China’s PTA producers look to futures to weather market volatility

China’s purified terephthalic acid (PTA) producers have been using the futures market to price PTA in the spot market, hedge against risks and manage inventory. This has allowed many to stay profitable, despite market uncertainty and disruption brought by the coronavirus pandemic, says Wood Mackenzie.

Since its inception 14 years ago, the Chinese PTA futures market has become a convenient financial tool for local PTA producers, together with their trading arms and allies, to weather market volatility.

Wood Mackenzie consultant Arthur Luo said: “Spot PTA prices in East Asia and China have slumped by 35% in the first four months of 2020.  In response, producers have been using the futures market to price PTA in the spot market, hedge against risks and manage inventory.”

Since the spot market was thinly traded and with no outright deals for prompt cargoes, price negotiation could have been time-consuming during nationwide lockdowns. Buyers and traders would have questioned the reliability of producers’ offers as the PTA market was in turmoil after a prolonged Spring Festival holiday.

Luo said: “The PTA futures market has proven to be an efficient and reliable price discovery system for producers to fix their offers to. Rather than trading at outright prices, spot PTA in China’s physical market is often pegged to main-month futures contracts, which are the January, May and September contracts within a 12-month period.”

PTA producers also use futures to hedge against pricing risks. A PTA producer with physical cargoes to deliver in a forward month, can open short positions in the same month futures contract. Underlying assets must be the same as physical PTA cargoes in volume and quality to mitigate risks from adverse price movement from present to the delivery month.

If PTA producers were to also open long positions in PX paper contracts on the Singapore Exchange or in crude oil contracts, they would be able to lock in PTA-PX (paraxylene) spreads. Widespread lockdowns have reduced gasoline demand in many Asian countries, lowering underlying feedstock values for PX.

Luo said: “As a result, PX prices have dropped further than PTA. The PTA-PX spread in East Asia rose to around US$117 per tonne in April, the highest since October 2019. Such a spread was deemed good by some PTA producers and traders who foresee downward pressure in future months as countries ease their lockdowns.

“But Chinese PTA producers, as well as their trading arms and allies, do not use PTA futures merely as an instrument to hedge their products' values or lock in PTA margins. In fact, some have managed to profit from the big PTA contango brought by the pandemic.”

PTA has become increasingly oversupplied this year, despite many producers either reducing runs or undergoing maintenance in February and March. Further weighing on spot values, the nationwide lockdown caused delays in PTA delivery to and inspection at registered warehouses.

Luo said: “As arbitrageurs, PTA producers and their trading teams have been sending cheaper physical PTA to warehouses registered under the Zhengzhou Commodity Exchange to settle their futures contracts at higher prices. Other traders with access to physical PTA followed suit and carried their short positions into the delivery month to capture the spread between spot and futures, instead of squaring their positions before expiration. This caused PTA physical delivery volumes from January to April in 2020 to be a lot higher than in the same period in previous years.”

Another incentive for producers to send PTA cargoes to registered warehouses is warehouse receipt financing. A warehouse receipt is a document to settle futures contracts, but it can also be used as collateral for loans from a financial institute, such as banks. Moreover, the Zhengzhou exchange allows PTA producers and other market players to use warehouse receipts as collateral for additional trading margin, at less than 80% of its underlying PTA market value, to open more positions or cover losses.

One more arrangement in PTA futures helps some local producers. From 2016, the Zhengzhou exchange added factory warehouses to ensure the physical delivery in a certain month does not exceed total warehouse capacity. Yisheng Dahua Petrochemical, Hengli Petrochemical (Dalian) Company and (the now defunct and subsequently renamed) Xianglu Petrochemical were the first three companies to receive approval from the exchange. The most recent company added to the list was BP Zhuhai Chemical in March 2020. These producers get more room to manage production in future months and save on costs, such as transportation, inspection fees and storage fees, by not sending products to a third-party registered warehouse.

Luo said: “PTA futures have proved invaluable to producers as well as other market participants amid the pandemic. PTA producers have been using PTA futures contracts on the Zhengzhou Commodity Exchange to discover prices, lock in PTA margins, manage their product inventories and profit from arbitrage.

“But the more interesting question is whether this could be an example for other petrochemical products. Will building financial layers upon physical markets become the new norm for petrochemicals products?”