Everyone wants to assume that markets will soon be back to “normal”. Consensus thinking now accepts that China will be a bit slower than before – but it argues that 6.5% GDP growth is still pretty good, even if it isn’t double digit. And it suggests that persistence, and “staying the course” is vital for success.
But what happens if the future isn’t simply a slower version of previous growth? What happens if it really was a one-off BabyBoomer-led economic SuperCycle? And even worse, if central bank stimulus simply created short-term demand – and left us with major debt problems for the future?
That is what the data seems to be trying to tell us, when we look at leading indicators such as the polyester market, and now propylene, as the chart above highlights:
- It shows the ratio of propylene prices to ethylene since 1978, when price histories begin
- And it provides the answer to the question I raised in 2012, when new propylene capacity was first discussed
- Very clearly, propylene is going back to selling at a major discount to ethylene
- It has already moved from near-parity to 69% of ethylene values so far this year, and will no doubt fall further
The key to the change is the new capacity now coming online. As we note in Demand – the New Direction for Profit, major increases have been taking place in China’s capacity. China is already using more propylene than ethylene, and its output has been increasing from refineries, olefin crackers, on-purpose plants and from coal. In the main derivative polypropylene, for example, volume has already surged 34% on a year-to-date basis between February 2014 and February 2016, and there is a lot more capacity to come.
Abundant supplies of propylene and its main derivatives also have a second-order impact, as they encourage product substitution with other value chains. As ICIS pricing reported in November:
“China’s PE spot import prices dropped in the week, especially for HDPE injection grade. Local traders lamented that some garbage and tray factories replaced HDPE injection resins with PP copolymer resins due to lower feedstock costs. Hence, the HDPE injection grade prices dropped by about $50/tonne from the previous week.”
Of course, not every application can be substituted. But it can impact 10% – 25% of polyethylene, PVC, PET, polystyrene, ABS and even polycarbonate. So the potential for major pricing upsets is large. And there is no reason to believe that China will act as a “responsible” Western producer, cutting back output to balance demand:
- Its aim is to maintain employment and act as a reliable supplier of critical raw materials to downstream factories
- The Communist Party stays in power by continuing to improve people’s living standards
- Shutting down plants, particularly the new plants built under the stimulus programme, is not on its agenda
What happens next? Worryingly, there seems only one likely outcome – a battle for market share, in which prices for all the affected products eventually end up being set on a roll-through basis to their ultimate feedstock. Cheap propane, oil and coal support lower prices for the propylene chain, whilst cheap natural gas and ethane support lower prices for the ethylene chain.
Developments in the paraxylene chain have already provided a clear warning of what is to come, as I discussed last week. Developments in the propylene chain suggest it is only a matter of time before similar pricing pressures hit the other major value chains.
Companies therefore need to find alternative outlets very quickly indeed, as we discuss in the Demand Study. Doing nothing, and hoping for the best, could prove a very risky strategy indeed.