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China threatens to shift global petrochemicals from inflation to deflation as self-sufficiency increases

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By John Richardson on 18-Apr-2021

By John Richardson

POLYPROPYLENE (PP) producers in Europe and the US are making very good money as the slide below shows, detailing LPG-based variable cost margins. In Asia, where margins have long lagged behind the other two regions, profitability has also picked up.

Demand isn’t going to be the problem

Part of the explanation is the secular shift in demand resulting from the pandemic. I don’t see consumption changing anytime soon, as increased hygiene needs and much greater demand for internet sales will be with us for several more years.

Demand for face masks, made from non-woven grades of PP, will surely remain at very elevated levels for a long time as offices, public buildings and public transport insist on mask-wearing. Many individuals seem likely to continue to take hygiene a lot more seriously than before the pandemic.

The Financial Times details the billions of dollars that have flowed into existing and new internet food-delivery companies. They are delivering everything from a can of Coca-Cola and pistachios to the standard full weekly shop – along with, of course, takeaway food.

Pistachios and other nuts are packed in biaxially oriented polypropylene film. Takeaway food containers are made from injection grade homopolymer PP.

Sure, only a few food delivery companies will emerge as winners, as is always the case with new investment fashions. But the winners will operate in a rapidly expanding market.

At some point the environmental pushback will intensify. But I sense that for a few years at least, most people will have other more pressing concerns than worrying about where the face masks they have thrown away ultimately end up.

As I discussed last month – when I provided three scenarios for global PP growth in 2021-2025 – it seems likely that our base case for growth will be too conservative because of the new demand trends.

Some PP end-use markets will, l believe, continue to struggle. Auto sales will remain depressed in some countries because of reduced work and leisure travel, and as people delay purchases of new conventional cars as they wait for electric vehicles to become cheaper.

In the EU – and possibly also the US if Joe Biden gets his infrastructure bill through Congress intact – the move to electric vehicles will gather pace, thereby reducing the resale value of petrol and diesel vehicles.

But the loss of PP demand in the autos sector was more than compensated for last year by gains in other end-use markets, say market sources. In percentage terms, autos only accounted for 4% of total global demand in 2020 versus 10% the previous year, say the sources. Meanwhile, the percentage share of PP going into packaging rose to 34% from 30% as overall volume gains were made.

Why shouldn’t all these trends continue?

The problems will instead be supply and trade flows

The chart below illustrates how the PP success story extends to naphtha-based integrated variable cost margins. I have included US Gulf Coast margins for the sake of full regional comparisons, even though there is very little US naphtha-based production. But in Asia and Europe, of course, naphtha-based production is big.

The tight supply, highlighted in the title of chart, is partly the result of the US winter storms that at one stage led to the shutdown of some 80% of US capacity. Another reason for reduced supply was low inventories in Europe at the end of last year, as producers preferred to export rather than sell locally because of better netbacks. Turnarounds delayed from 2020 until this year are also expected to further tighten the European market.

But one of the explanations I have given on the chart for comparatively low Asian margins points towards what I believe will become a very different PP market. This is the Chinese practice of running PP plants as national utilities rather than just as profit centres.

Despite a secular improvement in demand, it is new Chinese supply which will become the dominant influence on the industry as China moves much closer to self-sufficiency and away from being the world’s biggest importer. In 2020, we estimate that China accounted for 43% of total global PP net imports amongst the countries and regions that imported more than they exported.

This would leave the major exporters to China – South Korea, Singapore, Taiwan, the United Arab Emirates and Saudi Arabia – with some difficult decisions to make. Where and how would they place their lost export volumes?

Before I provide my latest outlook for how China could raise its PP self-sufficiency to the point where it might even become a net exporter, it is useful to summarise why this could happen. These same key points apply to other petrochemicals and polymers:

  • As mentioned above, China has long run its petrochemicals capacity as utilities to guarantee enough raw material supplies to keep employment-intensive washing machine and TV factories operating. Because of a very volatile geopolitical environment that risks interruptions in imports, China is set to also add a lot more capacity.
  • In products where it cannot reach self-sufficiency by itself it will support investments overseas and then import at low cost. This may apply to high-density polyethylene (HDPE) and low-density PE (LDPE) following the signing of the $400bn Iran/China deal.
  • China needs to maintain its position as the lowest cost workshop of the world. This makes it essential that China obtains adequate supply of competitively priced raw materials.
  • Investing in countries such as Iran would push forward China’s Belt & Road Initiative (BRI) as it tries to build a new geopolitical and economic trading zone. We are drifting towards a bipolar world of two geopolitical and economic zones, one led by China and the other by the US.
  • Most of China’s new petrochemicals capacity is world-scale and very well integrated. It thus ticks the box of being a value-added industry that will help China escape its middle-income trap.

How China could reach PP self-sufficiency

The chart below provides two scenarios for China’s PP net (imports minus exports) and net exports (exports minus imports) in 2021-2031.

The base case scenario, from our ICIS Supply & Demand Database, assumes an average annual operating rate of 87% and no unconfirmed capacity goes ahead. The downside, from an exporter’s perspective, is a 90% average operating rate with all the 27.7m tonnes/year of unconfirmed PP capacity that we have listed going ahead. Both scenarios assume our base case for demand growth which is an average 4% per annum.

This of course might not happen as this was a very straightforward mathematical exercise and doesn’t represent anything close to the value-added scenario work that our team of consultants and analysts could provide you with. But it does highlight the risks ahead. In my view, it is only a question of time before China reaches much greater PP self-sufficiency.

From inflation to deflation

We are in an inflationary petrochemicals world in general, as it obviously not just PP that has been affected by very tight supply and secular shifts in demand.

But there is a strong scenario that in quite a short space of time we will shift into deflation because of greater Chinese direct and indirect (through its strategic partners) petrochemicals self-sufficiency. In previous blogs I have detailed how this risk also applies to HDPE and LDPE (through its closer relationship with Iran) ethylene glycols, paraxylene and styrene monomer. Also see this LinkedIn post indicating how this could happen in methanol.

Producers, buyers and investors need to prepare for a seismic shift in global markets.