Rocketing Prices and Price Slashing of 2008 Worsened Slump   

By Feng Fei    

China's petrochemical industry has grown rapidly in the past few years, with an average annual growth of 28.5% for production value between 2003 and 2007 and 32.6% for profit. This dramatic growth lasted through the first half of 2008, but ended suddenly in October 2008. The production value of China's petrochemical industry showed a year on year growth of 31.3% in the first half of 2008, compared with the 22.3% growth in the first half of 2007. However, production growth slowed down in the second half of 2008. Therefore, to stimulate the petrochemical industry, the existing key problems should be settled down first, and technology upgrades must be promoted to improve the competitiveness and sustainability of the industry.  

Rocketing prices and price slashing disrupted normal operations, and this is believed to be the main reason for the dramatic decline of growth in petrochemical production.  

Soft demand from downstream industries, including decreased demand abroad, was undoubtedly a reason for the slowed growth of petrochemical production, adjustments in export policies and the softened domestic demand that was signaled by the recession of downstream industries such as homebuilding, garments and textiles. However, none of these three was the majority factor. China's petrochemical industry has always been a net importer, with the exception of few products, therefore it can be less impacted by the variation in oversea demand. By viewing domestic demand, production growth of the main downstream industries in China went down moderately, with no drastic drop of growth. So the slowdown in domestic downstream industries is not the main reason for the dramatic drop of growth in petrochemicals. Export policies also have low impact on this industry.
   In fact, the essential reason was that rocketing prices and price slashing disordered the normal operation of the market. In the first half of 2008, driven by rocketing raw materials prices around the world, particularly crude oil, the prices of primary petrochemical products surged markedly. Dealers and downstream consumers, expecting that petrochemical prices would continue to go up, scrambled to accumulate a surplus of petrochemicals in their inventory. When the crude oil price fell rapidly, the prices of various petrochemicals followed, falling even more rapidly than crude oil. When the slashing began, dealers and consumers who projected that petrochemical prices would continue to go down started to use petrochemical materials in their inventories and quit buying, with the result that the apparent consumption approached zero, far less than the actual consumption. Petrochemical makers, in reaction to the drastic decrease of demand, had to reduce production and took their units offline while scrambling to recover cash by selling down existing inventories at any cost, causing the price to go down even more rapidly. This vicious cycle lasted till November 2008.

Attention should be paid to the
internal and actual factors for
the drastic drop of growth  

The petrochemical industry, as an intermediate industry, has always shown an obvious periodicity in growth, according to historical data. Its growth is faster than the growth of the GDP in the rising stage of each economic cycle and was lower than the growth of GDP in the declining stage. The decreased growth in the second half of 2008 was similar to historical experience. The difference from before was that the growth fall of the petrochemical industry in early 2008 was more rapid and the drop touched a deeper bottom. In the slowdown of 1997-1998, the output of primary chemical products grew at a slowed rate, but still grew, moderately and stably, unlike the decreased output of most chemicals in 2008. This illustrates that new variations has happened to the operating pattern of the petrochemical industry.  
   The first variation was that price played a more important role than ever before. The price changes of key products have, however, deviated profoundly from the relation between supply and demand. More significantly, the market pattern has affected the petrochemical industry, and producers, traders and consumers have become more sensitive to prices. However, the price of crude oil, which is the most important factor for the petrochemical industry - as for all energy and raw materials industries - is no longer decided by the domestic supply/demand balance only, but depends on the international crude oil price that has less and less relation with the balance between supply and demand because of the speculations of financial organizations.    
   The second was that the banks amplified the short-term fluctuations of real economy when strengthening risk management. In order to control risk, most banks initially tightened credit as we entered the recession. On one hand, tightened credit can force enterprises facing the recession to adjust production schedules, digest inventories and make cash flow stable, which differs fundamentally from the enterprises?usual practice of continuing to operate according to plan in spite of increased inventory. The market principle played its role. On the other hand, the tightened credit will have further tightening impact on the industrial economy, accelerating the decline.
   The third was that confidence and expectations played more and more important roles in economic operations, but there is no experience or proven measures to manage expectations well. After the market mechanism replaced governmental orders to coordinate economic operations in China, confidence and expectation have played more important roles than before. The petrochemical industry, which features a long product chain, high fixed costs and product prices that are easily affected by international markets, is affected more by confidence and expectations than other industries. Lack of experience and effective measures to manage expectations caused big fears for market players, which contributed to the main factor leading to a crazy irrational price fall.
    In 2009 the output of China's petrochemical industry will grow to a certain extent, but operational difficulties may arise for some enterprises. At present, the prices for quite a number of chemicals are already lower than their cost. On the support of actual demand, the prices will go up stably when the accumulated inventory decreases to a low level. Once the price picks up, petrochemical production will also stop falling.
   The total output and production value for petrochemical industry tended to stop declining in the first half of 2009 with a month-on-month increase, but due to the boom of the first half of 2008, which witnessed a 30% growth year over year, the year-on-year growth was probably negative. For the second half of 2009, the year-on-year growth will be positive, driven by the RMB4 000 billion stimulus program, along with the low level in the second half of 2008. The automobile output in China will increase 8 million to ten million units this year, which also gives strong support to the refining sector. To sum up, the petrochemical industry will achieve a positive growth throughout 2009, at least, no less than that in 2008.   
   In contrast to the relative better projection on the operation of the industry, the industrial enterprises will suffer more difficult operational problems in 2009. There are three main factors. First, from October 2008 domestic enterprises started to consume the high cost raw materials in their stocks while withstanding the drastically reduced selling prices of their products, and some of them me