China's commodity chemicals industry will face another challenging year. The downturn that began in the second half of 2022 shows no signs of meaningful turnaround.

A structural oversupply, resulting from an unprecedented capacity expansion cycle that began in 2018, will persist for at least the next two years. It will take a material rationalization of inefficient capacities and pick-up in the domestic demand to offset this.

Product spreads will likely improve modestly with the support of government stimulus, some continued capacity rationalization, and moderating input costs in 2025. But they will remain well below the mid-cycle levels.

The crop protection (CP) sector is normalizing, but sustained supply gluts in generic products and still-high interest rates globally mean the path to recovery will be gradual and bumpy.

For some of the chemicals entities we rate, this downcycle could be the most difficult ever.

Commodities Chemicals: More Supply, Weak Demand

The industry's structural oversupply will persist in 2025, with continued growth in new capacity and still soft demand. Some supply-side control and demand-side stimulus may, however, generate a modest improvement.

China's chemical capacity expansion should continue, albeit at a slower pace over the next four years on average. The industry players will continue to cut back some capacity, and delay or cancel projects. At the same time, the government has been encouraging industry consolidation and tightening environmental policies.

That said, significant rationalization of inefficient, smaller capacities will take time, given the fragmented and heterogeneous nature of the industry. So far, shutdowns of some major chemical plants have occurred in Europe, where costs are higher. China generally has the newest large facilities, many of which are integrated, and consequently operate more efficiently.

Chart 1

On the demand side, we anticipate some recovery this year in China, the world's largest consumer of chemicals, supported by government stimulus. However, there are significant downside risks due to ongoing woes in the property sector, low consumer confidence, and the potential for escalating trade conflicts.

Our base case assumes the country's GDP growth will slow to 4.1% in 2025, from 4.8% in 2024. This factors in a rise in weighted average U.S. tariff on Chinese imports to 25% from 14% from the second quarter of 2025.

Chemical products with more balanced supply and demand will generate more resilient profitability. These include chemicals applied in new energy, electric vehicles, and import-reliant, high-end new materials, such as methylene diphenyl diisocyanate (MDI), tolylene diisocyanate (TDI), and polyolefin elastomers (POE).

Cooling prices for raw materials such as oil and coal will slightly ease cost pressure. However, amid ample supply and soft demand, chemical companies may not reap the full benefits.

The Crop Protection Sector Is Normalizing

The CP sector will likely see more supportive industry conditions, with the prolonged global destocking gradually winding up. The notable rise in China's export volumes of CP products by 29% in the first 10 months of 2024 implies that stockpiles in overseas markets have depleted.

We expect market volatility to gradually ease in 2025. The global CP market has endured high demand and price volatility in the past three years, stemming from abnormal stocking patterns associated with the Ukraine-Russia conflict, adverse weather, and an increase in China supplies.

In response, demand should steadily grow and product prices may gradually stabilize. Yet the pace at which prices recover will differ between patented products and their generic counterparts.

Prices of patented products will be more resilient, due to the higher entry barriers and less excess supply. Generics will still suffer from persistent overcapacity. Supply discipline in China, the largest producer and exporter of generic CP products, should help ease some pricing pressure. This includes the continued phasing-out of costly, small producers, and new industry policies such as "one product, one certificate" to promote product quality and industry upgrades.

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However, some factors may constrain the CP sector's recovery. These include continued overcapacity, erratic weather, and just-in-time purchasing habits stemming from ongoing market volatility. The potentially slower pace of interest rate cuts globally may also discourage farmers from increasing their spending or stocking CP products.

Trade Tensions May Have Indirect But Meaningful Implications

We see a limited direct impact on Chinese chemical producers from the increasing trade tensions globally on Chinese goods. In line with China's rapid increase in self-sufficiency over the past few years, most commodity chemicals are produced and consumed domestically. Most of the countries that have imposed, or potentially will impose, more stringent tariffs or trade barriers on China's chemicals export are not key trading partners. And tariffs or barriers are also often on specific and limited product categories.

The second-order impact could be meaningful, considering the wide end applications of chemical products. Some of the key end-use industries--including cars, machinery, electronics, and home appliances--also face escalated trade actions. Such actions would further weigh on the demand of chemical products and exacerbate oversupply in the industry.

Partly mitigating the risks are China's continuous efforts to strengthen its domestic demand, upgrade products, and further diversify sales markets, such as emerging Southeast Asia.

China's CP sector could be more vulnerable to trade conflicts. The country is the largest producer and exporter of generic products and has been exporting 65%-85% of its output. Some mitigants include its diversified products and sales markets globally. For example, the main markets include the Regional Comprehensive Economic Partnership (RCEP) countries, Latin America, and Africa. We also anticipate that Chinese players will continue to improve their products, which includes efforts to make them more environmentally friendly.

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The Buffer Will Remain Narrow For Rated Companies

Although we anticipate a small improvement in the key credit metrics of rated companies in 2025, their rating buffers should remain thin amid the downturn. Below mid-cycle profitability and cash flow generation, coupled with still high investment spending, will constrain the ability of producers to meaningfully improve leverage in the near term.

We expect the profitability of most oil- and coal-based commodity chemicals to stay at historically low levels. In contrast, the high-barrier-to-entry polyurethanes market should have better profitability. Thus, the strong position of Wanhua Chemical Group Co. Ltd. in this niche market should enable it to achieve higher profitability, compared with general commodity chemical companies.

Spreads for patented CP products, which Syngenta Group Co. Ltd. focuses on, should continue to be more resilient than those of generic chemicals.

New projects will be key contributors to revenue and earnings growth in 2025 for the rated commodity chemical companies. Some major projects include Wanhua's integrated ethylene project, and Shanghai Huayi Holdings Group Co. Ltd.'s further ramp-up of petrochemicals and the launch of new projects for tires and fluorine chemicals.

We forecast an 18% rise in overall EBITDA for rated chemical companies in 2025, partly thanks to new projects and continued cost controls. These companies are among the most competitive in the industry, with broader product offerings and better cost positions.

In 2024, new projects should help increase the average EBITDA of commodity chemicals players whereas for agrochemical companies, EBITDA should fall because of prolonged destocking.

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Leverage of rated entities will remain elevated. This is despite that earnings improvement and financial discipline will help rein in the highs of 2023-2024. We estimate the average debt-to-EBITDA ratio among rated entities will moderate to 6x-7x in 2025, following multi-year highs of 8x in 2023-2024. High leverage in some commodities chemical companies can be stubborn, such as Sinochem International Corp., which has a high exposure to the severely oversupplied epoxy resin chain.

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Rating headroom for our rated entities will stay limited for the next two years. Factors supporting the stable outlooks on the ratings of these companies include:

• Our assumption of moderately improving industry conditions;
• Continued access to the favorable domestic funding given their state-owned background; and
• Commitment to strengthening cash flow and cost management. This includes cutting capex and lowering inventories and receivables, among other measures.

Key risks to our base case include: softer-than-expected product demand amid weaker macroeconomic conditions and rising risk of trade conflicts.

Table 1

The rated companies have buckled up for the highly competitive and challenging ride.

Editor: Lex Hall

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