Asian Chemical Connections

By John Richardson

DESTOCKING is obviously not the main driver of the decline in China's polyolefins market, despite what a dwindling band of optimists are still arguing.

The glaringly transparent reason for the fallacy of the fading belief is a decline in key end-use markets for polyoleifins - and for other polymers and chemicals.

Today we are going to look at autos and next week the housing sector, which, according to some estimates, accounts for 50% of China's GDP.

The auto industry is a very important consumer of chemicals globally, accounting for 10-15% of the industry's revenues, according to a report released by HSBC last week. $2,800 of chemistry goes into each auto manufactured in the US, estimates the American Chemistry Council.

Polymers used in autos include a large amount of polypropylene (PP), high-density polyethylene (HDPE) for fuel tanks, polyurethanes (PU), nylon resins, polycarbonate and acrylonitrile butadiene styrene (ABS). 

China is now the largest auto market by production in the world and so its continued health matters a great deal for the global chemicals industry.

Auto sales have fallen as a result of government policy changes.

The battle against inflation is likely to continue for the next few quarters at least and so it seems unlikely that overall credit conditions will be eased.

Bank-reserve requirements and interest rates wil more probably be further increased as the government tries to bring inflation rate below its 2011 full-year target of 4%.

Incentives that were specifically introduced to boost auto sales have also been rolled-back.

The hope is that some of these incentives might be re-instated. But how likely is this given the contribution that booming sales have made to overall economic overheating - and to chronic traffic-congestion problems?

Sales grew by a staggering 32% last year to 18.06m vehicles.

April this year saw a monthly decline for the first time since 2009 and May sales also dipped - by 3.98% to 1.38m units.

Full-year 2011 sales growth estimates are, as a result, being revised down. The Chinese Association of Automobile Manufacturers (CAAM), for example, now expects growth to be below the increase in GDP (expected to be around 9%) compared with its previous prediction of a 10-15% expansion.

Light-vehicle sales could actually decline by 10% in 2011, according to Rao Da of the China Passenger Car Association and Zhao Hang - president of the China Automotive Technology and Research Centre.

The outlook has become much bleaker, adds the HSBC report, as a result of:

*The reinstatement of a 10% purchase tax on cars with an engine size of 1.6 litres or smaller from December last year. The tax was cut to 5% in January 2009 and then raised to 7.5% before being returned to the full 10%

*The removal of one-off subsidies for trading-in old, and therefore highly-polluting, cars in rural areas

*Beijing cutting the issuing of new licenses in 2011 to one-third of last year's level in order to tackle congestion. Only 240,000 new licenses will be issued this year. While Beijing only accounted for 7% (800,000) of nationwide auto sales in 2010, the concern is that the other major cities will follow suit, such as Nanjing, Chengdu and Guangzhou.

The one remaining incentive - a Rmb3,000 incentive for each fuel-efficient car that is purchased - might soon be brought to an end, says HSBC.

Share prices of local auto companies rallied last week on a local media report that the National Development and Reform Commission was set to ask the State Council to re-instate incentives. However, the CAAM denied the report.

The auto sector perfectly illustrates how Beijing faces the very-difficult balancing act of trying to cool the economy down while avoiding an economic hard-landing.

And the 32% growth in 2010 auto sales raises another important point: How many chemicals companies paused for thought when they saw this number, realised it could not possibly be sustainable and planned for lower growth - or even a contraction in the market?

The widespread panic and surprise over, along with denial, over a weaker China suggests the answer is probably "Not many".

By Malini Hariharan

The doom and gloom affecting many segments of the petrochemical industry has yet to reach methanol. Asian spot prices have been stable since January and have hovered in the $340-350/tonne range during the last three months.

Methanol traditionally tracks crude oil prices but the product has been unaffected by the recent slide in crude. Producers have successfully held on to contract prices with Methanex recently listing its July contract price as a rollover of June's $420/tonne. In the US, Methanex has maintained a contract price of 128 cents/gal for the last six months.

Buyers are hoping for a price correction in the coming weeks, writes Heng Hui, ICIS pricing editor for methanol in Asia in this week's pricing report.

First, they expect supply to improve following the restart of Brunei Methanol's 850,000 tonnes/year plant and Petronas' 1.7m tonnes/year plant this week. However, the Petronas plant may not run at full capacity after restart. Some pipelines that supply natural gas to the plant have reportedly been affected by the massive Japanese earthquake in March and may need to be replaced.

Buyers also expect recent declines in Chinese domestic prices to trigger methanol exports. Prices and demand from key sectors such as formaldehyde and MTBE have been easing since May. Power shortages, documented by the blog earlier, have also hit operations of formaldehyde plants in some provinces.

Discussions for exports have started with talks centred around re-exporting imported product as shipping out locally produced methanol is not viable because of high logistic costs.

But these developments could be shortlived.

China, which accounts for around 40% of the global market, saw demand in April drop by around 3% month on month to 2.15m tonnes, estimated Ken Yin, the China methanol editor, in the Chemease China Methanol Monthly for June.

However, demand was up 25% compared with April 2010 and China appears to be on track to post an impressive 18% growth in methanol demand this year driven primarily by the dimethyl ether (DME) and gasoline blending segments. These two sectors currently account for around 33% of Chinese methanol demand and are poised to grow by 30% this year.

If that materializes methanol could stay firm for the rest of the year. The blog will be discussing the future for methanol, especially in China, in another post later this week.

By John Richardson

EUROPEAN polyolefin converters seem quite justified in pressurising their suppliers for further price reductions, given weak macro-economic fundamentals and still-excellent profitability at the cracker end of the value chain.

The news from China continues to get worse. China's Vice-Premier Wang Qishan said last week that the government's 2011 targets for GDP growth and inflation would be difficult to achieve.

China's Premier Wen Jiabao also admitted last week that the official 2011 target for inflation of no more than 4% would be hard to attain.

Wen's comments, made during a trip to Europe, were in marked contrast to his article in the Financial Times a couple of weeks ago when he talked about victory in the battle against inflation.

The $64,000 dollar question is WHEN this victory will be achieved. While inflationary pressures might ease by the third quarter, they are forecast to intensify again in Q4 because of strong underlying inflation.

Further increases in bank-reserve requirements and interest rates now seem almost certain, making life even harder for China's small -and medium-sized enterprises (SMEs). These companies are, of course, the life-blood of chemicals and polymer demand in China as most buyers are SMEs.

In a post later this week we shall examine in detail why the SMEs are being hurt more by credit restrictions, higher borrowing costs - and also a sharp increase in wages - than the state-owned enterprises (SOEs).

Returning to Europe, it is evident from comments made to our ICIS pricing colleagues that the China factor looms large.

Polyolefin exports that would have gone to China are now being diverted to Europe, with this surplus availability accelerating the global price-equalisation we have discussed before.

A Greek debt default still seems inevitable, despite last week's optimism following parliamentary approval of an austerity package. And given the level of public protest and political opposition, one would have to be pretty deluded to believe that the cuts will all be implemented on-schedule.

So if you are buying polyethylene (PE) and polypropylene (PP) plastic pellets in Europe you will hardly be in a hurry to stock-up on volumes. 

This is also the summer holiday season when demand traditionally falls.

A further reason for buyers to remain on the sidelines is high stock levels among the producers.

Several PE and PP producers told ICIS pricing late last week that they were sitting on 2-3 months of stocks, with one admitting that his inventory was to close to its 2008 level just before the great crash.

"Since the 2008 financial disaster producers have been on the whole very disciplined, keeping stocks at no more than 3-4 weeks," a European-based industry observer told the blog yesterday.

This suggests to us that the extent of the problems in China have not been fully understood, and that stocks were built on anticipation of firmer crude.

Strong overall cracker profitability could also be a reason for PE and PP output remaining high relative to the state of the polyolefin markets. 

European contract margins based on naphtha feedstock did fall by almost a quarter last week on lower ethylene and propylene July contract settlements and high naphtha costs, ICIS margin analysis showed on Monday.

