Europe Equity Research 26 July 2010

Chemicals Primer

An investor's guide to the world of chemicals

Chemicals Neil C TylerAC (44-20) 7325-9935 [email protected] J.P. Morgan Securities Ltd. Martin EvansAC (44-20) 7155 6169 [email protected]

J.P. Morgan Securities Ltd. Heidi VesterinenAC (44-20) 7325-4537 [email protected]

J.P. Morgan Securities Ltd. Neeraj Kumar (91-22) 6157 3289 [email protected]

J.P. Morgan India Private Limited Hella Zouiten (44-20) 7155-6408 [email protected]

J.P. Morgan Securities Ltd.

See page 313 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan 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.

2 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table of Contents Chemicals primer – An investor’s reference guide...... 6 Introduction ...... 7 What makes up the chemicals sector?...... 7 Five main subsectors...... 7 1. Commodity chemicals ...... 8 2. Fertilisers/Agrochemicals ...... 9 3. Industrial gases ...... 10 4. Specialty chemicals...... 10 5. Pharmaceutical hybrids...... 10 The global chemical industry in numbers ...... 10 Production costs and energy structure...... 16 Investing in chemicals ...... 18 Key factors to look out for...... 18 1. Demand growth...... 18 2. Macroeconomic trends...... 21 3. Input costs/pricing power...... 23 4. Restructuring...... 24 5. Capital discipline ...... 26 Valuation...... 28 1. Key valuation methodologies...... 28 2. Peak to trough valuation ...... 30 Mergers and Acquisitions...... 31 1) Increasing portfolio focus...... 33 2) Increased balance sheet liquidity...... 36 3) Globalization ...... 37 4) Need to reduce cyclicality ...... 38 5) Interest from financial buyers...... 41 Commodity Chemicals...... 44 Inorganic Chemicals ...... 44 Introduction...... 44 Chlor-alkali...... 44 Soda Ash...... 51 Titanium Dioxide...... 54 Hydrogen Peroxide ...... 58 Petrochemicals...... 60 Introduction...... 60 Feedstock ...... 61 Olefins (primary)...... 64 Ethylene ...... 65 Propylene ...... 69 Butadiene ...... 73

2 3 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Aromatics (primary) ...... 77 Benzene...... 77 Toluene ...... 81 Paraxylene...... 83 Other monomers (intermediates)...... 87 Ethylene Glycol ...... 87 Methanol...... 90 Phenol ...... 94 Styrene Monomer ...... 97 Acrylic Acid...... 100 Acrylonitrile...... 102 Plastics (or Polymers)...... 106 Polyethylene...... 107 Polypropylene ...... 115 Polyvinyl Chloride (PVC)...... 119 Polystyrene ...... 123 Polyethylene Terephthalate (PET)...... 126 Other Polymers...... 130 Polyurethanes...... 130 Methylene-diphenyl diisocyanate (MDI)...... 130 Toluene diisocyanate (TDI) ...... 133 Polycarbonate...... 135 Fibres...... 138 Polyester Fibre ...... 138 Polyamide (Nylon)...... 140 Fertiliser ...... 145 Fertiliser Measurement ...... 145 Fertiliser Market and its Drivers ...... 147 Nitrogen fertiliser...... 154 1. Ammonia ...... 160 2. Urea...... 164 Phosphate...... 168 Potash...... 170 Agricultural Chemicals ...... 174 Herbicides...... 179 Fungicides...... 181 Insecticides ...... 182 Seeds and GMOs ...... 182

3 4 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

The industrial Gases industry ...... 186 Introduction...... 186 Industrial Gas companies are treated as defensive...... 188 Air Separation Technology...... 190 Distribution...... 192 Cost structure ...... 193 New opportunities...... 194 Atmospheric Gases...... 199 Nitrogen ...... 199 Oxygen...... 200 Argon ...... 203 Other Noble Gases ...... 204 Non-atmospheric Gases ...... 205 Hydrogen ...... 205 Helium ...... 208 Carbon Dioxide...... 208 Specialty Chemicals...... 210 Introduction...... 210 Overview...... 210 Specialty Chemicals Product Categories ...... 214 Paints and Coatings...... 217 Adhesives & Sealants ...... 221 1) Adhesives ...... 222 2) Sealants...... 226 Colourants...... 228 1) Dyestuffs...... 229 2) Pigments ...... 230 3) Masterbatches...... 234 Plastic Additives ...... 235 Water management chemicals ...... 238 Leather chemicals ...... 241 Consumer chemicals ...... 242 1) Flavours and Fragrances...... 243 2) Food ingredients ...... 249 3) Cosmetic ingredients ...... 253 Fine Chemicals ...... 256

4 5 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Catalysts ...... 259 European Chemicals: Companies at a glance ...... 263 Air Liquide...... 264 Akzo Nobel...... 266 Arkema ...... 268 BASF...... 270 Bayer ...... 273 Clariant ...... 275 Croda ...... 277 DSM ...... 279 Elementis ...... 281 Johnson Matthey...... 283 Kemira ...... 285 K+S (Kali und Salz)...... 287 Lanxess ...... 289 Linde...... 291 Rhodia ...... 293 Solvay...... 295 Symrise ...... 297 Syngenta ...... 299 Umicore ...... 301 Victrex ...... 303 Wacker Chemie...... 305 Yara...... 307 Yule Catto...... 309

5 6 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Chemicals primer – An investor’s reference guide We are publishing the second edition of our European Chemicals “Primer” to provide a broad introduction to both the major product areas and applications as well as an overview of the major European industry participants. This is intended as a reference guide for either information on specific areas of the chemical industry as well as on companies that are included in the sector.

We have broken the industry down into a number of larger segments for the purpose of this overview. These ‘sub-sectors’ include commodity chemicals, fertilisers and agrochemicals, industrial gases and the broad spectrum of specialty chemicals. It can be used in different ways: whether you need a general sector overview or specific information on chemical products, their production processes end markets, the supply/demand balance or price outlook. In addition, we have provided a series of company snapshots to offer a quick reference guide on some of the major listed European industry participants.

Although this primer is primarily aimed at those who are new to the sector, we hope that it will also prove a useful source of reference for those who have worked on the sector for some time already.

We also welcome your comments and suggestions on topics to be included in our next edition.

6 7 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Introduction

What makes up the chemicals sector? What are chemicals? The chemicals industry converts raw materials derived principally from oil and natural gas, minerals, and air as well as plant based raw materials into more valuable products for use in industrial and consumer markets. The sector consists of a vast array of products, including fertilisers, paints and coatings, plastics, industrial gases, petrochemicals and vitamins. The range of 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.

Chemicals is one of the most The chemicals sector is one of the most heterogeneous sectors in which to invest. heterogeneous sectors in which Companies differ tremendously in their product offering, primary feedstock, to invest customer structure and underlying technology. The vast range of end markets mean companies’ fortunes are driven by many different factors, with one of the key influences of its fortunes being GDP. As a result, the sector is still perceived as cyclical. This has resulted in a number of companies initiating portfolio moves in recent years to shift their portfolio base towards less cyclical products (e.g. DSM's sales of its Base Chemicals & Materials assets, Linde’s disposal of KION forklift, Lanxess’ disposal of Lustran Polymers, Umicore’s spin-off of Nyrstar and BASF’s acquisition of Cognis).

The sector is characterized by global markets, with all of the major operators having international businesses. In response to globalization, and as part of the continued search for scale efficiencies, the industry has undergone considerable consolidation in recent years and we anticipate the trend of geographic diversification (investments as well as M&A) to continue.

Five main subsectors Although the chemicals sector consists of a vast array of products, companies’ operations can broadly be divided into five main categories:

• Commodity chemicals • Fertilisers/agrochemicals • Industrial gases • Specialty chemicals • Pharmaceutical hybrids

Although the activities of the companies often span more than one of these areas, we adopt this demarcation in order to approach the sector methodically.

7 8 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

1. Commodity chemicals Commodity chemicals are bulk Commodity chemicals are typically produced in large quantities, and sold on the chemicals, increasingly basis of price, and, in some cases, by small, targeted variations in compositions. As produced by upstream the name suggests, customers tend to differentiate between suppliers on the basis of producers price rather than effect. Product types included within this category include organic chemicals, petrochemicals, basic plastics and other resins, inorganic chemicals, and man-made fibres.

Because of the relative ease of vertically integrating production with the manufacture of its (usually petrochemical-based) feedstock, commodity chemicals are increasingly produced by companies with access to lower cost oil & gas reserves (e.g. Middle Eastern players) such as SABIC. Increasingly, these production assets are housed within the oil refining businesses. However, some oil companies have chosen to spin off their business (Total, BP).

Prices tend to be set on a monthly contract basis or on a spot basis and the market participants are largely obliged to sell at this price ("price takers").

A number of companies remain in the US and Europe, although competition from Middle Eastern players and concerns over cyclicality has meant that Western companies are increasingly looking to exit these business areas (e.g. GE Plastics and DSM Petrochemicals sold to SABIC, Dow's attempted JV with PIC).

It is worth noting that in the European chemicals sector there are now no listed commodity chemicals players of significant scale – only parts of larger conglomerates, such as BASF’s petrochemical business and Solvay and Arkema’s PVC business. The two main petrochemical players in Europe are INEOS (ex Bayer) and LyondellBasell (ex BASF/Shell), both of which remain in private hands.

8 9 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 1: Main Types of Commodity chemicals Commodity chemicals

Inorganic chemicals Organic chemicals (Petrochemicals)

Inorganic chemicals are principally derived from Organic chemicals are either derived from crude oil or brines and minerals such as sulfur or phosphate natural gas and can in turn be further broken down rock. They form the foundations of major chains, into single molecules (including the subsector such as the chlor-alkali chemicals, and of products “monomers,” which are typically combined to form such as salt, fertilisers, and oxides, including long-chain compounds—polymers). titanium dioxide and iron oxide

Source: J.P. Morgan

• Key European commodity chemical players: BASF, Solvay, Arkema, Ineous, Lyondellbasell • Key U.S. players: Dow, Du Pont, Eastman, Georgia Gulf

2. Fertilisers/Agrochemicals Fertilisers and agrochemicals Fertilisers, agrochemicals and seeds are often categorized together, as they all assist are used at different stages of different stages of the farming process. the farming process Fertilisers 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 also contain secondary trace nutrients (calcium, magnesium, sulfur, iron, copper, and zinc). Urea is the most basic of Nitrogen fertilisers, whereas DAP, NPK and CAN are more specialized compounds which command higher prices and margins.

• Key European fertiliser players: Yara, K+S Agrochemicals are 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 companies to dominate the industry globally.

Many agrochemical manufacturers also have a seeds & GMO (genetically modified seeds) business which allows them access to a greater percentage of the farming value-chain.

• Key European agrochemical players: Syngenta, Bayer CropScience, BASF Agricultural Solutions

9 10 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

3. Industrial gases Industrial gas companies sell Industrial gas companies separate air into its components and sell the units onto components of air and synthetic third parties. In addition, gas producers now provide an array of specialty gases for a gases wide variety of uses, including steel production, electronics and healthcare. Because of the comparatively high reliance on long-term contracts, the industry tends to be less cyclical than many other areas of the chemicals sector.

• Key European industrial gas players: Linde, Air Liquide

4. Specialty chemicals Specialty chemicals encompass Specialty chemicals, in contrast to commodities, are those chemicals that are sold on a vast array of products and are the basis of their performance (and increasingly, technical service) rather than for not typically large volume their chemical composition or price. The variety of end products is vast, including commodities both industry and function-specific chemicals. However, margins and returns vary dramatically within specialty chemicals. Examples of specialty chemicals include paints, plastic additives, high performance plastics, cosmetic ingredients and automotive catalysts.

• Key European specialty chemical players: Akzo Nobel, Arkema, BASF, Clariant, Croda, DSM, Givaudan, Kemira, Johnson Matthey, Lanxess, Rhodia, Symrise, Umicore, Victrex.

5. Pharmaceutical hybrids A few chemical/pharma hybrids A handful of chemical companies retain significant pharmaceutical operations. remain in Europe Although the majority of these hybrids have now spun off or sold their pharma business to become pure-play chemical players (eg BASF in 2000, Akzo Nobel and Altana in 2007, Solvay in 2009), there remain a number of European businesses which have retained a hybrid structure.

• Key European hybrid players: Bayer, Lonza and Merck

The global chemical industry in numbers The global chemicals industry generated about €1.8tn of sales in 2009, as per BASF and CMAI. Asia accounted for the largest proportion of sales (37%), led by China (global #3) and India (#7). The EU25 accounted for 31% of the global sector, followed by NAFTA, accounting for 22%.

Global chemical production is expected to continue to grow at a healthy rate in the next few decades, with the OECD estimating global output in 2020 to be 85% higher than in 1995 (CAGR=2.5%).

10 11 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 2: Geographical distribution of world chemical sales (2010E)

Rest of Asia China 15% 15%

Others* Japan 2% 7%

Latin America EU25 5% 31%

Rest of Europe** 3%

NAFTA 22% Source: CEFIC and J.P. Morgan estimates Others* = Oceania and Africa, Rest of Europe** = Switzerland, Norway and other Central & Eastern Europe (excluding the new EU 12 countries)

According to CEFIC, the European chemicals sector accounts for 2% of GDP, or more than 7% of manufacturing value-added in Europe. Germany is the largest producer, with a 24% share of the European chemicals sector. European production is relatively concentrated, with the top four (Germany, France, UK and Italy) constituting almost two thirds (€296bn, 60%) of the industry.

Figure 3: Geographic distribution of European chemical industry sales (2010E) Belgium Ireland Others 6% 5% 12% Spain 7%

Netherlands Germany 10% 24%

Italy 11% UK France 10% 15%

Source: CEFIC and J.P. Morgan estimates, Others include Poland,Sweden,Finland,Austria,Czech republic,Hungry,Slovania,Portugal,Denmark

11 12 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 4: Chemicals demand (excluding pharma) 2009 Figure 5: Chemicals demand, expected CAGR (2009-2020E)

World World

South America South America

North America North America

Western Europe Western Europe

Asia pac Asia pac

0% 1% 2% 3% 4% 5% 6% 7% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Source: BASF Source: BASF

From 2000-2010E, European production growth has slowed (+1.3% vs world average of 4.8%), as production was increasingly shifted to the emerging markets. World chemicals demand will however grow by 6.2% through 2009-20, as per BASF.

Highest growth rates in China, Figure 6: Chemicals sales growth rate in % (2000-2010E CAGR) Mexico and India 18% 16.5%

15%

12% 8.7% 7.6% 7.6% 7.3% 9% 6.8% 5.4% 4.8% 6% 4.0% 3.9% 3.4% 2.9% 2.1% 3% 0.1% 0%

o a n lic il 7 A n ina ic a b z rld -2 S a h x Indi u o U p C Bra W a Russia EU Africa anada J Me Taiw Re p C , a re Switzerland Ko Source: CEFIC and J.P. Morgan estimates

Growth rates vary considerably between product groups (Figure 7). According to CEFIC, pharmaceuticals and consumer chemicals showed more resilience during the downturn in 2009. More cyclical areas - petrochemicals and polymers – declined year on year.

12 13 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 7: Chemical production growth rate by sector in %

6% 5.5% 5% 3.9% 4% 2.7% 2.4% 2.6% 3% 2.4% 1.8% 1.5% 2% 0.8% 0.3% 1% 0.3% 0.0% 0%

-1% -0.6% -1.2% -0.8% -0.9% -2% -1.5% -1.4% -1.3% -1.3% -3% -2.3% Pharmaceuticals Consumer Overall Specialty Petrochemicals Basic Poly mer s Chemicals Chemicals Chemicals Inorganics

2007 2008 2009

Source: CEFIC and J.P. Morgan estimates.

In terms of product type, base chemicals account for the largest share of the European chemicals sector, estimated at 43% in value terms. This category covers petrochemicals and derivatives, as well as basic inorganics. However as we outline below, the majority of the listed space in Europe occupies positions further along the value chain. Pharmaceutical, specialty and fine chemicals account for 28% and 19% respectively. These are followed by consumer chemicals, contributing c.10% in sales. These products are sold to producers of finished consumer products including soaps, detergents, perfumes and cosmetics.

Figure 8: Sectoral breakdown of EU chemical sales (2010E) Figure 9: End market breakdown (2010E) Crop protection Fertilizers Textile & Clothing Pharmaceuticals 1% 2% Rest of Indus. 6% 28% 10% Industrial gases Agriculture 6% 2% Elec. Goods 4% Man-made fibres 2% Office Mac. 1% Other basic inorganics Indus. Mac. 2% Metal Products 4% 3% Plastics & Sy nthetic Soaps & detergents Consumers 31% rubber 4% Services 16% 17% Paints & inks 6% Perfumes & cosmetics Rest of Manufac. Other specialty 6% Paper & Printing Petrochemicals 6% chemicals 5% 16% 12% Automotive 5% Construction 5% Source: CEFIC and J.P. Morgan estimates Source: CEFIC and J.P. Morgan estimates

The chemical sector supplies a vast array of sectors across the economy. The largest end market is ‘consumers’ like private households, government and non-profit organizations, with a share of 31%. Other important end markets in the industrial space are metals, mechanical & electrical industries, textile and clothing, and automotive and paper - which contribute 25%. In addition, services represent the other large end market, with a 16% share.

13 14 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

European and US chemical companies still dominate in terms of sales. However, new players in China, Saudi Arabia and Taiwan already take important roles in the global chemical industry.

Figure 10: Top 30 chemicals producers by sales (2009) $ million

80,000

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0

) ) ) ) ) ) ) ) ) ) ) ) ) S) U em an) wan U U) an S U) U) S) U E (EU (US) i (E E (India E E U (US) r ( s (China och (Jap el (EU (Ta e ( (Jap s y (EU s SF (EU o c ont i l nd (Japan)* a A aye ne etr P Total (EU) ob a mo (Japan) i Yara (EU) uct B B I pe udi Arabial P N ic o atthey L tsu stries (U DSM ( a u it M E du Solv yngenta ( Praxair ( no (S D subish zo S Umicore (EU) Si it um Air Liquide (EU) Chemicals (EU) ic M Ak S Shin- G In rochemical Air Prod ab rochem k P Dow chemicals ( LyondellBasell (US) S t Asahi Kasei P Pe ExxonMobi Johnson Toray IndustriesEvoni (Japan liance Pet rmosa o Re F Source: Company reports and J.P. Morgan, numbers for ExxonMobil, Reliance, Total and Evonik include only the Chemicals division of these companies. Currency exchange rate: 2009 average FX rates.

14 15 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 11: Top 34 chemicals producer by market cap (2009) $ million

90000

80000

70000

60000

50000

40000

30000

20000

10000

0

) ) a ) ) n) a ) ) ) ) ) n) ) U) a ic an) U an) n U) EU US) US US) US) US) r EU) (EU (E (US) EU pan) p E (E ( (EU) ( ap ( (EU) Af ( (US (EU) iw (EU) a ( O ( E J IR ( h E a B (J (Japa (Ja N c (Chin SF RA I (Japa e NT XA ut IND K+S PPG (US) DSM (EU) op AYER ( BA PONT So L YA IES SE in B CORP RA GENTA ( DUCTS R UDA S NSA H DU P MOSAIC N HENKEL (EU) ECOLA AGRIUM (US) SOLVAY ( T KA VA O NAN YA (T GI UMICORE (EU) M AIR LIQUID SY SOL PRO LASTICS (Taiwan DUS SHIN-ETSU ( R AKZO NOBEL P SUMITOMO SAHI POTAS SA CKER CHEMIEIN A DOW CHEMICAL (US) AI A Y W RA O T JOHNSON MATTHEY (EU) FORMOSA ITSUBISHI CHEMICAL M Source: Company reports and J.P. Morgan Currency exchange rate: 2009 average FX rates

15 16 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Production costs and energy structure For the chemical industry as a whole, external purchases account for c.70-75% of total costs. On average the costs incurred by chemical companies are similar to that of other businesses, although there can be significant variation in cost structure, depending on the type of products produced. For example, the industrial gases business is more capital-intensive but requires less marketing costs, whereas many specialty chemicals businesses are the opposite.

Figure 12: Average cost structure of the EU chemical industry (2010E) Gross operating surplus* 10% Trading 11%

labour cost 14%

Energy** 8%

Other costs 57% Source: CEFIC and J.P. Morgan estimates * Gross operating surplus = value added - labour cost (payroll) = = profit before taxes, financial charges and depreciation **Energy is defined as all energy mining products, oil refining products and electricity and gas products

Input costs take a key position The chemical industry upgrades energy and raw materials into products required by for chemical companies other industrial sectors as well as by final consumers. Therefore, input costs are a key determinant of a given operation’s competitiveness on the world market. Feedstock accounted for almost 60% of total input costs and fuel and power for the remaining 40%. Cost structures however differ significantly within the chemicals industry, as certain sub sectors like petrochemicals or industrial gas manufactures are much more sensitive to energy costs but have lower payroll and marketing costs. The opposite is true for specialty chemical companies, where service levels take a higher percentage of overall costs.

Figure 13: Energy consumption by source for the EU chemical industry 80

60

40

20

0 Oil Gas Electricity Heat Coal Renew ables Others

Feedstock Fuel & Pow er Source: CEFIC

16 17 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Consistently since energy costs comprise a high percentage of overall costs and prices have been increasing in the recent few years, improving energy efficiency is essential for the chemical industry.

The chemical industry lowered In 2005, energy consumption per unit of production (incl. pharmaceuticals) was 42% its energy consumption by 42% lower than in 1990. Over the past 15 years, the chemical industry has succeeded in in 15 years increasing continuously its output while at the same time decreasing the percentage of energy input. On average, the chemical industry has lowered its energy intensity per production unit by 3.6% annually.

Figure 14: Energy consumption (1990-2006) Index 1990=100

160

140

120

100

80

60

40 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Energy Consumption Chemicals Production Energy Intensity

Source: CEFIC and Eurostat

The sector in recent years has increased its focus on utilizing natural raw materials (eg. Plants) in an effort to lower their carbon footprint and reliance on petrochemicals inputs. Biopolymers are a key example.

Figure 15: The EU manufacturing industry: Added value per employee- 2005 Index (chemicals=100) Pharmaceutical Chemicals Office Machinery and computers Radio, TV and communication Basic metals Automotive Pulp & Paper Other transport equipment Medical,pres. & other optical ins. Publishing & Printing Machinery and equipment Manufacturing Recycling Other non metallic mineral products Electrical machinery & apparatus Rubber and plastic products Food products & beverages Fabricated metal products Furniture; manufacturing Wood & w ood products 0 20 40 60 80 100 120 140 Source: CEFIC, J.P. Morgan

Chemical is the second leading manufacturing sector (after pharmaceuticals) in terms of "added value per employee" in Europe. As a consequence, labor productivity in the chemical industry is growing by 3.9% annually and therefore faster than labor productivity in the total industry (2.4%).

17 18 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Investing in chemicals

Key factors to look out for Given the heterogeneous nature of the chemicals sector, it is difficult to pinpoint any one theme that uniformly impacts the whole of the sector. As with most sectors, there is not one dominant variable, but a complex interaction of external factors. Below we present the five key factors to look out for, in our view, in evaluating any investment opportunity.

1. Demand growth 2. Macroeconomic developments 3. Input costs/pricing power 4. Restructuring and fixed cost base 5. Capital allocation

1. Demand growth The global chemicals sector is In summary – European chemicals are not as cyclical as often believed as end- influenced by expectations of market exposures differ significantly, and in assessing demand growth it is critical to GDP growth… examine the end-market characteristics on a case-by-case basis.

Demand remains the most important determinant of company profitability and returns. Therefore, the chemicals sector is heavily influenced by expectations about GDP growth and industrial production.

Figure 16: European Chemicals – Average Capacity Utilisation 88.0%

86.0%

84.0%

82.0%

80.0%

78.0%

76.0%

74.0%

72.0%

70.0%

68.0%

66.0%

3 93 5 95 97 97 8 99 99 0 0 1 2 03 04 05 6 6 07 07 8 8 0 99 99 1996 1998 99 00 00 00 00 2004 2005 00 00 00 00 01 1Q1 3Q19 1Q1994 3Q1994 1Q1 3Q19 1Q1996 3Q 1Q19 3Q19 1Q 3Q1 1Q19 3Q19 1Q2 3Q2 1Q2 3Q2001 1Q2002 3Q2 1Q20 3Q2003 1Q 3Q20 1Q20 3Q 1Q2 3Q2 1Q20 3Q20 1Q2 3Q2 1Q2009 3Q2009 1Q2 Source: CEFIC, J.P. Morgan research

18 19 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 17: European Chemicals: Average volume growth* (yoy) % 25.0%

20.0%

15.0%

10.0%

5.0%

0.0%

-5.0%

-10.0%

-15.0%

-20.0%

-25.0% 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110

Volume Source: J.P. Morgan estimates, Company data. * Excluding Agchem/ fertilizer

… yet the European sector Although from a global standpoint we believe the sector remains relatively cyclical remains relatively defensive, vs and heavily exposed to economic activity, we believe the European sector to be less its US and Asian peers cyclical than the US and Asia due to the significant level of “defensive” elements in their portfolios. Table 1 shows the key end-markets serviced by each of the companies in the European sector. We estimate that over 50% of the market capitalization of European Chemicals plc is exposed to end-markets with strong structural growth drivers, and hence less dependent of GDP development.

19 20 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 1: European Chemicals end market split (% of sales) DEFENSIVE GDP LINKED PHARMA/HEALTH/CONSUMER AGRICULTURE AUTOMATIVE CONSTRUCTION Gen. Health / Paper & Metals Marine & Construction Construction Industrial/ Pharma Nutrition Consumer Fertiliser CP/ seeds Textile Packaging processing Aero-space Electronics OEM Tyres Autocats (new) (renov) Engineering Chems Other Air Liquide* 11% 11% 27% 8% 9% 8% 20% 6% Akzo Nobel 3% 12% 2% 6% 5 9% 5% 5% 6% 11% 22% 5% 12% 5% Arkema 5% 5% 10% 5% 10% 10% 5% 15% 10% 20% 5% BASF 1% 2% 5% 6% 7% 2% 7% 4% 11%1% 5% 14% 1% 19% 14% Bayer 33% 15% 19% 3% 2% 5% 5% 5% 6% 3% 3% Clariant 17% 3%14% 14% 5% 4% 13% 7% 20% 3% Croda 10% 50% 10% 5% 5% 5% 5% 5% 5% DSM 10% 38% 5% 5% 6% 5% 7% 11% 13% Elementis 10% 30% 20% 20% 10% 10% JMAT 12% 8% 6% 4% 52% 4% 2% 5% 7% K+S 68% 32% Kemira 10% 40% 20% 20% 10% Lanxess 5% 15% 7% 5% 15% 24% 5% 5% 15% 4% Linde* 11% 11% 16% 5% 7% 21% 22% 7% Rhodia 10% 12% 3% 12% 5% 15% 5% 3% 10% 5% 5% 6% 10% Solvay 2% 10% 9% 6% 11% 12% 12% 5% 11% 23% Symrise 50% 50% Syngenta 100% Umicore* 5% 15% 20% 30% 15% 10% 5% Victrex 30% 5% 10% 10% 20% 20% 5% Wacker* 5% 4% 50% 5% 23% 9% 4% Yara 95% 5% Yule Catto 20% 10% 20% 10% 10% 20% 10% Source: Company data and J.P. Morgan estimates, *adjusted for take-or-pay

20 21 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Key sectors which have historically shown “defensive” characteristics include pharma, consumer goods and oil & gas. The automotive catalyst producers, although influenced by cyclicality of the automotive sector, benefit from strong secular growth drivers, due to regulatory influences impacting volumes. The relative share price performance of the sector in the last period of slow demand (2008) indicates the relative strength of these “defensive” elements (Figure 18).

Figure 18: European Chemicals: Share price performance in 2007 Figure 19: European Chemicals: Share price performance in 2008 120% 0%

-10% 100% -20% 80% -30%

60% -40%

40% -50%

-60% 20% -70% 0% -80%

-20% -90%

E AG C SA AG EG EG NV € Pr BEL AG TO -40% S -R -R E AG YARA PL F SE 0 O S AG AT IA K+ CRODA LONZA G G D SM 0 C ANA BAS 6 MICOR XES ARKEMA LT IQUIDE SA BAYER AGLIN U HOD A L KE D SOLVAY SA EMIRA OYJ R ANT A IJ K LAN ENTA A STXE AKZO N YULE GIVAUDAN-REG AIR G KL LARI -60% C NIN SYN STXE 600 Chem € Pr KO WACKER CHEMIE JOHNSON MATTHEY -80%

R F E L E A D M A S A IE +S E Y R TA E D I S 600 N TO N M K AS N U D VAY YARA AY B HE OB LIN EM Q DA L AT B ICO LONZA N K LI TXE RODA U HODIA C LTA TT M S C KEMIR R SO A CHE A U AR IR IVA LANXESCLARIANT R M SYNGE KZO A G ULE N A Y STXE 600 Chem ACKE SO W JOHN Source: Bloomberg Source: Bloomberg

2. Macroeconomic trends In summary – Earnings in European chemicals remain heavily influenced by currency fluctuations, with developments in €, CHF, £ and $ being key. Changes in interest rates, on the other hand, have limited impact due to the low level of gearing across the sector.

In addition to demand, exchange rates and interest rates are two other key macro economic drivers.

Exchange rates Exchange rate developments can impact a company’s earnings in three ways:

• First, there is the direct and simple translation 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). This has limited impact in Europe, since for the majority of European companies sales and assets tend to be fairly well managed. • 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.

Figure 20 shows the geographic exposure of our coverage universe. European chemicals companies derive an average of c.50% of sales within Europe, and another c.20-25% from the US. However we note that the recent € weakness has benefited a large number of European players.

21 22 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 20: Sales by region – 2009 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

t el a a tis y yj a y a e x o m ian d n ss di a nt e tt o K+S O e o lv e icor tr Yara a Nob BASF Cr DSM a Linde h C o Arke Clar R So Symrise m Vic le Eleme mir Lanx Syng U Air LiquideAkz Ke Yu Wacker Chemie Johnson Matthe Europe North America Asia Latam ROW Source: Company data and J.P. Morgan estimates.

Table 2: Annual US$/EUR exchange Figure 21: US$ /EUR spot rate rates USD/EUR Year Exchange 2 1998 1.11463 1999 1.06579 2000 0.92395 1.5 2001 0.89672 2002 0.94632 2003 1.13245 1 2004 1.24340 2005 1.24324 2006 1.25774 0.5 2007 1.37193 2008 1.47016 2009 1.39465 0 2010 1.33438 Source: Datastream 8 9 0 1 2 3 4 5 6 7 8 9 0 99 99 00 00 00 00 00 00 00 00 00 00 01 1 1 2 2 2 2 2 2 2 2 2 2 2 Source: Bloomberg

Interest rates Interest rates and the perception over monetary policy have historically had a significant influence on the performance of the chemicals sector relative to the market. However, given the relatively low level of gearing in the sector resulting from a period of healthy earnings growth and non-core asset disposals, we view the direct impact of changes in interest rates on the earnings in the sector as limited. We estimate that a 100bps increase in net borrowing cost would have an average impact of 1-2% on profit before tax.

Moreover, interest rates also play an important role in overall industrial investment activity and are key for calculations on future projects.

22 23 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

3. Input costs/pricing power In summary – the input cost/pricing power dynamic differs significantly across the sector, with those benefiting from strong market positions or differentiated product portfolios benefiting from greater pricing power, and thus greater earnings security.

The balance between changes in input costs and selling prices is of significance in any industry. With the price of Brent crude remaining volatile, the topic has been an area of great concern within the chemicals sector due to its high level of reliance on petrochemical feedstock. Figure 22 indicates that the contract prices of the five main raw materials used by the sector have closely tracked the spot price of Brent crude.

Figure 22: Contract petrochemical prices have closely followed the Figure 23: DJ Stoxx Chemicals vs Brent Oil price of spot Brent Rebased on the 31/12/1999=100

400 400

350 350

300 300

250 250

200 200

150 150

100 100

50 50

0 0 Jan-2000 Jan-2001 Jan-2002 Jan-2003 Jan-2004 Jan-2005 Jan-2006 Jan-2007 Jan-2008 Jan-2009 Jan-2010 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Benzene Butadiene Ethylene STXE 600 Chem Crude Oil €/BBL Polyethylene Low Density Propylene Contained Value Crude Oil Source: CMAI and CMAI estimates Source: Bloomberg, Datastream Note: Contract petrochemical prices in € and Brent spot €/BBL

Although input cost developments have impacted earnings across the sector, it is worth noting here that the lack of commodity chemicals names in Europe has meant that there has been some level of decoupling between input costs and earnings momentum.

Figure 24 show that pricing power differs significantly across the European sector due to wide variations in end-market characteristics, product lines and market positions.

Companies with greater pricing power have tended to be those with (i) dominant market positions, (ii) a high quality product offering with high barriers to entry, (iii) a profit-incentivised sales force, (iv) a favourable supply/demand balance and (v) a consolidated industry environment. Key examples of companies with above-average “pricing power” in our view include the gas companies (Air Liquide, Linde), automotive catalyst companies (Johnson Matthey, Umicore) and Croda.

23 24 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 24: European Chemicals: Average Pricing momentum (%, yoy) Average Pricing Growth (YoY) 10%

5%

0%

3 3 03 3 4 4 5 05 5 6 6 06 6 7 7 8 8 8 9 9 09 9 10 Q0 Q Q0 Q0 Q Q0 Q Q0 0 2 0 10 3 1 -5%1 2Q0 3 4Q0 1Q04 2 3Q04 4 1Q0 2 3Q0 4Q05 1 2Q0 3 4Q0 1Q07 2 3Q 07 4Q Q10 Q Q30 Q408 Q Q20 Q Q40 Q

-10% Source: J.P. Morgan estimates, Company data. Excluding K+S.

Many ‘commodity’ chemicals have enjoyed strong pricing power following several years of robust demand combined with limited supply growth. This has meant that input costs have been relatively quickly passed through in the form of price increases. Elsewhere in the sector, ‘pricing power’ has been far more varied both between companies and also between individual businesses within those companies. With the recent exceptional environment being an exception, on the whole, companies have struggled to raise prices sufficiently to offset cost pressures and maintain gross margins.

Although a rising oil price would normally be associated with some level of earnings pressure across the sector, we note that BASF, due to its Oil & Gas business, is a net beneficiary of an increased oil price. Chemicals companies have typically performed well during a high oil price environment since this is more often than note reflective of robust economic growth, and hence healthy demand, which we note above, is the most important factor n dictating operating performance.

4. Restructuring In summary – Restructuring remains a continuous theme, but optimization of COGS is the key to uplifting earnings. To focus on restructuring only is fairly ineffective without being able to generate any pricing power.

Portfolio re-shaping and restructuring remain a perennial theme within the sector, with a view to increasing cost efficiency through effective utilization of plants, materials and workforce. An overview of the key ongoing programmes in this area is shown below:

24 25 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 3: European Chemicals: Overview of ongoing restructuring programs- June 2010 Update Company Cost cutting programme Timeframe Targeted savings (m) Savings still outstanding (m) Air Liquide ALMA 2008-2012 € 600 € 265 Akzo Nobel ICI synergies/restructuring 2008-2011 € 340 € 48 Arkema Restructuring 2006-2010 € 600 € 92 BASF NEXT 2009-2012 € 1,000 € 700 Clariant 2007-2010 SFr. 500 SFr. 350 Croda Wilton closure 2009-2010 £5 £5 DSM Restructuring 2009-2010 € 200m na Lanxess Challenge 09 & 12/Petroflex 2010 € 140 € 0 Linde HPO 2009-2012 € 650-800 € 350-500 Rhodia Restructuring 2010 € 130 € 130 Solvay Horizon project 2010-2012 € 120 € 120 Syngenta Operational efficiency restructuring prog 2008-2011 $290 $165 Source: Company reports and J.P. Morgan estimates

Although many of the current programmes are focused around reducing fixed costs with the aim to uplift margins, recent history suggests that for the majority of companies it is the gross margins, and not the operating expenses below that are key to determining operating performance. Figure 25 indicates that on average, COGS represents c.65% of sales across the sector, while SG&A typically represents only c.25% of sales. In addition, we highlight that although the recent credit crisis has prompted the majority of corporates to cut further cost, the sustainability of these savings remain questionable, with on average 50% of savings being variable in nature.

Figure 25: European chemicals: COGS/Sales (%), 2009 100% 90% 80% 70% 60% 50% 40% 30% 20%

a t e i yj ss e da F tis d y l a e ey od O ema ara o S SM +S va uid k icore Y nxe Cr A D Lin K obe q Rh Ar m a Clarian B Sol N Li Victrex U L Elemen Symrise zo Syngent ir Kemira Ak A nson Matth Joh Wacker Chemi

Source: Company reports Our discussions with management teams in the sector indicate that raw materials and energy account for up to 65% of COGS, with an average of c.55%. Consequently, in the absence of price increases, we estimate that a 3% increase in raw material/energy costs would equate to c.100 bps of operating margin, or c.5% of costs below gross margin, all else remaining equal.

Therefore we take the view that restructuring programmes are most effective when focused around improvements at the gross margin level, either through (i) optimization of COGS or (ii) when accompanied by pricing power.

25 26 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

5. Capital discipline Capital allocation has been a key area of concern for investors in the past decade, with the industry track record punctuated with examples of destroying value through making expensive investments. Often at the top of the cycle, only for margins to be adversely affected at the bottom of the cycle, and paying excessive multiples for acquisition targets in order to fuel growth as a cycle run out of steam. However, capital discipline appears to have improved over time, with management teams increasingly focused on value creation and return-based management. This has rewarded companies with a significant improvement in ROIC.

Figure 26: European Chemicals: ROIC development %

12

10

8

6

4

2

0

6 8 0 1 2 3 5 7 9 995 9 997 9 999 0 00 0 00 004 0 006 0 008 0 0E 1 19 1 19 1 20 2 20 2 2 20 2 20 2 20 1 011E 20 2 2012E Source: Company data and J.P. Morgan estimates.

Figure 27: European chemicals: capex/sales development Figure 28: European chemicals: capex/depreciation development 12% 200%

180% 10% 160%

140% 8% 120%

6% 100%

80% 4% 60%

40% 2% 20%

0% 0%

7 0 4 7 E E E 996 99 999 00 003 00 006 00 009 0 6 9 01 2 04 5 7 09 E E E 1995 1 1 1998 1 2 2001 2002 2 2 2005 2 2 2008 2 011 995 998 003 006 0 201 2 2012 1 199 1997 1 199 2000 20 200 2 20 200 2 200 2008 20 12 201 2011 20

Source: Company data and J.P. Morgan estimates. Source: Company data and J.P. Morgan estimates.

26 27 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

M&A Starting in the late 1990s, the sector has witnessed a number of major corporate deals, with a proliferation of demergers which created a stream of new companies – e.g. Arkema, Ciba, Clariant, Givaudan, Lanxess, Rhodia, Symrise, Syngenta and Yara. Smaller asset disposals have also continued to be a key theme in the past three years, as companies increasingly strive to focus their portfolios.

However, some companies sought to increase scale, and looked to reach critical mass through acquisition. Newly demerged companies, in an attempt to increase scale and utilize their balance sheets, acquired a number of assets, more often than not paying too high a price. We believe this has progressively improved over time, with management teams showing greater sensitivity to investor concerns over acquisition risk.

We present further detail on the drivers and themes of chemicals M&A in the separate M&A section in this document.

Return of cash to shareholders Lack of M&A targets at a fair The increasing balance sheet strength of the sector in recent years has prompted a price has resulted in increased number of companies to increase distributions. Also, many companies are targeting cash distributions the same assets for potential acquisitions (e.g. growth regions), resulting in difficulty in justifying high multiples.

In the years of healthy demand growth (before the crisis of 2008), a number of companies including BASF, Akzo, DSM and Umicore all announced significantly increased shareholder distributions. The use of cash distributions in our view indicates a realization amongst companies that value-accretive acquisitions are increasingly difficult to identify. Cases where investment opportunities offer significantly positive returns are likely to remain limited, and where such opportunities are not available, we view this as an appropriate use of capital.

27 28 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 4: European chemicals: 2009 dividend yield* (%) Company Dividend policy Yield (%) Air Liquide 45-50% of net income 3.2 Akzo Minimum pay-out 45% of net income (adj) 4.3 Arkema Grow dividend inline with group’s performance 3.1 BASF Aim to increase each year or at least maintain 5.4 Bayer 30-45% of net income 2.8 Clariant No explicit policy 0.0 Croda Growth to be closely aligned to EPS (adj) 3.6 DSM Stable and preferably rising dividend 4.8 No explicit policy (The Board intends to continue to review the dividend Elementis 7.2 policy as earnings performance and debt levels permit) Johnson Matthey In line with EPS growth 2.4 Kemira Aim is to distribute 40-60% of the operative net profit as dividend 3.7 K+S Payout ratio of 40-50% of group earnings (adj.) 0.5 Lanxess No explicit policy 2.7 Linde Earnings based policy 2.8 Rhodia No explicit policy 3.6 Solvay Stable or preferably increasing 3.5 Symrise To pay attractive dividend inline with peers 4.5 Syngenta No explicit policy 2.4 Umicore Steady or gradually increasing 3.7 Victrex Increase every year in line or above earnings growth 3.1 Wacker Atleast 25% of net income 1.2 Yara Minimum 30% net income over business cycle 2.4 Dividend was suspended in Dec 2008 to reduce the debt level below Yule Catto 0.0 £100m. Now dividend distribution will commence from 2010 interims. Source: Company reports and J.P. Morgan estimates. * calculated at 2009 average share price.

Valuation 1. Key valuation methodologies Given the highly disparate nature of European chemicals companies, covering a wide range of sub-sectors including pharma, fertilisers, paints & coatings and oil & gas, we use a combination of relative and absolute methodologies to value each investment opportunity. The key methodologies are shown in Table 5. We use the DCF approach, which we treat as the most accurate methodology in setting the majority of our price targets, sense-checked against a number of relative valuation methods including EV/EBITDA, P/E, EV/IC vs ROIC and FCF yield.

28 29 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 5: Key valuation methodologies Method Advantages Disadvantages Popularity Watch out for… DCF * Reflects growth * Highly sensitive xxx * Sensitivity to key assumptions (terminal growth/WACC) potential and to key assumptions * Sustainability of long-term margin assumption profitability (terminal growth, * Sustainability of capex/depreciation ratio * Reflects capital WACC) intensity (& leverage) * Allows calculation of growth rate implied by current/target price ROIC * Reflects value * Requires good xx * Working capital movements Absolute creation and visibility over profitability of working capital business movements Sum-of- * Comparable * "Parts" reliant on xx * Difficulty in assigning a peer group to "parts" given conglomerate nature of many the-parts across different relative valuation business models and lack of direct standalone peers. jurisdictions * Subjectivity of multiples applied

EV/sales * Comparable * Does not reflect x * Consistency in calculation of EV liabilities (pensions/off-balance sheet items, financial across different operational assets) jurisdictions efficiency * Does not reflect profitability of business * Enables valuation of loss-making businesses EV/ * Comparable * Does not take xxx * Consistency in calculation of EV liabilities (pensions/off-balance sheet items, financial EBITDA across different into account assets) jurisdictions leverage * Somewhat * Does not take reflects capital into account growth intensity (through potential D&A) P/E * Key indicator of * Not comparable xxx * Relative differences in tax/interest rates shareholder returns across different * Consistency of EPS figures - reported, adjusted, company-defined

Relative Relative * Reflects financial jurisdictions leverage * Relative difficulty of sourcing "clean" consensus EPS

FCF yield * Comparable * Requires good xxx * Pre- vs post-interest calculations across different visibility over * Working capital movements jurisdictions working capital * Reflects capital movements intensity EV/IC * Reflects value * Requires good xx * Consistency in calculation of EV liabilities (pensions/off-balance sheet items, financial creation visibility over assets) working capital * Working capital movements movements Source: J.P. Morgan

29 30 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

2. Peak to trough valuation Although the high level of corporate activity, including the “birth” of new companies in the past five years, has meant that historical analyses are unlikely to give a clear indication of the sector's performance through a cycle, we nevertheless provide some data on historical valuation, with the above caveat in mind.

Based on current year estimates, our valuation analysis shows that the sector is trading inline with the long-term average. This can be explained in our view by the improvement in margins and ROIC across the sector, as capital discipline gained an increasing level of importance over the years, and portfolio moves and new restructuring programmes helped uplift margins.

Figure 29: European Chemicals: Average EV/EBITDA (x) Figure 30: European Chemicals: Average P/E* 10.0x 25.0x 9.0x 8.0x 20.0x 7.0x 6.0x 15.0x 5.0x 4.0x 10.0x 3.0x 2.0x 5.0x 1.0x 0.0x 0.0x

7 9 95 6 8 9 1 06 09 E E E 0E 9 003 005 0 007 008 0 0 1 12 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 200 2008 200 1 199 1997 199 199 2000 200 2002 2 2004 2 2 2 2 2 01 0 201 2011E 2012E 201 2 2

Source: Company data and J.P. Morgan estimates. Source: Company data and J.P. Morgan estimates, *P/E average excl. Rhodia

Figure 31: European Chemicals: Average EBIT margin Figure 32: European chemicals - 2010-2012E ROIC vs 2010E EV/IC 16% 30%

Vic trex 14% 25%

12% 20%

10% Yule Catto Croda 15% 8% Yara Symrise Givaudan Umicore K+S Arkema BASF Syngenta 6% ROIC Avg 2010E-2012E 10% Rhodia Air Liquide Johnson Matthey Clariant Solvay Akzo Nobel Linde Elementis Wacker Chemie 4% DSM Lanxess 5% Kemira 2% Bayer 0% 0% 0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0x 3.5x 4.0x 4.5x 5 8 9 0 1 2 4 5 6 7 EV/ Invested Capital 2010E 9 9 0 0E 199 1996 1997 19 19 200 200 200 2003 20 200 200 200 2008 2009 201 2011E 2012E Source: J.P. Morgan estimates Source: Company data and J.P. Morgan estimates.

30 31 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Mergers and Acquisitions

Solvay, DSM and Akzo Nobel are Last month BASF announced the acquisition of Cognis for €3.1bn while Akzo Nobel likely to be actively looking for announced the sale of National Starch for €1.1bn. As economic activity improves, we M&A see further M&A activity.

We believe the combination of below drivers as likely to trigger an increasing level of M&A activity going forward.

1) Demand for portfolio focus,

2) Balance sheet liquidity,

3) Globalization

4) Need to reduce cyclicality

5) Financial sponsor activity

31 32 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 6: Recent transactions greater than $500mm ($mm)

Transaction value Synergies LTM LTM LTM EBITDA Date Acquirer Target TV ($) ($) sales EBITDA (w/synergies) Rationale 06/23/10 BASF Cognis 3,795 159 1.2x 7.3x 5.6x ƒ Becomes world leader in personal & home care ingredients ƒ Expands position for nutrition and health products ƒ Reduces earnings cyclicality

06/21/10 Corn National 1,300 50 1.1x 9.1x1 6.8x1 ƒ Expansion of ingredient portfolio with improved product mix Products Int. Starch ƒ Complementary geographic footprint 06/16/10 Rhodia Feixaing 489 N/A N/A 9.0x2 N/A ƒ Strengthens leadership positions in specialty surfactants for the home & personal care, Chemicals agrochemicals, oilfield and industrial markets 03/02/10 CF Terra 4,720 100 2.5x 9.1x 7.6x ƒ North American consolidation Industries Industries ƒ Response to recent Yara – Terra agreement 03/02/10 Bain Dow Styron 1,630 N/A 0.5x 6.2x N/A ƒ Deleveraging and portfolio realignment for Dow Capital 03/01/10 Solutia Etimex 310 N/A N/A 9.1x N/A ƒ EVA photovoltaic encapsulant technology complements Solutia’s existing PVB offering

02/05/10 Air Products Airgas 6,998 250 1.8x 10.5x 7.7x ƒ Consolidation of North American industrial gas industry & chemicals ƒ Unsolicited all cash transaction 11/19/09 Mitsubishi Chemicals Mitsubishi 5,809 111 1.3x 18.6x 13.7x ƒ Expanding the corporate scale while strengthening business competitiveness Holding Corp. Rayon Co. Ltd ƒ Realize high performance an high added-value businesses 09/28/09 America Gentek 673 N/A 1.2x 5.5x N/A ƒ Depressed equity valuations Securities 04/01/09 K+S Morton Salt 1,675 N/A 1.4x 6.2x N/A ƒ All-cash sale to help fill funding gap left by Rohm and Haas transaction

02/23/09 IPIC Noca 2,329 N/A 0.3x 5.3x N/A ƒ Expands IPIC footprint into North American Chemicals ƒ Sale driven by NOVA’s need for liquidity 11/11/08 Mitsubishi Rayon Lucite Int. 1,600 103 0.9x 7.0x 4.8x ƒ Distressed sale: liquidity and covenants Co. Ltd ƒ Additional consolidation in MMA 09/15/08 BASF Ciba 5,395 568 0.9x 7.3x 5.5x ƒ Complementary portfolios ƒ Expands BASF specialty chemical presence Source: Company fillings, press release, investor presentations, equity research 1 Based on mid point of 2010E normalized EBITDA range of $135mm to $150mm 2 Based on 2010E EBITDA multiple 3Based on a sale price of $600 (excluding $125mm for working capital)

32 33 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

1) Increasing portfolio focus An increasingly important motivation in sector M&A activity has been to increase focus. Strategic moves by several companies have demonstrated a desire to move away from conglomerate business models, in order to concentrate on a reduced number of industries and end markets or acquire high growth/high margin businesses.

For example Akzo Nobel sold National Starch to focus on its core business while BASF acquired Cognis to get entry in high margin consumer markets. Rhodia acquired 87.5% of the Feixiang Chemicals, the top player in specialty amines and surfactants in China to increase its presence in high growth emerging markets.

We believe a more focused business is not only easier to optimize and to manage, but also more likely to generate higher returns, and hence benefit from a higher valuation. Focused assets tend to benefit from:

• Greater industry consolidation prompting improved capital discipline • Increased scale leading to improved pricing power • More efficient allocation of capital • Simplified group structure leading to lower group overheads

Disposals have so far led the drive for greater focus Improving portfolio focus within the sector has in large part been led by disposals. Value-creation through disposals is easier to achieve, particularly in the environment of buoyant asset prices like in 2006 and 2007. Currently we see asset prices as being less buoyant as not many buyers are available due to difficult economic conditions in the recent past.

33 34 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Recent examples of key divestitures which we believe were motivated by these drivers include:

• Akzo Nobel’s sale of National Starch for €1.1bn. • Kemira’s spin-off of Tikkurila • Solvay’s €5.2bn disposal of Pharma • Solutia’s c.U$50m disposal of its Nylon assets • DSM’s Base Chemicals & Material disposals • Akzo Nobel’s €11bn sale of Organon and chemicals divestment programme and ICI’s £410m sale of Uniqema and £1.2bn sale of Quest before the merger with Akzo Nobel. • Lanxess’ €35m sale of Lustran Polymers. • Altana’s €4.5bn sale of its pharma assets. • Bayer’s disposal of HC Starck and Wolff Walsrode (and previous demerger of Lanxess).

Acquisitions set to continue the trend (but carry greater risk) Acquisitions a key focus, yet A number of chemicals players are targeting acquisitions as a key component of their carry a degree of risk growth strategy. A direct effect of the significant disposals that have taken place is the increased ability of companies to pursue acquisitions. The track record of European Chemicals companies in making value-accretive acquisitions is far from blemish-free. In particular, at the peak of the last M&A ‘cycle’ in the late 1990s, early 2000s, a number of deals were pursued that subsequently proved to be significantly value-destructive.

We believe these deals contained factors that significantly increased risk. First, most were at the very top end of the multiple ranges, and second, in many instances the buyers were entering new business areas in which they did not have existing strength or expertise.

Management discipline has however improved in recent years, in our view. We see Rhodia’s recent acquisition of shares (87.5%) in Feixiang Chemicals as expensive relative to Rhodia's current valuation, but with a strong track record of growth in the past 5 years (c.20% CAGR sales, c.40% CAGR EBITDA) and a likely healthy margin (JPMCe c.20% at EBITDA level) we view the valuation as fair. Rhodia paid $428m for Feixiang Chemicals share.

BASF’s acquisition of Cognis for €3.1bn (1.2x ‘09a sales and 9.1x adjusted EBITDA) marks another sensible strategic step that will help them in reducing cyclicity, in our view. The size of the deal is relatively modest in the context of the BASF balance sheet.

34 35 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 33: Multiples of key chemicals transactions

Transaction multiple Yearly average for Transaction multiple Volume ($bn)

20.0x 120

Mitsubishi Chemical/Mitsubishi Rayon

MON/Delta & PineLand Lubrizol/Noveon Henkel/ICI-National starch 100 16.0x Givaudan/Quest GE/Organosilicones Clariant/BTP Business (Crompton) Cytec/SurfaceSpecialties (UCB)

PAI/Food ingredients (Chr. Hansen) 80 BASF/Engelhard Apollo/GE Silicones

DuPont/24% of 12.0x DuPont Canada BASF/Construction Chemicals (Degussa) Akzo/ICI Air Products/ Airgas Solutia/ Etimex Degussa/Laporte Bayer/Aventis CropScience Air Liquide/ Citicorp/ Messer Griesheim Invitrogen/Dexter MacDermid Ferro/dmc2 Givaudan/Food PPG/ assets Ingredients (Nestle) Linde/BOC SigmaKalon Corn Products / 60 Warburg/Polypore Crompton/ National Starch GreatLakes UCB/Solutia’s Carlyle/PQ ASH/Hercules CF Industries/ businesses Terra KKR/ Industries Laporte Altana Chemie/Eckart Wendell/Materis Yara/Saskferco 8.0x BASF/Ciba BASF/ Cognis Dow/ RAG/Degussa Mitsubishi Rayon/ R&H AgChem Lucite Bain/ Styron Umicore/ Apollo/Borden Yara Nederland/ 40 Precious Metals Kemira GrowHow American Securities/GenTek DSM/Roche Vitamins & AEA/BF Fine Chemicals Goodrich Rockwood/ Carlyle-Advent IPIC/ NOVA Chemicals Dynamit Nobel /HC starck 4.0x Allianz Capital & GS Capital/ Messer Griesheim Blackstone/ 20 General Electric/ Celanese Berkshire BetzDearborn Hathaway/ Benjamin Moore Schroder Ventures & Apollo-GS BASF/American Goldman Sachs/Cognis Capital-Blackstone/ Cyanamid Ondeo Nalco 0.0x 0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20102

Volume ($bn) 73 31 35 25 34 52 56 103 49 18 27

Number of 55 30 20 28 37 33 39 43 21 19 15 transactions¹ Source: Company filings, equity research ¹ Includes deals with transaction value above $200mm 2 YTD as of 06/25/2010.

35 36 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

2) Increased balance sheet liquidity The European Chemicals sector has de-levered significantly in recent years. This has Delevered balance sheets make acquisitions more affordable been driven by the combination of a number of factors.

• Several years of robust economic growth, combined with cost-base rationalization (excluding recent economic slowdown) • Improved capital discipline • Significant proceeds from disposals of non-core assets.

Figure 34 indicates that average net debt/EBITDA is likely to decline to 0.9x in 2010e — below its 10-year trough — and in the absence of any further corporate activity projected to reduce further to 0.7x-0.8x by 2011e.

Figure 34: European chemicals sector average Net debt/EBITDA (x) 2.0x 1.8x 1.6x 1.4x 1.2x 1.0x 0.8x 0.6x 0.4x 0.2x 0.0x 1998a 1999a 2000a 2001a 2002a 2003a 2004a 2005a 2006a 2007e 2008a 2009a 2010e 2011e 2012e Source: Company data and J.P. Morgan estimates.

The low level of sector gearing (1.4x avg net debt/EBITDA between 2000 and 2009) has meant that chemicals players have had the possibility to play a significant role in consolidation, driving transformational deals including:

• BASF’s acquisition of Cognis for €3.1bn • Dow’s U$19bn acquisition of Rohm & Haas • BASF’s CHF6.1bn acquisition of Ciba • Akzo Nobel’s £8bn acquisition of ICI and €4bn on-sale to Henkel • Linde’s £8bn acquisition of BOC

36 37 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

3) Globalization Globalization to address The need for scale and increased global reach remain key motivations for M&A, in customer shift and fill market our view. Market leadership is associated with a number of advantages, including share gaps lower production costs, greater pricing power and greater negotiating power, both in terms of raw material procurement and customer contracts. The increase in global M&A in recent years has been driven by:

• the geographic shift in customer industries (e.g. automotive, manufacturing), to the emerging markets, • the need to fill market share gaps and gain scale in the mature markets, • to gain scale to optimize costs and compete with lower-cost players, as well as • the desire for players in the emerging markets to establish a foothold in the Western markets.

A recent examples of deals motivated by the desire to enhance global footprint and market leadership include Rhodia acquisition of share in Feixiang Chemicals, BASF’s acquisition of Cognis and K+S's acquisition of Morton Salt. We view a handful of sectors (industrial gases, automotive catalysts) as fairly consolidated and therefore unlikely to see further large scale moves motivated by a desire for scale.

37 38 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

4) Need to reduce cyclicality Another key driver for sector M&A has been the drive to reduce cyclicality – which has become an increasing focus following the unprecedented demand destruction experienced last year. As outlined previously, Solvay, as an example, is seeking a sizeable acquisition that would reduce its portfolio's cyclicality. BASF recently acquired Cognis for €3.1bn which will help BASF to reduce cyclicality as Cognis is more exposed to consumer markets. With a scarcity of defensive/less-cyclical assets in the chemicals sector, we view near-term value creation as likely to remain a challenge, in the absence sufficient synergies and/or a longer term focus.

Screening for potential targets In assessing potential targets in a consolidation scenario, we screen for (i) assets currently officially held for sale, (ii) those currently owned by financial sponsors, and (iii) strategically attractive assets among listed European chemicals companies.

(i) Assets currently for sale We are aware of several assets Despite recent sale of National Starch by Akzo and Cognis acquisition by BASF, we under strategic review or for sale are currently aware of several assets in the European chemicals space which are within our coverage universe either officially for sale or under “strategic review”, based on public management comments. Some of the examples are DSM Base Chemicals & Materials, BASF Styrenics (ex-Brazil PS – sold) and INEOS – various assets.

However, the ongoing drive for increased focus should mean that more are likely to become available. In addition, many management teams choose not to publicize the non-core nature of a business in advance of its sale in case this has a negative impact on the performance of the business, as well as valuation.

(ii) Sponsor-owned assets Financial sponsor-owned assets With a large number of chemicals assets in the hands of private equity, and numerous may also provide opportunity financial players reported by the press to have reported significant writedowns in response to the economic crisis last year, we expect a number of financial sponsor- owned assets to become potentially available in the near term. Recent examples include Brenntag and Chr Hansen, which were both listed on the market. Cognis was acquired by BASF.

38 39 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 9 shows an overview of 100+ private equity-owned chemicals assets that we have been able to identify from public sources in Europe and the US. Although we are not aware of the strategic intentions or financial situation of each owner, we highlight that a large number of assets appear to fit the strategic aims of many of the companies across our sector — namely to (a) enhance growth or margins, (b) reduce cyclicality, and increasingly to focus on (c) environmentally friendly solutions.

In addition, we note that there are a few sizeable assets (€1bn sales+) for which we would not rule out a potential IPO exit.

Table 7: Chemicals — Sizeable private-equity-owned assets Asset Owner Investment year SalesCountry Comment Arizona Chemicals Rhone Dec-06 U$1bn US Pine-based materials for adhesives, inks, coatings, tyres, HPC, etc Arysta Life Sciences Permira 2008 U$1.2bn Japan Agrochemicals and life science Ascend Perf Materials (Solutia Nylon) SK Capital Jun-09 U$1.9bn US Nylon 66 Borsodchem Permira 2006 €900m Hungary Isocyanates (MDI, TDI) and vinyls (PVC, chloralkali) British Vita TPG 2005 €1.5bn Luxembourg Cellular and industrial polymers, engineered thermoplastic sheet, non-wovens Clondalkin Warburg Pincus 2004 €900m Netherlands Packaging and printed products Dynea Industri Kapital 1999 €875m Finland Adhesive and surface solutions for wood-working DyStar Platinum Equity Aug-04 €800mGermany Dyes for textile & leather chemicals Evonik (25%) CVC Sep-08 €15.9bn Germany Specialty chemicals (Degussa), power generation, real estate Flint CVC Nov-04 €2.4bnGermany Printing inks/plates/blankets/pigments Fortis Plastics Monomoy Cap Sep-08 na US Moulded plastics (injection moulding/extrusion capabilities) HC Starck Advent/Carlyle Jan-07 €856m Germany Refractory materials, advanced ceramics, electronic chemicals Hexion Apollo Aug-04 $6.1bn US Global #1 in thermosetting resins Innophos Bain 2004 U$935mUS Chemical grade phosphates; listed on NADAQ Materis Wendel Feb-06 €1.9bn France Construction Chemicals and paints Momentive Perf Materials Apollo Dec-06 $2.6bn US Global #2 in silicones and derivatives Oxea Advent Feb-07 €1bn Germany Oxo chemicals and derivatives Perstorp PAI Dec-05 SEK7.3bn Sweden Value-adding ingredients for paints, resins, coatings Rockwood KKR/CS Jan-01 U$3.4bn US Specialty chemicals, pigments & additives, advanced materials; listed on NYSE Sud Chemie (50%) One Equity Partners na €1.2bn Germany Adsorbents and catalysts Univar CVC Oct-07 U$9.4bnUS Chemical distribution Vinnolit Advent Jul-00 €846mGermany PVC

Source: J.P. Morgan estimates, Company data.

Whole company takeouts cannot be ruled out A number of companies in the European chemicals sector have been taken over in the recent past. Key examples include

• BASF/Cognis (2010) • BASF/Ciba (2008) • Akzo Nobel/ICI (2007) • Linde/BOC (2006) • TPG/British Vita (2005)

In each case, the rationale for the deal has been either to consolidate the buyer’s market positions (with the exception of TPG) or get the entry to high margin business (BASF-Cognis deal). However – going forward, with limited remaining overlap between different conglomerate portfolios or anti-trust concerns likely to prevent further consolidation (e.g. Industrial Gases), we expect consolidation to focus on (i) enhancing exposure to high-growth product areas and the emerging markets; (ii) reducing cyclicality; and (iii) gaining exposure to “green” trends.

39 40 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 8: European Chemicals: Screening for Potential Acquisition Targets Signif. Non-cyclical Signif. Emerging markets Significant “green” Signif. GDP++ exposure exposure exposure exposure Pricing power Air Liquide x x xx xx Akzo Nobel x x x Arkema x BASF x Bayer x xx x x xx Clariant xx x Croda x xx xx xx DSM x xx x x x Elementis Givaudan xx xx xx x x JMAT xx xx xx xx Kemira xx x x Lanxess x x Linde x x xx x Lonza xx xx x xx Rhodia xx xx Solvay x Symrise xx xx xx x x Tessenderlo Umicore xx x xx x Victrex xx x Wacker xx xx xx xx Yule Catto xx x Source: Bloomberg and J.P. Morgan estimates. Shading indicates companies with assets that we view as strategically attractive based on our screen.

40 41 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

5) Interest from financial buyers Financial buyers played an active role in chemicals M&A in 2006/7, as they benefited from a wide availability of funds, combined with the sector’s under- leveraged balance sheet and significant restructuring potential. Investment from financial buyers has slowed down since then. However it has started picking up once again as the economic growth is returning to normal pace.

Aside from restructuring businesses and tightening expenditures to enhance cash flow, private equity firms have in the past come up with increasingly creative ways to create value, including the integration of several assets to create a scale leader (Flint Group, Hexion, and Symrise).

Financial buyers have in the past raised competition for assets, and consequently valuation multiples. A key example is the apparent participation of Bain, Blackstone and Carlyle in the auction of GE Plastics - which resulted in SABIC paying 10.5x EBITDA for a highly cyclical, commodity business. This has made value creation through acquisition increasingly difficult from the point of view of the strategic buyer, with accurate and realistic identification of synergy potential being key to value creation.

