HOW TO MAKE MONEY AT COMMODITY CHEMICALS

HOW TO MAKE MONEY AT COMMODITY CHEMICALS

Dan Boivin, President Olefins/Polyolefins, Nova Chemicals Corporation

volumes, sell products that are defined as

INTRODUCTION
Commodity chemicals are one of the more
difficult areas of business to succeed in. The
history of the industry is littered with
companies which have failed to return their
cost of capital and have subsequently left the
industry. In this paper we discuss (1) the key
drivers and challenges for success in
commodity chemicals and (2) the strategies
NOVA Chemicals uses to pursue success and
make money.
1. WHAT ARE COMMODITY
CHEMICALS?
You could use many definitions to
describe commodity chemicals, but the
simplest can be found by examining the
relationship between the price of a chemical
and the volume of the chemical produced
(Figure 1). Volume and price are inversely
related, with higher volumes equating to lower
prices. So we would define commodity
chemicals as products that sell for between 10
cents and $1.00 a pound, and that are produced
commodities.
2. THE COMMODITY CHEMICAL
CYCLE
The economics of commodity chemicals
are driven by a number of key factors. It is
essential to understand these key drivers in
order to understand how to make money in the
commodity chemicals business. Figure 2
shows you a price index that has been
maintained by The Economist magazine and
covers the last 150 years. This index is made
up of a wide range of traded commodity
products, including items like wheat, barley,
wood, paper, metals and minerals, rubber and
plastics.
Source - The Economist, April 17, 1999
(Adjusted by GDP deflator)
160
140
120
100
Index

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in volumes over a billion pounds per year.
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0
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45

65

85

05

25

45

85
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Figure 2 – Economist Industrial

Source - NOVA Chemicals, January 1999
Figure 1- What are Commodity
Chemicals?
At the far right of this chart, you see
things like medicines and antibiotics that sell
in the range of hundreds of dollars per pound
and are clearly specialty chemicals. At the far
left of this chart, we could include things like
sand or dirt, which sell for 1 to 2 cents per
pound. Most of us, whether we are dealing
with aromatics, benzene, ethylene, chlorine,
polyethylene or any of the basic
petrochemicals that are produced in large
Commodity Price Index
When you study this chart, you start to see
certain patterns. First, the many spikes in the
graph demonstrate that commodity prices are
volatile. Second, you also observe that when
prices move, they tend to move rapidly and
form peaks and valleys. Third and perhaps
most importantly, this chart clearly
demonstrates that, since the turn of the
century, there has been a consistent and
persistent decline in the price of commodities,
when you adjust for inflation. If you started
with a basket of commodities worth $100
dollars in 1845, an equivalent basket today is
worth about $20 dollars. You can also see that
most of that value has been lost since the end
of World War II. For those in the commodity
chemicals business this is a pretty sobering
picture.

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 HOW TO MAKE MONEY AT COMMODITY CHEMICALS

When you look at this graph, it’s also easy consider. Let’s touch on a couple of other
to see why people refer to commodity major influences on our business. As you
chemicals as a cyclical business. You can spot know, the economic measure known as gross
the peak years in 1979/80, another peak in domestic product is made up of dozens of
1988, and another in 1995. These peaks tend different business activities in today’s modern
to coincide with, and are driven by, overall economy. Figure 4 looks at growth in two
economic activity. specific subsets of GDP, and compares their
The peaks and valleys seen here are
primarily event-driven. The sharp peak in the Billions
US$
Billions
US$
early 1910’s was caused by the First World 9,000 90
War. The big dip in the late 20’s occurs 8,000 80
during the Great Depression. You can see that 7,000 70
during the Second World War, prices were 6,000
Total GDP
(left scale)
60

also held up, but the great decline from 1945 5,000 50

on reflects the conversion to the modern 4,000 40

industrial economy. The twin forces of larger- 3,000

Rubber & Plastics
30

2,000 (right scale) 20

scale operations and more efficient production
1,000 Mfg 10
methods reduced the cost of producing a wide (Left scale)
0 0
range of commodities.

