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European and US LLDPE margins may in 2022 sink towards northeast Asian levels

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By John Richardson on 14-Jan-2022

By John Richardson

A GOOD FRIEND and contact messaged me this week to say, “Wow, this is complicated”. Yes, I am afraid so. These are the most difficult-to-read polyolefins markets I can recall in my 25 years of following the industry. I don’t see forecasting outcomes for this year becoming any easier.

But, using linear low-density polyethylene (LLDPE) as an example –- and the slide below as a starting point – see my three scenarios to provide you with guidance.

See my percentage ratings out of 100% for the likely realisation of each of the outcomes which I will revise as events develop.

Here is the essential context before we go into the scenarios in detail

The chart you are seeing shows that Northeast Asian (NEA) naphtha-based margins dipped into negative territory last year for the first time since late 2019. They were at -$75/tonne during the week ending 7 January 2022.

Meanwhile, despite recent dips from record highs, European and US margins remain extremely strong. Margins in the West are being supported by much tighter supply and demand balances than in NEA.

Now look at the chart below which helps to explain the weak NEA margins.

Last year was always going to see a growth deceleration because 2020 was a bubble year.

During 2020, China exported itself into a strong recovery from the pandemic as it provided most of the goods the West wanted or needed during lockdowns. This led to LLDPE demand in 2020 rising by 13% over 2019.

What also contributed to the 2021 slowdown from August onwards was the Common Prosperity policy shift around that time.

This involved a deflation of the property bubble, leading to less LLDPE demand linked to real estate. Think of all the packaging for the carpets, and washing machines etc) that furnish new homes, that was no longer required as home sales fell.

Also consider the decline in discretionary consumer spending as the growth in personal wealth slowed down due to the government’s deleveraging of real estate. Less discretionary spending again led to less demand for LLPDE used for packaging.

China introduced new restrictions on the use of single-use plastics in early February 2020, just before the pandemic.

The restrictions were put on hold because of the pandemic but were enforced last year, I’ve been told. This would again fit in with Common Prosperity as another of its objectives is cleaning up the environment.

See the chart below for important context. Notice the slight dip in China’s share of global demand as the post-2009 credit bubble was deflated by Beijing.

Another reason for the weak NEA margins in 2021 and during the first week of 2022 was last year’s 13% increase in China’s LLDPE capacity to 10.1m tonnes/year.

China imported 6.7m tonnes of LLDPE in 2020. This looks is likely to have fallen to around 5.6m tonnes in 2021, based on the January-November 2021 China Customs data.

Now let’s consider what could happen to China’s LLDPE market during the rest of this year and the global implications.

China’s LLDPE net imports in 2022 at either 7m tonnes or 4.7m tonnes

China accounted for some 60% of global net LLDPE imports in 2021 among the countries and regions that exported more than they imported. So, clearly, the risks of greater Chinese self-sufficiency in 2022 are significant.

Our base case assumes 5% growth in China’s LLDPE demand in 2022 over 2021 (our base case also forecasts 5% growth for 2021 over 2020 compared with my estimate of flat growth).

ICIS assumes an 83% operating rate in 2022, down from our estimate of 92% last year as the market absorbs more new capacity. We expect a further 9% increase in capacity in 2022.

But what if growth were to be just 2% because of Common Prosperity? I don’t see China backing away from its policy shift as the old economic growth model no longer works.

A further reason to believe that growth could be lower than our base case 5% is China’s zero covid policy – hard borders and severe local lockdown restrictions that are hurting the economy.

There were no indications that China would change its policy until at least this year’s Communist Party National Congress in either October or November, when China’s president, Xi Jinping, was expected to be given a third time in office, said the Financial Times.

And what if 2022 LLDPE operating rates were at 87%? Another government policy headline, Dual Circulation, involves greater self-reliance through reduced imports of all commodities.

More feedstock from local refineries may be available to make LLDPE because of a government-driven restructuring of the refining sector.

