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In recent years, the price of propylene has been lower than that of ethylene, yet the price increases for its downstream products have been much greater than those for ethylene’s downstream products. We believe that, in addition to domestic supply-side reforms, global supply and demand tensions are the more critical factor. After all, unlike steel and coal, which are more dependent on China’s demand, petrochemical products have a high proportion of supply and demand overseas, meaning their prices are determined on a global scale. With the recovery of the global economy, there is significant upward potential for these prices. Meanwhile, the price of the raw material propylene is unlikely to rise significantly in 2018; as a result, the profitability of industries that use propylene as a raw material is set to improve markedly. Profits from propylene derivatives are set to improve significantly in 2018. As the two most important petrochemical products, ethylene and propylene have historically shown an inverse relationship in terms of price trends. From 2009 to 2013, the price of propylene was much higher than that of ethylene; as a result, many propane PDH and coal-based MTP plants dedicated to producing propylene were built in China at that time, causing the growth rate of propylene supply to far exceed that of ethylene. After 2014, amid tight supplies of ethylene, it entered a new cycle of strong demand, and its price performance was significantly better than that of propylene. Looking at the C2–C3 price differential since 2005, both ethylene and propylene have maintained strong prices for about 5 years each; essentially, each has accounted for roughly half of the 10-year cycle associated with petrochemical capacity fluctuations. Based on this, it is likely that ethylene will continue to be more expensive than propylene next year, after which a new cycle in which propylene gradually gains strength will begin. Looking at the actual changes on the supply side, this pattern is also largely consistent: both ethylene and propylene supplies will be limited next year. After 2019, ethylene will enter a period of capacity expansion, with domestic oil-based and gas-based production facilities starting to expand gradually. As profits related to propylene have been significantly lower than those associated with ethylene over the past few years, the scale of expansion for propylene will be much smaller in the future. As for the chemical products derived from propylene, their cyclical trends begin even earlier than those of propylene itself. Although petrochemical prices rose overall in 2017, we observed that the price increases for C3-derived products were significantly greater than those in the C2 industry chain. Excluding polyolefins, since the beginning of 2016, almost all downstream products of propylene have seen price increases of 50% or more; in some cases, the increase was even over 70%. Epichlorohydrin and acrylic acid experienced price increases of over 120%. In the C2 chain, apart from ethylene glycol, the price increases for other varieties were significantly lower. Although each sub-product has its own supply and demand dynamics, the significant difference between the downstream applications of ethylene and propylene indicates that propylene has begun to outperform ethylene in these downstream areas. Looking ahead to next year, if the price of propylene remains relatively low while the prices of its downstream derivatives continue to rise, the profits of these downstream products will increase significantly. In the longer term, rising propylene prices will further drive up the prices in the C3 industry chain; in particular, companies that have access to upstream propylene resources will see a significant increase in their profits. The supply and demand dynamics in the propylene industry chain are as follows: 1) Over the past few years, domestic investment has focused on propylene-related projects (mainly PDH and coal-based chemical industries), while overseas investment has been directed toward ethylene-related projects (mainly ethane cracking), with less investment in the propylene industry chain. However, since most newly established enterprises do not have the existing C3 industrial chain infrastructure, they tend to use the simplest polypropylene for their downstream products (especially those derived from coal chemical processing). This has also resulted in polypropylene accounting for nearly 75% of the total, a figure significantly higher than the 65% global demand share; as a result, investment in other C3 products worldwide remains low. Benefiting from the recent economic recovery in Europe and the United States as well as domestic supply-side reforms, the C3 industry chain has seen a clear turning point, with product prices rising significantly as a result. 2) Since the profitability of ethylene is currently significantly higher than that of propylene, investment interest in the overseas C2 industry remains higher than that in the C3 industry. Meanwhile, investment enthusiasm in the domestic C3 industry has also declined significantly, with the growth rate of propylene supply dropping from 3.2% to 2.2%. The growth rate of supply for non-PP products in the downstream market is also very low; for example, the average annual compound growth rate of acrylic acid supply is expected to be 1.9% from 2018 to 2020, while that of propylene oxide (PO) is expected to be 2.9%. Driven by the demand fueled by the global economic recovery, growth rates will remain strong; therefore, we believe that the C3 industry chain is about to enter a period of robust development. 