By John Richardson
WE ALL NEED TO ASK ourselves whether the global patterns in polyethylene (PE) and polypropylene (PP) pricing and margins that we have seen over the last year represent a long-term divergence in global markets or something temporary.
As discussed on Monday, when I examined linear low-density PE (LLDPE) market (and the same applies to the other two grades of PE), I see the above chart as nothing more than temporary.
All the talk about deglobalisation and more regional markets has a lot of validity over the long term. But we shouldn’t muddle the long with the short and medium-term.
What is keeping both PE and polypropylene (PP) markets divided right now is the cost of containers and the difficulties in finding container space. Otherwise, the extraordinary pattern in 2021 pricing that you see in the above chart wouldn’t have happened. More of the oversupply in Asia would have found its way West.
And there is evidence that some of the supply squeeze in the container freight business is beginning to ease.
Sure, because many developing countries remain way below adequate vaccination levels, there is always the risk of port lockdowns from new outbreaks that would further disrupt the container business.
But as economies continue to open-up, there will, I believe be an inevitable cycle out of spending on goods and into services.
Less spending on exercise equipment, TVS and game consoles etc. will mean less demand for containers. There is no global shortage of containers, if anything the opposite. The problem is instead that many of the containers are in the wrong places.
Broader supply chain pressures were beginning to ease, wrote the Wall Street Journal (WSJ).
Manufacturing in Asia of textiles and semiconductors was picking up as the pandemic was brought under better control, said the newspaper.
“Shipping and retail executives say they expect the US port backlogs to clear in early 2022, after the holiday shopping season and when Lunar New Year shuts many factories for a week in February, slowing output,” added the WSJ.
A survey by Oxford Economics among country experts covering 45 economies found that almost all believed supply-chain disruptions would peak or had peaked in the last quarter of this year, the newspaper added.
Before I am accused of selective interpretation, the same article said many company executives warned of supply chain shortages dragging on well into 2022, especially due to tight labour markets resulting from the pandemic.
Politicians are however engaged in tackling the supply chain crisis. The US and China have also said they could release oil from their strategic reserves to lower prices. High energy costs are another factor behind the surge in inflation.
There is so much money available to fund the pandemic recovery that political initiatives to ease supply chain tightness could make a big difference, as might US president Joe Biden’s push to pressure OPEC+ to raise crude production.
The good old-fashioned laws of supply and demand will one way or another weaken crude pricing, I believe.
The US Energy Information Administration (EIA) argues that there has been no underlying shortage of oil supply during the recent run-up in prices, unlike previous similar bull runs. Both the EIA and the Paris-based International Energy Agency are predicting longer global oil markets next year.
When it comes to the demand side of the equation, fellow blogger Paul Hodges says that whenever crude has cost more than 3% of global GDP, as is the case today, recessions have happened.
This explains the political pressure on OPEC+ and more investment in energy storage (the lack of sufficient energy storage is one of the reasons for the run-up in UK gas prices).
The politicians could succeed in tackling energy shortage, leading to supply-driven price declines. Or they will fail, we end up in a recession, and oil and gas prices fall on lower demand
As for the brief scare over China coal shortages, the shortages appear to have been fixed.
The specifics for the global PP business
Demand for PP in the West has been hugely supported by the pandemic because of increased consumption into end-use sectors such as packaging and hygiene. I see this support continuing during 2022.
But until or unless adequate vaccination rates are reached in the developing world, the region’s PE and PP demand will remain depressed. Next year could be the third disappointing year in a row for developing-world growth.
Much more important for global consumption is what’s happening in China as in 2020, China accounted for 41% of global demand. In distant second place was Asia and Pacific at 19%.
China’s demand growth in 2021 is, I believe, heading for a 3% year-on-year increase versus a 10% rise in 2020. The slowdown is the result of container and semiconductor shortages that have restricted China’s finished goods exports and the Common Prosperity pivot.