41 42 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 9: Chemicals assets under private equity ownership Asset Owner Investment year Sales Country Comment Acomon Auctus Oct-07 U$35m Switzerland Chemtura's optical monomers business Acordis CVC Dec-99 €390m Netherlands Industrial & textile fibres A-D Technologies Audax Group Apr-07 na US HDPE duct, pipe and conduit products ADCO Global Aurora 1998 na US Adhesive, sealant, tape solutions Akzo Nobel Crown Paints Endless Aug-08 £200m UK/Ireland Decorative paints Almatis DIC Nov-07 U$360m Germany Specialty alumina materials for steel refractories, ceramics, flame retardants Archimica Towerbrook Jun-06 U$150m+ US API's and late stage pharma intermediates for the pharma industry Arclin (Dynea North America) Teachers' Pension Plan Jul-07 na Canada Adhesive and surface solutions for wood-working Aristech Acrylics SK Capital Apr-08 na US Acrylic sheets Arizona Chemicals Rhone Dec-06 U$1bn US Pine-based materials for adhesives, inks, coatings, tyres, HPC, etc Armacell Investcorp 2006 naGermany Engineered foams ArrMaz Custom Chemicals Snow, Phipps & Guggeheimn Aug-08 na US Mining chemicals, asphalt additives, fertiliser, industrial minerals, water treatment Arysta Life Sciences Permira 2008 U$1.2bn Japan Agrochemicals and life science Ascend Perf Materials (Solutia U$1.9bn Nylon) SK Capital Jun-09 US Nylon 66 Atrium Innovations AXA Apr-08 U$222 Canada Active ingredients & chemicals for cosmetics, pharma, chemicals, nutrition Avecia Biotechnology Cinven/Investcorp Jun-99 £60m UK Biologics and DNA manufacture; rest of Avecia businesses sold Aventine Metalmark Capital May-03 U$2.2bn US Bioethanol; listed on NASDAQ AZ Electronics Carlyle/Vestar Capital Sept-04/Mar-07 €400m Luxembourg Electronic materials for semiconductors/flat panel displays Azelis 3i Dec-06 €1,120m Belgium Chemicals distribution; targeting flotation in 2012 Berry Plastics Apollo Jun-06 na US Film, containers, packaging Bio Agri Mix Birch Hill Apr-06 na Canada Medicated feed additives BIOX Birch Hill Aug-06 na Canada Biodiesel Borsodchem Permira 2006 €900mHungary Isocyanates (MDI, TDI) and vinyls (PVC, chloralkali) Brenntag BC Partners Jul-06 €7.4bn Germany Chemicals distribution; targeting flotation in 2009/10e British Polythene Industries 3i £480mUK Polythene products British Vita TPG 2005 €1.5bn Luxembourg Cellular and industrial polymers, engineered thermoplastic sheet, non-wovens CariSal Denham Aug-08 naUS Calcium chloride, caustic soda, other specialty chemicals Chicago Oleochemicals HIG May-08 £88m US Fatt acids and glycerin for HPC, industrial formulations China National Bluestar Blackstone Sep-08 RMB30bn+ China Subsidiary of China national Chem Corp/ Chr. Hansen PAI Jul-05 €477m Denmark Natural food ingredients; listed on CSE Citadel Plastics Wind Point Partners na US Compounder of thermoplastic and thermoset resins Clondalkin Warburg Pincus 2004 €900m Netherlands Packaging and printed products ColorMatrix Audax Group May-06 na US Plastic colourants and additives Columbian Chemicals One Equity Partners Feb-09 na US Carbon black additives for rubber, plastics, liquid products Compression Polymers (Vycom) AEA Apr-05 na US Industrial plastic sheet products CR Minerals Imin Partners na na US Processed pumice for water filtration, abrasives, polishes CVR Energy Goldman Sachs/KELSO & Co Jun-05 U$5bn US Petroleum refining, fuels, nitrogen fertilisers (Coffeyville Resources); listed on NYSE DC Chemicals One Equity Partners na na S Korea Inorganic chemicals, petrochemicals, coal chemicals, PVC window systems Diana Ingredients AXA Jun-07 €318m France Flavouring, pet food products, colorants, health food products Druck Chemie 3i May-08 na Germany Provides printing industry with chemicals, consumables & services Dufa Advent Aug-05 naRomania Romanian decorative paints Dynea Industri Kapital 1999 €875m Finland Adhesive and surface solutions for wood-working DyStar Platinum Equity Aug-04 €800mGermany Dyes for textile & leather chemicals Eco-bat Technologies Apax na na Italy Recycling of lead batteries Eliokem AXA Sep-06 €148m France Special resins, elastomeric modifiers, antioxidants, rubber chemicals Emerald Performance Sun Capital May-06 na US Polymers and performance materials Endeka Ceramics Pamplona Mar-07 na Spain Raw materials and intermediates for ceramics Evonik (25%) CVC Sep-08 €15.9bn Germany Specialty chemicals (Degussa), power generation, real estate Excel Polymer Lion Chemical Aug-04 na US Rubber/elastomer compounding, roll compounds, rubber chemicals Fibervision Snow, Phipps & Guggeheimn 2006/8 na Denmark Polyolefin staple fibres for non-wovens Flint CVC Nov-04 €2.4bn Germany Printing inks/plates/blankets/pigments Fortis Plastics Monomoy Capital Sep-08 na US Moulded plastics (injection moulding/extrusion capabilities) Frontier Spinning Mills Sun Capital Mar-08 na US Cotton and cotton/polyester yarns Genovique/Velsicol Chemical Arsenal Nov-05 na US Benzoic acid, agrochemical intermediates Graham Packaging Blackstone/CD&R Feb-98 U$4bn US Blow-moulded plastic containers for consumer products; listed on NYSE HC Starck Advent/Carlyle Jan-07 €856m Germany Refractory materials, advanced ceramics, electronic chemicals Hexion Apollo Aug-04 $6.1bn US Global #1 in thermosetting resins Holliday Chemical Apax na na UK Houghton AEA Dec-07 na US Metalworking fluids and chemical mgmt Innophos Bain 2004 U$935m US Chemical grade phosphates; listed on NADAQ Innovia Candover Sep-04 €400m Belgium Cellulose film, biaxially oriented polypropylene film, surface engineering InteliCoat Sun Capital na na US Coated film and specialty substrates Isola TPG Apr-04 na US High performance base materials for multilayer circuit boards KaMin Performance Minerals Imin Partners na na US High quality hydrous and calcined kaolin KemFine 3i Sep-08 €50mFinland Custom manufacturing of fine chemicals for agchem, pharma and specialties

42 43 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Asset Owner Investment year Sales Country Comment Klockner Pentaplast Blackstone Jul-07 €1,100m Germany Rigid plastic films for pharma, medical, food, electronics, printing, etc. Koppers Saratoga Dec-97 U$1.4bn US Carbon materials & chemicals, railroad ties, roof systems; listed on NYSE Kraton Polymers CCMP Capital/TPG Dec-03 U$1226 US Styrenic block copolymers Lion Copolymer Lion Chemical 2005/7 na US Synthetic rubber (DSM SBR, Chemtura EPDM) Lonza (PIA Singapore) PAI Sep-07 na Singapore Purified isophthalic acid; integrated into Perstorp MacDermid Court Square/Weston Presidio Dec-06 U$738m US Electronic and industrial solutions Marsulex (61%) Birch Hill Jan-09 C$320m Canada Emission control, handling of industrial by-products, industrial chemicals Merisant Pegasus 2000 U$260US Artificial sweeteners; currently under chapter 11 bankruptcy MetoKote CCMP Capital na na US Custom protective coatings; environmentally sound coating solutions Midcontinental Chemical Imin Partners na na US Additives for petroleum, lubricants, pipeline operators Molycorp Minerals Pegasus na na US Rare earth mining and technologies Momentive Performance $2.6bn Materials Apollo Dec-06 US Global #2 in silicones and derivatives Neochimiki Carlyle May-08 na Greece Chemical distribution/production & distribution of fertilisers, raw materials for coatings New Horizon Plastics Recycling JHW Greentree 2005 na US Recycling of PET Niotan na na US Tantalum and niobium materials for electronics Norit Doughton Hanson Jun-07 €370mNetherlands Purification technologies for water/beverage markets NOVACAP Bain na €520m France Soda ash, sodium bicarbonate, phenol, acetone Novasep Gilde Jan-07 €350mFrance Custom synthesis; tun-key physical purification solutions Novolyte Arsenal Oct-08 na US Specialty electrolyte materials/solvents for lithium ion batteries NuCO2 Inc Aurora May-08 na US Bulk CO2 provider for food service/hospitality Nusil Quad-C Sep-05 U$75m US Silicone compounds Oxea Advent Feb-07 €1bnGermany Oxo chemicals and derivatives Panolam Industries Sterling Group 2005 U$267m US Decorative laminate PC Cox CVC May-97 £18m UK Sealant applicators Performance Fibers Sun Capital Dec-04 na US High-tenacity polyester and other synthetic fibres and fabrics Perstorp PAI Dec-05 SEK7.3bnSweden Value-adding ingredients for paints, resins, coatings Pliant CCMP Capital 2000 U$1bn+ US Flexible film packaging materials; #1 in North America Polymer Group (69%) Matlin Patterson 2003 U$1bn US Engineered materials for non-wovens; listed on NYSE PolymerLatex Towerbrook May-03 €516m Germany #3 latex producer in Europe Polypipe Halifax Group Feb-05 na US Polyethylene pressure pipe Polypore Warburg Pincus 2004 U$610m US Engineered filtration products; listed on NYSE PPC Industries AEA Mar-06 na US Flexible packaging for medical/pharma, food processing, industrial applications PQ Carlyle Jul-07 na US Inorganic specialty chemicals and engineered glass materials Profine Arcapita Aug-07 €869mGermany World leader in PVC profiles Provimi Permira 2007 €2bn Netherlands Animal nutrition Rockwood KKR/CS Jan-01 U$3.4bnUS Specialty chemicals, pigments & additives, advanced materials; listed on NYSE Royal Adhesives & Sealants Quad-C na na US Commercial and industrial adhesives & sealants Rutgers (Evonik) Triton Dec-07 €650m Germany Coal tar Sonneborn Sun Capital Jun-05 na US White oils, petrolatums, waxes, hydrocarbons Stahl Carlyle Jun-06 €307mNetherlands Leather chemicals & non-leather coatings Sud Chemie (50%) One Equity Partners na €1.2bn Germany Adsorbents and catalysts Synagro Carlyle Apr-07 U$1,200 US Recycler of organic, non-hazardous waste and wastewater residue Synbra Gilde Dec-99 na Netherlands Expanded polystyrene and specialty foams Synutra (7%) Warburg Pincus 2007 U$310m China Dairy-based nutritional products; listed on NASDAQ Taminco CVC Aug-07 €650m Belgium Animal feed and water treatment Treofan Goldman Sachs Apr-05 €480m Germany Polypropylene films True Textiles Sun Capital Jul-07 na US Largest US contract manufacturers of interior fabrics Turf Care Platinum Equity Oct-05 na US Fertiliser products, grass seed, turf management solutions Unifrax Holding AEA May-06 na US High temperature insulation products United Plastics Group Aurora Sep-08 na US Univar CVC Oct-07 U$9.4bn US Chemical distribution Universal Fiber Systems Sterling Group Oct-07 na US High performance synthetic fibres Universal Lubricants Pegasus May-07 na US Lubricants, advanced engine oils Vertellus Specialties Wind Point Partners na na US Specialty chemicals for agroscience, nutrition, pharma, performance materials Vestolit Srategic Value Partners Sep-06 €300m Germany PVC products Vinnolit Advent Jul-00 €846mGermany PVC VitAG Denham Aug-08 na US Converts municipal biosolids into nitrogen fertiliser Warwick International Close Brothers Aug-08 na UK Bleach activators for laundry/detergents; chemical distribution Wellman International Aurelius na €110m Germany Polyester staple fibres, recycle PET bottles Source: Company reports, media reports.

43 44 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Commodity Chemicals

Inorganic Chemicals

Introduction Inorganic Chemicals are derived The majority of inorganic chemicals are derived from mineral ores or brines. These from ores or brines whereas substances are used as building-block materials and as processing aids and catalysts organic chemicals are derived in the production of other chemical and non-chemicals products, particularly within from crude oil or natural gas the agricultural and industrial sectors.

Inorganic chemicals differ from organic chemicals, which are principally derived from hydrocarbons such as crude oil / natural gas.

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 through process improvements. Economy of scale is of key importance.

There are four main types of inorganic chemicals: Chlor-alkali, Soda ash, Titanium dioxide and Hydrogen peroxide.

Chlor-alkali Introduction Two of the most important products of the alkali industry are chlorine and caustic soda (also known as sodium hydroxide). These chemicals have an enormously diverse range of applications, so wide in fact 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).

Since the chlor-alkali industry is greatly influenced by economic growth, the profitability of the industry is highly cyclical.

Table 10: Chlorine and caustic soda at a glance Chlorine Caustic soda Growth rate (CAGR to 2014E) 3.7% 3.6% Current operating rate c.75% c.75% Key end-markets Vinyls, Organics Organics, Soaps/ Detergent/ Textiles, Pulp & paper, Key demand regions Asia (53%), N America (20%) Asia (52%), N America (19%) Key players Dow, Oxy, Olin, PPG, Bayer, FPC, Solvay Dow, Oxy, PPG, Olin, FPC Market structure Top 10 producers amount up to 25% of Top 10 producers amount up to 25% of world production world production Key Inputs Salt, water, power Salt, water, power Threats New capacities in China and the Middle East New capacities in China and the Middle East Source: J.P. Morgan estimates

44 45 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Overview & Outlook Chlorine demand is highly Chlorine capacity grew by 4.8% per year from 2004-2009. In the same period, dependent on demand for PVC, demand grew by 1.6%. Chlorine demand is expected by CMAI to grow by a much whereas caustic soda is used in higher rate of 3.7% until 2014, whereas capacity growth is estimated to be 2.7% for many different applications the same period. Chlorine demand is highly dependent on demand for PVC, and thus, on the health of the construction industry (for example, PVC pipes).

Caustic soda demand grew by 2% CAGR from 2004-2009. In the same period, capacity grew by 5%. Through 2009-14, CMAI expects caustic demand growth to be higher at 5.4% and capacity growth to be lower at 2.0%. Demand for caustic soda does not have one single end use category such as the size of PVC for chlorine. Since caustic is consumed in a large variety of end uses for many different applications, it is the local manufacturing sector that tends to be the primary driver of caustic demand growth.

For both Chlorine and Caustic soda, Asia (dominated by China) is the only region with strong chlor-alkali capacity growth.

Western European companies are suffering a loss of competitiveness in exports markets. This is due to a combination of new capacities coming from China and cheaper US energy prices. As a consequence, exports in Europe will be falling in the coming year; whereas US companies will see their exports increase.

Production process Chlorine and caustic soda are made simultaneously by the electrolysis of brine (sodium chloride/salt solution), which is an energy-intensive process, making it the second largest consumer of electricity (2,400 billion kWh) among all electrolytic industries. Electricity and other utilities typically account for 40–50% of production costs.

The demand for Chlorine, as a corrosive, toxic gas that is dangerous to store, has a greater impact on the operating rate than Caustic’s demand.

Figure 35: Chlor alkali production process Electrolysis

Salt solution Chlorine (1 unit) PVC

Caustic soda (1.1 unit)

Source: J.P. Morgan estimates

45 46 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

There are three different production processes:

Table 11: Production types within the chlor-alkali industry Mercury cell Diaphragm cell Membrane cell. 9% 88% This is the oldest and most energy-intensive method In this process, the electrolysis cell contains a Similar to the diaphragm cell, the membrane tends to of production. It is being phased out because of diaphragm (usually made of asbestos fibres) in order be more effective, and thus, although more environmental risks surrounding the use of mercury. to keep the chlorine and caustic soda separate. concentrated brine is required, a far more Mercury, which is used as the cathode, is highly toxic Although this method of production can use fairly concentrated product is produced. and would be extremely damaging if released into the impure brine, it tends to produce less concentrated water table. The advantage of this process is the caustic soda, and consumes a large amount of energy ability to produce caustic soda in high concentration, in the process. reducing the need for evaporation. Source: J.P. Morgan

Table 12: Comparison of key chlor-alkali technologies Diaphragm Mercury Membrane Global capacity Medium Least common Most common % World 30% 10% 60% % Europe 18% 30% 53% % US 65% 33% 2% Future expansion None Low High Overall cost Medium High Low Energy usage (KWH/mt) 3,803 2,921 3,142 Salt purity requirement* Low Low High Purity of by-product (caustic)** Low High High Capital intensity Medium High Medium Environmental concerns Asbestos Mercury None

Overall rating x xx xxx Source: J.P. Morgan estimates, CMAI. * Purity of input; ** Purity of by-product (caustic soda) which can be sold on the market

Mercury capacity will continue to be under pressure, more so from a cost perspective than from environmental and/or legislative pressures, since production costs for mercury cells are about 30 percent higher than for membrane.

Figure 36: World Chlorine Technology Change 120% 100% 80% 60% 40% 20% 0% 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Membrane Diaphragm Mercury Others Source: CMAI and J.P. Morgan

46 47 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 37: European chlorine players - exposure by technology (% capacity, 2009E) 100%

75%

50%

25%

0%

s a lit F o m d. S Dow yer ne n A Ba Akzo I ke Erros B Solvay Ar Vinno esse T Diaphragm Membrane Mercury Other Source: CMAI.

Approximately 1.1 units of caustic soda are produced per unit of chlorine. As the ratio for the production of the two products is fixed, the pricing of each commodity can be volatile when demand for one product is out of balance with other.

However, these two products are consumed in quite different industries, leading to a problem of balancing the demand on a chlor-alkali plant. Chlor-alkali production is generally chlorine driven.

Demand Demand growth for chlorine and Chlorine has a wide variety of applications; the largest use is in the manufacture of caustic soda in Northeast, ethylene dichloride (EDC), which is used to make vinyl chloride monomer for PVC. particularly China, will be the It is also used in the pulp and paper industries as a bleaching agent, but it driving force for additional chloralkali capacity. Demand increasingly is being replaced by hydrogen peroxide and especially sodium chlorate growth in this region is forecast because of environmental reasons. by CMAI to increase by 6-7% through 2009-14 Caustic soda is used in many industries, mostly as a strong chemical base in the manufacture of pulp and paper, alumina, textiles, drinking water, soaps and detergents and as a drain cleaner. More than 50% of caustic soda production is used in the manufacture of other chemicals.

Figure 38: Chlorine by end market Figure 39: Caustic soda by end market

Others Vinyls Pulp & Others 27% Paper 13% 31% 33% Alumina 11%

Water Water Treatment 7% Treatment 5% Organics 17% Pulp & Inorganic Paper 2% Inorganics Organics 25% Chemicals Soaps/ 2% 12% Detergents/ Textiles 15%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

47 48 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 40: Chlorine demand by region Figure 41: Chlorine demand growth by regions in % (2008-2014E CAGR)

North AME

America Asia

20% WORLD

South Central Europe America 3% Asia 53% South America West Europe West Euro pe

16% North America Central 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% AME 4% Europe 4%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Figure 42: Caustic demand by region Figure 43: Caustic demand growth by regions in % (2008-2014E CAGR) America 19% AME Asia South America 6% WORLD Asia 52% Central Europe

West Europe South America 14% West Euro pe North America Central AME 5% Europe 4% 0% 1% 2% 3% 4% 5% 6% 7% Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key players The chlor-alkali market is highly fragmented, with Dow holding the largest market share (c.8%), followed by Oxy, PPG and Olin.

Capacity moves to the Middle Until the end of 1990, the United States dominated the global market. The East and Asia. competitive advantages in its chlor-alkali production have largely vanished with the steep increase in energy prices, and future capacity growth is now expected to come from the Middle East (7%) and China (6%) in particular.

Figure 44: cash cost of chlor-alkali production by region (2008), US$/mt 600

400

200

0 Western Europe NE Asia US China Middle East Source: CMAI, 2008

The supply/demand balance was tight until 2007. However, operating rates declined from 88% to 70-75% in 2009 with the weak economic environment. Operating rates have started rising as the economic condition improving.

48 49 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

From now and until 2014, approximately 14.7 million metric tons of capacity is scheduled to be brought on-stream, with almost 72% of the new capacity projected to be in China. In order to fill the gap between the supply and the demand, the additional net capacity will be much lower than the rise in demand of 32.5 million metric tons.

Figure 45: Chlorine demand/capacity (‘000- Metric tons) Figure 46: Caustic demand/capacity(‘000- Metric tons )

100000 90 100000 90 80000 85 80000 85

60000 80 60000 80 40000 75 40000 75 20000 70 20000 70 0 65 0 65 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Total Capacity Total Demand Operating Rate, % Total Capacity Total Demand Operating Rate, %

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Table 13: Top 10 chlorine producers (2009) Thousand of metric tons West Europe North America Asia Middle East Rest of the World Dow 1,795 Dow 3,601 FPC 1,452 SADAF 690 Braskem 480 INEOS Chlor Vinyls 1,249 Oxy 2,610 TOSOH 1,145 QVC 296 Tianyuan Huasheng 431 Bayer 1,187 Olin 1,630 Hanwha Chemical 739 Bandar Imam PC 220 Xinjiang Zhongtai 418 Akzo Nobel Chem 1,167 PPG 1,611 Juhua Group 536 Dead Sea/VW jv 100 Dow Brasil 415 Solvin 868 FPC USA 736 Tianjin Dagu 527 Petkim 100 Yibin Tianyuan 409 Solvay 842 Oxy Vinyls LP 500 JAP_CHL 500 Cristal 73 SP Chemicals 409 Arkema 836 Georgia Gulf 427 Asahi Glass 493 Dead Sea Brom. 45 Qilu PC 409 Ercros SA 462 Mexichem 341 Shandong Bohui 454 JANA 45 BASF SE 385 Vinnolit 448 SHINTECH 320 Shanxi Yushe 454 AIP 40 Suzhou Fine Chem. 382 Tessenderlo 438 Bayer 310 Tokuyama Corp. 440 BCI 39 Shenyang Chem. 364 9,292 12,086 6,740 1,648 4,102 Source: CMAI and J.P. Morgan

Table 14: Chlorine world capacity overview Thousand metric tons `REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 13,789 13,595 13,801 14,105 14,425 14,425 14,425 South America 2,153 2,248 2,257 2,257 2,302 2,347 2,347 West Europe 11,570 11,499 11,302 11,281 11,281 11,281 11,281 Central Europe 1,563 1,517 1,578 1,578 1,578 1,578 1,578 CIS & Baltic States 1,888 1,888 1,888 1,888 1,888 2,093 2,093 Middle East 1,928 1,959 2,259 2,552 2,664 2,867 2,867 Africa 815 818 866 914 914 914 914 Indian Subcontinent 2,747 2,949 3,029 3,029 3,029 3,029 3,029 Northeast Asia 29,830 33,052 36,178 39,134 40,836 41,082 41,082 Southeast Asia 1,931 1,934 1,934 1,934 1,934 1,934 2,184 WORLD 68,215 71,460 75,094 78,674 80,853 81,552 81,802 Growth rate 6.64% 4.76% 5.09% 4.77% 2.77% 0.86% 0.31% Source: CMAI and J.P. Morgan

49 50 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 15: Top 10 Caustic producers (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World Dow 1,975 Dow 3,957 FPC 1,597 SADAF 759 Braskem 540 INEOS Chlor Vinyls 1,375 Oxy 2,662 TOSOH 1,260 QVC 325 Xinjiang Zhongtai 460 Akzo Nobel Chem 1,284 PPG 1,772 Hanwha Chemical 814 Bandar Imam PC 250 Dow Brasil 457 Bayer 979 Olin 1,733 Juhua Group 590 Petkim 110 Yibin Tianyuan 450 Solvin 955 FPC USA 810 Tianjin Dagu 580 Cristal 80 SP Chemicals 450 Solvay 926 Oxy Vinyls LP 550 Shandong Bohui 500 JANA 50 Qilu PC 450 Arkema 919 Georgia Gulf 470 Shanxi Yushe 500 Dead Sea Brom. 50 Suzhou Fine Chem. 420 Vinnolit 491 Mexichem 375 Asahi Glass 489 AIP 44 Shenyang Chem. 400 Syndial 380 SHINTECH 352 Tokuyama Corp. 484 BCI 43 Shandong Befar 400 Tianyuan BASF SE 364 Bayer 341 Huasheng 473 Makhteshim Chem 39 Xinjiang Tianchen 400 9,647 13,022 7,287 1,750 4,427 Source: CMAI and J.P. Morgan

Table 16: Caustic world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 14,541 14,453 14,670 15,009 15,364 15,364 15,364 South America 2,364 2,468 2,468 2,468 2,518 2,568 2,568 West Europe 11,842 11,774 11,657 11,634 11,634 11,634 11,634 Central Europe 1,691 1,640 1,707 1,707 1,707 1,707 1,707 CIS & Baltic States 2,254 2,259 2,259 2,259 2,259 2,485 2,485 Middle East 1,992 2,026 2,357 2,678 2,803 3,028 3,028 Africa 875 878 932 985 985 985 985 Indian Subcontinent 2,889 3,119 3,199 3,199 3,199 3,199 3,199 Northeast Asia 31,561 34,911 38,518 41,775 43,653 43,923 43,923 Southeast Asia 2,109 2,111 2,111 2,111 2,111 2,111 2,391 WORLD 72,118 75,640 79,879 83,827 86,235 87,005 87,285 Growth rate 6.81% 4.88% 5.60% 4.94% 2.87% 0.89% 0.32% Source: CMAI and J.P. Morgan

Figure 47: Caustic soda: European market shares

Source: J.P. Morgan estimates, Company data

50 51 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Pricing In 2009, Global chloralkali operating rates fell to their lowest level in 10 years on weak demand for chlorine especially from the construction sector although demand for caustic soda remained more resilient until mid 2009. A combination of a strong caustic demand and a low chloralkali production rate had led to a sharp increase in the caustic price until mid-2009.

Prices are returning back to normalized levels as the economy gains momentum. CMAI expects chlorine prices to slightly decrease in 2010-2011 and come back to pre-crisis levels.

Figure 48: Chlorine price chart Figure 49: Caustic soda price chart 500.00 1,000.00 400.00 800.00 300.00 600.00 200.00 400.00 200.00 100.00 0.00 0.00 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Caustic Soda Flakes ($/ MT) Caustic Soda Pearls ($/ MT) Chlorine (US$/Short ton) Forecast

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Soda Ash Introduction Soda ash is a white crystalline solid that is also known as disodium carbonate or sodium carbonate.

It is the second-largest alkali in volume terms behind caustic soda and has a number of diversified uses (mainly glass manufacturing and air treatment).

Table 17: Soda Ash at a glance Growth rate (CAGR 2008- 2013E) 2.3% Current operating rate c.87% Key end-markets Glass manufacturing, air treatment, water softening Key demand regions Asia (49%), N America (15%), Europe (17%) Key players Solvay, FMC, Tata Chemicals Market structure Top 3 producers amount to up to 31% of global capacity Chinese companies represents 35% of global capacity Key Inputs Trona, Limestone, Salt Threats New Capacity in China Source: J.P. Morgan estimates.

Overview & Outlook World consumption of soda ash is forecast by SRI to increase at an average annual rate of 2.3% from 2008 through 2013 to reach 54 metric tons. Of this, Asian demand is expected to account for about 53.5% of total demand and 94% of the incremental volume growth through 2014.

For the U.S. and Europe we expect demand for soda ash to fall because of the continued demise in demand for derivative products, notably glass.

51 52 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Production process Soda Ash can be produced either through synthetic processing using limestone, salt and ammonia (known as Solvay process) or through the refining of mined trona. About 70% of world soda ash production is derived from synthetic processes and 30% is recovered from natural trona deposits.

The Solvay process This process combines limestone and salt to produce soda ash. This process is more expensive than mining natural sodium carbonate deposits due to high-energy requirements. In addition, the effluent containing highly visible pollutants that settle to the bottom of the solution are a big environmental problem.

Refining of mined trona This process involves mining trona ore and then refining it to produce soda ash. The refining can refine trona in either dense soda ash (used for glass manufacture) or light soda ash (used for dry detergent compounds and applications which involve dissolving the ash). The enormous natural trona deposits will not be exhausted for decades to come.

Demand Glass manufacturing is the largest application for soda ash, whether it is in the production of containers, fibreglass insulation, or flat glass for the housing, commercial building, and automotive industries.

Soda ash also is used to clean the air, soften water and as an intermediate to manufacture products that sweeten soft drinks (corn sweeteners), relieve physical discomfort (sodium bicarbonate) and improve foods and toiletries (phosphates)

Soda ash consumption in flat glass production has been declining in past few years because of weak economic conditions especially in the construction and automotive sector industry. Flat glass demand is considered as highly cyclical rises as the economy recovers.

Globally, glass output for packaging applications has shown lower demand growth in recent years; demand for soda ash has been dented by the replacement of glass bottles in the beverages industry with PET and recycled glass bottles. The economic crisis has led to further negative impact in 2008-2009. In the coming five years, container glass consumption is expected, by SRI, to be slightly decreasing in developed countries and to increase at an average annual growth rate of 5.7% in Asia.

To sustain new capacity from China, the European soda ash industry will be forced to further modernize. Restructuring will likely lead to integration into global players in our view, which include additional trans-European players created through mergers, alliances or joint ventures.

52 53 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 50: Soda Ash consumption by end market Others 20%

Soaps and Glass 49% Detergents 8%

Chemicals 23% Source: SRI and J.P. Morgan

Figure 51: Soda Ash consumption by region Figure 52: Soda Ash demand growth by region (2005-2013E CAGR)

Others North America Others 15% 8% Asia Central & South America Central & South America

5% Wo rld

Africa & the M iddle East

Europe North America

17% Europe Asia 49% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% Africa & the Middle East 6%

Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

Supply/Key players In 2008, globally, soda ash was produced in over 100 plants, in 30 different countries, according to SRI. Almost 32% of capacity was concentrated in China, 24% in the U.S. and 18% in Europe.

Most soda ash producers are back-integrated into trona. Synthetic producers have access to captive raw materials or purchase them under long-term supply contracts. Some companies, for example Solvay, control and own production locations for salt and limestone.

53 54 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 53: Soda Ash capacity/demand, 2008 (-000 Metric tons) 25000 100 20000 80 15000 60 10000 40 5000 20 0 0 North America Central & South Europe Africa & the Asia Others America Middle East

Capacity Demand Av erage Operating Rate % Source: SRI and J.P. Morgan

Figure 54: Top 10 Soda Ash producers (mt) 10000

8000

6000

4000

2000

0 OCI FMC Ciech Nirma Group Group Soda soda Solvay Sanayii Tata General Haihua Russian chemical Shandong Chemicals Source: SRI and J.P. Morgan

Pricing The price of soda ash and caustic soda is linked, as they are interchangeable in certain applications (a volume of 200-400 thousand metric tons is interchangeable between the two alkali sources). However, as caustic soda is produced in far larger volumes, soda ash is more influenced by the price of caustic soda than vice versa.

Titanium Dioxide Introduction Titanium dioxide, or "TiO2", is a multi-million ton-per-year global product, manufactured by a relatively small number of specialist producers.

It is the brightest white pigment with the highest opacity of any commercial product and therefore the most important pigment in the world, accounting for approximately 70% of total volume.

Table 18: Titanium Dioxide at a glance Growth rate (CAGR 2008- 2013E) 3.5% Current operating rate 80% Key end-markets Paints, Coatings, Plastics, Paper and paper boards Key demand regions China (26%), North America (22%), Western Europe (21%) Key players Du Pont (19%), Cristal Global (12%), Various Chinese Producers (20%), Market structure Top 10 producers account for more than 70% of production Key Inputs Minerals (ilmenite ore, titanium slag) Threats Increase in raw material prices Source: J.P. Morgan estimates.

54 55 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Overview & Outlook The titanium dioxide industry is consolidated with the top ten producers accounting for more than 70% of production. Its growth rate is broadly in line with demand for paint as a significant consumption of titanium dioxide is within the paints industry.

Since 2000, approximately 80% of the global growth in demand for titanium dioxide has been in Asia, with 50% of that attributable to China. In 2008-2013E, the region is expected to grow by 6-7% per year, with China seeing about 8.5% per year and above. Forecasts for growth in the U.S. and Europe are only at 1.5-2.5% per year, with higher growth at around 6% per year in Eastern and Central Europe (by SRI).

Production process TiO2 pigments are made from one of two chemical processes - the chloride process which produces TiO2 products by reacting titanium ores with chlorine gas; and the sulphate process which produces TiO2 products by reacting titanium ores with sulphuric acid.

Figure 55: Titanium Dioxide production process Titanium Ore

Sulphate Process Prod. & Sulphuric acid Purification Titanium Dioxide

Recycled

Titanium Ore Chloride Process Prod. & Chlorine Purification Titanium Dioxide

Recycled Source: J.P. Morgan

Waste disposal is an important factor in the production choice of TiO2 pigments: The sulphate process causes more problems in waste disposal than the chloride process because of large amounts of iron sulphate as a by-product.

Moreover, the chloride process is less energy & labour cost-intensive and results in a better quality. Therefore, the chloride route is increasingly being adopted: Currently, about 70% of European production is from the sulphate route and 30% from chloride.

Demand Titanium Dioxide is used to provide whiteness and opacity to products such as paints, coatings, plastics, papers, inks, foods, medicines (i.e. pills and tablets) as well as most toothpastes. It can also improve the durability of coatings and films. Additional demand stems from the manufacturing of rubber, printing inks, floor coverings, ceramics, textiles, and cosmetics. An architectural coating is a key end market contribute (36%) in paints and coatings.. As per SRI, top ten coating producers accounted for 50% of the market versus 20% in 1980.

55 56 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 56: Titanium dioxide consumption by end market Plastics 24%

Paints and Coating 49% Paper 13%

Others 14% Source: SRI and J.P. Morgan

Figure 57: Titanium Dioxide consumption by region Figure 58: Titanium dioxide capacity growth by region 2008-2014E (%) Central and ROW 11% AME Eastern North America Asia Europe 6% 25% Central and WORLD

South America Central Europe

5% North America Japan 4% South America AME 4% West Euro pe Western -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% China 21% Europe 24%

Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

Supply/Key Players Capacity growth is expected In recent years, the industry has undergone considerable consolidation and only for China. considerable amounts of capacity have been added, mainly in China, since 2006. Titanium dioxide capacity is expected to increase by a CAGR of 2% through 2014E with capacities mainly in China, Africa and the Middle East region. Its capacity in Asia is expected to grow by a CAGR of 6-7% through 2014E.

Table 19: Top 10 Titanium dioxide producers (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World Huntsman PC 370 DuPont 1,025 DuPont 165 Cristal 210 Krymsky Titan 91 KRONOS 288 Tronox 335 ISK 160 Cristal 80 Sachtleben 220 Cristal 265 Tiwest 135 JSC Sumykhimprom 50 Tronox 190 Louisiana Pigm. 145 China_TIO2 130 Z.C. Police 36 Cristal 185 KRONOS 99 Gansu Ying. 100 Precheza 35 Kronos Titan 69 Huntsman PC 52 Nanjing TIO2 100 Huntsman PC 25 Cristal 95 Cinkarna Metal 25 Sichuan Lomon 80 Henan Billions 80 Yuxing Chem Wks 80 1,322 1,921 1,125 210 342 Source: CMAI and J.P. Morgan

56 57 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 20: Titanium dioxide world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 1,921 1,921 1,761 1,761 1,761 1,761 1,761 South America 95 80 80 80 80 80 80 West Europe 1,507 1,322 1,117 1,117 1,117 1,117 1,117 Central Europe 96 96 96 96 96 96 96 CIS & Baltic States 141 141 141 141 141 141 141 Middle East 180 210 330 330 330 330 330 Africa 25 25 25 25 25 25 25 Indian Subcontinent 84 97 97 97 97 97 97 Northeast Asia 1,652 1,932 2,482 2,742 2,802 2,802 2,802 Southeast Asia 361 386 411 411 411 411 411 WORLD 6,062 6,210 6,540 6,800 6,860 6,860 6,860 Growth rate 6.37% 2.44% 5.31% 3.98% 0.88% 0.00% 0.00% Source: CMAI and J.P. Morgan

Pricing Titanium dioxide prices have been increasing together with energy costs, transportation costs and other costs. Producers using the sulphate process have been more affected due to its higher intensity compared to chloride process.

Figure 59: Titanium dioxide price chart 2.5

2.4

2.3

2.2

2.1

2.0 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Source: DataStream

57 58 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Hydrogen Peroxide Introduction

Hydrogen peroxide (H2O2) is a very pale blue liquid which appears colourless in a diluted solution, and is slightly more viscous than water. It has strong oxidizing properties and is therefore a powerful bleaching agent that is mostly used for bleaching paper.

Table 21: Hydrogen peroxide at a glance Growth rate (CAGR 2008-2013E) 4.4% Current operating rate 75%-80% Key end-markets Bleaching in the paper industry Key demand regions Europe (27%), North America (20%), China (26%) Key players Solvay, Evonik, Arkema Market structure Top 6 producers amount to up to 56% of capacity Key Inputs alkylanthraquinone, hydrogen and gas Opportunity Move to total chlorine-free bleaching, HPPO Source: J.P. Morgan estimates.

Overview & Outlook Overall, growth for hydrogen peroxide is expected to be 4% in 2008-2013E (SRI). However, growth and demand is largely driven by Asia (6% annual growth rate) due to the large demand for hydrogen peroxide in its growing pulp and textile bleaching industry. There is a significant increase in hydrogen peroxide demnd in China up to 30 times from 1990 level.

Production process The most widely used processing method is the AO (Autoxidation) process. This production type is environmentally friendly; it uses alkylanthraquinone, hydrogen and gas only. Due to this, hydrogen peroxide is replacing chlorine more and more in pulp bleaching and other applications.

Dow Chemical invented a process that produces hydrogen peroxide by an oxygen reduction electronic route. The technology is economically only useful for high capacity plants that produce seven or more tons of hydrogen peroxide per day.

Demand The Pulp & paper industry represents by far the largest end-use market of hydrogen peroxide, with 54% of demand. The estimated market growth of the paper industry is expected to be in line with GDP. However, the primary factor for growth in hydrogen peroxide consumption is the concern for the environment. Hydrogen peroxide decomposes into water and oxygen and is replacing oxidizing compounds such as chlorine.

While the hydrogen peroxide market has traditionally been diversified across a broad spectrum of uses, rapid growth in consumption in pulp bleaching has forced the business to be driven primarily by demand in this one application. A relatively new demand driver for hydrogen peroxide is the commercialization of a process to produce propylene oxide from hydrogen peroxide (HPPO process) developed by BASF and Dow. The benefits of this alternative process include (i) lower capital costs than traditional PO plants, (ii) reduced dependence on petrochemical inputs and (iii) reduced waste (wastewater reduced by 70-80%, energy reduced by 35%).

58 59 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 60: Hydrogen peroxide consumption by end market Env ironmental Specialty / Mining Grades & Other application 8% 4% Tex tiles 12% Pulp and Paper 54% Chemicals & Laundry Products 22% Source: SRI and J.P. Morgan

Figure 61: Hydrogen peroxide consumption by region Figure 62: Hydrogen peroxide demand growth rate, (2008-2013E CAGR) North America Others 11% Other Asia 20% Commonwealth of Independent States

C&S America

C&S America Wo rld China 26% 7% AME China

Europe

North America Japan 6% Europe 27% AME 3% Japan

-2%0%2%4%6%8%10%12%14%16%

Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

Supply/Key Players Europe is the largest hydrogen dioxide producer. China has overtaken the United States as the world’s second largest hydrogen peroxide producer with a capacity of 1.26 million metric tons in 2008, very close to total European capacity.

Figure 63: Hydrogen peroxide top producers (%) Solvay 16%

Others 41% Degussa 14%

Arkema 9% Mitsubishi 3% Kemira 5% FMC 6% Eka 6% Source: SRI and J.P. Morgan

Pricing Hydrogen peroxide prices are heavily influenced by the health of the paper and pulp industry.

59 60 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Petrochemicals

Introduction Organic Chemicals are derived In value terms, around 35%- 40% of all chemicals produced are petrochemicals (or from crude oil or natural gas “organic chemicals”). They are often manufactured as part of the oil refining process whereas inorganic chemicals are and are derived from crude oil and natural gas. Increasingly, oil and gas companies derived from ores or brines are undertaking the manufacturing of first-generation commodity organic chemicals, as they possess 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.

Middle Eastern players strongly Oil/Gas producers located in the Middle East and other oil-rich zones are also increase their position in the expanding their market positions fairly rapidly, taking advantage of cheap raw petrochemicals industry. materials in their locales and exporting the derived chemical products. In this context, a number of joint ventures have been set up in recent years involving Kuwait, Petronas, and SABIC together with Western partners including Dow Chemical, Exxon Mobil and Royal Dutch.

Base chemicals are used for “Primary” or “base” petrochemicals are the building blocks for polymers that are part polymerization of everyday life and are used in the production of industrial chemicals. These polymers can either be produced directly from primary chemicals only, or by using more steps and the addition of intermediates. The whole process by which primary and intermediate petrochemicals are converted into plastics, fibres and resins is known as “polymerization”.

Figure 64: Overview of key petrochemicals Monomer Polymer

Primary/ Interm ediates/ End-Products Base Chemicals Derivatives

Plastics Ethylene Glycol Polyethylene Olefins Polypropylene Ethylene Methanol P o lyvin yl C hlo ride Propylene Phenol Polystyrene Butadiene PET Propylene Oxide Synthetic Resins

Aromatics Styrene Monomer M D I/T D I Benzene Polycarbonate Acetone Toulene Fibers

Xylene A crylic A cid Polyester Fiber

A crylic F ib er Acrylonitrile Nylon 6 and 66

Source: J.P. Morgan

60 61 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

The manufacture of the primary monomer is rarely part of the plastics industry and is usually carried out at a chemical or petroleum plant. Primary chemicals fall into two broad categories:

• Olefins (Ethylene, Propylene and Butadiene): A class of unsaturated aliphatic hydrocarbons characterized by a straight carbon chain. • Aromatics (Benzene, Toluene and Xylene): A group of unsaturated cyclic hydrocarbons containing one or more structural carbon rings which are highly reactive and chemically versatile. The group’s name derives from the strong odour characterized by chemicals in this family.

The most important organic chemical is Ethylene, with around 100m tonnes produced each year, forming a base for approx. 350m tonnes of chemicals and polymers.

Feedstock Naphtha and natural gas are the Crude oil consists of many different hydrocarbons, and includes many undesirable main feedstocks in the chemical impurities. Therefore, refineries are used to separating these different elements and production chain maximizing the creation of particular products. 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) - ethane, propane, and butane), used more often in the United States and the Middle East.

Organic base chemicals are Besides the distillation of crude oil (naphtha has a boiling point of approx. 100- produced by “cracking” 200oC) the majority of organic base chemicals are manufactured in an olefin plant or hydrocarbons “cracker.” This conversion process breaks heavy hydrocarbons into simpler molecules (e.g. light hydrocarbons) that change the molecular structure, essentially. The rate of cracking and therefore the end product that is produced is heavily dependent on the temperature, the catalyst, or the chosen degree of pressure.

Figure 65: Oil refinery process Oil Refinery Petrochemical Industry Fractional Distillation Olefin Plant (Cracker)

Petroleum Gas Olefins

Ethylene Naphta Propylene

Kerosene Butadiene Crude Oil

Diesel Aromatics Lubricating Oil Benzene

Bitumen Toulene

Xylene

Source: J.P. Morgan

61 62 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

The cost of the feedstock has a significant influence on the profitability of the participants in the olefin industry. It is the principal component in the manufacturing of the majority of base chemicals and polymers and it also reflects the cost of the energy that the cracking process consumes in large quantities.

Also, global operating rates play an important part in determining profitability, reflecting any potential for further volume or price increases.

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.

Figure 66: Crude oil prices vs. natural gas price chart 250

200

150

100

50

0 Feb- Jun- Oct- Feb- Jun- Oct- Feb- Jun- Oct- Feb- Jun- Oct- Feb- 06 06 06 07 07 07 08 08 08 09 09 09 10

Brent Crude Oil Index U$/ BBL- PRICE INDEX Natural Gas- Henry Hub $/MMBTU- PRICE INDEX Source: Bloomberg and J.P. Morgan

Higher costs for natural gas lead Although the gap is narrowing, natural gas costs in North America and Western to disadvantages for Western Europe are still much higher than in other regions, in part due to higher industrial producers. demand and lower supply. This leads to a big disadvantage for producers in those regions.

For petrochemical companies, consumption of oil, natural gas, and/or their derivatives for both fuel and raw materials accounts for the vast majority of the total cost of production. Even chlorine and caustic soda production requires energy (in the form of electricity) as the largest input cost. A significant proportion of the feedstock 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 volatility can still have a large effect on margins within the industry.

62 63 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 67: World Natural Gas Costs (July 31st, 2009) Figure 68: Ethylene Price and Cash Margins $US/MMBtu 1,500

1,300

1,100

900

700

500

300

100

-100

-300 Jun-2009 Sep-2009 Dec-2009 Mar-2010 Jun-2010 Ethy lene Spot ($/mt) Cash Margins ($/mt)

Source: Potash Corp and Fertecon Source: CMAI and J.P. Morgan estimates

63 64 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Olefins (primary)

Olefins form the building blocks The three most important olefins are ethylene, propylene, and butadiene—these form for a vast variety of chemicals the building blocks for the majority of both organic chemicals and synthetic materials. About 75% of all chemicals produced are based on these three olefins.

Feedstock costs are the key After supply/demand dynamics, the price of crude oil (or more specifically, of driver for profitability naphtha or gas oil) and natural gas are the most important drivers of profitability in olefin production. The commodity nature of these businesses implies that a significant change in raw material pricing passes straight to the bottom line. Over the short term, this is because NGLs and naphtha pricing are established daily, but contracts for olefins prices are set on a monthly basis and the majority of volume is sold under monthly contracts.

Figure 69: Olefins and their derivatives 60% Polyethylene HDHD Polyethylene Polyethylene

12% Vinyl Chloride Polyvinyl Chloride Ethylene Dichloride

14% Ethyl Glycol Ethylene Ethylene Oxide

7% Ethyl BezeneBenzene Styrene Polystyrene

7% OthersOthers

68% Polypropylene

Acrylic fibers 7% Acrylonitrile ABS resins ABS resins 4% Propylene Cumene

Phenolic resins 7% Propylene oxide

PolyurethanesPolyurethanes resins resins 11% others

Styrene butadiene 55% Synthetic rubbers Polybutadiene Butadiene

Latexes 45% othersother Nylon fibers and resins

Source: J.P. Morgan

64 65 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Ethylene Introduction Ethylene is a colorless gas and is the lightest and most used hydrocarbon in the world. Ethylene itself has no end-use, but it is a basic chemical raw material for a variety of industrial products. As one of the largest-volume petrochemicals worldwide with a diverse derivative portfolio, ethylene is often used as a surrogate for the performance of the petrochemical industry at large.

Table 22: Ethylene at a glance Growth rate (CAGR to 2014E) 4.8% Current operating rate 80-85% Key end-markets Plastics (Polyethylene, Polyvinyl Chloride, Polystyrene) Key demand regions Asia (35%), North America (24%), Western Europe (17%) Key players Exxon Mobill, Equistar, Dow, Ineos, Chevron, Market structure Top 10 producers amount to up to 26% of total production Key Inputs Crude oil, Natural Gas, Naphta Threats Increase in feedstock prices, new capacity in the Middle East and Asia Source: J.P. Morgan estimates.

Overview & Outlook Global ethylene demand has grown by 1.1% CAGR from 2004-2009. In the same period, capacity grew by 3.6%.

Through 2009-14E, world ethylene demand growth is expected to grow by 4.8% CAGR (according to CMAI), with polyethylene and ethylene oxide (for ethylene glycol & polyester) being the dominant drivers for growth. For the same period, capacity growth is estimated to be 3.1% CAGR.

Production Process Steam cracking is the primary process for production of ethylene. The recovery from refinery off-gas streams, ethanol dehydration (in India and Pakistan) and the recovery from coal and coal-based liquids (in South Africa) are alternative production methods. Ethylene may also be recovered from coal and coal-based liquids (in South Africa).

Construction costs for ethylene plants vary with the choice of feedstock. Ethane- based facilities require the least capital investment because the small quantities of by- product may not warrant inclusion of recovery equipment for these products. Naphtha- and gas oil–based crackers are about 1.5 and 1.7 times more capital intensive than ethane-based plants, but offer value of the by-products obtained from their cracking.

There is a high degree of product technology standardization in particular with regard to product quality and purity of polymer grade product. Competitors therefore focus on producing the product at the lowest cost. Many companies are creating joint projects and alliances in either monomer or derivative production to spread the investment risk.

65 66 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Demand 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 more than 78% 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 the manufacturing of antifreeze, PET bottle resin and polyester fibres.

Figure 70: Ethylene and its derivatives

60% Polyethylene High Density Polyethylene

12% Ethylene Dichloride Vinyl Chloride Monomer Polyvinyl Chloride

14% Ethylene Ethylene Oxide Ethylene Glycol

7% Ethyl Benzene Styrene Polystyrene e

7% Others

Source: J.P. Morgan

Figure 71: Ethylene demand by region Figure 72: Ethylene demand growth by region (2008-2014E) North America, 24% AME Asia Asia, 35% WORLD

South South America

America, 4% Central Europe

North America

West Europe, West Europe AME, 15% 17% Central -2% 0% 2% 4% 6% 8% 10% 12% 14% Europe, 4%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key Players 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.

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.

66 67 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 73: Ethylene demand/ capacity Thousands metric tons 200000 95

90 150000 85 100000 80

50000 75

0 70 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Total Capacity Total Demand Oper. Rate Source: CMAI and J.P. Morgan

Until 2000, North American olefins producers dominated global trade of ethylene derivatives, based on natural gas and feedstock prices that enabled a competitive position. Since then, changing energy market dynamics in North America, as well as in global crude oil markets, have caused regional competitiveness to change dramatically, causing a reduction of North American market share towards Asia and the Middle East. By 2015, Asia Pacific will account to 33% of world ethylene capacity. Almost half of this new capacity will be added in China. Despite this Asia Pacific will remain a net importer until 2015. The Middle East will account for around 36% of new capacities coming online from 2010-15. Some of these new capacities are coming at the expense of closures in North America.

Table 23: Top 10 Ethylene producers (2009) Thousand metric tons Western Europe North America Asia Middle East Rest of the World Ineos 2,260 Equistar 4,467 FPCC 2,935 Petrokemya 2,900 Braskem 2,530 SABIC Europe 2,115 ExxonMobil 3,988 Reliance Industries 2,032 YANPET 1,855 Quattor 1,240 Polimeri Europa 2,055 Dow 3,628 YNCC 1,800 JUPC 1,350 PBB Polisur 828 Dow Benelux 1,785 Chevron Phillips 3,413 Honam PC 1,750 Jam PC 1,320 SASOL 720 LyondellBasell 1,780 Shell Chemical 2,632 LG Chem 1,620 SADAF 1,280 PKN Orlen 700 FAO 1,380 Nova Chemical 2,375 PTT Chemical 1,378 Marun PC 1,100 TVK 650 Repsol Quimica 1,300 Ineos 1,746 Mitsub. Chemical 1,275 Arya Sasol PC 1,000 NKNK 600 Ruhr Oel 1,080 FPC USA 1,495 CPC-Taiwan 1,115 SEPC 1,000 Pequiven 600 BASF Antwerp 1,080 PEMEX 1,382 Idemitsu Kosan 1,101 Petro-Rabigh 975 Unipetrol RPA 544 OMV 945 Westlake 1,334 PCS 1,080 Equate 920 Kazanorgsintez 430 15,780 26,460 16,086 13,700 8,842 Source: CMAI and J.P. Morgan

Table 24: World Capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 35,135 33,474 32,690 32,639 32,639 32,639 32,639 South America 5,286 5,399 5,399 5,399 5,399 5,399 5,399 West Europe 24,581 24,268 24,268 24,268 24,348 24,428 24,428 Central Europe 2,754 2,754 2,754 2,754 2,754 2,754 2,754 CIS & Baltic States 3,709 3,746 3,816 3,886 3,886 4,306 4,306 Middle East 17,094 20,810 25,059 27,793 28,851 28,851 29,601 Africa 1,810 1,810 1,810 1,810 1,810 1,810 1,810 Indian Subcontinent 3,170 3,170 3,998 4,237 4,237 5,107 5,557 Northeast Asia 29,512 30,427 34,517 34,999 36,232 38,802 39,664 Southeast Asia 7,200 7,300 9,559 11,000 11,000 11,240 12,370 WORLD 130,250 133,158 143,870 148,785 151,156 155,336 158,528 Growth rate 3.77% 2.23% 8.04% 3.42% 1.59% 2.77% 2.05% Source: CMAI and J.P. Morgan.

67 68 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 25: Key Ethylene capacity additions by producer Thousand metric tons Year Region Producer New Capacity In % of 2009 Capacity Feedstock 2009 Korea Honam PC 1000 0.75% Naphtha Saudi Arabia Petro-Rabigh 975 0.73% Ethane/ Propane Saudi Arabia Yansab 867 0.65% Ethane/ Propane Kuwait TKOC 743 0.56% Ethane Saudi Arabia SEPC 550 0.41% EPB China Dushanzi PC 333 0.25% EPB/ Naphtha/ Gas Oil/ Residues Iran Jam PC 330 0.25% EPB Naphtha China Fujian Ref & Chem 267 0.20% EPB/ Naphtha Saudi Arabia Jubail ChevPhill 150 0.11% Naphtha China Secco 150 0.11% EPB/ Naphtha 2010 Saudi Arabia SHARQ 1100 0.83% Ethane/ Propane Qatar RLOC 975 0.73% Ethane Thailand PTT Polyethylene 917 0.69% Ethane China ZRCC 750 0.56% EPB/ Naphtha Abu Dhabi, Ruwais Borouge 700 0.53% Ethane Thailand MOC 675 0.51% Naphtha China Dushanzi PC 667 0.50% EPB/ Naphtha/ Gas Oil/ Residues Singapore Shell Chemical 667 0.50% Naphtha/ Gas Oil/ Residues India Indian Oil 643 0.48% Naphtha China Fujian Ref & Chem 533 0.40% EPB/ Naphtha China Panjin Ethylene 450 0.34% EPB/ Naphtha Saudi Arabia Yansab 433 0.33% Ethane/ Propane Iran Morvarid PC 334 0.25% Ethane Saudi Arabia Petro-Rabigh 325 0.24% Ethane/ Propane Romania Oltchim 200 0.15% Naphtha China Secco 150 0.11% EPB/ Naphtha 2011 Saudi Arabia Kayan 1325 1.00% EPB Singapore ExxonMobil 1000 0.75% Naphtha/ Gas Oil/ Residues Abu Dhabi, Ruwais Borouge 700 0.53% Ethane Saudi Arabia Saudi Polymers 600 0.45% Ethane/ Propane Qatar RLOC 325 0.24% Ethane China ZRCC 250 0.19% EPB/ Naphtha Thailand MOC 225 0.17% Naphtha India Indian Oil 214 0.16% Naphtha Iran Morvarid PC 166 0.12% Ethane 2012 Saudi Arabia Saudi Polymers 600 0.45% Ethane/ Propane China Fushun PC 533 0.40% Naphtha/ Gas Oil/ Residues Iran Ilam PC 458 0.34% EPB/ Naphtha China Sichuan PC 400 0.30% Naphtha/ Gas Oil/ Residues 2013 China SINOPEC Wuhan 733 0.55% EPB/ Naphtha India OPAL 642 0.48% EPB/ Naphtha Taiwan CPC-Taiwan 600 0.45% Naphtha China Daqing PC 450 0.34% EPB/ Naphtha/ Gas Oil/ Residues China Sichuan PC 400 0.30% Naphtha/ Gas Oil/ Residues China Fushun PC 267 0.20% Naphtha/ Gas Oil/ Residues China Yulin Energy & Chemical Co. 225 0.17% Methanol to Olefins India BCPL 220 0.17% EPB/ Naphtha 2014 Abu Dhabi, Ruwais Borouge 750 0.56% Ethane China Shanghai PC 600 0.45% Naphtha/ Gas Oil/ Residues India OPAL 458 0.34% EPB/ Naphtha China Daqing PC 150 0.11% EPB/ Naphtha/ Gas Oil/ Residues Source: CMAI and J.P. Morgan.

Pricing Ethylene prices started to rise strongly in 2003 and were pushed further in 2005 and 2006 by rising input costs and tightening supply/ demand. However, there was a huge fall in prices on demand weakness as a result of recession in late 2008-early 2009. In the longer term, we see weakness in ethylene prices on new capacity coming online especially in the Middle East. In near Term, we see strong prices on unplanned cracker incidents around the world.

68 69 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 74: Ethylene price chart 2,100 1,800

1,500 1,200 900 600

300 0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Ethy lene (Contract) €/ MT Forecast (Contract) Ethy lene (spot) $/ MT Forecast (Spot) Source: CMAI and J.P. Morgan

Propylene Propylene is a colorless, odorless and highly flammable gas. Of the two principal grades of propylene, chemical grade can be manufactured in both crackers and refineries, while polymer grade can be manufactured only in crackers.

Table 26: Propylene at a glance Growth rate (CAGR to 2014E) 5.5% Current operating rate 75-80% Key end-markets Production of Polypropylene Key demand regions Asia (45%) – of which China (15%)-, North America (19%), Western Europe (19%) Key players Exxon, Reliance Industries, Equistar, FPCC, Ineos Market structure Top 10 producers accumulate up to 22.4% of capacity Key Inputs Crude oil, Natural gas, Naphta Threats New capacity in the Middle East and Asia Source: J.P. Morgan estimates.

Overview & Outlook According to CMAI, Propylene demand grew by 1.6% CAGR from 2004-2009. In the same period, capacity grew by only 5%, causing an overcapacity in the propylene market. For the future, Propylene is estimated by CMAI to grow by 5.5% CAGR until 2014, whereas capacity growth is estimated to be lower at 1.5% CAGR.

Strong demand growth coming The highest growth in consumption is expected in the Middle East at a CAGR of from the Middle East and China 17% through 2009-14E, followed by China at about 13% per year. The established consuming regions of North America, Western Europe and Japan will be hard pressed to show any measurable growth. North America is expected flat demand while Western Europe is expected to decline by CAGR of -1.4% through 2009-14, as per CMAI. Production Process Like ethylene, propylene can be manufactured either in an olefin plant or as part of the oil refining process. About 58% of the worldwide production of propylene is obtained as a co-product of ethylene manufacture. Another 34% is produced as a by- product of petroleum refining.

69 70 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

There are a number of projects using alternative on-purpose technologies, including propane dehydrogenation (PDH) and ethylene/butene metathesis; these forms of supply are growing at a fast pace. In 2009, around 6% of global propylene was produced from on-purpose technology. SRI estimates that 23% of global propylene capacity growth over the next five years will come from these plants. A few projects are looking at other technologies such as methanol-to-olefins (MTO) and methanol-to-propylene (MTP).

Demand Propylene has only a few direct The largest market for propylene is manufacturing of polypropylene resin, an uses. By far the biggest market important intermediate product in the manufacturing of a wide range of consumer is production of polypropylene and industrial goods (see polypropylene section). resins. It is also used in the manufacture of a number of derivative chemicals that are used to produce certain textiles, fibres, coatings, and plastic- Acrylonitrile is used in a variety of elastomeric polymers and fibre applications such as nitrile rubber, ABS resins and acrylic fibres. Propylene oxide is used mainly in producing propylene glycol and in the polyols/urethanes industry. Cumene is the main feedstock for the manufacture of phenol and acetone. Figure 75: Propylene and its derivatives

65%68% Polypropylene

Acrylic fibers 7% Acrylonitrile ABS resins 4% Propylene Cumene

Phenolic resins 7%% Propylene oxide

Polyurethanes resins 11% others

Source: Company data and J.P. Morgan estimates.

Propylene demand growth has continued to outpace ethylene demand growth for a number of years. This stronger demand growth for propylene over ethylene is based upon the rapid growth of polypropylene, which has been led by demand for injection molding in the automotive and transport industry.

70 71 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 76: Propylene demand by region Figure 77: Propylene (Polymer/ Chemical grade) demand growth by region in % (2008-2014E) North America AME 19% Rest of Asia China 30% South America South America WORLD 4% Central Europe Rest of Asia North America West Europe Wes t Euro pe 19% China 15% -5.0% 0.0% 5.0% 10.0% 15.0% 20.0% Central Europe AME 8% 5% Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key Players During 2010-2014E, an additional 20 million metric tons per year of propylene capacity are forecast to come on stream worldwide (CMAI). Most capacity additions will be in Asia and the Middle East. China will account for 38% of new capacity additions in the next five years while the Middle East will account for 20%.

Dow aside, the majority of propylene producers are petroleum-refining companies. Therefore, most propylene is produced as a by-product of steam cracking for the production of ethylene. However, propylene demand has grown quicker than ethylene demand in recent years as new steam crackers have not provided adequate growth in propylene supplies. Also, much of the new capacity in the Middle East is based on an ethane feedstock that produces negligible propylene.

Figure 78: Propylene demand/ capacity (-000- Metric tons) 100000 90

80000 85 60000 80 40000

20000 75

0 70 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E Total Capacity Total Demand Total Oper. Rate % Source: CMAI and J.P. Morgan

71 72 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 27: Top 10 propylene producers (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World Polimeri Europa 1,200 Equistar 2,527 Reliance Industries 2,599 Petrokemya 710 Braskem 1,287 SABIC Europe 1,161 ExxonMobil 1,779 FPCC 2,468 Petro-Rabigh 608 SASOL 990 LyondellBasell 1,155 Shell Chemical 1,593 Nippon Petrol. 1,220 Saudi Polyolefins Co. 450 Petrobras 568 Ineos 1,155 Chevron Phillips 1,324 SK Energy 1,040 Carmel Olefins 450 PKN Orlen 485 OMV 955 Dow 1,257 LG Chem 960 NATPET 420 Quattor 375 Dow Benelux 870 Enterprise/Total 1,235 Mitsub. Chemical 955 Oman Ref. Co. 340 TVK 320 Ruhr Oel 770 Enterprise 862 YNCC 910 Al-Waha 338 Slovnaft 295 Shell Chem Neth 750 BASF/FINA LP 856 Honam PC 880 Jam PC 305 NKNK 270 Borealis 730 FPC USA 823 CPC-Taiwan 835 Advanced PP Co. 300 Unipetrol RPA 266 FAO 710 Ineos 790 PCS 820 SEPC 285 Pequiven 260 9,456 13,046 12,687 4,206 5,116 Source: CMAI and J.P. Morgan The supply of propylene remains highly dependent on the health of the ethylene industry as well as refinery plant economics. Propylene availability from ethylene plants is dictated by the supply/demand balance for ethylene, its feedstock slate and cracker operating conditions.

Table 28: World Capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 20,498 19,871 20,076 20,358 20,374 20,374 20,374 South America 3,551 3,551 3,551 3,551 3,551 3,779 4,006 West Europe 17,290 17,097 17,122 17,147 17,187 17,227 17,227 Central Europe 1,926 1,926 1,926 1,926 1,926 1,926 1,926 CIS & Baltic States 2,002 2,020 2,051 2,083 2,580 2,793 2,793 Middle East 4,617 6,693 7,614 9,208 9,878 10,007 10,636 Africa 1,386 1,386 1,586 1,786 1,786 1,786 1,786 Indian Subcontinent 2,524 3,199 3,979 4,374 4,594 5,264 5,434 Northeast Asia 24,938 26,018 29,665 30,633 31,815 33,373 33,841 Southeast Asia 4,887 5,213 6,479 7,469 7,659 7,902 8,549 WORLD 83,618 86,974 94,049 98,535 101,350 104,431 106,572 Growth rate 5.59% 4.01% 8.13% 4.77% 2.86% 3.04% 2.05% Source: CMAI and J.P. Morgan

Pricing In 2H10, we expect propylene prices returning to more normalized level of €800/tn from peak level of €1000/mt as the capacities are back from overhaul. New capacity additions will further put downside pressure on propylene prices.

Figure 79: Propylene price chart 1,200

1,000

800

600 400

200 0 Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- 1991 1992 1994 1995 1997 1998 2000 2001 2003 2004 2006 2007 2009 2010

Propy lene Chemical Grade (€/ MT) Forecast (Chemical Grade) Propy lene Poly mer Grade (€/ MT) Forecast (Poly mer Grade) Source: CMAI and J.P. Morgan

72 73 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Butadiene Butadiene is an important industrial chemical used as a monomer in the production of synthetic rubber. This in turn is used in the manufacturing of tyres and other fabricated items.

Other demand for butadiene comes from manufacturers of latex, ABS resins (used in engineering plastics, such as computers), and nylon 66 fibres.

Table 29: Butadiene at a glance Growth rate (CAGR to 2014E) 3.9% Current operating rate 75-80% Key end-markets Rubber, Latex, Plastics and Fibres Key demand regions Asia (40%) –China(15%) & Japan (9%)- , W Europe (19%), N America (17%) Key players Texas PC, Equistar, FPCC, Shell, Sabina Market structure Top 10 producer account for 35% of world production Key Inputs Crude Oil, Natural gas, Naphtha Threats Asia becoming self-sufficient Source: J.P. Morgan estimates. Overview & Outlook There has been lot of volatility in butadiene prices in last 2-3 years. Butadiene production is governed by the demand of Ethylene and the feedstock used as it is mainly a byproduct in ethylene production. Demand depends on health of the autos and tyre industries as it is mainly used to make intermediates (SBR, PBR) for making tyres.

Production process The raw materials for butadiene production are (as for ethylene and propylene) crude oil, natural gas or naphtha. Therefore, most butadiene is not produced per se, but occurs as a by-product of ethylene production from steam crackers (96% of production).

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 is dependent upon the feedstock used.

Demand The production of the two major commodity types of synthetic rubber - polybutadiene rubber (PBR) and styrene butadiene rubber (SBR) - accounts for over 50% of global butadiene demand. Butadiene is also used for ABS resins for common plastics found in telephones and computers, carpet backing and other rubber materials such as neoprene wet suits.

