Source of picture: www.walletpop.com
By John Richardson
In his own words Paul Hodges of International e-Chem - and also a fellow blogger - puts in a nutshell some of the dangers confronting the chemicals industry as we approach the New Year, with a few interspersed further thoughts from this blog:
“If crude were to fall back to $40 a barrel – where based on fundamentals it should be – this would further cloud visibility about the real state of end-user demand. It would become hard to distinguish between a fall in demand down the chain because of de-stocking and greater caution, and a fall in the final consumption of chemicals.
“Oil at its current price is hindering rather than helping the recovery because we are seeing demand destruction again. This is because we are already seeing greater caution on the part of those companies that recognise the risks of lower demand for chemicals. “For example, as the gasoline price has gone up, people are driving less to the shopping malls in order to buy stuff made from plastics – i.e. discretionary spending.”
There are even reports of this happening in China as a result of higher crude and fuel-price liberalisation.
“In Our Feedstocks for Profit Study, and I think this still holds, we saw a green light for growth was $25 a barrel, an amber light $50 a barrel and red at $75-80 a barrel.
“It’s generally accepted that demand destruction occurs at $80-100 a barrel.”
The last US recession began in December 2007 when crude touched $100 a barrel. This came at the same time as the sub-prime crisis. An important question now is with real wages in the West in decline and unemployment rising are we talking about demand destruction much closer to the $80 a barrel level?
“The crude price is being driven by irresponsible bankers, who are simply focused on generating maximum short-term trading profits (and personal bonuses for themselves). The money to support these trading activities is effectively being provided by taxpayers, as a result of the bailouts that have taken place,” continued Hodges.
“The strength in crude oil is directly correlated to movements in the value of the US$, often on a minute by minute basis. This is not about free markets. It is about bankers using the low interest rates now on offer in the US, caused by their earlier greed and reckless lending, to once again bite the hand that feeds them.
“Bankers need to behave more responsibly, especially at a time of crisis such as today. If they are not prepared to do so of their own will, we need effective legislation.
“When this unwinds you could see a big return to dollars, strengthening the currency significantly,” Hodges continued.
“This is hardly going to help progress in the US government’s effort to make the economy more export-based – part of the global rebalancing efforts.”
“Today’s oil prices are not the fault of chemicals companies, but they will suffer as a result.”
The risk is that the unwinding of these trades causes further disruption. As oil prices fall, so will chemical volumes as everyone de-stocks.
“This is why chemicals companies need good hedging strategies,” said Hodges.
“Another problem is the cost in terms of working capital. This will lead to a further problem as demand recovers. When demand is really weak, it’s possible to conserve working capital by cutting operating rates and other costs – hunkering down until the recovery arrives.
“But when the recovery does arrive, the difficulty is estimating how much to ramp up rates at the expense of working-capital preservation.
“Demand visibility – even without as yet a collapse in crude – is already extremely poor, making planning very difficult. “
“More companies go bust in an upturn than a downturn, because of the inevitable increase in working capital. This is a major risk in 2010, given the fragile state of the financial system, and banks’ unwillingness to lend.”