Study on European Energy- Intensive Industries The Usefulness of Estimating Sectoral Price Elasticities

Transcription

1 Study on European Energy- Intensive Industries The Usefulness of Estimating Sectoral Price Elasticities Within the Framework Contract of Sectoral Competitiveness Studies ENTR/06/054 Methodological Review, First Interim Report Client: Directorate-General Enterprise & Industry Cambridge, 16 th of March 2009

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3 ECORYS SCS Group P.O. Box AD Rotterdam Watermanweg GG Rotterdam The Netherlands T +31 (0) F +31 (0) E fwc-scs@ecorys.com W Registration no ECORYS Macro & Sector Policies T +31 (0)31 (0) F +31 (0) FWC Sector Competitiveness European Energy-Intensive Industries FN97622

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5 Table of contents 0 Introduction 7 1 Characteristics of the Energy-Intensive Industries in the EU 11 2 Armington Elasticities 32 3 Discrete Choice Modelling 49 4 Methodology Review Production Function 59 5 Heuristics and Non-parametric 74 6 Direct Ways to Estimate Price Elasticities 87 7 Direct Ways to Estimate Cost Pass-Through 94 8 Cross-cutting issues Data Review Conclusions and Recommendations References 124 FWC Sector Competitiveness European Energy-Intensive Industries FN97622

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7 0 Introduction 0.1 Introduction This report presents a review of the published literature and methodologies that have commonly been applied in estimating price elasticities and the extent to which firms and industries may pass on an increase in their cost base to their customers. The objective of the report is to outline the main assumptions underlying each of these methodologies, demonstrate when it is and is not appropriate to apply each methodology and to make a recommendation on the suitability of each methodology to the energy-intensive industries (EIIs). The report has been put together by a relatively large team 1, with each member contributing his or her specific expertise to the review; the final chapters bring this together, discuss the data issues and pass recommendation on which method should be applied to the EIIs The ETS and energy-intensive industries Although much of the discussion in this report is general, the focus of the study is the competitiveness of the energy-intensive industries that are included in the European Emission Trading Scheme (ETS, see Table 0.1 for a formal definition of the sectors at the NACE 3-digit level that were considered during this review). The ETS came into operation in 2005 and was reviewed in At the beginning of 2008 the European Commission (EC) adopted a legislative proposal aimed at introducing a significantly higher level of harmonisation into the ETS and adapting the scheme to the EC s climate change policy for the period post Practical considerations This report covers both theoretical and applied studies and discusses the results from the methodologies as well as the methodologies themselves. As the focus is on application to the energy-intensive industries, particular attention is paid to methodologies that are relevant in this context. Crucially, this includes data requirements. Other issues that may be relevant to these sectors include firm size, degree of international competition, homogeneity of product and the difference between production of intermediate and final goods. The industries in Table 0.1 are described in more detail in Chapter 1, with these general concepts being observed throughout this report. 1 The main contributors at Cambridge Econometrics were Hector Pollitt, Unnada Chewpreecha, Eva Alexandri, Daniel Lee, Sunil Joshi, Ben Gardiner. Estimating Sectoral Price Elasticities for the EIIs: Methodological Reviews 7

8 0.1.3 Report structure The report is structured into the five broad topics outlined in the terms of reference for the study, with the direct methods split into price elasticities and cost pass-through. The chapters are: - Armington and trade elasticities - discrete-choice modelling - production function methodologies - non-parametric and heuristic methodologies - other direct estimates of price elasticities - other direct estimates of cost pass-through Finally we look at the data and some more general issues that cut across all of the different methodologies, consolidate the findings into a set of clear conclusions, and provide recommendation for future steps in estimating price elasticities and cost passthrough. TABLE 0.1 NACE-3 SECTORS UNDER THE EU-ETS NACE 3-digit Sector code Manufacture of cement, lime and plaster 265 Manufacture of basic iron and steel and of ferro-alloys (including production of non-ecsc ferro-alloys in NACE Rev.1.1) 271 Manufacture of coke oven products 231 Manufacture of refined petroleum products 232 Manufacture of pulp, paper and paperboard 211 Manufacture of basic chemicals 241 Manufacture of basic precious and non-ferrous metals 274 Manufacture of non-refractory ceramic goods other than for construction purposes; manufacture of refractory ceramic products 262 Manufacture of glass and glass products 261 Manufacture of ceramic tiles and flags 263 Manufacture of bricks, tiles and construction products 264 Other first processing of iron and steel (excluding production of non-ecsc ferro-alloys in NACE Rev.1.1) 273 Source(s): DG Enterprise & Industry 8

