1. Shale gas Danger recognised or danger averted? Learn from 60 top managers from more than 30 chemical companies in Europe bar low high 03

2. These are challenging times for the chemical industry in Europe: energy-intensive industries are under threat from higher costs due to the Energiewende. Simultaneously, overseas companies are prof- iting from less expensive North American shale gas. Only a few years ago, the USA was one of the largest buyers of oil and gas in the worlds markets. Now, the US and Canada can cover almost all of their energy needs from domestic sources, and even act as exporters. Presently, hardly a day goes by without reports on shale gas. Thus, what is the point of this study? The answer is simple this study allows those who are most impacted by the upheavals, those whose daily actions determine the future of the industry, to voice their opinions: i.e., the top managers of the companies most concerned. Sixty decision-makers from 30 companies across Europe answered the questions and made their opinions clear on the situation and how they plan to respond. The result is a deeply interesting and highly differentiated picture of attitudes in an important core industry. It becomes clear that the matter is far beyond the businesses of just a few individual compa- nies. It is about the very existence of a significant part of the European industrial landscape and thus, in essence, the prosperity of Euro- pean communities. I am convinced that the chemical industry will master these chal- lenges. The potential is there. Now is the time to set the right course and recognise the opportunities which shale gas provides for the European chemical industry, too. 1 Dr Walter Brger-Kley Managing Partner, Stratley 3. The North american shale gas boom is not just a major topic for the global media industry; it is also important for managers in the european chemical industry. In general, they see shale gas as one of the top three issues in their companies. Shale gas is seen as a long-term trend in the chemical industry with extensive repercussions for europe. Over 50% of the interviewees expect competitive disadvantages for their european businesses as a result of shale gas. The managers main concern is access to less expensive raw materials and energy. Whilst the petrochemical industry is investing mainly in the USa, the downstream is concerned with re-working its procurement strategy in europe. The majority of managers in the chemical industry are preoccupied with analysing the impacts of shale gas on their company and deriving generalised measures for action. eighty per cent of the participants believe that North american shale gas will have negative impacts for the european chemical industry as a whole. Furthermore, they believe that the european petrochemical and basic chemicals industries face particularly tough times. approximately 30% also see the downstream industry impacted by shale gas. a large majority feels that a restructuring of the industry is both necessary and highly probable. In general, the european chemical industry is open to local shale gas extraction. however, the extraction of european shale gas is not seen as a solution to equip europe for global competition in the long term. There are clear calls for politicians to define the general framework for a coherent european energy strategy. Chemical industry managers see the future of the european chemical industry as focusing on its strengths: the ability to innovate and specialise. Thus, it is time for compa- nies in the european chemical industry to act. Those companies which act appropriately now will be able to compete on the global stage in the medium to long term. Summary Methodology This study illustrates how chemical industry managers gauge the transformation of the european chemical industry as a result of North american shale gas. The Stratley Shale gas Team surveyed 60 operations executives and top managers from over 30 companies in europe. The majority of the interviews were carried out face-to-face with a small number of telephone interviews over a period of six months up to april 2014. The replies were subjected to both qualitative and quantitative analyses. Insights and conclusions from Stratley experts were also incorporated in order to align the interviewees statements in a broader context. 3 4. The shale gas boom: a lot of hot air or the end of the chemical industry as we know it? In recent years, North american shale gas has achieved much attention as a new resource across the world. Technological improvements in extraction from unconventional sources sparked the birth of the shale gas boom. horizontal drilling and hydraulic fracturing abbre- viated to fracking are particularly noteworthy in this context. In this process, countless fis- sures are created in the rocks, making the efficient extraction of shale gas possible in the first place. Currently, the USa is the only nation which extracts shale gas on a commercial scale, despite its availability across the globe. One of the main driving forces behind the efforts in the american oil and gas industry is the political will to become less dependent on raw materials imports. The extensive extrac- tion of less expensive shale gas has led to a decoupling of the gas price from the oil price in the USa and driven it down to a level of approx. $5.00/MMBtu. In comparison, the gas price in europe is much higher at approx. $11.00/MMBtu currently (Japan, approx. $16.00/MMBtu). (Source: World Bank: World DataBank, global economic monitor commodities, nominal prices: March 2014; eIa website). North american shale gas tends to be wet. along with methane, it also contains sig- nificant amounts of natural gas liquids (Ngls), which are composed