INSIGHT: Squeezing the China polyolefins price bubble

17 July 2009 17:29  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)--If you predict a collapse in any market for long enough it will surely happen - or maybe not in this case.

Many of us have had to wipe large amounts of egg off our faces as the Asian polyolefins price “bubble”, which began mid-November last year, has continued.

Asian olefin and polyolefins prices remained firm as this article was published – close to their levels for the week ending 10 July, despite the recent fall in oil prices.

High-density polyethylene (HDPE) film grade reached a low point of $750/tonne CFR (cost and freight) China on 7 November last year, according to ICIS pricing.

Markets have not looked back since, with prices more or less following a constant upward or stable trajectory. HDPE film for August delivery business was recently settled at $1,220-1,280/tonne CFR China.

Pessimists (or maybe realists) continue to question the sustainability of the recovery, however.

China prcies continue to climb

This questioning hadn’t lost any of its intensity on Friday 17 July, despite the official announcement that China’s GDP expanded by 7.9% in Q2. This compared with only 6.1% in the first quarter.

“Monthly PE demand in China (production plus imports) was very steady in 2007-08,” writes Paul Hodges, consultant with UK-based International eChem, on his blog, Chemicals & the Economy.

“It averaged 980,000 tonnes in 2007 and 970,000 tonnes in 2008 and yet soared to 1,270,000 tonnes up until May this year.”

This has occurred despite the steep fall in China’s finished-goods exports. June exports, for example, fell by 21.4% as against the same month in 2008.

The reductions seem to be far too big to be entirely replaced by stronger local demand in 2009, largely the result of huge government spending.

One often-expressed concern is that speculators, awash with credit as bank lending has risen, have poured into the local stock market (which has gone up by 75% this year) and all sorts of commodities and exchanges.

More than 80m tonnes of linear-low density PE (LLDPE) were traded on the Dalian Commodity Exchange during the second quarter – around four times global annual demand.

Rising oil prices have contributed to the polyolefins price-rally in the physical market.

“If a lot of this product has gone into storage as either as polymers or finished goods, then at sometime it will re-emerge on world markets,” adds Hodges.

“And if it all comes at one time, when 'everyone' decides prices are falling, there is clearly a risk that it might have a major deflationary impact.”

There are many other factors behind the extraordinary and largely unexpected rebound.

“I remember going to ChinaPlas in May (the big plastics exhibition). There were a lot of Doomsday scenarios being bandied about because of the coming supply surge and the unsustainability of the Chinese economic recovery,” said a Singapore-based polyolefins trader.

“I think the rally is mainly down to tight supply. Production cutbacks in Europe and the US are important but delays to Middle East capacity have had a bigger impact.”

PP has been a major beneficiary: of the 2.77m tonnes/year of capacity, or thereabouts, due on stream in Saudi Arabia in 2008 only 450,000 tonnes/year started up on schedule, said a source with a European polyolefins producer.

As little as 1.02m tonnes/year of the 2.77m tonnes/year was understood to have started up by mid-July.

“I think a reason has been that EPC (engineering, procurement and construction) resources were severely overstretched,” added the European source.

“You just couldn’t get enough experienced project managers to oversee these big investments.

“Cost constraints have caused problems as have efforts to commission entire complexes at once when phased start-ups might have been better.”

Gas feedstock shortages resulted in low operating rates at Middle East plants already on stream, said ChemSystems in its second-quarter petrochemical review.

A substantial maintenance shutdown programme has taken place in Asia.

“Operating rates at many crackers unaffected by maintenance were also turned down as rapidly strengthening feedstock prices squeezed cracker and integrated derivative margins close to breakeven,” added ChemSystems

The Middle East and China haven’t seen the start-up of any big new complexes for about 12 months, said the European source.

“When you think about the China market, if it grows at 5% a year that means there is a need for one new world-scale plant every year. If it grows at 10% you need three new plants.

“Despite the global economic problems the market is still growing.”

PP has also been tight because small plants in China have shut down due to a lack of propylene supply from refineries.

Refineries have been running at low operating rates due to, first of all, weaker fuels demand and, more recently, higher crude prices.

Tight supply in all grades of polyolefins seems to have so far counter-balanced the $10/bbl or so decline in oil prices over the last few weeks.

“US dollar-priced material (for shipment to China) remains very limited with hardly any availability for July negotiation and August arrival,” the Singapore trader added.

He gave two further reasons for the strength of the market.

“The Chinese government has been building up stocks of goods for disaster relief. It doesn’t want to be embarrassed again by the shortages that followed last year’s Sichuan earthquake.

“HDPE yarn grade is very tight, for example, as it is used to manufacture tents.”

Imports of recycled or scrap plastic into China have fallen by as much as 30% over the first five months of this year.

“Consumers in the West are buying fewer durable goods, such as electronics, which arrive wrapped in plastic,” continued the trader.

“During the economic mega-boom lots of this plastic was collected in the US and Europe and exported to China for recycling.”

Chinese traders handling recycled material went bust by the legion in 2008. This was the result of the great petrochemicals price collapse which left virgin resin cheaper than re-used product.

Stricter government regulations on scrap imports due to concerns over pollution have also slowed trade.

But still, you keep coming back to the apparent PE demand numbers at the beginning of this article.  How can they be up on 2007-08 with the world economy still in deep crisis?

“I know - you have to be worried. Something doesn’t seem quite right,” added the Singapore trader.

“The bonded warehouses (where US dollar material is stored) I visited in northern and southern China last week were almost empty.

“But inventories of RMB-priced material held by local traders and distributors seemed to be very high indeed.”

Some contacts we spoke to want a sentiment survey on PE and PP inventory levels in China.

The feeling is that PP imports and production may also have also increased in 2009, but the data were not immediately available.

“I think many people are having a hard time applying logic to the current market,” the European producer added.

“This is more supply than demand driven and once the new capacities finally start up, we will face a bloodbath.”

Yes, but exactly when? Maybe, just maybe, if project delays continue and the global economic recovery is sustained the air will be gently released from the polyolefins price bubble.

Or, if we can get a handle on inventory levels in China and they turn out to be huge (whether as polyolefins or finished goods), let the last person to leave the room turn out the lights.

Read John Richardson's Asian Chemical Connections blog and Paul Hodges’ Chemicals & the Economy blog
To discuss issues facing the chemical industry go to ICIS connect

By: John Richardson
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