INSIGHT: Planning is tough in a time of uncertainty

09 December 2011 16:33  [Source: ICIS news]

By John Richardson

Fog on Dal Lake, Srinagar, IndiaPERTH (ICIS)--A lack of visibility over what the new year will bring for the global chemical industry is a key feature of just about every conversation held with industry executives at the moment.

Perfect forecasting is, of course, impossible – but with the eurozone in crisis and even China potentially facing its own bad-debt problemsthe immediate outlook seems exceptionally murky.

The fear factor dominates, according to the CEO of a major Europe-based performance chemical and polymer producer.

"Buyers have become very worried. They are buying in smaller individual lots – in smaller total volumes – and are waiting very late in each month to make their purchases," he said.

But take away the fear and the hope is that the world will return to normal by as early as January next year.

In fact, a positive result reported from the meeting of European leaders today would be likely to boost stock markets and oil prices – and in turn petrochemical prices.

A good example of the instant effect of positive macroeconomic news was last week’s increase in the Dalian Commodity Exchange’s linear low density polyethylene (LLDPE) futures contract.

This followed China’s decision to lower bank reserve requirements by 50 basis points which, according to one polyolefin industry source, was also a factor behind the decision by two producers to raise their LLDPE December offer prices to China.

However, while chemical traders want to get in and out during brief market rallies, producers face the pressing need to draw-up robust scenarios for all of next year and beyond.

This task is complicated by the fact that even a successful deal announced this Friday by Europe’s leaders seems unlikely to resolve the eurozone’s underlying problems.

And as for China, while the cut in reserve requirements was good news, the polyolefin industry source added: “I don’t see any change in the government’s overall policy of keeping liquidity much tighter than during the great lending binge of 2009–2010.

“It wants to bring property prices down to more affordable levels, it wants to reduce overall inflation and it wants to try and reduce the speculative element in the economy. We can therefore expect more bankruptcies of polymer traders.”

Another aspect of Chinese government policy involves providing ample financing to “value-added” consumers of chemicals and polymers. These are the converters which are, for example, producing high-quality food packaging films using the latest technologies.

“The lower value processors are being deliberately forced out of business,” the source added.

Not only has overall demand been less in 2011 than just about anybody forecast because of credit tightening, but the nature of demand also seems to be changing. A return to the way things were in 2010 seems highly unlikely.

How do companies respond?

Putting large volumes of commodity-grade polymers on a ship and sending them to China via traders – in confidence that this will always deliver decent returns – has been the successful strategy of both high and low-cost producers.

However, this is going to become much more difficult for the high-cost players. The demand growth outlook looks uncertain because of China’s macroeconomic problems – and its increasing self-sufficiency in commodity grades as its manufacturing industries move up the value chain.

More investment will be needed in higher-value grades for those without a feedstock-cost edge – and in on-the-ground market intelligence to identify opportunities.

Companies need to also consider the worst of possible outcomes – for instance, what if a global trade war erupts?

"We are seeing a rise in antidumping cases involving chemicals," said a Singapore-based trade lawyer specialising in the chemicals industry.

He forecast such an event would occur in early 2009, but believes fiscal stimulus in the US, Europe and China delayed the problem.

The current withdrawal of stimulus programmes might therefore explain the rise in the number of antidumping cases.

Conventional thinking is that China will allow the yuan to appreciate further.

But what if, faced with the loss of export trade to the European Union – its biggest trading partner – it is forced to competitively devalue its currency in order to protect jobs? This would likely encourage a global trade war.

However, China is not the only emerging market where growth has declined.

In India, polypropylene (PP) demand for the year ending 31 March is expected to contract after two years of double-digit growth. This reflects an overall slowing of the economy due to inflation, problems in the West and a lack of investor confidence resulting from corruption scandals.

But there is another possibility to consider – what if the current policy paralysis affecting the Indian government continues? What will this mean for growth prospects in 2012 and beyond?

It increasingly feels as if the post-Lehman Brothers period was a “one-off” for the global chemical industry, thanks to temporary fiscal stimulus and the return of confidence when it became clear that the global financial system wasn’t going to collapse.

Long-term growth in developing markets is still a reason for great optimism. Hundreds of millions of people are emerging from poverty and beginning to buy items made from chemicals and polymers for the first time

But how do chemical companies cost-effectively supply markets where the vast majority of people are living on $2 – or less – a day?

The planning process has, perhaps, never been more difficult.

Read John Richardson & Malini Hariharan's Asian Chemical Connections blog
Bookmark Paul Hodges' Chemicals & the Economy blog

By: John Richardson
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