Horizon Summer 2011

HorizonASIA PETROCHEMICALS OUTLOOKwww.platts.com Summer 2011

ResurgentThe strength of recovery and challenges remaining in post-disaster JapanShock to the system Forcing the world to question business practices in the wake of the disaster Made in China? Why attempts to temper growth are creating opportunities for others Driving biofuels Mandate vs free market. How best to get the industry off the ground

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EDITORhis years Asian Petrochemical Industry Conference comes against the tragic backdrop of the earthquake and tsunami that struck northeast Japan on March 11 with such devastating consequences. While being shocked by the sheer scale of the destruction, people around the world were moved by the stoic and dignified behavior of the disaster victims. Even as the damaged Fukushima nuclear reactors threatened another wave of catastrophe the people of northeast Japan still managed to conduct themselves in an exemplary fashion. They pulled together, remained disciplined and refrained from looting the latter showed particular restraint, which probably would not be mirrored almost anywhere else. Given the enormity of the earthquake Horizon has dedicated a major section of this issue to looking at how Japans petrochemicals industry was affected by the disaster and how it is reacting to it. So far the countrys industry is getting back on its feet surprisingly quickly. Various petrochemicals plants, that were hit managed to be operational again relatively quickly, while much of the electricity generation sector, against strong odds, was also steadily restoring power. Tragedy aside, there has also of course been plenty of activity across the rest of Asia. China continued to step up its fight against inflation by trying to cool its roaring economy, which has had an interesting knock-on effect of extinguishing speculative activity in certain petrochemical products. The Middle East is emerging as an increasingly interesting destination for Asian investment as the various oil producing countries there attempt to move further downstream in a bid to create new jobs. Meanwhile, the high prices and extreme volatility in commodities markets witness the sudden, dramatic rout at the beginning of May will no doubt provide plenty for APIC candidates to talk about. The recent correction poses questions over the outlook for prices of petrochemicals, many of which have been hiked recently. It will also make many wonder if the fall in the commodities complex points to a return to recession in many key consuming countries or if its just a blip in what is a long-term bull market. The answers to these questions will prove vital to the future profitability of the petrochemicals industry moving forward and are topics that will no doubt be visited in future issues of Horizon.

FROM THE

T

Justin Pugsley

EDITORIALPRESIDENTLarry Neal [email protected]

TEAMVICE PRESIDENT, GLOBAL EDITORIALDan Tanz [email protected]

GLOBAL EDITORIAL DIRECTOR, PETROCHEMICALSShahrin Ismaiyatim [email protected]

GLOBAL DIRECTOR, MARKETS & PRICINGJorge Montepeque [email protected]

EDITORIAL DIRECTOR, ASIAVandana Hari [email protected]

MANAGING EDITOR, PETROCHEMICALS ASIAIhsan Rahim [email protected]

MANAGING EDITOR, PETROCHEMICALS AMERICASKevin Allen [email protected]

MANAGING EDITOR, PETROCHEMICALS EUROPEIlana Djelal [email protected]

MANAGING EDITOR, PETROCHEMICAL NEWSJustin Pugsley [email protected]

SENIOR EDITOR, PETROCHEMICAL ANALYTICSJim Foster [email protected]

GLOBAL PETROCHEMICAL EDITORSLondon - Miguel Cambeiro, David Potter, Monicca Egoy, Nandita Lal, Guilherme Kfouri, Kimberly Peterson, Francinia Protti, Maria Tsay Houston - Paulene Camargo, Maria Eugenia Garcia, Bernardo Fallas, Shameek Ghosh, Carlos Silliman New York - Benjamin Morse Singapore - Chua Sok Peng, Michelle Ho, Clement Choo, Gustav Holmvik, Kimitsu Yogachi, Ng Bao Ying, Joycelyn Chua Tokyo - Anton Ferkov, Fumiko Dobashi Dubai - Shashank Shekhar

CENTRAL EDITING DESKMaurice Geller Chief, Central Editing Desk, EMEA [email protected] Special thanks to: Jonathan Dart, Martin ORourke Platts Editorial Offices: London: 20 Canada Square, Canary Wharf, E14 5LH t: +44 20 7176 7000 Singapore: 30 Cecil Street. #13-00, Prudential Tower, 049712 t: +65 6530 2800 Tokyo: Marunouchi Kitaguchi Bldg 28F, 1-6-5 Marunouchi, Chiyoda-ku. t: +81-3 4550 8831 New York: 2 Penn Plaza 25th Floor, NY, 10121-2298 t: +1 212 904 3070 Houston: Three Allen Center, #3800333 Clay Street, TX 77002 t: +1 713 658 9261 Dubai: Office 212, Building 1, Dubai Media City P Box 73360 .O. t: +971-4391 3170

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HorizonASIA PETROCHEMICALS OUTLOOK

Contents05 Cover story: From the ashes The resilience of Japan's petrochemicals sector in the face of disaster is proving remarkable. Yet many challenges remain Rebooting the economy The Japanese disaster is shaping up to be the most expensive ever. But the reconstruction effort also offers a giant boost to the industry Petchems, power and psychology The vital need to innovate, blowing away gloomy moods, and why electricity is not like air. JPCA Chairman Kyohei Takahashi Shock to the system How the world needs to address a whole spectrum of business practices, from site centralization to just-in-time supply Building the biofuels model Government mandate - or free market? Or is there a middle way? How best to get this nascent industry off the ground The price of relevance Of all the feedstocks that impact on petrochemicals one single commodity ultimately stands out: oil Chinese credit squeeze Measures to clamp down on inflation and temper growth are translating into tighter liquidity. Is there a crunch ahead? The promise of ASEAN-China free trade We examine the impact and extraordinary potential of the 1.9 billion consumer, $6 trillion GDP trade zone The Middle East's move downstream The imperatives of demographics and employment that are prompting a dramatic shift across the region Platts Global Petrochemical Index

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CONTRIBUTORSIhsan Rahim Managing Editor, Petrochemicals Asia Maurice Geller Chief, Central Editing Desk EMEA

Chua Sok Peng Deputy Managing Editor

Anton Ferkov Senior Editor

Fumiko Dobashi Editor

Michelle Ho Senior Editor

Joycelyn Chua Associate Editor

Gustav Holmvik Editor

Clement Choo Editor

Ng Baoying Associate Editor

Kimitsu Yogachi Editor

Shashank Shekhar Associate Editor

04 I Horizon I Summer 2011

Horizon Asia Petrochemicals Outlook

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From the

ashesapanese petrochemical production was badly hit by March's disaster, which caused a 15.3% plunge in industrial output. Not only was production capacity cut but key consumer industries such as automotive and electronics were severely affected. Yet looking further out it is not all doom and gloom. As the year rolls on demand for petrochemicals in Japan is likely to fire up on the back of efforts to rebuild the quake-hit northeast region. Market sources anticipate this demand to materialize after the summer when most petrochemical plants are expected to be running normally again. We may see some decline in the acrylonitrile butadiene styrene sector. Styrene monomer demand may drop in the short term but once the rebuilding [of houses] starts, demand will increase, one Japanese trader said. ABS is heavily used in the electronics and automotive sectors, while SM is a polymer feedstock. The trader also expected demand for expandable polystyrene, which is widely used in the construction industry, and PS for electric equipment, to increase once the rebuilding of destroyed towns begins. Demand for polyvinyl chloride, mainly used for construction, is very likely to increase.

The petrochemicals sector reeled from the impact of the devastating March 11 earthquake and tsunami which battered the northeast of Japan. Yet the speed with which Japans petrochemical industries are recovering is impressive. But as our Asia team finds out many challenges remain

J

ONE MONTH LATER

In the immediate aftermath of the quake fear of not having feedstocks was the dominant sentiment in the industry, which drove prices for many petrochemicals considerably higher. For instance, just over a week after the quake prices of isomer-grade mixed xylenes soared 13% to $1,223/mt FOB South Korea, the highest since July 2008 as market players scrambled to secure cargoes. Meanwhile, PX surged to a record high of $1,815/mt CFR, gaining 12% in just three days after the quake. But despite the scale of the devastation the petrochemicals markets were managing to find some form of equilibrium by the end of April. The industry quickly adapted itself to the new reality defying predictions by some analysts of prolonged serious shortages. In an unprecedented move to counter sharply rising PX prices, the major Chinese purified terephthalic acid producers announced a series of turnaround plans to cool prices. Between March and May, Chinese PTA makers cut production by 500,000 mt, which reduced their combined PX requirement by 335,000 mt over three months.



