Sustainability 200 9

, 1

, 592

- 611 ; doi:10.3390/su1030592 

# sustainability

ISSN 2071

- 1050 www.mdpi.com/journal/sustainability

Article 

## Potential Challenges Faced by the U.S. Chemicals Industry under a Carbon Policy

Andrea Bassi 1,2, * and Joel Yudken 3

1 Millennium Institute, 2111 Wilson Blvd, Suite 700

, Arlington, VA 20001, USA

2 University of Bergen, Postboks 7800, 5020 Bergen, Norway

3 High Road Strategies / 104 N

, Columbus Street, Arlington, VA 22203, USA ; E

- Mail : jyudken@highroa dstrategies.com

* Author to whom correspondence should be addressed; E

- Mail: ab@millennium

- institute.org ; Tel.: +1

- 703

- 351

- 5081 ; Fax: +1

- 703

- 351

- 9292

.

Received: 2 9 July 2009 / Accepted: 31 August 2009 / P ublished: 3 September 2009

Abstract: Chemicals have become the backbone of manufacturing within industrialized economies. Being energy

- intensive material s to produce, this sector is threatened by policies aimed at combating and adapting to climate change . This study examines the

worst

- case scenario for the U.S. chemicals industry when a medium CO 2 price policy is employed. After examining possible industry responses, the study goes on to identify and provide a preliminary evaluation of potential opportuni ties to mitigate these impacts. If climate regulations are applied only in the United States, and no action is taken to invest in
advanced low

- and no

- carbon technologies to mitigate the impacts of rising energy costs, the examination shows that climate po licies that put a price on carbon could have substantial impacts on the competiveness of the U.S. chemicals industry over the next two decades. In the long run, there exist technologies that are available to enable the chemicals
sector to achieve sufficien t efficiency gains to offset and manage the additional energy

cost s arising from a climate policy

.

Keywords: chemicals; petrochemical; chlorine; alkaline; climate policy; dynamic modeling; industry competitiveness; cap and trade OPEN ACCESSSustainability 2009

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1

. Introduction

With t he growing use of chemicals in the manufacturing of goods within the economy, comes an equally large increase in the amount of energy used in the process. The chemicals industry covers a broad spectrum of bases and products used in everyday items, and the energy usage of the sector is
often overlooked. When attempting to analyze such a large entity with so many facets, it becomes difficult to develop projections of future impacts of external forces. One shift that will have ramifications on this industry is the move towards carbon pricing and attempt s to mitigate the negative impacts of anthropogenic emissions on the climate. When artificial costs are imposed on the industry, it is difficult to predict the outcome. When the U.S. Department of Energy’s Energy Information Administration analyzes different pieces of climate legislation it mostly calculates projected impacts on broad economic indicators, such as GDP, total consumer spending, and industrial output [ 1

- 4 ]

. Many other studies, by
environmentalists an d academic economists, use general equilibrium models that also mostly yield

economy

- wide impacts, though some contain industrial input

- out (I

- O) modules, which can calculate distributional effects, mainly at a high level of sector aggreg ation [5 ]

. In rec ognition of these challenges, the present study, which uses the Integrated Industry Model

— Carbon Policy (IIM

- CP), examines the carbon permits system ’s impacts (e.g.

, energy price changes resulting from a carbon

- pricing policy) on the competitiveness of the U.S. chemical sector

, which produc es among the most energy

- intensive products , and its participation in the international market. It further examines possible industry responses, and identifies and provides a preliminary evaluation of potential opportunit ies to mitigate these impacts. Since the new administration has made public that it intends to approve climate legislation before the Conference of Parties (COP15) to be held in December 2009, the main body of the study proposes
what can be considered the worst case scenario for the U.S. chemical industry. This is due to the boundaries of the analysis and the assumptions underlying various scenarios. Furthermore, this partial equilibrium study hopes to build on the general equilibrium analyses already a vai lable [2

- 4 ] by researching the impacts of climate legislation on selected four to six digits
NAICS (North American Industry Classification System) , while avoiding the study of the broader

economy

- wide policy repercussions (both positive and negative). Emp loying a computer

- based, System Dynamics modeling approach, supplemented by econometric and qualitative analyses, the study investigates three questions:

 How will climate policy

- driven energy price increases affect the production costs and profitability o f manufacturers in the chemical sector?

 In the face of energy

- driven cost increases, and constraints on manufacturers’ ability to pass these costs along to consumers, how will international competition affect the industry’s competitiveness (i.e., profitab ility and market share)?

 How could manufacturers respond to the energy price increases and possible threats to their competitiveness? These questions have been examined for a selected energy price increase associated with the Climate Security Act of 2007 (S. 2191) [6 ] , a ―Mid

- CO 2 Price Policy‖ case, introduced by Senators Joseph Lieberman (I

- CT) and John Warner (R

- VA). EIA’s analysis of the ―Mid

- CO 2 Price Policy‖Sustainability 2009

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projects the inflation

- adjusted (USD 2006) allowance price to be $30 per metric ton of CO 2 - eq uivalent by 2020 and $61 by 2030 [2 ] . The AEO 2008 projects the highest price increases by 2030, under the
Mid

- CO 2 Price Policy case, for carbon intensive energy sources, such as coal coke and metallurgical coal (+180%), followed by residual fuel oil (+43% ), natural gas (+39%) and distillate fuel oil (+24%). Finally, electricity and liquefied petroleum gas will incur small and no increases, +13.1%

an d

– 0.1% respectively [2 ]

.

