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The Outlook for the US Chemical Industry kpmg.com Chemicals and Performance Technologies

KPMG’s Chemicals and Performance Technologies Practice
• Honest, independent advice • Built on deep sector knowledge • Delivered by an integrated global team

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Executive Summary
Is the worst over? A cautious but growing consensus among economists and industry analysts suggests that after more than two years of turbulence, the global economy in general and the chemical industry, in particular, are entering calmer waters.1 While a full recovery for chemical companies is not expected this year, certainly, the earnings releases across the industry for the first half of 2010 suggest that growth is returning at a faster rate than many had expected.2 Increased production in the domestic auto industry is supporting new demand for US chemical products, but the construction sector – another major market for US chemicals – is recovering more slowly. However, after massive layoffs, improvements in cash management and operational belttightening, the US chemical industry is expected to realize a year-over-year increase of around 7 percent in 2010, according to the American Chemistry Council (ACC).3 At the same time, this recovery presents its own set of challenges for US chemical companies. The growing size and diversity of emerging markets, the increasing influence of chemical producers in the Middle East, Asia and Latin America, the increased burden of environmental regulations and many other factors have created a new global playing field in which US companies are no longer taking their technical, financial and market advantages for granted. In fact, “business as usual” will never be the same again as the US chemical industry moves into a post-recession global economy. Currently, the US produces 19 percent of the world’s chemicals, more than any single country.4 While this position may soon be usurped by China5, US chemical companies have already started to transform themselves into science and technology companies, placing them at the forefront of the response to emerging global mega trends such as climate change, resource scarcity and population growth. In particular, this transformation has focused on: • The increased use of research and new technology supporting an evolution from base chemical production to specialties • Rationalizations and other efforts to increase their competitive advantage, both domestically and abroad • Innovations to address a growing number of environmental regulations that include global protocols and legislative mandates in other countries Even these current efforts, however, will not be enough for the US chemical industry to stay ahead of strong, new competitors emerging on the horizon. Instead, US chemical companies are redefining their traditional role as chemical producers and literally reinventing themselves as the global industry’s leading science and technology companies for the 21st century.

Mike Shannon Global and US Sector Leader Chemicals and Performance Technologies
1 2 3 4 5

American Chemistry Council (ACC): ‘Industry Operations Have Largely Returned to Normal,’ Chemical Week, June 22, 2010 Ibid. Ibid. ACC: ‘Industry Fact Sheet,’ June 2010 KPMG: ‘Issues Monitor: Sharing Knowledge on the Chemicals Industry,’ Issue Two, April, 2010

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 1

Contents
1. Current state of the industry 1.1 Industry overview 1.2. Impact of the global downturn 1.3. Tariffs and protectionism 1.4. Forecasts for 2010 2. The new global context 2.1 US focus on emerging markets 2.2. Growth in Brazil 2.3. New opportunities in Canada 3. 4. Regulatory issues and response The evolution in science and technology solutions Conclusion 2 2 3 5 7 10 10 12 13 15

18 19

5.

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2 | THE OUTLOOK FOR THE US CHEMICAL INDUSTRY

1. Current state of the industry
After a rough two years, US chemical companies are looking for new ways to grow their customer base, enter new markets and develop their product offerings.
KPMG believes that US chemical companies can help address these goals through a re-assessment of goals and strategies in terms of global markets, environmental regulations, and the evolution of US companies from producers of basic chemicals to what can truly be called science and technology companies.

1.1 Industry overview
US chemical products – value of manufacturers’ shipments (US$ millions) Not seasonally adjusted Monthly Industry April 2010* March 2010** February 2010 2010* Year to date 2009 % change 2010/2009 10.1 48.2 -4.8 3.0

(US$ million) Chemical products Pesticides, fertilizers, and other agricultural chemicals Pharmaceuticals and medicines Paints, coatings, and adhesives
Source: US Census Bureau, accessed on June 29, 2010 * Provisional ** Revised

62,116 5,984 15,271 2,920

64,266 5,577 16,207 2,798

54,683 3,601 14,269 2,299

234,291 17,864 60,234 10,114

212,760 12,050 63,276 9,815

US chemical products – sales and profits (US$ millions) Sales Industry Q1 2010 Q4 2009*** 180,737 52,226 83,019 45,492 Q1 2009*** 170,927 47,250 75,834 47,843 Operating profits** Q1 2010 Q4 2009*** (US$ million) Chemicals products Basic chemicals, resins and synthetics Pharmaceuticals and medicines All other chemicals 184,807 56,769 79,548 48,490 18,475 3,182 8,772 6,521 16,513 1,741 9,224 5,548 20,323 535 13,131 6,657 26,841 3,027 18,192 5,622 38,542 826 30,676 7,040 21,994 -668 17,018 5,644 Q1 2009*** Q1 2010 After tax profits Q4 2009*** Q1 2009***

Source: US Census Bureau, accessed on June 29, 2010 * Not seasonally adjusted sales and profits ** Operating profits are profits before non-operating income, expense items, and income taxes *** Revised

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THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 3

The chemical industry is a major component of the US economy, converting raw materials such as oil, natural gas, air, water, metals and minerals into more than 70,000 different products.6 According to the ACC, over 96 percent of all manufactured goods are dependent in some way on the chemical industry.7 The US chemical industry produces 19 percent of the world’s chemical output, amounting to US$689 billion. The industry directly employs over 800,000 people nationwide. A total of nearly 5.5 million additional jobs are supported by the purchasing activity of the chemical industry and by the subsequent expenditure-induced activity.8 In addition, the US chemical industry is responsible for 10 percent of US merchandise exports, totaling US$145 billion annually, as well as 11 percent of all US patents.9 US chemical products can be divided into four general categories: Basic and intermediate chemicals: The major products of this segment include polymers, bulk petrochemicals and intermediates, fertilizers, inorganic chemicals and other industrial chemicals. Employing almost a third of workers in the industry,10 this segment is the largest of the four, providing plastics for packaging, home construction, appliances, polyvinyl chloride (PVC), piping, toys and games. Specialty chemicals: These chemicals are typically highvalue-added products with many differentiations. The major products of this segment include paints and coatings, adhesive sealants, catalysts, dyes and pigments, industrial gases, resins and plastic additives.

