Morgan Stanley lays out the bull case for global petrochemicals, driven by China

23 January 2012 00:00  [Source: ICB]

China's PE demand has been vastly understated, says Morgan Stanely analyst Vincent Andrews. He sees China leading the way to high ethylene utilization rates by 2014

While the slowdown in China's economy is one of the major concerns weighing on the chemical sector, one Wall Street analyst is making a bull case for global petrochemicals, with China leading the way to ethylene operating rates exceeding 90% by 2014.

"Chinese plastics demand is the key driver of our bullish view on petrochemicals," said Vincent Andrews, analyst at US-based financial services firm Morgan Stanley, in a January 4 research note. "Consensus has mistaken Chinese inventory destocking for demand destruction."

China is the world's largest consumer of polyethylene (PE), representing 23% of global demand, and its estimated 7.8% compounded annual growth rate from 2011-2016 will be the largest driver of global PE demand growth, he notes. The production of PE represents around 60% of total ethylene consumption.

Andrews contends that Chinese government data has significantly understated PE demand. Data from the China Petroleum and Chemical Industry Association (CPCIA) suggest China PE demand was down 2% in 2011 through November (latest data), but this does not reflect changes in inventories, he said.

"Importantly - and unbeknownst to most observers - the CPCIA does not take into consideration changes in inventory, which we believe can have a material impact on the overall analysis," said Andrews.

Morgan Stanley's proprietary analysis, adjusting for inventories, shows PE market demand actually increased 15% in the same timeframe. Andrews estimates that in the first half of 2011, China's PE inventories fell by about 1m tonnes.

For all of 2011, inventories declined by an estimated 1.5m tonnes. He projects underlying China PE demand of 18.7m tonnes in 2011, growing to at least 19.2m tonnes in 2012, though he notes that the latter figure could prove to be conservative.

The investment bank's analysis shows that November PE demand jumped 23% year on year to 1.67m tonnes - the second highest month in history - versus the 5% gain reported by the CPCIA.

"This data supports our bullish call. Importantly, our adjusted data continues to show robust Chinese end-user demand in excess of local GDP growth," he said.

In addition, the inventory cycle is about to turn, notes Andrews. "Recent Chinese policy easing and PMI (Purchasing Managers' Index) improvement likely marks the end of inventory destocking," he said.

China eased monetary policy for the first time in three years on November 30, 2011, lowering bank reserve requirements. The latest China Manufacturing PMI reading for December 2011 rebounded to 50.3 versus 49.0 in November, showing expansion (any reading above 50 indicates expansion, while under 50 indicates contraction).

"The cut in reserve requirements for Chinese banks may already be having a positive impact on manufacturer inventory levels earlier than we anticipated," said Andrews.

The three key drivers of China PE demand growth are demographics, urbanization and "industrial upgrades," the analyst said.

"By 2015, people born after 1980 will represent 50% of China's population. We expect this group to desire greater product substitutes, much like US baby boomers did in the 1960s, necessitating increased manufacturing to keep pace with consumer demand," said Andrews.

He expects the urbanization trend to continue in China, with the percentage of the population living in urban areas climbing from 47% to 63% over the next decade.

This will be aided by government policies that will give migrant workers access to benefits when they relocate from rural to urban areas. More people moving to urban areas will require more construction, and PE consumption rises.

"Industrial upgrades" refers to a growing portion of the workforce with higher education. The analyst expects the percentage of the workforce with college degrees to rise from 10% today to 35% by 2020.

"There is a clear correlation between education and the overall manufacturing economy - a good proxy for PE consumption, in our view," Andrews said.

Bull case

By: Joseph Chang
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