European chemicals industry - what future?
The chemicals industry is one of the largest and internationally most successful European industries. The first of three articles in the Sector Futures series on this sector - excluding pharmaceuticals - delineates the chemicals industry sector, looking at its market size, structure and nature of employment. The chemicals sector is capital-intensive and has traditionally enjoyed a comparative advantage in mature industrialised countries. This advantage, however, is now being challenged by globalisation. This factor is explored here, along with other trends and drivers likely to shape the sector’s future.
Main features of the chemicals sector
This article deals with chemicals but not with pharmaceuticals because the two industries are driven by different factors. Because of this difference, the major companies have in recent years been separating their chemicals and pharmaceuticals businesses and now concentrate on one or the other, but not on both.
Chemicals are typically intermediate products and therefore innovation is highly important, as it is for all downstream industries. Many chemicals products thus require a high research and development (R&D) input. Chemicals is also a capital-intensive industry and that has made it appropriate for its production to be located in mature industrialised countries. In the era of globalisation and capital mobility, however, this is no longer valid for the manufacture of commodities and consequently there is very substantial foreign investment in chemicals production in the booming markets of Asia. Since commodities have a substantial share in the product portfolio of the chemicals industry, the European industry has to accelerate its pace of innovation to stay in the lead. As a result, economic policymakers face the challenge of providing conditions that promote a more knowledge-driven industry with a sound basis for production in Europe. If this challenge is not met, the decline in chemicals employment will become even more pronounced.
Within the chemicals sector, petrochemicals is the second largest product group as shown in Figure 1, accounting for about 40% of chemicals output. Petrochemicals is located near the beginning of the value-added chain and provides intermediate goods for other types of chemicals products. Its products are manufactured and sold globally. Petrochemicals is characterised by high capital intensity, by considerable opportunities for the exploitation of economies of scale and by high feedstock costs. The output is standardised and price is an important determinant of sales. As a result, margins are low and research and development (R&D) expenditure - measured as a share of turnover (R&D-intensity) - is small. The success of a petrochemicals production plant depends crucially on its physical relationship to other parts of the value-added chain. The most important considerations governing location are upstream linkages, especially the availability of raw material, and/or downstream linkages, i.e. the location of facilities for further processing. For all these reasons, several new plants were built in the Middle East and Asia during the 1990s.
Like petrochemicals, inorganics also stands close to the beginning of the value-added chain, but it accounts for only around 5% of total chemicals output.
Figure 1: Output of the EU25 chemicals industry by subsectors, 2002
Source: Based on Eurostat data; calculations by the Institute for Economic Research (Ifo), Munich, 2005.
The manufacture of speciality chemicals involves the processing of petrochemicals and inorganic products. The output of speciality chemicals is supplied to other subsectors of the chemicals industry (and to other industries not discussed in this article, such as pharmaceuticals). Speciality chemicals is the largest single group within chemicals, accounting for about 45% of the output of the sector. Speciality chemicals covers a very wide product range and is thus divided into two subgroups. These differ according to the importance of specialist knowledge and expertise in their manufacture, and according to their market environment.
The first subgroup is fine chemicals. Processing expertise is of great importance, but does not represent a high market-access barrier because it is not tied closely to the special requirements of the clients. Different manufacturers can supply products of the same quality to downstream clients without any effect on the quality of the final product. In this respect, the market environment is very similar to that of commodity chemicals of the upstream industries. Consequently, product quality and cost efficiency are as important as processing expertise.
The second subgroup of speciality chemicals is performance chemicals. These have to meet the clearly defined requirements of clients to guarantee the proper functioning of final products. One example is the development of ink for specific inkjet printers. The manufacture of performance chemicals therefore requires an exchange of technical information and expertise between their manufacturer and the client. This creates high market-access barriers. For the clients, there is a trade-off between the risk that competitors will gain access to their expertise and the advantages of lower prices from standardised producers.
The remainder of chemicals output, around 10%, is accounted for by the processing of intermediate products for specific industries and by industrial gases. The specific industries are agrochemicals, in particular fertilisers, and man-made fibres, which comprise synthetics and celluloses. In contrast, industrial gases are used in a wide range of different industries, including welding in metal-working, chemical processes, the health sector and agriculture.
