By John Richardson
BASF CEO Kurt Bock has underlined some of the major shifts in the Chinese economy that I have been flagging-up for the last three years.
He acknowledged, during a two-day investor event to mark the German chemicals giant’s 150th anniversary, that China’s GDP 2015 growth would likely be below the official estimate
And he also warned of a wider slowdown in emerging markets as my colleague Nigel Davis pointed out when he wrote in this Insight piece:
The BRICs currently are running on just one cylinder, not four, BASF CEO Kurt Bock said on Monday. The company knows that China’s economic growth this year is certainly not 7% (the target still made publicly by China’s government officials). Brazil and Russia are in recession.
My view on GDP growth in China is that many people have long known that the official numbers are suspect.
But when everything was nearly always heading in the right direction this didn’t matter. Who cared if one year’s growth rate was over-estimated at say 12% when the economy was only really growing at 10% as 10% was still fantastic? And if this was the other way round – i.e. growth was underestimated at 10% rather than 12% – this was obviously even better news. This made forecasting chemicals demand growth in the world’s most important market a lot easier.
Today, though, the problem is that there can only a be downside on the government’s official forecast of 7% GDP growth for 2015 – and there is every reason to think that the downside will be so big that we will see negative growth in some provinces in China.
In his presentation, Bock added that there had been a faster than anticipated build-up in new chemicals capacities in China, with commodisation in some chemicals occurring quicker than had also been forecast.
To illustrate his point, he showed the above slide from this presentation for average operating rates in Asia in some of BASF’s key products. When the world’s biggest company by sales talks in this way people should listen.
On BASF’s point about overcapacity in Asia, this is of course driven by China. In thy nylon intermediate caprolactam, for example, China’s capacity was at 365,000 tonne/year versus consumption of 1.1 million tonnes, according to ICIS Consultancy. By the end of this year we expect capacity of 2.3 million tonnes/year as against demand of 1.9 million tonnes.
So where do we go from here? I think that China will be quite happy to a maintain surpluses across many chemicals and polymers, whilst pushing for greater self-sufficiency in chemicals such as paraxylene and polypropylene and polyethylene where at the moment it is a big importer.
This will enable it to more fully capture the whole value of manufacturing chains from basic raw materials such as caprolactam, right through to not only nylon fibres but also higher-value nylon resins for car-engine components.
The lower-value nylon fibres might be produced in the western provinces of China, where there is still the need for lots more jobs in basic manufacturing.If you have local supplies of nylon fibre this would, for instance, help support downstream carpet production – where a big employment opportunity lies.
But in the eastern developed provinces of China the focus will instead be on making the higher-value nylon resins so China can escape its “middle income trap”. This is where higher-value companies such as BASF face their challenge.
The end result of this push into the production of higher-value chemicals and polymers will be more of the commodisation that BASF warns about, as these raw materials have to be priced right to make a car perhaps as cheap as $600 or a smartphone that costs $100 or even less.
The reason why the price of these raw materials will have to be cheap is now that the “wealth effect” of China’s 2008-2013 credit boom is over, we are back to what is has always meant to be high or middle income in China.
High Income groups in urban areas had risen to $9,000 income in 2013 versus $4,000 in 2007, according to the latest government figures. And middle Income group in urban areas had $4,000 in 2013 versus $1,600 in 2007.
Despite these big improvements, these latest income levels would still represent severe economic hardship in the West – not a life of Gucci and Ferrari.
As you can also see from the above slide, BASF is positioning itself to be in a strong low-cost position as this New Normal develops. But the key for speciality companies will also be how to maintain the value further downstream as the pace of commodisation picks up.