De-risking or Doubling Down?
Strategic Alternatives for German Chemical Companies in China
Many German chemical companies heavily rely on China as the world’s largest chemical market, with mainland China accounting for about 43% of global chemical sales, far more than the combined 26% global share of the EU and the USA. Given that China’s chemical production has increased at an annual rate of about 7.3% between 2011 and 2021 compared to substantially no growth in the EU and the USA, estimates that China will account for half of global chemical sales by 2030 sound reasonable despite the slightly lower growth of the industry in the last 2 years. As a consequence, it is virtually unthinkable for a chemical company aiming for a global presence to ignore China and thus almost half of the global market.
For German chemical companies, an additional factor for strong engagement in China is the perceived or real limited attractiveness of chemical production in Germany, as factors such as high energy prices, high regulatory hurdles and high ESG costs lower the return on investments. German chemical companies thus have a history of investing in production capacity abroad, with China a particular favorite due to the large domestic market. Indeed, in some way one could make the argument that German chemical companies still only have a limited share of their global sales in China – for most companies, this share ranges between 5% and 15% (e.g., Evonik 8%, BASF 14%) though for some companies the share is already substantially higher (e.g., Covestro 20%, Wacker 30%). Still, even these high shares could be considered low compared to China’s share of the global chemical market (43%).
However, political tensions between China and the West have been increasing in the past few years. The combination of a strengthening Chinese economy and protectionist policies particularly in the USA have led to a low-level trade war characterized by mutual restrictions (e.g., on US semiconductors for China, or on Gallium and Germanium exports from China), and these restrictions would certainly massively escalate in the case of an open conflict around Taiwan. Additional risks for German chemical companies may be reputational, for example, if related to materials sourced in Xinjiang, where the situation of the Uyghurs has been criticized by Western countries.
Given the complexity of the situation, it is almost surprising that so far, larger German chemical companies seem to be largely undeterred in their investment in China. BASF continues with its EUR 10 billion investment in its new Verbund site at Zhanjiang, which will be the third largest global BASF site after Ludwigshafen and Antwerp. This investment has been criticized not only for its China focus but also due to the potential resulting job losses at Ludwigshafen. However, critical voices within BASF seem to have lost the argument, as witnessed by the unexpected departure of BASF board member Saori Dubourg, reportedly a consequence of her resistance to BASF’s heavy China focus. At an earnings conference, Martin Brudermüller, CEO of BASF, put the rationale for investment in China very bluntly: “Without the business in China, the necessary restructuring here would not be so possible … Name me just one investment in Europe where we could make money.”
Similarly, Merck has announced further investments in China, for example, a recent capacity expansion for highly-purified reagents at its Nantong site. In a recent interview, Merck CEO Belén Garijo explicitly rejected the demand to reduce activities in China, instead highlighting the importance of China for Merck’s growth: "We are expecting acceleration of our operational dynamics in China".
Other examples include Covestro, which will build its globally largest TPU (thermoplastic polyurethane) site in Zhuhai, Evonik, which recently invested in a Chinese battery maker, and Henkel, which is investing EUR 120 million in a new adhesives plant.
It is not just German chemical companies concentrating their investment. According to UNCTAD, China’s share of the global chemical investment rose from 40% in 2011 to 48% in 2021, and even several US companies – which given that tensions between China and the USA are higher than between China and the EU – pursue huge investments. For example, ExxonMobil is moving ahead with a multi-billion-dollar petrochemical complex in Huizhou, signaling China’s importance for ExxonMobil’s growth.
However, the China activities of German chemical companies may not be fully aligned with official German government policy as presented in a China position paper in July 2023. This paper names China as partner, competitor and systemic rival, and recommends de-risking.
Thus, German chemical companies may be well advised to at least examine options that reduce the risk of an overreliance on China. A sensible first step is to establish a de-risking task force to monitor risks and plan relevant measures. This task force should then evaluate specific de-risking options. What are these options?
- Focus on China as a production site for the Chinese market rather than for the global market (“in China for China”)
- Reduction of sourcing from China, selection of multiple suppliers from different regions (e.g., “China plus one”), increase buffer stock of raw materials coming from China
- Fine-tuning of cooperation with Chinese institutions and universities (unless strictly limited to Chinese business)
- Potential reduction of technology transfer to China (e.g., for differentiating process technologies)
- Potential restrictions on conducting globally relevant R&D being done in China (though this will not be practical for areas in which China is in the lead, e.g., batteries for electric vehicles)
- Reduction of the amount of sensitive global data stored in China, as this is potentially accessible to the Chinese government
- Localization of the Chinese business (e.g., regarding staff, value chains, etc.) and separate and localize overhead functions (e.g., IT, legal, taxes)
To be fair, the item mentioned first is one that most German chemical companies already pursue. While in the past frequently only a limited variety of chemicals was produced in the Chinese plants of German firms while the smaller-volume products were imported, there is a trend toward producing more and more specialties in China as well.
For example, Byk, a part of Altana, recently opened its second Chinese production site, with the press release highlighting the expansion in the locally produced portfolio with a focus on local customers. A year ago, BASF started producing fuel additives in Shanghai, China, catering to local demand and expanding local production to smaller-volume products.
The “In China for China” Approach
This “in China for China” approach also extends to R&D. For example, Evonik claims to focus on ‘innovation in China for China’. And indeed, many of the research centers established by German chemical companies in China and particularly in Shanghai focus less on fundamental research (the “R” in “R&D”) and more on development, i.e., the application and adaptation of existing knowledge and materials to local conditions and customer demands. Thus, despite being generally bullish about China, in embracing the “in China for China” approach, German chemical companies already take some of the corresponding risks of their China activities into account.
Nevertheless, it may be worth preparing a worst-case scenario that could include a sale of the Chinese business or – more likely – a spin-off. This has already been done in other industries (e.g., US venture capital firm Sequoia Capital will split its business into three geographic units) and is being considered in an industry closer to the chemical one, pharmaceuticals. AstraZeneca, a British pharmaceutical company, is considering a spin-off of its China business to protect itself from rising geopolitical tensions. According to the Financial Times, another driver for the consideration is that AstraZeneca expects weaker growth in China in the coming years, making the company one of the first to be openly sceptic about China. While this certainly is not a desirable option for German chemical companies, in the case of an open US-China conflict and resulting US restrictions on companies with a large China presence it may well be the only one. And if the separation has been well prepared in advance and the split-off Chinese company already explicitly focuses on the domestic Chinese market, the economic consequences might just be bearable.
Volker Schlüter und Simon Heckmeier, ChemAdvice, Wiesbaden, Germany
Kai Pflug, ChemAdvice und Management Consulting - Chemicals, Shanghai, China