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China’s Chemicals Strategy: More Complexity

Business, China, Company Strategy, Economics, Environment, Naphtha & other feedstocks, Olefins, Polyolefins
By John Richardson on 19-Nov-2015


By John Richardson

THE more that things change to some extent the more they stay the same in China. This is adding another layer of complexity to forecasting where the country’s chemicals industry is heading.

Take this article from the New York Times as a great example, where an astonishing 155 coal-fired power plant projects have received construction permits this year.  They have a capacity equal to nearly 40% of operational coal power plants in the United States.

This is despite the fact that, of course, central government officials are attempting to tackle what is nothing short of an existential environmental crisis.  It also despite the fact that in 2014, thermal power plants, mostly coal-fired, operated an average of 4,706 hours, 314 hours less than in 2013, according to the National Energy Administration. This was the result of a slowing economy and thd switch to other sources of electricity generation, such as renewables.

So what’s going on? As the NYT writes:

China’s state-controlled economy creates strong incentives for provinces to manage their own energy sources to generate jobs and revenue. Coal plants have long been the easiest, fastest way for provinces to meet their own energy needs and stimulate local economic growth.

Provinces have an economic interest in keeping coal-fired power generation close to home, despite concerns over air pollution. Provincial state-owned enterprises running the plants have a guaranteed source of revenue. Also

, officials can tax coal power plants but not renewable-energy projects. And plant construction improves economic growth, an important measure in evaluations of provincial officials.

During the pivotal 4th Plenum meeting in November 2013, Beijing pledge to dis-assemble and rebuild from scratch how local governments finance themselves.But this is clearly still work in progress. Local governments still have strong incentives to build a manufacturing or power plant for the sake of building a manufacturing or power plant. This is because a vital source of their funding remains selling the land to industrial developers, along with gaining tax revenues when plants are running.

It still doesn’t seem to always matter if a plant runs at only an operating rate of say 50%, which is the average operating of polyvinyl chloride plants in China. Fifty per cent is better than no percent towards meeting local healthcare and education costs etc. More attention to supply and demand balances and cleaning up the environment are great in theory, but what about the practice?

Economic reforms were always going to be one step forward, or one sometimes one step forward and two steps backs, given China’s size and its many layers of government. Hence, approval has been given to build the 155 new coal-fired power plants. Why not also more unneeded chemicals plant in already oversupplied sectors of the industry?

Perhaps this latter point is a stretch, but at the very least it is difficult to envisage existing chemicals plants shutting down in oversupplied parts of this business because, as I said, they generate important tax revenues. Closing the plants down would also cost jobs as the overall economy slows down, and so this is another reason to think that this won’t happen. And if the plants are brand new, and so world-scale, such as in purified terephthalic acid, closure seems even more of a stretch.

Take this is a step further and let’s think about chemicals and polymers where China remains in deficit (there are not many of those left).The biggest deficits of all by volume are in polyethylene, as the above chart demonstrates.

We expect imports to total around 9.3 million tonnes this year. In January-September, the actual volume of imports was 7.4 million tonnes and so our estimate seems pretty reasonable. Under the 13th Five-Year-Plan (2016-2020), full details of which have yet to be released, Beijing might decide to carry on importing some 40% of its PE needs.

But relative to the cost of naphtha, PE is very expensive these days. Money is thus being transferred into the hands of foreign companies.There is an argument, though, that all that China has to do is wait two years or so and there will be plenty of cheap PE around when the new US capacity come on-stream.

What if, though, China buys the argument, which I heard expressed at this year’s Gulf Petrochemicals and Chemicals Association, that all the new US PE will be very easily absorbed into the global market? In that case, the spread between both ethane and naphtha-based PE would remain very good and China would end up handing money over to foreigners for a lot longer than just up until 2017-2018.

China might instead decide to further monetise its coal reserves, in the way it already done in polypropylene. Coal is just $20 a tonne and it is a very competitive feedstock indeed, even though oil is only around $50 a barrel.

And getting back to my point, building more coal-based PE plants, or even naphtha crackers, might end up being a “win, win” for both the local and central governments. Local governments would get much-needed revenue from lands sales and taxes, and Beijing would get to use coal-to-PE to help close the gap between income levels in its western and eastern provinces.