Caprolactam: upstream or downstream, long or short?

Striking contrast between CPL upstream and downstream

Since April, the market performance of the upstream and downstream of caprolactam market has been deviating continuously, and the strong performance of upstream and the weakness in downstream have formed a strong contrast. According to feedback from many companies, the market in the second quarter of 2022 has seen the most acute conflict between upstream and downstream.

There are many reasons for weak demand, and the impact of the epidemic is the most important. In addition to its impact on China domestic consumer confidence and behavior, a large number of textile and apparel export orders have been transferred to Southeast Asia due to challenges to the stability of the supply chain. The epidemics in Shanghai and Jilin directly impacted the auto industry, and the auto production and sales were nearly halved from April to May. Therefore, the current performance of each link of the industrial chain (downstream from nylon 6 chip) is bleak.

The strength of raw materials is mainly caused by external factors. In the past two years, due to the impact of the epidemic and war, the fragile global supply chain has continued to cause problems, and many commodities have been trending strongly, typical representatives are oil and grain, tight supply of which has caused many systemic problems, including the high cost pressure of CPL. Stronger oil prices directly pushed up the prices of naphtha and benzene. Due to the turbulent overseas environment, food security is particularly important in China this year. The increase in overseas food prices has driven China domestic fertilizer prices. As the main raw material of urea, the price of liquid ammonia has broken through historical highs in 2022. Both benzene and liquid ammonia hit the historical high, which caused huge cost pressure on CPL.

The recent strength of benzene is actually driven by another major factor in addition to oil prices, overseas aromatics production cut and the RMB depreciation. In the global market, especially in the U.S. market, the consumption of refined oil products is booming. In order to maximize the profit, the refinery output is more inclined to oil products, thus the output of aromatic olefin chemicals is reduced. Furthermore, some aromatics (such as toluene) can be used for oil blending, thus further cutting down the output of aromatics. As a result, the price of benzene continues rising up in the U.S. At meantime, China's domestic demand is weak, and most of the downstream products of benzene suffer losses. China's benzene price has become a depression in the global pure benzene price. With this diverged price trends, the Asia-US arbitrage window is open, and Asian supply flows to the US Gulf. Superimposed the depreciation of the RMB against the USD, the supply of imported goods to China has been significantly reduced. Therefore, the inventory of benzene in East China ports has continued to decline and RMB-based benzene prices have been driven up significantly.

CPL market fundamentals

1. June supply may reduce further under heavy losses

2. Nylon 6 demand may worsen further in June

Back to CPL market itself, based on current CPL-benzene price difference, there is no downward room for CPL market. In the first quarter, CPL producers have suffered a serious loss, with some factories losing more than 100 million yuan. In April, the situation deteriorated under the impact of the epidemic, so the reduction and shutdown of production increased significantly. In May, the supply of CPL tightened gradually tighten, and according to major suppliers' plans, the tightness may rise in certain point of June, as the industry average operating rate may drop below 65%.

Major CPL plant turnaround plans for June

The downstream situation in June may be even worse. Nylon filament yarn market, in particular, may completely fall out of upstream uptrend, as downstream fabric mills are still loaded with heavy finished goods and their capital flow is tight. In another major downstream sector, engineering plastics, the demand performance in June is also unknown. Maybe it will gradually get out of the predicament due to the resumption of work and production in Shanghai. But as insiders uphold this expectations for a long time already, their confidence has been depleted and their current attitude is conservative.

CPL market logic: long or short?

The current CPL market is facing a classic dilemma: strong upstream and weak downstream. But it is more difficult than ever to choose a long or short logic in predicting market development. This conclusion may be unacceptable for the majority of the fiery downstream, but the author's judgment for the direction of CPL and nylon 6 chip is still bullish.

1. Compared with the variables on the demand side, the logic of strong costs and tight supply is more certain.

2. There is no flexibility for benzene or CPL supply. Similar to crude oil this year, when the supply capacity is inflexible, the price will be strong despite of any suppressions.

3. In a long or short logic game, the side with the logic in a more forward time will be more dominant. One of the support for the bullish logic is the gradual recovery of demand, and it is expected to happen in a more forward time point, so winning rate is higher.

The analysis of the above three points may be somewhat idealistic, but the market really needs some so-called belief support at current time being. Pessimists are often right, but optimists are closer to success. After a series of intensive stimulating policies, the author thinks the hardest moment is over.