Quiet China polyolefins market points to lower demand

21 May 2011 10:52  [Source: ICB]

Calm tides for the Chinese polyolefins market may be a sign of lost pricing power

Low volumes and flat pricing for polyethylene and polypropylene indicate that producers are losing pricing power

The one positive aspect of what has been a very quiet polyolefins market in China since the Lunar New Year has been a considerable improvement in golf handicaps in Singapore.

One trader claims his handicap is now below 10, down from the mid-teens, thanks to all the time he has on hands.

"There has been very little else to do apart from play golf. It has been a desperately quiet market since the Lunar New Year - the quietest period I can remember in the seven years I've been in this business," he said.

Pricing has remained more or less flat for polyethylene (PE) and polypropylene (PP) since the early February week-long holidays.

This is despite the rise in the price of oil and therefore, naphtha and monomer costs, indicating that the producers have lost the pricing power they enjoyed from the second half of 2009 and throughout most of 2010.

DEMAND RATHER THAN SUPPLY
One of the reasons for this loss of power is that some extra supply is reported to have hit the market. This is the result of more stable production at recently commissioned Middle East plants and a ramping up of output at new facilities in China.

However, the much-feared rise in the availability of associated gas on higher Saudi Arabian crude output doesn't appear so far to have materialized.

Throughout last year, Saudi crackers ran at operating rates of around 85% as a result of the capping of the country's oil production at approximately 8.5m bbl/day. This was part of OPEC's efforts to prop up the oil price.

"Saudi Arabia needs to be producing around 10m bbl/day of oil to run its crackers at 100%," said a UK-based industry observer in January.

But then in early March, OPEC appeared to have relaxed quotas over concerns that the surge in oil prices was threatening the global recovery. Later that same month, a second industry observer, who is based in the Middle East, said that Saudi Arabia had raised crude output to 9.4m bbl/day.

This led to concerns that the extra associated gas would enable cracker complexes to ramp up PE and monoethylene glycol (MEG) output.

Extra production wasn't reported to have arrived in Asia, however, during April, which logically should have been the case.

This is a result of what Paul Hodges, chairman of UK-based consultancy International eChem, believes was an almost immediate re-imposition of quotas by Saudi Arabia.

"The Saudis face a very difficult task of needing to maintain high-enough crude prices to balance their budget, while also not causing demand destruction," he says.

Saudi Arabia has spent an estimated $129bn (€86bn) over March and April on creating new public-sector jobs, on state employee pay increases and on higher allowances for the unemployed.

This is part of the effort to prevent the "Arab Spring" - the social and political turmoil that has occurred in many countries in the Middle East - spreading to the Kingdom.

The US's Institute of International Finance, a Washington, D.C.-based association of financial institutions, assesses the Saudi breakeven crude price necessary for it to balance its budget to have risen from $68/bbl last year to $88/bbl in 2011. US-based investment bank Merrill Lynch says the breakeven price is now even higher - at $95/bbl.

INFLATION AND CREDIT TIGHTENING
So if the weakness in China hasn't been the result of greatly increased supply, it makes sense that this must be more of a demand story.

Volumes have been extremely weak since the New Year as a result of government measures taken to tackle inflation, according to some producers and traders.

"Every time the government increases bank reserve requirements by half a percentage point, it takes around $30bn of liquidity out of the banking system," notes the Singapore-based trader.

By April 21, the People's Bank of China had already made four half-percentage-point increases to the reserve requirement during 2011. On that date, the requirement stood at 20.5%, and most economists and analysts expect further increases will take place this year.

"Every increase in the reserve requirement has made it harder for small- and medium-sized enterprises (SMEs) to access credit," said a Singapore-based source with a global polyolefins producer. Most plastic converters in China are SMEs.

A source with a Canada-based polyolefins producer, however, claims that financing is still easily available, even for the SMEs, because of the emergence of a "shadow" banking system in China.

"The state-owned banks, aware for a long time that tighter lending conditions were inevitable, have shuffled money off their books into trusts that have been able to avoid government credit-growth restrictions," he says. "Borrowing in Hong Kong or from wealthy private individuals are other ways of getting round the cutbacks in conventional credit." Perhaps, though, the trader is right and credit has become universally tight in China. In early April, the government published a new statistic - total national financing - to reflect the scale of new lending through both the conventional banks and the shadow system. Total national financing was down by 7.1% in the first quarter of 2011, compared with the same quarter in 2010.

Weaker demand, therefore, starts to add up, especially when you also consider government-encouraged price controls on finished goods. This has squeezed the margins of the converters, forcing them to run at reduced ­operating rates.

The Anglo-Dutch consumer products giant, Unilever, for instance, was persuaded by the government to postpone 15% increases in product prices in China.

And the All China Federation of Industry and Commerce, an industry association, has urged all the industrial groups it represents to heed Beijing's call not to raise prices.

CHINA RE-EXPORTS
Demand appears to have been so weak in China that overseas traders have been re-exporting material originally shipped to the country slightly before, or just after, the Lunar New Year.

"We had all thought that pricing and demand would be so much better. We instead were left with high inventory levels in the bonded warehouses," says the Singapore trader.

March import/export data from China Customs, the government customs department, confirms the strength of the re-export trade.

China imported 357,077 tonnes of high density polyethylene (HDPE) in March, 3% less than in the same month last year, while its exports of the same product more than tripled to 21,663 tonnes.

In the case of linear low density polyethylene (LLDPE), China's imports fell by 14% year on year to 234,881 tonnes, but its exports of the polymer nearly quadrupled to 4,677 tonnes.

Its low density polyethylene (LDPE) imports slumped by 45% to 124,136 tonnes, while it shipped out 151% more LDPE at 7,000 tonnes.

PP import volumes also slipped, down by 9% at 339,240 tonnes with a corresponding sharp increase in exports at 15,478 tonnes - nearly double the March 2010 levels.

As of early May, European prices were a lot higher than those in China. This is a dramatic reversal from the situation in 2009-2010 when, thanks to China's huge economic stimulus package, China's pricing was far ahead of the rest of the world. This led to record-high imports.

HOW WORRIED SHOULD WE BE?
On numerous occasions over the last decade - since China entered the World Trade ­Organization and its economy began to really take off - pessimists have been predicting a major downturn.

Andrew Liveris, CEO of US-based Dow Chemical, appears to be on the side of the optimists. During a conference call in April to announce his company's first-quarter results, he described demand in China as "quite robust."

He also echoed conventional wisdom that China's new five-year economic plan would stimulate domestic consumption.

"They are spending on infrastructure, energy, the environment, new materials for aerospace and automotive, and that is all very directed," he said. "In the next five years, they want to spend $1.7 trillion. I don't think we have a lot to worry about in the short term."

Let us hope for everyone's sake that he is right.

Additional reporting by Judith Wang and Dolly Wu in Shanghai, and Joseph Chang in New York

By: John Richardson
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