Indeed, the measure appeared to have an effect as many in the industry were predicting prices for April Asia PX to reach as high as $1,700/mt CFR. In the end they hit $1,690, still a historic high, but eventually prices did start to fall off. Even Japan managed to resume normal PX exports sooner than many had expected with JX Nippon Oil & Energy Corp lifting its PX force majeure from May and even beginning to sell spot cargoes by mid-April. The initial impact on spot benzene prices was also not prolonged as demand from Japan was not as big as expected. At the end of March, the benzene benchmark stood at $1,149/mt, down $63.50/mt from the months high. A key factor that provided relief to the market was that JX had exported most of its benzene cargoes to its contract buyers before the earthquake struck. It was also able to meet remaining demand for March even though several of its plants were affected by the quake. By the end of April, JX had restarted its 165,000 mt/year benzene plant at Negishi and a 107,000 mt/year plant at Kawasaki, both located in eastern Japan. A similar story played out in the aromatics sector where demand for gasoline blending turned out to be smaller than initially expected. Just after the quake, market sources were predicting that Japans domestic gasoline demand would become bullish for gasoline blending in order to compensate for production shortfalls due to refinery shutdowns. But just one month after

the quake, Japans gasoline supplies were once again ample after domestic refiners raised their refining capacities in western Japan. Many refineries are running at full capacity. Previously, just after the earthquake, there was buying and stocking up of gasoline. But recently, there has been a softening of gasoline demand. The market may realize that there is more gasoline supply than actual demand, said a Japan-based trader in April. The Asian polyolefins markets also calmed down within one month. Olefins supplies from Japan have become tight but demand has also been sluggish from China. There are no desperate olefins buyers in the market, a trader said. In addition, market sources said the operational recovery of petrochemical plants was much swifter than expected. Just after the earthquake, four naphthafed steam crackers out of the total 15 were shut down, accounting for 23.5% of Japans total ethylene capacity. But all the steam crackers in eastern Japan were now scheduled to be restarted by June 20 after completing inspections and repairs. On the other hand, the Asian PVC market is seen remaining firm. Even though all of the quake-hit PVC plants are scheduled to be restarted by the end of May Japans imports of commoditygrade PVC are likely to remain high. Japanese producers will produce specialgrade PVC for their customers, but they will continue relying on imports for commodity grade, a market source said.


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POTENTIAL SHORT CIRCUIT?

Japans industry is certainly not yet out of the woods. The countrys electricity generation capacity was badly affected and for the power-hungry petrochemicals industry that represents a potentially serious threat. Though utilities companies have responded quicker than many analysts had expected, and cutting excessive power consumption has helped too, the northeast of the country could still face power shortages, especially during the peak summer months due to the surge in power demand for air conditioning. The PVC industry, for instance, is particularly concerned due to its high power usage compared with the energy levels required for other types of petrochemicals. Japans petrochemical crackers are also anxious. Japanese SM producers voiced concerns over possible demand slowdowns as SMs key downstream products are ABS and polystyrene, which are used in the automotive and electronics industries. We are investigating the impact of the disaster on the downstream market, one Japanese producer said in April. It is difficult to forecast even the customers cannot forecast their operating rate after June. Domestic demand is unclear. Post-quake parts shortages have forced Japanese car makers such as Toyota and Honda to reduce their production. Production rates were

getting back to normal in April but the auto industry is considering reducing production again during the summer. This could cause a downturn in demand for ABS and high impact PS for use in the car industry, Japanese market sources said. ABS demand from the Japanese automotive sector was estimated to be down by about 20%, according to estimates made in late April by an Asian ABS producer. He also anticipated that there would be a 20-30% fall in demand from makers of office equipment typically turning out items such as printers and photocopiers. He added that the situation and outlook was not very clear within the sectors themselves, but operating rates were expected to fluctuate over April to July and possibly longer due to power shortages. Market sources noted a potential threat to the production of olefins, and consequently, aromatics. Typically, steam crackers and aromatics plants are supported by power generators based within their complexes. But the fuel oil and gasoil shortage, in line with rising thermal power operations by Tokyo Electric Power Co, the owner of the stricken nuclear power plant in Fukushima, may reduce fuel supplies for these power generations. We cant just switch petrochemical plants on and off, like automobile assembly lines, lamented a source at Tosoh, the largest vinyl chloride monomer producer in Japan. Run cuts during the peak summer demand season are a more realistic option for petrochemical producers.



SHIPOWNERS NERVOUS

The Japanese petrochemical industry is also experiencing difficulties in securing imports as some ship owners do not want to go to east Japan because of radiation fears, especially after the government raised Tepcos nuclear crisis to Level 7 making it one of the worst nuclear accidents ever. Foreign shipowners are particularly concerned about going to Japan, said a source at Maruzen Petrochemical. The company needs to import naphtha to run its steam crackers due to supply shortage from Cosmo Oils Chiba refinery.

Radiation fears also looming in the aromatics freight market. Fewer want to go to Japan, said a shipbroker. There are several cases of foreign ship owners not wanting to come to Japan. It may lead to export delays of petrochemical products, the the Japan Petrochemical Industry Association (VEC) said in late April. Nonetheless, the speed with which Japans petrochemicals industry has started recovering is impressive. It still faces challenges, many beyond its control such as the state of the power industry,

but there are grounds for optimism that the industry will once again assume the dominant position it enjoyed in Asia before the disaster struck. [email protected] [email protected] [email protected] [email protected] [email protected] [email protected]

JAPAN CRISIS FACT BOX

The 9.0 magnitude earthquake and the following tsunami that devastated northeast Japan on March 11, 2011, shut a number of petrochemical assets near the epicenter. There are nine naphtha-fed steam crackers located near the epicenter of the quake with a combined ethylene capacity of 4.41 million mt/year, accounting for around 57.5% of Japans total ethylene capacity. Of the nine, four steam crackers were immediately shut following the disaster. They have a combined ethylene production capacity of 1.805 million mt/year, accounting for 23.5% of Japans total ethylene production capacity. The following is a list of petrochemical plants that were shut immediately after the disaster and scheduled restart dates.LOCATION Kashima COMPANY NAME Mitsubishi Chemical STATUS STILL SHUT MAY 20 RESTART UNIT No. 1 No. 1 No. 2 No. 2 PRODUCT Ethylene Propylene Ethylene Propylene Polypropylene Low density polyethylene Linear LDPE High density/LLDPE Benzene Acetone Phenol Styrene monomer Ethylene oxide Ethylene Propylene Propylene Monoethylene glycol Benzene Toluene Solvent-grade MX Benzene Toluene SM Ethylene Propylene Benzene Paraxylene Propylene Refinery-grade propylene Paraxylene Refinery-grade propylene Polymer-grade propylene CAPACITY 375,000 170,000 476,000 260,000 300,000 62,000 168,000 110,000 412,000 150,000 250,000 371,000 290,000 550,000 230,000 230,000 115,000 200,000 85,000 72,000 120,000 36,000 40,000 404,000 260,000 107,000 350,000 140,000 120,000 590,000 60,000 100,000

END-JUNE RESTART

Chiba

Maruzen Petrochemical

APRIL 4 RESTART APRIL 4 RESTART

Chiba

JFE Chemical

END-APRIL RESTART

Kawasaki

JX Nippon Oil & Energy

MARCH 29 RESTART END-MARCH RESTART OCU

Negishi Kashima

MAY RESTART EARLY MAY RESTART

RFCC

RFCC RFCC

Sendai

MAY RESTART


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Rebooting the

economyfrom the construction of new buildings. PVC tends to be highly sensitive to the vagaries of the economy, and its fortunes correlate closely with those of the construction industry. There are a number of factors, though, such as power shortages, which suggest that domestic producers could find it difficult to fully participate in the forthcoming construction boom. Of the economy, US brokerage firm AllianceBernstein in a special report on the disaster characterizes the process of economic recovery from a typical natural disaster as a game of two halves: Initially, there is a significant hit to growth, reflecting the loss of lives, destruction of productive capacity, and the resulting inability of normal business activity to be conducted. Indeed, this seems to be whats happening with Japanese industrial production plunging 15.3% month-onmonth in March, the sharpest drop since records began in 1953. The report added that the cleanup process that follows along with monetary easing and reconstruction activity does end up boosting GDP over a number of quarters. Many economists believe that by the third quarter the economy should be growing again anyway. AllianceBernstein analysts hacked back their forecast for Japans GDP growth for 2011 in view of the disaster to minus 0.2% from a positive 1.6%. However, the broker sees brighter prospects for 2012-13 where it forecasts GDP growth in excess of 3%. Swiss global bank UBS meanwhile, is more tempered putting less emphasis on the hit to economic growth from the disaster and pegs it at plus 1 % for 2011. But by the same token it sees less of a pick-up effect from the reconstruction in 2012 where its forecasting GDP growth of 2.5 %. Meanwhile, the Bank of Japan reduced its growth forecast for the year to April 2012 to 0.6% from the 1.6% it was estimating before the disaster. But it also upped its projections for growth in the year to April 2013 to 2.9% from 2.0% previously.A TYPICAL NATURAL DISASTER?