Life science chemicals: These are differentiated biological and chemical substances used to induce specific outcomes in humans, animals, plants and other life forms. The major products of this segment include agrochemicals, pharmaceuticals and biotechnology products. Science and technology chemicals: These products include advanced materials that transform current technologies. They enhance the characteristics of traditional specialty chemical products, as listed above.

1.2 Impact of the global downturn
US Chemical Industry Employment (in 1000s) January 2008 – May 2010
880 860 840 820 800 780 760 740 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10

Source: Current Employment Statistics, Bureau of Labor Statistics, accessed on June 29, 2010

6 7 8 9 10

US Energy Information Administration: ‘Chemical Industry Analysis Brief’ Op. cit., ACC: ‘Industry Fact Sheet’ Ibid. ACC: ‘Industry Profile,’ January 10, 2010 US Bureau of Labor Statistics: ‘Career Guide to Industries, 2010-11 Edition’

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4 | THE OUTLOOK FOR THE US CHEMICAL INDUSTRY

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 5

Number of bankruptcy filings in the US chemical industry, 2000 – 2009*
60 Number of bankruptcy filings 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 10 4 11 11 11 12 12 27 45 55

1.3 Tariffs and protectionism
In general, the financial crisis sparked a marked increase in the number of antidumping cases raised by US regulators. Asian companies have been the most prominent targets. During the first six months of 2008, China and South Korea were the top targets of antidumping investigations, and a record 44 percent of the world’s antidumping investigations during the period involved China.12 This trend continued into the next year. To give just one example, in August 2009, the US Department of Commerce (DOC) imposed duties of up to 4.2 percent on importers of plastic bags from Vietnam.13 This followed an initial ruling that the Vietnamese government had provided subsidies ranging from 0.2 percent to 4.24 percent to local plastic bag players.14 Although Asian companies are still targeted for antidumping investigations by Western manufacturers, China has shown a growing assertiveness in regards to antidumping issues. In April of 2010, China imposed anti-dumping duties on imports of Nylon 6, a synthetic-material nylon.15 The government announced tariffs of up to 96.5 percent on imports of this nylon from the US, as well as from Europe, Russia and Taiwan.16 Current economic pressures continue to encourage protectionist measures. However, the global chemical industry is built on free trade across national borders and trade zones. The US chemical industry exports 20 percent of its output, totaling US$145 billion.17

Source: Capital IQ (accessed on March 23, 2010) Note: *Includes both chapter 7 and chapter 11 bankruptcy filings

US chemical shipments
70 Chemical shipments 60 $ Billions

50 Shipments excluding drugs

40

30 May May Mar Mar Aug Nov Dec Aug Sep Sep Jan Jun Jan Jun Feb Apr Feb Apr Oct 2008 2009 Oct Jul Jul

Source: US Department of Commerce, cited in Chemical & Engineering News: ‘United States: Chemical industry prepares for a slow recovery in 2010,’ January 11, 2010

The global recession that began in late 2007 has had an enormous impact on consumers’ disposable income. This in turn has led to a massive decrease in spending for automobiles and consumer products such as appliances, furniture and personal care items – major markets for the chemical industry.11 The commercial or business-to-business side of the economy has been affected as much if not more. Construction – another key market for US chemicals – came to a virtual halt as business lines of credit began to disappear, limiting new building activity and reducing the market demand for chemistry-intensive goods.

12 13 14 15 11

ICIS Chemical Business: ‘Impact of the downturn on chemical distributors will be significant,’ June 1, 2009

16 17

All Business: ‘Chemicals anti-dumping cases on the rise,’ January 20, 2009 All Business: ‘Asia producers expect high levels of protectionism,’ September 16, 2009 Ibid. Voanews.com: ‘China Levies Punitive Duties on US Chemical Imports,’ April 22, 2010 Ibid. Op. cit., ACC: ‘Industry Fact Sheet’

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6 | THE OUTLOOK FOR THE US CHEMICAL INDUSTRY

The sharp drop in these markets for the chemical industry caused severe inventory imbalances that persisted throughout 2008 and into 2009, thereby lowering the demand for chemical production. Output in the US chemical industry (excluding pharmaceuticals) fell by 6.7 percent in 2008 – then fell again by 8.4 percent in 2009, resulting in an average capacity utilization rate of 70.1 percent.18 Some market segments reported even sharper declines in capacity utilization. Basic chemicals were especially impacted in 2009, contracting by 21.5 percent.19 Massive layoffs followed these cutbacks in production. Between December 2007 and March 2010, the US chemical industry lost over 66,000 jobs, or 7 percent of employees.20 Commodity chemical .7 companies were most affected, driven mainly by declines in the automotive and construction industries. The industry also suffered from a number of bankruptcies among small chemical producers in addition to several larger companies. Many companies had gone through years of merger and acquisition (M&A) activity, leveraged buyouts (LBOs) and share buybacks. In the first quarter of 2009, 72 percent of the North American chemical companies covered by Moody’s Investors Service were in the highyield (elevated leverage) category – more than double the percentage in 2001.21 With increased financial pressures and the deterioration of business fundamentals, highly leveraged companies were often unable to refinance their debt, which resulted in further financial stress.22 In response to these upheavals, US chemical companies undertook rigorous measures to cut costs and align production with demand. In addition to further layoffs, a number of chemical manufacturers announced production cutbacks. Numerous plants were idled and operation rates were cut.23 In addition, chemical companies reduced capital spending by 20.1 percent.24 Other cost-cutting and cash-generating measures included aggressive working capital management, the delay of orders until products were absolutely needed, software solutions to drive inefficiencies out of the supply chain, and the improved management of labor costs.25

