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US petrochemicals export exposure grows at the wrong time in history

Business, China, Company Strategy, Economics, Europe, European economy, Naphtha & other feedstocks, Oil & Gas, Olefins, Polyolefins
By John Richardson on 25-Sep-2019

As always, the views in this blog post are my own and do not reflect the views of ICIS. Thank you

By John Richardson

THE US economy is enjoying an unprecedented economic recovery. It has been expanding for the past 122 consecutive months, the longest period in history.

But, in my opinion, this is largely irrelevant for the country’s polyethylene (PE) and ethylene glycols (EG) industries because of large scale expansions that are heavily targeted at exports.

The above chart is a starting point for explaining why events in the US economy will have little bearing on the future prosperity of US PE and EG producers:

  • Between 2019 and 2030, we forecast that US PE demand will increase by 3m tonnes, whereas in China our base case assumes a 20m tonnes increase. Total consumption in the US in 2019-2030 will be at 192m tonnes versus 528m tonnes in China. As recently as 2009, US consumption was bigger than that of China. But the rapid growth of the Chinese economy has entirely changed the picture
  • In 2019-2030, we see US EG demand increasing by 1.3m tonnes versus 13m tonnes in China. Total US consumption will be at 32m tonnes versus 251m tonnes in. China has long been the biggest EG consumer in the world because of its dominance of the global textiles and garments industries. This isn’t going to change much up until 2030 as textiles and garments production drifts from China to other developing countries because of its ageing population. The scale of China’s existing dominance of textiles and garments guarantees that its demand will continue to drive the global EG business.

This underlines why the global petrochemicals business, on the demand side of equation, is all about China and all the other developing countries and regions that are intricately tied into China’s economic fortunes. The development of China’s Belt & Road Initiative, a subject I shall revisit in later posts, is increasing the links between China and the rest of the developing world.

It is possible – as I have done for polypropylene – to devise downsides for China’s demand growth over the next decade or so as its economy struggles from debt issues, an ageing population and continuing trade and geopolitical disputes with the US.  The global pie would also shrink substantially because of the links between China and the rest of the world.

The US and EG industries therefore need a healthy China because a healthy China means a healthy global economy.

The latest date on US exports heavily underlines this point. US net HDPE exports jumped by 70% to 1.2m tonnes in January-July 2019 compared with the same seven months last year. Net LDPE exports rose by 98% to 630,057 with LLDPE rising by 116% to 1.1m tonnes. EG net exports rose 173% to 147,191 as the US swung into a net export from a net import position for the first time in a decade.

Making a virtue out of a necessity

US producers have quite rightly highlighted their nimbleness, their success, in shifting PE exports away from the China market in order to avoid trade-war tariffs as the above chart, on the left, so amply demonstrates. This in response to the 25% tariffs China imposed on US HDPE and LLDPE from last August (these tariffs were increased to 30% from 1 September this year).

But also take a look at the chart on the right. You can see a big increase in US LDPE exports to China when the same two 12-month periods are compared – September 2018 until July 2016 versus October 2017-August 2018.

The earlier 12-month period was before China imposed its trade-war tariffs on HDPE and LLDPE, with the second period after the duties came into force. But during both these periods there were no additional Chinese duties on LDPE.

These charts help explain this:

  • Where the US can export maximum PE volumes to China it will do so, because China is by far the biggest net import market in the world (it will account for 60% of all global net imports amongst the world’s net import countries and regions in 2019-2030. Its nearest rival will be Europe at just 16%).
  • These are just made up numbers, but the proportions are right: It is better to export 2,000 tonnes to China at lower netbacks than, say, Malaysia, because Malaysia will only require a cargo size of 500 tonnes. Much more volume equals more margins because of the economies of scale of reduced logistics costs.
  • Dealing with a wider range of smaller markets in order to compensate for loss of volumes to China incurs more trader and distributor fees, with the fees particularly high when you are dealing with opaque and complex markets in say West or North Africa.

A test of my argument will be how the US responds to the Chinese decision to impose 15% duties on US cargoes of LDPE as a result of an acceleration in the trade war. The duties came into effect on 1 September this year. If these tariffs stay in place for long enough, I believe we are bound to see a shift of US exports away from China at the cost of lower returns per tonne.

The data indicating China’s dominance of global EG imports is even more eye-watering. In 2019-2030, we estimate that China will account for 83% of global net imports amongst the world’s net import countries and regions.

The US would therefore again quite obviously prefer to export EG to China than anywhere else for the same reasons I highlighted above. But last August, China imposed 25% duties on US EG, again as a result of the trade war. This has led to a shift in US export flows. When September 2018-July 2019 is again compared with October 2017-August 2018, US EG exports to China fell by 93,811 tonnes, with gains in US exports to smaller markets.

Conclusion: The wrong location

The vast investments in new US PE and EG capacity, based on access to cheap shale gas feedstock, will therefore only provide decent returns if the Chinese economy continues to be successful. That is, in my view, the only conclusion that can be reached from the data.

And note that even without the trade war, the success of the new US investments would still be in doubt because of a.) The major structural changes in the Chinese economy that are playing a bigger part than the trade war in the decline in Chinese growth, and b.) The rise of sustainability pressures that is challenging economics of all new capacity based on any hydrocarbon feedstock.

But the trade war is of course not helping. It is not only hurting the global economy outside China, but it is also dragging us towards a bipolar world of two competing trading and geopolitical blocs, one led by the US and the other by China. In this scenario, US PE and EG producers might in the future not be able to export any volumes to China – and possibly, also, much of the rest of the developing world that could end up in the China-led bloc.

There is a lot of talk about a temporary truce ahead of the US presidential election. This would suit Trump. But his speech at the UN General Assembly yesterday, where he again heavily criticised China for its trade practices, indicated the extent of the gulf between the US and China. So did comments made last week by a former Chinese government official, who compared the US stance in recent trade talks as an attempt by the US to “colonise” the Chinese economy. This is hugely sensitive given how China was treated by the Western powers in the 19th century.

Remember this goes beyond just one or two terms of Donald Trump. The Democrats are equally committed to confronting China. This risks a new cold war. This year’s Report on Chinese Military Power, from the US government, identified China as the primary strategic competitor of the US for the first time.

So, as I said at the outset, a strong US economy will matter little for the US PE and EG industries, no matter how long the US boom continues. The same applies to any other US petrochemicals industry, such as methanol, that is also heavily reliant on exports.

The new US PE and glycols plants may have been built in the wrong location. Building them outside the US could have made more sense given the world in which we now live. Hindsight is of course a wonderful thing. But you don’t need hindsight to ask difficult and important questions about plans for further US capacity.