By John Richardson
AS THE chart above shows, China is suffering from a bout a polyolefins indigestion right now as a result of a sharp rise in both imports and domestic production. This helps to explain the recent falls in pricing.
This extra supply might have been very easily absorbed if markets had bounced back after the Lunar New Year holidays, which this year took place from 29 January until 4 February. But that hasn’t happened.
One of the reasons given for this is increased environmental inspections at finished-goods manufacturing plants, which are the end-users of PE and PP. Beijing has apparently become more serious about enforcing existing rules governing emissions etc. and this has reduced operating rates at factories just as they try to ramp-up production after the LNY.
The fall in oil prices is also making converters, or plastic processors – the buyers of PE and PP resin – reluctant to commit to purchases.
But against this weak demand is tight supply across Asia as a result of a fairly large number of scheduled and unscheduled shutdowns, which we detail in terms of lost tonnes of production in our monthly Asian PE and PP Price Forecast Reports.
Here’s the thing, though: Supply in the key China market clearly isn’t tight because, as the above chart shows, there has been a sharp rise in domestic production – along with the big jump in imports to the point where some imported material is being re-exported. PE imports were up up 22% year-on- year in January, with PP imports 18% higher. PE production in January-February was up by 11% with PP 15% higher – again on a year-on-year basis.
What Happens Next
Whilst the increased environmental inspections might be a temporary issue, I believe the oil-price issue is not temporary. Yesterday, crude prices reached a three-month low on a rise in OPEC’s estimate of its 2017 production and higher inventories in the industrialised world. So China’s buyers of PE and PP – the converters – are likely to remain reluctant to build their raw-material inventories. Why buy resin today when it might be cheaper tomorrow?
And on supply, the sharp increases in domestic production in January-February could be the result of recent falls in coal prices on government efforts to prevent a repeat of last year, when coal prices went through the roof on lots of coal-mine closures and booming demand from the steel sector.
I discussed a new government pricing mechanism for coal earlier this month. And Beijing has since announced that it will leave the timing of the closure of a further 150m tonnes/year of coal capacity to local authorities. This suggests less coal mines will be shuttered this year than in 2016.
We are also likely to see more shutdowns of steel plants this year, which would obviously reduce the demand for coal and thus potentially push its price down. At China’s annual parliamentary meeting, the National People’s Congress, which took place earlier this month, plans were announced to force closure of operating steel mills during 2017. A lot of the steel plants that were shuttered in 2016 were apparently already idled – and on a net basis, China’s steep capacity actually increased.
This obviously matters hugely for the economics of China’s coal-based PE and PP plants. Their operating rates were constrained in 2016 by expensive coal, and so perhaps the January-February increases in overall China PE and PP production can be partly explained by recent declines in the cost of coal on new government policy initiatives.
The same might apply to naphtha-based PE and PP. The government has taken the crude import quotas away from some of the the teapot, or independent refineries. They are also no longer receiving tax exemptions for exporting fuel products – gasoline, diesel etc.
This could have already relieved the economic pressure on the state-owned refineries, enabling them to raise operating rates in January-February. This might have led to greater naphtha availability for downstream crackers and their PE and PP plants – hence, a second reason for the jump in China’s polyolefins production during those two months.
If government policies on coal prices and teapot refineries remain unchanged throughout 2017, this could mean an increase in China’s polyolefins self-sufficiency versus 2016. This might be weaker demand growth for imports during the rest of this year.
Then there is obviously the China polyolefins demand growth issue. A slew of positive economic data was released yesterday on real-estate investment, fixed-asset investment in general and industrial production. I suspect that this is a carry-over from last year’s re-inflation of the credit bubble.
But by March or April, I believe that economic data will start reflecting a slight slowdown in the economy now that lending conditions have been tightened; not a collapse just a slight slowdown, that is unless we end up in a global trade war.
What will all of this mean in terms of pricing, margins, demand growth and imports in the key China polyolefins market? Subscribe to our monthly Asia PE and PP Price Forecasts to find out.