Asian Chemical Connections

Have you ever been away on holiday and have cut yourself off from from work, only to return and find that nothing has changed?

So it seems in polyolefin markets. As this blog has been writing about for several months, the recovery in pricing seems to have been mainly feedstock-driven as this article from ICIS news points out.

Demand from converters in south China is reported to be weak; hardly surprising given the chart below from The Wall Street Journal which indicates that China's economy is 36.5% dependent on exports with south China the heartland of China's export sector.

No matter what the wisdom of the Chinese government's huge fiscal stimulus aimed at boosting local demand, a sustained recovery in Western consumer spending remains crucial for China's economic health over the next few years.

You have to doubt the wisdom of the stimulus packages because China could well be borrowing from the future to pay for growth today. And secondly, as we discussed earlier this week on this blog, the enormous increase in loan growth will put China's banking system under pressure.

Chemical prices have risen in tandem with crude prices and with the broader sense of optimism - reflected in equity markets - that the worst of global economic crisis might be over.

True, the rate of declines in the real economy might have slowed down but as Mohamed El-Erian, chief executive and chief investment office of Pimco, argues in this Financial Times article "it is going to take time to restructure an economy (the US) that became over-dependent on finance and leverage. Meanwhile, companies will use this period to shed less productive workers."

This could mean US unemployment will only peak at 10.5-11% and not until 2010. Yesterday saw the release of jobless figures for June which indicated a 467,000 drop in employment, raising the current jobless rate to 9.4% from 9.5%.

I am sticking to my belief that a sharp correction in polyolefins pricing is likely very soon with markets set to get a dreal longer when the Asian turnaround peak season ends - and when new capacity comes online in China and the Middle East

Evidence of this is clear from the ICIS Ethylene Worldwide Report, which is soon to be relaunched.

As this slide shows detailing China alone (and the picture looks equally disturbing for the rest of the world, also of course including the Middle East), capacity is set to sharply increase as maintenance work tapers off.

View image

But there might be more start-up delays and of course we don't know the maintenance schedules for next year.

Clearly the risks are high, though, for any petrochemicals producer or buyer (I think what I've said for olefins and polyolefins applies to many other products) that has swung from the fear of Q4-Q1 last year to over-optimism.

If production or buying have been ramped up by too much and inventory levels have once again been badly managed, the risk of heavy losses from the bursting of this mini-price bubble remain high.

For the cautious and prudent company - and for the likes of Ineos and Dow Chemical that have taken opportunities to refinance during the current stockmarket boom - though, the prospects might not be that bad.

But for everyone, evidence of a real improvement based on stronger global consumer spending has yet to emerge.

Indeed, if El-Erian's analysis is correct overall consumer spending on the things made from chemicals might get worse in H2 this year and throughout 2010.

And as foor beyond the end of next year, again, since I've been away nothing has really changed.

This comment from the economist Nouriel Roubini - although a bit dated as it's from May - still rings true:

"We cannot rule out a double dip W-shaped recession with the wings of a tentative recovery of growth in 2010 at risk of being clipped towards the end of that year or in 2011 by a perfect storm of rising oil prices, rising taxes and rising nominal and real interest rates on the public debt of many advanced economies as concerns about medium term fiscal sustainability and about the risk that monetization of fiscal deficits will lead to inflationary pressures after two years of deflationary pressures."

As I've been warning on this blog for some time, the explosion of credit in China has created a great deal of paper-bottomed optimism over the recovery.

Fitch, the ratings agency, has just raised its macro-prudential risk indicator ffor China from category 1 (safe) to category 3 (Iceland et al) because of the lending surge and public debt.

China's Banking Regulatory Commission warned last week: "The top priority at the moment is to stop explosive lending. Banks should carefully monitor the process of credit approval and allocation, and make sure that loans flow into the real economy."

And Andy Xie, the often-quoted Sino-bear, says in the same article I've linked to above from The Daily Telegraph: "Commodity speculators have been using cheap credit to play the arbitrage spread between futures and spot on the oil markets. They have even found ways to trade lumber to iron ore by sheer scale of leverage. "They've made everything open to speculation."

This is probably one of the main factors behind the boom in speculation in linear-low density polyethylene (LLDPE) futures on the Dalian Commodity Exchange. PVC futures were also recently launched on the exchange.

