China’s increase in chemicals self-sufficiency will hit US shale gas expansions

China C2,C3 May17Some 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

China PTA May17Ethylene 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

China PX May17PTA 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

 

China becomes net PTA exporter, whilst cotton prices tumble

PTA Aug16China used to be the world’s largest importer of PTA (the raw material for polyester). But not any more. Instead it has become a net exporter for the first time in history:

□  Its imports ramped up from 400kt in 1995 to 7 million tonnes in 2006, as Western textile manufacturing moved East
□  They remained around that level until 2012, when China began to install major new PTA capacity
□  It now has sufficient capacity to supply the entire world’s demand, and its imports have stopped
□  Instead, as the chart shows, it exported a net 120kt in H1, and no doubt volume will rise further in H2
□  NE and SE Asia have been the big losers, with their volume down 84% and 47% respectively

But as with polypropylene, these plants haven’t shut down.  They have instead increased their exports to other markets, primarily in Europe, where Korean volume has more than doubled from 200kt in 2014  to 500kt this year. Thailand has also nearly doubled ts exports to the Middle East from 70kt to 120kt over the same period.

Naturally enough, domestic European producers are feeling the pain, and have filed an anti-dumping suit against Korean producers with the European Commission.  Meanwhile, India has this month announced anti-dumping duties on a wide range of importers from China, Taiwan, Iran and Malaysia, whilst Mitsubishi Chemical plans to divest its PTA plants in China and India due to the “oversupply of material in the 2 markets”.

Cotton Aug16The pain could well get worse in H2, due to developments in cotton markets.  These had been expected to see lower prices from April, as China finally launched its long-awaited auction process to reduce its vast cotton stocks.  But the auctions had a very slow start, with latest USDA estimates suggesting China still holds 13 million tonnes of stock, down only 1MT since March.

This failure forced some consumers to go back into spot markets to cover their needs, where they were joined by a large number of hedge funds, who saw the opportunity for a quick profit. As the chart shows of US futures positions, their net long position soon reached near-record levels.

But now prices are falling again, after their near-50% rise.  They have already fallen 14% in the past 2 weeks, and could well retest their lows under 60c/lb:

□  China has just announced an extension to the planned auction period, suggesting it is serious about reducing inventory levels despite ongoing resistances from key producers
□  In addition, improved rainfall has prompted USDA to increase its volume estimate for the current crop in Texas and Louisiana – the main growing areas.

Hedge funds are not long-term investors.  And it seems likely they will now take their profits and exit the market, leaving producers and consumers to pick up the pieces.  At the same time, oil prices are also now weakening again, after their “silly season” August rally.

It could be tough times for cotton and polyester markets, as attention returns to today’s record surpluses.

Global cotton markets wait for outcome of China auctions

Cotton May16

China’s long-promised cotton auctions have begun this week.  Their outcome will tell us a lot about President Xi Jinping’s ability to force through his New Normal changes in the economy.  It will also, of course, have major impact upon the polyester value chain, given the competition between the 2 fibres.

As the slide from the US Dept of Agriculture’s (UDA) new monthly report shows, China’s current stock equals 169% of its annual use, nearly five times higher than the 36% figure in the rest of world. And at the moment (cotton year 2015/16), this means that global stocks are very close to all-time record highs.  There is enough in store to make 3 pairs of jeans for everyone in the world –  following the disastrous impact of China’s stimulus policies post-2008.

The fact that auctions are now being held does suggest that progress in potentially being made, but as I noted last month:

  • Last year, an auction was announced for 1 million tonnes, but prices were set so high that only 63kt was sold
  • The problem was resistance from an army-owned company, Xinjiang Production and Construction Corps
  • It produces around 30% of China’s cotton, and opposed policies that would reduce its income by lowering prices
  • It is also an important employer in Xinjiang province, accounting for 17% of its GDP

There seems more confidence this time, with the International Cotton Advisory Committee suggesting that:

Chinese cotton stocks will fall to a five-year low, as the government auctions off its huge reserves

And a further positive sign is that the limit for daily sales has been raised from 30kt to 50kt, with the government now planning to sell 2 million tonnes in the May to August period, with prices based on international and domestic levels.

China’s cotton stocks have been hanging over world markets for some time.  A successful auction process will almost certainly push prices lower in the short-term, as it comes at a time when USDA is already forecasting a 5% increase in global production for the 2016/17 cotton year, with US output expected to be up 15%.  It notes that:

“Nearly the entire decline in (global) stocks is forecast to occur within China”

But there is really no alternative.  The mistake was made, and it now has to be unwound.  Only then can the global cotton market hope to return to being based on the fundamentals of supply and demand rather than stimulus policies.

