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Germany: Recovery Slows for Europe’s Growth Engine
8:19 AM MST | November 21, 2011 | By IAN YOUNG
Germany’s chemical industry, the biggest in Europe and fourth biggest worldwide in sales terms, made a dramatic recovery from the recession of 2008-09 and posted extremely strong results in 2010 and early 2011. The rebound was driven by Germany’s prowess as an exporter of a wide range of manufactured products, not just chemicals. However, the upturn ground to a halt in mid-2011 due to stalling global economic growth and mounting concerns over the eurozone sovereign debt crisis. Industry executives and analysts are cautiously optimistic that the German chemical industry can ride out the current turbulence and achieve record sales in 2011 followed by growth, albeit at a much lower rate, in 2012.
Chemicals are the third-biggest industrial sector in Germany and chemical manufacturing in the country generated revenues of about €171 billion ($235 billion) in 2010, industry association VCI (Frankfurt) says. The chemical industry is firmly embedded in the German economy, making it highly responsive to customers’ changing needs, VCI president and Evonik Industries chairman Klaus Engel tells CW. “Ours is a key industry in Germany,” Engel says. “The chemical industry works hand in hand with practically all other sectors. It is also a major employer with more than 423,000 staff.” VCI represents about 1,650 German chemical companies and German subsidiaries of overseas firms, accounting for more than 90% of the industry.
Germany’s chemical industry hit a peak in the first three months of 2011, achieving record quarterly output volumes. Unexpectedly strong production growth of 3.2% compared with the previous quarter and average plant utilization of 87% prompted VCI to raise its full-year 2011 output growth forecast for the German chemical sector from 2.5%, to 5%.
But the rebound had come to a standstill by the second quarter of this year as the global economy started to cool, and the recovery went into reverse in the third quarter. Chemicals output decreased 2% between July and September compared with the previous three-month period, although production levels were still 2.5% higher than in the third quarter of 2010. The decline reflects destocking by customers as a result of the economic slowdown, and anxiety and uncertainty over the eurozone debt crisis, VCI says. Sales by the German chemical industry also slipped 1% in the third quarter, to €44.5 billion compared with the previous quarter.
The slowdown has been complicated by rising raw material costs that are undermining profitability across the chemical industry worldwide, analysts say. “After the roller-coaster ride of the past three years, it is safe to say that the first signs of softening in the market are causing a few jitters,” says Vir Lakshman, partner and head of chemicals/Germany at KPMG (Düsseldorf). “The first two quarters of 2011 saw prices recover rapidly. However, rising costs, in particular for raw materials and energy, are proving difficult to contain and are eating into margins.”
The recent slowdown does not, however, overshadow the German chemical industry’s exceptional achievement in pulling itself rapidly out of the last recession. The increase in output in the first three months of 2011, the industry’s eighth consecutive quarter of rising production, was the culmination of a “breathtaking catching-up process,” Engel says. Germany’s 11% annual increase in chemicals output in 2010 was the industry’s strongest growth rate since 1976. The industry also outperformed the German economy, which expanded 3.6% last year.
The recovery would not have been possible without an upturn in the global economy, especially emerging markets. But the German chemical industry also has specific strengths that positioned it to take quick advantage of the upturn. The foundations of these strengths have been laid over a period of years.
Close collaboration between German chemical manufacturers and their customers is a critical strength, Engel says. “Germany’s strong industrial landscape is essentially the backbone of our success,” he says. “The automotive, mechanical-engineering, electronics, and metal industries all are globally renowned. The chemical industry is a decisive element in the value chains of these and many other sectors, with its innovative materials and specific solutions acting as a driving force for new product lines and processes in other fields of industry. This cross-pollination gives us a competitive edge on world markets.” The country’s network of chemical parks and the widely employed principle of integrated chemical production, typified by BASF’s Verbund concept, are additional structural advantages.
The close partnership between the German chemical industry and its customers is underpinned by intensive levels of R&D activity, industry executives say. “The most valuable assets of Germany’s chemical industry have always been its experts, specialists, and researchers,” Lanxess chairman Axel Heitmann tells CW. “I like to say that we don’t have the raw materials, but the best brains. It is this focus on innovation and technology that has put the German chemical industry in leading positions in many attractive markets worldwide.”
