CHINA: What's hot, what's not

If you are looking for inexpensive sources of chemicals, China may or may not be the place to look. It all depends on the chemicals you need. Unlike the country's burgeoning manufacturing industry, which is driven by exports, the chemicals industry in China, for the most part, was created with

That is, while China's total exports have exploded to $228 billion during the first seven months of 2003 alone, most of this involves the sale of manufactured goods. China continues to have a huge negative trade balance in many of the basic chemicals necessary to produce those manufactured goods. In sum, China is actually a net importer of most chemicals. The country has a $97 billion a year chemical sector, and the government is actively fostering growth. Examples include the Shanghai Chemical Industry Park in the Caojing District of Shanghai and the new China Fine Chemical Industry Park just west of Shanghai. Work is also underway for the Nanjing Chemical Industry Park, which will be home to numerous foreign and local manufacturing facilities within its 11 square miles.

"Chemical manufacturing is in its early stages in China," reports Yimin Feng, vice president of business development for Pacific Genuity, Palo Alto, Calif., which operates the eChinaChem Web site. The company works with U.S. companies that are interested in purchasing chemicals from China, and the Web site has listings for 20,000 suppliers. "While there are currently approximately 30,000 chemicals producers in China, about 20,000 of these are quite small, and many of these smaller ones are either going out of business or merging with larger companies."

Despite the country's attempts to boost output, chemicals imports to China doubled from 1998 to 2002, to $41 billion. Its exports were up only 50%, to $15 billion. As such, China is a net importer of chemicals to the tune of $26 billion a year.

Imports

China is one of the world's largest importers of industrial chemicals. In fact, it is the world's largest importer of polyolefins. According to Nexant Chem Systems, White Plains, N.Y., a chemical consulting firm, the projected demand for polyolefins in China will be 28 million metric tons by 2010. However, without the ability to manufacture that much domestically, it is projected that annual imports of polyolefins to China will double from current levels of five to ten million metric tons by 2010. In fact, China will be the destination of almost one-half of all polyolefin exports by that year, compared with one-third now.

As such, don't look to China as a source in this area. "In terms of buying commodity resins and engineering plastics from China, opportunities are virtually nil," reports Robert Baumann, vice president of Nexant, who heads up the polymers practice. "China is always in a deficit position, because their capacity to make derivatives and products is much greater than their ability to make the chemicals and plastics that go into them."

For the first six months of 2002, demand for rubber, synthetic resins, and synthetic fibers in China grew an average of 15% over the same period a year earlier. "China is a net importer of polymers and resins," adds David Durand, Ph.D., director of global research for Philip Townsend & Associates, Houston, Texas, chemical consultants specializing in polymers and other downstream markets. "This won't change at least in the near future, despite the fact that there are some huge plants being built in China to try to meet the increasing domestic demand."

According to Philip Townsend, Asia/Pacific has overtaken North America as the world's largest consumer of polyethylene. Asia/Pacific demand jumped 60% from 1998 to 2002 to exceed 16 million metric tons, while North American demand increased a mere 7% during the same time period, to 15 million metric tons. Asia/Pacific demand is expected to reach 23 million metric tons by 2007, while North American demand will increase to 19 million metric tons.

Joint ventures

If you are purchasing any chemicals that are manufactured in China, there's a good chance you may actually be purchasing from a U.S.- or other Western Hemisphere-based company.

Here's why. Manufacturing and labor costs are much lower in China than in the U.S. For example, it is estimated that a plant costing $500 million in the U.S. can be built in China for as little as $15 million. However, frequent complaints arise over unreliable delivery schedules and, worse, poor product quality of domestically-manufactured chemicals. In response, many U.S. and European chemicals manufacturers are setting up operations in China, where they can build and staff plants for a fraction of the cost of doing so in their home countries. This also gives these companies direct access to the exploding market demand for these chemicals in China and other Asian countries. Some examples:

• Eastman Chemical has a number of joint ventures in China.

