New US-China trade clash raises risk – could US LDPE be a target?

Author: Joseph Chang

2019/08/08

NEW YORK (ICIS)--The US-China trade war is intensifying, with the big guns coming out on both sides. US President Donald Trump’s threat on 1 August to slap 10% tariffs on an additional $300bn in imports from China starting on 1 September drew a strong response from China - the start of a currency war in the form of devaluation, along with the halt in agricultural purchases from the US and potential additional tariffs.

Chemical stock prices took a beating on 5 August following China’s retaliatory response after falling hard late last week on the US tariff announcement. Notable decliners included Chemours (-6.2%), Trinseo (-5.1%), DuPont (-4.3%), Celanese (-3.7%) and Eastman (-3.5%). Dow fared better, falling just 1.8% while LyondellBasell was actually higher by 0.2%, although both were down significantly the prior week.

The latest trade salvos come towards the end of a disappointing Q2 earnings season for chemicals where volumes were down across the board amid end-market headwinds in automotive, housing, consumer electronics and durable goods, and geographic headwinds in China and Europe in particular.

Trump’s latest tariff plan is about to hit arguably the one bright spot in the global economy – the US consumer.

What’s different this time is that the latest tariff threat of 10% on an additional $300bn in imports from China, on top of the existing three rounds of 25% tariffs on $250bn of Chinese imports, is that the fourth round targets primarily consumer goods such as apparel, electronics, toys and footwear.

For bulk chemicals directly, the US fourth round of tariffs targets vinyl chloride monomer (VCM) along with fatty alcohols, fatty acids and glycerine. However, US imports of these materials from China are minimal.

The bigger impact will be on finished plastics and other products that will have an indirect impact on demand for US chemicals and polymers, along with the shock to global confidence of a protracted and more costly trade war between the world’s two largest economies.

The fourth round of US tariffs at 10% will directly impact a far greater amount of Chinese chemicals and finished plastics, according to the American Chemistry Council (ACC).

The second round of US tariffs implemented in August 2018 impacted $2.2bn of these imports from China at 25%, and the third round covered an additional $13.2bn (implemented in September 2018 at 10% and ramped up to 25% in May 2019), according to the ACC.

The impact on US imports of China chemicals and finished plastics from the fourth round of tariffs runs far higher at an estimated $26.6bn with 51% of the total in finished plastics, according to Emily Sanchez, director of economics and data analytics at the ACC.

If the US enacts the fourth round of tariffs at 10%, the threat of bringing these to 25% or higher still looms. Global supply chains have already been shifting away from China and this will only accelerate.

CURRENCY WARS
China is already striking back, letting its currency fall beyond the level of 7 Chinese yuan (CNY) to the US dollar without intervening. That psychological 7 level had been defended by China’s government with currency interventions in the past. A weaker yuan makes Chinese exports more competitive and mitigates the impact of tariffs. This in turn makes US exports to China less competitive.

That China’s currency would fall in the face of the latest major tariff threat is no shock - it is a natural consequence of a weaker economy, especially one that is expected to get weaker in the face of more tariffs. The shock is that China’s government would give up the ghost to defend the currency, putting at risk additional capital flight.

The US responded by labelling China a currency manipulator, a move largely viewed as symbolic.

Weaponising the yuan opens up an entirely new front on the US-China trade war. China cannot match the US tit-for-tat on tariffs - as it imports far less goods from the US than the US does from China - so it must find other ways to retaliate.

Currency devaluation can be an effective tool in blunting the impact of the tariff. Thus the reaction from Trump decrying the move, and pushing the US Federal Reserve once again to cut rates so that the US dollar can fall in turn.

And let’s not forget that China still has the tariff lever to pull. While the US is putting just about all Chinese imports under tariff (with some exceptions), China has additional US products it can target. By threatening tariffs on imports of US agricultural goods, it hits Trump politically in key midwestern states ahead of the 2020 election.

US LDPE NEXT TO BE TARGETED?
Yet there are plenty of other key US exports to China that could be targeted. In chemicals, an obvious one is low density polyethylene (LDPE), notes ICIS senior consultant John Richardson.

US LDPE was exempt from the 25% tariffs China imposed in August 2018 on high density PE (HDPE) and most grades of linear low density PE (LLDPE). “As with HDPE and LLDPE, the US is undergoing major capacity expansions in LDPE. LDPE represents another opportunity for China to hit the US economy where it hurts,” said Richardson in the ICIS Asian Chemical Connections Blog.

While the US has dramatically scaled back exports of HDPE and LLDPE to China in the face of 25% tariffs, it has ratcheted up exports of LDPE to China. From January through May 2019, the US exported over 138,000 tonnes of LDPE to China - more than triple the almost 43,000 tonnes from the year-ago period and much higher even than the 102,000 tonnes exported to China for all of 2018.

Prior to the start of the China tariffs on US PE in August 2018, US exports of LDPE were the lowest among the PE grades, trailing HDPE and LLDPE. Today LDPE is the highest volume US PE export to China. For any China tariff retaliation, it’s a juicy target.

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Insight article by Joseph Chang