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China new vehicle sales: A long term decline and what this means for petrochemicals

Business, China, Company Strategy, Economics, Environment, Polyolefins, Sustainability, Technology, US
By John Richardson on 29-Nov-2019

By John Richardson

THE MAINSTREAM view is that there is nothing fundamental about the decline in new vehicle sales in China. Conventional analysis blames the 2018-2019 slump on the 50% cut in value-added taxes on new autos that came to end in December 2017. This brought forward demand as buyers scrambled to beat the end of the tax cut.

Reductions in subsidies for new energy vehicles (plug-in hybrid, electric battery and fuel cell autos) and tougher municipal and provincial emissions standards are also blamed for this year’s weak market. A lot of potential buyers are said to be holding back until new local electric battery models become available next year.

A big rise in new energy vehicle sales, especially electric battery vehicles, is being predicted in response to another factor behind the slowdown in sales and that is of course sustainability pressures. Pollution from gasoline and diesel engines has led to provincial and city-level restrictions on new purchases.

All of this, in my view, represents a form of denial as acceptance of the long term structural reasons for the slowdown in the China autos market is too difficult for many people. Whilst the above factors have played a role, they do not come close to telling the whole and most important part of the story. What makes acceptance so difficult is the critical role China plays in global autos demand and with it petrochemicals and polymers consumption.

China accounts for an ever-rising percentage of global new vehicle sales. In 2005, just 8% of global light vehicle sales occurred in China. This is expected to have increased to 29% by the end of this year.

This is reflected in polypropylene (PP) demand – a polymer heavily used in production of auto components. Back in 2008, before the big boom in Chinese new auto sales began, China accounted for 18% of global PP consumption. By the end of last year, this had reached 30%.  In the ten years between 1999 and 2008, China’s PP consumption grew by 6.5m tonnes. But the 2009-2017 decade saw consumption rise by an astonishing 14.4m tonnes.

Coming to terms with much lower future growth requires a complete overhaul of investment and sales targets, which of course is never politically easy in any company.  How do you go to your boss and say, “Look, we really shouldn’t build our new PP plant,” without damaging your career? This is especially difficult when there are plenty of mainstream analysts out there who are telling you that there is nothing to worry about.

But denial isn’t going to help us sensibly plan for a future of permanently lower growth in China new autos sales, and thus weaker expansion of demand in all the petrochemicals that are used to manufacture autos.

Debt issues reshape China autos

It stands to reason that debt must have been a major factor behind the extraordinary increase in average annual growth in China new vehicles sales between 2009 and 2017, as this was the period when China was in the midst of the world’s biggest ever economic stimulus programme.

In the eight years before the programme was launched – 2001-2008 – annual average growth in new vehicle sales was 900,000. This rose to 2.2m in the nine years from 2009 until 2017 as economic stimulus reached its peak.

But from January last year, as the official government credit data has consistently told us, the availability of new lending has contracted. This has coincided with the decline in new vehicles sales. In 2018, year-on-year sales were down by 3%, the first annual decline 1990. January-October 2019 data point to a decline of no less than 12% for the full-year 2019.

In 2018-2019, average annual growth in new vehicle sales is likely to be the region of minus 2.1m vehicles – almost exactly in line with the increase we saw during the peak stimulus years.

As the excellent latest issue of the PH report writes, China new vehicle sales during the peak stimulus years were “sub-prime on steroids”. During those peak years, lending via the very speculative and so high-risk shadow banking sector went through the roof. This high-risk lending found its way into real estate. As a real estate speculation boomed, so did new auto sales.

In 2017, lending via the shadow banking system averaged $495bn a month. But availability of credit via the shadow system began to decline from January of last year to the point where during 2019 it has averaged just $68bn a month. The bubble in real estate, and with it auto sales, has significantly deflated.

What are the chances of re-inflation? They are vanishingly slim because Beijing has indicated through all of its statements that it is very concerned about the level of debts left behind by the peak stimulus years.

Actions speak louder than words, of course. The government has backed up its words through relatively minor new economic stimulus in response to another factor behind the slowdown in the Chinese economy and the decline in auto sales – the trade war.

Stimulus will remain muted even if the trade war accelerates for two reasons. One is the scale of bad debts that China cannot afford to make any worse, with the second reason the diminishing law of returns. Even if Beijing were to throw the proverbial kitchen sink at the problem of lower growth, its own data show that, because of the flood of existing lending, the positive effect on GDP would be very limited.

How bad is the debt problem? China’s consumer debt as a percentage of average household income surpassed that of the US in 2017 and has, quite literally, skyrocketed since then. This is no hyperbole. It is based on the data.