In the week ending 1 July, contract cracker margins fell by Euros162/tonne ($235/tonne) to Euros579/tonne.

But the average margin for June was Euros667/tonne - the best seen in 2011 so far and the highest margin since the 2008 crisis.

Upstream margins, as we have talked about before, have long been supported by strong co-product credits, disciplined operating rates and a high number of force majeures.

The ability of non-polymer consumers of ethylene and propylene to pay high prices for their raw materials has delivered a further benefit.

The July ethylene contract settlement - Euros95//tonne lower than in June - is therefore expected to be fully passed-on to July PE contracts, said our European-based poyolefins ICIS pricing editor, Stephanie Wilson.

Incidentally, the C2 settlement was the biggest movement in pricing since the monthly contract system was introduced in March 2009, added our European olefins editor, Nel Weddle.

PP markets were slow to react last week to the Euros75/tonne fall in the July propylene contract, added Stephanie.

But given that June PP contract prices fell by Euros80/tonne, further reductions in July contracts seem very likely.

Both PE and PP spot prices weakened further last week. PE declined by Euros20-50/tonne and PP by Euros40-70/tonne.

By Malini Hariharan

The impending oversupply in purified terephthalic acid (PTA) and likely problems in securing feedstock paraxylene (PX) does not seem to have dampened enthusiasm for new investments,

Around 10m tonnes of PTA capacity is expected to come on stream from the third quarter of 2011 to late 2012, while another 12.9m tonnes of capacity is due to start during 2013-15, according to a recent estimate by ICIS.

China is of course leading the way with nearly 7m tonnes of new PTA capacities due in 2012. By the end of that year, Chinese PTA capacity would total to 32m tonnes/year as against a demand forecast of 23m tonnes. This could result in Chinese PTA exports provided new plants are able to source sufficient PX as capacity additions for the feedstock are taking place at a slower pace.

PX is likely to remain short in Asia until 2013 when five new plants are due to start. But the respite could be shortlived as new PTA projects are once again being lined up post 2013.

The recent entrants to a long list of companies planning new plants includes Ningbo Mitsubishi Chemical which is mulling a 1m tonne/year facility at Ningbo, China. The company has yet to set a start-up date.

Thailand's Indorama Ventures is also studying PTA projects in the Middle East and India, the company's chief executive said recently. These are part of the company's plans to raise its global production capacity, for PTA, polyethylene terphthalate (PET) and fibers, to at least 10m tonnes/year by 2014, from approximately 5.5m tonnes/year today.

Indorama has yet to disclose the location of its proposed Middle East facility but it could be Saudi Arabia where attempts are being made to draw in PTA investments that would offtake PX from a new refinery.

Lotte Pakistan is planning to triple its PTA capacity to 1.5m tonnes/year by late 2014 while Indian major Reliance Industries is working on two new PTA plants with a total capacity of 2.2m tonnes/year for start up in 2013-14. A third plant is also likely although details have yet to be firmed up.

At an industry conference earlier this week, a Saudi Aramco executive confirmed plans for a PTA plant at Al-Jubail based on 700,000 tonnes/year of PX supplied for the new Sartorp refinery. The refinery, a joint venture between Aramco and Total, is due to start operations in H2 2013.

"We've had two players coming forward previously but the negotiations have stopped. We are still looking for people to invest in the PTA unit," said the official, who did not disclose the names of the parties.

Oman and Kuwait, which currently export PX, are also interested in venturing downstream.

India's JBF had announced last year plans for a 1.2m tonnes/year joint-venture PTA plant with Oman Oil in Oman with PX to be supplied by Aromatics Oman. However, the blog understands that JBF has abandoned Oman and is now looking at building a plant in India.

This is likely to be a temporary setback for the Oman Oil which recently integrated its three subsidiaries Aromatics Oman, Oman Polypropylene and Oman Refineries and Petrochemicals into Oman Oil Refineries and Petroleum Industries Co (Orpic). The newly structured Orpic should be in a better position to pursue a PTA project on its own.

The investment wave is no doubt being driven by optimistic projections for polyester and PET and many of the projects probably have sound economics. But the risk of overinvestment needs to be carefully assessed.

Here is the first of two posts that will analyse the implications of China's decision to raise interest rates for the third time this year 

By John Richardson

CHINA'S decision to once again raise interest rates will put further pressure on the hard-pressed small and medium-sized enterprises (SMEs) that make up the bulk of the country's chemicals and polymer buyers.

Cheap and plentiful capital is still available to the state-owned enterprises, real-estate developers, infrastructure investors and local and municipal governments, said Michael Pettis  - a professor at Peking University's Guangzhou School of Management. 

But life has been made more difficult for the SMEs each time benchmark interest rates and bank-reserve requirements have been increased, as they are the last in the queue for whatever favourable lending remains in the banking system.

The SMEs have to often go to the "shadow banking system" to source their lending where borrowing costs have risen even more sharply than in the formal trade-financing system, according to an article in the Financial Times.

"China has raised benchmark lending rates by 100 basis points to 6.31%, but small businesses have seen much steeper increases," wrote the FT before yesterday's increase to 6.56%.

"Monthly lending rates at credit unions and informal lending institutions in the entrepreneurial cities of Wenzhou and Xiamen have reached 5% in the past few weeks, up from 1.5%, according to Credit Suisse.

"Small Chinese businesses are feeling the effects the government's monetary tightening and face a cash squeeze that may be worse than during the global financial crisis in 2008, according to an official warning.

From tile manufacturers in Shanghai to shoe factories near Hong Kong, smaller businesses have driven Chinese growth over the past two decades, accounting for about 60% domestic product. So, a sharp slowdown in their activity would weigh heavily on the Chinese, and by extension, world economy."

The government has launched an initiative to try and help the SMEs which involves banks not being forced to count loans of less than Rmb5m ($77,000) towards their loan-to-deposit ratios.

"This seems to me a very complicated way of alleviating the cash crunch among SMEs," continues Pettis.

"The proper way would be to reduce the demand for credit from real estate developers and infrastructure investors, but of course Beijing loves its administrative measures.

"The only efficient way of reducing demand from real estate developers and infrastructure investors would be to have them pay a fair cost for their capital - and remove the implicit credit support. This however would threaten to throw a huge number of essentially insolvent projects and companies into bankruptcy, so the preferred solution is to keep their cost of capital low and to keep their borrowings growing."

He is not convinced that the new initiative will provide any relief for the SMEs

China's banks are expected to issue Rmb6.7 ($1.04 trillion) of new loans this year compared with Rmb7.95 trillion in 2010, according to the China Securities Journal.

This is further bad news for the SMEs because, as we have already said, they are the last in the queue for official lending. A reduction in formal credit growth is likely to increase their reliance on shadow banking.

Making their plight even worse is the labour-intensive nature of many of China's smaller companies. Wage costs have risen by 20-30% so far this year as central and local authorities try to reverse the widening gap between the rich and poor.

In the second part of our analysis of the effect of China's latest interest-rate rise we look at how the polyolefin market has alllegedly taken the decision in its stride. Crude markets are a different story altogether....

By John Richardson

CHINA'S polyolefin market has improved over the last week thanks to a recovery in oil prices and anticipated tighter supply of polyethylene (PE) and polypropylene (PP).

A euphoric trader told us this morning that pricing for physical cargoes across many grades had increased by $50-100/tonne over the last week.

"It is about time as business has been flat for so long. The market has taken the latest interest-rate rise in its stride," he said.

"All the bad news that can happen this year has already been priced-in."

Linear low-density (LLDPE) futures prices on the Dalian Commodity Exchange had risen by around Rmb400/tonne since last week, he added.

But a source with a major global producer was less upbeat. He said that in general prices for physical cargoes had risen by only $50/tonne over the last week, and added: "The recovery is very welcome but nobody should be popping any champagne corks. We are a long way from being out of the woods."

One very good reason to keep the bubbly on ice is the increasingly erratic nature of crude-oil markets.

When pricing was heading in a clear upward direction earlier this year, as we have already discussed on the blog, chemicals and polymer buyers built inventories.

