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Record levels of oversupply and the “Doublespeak” of the old market language

China, Company Strategy, Middle East, Olefins, Polyolefins, Singapore, South Korea, Taiwan, Thailand
By John Richardson on 15-Feb-2024

By John Richardson

A DISTRACTING DEBATE is taking place out there over whether Asian polyolefin markets have become tight because of disruptions to exports from the Middle East caused by the Red Sea crisis and a wave of plant shutdowns.

I prefer “perhaps tighter” rather than tight. The market could be tighter than it was last December. But even if this is the case, longer-term data continue to tell us that we face all-time levels of oversupply:

  • Global polyethylene (PE) capacity exceeding demand is forecast to average 26m tonnes a year in 2024-2030, according to the ICIS Supply & Demand Databased. This compares with just 7m tonnes a year in 1993-2023 (1993 marked the start of “China’s economic miracle”).
  • Global polypropylene (PP) capacity exceeding demand is forecast to average 24m tonnes a year in 2024-2030 versus 6m tonnes a year in 1993-2023.

The global oversupply crisis centres on China because our industry got China so badly wrong. And China of course really, really matters because it is by far the biggest driver of global demand.

Project proponents believed that the country’s petrochemicals demand would continue to grow at 6-8% per year. But as I’ve been flagging up on the blog for a long time, demographics and debt told us that growth would fall to 1-3%.

China’s demand growth has now, in my view, fallen to a long-term trend of 1-3% per year. This has resulted in far too much global capacity that was added to serve China growth that isn’t going to happen.

In every discussion over short-term fluctuations in supply, this is the essential context that must not be forgotten.

NEA PE and PP margins at record lows

Despite what might be tighter supply relative to last December, my new Northeast Asian (NEA) polyolefin margins indices suggest that producers are not seeing any benefit. Quite the contrary, in fact, as they are worse off than last year.

So far in 2024, average NEA PE integrated variable cost margins have fallen to minus 27 compared with the starting year of 2014. This is a record low.

The $/tonne margin for 2014 represents 100 with the $/tonne margins in subsequent years measures measured as multiples over 100. The importance of each of the PE grades is weighted according to their percentage shares of total virgin NEA PE production.

NEA integrated naphtha-based variable cost PP margins have so far this year been at minus 28, equalling the previous record low in 2022. The PP margin index uses the same methodology as the PE margin index.

China consumer confidence: A critical turning point

These data sets underline my argument that global petrochemical markets in general reached a critical turning point in late 2021.

This was when the China property bubble burst, delivering a blow to Chinese consumer confidence which has been compounded by growing geopolitical tensions with the West and China’s ageing population.

We must also consider the impact on consumer confidence of the collapse of China’s stock markets. As my good friend and colleague, Joe Chang, writes in this ICIS Insight article:

The collapse in real estate as well as the stock market – the two main repositories of wealth for much of the population – will have further repercussions for consumer confidence and ultimately, demand going forward.

With China’s social media censored by the government, retail investors in early February took to an unlikely forum to express frustration about the stock market which has declined for three consecutive years and is now into its fourth year of decline thus far. China’s CSI 300 Index is down around 42% from its peak in February 2021.

A US Embassy social media post on Weibo on giraffe conservation, of all things, suddenly became ground zero for thousands of comments on China’s stock market and economy.

Joe added the following in the same article: While the government is expected to introduce more stimulus measures to prop up the property market, it would take a bazooka of new stimulus to restore consumer confidence in real estate – something unlikely as the excesses of past spending are now being unwound.

I respectfully disagree. I don’t believe that any amount of stimulus can return China’s economy to its old levels of growth because of a long-term decline in a willingness to spend money.

