US embassy cable - 05TAIPEI3122

C O N F I D E N T I A L SECTION 01 OF 04 TAIPEI 003122 
 
SIPDIS 
 
DEPT FOR EAP/TC 
PLEASE PASS AIT/W 
 
E.O. 12958: DECL: 07/22/2015 
TAGS: ECON, EINV, ETRD, EPET, CH, TW, Cross Strait Economics 
SUBJECT: TAIWAN PETROCHEMICAL INDUSTRY EAGER TO GET 
"CRACKING" IN PRC 
 
REF: A. TAIPEI 2601 
     B. TAIPEI 3100 
 
Classified By: AIT Director Douglas H. Paal, Reason 1.5 d 
 
Summary 
------- 
 
1. (C) Taiwan's petrochemical industry is increasingly 
focused on cross-Strait trade and investment, with exports 
to the PRC accounting for up to 50 percent of total 
output.  However, Taiwan's prohibition against investment 
in the PRC in naptha crackers is holding back even more 
high-value upstream investment.  The Taiwan government has 
been considering liberalization of naptha cracker 
investment for some time, but the large amounts of capital 
required for such investment could make it a contentious 
political issue.  Nevertheless, some Taiwan petrochemical 
firms are proceeding to develop investment plans, including 
Formosa Plastics Corp.'s plan for a USD 5 billion complex 
at Ningbo.  State-owned Chinese Petroleum Corp., on the 
other hand, plans to supply Mainland customers from a 
proposed USD 11 billion facility in Yunlin County, Taiwan. 
Further delay in liberalization could impede Taiwan firms' 
ability to enter the PRC market and give other foreign 
firms a strong advantage there.  In addition, some industry 
executives fear that PRC trade policy as well as Taiwan 
environmental concerns could inhibit Taiwan firms from 
expanding exports to the PRC.  As in other cases, the DPP 
government is letting politics interfere with economic 
policies that would help Taiwan industry.  In the process, 
it may be aiding KMT efforts to portray it as a party that 
doesn't understand business.  End summary. 
 
 
Heavy Dependence on PRC Market 
------------------------------ 
 
2. (SBU) Taiwan's petrochemical industry is increasingly 
focused on cross-Strait trade and investment.  According 
to data from Taiwan's Industrial Technology Research 
Institute, 64 percent of commodity polymers -- 
acrylonitrile butadiene styrene (ABS), polyvinyl chloride 
(PVC), polypropylene (PP), polyethylene (PE), and 
polystyrene (PS) -- produced in Taiwan are exported.  Of 
those exports 85 percent are destined for the PRC.  Sidney 
Chow, Chairman of the Petrochemical Industry Association 
of Taiwan (PIAT), estimated that of Taiwan's total 
petrochemical industry output, nearly half is exported to 
the PRC.  Petrochemicals form a key component of overall 
cross-Strait trade.  Taiwan trade statistics show that 
organic chemicals accounted for 9 percent of Taiwan's total 
exports to the PRC in the first four months of 2005. 
 
3. (SBU) Petrochemicals industry investment in the PRC is 
also growing.  Taiwan investment data indicate that Taiwan 
chemical manufacturing firms were approved to invest USD 62 
million in the PRC during the first half of 2005. This 
represented more than 6 percent of all Taiwan investment in 
the PRC during the period, and made chemical manufacturing 
the fourth highest industry category.  According to data 
compiled by Taiwan's Chinese Petroleum Corporation (CPC), 
at least 20 Taiwan petrochemical firms have invested in at 
least 32 different projects, primarily downstream 
manufacturing facilities, in the PRC. 
 
Naptha Cracker Domino Effect 
---------------------------- 
 
4. (U) Nevertheless, Taiwan government restrictions on 
petrochemical investment in the PRC, specifically the 
prohibition against investment in naptha crackers, are 
holding back a much higher degree of cross-Strait 
integration of the industry.  Naptha crackers produce most 
of the inputs for downstream production of petrochemicals 
and are therefore a lynchpin in the entire supply chain. 
Many of the chemicals produced by naptha crackers can only 
be transported economically to downstream facilities by 
pipeline.  Because Taiwan firms cannot build naptha 
crackers in the PRC, they are limited to investing in those 
downstream facilities that use inputs that can be easily 
transported and traded. 
 
