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European polyolefins could be dragged down by China

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By John Richardson on 03-Aug-2022

By John Richardson

AGAIN, please don’t say I didn’t warn you. Last April, when the historic divergence between European and Chinese polyethylene (PE) and polypropylene (PP) markets began, I warned that it wouldn’t last forever. I said that European price premiums over China would eventually return to normal.

This process may have already begun, as the chart below, detailing monthly Free Delivered northwest Europe (NWE) high-density polyethylene (HDPE) injection grade price premiums and discounts over CFR China HDPE injection grade prices indicates (it is a similar story in the other grades of PE). The chart runs from when our price assessments began in January 2000 until July 2022.

Now let’s look at the actual NWE HDPE prices versus those in China.

Here is the historic context behind the first chart:

  • From March 2021 onwards, tight container-freight markets limited the ability of the big exporters in the Middle East and Asia to relieve oversupply in China by exporting to Europe.
  • Chinese demand slowed as the country’s consumption fell by 4% in 2021 over 2020. This occurred as China and South Korea added substantial new capacities.
  • The Texas winter storm in February 2021, followed by hurricanes later in the year, sharply reduced US production. The US is Europe’s biggest source of PE imports.
  • And, of course, inflation last year was seen as “transitory” by the Fed with energy prices much lower than they are today.

But container spot freight rates had fallen significantly up until the middle of last month on both the Asia-to-Europe and Asia-to-the-US routes, according to this 17 July Freightwaves article.

The 29 July ICIS Europe PE price report said: “Europe’s market was very depressed, facing a weak August after a weaker than hoped-for July. Players were waiting for the monomer to settle for a further idea of market movements in August. Converters were minimising inventories.”

Some sellers believed that customers’ stocks were low and that there would be a natural revival in demand when the holiday season ends in September. However, inflation and the energy crisis were major concerns with talk of inflation-driven demand destruction, the report added.

Last year, US HDPE exports totalled 2.8m tonnes, down from 3.9m tonnes in 2020 on production problems. The latest 2022 US export data I have available is only for January-May, but when annualised (divided by five and multiplied by 12), this suggests full-year exports of 3.7m tonnes.

Until China steps away from its zero-COVID policies, which is very unlikely to happen at least for the rest of this year, local demand will remain under a lot of downward pressure. The latest ICIS data suggest a 3% fall in consumption in 2021.

Further downward pressure is likely to be exerted on China’s HDPE market by the Common Prosperity economic reforms with the biggest negative impact on the real estate sector.

China’s HDPE capacity is due to  increase by 22% this year. A further 10% increase is scheduled for 2023. World-scale plants are also due on-stream in Malaysia and Vietnam this year and in 2023.

Asia and Middle East exporters may therefore increasingly target Europe, especially if container-freight markets become longer. However, spot rates had risen since mid-July on port congestion in Europe and the US, said Xeneta in this 28 July article.

But Xeneta added in the same article: “July’s contract rate increases were the slowest since January, reflecting an easing of spot rates. Xeneta also noted lower demand, with volumes to and from Europe falling 3% and 6% respectively over the first five months of 2022.”

At some point, I believe demand destruction resulting from the global inflation crisis will lead to a significant and long-term decline in container-freight rates.

We must then ask ourselves the question, when we look at the extraordinary divergence in annual NWE and China pricing trends detailed in the chart below, whether a return to long-term historic average premiums will happen.

Will China, the world’s most important HDPE demand centre, and an increasingly important supply centre, drag Europe and other regions down to its levels? (other regions have seen a similar big jump in premiums over China)  Or will the China market increase closer to today’s levels in Europe and elsewhere?

I see the former outcome more likely, given China’s economic problems and the global inflation crisis. If such an outcome were to  happen, we would need to consider the implications for European profitability.

The story is the same in PP with oversupply a bigger problem

The 29 July ICIS European PP report said: “The spot market is very quiet at the end of July as buyers aim to keep inventories low. There is very little demand expected in August due to the summer holiday period and economic woes”.

Bigger volumes of imports were said to be arriving in Europe in August from the Middle East and South Korea.

The chart below shows monthly Free Delivered NWE PP injection grade premiums and discounts over CFR China injection grade since the ICIS price assessments began in November 2002 until July this year. It is a similar story in other commodity grades of PP. As with HDPE, premiums fell substantially in July 2022. As with HDPE again, NWE premiums soared from March 2021 onwards.

Here are the actual European PP injection grade prices versus those in China. The decline in Europe in July was greater than  in China, again mirroring what occurred in HDPE.

China’s PP demand could fall by as much as 4% this year, and even though it is a stretch as this is an unlikely outcome, China might end up being a net exporter of around 270,000 tonnes this year.

The more likely outcome is that net imports fall to 2.4m tonnes as China’s self-sufficiency continues to increase on capacity additions. Chinese capacity is scheduled to increase by 12% in 2022 after a 13% increase in 2021.

If this year’s net imports fell to 2.4m tonnes, this would be a million tonnes lower than in 2021, and no less than 3.7m tonnes lower than in 2020!

China’s net import, or even net export position, is critical for global markets as China accounted for more than 40% of global net imports last year among the countries and regions that imported more than they exported. This was a far higher percentage than any other region.

South Korean capacity is due to increase by 12% this year following a 13% increase in 2021.

Malaysia’s Pengerang Refining and Petrochemical may come back on-stream this year, leading to Malaysia beginning the process of shifting toa significant net exporter from being a small net importer.

In Vietnam, two new plants are in the process of coming on-stream that will add 1.6m tonnes/year of capacity.

Demand in the developing world ex-China among the non-resource exporting countries is being damaged by the strength of the US dollar and the food and energy crisis. I should add that this, of course, is also a problem for HDPE demand.

Therefore, when we look at the annual average NWE PP injection grade price premiums over those in China, we need to ask the same questions as in the case of HDPE.

Will the China market recover to the levels of Europe and other regions, or will China drag China down Europe and other regions closer to its levels?

Conclusion: We face very, very difficult times

Rory Stewart, the former UK government minister and MP, said in this Rest Is Politics podcast that we faced a ten-year recession similar to the stagflation of the 1970s because of geopolitics and inflation. I worry that he might be right.

Add this to the zero-COVID polices in China, the disruptions caused by its attempts to build a largely new economic growth mode and the constant push for greater petrochemicals self-sufficiency, and we face very challenging times ahead.

I obviously hope I am wrong. But it would be wise to prepare for this scenario as it surely cannot be dismissed given today’s extraordinary events.