The Chinese chemical industry is at the dawn of a new major upcycle. A recent in-depth report from UBS Group AG points out that, with a deceleration in capital expenditure growth, an accelerated exit of outdated overseas capacity, and stringent policy controls on new capacity additions, the industry is poised for a trend-driven cyclical recovery starting in 2026. The report indicates that after hitting a historical bottom in 2025, industry profitability is now showing clear signs of recovery. The accelerated closure of overseas capacity, particularly high-cost facilities in Europe, combined with voluntary production cuts across several domestic sub-sectors, is gradually improving the supply-demand balance, providing substantial support for the restoration of chemical companies' profit margins. While geopolitical conflicts in the Middle East have introduced short-term uncertainty into global supply chains, UBS views this as a temporary disruption rather than a structural inflection point. This situation has elevated the central price level of crude oil, thereby significantly enhancing the cost advantages of alternative production routes like coal-to-chemicals and light hydrocarbon cracking, directing market capital towards targets with feedstock advantages.
Valuations for the Chinese chemical sector remain at relatively low historical levels. In terms of investment strategy, the market focus is shifting from concerns over short-term cost inflation and supply chain disruptions towards cyclical improvement. Industry leaders with global competitiveness, economies of scale, and significant cost advantages are becoming the core focus for capital allocation.
Declining Capex and Policy Tightening Drive Cyclical Reversal Historical data shows a high correlation between capital expenditure and profitability in the chemical industry. High profits typically drive capex and capacity expansion, while a significant decline in capex often precedes a profit recovery. UBS notes that following a period of concentrated capacity additions, the growth rate of capital expenditure in China's chemical industry is slowing, which will provide momentum for profit recovery over the next one to two years.
Policy tightening is another core driver of this major cyclical reversal. During the 15th Five-Year Plan period, the government is expected to tighten approvals for new petrochemical capacity. As the 2030 carbon peak target approaches, obtaining approval for new chemical capacity will become significantly more difficult. Concurrently, policies controlling both total carbon emissions and intensity, along with the push to upgrade and renovate outdated capacity, will accelerate the elimination of inefficient operations. Furthermore, adjustments to import and export policies are reshaping the industry landscape. Starting April 1, 2026, China eliminated export tax rebates for numerous chemical products and imposed controls on exports of refined oil products and fertilizers. This series of policy measures signifies that China's chemical industry is transitioning from a phase of extensive capacity expansion to a new cycle focused on optimizing existing assets and pursuing high-quality development. Geopolitical Conflicts Disrupt Supply, Cost Advantages Reshape Market Focus Since the outbreak of conflict in the Middle East, market concerns over rising costs and supply disruptions have intensified. UBS forecasts the average Brent crude price for 2026 and 2027 to reach $86/barrel and $80/barrel respectively, with the central price higher than pre-conflict levels. Elevated crude oil prices have directly altered the profitability of different chemical production routes. Taking basic petrochemicals like ethylene and propylene as examples, traditional naphtha cracking routes face profit compression due to rising crude costs, with some overseas new plants even at risk of exit due to prolonged losses. In contrast, China's coal-to-olefins (CTO) and ethane dehydrogenation (EDH) routes demonstrate significant cost advantages. Baofeng Energy, as China's largest coal-to-olefins producer, directly benefits from the widening "oil-coal price spread." Satellite Chemical, relying on its light hydrocarbon cracking route using imported US ethane, has built a deep cost moat.
UBS believes geopolitical risks will prompt companies to place greater emphasis on feedstock supply security, leading to more cautious expansion of naphtha-based petrochemical capacity in the future. As geopolitical risks gradually ease, the market's investment focus will return to fundamentals, concentrating on companies capable of leveraging alternative feedstock routes for low-cost expansion. Divergence Among Sub-Sectors, Polyurethanes and Agrochemicals Show Recovery Resilience Among the over 20 chemical sub-sectors covered, UBS notes significant divergence in their recovery paces. Fundamentals in the polyurethane (PU) industrial chain continue to improve. The MDI and TDI industries feature extremely high technical and capital barriers, with a global oligopolistic supply structure. Industry leaders like Wanhua Chemical possess strong pricing power, enabling them to maintain profits through coordinated price support during market downturns. Future new capacity is also primarily concentrated in the hands of these leaders, resulting in a stable supply-demand structure. Within the agrochemical sector, pesticides and potash fertilizers show strong recovery resilience. Glyphosate, the world's most widely used herbicide, faces limited new domestic capacity additions. Notably, a 2026 executive order signed by former US President Trump to protect domestic yellow phosphorus and glyphosate production has elevated the product's global strategic importance. Regarding fertilizers, changes in China's export policies for urea and phosphate fertilizers will directly impact corporate profits, while potash fertilizer requires close monitoring of the commissioning progress of new overseas capacity. Asia-Potash International, with its vast potash salt resource reserves in Laos, possesses significant production growth potential; Zhejiang NHU has broken overseas technological monopolies in vitamins and methionine, holding industry-leading cost advantages. In the fluorosilicone and refrigerant sector, prices for third-generation refrigerants continue to rise, supported by a quota system, with solid fundamentals. Concurrently, driven by new energy vehicles and the energy storage market, downstream demand for electrolytes, industrial silicon, and PVDF maintains rapid growth. In contrast, products highly correlated with real estate, such as titanium dioxide (TiO2), PVC, and soda ash, still face significant demand and profit pressure in the short term due to weak domestic real estate demand and overseas anti-dumping pressures. Valuations at Historical Lows, Focus on Globally Competitive Leaders Quantitative analysis by UBS shows that the price-to-earnings (P/E) ratio of chemical stocks is negatively correlated with chemical product prices, while the price-to-book (P/B) ratio is positively correlated. Current valuations and institutional holdings for the Chinese chemical sector are at low levels, providing a favorable window for long-term capital deployment. UBS advises investors to adopt a long-term perspective, favoring Chinese chemical industry leaders with global competitiveness, integrated industrial chains, and absolute cost advantages.
Comments