5. (SBU) Many of the Taiwan manufacturers who consume 
petrochemicals have moved their factories to the PRC, 
adding pressure for more petrochemical investment in the 
PRC farther up the supply chain.  Meanwhile, excess 
production capacity in Taiwan continues to grow.  C.T. Lee, 
President of Formosa Plastics Corp. (FPC), commented to 
AIT/T that Taiwan's current situation of exporting nearly 
half of petrochemical output to the PRC is not an 
economically sound strategy for the industry.  He pointed 
out that the U.S., for example, exports less than 
15 percent of petrochemical output. 
 
6. (C) Taiwan's petrochemical firms have been active in 
lobbying the Taiwan government to drop the restriction on 
naptha cracker investment, and the government has been 
considering liberalization for at least four years. 
According to Mainland Affairs Council (MAC) Economics 
Department Director Fu Don-cheng, naptha cracker investment 
has not yet been approved because of the amount of capital 
required for such investment.  Taiwan National Security 
Council Senior Advisor Chen Chung-shin further explained to 
AIT/T that because any investment in a naptha cracker 
facility in the Mainland would be so large, approval of 
this category had important political implications.  Chen 
argued that if the Democratic Progressive Party government 
were to liberalize naptha cracker investment it would be 
more vulnerable to criticism from those factions within its 
Pan-Green alliance that seek to slow the growth of 
cross-Strait economic ties. 
 
7. (C) An economically viable naptha cracker facility would 
require capital investment in excess of USD 1 billion. 
Recent naptha cracker investments in the PRC have ranged 
from USD 2.7 billion for a BP-Sinopec joint venture in 
Shanghai to USD 4 billion for a Shell-Chinese National 
Offshore Oil Co. (CNOOC) joint venture at Daya Bay, 
Guangdong, according to PIAT's Chow.  However, industry 
executives are quick to point out that the amount of 
capital that Taiwan petrochemicals firms would have to 
provide would only be a fraction of the total cost.  Chow 
estimates that international and PRC financial institutions 
would provide 30 to 40 percent of the investment capital 
and a PRC joint venture partner would provide up to half of 
the remaining portion. 
 
8. (C) Taiwan policymakers might also fear that opening 
naptha cracker investment will cause the petrochemical 
industry in Taiwan to "hollow-out."  Tsao Minh, Vice 
President of CPC, speculated to AIT/T that if naptha 
cracker investment in the PRC were liberalized, the 
petrochemical industry would abandon Taiwan and move nearly 
all production to the Mainland.  However, Taiwan firms 
currently appear committed to continuing high levels of 
production in Taiwan.  CPC has plans for a major new 
facility in Yunlin County, and FPC initiated in 2004 the 
fourth expansion phase of its USD 19 billion facility also 
in Yunlin. 
 
Industry Investment Plans Already in Development 
--------------------------------------------- --- 
 
9. (C) In anticipation of pending liberalization, Taiwan 
petrochemical firms are proceeding with the development of 
naptha cracker investment plans.  Chow's firm, USI Group, 
has been in discussions with Sinopec about possible naptha 
cracker joint venture options.  FPC's Lee described more 
advanced plans to AIT/T.  His firm plans to invest in a USD 
5 billion complex in Ningbo.  According to Lee, FPC would 
provide one third of the capital and two thirds would come 
from Mainland and international banks.  FPC also plans to 
list the new venture to further reduce its own risk in the 
project. 
 
10. (C) CPC's Tsao told AIT/T that because his firm is a 
state-owned enterprise it has abandoned plans to invest in 
the Mainland.  It had developed a plan for building a 
naptha cracker facility in Zhenhai, Zhejiang Province, 
which was rejected by government authorities.  Instead the 
firm plans to take advantage of growth in PRC petrochemical 
demand with its new petrochemical facility in Yunlin 
County.  The complex will include a refinery, naptha 
cracker and downstream production facilities and will cost 
more than USD 11 billion to build.  He argued that 
inexpensive transportation costs will make the Yunlin 
facility on Taiwan's west coast very competitive in serving 
the PRC market.  Although CPC currently exports only a very 
small portion of its petrochemical output, Tsao said that 
the firm expects to export up to 85 percent of the output 
of the Yunlin plant to the PRC. 
 
