China growth debate rages on

12 October 2012 09:38  [Source: ICB]

One view of China is that everything will soon return to normal.

The past two years have seen exceptionally weak markets. First, 2011 was a story of the withdrawal of credit as China battled inflation, and this year has been mainly a tale of deflationary pressure as the legacy of industrial overcapacity has been highlighted by exceptionally weak export demand.

China outlook Rex Features

 Rex Features

There is much disagreement over the future of China's economy

The fall in construction activity, as a result of the slowdown in the real estate sector, has been another explanation for a very disappointing 2012.

"Secular" changes in China's economy also have played a big role in flat, or very low, petrochemicals demand growth in 2011 and 2012. These include rising labour costs resulting from Beijing's efforts to boost domestic demand over investment.

But, typifying the long-term confidence, a vice president with a major European petrochemicals producer, said: "I remain convinced that strong growth rates are secure as a result of rising urbanisation and the growth of China's middle classes."

He will be proved right, according to Queensland Australia-based petrochemicals, mining, metals and electricity consultant Michael Komesaroff.

"McKinsey Global Institute reckons that China will have 23 cities with more than 5m inhabitants by 2025," wrote Komesaroff, principal of consultancy, Urandaline Investments, in an article in the September 2012 issue of the online economic research publication, the China Economic Quarterly.

"China's urbanisation is far from complete, and many fast-growing cities will continue to devour larger and larger quantities of construction materials, especially steel and cement," he added.

"Rapid urbanisation is projected to continue for another 15-20 years, by which time the urban population could swell from 700m to 1bn."

And, fascinatingly, it is the intensity of urban construction that Komesaroff believes will guarantee another decade of strong demand growth for steel.

"China's industrial development is following the same general path as other countries, most obviously Japan and South Korea, which have grown from rural agrarian societies to organised urban industrial economies," continued Komesaroff.

He argued that China is different in that its huge population and a technocratic and authoritarian leadership make it more metals intensive than its northeast Asian neighbours.

"Above all, the scarcity of land in a country that must feed one-fifth of the world's population with just 7% of its arable land, means that urban development in China has to be dense," he said.

"Tokyo's residents are famous for living in often tiny apartments, but the Japanese capital is actually much less densely populated than most large Chinese cities.

As China's urban population expands, more urban residents are moving into tall, multi-storey apartment blocks that allow a lot of people to live in a small space."

He added that the impact on metals demand would be enormous because tall buildings are far more steel-intensive than low-rise structures.

"Until the 1990s, most urban apartment blocks in China were six storeys, and required less than 30kg of steel per square metre of floor space," said Komesaroff.

Taller buildings require much more steel to stay upright: A 32-floor building consumes twice as much steel per unit of floor area as a shorter eight-floor structure.

And the more intensive the urbanisation process, the greater the demand will be for all the chemicals and polymers that make city-living more sustainable.

These include expandable polystyrene (EPS) and polyurethane (PU)-based insulation foams and water-treatment chemicals.

STIMULUS-DRIVEN GROWTH

This would be excellent news for chemicals and polymer companies such as Borealis, BASF and Bayer Material Science (BMS), which focus heavily on the megatrends such as the sustainability of urban living.

BMS, for example, promotes PU solutions that can be used to repair fractured metal or ceramic water pipes, which is cheaper than replacing the pipes.

The company estimates that 30% of water in old cities goes to waste because of faulty pipes. Chemical companies highlight Beijing's 12th Five-Year-Plan (2011-2015), which places great emphasis on more sustainable routes for both urban and industrial development.

But John Lee, Michael Hintze Fellow and adjunct associate professor at the Centre for International Security Studies, Sydney University in Australia, takes a radically different view of China's long-term economic prospects.

"Much of the optimism is based on the decade-long orthodoxy - popular with executives and investment analysts hardwired into talking up the China story - that Chinese urbanisation has a long way to go," wrote Lee in a 3 September article of the Australian online business publication, the Business Spectator.

"As China bulls point out, half of the population is still classified as rural and will need modern housing and other infrastructure over time."

He added that the above narrative guaranteed strong demand growth for commodities over the next 10 years.

"The reality is that China's voracious consumption of commodities over the past decade has remarkably little to do with the genuine demands of urbanisation, makes little economic or commercial sense, and cannot continue," he said.

Since the mid-1990s, urbanisation has been advancing at the rate of less than 1.5% each year, said Lee.

Yet fixed investment has been growing at 20 to 40% each year for the past decade. Fixed investment as a proportion of GDP increased from 38% in 1999 to 45% in 2003 and over 50% currently.

China had embarked on a dangerous economic path that had resulted in formal bank loans increasing from $750bn (€577bn) in 2008 to $1,400bn in 2009, he wrote.

"In the two years from 2008-2010, the amount of outstanding loans on the books of the country's banks increased by 58%. Chinese levels of fixed investment, and levels of steel production specifically, over the past decade have been predominantly driven by politically-motivated stimulus policies rather than market-determined demand."

This "unprecedented" reliance on fixed investment to maintain jobs, stimulate economic growth in urban areas, and to enable ambitious provincial government to exceed growth targets, had to lead to China's well-documented "ghost cities" of empty apartment blocks and other buildings, said Lee.

As a result, he said that were "tens of millions of uninhabited high-end apartments that are bought as speculative capital assets rather than as investments based on rental yield, and world class infrastructure projects that will be never be adequately utilised.

"Estimates by Chinese state-backed researchers suggest that still empty apartments built over the past four years could house over 200m Chinese."

The investment community, and the media, is similarly divided over whether or not the commodities boom will continue in China.

An analyst with a Perth-based stockbroker and investment services firm falls into the negative camp.

"The press down this way plays its part in driving up hope levels," he said.

"People don't realise that like the tech bubble, levels of pricing we have seen in iron ore etc may not ever come back.

"The world survived quite nicely with iron ore at $50/tonne."

Iron ore was trading in the region $100/tonne in late September, compared with around $180/tonne a year earlier.

The commodities slowdown has led to postponement of some iron projects in Australia.Similarly, if the investment analyst proves to be right, it is not too much of a stretch to imagine petrochemical projects also being delayed.

Some of the most obvious candidates seem to be the numerous shale gas-based cracker and derivatives expansions in the US.


By: John Richardson
+65 6780 4359



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