INDUSTRY INSIGHTThought Leadership

Implications of US-China trade war on GCC chemical markets (Part 2)

By John Richardson, Senior Consultant, Asia, ICIS

China is levying 25% additional tariffs on US high-density PE (HDPE) and linear-low density (LLDPE) imports as part of its response to US tariffs on its imports. The PE tariffs came into effect in August last year. The performance of Middle East PE exporters in China since the tariffs were imposed has been mixed, based on Chinese Customs data. Kuwait, Qatar and the United Arab Emirates (UAE) saw lower LLDPE exports in the seven months from September 2018 to March 2019 compared with the seven months from February 2018 until August 2018 – the pre-tariff period. Saudi Arabia’s exports edged up. This was despite US exports collapsing from 267,810 tons to 69,963 tons.

But in HDPE, Kuwait, Qatar, Saudi Arabia and the UAE all gained ground over the US. The opportunities for further gains by the Middle East in China are, as we said, significant the longer the trade war drags. But a trade war that lasts the rest of this year and into 2020 would likely slow global economic growth and damage PE consumption. While it might be true that PE growth is divorced from GDP in China, this is not the case in many other countries and regions.

The US is in the midst of its biggest ever capacity build in PE, hence the decision to levy tariffs as Beijing is well aware that China is the world’s biggest import market.

So far, the US has been able to shuffle the pack by raising exports to Europe, Turkey and Southeast Asia to compensate for loss of China trade. In turn, Thailand, Malaysia have raised their exports to China to compensate for greater competition at home from US material.

But in the event of a trade war pushing the world into recession, the US would find it more difficult to place all of its additional production – especially in LLDPE where the expansions are the greatest.

Price wars would be inevitable with higher cost naphtha-based producers likely to be the biggest losers. The ethane-based Middle East producers would also see lower returns.

“So far, the US has been able to shuffle the pack by raising exports to Europe, Turkey and Southeast Asia to compensate for loss of China trade.”

“Confidence has been badly affected by the trade war. Now that the war looks like continuing for the rest of this year, I can’t see any recovery in autos and PP demand.”

Durable goods and polypropylene

Polypropylene (PP) is an entirely different story in China. Demand growth was a disappointing 4.7% in 2018 compared with our forecast of 6.5%. This left demand at 27.1 million tons – 454,000 tons less than we had expected.

This year looks set to be a great deal worse. The Q1 data imply full-year demand growth of just 2% as against our forecast of 6%. This would leave 2019 consumption at 27.7 million tons – 1.6 million tons less than we had predicted.

The problem with PP is that it predominantly goes into big ticket or expensive consumer goods such as autos. Sales of big ticket items have seen a big slowdown in China.

Last year saw the first annual decline in Chinese auto sales since the early 1990s. In the first four months of this year, auto sales continued to decline and were down by a very worrying 14.6% in April.

“You don’t make a big financial commitment of buying a car or a house when you are not feeling confident about the future and people in China are not feeling confident about the future,” said a Shanghai-based sales and marketing executive with a global PP producer.

“Confidence has been badly affected by the trade war. Now that the war looks like continuing for the rest of this year, I can’t see any recovery in autos and PP demand.”

Another problem for PP, and all the polymers that mainly go into durable big ticket end-use markets, is slower growth in Chinese credit availability during 2018. This reduced discretionary spending on autos, washing machines, TV and refrigerators.

Meanwhile, the trade war damaged exports of auto components and washing machines etc. Thirty to forty percent the PP that China imports is re-exported as finished goods. Some 50% of ABS imports are re-exported.

Whilst there has been a lot of talk about new economic stimulus in Q1, in reality on a net basis loans from the state-owned banks fell by 6%. This was the result of most of the extra money pumped into the economy going to service loans of heavily indebted companies.

And the trade war is dragging on. A sign of its impact was the 2.7% fall in China’s total exports in April.

The Chinese government might launch much more economic stimulus later this year in response to trade war. But, as in Q1, further stimulus would have a limited effect because of the large scale of China’s bad debts.

This is why China’s ABS demand looks likely to contract by 4% in 2019 over last year to consumption of around 5.1 million tons.

The decline in SBR demand is the most dramatic of them all. Consumption is in line to be as much as 13% lower in 2019 at 1.2m tons.

SBR is used to make autos tyres with the collapse in demand reflecting short term issues with China auto sales, as well as a long-term shift in the nature of demand for cars in China as the second-hand car market expands.

The weakness in the polymers that are heavily used in autos and electronics manufacturing is a major reason why Asian PE naphtha-based integrated margins have seen a sharp contraction in 2019.

The returns PE itself remains OK. But the ICIS margin analysis shows that reduced co-product credits from selling propylene, butadiene and aromatics have led to the fall in profitability.

Northeast Asian HDPE integrated naphtha-based HDPE margins had fallen to an average USD 214/tons in 2019 up until 18 May. This compares with full-year 2018 margins of USD 322/ton and USD 522/ton in 2017 (see the chart).

If the trade war remains unresolved for the rest of this year and into 2020, Asian PE profitability seems certain to further weaken. This might lead to operating rate cuts that benefit the Middle East through less availability of Asian PE in China.

In terms of the weak growth in Chinese PP demand and its effect on the Middle East, the region’s major exporters have yet to feel any effect.

In 2018, shipments to China from the region’s major exporters – Kuwait, Oman, Saudi Arabia and the UAE – remained virtually unchanged over the previous year at around 1m tons.  And in Q1 this year, the exporters maintained a collective market share of total Chinese imports of 20%.

But the longer that the weakness in China’s PP demand continues, the greater the risk that Middle East exporters will star to lose sales.

Just to note that the Chinese tariffs also include 25% duties on US PP. While its exports to China have fallen, this will have very little effect on the global PP supply and demand balance as the US domestic PP market is in tight supply.

Beyond just trade: A bi-polar world.

US/China tensions are not just about trade. They are also about growing geopolitical differences that could lead to a New Cold War.

There has been a major shift of opinion across the US political spectrum. Republicans and Democrats are in broad agreement that China represents as big a geopolitical rival as the Soviet Union was during the 1950s-1980s.

This could lead to a bi-polar world – two rival economic and geopolitical zones, one centred on the US and the other on China. Which side will the Middle East choose or will it attempt to compromise and support both sides? Will such a compromise be even possible?

These are profound and complex problems beyond the scope of this article, the answers to which will have major implications for petrochemicals investments, demand and trade flows. This is a subject that ICIS may consider in future articles.