Capacity transfer

First, capacity transfer

Natural gas in the chemical industry has the dual properties of energy and raw materials, about 40% of the natural gas used in Europe comes from Russia, and it is difficult to obtain an effective replacement in the short term, and the supply shortage or high price of natural gas will have an impact on the supply of chemical products. This energy crisis affects the industry on the supply side, resulting in insufficient production, and continues to raise product costs on the demand side, which weakens competitiveness and frustrates downstream demand. At present, some chemical manufacturers in Europe have successively raised the prices of related products, and successively implemented production cuts and shutdowns, and the load reduction of overseas production caused by the impact of the epidemic in 2020 May be repeated, and the supply contraction of chemical products with relatively high production capacity in Europe is expected. With the industrial chain advantage of China's capacity expansion continues to accelerate, competitive advantage continues to strengthen, we expect that the overseas chemical industry capacity transfer is expected to accelerate, the domestic market share and profitability of the corresponding manufacturers or will be further improved.

1.1 The gas crisis may lead to the reduction of chemical production capacity in Europe

1.1.1 The cut-off of natural gas supply may trigger a decline in the German chemical industry

If the gas supply is cut off, BASF may close the world's largest chemical base. On March 31, 2022, Russia signed a decree on gas trading rules, requiring "unfriendly countries" to buy Russian gas in rubles from April 1, or face forced supply cuts. All 27 members of the European Union are on the unfriendly list and have said they reject the proposal, after fears of a supply cut were becoming a reality. In response, the CEO of BASF said that if gas supply falls below 50% of maximum demand, BASF will have to scale back or completely close its production site in Ludwigshafen, Germany.

The Ludwigshafen site is BASF's headquarters and currently the world's largest integrated chemical production site, covering an area of 10 square kilometers, about 200 production units and 39,000 employees, accounting for nearly 35% of BASF's global workforce. Among BASF's six integrated bases in the world, Ludwigshafen base has the largest production scale and the earliest production time, and is also one of the world's main VA and VE production bases, with about 12,000 tons of VA and 20,000 tons of VE production capacity, accounting for 26.7% and 13.8% of the global total production capacity, respectively. If the German natural gas supply continues to be affected, the base faces production cuts or production shutdowns, it is expected that the global supply of vitamins VA and VE will be greatly affected. The Ludwigshafen site's energy consumption level has increased in 21 years compared to 20 years, with fossil energy generation increasing by nearly 8% year-on-year.

In 2021, BASF's European gas demand will total 48TWh, of which 37 TWh, or nearly 77%, will be required at the Ludwigshafen site. The surge in European natural gas prices since the second half of 2021 has led to a significant increase in the company's production costs throughout the year, with Q4 production costs reaching 15.06 billion euros, of which natural gas costs are 800 million euros. Gas costs increased to €1.5 billion for the full year and are still expected to increase by an additional €2 billion in 2022.

As a raw material and energy source for chemicals, natural gas cannot be replaced in Germany in the short term. According to the German Chemical industry association VCI, the German chemical and pharmaceutical industry consumes about 2.8 million tons of natural gas per year, accounting for more than 25% of the total gas consumption in Germany, the highest among all industrial sectors. Germany is the continent's most dependent country on Russian gas, accounting for more than half of its 2021 gas imports, and it is difficult to replace other sources of imports in the short term. About 60% of the natural gas used by BASF is used to produce the required steam and electricity energy, and the remaining 40% is used as a raw material to produce basic chemicals. The shortage of natural gas supply will have an impact on both energy and raw materials in the chemical production process, and the output of key basic chemicals and downstream products will be significantly reduced, and even lead to the closure of chemical production facilities, which will trigger a domino effect in downstream agriculture, food, automotive and other industries.