of ethane, propane and butanes, amongst others. The higher alkanes, propane and butanes, are used in the thermal market and petrochemical industry. They are also used as fuels, for liquid gas or as fuel com- ponents, for example. The availability and the low price level of shale gas-based ethane have led to naphtha being pushed out as a raw material for crackers in North america in recent years. The main cracker product ethylene can be manufactured at very attractive costs in this manner and sold at a high margin. The availability of less expensive methane as an energy supply, on the one hand, and ethylene as a raw material for the chemical and petrochemical industries, on the other, has increased the attractiveness of North american sites enormously. as a result, the North american chemical industry is currently experiencing a flood of investments. Naphtha and flexi-crackers are being converted whilst new capacities for eth- ylene and ethylene derivatives are being created. Due to the use of the lighter raw material, ethane, extraction of the higher olefins and aromatics (benzene, toluene and xylene) from North american crackers is decreasing. The implications of the US shale gas boom are a matter of intense debate: will there be a consolidation wave in european petrochemicals? To what extent will manufacturers of spe- cialties in europe and the downstream chemical industry be impacted? how can the european chemical industry withstand North american competition in the long term? Or is the so-called North american shale gas boom perhaps just hot air? 4 5. 5 1.1 The shale gas boom is a long-term phenomenon and highly relevant for the future of the industry Shale gas hasnt been just a North American issue for some time now. The significance which European chemical industry managers place upon it illustrates this clearly: 81% of those inter- viewed see shale gas as one of the top three issues for their companies (Figure 1). The scope of the shale gas boom is one reason for this. The majority of those interviewed believe that shale gas in North America will influence the global chemical industry for the next two to three decades at least. They expect that gas will have a competitive price advantage over crude oil (Figure 2). However, they also believe that the natural gas price differential between North America and Europe will decrease, as will the price differential between oil and natural gas. Managers expect that the demand for natural gas in the USA will rise and that production costs to extract shale gas will also increase. Two factors drive demand for shale gas. On the one hand, it quenches the thirst for methane in the thermal market. On the other hand, the wet components the NGLs are extremely interesting as raw materials for the petrochemicals and basic chemicals industries. These are offset by rising production costs which are driven by increasing development costs per bore- hole. The depth of the reserves and the characteristics of the overlying rock layers are the main factors. However, improvements in shale gas technology counteract cost increases, making a I.The situation is grave but not without hope attitudes of european chemical decision-makers The impact of shale gas on Europes petrochemical sector could threaten our supply chain. figures 1 and 2 how important is the topic of shale gas for your company/your business right now? Less relevant topic 13% Not a topic at all 0% Major topic 6% Among the top three topics 81% I strongly disagree I disagree I agree I strongly agree agreement Disagreement 15% 60% 25% 55% 43% 2% 0%100% 100% 0%100% Shale gas in North america is just a short-term trend. North american shale gas will maintain its price advantage over crude at least up to 2020. 100% 6. clear prediction on production costs developments almost impossible. These two trends will lead to an increase in the price of North American shale gas. Additional future demand may also be driven by LNG exports. Overall, there is a broad consensus that the significant cost advantages in North America will remain. 1.2 Managers fear decreasing competitiveness of their european businesses More than half of the managers see the competitiveness of their European production sites in danger (59%, Figure 3). They fear disadvantages in relation to raw materials and energy costs, as well as increasing competitive pressure in their export markets. They already see a partial reverse of trade between Europe and North America today. The massive expansion of ethane cracker capacities and the respective downstream in the USA will only serve to intensify this negative effect in the future. Fourteen per cent of those interviewed also see shale gas as an opportunity. Companies in Europe which supply the shale gas producers in North America with additives and oil and gas field chemicals could profit. In addition, the overall improvement in US industry could provide new markets. As far as the influence of shale gas on energy costs is concerned, almost 80% of those inter- viewed expect to be at a disadvantage as competitors in North America pay much less for their energy. Those responsible for production sites in Germany, in particular, see politics as a specific additional price driver for energy costs e.g., via the Energiewende. The impact of shale gas on energy costs is just one aspect of the shale gas scenario. The second important discussion topic in the European chemical industry is the security of petro- chemical raw materials supplies. Concerns about the availability of less expensive raw materials are, however, less than the fears about the strong disadvantage in energy costs. Most of those interviewed expect that key raw materials will be harder to procure or manufacture and only