By John Richardson
CHINA will hold one of its Third Plenum government meetings on July 15-18, according to Reuters in this 30 June article. Mark these dates in your diary as any announcements of further economic stimulus during the Plenum are likely to move petrochemicals markets in a positive direction, even if fundamentally not a lot changes.
Day-to-day markets in China are these days shaped by headline changes in government policy (always so, so important in China) and the value of petrochemical futures contracts on the Dalian Commodity Exchange.
Fundamentally, though, I don’t see a lot changing immediately following the Plenum given the scale of China’s economic challenges and current political priorities.
“Expectations of what may emerge are mixed; the latest plenum is over six months delayed and follows a period of political change that culminated in the abrupt removal of three ministers,” wrote Reuters.
The wire service added that the meeting was taking place three years into a property slump (I flagged-up the start of the slump in September 2021 when everything changed – the Evergrande moment). Reuters added that there had been a $2 trillion sell-off in Chinese equities in 2022-2023, the result of Beijing’s regulatory clampdowns and its worsening geopolitical relationship with Washington.
A plethora of other recent media commentary underlines the arguments I’ve been making over the past year: That if China is going to unlock stronger growth in domestic consumption, it needs a root-and-branch reform of its pension and healthcare systems and its Hukou residency system. This would have to be paid for by a new tax framework.
Yuhan Zhan, a Political Economist based at UC Berkeley, warned in this 30 June East Asia Forum article that the mid-May efforts to rescue the property sector merely scratched the surface. A lot more money would have to be spent, he said. I believe that an adequate bailout o real estate would raise issues of moral hazard and affordability.
Zhang added that a sustainable economic turnaround could only be achieved through “introducing and expanding local taxes — such as a high-end property tax, a resource tax and a carbon tax.” This would provide stable revenue and reduce reliance on land-transfer income, he said.
“Not only will these tax measures increase local fiscal revenue, but they will also guide local economies towards technological innovation and low-carbon development,” wrote Zhang.
Sourabh Gupta – Senior Fellow at the Institute for China-America Studies in Washington, DC – provided a list of major reforms in this 28 June East Asia Forum article that would be ideally announced during the Plenum:
- Progressively lifting Hukou restrictions — the points system designed to shape migration in China — to make public services more equitable.
- Building a unified and portable social security net more in line with advanced economies.
- A shift from indirect to direct taxes. Individual income tax revenues comprise 33% of total revenues in OECD countries compared to 9% in China.
- The tax base must expand as four out of five Chinese households do not pay personal income tax.
He cautioned that reform would not be easy in a country that preferred top-down capital-intensive approaches and was disdainful of “welfarism” — high welfare spending that disincentivised working.
China appears to have doubled-down on its capital-intensive approach since the end of the property bubble through investing in higher-value export-focused manufacturing.
This brings us back to the geopolitical threats to its GDP growth, illustrated by the US and the EU recently raising tariffs on imports of Chinese electric vehicles and batteries.
“If China is to maintain growth rates of 4-5% per year [though exports], it can only do so if the rest of the world agrees to reduce its own investment and manufacturing levels to less than half the Chinese level” wrote Michael Pettis, Professor of Finance at Peking University, in a December 2023 article for the Carnegie Endowment for International Peace.
The Economist reported in its 9 May 2024 issue that as reshoring accelerated, governments around the world had adopted over 1,500 policies to promote specific industries in both 2021 and 2022. This compared with almost none in the early 2010s.
Watch the China polyolefin-naphtha spreads over the next six-to-12 months
Spreads remain a good guide to demand and supply fundamentals in any petrochemicals market.
The latest China CFR polyethylene (PE) price spreads over CFR Japan naphtha costs for 2024 show a sharp improvement compared with up until mid-June. This reflects a decline in oil and therefore naphtha prices. Petrochemical prices tend be quite sticky when feedstock costs suddenly decline even in weak markets, as is the case today.
But the spreads year-to-date in 2024 are the second worst since we began our price assessments in 1993. The table below the above chart is also crucial context as it shows in percentage terms how much spreads would have to recover before they return to their levels during the Petrochemicals Supercycle, which began in 1992 and ended with the Evergrande Moment in September 2021.
January 2022-June 2024 represents the new economic era. During this period, HDPE spreads remain 116% lower than during the Supercycle with LDPE spreads 46% lower and LLDPE spreads 80% lower. This means an average spread recovery of 74% is required to get back to normal.
My personal view is that China’s 2024 PE demand growth is likely to be in the low single digits over last year, if not flat, barring Third Plenum reforms that significantly move the economic needle.
The latest China CFR polypropylene (PP) price spreads over CFR Japan naphtha costs for 2024 again show an improvement since mid-June on lower naphtha feedstock costs.
But as with PE, the table below the chart shows the percentage spread improvements necessary to get back to Supercycle levels. And as with PE again, I believe China’s PP demand growth in 2024 will be in the low single digits or flat over 2022.
I could be wrong, of course. This latest Third Plenum could be as defining, as significant, as the ones cited by Reuters in 1978 and 1993. The 1978 Plenum opened China up to foreign investment. In 1993, the Plenum liberalised trading in the Yuan and launched “socialist market” reforms following Deng Xiaoping’s Southern Tour a year earlier.
How will we know if I am wrong? If China’s PE and PP price spreads return to their Supercycle levels over the six-to-12-months. If this doesn’t happen, more reforms will be needed as too much supply will continue to chase too little demand. It really is as simple as this.