Chemicals Primer

Equity Research

14 June 2005 Global Chemicals

Chemical Industry Primer, 2005–2006

THIS CHEMICAL INDUSTRY PRIMER IS A BROAD INTRODUCTION TO THE CHEMICALS SECTOR, ITS STRUCTURE, ITS PRODUCTS, AND ITS KEY DRIVERS.

CSFB'S GLOBAL CHEMICAL TEAM HAS UPDATED AND EXPANDED THIS VALUABLE REFERENCE SOURCE.

WE HAVE INCLUDED A SECTION DESCRIBING OUR GLOBAL INVESTMENT METHODOLOGY, EXPANDED OUR DESCRIPTION OF ETHYLENE ECONOMICS, ENLARGED OUR DISCUSSION OF GENETICALLY MODIFIED FOODS (INCLUDING CORPORATE STRATEGIES), AMPLIFIED OUR PORTRAYAL OF THE FERTILIZER SECTOR, AND REORGANIZED THE PRESENTATION TO FACILITATE EASIER ACCESS TO KEY INFORMATION.

. . . Making Chemicals Less Hazardous to Handle

ANALYST CERTIFICATIONS ARE IN THE DISCLOSURE APPENDIX. FOR OTHER IMPORTANT DISCLOSURES, visit www.csfb.com/ researchdisclosures or call +1 (877) 291-2683. U.S. Disclosure: CSFB does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Customers of CSFB in the United States can receive independent, third party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.csfb.com/ir or call 1 877 291 2683 or email [email protected] to request a copy of this research.

Research team

North America

William R. Young, Ph.D. 212/538-8922 [email protected]

John McNulty, CFA 212/325-4385 [email protected]

Nancy F. Traub, CFA 212/538-3950 [email protected]

Keith Siegner, CFA 212/538-3094 [email protected]

Nils-Bertil Wallin 212/538-8127 [email protected]

Europe

Andrew Stott 44 20 7888 0300 [email protected]

Neil Tyler 44 20 7888 6553 [email protected]

Catherine Haynes 44 20 7888 3270 [email protected]

Fraser Hill 44 20 7888 0331 [email protected]

Asia

Prashant Gokhale 852 2101 6944 [email protected]

Masami Sawato 813 4550 9729 [email protected]

Jim Hung 886 2 2715 6368 [email protected]

A-Hyung Cho 82 2 3707 3735 [email protected]

Sou

rce:

CS

FB

Res

earc

h. Wear Goggles and

Rubber Gloves When Handling Chemicals

Wear Goggles and Rubber Gloves When Handling Chemicals

Chemical Industry Primer, 2005–2006 14 June 2005

2

CSFB GLOBAL CHEMICAL TEAM William R. Young, Ph.D. (N. Amer. Major Chem)� 1 212 538 8922 [email protected]

Nancy F. Traub, CFA (N. Amer. Major Chem)� 1 212 538 3950 [email protected]

Nils-Bertil Wallin (N. Amer. Major Chem) 1 212 538 8127 [email protected]

John McNulty, CFA (N. Amer. Spec. Chem)� 1 212 325 4385 [email protected]

Keith Siegner, CPA, CFA (N. Amer. Spec. Chem)� 1 212 538 3094 [email protected]

Andrew Stott (Europe)� 44 20 7888 0300 [email protected]

Catherine Haynes (Europe)� 44 20 7888 3270 [email protected]

Neil Tyler (Europe)� 44 20 7888 6553 [email protected]

Fraser Hill (Europe)� 44 20 7888 0331 [email protected]

Prashant Gokhale (Asia)� 852 2101 6944 [email protected]

Masami Sawato (Japan) 813 4550 9729 [email protected]

A-Hyung Cho (Asia) 82 2 3707 3735 [email protected]

Jim Hung (Asia)� 88 62 2715 6368 [email protected]

Emerson Leite, CFA (Latin America)��

�

55 11 38416290 [email protected]

Rohan Gallagher (Australia)� 61 2 8205 4858 rohan.gallagher@csfb


3

Table of Contents

I. Executive Summary .......................................................................................................6 Purpose of This Report .................................................................................................6 The Chemicals Sector ...................................................................................................6 Six Main Subsectors......................................................................................................7

II. Investment Methodology.............................................................................................11 U.S. Major Chemicals..................................................................................................11 U.S. Specialty Chemicals ............................................................................................15 European Chemicals ...................................................................................................17 Asian Chemicals..........................................................................................................21 Japanese Chemicals ...................................................................................................25

III. Commodity Chemicals ...............................................................................................26 Introduction..................................................................................................................26 Commodity Chemicals Industry Trends and Value Drivers ........................................26

IV. Inorganic Chemicals ..................................................................................................28 Chlorine, Caustic Soda, and Soda Ash: The Chlor-Alkali Industry .............................28 Phosphates (Nonfertilizer) ...........................................................................................34 Titanium Dioxide..........................................................................................................38

V. Organic Chemicals .....................................................................................................40 “Cracking”: Production of Ethylene..............................................................................40 Feedstocks ..................................................................................................................41 Ethylene and Other Olefins: Introduction ....................................................................43 Ethylene.......................................................................................................................48 Propylene ....................................................................................................................51 Butadiene ....................................................................................................................53 Benzene and Other Aromatics: Introduction ...............................................................56 Benzene ......................................................................................................................57 Toluene........................................................................................................................58 The Xylenes.................................................................................................................59 Acetone .......................................................................................................................62 Acrylates......................................................................................................................64 Acrylonitrile ..................................................................................................................67 Ethylene Glycol............................................................................................................69 Ethylene Oxide ............................................................................................................71 Methanol......................................................................................................................73 Phenol .........................................................................................................................75 Propylene Oxide ..........................................................................................................77 Styrene Monomer........................................................................................................79 Surfactants (Surface Active Agents) ...........................................................................81 Vinyl Acetate................................................................................................................84 Vinyl Chloride Monomer (VCM)...................................................................................86


4

VI. Thermoplastics and Thermoset Resins .....................................................................88 Polyethylene ................................................................................................................89 Polypropylene..............................................................................................................92 Polyvinyl Chloride (PVC) .............................................................................................94 Polystyrene..................................................................................................................96 Polyethylene Terephthalate (PET) ..............................................................................98 Polyurethanes............................................................................................................100

VII. Man-Made Fibers....................................................................................................102 Polyester Fiber ..........................................................................................................103 Acrylic Fiber...............................................................................................................106 Nylon 6 and 66 Fibers ...............................................................................................108 Elastane/Spandex .....................................................................................................110 Rayon/Lyocell ............................................................................................................112

VIII. Fertilizers (Plant Nutrients) ....................................................................................114 Nitrogen (N) ...............................................................................................................116 Ammonia ...................................................................................................................117 Urea...........................................................................................................................120 Phosphate (P)............................................................................................................122 Potash (K)..................................................................................................................125

IX. Agricultural Chemicals (Crop Protection, GMOs)...................................................130 Introduction................................................................................................................130 Herbicides..................................................................................................................130 Fungicides .................................................................................................................131 Insecticides................................................................................................................131 Seeds and GMOs......................................................................................................132 Product Development in Breeding and Ag-Biotech...................................................134 Agrochemical Industry Trends and Value Drivers.....................................................138 Agrochemical Near-Term Growth Prospects ............................................................144

X. Industrial Gases........................................................................................................145 Introduction................................................................................................................145 Air Separation Technology ........................................................................................146 Industrial Gases Industry Trends and Value Drivers.................................................149 Industrial Gases Growth Drivers ...............................................................................151 Industrial Gases Growth............................................................................................151

XI. Atmospheric Gases .................................................................................................152 Nitrogen .....................................................................................................................152 Oxygen ......................................................................................................................156 Argon .........................................................................................................................162 Other Noble Gases....................................................................................................164

XII. Nonatmospheric Gases ..........................................................................................165 Hydrogen ...................................................................................................................165 Helium .......................................................................................................................171 Carbon Dioxide..........................................................................................................173


5

XIII. Specialty Chemicals ..............................................................................................177 Background ...............................................................................................................177 Specialty Chemicals Industry Trends and Value Drivers ..........................................177 Specialty Product Categories ....................................................................................182 Paints and Coatings ..................................................................................................183 Adhesives and Sealants............................................................................................184 Water Treatment........................................................................................................185 Flavors and Fragrances ............................................................................................187 Catalysts....................................................................................................................191 Additives ....................................................................................................................194 Fine Chemicals..........................................................................................................198 Colorants ...................................................................................................................201

XIV. Pharmaceutical Hybrid Companies.......................................................................203 Introduction................................................................................................................203 Company Overviews .................................................................................................203 Industry Trends and Value Drivers............................................................................205

XV. Sources ..................................................................................................................208

Appendix 1 ....................................................................................................................209

Appendix 2 ....................................................................................................................210


6

I. Executive Summary

Purpose of This Report CSFB’s Global Chemical team has updated and expanded this reference resource this year, and we welcome your suggestions to further enhance it next year. The goal of this report is to provide a broad introduction to and overview of the chemicals sector. Rather than being stock-specific, this “primer” is intended as a reference guide for information on specific areas of the industry. It is, therefore, primarily aimed at those who are new to the sector. We hope it will also prove a useful source of reference for those who have worked on the sector for some time.

The Chemicals Sector The chemicals industry converts raw materials derived principally from oil and natural gas, minerals, and air into more valuable products for use in industrial and consumer markets. The range of these products is so vast that it would not be exaggerating to say that the products are involved at some stage in virtually everything we do and consume on a daily basis.

Exhibit 1: Share of Global Chemical Output by Market Exhibit 2: Share of Global Chemical Output by Subsector

Healthcare & Other Services

13%

Paper & Printing6%

Construction5%

Motor Vehicles6%

Consumer Products

21%

Rubber & Plastic Products

14%

Agriculture7%

Furnishing Textiles & Apparel

10%

Other Manufacturing

8%Metals, Mining & Petroleum Refining

10%

Plastics & Polymer Related

Products15%

Consumer Products

14%

Industrial Gases2%

Additives & solvents

2%Coatings

4%

Inorganic Chemicals

7%

Crop Protection2%

Fertilizers4%

Man-Made Fibers

2%

Petroleum-Derived Organic

Chemicals14%

Pharmaceutical & derivatives

19%

Other Specialty Chemicals

15%

*Excluding pharmaceuticals. Source: CSFB research.

Source: CSFB research.

The huge range of products also means that the industry’s returns and financial condition in general are heavily reliant on the overall health of the economy. As a result, the sector is cyclical, with one of the key bellwethers of its fortunes being GDP trends.

The sector is characterized by global markets, with all of the major operators having international businesses. In response to this globalization, and as part of the continued search for scale efficiencies, the industry has undergone considerable consolidation in recent years. We expect M&A activity to continue, perhaps at a reduced rate, as industry participants tune their portfolios.


7

The CEFIC (European Chemical Industry Council) estimates world chemicals sales were €1,736 billion in 2004. Exhibits 4 and 5 list the major U.S., European, and Asian producers by market cap and by revenue.

Six Main Subsectors For analytical purposes, we divide the companies within the sector into six main categories: Commodity Chemicals, Fertilizers, Crop Protection/GMO (Genetically Modified Organisms), Industrial Gases, Specialty Chemicals, and Pharmaceutical Hybrids. Although the activities of the companies often span more than one of these areas, we adopted this demarcation to approach the sector methodically.

Exhibit 3 provides a rough overview of where the companies covered by CSFB fall within each segment.

Exhibit 3: Global Chemicals by Segments Commodity Fertilizers Crop Protection/GMO Industrial Gases Specialty Pharma Hybrids

BASF, Celanese, DuPont, Dow Chemical, Eastman Chemical, Georgia Gulf, Lyondell Chemical, PPG Industries, Nova Chemicals, Huntsman, PolyOne, Westlake Chemical, Compass Minerals International, Asahi Kasei, Showa Denko, Sumitomo Chemical, Mitsubishi Chemical, Tosoh, Mitsui Chemicals, Ube Industries, Formosa Plastics, Honam Petrochemical, Reliance Industries, Hanwa Chemical, Nan Ya Plastics, SABIC, ExxonMobil, Royal/Dutch Shell Group

PotashCorp, Yara, CF Industries, Agrium, Terra, Mosaic

Syngenta, Monsanto, UAP Holding

BOC, Air Liquide, Praxair, Air Products & Chemicals, Linde, Taiyo, Nippon Sanso

ICI, Johnson Matthey, Rhodia, Givaudan, Degussa, Yule Catto, Ciba Specialty Chemicals, Lonza, British Vita, Croda, Lanxess, Rohm & Haas, Cytec, Sealed Air, Ecolab, 3M, Engelhard, Ferro, Avery Dennison, Valspar, DSM, Hexcel, Mitsubishi Gas Chemical, Tokuyama, Shin-Etsu Chemical, JSR, Zeon, Hitachi Chemical, Rasa Industries, Mimasu Semiconductor

Solvay, Bayer, Akzo Nobel

*High-value-added mix. Source: Company data, CSFB estimates.

• Commodity chemicals are typically produced in large quantities and sold on the basis of price, and, in some cases, by small, targeted variations in compositions; that is, customers tend to differentiate between suppliers on the basis of price, rather than effect. Product types included within industrial commodity chemicals are organic chemicals, petrochemicals, plastics and other resins, inorganic chemicals, and man-made fibers. Because of their ability to integrate production with the manufacture of feedstocks, many commodity chemicals are increasingly becoming the domain of the oil companies and firms in areas such as the Middle East, which have access to cheap raw materials. Approximately 55% of the industry is currently held by oil companies.

• Fertilizers are substances that are added to the soil to replace essential nutrients depleted by crops. They contain one or more of the primary plant nutrients (nitrogen, phosphorous, and potassium) and sometimes contain secondary trace nutrients (calcium, magnesium, sulfur, iron, copper, and zinc).

• The crop protection/GMO sector includes pesticides, which can be divided principally between herbicides, fungicides, and insecticides, all of which are used to increase crop yields by combating weeds, fungal pests, and insects, respectively. The agrochemicals industry is characterized by high barriers to entry, as significant R&D costs and extensive intellectual property rights allow a small number of significant


8

companies to dominate the industry globally. In addition, the discovery and commercialization of genetically modified organisms (GMOs) by Monsanto and others brought an entirely new paradigm to the agrochemical industry.

• The industrial gases industry separates air into its components and sells these components to third parties. In addition, gas producers now provide an array of specialty gases for a wide variety of uses. Because of the high reliance on long-term contracts, the industry tends to be less cyclical than many other areas of the chemicals sector.

• Specialty chemicals, in contrast to commodities, are those chemicals that are sold on the basis of their performance (and, often, technical service), rather than for their chemical composition. The variety of end products is vast, including both industry and function-specific chemicals.

• Pharmaceutical hybrids. The final section of the report becomes more company-specific as it examines those hybrid companies—which are European-based, as the U.S. hybrids sold their pharma operations—that have significant pharmaceutical businesses in addition to chemicals operations. As scale becomes ever more important in the pharmaceutical sector, we examine the issues faced by these companies as a result of their presence in this industry.

Chem

ical Industry Prim

er, 2005–2006 14 June 2005

9

Exhibit 4: Global Chemical Producers by Market Capitalization/Share Prices as of June 10, 2005

US$ in millions

0

10,000

20,000

30,000

40,000

50,000

60,000

3M Du Pont

Dow

Chem

icalBASFBayerAir LiquideR

eliance IndustriesM

onsantoShin-Etsu C

hemical

PraxairAir Products and C

hemicals

Akzo Nobel

PPG Industries

SyngentaR

ohm and H

aasPotashN

an Ya PlasticsBO

CForm

osa PlasticsSolvayLindeEcolab D

egussaSum

itomo C

hemical

Asahi KaseiD

SMM

itsubishi Chem

icalLyondell C

hemical

ICI

Avery Dennison C

orpJSRSealed Air C

orpYaraEastm

an Chem

icalM

itsui Chem

icalH

untsman

Johnson Matthey

Ciba

Givaudan

Hitachi C

hemical

Engelhard Corp

Orica

Clariant

LonzaN

ova Chem

icalsShow

a Denko

LG C

hemical

ValsparAgriumSinopec ShanghaiTosohM

itsubishi Gas C

hemical

FMC

Taiyo Nippon Sanso

ZeonTokuyam

aU

be IndustriesC

ytec Corp

Sinopec Beijing YanhuaLanxessW

estlake Chem

icalsH

excelSum

itomo Bakelite

Honam

Petrochemical

British VitaG

eorgia Gulf

Hanw

ha Chem

icalLG

Petrochemical

Rhodia

Delta and Pine Land

Croda

Ferro Corp

UAP H

oldingC

ompass M

ineralYule C

attoPolyone C

orpM

imasu Sem

iconductorSinopec Yizheng C

hemical

Rasa Industries

Source: Company data, CSFB estimates.

Chem

ical Industry Prim

er, 2005–2006 14 June 2005

10

Exhibit 5: Global Chemical Producers by Revenues, 2004

US$ in millions

0

10,000

20,000

30,000

40,000

50,000

60,000

BASFD

ow C

hemical

BayerD

u PontR

eliance Industries3M M

itsubishi Chem

icalAkzo N

obelD

egussaN

an Ya PlasticsAir LiquideLindeAsahi KaseiH

untsman

Sumitom

o Chem

icalIC

IForm

osa PlasticsD

SMSolvayM

itsui Chem

icalPPG

IndustriesLanxessShin-Etsu C

hemical

Air Products andBO

CR

ohm and H

aasC

lariantShow

a Denko

Rhodia

YaraPraxairEastm

an Chem

icalSyngentaLyondell C

hemical

Ciba Specialty C

hemicals

Monsanto

Avery Dennison

Nova C

hemicals

Celanese

LG C

hemical

Hitachi C

hemical

Ube Industries

TosohEcolab EngelhardSinopec ShanghaiO

ricaSealed AirM

itsubishi Gas C

hemical

Potash Corp. of

AgriumJSRH

anwha C

hemical

UAP H

oldingValsparJohnson M

attheyG

ivaudanG

eorgia Gulf

PolyoneFM

CTokuyam

aZeonW

estlake Chem

icalBritish VitaLonzaFerroSinopec Beijing YanhuaH

onam Petrochem

icalC

ytecSum

itomo Bakelite

LG Petrochem

icalYule C

attoC

rodaC

ompass M

inerals Int'lSinopec Yizheng C

hemical

Delta and Pine Land

Mim

asu Semiconductor

Rasa Industries



11

II. Investment Methodology

U.S. Major Chemicals When is the right time to buy chemical stocks as an investment—i.e., beyond a one- or two-month move? Said differently, how do the supply/demand cycles affect chemical stock performance?

The first point to emphasize, if an investor hopes to outperform the market, is that basic U.S.-based chemical stocks are bought to be sold. Since 1970, the share price appreciation of the S&P Chemicals has been 7.7%, while that of the S&P 400 Industrials has been 8% (CAGR).

Furthermore, we have learned that, over the long term, most major U.S. chemical companies do not create shareholder value, in that they fail to return the cost of capital. The commodity end of the industry is capital intensive, and significant mistakes have been (and will continue to be) made. This may involve building plants that cost $100 million or more, which become underperformers as a result of overcapacity. Also, returns on acquisitions have been below par, in view of prices paid relative to earnings generated—even when including synergistic cost reductions; one should simply examine goodwill impairments taken in 2002 to get a handle on this. Too frequently, the high returns generated at the peak are too fleeting to compensate for the low returns produced in less robust times, which can often be prolonged. Moreover, whereas unit growth in the chemical industry overall still exceeds GDP on a global basis, we would generally not categorize the chemical companies as “growth vehicles.”

Now that a good case has been presented for not owning equities of major chemical companies on a long-term basis, why bother? Timing is the key to developing a winning formula. That is, we believe investors can outperform the market if they play the chemical cycles correctly. As shown in Exhibit 6, comparing EPS for the S&P Chemicals versus the S&P 400 Industrials, obvious cycles are apparent. (Note: The old S&P 400 Industrials Index—a so-called non-“GIC” measure, according to S&P—includes such “industrial” giants as Intel, Pfizer, McDonald’s, Federated Department Stores, Citigroup, etc.; that is, large firms that are not primarily transportation or utility companies.)


12

Exhibit 6: Relative EPS: S&P Chemicals versus S&P Industrials

RELATIVE EPS

S&P CHEMICALS vs S&P Industrials

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8


Between 1970 and the present, it is clear there are three distinct periods during which chemical company earnings outperformed industrial firms as a whole over a multiyear period: 1971-1975, 1986-1990, and 1994-1997.

How do these periods relate to the secular chemical cycle? As in all commodity products, supply/demand determines the profitability. That is, high capacity utilization should correlate with margins and earnings performance. Since it is unlikely that all “industrials” will march to the same supply/demand cycle, it stands to reason that earnings for major chemical companies should outperform results for their nonchemical peers when capacity operating rates are high, and conversely. This is borne out in Exhibit 7 and Exhibit 8.


13

Exhibit 7: U.S. Ethylene Operating Rates

50%

60%

70%

80%

90%

100%

110%

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

9319

9519

9719

9920

0120

03

2005

E


Exhibit 8: U.S. Chlorine Operating Rates

50%

60%

70%

80%

90%

100%

110%

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

9319

9519

9719

9920

0120

03

2005

E


We have utilized ethylene and chlorine as proxies for the commodity end of the chemical industry, since they are big, basic, nondifferentiated, building-block commodities that are upgraded into other chemical products. Without these key intermediates, a huge range of high-volume derivatives could not be manufactured. A corollary that follows is that derivative supply/demand trends should mirror those of ethylene and chlorine. Also, as shown in Exhibit 9, our estimates of overall capacity utilization for major U.S.-based chemical companies (including their ex-U.S. components) correlate quite well with the relative earnings performance for major chemicals companies.


14

Exhibit 9: U.S. Chemical Industry Shipment Rates (Shipments/Capacity)

60%

70%

80%

90%

100%

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

E


How about the stocks? Exhibit 10 portrays the relative share price performance (logarithmic scale) for S&P Chemicals versus S&P 400 Industrials.

Exhibit 10: Relative Stock Price: S&P Chemicals versus S&P Industrials

RELATIVE STOCK PRICE

S&P CHEMICALS vs S&P Industrials

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0


While it certainly doesn’t look much like the other exhibits, further examination indicates that the relative movement in chemical stocks mirrors operating rates and relative earnings from a timing perspective, although the magnitudes vary substantially. Also, in most (but not all) cases, chemical stocks peak (relatively speaking) two or three quarters ahead of relative earnings. This is no big surprise given that the stock market is a mechanism for discounting future trends.


15

How does economic activity (i.e., expansions and recessions) factor into the equation? The shaded areas in the exhibits mark recessions and, in the 1984-85 period, a significant soft landing. It is noteworthy that chemical stocks outperformed the market—for three to six months at a minimum—at the end of each slow period in the economy. This makes sense, since investors tend to buy cyclical stocks ahead of an economic expansion. But whether this three- to six-month trend continues (as in 1985) or not (1975 or 1980, for example) depends on other factors. If the initial phases of economic recovery coincide with a period of heavy capacity expansion in the chemical industry, one might expect the positive relative price trend to be short-lived, as it was following the 1975-1976 rebound. Or if there is a double-dip recession (such as in 1980 and 1982), chemical stocks could outperform initially but are likely to underperform once investors believe another GDP downturn is in the cards.

Our conclusion: To enjoy relatively good returns when the cycle turns (i.e. to maximize the upside in the stocks), such as in the 1970-1975, 1985-1989, and 1993-1997 periods, an investor should look for the following conditions before overweighting a portfolio with commodity chemical stocks:

• An economy that is relatively sluggish;

• Low operating rates in the chemical industry;

• Low EBIT margins in the chemical industry;

• Relatively little capacity expansions expected to come onstream; and

• Healthy prospects for economic growth—at home and abroad (including, especially these days, China).

U.S. Specialty Chemicals The U.S. specialty chemical group is an eclectic group of companies. Each firm is composed of one or more segments that basically make up their own niche industries where there is minimal overlap with other companies. As a result, to look at the entire group as one industry and make a generalization on how the “sector” will perform relative to the broader market leaves quite a lot of room for error. That being said, we believe there are a number of fundamentals/characteristics that the majority of the companies possess (especially on a market-cap-weighted basis). These drivers/fundamentals include:

• Defensive in nature. Many of the specialty chemical names are viewed by the market as being defensive in nature and subsequently perform best when the economy is soft or there is economic uncertainty. In those periods, the stocks tend to outperform the broader market. The group tends to perform in-line with the market when the economy is seeing normalized growth of 2.5-3.0% and tends to underperform when the economy is accelerating. We believe this is the case for a number of reasons: (1) the bulk of the companies generate significant levels of free cash even at the trough of the economic cycle, making them less financially risky than many other groups (such as the commodity chemical names); (2) in many cases the products produced by specialty chemical companies are essential to their end customers’ products and difficult to replace, resulting in a price set by a value proposition instead of industry supply/demand balance or capacity utilization rates;


16

and (3) in some cases, the companies have been able to negotiate take-or-pay contracts, as well as energy price pass-through clauses, which help them maintain profitability during periods of economic weakness (especially the industrial gas companies).

• Improving return profiles. We believe a number of the specialty chemical names in our universe have started to see or will see improving midcycle returns over the next few years (not just improvements driven by an expected economic recovery). Such improvements may result in greater earnings power and multiple expansions, both of which should lead to solid stock performance—this has already started in some of the names. Some of the catalysts behind this trend include management changes and industry consolidation, which has resulted in improved capital discipline (the industrial gas companies); acquisitions that may drive returns higher (ECL and FOE); and cost-cutting/restructuring that should potentially result in higher midcycle returns (SEE, CYT, and EC—although EC has other offsetting headwinds).

• Foreign currency exposure. Many of the companies we follow have a sizable global reach and international platforms. As a result, these companies are benefiting from the recent weakening of the U.S. dollar, especially relative to some of their European competitors. While this trend may continue in the near term, it is one to stay focused on because a reverse in the dollar’s weakness could negatively impact the U.S. names while helping the European companies.

• Raw material pressure. The specialty chemical names have been and will likely continue to see significant raw material pressures, owing to (1) rising energy prices and (2) a tightening supply/demand balance on some of the commodity chemicals that they use. This has resulted in severe margin pressure because the specialty companies that price their products on a “value proposition” often find it difficult to raise prices in conjunction with their raw materials (because the “value” of the product to their customer has not grown just because the specialty chemical company’s costs went up.) Most specialty chemical companies have started to put through price increases, and most of their customers are willing to take them (to a degree) because of the extreme nature of the cost pressure being seen. However, the names are in a game of “catchup.”

• Financial strength may lead to acquisitions. Because the specialty chemical group generates significant levels of free cash and they had been working aggressively through the recession to pay down debt, most specialty chemical companies have relatively strong and underleveraged balance sheets. We believe they will be putting them to work in the form of acquisitions over the next few years. These will likely be in the form of both bolt-on and larger acquisitions.

Again, to make investment generalizations about the entire specialty chemical group is often difficult, but the above three trends/fundamentals seem to occur in many of the names that we cover. Beyond that, we would look carefully at the (1) individual business models and stories, (2) end markets served, and (3) the R&D platforms and pipelines to get a better understanding of what names will enjoy solid outperformance while others disappoint.


17

European Chemicals

What Are the Drivers behind the European Chemicals sector? Our first point is that this is a difficult question to answer because of the heterogeneous nature of the sector. It is fair to say that, as with most sectors, there is not one dominant variable, but a complex interaction of external factors.

For the purposes of this note we intend to talk only about the top-down factors, rather than bottom-up corporate issues, and thus we are only interested in what dictates fund managers’ asset allocation decisions with regard to chemicals (whether it is from one quarter to the next or one cycle to the next). The chemical sector is highly volatile as seen in Exhibit 11.

Exhibit 11: EV/Sales by Subsector for European Chemicals

0.3

0.8

1.3

1.8

2.3

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005e 2006e

Commodities Pharma hybrids Specialties Gases Sector



18

We propose to split our driver categories into five sections:

1. Macroeconomic Drivers Being a mature sector by and large, the chemicals sector is heavily influenced by perceptions of GDP and industrial production growth. These factors themselves are in turn heavily influenced by three main variables:

• interest rates

• exchange rates

• energy prices

Interest rates and the perception of the direction of monetary policy are critical determinants of the performance of the sector relative to the market. Clearly, it is not just a case of the sector performance being aided by the easing of monetary policy, but also the expectations of the effect of that monetary policy. CSFB strategists believe a steepening of the yield curve at the long end, not the short end, is a reasonable basis for positive performance of the sector, and there is evidence to support this with certain stocks, especially BASF.

Exchange rates are important from three aspects. First, there is the direct and simple effect on overseas earnings. Second, there is the potential impact on margins from transaction risk (i.e., where a company has a geographical mismatch between assets and sales). Third, there is a potential competitive effect, whereby a company’s pricing strategies in international markets can be affected by exchange rates and can thus lead to market share gains or losses. We show below how influential significant swings in currencies can be on the sector’s performance.

Exhibit 12: Euro Strengthening Correlates with Sector Relative De-Rating

70.0

80.0

90.0

100.0

110.0

120.0

130.0

140.0

Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05

$ to € Chemical sector relative to DJSTOXX (RHS)

Significant strengthening of Eurospells start of sector underperformance

Source: Datastream.


19

Energy prices are clearly critical for an industry that typically consumes significant volumes of oil and natural gas for purposes of raw materials, energy, and distribution. However, we would caution about seeing the oil price as an especially influential factor within the sector. Far more important, in our view, are expectations of inflection points in GDP, industrial production, and currencies. Exhibit 13 shows little correlation in the past between chemicals sector performance and the oil price.

Exhibit 13: Oil Price and European Chemicals Sector Relative Performance since 2000 Shows Little Correlation

60

80

100

120

140

160

180

200

220

240

260

Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05

Oil Chemical sector relative to DJSTOXX

Source: Datastream.

2. Lead Indicators This ties in with the above section, in the sense that perception of economic growth can be influenced as much by lead indicators as by monetary policy. The key lead indicators that we use are the ISM and IFO surveys, as well as regional consumer confidence surveys. The new orders sections of the ISM and IFO are especially influential for most of our stocks. Stocks that are more sensitive to the perception of consumer demand trends are Croda, Givaudan, ICI, and Johnson Matthey.

3. Mergers and Acquisitions/Consolidation Corporate developments in the industry and the level of consolidation can have significant influence on money flows in and out of the sector. In the late 1990s and the very early stages of this decade, the industry witnessed a number of major corporate deals. In particular, this period saw a proliferation of demergers, creating new companies, which stemmed from the life science industry’s efforts to focus on pharmaceuticals and other healthcare businesses. Thus, ICI (which set the ball rolling in 1993 with the demerger of Zeneca), Ciba Specialty Chemicals, Clariant, Celanese, Givaudan, Rhodia, and Syngenta all appeared in their varied forms. Following and during this phenomenon was another theme: value destruction. This was a simple phenomenon: Newly demerged companies, in an attempt to increase scale and utilize their balance sheets, acquired a number of assets and more often than not paid too high


20

a price during this period of aggrandizement. For example, Ciba (Allied Colloids), Clariant (BTP), ICI (Unilever Specialty Chemicals), and Rhodia (Chirex and Albright and Wilson) all paid the price for expansionary moves.

We expect M&A to be a greater feature of the industry’s development in the short term, compared with the relatively barren 2001-2004 period. Our view in this regard is based upon the strengthening of balance sheets in the last few years through a process of disposal programs and capital restructuring. Private equity companies are also taking an increasing interest in the sector’s fortunes and provide liquidity as both buyers and sellers of chemical assets.

4. Capital Discipline This will always be an important theme among investors. The chemicals sector has a rotten reputation for reinvesting at the top of the cycle, only for margins to be adversely affected at the bottom of the cycle.

Another important issue is, What is happening with regard to capital discipline relative to other basic materials sectors and is it sustainable?

At present, it is fair to say that the industry in Europe at least is at a relatively low level of expenditure. Whether this is sustainable or not remains to be seen and, based upon recent guidance for 2005 estimates, there is every reason to view 2004 as a trough.

Exhibit 14: Capex/Depreciation Ratios for European Subsectors

50%

70%

90%

110%

130%

150%

170%

190%

210%

230%

250%

1997 1998 1999 2000 2001 2002 2003 2004e 2005e 2006e

Commodity Specialty Hybrid Industrial Gases Average



21

Asian Chemicals Asian companies have a relatively short history (short in terms of chemical cycles), and the markets have evolved over the last decade, with investment methodologies getting fine-tuned. There is a greater appreciation that petrochemicals are cyclical, and for cyclical companies, earnings multiples tend to be high at the trough, low at the peak. Most Asian companies are trading at EV/EBITDA multiples of 3-5 for 2005E—a point where we believe chemical margins are likely to peak. (This does not necessarily mean margins are going to collapse thereafter—we expect above-average margins.)

At this point in the cycle, we look at what market expectations are in terms of future returns and use HOLT to analyze embedded return expectations. Using multiplies is more complicated given where we are in the earnings cycle.

Asian companies have been the biggest beneficiaries of the current earnings upcycle in the petrochemical sector—the chart below highlights that they have generated the greatest spread in CFROIs from the median achieved between 1998 and 2003 and to 2004.

Exhibit 15: CFROI Spread from Median to 2004

(5.0)

-

5.0

10.0

15.0

20.0

25.0

ATC

1117

0

1326

TOC

1301

1299

0

6000

02

GG

C

1303 32

5

338

9830

NPC

5191

0

LYO

DO

W DD

EMN

BASF

PPG

REL

I

4063

C

DSM

N

1033

AKZO

2004 CFROI less -5Y Median CFROI


The chart above highlights that most companies at the left-hand side of the chart are from Asia. A combination of higher operational leverage, greater commodity exposure, and greater gearing into spot pricing (versus contract pricing) is likely to be behind this dramatic difference in the way earnings have performed in Asia, and in the rest of the world.

The key question for Asia is, therefore, What happens to returns in a downcycle? We note that even the most optimistic views see a downcycle by 2008-2009—HOLT allows us to look at implied returns in that time frame. We assume that asset growth for the companies will be limited to 5% per year, in-line with global growth in volumes. This represents our estimate of what the industry can bear as a reinvestment rate, for a given outcome on returns. Too much capex would crush returns and profitability in the future.


22

Exhibit 16: Median Returns in the Past Have Been below Cost of Capital

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

1299

0

1117

0

1326

1301

ATC

TOC

NPC

1303

5191

0

9830 32

5

REL

I

338

6000

02

4063

C

1033

Cost of Capital -5Y median CFROI 2004 CFROI


Our analysis suggests that the market is implying that returns for chemical companies in Asia will fall from 2004 levels. It also indicates that the returns implied by the market in 2008 are now low enough, if one looks at history. We note that returns for Asian companies fall below the cost of capital through a downcycle—i.e., even an assumption of a reversion of WACC in the case of Asian chemical companies might be too aggressive

Exhibit 17: What Does the Market Expect in the Future?

-10

-5

0

5

10

15

20

25

AT

C

TO

C

1301

1326 DD

1303

DO

W

6000

02

1299

0

GG

C

LYO

EM

N

5191

0

RE

LI

1033 33

8

325

1117

0

NP

C

4063

C

BA

SF

9830

PP

G

DS

MN

AK

ZO

2004 CFROI -5Y median CFROI Market Implied T+5 CFROI



23

Finally, we look at what the market is implying in terms of CFROI in 2008 (the dot in Exhibit 17), relative to the 2004 CFROI and the median CFROI in 1998-2003. In the case of most stocks residing on the left of the chart, the return expectations in the future look aggressive relative to where we are today—i.e., in the case of ATC and Thai Olefins, the market expects returns to remain at current levels to 2008. ATC, we note is also one of the biggest beneficiaries of the current upswing (as its 2004 CFROI is not muted for one-off reasons). Expectations here are high and are likely to be disappointed. At the right-hand side of the chart, we move toward companies where returns are expected to fall from current levels. However, in most cases, return expectations are still above the historical median levels achieved. As noted above, returns for many Asian companies fall below the cost of capital in a downcycle.

Exhibit 18: Upside/Downside if T+5 Returns Equal Cost of Capital

(60%)

(40%)

(20%)

0%

20%

40%

60%

80%

100%

1033

DSM

N

9830

EMN

338

BASF

1117

0

325

AKZO

6000

02

4063

C

5191

0

DO

W

1303

PPG

REL

I

GG

C

1299

0

NPC

1326

1301

LYO DD

TOC

Upside/Downside if t+5 CFROI is Equal to Cost of Capital



24

Exhibit 19: Upside/Downside if T+5 Returns Reach Median Historical Levels

-140.0%

-120.0%

-100.0%

-80.0%

-60.0%

-40.0%

-20.0%

0.0%

20.0%

40.0%

DSM

N

AKZO

9830

PPG

BASF

1117

0

4063

C

NPC 32

5

338

REL

I

1299

0

1033

GG

C

LYO

5191

0

1303

6000

02

1326

EMN

1301

DO

W DD

TOC

ATC

Upside/Downside if t+5 CFROI is Equal to -5Y median CFROI


Conclusions

Asian companies have been the biggest beneficiaries of the current cycle—that probably explains why we are more cautious than our U.S. and European commodities analysts.

CFROIs are high, and the market implies in general that they will fall. That is the good news.

The bad news is: (1) Asian companies have higher earnings volatility, and hence the risk of getting earnings wrong is high both on the upside and on the downside; and (2) while returns are expected to fall, current expectations are not low enough to invest in the stocks. We would avoid the Asian chemical sector for now.


25

Japanese Chemicals Over the last ten years, Japanese major chemical stocks mainly outperformed during three periods: (1) the Asian demand increase around 1994-1995, (2) the IT bubble in 2000-2001, and (3) Asian demand recovery with price rises in 2003-2004. Share price momentum had been strong during these periods, and earnings had also increased, so such valuations were justified.

Exhibit 20: Ethylene Margin and Relative Performance of Major Chemicals

300

550

800

1,050

1,300

1,550

11/1/95 1/1/97 3/1/98 5/1/99 7/1/00 9/1/01 11/1/02 1/1/04 3/1/05

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0

0.1Ethylene margin (3 month moving average)

Relative performance of 7 major chemicals (RHS)

�$/tons�

Source: Datastream.

We expect domestic demand for petrochemical products to stay relatively strong in 2005 after a strong 2004. We anticipate that 2005 ethylene production will drop 0.4%, to 7.54 million tonnes from 7.57 million tonnes in 2004, as domestic demand drops slightly. However, we expect a continued increase in the export of monomers to non-Japan Asia for use as intermediate products in chemical production, and even if there is a reduction in exports of polyethylene and some other products, we expect growth in exports overall to be roughly flat year over year.

Any upward move in petrochemical stocks would probably come once demand in China recovers from its seasonal downturn, and prices should improve in the autumn (August through September), when we expect to see general strength in the petrochemical sector. Once earnings start to recover as a result of the adjustment in raw materials prices, we should start to see some positive surprises, in the form of upward earnings revisions for the second half. As a result, we expect to see a recovery in the petrochemical stocks that have been underperforming since the start –of 2005. From year-end 2004 through the beginning of 2005, the drop in Asian market prices has been undermining ethylene margins, but once recovery starts to come through, we expect to see an improvement in share price performance at the general chemical makers.


26

III. Commodity Chemicals

Introduction There is no strict definition of what constitutes a “commodity chemical.” Instead, the term refers to chemicals that share a number of characteristics. They are typically those products that are manufactured in large volumes and by a number of different producers. Quality of the product is largely generic; thus, customers rarely distinguish between manufacturers on this basis. Instead, price and location are often key determinants in choosing a supplier. Commodity chemicals tend to form the building blocks of a vast array of specialty chemicals and consumer products. But value-added products can easily become commodities over time; one need only consider generic pharmaceutical or crop protection products as examples.

We divide the basic commodity chemicals subsector between organic and inorganic chemicals. Organic chemicals—derived from either crude oil or natural gas—are carbon-containing entities. Some organic chemicals are used “straight away,” such as ethylene glycol as antifreeze or acetic acid as a solvent. Some are intermediates in the synthesis of other organic materials. An important subclass of organic chemicals is known as “monomers;” monomers are typically combined to form long-chain compounds, known as “polymers,” almost like a string of paper clips. Examples of polymers are such ubiquitous plastics as polyethylene or polystyrene, or man-made fibers such as polyester or nylon. Inorganic chemicals are derived principally from salt-containing brines and various minerals such as trona (for soda ash) or phosphate rock (for fertilizers). They form the foundations of major classes, such as the chlor-alkali chemicals, and of products such as salt, fertilizers, industrial phosphates, and metal oxides, including titanium dioxide and iron oxide.

Commodity Chemicals Industry Trends and Value Drivers Because of the integral role played by commodity chemicals in a vast array of manufacturing processes, a huge number of factors drive demand for them. Of these, the most influential are cyclicality, globalization/consolidation, and capital intensity.

• Cyclicality. Volume growth and pricing flexibility are the main factors driving the top line in the commodity chemical industry, while profitability relies on capacity utilization, operating efficiency, product mix, and raw material costs. The largest customers are the general manufacturing, automotive, agricultural, and construction industries. As the health of the industry is heavily reliant on the health of these cyclical industries, the chemicals industry itself is cyclical. In addition to shifts in demand, imbalances in supply caused by capacity additions within the industry can lead to sharp price/margin swings, and can thus increase cyclicality further. As a result, we traditionally measure growth in terms of GDP, although industrial production (IP) can also be used. CSFB global economists currently estimate global GDP growth was 4.9% for 2004 (the largest gain in 20 years) and forecast growth of 4.0% for 2005 and 4.3% for 2006.


27

• Consolidation/globalization. Competitive pressure and the search for growth are forcing chemicals companies to expand globally, both through “organic” growth and via consolidation. The chemicals industry in the developed economies of Europe and the U.S. is largely mature, with growth only marginally outpacing that of GDP. In developing markets, however, rapid industrialization and improving living standards are attracting large numbers of manufacturing companies to the regions. To serve these customers, and to benefit from lower-cost labor, many chemicals companies are building facilities nearby.

• Capital intensity. Commodity chemicals companies are characterized by their capital-intensive nature. Significant scale is required to manufacture the majority of commodity chemicals efficiently, and the consequent capacity also requires continual maintenance and upgrading. In addition to the standard production technology, stringent environmental regulations require extensive protection equipment for every plant, leading to further expense.

• Energy intensity. Commodity chemicals companies are huge consumers of energy. For petrochemical companies, consumption of oil, natural gas, and/or their derivatives for both fuel and raw materials represents the largest single component of the total cost of production. Even chlorine and caustic soda production requires energy (in the form of electricity) as the largest input cost—far larger than that of the other key ingredient, salt. A significant proportion of the feedstocks is often purchased under long-term contracts in an attempt to stabilize this proportion of the cost base. These contracts typically “lock in” volumes, but fixed-price contracts are difficult to engineer. Thus, significant raw material volatility can still have a large effect on margins within the industry, especially on a short-to-intermediate-term basis.