Chemical Engineering Progress: ‘The Business of Chemistry: Forecast for 2010,’ statement by Kevin Swift, January 1, 2010 Chemical & Engineering News: ‘United States: Chemical industry prepares for a slow recovery in 2010,’ January 11, 2010 20 ICIS Chemical Business: ‘The worst is over,’ March 3, 2010 21 ICIS Chemical Business: ‘Chemical industry credit quality deteriorates while refinancing risk rises,’ February 3, 2009 22 Op. cit., KPMG: ‘Issues Monitor: Sharing Knowledge on the Chemicals Industry’ 23 ICIS Chemical Business: ‘Idling and mothballing chemical plants provides respite in downturn,’ April 28, 2009 24 Chemical & Engineering News: ‘United States: Chemical industry prepares for a slow recovery in 2010,’ January 11, 2010 25 ICIS Chemical Business: ‘Focus: Chemical firms slim down supply chain to save money,’ March 12, 2009
18 19

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THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 7

1.4 Forecasts for 2010
Dow Jones US Chemicals Index, April 10, 2008 – June 24, 2010
350 300
Index Value

US chemicals and manufacturing operating rates, April 2008 – April 2010
80 78 76 74 72 Latest month Previous month Year ago 70.3% 74.0% 74.5% 45.0% 71.2% 70.4%

250 200 150 100 Jul-08 Apr-08 Apr-09 Jul-09 Jan-09 Jan-10 Apr-10 Oct-08 Oct-09 Jun-10

70 68 66 64 May May Mar Mar Aug Dec Aug Dec Nov Nov Sep Sep Jun Jan Jun Jan Apr Apr 2008 Chemicals All manufacturing 2009 2010 Apr Feb Feb Oct Oct Jul Jul

Source: Reuters 3000Xtra Media Source: Profits On the Rise, Chemical Week, June 11, 2010

JP Morgan Global Manufacturing PMI DI, sa
60 55 55 45 40 35 30 2003 2004 2005 2006 2007 2008 2009 2010

US chemical profits (in billion of after-tax dollars)
120 100 80 60 40 20 0

2004

2005

2006

2007

2008

2009

2010

Source: JP Morgan, 1 April 2010

Sources: Haver Analytics (New York), based on data from the U.S. Bureau of the Census; estimates by The Industry Performance Monitor (Sandy Hook, CT). [Table from Chemical Week: ‘Forecast: What to expect in a year of recovery,’January 8, 2010]

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8 | THE OUTLOOK FOR THE US CHEMICAL INDUSTRY

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 9

US chemical industry output projections (% annual change) Industry All Chemicals Pharmaceuticals Chemicals, excluding pharmaceuticals Agricultural chemicals Basic chemicals Specialty chemicals Consumer products 2008 -4.7 -1.9 -6.7 -9.0 -8.7 -4.6 2.0 2009 -4.5 0.4 -8.4 -8.6 -5.4 -15.3 -5.1 2010 6.0 4.7 6.8 7.0 8.8 2.4 4.1 2011 4.0 4.5 3.7 0.8 3.8 4.1 2.6 2012 3.6 4.8 2.9 2.3 2.5 4.2 2.9 2013 3.2 4.8 2.2 2.1 1.7 3.0 2.4 2014 2.8 4.3 1.9 1.9 1.5 2.0 2.0

Soucre: Bureau of the Census, Federal Reserve Board and ACC analysis, June 22, 2010

In 2010, the global economy appears to be slowly moving out of the recession. According to the International Monetary Fund Forecast released in April of 2010, world economic growth is expected to rise by about 4.25 percent in 2010 and 2011.26 The JPMorgan Global Manufacturing Purchasing Managers Index (PMI) reached a 70-month high in March of 2010.27 Forecasts for the US economy are also improving. The National Association for Business Economics (NABE) forecast panel in May increased its expectations for growth in 2010 to 3.2 percent for real GDP from 3.1 percent in its February forecast. The panel is also predicting a 3.2 percent pace of real GDP growth for 2011.28 The US chemical industry reflects these upward trends. The ACC stated in its mid-2010 outlook that the industry is moving towards self-sustaining growth, based on rising demand, business investment, and cost advantages.29 The US chemical industry’s leading indicator gained 2.3 percent in May of 2010.30 This represented an increase of 14 percent over a low in March of 2009. US chemical industry output also rose 6.7 percent in May. Industrial production in the chemical-process industries, an important part of the index, rose 2.9 percent.31

End markets for chemical products are showing strong growth. In July, US auto industry sales rose 5.1 percent over July of 2009.32 For the second quarter as a whole, total industrial production increased at an annual rate of 6.6 percent.33 Iron and steel, computers, electronic components and appliances are all forecast to experience doubledigit growth in 2010, although most of these increases are measured against significant declines from the year before.34 This growth has been reflected in the earnings releases of most chemical companies for the first half of 2010 (H1). Eastman Chemical Company, for example, reported a 38 percent increase in sales revenues,35 primarily due to improved customer demand. Combined with the restructuring and cost saving programs that many chemical companies implemented last year, output growth is driving high earnings across the sector, to the extent that many companies are confident of out-performing full year forecasts. However, the news is not all positive. Sustained expansion in the construction industry has yet to occur. The volume of non-residential building remains quite low, and little improvement is expected in 2010.36 In addition, it is possible that many of the jobs lost during the recession are not expected to be replaced as business improves.

