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EU Enlargement: New Opportunities for Chemical Companies in CEE and CIS

This article explores the challenges and opportunities brought about by the enlargement of the European Union for EU 15 chemical companies. It discusses the changing face of Europe, the economic integration process, and the potential for growth in Central and Eastern Europe and the Commonwealth of Independent States. The article also highlights the need for structural change and innovation, increased competition, and potential sales and investment opportunities for EU 15 companies.

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EU Enlargement: New Opportunities for Chemical Companies in CEE and CIS

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  1. 欧盟东扩–化工企业布局新机遇

  2. Contents • The changing face of Europe • Challenges and opportunities of enlargement for EU 15 • Opportunities for EU 15 chemical players in CEE and CIS • Conclusion

  3. A. The changing face of Europe

  4. Population [m] 227 78.0% 50.0% GDP/capita [USD] 28,608 1.1 France, Germany, Italy and Benelux: Six wealthy core countries start economic integration process in 1957 EU 6 (1957)* % of US % of EU 25 GDP [USD bn] 6,494 59.0% 58.9% 75.5% 118.0% * 2003 data > Europe's core countries had sluggish growth over the last ten years: Average growth 1.3% p.a. in Germany, 1.7% in France, 2.5% Netherlands

  5. Population [m] 297 102.0% 65.0% GDP/capita [USD] 29,141 1.2 Denmark, Ireland and the United Kingdom: First acces-sion round after 16 years increases economic power EU 9 (1973)* % of US % of EU 25 GDP [USD bn] 8,655 78.8% 78.5% 76.9% 120.2% * 2003 data > As a result of EU integration, Ireland's economic growth has been out-standingly high over the past ten years: 7.6% p.a. (DK 2.1%, UK 2.8%)

  6. Population [m] 308 106.2% 67.7% GDP/capita [USD] 28,659 1.3 Greece: A poorer country joins the European Union in 1981 – first discussions about dilution EU 10 (1981)* % of US % of EU 25 GDP [USD bn] 8,827 80.3% 80.0% 75.6% 118.3% * 2003 data > Greece now has high average growth rates (3.8% p.a. from 1995-2004) – partly due to European money from structural / regional funds

  7. Population [m] 359 123.0% 78.9% GDP/capita [USD] 27,343 1.4 Spain and Portugal: Accession of two less developed southern countries reduces EU's average wealth EU 12 (1986)* % of US % of EU 25 GDP [USD bn] 9,816 89.3% 89.0% 72.2% 112.8% * 2003 data > Today, the southern countries contribute to EU growth: Spain (3.3% p.a. since 1995) and Portugal (2.4% p.a.) achieved high average growth rates

  8. Population [m] 381 130.5% 83.7% GDP/capita [USD] 27,648 1.5 Sweden, Finland and Austria: Europe's northern enlargement pushes up the average GDP per capita EU 15 (1995)* % of US % of EU 25 GDP [USD bn] 10,534 95.9% 95.5% 73.0% 114.1% * 2003 data > Stimulus to EU growth over the past ten years: Finland's economy grew 3.5% p.a. on average, Sweden's 2.7 % p.a., and Austria's 2.0% p.a.

  9. Population [m] 455 156.0% GDP/capita [USD] GDP [USD bn] 24,237 11,028 100.4% 1.2 Eastern Europe, Malta and Cyprus: The biggest round of enlargement ever changes the face of Europe EU 25 (2004)* % of US 64.0% * 2003 data > GDP growth rates of up to 6.5% p.a. in CEE (average 4.4% p.a. since '95) > But: Enlargement is a big challenge for European Union to create wealth

  10. 1.3 50 years of enlargement: Compared to the US, the EU has gained size at the expense of average wealth EU vs. US* [US=100%] 156.0 Inhabitants 130.5 123.8 106.2 100.4 GDP 102.0 95.9 89.3 US = 100 80.3 77.5 78.0 75.5 76.9 75.6 64.0 GDP per capita 72.2 73.0 59.0 1957 EU 6 1973 EU 9 1981 EU 10 1986 EU 12 1995 EU 15 2004 EU 25 * based on 2003 data > Today, Europe's GDP per capita is only about two-thirds that of the US – in terms of total GDP, both economies are now comparable

