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.
Difficult times lie ahead for global polymer markets. It would be bad enough that downstream users have been busy building stock in recent weeks as the oil price rose, as Linda Naylor reports on polypropylene (PP) for ICIS:
“PP demand is slow, slower than many expected, and the strong growth of recent months is now considered to be partially down to stock building. “The market appears to have gone long quickly,” said one buyer. Some sources thought that inventories along the chain were higher, and concerns over working capital were leading to destocking.”
Now these stocks are likely to be unwound, as oil prices return to more normal levels with Iran and Iraq (and probably others) ramping up production just as demand weakens seasonally.
But there are more fundamental reasons for concern in the polymer markets themselves. As the chart above shows:
- China’s PP production is up 38% in January-April versus 2014 levels, and its imports are down 28%
- NE Asia and the Middle East have been badly hit, with their volumes down 10% and 38%
In turn, this is now starting to pressure the US market, as these producers seek to replace lost volumes. US imports from both regions have jumped to 25kt this year from 9kt in January-March 2015 (US Customs data is a month later than China’s). There are likely to be further increases through the year as China’s imports continue to reduce.
A further problem was a further 25kt of PP imports from Latin America – up from just 1kt in 2015 – as China’s slowdown forces LatAm producers to seek new markets. Unfortunately, US demand is also slowing, and so US inventories are now back at April 2013 highs.
As suggested 3 months ago, a major battle for market share is now developing, with US prices for PP starting to tumble. Contract prices fell 4c/lb ($88/t) in May after a 3c/lb fall in April, and ExxonMobil have told customers its prices will reduce by 3c – 5c/lb in June.
Europe is seeing a similar reversal of trade patterns, with Middle Eastern and NE Asian imports each up 20kt in January-February versus 2015 (Europe’s trade stats are even slower to appear than the US). And worryingly, many market players have failed to understand the extent of the downward pressures, with respondents to the latest ICIS sentiment index expecting a “sustained period of bullishness”. I fear they have a nasty shock ahead of them.
The problem goes far deeper than just PP, of course, as the second chart shows. European contract propylene prices have fallen sharply in H1 versus ethylene, averaging just 69% of the C2 price – a level last seen nearly 20 years ago. Already, as I found when giving the keynote presentation at last month’s World Polyolefins Conference, convertors are starting to think about switching from other polymers to PP in certain applications.
This is bound to put further pressure on polyethylene (PE), where China’s import volume has also fallen so far this year. It was down 3% versus 2015, whilst China’s production was up 6% – and overall demand up just 1%. The slowdown couldn’t be worse timed, as the first of the major new US capacities will be online in less than a year.
Unfortunately all my warnings have been lost in the recent euphoria – understandably, everyone wanted to instead believe that demand was returning to pre-2008 SuperCycle levels. But hope is not a strategy.
The good news is that our new Study, Demand – the New Direction for Profit, is now available to guide you through the difficult times that likely lie ahead. I honestly believe that buying it could be the best decision you make all year.
“The reality is the US from a chemical standpoint is a very mature market. We have some demand growth domestically in the US but it’s a % or two – it’s not strong demand growth,” Pryor said, adding that polyethylene hardly grew in the US in a decade. “That is not going to change.
“The domestic market is what is it and therefore, part of these products, I would argue, most of these products will have to be exported,”
That was the view of Stephen Pryor, then President of ExxonMobil Chemical, just 2 years ago. Latest data for US ethylene production in 2015 confirms his analysis, as the chart shows:
- It has finally reached a new high, 11 years after the previous high in 2004 – but only by 2.9%
- PE also reached a new high, versus the previous high in 2007, by 7.2%
- But the other derivatives – PVC, styrene and ethylene glycol – were still below their 2004 highs
- PVC was 11.3% lower, styrene was 14.8% lower, and MEG lower by 42.1%
Now, of course, things are about to change quite dramatically, as the massive US expansions come online and start to export their product. The competition they provide will likely be extremely tough, as we discuss in our new Study with ICIS, Demand – the New Direction for Profit,
Everyone knows what happens to margins when a major battle for market share takes place. It is almost certain, for example, that the US will need to start selling some or all of its new capacity on the basis of roll-through margins back to the well-head.
