Chemical Sector Finding Ways to Face Challenges

Covestro

The Covestro factory in Noginsk

The devaluation of the ruble has practically stopped the development of the Russian chemical sector — in which Germany has invested heavily — but companies are still hoping for the best in the long term.

In August, the political tensions between Russia and the West finally reached into the chemical sector. Russia's Federal Service for Oversight of Consumer Protection and Welfare declared a number of household cleaning products unsafe for use in Russian homes. The service has made claims against American, Turkish, German and Russian manufacturers.

In Russia, it is customarily understood that allegations by such watchdogs more often reflect political struggles than a drive for higher quality standards. Germany is heavily invested in the Russian chemical sector, but German firms have kept a meticulously clean name.

"We are currently speaking clearly and directly with the Russian government and requesting they review and cancel their decision in short order," said Rainer Seele, president of the Russian-German Chamber of Commerce, in a statement. "It is highly improbable that enterprises that manufacture their products in hundreds of countries worldwide somehow do not observe toxicity safety requirements specifically in their Russian operations."

The issue died down as quickly and unaccountably as it flared up, but German businesses operating in the sector continue to face challenges. While the political situation has undoubtedly been a challenge, the devaluation of the ruble has been at least as significant a factor.

A recent report from the Russian-German Chamber of Commerce showed that 80 percent of surveyed companies found the drop in the ruble exchange rate to be the most challenging issue for their businesses in Russia. Other major concerns include weak market activity and lagging confidence in market development. A significant share of the primary goods required for the chemical manufacturing process is purchased from abroad, which drives up the production and final product costs.

"More than a half of Russia's chemical sector is dependent on imports. Certainly, owing to the drop in the ruble, all imported products have become more expensive, and to shift these costs onto consumers is not possible for a majority of firms. The situation changes in different industries. The most difficult situation is in the automotive industry. Sales in the first half of the year fell by 42 percent in comparison with the previous year," said Muzaffer Ünver, managing director for Covestro, a leading manufacturer of polymer materials. Since Sept. 1, it has been a part of pharmaceutical giant Bayer.

The situation is also difficult in the oil and gas chemical sectors, and here smaller firms are really feeling the pinch. "Large engineering firms, including giants such as BASF or Linde Engineering, have multiyear contracts with Russian companies, which they need to maintain. At the same time, the largest companies have the ability to speak with the Chancellor, and to adapt to the political situation. The stress to the small and medium size German business sector has been more significant and immediate," says Fares Kilzie, head of the Creon Energy consulting firm. "This relates not only to falling demand in Russia, but also with the inability to find financing. Due to sanctions, the European market for credit is restricted. Russian banks offer credit at rates that make investments uneconomical. Development is possible only if the company invests its own capital, and this is a very rare event."

The chemical sector is also affected by problems in other segments of the Russian economy. The car production and construction industries, which are core markets for polymer producers, are both facing significant downturns and demand has also fallen in the consumer market.

Some manufacturers have begun to focus their manufacturing on exports. For example, in June, the Continental automotive manufacturing firm said that its Kaluga-based plant would begin supplying tires to Finland. In September, the company further announced that deliveries would be made "to several European and Asian countries."

"In the current economic situation, the instability of the Russian tire market and ongoing developments in the exchange rate favor the export of Russia-made goods. It has become economically viable for the group to produce tires in Russia and supply them for export," said George Rotova, general director for Continental Kaluga.

According to customs statistics, in the first half of 2015, exports of plastics and items made from plastic increased by 15.4 percent. For rubber-based goods and resins, the increase is 22.8 percent. "German suppliers may also earn on the production mineral fertilizer," noted Fares Kilzie. "All major Russian producers of fertilizers, such as EuroChem or URALCHEM, are exporting their products at reduced prices because of the devalued ruble and low gas prices. At the same time, these companies have the funds to buy the equipment and polymer-based raw materials in Germany."

There are growth opportunities for German companies that have already thoroughly localized in Russia and found local suppliers for primary materials. Andrew Beloyedov, executive director for sales and marketing at REHAU Eastern Europe, says that sales of window frames have dropped. Nevertheless, the company is considering building a second plant in Russia that will produce windows, piping systems and furniture fittings.

Beloyedov gives the material PVC, which his company uses in window frames, as an example. "There are no problems with the PVC itself. However, local vendors cover the basic needs of the market. At the same time, the production systems for frames require other components, such as stabilizers and various fillers and dyes. All of these components are for the most part imported. We have the ability to import them from India or China, but we still pay import prices. For all the talk of import substitution — it is first and foremost a political campaign. In reality, we are still very dependent on raw materials, and this applies to not only the construction industry."

Muzaffer Ünver from Covestro said that it's impossible to make any kind of assessment of profits given the current situation, but that he remains positive about the Russian market overall. "Demand is fluctuating greatly and this reduces the number of long-term contracts. In Russia, in many industries, consumption per capita is far behind the global average. A clear example is with under-utilization of polymers. Therefore, in the medium term, I still see positive developments for our industry. Apart from the interest and confidence in the market by any investors, much also depends on how the government tries to improve the investment climate in the chemical industry."


Russia - Germany 2015
Russia - Germany 2015
Despite the difficult political climate and economic downturn, German companies remain committed to Russia. Read about the challenges facing them, as well as success stories in this supplement.
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