Estimation of production cost and revenue

Authors: Nick Pinkerton, Karen Schmidt, and James Xamplas (ChE 352 in Winter 2014)

Steward: David Chen, Fengqi You

Variable Cost of Production

Variable costs of production are dependent primarily on plant output and rate of production. There are many variables to consider when costing a plant.

1. Raw materials consumed
2. Utilities-steam, electricity, cooling water, fuel, etc.
3. Consumables - acids, bases, solvents, catalysts, etc.
4. Disposal
5. Shipping

The majority of the variable costs for a production plant are the raw materials and utilities costs. Variable costs can be greatly cut through optimization techniques and intelligent plant design (Towler and Sinnott, 2013).

Raw Materials Cost

Calculating the annual cost of a raw material is calculated by simply multiplying the feed rate of the process by the appropriate price per volume or mass. These are the costs of chemical feed stocks required by the process. Feed stocks flow rates are obtained from PFD (Turton et al., 2013).There are several ways to optimize this cost to ensure that a process is not costing more than it should. First one should assess the actual consumption of a plant to see if it is significantly different from what should be expected based on process stoichiometry and selectivities (Towler and Sinnott, 2013). Finding may prove that a process is less efficient than it originally claimed. It is smart to benchmark a new plant design against an existing plant or pilot plant. Raw materials are typically the largest contributor to overall variable costs. For bulk chemicals and petrochemicals, raw materials represent 80-90% of the total cash cost of production (CCOP).

Utilities Cost

These are the costs of the various utilities streams required by the process. The flowrates for the utilities streams are located on the PFD (Turton et al., 2013). This includes:

• Fuel gas, oil, or coal
• Electric power
• Steam
• Cooling water
• Process water
• Boiler feed water
• Air
• Inert gas
• Refrigeration

Utility streams are excellent ways to streamline a process and are often indicative of how efficient of a process the project is. Process methods such as steam generation and pinch analysis can be used to greatly reduce utility costs across a plant. Further analysis of pinch analysis techniques and optimizing heat exchanger networks can be found in plant design texts such as first reference from Gavin Towler. The determination of process utility costs is often more difficult than the determination of raw material costs; however, the utilities are typically between 5-10% of CCOP (Towler and Sinnott, 2013). The cost of heating a process can be reduced by using process waste streams as fuel which consequently also reduces the need for waste disposal.

Waste Disposal Costs

These are defined as the cost of waste treatment to protect the environment (Turton et al., 2013). These are materials that cannot be recycled or sold off as by-products. Often times these streams require additives or additional treatment to meet governmental regulations. Hydrocarbon waste can often be incinerated directly to the atmosphere or used as process fuel to heat other streams in the system. Using the stream as process fuel allows the fuel value of the stream to be recovered into the system. The substituted value can be calculated by multiplying the conventional fuel price by the heat of combustion of the waste stream.

$P_{WFV}=P_{F}*\Delta H_{C}^{o}$

where $P_{WFV}$ = waste value of fuel ($/lb or $/kg)

$P_{F}$ = price of fuel ($/MMBtu or $/GJ)

$\Delta H_{C}^{o}$ = heat of combustion (MMBtu/lb or GJ/kg)

Dilute aqueous streams must be sent to wastewater treatment typically prior to purging from the plant. Acidic or basic wastes are neutralized prior to treatment by salting out the acid or base. The cost of wastewater treatment is typically about $6 per 1000 gal but this is only an estimate that doesn't account for regional charges (Towler and Sinnott, 2013).

Solid waste treatment can typically be sent to a landfill at a cost of approximately $50/ton (Towler and Sinnott, 2013).

Hazardous wastes arise from the production of concentrated liquid streams that cannot be incinerated. Hazardous wastes should be avoided if possible, but that is not always feasible for some processes. The cost of hazardous waste disposal is strongly dependent on the location of the plant, the plants proximity to waste disposal plants and the degree of hazard of the waste.

Fixed Cost of Production

Fixed costs are those whose amounts are independent of production rates. Much of these costs are personnel salaries, taxes, insurance, and legal payments.

Labor Costs

These are the costs attributed to the personnel required to operate the process plant [5].

