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China Polyethylene Self-Sufficiency: The Right Questions To Ask

Business, China, Company Strategy, Oil & Gas, Olefins, Polyolefins, US
By John Richardson on 01-May-2017


By John Richardson

THERE is a lot of talk right now about now China’s coal-to-olefins (CTO) capacity additions are slowing down on rising concerns over the emissions produced by the technology.

A further factor behind the widespread view that capacity additions are slowing down is forecasts that CTO margins will weaken over the next few years. This is based on the assumptions that a.) Oil prices and therefore naphtha costs remain low, making naphtha cracking relatively more competitive and b.) Coal in China will be expensive because of the closure of coal mines on environmental reasons.

Add this together and the conventional view is that there will be an easy home for all the polyethylene (PE) capacity being added in the US over the next few years.

Such is the confidence in the US over the scale of the export opportunity in China, and in emerging markets in general, that there have recently been announcements of new cracker-PE projects in the US.

In the short term, it might be right that CTO capacity growth is slowing down in China. Our latest forecast is that only 1m tonnes/year of coal-based PE will be added in 2017 compared with our earlier expectation of 2.1m tonnes/year.

But anyone planning a new cracker complex has to of course look beyond just one year. Companies and investors need to be as certain as is reasonably possible about a favourable Chinee supply story over the next 10-20 years. What worries me about today’s consensus thinking is that we might end up with the wrong answers about the strength of China’s long-term PE imports because we don’t ask all the right questions.

In this post, I look only at the complexities of future PE supply in China. Don’t forget demand as well, though.

Assessing the net environmental impact

Let’s start with the question of emissions. There is no doubt that big integrated coal gasification complexes (see the diagram at the beginning of this blog post) produce a lot of CO2 emissions. They also add to China’s air-quality crisis in the locations in which they are built.

But what about the net effect on the environment? As the diagram above shows, one of the outputs of a gasification complex can be synthetic natural gas (SNG). This is being piped from the countryside, where many of these gasification complexes are located, to the big cities. The SNG is then used to replace coal in power plants. This is improving the air quality in the big cities as coal-fired electricity generation is one of the biggest causes of respiratory illnesses and cancer in China. But the downside of SNG is that it generates high levels of CO2 emissions, according to a new Princeton University study.

So imagine a situation where a big new integrated gasification complex is partly justified based on the net environmental advantage of SNG – i.e. it is decided that better air quality is more important than the impact on global warming. The economics of building other plants downstream of gasified coal – or rather syngas, which is carbon monoxide and hydrogen – might be supported by the perceived net environmental gain from replacing coal in power generation with SNG.

But then there is of course the issue of the amount of water that the CTO process is said to consume, with many CTO complexes located in provinces where water is in tight supply. This really depends on who you talk to. Some people say excessive water consumption remains a barrier to investment, whilst others claim  technology solutions are already available. We need clear answers here.

Assessing the net economic benefit

I think it is equally risky to look at standalone CTO, or coal-to-PE, margins in isolation. Sure, if you forecast poor standalone margins over the next 10-20 years, based on say cheap oil and expensive coal, then this clearly weakens the case for new investments. But to what extent do Chinese companies, and crucially also the Chinese government, look at standalone margins versus margins across a whole gasification complex? What if the money to be made from transportation fuels and SNG etc. is expected to be so good that it in effect subsidises CTO production?

It is essential to broaden this out even further. We need to consider the wider economic value of gasifying coal:

  • Turning coal into gasoline, diesel and kerosene etc. helps replace imports of crude oil – and thus improves China’s energy security.
  • Turning coal into PE generates lots of jobs downstream in plastic processing and in manufacturing in general. The inland provinces of China where the major coal reserves are located, and so where the gasification industry is located, are poor provinces relative to the economically booming coastal provinces of China. Investing in coal-based PE complexes is thus one route by which the Chinese government can close the economic gap between its poorer and richer provinces.

However, our base case is that only 61% of China’s PE demand will be met by local production by 2020 – only slightly up from around 58% in 2010. This would leave room for imports of around 12m tonnes in 2020. And beyond 2020, we see local production remaining in the region of 60% of total demand.  It is important to stress, though, that if this base case comes true, this would be the result of China making a broad assessment of the viability of new coal-to-PE plants based on all the factors I’ve outlined above. You cannot just look at standalone coal-to-PE margins and conclude that this will tell you the whole story.

“Virtual” PE self-sufficiency

Even if China has big PE deficits in 2020 and beyond, other questions to ask are these: Who will benefit from this deficit? Will it be the US or will it be fellow members of China’s One Belt, One Road (OBOR) initiative? In today’s febrile international trade environment, it is very possible that US PE producers end up behind new trade barriers that make it very difficult, or even impossible, for them to export to China.

China might use its OBOR partners to create much-greater “virtual” PE self-sufficiency, whereby the majority of its PE requirements come from within this huge new trading bloc. Here is an example of how this might work:

  1. One of China’s OBOR 0bjectives is securing the oil and gas it needs to secure long-term economic success. China has plenty of coal, but has low domestic oil reserves. It has big shale-gas reserves, but these are a long way from being commercially exploitable. But China has strong engineering and construction capabilities in refining and petrochemicals.
  2. In return for cheap oil and gas imports from Middle Eastern and Central Asian countries, China invests in their refinery sectors. China also invests in petrochemicals, including PE plants, downstream of these new refineries. In such circumstances, it would of course favour importing PE from these partner countries.

Speaking truth power – asking the right questions

You may strongly disagree with the above analysis. If so, I would be delighted to hear from you. But this needs to be a comprehensive, thorough debate on all the issues I have just raised – and probably many more issues that I am not aware of. I believe it is misleading to only focus on estimates of standalone coal-to-PE margins, and the problem is that far too much of today’s debate is confined to this too-narrow focus.

Investors and financial analysts also need to speak “truth to power” by putting these broader issues to the CEOs of US petrochemicals companies during earnings calls and other investor meetings. I am not saying this hasn’t happened – it might have already happened. It is just that what I have read about these meetings points to analysis short of what is necessary to get a true picture of what might happen with China’s level of PE self-sufficiency.