By John Richardson
THE PROBLEM with the petrochemicals industry’s management of demand is that is has too often, in my view, been outsourced and so given minimal attention. This worked fine during the “golden era” that’s summarised in the chart below.
Such was the favourable nature of events that the attitude seemed to be, “Don’t worry, be happy”. It was assumed the future would remain just as favourable.
While it was accepted that China’s population was, of course, ageing (China came to matter more than any other region as the above chart tells us), the growth of China’s middle class was thought to guarantee a continued boom in demand.
The phrase the “growth of China’s middle class” became almost a mantra, repeated in conference presentation after conference presentation and investor meeting after investor meeting.
But here’s a thing to consider: China’s per capita income was just $13,000 in 2022 and yet, as the chart shows, in 2022 its per capita polymer consumption overtook the developed world when the developed world had a per capita income of $48,000.
Pew data show that only 23m Chinese earned more than $50/day in 2020 (India had just 2m).
Projects were sanctioned on the basis that nothing could possibly go wrong with the China growth story. But it did go wrong following the late 2021 bursting of the property bubble. Planners should have seen them coming.
Here is the evidence that was hiding in plain sight if the planners had taken note:
- Look at how China’s per capita growth (the green line) took off from 2009 onwards as China doubled down on investment and debt-driven growth by launching the world’s biggest-ever economic stimulus package.
- China’s domestic growth since 2009 has been based on its real estate bubble, with prices peaking at 45 times disposable income. Real estate is now 29% of GDP, the highest in global economic history, while China’s debt has reached 295% of GDP.
What also appears to have been missed by some companies is the deterioration in the geopolitical relationship between the West and China.
A turning point was the October 2018 speech by the then US vice-president Mike Pence, in which he said: “The Chinese Communist Party has used an arsenal of policies inconsistent with free and fair trade, including tariffs, quotas, currency manipulation, forced technology transfer, intellectual property theft, and industrial subsidies that are handed out like candy to foreign investment.
“Beijing has directed its bureaucrats and businesses to obtain American intellectual property –- the foundation of our economic leadership -– by any means necessary.”
Joe Biden’s vast Inflation Reduction Act is partly driven by reshoring manufacturing in response to the increased geopolitical tensions with China. Through, for example, $115bn worth of tax credits for clean energy manufacturing such as electric batteries, the US is seeking to create a more self-reliant economy less in need of imports from China.
“Ursula von der Leyen [the European Commission president] told reporters that the root causes of China’s trade surplus with the EU were ‘well-known’ — a lack of market access for European companies and Beijing’s preferential treatment of domestic companies as well as overcapacity in Chinese production,” the Financial Times wrote in this 7 December article.
The newspaper was reporting on last week’s EU-China summit, during which China “dismissed growing concern in Brussels over the country’s record €400bn trade surplus with the EU in 2022”.
In 2022, China’s 1.4bn people consumed 107m tonnes of the nine synthetic resins detailed in the above chart versus 84m tonnes by the 5.3bn people in the developing world outside China and 82m tonnes from the 1.1bn population in the developed world. This is according to the ICIS Supply & Demand Database.
These extraordinary imbalances, which have been apparent for many years, could and should have given more petrochemicals companies pause for thought as they planned new investments.
Bringing demand analysis inhouse through workshops
Companies need to “reshore” their demand analysis by bringing it in-house. Only by doing so can they avoid history repeating itself.
They need to hold demand workshops to build scenarios for what happens next in China – and elsewhere as we face global challenges to consumption from ageing populations, sustainability and climate change.
On scenarios for China, you should factor in the work of Michael Pettis, a professor of finance at Peking University’s Guanghua School of Management, where he specialises in Chinese financial markets.
Pettis has consistently made the right calls on China. You should take particular note of his 4 December article for the Carnegie Endowment for International Peace, where he writes:
“If China were to maintain current growth rates [4-5% per year] while keeping its high investment and manufacturing shares of GDP, its share of global investment and manufacturing would expand much faster than its share of global GDP,” he said.
“In that case, it could only do so if the rest of the world agreed to accommodate that growth by reducing its own investment and manufacturing levels to less than half the Chinese level,” wrote Pettis.
He added that even without the geopolitical tensions and policies in the US, India, and the EU to boost domestic investment and manufacturing, this would still be highly unlikely.
But now, as we’ve seen, reshoring in the US is gathering pace as the EU seeks to reduce its trade deficit with China.
“Globally, according to the World Bank, investment represents on average 25% of each country’s GDP. But China’s investment share of GDP has never been below 40% during the past 20 years,” continued Pettis, as he added support to his argument about China’s difficulties in continuing with investment-led growth.