China caught between a rock and a hard place

Further, China appears to be caught between the rock of being unable to export itself out of its economic difficulties and the hard place of not being able to sufficiently grow domestic consumption to achieve the same end. In this context, it is worth repeating this section from my 12 December 2023 blog post:

Michael Pettis, The Peking University professor, has consistently made the right calls on China. You should take particular note of his 4 December article for the Carnegie Endowment for International Peace, where he writes:

“If China were to maintain current growth rates [4-5% per year] while keeping its high investment and manufacturing shares of GDP, its share of global investment and manufacturing would expand much faster than its share of global GDP,” he said.

“In that case, it could only do so if the rest of the world agreed to accommodate that growth by reducing its own investment and manufacturing levels to less than half the Chinese level,” wrote Pettis.

He added that even without the geopolitical tensions and policies in the US, India, and the EU to boost domestic investment and manufacturing, this would still be highly unlikely.

But now, as we’ve seen, reshoring in the US is gathering pace as the EU seeks to reduce its trade deficit with China.

“Globally, according to the World Bank, investment represents on average 25% of each country’s GDP. But China’s investment share of GDP has never been below 40% during the past 20 years,” continued Pettis, as he added support to his argument about China’s difficulties in continuing with investment-led growth.

Under a scenario where China continued to focus on investment-led growth, the rest of the world would have to agree to reduce the investment share of its GDP by roughly 1 full percentage point to 19% of GDP, well under half of the Chinese level, Pettis added.

“This would also require China’s debt-to-GDP ratio to rise from just under 300% to at least 450–500 % in a decade,” he wrote.

“Given the huge difficulties the Chinese economy is already facing at current debt levels, and the difficulties Beijing has had in its attempts to reduce the debt burden, it is hard to imagine that the economy could tolerate such a substantial increase in debt,” continued the author.

But there is another way of China achieving long-term GDP growth of 4-5% year and this by raising consumption by 6-7% per year. In the process, investment growth could fall to 1% per annum.

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

“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.

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”.

China’s economy had been structured for four decades on direct and indirect transfers from households to subsidise manufacturing and investment, he added.

This took the form of easy and cheap credit, weak wage growth, an undervalued currency, excess infrastructure spending, a weak social safety net, and other explicit and implicit transfers, wrote Pettis.

Transforming China’s economy to one to mainly driven by consumption instead of investment appears to be very difficult.

We must, as a result, plan for a scenario where China cannot maintain GDP growth at a long-term average of 4-5% per year.

Still not convinced? Here’s some more data

The chart below provides a far longer-term perspective on polyolefins producer profitability than the PE margin index.

The average China CFR PE price spread over CFR Japan naphtha costs has fallen to just $73/tonne so far this year, the lowest since our price assessments began in 1993.

Note that this data set again shows the critical turning point from 2022 onwards, following the late 2021 bursting of the China real estate bubble.

PE spreads are weighted according to the percentages of China’s high-density (HDPE), low-density PE (LDPE) and linear-low density (LLDPE) virgin production over total virgin production.

Since 1993, LDPE’s share of total PE production has diminished due to stronger LLDPE demand growth. In 1993, LDPE accounted for 37% of total PE production versus 20% for LLDPE. This year, ICIS estimates that LDPE will be just 11% of the total production compared with 40% for LLDPE.

We don’t have a breakdown of production by grades of PP. This is something I am working on so watch this space.

But on a non-adjusted basis, the latest data show that the average China CFR PP injection, raffia and copolymers spread from the beginning of 2022 until 9 February this year was 140% lower than in 2003-2021.

Note that our PP price assessments only began in 2003 compared with 1993 in PE.

Conclusion: A change in the meaning of language

Because of the petrochemicals new normal we confront that goes well beyond just China-centred global oversupply, the meaning of the very language we use is going to change.

Whenever, for example, market participants say markets are tight from now on, instead read “slightly less long”. We have thus entered the world of George Orwell and his concept of Doublespeak from 1984: Deliberately euphemistic, obscure or ambiguous language.

Stick with the ICIS data and you will always understand the true meaning of words.