9 0.2 Key concepts and glossary Key concepts Cost pass-through The implication of the ETS and its revisions is that some large firms in the energyintensive industries will face an asymmetrical increase in their cost base (see Glossary below). The cost pass-through rate is the share of these costs that the firms are able to increase the prices of their final products to compensate. Price elasticities Connected to this is the concept of price elasticities because, under the assumptions that firms maximise profits (see Section 8.2), cost pass-through rates may be derived from price elasticities directly. Although neither pass-through rates nor price elasticities are directly observable, this feature may be helpful to the researcher and to the policy maker because it is often easier to derive price elasticities from observable data. The price elasticity of demand for a particular product is the relative amount that demand will change for that product in response to a change in own price. For example, if the price increases 10% and demand falls by 1% then the price elasticity is Elasticities may be defined at the product or sectoral level, and this report provides details of the relative strengths and weaknesses of each. Further information on price elasticities is provided in Section 6.2. A selection of more complex elasticities that take into account other factors, such as prices of other goods (cross-price elasticities) are also described in this report Glossary The following terms are used throughout the report and usually have a special meaning attached. They are outlined in this section for reference. Asymmetrical shocks In most of this report (except Chapter 7) an asymmetrical shock is one that affects companies in one region but not in another. For the energy-intensive industries, the ETS is an example of this, as it means that production costs increase in Europe but not in the rest of the world. Calibration Calibration is the method used to determine the parameters of CGE models. The method uses a single year of data and adjusts the parameter values until supply equals demand and markets are in equilibrium. CGE/Econometric These are the two main types of large-scale computer model that are used for macro and industry-level analysis. Both types of model include price elasticities in their parameters. Estimating Sectoral Price Elasticities for the EIIs: Methodological Reviews 9

10 Estimation Estimation is the formal process for deriving values for unobservable behavioural characteristics, including price elasticities. The inputs to the estimation procedures are a set of historical data and a specified function. Homogeneity and heterogeneity These are two important assumptions that are relevant to many of the estimation methods. Homogeneity assumes that all of the production of a sector is identical and therefore any one good is perfectly substitutable for another. This implies that trade price elasticities are either zero or infinite as consumers will always buy the lowest-price good. Heterogeneity assumes that goods are similar but differentiated (for example between production in two countries) so that they are not perfect substitutes. In this instance consumers may still choose to buy the higher-priced good. Intermediate goods Intermediate goods are ones that are purchased by other companies rather than by households (who buy final goods). Most of the energy-intensive industries produce intermediate goods, but much of the analysis of elasticities looks at final household demands. NACE The NACE classification is an international system for allocating industrial production into a consistent set of categories. There are various levels of disaggregation which increase with the number of digits used in the classification. The focus in this report is on energy-intensive industries at the NACE 3-digit level. The ISIC and SIC classifications are also sometimes referred to. They are similar in structure to NACE. SITC classification is an equivalent classification for traded products. Time-series and cross-section The two main types of data sets are time-series and cross-section. Time-series data show a path of development over time, while cross-sectional data show differences between countries, sectors or another dimension. Panel-data sets include elements of both. 0.3 Sources of information An initial set of sources was provided to the team by the Commission services. These were taken on board and used to find additional sources through references within these publications. As this could lead to a rather narrow approach (as authors tend to reference similar methodologies), this process was supplemented by more general internet searches. The sources used are a mixture of journal publications, book chapters, working papers and official reports. Many of these are freely available online, although access rights may vary for academic and non-academic users. A full set of references, split by chapter, is provided at the end of this document. 10

11 1 Characteristics of the Energy-Intensive Industries in the EU 1.1 Introduction This part of the literature review under Task 1 focuses on the economic characteristics of energy-intensive industries. This research will provide essential input for choosing and developing the most suitable model for examining to what extent energy-intensive industries would be able to pass through extra costs incurred from the EU ETS to their customers via the concept of elasticities of demand; both price elasticity of demand and Armington (trade) elasticities. Table 0.1 identifies energy-intensive industries at NACE-3 level which are the main focus of this literature review. Later on in the study, the modelling will be limited to four of these sectors. Companies included in the ETS are faced with additional costs compared to those engaged in similar activities outside the EU. This may affect their international competitiveness; an extreme outcome could be the company going out of business, or (more likely) relocating to outside Europe. It is therefore important to understand the degree to which European producers affected by the EU-ETS can pass on cost increases to their consumers. There are various factors that can influence this cost pass-through, including the degree of substitution possibilities between products and competition from firms outside the EU. This determines where the final cost increases are located, either with final consumer or absorbed internally through lower company profits. The level of competition in a particular sector is often thought to be a key determinant in price formation; for example, under perfect competition no additional costs may be passed to customers but monopolies are able to set their own prices. This part of the literature review therefore aims to explore in more depth the economic characteristics of energy-intensive industries. The structure of these sectors determines the extent to which the sector will be able to pass through the additional costs or whether its competitiveness will be severely hampered by the ETS obligations. Estimating Sectoral Price Elasticities for the EIIs: Methodological Reviews 11

