abare.gov.au - research report 08.02

6	Implications for the TiRO pilot plant project and an australian titanium metal industry

The role of government in encouraging the further development and possible commercialisation of the TiRO process and the potential development of an Australian titanium metal industry is examined in this chapter. An initial assessment of the TiRO/CSIRO R&D project that was undertaken by ACIL Tasman in 2006 is presented first. Several further issues are then discussed, with a focus on the potential role of the Australian Government in facilitating the technology innovation process in the titanium market and in enhancing prospects for the development of an Australian titanium metal industry.

ACIL Tasman estimates of the value of the TiRO/CSIRO R&D project

In October 2006, ACIL Tasman released an initial assessment of CSIRO’s ‘light metals flagship’ (LMF) research program (ACIL Tasman 2006). The five themes in the LMF program are alumina, aluminium, magnesium, aluminium and magnesium manufacturing, and titanium.

As given in ACIL Tasman (2006, pp. 37–8), the ‘main goal of the titanium theme is to establish a 20 000 tonne per annum titanium metal industry in Australia by 2012. The theme is split into three streams. These are:

to optimise Australia’s resource base

to develop continuous scaleable metal production technologies and

to establish new markets through low cost fabrication technologies.’

The focus in this section is on ACIL Tasman’s assessment framework and estimates of the value of TiRO, the CSIRO patented technology for producing commercially pure titanium. ACIL Tasman notes that the assessment framework used in the report aims to provide conservative estimates of the value of an R&D program from the bottom up.

The assessment framework for the TiRO/CSIRO R&D project, based on ACIL Tasman (2006), is presented in table 12.

TiRO/CSIRO R&D project

ACIL Tasman (2006) assessed the value the TiRO/CSIRO R&D project where a successful outcome is investment in a commercial plant in Australia. ACIL Tasman (2006) identified three key investment stages in the successful progress of the TiRO/CSIRO R&D project to the development of an Australian titanium metal industry:

pilot plant — the aim is to test the technology in a pilot plant over a two year period at an assumed cost of $10 million

demonstration plant — the aim is to confirm the scalability of the technology in a demonstration plant with an annual production capacity of 1500 tonnes; this phase is assumed to take two years to complete and cost around $32 million

commercial plant — the aim is to construct a commercial plant with an annual production capacity of 20000 tonnes; the construction phase is assumed to take two years to complete and cost around $147 million.

Six possible outcomes from the TiRO project are considered in the simplified decision tree presented in the first part of table 12:

possible outcome 1 — the TiRO project is abandoned (15 per cent probability of this outcome occurring)

possible outcome 2 — the TiRO project proceeds to the pilot plant stage to test the technology but is then abandoned (34 per cent probability)

possible outcome 3 — the TiRO project proceeds to the demonstration plant stage to confirm the scalability of the technology but is then abandoned (15 per cent probability)

possible outcome 4 — the demonstration plant indicates that the TiRO process is viable but is abandoned as it is not cost competitive with an overseas technology (18 per cent probability)

possible outcome 5 — the demonstration plant indicates that the TiRO process is viable and there is no overseas technology but is abandoned (9 per cent probability)

possible outcome 6 — the TiRO project proceeds to the commercial plant stage (9 per cent probability of success).The variables listed in the first column of table 12 are defined in the footnote and are consistent with those used in the economic framework for investment decisions presented in box 2. It should be noted that ACIL Tasman (2006) uses slightly different terminology — net present value (NPV) is referred to by ACIL Tasman as the net return in NPV terms and the expected net present value (ENPV) is referred to as the weighted average value in NPV terms. The two approaches are identical if the discount rate used by ACIL Tasman is assumed to be the risk free interest rate — in this case, the ENPV is the appropriate profitability measure for a risk neutral investor. If the discount rate incorporates a risk premium, however, the weighted average value in NPV terms is an approximation of the certainty equivalent value (CEV) of the project (that is, a risk adjusted valuation) — the CEV is an appropriate profitability measure for a risk averse investor. In table 12, the discount rate is assumed to be the risk free interest rate and the weighted average value in NPV terms is assumed to be equal to the ENPV.

The net present value of each possible outcome and calculations for the expected net present value is provided in the second part of table 12 for the TiRO/CSIRO R&D project. As indicated above, there is a 9 per cent probability of success in establishing a commercial plant in Australia based on the TiRO process — the net present value of this outcome is $1303 million. The expected net present value of the TiRO/CSIRO R&D project is $107 million.

TiRO pilot plant project

The ACIL Tasman estimates have been used to derive the expected net present value of the pilot plant project. It is assumed that the decision is whether to proceed with the investment in the pilot plant to test and debug the TiRO technology or not. In this case, there are five possible outcomes with an 11 per cent probability of success in establishing a commercial plant in Australia. The expected net present value of the pilot plant project is estimated to be $126 million.

A risk averse investor in the pilot plant would need to assess the risk profile of the possible outcomes including:

a 40 per cent probability that the pilot plant will be abandoned, with a loss of $8 million in NPV terms

a 49 per cent probability that the project will subsequently be abandoned before the commercialisation stage, with a loss of $15 million in NPV terms

an 11 per cent probability that a commercial plant will be established, with a profit of $1.3 billion in NPV terms.

In practice, a private investor would undertake a more detailed risk assessment of the profitability of the commercial plant, particularly given the market risks associated with the project. The risk adjusted value of the pilot plant, or the certainty equivalent value (CEV), would be lower than the ENPV by the risk premium that is required to compensate the private investor for the risks associated with the project.

