Industry Overview

8. INDUSTRY OVERVIEW (Cont’d) 8. INDUSTRY OVERVIEW (Cont’d) Section 1 Introduction
1.1 OBJECTIVES Nexant has been appointed as an Industry Consultant to provide an independent industry report (this “Report”) to support the Prospectus and Offering Circular for an initial public offering of LoUe Chemical Titan Holding Berhad (“Company”) on Bursa Malaysia Securities Berhad. The scope of this Report covers key aspects of the global and South East Asia (SEA) petrochemicals sector, with particular focus on the markets of Malaysia and Indonesia. This Report covers the following major petrochemical products: • Polyolefins (polyethylene and polypropylene)
• Olefins (ethylene and propylene) Related products including Butadiene and Benzene


1.2 PRODUCT OVERVIEW Petrochemicals are chemical products derived from petroleum and other hydrocarbon sources. Feedstocks for petrochemical production includes natural gas, ethane, LPG, naphtha and coal (see Section 2.2.3). In 2016, total global industry revenues for the sector were estimated at approximately US$3 trillion. They are used principally as building blocks for a wide variety of materials and applications. Key market end-use sectors include transportation, packaging, construction, agriculture, textiles, consumer goods and electronics. Table 1.1 Overview of Petrochemical Products Covered within this Report Global SEA’ Malaysia Indonesia Demand CAGR Demand CAGR Demand CAGR Demand CAGR Building Block Derivative Key Derivatives and/or Applications 2016 (2017·2027jF 2016 (2017 ·2027)F 2016 (2017·2027jF 2016 (2017·2027jF Ethylene Feedsbck for po~elhylene 146.5 3.7 10.3 43 1.4 4.8 1.4 10.3 Po~el1ylene Packaging, agricu~re, aulDmolve, consb’uclon 90.7 3.9 5.7 4.3 1.2 4.0 1.3 4.7 Propylene FeedslDck for po~propylene 97.5 3.8 6.0 6.4 0.6 11.1 0.8 12.1 Po~propylene Packaging, !exiles, aulDmolve, consb’uclon 63.8 3.9 4.8 46 0.5 3.2 1.5 5.0 Butadiene Feedsbck IJr SB Rubber, Butadiene Rubber, ABS 11.3 2.B 0.7 7.3 0.2 7.0 0.1 14.0 Benzene FeedslDck for Styrene 45.5 2.5 2.4 3.3 0.2 6.6 0.3 2.3 Note: SEA including Indonesia, Malaysia, PhilipjJines, Singapore. Thailand and V1elnam Note: CAGR =Compound Annual Groom Rate Nole: Unit =Million Ions Note: F=Forecast Source: Nexanl The petrochemical industry is predominantly a process-based industry that is characterised by the following key issues: • Feedstock inputs: Raw materials typically account for the majority of operating expenses. Although diverse, feedstocks used are predominantly petroleum based. Therefore many petrochemical producers have significant exposure to crude oil pricing. Given the importance of feedstock, producers with access to low priced gas feedstocks typically have a competitive advantage and higher levels of profitability over naphtha based producers.
Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad
38366 148 8. INDUSTRY OVERVIEW (Conf’d) Section 1 Introduction •  Regional diversity: Whilst the industry is global, market demand growth for chemicals is highest in developing regions. Asia has become a major consumer and demand driver for petrochemical products. This is attributed to the rapid expansion in the region’s industrial and manufacturing sectors and its large population base and rising income levels. Mature markets such as the US and Europe are significant in size but exhibit much lower growth;  •  Capital intensity: Economies of scale through construction of large facilities and continued asset reinvestment to leverage improved technology and maintain plant equipment are essential to sustain competitiveness. Access to capital is therefore a significant barrier to entry to the industry. Capital spending is also cyclical and follows industry peaks when cash pools are more readily available;  •  Cyclicality: Demand for petrochemicals is subject to business and economic developments driving cyclicality in industry profitability. This is further impacted by industrial supply typically increasing during peak levels of profitability due to easier access to capital;  •  Portfolio realignment: Despite a high level of diversity, the industry has also experienced considerable portfolio realignment and increased levels of vertical integration. This is predominantly the consequence of increased competitive rivalry which has resulted in restructuring, mergers and acquisitions and demergers.
tDNexanr Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 149
8. INDUSTRY OVERVIEW (Cant’d) Section 2 Industry Overview
2.1 INDUSTRY OVERVIEW 2.1.1 Key Industry Value Chains Primary petrochemical building blocks can be divided in the folloWing major categories:
• Chemicals derived from methane (“C1 chemicals”) such as methanol and ammonia
• Olefins -primarily include; ethylene and propylene

