Investment direction of chemical industry in the context of dual carbon

The pro-cyclical recovery accelerated, the industry prosperity increased significantly, and the performance of domestic chemical industry leaders continued to improve. Since the second half of 2020, with the continuous strengthening of economic recovery expectations at home and abroad, the international crude oil price has now significantly increased, the real estate industry in the United States has recovered and maintained a high prosperity, the supply side has taken the lead in recovering after the control of the epidemic in China, and the transformation and upgrading of the domestic manufacturing industry has steadily advanced. Since May 2020, the chemical industry has accelerated its recovery process after crossing the recession inflection point caused by the NCP epidemic. Some global orders for chemical products have shifted to domestic markets, resulting in a U-shaped reversal in the business scale and capital market performance of the chemical industry.

In 2021, due to the impact of the epidemic and extreme weather on overseas supply, the transfer of domestic orders for some chemical products, the effectiveness of supply side reform policies during the "13th Five Year Plan" period, the general rise in raw materials for most chemical products in the context of global liquidity easing, and the improvement in marginal demand in the middle and lower reaches of the industry, The chemical industry market presents a "resonant rise" in the prices of bulk chemical basic raw materials and resource products, driving up the middle and downstream industrial chains of various chemical industries; In the second half of 2021, under the influence of "dual control" and production restrictions, the domestic chemical industry sector further contracted, and the traditional "golden nine silver ten" demand peak season arrived, and the mismatch between supply and demand drove the chemical industry boom further upward. Overall, in 2021, the pro-cyclical recovery accelerated, and the industry prosperity significantly increased:

Chemical Product Price Index: The CCPI (China Chemical Product Price Index) has rebounded from its bottom (April 2, 2020) of 3154 points to a high of approximately 6467 points in the past eight years (October 19, 2021). The high point is up 55.72% from 4153 points at the beginning of the year (January 4, 2021). As of December 8th, the CCPI price index has retreated from a higher point by more than 20%. It is worth mentioning that the "Golden Nine Silver Ten" is the traditional peak demand season in the chemical industry. From September to October 2021, chemical products performed well, with major chemical varieties continuing to adjust prices, and prices of multiple products continuously rising and reaching new or even historical highs. Since the beginning of 2021, the PPI of all industries such as industrial products, chemical raw materials and chemical product manufacturing, chemical fiber manufacturing, rubber and plastic products, petroleum, coal, and other fuel processing industries has changed from negative to positive year-on-year, and has significantly increased and reached a new high.

Performance repair: Benefiting from the impact of the epidemic and extreme weather on overseas supply, the transfer of orders for some domestic chemical commodities, the effectiveness of supply side reform policies during the "13th Five Year Plan" period, the general rise in raw materials for most chemical products in the context of inflation, and the improvement in marginal demand in the middle and downstream industries, the chemical market showed a "resonance rise in the industrial chain" trend in the first half of 2021; In the second half of the year, under the influence of "dual control" and production restrictions, the supply side of domestic chemical products further contracted, and the traditional "golden nine silver ten" peak demand season arrived, and the mismatch between supply and demand drove the prosperity further upward. We selected a sample of 410 mainland chemical listed companies (excluding Sinopec, PetroChina, and B shares) that have been operating stably in Q1 2020 to calculate total operating revenue and total net profit attributable to the parent company. Overall, from Q1 2020 to now, the operating revenue of 410 listed chemical companies has continued to recover significantly year-on-year and month-on-month; The total net profits attributable to the parent company of the 10 listed chemical companies from Q1 to Q3410 in 2021 were 637.81 billion yuan, 81.222 billion yuan, and 72.479 billion yuan, respectively, with year-on-year growth of 232.60%, 112.75%, and 74.01%, and year-on-year growth of 100.84%, 27.35%, and -10.76%, respectively. The chemical industry prosperity further increased. In Q4 2021, with the cost reduction and downstream demand entering the off-season, we expect the chemical industry boom to decline somewhat.

