INSIGHT: The threat from financial turmoil

19 September 2008 17:12  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS news)--Towards the end of an extraordinary week some confidence has returned to the world’s financial markets while manufacturing industry still has to take stock.

At the time of writing the US federal government was poised to release details of a bail-out plan for banks saddled with illiquid assets.

It was expected to take on billions of dollars worth of mortgage-related debt, the toxic loans that are the root cause of this unprecedented financial collapse.

Inter-bank lending is all but frozen and the future of once strong financial institutions still under threat.

Markets reacted positively to news of the US government’s expected life-line and appeared to be moving in the right direction on Friday. Chemicals stocks were showing some strength following the losses of the past few days.

But the recent turmoil will not easily be left behind.

The knock-on effect on companies and markets could in itself be unprecedented.

Manufacturing industry is heading for a steeper than expected slowdown and chemicals growth is expected to stall. There is continuing high risk of a major economic downturn.

Weaker demand is already having an impact on important polymer and other chemicals markets in North America and Europe.

Projections of sector output have been lowered substantially since the start of the year based on the spreading slowdown and fears of recession in western economies.

This banking sector turmoil, however, could dent the decoupling theory which suggests that the fast growing economies in Asia and other parts of the world are somehow immune from events in the West.

Russia’s stock markets have this week demonstrated extreme sensitivity in being closed automatically as shares fell and then rebounded. Significant value had been lost on the Asian financial markets as the contagion had appeared to spread.

Of vital importance for chemical makers is the health of demand from China and other Asian nations.

China’s unprecedented demand growth has helped buoy the sector and militate against the effects of the sharp downturns in key markets for chemicals such as construction and automobiles.

The balance then between China’s ongoing domestic demand for the goods of all sorts that require chemicals to make them, and goods manufactured for export, is crucial.

Slowing demand growth began to take its toll in the second quarter: the American Chemistry Council’s global chemicals production index (for chemicals excluding pharmaceuticals) fell from 9.5 to 6.1 between April and June.

Chemicals growth in North America and Western Europe has slowed markedly and the statistics are showing demand growth under pressure in China and wider Asia.

Asia's petrochemical industry could face its worst downturn since the 1997-2002 financial crisis, commentators said this week.

"We were riding on the astronomical growth of China and India in the early 2000s through to 2007 but from now on, we're looking at a possible three-to-four-year downturn," one Thailand-based analyst said.

The chemicals world needs continued strong demand growth from China, and India, to help soak up the bulk of new production capacities coming on stream in the Middle East.

Without that demand growth, product will back up into markets in Europe, North America and elsewhere threatening the weakest local producers.

Some firms are more vulnerable than others. The coming downturn will test production and operating efficiencies and, indeed, the balance sheets of some.

Turmoil in the financial markets could temporarily disrupt merger and acquisition (M&A) activity and add risk to existing deals, Scott Anderson, senior economist with US financial services company Wells Fargo, said on Thursday.

But on the other hand, the disruption to credit markets could help generate more interest in consolidation.

At the ICIS Chemical Purchasing summit in Boston, Massachussets, this week, Laurence Alexander, an analyst with the investment bank Jeffries, said: “The main question is whether the credit market dislocations will have an impact on credit availability next year, and how sensitive the market will be to balance sheet ratios.

"It’s possible the market may penalise companies for having high debt levels."

You are fine if you can continue to service debt, but physical market dynamics suggest that cashflows are likely to diminish over the coming quarters. Woe betide any chemical producer in need of refinancing over the next six months.

Chemical companies have come rapidly off a plateau of performance still manifest in 2007 but clearly weakened in the first half of 2008.

How that performance might be affected by the storms raging in the financial markets may not be clear but the prognosis is not good.

“The credit crisis is like an uncontrollable forest fire, with the potential damage to the US economy at the whims of the markets,” Well’s Fargo’s Anderson said in Boston.

The financial market turmoil threatens chemical companies worldwide as well as the markets they serve.

Bookmark Paul Hodges' Chemicals and the Economy and John Richardson’s Asian Chemical Connections blogs

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