Asian Chemical Connections

By John Richardson

I HAVE been speaking to my colleagues who attended this week's NPRA conference in San Antonio, Texas, and it didn't appear from discussions during the event that a potential slowdown in China was high on anyone's radar screen. In fact, for many of the delegates it didn't seem to be blinking on the screen at all.

Evidence on the ground from our contacts in the polyolefins market is that selling activity remains very subdued and has been so since the Chinese New Year (CNY).

Fellow blogger Paul Hodges pointed out earlier this week that new official figures indicated a decline in lending and a slowdown electricity consumption growth in February. Although February numbers are usually heavily distorted by the CNY effect, both of these key economic indicators were a great deal weaker than for the same month in 2010.

As Paul says it is too early to say that the pause in China's breakneck growth will turn into a significant trend.

But it does feel very strange out there. Maybe the lack of willingness by buyers to commit to big volumes mainly reflects anxiety over an exceptionally uncertain global economic environment rather than lack of credit and inflation in China.

The blog, however, would have thought that delegates at NPRA would have at the very least flagged up this hopefully temporary lull in China as a risk to volumes and earnings growth in 2011. It is always best to under rather than over promise.

Or are we wrong? Please tell us.....

By John Richardson

THE global growth outlook grows ever murkier as a result of credit tightening in China (or is the problem instead continued strong growth in lending?), inflation problems throughout Asia, possible monetary tightening in the West, the direction of oil prices and the Japanese tsunami-earthquake.

We feel that this is making the rest of 2011 and next year perilously hard to forecast.

What follows is a brief summary of these key challenges, which we will examine in more details over the coming days and weeks.

As always we are working closely with fellow blogger Paul Hodges in an attempt to provide valuable support to chemical industry planners.

We don't want to get above ourselves here - this particular blog is run by journalists. But we hope that what follows helps you to challenge any blithe comments you come across about guaranteed continued strong expansion of the world's economy.

Here goes:

1.) We have picked up anecdotal reports from polyolefin traders and producers that credit tightening in China is making it harder for small -and medium-sized businesses, including the plastic converters, to access working capital. But does China's shadow banking system mean that, in fact, credit continues to expand? How does one then explain what appears to be flat polyolefins demand in China right now? Is this just a temporary lull due to overstocking? If Beijing cannot control credit growth, and thereby inflation, what does this mean for the battle against inflation and the long-term health of the economy? If property values continue to increase because of easy lending what will this mean for social stability and the struggle to create a more equitable society?

2.) Inflation, mainly driven by higher wages and oil and food prices, is a problem across Asia. Central banks are being criticised for being too slow to lift interest rates and allow currencies to appreciate. A repeat of the 1997 Asian Financial Crisis seems unlikely because of big foreign currency reserves. But Richard Martin, the managing director of strategic consultancy IMA Asia, was recently quoted in this article in the Australian Financial Review as saying: "Everything you buy is increasing 20 per cent year-on-year - labour, materials. Margins are down. In the second quarter companies will need to lift prices that will lead to a significant shift to inflation. The pace will step up each quarter to 2012. At that point inflation pressures within the production system will be strong enough for central banks to lift rates for a mid-cycle slowdown." His comment on weaker margins is interesting and could well be one of the reasons why Asian cracker operators are struggling compared with their western competitors

3.) Inflation in the West is also an issue, though more muted than in Asia. The Fed may decide on no further major boost to liquidity - i.e. it will complete QE2 but there will be no QE3. There are also indications that US interest rates could be increased by the end of the year. The European Central Bank is talking about rate rises while maintaining funding support for banks. Austerity programmes across Europe represent another danger to growth

4.) Once there are definite indications that there will be no QE3 this will likely result in some unwinding of the oil price, provided problems in the Middle East do not escalate. Speculators have indulged in a one-way bet on the Fed maintaining exceptionally high levels of liquidity. This has helped drive the oil price up and the dollar down. The reverse could now occur. What should this danger mean for chemical company raw-material purchasing strategies?

5.) Paul Hodges' excellent posts on the effects of the Japanese tsunami-earthquake are well worth reading. We would add that in the short term rolling electricity blackouts, as a result of the nuclear crisis, will continue to disrupt chemicals and downstream production for the next few month. New suppliers may, as a result, be sought for some of the chemicals that Japan makes for high-end goods such as printed circuit boards. An estimated 70% of one particular grade of epoxy resins for all the world's circuit boards is made in Japan, for example, with around 90% of Japanese production reported to be down two weeks ago. It might not be, of course, that easy to replace highly specialised chemicals technology at such short notice, leading to economic problems that will linger and continue to spread beyond Japan. This could mean further disruption for the rest of this year, for instance, in auto production in the US and final assembly of electronic goods in China. In the longer term, will procurement managers seek to move away from such a heavy reliance on one Japanese supplier because of the risk, however statistically remote, of another major earthquake in the next 5-10 years?

By Malini Hariharan

After sorting out their merger, PTT Chem and PTT Aromatics and Refining (PTTAR) are looking at a major new investment to take care of their future.

In an interview with the blog's colleague Tahir Ikram, PTT Chem's president and CEO disclosed that the two companies are jointly studying a cracker project.

"We are exploring the possibility of a new cracker. Whether it is going to be gas or naphtha, or where it is going to be located, it is under study," said Veerasak Kositpaisal.

Details at this stage are sketchy.

It is not yet clear if the project would be at Map Ta Phut, Thailand, which has finally seen the end of a protracted legal battle between environmental activists and the government. The settlement has no doubt given companies the confidence to look at new projects.

But what about feedstock availability? In an interview to ICIS news last year, Kositpaisal had said that while Thailand has gas it was not clear if it would be enough to support a world-scale cracker.

So will the project be located elsewhere in Asia?

Well, China is on the ceo's mind. Kositapaisal said in the recent interview that the company is looking at investment opportunities in the country.

"China is a big market. We think China will continue to grow at least by 8% and with that kind of growth they need new capacity, big capacity," he said.

