Market Intelligence: China's polyolefins rebound remains elusive

19 March 2012 00:00  [Source: ICB]

The question that now needs to be asked is: "Why should polyolefins markets in China recover in 2012?" rather than: "When is the bounce-back going to happen?"

In early January, the inevitability of a strong rebound became firmly planted in the minds of most chemical analysts, and some traders and producers. But as time goes on, with no sign of the much-anticipated rebound, doubts have emerged over whether it will happen at all.

Wen Jiabao, Rex Features

© Rex Features

Wen Jiabao: 'accelerate pattern of economic development'

The huge economic stimulus package of 2009-2010 laid the foundations for last year's disappointments. Inventory levels rose from plastic pellets all the way down to finished goods thanks to historically lax lending conditions, and government subsidy programs that encouraged a sharp increase in the sales of autos, washing machines and other consumer goods.

When credit was therefore tightened in 2011, and the subsidy programs were withdrawn as part of the government's fight against inflation, the great "destocking" began from around March/April.

Pricing was highly erratic from that time until the end of last year. Recoveries did occur, but they were modest and short in duration.

While sentiment ebbed and flowed, the fundamentals remained unchanged.

This was reflected in polyethylene (PE) demand. It grew by just 1% - 200,000 tonnes - as domestic production increased by 3%, or 300,000 tonnes, according to ICIS data.

Imports declined with producers in Northeast Asia, the North American Free Trade Agreement (NAFTA) countries, the EU and Northeast Asia suffering the most, said Global Trade Information Services (GTIS).

From 2009-2011, for instance, NAFTA PE exports to China declined by 53% and Northeast Asia exports by 32%. Middle East exports surged 69% over the same period. This reflected higher production, and the region's ability to gain market share in a cost-pressured market.

Arguments over why this year will be better than 2011 include:

  • The government reducing bank-reserve requirements late last year, and again in February, easing the credit squeeze on end-users
  • Broad policy statements that have been interpreted as an indication of a new "pro-growth" approach, following success in bringing headline inflation under control.
  • GDP growth was 9.2% in 2011. For as long as anybody can remember, polyolefins demand growth has been well in excess of GDP.
  • Once inventories have been exhausted, all the way down the industrial chains from plastic pellets to finished goods, a strong bout of restocking will have to begin.

But since the end of the Lunar New Year, the traditional period when demand patterns for the year become a little clearer, the recovery hasn't happened. Import prices have edged up, and have sometimes remained flat or have declined, while volumes have reportedly been weak.

It now appears that all of the above reasons for optimism are unfounded, as result of:

  • The mandated 13%/year increase in minimum wages under the 12th Five-Year-Plan (2011-2015) and increased environmental compliance costs, as the government tries to reduce pollution. This has exerted further pressure on small and medium-sized enterprises (SMEs), which buy most of the imported commodity grades of polyolefins.
  • Labor shortages post-Lunar New Year. Plastics processors in eastern and southern China are unable to operate their plants at full capacity because migrant workers have failed to return in sufficient numbers from inland, or western, China. This is the result of government efforts to raise rural incomes.
  • The government's statement, first announced in March last year, that headline GDP growth has become less important than the "quality of growth." This was further underlined by Premier Wen Jiabao earlier this March, during the annual National People's Congress meeting, when he said: "The key to solving the problems of imbalanced, uncoordinated, unsustainable development is to accelerate the transformation of the pattern of economic development. This is both a long-term task and our most pressing task at present." This means more focus on domestic consumption, and less on investment and low-value manufacturing, as drivers of growth. The government, because of this commitment, has less flexibility to pursue short-term fixes, such as another major stimulus package. The policy shift was further underlined by Wen's announcement, during the same speech, that the official GDP growth target for 2012 would be 7.5%. This is the first time it has been below 8% since 2004.
  • Economic growth rates will slow because of weak export sales as a result of long-running economic problems in the US and the EU. Reflecting this weak trade, the Commerce Ministry is reportedly planning to increase tax rebates for exporters. The value of the yuan has also been allowed to weaken against the US dollar. These measures might boost demand for imported polyolefins re-exported as finished goods. An alternative outcome is merely an increase in international trade tensions, if, as seems likely, growth remains weak in the West.
  • Inflation is still a threat as a result of high food and oil prices, further restricting the room for economic stimulus. Food-price inflation remains in double digits. Expensive crude is causing demand destruction in China and elsewhere, according to Paul Hodges, chairman of UK-based consultancy International e-Chem. The government's National Development and Reform Commission may further reduce gasoline and diesel price subsidies during 2012, according to media reports. This would fit in with another objective of the 12th Five-Year-Plan - boosting energy efficiency - while adding to inflationary pressures.

The optimists continue to argue that it is still only a matter of time before demand roars back in China, and before hard-pressed overseas naphtha-based polyolefins producers regain pricing power.

But it is easy to assemble evidence that their confidence is misplaced, and that, just as was the case last year, the market will be dominated by local producers and the cost-advantaged Middle East players.

Earlier this month, for example, integrated high density polyethylene (HPDE) margins fell to their lowest level since ICIS records began, according to the weekly ICIS Asian PE Margin Report.

Low density polyethylene (LDPE) has done very well in recent years because of restricted supply. However, according to the same weekly margin report, integrated Asian LDPE margins slipped into negative territory for the first time since our records began.

If this carries on, do the naphtha-based producers have a Plan B? What might that Plan B look like in a world where growth, in general, looks pretty fragile?

By: John Richardson
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