As my fellow blogger Paul Hodges points out on his blog, Chemicals & The Economy, China is at risk of repeating the mistakes of the West: an unsustainable rise in credit.

The obvious danger, as has been flagged up before, is a sudden collapse in chemicals demand and pricing as inventories are unwound (built up with too-easy) as tougher lending conditions are imposed. This could be an even more dramatic bursting of the current equities and commodity price bubbles if it occurs at the same time as sharp fall in crude (which seems likely if equities are hammered.

Picture: The Daily Mail

Ok, I lied - I am having trouble getting back into my petrochemicals bubble and so this post is not about polypropylene. Apologies to all those disappointed C3 H6 molecules out there.

I was sharing lunch with a highly demotivated Singapore-based chemicals industry employee recently and the great British 1970s sitcom, The Good Life, came to mind (see above picture for the full cast - don't you just love the clothes?).

In that sitcom, Tom Good, played by the actor Richard Briers, is meeting "Sir", the boss of the plastics processing company where he works as a draftsman. The company specialises in desiging and molding those little plastic toys you used to get (or might still get - I am not sure) free in your breakfast cereal.

"Sir" puts his arm around Tom, who he has noticed for the first time because he has been introduced by his friend Jerry, played by the late and great Paul Eddington, as "our top designer". Jerry is a monumental crawler and, as a result, is in an executive position.

Anyway, "Sir" says to Tom, or roughly words to this effect: "A new bubble has just come off the top of our think tank and I want you to take charge of this project - plastic hippopotamuses (or was it giraffes? Couldn't find on Google). Are you excited? Do you think you are the man for the job?". He is speaking in one of those annoyingly enthusiastic voices you may have heard in meetings and wished "if only I could have the presence of mind to fake it that well".

Tom, is of course, supposed to show enthusiasm in order to crawl up the slippery corporate ladder, but instead bursts out laughing, goes home, quits his job, and decides to become self-sufficient by growing all his own food - and keeping lifestock - in his suburban back garden.

To return to my lunch with the unhappy chemicals-industry employee, he had been ground down by having to bite his tongue in so many long and dull meetings that when his boss asked for ideas for a new corporate slogan, he replied: "How about 'The Relentless Pursuit of Mediocrity?' ".

He lives in a condo with a window box as a back garden and so growing fruit and vegetables for a new career is not option.

Anonymous contributions would be gratefully received for comments you would have liked to have made in company meetings, but felt unable to do so. This is your chance to let off some steam.

Cartoon: Peter Brookes, The Times

Yes, this blog has gone staggeringly quiet over the last few weeks as I gained a life: I went home to the UK and mixed with some people who had no interest in or desire to know anything about polypropylene. Do you realise that there are some people out there who have never even heard of catalytic reformers? Amazing....

Anyway, before I return to my sad little petrochemicals bubble, here are some reflections on the political chaos gripping good old Blighty caused by MPs' expenses.

The pleasure the Brits are deriving from their fuming indignation over some upper-class twit claiming the cost of cleaning out his moat, and other such extraordinary fiddles, almost makes up for the misery inflicted by collapsing house prices.

But as I kept saying over many a pint of wonderful British real ale during my leave: "Corruption? Call this corruption. If you want real, decent corrupt politicians then go to India or the Philippines, to name but two Asian countries affected by this problem.

"The good people there would be delighted if all that their political leaders did was claim the odd household plant or a bit or mortgage tax relief off the State."

It's good fun to have a go at politicians, though - God knows they all deserve it.

And there is never any excuse to fiddle your expenses and quite obviously, all the journalists enjoying the hunt have never, ever over claimed or falsely claimed for anything (you can be probably tell, except if you are American that is, that this is intended to be sarcastic).

I had a friend many years ago who worked on a national newspaper who received a major telling off for not claiming enough fraudulent lunches, dinners and gallons of alcohol, the reason being that if the accountants saw one person managing on less everyone else might have been forced to follow suit.

Most national newspaper journalists, certainly in the 1990s anyway and so this may have changed, could double their salaries by being on the fiddle.

But in the row over MPs' expenses perhaps not enough focus is being placed on a much bigger issue. This is how Britain is going to repair its government finances without creating major inflation problems or interest-rate hikes that will limit inflation but nip the recovery in the bud. The same applies, of course, to the US.

