Traders lucky enough to be holding long positions in the polyethylene (PE) market prior to the 14 September attack on Saudi oil and gas facilities want everyone to believe that this has changed everything.
They will tell you over and over again, if you’re prepared to listen, that the resulting reduction in ethane supply to Saudi Arabian PE plants, leading to cutbacks in Saudi PE output, will turn a globally long PE market into a tight market. Producers will also be anxious to talk up tighter supply after months of tepid pricing.
Inevitably, therefore, PE prices will rise over the next few days, and possibly weeks, as the full extent of the damage to the Saudi facilities becomes clear.
Saudi Aramco claimed late on Tuesday that the damaged processing plant is running at 2m bbl/day, and should recover from recent drone attacks by the end of September.”
Even assuming that the repairs are not completed by the end of this year and Saudi PE plant operating rates are only half of what we had expected for September-December, the global impact would only be as follows, based on calculations using the ICIS Supply & Demand Database:
■ Saudi high density PE (HDPE) production would fall by around 825,000 tonnes versus what we had for the full-year 2019. The loss of Saudi output would amount to a 2% reduction of our forecast for full-year global production.
■ The Kingdom’s low density PE (LDPE) production would be down by 212,000 tonnes versus what we had expected. This would lower global production by around 1%.
■ Linear low density PE (LLDPE)output would drop by 642,000 tonnes, 2% of global output.
These seemingly minor percentage reductions would however make a difference in a tight market. But you would need to have spent the last nine months on Mars, out of communication with earth, to believe that the global PE market was tight prior to the drone attacks.
Supply has instead been long as a result of the biggest ever build-up in US capacity and the slowdown in the global economy.
The economy has been slowing because of the US-China trade war and a decline in Chinese economic growth as it deals with debt issues.
HUGE CHINA STOCKPILES
I am sure the story among traders and producers will be that the Saudi cutbacks will leave Chinese buyers scrambling to get hold of PE cargoes from other countries. But my latest estimate of Chinese stock levels, using China Customs department import and export data and our forecasts for local production, suggests otherwise.
In January-July 2019, compared with the same seven months of 2018, China’s apparent demand growth for the three grades of PE were as follows: HDPE at 17%, LDPE at 10% and LLDPE at 13% (apparent demand is net imports plus local production). Despite the economic slowdown, this will be another good year for PE demand growth in China, but nothing like the average of 14% growth across the three grades during January-July.
Instead, in the best-case scenario, our base case, actual demand across the three grades will average 7.7% for the full-year 2019. In my downside, and I see this as more likely, growth will be 6.7%. Growth at 7.7% indicates January-July overstocking of 942,530 tonnes.
If growth ends up being 6.7%, this indicates overstocking at slightly above 1.1m tonnes.
In either outcome, it is obvious that the Saudi production cutbacks have occurred during a period of very long Chinese supply.
EASY TO FILL THE GAP
Let’s assume, though, that the loss of Saudi output creates temporary shortages.
These can easily be filled by higher operating rates among other advantaged feedstock, or ethane-based, PE producers.
Raise our forecast average operating rates at crackers in the US, Kuwait, Qatar, Kuwait, Abu Dhabi, Thailand and Malaysia by just two percentage points for 2019 and this is more than enough to fill the projected Saudi supply gap.
Liquids crackers could also step into the breach. Crackers linked to refineries dependent on Saudi crude would likely find this difficult as of course Saudi crude is in tight supply following the drone attack.
But crackers linked to refineries in locations such as Singapore, where ExxonMobil and Shell can supply more of their own oil production, are obviously in a different position.
On the other hand though, expensive oil resulting from the attack will undermine the economics of the less integrated and smaller scale liquids crackers that lack liquids feedstock flexibility.
A bigger issue is not in bridging a supply gap, but rather the dampening effect on PE demand that could result from a sustained rise in oil prices.
The good news is that we seem to be in a lot better place than during previous major disruptions in oil production.
The global economy is, for instance, worth $84.4tr versus $37.9tr during the first Gulf War in 1990, making expensive crude more affordable. The rise of US shale oil production also reduced the dependency on Saudi Arabia.
However, DataTrek Research notes that every US economic downturn since 1970 was preceded by a doubling of oil prices in the previous 12 months. Crude would need to reach $80/bbl for that to happen, which is very conceivable in the current geopolitical climate.
For a while now, I’ve been pondering whether the next global recession will be a long and gradual event or something more sudden and more systemic.
A sudden downturn that exposes long-standing fault-lines needs a catalyst - and a rally in oil prices could provide the catalyst.
The fault-lines include the huge build-up in global debt since 2008, especially in China which has been responsible for around half of total global economic stimulus since that year.
China has in effect been sub-prime on steroids. The world’s other central banks have hardly shied away from lending, either.
How much longer can stimulus and the global debt build- up continue?
In China’s case it is running out of room to further stimulate its economy. The European Central Bank also seems to have run out of space to reverse declining EU growth through stimulus alone. Instead, long term structural reforms are needed, including raising productivity. The underlying No 1 problem is that as the extraordinary build-up in global debt since 2008 occurred, demand has been weakening due to ageing populations in the West and, crucially, also, in China.
Too much manufacturing capacity, including in petrochemicals, is chasing too little demand.
Expensive crude might therefore be the catalyst that exposes these issues as we enter a period of stagflation - higher inflation and lower growth.
Very few people would then be talking about tight PE markets.