The number of operators required per shift, $N_{OL}$ can be estimated by

$N_{OL}=(6.29+31.7P^{2}+0.23N_{np})^{0.5}$

where $P$ is the number of processing steps involving particulate solids and $N_{np}$ is the number of other processing steps [5]. For each of the $N_{OL}$ operators per 8-hour shift, approximately 4.5 operators must be hired for a plant that runs 24 hours per day, to account for the 3 shifts per day and the 3 weeks of leave typically taken by each operator per year [5]. The salary for a chemical plant operator varies by location, and the estimator should look up the average value for the area.

Maintenance Costs

These are the costs associated with labor and materials necessary to maintain plant production. An estimate of these are 6% of the fixed capital investment [5].

Research and Development

These are the costs of research done in developing the process and/or products. This includes salaries for researchers as well as funds for research related equipment and supplies. An estimate of these costs are 5% of the total manufacturing cost [5].

Taxes and Insurance

Taxes vary by location, but a first estimate of property taxes and liability insurance is 3% of the fixed capital investment [5].

Plant Overhead

Overhead costs are the miscellaneous but necessary costs of running a business, including payroll, employee benefits, and janitorial services. This may be estimated as 70% of the operating labor costs, added to 4% of the fixed capital costs [5].

Licensing and Royalties

The costs of paying for the use of intellectual property clearly varies, but an estimate that may be used is 3% of the total manufacturing cost [5].

Revenues

The revenues of a process are the income earned form sales of the main products and the by-products. Revenue can be impacted by market fluctuations and production rates.

By-Product Revenues

Besides selling the main product from a process, by-products from separations and reactions can also be valuable in the market. Often it is more difficult to decide which by-products to recover and purify than it is to make decisions on the main product.

By-products made in stoichiometric ratios from reactions must be either sold off or managed through waste disposal. Other by-products are sometimes produced through feed impurities or by nonselective reactions. There are several potential valuable by-products from a process:

1. Materials produced in stoichiometric quantities by the reactions that create the main product. If they are not recovered then the waste disposal expenses will be large.
2. Components that are produced in high yield by side reactions.
3. Components formed in high yield from feed impurities. Many sulfurs are produced as a by-product of fuels manufacture.
4. Components that are produced in low yield but have high value. An example includes acetophenone which is recovered as a by-product of phenol manufacture.
5. Degraded consumables (e.g. solvents, etc.) that have reuse value.

A rule of thumb that can be used for preliminary screening of by-products for large plants is that for by-product recovery to be economically feasible the net benefit must be greater than $200,000 a year. A net benefit can be calculated by adding the possible resale value of the by-product and the avoided waste disposal cost [1].

Margin

The gross margin of a process is defined as the sum of product and by-product revenues minus the raw material cost.

Gross margin = Revenues - Raw materials costs

Because raw materials are most often the most expensive variable cost of a process, the gross margin is a good gauge as to what the total profitability of a process will be. Raw materials and product pricing are often subject to high degrees of variability which can be difficult to forecast. The size of margins are highly versatile depending on the industry. For many petrochemical industries the margin may be only 10%; however, for industries such as food additives and pharmaceuticals the margins are generally much higher [1].

Profits

There are several standards for calculating company profits. The cash cost of production (CCOP) is the sum of the fixed and variable production costs.

$CCOP=VCOP+FCOP$

where $VCOP$ is the variable cost of production and $FCOP$ is the fixed cost of production.

Gross profit, which should not be confused with gross margin, is then calculated by the following equation,

$Gross\ profit=Main\ product\ revenues-CCOP$

Finally profit can be calculated by subtracting the income taxes that the plant would be subject to depending on the tax code of the county the plant is located in.

$Net\ profit=gross\ profit-taxes$

Pricing Products and Raw Materials

The revenues and costs of a project are vital to determining its economic feasibility. To calculate these values one needs to multiply the respective product and feed streams by their respective prices. The major difficulty of this process is determining the prices that should be used in this formula. When analyzing a plant, not only do the current prices need to be acknowledged but also the stability of the market to forecast future fluctuations and deviations.