Polyester producers are already in the eye of the storm, following China’s decision during the stimulus period to build sufficient PTA capacity to supply the needs of the entire world.   Lower cotton prices will obviously increase the pressure.  All they can hope is that oil prices may now weaken again.  One positive is that last month’s speculative commodities bubble on the Dalian futures exchange has indeed collapsed as expected.

Clearing up the mess created by the stimulus programme was never going to be easy.  But we are, where we are.  And the alternative of doing nothing, solves nothing.

China’s cotton auction key pointer for global economy outlook

Cotton Mar16Cotton markets are poised for another testing month in April.  The outcome will also have potentially major implications for the polyester chain – and in turn for commodities markets more generally.

The reason is that China has announced that its long-awaited cotton auction will take place in the second half of the month.  Cotton stocks are at all-time record highs – enough to make 3 pairs of jeans for everyone in the world –  following the disastrous impact of stimulus policies, and China currently holds 11 million tonnes in store.

A lot is hanging on this auction, which will also tell us whether President Xi Jinping has now taken full charge of economic policy:

  • Last year, an auction was announced for 1 million tonnes, but prices were set so high that only 63kt was sold
  • The problem was resistance from an army-owned company, Xinjiang Production and Construction Corps
  • It produces around 30% of China’s cotton, and opposed policies that would reduce its income by lowering prices
  • It is also an important employer in Xinjiang province, accounting for 17% of its GDP
  • But recently, as I noted in January, there have been signs that Xi is determined to make progress on the issue

This will have important implications for the polyester chain, as the chart above confirms.

Retailers vary their blends of polyester/cotton depending on relative prices, and the oil price fall has helped to support PTA/polyester demand in recent months.  But as we note in the new “Demand – the New Direction for Profit” Study, China now also has enough PTA capacity to supply total world demand. So lower prices on cotton will likely lead to major price pressure on polyester, and across the textile chain.

In turn, this will pressure commodity markets more generally.

China’s New Normal policies have burst the commodities bubble created by policymaker stimulus.  There has been a brief respite in recent weeks, as hedge funds realised the central banks were about to panic, once again. They knew the stimulus policies weren’t working, and that more free cash would soon become available.   Oil prices jumped 50% as a result, along with other commodities.

But China is the real key to the outlook, as it has been since Xi became President in 2013.  His most logical policy is to take the pain of restructuring this year.  He can then move towards reappointment in 2017 by stressing that he has dealt with the problems he inherited, and can promise a better future ahead.

The outcome of the cotton auctions will be a key indicator for the global economic outlook for the rest of 2016.

China’s PTA market moves to self-sufficiency and exports

China PTA Mar16Credit conditions are tightening day by day in China.  Companies with good payment records over many years are seeing their borrowing limits cut back.  2016 is indeed proving to be the year that President Xi Jinping “takes the pain of restructuring”.

At the same time, self-sufficiency has become a key strategy for many industries, in line with the objectives of the new 2016 – 2020 Five Year Plan.  The above chart for PTA net trade, the intermediate product for the polyester chain, highlights the result:

  • China had been the world’s largest PTA importer, with rising volumes until 2010/2011
  • Its net imports were 6.5m tonnes in both years, as its stimulus programme expanded
  • But its own capacity was also expanding as part of the stimulus programme
  • Net import volumes have since collapsed as the new plants have come online

They disappeared almost entirely last year.  And even more ominously, exports are ramping up – reaching 620kt.

Cotton global stocks shrinking: ICAC

The issue is that China now has sufficient capacity to supply the entire world demand, as we discuss in our new joint Study with ICIS, Demand – the New Driver for Profit.  And, even worse, is the fact that another part of the stimulus programme caused cotton stocks to climb to all-time record levels.  There is now enough cotton in store to make 3 pairs of jeans for everyone on the planet:

  • International Cotton Advisory Committee data above shows stocks now equal to 92% of production
  • USDA estimates stocks are even higher at 22.6m tonnes (104m bales), with China at 14m tonnes
  • China’s inventory needs to be sold off, but this has been resisted by the military, who are the largest producer
  • Recently, however, cotton prices have fallen below the 60c/lb level, suggesting that sales may be about to start
  • Cotton prices on China’s Zhengzhou futures exchange have fallen back to 2004 levels as a result

PTA producers outside China are already facing major difficulties.  And any sale of the cotton stocks will make the situation very much worse.  But there is more to worry about than just PTA markets.

Other value chains can see the same developments taking place.  PVC is in a very similar position, whilst polypropylene production (PP) is rising fast as China expands its on-purpose propylene capacity.  And its aim under the 5 Year Plan is to to reach 93% self-sufficiency by 2020.