In terms of basic chemicals, the growth rate of demand for new energy vehicles, photovoltaic, semiconductor industry chains, and other related chemical products (such as lithium hexafluorophosphate, iron phosphate, dimethyl carbonate, PVDF, EVA, soda ash, trichlorosilane, etc.) is outstanding; The supply and demand of titanium dioxide, glyphosate, spandex, silicone, soda ash, acetic acid and other products are mismatched, and the prosperity has increased significantly; Against the backdrop of high global crop prices and rising costs, the prosperity of the simple fertilizer (urea, phosphate fertilizer) and compound fertilizer industries has significantly improved, and the supply and demand patterns of glyphosate, ammonium glyphosate, and other pesticide products have continued to optimize; The sub industries such as glass fiber, coatings, paint, and ink will continue their strong recovery trend;

In addition, due to the dual control and limitation of energy consumption, some high-energy chemical products have experienced a phased imbalance in supply and demand, such as the price of yellow phosphorus, industrial silicon, kerosene and gas, which has skyrocketed in the short term; In the field of petrochemical industry, the leading company's refining and chemical plants are competing for outstanding advantages, and the backward production capacity of the polyester industry's supply side will accelerate the liquidation; The global demand for chemical products such as disinfectants, masks, goggles, and plastic packaging is strong; In terms of new materials, downstream demand for automotive exhaust purification materials, plastic, and other industries is stimulated by the implementation of policies, and there is significant room for growth; Import substitution logic such as semiconductors, new energy chemicals, and carbon fibers remains sustainable; High performance engineering plastics and high-performance film materials are expected to enter a stage of rapid growth, benefiting from the release of downstream demand.

Investment Strategy for the Basic Chemical Industry in 2022: Investment Direction in the Chemical Industry under the Background of "Double Carbon"

The supply side contradiction of chemical products in China will further intensify in 2020-2021. From the perspective of China's production capacity cycle, the duration of a production capacity cycle is about 7-11 years, mainly experiencing four stages: "passive capacity removal - active capacity replenishment - passive capacity replenishment - active capacity removal". Since the reform and opening up, China has experienced four rounds of production capacity cycles. Taking advantage of the "13th Five Year Plan" supply side reform, the chemical industry has gradually eliminated old production capacity, and the industry concentration has increased and concentrated towards the top. Since 2017, China has started the bottom and starting point of the fifth round of production capacity cycle, characterized by:

1) Under the dual effects of supply side reform and equipment upgrading cycles, mass production capacity has been upgraded and optimized. At the same time, in 2016-2017, chemical enterprises achieved significant results in deleveraging; 2) From the perspective of the completed amount of fixed assets investment, the pace of capacity delivery in the upstream raw material industry has slowed down, while the capacity of petrochemical/chemical fiber industries has rapidly released; 3) Local and various levels of environmental supervision have intensified and repeatedly "looked back", and continue to attach great importance to safety production issues. Chemical enterprises that violate regulations, fail to meet production standards, and have prominent safety hazards will accelerate their exit. From 2017 to 2018, the liquidation of capacity in most chemical sub industries in China has ended, and a new round of capacity cycle launch/release period is about to start. However, in 2020, the global economy will slow down and the chemical industry will face pressure due to the impact of trade frictions, counter globalization, and the COVID-19; At the same time, many new chemical projects have been put on hold. This set the tone for the prominent supply side contradiction of chemical products in 2021.

As an important upstream and midstream industry, the development of China's chemical industry always follows the direction of the national economic industry. Whether it is the "three acids and two alkalis" before liberation or the "fertilizer and pesticide" after liberation, it is the rapid development of the chemical fiber, rubber and plastic industries after the reform and opening up, all of which serve the socio-economic development and industrial structure upgrading of China. The year 2021 is the opening year of the "14th Five Year Plan", which states that the goal of China's petrochemical industry is to move from a large country to a powerful country; At the same time, in the context of the "carbon neutral" and "carbon peak" vision, energy transformation and long-term deep emission reduction have become an inevitable trend in China's future.