Pricing Fundamentals

The pricing of a substance is determined by the fundamental economic principles of supply and demand. A supply curve and demand curve can be graphed and added to determine the market equilibrium price and projected market size. There are many ways a company can combat if the market equilibrium pricing is not suitable for a process. One of these ways is changing the market that the company is selling to. Instead of selling industrial grade product there may be markets for pharmaceutical grade or food grade that would allow for a company to sell their product at higher margins. Another avenue to look into is changing the geographic market being sold to. Rarely is there a global synchronous market, but rather a variation depending on where in the world the product is being sold. It is possible that a company could make more money by dedicating their sales to the Asian market as opposed to the US or vise versa.

Price Data Sources

There are many resources when trying to determine the price of a chemical or utility. This are important for looking at current pricing information as well as historical data that can be used for forecasting purposes.

Internal Company Forecasts

Large companies will often have the marketing or development departments develop a forecasting database that can be used internally in the company. Forecasts of this magnitude will often have multiple scenarios and projects that are evaluated under the given parameters. Companies may even license these forecasts to other companies for high fees if they desire.

Table 1 provides common industry acronyms that are used to indicate certain key words when determining pricing information.

Trade Journals

There are also many publications that report pricing data weekly. ICIS Chemical Business Americas used to publish the prices for hundreds of chemicals but have more recently changed their data to an online database that requires a subscription. This service is very expensive, but necessary for many companies. Oil and Gas Journal publishes the market prices of many crude oils and other petrochemicals using data from several continents. This journal also provides margin data for many refineries and plants on a monthly basis. Chemical Week provides the spot and contract prices for 22 chemicals in the US and European markets.

Consultants

If trade journals are not adequate for the information needed, some companies will contract consultants to do deep research into the subject. Consultants are excellent resources for providing economic and marketing information but come at a large price. There are several companies that provide this type of service but some of the larger firms include: Purvin and Gertz, Cambidge Energy Research Associates, Chemical Markets Associates Inc., and SRI: The Chemical Economics Handbook

Online Brokers and Suppliers

Often time price data can be supplied by the supplier themselves and using online directories. Restraint should be used when quoting these prices however because they are often spot prices that are much higher than what would be expected from bulk contract supplying.

Example Case: Estimating Cost of Production

Use the following information to estimate the manufacturing cost of a plant producing 120*10^6 lb/year with a product price of $0.20/lb.

Fixed Capital: $15,000,000

Working Capital: $3,000,000

Fixed and Working Capital = FC + WC = $18,000,000

Raw Material Cost: $9,600,000/yr

Utilities: $1,440,000/yr

Labor: $1,800,000/yr

Maintenance (6% yr f.c.): $900,000/yr

Supplies (2% yr f.c.): $300,000/yr

Depreciation (8%/yr): $1,200,000/yr

Taxes, insurance (3%/yr): $450,000/yr

Total Manufacturing Cost = RMC + U + L + M + S + D + T = $15,690,000/yr

Gross Sales = Production * Product price = $24,000,000/yr

Gross Profit = Gross Sales - Manufacturing Cost = $8,310,000/yr

Conclusion

Thermodynamics and kinetics are essential to designing an operational plant, but at the end of the day profits and margins are what make plants go from the engineering paper pad to operating continuously. Before any ground is broken, estimation of production costs and revenues are absolutely necessary to assure CEO's and shareholders that this process is a profitable and worth while venture. There are many avenues to achieve these answers with some being more accurate than others. The best indicator of these answers will be in pilot plant design which will provide appropriate estimations for scaled up processes.

References

1. Towler, G.P. and Sinnot, R. (2012). Chemical Engineering Design: Principles, Practice and Economics of Plant and Process Design.Elsevier.
2. Biegler, L.T., Grossmann, L.E., and Westerberg, A.W. (1997). Systematic Methods of Chemical Process Design. Upper Saddle River: Prentice-Hall.
3. Peters, M.S. and Timmerhaus, K.D. (2003). Plant Design and Economics for Chemical Engineers, 5th Edition. New York: McGraw-Hill.
4. Seider, W.D., Seader, J.D., and Lewin, D.R. (2004). Process Design Principles: Synthesis, Analysis, and Evaluation. New York: Wiley.
5. Turton, R.T., Bailie, R.C., Whiting, W.B., and Shaewitz, J.A. (2003). Analysis, Synthesis, and Design of Chemical Processes Upper Saddle River: Prentice-Hall.