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China’s Accelerating War On Air Pollution: Latest Implications For Petchems

Business, China, Company Strategy, Economics, Environment, Naphtha & other feedstocks, Olefins, Polyolefins
By John Richardson on 10-Nov-2017

By John Richardson

CHINA has steadily increased the intensity of its war against pollution over the last three years – especially the war against pollution generated by burning coal. This has major implications for the petrochemicals industry, which we will detail later on this post.

Firstly, though, here is a timeline of events over the past three years:

  • In 2014, some regions in China stopped using GDP as local government performance indicators. This set the stage for stopping the “building a factory for the economic multiplier sake of building a factory” habit of local governments. A great deal of industrial capacity has been added regardless of supply and demand fundamentals and the impact on the environment. This has been a particular problem since the launch of China’s huge post-Global Financial Crisis economic stimulus package.
  • In early 2016, the National Energy Administration followed this up through cancelling licenses to build new coal-fired power stations. Faced with slowing electricity demand, local governments had accelerated the pace of coal-fired power station construction because of their heavy reliance on revenues from the power stations.
  • And again from early last year, many provinces were required to start compiling “natural resource balance sheets”. These are being used as the basis for performance indicators, based on better environmental protection, for local government officials.
  • In late 2016, China launched a nationwide programme of environmental inspections. Led by ministerial-level officials, these involve genuinely effective checks on how environmental clean-up measures are being implemented. “For the first time, very senior officials started turning up unannounced. And for the first time that I can remember, they started properly checking whether environmental rules were being applied,” said a Beijing-based chemicals industry source.
  • During 2017, several more waves of these environmental inspections have taken place, leading to the temporary closure of some 40% of China’s total manufacturing capacity. Plants have been typically shut down for 2-4 weeks until they have rectified problems with emissions.
  • In September of this year, a five-month campaign was launched in 28 northern cities to improve air quality during the winter months, when air quality normally deteriorates because of the greater use of coal for heating purposes. Restrictions include reduced steel output amounting to some 7.5% of annual output. By the end of October, 72 coal-fired electricity plants had been shut down and 44,000 small coal-fired furnaces. Manufacturers in sectors such as plastics processing and printing were forced to upgrade plants by end-October to meet higher emissions standards. This forced the closure of many plants.
  • President Xi Jinping mentioned the word “environment” 20 times and the word “ecological civilisation” 12 times in his keynote speech at last month’s critical 19th National Party Congress. The Congress also saw the announcement of the formation of a new Environmental Protection Bureau. This will explore ways to reduce PM2.5 particulate pollution in China’s big cities.
  • As an indication of just how serious Beijing is about this campaign, October 2017 saw the sacking of 69 government officials in Hebei province, China’s most-polluted province, for failing to implement pollution controls. A further 154 Hebei officials were handed over to police for investigation.

Implications for the petrochemicals industry

Back in 2000, 11% of China’s benzene production was via a coal as a feedstock, according to our ICIS Supply & Demand database. This will have risen to 20% by the end of this year. Coal-based benzene is a by-product of steel production.

This means major implications for benzene and its value chain of the loss of the some 7.5% of China’s steel production during the five-month long winter air pollution campaign

As you can see from the chart at the beginning of this blog post, China’s benzene net benzene imports had also already risen very strongly in January-September 2017 over the same period in 2016. They stood at a seven-year high.

This has been the result of shutdowns of US styrene plants which forced China to import more benzene to run its own styrene plants at higher operating rates. Styrene demand growth in China during 2017 has also been very good.

We might well now see a further surge in China’s benzene imports on the closure of steel capacity.  This would of course be great news for exporters of benzene to China.

Every petrochemicals value chain will be similarly disrupted, but in different ways.

Take polyolefins as another example. Shutdowns of downstream plastic processing capacity will be far in excess of shutdowns of polyolefins plants during the winter air campaign.

The reason is that most of China’s polyolefins plants are modern, state-of-the-art facilities with good emissions standards. Meanwhile, China has numerous smaller plastic processors where emissions standards do not meet today’s expectations.

Subdued demand resulting from processor shutdowns is one of the reasons why, under our base case assumptions for crude and naphtha prices, we expected China polypropylene (PP) prices to fall in November 2017-April 2018. For the details, subscribe to our ICIS Asian Monthly PP Price Forecasting Report.

And whilst we are on the subject of polyolefins, what of the longer term future of coal-to-olefins (CTO) capacity additions? Will CTO investments come to a halt because of China’s move away from coal as an energy source? Or will employment creation, via CTO plants, be more important than the environment?

Several styrene butadiene rubber (SBR) plants were also forced to shut down in October because they were operating coal-fired furnaces. These have been replaced by furnaces run on electricity. This of course tightened SBR markets.

This scratches the surface. Every product chain is likely to have its own slightly different dynamics, creating great opportunities and challenges.

What we can conclude in general  is that supply disruptions will continue throughout the five months of the winter pollution campaign.

And because the Chinese government is so deadly serious about its war against pollution, the nationwide programme of environmental inspections will continue throughout 2018. Expect therefore more petrochemicals and downstream plant closures.

Nobody should also be surprised if further legislation to clean up the environment is introduced. Take the national emissions trading scheme which is expected to be launched by the end of this year as an example. Initially, it will cover just power generation, but could eventually be expanded to cover petrochemicals.

Here is another broad key takeaway. The environmental campaign is just one element of an entirely new economic growth model that China is attempting to build. Gauging the implications of this new growth model on the petrochemicals industry depends on a good understanding of government policy.

You will firstly need to know every detail of each new policy initiative. Then you will have to constantly monitor how policies are being implemented. Are you adequately resourced to achieve this?