Supply Constraints Should Mean A Healthy China

By John Richardson

THE extent of the weakness in China ‘s polyolefins market has become more apparent as a result of reports that a much-anticipated increase in Middle East production hasn’t happened.

Back in February, oil production in Saudi Arabia had been raised to 8.9m barrels a day from around 8.5m barrels in January, a Middle East industry source told the blog.

This was in response to the unrest in Libya , and elsewhere in the Middle East , that had driven crude prices to levels viewed by OPEC as threatening the global economic recovery.

“However, it quickly became obvious that the extra oil being produced by Saudi wasn’t helping the market as it was sour, whereas the shortage was in the light, sweet crude that Libya produces,” the source added.

Saudi oil production was therefore cut back to 8.4m barrels a day in March and 8.6m barrels a day in April, he said.

The result was that the country’s petrochemical producers, who have suffered from reduced associated gas supply since early 2010, did not receive the expected increase in feedstock.

“Crackers in the Kingdom, are as a result, still running at operating rates of approximately 85% – the same as in Q4,” he added

If all the crackers were running at 100% this would amount to 1m tonnes of more ethylene production – or one additional worldscale plant.

And when you add this to the 4% reduction in ethylene production by Sinopec in April and the 10% reduction reported to have occurred in May, markets should, if growth was strong, be in a lot better state.

The Asian cracker turnaround season is also still in progress, albeit nearing its end – and we are picking up reports of further logistics problems that are constraining exports from the Middle East.

But last week saw a $10-30/tonne fall in polyethylene (PE) prices in China , according to our colleagues at ICIS pricing – despite this pretty favourable supply scenario.

Polypropylene (PP) prices were flat as buyers retreated to the sidelines on the volatility in crude and a further increase in China ‘s bank-reserve requirements.

And a we reported last Friday, inventories are building in the Middle East, and perhaps, elsewhere, on weak China buyng.

Inflation fell only marginally in April – to 5.3% from 5.4% in March – indicating that further interest rate rises might also be on the way.

A further cause for alarm is that the reason why Sinopec has been forced to cut back on petrochemicals production is related to inflation.

This is not to do with weak petrochemical demand (the state-owned giant never cuts back on production for demand reasons), but is instead down to the need to prioritise gasoline and diesel production.

Refiners have been cutting back on fuel output because government price controls have prevented them from fully passing-on higher costs of crude.

A further factor behind this latest diesel shortage – following the one last December that also led to petchem production cuts - has been the switch to diesel-fired generators by manufacturers of finished goods. Diesel generators have been switched-on because of reduced supply from coal -and hydro-based power facilities.

One could argue that reduced industrial production on the constrained power supply we first reported last month  is good news for inflation.

But from a petrochemicals perspective we are coming up to the peak manufacturing season – when petchems are normally imported in great volume for re-export as finished goods to the West in time for Christmas.

Here are a couple of suggestions for chemical company CEOS:

1.)Do you really want to nail your reputations on forecasting a strong Q3 based on China ?

2.) Shouldn’t you be a little cautious on how you explain any good second quarter numbers your companies report, as they might have been distorted by pre-production and pre-buying in order to beat the China credit crunch.

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