Other Building Blocks including butadiene and aromatics or BTX (benzene, toluene and xylenes).These products form the basis of the majority of all organic chemical products being processed by the industry today. Figure 2.1 provides a high level overview of the principal petrochemical value chains and major applications and end uses. Figure 2.1 Overview of Principal Petrochemical Value Chains Further Derivatives Major Applications
Nexanr Independent Market Report on the Petrochemicals Industry LaUe Chemical Titan Holding Berhad 38366 150
8. INDUSTRY OVERVIEW (Cont’d) Section 2 Industry Overview 2.1.2 Industry Outlook Petrochemical industry margins are subject to cyclicality. Changes in supply and demand and resulting plant operating utilisation levels (“operating rates”) are key factors that influence the cycle and the profitability of the petrochemical sector. Additionally the sector is highly capital intensive. This also contributes to cyclicality as new investments usually occur at the same time, following periods of sustained higher profitability. Crude oil pricing impacts the production costs and selling prices of many petrochemical products. Growth in global oil demand has occurred at a modest rate (i.e., just above one percent per year) during the 2011-2016 period. Demand growth has been concentrated primarily in the emerging economies in Asia and the Middle East, with oil demand in the most developed markets generally declining or exhibiting marginal growth. Crude oil prices consistently remained in the US$40-60 per barrel range during 2015 as OPEC and non­OPEC countries competed for market share through continued production. In addition, significant cost reductions for U.S. shale oil production led to record production for this oil source. Iran started to increase crude oil production substantially to recover lost market share as sanctions began to be removed in January 2016. This led to further oversupply in leading to prices below US$30 per barrel in 01 2016. Oil prices have since risen from those low levels to trade within the US$40-60 per barrel range once again supported by OPEC and non-OPEC decisions to cut production towards the end of 2016. Going forward, the major effects of the crude price decline since 2014 on supply may be felt over the next few years as almost US$300 billion of investment projects have been delayed or cancelled, and production decline rates are higher due to reduced expenditures. This could result in a price recovery in the medium term to incentivise investments in conventional oil production to offset declines from eXisting fields and meet continued oil demand growth. Petrochemical markets have been exposed to cyclical changes in supply and demand. These changes are usually closely linked to economic growth patterns, especially in China given its strong manufacturing base. Global supply continues to increase, with renewed investments in the United States following increased shale gas availability adding to development of capacity in the Middle East. Asian capacity also continues to grow rapidly, led by investments in China. Advancing technology has accelerated the size of new investments. European producers remain heavily exposed to imports penetrating into Europe and displacement of uncompetitive material from traditional export markets. Demand for olefins globally is projected to grow at approximately 3.7 percent CAGR (compound average annual growth rate) over the 2017-2027 period. Demand growth for propylene is anticipated at approximately 3.8 percent CAGR, while ethylene and butadiene demand growth over the same period is forecast at 3.7 and 2.8 percent, respectively. Investments in new downstream derivatives capacity of olefins are continuing throughout the Asian region, driving demand for olefins. Global polyethylene demand was estimated at approximately 91 million tons while polypropylene demand was around 64 million tons in 2016. Those are forecast to grow at approximately 3.9 percent CAGR over the period 2017-2027. Demand for benzene globally reached 46 million tons in 2016. Nexant forecasts benzene demand to grow at 2.5 percent CAGR over the period 2017-2027. Common key demand drivers for these petrochemical products are for packaging, automotive, construction and electrical/electronic markets.
2.1.3 Pricing and Profitability Industry demand is primarily influenced by economic activity while supply is affected by new capacity additions. Capital spending cycles are a common theme of the petrochemical sector as companies Nexanr Independent Market Report on the Petrochemicals Industry LaUe Chemical Titan Holding Berhad 38366 151 8. INDUSTRY OVERVIEW (Cont’d) Section 2 Industry Overview usually have access to large cash reserves at the same time. In times of economic growth, profitability is high resulting in multiple new investments in plant capacity. This often results in periods of oversupply as large increments of new capacity are realised at the same time. This leads to lower pricing and depressed margins for extended periods of time until the new capacity can be absorbed by new demand growth. Cyclicality also promotes industry restructuring, mergers, demergers and acquisitions. These factors may also result in capacity rationalisation whereby older, smaller scale, higher cost production units are closed. Petrochemical industry cycles vary in length. However, historic data suggests that average cycle lengths have been between 6-11 years in duration, measuring peak to peak. Due to the global nature of the industry (connected through trade and pricing), the profitability of most commodity petrochemicals tends to follow the same cycle. Therefore most products typically demonstrate peak or trough levels of profitability over the same periods. Occasionally, structural changes in a given market can cause profitability of one sector to diverge from the overall industry cycle. Figure 2.2 Petrochemical Industry Cyclicality (Cash margin -commodity chemicals &polymers) 400 140
00 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 -Cash Margin Index = =-Brent crude OilSource: I~exant 9 Figure 2.2 provides an overview of petrochemical industry profitability and highlights the cyclicality of the sector. Profitability is represented as a cash margin, expressed in US$ per ton petrochemical product. The cash margin presented represents the price of a petrochemical product minus its cash cost of production (i.e. feedstock cost plus direct operating costs, and excludes finance costs, depreciation and taxes). Data is based on an average for leading petrochemical plants in the region. This gives an estimated weighted average cash margin for the industry. Asian Petrochemical Profitability Long term trends in average profitability of the Asian petrochemical industry have closely reflected trends in the average industry operating rate. Profitability declined in 2008 due to the global economic crisis. Demand growth slowed, with exports of finished goods curtailed as the crisis took hold. Some demand recovered in the second half of 2009 as government stimulus packages proved successful in restoring liquidity and confidence to markets. Global GOP growth rates declined steadily and dropped below their long term average in 2012. Growth rates of the Chinese and Indian economies which provided a large component of the growth in Asian markets over the last decade slowed considerably as the economies matured. Much weaker than expected demand growth resulted in oversupply in many petrochemical markets. Meanwhile, Nexanr Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 152 8. INDUSTRY OVERVIEW (Cant’d) Section 2 Industry Overview competitiveness of many petrochemical derivatives was reduced by the sustained high prices of crude oil and naphtha, the preferred feedstock for much of the Asian industry. Figure 2.3  Asian Petrochemical Industry Profitability  (Based on annual average integrated cash cost margin in SEA)  0  160  90  a  ”  140  89  f”­a  a ~  120  88  cF­ x Q) -0 E  100  86  cD ron::  c”e> (‘(J ::;;;: ..c: (fj  80 60  85 84  CJ) .S; ro <u 0.. 0  (‘(J  u -0  40  83  -§ CJ)  20  81  Q)  E  0  80
2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 -Integrated Cash Margin’ -Operating Rate Note: Integrated cash margin for all commodity petrochemical products, across all integrated complexes in SEA.
Cash margin for 2007 has been equated to 100 with cash margin of other years benchmarked against 2007 to produced index for Figure 2.3. Source: Nexant Despite some recovery in the global economy through 2014, profitability of various value chains failed to rebound due to overwhelming capacity additions in Asia Pacific, reducing profitability in this period. In 2015, a large drop in both crude oil and naphtha costs relieved cost pressure on those petrochemicals, and coupled with increasing demand of derivatives, improved cash margins for producers. I\lew capacity, particularly in China, has been partially offset by some capacity closures of non-competitive units in other North-East Asia countries. Profitability declined modestly in 2016, owing principally to an oversupplied propylene value chain, but was still supported by the lower crude oil environment and demand in the ethylene value chain. Asian markets are more heavily influenced by transactions in spot markets, contrary to the preference for contract volumes in Western markets. Market sentiment and opportunistic purchasing patterns in spot markets promote more volatility in profitability of Asian operations. However, strength of underlying markets (indicated by operating rates) remains the principle influence of profitability in the longer term. Feedstocks continue to play a significant role in the petrochemical business, impacting on the cost position of a producer and the type of products that can be produced. Naphtha allows for a relatively diverse range of building blocks to be produced from steam cracking (i.e. ethylene, propylene, butadiene, benzene). When lighter feedstocks are used in steam cracking, such as ethane or LPG, relatively less propylene, butadiene and benzene are produced, which has been a recent trend as producers capture lower value of lighter feedstock opportunities (such as from US Shale gas). The implementation of Chinese coal to olefins projects on a commercial scale, has also had an effect of the range of building blocks available as such a production route focuses on the production of ethylene and propylene. Meanwhile profitability of on-purpose propylene production was supported by stronger market demand conditions for propylene downstream derivatives. It is assumed that Asia will lead global demand growth, progressively absorbing major new capacity additions. The profitability of the Asian petrochemical industry is forecast to fluctuate near historical average over the next five years. Future margins are expected to be sufficient to support selective investment in new capacity capturing some form of cost advantage through feedstock sourcing or downstream integration. Independent Market Report on the Petrochemicals Industryt:~Nexanr Lotte Chemical Titan Holding Berhad 38366 153 8. INDUSTRY OVERVIEW (Cont’d) Section 2 Industry Overview


