INDUSTRY INSIGHT

Implications of US-China trade war on GCC chemical markets (Part 1)

By John Richardson, Senior Consultant, Asia, ICIS

The good news is the startling, amazing, performance of polyethylene (PE) in the key China market.

Despite increasing trade war tensions, evidence is mounting that the growth of PE is to a considerable extent divorced from fluctuations in Chinese GDP growth. Even if the trade war were to result in significantly lower Chinese economic growth, PE demand in the world’s most important market may not suffer.

This could deliver two benefits for GCC producers. Firstly, they may benefit from rising import demand as Chinese PE consumption growth remained robust. Secondly, they could gain more market share in China as the trade war tariffs further limited the ability of the US to export to China.

There is a further upside for the GCC if the trade war carries on throughout the rest of this year and into 2020, as now looks likely as a result of harder US approach to China. Naphtha-based PE producers could be forced to cut operating rates, thereby reducing their ability to export to China.

But herein also lies a threat to the GCC region in that the rate cuts forced on the naphtha players might be the result of further declines in Chinese demand for polypropylene (PP) and for other polymers such as acrylonitrile butadiene styrene (ABS) and styrene butadiene rubber (SBR). The Middle East is also of course a major exporter of PP to China and thus stands to suffer from continued weakness in PP.

Internet sales and polyethylene

Last year was a terrific year for PE demand in China. Our ICIS Supply and Demand Database had only expected 2018 consumption growth of 5.6% over 2017, resulting in demand at 29.8 million tons. Instead, demand expanded by 9.3% to reach 30.9 million tons

What we got wrong, and what most other analysts got wrong if they were being honest, was the impact of the heavy restrictions on imports of scrap or recycled PE and other polymers that China introduced in January last year for environmental reasons. This forced converters to use greater quantities of virgin resins.

“There is a further upside for the GCC if the trade war carries on throughout the rest of this year and into 2020, as now looks likely as a result of harder US approach to China.”
“Areas of China’s rich cities have become virtually cash free as a result of people buying all of their daily needs via their smartphones.”

Another factor behind the outstanding growth was the rapid expansion in sales of daily necessities, such as food and personal care products, over the internet. The sales required packaging and large volumes of this packaging was made from PE.

Another reason why forecasters were wide of the mark in 2018 was their top-down centralized approach to estimating China. Treating China as one region when, in fact, it is four distinct economic regions with very separate growth dynamics, simply doesn’t work and will always deliver inaccurate results.

The four regions are rich eastern and southern China, the declining northeast rust belt that has been pressured by the shutdown of inefficient factories, the booming middle provinces adjacent to the rich eastern seaboard and the very poor far west.

If you want to accurately assess China, you have to estimate PE consumption in each of China’s 31 mainland provinces and then group the results into the four regions. The same applies to all other petrochemicals and polymers. ICIS is working on a methodology to achieve this.

This year promises to be another stellar year for Chinese PE demand growth, even though the benefits of the recycling restrictions are already built into existing consumption.

Recycled imports are already at very low levels, meaning very little further benefits to demand from the restrictions. This suggests that a more important factor behind booming Chinese PE demand is the internet sales revolution.

Areas of China’s rich cities have become virtually cash free as a result of people buying all of their daily needs via their smartphones.

Government investment in high speed internet connections, and state support of Alibaba and Tencent etc., is paying off. Growing internet sales are to some extent helping China move from being an investment-led to a consumption-led economy.

Because the bulk of internet sales are of daily necessities, sales are not under threat from a slowing Chinese economy. You don’t stop buying food and shampoo when economic conditions become more difficult.

The logistics and volume efficiencies of internet sales also mean that buying food online is cheaper than buying from shops. One can therefore argue that in a slowing economy, the expansion of online sales will gather pace.

Take as a real example last year’s booming demand for restaurant food ordered online and delivered to people’s homes. As economic times were more challenging, people stopped visiting restaurants in favour of cheaper home deliveries. The deliveries are predominantly packaged in PE.

In the rural poorer provinces, the Chinese government is investing in better internet connectivity and in online sales platforms. In many of these provinces there is a shortage of shops. Low cost internet sales are as a result creating new demand in rural areas.

Global pressure from US polyethylene production

All of the above is evident from the strong PE demand growth data for Q1. On annualized basis for the full year 2019 the Q1 data imply 11% consumption growth that would leave this year’s demand at 34.9 million tons. This compares with our original demand-growth forecast for 2019 of just 5.3%.

It won’t be quite as good as this. The 11% increase in apparent demand will more likely end up as real demand growth of 8% when inventory distortions have been taken into account.

A flood of imports in March, the result of the arrival of cargoes delayed from late last year, has led to Q1 overstocking at around 235,000 tons. This explains the recent weakness of PE pricing in China.

Nevertheless, 8% growth would still leave this year’s demand at 33.4 million tons with 2020 promising growth once again in the high single digits. The longer the trade war goes on the bigger the downside for US PE producers as they lose ground in China