German chemical companies cut capital expenditure during the crisis but the industry left R&D spending largely untouched. Capital investment by Germany’s chemical sector fell 14% in 2009, to €6.1 billion, but R&D spending increased more than 8% during the same year. VCI says R&D investment rose by a further 4% in 2010, to almost €10 billion. “Our core competencies have always been and will always be research, development, and technology,” Heitmann says. “We have continuously strengthened those skills in recent years.” Lanxess is increasing its R&D spending 15% this year, to about €130 million, with 80% allocated to Germany, he says. Separately Altana (Wesel, Germany), a leading specialty chemicals producer, says it continued to spend 5%-6% of its sales on R&D, much higher than the industry average, throughout the last recession.
Decisive action by German chemical companies to address the 2008-09 crisis also enabled them to recover swiftly to full production when worldwide economic growth resumed, analysts say. “German chemical companies took a very measured approach to the economic crisis,” Lakshman says. “They retained their workforce by offering part-time working arrangements and were in a position to ramp up quickly once markets began to recover. The ability to supply their customers in the automotive, pharmaceutical, and other consumer sectors stood them in good stead as spending increased on the way out of the crisis. German companies are also ideally located to get their products out to customers in the growing markets of Central and Eastern Europe.”
BASF introduced part-time working, on a temporary basis, for about 1,000 employees across 20 plants at the Ludwigshafen complex from mid-2009. Employees’ working hours were cut by 20%-100% for up to four months and their wages reduced by about 10% during this period. Bayer MaterialScience introduced part-time working for about 1,500 workers across sites in Germany, including Leverkusen, between February and November 2009 and cut their pay temporarily by about 6.7%. BASF, Bayer, Merck KGaA, and many other firms also idled plants or cut operating rates substantially in 2009.
Lanxess “used the last crisis to set up its plants in Germany more efficiently through flexible asset management,” Heitmann says. The company has spent about €600 million since 2008 to modernize and expand its German sites.
The effectiveness of these measures, together with the German chemical industry’s long-term competitive strengths, yielded a stunning performance by German chemical producers in export markets last year. Chemical exports—comprising foreign sales by German chemical companies as well as re-exports and chemical exports by third parties—jumped 17%, to €143.8 billion in 2010. The result confirms Germany’s status as “the export world champion for chemical products,” ahead of the U.S. chemical industry with overseas sales in 2010 of €129 billion and Belgium with chemical exports last year of €97 billion, according to a recently published VCI study. German chemical exports increased by a further 10% year on year in the first half of 2011, to €77 billion, extending Germany’s lead over the U.S., VCI says.
The German chemical industry “has always been very much export focused,” says Christof Bachmair, senior manager at Wacker Chemie. “In 2010, Germany-headquartered chemical companies generated about 60% of their total sales on international markets. For Wacker, the share of sales generated with customers outside Germany was even higher—more than 80% in 2010. This substantial exposure to international markets requires a strong focus on competitiveness. Innovation, high-quality products, high productivity, and the lowest possible manufacturing costs have been top priorities with the German chemical industry for decades.”
Germany’s chemical trade surplus was €43 billion last year with the chemical industry accounting for about one-quarter of the country’s overall positive trade balance. The biggest increases were in exports to emerging markets but German chemical companies also increased their sales to other European countries (chart, p. 29).
Investment in enhanced competitiveness is set to continue in Germany’s chemical sector. BASF’s management and employee representatives agreed in late 2010 on a €9 billion-€10 billion investment by 2015 to ensure “the future viability” of the Ludwigshafen site. The program includes €1.15 billion-€1.25 billion/year for investments, modernization, and maintenance measures. Ludwigshafen is the world’s biggest chemical manufacturing complex. “We are constantly developing the Ludwigshafen site so that it is always state of the art and remains successful in international competition,” says Ludwigshafen site manager Bernhard Nick. “In addition to investments in production, this involves modernization and targeted development of structural infrastructure.”
