ECONOMY TOXIC FOR SOUTH CHINA'S CHEMICAL INDUSTRY

UNCLAS SECTION 01 OF 02 GUANGZHOU 000276

SENSITIVE
SIPDIS

STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/LEE

E.O. 12958: N/A
TAGS: ECON ETRD EINV CH
SUBJECT: ECONOMY TOXIC FOR SOUTH CHINA'S CHEMICAL INDUSTRY

(U) This document is sensitive but unclassified. Please protect
accordingly. Not for release outside U.S. government channels. Not
for internet publication.


1. (U) SUMMARY: It doesn't matter too much where you fall in the
supply chain - upstream manufacturers in the Pearl River Delta (PRD)
are suffering the same impact from the global economic downturn as
their downstream customers. The chemical industry in South China
has been hit hard with orders from the U.S. and Europe falling
sharply during the fall of 2008. Domestic demand, however, has
remained relatively steady, leading many export-oriented firms to
shift focus to the local market. Many firms have seen possible
signs of recovery in recent months, and their optimism about the
future may bode well for the PRD's manufacturing industry as a
whole. END SUMMARY.

Bulging Warehouses
--------------


2. (SBU) The warehouse at the Sartomer Chemical plant in Nansha
clearly shows effects of the economic downturn. The massive space,
roughly the size of two airplane hangars is stocked floor to ceiling
with drums of chemical resins ready for shipment to customers in the
United States. Those orders, however, have long since been
cancelled. Sartomer saw a dramatic drop in U.S. orders beginning in
November of last year and leading to a 1,000 ton surplus. "We never
thought that we'd fill it," Sartomer Chemicals Operations Director
Phil Jackson said of the warehouse. Sartomer manufactures polymers
and oligomers for use in inks, paints, CDs, and many construction
related applications. The company's largest customers are
construction material producers and printing shops. U.S. demand was
propped up through November by the printing industries need for inks
to make campaign signs, according to Jackson, but fell abruptly
during the final weeks of 2008. In China, the company depends
heavily on the construction industry. While sales within China are
still robust, the company is waiting for an indication that
international demand will pick back up.


3. (SBU) Sartomer's experience is consistent with what other
chemical makers in the PRD have told us. The South China's chemical
industry was hit hard by the economic downturn. Many factories
showed record sales during 2008, but demand collapsed during the
fall as orders from overseas customers plummeted. Domestic demand
has remained relatively strong, insulating companies that produce
primarily for the domestic Chinese market. But companies dependent
on demand from the U.S. and Europe have been severely affected, many
enduring the worst stretch in their respective histories.


4. (SBU) The chemical industry's exhibition hall at this year's
Canton fair was lined with about the same number of booths as in
years past. Chemical company representatives passed out glossy
brochures to anyone who happened by, but companies expressed
frustration over the lack of customers. Stephen Zhao of Sundia
Chemical Industry Limited complained that attendance at the fair was
significantly down, and a nearby vendor worried that as of 4:00 pm
on the opening day he had yet to make a single sale.

Eyeing the Local Market
--------------


5. (SBU) Several export-oriented companies have reported re-thinking
their business strategy and adopting a new focus on domestic demand
in response to the crisis. Last year, both Sartomer and Sabic were
selling over 70% of their output overseas. This year, Sartomer
predicts that it will sell over 90% of its total production on the
Chinese market. Sartomer has seen its largest sales growth in the
domestic construction supplies industry, which according to Jackson
has continued to increase orders despite the downturn. Sabic's
Maggie Wang said that her company hoped Chinese sales will soon
account for 75% of its total business. Sabic is a high-end
manufacturer whose plastics are used in a wide range of products
including electronics, automobiles, medical supplies, and sporting
goods. Their major customers include Microsoft, Canon, Nokia, Dell,
GM and Toyota, but their new focus on the domestic market has led
them to increase sales to customers within China including
rechargeable battery producer BYD, Huawei and Lenovo. Wang
predicted that the firm's sales to Chinese customers would remain
strong in part due to growing demand within China for small laptops,
which require high-end plastics.


GUANGZHOU 00000276 002 OF 002


Signs of Recovery?
--------------


6. (SBU) While international orders for the PRD's chemical makers
remain well below the levels they reached in mid 2008, some
companies have reported signs of recovery. Many have seen orders
begin to increase slowly in the first few months of 2009 and a few
have already returned to their pre-downturn sales levels. According
to Maggie Wang, Microsoft, which uses plastics produced in South
China in many of its consumer electronics, has predicted that by mid
2009 their orders for Sabic's plastics will return to their
pre-downturn levels. Many chemical manufacturers still express a
great deal of confidence in the industry's future in South China.
Exhibitors at the Canton Fair expressed optimism despite
disappointing sales at the trade event. Some firms have continued
to show some growth even during the economic crisis. Firms such as
Sabic, LG, and Guangdong Chemical have all moved forward with large
expansion projects in the region despite lagging sales.


7. (SBU) Anticipating a recovery in orders, some companies are also
bracing themselves for a lack of raw materials. Sabic CEO Mohamed

H. Al-Mady has warned that the company may face a serious shortage
during the second half of this year. The downturn has caused a
major shakeup in the market for the industry's raw materials. Ketty
Zhu of Guangzhou Ganglian Chemical, a producer of chemicals for use
in health and beauty products, says that many low-end producers were
driven out of business in recent months. Zhu worries that if demand
picks up again, competition for raw materials may push prices to
much higher levels.

Frustrated by Regulatory Environment
--------------


8. (SBU) Even as they remain focused on the challenges posed by the
economic downturn, foreign-owned chemical companies in Guangdong
express frustration with the province's complex and non-transparent
regulatory environment. Phil Jackson of Sartomer recently learned
firsthand how difficult working with the Chinese government can be.
The company's new plant opened last spring, but only after years of
struggling to obtain all the proper permits. Jackson expressed
frustration at the overly complex process that included many
different rounds of inspection and lacked transparency. Among the
requirements that delayed the issuance of the permits were the
installation of a complex fire-fighting system, the requirement for
a greater distance between buildings than would have been called for
in the U.S. or Europe, and a $20,000 piece of equipment to clean the
emissions from the plant's cafeteria. Several companies complained
that regulations often change so fast that they are unable to keep
up with them, a criticism we heard frequently from U.S. firms across
a broad range of industries.

GOLDBERG