Market Intelligence: Downside Risk From Crude

25 June 2012 00:00  [Source: ICB]

What goes up can come crashing down, which is most obviously the risk with crude oil.

"Ironically, a geopolitical crisis might help the chemicals industry, as the price of crude would remain firm - thus enabling companies to avoid inventory losses," says Paul Hodges, chairman of UK-based chemicals consultancy International eChem.


More action in soccer bets than polyolefins, trader says

Copyright: RexFeatures

The risk is that chemicals companies and end-users built up raw-material inventories when oil prices were on their way up earlier this year.

Many people might well have been rushing to protect margins, particularly buyers of chemicals who had made price commitments to their customers for the next three to six months.

Such action could have created the illusion of strong demand when, in fact, buyers were merely panicking as oil prices increased.

Stocking up might have also been the result of more confidence about the eurozone than in the fourth quarter of last year, and the belief that China would bounce back after a disappointing 2011 as a result of stronger economic stimulus.

The US economy also looked as if it was in the midst of a reasonably strong economic recovery. But the eurozone is now in deeper crisis and China's economy is slowing down far more quickly than most people had expected.

The New Democracy party's June 17 election victory in Greece resulted in only a very brief relief rally in crude and equity markets. Investors soon lost confidence as they focused on longer-term problems in Greece, Italy and Spain.

In China, apparent demand growth (imports plus production)for polyethylene (PE) fell by 6% in the January-May period from the same periods in 2011 and 2010, according to Global Trade Information Services.

Margins for Northeast Asian naphtha cracker operators have been squeezed, forcing production cuts, including the closure of the 1.2m tonne/year Formosa Petrochemical Corp. No 3 cracker complex at Maliao, Taiwan, for two weeks earlier this month.

"We had expected full-year PE demand growth in China to be around 8%, in line with GDP growth. Now we are expecting flat to minus 5% growth for 2012," an industry source said.

"As for crude-oil prices, I think there is a very real chance that they could trade within $40-80/bbl. PE buyers are holding back in anticipation of weaker crude and therefore resin prices."

On Tuesday, June 19, West Texas Intermediate for July delivery was at $84.06/bbl.

US jobs growth in May was the slowest for a year, casting further gloom on the outlook.

Expensive crude has caused demand destruction, according to Hodges. In the first quarter of this year, oil prices averaged $119/bbl, just 7% below Q2 2008's record $127/bbl, adjusted for inflation, he estimates.

oil is consuming more of gdp

"Today's oil price is now costing 5.5% of global GDP," Hodges wrote inan April 2 blog post. From 1982 until 2007, the cost was between 1% and 3% of GDP.

He said this year's figure had left consumers, already struggling with economic problems in the West, with less money to spend on discretionary items.

Support for his argument has come from India's petroleum minister, Jaipal Reddy, who on Wednesday June 13 was quoted in India's Business Standard newspaper as saying that high oil prices had reduced his country's 2011 GDP growth to 6.9% from what otherwise would have been 8%.

"It is estimated that a sustained $10 increase in oil prices leads to a 1.5% reduction in the GDP of developing countries," Reddy told the newspaper during the fifth OPEC International Seminar in Vienna.

Whether the recent high price of oil was justified by supply and demand fundamentals, or was mainly the result of financial speculation, is a separate and complex debate.

But what seems clear is that the downside risk to crude is now substantial as the global economy weakens, leading to what could be a prolonged destocking cycle in the chemicals industry.

"Global demand [for oil] is softening," Peter Voser, Shell CEO, said in a press conference during the June 4-8 World Gas Conference in Kuala Lumpur, Malaysia. "We have got recessionary elements in Europe and a small slowdown in Asia-Pacific. At the same time, some of the geopolitical elements of price volatility in the past few months have kind of receded and, therefore, we see a softening of prices that I expect to go well into the second half of this year."

The lack of visibility in crude, chemicals and polymer markets is also likely to make everyone down all the value chains reluctant to acquire raw materials on anything more than a hand-to-mouth basis.

China's polyolefins market is once again a good case in point, where buying activity has been exceptionally weak since April.

"Traders have nothing to do apart from bet on the Euro 2012 soccer championships because demand is absolutely dismal," a Singapore polyolefins trader said.

"This is the worst I can remember in 10 years in this business, and it is definitely now worse than in 2008."

He added: "The shock of 2008 was more sudden, more dramatic, but shorter-lived. In 2011-2012, we have seen longer periods of depressed demand, when prices have been flat or declining, with very brief periods of recovery that have followed improvements in equity markets and crude oil.

"The problem is that there is absolutely no visibility out there - nobody knows when the market will bottom out and nobody is prepared to take any risks."

During 2011, lack of liquidity held the market back as the Chinese government increased bank-reserve requirements and raised interest rates, the trader said.

That forced polyolefin buyers either to cut back on activity or turn to the shadow banking system, in which they paid very high interest rates.

"In the past couple of months, there has been a very significant sea change," the trader said.

"Our customers no longer want to borrow money, even though financing is more available and cheaper.

"There is no demand out there, so why would they borrow money?"

The market was so bad that the prospect of new supply from start-ups in Saudi Arabia, Qatar and Singapore had not caused panic, he added.

"The attitude towards this new supply is, 'bring it on because it surely cannot make the demand any worse'," he said.

Read more of Paul Hodges' analysis of the state of the global chemical industry on his Chemicals and the Economy blog at

By: John Richardson
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