Under the joint catalysis of significant achievements in supply side reform, lower than expected capacity release under the impact of the epidemic, and limited production under the background of "dual control of energy consumption", the contradiction between supply and demand of chemical products in China will further highlight in 2021. At the present stage, China's chemical industry is still in a period of strategic opportunities, with great potential for industrial structure optimization and upgrading. The upstream material field of new energy is facing significant development opportunities; In addition, the long-term implementation of the "dual control of energy consumption" policy and the recent liberalization of electricity prices for industrial products related to high energy consumption will drive up their production costs in the long term. In the future, chemical enterprises will face significant changes in the way they use energy, production emissions, new energy and materials manufacturing, and consumption habits.

Entering the stage of passive inventory replenishment exacerbates the uncertainty of the supply and demand pattern in the chemical industry, and it is recommended to seize structural opportunities in 2022. A complete inventory cycle lasts from 30 to 45 months, including four stages: "passive destocking - active replenishment - passive replenishment - active destocking". At the beginning of 2000 and 2020, China has completed six inventory cycles. The previous (sixth) inventory cycle began in July 2016. Against the background of supply side reform, elimination and liquidation of upstream industry capacity, and a rebound in real estate and infrastructure investment, industrial enterprises' profits have been gradually restored, and the inventory cycle has entered the active inventory replenishment stage; After that, after Q2 2018, it entered the passive inventory replenishment stage; In September 2018, it entered the proactive phase; At the end of 2019, inventory in the chemical industry (a midstream industry) entered the bottom range.

In the first quarter of 2020, due to the impact of the NCP epidemic, the production and consumer demand recovery processes of enterprises were mismatched, resulting in a rapid accumulation of inventory in the industrial and manufacturing industries, opening a new (seventh) inventory cycle. From April to October 2020, the inventory cycle was in a passive state, and China's economy recovered strongly; Since November 2020, China has entered the active inventory replenishment stage and gradually transitioned to the passive inventory replenishment stage. Our economy may enter an overheated and gradually slow down, and then transition to recession. According to the data of the National Bureau of Statistics, as of October 2021, the inventory of finished products in the chemical raw material and chemical product manufacturing industry, chemical fiber manufacturing industry, rubber and plastic products industry, oil, coal, and other fuel processing industries was+25.50%,+18.60%,+19.50%, and+18.70% year-on-year, respectively. This has been a positive year-on-year growth for seven consecutive months since April 2021, and the growth rate has shown a trend of increasing month by month.

Main investment line 1: Double carbon boosts the new energy industry, and upstream demand for chemical materials grows

Phosphorus chemical industry: Under the background of "dual control", the cost of the phosphorus chemical industry chain has risen, and the surge in LFP demand has driven the prosperity of the "wet process phosphoric acid iron phosphate" industry

Under the background of "dual control", the cost of phosphorus chemical industry chain is rising, and the price of phosphorus chemical products is expected to continue to rise

The supply side reform has achieved significant results, and the "three phosphorus" renovation has helped to continuously optimize the capacity structure of phosphorus chemical industry. In recent years, with the continuous promotion of supply side structural reform and the policy guidance of reducing energy consumption and promoting environmental protection, the structure of China's phosphorus chemical industry chain has been gradually adjusted. Protecting phosphate rock resources, reducing phosphate rock mining, reducing phosphate fertilizer exports, and controlling yellow phosphorus production capacity can effectively reduce phosphorus pollution, which is the fundamental way to solve the "three phosphorus" problem. At the beginning of 2019, the Ministry of Ecology and Environment made the inspection and rectification of phosphorus chemical enterprises such as phosphate rock, phosphate fertilizer, and phosphorus containing pesticide manufacturing along the Yangtze River, as well as phosphogypsum warehouses (referred to as "three phosphorus"), a key task for reducing "phosphorus" in the Yangtze River.

In retrospect, since the implementation of the remediation action, China has achieved significant results in reducing "phosphorus". In 2016, the concentration of total phosphorus in the nine heavily polluted rivers in the Yangtze River Economic Belt with total phosphorus as the classification index fell below the limit of the Class V standard in 2019, and all of the original total inferior Class V rivers fell to Class 5. On the whole, the supply side reform of the phosphorus chemical industry has achieved remarkable results. Under the continuation of the environmental protection policy, according to the statistics of Baichuan Yingfu, (1) in terms of phosphate rock, the mining output of phosphate rock in 2016 reached the peak of 144 million tons, about three times the mining output in 2007, and the CAGR in 10 years was 12.30%. By 2017 and 2018, China's phosphorus ore production had significantly decreased, and in the past two years, it still showed a slight downward trend. In order to limit the excessive outflow of phosphate rock, the state has introduced policies to restrict exports;