at higher prices. Along with the implications for C2 derivatives, many managers see the future of the C3+ value chain in Europe under threat from North American shale gas. They expect that the supply of higher olefins will dwindle not only due to the shortage caused by ethane crackers in North America, but also due to the erosion of the European petrochemical industry which can al- ready be seen today. Managers have different views on the significance of the changing raw materials situation for the competitiveness of their European sites. Fifty-two per cent of the study participants expect that raw materials costs will be higher in the future and that it will be difficult to pass the costs on to their customers. Thus, they will automatically suffer a loss of margin (Figure 3, bottom right). In contrast, 35% expect no ill effects from rising raw materials costs. Although a few doubt that prices for monomers (cracker products) will rise, some managers do not see a corresponding impact on their businesses. They cite three reasons: 1) The higher costs can be passed on to their customers. 2) Due to their global set-up, profits and losses can be compensated across different regions. 3) Their products are not impacted by shale gas. 6 Manufacturers in the US benefit from cheaper production routes. (Non-C2 player) C4+ prices will rise, but we will have an advantage in Europe over the US. We face a certain substitution risk for our products due to shale. 7. A third group of optimists can be found alongside those concerned about raw materials costs, and the unconcerned (13%, Figure 3). The optimists expect that European producers may even profit from less expensive raw materials, LNG or ethane, via imports from North America, for example. Most chemical industry managers are fully aware of the significance of shale gas for their European activities and confirm that the issue will only become more contentious in the future. Without a doubt, the more the participants occupy themselves with shale gas, the higher their expectations of its significance and the more critical their opinion of its implications for their European sites. From the companies viewpoint, both the risks and the opportunities of shale gas are abun- dantly clear. However, what does that mean for managing their businesses? How do the managers react to these risks? What are they doing to participate in the shale gas boom? 7 We run crackers in Europe, so shale is an opportunity and a threat at the same time. figure 3 how will the effects of shale gas in North america impact the overall competitiveness of your company/business area in europe? Negative 4% Positive 0% Slightly positive 14% Neutral 27% Slightly negative 55% negative positiveneutral and on the level of energy prices? and on the level of raw material availability/costs? 0% 20% 40% 60% 80% 100% 81% 15% 4% 0% 20% 40% 60% 80% 100% 52% 35% 13% 8. 8 2.1 Concrete action by european chemical players (as yet un)seen European chemical industry managers are paying a lot of attention to shale gas, and many see an urgent need for action (Chapter 1). Four out of five discussion partners confirm that their companies are taking internal measures in reaction to the North American shale gas boom. Discussions reveal that the intensity of activity varies greatly across the industry. Many companies are still in a very early orientation phase despite the relevance of the issue for their businesses (Figure 4). Forty-two per cent of those surveyed are currently occupied with the analysis of the conse- quences of North American shale gas for their business and examining potential measures. Only 30% are developing concrete action steps, of which only 15% have already implemented, or are in the process of implementing, specific projects. 2.2 The petrochemicals industry is investing in less expensive US ethane; the downstream is re-working its procurement strategy The position of a company in the value chain influences the activities it pursues as a reaction to shale gas. Those who are directly impacted by the shale gas boom are trying to participate in the attractive North American production conditions where possible. Upstream compa- nies are investing either in North America to convert crackers to use ethane as a raw material, or in Europe to facilitate access to less expensive raw materials. Both courses of action aim to ensure competitiveness in ethylene (Figure 5). Other investments at European petrochemicals sites aim to optimise product output or forward integrate to improve value creation. This applies in particular to monomers. Value creation for producers of pure monomers is rising as availability drops and prices increase. The hope is that those who invest early on will profit from these investments in the medium to long term. II. Nothing remains the same strategic options and potential in a dramatically changing industrial landscape figure 4 assessment on progress of activities and measures related to shale gas Detailing phase 30% Advanced/implemented projects 15% 13% Not active at all Early phase/Analysis 42% Level of actions 9. 