The critical point here is the affordability of debt rather than its overall percentage against GDP. China remains a poorer a country than the US in terms of incomes. We should as a result question whether China can afford to meet the consumer debts it has incurred. We must also question the extent to which the government can allow the consumer lending build-up to continue.

The overall debt problem has been in two phases. First came the rise in corporate debt immediately following the Global Financial Crisis. China’s giant economic stimulus package, designed to mitigate the impact of the crisis, led to petrochemicals and other plants being built for the sake of the economic activity generated by the construction work. Long term supply and demand fundamentals were overlooked.

Next came the increase in consumer debt. Take a close look at this Wall Street Journal article where you will see some quite extraordinary evidence of the consumer debt problem, which is largely centred on young people born after 1990.

Mortgage debt outstanding grew from $1.1 trillion in the fourth quarter of 2012 to $3.9 trillion as of June. Mortgages accounted for about a third of China’s medium- to long-term loans, up from 20% in 2012, according to the People’s Bank of China.

Parents often help young Chinese to buy a home with multiple generations now required to afford a single property. A similar phenomenon occurred in Japan in the 1980s before its real estate bubble burst.

Nearly a third of the young Chinese people who took part in a 2018 survey had taken out more short term loans to service existing debt. Half had missed debt repayments. The average consumer spending of Chinese credit-card holders between ages 21 and 30 in 2016 was 39% higher than their average credit line.

Perhaps, though, local governments can come to the rescue through the old economic multiplier effect of boosting spending on infrastructure. This could raise incomes and so boost auto sales back to their peak-year levels.

No. some provincial governments are running out of bridges, roads and railways to build because the more developed provinces of China have become saturated in infrastructure. Another problem is a change in infrastructure financing rules. Projects have to be profitable by themselves whereas before, loss-making projects could be paid for by other sources of local government revenue.

In H1 2019, nationwide infrastructure spending was down on the first half of last year. As with the growth in consumer spending, we have gone beyond the peak in infrastructure investment because of the reasons cited above, and because outstanding local government bad, even by Beijing’s estimates is at $2.5 trillion. One independent estimate places debts at $8 trillion.

So much for the big shift to inland China

The growth in new auto sales in the Tier 1 and Tier 2 cities, on China’s hyper-developed eastern and southern seaboard provinces, has reaches saturation point. As Reuters reports:

Much of the urban middle class has already purchased a vehicle. Household ownership rates were nearing 50% in the provincial – level cities of Beijing and Tianjin and the wealthy province of Zhejiang by the end of 2017.

“Nothing to worry about here,” I can here you say, “Sales growth of new autos will just march ever further inland as poorer regions of China catch up with the coast.”

No. This would first of all require the tax incentives and generous growth in credit that China can no longer afford because of the scale of its debt problems. And secondly, even if this were to happen, Beijing would be pushing on a piece of string because of demographics:

  • Between 2015 and 2040, China’s population aged 50 and over will increase by roughly 250m as the population under 50 falls by the same amount. During the same years the 15-29 age group – which across all modern societies has the highest education and is the most IT and tech savvy – will shrink by 75m.
  • Equally as bad will be the fall in the 30-49 age group during this same time frame. It is forecast to fall by a quarter or by more than 100m. This is the generation that tends to be the most innovative and entrepreneurial.
  • The only cohort that will grow in size will be the 50-64 age group and those over 64. In 2015-2020, the 65+ population will jump by almost 150% – from 135m to close to 340m.
  • And here is the most critical point of all: In 2040, a third of the total rural population will be 65 or over, double the ratio for urban China. This is the result of the movement of hundreds of millions of young people from the countryside to the cities during China’s low cost manufacturing-led economic boom

Demographics are economic destiny. All the data show that old people consume less things including autos, as of course they are retired and living on a pension. In China’s rural areas, people often don’t own cars in the first instance. Their ability to clear the income levels necessary to buy a new vehicle is being reduced by the lack of young people and weak pension and healthcare provision.

Affordability is the key for increased mobility. Better public transport is one answer, assuming that the further infrastructure investments can be afforded. So is growth in the second-hand autos markets. As the latest PH report again points out, used auto sales were up 7.4% in September 2019 and were 4.3% higher in January-September versus the same period last year.

Bu the ratio of used to new sales is still only 0.58 in China, whereas in Western markets used auto sales are 2-3 times new car sales. Why shouldn’t China follow this pattern? As China is likely to remain a poor country relative to the West, it is reasonable to expect the multiple to reach three or even higher.

