14 December 2012 10:02 [Source: ICB]
Petrochemical traders live or die by volatility and so for those who took the right positions during 2012 this has been a very good year.
For example, in the case of polyethylene (PE), one Singapore trader in late October anticipated that there would be re-stocking in China because of low inventory levels. In early November, he was proved right as markets briefly rallied.
China's growth is being jeopardised by rising healthcare and pension costs
But sadly, for most of the rest of the petrochemical industry this has been a disappointing year and doubts are increasing over whether 2013 will be any better - thanks to events in China.
As the chart shows, from the ICIS pricing Asian PE Margin Report, northeast Asian integrated high density PE (HDPE) margins have fallen to their lowest levels since 2000.
This is a reflection of what we have discussed before in this column - exceptionally weak demand in China. The northeast Asian nations (South Korea, Taiwan and Japan) are heavily dependent on the strength of China and so, when China is weak, they really suffer.
They are high-cost producers because they depend on naphtha as their feedstock, and so in a weak market they are affected the most.
As we discussed last month, China's PE demand rose by just 4% over two years in January-September 2012 compared with the same periods in 2010 and 2011, according to Global Trade Information Services (GTIS). This compares with double-digit growth throughout the past decade, peaking at 53% during 2008-2010, as China launched a huge economic stimulus package to compensate for the global financial crisis.
Middle East imports rose by 44% as northeast Asian shipments declined by 28% in January-September 2012, again according to GTIS. Another fact of life in disappointing markets is that the low-cost producers can seize bigger market share because of their ability to undercut their feedstock-disadvantaged competitors.
"Exports from the US have been down this year because of stronger local demand and reduced production" said a source with a Singapore-based global polyolefins producer.
North American Free Trade Agreement shipments to China in January-September 2012 fell by 44%, said GTIS.
"I am worried that this trend might go into reverse as ethylene demand has weakened and production has increased in the US," added the source.
US ethylene prices fell in mid-November, according to ICIS. This was the result both of weak demand and the re-start of two crackers in Texas.
Nobody ships ethylene from the US to Asia in big volumes and so weaker C2 prices would have to translate into a fall in US PE prices in order to create arbitrage opportunities. So it would be dangerous to read too much into what might turn out be a short-term shift in markets.
But the fact that several producers say they are worried about larger volumes of US material heading east underlines the level of anxiety and uncertainty over 2013.
Part of this anxiety and uncertainty relates to whether the US can avoid the January "fiscal cliff".
The other big concern is whether the Chinese "economic miracle" is over, as we have detailed throughout this year.
"OK, there will be opportunities to make money on short-term market rallies, on technical corrections, but I think China is undergoing major changes," said the Singapore-based polyolefins trader, who successfully guessed the early November rebound in markets.
"There is no visibility on growth. We just don't know where China is heading."
China's problems are so numerous, so complex, and so deeply entrenched that they might take years to be fixed, assuming that they can be fixed.
"We hope the new leadership will get it right, but nobody really knows," added the source with the global polyolefin producer. In early November, China completed its once-in-a-decade leadership handover when the new seven-man Standing Committee - the country's most-senior government body - was unveiled.
"Some of my sources think that [the first half] of next year will be difficult, but that there might be a recovery in the second half. They said the same thing about this year," he said.
MODERN CHINA VS 1980S JAPAN
In 2012, opinion has shifted markedly on China. At the start of the year, most of the people we talk to in the petrochemicals industry were confident that the country would carry on booming; now the majority are either uncertain or pessimistic about China's future.
As a brief recap, the problems that China faces include the need to shift from investment to domestic-focused growth, a major bad-debt problem, overcapacity across many industries, rising income inequality, environmental degradation and growing social unrest.
Comparisons are being drawn between China now and Japan in the 1980s.
"The important characteristics of Japan in the late 1980s would almost certainly include the following," wrote Michael Pettis, a finance professor at Peking University's Guanghua School of Management, in a 27 October blog post.
"Japan in the late 1980s grew at extraordinary rates fuelled by a credit-backed investment boom funded at artificially low interest rates.
"Although for many decades much of the investment may have been viable and necessary, by the 1980s investment was increasingly misallocated into expanding unnecessary manufacturing capacity, as well as fuelling surges in real estate development and excess spending on infrastructure."
Artificially low interest rates, set nominally by the central bank but in reality by the Ministry of Finance, led to a bubble in housing and other asset prices and penalised household savings, he added.
"An artificially low currency fuelled very rapid growth in the tradable goods sector while also constraining household income growth," he said. "Because the growth model constrained growth in household income and household consumption, it forced up the domestic savings rate to extraordinary levels."
Low consumption and excessive manufacturing capacity required a high trade surplus in order to balance production with demand as debts soared way beyond the ability to service debts, he added.
All of the above apply to China today.
Another parallel with Japan is China has a rapidly ageing population, but unlike Japan, China is a poor country in terms of per capita GDP.
Favourable demographics were one of the factors that supported China's strong growth during the 1990s and 2000s. But now that the demographic dividend seems to be over, growth is being jeopardised by rising healthcare and pension costs.
Over the past three years, the Chinese government has spent $125bn to provide health insurance to 95% of the population, said McKinsey in a July 2012 study. But China still has a long way to go to deal with a big gap between the quality of rural and urban healthcare, added the study. "China could face a pension fund shortfall of 18.3 trillion yuan ($2.9 trillion) by 2013 due to accelerated population ageing," wrote the 27 September issue of the China Daily, the official government newspaper.
A senior government official "advised that improving the current pension system should include moving back the retirement age for some people from 60 to 63 years old and asking employees to pay pension premiums for 35 years instead of the current 30 years," said the same article.
Inadequate healthcare coverage and not enough money to pay for pensions suggest that China's rebalancing, towards domestic consumption as the biggest driver of growth, may take a long time.
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