Asian Chemical Connections

As everyone focuses on when the next downturn might arrive, macro issues such as the implications of a likely US withdrawal from Iraq are rarely publicly discussed.
But if I were on the board of any company making investment decisions, I'd be worried.
If the US withdrawal from Iraq is well managed then fears such as those expressed in this article will come to nought. Sadly, "Iraq" "the US" and "well managed" are words and phrases that rarely share the same sentence and so the future looks a little shaky to say the least.

As the Middle East struggles to find labour and raw material supply with contractors' order books bursting at the seams, the Chinese seem to have no difficulty in executing their projects.
See below for detailed analysis of what's happening with the current wave of Chinese crackers. Suffice to say here that nearly all of China's cracker projects will be on time, unlike the Middle East where the delays are mounting.
Contractor markets are forecast to be tight until 2008--09. Could the Chinese be able to leverage their way into joint ventures in the Middle East before the market slackens by offering a one-stop shop of labour, equipment, contractors and financing?
Technology supply, marketing reach and cash have been the traditional means the foreigners have used to get their hands on highly competitive Middle East gas supply. Perhaps the Chinese might also offer lump-sum turnkey contracts plus a dollop of cash from one of China's state-owned banks with highly attractive lending terms, given that they are weaker on technologies and marketing.
The Middle East project builders would be, of course, happy and so would the Chinese government. Its priority is energy security, whether at the oil and gas or basic petrochemical level.

The collective sigh of relief was almost audible late last week when the Fed cut its discount rate - the rate banks charge each other for lending.

Action from other central banks, including the European Central Bank, could follow this week. Analysts also rate the likelihood of the Fed cutting its formal interest rate at its meeting next month at 50 per cent or more. This is the rate charged to companies and other non-bank borrowers.

But still, this credit crisis is not going to away that easily. See more detailed analysis below, but in short here, the implications could be:

*A weaker Chinese economy. Roughly one-third of China's GDP is dependent on exports and if the US goes into recession, this is serious. Many overseas chemical projects have been justified by estimates of persistently strong demand from China for imported chemicals that will be re-exported as finished goods. Sales of locally made chemicals would, of course, also suffer

*Unfunded projects backed by smaller private companies being shelved.

But a lot of capacity in the Middle East and China is too far advanced to be cancelled. In the Middle East, many of the projects already under construction might come on stream bang on time because the producers there can make money in any market conditions. Projects under construction in China start up on schedule because the government wants to gain greater independence from imports.

Let's hope this crisis goes away, but if it doesn't why on earth didn't the supposedly smart people who run the global financial system realise the dangers? Joseph Stiglitz, a genuinely smart guy, has been warning for years about the risks, which he outlines in this excellent article

Last night I was feeling a little mellow after consuming far too much ethanol (the French variety - a very reasonable bottle of Cotes du Rhone) when the idiots on CNBC began to rant on about this being 2007, which explained why were in the midst of potentially a global financial meltdown.
There was the global financial disaster of 1987 when the Dow Jones Industrial Average fell by 22.5% in just one day.
And, of course, everyone remembers 1997 - the year of the Asian financial crisis.
It occurred to me, in my ethanol-induced haze, that we should sack all the mathematicians, scrap all the complex computer models, drown all the analysts along with the economists, and my mother-in-law because she is an awful cook, for failing to spot something as obvious as the fact that bad luck always comes in threes and this is a third year with a seven in it - hence, the crisis could have been predicted. I could have not bought that bloody house in Australia and not listened to that financial adviser who told me to park my money in equities.
I am sober this morning, but I still think widespread sackings and drownings are in order.
What about the supposedly smart people at Goldman Sachs who fed numbers through their computers and estimated that the likelihood of this crisis occurring was once in 100 millennia? First off the short plank, I'd say, minus their bonuses.
Oh, and the by the way, as sevens are clearly worth avoiding like The Plague, here are some tips if you are a chemicals or oil trader:
*Do not buy naphtha as it's going to fall in price (ICIS pricing placed second-half October contracts at $664-667.50/tonne CFR this morning).
*Brent crude might be worth a punt as it has fallen below the evil $70.33/bbl to $69.49.
*Benzene - go short as it's $960-970/tonne FOB Korea
*And whatever you do, get out of toluene now as it's double trouble - $775/tonne FOB Korea
Now where's my rabbit's foot gone?

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As Paul Hodges notes in his Chemicals and the Economy blog http://www.icis.com/blogs/chemicals%2Dand%2Dthe%2Deconomy/, China's Finance Minister quit this morning - either over his role in a sex scandal or because inflation and the stock markets are out of control.
Petrochemical demand growth has been booming in China because, as a bureaucrat put it shortly after WTO entry, "China is like an elephant riding a bicycle".
By that comment he meant that China had to achieve growth of at least 10 per cent year (peddle hard) to avoid a heavyweight crash. High growth has been viewed as essential to maintain social stability through creating sufficient new jobs to replace those lost by WTO accession and the constant drift of migrant workers from the impoverished countryside to the towns and cities.
But perhaps now, with inflation rising alarmingly and the stock market in the midst of an enormous bubble, the government really does want to cool the economy down instead of just paying lip service to this objective - it's current approach. Perhaps the calculation is that high inflation and the potential for a stock market collapse represent a bigger risk to social stability than a moderation of growth.
But if policies are introduced that cut growth by too much, every industry from petrochemicals to the overseas retail and auto giants that have staked so much on China will find their profits trimmed. Make sure you steer well clear of any passing bikes with elephants on board, therefore, the next time you are driving through Beijing.
All should become clearer in six weeks when the Communist Party Congress, which only takes place every five years, is held.