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

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

2 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, and this 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 due to 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.

3 The products of the chlor-alkali industry rarely go directly to consumers. However, an enormous range of products and 2,000,000 jobs in Europe depend directly or indirectly on chlorine (see Exhibit 4.0): Sources: Euro Chlor, Annual Report 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.

4 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 CO 2 Ability to pass on costs is extremely limited Future investment is under severe threat

5 P R O C H E M I C S Project Nr r Impact of Electricity Price on the Competitiveness of the European Chlor-Alkali Industry Prepared for Euro Chlor Brussels, Belgium Project Nr r Prepared by P R O C H E M I C S Ltd. Zurich, Switzerland October 2007 Tel.:

6 P R O C H E M I C S Project Nr r 3. Project Scope and Methodology

7 P R O C H E M I C S Project Nr r 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

8 P R O C H E M I C S Project Nr r The project scope is as follows (contd.): 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

9 P R O C H E M I C S Project Nr r Global Electricity Prices The electricity prices traded in the European exchanges have more than doubled in the last four years: Increase ~ +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

10 P R O C H E M I C S Project Nr r Global Electricity Prices Impact of different cost of CO 2 allowances rates on the electricity full cost: Source: Prochemics based on Information from DGEMP of the Ministiere de lEconomie, de Finances et de lIndustrie, France (2003). Note: These prices do not necessarily reflect prices paid by chlorine producers. EXHIBIT 6.3

11 P R O C H E M I C S Project Nr r Global Electricity Prices EXHIBIT 6.6 General Industrial Power Price (in /MWh) EU average * = 45 Sources: Prochemics based on Information from IEA; Eurostat; EIA (2006). EU range * (*) Estimates for the European chlor-alkali industry

12 P R O C H E M I C S Project Nr r 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 CO 2 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 CO 2 allowances.

13 P R O C H E M I C S Project Nr r 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 CO 2 emissions.

14 P R O C H E M I C S Project Nr r 7. Comparative Production Costs of Chlor-Alkali

15 P R O C H E M I C S Project Nr r Comparative Production Costs of Chlor-Alkali Production costs for chlorine in Europe: Source: Prochemics Manufacturing Economics Model Process TechnologyMembrane CellDiaphragm CellMercury Cell PRODUCTION CAPACITY (kty) 500 PRODUCTION COST (/mt) RAW MATERIALS (/mt) /mt NET RAW MATERIALS NET UTILITY COSTS [of which electricity (/mt)] [210][207][250] NET VARIABLE COSTS OPERATIONS & MAINT COSTS NET OPERATIONS & MAINTENANCE PLANT GATE COST CORP G&A 13.8 TOTAL PRODUCTION COST (ECU) TOTAL CASH COST Cl 2 PRODUCTION COST (ex NaOH) EXHIBIT 7.1

16 P R O C H E M I C S Project Nr r Comparative Production Costs of Chlor-Alkali 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 Source: Prochemics Manufacturing Economics Model EXHIBIT 73 ASSUMPTIONS Membrane Electrolysis Technology Plant Capacity: 500 kta chlorine Operating rate: 100 % Salt price: 30 /t Caustic soda price: 275 /t

17 P R O C H E M I C S Project Nr r Comparative Production Costs of Chlor-Alkali The chlorine production costs resulting from the model in different regions are as follows: Source: Prochemics Manufacturing Economics Model REGIONEUROPE US GULF COAST SAUDI ARABIA CHINARUSSIA RAW MATERIALS (/mt) /MT NET RAW MATERIALS UTILITY COST (/MT) NET UTILITY COSTS NET VARIABLE COSTS OPERATIONS & MAINT COSTS NET OPERATIONS & MAINTENANCE PLANT GATE COST CORP G&A 13.8 TOTAL PRODUCTION COST (ECU) TOTAL CASH COST (ECU) Cl 2 PRODUCTION COST (ex NaOH) EXHIBIT 7.4

18 P R O C H E M I C S Project Nr r Comparative Production Costs of Chlor-Alkali 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 Source: Prochemics Manufacturing Economics Model (*) Cash costs, excl. depreciation (**) US Gulf Coast EXHIBIT 7.5 ASSUMPTIONS Membrane Electrolysis Technology Plant Capacity: 500 kta chlorine Operating rate: 100 % Salt price: 30 /t Caustic soda price: 275 /t Saudi Arabia China Russia USA** Europe

19 P R O C H E M I C S Project Nr r 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).

20 P R O C H E M I C S Project Nr r 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 Source: Prochemics based on published information EXHIBIT 7.6

21 P R O C H E M I C S Project Nr r Comparative Production Costs of PVC Production costs of PVC by country: Source: Prochemics Manufacturing Economics Model REGIONEUROPE US GULF COAST SAUDI ARABIA CHINARUSSIA RAW MATERIALS (/mt) /MT PVC NET RAW MATERIALS UTILITY COST (/MT) NET UTILITY COSTS NET VARIABLE COSTS OPERATIONS & MAINT COSTS NET OPERATIONS & MAINTENANCE PLANT GATE COST CORP G&A 13.8 PVC TOTAL PRODUCTION COST PVC TOTAL CASH COST EXHIBIT 7.8

22 P R O C H E M I C S Project Nr r 8. Implications for the European Chlor-Alkali Industry

23 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry The cost position of the European chlorine industry relative to other regions is shown below. European Current Case Increase of Electricity Costs in Europe Increase of Chlorine Costs in Europe Saudi Arabia China Russia Chlorine Costs Euro- pean Current Case USA* Europe Chlorine Costs Euro- pean Future Case European Future Case +55% +46% Source: Prochemics Manufacturing Economics Model (*) US Gulf Coast ASSUMPTIONS Membrane Electrolysis Technology Plant Capacity: 500 kta chlorine Operating rate: 100 % Salt price: 30 /t Caustic soda price: 275 /t EXHIBIT 8.1

24 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry 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.

25 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry 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. 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 Source: Prochemics Manufacturing Economics Model

26 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry 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 8.3 Source: Tecnon OrbiChem - CHEMICAL BUSINESS FOCUS – Soda – Chlorine - ISSUE NUMBER 321 / 15TH NOVEMBER 2007 (*) ECU market price= Value of Cl 2 plus 1.1 times market price of NaOH Historical range of ECU* market prices

27 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry 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 Historical range of ECU market prices: /t ECU full production costs ECU cash costs Current ECU market prices ~575 /t Source: Prochemics Manufacturing Economics Model and Tecnon OrbiChem Information

28 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry 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.

29 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry 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.

30 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry 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

31 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry 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.

32 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry As can be seen in Exhibit 8.5, the costs of producing PVC in Europe 1 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. 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 (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.

33 P R O C H E M I C S Project Nr r Implications for the European Chlor-Alkali Industry 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.

34 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 CO 2 on electricity prices by – for example – direct allowances to intensive electricity users


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