2. Chemicals Industry Overview

Chemicals manufacturing is one of the largest man ufacturing industries in the U.S. economy. In 2006, it shipped a total of more than $637 billion (10 9 ) worth of goods and emp loyed 869,000 workers [7 ] . In 2005, there were over 9,500 firms with 13,200 establishments that manufacture chemical products, loc ated in every state in the union. These include businesses of every size, including 1,425 medium

- size d manufacturing plants with 100

– 500 employees, and 3,405 large facilities with more than 500 employees, which employ more than 85 percent of workers in the industry. Chemicals manufacturing is also the largest exporting sector in the U.S. economy. In 2006, the U.S. chemicals industry exported $135.1 billion and imported $142.8 billion producing a trade
de ficit of $7.7 billion [7 ]

. The chemicals industry pro duces over 70,000 products used in every sector of the economy. It is a primary supplier of intermediate inputs to agriculture, other manufacturing industries, construction, and service industries, as well as thousands of consumer goods. Major manufacturin g sector customers include rubber and plastic products, textiles, apparel, petroleum refining, pulp and paper, and primary metals. It also consumes 26 percent of its own output to produce downstream products that are intermediate goods used in other indust ries or in end

- use products. Chemicals manufacturing (NAICS 325) has five major divisions. Its largest sector, basic chemicals (NAICS 3251)

, which accounted for more than a third of the total dollar output of t he chemicals industry [7 ] , consists of several smaller industrial sectors. These include inorganic chemicals (including alkalies and chlorine, industrial gases, acids and inorganic pigments), petrochemicals and
derivatives (including organics), and synthetic materials , such as plastic resins, synthe ti c rubber, and

man

- made fibers

. In this study, we examined two important and highly energy intensive industries within the basic
chemicals sector: petrochemical manufacturing (32511) which includes establishments that manufacture acyclic (aliphatic) hydroc arbons (ethylene, propylene, and butylenes), and cyclic aromatic hydrocarbons (benzene, toluene, styrene, xylene, ethyl benzene, and cumene) made from refined petroleum or liquid hydrocarbons; and, alkalies and chlorine (chlor

- alkali) manufacturing (325181 ), comprised of establishments primarily engaged in manufacturing chlorine, sodium hydroxide (i.e.

, caustic soda), and other alkalies [8]

.Sustainability 2009

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Table 1. Energy i ntensity * † for s elected e nergy s ectors, 2006

. Industries in bold are examined in the study.

NAICS Co de Industry Sector Energy Intensity* [Percent]

1

- 33 Manufacturing 2.9
325 Chemicals Manufacturing 5.6
3251 Basic Chemicals 10.2
32511 Petrochemicals 8.0
325181 Alkalies and Chlorine 38.9
331 Primary Metals 6.4
322 Paper Manufacturing 7.3

* Energy i ntensity is calculated as the share of total energy expenditures (fuel and electricity) as a share of total operating expenditures (roughly equal to sum of materials costs, labor compensation and new capital expenditures in
the Census Bureau's Annual Surve y of Manufactures, 2006) ; † Does not include expenditures on energy fuels used as manufacturing feedstock (e.g., natural gas used in petrochemical production; coke used in steel production).

2.1. Petrochemical M

anufacturing

According to 2005 Census Bure au data [9] , the U.S. petrochemical industry is comprised of 34 firms with 45 establishments employing nearly 7,400 workers, including 24 large manufacturing facilities with more than 500 employees. About 70 percent of petrochemicals and downstream
derivat ives are produced in facilities located in the Gulf Coast region. Because the refining industry is the major supplier of raw materials for ethylene production, more than 50 percent of all ethylene plants are located at petroleum refineries. In 2006, U.S. petrochemical manufacturers produced 127.5 billion pounds and shippe d $60.8 billion worth of goods [10] . Ethylene is the largest volume product made by the industry. Others include propylene and benzene. These products are feedstock used in the production of a very large number of derivative chemical products, many in turn used to produce further downstream products that are inputs for many different industries. For example, ethylene is used to produce ethylene dichloride, used in turn to produce vinyl chlo ride, and then polyvinylchloride (PVC) used in pipes, siding, windows, pool liners and other construction items. The U.S. petrochemical industry ended 2007 with a net trade deficit, with 3.1 million metric tons (mmt) or $2.8 billion worth of imports, expor ts of 1.5 mmt tons ($1.6 billion) and net imports of 1.6 mmt ($1.2 billion). Trade flows between U.S. and Canadian buyers and sellers far outpaced trade with any other country. Canada is an especially large net exporter of petrochemicals to the United
Stat es. Other major trade partners include South Africa, Mexico, Norway and Belgium.Sustainability 2009

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2.2. Chlor

- A lkali M

anufacturing

The chlor

- alkali industry has 29 firms with 47 establishments employing nearly 7,800 workers, including 25 establis hments with over 500 emplo yees [9] . The vast majority of chlorine production takes place in the South, where companies are located to take advantage of low electricity prices and
reasonable labor costs. Chlor

- alkali plants in the United States are aging. A 2000 Lawrence Berkeley
Na tional Laboratory report indicates that most U.S. chlor

- alkali plants were 20

– 25 years old at the time, and some were considerably older [ 11 ]

. U.S. chlor

- alkali firms produced 32.5 million short tons

, valued at $6.4 billion [10] . Chlorine is
used in downst ream products (e.g.

, vinyl, phosphene, HCL, solvents), in water treatment and in other industrial processes, such as in pulp and paper manufacturing. Caustic soda finds applications in the production of organic chemicals, pulp and paper, inorganic chemical s, alumina refining, soaps and detergents, textiles, water treatment, food industry, among others.
The chlor

- alkali industry has a large positive trade balance, with net exports of 7.2 mmt, worth $1.1 billion. In both industries, trade flows between U.S. and Canadian buyers and sellers far outpaced trade with any other country. Canada is a net importer of U.S. chlorine and alkaline products. Other major trade partners include Mexico, Brazil, Japan, and Australia.

