Supply chains shift from China

John Richardson

14-Jun-2019

Global manufacturing supply chains are adjusting to the US tariffs against China, accelerating a process that began a decade or so ago because of China’s ageing population, versus more youthful populations elsewhere.

Let’s use Vietnam as an example to first of all examine the longer-term drift away from China. Since 2010, Adidas has reduced the share of footwear it makes in China by 50% as production has shifted to Vietnam. The same applies to Nike. Ten years ago, China was its main footwear producer, but now it is Vietnam.

As of last year, 16.6% of China’s population were pensioners, compared with just 6% of the Vietnamese population. Birth rates are falling in Vietnam but its demographic dividend – a surplus of young versus old people – will not run out until around 2034. By then China will already be a very old society.

It is the simple law of supply and demand. There is ample supply of young people in the developing world ex-China willing to make plastic bags, rolls of film, TVs and refrigerators for low wages. In China, there is an undersupply. And, as we said, the trade war is accelerating relocation of manufacturing because US tariffs on Chinese imports have further eroded China’s competitiveness.

One of the US’ objectives of the trade war is to reshore low-value manufacturing to economically struggling regions such as the US Midwest. However, the US has an undersupply of young people because its population is ageing.

IMPLICATIONS FOR POLYETHYLENE

China’s loss is a gain for other developing nations such as Vietnam, Bangladesh and Pakistan, which have all seen their trade surpluses with the US widen since the start of the trade war. Like Vietnam, Bangladesh and Pakistan also have the advantages of youthful populations.

Vietnam’s trade surplus with the US rose 45.5% year on year to $13.5bn in the first quarter of 2019, a 23 May article in the Financial Times showed. Vietnam’s exports to the US surged in products such as headphones and earphones, wooden furniture, clothing and footwear.

Vietnam

The fall in Chinese clothing exports to the US, because of the tariffs, explains why China’s monoethylene glycol (MEG) spreads over naphtha were recently in negative territory for the first time in five years.

Paraxylene profitability in China is also weak, and is likely to weaken even further, as a result of US tariffs on Chinese apparel and non-apparel exports. In clothing alone, the US accounts for 17% of all Chinese exports.

Meanwhile, though, chemicals demand in Vietnam is booming. Let’s look at polyethylene (PE) as an example. Low-end plastic processors are moving in greater numbers from China to Vietnam to avoid the US tariffs on Chinese shipments of plastic products.

PE imports reportedly surged in the first quarter. 
Net imports (imports minus re-exports) are a perfect measure of demand as Vietnam has no domestic 
PE production.

This included a big rise in imports of US high-density PE (HDPE) and linear low density PE (LLDPE). The US has recently been shipping more HDPE and LLDPE to Vietnam than to China. Since last August, US HDPE and LLDPE exports to China have carried 25% import duties as a result of the trade war.

This has led the US to seek markets other than China, including Vietnam and the rest of southeast Asia.

From February 2018 until August 2018, a pre-tariff period, the US for example exported 314,632 tonnes of LLDPE to China, while only 22,180 tonnes went to Vietnam, according to the ICIS Supply & Demand database.

From September 2018 to March 2019, after the tariffs were levied, US exports to China shrank to 75,984 tonnes, while shipments to Vietnam rose to 119,082 tonnes. Cheap plastic films and bags made from PE are then shipped from Vietnam to the US under the tariff barriers.

“It takes just two months to set up a basic plastic conversion facility in Vietnam and we’ve seen a big shift in production since the trade war began,’ said a polyolefins industry source. “We are likely to see the process speed up considerably now that it looks like the trade war will drag on for the rest of this year.”

This could be favourable news for the overall Vietnamese economy, which ICIS estimates will see a GDP growth of 6.8% in 2019 versus 7.1% last year.

Perhaps growth will be higher than 6.8%. Foreign direct investment from Hong Kong and China to Vietnam was at $2bn during the first four months of this year, according to Deutsche Bank. This compares with around $400,000 during the same period last year.

“China’s investment in Vietnam includes sectors such as energy, construction, manufacturing, and property. Ongoing trade wars may make the January-April figures a major trend in the coming years, in our view,” said Deutsche Bank.

This might mean that we have also underestimated Vietnam’s PE growth. In HDPE, the ICIS base case sees Vietnam’s consumption growing by 7.5% in 2019 over 2018 to around 900,000 tonnes. We see LLDPE demand rising by 7.7% to approximately 640,000 tonnes.

“PE demand seems to be growing at around 14% thanks to the bigger inflow of imports,” said a second polyolefins source. But there might be an irony in all of this: Quite a few converters that relocated from China to Vietnam are said to be under Chinese ownership.

RE-ASSESSING TRADE FLOWS AND DEMAND

The example of Vietnam clearly adds complexity to monitoring global chemicals trade flows and demand.

“Do I make more space in my storage tanks in Vietnam because of the increased pace of manufacturing growth in that country? That’s the type of question I want answered,” said a source with a chemicals logistics supplier.

Nothing short of an investment boom is being talked about across much of southeast Asia – in Thailand, Malaysia, Indonesia, Laos and Cambodia – as manufacturing plants are shifted from China. But what complicates the picture is that some countries, such as South Korea and Taiwan, are heavily dependent on exports of high value electronic components to China.

As China’s economy slows because of the trade war, and as US restrictions on Huawei start to really bite, these exports will inevitably suffer. This means that tonnes of demand gained in other developing markets may not equal lost demand in China.

In polypropylene (PP), for instance, China accounted for 37% of global demand in 2018, up from 24% a decade earlier. In 2009, China surpassed Europe to become the world’s biggest PP consumer.

This year, China’s PP demand in China may grow by as little as 3% over 2018, which would be 1.1m tonnes lower than the initial ICIS forecast. Just 3% growth, the lowest in seven years, would be the result of the worsening trade war and the Chinese government’s limited ability to implement effective economic stimulus.

Let’s assume, for argument’s sake and not based on any evidence whatsoever, that Vietnam’s PP market follows reports about its PE market and also grows by 14% in 2019 over 2018. This would deliver 80,000 tonnes of extra demand versus our current forecast of 6.8% growth. It would take a lot of Vietnam-sized booming PP markets to replace the potential for lost growth in China.

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