Figure 80: Butadiene and its derivatives

Styrene butadiene 55% Synthetic rubbers Polybutadiene Butadiene

Latexes 45% othersother

Nylon fibers and resins Source: J.P. Morgan

73 74 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Global demand for butadiene consumed into ABS resin production is estimated to grow at an annual rate of around 5-6%, due to heavy use of thermoplastics in the manufacture of computer equipment and other appliances, mainly in China.

Figure 81: Butadiene demand by end market ABS Resins 13% Others 22%

Sty rene Butadiene Poly butadiene Latex 10% 28%

Sty rene Butadiene Rubber 27% Source: CMAI and J.P. Morgan

Figure 82: Butadiene demand by region (2009) Figure 83: Butadiene demand growth by regions % (2008-2014E) North America AME 17% Rest of Asia 26% China South America Central Europe 3% South America WORLD Asia West Europe 19% Wes t Euro pe China 15% North America

Central Europe -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% Japan 9% AME 4% 7% Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Figure 84: Tire production growth rates Figure 85: Tire demand growth rate % %

15% 20%

10% 15%

5% 10%

0% 5%

-5% 0%

-10% -5%

-15% -10%

t a n e rld s e ld S s e p p US na or U er in ther apan ro hi h Chin nt Wo O J u C W Japan Euro E ontinent Ot bco c rn Europe u tral tern ub e s n s n e n s ia C We ia West Central Europe Ind 2009-14 2004-09 Ind 2009-14 2004-09

Source: CMAI Source: CMAI

74 75 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Tyre industry trends have a significant impact on the butadiene market. The industry is already dominated by demand in China, which is expected to produce 38% of the global tyre production by 2014. Japan and Western Europe will have just under 10% of global production each, as per CMAI.

Supply/Key Players Worldwide capacity for butadiene is estimated at 11.9 million metric tons in 2009. Of this total, 97% is based on the extraction of crude C4 streams generated as a co- product of ethylene production.

92% of global butadiene capacity additions planned between 2009 and 2014 will be coming in Asia, particularly in China, Singapore, Korea, India, Taiwan and Malaysia.

Key additions (2010-2014) are coming from:

• TPC Group, 380,000 metric tons in Houston (3.2% of 2009 global capacity), Texas and 260,000 metric tons in Port Neches, Texas (2.2%) • Shell Chemicals 155,000 metric tons plant (1.3%) in Singapore • Chinese companies: 9 SINOPEC/SABIC Tianjin PC: 166,000 metric tons in Tianjin, Tianjin (1.4%)

9 ZRCC: 150,000 metric tons in Ningbo, Zhejiang (1.3%)

9 Sichan PC: 150,000 metric tons in Chengdu, Sichuan (1.3%)

9 BASF/Yangzi JV with 130,000 metric tons (1%) in Nanjing (1.1%)

9 Dushanzi PC 120,000 metric tons in Dushanzi, Xinjiang (1%)

9 Fushun PC: 120,000 metric tons in Fushun, Liaoning (1%)

9 SINOPEC Wuhan: 120,000 metric tons in Wuhan, Hubei (1%)

Figure 86: Butadiene demand/ capacity (-000- Metric tons) 15000 90 85 10000 80

5000 75 70 0 65 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Total Capacity Total Demand Operating Rate, % Source: CMAI and J.P. Morgan

75 76 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 30: Butadiene Top 10 producers (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World Ineos 310 Texas PC 835 FPCC 447 Petrokemya 130 Braskem 299 Polimeri Europa 285 Equistar 483 JSR 268 Bandar Imam PC 77 NKNK 254 LyondellBasell 250 Shell Chemical 411 LG Chem 260 Amir Kabir PC 50 Tobolsk-Neftekhim 195 SABIC Europe 230 Sabina PC 408 Korea Kumho 237 Arak PC 33 Synthos Kralupy 90 Oxeno 220 ExxonMobil 322 YNCC 218 Tabriz PC 17 Omsk Kauchuk 90 Repsol Quimica 207 Lanxess 120 Yangzi PC 210 Jam PC 10 Quattor 80 Dow Benelux 170 Ineos 98 Reliance Industries 200 Syntezkauchuk 75 Naphtachimie 120 Chiba Butadiene 177 PKN Orlen 70 Shell Chem Neth 115 CPC-Taiwan 173 Lukoil Neftochim Bourgas 50 Dow 105 CNOOC & Shell PC 165 FSK Elemir. 45 BASF SE 105 Maoming PC 150 Kauchuk Sterlitamak 45 2,117 2,677 2,505 317 1,293 Source: CMAI and J.P. Morgan

Table 31: Butadiene World Capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 2,878 2,677 2,387 2,387 2,387 2,387 2,387 South America 379 379 379 379 379 379 379 West Europe 2,372 2,372 2,372 2,372 2,372 2,372 2,372 Central Europe 250 255 275 295 295 295 295 CIS & Baltic States 700 700 700 700 700 700 700 Middle East 307 317 422 422 422 422 422 Indian Subcontinent 275 275 293 297 297 345 392 Northeast Asia 4,381 4,505 5,135 5,310 5,565 5,914 6,030 Southeast Asia 348 365 494 520 520 520 520 WORLD 11,890 11,845 12,457 12,682 12,937 13,334 13,497 Growth rate 2.77% -0.38% 5.17% 1.81% 2.01% 3.07% 1.22% Source: CMAI and J.P. Morgan

Pricing There has been volatility in butadiene prices in the last 2-3 years. Spot prices reach a level of $2500/mt before returning to lows of $200/mt in 1H 2008. We expect moderation in butadiene prices as auto production rates moderate, but we expect volatility to continue on continued tight supplies at least in the short term. In the longer term, CMAI expects butadiene prices will be set by Asia as most of the new capacities are arriving there. Western Europe and North America seem likely to track Asian prices.

Figure 87: Butadiene price chart 3,000

2,500

2,000

1,500

1,000

500

0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Butadiene (Contract-Market) €/ MT Forecast (Contract) Butadiene (Spot) US$/MT Forecast (Spot) Source: CMAI and J.P. Morgan

76 77 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Aromatics (primary)

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

Figure 88: Principal Derivatives of Aromatics Nylon 6, 66

Cumene Phenol Polycarbonate

Benzene Ethylbenzene Styrene Polystyrene

Toluene Dinitrotoulene Polyurethanes (MDI/TDI)

Xylene Paraxylene PTA PET

Acetic acid Ethylene Glycol

Source: J.P. Morgan

Benzene Benzene is the largest of the Benzene is one of the largest volume petrochemicals and is the largest of the aromatics aromatics. Benzene is a colorless and highly flammable liquid. It can be derived from petroleum-based sources or coal and is the most important aromatic hydrocarbon in terms of world consumption. Benzene is used to produce a number of petrochemical intermediates such as ethylbenzene for styrene production, cumene for phenol and acetone, cyclohexane and nitrobenzene.

Table 32: Benzene at a glance Growth rate (CAGR to 2014E) 3.7% Current operating rate 70-75% Key end-markets Plastics and rubber Key demand regions North America (19%), Western Europe (18%) and Asia (49%) Key players ExxonMobil, FCFC, Total PC, Dow Chemical Market structure Top 20 producers amount to up to 41.5% of capacity Key Inputs Petroleum or Coal Threats Increasing supply in Asia and the Middle East Source: J.P. Morgan estimates.

Overview & Outlook According to CMAI, Benzene demand grew by 0.5% CAGR from 2004-2009. In the same period, capacity grew by 3.8% which created an oversupply in the market.

Through 2009-14, 57% of incremental capacity is coming from China. CMAI estimates Benzene to grow by 3.7% CAGR until 2014 whereas capacity growth is estimated to be 2.5% CAGR. Because of high cost economies, North America and Europe will be net importers in 2010, while India and Middle East will be net exporters.

77 78 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Production Process Benzene is derived from petroleum or coal, with petroleum accounting for approximately 95% of global supply. Petroleum sources include refinery streams or pyrolysis gasoline (a by-product of ethylene manufacture in cracking naphtha, gas oil or LPG feed).

A growing source of benzene is by the selective disproportionation of toluene, where benzene is co-produced in the manufacture of paraxylene-rich xylenes streams.

Demand Benzene demand throughout the world is dominated by the production of three derivatives: ethylbenzene (styrene production for polystyrene plastics and synthetic rubber), cumene (phenol for resins and adhesives) and cyclohexane (nylon and gasoline component). These derivatives accounted for more than 80% of benzene consumed globally in 2009. Smaller amounts of benzene are used to make some types of rubbers, lubricants, dyes, detergents, drugs, explosives, and pesticides.

Figure 89: Benzene consumption by end market Others 2% Alkylbenzene 3% Chlorobenzene Nitrobenzene 8% 2% Maleic Anhyd. Cumene 19% 2%

Cy clohex ane 12%

Ethy lbenzene 52% Source: CMAI and J.P. Morgan

Figure 90: Benzene consumption by region Figure 91: Benzene demand growth by region North America 19% AME Asia South America 2% WORLD Central Europe Asia 49% South America Wes t Euro pe West Europe 18% North America

-1%0%1%2%3%4%5%6%7%8% Central Europe 5% AME 7%

Source: SRI and J.P. Morgan Source: CMAI and J.P. Morgan

78 79 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Supply/Key Players New capacity moves to Asia and The regional concentration of new investment in both benzene production capacity the Middle East and derivatives is driving a global shift away from the traditional established markets towards Asia and the Middle East. The established western markets are continuing to see pressures on production caused by high alternative feed costs, diminishing refinery feed volumes and an aging asset base. The three major regions (North America, Western Europe and Japan) accounted for 55% of total world production in 2009. Due to capacity build-ups in Asia and the Middle East, this number should continue to fall to below 40% by 2014E.

Most of the new capacities in the next few years will be coming in Northeast Asia, particularly China and Japan. Through 2009-14E, China will be adding 5.9 million metric tons of new capacity or equivalent to 11% of 2009 global capacity for benzene. Japan will add 1.1 million metric tons of new capacities through 2009-14.

Figure 92: Benzene demand/capacity (-000- Metric tons) 70000 90 60000 85 50000 80 40000 75 30000 70 20000 10000 65 0 60 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Total Capacity Total Demand Total Oper. Rate % Source: CMAI and J.P. Morgan

Table 33: Top 10 Benzene producers (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World Dow Benelux 900 ExxonMobil 1,635 FCFC 1,235 Saudi ChevPhill 845 Braskem 733 Total PC 890 Equistar 870 Idemitsu Kosan 911 Borzuyeh PC 430 Unipetrol RPA 340 ExxonMobil 725 Flint Hills Resources 847 PTTAR 874 Ibn Rushd 350 Quattor 255 CEPSA 665 BP 847 GS-Caltex 829 SASREF 300 Ufaneftekhim 250 Polimeri Europa 600 Dow 751 Nippon Petrol. 800 Petrokemya 230 Omsknefteorgsintez 235 Deutsche Shell 600 Shell Chemical 670 Samsung Total PC 730 Bandar Imam PC 230 RUS_Benzene 200 SABIC Europe 515 Chevron Phillips 601 Reliance Industries 670 Bou Ali Sina PC 180 MOL Group 195 Shell Chem Neth 500 CITGO 558 SK Energy 650 Gadiv 135 PKN Orlen 180 Ineos 490 ConocoPhillips 492 Mitsub. Chemical 622 Petkim 134 Lukoil Bourgas 173 Ruhr Oel 375 Shell Canada 435 Yangzi PC 608 Yansab 134 NKNK 172 6,260 7,706 7,929 2,968 2,733 Source: CMAI and J.P. Morgan

79 80 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 34: Benzene world capacity Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 10,585 10,294 10,111 10,291 10,291 10,291 10,291 South America 1,320 1,353 1,353 1,353 1,353 1,353 1,353 West Europe 10,048 9,793 9,853 9,853 9,853 9,853 9,853 Central Europe 1,549 1,549 1,549 1,659 1,659 1,659 1,659 CIS & Baltic States 2,603 2,603 2,618 2,618 2,618 2,618 2,748 Middle East 3,038 3,307 3,788 3,903 3,903 3,973 4,043 Africa 211 211 211 211 211 411 411 Indian Subcontinent 1,227 1,227 1,337 1,371 1,371 1,939 2,106 Northeast Asia 17,772 19,594 21,562 22,503 23,338 24,300 24,476 Southeast Asia 2,826 3,135 3,481 3,909 3,909 3,909 3,909 WORLD 51,179 53,066 55,863 57,671 58,506 60,306 60,849 Growth Rate 5.67% 3.69% 5.27% 3.24% 1.45% 3.08% 0.90% Source: CMAI and J.P. Morgan

Pricing In the short term, benzene prices will depend on the demand of benzene derivatives, which depends on the overall health of economy, and the cost of incremental supply from domestic production and/or imports. In the long term, it will be more governed by cost of supply of incremental production from Asia.

Figure 93: Benzene price chart 1,500

1,200

900

600

300

0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Benzene (Contract) €/ MT Forecast (Contract) Benzene (Spot) $/ MT Forecast (Spot) Source: CMAI and J.P. Morgan

80 81 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Toluene Toluene is primarily used in the chemicals industry to produce xylenes, benzene and phenol, and as a solvent for use in paints, lacquers, gums and resins. It is also blended into unleaded gasoline for octane improvement.

Table 35: Toluene at a glance Growth rate (CAGR to 2014E) 5.4% Current operating rate 60-65% Key end-markets Feedstock for Benzene, Xylene, Phenol Key demand regions Asia (61%), North America (21%), Western Europe (7%) Key players Exxon, China petrochemical corporation, China National Petroleum Market structure Top 10 producers amount to up to 40.5%% of capacity Key Inputs Naphta Threats Additional Asian capacity Source: J.P. Morgan estimates.

Overview & Outlook Toluene consumption is expected to grow globally by 5.4% per year until 2014E according to CMAI, with China growing by 7% and the Middle East growing 8% per year. In the US and Western Europe, consumption growth is not expected to be as high as in emerging markets but still positive (CAGR of 2.4% per year and 3.7% per year respectively).

Production Process Toluene is present in low concentrations in crude oil and is also present in the gasoline fractions that result from thermal and catalytic cracking. However, toluene is not isolated from either of these sources. The chief source of toluene (about 90%) is Naphtha (via catalytic reformate). Three grades of Toluene are produced:

• TDI grade with a Toluene content of over 99% • Nitration grade with a toluene content of 98.5% • Commercial grade with a toluene content of 90-98%

Demand Toluene demand is highly Demand for Toluene is strongly dependent on the demand for its end products: The related to the Benzene and majority of toluene produced is used as a feedstock for xylene, benzene and phenol Xylene demand ratio. production (which is the reason why Toluene is never really removed from refinery streams).

Toluene hydrodealkylation converts toluene to benzene.Where a chemical complex has similar demands for both benzene and xylene, then toluene disproportionation (TDP) may be an attractive alternative to the toluene hydrodealkylation (HDA), although this needs twice as much Toluene as an input.

Table 36: Two production types for Benzene production Production unit Raw material End-product Toluene/Benzene ratio Toluene Hydrodealkylation (HDA) Toluene Benzene 1:1 Toluene Disproportionation (TDP) Toluene Benzene/ Xylene 2:1 Source: J.P. Morgan estimates.

When xylene demand is stronger than benzene demand, TDP units will operate, tending to cause HDA units to shut down and demand for toluene increases.

81 82 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 94: Toluene consumption by end market Other 21%

Toluene Diisocy anate (TDI) 6% Benzene/ Xy lenes 60% Solv ent 13%

Source: SRI and J.P. Morgan

Figure 95: Toluene consumption by region Figure 96: Toluene demand growth rate % (2009-2014E CAGR

ROW 1% North Middle East

America 21% C&E Europe

C&S Asia America 3% World

Western Western Europe

Europe 7% ROW

Asia 61% C&E Europe North America 2% C&S America Middle East 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 5% Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

Supply/Key Players Total capacity of toluene amounted to 30 million metric tonnes in 2009, with North America holding 28% of overall capacity. Western Europe accounts for 9.6%, Middle East 6% and Asia 53%. Most of the new capacities are coming in Asia, particularly China. China is adding new capacities of around 7 million metric tons by 2014E.

Figure 97: Toluene capacity demand by region (-000- Metric tons) 18000 80.0

13000 60.0

8000 40.0

3000 20.0

-2000 0.0 North C&S Western C&E Europe Middle East Asia Others America America Europe

Demand Capacity Operating Rate (%) Source: SRI and J.P. Morgan

82 83 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 37: Top 10- Toluene producers (2010) Thousand metric tons Western Europe North America Asia Middle East Rest of the World Shell & DEA Oil 415 ExxonMobil 901 Reliance Industries 1168 Ibn Rushd 358 Braskem 421 Polimeri Europa 375 Flint Hills Resources 814 SK Energy 894 Saudi Aramco Shell 310 PEMEX 309 Dow Benelux 338 INEOS 806 FCFC 745 Bandar Imam 285 PKN Orlen 180 ExxonMobil Chemical 250 ConocoPhillips 557 Nippon Petroleum 744 Saudi Chev Phill 250 Repsol YPF 170 CEPSA 240 Suncor Energy 440 PTT Aromatics 738 Gadiv 188 Petrobras Energia 150 Ruhr Oel 220 Husky Energy 352 GS- Caltex Oil 710 Safia 103 Pavlodar Refinery 150 Petroleos de Portugal 155 Hovensa 295 CPC-Taiwan 551 Naftan 150 BASF 155 CITGO 289 Petrochina Dalian 475 TNK- BP 140 Shell Chemicals UK 150 Sunoco 269 CNOOC 450 Lukoil 90 INEOS 120 Valero Energy 224 Fujian 450 Petrobras 83 2,418 4,947 6,925 1,494 1,843 Source: CMAI and J.P. Morgan

Pricing Toluene economics depends on the price of oil, refining margins, and supply/demand conditions in the aromatics business in general, including benzene. Because of its use as a gasoline additive, prices are primarily driven by gasoline prices and are also therefore closely linked to the price of oil.

Figure 98: Toluene price chart 1,400 1,200 1,000 800 600 400 200 0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Toluene Nitration Grade (Spot) $/ MT Forecast Source: CMAI and J.P. Morgan

Paraxylene Introduction Mixed xylenes are the second most important aromatic product in terms of world consumption for chemical manufacture, ranking behind benzene and ahead of toluene. Isolation of paraxylene accounted for more than 80% of global mixed xylenes consumption

Xylene is a colourless, sweet-smelling liquid that is very flammable. It is used primarily as a solvent and as an additive in gasoline. For use in the chemical industry, xylene is separated into three isomers: paraxylene, orthoxylene, and metaxylene - which slightly differ in configuration, in the way the CH3 groups are attached to the benzene ring.

83 84 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 38: Paraxylenes at a glance Growth rate (CAGR 2009-14E) 6.0%-6.5% Current operating rate 75% Key end-markets Feedstock for Polyester Key demand regions NE Asia (76%), N America (17%), W Europe (7%) Key players Exxon, China Petrochemical, BP Market structure Top 10 producers amount to up to 43% of paraxylene production Key Inputs Naphtha or Coal Threats New capacity in Asia Source: CMAI and J.P. Morgan estimates.

Overview& Outlook- Paraxylene Overall, annual demand for paraxylene is expected to grow by 6.0%-6.5% over the next few years (2009-14E), according to CMAI. However, this demand growth will be very regional: Asia accounts for 60-70% of this global demand growth, growth in Western Europe will be 2% and U.S is expected to be almost flat. Although, China will have the largest capacity increase it will continue to be a major importer of paraxylene even with this substantial amount of added capacity.

Production Process Xylenes can be produced by several methods. When petroleum is catalytically reformed in refineries, aromatics are a major component of the product stream and the isolation from this stream is the major source of xylenes. Toluene (or toluene-rich streams) may also be converted to benzene and xylenes through disproportionation (see Toluene section). Figure 99: Production of Xylenes

Source: SRI

84 85 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Demand Almost all paraxylene is converted into either terephtalic acid (TPA) or dimethyl terephtalic acid (DMT), which comprises the basic intermediates for polyester fibres and films and polyethylene terephtalate (PET) resins. It is also used to manufacture polybutylene terephtalate (PBT), a specialty engineering resin. Most of the demand is coming from North East Asia, particularly China on increasing demand of fibres from textile industry. As per CMAI, terephthalic acid demand will increase by CAGR of 7% through 2009-14E.

Figure 100: Paraxylene demand Dimethy l Terephalate 4%

Terephthalic Acid 96% Source: CMAI

Supply/Key Players Asia is the largest paraxylene producing region, with 64% of global capacity; North America accounts for 13% and Western Europe amounts to 7%. A significant amount of paraxylene is traded, with the major trade route being from North America to Asia as a net importer.

Most of the new capacities are coming in Asia particularly, China and Indian subcontinent. Northeast Asia will account for 50% while Indian subcontinent will account for 20% of new capacity additions through 2009-14E.

Figure 101: Para Xylenes demand/capacity (-000- Metric tons) 50000 95

40000 90

30000 85

20000 80 10000 75

0 70 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Total Capacity Total Demand Oper. Rate % Source: CMAI and J.P. Morgan

85 86 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 39: Top 10 Para Xylene producers (2009) Thousand metric tons Western Europe North America NE Asia Middle East Indian subcontinent ExxonMobil 650 BP 1,600 FCFC 1,460 Borzuyeh PC 750 Reliance Industries 1,910 BP 600 ExxonMobil 948 Nippon Petrol. 1,200 Bou Ali Sina PC 400 Indian Oil 360 Ruhr Oel 190 Flint Hills Resources 590 GS-Caltex 1,050 Ibn Rushd 386 Deutsche Shell 140 Chevron Phillips 450 Yangzi PC 850 KARO 206 Total PC 135 Parachem 350 SK Energy 750 Bandar Imam PC 180 PETROGAL 125 Chalmette LLC 185 KP Chemical 730 Gadiv 160 Polimeri Europa 100 CPC-Taiwan 720 Petkim 139 CEPSA 100 Liaoyang PC 700 Oman Oil Co JV 132 PCK Schwedt 60 Lidong Chemical 700 Esfahan PC 44 S-Oil 700 2100 4123 8860 2,397 2270 Source: CMAI and J.P. Morgan

Prices Prices were firm in the past few months on strong demand mainly from China, particularly from textile industry. However, we expect prices to soften as the demand stabilizes and new capacities come online. New capacities of 1.2mmt will come online in Middle East and 1.7mmt will come online in NE Asia in 2010.

Figure 102: Paraxylene price chart 1,200

1,000

800

600

400

200

0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Parax y lene(€/mt) forecast Source: CMAI and J.P. Morgan

86 87 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Other monomers (intermediates)

Ethylene Glycol Introduction Ethylene glycol is an ethylene derivative and is used primarily in the manufacture of polyester (84%) and antifreeze (10%).

Of the ethylene glycol consumed for polyester production, 50% is used for PET resins (bottling), 40% for polyester fibres, and 10% for polyester 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.

Table 40: Ethylene Glycol at a glance Growth rate (CAGR to 2009-14E) 4% Current operating rate 70-75% Key end-markets Bottling, Fibres and Antifreeze Key demand regions Asia, China in particular Key players Sabic, Dow, Formosa Market structure Top10 producers amount to up to 60% of capacity Key Inputs Ethylene, Oxygen Threats Increasing capacity in the Middle East and China Source: J.P. Morgan estimates.

Overview & Outlook Ethylene glycol’s growth is highly dependent on demand for polyester fibres and resins. Demand for Ethylene Glycol grew by 5-6% in the past three years due to strong demand for polyester fibre in Asia, in particular China. SRI anticipates growth rates of 4% through 2009-14. Both China and Middle East will grow by more than 5% (China +5.4%, Middle East +5.2%) through 2009-14. While Western Europe and the U.S. are expected to grow at lower rates (each will grow by +2.5% through 2009- 14). The ethylene glycol market is consolidating and moving more towards China and other Asian countries (ex Japan).

Production Process Ethylene Glycol is produced predominantly by the noncatalytic liquid-phase hydration of ethylene oxide.

Nearly all big producers operate an integrated ethylene oxide facility. The most competitive ethylene oxide/glycol producers have a basic position in ethylene and/or a technology and manufacturing cost advantage.

Figure 103: Production of Ethylene Glycol

Ethylene Etyhlene Oxide

Ethylene Glycol Oxygen Water

Source: J.P. Morgan

87 88 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Demand Ethylene Glycol demand growth depends on growth in the general economy as it is mainly used to make polyester resins and automotive antifreeze which grow in line with the GDP. Going forward demand may be impacted by recycling as ethylene glycol has recycling potential.

Figure 104: Ethylene glycol consumption by end market

Antifreeze 10% Poly ethy lene Other Terephthalate (PET) 6% 84%

Source: CMAI and J.P. Morgan

Supply/Key Players In 2009, Ethylene Glycol capacity amounted to 23.7 million metric tonnes worldwide, and the largest producers are located in Saudi Arabia, Kuwait, Canada and the United States.

With the new capacity expansions, global operating rates are dropping and now production is shifting from developed markets to the Middle East, Taiwan, Korea and China.

Figure 105: Ethylene glycol: Capacity and demand growth rate through 2009-14E % 20%

15%

10%

5%

0%

-5% North America Central and Western Middle East Japan China Others Total South Europe America capacity grow th rate demand grow th rate Source: SRI and J.P. Morgan estimates.

88 89 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 106: Top 10 monoethylene glycol producers (-000- Metric tons) 3 14% 12% 10% 2 8% 6% 1 4% 2% 0 0% SABIC Dow Formosa Shell China SPDC Ltd. Honam Reliance Petchem BASF Plastics Petrochemical Petchem. Indus. Indus. (Kuw ait) Global percentage share Capacity Source: SRI and J.P. Morgan

Pricing Ethylene glycol prices are primarily governed by demand/supply conditions and input cost pressures. Movements in the ethylene prices have a marked influenced on ethylene glycol prices.

Figure 107: Ethylene glycol price chart 1200

1000

800

600

400

200

0 Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010

Western Europe Ethylene Gly col price (€/TN) Source: CMAI and J.P. Morgan

89 90 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Methanol Methanol (methyl alcohol or wood alcohol) is one of the most important commodity chemicals as it is used as a raw material in several intermediate chemicals and end uses. Its most important derivative is formaldehyde for the construction industry.

Table 41: Methanol at a glance Growth rate (CAGR to 2014E) 9.9% Current operating rate 61.6% Key end-markets Formaldehyde (Wood Industry) Fuel Additive Key demand regions N America (10%), Asia (38%), W Europe (11%), AME (22%) Key players Methanex, Ar Raz Market structure Top 10 Producers (34%) Key Inputs Syngas Threats Oversupply of Chinese Production, ban of MTBE usage in the U.S., Increasing concern about Formaldehyde side effects. Source: J.P. Morgan estimates.

Overview & Outlook World demand for methanol is projected by CMAI to grow at CAGR of 9.9% from 2009 to 2014E, with much smaller growth in the industrialized areas where markets are mature. Capacity growth is estimated at 7% per year through 2009-14.

More than 50% of demand for the next five years is coming from China. Other key demand areas are the Middle East and South America while only 34% of capacities are concentrated with the top 10 producers.

Key use of methanol is to make formaldehyde. It is important to point out that formaldehyde causes concerns because it is a probable human carcinogen. Many studies have been conducted to assess the risk of human exposure, but results are varied among different research reports. The lack of conclusive evidence has led to widespread disagreement among industry, government agencies and unions regarding the appropriate risk assessment of formaldehyde.

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

Figure 108: Production of Methanol

Carbon Monoxide Methanol

Synthetic Gas Hydrogen Water

Carbon Dioxide or other gases

Source: J.P. Morgan

90 91 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Because of the various applications of input materials used for the production of Methanol, such as Hydrogen (also used in the Steel and Healthcare Industry and for LNG and CTL applications) and Carbon Dioxide (for urea fertilizer production), Methanol producers face strong competition for resources. Since price increases in these industries outperformed price increases for Methanol, increased prices for input costs decreased margins for methanol producers.

Demand Globally, formaldehyde production is the largest consumer of methanol, accounting for 32% of world methanol demand. This demand is driven by the construction industry, since formaldehyde is used primarily to produce adhesives for the manufacture of various construction board products. Other important derivatives of methanol are MTBE (fuel additive) and acetic acid.

The conversion of methanol to gasoline has been used commercially by Exxon at a 14,500/bbl/d plant in New Zealand. This process converts methanol to an equilibrium mixture of methanol, dimethylether and water. This mixture can then be converted to a premium quality, high octane gasoline which can be blended with refinery gasoline or sold separately. Although this technology is not widely used in the coal-to-liquids industry, if the oil price returns to high levels and alternative fuel solutions become more economically important, we expect increasing demand for methanol coming from these technologies.

Figure 109: Methanol consumption by end market Others 19% Formaldehyde 32% Solv ents 4%

Dimethy l Ether 7%

Gasoline/Fuel Acetic Acid 13% MTBE/TAME 12% 13% Source: CMAI and J.P. Morgan

91 92 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 110: Methanol consumption by region Figure 111: Methanol demand growth rate (%) 2008-2014E North America 10% Asia

AME South America WORLD 14% Asia 38% South America

West Europe

North America West Europe Central Europe 11% -10% -5% 0% 5% 10% 15% 20% Central Europe 6% AME 22%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key Players In 2009, world methanol capacity amounted to 68 million metric tonnes. NE Asia holds the largest share (36%, mainly China), followed by Middle East (21%) and the South America (19%). World methanol capacity is expected to reach almost 96 million metric tons by 2014 by CMAI.

Figure 112: Methanol demand/ capacity (-000- Metric tons) 100000 100 80000 80 60000 60 40000 40 20000 20 0 0 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Total Capacity Total Demand Operating Rate, % Source: CMAI and J.P. Morgan.

A significant factor in the methanol market is that the new mega-methanol plants (1.5–4.0 million metric tons per year) are much larger than existing plants. Thus they will have reduced fixed costs, as well as greatly reduced natural gas costs due to strategically located feedstock giving a significant cost advantage. This is likely to drive down the cost of methanol, and cause major shifts in trade patterns. Locations for these large new methanol plants will be Iran, Saudi Arabia, Qatar, and Trinidad and Tobago.

Methanex is the largest producer and marketer of methanol in the world, accounting for approximately 8% of worldwide 2009 methanol capacity. Methanex is a genuine worldwide supplier, with plants currently operating in Trinidad and Tobago, Chile, China and New Zealand.

92 93 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 42: Top 10 Methanol producers (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World STATOIL 900 Millennium 620 Petronas 2,520 Ar Razi 4,850 Methanex 3,840 TOTAL 660 Eastman 195 Methanex 1,220 Zagros PC 2,500 MHTL - M5 1,900 BASF SE 460 PEMEX 180 Boyuan Unichem 1,000 IMC 1,100 Methanex - Atlas 1,750 Shell & DEA Oil 400 Terra Industries 120 Shanghai Coking 850 Oman Methanol 1,050 AMPCO 1,150 BioMethanol Chemie 365 Praxair 45 Kingboard 795 Fanavaran PC 1,000 Azot Togliatti 1,000 BP RP 285 Zhongyuan Chem 730 Ibn Sina 1,000 Metafrax 1,000 Kaltim Methanol 710 QAFAC 990 Methanex - Titan 850 Henan 700 Kharg 660 Metor 850 Shaanxi Yulin 610 GIPC 425 Supermetanol 790 Yanzhou Coal 600 Chemanol 230 Tomsk Methanol 750 3,070 1,160 9,735 13,805 13,880 Source: CMAI and J.P. Morgan

Table 43: Methanol world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 1,160 1,160 1,160 1,160 1,160 1,160 1,160 South America 12,656 12,756 13,256 13,606 13,606 13,606 13,606 West Europe 3,205 3,070 3,105 3,205 3,305 3,405 3,505 Central Europe 805 805 805 805 805 805 805 CIS & Baltic States 4,243 4,316 4,367 4,777 4,917 4,917 4,917 Middle East 12,114 13,944 15,244 16,044 16,044 16,044 19,044 Africa 2,100 2,100 2,700 3,360 3,360 4,360 4,360 Indian Subcontinent 420 470 470 470 470 470 470 Northeast Asia 18,848 24,558 34,373 39,098 39,798 41,148 41,598 Southeast Asia 3,430 4,750 5,980 6,230 6,230 6,230 6,230 WORLD 58,981 67,929 81,460 88,755 89,695 92,145 95,695 Growth rate 17.78% 15.17% 19.92% 8.96% 1.06% 2.73% 3.85% Source: CMAI and J.P. Morgan

Table 44: Top Methanol capacity additions (2010) Thousand metric tons Company Country Location 2010 2011 2012 2013 2014 Total in % of 2009 capacity Metor Venezuela Jose, Anz 500 350 ------850 1.3% Kharg Iran Kharg Island ------1,400 1400 2.1% Zagros PC Iran Bandar Assaluyeh 800 ------800 1.2% Salalah Methanol Oman Sohar 650 650 ------1300 1.9% Almet Algeria Arzew ------1,000 1000 1.5% Emethanex Egypt Damietta 400 860 ------1260 1.9% Baotou Shenhua China Baotou, Mongolia 500 1,500 ------2000 2.9% Datang Int'l Power China Duolun, Mongolia 420 1,260 ------1680 2.5% Kingboard/CNOOC China Dongfang, Hainan 200 600 ------800 1.2% Shandong Jiutai China Erdos, Inner Mongolia ---- 1,000 ------1000 1.5% Shenhua Ningmei China Ningdong, Ningxia 1020 1260 ------2280 3.4% Yulin Energy & Chemical Co. China Yulin, Shaanxi ------1350 450 1800 2.6% Brunei Methanol Company Brunei Sungai Lang 600 250 ------850 1.3% Source: CMAI and J.P. Morgan.

Pricing Methanol pricing was relatively volatile over the last few years. Apart from recessionary pressures last year, it was more the supply issues than the demand issues which unpinned the extreme volatility. We expect tight supply condition to soften as new capacities equal to 20% of 2009 capacity will be coming through 2014. More than 50% of the new capacities are coming in China.

93 94 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 113: Methanol price chart 600

500

400

300

200

100

0 Jan-1995 Jan-1997 Jan-1999 Jan-2001 Jan-2003 Jan-2005 Jan-2007 Jan-2009 Jan-2011

Methanol (Contract) €/ MT Forecast (Contract) Methanol (Spot) €/ MT Forecast (Spot) Source: CMAI and J.P. Morgan

Phenol Phenol (carbolic acid) is a toxic, colourless crystalline solid with a sweet, tarry odor. Key phenol derivatives are bisphenol A (used in production of polycarbonates and expoxy resins), phenol-formaldehyde resins (used in wood products) and caprolactam (nylon production). The remaining derivatives are mainly alkyl phenols.

Table 45: Phenol at a glance Growth rate (CAGR to 2014E) 4.7% Current operating rate 70-75% Key end-markets Plastics (Polycarbonate via Bi-Phenol A and and Nylon via Cyclohexane) Key demand regions Asia (47%), North America (23%), Western Europe (23%) Key players Ineos, Sunocco, Shell Chemicals Market structure Top10 producers amounting to 60% of capacity Key Inputs Cumene, Oxygen Threats Volume decrease in Polycarbonate demand Source: J.P. Morgan estimates.

Overview & Outlook Phenol demand is expected to grow by CAGR of 4.7% through 2009-14. Stronger growth is possible, depending on whether polycarbonate demand returns to double- digit growth rates.

The main demand driver of Phenol is demand from the North East Asia region, particularly China. NE Asia will account to 41% of global phenol demand in 2014E versus 33% in 2008.

Production Process Phenol can be produced via several processes. However, cumene peroxidation is the most common, since it currently offers the most cost-effective process economics. In this process, cumene is prepared by alkylating benzene with propylene.

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.

94 95 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 114: Production of Phenol Phenol Benzene

Cumene Propylene Acetone Oxygen

Source: SRI and J.P. Morgan

Demand 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 polycarbonates, which are engineering plastics used in various applications such as a substitution of glass (car industry) and epoxy resins, which are employed in various Plastics (also CDs/DVDs, especially in China). Phenol has a positive demand growth outlook as the steady growth in mature markets and expanded market penetration of polycarbonate.

Figure 115: Phenol consumption by end market Alky lphenol Others 6% 4% Aniline 1%

Phenolic Resin 27%

Bisphenol A 47%

PPO/Orthox y l enol 2% Nylon-KA Oil 13% Source: CMAI and J.P. Morgan

Figure 116: Phenol consumption by region Figure 117: Phenol demand growth rate (%) 2008-2014E CAGR North America, 23% AME Asia

South America South Asia, 47% WORLD America, 2% Central Europe

West Europe

West Europe, North America AME, 1% 23% Central -5% 0% 5% 10% 15% 20% 25% 30% Europe, 4%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

95 96 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Supply/Key Players It is important to consider that the economics of producing phenol are strongly impacted by the demand for its by-product acetone, with 0.6 tonnes produced for every tonne of phenol. This reduces the potential for phenol producers to improve margins when phenol markets are tight and vice versa.

74% of new capacity additions through 2009-14E will be coming in NE Asia, particularly China. Middle East will contribute to 18% of new capacity additions through 2009-14.

Figure 118: Phenol demand/ capacity (-000- Metric tons) 14000 100 12000 80 10000 8000 60 6000 40 4000 20 2000 0 0 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Total Capacity Total Demand Total Oper. Rate % Source: CMAI and J.P. Morgan

Table 46: Top 10 Phenol producers (2009) Thousand metric tons West Europe North America Asia Rest of the World Ineos Phenol 1,340 Sunoco 860 Kumho P&B 405 Rhodia 245 CEPSA Quimica 570 Shell Chemical 600 FCFC 400 Samara Syn Alc 74 Polimeri Europa 300 Ineos Phenol 540 Mitsui Chemicals 390 Ufaorgsintez 71 Borealis Poly 190 MtVernon Phenol 350 Taiwan Prosperity 340 Kazanorgsintez 65 Syndial 180 Dow 295 Chang Chun PC 300 PKN Orlen 60 NOVACAP 155 Georgia Gulf 227 Mitsui Phenols 300 Omsk Kauchuk 58 DOMO Chemicals 150 Blue Island Phenol 45 Mitsub. Chemical 250 Slovnaft 50 Dakota Gas. Co. 20 Chiba Phenol 230 Saratovorgsintez 43 Merisol 8 LG Chem 230 Merisol 40 Sinopec Gao Qiao 205 Carom S.A. 25 2,885 2,945 3,050 731 Source: CMAI and J.P. Morgan

Table 47: Phenol world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 2,945 2,945 2,945 2,945 2,945 2,945 2,945 South America 195 245 245 245 245 245 245 West Europe 2,855 2,885 2,885 2,885 2,885 2,885 2,885 Central Europe 157 157 157 157 157 157 157 CIS & Baltic States 318 318 334 364 364 364 364 Middle East ------54 216 216 216 Africa 40 40 40 40 40 40 40 Indian Subcontinent 82 82 82 82 82 82 82 Northeast Asia 2,962 3,215 3,396 3,451 3,451 4,039 4,101 Southeast Asia 317 500 546 550 550 550 550 WORLD 9,871 10,387 10,630 10,773 10,935 11,523 11,585 Growth rate 4.97% 5.23% 2.34% 1.35% 1.50% 5.38% 0.54% Source: CMAI and J.P. Morgan

96 97 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Pricing Phenol is mainly used in the autos and construction sectors where growth is very much GDP dependent. Phenol prices had good run in the 1H10 on autos recovery. We see moderation in phenol prices in 2H10 as the growth subsides and new capacities come online.

Figure 119: Phenol price chart 1,500

1,000

500

0 Jan-2000 Jan-2002 Jan-2004 Jan-2006 Jan-2008 Jan-2010

Phenol (Contract Mkt) €/ MT Forecast

Source: CMAI and J.P. Morgan

Styrene Monomer Introduction Styrene is a colourless, water-insoluble liquid. It is a monomer that is predominantly used to manufacture of polystyrene (which is used for the production of Plastics). Other uses are the production of acrylonitrile-butadiene-styrene (ABS)/styrene- acrylonitrile (SAN) resins and also styrene-butadiene (S/B) copolymer latexes.

Table 48: Styrene monomer at a glance Growth rate (CAGR to 2014E) 3.6% Current operating rate 70-75% Key end-markets Plastics (via Polystyrene) Key demand regions Asia (54%), North America (18%) and Western Europe (16%) Key players INEOS, LyondellBasell, FCFC Market structure The Top 10 producers amount to up to 36% Key Inputs Etylene Benzene or Ethyl Benzene Hyperoxide and Propylene Threats New capacity in Asia Source: J.P. Morgan estimates.

Overview & Outlook Consolidation has been a key trend in the styrenics industry. In 2007, Ineos and Nova put their global styrenics businesses into a joint venture, with plant closures in Europe and North America. Lanxess moved its Lustran Polymers business into a global joint venture with Ineos. Dow Chemicals sold it styrenics business in 2010 to Bain Capital for $1.6bn while the styrenics business of BASF is up for sale.

According to CMAI, styrene demand grew by -0.2% CAGR from 2004-2009. In the same period, capacity grew by 2.5%, leading the market into oversupply. Styrene is estimated to grow by CAGR of 3.6% through 2009-14, whereas capacity growth is estimated to be 2.1% during the same period.

Production Process Styrene monomer is mostly manufactured through the oxidation of ethyl benzene, which is produced via the alkylation of benzene with ethylene using a catalyst.

97 98 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 120: Ethyl benzene dehydrogenation process Styrene

Ethylbenzene

Hydrogen

Source: SRI and J.P. Morgan

Dow and Snamprogetti are also jointly developing a new process to manufacture styrene monomer from ethane and benzene. If this process becomes operational, they would be able to take advantage of a much lower-cost feedstock in ethane (90% lower in the Middle East than in the US), eliminating the need for upstream investment in ethylene production at a stream cracker or ethylene purchase. It is expected that this process results in a cost of production of about 10% lower than the ethylene-based process.

Demand World styrene demand is still dominated by its main derivative: polystyrene (58%), which is estimated to grow by 3-4% per year, while second largest demand comes from ABS resins which is expected to grow by 4%.

Demand growth is strongly fueled by China, representing more than 50% of overall growth (driven by additional demand for Polystyrene and ABS production) through 2009-14E. Traditional Markets in North America and Western Europe, still represent about 40% of capacity, are expected to decline by -0.5% through 2009-14E.

Figure 121: Styrene consumption by end market Others 17%

Copolymers Latex es 8%

Poly sty rene ABS/ SAN 58% Resins 17%

Source: CMAI and J.P. Morgan

Figure 122: Styrene consumption by region Figure 123: Styrene demand growth rate 2008-2014E CAGR North America AME 18% South America Asia South America WORLD 3% Central Europe West Europe Asia 54% West Europe North America 16%

-2%0%2%4%6%8%10%12%14% Central Europe AME 7% 3%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

98 99 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Supply/Key Players Styrene capacity is expected to increase by a CAGR of 2.1% through 2009-14E versus 2.5% through 2004-09. Most of the new capacities will be coming in NE Asia (particularly China) and the Middle East. No new capacities will be added in Western Europe while capacity will contract by 2% in North America through 2009-14E.

Figure 124: Styrene demand/ capacity (-000- Metric tons) 40000 95 90 30000 85 20000 80 75 10000 70 0 65 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E Total Capacity Total Demand Oper. Rate % Source: CMAI and J.P. Morgan

Table 49: Top 10 Styrene producers (2009) Thousand metric tons West Europe North America Asia Rest of the World Polimeri Europa 655 INEOS NOVA 1,702 FCFC 1,200 NKNK 275 Lyondell/Bayer 640 LyondellBasell 1,259 Samsung Total PC 930 Innova 256 Repsol Quimica 610 Cosmar 1,150 Asahi Kasei Chem. 710 Salavatnftgsz 200 Total PC 600 Americas Styrenics 953 LG Chem 670 Synthos Kralupy 170 Ellba 550 Dow 467 Secco 575 Petrobras Energia 160 BASF SE 550 Shell Canada 450 CNOOC & Shell PC 560 EDN 160 BASF Antwerp 500 Westlake 261 Idemitsu Kosan 550 Sibur Khimpron 135 Dow Benelux 500 PEMEX 150 Ellba Eastern 550 Synthos Dwory 120 Shell Chem Neth 440 Honam PC 500 CBE 120 Ineos 350 Nippon Steel 440 Angarsk Petchem 44 5,395 6,392 6,685 1,640 Source: CMAI and J.P. Morgan

Table 50: Styrene world capacity overview Thousands metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 6,384 6,392 5,925 5,925 5,925 5,925 5,925 South America 536 696 696 736 776 901 1,026 West Europe 6,342 5,722 5,722 5,722 5,722 5,722 5,722 Central Europe 290 290 290 290 290 290 290 CIS & Baltic States 689 724 724 724 724 724 724 Middle East 1,504 2,178 3,095 3,095 3,095 3,095 3,095 Indian Subcontinent ------Northeast Asia 11,687 11,593 13,286 13,611 14,313 14,313 14,313 Southeast Asia 2,080 2,080 1,980 1,980 1,980 1,980 1,980 WORLD 29,512 29,675 31,718 32,083 32,825 32,950 33,075 Growth rate -0.75% 0.55% 6.88% 1.15% 2.31% 0.38% 0.38% Source: CMAI and J.P. Morgan

Pricing Styrene is a global, non-differentiated commodity product and thus the styrene market is highly price-competitive. Styrene market is oversupplied and operating rates are low and hence margins can be compressed.. Traditionally North America has been one of the major exporters. Longer term North East Asia will be the price driver as this region will be largest net exporter of styrene.

99 100 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 125: Styrene price chart 100 90 80 70 60 50 40 30 20 10 0 Jan-1990 Jan-1993 Jan-1996 Jan-1999 Jan-2002 Jan-2005 Jan-2008 Jan-2011

Sty rene (Contract) Cents/ Pound Forecast (Contract) Sty rene (Spot) Cents/ Pound Forecast (Spot) Source: CMAI and J.P. Morgan.

Acrylic Acid Introduction Acrylic Acid is a clear, colourless liquid with a characteristic acrid odor. The most common grades are crude acrylic acid and glacial acrylic acid, while only the latter is sold commercially and in bigger volumes.

Together with other monomers, acrylic acid is used for the production of polymers that are used in the manufacture of plastics (hygiene applications), coatings, adhesives, elastomers as well as floor polishes and paints.

Table 51: Acrylic acid at a glance Growth rate (CAGR to 2014E) 2-3% Current operating rate 70% Key end-markets Plastics, Coatings, Adhesives Key demand regions Western Europe, Japan, NE Asia (China) Key players Dow, FPC, Nippon Shokubai, BASF Market structure The Top 10 producers amount to up to 81% of overall production Key Inputs Propylene, Oxygen Threats New capacity in Middle East Source: J.P. Morgan estimates.

Overview& Outlook World demand for acrylic acid is expected to grow at approximately 2% CAGR in the next few years (2009-2014E), mainly because of an increase in super-absorbent polymers (SAP). Key areas of growth are Asia Pacific mainly China, Latin America, Central and Eastern Europe.

Global acrylic acid capacity was 5.3 million metric tons in 2009, according to CMAI. Consumption is expected to overtake production levels by 2014, driven by strong demand in developing countries.

Production process 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.

100 101 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Demand The main end-use for acrylic acid is for super absorbent polymers, which are able to absorb and retain large amounts of water. These polymers are often used in hygiene applications (e.g. diapers). The market is estimated by SRI to grow 3-4%, driven by growth in adult incontinence products, and increasing demand for diapers in the emerging markets.

The next important end use is in surface coatings (waterborne acrylic and styrene- acrylic coatings), of which c.65% is in architectural coatings. SRI expects growth of c.2.8% per year through 2011. Wood coatings are a much smaller end use, but it is expected that consumption of acrylic esters will see above-average growth in this segment. Overall demand for wood coatings is rising, since more consumers in Western Europe are opting for wooden or parquet flooring instead of carpeting.

Figure 126: Acrylics - demand by end market Figure 127: Acrylics - demand by geography Others S America Detergents 11% 2% 5% Hy giene Plastic Europe (SAP*) N America additiv es 29% 35% 36% 5% Water treatment 6% Adhesiv es 9%

Coatings Asia 29% 33% Source: SRI, Arkema H109 presentation Source: SRI. * Acrylic acid & esters

Figure 128: Acrylic acid capacity growth by region 2008-2014E CAGR

AME

Rest of the world

Asia

WORLD

Wes t Euro pe

North America

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%

Source: CMAI and J.P. Morgan

Supply/Key Players The industry is highly consolidated, with the Top 10 producers amounting to more than 80% of global production. Consolidation in the industry is expected to be almost complete, following Dow’s acquisition of Rohm & Haas.

BASF is the largest producer and remains the global cost leader due to its expanding productivity work on catalyst efficiency.

101 102 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

For SAP, Evonik is one of the leaders after the acquisition of Dow’s superabsorbent business in 2006 and expanding existing plants. Currently it accounts for more than 65% of global capacity in SAP.

Figure 129: Top 10 Acrylic acid producers (-000- Metric tons) 25.0% 1,200 1,000 20.0% 800 15.0% 600 10.0% 400 200 5.0% ---- 0.0% BASF Dow StoHaas FPC Nippon Arkema Jiangsu LG Chem Shokubai Jurong Capacity Global percentage share Source: CMAI and J.P. Morgan estimates.

Table 52: Acrylic acid world capacity overview (2009) Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 1,369 1,369 1,369 1,369 1,369 1,369 1,369 West Europe 1,216 1,360 1,360 1,360 1,360 1,360 1,360 Central Europe 55 55 55 55 55 55 55 CIS & Baltic States 29 29 64 64 64 64 64 Middle East ------125 250 250 Africa 80 80 80 80 80 80 80 Northeast Asia 1,904 2,114 2,265 2,265 2,265 2,265 2,265 Southeast Asia 280 280 280 280 280 280 280 WORLD 4,933 5,287 5,473 5,473 5,598 5,723 5,723 Growth rate 4.05% 7.18% 3.52% 0.00% 2.28% 2.23% 0.00% Source: CMAI and J.P. Morgan

Acrylonitrile Introduction Acrylonitrile (or cyanoethylene or vinyl cyanide) is a pungent-smelling, colourless liquid that is used principally as a monomer in the manufacture of synthetic polymers, especially polyacrylonitrile which comprises acrylic fibres. It is also important for the manufacture of ABS and SAN resins used in the electronics (televisions, computers) and car industry.

Table 53: Acrylonitrile at a glance Growth rate (CAGR 2009-2014E) 2% Current operating rate (2007) 70-80% Key end-markets Fibres, Synthetic rubber Key demand regions (2007) Asia, North America , Western Europe Key players (2009) Ineos, Asahi, Secco, Solutia, BASF, Lanxess, DSM Market structure (2009) Top 10 producers amount to up to 66.5% of global capacity Key Inputs Propylene, Ammonia, Oxygen Threats New capacity in Asia Source: J.P. Morgan estimates.

102 103 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Overview & Outlook Global Acrylonitrile demand is estimated to grow at a CAGR of 2% through 2009- 14E, according to CMAI. Robust Asian demand growth is expected to be partially offset by much slower growth in the mature European and North American markets.

World production of acrylonitrile saw a shift from Western to Asian countries during the past 5 years, with the most growth coming from China. For the following years this trend is expected to continue, with global production growth in line with demand growth around 2% per year until 2014E.

North America is still the largest acrylonitrile exporter while Asia is the major import area. However, the shift in global expansion should result in a shrinking export market for North America.

Production process Acrylonitrile is produced via “ammoxidation” from propylene, ammonia, and air. The by-products of this process are acetonitrile and hydrogen cyanide.

This propylene-based route was developed by Standard Oil of Ohio in the 1950s and is referred to as the Sohio process. The process replaced a higher-cost route that employed acetylene and hydrogen cyanide.

New production processes based on propane ammoxidation are currently being developed by a number of producers who claim a 30% production cost advantage compared to the propylene route.

Figure 130: Manufacturing process for acrylonitrile

Propylene

Hydrogen Cyanide Ammonia Acrylonitrile

Ammonium Sulphate Oxygen

Source: SRI and J.P. Morgan

Demand The largest end use for acrylonitrile is acrylic fibres, which accounts for nearly half of total output. The second biggest demand (32%) comes from the production of Acrylonitrile-butadiene-styrene (ABS) and styrene-acrylonitrile (SAN) resins. The consumption of these thermoplastic resins is primarily in the manufacture of durable goods, including automobile components, appliances, business machines, and pipes and fittings. Adiponitrile (ADN) is used exclusively in the production of hexamethylenediamine (HMDA), which is a precursor for nylon 66 resins and fibres. The growth of acrylic fibres and ABS resin capacity in the Far East has been the key driver of acrylonitrile demand in the past few years.

103 104 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 131: Acrylonitrile consumption by end market Nitrile Rubber Other 4% 4% Adiponitrille 6%

Acry lamide 9% Acry lic Fibers 43%

ABS/SAN Resins 34% Source: SRI and J.P. Morgan

Figure 132: Acrylonitrile consumption by region Figure 133: Acrylonitrile capacity growth by region (%) 2008-2014E North America 10% Others 12% Central Europe Western Asia Europe 16% WOR LD Other Asia 23% Wes t Euro pe

North America

Japan 11% South America

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% China 28%

Source: SRI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key players Globally, Ineos and Asahi are the leading producers of Acrylonitrile. The market is still very regional, with Ineos and Solutia in the U.S., BASF, DSM and Lanxess in Western Europe and Asahi and Sinopec in Asia.

In next 5 years, new capacity equivalent to 10% of 2009 capacity is coming online. Significant part (50%) of new capacity will come from China. However, there will also be combined capacity closure of 0.2 million metric tons in US and Spain through 2009-14E.

Figure 134: Top 10 Acrylonitrile producers (-000- Metric tons) Jilin Others

Taekwang

FPC

Secco

DSM Ineos

Solutia Asahi Source: DSM

104 105 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 54: Acrylonitrile world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 1,328 1,328 1,385 1385 1,385 1,385 1,385 South America 45 45 45 45 45 45 45 West Europe 1,614 1,654 1,674 1,684 1,694 1,894 1,894 Central Europe 190 190 190 245 300 300 300 Middle East ------40 40 40 40 40 Indian Subcontinent 30 30 30 30 30 30 30 Northeast Asia 1,778 2,016 2,098 2,398 2,498 2,498 2,498 WORLD 4,985 5,263 5,462 5,827 5,992 6,192 6,192 Growth rate 0.51% 0.93% -1.31% 1.73% 1.70% 1.92% 1.72% Source: CMAI and J.P. Morgan

Pricing Costs of acrylonitrile production are highly dependent upon propylene and ammonia prices. Acrylonitrile prices have recently risen because of demand recovery and increase in feedstock prices. According to CMAI, significant acrylonitrile trade (more than 80%) is under long term contracts (based on pricing formulas) in the US. Acrylonitrile prices most often adjust monthly based on raw material price- propylene, ammonia- along with conversion fee.

Figure 135: Acrylonitrile price chart 2,500 2,000 1,500 1,000 500 0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Acry lonitrile (Spot) $/MT Forecast Source: CMAI and J.P. Morgan

105 106 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Plastics (or Polymers)

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.

The combination of performance and processing flexibility allows plastics to be used in numerous applications ranging from inexpensive disposable items to expensive components. Applications are in the automotive, construction, packaging, electronics and even the healthcare industry.

Plastics can provide the following advantages for product designers and manufacturers:

Table 55: Advantages of plastics Design flexibility Stiffness High strength and toughness Low weight Corrosion resistance High manufacturing throughput High reproducibility of parts Reduced manufacturing costs Electrical insulation Almost any color of surface texture Thermal insulations Waterproof Source: Instron

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.

Table 56: Types of polymerization

Polymerization Process Description Bulk/Gas phase polymerization This method is used with gaseous monomers such as ethylene, tetrafluoroethylene, and vinyl chloride. The monomer is introduced under pressure into a reaction vessel containing a polymerization initiator. Once polymerization begins, monomer molecules diffuse to the growing polymer chains. The resulting polymer is obtained as a granular solid. Solution polymerization A polymerization process in which the monomers and the polymerization initiators are dissolved in a nonmonomeric liquid solvent at the beginning of the polymerization reaction. The liquid is usually also a solvent for the resulting polymer or copolymer. The conducting of polymerization reactions in a solvent is an effective way to disperse heat; in addition, solutions are much easier to stir than bulk polymerizations. Solvents must be carefully chosen, however, so that they do not undergo chain-transfer reactions with the polymer. Slurry polymerization In this process polymer is produced as a slurry or paste from a solvent based systems Suspension polymerization A polymerization process in which the monomer, or mixture of monomers, is dispersed by mechanical agitation in a liquid phase, usually water, in which the monomer droplets are polymerized while they are dispersed by continuous agitation. Used primarily for PVC polymerization. Emulsion Polymerization A type of radical polymerization that usually starts with an emulsion incorporating water, monomer, and surfactant. The most common type of emulsion polymerization is an oil-in-water emulsion, in which droplets of monomer (the oil) are emulsified (with surfactants) in a continuous phase of water. Water-soluble polymers, such as certain polyvinyl alcohols or hydroxyethyl celluloses, can also be used to act as emulsifiers/stabilizers. Source: J.P. Morgan estimates

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.

106 107 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 57: Common types of plastics Thermoplastics Thermo sets Polyvinyl chloride Phenolic resins Polystyrene Epoxy PET resins MDI HDPE/ LLDPE/ LDPE TDI Source: J.P. Morgan

Thermoplastics 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).

Figure 136: Demand by major polymers ABS PC PS 4% 2% 5% PP PET 25% 8%

LDPE 10%

LLDPE PVC 11% 18%

HDPE 17% Source: CMAI

Polyethylene Introduction Polyethylene is the largest volume plastic. About two-thirds of all ethylene produced is polymerized to polyethylene.

The three principal types of polyethylene are high-, low-, and linear low-density polyethylene (HDPE/LDPE/LLDPE). Their manufacturing process differs in usage of different combinations of pressure, temperature or additives.

The majority of polyethylene is used for packaging in consumer and institutional products (mainly plastic bags).

107 108 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 137: Polyethylene consumption by end market Figure 138: Polyethylene consumption by product type Other 16% LLDPE 28%

Blow HDPE Molding Film & 45% 12% Sheet 52% Pipe & Profile 7% Injection LDPE Molding 27% 13% Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Figure 139: World consumption of polyethylene by region (-000- Metric tons) 25,000

20,000

15,000

10,000

5,000

---- North South Western Cent ral and M iddle East China Japan Rest of Asia Ot her America America Europe East ern Europe 2009 2014E Source: CMAI and J.P. Morgan

High and linear low density polyethylene

• High-density polyethylene. HDPE is a rigid plastic made at low temperature and low pressure. After PVC and polypropylene (PP), it is the third largest commodity plastic material. It is used as a resin for blow-moulding bottles and containers (32%), or can also be manufactured into sheets or films for packaging and bags (26%). It is also used for injection-molding items such as crates, tubs, fuel tanks, and containers (22%). • Linear low-density polyethylene (LLDPE). LLDPE is actually a copolymer, as other monomers, such as butene or octane, are added to it. The main use (75%) is for film applications for food and non-food packaging. Another key use is for molding (15%).

HDPE and LLDPE are often produced in the same plant and can be replaced by each other (“swing facility”).

108 109 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 58: HDPE and LLDPE at a glance HDPE LLDPE Growth rate (CAGR to 2014E) 6% 6-7% Current operating rate 80-85% 85-90% Key end-markets Containers, bottles, fuel tanks, plastic bags, waterpipes, fuel Plastic bags and sheets, toys, flexible tubes tanks Key players Ineos, Chevron Philips, ExxonMobil, Equistar Exxon Mobil, Dow, Nova Chemical, KEMYA Market structure Top 10 producers amount to up to 33% of world capacity Top 10 producers amount to up to 43.5% of world capacity Key Inputs Ethylene Ethylene Threats New Capacity in the Middle East and Asia and reduced Substantial new Middle Eastern capacity European and US exports Source: J.P. Morgan estimates.

Overview & Outlook The global HDPE industry saw extensive restructuring and consolidation in recent years. While low feedstock costs are still the most important factor in decreasing costs per unit, production scale has diminished as a significant cost advantage due to the need of improving profitability.

During the next five years, world consumption of HDPE is estimated to grow at over 6% per year. Regions expect to exhibit high growth rates include the Middle East (14%), Indian subcontinent (11%, though on low base) and NE Asia (particularly China, 5%) through 2009-14. Capacity growth is estimated to be CAGR of 4.2% through 2009-14.

For LLDPE, annual growth will be CAGR of 6-7% until 2014 also with strong demand from Middle East (13%), Indian subcontinent (13%) and Southeast Asia (11%) through 2009-14. Capacity growth is estimated to be CAGR of 4.3% through 2009-14.

Strong capacity additions in the Middle East and China in the last three years -with higher growth rates than demand - have caused existing producers outside the low- feedstock-cost region to fear a major downturn. These regions continue to show huge expansions in the petrochemical industry involving increasing capacity for ethylene.

Production process HDPE and LLDPE are produced by the polymerization of ethylene via a variety of processes and catalysts. A number of companies use different technologies and manufacturing processes according to product capabilities, plant flexibility and production economics. Major advances in polymerization technology have been a result primarily of catalyst development.

Because ethylene is the largest component of production costs, producers tend to have either a captive or guaranteed supply of ethylene feedstock. LLDPE is manufactured using lower temperature and pressure than either HDPE or LDPE. Thus, the manufacturing process is more cost-effective.

109 110 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Demand Figure 140: HDPE demand by region Figure 141: HDPE demand growth by region (%), 2008-2014E North America

22% AME

Asia

Asia 37% WORLD

South America Sout h A merica 5% Cent ral Europe

West Europe

West Europe Nort h A merica 14% -1% 1% 3% 5% 7% 9% 11% 13% 15% Central Europe AME 15% 6%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Figure 142: LLDPE demand by region Figure 143: LLDPE demand growth by region (%), 2008-2014E North America 28% AME

Asia 37% Asia Central Europe

WORLD

South America South America 6% West Europe

North America West Europe AME 14% Central Europe 13% -2%0%2%4%6%8%10%12% 2%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key players Due to the need for cost reductions and lower unit costs the average size of world- scale polyethylene production units has increased substantially over the years. From 50 thousand metric tons in the 1970s, reactor sizes have increased to 350 thousand metric tons per year for conventional HDPE units and even 450 thousand metric tons per year for Ziegler and chromium-based swing plants.

The short term outlook for HDPE and LLDPE indicates capacity growth will outpace demand growth. This will result in lower utilization rates.

However, for the long term it is expected that units in higher cost areas such as Japan and Western Europe will be forced to shut down and new volumes from the Middle East will refocus trade flows in Western Europe and Asia.

China is adding new HDPE capacities of 3.8 million metric tons or 32% of new capacity additions through 2009-14. Saudi Arabia will add HDPE capacities of 2.9 million metric tons or 25% of new HDPE capacities coming online through 2009- 14E.

In addition, China is adding 3.3 million metric tons of new LLDPE capacities equivalent to 37% of new capacities coming online through 2009-14E. Saudi Arabia will add 1.5million metric tons of new LLDPE capacities.

