Tuesday, 15 th January 2008 Andrew Mackenzie Ad Hoc Group Energy

Tuesday, 15th January 2008Andrew Mackenzie

Ad Hoc Group Energy

The European Chlor-Alkali Industry

The chlor-alkali industry is a major contributor to European economic activity.

Chlorine is produced via electrolysis of salt solutions, andthis process requires large inputs of electricity.

Although chlorine is a key building block for the chemical industry, its co-product caustic soda is also important dueto its wide applications.

The European chlorine production was 10.4 million tons in 2006, about the same as in the preceding three years, and the average regional utilization of production plants was about 83%.

Chlorine and caustic soda are used in more than half of all commercial chemistry applications to create hundreds of secondary compounds that in turn contribute to plastics, pharmaceuticals and thousands of other products.

The products of the chlor-alkali industry rarely go directlyto consumers. However, an enormous range of productsand 2,000,000 jobs in Europe depend directly or indirectlyon chlorine (see Exhibit 4.0):

Sources: Euro Chlor, Annual Report 2006-2007

Chlorine and caustic soda – key chemical building blocks Adhesives Ceramics Fibre-glass Lubricants

Advanced composites Computers Flame-proofing Paints

Air bags Cosmetics Footballs Paper

Antibiotics Credit cards Fungicides Perfumes

Antifreeze Detergents Gaskets Pharmaceuticals

Bleach Disinfectants Golf bags Plastics

Blood bags Drilling fluids Greenhouses Refrigerants

Brake fluids Drinking water Hairdryers Roller blades

Bullet-resistant glass Dry cleaning Herbicides Roofing

Bumpers Dyestuffs Inks Safety belts

Car seats Electronics Insulation Vitamins

Carpets Explosives Intravenous drips Window frames ...

CDs and DVDs Fertilisers Lighting ... and much more.

Key Messages

Electricity is a large cost element in chlor-alkali production cost (60% of variable cost)

Electricity prices vary greatly but the ‘average’ price in Europe, though comparable to USA, is high compared to other key economic zones,e.g. Middle East, China, Russia

Prices are high because of : European market effets Cost of CO2

Ability to pass on costs is extremely limited Future investment is under severe threat

Project Nr. 7-05-873r

P R O C H E M I C S www.prochemics.com

Impact of Electricity Price on the Competitiveness of the European Chlor-Alkali Industry

Prepared for

Euro ChlorBrussels, Belgium


Prepared by

P R O C H E M I C S Ltd.Zurich, Switzerland

October 2007

Tel.: +41 44 341 1973Email: [email protected]



3. Project Scope and Methodology



• The project scope is as follows:

Geography

The study will compare the European energy prices with those of the key competing regions, namely:

• Middle East / Saudi Arabia

• Russia

• USA

• Asia Region / China

Project Scope and Methodology



• The project scope is as follows (cont’d.):

Products

The following major chlor-alkali derivatives, which can be considered to be representative, will be studied to illustrate the impact of electricity prices on their production costs and their competitiveness:

• Chlorine and co-product caustic soda

• EDC PVC

• Phosgene Isocyanates Polyurethanes

• Phosgene Polycarbonates

Project Scope and Methodology



Global Electricity Prices

• The electricity prices traded in the European exchanges have more than doubled in the last four years:

EEX SPOT-Mix Electricity Prices (Dec. 2006)

0

10

20

30

40

50

60

2001 2002 2003 2004 2005 2006 F 2007 F 2008

€/M

Wh Increase 2001-2006 ~ +110%

Source: Prochemics based on Information from EEX (electricity base prices).

Note: These prices do not necessarily reflect prices paid by chlorine producers.

