The Japanese Chemical Industry: Finding the Right Path

Transcription

1 CHEMICALS AND PERFORMANCE TECHNOLOGIES The Japanese Chemical Industry: Finding the Right Path kpmg.com/chemicals KPMG INTERNATIONAL

2 b The Japanese Chemical Industry: Finding the Right Path KPMG s Global Chemicals and Performance Technologies Practice Market leading audit presence Integrated global network Recognized thought leadership position Commitment to the industry

3 Foreword We would like to offer our deepest condolences to the Japanese people and particularly those who have been personally affected by the terrible events of March 11th, Our thoughts are with you at this time. Mike Shannon Global Chair, Chemicals and Performance Technologies Impact on the chemical industry As we were due to go to print, Japan was rocked by the terrible events related to the earthquake and tsunami of March 11th, The initial impact on the Japanese chemical industry was equally devastating, with plants closed across the country and a number of key end market customers, most notably in the automotive industry also shutting down production. In addition, chemical producers were faced with the ongoing impact of rolling power blackouts in the areas under the management of Tokyo Electric Power. However, the response of Japanese chemical manufacturers attests to the resilience of the industry. While the medium term domestic demand outlook remains highly uncertain, there is likely to be a longer term opportunity for Japanese chemical manufacturers to play a central role in the post-disaster reconstruction process.

4 Executive Summary Beginning is easy Continuing is hard. Japanese proverb The global chemical industry appears to be on track for solid gains in 2011, with worldwide production expected to increase by five percent. 1 The question for the Japanese chemical companies is how much of this good news will apply to them and how much to their competitors. After decades of brilliant achievements and growth, the Japanese chemical industry now struggles to maintain its position in the marketplace. Dependent on sluggish domestic markets, weighed down by overcapacity and over-diversification, impeded by a traditional business culture, and faced with increased competition from China and the Middle East, today s Japanese chemical companies find themselves in an increasingly precarious position. Indeed, to say that the Japanese chemical industry is at a crossroads is not an understatement. Change is required by Japanese companies; not cautious, incremental change but swift and radical change affecting their very structure, culture, and long-term strategies. This will not be easy or straightforward. With their eyes on the future, Japanese company leaders must make tough decisions that include: A rigorous process of rationalization to eliminate unprofitable facilities and business units Asset swapping to generate scale Consolidation through mergers and acquisitions (M&A) to drive a new focus on core business A stronger push into overseas operations, especially through joint ventures in emerging markets A continued commitment to research and development (R&D) and innovation to support new growth areas. Like their counterparts in the US and Europe, Japanese chemical companies have access to well-developed facilities, strong client relationships, a highly trained workforce and significant levels of intellectual property (IP). They also enjoy proximity to rapidly growing markets in Asia. With a firm commitment to change, the Japanese chemical industry may regain competitive advantage in today s growing markets. Paul Harnick Global Executive Chemicals and Performance Technologies Mike Shannon Global Chair Chemicals and Performance Technologies 1 Chemical Demand Improvement to Continue in 2011, ChemWeek, December 3, 2010

5 Contents Introduction to the Japanese Chemical Industry 2 Size and Characteristics 3 Key Players 4 Recent Trends 6 Key Challenges Today 10 Overcapacity 10 Rise of the Middle East and China 11 Comparisons to Europe 14 Structural Issues 16 Diversification 17 Domestic versus Global Strategies 18 Change in Perspective 20 Chronic Overcapacity and Inefficiencies 20 Support for Employees 20 Rising Protectionism 20 Uncompetitive Downstream Industries 21 Solutions for Change 22 Asset Swapping 23 Geographical Expansion 23 Rationalization 24 Focus on Core Business 24 R&D and Innovation 25 Conclusion 26

6 2 The Japanese Chemical Industry: Finding the Right Path Introduction to the Japanese Chemical Industry Japan struggled through a lost decade that in fact continued into the 2000s, and the chemical industry steadily lost ground. To understand the Japanese chemical industry, we need to consider both its amazing post-war growth and its relative decline in recent decades as a global player. In 1959, Japan, the US and Western Europe, known as the Triad, controlled the global chemical industry. Supported by expanding markets, low prices for feedstock, a highly trained workforce, major investments in plants and extensive research, the Triad produced almost all chemical exports worldwide. For Japan, the chemical industry was only one more example of a period of astonishing growth and productivity. Within two generations after World War II, Japan had become a powerhouse, the world s second largest economy. Japan, Inc. was considered the very model of how to do business, and Japanese manufacturing and management methods were carefully studied and adopted by companies everywhere. By the 1990s, however, the combined share of global chemical exports from the Triad had fallen to two-thirds. 2 Japan struggled through a lost decade that continued into the 2000s, and the chemical industry steadily lost ground. From 2000 to 2007, the average operating profit of all Japanese chemical companies declined from 6.4 percent to 2.8 percent. 3 By 2009, Japan accounted for only 8 percent of global chemical shipments. Faced with chronic challenges, the question today is whether the Japanese chemical industry can survive by honoring the spirit of change and innovation that served it so well for decades in the 20 th century. 2 Kent and Riegel s Handbook of Industrial Chemistry and Biotechnology, James Kent, ed., 11th edition, Industry Review Japan: Consolidate or Lose!, Roland Berger Strategy Consultants, 2009

