By John Richardson
THE MOOD OUT THERE over the last week, based only on my WhatsApp traffic as I’ve been laid low by COVID, still seemed to contain a worryingly high amount of denial about the extent of the challenges that the Asian chemicals and polymers industry faces.
As I’ve been out sick, I’ve had the time to re-read Charles Dickens’ magnificent novel, David Copperfield (bear with me here).
A character in the novel, Wilkins Micawber, is convinced that “something will turn up”, even as he languishes in a debtors’ prison. Nothing does or can turn up because his debts exceed his income.
His name has become synonymous with the psychological condition of living in hopeful expectation – “Micawberism”. I worry that some of my WhatsApp contacts have succumbed to Micawberism.
To be fair, however, up until August 2021, something always did turn up. This was Chinese economic stimulus, the effects of which you can clearly see in the above chart.
In November 2008, when the Global Financial Crisis was in full swing, the multiple of the Brent Forties Oseberg Ekofisk (BFOE) crude price per barrel over the CFR Japan naphtha price per tonne fell to just 5.4 (the BFOE price per barrel multiplied by 5.4 to get to the ICIS assessment of the CFR Japan naphtha price per tonne).
This remains the lowest monthly multiple since our CFR Japan naphtha price assessment began in March 1990.
The higher the multiple, as all chemical analysts should know, the stronger the demand for naphtha as a feedstock for chemicals production; the lower the multiple, the weaker the demand.
Refinery economics also play a role in determining crude-to-naphtha multiples, including the blending values of gasoline into naphtha. So does the impact of refinery turnarounds and outages.
But because the main demand driver for naphtha is chemicals, the multiple is, as I said, an excellent indicator of chemicals demand.
And we know that in November 2008, global chemicals demand had completely collapsed. Chemical and polymer buyers were hardly in the mood to make purchases given the state of the global economy and because crude prices in November were at $53/bbl versus $133/bbl in June 2008.
Such was the rapid fall in crude prices (they bottomed out at $40/bbl in December) that several chemical companies were at risk of bankruptcy, as they were sitting on vast quantities of overpriced feedstock and finished product.
But then the chemicals industry was dragged out of the proverbial debtors’ prison from January 2009 onwards, as the slide below confirms. The chart shows the percentage shares by region of global demand for the seven major synthetic resins between 1990 and 2021.
The permanent end of the property bubble
China’s share of the global polymers pie saw a big climb from just 6% in 1990 to 26% in 2009. Annual increments up until then were 1-2%. Then, whoosh, between 2009 and 2010, China’s share jumped by four percentage points from 26% to 30%.
This was, as everyone should know, the result of the world’s biggest-ever economic stimulus package, the main outcome of which is an epic housing bubble. And up until August 2021, every time the Chinese economy stumbled, more stimulus was thrown at the problem.
Back to the chart at the beginning of this post. The rapid recovery in the BFOE crude multiple over CFR Japan naphtha between late 2008 and early 2009 was the result of this extraordinary release of stimulus.
As I said, in November 2008 the multiple had fallen to an all-time low of 5.4. But by February 2009, the multiple had surged to 10.2. The average 2008 multiple was 8.2. But in 2009, this rose to 9.2.
There will be no such stimulus-led rebound on this occasion, though, because of Common Prosperity. The age of mega-stimulus is over, for good.
This is confirmed by the latest Total Social Financing (TSF) data, courtesy of Paul Hodges from New Normal Consulting. TSF, which is lending from the state-owned and private banks, reached Yuan (CNY) 8018bn n Q1 this year. This fell to CNY5345bn in Q2 and CNY4339bn in the third quarter.
The fall in lending is despite the biggest China economic downturn for many years.
And consider the following:
- Some 29% of China’s GDP is driven by the real-estate sector. The real estate bubble has burst, for good, leaving behind vast amounts of debt and large quantities of unsellable apartments and land.
- China’s president, Xi Jinping, in a speech to last week’s 20th National Congress, emphasised national security and praised the success of the Zero-COVID campaign. This indicates that the zero-COVID polices, which have hamstrung China’s economy, will continue. What choice does China really have, though? Because of the limited effectiveness of local vaccines, relaxation of zero-COVID could overwhelm the healthcare system.
- Around 20% of China’s economy is dependent on exports. There was always going to be a decline in China’s exports because of the cycle out of goods and into services when the peak of the pandemic was over. This decline is being exacerbated by the global inflation crisis.
Let’s again return to the first chart in this post. The January-September 2022 multiple averaged just 7.9. The lowest multiple so far this year was 6.9 in August. The January-September 2022 multiple was the lowest on an annual basis since our naphtha price assessments began in March 1990. Surprise, surprise, the previous annual low was 8.2 in 2008.
And as the trendline shows, there has so far been no sudden recovery in the 2022 multiples, unlike in late 2008-early 2009. This year’s steep decline stretches back to June, when Chinese and global economic conditions worsened.
What’s so unusual about this downturn is that Chinese cracker, reformer and derivatives operating rate cuts, which have taken place since March this year, have probably been the biggest on record.
People keep making the mistake that the cuts – which have, of course, reduced the demand for naphtha – are driven just by attempts to improve profitability.
But Chinese chemicals plants have never been run just mainly for profit. The ICIS operating rate data show that in previous periods of poor margins or spreads, rates have been kept high.
As I was taught in 2000 by a former CEO of a global chemical producer, the approach of running hard in downturns is about keeping people employed in downstream manufacturing plants.
This time around, deep rate cuts have simply had to happen because there isn’t enough demand. Keeping people in jobs is no longer a raw-material supply challenge. It instead about dealing with a contracting economy that, according to this France 24 report, has led to one in five Chinese under 24 being out of work – the highest on record.
I suspect that China’s 2022 demand growth for the seven major synthetic resins will be negative. In the case of polyethylene (PE) and polypropylene (PP), I am certain this will be the case. The breadth and depth of negative polymers growth in 2022 is likely to be the worst on record.
I wish I could offer some cheer, but to do so would be dishonest to what I think. China isn’t the only problem, of course, as rest of the global economy is heading for the deepest recession since at least the 1970s.
Conclusion: We have run out of good luck
The Micawber approach to chemicals used to work fine because a series of favourable external events ensured a long period of strong profitability.
As I said, one set of lucky events were the repeated rounds of Chinese government stimulus. Also greatly supporting chemicals consumption were the repeated rounds of stimulus by the Western central banks following the Global Financial Crisis.
Benign inflation enabled yet another massive injection of stimulus into the global economy at the height of the pandemic. This led to the boom in demand for durable goods.
We also used to live in a very stable, very safe geopolitical environment, making global trade very easy. This also kept energy costs down.
Everything has gone into reverse. Global stimulus has collapsed with inflation at multi-decades highs. We are in a new era of highly unstable geopolitics. China’s economy will never the be same again.
Given today’s turn of events, something isn’t just going to turn up to make everything right. This means that chemicals companies must much more actively manage their businesses, including greater investments in sustainability.