By John Richardson
PERTH (ICIS)--The good news is that China’s polyethylene (PE) markets stabilised slightly last week on the back of a little more activity amongst buyers because the latest agricultural film-buying season has started. During each season, sales of low density (LDPE) and linear low-density PE (LLDPE), which are blended together to make the film, increase.
Post-Lunar New Year labour shortages were also reported to have eased as more workers returned from the countryside to coastal towns and cities, enabling converters to raise their operating rates.
On the downside, there were concerns over the potential impact of new capacity.
China’s Sichuan Petrochemical, for example, achieved on-spec production at its new 300,000 tonne/year LLDPE plant on 20 March.
And worries remain about the impact of output from the Borouge 3 complex in Abu Dhabi, which is scheduled to come on-stream this year.
The complex includes two Borstar PE plants with a combined capacity of 1.08m tonnes/year and a 350,000 tonne/year LDPE unit. This is probably the single most-important production event of 2014 for PE.
These are familiar types of analyses, and, of course, will remain essential for reading the direction of any chemicals and polymers market.
But what is also becoming ever-more important to understand is the impact of China’s economic reforms on growth.
One aspect of particular concern at present is the efforts to reduce the inflows of “hot money” into China that have contributed to asset bubbles and problems in the shadow-banking sector.
The Chinese government has, as expected, increased the range within which the value of the yuan trades against the US dollar. This has sent a very important signal to speculators in polyolefins and other commodity markets, which is: You can lose as much as gain on the yuan, because currency appreciation is no longer a one-way bet.
‘Froth’ has been added to chemicals demand growth as a result of speculative trading around both the assured, constant rise in the value of the yuan and interest-rate arbitrage. It seems inevitable that some of this froth will now disappear as a result of the yuan’s wider trading band.
“The big question, which nobody can answer, is ‘how much froth are we really talking about?’” said a polyolefins trader.
Another major uncertainty is over the time-frame of completing the crackdown on trade finance excesses.
“In contrast to some media reports, we find that the bulk of Chinese commodity financing deals are ongoing, facilitating ‘hot money’ inflows into China and providing a mechanism to import low cost foreign financing,” wrote Goldman Sachs, in Metals Note, which was quoted in a 19 March Financial Times blog post.
“In general, the profitability of most currency and commodity hedged Chinese commodity financing deals remains substantial, owing to a still positive yuan and US dollar-based interest rate differential (4%) and limited depreciation in the yuan over the past month (2%),” the bank added.
China’s economic growth has been increasingly supported by different types of foreign exchange inflows, said Goldman Sachs. For example, no less than 42% of the increase in China’s monetary base was the result of low cost foreign funding, or hot money inflows, added the bank.
“Clearly, those are not the kind of flows you can just kill without kneecapping your growth rate at the same time,” concluded the author of the FT Alphaville blog post.
“The bet is for a slow unwind over the next one-two years but as with everything in China the lack of transparency in the market makes it ‘finger waved in the air’ stuff,” he concluded.
The interconnections between all the economic problems in China that also matter. These interconnections are a huge distance from being fully understood.
For example, as the same blog post points out, a lot of the main players in copper financing are also involved in the property market.
Similarly, there have been reports that traders in some chemicals and polymers in general have also been involved in the property sector.
Overseas chemicals cargoes have sometimes been purchased not because of their underlying value, but because of the cheap US dollar-based credit that these shipments have generated. The chemicals have then either been sold immediately or put into storage, and the finance used to speculate on property.
Nobody, again, seems to be clear about whether the chemicals volumes involved in these “circular trades” amounted to merely a rounding error or something much more significant.
In copper, though, traders have estimated that up to half of China’s imports have been used as collateral to raise cheap US dollar loans.
Copper prices have fallen during the early months of 2014 because of both the clampdown on trade financing and wider economic reforms aimed at moving the economy away from its investment-focused growth model.
Might property prices also therefore decline if copper prices continue to weaken? Or is this a leap too far?
Could the same the same link be made between any further declines in other commodity markets, including chemicals?
The health off the property market in general is a huge deal for the chemicals industry.
For example, according to Nomura, China’s real estate sector was responsible for 16% of the country’s GDP growth, 33% of fixed asset investment, 20% of outstanding loans, 26% of new loans, and contributing 39% of government revenues in 2013.
While on the subject of housing, the threat of a real-estate correction not only comes from the stricter trade-financing environment, but also from tighter liquidity conditions in general.
Earlier this month, the property company, Zhejiang Xingrun Real Estate, defaulted on $565m of debt.
When a property company had previously faced default either a local government or the central government had always come to the rescue, say financial analysts.
The decision to let Zhejiang Xingrun default is, thus, widely viewed as another sign that Beijing wants to get rid of speculative forms of growth.
“We believe more property developers will face similar pressures as transaction volumes slow and cash flow conditions tighten, and expect this problem to be more severe for unlisted developers in third- and fourth-tier cities with limited access to financing,” said Nomura economist, Zhiwei Zhang, in a March research note quoted in several newspapers, wire services and blogs.
The risk for developers is particularly high in third- and fourth-tier cities, which accounted for 67% of housing under construction in China in 2013, added Zhang.
“This risk does not seem fully recognised in the market partly because data are not readily available for these cities, and some investors may be misled by the boom in first-tier cities,” he said, adding that most investors aren't aware that first-tier cities (Beijing, Shanghai, Guangzhou and Shenzhen) only account for 5% of housing under construction.
Nationwide, residential floor space per registered urban resident reached 37 square metres by 2013, compared with 35 square metres in Japan and 33 square metres in UK, according to Nomura. And, if the current trend holds, it could reach 51 square metres by 2017.
More importantly, perhaps, Nomura believes that the pace of urbanisation has started to slow and will drop further. This would make it harder for real-estate supply to be absorbed by demand.
How might all of this end for the chemicals industry?