True, but what can PTT bring to the table to tempt the Chinese to give a share of their market?

By John Richardson

LUNCH with a chemicals analyst yesterday, during the blog's latest trip to Singapore, gave an intriguing glimpse into the world of those who invest in the chemicals industry.

"The Morgan Stanely "Supercycle" report (which the blog wrote about late last year) seems to be on every fund managers desks," he said.

"These are long-only funds in that while they might trim their positions if markets turn bearish, they remain committed to petrochemicals for several years and therefore believe the Morgan Stanley argument about supply becoming very tight beyond 2012."

The blog believes that the famous report's argument - that Asia alone can carry the global chemicals industry to a new sunny upland of sustained profitability - doesn't stand up. The US and Europe remain too important for consumption.

But the accepted wisdom among these fund managers seems to be that nothing can go wrong, the analyst added.

All the risks we highlighted on Monday - and those further detailed by Paul Hodges in his  blog posting on that same day - point to grounds for serious concern.

"What is interesting is that the confidence in petrochemicals has been so great that the sector's share prices are outperforming overall Asian indices so far this year," the analyst continued (data to support his argument will follow a little later).

Now what if the short-term investors, those in it for a quick gain, have helped pump-up chemicals share prices by spinning a highly calculated, misleading story about the health of the industry? They may suddenly exit petrochemicals, and lots of other investments, when the punch bowl is finally taken away from the party - leaving "long only" investors severely burnt.

By Malini Hariharan

The shale gas based ethane rush in the US continues with Westlake Chemical the latest to announce big expansions at its two crackers in Lake Charles, Louisiana.

Each of Westlake's two light feedstock crackers will be expanded to provide ethylene for existing internal derivatives units and the merchant market, said the producer.

Westlake currently buys ethylene, estimated at around 135,000 tonnes, to support its styrene and vinyls production.

The first cracker expansion will increase capacity by approximately 230m-240m lbs/year (104,000-109,000 tonnes/year), while also increasing feedstock flexibility, Westlake said.

Current capacities of the crackers are 590,000 tonnes/year and 544,000 tonnes/year, according to ICIS. Westlake did not specify which cracker will be expanded first but said that the first expansion will be completed by late 2012 and the second by end-2014.

Westlake is also evaluating conversion of its Calvert City cracker (current capacity of 195,000 tonnes/year ethylene) from propane to ethane. Additionally, expansion options are being evaluated for the site and engineering and design studies are underway, said the company.

Westlake joins a number of other US producers looking to boost ethane-based cracking capacity despite the concerns surrounding the long-term future of shale gas.

The other risk is market related as the most of the ethylene derivative capacity will have to be exported, mainly to Asia.

But the risks are worth taking especially if a company is able to tie up with a gas operator to secure ethane at a cost plus pricing; the other option is to set up a fractionator, points out an industry player.

The opportunity is immense as gas is projected to remain at around $5/mmbtu while crude oil is unlikely to fall below $70/tonne, he points out.

His only worry is whether predictions will go wrong.

"Four years ago this place was dead; North America was written off. Now it has changed, but what is the guarantee that it will not change again?"

By Malini Hariharan

US chemical producer Huntsman plans to rapidly expand capacities and sales in India, a country that has caught the attention of global majors.

The blog caught up with the company's President and CEO Peter Huntsman in Mumbai yesterday.

"In every one of our businesses, except titanium dioxide, we will be spending money to build or buy in India," Huntsman said. "In textile effects, we will be doubling capacity in three years and we will also expand the Laffans facility," he added.

US-based Huntsman recently completed the acquisition of India's Laffans Petrochemical, which has a 60,000 tonne/year ethylene oxide (EO) derivatives facility at Ankleshwar in Gujarat state.

"We will first bring Laffans to the same standards as other Huntsman facilities, which should be easy, and we will then look at expansion," Huntsman said.

He added that details of the expansion were not yet firmed up but the ambition was to complete it in two years.

The company's other major expansion will be in Baroda, Gujarat, where it plans to spend $10m (€7m) to raise its dyes capacity by 80,000 tonnes/year.

"Some of the dyes produced elsewhere will move to India and we will also be producing some new products," Huntsman said.

Production would be targeted at the Indian market first and then exports. Huntsman acquired the Baroda facility from India's MetroChem Industries in 2009.

Earlier this year, the company announced plans to build a $10m polyurethane (PU) systems house in Pune, India, by April 2012.

However, Huntsman ruled out an Indian investment in methyl di-p-phenylene isocyanate (MDI) in the near future.

"The Indian market is not large enough to support a worldscale MDI plant," Huntsman said.

"We are going to start with a systems house, bringing MDI from the US and China. We hope we will be the first to produce MDI locally, but we need to build the end-use markets first," he pointed out.

As well as adding capacities, the company has budgeted $10m for an office complex in Mumbai, which will also house a technical support centre and laboratory.

Huntsman said he expects sales from India, currently $400m, to grow at 10%/year, while sales should double every five years.

He also expects sales from China to grow at more than 10%/year from the current $1.2bn.

"In the next five to seven years, Asia-Pacific will account for one-third of our sales," Huntsman said.

"Two years ago Europe was our single largest market. Within three years it will be North America, followed by Asia, Europe and Latin America," he added.

Huntsman posted sales of $9.25bn in 2010.

By Malini Hariharan

The blog was at the Vinyls India - 2011 conference in Mumbai which has attracted over 400 delegates interested in hearing about the Indian market.

The country has emerged as a major importer of polyvinyl chloride (PVC) with nearly 650,000 tonnes of suspension grade imported in 2009-10.

But no PVC conference can ignore China where demand grew by around 15% in 2010 to reach 12m tonnes.

Demand is expected to reach 13m tonnes this year, estimated Chi Junqing, head of marketing at Shandong Xinfa Huayu Co.

Demand will be supported by China's construction sector, as the government this year plans to start building 10m low-cost housing units, said

"This will provide a reliable guarantee for PVC building materials' construction growth," he added.

