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PE and PP production decisions become super-critical amid Ukraine-Russia, zero-COVID complications

China, Europe, European economy, European petrochemicals, India, Indonesia, Middle East, Naphtha & other feedstocks, Olefins, Philippines, Polyolefins, Singapore, South Korea, Thailand, US
By John Richardson on 11-May-2022

By John Richardson

I CANNOT STRESS ENOUGH the importance of this old maxim, which I was taught back in the grim days of late 2008, when there was a very real risk that, if the global financial market  system wasn’t rescued, we would have been in a new Global Depression and not just a recession:

Every tonne you don’t produce, when you correctly assess that the demand isn’t there in a particular market, will be important in preserving cashflow. Cashflow could once again be king, as it was during the 2008-2009 Global Financial Crisis; and every tonne that you do produce, when you accurately assess that demand is there will, of course, support your revenues.

I am not saying that current market conditions are analogous to the pre- financial sector-rescue conditions of 2008.

We face a whole different set of problems relating to record-high inflation because of pandemic stimulus and supply- chain problems that, as this article from my ICIS colleague Will Beacham says, are not going away. Instead, as I discussed last week, the disruption to ports caused by China’s zero-COVID lockdowns might be about to make supply -chain disruptions even worse.

On the theme of zero-COVID, I think China is in recession. Yes, recession, which is something I haven’t seen previously in the 25 years I’ve been following China’s economy very closely.

The UK’s Guardian newspaper reported on 7 May: “Xi Jinping has confirmed there is no intention to turn away from China’s zero-COVID commitment, in a major speech to the country’s senior officials that also warned against any criticism or doubting of the policy.

“Addressing the seven-member politburo standing committee, China’s highest decision-making body, specifically about the Shanghai outbreak, the president said China’s response was ‘scientific and effective’”. He told officials to ‘“unswervingly adhere to the general policy of dynamic zero-COVID’,.’ “.”

As I’ve been highlighting for the last month, until the zero-COVID policy is relaxed, the bulk of China’s economy, namely its richer provinces, will remain largely frozen. No amount of economic stimulus will make a difference, as, because of the lockdowns, people are unable to spend the extra money.

The Chinese president’s Xi’s comments suggest that relaxation of the zero-COVID policy won’t happen anytime soon. The accepted wisdom is that relaxation won’t happen until at least November this year when an important political meeting is to take place, during which Xi is expected to be given a third time term in office.

With China’s economic heartland effectively frozen, this makes it quite probable that China’s economy will remain in recession for the rest of the year, when one looks at economic data apart from the questionable official GDP numbers.

This would be the opposite of 2009 when all-time high levels of economic stimulus in China, pumped into an economy that remained very much open, rescued global demand for everything including petrochemicals.

I see recession in China likely resulting in the country’s growth in most petrochemicals turning negative in 2022.

I do worry about the developing world ex-China because of the food and fuel crises along with lack of fiscal flexibility to support lower-paid workers. This creates the risk that many more people will experience extreme poverty.

The extremely poor cannot afford even the most basic modern-day goods made from petrochemicals or polymers or wrapped in polymers. Some one-third of global polyethylene (PE) and polypropylene (PP) demand is generated by the developing world ex-China. The region comprises of Africa, the Middle East, South and Central America, and Asia and the Pacific, minus the fully developed economies of Australia, New Zealand and Singapore.

Could the tragic events in Sri Lanka be the prelude to a developing world ex-China debt crisis, as the US dollar continues to strengthen on higher interest rates?

But Indian packaging demand is booming, say market sources. Perhaps this is due to a continued rebound from the peak pandemic lockdowns. Big public events, like the fabulous Indian Premier League, must be supporting consumption. Last year, the event was held behind closed doors.

Are recoveries from peak lockdowns supporting packaging demand in other developing world markets ex-China? To what extent are these recoveries offsetting the negative impact of the rise in extreme poverty?

In developed markets, discretionary spending is being hit from inflation and will be further damaged by supply- chain problems set to occur in May and June, the result of a shortage of exports from China as zero-COVID disruptions take effect.

But the effect on essential spending, meaning consumption of single-use polymers, is far less clear.

You can make a case, as I did on Monday, using the example of the humble chocolate biscuit, that the cost- of- living crisis is affecting demand for even the most basic of goods.

But Olivier Blanchard, former chief economist of the International Monetary Fund (IMF), and French economist and public policy expert Jean Pisani-Ferry, believe that despite the increasing costs of borrowing, cash transfers to the lower-paid in the EU need not exceed half a percentage point of the EU’s GDP. This would be below fiscal spending at the height of the pandemic.

Consider this further complication, however trivial this sounds versus what really matters, which is nothing short of a humanitarian disaster: The extra single-use demand generated by the millions of people displaced by the Ukraine-Russia conflict.

As I said, the humanitarian aspect is what really matters. But businesses must continue to function in this crisis and the opacity of demand is making running polyolefins businesses very difficult indeed.

Still, though, a hot topic in my off-the-record discussions with polyolefins industry executives is the extent to which single-use PE and PP demand might decline as we, hopefully, continue to move into the endemic phase of the coronavirus.

Clearly, therefore, highly complex demand models are essential that factor in all the above and probably more

On the supply side, complexities include the degree to which US domestic supply -chain problems will limit its PE exports in 2022, and, crucially, the impact on European petrochemicals production of reduced purchases on Russian oil, naphtha and natural gas -– and whether reduced purchases will lead to higher-than-expected European imports of petrochemicals.

Taking a short cut to the here and now of demand: examples of pricing and margins data

But while you build these models, how do you go about allocating supply to the right regions right now? By making use of ICIS pricing and margins data.

For instance, consider the two charts below.

 In 2021, as China underwent the Common Prosperity slowdown and as PE and PP capacities increased, China price discounts over European prices reached their highest levels since we began our assessments in 2000 or the early 2000s.

Or to put it another way as presented in the above charts: European price premiums over China reached record highs on tighter supply in Europe due to the container-freight shortages and strong European demand versus the weaker China markets.

As you can see, premiums dipped in early 2022, but from March up until the end of last week – 6 May, – they rose again. And even when the premiums dipped, they remained well above their long-term historic trend.

Now let us look at high-density PE (HDPE) and PP in terms of profitability.

As you can again see, in line with the pricing trends, European variable cost margins dipped briefly earlier this year as feedstock costs went up, but the pass-through of extra costs to customers has clearly been successful since March. Margins in the week ended 6 May were close to record highs.

Meanwhile, northeast Asia (NEA), which includes China, remains in a long-running loss-making spell that began in December 2021. It is worth noting that NEA northeast Asian markets is are still suffering losses despite deep PE and PP operating rate cuts in China.

Ergo, European demand is strong whereas China is weak. So, allocate more tonnes of production to Europe, until we see these trends change, and less to China. If this on balance means you need to make rate cuts across your global businesses, so be it, especially if you are naphtha-based. Naphtha and other liquids-based producers cannot afford to overproduce at a time of volatile and high feedstock costs.

Global pricing and margins data

You obviously need more than just China and Europe data to get the full picture. ICIS pricing for all the other regions -– and, crucially, also, spreads over feedstock cost, along with our on-the-ground market intelligence -– will help you interpret the “here and now” of demand.

So will our margins coverage across different regions and for feedstocks other than naphtha.

To reiterate again, the short-term micro decisions you make during the rest of this year will be crucial in helping you hit your cost and sales targets.