The “China Chill” slows global economy and petrochemicals

ACC Oct15aThere were record numbers at last week’s European Petrochemical Association annual meeting in Berlin.  But most of the 2900 attendees were in subdued mood.  Once again, it seems, the industry has chosen to sanction vast new investment at the top of the cycle, and will now suffer the consequences as it all comes online at the trough.

The chart above of global capacity utilisation (CU%) from the American Chemistry Council, highlights the temporary nature of the post-2008 recovery, when stimulus policies went into overdrive.  It also highlights today’s problem:

  • August CU% slipped again to just 81.7%, a all-time record low for August
  • The only time it has been close to this level before, was the 81.9% of August 2009
  • Then, the industry seemed to be in recovery mode, but now it is clearly in decline
  • The CU% average since 2009 is just 83.4%, nearly 10 percentage points below the 1987 – 2008 average

ACC Oct15

The slowdown is also taking place across all major regions with the exception of Central/East Europe, where Russian production has been boosted by the collapse in the value of the rouble.   This explains the serious faces in Berlin:

  • Asian and Middle East/African regions have seen growth rates halve over the past year from 8% to below 4%
  • US and W European rates have slipped to around 3% and Latin America continues in negative territory

The key issue, of course, is China’s slowdown.  It is casting a shadow across the world, as its massive stimulus had led the temporary recovery in 2009.  But now its New Normal policies are changing everything, as state-owned China Daily confirms:

“After years of double-digit growth, the Chinese economy is going through a transformation. The export-fueled model of the past is being replaced by a more balanced economy, revolving around innovation, services and domestic consumption.

“As the second-largest economy in the world, what happens in China will have global implications. But the long-term outlook is far from bleak. Services, not industry, are now driving the country’s growth.” 

The problem is that China’s new focus on services will not support all the new capacity that has begun to come online.  It means that the trough will be even worse than usual, as too much supply chases too little demand.   I will look at this issue in more detail next week, as we move into Budget time with a review of last year’s Budget Outlook.

My fear is that the industry will not only see weak demand, but also weak pricing:

  • In good times, margins benefit from a’price umbrella’ – the highest-cost plant has to run to supply demand
  • This provides windfall profits for everyone else, particularly if they are low on the cost-curve
  • But in bad times, cost curves become irrelevant, as pricing is instead based on roll-through margins
  • Integrated sites continue to run as long as they cover their costs, and weak product areas are subsidised

This is why the China chill is so worrying.  Petrochemicals, like the mining industry, has vastly over-expanded.  And no other region or country can possibly replace China’s lost demand growth.  I fear it will take a very long time, perhaps a decade or more, before supply and demand re-balance again.

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