INDUSTRY INSIGHT

China’s capacity expansions amid weak recovery threaten imports

By John Richardson, Senior Consultant, ICIS

During the first quarter of this year China’s economy shrank by 6.8% compared with Q1 2019, according to the official data. Unofficial estimates put the fall in growth at around 8%.

This illustrates the problem we all face as we try and gauge the pace of China’s real recovery versus the government narrative of a rapid rebound.

Understanding what is happening on the ground in China versus unreliable government data has always been important. Deeper knowledge of China has now become critical because of the wide range of potential outcomes.

China might achieve positive 2020 GDP growth thanks to a big stimulus package, which was announced at this month’s delayed National People’s Congress.

But how quickly and how effectively will the package be implemented? (The package largely comprises infrastructure spending.) Will the package be enough to offset steep declines in China’s exports of finished goods?

The demand problems

The pandemic has decimated global sales of durable goods and demand for all the petrochemicals and polymers that go into durable goods.

Think of the big drop in demand for clothing and the effects on mono-ethylene glycol (MEG) – one of the Gulf Cooperation Council (GCC) region’s key exports.

China’s total ethylene glycol (EG) demand – which includes MEG as well as di-ethylene glycol and tri-ethylene glycol – will be 4% lower in 2020 compared with last year, according to ICIS forecasts.  2020 consumption is estimated at 16.9 million tonnes.

“China might achieve positive 2020 GDP growth thanks to a big stimulus package, which was announced at this month’s delayed National People’s Congress.”

“Petrochemical and polymer imports in general saw big increases in April because of rising oil prices during the second half of the month. Confidence was also high that China was bouncing back very quickly from the coronavirus outbreak.”

This would be the biggest percentage decline in China’s EG demand since 2008, when consumption fell by 5% during the Global Financial Crisis.

China imported 5.6 million tonnes of EG from four GCC countries in 2019 – Kuwait, Oman, Saudi Arabia and the United Arab Emirates (UAE). This represented 56% of the country’s total imports.

Also consider that China will account for 87% of total global net imports of EG in 2020. This is amongst the countries and regions in the world which import more than they export.

In other words, there are no other major markets the GCC can turn to in the event of weak Chinese demand.

But if you look at the January-April 2020 ICIS estimates of China’s EG production and the Chinese government import data, everything appears to be fine.

Net imports were 4% higher on a year-on-year basis at 3.7 million tonnes as local production increased by 5% to 2.6 million tonnes. This indicated a 4% increase in apparent demand, based on the exact numbers.

Petrochemical and polymer imports in general saw big increases in April because of rising oil prices during the second half of the month. Confidence was also high that China was bouncing back very quickly from the coronavirus outbreak.

EG imports were no exception to the broader trend: they rose by 32% in April month-on-month to 1.1 million tonnes, their highest monthly level on record.

This points towards overstocking In EG and other products because of the crisis confronting China’s exports.

China’s factories normally run at high operating rates in August-September each year, the country’s peak manufacturing season, so goods can be exported to the West in time for Christmas.

We should all expect a very weak peak manufacturing season in 2020. When this is broadly recognized, it seems likely that there will be destocking up and down most of the petrochemicals value chains.

Exports are not the only problem. China’s retail sales fell by 2.8% in May year-on-year following 7.5% in April, indicating local demand is a long way from recovering to pre-pandemic levels.

As we said earlier, China might manage positive GDP growth in 2020. But maybe not, according to China Beige Book, the US-based economic forecaster. Its June survey of 3,300 Chinese businesses indicated a significant risk of negative growth.

Rising China supply – the effect on the GCC

China is conducting a major wave of capacity expansions in polyethylene (PE), polypropylene (PP) and paraxylene (PX) that will push the country much closer to self-sufficiency over the next ten years.

In the cases of PP and PX, as detailed on the ICIS blog – Asian Chemical Connections – there is a good chance that China will move into net export positions.

This would have major implications for the GCC, and for the rest of the global petrochemicals business, when you consider that today China is the world’s biggest importer of PP and PX.

Focusing just on PP here and the outlook for 2020, the ICIS base case sees 4% local production growth in 2020 compared with last year. Combine this with demand growth at 2% and total imports would fall to just 3.9 million tonnes from last year’s actual imports of 5.2 million tonnes.

But the ICIS estimate of production growth in January-April was around 9%. If this were to continue throughout 2020, China’s PP plants would have run at an operating rate of 85% rather than our base case assumption of 81%.

Imports under this scenario, also assuming 2% demand growth, would fall to just 2.8 million tonnes.

“China is conducting a major wave of capacity expansions in polyethylene (PE), polypropylene (PP) and paraxylene (PX) that will push the country much closer to self-sufficiency over the next ten years.”

“Assuming the downside of a higher Chinese operating rate of 85%, imports from Saudi Arabia would fall to just 300,189 tonnes.”

China might well run its new and existing PP plants very hard because:

  • China’s January-April oil inventories increased by 670,000 bbl/day on a year-on-year basis, easily exceeding the previous record increase set by the US in 2014 at around 100,000 bbl/day. This was the result of China stocking up on crude when oil was very cheap.
  • China has lots of new refinery capacity. The capacity could be run hard to take advantage of the cheap crude and to increase gasoline and diesel exports as the rest of the world comes out of lockdown.
  • This might lead to plenty of naphtha to make propylene in steam crackers and then PP. Fluid catalytic crackers running hard to make gasoline might lead to ample of availability of co-product propylene to make more PP.
  • China’s new PP capacity is world-scale and so far to the left of the global cost curve.

Look at the chart on pxx to assess the implications for GCC producers. Even under our base case for China PP production growth, imports by China from Saudi Arabia would fall to 416,996 tonnes from last year’s 555,484 tonnes.

Assuming the downside of a higher Chinese operating rate of 85%, imports from Saudi Arabia would fall to just 300,189 tonnes.

You can also see the effects in the same chart on the other GCC PP producers – Kuwait, Oman and the UAE.

The forecasts for 2020 imports are based on the assumption that GCC countries will win the same percentage shares of the total China import market as they did in 2019.

The set of challenges facing GCC producers are unprecedented and this article has barely scratched the surface of what lies ahead.

Petrochemicals demand growth in China and elsewhere could take many years to return to the levels expected before the pandemic. As we said, China’s GDP growth might be negative in 2020 and there is no guarantee of a strong recovery in 2022.

Another challenge is China’s rising petrochemicals self-sufficiency. We could even see a collapse in China’s PE imports under scenarios of high operating rates over the next decade and unconfirmed local capacity being built.

The GCC petrochemicals business needs a whole new business model. We will discuss the nature of this model in future articles.