Keyword

11.1 Introduction to China’s Chemicals Industry Chain

Petrochemicals are the main chemical materials and are used in a wide range of industries. The petrochemical sector is a midstream manufacturing industry with a long and complex industry chain. It can be further divided into commodity chemicals and fine chemicals by market size, and area of application. Major raw materials for petrochemicals are oil, gas, and other ores. Oil and gas contain carbon and hydrogen elements, and produce a range of organic compounds. Phosphate, potash, fluorite, quartz, and salt are raw materials of inorganic compounds. Downstream industries for petrochemicals include apparel & textiles, foods, housing, transportation, and many emerging strategic industries. The petrochemical sector plays a crucial role in securing the safe and stable development of China's industry chains.

11.1.1 Commodity Chemicals: China Maintains Competitive Advantages and a Leading Global Position by Output of Most Commodity Chemical Products

China's global market share of commodity chemicals by output and consumption volume is sizable; it has strong competitive advantages. According to the European Chemical Industry Council (CEFIC), chemical sales in China amounted to EUR1.5trn in 2020, representing 44% of the global total, making it the world's largest chemicals market. The growing chemical demand in China accelerated the transfer of production capacity for basic chemicals and general materials to the country. This, together with the engineering bonus and rapid growth of the equipment manufacturing sector in China, has enabled the country to make several breakthroughs in the field of commodity chemicals in the past 20 years.

China has a sizable global market share by output and consumption volume of polyurethane products such as methylene diphenyl diisocyanate (MDI) and toluene diisocyanates (TDI); titanium dioxide; chemical fibers such as polyester filament, viscose, and spandex; basic chemical products such as ethylene oxide, acetic acid, and acrylic acid; and major commodity chemical products such as fertilizers and chlor-alkali. The country has the largest production capacity in the world for most of these products. In addition, China has significant cost advantages on the back of its scale effect, integrated industry chains, and engineering capabilities. With regard to nylon 66, polycarbonate, ethylene–vinyl acetate (EVA), and polyethylene, China still relies on imports and domestic companies are increasing capex to make breakthroughs. As some capacity expansion projects in China start operating, we expect China's dependence on imports to decrease significantly (Fig. 11.1).

Fig. 11.1
A table of 10 columns and 7 rows lists China's capacity, China's production, global production, China's share of production, China's apparent consumption, global consumption, China's share of consumption, and China's production over apparent consumption.

Source China Petroleum and Chemical Industry Federation, www.oilchem.net, Sci99, Baiinfo, CICC Research

China was one of the world’s main producers and consumers of commodity chemicals in 2020. Note (1) MDI and TDI are widely used in light industry, textile, transportation, and automobile industries; (2) EVA is widely used in foam in shoes, photovoltaic film, and functional film.

Full size image

11.1.2 Fine Chemicals & New Materials: Improving Industry Chain Security; High-End Materials Are Mainly Imported

There is a large gap between Chinese companies and overseas peers in the high-end fine chemicals & new materials market; China imports products to meet domestic demand. The production of fine chemicals and new materials requires advanced technologies, but in China, advanced application scenarios in downstream industries as well as the supporting equipment are still in the early and middle stages of development. Moreover, China’s new materials segment lacks a development trajectory of trial and error, feedback, technological iteration, and improvement.

For downstream companies, the cost of acquiring fine chemicals and new materials is relatively low, but producing their raw materials requires advanced technology. We believe that the fine chemicals & new materials industry is crucial to product quality and to the stable growth of downstream industries, and that downstream companies are not willing to replace existing business partners in the fine chemicals & new materials segment. China’s high-end chemicals industry has seen insufficient R&D investment over a long period, and faces challenges from relatively weak independent innovation capability and development of advanced technology. At present, domestic fine chemicals and new materials manufacturers mainly produce low-end products, and the industry is facing fierce competition as well as low added value. There is a large gap between Chinese companies and their overseas counterparts in the high-end fine chemicals & new materials industry, which requires R&D and innovation strengths, and has high added value (Fig. 11.2).

Fig. 11.2
A table of 3 rows and 5 columns lists the industry, sector, major overseas manufacturer, major manufacturers in China, and self-sufficiency ratio in China. Industries are semiconductor materials, display materials, and other materials.

Source SEMI, IHS, China Petroleum and Chemical Industry Federation, 2020 Report on the Development of China's New Chemical Material Industry, CICC Research

China’s high-end fine chemicals & new materials industry with low localization rate.

Full size image

There are various types of fine chemicals and new materials, and high-end semiconductor materials directly affect the development of emerging strategic industries. In our opinion, there is still a substantial gap between Chinese companies and overseas leaders in the area of high-end fine chemicals & new materials.