28

IV. Inorganic Chemicals The majority of inorganic chemicals are derived from mineral ores or brines. These substances are used both as building-block materials and as processing aids and catalysts in the production of other chemical and industrial products, including fertilizers, paper, metals, and glass. Inorganic chemicals are largely considered high-volume commodities, and operations are characterized by limited R&D spending, with emphasis placed instead on improving margins by reducing feedstock costs, energy requirements, and labor costs though process improvements.

Chlorine, Caustic Soda, and Soda Ash: The Chlor-Alkali Industry The chlor-alkali industry produces chlorine and the well-known alkali, caustic soda (sodium hydroxide). Beyond chlorine/caustic soda, another alkaline product, soda ash (sodium carbonate), is produced either via the synthetic Solvay process, using salt and limestone, or in certain areas, including Green River, Wyoming, from trona or a similar mineral. Between them, these three chemicals have an enormously diverse range of applications, so wide that almost all consumer products will, at some stage of production, be dependent on them. As a result, the chlor-alkali industry is one of the largest chemical industries by value.

Chlorine and Caustic Soda (Sodium Hydroxide) Chlorine and caustic soda are produced simultaneously in a fixed ratio, through the electrolysis of brine (sodium chloride solution). The three existing methods of electrolysis all generate 1.0 part chlorine to 1.13 parts caustic soda.

• Mercury cell. This is the oldest and most energy-intensive method of production. It is being phased out because of environmental risks surrounding the use of mercury. Mercury, which is used as the cathode, is highly toxic and would be extremely damaging if released into the water table. The advantage of this process is the ability to produce caustic soda in high concentration, reducing the need for evaporation.

• Diaphragm cell. In this process, the electrolysis cell contains a diaphragm (usually made of asbestos fibers) to keep the newly formed chlorine and caustic soda separate. Although this method of production can use fairly impure brine, it tends to produce less concentrated caustic soda and consumes a large amount of energy in the process.

• Membrane cell. Similar to the diaphragm cell, the membrane tends to be more effective, and thus, although more concentrated brine is required, a far more concentrated product is produced. The membrane cell process is the method of choice today.

Chlorine and Caustic Soda Uses

• Chlorine. The major use for chlorine is in the manufacturing of PVC plastics and a variety of other chemicals. It is also used as a bleaching agent in pulp and paper manufacturing, although this application has lost position (owing to environmental issues, as dioxin is a by-product) in favor of sodium chlorate.


29

Exhibit 21: Major Uses of Chlorine by End Market, 2004

Vinyls34%

Organics20%

Pulp & Paper4%

Water treatment6%

Chlorinated intermediates

6%

Inorganics2%

Other28%

Source: Chemical Week, CSFB research.

• Caustic soda. More than 50% of caustic soda production is used in the manufacturing of other chemicals. A large proportion is also used as an alkali in pulp and paper manufacturing. Other significant markets are water treatment, alumina, soaps and detergents, textiles, and petroleum and gas processing.

Exhibit 22: Major Uses of Caustic Soda (Sodium Hydroxide) by End Market, 2002

Pulp and paper17%

Organics17%

Other24%

Water treatment5%

Soaps, detergents, and

textiles12%

Inorganics17%

Alumina8%



30

Exhibit 23: Major Chlorine Producers, 2005E 2005 Average Capacity % share of

metric tons (000) Global Capacity

Dow Chemical 6.448 31.7%

Occidental Petroleum 2.676 13.2%

Formosa Plastics 2.016 9.9%

Solvay SA 1.703 8.4%

PPG Industries, Inc. 1.696 8.3%

Bayer AG 1.507 7.4%

Olin Corporation 1.105 5.4%

Akzo Nobel AB 1.073 5.3%

Asahi Glass Co., LTD 1.065 5.2%

TotalFinaElf 1.027 5.1%

Source: CMAI, Company data, CSFB estimates

Exhibit 24: Major Caustic Soda Producers, 2005E 2005 Average Capacity % share of



Occidental Petroleum 2.671 12.4%

Formosa Plastics 2.218 10.3%

Solvay SA 1.873 8.7%

PPG Industries, Inc. 1.836 8.5%

Bayer AG 1.32 6.1%

Olin Corporation 1.171 5.4%

Akzo Nobel AB 1.117 5.2%

Asahi Glass Co., LTD 1.115 5.2%

TotalFinaElf 1.109 5.2%

Source: CMAI, Company data, CSFB estimates

Chlorine and Caustic Soda Industry Growth Trends and Value Drivers

Chlorine and caustic soda are produced in a fixed ratio, 1.0 to 1.13. An electrochemical unit (ECU) is defined as 1 short ton of chlorine plus 1.13 tons of caustic soda. Chlor-alkali prices are often quoted in terms of $/ECU, and costs are often measured on a per ECU basis.

Because chlorine is a toxic green gas and expensive to store, chlor-alkali production is typically tied to demand for chlorine. Caustic output, therefore, is tied to chlorine demand, meaning caustic is often overly abundant or in short supply.

It should be noted that chlorine increasingly is being replaced as a bleaching agent in the pulp and paper industry by hydrogen peroxide and especially sodium chlorate. Hydrogen peroxide not only produces excellent whiteness with very little deterioration of the substance being bleached, but is also far more environmentally friendly, decomposing into water and oxygen. It is, however, more expensive than sodium chlorate, which has gained a considerable market position in North America.


31

Demand for chlorine is highly dependent on demand for PVC, and thus, on the health of the construction industry. But it should be kept in mind that PVC is utilized not only in new construction, but also in-house remodeling, siding, fences, decks, and windows. Furthermore, infrastructure is also an important application; for example, in large diameter sewer pipes and water mains.

As demand for chlorine is more cyclical than the need for caustic soda, this alkali can be in long or short supply when production of chlorine increases or decreases. Aggregate GDP is most heavily correlated with the use of caustic soda.


32

Soda Ash Soda ash is the second-largest alkali in terms of volume behind caustic soda. It can be produced through either refining of mined trona ore or the synthetic processing of ammonia-soda. Naturally based soda ash is more “dense” than synthetic soda ash; it is also more environmentally friendly and cost-efficient to produce. However, synthetic soda ash can be processed further to increase its density, and about half of the synthetic soda ash produced today is sold as dense soda ash. Today, more soda ash is produced from trona than through the older synthetic Solvay method, which was a major advance when it was discovered in the late 19th century.

Soda Ash Uses

Glass manufacturing is the largest application for soda ash. Other uses are chemical production, soap and detergents, and flue gas desulfurization.

Exhibit 25: Consumption of Soda Ash by End Market, 2004

Container Glass23%

Flat Glass22%

Soaps & Detergents

14%

Chemicals10%

Metals & Mining4%

Other Glass7%

Pulp & Paper1%

Others19%

Source: CMAI, CSFB research.

Soda Ash Manufacturers

Exhibit 26: Major Global Soda Ash Producers, 2004 2004 Average Capacity % share of


Solvay SA 7,225 15.32%

FMC Corporation 2,546 5.40%

Soda Alkali Industrial Corporation 2,527 5.36%

Sterlitamsk Combine 2,098 4.45%

Shandong Ocean Chemical Group 1,600 3.39%

General Chemical Soda Ash Partners 1,273 2.70%

Tangshan Jidong Chemical Plant 1,200 2.54%

Sun Capital Partners 1,105 2.34%

Ciech 1,100 2.33%

Oriental Chemical Industries 1,066 2.26%

Source: CMAI, CSFB estimates.


33

Soda Ash Industry Trends and Value Drivers

The production of soda ash through the refining of trona ore is far more cost-efficient than the Solvay process. As a result, U.S. producers who have large natural trona deposits at their disposal have a significant cost advantage over their non-U.S. competitors. Hence, the European industry has seen extensive consolidation in recent years in the face of increasing imports of soda ash from the U.S. The same is true in Asia and Latin America. In fact, about one-third of soda ash produced in the U.S. is exported through a legal cartel, ANSAC, sanctioned under U.S. law.

The price of soda ash and caustic soda is loosely linked, as approximately 5-10% of their demand is interchangeable. However, as caustic soda is produced in far larger volume, soda ash is more influenced by the price of caustic soda than vice versa.

Demand for soda ash has been dented in recent years by the replacement of glass bottles in the beverages industry with PET and recycled glass bottles.

Soda Ash Growth Prospects

We expect growth in soda ash to fall short of GDP growth because of the continued decline in demand for glass in favor of plastic materials.

We, therefore, forecast no growth in European demand for production of soda ash for the next five years. However, we do expect usage to continue to increase in emerging parts of Asia.

The soda ash industry has experienced widespread oversupply in recent years. Capacity in Asia has expanded, and a new Colorado-based operation (now idled) was opened in the U.S. Price wars between Asian soda ash producers, especially the Chinese, and U.S. manufacturers (through ANSAC) have prevailed for several years. However, several U.S. producers have curtailed output, allowing supply and demand to come into better balance. Prices in the U.S. began to recover in 2004 and are advancing noticeably in 2005-2006.


34

Phosphates (Nonfertilizer) The primary market for phosphate rock is the production of phosphate fertilizer products such as ammonium phosphates and super phosphates. (We provide detailed analysis of this in the fertilizer section to follow.) It is estimated that 95% of the world consumption of phosphate is in the form of fertilizers. The balance is consumed for a variety of industrial, consumer, and animal feed applications. Exhibit 27 shows the major derivative products of phosphate and their end uses.

Exhibit 27: Major Products and End Uses of Phosphate Products Primary End Uses

Merchant-grade acid Feedstock for other phosphate products: technical and food-grade purified acid, feed supplements, fertilizer for agriculture

DAP/MAP Solid fertilizer

SPA, LoMag, Poly-N Liquid fertilizer, feed, industrial products

Dical/Nonocal/DFP Livestock and poultry feed supplements

Industrial acid Soft drinks, food products, industrial detergents, personal care items, metal treating, water treatment, pharmaceuticals.

Source: SRI, CSFB research.

Phosphorus and High-Purity Phosphoric Acid

Elemental phosphorus and high-purity “wet process” phosphoric acid (PPA, or purified phosphoric acid) are the starting points for phosphorus-containing chemicals used in a wide range of nonfertilizer markets. Phosphorus itself is the key feedstock where ultra-high-purity phosphoric acid (thermal acid) is required in the end product or when the desired products cannot be manufactured conveniently from high-purity acid.

Phosphorus is a nonmetallic element (atomic weight 30.97) that can occur in several allotropic forms (white/yellow/red/black). It is produced in furnaces that require large amounts of electric power. The resultant element is then oxidized and converted to high-purity phosphoric acid.

In recent years, the ability to economically produce PPA directly from phosphate rock—the so-called “wet process”—has evolved as a major alternative route. Potash Corporation of Saskatchewan has been quite successful in this endeavor, but its process cannot be employed universally, probably owing to the different characteristics of various phosphate rock types.

Uses for Phosphorus and High-Purity Phosphoric Acid Elemental phosphorus is used as a process input to produce a wide array of phosphorus chemicals, including phosphorus sulfides and halides, phosphorus pentoxide, and phosphoric acid. Exhibit 28 shows consumption of elemental phosphorus by end use. Among the pesticides that require high-purity phosphoric acid are the herbicide glyphosate (including Monsanto’s Roundup brand) and a wide class of insecticides known as organophosphates.


35

Exhibit 28: Consumption of Elemental Phosphorus by End Use, 2004

Pesticides 60%

Plastics and Elastomer Additives

10%

Other 8%

Lubricating Oil Additives

11%

Surfactants and Sequestrants

11%


Elemental Phosphorus Manufacturers

Exhibit 29: Major Global Elemental Phosphorus Producers, 2005E Capacity 2005 Average Capacity.

short tons ('000)

Astaris 0 (Exited the market)

Monsanto 120

Thermphos International 170

Chinese Producers 500


Phosphorus Industry Trends

Historically, the elemental phosphorus industry had been highly concentrated, dominated by a few major producers with relatively large-capacity plants sized for production of thermal phosphoric acid in addition to phosphorus derivatives. In 1985, Albright & Wilson, FMC (now a 50% owner of Astaris), Hoechst, Solutia (now a 50% owner of Astaris), Occidental, and Rhodia (formerly Stauffer) accounted for almost half of world capacity with 10 plants. By 1995, Albright & Wilson and Occidental had both stopped elemental phosphorus production; and FMC, Hoechst, Solutia, and Rhodia had rationalized to one plant each, representing only 33% of the world total. In 1996, Hoechst then exited the business. Rhodia acquired Albright & Wilson in 2000, and Astaris was created as an FMC/Solutia joint venture in that same year. Rhodia’s operation was purchased by Thermphos. Monsanto remains a significant player, with the vast majority of its production used to manufacture Roundup, the firm’s brand name for the ubiquitous, nonselective herbicide, glyphosate.

The newer Chinese phosphorus plants are much smaller in scale, but there are over 100 producers. As a result, although there has been a net decline in capacity over the past decade, the number of participants has risen substantially. Major companies in the phosphorus industry are now shifting their production to China by way of joint ventures.


36

Unfortunately, the output from some of these phosphorus furnaces in that country has been curtailed due to power shortages.

The successful producers of wet–process, high-purity phosphoric acid include Astaris and PotashCorp. Other manufacturers include FMC’s Foret unit in Europe; Innophos (a company controlled by Bain Capital, which purchased Rhodia’s U.S. phosphate operations in 2004); Prayon (based in Belgium); Tata Group (India); Thermphos (Holland); and Budenheim. (Germany).

Exhibit 30: Major Producers of Purified Phosphoric Acid and Phosphorus Salts, 2001 Annual Capacity

Short tons ('000)

Rhodia 1405

Astaris (FMC & Solutia) 861

Thermphos (Holland) 325

Prayon (Belgium) 245

Potash Corp. of Saskatchewan 195

GIRSA, S.A. de C.V. and Quimir, S.A. de C.V. 195

Israel Chemicals Ltd. (BK Giulini Chemie) 116

Europhos 95


The following chart illustrates the proportion of products derived from wet-process phosphoric acid (includes detergents/animal feed/personal care/food ingredients) in North America (2003).

Exhibit 31: Consumption of Wet Process Phosphoric Acid by End Use, 2003

Food Salts (Largely as preservative for

baked foods)32%

Speciality Acids3%

Phosphoric Acid (Beverages &

Foods)22%

Technical Grade Salts18%

Phosphorus Pentasulfide

5%Phosphorus Trichloride

4%

Sodium Tripolyphosphate (STPP) detergent

builder16%

Source: FMC, CSFB research.

STPP is a more prevalent product outside of North America, as it has been banned for use in laundry detergents in the U.S.


37

Phosphorus Industry Growth Prospects

Demand growth for phosphorus chemicals, which tends to mirror GDP, improved in 2004 with the strengthening of economies in North America and Europe. Though the demand has not changed appreciably, several factors have led to much tighter market conditions for key phosphorus chemicals, including Astaris’s actions to close several of its plants and exit commodity-grade sodium tripolyphosphate (STPP) as part of its restructuring; Rhodia’s action to close its Rouen plant in Europe; and Chinese production constraints resulting from energy shortages. As a result, in both North America and Europe, purified phosphoric acid and phosphorus salts, particularly STPP, are in short supply. In 2005, we anticipate growth continuing at GDP levels.


38

Titanium Dioxide Titanium dioxide is a white pigment. It is manufactured from mined titanium ore through one of two processes, the sulfate or chloride process.

The sulfate treatment uses a wet-chemical process, in which concentrated sulfuric acid is added to ilmenite titanium ore to produce a titanium solution. This solution is converted into titanium dioxide through hydrolysis and calcination.

The chloride route is increasingly being adopted worldwide, as it is more cost-effective, produces a higher-quality end product, and is more environmentally friendly.

Titanium Dioxide Uses

This white pigment is used primarily to enhance brightness and opacity. Fifty-five percent of the demand for titanium dioxide comes from the paints and coatings industry, while other major users are plastics, paper coating and fillers, and, to a lesser degree, man-made fibers. Additional demand stems from the manufacturing of rubber, printing inks, floor coverings, ceramics, textiles, and cosmetics.

Exhibit 32: Global Consumption of Titanium Dioxide by End Market, 2004

Coatings58%

Printing Inks2%

Other6%

Paper10%

Plastics24%

Source: Kerr-McGee, CSFB research.


39

Exhibit 33: Global Capacity for Titanium Dioxide, 2004

DuPont23%

Huntsman13%

Other18%

Kemira3%

ISK4%

Lyondell Chemical16%

Kerr-McGee13%

Kronos10%

Source: Orr & Boss, CSFB research.

Titanium Dioxide Industry Growth Prospects, Trends, and Value Drivers

Reliance on the paints and coatings industry creates exposure to both consumer and industrial confidence. Demand for architectural paints is not that cyclical. Following a period of downstream destocking that ended in the latter half of 2003, shipments of TiO2 reverted to their moderate growth rate in the U.S. In Europe, migration to the more cost-effective chloride manufacturing process, combined with the increasing substitution of titanium dioxide for kaolin in the lamination of paper and board, has fueled strong demand.

The industry has seen considerable consolidation in recent years and, as a result, returns have improved somewhat. Following a period of dismal earnings during and after the 2001 recession (as the inventory correction intensified price competition), pricing and profitability are on an upswing.

Growth rates over the medium to long term have been largely in-line with GDP, and this correlation is expected to continue in the future.


40

V. Organic Chemicals Organic chemicals are derived from either of the two hydrocarbon feedstocks, crude oil and natural gas. Oil and gas companies, as well as chemical companies, have undertaken the manufacturing of first-generation commodity organic chemicals. The former group has gained some market share, as it often possesses a number of cost advantages that lead to greater production efficiency. Foremost among these are: security of feedstock, or the ability to integrate the chemical production into a refinery, and consequently, gain significant capex advantages; and location in a deep-sea port enabling ease of transport of the end product.

Oil/gas and chemical producers located in the Middle East and other oil-rich zones are expanding their market positions fairly rapidly, taking advantage of stranded natural gas in their locales and exporting the derived chemical products. And, if you can’t beat ’em, join ’em, as evidenced by joint ventures, which include the raw material “owner,” such as Kuwait, Petronas, and SABIC and a Western partner, such as Dow Chemical, ExxonMobil, and Royal Dutch/Shell. Elsewhere in Asia, backward integration by Reliance and Formosa groups from chemicals to refining and exploration, as well as creation of vertically integrated oil and chemical giants in China, stand testimony to this latest trend in which organic chemical production is becoming a forte of oil companies.

“Cracking”: Production of Ethylene The organic chemical industry begins with the manufacturing of base chemicals. These form the building blocks for an enormous array of other chemicals and products. The majority of organic base chemicals are manufactured in an olefin plant or “cracker.” The “thermal”—also known as a “steam”—cracker uses heat and steam in tubes within furnaces to break down longer-chained carbon molecules into smaller units. Regardless of the feedstock, crackers always produce the smallest olefin ethylene, but propylene, butenes, and butadiene may also be generated. Beyond these olefins, aromatics and fuel components may also be manufactured.


41

Exhibit 34: Inputs and Outputs in the Petrochemical Industry


Feedstocks The cost of the feedstock has a significant influence on the profitability of the participants in the olefin industry. Not only is it the principal component in the manufacturing of the majority of base chemicals and polymers, but it also reflects the cost of the energy that the cracking process consumes in large quantities. The principal feedstocks for an olefin plant are the derivative naphtha (a low-octane form of gasoline made by fractional distillation of crude oil), used more frequently in Europe and Asia/Pacific, and natural gas (or more specifically, its natural gas liquids [NGLs] components—ethane, propane, and butane), used more often in the U.S. and the Middle East. A cheap raw material base (predominantly natural gas feed) is the key driver of capacity growth in the Middle East. Natural gas-fed units produce a far higher proportion of ethylene than naphtha-fed units (and thus, a reduced proportion of butadiene, propylene, and aromatics), and also require less capital investment.


42

There is no European spot market for natural gas, as all of the capacity is traded under long-term contracts, the terms of which are kept confidential. The price of natural gas liquids tends, however, to track the price of crude oil, sometimes with a lag of three to six months.

Exhibit 35: Crude Oil and Natural Gas Prices

on a monthly basis

0

10

20

30

40

50

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Cru

de

Oil

$/b

bl

0

1

2

3

4

5

6

7

8

9

10

Natu

ral Gas $/M

M B

tu

Crude Oil (WTI) Natural Gas (Delivered Texas)

Severe Winter

Low Natural Gas

InventoriesGulf War I

Gulf War II



43

Exhibit 36: Oil and Naphtha Prices

on a monthly basis

50

85

120

155

190

225

260

295

330

365

400

435

470

505

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

US

$ / t

onne

Brent West Europe Naphtha West Europe


Ethylene and Other Olefins: Introduction The three most important olefins (a subsector of so-called aliphatic organic chemicals)—ethylene, propylene, and butadiene—form the building blocks for the majority of organic chemicals and synthetic materials.

After supply/demand, the prices of crude oil (or more specifically, of naphtha or gas oil) and natural gas are important drivers of profitability of olefin production, as a significant change in raw material price passes straight to the bottom line. Over the short term, this is because NGLs and naphtha pricing are established daily, but contract olefins prices are set on a monthly basis.

Changes in production capacity determine the level of olefin supply. A producer may build new capacity, marginally expand an existing facility, or may suffer a loss of capacity because of technical problems at one of its plants. Demand is reliant on production of derivative products, which are used in a wide variety of industries.

Profitability of Ethylene—The Most Important Petrochemical Intermediate

What is the best way for investors to measure profitability in ethylene in particular and in the ethylene chain in general? No matter how you slice and dice, it is not a simple matter.


44

Looking at ethylene itself is complex enough! We at CSFB have typically looked at the spread between ethylene and the principal feedstock ethane (which contains 2 carbon atoms—C2), one of the NGLs derived from natural gas. This methodology is relatively simple, since for every pound of ethane used, 0.8 pounds of ethylene are produced, with the bulk of the remainder being hydrogen and methane, which can be recycled as fuel.

The Impact of Heavier Feedstocks

Moving to heavier NGLs, propane (3 carbons, i.e., C3) and butane (C4) provide 0.44 and 0.37 pounds of ethylene per pound of feedstock. In these cases, co-products include not only hydrogen and methane, but also propylene and, in the case of butane, butenes and butadiene.

Exhibit 37: Olefin Cracker Output by Feedstock

Olefin Cracker Output by Feedstock(Pounds of Ethylene/Pound of Feedstock)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

ethane propane butane light naphtha gas oil heavy gas oil

ethylene co-products


If even heavier oil-derived liquids (known as distillate fractions that contain C5 molecules or higher) are employed, the ethylene output as a proportion of input feeds drops to 0.34 (naphtha), 0.29 (gas oil), and 0.22 (even heavier vacuum-distilled gas oil). This means that for every pound of ethylene produced in a gas-oil-based cracker about 3.5 pounds of co-products are also produced, as illustrated in Exhibit 38. Hence, co-product prices can be even more important than ethylene prices when utilizing heavy feedstocks.

Co-Product Values Are Critical to the Profitability Equation

Because more co-products are produced, their values become increasingly important as one moves from ethane to the slate of heavier feedstocks, in which heavier means higher molecular weight (i.e., more carbon atoms per molecule) and higher boiling points.


45

Hence, ethylene economics are determined not only by the cost of feedstock and the price of ethylene, but also by the value of the entire slate of co-products. Key ethylene co-products are shown in Exhibit 38. Beyond ethane raw material, this is not a simple task, and it becomes downright confounding by the time naphtha or gas oil is employed. To complicate matters even further, there are different types of naphtha and gas oils, and different cracking conditions (known as cracking severity) that cause the range of co-products to vary.

Exhibit 38: Ethylene Co-Products and End Uses

Key EthyleneCo-products Derivatives/End uses

PolypropyleneAcrylonitrile

Propylene Propylene OxideAcetoneGasoline Alkylate

PE ComonomerButenes MTBE

Gasoline

Synthetic rubberButadiene ABS Resins

Nylon

StyrenePhenol

Benzene NylonUrethanesGasoline

BenzeneToluene Urethanes

Gasoline

PET resinsPolyester Fiber

Xylenes PVC PlasticizersGasoline


Optimizing Feedstocks

When determining their choice of feedstock and cracking severity, ethylene producers use sophisticated models to maximize their economics. Moreover, since the bulk of these manufacturers utilize cracker output “in house” for upgrading into higher value derivatives, the various internal requirements for these co-products is another variable that has to be evaluated.


46

CSFB measures ethylene spreads versus ethane, as it is the simplest method by far and does not require access to linear programming models that ethylene producers employ.

How Important Is the Oil:Gas Ratio?

One rule of thumb that we (and others) have used is the thermal ratio between oil and gas. When the oil:gas ratio is 6:1 (such as $18 oil and $3 gas), the cost of generating heat from either fuel source is the same. A ratio above 7:1 typically favors natural gas-derived ethylene feedstocks, while below 5:1 generally supports the use of those raw materials derived from oil. But this ratio guideline certainly does not indicate which NGL or which oil distillate fraction would be the most cost-effective.

Moreover, even the “rule of thumb” can provide the incorrect answer if co-product values are especially high or low. For example, in recent weeks, when the oil:gas ratio was in the neighborhood of 7:1, the use of naphtha was preferable to NGLs, as gasoline values were above normal relative to crude oil. This led to a situation in which propylene and the simple aromatic compounds (benzene, toluene, and the xylenes) were particularly valuable, since they are utilized through upgrading (in the case of propylene) or directly (aromatics) to enhance the properties of motor fuel. In fact, generally speaking, oil distillate fractions had better economics through most of the first half of 2004, a switch from the fourth quarter of 2003 when co-product values were particularly low. This was a strong contributory factor to the impressive earnings performance in 2004 for ethylene producers that crack naphtha.

How Flexible Are Ethylene Units with Regard to Feedstock Selection?

Another interesting corollary relates to the feedstock mix that any given company (or ethylene cracker) can utilize. Units based on natural gas liquids can often use a mix of C2, C3, and C4, although in some cases only ethane (C2) can be utilized. But they cannot, in general, use naphtha or gas oil, although some NGL-based plants are being modified on the back, or “cold end” (i.e., enhancing the co-product separation part of the plant), with only minor changes to the cracking furnaces in the front section, or “hot end,” to use what are called “light naphthas.” These are oil fractions that are limited to lower boiling materials that contain C5 molecules, and possibly some C6 as well. Light naphthas yield far fewer co-products than full-range naphthas.

Facilities based on naphtha or gas oil are usually flexible in that they can often employ NGLs as well.

The Feedstock and Geographic Mix Is Critical to a Firm’s Profitability

It is just plain wrong to state categorically that, since the U.S. natural gas cost advantage has disappeared (i.e., assuming foregone days of an oil:gas ratio of 9:1 or 10:1 are not returning), the domestic ethylene industry can essentially be written off because economics have turned against it. Since there is a constant arbitrage between fuel oil and natural gas prices, we certainly do not believe NGLs are washed up as an economically viable ethylene feedstock, but what if they were? Whereas about two-thirds of the U.S. olefin industry is based on NGLs, there are lots of facilities that are not. For example, Lyondell’s Equistar unit has about two-thirds of its ethylene output based on naphtha and only one-third on NGLs. While about 70% of the ethylene


47

produced by Nova Chemicals is made in Alberta and based on ethane (the remaining output is derived from a naphtha cracker in Ontario), it should be emphasized that Alberta ethane is derived from natural gas priced about $0.70/mcf below the U.S. Gulf Coast price. Dow Chemical has several flexible naphtha crackers in the U.S. and has closed two uneconomic NGL units. Furthermore, with four naphtha crackers in Europe and three low-cost operations that employ NGLs based on very inexpensive stranded natural gas (Argentina, Kuwait, and Malaysia—the latter two of which are not majority-owned), less than 20% of its global ethylene feedstock mix is U.S. Gulf Coast NGLs.

What about the Ethylene Chain in General?

When going beyond just ethylene and examining the profitability of the ethylene chain in general, what is the best approach? While some ethylene is sold into the merchant market, the bulk is used internally to produce such products as polyethylene, ethylene oxide/ethylene glycol, ethylene dichloride/vinyl chloride, styrene, vinyl acetate, etc. PE, EO/EG, and EDC/VCM account for over 80% of ethylene consumption, with PE alone constituting slightly over half.

Some observers try to “shortcut” the issue by looking at polyethylene spreads, since this thermoplastic typically guzzles more ethylene than any other derivative. This approach can often yield misleading results, however. For example, while polyethylene margins were relatively lackluster during the first half of 2004, giving pause to some investors that use this as a proxy for trends in the ethylene cycle, this was certainly not the full answer to the question.

The best way to attack the problem, in our view, is to examine the entire array of products. Again, this is no simple matter, but even a rough look at a series of compounds manufactured along the chain can be more helpful. Thus, while profitability of PE had been lagging during the first half of 2004, margins for ethylene oxide/glycol and EDC/VCM were on a sharp upward trajectory. In addition, when factoring the high value of ethylene co-products generated in naphtha or gas oil crackers, it is clear that profitability in the ethylene chain was at the time advancing sharply after several dismal years. That is, ethylene feedstocks are critical in evaluating ethylene chain economics.

How Does Middle East Output Affect Profits in Various Scenarios?

An interesting counterintuitive example of ethylene chain profitability concerns petrochemical complexes that are based on ethane derived from stranded natural gas (such as in the Middle East), which sells at $1.00/mcf or less. The higher the free market price of oil and gas, the more profit is generated in these facilities when downstream output is factored into the equation. For example, polyethylene or ethylene glycol production costs, including inexpensive ethane feedstock, are considerably lower when manufactured in the Middle East. Yet these products command world-selling prices, which are largely determined by oil costs in the U.S., Europe, China, Brazil, Japan, Korea, etc. and gas prices in the U.S. Besides the owners of stranded gas, beneficiaries include joint venture partners such as ExxonMobil, Dow Chemical, Royal Dutch/Shell, BP, and ConocoPhillips.

As of the start of 2005, announced capacity expansions in the Middle East approximate 50 billion pounds of ethylene, roughly 20% of current global capacity. However, about 40 billion pounds of this incremental capacity, domiciled mainly in Saudi Arabia and


48

Iran, are not slated to come onstream and be operable until after 2007; this should protect less cost-advantaged producers in the interim. About 10% of the potential Saudi Arabian capacity seems unlikely to be built, and about 20% of the Iranian capacity startup has been pushed back. It could take up to a year after startup for new capacity to affect the market fully.

The completion of the Iranian facilities in a timely manner is somewhat more challenging, since different facets of a given project—such as raw material procurement, downstream manufacturing, utilities, the cracker itself—typically are owned by different groups, making coordination more difficult. Also, unlike the situation in Saudi Arabia and most other Middle East countries, Iranian projects do not usually include partners from outside the country.

Ethylene Ethylene Uses

Ethylene is produced predominantly in thermal (steam) crackers and is used in the manufacturing of a huge variety of chemicals and products. Demand for ethylene, and therefore its price, is largely driven by demand for its derivative plastics—polyethylene, polyvinyl chloride, and polystyrene—which combined account for approximately 75% of demand for ethylene. (These plastics are discussed in more detail later in this report.) Much of the remaining use is linked to demand for ethylene glycol, used in manufacturing antifreeze, PET bottle resin, and polyester fibers.

Exhibit 39: Global Ethylene Demand by Derivative, 2004

Polyethylene59%

Alpha Olefins3%

Vinyl Acetate1%

Ethylbenzene7%

Ethylene Oxide13%

Ethylene Dichloride13%

Other4%

*Ethylene dichloride is a precursor of PVC **Ethylene oxide is a precursor of ethylene glycol Source: CMAI, CSFB research.


49

Exhibit 40: Ethylene Derivatives

Ethylene Oxide

Ethylbenzene

Ethylene Dichloride

High-Density Polyethylene

ETHYLENE

+ chlorine

VCM4

Ethylene Glycol

Styrene

+ benzene

Others

PVC5

Polystyrene

1. LDPE =Low Density Polyethylene

2. LLDPE = Linear Low Density Polyethylene

3. HDPE = High Density Polyethylene

4. VCM = Vinyl Chloride Monomer

5. PVC = Polyvinyl Chloride

59%

13%

13%

7%

8%

Low-Density Polyethylene

Linear Low-Density

Polyethylene

Linear Low-Density

Polyethylene

Ethylene GlycolOther EO

Derivatives

Source: ECN, CSFB research.

Ethylene Manufacturers

Exhibit 41: Major Global Ethylene Producers, 2004 Capacity 2004 Average Capacity. Metric tons ('000)Dow Chemical 9,772ExxonMobil 8,228Royal Dutch/Shell Group 6,848SABIC 6,203Lyondell Chemical 4,749BP 4,741TotalFinaElf 3,490China Petrochemical Corp 3,292Formosa Plastics 3,165BASF 3,020


Ethylene Industry Trends, Growth, and Value Drivers

As with many commodity petrochemicals, ethylene production is increasingly being consolidated among only the largest oil and chemical companies, including those with secure sources of cheap feedstocks. The increasing need for scale in petrochemicals is leading to sizable global players and reducing the aggregate market positions of smaller companies that are reluctant to commit further capital to this business. In addition, the limited ability of producers to pass on feedstock price changes to their customers during periods of oversupply tends to lead to a level of earnings volatility that only the largest and/or most diversified players can handle. Finally, the ability of oil and gas companies to integrate an ethylene plant into a refinery presents significant cost advantages and consequent production efficiencies that are unmatchable by those without this ability.


50

As demand growth is closely linked to economic health, ethylene usage is often measured in relation to GDP. We use a trendline global GDP multiplier of 1.5 through 2006 to forecast future demand for ethylene and its derivatives.

Exhibit 42: Ethylene Prices, 1993–Present

on a monthly basis

200

300400

500

600

700

800

900

1,0001,100

1,200

1,300

1,400

1,500

1,600

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

US

$ / t

onne

US Ethylene EU Ethylene Asian Ethylene


Exhibit 43 presents our supply/demand forecast for ethylene. Demand growth is expected to approximately match capacity growth, most of which is centered in the Middle East and, to a lesser extent, China. Hence, global capacity utilization is

Exhibit 43: Estimated Global Supply/Demand for Ethylene

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E

World Capacity (Avg) 72,359 75,010 78,475 81,707 85,171 89,229 92,981 95,965 103,563 110,365 111,699 113,298 119,327 126,437 131,772 138,667

% change 5.4% 3.7% 4.6% 4.1% 4.2% 4.8% 4.2% 3.2% 7.9% 6.6% 1.2% 1.4% 5.3% 6.0% 4.2% 5.2%

Demand* 61,614 66,976 69,999 74,306 78,045 81,245 87,302 90,579 92,286 95,717 98,063 104,615 111,242 116,714 122,527 128,707

%change 2.4% 8.7% 4.5% 6.2% 5.0% 4.1% 7.5% 3.8% 1.9% 3.7% 2.5% 6.7% 6.3% 4.9% 5.0% 5.0%

Shipment Rate 85% 89% 89% 91% 92% 91% 94% 94% 89% 87% 88% 92% 93% 92% 93% 93%

Source: Credit Suisse First Boston Estimates * Projections based on the IMF's GDP forecasts


expected to remain in the low 90s, a healthy environment for profitability. It appears more likely that some of the projects that were scheduled to come onstream between 2005 and 2007 may be delayed, a phenomenon that would boost shipment rates in those three years somewhat. In support of this view, we cite a recent report from CMAI, which projects that 20% of Middle Eastern ethylene capacity scheduled for 2005-2010 will come onstream in 2005-2007, with the remaining 80% in the following three years.


51

Propylene Like ethylene, propylene can be manufactured either in an olefins plant or as part of the oil refining process. There are three different grades of propylene: refinery (the least pure, used to make high octane gasoline alkylate); chemical (used to make various chemical products such as acrylonitrile, cumene, propylene oxide, and acrylate monomers); and polymer (used to make polypropylene). Refinery grade propylene is often upgraded to chemical or polymer grade material. A small proportion of propylene is derived from the propane dehydrogenation process, a more expensive route, but one that is helpful if no alternate sources are available. Moreover, some can be produced by olefin metathesis, as described below.

Exhibit 44: Propylene Derivatives

Polypropylene

Cumene

Propylene Oxide

Acrylates

Acrylonitrile

Acrylic Fibers

PROPYLENE

61%

9%

7%

6%

Other

ABS* Resins

Phenolic Resins

Polyurethane resins & coatings

Solvents

* ABS = Acrylonitrile Butadiene Styrene

Paints,Coatings,

Superabsorbers

2%

15%


Propylene Uses

Propylene itself has few direct uses. Its largest chemical market is for the manufacturing of polypropylene resin, an important intermediate product in the manufacturing of a wide range of consumer and industrial goods. (See the “Polypropylene” section.) This accounts for around 60% of output. It is also used in the manufacturing of a number of derivative chemicals that are used in the manufacturing of certain textiles, fibers, coatings, and plastics.


52

Exhibit 45: Global Propylene Consumption by Derivatives, 2004

Polypropylene60%

Others6%

Propylene Oxide7%

Acrylonitrile9%

Cumene6%

Oligomers2% 2-Ethyl Hexanol

4%

Isopropanol2%

Butanols4%


Exhibit 46: Major World Producers of Propylene, 2004 (annual capacity) 2004 Average Capacity

metric tons ('000)

Royal Dutch/Shell Group 4,686

ExxonMobil 4,466

BP 3,183

TotalFinaElf 3,141

Dow Chemical 3,066

Lyondell Chemical 2,790

China Petrochemical Corp 2,779

Ente Nazionale Idrocarburi SpA 2,386

BASF AG 2,272

Formosa Plastics 1,924


BASF and Dow aside, the majority of propylene producers are petroleum-refining companies. Approximately 70% of propylene production is derived as a co-product of ethylene manufacturing; the remainder is produced as a by-product of petroleum refining.

Propylene Industry Trends, Growth, and Value Drivers

The value of propylene is closely allied to general economic activity because propylene forms the base for a huge number of derivative products that are used in a wide variety of industrial and consumer goods. In addition, as propylene is produced as a by-product of ethylene production, the manufacturing base is broadly similar. Thus, the trends toward consolidation, scale, and participation by oil and gas producers also apply.

One interesting situation that may be unfolding is tightening propylene availability through the rest of the decade, ethylene expansions notwithstanding. The reason behind this apparent dichotomy relates to the nature of the new ethylene facilities. The largest portion of world expansion in ethylene is coming from the Middle East, and ethane is the predominant feedstock there. Hence, hardly any propylene will be


53

produced in these new olefin units. This will put more pressure on refineries to supply incremental propylene demands (raising the price of propylene vis-à-vis ethylene over the next five years). Another possibility is the increased use of the propane dehydrogenation route to propylene, another relatively expensive proposition. A third source would be olefin metathesis. For example, a combination of ethylene and butylenes can be metathesized to propylene in a catalytic reaction; the BASF/Total cracker in Port Arthur, Texas, utilizes this process to bolster propylene output from its facility.

Long-term demand for propylene has grown at twice the annual rate of GDP historically. We expect growth to remain at 1.5-2.0 times GDP on a long-term basis.

Butadiene

Butadiene Uses

The primary use of butadiene is as an intermediate product in the production of two principal types of synthetic rubber. This in turn is used in the manufacturing of tires and other fabricated items. The remaining demand for butadiene comes from manufacturers of styrene-butadiene latex (often used as an adhesive or coating); ABS resins (used in engineering plastics); and nylon 66 fibers—by those who utilize the DuPont technology.

Exhibit 47: Butadiene Derivatives

Styrene-butadiene

Latexes

ABS resins*

Nylon fibersand resins**

Polybutadiene

BUTADIENE

66%

•* ABS = Acrylonitrile Butadiene Styrene

** DuPont Technology

33%

Synthetic rubbers



54

Exhibit 48: Global Butadiene Consumption by Market, 2004

Other5%ABS resins

11%Adiponitrile/HDMA5%

2, 6 NDC0.2%

SBR & Latex36%

Polybutadiene rubber26%

SB copolymer latex11%

Polychloroprene rubber

3%

Nitrile rubber3%


Butadiene Manufacturers

As the third major product of the cracking process, butadiene is produced by the same companies that produce ethylene and propylene, although the proportions of butadiene produced depend upon the feedstock used. Ethane and propane feedstocks do not lead to commercial amounts of butadiene; butane or higher-molecular-weight raw materials (such as naphtha and gas oil) are required to provide healthy output.

Exhibit 49: Major World Butadiene Producers, 2004 2004 Annual Capacity % share


Royal Dutch/Shell Group 975.9 8.8%

China Petrochemical Corporation 789.1 7.1%

Texas Petrochemicals 762 6.8%

ExxonMobil 536.75 4.8%

Huntsman 520 4.7%

BP 494.5 4.4%

Lyondell Chemical 390.5 3.5%

JSR Corporation 333 3.0%

SABIC 320 2.9%

EniChem 313.1 2.8%


Source: Company data, CSFB estimates

The companies mentioned in Exhibit 49 accounted for approximately 51% of global butadiene production.


55

Butadiene Industry Trends, Growth, and Value Drivers

Traditional markets for butadiene derivatives tend to be largely mature (such as automotive); thus, butadiene growth has been modest. In recent years, however, demand has picked up because of increased use of ABS resins as an engineering plastic.

We expect butadiene demand growth to remain broadly in-line with GDP over the next five years. Demand suffered in 2001-2002 because of the weak economies, particularly in Western Europe and the U.S. However, meaningful recovery was noted in late 2003 and 2004.


56

Benzene and Other Aromatics: Introduction Like the olefins, the aromatics—including benzene, toluene, and the xylenes—are derived either from the cracking process or from petroleum refining. As a large proportion of aromatics are produced in the petroleum refining industry, the economics of the aromatic chain are closely linked to those of crude oil and gasoline. Prices for aromatics, therefore, tend to be some of the most volatile of any of the base chemicals.

Exhibit 50: Principal Derivatives of Aromatics

Benzene

Toluene

Crackers orRefineries

Xylenes

Styrene

Phenol

Cyclohexane

Para-Xylene

Dinitrotoluene

Aniline

Acetic Acid

Bisphenol-A

PhenolicResins

Caprolactam

Adipic Acid

PurifiedTerephthalicAcid (PTA)

MDI

EthyleneGlycol

Polystyrene

TolueneDiisocyanate

(TDI)

Polycarbonate

EpoxyResins

Adhesives

Nylon 6

Nylon 66

Polyurethane

Polyurethane

Polyester/PET Resin

Base Chemical Intermediate Product End Product



57

Benzene

Benzene Uses

Benzene is the most widely used aromatic compound. Of its derivatives, styrene is produced in the greatest volume for use in polystyrene for packaging, as well as in ABS resins and styrene-butadiene rubber. In addition, phenol is employed as an intermediate in the manufacturing of adhesives and epoxy resins. The other large derivative of benzene, cyclohexane, is widely used in the production of nylon and as a gasoline component.

