INSIGHT: Maintaining a grip as China PE demand drops

22 February 2011 18:12  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS)--A sense of perspective is never easy for those fighting for every last dollar on every last tonne they sell.

A sharp decline in demand can therefore feel like the end of the world for sales and marketing executives and for traders, even if a recovery is only a matter of weeks away.

But it is possible that what we are seeing in China’s polyethylene (PE) market right now indicates something more fundamental than a few traders getting their fingers burnt.

“There is a stand-off between the overseas producers and the domestic buyers,” said one trader.

“None of the producers is budging on their offer prices because they are claiming that supply of certain grades remains tight, that their stock levels are low and that raw material costs have gone up.”

The first claim seems justified because of continued tightness in, for example, structurally short low density PE (LDPE).

Linear low density polyethylene (LLDPE) production remains constrained by a lack of butene-1 co-monomer feedstock, according to an olefins trader.

Butene-1 has been in tight supply for the last couple of years due to too much new LLDPE capacity chasing insufficient supply.

The olefins trader added: “The situation has eased slightly recently, but is set to get worse again because European crackers are cracking more propane than naphtha, and propane yields less C4s.

“Propane has got cheaper relative to naphtha due to new liquefied natural gas (LNG) start-ups and the rise in crude oil costs (a co-product of LNG is liquefied petroleum gas that mainly contains propane).

“Another reason why I expect butene-1 to get even tighter is the upcoming Asian cracker turnaround season.”

It is impossible to verify the comment that importers continue to sit on low inventories. But one can blow a hole in the argument that feedstock costs in Asia went up last week.

Naphtha costs remained flat as margins for cracker-to-PE operators improved, according to the ICIS Weekly PE Margin Report for Asia.

Integrated LDPE margins rose by $48/tonne (€36/tonne) to their highest level since February 2010, with high density PE (HDPE) margins $65/tonne higher.

Improvements were the result of better co-product credits, particularly butadiene, which has been the case for several weeks now.

It is a moot point as to how much longer co-product credits can continue to support Asian producers, as their main business is making ethylene to convert to PE.

In Europe, naphtha costs increased by $22/tonne, squeezing margins a bit. But this was mainly a sideshow, as Europe is the most expensive region in the world right now. This makes exports to Asia very difficult.

Rising ethylene costs on reduced ethane supply have also made PE shipments from the US difficult.

But, despite these positive factors for the length of supply in China, inventory levels are very high among local producers and traders.

“The reason is that demand after the Chinese New Year has been a lot weaker than anyone had expected. Cargoes were, as a result, overbooked before the holidays,” the olefins trader, who is based in Singapore, added.

Traders are trying to relieve the pressure by re-exporting material to Turkey, Vietnam and South America, he said

The trouble is that more shipments booked before the New Year are still at sea and heading towards the moribund China market.
                      China PE prices

“Unless you know a very friendly customs officer, it is pretty much impossible to find space right now in any of China’s eastern or southern bonded warehouses,” he added.

The first of the two reasons given for the weak market is the Chinese practice of job-hopping after the holidays.

Workers traditionally return to urban areas from the countryside, collect their annual bonuses and then immediately quit for new, higher-paid positions.

“It is such a big problem this year that although lots of the converters have good orders, they cannot run their plants,” said the trader.

This was one of the worst years for job-hopping that he could remember, said a source with an Asia-based producer.

“Migrant labour supply has got a lot tighter because better standards of living in the countryside are persuading a lot more people to stay at home,” he added.

“For those who are still prepared to move to the south and the east, inflation is a big issue.”

But maybe the far bigger reason for the flat market is tighter lending conditions. Bank-reserve requirements have been raised eight times since early in 2010, with a further half a percentage rise planned for 24 February.

Despite the highest reserve requirements in more than two decades, bank lending is reported to have more than doubled in January compared with December 2010.

But the feeling on the ground is that trade finance has become a lot harder for small and medium-sized companies, suggesting that that ample liquidity remains in the hands of the well-connected big companies and speculators.

“The converters and fabricators have the orders but cannot get the credit,” said a source in Shanghai with another Asia-based producer.

The government might be caught between the rock of rising inflationary pressures and the hard place of the manufacturing economy suffering from less financing. According to the Singapore-based trader, every half-percentage increase in the reserve requirement takes $30bn of liquidity out the economy.

The Asian cracker turnaround season, which we referred to earlier on, could help tighten supply considerably.

A commonly expressed view is that the upcoming turnarounds and perhaps a recovery in Chinese demand, as credit conditions are improved for the smaller companies  will result in a recovery in import prices by late April or early March.

But confidence in the immediate future is a little hard to find at the moment, mainly because of what’s happening outside, rather than inside, China.

“If the Middle East crisis escalates and crude goes to say, $150/bbl, then we could see demand suddenly dip by 20% as governments everywhere raise interest rates. This is our biggest concern at the moment,” added the source whom was first quoted as someone who works for an Asia-based producer.

Click here to find out more on the Asia, Europe and North America margin reports
Read John Richardson and Malini Hariharan’s Asian Chemical Connections blog
To discuss issues facing the chemical industry go to ICIS connect

By: John Richardson
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