By John Richardson
IT would be very interesting to go back to 2000 and compare the strength of positive sentiment towards the future of the Asian polyethylene (PE) industry to the above chart.
The chart shows spreads between naphtha costs, which is the main feedstock for making PE in Asia, and the prices for one particular grade – high-density PE (HDPE) injection grade. As you can see, last year spreads were at a 15-year and so far this year they have held up very nicely indeed. It is the same story in all other grades of PE tracked by ICIS Pricing.
This measure is of course a rule of thumb as it takes around 3.3 tonnes of naphtha to make a tonne of ethylene, and then approximately a tonne of ethylene to make a tonne of any grade of PE. Plus, this doesn’t take into account production costs and money made from selling co-products such as propylene, benzene and butadiene.
But crucially, our assessment of variable cost naphtha-based PE margins shows the strongest margins since at least 2000, when our records begin. And one Asian industry source believes that today’s profitability is the strongest since the early 1990s.
As I said at the beginning, it would very useful to go back to 2000 and compare both spreads and margins at any particular point in time to the levels of confidence about future success. Anecdotally, my experience tells me that the higher the numbers, the greater the levels of confidence about strong future profitability. Underlining this impression was the buoyant mood at last week’s Asia Petrochemical Industry Conference in Singapore.
What worries me is that recent industry success is leading to talk of a ‘new paradigm” involving a decoupling of demand growth in China from growth in the country’s GDP. Reasons given include rising food safety concerns that are driving booming purchases of modern-day packaged food and the surge in internet sales. Even if you therefore have a very negative view of future GDP growth in China, you might still end up with a very positive outlook for PE. In other emerging markets, too, PE consumption growth is also said to have decoupled from GDP for slightly different reasons.
On the supply side, the new consensus seems to be that for the next five years at least, China will struggle to significantly raise its local production. This positive supply-side story also includes the assumption that the big wave of new US capacity, due on-stream from H2 2017 onwards, will be introduced into global markets in a very staggered fashion – and may even be substantially delayed.
Many people are thus putting all this together and forecasting strong profitability for the next 2-3 years at least, probably quite a lot longer.
But you need to vigorously “stress test” this growing belief in a new paradigm for PE. Here are some of the reasons why:
- Converters have choices, in China and elsewhere. They don’t have to use PE to wrap food or goods sold via the internet. Other polymers, such as polyethylene terephthalate and polypropylene (PP), confront much greater supply and so lower costs for converters.
- The conventional view in the case of PP replacing HDPE is that future opportunities remain thin on the ground for technical reasons. But what if converters push the envelope on innovation in order to save money in a deflationary world? This has happened before, with innovation surprising on the upside.
- There is a race against time taking place in China right now. Sure, there are tremendous news sources of growth. But nobody can be sure that these new sources of growth will be sufficient to replace the lost growth momentum from lower investment.
- Or China might continue to “kick the can down the road” in order to sustain the old investment-led growth model. There are two outcomes here: either a major financial crisis when debt is finally dealt with or Japan-style economic stagnation as “extend and pretend continues for perhaps decades.
- China’s PE production was up by 200,000 tonnes in Q1 over the first quarter of last year with new coal-based supply scheduled to start-up at the end of this month. Sure, some projects appear to have been delayed, but this is a moving target. The self-sufficiency level depends on government policy.
- And returning to macroeconomics, the global Economic Supercyle is, I believe, over – for good.
- US PE capacity could largely come on-stream all at once, and on time. Investors need returns, and many of the companies involved in these projects are very experienced in bringing plants on-line.
- Most roads point to China for much of this US surplus, given what could be persistently weak Latin American and other ex-China markets. In Q1, there are reports that as much PE from the Americas in general was shipped to China as was shipped from Iran to China. And in a low oil-price world, Asia’s naphtha crackers would be in a strong position to battle for market share in Asia. So the upshot could be greater length in the Asian market than you currently expect.
You can take a gamble on all the above being wrong. Or you can instead ask yourself this question, “How do I protect my business if at least some of these assumptions are right?”
The answer is to start securing your own demand. That way, your future sales volumes will be secure – and crucially also stronger than your competitors – no matter what are the background factors beyond your control.