Now, though, "buying forward" is a very-risky strategy, as illustrated by events over the last few days.

Oil started to rally late last week after Greece's parliament approved austerity measures.

This led to this extraordinary statement in a Bloomberg report from earlier this week, justifying stronger crude pricing:

"The economic outlook looks better and the Greek situation looks significantly improved and is no longer a major concern for people," said Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts.

"That's giving people a lot of optimism about the economy in Europe and the US."

In the very short-term maybe this was true - until Moody's decision on Tuesday to downgrade Portugal's debt to junk status.

The downgrade and the latest interest-rate rise in China resulted in both Brent and WTI prices falling on Wednesday as equity markets also took a hit.

Oil markets had clearly not factored-in another rate rise in China, and are now reflecting concerns about what the battle against inflation will mean for economic growth in 2011.

PE and PP supply is set to tighten, however, as several cracker complexes are due to undergo turnarounds in August.

The maintenance work will see China's August ethylene production dip by more than 100,000 tonnes over July, according to this graph from the ICIS pricing World Ethylene Plant Report:

Chinaethyleneslide.ppt 

Shell Chemicals will reportedly continue to run its mono-ethylene glycol (MEG) plant in Singapore during an August turnaround at its cracker.

This will mean it will have to purchase around 40,000 tonnes/month of ethylene, potentially driving-up C2 and therefore PE pricing, ICIS news was told by market sources.

"The sentiment is certainly a lot better than a week ago and it looks if the slide in pricing has been arrested," continued the source with the polyolefin producer.

"Supply will be tighter in August. Linear low-density (LLDPE) and low-density (LDPE) demand will also pick-up during that month as a result of the start of the next agricultural film season.

"A week ago, people were talking about PE and PP pricing for several grades falling to below $1,000/tonne CFR China.

"But the credit problems remain in China, particularly for the small and medium-sized companies (SMEs) - which make up the bulk of polyolefin buyers.

"I have heard that the biaxially-oriented PP (BOPP) film sector has been particularly badly affected. The big scale of modern BOPP production lines means there is a requirement for a large amount of credit.

"Plus, I am very worried about the effect on sentiment when the full scale of the local government debt problem in China is recognised. Then we could see commodity and share prices falling by 5-10%."

Weakness in key end-use sectors such as autos is also adding to the problems caused by tighter credit.

Volatility in crude and the demand outlook is therefore likely to make any price recovery short-lived.

By Malini Hariharan

China is well set to take on an even larger role in the global methanol industry. The country already accounts for a little over 40% of demand and its share is set to expand rapidly in the coming years.

The blog recently caught up with Ken Yin, the China methanol markets editor at Chemease for an update on future prospects.

Ken expects Chinese demand to touch 24m tonnes this year as against 20m in 2010. There is plenty of local capacity - estimated at 42m in 2010 which is likely to reach 50m by the end of this year.

Companies are rushing to start up new plants in anticipation of demand for from the dimethyl ether (DME), gasoline blending and methanol-to-olefin (MTO) sectors.

These three end-uses will be the key drivers to Chinese methanol demand in the future with only moderate growth coming from the traditional end-user sectors of formaldehyde and acetic acid.

DME has seen some hiccups this year as the Chinese government clamped down on its use in LPG blending because of safety issues. But it has started drawing up national standards for DME use with LPG and also specs for the gas cylinders. These are likely to be ready by June 2012.

And DME could emerge as a much bigger play if producers are successful in their trials of using pure DME as a household fuel, points out Ken.

Methanol use in gasoline blending is also ready to take off once the government introduced national standards. These were due last year but were delayed as trials were not completed.

The government is widely expected to introduce a M15 national standard this year which will allow 15% blending of methanol with gasoline. Some provinces have carried trials of 85% blends but The M15 blend is the most favoured as it does not require retrofitting of engines.

Methanol use in gasoline blending and DME is projected to grow by 30%/year. The figure could be higher if government speeds up implementation of new standards.

But the industry is likely to see resistance for state-owned refining companies such as Sinopec as increased use of methanol in gasoline blending or blending DME with LPG would affect its sales.

China's methanol economy is gradually taking shape and no doubt providing ideas to other countries around the world.

By John Richardson

HOPEFUL theories espoused by traders can sometimes sound a little hollow - as was the case with the one doing the rounds in Asian polyolefin markets late last week.

"We think the latest interest rate rise in China will be the last this year and so, in a way, the announcement was good news. It means all the bad news is now out of the way," a trader told the blog on Friday.

Several other traders agreed as they argued - perhaps because of the positions that they have taken - that the recovery  would hold.

When we raised the fact that many economists believe at least one more rate rise is on the cards this year, with further increases in bank reserve requirements possible and lending set to dip sharply in 2011 over last year, the phone line went dead in our discussion with the first trader mentioned above. We tried calling back but with no success.

China's Premier Wen Jiabao thinks the 2011 annual inflation target of 4% or less will be hard to achieve. He might know a thing or two.

As long as the crucial 4% remains out of sight the lending environment will remain restricted - and could well get worse. This is a major problem for China's small and medium-sized enterprises (SME), which make up most of the country's chemicals and polymer buyers.

Interestingly, the exact opposite view on the impact of the latest interest rate increase was being expressed in the C2s market, according to our colleagues at ICIS pricing.

Ethylene prices rose by $20/tonne to $1,130-1,170/tonne FOB Korea last Friday.

But this and other gains were being "tempered by China's interest rate hike and uncertainty if the hike in the key downstream polyethylene (PE) segment can be sustained," wrote ICIS pricing in its Asian ethylene report.

Polyolefin traders are understandably sighing with relief that the market is finally showing signs of life after being flat or in decline since March. Import volumes and demand have been sharply lower.

The pricing improvement is significant: PE was assessed $10-80/tonne higher last Friday over the previous week with polypropylene (PP) increasing by $10-60/tonne, according to ICIS pricing.

But another producer we talked to this morning, confirming the views of the producer we spoke to last Thursday when we broke the news about the price rally, warned that it was important to put the recovery in the right context.

"There has been some improvement in demand, but that was to be anticipated," he said.

"We are about to enter the peak manufacturing season for exporting finished goods to the West for Christmas. The next agricultural film season is also about to begin in August.

"Maintenance shutdowns are the other factor but crucially, where do we stand now in terms of demand compared with this time last year? Down is the answer."

In a report released late last month, HSBC talked about consensus demand-growth forecasts for PE, PP and polyvinyl chloride (PCVC) in China being in the range of 11-13% for 2011. No way is this going to happen.

Tomorrow we will look at similar widespread caution among European producers. Despite recoveries in olefin and polyolefin spot markets, further reductions in contract prices are still being very-seriously discussed.

On the Asian supply side, a US-based chemicals analyst told us that the peak production loss for 2011 was forecast to be in February-March this year.

After the steep rise in cracker turnarounds in August, he sees supply being well-balanced in the fourth quarter.

And sorry to bore you to death about this, but we are still searching for an answer to our question of whether the Saudis, and also the Kuwaitis, have upped production on greater availability of associated gas.

Could this extra supply make the market long in the last quarter of this year?

By John Richardson

EUROPEAN ethylene and polyethylene (PE) market participants seem a million miles away from buying into the idea that the recovery in Asia is sustainable.

This is a realistic view following last week's interest rate rise in China, the fifth in eight months - and with the announcement over the weekend that inflation in June had risen to 6.4%.

We will discuss the implications of China's inflation problem in detail in a later post. But here it it is worth saying that this official govenment pronouncement supports our view that more monetary tightening is on the cards.

The argument that last week's interest rate rise would be the last this year, used to justify polyolefin price rises in Asia, looks as if it has been built on very shaky ground.

Consensus opinion on the European ethylene market late last week was that it had found its floor, wrote Nel Weddle, ICIS pricing olefins editor in Europe.

But she added: "Sources caution it is too early to determine whether the reversal of trend in Asia will be either large enough or sustained enough to make a significant difference to the supply and demand balance through the July-August period and beyond, when the next round of European cracker turnarounds start.