2.2 PETROCHEMICALS KEY DRIVERS &TRENDS 2.2.1 Demand Side Fundamentals Olefins (ethylene and propylene) form two of the key industry building blocks, and are primarily used to produce other downstream derivative products from ethylene and propylene (such as polyolefins) onsite. As such consumption of polyolefins can be used to reflect petrochemicals demand by region as they are consumed directly by end users in a wide variety of key end uses such as construction, automotive, packaging, agricultural products, textiles and various consumer goods. The market growth potential within developing markets for plastics is evident on a consumption per capita basis. Key developing regions such as India, Indonesia, SEA and China still have a relatively low consumption per capita for polyolefins, relative to more developed regions, Malaysia, compared to other developing and some developed countries such as Japan and Western Europe (“WE”), has a comparatively high polyolefin consumption, for its population size. These and other high population countries provide high consumption potential for plastics as living standards improve and material substitution continues to take place. The polyolefins markets vary substantially country by country, as can be seen in Figure 2.4. Figure 2.4 Polyolefins Consumption per Capita 10% Bubble size indicates Note: *Exclude Indonesia and Malaysia demand in 2016, million tons LL 8% l;j India o C’ol r–:.. C; 6% C’ol • Brazil DC
t9 Indonesia••
Malaysiat3 4% @TI Former Soviet Q)
USt5 Union Q)WE ‘e 2% (L South East Asia* Japan. 0%