12 1.2 Common characteristics of energy-intensive industries in the EU The chapter reports on the following economic characteristics of energy-intensive industries: - Market size and share; - Firm size; - Degree of competition; - Ability to set own prices, pricing strategy; - Product characteristic (homogenous/differentiated); - Product characteristic (consumer/intermediate); - Degree of foreign trade, openness and trade barriers; - Any indication of possibility of substituting with other industries. Furthermore, the sectors approximate share of energy in total production cost, the energy type used and estimated greenhouse gas emissions are reported. Overall, 1/3 of all energy and 1/5 of all electricity in Europe is used for manufacturing. The average share of electricity in manufacturing in the EU is about 2.5% of the total production value and primary energy around 4.5%. As regards the possibilities for pass through of extra costs, in general for European energy-intensive industries, the pass through rate typically depends on: - The shape and elasticity of the demand curve; - The shape and elasticity of the supply curve. In turn these are affected by: - The nature and intensity of competition among firms subjected to the rise in marginal cost (the higher the market power, the lower the pass-through); - The nature and intensity of competition between these firms and those not subjected to the rise in marginal cost (especially foreign firms). The potential for pass-through of extra costs is also assessed per energy-intensive industry. In the short run, the pass-through potential is determined by the tightness of the market and in the longer run by more structural features such as the value added of producing close to the market, other trade barriers, and technical substitution possibilities of clients. The degree of vertical integration and regional clustering of value chains (e.g. of aluminium or steel production and of its processing or the importance of transportation cost in relation to the carbon cost) can provide useful information in this context. 1.3 Economic characteristics per sector This section reports on the common economic characteristics in some of the key energyintensive industries and highlights some of the key structural features that will play a role later on in the study when determining the possibilities for pass-through. 12

13 1.3.1 Characteristics of the cement, lime and plaster industry The economic condition of the EU cement, lime and plaster industry will depend highly upon the demand from the construction sector. This sector itself follows very closely, normally after a short delay, the evolution of the economy in general. Furthermore, the EU cement, lime and plaster industry has to face and cope with new environmental legislation concerning its production procedures. Historically, dust emissions were the main environmental concern of cement manufacturers. The industry managed to reduce these by 90% over the last 30 years. Basic industry structure Product characteristics (homogenous/ differentiated, consumer/ intermediate) Market size / share Firm size Basic cost structure Fundamental business conditions Raw materials & distribution Although produced from natural raw materials which vary from plant to plant, cement can be considered a standard product. There are only a few classes of cement and in each class, products from different producers can generally be interchanged European prices for cement are around Euro/ton, whereas Latin America and the United States have prices of around 100 Euro/ton. As cement plants usually serve customers within a 150 km radius, there may be price variations even within a country. Compared to other regions of the world, Europe has low prices and high production costs. The current annual output is circa 200Million Tonnes of which various grades of Portland cement account for about 85%. Compared to other regions of the world, Europe has low prices and high production costs. A typical characteristic of the cement market is that the top five players also hold a large share in the global cement market with an estimated market share of around 30%. Over the last 25 years, some European countries have doubled or even tripled their consumption (Greece, Portugal, Spain and Turkey), since these countries have experienced significant growth over the last 10 years. In mature markets, such as in Europe, where cement consumption per capita still varies considerably from one country to another, cement sales are dependent on evolution and habits in the construction sector. There are no generally accepted criteria for ranking cement companies or groups, as both turnover and capacity can be defined in different ways. The cement industry has seen consolidation in recent years; five large multinationals now have a market share of 58% in the EU25 market. Of a total production capacity of 283 million metric tons of cement, the top five players hold58% of the market while the top 10 players hold 76%. The largest operating companies in the world with cement interests in the European Union are generally regarded to be (in alphabetical order): CEMEX (Mexico), HeidelbergCement (Germany), Holcim (Switzerland), Italcementi (Italy) and Lafarge (France). Modern rotary kilns for cement production operate continuously and are highly automated; therefore labour and maintenance can be regarded as fixed costs. With the development of modern automated machinery and continuous material handling devices, the cement industry has become a process industry using a limited amount of skilled labour. A modern plant is usually manned by less than 150 people. In the EU the cement industry represents direct jobs. Today location in proximity of large sea ports or waterways. Estimating Sectoral Price Elasticities for the EIIs: Methodological Reviews 13