I don't pretend to understand Bond yields etc.

Perhaps nobody understands, nobody has control, nobody has a flipping clue and so in the absence of any clarity the only debate worth having is over why the former Home Secretary's husband, working as a government-paid political assistant, claimed porn movies on his expenses (still my favourite of all the scandals).

Toodle pip. I promise you in my next post that I'll write about polypropylene for all you fellow sad people out there.

Source: The Guardian newspaper

Apologies for letting this bog slip again. I am on leave, but still pondering where on earth we are heading. This makes a welcome relief from staring up at the grey skies and thinking "summer? What summer?" Yes, I am on leave in the UK and Wimbledon is about to start. I would recommend moving the tournament to drought-affected areas of the world, maybe on an annual rotation basis, to guarantee rainfall.

Anyway, back to the business of oil prices.

If you succeed in making acrylic acid from enzymes and microbes, as the company Novozymes is attempting to do, then maybe you can worry slightly less about the long-term likelihood of very high crude prices.

But as oil hits $70/bbl again, the old concern about boom and bust cycles driven by energy costs has to be very much in the forefront of everyone's minds - whether or not they are trying to break the direct link between oil and chemicals.

As the excellent Buttonwood column in The Economist points out, we are back in a commodities supercycle.

The 45 cents a gallon rise in gasoline prices over the last month is costing the American consumer an extra $60 billion.

As confidence in the economic recovery increases, might we soon be back to square one?

What are the solutions for the chemicals industry?

It's easy to get caught up in the excitement over the rebound in the Chinese economy and miss underlying weaknesses which point to some major problems ahead.

To some extent, in a desperate effort to compensate for collapsing export trade, China might have borrowed from the future in order to achieve a swift recovery.

"The (Chinese government's economic) stimulus programme borrows from a future investment cycle," writes the online research publication, the China Economic Quarterly (CEQ), in its Q2 report.

"Since 1978 China has run relatively regular five-year investment cycles followed by five years of retrenchment."

Spending by the State on infrastructure and industry boomed in 2003-07 and so the following five years were supposed to involve the reductions in expenditure necessary to repair a big hole in the national balance sheet.

But, of course, the reverse has happened with infrastructure and industrial projects scheduled for the next 5-10 years now set to be completed over the next 3-4 years. This includes speeding up investments in the refinery and petrochemical industries.

"China could be in for some rough times after the stimulus money runs out in 2011," the CEQ adds.

Repair work to the national budget might not be the only reason why longer-term prospects could be a lot bleaker than many expect.

China might also fail to boost domestic demand sufficiently to compensate for export trade which might take many years to recover.

"For the first time in the 30-year reform era, China faces an extended period - five years or perhaps longer - in which exports will provide no significant contribution to growth," says the CEQ.

The reason is the well-documented collapse in the West's debt-financed consumption binge.

On the surface, it looks as if China is making great headway towards realising more of its enormous domestic-growth potential: retail sales grew by 16% in Q1 this year, up from 15% in the first quarter of 2008.

If you dig deeper, though, as the CEQ again does, you discover that retail sales include many "institutional" purchases, meaning those by state-owned enterprises (SOEs).

The government has increased military salaries by 50% and is providing rebates of 13% and 10% respectively off rural purchases of household appliances and automobiles.

Despite all this cash sloshing about, however, when you take away the institutional purchases from the retail sales figures, the CEQ concludes that there is little evidence of a pick-up in consumption.

Longer term, this can be fixed if efforts to create much better pension and healthcare systems lead to more spending and lower savings levels.

Compared with the West, and particularly the US, the Chinese keep an awful lot more of their money bank deposits.

But here's another potential pitfall: all that money sloshing around (the CEQ estimates the total stimulus will be worth Yuan5-6 trillion, or 15-18% - much bigger than the originally announced Yuan4 trillion) could end up creating another non-performing loans crisis similar to that of the early 1990s.

This could force China's banks to lower interest rates on deposits in order to repair their balance sheets, warns Peking University finance professor Michael Pettis on his blog, China Financial Markets.As bank deposits are such an important method of saving money in China, lower interest rates could lead to more money being saved as compensation, leading to damaged consumer growth, he adds.