From next year until 2031, I see China’s demand growth averaging 2% per year as against our base case of 4%. This would be the result of the Common Prosperity push to make GDP growth less commodity intensive.
Meanwhile, China’s imports will continue to decline on rising local capacities and high operating rates.
This year, we expect China’s capacity to rise by 13% and by a further 10% in 2022. I see local operating rates at a 2021-2031 average of 87% versus our base case of 82%. I am predicting the higher rate on the government’s push for greater self-sufficiency and refinery restructuring that will increase feedstock availability.
I see this has having a dramatic effect on China’s imports. This year’s net import look set to fall to around 3.4m tonnes from 2020’s 6.1m tonnes. In 2022, net imports could be as low as 574,000 tonnes and in 2023, China could be in a net export position of 2m tonnes.
Such a decline in imports would have huge, huge implications for the global PP business as China is by far the world’s biggest importer. In 2020, we estimate that China accounted for 43% of total global net imports among the regions that imported more than they exported.
Flip China into the reverse position of being a big net exporter – and we are seeing early indications of what this would mean for markets with this year’s rise in its overseas PP trade – and everything changes. Everything…
Margins seem likely to return to their pre-2021 trends
It is worth adding, by the way, that another factor behind the great price divergence you can see in the pricing chart at the beginning of this post is tight supply in the West.
Supply has been tight due to US production losses caused by Winter Storm Uri and hurricanes, with supply in both the US and Europe reduced by lower availability of feedstock from refineries because of the pandemic-related collapse in demand for transportation fuels.
But these disruptions are not going to obviously last forever. US PE and PP production is expected by our US Chemical Data team to return to improve in Q4 2021. More feedstocks from refineries will become available as demand for fuels builds now that the worst of the pandemic seems to be behind the West.
I therefore expect PP pricing at some stage to equalise across the regions as oil prices decline and as supply chain tightness eases, allowing more of the Asian oversupply to depress values in other regions. This could happen by as early as Q1 2022.
Following on from my slides on LLDPE margins on Monday, look at what’s happened to Northwest Europe (NWE) versus Northeast (NEA) PP margins in 2021.
The red line shows actual NWE margins in January-November this year with the blue line indicating NEA margins. During the second week of November, NWE margins were at $1,005/tonne versus just $11/tonne in NWE, reflecting the trends I discussed above.
The average January-November 2021 NWE margin premium over NEA soared to $1,045/tonne from only $268/tonne in 2014-2019 and $427/tonne last year.
It is worth carrying out the exercise of seeing what would have happened if earlier premiums had applied in 2021.
If the average 2014-2019 premium had applied this year, NWE margins during the second week of November 2021 would have been just $279/tonne versus their actual $1,005/tonne (the grey line. Assume exactly the same pattern of premiums this year as in 2020 and NWE margins during the second of November would have been only $117/tonne (the blue line).
See the chart below for the US.
The red line is again actual US margins and the blue line actual NEA margins in 2021. The average US premium over NWE has so far this year increased to $1,161/tonne from $601/tonne in 2014-2019 and $701/tonne in 2020.
Assume again that the 2014-2019 average had applied in 2021 and US margins during the second of week of November this year would have been $613/tonne versus their actual $1,893/tonne (the grey line). Apply last year’s pattern of premiums and US margins for the second week of this month would be at $301/tonne (the blue line).
Conclusion: prepare for this downside and upside
Global PP producers must prepare for this downside – a return to these historic patterns of margins as pricing equalises across the regions. But they can take a lot of comfort from tremendously strong earnings over the last 18 months.
But I see what lies ahead as than one of the global downturns that always happens. This is more structural because of events in China. Producers need to consider this and plan for a very different global PP business.
As for PP buyers, this is obviously a tremendous opportunity.
As always, my post just scratches the surface. For more information on how our data and analysis can support your business, contact me at john.richardson@icis.com.