However, most indices are encouraging, suggesting a mild but steady improvement for the US chemical industry. Growth will continue beyond 2010, the ACC says, with US chemical output expected to increase 3.7 percent in 2011 and 2.9 percent in 2012.37 At the same time, strong elements of uncertainty remain about this recovery, based on factors such as the possibility of a sovereign debt crisis in Europe. The crisis sent the euro to a four-year low against the US dollar on June 7 2010, , and it has wiped out more than US$4 trillion from global stock markets.38 Even with massive government rescue mechanisms and tough proposals to reduce public spending, a continued lack of investor confidence in countries such as Greece and Spain might have grave repercussions in Europe and throughout the global economy. Over US$33 billion in chemical goods are exported annually from NAFTA to Europe,39 and US chemical companies are keeping close watch over developments in Europe.

26

27

28

29

30 31

International Monetary Fund: ‘World Economic Outlook April 2010: Rebalancing Growth’ JPMorgan and Markit Economics: ‘Global Manufacturing PMI rose to 70-month high,’ news release, April 1, 2010 NABE Outlook: ‘U.S. Recovery Approaches One-Year Anniversary in Good Shape,’ May 2010 Op. cit., ACC: ‘Industry Operations Have Largely Returned to Normal’ Chemical Week: ‘Gaining Momentum,’ June 4, 2010 Ibid.

Yahoo Finance: ‘US Auto sales rise in July,’ August 9, 2010 US Federal Reserve: ‘Industrial production report,’ July 15, 2010 34 ACC: ‘Industry Operations Have Largely Returned to Normal’ 35 Eastman Chemical: ‘Eastman Announces Record EPS in Second Quarter 2010,’ press release, July 29, 2010 36 McGraw-Hill Construction: ‘May Construction Grows 3%,’ June 22, 2010
32 33

37

38

39

Op. cit., ACC: ‘Industry Operations Have Largely Returned to Normal’ Bloomberg News: ‘Investors Ignore Positive News as Europe’s Debt Crisis Persists, BIS Says,’ June 13, 2010 Cefic: ‘Facts and Figures, 2009,’ chart 2.2., page 16, ‘Extra-EU chemicals trade flows with major geographical blocs, 2007’

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10 | THE OUTLOOK FOR THE US CHEMICAL INDUSTRY

2. The new global context
Average Real GDP Growth during 2010 – 11

Below 1

Between 1 and 3

Between 3 and 5

Above 5

Insufficient data

Source: IMF staff estimates

Consider these facts: • By 2015, China is expected to overtake the US as the largest chemical producer in the world.40 • By 2025, India will have over 400 million middle class consumers, more than the present population of the US.41 • Between 1995 and 2005, over 95 percent of world chemical growth was concentrated in developing countries.42 In a post-recession economy, new market leaders are emerging from outside the West. Generally speaking, the recession hit the developed countries hardest, and recovery in the US and Europe has not kept pace with recovery in markets such as Asia, the Middle East and emerging markets in Latin America. At the same time, these markets are rapidly increasing in both size and purchasing power. This shift in market importance will be a defining factor for the future of the US chemical industry in 2010 and indeed for the 21st century.

2.1 US focus on emerging markets
International comparison of chemical production growth
175
Production Index (1997 = 100)

1997 – 2007 Average growth p.a.(1997-2007) Asia Pacific* 5.7% Latin America 3.2% NAFTA 1.4% EU 1.3%

165 155 145 135 125 115 105 95

1997 EU

1998 NAFTA

1999

2000

2001

2002

2003

2004

2005

2006

2007

Asia Pacific*

Latin America

*Asia Pacific includes Japan, China, India, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand, Pakistan, Bangladesh and Australia. Source: Cefic Chemdata International

Deutsche Bank Research: ‘World chemicals market: Asia gaining ground,’ July 2008 McKinsey Global Institute: ‘The ‘Bird of Gold’: The Rise of India’s Consumer Market,’ May 2007 42 European Commission: ‘The state of the European Chemicals Industry – a thoughtstarter for the High Level Group on the competitiveness of the European Chemicals Industry,’ 2007
40 41

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THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 11

US chemical companies are increasingly focused on emerging markets, recognizing their tremendous market potential. China is expected to add approximately 500 million consumers between 2005 and 2020. These consumers will have an estimated annual income of at least US$10,000.43 As consumer spending increases in China, the demand for differentiated products is expected to follow suit, driving the chemicals market toward specialty chemicals. Equally significant market opportunities exist in India. The country is currently the second-biggest market in Asia with a population of 1.12 billion. However, by 2025 the population of India will approach that of China due to the Chinese government’s policies restricting births. Meanwhile, India’s population will continue to drive increased levels of consumption. By 2015, over 63 million Indian households are expected to reach a household income of over US$6,500 annually,44 ensuring greater demand for food and healthcare products as well as consumer goods like automobiles, housing, home appliances and items for personal care.
43

For the moment, most US chemical companies see Asia and Latin America primarily in terms of market opportunities, not competitive threats. However, that perspective will most likely change in the near future. The ACC expects chemical industry output in emerging nations to increase 6.9 percent in 2010 and 7 percent in 2011, surpassing expected .6 growth rates for the US.45 To maintain their competitive advantage, many US chemical companies are taking steps now to realign or expand their global initiatives and strategies. Recent activities include the following: • In November of 2009, Air Products opened a new specialty amines plant in Nanjing, China, which will complement its existing local capabilities.46 • ExxonMobil Chemical has announced that the majority of growth for its products in the near future will be in Asia, especially China and India.47 The company intends to supply these markets from its global network, including its Singapore manufacturing facilities.

