Margins will fall to a record low in 2024
Northeast Asian Integrated Variable Cost Naphtha Based PE Margin Index
Chemicals are the best leading indicator for the global economy.
They tell a very worrying story about the impact of China's move to massively increase its production capacity, as the graphic confirms:
- It shows Northeast Asian margins for polyethylene (PE), the world's largest polymer, based on 2014 = $100/t
- Margins have collapsed from $202/t in 2016 to -$25/t in 2022; $3/t in 2023; and -$27/t so far this year
U.S. producers saw operating rates fall due to capacity expansion
US ETHYLENE PRODUCTION AND OPERATING RATE %
Producers clearly face some painful decisions in the coming years:
- The initial problem was that North America massively increased production during the Shale Revolution
- Unfortunately and predictably, their sales have not reached expected levels since then
- And so operating rates fell sharply over the period to just 80% last year, as the chart shows
We warned here in March 2014 that this was likely:
“U.S. ethylene producers need to figure out where all new ethylene production will be sold before beginning planned firecracker construction.”
But as one CEO told us after reading the analysis, “Maybe you're right, but every time I mention shale in an earnings release, the stock goes up $5.”
Of course, this in turn illustrates the underlying problem:
- The Federal Reserve's focus on raising asset prices to stimulate economic growth resulted in investors not paying attention to the details of investment decisions
- They wanted a simple story along the lines of how shale gas delivered: “U.S. ethylene producers faced a production renaissance based on a massive increase in exports.”
- After all, everyone “knew” that China would always record double-digit growth rates and “always” require increasing import volumes
Middle Eastern producers have been expanding to offset declining oil sales in China
CHINA EV CAR SALES & EV %
More recently, producers in the Middle East have increased excess capacity. The problem is that China was the main growth market for their oil exports. And now China's demand is likely to decline as electric vehicles (EVs) replace gasoline and diesel.
Transportation accounts for 60% of oil demand. And electric vehicles already account for 35% of car sales, as the chart shows. By 2026 they are expected to be at 50% – and by 2030 at 100%.
And unfortunately, oil producers don't really understand chemicals:
- They think in terms of millions of barrels of oil per day
- But chemical markets are much smaller – even PE is only 90 million tons/year
- And other products are usually significantly smaller
So they contribute massively to the problem of overcapacity.
BUSINESSES MUCH OVERESTIMATE THE SIZE OF AFRICA'S ECONOMY
GDP per capita, current prices
The core problem is that no market is big enough to replace China. Some producers have argued that Africa could potentially absorb the surplus:
- There are 1 billion people, but unfortunately they are too poor to generate anywhere near the volume required
- GDP per capita is just $2,080 compared to an average of $62,000 in wealthy G7 countries, the IMF chart confirms
Rethinking, repositioning and restructuring are now essential for the industry
Future winners of this “New Normal” will be those companies that recognize that today’s central question is no longer “Do we have a cost-effective offering?”
Instead, it’s “Do we have a customer who is willing and able to buy from us?”
As the Antwerp Declaration confirms, there is an urgent need to combine the green agenda with a forward-looking industrial strategy.
Governments must lead the way (as the US is already doing) in driving the transition to net-zero products and services and developing advanced chemical recycling technologies.
There is no doubt about the challenges ahead. But every challenge is also an opportunity for those who are willing to think “outside the box” about the way forward. They will be the big winners of the future.
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