Chinese HDPE market weakest since at least 1990 – Asian Chemical Connections

By John Richardson

NOW I WILL show my age here. 1990 was the year I got married and the year football great John Barnes finished on New Order’s World in MovementEngland football team song Italy ’90 world cup campaign.

This is how far back our evaluation of high density polyethylene (HDPE) injection price CFR (cost and freight) in China. And as the chart above shows, the price gaps or spreads between China’s CFR HDPE injection grade and Japan’s CFR naphtha costs are this year the lowest since 1990.

In January-August 2022, the gap averaged just $200/tonne, down from the previous high of $288/tonne in 2002. Last year, the gap was more than double the January- August 2022 at $405/tonne.

The significant production cuts have raised hopes among producers that HDPE prices may recover in the coming months. It also depends, of course, on what happens to oil prices.

Whether prices recover or not is largely irrelevant. What matters instead is the strength of the spreads between raw material costs and product prices (the trends are very similar in many other chemicals and polymers markets to what you can see in the chart below -above).

Of course, apparent demand usually picks up when polymer prices rise, as processors buy ahead of their immediate needs to hedge against further price increases; in other words, they constitute stocks. The reverse happens when prices fall as converters destock, reducing apparent demand.

But in a fundamentally very weak market, like today’s. there is always the risk of rapid pushback from converters when their resin costs rise.

And as the spread data tells us so clearly, we are seeing the weakest market conditions in at least 32 years, for three reasons:

  1. China is trying to build a new model of economic growth that involves deflating a real estate bubble that is the biggest in world economic history. As I will talk about in an article next week, now that the bubble is deflating, it cannot be reinflated. Much of the extraordinary boom in Chinese demand for chemicals since 2009 is the result of the housing bubble.
  2. China’s zero-COVID policies look likely to add further downward momentum to the country’s economy through the rest of this year and possibly into 2023 as well. Government seems unable to ease policies due to limited effectiveness Chinese vaccines.
  3. China is becoming much more self-sufficient in another wave of chemicals and polymers, including HDPE, as significant capacity additions take place elsewhere. The market is also struggling to absorb plants commissioned in the last 12 months.

Now let’s look at spread data on a monthly basis.

Before you get too excited about the rebound in spreads from their all-time low of $98/tonne in March 2022, that’s just the result of oil prices, and therefore naphtha costs, falling more as HDPE prices decline.

Every month since March, HDPE prices have fallen while naphtha prices have fallen. In August versus July, for example, CFR China injection HDPE prices fell to $946/ton from $1,001/ton while CFR Japan naphtha costs fell to $692/ton from $790. /tonne. This is hardly an indication of renewed power in the growers market.

Now take a look at what the latest data tells us about HDPE demand in China in 2022.

As shown in Scenario 2 in the chart below, when you add the ICIS January-July estimate of local production to the China Customs net import count, then annualize the result (divide by seven and multiply by 12), you get minus 4% growth for the whole year. This compares to the 3% decline in growth suggested by the January to June figures.

Production cuts don’t seem to work

As usual, I have provided you with two alternative scenarios – Scenario 1, an optimal outcome of minus 2% growth and a worst case scenario 3 of minus 6%.

Let’s assume, for the sake of argument, that minus 4% is the correct number for that year. It would be the second year in a row that Chinese demand would contract by 4%. Every year, from 1990 to 2020, growth has been positive.

We can explain last year’s growth slump as a response to the bubble year of 2020, when demand grew by 11%. This is the result of the “China in, China out” story – the rise of Chinese chemical imports and demand to meet booming sales of Chinese finished products, as the bored jailers of the West bought a lot of durable goods.

But how to explain what appears to be negative growth in 2022? I believe this is the first of the three market shapers I detailed above. With regard to the third factor – China’s growing self-sufficiency – consider the chart below.

Net import data from China Customs from January to July suggests that net imports for the year 2022 will fall to 5.5 million tons from 6.4 million tons in 2021. This is the basis for Scenario 2 I again provided two more scenarios. Net imports from January to June indicated a drop in net imports this year to 5.6 million tonnes.

The ICIS estimate of production in January-July indicates a full-year exploitation rate of 79%. This would set another record as it would be the lowest annual exploitation rate since 1990. The lowest rate since 1990 was 82% in 2015.

But despite this apparent producer discipline, spread data shows that the desired effect does not seem to be happening. The market still appears to be heavily oversupplied.

Coming back to the spread data, the chart below is a reminder that this year’s compressed spreads are not the result of soaring oil prices and therefore naphtha costs. Study the chart and you will see that during other periods of sharp oil price increases, HDPE producers have been much better at passing their additional costs onto converters.

What applies to spreads also applies to margins – the correct measure of producer profitability.

The graph below shows the weekly HDPE injection grade margins in China since the first week of January 2014 when our assessments began. The integrated variable cost margins based on naphtha and liquefied petroleum gas (LPG) are shown below.

Let us then put these margins in the annual context.

From January 1 to August 26, 2022, the naphtha-based margin averaged minus $192/tonne. The margin based on LPG was exactly zero. This compares to the average naphtha-based margin of $410/tonne in 2014-2021 and $465/tonne for the LPG-based margin.

Conclusion: a recovery seems very unlikely this year

As I said, prices could rebound over the next two months, but I doubt we’ll see much improvement in spreads as we face a new China. Add to that the very tough market conditions elsewhere and it’s far from a typical chemical downturn.

This kind of integrated data processing, using ICIS’ extremely valuable data, will remain so important for many years to come as older business models are retired. They need to be removed because the way forward is not the steady volume growth we’ve all become addicted to. Rather, it is by providing services to customers that sustainability is redefining our industry.