January 14, 2005

EU Monitor

Western chemical companies move into Eastern Europe Like other companies in the new EU member states, chemical companies are also faced with the major challenge of withstanding the pressure of competition within the European Union. In the chemical sector too, the transition to the market economy in the early 1990s heralded a gradual adjustment to western standards of production and quality, which is not yet complete. In the new EU member states, the sector presently generates an average of 6% of all industrial turnover whereas the equivalent figure for the EU-15 is approximately 10%. In the meantime, the gross domestic product of the Central and Eastern European states is growing by approximately two percentage points more than that of the EU-15 in real terms. Rising wages and salaries are also leading to an increase in the demand of Eastern European consumers for chemical products. In addition, the demand from industry, (auto manufacturers and construction among others) is rising. Between 1998 and 2003, the consumption of chemical products in the new member states doubled and last year reached approx. EUR 31 bn (EUR-15 approx. EUR 450 bn).

Chemical turnover in the new EU member states* 25

EUR bn 20 15 10 5 0 93 94 95 96 97 98 99 00 01 02 03 * Poland, Czech Rep., Slovakia, Hungary, Slovenia Source: CEFIC

I. Eastern chemical industry has a minor role in EU In 2003, the turnover of the chemical industry in the biggest five of the new member states was EUR 22 bn, up 50% in five years. In spite of that, their share of the chemical industry in the enlarged EU totals no more than 4%, roughly corresponding to their share of the new member states’ GDP. Despite the high yearly growth in productivity of almost a tenth in the last five years, domestic firms have not been able to meet the demand for chemicals in the CEECs. For that reason, imports rose by a tenth annually in the same period. Germany’s geographical proximity opens up new export opportunities, for the German chemical industry in particular. In 2003, according to figures issued by VCI, the German chemical industry association, EUR 6 bn (7%) of German chemical exports were to the new member states. The main buyer was Poland, followed by the Czech Republic and Hungary. The three most important export products from Germany are fine and speciality chemicals, polymers and pharmaceuticals.

1. Restructuring not yet completed In the five big new member states (Poland, the Czech Republic, Slovakia, Hungary and Slovenia), the privatisation of the chemical industry has progressed to different degrees. While the process has been broadly concluded in Hungary and Slovakia, the state continues to be a significant shareholder in important chemical companies in Poland and the Czech Republic. In these countries, it is possible that the ongoing privatisation will result in unprofitable facilities being shut down. This may well be the case with many basic products (e.g. PVC) where overcapacity is a problem all over Europe.

German trade in chemical products with new EU member states by sector - 2003 Exports

Imports

Balance

EUR m Inorganic basic chemicals

143.5

91.5

52.0

Petrochemicals

455.2

394.7

60.5

Polymers

1,606.3

521.7

1,084.6

Fine and speciality chemicals

1,663.5

193.9

1,469.6

Pharmaceuticals

986.8

133.5

853.3

Agrochemicals

192.0

206.5

-14.5

Detergents and toiletries

516.8

125.7

391.1

Total chemicals

5,564.0

1,667.6

3,896.4

Total trade with new EU member states

55,802.8

56,955.3

-1,152.5

Source: Statistisches Bundesamt

2. Basic chemical industry predominant Owing to the focus on heavy industry, the basic chemical industry was predominant in the past. Given the lack of raw materials, this was dependent on supply from Russia and the former Soviet Union respectively. Due to this orientation, petrochemicals, polymers and agrochemicals are among the leading exports of the new member states even today. Only Hungary as an important producer of pharmaceutical products occupied a special position within COMECON (Council for Mutual Economic Assistance). Economics

11

EU Monitor

January 14, 2005

3. Adaptation to western standards necessary The post-accession increase in production standards, especially regarding environmental regulations, has proved a handicap for the chemical industry in Eastern Europe. In the run-up to membership, facilitating stricter EU environmental standards spurred investment in many sectors. Nonetheless, the companies still in state hands still have a lot of ground to make up. Hence, Poland for example has to raise at least EUR 1 bn in order to bring the sector fully into line with EU environmental standards. In the long term, the restrictive EU chemical policy with its proposed and deeply controversial rules and regulations known as REACH (Registration, Evaluation, Authorisation of Chemicals) will also impact negatively in the new member states.

