Home Blogs Asian Chemical Connections How increased global trade tensions could shape China’s PP exports and operating rates

How increased global trade tensions could shape China’s PP exports and operating rates

By John Richardson on 14-Dec-2023

By John Richardson

THE STANDARD WAY to forecast petrochemical trade flows is to examine the cost-per-tonne economics of each producer in an exporting country, how much new capacity the exporting country is adding versus local demand and the scale of import demand across the rest of the world. This leads to assessments of the export country’s operating rates.

But way back in 2000, I was given a tutorial by a senior petrochemicals industry leader who tore holes in an article I’d written about China in the magazine I then edited.

“You’ve got understand that China’s petrochemicals industry doesn’t always run for profit. There are social, political and economic factors here. Sometimes, plants will be run hard, even if they are losing money in order to guarantee enough supplies of resins to keep people in work in the washing machine factory.”

Despite the emergence of privately owned petrochemical giants over the last 10 years, including non- state-owned companies integrated all the way back to sophisticated full-conversion refineries, I’ve been told that nothing has changed.

Central and local governments are still said to play a significant role in petrochemical operating decisions.

It appears as if the political, social and economic factors shaping production decisions – not just in petrochemicals but also downstream into semi-finished and finished goods – have significantly changed.

In the good old days, maintaining high levels of production, even if some manufacturers were losing money on a stand-alone basis, was about sustaining a golden period of economic growth. This ran from 1992 until late 2021, with just the occasional brief downturn.

Voracious overseas demand for China’s exports resulted from the west’s Baby Boomers being at the height of their spending power, before they started to retire in large numbers while being replaced by a much smaller working age cohort.

Crucially, also, China’s population for most of the period form 1992 until late 2021 was very youthful. This meant there were lots of young people willing to work for low wages in export-focused manufacturing plants.

While at any one time not every link in a manufacturing chain might have been making money, whole chains usually were. So, they were often told to run flat out.

Further, the local-for-local economy was going great guns, buoyed by the post-2009 property boom. The real estate sector is now worth some 29% of GDP, the highest percentage in economic history.

But late 2021 marked the end of the real estate bubble, signalled by the financial problems of Evergrande.

And since 1990s, China’s births per woman have been below the population replacement rate of 2.2. Every year, the demographic drag on the economy has worsened and we now appear to have gone past a tipping point.

Young people are “lying flat”, rejecting societal pressures

Economic activity is being dampened by the need to save more money to cover pension and healthcare costs to care for a rapidly increasing elderly cohort. Savings rates are also said to have been pushed higher by weak state healthcare and pension systems.

A further drag on economic growth is said to be anxiety over growing geopolitical tensions with the west, and despite fewer young people, record-high youth unemployment.

Combine all the above with earnings-to-house-price-multiples still at 45 in the big cities (it is said that Beijing cannot afford to allow house prices to collapse), and young people are said to be “lying flat”, a Chinese slang neologism that describes rejection of societal pressures to overwork and over-achieve.

“In 2022, President Xi Jinping laid out a long-term vision of ‘Chinese-style modernisation’ at a key party meeting, with a goal of doubling China’s economy by 2035 that government economists say would require average annual growth of 4.7%,” wrote Reuters in this article from 22 November of this year.

But in order to maintain GDP growth at the current levels of 4-5% per year, China would have to achieve consumption growth of 6-7% per year if it didn’t instead successfully double down on investment-led growth, said Michael Pettis, a professor of finance at Peking University’s Guanghua School of Management.  He was writing in this 4 December article for the Carnegie International Endowment for Peace.

Given all the above challenges, achieving 6-7% per consumption growth seems a stretch.

Further, Pettis asked: “With consumption growing at roughly 4% a year before the pandemic (and much less since), is 6–7% growth in consumption possible?”

“No country in history at this stage of the development model has been able to prevent consumption from dropping, let alone cause it to surge, but that doesn’t mean it’s impossible,” he said.

Consumption growth at 6-7% per year would require businesses to pay higher wages and higher taxes. China’s currency might also have to be strengthened in order to reduce China’s dependency on exports (exports being the same as manufacturing investments) as a driver of growth.

But Pettis said that China’s manufacturing competitiveness was based mainly on the very low share of income Chinese workers retained relative to their productivity. Making businesses pay more would seriously undermine China’s manufacturing competitiveness.

If government financing was reformed, however, Pettis said it was possible that local governments could foot the bill to achieve 6-7% per year consumption growth.

