INSIGHT: High crude can wipe out QE benefits in Asia

14 September 2012 14:32  [Source: ICIS news]

By John Richardson

PERTH (ICIS)--THE Federal Reserve’s decision to launch quantitative easing 3 (QE3), a series of open-ended steps more radical than anything it has attempted before, is bound to drive Asian petrochemical pricing higher, in response to the surging cost of crude.

But as a corporate planner with a US polyolefins producer said: "The cost of crude is a major problem for us as it doesn't reflect real demand in the real economy.”

Although most polyolefin buyers in China are said to have accepted September price rises, producers complain that these are nowhere near enough to compensate for rising crude oil and therefore naphtha and olefins costs (see the chart below). Price-hike requests have been severely limited by the weakness of demand.

NE Asian variable margins

A sales and marketing executive with a North American polyolefins producer added: "The issue today is that the majority supplier of polyolefins to Asia is no longer the regional producers. It is instead the Middle East which sits on much lower costs. It has the power to price according to market demand.

"The Asian naphtha-based producers are seeing great cost pressures in China and are therefore trying to export to better-priced markets such as Latin America, Africa and Russia.

"But this is offering limited help as long sailing times mean that Asian producers are not viewed as preferred suppliers.

"I am not sure if 2013 will be any different."

The key issue for the Asian petrochemicals industry is whether the Fed move on Thursday, and last week’s decision by the European Central Bank (ECB) to buy bonds, will eventually benefit real economies, rather than merely the traders in financial and commodity markets who have made the right bets.

In China, oil prices were already approaching a record-high before the Fed announcement.

For developing countries such as China and India, where per capita incomes remain low by Western standards, this is a very serious problem, as poorer people spend a bigger proportion of their incomes on fuel and food than the rich.

For example, a Bloomberg survey, published on 30 August, estimated that US consumers were spending 2.8% of their daily incomes on gasoline. In India, despite heavy government fuel-price subsidies, a premium gallon of gasoline costs 37% more than the average worker earned in a day.

Rising fuel and food prices could already be hindering China’s efforts to stimulate its own economy. Overall August inflation accelerated to 2% from a year earlier after a 1.8% rate in July, according to the National Bureau of Statistics.

Food inflation accelerated for the first time in five months, rising 3.4% from a year earlier.

Consumer prices increased 0.6% from the previous month, the biggest increase since January, while food prices increased 1.5% from July.

China thought it had dealt with its inflation problem, thus giving it more latitude to further reduce interest rates and bank-reserve requirements – the amount of money the banks have to set aside against lending,” said a Perth, Australia-based investment fund analyst.

China lowered interest rates in June and July. It has also cut the reserve requirement on three occasions since last November.

Monetary easing has already produced positive results. In August, new local currency lending rose to yuan (CNY) 703.9bn ($111bn), way ahead of July's CNY540.1bn.

But as the analyst pointed out: “The August inflation numbers complicate the picture. China now faces renewed difficulties in trading-off growth versus inflation.”

China’s small- and medium-sized enterprises (SMEs), which make up the bulk of the country’s chemicals and polymer buyers, struggled with rising fuel and wage-cost inflation throughout 2011 and during the early part of this year.

Renewed inflationary expectations could, therefore, both restrict Beijing’s stimulus options and squeeze the profit margins of the SMEs.

Despite the unexpectedly large rising in August bank lending, business confidence remains low, supporting the notion that China needs to provide more support for its economy.

"Any optimism (over the August bank lending) should be tempered by the fact that borrowing by firms, as opposed to households, remains weak," said Mark Williams and Qinwei Wang of Capital Economics, in a research note, quoted in the 12 September issue of The Irish Times.

"The further we dig into the data, the more sceptical we become that they are particularly encouraging. It is hard to see how the economy can be turned around unless firms decide to invest. There is not yet much sign of that happening on a large scale."

But some economists argue that while inflation might be a renewed problem for China’s consumers, deflation is the issue for its manufacturers. Producer prices fell by 3.5% in August, marking the sixth month in a row that factory gate prices had fallen.

Manufacturing oversupply, resulting from weak global demand and the huge economic stimulus package of 2008-2010, could be another factor – along with rising consumer-price inflation – in restricting further stimulus efforts.

Glenn Maguire of the Sydney-based economics consultancy, Asia Sentry Advisor, says in a video on his company’s website that the People's Bank of China has of late been reluctant to further reduce interest rates and bank-reserve requirements. This is because average industry operating rates in China are now lower than they were during Japan's “lost decade”, and the "Volcker Recession" in the US; and because flooding the economy with more lending, resulting in even more industrial overcapacity, could thus drive China's operating rates even lower.

Ever since late 2008, when the global financial crisis began, central banks and governments have experimented with numerous policy initiatives in the hope of achieving sustainable recoveries.

Experimentation is likely to continue into next year and beyond, making effective analysis of government policy crucial for the global chemicals and polymer industries.

($1 = €0.77) ($1 = CNY6.33)

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

By: John Richardson
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