INSIGHT: Chemicals confidence is key but must be held in check

24 August 2009 16:36  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)--Confidence along all the chemicals value chains is always a key issue because of the ability to aggressively manage inventories, according to the London-based chemicals analyst Paul Satchell.

So there’s the ever-present risk of sudden and very disruptive de-stocking. The longer the current rallies in commodity prices and stock markets continue, the greater might be the risk that confidence becomes excessive and mistakes made last year are repeated.

If 2008’s events have taught us anything, it’s that markets don’t behave rationally.

Those who arrive late for the party just as the punch bowl is taken away might suffer the most – along with those who’ve been there for a while but don’t make an exit before the bar closes.

There’s plenty of evidence of inventory building in Asia which might not always be in response to strong underlying demand.

Polyethylene (PE) inventories in China at the second and third distributor levels were at very high levels in June, according to one industry report. Polypropylene (PP) inventories were, however, at normal levels.

Benzene, toluene and monoethylene glycol (MEG) inventories were said by several sources to be also very high in July. Hydro-dealkylation (HDA) and toluene disproportionation (TDP) operating rates were reported to have been raised - along with benzene production from coal-based steel plants

Polyester operating rates were said to have risen from the second half of July as producers tapped into ample bank lending in order to increase rates.

This was on the assumption that the September buying season for textiles and garments would be strong, leading to a big improvement in exports. The next Canton Trade Fair will also be a major indicator (the textile and garments phase of the fair takes place between 31 October-4 November).

A big influence on confidence will be whether China can be successful in taking the air out of its current real-estate and stock market bubbles.

Supply of new loans in July dropped to $52bn from $197.5b in June – a 77% reduction.

China might not want to do anything more to spoil the mood of the party before the 60th anniversary of the Revolution, which takes place on the 1 October.

But this bubble has yet to reach the scale of the last one which went pop in October 2007.

At its peak so far this year the Shanghai Composite Index has traded at 3.8 times its book value, barely half the 7.2 book multiple in October 2007, according to the Financial Times newspaper.

Inventory building only appears to apply to China and to traders in just about every commodity everywhere in the world.

Chemicals companies outside China seem to be exercising extreme caution because of the huge inventory losses incurred in the fourth quarter of last year.

“Inventories are being kept low because there is very little visibility down the value chains,” said a UK-based chemicals consultant.

“The credit crunch means that it remains difficult to finance inventories.

“Chief financial officers have just spent months explaining away large inventory losses from the fourth quarter. They are unwilling from a career point of view to risk having to go through the same performance again. “

The focus is cost control with market share taking second place.

As one Asian industry source put it: “Sixty percent of our focus used to be winning on business across a broad range of markets with 40% on cost efficiency.

“Now these percentages have been reversed and we would rather lose sales than break our tighter budgets.”

The same applies to operating rates. The US and Europe have maintained deep operating rate cuts – and have idled or permanently closed many plants – with northeast Asia also said to be showing very good discipline at the cracker level.

Middle Eastern players were, in contrast, reported to be running flat out in August following production problems in the first half, which prevented them from taking full advantage of strong Chinese import demand.

A big focus in polyolefins is on selecting which grades to be produced based on pure economics rather than, again, on winning or maintaining market share.

But will this type of caution be enough to prevent a sudden reversal in petrochemical pricing?

The big danger is that any retreat could be driven by an unwinding of heavy speculation in crude.

At the moment the market remains in full-carry contango, meaning the combined cost of storage and borrowing (the full-carry cost) is below the futures price.

If this changes - or quite simply storage space runs out - there could be a sudden stampede for the exit.

Crude prices have more than doubled from December when they were in the low $30s/bbl. This seems out of step with falling demand unless you accept that the oil market was again being speculator-driven.

Petroleum demand would be 1.8m barrels of oil per day lower than it had forecast in June, said oil, gas and refining consultancy Purvin & Gertz.

OPEC said in a report in August that the “market remains fundamentally weak”. And it noted that US consumption was “still showing a massive reduction”.

Chinese growth could fall on less economic stimulus as oil prices collapse and much-delayed new Middle East petrochemical capacity hits the markets.

China is also due to start up several major cracker projects in the second half of this year.

But the first half was far better than anyone dared to expect.

Let’s just hope that the traders in all the commodities, including chemicals, don’t spoil the recovery before real demand has the chance to catch up with improved confidence.

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By: John Richardson
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