Polyolefins - A Volatile or Cyclical Future?

APIC 200612 May 2006

Sukanya Jira-arnontConsultant, Nexant (Thailand) Ltd.

- 1 -

Some definitions

Cyclicality: A structural situation that occurs when global operating rates exceed 90% indicating that the market is really tight. Prices increase rapidly and customers hedge further price increases and potential supply constraints by building inventory

Volatility: Sudden price changes caused by global events, competitive action or China’s purchasing behavior. Speculative inventory changes also fuel volatility

Fly up: Sharp increase in prices and inventory building driven by a tight supply/demand balance (global operating rates reach 92%)

Surge: Sharp increase in prices and inventory building driven by a short-term event (Gulf War, hurricanes, etc.): Temporary

- 2 -

What a year!

About the only thing we did not have was a plague!

Katrina

Rita

War

Inventory Building

Record Energy Prices

China

Plant explosions

Volatility: 2005…

YET!

- 3 -

Causes of Volatility

• China• Unplanned supply outages

– Weather related (e.g., US Gulf Coast hurricanes)– Plant operating problems (fires, equipment failure, etc.)– Problems in restarting after a planned shutdown

• Global events – volatile crude oil price, political instability in the Middle East, etc.

• Changes in inventory– Building when it is tight– Depleting when prices start to drop

Volatility can be monitored but not forecast

- 4 -

0200400600800

1,0001,2001,4001,600

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004LDPE LLDPE HDPE

Price

s, CI

F Ho

ng K

ong,

USD

/MT

Asian polyethylene prices appear to be in random disorder until we analyze the causes

Asian PE PricesCIF Hong Kong, USD/MT

Asian PE PricesCIF Hong Kong, USD/MT

- 5 -

Asian polyethylene prices show the impact of cyclicality (fly up) and volatility (surge/events)

¹ 15 CRACKERS/30 POLYOLEFIN PLANTS DOWN

Asian PE PricesCIF Hong Kong, USD/MT

Asian PE PricesCIF Hong Kong, USD/MT

During fly ups and surges, customers build inventory to hedge future price increases which worsens the problem

0200400600800

1,0001,2001,4001,600

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Price

s, CI

F Ho

ng K

ong,

USD

/MT LDPE LLDPE HDPE

Demand and Inventory Buildup(shortage)

Recession

Fly-up

Phillips HDPEExplosion

Surge

China Stops Buying

Gulf War Multiple Supply

Problems

Recession

End of Supply Problems

China Resumes Purchases

China Closes Ports

Asian Crises

AsiaRecovery

September 11

SARS

- 6 -

Cyclicality and volatility are also evident in profitability which generally follows the price curve

Chemical Industry Return, Japan, Korea and U.S.(percent on replacement capital)

-20-10

0102030405060

1990 1993 1996 1999 2002 2005

Perc

ent

Japan South Korea U.S.

- 7 -

China’s behavior is one main driver of volatility – China is the world’s largest polyolefin importer

• Current polymer demand is about 45 percent of total Asian demand. This is projected to exceed 50 percent by 2010

• Polyethylene demand in 2004 accounted for 15 percent of total global demand; polypropylene for 18 percent

• About 50 percent of demand is produced domestically and 50 percent imported. The percentage of imports will increase

• Essentially all polyolefins used for process exports is imported to take advantage of the duty drawback and no VAT

• On a net trade basis, China imports about 42 percent of globallyexported polyethylene and 44 percent of globally traded polypropylene

Sudden changes in China’s purchasing pattern causes volatility

- 8 -

Understanding the China market is difficult. Predicting it is impossible

• Purchasing patterns have always been erratic causing volatility– Government actions (e.g., closing ports)– Inventory building (speculative)– Price sensitivity (lowering purchases when prices are high)– Interpolymer/intermaterial substitution– Other factors (e.g., SARS epidemic, power shortages)

• Polyolefins imports in 2004 and 2005 were below expectations leading to the belief that demand had weakened

• However, in retrospect, this was not the case

A structural change occurred in the China market in 2004

- 9 -

Intermediates import growth was much higher than polymers (as were imports of essentially every other raw material)

0

2000

4000

6000

8000

10000

12000

14000

16000

1990 1995 2000 2003 2004

Kt

MEG SM PTAAN BD VCMEDC

At first glance, polymer demand growth, as seen from imports, was much lower in 2004

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

1990 1995 2000 2003 2004

Kt

PE PPPVC ABSPS/EPS

Only 4% PE growth

- 10 -

A structural change occurred in the China import market in 2004 that continued in 2005

