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Main page » 2009 » September » 28 » China's robust chemical market could be a bubble about to burst
China's robust chemical market could be a bubble about to burst
15:07


Separating the hard facts from the hype has never been harder in the Chinese market, which is either a huge speculative bubble, the lifeboat for the global chemical industry or anything in between

IT NEVER gets any easier trying to work out what's happening in China.

The country's economic rebound is sustainable and the global recovery is just around the corner, insist some ­industry sources.

Fears of an L-shaped recovery appeared to be receding as this feature went to press. The much hoped-for V-shaped bounceback was the more popular forecast.



There were plenty of pessimists still around, though, all too eager to rain on the parade.

As Winston Churchill so memorably said: "A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty."

This goes to the very heart of this argument - that the rebound in Chinese polymer and chemical demand might well have been mainly driven by traders who have taken their opportunities.

They, of course, don't care about prices tomorrow if they exit today.

Here is an attempt to separate the hard facts - if they really exist - from all the hype.

The Hard Facts on Polyolefins
High-density polyethylene (HDPE) imports rose by 94% in the first half of this year compared with the same period a year ago, according to China Customs.

Low density polyethylene (LDPE) and linear low density polyethylene (LLDPE) shipments from overseas were up by 62% and 50% respectively, with polypropylene (PP) imports increasing by 50%.

Total PE imports were at 3.75m tonnes in the first half, versus 4.5m tonnes for all of 2008. Some of these extraordinary increases can be attributed to deep operating cuts by Chinese refiners and petrochemical producers in the wake of the fourth quarter (Q4) of 2008 economic collapse.

This created strong arbitrage opportunities. But a lot of polyolefins, particularly PE, might have ended up in the inventories of traders and distributors.

"While PE inventory levels up until May were low in bonded warehouses and ­normal at the first level of local distribution, they were very high at the second and third levels of distribution," says one major Asian producer.

"The bonded warehouses [which store imported material] I visited in southern and eastern China in mid-August were virtually empty," says a Singapore-based polyolefin trader. "But I agree that when you got down to the smaller local traders and distributors, at the second and third levels of the supply network, stocks were very high."

One overwhelming reason seems to be that the extraordinary increase in bank lending resulted in the emergence of occasional or completely new PE traders.

"Bank loans were so cheap and easy that many commodity traders and distributors used financing for speculation," the Asian producer adds.

As a senior Singapore-based investment banker puts it: "This didn't necessarily indicate a genuine recovery - just excess cash searching for a home."

We have a lot of data for PE, some for PP but far fewer for other polymers and chemicals. But it does seem logical that the impact of the credit glut will have been widespread.

The government extended $1 trillion (€685bn) of new loans in the first half of 2009 through the state-owned banking sector. This was triple the amount lent during the same period last year.

PE apparent demand averaged around 970,000 tonnes/month in 2008, says a second Asian polyolefins producer. In the first six months of this year, it reached 1.3m tonnes/month.

Overall trading activity in PP increased by more than 250%, the producer adds.


How On Earth Could This Happen?
How could apparent demand have risen in the first half when exports of finished goods suffered such steep declines?

The obvious explanation is a huge rise in domestic demand. We'll deal with this later.

First of all, here is the export picture: Overall total exports were down by 23% in July 2009 over the same month last year, according to China's National Bureau of Statistics.

Exports of PE film and sheet fell by 10.1% in the first of six months of 2009, while PP film and sheet overseas shipments declined by 37%.

Domestic demand was a lot better than anyone had expected. Government subsidies aimed at encouraging rural residents to buy electrical appliances, computers and vehicles helped. So did a nationwide government stimulus plan for autos. Sales of locally made cars rose year-on-year by 36.5% in June.

But the existence of subsidies doesn't guarantee they will be taken advantage of, especially at a time of increased anxiety over job losses.

The government has employed thousands of students to tour the country to promote the subsidies and to find out exactly how successful they have been.

Styrenics producers are concerned that inventories of finished goods could have been built up in anticipation of sales yet to happen.

Another factor behind the rebound in demand for virgin resin has been lack of availability of scrap or recycled imports.

Availability dipped during the first few months of this year because of reduced exports of finished goods to the West wrapped in plastic that were then shipped back to China.

A lot of traders in scrap plastic also went bust in China during last year's price collapse when virgin resin became cheaper than the recycled material. This has made the few who remain reluctant to resume trading.

The real estate sector has also boomed, which has been of great benefit to a wide range of polymer and chemical players.

But like so many other end-use sectors, has easy lending been the main driver in rising property prices and a pick-up in construction activity?

