2005,

to 3.7% in 2006, and 4.4% in 2007. The widening is mainly the result of an increase in the trade surplus,

mostly due to strong export demand from China. There is a possibility, however, that high oil prices and

strong domestic demand will result in stronger-than-expected import demand, which may lead to a fall in

the trade surplus.

Japan’s Medium-Term Prospects

Japan’s medium-term economic prospects remain uncertain, with two main factors set to depress growth

prospects over the next five years. One major concern is the growing public-debt to GDP ratio, which is

now well over 100% of GDP, and the size of the government’s fiscal deficit, which is over 7% of GDP.

The government is committed to raising taxes and cutting spending in a bid to reduce its deficit. This

policy, while welcome, will depress growth. Demographics are another major concern. Japan’s

population is already the oldest in the world, and actually started to fall for the first time last year.

Although the government is increasing incentives to boost the birth rate, the demands on the pension

system and on the labour market of a rapidly ageing population will be significant.

China

China In 2006 & 2007

China’s red-hot economy is showing no signs of slowing, with growth accelerating in the first quarter of

2006 to reach 10.2% y-o-y. The main drivers were again fixed-asset investment and net exports. The

momentum will continue for the rest of this year when we forecast the economy will expand by 9.3%, and

by 9.4% in 2007. The government is trying to re-balance growth away from investment, and towards

consumption, however, in the first quarter, investment again expanded by over 25%. There are concerns

that this rate is not sustainable, and that it is leading to a build-up of spare capacity, which could cause a

more sudden slowdown later in the forecast period.

Inflation is forecast to increase to an average of 2.5% in 2006 and 3.4% in 2007, compared with just 1.8%

last year. The main cause of the increase is robust demand, especially for commodities, which is leading

to higher producer price inflation. This will eventually feed through to higher consumer price inflation.

There are, however, significant downside risks to our forecast, most notably the possibility that the high

levels of investment over the last couple of years have created significant spare capacity in the economy,



with the result that an estimated 90% of all manufactured goods suffer from over supply. This is already

leading to some manufacturers cutting prices in an attempt to sell surplus stock.

The exchange rate, after last July’s revaluation, will continue to experience a modest appreciation, with

the rate to the US dollar forecast to average CNY7.9/US$ in 2006 and CNY7.6/US$. The Chinese

authorities may allow a faster appreciation in the event that trade tensions with the US worsen, or that

further attempts to slow the economy fail. The authorities are also likely to focus more attention in

keeping the trade-weighted value of the yuan fairly stable. In the event that the US dollar undergoes a

sudden and steep depreciation against other major Asian currencies this year, the Chinese may allow the

yuan to appreciate more against the US dollar.

The current-account surplus, after reaching an estimated 4.7% of GDP in 2005, will narrow slightly over

the next couple of years, reaching 3.6% of GDP in 2006 and 1.8% in 2007. The main cause of the fall will

be a smaller trade surplus, which is set to narrow as import growth, fuelled by booming domestic demand

and the high oil price, outstrips exports, which are set to grow at a more moderate pace over the next

couple of years.

China’s Medium-Term Prospects

The government’s main focus over the medium term will be to rebalance growth away from investment

and exports, which at their current rate of growth are unsustainable, towards consumption. Attempts to

boost personal consumption are finally showing signs of working, with retail sales growth slowly

increasing. To boost consumption further, the government needs to introduce a comprehensive social

security and health care system, which it hopes will encourage the average Chinese person to save less

and spend more. However, these reforms will take some time to introduce on a countrywide basis, and

until such time, consumption will continue to grow at a slower pace than the rest of the economy.

Commodities

Industrial Metals Breaking Records

BMI’s metal price index considers the following industrial metals: aluminium, copper, iron, lead, nickel,

tin and zinc. The index has risen sharply since its low of 83.6 in Q401. We remain bullish short term as

prices are yet to reach their peak of 240.0 in Q206, after which they will fall gradually over the medium

term, reaching an average of 230.2 for the year, before slowly dropping off to reach 140.5 by 2010.

Base metals have set new records in 2006 and further upside could be ahead. Indeed, the global

environment for industrial metals has rarely been so benign. Coupled with still low G7 interest rates (and

signs that the US tightening cycle is near its peak), strong global economic growth in recent years has

propelled base metals to new heights. The fundamental outlook for metals looks good too, with key

economies likely to expand at a fast pace this year and next. US real GDP growth is likely to be in excess



of 3.4%, China’s as high as 9.0%, and there are signs that Germany’s hitherto moribund economy could

post 2.0% growth. Meanwhile, continued instability in the Middle East and high oil prices mean that

investment funds continue to direct large proportions of their holdings into commodities. Structural

supply-side dynamics also continue to point towards upside for our metals index, particularly given that

the rally in base metals over recent months has occurred despite upward trending stock inventories – a

sign of strength in the market. These tight markets will continue to push up metals but prices will

gradually decline from Q206 as markets move into surplus.