• Chevron Phillips Chemical Company (CPChem) is increasing its production capacity in the Middle East with two new joint ventures between affiliates or subsidiaries of CPChem and companies in Saudi Arabia and Qatar.48 CPChem already owns three plants in the region, with another one under development. • In March of 2010, Eastman Chemical Company announced the acquisition of Genovique Specialties Corporation, a global producer of specialty chemicals. Through the deal, Eastman will acquire operations in the US and several countries overseas, including a joint venture in Wuhan, China.49

44

ICIS Chemical Business: ‘Specialty chemical industry presents growth opportunities,’ September 21, 2009 Investment Commission of India: ‘India – Opportunities in the World’s Largest Democracy’

45 46

47

Op. cit., ‘Forecast: What to Expect in a Year of Recovery’ Air Products: ‘Air Products Opens New Specialty Amines Plant in China,’ press release, November 3, 2009 ICIS Chemical Business: ‘China, India key for ExxonMobil Chemical growth,’ February 2009

48 49

ConocoPhillips: ‘Fact Book,’ 2010 Eastman Chemical Company: ‘Eastman Completes Acquisition of Genovique Specialties,’ press release, March 3, 2010

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12 | THE OUTLOOK FOR THE US CHEMICAL INDUSTRY

2.2 Growth in Brazil
Brazilian chemicals industry output, 2004 – 09*
140 120 100 80 60 40 20 0 2004 2005 2006 2007 2008 2009 60.3 72.3 82.6 103.5 122.2 103.3

Net sales (in US$ billion) * Estimates Source: Abiquim (translated): ‘The performance of the Brazilian chemical industry in 2009’ Note: Chemicals industry output includes sales from pharmaceuticals.

Estimated GDP growth rates 2010 Brazil South America and Mexico United States Western Europe 5.5% 4.1% 3.1% 1.0% 2011 4.1% 4.0% 2.6% 1.7%

Source: International Monetary Fund: ‘World Economic Outlook April 2010: Rebalancing Growth’

For many years, Latin America’s petrochemical players have had to cope with political uncertainty and complex and impenetrable rules. However, in recent years many Latin American countries have enjoyed political and economic stability, paving the way for industrial development in the region.50 Brazil is the most active Latin American country in terms of the development of petrochemicals capacity and new international alliances.51 New oil and gas discoveries in Brazil have put the petrochemicals sector and the country on a path to strong growth and development. The promise of Petrobras’s pre-salt hydrocarbons program, demand from China and the success of tax reductions for autos and consumer appliances have increased confidence in the region.52 By 2014, Brazil is estimated to receive investments of over US$26 billion for the chemicals industry, according to a survey by the Brazilian Association of Chemicals Manufacturers (Abiquim). The investment is expected to generate 5,800 direct jobs.53 Opportunities in Brazil have not been overlooked by US chemical companies. In the first quarter of 2010, Dow Chemical’s sales in Latin America increased 25.5 percent yearover-year from US$1.13 billion to US$1.41 billion.54 DuPont witnessed a 21 percent increase in its Latin American sales in the first quarter of 2010, to US$800 million.55 Latin American sales contributed 9 percent of the company’s global sales.56

The growing economic importance of Brazil to the US is reflected by the complex trade relationships between the two countries. Of particular importance to the US chemical industry is a long running dispute between Brazil and the US over US cotton subsidies. This dispute has led to the possibility of “cross-retaliation” penalties by Brazil involving the suspension of patent and intellectual property rights on goods including agricultural chemicals, biotechnology products, and pharmaceuticals.57

Chemicals-Technology: ‘South America’s Chemical Growth,’ May 21, 2010; content includes statistics from Business Monitor International (BMI): ‘Brazil Petrochemical Report Q2 2010’ 51 Ibid. 52 Ibid. 53 Indexet.investimentosenoticias: ‘CHEMICALS: Chemical industry plans to invest US$26 billion,’ January 8, 2010 54 Dow Chemical: ‘Q1 2010 Earnings Statement’ 55 ICIS Chemical Business: ‘DuPont’s Latin America sales up 21% in 1Q 2010,’ April 27, 2010 56 Ibid.
50

57

Chemical Week: ‘U.S.-Brazil Trade Rift Threatens Patents on Agchem, Biotech Products,’ March 17, 2010

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THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 13

2.3 New opportunities in Canada
Canadian Chemical Industry: Principal Statistics Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Number of Companies 2061 2067 2145 2122 3315 3049 2955 2945 2945* 2945* Shipments (C$ billions) 37.16 38.41 40.52 42.69 47.16 48.64 49.89 48.63 50.62* 42.47* Employment 83 252 87 861 88 129 87 166 84 091 81 882 79 990 78 709 78 630* 71 400* Imports (C$ billions) 29.17 31.08 32.93 33.28 35.57 37.40 39.35 40.42 42.10 39.76 Exports (C$ billions) 18.61 19.84 20.21 20.40 24.29 26.86 28.93 32.33 31.39 26.51