In addition to BASF Ludwigshafen, other major chemical production bases in Germany may be affected by natural gas supply shocks, such as Linde Group, which produces industrial gases, special gases and natural gas, and Bayer Group, which produces pharmaceutical and chemical products, will be similarly affected. According to VCI, the German chemical and pharmaceutical industry accounts for 60% of the production capacity of chemicals such as fine chemicals, polymeric chemicals and petrochemicals. If Russian gas imports are sharply reduced or even cut off, related companies will gradually reduce capacity and close factories, Germany's chemical industry may fall into recession and trigger Germany's worst economic crisis since the end of World War II.

1.1.2 Natural gas and the European chemical industry: A single issue affecting the whole body

Gas still accounts for a significant share of power generation in Europe. Since the signing of the Paris Climate Agreement in 2015, natural gas power generation in Europe has continued to rise, maintaining about 20% of electricity generation in recent years. Natural gas generated 524TWh of electricity in 21 years, down from 20 years, and the rapid growth in demand and relatively slow supply caused natural gas prices to rise by about 585%, one of the largest energy price shocks since the Opec oil embargo in 1973. Fossil fuels will still account for 37% of EU electricity generation in 2021, and while natural gas is the main driver of this round of fossil energy price increases, the price of coal and carbon emissions has also risen sharply, sending European electricity prices soaring.

Europe will find it difficult to replace Russian gas with other sources in the short term. In 2021, only about 9% of Europe's natural gas source structure will be local production, with the remaining 90% dependent on imports, of which Russia accounts for about 40%. Since 2022, due to geopolitical influences, European gas imports from Russia have been significantly lower than the same period last year. If the EU countries refuse to accept the ruble payment for natural gas bill, it is expected that Russia will gradually stop the supply of natural gas to Europe in late April to May, even if the Russian gas supply is temporarily stopped, Europe will passively accept the high price of natural gas supply status quo. From the perspective of Europe's natural gas import supply capacity, the LNG supply utilization rate in 2021 is less than 40%, while Norway, North Africa and Azerbaijan have basically maintained a high utilization rate. Since 2022, LNG supply has increased significantly, and there is not much spare capacity left. In addition to Russia, the supply capacity of other natural gas import sources is close to saturation, and it is difficult to achieve other sources of replacement in the short term.

1.1.3 The gas crisis may trigger the contraction of European chemical production capacity

The European chemical industry relies on natural gas as its main energy supply. In the energy consumption structure of the European chemical industry, natural gas consumption accounts for 36%. The sharp rise in the price of natural gas since 2021 has significantly pushed up the energy cost of chemicals in Europe, and we have calculated the power generation costs and electricity prices of various energy sources in Europe in detail in the previous industry report "Focusing on the continuation of the boom and electricity price arbitrage opportunities for high-power consumption chemicals", which will not be repeated here. According to VCI data, nearly 30% of the natural gas consumed by the chemical and pharmaceutical industries in Germany is used as a raw material, while the remaining 70% is used to produce steam and electricity. It is foreseeable that in the short term, European chemical production will remain significantly dependent on a stable supply of natural gas, and any supply shocks will have a significant impact on downstream production.

The German-induced cuts could spread across European markets. Germany, as the leader of the European chemical industry, is currently the largest chemical production and consumer in Europe, and the total sales of the European chemical industry in 2020 are nearly 490 billion euros, of which Germany's sales account for 32.1%, exports account for 22.9%, and R&D expenditure accounts for 35.0%, ranking first in Europe. The main chemical parks in Europe are mainly concentrated in Germany, the Netherlands and Belgium, and the final consumption of natural gas energy in the major chemical producers in Europe is more than 20%, of which Germany, Italy and Austria's natural gas imports from Russia account for 54%, 33% and 80% respectively.

1.2 Capacity transfer of overseas chemical industry is expected to accelerate

1.2.1 Under the energy crisis, the pace of overseas capacity transfer is expected to accelerate

European chemical industry shut-down manufacturers and scale or further expansion. In the current context of high energy costs and weak supply stability, superimposed European sanctions on Russia and counter-threats continue to increase, soaring natural gas prices are expected to continue to increase the impact on industries with high energy consumption. Since April 1, European chemical manufacturers, including BASF, have raised the prices of related products. Uniden, a French energy group, estimates that about a fifth of the industrial output of France's 300 largest chemical industry gas users could be cut. At present, some chemical industries represented by chemical fertilizers and other products in Europe have been reducing production and shutting down, and with the possibility of Russian natural gas supply interruption gradually increasing or prices continuing to rise, the scope and scale of subsequent shutdowns may be further expanded.