2.3 Resource shortage slows the US investment wave implementation time and project costs on the increase Whilst two thirds of the managers feel that the investment potential in North America is funda- mentally attractive, opportunities for their realisation are studied very carefully. Not all planned investments independent of their value chain position have actually been carried out or are about to be. Whilst the early movers have already been able to complete their projects, a con- tinuation of the US investment wave in its previous form is questionable. A lack of qualified employees is a significant hurdle for many companies activities. This lack of manpower leads to both lengthening implementation times and rising project costs. Players in the ethylene downstream which are not backward integrated also have to ask themselves whether or not they can actually profit from lower ethylene costs in North America. Or, will the margin perhaps remain in the coffers of the ethylene producers and the integrated value chain steps? Downstream producers who are not integrated into monomers are currently mainly preoccupied with purchasing and procurement of their raw materials. The issues vary greatly across the industry. Purchasing organisation heads are occupied with questions about potential inter-regional arbitrage windows and the security of supply from their current suppliers. Rene- gotiation of contracts with regard to duration and pricing is also a current topic. Companies can react quickly to the changing situation through their purchasing organi- sations. The scope of these measures is, however, somewhat short-term and cannot replace a long-term strategy as the answer to shale gas challenges. 9 We missed the boat. figure 5 What measures has your company/business area already taken due to North american shale gas? 0 5 10 15 20 Investment (feedstock + market access) Sourcing optimisation Product portfolio optimisation (e.g., innovation and specialisation) Restructuring/reorganisation Value chain optimisation Communication to regulatory bodies Any analyses/monitoring Increasing efficiency of operations No comment/I don't know No activities so far Multiple nominations possible 10. 2.4 Supply security across the entire value chain under review Security of supply is the most important issue as far as experts are concerned. It is important to examine the influence of shale gas on each individual supplier in this context. Which supplier will have the edge due to their production route? What is the situation in upstream value chain steps? Up to now, only a few have fixed their minds upon these questions. The value chain right back to the borehole is seldom examined. Those who examine the value chain in its entirety frequently discover that it depends on perhaps one or very few petrochemical raw materials which, in turn, are highly influenced by shale gas. Very few companies go so far as to switch suppliers, replace raw materials or even adjust their product portfolios as a consequence of this inter-dependency (Figure 5). Companies which are prepared to take these steps also see the impacts on research and development and the necessity to take into account changing raw materials trends on this level. Only very few companies actually plan steps in the other direction in order to secure access to less expensive raw materials for example, through strategic partnerships and participation in on-purpose technologies. The significance of on-purpose processes is a matter of contention. On the one hand, individual study participants see the importance of crackers deteriorating due to on-purpose paths. On the other hand, others see this as being too expensive in the near future to have a significant impact on the established production structures in the chemical industry. The issue of energy costs remains, along with raw materials supply, a security issue for many companies independent of their position along the value chain. As a consequence, energy conservation measures accompanied by intensified lobbying are on the agenda: companies are trying to sensitise politicians and the general public to their energy cost concerns and competi- tive risks. The interviewees see this type of opinion building as being very important in order to facilitate affordable energy in the future. 2.5 european sites continue to lose appeal for new investments North American shale gas is the initiator of a tidal wave of investment in petrochemicals and basic chemicals. Ethylene manufacturers are investing in both their crackers and in the infra- structure to gain access to the attractive US ethylene margins via less expensive ethane feedstock. The fact that a significant portion of this investment is occurring in the USA poses a problem for European sites in the medium to long term. This emigration of internal financial means to North America could lead to an orphaning of the European chemical industry. There are two reasons for investment decisions in a specific region: either production costs (raw materials, energy) are attractive, or demand is increasing sharply. Both factors are currently driv- ing investments also independently of shale gas both in North and South America, and in Asia. Europe risks being left behind. So what are the immediate impacts of North American shale gas when examining the consequences for energy costs and the shift in cracker output? And, what indirect long-term changes do chemical industry managers expect for the European chemical industry? 10 Internal investments are shifted to the US. You have to check the supply chain all the way back to the well-head. 11. 