  11. 2.1 Wealth gap: Ten years ago, the north of the European Union was rich and the south was poor 1995: Gap between north and south* 1995 NORTH** SOUTH*** RATIO GDP[USD bn] 1,161 9:1 9,373 Population[m] 319 62 5:1 Unemployment[%] 9.2 13.4 2:3 GDP per capita[USD] 29,383 18,726 3:2 * 2003 data ** EU 12 *** Portugal, Spain, Greece > South gained wealth in EU: From 34.4% of EU-9 (1986) to 59.8% today

  12. 27,620 7,429 4:1 2.2 Today, the gap is between east and west – GDP per capita in the EU 15 is four times higher than in EU 10 2004: Gap between east and west 2003 EU 15 EU 10 RATIO GDP[USD bn] 493 21:1 10,534 Population[m] 381 74 5:1 Unemployment[%] 8.5 10.5 4:5 GDP per capita[USD] > EU support will help EU 10 economic development to reach EU 15 wealth

  13. 3. EU 25 vs. US vs. Asia: Enlarged EU is a still powerful, but the slowest growing economic region in the world Comparative indicators 2003 US EU 25 ASIA* ECONOMIC POWER [GDP, USD bn] 11,028 10,988 8,458 POPULATION [m] 455 290 1,947 WEALTH [GDP per capita, USD] 24,237 37,890 12,058 GROWTH [avg. GDP growth 1999-2003, %] 2.3 3.3 4.8 * Aggregated data for Japan, China, ASEAN > Opportunity: Ten new states give the EU momentum to increase growth

  14. B. Challenges and opportunities of enlargement forEU 15

  15. Eastward enlargement entails threats and opportunities for economies, companies, and governments • Economies • Unit labor cost advantages in EU 10 challenge existing value creation structures in EU 15, but also offer momentum for structural change / innovation in EU 15 • Companies • Competition in EU 15 as well as in EU 10 is increasing, but also new sales, investment, growth and relocation opportunities for EU 15 companies in Eastern Europe • Governments • Existing institutional setups in EU 15 are challenged by lower taxes / contributions and higher flexibility in EU 10, but also momentum for political change > Effects of enlargement on macroeconomic and microeconomic levels

  16. 1.1 Macroeconomic threats: Pressure on EU 15 labor markets and competition for best institutional setup • Low wage-competition / unemployment threats • Migration (up to 3.8 m people from CEE will move to the EU 15) • Offshoring (e.g. 830,000 people in CEE employed by German firms in 2004) • Low tax / social contributions competition • Also: Less regulation (e.g. IMD bureaucracy index: Estonia ranked 9th, UK ranked 33rd) • Financial burden (EU budget) • Cost of enlargement (2004-2006): 49 bn EUR CORPORATE TAXES [%] / SOCIAL CONTRIBUTIONS 2004 [% of GDP] 39,0 19,0 17,4 15,0 15,0 12,5 8,5 0,0 GER POL LIT EST Taxes Contributions > Differences: Countries with high degree of regulation, geographical proximity to CEE and net contributors to EU budget are more affected

  17. +1.3-2.1 p.a. 2005-09 +0.5-0.7 cum. 2000-09 CEE 8 EU 15 1.2 Macroeconomic opportunities: Higher growth momen-tum for structural / institutional change and innovation • Enhanced growth in east and west • EU 15 benefits from backlog of demandin CEE • New momentum in 'New Europe' through increased trade / know-how • Momentum for structural change / innovation • Labor-intensive / low value creation industries/ productsno longercompetitive in EU 15 • Structural change towards high-tech goods and services the only choice for 'Old Europe' (-> growth / wealth) • Momentum for institutional change • Regulations, taxes, subsidies, flexible markets IMPACT OF 2004 ENLARGEMENT ON GDP GROWTH [%] Source: EU Commission > EU enlargement helps policymakers bring about necessary but often unpopular structural reforms in their respective countries

