INSIGHT: China polyolefins markets firm but producers cautious

07 July 2011 17:26  [Source: ICIS news]

By John Richardson

PERTH (ICIS)--China’s polyolefins markets have enjoyed a recovery over the past week thanks to the anticipation of tighter supply in August.

Stronger crude also helped lift polyethylene (PE) and polypropylene (PP) prices by $50-100/tonne, said a Singapore-based trader.

Several Asian crackers are set to undergo maintenance work during August. This graph from the ICIS World Ethylene Plant Report confirms the extent of the expected loss of ethylene production in China.

China ethylene capacity

There is a feeling that markets might have bottomed-out and that it is therefore time to re-stock after the longest period of de-stocking for many years. Buyers ran heavily on inventory from March until now - if reports of better sales volumes as well as pricing are to be believed.

As supply tightens in August, demand for linear low-density PE (LLDPE) and low-density PE (LDPE) is expected to pick-up due to the onset of the next agricultural film season.

But a source with a major polyolefins producer said: “Sentiment has certainly got better, but we are a long way from being out of the woods.”

One thing that needs to be keenly observed is whether this mini-rally survives Wednesday’s decline in crude pricing.

Oil rose late last week on the Greek parliament approving an austerity package, only to slip back again on Moody’s decision to downgrade Portugal’s debt to junk status and another interest-rate rise in China.

China has now increased interest rates on three occasions this year. Bank reserve requirements - the amount of money banks have to set aside against lending - have been raised six times in 2011.

Further monetary tightening seems a distinct possibility as several economists are predicting that China's inflation rate will have risen to around 6% in June from 5.5% in May.

China’s government has identified getting the 2011 annual inflation rate down to 4% as a major priority. Premier Wen Jiabao has reportedly said that achieving this objective will be very difficult.

The prospect of further credit tightening might weigh heavily on polyolefins markets, especially given that those hurt the most by harder lending conditions are the small and medium-sized enterprises (SMEs).

“The situation for the SMEs, which make up the bulk of the buyers of polyolefins in China, is a big concern,” added the source with the polyolefins producer.

"I have heard that the biaxially-oriented PP (BOPP) film sector has been particularly badly affected. The big scale of modern BOPP production lines means there is a requirement for a large amount of credit.”

The SMEs have long been at the back of the queue for lending through official channels, according to Michael Pettis, finance professor at Peking University’s Guangzhou School of Management.

As officially available credit has become more expensive and less-available, the SMEs have been increasingly forced to pay very high borrowing costs levied in the informal banking sector, he said.

SMEs are often labour-intensive and so have been further damaged by a steep rise in wage costs. Wages in China have been increased by 20-30% during 2011 as the government tries to narrow the gap between the rich and poor, according to media reports. 

“I am also very worried about the effect on sentiment when the full scale of the local government debt problem in China is recognised,” added the source who works for the polyolefins producer. 

“We could see commodity prices, including chemicals, fall by 5-10% when this happens.”

Beijing released figures last week showing that borrowings by Chinese local governments had climbed to yuan (CNY)10,700bn, equal to 27% of China’s GDP.

When you add central government debt to this number, some economists argue that China’s total liabilities are as much as 70% of GDP, perhaps even higher.

As much as 30% of this lending is reported to have turned bad due to excessive speculation in real estate and other red-hot sectors of the economy.

Further adding to the gloom is the state of one of the key end-use markets for PP, polyurethanes, polycarbonate and nylon resins - autos. High-density PE (HDPE) is also used to make petrol tanks.

Auto sales grew by a staggering 32% in 2010 to 18.06m vehicles, but April this year saw a monthly decline for the first time since 2009.

Sales in May also dipped - by 3.98% to 1.38m units - as a result of the removal of government incentives and tighter lending conditions.

The outlook has become much-bleaker, according to an HSBC report released late last month, as a result of:

  • The reinstatement of a 10% purchase tax on cars with an engine size of 1.6 litres or smaller from December last year. The tax was cut to 5% in January 2009 and then raised to 7.5% before being returned to the full 10%
  • The removal of one-off subsidies for trading-in old cars in rural areas
  • Beijing cutting the issuing of new licences in 2011 to one-third of last year's level in order to tackle congestion. Only 240,000 new licences will be issued this year. While Beijing only accounted for 7% (800,000) of nationwide auto sales in 2010, the concern is that the other major cities will follow suit, such as Nanjing, Chengdu and Guangzhou.

This week’s price-recovery is well overdue and has provided some relief for producers and traders.

But all of the fundamentals appear to indicate that a sustained upswing in both pricing and volumes is going to be difficult to achieve.

Bookmark Paul Hodges’ ICIS Chemicals and the Economy blog
Read John Richardson and Malini Hariharan’s Asian Chemical Connections blog

By: John Richardson
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