By John Richardson
CHINA'S decision to temporarily halt lending by some banks - which was announced yesterday - as it attempts to further cool the economy will likely have a significant effect on chemicals demand and pricing.
This follows last week's decision to raise bank reserve requirements and two increases in the inter-bank lending rate in the space of just one week earlier this month.
"The last time China tightened liquidity in 2007 we saw a dip in polyethylene (PE) imports. The imports fell to 4.6m tonnes in that year from 4.9m tonnes in 2006," said Mazlan Razak, Kulua Lumpur-based petrochemicals consultant with DeWitt & Co.
Traders have used easy lending conditions to speculate in polyolefins, other commodities and real estate, boosting sentiment, adding to overall consumption, he added.
China's huge increase in bank lending has led to traders in chemicals and polymers sometimes only buying a particular cargo in order to get their hands on credit so they can speculate elsewhere, a Singapore-based polyolefins trader told us late last week.
"This has led to some chemicals and polymers cargoes being sold at below cost because sufficient profits have been made in other commodities," he added.
"It's also worked the other way round - i.e. somebody raising credit through buying another commodity because his main objective has been to speculate in chemicals and polymers."
This is a view shared by the Shanghai-based chemicals information service, CBI China.
The fall in local equity markets in response to the latest tightening announcement will - if sustained - have a negative wealth effect, leading to less consumption of finished goods.
And yesterday's announcement of a moratorium on some new lending could affect the overheated property sector.
Stronger chemicals and polymers demand has been partly the result of people buying homes - sometimes for speculation or just to get in before costs have gone higher.
The improved demand was through the pick-up in construction and furnishing new homes - for example, kitchen utensils.
Credit to sustain last year's huge improvement in auto sales may also become more limited.
But with China needing to sustain strong consumption growth as it attempts to rebalance its economy, and for reasons of social stability, the government might need to take some steps to sustain consumption - particularly in the property sector.
On other hand, if inflationary pressures get worse necessitating a deposit and/or lending rate rise, a dip in final demand for chemicals seems unavoidable.
Rate rises would likely be accompanied by a strengthening of the Yuan - a further disincentive to the speculation in chemicals and other commodities that's been drive by the desire to maximise local currency earnings. The motive has been to generate as many Yuan as possible in order to switch to US dollars once an appreciation occurs.
A gradual appreciation seems likely from the current rate of around Yuan6.8 to the US dollar with the betting on a final medium-term target of Yuan4.8.
Morgan Stanley has predicted a possible 3 per cent increase in the value of the Yuan this year so you can imagine some investors cashing in on their speculative earnings when and if this occurs. Others might hold on for further increases.
A stronger Yuan would also weaken export competitiveness and possibly import volumes of chemicals and polymers for re-export as finished goods.
Chemicals and polymer pricing (see chart below as an example) has been driven up tight supply and higher feedstock costs in the early weeks of this year.
The outlook for supply remains exceptionally uncertain with production problems likely to continue. On the supply side, therefore, a strong argument has been made for continued tightness.
But with crude already weakening on China's credit tightening, the growth in US stockpiles and warmer weather in the northern hemisphere, this could well give chemicals and polymers end-users a bit more leverage.
Last week's dip in crude, and therefore naphtha, has already resulted in a fall in benzene by $30/tonne to tonne to $1,020-1035/tonne FOB Korea, according to the ICIS pricing assessment for the week ending 15 January.
While naphtha and benzene spreads and therefore margins have been spectacular and overall cracker margins excellent - with cracker-polyolefin margins also very good - the end-users we've spoken to have complained about their own contrasting poor profitability.
Sentiment was already pointing to possible price corrections in Middle East polyolefins with oversupply creating short-term bearishness in paraxylene, my fellow Asian Chemicals Connections blogger Malini Hariharan wrote in a post earlier this week.
And as one senior polyolefin industry source commented following last week's announcement of an increase in the bank reserve requirement, prices had "paused for breath" after their strong New Year rally.