The earthquake and tsunami that hit Japan on March 11 was the most expensive natural disaster on record. Though the economy is widely expected to rebound, issues such as power shortages and worries over government debt levels could still throw a spanner in the works. Justin Pugsley reports

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he destructive power of natural disasters and wars, while always tragic for affected populations, more often than not act as a catalyst for rapid economic growth later on. Damaged infrastructure, homes and factories need to be repaired or rebuilt and this inevitably feeds through to more demand for labor, materials and sees an increase in corporate activity. Certainly this dynamic will play out in some form in Japan following the earthquake and tsunami that struck the northeast of the country on March 11 with such deadly force. The Japanese disaster is shaping up to be the most expensive ever in terms of the pending reconstruction bill. The World Bank thinks the cost could be between $122 billion and $235 billion 2.5-4.0% of GDP while Japans Cabinet Office thought the figure could reach as high as $300 billion. By contrast the last big quake to hit Japan in Kobe in 1995, and itself among one of the most expensive natural disasters ever, cost $100 billion, equivalent to 2% of GDP . Typically, developed states, and Japan counts as among the most advanced in the world, have far more expensive and complex infrastructure in place than would be the case in many developing countries. That makes the cost of rebuilding very high. But therein lays a potentially favorable backdrop going forward for parts of the petrochemicals industry. If the pattern of recovery, led by reconstruction, plays out it would be expected that a sector such as polyvinyl chloride will benefit considerably

The disaster in Japan prompted US investment bank Goldman Sachs to do some probing into the economic impact of similar natural shocks. After sifting through reams of data from case studies it concluded that natural disasters tend to result in a big reduction in average GDP growth followed by a quick rebound in the following quarter. It noted that even in the case of very large disasters the impact on economic growth tends to fade quickly from the data, in part because in most cases the boost from government spending offsets the fall in activity in other parts of the economy. After whittling hundreds of samples down to the most relevant cases Goldman Sachs was left with 40 disasters in 23 different countries to analyze. Of those, nine occurred in developed countries and the remaining 31 in emerging market countries. Examples include the Kobe earthquake, Hurricane Katrina in the US in 2005, and the Indonesian earthquake and tsunami in 2004. It found that earthquakes are by



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Ongoing electricity rationing will undoubtedly cause further widespread disruption, given that shipments from manufacturers in the Tepco service area account for about one third of national productionfar the most destructive of natural disasters in terms of the human impact and direct economic damage. Goldman Sachs estimates that growth is reduced by an average of 3 percentage points, on an annualized basis, in the quarter in which the disaster occurs, although this finding is distorted by the experience of emerging market countries. Unsurprisingly, Goldman Sachs economists found that the more destructive disasters produce a bigger hit to growth. But in purely economic terms there is often a favorable trade-off with the bigger events. Investment growth dips but then accelerates strongly in the next one to two quarters, which suggests that the rebuilding of destroyed capital stock is an important component of post-disaster GDP resilience, the reports authors wrote. Also, disasters have historically had a negligible impact on average on the short-term dynamics of inflation, government budget deficits and even on exchange rates, the reports authors found. Homing in on the case of the Kobe earthquake, Japanese industrial production fell 2.6 % month-on-month in January 1995, but swiftly rebounded by 2.2 % in the very next month said Goldman Sachs. For the three months after the January earthquake, industrial production growth in Japan averaged 1.5 % month-on-month, double the average of the three months prior to the earthquake. It appears that the speed of the economic recovery is largely attributable to government spending and that applied to other cases as well, the investment bank said.POWER FAILURE

But economists warn that there are three potential harbingers of bad news that could trip up the recovery. There are the lingering worries over the state of the damaged nuclear reactors, electricity shortages, and the very high levels of government debt. In the immediate future the big worry is the damaged nuclear reactors at Fukushima, which have contaminated nearby land. This is being classified as the worst nuclear disaster since Chernobyl, 25 years ago in Ukraine then part of the USSR. And for as long as the problems linger at Fukushima and they could do so into next year there will be some hesitancy to invest nearby or even in areas largely unaffected. The issue with the nuclear reactors has quickly cascaded into another problem10 I Horizon I Summer 2011

which is particularly pertinent to the power-hungry petrochemicals industry. Damage to power supplies has led to the rationing of electricity, which inevitably causes expensive production shutdowns for industry. Some companies for example have been giving employees extended vacations to help save on power. In Japan the problem is compounded by the fact that it has two different electricity grids operating on different frequencies, one for the east and the other for the west, making power sharing between them very difficult. Those grids are also not interconnected to any foreign ones. This means that when one grid struggles it cannot rely on other grids for extra capacity. Ongoing electricity rationing will undoubtedly cause further widespread disruption, given that shipments from manufacturers in the Tepco service area account for about one third of national production, said Japanese brokers Daiwa in a report. Tepco the Tokyo Electric Power Company is the utility that owns the stricken Fukushima plant. A number of non-nuclear plants were also affected with Tepco seeing around a third of its power generation capacity out of order as late as one month after the disaster. Another utility group Tohoku Electric was also impacted by the disaster. Much of the power supply has now been restored though it does remain fragile and during the peak summer season its resilience will be tested again, a point highlighted by investment bank Barclays Capital. It warned in a report that power supplies could become really strained during the summer leading to potential rolling blackouts. The use of air conditioning spikes dramatically during the summer. But thats not all: Note that commercial and industrial facilities and residential buildings were also damaged or destroyed by the tsunami and earthquake, the reports authors said. This means that power loads are unlikely to recover to their pre-earthquake levels in 2011, and possibly some load was lost forever.SOME PETCHEMS MAY MISS OUT

In the end the domestic PVC industry may miss out on some of the expected demand from the rebuild. Though plants that were affected by the disaster are coming back online they may well produce below capacity for some time. This could see some reliance on imports to fill the demand gap.

Power rationing, especially over the summer months, certainly wont help and may not only impact the production of PVC, but also hit it further upstream such as with the manufacture of feedstocks like vinyl chloride monomer and ethylene dichloride Then, for producers of petrochemicals that are used in automotive products, such as butadiene, acrylonitrile and styrene monomer, there could be a structural shift in some of their downstream markets. The automotive industry for example, stung by its heavy reliance on Japan for some components, is likely to consider shifting some manufacturing abroad, to ensure security of supply. The same applies to Japanese car makers, which suffered the most. The other potential spoiler to a textbook post-disaster recovery is Japans public sector debt mountain, which is among the highest in the developed world standing at 200% of GDP This is . important because it is heavy government spending that typically kicks off the reconstruction process. In the immediate aftermath of the disaster fixed income investors were giving Japan the benefit of the doubt over its long-term creditworthiness. Besides most holders of Japanese government bonds are domestic investors. However, in response to the disaster and its potential economic and fiscal impacts rating agency Standard & Poors (like Platts, a member of The McGraw-Hill Companies) reduced its outlook on Japan to negative, but did at least reaffirm the rating at AA-. A deteriorating demographic profile and little likelihood of substantive policy change we have argued that Japans fiscal position is unsustainable, warned AllianceBernstein. With the savings rate declining, prospective asset allocation shifts make the tipping point closer. And the scary part is that this was the case before the cost of reconstruction was even factored in. The rebuilding of northeast Japans broken infrastructure and the subsequent economic recovery still face a number of hurdles before reaching their zenith. But there could be a glimmer of hope as some economists think the disaster could galvanize a renewal, which might lead to a more dynamic economy. Indeed, the Japanese have successfully reinvented themselves following national disasters on numerous occasions during their long history. [email protected]

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Petchems, power and

psychologyWhere will Japans petrochemical industry fit in the Asia of the future? How much disruption will the new complexes in the Middle East and China present? And what unique challenges will Japan face in the aftermath of the March 11 disasters? Anton Ferkov talks to Kyohei Takahashi, Chairman of Showa Denko and Chairman of the JPCA

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his years Asia Petrochemical Industry Conference takes place in extraordinary circumstances. It was long planned for late May in Japan. Then disaster struck on March 11 with the magnitude 9.0 earthquake, devastating tsunami and resulting and continuing nuclear crisis. But while the country was hit by its biggest human tragedy in recent modern history, the Japan Petrochemical Association decided not to cancel APIC 2011, but to move ahead with it, its goals only reinforced by the chain of disasters. We want to make this event a big success, says JPCA Chairman and Chairman of the board of directors of Showa Denko KK, Kyohei Takahashi. The theme of APIC 2011 is Realizing New Opportunities through Petrochemistry, which was already decided before the disasters this year, Takahashi said. By choosing this theme, the JPCA wanted to reflect that the world is changing and changing, and that instead of fighting for each others share in existing markets, the way to go for especially Japanese and other Asian petrochemical producers is to grab opportunities by developing new products. We deliberately said petrochemistry not petrochemicals to reflect that feeling of the need for continuing development of new value-added products, Takahashi explained, noting that already the petrochemical industry of 20-30 years ago was a very different animal from what it is now. We need to keep on changing that. In innovation and developing new products for electronics, IT-related products, lightweight products for automobiles, the Japanese petrochemicals industry has been heading this way already and is at the cutting edge in many fields. It will need increasingly to move in this direction, Takahashi said.