EXHIBIT 6.1




• Impact of different cost of CO2 allowances rates on the electricity full cost:

Electricity Full Cost

17 14 14 146 6 6

7 7 7 7

4 4 4

4

23 23 23 49 49 492

3 3 3

3 3 316

477

22

2

3

0

10

20

30

40

50

60

70

80

90

100

Nuclear Coal 60€/t(CO2=4€/t)

Coal 60€/t(CO2=20€/t)

Coal 60€/t(CO2= 60€/t)

Gas25€/MWh(CO2 4€/t)

Gas25€/MWh

(CO2=20€/t)

Gas25€/MWh

(CO2=60€/t)

€/M

Wh

CO2

Taxes

Fuel

O & M

Capital (IRR 8%)

Source: Prochemics based on Information from DGEMP of the Ministiere de l’Economie, de Finances et de l’Industrie, France (2003).

Note: These prices do not necessarily reflect prices paid by chlorine producers.

EXHIBIT 6.3




EXHIBIT 6.6General Industrial Power Price (in €/MWh)

15

19

30

47

58

63

64

70

90

99

121

0 20 40 60 80 100 120 140

Saudi Arabia

Russia

China

USA

France

Switzerland

United Kingdom

Spain

Netherlands

Germany

Italy

EU

ave

rag

e *

= 4

5

Sources: Prochemics based on Information from IEA; Eurostat; EIA (2006).

EU range *

(*) Estimates for the European chlor-alkali industry



Future European Electricity Prices

• For the purpose of the comparison in the study, Prochemics has estimated a future representative average electricity price for the chlor- alkali industry in Europe.

• In the future, as the supply contracts expire, the assumed base price for new contracts will be the prices in the European Exchanges (which are currently about 50 €/MWh) plus a premium to take account such as distribution, etc. mentioned previously. According to major industry sources, this premium can vary between 5 and 15 €/MWh.

• In addition, if the Phase 2 of the EUETS is implemented as planned (with a CO2 cost of 20 €/te), it could add as between 10 and 20 €/MWh to the electricity price, as shown in Exhibit 6.3.

• Phase 2 of the EUETS is planned to run until the end of 2012, at which time there could be further increases in the cost of CO2 allowances.



Future European Electricity Prices

• Therefore, for the sake of the study, Prochemics has adopted a base value of 70 €/MWh as a representative value for the future electricity prices for the European chlor-alkali industry for comparison with the other regions.

• The EUETS is limited to the European Union and therefore, chlor-alkali producers in other regions do not face the additional costs for CO2

emissions.



7. Comparative Production Costs of Chlor-Alkali



Comparative Production Costs of Chlor-Alkali

• Production costs for chlorine in Europe:

Source: Prochemics Manufacturing Economics Model

Process Technology Membrane Cell Diaphragm Cell Mercury Cell

PRODUCTION CAPACITY (kty) 500 500 500

PRODUCTION COST (€/mt)

RAW MATERIALS (€/mt) €/mt €/mt €/mt

NET RAW MATERIALS 81.3 55.4 63.8

NET UTILITY COSTS 253.7 268.4 281.9

[of which electricity (€/mt)] [210] [207] [250]

NET VARIABLE COSTS 335.0 323.9 345.8

OPERATIONS & MAINT COSTS

NET OPERATIONS & MAINTENANCE 37.2 36.0 40.5

PLANT GATE COST 528.1 512.1 552.3

CORP G&A 13.8 13.8 13.8

TOTAL PRODUCTION COST (ECU) 541.8 525.8 566.1

TOTAL CASH COST 421.2 407.9 438.0

Cl2 PRODUCTION COST (ex NaOH) 239.3 223.3 263.6

EXHIBIT 7.1




• Using membrane technology as a base case, the following graph shows how the cost of producing chlorine in Europe is linear with the increasing cost of purchased electricity

Impact of Electricity Costs on Chlorine Production Costs

0

50

100

150

200

250

300

350

400

450

10 20 30 40 50 60 70 80 90 100 110 120Electricity Cost (€/MWh)

Cl 2

Co

st

(€/m

t)


EXHIBIT 73

ASSUMPTIONS• Membrane Electrolysis Technology• Plant Capacity: 500 kta chlorine• Operating rate: 100 %• Salt price: 30 €/t• Caustic soda price: 275 €/t




The chlorine production costs resulting from the model in different regions are as follows:


REGION EUROPEUS GULF COAST

SAUDI ARABIA

CHINA RUSSIA

RAW MATERIALS (€/mt) €/MT €/MT €/MT €/MT €/MT

NET RAW MATERIALS 81.3 73.9 83.9 77.9 83.9

UTILITY COST (€/MT)

NET UTILITY COSTS 253.7 183.9 66.7 129.8 72.5

NET VARIABLE COSTS 335.0 257.8 150.5 207.6 156.4


NET OPERATIONS & MAINTENANCE 37.2 31.1 31.9 19.1 38.3

PLANT GATE COST 528.1 418.9 324.1 319.6 368.1

CORP G&A 13.8 13.8 13.8 13.8 13.8

TOTAL PRODUCTION COST (ECU) 541.8 432.7 337.8 333.3 381.8

TOTAL CASH COST (ECU) 421.2 332.2 227.3 260.0 246.1

Cl2 PRODUCTION COST (ex NaOH) 239.3 130.2 35.3 30.8 79.3

EXHIBIT 7.4




• The cost of producing chlorine in Europe compared with other regions is shown below. Since other cost factors such as labor, construction costs etc. are lower in other regions, the manufacturing costs ranges for chlorine are generally lower than in Europe for comparable electricity price ranges:

Europe

Europe

Source: Prochemics Manufacturing Economics Model(*) Cash costs, excl. depreciation (**) US Gulf Coast

EXHIBIT 7.5Impact of Electricity Costs on Chlorine Production Costs* in Europe

0

50

100

150

200

250

300

10 20 30 40 50 60 70Electricity Cost (€/MWh)

Cl 2

Co

st

(€/m

t)


Saudi Arabia China

Russia

USA**

EuropeEurope



Comparative Production Costs of Chlorine Derivatives

• In order to determine the impact of higher chlorine prices on the main chlorine derivatives, Prochemics has prepared similar manufacturing cost models for the main polymers derived in part from chlorine.

• These include PVC (polyvinyl chloride), polycarbonate, and polyurethane (both rigid and flexible).



Comparative Production Costs of PVC

• Polyvinyl chloride (PVC) is a major derivative of chlorine. PVC is used extensively in Europe and is one of the major polymers with a European consumption of 5.8 million tons in 2006.

Global Consumption of Commodity Plastics - 2005 (in million tons)

30 29

39

31

17

7

3 2

11

0

5

10

15

20

25

30

35

40

45

PE-LD/L

LD

PE-HD PP

PVC

PS+EPS

ABS/ASA/S

ANPA PC

PET

Source: Prochemics based on published information

EXHIBIT 7.6



Comparative Production Costs of PVC

Production costs of PVC by country:


REGION EUROPEUS GULF COAST

SAUDI ARABIA

CHINA RUSSIA

RAW MATERIALS (€/mt) €/MT €/MT €/MT €/MT €/MT

PVC NET RAW MATERIALS 517.3 453.5 398.1 395.5 423.8

UTILITY COST (€/MT)

NET UTILITY COSTS 44.7 38.6 41.0 67.4 14.4

NET VARIABLE COSTS 562.0 492.1 439.0 462.8 438.1


NET OPERATIONS & MAINTENANCE 41.5 34.9 33.9 18.7 40.1

PLANT GATE COST 766.3 662.8 619.9 576.8 657.6

CORP G&A 13.8 13.8 13.8 13.8 13.8

PVC TOTAL PRODUCTION COST 780.0 676.5 633.6 590.6 671.4

PVC TOTAL CASH COST 655.4 572.6 519.3 514.7 531.1

EXHIBIT 7.8



8. Implications for the European Chlor-Alkali Industry



Implications for the European Chlor-Alkali Industry

• The cost position of the European chlorine industry relative to other regions is shown below.

