利安德巴塞爾 (LYB) 2005 Q2 法說會逐字稿

Hello and welcome to the Lyondell Chemical second quarter 2005 earnings teleconference. At the request of Lyondell Chemical this conference is being recorded for instant replay purposes. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Doug Pike, Director, Investor Relations. Sir, you may begin.

Thank you. Good morning, everyone. This is Doug Pike and I'm joined today by Dan Smith, our President and Chief Executive Officer; Morris Gelb, our Chief Operating Officer; and Kevin DeNicola, our Chief Financial Officer. And the agenda for today's call will be as follows. I will review our second quarter performance. Kevin will then review some financial metrics and activities. And before we open the call up to your questions, Dan will summarize our view of the market. And the call is scheduled to last approximately 60 minutes.

Before we begin I would like for you to note that statements made in this teleconference relating to matters that are not historical facts are forward-looking statements that are subject to risks and uncertainties. Actual result could differ materially from those forward-looking statements. For more detailed information about the factors that could cause our actual results to differ materially, please refer to our earnings release issued this morning and please also refer to Lyondell's, Equistar's, and Millennium's annual reports on Form 10-K, for the year ended December 31, 2004, which were filed with the SEC on March 16, 2005. And Lyondell's, Equistar's, and Millennium's quarterly reports on Form 10-Q for the quarter ended June 30, 2005, which will be filed with the SEC in August of 2005. I would also like to point out that a replay of today's call will be available from 1:30 p.m. eastern time today until 5:00 p.m. eastern time on August 5. And the replay can be accessed by calling 1-800-216-3053, or 1-402-220-3760. And the access code at both numbers is 5549. The replay can also be accessed beginning at 2:30 p.m. eastern time today at the Investor Relations page of our website, at www.Lyondell.com/earnings. Reconciliations of non-GAAP financial measures to GAAP financial measures together with any other applicable disclosures including the earnings release are currently available on our website at www.Lyondell.com/earnings.

Now, let's proceed to a discussion of our earnings. During the second quarter of 2005, Lyondell had net income of $126 million, or $0.48 per share on a fully diluted basis. And this compares to net income of 254 million in the first quarter of 2005. And the decline versus the first quarter is primarily the result of declines in the ethylene co-products and derivatives and refining segments. And these declines were partially offset by stronger performance in the propylene oxide and related products segment. Our second quarter includes noncash pre-tax charges of $14 million, related to industry mutual insurance consortia. Additionally, the second quarter includes a 9 million charge related to the early retirement of debt, while the first quarter included a $12 million charge related to debt reduction.

Compared with the second quarter of 2004, net income improved by $123 million. An improvement was driven by the Millennium acquisition, and by stronger results in the ethylene co-products and derivatives and propylene oxide and related products segments. Regarding our tax rate, we estimate that Lyondell's 2005 effective tax rate will be 36%. Due to the expected utilization of previously accumulated net operating losses, our 2005 cash taxes payable are estimated to be quite modest. And finally our second quarter average outstanding share count was approximately 246 million shares, the corresponding share count and diluted earnings calculation is 259 million shares.

Now let's turn our attention to the ethylene co-products and derivatives segment performance. The primary products for this segment are ethylene, ethylene co-products including propylene, butadiene, benzene, toluene, and derivatives of ethylene which include polyethylene, ethylene oxygenates, and vinyl acetate monomer, or VAM. Second quarter EBITDA was 920 -- excuse me $294 million, down from 486 million during the first quarter. And the key contributor to the quarterly decline was reduced ethylene, propylene, and ethylene derivative product prices. The quarterly average price for ethylene and the principal ethylene derivatives, polyethylene, ethylene glycol decreased by approximately $0.05 to $0.06 per pound.

Raw material costs continued to increase during the second quarter and unlike the first quarter, these increases were not fully offset by increased co-product prices. Thus, our cost of ethylene production metric increased by approximately $0.01 per pound, with the majority of the increase attributed to the crude oil based liquid raw materials. And within the co-product area, it is interesting to note that during the second quarter, prices increased for two of the major co-product, butadiene and fuels while the average benzene price was relatively unchanged and the propylene price declined significantly. Combined, ethylene and ethylene derivative sales volumes were approximately 60 million pounds, or 2% below first quarter levels. And the majority of this reduction was in the ethylene, ethylene glycol sales. Our acetyls results remained strong as increased costs were offset by increased prices in volumes.

Now, overall the quarter was characterized by reductions in industry operating rates and prices as the market adjusted to overproduction during the late fourth quarter 2004 and first quarter 2005. And these reductions coupled with volatile raw material costs, necessitated increased focus on the optimization of production, inventory, and raw material mix during the quarter. For example, some crude oil-based raw materials were resold in the fuels market and consumption of some natural gas based raw materials increased. But in aggregate, crude oil based raw materials were favored versus ethane for the majority of the quarter and on balance the cost of ethylene production at our flexible liquid plants was favorable versus our natural gas based facilities.

During the quarter, we operated our ethylene capacity at slightly below 90% effective utilization. And as a result, our combined ethylene, ethylene derivative inventory declined during the quarter. And further inventory reductions are expected during the third quarter, as a result of our Clinton Iowa maintenance turn-around.

