Polymer markets face two major challenges in coming months. The most immediate is the arrival of the major US shale gas-based ethylene and polyethylene expansions. The longer-term, but equally critical challenge, comes from growing public concern over plastic waste, particularly in the ocean.
The EU has set out its vision for a new plastics economy, where:
“All plastic packaging is reusable or recyclable in a cost-effective manner by 2030”.
Similarly, China has launched a ‘War on Pollution’, which has already led to all imports of plastic waste being banned.
Together, these developments mean there is unlikely to be a “business as usual” option for producers or consumers. A paradigm shift is under way which will change business models.
Some companies will focus on being low-cost suppliers, integrated back to the well-head or refinery. Others will become more service-led, with their revenue and profits based on exploiting the value provided by the polymer (virgin or recycled), rather than just the value of the virgin polymer itself.
The next 18 months are therefore likely to see major change, catalysed by the arrival of the new US production, as I discuss in a new analysis for ICIS Chemical Business.
The second chart indicates the potential impact of these new capacities by comparison with actual production since 2000, with 2019 volume forecast on basis of the planned capacity increases. But can this new PE volume really be sold? It certainly won’t all find a home in the US, as ExxonMobil Chemicals’ then President, Stephen Pryor, told ICIS in January 2014:
“The domestic market is what it is and therefore, part of these products, I would argue, most of these products, will have to be exported”.
And unfortunately for producers, President Trump’s new trade policies are unlikely to help them in the main potential growth market, China. As John Richardson and I noted a year ago, China’s $6tn Belt and Road Initiative:
“Creates the potential for China to lead a new free trade area including countries in Asia, Middle East, Africa and potentially Europe – just as the US appears to be withdrawing from its historical role of free trade leadership”.
The task is also made more difficult by the inventory-build that took place from June onwards as Brent oil prices rose 60% to peak at $71/bbl. As usual, buyers responded by building inventory ahead of price increases for their own raw materials. Now they are starting to destock again, slowing absolute levels of demand growth all around the world, just at the moment when the new capacity comes online.
SUSTAINABILITY CONCERNS ARE DRIVING MOVES TOWARDS A CIRCULAR ECONOMY
At the same time, the impact of the sustainability agenda and the drive towards the circular economy is becoming ever-stronger. The initial catalyst for this demand was the World Economic Forum’s 2016 report on ‘The New Plastics Economy’, which warned that on current trends, the oceans would contain more plastics than fish (by weight) by 2050 – a clearly unacceptable outcome.
Last year’s BBC documentary Blue Planet 2, narrated by the legendary Sir David Attenborough, then catalysed public concern over the impact of single use plastic in packaging and other applications. Even Queen Elizabeth has since announced that she is banning the use of plastic straws and bottles across the royal estates, as part of a move to cut back on the use of plastics “at all levels”.
Single use plastic applications in packaging are likely to be an early target for the move to recycling and the circular economy. This will have a major impact on demand, given that they currently account for more than half of PE demand:
- Two-thirds of all low density and linear low density PE is used in flexible packaging – a total of 33 million tonnes worldwide
- Nearly a quarter of high density PE is used in packaging film and sheets, and a fifth is used in injection moulding applications such as cups and crates – a total of 18 million tonnes worldwide
Virtually all of this production is potentially recyclable. Producers and consumers who want to embrace a more service-based business model therefore have a great opportunity to take a lead in creating the necessary infrastructure, in conjunction with regulators and the brand owners who actually sell the product to the end-consumer.
Please click here to read the full analysis in ICIS Chemical Business.
The post Goodbye to “business as usual” model for plastics appeared first on Chemicals & The Economy.
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.
Sinopec, China’s largest chemical company, has just published its operating results for 2014. We don’t yet have all the details, but the chart above highlights the key points of its cumulative performance since it first filed public accounts in 1998:
- It has invested Rmb 288bn ($41bn) in capital expenditure for refining, and Rmb 239bn ($33bn) for chemicals (blue columns)
- It has lost Rmb 75bn ($11bn) at EBIT level in refining, and made just Rmb110bn ($15bn) in chemicals (red)
- Overall in refining and chemicals it has invested $74bn in capex, for a total operating profit at EBIT level of $4bn
- And it does not slow down when markets are bad: average operating rates are above 100% for ethylene/propylene since 1998
No Western company would dream of investing $74bn over 16 years for a total return at Earnings before Interest and Tax level of just $4bn. But Sinopec is not a Western company. It is 73% owned by the Chinese government.