7 The Japanese Chemical Industry: Finding the Right Path 3 Size and Characteristics Geographic breakdown of global chemical shipments*, 2009 Country/Region Sales (US$ billion) Central and Eastern Europe 4% Latin America 6% Others 6% China 635 Japan 286 US 20% United States (US) 674 Central and Eastern Europe 123 Western Europe 26% Latin America 217 Western Europe 894 Other Asia-Pacific 390 Others 212 China 19% Other Asia-Pacific 11% Japan 8% *The term shipments is equivalent to value of output Note: Chemical industry sales include sales from basic chemicals, specialty chemicals, agricultural chemicals, pharmaceuticals and consumer products. Source: American Chemistry Council, 2010

8 4 The Japanese Chemical Industry: Finding the Right Path Sector-wise breakdown of Japanese chemical industry sales in 2009 Sub-sector name Sales, 2009 (US$ billion) Base Chemicals Pharmaceuticals 30.2% Pharmaceuticals 80.3 Specialty & Fine Chemicals 42.9 Agricultural Chemicals 2.1 Base chemicals 52.8% Specialty & fine chemicals 16.2% Source: Japan Chemicals, Datamonitor, September 15, 2010 Agricultural chemicals 0.8% The Japanese chemical industry is the second largest industry in the country and the world s fourth largest in terms of shipments, totaling US$286 billion in The industry can be divided into four general areas of production: Base chemicals that include petrochemicals, their derivatives and basic inorganics. Produced in large volumes, they are sold as commodities to manufacturers in the chemical industry or to other industries. Specialty and fine chemicals that are intended for specialized use and produced in lower volumes than base chemicals. Examples include ingredients used in adhesives, additives, plastics, coatings, paints and inks, crop protection, dyes and pigments. Pharmaceuticals including both basic pharmaceutical products and pharmaceutical preparations. Agricultural chemicals that include pesticides and chemical growth agents such as synthetic fertilizers and hormones. Key Players The chemical industry in Japan is dominated by a small group of major corporations, most of which are highly diversified with a large number of subsidiaries. All have strong alliances with other companies through their membership in keiretsus (companies with interlocking business relationships and shareholdings). Japanese industry leaders include the following: Mitsubishi Chemical Holdings (MCH) is Japan s largest chemical concern. MCH and its network of subsidiaries manufacture petrochemicals, pharmaceuticals, functional materials and plastic-based products, specialty chemicals, carbon and a range of products used in the electronics industry. Sumitomo Chemical includes over 100 subsidiaries and affiliates operating in six business sectors. The company produces basic chemicals, petrochemicals and plastics, fine chemicals, IT-related chemicals, agricultural chemicals, and pharmaceuticals. 4 American Chemistry Council, 2010

9 The Japanese Chemical Industry: Finding the Right Path 5 Mitsui Chemicals is a leading manufacturer and supplier of valueadded specialty chemicals, plastics and materials for the automotive, healthcare, packaging, agricultural, building, and semiconductor and electronics markets. Shin-Etsu Chemical produces over 4,000 silicone-related products that meet user needs in a wide range of industries, including electric/electronics manufacturing, the construction industry, the auto industry, cosmetics and toiletries, and the chemical industry. Toray develops products using organic synthetic chemistry, polymer chemistry and biotechnology. Key manufacturing areas include aromatic fine chemicals, high-functional catalysts, specialty chemicals, chiral compounds and other products. Asahi Kasei Corporation provides innovative solutions based in chemistry and materials science to a diverse range of markets including fibers, chemicals, consumer products, housing, construction, electronics, and health care. Hitachi Chemical prioritizes four key business fields with high growth potential telecommunications and displays, environment and energy, life sciences and automobiles and transportation infrastructure. The Japanese chemical industry is the second largest industry in the country and the world s fourth largest in terms of shipments.

10 6 The Japanese Chemical Industry: Finding the Right Path Recent Trends Annual GDP growth rate (%) for China, EU, Japan and US Country/Group F 2011F 2012F China EU (4.1) Japan (1.2) (5.2) US (2.6) F = Forecast Source: International Monetary Fund, World Economic Outlook, October 2010 Producer s Shipments Index Japanese Manufacturing Industries & Chemical Industry Index (2005 average = 100) Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Manufacturing Industries Chemicals (excl. pharmaceuticals) Source: Ministry of Economy, Trade and Industry, Source: Japan Chemical Industry Association, 2010

11 The Japanese Chemical Industry: Finding the Right Path 7 Yen to US dollar exchange rate (January 1, 2008 October 25, 2010) Exchange rate (JP to US$) Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Source: Oanda.com, accessed on October 25, 2010 Japanese chemical industry monthly output, September 2008 August ,000 50% Thousand tons 6,500 6,000 5,500 5,000 4,500 5,916 5,818 5,572 5,556 5,214 4,664 4,925 5,214 6,537 6,662 6,259 6,179 6,057 6,124 6,169 5,993 6,029 5,945 5,849 5,811 5,771 5,641 5,452 5,503 40% 30% 20% 10% Change (%) 4,000 3,500 0% 3,000 (10%) Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Chemical Production Year-on-year growth Source: Ministry of Economy, Trade and Industry (METI), Japan, 2010 Note: Chemical industry output includes production of fertilizers, industrial sodium chemicals, industrial inorganic chemicals, pigments, catalysts, aromatic hydrocarbons, cyclic intermediators, industrial organic chemicals, plastic materials, synthetic rubber, soap, synthetic detergents, surface-active agents, cosmetics, paints and printing inks.

