As a result of China's membership of the World Trade Organisation (WTO), and its own economic reforms, its domestic markets have been deregulated, allowing entry to international companies for the first time.
Previously, foreign companies were only able to trade in the Chinese US dollar (USD) chemicals market, often via regulated free trade zones, with customers in the re-export processing industry.
Imports of products into the domestic market were complicated by prohibitive import duties, the need to use agents and the presence of numerous local traders and distributors involved before the product reached the end-user customer.
Under de-regulation, import duties have been substantially reduced and import licences made available, giving foreign companies the flexibility to both import directly and trade locally.
Extended business licence
In mid 2006 Shell China Ltd was granted an extension to its business licence enabling it to import, export, buy and sell chemicals in local Chinese renminbi (RMB) currency. Having established the necessary sales, marketing, logistics, governance and customer service operations, the company had completed the first commercial transactions by the end of the year.
"The local currency business is a third leg to Shell's chemicals interests in China, along with the USD re-export business and its stake in the CNOOC and Shell Petrochemicals Company Ltd (CSPCL or 'Nanhai') joint venture," says Stephen Kinder, Project Venture Manager, who is leading the development of the chemicals trading business in China.
"The scale and growth of the domestic Chinese market offer tremendous scope for developing a significant business presence in the next few years, as well as increasing our firsthand knowledge of Chinese customers, some of whom could be the global accounts of the future."
He says the market is currently fragmented but dominated by major local producers - Sinopec and Petrochina - as well as importers, speculative traders and distributors. "All of these players could be impacted by de-regulation and there is likely to be some restructuring. A number of global players are expected to establish operations in China, which could lead to consolidation and alliances," he explains.
Valuable experience
And while the prize for those entering China is attractive, Kinder says there are still significant barriers. "China is a very different and challenging market. We have some valuable experience from our involvement in Nanhai and are also one of the larger players in the re-export market, with over $500 million of annual sales. But operating in the local currency, through local business practices, and with rapidly changing legislation, is still new territory."
The spot nature of pricing, short lead times combined with commonly used cash before delivery terms, recruiting experienced local people and sourcing appropriate logistics, he says, pose major challenges to newcomers.
"International companies in China will be operating without many of the business processes, systems and safeguards they are used to in other parts of the world. Understanding how the domestic market works requires a pragmatic approach to marketing and trading activities.
"The large volume commodity products commonly use 'cash before delivery' terms, which increases the demands on finance and sales operations, and requires responsive supply chains and payment processing systems.
"In the performance products market there is increasing use of credit and, as the scope of the business grows, the risks associated with provision of credit will need to be understood and managed.
"At the same time we have to ensure that all our activities comply with Shell Group standards in terms of product stewardship, HSSE (Health, Safety, Security and Environment) and its Code of Conduct."
HSSE compliance
HSSE compliance can be a challenge in a market where standards, infrastructure and training are not as established as in developed markets. "It's important to work closely with service providers to convince them of the value of Shell's commitment to protection of people and the environment, and to provide local support and expertise to drive HSSE performance."
To mitigate commercial and HSSE risks he says Shell has been taking a step-wise approach to the market entry. "We started with relatively simple transactions to build understanding of the market, customers and Chinese business practices - while leveraging and introducing our global processes wherever possible."
The first transaction, a truck delivery of slabstock polyols, took place at the end of 2006. The customer, Chiao Fu, is a polyurethane foaming company operating across Asia-Pacific. "We supply Chiao Fu in several other countries in the region and having recently opened a new foaming plant in Shanghai, it was keen to establish a relationship with us in China," says Kinder.
In early 2007 the chemicals business was expanded with the first bulk ship sales of monoethylene glycol (MEG) with product purchased from CSPCL in South China and shipped directly to customer storage tanks in East China. "These early transaction are key to developing experience and learning for the future."
The business is expected to expand to include ex-stock sales of imports of a wider range of chemicals products, a broader network of domestic supply sources and contracting of storage facilities as well as land, marine and rail logistics. Additional capabilities, such as IT systems, will grow in line with the Shell Group's overall development of its business infrastructure in China.
To manage the chemicals business, Shell China Ltd has been building a locally recruited team, including a Commercial Operations Manager with extensive experience of the market.
One new area of business the team is already looking at is the bulk trading of aromatics. "There's potentially a lot of new domestic aromatics production capacity coming from cracker complexes planned or under construction, as well as from reformers and the coal industry.
"By building on the existing relations we have with some of those producers we hope to grow the aromatics business in China to complement our existing activities in Asia-Pacific," says Kinder.
Future scale
The six new ethylene crackers coming onstream within the next 4-5 years, and the expansion of existing crackers, point to the potential future scale of the business.
CSPCL in southeast China could play a role in the business development, as both a customer and supplier. "Nanhai could be a potential customer of the aromatics marketing operation and also a supplier of a variety of products," he says.
"Being able to offer both domestic and imported supplies of MEG, for instance, will be a major advantage as the market is short of product due to the rapid growth in the Chinese polyester industry."
He expects the business to develop largely through product deliveries by sea. "Industrial development is focused on China's south and east coasts, and to a lesser extent in the North, and so most deliveries involve moving product by sea between storage tanks and terminals."
Strategic impact
Iain Lo, Shell Chemicals Vice President Asia-Pacific/Middle East Ventures and Development, says having a strong local presence in China is essential. "The domestic market is not only huge in itself, it also has a strategic impact on global markets. Markets and business practices could change rapidly as China fully implements WTO requirements and if you are not part of that you can get left behind.
"The first steps we have taken will allow us to accumulate valuable market intelligence and provide a good platform to be part of China's growth and expansion. In future this platform will provide an important new channel for the sale of products from our existing plants in Asia-Pacific and the Middle East, as well as those from the expansion of our Singapore Eastern Petrochemicals Complex currently underway."
Local experience
Franklin Zhang, Commercial Operations Manager, was recruited to manage Shell's chemicals business in China because of his extensive experience of the domestic market and business practices, which have some unique and challenging characteristics.
"When you sell any chemicals products in China you're effectively in a spot pricing market, even though there are increasing numbers of annual supply contracts. Transactions are generally on cash before delivery terms, lead times are short, and competition is tough. Customers demand just-in-time deliveries and you have to be able to react quickly.
"Once you move into the RMB market you are also trading under Chinese law so you have to ensure that you understand and implement appropriate governance."
He says being able to offer local currency sales is key to developing a presence in the market. "If you only sell in dollars, you may be perceived as an outsider. Trading in local currency means you are viewed differently and as a result you get closer to the customers."
He believes international companies could have a significant impact on the development of China's chemical industry. "Customers in China are becoming more sophisticated in their approach to governance and product stewardship as well as quality and service. Increasingly they want to deal with suppliers that know how to make, handle and transport products responsibly."
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