Market size, structure and employment
The chemicals industry (excluding pharmaceuticals) is one of the largest and internationally most important European industries. In 2004, the value of EU25 chemicals production amounted to €417 billion and the industry employed a workforce of around 1.45 million people. Between 1995 and 2000, output of this industry grew strongly at an average rate of 3.2% per year at constant prices. After 2000, growth slowed to an average of 1.4% per year. Output share is closely related to the size of the Member States’ economies. This is true for the 15 'old' Member States (EU15) and the 10 'new' Member States (NMS), as seen in Figure 2.
Figure 2: Regional distribution of the EU25 chemicals production, 2002
Source: Based on Eurostat data; calculations by the Institute for Economic Research (Ifo), Munich, 2005.
The European chemicals industry has been highly successful in international markets, largely because of the marketing activities in Asia of the big European players. The chemicals trade balance is in a healthy surplus. After growing by an average of 12% per year over 1995-2000, the surplus grew by 6.5% per year after 2000. This is quite an unusual development because most European manufacturing industries have seen their trade surplus shrink. Nevertheless, exports amount to less than one-thousandth of the total production of the European chemicals industry according to the European Chemical Industry Council (CEFIC, 2004).
Until the mid-1990s, the European chemicals industry had too many manufacturers in upstream segments, such as petrochemicals and polymers. This was partly a legacy from the former focus on having a chemicals industry in each country covering the complete value chain. Moreover, many large diversified groups, for which commodity petrochemicals represented a significant component of their portfolios, played a key role in the European chemicals industry. As a result, companies were not able to exploit economies of scale and thus were at a cost disadvantage in international competition with US firms and emerging suppliers from the Middle East and other oil-producing countries.
From the mid-1990s, European chemicals companies have been responding to growing competitive pressure by restructuring and focusing on their core businesses according to a report on Industrial restructuring in the chemical industry 900kb (ChemSystems, 1998). Only a few conglomerates still have broad and diversified portfolios. The most noteworthy feature of this restructuring is the separation between chemicals and life-sciences products. Among other recent examples, DuPont sold its pharmaceuticals division to Bristol-Myers Squibb in 2001, and in 2005 Altana announced that it would split its chemicals and pharmaceuticals activities. In the speciality chemicals subsector, Lonza, DSM and Clariant improved their position between the manufacturers of commodities and research-intensive downstream clients, following cost-cutting programmes during the 1990s. Companies specialising in fine chemicals are now reaping the benefits of their restructuring and cost-saving programmes as their profits are growing despite high feedstock prices (Ernst & Young, 2001; Handelsblatt, 2005; Frankfurter Allgemeine Zeitung, 2005a and 2005b).
The restructuring of the industry has been accompanied by changes in ownership. Institutional investors, who played only a minor role in the past, have become engaged in the consolidation of the sector. The acquisition of Cognis from Henkel in 2001 for €3 billion by a consortium of investment funds was one of the largest private-equity deals in the European chemicals industry. Another indicator of increasing globalisation of this industry is the growing activity of industrial investors from oil-producing countries in acquiring stakes in downstream production companies.
The slowdown in chemicals output growth has affected employment. Employment increased, albeit at a low rate of 0.4% per year, when output was growing strongly at 3.2% per year between 1995 and 2000. But it started to decline by about 0.5% per year after 2000, when output growth slowed to 1.2% per year. Labour productivity, however, increased at the impressively high rate of 2.3% per year on average over the whole period 1995-2004.
In the new Member States (NMS), which joined the EU in May 2004, the pattern of employment decline is different. Chemicals output grew at an average rate of 6% per year between 1995 and 2004, but employment declined by 0.7% per year (see Figure 3). This implies that productivity improved by nearly 7% per year. This improvement is not only related to organisational and technological progress, but also, in the case of the eight former communist countries, to the reduction of over-high levels in the workforces inherited from the previous regime. This is not specific to the chemicals industry in the NMS; many other manufacturing industries in these countries have also shed surplus labour.
Figure 3: Production and employment development of the EU25 chemicals industry
Source: Based on Eurostat data; calculations by the Institute for Economic Research (Ifo), Munich, 2005.
