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Asian PE margins to test 2012 lows as consensus catches up with economic realities

Business, China, Economics, Environment, Oil & Gas, Olefins, Polyolefins, Sustainability, US
By John Richardson on 17-Dec-2018

By John Richardson

IT HAS been evident since as early as February this year that China’s economy is slowing down. But once again, as in 2014, companies and investors have overlooked the key indicator of a slowdown: The sharp decline in credit availability, particularly via China’s shadow banking system.

“Not to worry,” I can hear you say as you respond to last Friday’s slew of negative economic data, including the lowest growth in Chinese retail sales in 15 years, “China will re-stimulate the economy and everything will be back to normal in 2019.”

But the put option of China injecting enough stimulus to fully turn the economy around no longer applies. There are three main reasons for this:

  1. If China were to launch stimulus on the scale of 2009-2017, the law of diminishing returns would apply. For every dollar of debt added, the returns from additional GDP growth would be very low. China would also add to existing overcapacity in real estate and in many industrial sectors.
  2. Stimulus on such a scale would worsen alarming bad debt challenges. It used to be that the challenges were centred on corporate debt. But recently, consumer debt has also become an issue.
  3. Old-style economic stimulus would add to the environmental problems that China has promised to reduce. Building more factories and raising operating rates at existing factories would worsen air, water and soil pollution. The Communist Party’s credibility rests on it delivering on its promise of a better quality of life.

It is important to place the end of the China put option in the global context.

Some 50% of the total stimulus of $33 trillion pumped into the global economy since 2009 has come from China. Absent any realistic chance of a repeat of stimulus on this scale and this is one of the reasons why I believe we are heading towards a global recession in 2019.

Implications for PE markets

Asian naphtha-based LDPE and HDPE variable cost margins are down by 46% and 33% respectively so far this year compared with the full-year 2017, according to ICIS.

This partly reflects the rise in oil prices. The declines are also the result of weaker economic fundamentals since the February turning point in Chinese credit availability.

Sadly, though, PE profitability is likely to decline much further in 2019.  Today’s margins are still a long way from their lowest point so far in the 2000s, which was in 2012. But profitability will, I believe, soon be testing these lows because of a weaker global economy and the big increases in US PE production.

Spreads between the prices for tonnes of naphtha feedstock and the prices for tonnes of PE are obviously not a measure of profitability, but they are a useful pointer in that direction.

Forecasts of naphtha-to-PE spreads are one feature of the monthly Asian PE Price Price Forecast Report that I author.

The above chart, taking just LLDPE as an example, shows my latest forecast for average China and SEA spreads in December 2018-December 2019.

As you can see, whilst not as low as in 2012, I believe spreads will be close to the 2012 lows – and there is a good chance that I may prove to be too optimistic. As with margins, 2012 was the lowest year for spreads so far in the 2000s.

Finally, it’s the right time of year to review the accuracy of my forecasts in the 2018 Asian PE and PP Price Forecast Reports:

  • In the first quarter forecast that there would be a China trade/Cold War. This has of course happened.
  • From Q1 I warned that China would likely impose import tariffs on US PE as part of the trade war. This happened in April with the severity of the tariffs increasing in August.
  • From February onwards I have been highlighting and detailing the fall in Chinese lending.
  • Throughout this year I’ve been flagging up the dangers of a significant global economic slowdown – and from October I’ve been predicting that a global recession is likely to happen in 2019. Consensus opinion is shifting in line with my view.

I’d be happy to provide sample reports demonstrating these forecasts. And anyone interested in subscribing to the reports should contact john.richardson@icis.com