Its mandate is to be a reliable supplier of raw materials to downstream users, to maintain employment and boost living standards. As such, it has no plans to cut back its expansion despite its poor financial results. Instead, it will be investing Rmb28bn of capex in refining this year, and a further Rmb16bn in chemicals.
But 2014 did show one major change from the past, namely that Sinopec published its first-ever environmental report, showing how its performance has begun to improve since 2010. Clearly this is a direct result of China’s New Normal policies, and the need to respond to concerns over pollution. Unfortunately, as often happens with first reports in this area, there is no scale given for the level of reductions, but no doubt this will come next year.
The Report is also important for its updating of Sinopec strategy, as shown in the chart above. In another example of the changes caused by the New Normal policies, it plans to move further downstream in its main value chains, following the example of China’s smartphone manufacturers such as Xiaomi .
In chemicals, this means a “transition towards high-end materials and differentiated fine chemicals”. It will also increase R&D investment, promote innovation-driven development, and establish an integrated service platform.
It would be very unwise to assume that these plans are unrealistic. Since 2000, after all, it has achieved 8% compound annual growth in gasoline production (from 20 million tonnes to 51 MT), and 12.5% in ethylene (from 2MT to 11MT).
Sinopec’s latest Report thus confirms major change is underway in China under its New Normal policies. Companies and investors stand to lose a lot of money, if they imagine that the future will be similar to the past.
By 2020, China will no doubt be a major exporter of many petrochemicals, as it is already for PVC. And it will likely also be a significant player in specialty/fine chemicals.
Sinopec is China’s largest chemical producer and its second largest refiner. The blog’s annual review of its published Results confirms its uniqueness in global markets.
The numbers confirm that it remains focused on increasing production, not profit. It will be No 2 in global ethylene capacity next year as a result. The chart above highlights the key metrics, based on the 15 years since 1998:
- It has spent Rmb 260bn ($36bn) on refining capex* and Rmb 223bn ($31bn) on chemicals capex (blue columns)
- It has lost Rmb 73bn (-$11bn) in refining at EBIT level**, and earned Rmb 105bn ($15bn) in chemicals (red)
- Collectively, therefore it has spent Rmb 483bn ($67bn) on capex, and earned Rmb 32bn ($4bn) at EBIT level
Nowhere outside China could this situation exist. No company would normally be able to spend $4.2bn/year on capex, but earn only $0.3bn/year at EBIT.
Equally, no company outside China would average an Operating Rate (OR%) of 102% on ethylene and 103% on propylene over the 13 years since 2000 (green columns).
The rationale is simple, however, when one remembers that Sinopec is 74% owned by the Chinese government. Its aim is to be a reliable supplier of raw materials to keep the economy growing, and living standards rising. As long as it continues to do this, then China’s Communist Party can expect to remain in power. Profit is irrelevant in this position.
Most companies and investors still find it hard to accept this wider context. They imagine that in the end, Sinopec will become more like a Western company. But why should it? China is a relatively poor country:
- Average per capita consumer spending in the towns is just $2600/year
- Rural incomes are only a third of urban ones
- Social unrest would break out overnight if Sinopec stopped production or aimed at Western profitability levels
It is little use hoping against hope that it will shutdown units due to cost pressures. It has never run its units to create profitability in the past, as the published numbers show. So why should it change policy now?
It is only our rose-tinted glasses that prevent us from seeing this reality.
CHINA IS RAMPING UP PETCHEM EXPORTS TO HELP MAINTAIN EMPLOYMENT
Meanwhile, major change is well underway in China’s economy due to the collapse of its export markets in the West, as state-owned China Daily confirmed last week:
“The concept of a “New Normal” for the world’s second largest economy is now prevailing both at home and abroad.”
