Running out of steam?

19 July 2004 00:01  [Source: ACN]

Will China’s chlor-alkali and vinyls industries continue to run on the expansion track? Or will a combination of factors such as recent government regulations relating to new investments, widespread power shortages, environmental concerns and uncertainty about the economy derail growth? John Richardson provides some answers

THERE are some hefty challenges confronting China’s chlor-alkali-to-polyvinyl chloride (PVC) project proponents. Not least is the government clampdown on petrochemical projects, beginning in mid-May, which is designed to cool down the economy and improve both environmental protection and workers’ health and safety.

As is always the case with new regulations in China, it will take a while before the effectiveness of the clampdown becomes clear, assuming clarity does emerge. Because of the inadequacy of much of the information emerging from China, the exact impact on project activity may never become entirely evident.

Plus, there is the economy. Will a hard landing occur, badly denting demand growth and therefore the viability of existing and planned production? Or will the government measures to cool the economy work? Evidence emerged in June that a soft landing looked more probable.

The power crisis, a symptom of economic growth taking place too rapidly, could also undermine the viability of projects. Nobody knows how long it will take to provide enough new-generation capacity to end the crisis. And, of course, supply and demand will play a big role in determining exactly how many projects go ahead.

This feature is based on a presentation made by Asian Chemical News to the 8th Asian Chlor-alkali Conference, which took place in Singapore in late June. The conference was organised by ACN, Tecnon OrbiChem and Anorganica.

Regulations galore

Starting with the government clampdown, the National Reform Development Commission (NRDC), the People’s Bank of China and the China Banking Regulatory Commission announced on 17 May that curbs would be placed on plants and projects in the petrochemical sector. Other sectors also affected are textiles, steel, aluminium, machinery, leather, salt, printing and pharmaceuticals.

In the PVC sector, the environmental argument for a crackdown must surely have been won. The carbide process, which dominates PVC production in China because of feedstock and logistics reasons (ACN 31 May 2004), is pretty vile. Carbide residue generated from the acetylene-to-PVC plants is either used as a building material or is buried in remote, mountainous areas.

The acetylene plants that use open furnaces produce a great deal of white dust that can cause breathing difficulties, with sulphur and hydrocarbon emissions being other major problems. The pollution from each plant affects an area at least 5km².

The focus of the clampdown is on plants and projects using technologies and machinery categorised as backward, and with low safety standards and high pollution levels. Even where construction work on certain projects has started, the authorities can order it to stop. Completed plants across many sectors are supposed to have been given deadlines to shut down.

Acetylene plants below 10 000 tonne/year, and those that use open-furnace technology, can, in theory, no longer continue to operate. Ethylene dichloride (EDC)-based PVC projects of less than 200 000 tonne/year will be subject to review, as will acetylene-based projects of less than 80 000 tonne/year and chlor-alkali projects of less than 100 000 tonne/year. However, plants already operating with these capacities will not be affected. Financiers and relevant authorities will conduct the reviews on whether the projects should be scrapped.

Less than a fifth of the acetylene units in China have capacities of below 10 000 tonne/year. As for those that use open furnaces, the government is expected to give plant operators some leeway through allowing them to install metal plates. For EDC-based PVC projects, there is likely to be a limited impact as the vast majority of projects are above 200 000 tonne/year for economy-of-scale reasons.

But how effectively will the regulations be implemented? China is famous for making a major noise about new regulations and laws, only for implementation to be, at best, patchy owing to the excessive power of government ministries and local governments, and the many levels of government. Projects, regardless of their scale, that have gone through the full approvals process are expected to continue. However, those that are pending might find it tough to pass the review process.

An indication of just how hard it will be to implement the new rules is that small-scale acetylene plants in Shanxi province that were ordered to shut down in March are still operating on alternate days. A Shanxi producer told us that it wasn’t even aware of the regulations.

