PRICING FOR PROFIT

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CREATIVE ENERGY FOR IMPORTANT ISSUES
PRICING FOR PROFIT A 5 price decrease requires
a 17.5 volume increase to
maintain break-even Accenture The First
ICIS-LOR World PE Conference Radisson SAS Hotel,
Antwerp 17 November 2004
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• AGENDA
• WHERE WE ARE TODAY
• PROFITABILITY IS A PROBLEM
• NO AGREEMENT ON THE SOLUTION
• BP HAVE NOW REACTED
• WHAT ARE THE UNDERLYING ISSUES
• THE PROBLEM IS COMPLEX
• MECHANISMS CREATE WINNERS LOSERS
• CUMULATIVE IMPACT CREATES INEFFICIENCY
• FUTURE OPTIONS
• LIQUIDITY IMPACTS PRICE MECHANISMS
• ALL SHARE A COMMON INCENTIVE FOR IMPROVEMENT
• VISION

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CREATIVE ENERGY FOR IMPORTANT ISSUES
INTERNATIONAL eCHEM Founded 2001 Senior
business/commercial experience with DuPont, ICI,
Lyondell, Shell, Syngenta Focus on commercial
strategy, business development, legacy issue
resolution, training Client list includes most
European majors Partnership with Wood
Mackenzie to cover refining/petchem interface
Optimized Solutions have undertaken value/risk
analysis of 4 current price mechanisms for this
presentation
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APPE SHOWS A PROBLEM EXISTS
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NO AGREEMENT ABOUT THE SOLUTION
The use of quarterly contract prices for lower
olefins is perverse. Ethylene prices should be
fixed on a monthly basis
Iain Conn, then CEO, BP
Chemicals, EPCA 2003 We would support a
European move to monthly olefin pricing...and
plan to change our pricing mechanisms
Clive Watson,
CFO Borealis, November 2004 Will the European
ethylene market move to monthly pricing? No!

Mike Smith, Commercial Director LVM,
October 2004
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BP HAVE RESPONDED
BP to fold chemicals arm into group European
Chemical News - 2 August, 2004 BP is already
moving ahead with plans to separate the OD
business into a stand-alone entity, to be managed
from Chicago. BPs incoming petrochemicals ceo,
Ralph Alexander, said the new company as yet
nameless would be internally separated by the
end of this year
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OTHER PLAYERS ALSO HAVE STRONG VIEWS

• Problems are due to over-capacity and a market
  share focus
• Pricing not a core competence
• Market reporters are the market makers
• Polymer prices are slow to rise because many
  salesmen demonstrate personal loyalty to
  individual customers by delaying/modifying
  increases, and are also quick to respond on the
  down slope
• Reference minus pricing should be replaced by
  LME plus

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• AGENDA
• WHERE WE ARE TODAY
• PROFITABILITY IS A PROBLEM
• NO AGREEMENT ON THE SOLUTION
• BP HAVE NOW REACTED
• WHAT ARE THE UNDERLYING ISSUES
• THE PROBLEM IS COMPLEX
• MECHANISMS CREATE WINNERS LOSERS
• CUMULATIVE IMPACT CREATES INEFFICIENCY
• FUTURE OPTIONS
• LIQUIDITY IMPACTS PRICE MECHANISMS
• ALL SHARE A COMMON INCENTIVE FOR IMPROVEMENT
• VISION

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• MANY KEY ISSUES ARE COMMERCIAL
• Pricing
• Volatility
• Liquidity
• Restructuring

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(No Transcript)
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EXAMPLES OF DIFFERENT PRICING MECHANISMS

• Real Time negotiated via an on-line market
  exchange.
• Spot following a one off negotiated agreement
  between buyer and seller.
• Cost Plus or Utility where the seller is
  rewarded by an agreed sum applied to actual or
  reference priced costs.
• Monthly Term Contract where the buyer and
  seller negotiate and agree a price to apply to a
  fixed period of one month.
• Quarterly Term Contract where the buyer and
  seller negotiate and agree a price to apply to a
  fixed period of three months.
• Margin Share where a buyer and seller pool
  the combined margin of a product and its
  derivative and share this between them.
• Reference Pricing where the buyer and seller
  apply published marker prices to their own
  transactions.
• Formula where combinations of market prices
  and other factors are applied to produce a
  selling price.
• Long Term where prices may be negotiated for
  periods of up to one year.

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MAYBE, THE PROBLEM IS OVER-COMPLICATION?
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MECHANISMS CREATE WINNERS LOSERS
QUARTERLY CP MECHANISM Vs NOTIONAL MONTHLY
ANNUAL
QUARTERLY
SWINGS lt 40 SWINGS
gt 150/T
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APRIL JUNE NAPHTHA DOWN 7/T HDPE LESS C2
DOWN 137/T LLDPE LESS C2 DOWN 215/T LDPE
LESS C2 DOWN 218/T
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OPTIMIZED SOLUTIONS ANALYSIS

• KEY TACTICAL STRATEGIC ISSUES
• What are the real risks to Gross Margin?
• What are the relative risks of different price
  formulas?
• What is the benefit of notice and volume options?

