Polyolefins start rate rebounded in the second half of the year, or stopped rebounding in the third quarter
2023/7/3
Polyolefin prices reached a three-year low in the first half of 2023 due to a weak supply and demand pattern, with domestic and international demand shrinking, coupled with falling energy and macro-positive factors, even though producers took the initiative to reduce production. In the second half of the year, we see a stop-and-go rebound in the third quarter and a downward pressure in the fourth quarter. The overall trend is similar to 2017 in an optimistic scenario and closer to 2019 in a pessimistic one. Considering the strong bullish sentiment and very low volatility in the options market, we recommend selling puts in the third quarter, waiting for confirmation of the uptrend before buying calls or bull spreads, and selling calls or buying bear spreads in the fourth quarter after the topping signal.
Supply tends to ease new capacity launch less than expected
PE and PP added 2.2 million tons and 2.6 million tons of capacity in the first half of 2023, respectively, and the launch time was mainly concentrated in the first quarter, which exacerbated the contradiction of oversupply and directly led to the continued decline in prices in the second quarter. In the second half of the year, only one 400,000-ton PE plant was put into operation in November, while half of the new PP capacity launch was postponed to 2024, and the actual new capacity may end up being only 1.05 million tons.
The actual number of new production capacity is far less than expected, and the impact on futures prices is more limited.
Production expected to grow by 10%
Declining demand and widening losses have caused polyolefin plant starts to continue to fall since Q4 2022 to date, with PE and PP production increasing 10% and 4% year-on-year respectively in H1 2023, and zero growth in drawing output for the first time in history. However, with the planned resumption of production in July, the start-up rate will steadily rebound in the third quarter and reach the highest in the year in the fourth quarter. PE and PP production is expected to increase by 10% and 11% year-on-year in the second half of the year, with production remaining low in July and August and growing significantly from September and reaching a record high in November or December.
Both import and export volume decreased
With sufficient domestic supply overlapping with internal and external price inversion, PE and PP imports continue to decline, decreasing by 8% and 1% year-on-year in the first half of the year, respectively, with import dependence reaching a new record low. In the second half of the year, as domestic production capacity rises and the arbitrage window opens, imports are expected to decrease further, with PE and PP decreasing by 9% and 12% year-on-year, respectively.
The growth of polyolefin export volume slowed down in the first quarter of 2023, and in the second quarter, with the overall weakening of overseas demand, the export volume showed a significant decrease, with PE and PP export volumes growing at 26% and -23% year-on-year in the first half of the year, respectively. In the second half of the year, PE and PP export volumes are expected to decrease by 16% and 1% year-on-year respectively as the overseas economic outlook is worrisome and the domestic low-price advantage disappears.
PE and PP table demand growth rate will increase
New production capacity was concentrated in the first half of 2023, and the polyolefin oversupply contradiction intensified, forcing producers to actively reduce production since March. Low domestic and international demand led to a rare simultaneous decrease in import and export volumes. The year-on-year growth rate of apparent demand for PE and PP is expected to be 3% and 5% respectively in the first half of the year.
In the second half of the year, production is expected to grow significantly after the start-up rate of producers picks up, while imports and exports continue to fall, and the year-on-year growth rate of apparent demand for PE and PP is expected to rise to 4% and 7%, with strong supply short expectations for PP in August, September and December.
Domestic demand is expected to pick up, downstream start rate is low
Due to the weakening of terminal demand, the number of orders from polyolefin downstream enterprises decreased significantly in the first half of the year, with the number of order days for packaging film, BOPP and plastic knitting reaching the lowest in the past five years. As a result, the PE downstream weighted start rate dropped to the lowest in the past three years in June, while the PP downstream weighted start rate has been at a very low level, and BOPP and plastic knitting have even suffered losses and production cuts. Referring to the law of "Golden Nine and Silver Ten" peak season, the downstream work rate is expected to gradually increase to the highest in August-October and fall slightly in November-December.
Weak internal and external demand
The decline in consumption capacity and consumer confidence directly led to a serious shortage of polyolefin domestic demand, plastic products production has been 11 consecutive months of negative year-on-year growth. However, with the fall in raw material prices, increased efforts to promote consumption policies and the traditional peak season, domestic demand is expected to usher in a phased recovery in the second half of the year from September to November. By the global economic slowdown and manufacturing industries to Southeast Asia's double impact, polyolefin overseas demand continues to deteriorate, rubber and plastic products export delivery value has been 10 consecutive months of negative growth. The risk of overseas recession may intensify in the second half of the year, and external demand is expected to remain sluggish.
PE and PP demand growth rate of 4.6% and 2.5%
Polyolefin demand performed relatively well in the first quarter of 2023, with major downstream starts once reaching a new stage high in March. However, polyolefin demand deteriorated sharply in the second quarter, dragged down by the weak performance of domestic and international terminal demand. The demand for PE is relatively stable, with pipe demand maintaining a high growth rate in the second half of the year, film demand ushering in the peak season, injection molding and hollow still weak, PE demand growth rate is expected to be 4.6%. The demand for transparent materials and pipes is expected to be good, and the demand growth rate is expected to be 2.5%.
Bullish sentiment emerged
In the first half of the year, polyolefin options transactions were very active, with the average daily volume of L and PP increasing by 102% and 151%, respectively, and the average daily position volume increasing by 16% and 40%, respectively. when the futures prices bottomed out in mid-June, the options volume and position volume jumped directly to a record high despite the stable futures transactions, and the highest single-day volume of PP options even reached five times the average value in the first half of the year. This shows that the futures market and the options market have formed a closely interconnected and mutually influential relationship. When the spot is long or short, and futures are mixed, you can judge the general trend of future futures with the help of indicators such as options' volume positions, volatility and sentiment.