Chemical industry employment in the new EU member states 300 in 1,000

250 200 150 100 50 0

93 94 95 96 97 98 99 00 01 02 03

4. New test procedures a burden

Source: CEFIC

The EU is expected to fundamentally change its chemical laws. By the end of 2003, the European Commission had already passed its proposal for a regulation. At present, in the region of 6,400 submitted commentaries are under review. As a result, the regulation might not be passed until 2006. For all chemicals of which every year a tonne or more is produced the proposal envisages compulsory registration. At the same time, companies will be obliged to have an estimated 30,000 potentially recyclable materials valued and registered within eleven years of the regulation coming into effect. This affects first and foremost the chemical industry in the new EU member states. The costs of testing and registering are expected to be unviable, especially for materials that are produced in small quantities. As a consequence, in the coming 10 to 15 years, in the region of 20-40% of all products of which less than 100 tonnes are produced yearly will disappear from the market. This will proceed hand in hand with the shedding of a large 1 number of jobs in the sector.

International turnover in chemical products 1993 to 2003 - EUR bn -

EU-15 Germany EU-New members*)

1993

1995

1996

1997

1998

1999

2000

2001

2002

2003

% change 03/93 p.a.

329.3

375.8

383.8

413.3

416.8

439.3

500.8

518.8

526.4

533.6

+4.9

102.6

112.3

110.3

118.2

116.8

121.4

135.0

133.9

132.5

136.4

+2.9

9.2

12.4

12.9

13.5

14.4

14.4

17.9

19.5

21.0

21.5

+8.9

EU-15+New members

338.5

388.2

396.7

426.8

431.2

453.7

518.7

538.3

547.4

555.1

+5.1

USA

282.1

288.8

303.5

366.4

371.8

392.4

479.9

477.2

445.0

405.1

+3.7

Japan

178.3

190.1

170.2

179.0

158.9

188.3

240.1

213.6

192.7

177.9

±0.0

World

995.6

1,140.7

1,193.5

1,320.8

1,327.7

1,435.8

1,768.6

1,838.3

1,679.9

1,618.4

+5.0

*) Poland, Czech Republic, Slovakia, Hungary, Slovenia Source: CEFIC

1

12

Perlitz, Uwe (2003): Chemieindustrie: Imagewandel durch forcierten Umweltschutz, Aktuelle Themen No. 253, Deutsche Bank Research, Frankfurt/M. (Available in German only).

Economics

January 14, 2005

EU Monitor

II. Significance of the chemical industry in selected new EU member states 1. Poland: biggest producer With a turnover of EUR 7.8 bn, Poland might be by some distance the biggest producer among the new member states but among the EU-15 it in fact still lags behind Denmark (EUR 8.1 bn). The sector consists of private companies in Polish and foreign ownership as well as state companies. The latter still control about 40% of the sector. In 2003, the government decided to restructure the producers of basic chemicals still in state hands. Within the framework of the “great chemical synthesis program”, six enterprises are being reorganised. They are at present in the possession of the privatisation agency Nafta Polska and although privatisation is expected in 2005/06, the state wants to keep its influence in key enterprises (e.g. basic chemicals). For this reason, the treasury ministry is expected to keep a representative on the board of directors as an observer. In many cases, the product spectrum of the company marked for takeover is expected to change very little. The majority will keep their Polish trademark but improve their image. Recently foreign firms have started with the petrochemical industry, the weakest link in the Polish chemical industry. This is a shrewd move, considering that the production of synthetics in Poland continues to look good. The leading synthetics manufacturer (Wavin) specialises in building supplies and lists PVC pipes among its products. Even though the demand for synthetics has risen sharply in Poland in recent years, consumption per head is approximately only half the average of the EU-15.

