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Chemicals companies face an unprecedented demand and supply crisis

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By John Richardson on 20-Jul-2022

THE GLOBAL CHEMICALS industry is, I believe, facing a demand and supply crisis on a scale and on a level of complexity that nobody has experienced before.

We must go right back to the stagflation crisis of the 1970s to find anything vaguely analogous to what is happening today. But even the oil supply-precipitated shocks of that decade, which led to a collapse in demand, don’t come close to what we are now experiencing. Today’s combination of events is unique.

This is a huge subject and will thus require a series of blog posts.  Let me start here by looking at China’s role in this crisis. In later posts, I will look at the climate crisis, disruptions to supply chains and the new era of volatile geopolitics.

But should today’s events be regarded as a crisis or an opportunity? Chemicals companies can mitigate short-term losses while delivering strong long-term returns through developing new business models. This is again a theme for another day.

As I said, let me start with China.

China is losing its role as the global “demand bank”

China in the short, medium and long-term will, I believe no longer act the “demand bank” for the global industry, the account from which we have long been able to draw consumption growth that has constantly surprised on the upside.

Chinese demand will surely still grow, but not on the scale widely assumed in some demand-growth models.

And, crucially, much of the demand that occurs will be met by local production as China increases self-sufficiency in products such as high-density polyethylene (HDPE), polypropylene (PP), styrene, ethylene glycols (EG) and paraxylene (PX). Over the long-term, rapid growth in mechanical and chemicals recycling could also play a role on China’s self-sufficiency.

Think of early 2009 as a great example of how the demand bank used to work. At the time, I told my ICIS colleagues in Singapore that, whoosh, there would be an explosion of demand and a surge in Chinese imports. I said that prices would also surge because of the world’s biggest-ever economic stimulus programme.

This of course happened. The chart below illustrates the effect on spreads using HDPE as an example. It was the same story in all the other chemicals and polymers. Spreads are a reasonable proxy for profitability.  

While spreads were down slightly in 2009 over 2008, they were still historically very strong as the chart below shows. The chart covers the period from 2003, when our price assessments began, until 2009.

And China’s year-on-year HDPE demand growth in 2009 was a staggering 33%, the highest on record. The following year, consumption increased by 13% before growth fell to a still healthy 4% in 2011.

As the next chart below reminds us, again focusing on HDPE (it is again the same for every other chemical), the role of China in driving global demand hugely increased up until 2020 as major domestic economic stimulus continued.

The next chart below shows how this has translated into millions of tonnes of demand. Look at the expansion of the brown shaded area, representing China, versus the other region. In 2021, there was no change in this pattern.

Negative economic effects of zero-COVID to last at least the rest of this year

When the zero-COVID lockdowns were relaxed in early June of this year, many of my contacts and friends predicted another “whoosh” in line with both early 2009 and H2 2020 – China’s post-lockdown export-driven economic recovery.

It was widely expected that demand and spreads would surge from early June onwards as the economy re-opened. Some sales and production targets were adjusted in line with this expectation, I have been told.

But I warned that this was unlikely to happen because of China’s firm commitment to its zero-COVID policies and the resulting stop/start nature of the relaxation of restrictions. The chart below shows that there has been no recovery in HDPE spreads. It shows month-on-month spreads since January 2003, when our price assessments began.

As the next chart indicates, spreads on an annual basis up until 15 July 2022 instead look set to be the lowest on record. Further, as I discussed in my 29 June post, China’s HDPE demand in 2022 could contract by 4% following a 4% decline 2021.

China cannot afford to step back from its zero-COVID approach because of what appears to be the ineffectiveness of local vaccines in preventing severe symptoms and low vaccination rates among the elderly. If the policies were abandoned, the healthcare system could be overwhelmed.

The policies have also become a test of political loyalty. It is said that local government officials will not be marked down for low GDP growth this year as this is a given. They instead risk poor work reports if they allow the number of coronavirus cases to get out of control.

Local officials appear to be competing with one another to be extra zealous in sticking to the policies. This is said to be continuing to disrupt domestic supply chains.

Delivery drivers are reported to be still finding it hard to move from one city or suburb to another because of unpredictable local lockdown rules. Demand for online deliveries, so important for maintaining growth as lockdowns persist, is therefore said to remain below pre-zero-COVID levels.

