INSIGHT: High oil prices a major threat to growth

19 March 2012 16:43  [Source: ICIS news]

By John Richardson

IMF managing director Christine LagardePERTH (ICIS)--The world economy might have “stepped back from the brink”, according to International Monetary Fund (IMF) managing director Christine Lagarde, but she has warned that oil prices have become a major threat to global growth.

The warning, issued in Beijing on Sunday, comes after months of evidence in petrochemical markets of demand destruction from high-priced crude.

Expensive crude has added to the problems in China, where demand has also been negatively impacted by major structural changes in the economy – and now, perhaps, even a leadership dispute. “Polyolefins have been too costly for converters for several months now, and have become more so since the end of the Lunar New Year holidays,” said a Hong Kong-based industry executive with a global polyolefins producer.

Price rises since the end of the holidays had been almost entirely driven by producers recovering higher costs, and did not reflect a big improvement in demand, he added.

This was reflected in commentary accompanying last week’s Asian ICIS pricing polyethylene (PE) report. While prices were assessed $10–40/tonne higher, plastic processors were reported to be strongly resisting further increases as they avoided large-volume purchases.

European petrochemical pricing has performed better than in Asia. For example, since December, European benzene contract prices have increased by 40%, propylene contract prices by 20% and ethylene contract prices by 21%.

But to what extent does this represent real demand recovery rather than restocking by chemicals and polymer end-users?

Inventories in Europe were badly depleted in the fourth quarter when it looked like the eurozone might collapse, and so some stock-building in the first quarter was probably inevitable. There is also the risk that end-users are again “buying forward” – that is, building inventories in expectation of further hikes in crude.

China PE prices

The obvious danger here is that oil prices suddenly collapse, as was the case in September 2008. This would leave everyone, down all the petrochemical production chains, once again sitting on high-priced inventories.

But 2008, of course, saw the bankruptcy of Lehman Brothers. Now, as Lagarde pointed out, the world economy has stepped back from the brink, thanks to the resolution of the Greek sovereign debt crisis, even if this is only temporary.

Thus another fall in the price of crude on the scale of what we saw in 2008 is perhaps unlikely.

We could instead see economic attrition, according to London-headquartered bank HSBC.

“While confidence has clearly rebounded over the last few months, it is no more than a repeat of developments seen at the beginning of 2011,” wrote the bank in a report released earlier this month.

“As last year progressed, initial optimism gave way to more grounded realism. Rather than a sign of lasting recovery, higher oil prices may simply be a contributor to persistent permafrost.”

It warned that the “fear of an economic slowdown” caused by expensive crude was already affecting the US, as concerns grew over shoppers staying away from the malls.

“For the emerging world, it’s a different story. Although most policymakers were engaged in continuous easing in the second half of last year, the mood is beginning to shift,” continued the report.

“The last thing policymakers in the emerging world will want to see is a return of inflationary pressures sufficient to generate renewed social instability; after all, the rising price of basics was one factor behind the Arab Spring.”

The evidence of demand destruction caused by expensive crude is obviously apparent not just in petrochemicals markets.

In December, China’s demand for oil grew by just 1% compared with 8–10% in early 2011, according to HSBC. US oil-product demand had fallen by 4–5% in early 2012 compared with the same period the previous year, the bank added.

The bank – and other commentators such as Paul Hodges of UK-based chemicals consultancy International eChem – also argue that the oil market remains well supplied.

“When it comes to supply, the picture is mixed but is not worrying overall. US production is rising gradually due to deepwater recovery and the shale-oil revolution. Russia and Brazil are also increasing production. But there are outages in countries including Libya (now easing) and Syria. Without these the market would be modestly oversupplied,” wrote HSBC.

Rising US oil production, and falling demand due to increased fuel efficiency and blending of ethanol in gasoline, was the subject of a Citi report released in February.

“The US is now a net exporter of refined products for the first time in 60 years. The percentage of oil imports as a percentage of domestic demand has fallen from over 60% in 2005 to 45% in 2011,” wrote Citi.

Other analysts disagree. They are sticking to the belief, which has underpinned the decade-long rally in crude oil prices, that Peak Oil is still a fairly imminent threat.

And then there is geopolitics. The potential for a west and/or Israeli crisis with Iran has helped to drive crude prices higher during 2012.

But would Iran be able to close the Strait of Hormuz for an extended period? HSBC thinks not.

The release of strategic reserves, the diversion of Middle East supplies in order to avoid the Strait of Hormuz and increased Saudi Arabian and Nigerian production would go a long way towards compensating for any lost Iranian production, HSBC added in its report.

So, if all these commentators are right, why on earth are oil prices so high? Could it be a result of financial sector speculation? 

That is another story, in need of separate telling. Watch this space….

($1 = €0.76)

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By: John Richardson
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