Semiconductor materials: Technological breakthroughs have been achieved for low-end materials, but high-end materials are essentially imported. Benefiting from policy tailwinds and growing demand in the downstream semiconductor industry, many domestic chemical materials manufacturers have expanded into semiconductor materials. However, as latecomers, they face pressure related to patents, skilled workers, and supporting facilities. In addition, the investment period for the semiconductor materials business is relatively long and the speed of technological advancement in the industry is increasing rapidly. As a result, the self-sufficiency ratio in China is low for most semiconductor material products, and imported products still dominate the market for advanced processes, thus weighing on the stable development of the integrated circuit industry chain in China.

For example, in the field of photoresists, the world's most advanced extreme ultraviolet (EUV) photoresists can be used for the production of semiconductor wafers below 7 nm. However, KrF photoresists that have recently started to be mass produced in China are mainly used for 130–250 nm processes, and ArF and EUV photoresists that can be used for advanced processes are still under development (Fig. 11.3).

Fig. 11.3
A chart presents the self-sufficiency ratio. A line graph indicates the self-sufficiency ratio of photoresists which decreases from 3 mu m to 5 n m along with the self-sufficiency of wavelength sources such as g-line and k r f. The table below presents the self-sufficiency of semiconductor materials such as silicon chips.

Source Official website of Taiwan Semiconductor Manufacturing Company, China Electronics Materials Industry Association, CICC Research

There is still a substantial gap between China’s semiconductor material manufacturing technologies and advanced technologies in overseas markets.

Full size image

11.2 Review and Outlook for China’s Chemicals Industry Chain

In this section, we review the three rounds of industrial transfer in the global ethylene market, as well as the development of Japan's photoresist industry and China's mixed crystal industry. We summarize the main driving forces behind the development and capacity transfer of the commodity chemicals and fine chemicals segments, providing a framework for projecting the potential changes in China’s chemicals industry chain.

Commodity chemicals: We review the three rounds of industrial transfer in the global ethylene market, and note that demand and cost are the main forces driving the industrial transfer for commodity chemicals.

Fine chemicals & new materials: We review the development of Japan's photoresist industry and China's mixed crystal industry. We note that the photoresist segment in Japan has high technological barriers, and that materials and formulas continue to change due to technological upgrading in downstream industries. As for China’s mixed crystal segment, the barriers to entry are also high, but the speed at which liquid–crystal display (LCD) technologies are being upgraded is relatively slow.

From Japan’s experience, we learn that the development of the photoresist industry is correlated with the development of the downstream semiconductor industry. Unlike commodity chemicals, technological factors played an important role during the development of the photoresist industry. During the early stages of development, Japan’s photoresist materials industry continued to introduce advanced technologies from the US, and carried out very large-scale integration (VLSI) research nationwide. It successfully narrowed its gap with global leaders. Later, it leaped ahead to be among the top in the world, and related Japanese companies captured growth opportunities brought by the technological upgrading for ArF photoresists, even though the production capacity of the downstream semiconductor industry had shifted from Japan to South Korea, the Taiwan region of China, and the Chinese mainland. Japan maintains its leading position by developing and upgrading supporting facilities for downstream clients.

After the LCD industry upgraded to thin-film-transistor (TFT) liquid crystal displays, Chinese mixed crystal companies saw a large technological gap with its overseas peers. However, they stepped up efforts in R&D and technological accumulation in the field of TFT mixed crystal, and penetrated into the supply chains of downstream panel manufacturers in China. In addition, there was a rapid shift in global LCD panel production capacity to China, which accelerated the localization of TFT mixed crystal.

11.2.1 Commodity Chemicals: Review of the Three Rounds of Industrial Transfer in the Global Ethylene Market and Corresponding Driving Forces

Ethylene is the basic chemical raw material for synthetic plastics (polyethylene and polyvinyl chloride), synthetic fiber, and synthetic rubber, among others. It is also used to prepare styrene, ethylene oxide, acetic acid, acetaldehyde, and explosive materials. According to the CNPC Economics & Technology Research Institute (ETRI), global ethylene production capacity reached around 210mnt and total demand reached around 180mnt in 2021. Ethylene is one of the most in-demand chemical products in the world and is also an important indicator that reflects the progress of development of the petrochemical industry. In our opinion, we can catch a glimpse of the development of the commodity chemicals industry chain by reviewing the changes in and development of the global ethylene industry.

The rise of the ethylene industry in the US. The history of the US ethylene industry can be traced back to the 1920s. At that time, separation of the refinery by-products and ethanol dehydration were the main methods of ethylene manufacturing. However, the scale of production was small and costs were high under these methods. In 1940, ExxonMobil Corporation built the world’s first ethylene production unit with refinery gas as the raw material. Following that, raw material categories expanded to naphtha, further enhancing the key position of ethylene in the petrochemical industry. From the 1930s to the 1950s, industrialization was achieved for a variety of vinyl polymers represented by polyvinyl chloride (PVC), high-density polyethylene (HDPE), and low-density polyethylene (LDPE), and the ethylene industry thrived in the US. The global ethylene industry before the 1950s was largely dominated by US companies.