Exhibit 51: Global Consumption of Benzene by End Market, 2004

Others15%

Ethyl Benzene/ Styrene

55%

Cyclohexane12%

Cumene18%


Benzene Manufacturers

Exhibit 52: Major World Producers of Benzene, 2002 2002 Annual Capacity

metric tons '000

ExxonMobil 3,276


Dow Chemical 2,264

TotalFinaElf 2,056

BP 1,912

China Petrochemical Corporation 1,655


ConocoPhillips 1,052

Petróleos de Venezuela 972

Nippon Oil Corporation 938


The companies mentioned in Exhibit 52 accounted for approximately 40% of global benzene production.


58

Benzene Industry Trends and Value Drivers

Benzene supply in Asia will likely be tight from 2005. Asian oversupply in 2004 was 200,000 tons. However, due to a demand increase for derivative products, we estimate supply will be 400,000-500,000 tons short in 2005. In 2008, we estimate supply will be short by over 800,000 tons.

Benzene Growth Prospects

The majority of benzene capacity additions are expected to be in Asia, where plans scheduled would add 1.64 million tons in 2005-2007. During the same period, capacity additions for 2.76 million tons of derivative products are also planned. We expect benzene demand to grow more than capacity during this period.

Toluene

Toluene Uses

Toluene’s major use is as an additive to gasoline to boost the octane rating. The major chemical use is in the production of the xylenes and benzene through disproportionation. Its use in the manufacturing of solvents is declining because of stricter emissions laws, but it is also used to make toluene di-isocyanate (TDI), which is used in the manufacturing of polyurethane foams.

Exhibit 53: Global Consumption of Toluene by End Market, 2003

Benzene35%

Xylenes30%

Solvents10%

Toluene diisocynate

10%

Gasoline blending5%

Other10%



59

Toluene Manufacturers

Exhibit 54: Major World Producers of Toluene, 2002 2002 Annual Capacity

metric tons '000

ExxonMobil 1,964

China Petrochemical Corporation 1,154

BP 1,075

Chevron 928

Reliance Industries 913

ConocoPhillips 887

Royal Dutch/Shell Group 873

Koch Industries 814

Petróleos de Venezuela 717

TotalFinaElf 686


The top-10 producers listed above accounted for approximately 41% of global toluene production.

Toluene Industry Trends and Value Drivers

The majority of toluene production is unrecovered (as it is consumed as a constituent of various refinery systems). Because of its major use as a gasoline additive, prices are primarily driven by gasoline prices and are also, therefore, closely linked to the price of oil.

Toluene Growth Prospects

Toluene economics depends on the price of oil, refining margins, and supply/demand conditions in the aromatics business in general, including benzene. We expect demand to grow for TDI and to firm for other applications.

The Xylenes Mixed xylene is used primarily as a solvent and as an additive in gasoline. In the chemical industry, xylene is separated into three isomers: para-xylene, ortho-xylene, and meta-xylene.

Xylene Uses

Mixed xylenes are the second most important aromatic product in terms of world consumption for chemical manufacturing. Almost all para-xylene is converted into either terephthalic acid (TPA) or dimethyl terephthalic acid (DMT), which comprises the basic intermediates for polyester fibers and films and polyethylene terephthalate (PET) resins. It is also used to manufacture polybutylene terephthalate (PBT), a specialty engineering resin.

The other major isomer is ortho-xylene, used to produce phthalic anhydride, which itself is used in the production of plasticizers, polyester resins, and alkyd resins.


60

Exhibit 55: Xylene Materials Flow

Toluene

Meta-Xylene

Ortho-Xylene

Para-Xylene

Isophthalic Acid

Phtalic Acid

DMT/PTA

Unsaturated Polyesters

Surface CoatingsPET Copolymers

PVC PlasticizersSurface Coatings

Unsaturated Polyesters

Polyester FibersPET Resins

Major End-Use Derivatives

Major Chemical Intermediates

Coal Processing

SteamCracking

Petroleum Reforming

Direct use of mixed Xylene

Mixed Xylene

recovery

Disproportionation

Separation Isomerisation

Benzene

Major Aromatic Source

Other Aromatic Sources

Source: SRI.

Xylene Manufacturers

Generally, oil companies recover xylenes and isolate the isomers, while the chemical companies purchase the isomers for manufacturing of derivatives.

Exhibit 56: Leading Producers of Xylenes, 2004 Mixed Xylenes Ortho-xylene Para-xylene

World Share

World Share

World Share

Company (%) Company (%) Company (%)

ExxonMobil 11 ExxonMobil 11 ExxonMobil 13

China Petrochemical 8 China Petrochemical 9 BP 12

Reliance Industries 6.5 Reliance Industries 8 Reliance Industries 7

TotalFinaElf 6 Kohap 5 China Petrochemical 7

BP 5 SK Group 4 Chevron 4

Nippon Oil Corporation 4 Formosa Plastics 4 Nippon Oil 3

China National Pet 3 Flint Hills 4 Kohap 3

ConocoPhillips 3 Sibneft 4 Formosa Plastics 3

Royal Dutch/Shell Group 2.5 Others 51 SK Group 3

Flint Hills 2.5 Flint Hills 3

Chevron 2.5 Others 43

Others 49



61

Xylene Industry Trends and Value Drivers

As the three xylene isomers are used in a broad range of applications, principally polymers, it is difficult to generalize regarding demand drivers. However, the majority of end markets for these applications tend to be fairly mature, although some end markets, such as PET for use in plastic bottles, are growing well above GDP and have prompted recent capacity additions.

Xylene Growth Prospects

Overall, we expect demand growth of around 3-5% for all xylenes over the next five years. However, para-xylene demand should grow around 7-8% in 2005-2006, so near-term demand growth for xylene may be higher.


62

Acetone Acetone is produced principally as a co-product of phenol in the peroxidation of cumene, although some production is via the dehydrogenation of isopropyl alcohol. Acetone is an intermediate in the production of methyl methacrylate, bisphenol A, and aldol chemicals. It is also widely used as a solvent.

Exhibit 57: Global Consumption of Acetone by End Use, 2006E

ACH/MMA30%

Direct Solvent28%

Bisphenol A23%

Aldol chemicals11%

Other8%


Exhibit 58: Leading Global Producers of Acetone, 2002 2002 Annual Capacity

metric tons ('000)

Ineos Phenol 899


Sun Chemical 536

Mitsui Chemical 357

EniChem 295

Dow Chemical 243

TotalFinaElf 217

General Electric 194

Rhodia 183

Georgia Gulf 181


Acetone Industry Trends and Value Drivers

Acetone derivative demand is highly affected by macroeconomic conditions, as shipments depend on the health of the auto and construction sectors. Acetone supply is driven more by phenol (its co-product) demand than by acetone (its own end markets).


63

Acetone Growth Prospects

Acetone remains in oversupply and is expected to remain so for a few years. Global phenol demand continues to outpace the growth for acetone, and with acetone thus perennially long, producers continue to explore economically efficient ways of producing phenol without acetone.


64

Acrylates

Acrylic Acid and Acrylate Esters

The most common (and economically efficient) path of acrylic acid production is the oxidation of propylene to acrolein and then to acrylic acid, employing various catalysts. The catalyst is a critical component of the associated cost economics of acrylic acid manufacture. Typically, the acrylic acid is either converted to polyacrylic acid—a superabsorbant polymer used in disposable diapers and incontinence pads—or to acrylate esters. In the latter case, the acrylic acid undergoes esterification with an alcohol (such as butanol or ethanol) to yield acrylate esters, which are heavily employed in the manufacturing of coatings and adhesives. Acrylic acid production accounts for about 5% of total propylene consumption in North America.

Exhibit 59: Global Consumption of Crude Acrylic Acid by End Use, 2003

Commodity Esters39%

Superabsorbents46%

Other15%

Source: CSFB estimates.

Exhibit 60: U.S. Consumption of Commodity Acrylate Esters by End Use, 2003

Surface coatings39%

Fibers2%

Adhesives/ Sealants

25%

Textiles7%

Others27%

Source: SRI, CSFB estimates.


65

Acrylates Manufacturers

Exhibit 61: Major Producers of Crude Acrylic Acid, 2004 Annual Capacity

metric tons ('000)

BASF 850

Rohm and Haas 739

Dow Chemical 517

Nippon Shokubai 406

ATOFINA 296

Formosa Plastics 111

Other 776


Exhibit 62: Major Producers of Commodity Acrylate Esters, 2004 Annual Capacity

metric tons ('000)

BASF 859

Dow Chemical 430

Rohm and Haas 396

Nippon Shokubai 231

ATOFINA 198


Other 1024


Acrylates Growth Prospects

We anticipate growth rates of 4-5% for acrylic acid and acrylate esters. The highest growth for these products continues to be witnessed in hygiene products, such as diapers and incontinence pads, as well as in the replacement of oil-based paints with water-based paints.

Methyl Methacrylate (MMA)

MMA is a monomer—produced from acetone—that is generally polymerized into pMMA and other polymeric systems for various end markets. It has a wide range of uses and is the principal building block for acrylic resins. In acrylic sheet form, it is often branded (such as Perspex or Plexiglas) or molded into household products. Acrylic polymers continue to be used as a substitute for materials such as glass because of their toughness and other attractive properties. However, the market is mature; thus, demand only marginally outpaces GDP. In addition, MMA can be co-polymerized with various acrylate esters (derived from propylene) to be formulated into water-based emulsions; these products are often used in surface coatings and also as fixatives in products such as hairsprays. One growth area, however, is mineral-filled acrylic surface materials such as Corian (DuPont), which continues to make a splash in sink and countertops.


66

Exhibit 63: Major End Uses for MMA, 2007E

Other26% Acrylic sheet

34%

Moulding & Extrusion

Compounds22%

Surface Coatings18%


Exhibit 64: Major Producers of MMA, 2003 2003 Average Capacity

metric tons ('000)

Rohm and Haas 615

Lucite International 365

Mitsubishi Rayon 287

ATOFINA 180

Asahi Kasei 100

Honam Petrochemical 100



67

Acrylonitrile Acrylonitrile (AN) is produced by the ammoxidation process from propylene, ammonia, and air. This propylene-based route was developed by Standard Oil of Ohio in the 1950s and is referred to as the Sohio process (now owned by BP). The process replaced a higher-cost route that employed acetylene and hydrogen cyanide.

Acrylonitrile Uses

The largest end use for acrylonitrile is acrylic fibers, which accounts for nearly half of total output. Acrylonitrile-butadiene-styrene (ABS) and styrene-acrylonitrile (SAN) resins represent 30% of acrylonitrile consumption. The consumption of these thermoplastic resins is primarily in the manufacture of durable goods, including automobile components, appliances, business machines, and pipe and fittings, and, hence, demand is economically sensitive. Adiponitrile (ADN) is used exclusively in the production of hexamethylenediamine (HMDA), which is a precursor for nylon 66 resins and fibers. Solutia (formerly Monsanto) is the prime practitioner of this process that converts AN to AND. Other smaller-volume end uses for acrylonitrile include acrylamide, nitrile rubber, and acrylonitrile co-polymers.

Exhibit 65: Global Consumption of Acrylonitrile by End Use, 2003

Others12%

Adiponitrile10%

ABS24%

Acrylamide4%

Acrylic Fibers50%

Source: Chemical Week, CSFB estimates.


68

Acrylonitrile Manufacturers

Exhibit 66: Leading Global Producers of Acrylonitrile, 2004 2004 Annual Capacity

metric tons ('000)

BP 935

Asahi Chemical 695

Solutia 467

China Petrochemical 355

Sterling Chemical 339

BASF AG 300

Tae Kwang Petrochemicals 250


DSM 235

Cytec Industries 215


Acrylonitrile Industry Trends and Value Drivers

The growth of acrylic fibers and ABS resin capacity in the Far East has been the key driver of acrylonitrile demand. Imported acrylonitrile from North America is a critical source of feedstock for the Asian markets, and that region is not expected to become self-sufficient for the next several years.

Acrylonitrile Growth Prospects

Global acrylonitrile demand is expected to grow at a 4% CAGR through 2005. Robust Asian demand growth is expected to be partially offset by much slower growth in the mature European and North American markets.


69

Ethylene Glycol

Ethylene Glycol Uses

Ethylene glycol is an ethylene derivative and is used primarily in the manufacture of polyester (81%) and antifreeze (11%). Of the ethylene glycol consumed for polyester production, 25% is used for PET containers, 52% for polyester fibers, and 4% for PET films. Antifreeze is used in motor vehicles, pumps, and heating, and serves to lower the freezing point of water. Other smaller outputs include resins for surface coatings, and hydraulic brake and shock absorber fluids.

Exhibit 67: Global Consumption of Ethylene Glycol by End Market, 2003

Industrial5%

Other3%

Polyester Fiber52%

PET Containers25%

Antifreeze11%

PET Film4%


Exhibit 68: Ethylene Glycol Manufacturers, 2003 2003 Annual Capacity

metric tons ('000)

MEGlobal* 2,158

SABIC** 1,050


Mitsubishi Corp 650

Lyondell*** 442

Honam Petrochemical 400

ExxonMobil 400

Mitsui Chemicals 380

Reliance Industries 370


*50/50 joint venture between Dow Chemical and Petrochemical Industries Company (Kuwait). **Includes capacity from JVs with Japanese consortium and ExxonMobil. ***Includes capacity from JV with DuPont. Source: Chemical Week, CSFB estimates.


70

Ethylene Glycol Industry Trends and Value Drivers

Increasingly, most producers believe manufacturing MEG in North America, Europe, and Japan is not as profitable as other petrochemicals. Many producers in this region cannot justify capacity expansion due to low or negligible returns. As a result, all new capacities are being developed in the Middle East due to the abundant supply of natural gas reserves in that region.

Ethylene Glycol Growth Prospects

Monoethylene glycol’s growth is highly dependent on polyester fibers and resins. We anticipate growth rates of 4-5% through 2007.


71

Ethylene Oxide Ethylene oxide is produced mainly via the catalytic oxidation of ethylene and is used in the production of ethylene glycols (used for antifreeze, PET bottle resin, polyester fibers, and polyurethanes), surface-active agents (alkylphenol ethoxylates), ethanolamines (soaps and detergents), and glycol ethers (used in surface coatings, cleaning products, and aircraft fuels).

Exhibit 69: Global Consumption of Ethylene Oxide by End Market, 2002

Polyols2%

Higher Glycols8%

Glycol Ethers3%

Ethylene Glycols67%

Ethoxylates11%

Polyethylene Glycol1%

Ethanolamines6%

Other2%


Ethylene Oxide Manufacturers

Exhibit 70: Leading Global Producers of Ethylene Oxide, 2004

2004 Annual Capacity metric tons ('000)Dow Chemical 2,758


BASF 1,040


SABIC 988

China Petroleum Corporation 603

Japanese MEG 583

BP 540

Huntsman 505

Lyondell Chemical 485


The top-10 producers accounted for approximately 55% of global ethylene oxide production in 2004.


72

Ethylene Oxide Industry Trends and Value Drivers

Most ethylene oxide is used by its manufacturer. In North America, for example, only about 10% of ethylene oxide produced is sold in the merchant market. The largest producers of ethylene oxide are located in North America and the Middle East, where the players have economies of scale and a cost advantage.

Ethylene Oxide Growth Prospects

Most of the capacity growth is expected in the Middle East and Asia over the next four to five years. Demand for ethylene oxide is expected to grow at an annual average rate of 5.1% through 2008.


73

Methanol Methanol (methyl alcohol) is one of the few organic base chemicals not produced in an olefin plant. Instead, the vast majority (90%) is produced by reforming natural gas, or more specifically, synthesis gas with steam.

Methanol Uses

The principal derivatives of methanol are methyl tertiary butyl ether (MTBE), formaldehyde and acetic acid. Methanol is also used as a solvent. Over 40% of methanol is used to produce the latter two derivatives in the manufacturing of polymers for adhesives, fibers, and plastics. It is also used in some types of antifreeze, but generally not as an automobile coolant. In the gasoline industry, MTBE is used as an octane booster and a blending agent.

Exhibit 71: Global Methanol Demand by End Market, 2004

Methylamines3%

Acetic Acid10%

MTBE21%

Formaldehyde34%

Other24%

Chlorinated methanes

4%

DMT1%

Methyl methacrylate3%


Methanol Manufacturers

Exhibit 72: Leading Methanol Producers, 2004 2004 Capacity

metric tons (‘000)

Methanex 7316

SABIC 2225

Celanese 1963

Ferrostaal AG 1575

National Iranian Oil 1510

Japan Saudi Methanol Consortium 1500

Terra Industries 963

Metafrax 825

Tomsk Group of Petrochemical Enterprises 825

PDVSA 780

Statoil 738

Petronas 726



74

Methanol Industry Trends and Value Drivers

Since almost all formaldehyde is manufactured using methanol, demand for formaldehyde is a key growth driver. Formaldehyde is used to produce resins for adhesives used principally in the construction industry. As a result, activity in this industry is a key determinant of demand for methanol.

The use of MTBE as a fuel additive was a major driver of demand for methanol during the early to mid 1990s. Because of environmental concerns (leaching into groundwater from leaking tanks at gasoline stations), the long-term use of MTBE in the U.S. has been called into question.

Methanol could well see a long-term fillip to demand growth from fuel cells if adopted as the fuel of choice. However, in our view, we are unlikely to see any meaningful effect from this source for several years to come.

Methanol Growth Prospects

There are concerns that new methanol facilities slated to come onstream will result in oversupply. However, we believe this is not likely, given that small-scale facilities in China and South-East Asia will shut down once these new plants are complete. In addition, since high prices for natural gas have significantly curbed methanol production, we expect the increases to methanol supply in 2005 to be limited.

Global demand rose to 31.2 million tons in 2003, and we expect demand to continue expanding at a pace of 2.5% annually. We forecast demand will grow by 0.9-1.0 million tons in 2005, and by a similar amount in 2006. New capacity amounting to 2.59 million tons is slated to come onstream in 2005 and a further 2.75 million tons in 2006. However, since total production capacity of 3.42 million tons will likely be halted, we expect supply/demand to remain tight in 2005. In 2005-2006, the increase in demand (assuming 1.8 million tons), combined with the expected halts to production capacity, should amount to 5.22 million tons, which is roughly the same level as the 5.34 million ton slated increase in production capacity. As a result, we expect supply/demand to remain relatively tight until 2007, when production capacity totaling 8.4 million tons (including that of Mitsubishi Gas Chemical) is slated to come onstream.


75

Phenol Phenol is an aromatic intermediate produced predominantly via the peroxidation of cumene, a process that also yields acetone. Other processes may be used, but this is the most economic route. Solutia has patented a production process that yields phenol from benzene and nitrous oxide through a one-step process without the intermediate cumene and the co-product acetone; however, commercialization has been put on hold owing to oversupply, and a change in Solutia’s strategy implies the company might prefer to license the technology, rather than committing its own capital. Key phenol derivatives are bisphenol A, phenol-formaldehyde resins, caprolactam, and alkylphenols.

Exhibit 73: Global Consumption of Phenol by End Use, 2006E

Bisphenol A43%

Alkylphenols4%

Phenol/ formaldehyde

resins27%

Caprolactam9%

Other17%


Phenol Manufacturers

Exhibit 74: Leading Global Producers of Phenol, 2003 2003 Annual Capacity

metric tons ('000)

Ineos Phenol 1,530

Sunoco Chemicals 976

Royal Dutch/Shell group 535

Polimeri Europa 480



Ertisa 350

Dow Chemical 295

Novapex* 275

* Bain Capital (Boston) acquired Rhodia’s Phenol business and formed Novapex.



76

Phenol Industry Trends and Value Drivers

Demand for phenol is highly sensitive to the overall economy, as end uses lie predominantly in the construction and auto sectors. Bisphenol A is a precursor of polycarbonate and epoxy resins, which are employed in various OEM- and construction-related materials, as well as in electronics. Phenol-formaldehyde resins are used to bind wood for construction and furniture. Caprolactam is an intermediate in the manufacture of nylon 6 fibers and resins. In addition to demand, phenol prices are also driven by raw material (propylene and benzene) tabs.

Phenol Growth Prospects

Phenol demand in 2004 grew by 4.2% year over year. Asian growth was 8.9% year over year due to good demand for BPA and phenol resins. Phenol demand should grow by 3% in 2005, as demand remains firm for BPA for polycarbonate and phenol resins. We envision long-term growth rates of 3-4%.


77

Propylene Oxide Propylene oxide (PO) is produced via two major routes commercially: (1) the chlorohydrination of propylene and (2) the peroxidation of propylene. The chlorhydrin process uses large volumes of chlorine (1.45 pounds of chlorine for each pound of propylene oxide) and is only competitive if employed by an integrated producer. There are two distinct process technologies that use the peroxidation process, and both yield co-products. One process yields tertiary butyl alcohol (TBA) as the co-product; the other yields styrene monomer (SM) as the co-product. These methodologies yield two to three times as much co-product (styrene or TBA) as propylene oxide, a significant disadvantage. Most of the recent capacity expansions have been in the form of propylene oxide/styrene monomer (PO/SM) plants.

Several firms are developing routes to manufacture propylene oxide through the direct oxidation of propylene. The advantage of these processes is that they will not yield a co-product. One is commercial at this point, but Lyondell Chemical Company and Sumitomo Chemical Company, through their joint venture Nihon Oxirane Co., Ltd., are in the process of building a 200,000-metric-ton-per-year propylene oxide facility in Chiba, Japan, that utilizes a proprietary process.

Propylene Oxide Uses

The largest end use, representing 60-70% of propylene oxide output, is polyether polyols, which are used with MDI or TDI to produce polyurethanes. Propylene glycol (PG), which accounts for 20% of end demand, is the second-largest use for propylene oxide. PG is used as an intermediate in the production of unsaturated polyester resins, as well as for deicing fluid or antifreeze, and is also employed as an additive in processed foods, drugs, and cosmetics. Glycol ethers represent 5% of PO output and are largely used as solvents in a variety of market applications.

Exhibit 75: Global Consumption of Propylene Oxide by End Use, 2003

Polyols65%

Other10%

Propylene Glycols20%

Glycol Ethers5%



78

Exhibit 76: Leading Global Producers of Propylene Oxide, 2004 2004 Annual Capacity

metric tons ('000)

Lyondell Chemical 1,861

Dow Chemical 1850


BASF 374

Repsol 215

Sumitomo Chemical 213

BP 200

Huntsman 181

Sunkyog Industries 165

Bayer AG 143

Source: CMAI CSFB estimates.

The top-10 producers accounted for 88% of global propylene oxide production in 2004.

Propylene Oxide Industry Trends and Value Drivers

The durable goods market, as represented by polyurethanes, is the key driver of the propylene oxide market. The industry is highly consolidated with two key players, Dow Chemical and Lyondell Chemical, accounting for 56% of global supply. The capital intensity of the business (it costs about $500 million to build a world scale POSM plant with 500 million pounds of PO capacity) as well, as the proprietary nature of the technology that is not freely licensed, limits the number of players.

Propylene Oxide Growth Prospects

Global propylene oxide demand is expected to grow at 3-4% per year in 2005. A large amount of capacity started up in the past three years, which the industry has been able to absorb. Currently, the supply/demand ratio is balanced globally and looks to become tight moving beyond 2005


79

Styrene Monomer Styrene monomer is manufactured through the oxidation of ethylbenzene, which is produced via the alkylation of benzene with ethylene using a catalyst.

The majority (about two-thirds) of styrene monomer is consumed in the manufacture of polystyrene resins. Other key derivatives include acrylonitrile-butadiene-styrene (ABS) and styrene-acrylonitrile (SAN) resins, styrene-butadiene (S/B) co-polymer latex emulsion, unsaturated polyester resins, and S/B elastomers.

Exhibit 77: Global Consumption of Styrene Monomer by End Market, 2003

Polystyrene47%

SBR10%

EPS16%

ABS/SAN15%

Others12%


Styrene Manufacturers

Exhibit 78: Leading Global Producers of Styrene, 2003 2003 Annual Capacity

metric tons ('000)

Dow Chemical USA 2,086

BASF* Germany 1,920

Lyondell Chemical USA 1,895

Royal Dutch/Shell Group UK 1,830

ATOFINA** France 1,628

Sadaf Saudi Arabia 1,050

Nova Chemicals Canada 997

Chevron USA 950

BP UK 804

Sterling Chemicals USA 750

* Includes Ellba JV between BASF & Royal Dutch/shell Group.

**Includes CosMar JV between ATOFINA and GE Plastics.

Source: Chemical Week, CSFB estimates


80

Styrene Industry Trends and Value Drivers

We expect an improved supply/demand, as the rate of capacity growth has eased and customer restocking should result in a meaningful shipment recovery for end products.

POSM (propylene oxide and styrene monomer) manufacturers will have to consider market dynamics for each co-product before pursuing further expansions; that is, a significant proportion of new styrene capacity reflects the construction of facilities designed primarily for producing propylene oxide, which is growing more rapidly than its less desirable co-product.

Styrene Growth Prospects

We anticipate a global growth rate of 3-4% for styrene monomer; lower rates are expected for developed markets, while much higher growth is foreseen for developing regions such as Asia and South America.


81

Surfactants (Surface Active Agents) Surfactants are chemicals that allow molecules to mix with water by having a water-seeking end and a water-repelling end. The water-repelling end is attracted to oil and creates a bond between the water and the oil. Surfactants can be manufactured from two main categories of raw material, naturally derived (oleochemicals) or synthetically derived (petrochemicals). Derivatives can either be combined or used individually to produce a wide range of surfactants.

Exhibit 79: Surfactant Production

Benzene

Amphoteric Surfactants

Anionic Surfactants

Paraffins

Linear Olefins

LAB

Ethylene OxideNon-Ionic

Surfactants

Synthetic Alcohols

Fatty Alcohols

AminesCationic

Surfactants

Coconut Oil, Palm Kernel Oil,

Tallow

Glycerine

Fatty Acid

•Heavy-Duty laundry liquids

•Light-Duty dishwasher

•Personal care

•Washing Powders

•Heavy-Duty laundry liquids

•Heavy-Duty laundry powders

•Industrial cleaners

•Disinfectants

•Fabric Softeners

•Baby products

•Shampoos

•Household Cleaners

•Conditioners

•Specialised toiletries

•Anti-static plasticizers

•Agrochemicals

ALCOHOLSSYN

TH

ET

ICO

LE

OC

HE

MIC

AL

S


Surfactant Uses

Broadly speaking, there are four types of surfactants, and each possesses distinct qualities, which make them suitable for different end uses. Commodity surfactants are used principally as detergents; however, their chemical properties can be further refined to create specialty chemicals for use in personal care products.

• Anionics (negatively charged) are used mainly in detergents, washing powders, and industrial applications, but also in the personal care market.

• Nonionics (uncharged) are synthesized principally from petrochemicals. They are used mainly in detergents and industrial applications.

• Cationics (positively charged) are milder than both anionics and cationics. They are used principally in fabric softeners and baby products.


82

• Amphoterics surfactants have an active chemical entity attached to both ends of the molecule and are used in specialty applications such as hair conditioners and agrochemicals.

Exhibit 80: Consumption of Surfactants by End Market, 2004

Paper3%

Other Industrials17%

Polymers & Coatings

5%

Construction3%

Household51%

Personal Care12%

Industrials & Institutional Cleaning

6%

Agrochemical3%


Surfactant Manufacturers

The range of surfactants is extremely broad; thus, the manufacturing base is widely diversified. Major manufacturers of the raw materials for many surfactants include, among others, Henkel, Huntsman, Dow Chemical, and Royal Dutch/Shell.

Exhibit 81: Principal Manufacturers of Surfactants, 2000

Huntsman8%

A&W8%

Goldschmidt4%

Others17%

RoyalDutch/Shell12%

Dow Chemical10%

Rhodia6% BASF

7%

Stepan10%

Sasol10%

Henkel8%

Source: Rhodia, CSFB research.


83

Surfactant Industry Trends and Value Drivers

The industry has suffered from significant oversupply at the commodity end of the surfactant spectrum, as the barriers to entry are low and the technology and feedstocks are readily available. Competition has, therefore, tended to be based on price, rather than on product differentiation, and this has been exaggerated by the enormous purchasing power of the customers (such as washing powder manufacturers). These competitive forces led to consolidation among the larger players.

Surfactant Growth Prospects

Growth in surfactants has traditionally been closely allied to growth in detergents, which tends to grow in-line with GDP. However, more recently, increased demand for products made from natural oils has meant that oleochemical-based surfactants have grown faster than those based on petrochemicals, and are likely to continue growing faster. Overall volume growth in major world areas is expected to average around 1.9% annually through 2008.


84

Vinyl Acetate Vinyl acetate (VAM) can be produced via several routes. The most common commercial process employs ethylene as a feedstock and reacts the gas with acetic acid and oxygen to form vinyl acetate. An older, alternative route reacts acetylene with acetic acid. This process is no longer used in North America and Japan but still accounts for much of the older Western European and Chinese VAM capacity. Another process that is based on the reaction of acetic anhydride with acetaldehyde is no longer practiced commercially because of the relatively high cost of acetic anhydride.

Vinyl Acetate Uses

Polyvinyl acetate, which accounts for 44% of global VAM output, is primarily used in latex paints for architectural coatings and adhesives for packaging and labeling applications. Polyvinyl alcohol represents 39% of VAM production and is used in the manufacture of plywood adhesives, as well as in the production of polyvinyl butyral for the manufacture of laminated safety glass. In addition, polyvinyl alcohol is used as a textile sizing. Ethylene vinyl acetate co-polymers represent 9% of vinyl acetate demand and are used in film applications, as well as in the production of hot-melt adhesives for bookbinding and packaging. Other end uses include vinyl acetate co-polymers used in the manufacture of adhesives and caulks.

Exhibit 82: Global Consumption of Vinyl Acetate by End Market, 2002

Polyvinyl Acetate44%

Other8%

Polyvinyl Alcohol39%

EVA Copolymers9%



85

Exhibit 83: Leading Global Producers of VAM, 2004 Annual Capacity

metric tons ('000)

Celanese 1,463

Dow Chemical 422


E.I. Du Pont de Nemours & Company 330

BP 308

China Petrochemical 276

Various China Facilities 250

Darien Chemical 240

Nippon Synthetic Chemical 180


The top-9 producers accounted for 71% of global VAM capacity in 2004.

Vinyl Acetate Industry Trends and Value Drivers

Vinyl acetate capacity expansions have been announced for Asia and the Middle East; these are expected to keep the industry well supplied for the next few years. The U.S. accounts for 70% of global exports, and as new capacity comes online in other regions of the world, North American producers will be the most vulnerable. Backward integration into low-cost acetic acid production is another critical ingredient to being a competitive vinyl acetate producer.

Vinyl Acetate Growth Prospects

Most of the applications of vinyl acetate are mature. The strongest growth areas are likely to come from end uses such as ethylene-vinyl alcohol, polyvinyl butyral, and acetate-ethylene resins. Overall growth of vinyl acetate consumption during 2003-2008 is expected to be 2.7% in the U.S., 2% in Western Europe, 1.1% in Japan, and 4.5% in China.


86

Vinyl Chloride Monomer (VCM) Vinyl chloride monomer (VCM) is a colorless, flammable gas with a sweet odor, and it is a key intermediate in the petrochemical industry. Historically, vinyl chloride monomer was used as a component in aerosol propellants for women’s hair spray, pesticides, and some medical applications. It is now mainly used in the production of polyvinyl chloride (PVC) polymers and vinyl co-polymers used primarily in construction markets, and less so in the automotive, electrical, and packaging sectors. PVC represents approximately 97% of VCM’s global consumption.

Exhibit 84: Global Consumption of VCM by End Use, 2007E

PVC97%

Other3%


Vinyl Chloride Monomer Manufacturers

Exhibit 85: Leading Global Producers of Vinyl Chloride Monomer, 2003 2003 July Capacity

metric tons ('000)

Dow Chemical 2,739


Occidental Petroleum 1,930

Georgia Gulf 1,467

Solvay 1,207

European Vinyls Corporation (INEOS Group) 1,110

Tosoh 1,050

ATOFINA 1,009

LG Chemical 920

Shin-Etsu Chemical 820


The top-10 producers accounted for 51% of global VCM capacity in 2003.


87

Vinyl Chloride Monomer Industry Trends and Value Drivers

The PVC industry has been under close scrutiny in recent years as a result of environmental concerns and because the manufacturing of VCM produces small quantities of toxic dioxins, which are believed to have a detrimental effect on human fertility and may be carcinogenic.

VCM prices are formula based, accounting for raw material (chlorine and ethylene) tabs as well as PVC prices.

Vinyl Chloride Monomer Growth Prospects

Future prospects of VCM depend on the demand for PVC products, which is expected to grow at an average annual rate of 3.5% through 2007. Geographic patterns will vary significantly, with developed regions demonstrating lower growth rates than other developing regions. The close ties of PVC to the construction sector make VCM heavily cyclical.


88

VI. Thermoplastics and Thermoset Resins Plastics are polymers that are combined with additives and other ingredients before being molded into a solid state using pressure and heat. Polymers are created through the linking of monomers (such as ethylene) into long chains, typically using heat, pressure, and a catalyst. A number of different polymerization processes can produce such output as pellets, flakes, granules, powders, lattices, liquid resins, sheeting, or film. Each polymerization process has its own merits and downsides, and the economics of each also vary. The five principal methods are bulk/gas-phase, solution, slurry, suspension, and emulsion polymerization. Also, some polymers are made from a single monomer, such as polyethylene and nylon 6, while others, such as styrene-butadiene latex, ABS, and nylon 66, are produced using two or more monomers.

The two types of plastics are thermoplastics, which can be heated and resoftened into their original state, and thermosets, which cannot be resoftened. Thermosets are produced in far smaller volumes than thermoplastics, and demand is tied closely to the construction industry and is thus highly cyclical.

Demand for thermoplastics tends to be more resilient to recession than some other areas within the chemicals sector, as the products are geared toward the packaging and consumer markets. However, they are subject to significant downstream inventory swings, which can foster significant earnings volatility, as shown in the past 12-18 months. They have accounted for approximately 90% of total plastic production in recent years. The five-largest volume thermoplastics are polyethylene (PE), polyvinyl chloride (PVC), polypropylene (PP), polystyrene, and polyester (PET).


89

Polyethylene Polyethylene is the largest volume plastic. The three principal types of polyethylene are high-, low-, and linear-low-density polyethylene. The majority is used for packaging and for consumer and institutional products.

Polyethylene Uses

Exhibit 86: Global Consumption of Polyethylene by Market, 2004

Extrusion coating 13%

Other13%

Wire & Cable2%

Pipe & Extrusion 6%

Blow Molding 13%

Injection Molding 13%

Film & Sheet50%


• High-density polyethylene (HDPE). HDPE is a rigid plastic made at low temperature and low pressure. Its principal uses are as a resin for blow-molding bottles and containers, or for injection-molding items such as crates, tubs, gasoline tanks, and containers. It can also be manufactured into sheets or films for packaging and bags.

• Low-density polyethylene (LDPE). LDPE is made at high temperature and pressure and is more flexible than HDPE. Its major use is for sheets and films for packaging.

• Linear-low-density polyethylene (LLDPE). LLDPE is actually a co-polymer, as other monomers, such as butene or octane, are added to it. It is manufactured using lower temperature and pressure than either HDPE or LDPE; thus, the manufacturing process is more cost-effective. As it is flexible yet tougher than either HDPE or LDPE, it is often used in films for heavy-duty applications.


90

Polyethylene Manufacturers

• HDPE.

Exhibit 87: Major Producers of HDPE, 2004 Company 2004 Capacity % share of

metric tons '000 Global Capacity

ExxonMobil 2,709 8.7%SABIC 1.715 5.5%Dow Chemical 1,589 5.1%Lyondell Chemical 1,364 4.4%Formosa Plastics 1,293 4.1%TotalFinaElf 1,292 4.1%BP 1,178 3.8%Solvay SA 1,155 3.7%Chevron 1,117 3.6%ConocoPhillips 1,117 3.6%

Source: CMAI; CSFB research.

• LDPE.

Exhibit 88: Major Producers of LDPE, 2004 Company 2004 Capacity % share of


Dow Chemical 1,819 9.3%

ExxonMobil 1,551 7.9%

Ente Nazionale Idrocarburi 837 4.2%

China Petroleum 801 4.1%

Lyondell Chemical 717 3.6%

TotalFinaElf 694 3.5%

SABIC 693 3.5%

Royal Dutch/Shell Group 588 3.0%

BASF AG 560 2.8%

Norwegian Government 503 2.5%


• LLDPE.

Exhibit 89: Major Producers of LLDPE, 2004 2004 Capacity % share of

metric tons ‘000 Global Capacity

Dow Chemical 3,938 20.1%

ExxonMobil 2,913 14.8%

SABIC 1,550 7.9%

Nova Chemicals 935 4.7%

China Petroleum 725 3.7%

BP 588 3.0%

Ente Nazionale Idrocarburi SpA 530 2.7%

Lyondell Chemical 512 2.6%

Formosa Plastics 414 2.1%

Japanese MEG Consortium 390 1.9%



91

Polyethylene Industry Trends and Value Drivers

The global polyethylene business is undergoing extensive restructuring and consolidation. The need to improve profitability, reduce costs, enhance scale, and expand geographic coverage has led to rather rapid consolidation in the industry. The HDPE industry is consolidating globally, while LLDPE is gradually gaining market share at the expense of LDPE as a result of its wider range of applications, as well as its more cost-effective manufacturing process.

The Polyethylene business is characterized by high profit volatility. Increased competition has forced attention toward building and maintaining a competitive cost position. So while low feedstock costs are still the most important factor in decreasing costs per unit, production scale has diminished as a significant cost advantage over recent years.

The majority of LLDPE is manufactured in “swing” plants that are also capable of manufacturing HDPE. Finally, increasing demand for recycled resin has begun to hamper demand for “virgin” resin, but at a very slow pace.

Polyethylene Growth Prospects

As a large proportion of the demand for polyethylene is linked to packaging and consumer markets, these polymers tend to be less vulnerable to cyclicality but are subject to significant inventory swings. More cyclical are those products used in the construction industry, but these account for a minority of the end uses of polyethylene.

In addition, we expect globalization and consolidation of the industry to continue.

Historically, polyethylene demand has grown at approximately twice the rate of GDP and should essentially continue to be driven by the overall health of world economies. We estimate global demand for HPDE, LDPE, and LLDPE will grow at 5.7%, 2.2%, and 5.9%, respectively, through 2008; however, Asia is likely to record a higher growth rate, with China contributing significantly to the pace.


92

Polypropylene Polypropylene (PP) is the second-largest volume plastic resin globally. It has a wide range of applications depending on the grade, including packaging, fibers, and automotive parts.

Polypropylene Uses

Film grade PP is used for packaging confectionary goods, cigarettes, and electrical capacitors. PP is used in thermoformed food containers, which can be either blown or injection molded. Co-polymer PP is used primarily in car and truck bumper manufacturing but also has medical applications, while PP fibers are used in carpets, clothing, and nonwoven textiles.

Exhibit 90: Global Consumption of Polypropylene by End Market, 2004

Film & Sheet21%

Pipe & Profile3%

Blow molding1%

Fiber16%

Raffia13%

Other8%

Injection Molding38%


Polypropylene Manufacturers

Exhibit 91: Major Producers of Polypropylene, 2004 2004 Capacity % share of


Basell 4397 10.48

BP 2180 5.19

ATOFINA 1957 4.66

ExxonMobil 1860 4.43

Borealis N.V. 1315 3.13

Reliance Industries Ltd 1100 2.62

SABIC 1100 2.62

Dow Chemical 1072 2.55

Japan Polypropylene 1067 2.54

Sunoco Chemical 784 1.87



93

Polypropylene Industry Trends and Value Drivers

As the European (naphtha) cracking process produces a comparatively low proportion of propylene (but far more than ethane crackers in North America and the Middle East yield), its availability is a key driver of the profitability of the PP industry. While new applications continue to develop for polypropylene, it is still largely a commodity chemical subject to economic cyclicality, where cost volatility plays a vital role, often undercutting the ability to recover pricing. Major players have, therefore, consolidated to secure feedstock, technology, and superior commercial positions in the hope of reducing profit volatility.

Polypropylene Growth Prospects

Unlike other commodity thermoplastics that have slowed relative to economic growth, Polypropylene consumption continues to grow at 1.5-2.0 times the GDP growth even in industrialized countries. Substitution of other polymers and significant improvements in process and technology have been the significant driving force for this growth. We expect polypropylene consumption to grow by 5-6%.


94

Polyvinyl Chloride (PVC) PVC is the most widely used plastic globally. It is manufactured through the polymerization of vinyl chloride monomer (VCM) using a slurry-based process, and it has a wide variety of uses. It is also cheap to produce.

PVC Uses

PVC’s principal use is in the building and construction industry, where it is employed to manufacture pipes, siding, gutters, flooring, windows molding, and wire coating. It is also used in food packaging in film form, a declining application.

Exhibit 92: Consumption of PVC Resins by End Market, 2004

Calendering7%

M olding4%

Coat ing2%

Paste Processes1%

Compounding4%

Other0%

Wire and Cable4%

Film and Sheet5%

Siding,15%

Fencing and Decking3%

All Other Extrusion Uses5%

Rigid Pipe and Tubing44%

Extruded Windows and Doors

6%

Extrusion70%


PVC Manufacturers

Exhibit 93: Major Producers of PVC, 2003 2003 July Capacity

metric tons ('000)

Shin-Etsu Chemical 3,041


OxyVinyls* 2,003

Solvay 1,481

European Vinyls Corporation (INEOS Group) 1,390

Georgia Gulf 1,273

LG Group 1,149

TotalFinaElf 848

Vinnolit GmbH 645

*Joint venture: 76% Occidental, 24% PolyOne. (Both companies produce small amounts outside of the JV.)


The top-10 producers listed above represented 47% of global PVC capacity in July 2003.


95

PVC Industry Trends and Value Drivers

As with many commodity resins, competition is fierce in the PVC business. So feedstock integration is critical to control production costs. Companies have adopted various strategies like consolidation, streamlining operations, and forward integration to remain competitive. The PVC industry has been under close scrutiny in recent years as a result of environmental concerns. The manufacturing of both chlorine and VCM produces small quantities of toxic dioxins, which are believed to have a detrimental effect on human fertility and may be carcinogenic. It is unlikely that further capacity additions will take place in the developed economies of North America and Western Europe, as the focus shifts to Asia.

We believe replacement of traditional materials such as aluminum in the construction industry is likely to be one of the key demand drivers.

PVC Growth Prospects

The close ties of PVC to the construction industry mean that demand for PVC can be very cyclical. The market for the product is fairly mature; thus, we expect medium-term growth of around 3.5% through 2007.