o 10 20 30 40 50 60 70 Consumption per capita (2017) kilogram per capita Source: Nexant Global demand for polyolefins exhibited good growth in 2016. Global demand was estimated at 155 million tons in 2016 representing around 4 percent consumption growth over 2015. A high proportion of global consumption growth is still in China. China’s total polyolefins demand in 2016 was estimated at approXimately 46 million tons or approXimately 30 percent of the global market. Future prospects for the global polyolefins market are closely linked to Chinese demand growth and sustained economic development. Its economy is increasingly benefiting from domestic consumption which is largely responsible for recent growth. However China continues to go through a transitional period with lower GDP growth year on year forecast, with GDP forecasts for China in the range of 5.3-6.2 percent between 2017-202i. This compares with double digit growth achieved over the last decade. As a consequence Nexant forecasts total polyolefins consumption growth in China to slow to 4.7 percent (CAGR) over the period 2017-2027, in line with slower economic growth. 1 IMF Statistics, October 2016 lVexanr Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 154 8. INDUSTRY OVERVIEW (Cant’d) Section 2 Industry Overview SEA is also expected to show ongoing levels of consumption growth. Nexant forecasts total polyolefins’ consumption in SEA to grow at a CAGR of 4.4 percent over the period of 2017-2027. Overall, total Asia Pacific (excluding SEA and China) is forecast to grow at around 4.4 percent CAGR over the same period. Demand growth is also highest in developing regions such as Brazil and the Middle East, and Africa which are forecast to grow at between 4-5 percent per year on average over the period 2017-2027. Although the Middle East/African has high demand growth, the total current market size of 16 million tons is relatively small, therefore the region remains a major exporter of polyolefins at between 11-13 million tons per year. North America and Europe are large markets for polyolefins, but growth rates have been relatively flat in recent years due to maturity of polyolefin end-uses and low population growth. Nexant forecasts growth at approximately 2-3 percent per year for both regions over the period 2017-2027. Demand in North America is also supported by the rapid development of the Mexican economy. Figure 2.5 Polyolefins Consumption by Region CAGR  Market Share, %  250  ’17.’27%  2017  2027  Actual  Forecast  4.4  14%  15%

200 4.4 7% 7% 4.7 30% 32% 4.8 10% 11% 2.0 18% 15%
3.3 21% 19%

2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 III Americas i!l Europe Middle East/Africa China SEA Asia Pacific (exc. SEA & China) Source: Nexant Developing markets provide significant consumption growth potential for material substitution. Petrochemical polymers are substituting basic materials such as wood, glass, metals, paper and card in packaging, automotive and construction industries. This substitution is easily promoted as plastics tend to offer higher performance at a lower cost. This is highly visible in the food packaging sector where plastic packaging provides increased storage life, hygiene and freshness compared to traditional paper or fibre packaging. Plastic pipes for water transportation are also proving to be more cost effective and out performing metal based pipes in construction. Asia Pacific has become a major consuming region for petrochemicals over the past decade. According to Nexant analysis, demand growth for polyolefins has been growing at approximately 6 percent CAGR over the period 2007-2016. This development has occurred largely in support of the region’s rapidly expanding manufacturing sectors. A large proportion of this manufacturing is for export-oriented goods. Nexant forecasts demand growth for petrochemicals in Asia Pacific during 2017-2027 to continue to outpace the rate of new supply additions in the region. As a result, Asia Pacific is expected to remain a significant importer of various chemical intermediates and polymers. The following figure provides Nexant’s estimate of net trade for Asia Pacific and China in 2016 for major petrochemical products. Net trade is the difference between production and consumption in a market. tJNexanr Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 155 8. INDUSTRY OVERVIEW (Cont’d) Section 2 Industry Overview Where production is greater than consumption, a market is a net exporter. Where consumption is greater than production, a market is a net importer. Fjgure 2.6  Net Imports of Major Petrochemical Products  (Basis 2016)  Asia Pacific Net Imports  China Net Imports
Ethylene Glycol   ParaXylene  HOPE Styrene ParaXylene  !~~~~::~.II  Ethylene Glycol HOPE Styrene  LOPE  PP  PP  LLOPE  LLOPE  LOPE  Ethylene  Propylene  Propylene  Ethylene

