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China goes global in PP perhaps quicker than had been expected, badly disrupting the global industry

Business, China, Economics, Environment, India, Japan, Malaysia, Middle East, Naphtha & other feedstocks, Olefins, Polyolefins, Singapore, South Korea, Taiwan, Thailand
By John Richardson on 08-Aug-2022

By John Richardson

CHINA’S polypropylene (PP) industry in the short- to medium-term is being pushed into going global perhaps quicker than it had intended. This is because of the collapse of local demand and the resulting all-time weak netbacks in China versus most of the other regions.

But this shift was one that was eventually always going to happen once China had made the decision in 2014 to push much harder for petrochemicals self-sufficiency.

I believed at the time – and I warned the blog’s readers – that an increasingly confident and technically capable China with lots of new highly integrated world-scale plants would turn the global PP business upside down.

I said that China would likely eventually reach complete self-sufficiency in PP, probably not just in homopolymer grades but also in copolymer grades, including perhaps even the highest value co-polymer grades.

More recent events appear to support my long-held view. China has accelerated its capacity growth through highly integrated, state-of-the-art coastal refinery-to-PP plants – and through world-scale coastal propane dehydrogenation-based plants with access to competitive feedstocks.

This is not because I possess some extraordinarily transparent crystal ball. It is instead because I talked to some senior strategic planners in the petrochemicals business, who, off the record, pointed the blog in this direction. Thank you! You know who you are.

China and the short-term to medium-term global PP crisis

As I discussed last week, the January-June ICIS China production estimate combined with the China Customs net import data indicate a 1% decline in full-year 2022 PP demand versus 2021. I see a worst-case outcome of a 4% decline in this year’s demand. This would compare with 6% growth in demand in 2021 over 2020.

This negative outlook is the result of the zero-COVID policies that cannot be relaxed because of what appears to be the limited effectiveness of Chinese vaccinations and low vaccination rates among the elderly. The challenges are occurring simultaneously with Common Prosperity economic reforms, including, most importantly, the deflation of the real-estate bubble.

The weaker growth outlook is happening as China’s PP capacity continues to increase. In 2021, capacity grew by 13% with a 12% increase forecast for this year, which would leave capacity at some 39m tonnes/year. This would be against demand that in 2022 could be as low as 33m tonnes.

Meanwhile, capacity has been increasing in South Korea (again up by 13% in 2022 with a further 12% increase expected for 2022).

The restart of Pengerang Refining and Petrochemical in Malaysia is expected to push Malaysia into small PP net export position in 2022 and a big net export position in 2023. Malaysia was a net importer in 2021.

The 300,000 tonnes/year Long Son Petrochemical PP plant in Vietnam is expected to come onstream early next year, reducing Vietnam’s net import needs.

This is occurring as higher container freight rates and lack of container availability have limited the ability of Asian and Middle East producers to export oversupply to destinations outside northeast and southeast Asia. Spot freight rates had declined in 2022 up until mid-July but have increased again on port congestion.

The extent of the short-term challenges for China’s PP producers, and for exporters to China, is illustrated by the chart below.

China CFR PP injection grade price spreads or differentials over CFR Japan naphtha costs fell to $167/tonne in March as the zero-COVID policies combined with a rapid increase in oil prices resulting from the Russian invasion of Ukraine. The previous historic low was in December 2019 – $259/tonne – since the ICIS price assessments began in November 2002.

In July this year, spreads had recovered slightly to $218/tonne, but had fallen from $261/tonne in June as China PP injection grades prices declined more than the fall in naphtha costs.

The pattern in China pricing for all the grades of PP over naphtha costs has been the same as in the above chart.

Now let’s look at the latest pattern of long-term average annual spreads. The average June-July 2022 spread was much lower than any other year since our assessments began.

China’s PP operating rate in January-June this year was just 80%, according to ICIS data. This compared with our earlier forecast for a full-year operating rate of 84%. If this year’s full-year operating rate ended up being 80%, this would be the lowest capacity utilisation since 2000.

But still, full-year 2022 exports look set to total 1.7m tonnes based on annualising the January-June export number (divided by six and multiplied by 12). This 1.7m tonnes would compare with 1.4m tonnes of exports in 2021 and just 424,746 tonnes in 2020.

