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“Out Of The Box” Solutions Can Prevent Global Trade Tensions

Business, China, Company Strategy, Naphtha & other feedstocks, Oil & Gas
By John Richardson on 06-Jun-2016


By John Richardson

IF you are a politician in the West, one approach to today’s crisis of global industrial overcapacity is heap most of the blame on China and threaten China with trade barriers. But if China doesn’t respond to your rhetoric, the problem is that you might be forced to follow through by actually imposing trade barriers. The 1930s Great Depression tells us that this is very unlikely to end well.

Or politicians and CEOS can get together and devise global solutions to overcapacity that help protect and create jobs both in China and elsewhere. Idealistic? Perhaps, but let’s shoot for the moon, as the last thing the world economy needs right now is a rise in global trade tensions.

Thus, I am with Macquarie Wealth Management, which wrote in its latest Commodities Compendium report that “out of the box solutions” may be required to deal with overcapacity in industries such as steel and aluminium.

Let’s, first of all, look at the scale of the overcapacity we are talking about in steel and aluminium. As Macquarie writes:

An 88% utilisation rate as a level which would be deemed healthy for these industries – one which we view as fair for a long-term norm – we would need to remove over 250 million tonnes of steel capacity permanently from the global market, and over 7 million tonnes of aluminium.

In steel, provided we do see Chinese capacity removal, the situation gets better over time, but is not solved. For aluminium, given the plans for new capacity additions, it keeps getting worse. To put things in context, the current level of overcapacity is almost 20x that seen after the break-up of the Soviet Union, when the industry was on its knees.

There are many chemicals and polymers where the situation is equally a bad, if not worse. Take caprolactam – the intermediate chemical use to make nylon or polyamide. Alpek, a Mexican caprolactam producer, estimates that China has enough capacity today to meet Chinese demand until 2047.

Audited agreements that fix production at a global level are one out of the box solutions that Macquarie suggests for the metals industry. Another of the bank’s ideas is to pay producers not to produce through, for example, issuing them with carbon credits.

The starting point for these types of global agreements needs to be a recognition that every country faces the same challenge, which, as I said, is preserving and creating jobs. Blaming one particular country won’t get us anywhere, as the end of the Economic Supercycle is a challenge for all of us.

China is obviously the focus of the blame game because it is where much of today’s overcapacities are located. But think about its position, using the refinery industry as an example.

  • China could have chosen to close down its independently owned refineries, many of which have poor economies of scale. But this would have caused job losses, particularly in Shandong province, where most of these refineries are located. China has instead relaxed the regulations that prevented many of these “teapot’ refineries from importing crude oil. This has made them more competitive in local gasoline and jet-fuel markets, thus creating new jobs both at the refineries themselves – and at the many service industries that are economically dependent on the refineries.
  • A knock-on effect of this decision is that state-owned refiners Sinopec and PetroChina face more competition in the local gasoline and jet-fuel markets. This has occurred at the same time as diesel demand has tanked in response to economic reforms, with the SOEs problems exacerbated by the fact that their refineries are heavily configured to make diesel. The government has, in response, supported the SOEs by giving them permission to export more diesel. The end result was a 328% increase in China’s diesel exports in January-April of this year to more than 4 million tonnes over the same period in 2015,

Overseas governments might be tempted to build trade barriers to protect their local refinery sectors. But why not instead work with China by, for example, helping it to raise its fuel standards in order to help it better protect its environment? Is there a technology and/or a process engineering gap here that another country could help fill?

And here’s perhaps a positive outcome from today’s globally oversupplied diesel markets: Can steam crackers be economically configured to crack more gas oil, which is of course used to make diesel? Could this make investment in new steam crackers more viable in China and elsewhere?