* Industry Canada estimates Source: Statistics Canada at www.statcan.gc.ca

A sample of key players in the Canadian chemical industry Agrium, Inc., a major retail supplier of agricultural products and services in North and South America and a leading global producer and marketer of agricultural nutrients and industrial products. ERCO Worldwide, the largest producer of sodium chlorate in North America and the second largest in the world. ERCO also has the world’s largest installed base of modern chlorine dioxide generators and ranks as the second largest producer of potassium products in North America. Methanex Corporation, the world’s largest supplier of methanol. As a global enterprise, Methanex has manufacturing, marketing and supply chain capabilities in North America, Latin America, Europe, the Caribbean and throughout the Asia Pacific region. NOVA Chemicals Corp., a leading producer of polyethylene resins, styrenic polymers, ethylene and a variety of energy co-products for construction, manufacturing and other industries. Raymor Industries Inc., a major developer of high technology in Canada and a producer of advanced materials and nanomaterials for high value-added applications. Raymor holds the exclusive rights to more than 20 patents throughout the world.

Any discussion of the global chemical industry must include Canada, a highly valued business and trading partner of the US. Canada offers chemical companies and investors a dynamic business environment, low business costs, highly skilled workers and ready reserves of competitively-priced feedstocks. Tax rates are also very favorable. In a Total Tax Index (TTI) ranking based on KPMG’s analysis of ten major countries, Canada has the second lowest TTI for R&D and Manufacturing and second lowest overall, with only Mexico coming in with a lower TTI ranking.58 Not surprisingly, nine of the 10 largest chemical companies in the world have major production facilities in Canada.59 In addition, a growing number of Canadian chemical companies are expanding their presence in global markets. (See box: A sample of key players in the Canadian chemical industry.) The Canadian chemical industry is one of the largest manufacturing sectors in the country, employing 78,000 workers at almost 3,000 firms.60 Canadian chemical output totaled US$49 billion in 2008.61 The chemical industry is the third largest manufacturing exporter in the country, and Canadian chemical exports have more than doubled over the past decade.62 In 2008, exports reached US$31.5 billion, with 76 percent sent to the US.63
58

Canada’s chemical industry is concentrated in Ontario (Toronto and Sarnia), Québec (Montreal) and Alberta (Edmonton and the surrounding area). Industry output centers on three subsectors: Synthetic resins: Shipments amounted to US$8.7 billion in 2008, with 83 percent exported to the US.64 Much of this subsector’s new capacity is driven by state-of-the-art technology. For example, NOVA Chemical’s proprietary Advanced Sclairtech technology was developed in Canada and now produces a new generation of polyethylene resins. Petrochemicals: This is one of the largest subsectors of the Canadian chemical industry, including 18 manufacturing plants, most of which are owned by foreign multinational companies.65 Ethylene is the subsector’s key product, which is also the leading chemical product made in Canada. Organic chemicals: Biotechnology is used to create organic chemicals from biofeedstocks such as corn, soy, wheat and biowaste. This sector enjoys ready access to these feedstocks due to Canada’s large agricultural and forestry industries.

59

60 61 62 63

KPMG: ‘Competitive Alternatives 2010, Special Report: Focus on Tax’ Invest in Canada: http://investincanada.gc.ca/eng/industrysectors/chemicals.aspx Ibid. Ibid. Ibid. Ibid.

64 65

Ibid. Ibid.

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

14 | THE OUTLOOK FOR THE US CHEMICAL INDUSTRY

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 15

3. Regulatory issues and response
Regulations are becoming more stringent in virtually all markets around the world. The Obama Administration and many in Congress are supporting a more rigorous approach to environmental and industry regulations. Tougher regulations may have a significant impact on US chemical companies, affecting their operations, cost structures, supply chains and end markets.
New regulations applied to other industries have the potential of affecting the business of US chemistry. For example, governments in developed countries, including the US, are not looking as favorably at petroleum producers as they have in the past. Incentives given to oil and gas companies might be reduced, perhaps resulting in price increases for petroleum feedstocks used by US chemical companies. US chemical companies are also concerned with the Regulation on Registration, Evaluation, Authorization and Restriction of Chemicals (REACH) implemented by the European Union (EU). While this regulation has no effect on US soil, US producers exporting an additive or solvent or other substances for use by an EU manufacturer may find their product within REACH jurisdiction.66 The European Commission has estimated that the direct costs of REACH to the chemical industry will total US$2.8 billion over the first 11 years of the regulation.67 In the US, mechanisms to limit carbon and other greenhouse gas (GHG) emissions have the greatest potential to influence the chemical industry. Existing US cap-and-trade programs include: • Acid Rain Program (part of the 1990 Clean Air Act) • NOx Budget Trading Program (first administered in 2003) • Clean Air Interstate Rule which uses a cap-and-trade system designed to reduce sulfur dioxide and nitrogen oxides nationwide by 70 percent Chemical News & Intelligence: ‘Costs of EU chemical regulations reach US businesses,’ February 17, 2010 67 European Commission: ‘REACH in Brief,’ October 2007
66

• Regional Greenhouse Gas Initiative, a market-based effort by ten northeast and mid-Atlantic states to limit GHG emissions • Midwestern Greenhouse Gas Reduction Accord and the Western Climate Initiative in which US states and jurisdictions in Canada and Mexico are designing regional capand-trade programs The long-term economic impact of these programs to companies is hard to determine, although clearly the cost of compliance will continue to rise as additional regulations are passed. A new cap-and-trade bill was introduced in May of 2010 in the US Senate. The bill included a mandate to reduce CO2 emissions by 17 percent by 2020 and by more than 80 percent by 2050.68 For the chemical industry, compliance would have been postponed until 2016, and afterwards provided allowances to emit CO2 to offset costs. Importantly, US industry groups argued that the bill would impose excessive costs and limit their competitive strength in global markets. The ACC estimated that new cap-and-trade legislation proposed by the current administration would have cost chemical businesses at least US$7 billion in new costs in its first year and a total of $69 billion in costs over 10 years.69 While the bill in its current form failed to gain enough traction to advance in the current sitting of Congress, the chemical industry remains watchful for any future proposals which may similarly impact its long-term competitiveness.