The dilemma for government officials at all levels, even if they are aware of all the rules and, in theory, would like to implement them, is that they also need to ensure enough economic growth. Jobs need to be replaced that are being lost as a result of the World Trade Organization-enforced restructuring of state-owned enterprises.

The other problem is the cost of better environmental safeguards. To return to acetylene plants, the typical open-furnace plant with a capacity of less than 10 000 tonne/year costs around Rmb5m (US$604 000). Operators usually break even within a year. However, environment-friendly production units usually have to be at least 100 000 tonne/year, which results in an investment cost of a minimum of Rmb100m.

The May announcement has created a great deal of uncertainty among Chinese producers and project proponents because of doubts over how effectively the new measures would be implemented, and whether they might be extended. For instance, a Shandong acetylene-based PVC producer has decided to speed up his expansion to 100 000 tonne/year from 40 000 tonne/year in case the regulations are extended. Other project proponents report that they are proceeding with more caution as they wait for the fine white dust to settle on the government announcement.

Concerns about the economy

As for the economy, it became trendy up until recently to be a doomsayer after the vogue for many years of waffling on at drunken conference cocktail parties about China’s unstoppable economic boom.

But during the past few months of this year, one gin and tonic too many and every professional and amateur economist from Mumbai to Christchurch has been declaring the rapid rise in raw-material and real-estate prices as symptoms of overheating. They also expressed concern about the surge in fixed-asset investment, often allocated to inefficient production, that had the potential to worsen China’s already severe non-performing loan crisis.

The numbers supporting their arguments were certainly very alarming. For instance, fixed-asset investment rose by 43% in Q1 of this year over the same period last year, with GDP (gross domestic product) increasing by 9.7%. What was even more alarming was that many experts, and pseudo experts, estimated that GDP had, in fact, grown by 12-13% in Q1. The discrepancy between the official and the actual figure was put down to local officials under-estimating their growth statistics in order to keep their Beijing bosses happy. In the old days, when China’s economy was not growing fast enough for the central government, local officials were under pressure to exaggerate numbers upwards.

Although there were some qualifying factors behind the headline numbers (for example, the 43% fixed-asset investment growth was partly put down to better weather this year than last, accelerating construction activity), alarm was widespread that a hard economic landing was a distinct possibility. However, fixed-asset investment grew by only 18.3% in May, significantly down from the 34.7% increase in April. This was attributed to measures such as the government clampdown on new projects.

Deutsche Bank expects that loan growth and M2 (money supply) growth will moderate from 19.1% in April to 17-18% in June.

Iron ore, steel, cement and aluminium prices have also eased slightly – a further indication that the economy is cooling down. But the concern now is inflation and whether an interest-rate rise is or is not necessary, and the impact that a rate rise, or no rate rise, could have on the economy.

Key government ministries and advisers have yet to reach a consensus on what to do about interest rates. The danger is that if rates are hiked too aggressively, or maybe at all, there will be no effect on the real problem – which is too much investment in certain overheated industrial sectors. The reasons are that companies would still be able to afford to borrow, as margins in many sectors remain very good and bank liquidity is high. High liquidity, because of high personal-savings rates, means that banks would discount an increased base-lending rate in order to find a home for their funds.

But, the biggest risk from a higher cost of borrowing is that it would stifle consumer spending and further dent local stock markets, which have already been driven down by policy uncertainties.

The arguments in favour of a rate hike include the risk that, if nothing is done to rein back inflation, there could be huge withdrawals from bank accounts, panic buying of consumer goods and inventory build-ups. The consumer price index was expected to touch 5% for June as this feature went to press, its highest level for several years.

Searching for power

Another major symptom of economic overheating is the power crisis, which is now affecting 24 provinces against last year’s 21. In Q1 2004, total electricity generated in China rose by 15.7% over the same period last year to 479.4bn kilowatt hour (kWh), according to figures supplied by the NDRC. However, consumption rose by 16.6% to 477bn kWh. There is evidence that this imbalance is starting to restrain growth. In the first quarter of last year when the gap between power generation and demand was not so great, consumption grew by 17.2%. China’s industrial consumption jumped by 18.1% to 226.9bn kWh in the first quarter of this year, indicating that industry accounts for 47.5% of electricity consumption.

