Market outlook: China’s internet sales explosion could spur LLDPE and other polymer volumes

High-speed connectivity and discounts are driving internet sales imaginechina/REX/Shutterstock

Just as hundreds of millions of people in the developing world went straight to mobile phones, bypassing landlines, so looks set to be the case for internet sales in China’s second- and third-tier cities.

Second-tier cities include Tianjin, Chongqing, Chengdu, Wuhan and Xiamen. Hangzhou and Chongqing are among the cities that fall into the third-tier category.

The potential in these cities for the equivalent of the jump straight to mobile phones stems from the fact that many lack major networks of smaller, neighbourhood shops. This is unlike first-tier giants including Beijing and Shanghai, where it is difficult to walk more than a hundred metres without coming across a Seven Eleven, or some local equivalent.

If you want quality packaged food that has been prepared with high food safety standards in many of these smaller cities, you have to travel considerable distance to a city or suburban shopping centre, and quite often you will not own or have access to a car. Food safety is a big problem in China, partly because of what are often poor food-preparation standards – thus, the expected explosion in online grocery sales in these less-developed cities.

The same lack of easy access in these second- and third-tier cities applies to durable goods, meaning there is also the expectation that there will be similar rapid growth in internet purchases of everything from washing machines and refrigerators to furniture.

This does not mean to say, however, that the potential for online growth in China’s biggest cities is not also very strong, given this startling estimate: buying anything online in China is some 50% cheaper than buying the same product in a shop.

The cost of running a conventional retail business in China has soared in recent years as a result of more expensive land and rapid increases in wage and welfare payment costs. This helps explain this big cost differential between buying from a shop versus online.

CHINA’S TAXATION CHALLENGE

Buying online in the US is in comparison said to be only around 10% cheaper than visiting a Walmart or other major retailer.

Another edge that China’s online businesses enjoy over those in the US is access to excellent infrastructure. China has spent literally trillions of dollars on upgrading road and rail links.

This compares with the consensus view that ageing US infrastructure is in dire need of investment.

The Chinese government-driven concept here has been to build roads and rail links ahead of demand – that is, quite often in remote inland regions with small local economies. This has created more jobs and thus stronger economic growth.

And then there’s internet speed. Connectivity in China’s smaller cities is described as very good, whereas as in Shanghai, it is outstandingly quick with lots of bandwidth.

IMPLICATIONS FOR POLYMERS

This might be fantastic long-term good news for the polymers business. Many of these additional internet sales will either be made of plastic or packaged in plastic, or both.

It is possible to therefore build any number of upside scenarios to the ICIS Analytics & Consulting “base case” – or medium case – scenarios for growth in polymers demand in China over the next 10 years.

The upside potential for linear low density polyethylene (LLDPE) could be particularly large from an internet sales explosion because LLDPE is heavily used in food and durable goods packaging.

But caution is also in order, especially over the next few years as China attempts to make the difficult transition from an investment-led to a services- and consumption-led economic growth model.

For every additional roll of LLDPE film needed to wrap online sales, there could be one or more rolls of film sales lost due to millions of job losses in oversupplied industries such as steel and coal. Laid-off workers will obviously be cutting back on their spending.

We also do not know whether the service-based growth model will be able to solve one of China’s major problems – how to raise enough tax revenue to pay for its rapidly ageing population.

China has to greatly improve its tax collection system, and then needs to make use of these extra revenues to boost pensions and healthcare provisions.

SELF-SUFFICIENCY VERSUS IMPORTS

Until or unless this happens, the propensity to save rather than spend will be high because of the lasting impact of the One Child Policy. The policy means that Chinese people are saving to pay for the pensions and healthcare of a rapidly rising number of elderly people.

Here are some examples of the shortfalls in China’s current state pension system:

■ China’s basic pension pays just 1% of average individual/province earnings for each year of coverage, subject to a minimum 15 years of contribution, according to the Organisation for Economic Co-operation and Development (OECD).

■ Some employees also pay 8% of their wages into a retirement fund and receive top-up annuities based on individual savings, but this only covers 210m urban employees, added the OECD.

State healthcare coverage is also very poor to the extent that if you don’t have enough money, you are often unable to afford hospital treatment.

One of the problems with China’s tax collection system rests with local governments, which are responsible for a significant percentage of welfare payments.

They have traditionally raised money for these services by acquiring land at cheap prices from rural residents and reselling the land to real estate and industrial developers.

But this model no longer works because of the shift away from the failed investment-led growth model. This way of raising local government financing has contributed to vast oversupply in real estate and manufacturing.

Another problem is that the slowdown in the economy is reducing central government tax revenues. For example, the money raised from the value-added tax (VAT) has fallen due to the deceleration in industrial activity.

The jury is also out over whether the corporate tax boost from internet sales will be sufficient to replace all the taxes lost from the closure of factories in oversupplied industrial sectors – and what is also bound to be a slimming down of the conventional retail sector.

And because the cost of each internet sale will be lower than the equivalent sale through a high street store, this obviously represents another downside risk for tax collection.

A significant percentage of internet payments in China are also made by cash on delivery, which raises the potential for tax avoidance by the internet companies.

Anyone exporting polymers to China must also consider to what extent China will decide to further raise its levels of self-sufficiency.

Following aggressive local capacity expansions, it already has big surpluses in polyvinyl chloride (PVC) and polyethylene terephthalate (PET), and has thus switched from being a major importer to being an exporter.

In polypropylene (PP), local capacity will have been raised by 163% from 2009 until the end of 2016, according to ICIS Analytics & Consulting. This will lead to capacity as a percentage of local consumption increasing from 63% to 99%.

The prospects for all grades of PE look more promising. Capacity will only have increased by 50% between 2009 and 2016, with capacity as a percentage of consumption edging up from 54% to 68%.

Last year, also, China imported no less than 9.9m tonnes of PE, up from 7.4m tonnes in 2009, according to the China Customs department. However, China has abundant coal supplies with which to add more PE capacity via the coal-to-olefins (CTO) route.

Building further PE capacity might also be a great way of stimulating growth as economic reforms continue.