INSIGHT: Credit crunch driving PE inventory building, concerns in China

30 August 2013 16:09  [Source: ICIS news]

By John Richardson

PERTH (ICIS)--The recovery in petrochemicals sales volumes is quite remarkable.

As Paul Satchell, UK-based analyst with global investment bank Canaccord Genuity, points out, volumes in Europe, the US and Asia have gone from a famine in July to a relative feast in August.

But in the China polyethylene (PE) market, which is often seen, rightly or wrongly, as a reasonably good benchmark for wider petrochemicals activity, a large number of markets sources continue to worry about the sustainability of the recovery. China, of course, drives the rest of Asia.

One key concern is whether issues surrounding the availability and affordability of credit in China have led to inventory building well in excess of real demand growth.

The country’s apparent demand (domestic production plus imports) for PE surged by 13% in the first half of this year compared with the same period in 2011. And yet one polyolefins industry observer believes that, when adjustments have been made for stock-building and a very weak first quarter, actual full-year 2013 demand growth will be only around 6-7%.

Concerns over credit are that:

*A big jump in total social financing during the first quarter (official bank lending plus loans via the shadow-banking system) led to a sharp increase in economic activity from July onwards, including more speculation in petrochemicals.

*Interest-rate arbitrage between lower borrowing costs overseas and more expensive rates in China is distorting PE markets, in the same way as in copper.

*The government’s decision to reduce short-term borrowing costs while raising long-term interest rates is having unintended consequences. This might have led to say, real estate investors buying PE in order to get hold of cheaper trade finance. They could then be gambling that their construction projects will be finished before their letters of credit are due to be repaid. In other words, they have no interest in the underlying value of PE because they are treating it as just another financial instrument.

“I just can’t see how real demand could have possibly gone up by 13%, the market has been far too quiet for that, at least when I talk to my customers,” said a Singapore-based polyolefins trader.

“All the end-users we deal with remain very cautious and are still unwilling to commit to big volumes. There has been a slight amount of ‘buying ahead’ because of concerns that supply, especially of LDPE, will get even tighter.

“But everybody we speak to continues to be very worried about the economy because of the weak state of export demand and all the domestic policy uncertainties.

“I am very bored, to be quite honest, sitting around waiting for something to happen. It is not as good as last year when business was fairly strong.”

One explanation about why this trader sees the market as so weak is that he deals mainly with re-export customers – ie converters who import resin in order to manufacture finished goods for export to the rest of Asia, the West and the remainder of the world. Evidence of a sustained and broad-based recovery in demand for China’s exports has yet to emerge.

The trader added that wage costs for export-focused converters in southern and eastern China continue to increase, leading to further relocation of production overseas.

“The re-export business in China is really squeezed. Lots of processors have moved to Vietnam,” said a source with a major western PE producer.

“And even Vietnam has become too expensive for some low-value converters. Overseas PE resin is, as a result, being shipped to Ho Chi Minh port in Vietnam and then trucked three hours inland to processors in Cambodia.”

Perhaps, though, as income levels rise across China and as food-contamination concerns increase, January-June 2013 saw one of those tipping points in PE demand growth that are impossible to model on any standard spread sheet.

But a source with an Asian-headquartered PE producer warned: “Your perception of China depends on where you visit and where you live.

“If you only visit the wealthier parts of Shanghai and Beijing, only visit big customers with ample cash flow, and you live in a place like Singapore, then you might get the wrong impression.

“Everyone should know that rich Shanghai and Beijing are not typical. More like the real picture are cities like Wuhan where a lot of businesses are short of money.

“The big converters are not typical, either. They have plenty of access to cash because of their relationships and/or are more ‘future proof’ because they have state-of-the-art machinery and good technology skills.

“The small customers, though, have poor sales and are still paying shadow-banking [very high] interest rates. These are the customers that account for the majority of commodity-grade PE sales in China.

“And optimism in Singapore, which of course, influences your view of the whole world, has largely been driven by the surge in property prices.

“But perhaps the biggest reason why real estate has been so strong in Singapore is Chinese money. Lots of Chinese businessmen have pulled money out of China in order to invest in Singapore. And why have they done that? They are worried about the Chinese economy.”

A source with a Middle East producer was also struggling to understand why PE demand has risen by 13%.

“Our sales volumes in China so far this year are about the same as in January-August 2012,” he said.

“I don’t know if we can really trust the 13% number. How reliable is the government data? Even if the number is about right, we think it could be mainly because of stock-building amongst traders.”

Read Paul Hodges’ Chemicals and the Economy blog
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By: John Richardson
+65 6780 4359



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