The Chinese government plans to build 36m units of subsidised apartments over the next five years.

Chi estimated Chinese PVC capacity at 20m tonnes/year while production was only about 11m tonnes in 2010.

Overall, the country has more than 90 PVC producers, with carbide-based PVC accounting for 81% of the total capacity, he said.

There are three carbide-based producers that have capacities that are more then 600,000 tonnes/year: Xinjiang Tianye, Xinjiang ZhongTai and Shandong Xinfa Huayu Co, according to Chi.

"After 2004, capacity has developed in provinces which have abundant raw material. Nearly 40% of the total capacity is now in the now in the northwest, southwest regions and in Inner Mongolia," he said.

He pointed out that the quality of carbide-based PVC has consistently improved in the last few years because of changes to technology and use of large reactors.

"Carbide-based PVC can meet the quality criteria of ethylene method. The product has already got the approval from many global customers and was exported to more than 100 countries," he said.

As for the Indian market, the blog will cover this tomorrow.

By Malini Hariharan

The outlook for polyvinyl chloride (PVC) in India is bright was the conclusion at the end of last week's Vinyls-India 2011 conference in Mumbai.

Plenty of indicators were put up to justify this conclusion. India's per-capita consumption of PVC is only 1.7kg as against 13.4 kg in the US, 9.2kg in China, 6.5kg in Malaysia and 4.5kg in Brazil, pointed out S Gopal, managing director of Chemplast Sanmar in his presentation.

The key drivers will be agriculture, healthcare, housing and water management.

The infrastructure sector is estimated to draw in nearly $100bn in investment in 2011. Additionally, the government plans to spend $16bn in the agricultural sector in 2011 while $15bn has been allocated for rural and urban housing development, he said.

Pipes and fittings, which accounts for 71% of India's PVC consumption of 1.87m tonnes, will continue to be the major end-user for this polymer. The Indian pipe market is estimated at 4.7m tonnes of which plastics accounts for 1.7m tonnes with the rest being steel, cement and iron.

Among the different plastic pipes, PVC has a dominant share of 86%, followed by PE (12%).

But India's PVC pipes sector is cluttered with a number of small processors many of whom are not particulary quality conscious. But Gopal believed that the sector will see changes in the coming years.

"I see consolidation; large players are growing faster than small players. I see advanced high productivity machinese being installed," he said.

So what does this mean for PVC demand which grew by 5% in 2010-11.

Gopal estimated that the country will need 200,000-250,000 tonnes of new capacity every year to keep pace with demand.

However, new projects have yet to announced.

Companies that are working on new ethylene capacity have not shortlisted PVC either because profitability for other ethylene derivatives has been stronger or an investment in chlor-alkali unit has been difficult to justify given India's high power costs. Other companies that are building new chlor-alkali plants have found it difficult to integrate to PVC in the absence of a secured source of ethylene. The only alternative is to import ethylene dichloride (EDC) or vinyl chloride monomer (VCM).

So it looks like India will continue to import large volumes of PVC for the next few years. Nearly 650,000 tonnes of suspension grade was imported during 2010-11; about 35% of total demand.

And Gopal predicted that the share of imports would rise to more than 50% of the local market.

By John Richardson

WHILE ethylene prices rose to a 14-month high last week on very expensive oil and the Shell Chemicals outage in Singapore, the ICIS pricing C2 margin report calculated a staggering $134/tonne fall in Northeast Asian margins. Rising naphtha is clearly not being passed on down the chain.

Meanwhile, low-density polyethylene (LDPE) margins in Northeast Asia plunged by $163/tonne to the lowest since November 2009, according to ICIS.

Northeast Asian integrated margins plummeted by $142/tonne.

This reflected a persistently weak China PE market that we have been writing about since the Chinese New Year. Pricing had been mainly flat-lining since the holidays up until last week, but last Friday was assessed lower - by $10-30/tonne.

One of the problems in China is that while efforts are still being made to re-balance supply and demand by re-exporting material from China, arbitrage appears to be closing.

"Pricing in Europe, Southeast Asia, Turkey and Latin America is coming more into line with that of China," a polyolefins trader told the blog last week during our latest visit to Singapore

"At the moment some cargoes are still moving, but I am worried these could be the last for a while. Inventory levels in the China bonded warehouses are still too-high."

One of the causes of the bad market since the New Year seems to be that traders bought too much material in January because they thought prices had a lot further to rise.

Polypropylene (PP) had fared slightly better up until last Friday.

"The positive thing from the perspective of the producers is that PP remains tight. Propylene affordability and availability is a big issue and there have been yet-more technical problems at a propane de-hydrogenation-to-PP complex in Saudi Arabia," the trader added.

"I don't think PE is as quite as tight as PP, although there is a lot of Asian capacity down right now because of the cracker turnaround season," added a source with a major producer.

"The shutdown season comes to an end in May. So potentially, unless there are some tough decisions made to extend maintenance work and/or resume production at low rates, a big extra slug of supply is heading our way."

The market has yet to see any evidence of more PE heading out of Saudi Arabia as a result of greater associated gas availability.

But it seems only a question of a few weeks before the extra volumes arrive. Saudi Arabia always runs at the maximum rate that feedstock availability and technical issues allow.

More output from other Middle East OPEC members seems logical also.

The demand outlook in China looks grim as everyone continues to search for an explanation as to exactly why it is so grim.

"It could be simply the case that we imported too much resin and the end-users know that so they are sitting on their hands," the trader added.

"Our ability to make the situation any better - and make some very nice money in the process - is about to disappear because, as I said, I think re-export arbitrage is about to close."

Or is it more because there is something wrong with the fundamentals of demand? The end-users would surely be unwilling to sit on their hands for such a long period if orders from their customers were good.

We have been picking up reports that credit is tight among the converters and fabricators for five weeks now.

The 'shadow banking system' theory challenges this view. But perhaps because converters are mainly small -and medium-sized companies, they cannot afford the higher interest rates that going through the shadow system entails.

