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Assessing global PP prospects next year: seeing the simplicity through all the complexity

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By John Richardson on 17-Dec-2020

By John Richardson

IT COULD be very complicated and yet, as the chart above indicates, it might instead by extremely simple. Here I use the example of polypropylene (PP), but similar complexities and one simplicity also apply to the paraxylene and styrene markets and all their downstream derivatives, as I shall discuss in later blog posts.

What might make things complicated 

Global PP demand in 2020-2025, as I discussed on Tuesday, might end up being a lot stronger than our base case anticipates. My upside sees cumulative global demand during these years at 554m tonnes, 24m tonnes bigger than our base.

This reflects my forecast for average annual Chinese demand growth at 7% versus our base case forecast of 5%, and Asia-Pacific’s growth at 6% rather than our base case of 5%. I have raised both European and North American growth to 3% versus our base case of 2%. I see growth in northeast Asia ex-China  (Japan, South Korea and Taiwan) reaching 2%, as opposed to our base case of 1%.

Does means that you can confidently expect firmer PP markets over the next few years? If only it were this straightforward. My optimism over stronger-than-expected demand could be wrong.

I might be wrong because of my assumption that Chinese exports of manufactured goods will remain strong next year. Most of the strong global growth we have seen in PP and other petrochemicals in 2020 has been driven by China’s booming exports.

China’s exports of computers and other high-tech electronics increased year-on-year by an astonishing 21.1% in November to a value of $86.1bn; exports of medical devices jumped by 38.4% to $1.6bn. China last month exported more goods in US dollar value than any other country in history.

Why I think this success story will be sustained is because I believe that the worst of the pandemic is behind us in the developed world. I am delighted to say that I was too pessimistic about the development of vaccines. The lesson here is that we should never underestimate human ingenuity.

I am also assuming that while demand for laptops, phone routers, data storage units and washing machines will likely decline next year as these are occasional purchases, demand for personal protective equipment will remain strong because of the precautionary principle. China dominates global export markets in all these products.

But it is not only human innovation that can surprise on upside; so, sadly, can viruses which evolve to survive.  What if the new strain of the coronavirus, which has been detected in the UK, is resistant to the vaccines?

What if the vaccines are not as effective as the initial data indicate? Or what if the distribution challenges facing the vaccines, some of which must be kept at minus 70°C, result in herd immunity taking a long, long time?

Or to be more optimistic, let us assume that all goes well with the vaccine rollouts, but that, along with the inevitable cyclical decline in demand for laptops, demand for personal protective equipment also sees a sharp decline.

Another threat is the record Chinese trade surplus with the US, but this is likely a tail risk as the resumption of the trade war under a Joe Biden-led White House seems very unlikely.

China’s retail sales grew year-on-year by 5% in November, the fourth consecutive month of increase. But because of the pandemic, January-November 2020 retail sales are still around 4.9% smaller than during the same period in 2019.

So, clearly, the local economy has not fully recovered and my assumption that a full recovery will happen in 2021 may not be realised.

The doom-mongers, including myself, have been warning about a bad debt crisis in China ever since 2008, but this yet to happen.

But if you predict a crisis for long enough one will perhaps eventually happen, and it could happen next year. China faces major overseas debt restructuring challenges because of lending that has gone sour to fellow Belt & Road Initiative members, according to the Financial Times.

The state-owned banks are said to have taken over most of the new domestic lending in 2020 from the shadow, or privately-owned, banks because of the latter’s extremely risky lending practices. The amount of credit that can be obtained from China’s online lending platforms is being restricted.

And there is the drip, drip, drip of the economic damage being caused by China’s rapidly ageing population. If the collapse in BRI lending that the same Financial Times article describes in 2020 is a long-term phenomenon (I don’t believe it is), then China will struggle to compensate for an ageing population at home by tapping into youthful populations  elsewhere in Asia, in the Middle East and in Africa.

