By John Richardson
YOU are a junior researcher working for a global polyethylene (PE) producer. This is your opportunity to help change “group thinking” and so greatly improve your career prospects.
It is not going to be easy, especially if your boss tells you, “I’ve been here many times before. China is just waiting for markets to bottom out and then all the buyers will come back together and re-build their stocks. This could happen in December, or at the latest, I think, in January”.
Your boss is likely basing this assumption on the last couple of years, when, in December and January, Chinese buyers did indeed move back into the market in concert. This enabled overseas producers to improve their financial books before the close of the financial year by selling lots of resin to China.
But we know that:
•China’s apparent demand for PE surged by 22% in January-September of this year compared with the same period in 2012 (see the first of our above charts). This is because imports were up by 20% as domestic production also increased by 22%.
•And yet in polypropylene (PP), as our second chart above illustrates, imports, when the same two nine month periods are again compared, actually fell by 2%. This makes much more sense as PP local production increased by 24%.
•Why should PE be different from PP? Both have seen very big increases in local production, they both have similar supply and demand balances and, of course, compete for the same end-use markets.
•And so would China require a 20% increase in PE imports?
We are pretty sure we know an important o the answer to this question: Speculation. Traders and distributors have been taking advantage of interest rates as high as 48% in the shadow banking system. PE has therefore become a speculative tool, as has been the case in the past. This time, though, a seeming great opportunity has met with desperation to result in what could well be a bigger than usual distortion to markets.
Let’s assume we are wrong about the above – and assume, instead, that there are other reasons why apparent demand in PE has jumped by 22%.
Buying ahead of future increases in oil prices is one possible explanation.
But now, of course, everyone recognises – as we flagged up last month – that Saudi Arabia is playing a market share game in crude.
We also know that US shale oil break-even costs are lower than some had estimated – and that, even if these levels are breached, there are no guarantees that large volumes of US production will shut down.
Most importantly of all, though, we know that oil prices have also fallen because of weak demand, and that the main cause of this weak demand is China.
How weak is China’s economy right now? The chart below helps tells the story.
his is one of several “Li Keqiang indices” out there at the moment, and compares growth in electricity consumption, rail freight and credit with increases in official GDP. Li, China’s Prime Minister, of course, was quoted back in 2007 as saying that these three measures were more useful than official GDP numbers.
The fact that these official numbers are pretty much manufactured for political purposes is also becoming more widely recognised. And so when your boss says, “anywhere else in the world would, surely, envy GDP growth of 7.3%,” (what China achieved in Q3) show him this chart.
And you also need to tell your boss that we might well be at the beginning of a very prolonged period of weaker growth in China.
The above has, of course, huge long term implications that you might well feel is above your pay grade and is instead something that vice presidents, presidents and CEOs need to worry about.
But you can at least do your bit by kicking back against what you see as overly aggressive growth targets for your PE sales in 2015 in the China market, especially if they factor in the assumption of a returning flood of buyers.
Instead we think that:
•All that excess end-use inventory in PE has to appear somewhere at some time in the market.
•China’s buyers will continue their “hand to mouth” purchasing strategies, given all the uncertainties around oil prices and the Chinese economy.
There is one more word you need to also mention to your boss, which should help him plan for both next year and beyond: Deflation.