A look at the Chinese market and implications for the GCC chemical industry
By John Richardson, Senior Consultant Asia, ICIS Commercial Strategy
The noise is deafening, making it very difficult to work out what is really happening in the world’s most important petrochemicals market. Politics, the unreliability of some macro-economic data and all our individual confirmation biases make understanding China even harder than usual in 2022. As we all know, China is never easy to fathom.
Luckily, though, we have the ICIS data that clearly tells us China’s economy is in a deep trough, meaning, of course, weaker-than-expected petrochemicals demand growth.
This is occurring at a time when China is raising self-sufficiency in several major petrochemicals and polymers, and when big new capacities have been brought on-stream or are close to being commissioned in South Korea, Malaysia, Vietnam and the US.
The importance of spreads data
Let us start with what this year’s spreads data is telling us in just one polymer – high-density polyethylene (HDPE). Patterns are similar in many other products.
Spread analysis – studying the differentials between prices per ton for a product and costs per ton of raw materials – has long been a good measure of supply and demand balances. Spreads also serve as a rough guide to profitability.
The above chart shows the monthly spreads between ICIS CFR (cost and freight) HDPE injection grade prices in China and our assessments of CFR Japan naphtha costs. The chart runs from January 2000, when our assessments began, up until 22 July 2022.
In December 2019, the spread fell to USD 206/ton, which at the time was the lowest since 2000, on a big build-up in new capacity. Linear-low density (LLDPE) and polypropylene (PP) spreads also fell to record lows during the same month.
Shortly afterwards, of course, the pandemic arrived, resulting in a dip and then a surge in spreads as China enjoyed an export-led recovery.
China’s exports surged in H2 2022 as it supplied most of the goods the rich world bought during lockdowns – computers, game consoles and white goods, etc. This trade boosted China’s petrochemical demand and its imports. Global markets tightened.
But look at what has happened since March 2022. During that month, as oil prices surged on the Ukraine-Russia conflict, Chinese demand began to weaken because of domestic lockdowns and other restrictions introduced under the zero-COVID policies.
The March 2022 spread declined to just USD 98/ton. Spreads have since recovered but remain historically low. In July, up until the week ending 22 July, the spread was USD 219/ton.
The next chart puts the whole of 2022 into the context of the years from 2000 until 2021.
The average HDPE spread in January-July 2022, again up until July 2022, was just USD 193/ton, easily the lowest since 2000.
You may argue that the very weak spreads since March this year are mainly the result of rapidly increasing oil prices and therefore naphtha costs. But spreads in other regions have been a lot stronger since March. Also consider the chart below.
This chart shows actual costs for naphtha and actual HDPE prices rather than the differentials. During previous rapid run-ups in oil prices, as you can see, HDPE producers were much better able to pass-on higher costs to converters through raising HDPE prices.
China’s HDPE demand and net imports
Now let us look at what the latest ICIS data say about HDPE demand in China.
The ICIS estimate for local production in January-May 2022 and the China Customs department net import number, when annualized, suggested full-year demand growth of minus 2% in 2022.
The January-June numbers point towards minus 3% (Scenario 2 in the chart). The outlook for the full year has been worsening month-on-month since March.
The chart also includes two other scenarios for China’s HDPE consumption in 2022.
The chart below provides three different outcomes for China’s HDPE net imports (imports minus exports) in 2022.
Based again on annualizing the January-June China Customs department number for HDPE net imports, full-year net imports look as if they will be 5.6 million tons (Scenario 2 in the above chart). This is unchanged from January-May.
But 5.6 million tons would compare with 6.4 million tons of net imports in 2021 and close to 9 million tons of net imports in 2020. China is scheduled to raise its HDPE capacity by 22% in 2022 to 13.8 million tons in a weak growth environment. This would follow capacity increases of 14% in 2020 and 18% in 2021.
The ICIS estimate for local production in January-June, however, suggests a full-year operating rate of 79% compared with our earlier expectation of 84%.
Deep production cutbacks have taken place in China since March across many petrochemicals. This the result of weak demand and poor profitability, evidence of which we can see in the very weak spreads. We might therefore also see delays to the start-up of some new plants in 2022.
But there is another outcome. China could decide to bring its new capacity on-stream on schedule and run its plants at a higher operating rate in H2 than in H1. Local producers might raise exports, taking advantage of what could remain a weak yuan versus the US dollar, while lowering the demand for imports.
This is Scenario 3 in the chart – an average annual operating that reaches 84% and demand growth at minus 5%. This would result in net imports of just 4.6 million tons in 2022.
Each ton not sold to China creates a major global problem as last year, China accounted for 55% of global HDPE net imports among the countries and regions that exported more than they imported, according to the ICIS Supply & Demand Database.
Conclusion: follow the data
We could have easily written an entirely different article where we focused on the reasons why the zero-COVID policies as the pandemic continued to force lockdowns, mass testing and other measures that damaged economic growth.
We could have added in this gloomy outlook why China’s economic recovery would remain stop/start until or unless it developed its own effective MRNA vaccine. Lack of a local version of an MRNA vaccine is said to be a major reason for the zero-COVID policies.
Or we could have predicted a whoosh in Chinese spreads, the result of a big rise in demand and prices because we believed China was close to containing the pandemic because of the effectiveness of its zero-COVID policies and indications that an effective local MRNA vaccine will be availability soon.
But this would have been of limited help as nobody has a clue about what will happen next, just opinions.
Instead, we advise following the data. When spreads return to normal and when demand and imports pick up for long enough for us to be confident that the worst is over, we will have our answers on China.
Disclaimer: All views expressed in this article belong to the author and do not reflect the position of GPCA.