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China’s multi-speed economy and the implications for PP demand

China, Company Strategy, Naphtha & other feedstocks, Olefins, Polyolefins, Singapore, South Korea, Taiwan, Thailand
By John Richardson on 04-May-2023

By John Richardson

THE MIXED CHINA macroeconomic data for April, including a month-on-month fall in the official manufacturing purchasing managers’ index (PMI) while the services PMI still expanded, indicate that I need to adapt my analogy for China’s economy.

China’s economy used to travel at 110 miles/hour (177km/hour) when its population was more youthful and the property bubble was inflating.

During the zero-COVID period, the economy was travelling at, say, just 30 miles/hour because large swathes of economic activity were not possible, including travel and services in general.

Now that zero-COVID is over, service activity will pick up as “revenge spending” takes place. This means the economy will, perhaps, recover to a speed of 70 miles/hour.

However, 70 miles/hour will be an average speed across all sectors. Some sectors might even be travelling at a speed less than this, and others, more.

When it comes to the petrochemicals industry, this means we must carefully ponder charts such as the one below and consider the implications for production, sales and marketing strategies.

The pie chart is a rough estimate of the percentage shares of global polypropylene (PP) consumption by end-use application, based and discussions with contacts.

Now consider, for further important context, the three critical phases of China’s extraordinary PP demand growth since 1990 relative to the rest of the developing world.

Note how by 2009, China’s population was already ageing, but the world’s biggest-ever economic stimulus package juiced demand for all petrochemicals from that year onwards. In other words, stimulus masked or blunted the impact of the ageing population.

The chart shows per capita or per person PP consumption in China versus the rest of the developing world from 1990 until 2022. I discussed the historical context behind the chart in detail in this earlier post. 

As you can see, in 1990, per capita consumption in the rest of the developing world versus China was almost the same. By 2022, however, there was a vast difference.

Turning per person demand into millions of tonnes, in 2022 these were the extraordinary outcomes:

  • Developing world demand created by 5.26bn was 27.6m tonnes.
  • But China’s demand from just 1.45bn people was 34.6m tonnes.

In the same earlier post, I suggested that such was the extent of the “juicing” of China’s demand by economic stimulus that the country’s PP consumption growth might even turn negative from 2030 onwards.

As my automobile analogy suggests, not all PP and other petrochemicals end-use sectors will be equal.

Scan your eyes back to the first chart in today’s post and let’s work through some of the PP end-use markets to consider the implications of demand patterns in the new China.

My fellow blogger, Paul Hodges, argued that from 2009 onwards, the growth of China’s auto sales was linked to booming property prices as China was, and still is, a poor country relative to the developed world. In 2022, China’s per capita income was $13,000 compared with the developed world’s average of $48,000, according to the IMF.

Capital appreciation on real estate meant that new autos became very affordable despite relatively low per capita incomes, was our argument. We thus warned from as early as 2011 that once the property bubble ended, so would the rapid growth in China’s auto sales.

Paul’s work ten years ago on what was then a small second-hand car market in China also pointed to the risk of a slowdown in new car sales. His contention was that as the second-hand car market grew, this would create more affordable options for those who hadn’t benefited from the property bubble.

“Even optimists see growth in China [new car sales] at barely 2.3% a year over the decade after 2019, compared with nearly 7% during the previous ten years,” wrote The Economist in this 14 April article.

“In 2021, about 17.59m used cars had been sold in China, an increase of 22.7% compared [with figures from] 2020. During the past twelve years, used vehicle transactions in China have increased approximately 3.5 times from 3.9m units in 2010,” wrote Statista.

This has implications for demand for all the auto components made from PP, such as bumpers, dashboards, wheel covers, chemical tanks, cable insulation and carpet fibres.

Oversupply in China’s auto market has led to a fierce price war, including very competitively priced electric vehicles (EVs) as China rapidly electrifies its transportation fleet (this is another theme I shall examine in a later post).

“Earlier this month, BYD launched the updated Qin Plus EV. It comes with a high-efficiency heat pump as standard. The electric motor has been upgraded to 150 kW. So, you can get a full BEV with a heat pump, with a 150kW motor, and with a 57.6 kWh Blade battery for just $20,350 in China,’” wrote CleanTechnica in this 29 April article.

Some good news for China’s exports, worth some 20% of GDP, was the surge in March this year of EV exports, which was of course supportive of local PP demand. This is exactly the kind of higher value industry China needs to be successful in, if it is to escape its middle-income trap.