14 The price of long road transportation may even be higher than the cost price. Transport Capital requirements Energy Share of energy in total costs Energy type used Bulk shipping has changed that, however, and it is now cheaper to cross the Atlantic Ocean with tonnes of cargo than to truck it 300 km. In large countries transportation costs normally cluster the markets into regional areas. High capital start-up (120 million Euro for a 1 million ton plant) The cost of a new cement plant is equivalent to around 3 years of turnover, which ranks the cement industry among the most capital intensive industries. Highly energy-intensive sector. Direct energy expenses equal to about 10% of total production costs, electricity expenses to about 5%. Each tonne of cement produced requires 60 to 130 kilogrammes of fuel oil or its equivalent, depending on the cement variety and the process used, and about 105 KWh of electricity. GHG emissions Degree of competition Ability to set own price Degree of foreign trade / openness / trade barriers Indication on possibility of substitution Barriers to entry Key challenges Emissions are on average tco2 per ton. The two main steps within the cement value chain are clinker production and cement production. The bulk of the CO2 emissions come from clinker production. The cost for a typical European cement production process will increase by 36.5% due to CO2 emissions trading. The biggest part of the increase (~93% ) is from direct emissions. The indirect impact from higher electricity prices is only a small share of the overall cost increase (7%). Today, the cement, lime and plaster market is fully globalised and prices are determined globally. As the product itself is so homogenous price setting plays an important role. Considerable price variations between countries and even within countries, likely due to high transport costs. European cement companies lead the race for internationalisation which is now an established fact in the cement industry. By 2004, European cement companies, albeit operating predominantly through regional markets, have positioned themselves as key actors throughout the world. Internationalisation, as opposed to globalisation, must be seen in a context where big cement companies are trying to take positions in new and emerging markets. Whilst in all markets where they operate, competition remains fundamentally local, each market being governed by its own specific characteristics and, as a result, not truly linked to others. No direct threats of substitution from another industry. High capital intensity and the access to privileged assets are the main barriers. Especially industry sites near waterways or seaports have substantially high barriers to entry. Substantial economies of scale exist; therefore only a few hundred kilns are currently operating in the EU, the majority of which are controlled by a group of five multinational firms. Growing impact of environmental aspects, particularly related to CO2 and emissions trading. Trade policies and the need for a level playing field. Access to capital markets is a key factor in the cement industry 14

15 1.3.2 Characteristics of the iron and steel industry The EU steel sector is facing challenges from new competitors particularly from China and is dependent on increasingly expensive raw materials imported from outside the EU. In addition, climate change and new environmental legislation pose challenges which the steel industry will have to counter. Until now, the EU steel industry has been able to cope relatively well with the rapidly changing fundamentals in the global steel market; intensive restructuring has enabled the industry to position itself as a reliable supplier of high quality steel products to the most demanding client sectors. Basic industry structure Differentiated products ranging from crude steel, sime-products, hot-rolled finished products, continuously cast products, cold-rolled sheets and plates, to coated sheets. Product characteristics (homogenous/ differentiated, consumer/ intermediate) Market size / share Primarily intermediate products serving as basic inputs for many other European industries. Only 60 % of steel products are shipped directly to the main consumer enterprises (automotive, shipbuilding, heavy mechanical industry, appliances, etc), 40% being routed by stockists and service centres to make it ready for final consumption. Production value is between 400 and 650 /ton depending on the quality of the steel and the product produced. Steel production takes place in two different processes with various stages: 1. Blast furnace route, integrated steel plants reducing iron ore into metal, including the following processing plants: raw materials storage and treatment; coke ovens; blast furnaces to produce pig iron; oxygen converters to convert pig iron into steel; hot rolling mills; cold rolling mills; coating and/or other treatments. 2. Electric arc route, involving the melting of recovered scrap to produce steel, including the following processing plants: scrap treatment; electric arc furnace; secondary treatment; rolling mills. Total production (EU): million metric tonnes of crude steel (2008). Total consumption (EU): million metric tonnes of steel products (2005) directly employed (2006); several times this number in indirect employment. EU27's overall share of world crude steel output therefore fell from 24.3% in 1997 to 16% in Despite this decline in global market share, the underlying performance figures of the EU steel sector have been mostly positive. Until 1990s, EU steel industry was either state-owned or highly regulated due to its position as a strategically important industry. After 1990s, deregulation, privatisation, internationalisation, increased concentration and rationalisation. The consolidation of the industry included increased emphasis on productivity, technological innovation, emphasis on downstream activity and recomposition of the industry through mergers and acquisitions. Firm size Today, the European industry can be characterised as a regional industry, both in terms of production and trade. The changes resulted in three principle outcomes: - A radical transformation of the industry due to technical innovations, turning the industry into a high-tech industry. This means that the industry has become less labour-intensive and more capital intensive. Today, the more efficient production of new, lighter steel requires less raw steel. - Deregulation and the change of ownership of the industry from primary state-owned companies to private companies. This process is virtually complete in western European countries. - Concentration into a small number of large multinational companies. Estimating Sectoral Price Elasticities for the EIIs: Methodological Reviews 15