Plus with resin prices so high it is a big risk to borrow money at, say, nine or ten percent with a significant price fall possibly just around the corner (last week's price declines might indicate it has already started).

This risk aversion also applies to the speculators in the physical market and the Dalian Commodity Exchange who have been a major force behind strong demand growth since H2 2009.

"To me it feels like 2008 all over again. I wish I had realised this before overbuying in January," continued the trader.

"Prices, in retrospect, have gone up by too much to quickly and we were all gambling on the rally continuing after the Chinese New Year. But this hasn't happened because inflation is now the big issue in China. The end-users cannot pass on any further cost increases."

If credit keeps expanding through the shadow banking system, inflationary pressures might get worse.

One of the big global threats is that oil prices fall quite sharply in H2 on the end of quantitative easing and interest-rate increases in the US.

There are also so many other uncertainties out there, including, for example, unrest in the Middle East, the longer-term implications of the Japanese earthquake and tsunami and sovereign debt risk in Europe

China seems to be more closely watching the world right now as well as the world watching China.

This is the result of the Dalian becoming the price setter for all domestic grades of PE.

Speculators, if they want to make excellent money, are playing on every available shift in sentiment, including those that occur both locally and overseas.

And as the bigger converters play on the Dalian, this means they have become much more attuned to international events.

"Overall I remain bearish. I made my money in Q1 and plan to be cashed-up in the second quarter and quite possibly into the second half if what you say about the Fed and oil prices comes true," said the trader.

The blog thinks that this is a very wise approach for all of us.

By John Richardson

THE blog remains extremely worried that there is about to be a major sell-off of commodities in general, including petrochemicals, as conditions right now feel very similar to those in 2008.

Whether we will face a systemic shock to the system, a black swan, on the scale of Lehman Bros is of course something nobody can predict.

But a sharp correction in pricing, regardless of such a shock, feels imminent and it might have already begun.

Goldman Sachs on Monday signalled it was time to take profits from its CCCP basket of commodities: crude, copper, cotton, soya beans and platinum.

"Not only are there nascent signs of demand destruction, but also record speculative length in the oil market," the bank said in a note to clients.

This was blamed for a subsequent correction in oil and other commodities within the Goldman Sachs.

But other forces, apart from Goldman prompting a sell-off, was behind the fall in oil prices by around $4 a barrel overnight on Monday.

In petrochemicals we saw declines in polyethylene (PE) week.

Paraxylene (PX), purified terephthalic acid (PTA) and mono-ethylene glycol (MEG) have been falling for two weeks in a row. MEG prices are down by 14% from $1,275//tonne CFR China February - a 37-month high, according to ICIS pricing.

Affordability seems to be a problem across petrochemicals in general as end-users struggle to pass on costs to their customers.

Fellow blogger Paul Hodges, in this excellent post, tracks the the long-term history of crude. He argues that average annual prices of over $50 a barrel, and of course we are well beyond that level now, have traditionally cause demand destruction.

In China, inflation is a major concern with increased interest rates and bank-reserve requirements restricting credit for small -and medium-sized enterprises.

A common story across several petrochemicals seems to also be that less bank lending in China is making it harder for the speculators to speculate. Speculative activity has offered big support to markets ever since the Chinese stimulus package was launched in late 2008.

And here's a worry on MEG: Inventory levels are reported to be very high.

"There is 600,000 tonnes in tanks in China a that the moment compared with the usual 400,000 tonnes," a source with a major producer told us last week.

As has been the case with PE since the Chinese New Year, might we see an attempt to re-balance markets through re-exporting this material?

By John Richardson

THE soaring confidence of the US petrochemicals industry over abundant ethane feedstock from shale gas could end up being colossally misplaced, as we have discussed before on the blog.

America is the most NIMBY (not in my backyard) of all societies and so it shouldn't come as a surprise to anybody that scrutiny is increasing over the environmental impact of the "fracking process". For example, several Senators said on Tuesday that the Environmental Protection Agency should step up regulations of shale gas because of concerns that toxic chemicals, such as barium and benzene used in fracking, could get into the water supply.

This followed another New York Times article on  Monday ahead of the release of a Cornell University study that will argue that as much as 7.9% of global methane emissions come from shale gas.

The gas is intentionally vented or flared from shale-gas wells or seeps out from loose pipe fittings along gas distribution lines, the study will claim.

This results in shale gas being worse for the environment than using coal for power generation.

But if the US wants to increase energy independence it is going to have to make some tough choices and with crude prices where they are right now, the natural gas industry might well find that its counter-arguments are well-received.

At the very least, though, this raises doubts over claims that the US is set to become the new Middle East of petrochemicals.

Chevron Phillips Chemicals has announced a feasibility study into a new cracker in the States and the blog has heard that that at least two more new facilities are under study.

Several expansions of existing plants are also under study amounting to a total of aorund 1m tonne/year of potential new capacity.

By Malini Hariharan

With all the buzz around shale gas in the US the blog is not surprised to read that China is also turning to this unconventional source of gas.

The country is looking to start shale gas production within the next five years, said a senior government official. It has drilled more than 10 wells and signed several cooperation agreements with foreign companies to develop more.

China National Petroleum Corp has completed its first horizontal shale gas well after 11 months of drilling. And the company is working with international majors such as Shell and Chevron on exploration and production.

China has also been busy gathering expertise to tap this resource. State-owned companies have already invested over $6bn in North American shale gas assets in the last three months, six times the figure for the whole of 2010.

And there is plenty of shale gas that the country can tap. In a recent report on shale gas resources outside the US, the Energy Information Administration (EIA) estimates that China has about 920 trillion cubic feet of potential shale-gas resources.

Source: EIA

The report assessed 48 shale gas basins in 32 countries and concluded that international shale gas resource base is vast.

If shale gas is added to other gas resources then the world's technically recoverable gas resources increases by 40% to 22,600 trillion cubic feet, said the EIA.