The first round of industrial transfer in the global ethylene market: Low raw material prices and technological upgrading drove the growth of the US ethylene industry. However, the rapid demand growth served as a catalyst that shifted related capacity to Europe. Ethylene production capacity per unit in the US increased significantly from the 1950s to the 1970s as prices of crude oil, which is a major raw material for ethylene manufacturing, were low and production techniques had been optimized. Ethylene production capacity per unit increased to around 500,000t/yr in the 1970s from approximately 50,000t/yr in the 1950s.Footnote 1 The US ethylene industry continued to develop in this period on the back of low raw material costs and technological upgrading. However, the rapid growth in demand drove industrial transfer to Europe. Europe’s economy grew rapidly from the 1950s to the 1970s. For example, Federal Republic of Germany's GDP grew at a CAGR of nearly 8% over 1950–1960, and the country became the third largest economy in the world in 1960.Footnote 2 The development of the European economy accelerated the growth of ethylene demand. As such, the ethylene production capacity of Western Europe accounted for 1.9% of the world’s total in 1950, and by 1960, the proportion reached 22%.Footnote 3

The second round of industrial transfer in the global ethylene market: Transfer to Japan and South Korea from Europe and the US was driven by demand growth. The second round of industrial transfer started in the 1970s and ended at the turn of the twenty-first century. Several periods of significant fluctuations in the international crude oil market and a slowdown in economic growth in the US and Europe weakened the growth momentum of their respective ethylene industries. During this period, Japan and South Korea’s ethylene industries grew on the back of soaring demand and cost advantages. Since the 1970s, the economies of Japan and South Korea have grown rapidly. For example, the per capita GDP of South Korea increased from less than US$300 in 1970 to US$12,000 in 2000. Production capacity of textile, automobile, and other downstream industries also moved to East Asia from Europe, triggering the growth of ethylene demand in the region. The Japanese and South Korean governments formulated export-oriented economic development strategies. They introduced a series of industrial policies to support the development of heavy chemicals industries represented by ethylene to ensure the supply of raw materials for downstream industries such as the textiles and apparel industry, fueling the transfer of ethylene production capacity to Japan and South Korea.

The third round of industrial transfer in the global ethylene market: Demand growth drove industrial transfer to China. Ethylene output in the Middle East and the US increased due to advantages in raw material costs. The third round of industrial transfer started at the turn of the twenty-first century. During this period, China, the Middle East, and the US saw a significant rise in ethylene production capacity due to rapid growth in demand. During this period, the focus of global economic growth began to shift to China, and production capacity of downstream textiles and automobile industries also moved to China from Japan and South Korea, spurring the growth in demand for ethylene in the country. Meanwhile, China’s government rolled out a series of policies to support the development of the domestic ethylene industry and ensure the raw material supply for the textiles & apparel industry, as well as other downstream industries.

The rise in ethylene production capacity in the Middle East and a return to growth for the ethylene industry in the US are mainly driven by cost factors. For example, the “Shale Revolution” in the US boosted the output of shale oil and shale gas. As a result, the ethylene output in the country grew to 2.5 mn bbl/day in 2021 from less than 1 mn bbl/day in 2010,Footnote 4 and ethylene prices dropped to less than US$200/t in 2010–2021 from more than US$400/t in 2007–2010. Stimulated by the sharp decline in costs, US ethylene companies initiated two rounds of capacity expansion. Thus, ethylene production capacity in the US grew to 44mnt in 2021 from 28mnt in 2010.Footnote 5

11.2.2 Fine Chemicals & New Materials: Growth Drivers for Japan’s Photoresist Industry and China’s Mixed Crystal Industry

11.2.2.1 Factors that Served as a Catalyst to the Rise of Japan's Photoresist Materials Industry and Helped the Country Maintain Its Leading Position

The semiconductor materials industry has a wide range of products, high technological barriers, and complex manufacturing techniques. Furthermore, downstream clients require a lengthy period to test and verify the products. In our opinion, R&D and industrialization of semiconductor materials are challenging, and should be further strengthened to ensure the stability and safety of China’s industry chains. Semiconductor-related photoresists are one of the high-end fine chemicals and new materials. In our opinion, Japan continues to be one of the global leaders in this area, although its overall semiconductor industry chain is declining.

We note two types of changes in the global competitiveness of Japan’s semiconductor material segment. First, some materials and related formulas continue to be upgraded, driven by technological iteration in downstream sectors. For example, Japan has been a leader in the global semiconductor-related photoresist segment, and continues to strengthen its competitive advantages. It captured growth opportunities amid transformation of the technological roadmap in the early twenty-first century and continued to optimize its photoresist products as technologies of its downstream clients advanced. Second, the continuous upgrading of semiconductor-related technologies poses higher requirements on the performance and purity of some chemical materials, including electronic wet chemicals, electronic special gases, polishing materials, and large-size silicon chips. Japan maintains a large global market share in these chemical material segments on the back of advantages accumulated in the past. However, its advantages in these segments are weaker than in the global photoresist market. In the following paragraphs, we mainly highlight the milestones of Japan’s photoresist industry, which we expect will inspire China’s high-end fine chemicals & new materials industry.