"Several players said that there has not been a structural shift in demand in Asia, and describe the renewed demand as a normal function ahead of planned maintenances given the extensive de-stocking during recent months.

"One source said any expectation of a return to the very healthy March-May period was akin to clutching at straws."

Cracker operating rates have recently been cut by 10-20% in an effort to rebalance lengthy supply, according to some producers.

PE and polyvinyl chloride (PVC) inventories were reported to be still very high.

"Initial (July contract) pricing ideas of minus Euros50-130/tonne are filtering through from producers in the European PE market this week," added European polyolefins editor Stephanie Wilson.

Triple digit reductions over June settlements, including as much as Euros120/tonne for low-density polyethylene (LDPE) and butene-1 grade linear low-density (LLDPE), were being discussed, she said.

European prices were still seen as too-expensive relative to Asia, suggesting the upper hand is now with the polyolefin consumers after two-and-a-half years of power residing upstream.

Or is it that the damage to the downstreamers has gone beyond a tipping point?

"The cracker operators can wheel their suitcases of money to their banks, but what about the longer-term prospects for European manufacturing?" said one rather jaundiced industry observer, who has since left for a sorely-needed summer holiday.

By Malini Hariharan

The fight against anti-dumping duties (ADD) imposed by India on polypropylene (PP) exported by Saudi Arabia, Singapore and Oman is not yet over.

Some of the major companies that face ADD have taken the matter to the Indian Customs, Excise and Service Tax Appellate Tribunal and the issue is due to come up for hearing later this month.

Among the producers affected by the ADD are Singapore-based ExxonMobil Chemical Asia Pacific, Saudi Yanbu Petrochemical Company, an affiliate of Sabic, and Saudi Polyolefins Company.

Regular readers of the blog will remember that final ADD was imposed on product from the three countries was imposed last year despite strong protests from exporters.

The duties came after local producers led by Indian major Reliance Industries complained about the heavy influx of product during April-December 2008.

India's commerce ministry subsequently ruled in favour of the domestic producers and further said that the Saudi formula for pricing propane, feedstock for PP, gives Saudi producers an 'unfair advantage' over other international producers. More than the duties the India's reading of the Kingdom propane discount structure become a matter of concern for the Saudis as they run the risk of similar cases being filed by other countries.

This is the first time that the Saudi price formula for propane and butane, which is linked to naphtha and gives local buyers a discount of around 30% on the Japan CFR (cost and freight) naphtha price, has been termed as unfair by another country.

Saudi Arabia later threatened to take the issue to the World Trade Organization (WTO) but has yet to do so. It has instead been exerting maximum political pressure to ensure that India withdraws the duties. Delegations have been visiting Delhi and the Saudi ambassador to India recently said that the ADD issue is likely to be discussed at a high-level meeting due later this year unless it is resolved quickly. "It will be on the top the meeting's agenda," he said.

The Indian government has withstood Saudi pressure quite well so far. But it is uncertain if it can continue to do is given Saudi Arabia's position as a major supplier of crude oil to the country.

A source familiar with developments told the blog that India's oil ministry is now involved in the case and will be paying close attention to see that the issue does not create problems in oil supplies.

"They [Saudis] are expecting the duties to be removed; they are confident," the source added.

By John Richardson

THE fascinating, but also at the same time frustrating, complexity of the Chinese economy has been thrown into further relief this week in the debate over the implications of the June 6.4% inflation rate.

The rate, the highest in close to three years, was seen as especially worrying by some economists because it included the highest "core" increase in the cost of living for at least five years.

Two thirds of the increase in overall Chinese inflation has, however, been attributed to food prices (food prices rose by 14.4% from 11.7% in May), creating the hope that the heat will soon be taken out of inflation when food prices moderate.

The cost of pork, for example, has risen by 57% in the past year and is often subject to boom-and-bust cycles. So the hope is that once pork and other highly volatile food prices moderate during the next down cycle, everything will be fine.

But the June core inflation rate of 3% has increased the concern that the huge 2009-2010 economic stimulus has created strong underlying inflationary pressures that won't easily be solved.

"Since Q4 2008, China has created the largest credit bubble in history," writes fellow blogger Paul Hodges in this post.

"First, it doubled bank lending to $1.4trn in 2009 (one third of GDP), and then maintained it close to this level. Secondly, it added a stimulus package worth another 13% of GDP ($580bn), focused on providing cheap electrical goods and autos."

As we discussed earlier this month, some of these stimulus packages are being unwound - for example, in autos - with important implications for chemicals and polymer demand growth.

But still, with all this money left over from the stimulus package sloshing around in the economy, some economists are becoming increasingly worried that inflationary pressures are going to persist.

This was one of the points made in this article from the Wall Street Journal.

Out of a poll of 13 economists conducted by the Dow Jones Newswire last Thursday, however, eight said that they believed there would be no further interest rate rises this year as inflation would soon peak.

The poll was taken before the weekend release of the June inflation number, which was not only close to a three-year high but was also sharply higher from the 5.5% increase in May.

But several economists, even after the announcement of the June figure, were quoted in the same article as still believing that inflation would ease later this year.

Worryingly, though, these same economists had predicted in June 2010 that the rise n the cost of living would moderate. Instead, inflation jumped to 5.1% last November, stayed at a high level for several months, and has now started to accelerate again.

This perfectly illustrates the point we made at the beginning - that figuring-out what is really happening with the Chinese economy remains incredibly frustrating.

Lack of clarity means that every comment made by senior politicians is analysed, perhaps over-analysed, as it is assumed that only they have the real inside-track on what is really happening.

A great case-in-point occurred earlier this week.

"Those still holding out for a policy loosening found some cause for hope in comments from Chinese Premier Wen Jiabao the day before the (June industrial production and second-quarter GDP) data were released," wrote Aaron Back in another article from the Wall Street Journal.

"He declared that fighting inflation still is the government's top priority, but also paid lip service to slowdown fears by pledging to prevent any 'large fluctuations' in economic growth.

"The domestic stock market, which fixates on official pronouncements, clearly detected dovish hints in this language, rising in early morning trading even before the data were announced.''

But then came the release of the data.

Second quarter GDP showed the country's economy expanded 9.5% from a year earlier, down only slightly from the first quarter's healthy 9.7%, adds Back.

On a sequential, seasonally adjusted basis, GDP accelerated, rising an annualised 9.1% in the second quarter, compared with 8.7% in the first.

Industrial-production growth rebounded strongly, rising 15.1% from a year earlier in June, the highest reading since May 2010. Economists had forecast a 13.1% rise, after 13.3% in May.

Australia's ABC TV news last night interpreted these figures as a sign that China's economy had further decoupled from the West, rather than discussing the implications for inflation.

This followed a rally in the Australian stock market on the argument that China was still booming.

But why exactly did industrial production rebound so strong?

"To meet the central government's target of conserving energy and reducing emissions in the period of the 11th Five Year Plan (2005-2010), many factories were shut down, cut- off electricity or reduced production last year," wrote the China Daily in this article.

"Since the beginning of this year, however, China has witnessed a sudden revival of the production of the heavy industries."

(Apologies for the bad grammar as these are obviously direct quotes).

The China Daily adds that this is the reason for the power shortages that have afflicted China's manufacturing heartland.

And so why, if industrial production has rebounded so strongly, has chemicals and polymers demand been so weak?

We think that "buying forward" was the reason and subsequently, the pressure of high chemicals and polymers prices (a global phenomenon) in a much-more restricted credit environment.

HSBC, in a report released late last month, estimates that polyethylene (PE), polypropylene (PP) and polyvinyl chloride (PVC) were more expensive that any other point in history in March this year, when inflation is taken into account.

Returning to the point about expectations of further monetary tightening, they might have dipped after Premier Jiabao's statements - but have now increased following the release of the latest industrial production and GDP numbers.

But as the China Daily also points out in the article above, this year's power shortages are still forecast to be the worst since 2004, perhaps limiting further growth in industrial production during the scorching summer months.

Could this, along with the restructuring of heavy industries the China Daily also discusses, take some of the heat out of inflation? What might this restructuring of energy-efficient industrial production mean for chemicals demand?