Prospects for natural gas, especially shale gas, have brightened after Japan's nuclear disaster. If the US can overcome all the environemental challenges surrounding shale gas then it is only a matter of time before other countries start developing their resources.

By John Richardson

LIKE the boy who cried Wolf the blog might not be believed as we once again warn about the risks ahead for China's economy.

We have been worried for a long time that eventually China's huge economic stimulus package, in response to the threat of social unrest, would cause some major problems.

As our fellow blogger Paul Hodges points out, Beijing had little choice but to pump-prime to such a huge degree because of the more-than 20 million migrant workers who had lost their jobs in early 2009.

Some of the money had to waste because it was so rapidly dispersed.

The state-owned banks, for example, have such close connections to the state-owned enterprises (SOEs). So the easiest and quickest way for the banks to follow the government order to go out and lend as much as possible was to lend to the SOEs.

We hear reports of a lot of this money going into unneeded industrial capacity and to arms-length trading companies that have greatly increased speculation in chemicals (for example, the story of an SOE official barred from trading who siphoned-off bank loans to his son so he could set up a chemicals and other commodities trading company).

But you didn't need to be related to an official in an SOE to get access to plentiful and cheap credit during the 2009-2010 explosion in loan growth, as money was no object across many levels of society.

The greater importance of the Dalian Commodity Exchange in setting prices points to the increasingly speculative nature of polyethylene (PE), thanks to all this easy lending.

Anecdotal reports suggest that there as many more traders in PE than before the crisis as dabbling in the futures and physical markets have, until recently, carried very little risks.

The same applies to other chemicals and polymers, whether or not they have a future market.

"There are far more traders in mono-ethylene glycol (MEG) than before the crisis. Right now there is around 600,000 tonnes in storage in tanks in China compared with the usual 400,000 tonnes. This has been a common pattern since early 2009 because it is so easy to gamble," a source with a major producer told us on the blog's recent trip to Singapore.

Easy lending has, of course, not only led to greater confusion in chemicals and polymer markets as to the real strength of underlying demand. Far more importantly, it has led to asset-price bubbles, most notably in the property market, creating a new "have not" generation that is a major threat to social stability (the very problem the government was trying to avoid through the stimulus package!).

And so we have felt a correction had to take place because of these economic distortions. What we didn't know (and if we did know we would be able to buy the odd yacht or two in the Bahamas) was the exact timing and extent of this correction.

We have, as a result, kept warning of the risks while being constantly surprised at the continued strength of growth - while occasionally losing our faith as we were sucked into the overall euphoria.

But now, believe us, the risks are greater than any time since late 2008 because of the battle to control inflation, the underlying causes of which are to do with the credit binge and the economic stimulus.

Will Freeman of Gavekal Dragonomics, an economic consultancy, said in the FT last week that the rising price of agricultural land and a surge in wages and input costs are behind the 11.7% year-on-year increase in food prices in March.

The government has blamed speculation, higher oil prices and hoarding for the rise in food costs, but Freeman argues that agricultural land has got more expensive because of the surge in demand for land for property. And as we have written about before, wages have been increased for rural workers (up 20% last year) and for factory workers in an attempt to tackle the inequalities created by the economic stimulus package.

The big worry now is whether inflation is out of control. Overall consumer prices rose 5.4% in March, the highest rate for 32 months, despite four interest rate rises since last October and six increases in the bank-reserve requirement to 20%.

More interest rate increases are expected later this year and very interestingly, Wen Jiabao, China's premier, talked about using the exchange rate as mechanism to flight inflation for the first time last week.

Another reason why the battle to control inflation has yet to be won might be an increase in bank lending, despite instructions by Beijing to the state-owned banks to cut back on new loans. Financial institutions extended Rmb679.4bn in new loans in March - roughly a sixth higher than the median forecast from 13 analysts polled by Dow Jones Newswires, according to the Wall Street Journal. 

This was the result of what we talked about before - the "shadow banking system".

But a new government statistic to capture this shadow system - total national financing - showed a 7.1% decline in Q1 over the first quarter of last year. This suggests that the rise in lending in March might be an anomaly.

Nevertheless, the struggle to deal with inflation will hang heavy over chemicals markets until or unless Beijing proves that it has achieved success. And as always with policies to deal with rising prices, there will be the constant worry of too heavy-handed action that sets growth back, as much as failure to be firm enough.

By John Richardson

POLYETHYLENE (PE) prices were assessed stable-to-weaker by my colleagues at ICIS pricing late last week as Sinopec was reported to be evaluating a 10% reduction in operating rates.

Sinopec hardly ever cuts production on market conditions as its main objective is not to make a profit, but rather serve local manufacturing industry as a whole. And so if the reports of a rate-cut evaluation are accurate this would further underline the dire state of the PE market.

Polypropylene (PP) seems to be benefiting from tighter supply due to maintenance work in the Middle East and feedstock shortages everywhere. Nevertheless, downstream sentiment remains equally glum on the big gorilla filling the room: Inflation.

In the fibre intermediates chain, mono-ethylene glycol (MEG) and purified terephthalic acid (PTA) firmed very slightly early last week on more speculation by the traders.

Click here for some recent pricing history - ICISpricing19April2011.ppt 

However, our ICIS pricing colleagues tell us that later in the week activity declined on the release of the 5.4% consumer price inflation number for March - the highest in 32 months.

Chemicals and polymers producers in general have been struggling since the Chinese New Year to pass on further cost increases down all the production chains.

And very interestingly, the All China Federation of Industry and Commerce has urged all the industrial groups it represents to heed Beijing's call not to raise prices. Twenty four of these groups attended a price conference last week in support of the Federation's position, including representatives from the textile, agricultural, fishery, pharmaceutical and bakery industries.

Polyester producers have already been forced to cut their operating rates on complaints from apparel and non-apparel manufacturers that the cost-push, driven by high crude and cotton prices, has gone too far. We could now see a concerted push for cost reductions following the textile industry's support of the Federation's stance.