A comparison of second quarter segment results to the year-ago quarter, indicates the following trends. EBITDA improved significantly with the key contributor being increased ethylene and derivative prices. For example, ethylene and ethylene glycol prices increased by approximately $0.04 per pound, while polyethylene prices increased by approximately $0.10 a pound. However, this was partially offset by an increase in our costs of ethylene production metrics compared to the second quarter of 2004. Our costs of raw materials increased significantly. More than $12 per barrel for our average crude oil based raw material but higher co-product prices offset a portion of the cost increase, and the result was an increase of approximately $0.03 per pound in the cost of production metric. Now, excluding the additional of vinyl acetate monomer, ethylene derivative sales volumes declined primarily due to lower ethylene and ethylene glycol sales.

Now, thus far, the third quarter has been characterized by improving sales volumes, coupled with the realization of price increases in some products such as benzene and propylene, while in several other products, prices are still under negotiation. Raw material costs have remained elevated, but increased co-product prices have expanded the availability of advantage crude oil-based raw materials. And we currently have our Clinton, Iowa, ethylene and polyethylene facilities down for scheduled six-week maintenance turn-around. However the quarterly financial impact of this will be mitigated by sales from inventory that was built earlier in the year. And from a cash standpoint, the estimated cost of the maintenance turn-around is 35 to $40 million. And this cost will be amortized over the next seven years.

Now, let's turn our attention to the propylene oxide and related products segment. Segments include propylene oxide, derivatives of propylene oxide, toluene, diisocyanate, MTBE and some styrene. During the second quarter 2005, EBITDA for this segment was $186 million, which is $40 million increase over first quarter 2005 results. MTBE was the key area of quarter to quarter improvement, as margins began the quarter quite strong and continued to increase throughout the period. Average quarterly raw material margins increased by approximately $0.33 per gallon, leading to an improvement of approximately $65 million.

In other products within the segment, propylene oxide and PO derivative product margins increased primarily due to lower propylene costs. However, I should point out that European propylene costs declines were considerably smaller than U.S. declines. You need to remember that European propylene is priced on a quarterly basis. Therefore, the margin increase from lower raw material costs may be less than a U.S. investor might anticipate. And typically differences of this nature will equilibrate over time. PO and PO derivative volumes declined by approximately 150 million pounds primarily due to the absence of seasonal de-icer sales. And the margin improvement and volume declines tended to offset each other, so overall results were relatively unchanged from the first quarter 2005.

Styrene results were also relatively unchanged versus the prior quarter. As styrene prices continued to closely follow raw material costs. And TDI results continue to be weak, and declined primarily as a result of lower margins, and increased costs related to maintenance activity. When compared with the second quarter of last year, segment results have improved by $104 million. Approximately $70 million of the improvement occurred in the PO and PO derivatives. Primarily due to increased margins, and the balance was primarily the result of increased MTBE margins. Styrene showed small improvement while TDI declined. And combined, styrene and TDI results declined by approximately $10 million.

Thus far, in third quarter, market continues for the segment's chemical products are relatively unchanged from June. But MTBE margins have been exceptionally strong during July. There are no major turn-arounds planned for the third quarter but I would like to point out that during the fourth quarter we will have a scheduled maintenance turn-around at one of our Bay Port PO plants.

The next segment I would like to review is inorganic chemicals and the primary product in this segment is titanium dioxide. During the second quarter of 2005, EBITDA for this segment was $49 million, relatively unchanged from the 45 million in the first quarter. When compared to the first quarter of 2005, titanium dioxide sales volumes increased by 12,000 tons or approximately 8%. Sales prices increased by approximately $15 per ton as prices increased in the Americas but on a dollar basis held study in Asia and declined in Europe due to a weaker Euro. Relative to the second quarter of 2004, prices increased by approximately $270 per ton, while sales volumes decreased by 33,000 tons. And during the second quarter of 2004, sales volumes were increased as part of an inventory reduction effort by Millennium, and therefore, the comparison does not accurately represent market conditions.

Thus far, in the third quarter, titanium dioxide market conditions are relatively unchanged from the second quarter. Consistent with Lyondell's approach to working capital, we are further reducing targeted titanium dioxide inventory levels, and as we make the operating adjustments to reach these targeted levels, we expect earnings to be negatively impact while cash flow will be positively impact.

Now, let me turn your focus to the refining segment which consists of our 58.75% ownership in LCR. LCR's second quarter net income was $28 million and this equates to EBITDA of 65 million, a decrease of $81 million versus the first quarter. Now, in addition to the impact of planned maintenance turn-around activity LCR's quarter was impacted by two other events. The first was a coker upset that occurred after the turn-around activity, and the second was a force majeure event at a third party which processes off gas from the refinery. And the combined impact of the three events was approximately 80 to $85 million. The turn-around impact was approximately $50 million. And the coker upset had an estimated 20 to $25 million impact, and the force majeure event is estimated to have impact the quarter by approximately $10 million.

But at this time, each of these problems has been addressed and the refinery is operating normally at full rates. Additionally, during the second quarter, aromatic margins were below first quarter levels while spot margins were stronger. In the final analysis these tended to offset each other and had a minimal impact on the quarter. Crude runs finished the second quarter averaging 165,000 barrels per day of CSA crude, and 28,000 barrels per day of spot crude. Now, as I mentioned, the refinery is now running at full rates and is processing a typical mix of 230,000 barrels per day of CSA crude, with the balance being spot purchases. Now, I would like to point out that LCR's contract with PDVSA, does not require its refinery make up the CSA crude consumption that was lost during the turn-around. However you should expect third quarter CSA consumption will average slightly higher than 230,000 barrels per day to account for a reduced consumption during the coker upset.