11 3.1 Petrochemicals and basic chemicals on the brink Over 80% of study participants expect that North American shale gas will have a negative im- pact on the European chemical industry. More than 20% expect a massive negative impact on domestic industry (Figure 6). Scenarios range from the closure of individual assets to a drip by drip erosion of the en- tire petrochemicals and basic chemicals industries with no end in sight. Both developments would force the European chemicals industry to shrink. More than 70% of the managers ques- tioned expressed this during open discussions. They base their concerns, above all, on ever- intensifying competition. North American ethylene derivatives and basic chemicals from the C1 value chain, and basic polymers also, will attack European products intensely in the future. Additionally, intensifying competitive pressure in export markets can be expected from Near East competitors in the coming years. A relocation of production to the USA is expected in addition to the increasing competi- tion from North American and Near Eastern products. This trend will be further intensified by the reluctance of investments in Europe a factor which is not just limited to companies in raw materials and energy intensive sectors. Thus, two trends are working in tandem: a lack of growth from new investments and ca- pacity closure in the European chemical industry which can already be observed. What are the options for the sector based on this situation? Managers fear that the industry may no longer keep abreast of technological developments and, with them, the potential to compete on the global stage. III. The future is on its way but for whom? figure 6 What do you think? how will North american shale gas influence european chemical operations/sites? Negative 21% Positive 2% Slightly positive 4% Neutral 10% Slightly negative 63% 12. 12 What happens to our customers: emigration, consolidation, closures? The vast majority (over 80%, Figure 7) are of the opinion that the North American cost advan- tage as a result of shale gas is very likely to cause massive restructuring of the European chemical industry. During the discussions, it became apparent that minimal restructuring of the industry will probably not suffice. The threat to the petrochemicals and basic chemicals industry is confirmed by almost 90%. In spite of the fact that many participants do not see shale gas as the cause of new move- ments (thus, 10% see the impacts as being neutral, Figure 6), it is seen as a catalyst of already existing developments. Thus, managers agree that the European petrochemicals and basic chemi- cals industries face tough times ahead. Sites in Southern Europe are in particular danger, as are small, technically outdated and non-integrated assets. A shake-out may well prove positive for the survivors. Market cleansing through removal of over capacities not only improves the competitive situation for the remaining cracker opera- tors, it also has a positive impact on the pricing of their products. 3.2 Why the downstream industry will not get off lightly Restructuring of the European chemical industry will begin in the raw materials intensive sec- tor. However, the downstream will also be affected, although somewhat less. Thirty per cent of the participants feel that there will be consequences for the downstream; the majority of them (28%) see this as highly likely. The smaller share of raw materials costs in overall costs and the low substitutability of products protect the specialties. Higher demand for specialties in the North American market is seen by some interviewees as a positive result of the shale gas boom (6%, Figure 6). Along with the cost advantage of production in North America and the lack of new in- vestment, indirect effects were also frequently discussed. To what extent will domino effects impact individual players, sites, clusters or ultimately the European chemical industry as a whole? Which players will exit first and what consequences will that have for their customers and suppliers? figure 7 Impact of North american shale gas on the european chemical sector I strongly disagree I disagree I agree agreement Disagreement 17% 2% 17% 53% 2% 31% 62% 27% 56% 0%100% 50% 50% 100% 28% 4% The cost advantages of the North American chemical industry due to shale gas will lead to a deep restruc- turing process of the European chemical industry on the medium term. European petrochemicals and basic chemicals will be impacted by North American shale gas. European speciality chemicals will be impacted by North American shale gas. I strongly agree 13. 13 Managers are asking themselves the question What protection does a cluster actually offer? Should a player either impacted or motivated by shale gas exit, the other players in the Ver- bund structure will feel the consequences. This, in turn, will lead to questions not just about absorbing materials flows, but also about site costs. The fixed costs at a site for infrastructure, security, supplies and waste are the same no matter how many companies are located at the site. 3.3 Chemical industry managers say yes and no to shale gas extraction in europe Driven by high energy costs and concerns over missing out on a technological/raw materials revolution, most participants support shale gas extraction via fracking in Europe. Eighty per cent support production as long as it is economically viable and the environmental risks are calculable and justifiable. Despite their overall broad support, managers feel that other regions have progressed fur- ther in developing technology and implementing it in commercial scale extraction. China is at the top of the list well ahead of Canada placed second (Figure 8). Due to the extent of the resources and the political drive in China, the interviewees assume deep Chinese interest in shale gas extraction. However, it is unlikely that the North American shale gas boom can simply be copied. The challenging geological formations combined with the lack of infrastructure in Chi- na are hurdles which, in contrast to the USA, have to be overcome first. Together with China, Canada and South America will initiate large-scale shale gas produc- tion. In the interviewees opinion, Australia is, as yet, behind Europe due to its large conventional gas reserves. The Near East and Africa are expected to follow later on but for other reasons. The influence of European shale gas on the domestic chemical industrys competitiveness is seen from differing perspectives. Two thirds expect falling energy prices as a result of shale gas. One third sees this theory somewhat more critically. These managers expect much higher production costs for domestic shale gas in comparison with the costs in North America. Thus, they expect that shale gas will not lead to a reduction in European gas prices. A select few partici- pants found it important to emphasise that European shale gas is different than North Ameri- can shale gas the reserves in Europe are probably largely dry. The higher alkanes which can serve as a raw material for the chemical industry are only present in small quantities. figure 8 Which countries or regions will become the next major producers of shale gas? China Canada South America Europe Australia Middle East Africa Multiple nominations possible 29 18 15 12 10 8 3 0 5 10 15 20 25 30 14. 