State wants to keep influence in key industries

2. Czech Republic: demand exceeds supply At EUR 3 bn, the turnover of chemical products in the Czech Republic is significantly less than that in Poland and similar in scale to that of Greece. In 2003, chemical consumption ran to EUR 6 bn and clearly outstripped domestic production. This is primarily due to strong demand for synthetic products in the car industry. Producing approximately 440,000 units in 2003, the Czech Republic is the biggest car manufacturer of the new member states. Admittedly, domestic chemical companies in other sectors are fighting for survival because many products are difficult to export due to problems with quality. In order to meet EU requirements, companies will have to invest heavily in the coming ten years, and this frightens off numerous investors from Western Europe.

3. Hungary: important producer of pharmaceutical products in Central and Eastern Europe

Chemical turnover in the new EU member states Changes 1993

2003 03/93 p.a.

- EUR bn Poland Czech Republic Slovakia

%

3.4

7.8

8.7

2

3.2

4.8

0.7

3.8

18.4

Hungary

1.9

3.4

6

Slovenia

1.2

3.3

10.6

Total

9.2

21.5

8.9

Source: CEFIC

In Hungary, with a turnover of EUR 31 bn in chemical products, the increasing export orientation of the pharmaceutical industry has positive implications for the entire chemical industry. In 2003, the export of pharmaceutical products expanded by approximately a quarter and in 2004 this trend gathered pace. International pharmaceutical companies have since acquired all the major local manufacturers, with the exception of Richter Gedeon, the largest, where most of the capital is held by international investors. The company has succeeded in establishing itself as a supplier in the EU and the USA, which provide one third of its turnover. It maintains three factories in Hungary and has four subsidiaries (in Russia, the Ukraine, Romania and Poland). The product spectrum covers in the region of 100 drugs that span the entire range of treatments. Chinoin, belonging to the Sanofi-Aventis group, has become the second most important company. In 2002, the company worked out a long-term

Economics

13

EU Monitor

January 14, 2005

investment plan. Modernising and expanding the production facility in Hungary is expected to cost EUR 200 bn.

4. Slovakia: increasingly attractive location for investment Due to drastic reforms, the Slovakian chemical industry has become a markedly more attractive location for investment. In the last 10 years, turnover rose by almost a fifth every year – much faster than in the other new member states. In 2003, imports totalled EUR 3 bn, up from only EUR 0.6 bn in 1993. That was mainly due to the strong economic upturn in the economy – due mainly to stronger investment and much improved domestic demand. This has opened up some bright prospects for western suppliers of capital and consumer goods. The fact that wage levels in Slovakia are significantly lower than in Poland, the Czech Republic and Hungary may also play a role in its increasing importance as an investment location.

Pharmaceutical market in the new EU member states - Turnover 2002 -

Slovenia 5%

Baltic states 6%

Slovakia 7%

Poland 47%

5. Slovenia: chemical industry expanding With a turnover of over EUR 3 bn, the Slovenian chemical industry is one of the country’s few industrial sectors that are expanding. The EU single market obliged manufacturers of parts and products for the auto industry to meet EU requirements early on in order to compete for contracts and tenders. In addition, the strong position of the pharmaceutical industry plays an important role, especially exports to the USA of the generic producer Lek. Among the most important areas of the chemical industry are the production of paint and dyestuffs. A reinvigorated construction industry and a revival in demand from the car industry have benefited the sector noticeably. Slovenia delivers many products to DIY markets in Western Europe.

Czech Rep. 15%

Hungary 20% Source: BPI

III. Trends favour consumption of chemicals Future GDP growth in the new member states is expected to be considerably higher than in the EU-15. According to DB Research (2004/05), the corresponding growth rates will range from 3% in the Czech Republic to 7% in Lithuania. Such economic expansion will boost the consumption of chemicals in these countries although companies should try to better satisfy the demand in their region by changing the range, and improving the quality, of their products. In this context, privatisation will offer opportunities to benefit from western know-how. On the one hand, this could enable companies from these countries to strengthen their competitive positions in the home markets and boost their sales figures; on the other, it will improve their export chances.