Underlining my point about China going global, the ICIS Supply & Demand Database trade data show the evolution of China’s export mix by destination.

Let’s start by looking at the changes between 2020 and 2021 in the percentage shares of total Chinese exports across the top ten destinations.

In 2020, Vietnam was the biggest destination at 34% of the total followed by Hong Kong. Eight out of the top 10 destinations were in Asia.

Last year was very different. Vietnam’s percentage share of the total halved to 17% with India, Pakistan and Turkey entering the top 10 for the first time. Brazil and Peru also made the top 10.

Vietnam has long been the top country for Chinese PP exports because of a free-trade agreement that makes exports duty free. But, as the chart below shows, Vietnam’s share of total exports fell in January-June 2022 to just 10%.

In joint first place was India at 10% followed by Pakistan and Bangladesh at 6% each. Brazil was in fifth place with 5% of the total. Peru and Guatemala were also in the top 10.

I wonder the extent to which the local producers are keeping on top of events in more distant markets versus the traders? Is it the producers gaining most of the value or is it the traders?

The next few slides show the price differentials between CFR China PP injection grade  and injection grade prices in other regions. They explain why China was been throwing its net much wider and align with the trade data.

Let’s start with India and Pakistan.

As I highlighted at the time, the great price divergence between China and most of the rest of the world began from March 2021 and continued up until July 2022. But India and Pakistan price premiums over China had fallen from May this year until July.

A steeper decline can be seen in Turkey premiums over China since April this year. Again, though, netbacks remained strong.

Differentials between Brazil and China tell the same story. Note that the huge Brazil premiums in October and November 2008 related to the weird state of global markets during the Global Financial Crisis.  But the run-up in premiums since last year has lasted a lot longer.

China PP over the long-term: Why it could become a net export country

Before we get onto the above topic, consider the chart below. In 2021, China came from nowhere to become the third biggest PP exporter among some of the major Asian and Middle East PP exporters (I don’t have the 2021 export data for Abu Dhabi).

This is a huge, huge deal for the global PP industry at a time of weak global demand, falling operating rates and weaker profitability.

Now consider the final chart for today.

ICIS estimates that China was responsible for 42% of global net imports in 2021 among the countries and regions that exported more than they imported, way more than any other country or region.

So, clearly, the potential loss of China as a net import market would be a big blow to the big exporters in the Middle East and Asia, aside from the extra competition the exporters would face from Chinese exports.

Let’s parse the above chart in detail. The ICIS base case assumes annual average demand growth of 4% between 2022 and 2030 and an average operating rate of 81%. This would leave cumulative net imports totalling 36m tonnes.

Actual operating rates were 90% in 2000-2021. For argument’s sake, let’s assume this operating rate is repeated between 2023 and 2030 )(n this first downside, 2022 net imports at 2.4m tonnes are based on the January-June 2022 China Customs number divided by six and multiplied by 12). Under this Downside 1, cumulative net imports would total just 7m tonnes!

Downside 2 again assumes net imports of 2.4m tonnes for 2022. I assume minus 4% growth for 2022, my worst-case outcome, and minus 2% for 2023. I then assume an average of 3% growth per year from 2024 until 2030. Given the lower demand growth, I stick with our very low base case of an operating rate of just 81% during the whole forecast period. But still, China ends up with net exports of 22m tonnes!!

Conclusion: Chinese PP companies could become much bigger global players

As the heading says, China’s PP producers could play a much bigger role on the global stage.

In the short term and perhaps in the medium term, this could be because they have no choice due to lower growth resulting from the zero-COVID polices and the Common Prosperity reforms during a period of big Asian capacity additions.

As for the long term, China may end up being a major exporter of both commodity and higher-value grades of PP. If geopolitics align appropriately, China might also acquire overseas PP assets. This could be part of a broader climb up the manufacturing value chain as China attempts to escape its middle-income trap.

There are many, many other outcomes possible for China’s and the world’s PP businesses because of the maelstrom of uncertainty created by geopolitics and sustainability. How might sustainability, for example, effect global demand and production processes over the next decade? I will look at this theme in a later post.

We must therefore plan for a range of scenarios. But these scenarios must include one where China’s PP players take on the global majors following a shift from a big import position to substantial exports.