1960s–1980s: Japan overtook advanced countries on the back of the VLSI research project. Photolithography technology originated in Europe and the US in the 1950s. In the early 1960s, US companies were relatively relaxed about the transfer of technologies (TOT). As such, Japanese semiconductor materials companies acquired advanced technologies from their US peers via TOT and made some progress.

In 1968, Tokyo Ohka Kotyo Co., Ltd. (TOK) brought Japan’s first cyclized rubber-based photoresist to the market. Later, the Japanese government encouraged related companies to work together on the R&D of core technologies, with the aim of accelerating the development of the country’s semiconductor industry. In 1976, the Japanese government, Fujitsu, Hitachi, NEC, Mitsubishi Electric, and Toshiba jointly launched a VLSI research project,Footnote 6 investing JPY70bn in building a laboratory while studying basic semiconductor-related technologies. The project set up six laboratories to develop key semiconductor materials, equipment, and production technologies. Specifically, three laboratories were responsible for semiconductor equipment R&D, while the other three were used for the development of semiconductor materials, photolithography technologies, and packaging and testing technologies.

With four years of R&D and cooperation, the VLSI obtained more than 1,000 patents and made many technological breakthroughs. The successful development of the key equipment for semiconductor processing, a lithography device using model reduction steppers, is remarkable. Its R&D of the supporting photoresists also accelerated Japanese photoresist manufacturers’ technological upgrading. In 1979, Japan’s first CIF photoresist product made by JSR Corporation entered the market. In 1981, TOK's first factory specializing in the production of semiconductor-related photoresists started operating. The 1980s was a period of rapid growth for Japan’s semiconductor industry. During this period, Japan grew into a leader in the global semiconductor industry. Benefiting from the robust demand in the downstream semiconductor industry, orders for photoresists made in Japan increased rapidly,Footnote 7 thus enabling Japanese photoresist companies that had achieved technological breakthroughs to secure a place in the global photoresist market then dominated by US companies.

1990s–2000s: Technological innovation and advanced equipment made Japan a leader in the global photoresist industry. From the 1990s to the beginning of the twenty-first century, Japan’s photoresist industry developed by leaps and bounds on the back of photoresist-related technological transformation, and the production of advanced supporting equipment. During this period, the industry switched to krypton fluoride (KrF) photoresist technology from g-line and i-line photoresists. Although the US company IBM invented KrF photoresists as early as the 1980s, it did not put the product into large-scale commercialization due to the backward process technologies at that time. During this period, Japanese companies managed to narrow the gap with their US peers in the field of KrF photoresists via technological R&D. In 1995, TOK successfully rolled out its own KrF photoresist, breaking IBM's monopoly in the KrF photoresist market. In terms of supporting lithography devices, Japan outperformed the US by output in 1985. In 1995, Nikon Corporation launched NSR-S201A, the world's first KrF lithography system that can be commercialized, overtaking its US peers. At this stage, Japanese companies surpassed US companies in the global lithography device market, and further eclipsed the original European and US leaders in the photoresist market on the back of their advanced lithography device-related technologies. At the end of the 1990s, Japanese photoresist manufacturers set up factories overseas, increasing their service coverage around the world. In 1997, TOK built Japan’s first overseas photoresist manufacturing facility in Oregon in the US.

2000s–present: Japan maintains a leading position in the global photoresist industry on the back of technology roadmap transformation, as well as R&D and upgrading of supporting technologies. In the twentieth century, Japan narrowed the gap with technologically advanced countries in the fields of i-line, g-line, and KrF photoresists by increasing R&D investment, introducing cutting-edge technologies, and developing supporting facilities. In the twenty-first century, Japan joined the ranks of leaders in the global photoresist industry as it captured growth opportunities amid the technology roadmap transformation and stepped up efforts to upgrade supporting lithography devices. It maintains a leading position at present. At the turn of the twenty-first century, the global semiconductor industry shifted to ArF photoresists from KrF technology. JSR officially started development of the ArF photoresist-based, 130 nm process technology-driven semiconductor in 2000 based on its experience in the photoresist industry. As a result of its efforts, the Japanese company became a leader in the global ArF photoresist segment.Footnote 8 As ArF lithography technology is applicable to 7–130 nm processes, JSR and TOK continued to cooperate with downstream companies such as ASML in the R&D of lithography devices, and increased efforts to upgrade their products to adapt to changing technologies. As a result, Japanese companies strengthened their first-mover advantages in the field of ArF photoresists. In 2019, the new-generation EUV photoresist-related technology was poised to enter industrialization. On the back of their close ties with ASML and other lithography device manufacturers, as well as their forward-looking research, Japan again took the lead in industrializing EUV photoresists, enhancing its competitive advantages.

