Here we go again – 1997 is back…..

I sincerely hope not, but all the signs are there because of:

*A financial crisis which nobody again saw coming, this time with global implications

*What could prove to be too much spending on new equipment and capacity. This time high equity prices have paid for these investments rather than US dollar-denominated bank loans, as was the case in 1997.

The fundamentals are still strong, as today’s article from ICIS news on share-price collapses points out. Asian demand is at much higher levels now than 11 years ago.

But the power of sentiment should not be underestimated.

It’s too early to read the long-term effect on petrochemical pricing. More volatility seems certain with sentiment driving shifts in pricing on every piece of negative or positive economic and stock market news.

Lower feedstock costs on cheaper oil will also play a role, but as the extended article below points out, the impact on the real economy will take time to assess. It is this impact that will set the long-term direction and determine whether we the downturn has, finally, arrived.
21 January 2008 13:16 [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)–There is a feeling that this can’t go on for much longer, that petrochemical markets are teetering on the edge of a sharp demand-driven correction caused by problems in the wider economy.

But as one industry executive with a major polyolefins and polystyrene (PS) producer said: “I remember at APIC [Asia Petrochemical Industry Conference] in Yokohama in 2005, a lot of traders and producers were saying that the beginning of the end had arrived.

“Subsequently, of course, we have had two of the best years in the history of the industry because of strong Asian and global growth and not much new capacity being added.”

On this occasion, however, he believes that markets are even more dangerously unbalanced because of a disconnect between what he is hearing from his sales team and very tight olefins and polyolefins supply.

Ethylene prices, for example, were approaching an all-time high of $1,470/tonne FOB (free on board) Daesan last week.

This was the result of high naphtha prices and chronically tight supply due to outages in Asia and reports of production losses in Iran.

Supply was also tight because of strong polyolefins values – high density polyethylene (HDPE) was trading at $1,600/tonne CFR (cost and freight) Asia and above.

This left integrated producers with little motive to cut back on PE production in order to make more ethylene.

The high price reflected what ICIS pricing has been hearing about PE – that it is tight, particularly HDPE and low-density polyethylene (LDPE), and should remain so throughout 2008 because of supply being insufficient to meet resiliently strong demand.

PE capacity additions are relatively minor this year, whereas a lot of polypropylene (PP) capacity is scheduled to come on stream in the second half, provided there are no further significant delays in the Middle East, where most of the capacity is being added, and elsewhere.

But the executive said that his sales team was reporting a dismal mood among some converters in Malaysia, Thailand and Vietnam.

“The converters are telling us that manufacturing sectors in all three countries have been badly hit by the economic problems in the west,” he added.

“Despite all the talk about the ‘decoupling’ of the Asian economies from the US and Europe, exports are very important for the Asean (Association of Southeast Asian Nations) countries in particular.”

Domestic consumption has risen sharply since Asia’s last big economic crisis in 1997 – the main plank of the decoupling argument.

But the Asian Development Bank (ADB), in a report released last week, backed up the executive’s viewpoint.

The ADB’s president was reported as saying that the bank has revised down its forecast of overall Asian GDP growth in 2008, excluding Japan but including China, to 8% from 8.2%.

This is hardly a disastrous-sounding reduction, but the ADB has also changed its mind on decoupling.

Last September, it revised its 2008 growth forecast up to 8% from 7.7% because it believed that Asia would not be affected by the western credit crunch.

Now it believes it will be affected and it is warning about the other big threat to Asia – rapidly increasing inflation on high food and fuel prices.

The big question is by exactly how much Asia will be affected by a US downturn.

Increased uncertainty, and with it rapid changes in mood on every piece of positive or negative economic or stock market news, could make petrochemical pricing even more volatile than usual in 2008.

Domestic demand has not only grown significantly since 1997. Export trade has also diversified with the Asean countries, Taiwan, Japan and South Korea benefiting enormously from a surge in exports to the booming Chinese and Indian economies.

But how many of the exports being sold to China – whether they are basic commodities, polyolefins, styrenics, engineering plastics or fibre intermediates – ultimately end up being manufactured into finished goods for shipment to the west? No-one has a handle on the exact numbers – another cause of uncertainty and jitteriness in markets.

A crude measure of China’s overall vulnerability to exports suggests that they accounted for 40% of GDP in 2007.

But UBS economist Jonathan Anderson said that the real percentage contribution of exports to China’s GDP was just below 10% in 2007 when correct calculations are made.

Arthur Kroeber of the Beijing-based research publication, the China Economic Quarterly (CEQ), added that only 7% of investments were tied to exports.

Investments in infrastructure, new industrial capacity and property have been China’s main growth drivers over the last seven years.

However, Kroeber said that more than half of investments were in infrastructure and property, which points to another concern: China’s property bubble.

Could declines in real estate values in the west spread to China, leading to the bursting of the bubble?

Some Asian economies are more vulnerable than others to a western slowdown. The Asean countries, as the industry executive pointed out, are perhaps the most vulnerable because they have relatively small domestic markets.

As for Japan, it is in danger of falling into recession because the biggest cause of its recent economic recovery has been strong exports.

If a US government stimulus package and further interest rate cuts work their magic, the Asian petrochemical industry might enjoy a good 2008 and possibly 2009.

This assumes that serious damage to growth is not caused by inflation, China’s property market, the dip in demand after this summer’s Beijing Olympics or any other Asia-specific economic problems.

Demand needs to continue to expand at healthy rates to lessen the depth and the duration of the capacity-driven downturn forecast for 2010-2011.

But if the US economic slowdown does become a recession, maybe we are teetering on the edge. The fall could be rapid and from the great height of record high petrochemical prices.

The problem, as always, is to what extent the record prices are the result of inventory building by end-users anticipating even further price increases.

Conclusions cannot be drawn from pricing over the next weeks because of the distorting effect of the Chinese New Year holidays.

Here’s something else to worry about: converters at last October’s K-Show in Düsseldorf, Germany, were in an upbeat rather than a dismal mood, according to an industry source.

“Asian converters were queuing up to buy brand new machinery with the money they had made from their high share prices,” he said.

“One sure way of further boosting your share price in the less-developed Asian equity markets is to gain ‘face’ by making big investments in new, high technology machinery.

“Investors often overlook the fact that a company is losing money or has a ridiculously high price/earnings ratio, provided it’s making big investments.”

This all sounds very much like 1997 when ego-driven, equity-fuelled investments across many industrial sectors helped to bring Asia down.

Oh dear. Here’s a message to Mr Bernanke, Mr Bush, the Congress, the Senate, the Bank of England and the European Central Bank: please, please get it right this time.

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