Tumbling Oil Prices: Implications For Asian Polyethylene

Business, China, Company Strategy, Economics, Environment, India, Middle East, Naphtha & other feedstocks, Oil & Gas, Olefins, Polyolefins, US


By John Richardson

DON’T say that I didn’t warn you. Oil prices now look much more likely to hit my forecast of $35//bbl, or lower, by Q4. Such is the downward momentum right now in crude markets that it is perfectly possible that this price level will be breached well before then. As of Tuesday, prices were down by 22% compared with January, pushing the oil market into official bear-market territory.

We have mounting volumes of crude in floating storage that too few people want to buy. This is the result of what I have been warning about since January – how a moderate slowdown in the Chinese economy would weaken demand. China is of course the most important global source of incremental demand growth for crude, and China’s economy will continue to decelerate during the rest of this year and into 2018. This will be the result of the Chinese government’s determination to further reduce the growth in credit. China feels that is has to act now before its bad-debt crisis gets any worse.

Meanwhile, US production continues to increase. The Baker Hughes rig count has now increased for 22 weeks in a row, the longest consecutive period since 1987, when the data first started being collected. Increased US drilling activity has led to predictions that production could reach an all-time high by the end of this year. Libyan and Nigerian oil production is also on the rise.

The next “shoe to drop” on the supply front could be a decision by OPEC to reverse its production cuts. Why should the cartel continue to sacrifice market share, as it clearly seems to have lost its ability to control prices? It might instead make sense for OPEC, led by Saudi Arabia, to pump greater volumes of crude as of course Saudi still has the world’ lowest production costs.

What this means for polyethylene

What follows is an example of the more comprehensive and in-depth analysis available in our monthly Asian Polypropylene and Asian Polyethylene  (PE) Price Forecasting reports, where we help you build scenarios to protect the viability of your business. For more details, contact john.richardson@icis.com.

Even without the collapse in oil prices, Asia’s PE industry would have likely seen a continuation of the weakness in pricing in June and July that first began back in February. Pricing has either been flat or declining across all grades and in both Southeast Asia and China since February.

The reason is the extraordinary rise in China’s imports, along with a sharp uptick in domestic production. China’s PE net imports (this is imports minus exports) were at around 3.8m tonnes in January-April 2017, according to China Customs department data. This was 20% higher than the 3.2m tonnes of net imports during the same four months last year. ICIS China estimates that domestic production was 10% higher in January-April 2017 – again on a year-on-year basis – at approximately 5.3m tonnes.

The end-result is a 14% growth in apparent demand in January-to-April 2017 to around 9.1m tonnes compared with the same period in 2016.

Apparent demand is a crude measure of immediate demand for any chemicals and polymer, as it is based only on net trade (imports minus exports) plus local production. It doesn’t take into account inventory distortions – e.g. the big build-up in PE stocks in China that has taken place so far this year. Real demand, though, discounts the distortions caused by either restocking or destocking.

China’s real PE demand for 2017 will increase by 5.6% over 2016, according to ICIS Consulting. This implies that we  are still some distance before apparent demand growth moderates back to real demand growth.

But inventories amongst plastic converters in China are said to be at lower levels in June compared with May as high stock levels are gradually consumed. Combine this with the s

tart of China’s peak manufacturing season in August, and, without rapidly falling oil prices, you could have made a case for a recovery in PE pricing from August. The peak manufacturing season is when China’s finished-goods manufacturers work flat out to deliver products to the West in time for Christmas. This, of course, boosts demand for all polymers.

But the events in crude markets change the outlook. Taking just linear-low density PE ((LLDPE) C4 film grade as an example in China, the above chart assumes that Brent crude prices fall to $39/bbl by the end of Q3, and then as low as $35/bbl by December. As I said this might even turn out be a conservative assumption, but let’s go with it to see what the results could be:

  • Brent averages just $40/bbl for the rest of this year compared with the actual average for January-May of $53/bbl.
  • To calculate monthly naphtha costs per tonne, I used multiples of the monthly Brent prices per barrel of well above 8 and slightly above 9 times. This follows the historic patterns. This results in an average naphtha feedstock cost of $357/tonne CFR Japan in June-December. Actual naphtha costs in January-May were at $487/tonne CFR Japan.
  • Plastic converters prioritise “hand-to-mouth purchasing – i.e. only buying the minimum amount of PE resin they need to keep their plants operating. The reason is that as oil prices are falling, they know that PE prices will be cheaper next week, or next month, and so it makes sense to hold back from purchases.
  • Weaker crudel, also, as I said reflect a slight slowdown in the Chinese economy. More importantly, the collapse in oil prices will indicate the end of global reflation. We are back to global deflation, or at the very best disinflation. This means a weaker global economy and lower demand growth for PE – a further incentive for converters to minimise their resin purchases.
  • The end-result is falling LLDPE prices until the end of this year. In June-December 2017, prices will average just $904/tonne CFR China over $1,130/tonne CFR China in January-May.
  • Crucially, also, the spread, or differential, between the cost of a tonne of naphtha and the price for a tonne of LLDPE will be lower. This is a very blunt, very basic measure of profitability, but is still quite useful. Spreads in June-December 2017 will average $547/tonne. This compares with $643/tonne in January-May.

New capacities a further challenge

This oil-price weakness is also taking place as a big slew of new PE capacities are set to arrive in Asian markets.

Focusing again on just LLDPE, Sadara Chemical, the joint venture between Saudi Aramco and Dow Chemical, started up a plant in Saudi Arabia in April. ICIS Consulting expects this will produce 375,000 tonnes in 2017.

The much-delayed new Oil and Natural Gas Corp (ONG) capacity in Indian has been commissioned with volumes now arriving in export markets. The ONG complex (also called OPAL) will produce 600,000 tonnes in 2017. Also in India, Reliance Industries is scheduled to start-up new LLDPE capacity from mid-2017. Its new facility will produce 300,000 tonnes in 2017.

US LLDPE start-ups include a new Dow Chemical plant, which is due online in mid-2017. Production will this year reach 360,000 tonnes.

This is just a few of the many other LLDPE start-ups in 2017 that we list in our Supply & Demand database.

Connecting the dots

Events in today’s oil market show the importance of “connecting the dots’, of seeing the links between society, politics and economics. For example, the US shale oil and gas industries are politically very important in the US as they are a great source of new jobs, and also of well-paying jobs during a period when wage growth is anaemic, if not downright negative.

This understanding would have helped you anticipate the surge in US supply. Understanding the shift in the political mood in China, which took place last year, could have also helped you prepare for today’s economic slowdown.

The Chinese government is prepared to accept lower growth as it tackles both its credit bubble and its environmental crisis. Linking societal changes with politics and economics have of course always been important. But now this kind of analysis matters much more than during the Economic Supercycle, when society and politics were relatively stable on benign economic conditions.

This is where ICIS can help as our holistic, big picture approach has proven value – for example, our accurate call on where oil markets are heading.


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