Trends and drivers
Part-time employment, sabbaticals, etc. have become important tools for companies to attract highly qualified applicants, in particular to tap into the full potential of the female labour force. The adoption of new patterns of working time has, however, been far from uniform across EU Member States. Within the EU15, the southern Member States lag behind the others (see Figure 4). They are roughly on the same level as the new Member States, where the share of part-time employees ranges between 2% and 4% of all employees.
Figure 4: Part-time employment in the EU25 chemicals industry, 2002
Research and development (R&D) is of outstanding importance in the chemicals industry, particularly for the downstream industries. Chemical products are intermediate goods that are incorporated in client industries’ products, from semi-finished metal products, consumer electronics and machinery and equipment, to domestic appliances and furniture. The stimulus for innovation comes from the development of products, as well as from joint R&D projects with client companies in other industry sectors (ZEW/NIW, 2003).
For many years, European chemicals companies were world leaders in technology and innovation, but they lost their lead during the 1990s. Since the mid-1990s, the US chemicals industry has regularly spent 2.5% of its total sales revenue on R&D and the Japanese industry has spent 3%, whereas the proportion of sales revenue spent by European companies has fallen from 2.4% in 1995 to 1.9% in 2004. One explanation for this slackening of research activity might lie in the considerable effort and share of resources given to restructure the chemicals industry in order to create companies capable of meeting the competitive challenges of global markets. If this proves to be the correct explanation, then companies can be expected to shift more resources to R&D activities after restructuring has been successfully completed. But one cannot be fully confident that this will happen because European companies face higher costs and generate lower profits than their foreign competitors, and thus face a major challenge in allocating sufficient resources. The gross-operating surplus of the European chemicals industry is only half that of its US counterpart (CEFIC, 2004).
The European chemicals industry faces two main obstacles to future innovation. The first arises from the relocation of production sites to locations outside the EU. This makes it more difficult to work closely with clients so as to develop innovations relevant to their requirements. This does not apply only to the supply of chemical products for the textiles industry, which has shifted the bulk of its production to Asia. Even the development of intermediate products for the electronics industry has become more complicated, despite the fact that European chemicals companies are on the leading edge of technology as suppliers of high-tech intermediates. Production has to be carried out in Asia, the region with by far the largest demand and the greatest number of clients. Most of the basic research activity is still carried out in Europe, but the fine tuning of chemical products to customer needs is carried out in Asia. Examples cited by ZEW/NIW (2003) include liquid crystals for television screens (Merck KGaA) and substrate for computer memories (Bayer AG).
The second obstacle arises from Europe’s delayed take-off in biotechnologies as outlined by a 2005 comparative study on biotechnology in Europe 2.2Mb (EuropaBio, 2005). While biotechnologies include some processes that have been well known for a long time, such as the fermentation of foodstuffs and beverages, they are also used in a broad range of processes and products. Innovations in these will change the chemicals industry’s structure and output.
The main activities of biotechnology are:
- red biotechnology, which belongs under life sciences and is thus not under discussion in this article;
- white biotechnology: industrial and environmental products and processes, such as biocleaning, bioremediation, environmental and industrial diagnostics, water and effluent treatment, as well as recycling;
- green biotechnology: veterinary healthcare, biopesticides, plant agriculture, food technology and processing;
- services, such as contract research, contract manufacturing, bioinformatics and functional genomics.
The biotechnology sector had a turnover of €19 billion in 2003 and employed 94,000 people. Around one-half of this sector’s activities are related to the chemicals industry; the other half being concerned with pharmaceuticals. The biotechnology sector is of outstanding importance for the future of the chemicals industry because of its research intensity. About one-third of biotechnology revenues are spent on the development of innovative processes and products. However, the biotechnology industry is small: its total workforce amounts to no more than 3% of the numbers employed in chemicals.