Now although the refinery is now operating at full rates the first several weeks of July continue to be impacted by a third party force majeure declaration and therefore quarterly results are estimated to be negatively impacted by approximately $10 million. This concludes my prepared remarks. I would now like to turn the call over to Kevin to discuss some of the elements of our cash management effort.

Okay. Well, as Doug mentioned during the second quarter, some portions of our business experienced an adjustment. While other products flourished. And in other areas we had significant maintenance. Through all this change our product breadth enabled us to continue to generate cash and reduce our debt level.

During the quarter, we repaid total debt of 328 million. This consisted of 300 million of Lyondell debt prepaid early in May and 28 million of Millennium debt. Now, in addition to the 328 million of debt paid in the second quarter, we retired another 28 million of Millennium debt in July and today recalled the final 200 million of Lyondell's nine and seven-eighths percent, 2007 bonds so completion of this call will bring our total debt reduction to slightly more than a billion or one-third of our $3 billion targeted debt reduction.

We're also in the process of replacing and restructuring Millennium's bank facility. This new five-year facility will include 125 million U.S. revolver, 25 million Australian revolver, and $100 million Australian term loan and we are adding the overseas term loan at Millennium as part of our cash repatriation efforts that are expected to result in our repatriating roughly 225 million of cash to the U.S. in the third quarter. Now, this cash, plus cash in Millennium already in the U.S. will be used to pay down debt at Millennium.

With that summary of financing activities in mind, let's talk a little about the current cash position. Lyondell closed the second quarter with 713 million of cash. That was 270 million at Lyondell, 68 million at Equistar, and 375 million at Millennium. Overall, this position is relatively unchanged from the 698 -- or 689 million balance held at the end of the first quarter. After taking into account the cash, various revolvers, accounts receivable, inventory facilities, letters of credit, our total consolidated liquidity was 1.9 billion at the end of the second quarter. Due to its maintenance activity, LCR finished the quarter in a somewhat different position. At the end of the quarter, it held 16 million of cash and its revolver was drawn by 45 million, which has since been repaid.

Distributions from the partnerships, probably the next topic I should address. As you can imagine, LCR distributions were limited in size, net distribution to Lyondell was only 19 million. On the other hand, Equistar distributed 475 million to Lyondell and Millennium combined. The final financial topics I would like to discuss are capital and working capital. Capital spending is pretty straightforward, remains on track with our plans. During the second quarter, the spending was 32 million in the ethylene co-products and derivatives, 16 million in PO and related products, 14 million in organic chemicals, and 49 million at LCR. For the first half of the year, total consolidated capital spending was 120 million. LCR's capital expenditures were 83 million. We continue to expect that full-year spending will be at or near the levels that reported in our January press release.

While we continue to manage all areas of working capital very closely. At this time I believe that inventory levels are your primary area of interest. In dollar terms, inventories held fairly constant in each of the consolidated segments, in terms of product inventory volumes, ethylene co-products and derivatives segments inventories were reduced and organic product inventories were relatively unchanged, propylene oxide and related product segment inventories were mixed. PO and PO derivative inventories increased ahead of the scheduled October maintenance turn-around and winter de-icing season while the co-product inventories declined. Now I will turn the call over to Dan for a brief review.

Okay. Thank you, Kevin. Since the energy bill is a very current topic, I thought it would be appropriate to speak to that briefly. We understand that it's being voted on in the floor of the House today, and anticipate it to be voted on in the Senate tomorrow. While we certainly would have preferred a different outcome from that pending bill, the truth is that we are essentially in no different legal position today than we were in before the bill was debated MTBE has not been banned at the federal level. There is no industry fund to support cleanup efforts, and MTBE producers will not have liability protection against defective product claims.

Granted, there will continue to be lawsuits. But we believe that we have a strong defense. After all, the responsible parties are those who have allowed gasoline to leak from underground storage tanks. To date, our spending related to these cases has not been material, and we do not expect it to be so in the future. So in summary, the public policy landscape has not changed appreciably, and therefore, we'll continue to pursue our established path. We will continue producing and marketing MTBE, as well as preparing ourselves to produce other fuel additives such as diso octane or DIB should the economics dictate. In other situation, we believe that we are well positioned to compete and the gasoline market appears to be a good market for the foreseeable future. So in summary our focus in this area has not changed.

With that, let's move ahead to the broader business discussion. I think from Kevin and Doug's summaries, it is evident that we diligently manage the volatility inherent in our day to day businesses. However on the strategic level, our actions are driven by broader economic and industry factors. Given this year's ethylene chain volatilities, it can be very difficult to keep these in focus. But when I look forward, I believe that the fundamentals remain in place for the industry to progress through the positive stages of the economic cycle. For example, both the U.S. and Chinese economies continue to grow very strongly. Chemical industry operating rates appear to be following previous projections and the markets for products such as gasoline and fuel components have tightened as one might anticipate after a long investment drought.

As we speak today, I'm happy to say that these fundamentals are being reflected in near term developments within the industry. For example, spot ethylene prices have rebounded by approximately $0.10 per pound, contract benzene price is back near the $3.00 per gallon range, domestic and export polyethylene orders have improved and polymer inventories are declining. Resigning margins are strong and the MTBE market is reflecting the significant value of an incremental barrel of gasoline.

So I think that the longer term upward trajectory is continuing. Let's remember that despite the challenging earnings situation we found in the second quarter, we still produced $126 million. When just one year ago, we were very happy to report the second quarter 2004 earnings had finally turned positive after an extended trough. I think that I will close with that thought and I would now like to turn the call over to the operator for your questions. Operator?