The German chemical industry, meanwhile, is keeping a close eye on customers’ short-term buying patterns as an indication of whether destocking in the third quarter of 2011 has continued into the fourth quarter. “Turbulence in financial markets and uncertainty triggered by the debt crises in the U.S. and Europe reached the German chemical industry in the third quarter,” says VCI chief economist Henrik Meincke. “Many industrial customers, irrespective of their own full order books, reduced their existing stocks as a precaution and ordered fewer chemicals. Chemical companies responded fast to the slower demand by cutting production. They accepted lower sales volumes, to stabilize prices and earnings.”
VCI nevertheless has maintained its forecast for 5% growth in chemical production in Germany in full-year 2011, and a 10% increase in industry sales to exceed the previous record of €180 billion, based largely on the sector’s strong performance in the first half of the year. It expects inventory depletion to come to an end in the fourth quarter and says there are still positive signs from downstream industries. “The automotive and mechanical-engineering industries once more visibly expanded production in the third quarter so demand for chemicals remains high,” Meincke says.
German companies face a difficult few quarters but their resilience, based largely on the actions taken in 2008-09, provides grounds for optimism, analysts say. “Volumes are being hit, with growth rates slowing in key markets such as China,” Lakshman says. “The eurozone debt crisis is likely to have a knock-on effect on consumer demand, which will depress volumes further. But although the outlook for the next two quarters is somewhat downbeat, German chemical companies have got their houses in order and are well positioned to navigate through turbulent waters.”
Lanxess sees a “normal seasonal softening” in the fourth quarter, Heitmann says. “Demand is weaker in the construction and electronics industries, and tires and agricultural chemicals remain stable,” he says.
Weaker business trends and the resultant decline in momentum are slowing demand for Wacker’s products and affecting customer ordering patterns, Bachmair says. “For the fourth quarter, we anticipate substantially lower sales volumes and revenues,” he says.
Trends in the chemical industry, such a critical component of supply chains throughout Germany’s manufacturing sector, tend to mirror developments in the wider economy. The German economy also made a strong recovery between mid-2009 and early 2011, fully recouping a 7% cumulative decline sustained in the wake of the 2008-09 crisis in financial markets and the collapse of Lehman Brothers bank. Germany outperformed most of its European peers during this period. “It reflected, in part, Germany’s ability—as a traditionally strong exporter, notably of investment goods required by emerging markets, which were growing again strongly—to profit from mid-2009 from the rebound in the global economy,” says Timo Klein, senior economist/Europe and CIS economies at IHS Global Insight (Frankfurt).
Three additional Germany-specific factors played an important role, including the part-time working practices that were employed so effectively in the chemical industry, Klein says. “The German government reacted not only with fiscal stimulus packages to the crisis of 2008 but also with a major extension of existing short-time work schemes,” he says. “This meant that companies were able to hold onto most of their workforce despite a massive drop in demand in late 2008 and early 2009. As the recovery in orders took hold in about mid-2009, firms simply expanded the number of working hours again and were able, unlike many of their foreign competitors, to react very rapidly to the rebound in demand.”
Structural reforms taken from about 2003 by government and industry also bore fruit during the recovery of 2009-10. “The reforms increased labor market flexibility and boosted employment levels, for instance through wage agreements in key industrial sectors with annual work-time accounts, allowing firms to adapt flexibly to shifts in demand without raising their overall wage costs,” Klein says.
Most importantly, perhaps, Germany has profited increasingly since the introduction of the euro in 1999 from an “ongoing loss of price competitiveness in other eurozone economies, notably in peripheral countries that initially enjoyed consumer-led and construction-led booms due to historically low interest rates,” Klein says. “So inflation and especially wage costs in these countries outpaced those in Germany during this period, and German companies had to make strenuous efforts to boost productivity to offset an initial competitive disadvantage and weak domestic demand. This situation has been bolstering demand again lately, unlike during most of the past decade, so that Germany’s economy has been able to act as a growth engine.”