Low volatility
Historical volatility for commodity futures generally continued to decline in the first half of 2023, and L and PP futures are no exception. The current 5-day, 20-day, 60-day and 90-day historical volatility for L and PP futures are all below the 25th percentile, with the 5-day historical volatility for L and PP in the 9.2% and 4.5% percentile since listing, which are extremely low levels. It is well known that volatility usually has mean reversion characteristics, and low volatility is often accompanied by increased price volatility in the process of increasing, and PP futures have always followed this rule over the past decade. The current very low historical volatility will start to rise around September at the latest, which is bound to bring a new round of extreme market.
In addition to low historical volatility, options implied volatility has also reached a new stage low. The current implied volatility of the L and PP main contracts at par strike price is 14% and 15%, respectively, at the 6% and 10% quartile level so far in 2021. Implied volatility has continued to decline over the past year, rising only briefly and to a limited extent in March of this year, and in accordance with statistical patterns, implied volatility is likely to increase significantly in the third quarter.
Volume position indicators show bullishness
As the extreme bearish sentiment in the polyolefin options market receded in April-May, bullish sentiment began to emerge. call options volume and positions have been increasing since mid-June, with PP volume PCR reaching a minimum of 0.34, i.e., call options volume is three times that of puts, and positions PCR reaching a minimum of 0.62, i.e., call options positions are 1.6 times that of puts. L volume PCR reached a minimum of 0.54, i.e., call options volume is 1.9 times more bearish, and position volume PCR reached a minimum of 0.88, i.e., call options position is 1.1 times more bearish, and if the short-term L call options position also increases significantly, the L and PP options markets are simultaneously experiencing extreme bullish sentiment, a similar situation also occurred in the third quarter of 2021 and the first quarter of 2022, when a sharp rise in futures was quickly ushered in. In addition, indicators such as spot transaction data, traders' long-short mentality, the relative strength index of futures and the number of net positions in the top 20 seats can be combined to further improve the accuracy of market sentiment judgment.
In addition to the PCR reflecting options market sentiment, the volume and implied volatility distribution of different strike prices can also reflect the long-short tendency. For the option volume of the 09 contract, L is concentrated in several strike prices of RMB 8300/ton and higher, and PP is concentrated in several strike prices of RMB 7600/ton and higher, and the call strike price is more active and concentrated, which intuitively reflects the bearish tendency of the option market, which is consistent with the results of the PCR indicator. In addition, the strike price of maximum volume can also be regarded as the key position of futures price, for example, the current support level of L is 7200 yuan/ton and the resistance level is 8300 yuan/ton, and the support level of PP is 6600 yuan/ton and the resistance level is 7600 yuan/ton, which is close to the results of futures technical analysis, which shows its effectiveness. It is worth mentioning that the strike price of the largest position also has the function of forecasting the futures price range, and we can refer to the distribution of volume and position at different strike prices to improve the winning rate when choosing the strike price for selling options.
Volatility Smile Right Skew
The implied volatility of different strike prices at the same expiration date becomes larger as the strike price becomes more real or imaginary, and reaches a minimum near parity, forming a "smile"-like curve with a low center and high sides, which is called a volatility smile. Since the liquidity of the dummy option is better than the real one, the volatility of the call option is used by default above the parity and the volatility of the put option is used below the parity when constructing the volatility smile. If the implied volatility of the call option is higher than the implied volatility of the put option with the same spacing from the parity, i.e., the volatility smile curve is skewed to the right, it reflects the bullish sentiment of the options market, and the greater the skew, the stronger the bullish sentiment. The current volatility smile of the PP main options contract is heavily skewed to the right, revealing an extreme bullish sentiment.
Trading Strategy Recommendations
Through the analysis of fundamental supply and demand factors and option-related indicators, we believe that polyolefin prices are about to bottom out, stopping and rebounding in the third quarter and falling under pressure in the fourth quarter. We recommend selling puts and waiting for the confirmation of the uptrend before buying calls or bull spreads, and selling calls or buying bear spreads after the top signal in the fourth quarter.
Specifically, we believe that selling PP2309-P-6800 is the best choice at this time. First of all, the species choose PP instead of L because L price is more vulnerable to crude oil, crude oil may appear similar to the sharp drop in coal in the third quarter, on the contrary, PP has the solid cost support of coal and methanol. Secondly, the put selling strategy is chosen mainly for its ability to deal with non-significant declines in the market. If the futures oscillate or rise in the coming month, the put option can be sold for more than 80% of the premium, and if the futures fall in a limited way, you can wait for the expiration of the passive exercise to turn into a long futures order and continue to hold or move to the 01 contract. Finally on the choice of strike price, is after taking into account the marginal cost of the production process, the maximum volume of put options and position strike price and the previous low price of futures, we believe that 6800 yuan / ton is the strongest support level of PP2309.
Therefore, despite the current extremely low volatility and the possibility of a secondary bottom in futures, we still recommend selling PP puts from a win rate perspective. In the future, if the futures continue to rise, the strike price of selling puts can be continuously adjusted upward, or directly changed to bullish spreads or even buy calls. If the futures fall below 6800 yuan/ton but not to 6600 yuan/ton, you can wait for the expiration to be exercised and switch to a long futures order. If there is no accident the strategy has a high win rate of more than 90%, can be described as both offensive and defensive, the ambition is to win.
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