Case Study Methanex WS 2021 - Strategy Making PDF

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Case study revised in the OCS session, that gives an example on Strategy Making and how to approach these cases in the industry....

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METHANEX: DEVELOPING STRATEGY IN A COMMODITY INDUSTRY

Adam Mills, Daniel Shapiro, Carolyn Egri and Michael Parent wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com. Copyright © 2014, Richard Ivey School of Business Foundation

Version: 2016-03-28

John Floren, chief executive officer (CEO) of Methanex, looked up from his notes and stared out his office window at the fog gently blanketing the harbour in Vancouver, Canada. It was January 2013. Floren had recently been appointed president and CEO of Methanex, the world’s largest methanol producer. Before the 2008 global economic crisis, the senior management team had developed a strategy that had increased annual revenues by more than 30 per cent and earnings by almost 60 per cent. Despite this success, Floren had concerns regarding the sustainability of the corporate strategy’s focused scope. Methanex had been successful in large part due to its cost leadership and reliable delivery, achieved by building multimillion-dollar production facilities in remote, natural gas-rich regions of the world that it supported through its own distribution and logistics system. Unlike many of its competitors, Methanex was not diversified. While Floren believed this lack of diversification allowed his organization to focus singularly and clearly on its strategy, he knew that the company was completely reliant on the stability of the market for methanol. At any time, problems of poor infrastructure and political instability in emerging market economies could result in inconsistent gas supply, crippling Methanex’s production and, therefore, impacting its supply chain. Top management at Methanex undertook a quarterly risk-review process that included a systematic review of corporate strategy and the competitive landscape in the methanol industry. The primary objectives were to identify organizational risks and opportunities and to develop appropriate strategic responses. The Methanex board of directors had taken a keen interest in the strategic positioning of the firm and had requested Floren present his strategic recommendations and action plan for the future of Methanex later that morning. The issue of strategy direction was particularly important in light of the market valuation of the company being only two-thirds of the replacement value of its assets. Among Floren’s many concerns were the impact of the global recession and, in particular, threatened production facilities in Egypt and Chile. In Egypt, unpredicted and unpredictable social unrest threatened production from a brand new $870 million1 facility. In Chile, once one of the firm’s major production 1

All currencies are in US$ unless otherwise stated.

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centres, 2.86 million tonnes of plant capacity sat idle because of the Argentinian government’s ban of natural resource exports. While these risks were substantial, Floren also saw an opportunity for Methanex to expand in China. China was becoming a significant player in the global supply and demand for methanol due to two recent discoveries for alternative methanol use: as a component of dimethyl ether (a substitute for propane as household fuel) and for conversion into olefins to make polypropylene plastic. However, Methanex had little presence in China and no significant investments in these new applications. Although the potential rewards were high, so were the entry risks. Floren knew the board was particularly concerned with strategic options for the future. With a $2.5 billion organization under their control, he and the board would need to carefully weigh their options for both short-term profits and long-term growth. METHANOL

Methanol was a widely traded chemical commodity consumed in all major regions of the world. Also known as methyl alcohol, methyl hydrate or wood naphtha, methanol was a simple form of alcohol that was used as a base ingredient in the production and manufacturing of a multitude of products globally. While methanol occurred naturally in the environment in minute quantities, firms operating in the petrochemical industry produced the global supply of commercial methanol. In 2011, annual global demand for methanol was almost 50 million tonnes. Methanol was created through a process of heating natural gas with steam to a temperature of 900°C to produce “syngas” (carbon oxides and hydrogen in gaseous form), cooling and condensing the resultant gas, then distilling the crude product with an additional catalyst into commercial-grade methanol (see Exhibit 1).

Demand

Methanol in its pure form is highly toxic and flammable and, therefore, has a very limited number of direct applications. Methanol was used primarily as a “feedstock” (a base ingredient) in the production of more stable chemicals. Approximately two-thirds of the global methanol supply was used in traditional applications, producing chemical derivatives such as formaldehyde and acetic acid. The remaining onethird was used in the energy sector for gasoline blending, the production of dimethyl ether (DME) and methyl tertiary butyl ether (MTBE) (see Exhibits 2 and 3) and the conversion of methanol to olefins (MTO). Roughly 34 per cent of the global methanol supply was used in the production of formaldehyde, a primary element in numerous building products, including wood adhesives (for plywood, particle board and fibreboard), polymers, paints, polyurethane and automotive parts. Demand for formaldehyde remained strong, although growing public concern surrounded the health risks associated with occupational exposure to the chemical. In May 2009, the U.S. National Cancer Institute (NCI) published a report on the health effects of occupational exposure to formaldehyde and a possible link to leukemia, multiple myeloma and Hodgkin’s disease2. 2 L.E. Beane Freeman, A. Blair, J.H. Lubin, P.A. Stewart, R.B. Hayes, R.N. Hoover and M. Hauptmann, “Mortality from Lymphohematopoietic Malignancies Among Workers in Formaldehyde Industries,” The National Cancer Institute Cohort, May 20, 2009, JNCI, Vol. 101, No. 10.