Ten provinces heavily affected by the power shortages are Zhejiang, Yunnan, Guangxi, Guizhou, Hebei, Shanxi, Inner Mongolia, Jiangsu, Hunan and Sichuan. What’s making the shortages even worse is the weather. A drought in Yunnan, Guangxi, Fujian, Hunan and Guizhou meant that hydroelectric generation in the provinces grew by only 2.2% in Q1. This compares with the 15% rise in generation elsewhere in China through coal and nuclear-based production.

But, coal supply is becoming a problem because of China’s monstrous industrial production growth across every sector. Supplies of coal at power stations dipped by 4.2m tonne in Q1 2004 to 8m tonne over the same period last year. Some stations had only one or two days of coal supply, with others forced to shut down because their inventories were exhausted.

This summer, the crisis is expected to worsen with the eastern, southern and northern regions expected to be the most affected. Supply, however, is forecast to be sufficient in the northeast and the Hainan, Shaanxi, Xinjiang, Tibet, Shandong and Anhui provinces. It is estimated that China will be short of 20m kWh of electricity supply this year.

Measures are already in place to curb demand, yet again the clampdown on projects being one of them. ‘Non-favoured’ chemical plants and factories will be forced to either shut down or run at reduced rates during 2004, as was the case last year. These plants are either non-favoured because they are small in scale, or because they belong to investors without the right connections.

What does this all mean for electricity pricing?

The NDRC increased the end-user electricity tariff by an average of Rmb22 (US$2.7)/megawatt-hour (mWh) on the eastern, northern, central and southern grids in late June. The adjustment ranges from Rmb40/mWh in east China’s Zhejiang province to Rmb7/mWh in Shandong province. Industry insiders say the commission will also raise the price for the northwestern and northeastern grids soon, but the hike should be less than the national average.

This is the second round of price hikes for the year. In January, the commission decided to raise the price for customers by Rmb8/mWh in order to pass on coal-price increases. Last month’s adjustment includes January’s rises.

But analysts say electricity prices are unlikely to be stable for a long period. They add that the tariff increases would help independent power suppliers, such as Hong Kong-listed Huaneng International, Huadian Power and Datang Power, to partly, if not completely, cover coal-price increases. In addition, local governments are expected to no longer be allowed to grant cheap electricity prices to companies.

The belief among foreign investors in petrochemicals is that it is going to take at least a couple of years for China to sort out its power-supply problems. The government has launched a huge electricity generation investment programme. For example, it announced in late May that it was to invite international tenders for four new nuclear power stations to raise generation and reduce China’s dependence on imported fuel.

The power crisis should, in theory, be a major factor in assessing the viability of PVC and chlor-alkali projects, particularly the acetylene-based PVC projects, given that the process consumes much more electricity than the ethylene route. However, in practice, social, political and relationship issues could quite easily carry much more weight.

Balancing the equation

And finally, on to some supply and demand estimates that will, of course, be influenced by all of the above. China’s demand for PVC is projected to increase from 6.39m tonne last year to 6.9m tonne in 2004. Demand growth rates of 9-10%/year are projected from now until the 2008 Beijing Olympics, with some hollowing out of growth expected thereafter. However, the 2010 Shanghai Expo is expected to provide a further boost to demand.

The booming property sector, as we have already mentioned, particularly in the Shanghai area, has provided a tremendous boost to PVC. The big question is whether government efforts to cool down the sector will go too far and cause a property price slump.