This will have two major implications.  Almost inevitably, China will start to become a major exporter of propylene derivatives, driving down prices and margins.  In turn, this will put pressure on other polymers such as polyethylene, which can be substituted by PP in several key applications.

Of course, it is easier to sit back and decide this will never happen.  That is what we describe as the Comfortable Middle scenario in the Study.  But suppose we are right with our alternative scenario?  What would you do, as a business?  And wouldn’t it make sense to prepare now, whilst there is still time to make contingency plans?

After all, consensus wisdom said China’s growth would never slow down, and oil prices would always stay at $100/bbl. These are painful reminders of the fact that wishful thinking is not always reliable.

Further chaos ahead for cotton and polyester markets as China aims to release its cotton stocks

Cotton Jan16Cotton has been on a roller-coaster ride over the past decade – to record high prices and then partial collapse.  This was followed by China’s decision to build the world’s largest ever cotton inventory as part of its post-2009 stimulus programme, to protect cotton farmers.

This inventory, being off the market, means cotton has been an island of calm in the commodity storm over the past year.  But there are signs this may be changing again.

Cotton prices are now under pressure from a vastly over-supplied polyester market – which has recently seen its raw material costs decline due to the oil price collapse.  The chart showing historical cotton and PTA prices (PTA is the raw material used to make polyester) tells the complex story:

  • Cotton and PTA prices normally move together, with manufacturers shifting blends between the two on relative pricing – if polyester becomes expensive, the cotton content of a shirt or blouse increases, to stabilise the price to the end-user
  • But in 2005, the oil price began to rocket in the subprime bubble period.
  • China and India took advantage of this to grow more cotton
  • But while their production rose around 30%, US farmers nearly halved their production between 2005/6 and 2008/9 as other crops were even more profitable

The story then became even more complex in 2009, after the subprime collapse.  Policymakers in the West rushed to do major stimulus, and once again this caused the oil price to rise to artificially high levels.  And at the same moment, nature took a hand, with the major US cotton-producing areas of Texas and Louisiana suffering a major drought. 

At the same time, China began its own, even larger, stimulus programme.  And part of this was aimed at providing major support for cotton farmers by building massive inventory.   By 2014, China’s stocks were up 4-fold versus 2010/11 and were sufficient to cover 6 years’ import needs

It was all a very long way of the simple story of the past, when cotton and PTA/polyester would compete against each other.  But clearly, at some point, the markets would have to take the pain of leaving stimulus behind.

And it seemed, if you didn’t dig too deeply, that this was starting to happen.  Cotton prices had already crashed from 230c/lb to 90 c/lb, as people began to recognise that global stocks were now sufficient to make 3 pairs of jeans for everyone in the world.  And they fell again in March 2014, as it became clear that the US drought was over.

But then, another result of the stimulus programme began to impact the textile market – as China’s PTA capacity started to increase.  Before long, China had opened enough capacity to supply the entire world market.  Almost overnight, it therefore stopped its PTA imports – which fell from 6m tonnes in 2012 to virtually nothing in 2015.  Effectively, China had exported its over-capacity problem to the rest of the world, causing major problems for all those exporters who had relied on its demand.

And while this madness was reaching its peak, financial markets were cheering, as I noted in July 2014:

Cotton, polyester – and the fibre market they supply – are all major world markets.  Financial players should therefore be panicking about what this downturn means for other parts of the global economy.  But instead they remain convinced that ”central banks now rule”:

  • They are therefore cheering China’s latest export data
  • They fail to understand this is not due to the sudden return of robust growth in the West
  • Instead it is driven by China’s need to support its own employment”

They are not cheering today, of course, as the message has finally begun to sink in about the real state of China’s economy.  But the story doesn’t end here.

The reason that cotton has been an oasis of calm over the past year is that its major cotton producer is an army-owned company.  This had the political clout to block necessary moves to sell off the cotton stocks.  But clearly President Xi couldn’t allow this situation to continue forever.  So now, the government is starting to force the issue, and is able to use the additional argument that the stored cotton is starting to age, which will impact its colour and spinning properties.

Thus Reuters has reported discussions are underway with the cotton industry and textile companies, with a government expert commenting:

“It’s completely unreasonable. Half of global stocks are in China, they have to release some.”

“Our 10 million tons of cotton in warehouses is no small thing, the financial burden is so huge and also it is impacting market prices.”

Clearly today’s cotton stocks have to be reduced to more normal levels.  But the pain of doing this is going to be immense – not only for the cotton industry outside China, but also for the PTA producers.

The whole saga is an excellent example of the follies of the stimulus period.  And it means the PTA industry desperately needs to find a new way forward.  We have some ideas on this, which will be set out in our new 5 Critical Questions Study, which will be published shortly.