o 1000 2000 3000 4000 5000 6000 7000 8000 o 2000 4000 6000 8000 10000 12000 14000 Source: Nexant Thousand tons per year Source: Nexant Thousand tons per year Nexant expects that a large proportion of these net imports are for ethylene derivatives such as ethylene glycol, polyethylene and styrene for the Chinese market. For example, Nexant estimates Asia Pacific’s total net import of ethylene glycol in 2016 to be approximately 7.3 million tons with approximately 98 percent of this volume for the Chinese market. Key drivers and trends for global petrochemicals’ demand (during the forecast period 2017-2027) include the following: • Olefins/polyolefins markets are forecast to exhibit growth in-line with global GDP -consumption is primarily driven by packaging, automotive and building and construction industries. Consumer spending and confidence tends to promote market consumption. Demand also benefits from the substitution of basic materials such as glass, metals, paper and card, which is more prevalent in emerging markets.
• Global butadiene market demand is driven by the auto sector and the production of tyres. High levels of demand are forecasted in emerging markets as car ownership continues to rise and increases in truck distribution. Supply of butadiene is expected to tighten as demand levels increase as a higher proportion of ethylene production is forecast to be derived from naphtha feedstock alternatives. This trend is influenced by increases in lighter feedstock cracking in the Middle East and North America (due to increased shale gas usage).
• Styrene demand, produced from benzene, is primarily driven by Expandable Polystyrene (EPS) and Acrylonitrile Butadiene Styrene (ABS). Consumption growth driven primarily by demand from packaging, automotive, construction and consumer goods (electrical/electronic) sectors. Material substitution in the polystyrene sector has resulted in lower demand growth. However, this has been partially off-set by strong growth for expandable polystyrene (EPS) and acrylonitrile butadiene styrene (ABS). Demand growth is highly focused in China, Taiwan and other parts of SEA.


Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 156 8. INDUSTRY OVERVIEW (Cant’d) Section 2 Industry Overview 2.2.2 Supply Side Fundamentals The majority of new petrochemical capacity developments are focused in the United States, Middle East and Asia (primarily China). These developments are largely associated with competitive feedstock availability and can be summarised as follows: • U.S. shale gas has resulted in increased feedstock supply, specifically ethane and other natural gas liquids. As a result, U.S. petrochemical feedstock prices have declined relative to most regions resulting in improved production competitiveness and a surge in new investment interest.
• Construction of new refineries in China is driving investment in naphtha cracking complexes. Additionally the country’s coal to chemicals sector is also expanding rapidly based on MTO/ MTP technology. China is also developing various propane to propylene projects based on imported propane.
• The Middle East continues to expand its petrochemicals capacity based on available feedstocks within the region. However the pace of development has slowed as advantaged low cost feedstocks, such as ethane, are in tighter supply within the region. New capacity developments are being focused on heavier feedstocks (LPG and naphtha) and include refinery integration projects utilising naphtha.

Global ethylene demand is forecast to grow at approximately 3.7 percent CAGR over the period 2017­2027. This is aligned with global GDP growth. On this basis actual consumption growth over the period is estimated at around 66 million tons and as a result, significant investment in new ethylene capacity would be required to meet market needs. Considering world scale cracker sizes of between 1.2-1.5 million tons per annum, total new cracker builds could be as high as 44-55 new ethylene plants. Nexant forecasts firm total net ethylene capacity additions which is based on announced and planned projects that are likely or will be implemented of approximately 25 million tons over the period 2017-2027. This increase includes a number of projects that are already under construction or have passed final investment decision. Additional speculative capacity additions, which are projects which have yet to reach final investment decision, are also expected over this period. Speculative capacity additions may total up to a further 50-60 million tons per annum. China has plans to develop both refinery/steam cracker projects as well as methanol-based olefin projects, most of which are being developed around coalfield methanol. Nexant forecasts that China will add approximately 5 million tons of additional ethylene capacity over the period 2017-2027. China is also expanding domestic propylene capacity with a surge in propylene production in China from methanol and PDH (propane dehydrogenation). The bulk of the methanol-based propylene developments are in inland, coal-rich areas, whereas most of the PDH plants are in coastal areas giving access to imported propane. Some methanol-based plants have also chosen coastal locations however, as imported methanol pricing can be competitive with domestic methanol pricing, and using purchased methanol avoids the restrictive permitting procedures which affect oil and coal-based chemicals developments in China. Nexant forecasts that China alone will add approximately 19 million of additional propylene capacity over the period 2017-2027. Nexanr Independent Market Report on the Petrochemicals Industry LoUe Chemical Titan Holding Berhad 38366 157 8. INDUSTRY OVERVIEW (Cant’d) Section 2 Industry Overview Figure 2.7 Olefins, Butadiene and Benzene Forecast Capacity Changes (Million tons, 2017 vs 2027F) 100 +—-‘——–1  ~  ~  80  t­ ~  60  ;  40  .~  20  o  2017  2027  2017  2027  Capacity Share 2016
China 150t——-1 2017 2027 2017 2027 I1!lII Ethylene iii Propylene s3;i Butadiene III Benzene Source: Nexant The pace of new petrochemical investment in the Middle East has slowed in recent years. This slowdown is attributed to declining availability of additional low cost ethane throughout the region. The majority of current ethane supply is allocated to existing olefin projects. As a consequence new ethylene projects in the region are more likely to be based on mixed feedstock slates, including naphtha based projects. Nexant forecasts 17 million tons of additional ethylene capacity in the Middle East over the period 2017­2027. Over the forecast period, Nexant forecasts the addition of new projects in Iran with the total of around 3 million tons while other investments are forecast in Oman. Shale gas in North America has reversed the fortunes of the region’s petrochemical sector. This is especially true for existing petrochemical hubs in the U.S. Gulf Coast region which have high connectivity to the nation’s gas infrastructure. Exploitation of shale gas reserves is resulting in increased natural gas supply and lower domestic gas pricing relative to global energy markets which remain driven by crude oil. Ethane supply, co-produced from natural gas extraction, is also increasing, It has minimum alternative value if not extracted from natural gas and hence its price is related to the low extraction costs to be monetized and used as feedstock in the petrochemicals industry. This results in lower feedstock costs for domestic ethylene producers and improved production competitiveness for many polymer and chemical intermediates sold into export regions. Nexant forecasts between 13 million tons of additional ethylene capacity over the period 2017-2027 in North America. The total ethylene capacity expansion in the region is forecast at around 25 percent and consists of both new projects and expansions of existing crackers. Furthermore many existing crackers have been converted to lighter feedstocks to take advantage of low prevailing ethane pricing. However, Nexant notes that the competitive advantage on ethane has declined with the recent falling oil prices.
Independent Market Report on the Petrochemicals Industry Lolte Chemical Titan Holding Berhad 38366 158
8. INDUSTRY OVERVIEW (Cant’d) Section 2 Industry Overview 2.2.3 Feedstock Considerations The majority of primary feedstocks employed for petrochemicals production are derived from crude oil refining or natural gas processing. Coal is also used in specific parts of the world such as China and South Africa but to a much lesser extent. Oil production is a major source of chemical feedstock via the following routes: • Associated gas production
• Co-products from refining (naphtha and LPG)