Under a scenario where China continued to focus on investment-led growth, the rest of the world would have to agree to reduce the investment share of its GDP by roughly 1 full percentage point to 19% of GDP, well under half of the Chinese level, Pettis added.
“This would also require China’s debt-to-GDP ratio to rise from just under 300% to at least 450–500 % in a decade,” he wrote.
“Given the huge difficulties the Chinese economy is already facing at current debt levels, and the difficulties Beijing has had in its attempts to reduce the debt burden, it is hard to imagine that the economy could tolerate such a substantial increase in debt,” continued the author.
But there is another way of China achieving long-term GDP growth of 4-5% year and this by raising consumption by 6-7% per year. In the process, investment growth could fall to 1% per annum.
“With consumption growing at roughly 4% a year before the pandemic (and much less since), is 6–7% growth in consumption possible?” asked Pettis.
“No country in history at this stage of the development model has been able to prevent consumption from dropping, let alone cause it to surge, but that doesn’t mean it’s impossible,” he said.
Consumption growth at 6-7% per year would require businesses to pay higher wages and higher taxes. China’s currency might also have to be strengthened in order to reduce China’s dependency on exports (exports being the same as manufacturing investments) as a driver of growth.
But Pettis said that China’s manufacturing competitiveness was based mainly on the very low share of income Chinese workers retained relative to their productivity. Making businesses pay more would seriously undermine China’s manufacturing competitiveness.
If government financing was reformed, however, Pettis said it was possible that local governments could foot the bill.
He warned, though, that transferring such a large share of local governments’ assets would be politically contentious and require “a transformation of a wide range of elite business, financial, and political institutions at the local and regional level”.
China’s economy had been structured for four decades on direct and indirect transfers from households to subsidise manufacturing and investment, he added.
This took the form of easy and cheap credit, weak wage growth, an undervalued currency, excess infrastructure spending, a weak social safety net, and other explicit and implicit transfers, wrote Pettis.
Transforming China’s economy to one to mainly driven by consumption instead of investment appears to be very difficult.
We must, as a result, plan for a scenario where China cannot maintain GDP growth at a long-term average of 4-5% per year.
Building different scenarios for China’s polymers demand
The green bars in the above chart measure GDP growth in percentages and the blue line multiples of polymers growth over GDP (times GDP) between 2000 and 2022.
There were a couple of outliers during this period when the multiples of polymers demand growth were unusually high.
The first of these was in 2009 with the launch of the world’s biggest-ever economic stimulus package. This was when, as mentioned earlier, China doubled down on investment and debt-driven growth.
In 2020, China enjoyed a boom in exports as it satisfied much of the increased global demand for durable goods during the pandemic’s lockdowns. This led to a record-high multiple of polymers demand growth over GDP.
Throughout the 2000-2022 period, macroeconomic data tell us that China’s economy was largely driven by investments and exports with local consumption playing a smaller role.
Multiples of polymers demand growth averaged 1.1 times GDP during 2000-2022.
Our base case forecast for China’s GDP growth sees it averaging 4% per annum in 2023—2040 compared with 8% in 2000-2022. We forecast GDP growth at between 4-5% up until 2030 before falling to less than 4% thereafter.
“In 2022, President Xi Jinping laid out a long-term vision of ‘Chinese-style modernisation’ at a key party meeting, with a goal of doubling China’s economy by 2035 that government economists say would require average annual growth of 4.7%,” wrote Reuters in this article from 22 November of this year.
ICIS sees China’s polymer demand growth multiple over GDP falling to an average 0.7 times GDP in 2023-2040.
If GDP growth were a percentage point lower than ICIS forecasts during each of the years between 2023 and 2040, and assuming the same 0.7 polymer multiple over GDP:
- Annual consumption of the nine synthetic resins would be around 10m tonnes a year lower than our base case. This would leave cumulative demand during this 17-year period some 170m tonnes lower than the ICIS base case.
Conclusion: The difficulty in counting the things that count
“Those who cannot count the things that count, count the things that don’t count,” I was told way back in 2000, when I was given a tutorial on how China’s petrochemicals business and its economy worked. This was delivered by a very senior industry executive who later went onto become the CEO of his company.
He was referring to the heavy industry focus on measuring cost-per-tonne economics while, as I mentioned earlier, it left the much harder measurement of economic growth to outside experts.
Even way back then, he believed that China’s investment-led growth model would run out of steam. This was before debt became a challenge for China.
He admitted that economic growth was something that could not be counted with any great precision, even though his company had their own team working on the problem.
So, the solution? Yes, you should have guessed it, the senior executive said it was scenarios. The only way to adequately stress-test your business is a range of scenarios, including my preferred scenario of China’s GDP growth at around 3% per annum over the long term.
This seems to make a great deal more sense to me than “Don’t worry, be happy”, although the phrase is the title of a good song.