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Polyethylene The “Last Man Standing”. For How Much Longer?

Business, China, Company Strategy, Economics, Naphtha & other feedstocks, Oil & Gas, Olefins, Polyolefins
By John Richardson on 21-Dec-2015


By John Richardson

POLYETHYLENE (PE) remains almost the “last man standing”. Whereas most of the other chemicals and polymers markets in China, including phenol,  polyvinyl chloride and purified terephthalic acid, are mired in almost vanished imports and poor profitability because of severe oversupply, PE appears to be fine. Take the latest import and local production data for PE in China as an example:

  • In January-October 2015 on a year-on-year basis, total PE imports were up by 8% over the same period last year at approximately 8.3m tonnes.
  • Low density PE imports rose by 7% to around 1.8m tonnes.
  • Linear low density PE imports were 3% higher at approximately 2.2m tonnes
  • But the real star performer, as has been the case throughout this year, were shipments of high density PE (HDPE). They were up by 12% at around 4.3m tonnes.
  • China’s PE production in January-November 2015 increased by 5% compared with the same period last year, to approximately 12.3m tonnes, according to ICIS China.

Profitability also remains historically very strong. Northeast Asian integrated naphtha-based variable cost HDPE margins have, for instance, averaged $505/tonne in 2015 up until 18 December, according to ICIS Consulting. This compares with $245/tonne for the whole of 2014 and just $130/tonne for 2013.

What is going to happen next in PE?

To answer this question you firstly have to understand all the variables out there. You must then build scenarios around these variables whilst also being aware that the scenarios will need to be constantly revised.  We are going through a period of exceptional volatility, uncertainty and ambiguity and so you cannot allow your knowledge of how markets function to remain static.

In this context, let’s again look at this latest import data and production data and consider what it might or not might mean for China’s PE market in 2016.

One theory is that real, final demand growth for PE is pretty much immune from the slowdown in the overall economy. Reasons given for this include increasing purchases of packaged food because of rising food-safety concerns (a theory that is now several years old) and a surge in demand for HDPE gas pipes because of government infrastructure spending.

But many of China’s plastic converters are reported to be running at operating rates of just 50%. This applies to both the low value and high value processors – e.g. those making cheap components for plastic toys and those making sophisticated multi-layer films for state-of-the-art food packaging.

The problem, as with so many other industries in China, is that plastic processing is oversupplied as a result of overinvestment during the 2008-2013 economic stimulus programme.

Based on the Western concept of economics, this oversupply combined with 50% operating rates should result in consolidation and so a dip in apparent demand (imports plus local production) in Q1.

But central Communist Party officials have toured the provinces and told local government officials in no uncertain terms not to allow processors to close down. The “damage limitation” exercise that I have been discussing for over a year is well underway in plastic processing and other industries as well. The legitimacy of the Communist Party largely rests on it being able to prevent economically and socially disruptive levels of unemployment.

Local government officials have, by the way, been told that if they provide financial support to loss-making plastic converters, they will receive compensation from Beijing.

You can therefore argue that if these processors keep on running in H1 2016, thanks to soft local government loans, they will still need more imports – especially if this cheap financing allows rates to be pushed higher than 50%. OK, too much processing supply might be chasing too little demand, but the sheer number of extra processors that have started up plants recently guarantees that import growth will remain strong – a long with the growth in local production.

Not necessarily because the current 50% operating rates mightalso  indicate that final demand for plastic goods is weaker than many people think. Perhaps a slower economy is major factor behind the low production levels of PE converters, as well as oversupply. This would marry with the evidence from other polymer markets.

This would mean that some of the rise in apparent demand that we saw in January-October went into inventories of PE resins being held by processors, traders and distributors.

There is also plenty of anecdotal evidence to support the notion that the processors, traders and distributors bought ahead of immediate demand up until around of October on the theory that oil prices had bottomed out.

But since then what I have long believed would happen is happening: Crude prices are returning to their long-term average price of $33 a barrel now that central bank stimulus has been sharply curtailed.

Nobody knows at what price the oil market will bottom out. Is it $25? Why not $10-15 a barrel? The oil market might not find its bottom until well into 2016. This could well result in China’s PE buyers keeping their purchases to a minimum in an attempt to avoid being on the wrong side of further falls in oil and then of course PE prices.

Let’s assume, though, that my first point is wrong and that the strong growth in apparent demand that we have seen so far this year has gone into end—use demand. The problem is how you define end-use demand. Are we talking about warehouses full of unconverted PE resin or instead warehouses packed with unsold PE packaging finished film?

But let’s again assume for arguments sake that this year’s strong apparent demand growth has found its way to the final, final end-user. Perhaps lots more packaged food has indeed been bought by Chinese consumers and the government had laid hundreds more kilometres of HDPE gas pipes.

Too much processing supply will still, however, be chasing too much demand in 2016 – perhaps even more so if easy financing terms allow Chinese processors to run harder than 50%. In an oversupplied market, deflationary pressures tend to dominate.

So, why should PE margins stay at their current elevated levels? It will be a buyers market downstream of plastic processing because of this oversupply. In addition, the processors themselves will have the cost-cutting option of switching to polypropylene because cheap propylene will guarantee cheap PP.

All the uncertainty around the future value of the Yuan is another factor that must be considered. The Yuan has today risen against the US dollar following a decision by the People’s Bank of China to change its “fixing rate”.

But the possibility of a much bigger, longer-term depreciation cannot be ruled out as China tries to shore-up its exports. This threat hasn’t gone away following the Chinese currency being given “special drawing rights” by the IMF. In fact, depreciation has gathered pace since last month’s decision by the IMF to give the currency special drawing rights, contrary to what many analysts expected. This is again about the one thing that the Communist Party must guarantee to maintain its legitimacy: Jobs. A weaker Yuan would, of course, increase the cost of PE imports during 2016.

I have just scratched the surface of the complexity out there. To emphasise again, this is why you must develop a set of new scenarios that will need to be constantly adjusted.