By John Richardson
IT REALLY ISN’T doom and gloom if you take the longer-term view. Instead, for the chemical companies with the right strategies, the opportunities to build new sustainable business models are huge. The winners will make an awful lot of money while also doing the right things for humanity and our natural environment.
The cynics, or perhaps more generously the sceptics, argue that this is just another downcycle and that like previous downcycles, everything will return to the Old Normal.
China will resume its journey to being a middle-class country by Western standards as it consumes enormous volumes of new things made from chemicals and polymers, they say. Even if percentage growth is lower in China as the country’s economy evolves, this will still deliver many millions of tonnes of extra demand because of the high base effect, they contend.
Meanwhile, record-high levels of inflation in the rest of the world will soon decline to much more manageable levels, they add.
Maybe. I am still not convinced that the best remedy for high prices isn’t high prices, especially for crude oil. Some of the supply-chain related inflation, the result of strong demand for durable goods during the pandemic, is easing. Container freight rates, for instance, keep falling.
But will geopolitics really return to the 1989-2017 comfort zone? Will the US and China reach a pragmatic accommodation because it is impossible to dis-assemble incredibly complex global supply chains? I don’t think so.
As last week’s G20 statement indicated, there are areas of cooperation that are in the interests of both Superpowers such as climate change. But the geopolitically driven desire for supply chain security in the West, given added momentum by the Russian invasion of Ukraine, will I think lead to the dis-assembly of global supply chains.
US and China economies may separate
Breaking up global supply chains will also satisfy the “local jobs for local people” push. Renewable energy is local as is plastics recycling – and both are obviously sustainable.
This doesn’t mean that the worst outcome is going to happen. It is just that we might end up with two trading and geopolitical zones, one led by the US and the other by China that could coexist but with limited economic interdependence.
I will never write off the capacity of China’s government to build a highly successful new growth model. Beijing has done this before with spectacular success so why not again? It is just that I see a successful new growth model being entirely different from the existing model.
Real estate, worth 29% of the country’s GDP, can no longer be as bigger a driver of growth because of excessive debts and economic inequality created by the property bubble. The Common Prosperity reforms aim to reduce inequality. The ICIS data show that real estate has been the main driver of the gargantuan Chinese chemicals demand boom since 2009.
China is no longer interested in “growth for growth’s sake”. It wants a more environmentally sustainable growth model that is less commodity intensive.
This means that China’s chemicals demand growth is, I believe, going to be substantially lower than conventional thinking suggests. Because China is so important to global markets, this will create a giant-sized hole in standard global growth forecasts over the next 10-20 years.
Or China may fail to escape its middle-income trap. The result would be the same – much lower growth than is commonly anticipated. Of the 19 countries that have escaped middle-income traps since the Second World War Two, only two had shrinking working-age populations. China’s working-age population started to decline in 2015.
What also makes this chemicals downturn different from all the others is that it is being partly driven by China’s rising chemicals self-sufficiency.
The list of products where China has moved from being a major importer to being entirely or almost entirely self-sufficient is growing longer. Polyester fibres and polyethylene terephthalate (PET) film and bottle grade started the trend. Then came purified terephthalic acid (PTA). Styrene imports are close to disappearing and by as soon as next year, China could become a polypropylene (PP) net exporter.
Climate change: The economic and social costs
This trend won’t reverse once the downturn is over because increased self-sufficiency is a cornerstone of government policy. The big China export markets will continue to diminish, which is bad news for all the overseas cracker and derivatives plants built on the opposite assumption.
The cynics or sceptics of the end of the Old Normal argue that humankind is incredibly adaptive, giving us permission to carry on burning fossil fuels with abandon.
Humans are incredibly adaptive, but adaptation can only happen if we are prepared to pay the economic and a political cost. There is a risk that the developing world not including China, as China is no longer a typical developing country, won’t get the investment needed to adequately compensate for climate change.
An important 2020 McKinsey study, Climate risk and response: Physical hazards and socioeconomic impacts, highlighted the threats to crop yields and water and energy supply from climate change – along with the potential costs of increased flooding and droughts.
