Chinas Chemical Industry.docx

Chinas Chemical Industry.docx

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ChinasChemicalIndustry

China'sChemicalIndustry:

FlyingBlind?

FormultinationalchemicalcompaniesworkinginChina,therulesofthegameareshifting.Successrequiresdramaticchangeinpastpracticesandnewstrategiestoensureimmediateandlong-termsuccess.

Rosyexpectationsfromheadquartersaboutgrowth,profitability,andcompetitioninChinaclashwiththemorerealisticpicturefromtheground:

Newforcesarereshapingthechemicalindustryformultinationalcompaniesworkingthere.

China's12thFive-YearPlan（approvedonMarch14,2011,andeffectivethrough2015）willfurtherchallengemultinationals'once-certaingrowthandprofitability,aspolicymakersputtheirstampontheindustryandcreateanunevenplayingfieldthatfavorsstate-ownedenterprises（SOEs）.ThenewestplanseekstoincreaseChina'sself-sufficiencyinchemicals,createnationalchampionswithmoreaccesstoWesterntechnologyandprocesses,secureinternationalaccesstorawmaterials,andprovideSOEswithprivilegedaccesstokeyrawmaterialsandenergy （seesidebar:

China'sDeterioratingAccesstoLaborandRawMaterials）.Atthesametime,theplanisaimingtoboostdomesticconsumptionbyexpandinginfrastructureandcreatinghousingforabout300millionmigrantsmovingtocities,whiledealingwithsevereenvironmentaldegradationandavoidingsocialunrest.

Thisreport,basedonourresearch,ourexperienceinChina,andmorethan25interviewswithpresidents,vicepresidents,managingdirectors,anddirectorsworkingforchemicalmultinationalsoperatinginChina,offersawindowintooneofthemostimportantindustriesinChina.

TheIndustry'sGrowth

Chemicalsarefundamentaltoalmostanyeconomy.Inthelate19thandearly20thcentury,forexample,formerlyagrarianandnewlyconsolidatedGermanydevelopeditschemicalindustrytomovepasttheeconomyoftheUnitedKingdom,wheretheIndustrialRevolutionfirsttookhold.TodayinChina,thechemicalandpetrochemicalindustriesarecriticaltomanyrapidlygrowingindustrialsectors,includingconsumergoods,automotive,andconstruction.Asaresult,thechemicalindustryhashighprioritywithintheChinesegovernment.

China'schemicalindustryhasgrowndramaticallyinthepast30years,inlinewiththecountry'soverallgrowthandthefundamentalsofkeycustomerindustries.Chinawillsoonrepresentone-thirdoftheglobalchemicalsdemand（seefigure1）.ThepictureremainsoptimisticforforeignchemicalcompaniesinChina,asthecountrycontinuestodependonforeignproducersformanychemicals,particularlyadvancedspecialtychemicals,despitethegovernment'sself-sufficiencygoals.

AsChina'smarketgrows,moretopmultinationalsareincreasingtheirexposuretothemarketastheyinvestinlocalChineseproductionfacilities.SomesmallerplayershaveinvestedsomuchinChinathatthemarketisnowoneoftheircorebusinesses—ifnottheircorebusiness.Intandemwithforeignmultinationals'increasinginvestmenthasbeentheriseofchemicalSOEs—theleadingSOEshaveincreasedtheirinvestmentbudgetsandhavegrownimpressivelysince2008.Overall,chemicalrevenuesinChinagrew24percentyearoveryearbetween2005and2010.

By2014,China'sshareoftheglobalchemicalsmarketisprojectedtoriseto29percent.Stronggrowthinchemicalscomesinlargepartfromgrowthincustomerindustries.China'sautomobileindustrygrowthwillaverage24percentperyearbetween2008and2012,eventhough2011growthwasalmostflat.Consumerelectronicswillgrow23percentayearbetween2008and2015,andconstructionwillsee24percentyearlygrowthoverthesameperiod.Chineseconsumersaredrivingthedemandintheautomotiveandconstructionsectors.Despitearecenteconomicslowdown,medium-andlong-termgrowthprojectionsaresound.

ThekeyissueforchemicalmultinationalsisthattheirfatedependsonChinesegovernmentpolicyatthenational,provincial,andlocallevels.GovernmentinfluenceinChinaiscomplexandoftenopaque.ItstartswiththeFive-YearPlan,whichincludesindustrialpolicygoals,safetyandenvironmentregulation,accesstofeedstock,pricing,licensing,andpermissions.Theattitudes,beliefs,andpressuresoftheextralevelsofgovernmentcanalsobedifficulttoassess.Chemicalmultinationalswillbenefitbyputtingmoreeffortintounderstandingandcommunicatingwithallstakeholdersandconsideringhowgovernmentactionsmayevolve,withcorrespondingscenarioplansattheready.

TheCapitalInvestmentPicture

ThechemicalindustryinChinareachedaturningpointin2008whenoutboundinvestmentfromChina,equaling36percentoftheglobalindustry'stotalforeigndirectinvestment（FDI）,becamesignificantforthefirsttime.In2009,whenWesterneconomieswerereeling,China'soutboundinvestmentdroppedsomewhatinabsolutetermsfrom$53billionto$44billion,butgrewrelativelyto56percent.Theincreasewillcontinue,reaching$137billionin2015.InboundFDIinchemicalswillplateauinthe$160billionto$200billionrangethrough2015,asChina'sgrossdomesticproductslows.