The chemicals industry is the largest of the energy-intensive industrial sectors. The following discussion of changes in energy intensity also applies to the pharmaceuticals industry. Analyses that solely focus on the energy consumption of the chemicals industry as defined in this article were not available. Between 1990 and 2000, the chemicals industry was substantially reoriented towards products of low-energy intensity. The output growth attributable to products of high-energy intensity, such as fertilisers, was far below the average growth rate of the industry (2.1% per year over 1990-2000). Despite strong output growth, the energy consumption of the chemicals industry declined by around 3% per year between 1990 and 2000. Most of these savings were achieved during the first half of the 1990s when the industry’s energy consumption declined by 5.5% per year. Between 1995 and 2000, energy consumption fell by only 0.5% per year.
The future energy intensity of the chemicals industry will depend on further structural change, investment in new process technologies and public policies aimed at the reduction of emissions. Among the new process technologies, combined heat and power generation (of electricity and steam) will play an important role. The dependence of the chemicals industry on fuel imports will decline somewhat faster than it did in the late 1990s because of the growing use of biomass and waste as energy inputs (see the Commission’s EU-15 energy and transport outlook to 2030, 2003).
The protection of the environment, consumers and workers from hazardous chemicals are institutional aspects of outstanding importance for the industry. Formerly, different national regulations hampered the free circulation of chemicals in the Single Market. The European Commission has to take into consideration the internal market aspects of free movement while preserving high levels of environmental protection. Member States are allowed to introduce even stricter rules, but they must not impede the free movement of goods. According to the principle of mutual recognition, established by the ‘Cassis de Dijon’ judgment of the European Court of Justice in 1979, products legally marketed in one Member State must in principle be admitted in any other Member State.
The development of a harmonised system for classification, packaging and labelling of dangerous substances and dangerous preparations began with the adoption of Directive 67/548/EEC. The system was enhanced by Directive 88/379/EEC, which also introduced the classification of dangerous substances. Principles for further action were adopted by the Commission on 16 January 1996 in the internal ‘Guidelines for regulatory policy’. One important principle is the risk assessment of chemicals. If there is an unacceptable risk, strategies for risk reduction have to be identified and the most cost-effective has to be taken. If no international agreement can be reached on the prevention of unacceptable risk, the EU introduces an adequate European regulation, but its effect on the European chemicals industry has to be taken into account (as outlined in the Commission’s communication on An industrial competitiveness policy for the European chemical industry in 1996). This institutional framework has made the free movement of chemicals easier within the internal market.
In early 2001 the White Paper on Strategy for a future chemicals policy was adopted (European Commission, 2001). It addressed shortcomings of the system that allows substances to be used without testing, places the burden of proof on public authorities, has no efficient instrument to ensure safe use of the most problematic substances and provides no incentives for the development of less hazardous substitutes. These considerations led to a proposal for a new EU regulatory framework, the Registration, Evaluation and Authorisation of Chemicals Proposal (REACH). The Commission adopted this proposal on 29 October 2003. REACH lays down the following requirements concerning the registration, evaluation and authorisation of chemical products:
- Registration: Manufacturers and importers of substances or preparations are obliged to register them at a European Chemicals Agency, which will be established under the REACH legislation. - Up to now, the European Chemicals Bureau (ECB), part of the Commission's Joint Research Centre, collects data on chemicals and assesses procedures on dangerous substances. - Nearly all chemicals are covered by this rule, with the exception of substances that are regulated under other legislation or manufactured or imported below certain quantitative thresholds. The rule applies not only to substances and preparations during their use and processing in the chemicals industry, but also to their subsequent processing in downstream industries. This affects the broad range of industries for which the chemicals industry is a manufacturer of intermediate products. A technical dossier is required and for quantities of 10 tonnes or more a chemical safety report (CSR) has to be created. Exposure scenarios have to be created to cover the manufacture and use of substances and preparations. Manufacturers have to describe how they control or recommend control of the exposure of humans and the environment. The exposure scenarios need to be developed to cover all identified uses, including further processing and distribution.
- Evaluation: An evaluation of the information has to be carried out by the authorities in Member States and this may lead to the conclusion that action needs to be taken.
- Authorisation and restrictions: For substances of very high concern, an authorisation is required for use and placing in the market. Downstream users may use substances for an authorised use if they acquire them from an authorised supplier. Any substance, whether on its own, in preparations or in an article, may be subject to Community-wide restriction. Interested parties will have an opportunity to comment on the ECB’s proposed restriction, which will give grounds for any proposed decision. The restrictions are understood as a safety net and the Bureau’s position has been described as a body with sovereign decision-making power.