110 111 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 144: HDPE demand/capacity (-000- Metric tons) Figure 145: LLDPE demand/capacity (-000- Metric tons) 50000 95 35000 90 30000 40000 90 85 25000 30000 85 20000 80 20000 80 15000 75 10000 10000 75 70 5000 0 70 0 65 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Total Capacity Total Demand Operating Rate, % Total Capacity Total Demand Operating Rate, %

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Table 59: Top 10 HDPE producers (2009) Thousand metric tons Western Europe North America Asia Middle East Rest of the World Ineos 1,130 Chevron Phillips 1,578 TPE 600 YANPET 1,300 Braskem 825 LyondellBasell 1,090 ExxonMobil 1,376 Japan Polyethylene 569 Q-Chem 469 Quattor 500 Total PC 905 Equistar 1,364 FPC 535 Borouge 455 TVK 410 SABIC Europe 720 Ineos 767 LG Chem 520 Jam PC 425 Kazanorgsintez 400 Borealis 705 FPC USA 766 Reliance Industries 508 SEPC 400 Unipetrol RPA 320 Repsol Quimica 380 Dow 730 Honam PC 460 Petrokemya/JUPC 400 BasellOrlen Polyolefins 320 Polimeri Europa 230 Dow Canada 700 Haldia 450 Equate 375 Stavrolen 300 Dow Belgium 165 Nova Chemical 515 KPIC 450 KEMYA 300 PBB Polisur 270 Syndial 110 Total PC 440 Chevron Phillips Sing. 400 Marun PC 300 Polinter 270 Dow Iberica 40 Imperial Oil 395 Daelim 380 Amir Kabir PC 290 Safripol 180 5,475 8,631 4,872 4,714 3,795 Source: CMAI and J.P. Morgan

Table 60: HDPE world capacity overview Thousand metric tons REGION 2008 2009 2010 2011 2012 2013 2014 North America 9,345 9,296 9,259 9,259 9,259 9,259 9,259 South America 1,755 1,888 1,865 1,865 1,865 1,865 1,865 West Europe 5,400 5,500 5,449 5,395 5,395 5,395 5,395 Central Europe 1,220 1,220 1,220 1,220 1,220 1,220 1,220 CIS & Baltic States 920 1,125 1,155 1,155 1,155 1,155 1,155 Middle East 4,561 5,769 7,258 8,629 9,479 9,479 9,749 Africa 638 638 638 638 638 638 638 Indian Subcontinent 1,245 1,313 1,741 1,870 1,870 2,250 2,520 Northeast Asia 7,242 7,638 9,195 9,317 9,955 11,109 11,402 Southeast Asia 2,985 3,023 3,589 3,985 4,035 4,035 4,285 WORLD 35,311 37,410 41,369 43,333 44,871 46,405 47,488 Growth rate 1.25% 5.94% 10.58% 4.75% 3.55% 3.42% 2.33% Source: CMAI and J.P. Morgan

111 112 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 61: Top 10 LLDPE producers by region (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World Borealis 680 Dow 1,630 ExxonMobil 555 KEMYA 900 Braskem 670 Dow Benelux 680 ExxonMobil 1,540 Reliance Industries 420 SHARQ 830 PBB Polisur 290 Dow Iberica 535 Nova Chemical 1,000 Hanwha Chemical 396 Petrokemya/JUPC 400 Quattor 270 Polimeri Europa 530 Dow Canada 745 Japan Polyethylene 373 Equate 375 Tomskneftekhim 200 Ineos 500 Equistar 512 Siam PE 350 Petro-Rabigh 283 Kazanorgsintez 197 ExxonMobil 425 Westlake 415 Secco 338 Yansab 188 Sintezkauchuk 157 Dow 210 Chevron Phillips 293 Yangzi PC 300 Borouge 165 SASOL 150 SABIC Europe 175 FPC USA 284 Jilin Chemical 300 Amir Kabir PC 150 Polinter 140 Dex Plastomer 120 PEMEX 238 FPC 264 Jam PC 125 Polimir 140 Repsol Quimica 40 Imperial Oil 100 Honam PC 240 Arak PC 75 ELEME PC 135 3,895 6,757 3,536 3,491 2,349 Source: CMAI and J.P. Morgan

Table 62: LLDPE world capacity overview Thousand metric tons REGION 2008 2009 2010 2011 2012 2013 2014 North America 6,801 6,832 6,807 6,807 6,807 6,807 6,807 South America 1,360 1,370 1,370 1,370 1,370 1,370 1,370 West Europe 3,895 3,895 3,861 3,850 3,850 3,850 3,850 CIS & Baltic States 150 265 265 265 265 265 265 Middle East 2,830 3,551 5,170 5,260 5,260 5,260 5,530 Africa 477 477 477 477 477 477 477 Indian Subcontinent 645 645 855 935 935 1,315 1,585 Northeast Asia 4,671 5,037 6,308 6,401 6,701 7,633 7,926 Southeast Asia 1,775 1,833 2,425 3,425 3,475 3,475 3,725 WORLD 22,604 23,905 27,538 28,790 29,140 30,452 31,535 Growth rate 1.86% 5.76% 15.20% 4.55% 1.22% 4.50% 3.56% Source: CMAI and J.P. Morgan

Pricing The increasing cost of ethylene, driven by a sustained high crude oil price and the inability of converters to pass on the full extent of such high price increase will lead to continuing margin decrease.

Therefore, upstream integration is becoming an essential component of the economic success of PE operations outside the low-feedstock-cost areas.

Figure 146: HDPE price chart Figure 147: LLDPE price chart 2,000 2,000

1,500 1,500

1,000 1,000

500 500 0 0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- t Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 HDPE (Blow Mol.) €/ MT Forecast (Blow Mol.) LLDPE, Butene film, €/ MT Forecast (LLDPE, Butene film) HDPE (Inj Mol.) €/ MT Forecast (Injection Mol.) LLDPE, Octene fil, €/ MT Forecast (LLDPE, Octene film)

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

112 113 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Low density polyethylene

• 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 and non packaging use (75%), extrusion coating (9%) and molding (9%). • LDPE was the first grade of polyethylene, produced in 1933 by Imperial Chemical Industries (ICI).

Table 63: Low density polyethylene at a glance Growth rate (CAGR to 2014) 3.7% Current operating rate 80-85% Key end-markets Containers, bottles, tubing, plastic bags and sheets, computer components Key players ExxonMobil, LyndollBasell, Dow,Polimeri Europa, Westlake Market structure Top 10 producers amount to up to 35% global capacity Key Inputs Ethylene Threats Continuing replacement from LLDPE, Capacity additions in the Middle East Source: J.P. Morgan estimates.

Overview & Outlook In recent years LDPE was continuously substituted by LLDPE in many applications due to its bigger range of properties and a cheaper manufacturing process.

LDPE demand grew by only 0.5% per year from 2004-2009. In the same period, capacity grew by only 1.8%. Demand (+3.7%) is expected to grow faster than capacity (+2.2%) through 2009-14E.

We believe the excessive capacity additions in China and the Middle East will force producers with the uncompetitive cost structures to shut down the least efficient operations. Therefore, probability of further shutdowns in Western Europe and Japan remains high, in our view.

Demand The largest market for LDPE is film applications accounting for 55% of world consumption. This includes packaging applications in the food industry and non packaging applications such as heavy-duty sacks, merchandise and garment bags.

Figure 148: LDPE demand by region Figure 149: LDPE demand growth by region (%), 2008-2014E North America 17% AME

Asia South America Asia 38% 6% WORLD South America

West Europe

West Europe Central Europe 19% North America

AME 12% Central Europe 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 8% Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

113 114 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Supply/ Key players Most of the new capacities are coming in the Middle East. Iran is adding 0.9 million metric tons of capacity through 2009-14E or equivalent to 4% of 2009 global capacity. Saudi Arabia is adding 0.75 million metric tons of new capacity through 2009-14E. While 0.85 million metric tons of capacity will be rationalized mainly in US and Western Europe through 2009-14E.

Figure 150: LDPE demand/capacity (-000- Metric tons) 25000 95

20000 90 15000 85 10000 5000 80 0 75 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E Total Capacity Total Demand Operating Rate, % Source: CMAI and J.P. Morgan.

Table 64: Top 10 LDPE producers by region (2009) Thousand metric tons West Europe Noth America Asia Middle East Rest of the World LyondellBasell 990 Westlake 692 Hanwha Chemical 420 QAPCO 370 Braskem 440 Polimeri Europa 837 Dow 679 BASF/Yangzi PC 400 Petkim 335 Quattor 270 ExxonMobil 690 ExxonMobil 666 Maoming PC 370 Arya Sasol PC 300 SASOL 220 SABIC Europe 585 Equistar 649 Japan Polyethylene 357 SEPC 283 Tomskneftekhim 200 Ineos 510 DuPont 347 LG Chem 335 KEMYA 215 Kazanorgsintez 197 Repsol Quimica 410 PEMEX 285 TPC 270 Laleh PC 175 Slovnaft 170 Borealis 340 Chevron Phillips 281 Daqing PC 265 Carmel Olefins 160 Sintezkauchuk 157 Total PC 305 AT Plastics 146 Petlin 255 Bandar Imam PC 130 Basell Orlen Polyolefins 150 Dow Benelux 265 Nova Chemical 125 CNOOC & Shell PC 250 Amir Kabir PC 75 Polimir 140 Dow 160 Flint Hills Resources 94 Yanshan PC 243 Ministry of Ind 60 Ufaorgsintez 90 5,092 3,964 3,165 2,103 2,034 Source: CMAI and J.P. Morgan

Table 65: LDPE world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 4,217 3,964 3,845 3,872 3,899 3,899 3,899 South America 1,065 1,065 1,065 1,065 1,065 1,065 1,065 West Europe 5,770 5,632 5,796 5,787 5,787 5,787 5,787 Central Europe 849 806 814 814 814 814 814 CIS & Baltic States 935 935 935 935 935 1,335 1,335 Middle East 1,295 2,103 2,570 2,570 2,820 3,170 3,345 Africa 285 285 285 285 285 285 285 Indian Subcontinent 200 200 200 200 200 200 200 Northeast Asia 4,985 5,000 5,056 5,075 5,075 5,075 5,075 Southeast Asia 1,100 1,100 1,375 1,400 1,400 1,400 1,700 WORLD 20,701 21,090 21,941 22,003 22,280 23,030 23,505 Growth rate 0.47% 1.88% 4.04% 0.28% 1.26% 3.37% 2.06% Source: CMAI and J.P. Morgan.

114 115 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Pricing The most important raw material for LDPE is ethylene. Prices of LDPE move with prices of ethylene feedstock and demand/supply in different regions. (Please see the section on 'Ethylene' for further information on the price drivers for ethylene).

Figure 151: LDPE price chart 2,000

1,500

1,000

500

0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Poly ethy lene Low Density (Contract) €/ MT Forecast Source: CMAI and J.P. Morgan.

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

Film grade PP is used for packaging of confectionary goods, cigarettes, and electrical capacitors, thermoformed food containers, which can be either blow or injection moulded.

Copolymer PP is used primarily in car and truck bumper manufacturing but also has medical applications, while PP fibres are used in carpets, clothing, and nonwoven textiles.

Table 66: Polypropylene at a glance Growth rate (CAGR to 2014E) 6.2% Current operating rate 80-85% Key end-markets Packaging products, Automotive and Electronic industry Key demand regions Western Europe (16%), Asia (47%), N America (15%), Key players LyondellBasell, Reliance industries, Total PC, Exxon Mobil Market structure Top 10 producers amout to up to 35% globally Key Inputs Propylene Threats New production capacity in the China and Middle East Source: J.P. Morgan estimates.

Overview & Outlook World consumption of polypropylene is expected by CMAI to reach 60 million metric tons in 2014E representing an average annual growth of 6%, whereas capacity growth is estimated to be CAGR of 4.5% through 2009-14E.

115 116 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Unlike other commodity thermoplastics that have seen decreasing demand relative to the economic growth, polypropylene consumption should continue to grow at a healthy rate of 6% through 2009-14. Regions like the Middle East (15%) and Indian subcontinent (13%) should grow strongly where it profits from investments in catalyst technology and continuous substitution of other polymers.

Global capacity is expected to grow by 4.5% per year mainly driven by Middle East and Asia where capacity is expected to grow by 10-15% pa until 2014. There will be a possible reduction in operating rates as the new capacity comes online resulting in lower margins for polypropylene producers.

Production process Gas phase production offers cost advantages over solution and slurry polymerization methods (see polymer introduction) and is the most applied production method.

However, 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.

Demand The biggest demand for polypropylene comes from injection moulding. The major market is the automotive and transportation sector due to the very low density of polypropylene (0.89-0.91 gram per cubic centimeter) which is important for the weight-conscious automotive market. Other uses for injection molding are container and a wide range of household and miscellaneous products.

Polypropylene film provides excellent optical clarity and low moisture vapor transmission. It is therefore mainly used in food packaging, tape backing and labels.

In the fibre arena, PP is used in carpet backing and carpet face yarn and the non- wovens market.

Figure 152: Polypropylene consumption by end market Other 8% Film & Sheet 23%

Raffia 17%

Fiber 14%

Pipe & Injection Ex trusion 3% Molding 35% Source: CMAI and J.P. Morgan

116 117 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 153: Polypropylene consumption by region Figure 154: Polypropylene demand growth by region (%) 2008-2014E (CAGR) North America 15% AME South America South America

5% Asia

Asia 47% WORLD West Europe Central Europe 16% North America

Wes t Euro pe Central Europe -2%0%2%4%6%8%10%12%14%16% AME 12% 5%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key players Polypropylene capacity is widely spread: SRI estimates currently over 12 major producers have capacities exceeding one million metric tons.

The biggest new capacity is thought to be coming from Saudi Arabia with 3.9 million metric tons or equivalent to 7% of 2009 global capacity through 2009-14E. India is number two in adding new capacity, adding 2.9 million metric tons of new capacity or equivalent to 5% of 2009 global capacity through 2009-14E. Other major capacity additions are in the UAE (1.3 mmt), Russia (0.8mmt) and Thailand (0.75 mmt).

Figure 155: Polypropylene demand/capacity (-000- Metric tons) 75000 95 65000 90 55000

45000 85 35000 25000 80 15000 75 5000 -5000 70 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Total Capacity Total Demand Operating Rate, % Source: CMAI and J.P. Morgan.

117 118 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 67: Top 10 Polypropylene producers by region (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World LyondellBasell 2,630 LyondellBasell 1,417 Reliance Industries 2,525 Ibn Zahr 1,220 Braskem 1,180 Borealis 1,700 ExxonMobil 1,230 Prime Polymer Co. 1,181 Saudi Polyolefins Co. 630 Quattor 875 SABIC Europe 1,130 Total PC 1,180 Japan Polypropylene 1,107 Carmel Olefins 410 SASOL 520 Total PC 1,100 FPC USA 822 Honam PC 950 NATPET 400 Ecopetrol 445 Ineos 790 Ineos 810 FPC 900 Petro-Rabigh 365 Basell Orlen Polyolef 400 Dow 560 Sunoco 688 Poly Mirae 700 Oman Polypropylene 340 TVK 285 Repsol Quimica 510 Indelpro 640 TPC 625 Marun PC 300 Unipetrol RPA 275 ExxonMobil 420 Flint Hills Resources 450 Maoming PC 610 Advanced PP Co. 300 Slovnaft 255 Appryl 300 Pinnacle Polymers 430 Samsung Total PC 570 Al-Waha 263 Oriental PC 200 Borealis Poly 245 Dow 420 FCFC 510 YANPET 260 NKNK 180 9,385 8,087 9,678 4,487 4,615 Source: CMAI and J.P. Morgan

Table 68: Polypropylene world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 9,397 9,089 9,055 9,085 9,085 9,085 9,085 South America 2,728 3,040 3,085 3,095 3,095 3,320 3,545 West Europe 10,176 9,995 9,603 9,415 9,415 9,415 9,415 Central Europe 1,395 1,420 1,420 1,420 1,420 1,420 1,420 CIS & Baltic States 730 805 820 1,000 1,292 1,500 1,500 Middle East 3,677 5,771 6,884 8,159 8,734 8,734 9,184 Africa 982 1,007 1,207 1,407 1,407 1,407 1,407 Indian Subcontinent 2,120 2,795 3,537 3,920 4,140 4,810 4,980 Northeast Asia 16,123 17,114 20,776 21,808 22,765 23,972 24,455 Southeast Asia 3,430 3,860 4,473 5,610 5,610 5,610 6,210 WORLD 50,758 54,896 60,860 64,919 66,963 69,273 71,201 Growth rate 4.38% 8.15% 10.86% 6.67% 3.15% 3.45% 2.78% Source: CMAI and J.P. Morgan.

Pricing The polypropylene market is expected to see significant oversupply by 2010 (by SRI). This will cause Western and North American producers to close some of their less efficient production plants due to negative cash margins. There will be capacity closures of over 1.5 million metric tons (mainly in US and Western Europe) which will offset some of the new capacity additions and improve the oversupply situation.

Figure 156: Polypropylene price chart 1,500

1,000

500

0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

PP (Copoly mer) €/ MT Forecast (Copoly mer) PP (Fibre Grade) €/ MT Forecast (Fibre Grade) Source: CMAI and J.P. Morgan.

118 119 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Polyvinyl Chloride (PVC) Introduction PVC is the most widely used plastic globally due to its diverse properties and production cost advantages compared to other plastics. 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.

Table 69: PVC at a glance Growth rate (CAGR to 2014E) 6.6% Current operating rate 70% Key end-markets Building and Construction, Packaging Key demand regions Asia (51%), Western Europe (14%), North America (18%) Key players Shintech, FPC, Oxy, Ineos, Solvay Market structure Top 10 producers amount to up to 31% of global capacity Key Inputs Vinyl chloride monomer (through Ethylene and Chloride) Threats Overcapacity Source: J.P. Morgan estimates.

Overview & Outlook The close ties of PVC to the construction industry means that demand for PVC can be heavily cyclical. The market for the product is fairly mature.

According to CMAI, PVC demand grew by 0.8% CAGR from 2004-2009. In the same period, capacity grew by a much higher pace of 6.6%. PVC demand is estimated to grow by 6.6% CAGR until 2014E whereas capacity growth is estimated to grow only at 2.8% CAGR helping to reduce oversupply according to CMAI.

Consumption growth rates are highest in Middle East (10.3%) and Indian subcontinent (9.5%) though on a lower base. NE Asia, particularly China, is expected to grow by 7%.

It is unlikely that further capacity additions will take place in the developed economies of North America and Western Europe due to high feedstock, energy costs and low profitability with further restructuring being likely. New capacity is expected to come in Asia and the Middle East.

The PVC industry has been under close scrutiny in recent years because of environmental concerns. The manufacturing of both chlorine and Vinyl chloride monomer (VCM) produces small quantities of toxic dioxins, which are believed to have a detrimental effect on human fertility and may be carcinogenic. Western Europe governments are planning to restrict PVC usage for some markets due to these concerns.

Production Process PVC is produced by the polymerization of vinyl chloride monomer using a slurry- based process. Therefore, the variable production cost of PVC manufacture depends primarily on the cost of ethylene and chlorine with an estimated 70-79% of total plant gate cost.

119 120 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 157: Production of PVC

Ethylene Vinyl chloride monomer Polyvinyl chloride

Chlorine

Source: SRI and J.P. Morgan

Historically, chlor-alkali prices have been generally lower in the United States than elsewhere in the world because of the favorable cost for electricity. However, the United States has lost these advantages in recent years, when natural gas prices rose dramatically.

Demand PVC is the most versatile of all thermoplastics. The general performance characteristic of PVC plastics includes mechanical toughness, good resistance to water and many chemicals (including strong mineral acids) and it also has electrical insulating properties.

Figure 158: PVC demand by end uses Transportation Home 3% Furnishings 2%

Electrical/ Other 3% Electronics 5%

Consumer Goods 7%

Packaging 7%

Construction 73% Source: SRI and J.P. Morgan.

Building/ construction is the key sector which generates almost 60% of PVC demand. The consumption is for pipe, fittings, windows, fencing and other applications. PVC has increasingly been used as a replacement for the traditional construction materials such as wood and metals. Because PVC is used as a substitute product; its growth has been above that experienced by the overall construction industry in recent years.

120 121 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 159: PVC consumption by region Figure 160: PVC demand growth by region (%) 2008-2014E (CAGR)

North America Asia 18% AME

WORLD South America 5% North America

Asia 51% South America

West Europe 14% West Euro pe

Central Europe

Central Europe 0% 1% 2% 3% 4% 5% 6% 7% 8% AME 7% 5% Source:CMAI and J.P. Morgan Source:CMAI and J.P. Morgan

Supply/Key players As for many petrochemical products, competition is fierce in the PVC industry. Feedstock integration is critical to control production costs and companies have adopted various strategies like consolidation, streamlining operations and forward integration to remain competitive. Typical world-scale plants are now in the 250 thousand metric ton-per-year capacity range.

Most of the new capacity additions (7.6mmt) through 2009-14E are coming in China or equivalent to 17% of 2009 global capacity. These new capacity additions in China are equal to 78% of new capacity addition through 2009-14E.

Figure 161: PVC demand/capacity (-000- Metric tons) 60000 100

50000 80 40000 60 30000 40 20000 10000 20 0 0 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E Total Capacity Total Demand Operating Rate, % Source: CMAI and J.P. Morgan

Table 70: Top 10 PVC producers by region (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World INEOS Chlor Vinyls 1,606 SHINTECH 2,340 FPC 1,753 Ibn Hayyan 406 Braskem 544 Solvin 1,120 Oxy Vinyls LP 1,649 LG Chem 880 Bandar Imam PC 175 Solvay Indupa 541 Vinnolit 792 FPC USA 1,210 Tianjin Dagu 800 Petkim 150 Oltchim 450 Arkema 685 Georgia Gulf 1,204 Reliance Industries 650 Abadan PC 60 Mexichem 416 LVM 500 Westlake 692 Thai Plastic 607 Borsodchem 400 Shin-Etsu 450 Mexichem 306 Qilu PC 600 Anwil SA 340 Vestolit 432 Policyd 235 Taiyo Vinyl 560 Sayanskkhimplast 250 Vinilis 315 Certain Teed 218 Shin-Etsu 550 SASOL Polymers 190 Vinylberre 285 PolyOne 116 Yibin Tianyuan 550 Pequiven 185 CIRES 210 Dow 40 Hanwha Chemical 545 Kaustik Sterlit 160 6,395 8,010 7,495 791 3,476 Source: CMAI and J.P. Morgan

121 122 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 71: PVC world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 8,338 8,042 8,118 8,592 8,592 8,592 8,592 South America 1,636 1,686 1,656 1,656 1,756 1,851 1,886 West Europe 6,896 6,974 6,889 6,819 6,819 6,819 6,819 Central Europe 1,445 1,483 1,483 1,603 1,603 1,603 1,603 CIS & Baltic States 629 629 653 953 953 1,283 1,283 Middle East 791 791 1,091 1,290 1,290 1,515 1,740 Africa 425 425 525 625 625 625 625 Indian Subcontinent 1,245 1,345 1,495 1,495 1,495 1,495 1,495 Northeast Asia 19,569 20,440 22,965 25,381 26,726 27,051 27,051 Southeast Asia 2,324 2,339 2,409 2,449 2,449 2,449 2,449 WORLD 43,298 44,154 47,284 50,863 52,308 53,283 53,543 Growth rate 6.72% 1.98% 7.09% 7.57% 2.84% 1.86% 0.49% Source: CMAI and J.P. Morgan.

Figure 162: PVC – Global market shares (2008A) Figure 163: PVC - European market share (2008A) CIRES Aiscondel Other Shin-Etsu Vestolit 3% 1% Formosa 3% 8% 7% 6% INEOS Occidental 4% Shin-Etsu 30% INEOS Solvay 7% 4% 3% LVM Georgia Gulf 7% 3% LG Other 2% Vinnolit 63% Westlake 10% 2% Vinnolit Solv ay Arkema Arkema 2% 20% 2% 13% Source: SRI. Source: SRI.

Pricing PVC prices are governed primarily by input costs and demand/ supply balance but it is strongly influenced by the construction and housing industry.

Figure 164: PVC price chart 1,500

1,000

500

0 Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 PVC Suspension (Contract Mkt) €/ MT Forecast (Contract) Source: CMAI and J.P. Morgan.

122 123 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Polystyrene Introduction Polystyrene is primarily used in the packaging industry for producing plastic model assembly kits, license plate frames, plastic cutlery, CD cases, and many other objects where a fairly rigid, economical plastic is desired.

It is manufactured by the polymerization of styrene monomer and occurs in several grades with general purpose (GP), high impact (HPIS) and expandable (EPS) being the most important ones.

Table 72: Polystyrene at a glance Growth rate (CAGR to 2014E) 1.5-2.0% Current operating rate 70% Key end-markets Packaging for the food, construction, IT and home application industries Key demand regions Asia (48%), North America (19%) and Western Europe (17%) Key players BASF, Total PC, Nova, Dow Market structure Top 10 producers amount to up to 47% of global capacity Key Inputs Styrene monomer (through Ethane and Benzene) Threats Increasing feedstock costs, substitution Source: J.P. Morgan estimates.

Overview & Outlook As packaging (one time use) accounts for 39% of demand for polystyrene, this area is relatively resilient against recession. However, its role in this industry is being eroded by the increasing use of polypropylene and ABS resins.

Lower consumption growth for polystyrene in the developed world (Western Europe: -1%, N America: +1%) is offset by high growth in the Middle East (+11%) and S America (+3.2%) through 2009-14E. Global consumption is expected to grow only by 1.5-1.2% until 2014E.

After increasing consumption and strong global capacity additions in recent years, oversupply is now an issue for the polystyrene market. Since margins are low for most producers, consolidation has become a key feature in the industry of the industry to reach future scale effects. Some of the recent mergers, acquisitions and divestitures in developed markets for styrenics are Ineos/Nova and Dow/CPChem. Part of BASF styrenics is up for sale since early this year. Consolidation has yet to start in Asia.

Polystyrene has recently been criticised for environmental concerns and its health effects caused by consumption when it migrates from food containers (primarily from a leaching caused by heat exchange) into food.

Production Process Polystyrene is produced by the polymerization of styrene monomer (produced by reacting ethylene and benzene). The solid plastic is then expanded into foam through the use of heat, usually steam.

HIPS is produced by dissolving polybutadiene in styrene monomer before bulk polymerization while EPS is produced from a mixture of about 90-95% polystyrene and 5-10% gaseous blowing agent, most commonly pentane or carbon dioxide.

123 124 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 165: Production of Polystyrene

Ethane

Ethylbenzene Styrene Polystyrene

Benzene Source: SRI and J.P. Morgan

Demand

General purpose polystyrene is a glassy and crystal clear plastic while high-impact polystyrene is a stronger and more durable plastic. Both forms are used in a variety of products, mainly for packaging- one time use (39%) and electronics/ appliances (30%).

Figure 166: Polystyrene consumption by end market

Others 31% Packaging - one time use 39%

Electronics / Appliances 30% Source: CMAI and J.P. Morgan

Figure 167: Polystyrene consumption by region Figure 168: Polystyrene demand growth by region (%) 2008-2014E North America 19% AME

South America

South America 5% Asia Asia 48% WORLD

Central Europe

West Europe 17% North America

Wes t Euro pe Central Europe 5% AME 6% -4% -2% 0% 2% 4% 6% 8% 10%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key players World polystyrene capacities estimated to increase at an average annual rate of only 0.4% through 2009 to 2014E.

New capacity additions will be 0.22 million metric tons through 2009-14E. Most of the new capacities are coming in China (0.8mmt, 6% of 2009 global capacity) and the Middle East (0.4mmt). These new capacity additions will be offset by capacity closures of 1.07mmt mainly in developed markets, through 2009-14E.

124 125 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 169: Polystyrene demand/capacity (-000- Metric tons) 78 15000 76 74 10000 72 70 5000 68 0 66 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E Total Capacity Total Demand Oper. Rate % Source: CMAI and J.P. Morgan

Table 73: Top 10 Polystyrene producers by region (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World INEOS NOVA 520 Total PC 749 FCFC 580 Petrokemya 165 Americas Styrenics 260 BASF Antwerp 440 Americas Styrenics 729 PS Japan 445 Tabriz PC 105 BASF SE 190 Total PC 400 INEOS NOVA 705 Zhenjiang ChiMei 360 Baser Petrokimya 50 NKNK 170 Polimeri Europa 360 BASF SE 160 Secco 300 Innova 150 Dow Belgium 265 Resirene 150 Chi Mei 300 Videolar 120 BASF SE 177 Dart Container 93 Supreme PC 300 SAT Operating Aktau 110 Dow 130 SABIC Plastics 45 Dow Pacific 285 Polystyrol 96 Total PC Iberica 80 Nova 45 Toyo Styrene 278 Synthos Kralupy 78 Dow Iberica 50 American PS 30 BASF Korea 235 Dunastyr 67 Dow Hellas 30 Productos Sesi 4 Denki KK 200 Petrobras Energia 65 Ebro-Quimex 4 BASF/Yangzi PC 195 Estizulia 63 2,452 2,714 3,478 320 1,369 Source: CMAI and J.P. Morgan

Table 74: Polystyrene capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 2,985 2,716 2,689 2,689 2,689 2,689 2,689 South America 891 891 891 891 891 891 891 West Europe 2,562 2,464 2,207 2,207 2,207 2,147 2,147 Central Europe 255 255 255 255 255 255 255 CIS & Baltic States 481 511 561 561 561 561 561 Middle East 366 366 366 466 766 766 766 Africa 5 5 5 5 5 5 5 Indian Subcontinent 476 476 476 476 476 476 476 Northeast Asia 5,527 5,535 5,620 5,800 5,800 5,800 5,800 Southeast Asia 1,006 953 888 888 888 888 888 WORLD 14,554 14,172 13,958 14,238 14,538 14,478 14,478 Growth rate -0.32% -2.62% -1.51% 2.01% 2.11% -0.41% 0.00% Source: CMAI and J.P. Morgan.

125 126 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Pricing The greatest influence on the polystyrene price is monomer cost. As the styrene prices increase there is a increase in polystyrene pricing though with a lag.

Figure 170: Polystyrene price chart 2,000

1,500

1,000

500

0 Jan-1990 Jan-1992 Jan-1994 Jan-1996 Jan-1998 Jan-2000 Jan-2002 Jan-2004 Jan-2006 Jan-2008 Jan-2010

Poly sty rene General Purp(Contract Mkt) €/ MT Forecast (General Purposes)

Poly sty rene High Imp(Contract Mkt) €/ MT Forecast (High impact Polystyrene) Source: CMAI and J.P. Morgan

Polyethylene Terephthalate (PET) Introduction Polyethylene terephthelate (PET) is a downstream product of paraxylene and ethylene glycol.

The largest outlet for PET is for the production of synthetic fibres because of its inherent properties that are well suited for lightweight, large-capacity and shatter- resistant containers. PET has also become the plastic packaging of choice for many food products, particularly beverages like bottled water, carbonated soft drinks and other liquid containers.

Table 75: Polyethylene Terephthalate (PET) at a glance Growth rate (CAGR 2009-14E) 5% Current operating rate 75% Key end-markets Textiles, Food Packaging Key demand regions Asia (39%), North America (22%), Western Europe (14%) Key players Mossi & Ghisolfi, Artenius, Jiangsu Sanfang Market structure Top 10 producers amount to up to 42% of global capacity Key Inputs Paraxylene, Ethylene Glycol Threats Oversupply/ New capacity in Asia Source: J.P. Morgan estimates.

Overview & Outlook Demand for PET increased greatly in recent years because of its rapidly expanding use in the bottled drinks industry. PET bottle resin is a material driver of growth in many developing countries.

CMAI estimates polyester (bottled resins) demand to grow by 5% CAGR until 2014E whereas capacity growth is estimated to be 3.4% CAGR.

However, global PET business has deteriorated since mid-1996 in terms of price stability, operating margins and industry profitability. Highly increased capacity in Europe, North America and Asia resulted in an excess of supply and a better demand/supply balance is not in sight for at least the next few years.

126 127 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Demand for PET is currently also affected by the development of ‘Ecobottles’. Ecobottles are plastic bottles that are made from 100% recycled PET - even the cap and trademark/description. Instead of using paper labels, the surface of the bottle is marked with the commercial and legal information using a deformation (or similar) process as well as inscription using laser beams or thermal shock. Ecobottles are stackable, very light, 100% recyclable and do not need a special process for recycling since they are free from label, gum, ink and paints. As ecobottles are ‘eco friendly’ their demand is expected to grow and the replacement of expensive glass bottles is expected to continue.

Production process Currently, the more popular and more economic route of PET production involves the co-polymerization of purified terephthalic acid (PTA) with ethylene glycol (EG), producing a by product of water. The main raw material is therefore paraxylene (PX). The polymer produced melt-phase PET can be melted and extruded through spinnerettes into man-made polyester fibre.

Figure 171: Production of PET

Propylene

Hydrogen Cyanide Ammonia Acrylonitrile

Ammonium Sulphate Oxygen

Source: SRI and J.P. Morgan

Demand Demand drivers for PET continue to vary by region. Absolute demand and demand growth in Asia continue to be dominated by polyester fibre, which dwarfs the market size of PET bottle resin even though the latter has grown significantly.

An untapped market for PET is beer packaging with substantial conversion still yet to materialize. Until 2006, PET was considered unsuitable for beer due to the material’s permeability and sensitivity to oxygen and carbon dioxide. Though things have changed now, PET bottle manufacturers have developed a barrier to minimize oxygen and carbon dioxide permeation and can preserve the flavour characteristics of beer in PET containers for up to six months. PET has captured only 5-10% of the beer market, in which glass has a 50-60% major share and metal cans have 25-30%.

127 128 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 172: Polyester bottle resins consumption by end market Other PET Food 6% Pharmaceutical 10% 1% Cosmetics 1%

Beverage 82%

Source: CMAI and J.P. Morgan

Figure 173: Polyester bottle resins consumption by region Figure 174: Polyester bottle resins demand growth (%) 2008-2014E (CAGR) North America AME 22% South America

Asia 39% WORLD South America Asia 7% Central Europe

West Europe North America 14% AME 9% Central Europe West Europe 9% -4% -2% 0% 2% 4% 6% 8% 10% 12% 14% 16%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key players New capacity additions of 6mmt are coming on line through 2009-14E or equivalent to 32% of 2009 global capacity. Most of the new capacity is coming in China (2.4mmt, 13% of 2009 global capacity). Other key capacity additions are Oman (0.75mmt, 4% of 2009 global capacity) and Brazil (0.65mmt, 3% of 2009 global capacity) through 2009-14E.

Figure 175: Polyester bottle resins demand/capacity (-000- Metric tons) 25000 90

20000 85 15000 80

10000 75

5000 70 0 65 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E Total Capacity Total Demand Total Oper. Rate % Source: CMAI and J.P. Morgan.

128 129 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 76: Top 10 Polyester bottle resins producer (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World Artenius 810 Invista 793 Jiangsu Sanfang. 923 JBF RAK 360 Mossi & Ghisolfi 600 Equipolymers 496 Mossi & Ghisolfi 765 KP Chemical 471 Shahid Tondguyan 309 Neo Group 308 Indorama Petrochem 320 Eastman 730 China Resources 470 Octal Holdings 300 DAK Americas 186 Novapet 225 DAK Americas 650 Shanghai Far Eastern 423 Ibn Rushd 300 Orion PET 170 M & G Polimeri 193 Wellman 435 Far Eastern Group 373 Artenius 135 HOSAF 120 Invista 113 Nan Ya 405 Yizheng Chem. 370 Korteks 30 SK Eurochem 120 Plastipak 100 StarPET 225 Reliance Industries 330 Polief 120 Tergal Fibers 38 Alpha PET 161 TK Chemical 280 Belpak 115 Jiangsu Chenxing 260 Europlast 100 Gatron 230 Sibur-PET 53 2,295 4,164 4,130 1,434 1,892 Source: CMAI and J.P. Morgan

Table 77: Polyester bottle resins world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 4,663 4,164 4,473 4,625 4,625 4,625 4,625 South America 674 826 876 1,214 1,326 1,326 1,326 West Europe 2,579 2,295 2,217 2,254 2,254 2,254 2,254 Central Europe 180 120 120 120 120 120 120 CIS & Baltic States 836 866 1,148 1,203 1,203 1,203 1,403 Middle East 1,185 1,434 1,434 1,559 2,144 2,354 2,354 Africa 147 145 120 120 120 670 670 Indian Subcontinent 821 993 993 993 993 993 993 Northeast Asia 6,213 6,281 7,106 7,985 8,400 8,400 8,400 Southeast Asia 1,296 1,371 1,477 1,477 1,477 1,477 1,477 WORLD 18,594 18,495 19,963 21,550 22,662 23,422 23,622 Growth rate 5.33% -0.53% 7.94% 7.95% 5.16% 3.35% 0.85% Source: CMAI and J.P. Morgan

Pricing Prices depend on how the key raw material prices are changing and the demand/ supply balance.

Figure 176: Polyester price chart 2,000

1,500

1,000

500

0 Jan-2000 Jan-2002 Jan-2004 Jan-2006 Jan-2008 Jan-2010

Poly ester POY, €/MT Forecast (POY) Poly ester Staple Fiber, €/MT Forecast (Staple Fiber) Source: CMAI and J.P. Morgan.

129 130 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Other Polymers

Polyurethanes Introduction Polyurethanes are types of thermoset foams that are used in a wide range of applications and markets because of their cushioning and insulating properties. They are made from glycol and di-isocyanate and are easily manufactured into a wide range of different physical forms. The two main types of polyurethane foam are MDI-based rigid polyurethanes and TDI-based flexible polyurethane.

Figure 177: Production of Polyurethanes (overview)

Benzene MDI Rigid Polyurethane

Toulene TDI Flexible Polyurethane Source: J.P. Morgan

Methylene-diphenyl diisocyanate (MDI) Introduction The main use for MDI is in the production of rigid and semi-rigid foams (for example shoe soles, foams for cars and furniture) which account for approximately 80% of global output of polyurethanes. MDI is also widely used to dampen noise and for energy savings through heat insulation in the construction industry. Other usages are for refrigeration, packaging and rubber.

Table 78: MDI at a glance Growth rate (CAGR 2008- 2013E) 5% Current operating rate 74% Key end-markets Construction, Automotive Key capacity regions Asia (42%), Western Europe (30%), North America (24%) Key players Bayer, BASF, Huntsman, Dow, NPU Market structure Top 6 producers amount to up to 84% of global capacity Key Inputs Benzene, Propylene Threats New capacity in Asia Source: J.P. Morgan estimates.

130 131 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Overview & Outlook Operating rates for MDI have fallen in the last 2-3 years due to Asian capacity additions, and weak demand from construction, though partially offset by good demand from auto industry in the last few months. MDI continues to take market share from TDI because of its wider applications.

CMAI estimates MDI demand to grow by 5% CAGR through 2008-13E while capacity growth is estimated to be 4%.

Production Process For the production of MDI, aniline (which is derived from nitrobenzene) is reacted with formaldehyde. MDI is then reacted with a poyol for the manufacture of rigid polyurethanes.

Figure 178: Production of MDI

Propylene Propylene Oxide Polyol

Benzene Aniline MDI

Formaldehyde Rigid Polyurethane

Source: J.P. Morgan

Demand MDI demand was depressed in 2008-09 on weak end markets - construction, autos, footwear. Since then demand has been improving driven by construction and automotive sector. Moreover, strong demand is coming from Asia, driven by a boom in the footwear, automobile and construction sectors.

Supply/Key players Several thousand producers in the world manufacture polyurethane foams, frequently at multiple plant locations. However, the MDI market is shared by just a few major players. The top ten six producers have 84% of the global capacities.

New capacities of c1.2mmt are coming online through 2009-14E or 23% of 2009 global MDI capacity. China is adding 0.65mmt of capacities or 12% of 2009 global MDI capacity through 2009-14E. Germany is adding 0.24mmt of new capacities or 5% of 2009 global capacity.

131 132 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 179: MDI capacity by region Figure 180: MDI capacity growth (%) 2008-2014E (CAGR) North America

24% Central Europe

Asia

Asia 42% WORLD

South America 1% West Europe

North America

South America

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% West Europe 30% Central Europe 3% Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Figure 181: Top MDI producers (-000- Metric tons) 1,400 25% 1,200 20% 1,000 800 15%

600 10% 400 5% 200 ---- 0% Bayer BASF Huntsman Dow NPU Ningbo SHG Lianheng Wanhua Iso. Capacity Percentage market share Source: CMAI and J.P. Morgan estimates.

Table 79: MDI world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 1,328 1,328 1,385 1,385 1,385 1,385 1,385 South America 45 45 45 45 45 45 45 West Europe 1,614 1,654 1,674 1,684 1,694 1,894 1,894 Central Europe 190 190 190 245 300 300 300 Middle East ------40 40 40 40 40 Indian Subcontinent 30 30 30 30 30 30 30 Northeast Asia 1,778 2,016 2,098 2,398 2,498 2,498 2,498 WORLD 4,985 5,263 5,462 5,827 5,992 6,192 6,192 Growth rate 13.73% 5.58% 3.78% 6.68% 2.83% 3.34% 0.00% Source: CMAI and J.P. Morgan.

132 133 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Toluene diisocyanate (TDI) Introduction TDI is used principally in the manufacturing of furniture (interior components of automobiles in seats, headrests, armrests, roof liners, dashboards and instrument panels). It can also be used to produce coatings, rigid foam adhesives, sealants, and cast elastomers.

Table 80: TDI at a glance Growth rate (CAGR 2008-2013E) 4% Current operating rate 70-80% Key end-markets Furniture, automotive interiors Key regions Asia (47%), North America (22%), Western Europe (18%), Key players BASF, Bayer, Mitsui Takeda, Dow, Market structure Top 8 producer amount to up to 80% Key Inputs Benzene Threats New capacity in Asia Source: J.P. Morgan estimates.

Overview & Outlook MDI continues to take market share from TDI because of its wider applications. This will continue to soften demand growth for TDI. TDI demand will grow by 4% versus capacity growth of 5% through 2008-13E.

Production Process For the production of TDI, Toluene (derived from Benzene) is converted into diamine which is then reacted to produce TDI. Like for MDI, TDI is also reacted with polyol to manufacture flexible polyurethane.

Figure 182: Production of TDI

Propylene Propylene Oxide Polyol

Toulene Toulene Diamine TDI

Flexible Polyurethane

Source: J.P. Morgan

Demand Low growth rate in developed markets -Western Europe (2%), North America (2%)- will be offset by high growth rates in Eastern and Central Europe, Middle East and Africa (4-5%), driven by rising incomes and increasing demand for TDI end products. Growth in Asia, where China accounts for three-quarters of TDI consumption, is put at about 5%/year.

With most of TDI’s output going into the furniture and automotive sectors, demand remains sensitive to economic activity.

133 134 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Supply/Key players Flexible and rigid polyurethane capacities are expanding and shifting to China and other Asian countries (excluding Japan). New capacity additions of 2.1mmt is coming online or equivalent to 34% of 2009 global capacity through 2009-14E. Ths biggest capacity addition is coming in China with 0.51mmt or 25% of 2009 global capacity. Some of the new capacity additions will be offset by capacity closures. As per CMAI, there will be capacity closure of 0.1mmt in US through 2009-14E.

Figure 183: TDI capacity by region Figure 184: TDI capacity growth (%) 2008-2014E (CAGR) Middle East 1% North America 22% Rest of the World

Asia

South America WORLD Asia 47% c 4% West Euro pe

North America West Europe 18% -6% -4% -2% 0% 2% 4% 6% 8% 10% 12% Central Europe

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Figure 185: Top 10 TDI producers (-000- Metric tons) 600 28% 23% 400 18%

13% 200 8% 3% ---- -2% BASF Bay er Mitsui Dow Perstorp Borsodchem Cangzhou KFC Takeda AB Dahua Capacity Global percentage share (%) Source: CMAI and J.P. Morgan estimates.

Table 81: TDI world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 460 460 385 360 360 360 360 South America 90 90 90 90 90 90 90 West Europe 385 385 385 385 385 385 500 Central Europe 168 168 168 243 318 318 318 CIS & Baltic States 4 4 4 4 4 4 4 Middle East ---- 30 40 40 40 40 40 Indian Subcontinent 45 45 45 45 45 45 45 Northeast Asia 865 907 1,015 1,268 1,380 1,380 1,380 WORLD 2,017 2,089 2,132 2,435 2,622 2,622 2,737 Growth rate 1.66% 3.57% 2.05% 14.21% 7.68% 0.00% 4.39% Source: CMAI and J.P. Morgan

134 135 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Polycarbonate Introduction Polycarbonate resins are tough thermoplastics usually derived from bisphenol A and phosgene. The major markets are the electrical/electronic sectors such as computer and business equipment and CDs and the automotive industry. They are also used for the production of safety helmets and shields, housing components, household appliances and sporting goods.

Table 82: Polycarbonates at a glance Growth rate (CAGR to 2014E) 5.7% Current operating rate 76% Key end-markets Electronics, glazing and sheets Key demand regions Asia (64%), W Europe (16%), N America (14%) Key players Bayer, SABIC, Dow Market structure Top 3 producers amount to up to 63.2% of production Key Inputs Acetone, Phenol Threats New capacities coming on stream in Asia Source: J.P. Morgan estimates and CMAI

Overview & Outlook Despite slower growth in optical media (CDs, DVDs), future demand is still expected to be healthy in the medium term. According to CMAI, polycarbonate demand will grow by 5.7% CAGR from 2009-2014E. In the same period, capacity will grow by 5.2%.

Asia Pacific already is the largest polycarbonate market worldwide representing almost half of the global market of 4.2mm tones in 2009. Major players will continue to announce capacity additions in this region.

Production Process Polycarbonate is produced from Bisphenol A (BPA) mostly by using the interfacial process, where BPA is reacted with phosgene in an aqueous solution with methylene chloride as a solvent.

Because of environmental concerns about the highly toxic nature of phosgene, the industry shows considerable interest in processes that do not involve phosgene.

The second production process, transesterification, reacts BPA with diphenyl carbonate (DPC) and without a solvent.

Figure 186: Production of Polycarbonate (interfacial)

Phenol Biphenol A Polycarbonate Methylene Chloride Phosgene

Acetone

Source: J.P. Morgan

135 136 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Demand Demand for optical media production is expected to slow significantly as CDs and recordable CDs are replaced by MP3 players, high internet bandwidth and USB drives. However, growth is still expected in other sectors such as alloys used in automotive and electronic products, cell phones, TVs, business equipment and sheet and construction products. Applications are expected to widen into back lights and rear windows in truck cabins, moveable side windows and vehicle top applications, promoted by the significant weight benefit over glass.

However, there has been strong resistance from the automobile manufacturers in the more general replacement of glass. One of the problems is the poor scratch resistance of polycarbonate. The higher cost compared to glass could be another limiting factor although polycarbonate does offer weight savings, broader design options and easier handling that could bring efficiencies on the automotive production line as well as improved fuel economy.

Figure 187: Polycarbonate uses by end market Electrical/ Other 18% Electronic 27%

Transportation 14%

Optical Media Glazing and 21% Sheet 20% Source: SRI and J.P. Morgan

Figure 188: Polycarbonate demand by region Figure 189 Polycarbonate demand growth by region (%) 2008-2014 (CAGR) North America 14% South AME America 1% Central Europe Asia

WORLD West Europe 16% South America North America

Wes t Euro pe Asia 64% Central Europe 3% -5% 0% 5% 10% 15% 20% 25% 30% AME 2%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key players The polycarbonate resin market is global, with three dominant producers. The market sees intense competition among the big players to gain market share. SABIC is the largest worldwide producer, accounting for 27% of world capacity, followed by Bayer.

136 137 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

New capacities of order 0.73mmt are coming online or equivalent to 18% of 2009 global capacity of polycarbonate. Most of these capacities are coming in China (0.41mmt or 10% of 2009 global capacity) and Saudi Arabia (0.26mmt).

Figure 190: Polycarbonate demand/capacity (-000- Metric tons) 6000 95 5000 90 4000 85 3000 80 2000 75 1000 70 0 65 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Total Capacity Total Demand Total Oper. Rate % Source: CMAI and J.P. Morgan

Until 2004, the requirement for initial large investments created high barriers to entry into the polycarbonate resin business. However, in recent years these costs have been rapidly falling so that many smaller plants have been created.

Table 83: Top 10 Polycarbonate producers by region (2009) Thousand metric tons West Europe North America Asia Middle East Rest of the World Bayer 568 SABIC Plastics 598 Teijin 226 Khuzestan PC 25 Kazanorgsintez 60 SABIC Plastics 505 Bayer 260 Bayer* 220 Unigel 15 Dow 105 Dow 90 Teijin Polycarb 210 ISL Polymers 5 Formosa Idemitsu 175 Thai Polycarbonate 160 LG Dow Polycarb. 160 Chi Mei-Asahi 140 Mitsubishi Eng Plastics 125 Sam Yang 120 Bayer Poly Shanghai 100 1,183 948 1,636 25 75 Source: CMAI and J.P. Morgan, * including poly shanghai

Table 84: Polycarbonate capacity additions Thousand metric tons COMPANY Country LOCATION 2010 2011 2012 2013 2014 TOTAL as % of global cap. 2009 Kayan Saudi Arabia Al Jubail ---- 65 195 ------260 6.2% Bayer Poly Shanghai China Caojing, Shanghai 66 34 ------100 2.4% Blue Star China Various_CHI ------100 ---- 100 2.4% Mitsubishi Eng Plastics China Shanghai ------40 40 ---- 80 1.9% Zhenjiang ChiMei China Zhenjiang, Jiangsu ------35 40 ---- 75 1.8% MCC/MEP/SINOPEC JV China Yanshan, Beijing ---- 40 20 ------60 1.4% Mitsubishi Eng Plastics Japan Kurosaki 45 15 ------60 1.4% Source: CMAI and J.P. Morgan

137 138 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Fibres

Synthetic fibres amount to significant portion of global fibre production. Polyester takes the most important role, leaving Nylon and Acrylic Fibres far behind. Other fibres are based on natural materials such as cotton or wool.

Figure 191: Global Man-Made fibre production (2009: 56kt) Acetate 0.2% Acry lic 5.1% Rayon 6.7% Ny lon 10.4%

Poly ester 77.6% Source: SRI and J.P. Morgan estimates

Polyester Fibre Introduction Polyester is the most economical among fibres used in textiles because its physical properties fit to apparel use and owing to low production costs. The most common polyester for fibre purposes is polyethylene terephthalate, or simply PET. This is also the polymer used for many soft drink bottles and it is becoming increasingly common.

Table 85: Polyester Fibre at a glance Growth rate (CAGR to 2009-14E) 8% Current operating rate 70% Key end-markets Textile Industry Key demand regions Asia (92%) Key players Reliance, China Petrochemical Corporation, Koch, Formosa Plastics Market structure Top 15 producers amount to up to 23% of global capacity Key Inputs Ethylene Glycol, purified Terephthalic acid, Dimethyl Terephthalate, Threats Capacity additions in Asia Source: J.P. Morgan estimates.

Overview & Outlook Significant low-cost capacity, especially in Asia, continues to hurt European and American producers and the shift from developed countries to emerging countries, especially to Asia, will continue with substantial decreases in both production and consumption

According to CMAI, Polyester (textile filament) demand grew by about 6% CAGR from 2004-2009E. In the same period, capacity grew by 4%. For the future outlook, CMAI estimates polyester textile filament demand to grow by 8% CAGR until 2009- 14, driven by growth in China and India. Global capacity growth is forecasted to be 5% CAGR through 2009-14.

138 139 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Production process Polyester filament yarn and staple are manufactured via “spinning” by extruding moulten PET polymer through a metal plate or thimble with fine holes, called a spinnerette.

The key raw materials are purified terephthalic acid (PTA) or dimethyl terephthalate (DMT) and ethylene glycol. PTA and DMT are derived from Paraxylene (produced in naphtha crackers or refineries), and EG is an ethylene derivative.

Demand China, the world’s biggest producer of polyester fibres, is also the biggest consumer. It consumes fibres in a chain of textile weaving, dyeing and apparel-making industries, and then exports large amounts of finished goods, including apparel, curtains and bedding to all countries in the world.

Polyester demand is also influenced by cotton, which is a competing but natural fibre, especially in apparel end uses. Current depressed cotton prices mean substitution demand is limited. In the long term, limitations on cotton supply, in the form of a finite area of cultivation, should work in favor of polyester in our view.

Figure 192: Polyester (textile filament) demand by region Figure 193 Polyester demand growth by region (%) 2008-2014E (CAGR)

Asia

WORLD

South America AME Asia 92% Others 4% North America

AME 4% Central Europe

Wes t Euro pe

-6% -4% -2% 0% 2% 4% 6% 8% 10%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Supply/Key players CMAI expects capacity addition of 6.9mmt through 2009-14E or equivalent to 26% of 2009 global capacity. Most of new capacities are coming in China and India. New capacities of order of 5.9mmt will be coming in China through 2009-14E or equivalent to 22% of 2009 global capacity. India will be adding new capacities of 1.05mmt through 2009-14E. Though, some of the new capacities will be offset by capacity closures. CMAI expects capacity closures of 0.31mmt through 2009-14E. Biggest closures will be coming in Taiwan (0.11mmt) and Turkey (72mt), as per CMAI.

139 140 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 194: Top 10 polyester (textile filament) producer Figure 195: Polyester (textile filament) demand/capacity (-000- Metric tons) (-000- Metric tons)

4.0% 35000 100 2000 3.5% 30000 80 3.0% 25000 1500 60 2.5% 20000 15000 2.0% 40 1000 10000 1.5% 20 5000 1.0% 500 0 0 0.5% 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E 2014E 0 0.0% Reliance China Koch Formosa Zhejiang Tuntex Group Lohia Toray Performance Teijin Total Capacity Total Demand Total Oper. Rate % Industries Petrochemical Industries Plastics Corp. Yuandong Industries Fibers Corporation Chemical Fibers Group

CAPACITY Global percentage share (%)

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Table 86: Polyester (textile filament) world capacity overview Thousand metric tons REGION 2008 2009 2010E 2011E 2012E 2013E 2014E North America 346 324 324 324 324 324 324 South America 148 153 144 190 329 329 329 West Europe 234 234 199 199 199 199 199 Central Europe 119 119 119 119 119 119 119 CIS & Baltic States 55 55 55 64 72 72 72 Middle East 444 372 372 372 372 372 372 Africa 48 48 48 48 48 48 48 Indian Subcontinent 2,492 2,608 2,860 2,993 3,220 3,360 3,540 Northeast Asia 20,001 21,202 22,457 24,672 25,647 25,772 25,772 Southeast Asia 1,689 1,699 1,699 1,699 1,735 1,735 1,735 WORLD 25,576 26,814 28,277 30,680 32,065 32,330 32,510 Growth rate 4.4% 4.8% 5.5% 8.5% 4.5% 0.8% 0.6% Source: CMAI and J.P. Morgan,

Polyamide (Nylon) Introduction Nylon 6 and 6,6 are the main nylon types and account for over 90% of all nylon production. Both types have a considerable interchange and are used as Nylon Fibre in the textile industry or as Nylon resins for injection molding and extrusion applications.

Nylon fibre is used principally for the manufacturing of carpets and rugs. Other uses include apparel goods and industrial applications, such as auto-related products (e.g., airbags, tyre cords and ropes). Important nylon fibre characteristics include abrasion resistance and high-tensile strength.

Nylon resins are characterized by high tensile strength and strong chemical and heat resistance, performing mechanical duties that have traditionally relied on metal parts. These advantages have led to many new automotive applications for nylon 6 resins as automobile manufacturers try to reduce the weight of motor vehicles by replacing metals with plastic.

140 141 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 87: Nylon resins at a glance Growth rate (CAGR to 2014E) 5% Key end-markets Textile/Carpet industry (Fibres), automotive applications (resins) Key demand regions (Resins) Asia (54%), Western Europe (20%), North America (16%) Key players (Resins) BASF, Invista,DuPont, Rhodia, Li Peng, Ascend, DSM, Lanxess, Ube Market structure Fragmented with Top 10 players contributing c.40% of total capacity Key Inputs Caprolactam, adipic acid Threats Capacity growth in Asia Source: J.P. Morgan estimates.

Overview & Outlook Nylon demand is projected to grow in line with demand for resins in automotive, construction and film application. Growth is in some applications affected by increasing replacement by polyester – e.g. in textiles and alternative flooring products in houses (like laminate, PVC, wood). However, the replacement of metal (e.g. in automotive applications, construction) has been a key growth driver in recent years.

With the end-use industries (textile, autos) shifting to the emerging markets, demand has shifted from mature to developing markets. Therefore most nylon capacity growth in recent years has been in Asia, particularly in China and Taiwan, where labour is cheaper and end demand is rising strongly.

Production process Nylon 6 is polymerized from caprolactam, which is mixed with water and other additives. Nylon 66 is made from adipic acid and hexamethylenediamine.

Figure 196: Production of Nylon 6

Caprolactam Condensation Aminocaprioc acid Nylon 6 Water Source: J.P. Morgan

Figure 197: Production of Nylon 66

Adipic acid Condensation Nylon salt Nylon 66 HMDA

Source: J.P. Morgan HMDA stands for Hexamethylene diamine

Demand The difference in performance characteristics between the two major types of nylon resins is limited, with some degree of substitution being possible over time. Nylon 6,6 generally tends to exhibit higher tensile strength and greater hardness and stiffness and has slightly better flame retardance. Nylon 6 has better surface appearance (particularly in glass-reinforced compounds) and flow characteristics and can be more easily colored.

141 142 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 198: Nylon resins consumption by region Figure 199: Nylon resins demand growth (%), CAGR 2008-2014E North America 16% SE Asia Middle East South America 3% North America WORLD Asia 54% West Europe West Europe 20% Central Europe NE Asia South America Central Europe 5% AME 2% 0% 2% 4% 6% 8% 10% Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

CMAI estimates nylon demand to grow at a CAGR of 6% in the mature market of North America (2009-14e) driven by engineering resins. However, much of the growth is expected in 2010/11e, after which point growth is expected to normalize to GDP rates.

Figure 200:Nylon-6 consumption by end market Figure 201: Nylon-6,6 consumption by end market Bulked Bulked Staple Fiber 2% continuous filament continuous filament 12% 3% Engineering Staple Fiber 1% Tex tile Filament Resins & Other 35% Yarn 23%

Textile Filament Yarn 35% Engineering Resins & Other 59% Industrial Industrial Filamant Yarn 14% Filamant Yarn 16%

Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Key end markets include the automotive, electronics, textile, carpet and construction sectors.

Supply/Key players The same feedstocks are used to produce nylon resins and nylon fibres. Relative to nylon resins, the production of nylon fibres consumes much larger amounts of feedstock. Therefore, the economics of nylon resin production are also affected by the supply and demand balance for nylon fibres.

Operating rates have been very high in the industry in H1 2010, with a number of players reporting full operating rates in Q1 2010. This has been driven by tight supply resulting from capacity closures (e.g. BASF, Invista) and plant turnarounds, combined with a surge in restocking-led demand. However, under more normalised conditions, CMAI anticipates overcapacity in the industry, with operating rates in nylon 6 unlikely to rise beyond 80%.

142 143 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 202: Nylon 6 resin demand/capacity (000 metric tons) Figure 203: Nylon 6,6 resin demand/capacity (000 metric tons) 6000 100 2500 95

2000 4000 85 1500 80 1000 2000 75 500

0 60 0 65 2004 2005 2006 2007 2008 20092010E2011E2012E2013E2014E 2004 2005 2006 2007 2008 20092010E2011E2012E2013E2014E

Total Demand Total Capacity Operating Rate % Total Demand Total Capacity Operating Rate % Source: CMAI and J.P. Morgan Source: CMAI and J.P. Morgan

Although demand at c.5% per annum is set to outpace capacity growth at c.2%, overcapacity remains a concern, which will likely place pressure on company margins in the medium-term.

Figure 204: Top 10 nylon 6 and 6,6 resin producers (-000- Metric tons) 700 9.00%

600 8.00% 7.00% 500 6.00% 400 5.00% 300 4.00% 3.00% 200 2.00% 100 1.00% ---- 0.00% BASF SE Invista DuPont Rhodia Li Peng DSM Eng. FCFC Ascend Xinhui Honeywell Zig Sheng Plastics Meida DSM Capacity Global percentage share (%) Source: CMAI Figure 205: Top nylon 6,6 Intermediates, Engineering Plastics and Fibre producers 2008 sales in EURO million

Source: Rhodia.

143 144 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

In recent years, a number of players have begun to develop niche, high performance polyamides (e.g. types 11, 12, 46), as shown below.

Table 88: Polyamide resins - key players by type 6 66 11 12 46 Arkema x x BASF x x DSM x x DuPont x x EMS x x x Evonik x x Lanxess x x Rhodia x x Solutia/Ascend x Source: SRI.

Pricing The nylon industry has enjoyed strong price momentum in H1 2010, benefiting from tightness of supply. However with overcapacity in the industry combined with rising input costs, we view this favourable trend as unlikely to be sustained. Resins for engineering plastics used in high-growth applications (e.g. metal replacement in autos) have tended to enjoy greater pricing power than resins for textile and carpet fibres. Also – niche polyamides such as 4,6 (DSM) and 1,1 (Arkema) tend to enjoy higher prices than more commoditised product (e.g. 6 and 6,6).

Figure 206: Nylon price chart 200

150

100

50

0 Jul- Apr- Jan- Oct- Jul- Apr- Jan- Oct- Jul- Apr- Jan- Oct- Jul- Apr- 2001 2002 2003 2003 2004 2005 2006 2006 2007 2008 2009 2009 2010 2011

Ny lon 6 (Fiber Grade) Cents/ Pounds Forecast (Nylon 6) Ny lon 6,6 (Fiber Grade) Cents/ Pounds Forecast (Nylon 6,6)

Source: CMAI and J.P. Morgan

144 145 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Fertiliser

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 or liming. Through trial and error, they were able to increase the three primary soil nutrients —nitrogen, phosphorus, and potassium —though not always in the most efficient or rigorous manner.

Today, from fertilisers that contain a specific quantity of the three essential nutrients to algorithms that quantify volume of fertiliser application for a desired crop yield on any given small plot, farmers have access to advanced methods to increase soil and crop efficiency.

Nutrients are classified into three primary nutrients and three secondary nutrients:

Figure 207: Market share of main • Nitrogen (N) is essential for development and growth in plants. Supply of nutrients nitrogen determines a plant's growth, vigour, colour and yield • Phosphorus (P) is used for vital root development and to help the plant resist drought. • Potassium (K) is essential to the translocation of photosynthesis within plants and for high-yielding crops.

The secondary nutrients Sulphur (S), Calcium (Ca) and Magnesium (Mg) are required for optimum crop growth.

The market for primary nutrients amounted up to 160 million tones. Thereof, Source: Yara and IFA statistics (2007/2008) Nitrogen is the largest nutrient by volume, with 62% of production.

Fertiliser Measurement As an industry convention, the comparison of fertilisers is based on concentrations of the primary nutrients.

• 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 fertilisers are measured in units of N. Some of the most common nitrogen- containing fertilisers include Ammonia (NH3), Urea (CO(NH2)2), or ammonium nitrate (NH4NO3). Nitrogen represents 82% of the content of anhydrous ammonia, 46% for urea, and 34% for ammonium nitrate. CAN, (calcium ammonium nitrate) and UAN (urea ammonium nitrate) solutions vary in nitrogen content from 28-32%.

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

145 146 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

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

Figure 208: Key global fertiliser product categories

Nitrogen N

Ammonia 4% Other 13%

DAP/MAP 6%

Urea 52% NPK 11%

AN/CAN 9% UAN 5%

99 million tons

Potash K2O Phosphate P2O5

Other 1% Other 2% TSP 6%

NPK 29% SSP 17%

DAP/MAP 48%

MOP/SOP 70% NPK 27%

24 million tons 36 million tons Source: Yara and IFA statistics 2008/2009 (nutrient totals) & 2005 (product split)

Because of their high market share, Urea, DAP/MAP and MOP play the most important role for primary nutrients. Also NPK, as a mix of all three types of fertiliser categories, takes a big share as well.

Table 89: Fertiliser Industry – key facts Potash Nitrogen Phosphate Base product Potassium chloride (KCL) Ammonia (NH3) Phosphate rock-Phosphoric acid(P2O5) Geographic availability of raw material Limited Readily available Availabel Cost of new capacity App.$2.8bn for 2 mn tons KCL App.$1.4bn for 1mn tons NH3 App. $1.5bn for 1 mn tons P2O5 Greenfield development time Min 7 years Min 3 yrs 3-4 yrs Producing countries 12 (Based on KCL) ~60 (based on NH3) ~40 (Based on P2O5) #1-Canada #1-China #1-China #2-Russia #2-India #2-US #3-Belarus #3-Russia #3-Morocco #4-Germany #4-US #4-Russia State/subsidy-controlled production 19% 57% 46% Expected long-term fertiliser consumption growth rate 3-4% 2.5-3% 2-2.5% Major importers KCL Ammonia DAP #1-US #1-US #1-India #2-Brazil #2-India #2-Brazil #3-India #3-South Korea #3-Japan #4-China #4-Pakistan Source: J.P. Morgan and PotashCorp

146 147 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Fertiliser Market and its Drivers Global fertiliser consumption amounts to around $70bn per year. The key publicly- traded players in the fertiliser market are Yara (ex Norsk Hydro), Mosaic (IMC and Cargill), PotashCorp, Kali und Salz – K+S (previously BASF), ICL, CF industries and Agrium.

Within the fertiliser market, grain crops account for around 60% of fertiliser usage. Corn requires around five times more Nitrogen fertiliser per hectare than Soybeans, and around twice as much as Wheat.

Figure 209: Fertiliser company revenues (2009) Figure 210: Fertiliser market by application

USD mn Fruit &

Mosaic Vegetables 17% Other 17% Yara Agrium K+S Sugar corps 5% ICL Cotton 4% Potash Wheat 15% Other oil seed CF Industry 4% Uralkali Soybean 4% 0 2000 4000 6000 8000 10000 Other cereal 5% Rice 14% Maize 15% Source: Company reports and J.P. Morgan Source: Yara, IFA (2008/2009) and J.P. Morgan Based on 2009 FX rates average NOKUSD=0.1599, EURUSD= 1.3947 and RUBUSD= 0.03163

Fertilisers increase crop yield, improve soil quality and add to the overall health of the plant. In fact, the correct application of fertiliser can increase the profitability of crops dramatically, with a net return on investment at current prices in fertiliser up to 700% (vs. Agchem 80-100%) in recent years.

Figure 211: Yield response (monetary value) to N fertiliser rate 1200

1000

a 800

600

Income €/ h €/ Income 400

200

0 0 50 100 150 200 250 300 350

Fertilizer application, kg N/ha Source: Yara

In 1989-1994 fertiliser consumption declined due to the collapse of communism in Eastern Europe and the Soviet Union and the very significant reduction in nutrient use in that region.

147 148 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 212: Consumption per nutrient Figure 213: Nitrogen consumption per continent Nutrient million t Nutrient million t

120 2.1% per year 40 100 35 China: 1.1% per year

30 80 N 25 60 India: 2.6% per year 20 P 4.1% per year Rest of Asia: 3.8% per year 40 15 Europe: 1.8% per year 10 N America: 1.7% per year 20 5 K 4.6% per year Latin America: 3% per year 0 0

5 9 5 F F 93 9 997 9 03 0 19 19 1 19 2001 20 20 2007 11 013 2009F 20 2 Source: Yara, IFA and J.P. Morgan Source: Yara, IFA and J.P. Morgan

Structurally, the long-term global We believe increasing food and grain consumption will continue to support global demand for fertilisers appears crop prices over the long term. A combination of population growth and the well supported. increasing population wealth should continue to place substantial demands on global crop production. On a regional basis and on a shorter time horizon, we concede that demand trends are more dependent on factors that are more difficult to predict, such as weather patterns.