1. Western firms impact on Eastern European market The favourable conditions for doing business (low wages, low taxes and costs as well as EU-wide uniform standards) continue to attract more companies eastwards. According to figures compiled by the German chemical industry, the average labour costs in the new member states’ chemical industry are only EUR 5 an hour, as opposed to EUR 27 in the EU-15. But productivity in the new member states is a mere half of the EU-15 average. At the same time, there are big differences between the countries: Hungary and Slovenia attain well over 60% of the average of the old EU while the Baltic states’ productivity lies well below the average. Although it is growing in all the Eastern European countries and will gradually converge with that of the EU-15, this also applies to wage levels. An additional problem is the availability of skilled labour. Investments by the German chemical industry in the new member states have risen markedly in recent years. Following the labourintensive sectors, capital-intensive chemical companies are increasingly investing in Eastern Europe. Many of the chemical industry’s 14

Economics

GDP growth of new EU member states new EU-member states

6 % yoy

5 4

EU-15

3 2 1 0 99

00

01

Source: DB Research

02

03

04

05

January 14, 2005

EU Monitor

customers have been establishing production facilities in the new member states. VCI figures show that the chemical industry has overtaken electrical and mechanical engineering in terms of direct investment in the new member states and is now in second place after car manufacturing. In order to remain competitive, direct contact with customers is often of pivotal importance; in addition proximity to markets further east is also an attraction. Furthermore, construction and engineering costs are relatively low and the licensing procedures considerably shorter than in Germany. VCI figures show that in the new member states approximately 90 German subsidiaries employing 14,000 people are responsible for a turnover of EUR 2 bn, making up almost a tenth of the new member states’ chemical markets. The most important location for German investment is Poland, followed by Hungary and the Czech Republic.

Chemical industry investments in the new EU member states EUR bn

2.0 1.5 1.0 0.5 0.0

93 94 95 96 97 98 99 00 01 02 03 Source: CEFIC

Hence it’s little surprise that foreign investors are active above all in the chemical sector, where there is a great backlog in demand. This is especially true of consumer-oriented sectors such as personal hygiene and cleaning agents, paints and dyestuffs as well as pharmaceutical products. Leading manufacturers such as Unilever, Procter & Gamble as well as Henkel are already represented in several CEECs with their own production facilities. This position was reached both by acquiring local manufacturers and by founding new subsidiaries.

2. Industry expanding in Eastern Europe Both the rising significance of businesses buying goods produced by the chemical industry in Eastern Europe (e.g. car industry, construction) and increased private consumption have led to the growth of demand for chemical products in the new EU member states. a) Car industry’s increased demand The chemical industry is pinning its hopes above all on the growing auto industry in Eastern Europe since an increasing proportion of a car's material is allotted to synthetics (2004: 13%; 1980 only 8%). In Central and Eastern Europe, the auto sector has become one of the major pillars of growth. Between 1995 and 2003, output rose by a total of 70% to 1.3 million units, while growth in the EU-15 was markedly lower (10%). Until 2000, Poland was the principal location for car manufacturing in Eastern Europe. The most important carmakers are Fiat and Opel, which together account for 80% of total production of around 360,000 units. Meanwhile, the Czech Republic has taken top position, with an increase in production of almost onetenth p.a. over the last eight years. The largest Czech manufacturer by far is Škoda (Volkswagen group).

Number of cars in EU* 1995

2003

EU-15

443

501

EU-new members

224

300

Hungary

226

275

Poland

196

294

Czech Republic

334

363

* Number of vehicles per 1,000 inhabitants Sources: German Association of the Automotive industry, DB Research

The volume of car manufacture in the new EU member states is still low, but the number of units is set to increase by an average of almost 10% p.a. over the next 10 years. Further evidence for this lies in the low ratio of car ownership of 300 per 1,000 inhabitants, as 2 opposed to 500 in the EU and 550 in Germany. b) Impetus from rising construction investment In addition, rising investment in construction is good news for chemical companies in terms of sales. According to a report by Euroconstruct, investment in construction in the new member states is expected to grow by almost a tenth every year up to 2006, to EUR 45 bn, while growth in Western Europe will only reach 1.5% p.a. 2

See Heymann, Eric (2004): Automobile market Eastern Europe: more important as a production location than as a sales market, in: EU Monitor No. 15, Deutsche Bank Research, Frankfurt am Main.

