By John Richardson
Whilst most people are coming around to the sensibel view that iron ore demand growth will never be the same again because China’s recent economic growth story was a “historical one off”, PE is being seen as different
This quite commonly held argument is outlined in a new Bernstein report entitled One of These Commodities Is Not like the others: (Hint: It’s Polyethylene). Bernstein makes the following four points in a full report only available to media and clients:
- Regardless of how much more China’s economy slows down on problems with its manufacturing sector over the next few weeks, years, or even decades, the Chinese consumer will still need lots and lots of plastic bags because they are cheap, easy to transport and a great way of preserving food.
- PE is also tied to consumption, and not investment, and so its long term future is bright as China rebalances it economy away from investment and towards consumption.
- The plastic hasn’t grown as stratospherically as iron ore and copper etc. and so it has less room to fall. Instead, it has relatively plodded along, growing in line with GDP in China – in fact Bernstein finds that there is a very high correlation between China’s PE demand growth and its increase in GDP. So provided GDP doesn’t go negative over the long term, which I agree won’t happen, PE will be fine.
- Whilst the US has reached saturation point in PE consumption – i.e. most people are using as much plastic as they can possibly ever need – China is still catching-up to the US and other developed countries. This room for catch up can easily be measured by looking at the big gulf between per capita consumption in the US and China.
Reasonable people can disagree, and so here are my four responses to the points made by Bernstein:
- That’s right, people in China will still needs lots more plastic bags over the next few weeks, years and decades. But the big question that investors need to ask is “Who will supply the PE resins for these bags?” I believe there is every chance that China will move to self sufficiency in PE as it further rebalances its economy. Just look at what is already happening in polypropylene as a guide to the future. Production of increased quantities of lower-value PE grades in western China makes sense in order to create lots of further basic manufacturing jobs. In the developed east the focus will instead be on the higher value grades as China tries to escape its “middle income trap”.
- Yes, PE is tied to consumption, but also investment as well. Lots of plastic film and other packaging is used by manufacturers of TVs, refrigerators etc., and these sales are undergoing a long term, secular decline in the West because of demographics. And in China, you will see nothing like the growth rates of 2008-2013 because of the end of the artificial “wealth effect” created by the economic stimulus package. PE is also used to wrap building materials, and is used to make kitchenware when people kit of their new homes. The slowdown in China’s real-estate sector is thus having a significant negative effect on growth in some PE end-use applications. The 2008-2013 real estate boom in China will again never be repeated.
- Yes, there is a close link between GDP and PE, but I would argue that credit cycles are also important. In 2009, for instance, during the height of the lending boom, China’s PE consumption rose by more than 25% before falling to growth in line with GDP in 2010 and below the rate of GDP in 2011 and 2012. True, a lot of these distortions were down to a surge in apparent demand (imports plus local production) as traders built up stocks in order to make money out of “collateral trading”. But you need to calculate how much of these numbers represent a temporary boost to end-user demand through excessively easy consumer credit conditions that can never been repeated. For example, look at how autos sales have surged and fallen. Auto components are wrapped in PE and high-density PE is used to make fuel tanks.
- Yes, absolutely on a per capita basis China is miles behind the West. But China will want to do “more with less” for environmental reasons because of its huge plastic rubbish problem. This is tied into moving into higher value linear-low density metallocene-grade production, as these grades allow downgauging – i.e. using less plastic resin to use the same quantities of plastic film. Two of the reasons why the US has reached saturation point in PE, and has been there for many years, are recycling and downgauging.
There are other complications, which for me will make the future very close correlation between GDP growth and PE demand growth less likely.
On the upside, these include people increasingly buying more food wrapped in plastics, and wrapped in more sophisticated better quality “barrier resins”, because of food safety concerns. You could, as a result, actually see PE growth in some developed provinces of China rising above increases in GDP .
What further muddies the outlook is the ambiguity over which producers would benefit from PE growth in excess of GDP.
Let’s assume I am wrong about China moving to self sufficiency on PE. Instead, the Chinese government might decide it makes more strategic and economic sense to continue importing lots of PE. The US might in such an event find it quite easy to find an export home for most of its expansions which are due on-stream after H2 2017.
This does not preclude China exporting ever-greater quantities of finished plastic products as part of its job creation and “value addition” drives. For every extra tonne of resin that the US and other exporters manage to sell into China, they could end up with a lost tonne-and-a-half of sales in their home markets because of greater Chinese exports of finished plastic products.
As you can see, though, it is not all doom and gloom for the PE industry and for any other commodity chemicals or polymer producer that makes the right strategic choices. But success isn’t going to be as easily achieved as in the past.