148 149 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 214: Planting calendar

Source: Potash Corp.

149 150 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 215: US & Global Corn yield - EXPECTATIONS REMAIN AT RECORD HIGHS (MT/HA)

12

10

8

6

4

2

0

69 05 1961 1963 1967 /1973 1975 1979 1981 1983 1987 1989 1995 1999 2001 2003 2007 2009 76/1977 92/1993 1960/ 1962/ 1964/1965 1966/ 1968/19 1970/1971 1972 1974/ 19 1978/ 1980/ 1982/ 1984/1985 1986/ 1988/ 1990/1991 19 1994/ 1996/1997 1998/ 2000/ 2002/ 2004/20 2006/ 2008/ 2010/2011 World US Source: USDA

The increasing influence of emerging economies in meeting the needs of growing populations will play a key role in supporting demand. We estimate that China, India and Brazil together account for over 50% of global nutrient demand. According to the International Plant Nutrition Institute (IPNI), China needs to more than double its annual potash applications and increase its nitrogen and phosphate use by 40 percent to properly sustain its agricultural land and maximize yields. The increase in Chinese Growing demand in emerging export duties on fertilisers from 35% to 135% in May 2008 and further to 185% in economies. September 2008 underlines how China tend to keep stable price environment and sufficient local crop supply, during strong domestic demand periods.

Figure 216: Current and Potential Fertiliser Consumption Growth Million Tons 80

60

40

20

0 Current Potential Current Potential Current Potential

N P2O5 KCL Source: PotashCorp, IPNI and Fertecon

• We expect the proportion of fertilizer consumption being driven by emerging economies to increase. Populations in these regions become wealthier, their dietary requirements increase, and this increases farming intensity. In fact, fertilizer consumption has grown by approximately 70% over the past 15 years in China, Brazil, India and Southeast Asia combined (fertecon). While this growth rate may moderate over time and despite the global economic crisis in 2009, we believe that the long-term fundamental fertilizer business drivers (population and economies expansion in the developing countries) remain undamaged. Moreover, since income will likely increase in these countries, people are expected to switch from starch-based to protein-rich diets. More meat means more grain and other feed supplements will be required to support commercial animal stocks.

150 151 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

• We expect little growth in domestic Fertilizer production in India. Constraints on Natural Gas have led to a significant rise in energy costs and a consequent lack of investment in capacity growth in the region. Therefore India will remain reliant on imports. In Brazil, fertilizer sales in 2009 were flat compared to 2008 (22.5 million tonnes). Local supply declined by 19 million tons which have led to a sharp decrease in distributors’ inventories. A combination of the recovery in the agricultural economy and low stock levels will support fertilizers consumption rebound for the coming years. • Furthermore, demand in the US and Europe in particular appears likely to continue to be supported by high grain prices and consequent healthy farm incomes. As well as growing demand for grain from emerging economies, biofuels have emerged as an additional source of demand (esp. for Corn in the US), which will likely support prices at levels well above historical averages.

Grain inventories levels are the key determinant of global grian prices. Until 2009, rising consumption was outpacing yields with the result that inventories had been declining for a number of years. This trend has reversed somewhat in 2009 due to record yields and a decline in demand. It remains to be seen whether the recent production can be maintained and how rapidly demand recovers.

Figure 217: Global Wheat & Coarse Grain Inventories. m tonnes

1000 50%

900 45%

800 40%

700 35%

600 30%

500 25%

400 20%

300 15%

200 10%

100 5%

0 0% 0 2 5 6 7 1 3 7 9 1 /89 9 9 /93 94 9 9 9 /98 /99 00 0 02 0 /04 /05 06 0 /08 0 /10 1 9/ 3/ 5/ 9/ 1/ 5/ 0/ 91/ 94/ 00/ 06/ 988 98 9 99 9 99 997 99 0 00 003 00 0 009 01 1 1 1990/91 1 1992 1 1 1 1996/ 1 1998 1 2 2 2002/ 2 2004 2 2 2007 2008/ 2 2 Production Consumption Ending stocks as % of comsumption Source: USDA

Figure 218: World Grain and Soybean Stocks Million Tons 250

200 Wheat Maize

150 Rice Soybeans 100

50

0 3 3 3 07 3 11 -0 0 -0 -0 2 05 - 8-09 2 6- 2 0- 0 4- 0-11 02 0 4-05 8-09 0 4-05 0 0 0 200 0 201 2 200 2006-07 2008-09 201 2 2004-05 2006-07 200 2010-11 2 200 200 2 200 2006-07 2008-09 2010-11 Source: Phillips McDougall, USDA.

151 152 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

An Ever-Rising Population The world’s population has more than doubled since 1950, from 2.5 billion people to 6.7 billion. Much of that growth came from Africa and Asia, where densely populated countries have significant demand for food.

Therefore, Global population growth continues to act as the principal long-term driver behind increased global demand for fertiliser. In addition, the improving dietary standards of that growing population have and will continue to place an increasing burden on available agricultural land. As people become wealthier, their dietary standards typically improve to include a greater proportion of protein. Raising animals (for example, chicken and cattle) to provide this protein in turn places greater demand on the available agricultural land in terms of required yield.

At the same time, the amount of cultivated land globally is decreasing, with the effect that less agricultural land has to provide food for more people. As outlined above, this trend is most evident currently in China. A combination of encroaching desert and the industrialization of the economy have led to decline in the land area being cultivated for grain production of 20% since 1999. Evidently, growth in demand for fertilisers is likely to be greater in those areas of the globe with higher population growth.

Figure 219: World population and arable land per capita trends to 2020 10 0.50

9 0.45

8 0.40

7 0.35

6 0.30 (bn)

5 0.25 (Hectare)

4 0.20

3 0.15

2 0.10 1960 1970 1980 1990 2000 2010E

Arable land av ailable per person (RHS) World population (LHS) Source: IFA, Worldmarkets.co and J.P. Morgan estimates

Crops for Fuel add new demand Besides food demand, the growing industry of biofuels made from grains and oilseeds is now also having an impact. World ethanol and biodiesel production increased significantly over recent years, which led to more corn, palm oil and sugar cane being used for ethanol production. World biofuel output is projected to more than double in 2010 from 2006 level by Potash Corp. For biofuels, U.S. is dominant producer, closely followed by Brazil. However, the biofuels remain a small segment of the global grain demand.

152 153 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 220:World ethanol* production Figure 221 World biodiesel* production Billion gallons Billion gallons

30 6 25 5

20 4

15 3 10 2 5 1 0 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: PIRA and Potash Corp. *for transportation fuel use only. Source: PIRA and Potash Corp. * for transportation fuel use only.

Rising crop prices support As well as the long-term (demographic) argument supporting demand for fertilisers fertiliser use (see above), short-term demand drivers may in fact play a more important role in influencing the operating performance of the fertiliser industry. Higher grain prices stimulate grain production as farmers attempt to take advantage of more favorable economics. As grain crops account for approximately 70% of fertiliser use (6% cash crops, 3% cotton, 21% other), rising grain prices tend also to lead to increased demand for fertilisers and upward pressure on fertiliser prices.

Figure 222: Crop prices (rebased to 100) 300 250 200 150 100 50 0 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Corn ($/bus) Soy bean ($/bus) Wheat ($/bus) Source: DataStream, J.P. Morgan research

Biotechnology not a major threat Owing to the likely limited availability of land suitable for cultivation, the ability of genetically modified crops to improve yields will likely provide an important component of the solution to the problem posed by the rapid population growth in a number of developing countries. However, the ability of fertilisers to significantly improve yield will likely support their continued use in conjunction with other biotech-driven solutions in our view. Therefore, we would not view the increased adoption of GM as a significant negative threat to the rate of global fertiliser consumption growth.

Fertiliser costs are small Fertilizers cost share in the total grain production costs increased from 15% in 2007- compared to total grain 2008 to 26% in 2009. However the return on investment for fertilizers application production costs. remains high as grain prices went up.

153 154 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 223: Breakdown of Grain production costs (2009) % Other 5% Labour 5% Fertilizer 26% Chemicals 5%

Seed 14%

Land 20% Pow er & Machinery 25% Source: Yara, USDA and J.P. Morgan

Figure 224: US & Global Corn yield - EXPECTATIONS REMAIN AT RECORD HIGHS (MT/HA) 12

10

8

6

4

2

0

7 3 1961 1973 1975 197 1979 1981 199 1995 1997 1999 2001 2007 / / 0/ / 1960 1962/1963 1964/1965 1966/1967 1968/1969 1970/1971 1972/ 1974/ 1976/ 1978/ 1980 1982/1983 1984/1985 1986/1987 1988/1989 1990/1991 1992/ 1994/ 1996/ 1998/ 200 2002/2003 2004/2005 2006 2008/2009 2010/2011 World US Source: USDA

Nitrogen fertiliser Introduction Nitrogen is a gas which makes up 80% of the atmosphere and is an essential nutrient for plant growth. Some plants, including legumes such as soybeans, can fix nitrogen from the air, but most take it from the soil. It must be applied to soil annually because its nutrient value is consumed during each growing season.

Nitrogen is essential for growth and development in plants. Supply of nitrogen determines a plant’s growth, vigour, colour and yield.

Production Process Nitrogen is produced by natural gas, which is synthesized with steam and air to produce ammonia.

154 155 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 225: Nitrogen Production

Carbon Dioxide Natural Gas Urea

Ammonia Air UAN

Nitric Acid Ammonium Nitrate

Calcium CAN

Potash (K) NPK

Phosphate (P)

Source: J.P. Morgan

Demand The main commercial fertilisers 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 fertilisers are anhydrous ammonia (NH3), urea [CO(NH2)2], ammonium nitrate (NH4NO3), nitric acid (HNO3) and nitrogen solutions (CAN, UAN).

Figure 226: Nitrogen fertiliser consumption by product Figure 227: Nitrogen fertiliser consumption by region MAP AME 7% Others 1% Urea 2% Amm. Sulphate 4% C&E Europe 5% 48% Cal. Amm. Nitrate C&S America 5% 4% Direct App.4% Western europe 9% DAP 5% Others UAN Asia 58% 11% 6% Amm. Bicarbonate North America Amm. Nitrate 9% 7% 15%

Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

The amount of Nitrogen depends The amount of nitrogen that farmers apply depends on soil quality, desired crop on many variables 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 five times as much nitrogen fertiliser as soybeans, but only 1.6 or 2.0 times as much as for cotton.

155 156 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Moreover, economic efficiency bears consideration. Farmers must analyze the marginal increase in crop yield provided by additional fertiliser 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.

As mentioned above, nitrogen fertiliser comes in many forms. Urea accounts for 49% of the world consumption of nitrogen fertiliser. Nitrate, Phosphate and Ammonia (CAN) and urea ammonium nitrate (UAN) solutions follow, but are significantly behind, accounting for only 9% and 6% of world nitrogen fertiliser consumption. However, Nitrates can easily be absorbed by plants and are therefore regarded as a quality fertiliser for European agricultural conditions.

While direct application of ammonia accounts for only 3% of the world nitrogen consumption, it makes up 20% of the consumption in the U.S.

There is also a considerable difference in the product mix for different regions of the world. Urea, the fastest growing nitrogen product, is particularly popular in warmer climates. Urea ammonium nitrate (UAN) is mainly used in North America, while nitrates (e.g. CAN) are mainly applied in Europe.

Figure 228: European fertiliser market : Nitrate the preferred fertiliser Figure 229: European fertiliser market: Yara the leading player DAP/MAP 2% Other 7%

Imports UAN 11% 12%

Nitrates 45%

NPK 14% Other Europe 65% Yara 23%

Urea 21% Source: IFA (2005), EFMA (2008/2009), Yara and J.P. Morgan Source: J.P. Morgan and Yara

In contrast to Phosphorus and Potassium, Nitrogen must be applied every year to maintain yield and biomass.

156 157 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 230: Nitrogen Fertiliser demand - 5 key regions

Source: Yara and IFA (2005) EFMA (2008/09)

Supply/Key players Before 2008, the nitrogen industry was affected by higher natural gas prices and rising construction costs. These conditions combined to the negative impact of the international economic crisis are making new Greenfield investment less attractive.

Yara expects a new, mid-size production plant for urea to cost about $1.5bn (compared to $500m two years ago).

The strong increase is fueled by higher equipment costs (steel) and strong demand coming from other petrochemical projects. Moreover, only a few companies have enough expertise to set up a new plant of that scale.

The Natural Gas price also plays a significant role in investment decision-making.

Replacement cost for nitrogen fertilizer Our analysis suggests if we are doing the investment of $2000m, total cost (capital cost and production cost) will be $197/mt gr of urea, assuming natural gas price of $4/mmbtu. If we do the sensitivity analysis of total cost keeping all the parameter same except natural gas prices, for every increase of $0.5 /mmbtu in natural gas price, total cost increase by 6-7%. Below Table 90 states the other assumptions we have used in our analysis.

157 158 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 90: Replacement cost for nitrogen fertilizer

Cash costs Ammonia Gas Price 4 US$ / mmbtu Gas consumption 36 mmbtu/mt NH3

Total Gas cost 144 US$/mt NH3

Other production cost 30 US$/mt NH3

Total Cash Cost Ammonia 174 US$/mt NH3

Urea Ammonia price 174 US$/mt NH3 Ammonia consumption 0.58 NH3 / my gr Urea

Total Ammonia cost 101 US$ / mt gr Urea

Process gas cost 21 US$ / mt gr Urea Other production costs 24 US$ / mt gr Urea

Total Cash production cost Urea 146 US$ / mt gr Urea

Capital Cost

Investment 2000 US$ m Capacity 1.3 m tonnes /annum Asset life 30 years

Capital cost / annum 67 US$ m Capital cost /tonne 51 US$ m

Total Cash production Cost 146 US$ / mt gr Urea Total Capital cost 51 US$ / mt gr Urea

Total cost 197 US$ / mt gr Urea Source: J.P. Morgan estimates.

Below Figure 231 illustrates IRR development at given urea prices. Our analysis suggests urea prices need to be more than $400/tn to generate IRR of more than 10%. key assumptions we are using i) $2000m capital investment over four years will create capacity of 1.3mmt of urea and ii) tax rate of 25%.

Figure 231: IRR at different urea prices 20%

15%

10% IRR (%) IRR 5%

0% 250 275 300 325 350 375 400 425 450 475 500 525 550 575 600 Urea prices ($/tn) Source: J.P. Morgan estimates.

158 159 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 91: Yara: Overview of Nitrogen supply/demand dynamics Likely influence Supply Driver Impact on supply on Prices vs 2007 Comments China Raising of export tariff Decrease Increase Govt varies export duty on fertilisers from 10% to 110% depending on domestic demand Removal/reduction of tariff unlikely given low inventory and growing population Closure of smaller players Decrease None Less efficient, unprofitable players may be forced to close due to high energy costs and domestic price caps Tightening envt regulations Decrease None Much of Chinese production based on older, less energy-efficient technology. Also some based on highly polluting Ammonium Bicarbonate. Stricter regulation may force closure of facilities Middle East Capacity growth Increase Negative Principal source of low-cost, export-orientated capacity growth. Resource (e.g. engineering) bottlenecks and competition for resources make it likely that forecast growth rates will not be met. Russia/CIS Capacity growth Decrease None Growing gas pipeline infrastructure 'de-strands' Russian gas, and limits attractiveness of its use for fertiliser. Rising input costs for FSU states, e.g. Ukraine provide margin pressure on smaller, inefficient producers. EU Capacity closures Decrease Small positive Capacity closures in 2007 decrease 'domestic' supply US Capacity closures Decrease Small positive Capacity closures (Agrium - Alsaka) in 2007 decrease 'domestic' supply

Demand Driver Impact on demand Comments China Efficient fertiliser use Decrease Small negative Inefficient/over-fertilization of Nitrogen by Chinese farmers has reduced soil fertility Balanced fertilization may reduce consumption Population growth Increase Positive Urbanization of rural communities reduces cultivated land and also increases need for greater farming efficiencies. Meat consumption Increase Positive Increased meat consumption requires increased farming for livestock feed Brazil Increased farming Increase Positive Brazilian ag economy benefiting from increased productivity and foreign investment Increased application rate Increase Positive Fertiliser application rates currently significantly lower than in US/Europe Scope for further agricultural productivity through increased fertiliser use India Population growth Increase Positive Indian population expected to grow 1.6% CAGR Farming subsidies Increase Positive Agricultural subsidies support farmers in face of increased fertiliser costs Fertiliser subsidies Increase Positive Doubling of fertiliser subsidies in 2008 to continue to feel growth US Crop rotation Decrease Negative Switch out of corn to less nitrogen-intensive crops would decrease demand Low Starting inventories Increase Positive Low inventories at the start of the application season should cushion the impact of lower domestic demand on the export market EU Postponement of set-aside Increase Positive Higher cultivated acres should lead to increased volumes Environmental applications Increase Positive Use of Urea in Heavy Duty Diesel and stationary emission reduction systems will provide additional demand ROW High crop prices/ low grain Increase Positive High crop prices encourage farming. Increased fertiliser costs may be passed on to customers given small % of total cost inventories Demand destruction Reduce Positive Significant negative impact on yield will force the majority of those who have postponed purchases back to the market in '08 Land vs population growth Increase Positive Continued emphasis on yield to support farmers Increased use of biofuels Increase Positive Limited land available for biofuel crops given debate over using land for fuel (vs. food) Key crops (rapeseed, corn) require more fertiliser per acre than others Source: J.P. Morgan

159 160 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Pricing In 2008, nitrogen prices and margins reached their peak, due to higher natural gas prices, rising construction costs, tight demand/supply fundamentals and the sharp rise of the Chinese taxes. Starting mid-2008, falling prices and the global economic downturn pushed demand down leading to temporary negative cash margins.

Figure 232: Ammonia and urea cash margins 250

200

150

100

50

0

-50 Jul-09 Sep-09 Nov -09 Jan-10 Mar-10 May -10

Ammonia cash margin - $/t NH3 Urea cash Margin - $/t Urea Source: Bloomberg, ICIS and JPMorgan.

1. Ammonia Introduction Ammonia is the basis for all nitrogen fertilisers and contains the highest amount of nitrogen (82%). It can be applied directly to the soil or further processed into urea or nitrates before application (e.g. to meet environmental standards). Ammonia is the basic building block for all of the nitrogen fertilisers.

Table 92: Ammonia at a glance Growth rate (CAGR to 2012E) 3% Current operating rate 83% Key end-markets Production of Specialty fertilliser, fertilliser for corn and wheat (US) Key demand regions Asia (50%), North America (13%), Europe (13%) Key players Yara, Terra, Agrium Market structure Top 5 producers amount to up to 14% of global capacity Key Inputs Natural Gas, Air Threats Large capacity additions in the Middle East Source: J.P. Morgan estimates.

160 161 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Production Process Natural gas, as a source of energy and hydrogen, fixes nitrogen from the air with hydrogen to create ammonia (NH3).

Figure 233: First Step: Production of Ammonia

Natural Gas (Hydrogen)

AmmonAmmonia (NH3) (NH3) Air (Nitrogen)

Source: J.P. Morgan

Natural Gas main Raw material Natural gas comprises the largest cost of ammonia production, amounting up to 75- 90% of total cost. Most of the other production costs are almost stable and therefore subject to scale advantages. Natural gas costs in North America and Western Europe have historically been much higher than in other regions. However, the gap is narrowing now. Natural gas price influences “the floor price” of nitrogen fertiliser. Moreover, global LNG activity and higher pipeline capacity into Europe might decrease the spread between low-cost producers in the Middle East/Trinidad and Western countries.

For the production of one tonne of ammonia, 36 mmbtu of natural gas are needed: a new, highly efficient plant may use natural gas in the low thirties range to produce one tonne of ammonia, the corresponding figure for old, poorly maintained plants will be in the mid forties.

Figure 234: Ammonia Production Costs $US/Short Ton Product 500

400

300

200

100

0 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00 Gas cost (€/ mmbtu) Conversion cost Source: Yara, Blue Johnson & Associates and J.P. Morgan

Since natural gas is relatively plentiful and special handling considerations for ammonia lead to high transport costs, only 13% of ammonia production was traded in 2008. Asia, led by China is the world’s largest ammonia consumer, but is largely self-sufficient. Ammonia consumption and capacity has shifted from the Western countries to Asia and South America in recent years.

161 162 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Demand Fertiliser use accounts for Fertiliser use accounts for around 85% of Ammonia demand. Other usages are as around 85% of Ammonia intermediate in the production of nylons, acrylonitrile for fibres and plastics, demand. isocyanates for polyurethanes, hydrazine and explosives.

Almost half of ammonia production is used to produce urea. It is important to highlight that urea capacity is always integrated with ammonia, as urea requires Co2 which conveniently is a by-product in the ammonia process.

Figure 235: Ammonia consumption by fertilizer end market(2006-08 Figure 236: Ammonia consumption by region (2008) average) Direct Latin America Other Application 3% Others 5% Fertilizers 5% 3% Middle East DAP/ MAP 6% 6%

Ammonium FSU 10% Nitrate 15% Asia 50% Urea 52% North America 13%

Non-Fertilizer Europe 13% 19% Source: Potash Corp, Fertecon and J.P. Morgan Source: Potash Corp, Fertecon and J.P. Morgan

Although only accounting for 3% of world consumption of nitrogen fertiliser, anhydrous ammonia comprises 20% 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, as it quickly becomes a hazardous gas under normal conditions.

Supply/Key players The global nitrogen market is less consolidated than for Potash or Phosphate, but some regions, such as Europe and the U.S., have seen significant restructuring of their nitrogen industries.

Several of the largest ammonia producers, including Agrium, Koch, PotashCorp, and CF Industries, have majority of their ammonia production based on U.S. Gulf Coast natural gas which has affected a competitive advantage in recent years. Yara International, the company formed by the demerger of the fertiliser and related operations from Norsk Hydro, became a public company in March 2004. The firm’s core business is nitrogen-based fertilisers, including ammonia, urea, and nitrates. Yara has cost-advantaged nitrogen production in the Middle East and in Trinidad as well as (high cost) production in Western Europe. The firm sells third-party-sourced phosphate and potash fertilisers to offer customers a balanced mix of fertilisers. Industry consolidation continues, with CF Industries purchasing Terra Industries in 2010.

162 163 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 237: Top Ammonia producers (MMT) 8 7 6 5 4 3 2 1 0 Yara Terra Agrium PCS Koch Source: Yara

Figure 238: Changes in Ammonia Capacity and Consumption Million Tonnes

Source: Fertecon

Pricing Ammonia prices soared in 2008 and Black Sea prices rose briefly to over $800/ton to a new record level. Prices were strong with higher gas prices in the U.S., Western Europe and the Ukraine lifting the floor price to new levels. However, things have changed in 2009 with depressed fertilizer demand. For most of 2009, ammonia prices were in the range of $200-300/tn. Now ammonia prices are picking up as the demand is improving.

We expect production capability to grow 2.0-2.5% per year in the coming years as new plants come online. The global operating rate is projected to remain in the low to mid 80s in 2010 and 2011.

163 164 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Tight nitrogen fundamentals have historically motivated capacity expansions, as new ammonia plants can be built in a relatively short lead time. Although several expansions have been proposed, high capital costs for new construction, low producer prices and weak market conditions are leading to delays in or even the abandonment of some projects.

Figure 239: Ammonia prices $/tn 1100

900

700

500

300

100 19-Apr-07 11-Oct-07 03-Apr-08 18-Sep-08 05-Mar-09 20-Aug-09 11-Feb-10 Source: ICIS

Environmental Concerns The production, distribution and sale of ammonia pose a number of special problems related to handling, transportation and storage: For example, for storage at atmospheric pressure at sea level, ammonia must be cooled down to –33°C. At higher altitudes, lower temperatures are required. Moreover, ammonia is very explosive, which requires specialized equipment and trained personnel.

Also, increasing concerns about nitrate in groundwater are affecting nitrogen fertiliser application and use.

2. Urea Introduction As opposed to ammonia with its specific, capital-intensive requirements for storage and delivery, urea is solid and, hence, relatively easy to store and handle. As a result, and due to its high nitrogen content (52%), urea is the nitrogen fertiliser of choice, accounting for 48% of global nitrogen consumption. It is particularly used in the developing regions of the world, and is traded widely in the international market. Most world output is in a solid form, either prills or granules, or crystalline for specialized small-volume uses.

Since Urea production is highly vertically integrated, only 30% of global production is traded

Table 93: Urea at a glance Growth rate (CAGR to 2012E) 3-4% Current operating rate 91% Key end-markets Fertiliser for Corn and Wheat Key demand regions China (35%), India (18%), Brazil (15%), US (8%) Key players Yara, Agrium, PCS, Terra Key Inputs Ammonia, carbon dioxide Threats New capacity in the Middle East Source: J.P. Morgan estimates

164 165 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Overview & Outlook We believe global demand for urea will continue to grow at 3-4% for at least the next three years and grow 2-3% driven by strong demand from India, Brazil, the US and Europe due to high grain prices. We expect capacity to grow at 3-4% leaving the market balanced.

Production Process 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. Typically, it takes 0.58 tonne ammonia for each tonne urea production.

Figure 240: Production of Urea

Carbon Dioxide (CO2) Natural Gas Urea (CO(NH2)2)

Ammonia (NH3) Air

Source: J.P. Morgan

Demand Urea is used in the developing regions of the world and is widely traded on international fertiliser markets due to its relatively cheap transport costs.

Figure 241: Urea consumption by region India ROW 18% US 29% 8% EU-15 5%

Brazil 3%

EU-10 China 2% 35% Source: Fertecon and J.P. Morgan estimates

Supply/Key players Since 2005 Urea capacity has grown at an average annual rate of 5% (3.3% excluding China) versus average growth of 2% (-0.2% ex China) in the period 2002- 2004. With the exception of China, all new capacity is expected in the Middle East or in other areas with low-cost gas. However, consumption increased even more, with an average growth of 5.5% over that period. (As outlined below, we exclude China on the assumption that its new fertiliser capacity will primarily be directed to the domestic market).

165 166 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Between 2008 and 2010, average urea capacity growth is likely to be 3-4%. According to Fertecon, average urea consumption growth has been 4.8% in last five years, 2.9% excluding China. Planned capacity growth is forecast to rise by 7.7% and 5.0% in 2011E and 2012E respectively. Excluding China capacity growth will be more moderate: 4.2% and 3.8% in 2011E and 2012E. However, we see most of Chinese production being retained for the own domestic market. Besides China, Pakistan, Qatar, Algeria and UAE are the other countries where new capacities are arriving.

Table 94: Urea capacity growth rate World Excluding China Driving regions 2009 5.0%(5.7%) 1.5%(2.3%) China (82%), Oman (8%) 2010 7.4%(7.7%) 4.2%(4.3%) China (67%), Pakistan (5%) 2011 7.7%(5.3%) 4.2%(3.2%) China (69%), Pakistan (7%) 2012 5.0%(3.9%) 3.8%(4.6%) China (57%), Algeria (14%) 2013 3.4%(3.3%) 4.8%(4.9%) China (22%), UAE (16%) Source: Fertecon and Yara

Exports of Urea from China have also provided a key source of supply onto the international market. The year 2007 saw significant Urea exports from China due to Government-imposed price ceilings, which meant that Chinese producers have turned to exports markets to benefit from higher prices. High international urea prices have allowed Chinese producers to absorb the export taxes and still generate a margin in excess of that available at Chinese domestic prices. However, export supply from China will likely remain limited due to the ongoing export tax regime.

Figure 242: Chinese Urea prices RMB/kg 900

800

700

600

500

400

300

200 May -07 Sep-07 Jan-08 May -08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10

Urea : Domestic Made ($/tn) Urea prilled bulk Yuzhny FOB ($/tn) Source: CEIC

166 167 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 243: China - Urea capacity growth '000 tonnes

12.00%

10.00%

8.00%

6.00%

4.00%

2.00%

0.00% 2005 2006 2007 2008E 2009E 2010E 2011E 2012E Source: Fertecon, J.P. Morgan research

Pricing In line with strong price increases in ammonia, urea prices rose by 49% in 2007 and 244% until May 2008 before it collapsed in 2H 2008.

Since ammonia is the key input for urea production, ammonia prices create the price floor for urea (ammonia price + upgrading cash costs) when the market is over- supplied. If the price for urea drops below this floor, “swing” producers will increase their ammonia production and less urea will be sold on the market.

There are two main hubs in urea trade – the Black Sea and Arab Gulf - which determine global Urea prices. The Black Sea normally supplies Europe and Latin America while the Arab Gulf supplies North America and Asia/Oceania.

Figure 244: Urea price history Yuzhny FOB - USD/Tonne 900

800

700

600

500

400

300

200

100

0 19-Apr-07 11-Oct-07 03-Apr-08 18-Sep-08 05-Mar-09 20-Aug-09 11-Feb-10

Urea($/tn) Source: ICIS

Environmental Concerns There are no serious environmental concerns around the use of urea as a fertiliser material. Unlike ammonium nitrate, urea is not explosive and does not contribute significantly to the problem of groundwater contamination by nitrates.

167 168 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Phosphate Introduction After nitrogen, phosphorous ranks second in terms of volume as a crop nutrient and component of fertilisers. Phosphate comes from ore beds rich with fossils of ancient marine life. Phosphoric acid also has several non-agricultural applications, and some producers, including PotashCorp are focusing on these markets as more profitable outlets for their ores. Examples of non-agricultural applications include detergents, dentifrice, carbonated beverages, and food ingredients.

Phosphate is important for root development and drought resistance. It is also key for plant growth and development, such as the ripening of seed and fruit.

Table 95: Phosphate at a glance Growth rate (CAGR to 2012E) 3% Key end-markets Fertiliser Key demand regions Asia (52%), N America (14%), S America (12%) Key players PotashCorp, Mosaic Key Inputs Phosphoric acid, Ammonia Threats New global production capacities Source: J.P. Morgan estimates.

Overview & Outlook During 2007 and early 2008 phosphate underpinned by rising demand and relatively tight supply. From mid 2008, prices then collapsed to a level reflecting the marginal cost of supply, but have firmed recently on improving demand.

Production Process Phosphate rock is crushed and combined with acids to produce phosphoric acid (P2O5). When the concentrated phosphoric acid has reached commercial grade, it can either be combined with ammonia, resulting in monoammonium phosphate (MAP) or diammonium phosphate (DAP) or be combined with additional phosphate rock to convert it into triple superphosphate (TSP). These three products are the principal phosphate fertilisers. Gypsum (CaSO4) is a key by-product in the production of phosphoric acid.

Figure 245: Phosphate Production

Nitric Acid TSB

Phosphate rock Phosphoric acid MAP

DAP

Sulphur Ammonia

Source: J.P. Morgan

In the U.S., Phosphate rock deposits are 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

168 169 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

reserves of phosphate rock; North Africa has over 50%; the remaining 15-20% is found in Jordan, China, Russia, South Africa, Mexico, and Israel.

Figure 246: Phosphate reserves MMT 10000

8000

6000

4000

2000

0 Africa Asia Middle East North America C&S America Others Source: SRI and J.P. Morgan

The differences in costs for Phosphate rock from location to location are relatively small and these are 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, (although Yara uses nitric feed) as the phosphate rock needs to be treated with sulfuric acid to generate H3PO4. The U.S., with its refinery-sourced sulfur, has about a $30 advantage on sulfur costs per tonne of phosphoric acid versus Morocco.

Demand The International Fertiliser Association forecasts phosphate fertiliser demand to grow at c2-3% per year.

Farmers may elect to not apply phosphorous fertilisers every year for the following 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.

Figure 247: World Phosphoric Acid Distribution Food & Industrial 9% Feed 6%

DAP 35%

Other 19%

TSP 5%

MAP 26%

Source: Fertecon, British Sulphur, PotashCorp

169 170 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 248: Phosphate fertiliser consumption by region Figure 249: Phosphate rock Demand-capacity* and Operating rate (%) Other 20% 100000 80 80000 China 31% 75 60000 70 Western europe 40000 6% 20000 65

0 60 Brazil 8% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2013E

Total Capacity Total Demand Operating Rate, % US 11% India 16% Other Asia 8%

Source: Potash Corp, IFA, Fertecon and J.P. Morgan Source: SRI and J.P. Morgan * MT of phosphoric pentoxide (P2O5)

Supply/Key players Historically, DAP/MAP production was led by the U.S., which accounted for 53 percent of world total production More recently, production has shifted to China and India, which are now producing to meet their own demand. U.S. production has shrunk to 13 million tonnes or 29% of worldwide production.

Pricing Historically, The DAP price had only covered the value of its two raw materials, phosphoric acid and ammonia, with no upgrading margin. This situation changed in 2007/08 with tightening supply/demand leading to significant production margins. Prices fell back to marginal production cost in late 2008, but are beginning once again to offer some modest upgrade margin following limited supply growth.

Figure 250: DAP-fertiliser prices Figure 251: Sulphur prices ($/tn) $/ton $/ton

1400 180 1200 160 1000 140

800 120

600 100

400 80

200 60 0 40 19-Apr-07 25-Oct-07 02-May -08 30-Oct-08 30-Apr-09 29-Oct-09 06-May -1 20

0 Jan-09 Mar-09 May -09 Jul-09 Sep-09 Nov -09 Jan-10 Mar-10 May -10 Jul-10

Source: Fertecon, J.P. Morgan Source: ICIS

Potash Introduction The third-largest fertiliser in terms of consumption, potash (mostly in the form of potassium chloride-KCl) comes, like phosphate, from mineral reserves. Potash is mined from underground ore bodies that contain minerals left behind by evaporated seas. Therefore production costs are affected by geological conditions like ore depth, K2O content, ore thickness and other.

170 171 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 96: Potash at a glance Growth rate (CAGR to 2012E) 3% Key end-markets Corn and Soybean Fertiliser Key demand regions Asia(38%), N America(19%), S America(16%) Key players PotashCorp, Belaruskali, Mosaic Market structure Top 1 producer (PotashCorp) holds 75% of global capacity Key Inputs Ore from mine Threats demand destruction through high prices Source: J.P. Morgan estimates

Production Process Potash is mined from ore bodies under the ground that contain mineral salts left behind by evaporated seas.

Currently, only 12 countries have meaningful potash deposits (mainly Canada, Russia and Belarus), while potash is consumed in more than 150 countries, with Asia and North America being the largest consuming areas. Therefore, almost 80 percent of production is traded across borders.

Figure 252: Potash Production Ore from mine Size reduction Remove Floatation to Clay Separate potash From salt Wet potash Concentrate

Sizing Dewatering &Drying

Dry Crystallization Compaction concentrate

Soluble or industrial Granular Standard Solid/Liquid fertilizer Solid fertilizer Solid fertilizer Industrial Source: PotashCorp

Figure 253: World Potash reserves MT of K2O 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 - N America Former USSR W Europe S America Middle East Others Source: SRI and J.P. Morgan

Demand The International Fertiliser Association forecasts potassium demand to grow at 3-4% per year.

171 172 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Potassium aids photosynthesis rates, fruit formation, and winter hardiness, and disease resistance, 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.

Unlike phosphate or the varieties of nitrogen fertilisers, 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.

Figure 254: Potash consumption by region Rest of the World West Europe 13% 12%

North America 18%

East Asia 29%

Latin America South Asia 16% 12% Source: Potash Corp, IFA and J.P. Morgan Supply/Key players Potash supply is extremely concentrated, with the top 13 global producers controlling almost 90% of global capacity. Supply is kept in line with demand and unproductive capacity is kept idled.

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 better than the 75% figure in 2010 would imply.

However, demand has recovered less quickly from 2008/09 downturn than for the other nutrients as the producers have tried to maintain prices well above the cost of production.

Figure 255: World Potash Producers (Total: 39.5 Million Tons KCI 2009) Million tons Belaruskali 11% Others 25% ICL 11%

Agrium 2% Silv init 9% APC 4%

K+S 6% Potas Corp 9% Uralkali 7% China 8% Mosaic 8%

Source: Potash corp, IFA and Food and Agriculture Organization of the United Nations

172 173 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

According to SRI, Potash demand grew by 3% CAGR from 2002-2007. In the same period, capacity grew by 2%. SRI estimates Potash demand to grow by 3% CAGR until 2011, whereas capacity growth is estimated to be 2% CAGR. Pricing The more consolidated nature of the potash industry has led to a somewhat different pricing development versus the other nutrients. Following the 2007/08 spike, producers have battled to maintain prices at record highs (especially relative to other nutrients) with the result that demand declined significantly. Nevertheless, prices remain well above both historic levels and also above the marginal cost of production (J.P. Morgan Cazenove forecast $230/tn). Figure 256: Potash prices (MOP) $/tn 900

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100

0 19-Apr-07 11-Oct-07 03-Apr-08 18-Sep-08 05-Mar-09 20-Aug-09 11-Feb-10 Source: ICIS

World potash deliveries declined by c50% in 2009 as buyers used up inventories and cut applications. An analysis of world supply/demand for 2010 indicates that the world market will remain well supplied for a number of years.

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, relative to history 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. Agrium and Mosaic also have low-cost expansion projects under review.

173 174 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Agricultural Chemicals

Today's modern farming relies on agricultural chemicals to increase both the level of production and also to maintain the quality of the final product.

The overall agricultural market can be divided into Agrochemicals and Seeds. Agrochemicals can then be divided into Crop Protection chemicals and Non Crop chemicals (not related to crop cultivation). The main agrochemicals are Herbicides, Insecticides and Fungicides. Seeds divide into conventional and biotech Seeds.

Figure 257: Agribusiness- Overview Agribusiness

Agrochemicals Seeds

Herbicides Conventional Seeds

Insecticides Biotech Seeds

Fungicides

Source: J.P. Morgan

Crop Protection is by far the largest market within agrochemicals; while Agricultural Biotechnology has the highest growth rates (see below).

The major long-term factors affecting the crop protection market are; commodity prices (maize, soybeans, wheat or rice), because of their direct impact on farm incomes and the uptake of biotechnology, predominantly in the Americas.

According to Phillips McDougall estimates, during 2009, the global market for agrochemical products for crop protection sector decreased by 6.5% to reach $37,860 m, while the market for the use of products in non-crop situations and agricultural biotechnology increased by 3.6 % and 15.5% to $5860 m and $10,570 m, respectively.

In many countries, access to and use of agrochemicals is highly regulated: Government-issued permits for the purchase and use of approved agrochemicals may be required, and significant penalties can result from misuse, including improper storage resulting in spillage or contamination.

174 175 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 97: Agrochemicals- Market Performance Global sales in $ million 2008 2009 % change Crop Protection Chemicals 40,475 37,860 -6.5% Non-Crop Agrochemicals 5,655 5,860 3.6% Total Agrochemicals 46,130 43,720 -5.2% Agricultural Biotechnology 9,150 10,570 15.5% Total market 55,280 54,290 -1.8% Source: Philips McDougall

Table 98: Global agrochemical market share by product (2007) US$ '000 Market Breakdown Market size Herbicide Insecticide Fungicide Other CCP Non-Crop Agchem Ag Biotech Total NAFTA USA 3914 1245 632 286 6077 1930 8007 4998 13005 Canada 877 56 118 12 1063 195 1258 367 1625 Mexico 140 117 100 10 367 50 417 3 420 Other 0 0 0 0 0 0 0 0 0 Total NAFTA 4931 1418 850 308 7507 2175 9682 5368 15050

LATAM Brazil 1813 1130 1092 106 4141 165 4306 413 4719 Argentina 510 146 127 18 801 60 861 802 1663 Colombia 150 72 94 8 324 18 342 1 343 Other 414 241 214 35 904 92 996 59 1055 Total LATAM 2887 1589 1527 167 6170 335 6505 1275 7780

Europe France 1000 274 1273 112 2659 210 2869 2869 Germany 785 120 680 88 1673 175 1848 1848 Italy 295 260 357 40 952 70 1022 1022 Spain 279 239 198 73 789 50 839 5 844 UK 355 80 263 31 729 102 831 831 Poland 254 40 164 9 467 27 494 494 Russia 256 31 79 5 371 38 409 409 Hungary 173 47 90 4 314 25 339 339 Netherlands 108 57 113 9 287 40 327 327 Other 1385 250 623 69 2327 248 2575 2 2577 Total Europe 4890 1398 3840 440 10568 985 11553 7 11560 42% 12% 33% 4% 91% 9% Asia Japan 822 982 823 85 2712 635 3347 3347 China 620 645 356 35 1656 275 1931 164 2095 India 275 416 139 6 836 180 1016 385 1401 S Korea 146 222 204 21 593 80 673 673 Australia 310 109 45 15 479 125 604 23 627 Other 723 596 175 45 1539 330 1869 7 1876 Asia Total 2896 2970 1742 207 7815 1625 9440 579 10019

M East / Africa 511 641 146 32 1330 245 1575 46 1621

WORLD 16115 8016 8105 1154 33390 5365 38755 7275 46030 Source: Philip McDougall

175 176 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 99: Global agrochemicals market share by company Syngenta Monsanto Bayer BASF DuPont Dow NuFarm MAI Others NAFTA USA 19% 14% 13% 10% 8% 12% 4% 3% 16% Canada 19% 17% 19% 8% 7% 7% 7% 4% 13% Mexico 27% 8% 22% 5% 3% 6% 0% 2% 27% Other Total NAFTA 23% 17% 16% 11% 9% 13% 5% 4% 1%

LATAM Brazil 18% 9% 14% 11% 7% 6% 5% 6% 24% Argentina 18% 34% 9% 6% 3% 6% 0% 3% 22% Colombia 13% 13% 18% 13% 8% 13% 3% 13% 10% Other Total LATAM 22% 15% 18% 13% 8% 12% 4% 8% 1%

Europe France 18% 4% 26% 16% 4% 6% 0% 3% 23% Germany 18% 4% 19% 23% 7% 3% 3% 6% 17% Italy 17% 3% 20% 12% 6% 7% 0% 0% 35% Spain 19% 4% 23% 13% 5% 9% 2% 6% 19% UK 18% 6% 20% 18% 10% 6% 5% 5% 12% Poland 11% 3% 22% 17% 12% 6% 0% 9% 20% Total Europe 19% 5% 27% 16% 6% 7% 3% 3% 13%

Asia Japan 6% 0% 9% 0% 0% 0% 0% 0% 85% India 16% 5% 12% 3% 6% 8% 0% 0% 50% S Korea 9% 0% 9% 0% 0% 0% 0% 0% 82% Australia 10% 0% 8% 0% 3% 7% 57% 6% 9%

Asia Total 11% 5% 13% 4% 4% 6% 7% 2% 49%

M East / Africa 19% 4% 28% 5% 3% 3% 2% 3% 32%

WORLD 18.8% 9.7% 19.2% 11.1% 6.2% 8.8% 4.7% 3.9% 18% Source: Philip McDougall

Amongst the major regions, only two countries reported a positive growth in the conventional agrochemical Market in 2009 in USD terms: Australia (+30.3%) and Japan (+8.2%). This is due to a favourable currency exchange impact combined with a higher rainfall in Australia and increased agrochemicals prices in Japan.

However, in the other leading countries agrochemicals market was negatively affected by weak economic conditions worldwide, a decrease in crop commodity prices, reduced glyphosate prices – mainly due to the Chinese oversupply- and a negative currency exchange impact. Brazil and Argentina suffered very dry weather conditions during crop season.

176 177 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 258: Crop Protection Market by Region- 2009 Figure 259: Crop Protection Market Growth 2009-2014E CAGR Rest of the World 17% NAFTA 17% 3.0% 2.5%

AME 3% 2.0%

1.5% Latin 1.0% America Europe 26% 0.5% 17% 0.0% NAFTA Europe Asia Latin America AME Asia 20% Source: Philips McDougall Source: Philips McDougall

Figure 260: Crop Protection Market by Application- 2009 Figure 261: Crop Protection Market by Crop- 2009

Sugarbeet 2% Others 3% Cotton 5% Rape 3% Sugarcane 3% Rice 9% Insecticides Sunflow er 1% 25%

Others 10% Fruit and Herbicides 46% v egetables 27%

Soy bean 10%

Fungicides Maize 12% 26% Cereals 18%

Source: Philips McDougall Source: Philips McDougall

The key influencing factors in the crop protection market in 2009 were: lower crop commodity prices, a strong decrease in glyphosates prices the global economic crisis and bad weather conditions (except in Australia). These conditions impacted global crop planting; global wheat (+0.6%) and soybeans (+5.7%) areas enlarged while maize (-1.1%), rice (-2.1%) and cotton (-1.1%) declined. However, maize and sugarcane demand for biofuel production increased.

177 178 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 262: Commodity Prices 2005-mid 2010 Rebased at100% on the 01/01/2005

400%

350%

300%

250%

200%

150%

100%

50%

0%

4 5 5 5 5 6 6 6 6 7 7 7 7 8 8 8 8 9 9 9 9 0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -1 ec ar n p ec ar n p ec ar n p ec ar n p ec ar n p ec ar D M Ju Se D M Ju Se D M Ju Se D M Ju Se D M Ju Se D M

CORN SOYBEAN WHEATH Source: Datastream

Table 100: U.S. Grower's Planting Inventories acres in million 2008/09 2009/10 % Change Feed Grain & Corn 101.8 100.1 -1.7% Wheat 63.2 59.1 -6.5% Rice 3 3.14 4.7% Soybeans 75.7 77.5 2.4% Cotton 9.47 9.15 -3.4% Source: USDA

Outlook Agrochemical consultant Phillips McDougall expect the conventional agrochemicals market to grow by 2%/ year in the next 5 years while the agricultural biotechnology market is expected to increase by 4%/ year, in 2009-2014E.

The crop protection industry normalized in 2009 after exceptional growth in 2008. The growth of the crop commodity prices and the crop protection market value was constant through 2006, 2007 and 2009, if 2008’s exceptional numbers are not considered. In 2010, market growth is expected to remain steady (1.5% in constant dollar terms), globally.

In 2010, Latin American crop protection market will grow positively in spite of the pressures due to the glyphosate inventories issue and to the drought experienced in South Argentina. A crop prices improvement and a weak Real versus US dollar will contribute to this growth.

The agricultural market in EU-15 will likely remain flat as an increase in crop prices is limited. However in Emerging Europe, thanks to better credit market conditions, the farm economy is expected to improve this year.

178 179 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

In the USA we expect lower glyphosate prices, a decline in the corn fungicides sector inventories against wider demand increase. The combination of these factors will still likely to have a positive impact on the US crop protection market.

Asia has proved resilient in 2009 despite difficult conditions (low prices, pest pressure, drought in Vietnam and Southern China, etc). Japanese agrochemicals market value will benefit from the 2009 price increase, while Australian exports may suffer unfavourable currency exchange rate.

Table 101: Agrochemicals- Company sales less GM, conventional seed and biotechnology (2007) $ million NAFTA Latin America Asia Europe AME Total Herbicides Insecticides Fungicides Others Bio-Tech Syngenta 2695 2040 1283 2889 324 9231 3881 1963 3142 245 yes Monsanto 2233 1450 650 905 95 5333 5260 -- 18 55 yes MAI 424 670 262 921 58 2335 1320 510 415 90 Du Pont 869 585 361 768 57 2640 1420 502 607 105 Dow 1485 895 580 1060 45 4065 2680 745 430 210 Bayer 1736 1511 1337 3620 478 8682 2717 3291 2501 173 yes BASF 1163 1103 464 2166 95 4991 1674 910 2287 120 yes Source: Philips Mc Dougall Herbicides Herbicides are by far the most important agrochemical, accounting for about 47% of the global agrochemicals market. They are used to prevent or inhibit weed growth and thus replace or reduce the need for manual and mechanical weeding.

Weeds, when growing within a crop, compete for nutrients, water and light and interfere with growing and harvesting operations. Without weed control, crop yields can be significantly reduced or crops may even fail. Because they reduce the need for cultivation, herbicides can also help prevent soil erosion and water loss.

Herbicides can be divided into two categories: • Selective herbicides: Selective herbicides act on specific targeted plant species only, without damaging other species. • Non-selective herbicides: Non-selective herbicides act on all vegetation with which they come into contact.

The non-selective products have taken market share from the selective herbicide class as sales of seeds with engineered resistance to certain non-selective herbicides (especially Roundup) increased. Plants resistant to a certain type of non-selective herbicide spray therefore allow this herbicide to be sprayed even when the plant has emerged without damage to it. Future growth of selective herbicides will therefore be dependent on the acceptance of biotechnology outside of the Americas. GM herbicide-tolerant crops have a particular negative effect on the selective herbicide sector.

179 180 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

However in recent years two major developments have negatively influenced the non selective herbicide market:

I. Increasing weed resistance (tolerance) to non selective herbicide has meant that farmers are forced to selectives. II. Supply growth (majority in China) has placed significant downward pressure on pricing.

The overall market for Herbicides was $17,527m in 2009, an 8.2% decrease versus 2008. Four major reasons drove this evolution. Firstly, a sharp decline in the glyphosate prices resulting from Chinese oversupply. Secondly, a fall in herbicides prices in Latin America and Asia. Thirdly bad weather conditions in Brazil and Argentina. And finally, a diminution in European cereal crops planted area.

Herbicides are expected by Philips McDougall to grow by 2.2% per year until 2014.

Figure 263: Leading Herbicides by value- 2008 Figure 264: Herbicide Market by Crop- 2008 Maize 18%

Others Others 44% 41% Soy beans 11% Gly phosate 56%

Fruit and Vegetables 11% Cereals 19% Source: PhilippsMcDougall and J.P. Morgan estimates Source: Philips McDougall

180 181 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Fungicides Fungicides prevent and cure fungal plant diseases that affect crop yields and quality. They may have protectant activity, being applied before an attack and preventing infection. Others can have eradicant activity, being able to kill the pathogen a short time after infection has taken place, but before disease symptoms are seen. In some cases, both types of activity may be present.

The main markets for fungicides are fruit and vegetables, cereals and rice.

According to Philips McDougall, the market for Fungicides amounted to $9,726m in sales in 2009. They expect the market to grow by 1.1% until 2014. In 2009, it had experienced a decline of 6.5% on 2008, a reverse trend compared to the last ten years where fungicides were Agrochemicals growth leader. This decline is mainly due to a high distributors' inventories level, dry weather in key regions, and a drop in crop prices during the planting season.

In 2010, fungicides demand is being supported by rainfalls in South of Brazil and in North Argentina (leading to high soybean disease, thus increased fungicides’ consumption).

Figure 265: Leading Fungicides- 2008 Figure 266: Fungicide Market by Crop- 2008 Azoxystrobin Rice 15% 6% Soy bean 8%

Others Py raclostrobin Non crop 42% 11% 11% Others 53% Mancozeb 9% Cereals Triflox y strobin 22% Epox iconazole Tebuconazole 8% 7% 8% Source: Philips McDougall Source: Philips McDougall

181 182 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Insecticides Insecticides are used to control chewing pests (such as caterpillars or greenfly) and sucking pests (such as aphids), which, in common with diseases, reduce crop yields and quality. Insecticides help minimize this damage by controlling insect pests, many of which can be potentially devastating.

Insecticides also play an important role in Public Health, targeting insects that spread debilitating diseases (such as mosquitoes, which carry malaria).

The insecticide market was estimated at about US$9,411 in 2009 by Phillips McDougall. Insecticides declined by the smallest rate amongst the three agrochemicals. It took advantage from the seed treatment expansion (eg: Thiamethoxam, Clothianidin, etc where seed is coated directly with the chemical) and new products entering the market (eg: Spinetoram, Flubendiamide, etc). Bioengineered seeds that provide insect control using Bt genes have gained share at the expense of conventional insecticides (especially in crops). Further penetration of such genetically modified organisms is anticipated.

Insecticides are expected to grow by 1.7% per annum until 2014.

Figure 267: Leading Insecticides- 2008 Figure 268: Insecticide Market by Crop- 2008

Imidacloprid 18% Fruit & Others 23% Vegetables 29%

Thiamethox a Others 45% m 13% Maize 10%

Chlorpyrifos 9% Fipronil 8% Rice 11% Non-crop 16% Clothianidin Cotton 11% 7% Source: Philips McDougall Source: Philips McDougall

Seeds and GMOs See can be split into two categories: conventional and GMO (biotech). Agrochemical consultant Philips McDougal expects $16,160m of sales for the conventional seeds industry in 2009, which represents a 4.2% decline compared to 2009. 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 genetically modified seeds (GMOs), whose genetic structure has been altered to enhance the properties of the crop. The first GM field crops were introduced in 1996 and since then this market has seen rapid growth:

182 183 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

The market increased by 15.5% to reach $10,570m in 2009. A combination of GM crop varieties market development, a geographical development of the technology and an increased consumption of premium priced stacked trait of Maize in North America contributed to the GM market improvement. The biggest growth has come from roundup (glyphosate herbicide tolerant)-ready varieties, which are mainly cultivated in the USA, Argentina and Brazil. Smaller markets are Paraguay, Canada, Mexico and Uruguay. The major crops affected by this technology are maize, soybeans, cotton and canola.

However, although the Americas have a high adoption of GM crop varieties, it is apparent that there is room for significant expansion on the current GM crop varieties in a number of Countries. Europe in particular is still reluctant to adopt GM crops.

Over the next five years, Phillips McDougall expects GM input market to evolve by 4% in real terms and commercially stacked trait varieties of maize and cotton to represent the most important share in the GM market.

Figure 269: Global production of Roundup-Ready Soybean Figure 270: USA share of GM Maize in Maize Crop area million acres 100% 200 80%

150 60%

40% 100 20% 50 0% 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Philips McDougall Source: Philips McDougall

Figure 271: Global GM Crop Market by traits- 2009 Figure 272: GM Crop Market by Crop (Total $10.6bn)

Canola 2.3% Others 0.5% Stacked Gene Cotton 7.8% 37.7%

Herbicide Tolerant 51.3% Maize 47.9%

Soy beans 41.5% Insect Resistant 11%

Source: Philips McDougall Source: Philips McDougall

Focus on Seeds R&D One of the key industry trends has been the increase in the proportion of the R&D budget that is devoted to the seeds sector.

From 2000-2008 the overall level of R&D expenditure by the15 agrochemicals leaders has grown by about 5.4% per year to $5,118m, whereas expenditures for R&D in the seeds sector grew by 9.1%.

183 184 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Inventing new products is the key method of achieving growth above market share and to be able to gain pricing power and to gain from scale effects. Overall, about 7% of global sales are spent on R&D.

Monsanto is currently the leading company in seeds and seeds technology, with more than 95% of the R&D budget spent only on seeds and traits. The company introduced Roundup-Ready (RR) varieties of cotton, soybean and maize and as well as insect resistant varieties of cotton and maize. The company is also licensing the use to derived traits.

The second largest company both in R&D spending and in revenues is DuPont.

GM seeds’ and traits’ share in Major players R&D expenditure is growing rapidly, compared to that of agrochemicals, as it represents a bigger potential growth both in volume and in value; In 2009-2014, Phillips McDougall expects conventional seeds market to grow at 1.8% versus Ag-Biotech at 4%.

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.

Figure 273: Total R&D expenditure by Leading Agrochemical Figure 274:Leading Agrochemicals: Agrochemical and seeds R&D Companies Expenditure 2008 $ million $ million

6,000 1200

5,000 1000

4,000 800

3,000 600

2,000 400 200 1,000 0 0 Bayer Syngenta BASF Monsanto Dow DuPont 2000 2001 2002 2003 2004 2005 2006 2007 2008 Agrochemicals Seed and Traits Agrochemicals Seed and Traits

Source: Philips McDougall Source: Philips Mc Dougall

DuPont (rank #2) has strong 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 rival in order to keep its corn and soybean seeds competitive). However, DuPont is also developing output traits, some of which are similar to those being developed by Monsanto. DuPont also continues to discover new crop protection chemicals and moves downstream into commercializing new soybean- based food ingredients.

BASF estimates the projected market value for biotech traits to be $50 bn in 2025, from around $7 bn in 2008, with yield as the major market. The company has a seeds R&D bundled in Seeds business in a joint venture with Monsanto with the first product launch, drought-tolerant corn, targeted for 2012.

184 185 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 275: Global market for biotech traits in 2025 Figure 276: BASF Monsanto JV pipeline Market value in billion $

Source: BASF Source: BASF

Table 102: Corn Trait opportunity, according to Monsanto in millions of acres Glyphosate Tolerant Corn Borer resistant Corn Rootworm resistant Stacked traits in millions of acres 2007-2010 2007-2010 2007-2010 2007-2012

United States 80 60-70 45-55 50-65 Brazil 15-20 15-20 5 15-20 Argentina 9 7 5 5-7 India 6 6 - 5-6 EU 27 24 8 5 15-20 134-139 96-111 60-70 100-118 Source: Monsanto

Table 103: Cotton and soybean traits opportunity according to Monsanto in million of acres Cotton Cotton Soybeans in millions of acres Glyphosate Tolerant Bollworm resistant Glyphosate Tolerant United States 8-11 7-11 65-70 Brazil 3 2 50-60 Argentina 0 0 40 India 15-20 15-20 0 EU27 0 0 1 South Africa 15 15 2 Australia 0.5-0.8 0.5-0.8 0 29-39 24-31 156-171 Source: Monsanto

.

185 186 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

The industrial Gases industry

Introduction The industrial gases industry supplies a variety of different gases to a broad range of industrial and consumer end markets. The largest end users are the steel, chemicals, electronics, and refining industries.

The industry is exposed to a variety of strong structured growth drivers as the uses for these gases increases. Currently, the energy industry, the electronics industry and the healthcare industry all offer varying long term growth prospects.

Since the early 1990s, consolidation has trimmed the number of global major industrial gas companies from ten to four, which today account for roughly 67% of the industry’s sales.

Recently, Taiyo Nippon acquired K- Air India gases for $50mn. There has been a some bolt on acquisitions by Air Liquide in recent past (H-Plus SGS for an undisclosed amount, AMCO-GAZ for an undisclosed amount, Medions Homecare for $6.3mn but deal is stil pending, DinnoSante for an undisclosed amount). However the bigger pending transaction is the Air Products- Airgas deal where Air Products is currently offering $6.6bn.

Table 104: Latest mergers in the Industrial Gases Industry Year Acquirer Target Size in $bn 2007 Air Liquide Lurgi Engineering 0.2 2007 Linde Malaysian Oxygen Bhd 0.3 2006 Linde BOC 15.0 2004 Air Liquide Messer Griesheim 3.3 2001 Allianz/Goldman Sachs Messer Griesheim 1.9 2000 Linde AGA 3.5 1986 Air Liquide Big three 1.0 Source: Company reports, Bloomberg and J.P. Morgan estimates. Announced deals more than $100mn

Further significant moves seem unlikely, as they would almost certainly encounter anti-trust obstacles. The four major players hold relatively stable market shares, and recently demonstrated greater focus toward profitability and returns than towards market share gains.

186 187 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 277: Global Industrial Gases Market—Breakdown by Revenue (2009) Others Air Liquide 23% 21%

Messer 2%

Airgas 4% TNSC Linde 4% 19%

Air Products 13% Prax air 14% Source: Gasworld.

Emerging markets are the key region for future growth, and all major industrial gas companies have made substantial investments in regions outside of North America, Western Europe and Japan over the past five years. Investment was particularly high in China, where all four big players have formed new joint ventures. Linde has announced joint ventures with China Petroleum, Flowserve Corporation in China in the recent past. For Air Liquide, 80% of new start ups are in emerging economies, particularly China, in 2010.

The Chinese industrial gas market is expected to double in value in the next 5-7 years due to strong demand from the local chemicals and steel industry. India and the Republic of Korea show similar growth (also driven by strong steel demand) and are expected to double their consumption volume during this time as well.

Figure 278: Industrial Gases - Historical Sales € million (US-companies in €) 14000 12000 10000 8000 6000 4000 2000 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Air Liquide Linde Praxair Air Products Source: Company reports, J.P. Morgan estimates

Table 105: Industrial Gases portfolio split- 2009 Air Liquide, Linde in € million, Praxair and Air Products in $ million Gases in % Engineering & others in % Total Air Liquide 10,180 85% 1796 15% 11,976 Linde 8,932 80% 2.311 20% 11,211 Praxair 8439 94% 517 6% 8956 Air Products 6184 75% 2072 25% 8,256 Source: Company reports

187 188 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Industrial Gas companies are treated as defensive Despite the significant upcoming growth drivers, the industrial gases industry is still treated as defensive. The main reasons for that are:

• the on-site business with its long-term “take or pay” contracts • Key product areas like food and beverages, healthcare and also environmental applications are less exposed to GDP. These end markets comprise approximately 40% of demand for gases. • Raw material costs (up to 90% electricity) are contractually passed through in the on-site business.

The strong consolidation in the industrial gases industry should allow higher levels of price discipline over the long term – however, much depends on the particular structure in the regions and the relevant market leader.

Because of its reliance on long-term contracts for a significant proportion of its revenues, the gases industry has always enjoyed relatively strong growth and lower cyclicality. On average, volumes have grown at around 1.5-2.0 times GDP globally, with more mature markets such as the United States 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 in recent years than had been the case in the late 1990s.

Figure 279: Industrial gases - high and resilient EBIT margins 25%

20%

15%

10%

5%

0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Air Liquide Linde Air Products Prax air Source: Company reports

We estimate that global industrial gases volumes should grow by growth rate of 6- 8% over the next few years. As well as the broadening base of applications, a key driver of growth in developed markets has been the desire of customers to "out- source" the production and supply of their industrial gases needs. This has allowed the customers to commit their capital in their core business. The steel industry was the first key end market to begin to outsource the provision of gas in the 1970s. This has been followed by the chemicals industry and more recently by the oil refining and energy industries.

188 189 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Still a significant proportion of the potential customer base has yet to adopt this "over-the-fence" model, especially in emerging markets, and this offers further growth opportunities.

Table 106: Industrial Gases—Major Participants’ End Markets- 2009 Air Liquide Air Products Linde Praxair Average Healthcare 18% 7% 11% 12% 12% Electronics 9% 15% 5% 9% 9% Chemicals/ Hydrogen/ Energy 36% 41% 22% 23% 31% Food & Beverages 4% 3% 8% 7% 6% Metal Production 9% 25% 37% 37% 27% Others 25% 9% 17% 11% 15% Source: Company reports and J.P. Morgan estimates.

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 also comprise significant markets, and while these gases are to be found in the atmosphere, commercial quantities of these gases are manufactured directly or produced as by-products from other chemical processes.

Overall, Oxygen and Nitrogen dominate the market, generating around 50% of overall sales.

Figure 280: The principal components of Air Figure 281: Industrial gas market by product value % Carbon diox ide Argon 9% Acty lene Argon Helium 12% Oxygen 0.93% 0.0005% 8% Krypton 20.95% Others 0.0001% Nitrogen Other Xenon 7% 0.0024% 0.00001% 21% Nitrogen Hy drogen 78.09% Neon 6% 0.0018% Carbon Dioxide Specialty Gases 0.03% 6% Helium Ox y gen 2% 29% Source: SRI and J.P. Morgan Source: SRI

189 190 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Air Separation Technology Air separation plants produce the atmospheric industrial gases nitrogen, oxygen, carbon dioxide and argon using air and electrical power as raw materials. While there are variations in process details, reflecting desired product mix and other factors, all air separation plants employ one of two types of process technology:

• Cryogenic plants - Produce gas (and liquid) products using very low temperature distillation to separate air components and achieve desired product purities. • Non-cryogenic plants - Produce gaseous products with near-ambient temperature and use differences in properties such as molecular structure, size and mass.

Choosing the optimum industrial gas production system for a particular application requires consideration of many variables:

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

Purity. Non-cryogenic 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 on-site plant). If a gas supply is an essential process requirement, as it usually is, an on-site 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.

Irrespective of the 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.

Capital intensity on new projects varies significantly between the business lines: Production of air gases in large industries is highly capital-intensive due to high investments in pipeline networks and high capacity plants.

Table 107: Capital intensity of industrial gas businesses Gas business Capital required to generate €1 of sales (€) Onsite Air gases 2-3 Industrial Merchant 1.5-2 Hydrogen and Cogeneration 1-1.5 Electronics and Healthcare 1.0 Source: Air Liquide

190 191 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Cryogenic Air Separation Cryogenic systems 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. Cryogenic processes are the most cost-effective separation process for producing at high production rates and are capable of making the highest purity products

Figure 282: Cryogenic Air Separation Distillation column

Gas Gas

CO2 and water removed Heat Exchanger system

Air cools Compressed & further as it is Air Vapor recycled or Heat removed passed through eliminated as waste by water or an expansion AIR refrigerant turbine to Liquid Liquid systems reduce Liquid air withdrawn for Reboiler / pressure distillation / separation condenser

Source: SRI and J.P. Morgan

The process begins with the intake of huge volumes of air from the atmosphere. The air is compressed and purified before entering the cryogenic equipment package. The air is cooled to about -300°F (-185°C) and then, relying on different boiling points, separated into its elemental components in the form of liquid oxygen, argon and nitrogen.

