China’s strategies for oil, refining and petrochemical production are very different from those in the West, as analysis of Sinopec’s Annual and 20-F Reports confirms. As the above chart shows, it doesn’t aim to maximise profit:
□ Since 1998, it has spent $45bn on capex in the refining sector, and $38bn in the chemicals sector
□ Yet it made just $1bn at EBIT level (Earnings Before Interest and Taxes) in refining, and only $21bn in chemicals
As I noted last year:
“Clearly no western company would ever dream of spending such large amounts of capital for so little reward. But as a State Owned Enterprise, Sinopec’s original mandate was to be a reliable supplier of raw materials to downstream factories, to maintain employment. More recently, the emphasis has changed to providing direct support to employment, through increased exports of refined products into Asian markets and increased self-sufficiency in petrochemicals”.
Commentary on China’s apparent growth in oil imports confirms the confusion this creates. Western markets cheered last year as China’s oil imports appeared to increase, hitting a record high. But they were ignoring key factors:
□ China’s crude imports were indeed 14% higher at 7.6 million bpd – nearly a million bpd higher than in 2015
□ But 700 kbpd of these imports were one-off demand as China filled its strategic storage
□ And at the same time, China’s refineries were pumping out record export volume: its fuel exports were up around one-third during the year to over 48 million tonnes
As Reuters noted:
“This broadly suggests China’s additional imports of crude oil were simply processed and exported as refined products.” In reality, ”China’s 2016 oil demand grew at the slowest pace in at least three years at 2.5%, down from 3.1% in 2015 and 3.8% in 2014, led by a sharp drop in diesel consumption and as gasoline usage eased from double-digit growth.”
The issue was simply that Premier Li was aiming to maintain employment in the “rust-belt provinces”, by boosting the so-called “tea-pot refineries”. He had therefore raised their oil import quotas to 8.7 million tonnes in 2016, more than double their 3.7 million tonne quota in 2016. As a result, they had more diesel and gasoline to sell in export markets.
The same pattern can be seen in petrochemicals, as the second chart confirms. It highlights how Operating Rates (OR%) for the two main products, ethylene and propylene, remain remarkably high by global standards. This confirms that Sinopec’s aim is not to maximise profit by slowing output when margins are low. Instead, as a State Owned Enterprise, its role is to be a reliable supplier to downstream factories, to keep people employed.
□ Its OR% for the major product, ethylene, hit a low of 94% after the start of the Financial Crisis in 2009, but has averaged 102% since Sinopec first reported the data in 1998
□ Its OR% for propylene has also averaged 102%, but has shown more volatility as it can be sourced from a wider variety of plants. It is currently at 100%
Understanding China’s strategy is particularly important when forecasting demand for the major new petrochemical plants now coming online in N America. Conventional analysis might suggest that China’s plants might shutdown, if imports could be provided more cheaply from US shale-based production. But that is not China’s strategy.
Communist Party rule since Deng Xiaoping’s famous Southern Tour in 1992 has always been based on the need to avoid social unrest by maintaining employment. There would therefore be no benefit to China’s leadership in closing plants. In fact, China is heading in the opposite direction with the current 5-Year Plan, as I discussed last month.
The Plan aims to increase self-sufficiency in the ethylene chain from 49% in 2015 to 62% in 2020. Similarly in the propylene chain, self-sufficiency will increase from 67% in 2015 to 93% in 2020.
It is therefore highly likely that China’s imports of petrochemicals and polymers will continue to decline, as I discussed last month. And if China follows through on its plans to develop a more service-based economy, based on the mobile internet, we could well seen exports of key polymers such as polypropylene start to appear in global markets.
Some years ago, when China was well on the way to becoming the world’s largest importer of chemicals, a reporter asked the chairman of Sinochem, China’s largest chemical company if China intended to keep increasing its imports? ”Not at all” was Su Shulin’s reply, “This is temporary. It is not our strategy. We will become self-sufficient.”
China’s current 13th Five Year Plan, covering 2016 – 2020, confirms his analysis. Wherever possible, China is now moving to increase its self-sufficiency as the above chart confirms:
In the ethylene chain, it intends to increase self-sufficiency from 49% in 2015 to 62% in 2020
In the propylene chain, self-sufficiency will increase from 67% in 2015 to 93% in 2020
Detailed investment plans are already being implemented to fulfill this strategy
Ethylene and propylene are following the pattern set in other major product areas. In 2014, China was the world’s largest importer of PTA, the key raw material for polyester fibre and PET bottles, as the second chart confirms:
It imported 1.7 million tonnes in January – March 2014. But then a series of major new world-scale plants began to come online, and China has since become a net exporter
NE Asian producers have lost 97% of their export volume to China and SE Asian producers have lost 90%
NEA and SEA are also now starting to face competition from China in Middle Eastern import markets
PTA is not alone in seeing this transition. There has really only been one major exception, paraxylene (PX) – the raw material used to make PTA. As the third chart shows, the new PTA plants have had to depend on PX imports for their feedstocks. The reason is that PX became the target of public concerns over environmental pollution and safety, causing expansion plans to be put on hold for some years.