14 3.4 Call for politicians to solve the problem with a sound energy concept and more technological acceptance Even if there is no short-term competitive advantage as a result of European shale gas, European shale gas should be pursued for strategic reasons. However, managers identified three main hurdles to European shale gas production: public opinion and a lack of acceptance, regulatory barriers and environmental risks. Discussions on shale gas in Europe are of a particularly emotional nature. The publics doubts about this allegedly unsafe technology are grave. Many people are worried about envi- ronmental and health risks as a result of fracking. According to the interviewees, politicians are not contributing to a more objective discussion; they expect a clear legal framework based on a rational evaluation of the potentials and risks of shale gas extraction. Besides acceptance of shale gas, a lack of available infrastructure is cited in fourth place (by almost 30%) as a hurdle. This is then followed by production costs. Less than 5% see the quality of the gas as a serious barrier to commercial shale gas extraction in Europe. Over 80% feel that the reaction of political decision-makers to the challenges facing the European chemical industry is inappropriate. They demand an underlying European energy strategy. 3.5 Securing the future through focusing on innovative ability and specialisation The chemical industry itself must also rise to the challenge along with politicians and the public. Is the chemical industry doing enough to meet the challenges of shale gas? What are the key issues of the future which will allow Europes chemical industry to remain competitive? Almost 40% demand a more active approach to changes in global competition. How- ever, all agree that increasing the reactive speed of the industry is no mean task. Capital- intensive assets planned over decades are at the heart of the chemical industry. Processes cannot be simply adjusted, and plants are only mobile to a limited extent. Nonetheless, these managers call for stronger use and expansion of the European chemical industrys strengths, such as its market size, infrastructure and innovative ability. How can the European chemical industry remain competitive in the future? One strength is named again and again (Figure 9): differentiation through innovation and specialisation. This includes more emphasis on specialties, but not just specialties. Even though the presumed higher product margins may appear appealing, specialties on their own will not utilise all the existing plant capacity. There is more to innovation and specialisation than just a pure product view. It also has to do with processes, services and business models which drive differentiation and help increase competitiveness. The utilisation of alternative raw materials (green raw materials) also receives more attention in this context. After differentiation, increasing efficiency (operational excellence) is the next most impor- tant topic for managers. The objective is to reduce costs through improved processes, less material and energy inputs, optimised processing. The chemical landscape needs to change: managers see a consolidated, globalised industry as the necessary future outcome of current developments. This will be the only path for companies to follow to exploit good opportu- nities in global markets and position themselves optimally. They expect a continuing trend toward clusters and Verbunds within the regions. Stop complaining and get on with it! 15. A social and political environment which is industry-friendly is one of the most important con- tributors to a strong chemical industry. Public acceptance of the chemical industry is an impor- tant aspect, along with competitive energy and access to raw materials. Introduction of new raw materials sources and technologies is often refused without an objective analysis of the options. The planning of new plants or pipelines also frequently leads to difficult, long drawn-out discus- sions between the industry and the public. This scepticism towards technology in many European countries is seen as a major problem overall. However, only a very few interviewees named extraction of European shale gas as a success fac- tor. What is the most important insight gained from the questions on the future of the European chemical industry? Copying the shale gas boom in Europe does not seem practicable and would notbeaforward-lookingsolutionforEuropeschemicalindustry.Also,onlytheindustryitselfcan resist the threat of restructuring by concentrating on its own strengths. 15 figure 9 Under the influence of North american shale gas, how can the european chemical industry survive the increasing competition in the future? Innovation/specialisation Efficiency improvement Industry consolidation & restructuring Internationalisation Supportive environment Feedstock strategy Increasing level of integration (Verbund) Domestic shale gas production 0 5 10 15 20 25 30 35 40 Europe has to define the future. 