The components of diisocyanate prices

The prices of key raw materials TDI and MDI have been at elevated levels for a number of years. James Elliott, principal analyst at IHS Markit, explained the reasons behind the continuing high prices to delegates at UTECH Europe 2018.

Price is one of the most important considerations in many areas of trade and commerce. Prices of the key polyurethane raw materials MDI and TDI have been at particularly high levels for many months.

At the heart of all business is the cost of producing the products we sell or buy.

Production costs are fundamentally important to all commodities. They provide insight into price contract negotiations. They provide insight into export opportunities and import threats. They allow us to benchmark regional production costs. From the production costs, we can derive plant profitability, and we can use this to analyse where we are in the margin and investment cycles. We can use this information to make strategic decisions.

It allows us to determine whether the seller’s price high because of high input costs, or whether there is another reason.

IHS Markit has developed a robust method to find the base cost of production of model plants in North America, Western Europe and China. The approach is straightforward: production costs equal raw material costs, plus other variable costs, plus fixed costs, minus by-product credits.

This approach allows us to understand some market fundamentals.

Looking at the Chinese MDI market in two snapshot years, 2015 and 2017, we see that in 2015 the Chinese market value was worth about CNY 21bn. This increased by 137% in 2017 to more than CNY 50bn. The average annual polymeric MDI price over these two periods was about CNY 11,000/tonne, increasing to about CNY 24,000/tonne in 2017.

Based on these data, one might think that a Chinese MDI plant in 2017 was much more profitable than it was in 2015. But the total cost of production is unknown, so we cannot calculate the margin or derive the profitability.

In 2015, our model shows that the MDI total cost of production was about CNY 8,000/tonne. This increased by 16% in 2017 to about CNY 9,300/tonne. The model MDI plant in 2017 was far more profitable compared to 2015.

This is because selling prices increased on the back of tight supply and demand dynamics in the MDI market in China and around the world, rather than cost-driven price increases.

These data give us information to help us decide the stance we should take in short-term contract negotiations. We can derive plant profitability, and analyse where we are in the margin and investment cycles.

We consider three model MDI plants in three different locations: the US in North America; Germany in Western Europe; and China in north-east Asia. We consider the capacity for each of the plants as 300 kT/year in the US and Germany and 600 kT/year in China. These are based on the amount of new capacity entering the market in 2012, the start of our cash costs model.

Making MDI is complex and involves the convergence of different chemical value chains. We consider four distinct steps in our MDI cost model. The first step is nitration of benzene to nitrobenzene; step two is the hydrogenation of nitrobenzene into aniline; step three is the production of phosgene; and step four is phosgenation to produce MDI, as shown in Fig. 1.

The three model plants are all equally integrated across all the chemicals shown. We assume that some chemicals are purchased on the merchant market, while others are produced on site.

I will concentrate on two main chemicals in the production of MDI, benzene and chloralkali, and I’m going to touch on the hydrogen chloride by-product. This is something that global chlorine derivative producers consider a nuisance.

Benzene is the foundation in the MDI production process, and in our cost model we assume that it is purchased on the merchant market. Our model producers are not integrated into benzene.

In 2017, Western European MDI producers had the highest benzene cost, while US MDI producers had the lowest benzene cost at around $535/tonne.

In 2017, benzene represented about 47% of the total raw material costs for MDI producers. In 2015, the price of benzene collapsed because of the lower oil price, and it remained low between 2015 and 2017. Our forecast is for the cost of benzene to MDI producers to moderate at just under $600/tonne in the next few years.

Benzene is generally produced as a by-product in the manufacture of other chemicals, and this can lead to considerable price volatility when supply cannot respond efficiently to demand. Benzene prices are closely aligned around the world, because it is easy to ship between regions. International trade flows of benzene are high, and the US, Western Europe and China all import around 15% to 20% of their total benzene needs.

Turning to chloralkali, the average global MDI plant has a capacity of around 340 kT/year. This means it requires between 200 and 250 KT/year chlorine. MDI and TDI plants are significant chlorine consumers.

Chlorine acts as a reaction facilitator in MDI/TDI production. It reacts with carbon monoxide to produce phosgene in step three of the production process. In our cost model, we assume that chlorine is purchased on the merchant market from a chlor-vinyl producer on a long-term contract.

At IHS Markit, we define the chlorine cost to each of our regional model producers differently. In the US and China, we derive the chlorine cost from the chlorine portion of the electrochemical unit cash cost, that is, the cost to produce caustic soda and chlorine. In Germany, we use the long-term chlorine contract price. Generally, chlorine is not a major cost in the production of isocyanates. In 2017, it represented about 8% of the US producers’ raw material costs. However, huge volumes are required, and it is a major consideration in isocyanate production.

Chlorine supply must be guaranteed before an isocyanate plant is built. Smaller volumes of caustic soda are needed in isocyanate production, but the cost of caustic exceeded the cost of chlorine to MDI producers in the US in 2017.

The global caustic market was tight in 2017, and there were price increases in each of the main MDI-producing regions. In Europe, the market became structurally tight following the closure of mercury-cell chloralkali production. In China, chloralkali capacity was closed following environmental inspections. In North America, a number of production issues tightened the market.