16 Basic cost structure Fundamental business conditions Raw materials & distribution Fixed costs: labour (15%), depreciation (12%), maintenance (4%), other overhead (3%) Variable costs: raw materials (56%), combustibles (5%), electricity (4%). Historically integrated steel plants around raw material sources (coal mines) Today location in proximity of large sea ports Transport-intensive industry (heavy and often bulky goods) Transport Almost 30% of all finished steel products pass from one country to another worldwide. Transport costs amount to 5% to 15% of the selling price of the products. High capital requirements constitute one of the main business conditions in steel production. Capital requirements Energy Share of energy in total costs Steel making is characterised by high levels of fixed costs especially in integrated steel mills. Large facilities are only profitable from 2 million tonnes annual capacity and upwards. It is expensive to operate plants below their capacity. Highly energy-intensive sector. Energy input corresponds to approximately 15% of production value and electricity to around 4%. The relatively big share of energy in the cost structure has always been a strong incentive for the industry to reduce energy consumption in the production processes. The EU steel industry cut its energy consumption by 47% per tonne of finished steel between 1975 and Energy type used GHG emissions Degree of competition Ability to set own price Electricity consumption of MWh/t steel depending on the type of furnace (2004) Coal = main source (of which 95% goes to coke ovens and 5% to other uses such as on-site electricity power generation). Natural gas (consumption has increased substantially over the past years). The third important energy source is electricity used primarily in electric arc furnaces. Fuel oil is also used. Direct emissions in EU-15 are approximately 0.7 tco2 per tonne of steel (2006). 95% of emissions are process emissions. Today, the steel market is fully globalised and prices are determined globally. Nevertheless, due to increasing transportation costs and the need for a close technical and service relationship with clients, the regional markets are the core business for steel producers. Degree of foreign trade / openness / trade barriers Indication on possibility of substitution Barriers to entry Relatively open to international trade: 10.7 million metric tonnes net exports (2005). 22% of world steel originates from the European Union. 2nd largest steel industry in the world behind China. High transport costs pose indirect barriers to worldwide trade. No direct threats of substitution from another industry. While the EU steel industry is structured to produce and deliver all types and qualities of steel products, its competitiveness is mainly linked to high quality and often tailormade products in demanding end-user segments. Consequently, the EU steel industry s competitive position is strongly connected to product innovation and value creation, supported by advanced technological development. High capital intensity. Large production requirements to reach economies of scale. 16

17 Key challenges Rising prices and imbalances in demand and supply for raw materials and energy increasing input prices. Growing impact of environmental aspects, particularly related to CO2 and emissions trading. The centre of the steel business is moving to the East, and EU producers are faced with new competitors. Trade policies and the need for a level playing field. Scarce supply of skilled labour in the future Characteristics of the coke oven products industry Coke ovens are primarily used as a production tool for various industries. Therefore, it was so far not possible to find separate data on the coke oven products industry. Instead, industry overviews, such as the iron and steel industry, include some of the economic and energy figures of coke ovens. During steel production, for example, when the coal route of production is chosen, coking coal from coal mines goes into a coke oven in order to transform it into coke. This process is likewise needed in order to use the coke as an input in the blast furnace. In most cases, a coking plant and a sintering steel plant are situated on the same site because coke dust from the coking plant is used in the sintering plant Characteristics of the refined petroleum products industry The refining industry produces a range of products from asphalt to fuel gas based on various crude oil grades. A refinery can consist of many different units of varied sizes, such as a distillation tower, vacuum flasher, catalytic cracker, coker etc. The refined petroleum industry in Europe is dominated by a small number of multinational companies. As regards the possibility for pass-through, various studies have come to the conclusion that estimated refinery margins should remain constant if assuming that 95% if the CO2 costs can be covered by free allowances under the ETS scheme and around 25% to 75% can be passed through to customers. Basic industry structure Product characteristics (homogenous/ differentiated, consumer/ intermediate) Refined petroleum products include: LPG, Naptha, aviation gasoline, gasoline type Jet Fuel, motor gasoline, kerosene type Jet Fuel, other kerosene, gas/diesel oil, fuel oil (residual), petroleum coke, other products. The EU-27 in 2007 had a primary refining capacity of 767 million tonnes per year, which equals 18% of global capacity. Crude oil distillation capacity of 15 million barrels per day in EU-25 (2004) Market size / share Total oil demand in the EU-27 in 2006 amounted to 715 million tonnes Production quantities currently affected by three trends: - Demand growth from transport sector; - Shrinking market for heavy fuel oil (industry is replacing it with natural gas); - Replacement of gasoline with expansion of market for automotive diesel fuel. Estimating Sectoral Price Elasticities for the EIIs: Methodological Reviews 17

