INSIGHT: Revisiting China demand growth

20 April 2012 17:30  [Source: ICIS news]

By John Richardson

Industrial and investment growth in China is slowing downPERTH (ICIS)--In the late 1990s and the first decade of this century, measuring chemical and polymer demand growth in China was remarkably straightforward.

As China became the workshop of the world, and as the west enjoyed a credit-fuelled economic boom, one could reliably predict constant double-digit annual growth rates for all chemicals and polymers.

Everyone was a winner, even the higher-cost producers, as China’s appetite for all kinds of raw materials seemed insatiable.

Then came the 2008 economic crisis, which brought the credit boom in the west to an end. Europe and the US are still coping with the aftermath, making future demand for China’s finished-goods exports very uncertain.

Temporarily, though, in 2009-2010, when the Chinese government threw money at the problem of  high unemployment among factory workers in export processing zones, all seemed right again.

Chinese demand for chemicals soared, in response to the economic stimulus. But from April 2011, the country’s chemicals markets have struggled as the stimulus has been withdrawn in an effort to tackle inflation and growing income inequality.

A further complication is government efforts to re-tool the economy away from an over-dependence on exports towards greater domestic consumption.

As early as mid last year, polyolefin industry executives were seeing the effects of these efforts.

In the south and east, the government had started to actively starve “low-value” plastic processors of credit in order to force them to either relocate inland or move overseas. Increasing wage, energy and environmental-compliance costs also began to squeeze the margins of these processors in the south and the east – the developed regions of China.

The end-result was that the higher-cost suppliers of resin to China struggled, as low-cost producers in the Middle East were able to raise output. This was the result of start-up problems being resolved at plants that should have been fully on-stream in 2009-2010.

At the same time, China increased its petrochemicals self-sufficiency as it brought on-stream new cracker complexes, placing further pressure on the South Koreans and the other higher-cost players.

The positive news is that while low-end markets in the south and east have become much more price-sensitive, demand from higher-value processors is booming. 

As a result, if you are good at making specialty grades of polymers, which has long been the strategy of some South Korean producers, this can help compensate for lost commodity volumes.

“But just  as the total volume of BMWs sold in China is low relative to the west, even if growth has been tremendous, so too is the case with higher grades of polymers,” said a Hong Kong-based polyolefin industry executive.

“Growth often looks wonderful in percentage terms when it’s from a low base.”

Inland provinces are a story of huge growth potential, both in percentages and in volumes, for the commodity grades. This might overwhelm the ability of China and the Middle East to corner the market, but logistics and distribution are major challenges for importers as supply lines lengthen.

The economic transformation being attempted by the Chinese government applies to all manufacturing industry, and therefore seems likely to affect all the petrochemical value chains.

Textile exports grew by just 1.4% in the first quarter of 2012 compared with 7.6% overall export growth, according to official government data.

This was the result of rising labour costs that had left low-value textile and garment manufacturers unable to compete for western export orders with Vietnamese and Bangladeshi competitors, said media reports.

Minimum wages are, officially, scheduled to rise by 13% per annum during the 12th Five-Year-Plan (2011-2015). However, average monthly wages rose by as much as 50% in 2011, with 10-20% increases expected for this year, added the same reports.

The extent of the fall in textiles demand - due to both these structural reforms and economic weakness in the west - looks as if it has taken fibre intermediates traders by surprise.

In monoethylene glycol (MEG), imports were above 800,000 tonnes in March as against the usual 400-500,000 tonnes, in anticipation of a post-Lunar New Year demand recovery that has yet to happen.

Last week, MEG inventories in China were 850,000 tonnes as against the usual 400,000 tonnes, according to ICIS.

As the chart below shows, MEG prices have declined, despite the steep rise in the cost of ethylene feedstock.

Ethylene and MEG, northeast Asia

Polyester yarn inventories were last week 15-30 days, compared with 10-15 days before the Lunar New Year.

In caprolactam, a raw material for nylon (or polyamide) 6, February imports rose year on year by 110%. Spot caprolactam prices fell by $70-140/tonne last week as nylon chip markers lowered operating rates, added ICIS.

Remarkably, demand is so bad in the textiles chain that fibre-intermediates players fear that there will be no peak manufacturing season in 2012. The peak season normally runs from April until June.

Returning to MEG, the accepted wisdom at the beginning of this year was that lack of new capacity and strong Chinese demand growth would lead to a very healthy market. The longer that China remains weak, the more likely it is this thinking will have to be revisited.

Scenarios taking all of this into account have, no doubt, already been drawn-up by forward-thinking chemicals companies.

Several potential outcomes from this year’s leadership transition need to also be factored into scenarios.

Even if the reformists win control of the Politburo, they might well struggle to fully implement their agenda because of resistance from those who have made a lot of money out of China’s existing economic system.

But what does seem crystal clear is that the job of forecasting growth in China has become an awful lot harder.

With additional reporting by Judith Wang and Junie Lin.

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By: John Richardson
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