68

69

Chemical & Engineering News: ‘Cap-And-Trade Bill Introduced,’ May 17, 2010 Chemical & Engineering News: ‘Industry Considers Carbon Options,’ March 30, 2009

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

16 | THE OUTLOOK FOR THE US CHEMICAL INDUSTRY

Importantly, any unilateral implementation of climate change legislation in the US (or Europe, as has been suggested by the EU) may raise the cost base of the local chemical industry, reducing its competitiveness and possibly encouraging a new round of protectionism. New EPA regulations also carry a heavy price tag for compliance. On September 22, 2009, the EPA finalized the Mandatory Greenhouse Gases Reporting Rule, which includes reporting for a wide range of public and industrial sources.70 Many chemical companies will be required to install some sort of monitoring devices, some of which will cost US$40,000 – 80,000 per emissions point, according to some estimates.71 The EPA estimates that compliance with the new rule will cost the private sector US$115 million in 2010, and US$72 million per year thereafter.72 The ACC predicts that the compliance cost for companies will be much higher, based on the costs of installing the monitors and the added costs of gathering data for reports to the EPA.73 Other proposals in 2010 that have prompted strong responses from US chemical and energy industries include the following: • Return of Superfund taxes: The US Environmental Protection Agency (EPA) has called for the reinstatement of Superfund taxes. Cal Dooley, President and CEO of the ACC, stated that “EPA’s call for the re-imposition of Superfund taxes is a lose-lose for the environment and the economy. We read with particular interest EPA’s comment that ‘parties who benefit from the manufacture or sale of substances commonly found in contaminated sites contribute to the cost of cleanup.’ The fact is, since the taxes expired in 1995, responsible parties have continued paying for the cleanup of Superfund sites and continue to reimburse EPA for all of its cleanup costs.”74

• Revisions to the 1976 Toxic Substances Control Act (TSCA): Revisions as described in drafts of the Safe Chemicals Act of 2010 would require producers to prove the safety of the chemicals they use and to disclose processing information, most of which is not protected by patents. “While we can’t predict what Congress will ultimately do – modification of the TSCA should be done carefully, deliberately and in consideration of all consequences,” said Jim Cooper, vice president of petrochemicals of National Petrochemical & Refiners Association (NPRA) in a public statement. “We firmly believe that TSCA can be modernized in a way that both effectively addresses chemicals risk management and preserves American jobs and the economy.”75 The US chemical industry will continue to work with government agencies and lawmakers to help develop new regulatory structures. At the same time, the industry can point to an impressive record in supporting sustainability and environmental safety. Since 1974, U.S. chemical companies have reduced the energy consumed per unit of output by nearly half.76 Since 1990, the industry has reduced GHG emissions by 23 percent, excluding emissions from purchased electricity.77 The industry has also invested US$13 billion in environmental and safety programs.78 Furthermore, many chemical companies were able to increase efficiencies, cut costs and tap new product markets during the global downturn – all while reducing their carbon footprint. This was achieved through process improvements, recycling, investing in renewable energy and creating energysaving products such as insulation and lightweight components for vehicles.79 These proactive directions in sustainability continue in 2010, supported in large part through the industry’s continued emphasis on science and technology.

70

71

72 73 74

EPA: ‘Final Mandatory Reporting of Greenhouse Gases Rule,’ EPA website accessed on December 29, 2009 Chemical Week: ‘EPA’s GHG Reporting Rule Raises the Bar on Monitoring,’ October 19, 2009 Ibid. Ibid. ACC: ‘Responsible parties paying for superfund site cleanup,’ press release, June 21, 2010

75

76

77 78 79

ICIS Chemical Business: ‘Proposed US law could cost jobs, competitiveness,’ June 15, 2010 ICCA: ‘Innovations for Greenhouse Gas Reductions: A life cycle quantification of carbon abatement solutions enabled by the chemical industry,’ July, 2009 Ibid. Op. cit., ACC: ‘Industry Profile’ ICIS Chemical Business: ‘Chemical firms lower energy use with new technologies,’ August 12, 2009

