Paraxylene: Another Chemicals World Turned Upside Down

Business, China, Company Strategy, Economics, Fibre Intermediates, Middle East, Oil & Gas

Yaar

By John Richardson

THE PARAXYLENE (PX) industry is enjoying an unprecedented period of demand growth, according to the above chart from our recently updated Supply & Demand database:

  • Between 2000 and 2016, global demand for PX will have jumped by 135%.
  • China will be the major driver because of its role as the workshop of the world: Its consumption will have jumped 1,459% by the end of this year. Its share of global consumption will also have risen to 53% from just 8%.

But we see a slowdown in growth in percentage terms in 2016-2026: Global growth will total 53% between those years and Chinese growth 56%.

So what? These lower percentage numbers would still deliver the requirement for big new PX investments as of course markets today are volume-wise a lot bigger than they were in 2000.

Crucially, also, we see China’s PX deficit moderating only very slightly from this year’s 18m tonnes to 17m tonnes in 2026.

The next step is for you to take our base-case numbers and build alternative scenarios – and this where we can also help.

 

Disappointing Demand Growth

What could go wrong for this chemical, which, as you read this post you could in effect be both wearing and sitting on? (PX is of course used to make the polyester fibres that make shirts, blouses etc. and non-clothing items such as seat covers, pillow cases and curtains).

We know that the Economic Supercycle is over, and so there is a very good chance that our base-case assumptions on global GDP growth will prove to be too bullish.

But complications specific to PX mean that even in a lower-growth world this doesn’t necessarily mean that the market won’t be tight.

What will be the effect, for instance, on global refinery operating rates of peak-oil demand? Most of the world’s PX capacity is immediately downstream of refining, and is run by companies who are also oil refiners.

If refinery capacity is rationalised on weaker oil demand we could conceivably end up with a shortage of PX supply, even if economic growth disappoints.

I don’t see this, though. I would instead give a lot more weight to a scenario of major expansions in refinery capacity. There are two reasons for this:

  1. In today’s permanent low oil-price world, and in a world where consumption growth has peaked, companies such as Saudi Aramco will want to find an easy home for their crude. It is about winning market share in order to avoid being forced to leave oil in the ground.
  2. Countries such as Iran are exporting oil but importing gasoline, diesel and kerosene etc. This doesn’t make national economic sense, even though globally fuel products are already oversupply.

When you are building a refinery why not add some value by including a PX plant?

“But what about the balancing effect of older refineries, along with their PX plants, shutting down elsewhere?” you might well ask.

I don’t this see as removing significant amounts of PX capacity because firstly, older refineries will continue to operate, via government subsidies, in order to guarantee local supplies of fuel.

Secondly, companies such as Aramco will be eager to acquire more overseas refineries even if they are loss making. This will provide Aramco etc. with guaranteed end-markets for their crude and will thus help major oil producers fight their market-share battle.

 

Location, location and Location

When you are buying a home, any estate agent will tell you that there are three things that matter most about making a good investment: Location, location and location.

The same applies to assessing tomorrow’s PX industry. Even assuming that I am too pessimistic on both  supply and demand growth, where supply is located could still end up undermining your business.

If China does indeed still need to import a huge 17m tonnes of PX by 2026, much of this might come from plants it owns overseas as it invests in refinery-PX capacity in countries such as Iran. This would be part of its One Belt, One Road initiative.

There is another reason to worry about location, and that’s the potential for a breakdown in free trade. It is far-too one dimensional, far-too risky, to build a PX plant in a country where there is feedstock advantage and good logistics, without also taking into account the potential for new trade barriers.

 

Back to disappointing growth again

The story in every chemicals and polymers value chain has been the same over the last 16 years: China taking the lion’s share of global growth.

But we know there are no guarantees China will be economically successful in the future. It could be that its economic reforms fail, leaving it unable to escape its middle-income trap. I believe that we won’t know whether or not reforms have been successful for at least the next five years.

More immediately, what about the impact of China’s debt on the country’s GDP growth? A new report by Fitch says that bad debts in China’s banking system are ten times higher than official numbers, and could reach one-third of GDP in two years.

The ratings agency adds it would cost $2.1trn to clean up these bad debts, and warns that these debt problems could result in a financial-sector crisis:

The longer debt grows, the greater the risk of asset quality and liquidity shocks to the banking system. Defaults in China could lead to mutual credit guarantees in the background pulling other firms into distress. A large increase in real defaults risks triggering a chain of bankruptcies that magnifies the potential for financial instability.

During the Economic Supercycle this kind of complexity simply didn’t exist. Instead, all that was required for success was quite often one set of supply and demand numbers for any chemicals value chain. This is no longer the case.

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