Getting the balance right

07 October 2002 00:00  [Source: ICB]

The chlor-alkali industry suffers from chlorine and caustic soda being produced in near equal volumes,even though their end-use profiles differ and demand for each is rarely balanced. Stephen Harriman reports

The key to any understanding of the chlor-alkali industry, either in Europe or any other region, is an understanding of the inseparable production of caustic soda and chlorine in approximately equal volumes. Electrolysis of common salt (sodium chloride) or brine solution accounts for in excess of 99% of all production of caustic soda and chlorine.

There are no other economically viable alternatives to this method of production available today. Strictly speaking, 2.1 tonne of

salt should produce 1.1 tonne of caustic soda and 1 tonne of chlorine.

While supplies of chlorine and caustic soda are in approximately equal quantities, the end-use profiles of demand for chlorine and caustic soda are quite different. Thus, as economic cycles influence chemical demand, with different industries experiencing up-cycles and down-cycles at different points in the general economic cycle, demand for chlorine and caustic soda are rarely balanced.

Normally, one of the products is in greater demand than the other. Furthermore, chlorine gas cannot be readily stored in large volumes, whereas substantial inventories of caustic soda can be held at any one time. This feature also affects the chlorine and caustic soda supply/demand balance.

Production of either chlorine or caustic soda is always limited by demand for and ability to store the other. Pricing of each of the two materials is heavily influenced by whether chlorine or caustic soda is in greatest demand at any one time.

When chlorine gas is most in demand, production is limited by demand for caustic soda and the ability to absorb caustic soda in inventories. Similarly, when caustic soda is most in demand, availability will be restricted by demand for chlorine.

Pricing for the two materials, therefore, tends to move through two opposing fluctuating cycles. The fluctuation in pricing can and has, over time, exhibited high volatility.

One other important influence on the chlor-alkali industry in Europe is the method of electrolysis being used. The

re are three important production methods globally, of which two are more predominant in Europe.

The first is the traditional method in Europe, and incorporates use of mercury cells in the electrolysis process. The second, more modern, method utilises polymer membrane cells. Gradually, membrane cell processes are replacing mercury cells in Europe. A third method, diaphragm cell manufacture, is less prevalent in the European scenario.

Shift from mercury

The method of production is important, because the European industry is committed to shift the bulk of chlor-alkali manufacture away from mercury cell use and replace this technology with membrane cells. This transition will continue to require huge investments, far more than would be needed for the maintenance and upkeep of existing plants.

Indeed, as mercury emissions to the environment have been minimised through technology investment, the deadline for closing mercury cell plants has been extended; the concept of replacement nevertheless remains. This additional facet to the European chlor-alkali industry has a bearing on the returns that operators of the plants would require in order to justify new investment.

The discussion of market developments in the European chlor-alkali industry in 2002 will be heavily influenced by the major drivers of the industry, already noted above, superimposed on which are the actual conditions that have existed over the past nine months.

First, the two charts above illustrate the different end-use markets into which chlorine and caustic soda are destined to go. As is clearly noted from the charts, 34% of European chlorine production is destined for PVC manufacture; adding isocyanates and oxygenates (propylene oxide), solvents, epichlorohydrin and chloromethanes brings the total to 75% of chlorine demand.

This three-quarters of chlorine demand is in quite different end-uses than caustic soda demand. As it happens, the remaining 25% of chlorine demand, described in the chart as 'others' and 'inorganics' also tends to be destined for different end-uses than caustic soda. There tends not to be much overlap with the industries listed as 'inorganics' and 'miscellaneous'Êin the caustic soda end-use profile.

The fact that the supply side results in equal volumes of the two materials, but demand can be completely different usually results in the demand side being the major driving force in the chlorine and caustic soda price cycles. While plant outages and shut-downs will have sub-regional implications for the supply/demand balances, on a European scale, such events are of less importance than whether chlorine or caustic soda is the most in demand at any one time.

Equally, because huge volumes of caustic soda are traded and transported around the world, but chlorine cannot be readily transported, plant outages and shutdowns tend to have a more immediate effect on chlorine and its derivatives rather than on caustic soda.

The third chart illustrates the price volatility of caustic soda and PVC in western Europe over the past five years (1998-2002). The chart relates to caustic soda liquor prices, denoted in dry metric tonne equivalent (dmt), as is the convention, and PVC pipe grade. PVC prices are given as a substitute for chlorine.

Relatively little elemental chlorine is traded, but PVC, being the largest end-use for chlorine provides a good indicator. Of course, the PVC price incorporates the conversion cost to PVC, as well as ethylene costs, but is a satisfactory indicator for the purpose of this article.

