Hi, everybody. Welcome to the Morgan Stanley Chemicals Conference. My name is Neel Kumar, and today we're going to start off with Westlake. With us from the company is Albert Chao, President and CEO, and Steve Bender, CFO. Thank you both very much for joining. We're going to start off with some comments from the company, then we'll go into Q&A, then we'll open it up to the audience for any questions.
Thank you, Neel. Good morning, ladies and gentlemen. Thank you for coming today to hear about Westlake. Westlake is a leading materials company focused in the vinyls and olefins business. Vinyls, that's the chlor-alkali, ethylene down to PVC. We have also a pretty big building products business. Then olefins is the ethylene and polyethylene chain. Some of you may know that this is the 31st year of Westlake history. We started in the olefins business. Olefins was predominant of our business for many years, until last year. We acquired Axiall Corporation. Today, revenue-wise, the vinyls business chain, including the building products, is about 75% or three-quarters of our revenue. It does not command the three-quarters of earnings yet, but we are growing the earnings on that side.
In the olefins business, we have three ethylene plants, primarily all ethane-based, two in Lake Charles, Louisiana, and one in Calvert City, Kentucky. We are also the largest LDPE manufacturer from a capacity point of view in all the Americas. About 60% of our polyethylene is LDPE, and 40% is linear low-density. The LDPE, some of you, if you don't have a book, I think a website, but we have it on the fifth floor of Benjamin. We can give you the booklet if you need it, so come to the fifth floor and get it. LDPE historically is a specialty polyethylene. It commands a higher margin, higher prices than linear low and high density. The reason that is LDPE is made under very high pressure. That was the old way to make polyethylene.
In high pressure, it takes a lot of steel to contain the pressure, hence very capital intensive for investment. Whereas linear low-density and high density are made under quite a low pressure. As a result, you can build very large plants, low operating cost. Hence, when linear low was invented by Union Carbide back in the '70s, '80s, much of the capacity of LDPE demand was replaced by linear low. LDPE has to find its own niche. Today, LDPE is focused on the specialty area. With less capacity built, LDPE commands higher prices, margins than linear low and high density. We have advantage position. Olefins side, one is from the low cost ethane-based feedstock compared to rest of world, which are primarily naphtha-based, which come from oil.
U.S. with low gas price, we still have a preferred position from low cost ethylene. From being one of the largest LDPE manufacturer in the U.S., in the world, we have a good position and good margin for our LDPE business, PE business. Hence the olefins chain. We have pretty good margins through many years. That's how Westlake started from olefins. On the vinyls business, it's more complicated. To produce a pound of PVC, which is the third largest commodity polymer used in the world, it takes about half a pound of ethylene and 0.6 pound of chlorine. Chlorine comes from salt and electrolysis through electricity to make chlorine. For every pound of chlorine you make, you make 1.1 pound of caustic.
We call it an ECU unit or electrochemical unit, which is one short ton, 2,000 pounds of chlorine, and 1.1 short ton of caustic. ECU. Every time you produce a pound of chlorine, you got to produce 1.1 pound of caustic. You have to sell both chlorine and caustic. Caustic is a commodity that's used in a lot of applications from cosmetics to utilization to chemicals. It's a very broad application. It's shipped typically on 50% aqueous solution basis. The growth of demand for caustic typically follows about half to one time GDP. It's a slow growth business. Whereas chlorine, it's a toxic, hazardous gas. Its transportation is very expensive, and people use it quickly to turn into a useful chemical rather than store as gas. The largest use of chlorine is vinyls PVC.
You take chlorine, there are three steps to make PVC. From chlorine, you react with ethylene to make EDC, then you make VCM, then you make PVC. If you want to invest in the vinyls business, you have to think about where's the ethylene come from. If you invest in ethylene plant, you have to invest in a chlor-alkali plant. You think about power. It's a very high power consuming business. Where's power come from? You buy power, you make your own power. Then you look at where's the use of chlorine. In our case, it's PVC. Then you go PVC, you want to go downstream.
