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China: Wrong Questions Will Give You The Wrong Answers

Business, China, Company Strategy, Naphtha & other feedstocks, Oil & Gas, Olefins, Polyolefins
By John Richardson on 07-Mar-2016


By John Richardson

IF you start with the wrong questions about China, you are obviously going to end up with the wrong answers.

In the case of China’s polyolefins industry, too many people are still asking themselves this wrong question: How can inland coal-to-polyolefins plants survive, never mind run at high operating rates, because of the collapse in oil prices?

Even though coal, too, has fallen in cost as a result of the slowdown in the economy and the dip in demand for environmental reasons, the comparative advantage that coal-based producers enjoy over their naphtha-based competitors has been significantly eroded, point out many analysts.

And here is another thing that they often argue: Coal-based polyolefins plants don’t produce coproducts, such as butadiene and benzene etc., when of course naphtha-based producers do exactly that.

There are two more factors that many analysts then build into their conventional view of the world.

Firstly, they quite rightly point that many coal-to-polyolefins plants are inland. From this they assume that high logistics costs make it very expensive to get product to the big consumption markets on the east coast. This is a very old argument, as it has been around for the best part of a decade.

And secondly, they contend that many of today’s coal-to-polyolefins businesses are privately owned, rather than owned by the State.  So they believe that this makes them more focused on profits, especially given the economic reforms taking place in China that place emphasis on these profits over government-subsidised manufacturing. It is these subsidies that have resulted in the failure of the investment-led growth model.

If you buy into this view of the world you are going to be in a lot of trouble.

The question I would instead start with is this: How can overseas polyolefins producers continue to prosper in China, now that the government has placed the polyolefins business at the very core of its new economic, social and political direction? Only then can you start to move towards the right set off answers.

With this question as the basis for all your analysis, you can then respond to the conventional challenges to the viability of China’s coal-to-polyolefins business.

Cost curves still don’t actually matter that much because of  the new priorities set by Beijing. Therefore, the coal-to-polyolefins business will receive more rather than less government financial support.

A reason why is that existing and new plants in the western provinces generate employment. And maintaining and adding new jobs is critically important as Beijing tries to narrow the income gap between its western and eastern provinces.

Coal miners are losing their jobs as a result of the closure of coal mines, due to declining demand for coal. Supporting and further growing the coal-to-chemicals business in general is thus a great way of keeping some coal miners in work.

You also have to consider the impact of the New Silk Road, or One Belt, One Road, initiative.

This is resulting in vast improvements in infrastructure links between the eastern and western provinces. So bang goes your outdated argument that logistics costs undermine the economics of the coal-to-poleyolefins business. My essential point , though, is that if these plants make money on a short term basis, this is a “nice to add” – or an added bonus – rather than a “must have”.

On the issue of these improved logistics links, also think of the example I gave last year of the smartphone manufacturer in Guangdong province and the smartphone assembler in Yunnan province.

Better road and rail services will enable the Guangdong phone marker, struggling with higher labour costs, to outsource basic assembly jobs to Yunnan, where wage costs are much lower.

From a government perspective, this keeps jobs in China that would have otherwise gone overseas and helps to narrow the west-east income gap by creating new employment in Yunnan.

The plastic packaging materials needed to wrap all the finished smartphones can then be made by coal-to-polyolefins plants in coal-rich Yunnan province, thus adding even more economic value.

These phones will then be exported overseas, via improved road, rail and sea links, which are also a pivotal part of the One Belt, One Road initiative.

Here is another option that will run in parallel to my above Guangdong-Yunnan example.

Again because of higher labour costs, it no longer makes economic sense to allow basic, low value plastic processing to continue to operate in China’s eastern provinces. Getting rid of basic plastic processing in the more developed provinces of China is also about escaping the middle income trap, through forcing manufacturers to move up the value chain.

This links back to my example of the smartphone maker in Guangdong, who will be given maximum government support to make smartphones from scratch. This will ensure that the whole smartphones value chain is located in China, from the basic raw materials through to the higher value electronic chemicals and memory chips.

But rather than lose longer-term economic value as a result of shutting these basic plastic processing plants down, they will be relocated to Yunnan etc. – thus providing off-take to new and existing coal-to-polyolefins facilities.

These plastic processing plants will also be moved across China’s border, to much-poorer neighbouring countries such as Myanmar and Laos. These will be supplied by Chinese polyolefins plants, with the finished plastic film etc. moving back across the board to customers in China.

Finally, let’s deal with the argument that because private companies are now running much of the coal-to-polyolefins business, they will be more short term profit-focused. No, not at all. Many of these companies have close relationships with local governments. They are also an important provider of local government revenues, so why on earth should they shut down?

Add to this the fact that they will also receive strong central government support and it is hard to see how the conventional thinking on private companies stands up.

As I said at the start, it is important to begin with the right question if you want the right answer.

Most analysts are in danger of starting with another wrong question, which is: Why should China move much closer to self-sufficiency in polyethylene? (This would follow the pattern we have already seen in polypropylene – see the chart at the beginning of this post.

This instead the question you need to start with: Why shouldn’t China move much closer to polyethylene self-sufficiency?

“But hold on, you will no doubt say, “you haven’t even answered your  original question of how I can still make money in China?” Email me at john.richardson@icis.com