LEANING ON CHINA

Takahashi was predicting an unstable year ahead although he expects China to continue supporting global demand. China seems to be the only country right now pulling up the global economy, and I dont see that changing, Takahashi said. But in China too the economic outlook is less rosy than before as the Chinese government needs to keep inflation under control, while at the same time maintaining steady economic growth. The government there sees that the economy has been overheating and is trying to cool that down, although it cannot afford to let the economy cool off too much. But the worry is that nobody else than China seems to be able to pull up global demand. If China grows by 10% for three years in a row, that growth will be equivalent to Japans total demand, therefore I am not worried about demand in Asia, he noted. However, there are problems galore in other parts of the world, which are seen as potentially threatening to economic growth and petrochemicals demand. Currently there are so many unstable factors such as the EU [sovereign financial straits] while the US is also unstable with political deadlocks that could last until the presidential elections [in November next year], but the biggest destabilizer in the world at the moment is the Middle East [and North Africa], he said. Revolutions by the people are not easily suppressed and we can expect that the region will remain unstable for the foreseeable future. This will take time and can spread to other countries as well.CRUDE OIL CRUNCH

Takahashi said the big focal point for Asias petrochemical industry is the soaring crude oil prices sparked, by unrest

in the Middle East and North Africa. He is concerned that the unrest may be prolonged and fan out to other countries, which would further fuel speculation and keep crude oil prices rising with no end in sight for very expensive oil. Noting that crude oil prices are much higher than economically justified, he called on politicians to step in to control abnormal speculation in crude oil, and undertake a global initiative to calm down the unrest in the Middle East. Takahashi said that the price of crude oil is a big worry for the JPCA, because if it continues for a very long time, it could cool off the demand for petrochemicals, If this continues for a very long time, will the [petrochemicals downstream] market be able to absorb this? I think this will be very difficult, and it could cool off the market. And while Japanese petrochemical producers are mostly dependent on oilderived naphtha as a feedstock, they cannot drastically lower operating rates at petrochemicals plants when customers retreat because of high prices as this would have a huge negative impact across the whole economy, triggering further rounds of falling demand for petrochemicals. On the other hand, can we really get hold of all the feedstock and pay those high prices? Takahashi asked. He stressed that the chances for Japanese petrochemical producers to be able to fully pass on feedstock costs to customers is small. This is partly because in the current Japanese economy it would be very difficult to see an environment that supports inflation. In reality we should increase our prices time after time, but if we increase too much, demand will fall, this will be a big dilemma for us for the coming two to three years.


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The Middle East has already brought online a lot of new petrochemicals productive capacity and will continue to do so in the coming years, but in reality not all of the vaunted capacity necessarily materializes, Takahashi said: Often just 60-70% of the nameplate capacity comes on stream. He also stressed that people should not forget that when comparing production capacity figures not everything can be fit into one big framework called petrochemicals, as it is a very diverse picture nowadays. Polyethylene is one example where there are numerous grades that cannot easily if at all be swapped by end users due to the different characteristics and qualities of the different grades. What kind of markets are expanding and by how much is the question it is extremely diverse nowadays, Takahashi said. To this end, he sees Japanese petrochemical producers continue increasingly to focus on electronics, IT-related petrochemicals, and automobile parts. High functional, lightweight material, isolation materials, all these products will grow very robustly in the coming years and Japanese petrochemical producers are focusing increasingly on these products. By coming up with these new products, we Japanese petrochemical producers create our own demand for our products, he said. Therefore I am not worried about oversupply for petrochemicals as some people have feared in the past.THE DARK CLOUD

Japanese offices and homes have been able to cut back as superfluous usage of electricity was seemingly rampant. People thought that electricity was like air, always and anywhere available in unlimited quantities, but it is not. For instance, those fully automatic toilets with heated seats, are perhaps too much convenience for what human beings really need... perhaps the cut in electricity supplies has brought us back to earth a little bit. However, the biggest problem facing the Japanese petrochemical industry at the moment is not the power shortage, nor new capacities in the Middle East and China, says Takahashi, but the gloomy mood in large parts of the country. I am not worried that electricity demand cannot be met, I am more afraid of the negative physiological consequences for the Japanese economy relating to the ongoing nuclear problems at Fukushima, he explained. If the problems at Fukushima carry on for a long time, this will continue to stall the Japanese from moving forward more positively. It will hang as a dark cloud above peoples minds, and they will tend to feel less inclined to use money or to go on trips, and will likely stay more indoors, things like that. Everybody will be very conservative in spending money. It will be a very difficult period in the short term for Japan, but we have very great recovery ability, we will surely recover.RIDING THE DISASTER

The tsunami of March 11 shut down a significant percentage of Tokyo Electric Power Cos power generation capacity and the general impression following the first few weeks of the disaster was that the electricity shortage would hit manufacturers in eastern Japan hard during the peak summer months. However, as the weeks have rolled by, a combination of massive energy savings and increased power generation volume by Tepco have softened that prediction. Takahashi was hopeful that in the coming months demand would not increase to the point where it would trigger blackouts, even during the height of summer. I dont expect that there will be a huge peak demand this summer partly because of all the energy-saving measures companies are already taking. Already, offices and shopping malls across eastern Japan, have been cutting back on their electricity use at an extremely fast rate, he noted. In addition, Takahashi stressed that petrochemicals and chemicals producers in eastern Japan have quite a lot of in-house power generation capacity which they are looking to use to the full. Some companies even will sell their electricity surplus to Tepco, he said.

In the aftermath of the disaster, many have asked whether current rules covering safety and earthquake resistance would need to be overhauled. Takahashi was adamant that this was not needed. He said petrochemical plants in Japan have already been built according to the tightest regulatory standards, based on the best estimates on the strength of earthquakes they could reasonably be subjected to. For instance, there was no liquefaction at the plants in Tokyo Bay,

although some residential areas had been hit by that phenomenon. He said this illustrates that measures taken to make petrochemicals secure have worked. The size of the tsunami that hit the Fukushima nuclear plants had been beyond the so-called scope of assumption, that made up scientists simulations. Based on the latest earthquake, the government may in future change the criteria but there is no need to have these instantly changed due to this earthquake, Takahashi said. Nor did Takahashi see any direct change in the location of petrochemical plants in Japan, though he thought that it could be a catalyst for more broad cooperation across petrochemicals hubs in Japan and could accelerate the process of having multiple global production sites for certain products. Takahashi said that there is no incentive at all to shut petrochemical plants in eastern Japan and move capacity to central or western Japan where the earthquake did not hit and where electricity supply is unlikely to be rationed in the coming years. It could be the other way around as well. He said that the disaster has forced companies and by no means just those in the petchems industry to think about spreading the risk for their product deliveries by having production sites and supply chains not concentrated on just one location but to have multiple ones around the globe. However, he said this should not come as a surprise, and would anyway be in line with the trend of globalization which Japanese companies have become very familiar with over the last few decades. Ultimately, Takahashi stressed that the typical Japanese reaction to these kinds of disasters is to make a strenuous effort to get everybody to pull together and get back on track as fast as possible rather than to leave the region. The Japanese temperament in this kind of situation is to stay put (in eastern Japan) and fight the challenges as hard as one can. [email protected]

espite the tragedy that struck Japan, just weeks before APIC 2011, the JPCA was determined not to cancel the event but forge ahead with it. We want to make this event a big success, Takahashi said, stressing that the events following March 11 have made this feeling even stronger. The JPCA wants to show a picture that Asia is not only India and China, but as a whole Asia is important with a lot of opportunities for petrochemicals for the rest of the world as well, Takahashi said. Asia is becoming increasingly the global center for petrochemicals.