If you want to get an olefins business, if you have cheap feed stock like U.S. today, like Middle East for many years, you build the biggest ethane plant, ethane to ethylene plant you can build, and you build the cheapest LD or linear low or high-density plant you can build. The value you get is the ethane, right? That's the value creation. You can build two plants. Whereas in the vinyls, you got to build a chlorine plant, you got to build maybe a power plant, you got to build a EDC VCM plant. You got to build a PVC plant. The investment is much heavy, much heavier, much larger compare olefins plant per ton or per pound of products. Then PVC business is very cyclical seasonally. Sorry, very seasonal. Wintertime, much of PVC, 60% goes construction.
Wintertime, when the weather is bad, you cannot build or the demand goes down. Most people do not make a good return on PVC chain. Hence, very little capacity added. China, who is the largest capacity owner of chlor-alkali or vinyls, is because they use coal. They use coal to burn coal for make electricity. They use coal to make calcium carbide, which replaces ethylene. Then you react with chlorine. If you have a chlor-alkali plant, use the power from coal burning. You react with calcium carbide and acetylene to make PVC. It's very capital intensive, also uses a lot of power and uses a lot of coal. It's polluting because you burn coal for make power. It's polluting. Then you use calcium carbide from coal to electrolysis to make acetylene. That's also very polluting, then you produce a lot of sludge.
The sludge, you have to go to a cement plant. It's carcinogenic. You can combine with cement to dispose of the sludge. Because of the cheap coal that China had, China grew their business. Acetylene business was the original way, 1930s, of producing PVC. As soon as ethylene was discovered and used, all the carbide plants in the world were gone, replaced by ethylene-based. China stick with the carbide because of coal, cheap coal, and lack of ethylene. Today, with Chinese sensitivity to pollution, the government has cracked down on much of the pollution industries, and the coal-burning generating power generation and carbide PVC has been impacted. There's been some curtailment of production, both from shutting down the high-cost plant as well as reduced production on some of the other plants.
Hence, recent year or so, the Chinese production of caustic from coal-based is coming down as well as PVC has reduced production. Hence, the margin has improved globally when the Chinese plants are now dumping cheap caustic or cheap PVC into the market. In summary, the chlor-alkali market is very strong. Demand globally is very strong because of global demand. The economy is growing well. Capacity is impacted by reduction of pollution in China. Mercury cell, one of the three processes to make chlor-alkali, is being shut down in Europe. It takes away 800,000 tons capacity away Europe. With a lack of investment because the poor returns globally, we are seeing operating rates going up, hence, the margin improving. PVC is the same story, along with the Chinese carbide business.
We are seeing, even though there are discussion of a new capacity being entertained in the U.S. of new chlor-alkali, 3,000 tons, the world needs 75 million tons of caustic chlor-alkali. The world, if you go by even 2%, 3% a year, you need quite a large capacity increase just to meet the global demand. Somebody announced one plant or so. That's not going to change the dynamics of the vinyl business. We see the vinyl business going forward, being quite robust.
Great. Thanks for that introduction. I thought maybe we can just continue with chlor-alkali and vinyls. Can you just maybe talk about where we are in the cycle today, and how much longer do you think this strength can last in both chlor-alkali and vinyls?
Well, hopefully from what I said earlier, that you agree that we are really on the upcycle of the chlor-alkali chain. If you see chlor-alkali, are we at replacement economics return wise? It depends on what you see in terms of the end product you sell. If you can sell chlorine at the highest price, caustic at a higher price, yes, it has replacement economics. Much of the chlorine, as I said, if it goes into EDC, VCM, other products, the price is much lower. If you sell caustic, again, you sell the highest price caustic a year, $700 a ton. That's not 100%. That's a very small part of it. Some caustic sells at much lower prices. If you use the average price of total chain from caustic chlorine down to end products. There's no replacement economics yet.
From that sense, we are seeing improvements going on for quite a while.
