By John Richardson
ECONOMIC ACTIVITY is picking up as Shanghai gradually reopens and as lockdown measures are relaxed in Beijing. But despite some of the optimism flowing through polyolefins markets, this is not like turning the taps back on and, whoosh, the proverbial bathtub is quickly refilled.
As Goldman Sachs wrote in a late May report quoted by CNBC, businesses in the service sector that involved close human contact would find it challenging to achieve a full recovery any time soon. Unsynchronised lockdowns and re-openings across major cities suggested that China’s post-lockdown recovery would be less steep than in the Spring of 2020.
And remember that with the West probably already in recession as we face the biggest inflation-driven global economic challenges since the 1970s, China won’t be able to resort to exporting its way to a strong recovery, as was the case in the second half of 2020.
Even if it hadn’t been for the impact of inflation on discretionary spending, it might well have been the case that purchases in the West of Chinese TVs, computers and washing machines fell in 2022. This is because so much money was spent on durable goods at the height of the pandemic.
This leaves domestic demand as the only realistic driver of any big economic recovery during the rest of this year.
A factor behind the backwards and forwards nature of re-openings (the lack of synchronisation highlighted by Goldman Sachs) might be the clear message that China’s president, Xi Jinping, issued in early May about the importance of adhering to the zero-COVID policy. Sticking to the policy is being perceived as a test of political loyalty.
Local officials didn’t need to worry about low GDP numbers because of every region would be reporting low growth, wrote The Economist in its 19 May issue. What was a bigger priority for officials was keeping infection rates low, leading to the risk of sporadic and localised lockdown measures, said the magazine.
The fantastic news was that as of 6 June, nationwide daily new coronavirus cases had fallen to below 50.
But nobody should forget the worrying peer-reviewed study by Shanghai’s Fudan University, which was published in the Nature journal in May. The study said that a decision by Chinese authorities to lift zero-COVID measures could see more than 112m symptomatic cases of coronavirus, 5m hospitalisations and 1.55m deaths.
“We find that the level of immunity induced by the March 2022 vaccination campaign would be insufficient to prevent an Omicron wave that would result in exceeding critical care capacity with a projected intensive care unit peak demand of 15.6 times the existing capacity,” the authors wrote.
The study, however, did say that with access to vaccines and antivirals and “maintaining implementation of non-pharmaceutical interventions”, authorities could prevent the health system from being overwhelmed. It suggested these factors could be more of a focus in future policies.
But implementing changes in policies would likely take considerable time, as it might involve importing foreign vaccines that are said to be more effective than Chinese versions and raising low vaccination rates among the elderly. China’s vaccination programme has slowed down because of the lockdowns.
A mid-April article from the Financial Times reported that only 57% of people over 60 had been fully vaccinated with three jabs.
A University of Hong Kong study, published in March, found that the over-60s who had received two doses of Sinovac’s vaccine CoronaVac ([a local vaccine)] were three times more likely to die from Covid compared with those who received two doses of the BioNTech/Pfizer vaccine, said the FT article.
If the number of new daily cases remains under control, none of the above will be an immediate concern. But if cases were to start ticking up again, China may have no choice but to re-impose severe lockdowns.
Assuming new cases remain under control and lockdowns continue to ease, the pace of the recovery will depend on the type of post-lockdown stimulus.
“During a press conference last week, People’s Bank of China Deputy Governor Pan Gongsheng gave little sign of additional large-scale support for the [real estate] sector,” wrote CNBC in a 6 June article.
The sector generates some one-third of China’s GDP, one of the highest in economic history. This has left a big debt overhang and millions of empty apartments. These are challenges Beijing has resolved to meet through its Common Prosperity economic reforms.
The government might change direction if the post-lockdown recovery is sluggish. But reflation of real estate and lots more infrastructure spending may deliver limited benefits because “supply side” stimulus faces the law of diminishing returns.
But if Beijing were to launch big demand side measures, such as cash transfers to households and spending vouchers, expect a very strong post-lockdown recovery. Such measures, though, could prove politically difficult.
The value of spreads data and what it says about demand
The good news in all this complexity is that we can use ICIS historic spread data – the gaps between the costs of a tonne of naphtha feedstock and polyethylene (PE) and polypropylene (PP) prices – as a good measures of the strength of any economy.
The above chart shows the collapse of China CFR high-density PE (HDPE), linear- low low-density PE (LLDPE) and polypropylene (PP) price spreads over CFR Japan naphtha costs which occurred from March this year onwards. During that month, HDPE, LLDPE and PP spreads reached their lowest points since we began our price assessments in November 2002 and remained weak in April and May.
Low-density PE (LDPE) spreads are a different story. Although they have also fallen since March, they remain above historic lows because LDPE is in very tight supply due to LDPE/ethylene vinyl acetate (EVA) swing producers swinging to more EVA production, in response to strong EVA demand. EVA demand is strong largely because of rapid growth in the solar panel end-use market.
But the latest ICIS estimate of apparent China LDPE demand (our assessment of local production plus the China Customs department net import data) shows an 11% year-on-year decline in January-April 2022. Clearly, therefore, high-cost LDPE is causing demand destruction in what is an overall a very weak polyolefins market. LDPE has become very expensive relative to oversupplied LLDPE, which competes for many of the same end-use markets.
“Hold on,” I can hear you say, “isn’t the collapse in spreads at least partly to do with the surge in oil prices?” Yes, but we saw similar rapid increases in oil and so naphtha costs in 2007-2008, in 2010 and in 2013-2014. The chart below makes this point, where I show actual prices rather than spreads.
I have not included LDPE film grade prices in the above chart for the reasons detailed above.
As you can see from this chart, something other than more expensive naphtha is happening this year. Producers are struggling to pass-on their extra costs, more so than at any other time since November 2002.
Now look at how average annual HDPE, LLDPE and PP spreads over naphtha compare from 2003 up until May this year.
Note that excluding LDPE from these last two charts makes sense not only because of pricing trends that run counter to demand, but also because LDPE is a much smaller market. Consumption of the other three polymers is far bigger.
At some point, exporters to China and the local producers will regain pricing power. This will become apparent from a widening of spreads as economic activity returns to normal. It really is as simple as this. So, you need our data and analysis.