3. Literature Review

There is increasing scientific evidence indicating that the climate is going through anthropogenic

induced changes; and policymakers are beginning to take action. One of the biggest fears is the effect that an artificial rise in energy costs would have on energy

- intensive ma nufacturing sectors. This study aims at quantifying the worst

- case scenario for the chemicals industry and to evaluate whether the concerns expressed over climate legislation during the last few years are well founded.
One of the main motivations for this study is the acknowledgment that until recently the economic debate on climate policies has been supported by general equilibrium studies, and limited to macroeconomic impacts of climate policies, which investigate the broader economic impacts of a policy intervention. When the U.S. Department of Energy (DOE

- EIA), and most other environmentalists and academic economists, analyze different pieces of climate legislation, they generally calculate projected impacts on GDP, total consumer spending, and ind ustri al output [ 1

- 4 ]

. Some other studies contain industrial input

- out (I

- O) modules, which can calculate distributional effects, mainly at a high level of sector aggreg ation [5 ]

. The modest climate policy impacts observed

— for example, from a fraction of a perce nt to only a couple of percent declines in GDP by 2020 or
2030

— indicate that climate policies will have small or minimal impacts on a nation’s economy [4, 12 ]

. At worst, they show that GHG policies are likely to have significant direct impacts on coal and o ther
domest ic energy industries [2 ]

. A relatively small number of studies have attempted to examine climate policies and their implications for manufacturing industries in much depth. One set of studies are largely qualitative

— they don’t quantify policy i mpacts on industry sectors, but include in

- depth industry profiles, and evaluate different energy and climate policy options in light of industry anal yses [3, 12

, 13 ] . Another set of studies apply modeling tools in atte m pts to quantify these impacts [5, 14

- 20 ]. Among others, theSustainability 2009

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latter category include Resources for the Future (RFF) ongoing studies aimed at understanding how
carbon

- dioxide charges affect industrial competitiveness, measured as impacts on operating costs, profits, and production output [5, 15 ]

. In addition, two detailed studies of the impacts of the European Union Emissions Trading Scheme (EU ETS) on the competitiveness of European manufacturing industries provide a good degree of detail. Their focus on the other hand was on narrower, more

energy

- intensive industrial categories than traditional economic stu dies usually evaluate [ 16

, 21 ]

. Important insights and lessons emerge from these studies, as a RFF paper notes, ―the impact of a
CO 2 price on domestics industries is fundamentally tied to the en ergy (and more specifically carbon) intensity of those industries, the degree to which they can pass costs on to the consumers of their products (often other industries), and the resu lting effect on U.S. production ‖ [ 15 ]. Another concern is
the carbon leak age problem: increased U.S. production costs cause energy

- intensive manufacturers to shift their operations to nations that have weaker to, or do not adopt, GHG limiting policies, undermining the environmental objectives of the domestic policy. Only a few studies over the past decade have attempted to evaluate climate policies and their impact on the manufacturing sector, especially on energy

- intensive industries, using dynamic modeling
tools [16

- 20 ] . This study is a new addition to this small group.

4. Research Approach

The research methodology employed utilized historical economic data and the construction of a substantial, System Dynamics partial equilibrium industry sector model to develop detailed economic and energy profiles of the chemical industr y. Accompanied by group model building sessions, more robust modeling techniques could be developed

, which in turn led to stronger and more
relevant conclusions. The System Dynamics methodology supports the representation of the context in which policies are formulated and evaluated, using feedback loops, non

- linea rity and delays [ 22 ] . Such properties of complex systems are explicitly analyzed and accounted for in the partial equilibrium model hereby proposed. This is particularly advised when considering that the enactment of a climate policy has no precedents in history and may trigger feedback loops generating unprecedented and unexpected behavior [ 23 ] . For this reason optimization tools, econometrics and Computable General Equilibrium (CGE) models may generate an analysis limited to historical experience, narrow boundaries and
det ailed complexity [ 23 ] . The IIM

- CP model customized to the iron and steel sector is intended to complement existing general equilibrium studies, assessing the impacts of climate policies on selected industry segments at a level of detail ( four to six digits NAICS) that cannot generally be addressed with economy

- wide models. The modeling work proposed in this study followed a three

- phased approach. First, we constructed a basic pr oduction cost model for the chemicals industry. This was then extended and broadened to enable modeling of market dynamic features, that accounted for international trade flows and their impacts on the industry’s bottom

- lines and outputs, under the differe nt emissions pricing scenarios and under different market assumptions (e.g., regarding cost pass along). Finally, results of the simulation helped to inform our analyses of investment and policy options, the third leg of the study, for the industry. Howeve r, although no direct modeling of investment issues was attempted, we did undertakeSustainability 2009

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a preliminary modeling of an important policy alternative aimed at offsetting cost and market impacts and we investigated needed energy efficiency improvements to offset in creasing energy costs. Finally, we carried out several sensitivity simulations using our models to examine variations in our results from different assumptions about key model variables, notably materials costs, domestic and world prices, elasticities of d emand and energy efficiency improvement rates. The main baseline assumptions used to calibrate the model are contained in Table 2 below. All assumptions were discussed with industry representatives to fully incorporate their view and understanding of the market/industry in the modeling work hereby presented. Many assumptions were directly simulated and tested in real time during group modeling sessions and meetings. Data were gathered from The U.S. Department of Energy’s Industrial Techno logies Program (I TP) [2 4 ] and the Manufacturing Energy Consu mption Survey (MECS) [2 5 ], the U.S. Census Bureau’s Annual Survey of Manufacturers ( ASM) [10 ], the United States International Trade Commission (USITC), the U.S. Geological Survey (USGS), and Global Insight (GI), which provided data projections on market prices that were then used to define market prices and materials cost trends
in t he II

- CPM simulations [ 26 ].