11.2.2.2 Factors Driving the Growth of China's Mixed Crystal Industry

The liquid crystal industry is technology-intensive, and the quality of materials directly affects the performance of panels. Manufacturing liquid crystal materials involves several processes, including preparing liquid crystal intermediates from basic chemical raw materials, synthesizing liquid crystal monomers (LCMs) from intermediates, upgrading to electronic LCMs via purification (removal of impurities, moisture, ions, etc.), and mixing LCMs in the right proportions. The production of mixed crystal requires dozens of steps of synthesis, purification, and mixing of multiple monomers. Therefore, we think the mixed crystal industry is technology-intensive. The cost of liquid crystal materials generally accounts for 3–4% of the total cost of panels, and the quality of these materials directly affects the response speed, brightness, viewing angle, and other indicators of the display. Due to the importance of liquid crystal materials, downstream panel manufacturers’ certification of mixed crystal material suppliers is strict and the certification cycle is long.

The improvement of material technology and the accelerated transfer of panel capacity to the Chinese mainland are driving the growth of the domestic mixed crystal industry. Based on technological strengths in the field of twisted nematic (TN) and super twisted nematic (STN) liquid crystal materials, domestic mixed crystal material companies expanded into the TFT business after 2000. In 2007, Yongsheng Huaqing (later acquired by Chengzhi) managed to produce TFT material in small batches in 2007. In 2010, Hecheng Display (later acquired by PhiChem) successfully developed the “indene ring” structure based on its cooperation with Daxin, a specialty chemical materials manufacturer in the Taiwan region of China. In 2011, BaYi Space started comprehensive R&D of TFT mixed crystal. With the improvement of TFT mixed crystal technology and product quality, domestic mixed crystal material manufacturers passed the tests of downstream customers and entered the supply chains of domestic LCD panel manufacturers by providing TFT mixed crystal material. PhiChem, BaYi Space, and Chengzhi were three leaders in the domestic mixed crystal market. By 2015, the localization rate of TFT material approached 15%. After 2015, the transfer of global LCD panel production capacity to the Chinese mainland accelerated, and domestic LCD panel manufacturers replaced all imported TFT mixed crystal raw materials with domestic products. As a result, the localization rate of mixed crystal increased rapidly.

11.3 Outlook for China’s Chemicals Industry Chain

Countries around the world have been paying more attention to industry chain and supply chain security due to the rise of deglobalization and the impact of COVID-19 resurgence on global supply chains. As one of the pillar industries of the national economy, the petrochemicals and chemicals industry is critical to the security and stability of China's supply chain due to its characteristics of “large trading volume, long industry chain, diverse product categories, and wide downstream applications”.

Outlook for China’s chemicals industry: (1) Commodity chemicals: We review the industrial transfer in the global ethylene market, and note that demand and costs have been the main drivers of the industrial transfer after the production technology of commodity chemicals matured. We believe that China will remain competitive in key commodity chemical segments given the strong demand and macroeconomic growth in China, leading companies’ capex growth for core capacity expansion and penetration into downstream sectors with high added value, rise in natural gas prices, and unstable supply in important chemicals production bases such as Europe. In the fields of polyolefin elastomers (POE) and EVA, which have high import dependency, we expect the self-sufficiency ratio in China to increase as related domestic production capacity expands. In our opinion, some commodity chemical production capacity will likely face transfer pressure due to the rise of deglobalization, increasing labor costs, and the green transformation of industries.

(2) Fine chemicals & new materials: The localization rate of high-end fine chemicals and new materials is relatively low at present. We expect the development of downstream sectors and related policy support to drive the growth of this industry in China. However, this industry has high technological barriers, and there is still a gap between China and advanced countries in terms of technological strengths as well as speed of technological iteration. These factors will likely slow China’s pace of localization in the high-end fine chemicals & new materials industry. Given the frequent changes in related materials and formulas, driven by technological iteration in the downstream semiconductor sector, we think it may take a long time for China to localize semiconductor photoresists. With the iteration of semiconductor technologies, requirements for the performance of electronic wet chemicals, electronic special gases, polishing materials, and large-size silicon wafers will likely increase, and the localization progress in these chemical materials segments will likely accelerate in the medium and long term.

11.3.1 Commodity Chemicals: Competitiveness Remains in Key Segments; Pressure from Industrial Transfer Emerges in Some Segments

China maintains competitiveness in the global commodity chemicals industry due to increasing demand and improving supporting facilities. In our opinion, the sustained growth of China's macroeconomy will likely continue to boost demand for chemical products. In addition, China accounts for a high proportion of the global market by production capacity of major commodity chemicals. At present, prices of natural gas and electricity have soared in Europe, one of the world’s main chemical manufacturing bases, due to geopolitical factors. Supply pressure has also emerged in the region. Therefore, we expect China to see cost advantages in key commodity chemical segments. In July 2022, BASF decided to accelerate the construction of a project in Zhanjiang, Guangdong province. Other global chemical giants also invested on a large scale in China, reflecting their optimism about the market prospects and competitiveness of commodity chemical projects in China.

