Ad Hoc Group Energy

Tuesday, 15th January 2008

Andrew Mackenzie
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.
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):
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.
Sources: Euro Chlor, Annual Report 2006-2007
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
 Impact of Electricity Price on the Competitiveness
of the European Chlor-Alkali Industry

Prepared for

Euro Chlor
Brussels, Belgium

Project Nr. 7-05-873r

Prepared by

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

October 2007

Tel.: +41 44 341 1973

Email: office@prochemics.com

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 3. Project Scope and Methodology

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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

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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

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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) EXHIBIT 6.1

60

50

40
€/MWh

30

20

10

0
2001 2002 2003 2004 2005 2006 F 2007 F 2008

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

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

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Global Electricity Prices

• Impact of different cost of CO2 allowances rates on the electricity full cost:
Electricity Full Cost EXHIBIT 6.3

100

90

80
22
70 47
2
7
60 3 3 3
€/MWh

16 CO2
50 3 Taxes
3 3 3
Fuel
40
49 49 49 O&M
23 23 23
30 2 Capital (IRR 8%)
4
20 7 7 7 7
10 17 4 4 4
14 14 14
6 6 6
0
Nuclear Coal 60€/t Coal 60€/t Coal 60€/t Gas Gas Gas
(CO2=4€/t) (CO2=20€/t) (CO2= 60€/t) 25€/MWh 25€/MWh 25€/MWh
(CO2 4€/t) (CO2=20€/t) (CO2=60€/t)

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.

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Global Electricity Prices

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

EU range *

Italy 121

EU average * = 45
Germ any 99

Netherlands 90

Spain 70

United Kingdom 64

Sw itzerland 63

France 58

USA 47

China 30
(*) Estimates for
Russia 19
the European
chlor-alkali
Saudi Arabia 15 industry

0 20 40 60 80 100 120 140

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

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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.

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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.

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 7. Comparative Production Costs of Chlor-Alkali

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Comparative Production Costs of Chlor-Alkali

• Production costs for chlorine in Europe: EXHIBIT 7.1

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

Source: Prochemics Manufacturing Economics Model

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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
Impact of Electricity Costs on Chlorine
EXHIBIT 73
Production Costs
450
ASSUMPTIONS
• Membrane Electrolysis Technology
400
• Plant Capacity: 500 kta chlorine
• Operating rate: 100 %
350 • Salt price: 30 €/t
• Caustic soda price: 275 €/t

300
Cl 2 Cost (€/mt)

250

200

150

100

50

0
10 20 30 40 50 60 70 80 90 100 110 120
Electricity Cost (€/MWh)
Source: Prochemics Manufacturing Economics Model

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Comparative Production Costs of Chlor-Alkali

The chlorine production costs resulting from the model in different regions
are as follows:
EXHIBIT 7.4

US GULF SAUDI
REGION EUROPE CHINA RUSSIA
COAST ARABIA

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

OPERATIONS & MAINT COSTS

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

Source: Prochemics Manufacturing Economics Model

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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:
Impact of Electricity Costs on Chlorine EXHIBIT 7.5
Production Costs* in Europe
300
Cl2 Cost (€/mt)

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

150
USA**
100
Russia

50
China
Saudi Arabia
0
10 20 30 40 50 60 70
Electricity Cost (€/MWh)
Source: Prochemics Manufacturing Economics Model
(*) Cash costs, excl. depreciation (**) US Gulf Coast

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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).

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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 - EXHIBIT 7.6
2005 (in million tons)
45
39
40
35 31
30
29
30
25
20 17
15 11
10 7
5 3 2

0 AN
C

PA
LD

PP
D

PC
PS

T
PV

PE
-H

/S
/L

+E
PE

SA
D

PS
-L

A
PE

S/
B
A

Source: Prochemics based on published information

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Comparative Production Costs of PVC

Production costs of PVC by country:

EXHIBIT 7.8

US GULF SAUDI
REGION EUROPE CHINA RUSSIA
COAST ARABIA

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

OPERATIONS & MAINT COSTS

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

Source: Prochemics Manufacturing Economics Model

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 8. Implications for the European Chlor-Alkali Industry

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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 EXHIBIT 8.1

Production Costs in Europe

Cl 2 Cost (€/mt)
450
ASSUMPTIONS
• Membrane Electrolysis Technology
400 • Plant Capacity: 500 kta chlorine
• Operating rate: 100 %
• Salt price: 30 €/t
350
• Caustic soda price: 275 €/t

300
Chlorine Costs Euro-
pean Future Case 250
Increase of Chlorine
200 Costs in Europe +46%
Chlorine Costs Euro- 150
pean Current Case
USA*
100
Russia Increase of Electricity
Costs in Europe +55%
50
China
Saudi Arabia
0
10 20 30 40 50 60 70 80 90 100 110 120
European European Electricity Cost (€/MWh)
Source: Prochemics Manufacturing Economics Model
(*) US Gulf Coast Current Case Future Case

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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.

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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. EXHIBIT 8.2

Chlorine Costs dependency on Caustic

Soda Prices

ASSUMPTIONS 300

• Membrane Electrolysis Technology 250

• Plant location Europe 200

• Plant Capacity: 500 kta chlorine
€/t Cl2

150
• Operating rate: 100 %
100
• Salt price: 30 €/t
• Electricity price 45 €/MWh 50

• ECU production costs 470 €/t -

200 250 300 350 400
€/t NaOH
Source: Prochemics Manufacturing Economics Model

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 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.

Western European Value of ECU in €/t EXHIBIT 8.3

700

600

500 Historical range of

ECU* market prices

400

300

200
1998 1999 2000 2001 2002 2003 2004 2005 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

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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
Relationship between the production and cash
costs of ECU vs. the historical ECU market prices
ECU Value
(€/mt)
700

600

Current ECU market prices

~575 €/t
500 Historical range of
ECU market prices:
350-600 €/t
400
ECU full production costs

300

ECU cash costs

Electricity
Cost (€/MWh)
200
20 45 70 95

Source: Prochemics Manufacturing Economics Model and Tecnon OrbiChem Information

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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.

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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.

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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

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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.

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 Implications for the European Chlor-Alkali Industry

• 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.
EXHIBIT 8.5
Regional Production Costs: PVC
(in €/mt)

Global Market Price

900
Range Across
780 Regions
800 732
125 677 671 630 to 1050 €/mt
700 634
125
104 591
600 140
114
76
500
Cash Costs (*)
400
655
300 607 573 531 xxx
519 515
200 Full Costs
100

0
Europe Europe US Gulf Coast Saudi Arabia China Russia
(*) i.e., excluding
@ 45 €/MWh @ 70 €/MWh
depreciation
(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.
Source: Prochemics based on Information from Industry, ICIS and Proprietary Manufacturing Economics Model

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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.

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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