96

Polystyrene Polystyrene is manufactured from styrene monomer in three main grades: general purpose/crystal, high impact, and high heat (ignition grade). Expandable polystyrene (EPS) is manufactured using a different process and is even considered to be a completely separate product in its own right.

Polystyrene Uses

High-impact polystyrene is a strong, durable plastic; thus, it is used in appliances and other demanding applications, competing against engineering plastics such as ABS. Ignition-grade PS is used in heat-generating appliances such as TV sets. General purpose/crystal polystyrene is mainly used for packaging (such as jewel boxes for CDs) and household items such as domestic food service items and toys. EPS is used for insulation and packaging.

Exhibit 94: Consumption of Polystyrene (GP/HIPS) by End Market, 2005E

Construction3%

Appliances20%

Housewares/ Furniture

8%

Others21%

Packaging/One Time Use

38%

Electrical/Appliances

39%


Exhibit 95: Global Consumption of Expandable Polystyrene by End Market, 2005E

Packaging39%

Others8%

Construction53%



97

Polystyrene (GP/HIPS) Manufacturers

Exhibit 96: Major Producers of Polystyrene, 2002 2002 Capacity metric tons ('000)

Dow Chemical 2,098BASF 1,548TotalFinaElf 1,200Nova Chemicals 955Chi Mei 570BP 498EniChem 405Mitsubishi Chemical 318Idemitsu Kosan 266Chevron 225


The top-10 producers of polystyrene (GP/HIPS) accounted for 61% of global capacity in 2002.

Polystyrene (EPS) Manufacturers

Exhibit 97: Major Producers of Polystyrene, 2002 2002 Capacity metric tons ('000)

BASF 540Nova Chemicals 465Taita Chemical 160Radnor Holdings 145BP 135EniChem 126Huntsman 105Kumho & Co. 90Mitsubishi Chemical 90Shinho Petrochemical 77


The top-10 producers of polystyrene (EPS) accounted for 53% of global capacity in 2002.

Polystyrene Industry Trends and Value Drivers

Industry oversupply in recent years led to consolidation and restructuring within the industry. Subsequent reduction in capacity provided some support for prices, although rising crude oil tabs drove up feedstock costs, further pressuring margins. As packaging accounts for over 50% of demand for polystyrene in Europe, this area is relatively resilient against recession. However, its role in this industry is being eroded by the increasing use of polypropylene.

Growth for EPS is driven largely through its use as an insulator in the building trade. However, this area is extremely competitive, and suppliers are exposed to cyclicality. Some high-cost capacity is being shuttered in an effort to help balance supply and demand.

Polystyrene Growth Prospects

As a fairly mature product and market, we expect polystyrene demand to grow largely in-line with GDP.


98

Polyethylene Terephthalate (PET) PET is a downstream product of para-xylene and ethylene (via PTA/DMT and ethylene glycol). Purified DMT is reacted with excess ethylene glycol in a catalytic reaction that facilitates ester exchange and polymerization; the by-product methanol is recycled. Currently, the more popular and more economic route involves the direct esterification of purified terephthalic acid with ethylene glycol, producing by-product water. (Additives are often used in the polymerization process to alter the color of the material.) The polymer produced, melt-phase PET can be melted and extruded through spinnerettes into man-made polyester fiber.

Alternatively, it can be “digested” further through the application of heat to manufacture high-molecular-weight solid-state resin. This PET is subsequently extruded and broken into resin chips, which can be converted into bottles through a two-step process utilizing injection-molding (into a “test tube” perform), followed by blow molding. (Note: Certain applications, such as packaging, require such higher-molecular-weight resins. The “digestion” step promotes further polymerization at below-melting temperatures, a process known as solid-stating.)

Demand for the solid-state resin increased greatly in recent years because of its rapidly expanding use in the bottled drinks industry. PET bottle resin is likely to be a material driver of growth in many developing countries, but growth of PET fiber remains dominant in terms of total polyester. The global PET business has deteriorated since mid-1996 in terms of price stability, operating margins, and industry profitability. The world market for PET solid-state resins is still oversupplied despite strong demand growth.

In the “Man-Made Fibers” section of this report, we discuss polyester fibers.


99

Exhibit 98: Global Consumption of PET by End Market, 2002

Fibers67%

Others2%

Film5%

Rigid Packaging26%


Exhibit 99: Major Manufacturers of PET Solid State Resins, 2005E 2005 Capacity

metric tons ('000)

Voridian (Eastman Chemical) 1500

M&G Group 1230

Invista (Koch Industries) 1100

Wellman 635

Nan Ya Plastics 610

Equipolymers 450

DAK Americas 310

DuSa 290



100

Polyurethanes Polyurethanes are types of thermoset foams that are used in a wide range of applications and markets for their cushioning and insulating properties. These materials are produced by reacting an appropriate glycol or glycol ether with a di-isocyanate. They are easily manufactured into a wide range of different physical forms. The two main types of polyurethane foam are MDI-based (methylene-di-para phenylene isocyanate) and TDI-based (toluene di-isocyanate).

Exhibit 100: U.S. Demand for MDI by End Market, 2004 Exhibit 101: U.S. Demand for TDI by End Market, 2004

Construction46%

Transport14%

Insulation3%

Carpet Cushion4%

Other19%

Packaging5% Appliances

(refrigirator)9%

Transport33%

Furniture20%

Carpet Underlay16%

Bedding10%

Packaging6%

Others15%

Source: SRI, CSFB estimates. Source: SRI, CSFB estimates.

• MDI. The main use for MDI is in the production of rigid and semi-rigid foams, which account for approximately 80% of global output and are used mostly in the construction industry. Demand for MDI has been strong in recent years on the back of the booming construction, automotive, and consumer industries.

Exhibit 102: Major Manufacturers of MDI, 2005

2005 Capacity

metric tons('000)

Bayer 895

BASF 805

Huntsman 745

Dow Chemical 705

Nippon Polyurethane 200

Yanatai Synthetic 130


Borsodchem 60



101

• TDI. TDI is used principally in manufacturing flexible foams for furniture and car seating. It can also be used to produce coatings, rigid foam adhesives, sealants, and cast elastomers. It enjoyed a resurgence in demand in recent years following a period of decreased usage, as it was replaced by MDI, which has a broader range of uses. This led to a period of modestly rising prices, as capacity was insufficient to meet the rebound in demand.

Exhibit 103: Major Manufacturers of TDI, 2005 2005 Capacity

metric tons ('000)

Bayer* 420

BASF 370


Dow Chemical 250

Mitsui 240

Borsodchem 70

Organika Zachem 65

Huntsman 40

*About 100KT of Bayer’s capacity is idle.



102

VII. Man-Made Fibers Man-made fibers are classified into two groups: cellulosic and noncellulosic. The former type is produced from wood pulp and includes rayon staple, acetate filament, and lyocell. Cellulosic fibers were introduced about 100 years ago. During the manufacturing process, wood pulp is dissolved in a solvent, sodium hydroxide, processed further with additional chemicals and/or solvents, and the resultant polymer is then put through a spinnerette, which resembles a showerhead (rayon is wet-spun into a sulfuric-acid bath and lyocell is dry-spun into air). Noncellulosic fibers are petrochemical derivatives and include polyester, nylon, acrylics, spandex, and polyolefin fibers. Except for spandex, which is solvent spun, the remaining types are formed from molten polymer that is passed through spinnerettes. Noncellulosic fibers are much newer (introduced in the 1930s-1950s) and have exhibited faster growth rates than cellulosic types, owing to more favorable properties and economics.

Man-made fiber production continues to gravitate to Asia, where manufacturing costs (particularly manual labor) are substantially lower than in North America and Europe. In 1970, almost 90% of the global fiber production was in the U.S., Western Europe, and Japan. Over the following two decades, fiber capacity grew rapidly in Asia, most notably in Taiwan, China, and Korea, and in 1987, the three previously dominant regions accounted for a much smaller 49% of global production. The man-made fiber producers in countries such as the U.S., Western Europe, and Japan responded to the influx of Asian companies in many ways. These responses include attempts at differentiation through product quality and designs, alliances with other producers and in some cases exiting the business completely. Thus, the list of major producers has undergone a major change over recent years.

Among the major producers of man-made fibers are DuPont, Formosa Plastics, and Sinopec Industries. Several companies have recently disappeared from the list of top producers, such as Akzo Nobel, Courtaulds, and Hoechst. In November 2003, DuPont announced it was selling its fibers and textiles business to Koch Industries for $4.4 billion. We expect this consolidation trend to continue, especially with companies in industrialized countries.


103

Polyester Fiber The key raw materials for polyester are purified terephthalic acid (PTA) or dimethyl terephthalate (DMT) and ethylene glycol. PTA and DMT are derived from para-xylene (produced in naphtha crackers or refineries), and EG is an ethylene derivative.

Polyester Fiber Uses

Polyester textile filament and staple fibers are woven (or knitted) into fabric used for apparel goods and home furnishings. Fabrics can be 100% polyester, which are wrinkle- and stretch-resistant, fairly durable, and water insoluble. Polyester fibers are often blended with cotton, wool, rayon, or acrylics. Polyester textile filament is employed in the production of women’s blouses and dresses, and is also used in manufacturing household furnishing such as curtains. Polyester staple is most commonly blended with cotton in manufacturing sheets and men’s shirts, for example, and is also used as fiberfill for upholstered furniture and bedding and spun into yarns for making carpet, although its market share in this sector is well below that of nylon.

Exhibit 104: Global Polyester (All Fibers) Consumption by End Market, 2004

Apparel48%

Home Furnishings32%

Industrial20%



104

Polyester Fiber Manufacturers

Exhibit 105: Global Leading Producers of Polyester Fiber, 2005E (Annual Capacity) Company Location Annual Capacity Metric Tonnes (000)

TF IF ST Total

Reliance Industries Ltd India & Germany 590 - 590 1180

Nan Ya Plastics Taiwan, USA, Vietnam 625 - 506 1131

Zhejiang Rongshan China 530 - 400 930

Tuntex Taiwan, China, Thailand 455 - 450 905

Yizheng China 250 3 600 853

Shaoxing Yuandong China 520 - 300 820

Far Eastern Taiwan, China 323 67 330 720

Jiangying Synthetic China - - 710 710

Huvis Korea, Indonesia, China 159 - 539 698

Sinopec China Excl Yizheng 215 22 350 587

Zhejiang Hengyi China 570 - - 570

Teijin Japan, Indonesia, Thailand, Germany, USA

175 60 331 567

Invista (Koch Industries) USA, Mexico, Germany 35 181 310 526

Zhejiang Tongkun China 500 - - 500

Hualon Taiwan, Malaysia 423 - 54 477

Source: SRI, PCI, CSFB estimates.

Polyester Fiber Industry Trends and Value Drivers

Significant low-cost capacity, especially in Asia, continues to hurt European and American producers, depressing their operating rates. A shift in the downstream textile manufacturing base from developed countries to emerging countries, especially to Asia, has affected fiber demand in developed countries. Developing countries in Asia have an inherent advantage in the form of lower manpower costs, as the textile industry is highly labor-intensive.

Expiry of the Multi Fiber Arrangement, which brings an end to the quota system, is expected to bring buoyancy to the market. The trend is toward globalization of the polyester fiber industry. Major fiber producers have begun to maximize production capabilities worldwide to optimize sales. Although the trend of consolidation through alliances and joint ventures is not new, the shipment of fibers across nations, based on factors such as subsidized production expenses, favorable currency exchange and low shipping and handling costs, may become more economical with the recent removal of tariff restrictions on textile goods shipped between nations.

Polyester demand is also influenced by cotton, which is a competing but natural fiber, especially in apparel end uses. Substitution (of cotton by polyester) demand has been a key demand driver for polyester in the past. However, current depressed cotton prices mean substitution demand is limited. Moreover, the trend in recent years favors natural fibers at the expense of noncellulosic fibers. In the long term, limitations on cotton supply, in the form of a finite area of cultivation, should work in favor of polyester.


105

Polyester industrial filament is widely used as a tire reinforcement material in passenger car, light truck, and minivan tires. Other nontire-related applications include sewing thread, hoses, belts, webbing, tape, and geosynthetic fabrics.

Polyester Fiber Growth Prospects

Polyester fiber demand is expected to grow at about 3.8% per year through 2007. Demand is projected to increase at a faster pace (5-6%) in developing regions, such as Asia, versus levels in mature markets (2-4%). Key textile exporting economies such as China and India will be the growth engines in Asia.


106

Acrylic Fiber Acrylic fibers are made through the polymerization of acrylonitrile, which itself is manufactured from propylene and ammonia.

Acrylic Fiber Uses

Acrylic fibers are consumed principally in apparel goods, such as sweaters, socks, and sportswear. Acrylic products also include home furnishings, such as blankets, upholstery, carpets/rugs, and curtains. Industrial applications of acrylics are minimal but include concrete reinforcement and asbestos replacement.

Exhibit 106: Global Acrylic/Modacrylic Fiber Consumption by End Market, 2002

Apparel54%

Other24%

Home Furnishings19%

Industrial3%


Acrylic Fiber Manufacturers

Exhibit 107: Major Producers of Acrylic/Modacrylic Fibers, 2004

Annual Capacity % of Global metric tons ('000) CapacitySINOPEC Group 410 13.7

Akrilik Kimya Sanayii 287 9.6

Montefibre 245 8.2

Dralon 176 5.9

PetroChina 156 5.2

Mitsubishi Rayon 138 4.6

Formosa Plastics 105 3.5

Source: SRI, PCI, CSFB estimates.


107

Acrylic Fiber Industry Trends and Value Drivers

Worldwide acrylic fiber capacity slightly declined over the past few years, as plant closures and capacity reductions were not offset by new capacity additions. Asian countries accounted for 54% of total worldwide capacity, up form 43% in 1999. Capacity utilization also saw an upward trend, increasing from 76% in 1999 to nearly 90% in 2004.

In 2004, nearly half of world capacity was held by the seven large companies listed in Exhibit 107. However, the industry has seen several restructuring measures by major companies. Prominent among them were Asahi Chemical Industries, which exited the business; Bayer Faser, which sold its acrylic fiber business to Dralon; and Solutia, which has significantly reduced capacity.

Acrylic Fiber Growth Prospects

Recent displacement of acrylic fibers by cotton in some of the traditional apparel segments not withstanding, we expect acrylic fiber consumption to grow at 2-3% annually through 2009.


108

Nylon 6 and 66 Fibers

Nylon 6 and 66 Fiber Uses

Nylon 6 and nylon 66 fibers, which account for about 90% of global nylon volumes, are produced as continuous filament yarn, monofilament, and staple. Nylon 6 is polymerized from caprolactam, and nylon 66 is made from adipic acid and hexamethylenediamine. Nylon is used principally for the manufacturing of carpets and rugs. Other uses include apparel goods, such as hosiery, and industrial applications, such as auto-related products (e.g., airbags and reinforcement for tires and hoses). Important nylon fiber characteristics include abrasion resistance and high-tensile strength.

Exhibit 108: Global Nylon 6 and 66 Consumption by End Market, 2004

Home Furnishings60%Apparal

20%

Industrial20%



109

Nylon 6 and 66 Fiber Capacity

Exhibit 109: Nylon 6 and 66 Fibers Capacity, 2005

Company Location Annual Capacity Metric Tonnes (000)

TF IF CF ST Total

Invista USA, Canada, Mexico, Germany, UK, Taiwan, Argentina, Brazil

98 53 465 58 674

Solutia USA, Canada, Mexico, Germany - 18 60 225 303

Honeywell USA, Canada, China 9 6 138 105 258

Radici (Includes Nylstar acquisition)

Italy, USA, France, Spain, Poland, Slovakia, Romania

162 4 26 10 202

FCFC Taiwan 112 62 - 2 176

Shaw USA - - 166 - 166

Rhodia Poland, Slovakia, Germany, Brazil, Switzerland, Latvia

29 78 5 50 162

Hualon Taiwan, Malaysia 142 - - - 142

DUSA USA, Argentina, Brazil, Turkey, Indonesia

- 139 - - 139

Toray Japan, Indonesia, Thailand 55 30 18 10 113

Hyosung Korea 50 25 - 3 78

Beaulieu Group (inc Domo) Belgium, USA, France, Germany - 1 72 - 73

Bonazzi Group Italy, Slovenia 15 - 54 - 69

China Shenma China - 62 2 - 64

Polyamide High Performance (Acords)

USA, Germany, Netherlands, India 2 57 - - 59

Source: PCI, CSFB estimates.

Nylon 6 and 66 Fiber Industry Trends and Value Drivers

Most capacity growth in recent years has been in the Far East, particularly in China and Taiwan, where labor is cheap and end-demand growth remains strong; this trend is expected to continue. In an effort to increase economies of scale to compete more favorably with Asian players, Honeywell acquired BASF’s nylon fiber business in May 2003, which doubled Honeywell’s capacity.

Nylon 6 and 66 Fiber Growth Prospects

Nylon is still growing strongly in engineering thermoplastics but near maturity in most fiber market segments. Record high raw material prices, competition from polyester, and growth in Asia have had a significant impact on the global nylon fiber market and put downward pressure on margins across the value chain. We expect modest growth of 1-2%, with Nylon 6 outpacing Nylon 66.


110

Elastane/Spandex Elastane, or spandex, fibers are urethane-based elastomers that are produced from polyols (either polyether or polyester) and di-isocyanates; they also include a variety of performance-specific additives, such as UV absorbers, flame retardant agents, and antioxidants.

The vast majority of global elastane production involves solution spinning. The filaments are typically dry spun, although some processes involve wet spinning. Production via dry spinning involves the extrusion of a polymer solution through a spinnerette and into a heated air column, where the solvent evaporates, leaving the elastane filaments. The monofilaments bind to each other and form a continuous multifilament yarn, which is treated and wound on spools.

Elastane/Spandex Uses

Spandex fibers are used in a wide array of applications, including men’s and women’s apparel, hosiery, home furnishings, and a small number of industrial applications. Newer uses include providing stretch in such mainstream articles as slacks, jackets, and dresses.

Exhibit 110: Global Spandex Consumption by End Market, 2002

Hosiery32%

Other16%

Active Wear28%

Intimate Apparel24%


Spandex Manufacturers

Exhibit 111: Major Global Spandex Manufacturers, 2003E

Annual Capacity % of Global Capacity

metric tons ('000)

Koch Industries U.S. 82 32.6%

Hyosung Korea 25 10.0

TaeKwang Korea 25 9.8

Bayer Germany 15 6.0

Asahi Japan 12 4.8

Huvis Korea 12 4.8

Others 80 32.0



111

Elastane/Spandex Industry Trends and Value Drivers

In April 2004, DuPont sold its DuPont Textile and Interior Division, rechristened INVISTA, to Koch Industries for $4.2 billion. INVISTA is the largest producer of spandex fiber in the world for both branded “LYCRA” and commodity “ELASPAN.” Asia is turning out be a significant market, with increasing size, scope, and complexity. All major producers are reorganizing their strategies to cater to the Asian demand.

Elastane/Spandex Growth Prospects

Globally, we expect elastane consumption to grow at a rate of 6-9%, with a higher figure for Asia and a lower one for developed markets. As for capacity growth, the majority of the expansions are planned for Asia.


112

Rayon/Lyocell Rayon staple, lyocell, and acetate filament are cellulosic fibers (that is, wood pulp is the chief raw material). Acetate filament has largely been displaced by polyester textile filament, while rayon has lost share to polyester staple. Rayon production is relatively costly, owing to a broad array of waste products that must be contained. Lyocell, a more expensive, newer cellulosic fiber than rayon, was launched in the 1990s and is produced by a more environmentally friendly process using a recyclable solvent.

Rayon/Lyocell Uses

Rayon staple, lyocell, and acetate filament are used predominantly in apparel. Because of its relatively high cost, lyocell tends to be used in premium apparel products.

Exhibit 112: Global Rayon (All Types)/Lyocell Fibers by End Market, 2002

Industrial17%

Nonw ovens16%

Apparel51%

Home Furnishings16%


Rayon Manufacturers

Exhibit 113: Major Global Producers of Rayon (All Types), 2004 Capacity March 2004 % of Global Capacity


Chinese producers China 750 30.3

Lenzing Austria 240 9.7

Grasim Industries Ltd. India 221 8.9

Formosa Plastics Taiwan 161 6.5

Accordis Germany 160 6.4

South Pacific Viscose Indonesia 125 5.0

Indo Bharat Rayon Indonesia 90 3.6

Thai Rayon Public Thailand 80 3.2

Other 644 26.0



113

Lyocell Manufacturers

Exhibit 114: Major Global Producers of Lyocell, 2004 Capacity 2004 % of Global Capacity


Accordis UK 87 68.5

Lenzing AG Austria 40 31.5


Rayon/Lyocell Industry Trends and Value Drivers

Acetate filament has largely been displaced by polyester textile filament (PTF), while rayon has lost share to polyester staple, owing to lower prices for these competing fibers and lower cotton prices. Also, just as for noncellulosic fibers, production continues to shift to Asia for the sake of lower production costs. In the last decade, Asia’s share of global production of rayon fibers has moved up to 70% from a mere 29%. However, the double-digit growth in rayon fiber production in the Far East has been offset by a double-digit decline in Eastern Europe.

Rayon/Lyocell Growth Prospects

We expect global production of rayon fibers over the next five years to increase annually by about 2.5%.


114

VIII. Fertilizers (Plant Nutrients)

A Short History of Fertilizers Since the beginning of agriculture, farmers have wished to improve soil quality and crop yield. To this end, they have employed such techniques as crop rotation, liming, and manuring. The Chinese were some of the earliest farmers to use manure to improve crop quality and yield. Later, the Greeks were known to have added varieties of waste products to the soil of their olive groves to enhance its nitrogen profile and olive production. Furthermore, the Greeks noted that legumes (such as beans) also replaced nitrogen in the soil, and frequently recommended them as general-purpose crops. The Romans, whose society was based heavily on agriculture, took an active interest in systematic farming techniques, including waste collection and soil evaluation.

Through trial and error, early farmers were able to increase the three basic soil nutrients —nitrogen, phosphorus, and potassium (N, P, and K)—though not always in the most efficient or rigorous manner, since there was insufficient knowledge of the underlying chemistry. While the white salt potassium chloride was well known, it was not until the Age of Enlightenment in the 17th and 18th centuries that other chemicals soon to be used as commercial fertilizers were discovered, such as ammonium sulfate, which contains nitrogen, and phosphorous-containing materials. Ammonia was first produced in 1774, and urea, another nitrogen product, was identified in 1773. As agriculturalists began to understand the growth and development of plants, other scientists began to experiment with chemical fertilizers. Justus von Liebig, the German chemist, was the first to establish that plant growth was linked to the amount of nutrients contained in the fertilizer applied. He also articulated the “Law of the Minimum”—that is, a deficient nutrient impairs plant growth even if all other nutrients are present in adequate quantities.

Sodium nitrate, the first commercial nitrogen product, was mined from deposits in Chile in the early 1800s. Factory production of sodium nitrate began in the U.S. in 1928. Phosphate mining began in 1867 in South Carolina. And the first potash factory was built in Germany in 1857. In 1943 the world’s largest potash deposits were discovered in Saskatchewan, Canada. Today, there are at least 12 different fertilizer products that provide the three basic nutrients. This figure does not take into account the various combination fertilizers, known as NPK for the three nutrients, which are formed by mixing the basic fertilizers.

Modern production and application exhibit significant sophistication compared with fertilizer usage even 100 years ago. Today, from fertilizers that contain a specific quantity of the three essential nutrients to algorithms that quantify volume of fertilizer application for a desired crop yield on any given small plot, farmers have access to advanced methods to increase soil and crop efficiency. Current breadth and range of product offerings indicate a substantial advance from some of the first commercial fertilizers, such as Peruvian guano and Chilean sodium nitrate sold commercially in the 1830s.


115

There are standards units for measuring the three key nutrients, nitrogen (N), phosphorus (P), and potassium (K):

1. Nitrogen is an element in the periodic table with the symbol N. As N2, it is a gas that makes up four-fifths of the earth’s atmosphere. Nitrogen-containing fertilizers are measured in units of N. Some of the most common nitrogen-containing fertilizers include, ammonia (NH3), urea [CO(NH2)2], nitrogen solutions, or UAN, and ammonium nitrate (NH4NO3). Nitrogen represents 82% of the content of anhydrous ammonia, 46% for urea, and 34% for ammonium nitrate. UAN solutions vary in nitrogen content from 28% to 32%.

2. Phosphorus is measured in units of phosphoric pentoxide (P2O5). To convert P into P2O5, multiply by 2.29. P2O5 tonnes are the unit of measurement of phosphorus-containing fertilizers, which vary in concentration from product to product. For example, typically DAP is 46% P2O5 and MAP is 52% P2O5.

3. Potassium is typically measured in units of potassium oxide (K2O). K2O tonnes are the measurement of the nutrient value of potassium-containing fertilizers. Potash (KCl) is a term typically used to denote potassium-based fertilizer. Most potash fertilizer is potassium chloride, also called muriate of potash. To convert KCl product tonnes to K2O tonnes, multiply by 0.61.

World Fertilizer Drivers It is clear that fertilizers increase crop yield, improve soil quality, add to the overall health of the plant, and ultimately, the health of livestock and humans who consume grains and vegetables for sustenance. As the world population grows, greater demands will be placed on a secure and plentiful food supply. Yet, as the world develops, less and less land will be available for planting, and fewer people will desire to work the land as rural areas give way to cities and opportunities for social advancement and greater utility become available. Clearly, one solution will be to increase and customize fertilizer applications to ensure maximum crop yield and nutrient quality. This phenomenon is already taking place. World consumption of fertilizers has grown at an annual rate of 2% since 1970, while in Latin America/South Asia/Soviet Asia, it has grown at a 6.6% rate. The decline in fertilizer consumption over the 1989-1994 time frame followed the collapse of communism in Eastern Europe and the Soviet Union and the reduction in nutrient use in that region of the world.


116

Nitrogen (N) Nitrogen reigns as the most important nutrient for plant growth and, if not supplied in sufficient amounts, both in an absolute sense and relative to the concentration of other nutrients, it tends to limit the usefulness of other nutrients. That is, even when sufficient amounts of other soil nutrients are present, if nitrogen levels are deficient, plant growth and crop yield will suffer. Nitrogen plays its most important role as (1) the key element in cell division; (2) an essential component of all the proteins and enzymes; and (3) a requisite element of the chlorophyll molecule, which drives photosynthesis.

The main commercial fertilizers that provide nitrogen either contain, or are by-products of ammonia, which is in turn produced primarily from natural gas and nitrogen in the air. These fertilizers are anhydrous ammonia (NH3), urea [CO(NH2)2], ammonium nitrate (NH4NO3), ammonium sulfate [(NH4)2SO4], and different types of ammonium phosphate, such as DAP and MAP.

The amount of nitrogen farmers apply depends on soil quality, desired crop yield, prior crops harvested, and the crop to be grown. Certain crops require greater amounts of nitrogen in the soil than others. Corn, for example, may require up to eight times as much nitrogen fertilizer as soybeans, but only 1.6 or 2.0 times as much as for cotton. Moreover, economic efficiency bears consideration. Farmers must analyze the marginal

Exhibit 115: World Consumption of Fertilizers

World Consumption of Fertilizers

0

20

40

60

80

100

120

140

160

1970

/71

1971

/72

1972

/73

1973

/74

1974

/75

1975

/76

1976

/77

1977

/78

1978

/79

1979

/80

1980

/81

1981

/82

1982

/83

1983

/84

1984

/85

1985

/86

1986

/87

1987

/88

1988

/89

1989

/90

1990

/91

1991

/92

1992

/93

1993

/94

1994

/95

1995

/96

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

2002

/03

Mill

ion

s o

f T

on

nes

of

NP

K

World

Latin America and South/Socialist Asia

Rest of World

FSU and Central Europe

Source: IFA, CSFB estimates.


117

increase in crop yield provided by additional fertilizer application. While greater nitrogen application does result in higher crop yields, the marginal returns, in terms of pricing, diminish prior to maximum yield. Of course, such an analysis must also include other variables, which cannot always be controlled—land price, weather, and government subsidies, for example.

Nitrogen fertilizer comes in many forms. Urea accounts for 48% of the world consumption of nitrogen fertilizer. Ammonium nitrate and urea ammonium nitrate (UAN) solutions follow but are significantly behind, accounting for only 9% and 6% of world nitrogen fertilizer consumption. While direct application of ammonia accounts for only 4% of world nitrogen consumption, it makes up 22% of consumption in the U.S.

Exhibit 116: Nitrogen Fertilizer Consumption by Product Exhibit 117: Nitrogen Fertilizer Consumption

Global Nitrogen Fertilizer by Product

Urea48%

Other11%

Ammonium Bicarbonate 7%

UAN 6%

DAP 5%

MAP 2%

Ammonium Nitrate 9%

Ammonium Sulfate 4%

Calcium Ammonium Nitrate 4%

Direct Application 4%

Global Nitrogen ConsumptionTotal 87.7 Million Tonnes N

North America15%

Western Europe13%

Latin America7%

Asia53%

Eastern Europe 2%Africa 3%

Middle East 2%Oceania 2%

FSU 3%

Source: Fertecon, CSFB estimates. Source: Fertecon, CSFB estimates.

Ammonia Produced by combining hydrogen and atmospheric nitrogen, ammonia is the basic building block for all of the nitrogen fertilizers. Natural gas, as a source of energy and hydrogen, fixes nitrogen from the air with hydrogen to create ammonia (NH3). About 34,400 cubic feet, or 33.5 MMbtu, of natural gas yields one ton of nitrogen. Anhydrous ammonia—ammonia free of water—contains around 82% nitrogen.

Although only accounting for 4% of world consumption of nitrogen fertilizer, anhydrous ammonia comprises 22% of U.S. consumption. In ambient conditions, ammonia is a gas, but it can be stored as a liquid under pressure or under refrigeration. Hence, direct application of anhydrous ammonia requires fairly sophisticated equipment to inject the liquid into the soil. Furthermore, ammonia must be shipped in refrigerated or pressurized ocean-going vessels, river barges, or railroad tank cars, for it quickly becomes a hazardous gas under normal conditions. Only developed nations can afford such capital intensity, thus accounting for the relatively higher U.S. consumption compared with the rest of the world.


118

Once injected into the soil, ammonia, which is in fact toxic to plants, dissolves in the soil water to form ammonium salts, which are nontoxic. Soil sterilization may occur from the injection, but the soil reverts to normal fertility within a few weeks and, provided the farmer did not inject the ammonia too close to the seeds, crop damage will not occur.

Outlook Global ammonia capacity has been relatively stable since 2000, growing at a CAGR of 0.5%. In 2005, we expect production capability to grow 3.4% year over year as new plants come online. Thereafter, capacity growth should ease to an annual rate of 2.0-2.5% through 2008. The global operating rate is projected to remain in the low-80s through 2010. While such a rate may seem low, the current operating rate is in the low-80s and the market is snug. In the view of some industry experts, an operating rate above 80% is good. The last peak in the cycle occurred when operating rates were in the mid-80s. The operating rate may be understated, as several ammonia plants that have been temporarily idled in the U.S., the Former Soviet Union (FSU), and Europe are unlikely to run again. Moreover, the ammonium bicarbonate-based ammonia plants that are located in China typically only run for short times during the season owing to a lack of warehousing capacity. On balance, it is likely that the ammonia market will be a relatively healthy market for at least the next two years, although some short-term pricing and margin volatility is possible at any time, particularly in the off-season.

Exhibit 118: Global Ammonia Supply/Demand

40

80

120

160

200

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E 2009E 2010E

Mill

ion

s o

f T

on

nes

74%

77%

80%

83%

86%

Operating RateProduction

Capacity

Source: Fertecon, CSFB estimates.


119

Exhibit 119: Global Ammonia Capacity, 2004 ( 165.8 Million Tonnes)

FSU13%

North America12%Western Europe

11%

Asia45%

Oceania 1%

Africa 3%

Eastern Europe 3%

Middle East 5%

Latin America 7%


Exhibit 120: Global Ammonia Capacity, 2004

Largest G lobal Am m onia Producers by Capacity

0

1000

2000

3000

4000

5000

6000

Yara Agrium Terra Koch TOA Z P otashCorp.

P EME X -m ostly id le

Ind ianFarm ersFertiliser

C oop

SaudiA rabia

FertilizerCo.

CFIndustries

Th

ou

san

ds

of

To

nn

es


Natural gas accounts for over 80% of the cash cost for ammonia production in North America when gas prices are $4 MMbtu or more, but only 70% when gas prices are at their historical average of $2. This compares unfavorably with the 50% gas prices account for in the cash costs of production in the Middle East. Consequently, high natural gas costs pushed U.S. producers’ ammonia cash margins into negative territory in 2001 and 2003. It is estimated that as long as gas remains above $4, the delivered cost of imported ammonia will be cheaper. Some U.S.-based facilities are being used to upgrade low-cost imported ammonia into products such as DAP, rather than produce the ammonia onsite. Alternatively, at its Geismar facility, PotashCorp converts ammonia imported from its facility in Trinidad into other products, including nitric acid. As ammonia is a key input for urea and various ammonium phosphates, costs have a domino effect for other nitrogen and phosphorous fertilizers.


120

Several of the largest ammonia producers, including Agrium, Terra, Koch, PotashCorp, and CF Industries, have a portion of their ammonia production based on high-cost U.S. Gulf Coast natural gas. More North American production could be shuttered in the coming years if natural gas prices remain above $5 for an extended period. Yara International, the company formed by the demerger of the fertilizer and related operations from Norsk Hydro, became a public company in March 2004. The firm’s core business is nitrogen-based fertilizers, including ammonia, urea, and nitrates. Yara has cost-advantaged nitrogen production in the Middle East and in Trinidad. The firm sells third-party sourced phosphate and potash fertilizers to offer customers a balanced mix of fertilizers. Industry consolidation continues. In late December, Terra completed its acquisition of Mississippi Chemical’s major nitrogen assets (in a bankruptcy liquidation), which include a 50% stake in Point Lisas Nitrogen Ltd. in Trinidad with access to low-cost natural gas, as well as two plants on the U.S. Gulf Coast.

Urea As opposed to ammonia with its specific, capital-intensive requirements for storage and delivery, urea is a solid and, hence, relatively easy to store and handle. As a result, urea is the nitrogen fertilizer of choice, accounting for 48% of global nitrogen consumption.

Once ammonia has been produced, urea is the next step in the production process. The carbon monoxide that results from the breakdown of natural gas is converted into carbon dioxide, which is then combined with ammonia to create urea. The process requires relatively high temperatures and pressure, producing a solution, which is then evaporated to form solid urea. Urea usually comes in two forms: prilled or granular. Prilled is finer and can easily be distributed by hand to cover the soil evenly. Granular is coarser with uniformly sized pellets and it degrades less than prilled. Moreover, granular stores better, forms less dust, and can be expelled further by farm equipment designed to distribute fertilizers. Yet the process to form granular urea requires more labor and additional chemicals to help it maintain its consistency. And investing in the equipment used to distribute granular adds further costs to the farmer. Consequently, farms with greater access to equipment and financing as well as greater acreage are more likely to use granular urea over prilled. Regions that favor granular are in North America, Europe, Australia, and Thailand. Countries with low labor costs and smaller farms tend to utilize prilled urea more often.

Outlook Several grassroots urea plants targeting the export market are scheduled to come online with 10.5 million tonnes capacity over the 2004-2008 time frame. Some of that capacity comprises Chinese ammonium bicarbonate plants that are being converted to produce urea, merely substituting a higher quality form of nitrogen for another. In this case, the net nitrogen capacity is not expanding significantly. Other units, which are based on low-cost natural gas, are being built in the Middle East (Saudi Arabia, Oman, Iran, and Qatar, Egypt), Trinidad, and Venezuela, and should gain share from higher-cost suppliers.

As with ammonia, marginal suppliers of urea tend to provide a floor for prices. However, if natural gas prices continue to rise, more high-cost U.S. producers may be forced to close additional capacity, as new low-cost capacity comes online. On balance, as in the


121

case of ammonia, urea producers in high-cost regions are unlikely to earn the cost of capital over the long term owing to overcapacity. Growth in demand at a greater rate than 2% or additional permanent shutdowns in high-cost regions, including the U.S. and Europe, would result in higher-than-anticipated operating rates. One should also keep in mind that capacity expansions in the Middle East and similarly cost-advantaged regions are designed for the export market and will run at full rates.

Exhibit 121: 2004 Global Urea Capacity

2004 Global Urea CapacityTotal: 141.6 Million Tonnes

North America8%

Latin America5%

Africa2%

Middle East8%

Asia (ex China)29%

China32%

FormerSoviet Union

8%

CentralEurope

3%

Western Europe

5%


The global operating rate is expected to remain in the low- to mid-80s for the foreseeable future, as capacity expansions offset demand growth.

Exhibit 122: Global Urea Capacity and Operating Rate

30.0

35.0

40.0

45.0

50.0

55.0

60.0

65.0

70.0

75.0

80.0

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Mill

ion

s o

f T

on

nes

N

75.0%

77.0%

79.0%

81.0%

83.0%

85.0%

87.0%

89.0%

Op

erat

ing

Rat

e

C apac ity

O perating R ate

P roduction



122

Phosphate (P) After nitrogen, phosphorous ranks second as a crop nutrient and component of fertilizers, essential for cell division, energy utilization, uniform plant maturity, seed production, nitrogen fixing, and resistance to disease. While the soil loses little phosphorous from leaching, soil erosion and crop removal do contribute to phosphorous deficiency.

There are a number of fertilizer products used to replenish or maintain phosphorous in the soil. All of these are derived from phosphate rock, a calcium phosphate ore. In the U.S., this ore is found primarily in Florida, North Carolina, Idaho, and Wyoming. Outside of the U.S., Tunisia, Algeria, and especially Morocco all have significant deposits. The U.S. has 8% of the economically viable world reserves of phosphate rock; North Africa has over 50%; the remaining 15-20% is found in Jordan, China, Russia, South Africa, Mexico, and Israel.

Morocco and the U.S. have excellent high-quality rock reserves, helping to account for the high level of phosphate exports—typically in the form of DAP, MAP, and especially for Morocco, triple superphosphate. However, the differences in costs from location to location are relatively small and it is mitigated to some degree by shipping costs. Compared with the U.S., Morocco’s phosphate rock quality is modestly higher, but this advantage is largely offset by higher extraction costs. The recent rise in ocean freight rates has elevated the price of imported sulfur; this yellow element is required to make phosphate, as the phosphate rock needs to be treated with sulfuric acid to generate H3PO4. Currently, the U.S. with its refinery-sourced sulfur, has about a $30 advantage on sulfur costs per tonne of phosphoric acid versus Morocco.

Exhibit 123: Economically Viable Phosphate Rock Reserves

0

1

2

3

4

5

6

7

8

NorthAm erica

LatinAmerica

Europe Africa M iddle East Asia Oceania

Bill

ion

s o

f T

on

nes

Source: USGS, Fertecon, CSFB estimates.

Once the phosphate rock has been mined, it is dissolved in a mixture of sulfuric acid and phosphoric acid, creating wet-process phosphoric acid. The dilute phosphoric acid produced may be evaporated into a more concentrated form. When the concentrated phosphoric acid has reached commercial grade, it can either be combined with ammonia, resulting in monoammonium phosphate (MAP) or diammonium phosphate


123

(DAP), or be combined with additional phosphate rock to convert it into triple superphosphate (TSP). These three products are the principal phosphate fertilizers. Gypsum (CaSO4) is a key by-product in the production of phosphoric acid.

Farmers may elect to not apply phosphorous fertilizers every year for two reasons. First, there is less risk of losing phosphate in the soil through leaching, unlike nitrogen. Second, plants tend to absorb at most 20% of the phosphorous latent in the soil, leaving sufficient amounts for the next growing season once cropping is complete.

In addition to fertilizer use, upgraded phosphate products are also used in livestock feed. As with plants, phosphorous plays a key role in helping animals grow and resist disease. Poultry consumes the most phosphate, followed by swine and cattle.

With a large variety of phosphate fertilizers, the phosphorous content is generally quoted in terms of phosphorous pentoxide (P2O5).

Phosphoric acid also has several nonagricultural applications, and some producers, especially PotashCorp, are focusing on these markets as more profitable outlets for their ores. Examples of nonagricultural applications include detergents, dentifrice, carbonated beverages, and food ingredients.

Outlook Exhibit 124 shows that phosphoric acid may continue to be in excess global supply for the next several years, implying that higher-cost players may not earn the cost of capital. In the U.S., phosphoric acid derived from North Carolina is low cost. However, the differences in costs from location to location are relatively small and it is mitigated by shipping costs.

Higher phosphate fertilizer output is anticipated to emanate from Morocco and especially China over the next three years. China’s imports of DAP and MAP have dropped significantly since 1998, and its growing capacity is likely to reduce imports even more. Given its relative proximity to India and favorable freight costs versus more distant suppliers, Morocco’s increasing production should bolster competition to the Indian market. This should put additional pressure on U.S. producers, whose DAP export levels have already fallen 45% from 9.9 million tonnes in 1999 to an estimated 5.5 million tonnes in 2004. India, a major importer of phosphate fertilizer, could boost output moderately in four years.

Over the long term, Saudi Arabia—with good phosphate rock reserves and low-cost sulfur and especially natural gas—is expected to become a major DAP player, with obvious transportation cost advantages.


124

Exhibit 124: Global Phosphoric Acid, 1981–2009E

Global Phosphoric Acid Capacity, Demand, and Capacity Utilization Rate

0.0

10.0

20.0

30.0

40.0

50.0

60.0

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

E

2007

E

2009

E

Mill

ion

s o

f T

on

nes

P2O

5

25%

35%

45%

55%

65%

75%

85%

Utilization Rate

Capacity

Demand


The U.S. is the world’s largest producer of phosphoric acid, accounting for about 35% of total production. On the other hand, the U.S. consumes almost 35% of all phosphoric acid, and thus exports only 4% of global supply. The largest exporter is Morocco, responsible for over 40% of all exports.

Exhibit 125: Global Phosphoric Acid Capacity, 2004

Global Phosphoric Acid Capacity

0

2000

4000

6000

8000

10000

12000

14000

NorthAmerica

Africa Asia FSU MiddleEast

LatinAmerica

WestEurope

Central Europe

Oceania

Th

ou

san

ds

of

To

nn

es

Source: Fertecon, SRI, CSFB estimates.


125

Exhibit 126: Leading Global Producers of Phosphoric Acid, 2004 2004 Annual Capacity

P205 tons ('000)

The Mosaic Company 6,100

OCP Group (Morocco) 4,616

PotashCorp 2,711

PhosAgro (Russia) 1,356

Groupe Chimique Tunisien 1,356

Other 17,751

Total 33,889

Source: Fertecon, NR Canada, PotashCorp - 2002

Potash (K) The third-largest fertilizer in terms of consumption, potash (mostly in the form of potassium chloride, KCl) comes from mineral reserves. Unlike phosphate or the varieties of nitrogen fertilizers, potash needs relatively limited treatment to make it suitable for soil application. The purity of the ore and extent of the presence of other materials such as salt, clay, or magnesium, help determine the relatively profitability of the ore bed. The word potash comes from early soap-making techniques in which wood ash was leached in large iron pots.

