How China’s OBOR Will Re-Order Global Petchems Value Chains

By John Richardson

EVERY petrochemicals company needs to understand the above map and its implications for global trade flows over the next 20 years. Failure to understand and respond to what this map is telling you would be a very costly error.

Let’s start with understanding what One Belt, One Road actually means:

• The One Belt is, in fact, improved road and rail links. As you can see, the One Belt will run from the city of Xi’an, the capital city of Shaanxi province, all the way to Rotterdam. This is about economically developing China’s less-developed provinces which lie in its west and north.
• And as you can see, the One Road involves better maritime links. Starting in the city of Zhanjiang in Guangdong province, these better maritime links are about giving China’s more developed provinces better access to global markets.

The Struggling One Belt Region

Surrounding the route of the One Belt are provinces that lag way behind in terms of income levels. Take the provinces of Jilin, Liaoning and Heilongjiang in northeast east China as examples. In 2016, their per capita GDPs were respectively the 12^th, 14^th and 21^st highest out of China’s total of 31 administrative regions. Heilongjiang’s per capita GDP was just $6,097 as against Tianjin in first place at $10,958.

And unless China acts quickly, this income gap is going to widen. China is closing coalmines down because many of its mines are either exhausted or have too-high labour costs to be economically viable. China is also trying to move away from coal as a fuel source for environmental reasons.

Many of China’s coalmines are in the northeast. These three provinces are also home to depleting oil fields and economically unviable steel mills. In total, China needs to find 2.3m new jobs by 2020 to replace the jobs being lost in coalmines.

It is not just the direct impact on these three provinces of the closure of coalmines and steel mills that China has to worry about. Many of the coalmines and steel mills are state-owned. The state-owned enterprises provide their workers with free education, hospitals, schools and even post offices. Close them down and you remove vital social infrastructure.

How the OBOR Will Help the One Belt Region

In the more developed provinces of China wage costs have risen to the point were low-value manufacturing of say textiles and garments is no longer economically viable.

One option is to move a garments factory to a partner OBOR country where labour costs are lower, thus keeping this factory under Chinese ownership. Or a factory can be relocated to the northeast of China, where there is a need for replacement jobs as coalmines and steel mills close down.

Better infrastructure is key to making these relocations work. Take the example of moving a garments factory to one of these northeastern provinces. Infrastructure investments will work in three ways:

1. China has oversupply of polyester fibre, with much of this excess capacity in the eastern and southern developed provinces. Better internal road and rail links will enable polyester fibre to be shipped cost effectively to supply a relocated garments factory in say Jilin province.
2. Better road and rail links between Jilin to the rest of China will then allow garments made in its new clothing factory to be transported economically around the rest of the country.
3. Local infrastructure spurs off the international One Belt artery will allow the factory in Jilin to export its clothing overseas.

How the OBOR Will Help the One Road Region

As described above, a sharp rise in labour costs in China’s developed provinces means that they can no longer compete in low value manufacturing.

The great news, though, is that the developed provinces are hubs for the innovative manufacturing and service industries that China must continue to develop if it is going to escape its middle-income trap.

Take the city of Shenzhen in Guangdong province as a good example. As The Economist writes:

Between 1980 and 2016 Shenzhen’s GDP in real terms grew at an average annual rate of 22% and today stands at 2trn yuan. The city’s Nanshan district, home to about 125 listed firms with a combined market value of nearly $400bn, has a higher income per person than Hong Kong.

Unlike Beijing, which has many top-flight universities, Shenzhen has only a handful of lacklustre institutions of higher learning; but so many graduates from all over China flock to the city that they make up a greater share of its population than do graduates in Beijing.

Shenzhen spends over 4% of its GDP on research and development (R&D), double the mainland average; in Nanshan the share is over 6%.

The One Road maritime links will help the developed provinces in two ways:

1. It will enable them to ship their high-value manufacturing goods more cost effectively to Western markets. The Greek port of Piraeus is set to play a crucial role here. COSCO China Shipping has acquired a two-thirds stake in Piraeus Port Authority as part of China’s strategy to make Greece the main gateway for Chinese exports to Europe.
2. Let’s use the example of a garment factory again. A garment factory could be moved from say again Shenzhen to one of the African countries on the One Road where labour costs are lower. The average minimum wage in Guangdong was, for example, $300/month in 2016 compared with just $50 month in Ethiopia. Polyester fibre raw materials could then be shipped from China to this relocated factory.

Geographic Re-Ordering Of Petchems Value Chains

The OBOR isn’t just about better infrastructure. In parallel, China is building a vast new free- trade zone, through new free-trade deals, involving the some 65 countries that are members of the OBOR.

It is also busy investing money overseas, not only in new roads, rail links and ports, but also in new industrial zones in countries such as Kenya.

There are plenty of sceptics who doubt whether China will come anywhere close to achieving its OBOR objectives. Cost overruns and project delays are obviously going to be major a hurdle given the scale of what is being attempted – $1 trillion of planned investment.

But let’s assume that the OBOR is only 50% successful. The end-result would still be a vast new eco-system of regional and sub-regional highly integrated petrochemicals value chains:

–  Oil and gas and petrochemicals feedstocks such as naphtha would flow much more freely across borders – and within China itself.

–  So would the petrochemicals themselves, the components of finished goods and the finished goods themselves.

Petrochemicals companies need to therefore make sure that they part of these new new eco-systems. Watch this space for thoughts on how this can be achieved.