He warned, though, that transferring such a large share of local governments’ assets would be politically contentious and require “a transformation of a wide range of elite business, financial, and political institutions at the local and regional level”.

It therefore seems more likely that China will, at least in the short term, try to double down on the investment model of growth, including adding more capacity in petrochemicals and other manufacturing sectors.

This would add oversupply to what are already very oversupplied markets. China could seek to export more of these surpluses to the rest of the world, potentially turning global inflation into deflation.

But will China be allowed to do so by the rest of the world?

One scenario: China caught between a rock and a hard place

China already appears to be trying to export its way to stronger GDP growth.

“Some Chinese factories, saddled with overcapacity in a struggling economy, are trying to export their way out of trouble and stoking new trade tensions in the process,” wrote the Wall Street Journal in this 10 November article.

“Makers of electric vehicles, solar panels and other products are cutting prices and trying harder to muscle into overseas markets as they face weakened demand at home, upsetting competitors who see threats to their bottom lines,” the newspaper added.  

The tensions were most acute in Europe, where EU regulators in September unveiled an ant-subsidy investigation into Chinese electric vehicles, said the WSJ (WSJ).

The US recently announced levies on tin-plate metal products from China and two other countries, the article continued.

“India is investigating whether China dumped a range of goods, from chemicals to furniture parts, into the country at unfair prices. Vietnam in September started examining whether wind towers imported from China have hurt domestic manufacturers,” wrote the WSJ.

Back to Europe and this week’s China-EU Summit. After the summit, Ursula Von Leyen, European Commission President, told the Financial Times that “the root causes of China’s trade surplus with the EU were ‘well-known’ — a lack of market access for European companies and Beijing’s preferential treatment of domestic companies as well as overcapacity in Chinese production.”

Returning to the US, the New York Times wrote in this 12 December article: “Bipartisan lawmakers on Tuesday called for severing more of America’s economic and financial ties with China, including revoking the low tariff rates that the United States granted Beijing after it joined the World Trade Organization more than two decades ago.”

A 53-page report produced by the lawmakers included nearly 150 recommendations for Congress and the White House.

They included new tariffs on older types of Chinese chips, reducing the flow of US capital and technology to China and requiring publicly traded US companies to disclose ties to China while investing in more in local research and development. The report highlighted the need for more US investment in pharmaceuticals and critical minerals to counter China’s dominance, wrote the NYT.

The newspaper added that many of the measures might not end up as legislation because of the fractious nature of Congress, but that the report could pave the way for some new regulations.

What could also prevent China from winning a bigger share of export markets is the huge US Inflation Reduction Act and the EU’s New Green Deal, designed to reshore manufacturing and improve sustainability.

Three scenarios for China’s PP net exports and operating rates

This post has sought to underline how we live in a much more complex petrochemicals world where I believe the old standard ways of forecasting markets no longer work as well as they used to. We need to overlay our traditional numerical tools with assessments that, because of the complexity, must be increasingly qualitative.

The above chart might at first glance send you head spinning. But it is what it is.

Taking polypropylene (PP) as an example, the ICIS base case assumes China’s operating rate falls from a 2010-2023 average of 86% to just 73% in 2024-2030 on overcapacity. But strong demand growth at an average of 4% per annum results in net imports averaging 5m tonnes a year.

Alternative Scenario 1 involves China deciding to run its plants at an average 86% operating rate to compensate for weak domestic growth. This ensures PP demand growth is again at 4% per year. But China moves into an average annual net export position of 2m tonnes a year.

This first alternative outcome assumes that the world is willing to largely accommodate China’s increased PP and other exports. Trade tensions simmer a little but don’t boil over with no big wave of new trade tariffs.

But I believe we are heading towards a more de-globalised petrochemicals world which is why Alternative Scenario 2 is my preferred scenario.

China, as in the base case, runs its plants at 73%. Increased trade tensions mean it cannot become a big exporter. This leaves it in an almost balanced position as it runs it plants just hard enough to achieve self-sufficiency. Demand growth falls to 1.5% per year due to weak domestic growth and China’s inability to compensate for weak local growth by becoming a major exporter.

Conclusion: Why it is good to be confused

Confused? You certainly should be as it’s through embracing complexity that you’ll be able to plan properly.

As mentioned, forecasting these days has become as much qualitative as well as quantitative, in my view. ICIS is here to support you in this new and more complex planning environment. Contact me at john.richardson@icis.com.