At what point do you think we'll start to see some more announcements for additional brownfield or greenfield chlor-alkali capacity? Where do you think prices would need to go to incentivize that capacity?
As I said earlier, if you read in the trade journals, they discuss companies looking at permitting for new chlor-alkali plants in the U.S. People are studying it, and from time of studying it to completing the plan can take three, four, five years. I think the investment cost is quite high. We finished our large-scale chlor-alkali plant with 350,000 short tons. It started in 2013. I think we started the project in 2009 and finished 2013, and it's very expensive for our investment. I think Oxy also came out with a similar plant about the same time. It's smaller, 200,000 tons. Dow, it's a joint venture. They came out maybe a few months earlier. One of the contractors which built the plant lost a lot of money because they bid a fixed cost plant, a fixed turnkey for the plant.
Chlor-alkali plants are very expensive to build, and you ought to build where there's cheap power. Do you buy power or do you cogen? Through the Axiall acquisition, we have about 900 megawatts of gas-based cogen capacity that came along with it, so we're able to enjoy the low-cost gas-based power. We do buy power in Louisiana from Entergy, and those costs are much higher. With the investment, you had to go and build your own power plant. Again, investment goes up. It's an expensive investment to go to chlor-alkali business.
When you think about PVC, are there any notable differences between the end market drivers for commodity PVC versus specialty PVC and building products?
Yeah, there's 2 types of PVC. One is suspension, one is called emulsion or paste. Suspension is about 90% of global PVC produced. Among the suspension grades, there's some minor differences, maybe a penny, a half a penny difference in price. Not a whole lot. The emulsion PVC is about 10%, and that today is called specialty. Because our acquisition of Vinnolit four years ago, we are the world's largest specialty PVC manufacturer. Those investments are much higher than the suspension PVC. The demand for those specialty products grows slower. I think the suspension PVC grows maybe one and one half times GDP. The emulsion PVC grows about one time GDP on the average.
Okay. Can you just talk about how you're thinking about your net short ethylene position today? Are you looking at anything beyond Lotte, and what would make you more constructive on adding ethylene capacity?
In the U.S., even though we have three ethylene plants, because of the Axiall acquisition, and Axiall has zero ethylene plants, we're about 1.8 billion pounds short. With the joint venture with Lotte, it's a 2.2 billion pounds or 1 million metric ton plant. We have 10% of that. Reduced by 220 million pounds. We have the option to acquire another 40%, up to 50% of the plant three years after plant startup, and the plant startup is estimated to be 2019. We can go to 1.1 billion pounds. Even with that, we are still 700-800 million pounds short. We are looking at when we debottleneck the last three years by 800 million pounds with our three ethylene plants. We could look at further debottlenecking our plants or do acquisitions, and we are looking at all the above.
Okay. When you think about the ethylene and PE cycle, how do you expect it to evolve into 2018? How does your LDPE outlook compare to your HDPE outlook?
Well, as I said earlier, we only produce LDPE at linear low. Our gas-based plant can make HDPE, but we decided to focus on linear low because our customers are mainly in the packaging business. In the packaging industry, LD and linear low are the two popular polymers used in PE. With high density, the applications go very broad into pipe, into milk jugs, into injection molded products. We are focused in our PE business in the packaging, which is the higher growth, higher margin side of the business. As you mentioned, there's 30%, 40% of ethylene capacity built in the U.S. and commensurate amount of PE plants, polyethylene plants built in the U.S. Majority, they are linear low. There's LD and high density as well.
On our book, I think page nine shows that if global GDP grows between, I think, OECD estimates about 3% for the next five years. We are looking at 1 to 1.5 times GDP growth. That's the historical growth pattern for polyethylene consumption demand growth. Over the next four or five years, it will absorb all the global capacity increases. Mention the 30%-40% only in the U.S. There's no capacity added in Europe. There's no capacity added in Latin America. Only Middle East and Asia has polyethylene, ethylene capacity added. Asia and China is mainly methanol-to-olefins, is expensive cost ethylene. Even though we have 30%-40% capacity added in the U.S. in PE, we believe that global demand growth will absorb all the global supply in polyethylene in the next few years.