And with the agricultural film season almost upon us (it starts in May), could we see strong pressure from farmers for lower linear-low density PE (LLDPE) and low-density PE (LDPE) costs?

Unilever has separately been persuaded to put on hold 15% price increases by China's National Development and Reform Commission (NDRC).

Finished-goods manufacturers have also been affected by rising wages costs, mandated by the central government in an effort to tackle the plight of those who have lost out during the stimulus-driven economic boom. These malcontents represent a major threat to social stability.

Inflationary pressure from rising input costs appears to be threatening the vital re-export trade (chemicals and polymer imports that are re-exported as finished goods).

Coastal factories are demanding higher prices for shipments, according to Dong Tao, a Hong Kong-based economist wit Credit Suisse, in this article in the New York Times. This is forcing the manufacturers to reject orders from Wal-Mart and other western retailers.

The sanguine view is that China's inflation problem is only temporary as it is mainly the result of more expensive oil on the Middle East crisis and more expensive food due to weather-related shortages and logistics problems. Speculation, which could in theory be tackled by a regulatory clampdown, is also being blamed by some commentators.

But Patrick Chovanec, professor at Tsinghua University's School of Economics and Management in Beijing, argues in this post from his blog that the causes of inflation are far more deep-rooted.

He has been warning since January 2010, as we have also been suggesting, that the huge economic stimulus package was a major inflationary threat.

China's money supply has risen by 50% since the stimulus began with far too much money pouring into fixed-asset investment and too little into consumption, he says.

Inflation in China represents one of the biggest risks to the global economic recovery. Chemicals companies need to be prepared for the worst possible outcome.

By John Richardson

THE refining industry enjoyed a golden era before the global economic crisis thanks to a booming economy and gasoline shortages caused by Hurricane Katrina. Inevitably, therefore, as is so often the case with commodity industries, too much new capacity was planned that came on-stream at the worst possible time.

But recently some financial analysts have been arguing that the worst is over for the industry. This is based on the premise that the world's economic recovery is on solid ground - which we strongly dispute - and less capacity additions over the next few years.

A recent report by Kunal Agrawal, Singapore-based energy and chemicals analyst with BNP Paribas, suggests a more negative longer-term view for the industry.

"We expect global utilisation rates and benchmark refining margins to improve steadily over 2011-12 owing to incremental refined products demand outstripping refining capacity additions, which we believe will result in a sweet spot for refiners and Asian refiners in particular," he writes.

"In our view, it is a good time to have exposure to refining, but a longer-term return to the 'golden period' of impressive refining margins of 2004- 08 is unlikely, as refining supply growth should exceed demand growth beyond 2012.

"We do not foresee global utilisations increasing beyond 85%. The utilisation outlook is healthy - but is unlikely to support a robust recovery in refining margins.

"We believe a longer-term positive sentiment on the sector is being a bit optimistic. Beyond 2012, we expect an excess of 1.8 mbd capacity to be commissioned annually, which would mean that supply will likely be ahead of demand growth. This is an unfavourable situation for a robust refining environment improvement, in our opinion.

"We also anticipate a significant amount of heavy-fuel processing capacities being commissioned over 2010-15, which will increase demand for heavy oil, and pressure the light-heavy spreads to contract. We believe this is negative for highly-complex refiners in the region that had enjoyed superior refining earnings during the refining supercycle of the middle part of the previous decade (owing to extremely strong light-heavy spreads).

"In the next refining cycle, we believe the ability of complex refiners to lock in the incremental dollar margin per barrel will be compromised."

This could have major implications for the availability and affordability of petrochemical feedstocks in different regions.

We can speculate that while older European refineries might be pressured by the overall problem of supply being in excess of demand, they might find themselves in a relatively strong position because of the greater strain on the newer, more complex refiners.

Last month we argued that the push by European refiners to meet strong diesel demand might make light ends, including naphtha, cheap for local petrochemical players.

The BNP Paribas report provides further reasons to believe that these European refiners could run relatively hard, providing advantaged raw materials to highly experienced and fully-depriciated domestic petrochemical industries.

The complex refiners, some of whom are integrated with new or fairly new petrochemicals capacity, might find their competitive positions challenged. They could be forced further to the right of the cost curve.

And overall with a significant oversupply of refining capacity being predicted, there might be plenty of spare naphtha to be traded globally, assuming there is no major consolidation.

What might this spare naphtha mean for the competitiveness of naphtha-based crackers versus the gas-based players?

By John Richardson

IT has been a fantastic party. Nobody expected that the drinks would last for so long, thanks to Wen Jiabao and Ben Bernanke working overtime to man the 24/7 off-licence (it is called "liquor store" in the States and a "bottle shop" in Australia).

But now the market has clearly reached the top with China facing the unenviable task of tackling deep-rooted, systemic inflation that has placed Beijing in an exceptionally difficult situation.

It will have to clampdown much harder on the cost and availability of money if it wants to bring food prices under control. The risk of failing to do so is major social unrest. As my fellow blogger Paul Hodges said the other day "how can any government expect to survive food inflation at 11.7%?" (its level in March).

But crackdown too hard on the extraordinary growth in liquidity post-2009 and the risk is a severe correction in house prices. All the millions of Chinese who would then find themselves in negative equity could then instead exert pressure on the government.

S&P's decision to put the US's AAA debt review on reviews is, as Hodges says in this post, a potential game changer.

"It means that policymakers can no longer pretend the $5trn they have spent over the past 2 years on stimulus measures somehow "doesn't count" in terms of needing to be repaid. Oil markets will be first in the line of fire.

"The S&P move makes it much less likely that the US Federal Reserve will be able to follow QE2 with QE3. And QE2 has been the prime reason why oil prices have risen from $75/bbl to $125/bbl since August, when it was first announced."

Even Barack Obama has said that he believes the rise in oil prices has been driven by speculation and not supply shortages.

Chemicals prices rose following the announcement last August that QE2 was going to take place with confidence further bolstered by the continuing boom in China.