12 8 The Japanese Chemical Industry: Finding the Right Path More than the US and Europe, Japan was hit hard by the global recession. The country suffered a two-year decrease in GDP growth, including a 5.2 percent decrease in Reflecting this decline, chemical shipments began to drop in January of 2008, and the Japanese petrochemical market fell steadily throughout the year, one of the sharpest drops in history. The Ministry of Economy, Trade, and Industry (METI) estimated domestic ethylene production sank 11.3 percent in By Q1 2009, Japanese naphtha crackers were operating at around 70 percent of capacity. In addition, 11 ethylene facilities reported a total loss of US$2.4 billion for fiscal Out of the six leading chemical companies in Japan, two reported losses at the operating level and four at their bottom line. 6 In 2009 and into 2010, the situation improved. The average operating rate of ethylene facilities in Japan increased from around 80 percent in April of 2009 to over 90 percent in May of 2009, and these rates have not dropped as of the middle of This increase has been mainly driven by growth elsewhere in Asia, especially China. Japanese exports such as LCD films and engineering plastics were supported by the Chinese government s stimulus package, which boosted sales of automobiles and domestic electrical appliances such as LCD TVs. As of September 30, 2010, profitability or improved earnings have been reported by several leading Japanese chemical companies. 8 However, year-over-year growth rates in production still show little increase, mainly because of sluggish domestic markets that are still recovering from unprecedented declines during the recession. The Japanese automotive industry is a prime example. In 2008, the headlines told a grim story Toyota Expects Its First Loss in 70 Years. 9 Suzuki to Cut Japan Output by Additional 30,000 Units. 10 Honda slashes profit forecast. 11 Although these automotive giants are recovering based on strong demand in emerging countries such as China and India, sales have not returned to pre-recession levels, 12 and this situation continues to trouble Japanese chemical companies. Overall, the Japanese economy is not expected to return to a GDP annual growth rate of 2 percent until the end of However, the government and financial institutions are taking steps that may have a positive impact on the chemical industry. In October of 2010, the Bank of Japan cut interest rates to zero and bought private sector assets in an effort to curb deflation. 14 These efforts are in line with government policies to bring down the value of the yen. Although Japanese chemical companies sell approximately 80 percent of output to domestic markets, they look forward to better control over a rising yen that may have a positive effect on exports, especially as Japan s LDPE exports, for example, plunged 29.6% in the first eight months of 2010 compared to the same period a year earlier Japan Petrochemicals Report 2010, Business Monitor International 6 Japan s chemical industry shifts to prepare for a new reality, ICIS, October 15, Ibid. 8 Major Japanese Firms Report Improved Earnings and Sales, ChemWeek, November 12, New York Times, December 22, Bloomberg, December 22, CBC News, December 17, Japan: Positioning for Recovery, ChemWeek, May 2, Ibid. 14 Japan s extraordinary move to zero, ReportonBusiness.com, October 6, Obscured by Clouds, Platts Horizon, Winter 2010/11

13 The Japanese Chemical Industry: Finding the Right Path 9 Overall, the Japanese economy is not expected to return to a GDP annual growth rate of 2 percent until the end of 2011.

14 10 The Japanese Chemical Industry: Finding the Right Path Key Challenges Today Overcapacity and the growing presence of the Middle East and China are issues faced by chemical industries around the world. Japanese chemical companies have addressed these issues in part by production cutbacks and joint ventures with Chinese and Middle Eastern companies. Overcapacity Ethylene supply/demand balance, 2009 (in thousand tons per year) China Japan US Europe Middle East Global Ethylene production 14,737 7,279 NA 31,783 20, ,963 capacity 1,2 Ethylene production 3,2 10,697 6,913, 22,610 NA NA NA Ethylene demand 1,2 24,476 6,367 NA 26,486 4, ,407 NA: Not available Source: 1. Future trends in global demand for and supply of petrochemical products, METI, May 14, Japan Petrochemical Industry Association, Output Declines in US, Europe, Chemical & Engineering News, July 5, 2010 Overcapacity remains a worldwide issue that will not go away, even with rising demand in emerging markets. Between 2009 and 2011, about 14 million tons of ethylene is expected to come on-stream, a 15 percent increase in 18 months. 16 In 2010, global demand growth is expected to reach about 4.4 million tons, while capacity is expected to increase by about 10 million tons. 17 In Japan, overcapacity has been a serious issue since the 1990s. Domestic demand has either declined or failed to increase for a large number of petroleum based products. Ethylene capacity in Japan has remained constant over the past decade while demand has decreased by 2 percent annually. Japanese producers are taking steps to mitigate declining domestic demand and the likely loss of exports. They are also rationalizing capacity (see Section 3.1) and moving away from commodity chemicals toward higher-end products. No net capacity growth is planned for olefins and aromatics in Japan through Petrochemicals, ChemWeek, March 26, Ibid. 18 Ibid.