18 Firm size The top five EU refining companies hold over fifty percent of the market share, while the top 10 companies hold nearly 70%. Total, Shell, Exxon Mobil, BP and ENI are the biggest players in the market. Basic cost structure Fundamental business conditions The overall cost for refining one barrel is between 1.0 and 2.5 Euro/ton depending on refining complexity. Raw materials & distribution Transport Capital requirements Energy Refining plants are traditionally located near demand areas and/or with access to export markets; almost every Member State has at least one refining station. Transportation costs and logistical aspects keep refining markets rather local, besides imports and exports due to structural shortages and surpluses. It is usually easier and cheaper to transport the crude oil in great quantities rather then the many refining products. Transport-intensive industry (heavy and often bulky goods) Simple refineries have consistently low or even negative margin, and only complex, high capital refineries, can produce a consistently positive margin. The financial performance of the refining industry is regarded as low as many companies struggle to cover their investment costs. Share of energy in total costs Energy type used GHG emissions Degree of competition Ability to set own price Energy use represents about 1% of total production costs. The share of energy in total costs is higher in the production of diesel. Burning of fuel oils Electricity On average CO2 emissions of around tco2 per ton of refined petroleum CO2 emissions correlate strongly with refinery capacity and the typical emissions are 15.0 tons of CO2 per 1000 barrels of crude oil in direct emissions and 1.4 tons of CO2 per 1000 barrels in indirect emissions. Yes (to a certain extent). The refining industry is subject to global competition. Degree of foreign trade / openness / trade barriers Indication on possibility of substitution Barriers to entry Key challenges Refined products are traded in and outside of the European Union to a fair extent. USA is the main importer of gasoline refined in the EU-27. The EU-27 mainly imports gasoil from the Former Soviet Union. The Middle East is the main exporter of jet fuel to the EU-27. No direct threats of substitution from another industry. High capital intensity. The introduction of auctioning under EU ETS from 2013 could place EU refiners at a competitive disadvantage to refiners outside the EU Characteristics of the pulp, paper and paperboard industry The European pulp, paper and paperboard industry can be seen as a progressive industry that approaches its challenges actively. Nonetheless, certain aspects, such as increasing energy and raw material costs as well as new environmental regulations demonstrate severe threats for the European industry. The greater resource potential of regions such as 18

19 Latin America, Russia and Southeast Asia, and their ability to supply wood at a lower cost presents a further pressure upon European competitors. The European paper industry is fully committed to increasing recycling as a mean to further advance its environmental performance. Nonetheless, new environmental regulations are seen as a danger for the international competitiveness of Europe s paper industry. Along with energy, environmental and natural resource issues, further aspects that are likely to occupy the European paper industry in coming years include the increasing lack of a skilled workforce, capital constraints and a requirement for innovation. Basic industry structure Product characteristics (homogenous/ differentiated, consumer/ intermediate) The European Pulp and paper Industry is characterised by a large variety of raw materials, products and manufacturing routes. Graphic paper grades make up around 50% of the EU's paper production, packaging paper grades account for 40% and hygiene and specialty papers for around 10%. The industry is characterised by the fact that machinery is rebuilt over years rather than replaced whole-scale (modular rebuilding of plants). Around 60% of the pulp and paper produced in Europe comes from mills certified in one of the major eco-management schemes. The European industry consists of more than 1,000 paper mills and 220 pulp mills with Germany leading the field as the largest paper producer in the EU, followed by Finland, Sweden and France. Finland and Sweden are the main pulp-producing countries. Within the EU25, the total production of primary pulp is around 38 million tons. 2.6 million jobs (2005) Market size / share 350 billion turnover billion value added (2005) The average value of production is 800 /ton of paper produced. EU has approximately a 30% share of the worldwide market share (2004). Main competitors are Canada, US, China (Asia), Brazil, Chile and Argentina. Sweden and Finland have the three most specialised manufacturing regions. There are no generally accepted criteria for ranking cement companies or groups, as both turnover and capacity can be defined in different ways. Firm size Leading companies active in Europe are domiciled in Scandinavia, the United States and South Africa. The top 10 companies within the EU15 account for 56% of EU capacity. Among the biggest European companies are: Stora Enso Oyj, a Finnish-Swedish pulp and paper manufacturer, SCA from Sweden and UPM-Kymmene from Finland. Large players are often integrated pulp and paper producers. Basic cost structure Fundamental business conditions Raw materials & distribution apparent labour productivity (2005) The cost structure consists of: 70% total purchase of goods and services / 25% personnel costs / 5% gross investment in tangible goods (2005) Fixed costs: depreciation (18%), labour (18%), maintenance (18%), other overhead (21%) Variable costs: raw materials (11%), combustibles (2%), electricity (12%) 11.5% gross operating rate (2005) Approximately one half of production is based on wood, the other half is based on wastepaper recovery (51%). Estimating Sectoral Price Elasticities for the EIIs: Methodological Reviews 19

