China PE demand boom will not stop further margin declines

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

By John Richardson

CHINA’S polyethylene (PE) market is being temporarily weighed down by overstocking which is the result of the big surge in March imports. Many of the arrivals in March were of material booked late last year when oil and so PE prices were falling, drawing traders and Chinese buyers into major commitments. This explains the sluggish response of China PE prices to the recent rise in naphtha feedstock costs on stronger crude.

BUT, despite the overstocking, 2019 is still set to be another excellent year for Chinese PE demand growth as a result of booming internet sales. This is driving strong new demand for PE-based packaging materials of daily necessities and low cost luxury goods sold online. Consumption growth of all polymers used for packaging cheap internet sales is divorced from declines or increases in Chinese GDP.

The bad news, though, continues in polypropylene (PP) and in other polymers that go mainly into durable “big ticket” or expensive end-use markets. Chinese economic stimulus has failed to turn around weak demand in key big ticket sectors such as autos. On a net basis, the economic stimulus we have seen so far this year seems likely to have detracted rather than added to economic activity.

In PP and other polymers heavily dependent on big ticket end-use markets I am now ready to make this call: There will be little if any recovery in Chinese demand during the rest of this year following a disappointing Q1. I see three reasons for this:

  1. In the pivotal autos market, long term structural changes in the nature of demand are gathering pace. The rise of the second-hand car market may mean that 2017 marked peak growth in new car sales.
  2. Sentiment drives big ticket purchases in China. People don’t buy a new car or a new house if they are not feeling confident about the future. Confidence has taken at least a temporary hit from the intensification of the US/China trade war.
  3. If China launched major rounds of further economic stimulus, stock markets would rally and Chinese Purchasing Managers’ Indices would strengthen. But this would have a very limited positive effect because of the scale of bad debts.

This means NEA and SEA polyolefin margins will, in my view, continue to fall in H2 2019 and in 2020. The only question is the extent of the declines which I cover in my three scenarios below.

Why margins will continue to fall

In the key China market, the effect of the big rise in US PE supply is still being felt. This is despite the US seeing a steep drop in exports to China because of the trade war. The US has shuffled the pack to compensate for lost China sales by exporting more to Europe and SEA etc. But SEA producers are as a result facing more competition from US material in their home markets. This is forcing them to export more to China. Oversupply is set to increase in H2 2019 and in 2020 as the US further increases production.

There is another factor behind the fall in integrated PE margins and that is the drop in co-product credits. Co-product credits have fallen on the weakness in propylene derivatives such as PP and propylene oxide. This is the result of the failure of, as I said, economic stimulus to turn around disappointing sales of big ticket durable goods.

Butadiene co-product credits are struggling because of the collapse – and this is no exaggeration – of the styrene butadiene rubber (SBR) market. SBR is used to make tyres which of course means that demand has been hit hard by weak auto sales. I expect negative full-year growth for SBR demand in China this year.

It is the same story for aromatics (benzene, toluene and xylenes) co-product credits. In benzene, downstream styrene is still burdened by overstocking in China because of the build-up in imports and production that have not been merited by demand fundamentals.

Downstream from styrene and into the polymers, I expect negative 2019 growth in China for acrylonitrile butadiene styrene (ABS). ABS, like PP, is heavily used in autos production and in other durable goods such as washing machines. Other polymers made from styrene will also continue to struggle. In expandable polystyrene, for instance, which is used for insulation material in housing, preliminary Q1 data suggest a full-year 2019 demand decline of 14%.

For integrated Asian naphtha-based PP margins, the co-product credits story is obviously the same as in PE. PP margins face additional downward pressure from the weakness in Chinese PP demand. On the supply side, though, there is far less pressure than in PE because of a relative lack of new capacity in 2019-2020

Sure, the big rise in oil prices over the last six weeks has played a role in PE and PP margin depletion. But it is important to note that the declines in margins pre-date the recent run-up in crude. These earlier declines were the result of all the factors highlighted above, which, as I have outlined, will continue.

My three scenarios for margins

How far might margins sink? Here are three scenarios with my percentage probability ratings:

  1. The trade war comes to an end and there is no US/Iran conflict and a resulting big spike in oil prices. PE and PP margins stay comfortably above the last major industry downturn in 2013-2014. A 40 % chance.
  2. The trade war continues throughout this year and into 2020, but there is no US and Iran conflict. A 45% likelihood, resulting in margins reaching at least their 2013 levels – perhaps a little lower.
  3. The trade war continues and the US and Iran end up at war – 15%.  Margins go well below their 2013-2014 levels.

Please note that these percentage ratings are based on my current reading of events and so might very easily change. I will keep you updated. Also note that you need to plan for many more scenarios.

There is a great deal of data behind all the above. The ability to analyse markets in this way shows the tremendous value of all the data available via our pricing, price forecasting and supply and demand services. I can share some of my calculations on an individual basis to clients.

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