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90
60

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Figure 3 shows you the same index from
The Economist, but this time, it is plotted
against the price of linear low-density
polyethylene (as reported by Chem Data).
Linear low-density polyethylene is a specific
type of polyethylene and it certainly falls into
the commodity chemicals definition. There is
clearly a very strong link (the correlation co-
efficient is 0.82) between the price behavior of
commodities in general, and the specific price
of this polyethylene, which is also one of
NOVA Chemicals’ core products. Many other
commodity chemicals follow this specific
pattern. In fact, the correlation between PE
prices and commodities in general is much
higher then between PE prices and oil. So
while its no doubt true that raw material prices
have a significant influence on the cost of
petrochemicals, it’s more important to
recognize that price moves according to a
different set of forces. We would suggest that
the major driver of price is the overall
commodity cycle, or overall economic growth.
160
140
120
Correlation Coefficient 0 .82
100
80
60
40
Jan80 Jan85 Jan90
INDUSTRIALS
Source - The Economist, Chem Data
Figure 3 - LLDPE Price Index vs
Economist Industrial Commodity Price
Index
While overall economic growth is the key
driver, there are other important factors to
95
growth to growth in GDP as a whole.
Source: Bureau of Economic Analysis
Figure 4 - Current $ GDP Relative to
Mfg GDP and Rubber & Plastic Products
GDP
First, let’s focus on the black line at the
top, which shows the growth in total GDP. As
you can see, from 1960 to today, total GDP
has grown from less than $1 trillion dollars to
more than $8 trillion dollars. The red line at
the bottom shows the manufacturing sector’s
total GDP. Clearly, growth in the
manufacturing sector, which includes the
commodity chemical industry, has lagged
behind growth in the economy as a whole.
While GDP has continued to rise rather
rapidly over the last 40 years, a growing
portion of the economy is now based on
information technology and services
industries, as opposed to the hard goods and
the manufacturing sector. Manufacturing has
fallen from being 40% of GDP at the
beginning of this period to only 15% of GDP
today.
For those who sell their commodities to
customers involved in general manufacturing,
as opposed to customers in some of the more
rapidly growing segments of the economy,
there is precious little opportunity to grow
your business. Plastics, on the other hand,
Jan95 continue to benefit because they are
LLDPE
increasingly being substituted in place of
traditional materials. Fortunately, for our
company, computers are not made of much
wood or metal, but use quantities of plastic and
the same holds true for fax machines and
cellular phones. Many commodity polymers
have been growing faster than GDP and appear
likely to continue that trend into the future.

