Market Intelligence: China fiber weakness surprises traders

07 May 2012 00:00  [Source: ICB]

PHOTO CAPTION:

China's textile boom may be shifting to slower growth

The impact of China's economic reforms have taken a number of petrochemical markets by surprise, including the fiber intermediates sector. Will there be a second-half recovery?

The late 1990s and first decade of this century were remarkably straightforward in measuring petrochemical demand growth in China. As China became the workshop of the world, and as the West enjoyed a credit-fueled economic boom, one could reliably predict constant double-digit annual growth rates for all chemicals and polymers.

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 of the end of that boom, making future demand for China's finished-goods exports very uncertain.

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

China demand for petrochemicals soared, in response to the economic stimulus.

But from April 2011, the country's petrochemical markets have struggled as the stimulus has been withdrawn in an effort to tackle inflation and growing income inequality.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 refocus the economy away from an overdependence on exports towards greater domestic consumption.

As early as mid-2011, industry executives were seeing the effects of these efforts.

In the south and east, the government had started to actively starve "low-value" manufacturers 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 manufacturers in the south and the east - the developed regions of China.

The economic transformation being attempted by the Chinese government applies to all manufacturing industry, and therefore appears to be affecting all the petrochemical value chains.

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

This is the result of rising labor costs that has left low-value textile and garment manufacturers unable to compete for Western export orders with competitors in Vietnam and Bangladesh.

Minimum wages are officially scheduled to rise by 13%/year 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, according to a media report.

MEG TRADERS SURPRISED

The extent of the fall in textiles demand - owing to both these structural reforms and economic weakness in the West - has taken monoethylene glycol (MEG) traders by surprise.

Inventory levels in China's coastal storage tanks totaled 860,000 tonnes for the week ended April 27 compared with the usual 400,000 tonnes.

This is the result of a surge in imports to 800,000 tonnes in March, against usual monthly shipments of 400,000-500,000 tonnes, in anticipation of a post-Lunar New Year demand recovery that has yet to happen.

The Lunar New Year holidays took place in late January. Not surprisingly, therefore, MEG prices have been declining, while ethylene feedstock costs have increased on higher oil and naphtha prices.

It was not supposed to be this way.

The accepted wisdom at the start of this year was that the market would become tight as global capacity additions were lagging demand, with China the main driver of demand.

Two new world-scale plants were said to be needed every year - about 1.5m tonnes/year of capacity.

Feedstock constraints in the Middle East and lack of investment in Asia had led to a big shortfall in investment, said industry observers.

Demand would also continue to boom in China, growing at around 12% in 2012, many believed.

But MEG demand may now only grow at 8% this year, say some commentators.

The market was so bad at the end of April that plants in Japan had been shut down on poor margins and weak demand, according to ICIS.

One major Middle East producer was reported to have chosen April for a shutdown, aimed at resolving technical problems, because of the poor market.

PTA MARKET ALSO WEAK

It is a similar story in purified terephthalic acid (PTA) , another feedstock required to make polyester. Despite a large number of South Korea, Taiwan and China planned shutdowns in late April, the market remained weak as pricing fell.

Demand is so bad in the synthetic textiles chain in general that fiber intermediates players fear that there will be no peak manufacturing season in China during 2012. The peak season normally runs from April until June.

SECOND HALF RECOVERY?

Petrochemical demand might recover in the second half of this year, as most economists believe that the decline of the Chinese economic growth has finished bottoming out.

This assumes that the external economic environment will not get any worse. Problems in the eurozone suggest that this is a fairly big assumption.

And if China sticks to its big economic transformation - all the indications are that this will be the case - there will be limited room in the country for new economic stimulus.

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

Several potential outcomes from this year's leadership transition in China are likely to have also been factored into these scenarios.

An extended struggle for political control between the reformists, and those backing the former head of the Communist Party's Chongqing branch, Bo Xilai, could be one outcome.

This might further weaken the economy.

Calculating petrochemical demand growth in China used to involve the safe assumption that it would always be well in excess of GDP growth.

The only debate was over the size of positive multiples over GDP.

But now, life is a great deal more complicated.

Additional reporting by Becky Zhang


By: John Richardson
+65 6780 4359



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