3) Among the downstream products of C3, we are relatively optimistic about acrylic acid and PO; in an upward economic cycle, there is still significant room for an improvement in their profitability. The relevant companies are Saturn Petrochemical (acrylic acid) and Binhua Co., Ltd. (PO); for every increase of 1,000 yuan in the price of acrylic acid or PO, the EPS elasticity for these two companies is 0.34 yuan and 0.18 yuan respectively. In addition, Saturn Petrochemical will start producing 380,000 tons of acrylic acid by the end of 2018, accounting for 79% of its current production capacity ； Binhua will begin producing 75,000 tons of epichlorohydrin via the glycerol method in mid-2018, and it also has strong growth potential. Investment imbalances have led to a tight supply and demand situation for C3 products. Ethylene and propylene are the cornerstone of chemical production, with several hundred million tons of chemicals being manufactured each year using these two substances. Due to a significant divergence in the direction of capacity investment at home and abroad in recent years, investment in downstream C3 products has remained insufficient, resulting in a very tight supply-demand situation recently. In China, C3 is given priority, while overseas C2 is given priority. The production of ethylene and propylene mainly relies on three methods: oil-based routes, coal-based routes, and gas-based routes (light hydrocarbons). The capacity from oil-based and coal-based routes is used for the combined production of ethylene and propylene, so relative changes in the supply of these two substances do not have a significant impact. The gas-based routes are primarily single-product processes, including ethane cracking and propane dehydrogenation (PDH); the differences in investment levels for these two processes lead to relative changes in the supply of ethylene and propylene. Thanks to the shale oil and gas revolution, U.S. production of ethane and propane has grown rapidly in recent years. The declining prices of ethane and propane have given ethane cracking and propane dehydrogenation a significant cost advantage over hydrocarbon-based and coal-based production methods, which in turn has spurred global investment in gas-based olefin production capacity. Since propane can be liquefied by applying pressure at room temperature, whereas ethane requires cooling in addition to pressure, the construction period and costs for the liquefaction outlet facilities and cargo ships using propane are shorter and lower. As a result, most of the facilities built in the United States are propane export terminals, with very few ethane terminals, which causes the price of ethane within the U.S. to be much lower than that of propane. In the United States, investing in ethane cracking projects is much more profitable than investing in PDH projects; as a result, the U.S. has built a large amount of ethane cracking capacity over the past few years, with almost no investment in PDH capacity. China is short of oil and gas; it lacks the resource advantages necessary for petrochemical production, and relies heavily on imports for its raw materials. Although it was mentioned earlier that PDH is less economical compared to ethane cracking, it is still clearly superior to the oil-based route (especially during the period of high oil prices in 2013 and 2014). Moreover, the large amounts of ethane resources in the United States and the Middle East are not exported, while global trade in propane is on the rise; as a result, domestic companies have chosen PDH as their preferred area for investment. Between 2013 and 2016, 4.12 million tons of PDH production capacity was put into operation in China, along with 4.42 million tons of CTO and MTO capacity (referring to propylene), which led to an increase in China’s propylene production by 6.68 million tons. Between 2013 and 2016, global propylene production increased by more than 13 million tons in total, with China accounting for half of this increase – a figure far higher than the 19% increase in ethylene production. There is an imbalance in investment in the downstream sectors of C3 in China. Ethylene and propylene are gases with high transportation costs; therefore, in China, olefins are generally converted into downstream derivatives on-site before being sold. Therefore, for C3, the capacity layout in domestic downstream derivatives has a significant impact on the global market. Among the downstream products of propylene, polypropylene (PP) is the most important one, accounting for around 65% of propylene consumption. It has a wide range of applications and is a standard commodity. Moreover, PP requires less capital investment for capacity expansion and has a shorter construction period; therefore, PP is commonly chosen in China as the supporting capacity for acrylic derivatives. Looking at the PP production and propylene consumption in recent years, the share of PP among the downstream applications of C3 in China has been increasing steadily; by 2016 it had reached nearly 75%, significantly higher than the global average of 65%. There is a tight supply and demand situation for C3 derivatives worldwide. Between 2013 and 2016, nearly 15 million tons of additional propylene production capacity was added globally; assuming that 50% of this capacity is used domestically, and considering that 75% of that domestic capacity is utilized for producing PP, only about 1.85 million tons of propylene capacity is used for producing other derivatives. Based on an average PP proportion of 65%, there should be approximately 2.55 million tons of propylene used to produce other derivatives. Therefore, over the past few years, due to differing investment trends in the C3 sector domestically and internationally, approximately 700,000 tons of propylene have not been utilized to produce other derivatives, which indicates that global investment in C3 derivatives other than PP is insufficient. Downstream products such as PO, acrylic acid, epichlorohydrin, and acrylonitrile are used in various sectors including real estate, automotive, textiles, personal care, and electronics. In recent years, the economic growth rate in overseas markets, particularly in Europe, has been on the rise, which has led to an increasing demand for these products. However, due to the persistent insufficient investment in these C3 products, the industry’s capacity utilization rate kept rising. Coincidentally, in 2017, domestic supply-side reforms and