TAIWAN PETROCHEMICAL INDUSTRY EAGER TO GET

C O N F I D E N T I A L SECTION 01 OF 04 TAIPEI 003122

SIPDIS

DEPT FOR EAP/TC
PLEASE PASS AIT/W

E.O. 12958: DECL: 07/22/2015
TAGS: ECON EINV ETRD EPET CH TW
SUBJECT: TAIWAN PETROCHEMICAL INDUSTRY EAGER TO GET
"CRACKING" IN PRC

REF: A. TAIPEI 2601

B. TAIPEI 3100

Classified By: AIT Director Douglas H. Paal, Reason 1.5 d

Summary
--------------


1. (C) Taiwan's petrochemical industry is increasingly
focused on cross-Strait trade and investment, with exports
to the PRC accounting for up to 50 percent of total
output. However, Taiwan's prohibition against investment
in the PRC in naptha crackers is holding back even more
high-value upstream investment. The Taiwan government has
been considering liberalization of naptha cracker
investment for some time, but the large amounts of capital
required for such investment could make it a contentious
political issue. Nevertheless, some Taiwan petrochemical
firms are proceeding to develop investment plans, including
Formosa Plastics Corp.'s plan for a USD 5 billion complex
at Ningbo. State-owned Chinese Petroleum Corp., on the
other hand, plans to supply Mainland customers from a
proposed USD 11 billion facility in Yunlin County, Taiwan.
Further delay in liberalization could impede Taiwan firms'
ability to enter the PRC market and give other foreign
firms a strong advantage there. In addition, some industry
executives fear that PRC trade policy as well as Taiwan
environmental concerns could inhibit Taiwan firms from
expanding exports to the PRC. As in other cases, the DPP
government is letting politics interfere with economic
policies that would help Taiwan industry. In the process,
it may be aiding KMT efforts to portray it as a party that
doesn't understand business. End summary.


Heavy Dependence on PRC Market
--------------


2. (SBU) Taiwan's petrochemical industry is increasingly
focused on cross-Strait trade and investment. According
to data from Taiwan's Industrial Technology Research
Institute, 64 percent of commodity polymers --
acrylonitrile butadiene styrene (ABS),polyvinyl chloride
(PVC),polypropylene (PP),polyethylene (PE),and
polystyrene (PS) -- produced in Taiwan are exported. Of
those exports 85 percent are destined for the PRC. Sidney
Chow, Chairman of the Petrochemical Industry Association
of Taiwan (PIAT),estimated that of Taiwan's total
petrochemical industry output, nearly half is exported to
the PRC. Petrochemicals form a key component of overall
cross-Strait trade. Taiwan trade statistics show that
organic chemicals accounted for 9 percent of Taiwan's total
exports to the PRC in the first four months of 2005.


3. (SBU) Petrochemicals industry investment in the PRC is
also growing. Taiwan investment data indicate that Taiwan
chemical manufacturing firms were approved to invest USD 62
million in the PRC during the first half of 2005. This
represented more than 6 percent of all Taiwan investment in
the PRC during the period, and made chemical manufacturing
the fourth highest industry category. According to data
compiled by Taiwan's Chinese Petroleum Corporation (CPC),
at least 20 Taiwan petrochemical firms have invested in at
least 32 different projects, primarily downstream
manufacturing facilities, in the PRC.

Naptha Cracker Domino Effect
--------------


4. (U) Nevertheless, Taiwan government restrictions on
petrochemical investment in the PRC, specifically the
prohibition against investment in naptha crackers, are
holding back a much higher degree of cross-Strait
integration of the industry. Naptha crackers produce most
of the inputs for downstream production of petrochemicals
and are therefore a lynchpin in the entire supply chain.
Many of the chemicals produced by naptha crackers can only
be transported economically to downstream facilities by
pipeline. Because Taiwan firms cannot build naptha
crackers in the PRC, they are limited to investing in those
downstream facilities that use inputs that can be easily
transported and traded.


5. (SBU) Many of the Taiwan manufacturers who consume
petrochemicals have moved their factories to the PRC,
adding pressure for more petrochemical investment in the
PRC farther up the supply chain. Meanwhile, excess
production capacity in Taiwan continues to grow. C.T. Lee,
President of Formosa Plastics Corp. (FPC),commented to
AIT/T that Taiwan's current situation of exporting nearly
half of petrochemical output to the PRC is not an
economically sound strategy for the industry. He pointed
out that the U.S., for example, exports less than
15 percent of petrochemical output.


6. (C) Taiwan's petrochemical firms have been active in
lobbying the Taiwan government to drop the restriction on
naptha cracker investment, and the government has been
considering liberalization for at least four years.
According to Mainland Affairs Council (MAC) Economics
Department Director Fu Don-cheng, naptha cracker investment
has not yet been approved because of the amount of capital
required for such investment. Taiwan National Security
Council Senior Advisor Chen Chung-shin further explained to
AIT/T that because any investment in a naptha cracker
facility in the Mainland would be so large, approval of
this category had important political implications. Chen
argued that if the Democratic Progressive Party government
were to liberalize naptha cracker investment it would be
more vulnerable to criticism from those factions within its
Pan-Green alliance that seek to slow the growth of
cross-Strait economic ties.


7. (C) An economically viable naptha cracker facility would
require capital investment in excess of USD 1 billion.
Recent naptha cracker investments in the PRC have ranged
from USD 2.7 billion for a BP-Sinopec joint venture in
Shanghai to USD 4 billion for a Shell-Chinese National
Offshore Oil Co. (CNOOC) joint venture at Daya Bay,
Guangdong, according to PIAT's Chow. However, industry
executives are quick to point out that the amount of
capital that Taiwan petrochemicals firms would have to
provide would only be a fraction of the total cost. Chow
estimates that international and PRC financial institutions
would provide 30 to 40 percent of the investment capital
and a PRC joint venture partner would provide up to half of
the remaining portion.


