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One of the most prominent trends in the global specialty chemicals industry over the last two decades has been the emergence of China as a key supplier in the specialty chemicals space. This is reflected in the increase in China's share in the global chemicals industry, from 24% in 2010 to 38% in 2018. Specialty chemicals market in China registered an annualized growth of 15% during this period, overshadowing India's above-market growth rate of 9% during the same period. However, over the past few years, there has been a systemic tightening of environmental regulations in China, which has had a significant impact on China's leadership position in the industry, thereby creating a whitespace for players in emerging markets, especially in India.
Changing Times - China's increased focus on environmental compliance at the cost of growth
China was the fastest growing major economy in the world from 2007-2015 period; led mainly by the growth in manufacturing activity, which took a severe toll on its environment, with China being home to some of the most polluted cities in the world in 2015.
Ahead of its 5-yearly Congress Committee meet in October 2017, the Chinese government initiated an unprecedented crackdown on factories, impacting 80,000+ factories across the country. The impact varied from fines, criminal offense cases to shutdowns and even imprisonment in some cases.
Subsequently, following several major chemical incidents, including the deadly explosion at the Xiangshui chemical park in Jiangsu in March 2019, which killed 78 people and injured 617 more, the authorities have introduced a host of regulatory changes. These include shifting of chemical production to chemical parks, the tightening of rules for some substances and substance classes, and the introduction of an environmental protection tax.
In the immediate aftermath of the Xiangshui explosion, the Jiangsu province released the ‘Plan for Regulating and Improving the Chemical Industry of Jiangsu Province (Consultation Paper)’ which outlined its intentions to
Simultaneously, to save the Yangtze river from further pollution, over 130 nearby chemical plants in the adjoining areas will be forced to shut down, renovate or relocate by 2020 and no factory would be allowed to operate within 1 km of the river. The major product areas being affected are dyes and fertilizers. These relocations and adjustments will not only entail supply chain disruption but would also lead to increased capital expenditure towards purchase of new machines, and increased costs associated with compliance to stricter emission control norms.
The key challenge that the industry participants are currently facing is the lack of transparency around the details of the policies and procedures. So, the operational factories run the risk of sudden shutdowns, and the one which have been shut down are not aware by when can they resume production.
India's Specialty Chemicals Industry - Well poised to benefit from import substitutions and exports
Leading players in the Indian specialty chemicals industry have witnessed a significant scale-up in their operations over the last couple of years. The top 10 Indian specialty chemical companies 1 saw revenue CAGR of 6% between FY14-FY17. However, in the period since FY17, the same 10 companies have demonstrated a revenue CAGR of 19%. It is important to note that global markets play a crucial role in their growth and performance, with exports contributing over 40% of their total revenues in FY19. Export revenues for these firms registered a CAGR of 15% from FY17-FY19 vis-à-vis the export revenue CAGR of 8.5% from FY14-FY17 period.
This trend indicates the increased preference amongst global end-user markets to diversify their supplier base beyond China. Low investments towards effluent treatment and environmental compliance was one of the key reasons why Chinese manufacturers were able to provide lower cost products vis-à-vis Indian counterparts. Indian manufacturers, in the meanwhile, have actively invested towards compliance with environmental norms, and there is growing adoption of environment friendly technologies like ‘Green Chemistry’ and Zero Liquid Discharge (ZLD) manufacturing in India. This has enabled the Indian companies to leverage the opportunity and establish a strong foothold in the erstwhile untapped markets.
This shift in dynamics has also resulted in increased confidence amongst the leading private players in India. The median capex for the Top 10 Specialty Chemical manufacturers in India is estimated to be 7.9% of sales for FY18-FY20E period vis-à-vis 6.5% of sales during FY14-FY17 period.
Apart from a potential market share gain at the cost of Chinese players, this represents a highly attractive opportunity for Indian manufacturers to expand into adjunct set of products, which were earlier being dominated by the Chinese players.
For instance, Himadri Chemicals, a manufacturer of carbon chemicals is now diversifying into high value-added products such as specialty carbon black, which is mainly used in the rubbers & tyres industry (China is the largest manufacturer of carbon black and India imports ~50% of its carbon black requirements). Within agrochemicals, PI Industries acquired Isagro’s Asia business in order to gain access to additional manufacturing capacities to meet growing demand of global customers, and also to hedge its supply chain for a few products. Similarly, Agrocel Industries acquired Solaris Chemtech to strengthen its presence in bromine and bromine-based specialty chemicals (China is the 4th largest producer of bromine globally). Furthermore, Indian aroma chemical manufacturers are looking to backward integrate into basic raw materials like organic acids due to the volatility of the supply chain in China.
This said, adherence to environmental guidelines/norms is an absolute must in a country reeling under severe climate change issues.
While these headwinds in the Chinese industry cannot be expected to be permanent, whenever the Chinese companies make a comeback, it would be at a significantly higher cost of production given the significant investment in environmentally compliant equipment and manufacturing practices. India, in the meantime, would have significantly strengthened its position in the global supply chain and would be a very viable alternative for global players looking to de-risk their supply chain, while retaining their sourcing costs. We believe that polymers, dyes & pigments, aroma chemicals and agrochemicals are some of the key sectors that are particularly set to benefit from this shift in dynamics, wherein the Chinese manufacturers continue to operate at lower capacity levels, given the increased monitoring of safety standards and compliance norms.
1 Top 10 by market capitalization