A further complication to ponder is what the Chinese government will do if inflation continues to increase.

Officially, it has said that it will stick to the conventional tools of raising interest rates and bank-reserve requirements, writes Karen Maley in this excellent article in Business Spectator.

But she adds: "Analysts note that further rises in the reserve ratio penalise the banks even more, and will only encourage both lenders and borrowers to seek out new ways to sidestep the official banking system."

As we wrote last week, the small and medium-sized enterprises, which make up the bulk of chemicals and polymers buyers in China, have been increasingly forced to side-step the official lending system. This has greatly increased their cost of trade finance, restricting their purchasing.

The alternative of further interest-rate rises would not only hurt the SMEs even further; as Maley points out, it would also raise government financing costs.

A stronger Yuan might therefore be the only solution. China's currency has risen by only 2% against the US dollar so far this year and has fallen in value against other currencies, she adds.

Increasing the value of the Yuan woud inflict extra pain on the SMEs as they struggle both with more expensive credit and higher wage costs.

All of these complications illustrate that the straight-line growth we saw in chemicals and polymers demand over the last two-and-a-half years, post the 2008 economic crisis, is no longer guaranteed.

Anyone who tells you otherwise is either being disingenuous or is ill-informed.

The next 12-18 month are going to be very challenging.

By Malini Hariharan

Styrene's addition by the US to a list of 'anticipated carcinogens' does not seem to have affected producers demand growth expectations for the product or for its key feedstock benzene.

Speaking at the 5th ICIS Asian Aromatics and Derivatives Conference in Singapore earlier this week, Alexander Farina, Shell Chemical's general manager for chemicals strategy development, drew out an optimistic picture for both benzene and styrene. (Full speech available here)

Styrene is projected to see global demand growth of 3%/year to 2020 supported by expandable polystyrene (EPS) and its application in the construction sector (average annual growth rate of 8% in Northeast Asia). EPS it offers good insulation properties helping countries achieve their objective of lowering carbon dioxide emissions.

Inter-polymer competition between polystyrene (PS) and polypropylene (PP) is also expected to ease as propylene and PP have been getting more expensive.

On the capacity side, a fall in ethane costs has improved export competitiveness of US styrene producers enabling an improvement in capacity utilization. While global styrene is still long with average industry operating rate at around 86%, the good news is just around the corner. With only 1.0-1.5m tonnes/year of new capacity due in the near future operating rates, said Farina, would swiftly recover in 2011.

Benzene is also expected to benefit from developments in the phenolic chain. Global polycarbonate (PC) demand is growing at 6%/year as its use in automobiles and electronics is being ramped up.

Farina did refer to some of the challenges facing benzene, the first being the slow addition to capacity - only 2%/year as against demand growth of 3%. There has also been a shrinking in on-purpose benzene capacity which now account for just 4% of global capacity, down from 20% before 2005.

This loss of swing capacity has made benzene more volatile with rapid fluctuations in prices with prices rapidly fluctuating to account for movements in crude oil or changes to demand.

Farina emphasised Shell's strategy of remaining an integrated low-cost aromatics producer. New technologies are being developed to retain this status. This includes a gas-to-aromatics route, he said, without giving further details.

"Gas-to-aromatics could be viable by the end of the decade... It is a strategic fit to our upstream gas business, which is where the growth is," Farina added.

The only other similar technology is the UOP/BP Cyclar process that makes aromatics from butane and propane. The technology has been implemented by Sabic in Saudi Arabia but the blog has been told that it has not been a commercial success.

Meanwhile, the US styrene industry is preparing for a legal fight to remove the 'carcinogen' tag. The US federal health regulators had declared in June that styrene is 'reasonably anticipated to be a human carcinogen'. Industry groups subsequently went to court to block the listing by asking for a preliminary injunction. They claimed that government researchers had relied on manipulated data and on information that had not been reviewed. But a US court rejected last week a plea for preliminary injunction but has still to consider the request for permanent injunction.

By John Richardson

RISING oil production in Saudi Arabia has resulted in bigger volumes of polyethylene (PE) being delivered into Asia-Pacific markets, a source with a major plastics processor told the blog late last week.

"Saudi Arabia has definitely, in my view, already raised PE production on more availability of associated gas. I am seeing more volumes in our local market," he said.

Clear evidence emerged last week that Saudi crude production has been on the up for at least two months.

Estimates for June production range from 9.4m barrels a day to 9.8m barrels a day, up from around 9m barrels a day in May.

Crucially, the International Energy Agency believes that Saudi Arabia has continued to raise production in July, possibly already reaching 10m barrels a day. This would, in theory, enable the country to once again run its crackers at 100% due to the greater availability of associated gas.

Saudi Arabia is producing more oil in order to pay for higher social costs following the Arab Spring. Another reason is concern over the effect of high crude prices on the global economy.

Polyolefin prices continued to rise last week - the second week in a row of increases. For example, PE rose on a delivered basis by $20-50/tonne in Northeast and Southeast Asia, according to ICIS pricing.

But with Middle East offers for August material expected to emerge in the third week of July, the big question remains whether the price recovery will be sustained.

Not only is supply not necessarily as tight as traders have argued due to the suspected increase in Saudi production, but also the macro-economic climate in China and elsewhere is getting worse.

The uptick in both prices and volumes over the last few weeks has mainly been attributed to traders re-entering the market on the perception that prices had bottomed.

Doubts are being expressed about how much of these volumes have been passed-on to end-users who remain very nervous about the risks ahead.

By John Richardson

SHELL Chemicals put an argument forward last week that polystyrene (PS) had regained ground from polypropylene (PP) as a result of expensive propylene.

And the petrochemicals major forecast a bright future for both PS and expandable polystyrene (EPS).

The blog pretty much always enjoys playing the devil's advocate and so later on in this post we will suggest some challenges to the Shell view.

First of all, though, here is a bit of background and some of the details of the case put forward by Shell.

From Feast to Famine

As we have discussed before on the blog, C3s have become very costly as a result of the switch to lighter cracker feeds in the US, the predominance of gas as a feedstock in recent steam-cracker capacity additions and above GDP demand-growth for PP.

So expensive has propylene become that since the global economic crisis, PS has regained its cost position against PP, said Alexander Farina, Shell's General Manager, Chemicals Strategy Development.

"Equally encouraging is that substitution of PS by PP seems to have reached a plateau, and estimates suggest global styrene demand will grow around 3% per annum to 2020," added Farina in a speech to the 5th ICIS Asian Aromatics and Derivatives Conference, which took place in Singapore last week.

"Reports from Asia confirm that further PS substitution is no longer an issue.

"There are ongoing challenges for PS in North America and Europe, where perhaps up to one-third of each market could be vulnerable to PP, but only with increased investment in production capacity for the latter."

"Substitution is not a threat to construction market-focused PS products - particularly insulation - where long-term demand outlook is good in both new build and refurbishment. There are other uses - such as snap-off multipacks for foods like yoghurts - where PS is clearly the material of choice."

Farina, however, earlier in his speech painted a challenging picture for benzene pricing.

Benzene went from a feast of oversupply in the 1990s to a famine of an over-tight markets in the 2000s, he recounted.

The last decade marked the introduction of tougher regulations on benzene content in gasoline, leading to the closure of on-purpose hydro de-alkylation (HDA) capacity.

"Before 2005, on-purpose swing capacity could add 20% to other (global) benzene production," he added

"Today, it is nominally about 4%, but practically non-existent.

"Back in 2005, a Shell colleague speculated on whether the severe reduction in swing capacity would - at some point - create the need for new, on-purpose benzene supply if incremental fatal supply remained unavailable.

"Well, to-date, it has not, and the jury is still out on if and when that may happen."

This had left benzene supply very-heavily dependent on how reformers and steam crackers run, he added. C6 pricing is therefore often driven by the demand for gasoline and olefins rather than the demand for benzene derivatives.

"In combination with high and fluctuating crude prices, the knock-on effect has been to make benzene prices much more volatile," he said.