20 Due to the bulky nature of pulp and paper products, transportation is an important issue. Transport Capital requirements Energy Share of energy in total costs Energy type used Improvement of transportation infrastructure has been observed during recent years. Furthermore, and increased and better mobilization of wood. Long investment cycles (up to 20 years) High investment costs (new paper and pulp machines cost up to 500 million) Energy intensity = 15-30% of total costs Biomass covers for 50% of total energy needs GHG emissions Degree of competition Ability to set own price Degree of foreign trade / openness / trade barriers Indication on possibility of substitution Barriers to entry Key challenges All installations producing more than 20 tonnes of pulp/paper per day fall under EU ETS = +/- 900 installations. Indirect emissions make up the bulk of total emissions in the pulp & paper industry. Depending on the production procedure between 0.12 tons of CO2 and 0.61 tons of CO2 per ton pulp or paper produced are emitted. Emissions stem from combustion (no process emissions) emissions. Final product prices affected by electricity and wood prices. As industry concentration is rather low, pricing is competitive (especially for major products, such as newsprint, case materials and office paper). Around 7.8 million tons of pulp is imported into the EU25 which is approx. 20% of the EU25 production of pulp while 2.2 million tons are exported (approx. 6% of the EU25 production of pulp). Paper and recovered fibre are exported more than imported. Dramatic increases in energy costs in Europe have placed the European paper industry at a competitive disadvantage in relation to most of its global competitors. No direct threats of substitution from another industry. High capital requirements and long investment cycles. Simplify the legislative and administrative burden for SMEs Increasing energy and transportation costs. Increased wood costs and lower supply due to renewable energy sources promotion and subsidies. New environmental requirements and less ambitious standards in competing areas. Declining investments in R&D Declining availability of skilled workforce Characteristics of the basic chemicals and other chemical products industry The European chemical companies rank among the biggest, most prosperous and innovative players within the global chemical industry. As far as environmental and sustainability efforts are concerned, the European industry has been very active. The EU reduced its GHG emission intensity (emissions per unit of production) by 55% since 1990, and is today more GHG emission efficient. 20

21 Besides that, different European chemical regions and companies have to cope with a large variety of challenges to safeguard their competitiveness. Among those challenges are the impacts of globalization, an enlarged European Union with chemical regions in Eastern Europe and above all the more stringent environmental requirements of a new chemicals policy. Basic industry structure 13% of worldwide fertilizers are produced in the European Union. Product characteristics (homogenous/ differentiated, consumer/ intermediate) Market size / share The output of the chemical and pharmaceutical industries covers four wide ranges of products: base chemicals, speciality and fine chemicals, pharmaceuticals and consumer chemicals. Base chemicals represented nearly 43% of total EU chemicals sales in Speciality chemicals represented 19% of total EU chemicals sales in Pharmaceuticals accounted for 28% of total EU chemicals sales in Consumer chemicals represented approximately 10% of total EU chemicals sales in In the EU, some 31,000 chemical and pharmaceutical companies employ a total staff of about 1.9 million, or 6% of the overall workforce in the manufacturing industry. The chemical industry's contribution to the EU gross domestic product amounts to 1.3%. When pharmaceuticals are added this figure amounts to 2%. Germany is still the largest chemicals producer in Europe, followed by France, Italy and the UK. SMEs account for approximately 35% of total employment and 25% of value added million employees (2005) billion value added (2005) Firm size Basic cost structure Fundamental business conditions Raw materials & distribution The EU chemical industry comprises about enterprises. In 2006, almost half (14) of the 30 world chemicals majors had their headquarters in the EU - representing 16% of world chemicals sales. The largest chemical company in the world, BASF, generated billion revenue in 2007 and had employees. The cost structure consists of: 80% total purchase of goods and services / 15% personnel costs / 5% gross investment in tangible goods (2005) apparent labour productivity (2005) 12.0% gross operating rate (2005) The chemical industry uses a broad variety of natural or processed starting materials, e.g. metals, minerals and agricultural raw materials (sugar, starch, fats, etc.). Transport Capital requirements Energy Share of energy in total costs Energy type used Relatively transport-intensive. Rely heavily on road transport and spend an above-average share of sales revenue on transport. High investment costs Feedstock accounted for almost 60% of total energy products and fuel and power for a little bit more than 40%, taking all sources of energy into account. This implies that most of the energy used by the chemical industry as feedstock is stored in the products and through recycling can still be reused. In 2005, energy consumption per unit of production (including pharmaceuticals) was 42% lower than in Consequently, the chemical industry lowered its energy intensity by 3.6% annually. From the energy sector, it consumes coal, oil products, natural gas, electricity and Estimating Sectoral Price Elasticities for the EIIs: Methodological Reviews 21