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from PJ Juvekar with Smith Barney. You may ask your question, sir.

Yes, hi, good morning. Disappointed with your Ti02 margins with the seasonal uptick and significant price increase amounts, you are still reporting less operating income than proposed 1Q and there doesn't seem to be any benefit of all the cost cutting after Millennium acquisition or the argument that Lyondell management can run these plants better.

That is a lot to load into one quarter, PJ but I would share with you that we're disappointed in results as well but I would point primarily to the fact that we're seeing a much weaker coating season than any of the paint companies or any of the Ti02 producers including ourselves expected here, and that's the primary thing you see going on. But if you dig a little deeper in that, don't neglect the fact that we are proactively reducing inventories and in this business there is a much higher component of fixed cost, so if you think about it that way, you are absorbing less fixed costs per pound produced, and that does get reflected in your financial results, and then thirdly, we have a curiosity in the way ours are reported, and the -- we have some functional currency impacts in there as well. So it is a confusing situation to look at.

But net-net, you're exactly right. The business is weaker than we would expect. I think that trend has been one that has been evident since the beginning of the year. I think it is not going to reverse very quickly. And it is especially pronounced in Europe with South America, North America, and Asia being stronger but it is not as strong in here as any of us expected.

Now, as far as the cost savings, et cetera, those are fully underway. But I think we didn't ever indicate to you we were going to get all of the operating results done in very short order. And indeed when you're operating at lower rates it is hard to reflect any of those impacts. But as far as infrastructure, that is -- a good part of that is done. The systems work is under way. And I think everything is on schedule there. So I know you would like to see it all in the first three days. Unfortunately, it is going to take us a little longer than that to produce it.

Well, three quarters what I would like. Just quickly on poly's and exports you mentioned that those are picking up. Can you just pinpoint where this demand is coming from? Is it China? Is it Southeast Asia like Thailand where some--?

I think it is pretty broad, PJ.. Again, I think we are looking carefully at all this because obviously the industry got psyched out to some extent in the fourth quarter going into the first, so we're not jumping on this with all fours trying to take advantage of every last pound here and indeed we're being very cautious maintaining our inventory position, and not overselling into a market, but we think we're seeing general growth across the board. And I think that's going to continue as we go through the third quarter.

Thank you.

Our next question comes from Sergey Vasnetsov with Lehman Brothers. Sir, you may ask your question.

A question about your aroma business. I understand the IP puts vegan is for sale, that's been rumored for a long time, and so previous the Millennium, had a very favorable view of that segment potentially to be -- to buy. What's your current view on aroma business is, it buy, sell, hold? What part does it place in your portfolio?

This is Kevin, Sergei. Yes, any of those are possible. You gave me all the options, right? I think the important thing is we're actually pretty pleased. It is a very small business, I didn't realize you guys even remembered we had it. It is a very small business. It is a very profitable business and it is operating very well. So we're kind of pleased with it. It was part of the package. We have no particular reason to do anything one way or the other on this thing this time.

One thing we are doing Sergey is making some improvements, I made some notation improvements in the physical plants that we think will improve the reliability and flexibility going forward. So we can see some physical actions we can take that we're going to improve it even further.

All right. Well my question was in regard to if it is such a good business it probably worth quite a bit of on the multiple to somebody else and so you have pretty ambitious debt pay down program, wouldn't it make sense to sell it?

It is relatively small. Even if were you to sell it.

Okay. Good. Thank you.

You're welcome.

Frank Mitsch with Fulcrum Global Partners you may ask your question.

Good morning. A couple of questions on the PO and RP business, you highlight the MTBE business in a couple ways, one, you did the -- the profitability picked up meaningfully in the second quarter, and given the driving season, is your sense that that is going to pretty much continue through the third quarter so we can look for a nice upside on the PO and RP business coming from MTBE?

Yes.

All right. And while I'm at it, TDI, we saw a couple of companies and shutdowns in that business. Is there any hope?

There is always hope. It comes right after faith and charity, I think. But oversupply in that business has been a problem, and it is reflected in the results, we're hopeful that the actions that have been announced once they're implemented will have a positive impact.

And Morris, when would that be, what year would that be?

Well, we are confining it to a decade, I think.

We believe that the two plants in question will be going down this year.

We believe that the tow plants in question will be going down this year.

Yes, the plants will be going down this year, so you think that that debt in and of itself, plus the internal measures you're taking will improve the profitability for '06?

I'm not making any firm predictions. I think these are steps that point us in the right direction.

For perspective, though, the operating rates are still in -- deeply mired in the 80s and the thing you got to look at, is while there is capacity coming offline there is also more capacity coming online in future years so I think you got to balance all that. And we would like to see improvements, but I don't think we have a whole lot of optimism at this point in time that this is going to take off and get where it needs to get. It is still a troubled business.

All right. Terrific. And then lastly, on the Ti02 front, you flagged 4X as having a negative impact there. Could you quantify that?

We kind of looked at it, and keep in mind, it is not an operating FX in effect, it is really below the line, other income effect, and it is roughly about $6 million or so. Net impact.

Terrific. Thanks a lot.

Kevin McCarthy with Banc of America Securities you may ask your question.

Good morning, guys. A question on propylene glycol, it looks like the margins in the first half of '05 are roughly double on a product basis versus what they were in the first half of '04. What's your outlook for the back half of the year there? Is it sustainable? Can it get any better?