And he added that current estimates were for benzene demand to grow by just over 3% per year with supply only increasing by about 2% per annum.

But despite these challenges, Farina said that the price of the feedstock would remain competitive.

His speech also pointed out the excellent insulating properties of EPS and how it could help reduce energy consumption. Better-insulated buildings had the potential to reduce global energy consumption by 20%, he said.

But just for sake of being miserable....

1.) What if new ethane-based crackers in the US 'crowd out" liquids-based cracker investments elsewhere? Might this sharply reduce the projected growth in benzene availability?
2.) What if the legal wrangle over styrene being declared a carcinogen by the US Department of Health and Human Services leads to consumer goods made from PS being banned?
3.) What if the propylene supply issues that have caused the surge in C3 costs are resolved? Unlike in benzene, on-purpose production of propylene is becoming ever-more popular. For example, several propane dehydrogenation (PDH)-to-propylene projects have recently been announced in the US and China
4.) And most importantly of all, what if crude oil pricing becomes even-more volatile, causing problems for more than just benzene? As we will argue in Chapter 3 of our e-book, 'Boom, gloom and the new normal - how Western baby boomers are changing global chemical demand patterns, again', oil markets have become dysfunctional and represent a major risk to the global economy.

By Malini Hariharan

CEOs of Asian petrochemical companies worried about rising feedstock costs, a weak economic outlook and profitability should have been reassured to read over the weekend that even Mohammed Al-Mady, vice-chairman and CEO of Sabic is having sleepless nights.

His chief concern is keeping Sabic's record profits at record levels.

Sabic churned out a net profit Saudi riyal (SR) 8.1bn ($2.16bn) on sales of SR13.2bn in the second quarter of this year beating analyst expectations. Net profit was up 61% while sales rose by 45.3%

"What keeps me awake at night is keeping the successes we have. This is about the 8.1 billion riyals ... How long can we sustain this? It is challenging," Al-Mady said after declaring the bumper results.

Success in the last quarter has mainly been a result of increase in production and sales volume as well higher sales prices for most of its products compared with Q2 2010.

Production volumes are set to grow if Saudi Kayan quickly achieves commercial production. Al-Mady indicated that this was likely to take place only in second half of the year, delayed from the earlier target of H1. But given an uncertain demand outlook, especially in the key China market, placing additional volumes at the best possible price is going to be a challenge.

Al-Mady is of course hoping that crude oil continues to stay firm. In his view today's price range is "quite good for everybody" although some of his Asian counterparts squeezed by high feedstock costs may not entirlely agree.

But Al-Mady's challenge extends beyond the short-term as he has to figure a way to keep Sabic on the winning track. New projects will certainly help and Sabic has 14 of them lined up during 2012-15 including a $1bn expansion at its joint venture with Sinopec in China.

India continues to be on the radar.

"India is a huge market, the (Indian) government is thinking of attracting new investments and SABIC is looking at investments in India -- if there are any good investments in petrochemicals there, products from refineries," said Al-Maady.

But as projects take time to materialize a quicker route to growth will be through acquisitions and Al-Mady is, as always, open to the idea. The issue now is finding the right asset at the right price.

By John Richardson

EUROPEAN polyolefin markets are at one of those fascinating tipping points following the recent price recovery.

Ethylene spot prices rebounded late last week with July sales much better than those in June, wrote Nel Weddle, European ICIS pricing olefins editor, in this report.

Propylene, however, remained under pressure because of a long market.

The same pattern was reflected downstream where polyethylene (PE) spot pricing had strengthened while polypropylene (PP) remained under downward pressure because it was perceived as still too expensive.

But in both ethylene and PE the rapid change in the European mood was such that reductions in August contracts were no longer the only option under discussion; rollovers or even increases were being mentioned.

In Asia, the recovery seems a little less clear cut. Traders, producers and buyers keep mentioning one word over and over again - "affordability".

They agree with a HSBC assessment, published in a report released last month, that in inflation-adjusted terms PE, PP and polyvinyl chloride (PVC) prices were the highest that they had ever been in March 2011.

That month marked the end of a clear upward direction in crude, reducing the incentive of resin buyers in China to "buy forward".

March and every month since then has also seen further monetary tightening as China attempts to bring inflation below 4%. This has placed a great deal of pressure on the small -and medium-sized enterprises (SMEs) that make up the bulk of the country's resin buyers.

So the worry is that if prices go up by too much too quickly - before the battle against inflation has been won, enabling Beijing to result to relax monetary conditions - there will be a kickback from the converters.

Another big worry is that crude, buoyed by greater stock market confidence, might enter a new mini bull-run.

"Some of the less well-integrated Asian cracker operators would then face either stomaching weaker margins or attempting to pass-through prices that might well not be acceptable to the buyers," said a source with one major producer.

This would be a familiar problem, according to a report released by Nexant ChemSystems late last week.

"(The) average profitability of the South Korean industry (in the second quarter) fell to a six quarter low," wrote the petrochemicals consultancy.

It attributed this to rising naphtha costs and weak polyolefin exports to China.

One trader repeated his earlier comment that a lot of resin remained in the hands of the traders.

"The improvement in Asian pricing over the last two weeks is mainly down to the traders acquiring volumes. If the buyers do suddenly come back in big numbers, then whoosh - pricing could really take off."

But, of course, the other possibility is that the traders end up getting burnt.

As for supply, the blog is still struggling to get a definitive answer on whether higher Saudi crude production has resulted in more polyolefin output. This would be the result of greater availability of associated gas.

Contradicting the plastics converter we quoted earlier in the week, our trader source said: "I am not seeing bigger volumes coming out of Saudi. Several grades remain tight."

A Middle East-based chemicals analyst, however, said that the Q2 financial results released by Yansab, the SABIC subsidiary, showed its production had increased. Two and two makes four or five?

"Parent company SABIC's volumes were also up in the second quarter, but this might have been to do with greater overseas output," he said.

One obvious explanation for tightness in PP is reports of mechanical problems at two Saudi facilities. This has taken 1.1m tonnes of annualised capacity out of the market, if the reports are accurate.

By Malini Hariharan

Dow Chemical appears to be ready to take a final decision on its huge cracker and derivatives joint venture with Saudi Aramco in Al Jubail, Saudi Arabia.

Media reports in the last two days indicate that the $18-20bn project, first announced in 2007, has moved forward with a final decision likely to be announced in the next few weeks.

Contractors have been shortlisted. According to one report, South Korea's Daelim Industrial has been selected as the engineering, procurement and construction (EPC) contractor for the multi-feed cracker while Fluor Corp has been selected for utilities.

Dow or Aramco did not confirm these reports. But the timing seems right as Dow's CEO Andrew Liveris had said earlier this year that the project, which was initially planned at Ras Tanura, would move to the final approval stage in July. Front-end engineering and design work was also expected to be completed in mid-2011.

Both companies have yet to confirm the product slate and start-up dates.

Dow has lined up an impressive list of projects for execution over the next 5-10 years. Besides the Saudi joint venture, it is also has plans for a cracker and two propane dehydrogenation (PDH) plants in the US and then there is coal-based joint venture with Shehua in China. Will it proceed with all or is time to make a choice?

By John Richardson

THE edgy and nervous nature of the recovery in Asian polyolefin markets became even more apparent from discussions the blog held with traders and producers during a visit to Singapore last week.

Such was the uncertainty that there were mid-week reports of falls in pricing.

By Friday, though, one producer told us he felt confident enough to raise his offer prices for August material.

This was reflected in the assessments made by ICIS pricing for the week ending 22 July. Polyethylene (PE) prices were assessed $20-40/tonne higher with polypropylene (PP) increasing by $30-50/tonne.

But interestingly, ICIS pricing wrote in its 22 July Asian PE report that the bulk of purchases made so far during this recovery have been by traders.

"China's plastics processors are expected to start replenishing their stocks at the end of July, ahead of the peak manufacturing season due to begin in August," continued the report.

As we have been reporting for the last three weeks, traders appear to have e-entered the market in fairly large numbers on the belief that prices by the week ending 8 July (when the recovery began) had bottomed out.

