INSIGHT: New routes to redistributing wealth

25 July 2008 17:39  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)--Where will the next ‘wealth effect’ in the West come from?

What might be the consequences for the chemicals industry if it takes many years for Western consumer spending to return to the high levels of most of this decade?

It took the UK property market more than 10 years to recover from its late 1980s/early 1990s crash. Could the US market suffer the same fate?

Real wages for the average worker remained pretty static during the housing boom because of the drift of manufacturing jobs to the developing world.

This drift will surely continue, meaning that a consumer-led recovery might only occur when there is another equity or asset-price bubble.

First we had the dotcom and then the housing bubble - when homeowners used their property as ATM machines to cash in on what were sometimes only notional increases in wealth.

In other words, they hadn’t sold their homes and were spending money on the assumption that they would be able to do so in future at handsome profits.

Perhaps a boom in the share prices of new-energy companies might provide this next bubble. But in these dark days of the credit crisis this seems a long way off.

Chemical companies that are already solution providers - the new buzz phrase - need strong growth in developed economies.

Developed economies consume a lot of speciality chemicals, even though emerging markets have grown rapidly and hold huge potential.

A lot of the old-world chemicals companies still depend heavily on the West for large proportions of their sales. This is despite many years of outsourcing research development (R&D) and building up production in countries such as India and China.

If the West suffers a prolonged downturn, some speciality chemicals players might be starved of cash for R&D.

And for those chemical companies still heavily dependent on commodities, the prospects look bleak if they have failed to shift production to the Middle East and/or China.

The drift of jobs to the developing world will continue, as already mentioned. This means a further hollowing-out of local demand.

High feedstock costs seem certain to persist in the West. All the talk about opening up the US Outer Continental Shelf to exploration is just talk and so increased oil and gas production could be as long way off.

In the UK and Norway, the big concern is the North Sea.  Reserves are declining more rapidly than just about anywhere in the world, according to the International Energy Agency (IEA).

Even for companies such as Dow Chemical, Shell Chemicals and ExxonMobil Chemicals that have successfully invested in the Middle East and China, prospects for conventional growth may have diminished.

China seems to realise that it is unsustainable for a population of its size to ever have per capita consumption levels approaching those in the West. The environmental effects of allowing consumption to grow to such levels seem certain to be catastrophic.

Conservation, recycling and perhaps even resource-sharing are likely to develop at a rapid pace in China.

For example, maybe sophisticated modern launderettes will spring up across China, resulting in a decline in washing-machine ownership.

The Chinese government is ideally placed to make rapid progress on implementing solutions to the environmental crisis because of strong central control.

High oil, food and other commodity prices are further reasons to believe that every emerging nation will have to throw the old growth model out of the window.

The need to conserve and recycle - and to develop renewable and more energy-efficient production processes - would become even more pressing if a global carbon trading and/or cap-and-trade system was introduced.

This creates great opportunities for companies such as Shell with its carbon capture and sequestration technology and BASF with its focus on innovative “green” technologies and processes.

But will new areas of revenue ever be big enough to compensate for lost potential in the old route to prosperity - rising per capita consumption of hydrocarbon-based chemicals and plastics using existing processes?

“Yes” seems certain to be the eventual answer because of government subsidies, corporate innovation and a huge influx of funds once the financial sector has recovered.

Western chemicals players are in a strong position to get a big slice of this new market because they have been around for so long.

But to repeat again the longer the economic crisis goes on, the greater pressure on R&D spending.

The experience gap could also shrink if Western companies run short of cash to spend on innovation as the Chinese government continues to throw money at its research institutes.

Working with Chinese research institutes and companies is always an option for the Westerners - but intellectual property right risks remain.

Could further Middle East investment in Western chemical companies be the answer?

SABIC bought GE Plastics in 2007 to get its hands on a US distribution network and polycarbonate and other engineering plastics technologies.

The Kuwait Investment Authority, a sovereign wealth fund, invested $1bn in the Dow takeover of Rohm and Haas earlier this month.

If the economic crisis worsens and becomes as bad as The Great Depression, Middle East companies and governments might end up with outright ownership of a chemical major.

Mideast governments are well aware that oil and gas reserves won’t last forever and so are eager to diversify their economies.

The Chinese chemicals giants - with the exception of ChemChina - have been focused on securing overseas energy supplies. However, Sinopec and PetroChina might one day emerge as buyers of overseas chemicals assets.

The Middle East and China both believe in long-term planning for the good of their people and are suspicious of unfettered capitalism - with good cause given what the mortgage brokers have been up to.

“Private ownership has given me a whole new level of freedom to think strategically over 10-20 years. I no longer wake up every morning worrying about the next set of quarterly results,” says an executive with a company that went from public to private ownership.

Just imagine the further freedom to innovate that might result from the support of more Middle East oil wealth.

Is this the death of capitalism as we know it?

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By: John Richardson
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