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 HOW TO MAKE MONEY AT COMMODITY CHEMICALS
3. NOVA CHEMICALS STRATEGY
Given this cyclical, and generally
challenging picture for the commodity
industry, how then can one hope to derive
value, return the cost of capital and make
money. At NOVA Chemicals, we believe that
there are a number of key drivers, which are
essential to success and making money. These
key drivers for success include,
• Raw Materials
• Business and Production Scale
(through both consolidation and
construction)
• Technology
With these key drivers, NOVA
Chemicals’ strategy is focused on those
elements, which we believe will enable us to
succeed.
• Focus only on commodity chemicals
• Deliver the lowest cost on every
product
• Build on sustainable competitive
advantages
• Feedstock
• Technology
• Invest only for high returns
• Be an industry consolidator
Each of these strategy elements appears
simple, yet this strategy focuses us on those
key drivers necessary to succeed in the
commodity chemical’s environment, an
environment where real prices steadily decline
and there are enormous swings in prices and
profitability. Let us now take some time to
show some specific examples of the
application of this strategy. The examples
include (1) ethylene, (2) consolidation in the
styrenics industry and (3) our Joffre expansion.
4. ETHYLENE
Ethylene is the most widely produced
commodity chemical and NOVA Chemicals is
one of North America’s top producers of
ethylene and polyethylene, so success in this
area is crucial if we want to succeed. You can
produce ethylene by cracking either ethane or
crude oil feedstock. At NOVA Chemicals, we
produce ethylene by both methods and as you
can imagine, the economics of cracking ethane
is integral to our success as a company.
Almost half of the total cash cost of
producing ethylene is taken up by feedstock
costs. For NOVA Chemicals to be successful,
we have to have a superior feedstock strategy
that provides a competitive advantage over the
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long term. The second-largest cost in
producing ethylene is tied up in variable costs,
including the cost of energy co-products.
Labor, maintenance and other fixed costs
comprise the balance. This breakdown tells us
that to succeed as an ethylene producer,
NOVA Chemicals, needs to focus on (1)
obtaining low cost feedstocks and (2)
achieving a production scale in each plant
which gives the lowest conversion costs.
Now let’s look a little more closely at the
specific raw materials for ethylene. Figure 5
shows that the price of the two major
petrochemical feedstocks do not move in
lockstep. Oil is a globally traded commodity,
and its price is significantly influenced by
political or global events. Natural gas, on the
other hand, tends to be a regional product and
regional variations in natural gas prices have a
huge influence on the profitability of our
business. In Western Canada, low-cost natural
gas has propelled petrochemical development
in chemicals like ethylene.
7
6
5
Current US $/mmbtu
4
3
2
1
0
1976 1981 1986 1991 1996
Source: www. economagic.com
Figure 5 - Crude vs Natural Gas Prices
With a strong feedstock position
established, the next key driver is to achieve
competitive conversion costs. These can only
be achieved through the development of large
scale, energy efficient facilities. Figure 6
shows the cash cost of producing ethylene for
small, medium and large size ethylene
crackers. You can see that the cash costs for
the largest crackers (over two billion pounds or
950,000 tons) can be 30% lower than for those
crackers at one billion pound (or 450,000 tons)
or less in size. Clearly, economies of plant
scale have a huge impact on the cost position
and the strategic position of various
commodity producers.
 HOW TO MAKE MONEY AT COMMODITY CHEMICALS

areas. First, sustaining our competitive

advantage in feedstocks through the use of the
‘Alberta Advantage’ and using our large
flexicracker in Ontario to the greatest
advantage. Second, we focus on developing
the largest, most energy efficient crackers to
achieve the lowest conversion costs in the
industry.

Source: Solomon Associates 1997 Ethylene Performance

Analysis
0.18
0.16
Figure 6 - Ethylene Production Cash 0.14

Current US dollars/lb
Cost 0.12
0.10

The need to move to larger facilities to 0.08

0.06
achieve the lowest cost is a world wide trend, 0.04

but it is most pronounced in certain regions. 0.02

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Figure 7 shows how ethylene steam crackers

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Net Raw Materials Utilities Direct Cash Costs Total Allocated Cash Costs
1982, the average size of a steam cracker was
E- ETHANE, E/P - ETHANE/PROPANE, N - NAPTHA
about 550 million pounds (or 250,000 tons).
In 2002, the average size on a global basis will Source: Chem Systems
be about one billion pounds, or double the size Figure 8 - Global Ethylene Cost of
they were 20 years earlier. It is also very clear Production in 2000
that the Middle East now has the largest sized
crackers in the world, on average, and 5. CONSOLIDATION IN COMMODITY
therefore among the lowest conversion costs. CHEMICALS
It is also worth noting that all of the NOVA
Chemicals ethylene steam crackers are over The increased scale of individual crackers
1.6 billion pounds, which places them among is one consideration for reducing costs, but so
the largest. is the increased scale of some of the individual
competitors. The recent major mergers of
BP/Amoco, Exxon/Mobil and Dow/Carbide
700 are having a huge effect on commodity
600
chemicals. This is true not only in North
500

