Asia's chemical industry set for a major downturn

Tip of the iceberg

30 December 2008 00:00  [Source: ICB]

Once a high-growth region, Asia is slowing down with the rest of the world. Will its chemical industry recover quickly or be mired for years?

THE GLOBAL economic crisis - at the very least the worst since the early 1980s - will have huge implications for Asia's chemical industry in 2009 and possibly well into the next decade.

"I hate to give you the bad news, but I think it could take five to six years to get through this. Most of the iceberg is still beneath the water," said Matthew Sullivan, director of energy structuring and origination for Standard Chartered Bank. He was speaking at the ICIS World Polymers Conference in Bangkok in November.

The danger is that the vicious cycle of declining consumer spending in the West, job losses and even further declines in consumption is only just beginning. We could also be entering a global deflationary spiral like the one that kept Japan in the economic doldrums for a decade. Why buy anything today when it could be cheaper tomorrow - and why buy at all when you are in danger of losing your job and the real value of your debt is increasing rather than decreasing because prices are falling?

Heavily export-based Asian economies, such as Singapore, Malaysia, Taiwan and South Korea have been severely hurt by the first major collapse in US consumer confidence this century. Singapore, already in recession, faces its biggest economic test since it became independent in the 1960s.

China's government has the financial muscle to further stimulate an economy that, by some estimates, is more than 30% dependent on export trade. It has already announced a yuan (CNY) 4 trillion ($581bn) stimulus package, has relaxed limits on lending by banks and has made its biggest interest rate cut in 11 years. The country has ample cash to do much more.

But more factory closures will surely follow among export-focused manufacturers in the southern and eastern provinces if the vicious circle continues. This will inflict a great deal more pain on those who ship chemicals to China, which are reexported as finished goods.

India not so lucky

Although India's economy is less exposed to the collapse in Western consumption than China's because India has a much smaller manufacturing sector, its companies - as is the case everywhere in Asia - have been walloped by lack of trade finance.

Ironically, governments in Asia have funded the US government by buying Treasury Bonds. The money was circulated back to Asian companies in US dollar-denominated trade loans from Western banks - until the credit markets seized.

Letters of credit have become hard to obtain, especially for small and-medium-sized companies. If you have credit, you need to ration it.

India faces the added problem that its government cannot as easily pump-prime the economy because of its weak fiscal position. Funding for vitally needed improvements to the country's appalling infrastructure was to have come from overseas lenders.

A lot of this money is no longer available, creating the fear that growth - even if it stays reasonable healthy in the short term despite the global crisis - will eventually slow down as a result of inadequate roads, railways, ports and airports.

Other economies face their own problems, including Thailand. The timing of another round of theatrical political unrest is nothing short of disastrous for many of the country's industrial sectors, not least petrochemicals.

Too much at the worst time

Even if the world economy hadn't been in major crisis, Thailand was taking a hefty risk in adding two cracker complexes, and a major new aromatics plant, at a time when the Middle East and China were also ramping up capacities.

Those two crackers, one by PTT Chemical and the other by Siam Cement and US-based Dow Chemical, are due to start up over the next few years. So too are new ExxonMobil and Shell Chemicals crackers in Singapore.

It is hard to see how these volumes will be placed in markets where demand will be much weaker than anyone had forecast. Any chemical demand-growth predictions drawn up before September 2008 (in other words, all the forecasts in feasibility studies that are used to justify the current wave of investment) are likely to be way off the mark.

Already, PTT expects a delay in the planned 2012 start-up of its other $1bn, 600,000-1m tonne/year naphtha cracker beyond 2012 on financing difficulties. Its 1m tonne/year ethane cracker is scheduled to come on by the end of this year.

The problem with demand is twofold. Firstly, the lack of credit and the volatility in energy prices is making every company at every stage in each production chain unwilling to buy or sell anywhere near close to the quantities seen before September.

The risk is that you stock up on polypropylene (PP) resin if you are a converter, for example, only to see the oil price fall the next day. This will almost instantly translate into lower PP prices.

Your hard-pressed customers, even your closest ones whom you've been doing business with for many years, will not be in a position to do you any favors by paying over the market odds for their packaging material.

Secondly, there is a great deal of uncertainty over what is the state of fundamental demand. Nobody knows the full extent of the damage to economies and how much worse it will become.

So trade volumes could remain far below expectations throughout 2009 and beyond, inflicting more pain on earnings.

Those saddled with debt from ill-timed capacity expansions (isn't hindsight a wonderful gift?) could, in theory, be subject to mergers and acquisitions.

For many years, South Korea has been singled out as perhaps the most vulnerable to further consolidation because companies expanded aggressively in 2004-2005 when they had the cash to maintain economies of scale. But government support might enable companies to limp through the crisis intact.

Thailand and Japan might also be vulnerable as they struggle to compete with the Middle East and China.

Middle East producers will be able to run their new complexes at high operating rates regardless of how bad markets become because of their low production costs, says Paul Hodges, chairman of UK-based consultancy International eChem. The Chinese, while not enjoying the same cost advantages, might also keep rates high out of a strategic desire to replace imports.

Will things ever be the same?

One advantage of this crisis is that it has reduced energy costs, even though oil prices remain erratic as they rise and fall in almost perfect alignment with stock markets.

But the International Energy Agency says we are heading for another major supply crunch once the world economy recovers because of the decline in investment in new conventional and unconventional oil fields. This could mean that future economic cycles are much shorter, with recoveries frequently nipped in the bud by soaring crude oil costs.

A disadvantage of the current economic turmoil is that everyone is obsessing with how governments can return the world to business as usual - a rebound in consumer confidence so everyone will once again rush out to buy more things that they have been convinced by marketing people that they need rather than only vaguely want.

Climate change, water scarcity, the threat to food supply from overfishing, poor agricultural practices, the loss of biodiversity and demographics have long been major challenges for chemical producers everywhere. The kind of growth Asia saw in 2001-2007 is unsustainable without an explosion in commercially viable innovation.

When you are struggling to keep your company going in perhaps the worst economic crisis since the Great Depression, the danger is that you slash research and development spending - and that good people leave because they become disillusioned with your cash-hoarding.

Ultimately, the chemical companies that fail to effectively innovate in the face of growing environmental pressures are likely to fail anyway, even if they get through the next few years.

Additional reporting by Pearl Bantillo in Singapore

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