Potassium aids photosynthesis rates, fruit formation, winter hardiness, disease resistance, and efficient uptake of nutrients, enzyme activation, protein formation, and respiration. Crops deficient in potassium exhibit weak stalks and wilted leaves. Such deficiency also occurs when the ratio of nitrogen to potassium is too high.

Potassium is found predominantly in the earth’s crust and bodies of water. Most of the economically recoverable potassium is found in sedimentary deposits that were the result of ancient seawater evaporation and is extracted through mining. However, when mine depths exceed 1,200 meters, extraction becomes unsuitable or too costly for conventional mining using boring machines. Solution mining was developed to overcome these obstacles, but this process may be more costly than conventional mining owing to the high cost of natural gas to heat the brine that is pumped underground. The process involves dissolving salts in deep deposits, pumping the solution to the surface, and then separating the salts through crystallization. The other method of isolating potassium chloride is to segregate salt (sodium chloride) via crystallization through partial evaporation of natural brine deposits found in “dry” lakes—e.g., the Great Salt Lake in Utah and the Dead Sea in Israel. Once the salt has been removed, the remaining brine is again evaporated to recover the potassium chloride, which then goes through a process of beneficiation to reach a desired level of purity. Brine-recovered potassium accounts for about 10% of commercial potash.

Outlook The world operating rate for potash fell to a nadir of 56% in 1993, following the collapse of communism in Eastern Europe and the Soviet Union and the decline in nutrient use in that region of the world. This resulted in a huge influx of material into the global market. Since that time, operating rates have slowly increased as capacity has remained relatively stable, and production has grown at a CAGR of 2.4% over the past ten years.


126

We estimate the global operating rate as a percent of nameplate capacity was 75% in 2003. Because PotashCorp., the world’s largest potash producer, has kept significant amounts of its capacity off-line, the effective supply/demand balance for potash is much better than the 75% figure would imply.

There are only a few proposed greenfield units, and these operations are not expected to come online until after 2008. They include a 1.5-2.0 million tonne facility in Argentina and two units in Thailand, each with 1.0 million tonnes of capacity. Hypothetically, in the unlikely event that all these projects materialize, global capacity would jump at least 10%. We have included one greenfield plant in our projections for startup in 2009. However, several industry officials believe these new units will be delayed or may never come online. Thailand has been an area where the development of the potash industry has been pursued unsuccessfully for many years, but there continues to be interest in developing a greenfield unit in that region. Rather than grassroots expansions, according to several of our industry contacts, the biggest threat to improving capacity utilization rates is incremental expansion, which is a much less costly process.

Where ore deposits are developed, it may be possible to increase output by improving the mine efficiency utilizing tools such as debottlenecking equipment, adding work shifts, and reducing vacation periods. As potash profitability is improving, we expect companies to look for opportunities for incremental expansions, which would take about 12-18 months to put in place. Recently, PotashCorp., which is expecting to boost output, announced that it had approved engineering design work for several alternative Saskatchewan projects. In addition, the firm already has engineering work under way at its Piccadilly potash site in New Brunswick. PotashCorp. plans to bring incremental capacity online to meet demand, and the exact location or locations will be decided when its studies are complete. In our forecasts, we estimate PotashCorp. will have 1 million tonnes of additional KCl capacity (0.6 million tonnes of K2O) in 2006. This capacity is in addition to the 1.6 million tonnes of KCl (1.0 million tonnes of K2O) that the firm is bringing online over the 2004-2005 time frame by reducing vacation periods and adding work shifts at the Allan and Lanigan mines in 2004 and incremental debottlenecking at the Rocanville mine in the first quarter of 2005. This will bring PotashCorp.’s effective capacity to 9.6 million tonnes of KCl versus its nameplate capacity of 12.1 million tonnes. Agrium and Mosaic also have low-cost expansion projects under review.

Exhibit 127 shows global capacity of 36.4 million tonnes of K2O in 2003, which we have assumed it will reach 40.5 million tonnes in 2010. Our projections include several capacity expansions that have not yet been officially approved. We expect Agrium to add 260,000 tonnes of capacity at its Saskatchewan mine in early 2006. We also assumed that Agrium and Mosaic will debottleneck their Canadian capacity by an additional 10%, or 650,000 tonnes, in 2007-2008. We have factored into our projections the startup of one greenfield project with 1.0 million tonnes of capacity in 2009 (probably in Thailand), and over our time horizon, we forecast 600,000 tonnes of incremental capacity in Russia/Belarus. However, it could be more than this, if additional planned greenfield expansions come online or more debottlenecking efforts get under way, particularly in Russia/Belarus. We believe production will increase at a faster rate than capacity, as some producers (particularly the Russians) currently are running their units


127

at below full rates. We estimate the global nameplate operating rate for potash was 75% in 2003, increased to 80% in 2004, and will be 81% in 2005, 80% in 2006, and 80% in 2007 before reaching 81% in 2010.

Exhibit 127: Global Potash Nameplate Capacity and Operating Rate, 1990–2010E

G lo b a l P o ta s h S u p p ly/D e m a n d T re n d s

0 .0

1 0 .0

2 0 .0

3 0 .0

4 0 .0

5 0 .0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

E

2005

E

2006

E

2007

E

2008

E

2009

E

2010

E

Mill

ion

s o

f T

on

nes

K2O

4 0 %

5 0 %

6 0 %

7 0 %

8 0 %

9 0 %

D e m a n d

C a p a c ityN a m e p la te O p e ra tin g

Source: SRI, Company Data, CSFB estimates.

Currently, the U.S. consumes the largest amount of potash, followed by Brazil and China. Together these countries account for about half of global potash fertilizer consumption. While the North American market is mature, use of potash in Latin America and Asia should grow as both the acres planted and the application rates increase.

Exhibit 128: Global Potash Consumption, 2003

Latin America19%

Europe23%

North America21%

Asia33% Oceania 1%

Africa 1%

Middle East 2%


Despite potash’s substantial reserve base, major deposits exist in only 17 countries. The largest known potash reserves are located in Saskatchewan. That ore body as measured in nutrient terms is also rich (K2O of 25-30%) relative to other regions of the world. The next largest supply of proven reserves is located in the Former Soviet Union, specifically in Russia and Belarus. The ore found in the FSU is of lower grade, with 10-15% K2O. Canada, Russia, and Belarus account for 84% of the reserve base. Smaller


128

developed reserves are located in countries that include Germany, the U.S., the U.K., Spain, Chile, Jordan, Israel, and China. It is estimated that there are 8 billion tonnes of proven reserves.

Exhibit 129: Global Potash Reserves

0

5 0 0

1 0 0 0

1 5 0 0

2 0 0 0

2 5 0 0

3 0 0 0

3 5 0 0

4 0 0 0

4 5 0 0

Canad

a

Russia

Belaru

s

Germ

any

Brazil

Israe

l

Jord

an

China

United

Sta

tes

Other

Mill

ion

s o

f T

on

nes

K2O

Source: USGS, CSFB estimates.

Exhibit 130: Leading Producers of Potash, 2004 2004 Annual Capacity

KCI tonnes (000)

PotashCorp 10,100

Mosaic 8,250

Belaruskali 9,000

Kali & Salz 6,500

Dead Sea Works (Israel Chemicals Ltd.) 5,100

Uralkali 6,500

Silvinit 4,300

Arab Potash 2,100

Agrium 1,750

China 1,300

Other 2,800

Total 57,500

Source: Fertecon, NR Canada, PotashCorp - 2002

As shown in Exhibit 131, potash production is dominated by North America (primarily Canada), and the Former Soviet Union (Russia and Belarus)—the areas that have the largest developed reserves.


129

Exhibit 131: Global Potash Capacity, 2003

2003 Global Potash Capacity

0

2

4

6

8

10

12

14

16

North America* Russia EU Belarus Middle East Latin America China

Mill

ion

s o

f T

on

nes

K2O

Production Idle Capacity* Primarily Canada

Source: Fertecon, CSFB estimates

Canada, Russia, and Belarus dominate the export market. The Russian producer, Uralkali, announced plans to increase output by 2.0 million tonnes by 2008, from 5.0 million to 7.0 million tonnes. Some industry participants believe the Russian facilities in their current states are not capable of raising output meaningfully without significant additional capital investment. However, since operating rates in the Russian facilities currently are well below nameplate capacity (70-80%) and output from the units has been increasing steadily in recent years, other industry observers are more optimistic that the facilities could increase output significantly by improving operating efficiencies and incremental debottlenecking projects.

While the global potash operating rate is expected to remain relatively unchanged over the next two to three years, we project potash output (including primarily incremental volume from Canada and Russia) will increase at a 3.0% CAGR, which is faster than projected 2.0% demand growth. This factor could put a lid on potash prices and margins, although the product should still deliver healthy profits.


130

IX. Agricultural Chemicals (Crop Protection, GMOs)

Introduction The traditional agrochemical industry was, according to the consultants Phillips McDougall, worth around $30.3 billion in 2004 (excluding GMO). In addition, the growing biotechnology segment has increased to $4.5 billion, largely, but not exclusively, as a result of the success of Monsanto’s seed technology franchise.

The overall industry has grown in the last five years at a compound annual average rate of 2.8% per year, we estimate, but thanks mainly to a very successful season in 2004 when the industry grew in nominal U.S. dollar terms by around 14%.

The industry can be narrowed into three main types of pesticides: herbicides, fungicides, and insecticides.

Herbicides By category we do not have the data as yet for 2004 and so concentrate on the last available annual data, 2003.

Herbicides, by far the most important market, prevent or inhibit weed growth, and thus replace or reduce the need for manual and mechanical weeding. The global market was estimated at US$13.4 billion in 2003 by Phillips McDougalll. The leading herbicide, glyphosate, accounted for US$2.9 billion in sales that year, or 22% of the total market.

• Selective herbicides: Selective herbicides act on specific targeted plant species only. We estimate that this sector was worth around US$9.9 billion in 2003, and we expect selective herbicides to remain relatively flat from 2005. In the years before 2004, the market contracted, we estimate, by an average of around 7.0% per annum, hurt by a weak farm economy and a secular shift to nonselective herbicide products such as Roundup, known generically as glyphosate.

• Nonselective herbicides: Nonselective herbicides act on all vegetation with which they come into contact. The overall market, we estimate, was worth about US$5 billion in 2003, and we expect nonselective herbicides to show a flat revenue environment in 2004-2007. The market grew at a swift rate in 1997-2001 (around 10% per year), as these nonselective products took market share from the selective herbicide class, due to the increased level of biotechnology-based acreage, especially in soybeans and cotton, but also corn. Thus, the higher level of sales of seeds with engineered resistance to certain nonselective herbicides directly fed through to higher growth of products such as Monsanto’s Roundup brand. However, growth recently has been impacted heavily by the loss of Monsanto’s patent on glyphosate, the most popular nonselective, which has been facing competition since 2001. Indeed growth in 2003 was only very marginal (less than 1%) as compared with 2002.

• Future growth for nonselective herbicides will depend on the acceptance of biotechnology outside of the U.S. and Canada, but, at the moment, Europe remains a sticking point from the viewpoint of consumers and governments. That said, growth drivers for nonselective chemicals remain: (1) Brazil should see higher GM acreage in


131

2005; (2) Monsanto’s stacked-trait technology could mean growth in biotech acreage in corn in the U.S.; and (3) an increasing emphasis of conservation tillage, in which a nonselective herbicide can be used as a preplant weed burndown agent.

Fungicides Fungicides prevent and cure fungal plant diseases that affect crop yields and quality. The market was estimated at about US$5.7 billion in 2003 by Phillips McDougall and has shrunk at about 3% a year over the last five years. The main crop markets are cereals and fruits and vegetables in Europe and rice in Asia. This area has been the worst performing in the industry during that period because of three main factors:

1. Weak demand in East Asia (especially in 1998-1999), where climactic conditions usually dictate higher-than-average demand for fungicides, due to currency devaluations at the end of the 1990s.

2. The U.S. experienced low disease rates over that period.

3. Europe’s heat wave in 2003 led to significantly reduced demand for that season.

That said, a reversal of fortune is under way, and we foresee a noticeable improvement in the next five years. Data has not come in for 2004 as yet, but the spread of Asian rust, a prolific virus that can devastate soybeans, has led to a booming market in Latin America in 2004, which should have resulted in a high level of growth for the overall fungicides segment. In addition, Europe saw a significant recovery in demand in 2004, following a dry season in 2003.

Beyond 2004, projections of 3.6% growth out to 2008 by Phillips McDougall can be justified, especially in the context of the potential for Asian rust to positively affect demand in the U.S. market—the extent to which benefits will be seen will depend on the extent to which the disease spreads in 2005, if at all. At the very least, though, we expect some sales in 2005, as a precautionary measure by farmers in the U.S.

Insecticides Insecticides are used to control chewing pests (such as caterpillars) and sucking pests (such as aphids), which, in common with diseases, reduce crop yields and quality. The insecticide market was estimated at about US$6.7 billion in 2003 by Phillips McDougall, and the firm expects insecticides to grow by 0.6% per annum in the medium term, having declined 2% per annum over the past five years.

Bioengineered cotton and corn seeds that provide insect control using Bt genes have gained share at the expense of conventional insecticides. Further penetration of such genetically modified organisms is anticipated.


132

Agrochemical Manufacturers

Exhibit 132: Global Market Shares for Crop Protection Only (Excluding Seeds), 2004 US$ in millions, unless otherwise stated

2004 Sales Global Market

Bayer 7000 23%

Syngenta 6309 21%

BASF 4166 14%

Dow Chemical 3143 11%

Monsanto 2864 10%

DuPont 2210 8%

Source: Phillips McDougall, CSFB estimates.

Seeds and GMOs In addition to pesticide operations, a number of agrochemical companies have significant seeds operations. We estimate that the seed industry was worth US$17 billion worldwide in 2003. The businesses supply seeds, tubers, or early-growth-stage plants to commercial and professional growers. Traditionally, improving seed characteristics have been achieved through cross-pollination or through selective breeding. More recently, genomics and biotechnology have led to the production of GMOs, whose genetic structure has been altered to enhance the properties of the crop. This industry is the subject of widespread publicity, and, as a result, at this stage it is difficult to gauge its prospects in detail. However, one way or another, we believe GMOs will play a major role in the fortunes of the major agrochemical producers over the long term.

It appears that Monsanto is the one agrochemicals firm that is still putting huge emphasis on ag-biotech, and its success in this endeavor is apparent. Within ag-biotech, the company’s technologies are the most widely used today, with emphasis on input traits—those traits that bolster grower economics. Monsanto is the undisputed leader in glyphosate-resistant (Roundup Ready) and insect-resistant (Bt) crops.

Beyond expanding its input trait technologies (including stacked multiple traits in one seed), Monsanto is moving into output trait development, as described below; these will enhance the properties of the crop, such as enhanced oil or amino-acid content. Monsanto is no longer developing new crop protection chemicals, and management believes it can grow EPS at a minimum of 10% per year and upwards of 15-20%.

Moreover, Monsanto has been the dominant participant in recent M&A activity with its upcoming acquisitions of two seed companies, Seminis and Emergent Genetics. The firm is using seeds as a way to leverage its technology and germ plasm in the marketplace. There is a scarcity of acquisition opportunities in the seeds industry, perhaps leading to premium prices for available properties. But whether the various firms are likely to pay such amounts remains to be seen, especially if the purported targets don’t have substantial growth prospects.

DuPont, in our view, would rank #2 in its focus on ag-biotech and molecular breeding. The firm is well behind Monsanto in commercializing input traits (and, in fact, must license certain traits from its arch opponent to keep its corn and soybean seeds competitive). However, it is climbing up the learning curve. It is also developing output


133

traits, some of which are similar to those being “cultivated” by Monsanto. DuPont isn’t putting all of its eggs in one basket, however, as it continues to discover new crop protection chemicals and moves downstream into commercializing new soybean-based food ingredients.

Bayer and BASF seem disenchanted with the outlook for ag-biotech. The prospects for achieving EU approval to plant GM crops are dismal, and the managements believe any meaningful payoff in this business is years away. Syngenta is a bit more sanguine than Bayer and BASF but continues to focus on crop protection.

Technological Issues

Development of Traditional Technology

Research suggests that full and appropriate use of current agrochemical technology could increase crop yield to around 60% of the theoretical maximum (compared with a 30% yield without any agrochemicals). The remaining 40%, therefore, would appear to be a significant untapped source for new “traditional” crop protection agrochemicals products. In reality, only a proportion of this untapped yield can be realized, as products tend to lose efficacy over time as resistances grow. Despite this, intermediate-term growth in the agrochemical marketplace is most likely to be driven by increased usage of traditional crop protection agrochemicals.

New Productive Techniques Required in the Long Term

Longer-term growth in the agrochemical industry is more likely to come from the increased adoption of new biotechnologies (such as GMOs, which are discussed below). Crops that are genetically modified have genes from other organisms (such as algae or bacteria) added to their genomes, altering the crop’s properties in various ways. Traditional approaches appear able to only postpone the trends that are leading to a critical point in world food supplies. However, GM technologies, beyond lowering the cost of growing crops, can actually improve the yield, quality, and value-added nature of particular crops. An alternative methodology that results in crops with better commercial properties is molecular breeding. Genetics of the crops are improved—without adding genes from other types of organisms—by breeding into the species beneficial genes that are present in other plants of the same species. That is, with enhanced knowledge of plant genomes and the use of molecular markers to spot the location of specialized genes, the conventional breeding process is noticeably accelerated.

At this stage, the most successful GMOs are Roundup Ready crops (especially soybeans, but also cotton, corn, and canola), and Bt crops, which transfer genes from Bt bacteria into crops so that they are naturally toxic to caterpillars (such as Bt corn and Bt cotton). The most recent major technology is Bt corn for corn rootworm (launched by Monsanto in 2003).

Well-publicized issues of consumer resistance are being displayed toward these technologies in certain parts of the world, notably in Europe and in such highly populated countries as Japan. While this view is unlikely to change in the short term, we believe the need for this new technology will lead to a gradual acceptance. Input traits—those that control properties such as insect, herbicide, and disease resistance—were


134

the first to be widely marketed. Output traits—those that affect end users directly, such as yield, food flavor, quality, texture, color, and nutritional enhancement—are still early in their development cycle.

In our view, the commercialization of biotech-related output traits could help lift the cloud surrounding the ag-biotech industry, particularly in Europe. However, after a five-year hiatus, the EU has finally begun to approve importation of new GM crops. This change was encouraged by (1) the establishment of EU rules governing the labeling of GM foods, and (2) pressure from the WTO, which threatened economic sanctions since the refusal to approve new GM foods was viewed as a restraint of trade, because there was no scientific basis for refusing to approve them. Ratification was certainly a politically charged issue in the EU due to the complicated pathway that relied heavily on most or all of the member states to agree on approval.

Product Development in Breeding and Ag-Biotech

Monsanto

Monsanto continues to emphasize some new soybean oil traits that it is developing with molecular breeding (non-GMO). The first product to be introduced is Vistive low linolenic soybeans, which is being launched in 2005; low-linolenic oil requires far less hydrogenation, thereby reducing production of undesirable trans-fatty acids. The second-generation product is mid-oleic acid plus low-linolenic soybeans, which is expected to be commercial in 2008-2009; higher concentrations of oleic acid improve the taste of soy oil-based products such as soymilk. The third-generation oil product will add low-saturated-fat content, thereby mirroring the traits of olive oil; this variety is targeted for 2010-2011.

Other products the firm continues to develop are high lysine GM corn (to be sold for animal feed by Renessen, its joint venture with Cargill), soybeans that produce their own omega-fatty oils in 2009 or 2010, and drought-tolerant crops by the start of the next decade, initially corn but there are many other crops behind it.

As of 2005, Monsanto has converted all of its Roundup Ready corn technology from the GA21 event to NK603. It expects RR corn acreage to grow in the U.S. from 16 million acres (2004) to 20 million (2005) and ultimately to 50 million acres (out of 80 million acres that are typically planted in the U.S. annually). The firm also stressed that the cost of goods sold for crops with double- or triple-stacked traits is virtually the same as it is for crops with a single trait. However, technology fees are collected for each of the traits, bolstering revenues with little or no increase in production cost.

With regard to Monsanto’s acquisition of the fruit/vegetable seed company Seminis, management expects the property to bolster its gross profit growth. We still believe Seminis could slow the firm’s overall growth rate, since we don’t believe this unit is expanding as quickly as the firm’s Seed & Trait business. Syngenta, which has the #2 position in fruit/vegetable seeds, admitted that it looked at this property as well but felt the expected transaction price would be too high to justify.


135

Exhibit 133: Major Biotech Markets (in Green, with Percentage of Global Market per Region)

Agricultural Biotechnology Market 2003

Latin America 20.5%

Total = 173.8 million acres (+11.8% over 2002)

Rest of World 3.5%

USA68.8%

Canada7.2%

Latin America

Total = million acres

Rest of World

USA

Canada

Latin America 20.5%


Rest of World 3.5%

USA68.8%

Canada7.2%

Latin America


Rest of World

USA

Canada

Agricultural Biotechnology Market 2003

Latin America 20.5%


Rest of World 3.5%

USA68.8%

Canada7.2%

Latin America


Rest of World

USA

Canada

Latin America 20.5%


Rest of World 3.5%

USA68.8%

Canada7.2%

Latin America


Rest of World

USA

Canada

Source: Phillips McDougall.

In early 2005, Monsanto announced its purchase of Emergent Genetics, a private cottonseed enterprise owned by an affiliate of Hicks-Muse. The two operations within Emergent are Stoneville and NexGen. This purchase provides Monsanto—the sole current GM trait supplier to Delta and Pine Land—control of a major DLP competitor. It ensures the rapid deployment of Monsanto’s new GM technologies and grants Emergent direct access to Monsanto’s cotton germ plasm that has been developed in house through Monsanto’s Cotton States unit.

DuPont

In contrast to Monsanto, DuPont is using a three-pronged approach to its ag and nutrition business: crop protection, seeds with enhanced germ plasm and GM traits, and Solae food ingredients. The firm has an array of new crop protection products in its pipeline. Building on its success in sulfonylurea herbicides, the company has 18 new SU blends in pre-launch stage for cereals and soybeans, with other blends two to four years away for corn. As a follow-on to its success in indoxicarb insecticide (known as Steward in some formulations), DuPont is developing E2Y—a low-toxicity, low-dose chemical for caterpillar control. The product is on track for a 2008 launch, and management believes it has $500 million in sales potential. Our challenge: Since caterpillars are controlled fairly well in cotton and corn with Bt crops (genetically modified), how will this sales target be achieved? Clearly, there are countries that don’t allow Bt crops and other


136

insect-sensitive crops such as potatoes and vegetables (a critical target market for E2Y). But are these markets sufficient to allow $500 million in revenues?

In the seeds , DuPont makes the point that its global revenue share in corn and soybeans continues to increase. This is a testament to its high-quality corn and soybean germ plasm that generates a superior price. For example, high-yielding and short-maturity corn varieties have been quite successful. Still, over the past several years—not necessarily every year—Dupont’s Pioneer Hi-Bred corn seed has lost market share when measured on a domestic acreage basis. Like its competitor Monsanto, the firm is developing a variety of new crops utilizing molecular breeding and GM technologies. Triple-stacked corn—three traits licensed from Monsanto (Bt corn borer, Roundup Ready, and Bt corn rootworm—is in the pre-launch stage. Also, Herculex Corn rootworm trait—developed jointly by Dow Chemical and DuPont—could be launched as early as 2006; Herculex stacked with a new generation of Roundup Ready gene (from Monsanto) could come one to two years after. Drought-tolerant proprietary GM corn is thought to be 4-5 years away, roughly in-line with Monsanto’s schedule. By 2009, the company hopes to have its own proprietary glyphosate-tolerant trait—known as GAT (glyphosate N-acetyltransferase) and developed with Maxygen—commercialized in corn, and perhaps in soybeans and canola as well. DuPont is also working on a glyphosate-tolerant trait for cotton through Verdia—a 50/50 joint venture with Delta and Pine Land. Commercialization of such a product is not likely until 2009 or 2010. With regard to output traits, its first generation of high-energy corn for livestock feed (via germ plasm breeding) is going commercial; an enhanced, second-generation GM variety is in Phase 2, suggesting a launch late in the decade.

The third prong in DuPont’s ag growth fork is Solae, its 72%-owned joint venture with Bunge. Customers of Solae already have 54 branded food varieties on store shelves, with more on the way. Soy protein-based Slim-Fast and 8th Continent Soymilk are just two examples. According to CSFB’s food industry analysts, the competing SILK brand of soymilk (from Dean Foods) has about 80% market share, while 8th Continent—sold by General Mills—has about 10% share but is growing. In addition to proprietary processing, Solae uses soybean varieties that have been bred to help achieve the desired results. That is, beyond the health benefits of soybean isoflavones, Solae’s focus is on helping food companies develop better-tasting and more-digestible foods with, if required, enhanced texture.

European Companies

It is becoming clearer that some agrochemical companies are choosing not to focus on ag-biotech (BASF) or have decided to concentrate their efforts on the U.S. biotech market—not Europe (Bayer and Syngenta). In late 2004, there was a meeting between German regulators and such companies as BASF and Bayer. According to one contact, the authorities are very willing to approve GM crop planting in Germany, but there were so many hurdles that had to be overcome before a product could receive such approval in the EU, that these firms believe it is not worth the expense. Syngenta has received EU approval to offer its GM sweet corn for planting in that region, but its commercial prospects are uncertain, to say the least.


137

Syngenta

Syngenta’s VipCot GM technology for insect protection in cotton is not expected to be commercial until 2007. Hence, it is likely there won’t be any substantial sales of VipCot cotton—a potential competitor of Monsanto’s Bollgard II insect protection technology—until 2008. In 2004, Delta and Pine Land signed an agreement with Syngenta to license the VipCot technology. Furthermore, it will probably be 2009 before Syngenta can offer a glyphosate-resistance technology that can be stacked with VipCot for cotton; Monsanto introduced Roundup Ready Cotton in 1997. Other areas of ag-biotech interest for Syngenta include the production of biopharmaceuticals; the firm feels this is the more efficient route to therapeutics (versus the enzymatic route) and hopes to be able to offer a product to a drug company by 2008-2010.

Among the other products Syngenta has under development is glyphosate-tolerant corn, with the GA21 event obtained from Bayer. Corn using this event had previously only been commercialized by Monsanto, but a recent court ruling said Syngenta had an IP (intellectual property) position associated with GA21. The court also ruled that Monsanto had an IP associated with GA21. Syngenta initially plans to market the glyphosate-tolerant corn only through its own seed companies—Northrup King, Garst, and Golden Harvest—which together account for 15% of North American market share in corn. Thus far, no technology-sharing agreement has been reached between Monsanto and Syngenta, and Monsanto is litigating the issue with Syngenta to extract value for its IP. Once the IP standoff is resolved, it is conceivable that Syngenta could license GA21 to others for use in other crops such as cotton and soybeans.

Syngenta is also developing a product using the Bt 11 event for control of the European corn borer in corn. Additionally, the firm has applied to U.S. regulators for approval of its corn rootworm product, which would likely follow on the heels of the traits from Monsanto (commercialized) and DuPont (to be launched in 2006-2007).

BASF

BASF only has one ag-biotech product far enough in development to discuss with investors. It is a single-starch potato that is suitable for the paper industry. The firm has an imidazolinone (imi) herbicide in the pipeline that is three to four years away from commercialization in the Corn Belt. To protect corn from damage, the firm has developed “imi-resistant corn.” The firm believes this new herbicide controls some weeds better than Roundup (glyphosate).

Bayer

Bayer believes that ag-biotech is not going to be important to its bottom line for the next four to five years. The firm has introduced three products: Fibermax cotton (which has 25% market share in North America); Arise hybrid rice that has been introduced in India; and Invigoro canola with resistance to the firm’s nonselective Basta herbicide.

China: Generic Glyphosate

China accounts for about 20% of the world’s glyphosate capacity. However, a shortage of power in that country has limited the production of elemental phosphorus, a key raw material in the production of glyphosate. As a result, Chinese glyphosate manufacturing plants are running at reduced rates.


138

Agrochemical Industry Trends and Value Drivers

Industry Consolidation The crop protection market has undergone major consolidation in recent years. We believe this trend still has some distance to run. In 2001, Hoechst and Rhône-Poulenc merged to form Aventis, and thus combined their agribusiness (as well as pharmaceutical) portfolios, while BASF bought Wyeth’s Cyanamid operations in early 2000. The formation of Syngenta at the start of 2001 from the agrochemicals businesses of Novartis and AstraZeneca marked the largest deal ever within agrochemicals. More recently, Bayer’s purchase of Aventis’s CropScience for €7.25 billion in June 2002 marked the most recent step toward a more consolidated industry. The top six producers now represent 77% of the industry.

Demographic Trends Demographics suggest that agrochemical growth should be driven most strongly in volume terms—more traditional agrochemical products should be used more widely to improve crop yields by reducing wastage. While this is likely to be a major effect, new technology and product introductions will also have major impacts on the market.

Global Population Growth

The key driver of demand for food is population growth. According to the U.S. Census Bureau, the global population in 2000 already reached 6 billion, having grown by 138% in the past 50 years. This equates to an incremental 3.5 billion mouths. The U.S. Census Bureau expects the global population to expand by another 50%, or approximately 3 billion people, in the next 50 years.


139

Exhibit 134: Global Population and Arable Land Trends to 2050E

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

(m)

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50

(Hec

tare

)

Arable land available per person (RHS) W orld population (LHS)

Source: U.S. Census Bureau, FAOSTAT, CSFB estimates.

Static Land Availability

According to our analysis, per capita land available for food production should decrease significantly in coming years. (We estimate approximately 33% by 2050.) According to the Food and Agriculture Organization of the United Nations Statistical Database (FAOSTAT), in the past 50 years, the total area of worldwide arable land expanded by only 9%, to 1.38 billion hectares (3.4 billion acres). Forecasts for the next 50 years suggest that only the same rate of growth in farmed acreage is likely. In other words, most of the worldwide accessible, available land that is suitable for agricultural purposes has already been exploited.

Agricultural Yields Must Increase

As a result of these trends, agricultural yields must improve significantly in coming years. Intrinsic crop quality needs to be improved, both in terms of yield and yield reliability, and wastage needs to be reduced. Generally, the most efficient and effective way to boost yields is to utilize plant nutrients (fertilizers), plus traditional crop protection agrochemical products such as herbicides, insecticides, or pesticides. As a crop is cultivated, various natural factors can affect (and reduce) its ultimate productive capability. These factors are varied but can include insect infestations, fungal growth, and competition for nutrition and sunlight from weeds. Broadly speaking, unless the intrinsic quality of a crop improves, yields will improve only if traditional agrochemicals are utilized more widely and effectively or if better agrochemical products are developed.


140

Selective Crop Breeding Also Boosts Yields

Advances in technology have meant that intrinsic crop quality can now be improved by changing the genetic instructions that dictate how a plant actually develops—the germ plasm. Essentially, all other things being equal, one germ plasm will be better than another if its “instructions” on how to use the available nutritional elements, or repel pests, or cope with an unfavorable environment are more efficient. For many years, selective crop breeding has been used to pursue or repel pests’ particular product traits, but this process has historically been slow and limited by the lifecycle of the plant in question. Recent advances in genetic technologies (biotechnology or genetic modification) have vastly accelerated this process, to the extent that crop quality and traits can be improved faster than ever before.

Economic Growth Boosts Caloric Requirements

Industrialization tends to drive up per capita caloric intake. As countries industrialize, and disposable income grows, typical consumers tend to increase caloric intake, and at the very least, demand food of a higher quality (taste, texture, and purity). More specifically, as a society becomes richer, more red meat is eaten. Given that poultry requires 2kg of cereal to produce 1kg of meat, swine 3kg of cereal per 1kg of meat, and cattle 7kg of cereal per 1kg of meat, the mechanism driving demand for grain is clear. This trend underscores even more clearly the need for the methods previously discussed to drive crop yield growth.

Trend toward Urban Dwelling: Cheaper Agricultural Labor Available

Global industrialization tends to reduce rural populations, which cuts the availability of labor to work on crop production. As an economy moves from primary through secondary and into tertiary economic production, higher-paying jobs are offered in towns and cities, reducing the attractions of working on a farm. As the use of certain agrochemicals can reduce the labor-intensity of crop production significantly (for example, the use of herbicides reduces the need for manual weeding), this loss of labor can be offset by the expansion of agrochemical use.


141

Cyclical Factors Despite these relatively healthy long-term fundamentals, there are a number of short-term drivers in the sector that can significantly affect the short-term growth characteristics.

• Crop prices. These dynamics are discussed in detail later in this section.

• Weather. This is inevitably linked with the section on crop pricing.

• Currencies. The industry is dollar-based, and the weakening of “soft” currency emerging markets can seriously hamper farmers’ ability to pay. This was witnessed when there were widespread local currency devaluations in Asia in 1998-1999 and in Latin America in 2001-2002, and these two periods of weakness materially affected global growth rates in the last five years.

• Government subsidies. The EU Common Agricultural Policy (CAP) and the U.S. Farm Bill are the most influential in this regard. The budget available to farmers from the CAP is frozen until at least 2006, and thus there is little incrementally positive in Europe within the context of subsidy levels. The U.S. Farm Bill, however, was recently reformed (for a six-year period from 2003) to the extent that the overall package could rise by as much as 80% over the old legislation (1997-2002). However, this is not an absolute number and depends on pricing levels of crops, among other things.

• Technological changes. These are discussed later in this section.


142

Exhibit 135: The Agrochemicals “Cycle,” 1989–2004 % change

4.3 3.7

2.1

0.1

-5.7-5.0

4.7

-1.6-1.0-0.5

2.2

-0.5.-1.6

-3.0

-6.8-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004% change

Conventional Agrochemical Market Real Growth 1989-2004

EU ‘CAP’ Reform

El NinoFreedom to FarmGATT

GM CropsWeak Crop Commodity PricesReduced SupportLAM / Asian Economies Weak

US glyphosate price fallImproved Crop PricesDrought Recovery in EuropeLAM Economy RecoverySoybean Rust in Brazil

GM Crop ExpansionImproving Commodity PricesDrought in Northern EuropeUS glyphosate price fall

4.3 3.7

2.1

0.1

-5.7-5.0

4.7

-1.6-1.0-0.5

2.2

-0.5.-1.6

-3.0

-6.8-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004% change

Conventional Agrochemical Market Real Growth 1989-2004

EU ‘CAP’ Reform

El NinoFreedom to FarmGATT

GM CropsWeak Crop Commodity PricesReduced SupportLAM / Asian Economies Weak

US glyphosate price fallImproved Crop PricesDrought Recovery in EuropeLAM Economy RecoverySoybean Rust in Brazil

GM Crop ExpansionImproving Commodity PricesDrought in Northern EuropeUS glyphosate price fall

Source: Phillips McDougall

Commodity Price Trends

Changes in farm profitability affect the profitability of the agrochemical industry by varying the type and amount of purchased seeds and crop protection products. A key driver to farm profitability is crop pricing, which itself is driven by the supply/demand balance for a given crop.


143

Exhibit 136: U.S. Commodity Prices cents/bushel

0

150

300

450

600

750

900

1050

1200

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Cen

ts/b

ushe

l

Corn (US) Soyabean (US) W heat (US)


Crop Cycles

High crop availability, usually driven by a good harvest, tends to drive down crop prices. As prices decline, so does income per acre for a farmer, which in turn may lead to farmers having less available to invest for the following planting season. This tends to reduce the yield from the following year’s harvest, which ultimately reduces product availability and eventually tightens the supply-demand balance, thus dragging prices up.

In addition to general crop cyclicality, short-term demand for agrochemical products is driven by factors such as crop planting mix and weather conditions. Different crops have different herbicide, fungicide, and insecticide requirements, and although this may not be a significant issue for an agrochemical company that offers a broad product portfolio, it could potentially present a risk to producers with narrow offerings. Climatic effects are completely unpredictable and generally have regional effects only, both positive and negative. As a result, companies with broad geographical exposure are best positioned to resist volatility caused by weather conditions.

Other Issues Technology has, since the mid 1990s, played a significant role in growth rates within the industry. This is typified by the success of Monsanto in the late 1990s, when the company managed to deliver a CAGR in sales of around 20% (in the period 1995-2000), thanks mainly to its seed and glyphosate technology. This for many soybean farmers fundamentally changed the economics of farming. However, the flip side of this is that the traditional agrochemical market has lost out—a number of selective herbicide products have suffered significantly because of the success of this technology.


144

As agrochemical technology advances, the industry is forced to pay closer attention to regulatory issues and to protect its intellectual property. The agribusiness marketplace is subject to strict and tightening regulation in the approved use of the various products and examination of emerging GM products; moreover, the Common Agricultural Policy in the EU has a deep influence on the types of crops grown. Finally, in an industry clearly and increasingly driven by technology and related issues, the availability of patent protection is important to ensure that a good return can be made on investments. Increasingly, companies are patenting genes, proteins, or new plant traits, in addition to traditional crop protection chemicals, to defend their intellectual property.

Agrochemical Near-Term Growth Prospects Sales and profitability in the agrochemical industry in recent years fell sharply in the early part of this decade, owing to a series of strong harvests in the U.S., the strength of the U.S. dollar, and a number of regional economic crises. However, it would now appear that the farm cycle might be on the verge of a gentle upswing; 2004 data from the major producers in the industry was very healthy and comments from a number of companies so far in 2005, while early, would suggest generally healthy conditions exist in the farm economy.

Growth is unlikely to match the 4.7% real growth of 2004, but we expect sales to grow by 1-2% in 2005. We point to the following positive development and potential further trends:

1. The absence of any major economic/currency crisis in 2005 thus far. The full impact of the reduction in set-aside in the EU will improve acreages in 2005. In addition, agrochemical product inventories in the pipelines are in general lower than in 2004, so greater feed-through of this robust volume progression to the company sales level is possible.

2. Crop prices. Recovery in some selected grain prices has started in recent weeks.

3. Eastern Europe is likely to continue to see improved prospects.

4. China. There has been a shift in industry structure to refocus on “row crops” and away from specialty crops, which should benefit agrochemical demand.

The main risks ahead, in our view, center on:

1. Monsanto’s rollout of stacked-trait seed technology, which could well impact growth in the conventional pesticide market.

2. Weather patterns (as ever), in particular the slow start to the planting season in Europe due to snow.

3. Currencies, especially in the “soft” currency regions of Asia and Latin America, where hedging is more difficult and/or expensive.


145

X. Industrial Gases

Introduction Five companies, all of which have operations worldwide, dominate the global industrial gases market—accounting for roughly 80% of the industry’s sales. The industry supplies a variety of gases to a broad range of industrial and consumer end markets. The largest end users are the steel, chemicals, electronics, and refining industries.

The main industrial gases are the principal ingredients of air (nitrogen, oxygen, and argon), along with the noble gases, neon, krypton, and xenon. All of these gases are produced using air separation units (ASUs). In addition, hydrogen, helium, and carbon dioxide comprise significant markets, and while these gases are to be found in the atmosphere, commercial quantities of these gases are derived primarily from other sources. The industrial gases companies also now supply a vast range of specialist gases.

Exhibit 137: The Principal Components of Air

Carbon Dioxide0.03%

Neon0.0018%

Krypton0.0001%

Xenon0.00001%

Oxygen20.95%

Nitrogen78.09%

Other0.0024%

Argon0.93%

Helium0.0005%

Source: BOC, CSFB research.


146

Air Separation Technology

Factors Influencing Choice of Separation Technology

Five factors influence separation technology choice:

• Volume. Cryogenic methods are most economical for large-scale users.

• Purity. Noncryogenic systems tend not to be able to produce high purities economically, although the companies are making significant headway in this area. Additionally, less pure products are suitable for many applications.

• Continuity. Fluctuating demand is best satisfied from liquid storage tanks filled by road tanker (or sometimes by an onsite plant). If a gas supply is an essential process requirement, as it usually is, an onsite plant would need to be backed up with liquid storage for emergency use.

• Location. Some places are too remote for delivery to be economical, or may be out of reach altogether (such as an offshore oil rig or on board a ship).

• Temperature. Only cryogenic systems are able to provide the liquefied gases that are essential for low-temperature applications such as food freezing.

Cryogenic Cryogenic system ASUs are used principally for medium- to large-scale production of the atmospheric gases nitrogen, oxygen, and argon. Production is either in liquid form for storage and transportation, or as a gas for piping direct to large-volume users. ASUs are complexes of compressors and heat exchangers with a tall column in which air is fractionally distilled at low temperatures.

Exhibit 138: Cryogenic Air Separation

Compressed & Heat removed

by water or refrigerant

systems

AIR

CO2 and water

removed

Air cools further as it is passed through an expansion

turbine to reduce

pressure

Air Vapor recycled or eliminated as waste

Liquid air withdrawn for distillation / separation

Heat Exchanger system

Distillation column

Reboiler / condenser

Liquid Liquid

Gas Gas



147

Ambient air is compressed in progressive stages, and the heat of compression is removed by cooling with water or refrigerant systems. The air is then purified to remove contaminants such as carbon dioxide and water vapor and then introduced into a heat exchanger system, where trace hydrocarbons that are potentially explosive in the presence of oxygen are removed. During this cycle, the cooled and compressed air is passed through an expansion turbine to reduce pressure, which results in further cooling of the expanded air. At this point, the air consists of both liquid and vapor.

While the vapor is recycled in the system, the liquid is passed into a distillation column, which contains perforated metal trays or structured packing. The liquid passes down through the column, while the vapor bubbles up through the liquid. The rising vapor tends to become progressively richer in nitrogen, and the descending liquid becomes richer in oxygen. To obtain high-purity products, two columns are used, separated by a reboiler/condenser.

In general, the greater the degree to which air is separated, the more separation stages are required, and the greater the height of the distillation column. This is particularly true when argon is to be recovered, because both nitrogen and oxygen must be high-purity products so that the small amount of argon in each can be recovered. Most ASUs are built with capacity to recover argon.

While the raw material for an ASU is free, the process is energy-intensive. The industry is constantly searching for ways of improving operating efficiency. In addition, it has become common practice for pricing agreements to include a clause for energy surcharges to apply should the energy costs rise above a certain level.

Noncryogenic Noncryogenic methods separate air at ambient temperature on the basis of physical property differences other than boiling points.

Membrane Separation

Membrane systems rely on special polymers, which allow more rapid diffusion of oxygen, leaving a higher concentration of nitrogen behind. Membranes are normally used to make only nitrogen from air.