And at the same time, polymer producers will also face increasing inter-polymer competition from polypropylene. Propylene’s recent price collapse is just a warning sign of what is to come, as China moves towards its target of achieving 93% self-sufficiency in the C3 value chain.
We are therefore heading towards a world where there will be Winners and Losers.
Companies urgently need to develop new outlets for their product, as we describe in the Demand Study. Such outlets do exist, in potentially large volumes in the water and food industries. But “potentially” means just that – the volume of new demand required means companies now have little time left to plan and implement the business development activity now urgently required.
Our aim in the Study is to help you go up the learning curve as quickly as possible,. If you don’t start to develop new markets today, it may well be too late tomorrow.
Everyone wants to assume that markets will soon be back to “normal”. Consensus thinking now accepts that China will be a bit slower than before – but it argues that 6.5% GDP growth is still pretty good, even if it isn’t double digit. And it suggests that persistence, and “staying the course” is vital for success.
But what happens if the future isn’t simply a slower version of previous growth? What happens if it really was a one-off BabyBoomer-led economic SuperCycle? And even worse, if central bank stimulus simply created short-term demand – and left us with major debt problems for the future?
That is what the data seems to be trying to tell us, when we look at leading indicators such as the polyester market, and now propylene, as the chart above highlights:
- It shows the ratio of propylene prices to ethylene since 1978, when price histories begin
- And it provides the answer to the question I raised in 2012, when new propylene capacity was first discussed
- Very clearly, propylene is going back to selling at a major discount to ethylene
- It has already moved from near-parity to 69% of ethylene values so far this year, and will no doubt fall further
The key to the change is the new capacity now coming online. As we note in Demand – the New Direction for Profit, major increases have been taking place in China’s capacity. China is already using more propylene than ethylene, and its output has been increasing from refineries, olefin crackers, on-purpose plants and from coal. In the main derivative polypropylene, for example, volume has already surged 34% on a year-to-date basis between February 2014 and February 2016, and there is a lot more capacity to come.
Abundant supplies of propylene and its main derivatives also have a second-order impact, as they encourage product substitution with other value chains. As ICIS pricing reported in November:
“China’s PE spot import prices dropped in the week, especially for HDPE injection grade. Local traders lamented that some garbage and tray factories replaced HDPE injection resins with PP copolymer resins due to lower feedstock costs. Hence, the HDPE injection grade prices dropped by about $50/tonne from the previous week.”
Of course, not every application can be substituted. But it can impact 10% – 25% of polyethylene, PVC, PET, polystyrene, ABS and even polycarbonate. So the potential for major pricing upsets is large. And there is no reason to believe that China will act as a “responsible” Western producer, cutting back output to balance demand:
- Its aim is to maintain employment and act as a reliable supplier of critical raw materials to downstream factories
- The Communist Party stays in power by continuing to improve people’s living standards
- Shutting down plants, particularly the new plants built under the stimulus programme, is not on its agenda
What happens next? Worryingly, there seems only one likely outcome – a battle for market share, in which prices for all the affected products eventually end up being set on a roll-through basis to their ultimate feedstock. Cheap propane, oil and coal support lower prices for the propylene chain, whilst cheap natural gas and ethane support lower prices for the ethylene chain.
Developments in the paraxylene chain have already provided a clear warning of what is to come, as I discussed last week. Developments in the propylene chain suggest it is only a matter of time before similar pricing pressures hit the other major value chains.
Companies therefore need to find alternative outlets very quickly indeed, as we discuss in the Demand Study. Doing nothing, and hoping for the best, could prove a very risky strategy indeed.