HOUSTON (ICIS)--The recent escalation in the trade dispute between the US and China is raising doubts about a recovery that the chemical industry has expected to take place in the second half of this year, analysts at an investment bank said on Friday.Image by Shutterstock
Throughout 2019, chemical companies have said they expected their markets to recover after a downturn in the fourth quarter, during which customers stopped buying material and relied on their existing inventories, in a phenomenon known as destocking.
Companies attributed the destocking to falling oil prices. Meanwhile, demand in China fell because of tightening financial conditions and a decline in confidence, caused in part by the trade dispute.
Since the fourth quarter, China has introduced several stimulus packages. The US Federal Reserve has indicated it would hold off on its campaign to raise interest rates. Oil prices have recovered. Until recently, it appeared that the US and China would resolve their trade dispute. All of this led chemical companies to expect a recovery in the second half of the year.
Those prospects became more distant after the US acted on threats to raise tariffs on $200bn worth of Chinese imports. The new rate rose to 25% from 10%.
In justifying the higher tariffs, the US accused China of retreating from specific commitments that it made in earlier rounds of negotiations, the Office of the US Trade Representative said in a filing in the Federal Register.
China has threatened countermeasures, which it has pursued every time the US has raised tariffs on its imports.
For now, it appears that the trade dispute will become more tense.
"A more extended dispute or even another round or two of escalations would be a stark contrast with forecasts of a sharp 2H19 recovery in earnings that used as one of 2-4 elements a stabilisation in trade policy and a consequent restock and pricing cycle," according to a research note from the investment bank Jefferies.
The threat to the chemical industry extends beyond the immediate effects that higher tariffs will have on individual products.
Tariffs act as taxes, and taxes slow down the economy.
Demand for chemicals rises and falls at multiples of GDP, so slower economic growth would hurt the industry.
Over time, that would reduce the need for new capacity. This would hurt the US, since its low-cost feedstock has made it one of the most attractive spots to build new chemical plants.
Companies have responded to tariffs by altering trade flows. This costs money because companies have to identify and cultivate different markets for their products. These new trade routes are also costly because they are targeting destinations that - without tariffs - would be less than ideal.
In the markets being targeted by new exports, producers there face increased competition and lower margins.
Jefferies noted other consequences of the trade dispute. Higher tariffs increase the likelihood that China will carry out plans to build new methanol, olefins and paraxylene (PX) projects.
Longer term effects are less clear. If the trade dispute erodes confidence in China, the government may keep existing stimulus measures in place for longer than expected. It may even introduce new ones.
In the US, the Federal Reserve may be more reluctant to raise rates if the nation's economy suffers as a result of the escalating trade dispute.
The US and China can still reach a trade agreement, since the two sides are still negotiating.
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