Economics

15

EU Monitor

although the volume there is considerably higher (EUR 1,000 bn in 2004). The new member states have some catching up to do in all areas of construction. Large-scale investment is to be expected in the course of restructuring large industrial combines and establishing new production sites as a result of moves to the east by Western European companies.

3. Big back-log in consumer demand

January 14, 2005

Real investment in construction 2003

4. Chemical production in CEECs remains low …

… but imports fuel increased consumption The new members continue to substantially increase their imports of chemical products. For one thing, consumption is rising as a result of predictions of strong economic growth. For another, the market is demanding high-quality products, which the CEECs will not be able to produce in sufficient quantities in the foreseeable future.

%

18.5

24.0

+9.1

Hungary

8.0

9.8

+7.0

Czech Republic

7.4

9.0

+6.7

Slovakia

1.7

1.9

+3.8

35.6

44.7

+7.9

1,016.0 1,065.0

+1.6

New EU members Western Europe Germany

195.4

199.8

+0.7

Source: EUROCONSTRUCT

Chemical turnover in Europe 2003

2005

2010 Changes 10/03

- EUR bn EU-15

Overall, we foresee the turnover in the chemical industry growing from EUR 22 bn at present to EUR 35 bn by 2010. The growth rates of around 7% p.a. are above the anticipated growth both for the EU15 (5% p.a) and Germany (3%). In these cases, the 2003 level, at EUR 534 bn and EUR 136 bn respectively, is a good deal higher. The new member states’ share of turnover in chemical products in the enlarged EU is expected to grow marginally by around 4 to 5%.

Change 06/03 p.a.

- EUR bn Poland

Even those sectors of the chemical industry dependent on consumption are geared towards expansion, encouraged by growth in incomes. In Poland, for example, some brand names are enjoying a revival and gradually rivalling their western counterparts in terms of quality. This means that home-grown manufacturers can perform relatively well in spite of the presence of big international firms. Companies such as Ziaja Kosmetyki in Poland that concentrate on inexpensive, mass-produced products are especially wellpositioned. The company’s range of products has come to contain about 130 products – among others – face, body and hair-care products. Having already established itself in the Baltic states, it now seeks to expand its exports to supermarkets in the USA and Germany. All in all, the market for toiletries still has considerable potential for growth. For that reason, foreign companies such as Beiersdorf, Avon, Johnson&Johnson and L’Oréal have already established manufacturing bases in the new member states.

2006

Germany EU new members* EU-15 + new members World

%

533.6

590

750

+5.0

136.4

145

170

+3.2

21.5

25

35

+7.2

555.1

615

785

+5.1

1,618.4 1,785 2,280

+5.0

* Poland, Czech Rep., Slovakia, Hungary, Slovenia Sources: CEFIC, DB Research

IV. Conclusion The new EU members have certainly made great progress in modernising their chemical industries. But the key figures show that they still have much to do to catch up with Western European levels of productivity. In future, product quality must be improved and the range of products adjusted according to need. As this is likely to take some time, we expect the economic upswing in the CEECs to lead to large-scale chemical imports from Western Europe. Privatisation has not yet been completed in all CEECs as potential investors shy away from spending considerable amounts on debt restructuring, modernisation and environmental protection measures. Overcapacity in Western Europe and worldwide have also played a role here. In addition, the state, e.g. in Poland, wants to have a say in restructuring, especially as regards job cuts. Overall, however, the chemical industry in the CEECs is on the right track to coping with the painful adjustment process. Uwe Perlitz, +49 69 910-31875 ([email protected])

16

Economics

New EU members: Chemical imports and exports EUR bn

25 20 15

Imports

10 Exports

5 0

93 94 95 96 97 98 99 00 01 02 03 Source: CEFIC