Non-Cryogenic Air Separation Several types of non-cryogenic air separation processes have been commercialized over the past 25 years or so. Many relatively small volume users of oxygen or nitrogen find that non-cryogenic processes offer a convenient and economical alternative to purchasing gas in high pressure cylinders or buying bulk liquid products to be vaporized to meet demand.

Non-cryogenic air separation processes are most likely to be a suitable and cost- effective choice when high purity product is not required and/or when the required production rate is relatively small.

191 192 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Distribution The supply of industrial gases typically takes place via one of three broad methods— on-site/pipeline, merchant/bulk and cylinder delivery—each attracting different margins and capital requirements.

Onsite/Pipeline 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 is 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.

To improve returns, many on-site 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.

Bulk/liquid 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 kilometers from the plant.

Cylinder 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 on-site levels, meaning that respectable returns are possible, particularly if cylinder rentals are included.

The large integrated gas producers tend to reduce their direct involvement and independent distributors - who buy merchant gas in bulk liquid form from the producers and then package it - become more important for the industry.

The cylinder segment is still the largest distribution channel, but producers are shifting more and more to pipeline distribution since that involves more stable and higher returns and has led the industry to be treated as defensive by investors.

192 193 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 283: Industrial gas market by distribution channel % Onsite/Pipeline 22%

Merchant Specialty gas 30% 10%

Cy linder 38% Source: SRI, company data

Table 108: Industrial gases – indicative contract length estimated contract length Air Liquide Linde Praxair Air Products On-site 15-20 years 40% 30% 28% 41% Bulk/merchant c. 1-5 years 25% 30% 34% 59% Cylinder < 1 year 35% 40% 37% - Source: Company data and J.P. Morgan estimates.

Cost structure Capital costs are significant within the industry because of the scale of plants and infrastructure needed (e.g. pipelines). Moreover, high operating costs are very dependent on power prices and transport costs. Power and gas costs are very high in the industry and can amount to up to 60% of overall production costs. In most cases, energy cost increases in the on-site business are passed through to customers via indices published by industry associations. Approximately 50% of bulk contracts are indexed as well, with the remainder priced in individual arrangements with customers. Standardization and better cost management have also led to improving returns.

Figure 284: Cost structure of a typical gas business % Capital costs Labor costs 20% 15% Logistics & Transport 30%

Energy & Electricty 35%

Source: Air Liquide

193 194 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 285: Capex/sales 1990-2009 25%

20%

15%

10%

5%

0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Air Liquide Linde Air Products Prax air Source: Company data, J.P. Morgan Capital expenditure in the industry decreased again from their peaks in the mid 1990s when companies invested strongly in new (and less defensive) merchant technology (particularly in the US). However, in the recent years, there is not much increase in capital expenditure. This time, most of the investment can directly be linked to investments in the onsite business. We believe only about 5-10% of sales is dedicated to maintenance capex, the remainder is dedicated to growth.

Figure 286: ROIC 1990-2009 14% 12% 10% 8% 6% 4% 2% 0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Air Liquide Linde Air Products Prax air Source: Company data, J.P. Morgan

New opportunities LNG (Liquefied Natural Gas) Natural gas is expected to replace petroleum as a cleaner and more economical energy carrier in the coming years. Also, with increasing energy prices and decreasing crude oil reserves, natural gas is becoming more important as an energy source as it has reserves should last longer than those of crude oil.

LNG (liquefied natural gas) is natural gas that has been converted to liquid form. By cooling it to approximately -163 degrees Celsius, LNG shrinks to about 1/600th the volume of natural gas at standard temperature and pressure, making it more cost- efficient to transport over long distances and to places where no pipeline network exists.

194 195 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

The LNG industry has developed strongly in recent years, with about 50% CAGR in volumes during1999-2007.

Gasification (gas-to-liquid, coal to liquid, chemicals-to-liquid) Converting low-cost gas into usable fuel/chemicals is an important market opportunity for industrial gas companies since natural gas is free of polluting agents, such as sulphur, and it complies easily with new legislation standards.

A number of critical structural factors remain in place that we believe will make this opportunity both significant and sustainable.

• US – desire for greater self-sufficiency in energy. • China – energy shortage and abundance of coal. • Global - Environmental concerns and the demand for clean fuel technology

Technology not only reliant on a We do not view this opportunity as entirely dependent on a continued high oil price. high oil price Although we would concede that, should the oil price fall significantly, some of the investments in this area (e.g. in the US) may be postponed.

First projects on the way… Currently, a number of chemicals/clean fuel projects are under discussion in China, which would each require between 2 and 4ktpd, and some more in the US of similar size. Furthermore, in China, the opportunities from the electricity industry could be even more significant. Studies are currently being undertaken to evaluate the possibility of gasification schemes to produce electricity. Each of these might require up to 25ktpd of oxygen. These studies are still at an early stage, and it is unclear at this point whether the opportunity for the industrial gases industry will be in the form of a long-term contract for the supply of gas or the (far less lucrative) sale of the plant itself.

Production via Fischer-Tropsch The first step in the production process is that natural gas needs to get partially oxidized at high temperature and pressure to produce synthetic gas (“Syngas”). Then, the second stage, called the Fischer-Tropsch synthesis step, is the heart of the process and converts gas into liquid hydrocarbons. Finally, for the hydro-cracking step, a reactor is used to fine-tune the product by selective cracking and fractionation to separate the desired middle distillate products.

For CTL and CHTL, the same process is used as for GTL. The main end product from CTL is Diesel for the transportation industry. For CHTL it is Methanol.

Figure 287: The gas-to-liquid (GTL) and coal-to-liquid (CTL) process

Natural Gas Synthetic Gas Fischer -Tropsch Product upgrading Reforming Conversion (Cracking) Coal Methane Oxygen

Air Separation Chemicals Diesel (Methanol) (low sulphur)

Source: J.P. Morgan

195 196 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

The process is expensive since it requires a huge amount of energy to convert these materials. Therefore, GTL has long been too expensive to compete with standard crude oil. Today, with crude oil currently between $70-80 per bbl, the price barrier is low and oil companies are pushing this technology hard.

The process also requires a huge amount of oxygen (GTL 0.2-0.3 t/barrel and CTL about 0.3-0.4 t/barrel). The US Department of Energy estimates a world production of about 0.9 million barrels per day by 2015. This would imply an additional oxygen demand of 270.000 tpd, which is more than 50% of oxygen production at Linde and Air Liquide.

The strategic logic of progressing CTL in coal-rich, oil-poor countries is undeniable.

Figure 288 World production of GTL/CTL 2004-2030E Figure 289 Energy Reserves by country million barrels/day Billion barrels oil equivalent

6 1200 1000 5 Coal-to-liquids Gas-to-liquids 800 4 600 3 400 200 2 0 1 r t A a lia a ia a E q a a si Iran d Kaz t Ira d 0 US s hina In Qa UA na Ru C stra Kuwai Nigeria 2004 2010 2015 2020 2025 2030 Au Ca Venezuel Saudi Arabi Coal Gas Oil

Source: US Department of Energy Source: BP, J.P. Morgan

Because the main part of the production process for GTL and CTL lies in the business and the know-how of industrial gas companies (air separation, production of Oxygen and Syngas), they are increasingly featuring in the construction of new GTL and CTL refineries. Equipment for Syngas production accounts for about 50% of total costs of the plant. Therefore, Industrial gases companies can be awarded both an engineering contract and also an over-the-fence contract for the delivery of oxygen.

Currently, Linde has significant share in the GTL/CTL business. However, Air Liquide is fast catching up with Lurgi which they acquired in 2007 to increase their GTL and CTL business.

Cleaner power generation/Co2 sequestration The opportunity from the electricity industry could be even more significant than the LNG, GTL or CTL processes. Clean coal technology should be driven strongly by increasing environmental legislation. The technology uses high amounts of oxygen.

The US Doe estimates that Energy Consumption will increase about 57% from 2004 to 2030, with strong growth coming from emerging markets. The biggest resource for growth will be coal, especially in China, India and Russia, with their abundant coal reserves. For example, coal-powered electricity accounts for 75-80% of demand in China and India compared to 30% in Europe and 50% in the U.S.

196 197 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 290: World Marketed Energy Consumption by Region, 2004- Figure 291: World Electricity Generation by Fuel, 2004-2030E 2030E Quadrillion Btu Trillion Kilowatt-hours

800 40 700 35 600 30 500 25

400 20

300 15

200 10

100 5 0 0 2007 2015 2020 2025 2030 2035 2007 2015 2020 2025 2030 2035

OECD Non-OECD Liquids Coal Natural gas Renew ables Nuclear

Source: EIA Source: EIA

The biggest problem of coal-powered electricity is that it is unfriendly towards the environment because of its huge Co2 emissions. Increasing environmental regulation for Co2 reduction will strongly affect coal-powered plants.

Co2 sequestration is the capture and sequestration and storage of carbon dioxide, rather than releasing it into the atmosphere, thereby contributing to global warming.

CCS is expected to become the main technology to solve the problem of demand for continued reliance on fossil fuels in combination with necessary reductions in Co2 emissions.

There are about four basic systems for capturing Co2 from use of fossil fuels and/or biomass:

• Capture from industrial process streams (mostly purification of natural gas and the production of hydrogen-containing synthesis gas for the manufacture of ammonia) • Pre-combustion capture (reacting a fuel with oxygen or air and/or steam to give a synthesis gas (“syngas”) to remove Co2) • Post-combustion capture (capture from flue gases before being discharged directly to the atmosphere and passed through equipment to separate Co2) • Oxy-fuel combustion capture (nearly pure oxygen is used for combustion instead of air, resulting in a flue gas that is mainly Co2 and H2O).

197 198 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 292: Co2 capture systems

Source: Intergovernmental Panel of Climate Change

Air separation and Oxygen supply are the typical day-to-day business of industrial gas companies who can therefore offer the know-how and equipment to the Co2 sequestration industry. Their business model might include permanent oxygen supply, Co2 removal and parts of drying and compression. The technologies needed for CCS have therefore been used and developed in other industrial applications in the energy, chemical and fertilizer industry and do not need a high degree of enhancement.

Most outlooks expect the CCS business to start substantially before 2015. However, the IPCC estimates that 20-40% of global emissions will be suitable for carbon capture and storage in 2040 and CCS has potential to account for 10bt of Co2 per year by 2050.

The opportunities outlined above are likely to be significant. Furthermore, in China, the opportunity from the electricity industry could be even more significant. Studies are currently being undertaken to evaluate the possibility of number of gasification schemes to produce electricity. Each of these might require up to 25ktpd of oxygen. These studies are still at an early stage, and it is unclear at this point whether the opportunity for the industrial gases industry will be in the form of a long-term contract for the supply of gas or the (far less lucrative) sale of the plant itself.

198 199 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Atmospheric Gases

Nitrogen Introduction Nitrogen is a colourless, odourless, tasteless and mostly inert diatomic gas which is used in many different areas.

Overview & Outlook For the mature markets (including Western Europe and Japan), we expect 2-3% volume growth and 4-6% for developing markets in the next 4-5 years. Major components for growth will be the refining, chemicals and electronics industries.

Production Process Nitrogen is separated from the other components of air, mostly by using cryogenic distillation (see introduction for industrial gases). It is distributed either in liquid or gaseous form.

Applications Nitrogen is the lowest cost inert gas for use in the chemicals/oils and electronics industries. Both applications use it to provide inert atmosphere against oxidation

Figure 293: Nitrogen consumption by end market (W Europe) Other 16%

Glass 3% Chemicals 37%

Food industry 11%

Petroleum Refining 8% Oil & Gas Metals 15% extraction 10%

Source: SRI and J.P. Morgan

199 200 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 109: Nitrogen consumption Area of usage Description Expected growth rate Chemicals Nitrogen is utilized in the production of chemicals and petrochemicals, fats and oils, and elastomers. It 2-3% is used primarily as an inserting agent to exclude oxygen and moisture Primary metals & fabrication Nitrogen is used primarily for inerting and blanketing applications in the steel industry and as an 2-3% 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. Oil and Gas Extraction Numerous stages of oil and gas production involve the use of nitrogen. The largest use is for advanced 8-12%. oil recovery (AOR). This uses large amounts of gaseous nitrogen, which is usually supplied by on-site cryogenic plants, to maintain reservoir pressure. In well-drilling, nitrogen is used to replace air in order to reduce the risk of”downhole” fires or explosions. It is also pumped into the drilling fluid to reduce its pressure during under-balanced drilling. Petroleum Refining The major use for nitrogen in this industry is as an inerting, purging, and blanketing agent for reactor 2-4% vessels, tanks, pipelines, and other equipment during start-up, shutdown, and cleaning operations. In addition, during normal petroleum production, processing, storage, and delivery nitrogen is widely used. Electronics Nitrogen is used primarily as a blanketing and purge gas in the manufacturing of semiconductors, 3-5% integrated circuits, single crystals, vacuum tubes, and other devices. Strong growth is expected from the TFT and LCD 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 Food Industry In its liquid form, nitrogen is commonly used to cryogenically freeze some foods. Its rapid freezing 3%. properties mean that the moisture content of the food is frozen rapidly into small ice crystals. 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.

Glass The majority of nitrogen consumed in the glass industry is in gaseous form. It is used as a blanketing 3%. 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 on-site plants.

Source: J.P. Morgan estimates.

Oxygen Introduction 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.

Overview & Outlook The market for oxygen is strongly driven by environmental legislation and the steel industry in Asia should also show continued demand for oxygen. Key drivers are also coal gasification and oxygen in the Healthcare industry.

Production Process Oxygen is mainly produced by cryogenic separation (see introduction section). Smaller volumes of oxygen are also produced by pressure swing adsorption (PSA) separation. Oxygen can be distributed either in liquid or gaseous form.

Applications Oxygen has a huge variety of applications, with the biggest demand coming from Metal Production and the Chemicals industry.

200 201 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 294: Oxygen consumption by end market Petroleum Other Refineries 8% Fabricated Metal 5% Products Primary Metals 5% Production Puld and paper 39% 5% Clay , Glass and Concrete 6% Health Serv ices 7% Coal Gasification Chemicals 7% 18% Source: CMAI and J.P. Morgan

Area of usage Description Expected growth rate Primary Metals Production By far the greatest consumer of oxygen is the steel industry. It is used in both blast furnace stage and combustion 2-3% in Europe/U.S. furnace stage. In blast furnaces, oxygen is being increasingly used to enrich the air mixture in order to aid combustion and 4-5% in Emerging and therefore increase efficiency. In the combustion furnace, oxygen is introduced to oxidize the impurities in the Markets molten pig iron and thus purify the steel. Oxygen is also extensively used in the smelting of non-ferrous 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. Chemicals Oxygen is used in a number of large-volume chemical production processes, principally as a catalyst in oxidation 2-3% 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. Coal Gasification This process uses oxygen to partially oxidize hydrocarbons (usually coal) to produce synthesis gas (“Syngas”), which 6-7%. 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. The nitrogen that is used as a byproduct 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. Health Services Oxygen has a significant number of uses within the medical industry (for example as a breathing gas, diagnostic and 5-6% anesthesia). Hospitals account for 75-80% of demand, with the remainder coming from home treatment. Fabricated Metal Products The principal use of oxygen is for welding and cutting. Oxyfuel gas cutting (OGC), is still widely used for cutting thick 2%. sections of material, as it is fast, effective, and inexpensive. Petroleum Refineries • Oxygen has two key uses in the petrochemical industry. First is that Oxygen is able to regenerate the catalysts 2-3%. used within catalytic crackers, by oxidizing the carbon that builds up on the catalysts. The second major use is for the debottlenecking of sulfur recovery units by enriching the atmosphere in which the acid gas feed is combusted. Pulp and Paper Oxygen is used at an increasing number of stages in pulp and paper manufacturing. Its use is being driven principally 2% 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. Clay, Gas, and Concrete Oxygen is used to enrich the atmosphere within the glass melt furnaces as well as brick and cement kilns, in order to 2% Products 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. Source: J.P. Morgan estimates

201 202 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Steel industry The steel industry is key driver for Oxygen demand. The International Iron and Steel Institute (IISI) is forecasting global steel consumption growth of 14.4%, excluding China in 2010. In 2010, most of the growth is coming from North America and Latin America. China steel consumption is expected to moderate to 2.8% in 2011 versus 24.8% in 2009.

Table 110: IISI forecasts strong global in global steel consumption millions of tonnes, % Y/Y Regions 2009 ∆% 2010E ∆% 2011E ∆% EU-27 118.4 -35.2% 134.6 13.7% 145.2 7.9% Other Europe 23.9 -12.5% 27.2 13.5% 30.4 11.9% C.I.S. 35.8 -28.2% 39.8 11.0% 43 8.0% NAFTA 80.9 -37.4% 99.9 23.5% 107.1 7.2% Latin America 33.6 -24.1% 40.4 20.0% 43.1 6.7% Africa 26.4 9.6% 28.7 8.6% 31.3 9.3% Middle East 40.7 -8.0% 44.7 10.0% 48.4 8.2% Asia 761.5 8.7% 825.7 8.4% 857.7 3.9% China 542.4 24.8% 578.7 6.7% 594.9 2.8%

World World (ex. China) 587.8 -24.5% 662.2 14.4% 711.3 7.4% BRIC 640.9 17.5% 692 8.0% 720.7 4.1% World (ex. BRIC) 480.3 -26.8% 548.9 14.3% 585.6 6.7% Source: World Steel Association (WSA)

The importance of China to the global steel industry cannot be underestimated since China is not only the world's largest steel market but also the world's largest steel producer.

Figure 295: China crude steel production 000’s tons 600,000

500,000

400,000

300,000

200,000

100,000

0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: IISI

Since global raw material and production costs are strongly increasing in the steel industry, cost absorptions would have to be done through improved efficiencies of the processes. Therefore, a lot of small-scale capacity in China is expected to shut down and will be replaced by high capacity steel plants. This change is important for industrial gas companies as the new plants will require large air separation units for oxygen.

202 203 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

All industrial gas companies vie with each other in setting up new plants in the region. In this context, it is important to mention that the Chinese steel production and the other industrial production zones are in the same region (China’s eastern belt). This situation is very suitable for industrial gas companies since they are able to serve not only the steel plant but also the production facilities (via trucks or cylinders) and gain scale effects.

Healthcare In the Healthcare industry Industrial gas companies are providing gases to hospitals and ambulances in tanks or cylinders. Moreover, gases and equipment are directly provided to patients for home usages.

Oxygen is the most important gas for the industry. It is used to increase blood oxygen levels and to aid breathing (during operations). Since the healthcare sector is facing cost reduction pressures, the industry sees a strong development to get patients out of the hospitals and into their homes (most of the patients don’t need cost- intensive 24/7 treatment). Also, patients demand to stay in their surroundings and treat this method as the better solution for their everyday life.

Emerging markets like Russia, Brazil and China spending a rising proportion of GDP on healthcare.

Argon Introduction 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.

Overview & Outlook In terms of worldwide volume sales Argon accounts for a relatively small proportion of only 1%, but with an average selling price of about 10-15x that of nitrogen or oxygen, it is the third-largest segment.

The argon market in the US and Europe has been fairly tight in the past recent year before it went in slowdown in 2009, fueled by strong demand from the steel industry in the U.S., Western Europe and Asia. Future growth will come from Asia and the Middle East, where strong industrial production should drive growth in the steel industry. We forecast the global use of argon to grow at approximately 4-6% per annum over the long term.

Production process As Oxygen and Nitrogen Argon is produced by cryogenic distillation, it is distributed either in liquid or gaseous form. Argon can be produced economically only as a byproduct 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, where argon is used to shroud the molten steel to protect it from oxygen as it is poured into molds.

203 204 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Applications Demand for Argon is mainly coming from the fabricated metals (protective gas for welding) and stainless steel (stirring for furnaces) industry, accounting for over 80% of total Argon usage. Applications in other industries such as glass (laser and filament lamps), electronics (protection for semiconductors) or the solar/photovoltaic industry are growing fast, but the volumes generated here are still quite small.

Figure 296: Argon consumption in US by end market Other Electric Lighting 6% Equipment 4% Electronics 10% Welding 42%

Primary Metals 38% Source: SRI and J.P. Morgan

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 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.

204 205 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Non-atmospheric Gases

As the name implies, none of these gases is extracted from the atmosphere, despite the fact that some are present in very small quantities. Hydrogen and carbon dioxide are the main gases generated by chemical synthesis.

Hydrogen Introduction Hydrogen is a colourless, odorless, tasteless, highly inflammable gas found at concentrations of about 0.00001% in the atmosphere. About 55-65% of Hydrogen production is used in the manufacture of ammonia for fertilizers and therefore most of the hydrogen is produced captively. Only 5-10% of the current hydrogen market is outsourced to the industrial gas industry.

Overview& Outlook Environmental legislation and an increasing use of heavier crude will be the main driver for hydrogen demand in the mid-term. We expect a growth rate of over 8-10%.

Currently Air Products is the key leader in the hydrogen industry, accounting for about 45-55% of the market and is very strong in the U.S. Linde (through the acquisition of BOC’s strong position in this area) and Air Liquide (organic growth) both has a strong position in the European hydrogen market.

Production Process Hydrogen is produced in large quantities through steam reforming of Hydrocarbons, which is the primary method of intentionally manufacturing large volumes of hydrogen. Methane (natural gas) is heated up with H2O (steam) to give Hydrogen and Carbon Dioxide (synthetic gas or “Syngas”), which 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. Nearly 96% of all hydrogen is derived from fossil fuels, with natural gas being by far the most frequently used, with an estimated 49%.

Applications Hydrogen is used for the production of ammonia, the production of methanol and the refining of petroleum (to reduce the amount of sulphur).

Figure 297: Hydrogen consumption by end market Figure 298: Hydrogen consumption by region Europe Refineries N. America 15% 29% 20% S America 7%

Methonol producers Japan Ammonia producers 10% 2% 60% AME Others 25% Other 1% 31%

Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

205 206 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Fertilizer 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. Therefore, industrial gas companies do not participate in this segment.

Other chemicals industry Syngas, a mixture of hydrogen and carbon monoxide, is also used in the production of a wide variety of chemicals. The biggest application is the production of Methanol.

Petroleum Refining The most important end use for hydrogen produced by industrial gas companies is therefore the refining industry. Within the oil industry, Hydrogen is used to reduce the sulphur content in products such as reformulated gasoline and low sulphur diesel.

Environmental legislation in both the US and Europe is seeking to reduce the level of sulphur dramatically. In the future, "clean fuel" legislation is also expected for locomotive, marine fuels and off-road diesel.

Figure 299: US Sulphur emissions legislation Figure 300: EU Sulphur emissions legislation

600 400 500 300 400 300 200 200 100 100 Sulphur content (in PPM) (in content Sulphur 0 Sulphur content (in PPM) 0 Gasoline Diesel Gasoline Diesel

2001 2010 2001 2010

Source: Company reports. Source: Company reports.

Growth in Europe is supported by Eastern Europe, as these countries will soon have to be in line with EU standards.

Moreover, since crude oil prices have been increasing dramatically in the last three years, it became more economically effective to buy cheaper, high sulphur oil and improve it (by using hydrogen). Therefore, High Sulphur regions such as the Persian Gulf will increase their market share in crude oil.

Oil companies are beginning to outsource the production of hydrogen towards the industrial gas industry because of their better cost structure (lower raw material costs, economies of scale) and the offer of technical and physical back-up.

206 207 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 111: Additional Hydrogen applications Industry Application Delivery method Food Starch Pipeline Electronics Bulk Liquid Glass Optical fibre 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 Source: SRI and J.P. Morgan

Potential future applications for Hydrogen Hydrogen has the potential to be used in a number of additional applications in the future.

Oil sands Oil sands are the largest potential source of oil, with an estimated 300 bn barrels globally and Canada as the main region. Since production of oil from oil sands is very expensive, it is only viable above a $40/bbl price for crude oil. The process requires significant quantities of hydrogen (to break bitumen into lighter components) and involves therefore a future potential for hydrogen. However, we believe significant usage of oil sands is not expected in the next few years.

Hydrogen for fuel-cells Hydrogen is considered as the cleanest fuel available because the only by-product - when burned - is water. Moreover, Hydrogen fuel cells are able to achieve higher efficiencies than commonly used internal combustion engines. The largest potential is therefore expected to come from the automobile industry. Logistics of hydrogen filling stations and of the safe on-board storage of this fuel is still in its infancy and hydrogen fuel will therefore not generate significant revenues in the next 7-10 years, in our view.

207 208 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Helium 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. About 80% of world production is in the United States, 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.

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

The largest use for 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. It is also used for lifting weather balloons as well as for filling ‘blimps’ and decorative balloons (minor usage).

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.

Carbon Dioxide Introduction Carbon dioxide is a colourless, odorless and inert gas. Depending on temperature conditions and pressure, it can be liquid or solid.

According to SRI, Liquid carbon dioxide consumption is likely to grow at an average annual rate of about 1.5% in the United States, 1.7% in Western Europe and 0.5% in Japan through 2009-14.

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 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.

Rather than being manufactured, carbon dioxide tends to be a by product of other processes, both industrial and natural (for example the production of ethanol and ammonia). The majority of carbon dioxide is recovered from industrial processes, although some is also recovered from natural deposits.

208 209 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 301: Carbon Dioxide World Consumption of by end market- 2009 Other 25%

Food Industry 43%

Welding 6%

Bev erage Carbonation 26% Source: SRI and J.P. Morgan

Enhanced oil recovery: Producers have attempted several enhanced oil recovery (EOR) techniques that offer prospects for ultimately producing 30 to 60 percent, or more, of the reservoir's original oil in place. The recovery of crude oil takes place in three different phases: Figure 302: Enhanced oil recovery

Primary oil recovery Secondary oil recovery Tertiary oil recovery

Natural pressure of Thermal recovery Water or gas is used oil and pumps is used is used to bring oil to surface to bring oil to surface to bring oil to surface

Source: J.P. Morgan

Gas injection uses gases such as natural gas, nitrogen, or carbon dioxide that expand in a reservoir to push additional oil to a production wellbore, or other gases that dissolve in the oil to lower its viscosity and improve its flow rate. Gas injection accounts for nearly 50 percent of EOR production.

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 in chilling to keep food cool while it is being handled, processed (such as dough mixing) or transported. Chemicals/ Fertilizer production. Gaseous carbon dioxide is used in the fertilizer industry to convert ammonia into urea (see Fertilizer section). Other uses are for the production of sodium carbonate, calcium carbonate and bicarbonate. 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 growth rate 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.

209 210 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Specialty Chemicals

Introduction What are Specialty Chemicals? “Specialty chemicals” is a loosely defined term. The companies within this sub sector are defined by the general characteristics of the products that they manufacture, rather than their molecular structure. 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.

Figure 303: Specialty chemicals consumption by region by value Figure 304 Specialty chemicals production volume growth rate CAGR Total consumption (2008) $472.6bn (2008-2013E) Rest of the North America World 24% 26% China

World

Japan

North America China 11% Western Europe

Western Japan 14% 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% Europe 25% Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

Overview Over the past 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. American Cyanamid spun off its specialty chemical operations into Cytec Industries in 1997. Rhodia was created from the chemicals, fibres and polymers businesses of Rhône-Poulenc in 1998. Lonza (1999), Givaudan (2000) and Degussa (now Evonik) (2001) have all emerged as prominent players on the specialty scene. At the start of 2005, Bayer demerged a number of its downstream chemicals businesses to create Lanxess. And, Arkema spun-off from Total in 2004. In 2007 Akzo Nobel acquired ICI after it spun off its pharmaceutical business to concentrate on coatings and chemicals completely. Solvay sold off its Pharma business in 2009.

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 and the majority of the European sector.

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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.

Table 112: History of key European Specialty Chemicals companies Company Key sectors/products Created out of Type Year Akzo Nobel Paints, pulp & paper chemicals Akzo and Nobel Merger 1994 Altana Coatings, additives, pigments Privately held Public listing 1977 Arkema Vinyl products, industrial chemicals, performance additives Total Spinoff 2004 Ciba [sold to BASF] Plastic additives, coating effects, water&paper treatment Novartis Spinoff 1997 Clariant Pigments & additives, leather & paper chemicals Sandoz-Chemicals Spinoff 1995 Croda Home & personal care ingredients, polymer additives Privately held Public listing 1964 DSM Vitamins, antibiotics, performance plastics Dutch State Mines Public listing 1989 Givaudan Flavours and fragrances Roche Spinoff 2000 Lanxess Synthetic rubber, engineering plastics, intermediates Bayer Spinoff 2005 Rhodia Engineering plastics, surfactants, silica-based products, CERs Aventis (Rhône Poulenc) Spinoff 1998 Solvay Vinyl products, plastics, specialty polymers, electrochemicals Privately held Public listing 1968 Symrise Flavours and Fragrances Privately held Public listing 2006 Syngenta Agrochemicals Novartis/Zeneca Spinoff 2000 Umicore Precious Metal products and catalysts Union Minière Mining Public listing 1989 Wacker Silicones, polymers, polysilicon, silicon Family owned Public listing 2006 Yara Nitrogen fertilisers Norsk Hydro Spinoff 2004 Source: J.P. Morgan

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 colour 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, innovation and, increasingly, customer service as well as certain logistical issues such as distribution capacity.

Figure 305: Specialty Chemicals value drivers External to the Chemical Industry Internal to the Chemical Industry • Downsizing • Search for Value-Added • Focus • Supplier Relationships • Benchmarking • Higher Service Levels • Outsourcing • Pricing Pressures • Supplier Concentration • Focussed Core Competencies • Reduced Competitive • Hunting for Growth Advantage • Risk/Reward • Volume Growth Slowdown • Increasing commoditisation • Deflationary Price Pressure Strategic Drivers

Geographic

• Regional vs Global • Structural European Weakness • Globalized Customers • Globalized Suppliers • Globalized Competitors • Global Positions Key

Source: J.P. Morgan

211 212 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

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 are not cyclical, and that they 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. However, this varies strongly between the sectors and market positions. Historically, Clariant has not had sufficient pricing power to offset rising input costs whereas Croda, Victrex and Air liquide have shown greater earnings stability.

Demand, Not Supply-Driven—a Stable Pricing Environment Prices for specialty chemicals tend to be more stable than for commodities. The comparatively limited 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 have tended to reflect increases in demand, the fundamental imbalance between supply and demand that exists within the commodity chemical industry has been 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 (especially in emerging markets) in recent years. As a result, many specialty categories now suffer from oversupply and price deflation as well as commoditisation. 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 higher level of intellectual property content, and some will be sold under patent (although these patents are more often than not superseded 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 less likely to switch supplier. (Good examples of such relationships are Givaudan, Symrise and Croda in the consumer ingredients industry and DSM in premixes.) Commodities, on the other hand, have very few comparable barriers to entry—customers will buy from the producer who can meet their requirements at the lowest cost.

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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. Currently, the industry faces a shift in capacity increases to the Middle East and Asia. Western producers have, therefore, changed the balance of their portfolios downstream, where they can compete on areas other than cost alone. Meanwhile, much of the world’s commodity chemical production resides within oil and gas companies.

Commoditisation Increasingly high levels of competition within certain product areas have, perhaps inevitably, brought with them a degree of commoditisation. 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.

Due to their complex production processes, specialty chemicals tend to be labour and R&D-intensive. Therefore, countries with a cheap and highly qualified labour force – like China or India- generate strong cost advantages compared to their western competitors. This has led to strong competition in specialty chemicals in recent years.

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.

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.

213 214 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Specialty Chemicals Product Categories The definition of what composes a specialty chemical is a loose one and the line between specialty and commodity is sometimes blurred, as we have outlined above. 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 earlier 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.

214 215 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 306: Specialty product categories annual growth rate (2008-2013E)

8%

7%

6%

5%

4%

3%

2%

1%

0%

-1%

-2%

ts -3% n s s es a s ls l ls iv x ls s s dit io a s ts st ive ica s s r tard c y t nces s nts e s yes s l a m emica l Ad Ant s s s nts al micals mi al atings ddi es a cta hibitors Biocide s t l ve a c D e e c rials dien Ch n c ticide n ic ca ti h re Co A Che rfa Chemica t me R i i ric igments inting Inks mi Cata t ic mi u n I g s a idan d b P r e Enzyme Fragr t Pes Polymer al Cleaneo la em d P g C l Ing ialty d en mbra e S n P Fl Textile Chemicals h A Chemi y in Ch a Food m e l y o osi l r g c y Che i r C ialt Synthetic le mic Mate ti ge osme p lt ialt cessin ld Oi etic Lu c Mining Ch a u Spec rs an a C e ia c Cor Electronic Chemicals ie h e Ima sca r o n S tion M c e Construction Chemicals F ing p e ce av p l t S no C ra l Ma S ynt d t F r ara Spe ater-Solub Adhesives and Sealants Oi rica S Na ce Nu te W b n a u ecialty Pape Rubber-Pro L p va W trial and Institut S d us A d In

Source: SRI and J.P. Morgan

215 216 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 307: Specialty product categories market value/ percentage share (2008)

10% 45000 9% 40000 8% 35000 7% 30000 6%

25000 5% 20000 4% 15000 3% 10000 2% 5000 1% 0 0% e ts es l s lants s nts ces es s als cid s idants ica s al n lean e s al s or s e cta C es tiv e it al rials v Sea itiv Dye mic Bio em s mic s e s Inks s s ical s s mic tardants ants hemical rfa agra nal rs g ddi Cataly Chemicalsd dd c e s ic mic ticid r ialty Coatings olymer m he he Antiox Ch zym Inhib he C c tio dditi A g n es Su A P s an il A theti he P c Mat Chemicals e C e R E Lubr y C i lty nd F Chemicalstics Field e Che n al g C m lt a Spe stitu Printin l g O e in ssin sion g C ction cia ood Sy ro in u In F las Oi etic tin osc Fla ce ecia pe aper P hesiv m extil eparation Membrane mag hetic p S vors nd P d an S I nt Cor Min nstr la A ica T Specialty Pigments -Pro S o l a ter-Soluble br N r Electronic ChemicalsC ed Ceram F Cos Sy c tria ialty Lu Wa c Water Management Chemical Nutraceutical Ingredient ubbe us R Advan Ind Spe

Total Market Size (Mn$) Percentage Share Source: SRI and J.P. Morgan

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Paints and Coatings Introduction 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.

Table 113: Paints and Coatings at a glance Growth rate (CAGR to 2012E) 3-3.5% Key end market Decorative (45%), “Performance” (30%) Key demand region Asia (31%), W Europe (28%), North America (25%) Key players Akzo Nobel, PPG, Sherwin Williams, Du Pont, Tikkurila Market structure Top 10 producers amount to up to 60% market share Key inputs Titanium dioxide, acrylic resins, toluene, dyes, solvents Source: J.P. Morgan estimates.

Overview&Outlook The coatings market is expected to grow c.3-3.5% p.a. However, growth rates within the sub-sectors vary widely, with decorative/industrial coatings growing largely in line with GDP, and marine & protective growing at high single-digit rates, driven by strong demand from Asia and a variety of structural drivers (e.g. high energy costs).

A major issue which has been facing the coatings industry has been the increase in raw material costs. In addition, increasing environmental regulations and recent litigation (Rhode Island lead in paints case) have driven demand for products which comply with legislations on volatile organic compounds (VOCs) or solvents.

Production process Paints and coatings are typically manufactured by a batch process, mainly due to the large number of raw materials (c.600 different chemicals) involved. Key raw materials include titanium dioxide, resins (acrylic, decreasingly alkyd), toluene, dyes and solvents. The production of conventional coatings is a series of unit operations including mixing, dispersing, adjusting and filling. In the final stages the mixture is adjusted or thinned and is then tested for viscosity, colour and other properties, before being strained and put into containers.

Paint manufacture is relatively capital unintensive, with capex/sales usually in the area of c.2%. The largest cost is the sourcing of raw materials, which accounts for some 50-60% of sales.

Demand The total market for paints and coatings is estimated by Euromonitor to be about $85bn. About 45% of the coatings produced globally are Decorative (also known as Architectural) paints, used to decorate and protect new construction as well as to maintain existing structures, including residential homes and apartments, public buildings, plants and factories. Decorative coatings are used in both the professional and do-it-yourself (DIY) markets. Other paints and coatings include industrial paints (e.g. for automotive OEM, wood, coil, packaging), Marine & Protective and Car Refinish.

217 218 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 308: Paints and Coatings Consumption by Major Country (2007) Figure 309 Coatings market - value split by type- 2009 Thousand metric tons (Total: 25514 Thousand metric tons) Global market around €78 billion Brazil 5% Canada 2% Special purposes USA 21% 24%

United Kingdom China 23% 4% Decorativ e 44% Taiwan 2% Spain 4%

Russia 5% France 3%

Mexico 2% Germany 6% Republic of Korea India 6% Industrial 32% 5% Japan 8% Italy 4%

Source: SRI and J.P. Morgan Source: Akzo Nobel and J.P. Morgan

Figure 310: Projected industry growth (2006-2020E) Average range (%) 10%

8%

6%

4%

2%

0% Americas EMEA Asia Pacific

Aerospace Automotive Refinish Industrial Wood Coil Marine Metal Packaging Protective Total Source: Irfab Global Industrial Coatings Report, 2006-2020, Akzo Nobel

The paints and coatings industry breaks down into four main categories:

Decorative/Architectural Coatings This segment accounts for c.45% of the market and is used on residential, commercial and industrial buildings, and sold through wholesalers and retailers. Due to recent environmental legislations, there has been a shift from solvent-based to water-based formulations, with the latter type now accounting for c.80% of the market. The market is considered mature, and we expect long-term growth to remain in line with GDP in developed markets, but likely above GDP in developing markets as “penetration” increases.

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.

218 219 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 311: Decorative market breakdown by channel Figure 312: Decorative market breakdown by application New build 30%

Retail Trade 50% 50%

Maintenance 70% Source: Euromonitor basis, Akzo Nobel Source: Euromonitor basis, Akzo Nobel

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. We expect demand growth to be in the range of 2-3% in the next three years.

The coatings are manufactured to each customer’s specifications and include powder coatings, which are dry solventless coatings, usually applied using heat.

Car Refinish Car refinish differs from automotive OEM in that the former services the car maintenance market. Passenger cars account for c.75% of the market, although the refinishes (mainly lacquers to enamels) can be used in light trucks, heavy trucks, delivery vans, buses and motorcycles. The sub-sector tends to be less cyclical and more resilient to fluctuations in GDP, as demand stems from the need for repairs (eg from accidents).

Special-Purpose Coatings These products are formulated for special conditions such as extreme temperatures or corrosive conditions. Major markets include industrial construction and maintenance and machinery refinishing, road markings and traffic signs, roof coatings and marine applications. An estimated 70-75% of protective coatings demand is for maintenance applications, with the remainder of demand accounted for by new construction.

Demand for these products is closely tied to the level of industrial activity. Marine and protective paint demand has soared in recent years due to increased shipbuilding and maintenance in Asia.

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.

Supply/Key players The paints sector in Europe and North America has seen a significant level of consolidation in recent years, with the top 10 players now accounting for c.60% of the market (vs 20% in 1980). However, in Asia Pacific, the sector remains more fragmented, with c.60% of the market serviced by small to medium-sized producers.

219 220 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Akzo Nobel has slowly cemented its position as a leader in paints and coatings, having acquired over 36 companies since 1985. Its acquisition of ICI (2007) marked a significant step in its transformation, positioning it as the undisputed world leader in the paints and coatings sector.

Figure 313: Top global players by sales (2009) € billion 9

6

3

0 Akzo PPG Sherw in DuPont- BASF - Valspar Nippon Kansai Jotun Nobel Williams Coating Coatings Paints Paints Source: Company reports, SRI.

Table 114: Paints & coatings – overview of key players Sales by product type

Decorative Decorative Industrial Car refinishes Marine & protective Automotive Packaging Other Country Country 2009A coatings (€bn) sales

Akzo Nobel Netherlands 8.7 53% 8% 10% 15% 7% 7% PPG US 6.4 15% 20% 25% 28% 12% Sherwin Williams US 5.0 85% 4% 8% 3% DuPont- Coating US 2.4 14% 48% 28% 10% BASF - Coatings Germany 2.2 15% 20% 25% 40% Valspar US 2.0 31% 31% 3% 24% 11% Nippon Paints Japan 1.5 21% 18% 11% 11% 33% 6% Kansai Paints Japan 1.7 18% 22% 23% 5% 23% 9% Jotun Norway 1.3 33% 5% 58% 4%

Source: J.P. Morgan estimates, SRI, Company data.

Figure 314: Major Paint Raw Materials

TitaniumTitanium AdditivesAdditives 13% 13% DioxideDioxide 18% 18%

OtherOther 12% 12% SolventsSolvents & & DiluentsDiluents 7% 7%

ResinsResins & & PackagingPackaging BindersBinders 22% 22% MaterialsMaterials 28% 28%

Source: Akzo Nobel, 2007

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Adhesives & Sealants Adhesives and sealants are used to attach two materials together, or to fill gaps between two surfaces to prevent the passage of air, water and/or chemicals. The distinction between the two categories is often blurred, but they are extremely versatile products, utilized in the majority of industrial sub-sectors. Leading end- markets include paper, packaging, construction, assembly/manufacturing, woodwork and consumer products.

Specialty adhesives and sealants producers compete more on performance than price, although major producers have a comprehensive product offering, and therefore also produce general purpose or commodity products. Products are often branded, which enable the producer to command a premium.

The industry is highly fragmented, with the top 8 accounting for c.42% of global sales. The remainder is estimated to be made up of over 1,000 companies.

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1) Adhesives Introduction Adhesives are materials used to attach or bond two solids together. They can be used in a variety of forms - water-based, solvent-based, solids, films and powders. Some modern adhesives are extremely strong, and are becoming increasingly important in modern construction and industry.

The polymer dispersion/emulsion adhesives category is the largest because of their versatility and comparatively moderate price. The consumption of solvent-based adhesives has been declining in developed countries due to VOC emissions regulations.

Table 115: Adhesives at a glance Growth rate (CAGR to 2013E) 3.5-4.0% Key end market Packaging, construction, furniture/woodworking, electrical/electronic Key demand region China (42%), N America (21%), W Europe (14%) Key players Henkel, Bostik, HB Fuller, Market structure Fragmented Key inputs Vinyl acetates, acrylic derivatives, phenol, resins, solvents, polyols Source: J.P. Morgan estimates.

Production process The most important component of an adhesive is the binder, which is typically a polymer. This acts to hold the system together and is a major determinant of adhesive performance. Other components which can be added to alter the properties in the final adhesive formulation include antioxidants, extenders, plasticizers, preservatives and thickeners. An appropriate balance is achived between performance requirements and raw material costs for each specific application.

Key raw materials include vinyl acetates, acrylate derivatives, polybutadiene, resins and solvents.

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Demand The overall market for adhesives is about $32bn. Demand is expected to grow on average by c.1% above GDP. Emerging markets such as Asia, Eastern Europe and Latin America are set to grow at levels significantly higher than global GDP (c.10%).

Demand is strongly driven by product innovation, and having a differentiated technology platform and effective customer service are critical to success.

Figure 315: Adhesive consumption by type in volumes (2008) Figure 316 Adhesive consumption by region in volumes- (2008) Assembly / Rest of the World Manufacturing/ 6% North America Rest of Asia 5% Other 16% 21% Footw ear/ Paper & Leather 3% Packaging 36% C&S America 1% Consumer Adhesiv es 5% Western Europe Transport 7% China 42% 14%

Woodw ork Rest of Europe 12% Japan 6% 5% Construction 21%

Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

Figure 317: Adhesives market by technology (2008) Figure 318: Adhesives - consumption per capita Use per capita (Kg)

Water-Soluble 8 Poly mers 1% Solv ant Based Formaldehy de 6.5 12% Based 18% 6 5.5 5 4.8 Reactiv e 10% 3.9 Hot Melt 10% 4 Natural Poly mers 4% 2 Other 5% 0.9

0.3 0.2 Poly mer 0 Dispersion/ Germany Japan USA France UK Brazil China India Emulsion 40% Source: ICI (Akzo Nobel) Source: Industrieverband Klebstoffe e.V., Henkel, 2006

223 224 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

There are two main types of adhesives:

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 plywoods, 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.

On a chemical basis, adhesives are broadly defined by the following categories:

• Natural Polymers—plant- and animal-derived adhesives such as casein, dextrin and starches • Water-Soluble Polymers—cellulose ethers (carboxymethylcellulose, methyl cellulose, etc.), polyvinyl alcohol, polyvinyl pyrrolidone and other • Solvent Based—polychloroprene, polyurethane, natural and synthetic rubber, and other • Hotmelt—polyethylene, polypropylene, ethylene–vinyl acetate, polyamide, polyester, styrene, polyurethane and other • Reactive—epoxies, polyurethanes, polyesters, cyanoacrylate and other acrylics, phenolic, urea, melamine, resorcinol, and others such as radiation curable • Polymer Dispersion/Emulsion—vinyl acetate, ethyl–vinyl acetate, acrylics, natural and synthetic rubber, polyurethane, and other

Adhesives can also be categorized by their form, chemical binder or end market:

224 225 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 116: Adhesive categories and applications Adhesive Form Types of Binder Used Major applications General Contact Phenolic Consumer Amino Construction Natural rubber Wood furniture SBR General industrial Polyvinyl acetate Textiles Transportation Hotmelt Ethylene–vinyl acetate Bookbinding Styrene block copolymer Packaging Polyvinyl butyral Diapers Polyamide Furniture Polyester Footwear Polyurethane Transportation

Pressure Sensitive Acrylic Tapes Natural rubber Labels Styrene block copolymer Decals Transfer films High Performance, Reactive Epoxy Automotive Urethane Electronic Modified acrylic Aerospace Anaerobic Consumer Radiation curable Appliances Cyanoacrylate Textiles Source: SRI

Supply/key players The industry has undergone a significant level of restructuring and consolidation in recent years, as players strive to gain economies of scale. The most recent transactions are Akzo’s sale of ICI’s Adhesives and Electronic Materials businesses to Henkel, which cemented Henkel’s position as the #1 player, as well as Dow’s acquisition of Rohm & Haas..

Figure 319: Adhesives market by competitor- 2008 Henkel 25%

Bostik 5% HB Fuller 3% Others 67%

Source: SRI and J.P. Morgan

225 226 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 117: Adhesives - product portfolio of key players- 2008 Henkel HB Fuller Bostik Electronics xxxx Engineered wood xxxx Footwear xxxx x xx Non-woven xxxx xxx xxx Consumer xxxx x xxx Flexible packaging xxxx xx Production assembly xxxx xx x Tapes & labels xx Transportation xxxx xx xxxx Packaging xxxx xxxx x Construction xx xx xx Paper converting xxxx xxx x Woodbond xxxx x x Source: ICI (Akzo Nobel)

Other key players include 3M, Dow/Rohm & Haas, Momentive and Hexion.

2) Sealants Introduction Sealants are materials used to fill the gap between two materials and prevent the passage of liquids and gases between them. They are thick, non-pourable materials and are often used for their adhesive properties.

Table 118: Sealants at a glance Growth rate (CAGR to 2012E) 3.5-4.0% Key end market Construction, Transport, Furniture/ Woodworking, Electrical/Electronic Key demand region W Europe (26%), N America (18%), China (15%), Japan (15%) Key players Henkel, HB Fuller, Bostik Market structure Fragmented Key inputs Ethylene, Formaldehyde, Urea Source: J.P. Morgan estimates.

Production process As with adhesives, sealants are produced through a process of mixing a wide range of raw materials, according to the formulation. As with the paints and adhesives sectors, it is a relatively low capital-intensive business.

Demand Today, silicone is the key product used as a sealant (generating 37% of sales). Another important product is polyurethane (18%). Polysulfides have been losing market share to silicone and polyurethane products and to more commoditised sealant products.

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.

As in the adhesives markets, synthetic materials continue to replace natural ones and there is a strong move to reduce VOCs (Volatile organic compounds) within the industry.

226 227 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 320: Sealants consumption by type in value- 2008 Figure 321: Sealants – consumption growth by region Other 13% Poly v iny l China Acetate 2% AME Buty l Rubber 4% Silicone 37% C/E Europe Sily -Modified S America Poly ethers 7%

W Europe Poly sulfides 9% Japan

Oil-Based Latex N America Utrethanes 18% and Solv ent 0% 2% 4% 6% 8% 10% 12% 14% Acry lic 10% Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

Figure 322: Sealants consumption by region- 2008 Figure 323: Sealants consumption by end-market- 2008 Rest of the World North America Assembly/ 9% 18% Other 13% Rest of Asia 9%

C&S America Consumer 10% 4% China 15% Construction 56% Transport 21% Western Europe Japan 15% 26% Rest of Europe 4% Source: SRI and J.P. Morgan Source: J.P. Morgan estimates

227 228 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Supply/Key players Consolidation has helped broaden the product lines of the major sealant manufacturers, yet the industry remains highly fragmented, with a lot of medium and small-sized companies.

Table 119: Sealants – key players Polysulfide Polyurethane Silicone ADCO x x x Bostik x x Cemedine X x x Dow x Dow Corning x x Henkel x x x Hutchinson x x Kommerling x x x PCI Augsburg x x x PPG x x x Rhodia x RPM x x x Ruetgers x Shin-Etsu x Sika x Sunstar Engineering x x x 3M x Wacker x Yokohama Rubber x x x Source: SRI consulting

Colourants Introduction Colourants are pigments and dyes that are used to give colour to certain products, mostly within the textile industry. They include dyestuffs, pigments and masterbatches. The main players are Dystar (owned by Platinum Investors), BASF/Ciba and Clariant which all hold significant colourant operations.

Figure 324: Different types of colourants Colourants

Dyestuffs Pigments Masterbatches

Source: J.P. Morgan estimates.

The traditional colourants industry was an important activity in Europe until the end of the 20th century. It suffers now displacement by the developing world due to increasing production-related environmental costs as well as high labour costs in Europe. Customer industries (e.g. textiles) have also migrated to lower cost regions.

228 229 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

1) Dyestuffs Dyes are used principally on textiles, but also on paper, plastics, inks, leather, detergents 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.

Table 120: Dyestuffs at a glance Growth rate (CAGR to 2012E) 1% Key end market Textile (48%), Paper (19%), Detergents (14%) Key demand region China, India Key players Dystar, BASF (Ciba), Clariant, BASF Market structure Highly fragmented Threats New capacity in Asia Key inputs Aromatic hydrocarbons (Benzene, Toluene, Naphthalene) Source: J.P. Morgan estimates.

Overview Growth rates of dyes are directly linked to the demand for the fibre on which they are used. As a result, growth of synthetic fibre dyes (especially for polyester) is the strongest, with 2% expected annual growth (according to SRI). In addition, fashion plays an important role in demand for pigments, as darker colours require significantly more dye.

Production process Aromatic hydrocarbons (Benzene, Toluene, Napthalene and Anthracene) are the main raw materials for the dyestuff production. These raw materials are at first converted into dye intermediates, which are then synthsised into dyes.

New investments are required within the dyestuff production industry as effluent treatment plants do not meet environmental legislation.

Demand Demand for dyes is highly dependent on the demand for textiles, leather and coloured papers. Textile is by far the largest end market, with a share of 48%, followed by paper (19%). Besides population growth and GDP trends, textile demand is highly dependent on short-term 'fashion': For example, dark colours consume more dyes in comparison to light colours.

Figure 325: Dyestuff consumption by end market Paper Detergent 19% 14% Ink 6%

Others 6%

Plastics 4% Tex tile Leather 48% 3% Source: SRI and J.P. Morgan

229 230 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 326: Dyestuff consumption by region (2007) Figure 327: Dyestuff demand growth by region (2007-2012E) ROW C & E Europe China ROW China 3% S America 38% 3% Av erage W Europe Rest of Asia 6% C & E Europe S America N America 6% W Europe

-2% -1% 0% 1% 2% 3% 4%

Rest of Asia N America 25% 19%

Source: SRI and J.P. Morgan Source: SRI

Table 121: Different Types of Dyes and their applications Dye type Characteristics Uses Acid Dyes Insoluble in acid baths. Used for dyeing protein fibres, 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 fibre. Very fade resistant Used for dyeing cellulose fibres and some nylons Sulfur Dyes Large low-cost category Used for 'natural' shades on cotton. Source: J.P. Morgan

Supply/key players 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 (BASF/Cognis).

Mostly, the Dyestuffs industry is fragmented, with many small and medium players. Overall we do not expect demand growth much ahead of 1%, with pricing trends remaining under pressure for the foreseeable future under a normalized environment.

In the US, DyStar, Clariant, Huntsman and M. Dohmen control an estimated 61% of the market. The remainder is being supplied by distributors located in Charlotte, North Carolina, selling Chinese and Indian material. In Western Europe, DyStar, BASF/Ciba and Clariant control the majority of dyestuff production. In Asia, China and India are the main producers and consumers.

2) Pigments Pigments consist of small molecules that are practically insoluble in those media in which they are applied. They have to be attached to a substrate by means of additional compounds, e.g . by polymers in paints, plastics, or melts.

Pigments can be divided into organic and inorganic pigments. The two types differ in terms of manufacturing process, volumes (organic pigment market segments are typically smaller), end-markets and prices (organic pigments typically command higher prices).

230 231 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 122: Pigments at a glance Growth rate (CAGR to 2012E) 3.0-3.5% Key end market Printing Inks, Paints & Coatings, Plastic industry Key demand region W Europe (29%), N America (27%), China (15%), Japan (12%), India (6%) Key players BASF/Ciba, Clariant, Lanxess, Rockwood Market structure TOP 5 producers amount to up to 60% of the market Key inputs Metal ore Source: J.P. Morgan estimates.

Overview The global specialty pigment market is valued at c.$5bn, half of which is organic and the remainder inorganic. Pigments are classified based on their composition, with azo pigments being the most common organic pigment, and iron oxide the most common inorganic pigment. Titanium dioxide and carbon black are also often classified as pigments, but they are more commoditised in nature and are sold on the basis of price rather than performance.

The sector has been threatened by commoditization and low-cost competition, with the majority of inorganic pigments (and an increasing level of organic pigments) now sourced from Asia. Western producers have thus focused more on higher-value segments, including pearlescent and metallic effect pigments.

Production process Specialty pigments are typically produced by a batch process. This is in contrast to commodity pigments (eg titanium dioxide), which are produced by a continuous process. The production process utilized varies depending on the pigment type and end application.

Natural inorganic pigments, such as iron oxide, are produced through a four-step process – (i) grinding of iron ore to reduce particle size and remove impurities, (ii) drying, (iii) calcination and (iv) further grinding. Synthetic iron oxide, on the other hand, is made by either precipitation reactions, thermal decomposition of iron compounds or organic reduction processes utilizing iron as the reducing agent.

Organic pigments, on the other hand, are typically produced in two steps – chemical synthesis, followed by finishing or conditioning.

Demand The US and Europe account for the majority of global pigments demand, with key applications being inks, paints & coatings and plastics. Inks comprise the largest end- use, which are used in publishing, packaging and printing. Although the market is relatively mature, and the use of ink in publishing has been on the decline due to their replacement with digital media, there has been a healthy level of growth in high-value applications including security printing (eg to prevent currency fraud). The global market is expected to grow about 3-3.5%, with China and India growing at 5-6%, driven by demand for the pigmentation of plastics, printing inks, surface coatings and textile printing.

231 232 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 328: Pigments consumption by product type Other inorganic 5% Chromes 8% Azo 28% Complex inorganic 13%

Iron oxides High performance 21% 14% Phthalocyanine 11% Source: J.P. Morgan and SRI

Figure 329:Pigments consumption by region Figure 330 Pigments consumption growth by region Other AME 8% LatAm China 2% 3% China AME NA FTA 5% 36% LatAM

Japan Europe 13%

NAFTA

Other

Japan Europe 0% 1% 2% 3% 4% 5% 33% Source: SRI and J.P. Morgan Source: SRI

Inorganic pigments Synthetic iron oxide is the largest segment of the global inorganic colour pigment market, accounting for c.75% in volume terms. The product has suffered from low cost competition and commoditisation, with production now dominated by China (54%), followed by Europe (28%) and North America (8%). Demand, however, remains dominated by Europe and North America (c.50% combined). Inorganic pigments have been losing market share to organic pigments due to the latter group’s greater level of brightness and tinctorial strength.

232 233 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 331: Inorganic colour pigment consumption by type Figure 332: Iron oxide pigments - consumption by end-market Other Other 10% Paper 6% 3% Plastics 5% Iron oxides Complex inorganic 45% 28% Inks, paints, coatings 25% Building materials 61%

Chromes 17% Source: SRI Source: SRI

Organic pigments The majority of the organic pigments market is made up of “classical” organic pigments (azo and phthalocyanine), which have suffered from price competition from low-cost producers. Although competition has not been as intense as in the inorganic pigments market, China currently accounts for 28% of the market. This is followed by the US (21%) and Europe (16%). The focus in recent years has been on high-performance pigments, which typically enjoy higher margins.

Figure 333: Organic colour pigment consumption by type Figure 334: Organic pigments – consumption by end market Phthalocyanine Plastics, 13% 20% Paints & coatings, 22%

Tex tile printing, 12%

Azo 53% Pigmented fibres, 8%

High performance Printing Inks, 29% Paper, 8% 27% Other, 8%

Source: J.P. Morgan, SRI Source: J.P. Morgan, SRI

Supply/key players The largest players in the pigments market are BASF/Ciba, Clariant and Sun Chemicals. The majority of pigments producers are specialized in either inorganic or organic pigments, with only a few companies (e.g. BASF), manufacturing both pigment types.

The largest producers of organic pigments are BASF, Clariant, Dainichiseika, Dainippon and Toyo Ink. The largest producers of inorganic pigments are Lanxess (c50% share of synthetic iron oxide) and Rockwood Pigments (which recently acquired Elementis’ pigments), followed Toda Kogyo and a number of Chinese competitors (e.g. Cathay Pigments, Deqing Huayuan Pigment).

233 234 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Regulatory concerns around carcinogenicity and neurological damage have triggered a shift in product portfolio among the major suppliers. Pigments receiving the most regulatory attention in recent years have been those containing lead, chromium and cadmium.

3) Masterbatches Masterbatches are the pelletized colourants and additives that plastics producers combine with resins to colour plastics.

Table 123: Masterbatches at a glance Growth rate (CAGR to 2012E) 3-4% Key end market Packaging (42%), Building (32%), Auto (7%), Electronic (5%) Key demand region US (30%), Europe (30%), Asia (15%) Key players Chemtura, Clariant, PolyOne Market structure Top 2 players amount to 35%, Rest of the market is very fragmented Key inputs Pigments, Antistatic agents Source: J.P. Morgan estimates.

Overview The overall market for masterbatches is expected by SRI to be worth over $5-6bn in 2008. The largest end markets are packaging and building. Due to strong demand in Asia in these end markets, we expect growth slightly above GDP at 3-4% in the next five years.

Production process Masterbatches are blended at a pre-agreed formulation according to customer requirements.

Ingredients may include pigments, titanium dioxide, UV blockers, antistatic agents and agents for effects such as pearlescence.

Demand The end market for masterbatches includes larger auto and consumer companies, but also a huge variety of smaller plastic producers. Therefore masterbatches are mostly custom-made and are characterised by many different individual specifications. This tends to lead to above-average working capital demands.

Figure 335: Masterbatches consumption by end market Figure 336: Masterbatches consumption by region Others Auto Row 10% Building 7% 25% Electronic Asia 32% 5% 15%

Durable goods 4% Europe 30% US Packaging 30% 42%

Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

234 235 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Selling to large customers, pricing power is limited in the masterbatch industry. Therefore, continous restructuring and low-cost production, combined with a local presence to customers, is the key to success.

Supply/key players The biggest players in the industry are Clariant (c.10%) and PolyOne, with an estimated combined global market share of 20-30%.

There has been intense competition and further restructuring in the industry, as witnessed by Clariant’s CHF 30 million purchase of Ciba’s masterbatch business in Europe in December 2006.

Plastic Additives Introduction Plastic additives, as the name suggests, are chemicals that are added to plastics to provide them with certain qualities that improve their functionality or processability. Examples include antioxidants, UV resistance and thermo resistance.

Table 124: Plastic Additives at a glance Growth rate (CAGR to 2013E) 2% Key end market Packaging, Automotive, Construction Key demand region N America (24%), W Europe (22%), China (19%), Japan (8%) Key players BASF, Chemtura, Arkema, Dow/Rohm & Haas Market structure Fragmented (Top 5 producers 33% share) Key inputs Phenol derrivatives Source: J.P. Morgan estimates.

Overview&Outlook The plastic additives industry is estimated to be worth $16.5bn. Market growth is strongly tied to the demand for plastics, which in turn is dependent on demand from its main end uses - including automotive, construction and packaging. Overall, demand growth is estimated to be c.2% p.a. through to 2013e (SRI).

Plastic additives have suffered rapid commoditization, and thus the focus in the industry has been on restructuring, as well as consolidation. Soaring input costs have placed significant margin pressures on even the larger players, including Chemtura and BASF/Ciba.

Production process The production of plastic additives is a capital-intensive process. Most plastic additives in Europe are manufactured by a batch process, with the majority of larger players being back-integrated into their raw materials. The key raw materials are phenol derivatives.

Although the majority of Western European producers tend to have multipurpose plants, in North America, each manufacturer tends to produce a given product at only one plant, and thus products are frequently shipped over great distances.

235 236 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 337: Typical cost structure of Plastic additives

Administration 7%

Manufacturing Sales & Adv ertising 84% 6%

R&D and Technical services 3% Source: SRI

Demand Almost all plastics additives are sold to manufacturers of plastics products. As the majority of plastics consumption is in Asia Pacific, the majority of additives are also consumed in this region. PVC production generates the majority of demand for polymer additives, particularly modifiers and processing aids, followed by PE, PP and PS.

Figure 338: Plastic additives demand by region- 2008 Figure 339: Plastic additive demand growth by region 2008-2013E CAGR South America

AME 9% 3% China

Western Central and India

Europe 21% Eastern Europe AME

5% Others

Others 1% South America

Western Europe China 20% North America North America The Rest of Asia 21% Japan Central and Eastern Europe The Rest of -3%-2%-1%0%1%2%3%4%5%6%7%8% Asia 20%

Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

Figure 340: Plastic additive consumption by type- 2008 Figure 341: Plastic additive consumption by polymer type- 2008 Anti-ox idents Other 12% Antistatic 6% Lubricants Agents 1% 14% Light Thermosets Stabilizers 1% PVC 40% 15%

Impact Modifiers 17% Flame Retardants 39% Chemical Blow ing Agents 4% Poly olefins/ PS Heat 33% Stabilizers 18% Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

236 237 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

The range of additives is broad, as summarized below.

Table 125: Key plastic additives and their uses Type Key use Antioxidant * Prevent or delay oxidization * Greatest demand comes from polyolefins (polyethylene, polypropylene, and polystyrene), while the major types of antioxidants are alkylated phenols, amines, phosphates, and esters. * Major end-use industries include rubber, plastics, food and feed, and petroleum fuel industries in decreasing order. Antistatic agents * Eliminates or reduces static electricity. Acts by permitting the body or surface of the material to be slightly conductive, preventing the formation of static charges and hindering the fixation of dust. * Examples of antistatic additives include long-chain aliphatic amines and amides, phosphate esters, quaternary ammonium salts, polyethylene glycols, polyethylene glycol esters, and ethoxylated long-chained aliphatic amines. Chemical blowing agent * Produces a cellular structure in a plastic. * Range from simple salts such as ammonium or sodium bicarbonate to complex nitrogen-releasing agents. Flame retardants * Resists combustion when exposed to extreme temperatures. Also widely used in furniture and textile manufacturing. * Main end-markets are construction, electronics and transport markets. * Non-halogen type replacing chlorinates/bromine type given heightened medical/environmental concerns. Heat Stabilizers * Increase durability of plastics resins * Most significant demand comes from PVC manufacturing, as resins are processed at high temperatures. Impact modifiers/ * Alter the physical properties of the plastic resin. Processing agents * Greatest demand is for plasticizers, which increase a material’s flexibility. * Demand largely driven by demand for flexible PVC resins, for which the most common plasticizer is phthalate. Rubber-based impact modifiers are used to improve a plastic’s resistance to stress by absorbing force. Lubricants * Assist resin flow during production and enhance mold release by compensating for any imperfections in machinery/materials * Include metallic stearates, hydrocarbons, fatty acids and alcohols. Light stabilisers * Absorb/deflect UV light to mitigate degradation * Used in plastics as well as paints. Source: SRI and J.P. Morgan

Supply/Key players The plastic additive industry is highly fragmented, although there has been some level of consolidation in recent years. The most recent transformational move was the merger of Great Lakes and Crompton to form Chemtura. Companies have also increasingly shifted their production to high growth areas – a recent example being Ciba’s intention to construct a new antioxidant plant in Singapore.

Figure 342: Top producers of plastic additives (2008) Arkema BASF/ Ciba Songw on 4% 10% 2% Albermarle 2% Chemtura 9% Dow 4% Kaneka Others 2% 67% Source: SRI

237 238 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 126: Plastic additives producers in Western Europe Chemical Anti Anti-static blowing Flame Heat Impact UV light Company oxidants Agents agents retardants stabilisers modifiers Lubricants stabilizers Akcros x x x x Akzo Nobel x x x Arkema x x x x Baerlocher x x x x BASF x x x x x x Chemson Polymer x x Chemtura x x x x x x Clariant x x x x x x Emery Oleochemicals x x x Lanxess x x x x Rohm and Haas (UK) x x x Source: SRI and J.P. Morgan

The additive market is service-intensive, with the capability to provide adequate technical support being a key success factor. Of increasing importance has been the recyclability of polymers containing a given supplier’s additives, as well as “green” polymers.

