INSIGHT: Stuff and nonsense - let's get physical

12 November 2008 17:56  [Source: ICIS news]

By Peter Salisbury

LONDON (ICIS news)--Say the words “global economic crisis” twenty times. Go on, say them. Repeat the exercise until they lose all real meaning. 

Then substitute the estate agent’s favourite “this current climate”, or a newscaster’s “recessionary fears” and do it all over again.

It’s a strangely satisfying feeling to reduce words which seem so loaded to mere repetitive sounds, if somewhat alarming, like the nagging fear you have left the gas on. 

Every day at the moment seems to herald another “boost” to stock and commodity markets through some new stimulus package or production cut in the Middle East, followed by falling values as “fears” over the “crumbling global economy” cause a “flurry of selling”.

Sometimes it is all too easy to lose sight of, for want of a better word, stuff - actual physical things, rather than abstract soundbites or forecasts from analysts at banks now worth cents rather than billions. 

And it is important not to do this, because in the petrochemical industry, as much as any other, it is the stuff that is causing and will cause any number of headaches.

Talking about consumer sentiment in Europe being on the downtrend, with the official index down three points month on month and 28.8 points year on year in October (October 2008: 42.0; September 2008: 45.0; October 2007: 71.80) sounds quite sobering. 

But compare this with truck orders at Volvo in the third quarter of 2008. Adjusting for cancellations, the company reported a net 115 orders, compared with 41,970 the previous year. That’s a lot of stuff not being bought all of a sudden.

A much quoted differential, but one which bears repeating, is the price of crude oil over the past few months.

Where WTI hit $147.50/bbl in July, at the time of writing both Brent and its western cousin were trading below $60/bbl, down some 63% in around four months, falling in part on “demand fears”.

With feedstock prices crashing and offtake from not just automotive, but construction  and consumer markets, haemorrhaging, surely what is needed, and can be provided, is lower prices? 

The cheaper things are, the logic goes, the more we can boost demand for stuff, and hence reinvigorate the economy. 

But here comes the kicker.

If people have to buy stuff, say, feedstock A, and use it to make other stuff, say product B, and this process continues until end-product Z, we have a value chain. 

And if product Z isn’t selling, then there is a chance that the chain will gradually back up until product A is no longer in demand and each producer fills up their inventory.

As demand weakens, and prices for product A diminish, it would be reasonable to expect product Z to drop in value.

But imagine, for a moment, that product A is crude oil, and it took a month or two for it to wind its way into product Z. 

No-one really wants product Z, because they have mortgages and credit cards to pay off and their jobs as analysts at major investment banks are looking a little shaky.

So product Z sits in a box for a while, and the producer of Z stops orders and cuts rates until he can sell and this winds its way back up the chain.

Then... Well, then comes one of the single largest monthly falls in spot and contract values ever witnessed, and we are in trouble.

Three November barge styrene contracts were agreed in the week ended 7 November at €580/tonne FD NWE, €700/tonne FD NWE and €710/tonne FD NWE. 

The settlements marked respective decreases of €530/tonne €462/tonne and €456/tonne. Market participants believed that the largest decrease was the greatest fall in a month on month contract price ever seen in the petrochemical sector.

The fall was in line with settlements seen in upstream benzene at $412/tonne FOB NWE, converted to a euro price of €316/tonne FOB NWE, down €481/tonne – a staggering 60% - in line with spot prices over the month.

This quote is from a polystyrene (PS) producer talking to ICIS news last week, explaining the pitfall of holding high (20 plus days’) inventory in a rapidly falling market:

“If you look at the [PS] market in Europe, which is about 2.3m [tonnes/year], that gives you a 190,000 tonnes/month market. Divide that by 30 and multiply by 22, say, and you have 140,000 tonnes.

“If you take the [November] decrease on styrene as €500/tonne on average, then you get €70m. We just can’t swallow these losses.”

A source at one major PS producer estimated its own potential losses at €14m, and several majors announced maximum decreases for November of €150-200/tonne, with INEOS Nova leading the field with a maximum €150-180/tonne decrease.

Even if contract drops were limited to €200/tonne – something consumers are unlikely to allow to happen – the total loss of value would be close to €28m, by the above quoted estimate, and the producer who would have lost €14m would now lose only €5.6m.

If benzene is product A, then there are any number of product Zs: end products include polystyrene, styrene acrylonitrile, styrene butadiene rubber, polycarbonate, the epoxy resins, the phenolic resins and nylon six. 

Bearing in mind that phenol producers alone estimate stocks as having lost €500/tonne of their value since the settlement of November benzene contracts, if each of these products were to fall by “only” €200/tonne over the coming months, the potential stock devaluation could well be in the hundreds of millions of euros. 

In some cases, the cost of feedstocks, already paid, may well outweigh any potential  earnings from end products. 

With a lot of the products at the end of these chains going into consumer goods, construction, and the automotive industry, who knows how long it will be before these devalued stocks are finally sold on?

As all this stuff gathers dust, and we approach the end of the financial year, the value of petrochemical companies comes increasingly into question. 

We are used to cars devaluing the second they leave the forecourt, or computers becoming outdated the day they are released. But we aren’t used to the actual physical stuff that companies make losing money before it even hits the stores and we cannot conceive of the impact this has on the outright value of the company.

Accountants balancing books at the end of 2008 will more than have their work cut out. 

Whilst many producers aggressively de-stocked in the third quarter of the year, there are any number obliged to hold large inventories who found demand even worse than expected – step up polymers producers. 

As product A’s value continues to collapse, they could well find themselves explaining an ugly looking profit and loss sheet in January for both the fourth quarter and the full year. 

“This could mean a negative EBITDA, not just for us, but for the whole industry,” says one source at a major producer.

Market analysts said on Wednesday that as they didn’t “have sight” of the level of individual inventories, and that a potential level of stock devaluation would be difficult “until companies came out and said it”.

“I would definitely assume the worst,” said an analyst at a major European bank.

“There is no doubt that the current situation is a complete disaster,” says International eChem chairman Paul Hodges. “Stocks are completely out of line with demand and we are approaching the end of the year where people don’t want to buy. It was great on the way up, but it’s on the way down where you lose.”

With styrene production cash margins now negative and tanks full of material losing money just by standing still, chances are it may not be such a happy New Year come 2009. And it will be because stuff is worth so much more than words.

To discuss issues facing the chemical industry go to ICIS connect

By: Peter Salisbury
+44 20 8652 3214

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