  18. 2.1 Microeconomic threats: Increasing competition for EU 15 due to lower labor / unit costs in Eastern Europe • More attractive business conditions in CEE • Labor costs only between 10.4% (Slova-kia) and 17.8% (Hungary) of EU 15 level • Taxes lower and social contributions only between 10.0% (Poland) and 16.3% (Czech Republic) of German level • Capital costs about 20% lower – because of lower investment needs due to flexible labor markets • Need for • Industry restructuring • Innovation (creative destruction) REVEALED COMPARATIVE ADVANTAGE–GERMANY VS. EASTERN EUROPE [Index] Industries with comparative ADVANTAGE in GER Industries with comparative DISADVANTAGE in GER 2.82 Auto-motive Steelindustry 1.19 Wood 0.56 -0.15 IT equip-ment Medicaltechno-logy Chemi-cals -1.03 -2.26 > Differences: Mature industries more affected than innovative ones, border regions more than western, small companies more than large

  19. 2.2 Microeconomic opportunities: CEE offers new markets and growth / investment / offshoring opportunities • New markets for infrastructure, capital and consumer goods • 75 m new consumers with increasing purchasing power for consumer goods • High demand for modernized infrastructureand capital goods • New growth and investment opportunities • Privatization of state-owned companies • Acquisition / restructuring of EU 10 enterprises • Low unit costs through offshoring • Setup of own production facilities • Outsourcing of labor-intensive production • Lower taxes and social contributions CONVERGENCE IN PER CAPITA INCOME [index, EU 15 = 100] 100 EU 15 84.1 SLO 78.5 CZR 71.5 67.9 EST 61.4 66.3 POL 42.4 39.4 2001 2010 2020 2030 > Labor costs in CEE will remain attractive for at least 30 more years

  20. 3. Result of 2004 enlargement: New European division of labor based on regional comparative advantages TRADE RELATIONS BETWEEN EU 15 AND CEE [EUR bn] WESTERN EUROPE: Capital/knowledge-intensive economies EASTERN EUROPE: Labor-intensive economies 132.6 134.7 121.1 RELATIVE ABUNDANCEOF CAPITAL AND TECHNOLOGY RELATIVE ABUNDANCEOF LABOR AT LOW COSTS 97.7 117.2 109.8 96.2 74.8 BRAIN BRAIN 1999 2000 2002 2001 = Imports from CEE = Exports to CEE > Free exchange of goods and services, financial and human capital will allow EU to compete head to head with the United States and Asia

  21. 4. Major industrial sectors are already reaping the benefits of the new European division of labor through FDIs Leading sectors in terms of FDI in Eastern Europe EU 15 FDI IN CEE 1997-2002 [EUR bn] 12.4 AUTOMOTIVE TELECOMS 19.9 16.3 16.1 12.1 9.8 6.0 4.9 4.5 6.3 3.9 5.5 FINANCIALSERVICES FOOD 1997 1998 1999 2000 2001 2002 = % of all extra-EU 15 flows 26.9% of all German FDI flows go to CEE > Also chemical firms have moved eastwards in search of new markets ...

  22. C. Opportunities for EU 15 chemical players in CEEand CIS

  23. 1. Chemical industry in CEE / CIS: Still small in size but growing at 2.5 times the speed of Western Europe Chemical output growth 2004-2014 [Ø % p.a.] 8.5 7.5 5.3 4.9 4.2 2.2 1.9 1.2 IND CHN CEE CIS Middle East EU 15 JPN NAFTA 2.3 5.3 1.6 0.8 3.6 33.0 11.0 27.8 Global share [%] > Chemical revenues of 34.3 bn USD in Eastern Europe (CEE 23.5 bn USD, CIS 10.8 bn USD) are comparable in size to Ireland or the Netherlands

  24. 2. CEE vs. CIS: Basic structural differences in chemicals – despite of similarly good growth perspectives CEE 1) CIS 2) Local / regional players producing value-added chemicals Big private oil/gas companies producingmainly petrochemicals and commodities PLAYERS / ACTIVITIES 1 COMPETI-TIVENESS Domestically but not yet globally com-petitive production / asset footprint Uncompetitive production / logistics, but competitive raw materials / feedstock 2 High imports of high-/medium-value chemicals, low level of exports High petrochemical exports, high consumer chemicals imports 3 TRADE Privatization of Russian players largely completed (Renationalization?) State-owned / -controlled companies still dominant DEGREE OF PRIVATIZATION 4 ACTIVITIES OF WESTERN COMPANIES Greenfield investments and JVs in consumer-driven segments Demand-driven Greenfield and supply-driven Brownfield investments / JVs 5 1) Poland, Czech Republic, Romania, Hungary, Slovakia, Bulgaria 2) Russia, Ukraine, Kazakhstan, Uzbekistan, Azerbaijan, Georgia, Moldova > Very different (market entry) strategies necessary for CEE and CIS !!!

