China Doubles Down On Pollution Clean-up: Consequences For Chemicals

Business, China, Company Strategy, Economics, Environment, Sustainability, Technology, US

By John Richardson

ECONOMIC GROWTH for the sake of economic growth was for so many years the No1 priority in China. It is hardly surprising, therefore, that there is a legacy of major environmental problems.

These include some 1.6m premature deaths a year from air pollution alone, according to an independent study in 2015. A government study from a year earlier found that 19% of farmland – 250,000 square kilometres – was polluted with heavy metals such as cadmium and lead.

But the world’s biggest environmental clean-up is now well under way. Environmental inspectors from Beijing are turning up announced and are forcing the temporary closure of factories that are in breach of tougher environmental rules. Fines are being imposed on companies forced to shut down.

Thousands of local government officials who fail to play their part in cleaning up the mess left behind by years of breakneck growth have been disciplined. Incentive schemes are being adjusted in a classic carrot and stick approach. Promotion for local officials has become tied to environmental as well as GDP growth targets.

In a separate initiative, chemicals and other factories that are heavily polluting, have poor economies of scale, operate in oversupplied factors and are too close to urban centres are being permanently shut down.

Some sceptics thought that China would ease back on the clean-up. But this failed to take into account the strengthened political position of President Xi Jinping and his fellow economic reformers. His position had strengthened long before the decision to remove presidential term limits.

The sceptics also failed to understand that the success of this environmental campaign is just about existential for China.

The campaign has to succeed if China is going to retain the educated, middle class people who are essential for escaping the country’s middle-income trap. Otherwise, they will just emigrate. Failure to adequately deal with pollution would also lead to unsustainable healthcare costs, adding to the burden on government spending resulting from an ageing population.

It also important to view the clean-up campaign as part of the five interlocking major reform priorities set by Xi Jinping and his fellow Princeling reformers. If one reform fails the rest are at risk of failure.

National People’s Congress decisions on environment

Xi is clearly using his strengthened position to push the environmental agenda very hard, as was evident from the just-concluded National People’s Congress meeting, China’s annual parliamentary.

Major announcements during the NPC relating to the environment included a 19% increase in spending on pollution mitigation in 2018 over last year to RMB40.5bn. Energy consumption per unit of GDP is to be reduced by 3% as China tries to lower sulphur dioxide and nitrogen oxide emissions by 3%.

A new “super ministry” has been set up – the Ministry of Ecology & Environment. This will centralise functions carried out by separate ministries. The aim is to ensure that initiatives targeted at limiting greenhouse gas emissions are coordinated with efforts to reduce air, water and soil pollution.

New, lower targets for concentrations of PM2.5 – particulate matter especially harmful to human health – will be introduced for 2018 until 2020. We don’t yet know the details of these new targets, but what is clear is that China still has a long way to go to make its air quality acceptable – and so expect tough new targets.

Whilst huge progress has been made, most of the progress is concentrated in China’s richer provinces and cities. Even in Beijing, average PM2.5 levels were last year 65% above the national standard and more than five times World Health Organisation guidelines.

In an effort to prevent unintended consequences, local authorities will be punished for not applying the regulations correctly. This will hopefully stop overzealous or panicky local officials from causing major economic disruptions, such as the complete ban on coal-fired boilers in some provinces late last year. Acute shortages of natural gas were the result, leading to gas supplies being cut off to chemicals and other plants.

A new environmental inspection system will be established with a wider, more nationwide reach. Responsibility for this system will be shared between Beijing and local authorities.

This indicates that a.) The number and severity of inspections will increase across a wider geographical area and b.) Devolving responsibility for the inspections to local authorities will add to the pressure on local officials to comply with the environmental crackdown.

Consequences for the chemicals industry

The table at the beginning of this blog post lists some of the chemicals sectors could identified by the Chinese government for an environmental clean-up, according to  Nomura.

The opportunities for exporters in these products could be significant. Our ICIS news and ICIS Pricing services will help you monitor these opportunities as we track all the shutdowns and the impact of closures on pricing and profitability.

Another opportunity is to sell higher-value chemicals technologies and pollution control equipment to chemicals plants that have a long-term economic future.

In some cases, though, as I said earlier, small-scale plants near to urban areas in oversupplied sectors will be shut down permanently. The supply gap will be filled by building one world-scale plant to replace, say, three smaller non-world-scale plants that have been shuttered. This is a great opportunity for engineering and procurement (E&P) contractors.

There is a geopolitical angle to all of this that must not be overlooked. The chemicals producers, technology companies and E&P contractors that China will want to do with more and more business will either be within the Belt and Road Initiative (BRI) region –or will be supportive of the BRI.

This is a further indication of the lost opportunity for US companies if the White House continues with its current protectionist approach to trade with China.

A broader implication is that China’s environment campaign will be one of several factors reducing GDP growth in 2018. Whilst the reduction in growth should only be very modest, it could have major negative macroeconomic consequences.

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