environmental inspections led to the elimination of many low-quality production capacities, which resulted in a significant shift in the supply and demand for these products, along with a sharp increase in their prices. Taking PO as an example, in recent years the global demand growth rate has been 3.6%, while the supply growth rate has been 2.3%; the utilization rate has reached a very high level, and prices have remained strong. The prosperity of C3 derivatives will continue to rise. Although there is already a clear supply-demand shortage for C3 derivatives, looking ahead, foreign investment focus remains away from C3, and domestic investment in C3 is also declining. We believe the C3 industry chain is poised for a long-term period of strong growth, with acrylic acid and PO being the most promising products. The growth rate of C3 investments worldwide is declining. We have analyzed the investment trends in C3-related chemicals derived from oil, coal, and gas in the future; as investments in these sectors are starting to decline domestically, it is expected that the global growth rate of C3 supply will also decrease. The production capacity for olefins mainly comes from integrated refining and chemical plants, and almost all new capacity additions in the future will be located in China. Based on the production capacity of ethylene, it is estimated that the production volume of propylene will not exceed 4 million tons by the end of 2018–2020. Due to the significant drop in oil prices, interest in coal-based chemical manufacturing has declined greatly. It is estimated that the additional production capacity for propylene produced from coal in China will be 1.95 million tons between 2018 and 2020, while the increase in PDH production will be only 1.77 million tons; moreover, the output associated with these processes is mostly in the form of PP. In overseas markets, although the profitability of the C3 industry chain has increased significantly recently, overall, the profitability of ethane cracking remains very high; particularly in the United States, the profits from ethane cracking are much higher than those from propane dehydrogenation. Therefore, future investments overseas will still focus on ethane cracking, with almost no propylene production capacity. Therefore, we expect the growth rate of propylene production to be only 2.2% over the period 2018–2020, and as a result, the growth rate of supply for downstream propylene derivatives will also decline further. The demand for acrylic acid is expected to increase significantly in 2018. Among the downstream products of acrylic acid, we are particularly optimistic about acrylic acid and PO; both are expected to see strong growth in demand in the future, while there will be very little increase in supply. As analyzed in our previous report titled \"Acrylic Acid is Expected to See a Strong Recovery; Satellite Petrochemicals Looks Promising,\" the growth rate of domestic demand for acrylic acid is expected to be around 9% in the future, while the global demand growth rate has remained at around 5% and is likely to continue at this level. On the supply side, under the current circumstances, there will likely be only an additional 380,000 tons of production capacity added by Satellite Petrochemicals between 2018 and 2020. It is expected that the global utilization rate will continue to rise, and the demand for acrylic acid will also continue to increase. The prosperity of the PO market is expected to see a significant boost in 2018. Thanks to global economic growth and a recovery in the real estate sector in Europe and the United States, we anticipate that its growth rate will remain above 3%; as a result, the annual increase in demand from 2018 to 2020 will be around 300,000 tons per year. The majority of future global supply growth will come from domestic sources; a total of 1.31 million tons will be added between 2018 and 2020. Considering the pace of commissioning of new production facilities, it is expected that demand and supply will be roughly in balance over the next three years, allowing PO prices to remain at high levels. It should be noted that a significant portion of the new production capacity comes from domestic HPPO processes; however, the two existing HPPO production facilities in China have not been operating efficiently, with actual output far below their rated capacity. Therefore, we expect PO supply to likely fall short of expectations, with business activity set to improve further. Conclusion: Investment recommendation – We are optimistic about Satellite Petrochemicals, the leader in acrylic acid production in China, and Binhua Co., Ltd., the leader in propylene oxide production. The former has a production capacity of 480,000 tons of acrylic acid, along with 450,000 tons of PDH capacity, while the latter has a production capacity of 280,000 tons of PO and 650,000 tons of caustic soda. When the product price increases by 1,000 yuan (with all other conditions unchanged and an income tax rate of 25%), the EPS elasticity for the two cases is 0.34 yuan and 0.18 yuan respectively. Meanwhile, Saturn Petrochemical is building production capacities of 380,000 tons of acrylic acid and 450,000 tons of PDH ； Binhua Co., Ltd. is building a production capacity of 75,000 tons of epichlorohydrin; both of these new capacities are expected to contribute to the company’s growth in performance. Risk warnings: 1. Sharp fluctuations in oil prices: Significant increases or decreases in oil prices can lead to substantial fluctuations in the prices of chemical products, thereby affecting the profitability of the industry ； 2. Product demand is lower than expected: If product demand falls short of expectations, it leads to a decline in prices and worsened profits ； 3. Supply growth exceeds expectations: We believe that the production capacity of propylene oxide produced via the HPPO method in China faces difficulties in operating at normal levels; however, if process stability improves, the supply of PO will exceed expectations, leading to a decline in prices and profits.