Table 2

. Main i ndustry a ssumptions u sed in IIM

- CP

.

Market Price (domestic and ROW)
and Material Costs Labor Costs Feedstock Energy
Costs GDP/Demand

Petrochemicals Indexed to GI prices projections,
3% average growth

rate 2008/2030 Compensation:
Constant in real terms Labor Intensity: long term trend then

flattens in 2020 Natural gas
and LPG

feedstock Lon g

- term trend:

slowly decreasing ratio. 1.67% average growth

rate 1992/2030

Alkalies & Chlorine Indexed to GI prices projections, 2% average growth

rate 2008/2030 Compensation:
Constant in real terms
Labor Intensity:

constant LPG

feedstock Long

- term tr end:

slowly decreasing ratio. 0% average growth rate
1992/2030, 0.2% growth rate after 2007

Other Assumptions and Specifications  Compensation: long term trend takes into account forecasted inflation (CBO/EIA) and historical increase in compensation.

 Ene rgy Intensity: based on MECS 2002 and energy efficiency increasing by 0.25% per year in reference case for future projections.

We simulated a variety of scenarios for the chemical industry, as summarized below:
Core Scenarios. Simulations es timating the impacts of the Mid

- CO 2 Price Case relative to BAU, assuming no cost pass

- along by the industry to its customers (NCPA).
Cost Pass

- Along Scenarios. Simulations of the CO 2 price case relative to BAU assuming that 100% of the additional energy costs are passe d along by the industry (CPA).Sustainability 2009

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Required Energy Efficiency Gains. Calculations of the energy efficiency gains required to offset the increased energy costs associated with the climate policy case relative to BAU.
Allowance Allocation. Simulations of the im pact of an allowance allocations equal to 90 percent (diminishing by 2 percent per year) of the increased prices for energy consumed by the industry resulting from the CO 2 price case.

5. Climate Policy Impacts on Petrochemical Manufacturing

Petrochemica l manufacturing is one of the most energy

- intensive industries in the U.S. economy

, yet, according to the II

- CPM simulations, the Mid

- CO 2 Price Policy would have very modest impacts on the industry’s costs, operating surplus (profits), and operating margin s (profit margins). These results reflect assumptions and contingencies, such as market price projections, energy mix data and energy price variations, and credit allocation for feedback energy use. In any event, the U.S. petrochemical industry has long b een concerned with energy costs, since its primary feedstock is derived from hydrocarbon fuels (petroleum, natural gas). Although in recent years the industry has been financially strong

– at least until the current economic crisis

– rising energy costs (in pa rticular, natural gas) have prompted some large manufacturers to explore making investments in offshore facilities closer to cheaper and abundant energy supplies, rather than expanding their domestic capacity. Hence, even an incremental increase in energy costs arising from a climate policy, which would apply only the United States, could influence domestic producers’ future location and
investment decisions.

5.1. Production C

ost S tructure (BAU

— Business As Usual)

In 2006, material costs accounted for two

- thirds of total costs, energy costs for 30 percent, and labor for only 3 percent. Energy feedstock accounts for the bulk of energy costs, fuel energy accounts for just a fraction, and electricity costs are all but negligible. Energy feedstock accounts for the largest share of the industry’s energy costs. As a share of total production costs, total energy costs were about 30 percent in 2006. They were projected to fluctuate
around one

- quarter of the total, most years thereafter, in the BAU scenario. Total e nergy costs are also substantially larger than labor costs; they were about 2

- 3 times the latter from 1992 through 1999. They would steadily climb to 17 times greater the labor costs by 2030. Energy costs were estimated to grow from only about 30 percent t o a third of materials costs in 2030. In contrast, the energy

- labor ratio in policy case would rise to over 19 times, and energy

- materials to 35 percent, by 2030.

5.2. Energy and P roduction C ost I mpacts

Table 3 summarizes the production cost impacts proj ected by the II

- CPM simulations for the petrochemical industry, assuming no mitigating actions to reduce energy costs and the implementation of climate policies only in the U.S. The table shows the small cost increases above the BAU, which
would rise to on ly 1 percent in 2020 and 1.7 percent in 2030. Yet, the energy cost share of total production costs for the industry, was 30 percent in 2006. But by 2020, it would fall to under a quarterSustainability 2009

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of the total, only about 1 percent greater than the BAU share, where it would remain through 2030. This share would change very little under the policy case. Feedstock accounts for the largest share of energy inputs

– about 80 percent of total energy costs in 2006, compared to 18 percent for energy fuels and 3 percent for el ectricity (see Table 3).
Under the Mid

- CO 2 Price Policy, overall energy costs would increase by a little over 4 percent in 2020, relative to BAU, and by 7 percent in 2030. The feedstock role in the energy cost increase under the climate policy would actu ally shrink over time, to 75 percent of total energy costs, in 2030, only 1.2 percent over BAU. Fuel costs for heat and power would grow relatively and absolutely, under the climate policy, to 33 percent higher than BAU and would be 21 percent of total co sts in 2030. Electricity would not grow relatively to other energy sources, but would be about 13 percent higher than BAU, in 2030

.

Table 3

. Prduction c osts, e nergy s hare and e nergy c ost c omponents for p etrochemical

m anufacturing.