Leading companies with strong competitiveness will maintain large capex, and China's global market share of commodity chemicals will likely continue to increase. Data from CEFIC shows that capex of Chinese chemical enterprises in 2020 was EUR92.2bn, implying a CAGR of 5.5% in 2010–2020. The large scale and high growth rate of capex continued to fuel the expansion of China's market share of chemicals. Based on our survey of some petrochemicals and chemicals providers, we expect Rongsheng Petrochemical, Hengli Petrochemical, and Wanhua Chemical to each maintain capex of more than Rmb100bn over 2022–2025, and capex of Tongkun Group, Xinfengming Group, and Hualu Hengsheng to each exceed Rmb20bn. Leading companies will mainly fund capacity expansion for existing products, industry chain extension, and development of new materials and high-end materials businesses. We are upbeat on the continuous expansion of chemical production capacity in China.

Some segments will likely face industrial transfer-related pressure due to higher labor costs and green transformation, in our view. (1) Labor-intensive industries: As labor costs rise in China, labor-intensive industries such as textiles will likely see industry chain transfer. For example, Jiangsu Guotai International is building processing plants in Southeast Asian countries, including Vietnam. In our opinion, demand in China will also decline against the backdrop of industrial transfer, thus putting pressure on the growth of the chemical materials industry in China. (2) Industries with high energy consumption: The implementation of low-carbon policies in China makes it difficult for projects with high energy consumption to be approved. Therefore, we think that companies in the oil refining, urea, yellow phosphorus, and industrial silicon segments may increase investment in overseas projects.

11.3.2 Fine Chemicals & New Materials: Prospects of Downstream Sectors Decide Material Demand; Multiple Factors Affect the Localization of High-End Materials

The trading volume of high-end fine chemicals and new materials in the market is relatively low. However, these materials have high technical barriers, and their quality, reliability, and stability greatly impact the performance of downstream products. The cost of these materials as a proportion of downstream clients’ total costs is low. If there are no restrictions on the purchase of raw materials, downstream clients tend to maintain business relationships with existing suppliers. This means that high-end fine chemicals and new materials have strong customer stickiness. However, some countries have increased restrictions on the export of certain materials considering the growing need for ensuring supply chain security and improving supply chain resilience. Although the technological gap between China and advanced countries is sizable and localization is facing major challenges, we are optimistic about new growth opportunities for the domestic high-end fine chemicals & new materials industry amid policy tailwinds and growing demand for domestic products from downstream sectors in China.

We believe the rapid growth of downstream demand and policy tailwinds in China will drive the growth of domestic products in some fields with relatively low localization rates. At present, the display panel and semiconductor industries are expanding in China. In terms of LCD panel capacity, China is a leading global producer. In terms of OLED panel capacity, Chinese companies’ global market share is increasing rapidly. The size and sales value of China's integrated circuit market and the market share of Chinese enterprises in the global wafer foundry market are also ramping up. In addition, China has introduced several policies and offered capital support to spur the development of the domestic semiconductor industry. Given that demand from the downstream semiconductor and display panel manufacturing industries is also increasing, we expect the localization of high-end fine chemicals and new materials to continue.

High technical barriers and downstream technological iterations will likely affect China’s progress in localizing high-end fine chemicals and new materials. Generally speaking, it is relatively challenging for Chinese companies to develop and industrialize fine chemical and new material products given the high technical barriers at present. However, the progress in technological iterations varies among downstream industries, and difficulties in material industrialization for different downstream industries are not comparable, in our view. If the materials industry and production technology are constantly changing along with the technological iteration of downstream industries, we believe that material localization will be more difficult. However, if downstream demand for materials and production technologies is relatively stable, we expect the localization to be smoother as domestic companies increase efforts to improve technologies and techniques. In the following paragraphs, we mainly analyze the prospects of semiconductor materials and some panel materials in China.

Localization of photoresists still requires a lengthy period due to the continuous changes in materials and formulations caused by downstream technology iteration. Driven by Moore's Law, the chip manufacturing industry continues to upgrade to more advanced techniques, and the requirements for key lithography technologies continue to improve. For example, by the wavelength of the exposure, lithography technology has evolved from g-line, i-line, KrF, and ArF to the most advanced extreme ultraviolet light. As photoresists are the core material required by lithography technology, the formulas for photoresist materials are constantly changing while the product purity keeps improving. The materials have shifted from the phenolic resin-diazonaquinone system used in g- and i-lines, and poly (p-hydroxystyrene) and derivatives for KrF lithography to poly (methacrylate) for ArF technology. At present, the world's most advanced EUV lithography technology uses 13.5 nm extreme ultraviolet light source, and photoresist materials for the technology have been upgraded to molecular glass and metal oxide, among others. As lithography technology is upgraded, the technological gap between China's photoresist companies and their overseas counterparts has widened. At present, g-line, i-line, and KrF lithography technologies are still the mainstream technology roadmap in China’s photoresist industry, and ArF and EUV photoresists are mostly imported. Given the large technological gap, as well as overseas countries’ regulations on the purchase of supporting advanced equipment and the high cost of trial and error for the application of domestic photoresists, we believe that the time required for the localization of high-end photoresists such as ArF and EUV will be long.

