By John Richardson
CHEMICALS markets are a great barometer for weather conditions in the wider economy because they are upstream of so many manufacturing industries. We should therefore take close notice of the above chart, from this excellent article by my ICIS colleague, Yvonne Shi.
What the chart shows is that by mid-March, weekly inventory levels for ethylene glycols (EG), styrene, pure benzene, acetone, toluene, xylenes, methanol, acetic acid, polyolefins and other products were at three-year highs. As Yvonne writes:
Mainstream tank storage for many products has reached the limit of capacity. Spare, smaller tanks that are usually left unused, are being activated. Taking EG as an example, main storage areas such as Zhangjiagang Changjiang International, Changjiang Petroleum, and Ningbo, have all reached bursting point.
She quite rightly points out that there is nothing unusual about post-Lunar New Year overstocking. Guessing what demand is going to be like after the holidays is always incredibly difficult. Another factor behind overstocking could have been anticipation of higher oil prices.
But the extent of overstocking – the three-year highs – should be a cause for concern given the seemingly contradictory message being sent by my second chart for today, which you can see below.
Dealing with bad debts and not a new flood of stimulus
We have to be careful that we of course don’t confuse causation with correlation. But chemicals markets time and again have given clear pointers to wider economic issues. My working theory is as follows:
- The 26% rise in Total Social Financing (TSF) in January and February of this year compared with the same months in 2018 does not signal a re-opening of the economic stimulus floodgates.
- Instead, the rise in new lending was more about ensuring bigger flows of financing to private sector companies that disproportionately suffered from the 2018 squeeze on shadow lending. A second motive was preventing further bond defaults of Local Government Financing Vehicles.
- Overstocking in chemicals supports this. Traders and producers saw the TSF numbers and assumed, wrongly, that most of the extra lending would end up generating new economic activity.
The March TSF data will clearly be an important pointer towards whether this working theory stacks up. So will the extent of any further separate stimulus measures that follow the March announcement of cuts in value-added taxes.
But, if a trade war deal is reached, I would be very surprised if we go back to the heady days of 2009 when TSF rose by an astonishing 61% during the whole year, or even to the pre-National Congress Period when TSF rose by 17% during 2017. 2009 was about dragging the Chinese economy out of the depths of the Global Financial Crisis; 2017 was about ensuring a solid economy and thus political stability ahead of the National Congress – a major political meeting.
The world has moved on since then, firstly because of the scale of China’s bad debts. Each dollar of new debt is producing much lower positive GDP growth compared with before 2008. This is the result of overcapacity across many manufacturing sectors, the property bubble and overspending on infrastructure such as subways. A second reason is that President Xi was confirmed for a second five-year term during the 2017 National Congress – and is set to stay in power beyond the usual ten years. This puts him in a very strong political position, enabling him to press ahead with essential economic reforms.
What is happening upstream in chemicals is reflected downstream. Sales of SUVs, minivans and sedans fell by 17.5% in January-February this year, compared with the same period in 2018, says the China Association of Auto Manufacturers. Total vehicle sales, including trucks and buses, fell 15%. Passenger car sales were down by 18% in January-February. Evergrande, the leading Chinese property developer, reports that its January-February sales fell by 43% year-on-year.
But China may have to panic
As I indicated earlier, everything hinges on the outcome of the trade talks. Despite recent setbacks, it still seems likely to me that a deal will be reached over the next few months, even though it will be paper thin and will not provide any lasting solutions. Why? Because it’s in the economic interests of both sides to come up with a temporary deal.
If a deal isn’t reached, though, China would have to panic and well and truly reopen the economic stimulus floodgates.
In summary, these are my two scenarios, with Scenario 1 carrying a likelihood of more than 50%:
- A trade deal is done over the next couple of months. This causes an immediate boost to oil prices, chemicals prices and chemicals demand, along with the wider global economy. This gives boost President Xi the leeway to press ahead with economic reforms. Credit conditions tighten in H2 as the battle is resumed against bad debts and overcapacity. Prices of oil and chemicals retreat again, with chemicals demand also weakening.
- There is no trade deal and the Chinese and global economies continue to be damaged by the trade war. President Xi has no other options but to further boost TSF and launch other stimulus measures. The pattern for chemicals and oil prices is reversed from Scenario 1: Oil and chemicals prices dip when trade talks collapse, but then rally as major stimulus kicks. But the extra stimulus makes China’s bad debt and overcapacity problems even worse, exacerbating the eventual downturn in oil prices, chemicals prices, chemicals demand and the global economy.
Fingers crossed for Scenario 1 isn’t, by itself, good enough, I am afraid (right now, I’ve got my toes crossed as well). It is instead essential to plan for both outcomes, in terms of your raw material inventory levels and the targets you set for chemicals sales in 2019 and 2020.