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The JPCA decided to hold APIC 2011 in Fukuoka, on the island of Kyushu, because it symbolizes the historical tight relationship between Japan and other parts of Asia. Through the centuries, Japanese civilization has been absorbing many new aspects introduced by China and Korea ranging from Chinese characters, architecture, moon calendar, agricultural products such as green tea, and Buddhism. This area (Kyushu) has been historically the most important entrance gate into Japan for cultural influences from China and the Korea, spreading from there to all over Japan.Summer 2011 I Horizon I13


Shock to the

systemapan is home to a myriad of global brands and household names in automotive, technology, and industrial sectors. Toyota, Honda, Nissan, Mitsubishi, and Sony all rank among Japans global elite and are prime examples of companies that grew during the post-war boom into brands that redefined quality, reliability and innovation. The auto and construction industry remain the biggest outlets for petchems markets, and provide a good indicator of demand. JD Power estimates that approximately 248 kg of resins go into the manufacture of a typical car. Looking upstream, a shutdown at an aromatics plant like JX Nippons PX unit certainly takes away feedstock for the polymer, but if the gasoline market is hit at the same time, as was the case with the quake, pygas, the feedstock for the feedstock, also gets diverted away from producing polymer. The process is difficult to control at the best of times. Throw in the most expensive natural disaster the nation has ever faced, and the link between petchems and consumer markets becomes increasingly clear. Quality control of consumer goods goes hand in hand with the ability to control processes along the entire supply chain. On March 11, the supply chain for some of the most famous consumer brands on the planet was disrupted by a massive earthquake and tsunami, which literally shifted the axis of the earth. Although the Japanese economy has a history of recovering quickly from devastation, things rarely go on as business as usual. In a typical market the consumer is protected from constantly fluctuating prices by term contracts at every stage of the supply chain. An increase in the price of wheat may be tempered down or dissipated to nothing by the time the price is passed

From petchems to consumer markets, the supply chain was hit at multiple points by the earthquake and tsunami in Japan. Ihsan Rahim investigates the impact and complexity of the petchems downstream markets, and looks at how the way business is done may change as a result

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A natural disaster does a lot more than attack a single point in the supply chain. Being a geographical phenomenon, it has more impact points than starting a single domino effect

down to a consumer product like bread. As wheat is sold to flour mills, flour is sold to dough makers, before selling it to bakers, then onto packaging, and ultimately ending up on shelves. The price of bread is comparatively stable, which means that someone, somewhere along the chain is absorbing the impact. Contracts along the supply chain are essentially series of dams that protect the customer from waves in upstream prices. The position of the dam under the most stress may vary depending on negotiating power of purchasers or producers, but typically the flow is lighter the further downstream. A natural disaster does a lot more than attack a single point in the supply chain. Being a geographical phenomenon, it has more impact points than starting a single domino effect. Different parts of the supply chain are attacked at the exact same time, resulting in an uneven and unpredictable knock-on effect. Prices of feedstocks markets like aromatics and olefins may shoot up on restricted supply at the same time as those of downstream polymers. Meanwhile the dough makers in the middle may be sandwiched by rising costs on either side, while they themselves cannot pass through increases in prices. This was seen in the PTA market which has been plagued by poor consumer demand, with the ceiling on prices set by Chinese buyers who could not afford to pay for increasing fiber prices. There is no doubt that the flow of prices from upstream to downstream will return to normal again, but in the meantime prices and risk along the chain are uneven, chaotic, and there is no guarantee that the leveling off in flow will be smooth. The pressure points every time are unique, and the market reaction too will be tailored to avoid similar losses going forward.


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Japanese companies had already taken measures to spread their supply chain risk before the quake. Honda, which produces the largest number of engines by volume of any company, has done its utmost to go global. More than 80% of Honda and Acura products sold in the US are produced in North America. The vast majority of these parts and materials are sourced from 600 suppliers based on the continent. However, the system is not standalone, and for global efficiency, a few critical parts continue to be supplied from Japan. The result has been shutdowns at manufacturing sites in the US and Europe. Car manufacturers may now be considering how to avoid these bottlenecks in the future. Toyota has taken extra measures to keep the factory line running with minimum disruption, but the business risks and threats of a downgrade in corporate rating are very real. The company has only recently experienced negative publicity from braking and accelerator systems in its cars, including the Walkman of green cars, the Toyota Prius.

Coincidently the Toyota Prius is only manufactured in Japan, and models on showroom floors in Europe and the US have demanded a heavy premium on the sticker price since the quake. This may not have led to cars selling at a premium, as buyers post 2008 will tend to stick within budget. But the bargaining power of the consumer is greatly reduced by the lack of supply. Only by mid-April did Toyota Motor restart vehicle output at all 18 plants in Japan. The three largest automobile manufacturers, Toyota, Nissan Motor and Honda, have had to cut back output in Europe. Toyota said three vehicle production plants Burnaston in England, Adapazari in Turkey and Onnaing in France will be affected by the latest production issues. Output at engine manufacturing facilities in JelczLaskowice in Poland and in Deeside, Wales, was also halted, as well as at 14 North American factories While the three prefectures in northeast Japan Iwate, Sendai and Fukushima hit hardest by the March 11

quake, may have seen up to 270,000 vehicles lost in the disaster, there is no official car loss figure, and the Hokkaido branch of the Japan Iron & Steel Recycling Institute has made an estimate based on the prefectures car ownership data and disaster damage reports. Industry sources said the 270,000 cars possibly lost would not necessarily mean that there would be fresh demand for 270,000 cars. We are not sure if these people who have lost their cars will buy a new one. Many have lost homes as well as cars, and possibly means to earn an income, said a spokesman for Japan Automobile Dealers Association. Non-Japanese motor companies have also had to deal with the bottleneck in auto parts supplies. General Motors production at its Shreveport, LA plant had to be halted and the company laid off workers temporarily at a second facility in Buffalo, New York, due to part shortages. In any case, manufacturers looking for alternative means of supply will loose an element of quality control, which has, for the most part, defined Japanese build quality.Summer 2011 I Horizon I15

Horizon Asia Petrochemicals Outlookmagnetic tapes, blu-ray discs, and lithium ion batteries have been hit by the quake, with Sony suffering production losses for all of the aforementioned. One thing seems clear: consumers will pay higher prices for Japanese goods if they can buy them at all. Japan produces small components like transistors and silicon wafers that are used to make microchips and the disaster puts into perspective the exposure to the risk of having a main global manufacturing site. Another impact has been the logistics of supplying Japanese parts to the rest of the world as a result of radioactivity concerns. Japanese cargoes have seen increased quarantine restrictions, prompting Japans government-run trade insurance company to cover financial losses caused to Japanese exporters as a result of unproven claims of cargoes tainted by high radiation levels. Changes in business culture are dependant on how quick the recovery is. The damage caused by the tsunami is on a much greater scale than previous quakes. Japans recent woes arguably are its worst. It is a threefold catastrophe including the devastating earthquake, tsunami and potential nuclear meltdown. The economic impact as a result could be closer to SARS in 2003, which saw a larger drop in private consumption than a typical natural disaster. Just as the chemicals sector became armchair experts at predicting weather during hurricane seasons in the US Gulf, economists may again start looking at correlations and relationships in nature to plan for large scale shocks to the supply chain. One of the most popular iPhone apps in Japan following March 11 is one that predicts quakes and tsunamis. The scientific community has been debating if the largest tectonic shifts in the earth occur when the moon is closest to the earth (a supermoon, as was seen in March the moon will make its closest approach to Earth in 18 years) due to the increased gravitational pull. The market will want to limit the impact of future disasters and may not discount this is a plausible theory as a forewarning of another earthquake. Even if the modus operandi reverts back to norm, when the right indicator predicts with enough forewarning, another shock to the system, be it an earthquake, tsunami, or volcano, a disaster prevention plan would go into effect. Just as technical analysis patterns like the Hindenburg Omen used to portend a stock market crash, may not be fact, when it triggers the market notices. As a result, geologists may get a louder voice, and if the supermoon theory holds true, it may not be unfeasible for supply chain managers in the future trying to identify constraints, risk along the chain, to alter their buying and supplying habits to look towards the sky. [email protected]

Polymers consumption in the auto sector has always veered towards specialty grades. Human interaction and safety concerns dictate that this will always be the case. Under normal circumstances polymer buyers for autos will require consistency of supply, and rigorous testing of materials to deal with stresses of everyday driving as well as for safety. So parts are not interchangeable, cannot be viewed as the commodities they are derived from, and will typically be supplied by contract to guarantee consistency of quality and supply. The quake has served to highlight exactly how rigid the supply chain has become to ensure uniformity on shelves and the showroom floor. Ford has had to stop taking new orders for cars in Tuxedo Black, and is limiting orders of three shades of red. While it works on alternative supply, the consumers choice gets limited. Of course in the long run the color palette of a new car may seem trivial, but the issue is indicative that the secondary supplier of paint will not be identical to pre-quake models. Another question for the consumer that arises is, will 2011 be a bad year for secondhand cars, in the same way that a bad harvest year impacts the price of wines? It is unlikely that any quality effect will last long enough to be noticed by the consumers. Although Japans industrial output focuses away from disposable goods, the average replacement rate of cars, gadgets and large electrical appliances is falling to a shorter time span. The iPad is yesterdays new toy as the ironically short-supplied iPad 2 becomes the model to have. Even during the recession, US buyers put off trading in their old vehicles with new ones as a means of saving money, but were quick to replace older stock quicker than consumer confidence figures could be published. The debate on whether the recovery was borrowing from the past or from the future ensued. In either case, no side believed that any recovery was real. Aside from diversification and alternate routes of production to protect the brand, the quake has highlighted how quickly the knock-on effects of one disaster could spread16 I Horizon I Summer 2011

