Sourcing Agchem from China: An Outlook that Demands Strategic Planning

CS Liew, Managing Director of Pacific Agriscience, Singapore, says buyers need to now work a lot harder to source more strategically and engage in aspects of Chinese plant audits that have not been done in the past.

The drastic anti-pollution measures taken by the Chinese Environmental Protection Agency (EPA) since last winter have led to tens of thousands of chemical plants being fined. Some managers and owners have also faced criminal charges resulting in jail terms being meted out.

The past 20 years of government plans to reduce the number of pesticide plants have finally been implemented. Many polluting plants and those situated too close to lakes and rivers have been permanently shut down. Many more have been slated for relocation, if the owners have the financial ability to do so.

Most, if not all, older plants face the additional issue of polluted sites. If they relocate, the owners will have to go through the costly exercise of cleaning the sites up. In some cases where there was deliberate burial of waste on-site over the years, cleaning up will be an impossible exercise! Twenty or 30 years ago, these plants did not have the standards of operation in terms of safety and pollution controls that we see in more modern plants that have been set up in newer national and provincial industrial parks.  In the past, it was common to see spills of chemicals from the production areas into the surroundings of the plants.

Concrete plans and government targets on numbers of plants to be shut down are now in place. Over the next two to three years, the surviving plants will be the larger ones with better financial ability to meet the much stricter enforcement of pollution standards. These will also tend to be the more modern plants situated in national and provincial industrial parks. In contrast, the smaller and financially weaker ones located in municipal industrial parks that are too close to towns and cities, or worse, water bodies, face a very bleak future. These are the “sitting ducks.”

The Usual Ugliness When There’s a Shortage

Whenever products are in short supply, unscrupulous traders emerge in the marketplace. The products shipped to unsuspecting buyers are of course sub-standard and are off specifications.

Hoarding of technicals and formulated products is the next common occurrence in such a situation. Producers and traders alike slow down or withhold sales and shipments waiting for prices to rise further.

Products tend to be available through “leakage,” meaning, while it is not possible to buy from the various known manufacturing plants, they are available through third-party channels. The objective is, of course, extracting higher prices from buyers.

Raw materials and intermediates are also being hoarded and speculated on. The manufacturers of technicals have to face their own issues of shortage in supplies of these as well.

Lately, a new phenomenon has emerged in that manufacturers of raw materials and intermediates are also getting into speculative trading of the end products. They are drawing up contracts with technical manufacturing plants such that a portion of the intermediates supplied are to be converted to technicals for themselves. The technicals made are not necessarily sold into the market by these intermediates suppliers, but in fact, are sold back to the technical manufacturers at a price that allows them to make another layer of profit downstream. It is not that widely practiced yet, but this phenomenon is emerging.

How Much Uglier Can It Get?

Situations in China can change very rapidly and ferociously. These situations are what I call the “Chinese Pendulum” syndrome — sudden swings between extremes of abundance to severe shortages. It has happened time and again in the past. Unlike a normal pendulum that swings between 4 and 8, it swings between 2 and 10 and sometimes even gets swung over the 12!

The current uncertain situation in terms of manufacturing and supply can reach a state where there is not enough products to supply the domestic Chinese market. This ugliest of situations will result in curtailment of exports. You will probably not find the government stopping exports but allowing exports in small packs only, as has been the case with fertilizers in the recent past. During the peak demand period in China, fertilizers could only be exported in small packs. Of course this is impractical and uneconomical, and is exactly the way they control or curtail exports.

Now that China owns ADAMA and Syngenta, it adds a new dimension in meeting domestic needs and ensuring food security. Both are capable of importing technical and formulated products from their overseas plants. This then explains yet another reason why the government has been bold enough to take the drastic measures of closing so many plants over the past year.

Another dimension that needs analysis and clarification is that when we talk about the drastic anti-pollution measure taken by “the government,” we are indeed referring to just the EPA. Their over-zealousness could eventually be tempered by the the ministries in charge of agricultural and food production. When the domestic needs are threatened, a natural equilibrium could be reached where food production and inputs supplies need to take precedent over environmental protection, in the short term at least. Here, my so-called “Chinese Pendulum” will be in full swing, yet again.

Credit Terms

Credit terms are a function of relationships, volume of purchase, price, contracts, competition, raw material and product availability, financial standing of the plant, and credit insurance.

With the shortages prevailing over the past year or so, credit terms have by and large disappeared. Buyers have to buy on cash basis or even have to pay in advance in order to secure supplies.

Not every product is sold without credit terms. Some products that are not facing that severe a shortage are still sold with some credit, albeit at a shorter period.

Overall, it is a tougher outlook, and this lack of credit will eventually filter all the way down the supply chain to the farmers.

Manufacturing Outlook

As discussed earlier, tighter EPA standards and controls will be the new world order. Quality of life, clean air, blue skies, and sunshine will take precedence over economic output.

Twenty to 30 years of lip service in cleaning up the pollution so prevalent in China has ended. Why? Today, we have corporate giants such as Tencent and Alibaba that are listed on the Hong Kong and New York stock exchanges, respectively, that crossed the $500-billion market capitalization earlier this year. In contrast, the 20 or so agchem manufacturing plants that are listed on the Shenzhen Stock Exchange have a total market capitalization of well under $30 billion! These non-polluting and enormous enterprises are the darlings of the government of the day as they provide the needed jobs without the harmful effects.

Going forward, we should see tremendous consolidation in the manufacturing sector — plant closures, relocations and mergers and acquisitions will be the order of the day.

The implications are well beyond the shortage of supplies and higher prices. Regulatory compliance on the buyers’ side dictates that they buy from registered sources or plants but if the registered plants have disappeared, what do they do?

Where Do We Go From Here?

An unprecedented strategic plan is needed, both on the buyer’s and the manufacturer’s sides. We have reached uncharted territory. Never before have we had such a turbulent and uncertain situation.

Plant audits are needed and are more relevant than ever before. We now not only need to audit from the standpoints of quality control and worker safety, but we also need to sort out the manufacturers’ supply chain and their locations so as to ensure their future and longer term supply capability. In other words, we need to proactively determine if they are “sitting ducks” or survivors.

More than one or two suppliers need to be qualified if this wasn’t already part of the previous plan of the buyers. Qualifying plants in distinctively different geographical locations within China is a prudent move in case an entire industrial area is shut down, as is the case now in Lianyungang, an industrial region north of Shanghai.

Is sourcing more intensively from India an option? In the short and immediate term, it is not really an option as the Indian manufacturers are not backward integrated to the needed raw materials and intermediates. Having said that, many Indian manufacturers are now looking hard into production of these needed raw materials, but it will take time.

I have written and published here in Agribusiness Global, and also given a speech in China, on the potential for Chinese and Indian manufacturers to collaborate by forming production JVs within India to overcome the supply crunch. I have elaborated on some major hurdles, such as mutual cultural distrust and geopolitical rivalries that need to be overcome before we see meaningful collaboration between the two.

Conclusions

The days of once or twice a year visits by buyers to Chinese plants to engage in “ganbeis” are over.  Buyers need to now work a lot harder to source more strategically and engage in aspects of plant audits that have not been done in the past.

Major challenges going forward also entail having to be compliant with overseas regulatory requirements when buyers evaluate a new source of each registered product of theirs.

Overall, strategic planning is indeed needed from both the supplier’s and buyer’s sides.

Both sides of the trade need to be proactive and avoid being “sitting ducks.”

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