But it is worth bearing in mind that the property boom is highly localised. It only really affects the wealthy eastern provinces. Home ownership in the west is still low, with very little speculation affecting the market. The potential for further sustainable growth is therefore huge in the west, and also in northern China. It is also worth bearing in mind that, despite the concerns over the economy, China’s private savings rates are very high, meaning there is great potential for further growth. In addition, although the emphasis is now on private investment, government spending on infrastructure projects in the west in particular is still huge.

Sinodata Consulting estimates that PVC imports will fall this year to 2.2m tonne from last year’s 2.29m. Much steeper falls in imports have been predicted by the Chinese industry, to well below 2m tonne/year over the next five to six years, because of new local capacity. To return to the Sinodata numbers, nameplate capacity is expected to rise this year to 5.82m tonne from last year’s 4.9m tonne.

However, a combination of the power crisis and the scrapping of some acetylene projects may create a greater opportunity for importers, assuming the processing industry is not badly affected. The longer the power crisis drags on, the more it could cause the cancellation of PVC projects and force plants to run at reduced rates.

It is worth noting that ACN has reported on 18 new acetylene-based projects (see page 18) this year, some of which fall below the 80 000 tonne/year minimum specified by the government, and we are only scratching the surface. There are dozens of small plants and projects in villages and towns that even some of those involved in the PVC market are probably unaware of. It is estimated that 300 000 tonne/year of acetylene-based capacity PVC was brought onstream last year that nobody had expected. This raises another point – that the government decision could make it easier to read markets.

Moving to the caustic soda market, the consensus is that the current market is balanced, but that oversupply will start to bite in the next few years. In terms of capacity, China Chlorine Alkali Online places last year’s production at 9.39m tonne, with production increasing to 16.1m tonne in 2005.

One view is that if all the projects come onstream on schedule – and that’s a big if – China would have excess supply by 2007, assuming demand growth from all applications averages out at around 15% per year. One has to ask the question, also, whether 15% demand growth is sustainable.

In order to solve the widespread expectation of oversupply, several local producers are attempting to raise their exports. For instance, last year Zigong Honghe Chemical exported 63% of its output against less than 50% in 2002. Plants are being built nearer to ports to make this export trade a great deal easier. Producers are also examining ways to increase captive caustic soda consumption. For example, Yibin Tianyuan is to build a sodium tripolyphosphate plant and also has plans to construct a hydrazine hydrate facility to consume more caustic soda. Also, the 100 000 tonne/year minimum project size should help move the market more towards balance.

So there it is. It would probably be more accurate to say that the challenges facing the sector are mightily heavy rather than simply hefty. But it seems certain, given China’s continued allure, that the number of companies queuing up to build plants will not diminish.

 
MAJOR ETHYLENE-BASED PVC PROJECTS IN CHINA

Company	Capacity (‘000 tonne/year)	Startup
Cangzhou Canghua Chemical Industry	400	Aug 2005; under construction
Changzhou Chemical Plant	(x)100 230T	post-2003
China General Plastics Corp	170	end-2004
	(x)130 300T	2006; planned
	(x) 200 500T	2010; planned
China National Blue Star (Group)	180	2004-05; in talks with licensors
Formosa Plastics	300	Oct 2004
Fujian Southeast Electro	450	in talks with LG
Hanwha Chemical	-	studying
Jiangyin Runhua Chem Prdts Co	300	2006; in talks with licensors
Liaoning United Chemical	400	2006-07; studying
Mitsubishi Chem / Jiangsu Faershen	200	post-2005; studying
Qilu Petrochem	(x)370 600T	Sep-Oct 2004
Qingdao Kailian (Group)	(x)80 200T	2004
Shanghai Tianyuan Huasheng	300	2008; planned
Shenyang Paraffin Wax and Chem	300	end-2006; seeking approval
Shenyang Chemical	(x)50 95T	2004-05
Thai Plastics & Chemicals	100-120	considering
Tianjin Dagu Chemical	200	May 2005
Tianjin Petchem / partners	250	2010; studying
Tosoh	110	spring 2006; in talks
Xiamen Haicang Investment Zone	200	post-2005; planned
Source: ACN database

