INSIGHT: Empty pipelines could cause price bubbles in 2012

27 December 2011 15:00  [Source: ICIS news]

By Mark Victory

Tight LONDON (ICIS)--To raise the pitch of a guitar string, you tighten the tuning peg, increasing the tension. The less slack in the string, the faster the pitch increases.

Replace pitch with price, guitar with chemical, tuning pegs with supply, and string with market. To raise the price of a chemical market, you tighten the supply, increasing the tension. The less slack in the market, the faster the price increases. It’s overly simplistic, but broadly true.

It’s traditional for chemical markets to reduce inventories in December as companies look to lower their gearing ratios on year-end accounts to encourage investors.

In 2012, though, destocking began earlier and has been deeper as buyers and sellers look to increase cash reserves to protect against a double-dip recession.

“The slowdown in demand is a seasonal problem, but right now there is slightly greater pressure because discussions about another recession are making a lot of customers reduce stocks to minimum levels,” an oxo-alcohols producer said.

Pipelines are empty in many parts of the chemical industry.

“People started to watch stocks closely, more so than in previous years because of uncertainty about developments,” an MEG producer said.

This means that an upswing in demand, logistical problems or production outages will impact the markets more rapidly as there are no buffer stocks.

“Inventories are low, so any spike in demand will cause problems,” a nylon compounder said.

Macroeconomic deterioration led to hand-to-mouth buying long before the approach of the year-end. The early signs of just-in-time purchasing were first seen in August 2011.

General economic uncertainty continues, and in markets as diverse as the polyamide chain, phthalic anhydride (PA), solvents, polyvinyl chloride (PVC), oxo-alcohols, and monoethylene glycol (MEG), buyers are expected to maintain low inventories into the new year.

The earlier-than-usual Lunar New Year in late-January is also expected to suppress export demand until February, which will lower buying interest for net export markets.

“January [2012] we expect [demand] to be 30% lower than [the same period] in 2011 as no-one wants big inventories,” a nylon compounder said.

An uncertain economic outlook and low inventories make stock management increasingly difficult.

Planning is a nightmare, one MA and PA trader said.

The major downstream markets for petrochemicals are automotive and construction, both of which are heavily linked to GDP. Demand will change based on economic outlook, just-in-time buying will mean that there is a lack of forward visibility, and empty pipelines will cause any market evolution to quickly be reflected in the supply chain. 

It’s like a musician trying to play along to a piece that changes to a random key every six notes – you can’t prepare the melody, only react as quickly as possible, and play it by ear.

Importers buying in material from Asia and the US, with average lead times of 8-12 weeks, will be attempting to accurately forecast conditions in markets which lack transparency – or they will be left with overvalued stock.

Exporters face the same problem, but inversed – a reluctance to buy because prices could fall in the short-term. 

Low GDP growth in Europe – if forecasts are to be believed – is likely to keep demand muted in 2012 in the downstream markets. PA, solvents and polyamide chain players are predicting 2012 volume offtake at broadly the same level as 2011, although, forecasts will be revised heavily as the economic situation evolves.

“Originally we had growth at 6% [in 2012] but we’ve revised that down to a flatline... we’re not sticking our neck out, no-one knows what will happen, the euro could collapse,” a PA buyer said.

If crude oil prices remain high in 2012, upstream chemical prices are also likely to remain high.

Nevertheless, with weak end-user demand because of low GDP growth, downstream chemical producers could struggle to pass-on feedstock costs. The result will be squeezed margins.

During the fourth quarter 2011, nylon 6 virgin polymer contract prices fell by €350/tonne ($455/tonne), and nylon 6,6 virgin polymer contracts dropped by €450/tonne. Nylon feedstocks capro and adipic acid (ADA) saw drops of €290–310/tonne and €390–490/tonne respectively. During the same period, the upstream benzene contract price fell by just €148/tonne.

“Our [profit] margin is very low, near to the minimum expected from the product. We’re just trying to keep production going for the steam for our main unit. If we could, we would stop production, it would be better for us,” an MA producer said.

If you turn the tuning peg on a guitar too far, the string will break – buckling under the tension.

NF Trading of the Ukraine halted production at one of its two adipic acid lines in the Ukraine in December because of unfavourable trading conditions, a company source confirmed. Each of the two lines at the plant has a nameplate capacity of 30,000 tonnes/year. The line will be shut until March, or until financial conditions improve, the company source said.

The plant was shut because of low margins and expectations that raw material prices will outstrip adipic acid price increases in the first half of 2012, according to the source.

The potential scenario is that a production outage coupled with low inventories causes shortages, and then sellers – having dealt with months of weak margins – rapidly increase prices to maximise profits wherever possible.

This would result in price bubbles – which would fall away as soon as supply recovers – heightening pricing volatility.  Several sources in downstream markets do not see this situation as unlikely.

“A buoyant start could catch everyone flat-footed. Whatever happens, it’s inevitable there will be [price] spikes because of low inventories, it just depends on when – it’ll be a quick turnaround,” a solvents distributor said.

Next year is fast approaching and stock positions have been taken – now it’s time to face the music.

($1 = €0.77)

Additional reporting by Abache Abreu, Cuckoo James,  Caroline Murray and Nel Weddle

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By: Mark Victory
+44 208 652 3214

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