Smartphone apps on which second-hand cars are increasingly being sold in Chin are also a neat way of boosting economic growth. Internet sales have in general become an important source of wealth creation, thanks to local entrepreneurs and strong government funding. Beijing’s focus in 2019 has been on improving internet connectivity and sales platforms in rural areas.

The quality of Chinese autos keeps on improving. A few years ago, the second-hand market was less viable because vehicles didn’t last long enough. Not now as quality improves. Improvement in autos quality is one aspect of a wider push across all manufacturing to move up the value chain. Only by becoming the manufacturer of high value goods can China escape its middle income trap.

Scenarios for China auto sales and PP demand

China’s new vehicle sales will be down by 8% in the full-year 2019 versus last year, according to the China Association of Automobile Manufacturers (CAAC). Whilst this is a lot better than the 12% decline indicated by actual data for January-October, the CAAC forecast is a lot worse than its prediction in July. Back then, it had expected an annual 2019 decline of 5%.

But next year and beyond, the CAAC expects good recovery. It forecasts that by 2023, new vehicle sales will total 30m and predicts that at some point the market will reach at least 40m.

I’ve taken these numbers to help compose the graph on the left hand side of the above chart, where I assume a steady growth to 40m sales by 2030. I have no idea whether this reflects the actual CAAC view. This is simply meant to demonstrate the conventional view of a return to steady growth in the China market; not as spectacular as the 2009-2017 boom years, but still steady.  Under this scenario, annual average growth is at 4%.

Let’s imagine how things might instead turn out, which you can see in the orange shaded area on the same chart.  Sales drop by another 8% in 2020 and by a further 3% in 2021. After that, we see several years of slight growth, at a maximum of 2%, with some years seeing declines of 3%. Average annual growth is at slightly below zero in 2019-2030.

The difference between these two scenarios in terms of total number of new vehicles sold is huge. Under Scenario 1, a conventional view, total sales during the period reach 414m new vehicles, whereas in the downside they reach 304m. The difference is of course 110m. Sales reach 40m in 2030 – the possible CAAC ceiling. Under the downside, they are just 24m in 2030 – some 800,000 lower than my forecast for this year.

This would of course have a huge effect on demand growth for all the petrochemicals and polymers used by the China autos sector. Our base sees annual average Chinese PP demand growth of 2.4% between 2019 and 2030.

Let’s, again for argument’s sake take this down to 2.4%. Certainly this year, PP demand in China is in course to be 760,000 tonnes less than we have forecast, based on net import and local production data. The net result under this downside is cumulative PP consumption over the whole forecast period being 8.2m tonnes less than our base case forecast.

Let’s take this a further step forward and imagine how Chinese PP plants might operate even in this weaker demand growth scenario. The new Chinese PP plants, and the existing units, are I believe likely to maximise production, even in the face of disappointing local demand, in order to boost self-sufficiency in a very uncertain global trade environment. China’s new state-of-the-art PP plants will also want to run hard in order to add value to the economy, as some of these facilities are focused on higher value copolymer PP production.

The end results are what you can see on the chart on the right

  • Our base see average 2019-2030 operating rates at 85% and annual average net imports at 4.1m tonnes.
  • For the sake again purely of argument, I raise operating rates to 92% in my downside and also use my downside for local demand. The net result is average annual net imports of just 1.1m tonnes.
  • In 2030, this downside sees net imports at around only 550,000 tonnes versus 4m tonnes under our base case.

Conclusion: A major paradigm shift

Events in the China autos market do not represent the end of the world, but rather just the end of the world we are familiar with. This is just one example in one market of major paradigm shifts taking place across the petrochemicals world in general.

We are moving into an era of lower growth because of debt, demographic and sustainability reasons that are affecting every petrochemicals market in every region. As I keeps stressing, instead of endlessly adding big new petrochemicals capacity, the industry needs to be much more focused on dealing with the big challenges of today such as global warming, the plastics rubbish crisis –  and in China’s case in in its autos market the need for affordable transportation.

One of the answers for China autos will be providing cheaper PP for dashboards, steering wheels, bumpers and pillars etc. which brings down the coast of owning a car to more affordable levels. Vehicles will also have to last longer in order to further boost the second-had car market. Again, the polymer scientists can get to work here.

A further value-add will be to work with China’s new energy vehicle suppliers. There will be a rapid growth in the sales of China’s new energy vehicles as they replace traditional gasoline and diesel engines, especially growth of electric battery vehicles. This will obviously be for sustainability reasons. But the overall growth in the sales of new vehicles will still remain way below the peak years because of the debt and demographic factors detailed above.

Hail the innovators! The future is bright for the petrochemicals companies which adopt the right strategies.