INSIGHT: China’s PP capacity growth challenges past assumptions

By John Richardson

PERTH (ICIS)–It is time for a great deal of honesty and courage in the boardrooms of all the world’s polypropylene (PP) producers. People need to stand up and ask their CEOs, “Did we see this coming? If not, why not? What do we do next?”

Source: ICIS Consulting

What the above chart shows is that between 2009 and 2016, ICIS Consulting expects China’s PP capacity to increase by 163%. This would leave capacity almost the same as consumption by the end of this year.

If you missed this capacity build-up, it is likely that this was the result of too much adherence to conventional thinking. That conventional thinking was that China would not build many of the PP projects it had planned on paper because of poor cost-per-tonne economics.

This kind of analysis overlooked the need to stimulate domestic economic growth in order to compensate for the Global Financial Crisis. This involved huge expansions of manufacturing capacities in general.

If this mistake wasn’t bad enough, some people then thought that China’s PP plants wouldn’t run that hard once they had been built – again because of poor cost-per-tonne economics.  In 2015, though, China produced 18m tonnes of PP – an 18% increase over 2014, according to an ICIS Consulting estimate.

On the other hand, China’s PP imports remained resilient in 2015 thanks to stronger than expected demand growth. Imports totalled 4.9m tonnes, only slightly down from 5m tonnes in 2014.

Still, though, the smart global PP producers out there would have been busy adjusting their sales and marketing strategies just in case Chinese imports registered a much sharper decline in 2016.

This is what has happened, as in Q1 of 2016 over the same period in 2015 imports fell to 1m tonnes from 1.3m tonnes. These were the lowest first quarter import figures since 2009, when Chinese PP consumption was a great deal smaller.

The fall in imports occurred as local production once again increased: In Q1 2016, ICIS China estimates that it was at 4.2m tonnes compared with 3.7m tonnes in Q1 2015.

Exports were also up, albeit from a very small base – and they remain dwarfed by imports. Chinese PP exports were 58,000 tonnes in the first quarter of this year, up from 40,000 tonnes during Q1 2015.

At the moment, it seems as if China is just feeling its way in PP export markets. There are reports, for example, of small Chinese volumes being shipped to Eastern Europe and Vietnam.

One of the issues that the exporters face is that end-users are not sure whether Chinese PP will meet their specifications, claim some traders.

And for the next few years at least, it seems likely that China will only play in lower-value grade export markets, as this is where most of their production is concentrated.

But it would be very dangerous to assume that all of the above will not change in the space of perhaps just a few years.

The Chinese government has a strong motive to push hard on manufacturing exports in general through providing more financial incentives to exporters.

Increased exports would help compensate for the slowdown in domestic growth resulting from economic reforms.

A key part of these reforms also involves moving up the manufacturing value chain. China could thus eventually move into production of higher-value grades of PP.

Some positive news, though, is that demand growth in the rest of the emerging world looks set to remain robust, both in the short and long term.

But volume-wise every other developing country and region is smaller than China – and will stay that way for many years to come, using any realistic estimates of growth rates.

This applies to imports as well. For full year 2015, the whole of the Asia and Pacific region imported 2.8m tonnes of PP compared with China’s 4.9m tonne.

Another issue is the deflationary effect on Asian pricing caused by growing Chinese PP supply – and the growth in Chinese propylene supply as well.

Spot propylene prices in Asia have collapsed compared with their 2009-2014 average, a substantial reason for which is new on-purpose propane dehydrogenation (PDH)-based propylene capacity in China. Spot propylene prices largely set Asian PP prices.

This also raises an intriguing possibility. Might new opportunistic standalone PP plants be built because of propylene markets that look set to remain long for the next few years?

Standalone PP plants are plants that have to buy propylene on the open market, as they do not have any of their own upstream propylene production.

Far-fetched? Perhaps, but standalone PP margins are performing exceptionally well right now, according to ICIS estimates, and are expected to remain strong well into next year. You should at least, therefore, build into your planning the possibility of higher-than-expected operating rates at existing standalone plants.

A steep fall in global propane prices are also benefiting those PDH producers who not only make propylene, but are also integrated downstream to PP itself.  Propane seems likely to remain very long, and so cheap, largely as a result of overproduction in the US.

To be positive again, though, the US PP market has become an excellent opportunity because of very tight local supply and demand balances.

And nobody should overlook the European PP market. In 2015, Europe imported 2.5m tonnes. Europe’s economic growth might well remain very low. But this import opportunity will continue to edge up, with little likelihood of significant European capacity additions because of competitive disadvantages.

Clearly, this is a much more complicated picture compared with just seven years ago, before China started its big ramp-up of PP capacities.

The great news, though, is that opportunities outside China are fantastic. But another big question to ask your board of directors is this: Have we the strategy already in place to take fully advantage of these opportunities outside China?