8. (C) Taiwan policymakers might also fear that opening
naptha cracker investment will cause the petrochemical
industry in Taiwan to "hollow-out." Tsao Minh, Vice
President of CPC, speculated to AIT/T that if naptha
cracker investment in the PRC were liberalized, the
petrochemical industry would abandon Taiwan and move nearly
all production to the Mainland. However, Taiwan firms
currently appear committed to continuing high levels of
production in Taiwan. CPC has plans for a major new
facility in Yunlin County, and FPC initiated in 2004 the
fourth expansion phase of its USD 19 billion facility also
in Yunlin.

Industry Investment Plans Already in Development
-------------- ---


9. (C) In anticipation of pending liberalization, Taiwan
petrochemical firms are proceeding with the development of
naptha cracker investment plans. Chow's firm, USI Group,
has been in discussions with Sinopec about possible naptha
cracker joint venture options. FPC's Lee described more
advanced plans to AIT/T. His firm plans to invest in a USD
5 billion complex in Ningbo. According to Lee, FPC would
provide one third of the capital and two thirds would come
from Mainland and international banks. FPC also plans to
list the new venture to further reduce its own risk in the
project.


10. (C) CPC's Tsao told AIT/T that because his firm is a
state-owned enterprise it has abandoned plans to invest in
the Mainland. It had developed a plan for building a
naptha cracker facility in Zhenhai, Zhejiang Province,
which was rejected by government authorities. Instead the
firm plans to take advantage of growth in PRC petrochemical
demand with its new petrochemical facility in Yunlin
County. The complex will include a refinery, naptha
cracker and downstream production facilities and will cost
more than USD 11 billion to build. He argued that
inexpensive transportation costs will make the Yunlin
facility on Taiwan's west coast very competitive in serving
the PRC market. Although CPC currently exports only a very
small portion of its petrochemical output, Tsao said that
the firm expects to export up to 85 percent of the output
of the Yunlin plant to the PRC.

Further Delays, More Consequences
--------------


11. (U) Further delay in approval of naptha cracker
investment in the PRC will have a serious impact on the
ability of Taiwan's petrochemical industry to continue to
grow. "Petrochemical Industry," a Taiwan trade journal,
reports that the PRC's 11th Five-Year Plan starting in 2006
includes a quota for constructing no more than five new
naptha crackers. The report indicates that four crackers
have already been proposed and Taiwan firms will have to
vie for the remaining quota. It suggests that if Taiwan
firms are unable to compete for the quota soon, they may
have to wait until the next five-year plan in 2011.


12. (C) PIAT's Chow emphasized that Taiwan firms are being
left behind while other foreign petrochemical companies are
expanding in the PRC. In addition to the BP and Shell
projects, Chow also noted a USD 3 billion BASF-Sinopec
joint venture in Nanjing and an ExxonMobil project in
Fujian. He underscored the advantages Taiwan firms have
over other foreign firms in the Mainland, due to its
geographic and cultural proximity.


13. (C) FPC's Lee pointed out potential difficulties should
Taiwan petrochemicals be forced to continue serving the
Mainland market primarily through exports. He speculated
that because the PRC currently imports 40 percent of its
energy needs, it may choose at some point to restrict
petroleum and petrochemical imports. He also fears that
because such a high portion of Taiwan's petrochemical
output is exported to the Mainland, the PRC may threaten to
impose anti-dumping duties.


14. (C) CPC's strategy of supplying the PRC market from
expanded production in Taiwan is not without pitfalls.
Plans for the Yunlin petrochemical facility have met fierce
opposition from some environmental groups (as reported ref
A). After initially receiving approval for the project
from the Executive Yuan, CPC has had to perform additional
environmental studies. Tsao told AIT/T that he now expects
the Taiwan government to wait until after local elections
scheduled for December 3 to give final approval for the
project. In addition, further expansion of the
petrochemical industry in Taiwan may be constrained by
Taiwan's efforts to comply with Kyoto Protocol emissions
standards.

Comment
--------------


15. (U) The petrochemical industry is an example of
profound cross-Strait economic ties that vary from the well
known model of Taiwan firms building labor-intensive
assembly plants in the Mainland to produce consumer goods
for export to the U.S., Japan and Europe. The industry
relies heavily on demand from the Mainland market and is
eager to invest large amounts of capital in upstream
production. There is already substantial cross-Strait
integration within the industry that will only become more
profound when and if Taiwan relaxes investment
restrictions.


16. (C) It also provides another example of Taiwan domestic
politics interfering with economic policies that would
allow Taiwan firms to further capitalize on the PRC's
remarkable economic growth. When explaining the Chen Shui-
bian administration's reluctance to move forward with
cross-Strait economic initiatives at this time, the NSC's
Chen explained that the PRC and Taiwan's opposition
Kuomintang (KMT) Party are cooperating with each other in
an effort to portray the ruling DPP as unable to manage
economic issues (reported ref B). He claimed that the DPP
government could not proceed with cross-Strait
liberalization at a time when it would be perceived to be
yielding to pressure created by KMT cross-Strait economic
initiatives. When discussing the naptha cracker investment
issue, both PIAT's Chow and FPC's Lee were quick to
criticize the DPP government and described its leadership
as being ignorant about business. If the DPP government
continues to delay naptha cracker liberalization as well as
other cross-Strait economic initiatives, it may only
strengthen an image of incompetence that it accuses the KMT
of trying to create. End comment.
PAAL