The German economy registered particularly strong growth of 1.3% in the first quarter of 2011, but since then the escalating sovereign debt crisis in Greece, Italy, and other eurozone economies has taken its toll. The German economy grew by just 0.3% in the second quarter compared with the previous quarter, although the slowdown was exaggerated by one-off factors such as unusually strong construction activity in the first quarter because of a mild winter. GDP growth increased to 0.5% in the third quarter of 2011 but the rebound is likely to be “short lived, reflecting the final stage of the previous recovery,” Klein says.
IHS broadly expects economic stagnation in Germany during the fourth quarter of 2011 and first quarter of 2012 with a 30% probability of a “mild slippage” into recession. “This is predominantly related to very high uncertainty about the eventual outcome of the eurozone debt crisis,” Klein says. “The recent dramatic events in Greece and Italy have raised market concerns that developments may have become uncontrollable for policy makers, with any disorderly default causing widespread bank failures. In such an environment, German business confidence and order levels would fall sharply, similar to the situation after the Lehman Brothers collapse.” Slowing growth outside the eurozone also presents “above-average risks” for the German economy, Klein says.
The outlook for Germany’s economy in 2012 nevertheless remains brighter than for the eurozone as a whole. IHS, assuming that a disorderly default of a eurozone economy will be prevented, predicts 0.8% GDP growth for Germany and just 0.1% growth in the eurozone next year. “This involves an expected renewed strengthening of economic activity from the second quarter onward,” Klein says. “Germany’s anticipated outperformance is linked to its current competitive advantages, a fairly resilient domestic economy due to a robust labor market, and the dampening effects of the debt crisis on the euro and interest rate levels.”
The outlook for Germany’s chemical industry in 2012 is similar to the overall economic outlook. The industry expects to continue generating growth next year, despite the weaker prospects. “There are more and more signs of the possibility of the global economy cooling down significantly, especially in industrial nations,” Meincke says. “But, all in all, the German chemical industry is confident that it will continue to do good business, even in a lower-growth scenario.” VCI had not issued its 2012 forecast for output and sales growth by Germany’s chemical industry, at CW press time.
German chemical companies are not expected to revert to the drastic measures they and the rest of German industry took during the 2008-09 crisis but they remain capable of doing so quickly if necessary. “German chemical companies were quick to cut production in 2008-09,” Meincke says. “They resorted to short-time work, postponed investments, and implemented cost-cutting programs while increasing their research budgets. At that time, companies were confident that they would overcome the crisis rapidly, and they were right. Should a situation arise where this becomes necessary, companies are likely to respond in very much the same way as they did back in 2008. But we believe the upward trend will last in the chemical industry and that companies will not need to go into crisis mode.”
Chemical manufacturers including Lanxess echo that view. “Currently, we are continuing on our growth strategy, but at the same time we are monitoring the economic uncertainty in the eurozone and U.S., which is leading to consumer uncertainty,” Heitmann says. “But should we need to react to any kind of economic crisis we will be able to do that as swiftly and successfully as in 2008-09.”
Wacker’s business strategy “is long-term oriented,” Bachmair says. “We are not considering plans to modify capital expenditure for our strategic growth projects to account for short-term trends. The same holds true for our R&D spending.”
German chemical companies have invested heavily in emerging countries, to capitalize on high growth in those markets. There could be a temporary cooling off in these investments next year as companies adjust to the lower-growth scenario even in key markets such as China, analysts say. “German chemical companies have invested heavily in fast-growing Asian markets,” Lakshman says. “The scale and quality of their production sites in China is testament to the seriousness of their intentions in the region. Major parts of their global businesses are now being managed directly from the region. However, the cyclicality of the chemicals industry plays havoc with even the best-laid plans. It is only expected that they will stop for breath until the outlook becomes clearer.”
Raw material costs will also have a major bearing on German chemical companies’ fortunes in 2012. “If the upswing lasts globally, raw material prices will remain high and chemical companies will be able to pass costs on to their customers because of strong demand,” Meincke says. “But if the global economy cools down more significantly, with falling raw material prices, chemical industry earnings would stabilize at lower output and sales volumes.”