globally. Plants and production sites around the globe shut down within days simply because factories did not have enough stock to tide them over while parts shipments were delayed. Along the petrochemical chain, suppliers and buyers have become increasingly sophisticated in their buying patterns as one means of protecting themselves from price volatility of raw materials. Polymer inventory levels among consumers are now measured in days compared to as little as five years ago when they were measured in weeks or even months. Just in time buying was viewed as the most efficient way to run a supply chain, and stocks were viewed as inefficient. The recent shock to the system may once again highlight the need for stocks as an insurance against disruptions to supply. However this will ultimately have a cost to the industry. For chemicals, companies typically avoid holding too much stock at the end of the year for tax purposes, but that too could become a secondary consideration. Stockpiling which was viewed as a cost to the manufacturer suddenly looks like it could cost the industry money in the long term. The reality of the petchems industry is that stocks are not easy to control. One process, like steam cracking, yields a mixed bag of output, and on a day to day basis what is made is determined by the highest value of the output, not necessarily as a supply chain consideration. Heavy olefins suffer globally, as ethylene remains the primary output from lighter feeds. Similarly styrene monomer, used to make polystyrene for insulation and as packaging for all of those consumer goods, is essentially manufactured as a by-product of benzene. As the world goes green, the demand for packaging falls, the applications decrease (eg, CD covers) and the market is characteristically oversupplied. Unsurprisingly markets like styrene have had to adopt a wait and see approach on how the quake has affected it, accepting that it is not the marginal product, is at the whims of the larger market around it. Consumer goods are no different. Manufacture of component goods such as

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Building the

biofuels modelWhat will it take to get the biofuels industry off the ground in Asia? Michelle Ho takes a look at two very different approaches, one in the Philippines and one in Thailand, to see whats working and whats not and why

hat does it take to build a completely new business? There are those who argue strongly that government intervention is instrumental even essential in getting new industries, such as biofuels, up and running. How else can a nascent industry stand up to more established counterparts in other countries, they say. But there is an opposing view, which sees the free market as the answer where economic agents are left to seek and exploit opportunity wherever it may reside. Free marketeers say that state intervention distorts the efficient allocation of resources in an economy, creates aid junkies and political patronage and saps competition even in the worst cases

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brings about stagnation. Such arguments are being heard now across Asia over the question of how best to stimulate the creation of a biofuels industry. As a starter, demand for biofuels is very much rooted in government mandates stipulating its use and that holds true for Asia. For biofuels schemes to get off the ground the industry has to establish infrastructure, manage global trade flows and drive transparency, but it is finding this difficult to do in Asia, because there is intense competition for feedstocks from other industries. At the same time, government measures such as subsidies and import tariffs tend to distort the market, creating an extra headache for industry to navigate.Summer 2011 I Horizon I17


THE PHILIPPINES STRUGGLES

The Philippines is the only Asian country with an extensive, nationwide 5% ethanol program, for transport fuel, which was mandated in 2006 and is the regions largest consumer of anhydrous fuel ethanol. The Biofuels Act was enacted for the purpose of developing and utilizing indigenous renewable and sustainable clean energy sources to reduce dependence on imported oil and to increase rural employment and income. But the Philippines has had little success so far in growing its domestic biofuels program, because simply put, the pricing mechanism does not work, market participants say. The proof is that more than four years after passing the Act and with 2011 being the year it was supposed to be in full force, the country isnt producing a single liter of ethanol. Thats because the feedstock for ethanol in the country is primarily sugarcane and molasses, which has all been sucked into sugar production because profit margins are far greater. Structurally, the Philippines is already severely short of ethanol, which is hardly surprising given that it is priced 40-50% less than its more developed and profitable cousin sugar that is in turn, due to differences in the import tariffs imposed on both products. Therefore since the second half of 2010, the Philippines has been importing all its ethanol requirements due to a production halt at local plants and inherent structural shortages. In order to meet the E5 mandate, the country requires 200 million liters/year of ethanol, and 400 million liters/year to fulfill its E10 mandate. Up to the last quarter of 2010, local production was only 40 million liters/year. In addition, scarcity of sugar, exacerbated by a delayed 2010 harvest on the back of El Nino helped prices rocket above 35 cents/pound in February though they have eased since.THE GULF EXCEPTION

For free marketeers there is at least one heart-warming example of success with practically no state intervention whatsoever for driving biofuel demand. For that they need to look to the Persian Gulf, which imported sizeably larger volumes of ethanol in the first quarter of

this year despite the absence of mandates, simply because the economics worked. At least 140,000 cu m of E90 cargoes were shipped to the Persian Gulf from the US for gasoline blending in the first quarter alone, 80,000 cu m of which went to Iraq, industry observers reported. That was more than half the 200,000 cu m volume shipped to the region in 2010, and around half of the 250,000-300,000 cu m volumes shipped there in 2009, sources said. Buyers were gasoline blenders and blending demand for non-conventional blendstocks such as ethanol have been surging since January when crude oil, gasoline and blendstock values started to rally. There is no mandate there, but in any given day when ethanol is cheaper than gasoline it gets sucked into, or out of the system, said one industry source. From the beginning of this year, the price of a key blendstock, MTBE, has soared 38% from $922/mt FOB Singapore on January 4 to $1,270/mt on April 21. Prices of MTBE in Northwest Europe had rallied 48% to fresh record highs from $915/mt FOB ARA on January 4 to $1,353/mt FOB ARA on April 20. This tracked a similar bullish price trend in the gasoline markets. From the beginning of the year, 92 RON gasoline values increased 25% to $129.51/b, 95 RON gasoline prices rose 25% to $131.35/b and 97 RON gasoline values gained 24% to $132.52/b, all as of April 21. As such, all available supplies of MTBE from the Persian Gulf were shunted towards Europe, leaving a gaping hole in demand for octanes in the region. Yet at the same time, blend values for MTBE weakened with the decline in inter-RON spreads and it grew to be less economical to use MTBE as a blendstock in gasoline. But comparatively, prices of undenatured, anhydrous grade ethanol on April 21 were at $805/cu m, a far cry from the $1,270/mt value of MTBE. I would buy US E90 ethanol for blending instead of MTBE, if the specs allow it, said the trader in late April. Already lots of E90 is going to the Persian Gulf if the prices remain [at these levels] I would expect the Far Easts blenders to find it as well, [with] big cargoes out of the US Gulf and New York Harbor.

And yet, the state-interventionist camp would argue that some form of government mandating is still needed to ensure that biofuels have stable demand and that this is needed to drive investment. It took considerable government intervention to spur ethanol production in the US and Brazil.THE THAI WAY

There could be something of a middle way, however. Several market sources point to Thailand as testament to a successful biofuel initiative for there are no mandates in place, although there are targets, and ethanol consumption levels have risen 138% to 2.96 million liters/day in 2011 from when the program first began in 2008. Thailand is Asias largest ethanol producer and as of January 2011, the total usage of ethanol-blended fuel in Gasohol 95, gasohol 91, E20 and E85 was 12.03 million liters/day. In 2010, energy consumption levels in Thailands domestic commercial market was estimated at 1.2 million b/d of oil a day, costing the nation Baht 1.52 trillion (around $50.75 billion), statistics from the Department of Alternative Energy Development and Efficiency showed. Thailands Renewable Energy Policy is targeting a 20.3% replacement of the countrys total energy consumption with biofuels ie, ethanol and biodiesel, by 2022 which means a daily ethanol consumption of 9 million liters/day. The Thai government has since 2008, adopted an effective pricing strategy in its bioethanol development plan that promoted the usage of E5, E20, and E85 ethanol-blended fuel. The DEDE publishes a monthly ethanol reference price on the official website of the Energy Policy and Planning Office under the Ministry of Energy, as part of its ethanol policy. The ethanol reference price serves as guidance for price discussions between the local ethanol producers and oil companies that provides some basis of a guarantee on the return on investment for producers. On that basis, negotiations then proceed on the terms of supply and demand. The Thai Ministry of Energy utilizes two measures to ensure the price of ethanol-blended gasoline is always lower than regular gasoline. The first is an


