Summary ICIS Weekly Margin – POLYETHYLENE (PE) Europe Methodology

This document is intended to provide methodology support for customers receiving the ICIS Weekly Margin – PE Europe report.

THE BUSINESS MODEL

The diagram below shows the main method of making PE from naphtha, a product mainly derived from crude oil. Naphtha with steam is fed into the cracker unit where ethylene and other coproducts (propylene, butadiene and benzene) are made.

The ethylene from the cracker unit is then further processed (polymerised) in the PE plant to make the PE pellets for sale.

THE MARGIN CALCULATION

• Margin measure provides assessment of the ex-works cash margin obtained for the product over raw material costs and key variable manufacturing costs, such as power, steam, catalysts and chemicals. This measure can also be termed as a variable margin, contribution or benefit.
• It represents a cash margin measure available for supporting the direct and allocated fixed manufacturing costs, working capital, taxes, royalties, corporate costs, debt service costs, capital costs and owner’s returns from the business.
• This margin measure provides simple signals on the direction of business margins, as dictated by the environment alone, thus informing market positioning by sellers, buyers and traders.
• ICIS chooses not to model beyond raw material costs and key variable manufacturing costs as this ceases to be generic to the integrated industry and highly specific to individual business operations, their site structure, location, ownership and financial structures. Such detail would not fairly reflect or be applicable in a wider industry context. It may also be more subjective, open to fair challenges and not feasible to reference in commercial discussions.
• Plant manufacturing and feedstock yield model data have been provided by Linde Engineering, a division of Linde AG. Linde Engineering (www.linde-engineering.com) is a leading international chemical plant designer, process engineering, procurement and construction contractor. It has extensive experience in ethylene and PE plant design.
• The process model is generic and not referenced to any individual operation, so that the contribution measure is only indicative. It can be most valuably referenced in index and step change terms as opposed to absolute value terms.
• Naphtha feedstock has been chosen as this represents the most commonly used feedstock for ethylene manufacture in Europe. As such, the cost model is broadly applicable to the majority of the European commodity PE business.
• Ex-works product price assessments are linked to ICIS pricing quotations for large volume commodity products with netbacks assessed using typical logistic cost assessments.
• The PE grades referenced in the ICIS PE Europe Margin report are low density polyethylene (LDPE) GP film grade and high density polyethylene (HDPE) injection moulding grade. These generally represent large-volume commodity grades in the PE market. The ICIS domestic FD EU quote is referenced as this is broadly representative of the entire west European market.

Below is a detailed calculation of how the integrated and standalone margins are calculated. The figures refer to averages for film-grade LDPE based on contract/domestic sales values for 2011; the calculation for injection-grade HDPE is similar. Figures indicated in red are those found in the tables of the margin report; others relate to underlying assumptions of the model.

Integrated margin (€/tonne)
LDPE film-grade price	1,448
Logistics costs/netbacks	(166)
Net selling price		1,282
Purchase feedstock (naphtha)1	(2,225)
Co-product sales/tonne of LDPE produced 2,3	1,633
Variable cost of PE unit4	(117)
		(709)
Integrated margin		573
Standalone margin (€/tonne)
LDPE film-grade price		1,448
Logistics costs/netbacks		(166)
Net selling price			1,282
Ethylene price	(1,138)
Logistics costs/netbacks	106
Net ethylene price paid	(1,032)
/tonne LDPE produced 3  ie Purchase feedstock (ethylene)		(1,042)
Co-product sales/tonne of LDPE produced		-
Variable cost of PE unit4		(117)
			(1,159)
Standalone margin			123

¹The model assumes 3.278 tonnes of naphtha are required to produce 1 tonne of ethylene and 1.01 tonnes of ethylene are required to produce 1 tonne of LDPE. The average net naphtha price (including freight costs) for 2011 was $933/tonne (with an average $:€ conversion rate of 1.393).

²Co-product sales include credits for propylene, butadiene, benzene, raffinate-1, pygas and a fuel export balance.

³The model assumes 1.01 tonnes of ethylene are required to produce 1 tonne of LDPE.

⁴Includes power and catalysts/chemicals for the PE.

DIFFERENCE BETWEEN NON-INTEGRATED AND INTEGRATED

• Non-integrated or standalone: market participant involved with PE production only. The business model is to buy ethylene, convert it into PE and sell the PE. Our margin model assumption is that the plants are co-located and that the ethylene is transferred at an FOB value. This business model is only applicable to a minority of manufacturing facilities in Europe.
• Integrated: market participant involved with both ethylene and PE production. The business model is to buy naphtha feedstock, process it into ethylene and cracker coproducts, convert the ethylene into PE, and sell both the PE and cracker coproducts. This business model is applicable to the majority of manufacturing facilities in Europe.

WHY INTEGRATED ANALYSIS

• Integrated analysis provides the key reason for being (or ‘raison d’être’) in the commodity PE business.
• Most west European PE plants (approximately 90% by capacity) are integrated back to cracker sources of ethylene. This may be co-located and/or connected by pipeline and with common equity ownership across both assets in the supply chain, that is, the economic boundaries for the majority of the industry producers are bigger than a standalone polymer unit.
• The margin is therefore measured across the supply chain from cracker feedstock (naphtha) through to PE and cracker coproducts.
• This analysis demonstrates the volatility of the business and the influence of price floors that can lead to an uneconomic integrated margin, and generally forcing a reduction in supply.
• In contrast, a non-integrated or standalone analysis that considers the polymer unit in isolation may be useful for understanding marginal opportunities where optimisation processes could result in ethylene being preferentially used for other ethylene derivative products. However, analysis of non-integrated historical data does show inadequate margins to justify fresh business investment to meet growing market demands.