16. 16 4.1 Shale gas has not (yet) made it onto the strategic agenda Most chemical industry managers are aware of the significance of shale gas for their businesses. Themanagersalsofeelthattheissuewillbecomemoreimportantinthefuture.Theconsequences for the industry as a whole are viewed with even more apprehension. It is somewhat surprising that shale gas has not made it onto the top managements stra- tegic agenda despite the fact that highly experienced managers and teams in the various de- partments are investigating its effects. In fact, shale gas frequently remains as an operative issue which is dealt with using short-term measures. One reason for this lies in the fact that shale gas is not the only cause of the challenges facing the European chemical industry it is simply an accelerator of already existing trends. A lack of growth in Europe and resource shortages is nothing new. Additionally, the painful consequences of the shale gas boom on the European chemical industry have not fully arrived. It is imperative that shale gas is placed on the companies strategic agenda and receives the necessary top managements attention. 4.2 Focus on rising energy costs risks to raw materials supplies under-estimated Raw materials costs mainly driven by raw materials availability make up a significant proportion of the overall costs of a product in the petrochemicals and basic chemicals industry. This does not quite hold true for the price of raw materials in the case of specialties; it does, however, apply to their availability. Therefore, why does the impact of shale gas on the availability of raw materials receive so little attention? There are two possible reasons: Time lag of impacts In contrast to the influences on raw materials, managers feel the squeeze of high European energy prices right now the grave consequences of the gradually changing raw materials situation goes, as yet, unnoticed. The extent of the global shift, limited availability and expected price increases will only come to bear in the coming years as a consequence of the North American downstream expansion thus, they are somewhat delayed. Problems somewhere on down the road do not receive attention (yet). Company manage- ment is structured along quarterly performance and annual returns, thus managers con- centrate on current tasks and acute challenges which require immediate action. high complexity of impacts The influence of shale gas on the availability of higher olefins and their derivatives must be seen in the wider context of other raw materials sources and global trends. For example, C3 and BTX aromatics are not only procured from crackers, but also from refineries or on-pur- pose production. This necessitates a complex cost analysis which reflects global capacities, various technological developments (e.g., propane dehydration) as well as demand curves. IV. Conclusion: Danger identified but not avoided 17. 17 Besides the raw material costs, investments in new as well as existing plants and assets are nec- essary. These expenses influence both manufacturing costs and product pricing the latter also being influenced by demand. When demand is high in relation to the availability of a chemical raw material, prices will increase. 4.3 Discrepancy between tentative actions and strategic requirements There is broad general consensus about the necessary strategic measures for the future. Differentiation through specialisation and innovation is at the top of managers lists. There is, however, a distinct discrepancy between measures which have actually been acted upon and managers intentions (Figure 10). Access to less expensive ethane as a cracker feedstock, and in particular, the procurement of raw materials is at the centre of todays activities. When it comes to the top six measures to retain future competitiveness, the latter is barely even mentioned. Innovation and specialisation are more in the midfield of todays activities whilst they are at the forefront of future activities. Managers clearly cite the issues facing the European chemical industry. However, todays priorities differ somewhat from those in the future. 4.4 Can innovation save the european chemical industry? all options must be put on the table Approximately one third of the interviewees primarily refers to product innovation and focus on specialties when asked about the topic of innovation. However, all agree that a specialty strat- egy for the European chemical industry as a whole is neither practicable nor desirable. Even without shale gas, product innovation and differentiation is important to defend and improve a companys own competitive position. Resource shortages or looming price increases cannot be Innovation/specialisation Efficiency improvement Consolidation & restructuring Internationalisation Lobbying Access tolow-cost feedstock and feedstock flexibility Sourcing strategy 20 10 0 10 20 30 40 50 figure 10 Measures taken/future of the chemical industry Under the influence of North American shale gas, how can the European chemical industry survive the increasing competition in the future? What measures has your company/business area already implemented in Europe due to North American shale gas? 18. 