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European PE pricing, margins and spreads versus China and the risks of a correction to long-term historic patterns

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By John Richardson on 19-Aug-2022

By John Richardson

THE CHEMICALS AND polymers world is behaving in ways that our industry has probably never seen before.

The above chart shows average monthly Northwest European polyethylene (PE) prices premiums and discounts for three major grades compared with the same grades in China, from when our assessments began in January 2020 until 12 August this year.

The all-time peak premium was reached in May 2021 at $1,149/tonne. We then saw a decline, a new surge of premiums to a 2022 year-to-date peak in April of $850/tonne, before another decline from May to $464/tonne during the first two weeks of August.

Now let us look at Northwest European annual average premiums (on an annual basis, Europe PE has always cost more than China PE) from 2000 until so far in 2022.

As I said, something very strange has been going on. Why?

Last year, the European PE market was tightened by the Texas winter storm and hurricanes. This sharply reduced US PE exports to Europe. The US is Europe’s biggest source of imports.

Pandemic stimulus was still slushing through the European economy, supporting demand.

Expensive container freight rates and lack of container space limited the ability of Asian and Middle East exporters to export oversupply from north and southeast Asia to Europe, and this has continued in 2022.

Now let us start to consider what might happen next, starting with the chart below on US PE exports.

Total US PE exports fell to 8.8m tonnes in 2021 from 10.5m tonnes in 2020, according to the ICIS Supply & Demand Database. But January-June 2022 exports when annualised (divided by six and multiplied by 12) point to this year’s full-year exports reaching 10.7m tonnes

US domestic demand, however, is strong, inventory pressure has eased and there is a heavy US turnaround schedule in the autumn, according to CDI – an ICIS service.

But this year’s capacity increases are not due to happen until the end of the third quarter and in Q4. US linear-low density (LLDPE) capacity is scheduled to increase by 17% in 2022 and high-density PE (HDPE capacity by 6%. Low-density PE (LDPE) capacity is forecast to remain flat.

The next chart shows North America-Europe container freight rates versus China/east Asia-Europe rates.

As you can see, cost inflation on the North America-Europe route has been nowhere near as much as on the China/east Asia Europe route. Availability of containers to move US PE to Europe is also said to not be a problem.

The ICIS Supply & Demand trade data show that during the first six months of this year, US exports to Europe rose. Belgium and Spain made the top ten destinations for US PE exports in 2021 and in January-June this year.

US PE exports to these countries were 573,590 tonnes in 2021. The January-June data, when annualised (divided by six and multiplied by 12), points to US exports to Belgium and Spain reaching 1.1m tonnes during the whole of 2022.

These extra US volumes may have helped to replace lost Russian imports. I don’t have access to sufficiently detailed and up-to-date European trade data to draw any conclusions here.

But increased availability of US PE could be a threat to European profitability later this year and into 2023, if high inflation in Europe continues to eat into demand.

And just at look at how average ICIS European PE margins have soared since 2021. I have again compared European margins with those in northeast Asia, which is dominated by China. Bear with me here as, later in this post, I shall explain the relevance of these links with China.

Now let us again look at this same data on an annual basis.

Next, look just at China/east Asia-Europe container freight rates.

As you can see, there has been a sharp decline in freight rates on this route during 2022, although there was a slight rebound from end-July until 8 August. This reflected the start of the peak manufacturing season, when China’s factories normally run flat out to make goods for export in time for Christmas.

But ICIS Pricing editors have heard of more PE making its away from Asia and the Middle East to Europe, which is perhaps the result of falling container-freight rates.

I believe that eventually, because of the demand destruction caused by inflation, China/east Asia container rates will fall much closer to pre-pandemic levels, thereby allowing Asian and Middle East PE exporters to relieve oversupply in the China market by shipping more resins to Europe.

The next two charts, from my 15 August post, illustrate the extent of oversupply in China.

Just in case anyone has been living on Mars for the last 20 years, China dominates global PE demand, both in volume and growth terms, and is by far the world’s biggest net importer.

As well as margins, spreads offer a good guide to supply and demand balances. An advantage of the ICIS spreads data (the differentials or gaps between PE prices and naphtha feedstock costs per tonne), is that the numbers go back further than January 2014 – when we started our margin assessments.

The chart below, which again runs from January 2000 until 12 August 2022, shows the big gulf between average PE spreads in Europe versus China that has opened up since February 2021. But the gap has narrowed since April this year.

Conclusions: The risks ahead for Europe

It seems more likely that China will pull Europe closer to its pricing, margins and spreads levels rather than vice versa. You might ask “Why should this happen?” A better question might be “Why shouldn’t this happen?”

Along with the PE demand destruction caused by inflation in Europe, we have must factor in the impact on the European economy of China’s long-term slowdown. For example, 2.7% of Germany’s total economic value added and 2.4% of total employment depend on exports to China.

The next chart, showing just China HDPE injection grade spreads over naphtha costs, illustrates just how remarkable today’s events are in China. I have only shown HDPE spreads as this is the only China PE pricing assessment that goes all the way back to January 1990.

The final chart for today shows the above spreads data in average terms between 1990 and 2021 and in just 2021 compared with this year -again from January until 12 August.

A lot of new stimulus is being pumped into the Chinese economy, including last week’s interest rate cut, to try and turn growth around. But if people don’t want to spend money, because of zero-COVID and the deflating property bubble (a symptom of Common Prosperity), money won’t be spent

It is important to bear in mind the weak spreads data also reflect rising Chinese HDPE self-sufficiency and big new capacity additions elsewhere in Asia. However, previous big waves of capacity have been much more easily absorbed by a nearly-always booming Chinese economy.

Unless spreads during the rest of August and up until end-December 2022 recover to much closer to their long-term averages, this, I believe, will tell us that problems with China’s economy will have persisted.

I don’t see a recovery in China spreads happening during the remainder of this year and in 2023 because:

  1. China cannot back away from its zero-COVID policies for political and healthcare reasons. This will mean a stop/start recovery.
  2. As mentioned earlier, Common Prosperity means lower economic growth over the long-term.

It remains to be seen whether the falls in European pricing, margins and spreads closer to the levels in China which we saw during July and August this year will be sustained. This could have been just a holiday-season lull and the impact on the European economy of the extremely hot weather that is hampering river traffic.

Given, however, what I’ve just described, every European PE produce, buyer and investor needs to keep a hawk eye on the all the above ICIS data sets, and the interconnections between the data sets.

You don’t have to listen to my opinion to find out what happens. Instead, just follow our data.