Item 2006 2020 2030
V alue Value % above BAU Value % above BAU Production Costs (USD 2000/ton)
BAU 457 508

– 506

– Mid

- CO 2 Price Case Above BAU

– 5 1.0 9 1.7 Energy Share of Production Costs (Percent)
Mid

- CO 2 Price Case 29.6 23.2 0.8 25.3 1.3 Energy Cost Components (USD 2 000/ton)
Mid

- CO 2 Price Case: Total Energy Costs 135 119 4.4 130 7.1
Fuel Costs 24 23 19.0 28 33.1 Electricity Costs 4 4 8.6 4 13.1
Feedstock Costs 107 92 1.2 98 1.2

These results reflect assumptions about the energy source used as feedstock in petrochemical manufacturing, based on the DOE’s Manufacturing Energy Consumption Survey (MECS) data, which assumes that all but a small amount of energy fuel used as feedstock is liquid petroleum gas (LPG) or natural liquid gas (NLG). The study therefore a ssumed that all the energy feedstock was LPG using EIA price projections to characterize the climate policy impacts. A source at the American Chemistry
Council (ACC) suggested to us, however, that much if not most of the fuel used as feedstock may in
fact be NGL rather than LPG

— especially ethane and propane

– basic building blocks of ethylene and other bulk petrochemical pro duction in the pyrolysis process. We subsequently did a rough estimate of what the cost impacts might be if it was assumed that a portion or all the feedstock energy consumed
as feedstock was in fact NGL. In particular, estimates of the impacts were done assuming that 10 percent, 50 percent and 100 percent of the feedstock was actually NGL, rather than LPG. The results
of this estimate show ed that the changes in feedstock costs would result in increases in overall production costs relative to BAU, but in cost declines in absolute terms, ranging from as low asSustainability 2009

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1.2 percent above BAU to a high of 3.2 percent in 2020, and a low of 2 percent to a high of 5.5 percent
in 2030. In short, if in fact U.S. petrochemical feedstock is in part, mostly or totally comprised of NGL rather than LPG, the results would range from small to modestly higher cost increases compared to the
II

- CPM results.

5.3. Oper ating S urplus and M

argins (NCPA

—

No Cost Pass

- Along )

Assuming NCPA seems reasonable for this sector due to its very large operating surplus and margins probably caused by the high capital

- intensiveness of petrochemicals. Not surprisingly, low production co sts under the climate policy would produce a small dent in industry’s operating surplus,
relative to BAU: there would be only a 1.2 percent reduction in the operating surplus relative to BAU in 2020, and a slightly higher, 2.2 percent, reduction in 2030. The operating margin change under the policy case also suggests very small impacts on industry’s
bottom line in the II

- CPM simulations, under the assumptions about fuels and prices used in the study. The modeling results showed only a 0.5 percent reduction in the operating margin in 2020 and a 1 percent reduction in 2030. In short, we should expect, at most, only a very modest reduction of the industry’s profits and profit margins by 2030 as a result of a climate policy, given the feedstock energy

source as sumptions used in the original II

- CPM simulations. If, however, the industry actually consumed NGL as feedstock, instead of or addition to LPG, which appears likely according to industry sources, the resultant operating surplus reductions would be
somewhat larger. A 10 percent NGL

— 90 percent LPG split would increase the operating surplus and operating margin impacts only slightly, even for the more volatile NGL price estimates. If we assume
a 50

- 50 split, the operating surplus reduction could rise to 4 per cent by 2030, and if a 100 percent NGL feedstock is assumed in lieu of LPG, the operating surplus reduction could grow to over 5 percent relative to BAU. Significantly, the operating margin reduction could range from nearly 2 in the 50 percent NGL case by 2030 and to 3 percent for the 100 percent NGL case, in 2030. Nevertheless, in absolute terms, the operating surplus and operating margin would be higher when using NGL, due to its lower price, compared to the II

- CPM original simulations of the BAU and Mid

- CO 2 Price Policy cases.

5.4. Operating S urplus and M arket S hares (CPA

— Cost Pass

- Along )

Under favorable market conditions, low cost and high operating surplus/margin under the Mid

- CO 2 Price Policy, petrochemical companies might decide to pass along some or all of the additional costs (CPA) from the climate policy to their customers. The operating surplus, operating margin (and therefore profit margin), and market share reductions would be very small and unlikely to threaten the industry’s competitive posi tion. Even if the NGL

- LPG scenarios represent more realistic situations in the industry, the operating surplus impacts, relative to BAU would still be relatively modest and CPA may remain an option for petrochemical companies, depending on market condition s at the time. In any case, whatever the impacts, under Mid

- CO 2 Price Policy (the core Lieberman

- Warner proposal) it is likely that a credit would be given to the petrochemical industry for feedstock energy use, which would mitigate the economic impacts of the climate policy on the sector.Sustainability 2009

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The extent to which the industry can pass along the added costs of feedstock and energy fuels under a climate policy would depend on the strength of domestic and international demand, the intensity of international compe tition, the extent of production oversupply, and the availability and price volatility of the primary feedstock. The petrochemical manufacturing is a global industry, which is especially sensitive to the availability and costs of raw materials, primarily h ydrocarbons mostly sold on world
markets. The prices of petrochemical products are strongly correlated

— some say as much as 80 pe rcent

— with the cost of crude oil. As a consequence, the industry is subject to a great deal of price volatility, tied to the pri ce fluctuations of petroleum and natural gas.

6. Technology and Policy Options

— Petrochemicals

Given the relatively low economic impacts from the Mid

- CO 2 Price Policy on the petrochemical industry projected by the II

- CPM, even with different assumptions regarding feedstock use (i.e., NGL versus LPG), the energy

- efficiency requirements to offset these cost impacts would be modest

– only about 1 percent through 2030. Although, it remains in the industry’s interest to continue investigating

new energy

- saving t echnology improvements, from short

- term incremental improvements to longer

term advanced or alternative process technologies.