China PX imports have risen by a third over the past 3 years to 2.7 million tonnes in Q1 this year
NE Asia has been the main supplier, with S Korea, Japan and Taiwan all moving major volumes
This, of course, has helped to compensate for the loss of their PTA exports
But now the logjam on new PX plants in China has been broken, and capacity is set to double from 13.6 MT to 29.7MT over the next 3 years. This expansion will not only support new downstream capacity in PTA, but will likely also lead to modest exports of PX as well.
This is further evidence, if more was needed, that the 4.5 million tonnes of new US polyethylene capacity will likely have major problems in finding a market, as it comes online later this year. As I noted back in March, the scope for disappointment with these projects is very high. US polyethylene exports had already fallen 50% since their 2009 peak – even before China began to increase its self-sufficiency
The financial crisis began a decade ago, yet production of the key “building block products” for the European petrochemical industry has still not recovered to its pre-Crisis peak, as the chart shows (based on new APPE data):
Combined production of ethylene, propylene and butadiene (olefins) peaked at 39.7 million tonnes in 2007
A decade later, 2016 olefin volume was 4% lower at 38.1MT, and lower than in the 2004 – 2007 subprime period
Olefins are used in a very wide variety of applications including plastics, detergents, textiles and paints across the European economy. The data therefore highlights the slow and halting timeline of the recovery – despite all the trillions of money-printing by the European and other central banks, and all the government stimulus programmes.
Worryingly, new data from the American Chemistry Council suggests that a new downturn may be underway in W Europe, as the second chart shows:
Output had been growing steadily at around 3%/year from 2014 to early-2016
But then it began to slide. It was just 0.5% in May, and only recovered to 2% in January – normally one of the seasonally strongest months in the year
This report is confirmed by Q1 results from BASF, the world’s largest chemical company. It cautioned that volumes were only slightly up compared to Q1 2016, despite “a sharp increase in prices for raw materials” due to the rise in oil prices. This is particularly worrying as demand was artificially inflated in Q1, due to many companies building inventory as the oil price rose following November’s OPEC/non-OPEC deal.
The issue is that oil prices are a critical factor along the entire value chain. Even retailers follow the oil price very closely, and every purchasing department aims to second-guess its direction, whether upwards or downwards. They buy ahead when they believe prices are rising, and leave purchases as late as possible when prices are falling.
This behaviour has a counter-intuitive impact on the market. Instead of demand reducing when prices rise, it actually appears to be increasing as companies build inventory. Thus producers are lulled into a false sense of security as price increases appear to have no impact on demand. But when oil prices are thought to have stabilised, volume then starts to reduce as buyers reduce their inventory to more normal levels.
The impact over a full cycle is, of course, neutral. But on the way up, apparent demand can often increase by around 10% and then fall by a similar amount on the downside, accentuating the basic economic cycle.
The European economy already faces a number of major headwinds due to the rise of the Populists and the UK’s Brexit decision to leave the European Union. Now the APPE and ACC data suggests that overall demand has actually been slowing for the past 9 months. And it is likely that underlying demand today is now slowing even more as companies along the value chain destock again as the oil price weakens.
Prudent CEOs and investors will no doubt already be preparing for a potentially difficult time in H2 this year.
“There isn’t anybody who knows what is going to happen in the next 12 months. We’ve never been here before. Things are out of control. I have never seen a situation like it.” This comment last month from former UK Finance Minister, Ken Clarke, aptly summarises the uncertainty facing the global economy.
As I note in a new analysis, major policy changes are now underway in both the US and China – the world’s two largest economies. Almost inevitably, they will create structural changes in the petrochemicals and polymers industry. These changes will not only impact the domestic US and Chinese economies. They will also impact every supply chain which has a link into either economy.
Half of Apple’s iPhones, for example, are currently made in the Chinese city of Shenzhen, using products from over 200 suppliers from around the world. Under President Trump’s new “America First” policies, it is highly likely that in the future, more and more iPhones will instead start to be made in the US.
This highlights how the world is now moving into the early stages of a “War of Words” scenario, where both the US and China are preparing to develop a totally new trading relationship:
Will this develop into an all-out “Global Trade War” scenario, as the new chairman of President Trump’s National Trade Council, Peter Navarro, has been advocating? This was the key message of his 2006 book, “The Coming China Wars: Where They Will Be Fought, How They Can Be Won”?
Will President Trump go ahead with his proposed 35% border tax on imports into the US?
Or will the two sides negotiate a less confrontational trading relationship that still takes account of the president’s desire to reshore manufacturing to the US?
Nobody can know at the moment. But we do know that China’s President Xi is equally determined to push forward with his reforms for the domestic Chinese economy. He also seems to have finally sidelined Premier Li Keqiang, who has been responsible for economic policy until now. This is a critically important development, as Li has masterminded the stimulus policies that meant China became the key driver for global growth in recent years.
Instead, Xi is determined to refocus on his $6tn “One Belt, One Road” (OBOR) project – which absorbed $450bn of start-up finance last year. OBOR creates the potential for China to lead a new free trade area including countries in Asia, Middle East, Africa and Europe – just as the US appears to be withdrawing from its historical role of free trade leadership.