Pressure Swing Adsorption (PSA)

PSA systems use specially tailored adsorbent materials, which preferentially retain either oxygen or nitrogen as the basis of their operation.

Inert Gas Generation

These systems work via the combustion of natural gas (or other hydrocarbon feedstock) and the oxygen in air to yield a nitrogen-rich product. The resultant product is not of high purity, and the popularity of this system has waned now that the majority of nitrogen is sourced from cryogenic systems, which were originally designed to produce only oxygen.


148

Ammonia Dissociation

Commercially supplied pure anhydrous ammonia is vaporized and then passed over a catalyst in a retort heated by gas or electricity. The vaporized ammonia is split into its component parts (nitrogen and hydrogen [1:3]), either cryogenically, or by burning off the hydrogen. This process is suitable when small amounts of nitrogen that are less pure than cryogenically produced nitrogen can be utilized, primarily in some metal-treating operations.

Nitrogen-Rich Natural Gas Wells

Nitrogen has long been separated and rejected from nitrogen-rich natural gas streams to achieve the purity of natural gas required for resale. Only recently has this nitrogen begun to be recovered, as it is useful in oilfield servicing and for enhanced oil recovery (EOR). In future years, increasing amounts of nitrogen will be produced at the wellhead as it has been injected into the reservoirs for EOR. Recovery is usually via small cryogenic units.

Electrolytic Dissociation of Water

This method used to be a significant source of oxygen, particularly in areas where hydrogen and oxygen are required, but where natural gas is not available. However, power requirements tend to be costly. More recently, interest in the process has risen for use in hydrogen-fueled fuel cells, which led to improvements in efficiency.

Argon from Ammonia Plants

It is possible to recover argon from plants that produce ammonia. Argon is a component of both the natural gas burned to produce hydrogen and the air separated to make nitrogen for ammonia production. This argon builds up in the purge gas stream and can be recovered.


149

Industrial Gases Industry Trends and Value Drivers Five companies worldwide supply the majority of the global industrial gases market. The industry itself is characterized by the three different methods of distribution—onsite production, pipeline, and cylinder/tanker delivery—and also by the nature of its production methods, with some products being produced purely as by-products while others are the result of capital-intensive processes.

Exhibit 139: Global Industrial Gases Market*—Breakdown by Revenue, 2004

Air Liquide25%

Linde12%

BOC12%

Air Products & Chemicals

13%

Praxair**15%

Other16%

Airgas3%

Taiyo Nippon Sanso

4%

*Market: US$43-44 billion—Gases and Services revenues only.

** Pro forma for Messer Acquisition.


Exhibit 140: Industrial Gases—Major Participants End Markets, 2004

Air Liquide Air Products BOC Linde Praxair AverageHealthcare 17% 12% 6% 9% 11% 11%Electronics 11% 23% 18% 7% 15%Chemicals 22% 11% 11% 10% 14%Hydrogen 6% 20% 4% 5% 12% 9%Food and Beverage 4% 4% 9% 5% 7% 6%Metal Production/Fabrication 35% 10% 45% 45% 16% 30%Other 5% 31% 7% 25% 37% 21%

Source: Company data, CSFB estimates

Industry Consolidation The industrial gases industry has seen a significant amount of M&A activity in recent years, with the latest being Air Liquide’s acquisition of Messer in 2004 (and PX buying the portion AL was required to divest.) As a result, at this point we view the consolidation as largely complete, with the only possible merger candidates being BOC and Linde—a topic that has been in peoples’ minds for a number of years. With those possible exceptions, further significant moves are unlikely, as they would most certainly come up against antitrust obstacles, similar to those encountered by Air Liquide and Air Products in their failed bid for BOC in 1999. The five major players hold relatively stable market share and recently demonstrated greater focus toward profitability and returns than toward further market share gains. We believe that this current industry structure should remain largely unchanged and that its profitability should benefit as a result.


150

Production Irrespective of distribution method, the gases industry is highly capital-intensive even in comparison with the broader chemicals sector. For the atmospheric gases, since the raw material is free, the major costs are capital costs, power, and distribution. For other gases, the cost of the feedstock also must be taken into account at times. The cost of power varies by region and is an important determinant of pricing. However, many long-term contracts now include clauses allowing for surcharges/rebates to reflect changing energy prices. This way, gases companies have managed to protect to a large extent their operating margin against this risk.

Distribution The supply of industrial gases typically takes place via one of three broad methods—onsite/long-term contracts, pipeline “over the fence” supply, and smaller-scale delivery—each attracting different margins and capital requirements.

Onsite/Long-Term Contracts

Long-term contracts typically involve a dedicated plant, high volume, and low prices. To offset much of the risk undertaken by the gas company in building the plant, the contract is generally constructed on a take-or-pay agreement over the depreciable life of the asset. Low variable costs (no distribution) mean that high operating margins are achievable, but the high capex requirements mean that return on capital measures are low. The age of a company’s assets plays a part in the level of its returns, because although plants are typically depreciated over 15 years, they may be operational for longer. In such an instance, the operator will enjoy a period of high returns once the capital base has been fully depreciated.

Pipeline “Over the Fence” Supply

To improve returns, many onsite plants are “overbuilt” in terms of capacity. The plants are then connected to a pipeline network, so that unused output can be sold to alternative customers also connected to that pipeline. A number of gas plants will typically supply a pipeline network, which can be hundreds of kilometers in length. Customers on this network can generally purchase their supply of gas either on a long-term contract, or on demand, which will typically be at a higher price. In this respect, in an infrastructure in a key strategic region (such as Air Products’ hydrogen network on the U.S. Gulf Coast) is able to provide significant incremental returns for relatively low incremental investment.

Smaller-Scale Delivery

Smaller-scale users buy gas as liquid (to conserve space), normally supplied by road tanker, but also by ship and rail. Liquid prices are typically significantly higher than onsite prices because of the smaller volumes and addition of transport costs. In addition, these transport costs limit the market to around 200 miles from the plant.

Gas is also delivered to small-scale users in cylinder form. The higher variable costs of supplying much smaller volumes in this way render operating margins much lower. However, prices can be up to 100 times onsite levels, meaning that respectable returns are possible, particularly if cylinder rentals are included.


151

Industrial Gases Growth Drivers Demand for industrial gases has shown resistance to much of the cyclicality that plagues many other areas of the chemicals sector. A large proportion of the revenue stream is derived from take-or-pay contracts that provide a level of revenue security. In addition, an increasing range of applications is being found for gases, in terms of improving productivity in existing processes, meeting more stringent emissions regulations, and meeting demand for new applications.

• In the steel industry, furnace atmospheres are being enhanced with oxygen and hydrogen in place of air to speed up the smelting process.

• In the oil industry, increasing amounts of industrial gases are being used in enhanced oil recovery techniques, as crude supplies become heavier and more difficult to extract, and assist in refining.

• Environmental legislation designed to lower the sulfur content in gasoline and diesel is driving demand from refiners for gases used in its removal, such as hydrogen.

• In addition, many new markets for industrial gases are being discovered, driven by both new technologies (such as fuel cells) and by lower gas production costs.

• The electronics industry continues to demand greater volumes and greater purity levels of gases, both bulk and specialty gases. While some of this incremental demand is from the semiconductor industry as more layers and more complex chip designs require more gases, some is from relatively new industries—most notably the LCD flat panel display industry.

• Home healthcare is another area of growth for the industry gas producers. Demographic trends, as well as a push by hospitals to move patients out and home faster, have resulted in demand for oxygen in the home.

Industrial Gases Growth As a result of these trends, we estimate that global industrial gases volume should grow toward the high end of its long-term historical growth rate of 5-8% over the next few years, driven in large part by the aforementioned drivers, as well as greater penetration globally—especially in emerging markets.

Because of its reliance on long-term contracts for the majority of its revenues, the gases industry has always enjoyed relatively strong growth and lower cyclicality. On average, volume has grown at around 1.5-2.0 times GDP globally, with more mature markets such as the U.S. and Western Europe averaging slightly lower growth. In addition, the improving capital discipline within the industry has led to improving utilization, and consequently a relatively robust pricing environment over the past two years than had been the case in the late 1990s.


152

XI. Atmospheric Gases

Nitrogen

Properties Nitrogen is the world’s most widely used industrial gas as a result of two key properties. First, it is virtually inert. Under normal conditions, nitrogen is chemically inactive; thus, it can be used as an inert blanket that prevents most reactions and combustion from occurring. Second, nitrogen has a low boiling point (-195.8 degrees centigrade). In liquid form, therefore, it is a highly effective, versatile, and nonpolluting agent for freezing and chilling.

Applications

Exhibit 141: U.S. Nitrogen Consumption by Market, 2002 Exhibit 142: Western European Nitrogen Consumption by Market, 2002

Chemicals33%

Primary Metals11%

Glass2%

Rubber & Plastics

1%

Other11%

Food Industry5%

Oil & Gas Extraction

14%Electronics

13%

Petroleum Ref ining

10%

Chemicals38%

Petroleum Refining

8%

Food Industry8%

Oil & Gas Extraction

10%

Metals15%

Glass 3%

Other18%

Source: SRI, CSFB research. Source: SRI, CSFB research.

Chemicals

Nitrogen is utilized in the production of chemicals and petrochemicals, fats and oils, and elastomers. It is used primarily as an inerting agent to exclude oxygen and moisture, but it is also used as a diluent to control reaction rates during processing.

Because of the large quantities of nitrogen required, chemical processing and manufacturing is generally served by onsite air separation plants, although blanketing and inerting applications can use noncryogenic nitrogen. We expect demand for nitrogen in the chemicals industry to continue to grow at approximately 3% per annum over the long term.


153

Primary Metals and Fabrication

Nitrogen is used primarily for inerting and blanketing applications in the steel industry and as an atmosphere in fabricated metal products manufacturing. Also, in aluminum processing, nitrogen is bubbled through the melt to remove hydrogen, which can create voids in finished castings.

Delivery methods for nitrogen in metal fabrication can take various forms depending on the location and scale of the production facility. Facilities commonly use pipeline systems and merchant liquid supply, while the largest contain onsite ASUs and cryogenic or noncryogenic nitrogen generators. We expect demand in these areas to remain relatively sedate and in-line with GDP.

Oil and Gas Extraction

Numerous stages of oil and gas production involve the use of nitrogen. The largest use is for advanced oil recovery (AOR). This uses large amounts of gaseous nitrogen, which is usually supplied by onsite cryogenic plants, to maintain reservoir pressure. In well drilling, nitrogen is used to replace air to reduce the risk of ”downhole” fires or explosions. It is also pumped into the drilling fluid to reduce its pressure during underbalanced drilling.

Drilling and oil field stimulation and production are comparatively small consumers of nitrogen, and hence can be supplied with liquid nitrogen. Onsite membrane units are increasingly meeting this demand. AOR requires large volumes of nitrogen and is usually fed by onsite cryogenic plants. Demand in this field is somewhat dependent on the demand for and price of oil. Based on our oil price forecasts, we expect a growth rate of roughly 10-15% within this market, because the high price of oil is resulting in oil producers looking for ways to squeeze more oil out of their assets.

Petroleum Refining

The major use for nitrogen in this industry is as an inerting, purging, and blanketing agent for reactor vessels, tanks, pipelines, and other equipment during startup, shutdown, and cleaning operations. In addition, during normal petroleum production, processing, storage, and delivery nitrogen is widely used. Finally, it is used in a number of additional processes, such as regeneration of catalysts, by carrying oxygen used to burn off deposited carbon; as a flotation agent for bringing foamed wax to the surface of waxy oils; as an agitating decolorizing agent; and as a safety agent in preventing fires and explosions.

Petroleum refining requires significant amounts of nitrogen. This is most commonly supplied either by onsite air-separation units or, location permitting, via pipeline systems. We forecast demand from petroleum refineries will outpace GDP growth over the medium to long term.


154

Electronics

Nitrogen is used primarily as a blanketing and purge gas in the manufacturing of semiconductors, integrated circuits, single crystals, vacuum tubes, and other devices. Liquid nitrogen is also used in cryogenic testing and to remove impurities, while gaseous nitrogen is used as a diluent, or carrier gas, for reactive gases (primarily etchants), used in the electronics industry.

For semiconductor applications, strict purity requirements have meant that gas suppliers tend to offer not only the gas itself, but also the design and installation of the gas distribution system, and to operate it at the customer site. Liquid nitrogen is generally used because of its purity, and this tends to be delivered in bulk form. In some locations, however (such as Air Products in Silicon Valley), producers established plants that can supply a large number of users via a pipeline.

For general inerting and blanketing applications, demand for nitrogen is not directly reliant on the level of production activity, and thus remains largely constant. However, the rapid contraction of the semiconductor industry in recent years has meant that demand for these specialist applications has also contracted. Although demand will depend largely on the weighting of a company’s activities between general electronics and semiconductor applications, overall, we expect long-term demand for nitrogen from the electronics industry to grow approximately 6-10%.

Food Industry

In its liquid form, nitrogen is commonly used to cryogenically freeze some foods. Its rapid freezing properties mean that the moisture content of the food is frozen rapidly into small ice crystals. Slower freezing techniques lead to larger crystals, which can rupture food cells and tissues and also lead to partial dehydration of the product.

Rather than immersing the product directly into liquid nitrogen, which tends to cause undesirable effects in food and often results in uneven freezing, it is more effective to use a two-stage process. First, the food is cooled and “crusted” (using carbon dioxide, as it is cheaper); then it is frozen by spraying with liquid nitrogen in a freezing tunnel.

Although liquid carbon dioxide freezes less quickly than nitrogen, liquid carbon dioxide competes with nitrogen for all stages in the cryogenic freezing of food because of its lower cost. Furthermore, cryogenic freezing competes with mechanical freezing and with newly developed forms of preservative packaging.

Elsewhere in the food and drink industry, nitrogen has further uses. It is used as an inert atmosphere for the processing, storage, and transport of foods. In addition, it is also injected into the headspace of aluminum cans that contain noncarbonated drinks. In the absence of carbon dioxide in the drink, sufficient internal sidewall pressure is created to prevent implosion or dents.

Supply of nitrogen to the food industry generally takes place in the form of bulk tanker deliveries, although some applications require gas in cylinders. For food industry uses in general, such as cryogenic freezing and inerting, we expect demand to grow approximately 2.5% (per year) over the next five years.


155

Glass

The majority of nitrogen consumed in the glass industry is in gaseous form. It is used as a blanketing agent in float-glass production, to prevent the oxidization of the bed of molten tin onto which the molten glass is poured. This nitrogen is usually produced in small onsite plants. Demand for float glass is driven by activity in the construction and automotive industries. As a result we forecast demand to grow in-line with GDP over the long term.

In addition to gaseous nitrogen, liquid nitrogen is used in a number of other glass applications. It is used as a mold cooler in the container glass industry, as well as for electrode inerting in both the container and fiberglass industries.

Rubber and Plastics

Liquid nitrogen is widely used in the cryogenic grinding of molded plastic and rubber products, a process used to remove imperfections. A similar process is used to grind down and recycle items such as tires. In addition, gaseous nitrogen is used to provide an inert atmosphere for a process called reverse polymerization. This process uses microwaves to break down the molecular bonding in rubber tires to form carbon black, fuel oil, and steel wire for recycling.

Demand for nitrogen for rubber and plastic manufacturing is reliant on the level of manufacturing activity in these areas, and is thus cyclical. Over the long term, we expect growth to be in-line with GDP.


156

Oxygen

Properties In contrast to nitrogen, oxygen is widely used because of its reactivity. It also possesses two key properties that drive its use across a number of industries: it supports combustion and it supports life.

Applications

Exhibit 143: U.S. Oxygen Consumption by Market, 2002 Exhibit 144: W. European Oxygen Consumption by Market, 2002

Primary Metals

Production49%

Pulp & Paper2%

Health Services

4%

Water Treatment

1%Other1%

Petroleum Refineries

6%

Chemicals & Gasif ication

25%

Clay, Glass & concrete Products

6%

Welding & Cutting

6%

Primary Metals

Production40%

Other4%

Health Services

6%

Coal Gasif ication

8%

Chemicals19%

Fabricated Metal

Products6%

Water Treatment

3%Pulp & Paper

4%

Clay, Glass & concrete Products

5%


5%


Primary Metals Production

By far the greatest consumer of oxygen is the steel industry. Steel manufacturing is essentially a two-stage process. In the first stage, iron ore, coke, and various fluxes are combusted in a blast furnace to produce pig iron. In the second stage, molten pig iron and scrap are converted into steel in a combustion furnace.

In blast furnaces, oxygen is being increasingly used to enrich the air mixture to aid combustion, and therefore increase efficiency. In addition, the expense and environmental concerns surrounding coke ovens led to new technologies being developed that replace coke with coal. As coal absorbs more energy when it burns, additional oxygen is being used to redress the consequent loss of heat.

The two common types of combustion furnace are the basic oxygen furnace (BOF) and the electric arc furnace. In the combustion furnace, oxygen is introduced to oxidize the impurities in the molten pig iron, and thus purify to steel. This oxidization generates additional heat, which in turn accelerates the combustion of the steel, improving efficiency. BOFs use approximately 50% more oxygen than electric arc furnaces, although changes in technology should lead to continuing increases in oxygen by the latter.


157

Oxygen is also extensively used in the smelting of nonferrous metals such as copper, zinc, and lead. Again, its primary use is to enrich the air to improve combustion and reduce energy consumption. In addition, oxygen is being used increasingly both at facilities that recycle aluminum and at those that recover gold from sulfide ores.

Because of the quantities used, most of the oxygen for the primary metals industry is delivered from large onsite gaseous oxygen plants via pipelines. The largest companies have their own onsite facilities. Additional demand is usually met by bulk liquid deliveries, and these also tend to be the preferred source for small mills.

We forecast oxygen consumption in the steel industry to grow at around twice the rate of GDP growth in the medium to long term.

Exhibit 145: U.S. Steel Industry Consumption of Oxygen

0

50000

100000

150000

200000

250000

300000

350000

197619

7719

7819

7919

8019

8119

8219

8319

8419

8519

8619

8719

8819

8919

9019

9119

9219

9319

9419

9519

9619

9719

98

Cu

bic

fee

t (m

)

0

20

40

60

80

100

120

140

160

To

ns

(m)

Oxygen consumed (lhs) Steel produced (rhs)


Chemicals

Oxygen is used in a number of large-volume chemical production processes, principally as a catalyst in oxidation reactions, although smaller quantities are used for oxychlorination processes. The advantages of using oxygen over air are that it generates improved reaction rates and eliminates inert nitrogen. Combined, these factors increase production capabilities and reduce pollution.

Other applications in the chemical industry include the manufacturing of ozone, injection into fluidized bed reactors, and injection for fermentation to increase yields.

Much of the oxygen used in the chemical industry is delivered by pipelines, either multi- or single-user pipeline. However, some of the largest plants produce their own oxygen. Bulk liquid deliveries are often used to meet fluctuations in demand over and above the pipeline capacity.


158

Exhibit 146: U.S. Consumption of Oxygen for the Chemicals Industry, 2001 Cubic feet (millions)

Acetylene 16,800

Caprolactam 2,300

Ethylene Oxide 67,000

Propylene Oxide 22,100

Titanium Dioxide 18,000

Vinyl Acetate 8,400

Vinyl Chloride 19,600


Given the strength of the commodity chemical recovery, we would expect demand over the next few years to remain relatively robust for oxygen and run at a rate a bit better than the normalized level. Over the long term, we expect growth to be in-line with GDP.

Gasification

This process uses oxygen to partially oxidize hydrocarbons (usually coal) to produce synthesis gas, which is a mixture of hydrogen and carbon monoxide. This, in turn, is used to produce substitute natural gas (SNG) or other chemicals, or to generate power through combustion.

Oxygen used in gasification is generally produced onsite because of the large quantities required. It can be supplied as air or elemental oxygen, with air-based plants less capital-intensive but also less efficient than oxygen-based plants. The nitrogen that is used as a by-product is usually used as a purge gas in the gasification process, but can also be used in the manufacturing of other chemicals such as ammonia.

More stringent environmental regulations and deregulation of the electricity markets make it likely that power generation holds the key to further growth in this industry. Nevertheless, we do not forecast significant growth above 3% over the long term.

Fabricated Metal Products

The principal use of oxygen is for welding and cutting. Oxygen fuel welding (OFW) is the oldest form of welding, but it is gradually being replaced by electric arc welding in all but some specialist applications. Oxyfuel gas cutting (OGC), however, is still widely used for cutting thick sections of material, as it is fast, effective, and inexpensive. For both applications, purity of oxygen is important, as impurities have a disproportionately large effect on the efficiency of the operation.

In addition, small quantities of oxygen are used in the electronics industry. In the manufacturing of semiconductors, it is used for oxidization of silicon, while it is also used in the manufacturing of optical fibers and electron tubes.

The link to the growth in semiconductors means that we do not expect demand for oxygen for these applications to grow at more than 2% per year.


159

Clay, Gas, and Concrete Products

Oxygen is used to enrich the atmosphere within the glass melt furnaces, as well as brick and cement kilns to enhance combustion efficiency. The result is decreased fuel consumption, increased productivity, and reduced pollutant emissions. It is the last of these reasons that has become the greatest demand driver.

The majority of companies that have migrated to oxygen enrichment have also moved to onsite generation of that oxygen. Companies that provide PSA and membrane-based systems have targeted this market because of the lack of need for absolute purity and its comparatively small scale.

Use in fiberglass and container glass manufacturing is becoming a significant end use, while applications in flat glass manufacturing are still emerging.


Oxygen has two key uses in the petrochemical industry, including regeneration of cracker catalysts, debottlenecking of sulfur recovery units, and gasification.

1. Oxygen is able to regenerate the catalysts used within catalytic crackers by oxidizing the carbon that builds up on the catalysts. As heavier crudes are used, carbon buildup increases, regeneration takes longer, and capacity falls. Oxygen is, therefore, used in increasing quantities to combat this effect.

2. Demand for this use is seasonal because of the higher demand for auto fuel during the summer months. As a result, while basic demand is met either with onsite facilities or pipelines, incremental demand is met using bulk-liquid deliveries.

3. The second major use is for the debottlenecking of Claus sulfur recovery units by enriching the atmosphere, in which the acid gas feed is combusted. Again, demand relies on a number of factors, with fluctuations matched by bulk-liquid deliveries.

As many of these uses are still emerging, we expect demand to reflect this, and to grow at over twice the rate of GDP. However, demand is also heavily reliant on the overall level of industrial activity, which itself drives demand for oil.

Health Services

Oxygen has a significant number of uses within the medical industry as a result of its ability to support life. Hospitals account for 75-80% of demand, with the remainder coming from home treatment.

Large medical centers and hospitals tend to have high-purity oxygen delivered in liquid form and stored on site before being revaporized for use. Oxygen in cylinders is generally used by smaller hospitals and to meet additional demand from larger hospitals. In addition, a few large hospitals produce their own oxygen in onsite oxygen concentrators (small PSA units).

Growth in demand is generally driven by population growth, although in developing countries, improving medical facilities drive demand at a faster rate. We expect growth of around 6-10%.


160

Pulp and Paper

Oxygen is used at an increasing number of stages in pulp and paper manufacturing. Its use is being driven principally by environmental concerns and tougher regulations in that field. In particular, oxygen bleaching reduces the need to bleach with chlorine, which itself has a poor environmental record.

Exhibit 147: Potential Oxygen Requirements for a 1,000-Short-Ton-per-Day Fully Bleached Kraft Pulp Mill Potential Oxygen Requirement Use/Benefit (short tons per day)

Oxygen Delignification 25 Reduced AOX formation

White Liquor Oxidation 3-5 Decreased caustic purchases

Oxidative Extraction 5-10 Decreased chemical cost

Black Liquor Oxidation 60 Environmental odor control

Black Liquor Oxidation Polishing 5

Lime Kiln Enrichment 1-10 Increased production

Wastewater Treatment 15-50 Environmental compliance

Wastewater Treatment Polishing 20

Ozone Generation 60

Hog Fuel Boiler Enrichment 15

Source: CEH estimates, CSFB research.

Oxygen for these processes has traditionally been delivered in bulk-liquid form. However, as it is being used in increasing quantities throughout the manufacturing process, so the investment into onsite production becomes justifiable.

Overall, we forecast oxygen consumption in paper mills to grow broadly in-line with GDP.

Wastewater Treatment

Oxygen is required by bacteria to oxidize organic matter to produce carbon dioxide and water. When the reaction occurs in nature, the dissolved oxygen content in water is used. However, if the level of organic matter is such that all of this water is consumed and not replaced, the fish and plant species in the water that are dependent on oxygen are harmed.

With increasing amounts of organic waste finding its way into waste systems, the demand for oxygen to combat this is increasing. Activated sludge systems and oxygen systems are the two principal methods of providing the oxygen required for this purpose. Oxygen systems are commonly chosen over air systems as they take up less space.

The oxygen is traditionally supplied by either a cryogenic oxygen plant or by a PSA unit, depending on the size of the wastewater facility, while liquid oxygen is usually also stored on site as a backup.

Although additional uses for oxygen exist within wastewater processing, it is essentially a mature market. As a result, we do not expect growth in excess of 2% over the long term.


161

Ozone for Drinking Water

Ozone (triatomic oxygen) is a powerful oxidizing agent that is increasingly replacing chlorine in water treatment applications. Ozone can be generated from ambient air, liquid oxygen, or oxygen generated on site. As ozone will spontaneously revert to diatomic oxygen, it is produced at the point of use.

The largest volume applications for ozone are in the processing of water for drinking. Major applications within this field are disinfection, color, taste, and odor control.

Industrial gas companies tend to have investment interests in ozone-generation companies, rather than undertaking the production of ozone themselves. Concerns over the use of chlorine in drinking-water preparation have led to rapid growth in the number of processors switching to ozone treatments. As a result, growth in recent years, particularly in the U.S., has been strong. We believe this transition should continue, albeit at a slower rate, and hence we forecast demand growth of around 5% over the long term.


162

Argon Argon is the most abundant truly inert (or noble) gas. While for the majority of metallurgical applications nitrogen is sufficiently inert, argon is the optimum choice in extreme conditions.

The argon business operates differently from the oxygen and nitrogen businesses, as argon can be produced economically only as a by-product of large air separation units. This means that the construction or closure of these facilities is based on the demand for oxygen and/or nitrogen, and this can result in a dislocation between supply of and demand for argon. This situation is made worse, since oxygen and nitrogen are consumed in a large number of industries, while argon is used almost exclusively in the steel industry.

Applications

Exhibit 148: U.S. Argon Consumption by Market, 2002

Welding43%

Electronics 4%

Primary Metals35%

Electric Lighting Equipment

4%

Other14%


Primary Metals Industries

The steel industry is the largest user of argon and usage is increasing as processes that consume argon are more widely adopted and more high quality steels, such as stainless steel are produced.

Specific uses are as an atmosphere in vacuum-induction furnaces, which are used to produce special alloys; “bottom blowing,” which is the process of bubbling argon through molten steel to stir it and aid oxidation of any impurities; ladle metallurgy furnaces where it is bubbled through to cause impurities to flow to the top; and continuous casting, during which argon is used to shroud the molten steel to protect it from oxygen as it is poured into molds.

In addition, the decarburizing of stainless steel involves an argon and oxygen mix, in which the argon reduces the partial pressure of the carbon monoxide reaction product of the furnace charge, thus increasing the rate of oxidation of the carbon and decreasing the rate of oxidation of chromium.


163

Argon is also combined with other gases as an inert blanket for melting, casting, rolling, and annealing operations, which require high-temperature refining and fabrication processes.

Finally, argon is used along with nitrogen, chlorine, and carbon monoxide in the aluminum smelting industry to remove dirt and other imperfections from molten aluminum. It has taken over this role from chlorine, which produced environmentally harmful by-products.

We forecast the use of argon in the steel industry to grow at approximately 3.5% per annum over the long term.

Fabricated Metal Products

• Shielding for gas welding. The major use for argon is as a shielding gas for electric arc welding of nonferrous and specialty metals. There are two principal welding processes: tungsten inert gas (TIG) and metal inert gas (MIG).

• TIG is used for welding aluminum, copper, and other metals. The tungsten electrode is not consumed, and the argon protects the areas between the hot filler metal and the weld zone. Helium can also be used for this purpose, but argon is the preferred gas.

• MIG is also used for aluminum and other specialty metals. Argon shields the molten beads of metal from the electrode as it is passed across the arc onto the weld joint. This prevents wide dispersal of the beads of filler metal.

• Consumables are only a small part of the cost base of welding (less than 10%). Gas companies, therefore, try to sell their products to welding companies on the basis of improvements in efficiencies that they may provide, as the labor savings should have a far greater effect on profitability.

• Electronics. Argon is also used as a blanketing and inerting agent and in the plasma processes in semiconductors and integrated circuit manufacturing.

• Electric lighting equipment. Although krypton is more effective, because it is cheaper, argon is used as a fill gas to protect the tungsten filament within incandescent lighting bulbs and fluorescent tubes.

Overall, we expect long-term growth in demand for argon to be slightly above GDP growth within these applications.


164

Other Noble Gases Other noble gases such as neon, xenon, and krypton together account for less than two thousandths of 1% of air. Like argon they are truly inert and are used almost exclusively by the lighting industry. High-powered lights, such as those in lighthouses, use xenon and krypton, while fluorescent tubes use a mixture of argon and krypton. Neon is used in lighting tubes and signs. Bar code readers containing continuous lasers are also filled with neon, while lasers that use krypton have recently found a niche in corrective eye surgery.


165

XII. Nonatmospheric Gases As the name implies, none of these gases is extracted from the atmosphere although some are present in very small quantities.

Hydrogen

Production Hydrogen is produced in large quantities, both as a principal product and as a by-product. Hydrogen producers may consume the product captively, sell it to end users, sell it to a company that specializes in marketing industrial gases, burn it for fuel, or vent it into the atmosphere.

Steam Reforming of Hydrocarbons

This is the primary method of intentionally manufacturing large volumes of hydrogen. The most common feedstock is natural gas, although ethane, propane, butane, and light and heavy naphtha are also less commonly used. The resulting mixture of hydrogen and carbon monoxide is known as syngas, and can be used as it is, or separated into its component parts. The cost of manufacturing depends largely on the cost of the feedstock, and therefore of natural gas.

Dissociation of Hydrocarbons

This process is generally used to produce smaller quantities of hydrogen that are to be used captively. Dissociation of methanol or ammonia result in mixed gas streams (hydrogen and nitrogen) that are primarily used as atmospheres for metal treating.

Electrolysis

This process accounts for only a small proportion of hydrogen generated in developed countries. Electrolyzers are best suited for producing small volumes of relatively high-purity hydrogen and oxygen for specialized applications or in countries without a well-developed transport system, and with limited local supplies of natural gas or merchant hydrogen.

By-Product Generation

In addition to intentionally produced hydrogen, large volumes of by-product hydrogen are generated from a variety of production processes. This hydrogen often requires a certain amount of purification. Processes that produce hydrogen as a by-product include catalytic reforming in refineries, production of chlorine and sodium hydroxide, and the manufacturing of carbon black.

New Developments

Research into hydrogen-fueled fuel cells has triggered improvements in the technology of hydrogen production. In addition, this new technology may mold the economics of small-scale hydrogen production in the coming years.


166

Properties Hydrogen is a key chemical reagent and reducing agent. It is highly combustible and is even colder than nitrogen in the liquid phase, with a boiling point of minus-252.8 degrees centigrade.

Applications

Exhibit 149: Global Hydrogen Demand, 2002 Exhibit 150: Outsourcing of Hydrogen Demand, 2002

Current Annual Global Hydrogen Consumption 540bn m3

Refineries46%

Ammonia *50%

Other1%

Chemicals3%

Global Hydrogen production (excluding ammonia) 270bn m3

Chemicals20%

Other10%

Hydrogen generated internally

90% (243bn m3)

Refineries70%

10% Outsourced to gases industry

(27bn m3)

* 100% of production consumed within industry, no external market.


Industry estimates of % outsourced range from 6% to 10%.


Exhibit 151: Additional Hydrogen Applications Industry Application Delivery method

Food Starch Pipeline

Electronics Bulk Liquid

Glass Optical fiber Bulk Liquid

Space Rocket fuel Bulk Liquid

Food Hydrogenation of fats and oils Bulk Liquid

Laboratory Cylinders

Heat Treatment Cylinders

Glass Float Glass Cylinders

Glass Polishing Cylinders


Chemicals Industry

Ammonia production is the single-largest consumer of hydrogen in the chemicals industry, although many other chemical products also consume hydrogen during their manufacturing. As the production of hydrogen from natural gas tends to be integrated into the ammonia plant, most producers consider themselves to be consumers of natural gas, rather than hydrogen. In addition, syngas, a mixture of hydrogen and carbon monoxide, is also used in the production of a wide variety of chemicals.


167

Significant quantities of both merchant and captive hydrogen are consumed by the chemicals industry. The merchant gas is usually delivered in either single or multi-user pipelines, while bulk-liquid deliveries satisfy the needs of both small-scale users and of users whose regular production fails to meet peaks in demand.

Petroleum Refining

Petroleum refining both produces and consumes large amounts of hydrogen.

• Production. The largest source of hydrogen is catalytic reforming of naphtha, which produces a gas that is typically 85% hydrogen. The gas is usually routed directly to hydrogen-consuming units of the refinery, where it is passed through once and then generally burned as fuel. In addition, fluid catalytic cracking and thermal processes both produce significant amounts of hydrogen.

• Consumption. The principal use of hydrogen in refineries is in the removal of sulfur and other contaminants from various petrochemical products. More stringent emissions regulations, combined with the increasingly high sulfur content of many remaining crude reserves, are expected to drive demand for the gas. The regulations aim to reduce the parts per million (ppm) of sulfur in gasoline and diesel. In the U.S., the maximum permissible sulfur content will be reduced from the current 350 ppm for gasoline and 500 ppm for diesel to 30 ppm and 15 ppm, respectively. (The deadline for this legislation is 2004 for gasoline and June 2006 for diesel.) In Europe, the maximum will be reduced to 50 ppm by 2005 and to 10 ppm by 2008, for both gasoline and diesel, which currently stand at 150 ppm and 350 ppm, respectively.

Exhibit 152: U.S. Emissions Legislation Exhibit 153: EU Emissions Legislation

350

30

500

150

50

100

150

200

250

300

350

400

450

500

Sulphur content ppm

2001 20052001 2001 2006

Gasoline Diesel

350

30

500

150

50

100

150

200

250

300

350

400

450

500

Sulphur content ppm

2001 20052001 2001 2006

Gasoline Diesel

150

50 10

350

50 100

50

100

150

200

250

300

350

Sulphur content ppm

2001 20012005 2008 2006 2008

Gasoline Diesel

150

50 10

350

50 100

50

100

150

200

250

300

350

Sulphur content ppm

2001 20012005 2008 2006 2008

Gasoline Diesel

Source: Company data. Source: Company data.

Chem

ical Industry Prim

er, 2005–2006 14 June 2005

168

Exhibit 149: Hydrogen—Production/Consumption in the Refining Industry

HS FUEL OIL

HEATING OIL

Acid gas from conversion units

SULFUR

Desalted

CRUDE OIL

nC4

Heavy Naphtha

Light Naphtha

Kerosene

Light Atm. Gasoil

Heavy Atm. Gasoil

GAS SEPARATION AMINE WASH CLAUS

Catalytic reformer

JET FUEL

FUEL GAS

LPG

PETROLEUM COKE

LS FUEL OIL

Diesel

ASPHALT

LUBE OIL

Hydrotreater

nC4 ALKYLATION

ETHERIFICATION

COKING

VISBREAKING

DEASPHALTING

DAO

SOLVENT EXTRACTION

DEWAXING

FCC Gasoline

AT

MO

SP

HE

RIC

D

IST

ILLA

TIO

N

H2

H2H2

H2

H2

H2

H2

H2

H2

H2

VA

CU

UM

H2

H2

HYDROCRACKING

AR/VR DESULFURISATION

VGO Hydrotreater

Hydrotreating Isomerization

MEROX

ISOMERIZATION

HYDROFINISHING

MEROX

Hydrotreating Gasoline

= Hydrogen Production = Hydrogen Consumption

FCC

HS FUEL OIL

HEATING OIL

Acid gas from conversion units

SULFUR

Desalted

CRUDE OIL

nC4

Heavy Naphtha

Light Naphtha

Kerosene

Light Atm. Gasoil

Heavy Atm. Gasoil

GAS SEPARATION AMINE WASH CLAUS

Catalytic reformer

JET FUEL

FUEL GAS

LPG

PETROLEUM COKE

LS FUEL OIL

Diesel

ASPHALT

LUBE OIL

Hydrotreater

nC4 ALKYLATION

ETHERIFICATION

COKING

VISBREAKING

DEASPHALTING

DAO

SOLVENT EXTRACTION

DEWAXING

FCC Gasoline

AT

MO

SP

HE

RIC

D

IST

ILLA

TIO

N

H2

H2H2

H2

H2

H2

H2

H2

H2

H2

VA

CU

UM

H2

H2

HYDROCRACKING

AR/VR DESULFURISATION

VGO Hydrotreater

Hydrotreating Isomerization

MEROXMEROX

ISOMERIZATION

HYDROFINISHING

MEROX

Hydrotreating Gasoline

= Hydrogen Production = Hydrogen Consumption

FCC



169

Edible Fats and Oils

Hydrogen is used in the hydrogenation of unsaturated fats and oils. Hydrogenation is a process that is used to raise the melting point of oils and fats, so that they remain solid at room temperature.

Many hydrogenators have captive or onsite hydrogen units, while the rest generally purchase their hydrogen in bulk liquid form. The hydrogen used needs to be of a relatively high purity (99.5%) to prevent damage to the nickel catalyst that is used during the hydrogenation process.

Metals

Hydrogen is used in both primary metals production and secondary metals processing, although the majority of the demand comes from processing. Primary production of tungsten, tungsten carbide, and molybdenum powder all involve the use of hydrogen, while heat treating, sintering, and brazing are all secondary processes that consume the gas.

Hydrogen consumption in the metals industry has increased significantly in recent years, primarily because of the increased demand from annealing furnaces. The hydrogen content of the atmosphere in these furnaces has increased from 6% to 100%.

Bulk-liquid, pipeline, and onsite hydrogen are all consumed by the industry. The industry produces its captive hydrogen in a number of ways, including generation from natural gas and dissociation of ammonia or methanol.

Electronics

Hydrogen is widely used during integrated circuit manufacturing, optical fiber manufacturing, and fused quartz manufacturing. The majority of hydrogen consumption is within the first of these processes, for polysilicon manufacturing, and in wafer production.

Because of the high purity required in these applications, bulk hydrogen sold to the electronics industry is usually in liquid form, or as gas vaporized from liquid.


170

Float Glass

Hydrogen typically forms around 5% of the atmosphere (the remainder being nitrogen) for float-glass manufacturing. (See also the “Float Glass” section within the nitrogen uses discussion.) Hydrogen acts as a scavenging agent, to ensure an oxygen-free environment, because the molten tin bed is highly sensitive to oxidation. Glass quality is also affected by oxygen, which can cause a residue to form on the glass, making it hazy.

As purity and reliability of supply are vital, and quantities required are comparatively limited, flat-glass producers do not generally produce their own hydrogen but prefer to purchase bulk hydrogen in liquid form.

Utilities

Hydrogen is used by utilities companies for two main reasons:

1. As it has greater thermal conductivity and generates less friction than air, it can provide more efficient cooling, and as a result, it is used to cool some forms of generator.

2. In addition, hydrogen is often added to the cooling water of nuclear power plants with boiling water reactors to prevent corrosion and cracking. The majority of such plants purchase their hydrogen in liquid form, although some produce their own.

Fuel Cells

Industrial gases companies are currently investigating the potential for hydrogen as a feedstock for fuel cell technology. However, not only does the large-scale commercial development of fuel cells still appear to be a distant reality (according to Air Liquide, it is at least ten years away), but also there is no guarantee that hydrogen will become the chosen fuel over methanol or gasoline. If methanol or gasoline (because of its easier storage and increased safety) becomes the preferred course of development, hydrogen, and hence gases companies, will play no part in this market. That said, the stationary market might be a significant growth driver, again depending upon the fuel infrastructure adopted.

Other

Hydrogen is also used in the space industry as rocket fuel, in instrumentation as a calibration gas, and in a variety of environmental applications.


171

Helium

Production Helium is extracted from helium-rich natural gas deposits. Only a few sources in the world contain a sufficient proportion of helium (at least 0.3% helium) to justify its separation. It is most commonly separated using a low temperature process that removes the crude helium from the natural gas. Further purification can also be undertaken using cryogenic separation, although technology is moving toward using a pressure swing adsorption (PSA) process, which requires less upfront investment and fewer personnel for operation. About 80% of world production is in the U.S., with the majority of the remainder located in Algeria, Russia, and Poland.

Natural gas companies tend to recover crude helium during their processing of natural gas. The prime objective is to remove impurities (including helium, carbon dioxide, and nitrogen), which reduce the value of the natural gas. A small number of these companies also refine the helium, but most send it to an industrial gas company for further refining.

Properties Helium is totally inert, lighter than air, and the coldest of all the nonatmospheric gases in liquid form. It has a small molecular size, is highly mobile, and has a low solubility in water.

Because of its high value, helium is the only major industrial gas to be traded internationally.

Applications

Exhibit 150: U.S. Consumption of Refined Helium—Gas, 2000 Exhibit 151: U.S. Consumption of Refined Helium—Liquid, 2000

Welding25%

Other14%

Fibre Optics3%

Breathing M ixture4%

Inert A tmosphere5%

Heat Transfer6%

Chromatography8%

Leak Detection8%

Pressure Purging9%

Lift Gas18%

M RI75%

Precool 2%

Superconductor Bath8%

Nuclear M agnetic Resonance

6%

Other9%



172

Applications—Gas

• Welding. The largest use for gaseous helium is in welding, where it provides an inert gas shield to protect the weld zone from the atmosphere. The susceptibility of many metals to oxidation means that many metals cannot be joined without such a shield.

• Lift gas. Helium has been used as a nonflammable substitute for hydrogen in balloons and lighter-than-air craft. It is used for lifting weather balloons, as well as for filling blimps and decorative balloons.

• Leak detection. In products that require leak-proof systems for safety or long-service life. Helium is used because it is capable of escaping through tiny gaps, and is easily detected in minute amounts.

• Breathing mixtures. Helium and oxygen are combined and used as a synthetic breathing mixture for deep-sea divers working underwater for long periods. The increase in offshore exploration and production within the oil industry in the 1980s fueled demand for this application.

• Pressure purging. Purging of air and spacecraft used to be a major use of helium. Now it is also used for purging cold boxes and gas storage equipment.

• Heat transfer. Because it remains gaseous under normal operating conditions, is chemically inert, and has a high thermal conductivity, helium is a useful heat-transfer medium, and is therefore used in gas-cooled nuclear reactors.