400
America, but also in Europe and Asia.
300 This data (Figure 9) shows that over the
200 last 25 years, the market share of the single
100 largest polyethylene producer has grown from
0
1982 1987 1992 1997 2002
14% to 22%. The combined share of the top
W. Europe USA Japan Middle East four producers has grown from 44% to 63%.
And the share of the eight largest has grown
Source: CMAI 1999 World Petroleum Conference
from 66% to 82%. All these numbers are
Figure 7 – 1982-2000 Average Steam based on the assumption that the Dow/Union
Cracker Sizes Carbide merger will proceed as planned. The
recently announced joint venture of the
Figure 8 shows what happens when you
chemical divisions of Chevron and Phillips
combine low-cost feedstock with scale,
will further propel this change.
efficiency and modern technology. As you can
see, cash costs for ethylene are lowest in the 1975 1985 1995 1999(1)
Middle East, followed by Malaysia and then Share of the 14.4 12.2 12.6 22.2
Western Canada. The U.S. Gulf Coast largest (%)

ethylene, when produced from ethane, is Share of four 44.2 43.2 45.7 63.2
further to the right and it costs about twice as largest (%)
much as Middle East ethylene. The producers Share of eight 66 76 69.9 82.7
in Asia, dependent upon imported naphtha and (1) Adjusted for Dow/UCC and Exxon/Mobile mergers
with higher energy costs are at the far right of Source: Chem Systems
the cost curve and even more disadvantaged.
Figure 9 - Consolidation is Having an
For NOVA Chemicals, this drives our Effect on Polyethylene in North America
ethylene strategy to be focussed on two key

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 HOW TO MAKE MONEY AT COMMODITY CHEMICALS

We talked earlier about the change thrust cost in selling and other general administration
upon our business through mergers and costs, while maintaining the business and
acquisitions. I think the next two charts leadership focus on commodity chemicals
(Figure 10 and 11) are interesting. They show which is essential to success.
that our company, NOVA Chemicals, has Finally, consolidation of this type allow us
become the largest player in North America in to achieve two other key components of scale.
styrene and number four globally. It’s a First, consolidation allows us to achieve the
similar story for polystyrene, except that we necessary scale to support the level of R&D
are #3 globally. We have made a good start at required to be among the leaders in commodity
becoming the leader in this industry. The chemicals and to achieve a competitive
interesting fact is that NOVA Chemicals has advantage with technology. Second,
never built a single styrene plant or consolidation gives us the financial scale to
polystyrene plant in the 12 years it has been in debottleneck and build only world scale plants.
this business. We own plants built by Fina, It is through plant scale, not the size of the
Monsanto, ARCO, Shell and others. overall business, that we achieve the lowest
Styrene Capacity conversion costs.
(mmlbs/yr)
North America Global
#1 NOVA Chemicals 3,000 Dow 4,635 6. NOVA CHEMICALS STRATEGY IN
Chevron 1,700 BASF 3,965 ACTION IN ALBERTA
Sterling 1,700 Shell 3,720
Dow 1,420 #4 NOVA 3,000
Lyondell 1,315 BP Amoco 2,135 Finally, let’s discuss how NOVA
Others 5,740 Others 33,015 Chemicals is putting this strategy into practice
Total 14,875 Total 50,470 here in Alberta. Earlier, we looked at a graph
showing that Western Canada has the lowest
Source: CMAI & NOVA Chemicals Feb, 2000 ethane feedstock costs outside of Saudi Arabia
Figure 10 - NOVA Chemicals Ranks and Malaysia. This comes from the influence
High in Capacity for Styrene, PS & EPS of the location factors discussed earlier, the
presence of large scale and highly efficient
Polystyrene and EPS Capacity ethane extraction and a favourable investment
(mmlbs/yr) climate. Alberta is a prime environment for
North America Global achieving a sustainable competitive advantage
#1 NOVA Chemicals 2,295 BASF 52,55 in feedstocks and therefore in ethylene costs.
Dow 1,655 Dow 4,130
BASF 1,370 #3 NOVA 3,655
Petrofina 1,070 Chi Mei 1,585
Chevron 550 ELF Atochem 1,170
Others 1,685 Others 20,850
Total 8,625 Total 36,645