If these dynamics next year combine with a sharp slowdown in exports, the recovery in retail sales we have seen in August-November may stall and my upside PP forecast for 2020-2025 would be, without any doubt, very wrong. I forecast that 64% of my upside for 2020-2025 global cumulative demand will be driven by China.

Also consider crude oil and the three ICIS scenarios for Brent Forties Oseberg Ekofisk (BFOE) average prices between January 2021 and November 2021. Our low case is $38/bbl, or our base case is $49/bbl and our high case is $57/bbl.

This is quite a range, reflecting all the uncertainties surrounding the pace of economic recovery and the willingness of OPEC to stick to production quotas.

Although I believe the long-term price of oil will be a lot lower than today, as we have moved beyond peak oil demand for sustainability reasons, 2021 will, I think, see a stronger market on “revenge travel” – economic recovery resulting in a rebound in overseas trips. It should also be safer for more people to return to the office.

At some point, also, I believe that the major producers will be forced, because of declining demand, to prioritise market share over production quotas. But I don’t believe that this will happen next year because OPEC production decisions have worked pretty well in 2020,

But as always, oil forecasting is a perilous game, and you need several scenarios. This is even more the case today because of the pandemic and sustainability pressures. The pressures will fluctuate in the short term, but over the long term these can, in my view, only increase.

Complicated? Indeed, but I haven’t finished yet. You also need to evaluate the rise in container freight costs from September onwards, the result of huge demand for containers to move Chinese exports compared with much-lower demand for shipments to China.

Other factors behind the run-up in freight costs include delays at Western ports because of labour shortages caused by the pandemic, consolidation in the container industry over the last three years and cutbacks in sailings in response to the pandemic.

A further factor, according to one of my sources, has been cutbacks in container services resulting from uncertainties over global trade created by the trade war.

How long will this last? The ICIS pricing editors have been told that container shortages and imbalances should ease after the end of the 2021 Lunar New Year holiday period In mid-February. However, my source believes that because the supply shortages and imbalances are so deep-seated, they will last another 2-3 years.

Either of these outcomes would make a huge difference. Polymer freight costs to China have reportedly risen from an average across all the major delivery ports of $55/tonne in January-August 2020 to $115/tonne in September-December.

I sometimes feel that complexity in petrochemicals markets is greater than at any other point I can remember in the 23 years I’ve been reporting on and analysing this business. On other occasions, though, the outlook seems blindingly simple.

The case for simplicity

This leads me onto the chart at the beginning of this blog post. Even assuming my upside for demand growth, China’s PP net imports could fall to as low as 3.7m tonnes in 2021 from this year’s estimated 6.1m tonnes.

And you can also see from the same chart that China might be in a small net export position of 240,000 tonnes by 2023. By the end of the forecast period – 2031 – the worst-case outcome for exporters to China would see PP net imports recovering to 3m tonnes.

Because China takes the lion’s share of global PP imports, then perhaps the No 1 variant that will set global market direction over the next ten years is how hard China runs its capacity and how many new unconfirmed plants it adds. Maybe all the other variants will fade into insignificance.

This is a long prelude to today’s advert: you need a multi-scenario view on Chinese rates of PP self-sufficiency in order to plan your global PP business, whether you are a producer or a buyer. This is what we provide at ICIS, so contact me for more details at john.richardson@icis.com.

When you’ve been provided with our scenarios for s self-sufficiency, you need to consider the chart at the beginning of this section. This shows the exposure of some of the world’s major PP exporters to China. In this context, what does the data in this chart mean for your business?

Assessing China’s rates of production and capacity additions is actually not that simple. You need to understand plant economics, levels of upstream integration, petrochemical site efficiencies – and, most importantly, government policy. In my opinion, assessing government policy will get you better answers than standard cost-per-tonne economics. All the above are hardly complex variables, the proper assessment of which requires a lot of skill.

But, hey, I am sure you get my general point. One variable, no matter how complex, is surely a lot simpler to assess than multiple, highly complex uncertainties.

And the final general message here is the same message I’ve been hammering home for years in an effort to help my readers. The three things matter in this business above all else are: China, China and China.