Macroeconomic challenges keep GCC PE and PP participants cautious
By Matthew Rajendra, Middle East Polymers Senior Reporter, Argus Media
Inflation. Higher interest rates. Weakening currencies. Recession. These 2022 buzzwords will not be going away any time soon. GCC plastics participants welcomed 2023 with an air of caution as macroeconomic woes from 2022 lingered. Polyethylene (PE) and polypropylene (PP) prices have fallen from the highs of 2020 and 2021 when the Covid-19 pandemic boosted demand for plastics, spurring growth and expansion in the industry. But all of this changed when Russia invaded Ukraine in February 2022.
Key global LLDPE film prices, Argus Media
Looking back at 2022
Russia’s invasion of Ukraine proved to be a tipping point as oil prices rose sharply in March last year, resulting in higher feedstock costs for petrochemical producers. Food prices worldwide also rose as Ukraine, a major grains exporter, was no longer able to export its typical volumes. As a result, prices of final goods rose sharply. In PE and PP markets, buyers of final goods started tightening their belts on spending. This coincided with the lockdowns in China, a major importer of PE and PP.
Higher raw material costs weighed heavily on participants, supporting a rise in PE and PP prices from March to the end of April. But buyers could not continue purchasing cargoes at these prices. Buying ideas weakened further in May and June, dragging down prices globally and shrinking production margins at key petrochemical producers.
To tame inflation, the US Federal Reserve began hiking interest rates aggressively from July 2022. This resulted in a stronger US dollar, which in turn weakened demand for imports globally. Developing countries, a key growth market for GCC producers, started restricting the opening of letters of credit to limit the outflow of US dollars and improve their trade balances. This trend continues today as the Fed aims to get inflation down to its target of 2%.
Exports stay robust despite interest rate hikes
Despite rising interest rates, exports out of Saudi Arabia remained robust in 2022. The impact of unfavorable macroeconomics has mainly been on prices. Buyers’ purchasing powers declined globally, pushing down polymer prices. But consumption levels have stayed robust, as downstream demand remained soft to stable in most parts of the world.
Saudi Arabia PE and PP exports vs Federal Fund Rate, Global Trade Tracker, and Board of Governors of the Federal Reserve System (US)
Saudi Arabia Annualised PE and PP exports, Global Trade Tracker
Exports out of Saudi Arabia grew in 2022. PE exports saw a 2.92% growth year-on-year (YoY) while PP exports grew by 2.84% YoY. Despite weakening macroeconomics, consumption levels have risen. GCC producers will be encouraged by the increase in global consumption as they brace for harsher macroeconomic conditions in 2023.
Producers respond to falling prices
The decline in prices from May to December posed a challenge to PE and PP producers in the GCC. Declining prices meant thinner margins, reducing overall profits. To mitigate this, producers chose to bring forward planned turnarounds for 2023 to the first quarter. By doing so, operational costs can be minimised at a time when margins are thin.
These planned shutdowns resulted in a slight price recovery in this year’s first quarter. Buyers were more eager to restock because of concerns that supplies could tighten further in the coming months. But as the quarter came to a close in March, prices began easing once again because of higher supplies as key GCC producers resumed production at their plants. The fall in prices was further exacerbated by worsening sentiment as bank runs in the US, beginning in March, kept participants cautious. The less-than-robust recovery in China, following its reopening, was also a concern for participants. Most buyers are exercising caution and only purchased as needed under current circumstances.
Chart 4: Crude Futures, Argus Media
Banking crisis’ impact on petrochemical markets
The shutdown of Silicon Valley Bank and the purchase of Credit Suisse by UBS caused major commodity prices to fall in March. Investor confidence was shaken, causing crude futures to fall sharply. OPEC+ responded to this by cutting oil production in early April. This in turn supported oil prices.
The same trend was observed in naphtha prices as they dipped initially in mid-March before recovering in late March to early April. The initial decline in naphtha prices prompted some Asian producers to restart cracker operations as well as PE and PP production. But the sharp rise shortly after has kept margins at Asian producers negative, causing many Asian producers to rethink this strategy.
Feedstock volatilities may prove to be an advantage for GCC producers that have access to significant cost advantages. Asian producers importing feedstock oil and naphtha are likely to continue facing thin margins. With polymer prices expected to remain subdued against the current backdrop of weak macroeconomic conditions in 2023, Middle East producers will need to maximise their cost advantage to expand their market share overseas by pricing their cargoes competitively.
Chart 5: Naphtha Prices, Argus Media
Declining freight rates: A silver lining?
From 2020 to the first half of 2022, increased freight rates eroded netbacks for GCC producers. Shipping lines were struggling to cope with the surge in demand for imports as lockdowns prompted increased online shopping, especially in the US. Allocating vessels efficiently to cope with the surge in demand was a challenge for shipping lines. Container availability was also tight. These factors pushed freight rates higher.
But as inflation began to set in, freight rates began falling gradually from the middle of last year. Freight rates have since eased to pre-pandemic levels as vessel and container supplies rise and demand for imports across most sectors fall.
Freight rates from Saudi Arabia’s Jubail and the UAE’s Jebel Ali have eased sharply since May 2022. Spreads for rates between different routes have narrowed. With rates converging and logistical bottlenecks easing, high freight costs are unlikely to erode netbacks for GCC producers.
As rates converge and deltas between different routes thin, GCC producers are now able to find alternative destinations without incurring substantially higher freight costs if they need to reallocate cargoes from one region to another.
Despite these newfound options, the decline in freight rates could also hint at a bigger challenge in 2023 – weak demand for final goods. A key driver for declining freight rates has been reduced import demand as consumers tighten their belts on spending. This could also result in a fall in demand for plastics globally.
Key freight rates, Argus Media and Freightos
Participants stay cautious for next quarter
With the US Federal Reserve planning further interest rate hikes this year, many participants remain cautious for the second quarter. The full extent of bank runs has yet to play out as other banks could be next in line if current macroeconomic woes continue for an extended period.
The fallout from the banking sector could also have long-term impacts on the shipping industry. UBS could look to reduce the sizeable ship finance portfolio held by its recent purchase of Credit Suisse, according to industry analysts, which would influence the newbuilding market. Credit Suisse is the 10th largest lender for ship finance with around $10bn, while UBS has an exposure of only around $20mn. Should new supplies of ships fall, freight rates could rise once again, threatening margins at GCC producers.
With uncertainty becoming the new normal, GCC producers will need to stay agile to navigate ever-changing macroeconomic conditions.