Okay. Maybe a question for you, Steve. In terms of your balance sheet, it's less than 2 times leverage right now. How do you think about additional, you mentioned some maybe debottlenecking opportunities. How do you just generally look at capital allocation from here?
Well, when you think of the use of capital that we've been deploying over the last couple of years, it's really been very consistent looking at, and especially very active this year. We've looked at really deploying the capital into the plants to make sure they run reliably and improve operability and performance and production. We also look at opportunities to find if there are opportunities to debottleneck. While there's nothing that we've announced yet, we'll continue to look at those opportunities. We'll look at de-leveraging opportunities as well. We've paid off over $700 million this year, and we'll continue to look to de-lever next year as well. At the same time, we'll look for ways in which we can return capital back to shareholders.
As you think about the waterfall, it's maintaining the plants and running them reliably, looking for opportunities to put capital to work that give us really good returning opportunities, de-levering, returning capital back to shareholders as opportunities provide.
Okay. Then in terms of the synergies with Axiall, it looks like you're on track to capture the $200 million. Is there any possibility of upside to this number?
Of course. The answer is, we've announced that we'll pursue, and I think we'll have in pocket $120 million of those synergies and cost reductions this year.
With a target of achieving the $200 million by 2018. Certainly, we won't stop there. The numbers that we talked about of $120 and $200 million are really cost related to cost reductions and cost reduction related synergies. There are other opportunities, and as Albert talked about, improving the reliability of the assets, looking for opportunities to see pricing power in the marketplace, and with improving reliability and improved production as well. Those are all synergies as well. We've just not publicly quantified them, but certainly, we're pursuing cost reduction opportunities and other synergy opportunities. The $200 million that we talked about achieving by 2018 is just those that we quantify to the marketplace, but we certainly won't stop there.
Okay, great. Maybe we can turn it over now to the audience to see if any questions.
Please, Mark.
Great. Thank you. If you could maybe talk a little bit more about the supply rationalization you're seeing in China. Is that structural, or is it just more seasonal right now as it relates to winter months? How do you expect that to ebb and flow looking into 2018 and beyond?
That's a good question. I think both structural and seasonal. Structural in the sense that China has finally realized the importance of the issue of pollution, both on air, water, and soil. The government really want to do something with it. We have a plant in China for 20 odd years, and for many, many years, no government agent ever came to visit us, and now they come twice a month. They are very conscious of pollution, and they're applying even stricter standards than some of the U.S. standards we're looking at. That's good. I think good for the Chinese people. They also talk about seasonality. There's the 2+26 applies to reduce PM 2.5. The particulate matter, 2.5 microns, which are the ones that are very serious in causing lung problems in China.
The government really want to reduce that, and in a sense, go to reduce 30% this winter from, I think from now until May of 2018, we want to reduce by 30%. Only way we can do it is by reduce production, reduce pollution. I don't think any technology can be applied that quickly to reduce this pollution. We are seeing a curtailment of production in steel, cement, alumina, smelting and all that, and coal as well as PVC. There's some of that going on, and question is that only for winter or that goes into other times of the year? I think the big picture is government want to do something, and they want to reduce pollution. Either companies have to invest a lot more money to improve operations or shut down high polluting plants.
Do you have a sense of how much % of PVC production that impacts?
There's some discussions about 10% of those PVC plants are in the 2+26 regions, which is two major cities, Tianjin, Beijing, and 26 secondary cities. That's all in the Northern Hemisphere. I think the pollution, not just in the Northern Hemisphere, it's all of China. I think these are the test markets, if you will, and whether they will spread to other cities or not.
Any other questions? I can ask one here. In terms of your building products segment, you mentioned buyers being interested in the past. How do you assess the strategic fit of that business today?
