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Drug chemical makers brace as China cracks down on pollution

Companies assess the short-term chaos and long-term promise that the campaign will have on their supply chains

by Rick Mullin
February 12, 2018 | A version of this story appeared in Volume 96, Issue 7

A memo alerting an API manufacturer that one of its suppliers' plants is among those shut down in an environmental enforcement sweep in China.
Credit: C&EN/Shutterstock
Excerpt from a memo received by the Italian chemical company Amsa.

When Xi Jinping came to power in China in 2013, the ambitious new general secretary claimed he would usher in an era of stricter enforcement of pollution control. Along with his highly publicized agenda to root out corruption, Xi declared that Chinese industry would be brought into line with global standards of environmental performance, significantly reducing smog and water pollution in and near major cities.

Not that China is lacking in environmental regulations. Pursuing necessary improvements is largely a matter of enforcing laws that have long been on the books but only capriciously enforced by local, regional, and national authorities.

A major push to root out polluters more systematically began last year. Government inspectors fanned out through industrial areas, closing plants, fining companies, and in some cases jailing plant operators for air and water pollution. It is widely reported that operations at nearly 40% of Chinese factories in 30 industrial provinces have been interrupted as a result of these inspections, which began last year.

The plants involved range across industries, affecting energy production, finished product manufacturing, and essential raw materials. Among companies on edge over China’s crackdown are producers of active pharmaceutical ingredients (APIs), many of whom claim the sector is on high alert for supply chain disruption.

“This is a big story,” says Guy Villax, CEO of the Portuguese API manufacturer Hovione. “I think the impact is going to be widespread.”

Enforcement sweep

Plant closures are widespread in a Chinese government inspection program targeting polluters.

Hebei province: 69,000

Henan province: 43,000

City of Chengdu: 14,000

City of Tianjin: 9,800

Shanxi province: 6,760

City of Beijing: 6,500

Note: Closures are across all industries since April, 2017.
Source: Shanghai Horse Construction

Executives at several companies contacted by C&EN say they have been buffeted by plant shutdowns at Chinese suppliers and have had to scramble to line up alternate raw material sources or prepare to do the manufacturing themselves. Prices are also on the rise. But no companies report any serious disruptions due to supplier plant closures.

Most Western companies, in fact, view the current crackdown as having a potentially positive long-term effect—through both a cleaner environment and a consolidation of suppliers that eliminates myriad bad actors. The quality of materials from China will improve, and prices will rise, they say, making it harder for Chinese makers of raw materials and APIs to undercut European and U.S. competition.

Nor does the crackdown come as a surprise. China began tightening environmental regulations shortly after Xi took office, instituting new air pollution control laws in 2013. The laws were revised in 2015, heavily emphasizing regional control of pollution from coal and gasoline and targeting the disposal of toxic pesticides. Last year, regulatory enforcement shifted to industrial environmental compliance.

In April, the Chinese government announced the largest nationwide plant inspection in its history. A program titled “2 + 26” deployed more than 5,000 inspectors. They marched through plants in Beijing, Tianjin, and 26 smaller cities in the Beijing-Tianjin-Hebei region, checking on the implementation of pollution controls and assessing operations against regulatory standards.

“This marks the first gunshot in the battle for the blue sky,” said an English-translated document from the Ministry of Environmental Protection introducing the program.

The managing director of Indena in a crowd on the Great Wall of China.
Credit: Indena
Indena's Giavini sees a more stable Chinese industry leading to technology partnerships.

In July, the government reported the results of what it says was the seventh round of inspections under the year-long program. In a two-week sweep that month, 5,322 businesses were inspected; 1,389 of them were found out of compliance with environmental regulations. By the end of July, an eighth round targeted industries in the Beijing-Tianjin-Hebei area.

Steven E. Spardel, president of Exeris, a New Jersey-based firm that links Western chemical producers with Chinese raw material suppliers, says the heightened activity is a matter of China’s government coming to terms with 20 years of rapid industrial growth in industries such as pharmaceuticals.

“When the Chinese fine chemical business started to emerge 15 to 20 years ago, the entrepreneurs built plants without a lot of specificity as to how those plants would affect the environment or impact safety,” Spardel says. “Ten years ago, the government started to recognize this was not sustainable, and the Chinese started building industrial parks with specialized infrastructure and pooled resources.” Now the government is implementing stricter controls, Spardel says.

“The chickens are coming home to roost,” he says. “And just because you are in an industrial park does not mean you are free of scrutiny.”

While it is difficult to get a comprehensive overview of plant closures, spotty regional information is available from various local sources. Lucy Dai, a China-based project manager who works with Spardel’s firm, cites reports from two chemical industry associations—the China Agrochemical Industry Network and China Environment Network—saying that in Shandong province, south of Beijing, the government plans to shut down at least 44 industrial parks.

In Yichang in the inland Hubei province, 25 plants have been closed. According to Dai, the government plans to “clean up” all chemical plants within a kilometer of the Yangtze River.

Several API producers say they have experienced manageable interruptions resulting from the crackdown. One of them, Flamma, shared details that illustrate the uncertainty and confusion innate to operating with Chinese suppliers.

