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China In 2014: Some Predictions

China, Company Strategy, Economics, Naphtha & other feedstocks, Oil & Gas, Polyolefins, US
By John Richardson on 30-Dec-2013


By John Richardson

Succesfailure30December2013IT was a year to remember, for the right reasons, for anybody who bet on a recovery in Chinese polyethylene (PE) demand.

Back in May, it was all doom and gloom. But since May, thanks to a surge in the availability of credit, apparent demand (local production plus imports) has bounced back.

What of 2014?

The blog thinks we are at a major turning point in macroeconomic policy that will have major implications for China’s PE markets – and, also, many other petrochemicals markets.

Expect a more volatile year, where the environment will be much less benign and, thus, fraught with more risks.

These risks include:

  • A shortage of trade finance. As efforts are made to control the shadow banking system, small business, including many of China’s higher-value plastic processors, may end up unable to obtain working capital, when, in fact, the government really wants to reduce the flow of preferential credit to inefficient state-owned enterprises (SOEs) – and not the “good guys”. Something drastic has to be done, as these articles from the New York Times and the Wall Street Journal indicate.
  • But also expect further sudden policy reversals as nobody really knows how to get from Point A – a dysfunctional, SOE-dominated economy to Point B – where the private sector innovators are truly allowed to thrive.
  • Thousands of plastic processors might, on the other hand, be deliberately starved of credit for strategic reasons, rather than because of policy error.  “I think it is quite likely that thousands of converters, which make low value products, will be allowed to go bust before the Chinese New Year [31 January]. The government is no longer prepared to write a blank cheque for any inefficient company in any industrial sector,” said a polyolefins industry source.
  • As credit becomes more unpredictable and harder to come by, prepare for the risk of China’s real inventory levels becoming a lot more obvious. Anecdotal reports have persisted of low stock levels amongst processors, but this does not marry with the 14% apparent demand growth seen in January-October 2013 and estimates of underlying, real demand growth for the full year of only 4-6%. Prepare, therefore, for a potentially very disruptive destocking process.
  • The closure of converters could be followed by an M&A wave amongst the smaller, remaining low value processors. Major distributors may be involved in consolidation through moving into manufacturing, added the industry source.
  • The government, in its radical reform blueprint released in November, pledged to get rid of “regional and bureaucratic protectionism”. Part of this process could involve the gradual dismantling of China’s ten or so regional PE markets, resulting in fewer opportunities for traders to make money through arbitrage between different provinces.
  • 2014 is likely to be another year of declining GDP growth. The economy expanded by 7.7% in 2012 and is expected to have grown by 7.6% in 2013, which would represent the slowest rate of expansion since 1999. All the indications are that this trend will continue into 2014 as a result of economic rebalancing.
  • But PE demand growth won’t necessarily decline in line with lower GDP because of “catch up growth” in China’s various regions. The country is, in, effect, 20 or so different micro economies.  2014 could mark the year that people just about give up on using GDP as a reliable measure of PE demand growth.
  • China could, therefore, become a market that requires more investment in good on-the-ground regional market intelligence and distribution networks in order to make money out of these micro-economies.
  • Might 2014 also mark the year when China erects more trade barriers in order to protect its domestic producers? We suspect not, as we think a more likely scenario is post-2017, when most of the new US capacity is due on-stream and China has substantially raised its local production. The rest of Asia may follow suit as petrochemicals markets become more regional.
  • Or is it better to try and share the successes of your competitor? 2014 may instead see more Chinese distributors and traders setting up networks in the US, ready to off-take all that cheap US PE and polypropylene (PP) post-2017. This year has already seen a flood of such investments.  Those with the best knowledge of China’s complex market – i.e. the Chinese traders and distributors – could well be the ones who leave the least money on the table.
  •  Might US producers head-off this risk by setting up strategic partnerships with major Chinese distributors?