The principal products of interest from associated gas are natural gas liquids or NGLs (ethane, propane, butane and condensate). Ethane in particular has a high value as it could be extracted at low cost and monetized to produce a high value petrochemical product, and has limited other industrial applications. As a result ethane resulting from associated production oil production was flared (burnt and released to the atmosphere) at many sites before downstream petrochemical investments were realised. Flaring of ethane still takes place at some sites around the world where there is no demand from neighbouring chemicals ‘plants. Propane and butane (LPG) can also be utilised as feedstocks for olefins production. However LPG’s primary use is as a fuel for both residential and industrial usage. Non associated gas also provides a source of natural gas liquids. However the composition of the natural gas stream is variable by different location. Rich streams are often referred to as ‘wet gas’ as they have a relatively high content of non-methane products whereas ‘dry gas’ has a high methane content and usually does not require further processing. Refineries produce naphtha as a co-product which is also a valuable feedstock source for olefins and aromatics product. Naphtha also has an alternative use as a blend component for gasoline production. Hence some refineries consume naphtha on-site for this purpose. The major feedstocks used in production of each of the primary petrochemical derivative chains are shown below. Figure 2.8 Overview of Typical Petrochemical Feedstocks VALUE CHAIN TYPICAL FEEDSTOCK
” ,,’ >. Natural Gas ~ ~ 0 ~~ ”  – ~”,  7  0 ,~ ~  ~  ,,~  ,  .  ”  Ethane, !!lPG, naphtlia, gas oil  ..  ~  $j “:~  ~  ~ ~ ,t> ~~”  >  c,~”\  ,


, Steam cracking I:)y·pro(.luct : • \ -“( r ‘~”
C represents number of carbon molecules in chemical Nexanr Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 159
8. INDUSTRY OVERVIEW (Cont’d) Section 2 Industry Overview New technology developments are also resulting in potential new opportunities for feedstocks including • Gas to LiqUids (GTL) which provides an additional source of naphtha.
• Coal to Liquids which produces syngas which can be converted into a range of different uses including methanol, ammonia and olefins.

