INSIGHT: A time for thinking outside the box

01 July 2008 17:17  [Source: ICIS news]

By John Richardson

Inflation fears set markets on edgeSINGAPORE (ICIS news)--It’s getting very tough out there and it could well become a great deal more difficult for anyone lacking the necessary creativity and innovation.

“Subprime is huge and is equivalent to the Great Depression,” said Daniel De Blocq van Scheltinga, a financial consultant.

Van Scheltinga, a former investment banker who is founding partner of Polarwide Investments, was speaking at the 4th Asian Aromatics and Derivatives Conference* which took place in Bangkok last week.

Inflation - driven by what now feel like unsustainably high levels of growth in Asia and surging commodity and food prices - also threatens to create a global downturn that could last three-to-four years.

Asian governments have been so focused on growth that, with the wonderful benefit of hindsight, seem to have taken their eyes off the ball. Inflation could be very hard to control as increasing numbers of people demand all the things that westerners already have.

The warning signs have been around for a long time. Fevered property speculation and wage-price spirals, all major contributors to the increase in oil and other commodity prices, emerged in Asia during the early years of this decade.

To date, the concern has been about appreciation of currencies on strong growth and capital inflows. But could the reverse occur in some Asian countries - excluding China - if investor confidence evaporates?

Unlike in 1997, governments have huge foreign currency reserves. But only in the case of China will these reserves last just about forever.

The traditional alternative of pumping money into public works programmes to boost demand during times of economic difficulty risks even more inflationary pressure.

The countries with currencies linked to the US dollar have been forced to import inflation as lending rates in the States have fallen – bringing down their rates in parallel. How sustainable are these currency links?

The 1997 Asian financial crisis was a regional event with some significant global implications.

This crisis will have a wider and deeper impact because of globalisation. Unintended consequences abound - for example, part of the reason why Vietnam’s inflation rate hit 27% in May was because of the relocation of manufacturing from China.

Foreign investors have shut down production and shifted it to Vietnam as a result tax of changes and rising costs in China.

Chemical markets could become more regional as feedstock and transportation costs keep on rising. The Middle East will be fine because of its cost advantages, as will China because its companies will be encouraged to keep capacity running for strategic reasons.

Japan, South Korea, Taiwan, Singapore and Thailand might suffer very badly, though - especially the latter two countries which are in the midst of major capacity expansions.

Chemical companies may resort to more anti-dumping claims to protect their home markets. And at a macro level again, trade barriers could be erected by governments in response to anti-globalisation.

Growth in Asia will still seem healthy relative to the west. China’s GDP is expected to expand by 8-9% this year compared with 11.4% in 2007. The IMFexpects US growth to be roughly flat this year and to rise to around 2% in 2009.

In some respects, lower growth in China would represent a welcome cooling down of the economy. But this would be bad news for anybody who has planned their business on GDP continuing to rise at 10% or more.

If you add all the new chemical projects together, growth remaining close to the 2007 level might have been the collective assumption.

What would happen if, as some commentators suggest, GDP in China only expands by 5% next year?

In polymers, there is increasing evidence of a China slowdown. Double-digit growth is still being forecast in official statements by companies. But privately, some of the companies are admitting that polyethylene (PE) and polypropylene (PP) consumption might only expand by single digits in 2008.

The fundamentals of crude oil supply and demand point to prices of well above $150/bbl this summer as Middle East power plants run flat out to keep all the air-conditioning units running.

Many of the plants run on fuel oil, meaning less crude available for export if there are no further increases in production.

The hurricane season in the US Gulf is also only just around the corner. And if Israel does attack Iran, could we be looking at $200/bbl plus prices by the end of this year?

It is a stretch to suggest that any international chemical company without sufficient access to discounted oil and/or gas will go bust.

But Middle East and Chinese companies are already reported to be on the prowl for more assets.

It is likely to remain a buyers’ market for a considerable time. Western companies might be able to avoid outright sales, but could still be forced to concede majority ownership in certain projects or business divisions.

Private equity owners might have to sell at returns less than they had anticipated.

Over the past few years it’s been a case of running plants hard, selling product to anyone as quickly as possible to keep operating rates high in order to maximise earnings and planning for new projects. Abundant credit made for an easy life.

Now that demand is weaker and credit a great deal tighter, it will be a case of looking at new ways of financing.

“If you go to a bank these days and ask for $100m, you will be told that you can only have $10m at much higher interest rates than previously,’’ added Van Scheltinga.

He suggested leasing rather than buying plants. For example, he was recently involved in the leasing of a polyvinyl chloride (PVC) facility in China.

Cash management will become king. Taking a much harder look at your customers, including cutting off those who you assess are in danger of going bankrupt, will be crucial. This might be particularly difficult in Asia where relationships and the concept of “face” are so important.

Methods of making money other than selling chemicals might also become important. This includes selling carbon credits under the clean development mechanism.

When the going gets tough the tough get going, is the old cliche.

Paul Hodges, chairman of UK-based consultancy International eChem, added on the sidelines of last week’s conference: “This is a great opportunity for creative and innovative thinking, for bright people who can think outside the box.”

This is a useful pointer for anyone who wants to keep their job.

($1 = €0.63)


*The 4th Asian Aromatics & Derivatives Conference was organised by ICIS and International eChem.
To discuss issues facing the chemical industry go to ICIS connect


By: John Richardson
+65 6780 4359

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