Kenneth Drew, the firm’s North American business development manager, explains that Flamma was checking up on the supplier of a halogenated thiazole that was working to remove an impurity. After Flamma was unable to reach the Wuxi-based firm, Drew and colleagues concluded that its plant had been closed for noncompliance. Later, Flamma learned that a different company in the same industrial park failed an inspection, causing authorities to close the entire park.

Flamma was preparing to manufacture the halogenated thiazole at its own plant in China when it learned that the park had reopened. Its original supplier would be able to ship material in time for Flamma to meet its obligations.

“What we are coming to see is that the government, as usual in China, has a heavy hand,” Drew says. “When they want to shut someone down, they shut everyone down.”

More broadly, he says, the current crackdown indicates that China wants to make structural changes in industrial areas. “What they are looking to do is move companies far away from water sources and densely populated areas,” he says.

Flamma’s plant, 45 minutes from the tourist town of Dalian, is not in an area being targeted in current inspections, Drew adds.

Another anecdote comes from Gabriele Rebuzzini, managing director of Amsa, an Italian API producer. He received an alert from a purchasing agent in China informing Amsa that the industrial zone in which a raw material supplier was based had been closed temporarily by the government because of waste treatment violations.

The message cites the current crackdown, adding that 144 API manufacturers in the Beijing-Tianjin-Hebei region and surrounding areas were required to close in November in addition to raw material makers that supply the drug industry.

Rebuzzini says he’s heard that over 1,000 plants were closed in Shandong province. “This means that for some of our suppliers, we’ve had to go to other sources.”

Companies have been cut off from a wide range of chemicals, he says, naming methylaminophenol as one of many drug intermediates that have been difficult to obtain. He also sees the potential for shortages of malonates and other intermediate chemicals no longer manufactured in Europe or the U.S. and primarily sourced from China.

Rebuzzini has operated in China long enough to know that companies must always be prepared to mitigate supply problems, either by maintaining emergency inventory or lining up multiple sources. With the volume of closures and the number of plants that may not reopen, raw material pricing is also a concern, he adds.

Another Italian firm, the botanical extract maker Indena, sources 5 to 10% of its plant materials from China. Managing Director Daniele Giavini says supply disruption from China is a routine concern, often having to do with natural products contaminated by synthetic chemicals such as pesticides. The current campaign, he says, has companies that are already prepared for such contingencies bracing for the threat to amplify.

But the crackdown is likely to have a dual effect, Giavini points out. “There will be some panic in the beginning but discipline and consolidation in the market in the future,” he says. Chinese companies willing to commit to the market will invest to survive. He foresees more technology transfer and business partnerships with players in a stabilized Chinese market.

Industry consultant Roger LaForce, formerly general manager of the Italian pharmaceutical chemical firm FIS, agrees that the pollution program will eventually benefit China and the drug industry as a whole, even as China loses its low-cost advantage.

LaForce points to China’s current five-year plan as well as Xi’s “Made in China 2025” initiative, both of which call for technology leadership in major industries, including pharmaceuticals. The country’s need for new technologies will present business opportunities, he says.

European API companies operating plants in China also take a long view, seeing a positive trend toward consolidation and an increasingly level competitive playing field. Built to Western standards, their plants are compliant with health, environment, and safety regulations, European executives say, and they are not worried about being shut down or fined. In the short term, some chaos may be expected, but chaos has been expected for quite some time.

“You had to have seen it coming,” says Rudolf Hanko, CEO of Siegfried, a Swiss API maker that operates a three-year-old raw material manufacturing facility in Nantong. “If someone you are dealing with is running a sewage treatment plant on the surface, but you see underneath polluted water going into the Yangtze River, you can say, ‘I don’t care.’ But you must have it in your books that one day or another the story will end.”

The environmental crackdown coupled with Xi’s anticorruption campaign marks an inevitable change for the country, Hanko says. “China is waking up to a culture of compliance.”

Two plant workers adjust a reactor vessel at an active pharmaceutical ingredients factory in China.
Credit: Siegfried
Siegfried, a Swiss API manufacturer, says it's not concerned about the Chinese enforcement blitz resulting in interruptions at its plant in Nantong.

Villax at Hovione, one of the first European API makers with a plant in China, predicts that the new inspection regimen will accelerate a migration of business back to the West as environmental compliance increases the cost of operating in China.

“European companies that operated properly went out of business because they couldn’t compete with noncompliant China,” he says. “Now the pendulum is swinging back.”

But the swing will not be painless. “Right now, there is a tremendous clampdown,” Villax says. “They are literally closing down plants without asking questions or worrying about the impact or implications.”

The hit to supply chains could be severe, he says, noting that most Indian pharmaceutical suppliers source their raw materials from China. Indeed, nearly everything made by the drug industry has roots in the sprawling, nebulous Chinese chemical sector.

Villax is also concerned that the focus on environmental compliance may be part of a larger campaign by the government to move industry out of particular regions, as it did before the 2008 Beijing Olympics. But Villax says he is not overly concerned that raw material supply interruptions due to Xi’s campaign will hobble Hovione.

“If we had our business damaged because of this kind of thing, my purchasing guy would be in huge trouble,” he says. “He has the job of making sure we have more than one source.”

With reporting by Jean-Francois Tremblay.


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