MTO and MTP are relatively new technologies but typically provide a route from natural gas or coal to olefins. The large scale commercialisation of this type of project is taking place now in China for the first time. Liquid based feedstock costs typically show a close correlation to crude oil prices. Gas based feedstock costs will depend upon whether the gas price formula is linked to crude oil pricing. Feedstock Pricing Global Naphtha Price Naphtha price projections refer to “open spec” material with a minimum paraffin content of 65 percent. Asian price formation is typically linked to the Japanese import price (C&F Japan or MOPJ) with Singapore and Middle East pricing determined as netbacks from Japan (i.e. MOPJ minus logistic costs), based on the significant trade flow eastwards to Japan, particUlarly from the Middle East. Prices for naphtha in Singapore, Japan and the Middle East are quoted for naphtha streams whose quality conforms to the specifications in the “open-spec” naphtha contracts utilised by Japanese traders and others in the region. Sellers of more highly paraffinic naphtha -well suited to steam cracking, or highly aromatic heavy naphtha -suited to catalytic reforming, will typically achieve a premium to this pricing basis. The premium depends on economics of downstream processing, but can be as high as US$30-50 per ton. Naphtha and gasoline prices are related by the economics of reforming (process of converting naphtha into a gasoline blendstock), and sets the floor naphtha price. As the relative demand for naphtha as a petrochemical feedstock increases, so naphtha values must increase, to attract more material away from reformers which are run principally to produce gasoline blendstocks. In recent times (2015 and 2016), the decline in crude oil prices have seen a decline in naphtha prices (as naphtha is a product from the refining of crude oil). Naphtha prices were also affected by competition from LPG feedstock. Asian petrochemical plants typically replace up to 15 percent of their naphtha feedstock with LPG when prices become favourable, usually during the middle of the year when LPG is not required for winter heating demand. Higher volumes of lower cost LPG feedstock from U.S. has been coming into Asia and competing with naphtha, reducing its price. In China, naphtha based olefins production capacity additions are expected to face competition from increasing use of coal and natural gas as feedstocks. Asia’s petrochemical industry faces impending regulatory requirements coupled with new capacity in the Middle East and the United States, which could negatively impact projected growth in the region. Thus, the Asian petrochemical industry may face downward pressure on margins due to the increase in global capacities and higher feedstock costs. But with prospects for the automotive and other manufacturing industries in Asia driving ongoing petrochemicals demand through the forecast period, regional naphtha demand is set to grow in tandem. Asia’s naphtha deficit is projected to grow through 2030 due to the region’s higher demand for petrochemical feedstock, despite increased naphtha production from the Asian refinery capacity additions as a result of increased refinery petrochemical integration and increased processing of Middle East condensate in Asian refineries and condensate splitters. Strong demand growth in Asia, driven by increases in naphtha use as a steam cracker feedstock for olefins production, may support naphtha Nexanr Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 160
Section 2 Industry Overview prices in the medium term. Increases in naphtha use as a petrochemical feedstock are likely to be primarily driven by increases in its use as a steam cracker feedstock for olefins production, which will be linked to the region’s steam cracker capacity additions. Figure 2.9 Global Naphtha Prices 1200 60 = c: Forecast <J)­0) Actual c: 40 .@,~ 1000 &S2.. c: Q;.8 800 20 .s:::.Q; DC: Q o 0<F>



o ;m ~~ 600 0)­~~ u &:::J(t 400 -20 (5 co “00 2.l« -40 (t200 co “00 « -600 ‘” Asia -U.S. Spread Naphtha prices in the United States are expected to be at slight premium over WE through the forecast. Naphtha prices in Asia are expected to remain above West European prices and support the naphtha trade flows between the Mediterranean and North Asia. Most Asian and Middle Eastern naphtha streams have a higher quality than the “open-spec” naphtha specifications. Sellers of more highly paraffinic naphtha -well suited to steam cracking, or highly aromatic heavy naphtha -suited to catalytic reforming, will typically achieve a premium to this pricing basis. u. S. Ethane Price U.S. ethane pricing, due to its exclusive use as a petrochemical feedstock, is highly dependent on the prices of competing petrochemical feedstocks as well as the price of natural gas from which it is extracted. In contrast, market prices for propane, butanes, and natural gasoline generally are relatively insensitive to the value of the natural gas from which they are extracted. Rather, their prices are influenced by competition with crude oil-derived products in markets where they compete as alternative fuels or petrochemical feedstocks. The only significant use for ethane is as a steam cracker feedstock for the production of ethylene. Approximately 70 percent of the ethylene produced in the United States is derived from ethane and ethane/propane cracking. Ethane produced in oil refining is generally consumed as a fuel gas within the refinery. The factors that influence ethane pricing are: • Its value to a steam cracker operator;
• The cost of intentionally extracting it from natural gas; and

More importantly, supply/demand balance. The gas plant operator controls the supply based on how much ethane can be extracted economically and in accordance with contractual commitments, and the ethylene plant operator controls the demand tlNexanr Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 161 8. INDUSTRY OVERVIEW (Cont’d) Section 2 Industry Overview based on how much ethane can be cracked at a lower net variable cost than that achievable with alternative cracking feedstocks. The U.S. Gulf Coast market price for ethane will vary between two limits of extracting the ethane and the price the steam cracker operator is willing to absorb. Those limits will be dependent upon: • The supply of ethane available versus the incentive for the ethylene industry to use it.
• The price of the natural gas relative to fuel oil.
• The demand for ethylene.