• Chromatography. Helium’s low solubility, inertness, and high thermal conductivity mean that it is a popular carrier gas during a technique used for separating mixtures of gases, liquids, or dissolved substances.

Applications—Liquid

• Magnetic resonance imaging (MRI). MRI use became popular in the late 1980s, as it proved to be a useful diagnostic tool. The liquid helium is used to cool the magnets within the machine.


173

Carbon Dioxide

Production Rather than being manufactured, carbon dioxide tends to be a by-product of other processes, both industrial and natural. The majority of carbon dioxide is recovered from industrial processes, although some is also recovered from natural deposits.

Industrial By-Product

• Hydrogen. Most carbon dioxide is recovered from plants that produce hydrogen or syngas through steam reforming of natural gas. These plants are typically used in the production of ammonia and other chemicals for hydrogenation. (See the “Hydrogen” section.) Syngas is composed mainly of hydrogen and carbon monoxide, with a small proportion of carbon dioxide. However, if more hydrogen is desired, the carbon monoxide is catalytically oxidized, also creating more carbon dioxide.

• Ethyl alcohol. Carbon dioxide is produced as a by-product of the fermentation process that produces ethanol. Some countries encourage the use of ethyl alcohol as a fuel, and as a result, its production is likely to be a growing source for carbon dioxide.

• Other. A number of other chemical production processes give rise to carbon dioxide. Substitute natural gas (SNG), ethylene oxide, sodium phosphate, and calcium carbonate operations all give rise to carbon dioxide in quantities sufficient for recovery.

Natural Deposits

Significant amounts of carbon dioxide are recovered from natural deposits, either as a proportion of natural gas or sometimes as pure carbon dioxide. Rather than being considered an impurity and vented into the atmosphere, carbon dioxide content in natural gas is now recovered for future use. As its use in oil-field applications has increased (principally for EOR), the amount of carbon dioxide recovered from oilfields has also grown.

In addition, a relatively limited number of pure carbon dioxide deposits exist naturally that can be recovered for processing and further use.

Properties Carbon dioxide is heavier than air, and when concentrated, can be compressed and cooled to form a colorless odorless liquid. If the liquid is exposed to atmospheric pressure, it converts into a mixture of gas and solid, which can be compressed to form blocks (dry ice). Carbon dioxide dissolves readily in most liquids, and forms a mildly acidic solution when dissolved in water. In addition, carbon dioxide does not support combustion.

Carbon dioxide can be transported in cylinders, road or rail tankers, or as dry ice in insulated trucks.


174

Environmental Issues The widely held belief that atmospheric carbon dioxide is responsible for global warming has led to an increased focus on reducing emissions. The European Union has imposed a tax on carbon dioxide emissions, while globally there is an increasing interest in capturing emissions.

Applications The balance between supply and demand for carbon dioxide is not necessarily an even one, as its principal source is as a by-product of other processes. Production of carbon dioxide is driven by demand for the primary product, which may not match demand for carbon dioxide itself. For example, supply of carbon dioxide is at a peak in the autumn and winter months as a by-product of ammonia production, which is at its highest level during this period in preparation for the spring fertilizer requirements. Demand, driven by food refrigeration and beverage carbonation on the other hand, is highest during the summer months.

Applications—Solid and Liquid

• Food industry. Liquid and solid carbon dioxide is used in the preparation, packaging, and preservation of a wide variety of food products. In a number of areas, it competes directly with nitrogen and holds an advantage in some situations because of its lower cost. A large proportion is used to keep food cool while it is being handled, processed (such as dough mixing), or transported. Liquid carbon dioxide is widely used as a direct refrigerant that is sprayed onto food for freezing. (See our discussion on nitrogen applications in the food industry.) Solid carbon dioxide, or dry ice, is widely used to lower the ambient temperature during food transportation.

Other uses within the food industry include creating an inert atmosphere for packaging to prevent food spoilage. Carbon dioxide is frequently used during two processes, controlled atmosphere packaging (CAP) and modified atmosphere packaging (MAP), because of its ability to inhibit growth of bacteria that cause spoilage. In addition, carbon dioxide is now being injected into some dairy products such as milk and ice cream to prevent the growth of microorganisms, and hence extend the shelf life.

• Beverage carbonation. Carbon dioxide’s primary use in the beverage market is for soft drinks. Not only does it generate “fizz,” but it also inhibits the growth of mold and bacteria. This is a mature market, and we do not expect growth to significantly exceed the historical average of around 3.5%.

In addition, the beer-brewing industry consumes significant amounts of carbon dioxide, principally for carbonation, to prevent oxygen coming into contact with the beer, or as a purge gas. The majority of this carbon dioxide is produced captively through fermentation, although some is also purchased over the fence.

We estimate that approximately 80% of the carbon dioxide used for this purpose is directed toward soft drinks, with virtually all of the remainder used for beer.


175

• Oil and gas recovery. Carbon dioxide is used in oil and gas recovery for both fracturing and in enhanced oil recovery (EOR). During fracturing, liquid carbon dioxide containing proppants, which open the pores of the rock, is injected into the well to aid the release of the hydrocarbons. Its principal use is in gas wells, although it is occasionally used in oil wells. For EOR, because of the quantities required, gaseous carbon dioxide is generally piped in. This is discussed in further detail below.

• Other. Exhibit 152 contains a brief summary of some of the wide variety of other uses for merchant liquid carbon dioxide.

Exhibit 152: Carbon Dioxide—Miscellaneous Uses Use Description

Chemical manufacturing As a raw material, for inerting and pressurizing and for cooling. The majority of carbon dioxide consumed for this purpose is in gaseous form (see below).

Metal working As a shield gas in gas metal arc welding (GMAW) and flux core arc welding (FCAW). Also as a stirring gas in steel manufacturing (see nitrogen section).

Inerting and pressurizing In a wide variety of applications, such as oil refining, as a blanketing and inerting atmosphere, to shut out oxygen. It is also used in some types of fire extinguishing equipment.

Solvent and supercritical fluid applications

Extractions (such as caffeine from coffee, flavors from spices), cleaning, solvent recovery, chemical reactions, particle formation, and chromatographic separation.

Water treatment To adjust the PH of drinking water (usually as a replacement to lime to soften water). Also to neutralize alkaline wastewater streams, replacing sulfuric acid as it is less toxic.

Fumigation Particularly at grain stores and flourmills. Use is on the increase as one by one alternatives are withdrawn for environmental and health reasons, although it is not suitable for soil fumigation.

Foam blowing Replacing chlorofluorocarbons, many of which have been banned under the Clean Air Act. It does not have the insulating properties of some gases, and hence use in some applications is limited. Used mainly for polyurethane and polystyrene foams.

Aerosol packaging Replaced CFC-12 during 1970s. Currently mixed with hydrocarbons for propellant use, although we expect demand from this source to decline as hydrocarbon-based propellants are replaced with emulsions of water and an organic solvent to reduce VOCs.

Pulp mills

To treat acid wastewater, also as a reactant to manufacture precipitated calcium carbonate. Also for brownstock washing.

Dry ice Compressed liquid carbon dioxide. Primarily used to keep items cold, but also in pellets for blasting, to clean surfaces by thermal shocking.


Applications—Gas

• Captive for chemical manufacturing. Large quantities are produced and consumed captively in chemical manufacturing, principally in the manufacturing of synthetic urea, sodium carbonate, and calcium carbonate.

Urea is the primary consumer, and hence demand for fertilizer is the principal driver for this source. Carbon dioxide is produced as a by-product of ammonia production. The ammonia and carbon dioxide are then reacted under high temperature and pressure to form ammonium carbamate. This is then dehydrated to form urea and water. Most urea is produced at plants that recover and recycle excess ammonia feed.


176

Carbon dioxide is commonly reacted with milk of lime to produce precipitated calcium carbonate, demand for which has increased rapidly in recent years for use in manufacturing paper. The gas is usually recovered as a by-product of other processes, such as the decomposition of limestone, although some plants purchase it in bulk-liquid form.

Carbon dioxide is also used in the production of sodium carbonate (soda ash), which is used both as a chemical reagent and in glass manufacturing.

• Pipelined for oil and gas recovery. As crude reserves in oil fields become depleted EOR techniques are implemented more frequently. The three principal methods are thermal (59% of EOR in 1998), gas (41%), and chemical (less than 1%) methods.

Carbon dioxide is the most commonly used gas for EOR, accounting for approximately 25% of all U.S. EOR in 1998, because at temperatures and pressures above its critical point, it is an effective solvent for oil. It, therefore, picks up the lighter carbon components, increasing the volume and reducing the viscosity of the oil, making extracting easier. Industry estimates of the extent to which recovery is enhanced range between 8% and 16%.

Over time, as some of the injected carbon dioxide will break through with the recovered oil, and this can be recovered and reinjected, demand for purchased carbon dioxide falls. At the end of the oil field’s useful life, the remaining carbon dioxide can in theory be recovered and used to flood another field.

The economics of using carbon dioxide depend on several factors: the price of oil, the unique characteristics of the field, the price and availability of carbon dioxide, and the level of government intervention (if any). However, once the decision has been made to inject a field with gas, the majority of the costs are sunk in the infrastructure, and the flood cannot be easily stopped.

EOR using carbon dioxide appears to become economically viable when the oil price reaches US$20/barrel, although companies that produce their own carbon dioxide will probably consider a lower oil price as their threshold. In addition, the amount of oil in the field will naturally play a part, because the fixed-asset costs can then be spread over a longer period.

As EOR requires large quantities of carbon dioxide, the gas can only economically be delivered by pipeline. Some oil fields are fortunate enough to be located near ammonia plants that produce large amounts of by-product carbon dioxide, but the majority used for EOR occurs naturally in fields developed for their carbon dioxide (or methane, which may include carbon dioxide) content.


177

XIII. Specialty Chemicals

Background

What Are Specialty Chemicals? Specialty chemicals is a loosely defined term. The companies within this subsector are defined more by the general characteristics of the products that they manufacture, rather than by any technical function of those products. It is these broad features that distinguish specialty chemicals companies from the more commodity-oriented operations. It is possible, however, to bracket specialty chemicals companies into a number of broad categories based on the end use of their products.

Exhibit 153: Specialty Sales League*, 2004 US$ in millions, unless otherwise stated

Company 2004 Sales

3M 20,014

Degussa 14,584

Clariant 11,006

DSM 9,826

Ciba Specialty Chemicals 9,095

Lanxess 8,462

ICI 7,155

Rhodia 6,757

Avery Dennison 5,341

Engelhard 4,169

Ecolab 4,131

Sealed Air 3,798

Givaudan 3,553

Lonza 2,824

Valspar 2,441

Ferro 1,801

Cytec 1,721

Johnson Matthey 1,584

British Vita 1,262

Yule Catto 698

Croda 376

* Excludes PMD division and auto catalysts.


Specialty Chemicals Industry Trends and Value Drivers

Overview Over the last decade, the global chemicals sector has seen a number of major diversified players trimming their portfolios, focusing operations on specialty products and consolidating to gain scale. Clariant was formed in 1995 from an IPO of the chemical operations of Sandoz, and acquired the specialty chemical businesses of Hoechst in 1996 in a transaction that propelled it into the top echelons of the specialty chemical industry. American Cyanamid spun off its specialty chemical operations into Cytec Industries in 1997, while ICI’s reinvention as a specialty chemical company began in the same year with the purchase of Unilever’s chemical businesses. Rhodia was


178

created from the chemicals, fibers, and polymers businesses of Rhône-Poulenc in 1998. More recently, Lonza (1999), Givaudan (2000), and Degussa (2001) have all emerged as prominent players on the specialty scene. Most recent, at the start of 2005, Bayer demerged a number of its downstream chemicals businesses to create Lanxess.

As the revenues and market capitalizations of these groups have grown, so have their importance as investment vehicles within the chemicals industry. Historically, this segment of the industry has been represented by a large number of small- to mid-sized producers. However, more recently, consolidation and restructuring within the industry has produced a league of larger manufacturers, which now dominate the specialty chemical landscape to the extent that specialties now make up around 20% of the market cap of the global sector.

One of the defining features of these companies is the immensely broad range of activities included within their portfolios. However, there are a number of key drivers, both positive and negative, behind the industry that are worth highlighting.

Effect More Important than Price Traditionally, the essential difference between commodity and specialty chemicals has been that the former are sold on price, while the latter are sold on effect; however, the distinction between the two categories is increasingly blurred. In general terms, specialty chemical businesses tend to form a low proportion of the cost of the end application in which they are used (typically a few percent). They provide important characteristics that enhance products with such elements as texture and color or provide key product qualities, such as high absorbency or anti-icing properties, to name just two. Competition within the industry is based upon product differentiation and innovation, and certain logistical issues such as distribution capacity. Specialty chemical producers often supply not just a product, but also a much broader range of services to their customers, including research, problem solving, bespoke product development, and storage solutions. As the specialty industry has matured, however, many of these distinctive features have become less clear, and the line between specialty and commodity chemicals is sometimes blurred.


179

Exhibit 154: Specialty Chemicals Value Drivers

Strategic Drivers

Geographic

• Regional vs Global• Structural European Weakness• Globalized Customers• Globalized Suppliers• Globalized Competitors• Global Positions Key

• Downsizing• Focus• Benchmarking• Outsourcing• Supplier Concentration• Reduced CompetitiveAdvantage• Volume Growth Slowdown• Deflationary Price Pressure

External to the Chemical Industry

• Search for Value-Added• Supplier Relationships• Higher Service Levels• Pricing Pressures• Focussed Core Competencies• Hunting for Growth• Risk/Reward• Increasing commoditisation

Internal to the Chemical Industry


Greater Profit Stability Pricing trends for specialty chemical companies tend to be more stable than for commodities, although that is not to say that specialty chemicals companies necessarily enjoy pricing power. The high price elasticity of a commodity chemical often leads to significant levels of volatility across the cycle. This tends to be less pronounced in specialty chemicals, which tend to be further down the chemical processing chain (and thus further away from inputs such as crude oil), and also tend to display a greater degree of product differentiation. As a result, while demand generally varies in-line with trends in the economy as a whole, growth rates tend to be at or slightly above prevailing GDP growth, boosted by new applications and new product development.

Although these factors do not mean that specialties will necessarily command higher selling prices or generate higher margins than commodities across the cycle, they create an environment in which both margins and prices display comparatively higher levels of stability across the business cycle. This has in the past tended to lead to higher stock market valuations for specialties than commodity stocks because of a lower perceived risk in specialty production, stemming from a less volatile earnings stream. Obviously, this premium will vary from company to company dependent on the product portfolio.

Demand, Not Supply-Driven—A Stable Pricing Environment A true specialty chemical product is typically characterized by a small number of global producers. Production of many specialties is on a relatively small scale and can be measured in terms of kilograms. In contrast, the production of many commodity chemicals is on an extremely large scale. These volumes apply particularly to products such as bulk actives for pharmaceutical or agrochemical products.


180

Prices for specialty chemicals tend to be more stable than for commodities. The relatively small number of competitors within each product area of the specialty chemical sector, on the whole, reduces the cyclical overcapacity problems that characterize the commodity chemical industry. As incremental additions to capacity tend to reflect increases in demand, the fundamental imbalance between supply and demand that exists within the commodity chemical industry is less of a feature of the specialty chemical industry. However, the features of the specialty industry that we have just outlined have attracted increasing numbers of participants in recent years. As a result many specialty categories now suffer from oversupply and price deflation. Moreover, consolidation among customers has in many cases increased their bargaining power, leading to further downward pressure on prices.

Barriers to Entry Higher than for Commodity Chemicals The high levels of technical expertise and the close nature of the supplier/customer relationship that typify the production of some specialty chemicals mean that some technical barriers to entry to the industry are often higher than for many commodity chemicals. Specialties tend to include a high level of intellectual property content, and some will be sold under patent (although these patents are more often than not superceded by advances in technology). In some end markets, once a strong relationship is established with a customer, the need for an assured supply of product of a consistently high quality means that customers are unlikely to switch supplier. (Good examples of such relationships are Lonza in some areas of the fine chemicals industry, Givaudan in the flavors and fragrances industry, and Engelhard in the gas-to-liquids catalyst industry.) Commodities, on the other hand, have very few comparable barriers to entry—customers will buy from the producer that can meet their requirements at the lowest cost.

General Portfolio Shifts and Downstream Consolidation Over the past few years, much of the chemical industry has made significant efforts to reposition their portfolios and reduce their exposure to the highly cyclical commodity end of the chemicals industry. The high cost of doing business globally is more suited to production of goods that carry higher levels of intellectual content and service. As a result, specialty chemicals often have lower levels of capital investment than are typically found in commodity chemicals. The chemical industry has, therefore, shifted the balance of its portfolios downstream, where it can compete on areas other than cost alone. Meanwhile, much of the world’s commodity chemical production resides within oil and gas companies

In the majority of cases, this portfolio shift has involved a wholesale reorientation of a company’s activities, for example ICI. A dwindling number of companies have maintained their presence in their traditional commodity markets while also diversifying into more specialty oriented businesses. DSM, which expanded its life sciences operations substantially with the acquisition of Gist-Brocades in 1998, initially continued to operate its more commodity-based operations in tandem with the new businesses. However, DSM sold its commodity operations in 2001. In addition, the company has accelerated the transition downstream with the acquisition of Catalytica in 2002, and Roche vitamins and Fine Chemicals in 2004.


181

Commoditization Increasingly high levels of competition within certain product areas have, perhaps inevitably, brought with them a degree of commoditization. Some product lines, which were once true specialties, are now only semi-specialties at best, and some, such as textile dyes and some plastic additives, would certainly now better be described as commodities. The commoditization of a product line implies that pricing declines will intensify over time. While this price deflation may put returns under pressure in the short term, increasingly this is driving out weaker competitors, leaving those who remain with prospects for improved profitability. The extent to which this is an issue for any given company depends entirely on the business portfolio and, hence, overall business trends between two different specialty producers could be completely different.

Customer Consolidation If consolidation was a defining feature of the specialty chemical industry in the 1990s, then the same is true, to an even greater extent, of the industries that it services. Examples of the trend toward consolidation can be found in the auto industry (Daimler Benz and Chrysler), the pulp and paper industry (Enso and Stora), paints (Akzo Nobel and Courtaulds), and pharmaceuticals (Hoechst and Rhône-Poulenc, Pfizer and Warner Lambert, Glaxo Wellcome and SmithKline Beecham). Industry worldwide is reacting to the need to globalize and pursue purchasing and operating synergies in a drive to improve returns.

Consolidation within the customer base has, to a certain extent, driven further consolidation activity within the chemicals industry—global customers want to be serviced by global suppliers. As the power of the customer has increased, so too have the pricing pressures faced by chemical producers. When combined with the trend toward commoditization that we have outlined, the pricing power that was once firmly in the hands of the chemical manufacturers is, in many areas, now shifting in favor of the customer. Price deflation within the industry looks set to remain a defining feature of the specialty chemical landscape from this point onward. From this point of view, we believe it is absolutely key for specialty chemical companies to pare their cost structure to the bone wherever possible, to find critical mass in their area of core competency, and to locate production assets in areas of lower production cost.


182

Specialty Product Categories The definition of what constitutes a specialty chemical is a loose one and the line between specialty and commodity is sometimes blurred. However, we have attempted to bracket the vast array of operations of the companies within this subsector into a number of broad categories. In addition to the categories outlined below, we examine the agricultural chemicals and industrial gases industries, which are sometimes considered specialty chemicals industries, as separate sections later in this report.

Specialty chemicals can be categorized either as market oriented or functional product oriented. Market-oriented products are groups of chemicals that are utilized by a specific industry or market such as oil field chemicals. Functional specialty chemicals are groups of products that serve the same defined function, such as adhesives, antioxidants or biocides. Naturally, therefore, there is considerable overlap in this categorization.

Exhibit 155: Global Specialty Chemicals Market Size, 2003

0

10000

20000

30000

40000

50000

60000

Active Pharmacuetical Ingrdients

Pesticides

Electronic Chem

icals

Advanced Ceram

ic Material

Specialty Polymers

Flavors & Fragrances

Industrial & Institutional Cleaners

Specialty Surfactants

Catalysts

Printing Inks

Specialty Coatings

Food Additives

Specialty Paper Chem

icals

Water-soluable Polym

ers

Cosm

etic Chem

icals

Synthetic dyes

Plastic Additives

Textile Chem

icals

Adhesives & Sealants

Image C

hemicals & M

aterials

Water M

anagement C

hemicals

Oil Field C

hemicals

Seperation Mem

branes

Nanoscale C

hemicals

Lubricating Oil Additives

Biocides

Anti Oxidents

Enzymes

$ M

illion

s



183

Paints and Coatings Paints and coatings are used to create a decorative and/or protective layer. The substances from which they are made include resins, solvents, additives, pigments, and in some products, dilutants.

Paints and Coatings Industry Trends and Value Drivers

Recently, the industry has been under pressure to reduce the amounts of solvents used in paint and to limit the emission of volatile organic compounds (VOCs). This has led to an increase in the use of water-based and solventless paints. Manufacturers have also been focusing on the development of new paints and process techniques to increase application efficiency. Somewhat ironically, this has in turn led to a decrease in paint consumption.

The industry breaks down into four main categories:

Architectural Coatings This is the largest market by volume. Used on residential, commercial and industrial buildings and sold through wholesalers and retailers, the majority (80%) is water-based. The market is considered mature, and we expect long-term growth to remain in-line with GDP.

Short-term swings in sales growth tend to reflect the level of home redecorating, and therefore are driven by general activity in the housing market. The usage ratio is approximately 60:40 interior to exterior use.

Competition comes from alternative materials such as interior wall coverings and wood paneling.

OEM Coatings Original equipment manufacturer (OEM) coatings are applied to equipment and objects during manufacturing. Such objects include cars and trucks, appliances, furniture and building products, and machinery.

The coatings are manufactured to each customer’s specifications and include powder coatings, which are dry solventless coatings, usually applied using heat.

Special-Purpose Coatings These products are formulated for special conditions such as extreme temperatures or corrosive conditions. Major markets include industrial construction and maintenance, automotive and machinery refinishing, road markings and traffic signs, roof coatings and marine applications. Demand for these products is closely allied to the level of industrial activity.

Other This final category includes products such as paint thinners and removers, wood fillers and sealants such as putty and other glazing compounds, as well as solvent cleaners. Demand for these products follows the fortunes of the architectural coatings market closely, as they are also used during decoration.


184

Adhesives and Sealants Adhesives are materials used to attach or bond two solids together. Sealants are materials used to fill the gap between two materials and prevent the passage of liquids and gases between them.

Adhesives and Sealants Industry Trends and Value Drivers

The adhesive sector comprises approximately 80% of global sales, while sealants generate roughly 20%. Adhesives make up a very small proportion of the fastening market, but they are the fastest-growing of all methods. However, it is unlikely that they will ever replace traditional fastening methods such as welding or rivets, because of continuing concerns about the long-term reliability of adhesive bonds. The largest end markets for adhesives are packaging, construction, and furniture/woodworking, although the increased use of plastic parts in engineering is fueling demand from this industry. In both the adhesives and sealants markets, synthetic materials continue to replace natural ones despite a strong move to reduce the emission of solvents and other VOCs within the industry.

Natural Adhesives

Animal Glues

These are made from animal bone, fish products, or milk derivatives. They are the oldest form of glues, but their popularity is waning because of the superior performance of synthetic substitutes and also because of their strong odors. Despite this, milk-derived glues are still widely used for woodworking and in the manufacturing of paper cups.

Starch Adhesives

These adhesives are manufactured from a variety of natural starches, including potato starch, cornstarch, tapioca flour, and wheat flour. The main uses for starch adhesives are in woodworking for veneers and plywood, as well as for postage stamps. They have the advantage of being cheap to produce, but their relatively low strength and poor resistance to water mean that they are being replaced by synthetics.

Synthetic Adhesives Synthetic adhesives use a broad range of raw materials, but many are derived from ethylene, formaldehyde, and urea. Their continuing substitution for natural adhesives means that they now account for over 70% of the adhesives market.

The use of solvent provides the adhesive with excellent wetting properties, and thereby gives very good penetration of the adhesive. However, the use of solvent-based adhesives is declining at approximately 2% per year. Other types of synthetic adhesives are reactive, hotmelt, and water-soluble.

Sealants Silicone sealant is the largest product type, followed by sealants made from urethanes. The major source of demand comes from the construction and transport equipment markets. Manufacturing assembly and consumer use comprise other important markets. Synthetic sealants continue to replace natural materials, which now make up a very small proportion of the market.


185

Water Treatment We define this category as those chemicals that are added to water to improve its purity before, during, and after its use in industrial, commercial, and municipal applications.

Water Treatment Uses

The major industrial consumers of these chemicals are the pulp and paper, chemical processing, petroleum refining, metal finishing electronics, and paint industries. Water softening and purification chemicals are widely used commercially in food and beverages manufacturing, while treatment chemicals for swimming pools also generate significant demand. Municipal applications consist of treatments for drinking and for waste water.

Water Treatment Industry Trends and Value Drivers The broad definition and the consequent wide range of applications mean that a wide range of factors drive demand. Environmental regulation is a key factor, as are industrial and consumer health and population growth. Industrial markets consume approximately 75% of water treatment chemicals, with cooling water the largest application and pulp and paper the largest market.

Corrosion inhibitors These chemicals are added to water used in industrial applications to prevent the formation of lime scale and to prevent corrosion of metal parts caused by dissolved salts. They account for the largest category of water treatment chemicals by volume. Growth in demand for corrosion inhibitors is, therefore, closely tied to the level of industrial activity.

Coagulants and Flocculants Used principally in the municipal water treatment industry, these chemicals help to separate suspended matter and contaminants, including solid waste, from water. The chemicals used include water-soluble polymers, such as polyacrylamides and acrylic acid polymers, and aluminum compounds.

Demand growth for the most part is allied to population growth and is, therefore, unlikely to exceed 1-2% per annum in developed economies. However, the developing economies of Latin America and Asia, with their improving living standards, offer the greatest potential for growth, in our view.

Oxidizers and Biocides This category of chemicals includes the bulk commodity chemicals of chlorine and hydrogen peroxide, as well as their derivatives. They are used as disinfectants in a wide variety of industrial and commercial applications. Smaller volume specialty products in this category include biocides and bromine compounds, which combat bacteria in water.

As specialty applications constitute a very small proportion of the demand for these major chemicals, demand growth is driven by alternative applications such as the health of the pulp and paper industry.


186

pH Adjusters and Water Softeners These chemicals also tend to be at the commodity, rather than the specialty, end of the production scale. They are used to maintain pH levels in both industrial and household water by eliminating the effects of calcium and magnesium. The chemicals used themselves include lime, sodium derivatives, and sulfuric and hydrochloric acid.

Other Uses Specialty chemicals are used in a number of other capacities in the treatment of water: defoamers and sequestering agents, as well as filter media and adsorbents, which provide another means of separating suspended matter and contaminants from water. Combined, these uses account for approximately 15% of the market for water-treatment chemicals.


187

Flavors and Fragrances

Industry Overview The global flavors and fragrances industry was, we estimate, worth around US$16 billion in 2003. However, the industry is by no means homogeneous and is an umbrella term for three differentiated business sectors:

1. Essential oils and natural extracts, which are derived from a multitude of botanical sources. Many of the suppliers of these products are from developing countries, relatively small-scale, and often privately owned.

2. Aroma chemicals, which are produced by the synthesis of naturally occurring essential oils for direct use in compounding and for chemical conversion to other aroma compounds.

3. Flavor and fragrance compounds, which are a reasonably complex mix of aromatic materials. These comprise a blend of the first two groupings of essential oils and/or aroma chemicals.

Exhibit 156: Flavors and Fragrances Market, 2003: $16 billion

Flavor Compositions

43%

Aroma chemicals13%

Fragrance Compositions

27%

Essential Oil/ Natural Extracts

17%


Although flavors and fragrances are two quite distinct product groups, using different chemical reactions and techniques and with different market dynamics, most major players in the industry are involved in the production of both flavors and fragrances, and the terms tend to be used together to describe a single segment of the chemical industry.


188

Exhibit 157: Structure of the Flavors and Fragrances Industry

Natural Synthetic

RawMaterial

OdoriferousSubstances

Flavor and Fragrance

Compounds

FinishedGoods

(End Users)

Animals Plants

Secretions Exudates Essential Oils

Captive Compounds(compounding by

end users)

Soaps and Detergents

Cosmeticsand Toiletries

Foodstuff, BeveragesTobacco, Pharmaceuticals

IndustrialUses

ChemicalIntermediates

Aroma Chemicals(natural and synthetic

Merchant Compounds(compounding by the flavour and fragrance

industry

Natural Synthetic

RawMaterial

OdoriferousSubstances

Flavor and Fragrance

Compounds

FinishedGoods

(End Users)

Animals Plants

Secretions Exudates Essential Oils

Captive Compounds(compounding by

end users)

Soaps and Detergents

Cosmeticsand Toiletries

Foodstuff, BeveragesTobacco, Pharmaceuticals

IndustrialUses

ChemicalIntermediates

Aroma Chemicals(natural and synthetic

Merchant Compounds(compounding by the flavour and fragrance

industry


Flavors and Fragrances Uses Fragrance products are sold principally to manufacturers of perfumes, cosmetics, detergents, and other personal and household care products.

Flavors are used in small quantities to enhance the taste and texture of all manner of processed food and beverages. Both flavors and fragrances may be derived from naturally occurring essential oils and plant extracts or from chemicals produced from organic synthesis.

Exhibit 158: Flavor Market End Uses, 2004 Exhibit 159: Fragrances Market End Uses, 2004

Confectionery16%

Dairy19%

Others13%

Beverages28%

Aroma/Flavor24%

Consumer products

50%

Fine Fragrances

16%

Fragrance ingredients

34%

Source: Givaudan, CSFB research. Source: Givaudan, CSFB research.


189

Flavors and Fragrances Manufacturers Worldwide, three types of chemical companies produce flavors and fragrances chemicals:

1. The traditional flavor and fragrance houses produce chemicals as needed for their own compounding and also for sale in the open market. Their competitive advantage is a very specialized technical know-how for manufacturing certain classes of chemical (such as IFF and Givaudan).

2. Large chemical companies participate in these markets by upgrading small portions of their large-scale chemical production to flavor and fragrance specification (such as Rhodia, BASF, Eastman and Cognis). The influence of such companies is dwindling as purified chemicals shift to less-profitable commodity status.

3. Small- to medium-sized custom synthesis houses with a specialized technical know-how.

Exhibit 160: Major Manufacturers of Flavors and Fragrances, 2003

Givaudan12%

Other40%

Quest5%

Firmenich9%

IFF11%

Symrise7%

Danisco2%

Ogaw a & CO2%

Mane2%

Takasago5%

Sensient3%

T. Hasegaw a2%

Source: Givaudan, CSFB research.

Flavors and Fragrances Industry Trends and Value Drivers Although few major flavor and fragrance manufacturers are involved directly in the sourcing of essential oils and natural extracts, a number are back-integrated into the production of aroma chemicals.

Biotechnology is playing an increasingly important role in the aroma chemicals industry, despite well-publicized fears over GMOs in Europe. However, since the process is more costly than synthesis, it remains restricted to a relatively limited range of aroma chemicals at present, with organic synthesis remaining the primary production method.


190

The flavors and fragrances industry is increasingly moving toward a two-tier structure, dominated by a handful of major players, with a large number of significantly smaller companies operating in niche markets. Despite the industry’s fragmented structure, significant consolidation has taken place over the past few years. In 1985, 23 companies accounted for around 55% of the total market for flavors and fragrances. By 1999, the pace of consolidation had been such that the combined sales of just five manufacturers accounted for around 55% of the total market.

Industrialization and higher disposable income lie at the heart of the demand for flavors and fragrances. The “money rich, time poor” society means that convenience foods and high-performance household products are high on most consumers’ shopping lists. In the developing world, as income rises so does demand for processed food and higher quality personal and household care products, as well as for luxury goods such as fine fragrances.

Flavor and Fragrances Growth Prospects The number of applications in which flavors and fragrances products are used has grown rapidly in recent years. In the fragrances market, demand for products such as male toiletries and deodorants has grown significantly, as has the market for designer fragrances. Meanwhile, the industry continues to find new and innovative uses for fragrances, such as aromatherapy. In the field of flavors, products such as convenience foods, soft drinks, and low-cholesterol, low-fat foods have all boomed in popularity, while new markets are constantly emerging.

Recently, however, product lines have been rationalized, while customer consolidation has led to increased buyer power. Consequently, demand has slowed, and pricing power has become less significant. We expect medium- to long-term growth in this industry to settle at around twice the rate of GDP growth.


191

Catalysts Catalysts are substances that alter the rate at which other chemicals react, while they undergo no reaction themselves. In theory, catalysts can be recovered in their original form following the reaction, but in practice, they have a useful life that varies according to the application.

Exhibit 161: Catalyst Markets by Type, 2001

Chemical Processing Catalysts

20%

Emmison control Catalysts

39%

Petroleum Refining Catalysts

41%


Petroleum Catalysts Petroleum refining, which is the source of by far the largest share of industrial products, consists almost entirely of catalytic processes. Used principally for the production of fuels and other petroleum derivatives, there are three types:

• Fluid cracking catalysts (FCCs) comprise roughly 50% of overall demand and are used to assist in the conversion of petroleum in gasoline and other fuels. Engelhard and Grace (which bought Akzo Nobel’s business in 2004) are the major manufacturers of FCC catalysts in the world.

• Hydroprocessing catalysts are used for the removal of impurities from crude oil prior to its distillation.

• Reforming catalysts are used to further refine and enhance petroleum components to create gasoline and petrochemical feedstocks. Johnson Matthey-owned Synetix is Europe’s principal producer of hydroprocessing catalysts.

Demand for these chemicals relies largely upon the health of the oil refining industry, which in recent years has not been good. We expect longer-term growth rates to be in the region of 2-3% per annum, although upside could be driven by a major expansion in gas-to-liquid (GTL) technology.

Chemical Catalysts Chemical catalysts are used in a variety of different industries, including chemicals, pharmaceuticals, polymers, and food. The vast majority of chemical processes involve a catalyst of some sort.

The greatest demand comes from manufacturers of polymers. Other large markets are for oxidization (in the production of ethylene oxide), organic synthesis, hydrogenation


192

and dehydrogenation, and gas synthesis (used in the manufacturing of hydrogen, ammonia, and methanol).

Recently, polymer catalysts have been developed that not only affect the rate of polymerization, but also increase the output of a polymer of a certain molecular weight, with certain properties and advantages.

Demand for these catalysts reflects a wide range of drivers but broadly follows overall industrial activity. We estimate long-term demand growth in this area of approximately 2-3% per year.

Environmental Catalysts Environmental catalysts are used to control pollutant emissions from a number of sources such as auto engines (in catalytic converters), power stations, and other industrial plants. They reduce the levels of substances such as carbon monoxide and volatile organic compounds (VOCs) and sulfurous substances within waste gases.

The auto market is the key driver of the environmental catalysts industry. As a result, tougher emissions legislation around the world has driven demand growth in recent years, and is likely to continue to do so. Demand stems from both OEM manufacturers and from retrospective fitting of catalysts to vehicles already in circulation. In addition, industrialization of developing economies offers further potential for growth, as emissions from industrial plants and other nonauto-related industries (construction vehicles, lawn care, snow mobiles, etc.) come under scrutiny. Growth in the industry has historically been in the region of 3%. However, we expect tightening emissions legislation to lead to growth of around 6.5% over the next five years, falling to 5.0% beyond this period.

Exhibit 162: Vehicle-Emissions Legislation

Source: Johnson Matthey.


193

Exhibit 163: HDD: World Diesel Fuel Standards

Source: Johnson Matthey.


194

Additives Additives are chemicals that are added to materials such as plastics to provide them with certain qualities, and thereby improve their functionality or processability. The overwhelming majority of additives are used in the manufacturing and processing of plastics. The range of additives is broad and includes modifiers, property extenders, plasticizers, flame-retardants, colorants, lubricants, detergents, and many others.

Approximately 75% of plastics additives are sold to the manufacturers of plastics products, while the remainder is sold to the manufacturers of plastics resins. As the majority of plastics consumption is in Asia/Pacific (for electronics products), the majority of additives are also consumed in this region. PVC is the resin that consumes the majority of polymer additives, particularly modifiers and processing aids.

The wide range of additives is manufactured along product lines by a large number of different manufacturers. As a result, the industry is viewed as largely fragmented. However, as with many areas within the specialty sector, consolidation is an ongoing theme.

The diversity of uses for plastics means that demand for the products is driven by a number of different factors. Overall manufacturing activity is the main driver that has seen the additives industry grow at around 4% in recent years. We expect the increasing substitution of polymers for other materials in manufacturing to continue to support growth of a similar level in the medium to long term.

Modifiers These are products that change the physical properties of the plastic resin. The greatest demand is for plasticizers, which increase a material’s flexibility. Demand is largely driven by demand for flexible PVC resins, for which the most common plasticizer is phthalate, a commodity derivative of phthalic anhydride.

In addition, rubber-based impact modifiers are used to improve plastic’s resistance to stress by absorbing force.

Property Extenders This category includes heat and light stabilizers, flame-retardants antioxidants and antistatic agents. They are used to ensure the stability of resins during use, or in some instances, during processing.

• Heat stabilizers are used to maintain plastics resins throughout their processing and service life. The most significant demand comes from PVC manufacturing, because of the high temperatures at which the resins are processed.

• Light (UV) stabilizers are used in plastics, but also in other products such as paints. They absorb or deflect UV radiation that would otherwise cause the plastic to degrade.

• Flame retardants help the material to which they are added to resist combustion when exposed to extreme temperatures. The majority of these chemicals are utilized in the production of plastics, but they are also widely used in furniture and textile manufacturing. Of the plastics applications, the vast majority of flame retardants are used in products for the construction, electronics, and transport markets.


195

Because of medical and environmental concerns, demand is growing for nonhalogen products to replace chlorinated and bromine-based products that currently dominate the market.

• Antioxidants prevent or delay the oxidization of plastics that would otherwise lead to their breakdown. The greatest demand comes from polyolefins (polyethylene, polypropylene, and polystyrene), while the major types of antioxidants are alkylated phenols, amines, phosphates, and esters.

Processing Aids This broad term covers chemicals that improve the compounding or molding of resins. Processing aids include lubricants, mold-release, antiblocking, and slip agents.

• Lubricants include metallic stearates, hydrocarbons, fatty acids, and alcohols. They assist resin flow during production, and also enhance mold release by compensating for any imperfections in machinery and materials.

• Antiblocking agents include talc, calcium carbonate, and silica. The most common use for antiblocking agents is to prevent two contacting layers of plastic film (such as kitchen film) from sticking together.

Colorants Colorants are pigments and dyes that are used to give color to plastics. Pigments and dyes are examined in more detail later in the report. The two largest volume pigments used in plastics are titanium dioxide (white) and carbon black (black). Additional colors are achieved using a variety of metal oxides, chromates, and cadmiums.

Other Additives

Food Additives

We use food additives as the generic term for a wide range of specialty chemicals that are added to foodstuffs for a variety of reasons, including preservative, fermentation, sweetening, and health benefits. These are distinct from products in the flavors and fragrances segment.


196

Exhibit 164: Global Food Additives Sales by Value, 2004

0 1 2 3 4 5 6

Other Food ingredientsFunctional Food ingredients

Cultures and mediaAntioxidants

Antimicrobial agentsEnzymes

Fat replacersVitamins

StarchColors

EmulsifiersAcidulants

Intense SweetenersFunctional Proteins

HydrocolloidsYeast

Flavor enhancers

US$ bn

Source: DSM.

Increasing demand for food to contain not only nutritional benefits but also added health value has driven growth for highly developed food additives. In addition, the aging population is fueling demand for foods that can provide circulatory, immune system, and even anticancer benefits.

The increasingly close fit with life sciences activities is attracting many of the same players to the food additives market, while the increasing R&D costs of these activities have led to industry consolidation in recent years.

Demand in the food additives market has grown at approximately 5% in recent years, and we expect this to be a good indication for future growth.

Cosmetic Additives

Cosmetic additives are the active ingredients in shampoos, conditioners, soaps, and moisturizers, among other things. They include vitamins, amino acids, minerals, and silicone oils.

Conditioning polymers are the largest raw material sector by volume and are used in hair conditioners and skin moisturizers. Specialty surfactants are also widely used, principally in soaps and shampoos. Ingredients from plant and vegetable origins are playing an increasingly important role. Products that mitigate the effects of aging are particularly sought after by consumers.


197

Exhibit 165: Cosmetic Additive Sales by Volume, 2004 Exhibit 166: Cosmetic Additive Sales by Value, 2004

Specialty emolients

11%

UV absorbers

5%Actives

1%

Fixative Polymers

5%

Conditioning Polymers

34%


24%

Thickeners13%

Antimicrobials7%

Specialty emolients

7%

Antimicrobials16%

Thickeners11%


15%

Conditioning Polymers

30%Fixative

Polymers6%

Actives6%

UV absorbers

9%

Source: CSFB estimates. Source: CSFB estimates.

Demand growth for cosmetic chemicals has been rapid in recent years and has even outpaced the growth of the cosmetics industry as a whole. However, fierce competition has meant that few companies have been able to generate significant profit growth in this field. Rather than purely functional products, the trend has moved toward providing perceived added value within cosmetic products. In addition, environmental laws have played an important role in shaping new formulations.

We expect demand growth to continue at around 3.5% but to vary between approximately 1.5% and 6.0% for different categories of additive.


198

Fine Chemicals The term fine chemical is now used almost exclusively in reference to life science intermediates. Fine chemicals are manufactured to an exact chemical specification and utilized for their medicinal or agricultural effect. The broad categories within this definition are pharmaceutical intermediates, bulk medicinals and pesticides, biocides (antibacterial or disinfectant agents that are added to a wide range of products and processes), and laboratory chemicals.

Fine Chemicals Manufacturers

Exhibit 167: Major Manufacturers of Life Science Ingredients, 2002

0

200

400

600

800

1000

1200

1400

DSM

Degus

sa

Dow C

hem

ical

Lonz

aBASF

Clarian

t

Boehr

inger

Inge

lheim

Cambr

ex

Diosyn

thBay

er

Rhodia

Reilly

Tesse

nder

lo

Sigma-

Aldrich

Siegfri

ed

AtoFina

SNPE's Iso

chem

Dynam

ic Syn

thes

is

Albem

arle

Avecia

LSM

Great

Lak

es

Oxych

em

Borre

gaar

d Syn

thes

is

Eastm

an C

hem

ical

Honey

wellPPG

Source: Company data, CSFB research.

