By John Richardson
CHINA’S STOCK MARKETS have rallied over the last two weeks, with local polyolefins prices also edging higher, on the launch of a 16-point real-estate rescue package and relaxation of some zero-COVID restrictions.
But last week I warned that the rescue package would only allow homes that had already been sold to be built, thereby defusing the risk of social unrest. I didn’t see any prospect of a big rebound in buyers’ confidence in real estate.
“This really is a temporary relief in terms of the developers having to meet less debt repayment needs in the near future — a temporary liquidity relief rather than a fundamental turnaround,” said Hong Kong-based analyst Samuel Hui, director, Asia-Pacific corporates, Fitch Ratings, in this 20 November CNBC article.
Goldman Sachs, in the same CNBC article, said that despite more local housing easing measures during the las few months, “we believe the property markets in lower-tier cities still face strong headwinds from weaker growth fundamentals than large cities, including net population outflows and potential oversupply problems.”
The real estate market across all the towns and cities will likely never see a return to the bubble conditions of 2009-2021, in my view. This is because the “government put option” – the idea that Beijing would never allow land and real estate prices to decline – no longer exists.
This is what the government wants as it tries to build a new and more sustainable growth model where capital is no longer mis-allocated to property speculation. Beijing wants lending to be more heavily focused on the manufacturing innovation required if China is going to escape its middle-income trap.
It has been clear since 2009 that the real estate bubble would at some point have to pop because of its role in driving up Chinese debts.
“In September 2021, [the country’s total] non-financial liabilities stood at 264.8% of GDP (Caixin, November 3, 2021),” wrote the Jamestown Foundation in a 21 November article for OilPrice.com. This puts China’s ratio of debt to GDP higher than the US but lower than Japan, wrote Reuters in a 13 October 2021 article.
The wire service added that when government debt was stripped out, China’s debt position became more alarming because of the rise in corporate and household lending.
This brings us back to the Jamestown Foundation article for OiPrice.com. Quoting Nikkei Asia, the article said that real estate accounted for 26% of China’s total outstanding loans. The negative effect of a continued decline in the property market on China’s GDP growth would be big, continued the article.
“It is estimated that a 20% decrease in real estate investment could cause the country’s GDP to contract anywhere from 5-10%,” the authors continued.
We know from the ICIS data that the surge in Chinese chemicals and polymers demand growth from 2009 onwards was the result of the credit bubble. This has left the global chemicals industry much more dependent on Chinese growth compared with before 2009.
Zero-COVID: Be careful what you wish for
China’s zero-COVID policies will be further relaxed in 2023, allowing the economy to re-open, according to a theory very common out there. But a very worrying 18 November article in the Financial Times suggests that people should be careful what they wish for.
The newspaper warned that because resources have been focused on prevention rather than treatment, a major rollback of the zero-COVID regulations would lead to a lot of new cases.
“The big threat in an exit wave is just the sheer number of cases in a short space of time,” Ben Cowling, a professor of epidemiology at the University of Hong Kong, told the FT.
“I would be reluctant to say there is a scenario in which an exit wave doesn’t cause problems for the healthcare system. That is difficult to imagine,” he added.
The same FT article said that only 40% of the over-80s in China have had three shots of local vaccines, the dosage required to gain high levels of protection.
A 19 April 2022 Economist article, citing a study by the University of Hong Kong, said that the local Sinovac vaccine provided only 44-94% protection across all age groups, whereas BioNTech was 75-96% effective. But at three doses, both vaccines were estimated to offer over 90% protection against severe disease and death across all age groups, the Economist added.
Most of the lockdown measures therefore seem likely to be in place well into 2023, as it will take a good while longer before China is able to bring zero-COVID to an end.
And, anyway, last week’s relaxation of some of the zero-COVID restrictions has been overshadowed by new outbreaks.
“Beijing says it is facing its most severe COVID-19 test yet after it saw the country’s first coronavirus deaths in six months and cases continue to soar,” wrote the BBC in a 22 November article.
“Three deaths have been reported in the Chinese capital since Saturday, bringing the country’s official death toll to 5,229,” the BBC added.