The chemicals industry accounts for around 12% of the EU’s total energy demand according to the CEFIC review 2004-2005 563kb (CEFIC, 2005). Energy is not only a major cost in the processing of chemicals, but gas and oil are also feedstock for the manufacture of many chemical products. This means that companies should benefit from the EU’s single market and the abolition of market-access barriers. But the liberalisation of gas and electricity markets within the EU is proceeding very slowly and unevenly due to incomplete and delayed implementation of a number of measures by Member States. Energy prices in the EU are roughly one-tenth higher than in the US (CEFIC, 1998 228kb). This turns out to be a disadvantage for production locations in the EU because chemical products are sold into the global market and higher energy prices cannot be passed on to clients.
EU and national environmental policies are directed towards the reduction of emissions. Emissions trading has become the preferred instrument for the economic allocation of scarce resources. In combination with absolute emissions reduction targets of 20% by 2020, emissions trading could curb the growth of the chemicals industry because it would raise already high energy prices yet further and weaken the price competitiveness of the European industry in global markets.
Since the early 1990s, the European chemicals industry has focused its activities away from products that require high-energy inputs. Under tough objectives for the reduction of emissions, these energy-intensive processes may well become even less competitive. As a consequence, EU production of upstream products might be substituted by imports of commodities. From a global point of view, such a development does not contribute to emissions reduction.
Traditionally, the bulk of chemicals production has been carried out in mature industrialised countries. The Triad accounts for two-thirds of global supply, with the EU15 and the US producing 28% and 26% respectively, while Japan accounted for only 10% in 2002. These figures represent, however, a reduction in the share of the industrialised countries. In 1990, the EU contributed 32% of global output of chemicals, with Japan contributing 12% and the US 29%. Asian output soared and its global share escalated from 13% to around 24% between 1990 and 2002 (see CEFIC review 2004-2005 563kb). Nevertheless, in spite of considerable investment in new capacity in Asia, domestic supply could not keep pace with demand and the shortfall was made up by exports from industrialised countries. That is why the European trade balance for chemicals improved. For example, exports to China grew at double-digit annual rates between 1995 and 2002 (see European competitiveness report 2004, p.270 1.75Mb). New plants are now being built in Asia, but it will take some time before sufficient capacity is available to meet soaring demand.
It is worth noting that the recently planned and built chemicals plants in Asia not only incorporate the latest production technology, but are also, in most cases, much bigger than European plants. This gives Asian companies opportunities to exploit economies of scale which are not possible in Europe. As soon as these plants come on stream, European commodity exports to Asia will slow down and it must be expected that, when Asian capacity exceeds demand, there will be exports to Europe based on marginal cost calculations.
The chemicals industry is characterised by strong upstream and downstream linkages. By far the most important raw material is crude oil and petrochemical intermediaries are used in most other subsectors of the chemicals industry. There is a tendency of oil-producing countries not only to invest in oil refineries, but also to take over primary processes of the chemicals industry. As a result, oil-producing countries are becoming ever-more important suppliers of intermediate chemical products.
New processing capacities are erected by Western companies close to oil and gas resources to exploit regional advantages. In many cases, joint ventures and cooperation with local companies facilitate access to the regions. A recent example of this is Acetex’s joint venture with Saudi Arabia’s Jubail: in 2004, Acetex signed a contract with Jubail to build a $1 billion petrochemicals plant, which will start production in 2007. Jubail is a branch of Sabic, a group founded in 1976 to invest in the petrochemicals industry. The activities of Sabic reveal that not only do Western companies invest in upstream industries close to natural resources, but that investment also flows in the other direction, into downstream activities. Sabic invests in the Middle East as well as in downstream industries in the industrialised countries. It has acquired chemicals companies in the Netherlands and Germany, such as the Dutch DSM in 2002. This development reveals that, besides growing cross-border linkages along the value-added chain, there are also equity affiliations between companies within the chemicals industry.