Localization of semiconductor materials will likely accelerate in the medium to long term, although requirements on performance of semiconductor materials continue to increase amid downstream technological iteration. The semiconductor manufacturing industry has stringent requirements for the purity of electronic wet chemicals, electronic special gases, and polishing materials; the content of metal impurities; the number of particles; and the consistency of particle size and quality. The continuous upgrading of semiconductor manufacturing processes has led to stricter requirements for the purity of semiconductor materials. For example, the continuous reduction of the semiconductor processes has resulted in lower tolerance for defect density and size of silicon wafers. As a result, wafer providers must control defects of monocrystalline silicon, the surface roughness of the silicon wafer, and the content of metal impurities. To date, domestic companies have made breakthroughs in the fields of electronic wet chemicals, electronic special gas, polishing pad and polishing fluid, and 300 mm silicon wafer. On the back of technological accumulation and experience in product purification and mixing accuracy, we expect the progress in localization of these materials to accelerate in the medium and long term.

The new energy material industry in China may face risks related to the rise of deglobalization in the industry chain. Data from www. guangfu.bjx.com and PV Infolink shows that the top 10 global leaders by PV module shipments in 2021 include eight domestic companies such as Longi Green Energy and Jinko Solar. Module shipments of these eight Chinese companies equaled approximately 90% of the global installed PV capacity in 2021. According to SNE, Chinese companies Contemporary Amperex Technology and BYD were among the top five global leaders by automotive battery shipments. Total automotive battery shipments of the two companies approached 132.7GWh, accounting for about 50% of the global power battery shipments. The development of Chinese midstream companies also facilitates the localization of new energy materials. In addition to conductive carbon black and POE, most new energy materials have been localized. However, some key economies are calling for increasing the use of their own products in the new energy industry chain. For example, the Inflation Reduction Act was passed in the US to protect their own new energy industry chain, and Chinese LiB-related companies may see risks related to industrial transfer.

11.4 Thoughts and Implications

11.4.1 Commodity Chemicals

11.4.1.1 Address Green and Sustainable Development and Cultivate Companies with Global Competitiveness in Segments with Strong Advantages

Strengthen green and sustainable development. Commodity chemicals have a longer history of development than other chemicals, and related technologies are relatively mature. As a result, participants in this segment may face global competition. China has established competitive advantages in terms of the market, costs, and security and stability of supply. We believe that China will continue to strengthen its advantages in MDI and other commodity chemical segments in the coming years. In our opinion, relevant domestic companies should enhance their long-term competitiveness by diving into green and sustainable R&D projects, including diversification of raw materials, carbon dioxide utilization, and atom utilization in the process.

Cultivate companies with global competitiveness. China has the world’s largest chemicals market. Among the top 50 chemicals manufacturers in the world in 2022, however, only nine were Chinese companies, namely Sinopec, Formosa Plastics, PetroChina, Hengli Petrochemical, Syngenta Group, Wanhua Chemical, Rongsheng Petrochemical, Tongkun Group, and Hengyi Petrochemical. In our opinion, China’s chemicals industry has its weaknesses but also growth opportunities. Given the country’s large chemicals market, we expect a number of domestic companies to grow into global leaders, thus helping China enhance competitive advantages in the global chemicals industry in the long term.

11.4.1.2 Industry Chains Facing Transfer Pressure Should Accelerate Overseas Expansion

For the tire industry and other industries facing overseas tariff barriers, we suggest building factories overseas. Since 2015, the US has imposed an anti-dumping duty of 14.35–87.99% and countervailing duty of 20.73–116.33% on the invoice value of tires (for passenger vehicles) exported from China.Footnote 9 The tariff barriers are relatively high. To weaken the impact of high tariff barriers, some big-name tire companies have stepped up efforts to expand capacity, mainly in Thailand, Vietnam, and other Southeast Asian countries, and the main category of their exports is semi-steel tire. However, the tariff barriers to tires from Southeast Asia have increased in recent years. As of May 2021, the total tax rate (combination of anti-dumping duty and countervailing duty) was 14.62–21.09% for products from Thailand and 6.23–28.76% for products from Vietnam. We survey the geographical distribution of related Chinese companies’ capacity expansion projects under construction, and believe that Europe, the Americas, and Africa will likely be the main focus of Chinese tire manufacturers.

Production capacity of the labor-intensive textile industry is moving to Southeast Asia, and Chinese raw material providers should mitigate risks related to decline in their market share via free trade agreements. There is an obvious trend of production capacity transfer in some industry chains, including the textiles & apparel industry chain, and Southeast Asia has strong competitive advantages in this round of industrial transfer. In our opinion, China should sign free trade agreements with Southeast Asian countries, thus strengthening industrial division and cooperation among regions. We expect China’s chemicals industry to maintain competitive advantages by providing capital-intensive industrial intermediates and processing downstream products overseas.