• High virgin resin prices in the Asian export market in the second half of 2004 resulted in an exceptionally strong increase China purchasing post consumer and post-industrial recycled polymer and scrap

• Imported scrap/recycled polymer increased 35 percent in 2004 reducing prime resin imports of which about 300,000 tons was polyethylene and 60,000 tons was polypropylene

• Domestic recycling accelerated as well due to the high prices increasing polyethylene recycling by about 150,000 tons and polypropylene recycling by about 85,000 tons

• This has continued through 2005 as scrap and recycled polymer imports increased to 5 million tons (25% increase from 2004)

• Based on industry sources, this may be peaking by mid-2006 requiring imports of virgin resin to increase again later this year

- 11 -

Imports of recycled polymers, including scrap increased 35% in 2004 and 25% in 2005 reaching 5 million tons

0

2

4

6

1995 2000 2003 2004 2005

Mill

ion

Tons

Polyolefins StyrenicsVinyls All Other

Nexant estimates based on adjusted import data and market research

This is the main reason for lower virgin resin imports

- 12 -

Sources of recycled plastics and scrap imports, 2004

Taiwan12%

USA11%

Japan5%

Australia5%

S. Korea5%

Germany4%

Hong Kong¹39%

All Other 19%

¹ Same approximate supply profile as the rest of China

About 25 countries

comprise All Other

About 25 countries

comprise All Other

- 13 -

Accounting for scrap and new recycling increases polymer growth to normal levels (10-12%)

02,0004,0006,0008,000

10,00012,00014,00016,00018,000

1990 1995 2000 2003 2004

Kt

PE PP PVC ABS PS/EPS

02,0004,0006,0008,000

10,00012,00014,00016,00018,00020,000

1990 1995 2000 2003 2004 2005K

t

PE PP PVC ABS PS/EPS

Polymer demand has not declined – the sourcing has changed!

Virgin Resin ImportsVirgin Resin Imports Virgin Resin + Scrap and RecyclingVirgin Resin + Scrap and Recycling

- 14 -

Two major hurricanes adversely impacted the petrochemical industry in late 2005

• There were two hurricanes (Katrina and Rita) that landed in the U.S. gulf coast

• Katrina had severe damage to New Orleans and surrounding areas• Rita, while less severe, caused damage in the Beaumont, Texas area.

However, due to the extent of damage of Katrina, the entire U. S. gulf coast petrochemical industry shut down

• This caused severe supply shortages with U. S. prices reaching $1800 per ton – a record

• As a result, polyolefins exports out of the U. S. gulf coast stopped and exports from Asia replaced them. In fact, more than 50 thousand tons of polyolefins were imported into the U. S. from Asia during the crisis

- 15 -

Hurricane Katrina hit the New Orleans Area

- 16 -

Hurricane Rita was less intense than Katrina but the impact was more severe (everything shut down)

- 17 -

Ethylene plants in Louisiana and Texas

PPoorrtt AArrtthhuurr CChhooccoollaattee BBaayyoouu

CCeeddaarr BBaayyoouu

SSwweeeennyy

LLaakkee CChhaarrlleess

FFrreeeeppoorrtt

PPllaaqquueemmiinnee

SSeeaaddrriifftt

TTaafftt

TTeexxaass CCiittyy

OOrraannggee

LLoonnggvviieeww

CChhaannnneellvviieeww

CCoorrppuuss CChhrriissttii

LLaa PPoorrttee

BBaattoonn RRoouuggee BBaayyttoowwnn

BBeeaauummoonntt

HHoouussttoonn

PPooiinntt CCoommffoorrtt

GGeeiissmmaarr

OOddeessssaa

PPoorrtt NNeecchheess DDeeeerr PPaarrkk

NNoorrccoo

More than 75% of U. S. polyolefins capacity was shut

down

- 18 -

This had quite large impact on US polymer prices, but not Asia

LDPE, HDPE and PP moved in the same directionPrices are moving back to the pre hurricane level

Asia prices were not impacted by this event

-200400

600800

1,0001,2001,400

1,6001,8002,000

Jan

Feb

Mar

Apr

May Ju

nJu

lA

ugS

ep Oct

Nov

Dec Ja

nFe

bM

arA

prM

ay Jun

Jul

Aug

Sep Oct

Nov

Dec Ja

nFe

bM

ar

2004 2005 2006

US

$/to

n

0

20

40

60

80

100

120

140

US

$/bb

l

LLDPE, US LLDPE, Asia Brent crude

- 19 -

Polyolefins margin has been impacted by the recent high crude oil price situation