15 The Japanese Chemical Industry: Finding the Right Path 11 Rise of the Middle East and China World natural gas costs $1.25 $0.75 $3.60 $2.00 $5.75 $0.80 $1.50 $5.00 $7.60 $2.50 $0.75 $7.65 Russia North Africa Ukraine Indonesia Canada Venezuela Argentina US West Europe Trinidad Middle East Japan Source: JP Morgan Chemical primer, June 2008; US Energy Information Administration, 2010

16 12 The Japanese Chemical Industry: Finding the Right Path Japan will likely see a sharp rise in competition from the Middle East as large-scale petrochemical projects in Petro Rabigh and Eastern Petrochemical (Sharq) come on stream in Q Ethylene plants in Japan Ethylene plants in Saudi Arabia Company Location Capacity (tons/year) Company Location Capacity (tons/year) Idemitsu Kosan Co Ltd Ichihara 374,000 Idemitsu Kosan Co Ltd Tokuyama 623,000 JX Nippon Oil and Energy Corp Kawasaki 460,000 Keiyo Ethylene Co Ltd Ichihara 740,000 Maruzen Petrochemical Co Ltd Ichihara 520,000 Mitsubishi Chemical Corp Kashima 375,000 Mitsubishi Chemical Corp Kashima 453,000 Mitsubishi Chemical Corp Mizushima 450,000 Mitsui Chemical Inc Ichihara 617,000 Osaka Petrochemical Industries Ltd Takaishi 450,000 Sanyo Petrochemical Co Ltd Mizushima 500,000 Showa Denko KK Oita City 675,000 Sumitomo Chemical Co Ltd Ichihara 415,000 Tonen Chemical Corp Kawasaki 515,000 Tosoh Corp Yokkaichi 527,000 Al-Jubail Petrochemical Co Jubail 810,000 Al-Jubail Petrochemical Co Jubail 800,000 Al-Jubail Petrochemical Co Jubail 800,000 Al-Jubail Petrochemical Co Jubail 830,000 Eastern Petrochemical Co Jubail 1,300,000 Jubail Chevron Phillips Co Jubail 300,000 Jubail United Petrochemical Co Jubail 1,450,000 Rabigh Refining and Petrochemical Co Saudi Ethylene and Polyethylene Co Rabigh 1,300,000 Jubail 1,000,000 Saudi Kayan Petrochemical Co Jubail 1,480,000 Saudi Petrochemical Co Jubail 1,300,000 Saudi Yanbu Petrochemical Co Yanbu 860,000 Saudi Yanbu Petrochemical Co Yanbu 920,000 Yanbu National Petrochemical Co Yanbu 1,300,000 Average capacity of Japanese ethylene plants 512,933 Average capacity of Saudi Arabian ethylene plants 1,032,143 Source: ICIS, accessed on October 22, 2010

17 The Japanese Chemical Industry: Finding the Right Path 13 Issues involving overcapacity cannot be separated from the current rise of the Middle Eastern and Chinese chemical industries. The Middle East region has about 67 percent of the world s oil reserves and 45 percent of all natural gas reserves, the largest such reserves found anywhere. The availability of these resources provides the chemical industry in the Middle East with both energy and feedstock at relatively low prices. Companies like Saudi Basic Industries Corporation (SABIC) currently pay only US$0.75 for one million British Thermal Units (BTUs) of natural gas compared to the average market price of between US$7 and US$8 in developed countries. 19 Even allowing for the increasing use of mixed feed and the expected ethane price increase of between 50 percent to 100 percent in Saudi Arabia in 2012, the cost advantage of Saudi producers will remain significant. This advantage is exacerbated by the economies of scale available to the new, highly efficient, world scale plants being constructed in the Middle East. The average ethylene cracker in Saudi Arabia, for example, is more than twice the size of similar units in Japan. Backed by a dependable supply of feedstocks as well as significant cash reserves, Middle Eastern countries have made huge investments to increase capacity in both upstream and downstream production facilities (principally in the form of world-scale, integrated complexes). More than 19 million tons per year of ethylene capacity will come on-stream in the Mideast by 2015, according to SRI Consulting. 20 The region is already becoming the leading producer for a range of petrochemicals and plastics, including ethylene glycol (EG), polyethylene (PE), and polypropylene (PP). EG capacity will increase in the region from 6.2 million tons per year in 2009, to 8.8 million tons per year in 2014, raising its share of the global total from 28 percent to 32 percent over the five-year period. 21 Japan will likely see a sharp rise in competition from the Middle East as large-scale petrochemical projects in Petro Rabigh and Eastern Petrochemical (Sharq) come on stream in Q In a study by Japan s Ministry of Economy, Trade and Industry on global supply and demand for petrochemicals, the Middle East is forecast to have a surplus in ethylene derivatives of 17.5 million mt in 2014, almost double the 2008 figure of 9.1 million mt, part of which will undoubtedly flow to Japan. In response, many Japanese companies have discontinued or cut back production of commodity products such as PE, EG and styrene that are not competitive with the ethane-gas fed products from the Middle East. 22 As for China and its impact on the Japanese chemical industry, the numbers speak for themselves. In 2005, global chemical shipments from China surpassed those of Japan, and the margin for China increases every year. In Q3 of 2010, China displaced Japan as the world s second largest economy in terms of GDP. Already the largest producer and market for polyvinyl chloride (PVC) and many other products, China is expected to overtake the US as the largest chemical producer in the world within the next decade. 23 Like companies in the Middle East, the Chinese chemical majors benefit from huge amounts of government support and funding. At the same time, Chinese companies face critical challenges in terms of poor logistics, tight raw material supply and the lack of advanced technology for downstream products. Accordingly, the industry will continue to need access to technologies and resources possessed by companies in established markets, particularly at the specialty end of the chemicals value chain. While Japan recognizes the threat of growing competition from China, Japanese chemical companies also recognize the market opportunities available in such a large and rapidly growing economy, which is on their doorstep. 19 American Chemistry Council, October Quoted in Reinforcing Leadership in Petrochemicals, Chemical Week, November 23, Mideast Influence Continues to Grow, Chemical Week, November 7, Japan s chemical industry shifts to prepare for a new reality, ChemWeek, October 15, World chemicals market: Asia gaining ground, Deutsche Bank Research, July 2008

18 14 The Japanese Chemical Industry: Finding the Right Path Comparisons to Europe As mature industries in developed regions, the Japanese and European chemical industries share a number of similarities. At the same time, Japan can perhaps look to Europe as a model for a more rigorous approach to consolidation, and the development of global strategies for future growth.