  25. 2.1 Players / activities: Local players producing value-added chemicals in CEE – CIS strong in raw materials CEE CIS • PLAYERS: Weak, big state-owned /-controlled players and some strong private local / regional chemical producers • Largest players on various value-chain levels: CIECH, Zaklady Azotowe, Unipetrol, Duslo, Novacke Chemicke Zavody, etc. • ACTIVITIES: Value-added chemical production sites in all parts of CEE • Ethylene: CZ, HU, PL, RO, BG, SL • Polyethylene: HU, PL, CZ, HU • Ammonium nitrate: PL, SK, BG, RO • PLAYERS: Strong oil / gas companies and weak SMEs • Large oil / gas companies: Yukos, Lukoil, Surgutneftegas • Some agrochemical companies: Azot, Akron, PhosAgro, Eurockim, Uralkalii • ACTIVITIES: Production of low-cost commodities (gas, raw material and energy-based chemicals) • Dispersed and dislocated production centers remain from Soviet era • Production in CIS dropped 60% in early 1990s – today more or less at 1990 level again • Unfavorable logistics for world markets > Local/regional players in CEE and strong resource-driven players in CIS

  26. 2.2 Competitiveness: CEE assets competitive domestically – CIS assets not, but competitive raw materials CEE CIS • ASSETS: Production sites are competitive (technology, scale) – but only on domestic markets • Example (Ammonium nitrate production in Pulawy, Poland): • Capacity 700 kt • Minimum domestic size 550 kt • Minimum global size 1,000 kt • LABOR PRODUCTIVITY: Uncompetitive vs. EU 15 industry – turnover per employee at 30% of EU 15 level in 2003 • Significant increases: Up from 19% in 1995 • ASSETS: Uncompetitive production sites, but competitive raw materials • Example: Methanol and derivatives (Natural gas at Middle Eastern costsof 60-75 cents / MBTU) • Fullyfledged combinates and dislocation of process chains • Uncompetitive logistics costs • LABOR PRODUCTIVITY: Uncompetitive vs. EU 15 industry – turnover per employee only at 3% of EU 15 level in 2003 • Stagnating or even decreasing: In 1995 CIS productivity level was 4% of EU 15 > CEE slowly catches up with EU 15 efficiency – unsolved problems in CIS

  27. 2.3 Trade: High level of imports in both CEE and CIS – CIS with significant exports of mainly commodities CEE* CIS* • HIGH IMPORTS: 16.6 bn USD • Specialty / fine chemicals polymers • Consumer chemicals • LOW EXPORTS: 5.0 bn USD • Polymers • Petrochemicals • DOMESTIC PRODUCTION covers 53%of domestic demand of 35.1 bn USD • HIGH IMPORTS: 8.1 bn USD • Consumer chemicals • HIGH EXPORTS: 7.0 bn USD • Agrochemicals / fertilizers • Raw material-based chemicals • Gas-based chemicals • DOMESTIC PRODUCTION covers 32%of domestic demand of 11.9 bn USD *) 2002/2003 data > Increasing high-value added imports in CEE / CIS in the coming years – likely to be followed by import substitution international investments