6.1. Technology O

ptions

According to the ACC, the chemicals industry has made substantial improvements in energy

efficiency ove r the past thirty years. One index indicates that the industry’s energy intensity has declined by about 60 percent between 1974 and 2006, and a reduction in GHG intensity of about 40 percent in the same period. Further incremental improvements may be possi ble

— and perhaps might be sufficient to offset the climate policy cost impacts, as long as they are as small as indicated in the
II

- CPM simulation results. Larger scale energy

- efficiency improvements might require substantial investments over a longer time period, in more advanced process technology improvements, and perhaps prevalent in the substitution of existing petrochemical production processes with
low

- carbon alternatives. Some technologies that could be explored are Combined heat and power generat ion (CHP)

— the simultaneous generation of electricity and heat from a facility that is located very close to the manufacturing facility

— and the substitution of fossil

- fuel feedstock by biomass.

6.2. Policy O

ptions to M

itigate I mpacts

The implementation o f a 90 percent allocation allowance to offset energy price increases under the climate policy would greatly alleviate any economic impacts of a climate policy on the petrochemical industry. But with such low impacts projected by the II

- CPM, it is not clear whether such an allocation should be applied in this case. On the other hand, more research is needed to determine the actual mix of feedstock energy sources used by the industry and the past and expected in the future, and make
new assessment of the cost impacts resulting from the climate policy. In any case, whether LPG or NGL are used as feedstock, the carbon content would be sequestered in petrochemicals products,Sustainability 2009

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rather than emitted as CO 2 , which under the Mid

- Price Policy (Lieberman

- Warner) would be compensated with a credit to the industry, to offset the cost impacts.

7. Climate Policy Impacts on Chlor

- Alkali Manufacturing

In contrast to petrochemical manufacturing, the chlor

- alkali manufacturing industry is among the most susceptible industries t o the impacts of climate policy on its profits and competitiveness. According to the II

- CPM results, chlor

- alkali would experience the second largest cost increase and third largest operating surplus reduction relative to BAU, under the Mid

- CO 2 Price Polic y. This industry’s manufacturing processes are heavily reliant on both electricity and fuels for heat and power. At the same time, it is the least sensitive to foreign imports

– and the only industry with a consistent trade surplus

— and therefore possibly mor e able to pass the policy

- driven costs along in efforts to maintain its profitability. On the other hand, basic chemicals, such as chlorine and caustic soda, produced in this industry are often upstream raw materials used in the production of downstream ch emical products by the same company and at the same facilities. Manufacturers therefore would have to weigh whether it is more

cost

- effective to continue internal production of an increasingly expensive feedstock, or look elsewhere (i.e., offshore) for les s expensive sources

— or, alternatively, consider investment in newer,

more energy

- efficient chlor

- alkali production technologies (e.g

., the membrane cell).

7.1. Production C

ost S tructure (BAU)

Figure 1 presents the historical trends and projections for th e production cost components for the
chlor

- alkali manufacturing processes in the BAU case. It also shows the additional energy costs that the industry would have to bear if the Mid

- CO 2 Price Policy were enacted. As with the other industries,
materials cost s constitute the largest share of total production costs

– fluctuating around 40

– 45 percent for the historical period and in the projections through 2030. But the share of energy costs, and to a less extent of labor costs, also are sizable. The former have f luctuated around 40 percent historically, but were projected to fall to a little over a third of total costs. The jump in labor costs in 2005 paralleled the rise in materials costs, and a comparable growth in energy costs, all of which were then projected to remain somewhat higher than their values in prior years. Labor costs have historically
been around one

- fifth of total costs, and were projected to remain at that level through 2030, for BAU. The costs of energy for the BAU case are estimated to be in t he range of double the costs of lab or through 2030, and nearly 2.5 times greater under the Mid

- CO 2 Price Policy. For the BAU case, energy costs ranged from 80 percent to roughly equal materials costs from 1992 through 1999, and then
fluctuated between 100

– 150 percent through 2008. They then were projected to fall to, and stay at, roughly three

- quarters materials costs through 2030 for the BAU case. They would be a little higher relative to materials costs under the climate policy, ranging between 80

– 100 per cent between 2009
and 2030.Sustainability 2009

, 1 604

7.2. Energy and P roduction C ost I mpacts

Energy cost increases under a climate policy would be fairly significant acco rding to the II

- CPM.
As Table 4 shows, total production costs would grow 5.5 percent by 2020 and nearly 10 percent by 2030, compared to BAU. The energy share of total production costs was 38 percent in 2006. It was projected to remain roughly the same for BAU throughout the period when the Mid

- CO 2 Price Policy
would be in effect. However, the modeling results show that this share would grow nearly to 42 percent, 6 percent above BAU by 2030. The role of the two main energy components responsible for this growth is externally purchased fuel energy and electric power. Fuel costs would account for the larger porti on of the rise in energy costs and consequently the overall growth in production costs. They represent about 60 percent of total energy costs and would increase by over a fifth by 2020 and over one

- third by 2030, relative to BAU. Natural gas is the primary fuel consumed in the industry, followed by coal and LPG. The large price increases for the two former fuels under the climate policy are responsible for almost all the growth in
fuel costs for chlor

- alkali relative to BAU. Electricity growth is much more modest, rising only by 13 percent above BAU by 2030. This reflects the relatively moderate price increases for that energy
source under the Mid

- CO 2 Price Policy.

Figure 1. Chlor

- Alkali r eal u nit p roduction c ost c omponents, b usiness as u sual, 1992

– 2030

.