In turn, this means that the petrochemical industry, like other major industries, faces an urgent need to adapt. As the blog warned in last year’s review, under the heading ‘Sinopec adapts to the New Normal’:
“As the world transitions to the New Normal, Sinopec’s new role will be to support the growth of China’s domestic demand. This will have considerable implications for the global petchem industry:
- Sinopec will continue to maximise production; as the chart shows, its average Operating Rates have been consistently over 100% since 2000
- This will dramatically reduce the need for imports, particularly from Asia and NAFTA, as domestic GDP growth will also be well below earlier levels
“The blog highlighted this potential in the first edition of the Study in 2011. Now it is becoming reality. But unfortunately very few companies have yet begun to appreciate the dramatic changes that will result. They now need to catch up very quickly.”
The rationale for these developments is simple, even if it doesn’t fit with Western financial logic. The new leadership has to burst the property bubble to maintain political and social stability. So it therefore needs to compensate by boosting employment in other parts of the value chain.
Thus China is now well on the way to becoming a major exporter of many key petrochemicals. And it will continue to reduce its import needs from Asia and other regions as fast as possible.
* capex = capital expenditure ** EBIT = Earnings Before Interest & Taxes
Sinopec is China’s main company in refining and chemical markets. Although it is listed on world stock markets, the government remains its largest shareholder with a 76% stake. As such, it follows government priorities rather than western commercial logic.
The chart above, from the blog’s major new study of the company, highlights some of the key issues. Between 1998 – 2011, Sinopec has:
• Spent a total of RMB 181bn (~$27bn) in chemicals capex (blue columns)
• Earned just RMB 110bn at EBIT level (Earnings Before Interest and Tax)
No western company would dream of spending this amount of capital for such poor returns.
But Sinopec operates as an arm of the government. Its role is effectively to act as a utility, ensuring reliable supplies of raw materials to the factories, to help maximise employment. For example, on ethylene it has:
• Inreased production by 14% per year over the period, from 2MT in 2000 to 10MT in 2011
• Normally run on a continuous basis (green columns), ignoring market downturns, at average operating rates of 102% over the same period
Thus it has enabled its downstream customers to maintain unbroken production schedules, and helped to ensure their reputation as reliable suppliers to global markets.
As discussed last November, Sinopec is thus an excellent example of our argument that economic factors are becoming less important in the global economy. Instead, social and political factors are beginning to dominate.
Globalisation had a golden age between 1982-2007. Trade barriers fell almost everywhere. Companies focused on achieving a ‘lowest cost’ position, in order to maximise their competitive advantage.
Today, however, the world is starting to look quite different.
The chart above summarises the changes underway. It shows US polyethylene net trade (PE) since 2009, based on GTIS (Global Trade Information Services) data, and updates that shown last November.
It presents a remarkable picture. Over this period, the USA gained major cost advantage, due to the increased extraction of ethane from cheap shale gas. Yet:
• Its net PE exports actually fell 39% from 2.6MT to 1.6MT
• Net exports to China were down 70% from 900KT to 266KT
The blog’s many US friends naturally find this very difficult to understand. They believe China should simply shut down its high cost, naphtha-based production and import cheaper US product.
But China operates on different values. Its petchem industry operates as a utility, providing reliable supplies of raw materials to the factories to keep people employed. If it shutdown plants, then social unrest would increase, threatening the existing Chinese political structure.
Sinopec’s own financial performance proves the point. Between 1998-2010, it invested RMB 166bn ($25bn) in chemicals capital expenditure. Yet its total EBIT (Earnings Before Interest and Taxes) was only half this at Rmb 84bn. No Western company would dream of investing on this basis.
But as the blog noted last week, China is continuing to expand production. And the government is currently expected to raise its stake in Sinopec from 76% to 78% over the next few months. It is paying the bills, not Western-minded investors.
The US thus faces a major dilemma. It has the 2nd cheapest ethylene feedstock in the world (after the Middle East). But its markets for this product are reducing:
• Braskem of Brazil is building new capacity in Mexico (with Grupo Idesa)
• It is also planning to build in Brazil
• Both expansions will reduce US exports still further
• Equally, Asian/ME producers are already expanding sales in Latin America, to compensate for lower import demand in China
The US position on ethane thus provides a good example of the changes underway as we transition to the New Normal. New value structures are emerging that focus on social and political factors, rather than economics.