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 17

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

18 | THE OUTLOOK FOR THE US CHEMICAL INDUSTRY

4. The evolution in science and technology solutions
Although the US chemical industry is clearly recovering from the global recession, production facilities in China and the Middle East are being built at a rapid pace. (See KPMG International, “The Future of the European Chemical Industry. ) Global overcapacity, particularly ” at the commodity end of the industry, is therefore a strong possibility, even with increased demand from emerging markets.
To an extent, the US industry is sheltered from these dynamics by its feedstock advantage. Natural gas, which in 2010 enjoys a cost advantage of 20 to 1 over crude oil provides the basis for approximately 70 per cent of US ethylene, while in Europe, for example, 70 per cent is derived from oil-based products.80 If the US chemical industry becomes more proactive at identifying and rationalizing un-economic plants than its European competitors, it may be better placed to face these new challenges.81 Undoubtedly, however, global overcapacity and emerging market competition will continue to change the market dynamics of the US chemical industry. At the same time, the US chemical industry is being presented with huge areas of opportunity by the emergence of a number of global mega trends including: • Climate change, resulting in the need to improve the efficiency of energy and resource use and to diversify the feedstock base away from fossil fuels • Sustainability and the importance of the chemical industry as an enabler for downstream industries – providing the innovation to deliver the more sustainable, higher performance products increasingly demanded by the end consumer • Population growth driving the need to provide innovative solutions to the problems of food and water shortage The US chemical industry has not remained idle in the face of these challenges, and many companies have already started to adapt through rigorous portfolio rationalization and a drive to advanced specialty chemicals, which focus on providing the solutions for the needs of a changing world. Science and technology have been key elements in this process, reflecting an industry-wide focus on research and development (R&D). The ACC reports that the US chemical industry is responsible for 10 percent of all US patents.82 The industry also invests almost US$50 billion in R&D every year.83 Major areas of research by US chemical companies include biotechnology in chemical production, nanomaterials, water-based coatings, sustainable chemistry and new fibers based on bio-materials such as corn. Work in these research areas is resulting in a wide range of new products and in some cases even new markets. PPG Industries, Inc. specializes in coatings, glass products and specialty chemicals. Over the past several years, the company has developed: • Passenger windows for the new Boeing 787 Dreamliner that can be darkened or lightened with pushbutton controls • Coated-glass auto windshields that also serve as a multi-purpose antenna • Glass-fiber reinforcement fabrics used in blades for wind turbines • Gas barrier coatings for plastic bottles to keep the carbonation and freshness in beverages84 In many cases, an emphasis on R&D has always been a part of the US industry’s core mission. Chevron Phillips Chemical has carried on a tradition of research that includes the invention of a modern-day plastic in the 1950s.85 The company now holds more than 2,000 patents and patent applications.86 Their proprietary loop-slurry process for polyethylene production is one of the most widely licensed processes in the world.87

80 81

Chemical Week: ‘The Gift of Gas,’ March 22, 2010 KPMG: ‘The Future of the European Chemical Industry,’ 2010

82 83

Op. cit., ACC: ‘Industry Fact Sheet’ Ibid.

84 85

86 87

PPG Industries: all examples from www.ppg.com Chevron Philips Chemical: http://www.cpchem.com/en-us/ rnt/Pages/ResearchTechnology.aspx Ibid. Ibid.

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

THE OUTLOOK FOR THE US CHEMICAL INDUSTRY | 19

5. Conclusion
The actions taken by US chemical companies during the downturn may have given them a head-start over their European counterparts in terms of realigning their business models to fit the needs of their long-term strategic goals. To remain competitive, US chemical companies must continue and even increase their drive to develop and productize world class scientific research and technology.

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

Contacts Global and US Sector Leader Mike Shannon KPMG in the US Tel: +1 973 912 6312 e-mail: mshannon@kpmg.com In Asia Norbert Meyring KPMG in China Tel: +86 (21) 6288 2298 e-mail: norbert.meyring@kpmg.com.cn In Europe Chris Stirling KPMG in the UK Tel: +44 (0)20 7311 8512 e-mail: chris.stirling@kpmg.co.uk Global Executive Paul Harnick KPMG in the UK Tel: +44 (0)15 1473 5226 e-mail: paul.harnick@kpmg.co.uk Global and US Tax Lead Frank Mattei KPMG in the US Tel: +1 267 256 1910 e-mail: fmattei@kpmg.com www.kpmg.com

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Designed by Evalueserve. Publication name: The Outlook for the US Chemical Industry Publication number: 100938 Publication date: October 2010

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...“Kent chemical: Organizing for Internal Growth” The case “Kent chemical: Organizing for Internal Growth” by Barlett and Wining shows the development of Kent Chemical, a US-based company, from a local rubber producer into a multinational chemical firm which main product divisions are plastic additives, fire protection products and medical plastics. In order to become one of the leading chemical companies in the world, Luis Morales, the president of Kent Chemical, is struggling, after two unsuccessful tries to integrate the regional and the global business, with his decision what the best way to coordinate the company in terms of the organizational change, structure and strategy is. In theory, organizational change occurs if a company changes from a current non-wanted state into a future desired one. According to Wischnevsky, J. and Damanpour, D. (2006) the company has pass through three different stages during this process; first they have to accept that their present situation is not sufficient anymore, secondly the need to develop a future view for the company and thirdly implementing the necessary measures to succeed. To be able to implement those measure correctly an organizational structure is needed. As Jones, G. R. (2012) states, organizational structure is defined as rules and policies to provide a structure on company level where roles and responsibilities are delegated, controlled and coordinated. The three dimensions of organizational structure according to......

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Administrator

...than 75,000 chemicals registered with the Environmental Protection Agency, only a fraction have gone through complete testing to find out whether they might cause problems for human health. Many that are produced in enormous quantities have never been tested at all. Usually, it takes dramatic episodes of workplace injuries or wildlife poisonings, combined with rigorous scientific proof of harm and public outcry, before the government will act to restrict or ban any chemical. And that is no accident. The current regulatory system allows synthetic chemicals into our lives unless proven beyond doubt to be dangerous. Terms Dioxins are not intentionally manufactured. They are unintentionally formed as byproducts of chemical processes involving chlorine, such as the manufacture of pesticides and the bleaching of paper. The manufacture and incineration of plastics such as polyvinyl chloride (PVC, commonly used in consumer product packaging and medical devices) is another major source of dioxin. Two of the most serious health effects of dioxin exposure are cancer and endocrine disruption. The endocrine system is a complex network of glands and hormones that regulate many of the body's functions including growth, development, and maturation, and the way various organs operate. The endocrine glands –- including the pituitary, thyroid, adrenal, thymus, pancreas, ovaries, and testes – release carefully-measured amounts of hormones into the bloodstream that act as natural chemical......

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