Further issues in the economic assessment of the TiRO pilot plant project

It is important to distinguish between the assessed private net economic benefits of an investment project (risk adjusted profitability or certainty equivalent value, CEV) and the expected social net economic benefits (expected social net present value, ENPV_S), the key criterion used to evaluate public investment options. The presence of positive externalities and risk results in a divergence between private and social net returns. Government involvement in the pilot plant based on the TiRO process would be justified if:

private investors, taking into account potential risks, assess the project to be unprofitable (that is, CEV < 0)

the government assesses the expected social net economic benefits of the project to be non-negative (positive or zero) — that is, the private risk premium and/or positive externalities are expected to be sufficiently large to provide a social net return on the public investment (that is, ENPV_S > 0)

the government ranks the project against alternative public investment options and assesses there would be merit in proceeding with the project.

The CSIRO project on the TiRO process represents a significant public investment in R&D on a new production technology in the titanium metal industry. The key issue for the Australian Government at this stage is whether it has a role in supporting the R&D project to the pilot plant stage. An economic assessment of this investment decision cannot provide the Australian Government with an unambiguous policy recommendation because the final assessment of the policy options relies to some extent on the subjective judgment of the government. Instead, the approach taken in this report is to analyse relevant issues in an economic framework that will assist the Australian Government in formulating its policy response.

Some key implications from the economic analysis in chapter 5 of this report include the following:

investment in the pilot plant represents an extension of the R&D project that involves testing and debugging the TiRO process — this is part of the technology RD&D (research, development and demonstration) phase.

consideration of policy intervention to support technology RD&D is justified on economic efficiency grounds — this phase in the technology innovation process is a relatively high risk activity that provides flow on benefits to others. The presence of market failures, including positive externalities and risk, is the main economic justification for consideration of government support for technology development and deployment.

the technology push policy approach emphasises R&D led innovation — R&D activity is encouraged by providing greater economic incentives for industry investment in R&D by reducing the costs and/or risks of the activity and through direct support for public investment in R&D. In this approach, policy options such as publicly funded R&D projects, public ‘proof of concept’ demonstration projects and associated public–private partnerships aim to address market failures.

ACIL Tasman (2006) provided a useful assessment of the TiRO project based on a simplified decision tree. This analysis indicates the direct net economic benefits of the pilot plant project are expected to be positive (details of the underlying assumptions are not available and, hence, the estimates should possibly be interpreted with some caution). There are several further issues that merit consideration by the Australian Government since these influence the assessment of any positive externalities associated with the project.

Australia’s participation in the TiRO project increases the probability that the international research effort will be successful in discovering a major new technology that reduces production costs in the titanium metal industry. Australia’s role in this research is based on its relatively abundant ilmenite and rutile resources that, in processed form, are essential inputs to the production of titanium metal. Given the quality characteristics of titanium metal, there is also significant scope for future growth in world titanium consumption in both established and new end use applications (see chapter 5).

Australia’s ongoing commitment to the TiRO project would further contribute to the international research effort that currently comprises twenty R&D projects, four of which are supported by the US Government. The impact that multiple independent R&D projects may have on the probability of success in discovering a new economic technology is indicated in table 13. The probability of success for an international R&D effort is provided under the simplifying assumption that the probability of success for each individual R&D project is 1 per cent, 5 per cent or 10 per cent. International R&D activity is assumed to comprise between one and twenty individual projects.

Multiple independent R&D projects can have an important impact on the probability of success in discovering a new economic technology. For example, if the probability of success for each R&D project is 5 per cent, the probability of discovering a new economic technology increases from 5 per cent for one project to 23 per cent for five projects and 64 per cent for twenty projects. If the probability of success for each individual project is 10 per cent, which is close to ACIL Tasman’s (2006) assessment for the TiRO project, an international effort comprising twenty independent projects has an 88 per cent probability of discovering a new economic technology.

If Australia is successful in commercialising the TiRO process, economic benefits may include:

the development of a titanium metal industry in Australia — this would represent an investment in a value adding economic activity, with economywide impacts such as an increase in the value of Australia’s exports.

royalty payments from intellectual property rights — TiRO is a CSIRO patented technology that would result in royalty payments if it is used in commercial operations in Australia and/or overseas.

increased competition in the world titanium market — in 2006, titanium sponge was produced in six countries by a total of fourteen companies (see table 1). There have been concerns in the past about the extent to which established companies may have used excess capacity as a barrier to entry to new firms, although the empirical evidence is mixed (see, for example, Koscianski and Mathis 1996). With excess capacity, firms can increase production in the short term to reduce prices and make it unprofitable for new firms to enter the industry, a practice that is referred to as predatory pricing. As a result of strong growth in demand in recent years, world capacity utilisation has increased from 60 per cent in 2000 to 95 per cent in 2006 (see chapter 3 for further information).

increased diversification in the geographic location of titanium production facilities — the development of an Australian titanium metal industry would reduce supply risks in the world titanium market by extending the range of geographic locations involved in titanium production.

If the TiRO process is not successful at the pilot plant or demonstration plant stages, an alternative path to the development of an Australian titanium metal industry may be to import a successful technology. The likelihood that Australia would have a competitive advantage in titanium metal production under a new technology is likely to be enhanced since private partners in the TiRO technology innovation process would benefit through learning by doing effects. This experience would also allow private investors to undertake a more accurate assessment of the profitability of alternative titanium investment options than would otherwise be the case.

In summary, information has been presented in this report to assist the Australian Government in its assessment of whether to support the TiRO/CSIRO R&D project to the pilot plant stage. It is beyond the scope of this study to provide the Australian Government with an unambiguous policy recommendation because the final assessment of the investment decision relies to some extent on the subjective judgment of the government. Should the government decide to invest in the TiRO pilot plant project, this is likely to enhance prospects for the development of a titanium metal industry in Australia. A domestic industry may be established through the commercialisation of the TiRO process or, if this technology proves to be not viable, by importing a successful technology.