DID WE REALLY live in a free-market petrochemicals world before the downcycle where the biggest players sought maximum profits? Will we live in such a world in the future?
I ask these questions because, as we seek answers to when the recovery might happen, we pore over profit-and-loss statements, margins, and operating rates. If the answers to my two questions are “no,” we are looking in the wrong places for answers.
A brief history lesson
In 2014, articles in China’s state-run press indicated a big push towards petrochemicals self-sufficiency. But because China was viewed through the Western lens of maximising profits, the objective was viewed with scepticism because of China’s perceived lack of feedstock advantage.
I warned at the time, based on what I was taught way back in 2000 by the former CEO of a major global chemicals company, that the profit motive wasn’t the only thing that drove China.
“Building petrochemicals capacity in China is partly about keeping people in jobs in the washing-machine factory by guaranteeing supplies of local raw materials,” said the CEO.
I thus warned in 2014 that China would move to close-to-complete, if not complete, self-sufficiency across a broad range of chemicals and polymers. We’ve seen this happen in polyester fibres, polyethylene terephthalate (PET) film and bottle grade resins, purified terephthalic acid (PTA), styrene and polypropylene (PP), etc.
Initially, the self-sufficiency push was driven mainly by wanting to add manufacturing value to the economy. More recently, as trade tensions with the US have increased, self-sufficiency has also been about supply security.
The Middle East has, of course, remained a major investor in petrochemicals in the region and overseas over the last decade, partly because of cheap feedstocks. But as with China, the region’s major players were and are state-owned. Job creation and adding economic value were important drivers of investment decisions.
In recent years, the Saudi objective of maximising oil consumption has dovetailed with China’s chemicals self-sufficiency ambitions. China’s government won’t approve any new refinery that doesn’t have a naphtha cracker attached. Crackers are being added to older refineries, enabling China to improve its feedstock cost position through better integration. Saudi Arabia has been able to lock in crude-oil consumption in China as downward pressure builds on global oil demand because of the electrification of transport.
In the years since 2014, the other major investor in new capacity has of course been the US thanks to the shale gas revolution. Were these investments pure capitalism? Maybe. But how do we frame or prescribe the boundaries of this capitalism? One can argue that building steam crackers was partly driven by the need to dispose of ethane in order to support the economics of the much-bigger upstream natural gas business.
During the post-2014 capacity surge, everyone, whether private or state-owned, needed stories to tell about demand. It was “the rise of China’s middle class” that largely helped justify investments. But, as we now know, the story was just a fiction because of demographics and debt.
History therefore teaches us that two of the most significant players in the game – China and the Middle East – were not always driven by the profit motive. What happens next?
Non-profit motives and the next wave of investments
A debate since Liberation Day and all the subsequent chaos over tariffs has been over China’s new capacity intentions. First, it was thought that China might slow down new projects because of demand uncertainties. Now, though, the consensus among the people I speak to is that China will press ahead to complete already-approved projects. Operating rates at existing plants will also be pushed higher to increase self-sufficiency in a more supply-insecure world.
Let’s look at PP and how this might play out in terms of China’s 2025–2028 self-sufficiency. Here I’ve kept the alternative outcome very simple by sticking to our base-case demand and capacity growth forecasts. The only difference in the alternative outcome is that I’ve raised operating rates. Note the quote from the Financial Times at the bottom of the slide.
As you can see, just a six-percentage-point increase in operating rates could see China swing into a net export position by 2027. While complete self-sufficiency cannot happen with higher operating rates in polyethylene (PE) – as this second slide shows featuring high-density PE (HDPE) – deficits or net imports could be much lower than base-case forecasts suggest.
It also seems logical to me that over the next three years at least, Saudi Arabia will push ahead with refinery-to-chemical investments in China. Substantial ethane-based capacity will also be added across the Middle East.
Here is another non-market factor that shaped the past and will shape the future: China has become very good at building highly efficient petrochemicals plants at costs that can be 50% or more lower than in the US, partly thanks to government support for innovation.
True, there are more private chemicals companies in China than ten years ago. But this latest wave of investment is more state-owned-enterprise-led than the previous one. And private companies can also benefit from local and central government support.
This leaves us to ponder what might happen in the US during this latest phase of commodity chemicals investment. Not a lot is the brief answer, as there are very few projects. I doubt this will change given the investment uncertainty created by the trade war. Why not instead just export surplus ethane to make some money, and to again help balance out upstream natural gas production?
So, here is the thing. Despite the worst-ever downturn, which is unlikely to end before 2028 at the earliest, capacities continue to be added mainly by companies that don’t act purely for profit. What does this mean for the rest of the industry?
Your thoughts? Let’s discuss.