INSIGHT: Assessing China investment plans is even more difficult

19 November 2013 16:30  [Source: ICIS news]

By John Richardson

PERTH (ICIS)--If you view China’s polyester chain expansions through the narrow lens of western economics, you might end up scratching your head to the point of near baldness. The numbers just don’t seem to add up.

For example, as delegates heard during last week’s ICIS Asia PET and Polyester Conference in Jakarta, Indonesia:

           Total world capacity in polyethylene terephthalate (PET) resin is set to reach 34m tons/year by 2016, with most of the increases taking place in China, said Hyun-Min Kim, consultant with Tecnon OrbiChem, during a presentation at the conference. This represents a worldwide capacity increase of 8% per year with demand growth at just 4-5% per year.

           China’s polyester fibre capacity growth was 14% in 2011, 16% in 2012 and an estimated 14% in 2013, according to industry assessments gathered by ICIS. This compares with demand growth of 8-11% during the same period. Average operating rates in China are expected to be below 80% until 2016.

           Moving upstream to purified terephthalic acid (PTA), industry sources have told ICIS that Chinese demand is likely to grow by 7-8% in 2013-2014. However, capacity will have increased by 21% in 2013 and a further 26% in 2014. Operating rates are expected to dip from 67% in 2013 to 59% in 2014 and 57% in 2015.

This China-led oversupply has widespread implications.

For example, South Korean PET resin operating rates are said to have fallen to 50-60% in 2013 compared with 95% last year - and 2013 PTA margins in Indonesia are reported to be the worst in 20 years.

China’s aggressive expansions fly in the face of standard economic logic.

Firstly, and most importantly of all, China’s economy could face lower GDP (gross domestic growth) for many years to come because of economic rebalancing.

China’s garments and textiles industries - the end-users of polyester fibre – are also losing their competiveness.

Wage costs are on the rise because of demographic weaknesses that are unlikely to change, despite last week’s announcement that the one-child policy will be relaxed.

This is driving up wage costs, resulting in the migration of low-value garment and textiles manufacturing away from China to countries such as Bangladesh and Vietnam. Global retailers are re-adjusting their supply chains to take into account the fact that China is no longer the automatic “go to” location for outsourcing.

The yuan (CNY) is also strengthening, which, again, reflects efforts to rebalance the economy. This is further eroding the margins of the textiles and garments manufacturers.

And so why, despite all of these competitive pressures, are so many more projects in the polyester chain still being planned in China?

For example, some 6.9m tonnes/year of polyester fibre capacity is due on-stream in China next year, according to industry estimates.

This is where a wider lens is needed in order to accurately view what’s happening in China. Analysts across every industry need to look beyond the standard cost-per-tonne assessments of what makes an individual plant competitive.

Commentators argue that industrial capacity in general continues to be added in China because of how local governments finance themselves. 

An important source of local government revenue is money from land sales to industrial and property developers. If they stopped selling land, they would be unable to meet their liabilities.

Tax income from manufacturers is another important source of income for town, city and provincial governments, add the commentators.

And some 70% of the points awarded to local officials are based on how rapidly they expand a region’s GDP, according to a 15 November article in the Financial Times. These points are used to determine promotions and demotions. An easy way to raise GDP is through building more factories.

But, as a result of policy announcements made after a crucial government meeting – the Third Plenum which took place on 9-12 November – conference delegates were hopeful that China’s polyester chain expansions would slow down.

The cost of capital should increase if Beijing follows through on its pledge to remove the cap on deposit rates.

State-owned banks, because they don’t have to compete for savings through raising deposit rates, are able to provide lots of cheap lending for industrial development.

This makes it even easier for projects to go ahead that, in western terms, seem unviable.

The cost of both land and energy might also increase following the plenum. Both are very cheap at the moment and so provide further subsidies for manufacturing.

Another key decision made during the plenum was to increase the “top down authority” of the central government.

In the past, local governments have often been able to ignore legislation from Beijing because of lack of central control, and, of course, the sheer size of the country.

The plenum promised that greater efforts would be made to ensure the independence of the judiciary and prosecutors.

“This will make it harder for local government officials to influence court decisions in their favour. At the moment, they are using their influence to avoid legislation designed to limit new industrial capacity, force consolidation of existing plants and improve environmental protection,” said a delegate on the sidelines of the conference.

A reform commission and a security council – akin to the US National Security Council – will also be established.

Both of these bodies should give president Xi Jinping, and other senior politicians, greater ability to force-through the radical shift in economic direction, say observers.

First of all, though, the incentive system which motivates local governments will have be dismantled and re-assembled from scratch, otherwise resistance to reforms will surely remain strong.

And, while job creation may no longer be the priority in southern and eastern China where labour markets are tight, the situation seems different in inland provinces.

In these less-developed regions of China, jobs are in shorter supply and income levels are lower.

PTA, polyester and other plants might, therefore, continue to be built, for social rather than just economic reasons in China in these inland provinces.

Assessing petrochemical project activity in China has never been easy.

Working out which project will be built and which will be scrapped has suddenly, though, become even more complicated because of China’s new economic direction.  

With additional reporting by Becky Zhang.

Read Paul Hodges’ Chemicals and the Economy blog
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By: John Richardson
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