MAJOR CHLOR-ALKALI PROJECTS IN CHINA

Company	Capacity (‘000 tonne/year)	Startup
Beiyuan Chemical	50	end-2004; under construction
Fujian Southeast Electro Chemical Corp	(x)160 200T	not known
Haiji Chloralkali Chemical	60	2004; under construction
Hebei Shenghua Chemical Industry	30	Q4 2004; under construction
	(x)30 60T	2005; planned
Hengtong Chemical	(x)70 200T	2005
Hubei Yihua Chemical Industry	50	post-2004; planned
Jiahua Chemicals	60	Oct 2004; under construction
Jiangsu Meilan Chemical Co	(x)100 150T	Q1 2005; planned
Jin Hua Chemical (Group)	(x)200 490T	2006-07; studying
Jinling Enterprise Group Corp	60	Dec 2004; under construction
Luzhou Xinfu Chemical Industry	(x)22 55T	2005
Nanjing Chemical Industry Park	100	2005; planned
Ningxia West PVC	100	H2 2005; under construction
	at least 250	2008; planned
Qihua Group	20	end-2004; under construction
Qilu Petrochemical	(x)200 430T	Sept-Oct 2004
Redsun Group Corp	200	end-2004
	(x)170 370T	2006
Shaanxi Jintai Chlor-Alkali	100	Oct 2005; planned
Shaanxi Tianqiao Huanbohai	100	H1 2005; under construction
Shandong Bohui Corp	(x)60 140T	Oct 2004; under construction
Shanghai Tianyuan Huasheng	360	H1 2006
Giant Star Group	(x)50 100T	end-2004
	(x)100 200T	planned
Shenyang Chemical	30	Sept 2004
	20	not known
Shenyang Paraffin Wax	200	end-2006; seeking approval
Sichuan Jinlu Group	(x)40 150T	H2 2004; under construction
Singpu Chemical Industries	(x)50 150T	mid-2005
Weifang Yaxing Chemical Co	60	July 2004; under construction
Yangquan Coal Industry Group	45	April 2005
	(x)45 90T	early 2006
Yili Chemical Industrial Co	340*	Sept 2005; approved
Yunnan Salt Chemical Co	100	2005; approved
Xinjiang Zhongtai Chemical	100	end-2005
* estimated
Source: ACN database

MAJOR ACETYLENE-BASED PVC PROJECTS IN CHINA

Company	Capacity (‘000 tonne/year)	Startup
Beiyuan Chemica	100	end-2004; under construction
Giant Star Group	(x)50 100T	end-2004
	(x)100 200T	not known
Hebei Shenhua Chemical Industry	(x)50 100T	by 2005; planning
Hengtong Chemical	40	June 2004
	(x)60 100T	end-2004
	(x)100 200T	2005
Hubei Yihua Chemical Industry	40	post-2004; planning
Ningxia West PVC	100-120	H2 2005; planning
	(x)380 500T	2008
Qihua Group	50	end-2004; under construction
Qinghai Salt Lake Potash	(x)80 200T	post-2006, studying
Qinghai Western Chem	150	2006
Redsun Group Corp	100	2006
Shaanxi Jintai Chlor-Alkali Chem	100	Oct 2005
Shaanxi Tianqiao Huanbohai Chem	150	H1 2005; under construction
Shandong Bohui	(x)60 140 T	end-Oct 2004; under construction
Sichuan Jinlu Group	(x)60 200T	H2 2004; under construction
	200	unknown
Yangquan Coal Industry Group	50	April 2005
	(x)50	early 2006
Yili Chemical Industrial	500	Sept 2005; approved
	500	2010; approved
Yunan Salt Chemical Co	100	2005; approved
Xinjiang Zhongtai Chem	120	end-2005
Source: ACN database

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