Implement differentiated policies to support the development of core fields in energy-intensive industries. China’s efforts toward reaching peak carbon emissions and achieving carbon neutrality have led to higher requirements for the development of energy-intensive industries. China’s urea and refining industries: We propose that related companies expand overseas capacity in a sustainable manner and transform into multinational companies with global competitiveness. Anode materials and industrial silicon industries: Anode materials and industrial silicon are necessary for the development of downstream new energy industries.

11.4.2 Fine Chemicals & New Materials

11.4.2.1 Localization Rate of High-End Materials is Relatively Low; Chinese Companies Should Step up Efforts to Tackle Technical Problems

Tackle technical problems in the industry chain. To accelerate the development of its semiconductor industry, Japan launched the VLSI research project, investing JPY70bn in related technology R&D and encouraging companies and research institutes to share information. Due to these efforts, Japan’s semiconductor industry has significantly improved its technologies. At present, there is a large gap between China and overseas countries in semiconductor material-related technologies. We believe China can learn from Japan and focus on tackling technical problems in the industry chain. First, domestic companies can select one process and focus on making breakthroughs in equipment, materials, and other related technologies. This can also lay a solid foundation for companies’ subsequent technological iteration. Second, major companies along the industry chain should work together. For example, in the field of materials, the key R&D tasks were mostly distributed to small- and medium-sized enterprises (SMEs) in the past. However, SMEs’ own profitability was weak, which affected their R&D investment. At this critical moment, we expect leading chemicals manufacturers in China to shoulder greater responsibilities. Third, in some sectors that involve multiple categories of materials, we suggest creating sector leaders via M&A. For example, there are hundreds of product categories in the fields of electronic wet chemicals and electronic specialty gases, and many companies in the two sectors have one or several competitive products. M&A can help create sector leaders with a wide range of product coverage. We think this is not only conducive to serving downstream application providers, but also helps create generic technologies, thus supporting the development of a wider range of product categories.

Encourage downstream customers to test and use domestic materials. For example, downstream companies are not motivated to use domestic photoresist materials as the quality of photoresists is crucial to the lithography process and trial and error costs in the downstream are high. As a result, we propose that China enhance the synergies between upstream and downstream industries by building a trial and error compensation mechanism, thus increasing subsidies for material purchasers and encouraging companies to work together in a research project. In addition, we suggest that China build a public test platform. For example, in the photoresist segment, the unit selling price of an EUV lithography machine is around US$150 mn. The cost of a machine is high for a single company and purchasing the machine is restricted by some overseas countries. A public platform may significantly reduce companies’ R&D costs and avoid wasting of resources.

Strengthen companies’ R&D. There are two ways for companies to enhance their R&D. First, create a culture of innovation. Management of companies should leave room for innovation and create a culture that supports employees’ innovative activities. Second, strengthen incentives for innovation and skilled workers. Chemicals companies should develop an efficient employee incentive and promotion system, continue to optimize organizational structure, enhance employees’ sense of belonging and pride, and reduce the loss of highly skilled personnel. Related government departments could also help Chinese chemicals manufacturers establish long-term and sustainable innovation capabilities.

Set up overseas R&D centers and strengthen the exchange of advanced technologies. Downstream industries in overseas markets have a long history of development, advanced technologies, and relatively complete employee education mechanisms. By building overseas R&D centers, Chinese chemicals companies may see three benefits. First, they can communicate with downstream customers and ascertain the actual demand for relevant materials. Second, domestic companies can attract skilled workers from local industries to help them improve R&D capabilities. Third, these chemicals manufacturers can cooperate with renowned universities, colleges, and companies in overseas countries in R&D projects.

11.4.2.2 Chinese Companies Are Competitive in the New Energy Materials Industry; We Expect Them to Accelerate the Development of New Technologies

Accelerating the development of new technologies and enhancing competitiveness to maintain a leading position. We review the announcements of a wide range of companies and note that in the field of LiB, Chinese battery company Contemporary Amperex Technology (CATL) has launched the Qilin battery, which has a record-breaking volume utilization efficiency of 72% and an energy density of up to 255Wh/kg. Meanwhile, the energy density of the E603P8S battery module from LG, the global leader, is only 226Wh/kg. We believe that China is a global leader in terms of battery technology due to its ternary and lithium-ion battery technology frameworks. Looking ahead, we believe that the energy density of solid-state batteries will likely exceed 400Wh/kg. As a result, there remains substantial room for technological upgrading by Chinese companies. In our opinion, related government departments could encourage companies to research and develop new energy materials and new technologies by launching advanced material projects and providing subsidies for related industries. New technological breakthroughs can also help China maintain a leading position in the global new energy materials industry.

Domestic companies with competitive advantages should proactively build factories in developed countries to meet the localization needs of industry chains in major countries and regions. In the future, the US and some other regions will likely enhance the competitive advantages of their local industry chains. The global new energy materials industry will likely face the risk of market protection by developed economies. We suggest related Chinese companies take the initiative to accelerate the construction of overseas factories and tap into overseas demand.