Drawing parallels can be a little risky, but a trader-inspired rally also occurred in copper around the same time, according to a report we read in the Financial Times.

Commonsense dictates that at some point end-user buying in polyolefins, and probably across a broad range of commodities, has to pick up. Regardless of the strength or weakness of Western economies, there is still going to be a peak manufacturing season for making finished goods for exports to the US and Europe in time for Christmas.

Further adding to the confidence of polyolefin traders is the expectation that supply will be tighter in August and September on turnarounds at Asian crackers.

And as we discussed last week, mechanical problems at two Saudi polypropylene (PP) facilities have reportedly taken an annualised 1.1m tonne of supply out of the market.

Several grades of PE are also pretty tight, according to one of the traders we spoke to.

But we are not able to walk around all the bonded warehouses in eastern and southern China in order to assess stock levels (now isn't that a wonderful idea?).

In other words, we, and everybody else trying to figure out this market, cannot gauge exactly how much material all the traders have bought in anticipation of increased purchases by end-users.

Adding to the nervousness and edginess of this three-week long rebound is an equal lack of certainty over the strength of the eventual upsurge in buying by the plastic processors.

"Most converters in China are small and medium-sized enterprises," a very senior source from a major polyolefin producer told us last week, underlining what we had already understood.

He also agreed with us that until or unless Beijing gets inflation below 4%, the SMEs could well continue to struggle to afford and source credit.

"Some of the end-users I know are being forced to pay interest rates as high as 15% from finance companies outside the official banking system," he added (the official lending rate is only 6.56%).

"There are rumours that measures will be introduced to help the SMEs get more finance at reasonable rates, but the question will then be whether the measures will work.

"If the extra lending ends up in the hand of the speculators, this would obviously not help the smaller companies and could add to inflationary pressures.'

His view was that sales volumes would likely remain lower than 2010 levels for the rest of this year.

One further factor that must surely be hanging over the markets is the possibility that the US will fail to raise its debt ceiling by the 2 August deadline.

If the worst outcome occurs will the peak manufacturing season even happen?

By Malini Hariharan

After last year's stunning rise, cotton prices have plunged 53% in the last four months from a 140-year peak of $2.15/lb on 4 March.

Prices have fallen 38% in July with cotton for December delivery quoted at 98.63 cents/lb on the Intercontinental Exchange.

The swift correction in prices is based on expected increase in acreage across the world. Global production for 2011 is forecast at nearly 123.2m bales, up 7.5% from 2010.

The US department of agriculture (USDA) recently estimated that cotton acreage in the country was up 25% from last year. China is forecast to produce 33.0m bales, an 8% rise from a year ago.

In India, the world's second largest exporter of cotton, cotton sowing has seen unprecedented growth and acreage is expected to rise 8% in the current season. And barring any flooding Pakistan too is likely to see production expand 17% this year.

This increase in global acreage should be sufficient to take care of weather disruptions such as the flooding in the Mississippi cotton belt and drought in Texas. The USDA has estimated 42% of the crop in the top 15 cotton producing states as very poor or poor and only 28% as good or excellent.

But any more disruptions could easily trigger a rise in prices as this report in the Financial Times suggests.

"The world has planted enough acreage to handle a disaster of one of the greatest proportions it has seen, in Texas. But it cannot handle a second one," warned Joe Nicosia, chief executive of Allenberg Cotton, the world's biggest cotton merchant.

Meanwhile, there have been problems on the demand side as well with Chinese imports from January to June falling 32%. Lower-priced polyester has expanded its market share at the expense of cotton. And now with prices correcting buyers are unlikely to be interested in building cotton stocks.

However, Nicosia suggested that cotton does not have much further to decline. Although he warned the industry to be prepared for another year of huge swings.

Meanwhile, polyester has yet to react to developments in cotton. Prices have remained firm based on the strength in raw material purified terephthalic acid (PTA) and monoethylene glycol (MEG) markets.

But some polyester producers have started expressing concern and expect polyester prices to also fall in the coming months. Cotton pulled up polyester last year and there is nothing to suggest that the reverse cannot happen.

By John Richardson

China's petrochemical imports continued to decline in June on tight credit conditions and price rises that deterred consumers, according to our colleagues at ICIS news.

Linear-low density polyethylene (LLDPE) imports fell by 18% month-on-month and 3% year-on-year, for example. High-density PE (HDPE) shipments slipped by 4% month-on-month and 8% year-on-year.

Benzene shipments halved both compared with May 2011 and with June last year, indicating the broad-based nature of the affordability issue that we have discussed before on the blog.

The June numbers provide further support to the argument that recent price increases are going to be hard to sustain, unless the government is able to introduce effective measures to ease the plight of chemicals and polymer buyers.

By John Richardson

DO you trust your government to always get it right?

The answer in the case of the West is "of course not", but in China's case the publicly-expressed assumption still holds that the economy is being effectively managed.

CEOs of chemicals and polymer companies might find it politically challenging to openly say "Beijing doesn't entirely know what it is doing" on any particular policy - never mind on the management of the economy as a whole. (How can anyone entirely know what they are doing as this is such a complex and mammoth task?)

And so what passes for a genuine debate about the future direction of the world's most-important chemicals market sometimes feels as if it is little more than repeated re-utterances of cosy platitudes.

The blog hasn't got out of the wrong side of bed this morning. It just feels that a more serious debate needs to take place with chemicals-industry investors about some of the risks ahead.

Take the slowdown in polyolefin markets that we have been extensively reporting-on over the last five months.

We have yet to discover a broad top-level recognition that a significant slowdown is even taking place and what it might mean for the timing of the next peak in the petrochemicals cycle.

Is it that we are merely miss-informed and not talking to the right people? We genuinely hope so.

Inflation is likely to have already peaked in China and should moderate in the third quarter, said the International Monetary Fund in a report released last week.

This might be excellent news for chemicals and polymers demand in general (we use polyolefins as a reasonable proxy for the whole industry) as the government could be in a position to relax monetary conditions. Small and medium-sized enterprises (SMEs), the lifeblood of chemicals demand in China, are being severely squeezed by higher interest rates and bank-reserve requirements.

But a few quarters of lost growth would still be a few quarters of lost growth. Even if the IMF is right, won't this lost growth push-back the peak of the next petrochemicals cycle beyond the current forecasts of 2014-2015? What should this mean for the timing of new projects?

If the IMF is wrong - and if any number of other economic challenges are worse than is generally assumed including the housing market - the consequences could be far more serious. We will look at the housing sector, which according to the IMF accounts for 12% of China's GDP, in detail in a later post.

"Most chemicals investors don't fully understand what's happening and remain long on the sector," a US-based chemicals analyst told us recently.

Nobody fully understands what's happening - least of all the blog, you might think.

But cosy platitudes will not be enough to settle our concerns.

By Malini Hariharan

Optimism has returned to the Indian polymer market fuelled by a sharp recovery in prices and buying sentiment over the last few weeks across Asia.

The talk these days is mainly about tightness in availability of polyethylene (PE) and polypropylene (PP) and when producers will announce the next price hike.

Supply is tight because of a shutdown at Haldia Petrochemicals and continued low operating rates at Indian Oil Corp (IOC). IOC is running its cracker at only 60-70% beause of technical issues. As a result, operations at the PE and PP plants have also been affected. The company is widely expected to shut its cracker in September although an IOC source says the exact schedule has yet to confirmed.

In polyvinyl chloride (PVC), a good monsoon has triggered hopes of resurgence in buying from September.

More than 70% of PVC is used for manufacturing pipes that are mainly used in for irrigation in the agriculture sector. A good monsoon should boost farmer incomes and demand for pipes.

The swift rise in polymer prices has come as a pleasant surprise to sellers but some are already wondering if prices have moved up too fast. One trader predicts that prices will continue to rise for another 2-3 weeks before the market once again slows down.

Macro-economic conditions continue to point towards a difficult year. The Indian government has yet to win its war on inflation, currently running at around 9%. Interest rates have been increased 11 times over the last 15 months with the most recent increase of 50 basis points announced earlier this week.

