China's reopening has yet to reignite Asia's chemical industry. The sector's exports remain subdued and prices are sluggish amid muted economic growth in China, a major chemicals producer and consumer. But S&P Global Ratings believes the turnaround is starting.

We project that most chemical companies will regain earnings momentum in the second half of 2023, leading to a stronger turnaround next year. In addition, some companies will diversify from commodity chemicals, such as lithium batteries and electronics materials, and that should help to lift revenue and cash flow.

After faltering growth in the first few quarters of this year, financial buffers have narrowed. We estimate that 60% of the companies we rate could breach our downward thresholds for financial risk profiles if EBITDA were to decline 30%. Our base case assumes only a slight margin dip this year.

A prolonged downcycle, however, would start to pick off shakier companies. The continued weakness in China's property and export sectors, such as home appliances, has particularly negative effects on chemical demand. This, coupled with continued capacity additions in China, will keep Asia's chemicals sector in significant oversupply and at low utilization rates for longer than we first anticipated.

Slow Demand And Capacity Additions

Demand in Asia's chemical sector should improve from the second half of 2023 and throughout 2024. Inventory restocking, recovering exports from the region, and improving consumption in China will support higher chemical prices and stronger EBITDA generation.

China's government is likely to roll out measures to revive the economy, which should help to strengthen demand in this key regional market. China's economic recovery was weaker than most expected in the second quarter of 2023. And that suppressed the prices of most basic chemicals during this period after a brief rebound in the previous quarter.

Further capacity additions will limit the sector's turnaround, in our view. China will continue to lead global capacity additions for base chemicals. The country surpassed the U.S. as the world's largest ethylene producer in 2022, adding about 5.7 million tons of new capacity. There are no signs of a material slowdown in the country's bid to increase its total capacity to about 70 million metric tons a year in 2025.

We forecast China will become self-sufficient in ethylene supply in 2026, from 64% self-sufficiency in 2021. Major Chinese integrated oil refiners are increasing their petrochemical exposure. This is due to decreasing demand for petroleum products, based on China's aggressive strategy in electrifying private and public transportation to achieve its climate goals.

Input Costs For Crude Oil Are Falling At A Milder Pace

Chemical prices are likely to be weaker than crude oil prices on continued supply growth, and that will constrain the gains in product spreads for most chemical companies. They will face cost pressure if demand does not pick up sufficiently.

Crude oil prices could also fall, but at a slower pace. S&P Global Ratings recently forecast that Brent crude oil prices will average US$85 per barrel for the rest of 2023 and stay flat for 2024-2025 (see chart 1). Supply controls by OPEC and the continued war between Russia and Ukraine could create a price floor for crude oil. Nonetheless, crude oil prices may still deviate from our base case to the downside, given weak global consumption.

Chart 1

Weak demand and capacity additions will constrain the pricing power of chemical companies. The product spreads of most basic chemicals will remain narrow but should slowly rebound because of crude oil prices. The impact will be more significant for Asia's chemicals sector than peers in other regions since the region's chemicals supply chain relies more on naphtha as an upstream raw material.

The hit will flow through to input costs for the production of base chemicals for downstream chemical producers, leaving them in a unfavorable cost position. Rising imports from chemical producers in the U.S. that focus on low-cost natural gas partly contributed to the weak chemical prices and product spreads in Asia for the first half of 2023, in addition to continued capacity additions in China.

Financial Buffers Are Holding Up

Our base case for rated chemical companies in Asia assumes a slight decline in EBITDA margins for 2023 after a sharp correction in 2022. Our forecast is a touch weaker than previously and mostly reflects the potential for a tepid rebound in the first half of 2023. We anticipate only a gradual recovery for the rest of the year, given the slower economic recovery in China.

Accordingly, we forecast that the median EBITDA margin of rated chemical companies will drop slightly to 10.5%-11.5% in 2023, from 11.7% in 2022 and 15.7% in 2021. This would put margins of most chemical companies below a typical mid-cycle level.

Nonetheless, the total EBITDA of our rated chemical companies could still grow slightly due to capacity additions and faster revenue from specialized products, such as lithium battery and green energy-related materials. We forecast that chemical companies' profitability will rebound more strongly in 2024, assuming demand for physical goods will resume growth after shrinking in 2023 amid higher demand for upstream materials, including chemicals.

In our view, the financial buffers on stand-alone credit profiles have weakened moderately on persistently weak EBITDA generation and elevated capital expenditure (capex). These factors have raised debt slightly since the industry downturn began in 2022. (See chart 2).

Chart 2

We estimate that about 30% of our rated companies could breach the thresholds for the financial profiles of rated companies if EBITDA dropped 10% below our base case. And only about 40% of rated chemical companies could withstand more than 30% declines in 2023 without breaching the thresholds for their financial profiles. Financial conditions should improve slightly in 2024 with improving free operating cash flow.

Most rated companies could keep their credit metrics within the financial thresholds for their financial risk profiles in 2023, according to our base case. The exceptions are the Formosa Plastics group and PTT Global Chemical Public Co. Ltd. But, given disciplined investments, these two companies should be able to improve their leverage in 2024 when the sector bottoms out from the current downturn.

