According to CEFIC (European Chemical Industry Council), in 2016, China accounted for almost 40% of global chemicals sales, or € 1.33tn, much larger than the EU area’s share of 15% of global sales and NAFTA’s 16%. Clearly, China’s share is far bigger than even the NAFTA and EU area combined. For now, with a global chemicals market share of just 2.3%, India is only about one-twentieth the size of China’s share.
Indeed, China’s chemicals industry has grown very rapidly in the past two decades. For example, between 2006 and 2016, the annual average growth was 12.4%. CEFIC forecasts that by 2030, China’s chemicals market will have a global share of 44% (accounting for almost half of the market), even though the forecast only implies a relatively modest annual growth rate of 4.6%.
However, recently, some smaller segments of the Chinese chemicals industry have come under pressure, as the government tightens both environmental regulation and its implementation. Since late 2016, the Chinese government has conducted a series of environmental inspections on production companies. These inspections have frequently led to short-term closures of a large share of plants – a report by the Ministry of Environment stated that 70% of all companies inspected failed to meet the standards for controlling air pollution (though most of them were allowed to restart production after reducing their emissions).
Compared to the previous government’s actions, these inspections are much stricter, and conducted on a larger scale. Since January 2017, a number of government agencies, including the State Council and the Ministry of Environment, have issued several policies mandating reduced energy consumption, lower carbon emissions, and stricter pollution control. And the government puts a strong emphasis on the implementation of these new regulations. For example, in October 2017, 69 Hebei government officials were dismissed for failing to implement pollution controls, and an additional 154 officials were handed over to the police for investigation. Similarly, changing the previous emission fee to an emission tax has shifted authority from local governments – which frequently favour local economic activity over the environment – to central tax authorities.
As China’s President, Xi Jinping, has made reduction of environmental pollution one of his three top priorities for China, these developments are not likely to be reversed, even though some Chinese experts estimate that the campaign has decreased GDP growth in 2017 by 0.2%. It is therefore worthwhile to examine their direct and indirect consequences for the industry.
First of all, the environmental inspections have led and will lead to halts in short-term production. In the recent past, about 40% of all companies inspected were affected by such halts, which typically lasted 2-4 weeks. Generally, the polluting companies have to choose between upgrading their equipment to meet the environmental requirements and stopping production altogether.
Second, much longer production stops may come about due to chemicals companies being forced to relocate. Broadly speaking, the government wants to relocate all production of toxic chemicals into dedicated industrial parks. The timeframe for the move depends on the plant size. Small- and mid-sized chemicals plants (with up to about 1,000 employees and up to about € 50mn of annual sales) need to start relocation in 2018 itself and complete the process by 2020. Larger plants have to start by 2020 and finish by the end of 2025. Of course, it will depend on the individual company whether such a production relocation will affect sales, or whether a sufficient buffer stock can be produced in advance to bridge the gap.
The number of affected companies is quite large. For example, in the Shandong province alone, almost 200 chemicals plants have been identified for relocation, though a majority of them have not yet started the process. Often, this is due to lack of funds for relocation. A chemicals park in Jiangsu province has stated that it will refuse permission to about two-thirds of the companies that have applied because these companies lack the required investment size. For these small companies, the only alternative is to stop production altogether.
Third, it will take much longer to get permissions for new plants. In one example, the author was told that a permission that previously took six months will now need about 18 months, primarily as the environmental due diligence will become more important in the approval process. As a consequence, markets for individual chemicals will take more time to adapt to demand increases.
Fourth, production costs will increase. Some examples of such cost increases include:
• Costs for VOC treatment. In several industries, including printing, ink production, and flexible packaging, the installation of VOC treatment equipment becomes mandatory.
• Costs for water treatment. In one example known to the author, a specialty chemicals producer will have to reduce emission of waste water by 90% after relocation, which will obviously require substantial additional investment.
• Higher costs of raw materials. Partly, this is due to the rise in the cost of input materials (which are other chemicals affected by the same cost increases as specialty chemicals). However, it is also due to the restrictions on imports of materials for recycling, such as paper and plastics. For example, paper prices have already doubled within the last few months. A producer of specialty chemicals estimates that his input prices will rise by 10-20%.
• Environmental tax. This tax will be higher than the current emission fees that it replaces, and implementation will be controlled by more powerful agencies. Eventually, this environmental tax may also turn to be higher than the previous fees.
• Higher transportation costs. According to some estimates, 80% of hazardous chemicals are being transported by road, and as measures to prevent accidents are implemented more strictly, the cost of such transportation may increase by up to 35%
In the longer term, the aspects listed above will also have an impact on the overall structure of the chemicals industry – an effect that the government desires. Many specialty chemicals segments in China are very fragmented and suffer from overcapacity. For example, there are more than 2,000 coatings producers, and the top-200 producers account for only about 60% of total industry sales. The tightened environmental regulations will lead to industry consolidation, as the weakest and smallest players will not be able to afford the necessary production upgrades. This will also lead to a reduction in overall capacity, along with an improvement in the technological level. Overall, tightened environmental regulation will help bigger and technologically more advanced players.
In terms of chemicals segments, downstream and specialty segments will be more affected, as they tend to be smaller and operate on a lower technological level. In particular, smaller plastics processors, adhesive producers, and coatings producers were among the most affected so far. This is well aligned with the government’s target to either force such companies into chemicals parks, where they can be controlled more easily, or to shut them down and thus improve both the industry structure and the environmental situation. How about companies relying on sourcing from China? Indeed, supply for a number of chemicals from China has temporarily dried up, leading to substantial price increases for specific dyes and agrochemical intermediates, and an increased investor interest in specialty chemicals producers in, e.g., India and Japan. However, given the huge importance of China for the global chemicals market, and the high importance of the chemicals industry for China, it is unlikely that the chemicals industry as a whole will suffer. Indeed, while chemicals production growth has decreased to 3.9% in Q1-3 of 2017 compared to 8.5% in the same period in 2016, it is still growing. As a consequence, it seems an overreaction to stop sourcing from China altogether. However, companies purchasing from China may consider reducing their risk by identifying alternative sources.
In 2018, the program of environmental inspections is likely to continue, and thus will keep causing supply disruptions. Personally, I think this will not lead to the Chinese chemicals industry losing its general global competitiveness. However, in the areas that the Chinese government does not see as vital for technological advancement, and in particular for those associated with elevated pollution, small players may indeed by wiped out. Areas that are particularly likely to be affected are – solvent-based coatings, leather chemicals, textile chemicals, dyes, pigments, and possibly lower-end plastics compounding. As China has overcapacities for most of the chemicals produced here, the bigger remaining Chinese players will certainly take up some of the slack. But foreign companies – including Indian ones that are active in these chemicals – may also benefit.
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