Polyethylene margin over ethylene has been dropped significantly in the recent past as ethylene producers can pass on their cost quicker

than polyolefin producers can pass on to their customers

-400

-200

-

200

400

600

800

1,000

1,200

1,400

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Ethylene HDPE PE Margin

-400

-200

-

200

400

600

800

1,000

1,200

1,400

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

PE Margin Brent Crude

CIF SE Asia PriceCurrent US dollar per ton Current US dollar per ton

- 20 -

Cyclicality - investment opportunity arises

• History will repeat and that petrochemical/polyolefin industry will continue its cyclicality pattern

• Industry cycle is 8 years period – Optimistic investment decisions drive a surge in new capacity, creating a glut of overcapacity, then growing demand absorbs excess capacity, restoring a balance to petrochemical markets.

- 21 -

Historically, the petrochemical industry cycle has averaged 8 years peak to peak but the current one is running 10 years

U.S. Petrochemical Industry Profitabilitycash cost margins - constant dollars - cycle case

050

100150200250300350400450

1975 1980 1985 1990 1995 2000 2005 2010

INDE

X, 1

982

= 10

0

10 YEARSPEAK-

TO-PEAK

7 YEARSPEAK-

TO-PEAK

9 YEARSPEAK-

TO-PEAK

Based on projected industry dynamics, a plateau rather than a peak could occur creating an extended period of good margins

- 22 -

New capacity additions in Asia as well as the Middle East contribute to the next petrochemical cycle – Operating rate drops significantly

LLDPE – Global Supply/Demand Balance

-

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2000 2002 2004 2006 2008 2010 2012 2014

thou

sand

ton

per y

ear

Capacity additions per year

-

200

400

600

800

1,000

1,200

1,400

1,600

2000 2002 2004 2006 2008 2010 2012 2014

thou

sand

ton

per y

ear

Asia

Middle East

Large additional capacities are expected in Asia and the Middle East during 2008-2010

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

2000 2002 2004 2006 2008 2010 2012 2014

Thou

sand

ton

per

year

75%

80%

85%

90%

95%

100%

Consumption Capacity Operating rate

- 23 -

So does PP – Operating rate drops sharply after 2008

PP – Global Supply/Demand BalanceCapacity additions per year

Asia shows much larger cumulative capacities added than the Middle East during 2006-2015

0

10000

20000

30000

40000

50000

60000

70000

80000

90000

2000 2002 2004 2006 2008 2010 2012 2014

Thou

sand

ton

per y

ear

75%

80%

85%

90%

95%

100%

Consumption Capacity Operating rate

-

500

1,000

1,500

2,000

2,500

3,000

2000 2002 2004 2006 2008 2010 2012 2014

thou

sand

ton

per y

ear Asia

-

500

1,000

1,500

2,000

2,500

2000 2002 2004 2006 2008 2010 2012 2014

thou

sand

ton

per y

ear Middle East

- 24 -

Based on the supply/demand balances, operating rates are projected to be high for the next couple of years

• The long-awaited cyclical fly up is projected to occur by year end based on the following:– No major global event affecting oil supply or economic stability– Energy prices remain at current levels– Global demand growth will be about 5 percent, essentially in line with

Global GDP growth – China returns to buying virgin resin in the second half of the year– Delays occur with new plant construction in the Middle East

• There is more upside potential than downside potential due to volatility– Unplanned outages could occur especially weather-related

An extended period of profitability could occur

- 25 -

Industry profitability could be sustained based on the lack of new capacity

• The fly up is forecast to start in the last half of 2006 as global polyolefins operating rates reach 92 percent. Prices increase rapidly and customers build inventory as a hedge against future price increases and supply constraints

• Very little new capacity coming on stream in 2007; producer profitability will be extended. Some debottlenecking occurs by year end

• Even in 2008 there still may not be enough capacity to meet projected demand growth (delays in the Middle East will be the main reason). As such 2008 could also be a good year for producers but debottlenecking will reduce operating rates and margins and start the downturn

• Downturn really begins in 2009 accelerates in 2010 with 2011 being the most likely bottom of the cycle. Depth depends upon the amount of new polymer capacity that is built

Companies need to use the period of extended profitability to plan for the downturn

Polyolefins- A Volatile or Cyclical Future?

APIC 200612 May 2006

Sukanya Jira-arnontConsultant, Nexant (Thailand) Ltd.