But since the Chinese New Year, the world's most-important chemicals market has stalled as the realisation has sunk-in that there is something deeply wrong with China's economy.

It has happened before as Patrick Chovanec, professor at Tsinghua University's School of Economics and Management in Beijing, says in this blog post we also linked to on Tuesday. He quoted a book called Red Capitalism, where the authors - Carl Walter and Fraser Howie - write of how there was a surge in bank lending and inflation ahead of the Tiananmen Square crisis in 1989.

In an attempt to confirm what we fear, the blog spoke to four chemicals and polymers traders yesterday to assess the current mood in China. They said that while some markets had seen slight rallies early last week on mild recoveries in confidence, volumes remained exceptionally subdued.

"All the end-users are buying hand-to-mouth. There is no visibility anymore over the economic outlook. We have done incredibly well since Q1 2009, but it is now time to reduce our exposure," said a polyolefins and polyvinyl chloride (PVC) trader.

This repeats what we heard from another trader on our recent trip to Singapore  

By Malini Hariharan

A question that every butadiene buyer has been asking for a long time is when will prices ease?

There are no signs yet although buyers are threatening to cut production.

Butadiene rose by more than $200/tonne last week to $3,080-3,120/tonne CFR Northeast Asia, reports my colleague Helen Yan on ICIS news.

Prices have been driven up by a number of cracker outages and turnarounds in Asia, Europe and the US. Butadiene supplies have tightened over the last year and the more recent shutdowns at two Iranian plants (Jam Petrochemical and Amir Kabir) and Shell's cracker in Singapore have not helped matters.

Butadiene prices have risen by around 50% since January.

But buyer resistance is on the rise and some are planning cuts in production.

Kumho Petrochemical, Asia's largest synthetic rubber producer, will shut a 70,000 tonnes/year styrene butadiene rubber (SBR) plant and cut operating rates at a second 100,000 tonnes/year plant in May.

Other SBR producers in Asia too are reportedly contemplating production cuts. Additionally, a few SBR producers have planned maintenance shutdowns in the coming weeks.

However, the production cuts may not materialise if high butadiene costs can be passed on. And there are signs that this is happening.

SBR prices in India have crossed $4000/tonne and are likely to remain firm in May, reports ICIS news.

Tyre producers are willing to pay high prices as they expect SBR availability to remain constrained because of production disruptions in Japan.

"We have received enquiries from some tyre producers in Japan. Their suppliers in Japan were not able to deliver their contract cargoes because of power outages and extensive damage to infrastructure after the earthquake," said a Korean SBR producer.

If this continues, SBR and butadiene can continue their upward march and provide much -needed relief to Asian cracker operators who have been hit by weak pricing for other derivatives.

By Malini Hariharan

A few weeks back after a post on the rise of shale gas the blog was asked a question about new petrochemical investments in North Americas. Were they feasible? Would ethane prices remain attractive for the long term especially considering the recent run up in spot prices.

Well, companies are certainly confident, or at least confident enough to start planning new cracker projects.

The most recent announcement is by Dow Chemical which said late last week that it plans to build a new cracker on the US Gulf Coast for start-up in 2017, restart a mothballed cracker at St. Charles by end-2012, improve ethane flexibility at a cracker in Paquemine in 2014, and at another cracker in Texas in 2016.

Interestingly, Dow also said that it plans to increase propylene supply by constructing a new on-purpose propylene facility for start-up in 2015 and also explore commercialization of its own technology for production of propylene from propane with potential start-up of a new plant in 2018.

As for feedstocks ethane and propane, Dow appears to have plenty of choices on hand. It is exploring a joint venture for a fractionator in Texas, supply from existing fractionators or new fractionators and deals with shale gas operators at Eagle Ford and Marcellus fields. It has already signed a MoU for long-term supply of ethane from the Marcellus region to Louisiana.

The list of US companies planning new cracker investments or expansions to capacity is steadily growing. It includes Chevron Philip Chemical which announced last month that it was conducting a feasibility study on a 1m tonnes/year ethane cracker at an existing US site.

Westlake and Ineos have plans for cracker expansions. Braskem said recently that it was considering investing in a new cracker in the US. And a Taiwanese paper reported last week that Formosa Plastics has planned to invest $2.1bn to expand its crackers in the US.

However, Formosa declined to confirm the report and would only say that it was still in the 'consideration and planning stage, seeking opportunities to ensure raw material availability and increase operational flexibility".

The shale gas-based ethane opportunity is hard to ignore and the interest in new projects and expansions is understandable. But how many of these projects will be completed?

Al Greenwood, the blog's colleague on ICIS news posed this question to industry analyst Bob Bauman of Polymer Consulting International.

Bauman believes some of the projects will fail to take off. But when companies announce that they are going to build then there is a good chance for the project to be completed as such announcments have an impact on share prices, he said.

What is probably very important in today's environment in the US is to be out with an announcement that would deter competitors from pursuing their own plans.

"For me, announcing is an absolutely prime strategy," he said. "You may stop someone else from going forward, "said Bauman.

And he expected more announcements to emerge in the future.

As highlighted by the blog earlier, there are still a few challenges surrounding shale gas. The environmental issues need to be sorted out and companies will have to gamble on sustained demand growth from Asian and Latin American markets.

On the plus side, crude oil prices are projected to remain high for the foreseeable future giving gas-based producers a strong advantage. And with the project pipeline in the Middle East drying out the US is well positioned to bridge the emerging demand supply gap.

By Malini Hariharan

China's status as factory for the world is under threat as rising costs of operating are startingto bite.

Estimates of wage cost hike this year range from 10% to 20%. And if higher prices of raw material such as cotton and plastics plus the appreciation of the yuan are factoried in, then there is every reason for companies to look at alternative production sites.

Chinese companies supplying products to major retail chains such as Wal-Mart have warned that export prices will rise by as much as 15% this year.

And US retailers are looking to raise prices in the coming months. Average apparel prices are projected to rise 10-12% in the second half of this year.