“The poorest communities and populations within each of our cases typically are the most vulnerable. Climate risk creates spatial inequality, as it may simultaneously benefit some regions while hurting others,” wrote McKinsey.
“While companies and communities have been adapting to reduce climate risk, the pace and scale of adaptation are likely to need to significantly increase to manage rising levels of physical climate risk. Adaptation is likely to entail rising costs and tough choices that may include whether to invest in hardening or relocate people and assets,” the consultancy added.
Climate change isn’t going to go away when this downturn is over. Around one-third of chemicals demand is derived from the developing world, with a large proportion of incremental growth forecast to be generated by the region over the next 10-20 years. As with China, growth in the developing world may be lower than is widely expected, creating another hole in global growth forecasts.
How will consumers in general behave when this downturn is over? Will they “shop until they drop” once inflation declines or are attitudes towards discretionary spending changing?
I am sure there will be a big surge in spending in China when the zero-COVID regulations are lifted because of a big rise in savings rates. We might see the same elsewhere when inflation is no longer keeping the shops empty.
But attitudes among young people have changed. Experiences are becoming more valued than things. Experiences require fewer physical things than before because of lives lived online.
A major brand owner says that knowledge of climate change and plastic waste has spread globally among young middle class people via smartphones. Fast fashion is becoming increasingly unpopular. The rise of plastics recycling and re-use and redesign in the West is largely the result of consumers putting pressure on regulators and brand owners.
A great opportunity for the European chemicals industry
The European chemicals industry has had a bad rap for a long time because of what are said to be poor economies of scale and hydrocarbon feedstock-cost disadvantages.
I have argued for a long time that these oversimplifications. Old crackers have become virtually new crackers through additions of new furnaces and mixed-feed technologies have further supported cost-per-tonne economics. These technologies make use of low value refinery products from the bottom of distillation columns.
This ability to innovate is now being focused on innovation in carbon mitigation through, for instance, the BASF, Linde and SABIC work on developing electric furnaces that are said to reduce carbon emissions versus standard crackers by 80%.
Shell no longer talks about refining, but instead refers to energy as it adapts to the electrification of transport. In July this year, Shell took a final investment decision to build Europe’s largest renewable hydrogen plant in Rotterdam. The plant will produce up to 60,000kgs of renewable hydrogen per day when it comes onstream in 2025.
“INEOS’ most significant investment, the Project One ethane cracker in Antwerp, Belgium is planned to start manufacturing in 2027,” wrote my colleague, Nigel Davis, in this 7 October ICIS Insight article.
“The cracker will have a 50% lower carbon footprint compared with the next best cracker in Europe and be 60% more carbon efficient than the average,’ he added.
“That efficiency is based on modern ethane to ethylene technology and designing with the expectation of the need to transition to net zero. A credible transition to net zero would involve the use of hydrogen as supply develops and of carbon capture,” he said.
It is important to stress that the chemicals companies listed above have global sustainability strategies. But my message here is about Europe and why its recovery from the downturn can be very strong if it focuses on sustainability:
- The EU is firmly committed to reducing carbon through its carbon trading system. A carbon border adjustment mechanism may eventually apply to chemicals and polymer imports. And, of course, oil, gas and chemicals producers face pressure globally from investors to decarbonise.
- Europe’s plastic recycling industry is growing rapidly, again because of EU regulations – along with commitments from brand owners who are reacting to public pressure. “Brussels is expected to boost the demand for recycled plastic by broadening recycled content targets from plastic bottles to all plastic packaging,” wrote EURACTIV in this 3 November 2022 article. The EU27 is likely to set a mandatory 55% recycled content target for single use packaging by 2030.
The European chemicals industry can occupy a position far to the left of a new global green cost curve that I see emerging over the next 5-10 years.
Service provision will replace volume growth as the main profit driver, certainly in Europe and hopefully in other regions as well. Profit growth centred on service provision will involve minimising carbon emissions and reducing the consumption of virgin plastics.
Idealistic? Pie in the sky? I would argue that no, this is instead very practical. What other choices do we have given the threats our natural environment? The chemicals industry must and can be part of the solution rather than part of the problem.