19 The Japanese Chemical Industry: Finding the Right Path 15 Chemical Sales: Japan, Europe and China Japanese chemicals sales, F Chemical sales (US$ billion) % 3.5% 0.8% 6.5% 2.7% 4.6% 4.5% 5.0% (17.8%) F 2011F 2012F 2013F 2014F 9 3 (3) (9) (15) (21) (27) Sales growth (%) Chemical sales (US$ billion) Sales growth (%) F=Forecast Note: Chemicals sector consists of base, consumer, pharmaceutical, specialty and fine chemicals. Source: Japan Chemicals, Datamonitor, September 15, 2010 European chemicals sales, F Chemical sales (US$ billion) % 7.1% 0.1% (14.3%) 3.3% 2.9% 3.2% 3.5% 3.7% F 2011F 2012F 2013F 2014F (3) (6) (9) (12) (15) (18) Sales growth (%) Chemical sales (US$ billion) Sales growth (%) F=Forecast Note 1: Chemicals market consists of base, consumer, pharmaceutical, specialty and fine chemicals Note 2: Europe consists of Western Europe and Eastern Europe. Western Europe comprises Belgium, Denmark, France, Germany, Italy, the Netherlands, Norway, Spain, Sweden, and the United Kingdom. Eastern Europe comprises the Czech Republic, Hungary, Poland, Romania, Russia and Ukraine. Source: Europe Chemicals, Datamonitor, September 15, 2010 Chinese chemicals sales, F Chemical sales (US$ billion) 1,400 1,200 1, % 21.6% 17.4% 14.9% 14.1% 13.2% 12.9% 13.1% 10.2% , , F 2011F 2012F 2013F 2014F Sales growth (%) Chemical sales (US$ billion) Sales growth (%) F=Forecast Note: Chemicals sector consists of base, consumer, pharmaceutical, specialty and fine chemicals. Source: China Chemicals, Datamonitor, September 15, 2010

20 16 The Japanese Chemical Industry: Finding the Right Path Over the past 20 years, European (and US) chemical companies have followed a basic trend toward product consolidation through M&A, helping them to generate scale and improve efficiencies. Chemicals index share price performance Index (1 January 2007 = 1) /01/07 01/03/07 01/05/07 01/07/07 01/09/07 01/11/07 01/01/08 01/03/08 01/05/08 01/07/08 01/09/08 01/11/08 01/01/09 01/03/09 01/05/09 01/07/09 01/09/09 01/11/09 01/01/10 01/03/10 01/05/10 01/07/10 01/09/10 Source: Datastream, accessed on October 26, 2010 MSCI Europe FTSE Japan Structural Issues Chemical companies in both Japan and Europe recognize the need to streamline operations and replace ageing plants and their supporting infrastructure. KPMG analysis shows that European petrochemical capacity may decline dramatically in the coming years. According to recent estimates, 40 out of 200 crackers worldwide are likely to become uneconomic by 2015, and approximately 14 out of these 40 will be in Europe. The closure of these plants would correspond to the loss of 26 percent of total cracker capacity in the EU. Similarly, 10 out of 17 European ethylene glycol plants may become uneconomic, corresponding to 65 percent of total European capacity. 24 In Japan, the competitiveness of naphtha crackers, which are relatively old and small in scale, remains problematic. Japanese chemical makers rely on imported naphtha as their main feedstock, whereas the global trend led by the Middle East is towards cheaper ethane feedstock. 25 Japanese companies are traditionally reluctant to close plants, but other solutions are being developed. Recently, Asahi Kasei and Mitsubishi Chemical agreed to unify their naphtha crackers in the Mizushima industrial zone of Kurashiki, Okayama, helping to establish a more efficient configuration for production and management. Similarly, Mitsui Chemical and Idemitsu Kosan have unified their cracker operations at Chiba. Such forward thinking strategies need to be the norm rather than the exception if the Japanese chemical industry is to continue to successfully compete on the world stage. 24 KPMG analysis 25 Op cit. Japan Petrochemicals Report 2010

21 The Japanese Chemical Industry: Finding the Right Path 17 Diversification Diversification in the global chemical industry Pharmaceutical products Agriculture products Chemical specialties Basic chemicals Hoechst BASF Dow Bayer DuPont ICI Sanofi Aventis Celanese Clariant BASF Dow Bayer Health Bayer Crops Bayer Mats. LANXESS DuPont Huntsman Akzo Nobel Syngenta Pharmacia Mitsubishi Chemical Sumitomo Chemical Petrochemical products Oil and gas Source: KPMG analysis, 2010 Over the past 20 years, European (and US) chemical companies have followed a basic trend toward product consolidation through M&A, helping them to generate scale and improve efficiencies. In contrast, Japanese chemical companies have remained, for the most part, highly diversified, with business units supporting a wider range of products. Unable to compete with cheap feedstocks from the Middle East and looking for ways to consolidate and reduce overcapacity, many European chemical companies are tightening their focus on high-end specialty chemicals. This strategy has yet to be widely adopted by Japanese companies, most of which continue to support hundreds or even thousands of products across the chemicals value chain.