Impact of Electricity Costs on Chlorine Production Costs in Europe

0

50

100

150

200

250

300

350

400

450

10 20 30 40 50 60 70 80 90 100 110 120Electricity Cost (€/MWh)

Cl 2

Cos

t (€/

mt)

EuropeanEuropeanCurrent CaseCurrent Case

Increase of Electricity Increase of Electricity Costs in EuropeCosts in Europe

Increase of Chlorine Increase of Chlorine Costs in EuropeCosts in Europe

Saudi ArabiaChina

Russia

Chlorine Costs Euro-Chlorine Costs Euro-pean Current Casepean Current Case

USA*

Europe

Europe

Chlorine Costs Euro-Chlorine Costs Euro-pean Future Casepean Future Case

EuropeanEuropeanFuture CaseFuture Case

+55%+55%

+46%+46%

Source: Prochemics Manufacturing Economics Model (*) US Gulf Coast


EXHIBIT 8.1




• Even at the current electricity prices of 45 €/MWh, European chlorine is more expensive to produce than in the other regions, in particular when compared with China, Saudi Arabia and Russia.

• The likely costs for electricity in Europe, once new contracts are negotiated, will result in ECU (and chlorine ) costs which will be even higher than those in the regions covered in this study.

• In fact, the differences are so substantial that the simplifications used in the model will have little impact on the overall findings.

• In addition, these models compare plants with a capacity of 500 kt of chlorine. Since a large number of the European plants have much smaller capacities, the economics of continuing to produce chlorine in these plants will be very poor.

• This will affect the cost and availability of large numbers of products which depend on the use of chlorine, either contained in the final product or used in the intermediate processing steps, such as in phosgene for polyurethanes.




• In Prochemics’ model, it has been assumed that the current value of the caustic soda co-product is relatively high by historic standards. Since this price has historically been quite volatile, it can be expected that in periods of low caustic soda market prices, the overall economics of producing an ECU, will be very unfavorable if the chlorine price cannot be raised accordingly, as it can not. This will have an impact on the profit margins of the chlorine chain.

Chlorine Costs dependency on Caustic Soda Prices

-

50

100

150

200

250

300

200 250 300 350 400

€/t NaOH

€/t

Cl2

ASSUMPTIONS• Membrane Electrolysis Technology• Plant location Europe• Plant Capacity: 500 kta chlorine• Operating rate: 100 %• Salt price: 30 €/t• Electricity price 45 €/MWh• ECU production costs 470 €/t

EXHIBIT 8.2





• The historical development of the ECU market price is shown in Exhibit 8.3. Historically, the ECU market price ranges between 350 and 600 €/t.

EXHIBIT 8.3Western European Value of ECU in €/t

200

300

400

500

600

700

2002200120001998 1999 2003 20052004 2006 2007

Source: Tecnon OrbiChem - CHEMICAL BUSINESS FOCUS – Soda – Chlorine - ISSUE NUMBER 321 / 15TH NOVEMBER 2007 (*) ECU market price= Value of Cl2 plus 1.1 times market price of NaOH

Historical range of ECU* market prices




• The following Exhibit 8.4 shows the profitability –as indicated by the difference between the production costs for an ECU and its market price- of the chlor alkali industry is strongly dependant on the cyclical variation of ECU prices and electricity costs: EXHIBIT 8.4

Relationship between the production and cash costs of ECU vs. the historical ECU market prices

200

300

400

500

600

700

20 45 70 95

Electricity Cost (€/MWh)

ECU Value (€/mt)

Historical range of ECU market prices:

350-600 €/t

ECU full production costs

ECU cash costs

Current ECU market prices~575 €/t

Source: Prochemics Manufacturing Economics Model and Tecnon OrbiChem Information




• However, at the higher ECU prices prevailing today, the industry can cover its full production costs and still has a good operating margin.

• If the electricity prices increase to 70 €/MWh, as assumed for the future case in this model, there would be little operating margin at full production costs, even at these high ECU market prices. This means that at this point, there will be no incentive for new investment.

• If the ECU market price falls from its current near-record high, the situation will become considerably worse.

• At the extreme, if the ECU market price falls to is historical lows (as can be seen for the year 2004 in the preceding Exhibit 8.4), at the current assumed electricity prices of 45 €/MWh, it will be barely able to cover its cash costs.