18 compensated for by downstream measures the problem must be tackled at its upstream source. Thus, a long-term strategy must be based on the deliberate use of all degrees of innovation. The trend toward ethane as a cracker feedstock as a result of the shale gas boom and the strong C1 chemical industry in North America are leading to a global shift in the raw materials situation in the chemical industry. This, in turn, has deep implications for the value chain. In our opinion, the value chains must be examined right back to the borehole. This is the only way to understand and analyse raw materials interdependencies and how they are influ- enced by shale gas. In doing so, it is important to include by-products and not just the main products in the various production paths. Price declines induced by shale gas for just one main by-product can render a complete manufacturing path uneconomic. In such instances, process innovation may prove to be a viable answer to shale gas. Along with the optimisation of reaction products, this approach also holds further potential to reduce energy and materials used. This would allow companies to offset energy cost disadvantages and help alleviate the risk of raw materials shortages as a result of shale gas. From a strategic point of view, backward integration or a raw materials alliance is a viable option. The use of non-conventional resources or manufacturing processes to supply raw ma- terials is the third field of activity in innovation. It is important to not only examine which raw materials and paths are technologically possible, but also which are commercially attractive. Should there be no attractive option to reduce dependence on a critical raw material, companies may even be forced to adapt their product portfolios. European chemical companies already have all the requirements to remain competitive in the long term. Stiff competition on cost level also provides opportunities for the future. The in- creased pressure to introduce innovations and gain access to more efficient raw materials could drive companies to take up the challenge themselves. Instead of waiting for broad initiatives from their own sector or politicians, the European chemical sector as a whole should actively engage with their processes and business models to remain competitive. In the medium to long term, European chemical players can profit from current developments and defend or even im- prove their strong position in the global competition providing they take on the challenges posed by shale gas! 19. 19 abbreviations and definitions Frequently known as fracking. A process in which a mixture of water, sand and chemicals is injected under high pressure into rock layers to create fissures in shale and thus make shale gas extraction possible Liquefied Natural Gas Natural gas is cooled to a liquid at 162 C, thus reducing the volume by a factor of 600 1,000,000 Btu (British Thermal Unit) 1 MMBtu is roughly equivalent to the energy content of 1 Mcf (1,000 cubic feet, approx. 28,3 m3 ) shale gas. 1MMBtu can be used to heat 3 m3 of water from 20 to 100 C, 1 Btu = 1055 J A mixture of various hydrocarbons with between 5.0 and 12 carbon atoms When compared with dry natural gas which mainly consists of methane (usually >95%) wet natural gas contains significant proportions of NGLs. Currently, there is no clear definition Natural Gas Liquids all hydrocarbons which occur along with methane when extracting natural gas/shale gas: ethane, propane, butane, pentane, as well as other heavy alkanes Propanedehydrogenation production of on-purpose propylene Natural gas trapped in shale which can be extracted via fracking Saturated hydrocarbons, primarily naphtha and ethane, are heated to high temperatures using steam and broken down into usually unsaturated hydro- carbons hydraulic Fracturing lNg MMBtu Naphtha PDh Shale gas Steam cracking Wet natural gas Ngl 20. acknowledgements We would like to thank all of the companies and their representatives who participated in the study. This study would not have been possible without these valuable contributions from European chemical industry managers. Thank you! Disclaimer This study is based mainly on the opinions of company executives from internationally-oriented European compa- nies. Small- and medium-sized companies from these sectors and petroleum companies were not included in this study therefore, the results of the study may not be applicable to them. All rights reserved. The text and/or graphics in this study may not be copied, reproduced, transmitted, published or distributed in any other way, either wholly or in part, without the prior written consent of Stratley AG. about Stratley Stratley is a globally active top management consultancy with offices in Europe, The Middle East, and China. We advise companies in the chemicals and primary industries, as well as associated sectors. Stratley focuses on the development and implementation of corporate and business strategies, marketing excel- lence issues, large-scale organisational transformation, and strategic issues relating to chemical parks, sites and services. We follow an implementation-oriented, strategic consulting approach and select highly experienced consultants to work together with our clients teams. We have access to a broad network of industry and functional experts in the chemical industry. Our unique combination of clients, consultants and industry experts guarantees imple- mentable solutions which work in practice. Due to our focus, we at Stratley regularly examine current topics and issues in the chemical industry. Stratley has been investigating shale gas, its implications for the chemical industry and potential options for action for a number of years now. authors 20 Dr Walter Brger-Kley Managing Partner w.buerger-kley@stratley.com Dr Kristina hackeler Consultant and Industrial Chemistry Expert k.hackeloeer@stratley.com Dr Peter Schache Consultant and Shale Gas Expert p.schache@stratley.com 21. All rights reserved. No part of this document may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of Stratley AG. 2014 by Stratley AG 22. SHALEGAS|Dangerrecognisedordangeraverted?