  28. 2.4 Degree of privatization: Most players in CIS are in private hands today – CEE still largely state-owned CEE CIS • EXTENT OF PRIVATIZATION: Only in Hungary / Slovakia privatization has been completed, in Poland / Czech Republic the state still holds major shares • RECENT DEVELOPMENTS • Poland: CIECH group partially privatized in September 2004 (IPO) • Czech Republic: Unipetrol sold 63% to PKN – but significant restructuring and further ownership changes are expected • OUTLOOK: Privatized CEE players will enhance their impact via M&As in CEE • EXTENT OF PRIVATIZATION: In Russia, more than 96% of the top 400 chemical firms are privatized, in rest of CIS ongoing process • RECENT DEVELOPMENTS • Russia: Joint ventures with Westerncompanies, e.g. Gazprom with Sibur and Nizhnekamskneftekhim with BASF • Ongoing activities also in rest of CIS: In the Ukraine a privatization program of large enterprises has just been approved • OUTLOOK: Technology- and know-how-based input of Western companies will increase > Privatization / restructuring is still an issue in Poland and the Czech Republic – companies in CIS are more open for partnership / know-how

  29. 3.1 Likely future developments in CEE: Significant changes in industry structure – opportunities for EU firms KEY DEVELOPMENTS IN CEE OPPORTUNITIES FOR WESTERN COMPANIES • Significant industry structure changes are expected • Only few competitive companies remain, many (even privatized, but uncompetitive) companies are likely to fail • Unclear role of state-owned companies – big, still state-owned companies are likely to stay (even if privatization fails) • Privatized companies that are active in restructuring / M&As will follow their path mainly without Western partners • CEE chemical companies can become serious competitors on the EU stage • Capture market potential and growth through export and FDI • Enter market with brand and marketing power • Participate in market developments through Greenfield investments • Use time window of low factor costs to optimize EU 25 global footprint • Capture the advantage of homogeneous EU-25 policy and market > EU firms must integrate the new CEE countries in their EU-25 strategies

  30. 3.2 Likely future developments in CIS: Large players win against small ones – also opportunities for EU firms KEY DEVELOPMENTS IN CEE OPPORTUNITIES FOR WESTERN COMPANIES • Big gas-oil-driven and Western com-panies will gain momentum against SMEs • Many SMEs are likely to disappear(weak financial resources, limited marketing power, lack of R&D, uncompetitive price position, etc.) • Gas-/oil-based and selected raw material-based companies will expand their chemicals portfolio downstream • Often in cooperation with international partners • Open for FDIs • Participate in raw material / supply advantage by trading in technology and process know-how and capital • Cooperate with big oil / gas and raw material firms • Capture consumption-driven market potential through Greenfield investments or joint venture with raw material / basic chemicals manufacturers • In the meantime: Build up consumer-driven segments with export and marketing activities in CIS > EU firms can capture supply / energy advantages and market potential

  31. 3.3 CIS with disadvantages vis-à-vis Middle East: Higher logistics cost for gas / raw materials production LOGISTICS COST [USD / t kdPD] Russia – Western Europe LOGISTICS COST [USD / t kdPD] Middle East – Western Europe Railway 28 USD / ton Shipping 5 USD / ton Loading 20 USD / ton Shipping 16 USD / ton Loading 20 USD / ton EU 15 CIS Total 53 USD / ton Total 36 USD / ton Middle East Tanker loading terminal Railway Shipping route > Similar production costs in CIS and Middle East – but much higher logistics costs from CIS to Western Europe diminishes competitiveness

  32. 4. Outlook: The focus of the global chemical industry is moving ever more to the east CEE / CIS • CEE: Increasingly competi-tive production site • CIS: Raw material provider FAR EAST • Demand powerhouse • Production center for fine / specification chemicals MIDDLE EAST • Future powerhouse of petrochemicals (especially natural gas / ethylene-based derivates) > CEE/CIS: Opportunities especially for EU companies to overcome growth barriers at home – but the "real" opportunities are in Far andMiddle East!

  33. D. Conclusion

  34. Conclusion: The changing face of Europe offers broad business opportunities – also for the chemical industry • The 2004 EU enlargement is changing the face of Europe – ten relatively poor but fast-growing countries have joined the largest economic region in the world • For the EU 15, this means opportunities and threats – both on the macroeconomic and microeconomic levels • The European / global chemical industry can benefit from the changes in Eastern Europe – more than it already does – … • by capturing the market potential / consumption gap in CEE and CIS • by seeing CEE as a catalyst to optimize EU-25 asset footprint and strategy • by participating in supply advantages in CIS > Western chemical firms should invest in / penetrate CEE and CIS now !!!

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