MODEL YIELD PATTERN AND CALCULATION

Plant manufacturing data relates to the variable cost components of the chemical unit operations. Yield pattern data relates to the overall material balance of the cracker unit, for example for 1 tonne of ethylene produced, a cracker requires 3.2 tonnes of naphtha feedstock, and will produce coproducts (propylene, butadiene and benzene) of 2.2 tonnes in addition to the 1 tonne of ethylene. The plant manufacturing and feedstock yield model data have been provided by Linde Engineering, a division of Linde AG.

The exact yield pattern used cannot be published in an unrestricted document such as this methodology statement. However, for PE Europe Margin report subscribers with a specific requirement to see this data, it can be shared on a case-by-case basis.

Please contact the Global ICIS Customer Support Centre if this data is required.

ASSESSMENT INPUTS

The following 16 ICIS pricing inputs are used to generate the full content of the ICIS Weekly Margin PE Europe report

• Polyethylene LDPE (GP Film) in Europe domestic FD EU [from 9 January 2009, previously domestic Germany] (€/ tonne)
• Polyethylene LDPE (GP Film) in Europe spot FD NWE (€/tonne)
• Polyethylene HDPE (Injection) in Europe domestic FD EU [from 9 January 2009, previously domestic Germany] (€/tonne)
• Polyethylene HDPE (Injection) in Europe spot FD NWE (€/tonne)
• Naphtha in Europe spot CIF NWE (Friday assessment) ($/tonne)
• Gasoline: unleaded premium in Europe spot FOB barges ARA ($/tonne)
• Fuel oil 1% in Europe spot CIF cargoes NWE (weekly average) ($/tonne)
• Ethylene in Europe monthly contract FD NWE [from January 2009, previously quarterly] (€/tonne)
• Ethylene in Europe spot CIF NWE ($/tonne)
• Propylene in Europe monthly contract FD NWE [from January 2009, previously quarterly] (€/tonne)
• Propylene (polymer grade) in Europe spot CIF NWE (€/tonne)
• Butadiene in Europe monthly contract FD NWE [from January 2011, previously quarterly] (€/tonne)
• Butadiene in Europe spot FOB Rotterdam ($/tonne)
• Benzene in Europe monthly contract FOB NWE [from January 2004, previously quarterly] (€/tonne)
• Benzene in Europe spot CIF ARA ($/tonne)
• Raffinate-1 in Europe spot CIF NWE ($/tonne)

The ICIS pricing methodology associated with each individual pricing quotation referenced above can be found in the free access methodology area of www.icispricing.com.

In addition to the above pricing inputs, ICIS pricing uses the $/€ mid-market exchange rate on the date of the report publication issued at 16:00 GMT/UTC by XE (www.xe.com). Mid-market rates are derived from the mid-points between the buy and sell rates of large-value transactions in the global currency markets.

A key objective of the calculation procedure is to provide a weekly summary that is most strongly aligned to the reported market price positions on the date of publication.

Where ICIS price quotations are not available for individual weeks due to public holidays, then prior week data is carried forward for the specific purpose of populating the model and preventing model inconsistency. This form of data interpolation is inferring some limited data points that may not be market derived, and customers should be aware of this assumption.

All data in the ICIS Weekly Margin – PE Europe report is denominated in euros unless specifically indicated otherwise.

LONGER RANGE VIEW:

SPOT VS. CONTRACT MARGIN

This provides a weekly comparison of the calculated margin for spot-based PE sales minus contract-based sales. This switch of ICIS pricing reference is also considered for the cracker products, so the analysis is deeper than a simple comparison of spot versus contract PE price netbacks. When this differential provides a positive numerical output, this implies that spot-based PE sales derive a higher margin for an integrated producer compared to contract-based sales. Similarly, when this differential provides a negative numerical output, this implies that spot-based PE sales derive a lower margin for an integrated producer compared with contract-based sales.

For the avoidance of any doubt, the basis on which ICIS pricing data is utilised for each of these respective models is summarised in the table below. For more detailed information about these quotations, please refer to the assessment inputs section above.

ICIS price	Spot margin model	Contract margin model
Polyethylene LDPE	Spot	Domestic
Polyethylene HDPE	Spot	Domestic
Naphtha	Spot	Spot
Gasoline	Spot	Spot
Fuel oil	Spot	Spot
Ethylene	Spot	Contract
Propylene	Spot	Contract
Butadiene	Spot	Contract
Benzene	Spot	Contract
Raffinate-1	Spot	Spot

The ICIS Weekly Margin PE Europe report will provide this comparative data chart for HDPE and LDPE on alternate weeks.

READING THE CHARTS

In the short-term charts and longer range margin view, the integrated margin is derived by reading the top of the wedge, the sum of the ethylene margin per tonne of PE (yellow) and the standalone PE margin (blue). Where the standalone margin is a loss (red), the integrated margin is read as the top of the yellow wedge or, where there is no yellow wedge, the bottom of the red.

PUBLISHING FREQUENCY

The ICIS Weekly Margin PE Europe report for European PE is produced on a Friday at the close of business in Europe and distributed to customers on the following Monday, subject to schedule planning. When the Monday is a public holiday in the UK, the report is distributed on the Tuesday. The report is not published on some public holidays. Holiday dates and days of publication may be subject to revision.

For information on ICIS' full portfolio of margin reports, visit http://www.icis.com/chemicals/channel-info-about/margin-reports/