Why VSF operating rate rises instead of falling under great cost pressure?

The cost of VSF has been rising this year with imported inflation, increasing demand in international market and higher logistics cost. It can be seen from the following table that the price of most raw materials is higher than the comparable 2021 level and there is substantial increase of energy and logistics cost, while the price of VSF is not very high.

VSF companies have been suffering losses this year with continued rising cost.

VSF price has gained ground by around 2,000yuan/mt this year, but profits have been in negative territory and losses seem to be widening since Apr, despite improving profits in Jan. Although the losses keep widening, the operating rate of VSF plants is rising constantly and is likely to reach 80% by the end of Apr.

The main reasons are as below:

1. The theoretical loss of VSF plants has been around 1,000yuan/mt, but is still lower than the peak of 2020 and 2021 when the deepest loss was more than 2,000yuan/mt. According to CCFGroup’s estimation based on theoretical calculation, the variable cost can almost be covered by current price by disregarding depreciation and labor cost, which is roughly around the equilibrium point of shutting/running the facility.

2. In fact, most VSF plants do not adopt on site procurement of raw materials and they generally purchase dissolving pulp as the major feedstock two months or even more than two months before. According to customs data, imported dissolving pulp arrived at Chinese ports in Mar is almost around $936/mt, which is lower than the trading price of $960-980/mt during the month.

3. Most VSF plants are equipped with feedstock or auxiliary materials. For example, Tangshan Sanyou and Zhongtai Chemical has caustic soda and Sateri has dissolving pulp. Once VSF units are shut down, those raw/auxiliary materials cannot be absorbed. Moreover, some companies are also coincided with downstream capacities, so the shutdown of VSF lines may cause lack of enough raw materials in downstream segment.

4. At present, the government's support for the economy is mainly to ensure the production, including financing and fiscal support to different enterprises. At the same time, some enterprises also undertake employment tasks, so it is not suitable for them to stop production.

What influence can be brought by continued rising operating rate? VSF operating rate in the first quarter is at 75% or slightly lower, which can be largely matched with current downstream demand. There will be minor surplus if the run rate rises to 80%, but when the demand remains unchanged during the month, the inventory of VSF plants may increase by 2 days, which is an acceptable range according to current situation, so the impact is theoretically limited.

But the problem is how the demand will change. At present, the operating rate of spinners will not change significantly in May, but the procurement is likely to be affected by the external environment. Spinners who realized the existence of inflation have been active in procurement and the purchasing volume has been more than 1-month consumption since the beginning of this year. However, the COVID-19 epidemic in China has been repeated since Mar, the economic growth is challenging and the Fed may significantly raise the interest rate in May. If those factors trigger the great change of financial market, downstream confidence may be influenced. Once downstream plants reduce feedstock inventory with changing expectation, the market may be under bigger pressure.

At present, inflation and risk prevention should be taken into account and market participants shall be neutral instead of too aggressive.