Compliance with environmental/health legislation has also been a key topic, given increased concerns over potentially toxic lead and cadmium-based products, as well as chlorinated and brominated compounds.

Water management chemicals Introduction Water management service companies provide the overall water treatment package, including monitoring, metering and dosing equipment and sensing devices, as well as bulk and specialty chemicals, as required by the specific customer.

There are five main types of specialty water management chemicals - ion exchange resins, organic polymers (coagulants & flocculants), corrosion inhibitors, scale inhibitors and biocides.

Table 127: Water Management Chemicals at a glance Growth rate (CAGR 2007- 2012E) 3.1% Key end market Pulp & Paper, Chemical processing, Petroleum refining Key demand region United Stated (38%),Europe(18%) Key players Nalco, GE infra, SNF Floerger, Ashland, Ciba, Market structure Fragmented Key inputs Organic polymer coagulants and formulated products Source: J.P. Morgan estimates.

Overview&Outlook The broad definition of “water treatment” and the consequent wide range of applications mean that a wide range of factors drive demand. Environmental regulations have been 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.

238 239 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

We expect the industry to grow c.3% per annum. China is one of the biggest consumers of water management chemicals, with a global share of close to 10%. The water management business should grow faster in regions where water is scarce such as the Middle East.

Production process Specialty chemicals consumed in the water management industry have a wide range of alternative end-uses, and are therefore produced in large quantities by large, well- established chemical companies with multiple plant sites, often located around the world. The majority of players are back integrated into their raw materials.

Demand 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.

Figure 343: Water management chemicals consumption by type-2007 Figure 344: Water management chemicals consumption by region- 2007 Scale Inhibitors Rest of the 20% Others 20% World 25% United States 38%

China 10%

Organic Corrosion Poly mers 28% Japan 9% Europe 18% Inhibitors 32% Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

239 240 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 128: Water management chemicals and applications Water-management chemicals Applications 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 closely tied to the level of industrial activity. Coagulants and • Used principally in the municipal water treatment industry Flocculants • These chemicals help to separate suspended matter and contaminants, including solid waste, from water. • Main 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 • This category of chemicals includes the bulk commodity chemicals of chlorine and hydrogen peroxide as well as their derivatives. Biocides • 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 comprise 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. PH Adjusters and • They are used to maintain PH levels in both industrial and household water, by eliminating the effects of calcium and magnesium. Water Softeners • The chemicals used themselves include lime, sodium derivatives, and sulfuric and hydrochloric acid. Ion Exchange resins • Main application of ion exchange resins are water treatment (more than 60% of total dollar value), food purification, adsorbents, metal recovery and remediation • Manufacturing is capital-intensive with precursor resin is chemically modified in suspension polymerisation process to obtain the desired ionic characterstics. • Arsenic removal from drinking water is a growth opportunity for ion resins after stringent regulations by the US Government Other Uses • Defoamers and sequestering agents. • Filter media and adsorbents, which provide another means of separating suspended matter and contaminants from water. Source: SRI and J.P. Morganand SRI

Supply/key players Recently, the industry has seen a number of consolidation moves. Nalco Company and GE’s infrastructure, water and process division share about 36% of the US market for water management and have a significant global market share. Ciba aquired Allied Colloids for £1.42bn in 1998. The other acquisition was Ashland’s purchase of Degussa (Evonik)’s water treatment subsidy, Stockhausen in 2006.

240 241 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Leather chemicals Introduction Leather chemicals form a small sector within the chemicals industry. They are used for tanning, re-tanning and finishing in the leather industry.

Table 129: Leather Chemicals at a glance Growth rate (CAGR to 2012E) 2% Key end market Shoes (50%), Furniture (22%), Automotive (18%) Key demand region Asia-Pacific (51%), EMEA (28%), Americas (21%) Key players Lanxess, Clariant, BASF, Stahl Market structure Consolidation expected Key inputs Chrome ore Source: J.P. Morgan estimates.

Overview The leather chemicals market is estimated to be worth €3-3.3bn according to SRI. Asia Pacific and China in particular are the largest sources of demand, accounting for more than 50% of the global market. The market is estimated by SRI to be growing at c.2% p.a., driven by meat consumption and cattle slaughter rates.

The industry has suffered rapid commoditization in recent years, and high input costs have resulted in margin pressure for the majority of Western players.

Production process The leather production process involves 3 major steps. At first, hides and skins have to be cleaned in order to remove the ingredients that are not suitable for further processing e.g. hairs and fat cells etc. Then, the hides and skins get tanned using chromium tanning materials or vegetable extracts. Finally, the subsequent wet finishing process is required to provide the leather with some appointed properties, like softness, colour and handle.

Demand Leather chemicals are mainly used in the production of leather shoes (c.50% of market), although in recent years we have seen an increasing level of demand from the automotive end market (eg leather seats in passenger cars). Furniture is an additional important end market. The European and NAFTA markets have declined in recent years, although Asia and South America have shown healthy growth.

Figure 345: Leather chemicals consumption by end market Figure 346: Leather chemicals consumption by region Furniture EMEA 22% 28%

Automotiv e 18%

Americas Asia pacific Shoes Others 21% 51% 50% 10%

Source: Lanxess Source: Lanxess

241 242 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Supply/key players The main players in the leather chemicals industry are BASF, Clariant, Lanxess, Stahl and TFL, who all focus on high quality innovative leather chemicals. Although the majority of players offer a full range of products used in the processing of leather, Lanxess is currently the only producer benefiting from its back-integration into chrome ore.

Table 130: Leather chemicals - product offering Chrome ore Tanning Re-tanning Finishing BASF x x x Clariant x x x Lanxess x x x x Stahl x x TFL x x x Source: Lanxess

Consumer chemicals Introduction “Consumer chemicals” is a broad term used to classify chemical ingredients which are used in the home, personal care and food end-markets. They include nutritional ingredients, cosmetic ingredients as well as flavours & fragrances. A key characteristic of these chemicals is that they tend to account for a small proportion of its customer's total cost, while being a key differentiator of the end product. Players in this industry tend to enjoy relatively defensive demand, as well as above-average returns and margins.

Figure 347: Key segments within the consumer chemicals sub-sector Consumer Chemicals

Flavors & Fragrances Food Ingredients Cosmetic Ingredients

Source: J.P. Morgan estimates.

The industry has seen significant consolidation in recent years, with recent moves including BASF’s acquisition of Cognis (2010), Givaudan’s acquisition of ICI’s Quest (2006) and Croda’s acquisition of Uniqema (2006).

242 243 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

1) Flavours and Fragrances Introduction “What's behind the foods people love? Great taste” (Givaudan).

The production and use of flavours and fragrances has a long history and goes back to the Middle Ages. Production on a larger scale started in the nineteenth century with the extraction of single chemicals that are responsible for the characteristic aroma of natural products. Nowadays, flavour and fragrance ingredients are one of the most numerous, and highest-value additives utilized by the food and personal care industries.

Although flavours and fragrances are two quite distinct product groups, using different chemical reactions and techniques and have different market dynamics, most major players in the industry are involved in the production of both flavours and fragrances.

Table 131: Flavours and Fragrances at a glance Growth rate (CAGR to 2012E) 2-3% Key end market Flavours: Beverages, Sweets, Dairy Fragrances: Home & personal care, fine fragrances (perfumes) Key demand region N America, APAC, W Europe Key players Givaudan, IFF, Firmenich, Symrise,Takasago Market structure Top 4 players have 70-75% market share Key inputs Essential oils and natural extracts (vegetables, fruit, herbs), aroma chemicals Source: J.P. Morgan estimates.

Overview&Outlook The global flavours and fragrances industry was, according to SRI, worth US$18.6 billion by consumption in 2006. With a share of 46%, Flavour composition has the biggest market share of the F&F market.

SRI estimates the growth rate for flavours and fragrances industry in the range of 3- 4% per year through 2011, with the larger players tending to show above average growth, as they take share from the smaller players.

Flavours are used in small quantities to enhance the taste and texture of all manner of processed food and beverages. Fragrance products are sold principally to manufacturers of perfumes, cosmetics, detergents, and other personal and household care products.

According to Givaudan, most Flavours and Fragrances comprise less than 3% of input costs for their clients (c.5% for fragrances) while being the key differentiating ingredient, and therefore tend to enjoy better pricing resilience than many other specialty chemicals producers.

243 244 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 348: FMCG customer costs Admin Distribution/selling 10% Consumer Care 19% input 1-5%

Other COGS 67% Source: J.P. Morgan estimates.

Figure 349: Key drivers of consumer repurchase decisions - food Figure 350: Key drivers of consumer repurchase decisions – fine fragrances Packaging Fragrance Other 10% Brand image 6% Price 5% 3% 15% Ov erall Smell/taste ex perience 45% 8%

Brand image 30% Scent 78% Source: AC Nielsen Source: AC Nielsen.

Demand The flavours & fragrances sector was estimated to be c.€11bn in size in 2009.

Figure 351: Flavours & fragrances sector (€11bn)

Aroma chemicals 15% Flavours 45%

Fragrances 40% Source: Company reports.

In the field of flavours, products such as convenience foods, soft drinks, and low- cholesterol, low-fat foods have all boomed in popularity, while new markets are constantly emerging.

244 245 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 352: Flavours - sales by geography Figure 353: Fragrances - sales by end-market S America Other E Europe 6% 12% 6% N America M East/Africa Bev erages 31% 7% 33% Sav oury 23% W Europe 24% APAC 26% Sw eet Source: IAL Consultants. Source: IAL Consultants.

The key characteristics and drivers of the flavours market include:

• Demand for healthy products, without compromising on taste (e.g. low-fat and low-sodium) • Demand for “natural” flavours • Increased use of functional foods (i.e. food products with an additional benefit – e.g. energy boosting, slimming) • Trend towards snacking; convenience without sacrificing taste • Emergence of new target groups with unique tastes (e.g. ethnic food) • Increasing requirements for labeling and food safety • Demand for unique delivery systems (e.g. encapsulation, delayed flavour delivery)

In the fragrances market, demand for products such as male toiletries and deodorants have grown significantly, as has the market for designer fragrances. Meanwhile the industry continues to find new and innovative uses for fragrances, such as aromatherapy.

Figure 354: Fragrances sector - sales by geography Figure 355: Fragrances sector - sales by end-market Other M East E Europe Fine 5% 6% 2% fragrances S America 21% 6% N America 34%

APAC Household 24% 49% Personal W Europe care 28% 25%

Source: IAL Consultants. Source: IAL Consultants.

245 246 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Key trends in the fragrances sector include

• Increased demand for “natural” ingredients • Increasing performance requirements (e.g. controlled release systems, reduced fragrance loss, prolonged top notes, increased stability) • Aromachology (e.g. use of fragrances for reduction of stress) • Increased use of environmental fragrances (e.g. air fresheners and scented candles) • Globalising and consolidating customer base, favouring larger-scale players • Increasing legislation on quality standards and labelling • Emergence of new target groups – e.g. men, children • Shortening end product life cycles

Typically, the major F&F houses have dual market research capabilities that focus on customers’ industries (e.g. detergent manufacture) as well as on consumers’ market trends (e.g. changes in lifestyle, demographics, social attitudes, health and nutrition trends).

Anecdotal evidence from the tier 1 F&F companies (Givaudan, Symrise, IFF) suggests that organic growth in the F&F markets is largely volume-driven, with limited pricing. The one exception was in 2009 – a period of unprecedented raw material price inflation – at which point a number of players have commented on initiating exceptional price increases through cost-push inflation.

Supply/ Key players There are three types of chemical companies that produce flavours and fragrance chemicals:

• The traditional flavour and fragrance houses produce chemicals as needed for their own compounding and also for sale in the open market. Their competitive advantage being a very specialized technical know-how for manufacturing certain classes of chemical (Givaudan, IFF, Firmenich, Symrise). • Large chemical companies participate in these markets by upgrading small portions of their large-scale chemical production to flavour and fragrance specification (such as Rhodia, BASF/Cognis, Eastman). The influence of such companies is dwindling as purified chemicals shift to less-profitable commodity status. • Small- to medium-sized custom synthesis houses with a specialized technical know-how.

246 247 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 356: Flavours - global market shares Figure 357: Fragrances - global market shares Giv audan Other Giv audan Other 23% 28% 28% 33%

Firmenich Sy mrise IFF Sy mrise 19% 14% 16% Firmenich 9% IFF 14% 16%

Source: J.P. Morgan estimates, Company data. Source: J.P. Morgan estimates, Company data.

The industry has seen considerable consolidation in recent years still most in the industry believe that there is more to come. Givaudan is the biggest player with a c.25% market share after its $2.4bn acquisition of Quest International in 2007. Symrise was publicly listed in 2006.

The F&F industry is characterized by high barriers to entry and limited risks of substitutes. This enables high levels of profitability, with Givaudan enjoying EBITDA margin of >20%. The industry relies on technological expertise of thousands of ingredients (some of which are patented) and their compounding.

The industry continues to consolidate – and favors those with larger R&D budgets (7~10% of sales). The change in ownership of two key players in the flavours and fragrances industry has put the spotlight back on the highly profitable sub-segment of the ingredients industry.

Raw materials for the F&F industry can be divided into three main categories:

• 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. • 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. • Flavour and fragrance compounds, which are a reasonably complex mix of aromatic materials. These are composed of a blend of the first two groupings.

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 for aroma chemicals.

247 248 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 358: Structure of the Flavours and Fragrances Industry Natural Synthetic

Raw Chemical Material Animals Plants Intermediates

Aroma Chemicals Odoriferous Secretions Exudates Essential Oils (natural and synthetic Substances

Merchant Compounds Flavor and Captive Compounds (compounding by the Fragrance (compounding by flavour and fragrance Compounds end users) industry

Finished Soaps and Cosmetics Foodstuff, Beverages Industrial Goods Detergents and Toiletries Tobacco, Pharmaceuticals Uses (End Users) Source: SRI

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2) Food ingredients Food ingredients and “nutraceutical ingredients” are generic terms used to classify a wide range of specialty chemicals that are added to foodstuffs for the purpose of: preservation, fermentation, sweetening, and/or to add health benefits. Some of the major food additive product categories include: thickeners and stabilisers, alternative sweeteners, colours, enzymes, shelf life extenders (including antioxidants and preservatives) and emulsifiers. One of the fastest growing areas of the market is the “nutraceutical ingredients” market – products focused on enhancing the nutritional value of food.

Introduction Food ingredients are chemicals used to add value to food, for example to aid preservation, fermentation or add colour. The major drivers of this product category include consumer demand for food and beverage products that offer: greater convenience, higher quality and increased safety, as well as an attractive appearance. Increased interest in health & wellness, as well as changing demographics (e.g. ageing population) are also key drivers.

Table 132: Food ingredients at a glance Growth rate (CAGR to 2012E) c.3%; but varies widely by sub-area (e.g. nutraceuticals c.7%) Key end market Food & beverage industry Key demand region US, Europe, Japan, China Key players Danisco, DSM, BASF/Cognis, ABF, Chr Hansen Market structure Fragmented overall, with consolidation in selected niches Source: J.P. Morgan estimates.

Overview & outlook The food ingredients industry is made up of a wide range of additives, all aimed at improving the appearance, quality or nutritional value of food and beverages. Innovation is key across much of the sector, resulting in the continued emergence of new niches. Estimates on market size have therefore varied significantly, with DSM estimating the global food ingredients market to be c.€32bn+.

Growth forecasts also vary widely, with SRI estimating the food ingredients industry in aggregate to grow at c.3% per annum (of which China c.6%). Individual sub- sectors can however vary markedly, with some areas (eg food enzymes) enjoying much higher growth rates (up to c.10%).

A recent trend (particularly among the larger players) has been the application of food ingredients-based technologies to industrial applications (eg technical enzymes, green polymers), opening up further growth opportunities.

The food additives sector is overall fairly fragmented, with a wide range of generalist and specialist producers. Consolidation has been a key theme, and is expected to continue medium-term.

Production process Manufacturing processes for food ingredients vary widely. Some of the production techniques include: chemical synthesis, microbial fermentation, extraction of biologically active compounds, concentration and stabilization, compounding, and tableting. Typically, chemical additives made by synthesis, extraction or fermentation require a high level of capital investment.

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The majority of these processes require technical know-how, as well as access to dedicated facilities with high hygiene standards. All products must be made to a high degree of purity and quality, and plants are subject to periodic inspection by local authorities (e.g. the FDA) as well as customers. Recent food scares (e.g. melamine- tainted baby milk in China) have also increased demand for quality, as well as traceability.

Raw materials are equally as varied - ranging from natural (plant) extracts and oils to sugars and petrochemicals.

Demand The food additives industry encompasses a broad spectrum of food (& feed ingredients. With the sub-sector made up of a large number of niches, estimates on market size have varied considerably. According to DSM, the global food ingredients market was worth c.€32 billion in 2009, of which nutritional ingredients and texturants accounted for c.50%. Danisco, in contrast, estimates the global food ingredients market to be c.U$24 billion in scale.

Figure 359: Global food ingredients market (€32 bn) Figure 360: Nutritional ingredients for food (€8 bn)

Colour Carotenoids Probiotics Other Preserv ation 3% 2% 5% Taste Amino acids Vitamins Proc. Aids 3% 26% Phy to chemicals Minerals Peptides 5% 20% Nutritional 8% Herbal ingredients Nutritional ex tracts Texture lipids 8% Dietary fibres 11% 9% Source: DSM, 2009 Source: DSM, 2009

Application areas vary widely, with savoury foods, beverages and supplements being the largest end-markets, according to DSM estimates.

Figure 361: Golobal food ingredients - key applications Preserv es Oils/fats Other Sav oury 1% 1% 11% 18% Confectionery 6% Meat/fish 6% Bev erages Functional food 16% 9% Dairy Bakery 9% Supplements 11% 12% Source: DSM, 2009

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In addition to human food, a number of players in the ingredient space service the feed ingredients market. According to DSM, this market was worth c.€16 billion in 2009, of which c.€7 billion was accounted for by nutritional additives.

Figure 362: Feed additives market (€16bn) Figure 363: Nutritional additives for feed (€7bn)

Other 15% Carotenoids 3% Nutritional Feed Amino acids Pharma additiv es enzy mes 50% veterinary 5%

Vitamins 27%

Source: DSM, 2009 Source: DSM, 2007

In addition to the food and feed markets, we also highlight the enzymes and cultures markets, which we estimate to be c.U$1-2 billion in scale.

Market sizing has becoming increasingly complex in recent years, given the introduction of new products and the increasing application of ingredients-based technologies to industrial applications (eg technical enzymes, green polymers).

Demand for food ingredients is driven by increasing consumer demand for foods which are: convenient, appetizing, appealing in appearance as well as nutritious. Increased media coverage of health & wellness trends, as well as changing demographics (e.g. ageing population) are also key drivers.

Growth forecasts for the sector vary widely, with SRI estimating c.3% per annum (of which China c.6%). Relatively well-established food additives such as texturants and emulsifiers are expected to grow at close to GDP rates, whereas new growth areas such as nutraceutrical ingredients – foods and ingredients with a proven health benefit - are expected to enjoy growth of c.7%. In addition, innovative sub-sectors including food enzymes and cultures are expected to enjoy annual growth rates in the high single digits.

251 252 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 364: Food ingredients - expected growth Figure 365: Global nutraceuticals - expected growth China China C/E Europe US US

RoW W Europe W Europe Japan Japan

0% 1% 2% 3% 4% 5% 6% 7% 0% 2% 4% 6% 8% 10% 12% 14%

Source: SRI Source: SRI * based on retail level figures

Nutraceutical ingredients, an emerging sub-sector within the food ingredients market, consists of substances within food which provide medical or health benefits, such as the prevention or treatment of disease. Key product examples include isolated nutrients, dietary supplements, and processed foods and beverages such as vitamin or mineral-fortified cereals, soups, soyfood, and fortified juices.

Nutraceuticals are currently classified as foods and not drugs. Therefore any medical claim of prevention, treatment or cure of disease cannot be made for nutraceutical products. However, health claims are permitted.

Table 133: Food ingredients and their functional properties Nutritional Preservation/ Process Appeal value protection improvement modification Thickeners and Stabilizers X X X X Sweeteners X X X X Colours X Enzymes X X X Vitamins X X X Antioxidants X X X Preservatives X Emulsifiers X X X Nutraceutical Ingredients X Source: SRI and J.P. Morgan

Supply/key players The food additives industry is overall very fragmented, with participants ranging from chemicals companies (e.g. BASF, DSM), pharma companies (e.g. Lonza) to pureplay food ingredients companies (e.g. Danisco). Among these players, some choose to offer a wide product range (e.g. DSM, BASF/Cognis), whereas others specialise in selected niches (e.g. Novozymes, Croda).

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Table 134: Major products by ingredient category Product Category Examples Market participants Acidulants Citric, malic, tartaric, phosphoric acids DSM, Danisco Antioxidants Vitamin C and E, TBHQ, BHA, BHT, erythorbates, sulphites, tocopherols DSM, Lonza, Danisco Colours Synthetic and natural food colours Chr Hansen, Sensient, Danisco Emulsifiers Mono- and diglycerides, lecithin, polysorbates Danisco, CSM, Cargill, Kerry, ADM Enzymes Rennets, proteases, lactase, amylase and pectic enzymes Novozymes, Danisco, DSM, Chr Hansen Nutraceuticalingredients Omega 3, xylitol, vitamins, lutein, phytosterols BASF/Cognis, Croda, Danisco, DSM Preservatives Benzoates, sorbates, propionates, parabens Celanese (Nutrinova), Danisco Sweeteners/bulking agents Aspartame, acesulfame-K, sucralose, polyols, polydextrose Tate & Lyle, Celanese (Nutrinova), Danisco Thickeners and gums Casein, starches, xanthan gum, alginates, pectin, guar gum ADM, Cargill, Corn Products, Danisco, FMC, Tate & Lyle Vitamins/minerals Vitamins (e.g. A, B, C, D, E, K), carotenoids, calcium, iron DSM, BASF, Lonza, Chinese players (e.g. NHU) Source: SRI and J.P. Morgan In some cases (e.g. vitamins), formulators operate between the producers of the ingredients and the food industry. The one exception being DSM, who prides itself in offering the full value chain: from bulk products to premixes. Formulators very often have specialist know-how about the interaction of the various compounds used in the premixes.

With innovation being a key success factor, R&D costs can be costly, with expenditure as a proportion of sales as high as c.10% in some product areas. These costs, coupled with the time and money needed to gain approval and market a new product have served as entry barriers for new comers. Increasing regulatory pressures have also in recent years added further pressures, favouring larger players.

The food additives industry has therefore seen significant consolidation. Recent large scale moves include Corn Products’ U$1.3bn acquisition of Akzo’s National Starch (2010), BASF’s €3.1bn acquisition of Cognis (2010), Cargill’s acquisition of Degussa Bioactives (2005) and Danisco’s acquisition of Genencor (2005). We expect consolidation to remain a key trend in the medium-term.

3) Cosmetic ingredients Cosmetic ingredients encompass a wide range of chemicals for the home & personal care sector – for the purpose of cleaning, anti-ageing and moisturizing – to name a few. Demand is generally defensive, due to its key driver being consumer vanity.

Table 135: Cosmetic ingredients at a glance Growth rate (CAGR to 2012E) c.3.5%; but varies by niche (e.g. men’s grooming c.6%) Key end market Personal care industry Key demand region Europe, US, Japan, China Key players Croda, BASF/Cognis, Symrise, Rhodia Market structure Fragmented; consolidation within niches Source: J.P. Morgan estimates.

Introduction The segment which we define as “cosmetic ingredients” encompass a wide range of chemicals, including: surfactants, emollients, fixative polymers, active ingredients and UV filters. With the home & personal care sectors being the end-market, key functionalities range from cleaning, anti-ageing, moisturizing and cooling to hair conditioning.

Ingredients from plant and vegetable origins are playing an increasingly important role, and demand tends to be fairly defensive, driven by vanity trends, changing demographics (e.g. aging population) and a growing affluent customer base in the emerging markets.

253 254 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Overview & outlook The cosmetic ingredients industry is expected to grow c.3-4% per annum, although innovation-intensive niches (e.g. anti-ageing) enjoy much higher growth prospects.

An emphasis on R&D, combined with quality and consumer know-how have served as barriers to entry, enabling those within this defensive sector to enjoy above- average returns. Consolidation has been a key trend, which we expect will continue in the medium-term.

Demand The cosmetic ingredients industry is expected to enjoy above-average growth, benefiting from defensive growth characteristics of the home & personal care markets. Although SRI estimates assume a growth rate of c.3.5% for the sector as a whole, we highlight that growth rates vary widely by product - ranging from 1% to 10% - with the highest rates enjoyed by those with a strong focus on R&D.

The mature markets of Western Europe and North America account for over half of global demand, with the emerging markets of Asia and Latin America gaining increasing importance. This has been largely due to the increasing affluent customer base in these markets, and an increasing interest in “western” vanity trends.

Figure 366:Cosmetic chemicals – consumption by region Figure 367: Cosmetic chemicals – expected growth by region

RoW China Latin America 7% W Europe Latin America 10% 32% RoW

China W Europe 11% N America

Japan Japan 12% N America 28% 0% 4% 8% 12% 16%

Source: SRI Source: SRI

Figure 368: Chinese sales of cosmetics - by type Figure 369: Chinese sales of cosmetics - expected growth

Toiletries Frag/perfumes 11% Skin care 35% Skin care Fragrances/ perfumes Toiletries 25%

Hair care Hair care 29% 0% 5% 10% 15% 20% 25%

Source: SRI Source: SRI

254 255 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Other key health & wellness trends, which we view as drivers include growing consumer interest in

• personal hygiene products with added extras (e.g. shampoos with hair lightening properties) • appearance enhancement (e.g. lip plumpers) • protection against harmful effects (e.g. sunscreens) • anti-ageing (e.g. anti-wrinkle creams) • slimming (e.g. cellulite treatment)

We also highlight the emergence of new target groups (e.g. men, children).

Supply/Key players The industry is fairly fragmented, with concentration within selected niches. Croda and Cognis (now part of BASF) are estimated to have a share of c.10% in its relevant “consumer care” markets, closely followed by ISP (c.5%). Other players including Rhodia and Akzo Nobel tend to compete in comparatively less R&D-intensive product areas (surfactants), and therefore have lower margins.

The sector is overall fairly fragmented, with a handful of global players and a large number of small. regional players with an expertise in selected product lines. Yet with the customer base seeking to become increasingly global, consolidation has been a key theme in the sector. Recent deals include BASF’s acquisition of Cognis (2010) and Croda’s acquisition of Uniqema (2006).

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Fine Chemicals Introduction The term “fine chemical” is used almost exclusively in reference to life science intermediates/molecules. 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 medicinal and pesticides, biocides (antibacterial or disinfectant agents that are added to a wide range of products and processes) and laboratory chemicals. They are sold on the basis of their composition and generally are interchangeable with other products of the same composition.

Table 136: Fine Chemicals at a glance Growth rate (CAGR to 2012E) Around 3%-6% Key end market Pharmaceutical Industry, Agrochemical, Biotechnology Key demand region Asia, Western Europe, North America Key players Lonza, Clariant, Avecia, Solutia, BASF, DSM, Lanxess Market structure Still fragmented Source: Company data and J.P. Morgan estimates.

Overview&Outlook According to SRI, the fine chemicals industry should deliver top-line growth of around 3-5% in the long term. Growth rates for fine chemicals ought to grow in line with their end markets (7-10% for pharmaceuticals and 2-3% for agrochemicals, on our estimates).

Much of the future growth is coming from emerging markets. Whether European or U.S. listed players within the chemicals sector are able to meaningfully compete with the numerous Asian competitors over the long term remains less certain in our view.

In recent years life sciences companies tended to reverse the late 1990s production outsourcing of key intermediates and favoured in-house solutions as dwindling pipelines have left in-house production vacant.

Demand After the pharmaceutical manufacturers, fine chemicals producers are the largest suppliers to the pharmaceutical industry (creating more than 50% of demand).

Figure 370: End uses of fine chemicals Agricultural Application 25%

Pharmaceutical Others 55% 12%

Dy es 8% Source: J.P. Morgan estimates.

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Production process In the production of (chemical-based) fine chemicals, chemical companies operate in one or more steps of production. At first they produce base chemicals and intermediates to create the advanced intermediates (through advanced refinery, see Petrochemical section). Then, these products are further manufactured for the specific requirements of the customer, giving them higher value-added.

Figure 371: Fine Chemicals - Production Chain

Oil/ Gas Base Chemicals Intermediates

Advanced Intermediates Finished Molecules Final Products

Source: J.P. Morgan

In the early stage of production, pricing appears the primary driver because of the commodity character of the products. Then, in the further steps of the process, barriers of entry become higher, with more technology and regulation requirements. For example, Producers need regulatory approval (eg FDA) of their facilities.

Key players The market for fine chemicals is highly fragmented. The main players in the industry are DSM, Lonza and Evonik. In the past few years companies have increasingly reduced their involvement in the first steps of production due to the commodity structure of products used and additional capacity in the Middle East and Asia. Instead, their focus is on the production of finished molecules and even final products.

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 costs involved in the production of these chemicals, many Asian competitors have been able to offer the products at a greatly reduced cost.

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.

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The consequence of this trend towards 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 over-supplied at the same time as demand was waning. (Dwindling pipelines at large pharmaceutical houses, increased challenges from generic producers and increased FDA scrutiny meant that in recent years a reversal in the outsourcing trend has taken place).

Fine chemicals have high capital Fine chemicals businesses tend to have comparatively high capital intensity and intensity 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 towards 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 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).

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 to maintain or improve margins, particularly given increasing levels of generic competition and intensification in the overall competitive environment.

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.

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Catalysts

Introduction Catalysts are substances that alter the rate at which other chemicals react, while they undergo no reaction themselves. They enable economic efficiency by speeding up the rate of a chemical reaction. Catalyst steps are required for about 90% of chemical manufacturing processes and 20% of industrial products. 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.

Table 137: Catalysts at a glance Growth rate (CAGR to 2012E) 4-5% Key end market Autos, Chemical processing, Petroleum refining Key demand region US (34%), Europe (28%), Japan (14%) Key players BASF, Johnson Matthey, Umicore, WR Grace, Albermarle Market structure Fragmented Key inputs Precious metals Source: J.P. Morgan estimates.

Overview Catalysts can be split into petroleum catalysts, chemical catalysts and environmental catalysts (see detailed explanation below). Due to strong demand from the gasoline and petrochemical industry, we believe petroleum catalysts ahould enjoy healthy growth of 8-10% CAGR until 2012. Demand for chemical catalysts reflects a wide range of drivers, but broadly follows overall industrial activity. We estimate long- term demand in this area of approximately 2-3% per year. For environmental catalysts we expect tightening emissions legislation to lead to growth of around 10- 12% CAGR over the next four years, falling to 6% beyond this period.

Figure 372:Catalyst consumption by region Figure 373: Catalyst market by type- 2006 Total consumption(2006) $13.4bn Total consumption(2006) $13.4bn

Other 13% Emission control Chemical North America catalysts 36% China 11% Processing 38% Catalysts 42%

Japan 11%

Petroleum W Europe 27% Refining Catalysts 22% Source: SRI and J.P. Morgan Source: SRI and J.P. Morgan

259 260 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 374: Catalysts average annual growth rate (2006-2011E CAGR)) 5.0%

4.5%

4.0%

3.5%

3.0%

2.5%

2.0%

1. 5 %

1. 0 %

0.5%

0.0% US Europe Japan ROW Source: SRI and J.P. Morgan

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, which is part of BASF AG now, is one of 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. Johnson Matthey-owned Synetix is Europe’s principal producer of hydroprocessing catalysts. • Reforming catalysts are used to further refine and enhance petroleum components to create gasoline and petrochemical feedstocks. Demand for these chemicals relies largely upon the health of the oil refining industry. Environment laws are getting stricter, with the mandate of production of cleaner fuels. Refineries are feeling pressure because of stringent guidelines for emissions of NOx, Sox, CO, and CO2, which fuels the demand for catalysts. We expect longer-term growth rates to be in the region of 8-10% per annum, although upside to this growth rate could be driven by a major expansion in ‘gas to liquid’ (GTL) technology. Chemical Catalysts 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. Major market segments include polyethylene, polypropylene, polyethylene terephthalate, polyvinyl chloride and polystyrene. Polyolefin catalysts are the largest single market sector with about 55% market share of total polymerisation market in 2006. Other large markets are for oxidisation (in the production of ethylene oxide)/ammoxidation/oxychlorination, organic synthesis, hydrogenation 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 polymerisation, but also increase the output of a polymer of a certain molecular weight, with certain properties and advantages.

260 261 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Environmental Catalysts Environment catalysts are based on platinum group metals (PGMs) that convert vapor into carbon dioxide and water. Environment 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 autos 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 also from retrospective fitting of catalysts to vehicles already in circulation. In addition, industrialisation of developing economies offers further potential for growth, as emissions from industrial plants and other non auto-related industries (construction vehicles, lawn care, snow mobiles etc) come under scrutiny. Growth in the industry has historically been in the region of 3% but is strongly increasing.

In recent months, the German cabinet announced plans to cut greenhouse gas emissions by 40% by 2020, and President Sarkozy in France unveiled a plan to correlate car fuel efficiency with taxes, and intends to invest €1bn into research into clean engine and fuel technology.

Over the past decade, the combination of tightening legislation and a more favorable mix (increasing proportion of larger vehicles, namely SUVs) has meant that demand for auto catalysts has exceeded autos production growth by c.10% each year. Although rising fuel prices have led to a shift to smaller vehicles, we expect impending legislation to be sufficient to enable the autocatalysts market to continue to grow c.400 bps above the autos market, at c.6% per annum. In addition, the legislative umbrella is covering an increasingly wide selection of vehicles such as trucks and buses, as well as farm and construction machinery. All of which will add to future growth.

Figure 375: HDD - On Road regulation development 0.2 New Models All Models Japan 2003 0.18 Europe Euro IV Oct 05 Oct 06 0.16 Euro V Oct 08 Oct 09 0.14 United States US 2002 3/4 US2007 Jan 07 Jan 07 0.12 US2010 Jan 10 Jan 10 EU III 0.1 Japan New Short Term 0.08 2.5-12t Oct 03 Oct 03 PM (g/kW -hr) (g/kW PM 0.06 12t + Oct 04 Oct 04 US 2010 New Long Term 0.04 Japan 2005 2.5t+ Oct 05 Oct 05 0.02 China EU V EU IV US 2007 Euro III – selected cities 2008? 0 India 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 Euro III – selected cities Apr 05 Euro III – nationwide 2010 NOx (g/kW – hr)

Source: Company reports.

261 262 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Figure 376: 'Non-road' emissions legislation Table 138: 'Non-road' emissions legislation 0.3 Europe New Models All Models EU IIIA Stage IIIB Jan 2011 Jan 2012 0.28 US 3 Stage IV Oct 2013 Oct 2014 0.26 United States 0.24 Tier 4a Jan 2011 Jan 2012 Tier 4b Jan 2014 Dec 2014 0.22

0.2

0.18

0.16

0.14

PM (g/kW-hr) 0.12

0.1

0.08

0.06 US 4b EU IV 0.04 EU IIIB US 4a 0.02

0 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 NOx (g/kW-hr) Source: Company reports. Source: Company reports.

Table 139: HDD - World Diesel Fuel Standards Sulphur content in PPM Year Country 95 96 97 98 99 2000 01 02 03 04 05 06 07 08 09E 10E European Union 350 50 10 USA 500 15 Australia 500 50 China 2000 (Ave 800) 350 for Beijing Hong Kong – China 50 10 India (11 Major Cities) 500 350 50 India 2500 500 Japan 2000 500 50 10 Korea 2000 130 50 30

Over 1000 pp m < 500 pp m 50 pp m Less than 30 pp m Source: Company reports.

Key players The top 3 key players in the catalysts industry are BASF (following its acquisition of Engelhard), Johnson Matthey and Umicore.

262 263 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

European Chemicals: Companies at a glance

lance g anies at a p European Chemicals: Com 263 264 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Air Liquide

Figure 377: Sales by division (2009) Figure 378: EBIT by division, €mn (2009) Industrial Merchant 36% Others 1000 5% 800

Electronics 600 7% 400

Engineering & 200 Construction 0 10% Large Industries Industrial Healthcare Electronics Engineering & Others Large Industries Merchant Construction Healthcare 27% 15%

Source: Company data Source: Company data Figure 379: Sales by destination (2009) Figure 380: EBITDA margin development North America 22% 27.0% 25.0% 23.0% 21.0% 19.0%

Europe Asia 17.0% 57% 19% 15.0% 13.0% ROW 2005A 2006A 2007A 2008A 2009A 2% Source: Company data Source: Company data, J.P. Morgan estimates

COMPANY DESCRIPTION: The world's leading supplier of industrial gases, with around 21% global market share. Gases and Services (85% of group sales in 2009) are used in a variety of end-markets. Key end markets are the refinery, steel, automotive and healthcare industry. Air Liquide also provides other gas-related businesses (15% of group sales), including Engineering and Construction.

The acquisition of Lurgi in April 2007 for a €500m equity value doubled the size of Air Liquide’s engineering business and enlarged its technology portfolio, particularly in hydrogen and synthetic gas production processes, in biofuels and in the developing Coal to liquid (CTL) and Coal to Chemicals (CTC) markets.

STRENGTHS: WEAKNESSES: • Truly global player with significant market share in each • Limited gearing to early stages of economic recovery. of the major industrial regions. • US healthcare gases business has struggled to compete. • Established strong infrastructure in N. Europe and the US. • Lower exposure to emerging markets than Linde. • High % of on-site business provides earnings stability. • Sheer size may limit growth. • Surcharge clauses allow pass-through of energy costs in on-site business (and some merchant business). OPPORTUNITIES: THREATS: • Expanding use of gases in healthcare. Market leader in • Merger of Airgas & Air Products can be potential threat healthcare gases in S. Europe. to its market share. Though transaction is still pending. • Increasing energy opportunity driven by high oil prices • Rising energy costs can prove tough to pass through in and energy security concerns (CTL, GTL, CTL) and smaller-scale gases operations. environmental concerns

264 265 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 140: Air Liquide: Divisions and products 2009 Sales % Division Business units (€m) sales Key products Key end-markets Key market positions Key competitors Gases and Industrial Merchant 4,276 36% Bulk & cylinder deliveries Food & pharma, automobiles and Globally #2 in bulk and cylinder Linde, Praxair, Air Products, Airgas, Services (Oxygen, Nitrogen, Hydrogen, manufacturing, materials & energy business Taiyo Nippon 85% sales Cryogenic & non-cyrogenic gases) Large Industries 3,218 27% Air gases and hydrogen Refineries, chemicals, energy, Globally #1 in Large industries Linde, Praxair, Air Products, Airgas, metal manufacturers, steel Taiyo Nippon Healthcare 1,825 15% Therapeutic gases, mainly Oxygen Hospitals, homecare, research #1 in Healthcare gases Linde, Praxair, Air Products, Airgas, institutes, hygiene industry Taiyo Nippon Electronics 872 7% Specialty gases, Equipment, Computers, flat screen, digital Linde, Praxair, Air Products, Airgas, services music players, mobile phones Taiyo Nippon

Engineering & Engineering & 1,226 10% Design, installation, construction of Healthcare, chemical, construction, Construction Construction plants food & beverages, metal 10% sales production Other activities Other activities 559 5% Chemical, Diving Chemical, pharma, aerospace, 5% sales auto, microelectronics, transportation Total 11,976 100% Source: Company reports and J.P. Morgan estimates.

265 266 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Akzo Nobel

Figure 381: Sales by division (2009) Figure 382: EBIT by division, €mn (2009) 600 Decorativ e Specialty Paints 500 Chemicals 34% 37% 400 300 200 100 0 Performance Decorative Paints Performance Coatings Specialty Chemicals Coatings 29% Source: Company data Source: Company data Figure 383: Sales by destination (2009) Figure 384: EBITDA margin development Other 4% North America Asia Pacific 21% 16% 20% 14% 12% 10% Latin America Emerging 8% 9% Europe 7% 6% 4% 2% 0% Western 2005 2006 2007 2008 2009 Europe 39% Source: Company data Source: Company data, J.P. Morgan estimates COMPANY DESCRIPTION: Akzo Nobel is a specialty chemicals company with three main divisions: Decorative Paints, Performance Coatings and Specialty Chemicals. Akzo Nobel is the global number 1 company in paints and coatings. Recently, Akzo Nobel announced the sale of National Starch for €1.1bn.

STRENGTHS: WEAKNESSES: • Global leader in paints and coatings. • End markets have significant exposure to GDP trends. • Strong presence in the high-growth emerging markets of • Profitability remains below peer group. Eastern Europe and Asia. • Pension deficit, legacy cash costs . • Strong balance sheet and successful restructuring post ICI. OPPORTUNITIES: THREATS: • Further organic and acquisition led growth. • Lack of recovery in housing/construction markets to further reduce demand. • Further restructuring potential of chemicals and coatings businesses. • Raw material/input cost pressures may impact margins. • Potential asset disposal ?

266 267 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 141: Akzo Nobel: Divisions and products 2009 Sales % Division Business units (€m) sales Key products Key end-markets Key market positions Key competitors Decorative Decorative Europe 2,531 18% Internal and external wall paints and Professional & DIY #1 Europe PPG (SigmaKalon), Tikkurila Paints lacquers 34% sales Decorative 1,413 10% Internal and external wall paints and Professional & DIY Top 3 in US, #1 Canada Sherwin-Williams, PPG, Americas lacquers #2 in Latin America Valspar, Benjamin Moore Decorative Asia 632 5% Internal and external wall paints and Professional & DIY Top 2 in Asia Nippon Paints, Kansai Paints lacquers Performance Industrial Coatings 725 5% Coil and extrusion coatings, Specialty Appliances, architecture, automotives, cosmetic packaging, #1 in coil & extrusion, DuPont, Valspar, BASF, Coatings plastics coatings and Packaging flooring, furniture, general industry, general trade coaters, #1 in specialty plastics, PPG, Nippon Paints, Kansai coatings IT, metal building products, sports goods #2 in packaging coating Paints 29% sales Marine & 1,260 9% Marine coating, protective coating, Abrasion/corrosion/chemical resistance, fouling control ,high #1 in marine, protective Ameron, Chugoku, Hempel, Protective yacht paints, aerospace coatings performance cosmetics, fire protection, tank lining systems #1 in yacht paints Jotun, PPG (sigmaKalon), Coatings Nippon Paints Car Refinishes 872 6% Primers, basecoats, topcoats and Car body refinishing, recoating, car repair, commercial #2 in aerospace BASF, DuPont, PPG, Kansai clearcoats for vehicle refinishes, vehicles, automotive plastics, bus, truck, specialty vehicle Top 3 in vehicles refinish & Paints, Nippon Paints Automotive plastic coatings and OEMs, fleet owners and operators OEM commercial vehicle customer service technology Wood Finishes 684 5% Wood coatings, Wood adhesives and Appliances, architecture, automotives, cosmetic packaging, #1 finished BASF, DuPont, PPG, Kansai and adhesives broad resins flooring, furniture, general industry, general trade coaters, #3 adhesives Paints, Nippon Paints IT, metal building products, sports goods Powder Coatings 597 4% Internal and external coatings and inks Food & beverages, packaging industry #1 in powder coating BASF, DuPont, PPG, Kansai for food, beverage, aerosol and general Paints, Nippon Paints line cans Specialty Pulp & Paper 935 7% Pulp and paper chemicals, Pulp and paper #1 in bleaching chemicals Kemira, , Hercules, Nalco Chemicals 37% sales Industrial 949 7% Energy, salt, chlorine, Caustic lye and Detergent, Pulp and paper, Plastic industries, Chemical, #1 in caustic/chlorine Arkema, BASF, Dow, PPG, Chemicals Monochloroacetic acid (MCA) Construction and Food (merchant) in Europe, #1 Solvay in MCA Functional 1,479 11% Cellulosic additives, Chelates, Additives Detergents, Personal care, Crop protection, Micronutrients, #1 in chelates, Albemarle, Arkema, BASF, Chemicals for the mortar industry, Ethylene Building materials, Paints, Pharmaceutical and Food #1 in sulphur derivates Bayer, Chemtura, , Clariant, amines, Salt specialties, and Sulphur #1 cross linking & Dow derivatives thermosat peroxides and additives, high polymer specialties Surface Chemistry 701 5% Surfactants and Synthetic and natural Agriculture, Asphalt, Personal care, Petroleum, Water #1 in industrial, agriculture Clariant, BASF, Croda, polymers treatment, Household cleaning and Mining #3 in HPC Huntsman (Hexion), Rhodia, Stepan Chemicals 405 3% Polyester fiber, Soda ash, Life Consumer products, electronics, engineering, extractive Local players Pakistan sciences, Chemicals and Paints industries, food & beverages, pharma, textiles

Total 13,893 100% Source: Company reports and J.P. Morgan estimate

267 268 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Arkema

Figure 385: Sales by division (2009) Figure 386: EBIT by division, €mn (2009) Vinyl Products

Performance 23% 200 Products 30% 150

100

50

0

-50

Industrial -100 Industrial Chemicals Performance Products Viny l Products Chemicals 47%

Source: Company data Source: Company data Figure 387: Sales by destination (2009) Figure 388: EBITDA margin development Rest of the Asia and World 4% 10% Middle East 18% 8%

6%

4%

Europe 54% 2%

0% North America 2005 2006 2007 2008 2009 24%

Source: Company data Source: Company data COMPANY DESCRIPTION: Arkema was formed in October 2004 from the reorganization of Total’s Chemicals’ business, and listed in Paris in May 2006. The business is focused on three key areas – Vinyl Products, Industrial Chemicals and Performance Products, encompassing 13 business units. After a period of extensive rationalization since the spin-off, the business holds top 3 position in c75% of its portfolio. Management’s strategy going forward is to i) grow through new product innovation, ii) increase the pace of development in Asia and iii) improve its competitive position helped by ongoing cost cutting. At some stage a total or partial exit from the volatile Vinyls area is possible given the drag on investor sentiment this unit creates.

STRENGTHS: WEAKNESSES: • Leadership in specialty portfolio (more than c75% of • Vinyl products dilutes group margins sales top 3) • Significant dependency on mature markets • Relative pricing strength (excluding Vinyls) OPPORTUNITIES: THREATS: • Expansion opportunity in Asia • Over-capacity in PVC • Margin upside through restructuring • Fluctuations in raw material and energy prices • Balance sheet health provides strategic flexibility • Legislative changes – eg in fluorocarbons, chlor-alkali (mercury technology)

268 269 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 142: Arkema: Divisions and products Division 2009 Sales, €m Business units Key products Key end-markets Key market positions Key competitors Vinyl 1,005 Chlorine/Caustic Chemicals, aluminum, pulp and paper, Construction, Chemicals, Automotive, electronics and home #6 in chlorine (Europe) Caustic(Dow, Oxy,PPG, Products soda detergents and soaps, solvents and raw appliance industry OLIN, FPC), Chlorine(Dow, materials for fluorinated products Oxy, Olin, PPG, Bayer) 23% sales PVC Construction, pipes, profiles, packaging, Construction, Chemicals, Automotive, electronics and home #3 in Europe in PVC Shintech, Formosa, cabling, automobiles appliance industry Occidental, Ineos, Solvay,Georgia Gulf Vinyl Cables, bottles, automobiles, medical Construction, Chemicals, Automotive, electronics and home Top 4 Shintech,Oxy Compounds appliance industry Vinyl,FPC,Ineos,Georgia Gulf Pipes & Profiles Pipes and profiles Construction and home building #6 in pipes & profiles (Alphacan) (Europe) Industrial 2,109 Acrylics Paints and coatings, super-absorbents, Coating, Plastic additives,Water treatment, Paper & #3 Dow, StoHaas,BASF, Chemicals Plastics additives, Water treatment, Paper adhesives Nippon Shokubai and Adhesives 47% sales PMMA PMMA granules and cast or extruded Construction, automotive ,plumbing, store sign, electronics #1/2 globally Mitsubushi, Evonik, Dow, sheets and home appliance industry Sumitomo Chemicals Thiochemicals Sulphur chemicals, Amines, Oxygenated Animal Feed,Polymers, Pharma,Cosmetics,solvents & #1 I hydrogen sulphide solvents, Rubber additives Petrochemicals derivatives Fluorochemicals Hydrochlorofluorocarbons, Refrigeration & Foam industry #2 globally Atofina, Ineous, DuPont, Hydroflouorocarbons Honeywell,Daikin,Asahi Glass,Solvay Hydrogen Hydrogen peroxide, chlorate,sodium Pulp, chemical (including organic peroxides), textile, #3 in hydrogen peroxide Solvay, Degussa, Peroxide perchlorate, and hydrazine hydrate Electronics Industry Arkema,FMC,EKA –Akzo-, Kemira, Specialty acrylic Acrylic polymer used as dispersants and Paper, Paint, Water treatment, Cosmetics and Textile polymers thickeners Industry (Coatex) Performance 1,318 Technical Polyamides 11 and 12, specialty Plastics, Construction, Automotive Industry #1 Polyamides 11 BASF, DSM, DuPont, EMS, Products Polymers polyamides, PVDF and functional #3 Polyamide 12 Evonik, Lanxess, Rhodia, polyolefins Co-leader in PVDF Solutia 30% sales Specialty Surfactants/Interfaces, Adsorbtion/ Detergent, Oil & Gas, Fertilizer Industry, Pharma, Building, #2 Molecular sieves Albemarle, UOP, Cosmo Chemicals Filtration (Molecular sieves, Diatomite, Agrifood,Personal care,Cosmetics Industries, WR Grace, PQ (CECA) Activated carbon and perlite) Functional Polymerization Initiators, PVC additives, Automotive, Construction, Chemicals #2 tin-based heat Additives Coating additives and catalysts stabilizers for PVC Other 12 Total 4,444 Source: Company reports, J.P. Morgan estimates.

269 270 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

BASF

Figure 389: Sales by division (2009) Figure 390: EBIT by division, €mn (2009) Functional products Other 9% 2500 14% Agricultural solution 2000 7% 1500 Plastics 1000 14% 500 0 Oil & Gas 23% Agricultural Chemicals Plastics Performance Functional Oil & Gas solution Products products Chemicals Performance 15% Products 18%

Source: Company data Source: Company data

Figure 391: Sales by destination (2009) Figure 392: EBITDA margin development

North America 25% 19% Asia 17% 20% 15%

Latam 10% 3% 5% ROW 5% 0% Europe 2003A 2004A 2005A 2006A 2007A 2008A 2009A 56%

Source: Company data Source: Company data

COMPANY DESCRIPTION: BASF is the world’s largest chemical company in terms of revenues. The group has six main divisions, encompassing oil & gas and agrochemicals, as well as a wide variety of chemicals, plastics, performance and functional products. The company holds a cost advantage due to its vertically integrated 'Verbund' production sites. BASF’s oil & gas activities are pooled in the Wintershall Group and include several joint ventures with Gazprom to bring Russian Gas to the European markets. In May 2010 BASF acquired Cognis for €3.1bn, reflecting another strategic move towards creating a portfolio that over time aims to offer reduced traditional industrial cyclicality and higher through-the-cycle returns (following on from previous acquisitions of Engelhard, Degussa Construction and Ciba S.C.).

STRENGTHS: WEAKNESSES: • Cognis acquisition is one more step forward in reducing • Majority of earnings still reliant on industrial end portfolio cyclicality. markets, and hence exposed to economic slowdown. • Verbund production sites provide significant cost • Agricultural Products division has limited biotech advantages. franchise. • Oil & Gas E&P business provides a significant earnings • Oil & Gas business holds low reserves to production hedge against rising chemicals input costs. ratio. OPPORTUNITIES: THREATS: • Expansion of E&P business through Gazprom JV should • Accelerating capacity growth in the petrochemical improve reserves ratio. industry principally from the Middle East. • Significant R&D into high growth areas such as • Input cost pressures. bioplastics and ag-biotech (Monsanto JV). • Double dip or European slowdown would affect earnings.

270 271 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 143: BASF: Divisions and products 2009 Sales % Key market Division Business units (€m) Sales Key products Key end-markets positions Key competitors Chemicals Inorganics 983 2% Inorganic specialties, Electronic materials, Inorganic Automotive, Construction, Medical sector, Electronic & #1 in inorganic salts Arkema, Yara, DSM, Evonik, Airproducts chemicals, Glues & resins, Carbonyl iron powder and electrical, Chemical in Europe, #1 in metal systems glues in Europe 15% of sales Petrochemicals 4,664 9% Cracker products, Alkylenes oxides and glycols, Coating, Pharma, Cosmetics, Plastics Oxo alcohols: #1 Cracker products: Dow, ExxonMobil Chemical, Sabic, Shell Solvents, Plasticizers & its raw materials, Acrylic Plasticizers: #2, Chemicals, LyondellBasell monomers Solvents: #2 in Alcohols and solvents: Dow, Eastman, Exxon, Oxea, Sinopec Europe, Ethylene Plasticizers: ExxonMobil Chemical, Eastman, Evonik, UPC, Aekyung oxide and ethylene Alkylene oxides and glycols: Dow, Sabic, Shell Chemicals glycols: #2 in Acrylic monomers: Dow, Nippon Shokubai, Arkema Europe Acrylic monomers: #1 Intermediates 1,868 4% Amines, Butanedoil and its derivatives, Polyalcohols & Detergent & hygiene, Process industry, Ag products, Top 3 in amines Amines: Taminco, Dow, Huntsman its derivatives, Acids & specialty intermediates Pharma, Coating, Feed & food, Textile and leather Butanediol and derivatives: ISP, LyondellBasell, Dairen, Mitsubishi, Meizhouwan, Shianhua, Yunwei Polyalcohols and specialties: Eastman, Perstorp, Ube Acids and specialty intermediates: Kemira, Perstorp, Eastman Plastics Performance 3,005 6% Nylon & its intermediates, PBT,POM, PES, Specialty Automotive, Electronic & electrical, Textile, Food Polyamide film: #1 Engineering plastics: DuPont, Lanxess, Rhodia, Sabic, Ticona polymers plastics and foam packaging Engineering Caprolactam: CPDC, DSM, Ube plastics: #2 Ultramid® (fiber polymers): Honeywell, LiPeng, Zig Shen Expandable Ultramid® (film polymers): DSM, Lanxess, Ube polystyrene: #1 EPS: Loyal, Taita, Xingda Biopolymers: #1 14% of sales Polyurethanes 4,123 8% MDI, TDI, Polyesters Polyols, Polyurethanes system, Automotive, Furniture, Shoe, Car, Cables & wires MDI: among top 2 MDI: Bayer Material Science, Huntsman Polyurethanes, Dow, Yantai TPU, Cellular elastomers TDI: among top 2 TDI: Bayer Material Science, Dow, Borsodchem, Mitsui PEOL: among top 3, PO/PEOL: Dow, Bayer Material Science, Shell PU Specialties: #1 Specialties: Bayer Material Science, Dow, Huntsman, Polyurethanes, Lubrizo Performance Paper Chemicals 1,326 3% Process chemicals, Functional chemicals, Coating Paper industry, Construction Coating chemicals: Process chemicals: Nalco, Ashland (Hercules), Kemira, Eka Products chemicals, Kaolin global #1, Process Chemicals chemicals: #1 Functional chemicals: Ashland (Hercules), Clariant, Kemira position for retention Coating chemicals: Dow, Polymer Latex, Omnova business 18% of sales Care Chemicals 3,405 7% Aroma chemicals, vitamins and carotenoids, Human & animal nutrition industry, cosmetic industry, Among top three Aroma chemicals: DSM, IFF, LyondellBasell, NHU, Innospec Pharmaceutical ingredients and services, Water- to colour foods, beverage industry, pharma industry, players in all Vitamins and carotenoids: DSM, several Chinese players soluble polymers, Superabsorbents, UV filters, Non- feed industry, personal care important product Personal care ingredients: ISP, DSM, Symrise ionic surfactants, Chelating agents groups Pharma ingredients & services: Lonza, Evonik, Shasun, ISP Superabsorbents: Evonik, Nippon Shokubai Care Chemicals for detergents and formulators: Shell, Sasol,Dow, Akzo Performance 2,180 4% Plastic additives, Oilfield and mining chemicals, Water Automotive, construction, decorative paints industry, Plastic Additives: Plastic additives: Songwon, Chemtura, Clariant Chemicals solutions, Chemicals for the automotive and refinery plastics, hygiene industry, textile industry global #1 Oilfield and mining chemicals: Nalco, Baker Sytec, SNF industries, Textile chemicals, Leather chemicals Water solutions: SNF, Ashland, Kemira Automotive and refinery chemicals: Infinium, Petrochem, Chemtura, Arteco, Lubrizol Textile chemicals: Clariant, Huntsman, CHT, Leather chemicals: Clariant, Lanxess, TFL

271 272 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

2009 Sales % Key market Division Business units (€m) Sales Key products Key end-markets positions Key competitors Dispersions & 2,445 5% Dispersions, Pigments, Resins, Additives Construction, Automotive, chemicals, paints Leading position in Dispersions: Dow, Celanese, Wacker Pigment dispersions, Pigments: Clariant, Altana, DIC pigments, resins Resins: Cytec, Dow, Bayer and additives Additives: Altana, Evonik, Everlight Functional Catalysts 2,961 6% Mobile Emissions Catalysts, Process Catalysts & Car/bus/truck industry, Power generation industry, Mobile emissions Mobile emissions catalysts: Johnson Matthey, Umicore Solutions Technologies, Precious and Base Metal Services Process industry catalysts: #1 Refinery catalysts: Grace, Albemarle Refinery catalysts: Chemical catalysts: Süd-Chemie, Haldor Topsøe, LyondellBasell, #3, Chemical UOP catalysts: #1 14% of sales Construction 1,991 4% Admixture systems, construction systems Construction Admixture systems: Admixture systems: Sika, W.R. Grace, Mapei chemicals global #1 Construction systems: RPM, Mapei, Bostik, Sika Construction systems: globally among top three Sports flooring: global #1 Coatings 2,163 4% Automotive coating solutions, industrial coating Automobile, construction OEM automotive Automotive OEM coatings: DuPont, PPG, Kansai Paint solutions, decorative paints coatings: #2 Automotive refinish coatings: DuPont, PPG, Akzo Automotive refinish Industrial coatings: Akzo, PPG coatings: #3, Coil Decorative paints South America: Akzo, Sherwin Williams coatings: #3 in Europe Decorative paints: #1 in South America Agricultural Crop protection 3,646 7% Herbicides, pesticides, fungicides, insecticides Agriculture industry Fungicides: #2 Fungicides: Syngenta, Solutions Herbicides: #6 Bayer 7% of sales Insecticides: #3 Herbicides: Monsanto, Syngenta, Bayer, Dow, Nufarm Insecticides: Bayer, Syngenta Oil & Gas Exploration and 3,847 8% Exploration & Production Oil& gas industry Shell, BP, Statoil, ENI, Saipem, Exxon Mobil, Chevron, Total production 23% of sales Natural gas trading 7,509 15% Natural gas trading Oil& gas industry E.on Ruhrgas, Verbundnetz Gas AG, Gaz de France, Centrica Other 4,577 9% Includes Styrenics (to be disposed), sale of raw material, fertilizer business, engineering services, rental income and leases Total 50,693 100% Source: Company reports and J.P. Morgan estimates.

272 273 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Bayer

Figure 393: Sales by division (2009). Figure 394: EBIT by division, €mn (2009) Crop Science

22% 3500 3000 2500 2000 1500 1000 Healthcare 500 53% 0 -500 Material Sciences Healthcare Crop Science Material Sciences 25%

Source: Company data Source: Company data

Figure 395: Sales by destination (2009) Figure 396: EBITDA margin development North America Asia 25% 18% 22% 21%

20%

19%

18% LaTAm/AME 17% 15% Europe 16% 42% 2005 2006 2007 2008 2009

Source: Company data Source: Company data, J.P. Morgan estimates

COMPANY DESCRIPTION: Bayer has undergone a period of portfolio reshuffling, having spun out Lanxess in 2005 and disposed of HC Starck and Wolff Walsrode in 2006. The HealthCare business acquired Schering in 2006 and has a wide product offering for pharmaceutical and consumer applications. CropScience is a market leader in crop protection and seed treatment. MaterialScience is a global leader in polycarbonates and polyurethanes, primarily used in the automotive, building/construction and electronics/electric end-markets.

STRENGTHS: WEAKNESSES: • Significant scale in Polycarbonates and Polyurethanes. • Margin pressure in MaterialScience due to rising raw material costs. • Leading player in Crop Protection. • Limited presence in seeds/biotech. • Limited patent expiries in Pharma franchise. OPPORTUNITIES: THREATS: • Well-positioned to benefit from emerging market growth. • Potential overcapacity in MDI and TDI . • Strong pipeline in CropScience. • Further penetration of GM technology cannibalizing agchem growth. • Rivaroxaban one of the most significant pipeline assets in EU pharma.

273 274 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 144: Bayer: Divisions and products 2009 Sales % Division Business units Key products Sub-division (€m) sales Key market positions Key competitors Material Science Materials Furniture, electrical goods Polycarbonates (6%) 7,520 25% Top 3 in polycarbonates, SABIC, BASF, Dow, DuPont 25% of sales (insulation), sportswear (soles for polyurethanes (12%) thermoplastic polyurethanes, Teijin, Chimei, Idemitsu, Mitsubishi and LG shoes), automotive, adhesives, Coating, specialties, adhesives polyurethanes colorants (4%) Industrial operations (2%) Crop Science Crop Protection Agriculture Herbicides (6%) 5,424 17% Top 3 globally in crop Syngenta, BASF, Dow, DuPont, Monsanto 22% of sales Fungicides (5%) protection Insecticides (4%) Seed treatment (2%) Environmental Non-crop pest control for Environmental Science (2%) 1,086 3% Syngenta, BASF, Dow, DuPont, Monsanto, Scotts Science, agriculture, gardening, BioScience (2%) BioScience household, golf courses, municipal; plant technology Healthcare Pharmaceuticals General medicine (11%) 10,467 34% Astrazeneca, Genentech, GSK, Johnson & 53% of sales Specialty medicine (10%) Johnson, Merck, Novartis, Pfizer, Roche, Sanofi- Women’s healthcare (9%) Aventis Diagmostic imaging (3%) Consumer Health Consumer Care (10%) 5,521 18% GSK, Johnson & Johnson, P&G, Schering-Plough, Medical Care (5%) Wyeth Animal Health (3%)

Total 31,168 100% Source: Company reports and J.P. Morgan estimates.

274 275 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Clariant

Figure 397: Sales by division (2009) Figure 398: EBIT by division, CHFmn (2009) Tex tile Chemicals Oil & Mining Serv ices 9% 12% 140 120 Leather Serv ices Pigments 100 4% 16% 80 60 Industrial & 40 Consumer Specialties 20 0 Masterbatches 21%

17% Leather Textile Services Pigments Services Consumer Specialties Chemicals Industrial & Industrial Chemicals Oil & Mining Performance Masterbatches Performance Chemicals Source: Company data Source: Company data

Figure 399: Sales by destination (2009) Figure 400: EBITDA margin development Latam Asia 18% 12% 23% ROW 10%

4% 8%

6%

4% 2%

North America 0% 11% Europe 2005A 2006A 2007A 2008A 2009A 44%

Source: Company data Source: Company data, J.P. Morgan estimates

COMPANY DESCRIPTION: Clariant is a diversified specialty chemicals company. It recently restructured its business into 10 business units from 4 business units under its new strategic initiative. Textile, Leather & Paper Chemicals was formed into 4 business units (Paper Specialties, Leather Services, Textile Chemicals, and Emulsions). Pigments and Additives were also separated out. Functional Chemicals formed 3 business units (Industrial & Consumer Specialties, Detergents & Intermediates, Oil & Mining Services). The Company has also been undergoing a major restructuring programme since the start of 2004, although the benefits have been largely consumed by raw material cost inflation.

STRENGTHS: WEAKNESSES: • Market leader in Textile Chemicals, Leather Chemicals • Still largely reliant on European and US production base. and Masterbatches. • Significantly exposed to industrial end markets. OPPORTUNITIES: THREATS: • New management team has the opportunity to provide • Ongoing structural pressures. new impetus to restructuring and may provide strategic • Raw material cost inflation. surprise. • Further restructuring costs. • Introduction of new pricing and business management model more focused on margin than volume growth.