• From the above it can be seen that the European chlor-alkali industry is quite vulnerable to electricity price increases, and it may very quickly come into a cost situation where it can not finance new investment, and, at the extreme, may not be able to cover its cash costs.

• This is a marked contrast with the situation in other regions, as can be seen from Exhibit 7.4, which shows that the European cash costs (assuming fully depreciated plants) will be higher than the production costs in other regions (which take into account the capital costs of new plants).

• As a result, there will be no incentive to build new plants in Europe or to invest in the conversion for mercury cell plant technology to membrane plant technology, as well as conduct major modernizations.

• In Europe currently 43 plants in 16 countries – accounting for 43% of the regional chlor-alkali capacity - operate with mercury cell plant technology. Industry has voluntarily agreed to phase out the remaining such plants by 2020.




• The technology conversion will require major investments, and therefore careful economic evaluation by the companies involved. The evaluation will involve comparison of (re-)building plants in Europe vs. building new plants in other regions.

• Given that the European chlor-alkali industry is already a high cost producer compared to the competing regions studied here, any increase in electricity prices will favor building new plants outside Europe, resulting in an industry migration to other regions.

• This migration will be irreversible once the investments for new electrolysis plants have been made outside Europe – these are very large high capital investments – and once moved they will not come back even if the economic situation then improves




• A high electricity price, and therefore chlorine cost will also have an impact on the economics of the derivatives studied here.

• In the case of PVC an increase in the electricity prices from the current 45 €/MWh to 70 €/MWh, will result in an increase of approx 8% on the production costs of PVC – large enough that European producers will continue to lose their export markets and could well see increased competition of imported product in their home markets.

• In the case of polyurethanes and polycarbonates, chlorine is a less important component of their cost structure, and the impact may be less direct.

• Particularly in polyurethanes, the industry structure, with the “System Houses“ represent an entry barrier to new non-European producers from outside Europe. Therefore, it can be expected that imports from this source may not be significant. However, new producers could compete with European producers in new export markets.




• As can be seen in Exhibit 8.5, the costs of producing PVC in Europe1 are already higher than in other regions, and at electricity costs of 70 €/MWh, Europe will be considerable more expensive than other regions, and will barely be able to cover its cash costs at prevailing PVC market prices.

Regional Production Costs: PVC (in €/mt)

607655

573519 515 531

125125

104114 76

140

0

100

200

300

400

500

600

700

800

900

Europe@ 45 €/MWh

Europe@ 70 €/MWh

US Gulf Coast Saudi Arabia China Russia

Source: Prochemics based on Information from Industry, ICIS and Proprietary Manufacturing Economics Model

EXHIBIT 8.5

(*) i.e., excluding depreciation

Full Costs

Cash Costs (*)

xxx

Global Market Price Range Across

Regions

630 to 1050 €/mt 732

677634

671

780

591

(1) Note: This calculation is based on global market prices for ethylene in order to compare only the impact of electricity prices. However there are indications that in some cases the ethylene transfer prices to PVC producers in Saudi Arabia, and possibly also Russia, are significantly lower than the global prices. This would make the competitiveness of PVC produced in these regions even greater compared to European product.




• Given the unfavorable economics of producing PVC in Europe, it can be expected the that the trend of moving EDC/PVC productions the Middle East and Asia or other regions will accelerate. At a certain point it can be expected that some of the extra-regional product may come back to Europe, seriously threatening the survival of the European PVC producers.

• This trend will be reinforced if new chlor-alkali investments in other regions replace chlor-alkali capacity in Europe, as EDC/PVC plants are best located near a chlorine source.

• As a result European employment in this industry will be reduced, and Europe would become increasingly dependent on imports for this key material.

Conclusions

We want :

EU Policy designed to give

Access to low cost, base load electricity Ability to negotiate long-term contracts Removal of entry barriers for new entrant

generators Measures to offset the impact of CO2 on

electricity prices by – for example – direct allowances to intensive electricity users

Documents

Tuesday, 15 th January 2008 Andrew Mackenzie Ad Hoc Group Energy