22 18 The Japanese Chemical Industry: Finding the Right Path Domestic versus Global Strategies Chemical subsidiaries outside home region Mitsui Chemical Shin-Etsu Chemical Toray Industries Sumitomo Chemical Mitsubishi Chemical ExxonMobil Chemical Bayer Air Liquide Evonik DuPont PPG Industries The Dow Chemical Company BASF Akzo Nobel Number of entities Source: Annual Reports, 2009 Chemical revenues outside home country 35,000 30,000 30,964 28,685 Sales 2009 (US$ billion) 25,000 20,000 15,000 10,000 5,000 21,912 16,188 10,748 9,587 6,863 6,606 5,575 4,209 4,120 3,142 2,860 2,714 0 The Dow Chemical Company ExxonMobil Chemical BASF DuPont Akzo Nobel Bayer Air Liquide PPG Industries Evonik Sumitomo Chemical Shin-Etsu Chemical Mitsubishi Chemical Toray Industries Mitsui Chemical Source: Annual Reports, 2009 Note: Home country for European companies designated as Europe

23 The Japanese Chemical Industry: Finding the Right Path 19 Japanese chemical majors have relatively few subsidiaries outside the country. In contrast, BASF has almost 100 subsidiaries and Akzo Nobel approximately 130 subsidiaries outside Europe. One area where Europe and Japan differ significantly is in their approach to global expansion. The chemical industries in both countries export approximately 20 percent of their output. However, the European majors are making a stronger push to increase their presence overseas, especially in emerging markets. Japanese chemical majors have relatively few subsidiaries outside the country. Sumitomo and Mitsubishi, for example, each have less than 20. In contrast, BASF has almost 100 subsidiaries and Akzo Nobel approximately 130 subsidiaries outside Europe. European chemical companies also post greater total sales from overseas. Even for leading companies like Sumitomo, foreign sales are significantly less than those generated by European companies such as BASF, Bayer and Air Liquide (as well as US giants such as Dow, ExxonMobil Chemical and DuPont).

24 20 The Japanese Chemical Industry: Finding the Right Path Change in Perspective At this point in history, Japanese enterprises generally lag behind their US and European competitors in terms of profit growth just 9 percent in Japan compared to 22 percent in the US and 28 percent in Europe. If current trends continue, Japanese chemical companies run the danger of becoming an island industry, plagued by reduced profits, inefficiencies, growing trade barriers and a chronic inability to compete with foreign competitors. To combat this, Japanese companies as well as their management and employees will need to fundamentally adapt their outlook to embed a number of business practices used by U.S. and European competitors. Chronic Overcapacity and Inefficiencies At this point in history, Japanese enterprises generally lag behind their US and European competitors in terms of profit growth just nine percent in Japan compared to 22 percent in the US and 28 percent in Europe. 26 For the Japanese chemical industry, profit margins may continue to be affected by chronic overcapacity and inefficiencies. US and European companies have streamlined operations through M&A, but this approach is still resisted in Japan. Mergers within Japan of any size have always been difficult, states Peter Young, president of Young & Partners, an investment bank. 27 Acquisitions can sometimes be difficult in Japan, said Kazuo Sasaki, president of Mitsubishi Gas Chemicals in a recent interview. Each company has its own culture and it can be difficult to bring operations together. Japanese companies need better consolidation management techniques to avoid strategic inconsistencies and problems with integration. In larger terms, the Japanese business culture must overcome traditional attitudes that place a premium on stability and continuity regardless of the consequences. Without significant consolidation and M&A to reduce what is now a large number of relatively small plants, Japanese companies will become increasingly uncompetitive against Chinese and the Middle Eastern competitors where world-scale facilities are becoming the norm. Support for Employees Japanese companies still prefer to reduce payroll and increase operational efficiencies through attrition and redeployment. This encourages employee loyalty. Retention rates among workers remain high, and the workforce shows little sign of mobility or job switching. However, the strong social pressure against layoffs make it harder for chemical companies to adopt a more rigorous approach to consolidations, divestitures, plant closures and other rationalization that might improve their competitive position. Rising Protectionism The Asia Pacific Economic Cooperation (APEC) Council recently agreed to establish a free trade agreement in the region. 28 However, tensions remain high among members, with China warning that protectionism was rising. Indeed, China is extending its antidumping measures for five years on ethanolamine imported from Japan Op. cit. Industry Review Japan: Consolidate or Lose! 27 Japanese chemical joint ventures could trump mergers and acquisitions, ICIS, October 19, Amid economic strains, APEC trumpets free trade, Reuters, November 14, China Extends Antidumping Measures on Ethanolamine Imported from Japan, Malaysia, Taiwan, and U.S., ChemWeek, November 17, 2010