However, inflation has eaten into its overall export trade this year, as has the post-pandemic global cycle out of spending on goods and into services.

Further, as China’s population further ages each year, it is losing competitiveness in low-value manufacturing. This is accelerating the drift, which began more than a decade ago, of low-value manufacturing to countries such as India, Pakistan, Bangladesh and Vietnam.

“Carmakers are reconfiguring supply chains to make them less exposed to geopolitical concerns, with reliance on China a growing issue,” wrote The Economist in another 14 April article on the global autos industry.

“The country is one of the world’s biggest exporters of car parts, to a value of over $45bn in 2021, a quarter of which went to America, says a study by Sheffield Hallam University,” the magazine added.

China’s geopolitical rift with the US appears to be a threat to its exports in general and efforts to escape a middle-income trap. US restrictions on exports of semiconductors and semiconductor technologies to China represent a significant hurdle.

Returning to the pie chart, we now look at the proportion of PP end-use demand that’s been taken up by furniture, houseware, carpets, sewerage and drain-pipes and white goods, such as washing machines.

Some fanfare has greeted the recovery in new-home sales.

“The value of new home sales by the 100 biggest real estate developers climbed 31.6% from April last year, according to preliminary data from China Real Estate Information Corp. That compares with a 29.2% increase in March,” wrote Bloomberg in this 1 May article. 

However, new household formations are obviously declining in China as the population ages. In addition, there is a big oversupply of housing in some cities.

Here is the critical thing: The government “put option” that it would never allow home and land prices to fall no longer applies, as prices have fallen.

Why spend money on a home that you don’t need, when there is no longer any guarantee that prices won’t fall, and when the investment is no longer a one-way bet?

This means lower growth in demand for new autos, as already mentioned. The same applies to furniture, housewares, carpets and white goods.

The growth in demand for sewerage and drain-pipes is also very probably moderating because of the end of the property bubble.

But what about demand for PP-made pipes that go into infrastructure projects, a tried and tested way of boosting GDP growth in China?

“China’s local governments have a ballooning debt problem that cries out for urgent resolution, but analysts suggest that this would be a Herculean task. If the problem worsens, it will affect banks, interest rates and GDP growth in China, as well as offshore bonds issued by government-owned companies,” wrote FinanceAsia in this 25 April article.

The danger of a liquidity crunch because of the local government debt issue is worth separate consideration. I’ve been warning about the risks of borrowing by local governments since 2014 as the security of their debts hinge on rising land prices – and, as mentioned, land prices have now fallen.

Suffice to say here, the ability of local governments to pay for new infrastructure projects (it is the provincial governments that pay for China’s new roads, bridges and airports) could be limited this year and in future years.

And the economic multiplier effect of infrastructure spending has weakened, according to Michael Pettis, a professor at Peking University.

“When this infrastructure was productive, the debt didn’t matter because these projects drove up GDP at least as fast as they drove up the debt,” he told the same FinanceAsia article.

“But once the investment was no longer productive, GDP was not able to rise as quickly.… When this happens, the debt burden must surge relative to the capacity to service it,” he added.

Producers which focus more on, say, producing PP film grades that go into food packaging might therefore benefit from the pick-up in spending on services, including during this week’s Labour Day holidays.

“Holiday spending figures on the first day of the five-day Labour Day break underscored the recovery in consumption. Some 19.7m railway trips were made across the country on Saturday, the highest on record for a single day, local media The Paper reported,” wrote Bloomberg in the same 1 May article linked to above.

However, consider the chart below.

If my estimate of China’s PP demand growth in 2023 is correct, 2022 and 2023 would see the lowest percentage increases in demand in consecutive years since 2000. Average annual growth between 2000 and 2021 was 10%.

Furthermore, spreads never lie. The annual average China PP price spread over naphtha feedstock costs so far this year is close to the record low since 2003, when we launched our price assessments. Spreads are the single best measure of supply and demand balances.

Yes, it is right, as I have long argued, that we must not view China as a “single lump” of petrochemicals demand.

Not only do we need a much more nuanced consideration of the strengths and weaknesses of different end-use applications, especially at times like this; we also need to look at demand at the provincial level.

Nevertheless, none of this nuanced analysis should overlook the likelihood that this is the worst petrochemicals industry downturn on record in China and elsewhere. A full recovery in China spreads and margins before 2025 at the earliest seems unlikely.