Numerous economists are also warning that too much of the stimulus is in the form of loans to the SOEs, which can be less efficient in boosting the economy than private companies.

The private sector, hammered by the collapse in export trade, is in contrast reported to be struggling for finance.

An inevitable slow down in bank lending, the result of the huge rise in loan growth during Q1, could also be put yet another brake on the economy.

"RMB (Yuan) net lending fell sharply to YuanB592bn in April from YuanMB1.9tn in March, broadly consistent with our expectation," writes Jun Ma, Chief Economist Greater China for Deutsche Bank, in a report.

"We believe this reflects the success of the window guidance by the PBOC (People's Bank of China) and the CBRC (China Banking Regulatory Commission) that advised banks to "appropriately control loan growth"; the decline in new project approvals; as well as the slower pace of equity capital injections from the central government budget.

"Going forward, the continuation of these factors will likely lead to a further decline in net lending to about Yuan300-400bn per month in the remainder of this year."

A further worry remains the potential global deflationary effect in H2 of China stockpiling raw materials, including perhaps chemicals and polymers.

Imports of polyethylene (PE) and polypropylene (PP) have, for example, been at record levels in Q1.

However, it's impossible at this stage to say whether this involves major stockpiling or is more the result of better demand and big production cutbacks by Sinopec and PetroChina earlier this year.

In the case of iron ore and copper, though, the steep rise in Q1 imports (iron ore was up by 33% and copper by 62%) are being widely attributed to state-backed inventory building and strong investment demand.

"China is stock piling commodities - everything from metals to oil," said a chemicals industry source.

"The argument is that it's better to store financial reserves in commodities rather than US dollars."

"There has also been some stock piling of gasoline and diesel in anticipation of price increases by the government."

Gasoline and diesel prices were indeed increased from early June - the first time since March.

But if you put five economists in a room, goes the old adapted saying, you are likely to get at least ten different opinions.

It can be just easy to interpret some of the recent data in a much more positive way, and it might just be possible that the current euphoria will create a self-fulfilling prophecy of a sustained recovery.

It's worth being aware, though, that a 50% rise in the local stock markets since the start of the year and lots of positive macro-economic news might not tell the full story.

Source:Amazon.com

I remain perplexed by the direction of chemicals, oil and commodity markets over the last few months - and now I understand the reason why.

It's not about feedstock, it's not about inventory levels or what end-use demand is really like, it's all to do with affairs of the heart.

Thanks again to my fellow blogger Paul Hodge who writes:

The Illicit Encounters website has a major increase in traffic when either the market collapses, or has a sudden rise. Apparently, when markets are up, traders "think they can have an affair because they feel they can get away with anything. When the market hits the bottom, they are looking for a way to relieve the pressure."

The site first came to the blog's attention in December, when the Financial Times reported on its rather lucrative business model - a male membership fee of £119/month ($190). Now it appears to have forecasting potential too.

As with financial markets, surely with c hemicals pricing. All we need to do is to produce an index, on a confidential basis,of course, which tracks this particular form of intra-industry activity.

Source of picture: The Nymex

To continue the same theme of earlier this week, I agree with my fellow blogger Paul Hodges when he warns that OPEC's price target for $75-80/bbl could nip the nascent economic recovery in the bud.

As he quite rightly argues, inventory building ahead of further crude rises in 2007-08 occurred despite evidence of slowing end-use demand for chemicals.

A recent Lex piece in the Financial Times calculated that crude prices averaged around $100/bbl last year. With the world consuming a total of $88m bb/day this therefore cost the world economy $3.200bn.

When the article was written earlier this month, prices were averaging around $50/bbl which would for the whole of 2009 represent a saving of $1,600bn.

This is more than the total of all the government bailouts - $1,600bn - and the bailouts are one-offs rather than the constant savings resulting from cheaper crude.

This year's crude bill looks likely to be more expensive that had seem the case in early May, though, as a result of oil around $60/bbl, assuming it stays around this level (one hell of a big assumption but hey, why not, the rest of the media has become adept at turning a short-term trends into a long term outlook).

As the excellent Schork daily oil and gas report points out, oil and gas inventories remain at record highs.

But traders are ignoring the underlying long term trend in favour of putting a positive spin on recent relatively minor reductions in stock levels.