25 The Japanese Chemical Industry: Finding the Right Path 21 Rising trade barriers would have a severe effect on the Japanese chemical industry, hindering its entry into emerging markets while threatening imports of feedstocks from the Middle East. Conversely, if structural change remains elusive and if competitiveness of the Japanese chemical industry continues to be eroded, will Japanese chemical companies themselves seek protectionist support from their government to lock out lower cost foreign competition, reinforcing the concept of the industry as an island? Although appealing in the near-term, protectionism rarely results in long-term stability and growth, and it can lower the ability to compete globally. Further, protectionism may have serious longterm negative consequences for the global chemical industry, the Japanese chemical companies and the Japanese industries that depend on the Japanese chemicals industry (downstream industries). Uncompetitive Downstream Industries tackle the challenges with which it is currently faced, and retreats into isolation, its competitiveness may be damaged to such an extent that it is no longer able to effectively and efficiently provide the solutions to drive the broader base of Japanese industry. Rather, the Japanese chemical companies will be left behind by the broader base of Japanese industries that will have succeeded in internationalization with a cosmopolitan spirit. With slow growth and overcapacity continuing and the potential for protectionism to lock out foreign competition, the impact of an island industry may have devastating consequences for key downstream industries in Japan. The automotive industry, for example, is currently more beholden to the chemical industry than ever to develop light weight composites and alternative fuel cells to support the next generation of vehicles. If the Japanese chemical industry fails to

26 22 The Japanese Chemical Industry: Finding the Right Path Solutions for Change Japanese Petrochemical Industry Restructuring Announcements in Product Company Details Ethylene/ propylene Mitsubishi Chemical and Asahi Kasei Mitsui Chemicals and Idemitsu Kosan Joint venture (JV) to be set up from April 1, 2011 for unified cracker operations at Mizushima JV formed for unified cracker operations at Chiba Polypropylene Polyethylene terephthalate (PET) Japan Polypropylene Prime Polymer Mitsui Chemicals and Teijin Close 90,000 ton/year plant at Kashima in May 2011; close 79,000 ton/year plant at Ichihara in June 2011 Close 90,000 ton/year plant at Ube in March 2011 Merge PET operations Benzene Asahi Kasei Close 300,000 ton/year plant at Mizushima in 2012 Ammonia Asahi Kasei Close 320,000 ton/year plant at Mizushima in 2012 Caprolactam Mitsubishi Exits business; closed 60,000 ton/year plant at Fukuoka in March 2010 Chemical Styrene Mitsubishi Chemical Exits business; to close 371,000 ton/year plant at Kashima in March 2011 Purified terephthalic acid Polyvinyl chloride (PVC) Polystyrene (PS) Bisphenol A (BPA) Source: ICIS Mitsubishi Chemical Close 250,000 ton/year plant at Ehime in December 2010 Closed 100,000 ton/year plant in Okayama in May 2010 V-Tech Close all PVC, vinyl chloride monomer and chlor-alkali plants by March 2011 PS Japan Japan Polystyrene Mitsubishi Chemical Mitsui Chemicals Close 85,000 ton/year plant at Yokkaichi in 2011 JV (Mitsui Chemicals and Sumitomo Chemical) dissolved and plants closed in September 2009 Exits PS Japan JV Closed 55,000 ton/year plant at Nagoya end-2009

27 The Japanese Chemical Industry: Finding the Right Path 23 Although Japanese chemical companies have lagged behind companies in the West in adjusting to new business realities, many companies have already taken significant steps to increase their competitive advantage through restructuring, joint ventures, consolidation, foreign investments and new research. Asset Swapping In 2009, MCH and DSM Engineering Plastics agreed to swap assets, with the Dutch company acquiring MCH s Asian polyamide operations and the Japanese company gaining a polycarbonate presence in Europe. 30 Under the agreement, DSM is compounding polycarbonate at its Genk, Belgium facility for MCH; MCH in turn is compounding polyamide in Kurosaki, Japan for DSM. For MCH, the swap offers a stronger foothold in Europe, which is where the bulk of DSM s polycarbonate business has been realized. While historical cultural differences between Japanese companies may make similar ventures difficult in Japan itself, identifying mutually beneficial swaps can enable companies to rapidly build scale in core areas, while divesting non-core areas to a competitor who can, in turn, give these areas the attention and focus they would not have received under existing management and strategy. Geographical Expansion Many Japanese companies have taken steps to partner with Chinese and Middle Eastern companies. Mitsui Chemical and China Petroleum & Chemical Corp (SINOPEC) announced a joint venture in November of 2010 for the construction of facilities for the production of ethylene-propylene-diene terpolymer (EPT). The new plant will have production capacity of 75,000 tons per year, where metallocene catalyst technology is expected to be adopted for the first time in China. This will be the largest EPT plant in the world. Also in November of 2010, Shin-Etsu Chemical announced a joint venture with Jiangsu Fasten Hongsheng Group Co. and TKH Group from the Netherlands. The three companies plan to build a factory in China for optical fiber preform in the Jiangsu Province city of Jiangy. Producing the equivalent of eight million kilometers of optical fiber a year, the plant is expected to begin operating in the second half of In the Middle East, Sumitomo Chemical is partnering with Saudi Aramco to develop Petro Rabigh, one of the largest integrated refining and petrochemical complexes ever to be built at one time, with over two million tons of olefins to be produced each year. With Chinese and Middle Eastern chemical companies continually searching for proprietary technology to support their expansion down the value chain, Japanese chemical companies need to do more to capitalize on their historical technological advantage to develop joint ventures which provide access to low cost feedstock and high growth markets. 30 DSM, Mitsubishi Chemical swap PC, PA business units, PlasticsToday, May 29, 2009