Well, Kevin, we are very pleased with the performance of that business. And the PO and derivatives chain in general. We believe that business conditions are still good, and we would expect that sort of performance to continue. Margin expansion from here may be a little bit more difficult, but these are very healthy margins that we're enjoying in that business right now.

Okay. And then to follow up on Ti02, Dan, you mentioned it was a weak coating season, a number of the companies that we follow in coatings seem to have done reasonably well. I'm wondering if you think you lost any share in that business? And how much your inventories might need to be drawn down here? Maybe you could give us some color on operating rates.

I think the first thing to think about is our view of how you run inventories is probably different from the way Millennium historically did it here. So we are really taking a one-time correction to get these down to more like what we think chemical inventories ought to look like rather than the way they had been run before. I can't speak to what the competitors do here. But I can tell you anecdotally that I think a lot of the paint companies were well prepared for a much bigger painting season than what they're seeing and therefore, they were stocked up and they're selling out of some of that inventory is well which is backing up in the chain. And also it was -- the fact that there are some other things going on in the industry that might cause some other people to have some different points of view about how they run their volumes so we keep ourselves busy running our business and doing what we think is important to set ourselves up going forward, not so much worry about market share from week to week.

And Kevin, this is Doug. I would also point out that, EBITDA in this business so far this year, we boasted a 45 and a $49 million EBITDA each of the two quarters which is well ahead of the performance over the prior three halves, so all of last year and the prior year. So we may feel a little disappointed versus our expectations. But actual performance of the business at that level is pretty solid versus where it's been. So we're seeing improvement.

And then finally, what is your polyethylene order book look like for July?

Very strong.

Enough said. Thanks very much.

Thank you.

Christopher Miller with J.P. Morgan. You may ask your question.

Good morning. I wanted to follow up just a little bit in terms of the debt pay down at Millennium and what the potential implications that may be for eventually starting to consolidate your capital structure a little bit. And what your thoughts are, and maybe even on timing for that sort of action.

Well, this is Kevin, clearly we have been buying some debt. That's clearly what we've been doing. And we've got the cash that we're moving over there to be able to do those kind of things. The debt does mature in November of '06. There is some other debt in '08. The notion of being able to consolidate is really when you get past the '08 pieces, unless we do something ahead of that differentially. So that is not something that's in our near term rate or screen nor do we see a real need to do, it frankly we had a plan originally to pay down of the $3 billion target, 500 was at Millennium so we're well on our way to doing that effectively, on a net basis, it is nearly done. So we're just doing that, and I think that over time, we can do the things you're talking about, but there is no compelling need to do that or spend extra money to solve that problem right now.

Okay. Great. I appreciate that help. Thank you.

Mike Judd with Greenwich Consultants. You may ask your question.

A couple of nitpicky things here. The industry mutual insurance consortia charge for $14 million, where did that show up in the income statement?

That charge is in our cost of sales, Mike. There is a split between the entities, about -- the majority of it is in Equistar, PO has a piece, and there is about our share of LCR piece would be about $1 million or so.

Okay. And then separately, in terms of crack spreads here, in the third quarter, could you just comment on the relative attractiveness of heavy sour versus light sweet, and how that is going?

Still very, very strong. I don't know the number today, but we've been in the 10 to $15 range for some time.

Okay. And then lastly, on MTBE, I heard, Dan, I heard your comments, and I certainly -- it certainly makes sense who the responsible parties are. But if this thing does turn into a little bit of a litigation quagmire, do you guys have any reserves or anything at this point? I wouldn't imagine that you do.

I think if you go back to our 10-Ks, you get the best picture of that 10-Q, 10-Ks and they speak specifically to the materiality or lack thereof of these situations. I think that really tells you what you need to know.

Specifically you don't have any reserves, right?

We do not.

Okay. Thank you.

The other thing I would remind you is when you talk about litigation quagmire, this is a nuisance, not a human health concern like we've is seen in some of these other situations, so the relative attractiveness of the litigation front is the ability of the plaintiffs to make a lot of money on the cases, and when you can point to human pain and suffering, you do a lot better than when you point to something that smells bad and tastes bad.

Understood. Thanks.

Thank you.

David Silver with J.P. Morgan, you may ask your question.

This is Jeff Zekauskas. Good morning.

Good morning, how are you?

The first question is a question of clarification, I think for Doug. Did Doug say in his introductory remarks that ethylene and co-products, raw materials, were up a penny a pound on a sequential basis?

I said, yes, I said our costs of production metric was up about a penny a pound quarter to quarter, yes.

Why was it so small? Or what did you do to contain the cost rise?

Well, you saw, obviously you saw increases in crude oil. So you saw some increases in the liquids but of course, as I said we worked pretty hard during the quarter to optimize that. You saw some smaller improvements in ethane. And there is a perception that co-products all fell during the quarter. What you really saw was propylene fell off during the quarter, quarter to quarter, benzene was relatively unchanged. Butadiene moved up. And the strength of fuels, and you have to remember that about 20% of the production, 25% of the production from those plant, the liquid plants, are fuels, and they were very strong in the second quarter. So yes, a lot of things moving up and down, and the end result, we were able to manage it and keep it to about a penny increase or so. A lot of work from a lot of people in optimizing things.

I wouldn't underestimate the optimization efforts.

We talk about liquids, there is a wide range of materials that we can run these through these plants and we are working very hard every day to find the lowest cost feed stocks, and we've done pretty well with it.

No, I mean those are very, very good raw material results on a sequential basis. The second question is, your volume, your order pattern seems good for July, and you've got some price increases on the table. So is it the case that you believe that your ethylene and co-products and derivatives, cash margins will rise in the third quarter?