As the report points out, it's all about market psychology:

What started out as a bear market rally in equities
back in March is now in the process of morphing
into a full fledged rally. Sidelined money,
disgruntled and dismayed that it has missed the
bull's party of the last two months, is now
reluctantly piling back into the market. Some of
this money is finding its way onto the NYMEX.
The Street has convinced itself the recession is
over. Two months ago traders were buying
because they wanted to "participate" in the
equities rally before the bear market resumed.
Today these same traders are spinning a dubious
fundamental case because dour economic
headlines, which the market receives nearly daily,
are less bad. Thus, the crude oil bulls have
hitched their wagon to the equities. And, they are
going to continue to do so until it stops working
for them.

I remain convinced this is just about market psychology and the economic news is going to get worse before it gets better - so prepare for a lot more volatilty in energy pricing.

A sharp dip in crude would help inject some more much-needed cash into the world economy.

But - again as Paul Hodges points out - if crude does reach the OPEC target of $75-80/bbl this will at least encourage some of the investment necessary to lessen the supply crunch when the economic recovery has conclusively arrived.

Apologies for letting this blog slip again, but have been busy trying to make a crust presenting ICIS training courses.

And so as a bonus for our army of avid readers, here are my extended thoughts on the above:

In the midst of the economic crisis it would be so easy to bury your head in the proverbial sand and forget that once the recovery does arrive, the same old feedstock-cost problems seem almost certain to re-emerge.

"The profitability of your average Asian naphtha cracker with the right level of investment in derivatives was extremely good throughout 2007. This was particularly the case if you were processing C4s into butadiene," said an industry observer.

"But in the first half of last year margins turned negative because of rising crude and naphtha costs. Every manufacturer down every product chain frantically built inventory because of the fear that oil would reach $200/bbl by the end of the year."

Of course we all know what really happened: Crude prices collapsed in Q4 resulting in the biggest inventory losses in the history of the chemicals industry. Stocks simply had to be liquidated due to the non-availability of working capital.

Governments are lavishing cash on stimulus packages in a desperate effort to return the world to business as usual.

This might on the surface seem the sensible thing to do, but unless that money is spent wisely in boosting energy conservation and renewable technologies, a return to strong growth could hasten the return of $100/bbl plus crude.

There's not much sign of smart investment in China. A surge in bank lending has been used to ramp up steel and aluminium production and provide the finance for manufacturers of finished goods to run their plants hard in order to limit job losses.

China announced a $586bn stimulus package last November and then in March disclosed plans for heavy investment in ten industrial sectors, including refining and petrochemicals.

"While the (investment) proposals may boost the economy, and thus energy demand in the short term, they could also lead to continued growth of energy-intensive industries in the medium to long term," writes the UK-based Cambridge Energy Consultants in an article on its website.

The Obama administration has also come in for some pretty fierce criticism over a cap-and-trade-bill before the House of Representatives. Lots of emissions permits would be given free under the bill, offering benefits to coal-based electricity generators and other energy-intensive industries.

Oil industry experts are queuing up to warn that the economic crisis has cut capital investment by the small independent oil companies in harder-to-get-at conventional crude reserves. The oil majors have slowed down development of unconventional sources of oil, such as the Alberta Tar Sands.

OPEC warned at its recent meeting that the fall in prices was resulting in lower investment, and the Paris-based International Energy Agency estimates that spending on oil and natural gas exploration will fall by 21% this year over 2008. This would represent $100bn less spending on building reserves.

The implications of a return of very expensive crude are obvious for Asia's petrochemical industry, which is largely naphtha-based.

The Middle East gas-based producers would once again stand to benefit due to another surge in margins as, of course, global petrochemical prices are oil-driven.

But what if everyone suffers? Could the return to crude in excess of $100/bbl re-awaken inflation, further stoked by excess liquidity resulting from government stimulus packages?

The danger is that we might repeatedly see nascent economic recoveries nipped in the bud by surging energy costs.

BASF announced last June that it was looking at making petrochemicals from biomass using its catalyst expertise, and said that it had made good progress at the laboratory stage.

Numerous companies were also looking at methanol-to-olefins technologies, including ExxonMobil and LyondellBasell.
China's coal reserves offer an opportunity to make methanol into large amounts of olefins and transportation fuels.