Exporters based in China are looking to move inland or overseas. But a move to the inner provinces of China is not easy as it involves building new supply chains and setting up a logistics infrastructure to efficiently move large volumes of end-products to ports.

So some companies are pursuing both options.

Take the case of Foxconn Technology, one of the largest suppliers of electronic parts to companies such as Apple and Sony, which is planning to gradually trim its 40,000 workforce in Shenzhen by a quarter. It will be moving inland and is also planning investments overseas.

Brazil's president recently announced that Foxconn may invest up to $12bn over the next 5-6 years to expand production in the country. A company spokesman would only say that the company is giving "serious consideration" to further investment in Brazil. Foxconn already has five plants in the country and it joins other electronics manufacturers such as LG and Motorola that are looking to expand in Brazil.

In a report published earlier this year, Credit Suisse predicted that China's labour issues would have a major impact on the "manufacturing outsourcing model" for the rest of the world.

China's vast army of migrant labour that keeps its factories ticking has already started diminishing. And the country's labour surplus is projected to disappear post 2014 as population growth is slowing down while demand for workers in the services sector grows. Wages are likely to rise by 20-30% annually for the next 3-4 years.

"It may take a decade for China to see its export competitiveness erode, but we have seen the beginning of this happening," said Credit Suisse.

It's time to start thinking about which country will be stepping into China's shoes

By Malini Hariharan

All is not well in the Asian polyester chain. Demand has slowed down exerting a steady downward pressure on prices.

Purified terephthalic acid (PTA) spot prices have dropped by $100/tonne in the last week to $1,290-1,300/tonne CFR China Main Port and the outlook for the coming months is bearish, reports ICIS news.

The price slide shocked many market players but the indications were there - futures prices on the Zhengzhou Commodity Exchange have fallen 14% since early March.

Monoethylene glycol (MEG) spot prices have also slipped, dropping by $30/tonne last week to around $1100/tonne CFR China. Earlier in the month, major producers decided to lower their contract nominations for May because of weak market fundamentals.

And paraxylene (PX) too has come under pressure with spot cargoes trading at a discount last week for the first time in six months.

The shift in markets follows changes in cotton, which had supported much of the prices gains seen in polyester and its raw materials since last year.

Futures prices for cotton on the Intercontinental Exchange have been falling since early April after hitting an all-time high of $2.179/lb on 7 March.

The fall is partly because production is expected to rise as record high prices last year have given farmers the right incentive to raise acreage.

This is likely to happen in the US and India but Chinese acreage may not grow as farmers have turned to other crops that offer better returns.

China would then have to import larger volumes of cotton which could reignite a rally in cotton prices and support a recovery in pricing of fibre intermediates.

By Malini Hariharan

Yesterday's announcement by Asahi Kasei, Sabic and Mitsubishi Chemical of a joint-venture acrylonitrile (AN) project in Saudi Arabia fills up one more slot in the kingdom's petrochemical value chain and supports the move downstream.

Sceptics might question the viability of this strategy but Saudi companies are slowly pressing ahead.

Mohammed Al-Mady, Sabic's CEO, said the AN project's key driver was the Saudi National Industrial Clusters Development Program which aims at growing and diversifying the kingdom's manufacturing sector.

The plan is to build plants for 200,000 tonnes/year of acrylonitrile and 40,000 tonnes/year of sodium cyanide at Al Jubail. A start-up date has yet to be confirmed but a final investment decision is due in 2012.

"AN and NaCN are very important chemicals for downstream diversification into acrylonitrile butadiene styrene (ABS), carbon fiber, acrylic fiber and acrylamide," noted Al-Mady.

For Asahi, completion of the project will fulfill its target of becoming the world's largest AN producer with a total capacity of 1.4m tonnes/year. It is currently at No2 with 750,000 tonnes/year of capacity with plants in Japan, South Korea. A new 200,000 tonnes/year unit in Thailand is due to start this year and a 245,000 tonnes/year plant in South Korea due in 2013.

Interestingly, the Saudi project will be based on propylene technology and not on the new propane process that Asahi is using in the Thai project. It's not clear why this is not being pursued, especially as Asahi had in the past talked about using the propane-based process in Saudi Arabia to boost its competitiveness.

By Malini Hariharan

The problems for Chinese manufacturers are multiplying. Besides having to worry about rising input costs, inflationary pressures and tightening of credit, companies now have to contend with unexpected power cuts.

This is usually the low season for power consumption in the country but supply to industrial units is being rationed in some provinces as power production has been affected by a dip in coal supplies. Affected provinces include Zhejiang, Hunan, Jiangxi and Chongqing with Zhejiang said to be experiencing its worst shortage in seven years.

Small and medium-sized enterprises have been hit the most. For instance, in Zhejiang province's Taizhou city, small enterprises that have an annual output value of less than Yuan 5m are not allowed to use electricity between 7 am and 5:30 pm, while medium-sized enterprises that have an annual output value of more than Yuan 5m are being asked to cut their use of power every two days.

Companies are turning to generators but this is an expensive option.

Besides supply side issues, the power situation is also being aggravated by increased demand from projects that were stopped last year to enable China to meet its carbon emissions reduction target for the 11th Five Year Plan.

It is not clear if things will improve before summer. The
National Development and Reform Commission (NDRC) has already warned that power supply will not be adequate in most places in 2011, and especially in eastern China, northern China and the southern regions of China.

The China Southern Power Grid has said that the country's five southern provinces will face power shortages of up to six gigawatts in the second quarter. And a power supply shortfall of 11.7 gigawatts, or 6% of peak power demand, is also being forecast in eastern China this summer.

Power costs could also go up as coal prices are projected to remain high. Demand for coal has been growing faster than supply which has been constrained by consolidation in the coal industry as provincial governments have been closing small and unsafe mines.

Some analysts expect the government to step in with measures to ease the situation. If that does not happen soon power shortages could be another factor depressing the region's petrochemicals market.