I think you need to go month by month. Remember, that the second quarter was characterized by coming off of a very strong first. And so sequential months in the second quarter were down month after month. So if you think of a V, then I think we have clearly passed the inflection point and are moving back up. It is still early in the third quarter to characterize the whole third quarter vis-a-vis the second quarter and first quarter. But clearly, we think we're moving up.

And lastly, with the price increases that are on the table, I guess, for polyethylene, I guess it is $0.06 a pound in July and $0.06 in August. Are you more optimistic about the August increase or equally optimistic about both July and August?

Well, we're working very hard on that first $0.06 increase and I don't think it will all be in in July but I think there is a good chance that over July and August it will be. And then once this ends we will start focusing on that second increase.

Okay. Thank you very much.

Thank you.

Don Carson with Merrill Lynch. You may ask your question.

Good morning. Two questions, really. First, on the ethylene side, Dan, the destocking seemed to go on a little longer than you thought. Was -- do you think that was a function that there is more inventories that have been built up in Q4 and early Q1? Or just the demand was actually weaker? And I guess the related question to that would be if the industry was somewhat surprised by the demand buildup or by the inventory buildup rather, in Q4, what's to prevent that from happening again. And then a related question on the styrenics cycle, styrene doesn't seem to be doing much more than just following benzene up and down here. Do you think -- do you see a scenario where styrene could ever get tight enough to actually get some decent margin expansion? And I know it is a co-product for you but just be interested in your views on the styrenics cycle.

I think that was three -- trying to go back on to--.

Okay.

I want to go back to the demand side, do we think it was more inventory or lack of demand, I wish I knew exactly but I guess my perception is it was probably more inventory. Although it is clearly debatable just how much inventory there was where, but clearly the perception in these large commodity industries is more important than the reality often. And I've told you before, I was hopeful we would see that destocking by the end of the second quarter, I think we actually, personally, we were well destocked before the end of the second quarter. I think the industry was close to there. Although we continue to see the information dribble out, so we're not quite sure that everybody really got there by the end of the second quarter. But the spot price movement would indicate that the perception is that the industry was there, because clearly, spot prices moved up smartly, and the polyethylene price increases are starting to take effect.

Now, the second question was what is to keep it from happening again. Absolutely nothing. I think we're all subject to our own judgment and the best information we can get, and certainly, we will be probably more cautious than we have been in the past, and I think we've always been fairly cautious, but I am not going to tell you that there is anything to prevent misjudgments in the marketplace again. It becomes less deleterious in the future as supply/demand continues to get tighter and tighter because there is less room for those errors to really make much difference. And I think that is the pattern that we continue to see that you can talk about whether demand is growing slowly or rapidly, but it is growing more rapidly than supply is. And therefore, the balance is getting tighter and the misjudgments about where inventories are will be less impactful then.

Finally, on styrene, we are finally starting to see some improvement in styrene. I think the spreads over benzene have moved up in Europe here recently over the last couple of weeks.

And in Asia.

And in Asia and the States. So it's not gangbusters but it is an improvement. And remember, if you simply looked at the price of styrene, you would think that that business was gangbusters. Because the price has been well up there. But it has been against a record benzene price environment and very high ethylene pricing. So the margins were not where they needed to be. I think now we're starting to see a little bit of margin expansion, but clearly, it has got a long way to go still.

And I guess the follow-up to that would be do you ever -- do you see styrene tightening up enough? It is hard to see how operating rates get much above 90% this cycle do you think--?

Historically, Don, 90% is pretty good for styrene. That will typically give you pretty good margins in styrene. So if it is not 90% for a few days and then fall back off, but rather 90% sustained for some period of time I think you could see some decent margins.

Okay. Thank you.

Nancy Traub with Credit Suisse First Boston. You may ask your question.

Hi, Nancy.

Hi, Dan. I wanted to hear your comments on the recent outages. We had problems at Nova, we had some turn-arounds, you had a turn-around, et cetera. You mentioned the spot ethylene price going up. How much of that was an impact -- was a result of these outages and how much do you think -- is there any evidence that it will be going down when they come back up here in August?

I think the way you got to look at this Nancy is that most people in the industry pretty well follow the scheduled outages, the turn-arounds, such as our Clinton, Iowa, outage. It is the unexpected ones, like the two Shell outages in the first quarter, and the Nova outage that are very hard to calculate what the impact is. I think we would tell you if you go back over history, and we use CNI, we know you do, everybody else looks at them, they actually have tried in the past to make some guesstimates about not only the planned but some unplanned as well, because there is a history, as there is in any operating industry, of things not working like they're supposed to sometimes. And over time, statistically, it would indicate that you should expect some amount of these.

However, we can never calculate what quarter they're going to happen in. And therefore, they're subject to causing flitterbations in the market whenever they do occur. If they occur at a time when the market is sloppy, it doesn't make much difference. But I think increasingly from where we sit today going forward, each and every one of these outages is likely to have a market impact, because the industry is starting to be in that tight enough zone that it can't easily heal for that loss. Does that make any sense to you?

Yes. And you mentioned how demand has improved quite a bit for polyethylene. How much of that do you think is pre-buying?

Well, it is not from the standpoint of our customer, because we're basically holding people to contract terms.

And how much would you expect volumes to be up third quarter versus second quarter?

I think it is early to make those kinds of statements. It sort of sounds like a projection.

Okay. Thank you.

Thank you.

Gregg Goodnight with UBS. You may ask your question.

