By John Richardson
THE ABOVE chart shows that in April the average spread between CFR Japan naphtha feedstock costs and CFR Northeast Asia (NEA) benzene prices was just $19/tonne, its lowest level since January 2009 during the Global Economic Crisis.
AS with Doctor Copper, benzene is a major raw materials building block for many manufacturing chains. Everyone should thus take notice, not just those involved in the petrochemicals business.
As benzene is close to oil production, one reason for the dip in spreads is this year’s surge in the cost of crude. But note that:
- Between August 2012 and August 2014, Brent crude prices averaged $102/bbl, resulting in an average naphtha cost of $941/tonne CFR Japan. But spreads over naphtha and benzene were at an excellent $403/tonne. This was way above the January 2000-May 2019 long-term average of $237/tonne.
- In January-May this year, Brent has averaged $65/bbl with naphtha at $546/tonne CFR tonne. But benzene spreads have been at just $58/tonne. This is very closest to 2001, the lowest annual level since 2000, when spreads were at $51/tonne/.
This tells us that there is a lot more about the weakness in benzene than the run-up in crude prices.
Chinese economic recovery? What recovery?
The April year-on-year Chinese economic data underlines my argument that in real terms, economic stimulus in Q1 did not create any substantial new economic activity.
The big rise in China’s headline Total Social Financing (TSF), which is a broad measure of all lending, should be ignored as most of the new loans went to paying off bad debts. In real terms, official bank lending was down by 6% year-on-year.
April data included an increase in industrial production of 5.4%, the lowest reading since last November and below analysts’ expectations of a 6.5% increase. Retail sales rose by 7.2%, the lowest rate of increase since May 2003.
And crucially, vehicle sales fell by an astonishing 14.6% compared with the same month last year. So much for a recovery in auto sales in 2019.
You shouldn’t have had to wait until last week’s release of the April economic data to know that no real recovery was taking place in China because, as I said, the TSF data pointed in this direction. So did Doctor Benzene as benzene spreads have been weak in every month from January until May.
Benzene weakness reflects what’s happening downstream in its key derivatives.
Styrene is oversupplied with some 270,000 tonnes of excess inventories in storage tanks in China right now. Average Q1 inventories were at their highest level since at least 2016, which is the earliest comparable data I have available.
Moving further downstream, China’s acrylonitrile butadiene styrene (ABS) demand is set to contract by 4% in 2019 over last year to consumption of around 5.1m tonnes. Expandable polystyrene demand seems likely to decline by 2% to 2.9m tonnes.
The decline in styrene butadiene rubber (SBR) demand is the most dramatic of them all. Consumption is in line to be as much as 13% lower in 2019 at 1.2m tonnes. SBR is used to make autos tyres with the collapse in demand reflecting short term issues with China auto sales – and a long term shift in the nature of demand for cars in China as the second-hand car market expands.
In contrast, China’s polystyrene (PS) demand looks likely to be at 4.1m tonnes in 2019 – a 10% increase over last year. 2018 was also a very good year when demand also increased by 10% compared with 2017.
The varying fortunes of ABS versus PS has led to the argument that ABS has suffered at the expense of the one of the two grades of PS – high-impact PS (HIPS). Both compete for some of the same electronics end-use applications and it is thought that a rise in China pricing premiums for ABS over HIPS has led to converters switching to HIPS.
I don’t buy this theory. ABS price premiums over HIPS surged in 2017 and yet ABS demand still grew by 14%. Last year, when premiums remained high, ABS demand growth was still strong at 7%.
What I believe is instead behind the good growth story for PS is what’s happening in its other grade – general-purpose PS (GPPS).
Strong demand for GPPS is the result of its use as packaging for cheap and essential goods sold online in China such as personal care items and food. This type of e-commerce is unaffected by the slowdown in the overall economy.
In contrast, most ABS consumption is into the autos sector and high-end electronics, the sales of which are heavily tied to economic growth.
“What about the trade war?” you may well ask. Absolutely. This played a role in dampening the economic data, the benzene spreads and the performance of its downstream derivatives in January-April.
You don’t buy a car or a house when you are worried about the economic future and the trade war was a significant concern in January-April, despite the near-universal consensus that the US and China would reach a deal.
In April, China’s exports were down by 2.7% as tariffs started to have an effect. Some 50% of ABS exported to China is re-exported as finished goods.
On the trade war, the disappointing April economic data and the weakness in benzene and its derivatives in January-April was obviously before the US about turn on 5 May.
The hardened US position threatens more damage to the economy and to Doctor Benzene. I shall come back to this theme later on.
More about trade deal confidence than arbitrage
There are other reasons for the collapse in benzene spreads beyond the rise in crude and the broader economy.
South Korea was unable to export benzene to the US in Q1 in its usual quantities because of weak arbitrage. Because South Korea is a major exporter of benzene, understanding South Korea is always crucial in understanding what’s going on in benzene.
In Q1, South Korea’s shipments to the States represented just 27% of total US imports, down from 48% during the full-year 2018.
Meanwhile, South Korea flooded China with benzene to compensate for the poor economics of moving cargoes to the States: In the first quarter again, South Korea shipped 540,785 tonnes to China and accounted for 57% of China’s total imports. This compared with 46% during all of 2018.
But a deeper dive into the trade data shows that there was an overall big increase in China’s overall benzene imports. China’s benzene net imports were at 936,547 tonnes in Q1 2019, 53% higher than in Q1 2018.
‘It was a confidence thing more than a weak US arbitrage thing. Every transaction needs a seller and a buyer and the Chinese buyers were willing to stock up on benzene,” said an Asian benzene trader.
“The buyers thought the trade war about to come to an end and the Chinese economy would see a big rebound, and they were betting on higher oil prices,” he added.
Benzene inventories at east China ports were at 213,700 tonnes in Q1 compared with the usual 100,000-150,000 tonnes.
The future of Doctor Benzene
Another other problem is that Hengli Petrochemical has only just come on-stream.
We expect that Dalian-based Hengli will produce 900,000 tonnes of benzene in 2019, all of which will go into the merchant market as its downstream styrene unit will not start-up until the end of this year.
Hengli’s production accounts for nearly all of our expected rise in total Chinese benzene production to 13.2m tonnes in 2019 from 12.3m tonnes in 2018.
“Chinese domestic benzene prices are below overseas prices and so imports have collapsed. South Korea is now being forced to sell much more to the US, even though the arbitrage still doesn’t really work,” the aromatics trader added.
Like everyone in the petrochemicals business, he worries about the impact of the escalating trade war.
“It could take a long time to work-off excess benzene inventories if there is no trade deal. What’s going to happen to benzene derivatives demand? It is all very, very worrying,” he said.
Here are the two scenarios that that I see as most likely:
- The trade war continues until at least 2021, but the US steps back from war with Iran – and so at least no crude prices back in the region of $100/bbl.
- The US goes to war with Iran and the trade war continues until 2021.
Scenario 1, as of today, seems the most likely outcome as the president has said he hopes there isn’t a war with Iran. But Scenario 1 should not be dismissed because hawkish nature of several of Trump’s key advisors.
Benzene and what’s happening in its downstream derivatives will continue to be excellent, real time guides to the broader economic impact of either of these two outcomes. Prepare, I am afraid, for a further contraction in benzene and its derivatives.