Overseas production load reduction phenomenon or will be repeated, capacity transfer is expected to further accelerate. Over the past decade, global chemical production capacity has gradually transferred from developed countries and regions such as Europe and the United States to Asia, and only Asia will maintain positive output growth in 2020 (mainly contributed by China). Under the impact and impact of the epidemic, the short board of the industrial chain of overseas countries has been gradually exposed, and the lack of some industrial links and labor difficulties have caused a rapid decline in the capacity utilization rate. The capacity utilization rate of the European chemical industry fell to a minimum of 74% in 20Q2, and the capacity growth rate was significantly reduced.

1.2.2 China's chemical industry is expected to undertake overseas production capacity with industrial chain advantages

In the past ten years, the rise of China's chemical industry has accelerated, and its competitive advantage has been continuously enhanced. According to CHEManager, China's chemical consumption in 2020 is nearly 1.6 trillion euros, making it the world's largest chemical consumption market. Benefiting from the huge domestic downstream consumer market and engineer dividends, the production capacity and sales of basic chemicals and general materials represented by bulk commodities have expanded rapidly. According to the European Chemical Council, China's global chemical sales market share has increased from 25.8% in 2010 to 44.6% in 2020, Europe is the world's second largest chemical sales market, its market share has fallen to less than 20%, the share of traditional chemical powers mainly in the United States and Europe is gradually shrinking.

From the level of technology and innovation, China's chemical industry in the past ten years of capital expenditure and research and development costs increased significantly, including 2020 research and development costs of nearly 14 billion euros, has achieved the European catch-up and beyond. At present, China still has a gap with European and American enterprises in fine chemicals and high-performance new materials, but the gap in research and development and technology has been shrinking, and in some bulk chemicals, China has established many competitive advantages, including product quality, production efficiency, personnel costs and low energy, etc. And through continuous technological innovation and capacity expansion to enhance the global market share.

Under the industrial structure of the whole industrial chain, the operating advantages of China's chemical industry have gradually emerged. At present, China has all the industrial categories listed in the United Nations industrial classification, complete industrial categories, perfect infrastructure, more than 500 kinds of major industrial products in the world, China has more than 220 kinds of industrial products ranked first in the world. The complete industrial system, the related supporting ability of the upstream and downstream of the superimposed industrial chain and the industrial agglomeration effect ensure the great operational resilience of China's chemical industry, and can effectively maintain the stability of the industrial supply chain even under the impact of external uncontrollable factors. As of 21Q4, the capacity utilization rate of China's chemical industry has exceeded the pre-epidemic level, and the stability of the overall production and operation has continued to improve.

1.2.3 The domestic vitamin, polyurethane and coal chemical industries are expected to benefit fully

At present, there are expectations of capacity transfer for chemical products with relatively high production capacity in Europe. We have calculated the production capacity of major chemical products in China and Europe, and sorted them according to the chemicals that account for more than 10% of the production capacity in Europe, as shown in the following table. At present, the production capacity of potassium fertilizer, vitamins (VA, VE, etc.), polyurethane (MDI, TDI), chlor-alkali (soda ash, caustic soda) and coal chemical industry in Europe is still relatively high, of which the production capacity of each vitamin accounts for more than 36%. We expect that with the tightening of energy supply and prices continue to rise, the above-mentioned chemicals are expected to further transfer capacity to the domestic, domestic potassium fertilizer, vitamins, polyurethane, soda ash and coal chemicals and other sectors of production capacity growth is expected to increase, the performance elasticity of relevant companies or will continue to enhance.