China’s Options for Economic Recovery in 2022 Narrow as HDPE Demand Outlook Deteriorates – Asian Chemical Connections

By John Richardson

BACK IN 2014, I first highlighted the risks of Chinese local governments selling land to raise funds for their public spending. It is estimated that about 85% of Chinese central and local government spending is done by local governments.

This approach worked very well as land prices continued to rise. But since China launched its Common Prosperity pivot last August, land and property sales have weakened.

Zero-COVID lockdowns have taken more air out of the housing bubble as travel restrictions have added to the downward momentum in sales.

“In April and May [2022]new home prices fell in more than half of China’s 70 largest cities for the first time since 2016, and sales of these properties fell nearly 60%,” the report wrote. New York Times in a June 20 article.

Efforts to stimulate the economy through more infrastructure spending have been stalled by a shortfall in local government finances caused by the deflated real estate sector, the report said. South China Morning Post.

An inspection by China’s audit bureau found that 10 regions used the 13.7 billion yuan (CNY) ($3 billion) they raised through the sale of special purpose bonds, which were supposed to be spent primarily on infrastructure, to pay salaries and cover operating costs, the newspaper said on June 22. The audit inspection revealed that 28 provinces misappropriated 1.4 billion yuan, including to repay debt.

The audit inspection reportedly found that 28 provinces used 1.4 billion yuan from the bonds for other infrastructure projects, including debt repayment. Special purpose bonds are bonds that the central government authorizes local authorities to issue, in particular to spend money on infrastructure.

Unless the real estate market is revived, we could therefore see a limited increase in infrastructure spending during the rest of 2022.

Given the stop-start nature of easing zero-COVID policies and the negative impact this is having on retail sales in China, increased infrastructure spending may be the only way to kick-start the economy. economy.

But even if infrastructure spending can be revived, it might not produce the kind of economic rebound we’ve seen in the past, according to François Godement, senior adviser for Asia at Institut Montaigne.

“Investment, especially in infrastructure, drives the economy. Even with this remaining engine, there is a big reserve: so many roads, railway lines, ports, airports, cities, power stations and model cities have been built that they barely leave room for more,” Godement wrote in a June 2022 research paper.

All of the above helped explain why prices for iron ore, so vital to Australia’s economy, had fallen 20% in the previous three weeks, writes Karen Maley in a June 28 Australian Financial Review article.

The above might also help us understand what is happening in another basic commodity market – high density polyethylene (HDPE).

The best outcome now may be steady growth in HDPE demand

My previous best for HDPE demand growth in China in 2022 was 6%. My worst case scenario was a 3% drop. Now, however, I fear that the best outcome for HDPE demand in 2022 will be flat or no growth. My worst case result is a 4% decline (see slide below).

But despite the stop-start nature of the easing of the lockdown, restrictions have mostly been less severe since early June.

So let’s look at what the June spread data tells us. This is the difference or spread between prices per ton of HDPE and costs per ton of naphtha feed.

As I explained in my LinkedIn post on June 27, the latest spread data for average CFR (cost and freight) prices of PE and polypropylene (PP) in China versus CFR naphtha costs in Japan do not suggest much recovery.

Focusing only on the prices of injection grade HDPE (this is the same trend in other grades of HDPE) versus naphtha, the chart below shows the market moving in the right direction in June .

In March 2022, China’s HDPE spread fell to just $98/ton – by far the lowest since our price assessments began in January 2000. The previous monthly low was $206/ton in December 2019 – i.e. 110% more.

I expected spreads to bounce off such an extraordinary low, which happened in April and May.

I was less convinced that the trend would continue in June. But, as you can see on the chart, the gap in June narrowed to $219/tonne from $155/tonne in April. And the June gap was above the record low of $206/tonne recorded in December 2019.

But consider the following:

  • The average monthly deviation from November 2002 to December 2020 was $502/tonne (in 2021 the average monthly deviation was $405/tonne).
  • Until the average monthly spread gets much closer to $502/tonne, HDPE producers will remain in a historically weak position.

As always, the economic views in the first section of this article represent only one perspective. And time and time again, China has proven skeptics wrong by managing to recover from brief economic downturns.

But the data on long-term deviations for chemicals and polymers in general are free from opinions – they are, of course, just numbers. Spread data is about as close as you can get to an objective view of what is really happening, on the ground, in any economy.

Let’s also put China’s HDPE spreads in the long-term context of oil prices. The graph below shows that during previous spikes in crude prices and therefore naphtha costs, HDPE producers have been better able to pass on cost increases to converters.

Chinese HDPE imports in 2022 could be 1.6 million tons lower than last year

In 2021, China accounted for over 30% of global HDPE demand, up from around 12% in 2000.

Interestingly, however, China’s share of global net HDPE imports declined slightly between 2000 and 2021. It was among the countries and regions that imported more than they exported.

In 2000, China’s net imports were 59% of the world total compared to 55% in 2021, according to the ICIS supply and demand database. This makes today’s final chart very important.

The chart shows three different scenarios for China’s net HDPE imports in 2022 compared to what happened last year.

The 1-year scenario assumes stable demand growth and an average local operating rate of 79%. The exploitation rate reflects what we estimate to be local production in January-May 2022.

In this scenario, net imports in 2022 would total 6.1 million tonnes compared to 6.4 million tonnes in 2021.

Scenario 2 maintains the exploitation rate of 79% but demand growth drops to minus 2%. This is based on data from January to May. Net imports would fall to 5.6 million tonnes.

Scenario 3 implies an operating rate of 84% and minus 4% demand growth. This would lead to imports of only 4.8 million tonnes. The operating rate of 84% is what we assume in the ICIS Supply & Demand database.

Standard Western economics is to reduce exploitation rates in a low demand environment, but this has often not been the case in China.

China could again choose to operate its factories at full capacity to increase its export earnings. A weaker yuan against the dollar could support this decision. Since the beginning of the year, the yuan has weakened against the dollar.

Conclusion: a single set of views

As always, this article only represents a set of views – obviously mine – and my interpretations of the data. And to emphasize again, my script work is for demonstration purposes only.

For suitable script work contact me and I can put you in touch with our excellent team of analysts, including our team in China

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