Underlining the stop/start nature of the economic rebound, the Financial Times wrote in an 18 July article: “China is at risk of more frequent lockdowns and mass testing as officials struggle to contain the spread of the highly transmissible BA.5 Omicron subvariant despite the damage pandemic restrictions have already wrought on the world’s second-biggest economy.”

The newspaper added that 41 Chinese cities were under full or partial lockdowns or district-based controls. This was affecting people in regions that accounted for around 18.7% economic activity, said FT in quoting analysis from Nomura. This compared with a week earlier when Nomura said that 17.5% of the economy was affected.

How long is this going to drag on for given that the coronavirus is showing no signs of mutating into less virulent forms? We are instead seeing the exact opposite with the BA.5 Omicron strain.

If or when China develops its own effective mRNA vaccine, the country’s ability to quickly vaccinate the population could bring a stop to the zero-COVID policies. Then we could well see a surge in chemicals pricing, spreads and demand.

A Chinese mRNA vaccine candidate had triggered a stronger antibody response in vaccinated adults when given as a booster shot than did a jab containing inactivated SARS-CoV-2, the vaccine platform that the country had so far mostly relied on, said Nature in a 27 June article.

But the magazine cautioned: “A highly effective mRNA vaccine would reduce the chances of widespread serious infections that could overwhelm hospitals. However, it is unlikely to bring an end to the country’s strict zero-COVID strategy, which uses mass testing and lockdowns to quash all infections.”

I think it is therefore very probable that the stop/start nature of the recovery will continue for at least the rest of this year and possibly well into 2023.

The economic damage being caused by the zero-COVID policies is being compounded by changes in China’s economic growth model – the Common Prosperity policy shift that began last August.

The short, medium and long-term implications of these changes is the subject of the final section of today’s post.

Less debt, greater economic equality and a cleaner environment

“China’s property prices have now been falling for a record 10 months. In June, sales by the country’s top 100 developers were down 43% versus last year, even after a 61% jump versus May,” wrote fellow ICIS blogger Paul Hodges in a 17 July post on his blog, Chemicals & The Economy.

“And now buyers in at least 100 projects across more than 50 cities have stopped making mortgage payments due to construction delays and concerns over falling prices,” he added.

This is the result of the Common Prosperity efforts to reduce alarming levels of real-estate debt, while also reducing the economic inequality resulting from the growth of a super-rich, multiple property-owning middle class.

The decline in real estate is also the result of loss of confidence caused by the zero-COVID policies, and, of course, the limited ability to view properties because of lockdowns.

Lots of real-estate stimulus measures have been introduced over the last few months to try and shore up short-term growth but with limited benefits – again because of zero-COVID.

In the long term, though, the direction of travel seems clear with major implications for chemicals growth, as discussed in my 5 January 2022 post. I believe China will stick to Common Prosperity because it has no other choices.

The slide below, from the post, shows the close links between the big growth in China’s Total Social Financing since 2009 and the increase in China’s HDPE demand in tonnes and its shares of global consumption. The same patterns can again be seen in other chemicals and polymers.

Some 30% of China’s economic growth has been generated by real estate, one of the highest percentages in economic history.

“One could regard what’s happening in China as a crisis, but I don’t see events as a crisis, but rather an opportunity to reset strategies,” said a senior chemicals industry source.

“China is no longer pursuing growth for the sake of growth. It instead only wants growth if it is sustainable in terms of both greater economic equality and a cleaner environment,” he added.

“The push for a cleaner environment will require new products and services. For example, I see China leading the way in carbon-efficient chemicals plants and in mechanical and chemicals recycling. They will need overseas partners.

“Nevertheless, the shock for chemicals companies that have built a lot of new capacity to serve Chinese demand that won’t be there will be big.”

He concurred with the view that China would move much closer to self-sufficiency – with perhaps mechanical and chemicals recycling playing a big long-term role in greater self-sufficiency.

Change is never easy. But the quicker we come to terms with the changes taking place in China the better.

In my next post in this series, I will consider climate change and how it could affect growth in the developing world. As with China, the standard “business as usual” chemicals growth forecasts may not reflect what is going to happen in Africa, Asia and Pacific, South and Central America and the Middle East.