For caustic soda, it can be clearly seen that from mid-2000, prices began to rise from a nadir, and peaked a year later at a little above E400/dmt, or almost three times the value at the low point. Prices then fell back rapidly to around E175/dmt in quarter two 2002.

At the same time as caustic soda prices were at a nadir in mid-2000, PVC prices were rising to a cyclical high point at E900/tonne. For PVC this represented an almost doubling in price since the previous low point in early 1999. The chart displays the counter-cyclicality of the two materials, since the fall in PVC prices from mid-2000 to mid-2001 was accompanied, in a somewhat delayed fashion, by a rapid escalation in caustic soda prices.

Since mid-2001, chlor-alkali manufacturers have suffered substantially from this price volatility, since, as caustic soda prices fell rapidly, PVC prices also continued in a broadly downward direction, until early-2002. Recovery of PVC prices since the beginning of this year has also been accompanied by a continuing slump in caustic soda values, a slump that may only now be starting to show the first signs of being reversed.

Thus, the price cycles of chlorine and caustic soda have interacted once more, with very low caustic soda prices early in 2002 stimulating an increase in chlorine prices (as PVC) throughout this year.

In spite of the volatile pricing in chlor-alkali markets, actual supply and demand may be relatively stable for long periods of time, thus making it difficult to manage the business. The data in the table (above) illustrate that chlorine, and thus chlor-alkali, production in the first half 2002 was almost unchanged from the same period a year ago. Supply side issues should have had little impact on prices, but that has not prevented the volatility from continuing.

Right now, caustic soda inventories have been falling, and after some months of very strong chlorine demand, the focus of the industry is beginning to shift somewhat, towards the caustic soda side of the business. PVC prices appear to have topped out for the moment; while producers were looking for further price increases, these are beginning to look increasingly difficult to achieve.

Meanwhile, caustic soda sellers are seeking a E75/dmt price increase for quarter four business in Europe, and there are suggestions that another increase is possible for quarter one 2003. Thus the next cycle continues.

In fact, over a period in excess of 25 years, chlor-alkali pricing has exhibited a volatility that appears to run in roughly seven-year cycles. However, the past two cycles have been somewhat shorter, and it appears that the cyclicality may be speeding up while losing none of its volatility. This can only exacerbate the task of chlor-alkali producers in attempting to manage their businesses.

The past year has been a tough time for producers, with prices falling on both the chlorine and caustic soda sides of the business in the latter half of 2001, margins have been very poor, and in no way reflected the potential costs of reinvestment in the industry.

ÊÊDuring the past 12 months there have been several chlor-alkali plant closures in western Europe, including operations in Italy, in Sardinia, and in the UK, at Wilton, with a smaller plant due to close in the UK at the end of the year. Recent strikes in France and Italy have also not added to the stability of the industry.

The subject of reinvestment is very important in Europe, because of the broad agreement between producers to switch all production from mercury cell to membrane cell technology by 2010. In fact, it seems this deadline is likely to be stretched to cover the foreseeable life of all plants, which in some cases may be as far away as 2020.

Little incentive to invest

In a business that is difficult to manage and which may present periods of very low returns, there is little incentive to invest in expensive new plant. A recent report stated that there are 47 plants in western Europe still to be converted from mercury cell technology, and more in eastern Europe. Euro Chlor currently manages recycling of unwanted mercury from its members' plants, thus reducing the need for mercury mining activities.

The situation is further complicated by the fact that in recent years several chlor-alkali producers have been bought by venture capitalists, whose measures of success may include tight financial performance that some businesses will be unable to achieve. Added to this is the possibility that some plants are owned by increasingly large chemical operations, where the chlor-alkali operation may not be considered the jewel in the crown of the business, and indeed, may find it difficult to compete for investment with more glamourous and profitable parts of the business.

Of course, Europe can survive with a smaller chlor-alkali industry, especially on the caustic soda side of the business, since caustic is readily traded over very long distances worldwide. However, any contraction in chlorine production would eventually impact on PVC manufacture, since chlorine cannot be transported over large distances.

This would also have reverberating effects on hydrochloric acid availability as a by-product from some chlorination processes. So, any continuing contraction in Europe's chlor-alkali industry would have wider implications for other chemical operations.

Stephen Harriman is head of Harriman Chemsult. Tel +44 20 7490 5700
e-mail enquiries@harriman.co.uk

Chlorine production volumes, western Europe, 2001-02, '000 tonne

	Chlorine production		Capacity utilisation (%)
Period	2001	2002	Change, %	2001	2002
Q1	2364.3	2312.5	-2.2	88.1	85.0
Q2	2300.5	2350.6	+2.2	86.0	87.3
H1	4664.8	4663.0	-0.04	87.0	86.1
Source: Euro Chlor