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How To Battle For Value In Oversupplied Markets

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By John Richardson on 24-Aug-2016


By John Richardson

FOR the moment all is good, as the chart above illustrates, which details the premiums that C6 metallocene-grade linear-low density (LLDPE) have enjoyed over standard commodity grade C4 LLDPE in the key China market.

The October 2010 start date in the chart is when we began our C6 assessment (we don’t assess the C8 grades). Between then and July 2016, premiums have averaged $207/tonne.

But there is a chance that at least some metallocene-grade producers will see their premiums eroded if the global LLDPE market ends up in severe oversupply by 2020. We could see two distinct groups – the winners and the losers.

The winners seem likely to be those that have excellent relationships in the key China market over many years.

These customers have grown from being small converters with unsophisticated machinery to ones that use state-of-the-art machinery – sometimes even manufactured by themselves, as several Chinese converters have bought machinery manufacturers.

The likely winners have also long realised that at this higher end of the LLDPE business, you cannot give value away by handing product over to a trader to sell. It is instead all about direct relationships with customers where the benefits of metallocene – e.g. downgauging – have already been convincingly explained.

Our base case, though, is that the global LLDPE market will look pretty much the same in 2020 compared with 2016 – meaning no major oversupply. This base case is included in our recently updated Supply and Demand Database.

We forecast that global operating rates will remain at around 91%. The logic behind this is that whilst we expect the North American LLDPE surplus to rise as a result of all the new capacities, this will be counteracted by strong import growth in other regions and countries.

In detail, whilst we see the North American surplus rising by around 1m tonnes to 2.4m tonnes between 2016 and 2020, China’s imports will increase by again around 1m tonnes to 3.7m tonnes.

Meanwhile, Europe’s imports are forecast to rise by 500,000 tonnes to 2.2m tonnes with good growth in other markets such as Africa.

This base case is an excellent starting point around which you need to build scenarios that take into account more negative outcomes, where the premiums that metallocene grades enjoy over C4 grades would be clearly be under threat for all producers . We can help you do this.

The need to create these scenarios is much more pressing than it was only a short time ago – before the end of the Economic Supercycle.

Here are just some of the things that could go wrong:

  • Global economic growth might be lower than anticipated. The failure of Western central bank stimulus policies means that the threat of another global economic crisis cannot easily be dismissed. It simply must be included in one of your scenarios.
  • We need a trigger for this to happen, and the trigger might be China – perhaps as early as the last few months of this year. What may squeeze this particular trigger would be the realisation that Xi Jinping intends to take most of the economic pain of reform over the next 12-18 months, now that he has strengthened his political position.
  • On the supply side of the story, China may decide to push its coal-based plants harder than is in our base case. Reasons include better monetising coal reserves in a lower coal-price environment.
  • Pushing both coal-based and naphtha-based commodity grade LLDPE plants (for the time being, China only produces C4 grades) very hard might also help China grow, or at least maintain, downstream employment . This could be an important means of compensating for job losses elsewhere as Xi’s economic reforms are accelerated.
  • A symptom – or perhaps another cause – of a new global economic crisis could be oil back below $30/bbl. In such a situation, naphtha crackers in China and elsewhere would see their competitive position greatly improve versus their ethane-based opponents. Global naphtha cracker operating rates could thus surprise on the upside.
  • There is also a risk that metallocene-grade players who do not have the right geographical distribution off production will face higher trade barriers if we see a reversal in global free trade. China might then be much more selective over the countries and regions with which it trades.
  • And let’s just imagine a world where gasoline demand struggles as a result of all sorts of reasons – including not just a slower global economy but also the environment.
  • Governments might then face the prospect of either allowing refineries to close down or subsidising refineries in order to guarantee local supplies of transportation fuels.
  • The latter outcome is, for me, more likely. These subsidies might then also apply to naphtha crackers downstream of these refineries, through refineries supplying discounted naphtha.
  • And/or refineries and petrochemicals plants in the West might receive government subsidies because they create a great deal of downstream employment. In a weak growth environment, preserving local jobs everywhere could become a bigger political priority.

The world is ever-more complex, though. There is some evidence of a decoupling of PE demand growth from the slowdown in China’s GDP growth rates. Strong demand growth for high-quality food packaging is one reason for this. Another is the rise in internet sales.

But more research is required in this critical area based on solid data rather than just anecdotes. And again you need upside and downside scenarios about the extent of decoupling.

A positive for metallocene LLDPE grades in particular is this stronger demand for better-quality food packaging in China on food-safety concerns. Multi-layer metallocene-based films can fill this need.

Another positive is, as I said, the growing sophistication of China’s plastic processors. Sophistication in the more developed provinces of China can only surely increase as part of the government’s drive to escape its middle-income trap.

Here is the thing, though: What price will China be prepared to pay for this sophistication if its economy continues to slow, and if global LLDPE markets are long?

There is the further problem that China has commoditised other chemicals and polymers that were once specialities through its aggressive capacity additions. In the long term, beyond 2020, is this a threat for the metallocene business?

None of the above will be news to the metallocene-grade LLDPE producers that have good people on the ground in key markets such as China.

They, as I have said, have spent many years building excellent customer relationships.

Their understanding of markets also means that these good people are on top of the social, political and economic trends that I have detailed in this post.

A very long market would still be a very long market, though, Even these producers might struggle to maintain their metallocene-grade premiums over C4 grades.

Where would that leave any producers that has failed to invest in the right amount quality and quantity of good people on the ground?