JanNaphtha2015

By John Richardson

A COMMENT I have heard so many times over the last two months is that once oil prices settle down, China’s petrochemicals buyers will have to come back in large numbers in order to replenish what must be, by now, very low inventory levels.

For example, last month I was told: “If oil stays at around $55 a barrel for a couple of weeks, our customers will have confidence to come back into the market in big numbers.”

What worries me is that this kind of thinking might well have led producers to run plants at too-high operating rates in anticipation of a recovery that might not happen in 2015 on the scale that has been anticipated.

And, of course, anybody who bought naphtha when crude was far higher than where it is today is likely to be sitting on substantial inventory losses.

Now that oil has breached the $50 a barrel level, how low might it ultimately go? A decline of another $20 a barrel seems perfectly possible.

How did this happen? It was because too many people are still getting China wrong, as they see weak buying in the world’s most-important petrochemicals market as mainly the result of a supply-driven global collapse in oil prices.

But the single biggest reason for the collapse in crude markets can, in fact, be summarised in one word: China.

The writing was on the wall in late 2013 following China’s pivotal November Plenum. It should have been obvious from that point onwards that had China had entered a “New Normal”.

And to put this into a global perspective, it was clear from as early as February 2014 as to the scale of the economic correction underway, when I wrote:

China has spent far more on stimulating its economy since 2009 than the Fed – in fact, crunching the data a little further, when you add shadow lending, it has raised total credit from $1 trillion in that year to $10 trillion in 2013. This compares with Fed spending since 2009 of $2 trillion on Treasury Bonds and $1.5 trillion on Mortgage Bonds.

Another important milestone was reached in November 2014 when the government admitted that economic stimulus had resulted in $6.8 trillion in wasted investment since 2009. In 2009 and 2013 alone, “ineffective investment” came to nearly half the total invested in the Chinese economy during those two years, Beijing added.

And read this statement very carefully, which was issued at the end of  last December’s meeting of China’s policy-making Central Economic Work Conference. It once again underlines that the “New Normal” is well and truly underway in China.

Perhaps because politicians have such a poor reputation for sticking to their word in the West, too many petrochemicals companies have chosen to ignore what China’s new leaders were clearly saying. This could well prove to be a very costly mistake.

The biggest, boldest and most risky set of economic reforms in at least 20 years have resulted in not only the collapse in oil prices. Iron ore markets are a further indication of a monumental shift in China’s economic growth prospects.

Evidence that the China story is the real story behind the collapse in crude is building.

For example:

  • The International Energy Agency’s December report said that a “sharp slowdown in Chinese oil demand growth”, along with weaker growth in Europe and Japan, waas contributing to the weak outlook for oil.
  •  It estimated Chinese demand growth of just 2.5% for oil in 2014 and 2015, with gains in transport fuels and petrochemical feedstocks only slightly outweighing weakening demand for gasoline, diesel and fuel oil. Growth in China’s oil imports would be just 3% this year compared with 9% in 2014, said Citigroup.
  • “The oil market is unlikely to find another country, or even a continent, that can take over this degree of heavy lifting in demand growth. Meanwhile, longer-term forecasts that China can maintain anything close to its recent pace of growth increasingly look misplaced,” wrote Marketwatch columnist, Craig Stephenson.

The other side of the argument is that lower oil prices will eventually deliver big benefits to China’s economy – and, of course, the rest of the global economy. International Monetary Fund researchers have, for instance, estimated that falling oil prices could boost China’s GDP by 0.4 to 0.7% this year and by 0.5 to 0.9% in 2016.

But, on balance, the unwinding of China’s lending bubble is going to create far more harm than good in 2015.

So much for even more bad news. Where do petrochemicals companies go from here? Come and talk to ICIS about how to navigate a new strategic course through all the debris of failed expectations.

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