275 276 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 145: Clariant: Divisions and products

2009 Sales % Division (mSFr) sales Key products Key end markets Key market positions Key competitors Industrial & Consumer 1,424 21% Ethylene oxide derivatives and specialty chemicals Automotive, biocides, coatings, Global leader in ethylene BASF, Croda, Evonik Specialties for a large variety of applications in the consumer construction, crop protection, defoamers, oxide derivatives and industrial markets engineering & aviation, industrial & home care, metal working nutrition, personal care, deicing

Performance 1,360 21% Performance chemicals, Process chemicals(refinery Chemicals, pharmaceuticals and BASF, Dow, Ashland, Kemira, Chemicals chemicals, functional fluids, metal working, laundry agrochemicals, household and cleaning, Organik Kimya detergents and household cleaning products paints, construction, paper Masterbatches 1,122 17% Colourants and masterbatches Automotive, consumer goods, electrical, Top 3 in Masterbatches Ampacet, PolyOne, Schulman medical, packaging,textiles and fibers Pigments 1,072 16% Organic pigments, pigment preparations and dyes Automotive, industrial, powder, wood/coil BASF, DIC/SUN used in coatings, printing, plastics, and other coatings, decorative paints, printing specialty applications) technology, masterbatch producers, compounders, processors, resin- and fiber manufacturers, consumer industries Textile Chemicals 777 12% Chemicals for pretreatement, dyeing, printing and Casual wear, sportswear, denim, BASF, Dystar, Huntsman, Long Shen finishing of textiles business, and work wear, home textiles, medical wear Oil & Mining Services 579 9% Products and services to the oil, refinery and mining Exploration additives, upstream, Baker Petrolite, Champion, Cytec, industries production markets, pipeline, refinery Nalco Additives, mineral processing, dust control Leather Services 279 4% Leather chemicals and services, Technical solutions Automotive, shoe & fancy goods, BASF, Lanxess, Stahl, TFL for the complete leather manufacturing process furniture, garment, fur Total 8,533 100%

Source: Company reports and J.P. Morgan estimates.

276 277 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Croda

Figure 401: Sales by division (2009) Figure 402: EBIT by division, £mn (2009) £ Mn 120

90 Industrial Specialties Consumer 60 49% Care 51% 30

0 Consumer Care Industrial Specialties Source: Company data Source: Company data

Figure 403: Sales by destination (2009) Figure 404: EBITDA margin development Asia 25% North America 16% 26% Latam 20% 3% 15% ROW 10% 8% 5%

Europe 0% 47% 2005 2006 2007 2008 2009 Source: Company data Source: Company data, J.P. Morgan estimates

COMPANY DESCRIPTION: Croda is a specialty chemicals company with two divisions – Consumer Care and Industrial Specialities. The Company specialises in producing naturally-derived products for a wide range of end-markets including personal care, pharmaceuticals, crop care, home care and industrial uses. Following its successful reverse takeover of ICI's Uniqema business in 2006, the company has gained significant scale in terms of product offering and R&D expertise, while implementing a wide range of cost cutting measures within the combined businesses. Growth arises from continued consumer demand for creams and personal care products such as anti-aging and skin creams which use Croda’s additives.

STRENGTHS: WEAKNESSES: • Significant exposure to high-growth personal care market. • Limited presence in the emerging markets. • State-of-the-art R&D. • Uncertainty over the impact of BASF’s recent acquisition of Cognis on the competitive landscape. • Pricing power helped by Croda products representing a low % of cost of end price of products (less than 3%). OPPORTUNITIES: THREATS: • Further growth through the removal of lower margin • Significant slowdown in Industrial and Consumer end products and the repositioning of Uniqema. markets not offset by consumers trading down. • Continued growth in end markets as consumer preference • Raw material pricing pressures threatening margins in for vanity creams such as anti-aging products increases. commoditized product areas. • Possible disruption created by Cognis’ integration into BASF providing a competitive advantage to Croda.

277 278 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 146: Croda: Divisions and products 2009 Sales % Customer Division (£m) sales segment Key products Key end markets Key competitors Consumer Care 468 51% Personal Alkoxylates, esters, plant extracts Hair care, skin care, colour cosmetics Cognis, ISP, Seppic care Healthcare Fish oil concentrates, medical grade lanolin, Nutraceuticals, pharmaceuticals, animal health Ocean Nutrition, Pronova high purity fatty acids, super refined oils, pharamaecutical emulsifiers carrier Crop care Formulation aid and adjuvants Agrochemicals BASF Industrial 448 49% Specialities Lubricant Additives for lubricant Automotive, machinery industry Lubrizol, BASF, Clariant additives Coating and Resin, paint, coating Paint industry, Construciton, Housing Akzo Nobel, BASF, Clariant, DSM polymer Geo Tech Mining Chemicals, oil field chemicals, water treatment Polymer Organic slip and anti-block additives, variety Polyethylene and polypropylene resin producers, Chemtura, Fine Organics additives of amides PET, PS, rubber Home care Sarcocinates, fatty acid amides, proprietary Household products, fabric care, tissue care Cognis surfactants, emollient blends Total 916 100% Source: Company reports and J.P. Morgan estimates.

278 279 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

DSM

Figure 405: Sales by division (2009) Figure 406: EBIT by division, €mn (2009) Base Other 600 Chemicals & 5% Nutrition 500 400 Materials 36% 300 15% 200 Poly mer 100 Intermediates 0 -100 11% Performance Pharma Pharma 9% Nutrition

Materials Base Materials Polymer Materials Performance Chemicals & 24% Intermediates

Source: Company data Source: Company data Figure 407: Sales by destination (2009) Figure 408: EBITDA margin development RoW 20% 10% North America 15%

18% Europe 10% 47%

5% Asia Pacific 14% 0% China 2005A 2006A 2007A 2008A 2009A 11% Source: Company data Source: Company data, J.P. Morgan estimates COMPANY DESCRIPTION: DSM has undergone significant change in the past decade. Following the sale of its petrochemicals operations in 2000, DSM acquired the Vitamin and Fine chemicals business of Roche in 2004. The company has also made a number of other alterations to the portfolio, and now consists of five main “clusters” – Nutrition, Pharma, Performance Materials, Polymer Intermediates and Base Chemicals & Materials. Base Chemicals & Materials was formed in 2008 and consists of a number of non-core assets which have been earmarked for disposal. DSM's 'Vision 2010' strategy is dominated by the goal of focusing on product areas (Life Sciences & Performance Materials), which create value for customers. (Update?)

STRENGTHS: WEAKNESSES: • Market leadership (vitamin-based nutritional ingredients, • Weak pharma business, with limited pricing power in Dyneema, Food Specialties, #2 in polyamide 6). Anti-infectives and limited contracts in Pharma Products. • Well-established presence in China. • Polymer Intermediates – highly cyclical and • Strong balance sheet and cash generation. commoditised. • ROIC below peer group. OPPORTUNITIES: THREATS: • Quality differentiation versus low cost competition. • Product commoditisation. • Continued focus on innovation. • Low-cost competition (esp. China). • Accelerate growth through M&A; disposal of non-core • Raw material price increases. assets (BC&M).

279 280 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 147: DSM: Divisions and products 2009 sales % Division Business units (€m) total Key products Key end-markets Key market positions Key competitors Nutrition Nutritional Products 2,463 32% Vitamins, carotenoids, nutritional Food/feed, nutritional Market leader in nutritional ingredients; vitamins Vitamins & carotenoids: BASF, Adisseo, NEPG, 36% of sales ingredients, UV filters, .premixes. supplements, cosmetics (c.35-40%), carotenoids (c.75%) NHU, NCPC, XP and Shijiazhuang Weishen Enzymes: Danisco, Chr Hansen Food Specialties 361 5% Food enzymes, cultures, yeast Food & beverages #1/2 in chosen segments Danisco, Chr Hansen, Novozymes, LeSaffre

Pharma Pharmaceutial 395 5% Custom manufacturing & development Pharmaceuticals Global #4 in contract manufacturing (2007A) Lonza, BASF, Siegfried, Evonik, Rentschler, 9% of sales Products services Boehrimnger Ingelheim, CMC, Patheon, Catalent Anti-Infectives 326 4%Active APIs (betalactams, Pharmaceuticals #1 in SSCs, SSPs & 7-ADCA, #3 in Penicillin Chinese/Indian peers (eg United Laboratories, cephalosporins & intermediates) and 6-APA CSPC, Aurobindo) as well as Antibioticos, Sandoz Performance Engineering Plastics 648 8% Polyamide 6 (some 66), polycarbonates, Automotive, electrical & #1 in high temperature polyamides, #2 in PA6: BASF, Lanxess, UBE Materials heat resistant resins, polyesters, POMs, electronics, (food) packaging, polyamide 6, #2 in thermoplastic copolyesters, High temperature PA; DuPont, Kuraray, Solvay, 24% of sales thermoplastic copolymers optical & glazing, #3 overall in engineering plastics Mitsui consumer/industrial Thermoplastic copolyesters: Dupont, Ticona Dyneema 222 3% Dyneema® - the world’s strongest fibre Life protection, marine, sports, Market leader in UHMwPE (ultra high molecular Honeywell (Spectra® UHMwPE), DuPont medical, high performance weight polyethylene) (Kevlar® aramid), steel & polyester producers textiles Resins 953 12% Coating and composite resins Building & architecture, European market leader in unsaturated polyester Coating resins: BASF, Dow, Cytec, Hexion, 3D automotive, metal (can & coil), resins (c.30%) Systems marine, optical fibre Composite resins: Cray Valley, Reichhold, Ashland Polymer Fibre Intermediates 849 11% Caprolactam, acrylonitrile CPL: textiles, floor coverings, Largest merchant CPL producer globally CPL: Capro Corp, CPDC, Ube, Honeywell, Intermediates industrial yarns, autos, (c.20%), major European player in ACN (c.25%) BASF, Sumitomo, Sinopec 11% of sales electronics, films, building & ACN: Ineos, Asahi, Solutia/Ascend, Secco, FPC, construction Taekwang, Jilin Base Chemicals & Elastomers 387 5% Elastomers EPDM rubber, thermoplastic One of the global leaders (c.16%) in EPDM, Dow, Lanxess Materials elastomers (TPVs) #2 in TPVs 15% of sales Other 258 3% Citric acid, maleic anhydride, Special Polynt, ADM, Jungbunzlauer Products Agro [SOLD] 338 4% Ammonia and other nitrogen fertilisers Agriculture Market leader in Netherlands Yara Melamine [SOLD] 151 2% Melamine Wood-based panels, laminates Leading global brand (c.15%) Borealis, Pulawy for furniture/flooring, car paints Other 381 5% Innovation Centre, Venturing, insurance 5% of sales services Total 7,732 100%

Source: Company reports.

280 281 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Elementis

Figure 409: Sales by division (2009) Figure 410: EBIT by division, £mn (2009) 25 Chromium 33% 20

15 Specialty 10 Products 53% 5

0 Surfactans Specialty Products Surfactans Chromium 14% Source: Company data Source: Company data Figure 411: Sales by destination (2009) Figure 412: EBITDA margin development North 18% Rest of the America 30% 16% World 33% 14% 12% 10% 8% United 6% Kingdom 5% 4% 2% 0% Rest of 2005* 2006 2007 2008 2009 Europe 32% Source: Company data Source: Company data, J.P. Morgan estimates * 2005 numbers including Pigments business sold in 2007 COMPANY DESCRIPTION: Elementis is a chemicals company manufacturing specialty chemicals and chromium chemicals for a range of industries globally. The group is comprised of three businesses: Elementis Specialty Products which manufactures rheological additives, compounded products and colorants; Elementis Surfactants which manufactures surface active ingredients used primarily in the formulation of detergents, and Elementis Chronium which is the world’s largest producer of chromium chemicals, manufacturing products for leather tanning, aerospace, timber preservation and refractories. The Group’s corporate headquarters are in London, and its operational headquarters are based in Hightstown, New Jersey, US. Each division of the group is managed on a global basis with operations at over 20 locations in 6 countries. The Company switched to US$ reporting in 2010, although the shares retain a London Stock Exchange listing.

STRENGTHS: WEAKNESSES: • Relatively high margin Specialty business supplying • Above average exposure to Industrial end markets. additives to the coatings market. • Vulnerable to slowdown in main markets such as • Largest Chrome producer worldwide. coatings. • Closure of UK chrome site allows more efficient • Potential failure of coatings end market to recover manufacture in the US and reduces global capacity. strongly due to continued weak housing and construction markets. OPPORTUNITIES: THREATS: • Further upside through additional restructuring. • Raw material price inflation. • Margin recovery faster than expected. • Downturn in chromium market with volumes falling • Further expansion in Asian region for Specialties. sharply.

281 282 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 148: Elementis: Divisions and products 2009 Sales % Division (£m) sales Key products Key end-markets Key applications Competitors Specialty Products 194.6 53% Rheological additives/ modifiers, Industrial coatings, Homes, offices & similar DSM, Clariant, Rhodia, BASF, Dow, organoclays, colourants, high performance Architectural coatings, environments. Protective Eastman Chemicals dispersing agents, defoamers, coalescing construction, Oilfield applications in automotive, agents, flow and leveling additives, wetting chemicals, Personal care Containers, Furniture, White and slip agents, other specialty additives goods, Flooring, Marine, Plastics, and resins, and lanolin and other natural oil Construction, Oil & Gas, derivatives Concrete, Plasters, Mortars, Renderings, Stuccos, Building adhesives, Make- up, Skincare products Surfactants 49.2 14% Range of surface active ingredients Oilfield, Textile and leather, Household/ domestic detergents, DSM, Clariant, Rhodia, BASF, Dow, Pulp and paper, Plastics and industrial cleaning, oilfield Eastman Chemicals resins, Chemicals and chemicals, leather and textiles, construction, Household and and pulp and paper Agrochemical and feed markets Chromium 119.9 33% Sodium dichromate, chromic acid, chromic Leather tanning, Timber Metal finishing, Organic products, oxide and liquid chrome sulphate treatment, Metal finishing, Pigments, Ceramics, Textiles, Chrome metal alloys, Chrome Tanning animal hides, Timber pigments and treatment, Chromium plating, Ceramics/refractory Automobile, Medical application, Aerospace, Power generation industries, Paints, Coatings, Plastics, Enamels, Concrete, Other construction materials, Ceramics, Production of refractory bricks Total 363.7 100% Source: Company reports and J.P. Morgan estimates.

282 283 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Johnson Matthey

Figure 413: Sales by division (2010) Figure 414: EBIT by division, £mn (2010)

Fine Chemicals 140 Div ision 120 3% Precious Metal 100 Products 80 71% 60 Env ironmental 40 Technologies 20 26% 0 Env ironmental Technologies Precious Metal Products Fine Chemicals Div ision

Source: Company data Source: Company data Figure 415: Sales by destination (2010) Figure 416: EBITDA margin development

Asia ROW 20.0% 22% 8% 15.0%

10.0%

5.0% North America 25% Europe 45% 0.0% 2006A 2007A 2008A 2009A 2010A

Source: Company data Source: Company data, J.P. Morgan estimates COMPANY DESCRIPTION: Johnson Matthey has three main divisions that are centered to varying degrees on the key competency of precious metals. The divisions are: 1) Environmental Technologies, which supplies both automotive and industrial catalysts; 2) Precious Metals Products which has a manufacturing arm as well as acting as a marketer and distributor for precious metals producers principally AngloPlatinum; 3) Fine Chemicals which manufactures a variety of APIs (advanced pharmaceutical intermediates) principally based either on platinum technology, or on opiate technology, as well as some other chemical catalysts.

STRENGTHS: WEAKNESSES: • Leading player (around 30% market share) in a highly • Exposure to precious metals price volatility through the consolidated autocatalyst market driven by legislation. PMP division. • Little exposure to raw materials costs due to pass-through • Influenced by fortunes of global automotive market where clauses where customers are invoiced separately. recovery remains volatile. • Long-term marketing contracts with AngloPlatinum. OPPORTUNITIES: THREATS: • Further tightening of emissions legislation (light duty for • Role of catalysts in electric cars and changing technology cars and HDD for trucks, and off-road) will provide requirements. longer term growth. • General automotive downturn if global economy stalls • Uses for catalysts in areas such as coal fired power would affect volume growth in autocatalysts. stations in China, and in energy such as syngas development, should provide further uses for catalyst technology.

283 284 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 149: Johnson Matthey: Divisions and products 2010 Sales % Division (£m) sales Business units Key products Key end markets Key market positions Competitors Environmental 2,056 26% Emission Control Heavy duty diesel catalyst, Automobile Industry, Power industry, Process industry, Top 3 in vehicle exhaust BASF, Umicore, Technologies Technologies Pollution control systems Chemical industry (Light duty applications, Heavy duty emission control and catalyst Argillion,Frauenthal, diesel applications, stationary source emissions control) systems for VOC for industrial Haldor Topsoe, processes Tokyo Roki Process Process catalyst for syngas, Chemical industry, Oil & Gas industry, Petrochemical Top 3 in specialist technology BASF, Umicore, Technologies methanol, ammonia, hydrogen, industry, Automobile Industry, Power industry, Process for diagnostic Argillion,Frauenthal, gas/coal to products, oil industry (Syngas and gas to liquid, Refinery and gas Haldor Topsoe, refineries processing) Tokyo Roki Fuel Cells Components for fuel cells Fuel cell Top 3 in catalyst components for fuel cell Precious Metal Products 5,562 71% Platinum Marketing Platinum marketing and Electronic & Electrical industry, Jewellery industry, High #1/2 distributor of platinum Evonik, N E Chemcat & Distribution distribution activities tech industry, Automobile industry group metals, sole marketing corporation, Anglo agent for AngloPlatinum(#1 American, Lonmin, Platinum producer) Rio Tinto Colour Technologies Colours, Black obscuration Glass industry, Chemical industry, Automotive industry enamels, Silver conductive materials for automotive glass Noble Metals Wide range of precious metals Medical, Industrial and other fabricated products Catalysts, Precious and base metal Chemicals, autos, refinery, mining BASF, DSM, Lonza, Chemicals and catalysts, electrochemical Clariant Refining product, gold & silver refining and bullion mfg. operations

Fine Chemicals and 221 3% Macfarlan Smith API and intermediate products Fine chemicals and Pharmaceutical industry Top 3 in opiate alkaloids Rhodia, Lonza, Dow, Catalysts for Pharma and Fine chemical Clariant, Cambrex, industry Avecia, Aventis, BASF, Bayer, DSM, Evonik Pharmaceutical API’s for controlled drugs and for Generic and branded pharmaceutical companies Lonza, Rhodia, DSM Materials and platinum based anticancer Services treatments Research Chemicals Specialty organic and inorganic Chemicals, healthcare, pharma Lonza, Rhodia, DSM, chemicals Lanxess Total 7,839 100% Source: Company reports and J.P. Morgan estimates.

284 285 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Kemira

Figure 417: Sales by division (2009) Figure 418: EBIT by division, €mn (2009) Oil & Mining Others

11% 15% 70.0 60.0 50.0 40.0 Municipal & 30.0 Industrial 20.0 10.0 29% 0.0 Paper Municipal & Industrial Paper Oil & Mining 45% Source: Company data Source: Company data *Including E.G. Chemsolutions

Figure 419: Sales by destination (2009) Figure 420: EBITDA margin development ROW

33% 16% 14% 12% 10% 8% Europe 6% 37% 4% 2% 0% North America 2005 2006 2007 2008 2009 30% Source: Company data Source: Company data, J.P. Morgan estimates ** APAC & South America COMPANY DESCRIPTION: Kemira is a Finnish chemical company that focuses on water and paper treatment chemicals. The Company has operations in 40 countries, occupying strong regional and niche positions. Kemira operates out of three primary business units: Paper, Municipal & Industrial (water treatment), and Oil & Mining. In early 2010, Kemira spun out its paints division Tikkurila as a separate unit. The Company’s main goal is to become a leading water treatment company.

STRENGTHS: WEAKNESSES: • The Tikkurila spin off will help Kemira to focus resources • Exposure to low growth industrial markets (paper & on its core business and their goal of becoming a leading pulp). water chemistry company. • European focused with less Asia and US than some • Well-positioned to benefit from growth in demand for companies. clean water and treatment of domestic and industrial effluent. OPPORTUNITIES: THREATS: • Water treatment business remains a growth area. • Raw material and input cost pressures may impact margins. • Benefits from recent significant restructuring programme still to be felt. • Volatility of pulp and paper market.

285 286 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 150: Kemira: Divisions and products 2009 Sales % Division (€m) sales Business units Key products Key end markets Key market positions Competitors Paper 906 45% - Pulp Chemicals -Pulp chemicals for de-inking, -Pulp Top 3 Worldwide Eka, BASF, Hercules - Paper Chemicals chemical and mechanical pulping -Printing & writing and Dow - Additives -Paper chemicals for deposit -Packaging & board control, defoaming, sizing retention, colorants an coating pigments paper industry Municipalities & Industrial 608 29% -Municipal -Inorganic coagulants -Municipalities Top 3 in coagulants Feralco, Kronos, -Industrials -Water treatment polymers -Private water treatment plants Ashland, SNF, and -Industrial wastewater treatment by chemical, metals & Nalco mining, oil, food & beverage, construction industries Oil & Mining 235 11% -TIO2 pigments -Titanium dioxide pigments for -Cosmetics, packaging inks, food, feed and detergents Top 3 coagulants DuPont, Huntsman, -Chemidet packaging inks industries. Top 3 in Titanium dioxide Tronox, Cristal -Organic acids and acid pigment derivatives for food, chemicals and pharmaceuticals, de-icers, feed acidification and preservation -Bleaching agents for detergent industries. Others 314 15% Specialty Chemicals specialty chemicals such as Food Industry, feed industry, Pharma industry & Others organic salts and acids, airport runway deicing Total 2,063* 100%

Source: Company reports and J.P. Morgan estimates, * excluding Tikkurila.

286 287 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

K+S (Kali und Salz)

Figure 421: Sales by division (2009) Figure 422: EBIT by division, €mn (2009) Others 3%

300 Potash and Salt 28% Magnesium 200 Products 41% 100

0

-100

-200 Nitrogen Potash and Magnesium Nitrogen Fertilizers Salt Others Fertilizers Products 28% Source: Company data Source: Company data Figure 423: Sales by destination (2009) Figure 424: EBITDA margin development Germany 18% 40%

30%

Ov erseas 47% 20%

10%

Rest of Europe 0% 2005 2006 2007 2008 2009 35% Source: Company data Source: Company data COMPANY DESCRIPTION: K+S is a leading potash and specialty fertiliser producer. The business is divided into fertiliser and plant care, and also salt and complementary businesses. In 2009, K+S merged the activities of fertiva with parts of COMPO’s professional business in the Company’s Nitrogen division to achieve an even stronger position in its core Fertilizers business sector. In April 2009, K+S acquired Morton Salt for $1.675bn to become a leading salt producer.

STRENGTHS: WEAKNESSES: • Leading position in Europe in potash and magnesium • Strong focus on Europe. products. • High production cost per potash relative to peers. • World leading Salt producer. • Resource-constrained production leaves very little scope • Leading cost effective salt producer. for volume expansion in the Potash business. • Partnership with BASF for distribution of Nitrogen • Leading position in Potash but insignificant presence in fertiliser/ Agricultural products. Nitrogen and phosphate fertilizers. OPPORTUNITIES: THREATS: • Expansion opportunity outside Europe - particularly • Little visibility over the strategic intentions of major India and China. private shareholder (10%). • Decreasing arable farm land. • Normalization of agricultural growth to lower levels. • Increasing use of Genetically Modified crops will • High energy prices and environmental restriction cost. increase fertilizer application.

287 288 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 151: K+S: Divisions and products 2009 Sales % Division Business units (€m) sales Key products Key end-markets Key market positions Key competitors Potash and Potassium 664 40% Potassium Chloride Fertiliser and Agriculture Industry Leading position in potash Potashcorp, Uralkali, Agrium, Mosaic, Magnesium Chloride and magnesium sulphate Yara, CF Industries, ICL Products globally Fertilizer 461 Industrial products Fertiliser and Agriculture Industry Potashcorp , Uralkali, Agrium, Mosaic, Specialties Yara, CF Industries, ICL Industrial 297 Potting salts, Plant care products, Garden Fertiliser and Agriculture Industry Potashcorp , Uralkali, Agrium, Mosaic, products fertilisers, Plant fertiliser product Yara, CF Industries, ICL Nitrogen Consumer 207 Special complex fertiliser for horticulture Fertiliser, Home care and Agriculture Industry Leader in Europe with Potashcorp, Agrium, Yara, CF Fertilizers Business and agricultural special products COMPO Industries, Professional/ 271 28% Nitrogen fertiliser distributor Fertiliser, Home care and Agriculture Industry Leader in Europe with Potashcorp, Agrium, Yara, CF Industries Industrial COMPO Business Complex 161 Nitrogen fertiliser distributor Fertiliser and Agriculture Industry Potashcorp, Agrium, Yara, CF Industries fertilizer Straight nitrogen 242 Nitrogen fertiliser distributor Fertiliser and Agriculture Industry Potashcorp, Agrium,Yara, CF Industries fertilizers Ammonium 135 Fertiliser and Agriculture Industry Potashcorp, Agrium, Yara, CF Industries. sulphate Salt Food grade salt 151 28% Table salt Akzo, Wacker Industrial salt 239 Industrial salt Food and Flavour Industry #1 salt supplier globally Akzo, Wacker Salt for chemical 63 Salt for chemical transformation Chemical and heavy industries #1 salt supplier globally Akzo, Wacker transformation De-icing salt 497 De-icing salt Chemical and heavy industries #1 salt supplier globally Akzo, Wacker Other 64 Waste management and recycling Chemical and heavy industries #1 salt supplier globally Akzo, Wacker Complementa Waste 67 3% Logistics Metals and Mining Leading provider of ry business management underground waste segment and recycling management logistics 12 Granulation Fertiliser and Agriculture Industry Animal hygiene 33 trading business Fertiliser and Agriculture Industry products Trading 8 Fertiliser and Agriculture Industry business Total 3,574 100% Source: Company reports and J.P. Morgan estimates.

288 289 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Lanxess

Figure 425: Sales by division (2009A) Figure 426: EBIT by division, €mn (2009A)

Performance Reconciliation 150 Chemicals 1% 30% Performance 100 Poly mers 47% 50

0 Adv anced Performance Adv anced Performance Intermediates Poly mers Intermediates Chemicals 22%

Source: Company data Source: Company data Figure 427: Sales by destination (2009A) Figure 428: EBITDA margin development Germany 12% Asia Pacific 21% 23% 9%

6% Latin America 10% 3%

EMEA 0% North America 31% 15% 2005A 2006A 2007A 2008A 2009A

Source: Company data Source: Company data, J.P. Morgan estimates COMPANY DESCRIPTION: Lanxess is a diversified specialty chemicals player which was spun out of Bayer in January 2005. The business has undergone an extensive restructuring programme post listing, involving the re-alignment of cost structures and the sale of €1.5bn of sales worth of non-core assets. The company is now made up of 3 divisions – Performance Polymers, Advanced Intermediates and Performance Chemicals. Lanxess’ core strategy remains to reduce volatility and cyclicality through ongoing structural improvement as well as increasing its exposure to areas of growth.

STRENGTHS: WEAKNESSES: • Top 3 players in most segments (#1 in PBR). • Cyclical, given significant exposure to GDP linked end • Above-average pricing power; proven culture of “price markets (eg autos). before volume”. • Profitability below sector average. • Proactive management team. • Cash flow currently limited (large scale capex programme). OPPORTUNITIES: THREATS: • Accelerate growth through further bolt-on’s / enhancing • Low cost competition / increasing global supply. exposure to growth markets. • Potential raw material price pressures. • Product differentiation through R&D (eg Nd-PBR) • Reversal of current FX benefit (U$/€). • Scope for further restructuring / disposals?

289 290 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 152: Lanxess: Divisions and products 2009s sales % Division Business units (€m) sales Key products Key end-markets Key market positions Key competitors Performance 47% Polymers Butyl rubber 597 Butyl rubber, Halobutyl rubber Automotive,adhesive,chewing gum, construction, pharma #1/2 in butyl rubber ExxonMobil, Sinopec, Sibur holding Polybutadine rubber 836 Polybutadiene rubber (PBR) Automotive/ tyre,plastics,golf balls #1 in SSBR Sinopec, Michelin, Solution SBR Goodyear, Firestone Technical rubber 358 NBR (nitrile butadiene rubber), E-SBR, Automotive, footwear, mechanical engineering, plastics, #1 in NBR, ESBR Nippon Zeon, Polimeri products CR (chloroprene rubber), EPDM, construction, electronics Europa, DSM, JSR EPDM, HNBR, EVM Semi crystalline 597 Polyamide (6)-based thermoplastics, Automotive, transportation, chemistry, packaging, electronics, Strong positions BASF, DSM, DuPont, products plastic intermediates, thermoplastic life sciences Rhodia polyesters, monofilaments Advanced 22% Intermediates Basic chemicals 773 Chlorobenzenes, chlorotoluenes, Agrochemicals, polymers, construction, coatings, Leading positions in all business Jiangsu Yangnong, Aarti, nitrotoluenes and their derivatives, autos/transportation lines Kureha, Merisol, Perstorp, inorganic acids BASF Tessenderlo Saltigo 331 Custom manufacturing of APIs Agro, Pharma, Specialties Among the leading global players DSM, Lonza, Weylchem, Albemarle Performance 30% Chemicals Functional chemicals 230 Plastic additives, flame retardants, Plastics, construction, chemistry, life sciences, electronics Supplier to a broad range of Albemarle, BASF/Ciba, water chemicals, specialty dyes, markets Chemtura, Clariant, Ferro, colourants Lonza, Sun Chemical, ICL/Supresta Inorganic pigments 306 Iron oxide, chromiun oxides Construction, paints & coatings, plastics Leaders in iron oxide & chromium Rockwood, Chinese oxide; Leading global supplier playes (Cathay Pigments, Deqing Huayuan Pigment, Hunan Three-Ring Pigments, Yixing Yuxing) Ion exchange resins 153 Ion exchange resins, water treatment Water & energy, nutrition, chemistry #2 in ion exchange resins; Leading Dow, Mitsubishi, Purolite, solutions position in technologically Rohm & Haas advanced monodisperse ion exchange resins Leather 306 Tanning agents, preservatives, finishing Shoes, furniture, automotive, garments Leading global supplier BASF, Clariant, Stahl,TFL auxilliaries, dye products Material protection 153 Biocides and specialities for beverage Construction/paimts, disinfection/consumer, water treatment Leading positions Arch, Dow, Lonza, Rohm products stabilization, preservatives, sterilization & Haas, Thor Rhein Chemie 184 Rubber, polyurethanes, plastics, Automotive, transportation, construction, footwear Leading position in additive BASF, Clariant lubrication oil additives formulations Rubber chemicals 199 Antidegradants, accelerators, Tyre, technical rubbber products, chemicals, latex, mineral oil Leading market position Flexsys, Chemtura specialties applications Reconciliation 35 1% Total 5,057 100% Source: Company reports and J.P. Morgan estimates.

290 291 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Linde

Figure 429: Sales by division (2009) Figure 430: EBIT by division, €mn (2009) Cy linder Healthcare 33% 9% 1,400 Tonnage 1,200 1,000 18% 800 600 400 200 0 Gas Engineering Engineering Bulk 21% 19% Source: Company data Source: Company data Figure 431: Sales by destination (2009) Figure 432: EBITDA margin development North America

18% 25.0%

20.0%

Europe 15.0% Asia 47% 10.0% 15% 5.0%

0.0% Latam 2005A 2006A 2007A 2008A 2009A 6% ROW Source: Company data Source: Company data, J.P. Morgan estimates COMPANY DESCRIPTION: Following its acquisition of BOC (closed Sept 2006), Linde is the largest Industrial gas company in the world. The company also has a significant plant engineering business that sells to a wide range of industries including chemicals and energy, as well as industrial gases.

STRENGTHS: WEAKNESSES: • Leading industrial gases company by sales following the • Legacy business has greater exposure to more 'cyclical' BOC acquisition. Defensive long term gases’ contracts. end of industrial gases market. • World-leading engineering technology. • Less exposure to longer-term “on-site” distribution. • Strong franchise in fast-growing regions of E. Europe and Asia. OPPORTUNITIES: THREATS: • Significant sales synergies from BOC acquisition. • Slowdown in industrial economy. • Continued strength of industrial capex cycle. • Weak order book in Engineering. • Greater leverage of Linde's engineering technology.

291 292 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 153: Linde: Divisions and products 2009 Business Sales % Division units (€m) sales Key products Key end markets World market position Competitors Gases division Tonnage 2,075 18% Air gases and hydrogen Refineries, chemicals, energy, metal manufacturers, Global #2 behind Air Liquide Air Liquide, Praxair, Air Products, 77% of sales steel Airgas, Taiyo Nippon

Bulk 2,192 19% Bulk deliveries (Oxygen, electronics & electrical, chemicals, food processing, #1 Global, #1 in 4 out of 5 emerging Air Liquide, Praxair, Air Products, Nitrogen, Hydrogen, Cryogenic glass processing, metal production, oil & gas regions ( #1 in greater China, #1 in Airgas, Taiyo Nippon & non cyrogenic gases SE Asia, #1 in Eastern Europe and Middle East, #2 in South America) Cylinder 3,635 32% Main gases: Nitrogen, Oxygen, Electronic Producers (Computers, flat screen, digital #1 in cylinders, Air Liquide, Praxair, Air Products, Argon, Hydrogen, Helium, music players, mobile phones), small customers Airgas, Taiyo Nippon Carbon dioxide, inert gases, medical gases Healthcare 1,030 9% Therapeutic gases, mainly Hospitals, homecare, research institutes, hygiene #2 in healthcare (global mkt. sh.15- Air Liquide, Praxair, Air Products, Oxygen industry 20%) Airgas, Taiyo Nippon Engineering 2,311 21% Air separation plants, gas Healthcare, chemical, construction, food & #1 in Air separation plants (Oxygen, Air Liquide, Technip, Haldor Topsoe, 23% of sales synthesis plants, olefin plants, beverages, metal production nitrogen, air gases), Top 2 in Uhde, ABB lummus, Stone & LNG plants hydrogen and synthesis gas plants webstar, KBR, Technimont, Toyo, (H2, ammonia, gas removal, gas Chiyoda, Bechtal, JGC, KBR, Air purification), Top 2 in olefin plants Products (ethylene, propylene, butadiene, aromatics, polymers), Top 3 in natural gas plants (LNG, NGL, LPG, helium) Total 11,211 100%

Source: Company reports and J.P. Morgan estimates.

292 293 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Rhodia

Figure 433: Sales by division (2009A) Figure 434: EBITDA by division, €mn (2009A) Acetow Other 200 14% 4% Eco Serv ices Poly amide 150 5% 36% 100 Energy Serv ices 50 5% Silcea 16% 0 Novecare Poly amide Nov ecare Silcea Acetow Energy Eco 20% Serv ices Serv ices

Source: Company data Source: Company data Figure 435: Sales by destination (2009A) Figure 436: EBITDA margin development Latin America 18% 17% 15% Europe 35% 12% 9% North America 20% 6% 3%

0% Asia Pacific 2005A 2006A 2007A 2008A 2009A 28% Source: Company data Source: Company data COMPANY DESCRIPTION: Rhodia is a diversified specialty chemicals company specialised in polyamide (66) derivatives, with also a significant presence in surfactants, acetate tow, high performance silica, rare earths for automotive catalysts and sulphuric acid regeneration. The business is also involved in the sale of carbon emission credits (CERs) through its abatement of N2O, a by-product of adipic acid. The group's strategy has been to focus its portfolio around high-growth, high-margin businesses with clear leadership positions.

STRENGTHS: WEAKNESSES: • Market leadership in chosen segments (global #2 in • Above-average cyclicality in polyamide polyamide 6,6, #1 in acetow and high performance silica, • Significant pension liability (€1.5bn) vanillin) • Significant cash flow dependency on sale of emission • Solid presence in the emerging markets (c.45% sales) credits (CER) • Improved cash management; low WC/sales OPPORTUNITIES: THREATS: • Accelerated growth through bolt-ons • Input cost fluctuation (butadiene/benzene-derivatives/gas) • Potential uplift in CER pricing/volumes • Uncertainty over CER cashflows in phase III

293 294 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 154: Rhodia: Divisions and products 2009 sales % Division (€m) sales Key products Key end-markets Key market positions Key competitors Polyamide 1,476 37% Polyamide 6,6 intermediates & derivatives: Automotive, clothing/textiles, construction, electronics #2 in Polyamide 6.6 Invista, DuPont, Ascend, BASF, Asahi, Engineering plastics, adipic acid, ADN, #3 in polyamide based Eng. Plastics Radici, Kordsa, CSM, Liao Hua, Toray HMD, textile & industrial yarns Acetow 549 14% Acetate filter tow, cellulose acetate flakes Cigarette industry #1 in W Europe (39% share), #1 in CIS Celanese, Eastman, Daicel, Mitsubishi (49% share in Russia), #1 in Latin America (68% share) Global market share of 17% Novecare 827 21% Surfactants and polymers, phosphorus Home & personal care, detergents, home & institutional #1 in specialty surfactants (NA and Akzo Nobel, BASF/Cognis, Clariant, derivatives cleaning, coatings, agrochemicals, food, textiles, oilfield China); #1 in oilfield biocides and guar Huntsman, Dow, Aqualon, Arkema for fracturing Silcea 635 16% Silica, Electronics & catalysis, diphenols Tyres, footwear, rubber parts, paper, nutrition, flavours & #1 in high performance silica (>50% Evonik, Huber, PPG, OSC, Borregard, fragrances, detergents, cosmetics, oral/dental hygiene, share), #1 in vanillin (c.50% share) Chinese suppliers electronics, catalysis Eco Services 211 5% Sulfuric acid production and regeneration Oil refining, chemical/petrochemical manufacturing, nylon, #1 in US merchant sulphuric acid, #1 DuPont, Marsulex, General Chemical, specialised mining, agricultural additives in sulphuric regeneration Chemtrade, Marsulex, PVS

Energy 189 5% Energy (gas, electricity) purchases, Greenhouse gas emission credits #2 gas purchaser in France; 14% Services management of greenhouse gas emissions market share in CER market (2008A)

Other 144 4% Total 4,031 100% Source: Company reports.

294 295 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Solvay

Figure 437: Sales by division (2009A) Figure 438: REBIT by division, €mn (2009A) 300

200 Chemicals Plastics 48% 52% 100

0 Chemicals Plastics Source: Company data * Ex-Pharma Source: Company data.

Figure 439: Sales by destination (2009A) Figure 440: REBITDA margin development Mercosur 18%

11% 15%

APAC/other 12% 13% 9%

6% Europe NAFTA 3% 59% 17% 0% 2005A 2006A 2007A 2008A 2009A Source: Company data * Ex-Pharma Source: Company data * 2009A excludes Pharma.

COMPANY DESCRIPTION: Solvay is a Belgian chemicals company with two core divisions - Chemicals and Plastics – following its recent disposal of Pharma (completed Feb 2010). The key products in the Chemicals business are soda ash, caustic soda and hydrogen peroxide, while the Plastics business produces PVC and a range of Specialty Polymers (including PEEK). The company’s ambition is to reduce cyclicality and accelerate growth through the reinvestment of its Pharma proceeds (€4.5bn) in high growth/high margin, environmentally friendly product areas with exposure to the emerging markets.

STRENGTHS: WEAKNESSES: • #1/2 scale leader in majority of segments. • Above-average cyclicality. • Strong balance sheet post Pharma disposal. • Structural overcapacity in PVC. • Attractive, secure dividend. • Mature market focussed OPPORTUNITIES: THREATS: • Accelerate growth through (scale) M&A. • Low cost competition. • “New Business Development” to fuel innovation-driven • Input cost pressures. medium to long-term growth. • Currency fluctuations. • Likely industry restructuring in PVC.

295 296 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 155: Solvay: Divisions and products 2009 Business units sales % Division (clusters) (€m) sales Key products Key end-markets Key market positions Key competitors Chemicals Minerals 1,275 22% Soda ash, advanced functional minerals Glass, construction, chemicals, automotive, paper, detergents #1 in soda ash and sodium Soda ash (Tata, FMC, Oriental bicarbonate Chemical, Nirma)

48% of sales Electrochemistry 977 17% Electrochemicals (caustic soda), fluorinated Chemicals, water & environment, detergents, cleaning and #2 in caustic soda (Europe), Caustic (Dow, Oxy, Formosa, & fluorinated products hygiene products, paper #2 in fluorinated products Olin, PPG, Ineos, Arlema, products Akzo) Fluorocarbons (Arkema, Ineos, DuPont, Honeywell, Daikin, Asahi Glass) Oxygen 434 8% Hydrogen peroxide, persalts Paper, detergents, cleaning, hygiene and cleaning products, #1 in hydrogen peroxide Hydrogen peroxide (Evonik, propylene oxide (HPPO) Arkema, FMC, Eka chemicals (Akzo), Kemira) Detergents (BASF/Cognis, Clariant, Huntsman, Akzo) Organic 27 <1% Peptides and oligonucleotides Pharmaceuticals

Plastics Specialties 1,252 22% Specialty polymers (eg PEEK), 50% stake in Construction & Architecture, Automotive, Chemical, Electronics #1 in fuel systems, leader in Specialty polymers (Daikin, Inergy Automotive Systems* Water & environment Specialty polymers DuPont, Dyneon, Ticona, Victrex) 52% of sales Vinyls 1,730 30% Vinyls (PVC), 50% stake in Pipelife (pipes & Construction & Architecture, Automotive, Chemical, Glass, #3 in Fluorinated polymers, Shin-Etsu, Formosa, Ineos, fittings) Water & environment #2 in PVC (Europe), #3 in Oxy, Georgia Gulf, Arkema, PVC (world), leader in Tessenderlo Pipelife

New Business - - Innovation centre focused on solutions Renweable energy, printable organic electronics, Development tackling: climate change, limited resources, nanotechnologies, renewable chemistry new consumers (e.g. Asia) Total 5,695 100% Source: Company reports.

296 297 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Symrise

Figure 441: Sales by division (2009A) Figure 442: EBIT by division, €mn (2009A) 110

100

Flavour & Scent & Care 90 Nutrition 50% 50% 80

70 Flav our & Nutrition Scent & Care

Source: Company data Source: Company data

Figure 443: Sales by destination (2009A) Figure 444: EBITDA margin development

Africa/Middle Asia (mature) 22% East 4% S America 7% W Europe 21% 8% 33% 20% E Europe 10% 19%

N America 18% Asia (EM) 22% 2006 2007 2008 2009 16%

Source: Company data Source: Company data

COMPANY DESCRIPTION: Symrise was created by a merger between Haarmann & Reimer and Dragoco in 2003, and subsequently listed in 2006. Symrise’s roots date back to 1874 and 1919, when the two companies were founded. The company is organised around two divisions: Scent & Care – with exposure to (i) fragrances, (ii) cosmetic ingredients/UV filters (“Life Essentials”), (iii) aroma chemicals and oral care (mint), as well as Flavour & Nutrition – which produces innovative flavours for sweet and savoury food, beverage and pharmaceutical applications, with an increasing presence in functional food (“Consumer Health”).

STRENGTHS: WEAKNESSES: • Tier 1 player in flavours & fragrances (#4) • Smallest in scale within tier 1 F&F universe. • Above-avg growth in Life Essentials/Consumer Health • Mid-sized customer focus; “top 10” exposure still limited. • Sector-leading FCF yield and ROIC • Limited track record as public entity. OPPORTUNITIES: THREATS: • Increase exposure to large-scale FMCG customers. • Loss of core list positions, investments not turning into contracts. • Potential pricing power through Life Essentials exposure. • Fluctuations in FX (mainly €/US$).

297 298 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 156: Symrise - portfolio overview Sub- % 09 Key market Divisions divisions sales Product areas End-products Competitors positions Scent & Fragrances 25% Home & personal care, fine fragrances Air fresheners, detergents, perfumes Givaudan, IFF, Firmenich #4 globally (9% Care share)

50% of sales Life 12% UV protection, botanicals, active ingredients, Cosmetics, sunscreen Croda, Cognis, ISP, Evonik, BASF, Leader in selected Essentials functionals Pentapharm, Cosmetochem niches; #1 in UV protection Aroma 7% Special F&F ingredients, fine aroma chems & Flavours & fragrances IFF, Givaudan, Firmenich, Rhodia, DSM, Leader in selected molecules sensates (menthol) Borregaard, BASF niches

Oral care 8% Mint aromas - e.g. for toothpaste Toothpaste Takasago, Givaudan, IFF, Firmenich #1 globally

Flavor & Beverages 17% Non-alcoholic, alcoholic, dry Blossom tea, Superfruits, Brewtopia®, flavoured vodka, Givaudan, IFF, Firmenich #4 globally in Nutrition Beer mix, flavoured coffee flavours (c.14% share) 50% of sales Savoury 20% Culinary, snack food, tobacco Meat flavourings, vegetable concentrates, seasonings, Givaudan, IFF, Firmenich flavoured tobacco

Sweet 13% Bakery, confectionery, dairy Chocolate, candy, chewing gum, ice cream, OTC drugs Givaudan, IFF, Firmenich Leader in vanilla aromas

Source: J.P. Morgan estimates, Company data.

298 299 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Syngenta

Figure 445: Sales by division (2009) Figure 446: EBIT by division, $mn (2009) Seeds 23% 2000

1500

1000

500

0 Crop -500 protection 77% Crop protection Seeds Business development Source: Company data Source: Company data Figure 447: Sales by destination (2009) Figure 448: EBITDA margin development Asia Pacific Europe, 14% 25% Middle East and Africa 20% 33% 15% Latin America 19% 10%

5%

0% 2005 2006 2007 2008 2009 NAFTA 34% Source: Company data Source: Company data, J.P. Morgan estimates. COMPANY DESCRIPTION: Syngenta is the world's leading agrochemical producer by sales. The group was formed via the merger of Novartis and AstraZeneca agrochemicals in 2000, and is the only European pure play agrochemical company. Syngenta is based in Basel, Switzerland, but has operations around the world.

STRENGTHS: WEAKNESSES: • High market shares in each of the major crop protection • Lower margin and profit expectations at Monsanto may categories. generate downward pressure among competitors. • Strong balance sheet and significant cash generation. • GM offering is some way behind market leader Monsanto. OPPORTUNITIES: THREATS: • Demographics should continue to drive demand for yield • Perennial threat from unfavourable weather conditions. improvements. • Slowing growth in traditional crop protection. • GMO technology platform should allow roll-out of • Further reform to subsidy regimes in either Europe or US. stacked trait technology offering. • European approval to grow GM products would damage • Crop price developments should support switch in favour traditional crop protection market. of Syngenta's products. • Strength of Real may further impact Brazilian demand. • Improving health of agro economy should support healthier pricing. • Chinese Glyphosate oversupply.

299 300 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 157: Syngenta: Divisions and products Business 2009 Sales % World market Division units ($m) sales Key products Key end markets position Competitors Crop protection Selective 2,221 20% Selective herbicide Selective herbicides control grasses and broad-leaved BASF, Bayer, Dow, DuPont 77% of sales herbicide weeds Non-selective 1141 10% Non-selective herbicide Non-selective herbicides reduce or halt the growth of all BASF, Bayer, Dow, DuPont and Monsanto herbicide vegetation with which they come into contact Fungicides 2,442 22% Fungicides Fungicides prevent and cure fungal plant diseases that BASF, Bayer, Dow, DuPont affect crop yield and quality Insecticides 1,312 12% Insecticides Insecticides control chewing pests such as caterpillars BASF, Bayer, Dow, DuPont and sucking pests such as aphids, which reduce crop yields and quality Seed Care 821 7% Professional 458 4% Professional products To protect the seedling and the young plant against BASF, Dow, DuPont and Monsanto products diseases and pests during the period when they are most vulnerable, specialized products for use in turf, ornamentals, vegetation management Others 96 1% Seeds Corn and 1,210 11% Corn and soyabeans Corn and soyabeans seeds BASF, Dow, DuPont and Monsanto 23% of sales soyabeans Diverse field 429 4% Diverse field crops Sugarbeets,cereals,oilseeds seeds BASF, Dow, DuPont and Monsanto crops Vegetables 594 5% Vegetables Vegetables seeds for tomatoes, peppers, melon, #2 in BASF, Dow, DuPont and Monsanto squash etc vegetables seeds Flowers 331 3% Flowers seeds for bedding plants, pot plants #1 in flower BASF, Dow, DuPont and Monsanto seeds. Total 10,992 100% Source: Company reports and J.P. Morgan estimates.

300 301 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Umicore

Figure 449: Sales by division (2009) Figure 450: EBIT by division, €mn (2009) Zinc Specialties Adv anced Materials

8% 7% 140 120 100 80 60 Precious Metals 40 Products & 20 0 Catalysts Precious Metals Precious Metals Zinc Specialties Precious Metals Adv anced Materials 32% Serv ices Products & Cataly sts Serv ices 53% Source: Company data Source: Company data Figure 451: Sales by destination (2009) Figure 452: EBITDA margin development Asia

18% 30% 25% 20%

North America 15% 10% Europe 10% 5% 57% 0% ROW 2005A 2006A 2007A 2008A 2009A Latam 9% 6%

Source: Company data Source: Company data, J.P. Morgan estimates COMPANY DESCRIPTION: Umicore is a Belgian materials technology group which has repositioned itself over the last ten years from a metals refining company to an Advanced Materials company. Umicore demerged its Copper business (Cumerio) in 2005, and completed the IPO of its stake in Zinc smelting JV Nyrstar, further reducing its direct exposure to pure commodity metals. The company now produces semi-finished compounds for a variety of metals-related applications including catalysts, electronics, solar panels, optics and tools. The group is also a world leader in the refining and recycling of precious metals found in industrial waste and end-of-life materials.

STRENGTHS: WEAKNESSES: • Joint global market leader in high-growth autocatalysts • Limited presence in Heavy Duty Diesel (HDD) where market following Delphi acquisition. emissions legislation is tightening. • Strong presence in Asian autocatalysts market (Korea & • Limited pricing power in some product areas (eg Tool China) and in Latin America. Materials). OPPORTUNITIES: THREATS: • Strengthening emissions legislation. • Competition from BASF and Johnson Matthey. • Tighter recycling legislation (scarcity of metals) driving • Volatile metal prices. demand for recycling capacity. • Competition from low-cost Asian producers in some • Greater acceptance of photovoltaics, and fuel cells, in product areas. consumer applications.

301 302 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 158: Umicore: Divisions and products

2009 Sales Division (€m) % sales Sub-division Business Lines Key products Key end-markets Key market positions Advanced Materials 320 18% Sales Cobalt & Specialty Materials Rechargeable Battery Materials Li- and Ni-based batteries Portable electronics Key metals: Ge, Co, Ni, Mn, Li, C Ceramics & Chemicals Recycling/ pigments Pigments/catalysts /paints

Electro-Optic Materials Optics Germanium blanks for fibre optics, thermal Medical/defense/ surveillance/ automotive imaging Substrates Germanium substrates for high-efficiency solar Photovoltaic /LEDs/space applications #1 in Ge-based photovoltaics cells Thin Film Products Microelectronics, data storage, evaporation materials, , Wear and Decorative Night vision (auto), fire fighting, surveillance, Optics & ophthalmic, wear Coatings, Optical Data Storage, Displays and Electronics protection, decorative coating, Solar Cells displays, photovoltaic, technical data download Element Six Synthetic diamonds Diamond grit Drilling/cutting tools Precious Metal Products & 821 47% Catalysts Automotive Catalysts Diesel catalysts, gasoline catalyst, particulate Automotive #1 globally (=BASF/JMat), filters #1 in Asia Catalyst Technologies Precious Metals Chemistry Catalysts for life sciences, chemicals (Non- Industry/petchem automotive catalysts) /pharma Key metals: Au, Ag, Pt, Pd, Rh, In, Ru Heterogeneous Catalysts Catalysts for fuel cells Automotive/portable electronics SolviCore (JV) Membrane Electrode Assembly for fuel cells Automotive Technical Materials Contact Materials Semi-finished products for Construction construction/electronic equipment/heating /electronics BrazeTec Alloy pastes Automotive Power technology materials hermetic sealing materials, spheres for the Electronics lighting industry, high-purity evaporation materials, and soft solder ribbons Jewellery & Electroplating Jewellery & Industrial Metals Semi-finished products for Consumer jewellery/coins/decorations/teeth Electroplating Decorative/industrial materials/PCBs Construction /electronics Platinum engineered materials Used in high quality special glass for high end High-end LCD glass applications - eg molten glass applications like LCDs and platinum gauzes and systems for the abatement of nitrous oxide

Precious Metals Services 361 21% Precious Metals Refining Refining & recycling of a wide range of metals Electronics (end-of-life scrap) #1 in precious metals recycling, #4 PGM refining

Key metals: Ag, AU, Pt, Pd, Rh, Precious Metals Management Sale/lease of metals Automotive, electronics, Ru, Ir, In, Se, Te, Sn, Bi, Cu, Pb, Ni, Sb, As Battery recycling recycling End-of-Life Batteries, HEVs Electronics batteries and GTL catalysts Zinc Specialties 252 14% Zinc Chemicals Zinc powders, zinc oxide Construction/shipping Top 3 in zinc specialties/recycling Building Products Zinc sheets (finished products) Construction Key metals: Zn

Total 1,755 100% Source: Company reports and J.P. Morgan estimates.

302 303 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Victrex

Figure 453: Sales development (£mn) Figure 454: EBIT, £mn development

160 60

140 50 120 40 100 80 30 60 20 40 20 10 0 0 2005 2006 2007 2008 2009 20052006200720082009

Source: Company data Source: Company data

Figure 455: Sales by destination (2009) Figure 456: EBITDA margin development Asia 11% North America 50%

44% 40%

30%

20%

10%

0% 2005 2006 2007 2008 2009 Europe 45% Source: Company data Source: Company data, J.P. Morgan estimates

COMPANY DESCRIPTION: Victrex is a leading producer of polyaryletheretherketone (PEEK), a high performance thermoplastic. PEEK is light weight, chemically inert and exhibits mould ability, high hydrolysis and temperature resistance, dimensional stability and durability. This combination makes it attractive for wide range of commercial applications, with a number of critical end uses, and over 90% of PEEK production is for export. Victrex also has a medical device materials business, Invibio, manufacturing premium grades of PEEK, for use in medical implants in areas such as spinal implants and cranial caps.

STRENGTHS: WEAKNESSES: • Presence in high growth businesses where PEEK is used • Exposure to cyclical end markets such as automotive and in critical end uses and also in medical (eg spine). electronics. • Above average EBIT margins (35% plus). • Occasional currency volatility given 98% exports from UK. OPPORTUNITIES: THREATS: • Increase presence in Asia and other emerging markets • Volumes contract as end markets weaken. • Significant opportunity for product application in further • Competition from Solvay as well as from other high uses for arthroscopy and orthopaedic market. performance plastics.

303 304 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 159: Victrex: Divisions and products Division 2009 Sales (£ m) % sales Key products Key end-markets Key competitors Victrex Polymer Solutions 69.6 67% The VICTREX PEEK polymer Automotive, Transportation, BASF, Clariant, Kemira, Lanxess, Elementis, DSM product range includes several Electronics, Industrial, aviation, different types of construction polyaryletheretherketones - a wide range of blends, compounds, high flow, high purity, films and coatings grades Invibio Biomaterial Solutions 34.2 33% Range of biocompatible PEEK-based Medical device industry Spolvay, Evonik, DSM, Lonza, polymers Total 103.8 100%

Source: Company reports and J.P. Morgan estimates.

304 305 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Wacker Chemie

Figure 457: Sales by division (2009A) Figure 458: EBIT by division, €mn (2009A) Siltronic Other 500 16% Poly silicon 4% 28% 250 Fine 0 Chemicals 3% Silicones -250 31% -500 Poly mers Siltronic Silicones Poly mers Poly silicon Fine 18% Chemicals

Source: Company data Source: Company data * reported

Figure 459: Sales by destination (2009A) Figure 460: EBITDA margin development Other Germany 30% 3% 21%

Asia 20% 34%

10% Europe 25% 0% Americas 2005A 2006A 2007A 2008A 2009A 17% Source: Company data Source: Company data * pre-exceptional

COMPANY DESCRIPTION: Wacker Chemie was listed in 2006 and offers a wide range of products and technologies including silicone and polymer chemistry, specialty and fine chemistry, polysilicon and semiconductor technologies. The group services a wide range of end-markets, including semiconductors, solar energy, construction and automotive. The majority of profits come from its Polysilicon business, which services the solar and semiconductor end-markets.

STRENGTHS: WEAKNESSES: • Market leadership (within top 3) in chosen segments • Exposed to deep cyclicality of semiconductor end-market. • Cost and quality leadership in Polysilicon. • Lacks scale in 300mm wafers (price taker) • High entry barriers given capital intensity and technology • Limited freefloat implies above-average share price requirements. volatility. OPPORTUNITIES: THREATS: • Expore to fast-growing solar market. • Oversupply in polysilicon and 300mm wafers. • Further expansion of polysilicon capacity • Input cost pressures.

305 306 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 160: Wacker Chemie: Divisions and products 2009 Sales % Division (€m) sales Key products Key end-markets Key market positions Key competitors Silicones 1,239 31% Performance materials, elastomers, basic Construction, chemicals, health & wellness, automotive, #3 in silicon worldwide; Dow Coming, Momentive, Shin-Etsu, Evonik, materials, silica, construction sealants plastics, energy & electronics #1 in building preservation, Bluestar #2 in elastomers for transportation and energy, #2 in fumed silica for merchant market

Polymers 744 18% Construction polymers, dispersions, Construction, automotive, eng. fabrics, adhesives, food #1 in dispersable polymer Elotex, Chinese players coatings & resins powders; Leading global supplier of VAE dispersions for adhesives, coating & engineered fabrics application Fine 105 3% Cyclodextrins, cysteine, ketene, biologics Food & flavours, Personal & home care, Life sciences, #1 in cyclodextrins (share DSM, Lanxess, Lonza Chemicals Biopharma >50%) and cysteines

Polysilicon 1,121 28% Polysilicon, pyrogenic silica, salt Solar panels, semiconductors (Siltronic) #2 in polysilicon Hemlock, REC, Tokuyama, MEMC, OCI, Chinese players

Siltronic 638 16% Electronic wafers (76 - 300mm) Semiconductors #3 in 300mm wafers Shin-Etsu, SUMCO, MEMC, LG Siltron

Other 181 4% Total 3,719 100% Source: Company reports. * total excludes consolidation of -307.7

306 307 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Yara

Figure 461: Sales by division (2009) Figure 462: EBIT by division, NOKmn (2009) Upstream 1000 13% 800 Industrial 600 14% 400

Dow nstream 200 73% 0 Downstream Industrial Upstream Source: Company data Source: Company data Figure 463: Sales by destination (2009) Figure 464: EBITDA margin development South and Central 30% North America America 17% 13% Australia and 20% New Zealand 1%

Asia Pacific 10% 9% 0% EU 51% Africa 9% 2005 2006 2007 2008 2009

Source: Company data Source: Company data, J.P. Morgan estimates COMPANY DESCRIPTION: Yara is a global chemical company that converts energy and nitrogen from the air into essential products for farmers and industrial customers. It builds its business strategy on nitrogen fertilizer leadership, based on strong ammonia production and trade activity, and a comprehensive downstream product offering. It is an integrated company with upstream, industrial and downstream products, with a global presence.

STRENGTHS: WEAKNESSES: • Leading market position in nitrates in Europe and strong • Limited exposure to faster growing demand regions. ammonia trading network. • Lack of potash and limited phosphate production. • European low-cost leader. • Limited access to low-cost natural gas (but growing). • Global marketing and distribution with economies of • Exchange rates (reliance on US$ prices products). scale. • Dependency on weather for good crop productivity and • Vertical integration reduces cyclicality. fertiliser sales. OPPORTUNITIES: THREATS: • Long-term population growth/improving dietary • Capacity growth in exporting regions (Middle East). standards. • Slowing growth in agriculture industry. • Energy/Natural gas shortages in China. • High energy prices. • Upward pressure on wheat, corn and soybean prices • Strengthening of NOK against USD. improves fertiliser demand. • Acquisition in low-cost gas regions. • EU expansion long-term increase in Russian gas price.

307 308 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 161: Yara: Divisions and products 2009 Sales % Division (NOK m) sales Key products Key end-markets Key market positions Key competitors

Downstream 45,061 73% Urea, UAN,Nitrates, Fertiliser industry #1 Fertilisers Mosaic, Potash,K+S, Agrium, ICL, CF industries NPK,MDP, MOS,Other value added fertiliser products

Industrial 8,465 14% Chemical products, industrial Chemical industry, Food & #1 Nitrogen applications ICL, Linde, Air liquide, CF industries gases, Nitrogen Beverage Industry, industrial (Europe) chemicals(urea,ammonia) explosive industry

Upstream 7,884 13% Ammonia, urea, Industrial & downstream #1 Ammonia Mosaic, Potash, Agrium, ICL, CF Industries, Nitrates,NPK,CN,UAN, divisions, different industry who #1 Nitrates Ammonia trading needs ammonia or Nitrogen #1 NPK products

Eliminations 8 <1% Upstream products used as inputs in Downstream Total (after elimin.) 61,418 100%

Source: Company reports and J.P. Morgan estimates.

308 309 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Yule Catto

Figure 465: Sales by division (2009) Figure 466: EBIT by division, £mn (2009)

60

Pharma 50 12% 40

30 Poly mer Chemicals Impact Chemicals 20 84% 4% 10 0 Poly mer Chemicals Pharma Impact Chemicals

Source: Company data Source: Company data Figure 467: Sales by destination (2009) Figure 468: EBITDA margin development ROW 21% 14% 12% 10% Europe 8% 6% 50% 4% 2% 0% Asia 2005 2006 2007 2008 2009 29%

Source: Company data Source: Company data, J.P. Morgan estimates COMPANY DESCRIPTION: Yule Catto specializes in manufacturing specialty chemicals for a wide range of end markets from industrial to personal care. The company has radically restructured the Group profile, and reduced previously high levels of debt through disposals. In addition the Company has created a non core division for potential disposal called Impact Chemicals, alongside its main Polymer Chemicals unit, and the smaller Pharma division. Yule Catto is based in the UK, with a significant part of its asset base in UK and other EU countries, with expansion occurring in the Far East and emerging markets.

STRENGTHS: WEAKNESSES: • A market leader in specialized polyvinyl alcohol and • May be vulnerable to short term rising input costs with nitrile latex for thin wall gloves. lag before pass through achieved. • Growing revenues from Asia (2006: 23%, 2009:30%) • Relatively small size of asset base limits growth with emerging markets now comprising around 44%. opportunities. OPPORTUNITIES: THREATS: • Pharma operations are sold or joint ventured, reducing • Raw material cost inflation. company’s exposure to a relatively low growth, generic • End markets slow with volume growth stalling. area • Radical restructuring and disposal programme has created a stronger business profile.

309 310 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

Table 162: Yule Catto: Divisions and products 2009 % Sales sales Division (£m) Key products Key end-markets Key market positions Key competitors Polymer Chemicals 455 84% Water based polymers, Paints, coating, construction, #1 in specialized polyvinyl DSM, Rhodia, Elementis, lanxess, Clariant, Specialty chemicals including textile, automotive alcohol, #1 in nitrile latex for Eastman, Croda lithenes and polyvinyl alcohol, thin wall gloves Latex Pharma 65 12% Pharmaceutical Ingredients Healthcare, biotechnology Lonza, DSM for both generic and ethical drug manufacture Impact Chemicals (William Blythe) 23 4% Range of metal salts Catalysts, electronic circuit boards and construction products Total 543 100%

Source: Company reports and J.P. Morgan estimates.

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Coverage Universe: Neil C Tyler: Air Liquide (AIRP.PA), Akzo Nobel (AKZO.AS), BASF (BASF.DE), Clariant (CLN.VX), K+S (SDFG.DE), Linde (LING.DE), Syngenta (SYNN.VX), Yara (YAR.OL)

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315 316 Neil C Tyler Europe Equity Research (44-20) 7325-9935 26 July 2010 [email protected]

J.P. Morgan Cazenove Chemical contacts

Europe Neil C Tyler (44-20) 7325-9935 [email protected] Martin Evans (44-20) 7155 6169 [email protected] Heidi Vesterinen (44-20) 7325-4537 [email protected] Neeraj Kumar (91-22) 6157 3289 [email protected] Hella Zouiten (44 20) 7155 6408 [email protected] Yuriy A Vlasov (7-495) 967-7033 [email protected] Valentin A Stollyar (7-495) 967-7009 [email protected]

North America Jeffrey J. Zekauskas (1-212) 622-6644 [email protected] Silke Kueck (1-212) 622-6503 [email protected] Ben Richardson (1-212) 622-6455 [email protected] Olga Guteneva (1-212) 622-6488 [email protected]

Asia Pacific Brynjar Eirik Bustnes (852) 2800-8578 [email protected] Jasmine Bai (852) 2800-8559 [email protected] Keith Chau (61-2) 9220-1582 [email protected] Marcus Shin (822) 758-5712 [email protected] Nick Lai (886-2) 2725-9864 [email protected] Nobuhito Owaki (81-3) 6736-8677 [email protected] Pinakin Parekh, CFA (91-22) 6157-3588 [email protected] Samuel Lee, CFA (852) 2800-8536 [email protected] Scott YH Seo (82-2) 758 5759 [email protected] Sukit Chawalitakul (66-2) 684-2679 [email protected]

Latin America Sergio Torres (1-212) 622-3378 [email protected] Brian P Chase 56 2 425 5245 [email protected] Debbie Bobovnikova (1-212) 622-3489 [email protected]

MENA Alex Comer (44-20) 7325-1964 [email protected]

European Credit Stephanie Renegar (44-20) 7325-3686 [email protected] Danielle Ward (44-20) 7742-7344 [email protected]

Soft Commodities Lewis Hagedorn (1-212) 834-8046 [email protected]

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