Guangzhou, one of China’s largest cities with nearly 19m residents, has imposed a five-day lockdown in the Baiyun district, said CNN in a 21 November article. Guangzhou, a key logistics and manufacturing hub, is experiencing its highest number of new cases in three years.
China’s PP market weakness will continue in 2023
China’s polypropylene (PP) prices increased across all the grades during the week ending 18 November compared with 11 November. As I said earlier, this was the result of the optimism created by the real-estate rescue package and the relaxation of some zero-COVID restrictions.
CFR China PP injection grade prices, for example, rose by $25/tonne. But as the chart below confirms, this has made not a jot of difference to record-low PP injection grade price spreads over CFR Japan naphtha costs.
The headline of this chart is important. Please bear in mind that when prices go up, this isn’t always good news for producers. A rise in prices less than the rise in feedstock costs is bad news; a fall in prices isn’t bad news if the drop in prices is lower than the decline in feedstock costs.
But when prices go up or down, market participants, depending on where they stand, will sometimes make claims about what price movements by themselves say about market fundamentals.
Last week, for instance, a trader I spoke to, responding to rising China PP and polyethylene (PE) prices, said: “I think the market has finally found its bottom. The worst is over.”
Good luck with that idea, as the above chart clearly tells us. Despite the rebound in prices, the average spread between CFR PP injection grade prices and CFR Japan naphtha costs was just $176/tonne between 1 and 18 November 2022. This beat the previous record monthly low of $201/tonne in March this year.
Now let’s look at actual PP injection grade versus naphtha prices.
The above chart is a reminder that during previous big run-ups in oil prices and therefore naphtha costs, such as the one which took place between January 2009 and October 2011, China’s PP producers and exporters of PP to China were much better able to pass on higher costs to converters.
We can see this from the gap between the red and blue lines. Just look at how the gap has been squeezed since March 2022. This was when the introduction of the zero-COVID measures combined with the Common Prosperity economic reforms to weaken PP demand, as feedstock costs rose on the Russian invasion of Ukraine.
Now let’s look at China’s PP injection grade spreads on an annual average basis since 2003.
The spread between 1 January and 18 November 2022 was just $251/tonne, the lowest by a long distance since 2003. The previous lowest annual spread was $415/tonne in 2003 .
Spreads are of course not the same as PP margins as they don’t include co-product credits generated from cracker-linked PP production and energy and logistics costs. But spread analysis has stood the test of time in reflecting industry upturns and downturns.
The $251/tonne spread so far this year reflects the worst PP industry downturn not just since 2003 when our price assessments started , but probably since at least the oil shocks of the 1970s.
But, as I’ve discussed before, this crisis is uniquely bad in its depth and complexity. China faces not only its own internal problems, but also a decline in manufacturing exports because of the inevitable decline in demand now that the peak of the pandemic is over – and also because of record-high global inflation. Exports are worth around 20% of Chinese GDP.
Will spreads get any better during the remainder of this year and during 2023? Near-term support might be provided by the some 1m tonnes/year of Chinese PP capacity that is said to be shut down for market and maintenance reasons.
But for the reasons I’ve detailed above, I believe the fundamentals of demand are unlikely to recover until 2024 at the earliest. The chart below, from my earlier outlook for China’s PP market in 2023, includes the full context of the details of the Common Prosperity reforms.
What’s also important to note is that China’s PP capacity is expected to increase by a further 16% in 2023 to around 44.4m tonnes/year.
Conclusion: Keep watching the spreads
I could be wrong, of course, as has been known. All you need to do to check whether I am right is to keep an eye on the China PP and PE spreads to detect whether a recovery to historic norms is taking place.
The story is the same so far this year across all the grades of PP and PE. China spreads have never been this low since we started our price assessments. Some of the assessments, such as high-density PE (HDPE) injection grade, go all the way back to 1990.
Let me finish with some important context here about just how much PP injection grade spreads need to recover to get back to normal. In 2003-2021, spreads averaged $546/tonne versus $251/tonne so far this year – a 118% difference.
When you consider China’s economic fundamentals, which I describe above, how realistic is it that spreads will recover by 118% in 2023? I believe the prospect of this happening is extremely remote.