ANALYSIS-China plastic demand slump may crimp Asian naphtha

Trade the News

Thursday June 02, 2011 10:06:06 PM GMT

* China's polyethylene imports fall 16 percent in Q1

* Slide in plastics demand may force crackers to pare output

* China's demand falls as tightening measures take effect

By Seng Li Peng and Judy Hua

SINGAPORE, JUNE 1 (Reuters) - Asian appetite for oil product naphtha is falling in tandem with a slump in Chinese plastics consumption in 2011 as Beijing's measures to slow runaway economic expansion bite.

Oil investors are watching Chinese demand growth closely for any signs of a sharp slowdown, as consumption in the world's second-largest economy has driven global fuel demand growth for the best part of a decade.

HSBC's China Purchasing Managers' Index (PMI) fell to a 10-month low in May, adding to evidence that the world's fastest-growing major economy is slowing. [ID:nL3E7H103M] This came after April industrial output growth eased more than expected. [ID:nL3E7GB0H2]

Plastic demand reflects manufacturing activity due to its wide use in industry in everything from cables and shampoo pouches to refrigerators and cars. Naphtha is one of the main building blocks for the plastics industry.

"We are now at the tipping point where the liquidity-fuelled boom which we had in the last two years is coming to an end," said Paul Hodges, chairman of chemicals consulting firm International eChem.

"We are not going to call it a crisis just yet, but the risk of a crisis may start to become apparent in the third quarter."

Profit margins for producing naphtha from crude in Asia have already fallen over 40 percent this year to $106.73 a tonne on Tuesday, down from a near three-year high in January of $186.50.

The fall in plastics margins might force crackers, which make polyethylene and other petrochemicals from naphtha, to cut runs in countries such as South Korea, Asia's top producer. For now, South Korean crackers are still running at full capacity.

"China is the only big outlet for North Asian exporters and without China, Asian cracker runs may be pushed down below 90% rates," said Mazlan Razak of petrochemicals consulting firm DeWitt & Co.

The worst run cuts were when operation rates fell to an average 75 percent in 2008 when the financial crisis hit. The loss in naphtha demand was huge due to the cuts and the light fuel's margins slumped to a historical low on Nov. 4, 2008, to a discount of $189.75 a tonne.

CHINA IMPORTS

Imports into China of polyethylene, made mostly from naphtha-based ethylene in Asia and one of the most widely used plastic materials, fell 16 percent from a year earlier in the first quarter to 1.18 million tonnes, data from the China Petroleum and Chemical Industry Federation (CPCIF) showed.

Implied consumption of polyethylene fell 1.5 percent in the same months against a 7-10 percent expansion in the last two years, while naphtha imports fell 4 percent in the first four months of the year.

The slide in plastics consumption comes as petrochemical supplies to China surge from the Middle East, eating into a market that typically belonged to North Asian producers.

Middle Eastern polyethylene exports to China rose 750,000 tonnes in 2010 compared to 2009, while shipments from North Asian and North American producers fell by 350,000 tonnes each, said Hodges.

Governments in the Middle East are expanding petrochemical plants to diversify economies reliant on crude exports. They often supply cheap gas, giving firms an edge over North Asian competitors.

SELLING STOCKPILES

The twin impact of rising supply and falling demand may force many crackers in Asia to pare output as competition for a shrinking market erodes margins.

The possibility that fundamentals will weaken further is prompting many in China to sell stocks to limit losses.

"Many Chinese players were kind of expecting a super cycle in 2011 after a brilliant 2010," Razak said. "A lot of pre-buying happened last year, but things did not turn out as expected. As a result, traders and distributors have to de-stock."

Sales from stocks are bloating supply more, pushing domestic prices down and encouraging traders to re-export cargoes from China to Latin America and elsewhere.

"They are not large in volumes, but the fact that they are happening at all tells you that some people got stuck with products that they cannot move," Hodges said.

The price of polypropylene, used in packaging materials and textiles, in early May stood at $1,600 a tonne in China against about $2,000 a tonne in the U.S. and Europe.

Low density polyethylene, used in containers and plastic bags, was at $1,650-$1,700 a tonne compared with $1,800 in the U.S. and $2,400 in Europe.

CHINA MARKET SHRINKS

Beijing has taken several steps to slow growth and inflation and has withdrawn some of the economic stimulus measures such as tax breaks on smaller cars or subsidies to buy home appliances that the government enacted during the financial crisis.

Car sales in China have slowed after years of speedy expansion. [ID:nL3E7GA0A9]

"Most farmers have fulfilled their home appliance needs.. resulting in a slowdown in domestic demand growth for plastics," an official at the CPCIF said, declining to be identified because he is not authorised to talk to the media.

Crude's volatility this year has complicated the industry's activity, analysts said.

"High crude prices have a very strong psychological effect," said Alastair Hensman of consulting firm Nexant Inc.

"With crude weakening recently the market knows that polymer prices should be coming down... there is every incentive to delay purchasing until those low prices are achieved." (Additional reporting by Jasmin Choo; Editing by Manash Goswami and Simon Webb)

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