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FOUR NOTIONAL C3 FORMULAE

• JANUARY 2000 SEPTEMBER 2004 ACTUAL PRICES
• SPOT
• spot Propylene polymer grade
• QUARTERLY CP
• Propylene CP less 3
• COST PLUS
• Naphtha 1.38 plus 80
• MARGIN SHARE
• Polypropylene less Propylene
• (a) Quarterly propylene CP less 3 unless
• (b) If PP less P gt 200 no discount or
• (c) If PP less P lt 120 discount is 6

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REVENUE VARIES Vs RISK FOR CRACKER
OPERATOR JANUARY 2000 SEPTEMBER 2004 ACTUAL
PRICES
HIGH
SPOT C3
REVEN U E
MARGIN SHARE
QCP
COST PLUS
LOW
HIGH
R I S K
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GROSS MARGIN RESULTS ARE NOT OPTIMISED ACTUAL
DATA JANUARY 2000 SEPTEMBER 2004
HIGH
SPECULATE
OPTIMISE
GROSS M A R G I N
SUB-OPTIMISE
HEDGE
MARGIN SHARE
QCP
COST PLUS
SPOT C3
LOW
HIGH
R I S K
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FLEXIBLE TERMS INCREASE GROSS MARGIN ACTUAL DATA
JANUARY 2000 SEPTEMBER 2004
QCP
COST PLUS
0
6 /T
20 VOLUME
8 /T
20 VOLUME
/T
20
25 /T
30 DAY NOTICE
40
HIGH
LOW
R I S K
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WHAT ARE THE IMPACTS?

• TACTICAL
• Margin distortion
• Derivatives cracker operating sub-optimally
• Wrong stock levels
• Distorted trade-flows
• STRATEGIC
• Inaccurate/inadequate knowledge of real costs
• Wrong investment decisions

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• AGENDA
• WHERE WE ARE TODAY
• PROFITABILITY IS A PROBLEM
• NO AGREEMENT ON THE SOLUTION
• BP HAVE NOW REACTED
• WHAT ARE THE UNDERLYING ISSUES
• THE PROBLEM IS COMPLEX
• MECHANISMS CREATE WINNERS LOSERS
• CUMULATIVE IMPACT CREATES INEFFICIENCY
• FUTURE OPTIONS
• LIQUIDITY IMPACTS PRICE MECHANISMS
• ALL SHARE A COMMON INCENTIVE FOR IMPROVEMENT
• VISION

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SOME DEFINITIONS MAY BE HELPFUL
Oxford English Dictionary Commodity, ME, a
thing of use or advantage to mankind a kind of
thing produced for use or sale goods,
merchandise, produce. Speciality, 1867 a
thing or article of a special kind, as distinct
from what is usual or common Liquidity, 1620,
the quality or condition of being liquid
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WORKING DEFINITIONS FOR THE O D MARKETS
A price mechanism is the vehicle by which supply
is matched with demand. A good price mechanism
achieves this goal quickly and efficiently. A
poor price mechanism distorts and hinders the
efficient matching of supply with demand. Market
liquidity refers to the ability to quickly
convert the value of an asset into cash, or vice
versa, without causing a significant movement in
the price, because ready and willing buyers and
sellers exist at all times. Commodity products
are typically more liquid than specialities, due
to the greater volumes involved. Increasing
liquidity enables price mechanisms to operate
more transparently and efficiently, but at the
cost of increased short-term volatility.
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KEY REQUIREMENTS FOR LIQUIDITY

• Broad demand market (1)
• Grade quality suitable for wide consumption (2)
• Large number of producer consumer
  participants (3)
• No threat from a potential dominant player (4)
• Traders willing to particpate (5)
• Large export and/or import quantities (6)
• Flexible, transparent and equitable terminal
  operator (7)
• Low cost logistics to facilitate arbitrage (8)
• Forward/spot trading encouraged by
  fiscal/commercial/political conditions (9)

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LACK OF EUROPEAN LIQUIDITY IMPACTS COMMODITIES
AND SPECIALITIES
HIGH
NAPHTHA
LIQUIDITY
C6
MEG
POLYMER Commod
C3
POLYMER Sp
C2
LOW
SPECIALITY COMMODITY
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EVEN THOUGH DIFFERENT COMPANIES HAVE DIFFERENT
GENERIC STRATEGIES
END 2003 SITUATION
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ALL SEE COST-LEADERSHIP AS CRITICAL
HIGH
VALUE CHAIN DOMINATION
P E R V C A E L I U V E E D
MASS CUSTOMISATION
COST LEADERSHIP
LOW
DELIVERED COST
HIGH
LOW
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IMPORTANT QUESTIONS HAVE EMERGED

• WILL QUARTERLY PRICING LAST ANOTHER 25 YEARS?
• WILL UPSTREAM VOLATILITY BE HEDGEABLE ON THE
  LME?
• SHOULD PRICING BECOME A CORE COMPETENCE?
• WILL MIDDLE EAST COMPETITION INCREASE
  LIQUIDITY?
• WILL INDUSTRY RESTRUCTURING IMPROVE
  PROFITABILITY?

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VISION
To enable a buyer and a seller, who have
previously ended their discussions in
deadlock, to sit down together and use these new
ideas to catalyse their negotiations towards a
mutually acceptable way forward
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CREATIVE ENERGY FOR IMPORTANT ISSUES
PRICING FOR PROFIT www.internationalechem.com
The First ICIS-LOR World PE Conference
Radisson SAS Hotel, Antwerp 17 November 2004