The downstream linkages to client industries are no less important than upstream for the globalisation of production networks. The clearest example is provided by man-made fibres. The relocation of fabrics, textiles and clothes manufacturing away from the EU has persuaded manufacturers of man-made fibres to follow their clients. Turkey, North Africa, the Far East and, in particular, China have become sales regions and locations for new facilities for man-made fibres. The latest surge in imports of textiles from China as a consequence of the phasing out of the Multi-Fibre Agreement (MFA) and the accession of China to the World Trade Organisation (WTO) has accelerated this long-term development (see Table 1).
|Company||Location||Capacity||Initial operation (year)|
Source: Oppenheim Research, as mentioned in Handelsblatt on 29 June 2005.
DG Research and the European chemicals industry have launched a common initiative for a sustainable chemical industry (SusChem). It is organised as one of those European technology platforms that aims to bring together researchers from industry and academia. It is directed towards the stimulation of innovation in the private sector and in that way can contribute to the Lisbon objectives. Its focus is on dynamic high-tech areas, such as biotechnology and materials technology, but it is also concerned with institutional impediments to innovation.
Important activities are arranged by EuropaBio, a European association representing companies from all areas of white, green and red biotechnology. It has become a well accepted contact institution for DG Enterprise and Industry, as well as for DG Research to stimulate communication among decision-makers of all political and societal groups and to formulate European research under the 7th EU Framework Programme. EuropaBio is also a major player in the creation of European framework conditions for biotechnology, which is a highly sensitive topic. It faces the challenge of taking into account the objections of various groups in society and yet creating an environment that will help the industry catch up with the United States.
The social partners in the European chemicals industry - namely, the European Chemicals Employers Group (ECEG), the European Mine, Chemicals and Energy Workers Federation (EMCEF) and the European Chemicals Industry Council (CEFIC) - have created a sectoral social dialogue with the aim of representing the shared views of the intra-industrial stakeholders in the processes of political decision-making, together with the views of stakeholders outside the chemicals industry. The underlying basis for this initiative was the perception that their interests had not been sufficiently considered (see common press release on 13 July 2005).
Uncertainties and issues
The major challenges and changes for the European chemicals industry derive from globalisation. European companies have to exploit the advantages of production locations anywhere in the world to maintain their strong position in the face of growing competitive pressures. Regional linkages to upstream and downstream industries not only provide cost advantages, but also growth opportunities. European companies that make use of opportunities in overseas markets will benefit from soaring demand in Asia and enjoy economies of scale. While this will certainly lead to some loss of employment in Europe, it will at the same time give opportunities to the companies to strengthen their position in areas of comparative advantages in the European Union. This means that global production and marketing networks will help to allocate resources for a more knowledge-driven industry in the EU.
In recent years, the European chemicals industry has undergone a major restructuring. Former national companies have become European players, but they have remained exposed to procurement markets that have not yet been fully liberalised. This means that input prices are high - higher than for important competing nations, such as the US. In particular, the European players face disadvantages in energy supply and transport services, which are of importance for the chemicals industry. This environment accelerates the relocation of production capacities and thus intensifies the challenges of globalisation.
In R&D, innovation efforts have slowed down since the mid-1990s. In biotechnology, Europe is lagging behind the US. This indicates that the European players, who traditionally have been on the leading edge of innovation, have lost some of their strengths. An optimistic explanation would be that companies have had to devote resources to restructuring in order to face the global market, but that they are now in a position to increase their research efforts. Only a monitoring of innovation in the next few years will show whether European companies will lose further ground or are beginning to catch up.
The future development of the European chemicals industry will depend also on the institutional frameworks, i.e. not only the liberalisation of upstream markets, but also the institutions of relevance for entrepreneurship in the chemicals industry. With regard to the administrative burden borne by the industry, the final agreement on the REACH initiative will be of importance. If a compromise is found that not only meets the requirements of the extra-industrial stakeholders but also of the intra-industrial stakeholders, the confidence of the industry in European locations will be boosted.
The European chemicals industry has to catch up on the US lead in biotechnology if it is to catch up in innovation more widely and replace jobs lost through the relocation of commodities production by new jobs in knowledge-driven activities.
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