INSIGHT: China slowdown will hit polymers hard

10 March 2008 16:33  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)--An avalanche of new polyolefins capacity is about to start-up just as the vital China market turns bearish.

More than 6m tonnes/year of polypropylene (PP) capacity is due on stream between the first quarter of 2008 and the first half of 2009 in the Middle East and Asia alone.

The global PP market totalled 49m tonnes in 2007 with demand growth likely to be 5-6% this year, said an industry source. This would amount to 2.45-2.94m tonnes of extra demand.

Polyethylene (PE) start-ups are less in number this year and in early 2009 than PP.

“The global market for PE was 75m tonnes last year and we expect it to grow by 4-4.5% this year,” added the first industry source.

This would work out at 3-3.375m tonnes of extra demand with as much as 15m tonnes/year of new capacity due on stream over the next three years, he added.

PP exporters to China are in a particularly sombre mood because of market-specific and macro-economic problems.

Only 229,000 tonnes of PP was imported into China in January this year. This was 20% down on the same month in 2007, according to China Customs.

The fear is that this could represent the beginning of the long-delayed downturn – made worse by lots of new capacity, but also by rising inflation and labour costs and a continuation of government efforts to change the structure of manufacturing industry.

But import statistics can be misleading. At the end of 2006, there was a big build-up in US PP inventories in anticipation of a repeat of the Hurricane Katrina disaster.

That didn’t happen and so the surplus PP was shifted to China, resulting in US-China PP imports rising to 290,000 tonnes last year over 195,000 tonnes in 2006, according to the source.

Buyers were also busy stocking up on inventory throughout 2007 in anticipation of further price rises.

“Sentiment has changed because the buyers know there is a lot of capacity on the way, they have high inventories in hand, and so they are only purchasing minimum quantities,” the industry source added.

Assessing inventory is always a problem in China. Big dips and rises in shipments occur even when the fundamentals of demand are exceptionally strong.

“There is a huge floating inventory issue comprising product already in storage with the converters, shipments at sea and contracts executed for future delivery,” he said.

“What can happen is that you get 2-3 months of sub-par imports when inventories are high.”

Total Chinese demand is 800-850,000 tonnes/month with average imports at 250,000 tonnes/month.

The below-average January shipments have led to an increased search for alternative markets.

Despite the much-heralded emergence of alternative destinations such as Vietnam, which has no domestic PP or PE production, other markets are miniscule in comparison.

Vietnam imported around 500,000 tonnes of PP last year with demand growth at 15%, according to one industry estimate.

This represents 75,000 tonnes of extra demand – or 6,250 tonnes/month.

“If China PP imports slump by 50,000 tonnes in any one month you have to find as many as ten alternative markets to make up this volume,” said the source.

This is presuming producers haven’t already anticipated problems and cut back on operating rates.

Buyers are further benefiting from the recent ramp-up in Chinese PP production. Local output grew by 19% to 7.71m tonnes in 2007, said the source.

Around 1.6m tonnes/year of capacity came on stream in 2006-07 with most of the impact felt last year.

Total PP imports for 2007 fared well despite the surge in local production. China Customs said that 3.02m tonnes were imported last year compared with 2.91m tonnes in 2006.

Demand grew at a breakneck pace of 14.6% on both the inventory build-up and the strong global economy, he added.

This is where another problem lies: the global economy is slowing down, particularly in the West, leading to a dip in China’s export-trade growth.

The re-export of finished goods from imported polymers is vital to overseas suppliers.

The Chinese government might make further cuts to export-tax credits that were introduced in June and July last year – making it much less economic to buy imported polymers.

A radical overhaul of the VAT rebate system took place in June, affecting those who buy raw material priced in Yuan, whether locally or from overseas via traders.

Rebates were cut on a wide range of chemicals and finished goods.

The following month saw an increase in the number of businesses that have to put money on deposit before they can claim VAT and import duties back on US-dollar priced imported raw materials.

Both measures have led to widespread factory closures of low-end manufacturers in oversupplied industries, whose only margins were often the tax rebates themselves.

“It’s not a question of whether there will be more cuts in the export-tax credits, it’s a question of when,” said Arthur Kroeber, managing director of the Beijing-based economic research and advisory service, Dragonomics.

“If the global economic picture worsens and export growth suffers a sharp decline, the government might go slow on further changes.

“If not we could see some more cuts this year; either way it’s bad news for anybody exporting raw materials to China..”

The government has set course on changing the growth model away from mass-manufacturing of cheap goods.

Previously booming sectors such as plastic products and garments are bearing the brunt of the changes as government support switches to industries with a lower labour and higher technology component.

Another motive for industry reform is the environment. This is one of Beijing’s top priorities and it is the low-end manufacturers who often employ outdated, dirty technologies and are energy inefficient.

The problem for the overseas polymer industry is that a lot of existing and future commodity grade production has been planned on the assumption that cheap manufacturing for exports will remain a big part of Chinas economy.

Perhaps in the long run this may be the case as western China develops, but this will involve longer supply chains that will surely favour local producers.

Domestic demand in China has huge potential, but this might again be increasingly met by local capacity.

A new labour law, introduced earlier this year, is yet another burden for labour-intensive industries.

A higher number of employees have to be given permanent contracts, resulting in pension and other social costs that can be 100% of existing salary bills.

Limits on overtime have also led to demands for higher pay.

Labour supply is also much tighter in provinces such as Guangdong, the heart of China’s low-end manufacturing sector. The Chinese Academy of Social Sciences issued a report last year, predicting that 2009 would mark the turning point of a nationwide switch from a labour surplus to a shortage.

There are two further inter-related problems for manufacturers – inflation and the appreciation of the Yuan.

Inflation soared to an 11-year-high of 7.1% in January as food prices went through the roof on global supply problems and the Lunar New Year bad weather.

Expectations of further price rises could create an inflationary spiral, warn economists.

The government has set an aggressive inflation target of approximately 4.8% for 2008.

Kroeber predicts that this could lead to 3-4 further interest-rate increases this year.

He warned that if the rate rises don’t work, the government might resort to administrative measures which would make it less profitable for banks to lend money.

The appreciation of the Yuan has been used both as a means of controlling inflation and as a way of easing trade tensions with the US. China’s currency increased in value against the dollar by 4.2% in the second half of last year and by a further 2.8% up until earlier this month.

Press reports have since indicated that the rise against the dollar may slow down or could even be brought to a halt. China might instead favour appreciation against the Euro to ease trade tensions with the European Union.

If you add higher labour costs, inflation and currency appreciation together, exporters are seeing their competitiveness eroded by as much as 15% per year, said Kroeber.

PE is also a victim of the ban on plastic bags of less than 25 microns in thickness.

Although the ban doesn’t come into force until June this year, factories are already shutting down because orders from retailers are placed 3-5 months in advance.

Ninety per cent of shopping-bad production is expected to be affected by the policy, resulting in a 5% reduction in PE consumption – or 600,000 tonnes/year.

The motive behind the ban is to reduce litter with a particular eye, say cynics, on making the right international impression during this summer’s Beijing Olympics.

Numerous start-up delays and robust global economic growth have kept markets strong for a lot longer than had been expected.

But global growth is slowing and China has embarked on a different growth course that will make importing polymers for re-export as finished goods a lot more challenging.

This is all happening at the worst possible time for the polyolefins industry - as the biggest wave of capacity in its history is brought on stream.

By: John Richardson
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