Source: CMAI & NOVA Chemicals Feb, 2000

Figure 11 - NOVA Chemicals Ranks

High inCapacity for Styrene, PS & EPS
Mergers, acquisitions, and financial
engineering are important components of
building a strong commodity chemical
business. Acquisitions frequently can be done
at 50-70% of replacement cost. This remains a
highly valuable way to leverage capital returns
in this business. The resultant combinations
also enable the companies to reduce sales and
general administration costs through
economies of scale.
To succeed, one does not have to
participate in mergers or acquisitions that
make you the world’s largest company. That
is a route to low cost, but not necessarily the
desired business focus. We believe that the
value of consolidation is in achieving a
position as one of the largest players in each of
the commodity chemicals we participate in.
This will allow us to achieve the desired low
Figure 12 - Joffre E3 Ethylene Cracker
October 1999
Figure 12 is a picture of our new ethylene
plant under construction at Joffre, about two
hours drive north of Calgary. It will have an
annual production capacity of 2.8 billion
pounds, which will make it the largest ethane
cracker ever built. This plant will have seven
furnaces of 400 million pounds capacity each
(Figure 13). Its energy and production
efficiency is at the leading edge. It will have
conversion costs and fixed costs better than
any other site in the world. This plant will
bring total ethylene production at our Joffre
site to 6.2 billion pounds and we believe this

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 HOW TO MAKE MONEY AT COMMODITY CHEMICALS
scale makes NOVA Chemicals the clear low
cost producer in ethylene.
Figure 13 - Joffre E3 Ethylene Furnaces
October 1999
We’re also improving the economics at
the Joffre site by building a 450 MW, gas-
fired, cogen plant that will provide low-cost
power and steam to the entire Joffre complex,
and have surplus energy to market into the
local energy grid (Figure 14). The
development of a cogen facility next to plants
with high steam requirements (like ethane
crackers and Advanced SCLAIRTECH®
polyethylene plants) is a very effective way to
achieve efficient energy integration with
resultant low energy costs for NOVA
Chemicals.
Figure 14 - Cogen (in background) E3
Cooling Tower
BP/Amoco is also building a linear alpha
olefins (LAO) plant on the same site using our
ethylene to produce comonomers. This allows
BP/Amoco to achieve lower costs by
integration into our larger site. NOVA will
now have a cost advantage on the hexene and
octene comonomers used in polyethylene
production on site, as well as low cost ethylene
and energy.
We’re also building a brand new,
Advanced SCLAIRTECH polyethylene
plant. At 850 million pounds of capacity, it
will be the largest single train solution process
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plant in the world (Figure 15). This plant will
be larger than any gas phase plant, except
Exxon/Mobil’s in Singapore. The Advanced
SCLAIRTECH® process is a technology
developed by NOVA Chemicals to produce a
wide range of high performance and
commodity polyethylenes, all at a low cost. It
will run both our proprietary, advanced
Ziegler/Natta catalysts and our proprietary
single site catalyst. Our process uses a new
multi-reactor technology to achieve effective
product tailoring that more precisely meets the
needs of customers. Our products will feature
the toughness associated with single site
catalysts, combined with processability
comparable to conventional low-density
polyethylene. The plant can transition quickly
from one product to another, resulting in
products which are customized for specific
markets, but with a manufacturing efficiency
which allows the business to operate with low
inventories of finished goods, a significant
advantage.
Figure 15 - Advanced SCLAIRTECH
Polyethylene - October 1999
This polyethylene plant is going to be a
winner. We’ll have the benefits of low-cost
ethylene, low cost octene, low cost energy, a
large scale plant for good conversion costs, all
combined with more differentiated end
products for higher value. In this case, NOVA
Chemicals’ developed technology provides a
sustainable competitive advantage and the
ability to achieve the lowest cost for each of
the different polyethylene grades we produce.
7. CONCLUSIONS
Commodity chemicals is a very tough
business because it’s highly competitive,
technically demanding, and it suffers from
ongoing declining prices and cyclicality. It
may be pedantic to repeat the cliché that
change is continuous, but change is crucial to
delivering earnings in an environment of
continuously lower prices.
 HOW TO MAKE MONEY AT COMMODITY CHEMICALS

Change must focus on managing the three Considering the many challenges in our
core factors of industry, it’s no surprise that some of our
competitors don’t want to be in this business.
• Raw materials Many players seem willing to sell and get out.
• Scale Consolidation will continue. We like
• Technology commodity chemicals and we think liking the
business you’re in is an essential ingredient of
winning and making money.

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