Strong demand and supply constraints are the key supports to high and rising metals prices, and changes

on either end of the equation would force us to revise our outlook. On the downside, slower-than-

expected growth in the US or China could ease demand, although we continue to be constructive on the

prospects for both economies. Similar risks exist should major suppliers manage to increase production

ahead of schedule. Still, in the event of a supply shock affecting any major supplier, prices could continue

to rally as inventories remain tight.

Agricultural Prices Boosted By Alternative Fuels Demand

Agricultural prices look set to retain their upwards trend, although some commodities are performing

better than others – sugar supply, for example, continues to fall short of demand pointing to further price

rises, while fats and vegetable oils fell over the year ended March, according to the World Bank. BMI’s

agricultural price index promises steady stable growth as far as it is possible to anticipate volatile

agricultural prices. The index is forecast to rise steadily throughout the forecast period to reach 110.2 in

2006, climbing to 121.4 by 2010.

In the long term, the main structural trend is likely to be an increase in demand from the booming

economies of South East Asia, a point which was recently stressed by the World Bank’s chief economist

for Africa, John Page. Not only is China’s per capita income rising – we forecast real GDP per capita will

be 61% higher in 2006 than five years ago – but demand for Western style goods and food has been on

the up. Emerging as a core driver of our agricultural price index is the growing popularity of bio-fuels as

an alternative fuel, ethanol (sugar-based) and soy-based fuels in particular. Indeed, record high oil prices

have promoted a move by governments around the world to seek out more sustainable (and cheaper)

sources of fuel, and ethanol provides an attractive option. Agricultural prices are typically volatile and

adverse weather conditions and political developments present the main risks to our outlook.

Oil

Concerns over Iran and Nigeria dominated the oil markets in Q1, keeping the OPEC basket price above

US$60/bbl for most of the quarter. Indeed, while oil prices declined in early February on the back of

lower demand projections and surging US crude inventories, the market became more bullish in response

to disruptions to Nigerian supply and ongoing tensions between the West and Iran. Since these political

risks to supply are likely to persist through 2006, while the market will remain very tight, we expect the



‘fear factor’ to keep prices well-supported, and now forecast the OPEC basket average at US$55.8/bbl

this year. We maintain our forecasts for 2007 and 2008 at US$50/bbl and US$45/bbl respectively, but

have nudged our 2009 and 2010 forecast up to US$45/bbl in both years (from US$40/bbl previously), in

light of anticipated market tightness.

Along with most forecasters, BMI has revised its 2006 demand forecast down, largely reflecting the

negative impact of persistently high prices on global growth. BMI’s global economic model now predicts

that global oil demand will rise by 1.5% in 2006. This forecast is in line with that of the International

Energy Agency (IEA) but marginally more bearish than OPEC’s expectation of 1.8% demand growth.

Risks to our forecast, primarily from uncertainty about Asian demand growth, are weighted to the upside.

Nonetheless, downside risks remain (including the possibility of a US housing market crash or a dramatic

drop in the US dollar), which could weaken global economic growth and thus global oil demand,

undermining oil prices if OPEC did not cut output.

We have also revised our 2006 supply growth forecast down. Indeed, we expect supply growth to be

slightly lower than demand growth in 2006, at 1.4%. Here, risks are weighted to the downside, reflecting

both political uncertainty and concerns that new projects could be delayed. Many oil projects are already

behind schedule. In this context, our core scenario assumes that the market will tighten marginally in

2006, pushing prices above the levels seen in 2005.

Beyond 2006, we believe that supply will struggle to keep pace with demand throughout our five-year

forecast period. BMI projects world oil demand to grow by an average of 2.0% per year through 2010,

while world oil supply will grow by only 1.7% on average per year. Furthermore, we assume that OPEC

will cut production if prices fall persistently below US$50/bbl, which constrains the potential for supply

growth over the forecast period. Nonetheless, we expect prices to decline gradually over the forecast

period because OPEC surplus capacity is expected to expand significantly.

Limited Effect On Global Growth…For Now

Interestingly, the high oil price environment of the past few years has proved less of a drag on global

growth than feared. Global growth in 2005 was 3.6%, or 0.5 percentage points lower than the 4.1% seen

in 2004. While higher energy prices were no doubt one of the factors behind this mild slowdown, they

have not had the severe negative impact seen in previous oil price shocks, when growth suffered

significantly and inflation rose sharply.

There are several reasons why the effects have been more benign. Principally, oil prices are still far below

those of past oil shocks in real terms, and they have risen more slowly. Secondly, the price spikes in the

1970s were caused by supply shocks, whereas now they are attributable to demand. Furthermore, strong

demand in China and India reflects the success of their export-led growth, which is based on mass-

producing cheap consumer goods. Consequently, underlying global inflationary pressures are



comparatively low. Finally, developed states have become more energy-efficient than before, and in light

of persistently high oil prices, we anticipate global efforts to make the world economy increasingly

energy-efficient.

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