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China Polyethylene Operating Rates To Rise On Govt Policies

Business, China, Company Strategy, Oil & Gas, Olefins, Polyolefins
By John Richardson on 22-Feb-2017


By John Richardson

EARLIER this month I reported on how China’s state-owned refineries faced increased competition from their domestic private competitors in 2016 in gasoline, diesel, kerosene and other refined-product markets. This forced Sinopec and PetroChina to reduce their overall refinery operating rates, which led to less availability of naphtha for their downstream steam crackers. The end result was less-than-hoped-for ethylene and polyethylene (PE) production.

There was also a spate of unscheduled crackers shutdowns in in Q2-Q3 2016 that further suppressed PE production.

There was a third reason why China’s overall PE production fell short of expectations in 2016, which was the price of coal. Under the Chinese government’s 13th Five-Year-Plan (2016-2020), it has set aggressive targets to reduce coal capacity in order to get rid of loss-making coal mines and clean up the environment. Last year, Beijing was ahead of its target for 2016 as it shut down 300m tonnes of capacity instead of its planned 250m tonnes.

Add to this the 2016 surge in steel production that I discussed on Monday, and this explains why coal prices shot up.  For example, the price of coking coal more than quadrupled during last year, hitting a high of more $300/tonne in December — a level last seen in 2011.

This matters for PE because of the rise of China’s coal-to-PE industry. This process involves first gasifying coal into synthesis gas (carbon monoxide and hydrogen) and then converting this synthesis gas into methanol. Methanol is then made into ethylene with most of the ethylene then converted to PE. In 2012, just one percent of China’s ethylene production was via coal, but we expect this to rise to 10% in 2017. So expensive coal squeezed the margins of China’s coal-to-PE plants, resulting in operating rate cutbacks.

A further constraint on coal-to-PE production was low oil prices and so cheap naphtha. Because naphtha was much more affordable in 2016 than it had been before September 2014, when crude was in the region of $100/bbl, the global naphtha-based PE industry enjoyed record levels of profitability. These strong margins encouraged higher operating rates at naphtha-based PE plants, and gave these producers the room to discount PE prices in order to gain more market share.

China’s total virgin PE production (excluding recycled material) was a result only 15m tonnes in 2016, according to ICIS China. This was some 500,000 tonnes less than had been forecast by ICIS Consulting.

But what you now need to know is this: What happens next?

 843,000 tonnes of HDPE imports could suddenly disappear

The Chinese government has changed course on the local private, or teapot, refiners, as I again discussed earlier this month. What enabled these teapots to put extra pressure on the state-owned refineries was from that from 2015 they were allowed to import high quality crude oil for the first time. This allowed them to make better quality fuels, both for domestic and export markets. But the state-owned refineries were so badly squeezed, and the local gasoline and diesel markets so badly oversupplied, that Beijing has decided to cut back on the number of licenses that will be given to the teapots to import crude.

A further reason for a reduced quota of licenses in 2016 is that some of the teapots resold these licenses to third parties rather than using them to actually import crude and make gasoline and diesel etc. In other words, the licenses became another means of financial speculation in China.

It is thus reasonable to expect that the Sinopec and PetroChina refinery businesses will be in healthier shape in 2017, which will allow them to supply more naphtha to their downstream steam crackers.There should also be less technical problems at China’s team crackers in 2017, given that last year saw an exceptionally high number of unscheduled shutdowns. Hence, you can make a case for higher naphtha-based PE production in China.

Coal-to-PE operating rates may also rise because China’s National Development and Reform Commission has introduced a new coal pricing mechanism designed to prevent 2017 prices rising too far above RMB570/tonne ($83/tonne). And returning to my post on Monday, you can build easily build a scenario where steel production falls in 2017 on re-acceleration of economics reforms. This would obviously reduce the demand for coal, making lower coal prices in 2017 more likely.

Add this all together and you end up with my three scenarios at the top of this blog post:

  • Using only high-density PE (HDPE) as an example, the ICIS Consulting base case is for a 2017 operating rate  of 86%, based on our estimate of nameplate capacity. This would leave room for around 5.3m tonnes of imports, also of course take into acount our forecast for demand.  Imports in 2016 were also close to 5.3m tonnes, according to China Customs data.
  • But rasie this operating rate to 91% whilst assuming the same capacity and demand, and 2017 imports slip to approximately 4.9m tonnes.
  • If China is however able to push capacity utilisation to  95%, imports slip to around 4.6m tonnes. Looking at the exact numbers, this would represent 843,000 tonnes less imports than our base case. Imports would also be down by around the same amount over the actual number of imports in 2016

The overall lessons from all of this

One obvious lesson is the critical role that Chinese government policy plays in setting petrochemicals production in China. It is not just the headline policies that matter, but how these policies are applied and adapted in response to unintended consequences – for example, last year’s squeeze on the profits of the state-owned refiners and the surge in coal prices to economically unsustainable levels.

You therefore need good people on the ground in China able to understand government policy and how it is applied and adapted, not just in petrochemicals itself, but across a wide range of other industries.

And the above blog post only of course looks at the supply side of the story. Chinese government policy will also be key in shaping demand for PE and other petrochemicals and polymers during the rest of 2017, as will what Donald Trump’s White House does over the remainder of the year.

On Friday, I will put the jigsaw pieces together of both supply and demand in China in order to give you a complete forecast for the country’s PE market during the rest of this year. US producers will in particular need to take note of this post, given their rising surpluses.