It is hard to over-estimate the potential importance of these changes. As President Trump said in his recent Inauguration speech, his aim is to completely overturn the framework that has governed the global economy during our working lives.
Today’s business models based on global supply chains are therefore under major threat, and companies probably have very little time to develop new ones. It seems most unlikely, for example, that the globalisation model of recent decades – whereby raw materials are routinely shipped half-way around the world, and then returned as finished product – will survive for much longer. Companies and investors also have to prepare for the risk that today’s moves are only the start of a more profound shift in the global economy.
The current “War of Words” on trade could well evolve into outright protectionism, with countries reimposing the trade barriers of the pre-globalisation era.
The imminent start-up of 4.5m tonnes of new North American polyethylene (PE) capacity confirms the scale of the potential challenges ahead. As the chart highlights:
US net exports in 2016 were 5,000 tonnes lower than in 2015
Normally, one would have expected them to be ramping up in advance of the new capacity coming on line
Even more worrying is that they were 22% lower than their 2009 peak
Exports to China were down by 50% due to its self-sufficiency having increased
The scope for disappointment later this year – and in turn the potential for the “War of Words” to be replaced by a “Global Trade War” – is obvious.
I analyse the risks in a new feature article for ICIS Chemical Business with John Richardson. Please click here to download a copy (no registration required)
Just when you think something really can’t get any worse, it does. Sadly, that’s the story on chemical industry force majeures since my last half-year review. As I noted then:
“There is no such thing as an accident. The chemical industry, like others, has known this for over 30 years, since the adoption of Quality Management techniques. Yet it seems that over the past 18 months either this important fact has been forgotten or, more likely, I fear, has simply been ignored.
The evidence for this worrying statement is in the chart, which shows the number of monthly references to “force majeure” in ICIS News:
□ Until recently, this has shown 20 – 40 references a month, too high, but at least stable
□ Since 2015 there has been an alarming increase, with the range now 40 – 80 references
□ And there is no consistency on a month-by-month basis, suggesting that nothing is being done to improve the position”
As the chart shows, force majeures have since climbed to new all-time highs, with October showing a new monthly record of over 200 reports. The average for 2016 was 75/month, even higher than the 2015 average of 65/month.
What is to be done? Part of the problem is undoubtedly that plants are getting older, and so more likely to break down. Part of the problem is that preventive maintenance and training has been cut back to save money.
But the main problem in too many companies is more fundamental – too many senior managers now see profits as being more important than safety.
This is something quite new. In the past, force majeures would have led to lower profits – companies who were unable to supply would lose sales, and have to sell afterwards at a discount to compensate for their unreliability. But with today’s lower demand levels and growing capacity surplus, this discipline no longer applies. As the second chart shows from the International Energy Agency:
□ European and Asian refineries have been running well below pre-2009 levels due to lack of demand
□ They have therefore been producing less naphtha as a feedstock for petrochemical plants
□ Only N America has seen good refinery rates – and, of course, most of its olefin production is gas-based, so the higher rates do not translate directly into more product
The result is that companies have been under no pressure from their feedstock suppliers to sell more petchem products in order to use more naphtha. Instead, this slowdown in feedstock availability has balanced today’s weak levels of demand growth in major petchem markets and, counter-intuitively, led to relatively high levels of profitability.
The real question therefore is perhaps how long today’s abnormal market conditions will continue. When they end, and customers once more penalise unreliable suppliers, attitudes will change. One can only hope that today’s downgrading of safety consciousness doesn’t, in the meantime, lead to a major incident somewhere.
The Financial Times kindly prints my letter this morning on pricing policies for polyethylene.
Sir, Conspiracy theories are always good fun, and Robert Bateman’s views on the polyethylene market are no exception (Letters, December 29). But there is a much more prosaic explanation for the pricing structures he describes.
The key issue is that until recently, lowest unit cost was the key driver for industry profitability. Soaring demand from the baby boomers rewarded business models based on the theme of “If you build it, they will come”, as highlighted in Field of Dreams, the blockbuster baseball movie of the late 1980s. In turn, this led companies to build ever-larger plants, and to develop a shrewd appreciation of the difference between full and variable costs. Local customers paid full price, to reward the investment made. Foreign customers were then supplied with anything left over on the basis of marginal cost economics. Not for nothing were these markets often known as “Rest of World”. It was this dynamic, rather than any conspiracy, which led prices in far-off emerging markets such as Asia to be much lower than in the home markets of the major producers.
Today, however, this business model is long past its sell-by date, as concepts of sustainability and the circular economy come to the fore. Asian countries are also rapidly becoming self-sufficient and no longer depend on low-cost imports from the west. Yet old habits die hard. The excitement over shale gas economics has blinded many North American producers to the outlook for future demand growth and encouraged them to sanction major capacity expansions. Mr Bateman and his fellow manufacturers can therefore look forward to receiving increasingly attractive prices as 2017 progresses, without any need to lobby for new antitrust legislation.
Paul Hodges, Chairman, International eChem