7.3. Operating S urplus and M argins (NCPA)

The chlor

- alkali’s operating surplus, assuming NCPA, is quite large in the BAU case, but, it would shrink by a sizable amount under the Mid

- CO 2 Price Policy. This is partly the result of projected declining market price relative to the rapidly rising production cost curve under the climate policy.Sustainability 2009

, 1 605

The reduction in the industry’s operating surplus resulting from the Mid

- CO 2 Price Policy would be substantial, 10 percent below BAU in 2020 and a shade under 20 percent in 2030. Operating margins also would shrink, by 3.6 in 2020 and 6.6 percent in 2030. The growing scale of both the operating surplus and operating margin reductions, over this period could begin to translate into a noticeable diminishment in the industry ’s profitability, leading chlor

- alkali producers to seriously explore options for containing their energy costs, contingent on its financial situation and market conditions.

Table 4

. Production c osts, e nergy s hare and e nergy c ost c omponents

– c hlor

- a lkali m anufacturing

.

Item 2006 2020 2030
Value Value % above BAU Value % above BAU Production Costs (USD 2000/Mt)
BAU 104 102

– 104

– Mid

- CO 2 Price Case Above BAU

– 6 5.5 10 9.9 Energy Share of Production Costs (Percent)
Mid

- CO 2 Price Case 38.3 37.3 3.5 41 .6 5.8 Energy Cost Components (USD 2000/Mt)
Mid

- CO 2 Price Case: Total Energy Costs 40 40 16.3 47 27.8
Fuel Costs 26 25 21.3 32 36.6 Electricity Costs 14 15 8.6 16 13.1

Mt = Metric Ton [=1.102 Short Tons]

7.4. Operating S urplus and M arket S hare s (CPA)

Faced with diminishing profitability, the industry might also consider passing along the costs to customers (CPA), to preserve its profit margins and minimize operating surplus reductions. But with higher prices come lower market shares, as the lo wer cost of foreign imports replaces domestic production and sales. Because the chlor

- alkali industry currently enjoys a net trade surplus (exports exceeds imports), the pressures of foreign competition may not be as great as for other industries, and

cost pass

- along may be more of an option. Under the cost basis CPA assumption, the industry would see a decline of less than 1 percent of its domestic market share, which would still total around 90 percent, as a result a CPA choice under the
Mid

- CO 2 Price Po licy. This is equivalent to a reduction in production of 270,000 metric tons of
chlor

- alkali products, out of a total net domestic output of 34.6 million metric tons. The industry’s operating surplus also would be diminished by less than 1 percent, which would translate into a negligible impact on its profits.
Given the revenue reduction projected under a NCPA assumption, and the projected gains if costs were passed along, manufacturers in the chlor

- alkali industry may decide to pass along some or all
thei r additional costs, despite modest losses in market shares. Given the low import vulnerability of
this industry

—up until now it has been a net exporter

— cost pass

- along may be a reasonable response by chlor

- alkali producers to offset and prevent future majo r economic harm. But market conditionsSustainability 2009

, 1 606

could greatly influence chlor

- alkali companies’ decisions about passing along cost increases or investment choices in response to them.

8. Technology and Policy Options

— Chlor

- Alkali

In the study, we reviewed some o f the technology investment options and evaluated a public policy option that could help the chlor

- alkali industry mitigate the economic costs of a climate policy. We first found that the industry would need to achieve fairly substantial energy

- efficiency gains to offset
these costs. At the same time, although there are incremental heat, power and process technologies and a major process technology that the industry already is moving towards, which could greatly reduce the industry’s energy costs, there re main barriers to their successful implementation. More research is needed to evaluate these options, their potential for generating sufficient energy

- savings, and the timing, cost, and technical barriers to their successful implementation. Finally, we fou nd that a 90 percent allowance allocation policy would alleviate some of the short

to

- mid

- term cost pressures on U.S. chlor

- alkali manufacturers, which could buy time, if not encourage them to make the transition to new energy

- saving technologies and advan ced chlor

- alkali manufacturing processes.

8.1. Energy E

fficiency R equirements

Figure 2 illustrates the energy efficiency gains that would be required in the chlor

- alkali industry to offset the production costs that would result from the Mid

- CO 2 Price Pol icy. The largest gains required would be to offset fuel energy cost increases. These rise from a little over 10 percent in 2012, immediately after the policy would go into effect, to about 19 percent in 2030. Electricity gains required would be around 7 pe rcent in 2020 and 10 percent in 2030. Because fuel costs are the primary
source of cost increases in the chlor

- alkali industry, according to the II

- CPM simulations, the primary emphasis on energy

- saving measures and technologies should be on making efficie ncy improvements in the delivery and use of heat and power.

8.2. Technology O

ptions

According to the International Energy Agency (IEA) [27 ] , the best opportunity for reducing energy
use and costs of the chlor

- alkali industry is to substitute membrane te chnologies for the mercury and diaphragm production methods currently in place. Membranes are a chemical separation process that is among the most energy

- intensive operations in the chemical industry, which includes distillation and
extraction. They use up to 40 percent of all energy consumed in the chemical industry and can account for more than 50 percent of plant operating costs. If the current membranes cells are replaced by more advanced cells using new state

- of

- the

- art technology (i.e., the oxygen

- con suming cathode), energy savings of at least 30 percent could be realized.Sustainability 2009

, 1 607

Figure 2

. Chlor

- Alkali i ndustry

– c umulative y early e nergy e fficiency g ains r equired to

o ffset c limate p olicy c osts

.

However, because of the relatively low cost of electricity in past years and the high capital investment required, U.S. firms have been resistant to invest in the new energy

- efficient chlor

- alkali process, unless there is a short

- term boost to their competitiveness. At the same time, investments in the new technology have already been made in Europe and Japan, where energy prices are higher and environmental regulations stricter than in the United States (FY 2004) . U.S. electricity prices, however, have risen over the past decade, which would be augmented by a climate policy. Coupled with sufficient investment incentives, this may provide some encouragement for U.S. chemical companies to make the transition to new cell technologies.