28 24 The Japanese Chemical Industry: Finding the Right Path Japanese chemical companies must identify those chemical products in which their historical technological advantage will provide a long term competitive advantage. However, Japanese chemical companies still lag behind their Western peers with respect to geographic expansion. BASF, for example, operates 23 wholly owned subsidiaries and 16 JV s in Greater China, generating revenue of more than 4.1 billion in In the Middle East, Dow Chemical operates a number of JVs with Petrochemical Industries Company of Kuwait which date back as far as A lot of this stems from the historical reluctance of Japanese companies to invest outside of Japan. In order to overcome the above disadvantage, Japanese companies need to seriously study how to make use of redundant workers in the context of globalization of their businesses, particularly with respect to the management and operation of new overseas ventures. Another big issue to consider is how to utilize and integrate foreign workers in companies as Japanese companies generally do not like the concept of buying people. Rationalization MCH is discontinuing the production of styrene monomer at Kashima and of vinyl chloride monomer (VCM) at Mizushima. The company had already divested its Singapore operations where it made styrene through a toll arrangement with Anglo- Dutch major Shell at Seraya and Ellba. Mitsui Chemicals has reduced capacity and consolidated production of ethylene oxide (EO), EG, bisphenol A and ethylene-propylene terpolymer (EPT). It also plans to reduce its PP capacity. In a similar development, Showa Denko is downsizing its ethyl acetate operations due to the mature domestic market. Based on this and other measures, its current production capacity is 150,000 tons per year, half of its former capacity. The challenge for the Japanese chemical industry is to be more agressive in its identification and rationalization of unprofitable facilities, enabling management time and investment capital to be focused on those areas which will be competitive for the long-term. This is an area where the US chemical industry, in particular, has displayed leadership. Despite the cost advantages of US Gulf Coast ethane (and latterly, shale gas), over 80 chemical plants were permanently closed during 2009 as US chemical companies sought to exit uncompetitive commodity chemical markets and focus their long term business strategy on science and technology based chemical products. Dow Chemical, LyondellBasell, Eastman Chemical and Huntsman are among those who have closed commodity chemical units over the last two years. Focus on Core Business To reduce overcapacity, streamline operations and increase profits, Japanese chemical companies are focusing more on core business units. Japanese chemical firms are buying in the specialty products in which they are already strong, including upstream and downstream in the chain, says Tetsuya Fujii, managing director of investment bank Lincoln International. 31 He cited a 2009 deal where Sekisui Chemical acquired US-based Celanese s polyvinyl alcohol (PVA) resins business for US$173 million. In a similar move to core businesses, Shin-Etsu plans to improve its position as a leading manufacturer of semiconductor silicon wafers by expanding the capacity of its Shirakawa plant. However, further action is required. As we have already seen, the trend in the West over the last fifteen years has been for all but the biggest (BASF, Dow) traditional chemical conglomerates to fragment into smaller entities focused on particular areas of the industry. Meanwhile, Japanese chemical companies continue to operate across the full spectrum of the chemical value chain which in many instances, denies them sufficient scale to compete. Japanese chemical companies must identify those chemical products in which their historical technological advantage will provide them with a long term competitive advantage (solar panels and Li-ion batteries for example) and develop a strategy to build scale and global presence, while exiting other areas considered non-core. 31 Op. cit. Japanese chemical joint ventures could trump mergers and acquisitions, ICIS, October 19, 2009

29 The Japanese Chemical Industry: Finding the Right Path 25 R&D and Innovation Patent applications by country: , ,000 Number of Patent Applications 300, , ,000 0 United States of America Japan China Republic of Korea European Patent Office Germany Russian Federation India Patent Office Source: WIPO Statistics Database, June 2010 Japanese companies continue to undertake a number of initiatives to increase their competitive advantage through research. Sumitomo s technology strategy will focus the company s R&D efforts on high-growth areas such as the environment and energy and life sciences, combining technologies in different areas to develop new products. 32 In addition, technological innovation from Japanese chemical companies is helping automakers develop environmentally friendly electric vehicles (EVs), reduce their production costs and increase mileage through the use of low-weight plastics in place of metal. 33 For example, fenders and back-door panels, door handles, emblems, and air intake manifolds are all now using plastic parts instead of steel. In the future, Japanese chemical companies might help automakers replace even the metal used for the chassis with carbon-fiberreinforced plastics. Such advances, if successfully productized will help to support the long-term competitiveness of the Japanese chemical industry. 32 Japanese Firms Launch New Business Plans, ChemWeek, March 14, Japan s automakers and chemical companies boost cooperation, ICIS, October 15, 2010

30 26 The Japanese Chemical Industry: Finding the Right Path Conclusion The Japanese chemical industry stands at an historic crossroads. Following two lost decades and faced with the rise of low cost competition from the Middle Eastern and Chinese competitors, the industry is beset by overcapacity, low profitability and low growth. With developing trends in the global chemical industry demanding adaptability and dynamism, Japanese chemical companies are struggling to react, with business practices such as keiretsu and ringi (collective decision making), which have served them so well for half a century, suddenly proving a barrier to change. One vision for the Japanese chemical industry in the future, shows an ageing industry beset by overcapacity, protected from global competition by trade barriers, struggling to provide the necessary solutions for downstream Japanese industry. However, if the leaders of Japanese chemical companies can drive a period of change focused on rationalizing unprofitable facilities, developing an increased global presence through beneficial joint ventures, developing future strategy around core business areas where long term competitiveness is protected by historically-strong Japanese technological advancement, the industry that emerges will be more suited to conquering the challenges presented by the global chemical industry of the 21st Century.

31 The Japanese Chemical Industry: Finding the Right Path 27 If the leaders of Japanese chemical companies can drive a period of change... the industry that emerges will be more suited to conquering the challenges presented by the global chemical industry of the 21st Century.

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