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excise tax that is imposed on gasohol (ethanol-blended gasoline) and regular gasoline. The excise tax on regular gasoline as of end April is Baht 7/liter (around $0.87/gal), while the excise tax on E10 gasohol was Baht 6.3/liter and Baht 5.9/liter for E20 gasohol. Therefore, the excise tax on gasohol with a higher percentage of ethanol is proportionally lower at every level, creating a permanent discount on ethanol-blended gasoline. Secondly, the Ministry of Energy imposes an oil fund levy on the consumption of fuels in the country, a surcharge on top of excise taxes. This levy is adjusted according to market conditions and not fixed, unlike the excise tax. But like the excise tax, the levy is proportionately lower in comparison to regular gasoline, based on the percentage of ethanol content. For instance, for regular gasoline, the levy as of the end of April was Baht 6-7/liter, but there was none for E20 gasohol and E85 gasohol receives a subsidy on top of that levy. Thus, instead of having a mandate, the government of Thailand incentivizes the consumption of biofuels by maintaining this price gap with conventional fuels. Our policy is to keep the price gap of the final retail price at a level that can psychologically promote the use of bioethanol, said Twarath Sutabutr, Deputy Director General of the Department of Alternative Energy Development and Efficiency. Thailands ethanol pricing strategy was also crafted on the basis of consumer psychology to ensure its effectiveness. We conduct consumer surveys to determine how much discount between regular gasoline and gasohol is required for them to make the switch to gasohol and adjust the spreads accordingly, said Twarath. We started with a Baht 1 discount then Baht 2, but saw no improvement in take-up rates. But when we moved it to Baht 3, we started to see an increase in consumption. Now the discount is around Baht 9-10 and it is very effective because consumption is going up on the basis of economics. We use market mechanisms to induce demand. On top of an effective pricing strategy, Thailand is also well-endowed with abundance in feedstock supplies for ethanol sugarcane and cassava which feeds its ambitions to grow its exports

to the region and allow the country to invest in the markets infrastructure. In effect the Thai authorities manipulate market prices to incentivize biofuel consumption, which in turn spurs investment in the sector.RISING GLOBAL INTEREST

In the global ethanol marketplace, competition for supply from the traditional centers of production in the world, namely Brazil and the US, is intensifying, especially as ethanol is fast gaining popularity as a gasoline blendstock globally. Brazil, the worlds largest exporter of ethanol has since December 2010, imported unprecedented volumes of the product due to a culmination of several factors a poor 2010 harvest, weak expectations for the 2011 harvest, an extended inter-crop season, high sugar prices and higher domestic demand. According to industry observers estimates, Brazil imported around 200 million liters of ethanol from the US between the end of last year and into the first quarter of this year. Brazil has also imported gasoline since then, in a rare move, due to a poor sugarcane harvest and the countrys domestic demand for gasoline sharply rising. That, coupled with the Persian Gulf importing a significantly larger volume of ethanol in the first quarter of this year, meant spot ethanol supplies to Asia have been substantially reduced. While it is difficult to say if those trends would evolve into longer-term scenarios, Asias production capacity is on the rise to meet the regions growing demand, especially from Thailand and Vietnam. While the only clear spurt of demand in Asia is from the Philippines, for a total of 400 million liters/year, there is a risk that Asia is heading for an oversupply of ethanol because of the growth in output. And that will be the case unless the blendstock market opens up further to ethanol. But that, say market participants, is what it is expected to do. Indeed, industry observers say, not only does ethanol as a biofuel have a good marketable image, but its competitiveness against other blendstocks is definitely on the rise. [email protected]

There is no mandate there, but in any given day when ethanol is cheaper than gasoline it gets sucked into, or out of the system

We conduct consumer surveys to determine how much discount between regular gasoline and gasohol is required for them to make the switch to gasohol and adjust the spreads accordingly

Summer 2011 I Horizon I19

Industry fact box

Methanol-To-Olefins At A GlanceMethanol as a feedstock for olefins production is considered increasingly an option despite the more complicated production methods compared with other feedstocks. Olefins, which are basic blocks for many petrochemicals, are in Asia mostly produced from naphtha, sometimes with some additional feedstock such as LPG and gasoil. In the Middle East and in some parts of Southeast Asia, olefins are mostly made from ethane. Methanol, which is a liquid, can be produced from methane gas or from syngas retrieved from coal. This is regarded as a key to push coal into a renewed limelight as a major feedstock for liquid fuels and petrochemicals. China is rich in coal reserves and is virtually the sole country currently trying to start a viable, large-scale methanol-to-olefins petrochemicals industry.

CHOICE FOR LAST RESORT

To use coal as feedstock for liquids production has long been regarded as a last resort due to the higher costs compared with crude oil or natural gas. Coal was first commercially used in Nazi Germany in 1936 due to the lack of oil for the production of gasoline. South Africa, which was also seeing a dearth in crude oil

supplies during the years of apartheid has also been pushing to use coal-to-liquids technology. Petrochemicals production has been mostly restricted to methanol in China, while in other countries some petrochemicals such as benzene can be produced from coking gas, which is released as a byproduct from coke production in the iron and steel industry.

CHINAS DOMINANCE

China methanol production capacity was around 38 million mt/year at the end of 2010, of which at least 80% was estimated to be downstream from coal, with the remainder produced from natural gas. The China Petroleum and Chemical Industry Association expects Chinas boom in new methanol capacity to continue and hit 50 million mt in 2015. Virtually all of Chinas new methanol capacity that will be brought on line in the coming years will be for methanol-to-olefins, or methanol-to-polyolefins complexes. At the end of 2010, total methanol capacity at methanol-toolefins/ polyolefins plants is around 5.6 million mt, while this is expect to grow to 46 million mt/year in the coming yearsalthough some of the expansion plans may never

be implemented. No other country is using coal to produce methanol and build up a downstream petrochemicals industry. Irans Fanavaran Petrochemical has a 120,000 mt/year propylene plant at Fanavaran under construction, which will use methanol as feedstock. The completion date of this plant is not fixed yet, although it was supposed to be finished in 2010. Total Petrochemicals started up its methanol-to-olefins pilot project in Belgium at the end of June 2010. The company said then that the pilot plant would open the way to a very efficient production of polyolefins based on methanol from alternative feedstock such as coal, natural gas or biomass.

ECONOMY OF SCALE

Although the expansion under way in China is unprecedented, the country is planning to have stricter guidelines in place to enhance to tighten regulation, improve efficiencies, and stave off haphazard development that has led to the underutilization of existing capacities of coal-based petrochemical industries such as methanolto-olefins and DME, Chinas National Development and Reform Commission announced in April 2011. As part of the guidelines it announced that the NDRC has suspended approvals for coal methanol-to-olefin projects

with an annual capacity of 500,000 mt/year or less, and coal-to-methanol projects of 1 million mt/year or less. Larger projects will be subject to approval according to standards set out by the NDRC. Projects that do not meet emissions guidelines will also be barred from purchasing land, applying for loans, or raising private funds. The NDRC is a macroeconomic management agency under the countrys State Council. It formulates and implements strategies for Chinas economic development, and also examines and approves major construction projects.

WHY CHINA IS MOVING AHEAD

China has a huge need for energy, and which is expanding rapidly. For instance, the metric ton oil equivalent an indicator for energy demand for China is forecast to nearly triple to 907 million mtoe in 2035, from 367 million mtoe in 2008, according to data from Japans Ministry of Economy, Trade and Industry. China already has a huge coal-based methanol production capacity of around 38 million mt/year. Methanol is widely used for gasoline blending in China, while methanol derivative dimethyl ether is used for blending into LPG China has one of the largest proved recoverable coal reserves in the world. According to the 2010 Survey of Energy Resources from the World Energy Council, it has the third largest reserves at 114.500 billion mt as of end-2008.

Investment in coal-based industries is also part of the central governments policy to expand jobs to the periphery of the country such as the provinces of Inner Mongolia and Shaanxi, which also have large coal reserves. As these methanol-to-olefins producers target local end-users nearby, they have a competitive edge compared with production hubs in the coastal areas or imports. High returns. The Chinese Academy of Science says that coal liquefaction plants are more likely to be located near coal mines, where the price of coal is low and stable, and not influenced by fluctuations in transportation and shipping costs. It estimates that the overall profits of direct coal liquefaction is 3.96 times higher than at an oil refinery.


WHAT MAY STALL A RAPID EXPANSION

The paper margins are negative at times, sometimes less profitable compared with other feedstocks such as naphtha. High energy and water usethis may be the key for many development projects. According to the Chinese Academy of

Science, the water consumption at a direct coal liquefaction plant is 5.95 times higher than at an oil refinery, electricity usage is 7.3 times higher, and fuel consumption is 7.52 times higher to get the same amount of output.