Let's hope that cutbacks forced on companies by the financial crisis have not included freezing research into attempting to break the crude-petrochemicals link.

Another concern is the long-term outlook for naphtha supply.

The US announced new car and truck fuel-efficiency regulations last week, which, in the short term could increase the availability of the feedstock.

By 2016, all new autos will have to meet a 39 miles per gallon standard (mpg) standard, up 42% from the current 27.5 mpg. Trucks will have to do 30 mpg versus 23 mpg today.

"Europe was already heading for an enormous gasoline surplus by 2015 even before this announcement," said Paul Hodges, chemicals consultant with the UK based International eChem.

Diesel demand in Europe has surged at the expensive of gasoline. However, the Europeans have been able to export their way out of gasoline surpluses due to shortages in the States.

But these exports were already under threat from increases in US refining capacity and the mandated steep rise in ethanol blending, added Hodges.

"The new fuel-efficiency standards will increase the pressure for European refinery closures, but in the interim there could be a disposal problem.

"This could create the opportunity for cost-advantaged naphtha supplies into the hard-pressed European and US petrochemical industries."

Eventually, though, refinery capacity will have to close because, as one Asian-based oil and gas consultant put it "there is going to be a worldwide glut of gasoline. Even on a straight-run basis before you look at more advanced processing, there will be a big surplus requiring rationalisation."

It is far too early to say whether refinery closures will lead to a net reduction in available naphtha.

Asia is adding capacity as Europe confronts the need to rationalise. In 2009-10 alone, 2.7m bbl/day of refining capacity is due to be come on stream in Asia Pacific, according to oil and gas consultancy FACTS Global Energy.

But naphtha exports from the Middle East could decline as the region looks to crack more naphtha in order to widen its petrochemical-product slate.

In Abu Dhabi, for example, a naphtha cracker complex is due to start-up by 2013.

Anyone with either access to advantaged ethane, propane and butane or with a proven technology that breaks the refinery/petrochemicals interface might be OK during the next oil shock.

The key for Asian liquids-based producers without either of the above must surely be maximising feedstock flexibility.

This flexibility could include cracking more liquefied petroleum gas (LPG).

LPG should be in abundant supply once liquefied natural gas (LNG) demand is booming again on higher oil costs and rising environmental concerns.

LNG producers either extract the gas during initial processing or leave it in the LNG to be taken out at re-gasification terminals.

Whatever are the solutions, they need to be found and found quickly if surging stock markets are proof of a quicker-than-expected economic recovery.

Consensus opinion tends to swing firmly in one direction and then the other.

For example, in the good old days of 2007 you would have been pretty hard-pressed to find many in the chemicals industry who saw anything but a mildly cyclical downturn.

But the widely-held view now - that we are facing five years of incredibly tough times, the first period of this length in the history of the business - might also not come true.

"In 1992, the same was being said but then within 12 months the industry was in recovery," said an old industry hand.

"I don't know what the macroeconomic factors might be on this occasion. If I did I could make a fortune. In 1992, it was the unexpected emergence of very strong Asian demand.

"But even if the economic news keeps getting ever-gloomier, the industry itself might make yet more adjustments to bring supply much more in line with demand."

He cited the sweeping production cutbacks that have already taken place as evidence that the will to make the necessary changes exists.

"Leveraged and private-sector companies will just not sit on their hands. In the distant past, action was slow because the industry was mainly state-owned."

These included Dow Chemical reducing operating rates to a 63% average in Q4 last year, BASF shutting down 25% of capacity in Q1and Bayer Material Science idling 300,000 tonne/year of polycarbonate (PC) capacity - again in the first quarter.

The cutbacks seem to have been more extensive than in a recession of this comparable severity - the one which occurred in the early 1980s.

"Chemical companies had no choice because raising working capital through re-financing was simply impossible," says a Singapore-based banker.

Maybe if cash flow remains constrained by ever-weaker revenues - even if the financial system is repaired - companies will face no option but to permanently shut down capacity and definitively cancel projects.

The extent of the capacity closures to date suggests that markets being brought back into balance is possible far more quickly than the doom-mongers (including myself) expect.

A few major bankruptcies might make this process very rapid indeed through closure of a large amount of a capacity in one fell-sweep.