By John Richardson
THE blog has sought to add to the debate during the four years it has been operating by thinking around the big macro-economic issues, and constantly keeping in touch with our market contacts at “ground level” in the petrochemicals industry, in an attempt to assess where markets might be heading.
We haven’t always been right, of course, but we have tried to apply a healthy dose of scepticism to whatever “angle” that traders, producers etc have been selling in an effort to convince everyone of a particular direction in pricing or demand.
And thus, over the last few weeks, we have questioned the “recovery” story being told by the financial analysts, and some of the traders and producers, concerning post Lunar New Year demand in China. As always, we have been focusing on polyolefins as a pretty reasonable bellwether for the industry as a whole.
The logic of the financial analysts covering the chemicals sector seems on the surface pretty solid.
Last year was an exceptional year as it was one of huge destocking and lack of confidence in the global economy and in the direction of oil prices, they argue. Thus, for the first time that the blog can remember, ethylene equivalent demand growth in China – at around 0.5 percent – was way below GDP (gross domestic product) growth of 9.2 percent.
It cannot not continue, is the foundation of the bulls’ argument, as:
*The Chinese government has adopted a new pro-growth strategy after last year’s tightening of lending conditions.
*Polyethylene (PE) inventories were “critically” low, as the slide below from a recent Morgan Stanley report illustrates, and so substantial restocking has to take place. The slide, as you can see, also draws a close correlation between days of inventory held and bank reserve requirements. Thus, as bank reserve requirements are further relaxed, it is assumed that the willingness of converters to stock-up will increase.
The market will further benefit from tight supply as a result of very few cracker and derivative capacity additions over the next four years, add the analysts and the producers.
Equity prices have already priced in a strong post- Lunar New Year recovery. For instance, South Korean petrochemical stock prices were recently 50 percent higher than their Q4 2012 lows. But as one analyst told us this week, “share prices might be up, but we haven’t seen any major revisions in earnings per share estimates,”
The reason is that as we predicted, the real recovery is not happening – and not might well not happen at all this year. This story from ICIS news supports our view. It points out that in the China polypropylene (PP) market:
*Downstream converters are still coping with tight credit, despite talk of a renewed “pro-growth” strategy. Fellow blogger Paul Hodges, in this post, argues that the government’s priorities are job creation, raising wages and reducing food-price inflation rather than re-stimulating the economy. Thus there can be no major relaxation of lending conditions. And contrary to what we suggested on Tuesday, Hodges believes that even if 2012 GDP growth threatened to crater, the government would not be able to launch a big new stimulus package, as rebalancing the economy is now more important than headline GDP numbers. This view is supported by this article from The China Daily.
*The converters are struggling with higher labour costs. This again fits with the government policy of raising minimum wages by 13 percent per year in 2011-2015. The small and medium-sized enterprises, which make up the bulk of chemicals and polymers buyers in China, are likely to be further hurt by the shift towards more collective bargaining in wage negotiations.
*Many workers have failed to return from countryside to the eastern and southern provinces after the Lunar New Year, providing another reason for the converters not to ramp-up production. “We have been talking about this type of labour-supply problem for three years, but only now has it become really significant. Workers are remaining in their rural homes because of the success of government efforts to boost income levels in western China,” said an senior executive with a global polyolefins producer.
A further factor that must be affecting the sentiment of the converters is Greece. It looks as it if it is stumbling towards a debt default by March. Greece could be followed by Portugal, Italy etc – which, of course, would severely damage China’s export trade.
Levels of uncertainty are so extreme at the moment that you can envisage oil prices falling to $50 a barrel, or even lower, or for geopolitical and speculative rather than demand reasons reaching $200 a barrel. Many converters in China closely follow the oil price because they often don’t have the resources to build-up a clear picture of what’s happening in petrochemical markets. Given the uncertainties over crude, why on earth would any end-user want to “stock up”?
What has been interesting to observe over the last few weeks, as the recovery has failed to kick in, has been the stories circulating in the market to justify why it is still only just around the corner. These have included:
*Four previously unreported PE turnarounds in China. These shutdowns do not substantially change the ICIS estimate, made earlier this year – that 2012 lost ethylene production will be around 50 percent less than last year because of a reduced maintenance schedule, we have been told.
*The recent outage at the Al-Jubail complex in Saudi Arabia. Despite some customers being reportedly placed on allocation, a source with a North American headquartered PE producer told us this week that the outage has had “no affect whatsoever on the market because demand is so bad”.
*Claims that a heavy turnaround schedule in the Middle East has also tightened the market. The data that we have seen indicates very few shutdowns in the region during Q1.
One theory about a recovery in PP that might have some credence is the extent to which supply-chain disruptions caused by last year’s Japanese tsunami and the Thai floods firstly negatively affected demand. As Japanese production returns to normal and Thai auto output also ramps up, demand for PP could rise.
But this will not be entirely “real demand”,as it will in part be demand for PP from auto makers refilling their supply chains. Real demand will only become clear as the impact of global economic problems on auto sales becomes more apparent.
And the danger is that a recovery in propylene co-product credits might tempt Asia’s naphtha-cracker operators to run harder at the expense of ethylene derivatives. It was co-product credits from C3s and butadiene that supported the naphtha cracker players in Q2-Q3 last year, until everything turned bad in the fourth quarter.
Butadiene has already bounced back, and so the temptation to run naphtha crackers a little harder might already be there.
There is a palpable sense of panic out there as the “recovery” story, week by week, loses steam.
“Ninety five percent of China’s plastics processing business is short of money because of tight credit and higher wage costs. Demand is also weak because of the export situation. I can’t see any reason why this is going to change for the rest of this year,” added the senior executive with the global polyolefins producer.
Where, therefore, is the predicted rebound in polyolefin consumption, and in pricing, going to come from?