Operating rates for U.S. ethylene were down the second quarter. What do you currently think the operating rates in the industry are as of right now?

As of right now, CMA makes second quarter effective operating rates, I believe 93.5%, and their outlook for the third and fourth quarter again, this is CMA's outlook, CMAI's outlook is about 96%.

Okay. What is your sense, though, of what the industry is running today? Those that can run.

I think those numbers are pretty close. If you look at our operation, we have one plant down for maintenance turn-around. That is our Clinton, Iowa facility. And the rest of our plants are running pretty much full.

Okay. The second question, MTBE, while it has been strong over here, it has been incredibly strong in Europe and elsewhere. Do you participate directly in any opportunities abroad?

We have large production facilities in Europe.

We manufacture about 30,000-barrels a day in Europe, and our facilities in France and Holland, and we're obviously participating very happily in the European market.

And are spot prices still $1,000 a ton in--?

I couldn't tell you what they are today but that is roughly the number that we've been seeing, and the European market is very strong indeed.

Okay. Would you split out your second quarter improvement say domestic versus Europe?

Greg, this is Doug. I would say the markets moved, pretty much together, one week, one was a little ahead of the other, the other one caught up, so I would say if you look at it, as the markets were pretty equal in terms of the cents per gallon improvement in margins.

Okay.

And our volumes are comparable in the region.

Okay, last question. If I could. In terms of the energy bill, the limited liability apparently isn't going to be put in that, but there was a compromise, a trust fund that was proposed for MTBE cleanup, some of the numbers were like $11 billion, 4 of which would be contributed by industry. Do you see any potential of that trust fund being split out separately from the energy bill? And if so, would you -- would your company have to contribute to the -- a portion of that?

No, Gregg, we don't see that. I think that was an attempt to package a whole series of things into the bill. And when that did not happen, I think that whole concept is gone now.

Okay. Thanks a bunch.

Thank you, Gregg.

Kunal Bannerjee with Morgan Stanley. You may ask your question.

Good morning. Just on that LCR, just trying to again move to the third quarter, the puts and peaks here, taking that 80 to 85 million out, but sticking with the 10 million on the force majeure that's a match of about 70 to 75 million, that just gets you back to square one, on normal operation, and then we should really be looking at any incremental sequential margin change in the spot crude out there, right? That's the way to look at that?

I think you got it pretty well.

Okay. Now, you talked about your CSA volumes being a little more than the 230. Is that going to be something like 235 so that would still give you about 30 to 35 out on the spot?

Yes, this is Doug, I think it would probably be in that range.

Okay. And then just quickly on Ti02, maybe I'm missing something here, your EBIT seemed to go down, and your EBITDA seemed to go up, and the swing was about 9. So, you know, D&A went up by 9, although I'm aware of that you are actually rationalizing capacity, and fixing that business, so was there something going on that I'm missing?

The D&A moved by about 2, but there is about 6 million of other income, which we don't pick up in the operating income.

Okay.

And so that's -- that's related to 4X changes and things.

Okay. And then finally, you talked about a $15 increase in sales price. On the cost side, apart from the FX, et cetera, just the operating costs on raw materials, it looks like chlorine kind of stayed flat, it wasn't moving much, or maybe moved up like $20, I don't remember, but is there anything happening on the ore side or are you pretty fixed on ore costs?

No I think it is just some changes of ones and twos and some of the operating costs at the various facilities in the quarter, and this -- as Dan mentioned, Ti02 has a larger fixed component, operating rates, and things will have a little bit more of an impact on things quarter to quarter than you might see in a business like ethylene which is very much a variable cost-driven business.

So we're not seeing a big trend in ore, to answer that question.

Okay. Thanks. Thanks a lot.

[OPERATOR INSTRUCTIONS] Our next question comes from Robert Goldberg with Scopist Asset Management. You may ask your question, sir.

Good morning.

Good morning, Bob.

On propylene, could you just give us some sense of the supply/demand as we go into the third quarter? There seems to be some supply removed from the market in terms of refineries switching over to other -- other fuels, and give us some idea of the outlook for propylene prices in the third quarter.

Well, the best sense I can give you is the spot prices have turned up. And we won't make any predictions about where it is is going but we think that the trend is in the right direction.

The thing to remember is that refiners tune their cat crackers according to profitability of the output. And when propylene pricing was much higher, you were attracting propylene out of the refineries, so they were optimizing the cat cracker that produced propylene. As the price came down, that incentive disappeared and so as a result of that, you see a drying up of the refinery propylene in the marketplace. So that is a continual process. It goes on every month throughout the year, every year. And I think you can see that continue but I think that's what you're seeing in the supply coming down a bit. Which of course does support spot price moving up, and contract price moving up.

And a quick question on polyethylene, I apologize if I missed this, but has the export market opened up any better for U.S. producers? Are you exporting any polyethylene into the Far East?

There is a margin to export and there are exports moving of some consequence. Again, it is not a huge deal for us, since the majority of our export business is NAFTA but yes, we observe it and we do participate from time to time as well. So I would tell you that the growth in Asia continues and that they are back in the market, and they are attracting suppliers from elsewhere in the world.

My last question was on MTBE. In terms of the sustainability, I know you said to an earlier question, you expect it to -- a strong market to continue through the third quarter. Can you give us again some idea on -- in terms of supply/demand dynamics, looking out a little bit further, capacity has been taken out, are there imports that can come in to the U.S., given the high prices, or into Europe, you have high prices in both regions, and what kind of demand outlook do you think we have now that this energy bill is not going to call for a national ban?