8.3. Policy O

ptions to M

itigate I mpacts

Figure 2 also illustrate s the potential miti gating benefits of the 90 percent allocation measure on the economic impacts of the Mid

- CO 2 Price Policy on the industry. The cumulative energy efficiency gains required for both fuel and electricity in the allocation case would be only about one

- tenth tha n that needed if there were no allocation, in 2012. By 2020, the requirements in the allocation case
would be one

- fifth that of the no allocation case, and by 2030, the requirement would fall to one

- third
the allocation case. The diminishing mitigating eff ects over time reflect the 2 percent annual reduction
in the allocation offset. Similarly, results show the substantially lower cost increase and operating surplus reduction that would result from imple menting the allocation measure. T he chlor

- alkali indus try would realize a 74 percent gain in 2020 and a 54 percent gain in 2030. By 2020, real unit production costs would fallSustainability 2009

, 1 608

from 5.5 percent to 1.5 percent, above BAU, and operating surplus would diminish from 10 percent to about 3 percent, below BAU. By 20 30, production costs would shrink from 10 percent to 4.6 percent above BAU, and operating surpluses would decline from nearly 20 percent to 9 percent, below BAU.

9 . Conclusions

The II

- CPM simulations results show that enactment of a mid

- price climate pol icy would have widely different impacts on the petrochemicals and chlor

- alkali industries. Although both industries are highly energy

- intensive

— the former heavily dependent on hydrocarbon

- based feedstock, the latter on natural gas and electricity

— the diffe rent energy mixes and the projected price variations for their primary energy sources under the climate policy result in, on the one hand, relatively small impacts on the petrochemical industry, yet large and potentially troubling impacts on the chlor

- alka li industry, on
the other. Under the assumptions regarding the nature of the energy mix and prices used in the II

- CPM simulations and with no mitigating action being implemented to reduce the impact of a climate policy, the petrochemical industry would exp erience very modest increases its production costs, which would translate into only small reduction in its operating surpluses, operating margins, and ultimately its profits. In contrast, the chlor

- alkali industry would experience large impacts.
At the sa me time, because both industries are relatively less sensitive to import substitution, under favorable market conditions, when demand is robust and prices for their goods are rising domestically and internationally, they may more easily be able to pass

- thr ough their costs to users of their products. However, both industries are more vertically integrated with producers of derivative and downstream products that rely on the processing and incorporation of their products (e.g., PVCs), than other sectors analy zed in this study. The downstream producers tend to be more price sensitive and perhaps less able
to pass

- through new costs in the global markets they operate within, than their basic materials suppliers. Therefore, to fully understand the implications of climate policy

- driven energy cost increases, it might be necessary to examine the ripple effect of petrochemical and chlor

- alkali cost increases, if they are passed through, on the profitability and competitiveness of their major
downstream customers.
Bot h industries are also very sensitive to the volatility of energy prices, in particular, natural gas, which under conditions of weakened demand and falling product prices, have led some chemicals
firms

— especially in petrochemicals

— to consider building new c apacity in, or sometimes shifting their operations to, foreign locations with abundant and cheap energy supplies, rather than upgrading or expanding their domestic facilities. Cost pass

- along in these situations is less feasible, and even incremental impac ts on production costs and profits from a climate policy could influence firms’ location and investment decisions, in efforts to maintain their margins. Our examination of technology and policy options found that corresponding to the II

- CPM cost, operatin g surplus, and profit margin findings, the petrochemical industry would require small energy

efficiency gains to offset rising climate policy

- driven energy costs. The required gains for the chlor

alkali industry, in any case, were estimated to be quite lar ge, consistent with the substantial cost and profit impacts projected by the II

- CPM.Sustainability 2009

, 1 609

Both shorter and longer

- run energy

- saving technology options are available to the industries

— and being researched by them

— but the usual financial, technical, and timing is sues need to be addressed to determine the economic feasibility of implementing these options, under the additional energy cost pressures from a climate policy. Both industries could benefit from incremental improvements from continued application of CHP, heat recovery, advanced sensors and process controls, and similar

energy

- saving applications. These in principle could help offset the relatively projected modest cost impacts in the petrochemical industry, and could help over the short

- run if they were im plemented in
the chlor

- alkali industry. However, the larger longer

- term technology improvements

– membrane cells in chlor

- alkali, more advanced cracking furnaces, biomass feedstock in petrochemical manufacturing

– needed to offset the
industries’ more substan tial profit reductions in later years, would require more research, development and demonstration of their technical and commercial feasibility, before companies would be willing to make the substantial investments required to replace their older, existing production facilities. At the same time, because the domestic chlor

- alkali industry reportedly is characterized by aging, and in some cases very old, plants, the industry may be more ready to replace some or most existing capacity with modernized, advance d membrane cells over the next decade or so, though other enabling policies may also be needed. Finally, the enactment of the 90 percent allowance allocation measure would greatly mitigate the cost impacts of the Mid

- CO 2 Price Policy for both industries, t hough the issue is disputable if the industry were to receive a credit for the carbon ―sequestered‖ in its products. The allocation policy also would be important to mitigate short

- to

- medium term impacts on the chlor

- alkali industry. In any event, we belie ve that other, supplemental policies might be needed to encourage chemicals manufacturers to adopt both incremental and advanced low

- carbon and low

- emissions process technologies over the next 10

- 15 years, to help them cope with increasing energy prices.

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- access article distributed under the terms and conditions of the Creative Commons Attribution license (http://creativecommons.org/licenses/by/3.0/).