(2) In terms of yellow phosphorus, after the normalized operation of environmental supervision in 2016, yellow phosphorus enterprises have been subject to stricter supervision, and there are often enterprises that shut down or even quit due to environmental inspections, resulting in continuous rectification of the yellow phosphorus industry. In 2019 and 2020, the yellow phosphorus production was 644900 tons and 777500 tons, respectively, with capacity utilization rates of 46.75% and 53.37%. In 2019, Guizhou and Yunnan strengthened the renovation of yellow phosphorus enterprises, resulting in a decline in the annual production.; (3) In terms of phosphoric acid, the overall production capacity of phosphoric acid also shows a downward trend. On the whole, we believe that due to the nature of upstream phosphorus ore resources, as well as the high energy consumption and high pollution issues of the important intermediate yellow phosphorus, the industry prosperity has undergone significant changes in the phosphorus chemical industry chain. At the same time, the industry concentration has significantly increased after the integration of the two phosphorus chemical giants in Guizhou Wengfu and Kaiphosphorus, and the pricing power of global phosphorus chemical products will be tilted towards China, Therefore, in the future, the prices of related products in the phosphorus chemical industry chain are expected to continue to rise, and the industry prosperity will continue to rise.

Under the background of "dual control", the cost of the phosphorus chemical industry chain has increased, and the iron phosphate production industry of "integration of mining, electricity, and iron phosphate" will have a core competitive advantage. It is optimistic that enterprises with mature purification wet process phosphoric acid technology will be developed. Phosphoric acid railway line will become the mainstream process for preparing lithium iron phosphate with relatively lower cost and better cost performance. The mainstream process of iron phosphate precursor includes two routes: "iron block+phosphoric acid" and "ferrous sulfate+monoammonium phosphate". Currently, thermal phosphoric acid occupies a leading position in the domestic phosphoric acid market, but the unit consumption of the vast majority of P2O5 products produced by purified wet process phosphoric acid per ton is 1.21 tons less than the standard coal of traditional thermal phosphoric acid, which is about 1/3 of the energy consumption of thermal phosphoric acid. The wet process purified phosphoric acid can greatly save energy consumption and achieve significant economic benefits. In the future, the proportion of wet process phosphoric acid production capacity in China's phosphoric acid industry is expected to continue to rise.

In addition, there are many advantages in the wet process for producing industrial grade monoammonium phosphate. However, the difficulty of purifying wet process phosphoric acid technology and the difficulty of solving the problem of by-product phosphogypsum are common problems faced by iron phosphate enterprises. China introduced the wet process phosphoric acid process in the 1960s, and domestic industrial phosphoric acid is mainly produced through thermal processes. In recent years, with the breakthrough in wet process phosphoric acid purification technology, refined wet process phosphoric acid has replaced partial thermal process phosphoric acid. Overall, at present, most wet process phosphoric acid in China is still used to produce high concentration phosphate compound fertilizers, with only 10-20% being used for purification and processing to produce industrial grade phosphate.

In recent years, China's phosphoric acid structure has been gradually adjusted, and the proportion of wet-process phosphoric acid production capacity in China's phosphoric acid industry is expected to continue to rise in the future, which will indirectly affect the demand for yellow phosphorus. We are optimistic that the market growth space for wet-process phosphoric acid in China remains broad. According to the statistics of Baichuan Yingfu, the production capacity of wet process phosphoric acid and thermal process phosphoric acid in China is currently 1 million tons and 2.61 million tons, respectively. The production capacity of thermal process phosphoric acid is gradually shrinking, and the production capacity of wet process phosphoric acid is stable. In recent years, the market share of wet-process phosphoric acid production capacity in China has gradually increased: in 2015 and 2020, the production of thermal phosphoric acid decreased from 1.97 million tons to 1.24 million tons, while the production of wet-process phosphoric acid increased from 470000 tons to 880000 tons. In addition,