Under Downside 1 for China, 2022 net imports in 2022 fall to 5.7m tonnes.

Downside 2, using the same arguments as above, involves a repeat of last year’s zero growth and operating rates at 92% –- the same as our estimate for 2021. This would leave 2022’s net imports at just 4.7m tonnes.

The chart below puts these three outcomes for China’s 2022 LLDPE net imports into the global context, assuming that our base cases for other countries and regions are correct.

Under the base for China, total global net imports would equal 11.6m tonnes. Under Downside 1 they would fall to 10.3m tonnes and under Downside 2, 9.3m tonnes.

And now for the logic behind my 2022 LLDPE margin scenarios

I attach just a 5% likelihood that NEA LLDPE margins will rise to closer to European and US levels in 2022 because of Common Prosperity, the zero covid policy and the further increase in China’s capacity. So, Scenario 1 is a long shot.

I rate Scenario 2 at 40%. This would involve the container freight costs and shortages that are making it difficult for NEA producers to export their surpluses continuing throughout 2022.

Container freight problems are another factor behind the weak NEA margins, with reduced deep-sea availability supporting European and US margins.

There’s a good chance that low vaccination levels in the developing world will cause more port disruptions as coronavirus outbreaks spread. Until all of us of are adequately vaccinated, none of us are adequately vaccinated.

The good news is that percentages of people who have been fully vaccinated have risen sharply in two major developing countries – India and Indonesia – over the last two months.

As of 11 January 2022, Our World in Data reported that 46% of Indians had been fully vaccinated and 43% of Indonesians had been fully vaccinated. But the Our World in Data numbers also showed that full vaccination rates remained below 10% across most of Africa up until 11 January.

But my preferred scenario – Scenario 3 at a 55% – assumes that during 2022, coronavirus moves from being a pandemic to being endemic – i.e. we learn to live with the disease much more comfortably, as we do with the flu.

Under this scenario, as lockdown restrictions are lifted, container freight markets return to normal.

Another reason why container markets could return to normal this year is a cycle out spending on goods and into more services as life returns more or less to the Old Normal.

Global trade in durable goods has increased, the reason for China’s 2020 economic boom, because of the increased spending on office furniture, TVs, computers and washing machines etc. by bored rich Westerners during lockdowns.

Scenario 3 also factors in a decline in LLDPE demand in the West as people eat more in restaurants and less at home, reducing “surface area demand” because of the larger package sizes used by restaurants.

Also consider the chart below, showing the potential rise in US LLDPE exports in 2022.

Last year, US exports were just 58% of production because the winter storm in Texas and hurricanes reduced output, forcing producers to focus on meeting local demand. In 2020, 65% of production was allocated to exports

But, assuming no further major disruptions to output in 2022 –- and with US capacity set to rise by 18% in 2022 over last year – it seems reasonable to assume that exports could return to 65% of production.

This would result in exports increasing to 6.1m tonnes in 2022 from 4.7m tonnes in 2021.

In summary, therefore, I see Scenario 3 as more probable because of longer supply and weaker demand in the West –- along with more imports from NEA, southeast Asia and the Middle East as container freight tightness eases.

Conclusion: rhyming history and LLDPE margins

Finally, look at the chart below.

The chart shows actual premiums in European and US LLDPE margins over NEA margins between the first week of January 2021 and the first week of this year.

To highlight the extent to which markets have become disconnected, I then show what would have instead happened in January 2021-January 2022 if the average 2014-2020 premiums had applied.

“History doesn’t repeat Itself, but It often rhymes,” said Mark Twain. There can be no exact repeat of the longer-term history of LLDPE margin premiums in 2022.

But the chart does show how much Europe and the US punched above their weight in 2021 and during early 2022. What goes up always eventually always comes down.,

If the rebalancing towards NEA levels of margins doesn’t happen this year because of continued container freight constraints, it must happen at some point, I believe.