Fine Chemicals Industry Trends and Value Drivers • In the early-to-mid-1990s, the trend within life sciences was toward outsourcing of key

functions such as drug discovery, clinical trials, and manufacturing. In particular, pharmaceutical majors were increasingly relying on third parties to produce and supply active ingredients and bulk intermediates, rather than on in-house manufacturing capabilities. Outsourcing allowed life sciences companies to focus their resources on core competencies, such as drug development and marketing, while freeing up capital and consequently improving returns.

• In recent years, costs of drug production have risen significantly, pushed up by more stringent regulatory requirements and more complex R&D procedures—the proliferation of technologies applied in drug manufacturing has made it increasingly less efficient for life sciences companies to invest in and maintain a complete “toolbox.” It has become essential to minimize time to market for new drugs or agrochemicals to keep down costs and maintain or improve margins, particularly given increasing levels of generic competition and intensification in the overall competitive environment.


199

• The consequence of this trend toward outsourcing was that operating margins and growth rates were generally higher than those experienced elsewhere in the specialty chemical industry. This trend attracted many of the more traditional broad-based specialty chemical companies to expand into the fine chemicals area. The consequence was that much of the industry became rapidly oversupplied at the same time as demand was waning. (Dwindling pipelines at large pharma houses, increased challenges from generic producers and increased FDA scrutiny meant that in recent years a reversal in the outsourcing trend has taken place.)

• In addition, the volatility and poor visibility associated with life sciences contracts present a clear risk, in our view. The growth of individual fine chemical players is likely to be tied to a handful of major products, whose success or failure is much harder to predict than that of the life sciences industry as a whole. In addition, the timing of the launch of new pharmaceutical products means that the revenue stream from pharmaceutical intermediates is inherently lumpy and difficult to predict. While increased scale helps combat this by reducing reliance on any individual contract, few fine chemicals producers have managed to survive.

• Furthermore, many Western producers of fine chemicals have found themselves increasingly subject to significant cost competition from Asian (particularly Indian and Chinese) producers. Because of the high proportion of personnel cost involved in the production of these chemicals, many Asian competitors have been able to offer the products at a greatly reduced cost.

• Fine chemicals businesses tend to have comparatively high capital intensity and R&D requirements. While the outsourcing argument has clear cash flow benefits for the pharmaceutical and agrochemicals industries, the burden of investment inevitably falls on the contract manufacturers. Significant R&D expenditure needs to be directed toward the development of new products and processes, as well as on improving existing processes.

• Production of active ingredients for pharmaceuticals must take place in highly sterile, FDA-certified plants designed to meet current good manufacturing process (cGMP) standards. Furthermore, customers must be convinced that the manufacturer is capable of providing a consistent, high-quality product in a reliable manner. As a result, large amounts of capital expenditure are required to build plants that meet cGMP standards (around 30% more than the cost of a non-cGMP fine chemical plant).

• Fine chemical companies, as a result, tend to be highly operationally geared, with high levels of fixed costs. It is, therefore, increasingly important to run plants as close to maximum capacity as possible, and this has become increasingly difficult for many of the leading listed fine chemical producers. However, the rewards can be significant if capacity utilization rates remain healthy. (We forecast that Lonza will generate an EBITDA margin of over 40% on its new, fully loaded capacity in Portsmouth, New Hampshire, in 2005.)


200

Fine Chemicals Growth Prospects According to SRI, the fine chemicals industry should deliver top-line growth of around 5-8% in the long term. This is driven by the growth of the end markets (7-10% for pharmaceuticals and 1-2% for agrochemicals, on our estimates), as well as by the increasing trend among life sciences companies to outsource production of key intermediates. Whether or not those listed players within the chemicals sector are able to meaningfully compete with the numerous Asian competitors over the long term and therefore take advantage of this growth rate remains far less certain, in our view.

According to DSM, the global market for pharmaceutical manufacturing is estimated at around US$120 billion, of which around 25% is currently outsourced. This includes both primary manufacturing (the manufacturing of active ingredients) and secondary manufacturing (the production and formulation of the final dosages). The manufacturing of active intermediates for the agrochemicals industry forms a smaller, although still substantial market.


201

Colorants Colorants are substances used to alter the color of a product. They include dyestuffs, pigments, printing inks, and masterbatches. Bayer, BASF, Ciba Specialty Chemicals, Clariant, and Engelhard all hold significant colorant operations.

Dyestuffs Dyes are used principally on textiles, but also on paper and leather and are soluble in water (whereas pigments are insoluble). There are a number of different chemical varieties of dyes, and these can be broadly classified according to their application.

Exhibit 168: Different Applications of Dyes Dye type Characteristics Uses

Acid Dyes Insoluble in acid baths. Used for dyeing protein fibers, wool, silk, leather, paper, nylon.

Azoic Dyes Made using ice to keep the chemicals at low temperature Long lasting, bright and very versatile, used principally on cotton.

Basic Dyes Soluble in acid, insoluble once alkali is added. Used for duplicator inks (carbon paper, typewriter ribbons)

Direct Dyes Soluble in water, used on paper, cotton, rayon and linen. Used to dye cotton and mixed cotton, wool and silk

Disperse Dyes Hardly soluble in water. Used to dye synthetics, mainly polyester

Reactive Dyes React to form chemical link between dye and fiber. Very fade resistant Used for dyeing cellulose fibers and some nylons

Sulfur Dyes Large low-cost category Used for 'natural' shades on cotton.


Growth rates of dyes are directly linked to the demand for the fiber on which they are used. As a result, the growth of synthetic fiber dyes (especially for polyester) should be strongest. In addition, fashion plays an important role in demand for pigments, as darker colors require significantly more dye.

The emergence of a significant number of Asian producers has led to a period of oversupply, and as a result operating rates and margins have declined. The industry has addressed this with a period of consolidation and restructuring, although overall we do not expect demand growth much ahead of the historical rate of 2-3%, with pricing trends remaining negative for the foreseeable future.

Pigments Titanium dioxide (white) and carbon black (black) are the two largest volume pigments. Color pigments are iron oxides (red, yellow, brown, and black), chromates (yellow and orange), cadmiums (red, yellow, orange, and maroon) and chromium oxides (green).

The principal uses for pigments are in paints and coatings and in printing inks. Carbon black’s principal use is in the manufacturing of rubber goods, especially tires. Titanium dioxide’s main use is in paper manufacturing, as well as in paints.

The pigments industry is viewed as mature and is reliant on the level of industrial production for its wellbeing. Global capacity has grown rapidly in recent years, operating rates have therefore fallen, and with them, margins. We expect demand growth for the pigments industry to remain broadly in-line with GDP%.


202

Printing Inks Printing inks comprise pigments, resins, solvents, and oils. They are used not only in publishing, but also in printing for packaging as well as commercial printing.

Demand is, therefore, largely driven by a wide variety of end-market factors, including the level of magazine advertising and demand for consumer goods.

We expect the printing ink market to grow faster than its end markets because of the increased popularity of improved graphics, which require higher-priced and better-quality inks. Digital inks for screen-printing have been the fastest-growing segment in recent years, followed by flexographic inks for packaging. Overall, we expect demand for printing inks to grow marginally ahead of GDP growth over the medium term.

Masterbatches Masterbatches are the pelletized colorants and additives that plastics producers combine with resins. Ingredients may include pigments, titanium dioxide, UV blockers, antistatic agents, and agents for effects such as pearlescence.

Demand from plastics producers is for less masterbatch concentrate per unit of resin, producers are therefore tending to load more ingredients into their masterbatches. However, the trend is toward price inelasticity in the industry, and as a result, many producers are pursuing higher-value niches. In addition to trying to pass on ingredients costs to the customer, masterbatch makers charge for technical support.

In particular, the boom in PET bottles for soft drinks has driven demand for masterbatches in recent years. In addition, a trend toward brighter colors for consumer goods such as computers and their peripherals has fueled demand.

Long term, the market for masterbatches has been growing at 3-4% per year; however, faster growth is likely in regions such as Asia and South America as the pace of industrialization picks up and living standards rise.


203

XIV. Pharmaceutical Hybrid Companies

Introduction The final section of this sector overview is not intended to deal with a particular part of the chemicals sector, but rather examines those companies that have significant pharmaceutical operations in addition to their chemicals businesses and considers the issues that are related to this structure. We do not propose to provide a synopsis of the pharmaceutical industry.

Within European chemicals, the three companies under our coverage that fall within the “hybrid” definition are Akzo Nobel, Bayer, and Solvay.

Undoubtedly the biggest challenges to these companies are:

1. The consolidation of the life sciences industry, which is raising a number of issues that bring into question the competitiveness of a pharmaceutical business within the hybrid structure.

2. The relatively slim pickings in the product pipelines.

Company Overviews

Akzo Nobel

Exhibit 169: Akzo Nobel: Sales by Division, 2004

Chemicals31%

Pharmaceuticals26%

Coatings43%

Source: Company data, CSFB research.

The three main business units within Akzo’s pharma division are human healthcare (Organon), animal healthcare (Intervet), and fine chemicals (Diosynth). Other healthcare businesses, OTC products and diagnostics, were sold in 2001. Akzo has a broad coatings portfolio, ranging from industrial coatings to decorative paints to automotive refinishing. This puts Akzo Nobel Coatings in one of the strongest positions globally, in our view. However, the coatings market remains fragmented, with less than 50% in the


204

hands of ten players in a market worth US$65 billion. Chemicals is the group’s third leg, consisting of nine different business units, the largest being pulp and paper chemicals, functional chemicals, and surfactants. The main strategic thrust here is to reduce capital intensity and sell off noncore assets.

Bayer

Exhibit 170: Bayer: Sales by Division, 2004

Material Sceince37%

Crop Science26%

Healthcare37%


Bayer has recently reorganized its structure, and there are four new elements to the Bayer structure relative to the shape of the group in 2003.

1. Bayer spun off Lanxess, a blend of some activities in its former Chemical and Polymer divisions.

2. Bayer agreed to buy Roche’s OTC consumer-care franchise for a total of €2.38 billion.

3. Bayer agreed to sell the Blood Plasma business to Cerebrus and Ampersand for €450 million.

4. Bayer agreed to form a strategic alliance with Schering-Plough in certain parts of its Pharmaceutical business.

While these changes do not affect the status of Bayer as a hybrid conglomerate, we believe this strategy will lead to stable cash flow. Also, in our view, Healthcare will be more critical for Bayer’s future performance.


205

Solvay

Exhibit 171: Solvay: Sales by Division, 2004

Chemicals32%

Pharmaceuticals22%

Plastics46%


Solvay operates through the following divisions: chemicals, plastics, and pharmaceuticals. The company's key strategic aim is to accelerate growth in the pharmaceuticals division via organic growth, the acquisition of new products, and the acquisition of companies. The Solvay family shareholding (55%), we believe, will continue to preclude any major strategic change over the short term. That said, the company has been successful in divesting some of the more commodity operations (polypropylene) and acquiring more stable downstream assets (Ausimont specialty chemicals).

Industry Trends and Value Drivers The life sciences industry has seen significant consolidation in recent years, fueled by the ever-increasing requirement for R&D resource and marketing and sales support. Against this backdrop, a hybrid strategy is, we believe, likely to continue to be increasingly questioned by investors, because the potential growth of the pharmaceuticals businesses might be compromised by focus on the chemical divisions. In theory, conglomerate companies could release significant value for their shareholders by disposing of their pharma businesses and reinvesting the proceeds into their core operations. BASF and DuPont did exactly this in 2000 and 2001. That said, given the current growth prospects in healthcare of both Akzo Nobel and Bayer, there is probably only limited potential for management to successfully add value through M&A. In other words, BASF and DuPont have, in hindsight, proved shrewder in strategic timing than any of the existing hybrids.


206

Lack of Pharmaceutical Scale Despite impressive market positions in a number of therapeutic areas, the pharma divisions of the hybrid companies are becoming increasingly small within the context of the overall pharmaceuticals market. A raft of M&A activity has taken place in recent years: Astra merged with Zeneca; Rhône-Poulenc with Hoechst to form Aventis; Glaxo Wellcome with SmithKline Beecham; and Pfizer with Warner Lambert. GlaxoSmithKline had (based on 2000 sales) a combined 7.3% share of the total global market. By contrast, we estimate that both Bayer and Akzo Nobel rank 16th and 29th, respectively, in global pharmaceuticals (although both have more significant market positions in other healthcare industries such as animal health).

We believe that, among other things, two major factors are playing a part in this process of consolidation: an ambition to increase each entity’s overall R&D budget and the creation of a powerful sales and marketing network on a global basis.

Questions Surrounding the Hybrid Model Structurally, the radical change in the industry is likely to leave the hybrids at a competitive disadvantage for two reasons: a limited R&D budget and a smaller-than-average sales network. As a result, some investors are questioning whether or not these pharmaceutical businesses are meeting their full potential as part of a chemical company, or whether more value could be released by a sale of these businesses before they cease to be competitive.

Limited R&D Budget

We believe a major driver behind the industry consolidation is the requirement to increase R&D firepower to diversify the risk associated with a drug product pipeline. With the chemical businesses also making significant demands on their capital, hybrid companies cannot realistically devote the funds to match the industry leaders in terms of scale. As a result, their narrower portfolios become more reliant on individual products and more exposed to the risk of failure of one of those products. The withdrawal of Bayer’s Baycol/Lipobay in August 2000 is an example of this risk.

Small Sales Network

The risk exists that the competitive advantage of individual drugs will be eroded by these industrywide developments. The U.S. sales force of Akzo’ Nobel’s pharmaceutical division, Organon, currently numbers approximately 1,300. This compares with AHP’s 3,800, and Pfizer’s 8,000, Novartis’ 4,000, and GlaxoSmithKline’s 6,800. (These numbers are pharmaceutical-related only.) This lack of scale can have a direct effect on profitability, as hybrid companies are forced to share profits within joint venture agreements, which are the only way to market and distribute their drugs.


207

Releasing Value

Superior profitability, sales growth potential, and higher ROIC have made the pharmaceutical divisions the key driver of the hybrid company’s share price performance over the long term. For this reason, and because of the defensive qualities of pharmaceutical businesses, management of hybrid companies historically tended to be keen to hold on to this prized asset. For now, especially with Akzo Nobel and Bayer, management has a very different proposition—the improvement of both their healthcare franchises represents one of the greatest challenges.


208

XV. Sources American Chemistry Council; www.americanchemistry.com

Asian Chemical News (ACN); A Reed Business Publication

Chemical Market Associates, Inc. (CMAI); www.cmaiglobal.com

Chemical News Intelligence (CNI); www.cnionline.com

European Chemical Industry Council (CEFIC); www.cefic.be

European Chemical News (ECN); A Reed Business Publication

Handbook of Petrochemicals and Process; G. Margaret Wells

Phillips McDougall; www.phillipsmcdougall.com

Oxford Dictionary of Chemistry; Oxford University Press

Shreves Chemical Process Industries Handbook; George T. Austin, Nicholas Basta

SRI Consulting (SRI); www.ecom.sric.sri.com


209

Appendix 1

Exhibit 172: Abbreviations Found in This Report ABS Acrylonitrile Butadiene Styrene

ASU Air Separation Unit

CAP Common Agricultural Policy

DMT Dimethyl Terephthalic Acid

ECU Electrochemical Unit

EOR Enhanced Oil Recovery

EPS Expandable Polystyrene

FCCs Fluid Cracking Catalysts

GMO Genetically Modified Organisms

HDPE High-density Polyethylene

LDPE Low-density Polyethylene

LLDPE Linear low-density Polyethylene

LPG Liquid Petroleum Gas

MDI Methylene-di-para phenylene Isocyanate

MMA Methyl Methacrylate

MTBE Methyl Tertiary Butyl Ether

PBT Polybutylene Terephthalate

PE Polyethylene

PET Polyethylene Terephthalate

PP Polypropylene

PS Polystyrene

PSA Pressure Swing Adsorption

PU Polyurethane

PVC Polyvinyl Chloride

SB Styrene Butadiene

TDI Toluene Di-isocyanate

TPA Terephthalic Acid

UAN Urea Ammonium Nitrate

VCM Vinyl Chloride Monomer

VOCs Volatile Organic Compounds



210

Appendix 2

Exhibit 173: Listed Stocks Mentioned in This Report

prices are as of June 10, 2005

N O R T H A M E R IC A T ic k e r S to c k C u rre n t S to c k T a rg e tC u r re n c y P ric e R a tin g P ric e

3 M M M M .N U S D 7 5 .7 9 O u tp e rfo rm U S D 9 9 A g r iu m A G U .N U S D 1 9 .1 3 O u tp e rfo rm U S D 2 3 A ir P ro d u c ts a n d C h e m ic a ls A P D .N U S D 6 1 .2 0 O u tp e rfo rm U S D 6 7 A v e ry D e n n is o n C o rp A V Y .N U S D 5 3 .6 2 O u tp e rfo rm U S D 5 9 C o m p a s s M in e ra l C M P .N U S D 2 3 .3 7 U n d e rp e rfo rm U S D 2 4 C y te c C o rp C Y T .N U S D 4 0 .8 3 O u tp e rfo rm U S D 6 2 D e lta a n d P in e L a n d D L P .N U S D 2 5 .8 8 U n d e rp e rfo rm U S D 2 9 D o w C h e m ic a l D O W .N U S D 4 5 .4 1 O u tp e rfo rm U S D 6 3 D u P o n t D D .N U S D 4 7 .2 5 N e u tra l U S D 5 2 E a s tm a n C h e m ic a l E M N .N U S D 5 6 .9 6 O u tp e rfo rm U S D 7 7 E c o la b E C L .N U S D 3 2 .4 2 O u tp e rfo rm U S D 3 8 E n g e lh a rd C o rp E C .N U S D 2 8 .9 3 U n d e rp e rfo rm U S D 3 4 F e rro C o rp F O E .N U S D 1 9 .6 9 O u tp e rfo rm U S D 2 4 F M C F M C .N U S D 5 5 .9 9 U n d e rp e rfo rm U S D 5 3 G e o rg ia G u lf G G C .N U S D 3 4 .9 0 O u tp e rfo rm U S D 5 4 L yo n d e ll C h e m ic a l L Y O .N U S D 2 4 .0 7 O u tp e rfo rm U S D 3 6 M o n s a n to M O N .N U S D 6 3 .7 6 U n d e rp e rfo rm U S D 6 3 N o v a C h e m ic a ls N C X .N U S D 3 0 .6 9 O u tp e rfo rm U S D 5 1 P o lyo n e C o rp P O L .N U S D 6 .5 8 N e u tra l U S D 9 P P G In d u s tr ie s P P G .N U S D 6 5 .1 4 O u tp e rfo rm U S D 7 7 P ra x a ir P X .N U S D 4 6 .5 1 N e u tra l U S D 4 9 P o ta s h P O T .N U S D 9 1 .2 0 U n d e rp e rfo rm U S D 8 5 R o h m a n d H a a s R O H .N U S D 4 7 .1 8 N e u tra l U S D 5 3 S e a le d A ir C o rp S E E .N U S D 5 1 .4 2 O u tp e rfo rm U S D 5 7 U A P H o ld in g U A P H .N U S D 1 6 .2 6 N e u tra l U S D 1 7 V a ls p a r V A L .N U S D 4 7 .2 6 N e u tra l U S D 4 9 W e s tla k e C h e m ic a ls W L K .N U S D 2 4 .5 2 O u tp e rfo rm U S D 3 5

E U R O P E T ic k e r S to c k C u rre n t R a tin g T a rg e tC u r re n c y P ric e P ric e

A ir L iq u id e A IR P .P A E U R 1 4 3 .4 0 N e u tra l E U R 1 3 5 .0 0A k z o N o b e l A K Z O .A S E U R 3 2 .5 2 U n d e rp e rfo rm E U R 3 0 .0 0B A S F B A S F .D E E U R 5 6 .1 3 O u tp e rfo rm E U R 6 6 .0 0B a y e r B A Y G .D E E U R 2 8 .4 9 N e u tra l E U R 2 8 .0 0B rit is h V ita B V IT .L G B P 3 .5 9 N e u tra l G B P 3 .3 0B O C B O C .L G B P 1 0 .7 3 N e u tra l G B P 9 .0 0C ib a C IB N n .V X C H F 7 7 .7 5 U n d e rp e rfo rm C H F 6 8 .0 0C la r ia n t C L R Z n .V X C H F 1 7 .7 0 N e u tra l C H F 1 9 .0 0C ro d a C R D A .L G B P 3 .8 5 N e u tra l G B P 3 .7 5D e g u s s a D G X G .D E E U R 3 3 .2 1 N e u tra l E U R 2 9 .0 0D S M D S M N .A S E U R 5 7 .7 5 O u tp e rfo rm E U R 6 7 .0 0G iv a u d a n G IV Z n .V X C H F 7 5 4 .5 0 U n d e rp e rfo rm C H F 7 1 0 .0 0IC I IC I.L G B P 2 .6 5 U n d e rp e rfo rm G B P 2 .4 5J o h n s o n M a tth e y J M A T .L G B P 1 0 .3 1 N e u tra l G B P 1 1 .4 5L a n xe s s L X S G .D E E U R 1 8 .5 0 U n d e rp e rfo rm E U R 1 1 .5 0L in d e L IN G .F E U R 5 8 .8 6 N e u tra l E U R 4 7 .0 0L o n za L O N Z n .V X C H F 7 6 .8 5 U n d e rp e rfo rm C H F 5 4 .0 0R h o d ia R H A .P A E U R 1 .4 5 U n d e rp e rfo rm E U R 0 .8 0S o lva y S O L B t.B R E U R 8 6 .7 0 O u tp e rfo rm E U R 1 0 2 .0 0S y n g e n ta S Y N Z n .V X C H F 1 3 4 .0 0 O u tp e rfo rm C H F 1 5 0 .0 0Y a ra Y A R .O L N O K 9 9 .2 5 N e u tra l N O K 9 5 .0 0Y u le C a tto Y U L C .L G B P 2 .5 2 N e u tra l G B P 2 .4 0AS IA Targe t

P rice

F orm osa P las tics 1301.T W N T $ 53.90 U nde rpe rform N T $ 45 H anw ha C hem ica l 09830 .K S W O N 11,900.00 O u tpe rform W O N 17,000 H onam P etrochem ica l 11170 .K S W O N 43,700.00 U nde rpe rform W O N 46,000 LG P etrochem ica l 12990 .K S W O N 25,350.00 U nde rpe rform W O N 25,000 N an Y a P lastics 1303.T W N T $ 43.25 U nde rpe rform N T $ 40 O rica O R I.AX A U D 16.73 O u tpe rform A U D 19 R e liance Industr ies R E LI.B O IR 566.75 O u tpe rform IR 475 S inopec Be ijing Y anhua 0325.H K H K$ 3.77 U nde rpe rform H K $ 2 S inopec Shanghai Pe trochem ica l 0338.H K H K$ 2.63 U nde rpe rform H K $ 3 S inopec Y izheng C hem ica l 1033.H K H K$ 1.29 N eu tra l H K $ 1 JAPAN Targe t

P rice

A sahi Kase i 3407 JP Y 528 N eu tra l 500S how a D enko 4004 JP Y 260 N eu tra l 280S um itom o C hem ica l 4005 JP Y 503 N eu tra l 550M itsub ish i C hem ica l 4010 JP Y 309 O u tpe rform 470T osoh 4042 JP Y 438 N eu tra l 500M itsu i C hem ica l 4183 JP Y 618 N eu tra l 650U be Industries 4208 JP Y 214 O u tpe rform 270M itsub ish i G as C hem ica l 4182 JP Y 563 O u tpe rform 700T okuyam a 4043 JP Y 818 O u tpe rform 950S hin-E tsu C hem ica l 4063 JP Y 3970 O u tpe rform 4500S um itom o B ake lite 4203 JP Y 702 O u tpe rform 790JS R 4185 JP Y 2240 N eu tra l 2300Z eon 4205 JP Y 957 N eu tra l 930H itach i C hem ica l 4217 JP Y 2025 O u tpe rform 2300R asa Industries 4022 JP Y 351 O u tpe rform 420M im asu S em iconducto r 8155 JP Y 1586 O u tpe rform 2000


211

Companies Mentioned (Price as of 10 Jun 05) 3M (MMM, $75.79, OUTPERFORM, TP $99.00, MARKET WEIGHT) Agrium Inc. (AGU, $19.13, OUTPERFORM, TP $23.50, OVERWEIGHT) Air Liquide (AIRP.PA, Eu143.40, NEUTRAL, TP Eu135.00, UNDERWEIGHT) Air Products and Chemicals, Inc. (APD, $61.20, OUTPERFORM, TP $67.00, MARKET WEIGHT) Akzo Nobel (AKZO.AS, Eu32.52, UNDERPERFORM, TP Eu30.00, UNDERWEIGHT) Asahi Kasei (3407, ¥528.00, NEUTRAL, TP ¥500.00, MARKET WEIGHT) Avery Dennison Corp. (AVY, $53.62, OUTPERFORM, TP $59.00, MARKET WEIGHT) BASF (BASF.DE, Eu56.22, OUTPERFORM, TP Eu66.00, UNDERWEIGHT) Bayer (BAYG.DE, Eu28.58, NEUTRAL, TP Eu28.00, UNDERWEIGHT) BOC Group (BOC.L, 1073.00 p, NEUTRAL, TP 900.00 p, UNDERWEIGHT) British Vita (BVIT.L, 358.75 p, NEUTRAL, TP 330.00 p, UNDERWEIGHT) Ciba Specialty Chemicals (CIBN.VX, SFr77.75, UNDERPERFORM, TP SFr68.00, UNDERWEIGHT) Clariant (CLN.VX, SFr17.70, NEUTRAL, TP SFr19.00, UNDERWEIGHT) Compass Minerals International (CMP, $23.37, UNDERPERFORM, TP $24.00, OVERWEIGHT) Croda International (CRDA.L, 385.00 p, NEUTRAL, TP 375.00 p, UNDERWEIGHT) Cytec (CYT, $40.83, OUTPERFORM, TP $62.00, MARKET WEIGHT) Degussa (DGXG.DE, Eu33.35, NEUTRAL, TP Eu29.00, UNDERWEIGHT) Delta and Pine Land (DLP, $25.88, UNDERPERFORM, TP $25.00, OVERWEIGHT) Dow Chemical Company (DOW, $45.41, OUTPERFORM, TP $63.00, OVERWEIGHT) DSM (DSMN.AS, Eu57.75, OUTPERFORM, TP Eu67.00, UNDERWEIGHT) E.I. Du Pont (DD, $47.25, NEUTRAL, TP $52.00, OVERWEIGHT) Eastman Chemical (EMN, $56.96, OUTPERFORM, TP $71.50, OVERWEIGHT) Ecolab (ECL, $32.42, OUTPERFORM, TP $38.00, MARKET WEIGHT) Engelhard Corporation (EC, $28.93, UNDERPERFORM, TP $34.00, MARKET WEIGHT) Ferro (FOE, $19.69, OUTPERFORM, TP $24.00, MARKET WEIGHT) FMC Corporation (FMC, $55.99, UNDERPERFORM, TP $53.00, OVERWEIGHT) Formosa Chemical & Fibre (1326.TW, NT$60.00, UNDERPERFORM, TP NT$51.00) Formosa Plastics (1301.TW, NT$53.90, UNDERPERFORM, TP NT$45.00) Georgia Gulf Corp. (GGC, $34.90, OUTPERFORM, TP $54.00, OVERWEIGHT) Givaudan (GIVN.VX, SFr754.50, UNDERPERFORM, TP SFr710.00, UNDERWEIGHT) GlaxoSmithKline (GSK.L, 1356.00p, RESTRICTED, OW) Hitachi Chemical (4217, ¥2025.00, OUTPERFORM, TP ¥2300.00, MARKET WEIGHT) Huntsman Corporation (HUN, $18.90, OUTPERFORM [V], TP $33.00, OVERWEIGHT) ICI (ICI.L, 264.75 p, NEUTRAL, TP 245.00 p, UNDERWEIGHT) Johnson Matthey (JMAT.L, 1031.00 p, OUTPERFORM, TP 1145.00 p, UNDERWEIGHT) JSR (4185, ¥2240.00, NEUTRAL, TP ¥2300.00, MARKET WEIGHT) Lanxess (LXSG.DE, Eu18.51, UNDERPERFORM [V], TP Eu11.50, UNDERWEIGHT) Linde (LING.F, Eu58.86, NEUTRAL, TP Eu47.00, UNDERWEIGHT) Lonza Group Ltd (LONN.VX, SFr76.85, UNDERPERFORM, TP SFr54.00, UNDERWEIGHT) Lyondell Chemical Company (LYO, $24.07, OUTPERFORM, TP $36.00, OVERWEIGHT) Mimasu Semiconductor Industry (8155, ¥1586.00, OUTPERFORM, TP ¥2000.00, MARKET WEIGHT) Mitsubishi Chemical (4010, ¥309.00, OUTPERFORM, TP ¥470.00, MARKET WEIGHT) Mitsubishi Gas Chemical (4182, ¥563.00, OUTPERFORM, TP ¥700.00, MARKET WEIGHT) Mitsui Chemicals (4183, ¥618.00, NEUTRAL, TP ¥650.00, MARKET WEIGHT) Monsanto Company (MON, $63.76, UNDERPERFORM, TP $63.00, OVERWEIGHT) Nan Ya Plastics (1303.TW, NT$43.25, UNDERPERFORM, TP NT$40.00) Nova Chemicals (NCX, $30.69, OUTPERFORM, TP $51.00, OVERWEIGHT) Orica Limited (ORI.AX, A$16.73, OUTPERFORM, TP A$19.10, OVERWEIGHT) PolyOne Corp. (POL, $6.58, NEUTRAL, TP $9.00, OVERWEIGHT) Potash Corporation of Saskatchewan (POT, $91.20, UNDERPERFORM, TP $85.00, OVERWEIGHT) PPG Industries, Inc. (PPG, $65.14, OUTPERFORM, TP $77.00, OVERWEIGHT) Praxair Inc. (PX, $46.51, NEUTRAL, TP $49.00, MARKET WEIGHT) Rasa Industries (4022, ¥351.00, OUTPERFORM, TP ¥420.00, MARKET WEIGHT) Reliance Industries (RELI.BO, Rs566.75, OUTPERFORM, TP Rs475.00) Rhodia (RHA.PA, Eu1.45, UNDERPERFORM [V], TP Eu0.80, UNDERWEIGHT) Rohm and Haas Company (ROH, $47.18, NEUTRAL, TP $53.00, OVERWEIGHT) Sealed Air Corp. (SEE, $51.42, OUTPERFORM, TP $57.00, MARKET WEIGHT) Shin-Etsu Chemical (4063, ¥3970.00, OUTPERFORM, TP ¥4500.00, MARKET WEIGHT) Showa Denko K.K. (4004, ¥260.00, NEUTRAL, TP ¥280.00, MARKET WEIGHT)


212

Sinopec Beijing Yanhua - H (0325.HK, HK$3.78) Sinopec Shanghai Petrochem - H (0338.HK, HK$2.65, UNDERPERFORM [V], TP HK$2.75) Sinopec Yizheng Chm.Fibre - H (1033.HK, HK$1.29, NEUTRAL, TP HK$1.40) Solvay (SOLBt.BR, Eu86.70, OUTPERFORM, TP Eu102.00, UNDERWEIGHT) Sumitomo Bakelite (4203, ¥702.00, OUTPERFORM, TP ¥790.00, MARKET WEIGHT) Sumitomo Chemical (4005, ¥503.00, NEUTRAL, TP ¥550.00, MARKET WEIGHT) Syngenta (SYNN.VX, SFr134.00, OUTPERFORM, TP SFr150.00, UNDERWEIGHT) Tokuyama (4043, ¥818.00, OUTPERFORM, TP ¥950.00, MARKET WEIGHT) Tosoh (4042, ¥438.00, NEUTRAL, TP ¥500.00, MARKET WEIGHT) UAP Holding Corp. (UAPH, $16.26, RESTRICTED [V], OVERWEIGHT) Ube Industries (4208, ¥214.00, OUTPERFORM, TP ¥270.00, MARKET WEIGHT) Valspar (VAL, $47.26, NEUTRAL, TP $49.00, MARKET WEIGHT) Westlake Chemical (WLK, $24.52, OUTPERFORM [V], TP $35.00, OVERWEIGHT) Yara International ASA (YAR.OL, NKr99.25, NEUTRAL, TP NKr95.00, UNDERWEIGHT) Yule Catto (YULC.L, 252.00 p, NEUTRAL, TP 240.00 p, UNDERWEIGHT) Zeon (4205, ¥957.00, NEUTRAL, TP ¥930.00, MARKET WEIGHT)

Disclosure Appendix Important Global Disclosures I, William R. Young, Ph.D., certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including CSFB's total revenues, a portion of which are generated by CSFB's investment banking activities. Analysts’ stock ratings are defined as follows***: Outperform: The stock’s total return is expected to exceed the industry average* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral: The stock’s total return is expected to be in line with the industry average* (range of ±10%) over the next 12 months. Underperform**: The stock’s total return is expected to underperform the industry average* by 10-15% or more over the next 12 months.

*The industry average refers to the average total return of the analyst's industry coverage universe (except with respect to Asia/Pacific, Latin America and Emerging Markets, where stock ratings are relative to the relevant country index, and CSFB HOLT Small and Mid-Cap Advisor stocks, where stock ratings are relative to the regional CSFB HOLT Small and Mid-Cap Advisor investment universe. **In an effort to achieve a more balanced distribution of stock ratings, the Firm has requested that analysts maintain at least 15% of their rated coverage universe as Underperform. This guideline is subject to change depending on several factors, including general market conditions. ***For Australian and New Zealand stocks a 7.5% threshold replaces the 10% level in all three rating definitions.

Restricted: In certain circumstances, CSFB policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of CSFB's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. All CSFB HOLT Small and Mid-Cap Advisor stocks are automatically rated volatile. All IPO stocks are automatically rated volatile within the first 12 months of trading.

Analysts’ coverage universe weightings* are distinct from analysts’ stock ratings and are based on the expected performance of an analyst’s coverage universe** versus the relevant broad market benchmark***: Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months.


213

*CSFB HOLT Small and Mid-Cap Advisor stocks do not have coverage universe weightings. **An analyst’s coverage universe consists of all companies covered by the analyst within the relevant sector. ***The broad market benchmark is based on the expected return of the local market index (e.g., the S&P 500 in the U.S.) over the next 12 months. CSFB’s distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Outperform/Buy* 39% (54% banking clients) Neutral/Hold* 43% (54% banking clients) Underperform/Sell* 15% (44% banking clients) Restricted 3%

*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

Important Regional Disclosures

Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with CSFB should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse First Boston Canada Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml.

Credit Suisse First Boston (Europe) Limited (CSFB) acts as broker to JMAT.L.

The following disclosed European company/ies have estimates that comply with IFRS: BASF.DE, BAYG.DE, BOC.L, CLN.VX, DSMN.AS, GIVN.VX, ICI.L, JMAT.L, LXSG.DE, RHA.PA, SOLBt.BR, SYNN.VX, YAR.OL. Important CSFB HOLT Disclosures With respect to the analysis in this report based on the CSFB HOLT methodology, CSFB certifies that (1) the views expressed in this report accurately reflect the CSFB HOLT methodology and (2) no part of the Firm’s compensation was, is, or will be directly related to the specific views disclosed in this report. The CSFB HOLT methodology does not assign ratings to a security. It is an analytical tool that involves use of a set of proprietary quantitative algorithms and warranted value calculations, collectively called the CSFB HOLT valuation model, that are consistently applied to all the companies included in its database. Third-party data (including consensus earnings estimates) are systematically translated into a number of default variables and incorporated into the algorithms available in the CSFB HOLT valuation model. The source financial statement, pricing, and earnings data provided by outside data vendors are subject to quality control and may also be adjusted to more closely measure the underlying economics of firm performance. These adjustments provide consistency when analyzing a single company across time, or analyzing multiple companies across industries or national borders. The default scenario that is produced by the CSFB HOLT valuation model establishes the baseline valuation for a security, and a user then may adjust the default variables to produce alternative scenarios, any of which could occur. Additional information about the CSFB HOLT methodology is available on request. The CSFB HOLT methodology does not assign a price target to a security. The default scenario that is produced by the CSFB HOLT valuation model establishes a warranted price for a security, and as the third-party data are updated, the warranted price may also change. The default variables may also be adjusted to produce alternative warranted prices, any of which could occur. Additional information about the CSFB HOLT methodology is available on request. For disclosure information on other companies mentioned in this report, please visit the website at www.csfb.com/researchdisclosures or call +1 (877) 291-2683. Disclaimers continue on next page.

CH0275.doc

Disclaimers Credit Suisse First Boston is the trade name for the investment banking business of Credit Suisse, a Swiss bank, and references in this report to Credit Suisse First Boston or CSFB herein include all of the subsidiaries and affiliates of Credit Suisse operating under the Credit Suisse First Boston division of Credit Suisse Group (“CSG”). For more information on our structure, please follow the below link: http://www.creditsuisse.com/en/who_we_are/ourstructure.html. This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Credit Suisse or its subsidiaries or its affiliates (“CS”) to any registration or licensing requirement within such jurisdiction. All material presented in this report, unless specifically indicated otherwise, is under copyright to CS. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of CS. All trademarks, service marks and logos used in this report are trademarks or service marks or registered trademarks or service marks of CSG or its affiliates. The information, tools and material presented in this report are provided to you for information purposes only and are not to be used or considered as an offer or the solicitation of an offer to sell or to buy or subscribe for securities or other financial instruments. CS may not have taken any steps to ensure that the securities referred to in this report are suitable for any particular investor. CS will not treat recipients as its customers by virtue of their receiving the report. The investments or services contained or referred to in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about such investments or investment services. Nothing in this report constitutes investment, legal, accounting or tax advice or a representation that any investment or strategy is suitable or appropriate to your individual circumstances or otherwise constitutes a personal recommendation to you. CS does not offer advice on the tax consequences of investment and you are advised to contact an independent tax adviser. Please note in particular that the bases and levels of taxation may change. CS believes the information and opinions in the Disclosure Appendix of this report are accurate and complete. Information and opinions presented in the other sections of the report were obtained or derived from sources CS believes are reliable, but CS makes no representations as to their accuracy or completeness. Additional information is available upon request. CS accepts no liability for loss arising from the use of the material presented in this report, except that this exclusion of liability does not apply to the extent that liability arises under specific statutes or regulations applicable to CS. This report is not to be relied upon in substitution for the exercise of independent judgment. CS may have issued, and may in the future issue, a trading call regarding this security. Trading calls are short term trading opportunities based on market events and catalysts, while stock ratings reflect investment recommendations based on expected total return over a 12-month period relative to the relevant coverage universe. Because trading calls and stock ratings reflect different assumptions and analytical methods, trading calls may differ directionally from the stock rating. In addition, CS may have issued, and may in the future issue, other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them and CS is under no obligation to ensure that such other reports are brought to the attention of any recipient of this report. CS is involved in many businesses that relate to companies mentioned in this report. These businesses include specialized trading, risk arbitrage, market making, and other proprietary trading. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Information, opinions and estimates contained in this report reflect a judgement at its original date of publication by CS and are subject to change without notice. The price, value of and income from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities and financial instruments is subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instruments. Investors in securities such as ADR’s, the values of which are influenced by currency volatility, effectively assume this risk. Structured securities are complex instruments, typically involve a high degree of risk and are intended for sale only to sophisticated investors who are capable of understanding and assuming the risks involved. The market value of any structured security may be affected by changes in economic, financial and political factors (including, but not limited to, spot and forward interest and exchange rates), time to maturity, market conditions and volatility, and the credit quality of any issuer or reference issuer. Any investor interested in purchasing a structured product should conduct their own investigation and analysis of the product and consult with their own professional advisers as to the risks involved in making such a purchase. Some investments discussed in this report have a high level of volatility. High volatility investments may experience sudden and large falls in their value causing losses when that investment is realised. Those losses may equal your original investment. Indeed, in the case of some investments the potential losses may exceed the amount of initial investment, in such circumstances you may be required to pay more money to support those losses. Income yields from investments may fluctuate and, in consequence, initial capital paid to make the investment may be used as part of that income yield. Some investments may not be readily realisable and it may be difficult to sell or realise those investments, similarly it may prove difficult for you to obtain reliable information about the value, or risks, to which such an investment is exposed. This report may provide the addresses of, or contain hyperlinks to, websites. Except to the extent to which the report refers to website material of CSG, CS has not reviewed the linked site and takes no responsibility for the content contained therein. Such address or hyperlink (including addresses or hyperlinks to CSG’s own website material) is provided solely for your convenience and information and the content of the linked site does not in any way form part of this document. Accessing such website or following such link through this report or CSG’s website shall be at your own risk. This report is issued and distributed in Europe (except Switzerland) by Credit Suisse First Boston (Europe) Limited, One Cabot Square, London E14 4QJ, England, which is regulated in the United Kingdom by The Financial Services Authority (“FSA”). This report is being distributed in the United States by Credit Suisse First Boston LLC; in Switzerland by Credit Suisse; in Canada by Credit Suisse First Boston Canada Inc.; in Brazil by Banco de Investimentos Credit Suisse First Boston S.A.; in Japan by Credit Suisse First Boston Securities (Japan) Limited; elsewhere in Asia/Pacific by whichever of the following is the appropriately authorised entity in the relevant jurisdiction: Credit Suisse First Boston (Hong Kong) Limited, Credit Suisse First Boston Australia Equities Limited, Credit Suisse First Boston (Thailand) Limited, CSFB Research (Malaysia) Sdn Bhd, Credit Suisse Singapore Branch and elsewhere in the world by the relevant authorised affiliate of the above. Research on Taiwanese securities produced by Credit Suisse Taipei Branch has been prepared by a registered Senior Business Person. In jurisdictions where CS is not already registered or licensed to trade in securities, transactions will only be effected in accordance with applicable securities legislation, which will vary from jurisdiction to jurisdiction and may require that the trade be made in accordance with applicable exemptions from registration or licensing requirements. Non-U.S. customers wishing to effect a transaction should contact a CS entity in their local jurisdiction unless governing law permits otherwise. U.S. customers wishing to effect a transaction should do so only by contacting a representative at Credit Suisse First Boston LLC in the U.S. Please note that this report was originally prepared and issued by CS for distribution to their market professional and institutional investor customers. Recipients who are not market professional or institutional investor customers of CS should seek the advice of their independent financial advisor prior to taking any investment decision based on this report or for any necessary explanation of its contents. This research may relate to investments or services of a person outside of the UK or to other matters which are not regulated by the FSA or in respect of which the protections of the FSA for private customers and/or the UK compensation scheme may not be available, and further details as to where this may be the case are available upon request in respect of this report. Copyright 2005 CREDIT SUISSE and/or its affiliates. All rights reserved.

ASIA/PACIFIC: +852 2101-6000 EUROPE: +44 (20) 7888-8888 UNITED STATES OF AMERICA: +1 (212) 325-2000

CH0275.doc

Chemicals Primer

Documents

Transcript of Chemicals Primer