"Underlying domestic demand remains weak, despite policies aimed at boosting consumer spending," said the UK-based Royal Bank of Scotland (RBS) in its August World Economic Outlook Report.

As much as 30% of all the new loans issued in the first half were used to speculate on property and another 20% on equity markets, say several reports.

"It might be PE one day, real estate the next day and the stock market the day after that," adds the Singapore polyolefins trader. "In China, if lending is easy, you speculate in whatever you can get your hands on."

Dalian Exchange Impact
Before we move on to the outlook for the rest of this year, the influence of the Dalian Commodity Exchange needs to be mentioned. As liquidity rose in the first half, so did trading volumes.

Volume traded in the LLDPE futures contract totaled just over 32m tonnes in August - an increase of 309.34% over the same month last year.

"In China, if lending is easy, you speculate in whatever you can get your hands on."
Singapore polyolefins trader 

But this was a big decline from April this year, the peak so far in 2009, when 77m tonnes was traded.

The contract has begun to serve as a reference point for domestic physical polyolefin markets in general.

There have even been some suggestions that local producers have set prices based on Dalian - a claim that state-operated energy and chemical giant Sinopec denied on its own behalf.

This is predominantly a paper game, as hardly any transactions conclude with physical delivery (hardly surprising when you look at the volumes involved - far in excess of even annual global demand for LLDPE).

It will be interesting to see whether the contract remains an important reference if there's a consistent drop in trading volumes.

Giving Credit Where It's Due
The prospects for the rest of this year largely hinge on whether the government will maintain high levels of economic stimulus and bank lending.

"An early withdrawal of fiscal and monetary stimuli could reveal a weaker than expected economy, and see growth fall below Beijing's target," adds RBS in the same report. "For now, the State Council is more likely to be concerned with the potential for social unrest than an over-accommodative monetary policy."

Fiscal tightening is unlikely to occur until the government becomes worried about inflation, says the bank.

The consumer price index actually fell by 1.8% year-on-year in July, according to China's Central Bank. But the index will start to rise again in Q4, adds RBS.

October 1 marks the 60th anniversary of the Cultural Revolution, a time when China will be anxious to show its best economic face, say some commentators.

But China Construction Bank, the country's second-biggest lender, has announced that it will cut its amount of new lending by 70% in the second half.

Loan growth in August was well below that of July, according to unconfirmed local media reports.

And the local and international media have been full of quotes from senior government officials of late, warning about asset price bubbles.

Officials have also told banks to be more prudent through only making loans to sound projects and not to speculators, say

 "An early withdrawal of fiscal and monetary stimuli could reveal a weaker than expected economy"
RBS World Economic Outlook Report, August
the same reports.

These statements and measures were said to be behind the sharp fall in the Shanghai Composite Index (stock market) in the second half of August.

If liquidity dries up, polymer and other chemical inventories might be sold off in a hurry, creating sharp downward price spirals.

A lot of new capacity is due to be added in China and the Middle East in the second half, which could, as has been well documented, hit markets just as the Chinese economy slows down.

These two blows might be delivered at the same time as a third even bigger one - global energy prices in retreat as traders stampede for the exit.

More start-up delays likely
But if history has taught us anything, it is that more delays in petrochemical start-ups are likely, especially in the Middle East.

The scale and complexity of some of these new projects seem to have made smooth start-ups more difficult.

And it could be that there is no tightening of credit in China for many months to come.

Premature tightening in late 2007 - through an increase in bank deposit rates - contributed to China's last slowdown.

It seems unlikely that the government will want to repeat the mistake at the risk of the social unrest already highlighted by RBS.

Therefore, commodity polymer and chemicals markets might not suffer a ­sudden overall collapse anytime soon. We might instead see a long period of ­much-reduced demand as high inventories are unwound.

Shipments from the West began to decline from July as reports of weaker Chinese demand emerged. But even if this turns out be an overall war of gradual attrition, individual battles might continue to be lost.

Benzene is a recent example. China's inventories were said to be at 43,500 tonnes in July - considered by local producers to be extremely high.

"The rise in benzene was out of proportion to that of styrene, one of its main derivatives," said Paul Hodges, chairman of UK-based consultancy International eChem in August.

"Go short on benzene now, unless you think styrene is about to tighten," added John Keeley, CEO of International eChem, who used to run Shell's European aromatics business. Prices in Asia and Europe subsequently fell by more than $100/tonne. Somebody got their fingers very badly burnt, but nothing new in that, of course.

Nevertheless, getting it wrong seems easier than at any other time during the 12 years this correspondent has been reporting on the chemical industry. All you can do is to keep on trying to separate the hard facts from all the hype.

Read John Richardson's Asian Chemical Connections blog


By: John Richardson
+65 6780 4359


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