• Shell Chemicals and China National Offshore Oil Corp. (CNOOC) are constructing a $4.3 billion petrochemical complex in China, the biggest investment commitment in Shell's history. The facility will feature an 800,000 metric ton/year ethylene cracker.

• Yangzi Petrochemical (a subsidiary of Sinopec) and BASF are building a $2.9 billion petrochemical complex, which will have a capacity of 600,000 metric tons.

• Celanese and BP are currently battling for the rights to build an acetic acid plant there.

• Shanghai Secco Petrochemicals and BP are building a $2.5 billion project in Shanghai that will feature China's largest naphtha cracker, with a capacity of 900,000 metric tons a year.

• Sinopec, ExxonMobil Chemical, and Saudi Aramco have recently launched a feasibility study to build an 800,000 metric ton per year ethylene plant.

• One of the first chemical companies to build in China was Ciba Specialty Chemicals, which entered a number of joint ventures in the 1990s. Now, due to legislative changes, it will be allowed to build 100%-owned plants in the future.

An increasing number of foreign companies are not only building chemical manufacturing plants in China to take advantage of inexpensive construction and labor costs and the burgeoning demand for chemicals in Asia, but are also setting up R&D facilities, taking advantage of China's growing R&D capabilities, including the increasingly well-respected Institute of Organic Chemistry and the Shanghai Institute of Pharmaceutical Industry.

Buyers' benefits Despite being a net importer of chemicals, China is competitive in exports in a few areas: inorganic chemicals (especially fluorspar, rare earths, elemental phosphorus, and soda ash), fine/specialty chemicals, and pharmaceuticals. Pacific Genuity's Feng adds that the country is also strong in exporting agro chemicals and colors.

Chemical exports to the U.S. grew from $1 billion in 1996 to $2.4 billion in 2002. The country touts the following advantages in terms of being competitive in the world marketplace for exported chemicals: inexpensive labor, inexpensive plant-building costs, lower energy costs, government programs designed to educate hundreds of thousands of chemical engineers and chemists, and government support for the creation of chemical manufacturing parks.

Soda ash production has risen almost 40% in the last three years, reaching 10 million metric tons in 2002. China is expected to surpass the U.S., currently the world's largest soda ash producer, by the end of this year. China soda ash exports are currently over 1 million metric tons, most of which are purchased by other countries in Asia and putting a dent in U.S. exports to those countries and leading to excess capacity in the U.S. and subsequent reduced domestic pricing. As a result, U.S. soda ash manufacturers are looking to set up joint venture operations in China so they can sell directly to other Asian countries.

China's 2.4 million metric ton production of fluorspar in 2002 accounted for over 50% of the world's supply. As such, it is a net exporter. China now accounts for two-thirds of U.S. fluorspar consumption. However, as demand for the mineral continues to grow domestically (for its aluminum production needs and fluorchemicals industry), China has dramatically cut back on its exports, now at about 1 million metric tons a year, down from 1.15 million in 2001, with projections to cut to 850,000 in 2003. China now produces 88% of the world's rare earths and continues to have huge reserves.

There has also been big growth in exports of generic pharmaceuticals and chemicals that require three to ten production steps, which are able to take advantage of China's low labor costs. For example, Aceto, a U.S. distributor of chemicals from China, purchases about $100 million a year of products from over 400 Chinese chemicals producers, up from $15 million a year a decade ago.

What are the benefits of buying chemicals from China? Labor costs are about 25% of what they are in the west, and capital costs are 25% to 50%. "As such, cost savings are 25-50% compared to U.S. prices," reports Peter Filipiak, executive vice president of Buckton Scott USA , Princeton, N.J., an international trading (importing and distribution) company headquartered in the UK with offices in China. The company actually began doing business with China about 30 years ago.

"Many of the large U.S. chemicals manufacturers, such as Dow and DuPont, are setting up plants in China to produce the chemicals that the country needs for its own production needs," adds Pacific Genuity's Feng. "As such, raw materials are becoming cheaper, which helps keep down the cost of the chemicals that China ultimately exports."