22 GHG emissions Degree of competition Ability to set own price renewables, using them both as raw materials (feedstock) and as power and fuel. In 2005, the European chemical industry (including pharmaceuticals) used a total of 131 million tonnes of oil equivalent (TOE) of energy. Between 1990 and 2005, production in the EU chemical industry (including pharmaceuticals) rose by 60%, while total energy consumption was rather stable and greenhouse gas (GHG) emissions fell by almost 30%. Pricing is competitive. EU chemicals sales were estimated at 476 billion in Degree of foreign trade / openness / trade barriers Indication on possibility of substitution Barriers to entry Key challenges In 2006 EU chemical industry exports outside the region were worth approximately 121 billion. Imports from outside the region amounted to some 80 billion. Removing both trade and non-trade barriers inside the EU area has been a key driver for the growth and competitiveness of the EU chemical industry. By 2006, half of sales were intra EU (excluding domestic sales). While intra EU sales are rising, the importance of domestic sales is decreasing, accounting only for 25% of EU sales. No direct threats of substitution from another industry. High capital requirements. Increasing energy costs. New chemicals policy. New emerging competitors in Eastern European countries Characteristics of the basic precious and non-ferrous metals industry About 50% of the aluminum in Europe is produced by primary smelting; 50% by secondary smelting (recycling). Primary smelting consumes about 20 times more electricity than secondary smelting (15 MWh per ton versus 0.7 MWh per ton). The industry is characterised by high environmental, energy and labour costs. Because prices are set internationally, increases in local production costs cannot easily be passed on to customers. Basic industry structure Product characteristics (homogenous/ differentiated, consumer/ intermediate) Main end-uses for aluminium products in Europe (2006) include transport (36%), building (27%), packaging (16%), engineering (14%), and other (7%). 60 billion value added to the European economy Two main production processes to be differentiated: primary aluminium production and secondary aluminium production (recycling) 22

23 directly employed 4.7 million tonnes mined, 8.6 million tonnes refined, and primary production of 5.0 million tonnes in In Europe 40% of the 13.2 million tonnes of aluminium used in 2006 came from recycling. Market size / share Global demand has been growing at a compound rate of 1.7% during the last 10 years. The European industry is mainly driven by competitiveness and sustainability, whereas the Asian market is driven by growth and the North American by innovation and capital efficiency. In Western Europe, there were 12 Merger and Acquisition transactions collectively worth over US$ 2 Billion in 2005, a 79% increase from the aggregate value that was swapped in Germany constitutes the biggest Aluminium market within the EU-25, both in terms of production and use, driven mainly by construction and transport sector. Firm size Basic cost structure Fundamental business conditions Raw materials & distribution A few companies have a large share of the international market. European shares are not very big in the global market. International key players are Alcoa Inc., Alcan Inc, Rusal, Norsk Hydro, and BHP Billiton. Fixed costs: labour (11%), depreciation (9%), other (10%) Variable costs: raw materials (35%), electricity (35%) Lack of domestic primary raw material Transport Capital requirements Energy Share of energy in total costs The raw material for aluminium, bauxite is usually transported per ship or rail to the refineries. From there, the alumina is also transported by ship or rail to the smelters. Depending on the end-user of the aluminium it is transported by ship, rail or truck. High initial capital requirements and also operating costs. Energy consumption of primary aluminium production is ca. 15 MWH per metric tonne produced Primary aluminium production needs about 20 times more electricity than secondary production. Energy type used GHG emissions Degree of competition Electricity Total CO2 emissions in primary aluminium production are 8.6 tons CO2 per ton of aluminium. Total CO2 emissions in secondary aluminium production are 0.3 tons CO2 per ton of aluminium. Ability to set own price Degree of foreign trade / openness / trade barriers Indication on possibility of substitution Barriers to entry Prices are set internationally The industry has cyclical prices with strong fluctuations Using about 8 million tonnes and producing 5 million tonnes, Europe imports around 3 million tonnes of primary aluminium per year. Semi-fabricated rolled products have a net-export position of approximately 0.2 million tonnes. Extrusions produced are all used in Europe, with very small quantities being netimported. In some end-user industry aluminium could be replaced by light compounds such as carbon fibres. High initial capital requirements. Estimating Sectoral Price Elasticities for the EIIs: Methodological Reviews 23

24 Very consolidated international market with few key players. Key challenges Rising energy costs and power prices. It is expected that a lot of capacity in Europe will be shut down in the next two decades due to increasing production costs Characteristics of the non-refractory ceramic goods (excl. construction purposes) and manufacture of refractory ceramic products industry Ceramics are non-metallic inorganic materials that lend themselves to permanent hardening by high temperatures (Peterson, 2003, p11) and are a very diverse group of products and range from computer chips and electrical insulators to bathroom fixtures and tableware. They are characterised by their high strength, texture, longevity, chemical inertness and electrical resistance. Their most distinguishing feature is that they are more resistant to heat than any other material on the face of the earth (Peterson, 2003, p11). EU ceramics manufacturers produce 23% of 120 billion world ceramics output, and, although there are some large firms, the sector is made up predominantly of SMEs (Cérame-Unie, 2007). Manufacturers have significantly improved efficiency in what is a highly energyintensive process, fuelled by the need for drying and firing at temperatures between 800 and 2000 degrees Celsius. Production Figure 2.2 below shows that the majority of ceramics production is in the form wall and floor tiles and bricks and roof tiles. Overall the value of EU ceramics production has increased since 1999 primarily due to expanded wall and floor tile and brick and roof tile production, but overall ceramics manufacturing growth has been hindered by the apparent decline in tableware manufacturing. 24