The cost of production of ethylene from alternative ethylene feedstocks (e.g., propane, butanes and naphtha). Lower natural gas prices since 2008 have dramatically improved the attractiveness of recovering ethane from natural gas. Ethane prices are also highly dependent on ethane’s value as a steam cracker feedstock relative to naphtha. Figure 2.10 Asian Naphtha vs U.S. Ethane Prices 1200 Actual Forecast
0 t–00 m 0 ~ N (Y) lO CD t–00 m 0 N (Y) lO CD t-­0 0co NNN N N N N N””” “”” 0 0 coc;c;c;c;c; coc;c; coc; 0 0 0 0 0 0 0 co NNNNNNNNNN NNN NN NNNNNN -Asian Naphtha —U.S. Ethane Source: Nexant Ethane prices and its pricing relative to natural gas is projected to increase during the forecast to reflect a premium to its natural gas value as a result of increased demand for ethane from major steam cracker capacity additions and the development of ethane exports. Export infrastructure in the form of pipelines to Canada and export terminals has been developed on the U.S. Gulf and East Coasts that will result in major quantities of ethane being exported, which will also make a substantial contribution to U.S. ethane demand by 2017. 2.2.4 Petrochemicals Cost Position The cost of producing petrochemicals varies greatly by location around the world. The principal factors in determining operating costs are linked to the cost of the prevailing feedstock. However, secondary cost advantages are associated with the following key points: Plant scale • Utility costs Technology/complexity
• Co-product credit (valuation of by-products in production) Fixed costs (location issues)

Nexanr Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 162 8. INDUSTRY OVERVIEW (Cont’d) Section 2 Industry Overview Currently, the lowest cost olefin producers are based in the Middle East. Leader ethylene crackers in the region are typically 100 percent ethane-based, although recent capacity additions are On a mixed-feed cracker designs rather than on a 100 percent ethane feedstock basis. Ethane is usually supplied at a fixed price that is considerably below market price levels available in Europe or the U.S., with nO linkage to the wider energy market. With gas and ethane prices in North America currently falling to relatively low levels, gas-based ethylene facilities in North America are considerably more competitive than naphtha crackers in various regions. However, the ethane crackers in North America still incur slightly higher cash costs than the ethylene plants in locations such as Venezuela and Africa, where there is good accessibility to low cost feedstock gas. Naphtha crackers in the world incur a range of cash costs; for example, naphtha crackers are estimated to be more competitive in Singapore and Thailand than in Japan and Western Europe. Ethylene plants in China and Europe cracking gas oil and heavy feedstocks are broadly the high-cost producers in the global industry. Ethylene is mainly produced from two different feedstocks (oil and gas) via steam cracking process. Oil­based ethylene feedstocks such as naphtha and condensate produce a greater proportion of propylene and butadiene per unit of ethylene produced while gas feedstocks such as ethane produce almost exclusively ethylene. In general, naphtha-based plants offer the highest cost route to ethylene production (via steam cracking). These operations have no noticeable feedstock advantage and are highly capital intensive due to the complexity of the facility required to separate and utilise co-product streams. Figure 2.11 Global Ethylene Cost Curve (Cash Cost Basis: 2016, Brent Oil at US$44 per barrel) Actual 2016 @ Brent US$44 per barrel800 o 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 Ethylene Cumulative Capacity (million tons)
Nexanr Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 38366 163 8. INDUSTRY OVERVIEW (Cont’d) Section 2 Industry Overview Figure 2.12 Impact of Crude Oil Pricing on Ethylene Production Costs (Basis -Leader Cracker) 1400 Q) c 1200 Q) >. -C Q) 1000 0 C 800.8 Q; a. <FT 600 Cf) ~ 400 200 0
,tP”‘-~’\’-‘-;<;!Illl-\ 140 120 ~ 100 ro .D Q;80 a. <FT Cf) ~60 40 –I ” ,,’ ‘V”,”‘” lI!i.$’ili;t'” J’ 20 0 2000 2002 2004  2006  2008  2010  2012  2014  2016  – SEA (naphtha cracker)  —@Mi ddle East  (ethane cracker)  Crude Oil Price  Source: Nexant
Prior to the rapid escalation in crude oil prices (before 2004), production cost comparisons between naphtha crackers and advantaged ethane crackers were more evenly matched. The average difference in production costs between a leader ethylene producer in the Middle East and a naphtha producer in SEA was approximately US$114 per ton of ethylene produced over the period 2000-2004, based on Nexant’s analysis. The difference in production costs between naphtha-based producers and ethane (stranded gas) producers increased greatly during 2005-2014 following the sharp escalation in crude oil pricing. The average difference in production costs between a leader ethylene producer in the Middle East and a SEAn naphtha producer increased to approximately US$430 per ton of ethylene produced over the period 2005-2014. Crude oil price volatility has continued to impact the global competitiveness structure of the industry. According to Nexant analysis, the cash cost spread between these two representative producers fell to around US$307 per ton in 2015 and US$93 per ton in 2016. When the crude oil price is high, ethylene producers with access to low cost gas feedstock are able to obtain a higher cash margin relative to an ethylene producer based on naphtha feedstock. During times of lower crude oil pricing, naphtha prices are lowered, increasing the competitiveness of naphtha based crackers relative to gas based crackers as observed presently. It is noted that whilst ethane based producers experience a strong advantage during periods of higher crude oil prices, naphtha based producers continue to set the basis for ethylene pricing, representing the marginal producers and a major proportion of the industry.
Independent Market Report on the Petrochemicals Industry Lotte Chemical Titan Holding Berhad 36366 164



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