INSIGHT: China polyolefins rally may be shortlived

11 April 2008 12:45  [Source: ICIS news]

By John Richardson

 

SINGAPORE (ICIS news)--Ever had that sinking feeling when you had made a prediction that looked as if it was turning out to be wrong?

 

Early last month was such an occasion when we wrote of a bleak outlook for exporters of polyolefins to China, only for a rally in pricing to occur shortly afterwards.

 

However, ICIS pricing has reported an edging down in the prices of some grades of PE over the past week.

 

For example, film grade high-density PE (HDPE) and blow moulding HDPE were notionally assessed $10-30/tonne lower at $1,570-1,640/tonne CFR (cost and freight) China/Southeast Asia.

 

Polypropylene (PP) has, however, edged up slightly by $10-20/tonne to $1,530-1,650/tonne CFR China, but buying interest was described as moderate on the slowdown in the PE market.

 

In Europe, buyers have been actively seeking, and sometimes obtaining, lower prices for April PP business on ample supply.

 

“The recent price rallies were a case of the final throw of the dice in the last-chance saloon,” said one Asian polyoefins trader.

 

“Polymer producers have been using higher monomer costs as a justification for price hikes in what amounts to a last margin grab. Everybody knows growth is slowing and the big capacity surge is on the way,” the trader added.

 

In PP, for example, 6.5m tonne/year of capacity is due on stream in the Middle East and Asia between now and the first half of 2009.

 

Some producers are even venturing as far as to predict that a severe PP capacity overhang will result in cash margins turning negative for many of the higher-cost operators.

 

Trade data consistently points to a weakening of China’s export growth.

 

Exporters of finished goods - the only ones who can often afford to buy imported polymers because of the tax advantages - are facing wage inflation, the appreciation of the yuan, high fuel costs and the US slowdown.

 

China’s ban on 0.25 micron thickness plastic shopping bags has also been weighing heavy on sentiment in the PE market.

 

There is strong anecdotal evidence of a severe squeeze on China’s lower value-added exporters.

 

“We came away from a recent field study with growing concerns over the deterioration in the exporters’ operating environment,” said Jun Ma, Deutsche Bank’s chief economist for Greater China, in a recent report.

 

The hard numbers supporting what he and his team picked up on the ground was a 13% underlying rise in exports in December 2007-February 2008 when compared with the same period in 2006-07. This compares with a 24% rise for the full-year 2007.

 

A 13% increase in exports is, by most other country’s standards, still very healthy.

 

But a lot of the polymer capacity being added in the Middle East and Asia might have been predicated on much stronger export growth.

 

The danger is that if all the new Middle East volumes cannot find a home in Asia - and this seems increasingly likely - shipments will increase to firstly Europe and secondly the US.

 

This will place yet more pressure on the European and US producers who haven’t already protected themselves by moving away from commodity-grade production.

 

Jun Ma and his team - who conducted field studies in the major exporting provinces of Guangdong and Zhejiang - picked up an alarming degree of negative sentiment.

 

A senior executive of a major apparel company in Zhejiang predicted that 50% of China’s small textile/apparel companies would go bust this year. Deutsche Bank predicts a 10-20% failure rate over the next 12 months in the low-end textile export sector.

 

A major furniture manufacturer, again in Zhejiang, said that it had been forced to lay off 2,000 workers over the last year because of “a massive decline in US orders”.

 

And a major TV manufacturer in Guangdong forecast that 10% of his smaller competitors would go bust because of their inability to pass on raw material cost increases to their customers.

 

This supports what the ICIS pricing team has been picking up from the markets: Strong buyer resistance to current polymer price levels because of an inability to pass costs down the chain.

 

“Costs keep rising, but there is no way we negotiate price rises with our US customers. Our gross margins have fallen from 20% to 10% over the past year,” said the general manager of an electric tool company in Guangdong.

 

The problem for China’s export sector is that it confronts a government effort to restructure the industrial base - along with slowing US growth, a stronger yuan, wage inflation and high fuel costs.

 

Export-tax credits for re-exporters who import raw materials were reduced last year. There was also a widening of the number of manufacturers who have to put money on deposit before reclaiming VAT on imported raw materials.

 

The government wants to reduce the volume of low-value, energy-intensive exports.

 

But Jun Ma warned: “Despite the government’s intention to engineer a shift in the industrial structure towards the higher-end of the value chain, most exporters are not prepared for such a transition. They lack capital, technology and management vision.”

 

The famously pragmatic Chinese government might reverse some its policy initiatives if the slowdown in export growth turns into a major crisis.

 

By then, though, the damage could have already been done, leaving overseas polymer producers facing a sharp slowdown in the growth of exports to China.

 

Non-integrated producers will almost certainly have to shut down, resulting in the floor for polyolefins pricing being set by the naphtha-based integrated players.

 

How bad might things get, though, not only in China but also globally?

 

The International Monetary Fund is predicting a 25% chance of a global recession - amounting to worldwide gross domestic product (GDP) growth of less than 3% in 2008 in 2009.

 

If this happened, the capacity overhang would be at an historic high - forcing even some of the fairly well-integrated naphtha or liquid-feed based producers to close down.

 

Hopefully, markets will not decline to the point where Middle East players become the price setters.

 

For the time being, this seems exceptionally unlikely and it is in nobody’s interests to let it happen.

 

But predictions so often go wrong, especially about the future.

By: John Richardson
+65 6780 4359

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