THOSE WHO don’t understand the role that real estate has played in China’s economic growth – and therefore also its petrochemicals and polymers demand growth – are destined to continue to get the country wrong.
Let’s start with the historical context. This involves a repeat of my earlier slide showing China’s per capita consumption growth for the nine major synthetic resins since 1992 versus the rest of the developing world and the developed world.
By 2009 when the world’s biggest-ever economic stimulus package began, China’s population was already ageing. The stimulus cushioned the impact of China’s chronically bad demographics at the cost of an unsustainable increase in debts.
As the chart below from this study by Kenneth Rogoff and Yuanchen Yang in August 2020 tells us, no other country in recent economic history has become as dependent on real estate for its economic growth as China. This has happened because of the stimulus package.
As everyone should know by now, China’s real estate bubble finally popped in late 2021. Although I was unable to tell you exactly when this would happen, I’d been warning since 2011 that the bubble would burst.
But as The Economist wrote in this 12 October article, Beijing cannot afford to allow property prices to fall to what would more accurately reflect affordability for the vast majority of China’s population.
“If property values were to drop by 30%, about 12% of China’s total loan book, or 4.7trn yuan, would suffer from negative equity, according to an analysis by ANZ, a bank. A 50% price collapse would put half of the national mortgage book underwater, leading to a full-blown crisis,” said the magazine.
As a result, the government intervenes to stop fire sales of real estate by the country’s heavily indebted property developers.
We thus have the next chart from Numbeo, the crowd-sourced global data base on quality-of-life data such as housing indicators, perceived crime rates, healthcare and transport quality.
Four of the world’s top 10 most expensive cities as of mid-2023 were in mainland China. If you include Hong Kong, five of the top 10 costliest places in the world to live when measured by house price to incomes ratios were in Greater China.
“China’s leaders face a predicament. Price drops are bad for anyone who has already purchased a home. But the unaffordability of Chinese cities is a separate crisis for the have-nots,” added The Economist in the same article.
During my travels over the past few weeks, I met the CEO of a Chinese petrochemical catalyst manufacturing company on the sidelines of this year’s EPCA conference in Vienna.
“The young middle classes often can’t afford to get married because houses are too expensive. Along with our very bad demographics, this is depressing the birth rate,” he said.
“Young people are ‘lying low’ – living at home with their parents, minimising their spending because of very low disposable incomes. To be honest, I am not sure how we can get past this problem,” he added.
Weaker-than-expected growth in travel and spending during China’s Golden Week holiday, which this year ran from 29 September until 6 October, could be one indication of lying low.
“China has concluded its Golden Week holiday on a muted note, with key travel and spending data showing weaker-than-expected recovery in consumption amid a wider economic slump,” wrote CNN in this 10 October article.
Before the holiday, China’s Ministry of Culture and Tourism had expected domestic travel to reach 896m trips and tourism spending to total Chinese yuan (CNY) 82.5bn ($107bn). But trips totalled 822m with spending at $103bn, said CNN.
Returning to The Economist article, the magazine quoted the economic research firm, CRIC, which estimated that Golden Week year-on-year property sales fell by 79% and 57% year on year in Shanghai and Shenzhen respectively.
“At least seven other large cities experienced decreases of more than 30% during the week,” the magazine added.
China’s PE spreads continue to reflect the real story
There was a lot of misleading chatter during September of a recovery in China’s polyethylene (PE) and other petrochemicals and polymer markets, based on a moderate uptick in pricing that was said to reflect recent economic stimulus measures, such as the relaxation of restrictions on real estate sales.
But as the data I have just quoted tells us, the property market continues to decline.
What matters more than short-term price movements are the spreads, or differentials, between petrochemical prices and raw-material costs. Over time, these remain the best measure of supply and demand balances.
The chart below shows the weekly spreads between CFR (cost & freight) China PE prices and naphtha feedstock costs from 6 January until 13 October this year.
Spreads have fallen rather than increased since the government’s new stimulus measures were introduced in August. From 6 January until 23 June, spreads averaged $312/tonne, but from 7 July until 13 October they fell to $280/tonne.
Further, as the chart below tells us, the average spread for the whole of 2023 remains the lowest since our China price assessments began in 1993.
Consider the table below the chart, which shows average long-term spreads from 1993 to 2021 compared with spreads since the downturn began in January 2022.
High density PE (HDPE) spreads would need to rise by 109% to get back to their long-term average. Low-density PE (LDPE) and linear-low density (LLDPE spreads) would need to be a respective 45% and 81% higher. Average PE spreads would need to be 72% higher.
Until these percentage increases happen, there will have been no full recovery.
The next chart, from the ICIS Cost Curve service, shows that every high-density PE (HDPE) producer in northeast Asia appeared to be losing money during the week from 30 September to 6 October 2023.
Hover over each point of the HDPE Cost Curve on the ICIS dashboard and you can see the variable and fixed costs of each producer in the region, with the dotted line representing the week’s price of $905/tonne CFR NEA. The cost position of every producer was estimated to be above this line.
The latest China PE demand story shows that growth continues to disappoint.
The ICIS base forecast is for an average 4% increase in 2023 demand over last year. This would leave consumption at 39.9m tonnes versus 38.5m tonnes in 2022.
But if you take the China Customs department net import numbers for January-August this year, add our estimates of local production, and divide by eight and multiply by 12 (in other words, annualise), this year’s demand appears to be heading towards 38.4m tonnes.
In every month so far this year, the pattern has been the same of overall consumption falling short of earlier expectations.
The January-August numbers suggest just about flat demand growth over 2022 and consumption 1.7m tonnes lower than our base-case forecast.
China’s PE net imports also appear to be falling short of our base-case forecasts, again based on the annualised January-August data.
Conclusion: What went up always had to come down
The demographics told us for many years ago that China’s property bubble was unsustainable. You cannot keep building homes, purely for speculation purposes, when birth rates and the population are declining.
The further problem in China was and is affordability. House prices have been allowed to inflate by so much that now, as mentioned earlier, the government cannot afford to let them collapse.
This leaves many young people priced out of buying their own homes in the big cities, leading to a potentially long-term drag on consumer spending. This is combined, of course, with what will be ever-fewer young people as the population ages.
PE and other petrochemicals producers could and should have seen this coming. They instead preferred to believe that the extraordinary demand growth we saw in China after 2009 was because China was becoming middle class by Western standards.
But this assumption was never backed up by the data.