INSIGHT: Asia petchems tragedy or farce

23 May 2007 16:25  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)--The out-of-fashion political theorist Karl Marx wrote “history repeats itself, first as tragedy and then as farce”.

The tragedy was the Asian Financial Crisis which devastated South Korea and Southeast Asia leaving economies, banks and businesses in ruins and tens of millions out of work. This decade-old crisis coincided with a big build-up in petrochemical capacity.

What could result in farce is that hardly anybody at last week’s Asia Petrochemical Industry Conference (APIC) in Taipei, Taiwan, seemed to recognise the scale of risks being undertaken by companies who are once again ploughing into huge investments.

Some 40m tonnes/year of ethylene capacity alone is due on stream in 2006-11, 40% of which is in the Middle East and therefore low cost, estimated one industry source.

Everyone, of course, acknowledged the big capacity ramp-up as large, complex and very expensive lumps of metal are hard to dismiss as mirages in the desert. Few, though, were prepared to concede that the “new paradigm” everybody was getting so excited about might be nonsense.

The paradigm is that nothing much can go wrong with growth. China, India and other emerging economies have become such major consumption drivers that even a US recession might not be so bad, was a familiar theme.

Everyone conceded that growth could moderate by a few percentage points. But they added that markets had become so big that the drops in growth wouldn’t make much difference, allowing the big new capacities to be easily absorbed.

“It took India 61 years since independence to become a trillion US dollar economy – a milestone we arrived at a couple of weeks ago. The next trillion dollars could be added in 6-7 years,” was the comment of one Indian delegate and fairly typical of the overall mood.

He believed that the downturn would not be before 2010 and when it did arrive, it would not be as bad as last time,

Other estimates, though, were for global cracker operating rates in the mid-80 per cent range in 2010-11. This would be as bad as the previous downturn in 2001-02.

But delays, delays and more project delays were a constant theme of discussions. A better-then-expected staggering of capacity and resilient growth would result in the mildest downturn in history, everybody kept repeating over and over again.

At least several of the keynote addresses touched on the need for Japanese and other high cost Asian producers to move further down the value chain. Sumitomo Chemical, for example, has made excellent progress in repositioning itself through the PetroRabigh joint venture and is the most prominent example of the patient and persistent changes that have been going in Japan for years.

The risk is that as Saudi Arabia diversifies into higher value-added petrochemicals such as the polycarbonate (PC) chain, polyurethanes, nylon intermediates and methyl methacrylate, these higher value-added products will become commoditised.

As many as three PC plants could be built in the Middle East over the next few years – representing around 600,000 tonnes/year of capacity into a relatively small market.

It is a perfect fit. The Saudis want diversification; the westerners and Asians with in-demand technologies want to get their hands on competitive olefins and polyolefins production to allow them to close down plants back home. Could the wrong decisions be made that disrupt niche markets for the sake of restructuring?

But to go back to the main point, growth cannot and surely will not continue its almost exponential rise of the last few years.

Lehman Brothers analyst Sergey Vasnetsov makes the point that because global GDP (gross domestic product) growth underwent a record boom in 2004-06, a cyclical slowdown is historically inevitable.

There is also always the possibility of a Black Swan. Nassim Nicholas Taleb, the author, mathematician and former trader, argues in his new book The Black Swan that long-term forecasts are a waste of time because we invariably fail to anticipate the unexpected. A classic example is 9/11.

He argues that we are so focused on the short term we don’t consider the possibility of the unexpected. The fabuluos earnings of the past few years make this a seductively easy trap to fall in to.

On crude oil, many are taking the sanguine view that more efficient use of oil, price resistant and replacement fuels will cap further price rises. Recent history also shows that consumers have been able to absorb the high cost of crude.

But a geopolitical shock could easily drive crude above $100/bbl. Have we also entered what Paul Hodges, consultant with International eChem, calls a second wave of globalisation where excessive credit growth and crude oil-driven inflation have inflated a bubble that must soon burst?

And what about global warming? Yet another alarming report, this time by the charity Christian Aid drawing on UN population and climate change figures, was released last week.

The report says that a billion people could be made homeless by 2050 as a deteriorating environment contributes to other two big causes of migration – conflict and major infrastructure development.

If Christian Aid is only half right, the economic effects could be significant.

One very cynical executive with a European oil-to-petrochemicals major added that if calamity struck, certain Asian companies would continue to operate at 100% out of macho posturing and a desire to sustain market share. History would then be farcically repeating itself, as this is exactly what happened in 1997-98

But the Indian delegate contended: “The sceptics have been crying wolf for years. I said in 2003 that this would be the best-ever upswing and nobody believed me.

“I am telling you again that the downturn will not be before 2010 and when it does arrive it will be mild. The sceptics keep saying the same old things. Eventually they might be proved right, but not for the next few years.”

Perhaps even longer. The Black Swan that the doom-mongers, including myself, have failed to recognise is a permanent and irreversible step-change in the scale of consumption, meaning that capacity will be absorbed without major harm to markets.

Demand is at a much bigger base. Every percentage point increase in growth is, as a result, going to consume far more capacity than a few years ago.

Constraints on resources, and a reluctance to invest in some parts of Asia post-1997, have also to some extent capped capacity additions. It is easy to look at what’s being built in the Middle East and China and lose overall perspective.

One could also argue that Marxism has hardly proved the best of economic models. So why on earth should anyone believe  Marx on history?

By: John Richardson
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