Analysts have been quick to predict a further slowing down of industrial activity with sectors such as auto and construction likely to be hit the hardest. This will surely have an impact on the petrochemicals industry.

Meanwhile, the dismal state of the polymer market in the last quarter is evident in the results of Reliance Industries for the April-June quarter.

The Indian refining and petrochemical major was able to post increases in sales and profits but this was mainly due to the strong performance of its refining business.

Petrochemical sales volumes increased but the company was forced to export higher volumes on persistent weakness in the domestic market. For instance, polypropylene (PP) exports by Reliance were up 81% year on year at 248,000 tonnes.

In a presentation to the financial community (available here), the company estimated that Indian demand for PP contracted by 4% in the last quarter while polyethylene (PE) was down 1% and PVC declined 2%.

Producers are still holding on to positive demand growth forecasts for the full year. But for this to materialize the current momentum in markets will have to be maintained for another few quarters which in turn would require positive developments on the economic front.

DOW Chemical is to sell its polypropylene (PP) business to Brazil's Braskem for $340m, according to our colleagues at ICIS news.

The blog is digging around for the implications for Dow in Asia.

For the time being, however, here are some initial thoughts....

Included in the sales are two plants in the US and two in Germany with a total capacity of more than 1m tonnes/year, according to a news release from Braskem.

Capacities include a 195,000 tonne/year facility in Cologne, Germany; a 250,000 tonne/year Schkopau unit in Germany; its 135,000 tonne/year Seadrift plant in Texas, US, and its 250,000 tonne/year Freeport, Texas, facility in the US.

Dow had classified PP as non-strategic because it felt that it had neither the scale nor the technology to compete with global giants such as LyondellBasell, the blog understands.

The sale to Braskem, however, does not include Dow's PP licensing and catalyst businesses. Will they now be sold separately?

A focus at Dow is on other propylene derivatives such as acrylics, propylene oxide (PO) and epichlorohydrin and acrylics. Dow is in the process of starting-up its first commercial propylene oxide-only plant in Thailand. The PO/styrene monomer route no longer makes sense for the US major as it sold its styrenics business to Bain Capital last year.

Andrew Liveris, Dow CEO, said that a benefit for exiting PP was that it would be able to move from a propylene deficit to a balanced position. Dow has well-advanced plans for propane dehydrogenation(PDH)-to-propylene facility at Freeport, Texas, due for start-up in 2015. It may build another PDH plant in the US, based on its proprietary propane route to C3s, by 2018.

US propylene markets look set to remain result of the switch to lighter cracker feeds and lower fluid catalytic cracker operating rates on weaker gasoline demand. Being in deficit in C3s, therefore, doesn't really add up.

In addition, the rise of shale gas supply in the US is resulting in increases in propane and ethane supply.

It will be interesting to observe what Dow does with its high-density polyethylene (HDPE), also viewed as non-core.

The future in PE for Dow seems to lie in low-density PE and in octene-grade linear low-density (LLDPE).

By John Richardson

THE consequence of either a failure by the US to raise the debt ceiling and/or a downgrading of the country's Triple A debt rating would have obviously have serious consequences for the Asian and global chemicals industries.

Just how serious nobody really knows as we are in uncharted waters.

At the very worst we could be talking about a global recession, even a multi-year depression, according to this excellent article from my ICIS news colleague Joe Kamalick.

"A short suspension of principal or interest payments on the Treasury's debt obligations would cause severe disruptions in financial markets and the payments system," Daniel Meckstroth, chief economist at the US Manufacturers' Alliance, was quoted as saying in the article.

Banks, money market mutual funds and many other financial institutions use the liquidity of short-term Treasury securities to manage cash needs.

"A default would (therefore) suddenly make the market value of Treasury securities difficult to determine, potentially destabilising the financial sector and creating panic", he added.

Even if a default is avoided at the 11th hour, and depending on how the debt limit is raised, the US government's credit ratings may very well be downgraded. Mekstroth warned that this "would hasten the decline of the dollar's role in the international financial system".

A ratings downgrade or an outright default would "call into question the status of Treasury securities as a safe haven for foreign investors", he said, noting that more than one-third of Federal debt is held by foreign governments, the largest being China and Japan.

Analysts at High Frequency Economics (HFE) have warned that a US default or credit downgrade would sharply reduce the value of Beijing's Treasury securities holdings.

If the US - China's top trading partner - had to as a result drastically cut spending, China too could slip into recession.

"We have no doubt the world economy would fold with it," HFE said.

A credit downgrade would drive interest rates up globally, reducing business investment - and in the US, deepening economic problems left over from the sub-prime crisis.

"This debt debate is already further entrenching the pressured US consumer," a US-based chemicals analyst told the blog.

"Businesses aren't hiring and consumers aren't spending.

"The global economy is largely based around the developed world's consumption of goods. Asia is seen as the growth market while the developed nations are the foundation.

"You take away more consumer spending, which would happen if there is a default or downgrade, and it is just a ripple-down to Asia.

Demand for Asian products would drop significantly from US consumers."

China is due to enter its peak manufacturing season in August - when factories making finished goods traditionally ramp-up production ready for the Christmas sales season in the West.

Polyolefin traders have partly justified recent prices rises, and their long positions, on the manufacturing season.

A US default and/or downgrade could therefore lead to a much-weaker manufacturing season and end the polyolefin price recovery, as we have discussed before.

At the very least, until or unless the debt crisis is resolved, the converters are likely to stay largely on the sidelines, leaving the traders with substantial stocks of resin.

"Asian petrochemical producers are high cost producers," continued the chemicals analyst.

"What will US producers do with all their excess material as local demand weakens? Shipping the product to Asia and cratering the market sounds likely."

The US polyethylene (PE) sector has benefited enormously from cheaper feedstock, as a result of shale gas, and the weaker dollar.

A debt default or downgrade is likely to weaken the dollar further, as well as, as we've already said, seriously weakening local demand.

"I don't think the US PE industry has yet to fully realise the opportunity it has to take market share away from their higher-cost Asian competitors," a senior executive with a global polyolefins producer told the blog late last week.

The obvious losers in Asia will be the South Koreans, who, according to a recent Nexant ChemSystems report, are already suffering from margin compression.

Other losers will include the Japanese and non-integrated producers which buy ethylene.

The debt crisis - along with the problems we have highlighted in China - should lead to a re-evaluation of the "2014-2015 peak of the cycle" theory.

Some of the numerous shale gas-based petrochemicals projects that have been recently announced in the US might, as a result, be delayed or even shelved (an industry euphemism for "cancelled").

The good news is that US politicians might have a little longer to reach a deal beyond the widely-publicised 2 August deadline, according to US-based wealth management and private equity company Robert W Baird & Co.

Inflows to the Treasury have been greater than forecast with expenditure lower than anticipated, said Robert W Baird in a fixed income investment note released earlier this week.

"The August 10 date (when it expects the Treasury to run out of money) is not much of an extension but it could provide the White House and Congress valuable additional time to come to an agreement," continued the note.

"However, we do not feel it will be enough to allow the 'warring parties' to come to an agreement on deficit reduction to avoid a ratings downgrade."

A downgrade would raise US long-term interest rates by 25-50 basis points and would also cut GDP growth by 25-50 basis points, it added.

The vast majority of analysts agree with Robert W Baird & Co that a default is unlikely because politicians realise the consequences would catastrophic.

"It would be Lehman Bros crisis times five," added the chemicals analyst.

But, as we have said, a downgrade is bad enough.

"My guess is that they have a triage plan to cut some less consequential payments in the short-term to avoid a default," added a UK-based chemicals consultant.

"But what does this say to the rest of the world about the dysfunctionality of the system?

"It is no longer just waiting weeks to find out who's been elected because Florida couldn't count its hanging chads.

"This is being unable to write a simple letter to the bank manager, asking for the loan to be extended. They've spent the money, so they have to have the loan.

What kind of planet do they think they are living on?"

Hear hear......