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Acetic acid, accounting for 13 per cent of the global methanol demand, was primarily used in the production of vinyl acetate for later use in polymer adhesives such as wood glues. Acetic acid was additionally used as a base component for such products as photographic film, solvents, textiles and vinegar. In the energy sector, demand for methanol had been increasing (see Exhibit 4). Eleven per cent of the global methanol supply was used in the production of MTBE. MTBE was primarily used as a source of octane and to oxygenate gasoline to reduce harmful automobile emissions. In response to environmental concerns in the late 1990s, demand for MTBE as a fuel additive in the United States rose to roughly two million tonnes annually by 2005, approximately 6 per cent of global demand. However, the presence of MTBE in some U.S. water supplies led to public concern regarding MTBE’s safety, which led to the 2005 passing of the U.S. Energy Policy Act, which called for the replacement of MTBE with an alternative gasoline additive. MTBE was almost entirely phased out of U.S. gasoline by 2007. MTBE demand was also affected by some European and Latin American countries imposing taxes on fossil fuels, with the intention of encouraging the use of alternative fuels such as biofuel. However, MTBE demand globally remained relatively constant due to its use as a clean energy component in Europe and many developing economies. Two relatively new uses of methanol, fuel blending and producing dimethyl ether (DME), had been increasing in demand annually. In 2010, approximately 10 per cent of the global methanol supply was used for fuel blending. To reduce reliance on crude oil for transportation fuel, methanol-blended fuels had been increasing in popularity as an alternative to gasoline. In 2009, China introduced national standards for the use of M85 and M100 (85 per cent and 100 per cent methanol blends) and, in the coming years, was expected to introduce M15 (a 15 per cent blend) as a national standard. Several countries, including Australia, Iran, Pakistan, Malaysia and Trinidad, were also researching methanol fuel blending as an alternative to pure fossil fuel. Dimethyl ether comprised approximately 7 per cent of the global supply for methanol. The primary use of DME was as a fuel substitute for propane, used for residential heating and cooking needs. DME was an attractive alternative fuel because it was non-toxic and harmless to the ozone layer. As fossil fuel prices and concerns about emissions from carbon-based fuels rose globally, DME was quickly becoming an attractive alternative for domestic heating. The single largest market for residential DME was China, but other countries, such as Indonesia, Japan, Sweden, Iran, Egypt and India, were developing DME applications. DME also had applications as a propellant in aerosol containers, a solvent base and a refrigerant. Annual global demand for methanol was 48 million tonnes. Due to regulations and restrictions around the uses of formaldehyde and MTBE, as well as rapid technological advancements in alternative energy sources, the North American market demanded only 14 per cent of the global supply, around seven million tonnes. China was the single largest consumer of methanol, in large part due to its fuel-blending policies and increasing reliance on DME. China demanded 37 per cent of the global supply, almost 18 million tonnes. The rest of the Asia-Pacific region (excluding China) accounted for 22 per cent of global demand, Europe for 23 per cent and Latin America the remaining 4 per cent (see Exhibit 5). Supply

Supply to the methanol industry was largely dependent on the delivery of the primary feedstock, either natural gas or coal, to production facilities. Natural gas supply was subject to fluctuating prices, interruptions to supply lines and international policies and regulations governing imports and exports.

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Methanol output supply could be greatly affected by planned and unplanned outages of methanol plants. The average annual output capacity of modern methanol production plants was between 1.3 million and 1.5 million tonnes, although most operated at approximately 85 per cent of total capacity to allow for output increases when economically beneficial. Considering the total market size, fluctuations in production from one large plant could have significant impacts on global supply and, therefore, on prices. In the long run, global methanol supply was largely dependent on industry growth and additions to global production capacity. Since storage of methanol was costly and not directly related to revenue generation, most producers attempted to closely match their production output to customer demand. As such, input fluctuations and unforeseen plant outages dramatically reduced the available supplies of methanol, which caused methanol prices to fluctuate widely. As with most commodity markets, significant supply shortages caused spot prices to rise steeply, leading to increased production output from high-cost producers, which then caused spot prices to fall due to abundant supply. However, traditional demand for methanol was largely unaffected by changes in spot price for two reasons: methanol had few cost-effective substitutes for its traditional uses in the production of formaldehyde and acetic acid, and methanol costs accounted for relatively small percentages of the final products’ downstream value. For methanol energy applications, demand was more elastic and impacted by the ratio of methanol and oil prices. When spot prices of methanol rose above $340, the energy equivalent of $90 per barrel for oil, high-cost Chinese and Russian producers (who primarily produced methanol from coal, not from natural gas) displaced imported methanol and often began exporting methanol (see Exhibit 6). However, with growing demand for methanol in fuel blending and DME production, Chinese producers had a decreasing incentive to generate methanol for export. The methanol market saw a compound annual growth rate (CAGR) of 4.7 per cent from 1997 through 2011 and was projected to have a future CAGR of up to 7.3 per cent, based on rising oil costs and increasing global demand for alternative fuel sources (see Exhibit 4). With the exception of 2009, methanol had traded above its energy value (i.e., its crude oil price equivalent) consistently for the past 15 years (see Exhibit 7). METHANEX Company History