In addition, some rated companies are supported by governments or parent companies with stable outlooks. This is why we are likely to maintain the stable outlooks on most companies over the next 12 months (see table).

Downside Risk Is Rising

Downside risk to our base case has increased recently in view of a slower economic recovery and weakening chemical prices. S&P Global Ratings recently lowered China's GDP growth to 5.2% from 5.5% for 2023 and forecasts that global GDP growth will remain relatively tepid at 3.1% in 2023 before accelerating to 3.4% in 2025, from 3.0% in 2023.

Slowing growth in the U.S. and China could particularly depress demand growth for basic chemicals since they are the major consumption countries. Uncertainty in the recovery of China's property and manufacturing sectors also weighs on chemical demand, in our view. This together with more sturdy crude oil prices adds additional risks to chemical companies' profitability over the next few quarters.

The most vulnerable rated chemical companies are those with:

• High exposure to commodity chemicals, particularly for base chemicals that originate from crude oil.
• High exposure to China's domestic chemical market.

In our view, about half of the companies we rate are more vulnerable to likely volatility in the commodity chemical market. These companies have high revenue exposure to both commodity chemicals and China's domestic markets. About one-fifth of rated companies will be largely shielded from the volatility. However, we believe China's disappointing recovery and weak exports from Asia will impact all companies to different degrees.

China: Rated chemical companies are the most vulnerable to weaker domestic demand and sustained oversupply.   That said, some companies, such as Sinochem Holdings and most of its subsidiaries, are less sensitive to prices of base chemicals. That's because a high portion of their revenues come from agrochemicals and other specialized chemicals. Financial buffers for their SACPs are also generally low to medium.

Taiwan: Most rated chemical companies are more exposed to China headwinds than their regional peers.   is because the companies have generally high market dependence and revenue is concentrated in crude oil-based commodity chemicals. Nonetheless, most rated Taiwanese chemical companies have strong financial buffers to withstand such volatility after building up robust capital structures during 2020-2022. For example, Chang Chun Petrochemical Co. Ltd., Chimei Corp. and Asia Polymer Corp. all maintain a net cash position.

The ratings on the four Formosa group companies are likely to come under more pressure, given their narrow financial buffers. But low capex and cash dividends could help the group to manage its debt.

Korea: Rated chemical companies typically have lower direct exposure to the China market.   However, they are highly exposed to crude oil-based commodity chemicals and therefore could be indirectly hit by a sustained oversupply in the region. Rated Korean chemical companies generally have sufficient financial buffers to withstand such volatility in 2023-2024. In addition, LG Chem Ltd. is rapidly increasing revenue and EBITDA generation from the production of lithium batteries, thus reducing the impact of the volatility in the company's commodity chemical business.

Southeast Asia: Rated chemical companies have low exposure to China and are focused on their domestic markets.   Performance risk for PTT Global Chemical Public Co. Ltd. is alleviated by its growing use of natural gas as feedstock. This reduces the negative effect of stickier crude oil prices on the company's profitability. But PTT Global Chemical has little financial headroom due to its past acquisitions and expansion. The company's SACP could come under pressure if its operating performance does not pick up as we forecast due to weaker-than-expected chemical prices in the region.

Australia and India: Rated chemical companies do not rely materially on petrochemicals as feedstock.   They therefore are not tightly correlated to commodity chemicals and crude oil prices. Nufarm Ltd., Incitec Pivot Ltd. and Orica Ltd. have no revenue exposure to China, either. UPL Corp. Ltd., which produces agrochemicals, and Rain Carbon Ltd., which produces carbon-related products, are least exposed to China and base chemicals.

Risk Of Sustained Oversupply Spurs Diversification

As China's GDP growth gradually trends down with less dependence on the property market and low-value manufacturing, demand growth for basic chemicals is also likely to follow suit. Nonetheless, the rapid additions of new capacity have shown no sign of slowing, given the structural shift in the country's vast oil refining and chemical industry. This will substantially reduce chemical imports from other countries in the region, adding pressures for chemical companies outside of China to look for new destinations for their output.

Some rated chemical companies, particularly Taiwanese ones, have taken action to diversify their end markets to reduce their dependence on the China market over the past few years. Further diversification is happening and could accelerate in view of slowing exports to China. Some companies are also shifting the product mix away from commodity chemicals towards specialized chemicals, such as eco-friendlier chemicals related to electric vehicles, renewable energy and electronics.

Nonetheless, the transition is unlikely to be smooth in our view. Market diversification is unlikely to fully mitigate the impact of growing output from China, with likely rising competition for other markets. In addition, the shift toward specialized chemicals could be constrained by market demand, technology and significant investments.

A longer and deeper downturn could ratchet up the risks for those companies whose financial buffers wore thin in 2022-2023. In our view, careful management of capex and cash flow remains critical to avoid sustained damage to credit quality. China's economic recovery is still key.

Related Research

• China Commodities Outlook 2023: An Uneven Recovery For Chemical Companies, Feb. 27, 2023
• Credit Conditions Asia-Pacific Q3 2023: China Grapples With An Uneven Recovery, June 27, 2023