INSIGHT: Second quarter could be weaker as buyers destock again

05 April 2012 18:04  [Source: ICIS news]

PERTH, Australia (ICIS)--Confidence is a strange thing. It can be derived from solid reasons for optimism over the future or from temporary factors that can rapidly disappear.

And what is the value of publicly-expressed confidence? Is it often politically motivated rather than being based on the genuine belief that the future holds tremendous promise?

Right now in the petrochemicals industry, it is easy to make the case that the recovery in sales volumes in Europe and the US during the first quarter was due mainly to stock-building by buyers.

Inventories were exceptionally low down many value chains in December 2011, when it looked as if the eurozone was about to collapse.

Once the immediate danger had been averted, therefore, some restocking was inevitable.

This was given further impetus by rising oil prices. Petrochemical end-users “bought forward” to hedge against crude and petrochemical prices going even higher.

The eurozone crisis was put on hold rather than resolved in December last year. This has become clear over recent weeks as the focus has switched to the next country facing a potential sovereign debt default – Spain.

Will the direction of crude remain as clear in the second quarter? Quite possibly not, given the evidence of demand destruction caused by expensive oil and the determination of Saudi Arabia to lower prices.

One can, as a result, make a pretty strong case for the second quarter being weaker than the first quarter as buyers once again destock.

In the European polyolefins sector, for example, pre-buying in the first quarter had left end-users with stocks, and April has fewer working days than March, an industry observer told ICIS news earlier this week.

“Consumption in April will be lower,” said a producer, in the same article.

“Demand for most applications is down, all except for personal care. Even food packaging has not been as strong.”

In the US, polyolefins buyers, who describe demand as relatively weak, are resisting further price hikes.

Price increases have been essential for cracker operators as they attempt to repair squeezed margins. The increases have been made possible by deep operating-rate cuts in Europe during the fourth quarter and maintenance work and outages in both Europe and the US in the first quarter.

But margins remain under pressure, which strongly suggests that demand is a major problem.

Demand has been exceptionally bad in China, quite possibly because the chemical industry underestimated the impact on growth of major structural changes in the economy. 

Down just about every value chain, forecasts that demand would come roaring back after the Lunar New Year have proved wrong.

“In January, all the evidence of a strong rebound was stacking up. As a result, we couldn’t find any reason why there wouldn’t be a big volume-surge after a difficult 2011,” said a Singapore-based polyolefins trader.

“Now, after a terribly disappointing Q1, we are struggling to find any reason why Q2 will be better.”

China’s petrochemicals buyers have faced the same cost pressures as their US and European counterparts. Asian cracker operators have pushed through oil-driven price rises in order to repair margins.

But the big difference has been that, on the whole, China’s end-users have maintained “hand-to-mouth” purchasing strategies.

This indicates that a continued tight rein on bank lending has limited their ability to buy forward.

In a country such as China, which remains poor by Western standards, the other big problem seems to be the steep rise in food prices, driven to a large extent by more expensive oil. A bigger proportion of incomes are spent on food in developing countries than in the West.

“Although the overall inflation rate fell to 3.2% in China in February, this is very misleading as it doesn’t reflect conversations we are holding with our customers,” said an Asian-based sales and marketing executive with a global polyolefins producer.

If you go to any plastics processor in China they will tell you the same thing – that real inflation is more like 8–9% a year as a result of double-digit increases in food prices.

The main reason why the overall inflation rate has fallen is because the government follows the Western model in calculating property prices as part of inflation. Property prices have fallen by around 10 percent over the last year.”

Just about everybody you talk to at ground level in China tells more or less, the same story: That the economy is going through some major adjustments that are likely to negatively impact petrochemicals consumption for the rest of this year.

The sales and marketing executive goes a little further when he says: “China is at a pivotal moment that will decide its long-term economic future.

“If you notice statements  from Beijing, you will see that China’s leaders continue to refer to the Philippines in the 1950s.

“Back then, the Philippines was the place in Asia for low-cost manufacturing, but wasn’t able to progress beyond this level because of corruption and bureaucracy.”

Rarely, though, do petrochemical company CEOs openly express any fears over the risks to growth in China and elsewhere. Why?

“CEOs have to toe the line, as is the case with the analysts, because if they go against the conventional view, they might end up upsetting someone,” said a petrochemicals industry source.

For example, if a CEO comes out and says, 'I don’t agree with the Chinese government that the country’s economy will grow by 8% this year,’ that particular company might not get approval to build a cracker in China.

And as with the analysts, it is better to hunt with the pack.  If you are an outlier and are wrong, you are in big trouble. But if everyone is wrong, you can always blame unforeseen circumstances and cut costs to hit your quarterly-results target.”

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

By: John Richardson
+65 6780 4359

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