Well, demand has actually grown considerably in Europe. And that's the result of changing gasoline specs, and a couple of other factors. And actually, in the States today, you've got about 150,000 barrels of supply. I would say that we are going to continue to see fairly snug conditions on a global basis for MTBE. As the MTBE situation States plays out, demand is going to decline, but we think that there is still a lot of high cost supply that will come offline. And we don't see demand diminishing or declining in Europe. We actually see strength for MTBE in other parts of the world as well. So our view on it, on a global basis is pretty balanced.

Are there any imports coming into the U.S.?

Oh, sure. There are always some imports coming in.

Yes, Bob, U.S. has always been supported by imports, both in blended gasoline and as MTBE. Current demand in July was estimated at about 200,000-barrels a day by some consultants, and supply in the U.S. is about 140,000, 145,000, so we couldn't be making the gasoline without the imports right now.

But the other trend taking place is with the change in European specification on gasoline. It is up, the demand for components like MTBE in Europe as well, so you got very good growth there, and I think it is the combination of reduced supply, balancing the supply/demand here and the rapid growth in Europe that has brought the world into this relative tightness. Now, as we go forward, we should not have you believe everything is hunky dory here, because we don't know what the situation is going to be like going forward in this country. We still face continued challenges state by state. We have state bans that have been enacted in several places. And I would not want you to believe that that's going to stop. We don't see any reason why you won't see more of that action. But I think what Morris was saying is that you come back to more of the concept of -- you have a possibly shrinking market but if you're in the best cost position, you should be able to stand it the longest, and the situation we see right now, with very tight gasoline is the margins are very good, and it makes sense to continue to participate.

And for the time being, at least, in July, it looks like the margins, raw material margins are about double the second quarter average, is that about right?

Yes, they're about -- well, raw material margins, market margins right now are about $1.16 a gallon.

Thanks a lot.

Thank you.

Kevin McCarthy with Banc of America Securities, you may ask your question.

Hi, Kevin.

Hi, Dan, I just had a couple of quick follow-ups on MTBE. At one point several weeks ago there was some talk of attaching the liability protection to another bill outside the energy bill. I was wondering if that is still a meaningful possibility at this juncture? And then my second question was, with these margins so high in July, is there any chance that we could see a restart of any units that were formally closed?

Well, on the first question, I think my take on it, which that and four bucks might get you a Starbucks, I'm not sure, is no, you will not see any attempts to attach anything like that to other bills. I think the arguments have all been made. The issues have been decided. For better or worse. And you're going to see the energy bill progress. And I think you're not going to hear more comments about this from any of the people that we know about. Your second question was what?

The second, I was just wondering if there will be any restarts in MTBE now that margins are so high?

I wish I knew the answer to that. I think clearly, I could tell you what we would be doing, if we were in that situation, we would look at it and say yes, it is very tempting but by the time you get out, who knows what the situation is going to be, and on balance, I'm not sure that we would rush into it. Now that doesn't necessarily mean that somebody else won't. So I think you would have to look on a case by case basis and say is there anybody out there who is likely to do that. But I would be surprised if you see much of a trend that way.

Okay. Thanks again, guys.

Thank you.

Sol Lenot with Longacre Management. You may ask your question.

Hi, I was wondering if you could give a sense of the outlook you're seeing 3Q for the PO market and its derivatives?

We still see reasonably good conditions in PO and derivatives. As I said a little while ago, we see healthy margins and we don't see any reason for that to change.

Any reason to believe margins will continue to expand throughout the rests of the year?

Well, as I said earlier, expansion is a relative thing and we've seen very, very strong expansion over the last year, I wouldn't advise you to consider that's the trend line that we're going to see going forward.

Especially as you see propylene recovering, it is an input to this segment, so you got to have things improved just to offset propylene going up.

Is demand tight enough that -- with propylene, the spot markets higher, is demand tight enough that you might be able to pass that on in price increases going forward?

Well, as I indicated earlier, we're running our PO plants somewhere in the mid-90% of capacity range and that would be an indication that the supply/demand balances are fairly snug.

Yes, I think we would expect -- here in that shape.

Thank you.

Our final question comes from Chris Willis with Impala Funds. You may ask your question, sir.

Hi, Chris.

Good morning. How are you?

Good.

Just had a quick follow-up on the MTBE thing with the Texas Petrochemical just restarted an MTBE plant, I presume that is what pushed pricing down $0.20, $0.30 a gallon in the last couple of days, although it looks like that is being absorbed pretty well, pricing still has exceptionally strong levels in it. Any thoughts there?

Well, I don't think that was unexpected and I would not couple the two quite as directly as you did there. I think what they were looking at is whether they restarted or made a conversion and they elected to restart because the timing of the work and everything else is what I understood. But I think the market was anticipating that, knew that was coming, so I think more likely, what you're seeing is just the day by day, week by week gasoline blending situation around the world dictating what the pricing is. It is like all the other fuels. They're not really settled on a monthly basis or quarterly basis. They're trade by trade basically.

And Chris, this is Doug. The TPC addition, they only added about 8,000 barrels. That was the unit they shut down previously. I'm not sure how long it is really going to be, they're planning to run it, so.

They're saying a month but I guess it will be day by day, okay.

Yes.

Okay. Thank you.

Thank you.

Are there any more question, operator?

There are no more at this time, sir.

Well, we thank everybody for your participation and your interest in the Company. We look forward to talking to you next quarter.