Over the next few years, we anticipate that the chloralkali price will increase in the US and China as excess caustic soda capacity decreases, and no new capacity additions are on the horizon.

In Europe, caustic soda prices have already started to soften. At IHS Markit, we expect prices to continue to soften over the next few years as the market is now more structurally balanced.

The chlorine used in the production of isocyanates is expelled as hydrogen chloride (HCl) gas. Removing HCl poses a problem to isocyanate producers; if there are difficulties in removing it, this can affect the isocyanate plant’s operating rates.

Isocyanate producers use three main strategies around the world to remove hydrogen chloride gas.

The first involves dissolving the gas in water to sell on the merchant market as hydrochloric acid. The second is to return hydrogen chloride gas to the chloralkali producer so that it can first be converted to ethylene dichloride through oxychlorination, and then into PVC. The final strategy is to electrolyse HCl to produce chlorine, which can be reused in the isocyanate production process. The strategy chosen can significantly alter an isocyanate producer’s costs position.

Our cost model assumes that isocyanate producers use the first strategy, and hydrogen chloride gas is dissolved in water, to make hydrochloric acid and sold on the merchant market.

To calculate the value of the HCl stream to the diisocyanate producers in the US, we use the US Gulf Coast price for HCl, in Germany, we use the German hydrochloric acid market price, and in China, we found that hydrochloric acid had no associated value in 2017.

In 2017, in the US, HCl significantly lowers the cost of production for MDI producers. Instead of being aligned with China, in terms of production costs the US becomes the lowest cost producer. The HCl credit also helps reduce MDI production costs in Europe.

Bringing all of this together allows us to compare the regional production costs for MDI in 2017.

In 2017, the US had the lowest raw material and variable costs. Variable costs comprise electricity, steam, fuel oil and other necessary inputs to production. Additionally, North American producers of MDI benefited from the credit from sales of hydrochloric acid.

China had the lowest fixed costs because of lower labour and capital costs.

Although the US had the lowest total costs of production in 2017, we believe that the Chinese producers have the highest margin. This was a result of the price flying up highest in the Chinese market as a result of the tight supply and demand dynamics there.

Western European model diisocyanate producers had the second-highest margins in 2017.

Costs for the Chinese MDI industry rose 16% between 2015 and 2017. This was mainly caused by increased raw material costs. Fixed costs were largely stable across the two snapshot years.

In 2017, the margin was approximately CNY 15,000/tonne. The higher margin in 2017 was because of the increased MDI selling price. Global supply was short because of the high frequency and long duration of plant outages.

And for our model MDI producer, if it had come on stream in 2016 and operated optimally between then and the end of 2017, we assess it would have repaid its total investment in 18 months.

This poses a number of questions, such as, where are we in terms of the margin and investment cycles? Did the number of outages, tight supply/demand and fly up prices make 2017 a freak year in terms of margin? Would we have otherwise reached the top of the margin cycle in 2016 or 2018? IHS Markit provides its analysis to these issues for clients as part of the MDI World Analysis.

IHS Markit has also developed a TDI costs model based on the same principles as our MDI model. We consider TDI production in three model locations, leading to three model producers. These are in the same locations as the MDI model.

Our model plants have the capacity to make 200 kT/year TDI in North America, and 300 kT/year in Germany and China. These are based on the size of new capacity entering the market in 2012, the start of our cash costs model.

It is assumed that all three plants use liquid-phase phosgenation. At IHS Markit, we do not believe the vapour-phase process is predominant in any of the regions, although we have developed a TDI cash cost model analysing this technology. There are four steps to TDI production in our cost model. Step one is nitrating toluene to produce dinitrotoluene. In step two this is hydrolysed to produce toluenediamine. Step three is phosgene production, and step four is phosgenation of the diamine to produce TDI.

At IHS Markit, we assume that all three model plants have identical raw material integration, that some chemicals are purchased on the merchant market, and others are produced on site.

Toluene is the main contributor to TDI raw material costs; our model producers purchase toluene on the merchant market. It is involved in the first stage of production where it is nitrated. In contrast to model MDI producers with the lowest benzene cost, TDI producers in the US have the highest toluene cost in 2017. Western European model TDI producers have the lowest toluene cost.

In 2015, the toluene cost to TDI producers collapsed with the oil price. The toluene feedstock was low cost between 2015 and 2017. We expect the toluene cost to TDI producers will moderate at around $450/tonne over the next few years.

In 2017, raw material costs became slightly higher for TDI producers, while fixed costs had been largely stable since 2015. The most striking difference during 2015 and 2017 is the fly-up margin in China in 2017. This stemmed from the higher TDI selling prices which were a result of the tight supply/demand dynamics. In 2017, there were a number of TDI production outages around the world.

In our model, Chinese TDI producers had a margin of around CNY 3,000/tonne in 2015. This significantly increased in 2017 leading to a return on investment per tonne of over 100%. Had our model TDI producer come on stream in mid-2016 it, would have received a total return on investment within 18 months, assuming optimal operations.

Again, we can question whether we are at the top of the margin cycle in 2017. Did the global spate of turnarounds drive up prices and margins, to place 2017 in a pseudo position at the top of the margin cycle? Under normal operating conditions, would we have seen the top of the margin cycle in 2018 instead?