Line up of Major Chinese MTO producersCOMPANY NAME Yancon Group Co LOCATION METHANOL Shaanxi (Yulin) 2.4 PRODUCTS OLEFINS DOWNSTREAM Aromatics 0.8 PROGRESS Phase 1: 600,000 mt meth completed in Aug 2009. Phase 2: 520 urea, 300 meth, commercial runs estimated 2012-13, Phase 3: 1.2 m meth, 600 PP . Phase 3 to be completed in 2015 In operations since Aug 2010 Phase 1 in operations, Phase 2 pending approval Start-up

Baotao Shenhua Petrochemical TangDa Duolun Zhongyuan Dahua Co of Henan Coal & Chemical Industry Corp Shenhua Ningxia Coal Industry Group

Inner Mongolia Inner Mongolia Henan (Hebei)

1.8 1.67+3.33 1.5

0.6 (estimate)

PE 0.3, PP 0.3 PP 0.46, PP 0.92

0.6

PP 0.6

Ningxia

1.67

0.6 (estimate)

PP 0.52

Startup 2010

Sinopec Zhongyuan Henan (Puyang) 1.8 (estimate) Dalian Fujia Liaoning (Dalian) Shandong (Zaozhuang) Inner Mongolia 3.6 + 3.6

0.6 1.2+1.2

PE 0.26, PP 0.1

2012 Phase 1 under construction, commercial runs estimated 2012-13. Phase 2 still plan. 2013 Phase 1 still under construction, commercial runs estimated 2012-2013 Under construction, commercial runs estimated 2012-2013

Legend Holdings Menghua energy

3 1.8

1 0.6

Yanzhou Coal Inner Mongolia Mining Erdos Energy Chemical Co. Shaanxi Yanchang Zhongmei Yulin Nengyuan Shaanxi Yulin Energy Chemical Co Chiatai Energy Chemical Group, Xinxing Group Corp, others Pucheng Clean Energy Chemical Company Shaanxi (Yulin, Jingbian) Shaanxi (Yulin) Shaanxi (Yulin)

1.8

0.6

1.8

0.6

PP 0.6, PE 0.6

under construction

1.8 3

0.6 (estimate) 1

PE 0.6, PP 0.6

Plan, on line after 2013 Phase 1 still under construction, commercial runs estimated 2012-13

Shaanxi (Weinan)

1.8

0.6 (estimate)

HDPE/LLDPE swing plant: 0.3; PP:0.4

Completion 2013

Sinopec and Henan Henan Coal Chemical Industry Group JV Sinopec Total Petrochemicals, China Power Investment Shenhua/ Dow Chemical Anhui (Huainan) Inner Mongolia

1.8

0.6

under construction, commercial runs estimated 2012-13 MEG 0.6 polyolefins 1 2013 2015

1.7 3 (estimate)

0.6 1 (estimate)

Shaanxi (Yulin)

3.32

1.22

MEG 0.4; Acrylic Start-up expected 2016 acid: 0.15; EDC/ VCM 0.51, PVC: 0.5



www.platts.com

relevanceThe extreme swings in the price of oil, seen in 2008 and again in 2011, have shown the inter-dependence between the global economy and arguably the most important global commodity. Platts explores this relationship furthert is well documented that the growth of energy consumption over the next 20 years will be dominated by Asia, with China and India leading the way, followed by Brazil, Russia and Africa. Two important ingredients work in their favor population growth and income growth. China, in particular, is expected to see its population reach around 1.4 billion by 2030 while Indias population is expected to peak around 1.5 billion, according to the 2010 Revision of the World Population Prospects report published by the Population Division of the United Nations Department of Economic and Social Affairs on May 3. The current world population of close to 7 billion is projected to reach 9.3 billion by 2050. In terms of economic growth, China overtook Japan as the second largest economy in 2010, behind the United States. Its first quarter 2011 Gross Domestic Product firmed 9.7% year-on-year. Although slightly lower than the 9.8% recorded in Q4 2010, the country remains in an enviable position, including putting

The price of

I

measures to slow down its growth in order to tackle its high inflation rate. India, meanwhile, is expected to see its Q1 GDP around 8.5%, according to the World Bank, but it will have to contend with an inflation rate of around 8.3%, attributed mainly to high food costs. The countrys central bank, the Reserve Bank of India, had in May hiked interest rates for the ninth time in 15 months by 50 basis points, warning there could be a likelihood of short-term impact on economic growth as the country fights inflation.NORTH AMERICA OIL DEMAND DOWN, ASIA PACIFIC UP

In 2009, total North American oil demand fell by 5% to 22.8 million barrels/day, compared to Asia Pacific, which saw oil demand up by 1% to 26 million b/d, according to a report by oil major BP published in January. Global oil demand is expected to hit 89.3 million b/d in 2011, led by growth in non-OECD (Organization of Economic Co-operation and Development) Asian countries.

China is the largest source of oil consumption growth, with consumption forecast to grow by 8 million b/d to reach 17.5 million b/d by 2030, overtaking the US to become the worlds largest oil consumer, BP said. In contrast, the International Energy Agency, in its latest monthly oil market report published May 12, estimated world oil to average 89.18 million b/d in 2011, down from its previous estimate of 89.36 million b/d. World oil demand is now expected to register year-on-year growth of 1.29 million b/d in 2011, 150,000 b/d less than previously estimated, the agency said. IEA said high oil prices in Q1 and weaker economic growth in the OECD were eroding expected oil consumption. The bulk of the downward revision came from the rich countries of the OECD, and was particularly prompted by slightly weaker prospects for North America, where high oil prices may have finally begun to dent oil demand, the IEA said in its report.

Top 25 Oil Consumers

Thousand barrels daily 2009Source BP Statistical Review



Several factors a large downward revision to US demand in February, weak March data, a higher oil price assumption and reduced expectations for economic growth have led us to cut expectations for regional demand growth in 2011, the agency said.GENERAL DEMAND WAVERING ON HIGH COST

The May report confirmed the agencys earlier report published in April, when it said world oil demand growth was showing signs of slowing down in reaction to current high crude prices. There are real risks...that a sustained, $100/barrel-plus price environment will prove incompatible with the currently expected pace of economic recovery, the agency said. In the US, the worlds biggest oil consumer, the IEA said retail fuel prices were reaching levels at which motorists start to cut their consumption. If prices remain at current high levels, the IEA said it believed US gasoline consumption will decline this year, despite the typically expected seasonal uptick over the summer. In the run up to the summer driving season, US regular retail gasoline prices have moved from $3.07/gallon at the start of the year to $3.96/gallon at the start of May, with the January-May period averaging around $3.50/gallon, according to figures from the Energy Information Administration. In contrast, the regular gasoline price for the same period of 2010 was around $2.76/gallon. In China, the worlds second-biggest oil user where consumption has been growing rapidly in recent years, demand growth slowed to an annual rate of 9.6% in February, down from 13% in January and 15.9% in December, the IEA said, adding that private Chinese motorists may be starting to feel the pinch from high fuel prices.BENCHMARK BRENT OFF YEAR HIGHS

the news that Al-Qaeda leader Osama bin Laden had been killed, although the kneejerk reaction was more pronounced on May 5. What was seen as positive news for the US pushed the dollar higher a higher dollar means it would be more expensive to pay for crude oil which in turn prompted oil market players to liquidate their positions on the futures floor. However, a number of market analysts more rationally attributed the fall in oil prices to a combination of weak economic figures from the US, as well as the digestion of the fact that oil supplies are at a comfortable level and demand from US may not be as forthcoming as typically anticipated ahead of the driving season.NOT OUT OF THE WOODS

GDP growth figures from Eurozone Country Eurozone Austria Belgium Cyprus Estonia Finland France Germany Greece Italy Netherlands Portugal Slovakia Spain Q1 2011 0.8% 1.0% 1.0% 0.0% 2.1% 0.3% 1.0% 1.5% 0.8% 0.1% 0.9% -0.7% 1.0% 0.3% Q4 2010 0.3% 0.9% 0.5% 0.4% 2.3% 1.7% 0.3% 0.4% -2.8% 0.1% 0.7% -0.6% 0.9% 0.2%

Note: Ireland, Luxembourg, Malta and Slovenia have yet to reportENOUGH STOCKS

Seemingly bucking the typical trend ahead of the summer driving season, physical crude oil prices have also shaved off over 10% from this years high as of mid-May, as market participants were spooked by a cocktail of news which presented more uncertainty to the market. The benchmark Dated Brent the price of the North Sea Brent, Forties, Oseberg and Ekofisk grades crude basket has fallen from a year-high of $126.64/barrel recorded on April 11, to $113.73/b on May 16, Platts data shows. The Dated Brent prices averaged the month of April at $123.49/b versus $116.16/b for H1 May. The broad sell-off in commodity prices, in particular oil, began on May 2 following

The rate of people unemployed in the US rose 0.2% to 9.0% in April, according to data released by the US Bureau of Labor Statistics, May 6. This rise erased the two consecutive falls recorded in February (8.9%) and March (8.8%), and brought the unemployment rate in the worlds largest economy back to Januarys level of 9.0% (December 2010 was at 9.4%). The positive development in April was that, since reaching an employment low in December 2009, US manufacturing sector added 250,000 jobs, including 141,000 in the first four months of 2011

Horizon Summer 2011

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