Methanex was first known as Ocelot Industries, incorporated in 1968 in Canada as an oil and gas exploration company. In 1991, Ocelot Industries split into three entities, with the methanol and ammonia businesses forming Methanex Corporation. Originally only a North American enterprise, Methanex began international expansion by acquiring interests in methanol operations in the Caribbean and Europe in 1992, and in New Zealand and Chile in 1993. The international expansion was prompted by an expected (and subsequently realized) escalation in the price of methane in North America, as demand for natural gas escalated. The company continued to expand internationally by seeking remote locations where natural gas was “stranded.” When high reserves of natural gas were identified, but local industry had limited use for the resource, Methanex was able to negotiate favourable long-term supply and pricing agreements. By 2000, Methanex had become the world’s largest producer of methanol, with production operations in Trinidad, New Zealand and Chile, and marketing offices in the Asia-Pacific region, North America, South America and Europe. The company had signed long-term contracts based on monthly volumes with

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numerous major multinational manufacturers, none of which represented more than 10 per cent of Methanex’s revenues. Trinidad. In 1992, Methanex acquired partial marketing rights to the 850,000 tonnes of methanol produced annually at the Titan facility owned by Metallgesellschaft of Germany3. In 2000, Methanex acquired exclusive marketing rights plus 10 per cent ownership of the plant and, in 2003, purchased the remaining 90 per cent from Metallgesellschaft. In 2004, its Atlas facility, a joint venture between BP (36.9 per cent) and Methanex (63.1 per cent), came online with a production capacity of 1.7 million tonnes per year, at the time, the largest methanol plant in the world. Trinidad was developed by Methanex as a low-cost production hub because of its convenient access to both North American and European markets (see Exhibit 8). The Trinidad operations generated 1.78 million tonnes of output annually. Contracts with the national natural gas suppliers for Methanex’s two plants ran until 2014 and 2024. In 2010, Methanex initiated a pilot program to introduce methanol fuel blending in Trinidad. New Zealand. By 1995, Methanex owned three methanol plants in New Zealand (two in Motunui and another in the Waitara Valley) with a total capacity of 2.23 million tonnes. Due to economics and resource extraction capabilities in the region, the local supply of natural gas was largely dependent on short-term contracts. In 2004 and 2005, unfavourable economic conditions led Methanex to idle its two larger plants, leaving only one smaller plant in Waitara operational. In 2007, sufficient supply contracts were secured to reopen one of the Motunui plants. By 2010, the company was producing 0.83 million tonnes annually from New Zealand facilities. With an additional 1.4 million tonnes of production capacity sitting idle, Methanex entered into a 50 per cent joint venture with Kea Exploration to develop oil and gas extraction facilities in the nearby Taranaki Basin. Chile. Although expansion into Chile in 1993 had been considered risky due to perceived political instability and relatively high capital investment costs, for Methanex, the move had delivered benefits as a result of low production costs and generally stable supplies. By 2005, Methanex had four fully operational plants and $1 billion invested in Chile. Largely dependent on natural gas inputs from Argentina, Chilean operations supplied 3.8 million tonnes of methanol, approximately 12 per cent of global supply. In June 2007, the Argentinian government decided to halt all exports of natural resources, almost instantaneously cutting off the primary supply of methane to Methanex’s production facilities. Three of the four plants were shut down, and annual output from Chile dropped to 0.94 million tonnes. By 2010, Methanex was operating only one production facility in Chile, but was aggressively backing natural gas exploration and acquisition in the country. Investment opportunities had been pursued with several large energy companies, including GeoPark Chile Limited and state-owned Empresa Nacional del Petróleo. Egypt. In early 2011, a 1.3 million tonne methanol production plant came online in Egypt. Located in Damietta on the Mediterranean Sea, the Egyptian plant was operated by EMethanex, a joint venture between Methanex (60 per cent) and the Egyptian government (40 per cent) that had been in place since late 2005. The capital cost of the facility was $870 million. The launch of the facility coincided with widespread anti-government protests and civil unrest in Egypt. For the safety and security of its assets and its largely Egyptian workforce, Methanex temporarily closed the plant and its Cairo offices until conditions stabilized. The plant, with capacity to generate more than $300 million in annual revenues, was brought online for a brief period in the spring of 2011 when peace was temporarily restored by Egyptian

3

Metallgesellschaft owned two facilities in the Point Lisas Industrial Estate in Trinidad and had named them Titan and Atlas, respectively.

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military control of the country. However, social unrest with the new regime began to swell in the following months, and the plant was again idled a few months later. Canada. Methanex’s original Canadian operations were serviced by short-term contracts, and thus were more sensitive to fluctuations in the supply and prices of natural gas. These fluctuations benefited the company in times of relatively low-cost North American pricing, but left it exposed when the price increased. Due to price volatility and high production costs, the original production facility in Kitimat, British Columbia, permanently ceased operations at the end of 2005 and was retained solely as a storage facility. Methanex’s three facilities in Medicine Hat, Alberta, were idled and shut down between 1999 and 2002, due to the...