Deutsche Bank Markets Research Industry Date 2 July 2014 China's Coal to Asia Olefins Industry China Energy Chemicals David Hurd, CFA Shawn Park Research Analyst Research Analyst (+852) 2203 6242 (+82) 2 316 8977 [email protected] [email protected] James Kan Research Analyst (+852) 2203 6146 [email protected] F.I.T.T. for investors Coal, to Syngas, to Methanol, to Olefins Only in China Converting China's coal into olefins (ethylene and propylene) is a multi-step, multi-industry process. Coal is first converted to syngas; syngas is then converted to methanol; methanol is thereafter converted to olefins. In this FITT report we look through the chain of China's coal-to- olefins industry by focusing largely on the economics and processes involved. In subsequent FITT Reports we will also consider China's coal-to-urea, coal-to-liquids and coal-to-syngas industries. Globally, only China uses coal to make industrial quantities of urea, methanol and now potentially, olefins. ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, 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. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 148/04/2014. Deutsche Bank Markets Research Asia Industry Date China 2 July 2014 Energy China's Coal to Chemicals Olefins Industry FITT Research David Hurd, CFA Shawn Park Research Analyst Research Analyst Coal, to Syngas, to Methanol, to (+852) 2203 6242 (+82) 2 316 8977 Olefins [email protected] [email protected] Only in China James Kan Converting China's coal into olefins (ethylene and propylene) is a multi-step, Research Analyst multi-industry process. Coal is first converted to syngas; syngas is then (+852) 2203 6146 converted to methanol; methanol is thereafter converted to olefins. In this FITT [email protected] report we look through the chain of China's coal-to-olefins industry by focusing largely on the economics and processes involved. In subsequent FITT Reports we will also consider China's coal-to-urea, coal-to-liquids and coal-to-syngas industries. Globally, only China uses coal to make industrial quantities of urea, methanol and now potentially, olefins. The economics Using US$ 110/ bbl naphtha to produce olefins is expensive (US$ 1,185/ ton); using US$ 42/ ton coal from Inner Mongolia is less expensive (US$ 640/ ton); but using US$ 5/ mmBtu natural gas from North America / Middle East is the least expensive (US$ 338/ ton) way to produce olefins. It's a slow moving train, but its coming as N. America starts to add low cost shale-gas-to-olefin capacity 2017-18e. As China sets out to build its uniquely-China coal-to-olefins industry, we contemplate the long-term contradictions of: 1) China’s coal-to- olefin industry displacing its naphtha-to-olefin industry; and 2) China’s push to find its cheap shale gas only to displace its various coal-to industries. Conclusions and potential beneficiaries We suspect: 1) the NDRC’s ambitious time table for Coal-to-Olefin and Coal-to- Methanol (CTO/ CTM) development in China (Appendix 1-2) will take longer to implement than designed; and 2) shale gas in China will also develop at a snail’s pace and thus be less transformational, due to a lack of competition in the market and various price controls throughout the system. Yingde Gases (2168 HK – Buy) has been a primary beneficiary of China’s developing CTO/ CTM industry. Starting from a low base, even a slower development pace than Plan should support Yingde’s growth. Sinopec Corp. (386 HK) has six CTO (2), MTO (3) and/ or GTO (1) projects, with 1 already operating and 2 scheduled for start-up in 2016e. The risk to these projects is an abundance of low cost shale gas coming to China anytime soon; we suspect this is not going to happen. The lack of success globally in developing Coal-to-MEG technology has led us to reiterate our Buy ratings on Nan Ya Plastics (1303 TT – Buy) and Lotte Chemicals (011170 KS - Buy); both benefit from higher MEG prices in Asia. Valuation and risks We value most of our commodity companies on a discounted cash flow model. The DCF model allows for the input of differing commodity prices over a multi-year period. The Hong Kong stock market trades mostly off of PE valuations and as a result, we will use both longer term (DCF) and shorter term (PE) valuation metrics to assess the value of most of our companies. The principal risk to China’s CTO/ MTO build out ironically comes from China’s drive to find its very own cheap, abundant shale gas. Coal-to-olefins is not cost competitive relative to cheap natural gas-to-olefins. We expect delayed implementation of China’s CTO/ MTO build out vs. the 5-Year Plan (2011-15e) due to on-going debates in Beijing surrounding scarcity of water, air pollution and the economics of coal-to-chemicals. ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, 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. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 148/04/2014. 2 July 2014 Chemicals China's Coal to Olefins Industry Table Of Contents Executive summary ............................................................. 3 Full of contradictions – just like China ................................................................. 3 Introduction ............................................................................................... 10 Some of the basics ............................................................................................. 10 China – unlocking energy value differentials ..................................................... 13 China’s coal markets .......................................................................................... 13 What is coal? ...................................................................................................... 22 Syngas ............................................................................... 26 Coal gasification - ............................................................................................... 26 Equipment used in the coal-to-syngas process ................................................. 33 Methanol ........................................................................... 38 What is it? ........................................................................................................... 38 Methanol synthesis from syngas ....................................................................... 55 The Syngas to methanol (vapor) reaction: ......................................................... 56 More about the catalysts .................................................................................... 58 Methanol refining: .............................................................................................. 58 Methanol production costs ................................................................................ 59 Coal to olefins .................................................................... 67 Ethylene .............................................................................................................. 69 Propylene ............................................................................................................ 70 Producing ethylene & propylene ........................................................................ 70 Converting methanol to olefins: ......................................................................... 72 Olefins synthesis and catalyst re-generation: .................................................... 73 Olefins separation ............................................................................................... 74 MTO technology(s) found in China .................................................................... 76 The Catalyst for methanol-to-olefins (SAPO-34) ................................................ 82 Financials ............................................................................................................ 83 Water & Pollution ............................................................................................... 90 Water scarcity in China (Figure 95) .................................................................... 90 Water usage in China ......................................................................................... 91 China’s water resource location vs. usage ........................................................ 91 Water use comparisons by product ................................................................... 91 Emissions ............................................................................................................ 93 CTO emissions: ................................................................................................... 95 Emission from Syngas production process........................................................ 98 Listed companies / DB rating as mentioned in FITT report