By John Richardson
LET ME firstly issue a “brain fade” warning. The first few paragraphs of this post are rather complex and difficult to follow (I had to rewrite them many times to make sure the paragraphs were, hopefully, clear). But I feel this is very important, so please bear with me. Here goes…
Beware of year-on-year comparisons during the rest of 2023
CHEMICALS MAJORS returned a grim set of first quarter (Q1) 2023 financial results on a year-on-year basis, wrote my colleague Will Beacham in this excellent ICIS Insight article, where he reviewed the results of BASF, Dow and the Siam Cement Group.
A major factor in the weak returns was the slowdown in China, On the BASF results for example, Will wrote: “China stands out as the worst performer, with sales down 28.5% compared with 13.8% in Europe.”
A further ICIS news article on the ExxonMobil Q1 financial results contained this quite startling table.
A danger the chemicals industry faces when the financial results for the remaining quarters of 2023 are released is that the consensus view might be that everything has returned to normal.
The results of the global chemicals majors could improve in Q2-Q4 2023 on a year-on-year basis due to a rebound in China sales. This would be the result of the Chinese economy gaining short-term momentum because of the end of the zero-COVID restrictions.
Note that it was at the end of Q1 last year that zero-COVID began with lockdowns in Shanghai. The measures then spread to elsewhere in China. So, it was from Q2 onwards that the first evidence of a big economic decline emerged.
Also consider that despite the scrapping of the policies in late November last year, there was no significant pick up in Chinese economic activity during the first quarter of 2023 compared with Q1 2022 And, crucially, Q1 last year was before zero-COVID was introduced.
The consensus was that once this year’s Lunar New Year holidays ended on 27 January, economic activity would sharply recover as the full benefits of the end of zero-COVID were felt.
But, as I warned could be the case, one reason this apparently didn’t happen were concerns over further sudden changes in government policy following the seemingly abrupt decision to end zero-COVID. Some people were said to be worried that zero-COVID might return.
Now, though, there appears to be greater clarity of policy direction, including an uptick in economic stimulus and no signs that zero-COVID will come back.
Further, because there have been reports of substantial stock building before the end of the Lunar New Year holidays in anticipation of a demand recovery that didn’t happen, chemicals demand during the remainder of Q1 2023 seems to have been damaged by producers and buyers working off excessive inventories.
And the “structures of zero-COVID” had to be dismantled, said Leland Miller of the China Beige Boom in this CNBC interview from two weeks ago. This took several months, he added.
Because of a long-term structural slowdown, he said that any China recovery would be short-lived. Hear, hear.
Seeing beyond the “head fake”
So, let’s avoid what Miller said in the same interview was the likely “head fake” of a few strong quarters of Chinese economic growth. We need to start this process by re-considering the chart below.
The chart shows the global capacity of the six big petrochemicals building blocks and all the derivatives made from these building blocks that have and will exceed demand. In other words, I have subtracted demand from the capacities to generate the coloured bars and the trend line, which shows the total excess capacity.
This trend line is worth careful study for the following reasons:
- Between 1990 and 2013, global capacity exceeding demand averaged 59m tonnes a year.
- But from 2014 onwards, when China’s government decided to push much harder towards chemicals and petrochemicals self-sufficiency, overcapacity began to build. This year, ICIS forecasts that it will reach 218m tonnes.
These next two charts, again from the excellent ICIS Supply & Demand Database, show the extent to which global capacity additions have become concentrated in China.
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The charts involve a selected range of products, indicating the extent to which China’s percentage shares of global capacity are forecast to increase in 2024 compared with 2022.
A problem has been the standard cost-per-tonne analysis used in isolation. The consensus view was that China wouldn’t follow through on many of its announced projects because of what were viewed as poor plant economics.
But projects in China have never been built, and never will be built in several countries, just for standard economic returns. The above charts include higher-value products, investments in which will hopefully help China escape its middle-income trap.
Back to the earlier chart and the estimated 218m tonnes of global capacity exceeding demand in the six big building blocks and their derivatives.
One reason for this, as just described above, is that not enough people used the right assessments in measuring the feasibility of Chinese projects.
Then there is demand. China’s long-term structural slowdown began in 2021 as the property bubble began to deflate and as the government changed policy direction. And as each year progresses, China’s demographic problems worsen.
So, Chinese consumption growth across most chemicals was in the low single digits or even negative in 2021 and 2022, rather than being in the widely forecast high single digits. This disappointing demand growth has contributed to the oversupply.
A few strong quarters of Chinese economic growth will probably barely make a dent in global chemicals oversupply, nor change China’s long-term economic direction.
As I’ve discussed before – and is underlined by the chart below – China’s ageing population and the end of its property bubble mean much lower chemicals consumption growth over the next few decades. Here, I use the example of the seven major synthetic resins.
These are the ICIS base case forecasts. But I believe there is a possibility that chemicals and polymers demand growth could even turn negative as China “dematerialises”.
Conclusion: Moving beyond conventional measures of growth
Because of an ageing population in China and Europe, and because of the impact that climate change is going to increasingly have on economic growth the chemicals industry must, in my view, undergo a long-term transition.
Will investors have the patience to stick with chemicals companies now that constant quarter-on-quarter improvements in financial results will be harder to achieve?
I prefer to put this another way. Investors must be persuaded by the chemicals industry to show patience, as the only path to future revenue growth is, I believe, through decarbonisation, recycling and “less is more”.