Sure. The building products, Westlake, before we acquired Axiall, we were already the second-largest PVC pipe manufacturer in North America. With Axiall acquisition, we are still number two. I think JM's been number one, but we are close second with a large position, second largest also in Canada. Axiall, as some of you remember, they were Georgia Gulf and acquired the Royal Group products, Royal Group Technologies back in the 2005 or 2006 area. They're very large in the PVC siding, trims, and molding business. If you look at our building products, the revenue has already exceeded $1 billion. It's a large operation. Before we acquired Axiall was in the process of selling that business. I think they got paid about $700 million. Is that right, Steve?
That's right.
Something in that magnitude. We asked them to stop the sale process and while we acquired them. After we acquired them, suddenly we had a much closer look, and we are very pleased with the business. Suddenly we can sell the business if we need to. It's a big consumer of PVC resin, as well as, I think we are still, as I said, number 2 in pipe. We're number 1 in specialty pipe. We acquired a CertainTeed business about five years ago, and we are the largest specialty pipe business, PVC pipe, in the U.S. Agriculture and mining and many other applications. We are number 3 in siding, PVC siding, which is the second largest use of PVC in the U.S. The first is pipe. The second-largest PVC market is sidings, and also trim. I think we're number 1 in trims and moldings.
We are in deckings or windows. We have a very broad portfolio in the building products. This is some of the area we can grow further, not only strengthening our position, but also can broaden our products, including if we are interested in non-vinyl building product business. We acquired not only a good portfolio of products, but also a good management team. We are looking forward to further grow that business, adding value.
If you could maybe just expand a little bit on that in the building product segment. What are you seeing in today's market environment? How does that compare versus where we were earlier in this year and versus expectations?
Sure. As you may know that 2006 to 2007 period, suddenly we had the housing bubble. We had 2.3 million residential units being built at that time period. With the housing crisis meltdown, 2008, it dropped to 400,000, an 80% drop in demand for housing units. Today, we climbed back to about 1.2 million units, still less than half of the 2.3 million. As I understand, the last 50 years, U.S. average home building is 1.5 million units, for 50 years average. Many, as you know, that many young people are living with their parents or rentals. The demand is still there. Population's grown in the last 50 years. We believe that over the next two, three years, I think maybe three years, we'll get back to the 1.5 million units.
I don't know what the tax reform will have, how much impact would it have on housing and housing demand. They have to live somewhere, and I think the parents doesn't want the kids living with them forever. Whether they have rental units or a house, each house will have four sides, and they use more material, whether it's PVC or wood, than apartment, which at best have two sides. We would like more housing built, single-family homes more than apartment, but apartment also is a good consumer of materials and plastic products. As we see that growth come back to the U.S., you have to ask, U.S. today exports 30% of PVC produced. As we see housing, and before the housing crisis, only 10% of U.S. PVC was exported.
As we see housing come back, demand, the house demand in the U.S. should increase, export will reduce, and it will also further support the pricing for PVC on a global basis.
On the back here.
Could you talk about scope for incremental opportunities at Axiall, both just from, you talked about just capacity creep opportunities, so potentially investing in brownfield expansion. Also, I think historically, you talked about their lower level of utilization versus their targets and that opportunity to just get to, I think more like your operating rates and just other scope percentages. Thank you.
Yeah, I think as you've seen the improvement in operability all throughout the course of this year as we've invested in the maintenance capital in the business. We'll continue to look for opportunities to grow that. We've got still room to grow because these assets are now still running at as high an operating rate as we would like. Before we think about putting additional capital in to grow additional plant, what we'd like to do is continue to grow operating rates and spread that fixed cost over those pounds. What we'd like to do is really see an improvement in operating rates still and get more economies of scale out of the existing plant before we look to deploy additional capital.
We're always doing that, but certainly what we'd like first to do is get the best economies out of the assets that we have.
All right. I think there's no more questions, so I think we'll end it right there. Thank you both very much.
Thank you.
Thank you very much. Right. Appreciate it.