KA Steel Chemicals

MARKET ANALYSIS UPDATE FEBRUARY 6, 2003

As we migrate well into the first quarter, we’ve experienced an unseasonably high demand for chlorine derivatives. There is a lot of speculation over the cause, but nevertheless this up-tick in demand has put further downward pressure on caustic soda prices. It is K.A. Steel Chemical’s opinion that companies are building inventory for PVC, as well as its derivatives, due to the anticipated problems that may occur as the world prepares for a potential war with Iraq. Most of Asia and Europe’s feedstocks are NAPTHA based, which, in general, is estimated to be 1.25 – 1.35 times the price of crude oil. As we get closer to war, oil continues to climb; therefore feedstocks continue to rise forcing most buyers of PVC and its derivatives to purchase in advance of further increases. We’ve seen December and January levels of demand unexpectedly pick up in anticipation of these increases. As chlorine demand has improved, production has risen; therefore caustic soda inventory has risen as well. Most producers, as well as distributors, currently have full tanks throughout the U.S. Most distributors fill their tanks in speculation of a solid January increase. Most producers’ inventories are on the rise due to the unexpected pick up in chlorine demand. It’s very unclear to what extent this pick up in chlorine demand will continue, or will the bubble burst forcing rates to drop and caustic to become snug. Recently, a large domestic producer announced an energy surcharge to offset the rising costs of natural gas. As a reminder to our customer base, natural gas historically was always centered on $2 an MMBTU. With this, ECU costs have always been centered in the proximity of $200 per ECU, with reinvestment costs at an estimated $350 per ECU. Based on the fact that natural gas has risen substantially over the years and the center point for natural gas seems to be closer to $3.50 an MMBTU, one has to adjust it’s historic thinking going forward. If for every $1 an MMBTU $30 is added to the cost of producing an ECU, then one must rethink an ECU’s value moving forward. Based on these changes, cost of an ECU today would be an estimated $245 per ECU, with reinvestment levels nearing the $400 mark. Today, we see natural gas as high as $6 an MMBTU, therefore, the cost of an ECU has risen by $75 a ton, based on the above center point being $3.50 an MMBTU and $120 an ECU based on historical center point being $2.00 an MMBTU. It is KA Steel Chemical’s belief that chlorine demand will continue to rise, potentially softening prices for caustic soda, until we near the summer months, in which we feel strongly that the demand for caustic soda will catch up to supply, allowing for prices to escalate during the second half. During 2002, the industry averaged an estimated 91% operating rates. Since then, Dow shutdown capacity at two of their facilities equating to 3.5% of the market. These previous figures would suggest the industry would run on average near 95% for 2003. For an industry that has seen little capital or reinvestment in their sites, 95% is pretty much considered maximum capacity, especially during the summer months of June, July and August. These plants run smoother during the winter months, but unfortunately this has historically been the weakest period for demand. I would like to emphasize that last year, 2002, we peaked through the summer months at 97% and with 3.5% less capacity, we would anticipate near 100% operating rates this summer. If chlorine typically is 2/3 of GDP and with most economists predicting a range of 2-3% GDP for 2003, it’s hard not to imagine a snug second half. Adding to the potential dilemma described above is the problems we are beginning to face with low water in the river system. With little snow in Canada and Minnesota, we are seeing problems develop down-stream in the river system centered below St. Louis with low water conditions. Without heavy rains or snow up north, we are likely to see a repeat of 1994 where river conditions were at historical low, not minimizing barge traffic upriver. In that scenario, producers announced a river surcharge to supplement inventories by rail, as well as initiating other f.o.b. points. K.A. Steel Chemicals has put a link on its web page for consumers to get current, updated information throughout the river system. K.A. Steel Chemicals fortunately has multiple tanks, as well as multiple sites, to service our customers’ needs. This, coupled with healthy inventories, should allow us to make it through any potential river crisis.

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The Advantage Newsletter — 2/6/2003