By John Richardson
THE NOISE is deafening, making it very difficult to understand what is really going on in the world’s largest petrochemicals and polymers market.
Politics, the unreliability of some macro data, and all of our individual confirmation biases make understanding China even harder than usual in 2022. As we all know, China is never easy to understand.
Fortunately, however, we have the ICIS data which clearly tells us that the Chinese economy is in a deep trough, which of course means weaker than expected demand growth for petrochemicals. Until or unless the data begins to correct towards long-term averages, we know that the bottoming will continue. It’s as simple as that.
The weak demand comes at a time when China is increasing its self-sufficiency in several major petrochemicals and polymers, and significant new capacity has come on stream or is about to come on stream in South Korea, in Malaysia, Vietnam and the United States.
The importance of spread data
The analysis of spreads, that is to say the study of the differences between the price per ton of a product and the costs per ton of raw materials, has always been a good measure of the balance between the supply and demand. Spreads also serve as a rough guide to profitability.
Let’s take a look at what the data tells us about this year’s spreads in just one polymer: high-density polyethylene (HDPE). This is an updated version of the chart I posted last week. This latest chart includes naphtha costs and HDPE prices during the week ending July 22, 2022.
The updated graph below shows the monthly differentials between ICIS CFR injection HDPE prices (cost and freight) in China and our CFR naphtha cost estimates in Japan. The graph goes from January 2000, when our assessments began, until July 22, 2022.
In December 2019, the gap fell to $206/tonne, which at the time was the lowest since 2000, thanks to a strong accumulation of new capacity. Linear Low Density (LLDPE) and Polypropylene (PP) spreads also fell to record lows in the same month.
Soon after, of course, the pandemic arrived, driving spreads lower and then higher as China enjoyed an export-led recovery.
Chinese exports surged in the second half of 2020 as it supplied most of the goods the rich world bought during the shutdowns – computers, games consoles, white goods, etc. This trade has boosted China’s petrochemical demand and imports. Global markets have tightened.
But look what has happened since March 2022. During this month, as oil prices soared due to the Ukraine-Russia conflict, Chinese demand began to falter due to nationwide shutdowns and other restrictions introduced as part of zero COVID policies.
The March 2022 spread fell to just $98/tonne. Spreads have since recovered but remain historically low. In July, through the week ending July 22, the gap was $219/tonne.
The pattern you see in the table above is the same in several other products.
The following graph puts all of 2022 in the context of each of the years from 2000 to 2021. The average HDPE spread in January-July 2022, again through July 22, 2022, was just $193 /ton, by far the lowest since 2000.
You can argue that the very small deviations since March of this year, which have driven the 2022 average lower, are primarily the result of rapidly rising oil prices and therefore naphtha costs. But spreads in other regions have been much wider since March. But consider the table below.
This chart shows actual naphtha costs and actual HDPE prices rather than differentials. During previous rapid oil price increases, as you can see, HDPE producers were much better able to pass on higher costs to converters by raising HDPE prices.
Between 2003 and the global financial crisis that began in September 2008, HDPE prices rose steadily as naphtha costs rose.
We can see the same pattern of effective cost pass-through from 2009 through the commodity price crash of late 2014, and from the China-led recovery in the second half of 2020 through this year. In contrast, look at the narrow gap between the blue and red lines so far this year.
HDPE demand and net imports from China
Now let’s see what the latest ICIS data says about HDPE demand in China.
CIHI’s estimate for local production in January-May 2022 and the net number of imports from China Customs, when annualized (divided by five and multiplied by 12), suggest demand growth for the year. 2022 minus 2%.
But the January to June figures point to minus 3% (scenario 2 in the chart). The outlook for the full year has deteriorated month by month since March.
The chart also includes two other scenarios for China’s HDPE consumption in 2022.
To be consistent with my monthly estimates since February, scenario 2 is the medium scenario. Scenario 1, the best outcome, is two percentage points higher than the average case outcome; Scenario 3, the worst case outcome, is two percentage points lower.
The chart below provides three different results for China’s net HDPE imports (imports minus exports) in 2022.
Based on the annualization of China Customs Department’s January-June figures for HDPE net imports, net imports for the full year appear to be 5.6 million tonnes (scenario 2 in graph above). This is unchanged from January-May.
But 5.6 million tons would compare to 6.4 million tons of net imports in 2021 and almost 9 million tons of net imports in 2020. China is expected to increase its HDPE capacity by 22% in 2022 to 13.8 million tonnes in a low growth environment. This would follow capacity increases of 14% in 2020 and 18% in 2021.
The ICIS estimate for local generation in January-June suggests a full-year operating rate of 79% compared to our earlier expectation of 84%.
Deep production cuts have taken place in China since March in several petrochemicals. This is the result of low demand and low profitability, as evidenced by the low spreads. We could therefore also see delays in the start-up of some new factories in 2022.
But there is another result. China could decide to commission its new capacities on schedule and operate its factories at a higher operating rate in H2 than in H1. Local producers could increase their exports, taking advantage of what could remain a weak yuan against the US dollar, while reducing the need for imports.
This result is represented by Scenario 3 in the graph above – an average annual operating rate of 84% and demand growth of minus 5%. This would translate to net imports of just 4.6 million tonnes in 2022.
Every ton not sold to China creates a major global problem, as last year China accounted for 55% of global HDPE net imports among countries and regions that exported more than they imported, according to the database. ICIS on supply and demand.
Conclusion: follow the data
I could have written a different article today, focusing on why zero COVID policies would continue to drive more lockdowns, mass testing, and other measures that hurt economic growth.
I could have added to the gloom by concluding that China’s economic recovery would remain stop/start until or unless it develops its own effective mRNA vaccine. The lack of a local version of an mRNA vaccine is said to be one of the main reasons for zero-COVID policies.
But even if or when such a vaccine becomes available, Nature magazine warned in a June 27 article: “A highly effective mRNA vaccine would reduce the risk of severe widespread infections that could overwhelm hospitals. However, it is unlikely to end the country’s strict zero-COVID strategy, which uses mass testing and lockdowns to nullify all infections.
I might have also detailed the implications of the inverted Chinese interest rate curve reported by the FinancialTimes in this July 25 article.
“Some of China’s largest banks are offering a lower interest rate on long-term deposits compared to short-term deposits, as the lack of quality lending opportunities indicates a sustained slowdown in the engine of global economic growth. “, writes the newspaper.
Normally, interest rates on long-term deposits must be higher than those on short-term deposits to attract savers.
I see the reversed performance as a sign that zero-COVID policies are combining with economic reforms as part of the shared prosperity agenda. I therefore see weaker than expected growth over at least the next three years.
But that’s obviously just an opinion, of course. To find out if I’m right, follow the data here. If there is no sustained return of deviations from historical averages over the next three years, I would have been right; a recovery will demonstrate that I was wrong.
Again, it’s as simple as that. This makes ICIS petrochemical data, when interpreted correctly, commercial gold dust.