Another benefit, according to Buckton Scott's Filipiak, is that U.S. companies are able to purchase certain products from China that are no longer manufactured in the U.S. because the volume is too small to attract U.S. manufacturers. "Examples include some vitamins," he reports.

Some concerns

Despite the attractive pricing offered for some chemicals being exported by China, there are still some concerns.

One relates to logistics and distribution, which can be problematic. For example, it can take four weeks to receive shipments. "Logistics remains a problem, simply due to the distance," admits Filipiak. "In addition, it will continue to be a problem, especially due to the new bioterrorism laws and regulations."

Another relates to the availability of energy. Because of the explosive industrial growth in the country, electric utilities are having a difficult time keeping up with demand.

A third concern is quality, but this may not be the problem it once was. "In the past, quality was a serious problem, but it has improved tremendously in the last ten years, especially with fine chemicals," emphasizes Filipiak.

A fourth concern relates to documentation, in terms of translating product documents properly into English. This will probably continue to lag the availability of product," admits Filipiak.

A final concern, more forward-looking, is that prices are expected to climb in the future. The reason: As China's explosive economy continues to expand, domestic demand may continue to eat away at domestic supplies of currently-exported chemicals, reducing the country's ability to export as much.

Pacific Genuity's Feng disagrees. "There is not too much concern about domestic demand pulling production away from current export markets," he says. "As domestic and export markets increase, the manufacturers are simply expanding capacity."

There is another reason that, even if domestic demand increases, current chemical exporters will continue to find the business attractive. "Since U.S. companies are typically used to paying higher prices in general, Chinese chemical manufacturers can often generate slightly higher margins selling to U.S. customers than to domestic customers," reports Feng. When selling domestically, on the other hand, they are competing against a large number of other manufacturers who don't export, and this competition is very strong.

Recommendations

If you're considering doing business with China, one option, if you have the resources, is to set up a fully staffed IPO in the country. DuPont, for example, recently opened a sourcing center in Shanghai to identify and quality chemical suppliers. It plans to place $250 million in new orders in China this year (fabricated equipment in addition to actual chemicals), small compared to its $17 billion annual total purchases, but important because past purchases in China have maxed out at $100 million a year. The company anticipates increasing purchases so much that, within five years, imports from China will represent a significant portion of the company's spend. Targeted chemicals include those for crop protection, dyes and additives for textiles, and pharmaceuticals.

Another is to work with a sourcing company like Pacific Genuity, or an importer and distributor like Buckton Scott or Aceto, which stock products in the U.S. In doing so, look for a company with a strong presence in China. "Many distributors do not have a strong presence in China, and even if they do have an office there, China is usually not their primary focus," notes Feng. "As such, they often don't go into much depth to find out what is available from China or go to much work creating tailored solutions."

In addition, find a company that is buyer-driven, not product-driven. "Many distributors focus on certain product lines," continues Feng. "As such, rather than finding out what customers need and being able to provide these chemicals, they focus on selling only what they have available."

Above all, the most important step is this: Create a strategy. "Find out what China can and cannot do," emphasizes Feng. "Then commit resources to the areas that make the most sense."

Then, decide how public you are going to make your strategy. Interestingly, despite the fact that we are in the midst of a "world economy," many companies still prefer to keep their international sourcing operations private. For example, Buckton Scott USA works with one of the top three consumer companies in the world. However, for purposes of this story, that company declined to be interviewed or even identified, as did other customers. "They consider their procurement practices from China to be confidential, because they don't want the competition to know what their strategy is and how much business they are doing with China," explains Filipiak. Pacific Genuity experienced the same challenge trying to find a customer willing to talk. We were at least able to talk with a spokesperson for one very large U.S. manufacturer that does business with Pacific Genuity, but he stated that, while the company is happy with the arrangement, it prefers not to go public with this relationship.