Mostexecutiveswespokewithareconfidentaboutfuturedemand.Nearlyallsurveyedsaytheirreturnoncapitalexpendituresimprovedin2010andtheyexpectfurtherimprovementin2011.TheybelievethatdoingbusinessinChinawillbecomeeasierasintellectualproperty（IP）protectionimprovesand,importantly,astheirunderstandingoflocalgovernmentdevelopsinparallel.

GovernmentPolicyGoalsHaveChanged

GiventheenormityofChina'spopulation,thegovernmentsetsgoalsaroundbotheconomicgrowthobjectives,includingemployment,andconstraintssuchasfoodsupply,water,energy,andoil.Thechemicalindustryisnodifferent.However,governmentpoliciesandgoalshaveshiftedsincetheeconomywasopenedupin1978.Weseethreephases:

1978-1990:

Reformandopeningup. Theeconomywasopenedtotheworldin1978,andthegovernment,understandingtheimportanceofthechemicalindustry,permittedbutheavilycontrolledFDI.MoreimportantthanFDIisthefactthatChina'sdomesticconsumptionboomed.MostcompaniesinvestedinChinatoproduceforChinesedemand.

1990-2000:

Foundationbuilding. MultinationalswerepermittedtoenterChinatogenerateexportsales,andjointventuresbetweenchemicalmultinationalsandChinesefirmswereallowed.IncentivesencouragedmultinationalinvestmentinChina,andchemicalindustrialparksweredevelopedtomanageandfacilitatelanduse.

2000-2011:

Alandofopportunities. Growthprojectionsduringthisphasewerelimitless.FDIbychemicalmultinationalsboomedasChinabecamemoreintegratedintotheworldeconomyandchemicalsbecameamajorChineseexport.

Anewphase,startingin2012,islikelytobemorechallengingformultinationals,withcapitalinvestmentpotentiallymuchriskier.Whilegrowthprojectionsremainhigh,weexpectthegovernmenttointervenemoreactivelytoupgradeandreconfigurethestructureofcompetition.Thegovernmentisseekingtoincreasethelocalvalueaddedinthechemicalindustrybygainingmoreaccesstospecialtyandfinechemicalsandimprovedchemicalproductionprocesses.Inmanysegments,thishasincreasedcompetition.

OpportunitiesinChinaremainimpressive,butthisneweraforthechemicalindustryisfarmorecomplicatedthaninthepast.MultinationalsthatarebetterinformedandbetterconnectedwithgovernmentagenciesandbuildmoresupportfortheirpresenceinChinawillhaveagreaterchanceofcounterweighingSOEs'politicaladvantages.AssimilatingintotheChineseeconomy—andbeingperceivedasdoingsobymeasuringandcommunicatingthebenefitstheyoffer—isastrategicimperative.

Self-Sufficiency

Unlikeconsumerproductsandotherareasoflessstrategicimportance,alargetradedeficitinchemicals—$54-5billionin2009—isamajorconcernforagovernmentthatwantsself-sufficiencyinstrategicallycriticalindustries.

Despitethegovernment'spush,thetradedeficitoffersanopportunityformultinationals.Forexample,domesticdemandformanychemicalsusedinplasticsoutpacescapacityandwillcontinuetodosothrough2020—representingapotentialinvestmentopportunityformultinationals（seefigure2）.Thetradeimbalanceismoredramaticinoilandgas,asChinahasalmostnooilreservesandfewanticipateddiscoveries.

Multinationals'IncreasingExposuretoChina'sMarket

China'sgrowthandpastcapitalinvestmentmeanthatChinarepresentsagreaterpercentageoftotalrevenuesforchemicalmultinationals.Between7.5and50percentofthetotalsalesforthetop15multinationalsinChinacomefromChina,andsmallerfirmshaveofteninvestedevenmoreaggressively.

Thelargerinternationalchemicalmultinationalsarenotsittingstill.China'sgrowthisleadingtoadditionalinvestmentinpetrochemicals,basicchemicals,polymers,andspecialtychemicals—includingDow's$8billionto$10billioncoal-to-chemicalsprojectwithpartnerShenhuaGroupandDuPont'sjointventurewithChenguangChemicalResearchInstitutetoproducefluoroelastomers.

Chinesecompaniesarealsogrowingstrongerandmakingsignificantcapitalinvestmentsdomesticallyandinternationally.SOEsSinopec,PetroChina,CNOOC,ChemChina,andSinochemallsawyear-over-yearrevenueincreasesofmorethan30percentin2010.Becauseofgovernmentsupport,theseSOEshavealmostunlimitedbudgetstopursuetheirstrategiesandinternationalexpansionandtoincreasetheircompetencies.Multinationals'competitivepositionisgrowingmoredifficult,notjustinChina,butpotentiallyglobally.

TheRulesHaveChanged

Withthechemicalindustry'sincreasedprominenceinChina,therulesofthegamehavechanged—moresuddenlythanmanyinglobalheadquarters