China PE overstocking rises to more than 1m tonnes as exporters continue to flood the market

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

By John Richardson

CHINA is heading for another good year of PE demand growth with estimates from several players of growth at around of 8%. This is in line with our forecast for 2019 growth of 7.7%.

But this is clearly not a market growing at 13%, which is what our estimates of local production plus net imports indicate year-on-year for January-August 2019.

If you assume our 7.7% annual growth rate is right, this implies that overstocking in HDPE, LDPE and LLDPE now stands at 1.1m tonnes (see the above chart for the breakdown into the different polymers). This is up from 942,000 tonnes in January-July.

The methodology here is simple and has, in my view, greater value that just relying on what producers and traders say about inventories, as of course word of mouth cannot always be relied upon. You take our annual estimates of demand growth, divide by 12 and multiply this by however number of months you are measuring. You then compare this with the latest numbers on local production plus net imports.

China’s PE inventories first reached high levels in late Q1. This explains flat or declining CFR China PE pricing spreads over naphtha costs since then.

What has happened is quite clearly this:

  • The China market remains the world’s standout global growth market as demand elsewhere suffers from the global economic slowdown. What continues to power Chinese consumption growth is single-use packaging for internet sales. Growth in online sales of cheap luxury goods and essential goods such as food remains strong.
  • But because so much material is being diverted to China from other markets we have ended up with substantial oversupply.
  • Global markets have reshuffled to take into account the extra tariffs imposed on US HDPE and LLDPE which are the result of the trade war. These now amount to 30% on each polymer. So, US material that would have otherwise gone to China has gone to Europe, Malaysia, Turkey and Vietnam etc. Saudi material that’s been edged out of Europe has gone in greater volume to China. Exports from Malaysia and Singapore to China are also substantially higher.

Now, let’s look at what the latest ICIS local production and China Customs data is telling us in more detail.

The October 1 clear sky campaign didn’t help

On a month-on-month basis, China’s PE production was down by an average 8% in August. The decline was greatest in LDPE where production fell by 13%.

These declines were very likely part of efforts to reduce pollution and create clear skies in time for China’s big 1 October party – the nationwide public holiday and parade in Beijing to mark the 70th anniversary of communist rule. Overall industrial production fell in August as factory closures and reduced operating rates across many industrial sectors came into force.

But exporters continued to scramble to place as much material as possible in China, August month-on-month PE net imports increased by an average 6% with HDPE seeing the strongest gain at 12%.

In January-August, year-on-year net imports increased by an astonishing 19% to 11.1m tonnes. LLDPE predictably saw the biggest increase at 23% to 3.7m tonnes. This reflects the fact that global oversupply in LLDPE is the most acute because of the scale of US capacity additions

Further weakening of naphtha-to-PE spreads

The latest chart on naphtha-to-PE spreads, which you can see above, shows that they have edged down a little further to a January-September average of $439/tonne.

But note that this year’s naphtha costs have only averaged $520/tonne. This is much, much cheaper than the last time spreads were lower than this, which was in 2012. In that year, spreads were at $353/tonnes and naphtha costs at a sky-high $954/tonne on far more expensive crude.

This therefore tells us, using very straightforward ICIS data and the right market intelligence, that the problem today has to be excess supply, as feedstock costs are relatively cheap.

It is inevitable, in my view, that spreads will test their 2012 low over the next year as increased US production combines with a weaker global economy.  They could well go lower. As we all know, spreads are a reasonable if imperfect proxy for PE industry profitability.

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