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Machiavelli’s “New Order Of Things”: Risks and Rewards

Business, China, Company Strategy, Economics, Fibre Intermediates, Oil & Gas, South Korea
By John Richardson on 29-Feb-2016

By John Richardson

IF you get it, you understand what is really happening out there, there is no guarantee that you will be successful as Machiavelli (see below right) – the great Italian Portrait_of_Niccolò_Machiavelli_by_Santi_di_TitoRenaissance historian, politician, philosopher and writer etc. – so aptly described when he wrote:

It ought to be remembered that there is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things.

Because the innovator has for enemies all those who have done well under the old conditions, and lukewarm defenders in those who may do well under the new.

Applying this to petrochemicals and one particular product – purified terephthalic acid (PTA) – the new order of things is that today’s imbalances between supply and demand aren’t going to very quickly correct themselves. I could have picked many other petrochemicals value chains to make the same point.

In the case of the data and the wider context specific to PTA, here is what I mean by this new order.

Late last year the South Korean government recommended that 30% of the country’s PTA capacity should shut down because of the competitive threat from China. This would result in the country’s capacity falling to around 4.2m tonnes/year, according to our calculations.

This would have a dramatic effect on South Korea’s PTA export volumes if this capacity rationalisation happened in its entirety in 2016. The 30% capacity reduction would leave South Korea with some 750,000 tonnes of PTA surplus to domestic needs compared with around 1.5m tonnes if there is no rationalisation of capacity during this year (these calculations are based on an average operating rate in the region of 80%).

Why this won’t make that much of a difference to global balances – and to the fortunes of the South Korea PTA business – can be summarised in one word: China.

In detail, China’s PTA imports have collapsed as a result of a vast build-up in its capacity during the 2008-2013 economic stimulus programme. These plants are thus new, and so world-scale, and so are not going to shut down in large numbers. And anyway, boosting PTA and other petrochemicals exports is a great way of supporting economic growth as very painful economic reforms continue.

As we discussed last week using the example of polyvinyl chloride, boostingpetrochemicals exports also fits into the long-term strategic goal of developing closer links with neighbouring countries through the One Belt, One Road initiative.

So, think about these scenarios – more details of which you can find in our new Study:

  • Our base case is that China will run its PTA plants at an average operating rate of around 60% in 2016. This would still leave room for approximately 500,000 tonnes of imports.
  • But if operating rates were instead just three percentage points higher – at 63% – this would leave space for in the region of 1m tonnes of exports. Just imagine what the global PTA world would like if China say ran its capacity at 70%.

Machiavelli’s “new order of things” is the disappearance of China as an import market for many of the major petrochemicals value chains. Even worse is that China, as I have illustrated, has the capability to become a very aggressive exporter.

The old “build and they will come” approach – of only worrying about feedstock advantage and building new plants just ahead of a rapid growth in Chinese import demand is thus over. For good.

But to stick your neck out and tell your colleagues this will be difficult. One of the reasons is that many  colleagues in your petrochemicals production company will have built their entire careers on “the build it and they will come approach” – the old order of things.  They will thus, understandably, resist change because they will be worried about their reputations.

Meanwhile, some off those who you think support you might instead be sitting on the fence, waiting to see if you are right or wrong. If in the short term there was, say, a sudden pick-up in the PTA business these “lukewarm defenders” could well change sides.

It is up to visionary CEOs to, of course, take the lead here. If they do take the lead in this new order of things, it will make it so much easier for everyone else to fall in line. This will be especially so if your CEO says words something like this: “Look, we’ve all made mistakes, including me, and so this is not a blame game. Let’s instead move forward together”.

Where are the opportunities of the future then for exporters to China? Here, very briefly, are five of our conclusions:

  1. Many of the opportunities will be around services rather than just products – for example, providing the expertise needed to clean up China’s polluted water and food.
  2. And where China still has to import products,  they will be higher value – e.g. high quality water-treatment chemicals and sophisticated polymers for food packaging.
  3. But higher value will not mean higher margins because of affordability pressures.
  4. The good news, though, is that higher value will not equate with low volumes– the traditional way that we view speciality market. Volumes will instead by huge.