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Credit, Commodities And China: History May Soon Repeat Itself

Business, China, Company Strategy, Oil & Gas, Olefins, Polyolefins
By John Richardson on 10-Apr-2017

PPapparentdemand By John Richardson

YOU should be getting that strong feeling that history might be about to repeat itself when you look at the January-February data on China’s petrochemicals markets. In polypropylene (PP), polyethylene, styrene, mono-ethylene glycol, phenol and acetone, the ICIS reading of China Customs data indicates big year-on-year increases in imports – way ahead of what the domestic market has been able to immediately absorb.

This helps to explain recent price declines in all of these products, with the other factors lower oil prices and a return to much-greater volatility in crude markets. If you then go a step further and look at both the import and domestic production data for some of these petrochemicals products, the feeling that history may well be repeating itself needs to become even more pronounced.

Take PP as an example. Whilst net trade in PP (imports minus exports) rose by 50% year-on-year in January-February 2017 to around 900,000 tonnes, ICIS China estimates that local production was also significantly higher. We place domestic output at 3.1m tonnes during the first two months of this year, 15% greater than a year earlier.

Add this all together and you end up with the chart above, which shows a 21% rise in apparent PP demand (net imports plus local production) in January-February.  This compares with the ICIS Supply & Demand database estimate that real consumption, which is adjusted for inventory distortions, will rise by just 6% in the full-year 2016 over 2017 to 23m tonnes.

Why history might be about to repeat itself was that we saw similarly-big surges in petrochemicals imports in 2009-2011 during the height of China’s post-Global Financial Crisis economic stimulus package. In some cases, domestic production also surged during thesethree years. Circular trades in all types of commodities, from petrochemicals to iron ore and copper, were very common.

These involved traders acquiring commodities not for their underlying value, but rather for the short-term credit that allowed them to buy cargoes. They then used this credit to gamble in other commodities, and even in real estate, in complex multi-level deals that depended on constantly rising prices to work. This game of “pass the parcel” functioned very well until the music stopped in 2012, when the Chinese government slowed the growth in credit.

The end-result in PP was that real consumption growth fell to just 3% in 2012 over 2011 as excess stocks were worked out of the system. This compared with 8% growth in 2010 over 2011 – and no less than 15% in 2010 over 2009.

We could be at another turning point. Lots of excess credit has again been flowing through the Chinese financial system with confidence high that economic growth will this year be above that of 2016. This helped fuel the broad rise in commodities imports and prices over the last few months. Now, though:

  • The growth in total social financing (the total of lending from China’s state-owned banks and its private lenders) was sharply down in January-February 2017 over the same two months of last year. The March data for TSF will be out shortly, and so this will be a key metric to tell us whether Xi Jinping and his pro-reformers have made further progress in their efforts to cool the economy down.
  • We have seen a flurry of new measures to take the heat out of China’s boiling-hot property sector. These include raising down payments on second homes to 60% from 50% of their value in many cities in China. The Beijing government has also closed a loophole where couples were getting divorced in order to be able to each benefit from the lower down payments that apply to a first-home purchase.
  • The Caixin/Markit China manufacturing purchasing managers’ index (PMI) fell to 51.2 in March from 51.7 in February, indicating a slower expansion of activity. The PMI has in the past been a very reliable reading of credit, manufacturing and commodity-price cycles (they are all the same thing) in China. Hence, it swung into positive territory last year as the credit bubble was re-inflated and is now moderating again. The official government manufacturing PMI pointed to a pick-up in activity in March. But the official PMI focuses on the big state-owned companies that tend to enjoy access to easy finance for longer than smaller, private companies when credit conditions tighten. The Caixin/Markit PMI measures the smaller, private companies.

Xi and the other pro-reformers might step back from reforms and let the bubble continue a bit longer. But I think this is unlikely as Xi realises he cannot afford to waste any more time because of the build-up in bad debts.

And interestingly, Beijing has indicated that the economy will slow down in Q2. This came via comments from Zhang Baoliang, a researcher at the economic forecasting department of the State Information Centre, who was reported as saying that falling automobile and housing sales would contribute to a slowdown.

The immediate upshot for some petrochemicals markets in China is destocking. This won’t be as bad as 2012 because the overhangs are not as big.

The other big factor to consider is oil prices and how they will shape petrochemicals demand over the rest of this year. Some people focus too heavily on the supply side of the crude story. But demand for crude is of course also crucial – with Chinese demand extremely important because of its role as the No1 global demand-growth driver. We expect growth in Chinese oil imports to fall to just 5% this year over 13.6% in 2016, partly because of the economic slowdown.

Oil prices, like all the other commodities, have been supported by China’s re-inflation of its credit bubble in 2016. Take this support away and crude might be about to see a significant downward correction.