INSIGHT: The importance of fundamentals for China polyolefins

20 April 2009 15:52  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)--A polyolefins trader had a Joseph Kennedy moment the week before last.

If you recall the famous story, this was when the father of John F and Robert Kennedy was given stock tips by a shoe-shine boy, rushed out and sold his shares just in time to avoid the Wall Street Crash.

“I knew something was very wrong because a customer in Bangladesh had asked me for ten full container loads of polyethylene (PE),” said the trader, who is based in Singapore.

“It was obvious this was for speculation as there is no way demand could be strong enough in Bangladesh to justify such a big volume.”

He then received another call, this time from a Chinese chemicals trader who had never dealt in polyolefins before.

“And it showed, as he knew nothing about melt indices, the product or its applications but wanted to buy a cargo on behalf of a friend of a friend.

“I could hear the sound of the herd stampeding towards the edge of the cliff and so I liquidated all my big positions.”

It remains to be seen whether the trader will be proved right because despite a slight softening in Chinese PE and polypropylene (PP) domestic markets late last week, import prices remained unchanged.

Flat-yarn raffia grade PP prices slipped by yuan (CNY) 450/tonne ($66/tonne), for example, to CNY9,000-9,500 ex-warehouse, according to the ICIS-Chemease report.

Import prices for raffia grade remained unchanged from the week earlier at $1,020-1,070/tonne CFR China main port, according to ICIS pricing.

However, sentiment had turned bearish with buyers resisting further price hikes.

The feeling remains that the rapid run-up in PE and PP prices (see chart) is a speculative bubble.

“I cannot see how current demand can sustain the recent price hikes because converters are only running at operating rates of about 60-80%,” said a markets analyst with a major producer.

“As for feedstocks, I don’t see any evidence to support the hikes either as integrated producers have been enjoyed comfortable margins (spreads) since February.”

A source with a major European producer agreed, adding that over the past two years propylene-to-PP spreads have held up exceptionally well, even in the midst of perhaps the worst economic downturn since the 1930s.

“If you had told me two years ago that spreads would not fall below $150/tonne I would have told you that you were totally off your head. The supply and demand fundamentals pointed to much weaker conditions.”

So what’s happened to maintain profitability to the point where worries are being expressed that this could be too good to last?

Propylene has perhaps been made a little more affordable because PP producers – the biggest consumers of C3s – have increased spot over term purchases, the European polyolefins player added.

Hard-pressed acrylonitrile, phenol and propylene (PO) producers have also cut back on purchases, which have always been mainly in spot markets, he said.

A “supply-time gap” was created by big Sinopec and PetroChina refinery operating rate cut backs in the fourth quarter of last year and in the first quarter of 2009, affecting the whole of polyolefins, the market analyst added.

This caused a naphtha shortage, thereby dragging down Chinese operating rates. Higher naphtha prices were also a big factor behind the price rallies.

“Demand then recovered, but importers kept purchases low to avoid anti-dumping investigations. There was also a delay in Middle East start-ups and some unplanned shutdowns.”

The result was that producers and traders speculated in order to plug the supply gap, leading to the current bad case of the jitters over the extent of inventories in the hands of Chinese traders and distributors.

The following extra factors have also being identified as leading to a much-better first quarter than anyone had expected:

• The rising influence of the Dalian Commodity Exchange which seems to be involving financial and other non-chemicals traders – as well as the polyolefin traders. The volume of futures trading in LLDPE (LLDPE) film grade rose to 24m tonnes in the first two weeks of April compared with 150,000 tonnes in the same period last year.
• Increased bank lending that’s allowed traders in futures and physicals markets to increase their activity (there are also very active futures markets in China in methanol and purified terephthalic acid. Speculation in all petrochemicals looks as if it might have increased)

Uncertainty over China’s economy is adding to the perennial anxiety over polyolefin inventories.

Contradictory opinions over the short-term benefits from the government’s huge economic stimulus package abound.

The release last week of first quarter macroeconomic results also resulted in widely different interpretations.

And a few of the statistics from the first quarter might be a cause for concern.

Industrial production increased by 8.3% in March whereas factory gate prices fell by 6% - up from a 4.5% decline in February.

Anecdotal reports continue that some manufacturing plants are running hard in order to keep people in jobs, despite the 20% fall in exports recorded in the first quarter.

Could this lead to low-priced exports in the second half or have all the factory closures left finished-goods inventories at comfortably low levels?

Would China really want to export deflation, anyway, at the risk of trade wars and damage to the global economy?

The problem, as always with China, is that nobody has reliable data to back up their opinions.

On this occasion, though, the nervousness is much greater because of the country’s relative strength.

Western polyolefin producers have been able to cash in on strong arbitrage to compensate for weak home markets.

US PE shipments to China are said to have risen very sharply in the first quarter thanks to ethane being relatively much more competitive than naphtha.

“The Gulf Coast ethane-based ethylene producers will remain at an advantage over the naphtha-based operators for the next two years,” said a second Western polyolefin producer.

 The rise in West-East trade is largely behind the big increases in China’s imports in January-February as Middle East production was constrained, he added.

Some exports might have been to cover delayed start-ups of new plants in the Middle East, one source suggested.

Low density polyethylene shipments to China rose 1.8 times in February this year over the same month in 2008, according data from China Customs.

The increase in high-density PE (HDPE) was 1.2 times with linear-low density (LLDPE) registering a 1.6 times increase.

Polypropylene imports rose between 82.15% and 1.4 times, depending on the grade.

PE imports totalled more than 600,000 tonne, the highest since 2005, with a similar quantity expected to have been shipped in March, according to ICIS pricing.

Anybody who fixes further cargoes for arrival from the West after May might be taking a big risk.

That cheaper crude and naphtha and increased petrochemical supply will cause prices to fall in the second half regardless of the speed of China’s economic recovery, is a widely held view.

But in bear market recoveries – which is what the recent rebound in pricing very likely represents – since when have fundamentals really mattered?

Sentiment could now be the only reliable measure and in almost every conversation you can sense it has shifted.

($1 = CNY6.83)

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By: John Richardson
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