Further Delays, More Consequences 
--------------------------------- 
 
11. (U) Further delay in approval of naptha cracker 
investment in the PRC will have a serious impact on the 
ability of Taiwan's petrochemical industry to continue to 
grow.  "Petrochemical Industry," a Taiwan trade journal, 
reports that the PRC's 11th Five-Year Plan starting in 2006 
includes a quota for constructing no more than five new 
naptha crackers.  The report indicates that four crackers 
have already been proposed and Taiwan firms will have to 
vie for the remaining quota.  It suggests that if Taiwan 
firms are unable to compete for the quota soon, they may 
have to wait until the next five-year plan in 2011. 
 
12. (C) PIAT's Chow emphasized that Taiwan firms are being 
left behind while other foreign petrochemical companies are 
expanding in the PRC.  In addition to the BP and Shell 
projects, Chow also noted a USD 3 billion BASF-Sinopec 
joint venture in Nanjing and an ExxonMobil project in 
Fujian.  He underscored the advantages Taiwan firms have 
over other foreign firms in the Mainland, due to its 
geographic and cultural proximity. 
 
13. (C) FPC's Lee pointed out potential difficulties should 
Taiwan petrochemicals be forced to continue serving the 
Mainland market primarily through exports.  He speculated 
that because the PRC currently imports 40 percent of its 
energy needs, it may choose at some point to restrict 
petroleum and petrochemical imports.  He also fears that 
because such a high portion of Taiwan's petrochemical 
output is exported to the Mainland, the PRC may threaten to 
impose anti-dumping duties. 
 
14. (C) CPC's strategy of supplying the PRC market from 
expanded production in Taiwan is not without pitfalls. 
Plans for the Yunlin petrochemical facility have met fierce 
opposition from some environmental groups (as reported ref 
A).  After initially receiving approval for the project 
from the Executive Yuan, CPC has had to perform additional 
environmental studies.  Tsao told AIT/T that he now expects 
the Taiwan government to wait until after local elections 
scheduled for December 3 to give final approval for the 
project.  In addition, further expansion of the 
petrochemical industry in Taiwan may be constrained by 
Taiwan's efforts to comply with Kyoto Protocol emissions 
standards. 
 
Comment 
------- 
 
15. (U) The petrochemical industry is an example of 
profound cross-Strait economic ties that vary from the well 
known model of Taiwan firms building labor-intensive 
assembly plants in the Mainland to produce consumer goods 
for export to the U.S., Japan and Europe.  The industry 
relies heavily on demand from the Mainland market and is 
eager to invest large amounts of capital in upstream 
production.  There is already substantial cross-Strait 
integration within the industry that will only become more 
profound when and if Taiwan relaxes investment 
restrictions. 
 
16. (C) It also provides another example of Taiwan domestic 
politics interfering with economic policies that would 
allow Taiwan firms to further capitalize on the PRC's 
remarkable economic growth.  When explaining the Chen Shui- 
bian administration's reluctance to move forward with 
cross-Strait economic initiatives at this time, the NSC's 
Chen explained that the PRC and Taiwan's opposition 
Kuomintang (KMT) Party are cooperating with each other in 
an effort to portray the ruling DPP as unable to manage 
economic issues (reported ref B).  He claimed that the DPP 
government could not proceed with cross-Strait 
liberalization at a time when it would be perceived to be 
yielding to pressure created by KMT cross-Strait economic 
initiatives.  When discussing the naptha cracker investment 
issue, both PIAT's Chow and FPC's Lee were quick to 
criticize the DPP government and described its leadership 
as being ignorant about business.  If the DPP government 
continues to delay naptha cracker liberalization as well as 
other cross-Strait economic initiatives, it may only 
strengthen an image of incompetence that it accuses the KMT 
of trying to create.  End comment. 
PAAL