INSIGHT: Better be prepared for the downturn

16 September 2008 17:15  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS news)--It’s not difficult to agree with the assertion that chemical company executives need to start preparing contingency plans now for a major economic downturn.

It makes good business sense at the very least to have such plans in place as prospects of a steep economic decline become uncomfortably high.

The global financial crisis has deepened with the collapse into Chapter 11 protection of 158-year-old Lehman Brothers and the $50bn (€35bn) Bank of America rescue of Merrill Lynch.

The future of AIG - the world’s largest insurer - also looked yet more uncertain on Tuesday.

The tough stance from the Fed following the $3,000bn bailout last week of mortgage lenders Fannie Mae and Freddie Mac has helped induce even greater financial turmoil and the end is not yet in sight.

The wider economy will not escape the impact of the winds blowing through the world’s major financial markets. Key economies stand on the brink of recession.

For chemicals, the deepening crisis augments concerns about slowing demand growth, overcapacity and the high oil price.

To be burdened by one of these negative factors is enough, but to be hit by all three could prove particularly difficult.

The collapse of one and the rescue of another investment bank gives further weight to the idea that the broker model will not survive this crisis but beyond that the commercial banks are being much more cautious.

The greatest impact in chemicals will be on day-to-day operations and on companies’ ability to borrow to support working capital, but longer-term investments could also be at risk.

As one analyst put it this week, the crisis will lead to “an amplification of everything”.

“We need to start planning for this,” said chairman of International eChem and ICIS blogger Paul Hodges.

He suggested that few firms had employees with experience of a sector downturn that encompassed overcapacity, economic decline and a high oil price, and they might be hard pressed to cope.

“Banks will be trying to cut back loans just as companies have high working capital," he said. " Are companies going to be able to repay their debts?”

Industry economists take a more sanguine and perhaps optimistic view.

“The crisis will depress worldwide GDP growth”, said Henrik Meinke, chief economist at the VCI, Germany's chemicals industry association. “We’ll definitely see a downswing in the world economy.”

But Meinke said the VCI does not see a recession in chemicals even though the financial crisis is harder than first thought.

It expects a year of stagnation in Germany in 2008 but not sharply negative growth.

Sector growth, including pharmaceuticals, is still forecast at 1% for 2008 with zero or slightly negative growth for the chemicals business, excluding pharma.

Europe as a whole could post a slightly higher rate of growth.

The German chemical industry, excluding pharmaceuticals, grew at just under 3% in 2007 (5% including pharmaceuticals) and after three strong years a correction was expected.

Financial crises have prompted the most recent downswings in the global economy in 1997/1998 and in 2001.

One question clearly following the Lehman Brothers collapse is whether there is worse to come.

Data from the European chemicals federation Cefic point to a small decline in chemicals output growth in the first five months of the year.

And the latest American Chemistry Council (ACC) production index data suggest that the output decline in Europe has been accelerating since April as it has in the US.

These are difficult times in chemicals and the second half is likely to prove worse than the first six months of the year. It is too early to be thinking much about 2009 but it could prove to be another year of stagnant growth.

The dynamics of the situation suggest that chemical companies should be prepared for worse to come even though a sharp downturn might yet not materialise.

($1 = €0.70)

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By: Nigel Davis
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