Asian Chemical Connections

By John Richardson

The blog has, in its naivety, for some time been perplexed over why certain chemicals company CEOs portray a relentlessly optimistic picture of developing-markets growth. This is despite all the evidence pointing to increasing uncertainties over how China, India, and other developing economies are going to progress over the next decade.

Last week, during a conversation with a chemicals industry source, the light came on when he told us:

"CEOs have to tow the line, as is the case with the analysts, because if they go against the conventional view, they might end up upsetting someone.

"For example, if a CEO comes out and says, 'I don't agree with the Chinese government that the country's economy will grow by 8% this year,' that particular company might not get approval to build a cracker in China.

"And as with the analysts, it is better to hunt with the pack, as if you are an outlier and are wrong, you are in big trouble. But if everyone is wrong, you can always blame unforeseen circumstances and cut costs to hit your quarterly-results target."

By John Richardson

THE hard numbers, in the chart above, support anecdotal evidence we have been picking up for over a month of increased Asian polyethylene (PE) exports to Brazil and other Latin American countries.

It also confirms reports that Middle East producers are raising shipments to the region.

This includes one major player that is said to have established a distribution hub in Brazil. The hub involves cargoes being shipped from the Middle East, stored there and then sold. This avoids long delivery periods for buyers, during which pricing can fluctuate several times.

The South Koreans and the Saudis have, in particular, raised their exports to Latin America in response to a weak China market, say several polyolefin industry sources.

This has occurred at the expense of the North American Free Trade Agreement (NAFTA) producers, particularly those in the US, as the above chart - from Global Trade Information Services - illustrates.

US producers have had an excellent first quarter thanks to record-low natural gas prices, restocking by buyers after heavy inventory depletion in Q4 last year, and cracker turnarounds.

But buyers, sitting on comfortable stocks, have described first-quarter demand as relatively weak and are resisting further price hikes.

Add this resistance to what is likely to be a continuing weak export performance and the second quarter looks set to be a great deal worse for the US.

By John Richardson

MUCH excitement heralded the announcement that February inflation in China had fallen to a 20-month low of 3.2 percent - well within the government's annualised target of 4 percent.

This led to the belief that the government would boost bank lending, and maybe further low bank-reserve requirements and interest rates. No doubt this idea will gain further traction if March inflation is also below Beijing's full-year target.

But a senior polyolefin industry source said last week: "Although the overall inflation rate has fallen to 3.2 percent, this is very misleading as it doesn't reflect conversations we are holding with our customers.

"If you go to any plastics processor in China they will tell you the same thing - that real inflation is more like 8-9 percent per year as a result of double-digit increases in food prices.

"The main reason why the overall inflation rate has fallen is because the government follows the Western model in calculating property prices as part of inflation. Property prices have fallen by around 10 percent over the last year."

The price of pork, a very important staple food in China, still rose by 15.9 percent in February.

Arthur Kroeber, editor of the China Economic Quarterly, wrote in the Q1 edition of the publication: "While inflation is clearly falling and is not an immediate threat, policy makers are still concerned - correctly, in our view - about future inflationary pressures from rising wages and delayed adjustments to resource prices.

"And as we have repeatedly argued, the rapid build up of debt over the last two years has increased risk to the financial sector. Bringing down overall debt levels from their peak of 200 percent of GDP (gross domestic product) in 2010 would be prudent, and give China more room to respond to future problems."

Rising resource prices, particularly crude oil, represent a major threat to a country which remains poor by Western standards.

Expensive oil hurts poor countries more than rich countries, as a bigger proportion of incomes are spent on food in these more-deprived nations. The cost of food rises as oil gets more costly, due to higher transportation and packaging costs etc.

And as Paul Hodges points out, despite heavy government fuel-price subsidies, China's diesel and gasoline prices recently reached record-high levels.  

By John Richardson

FURTHER evidence of weakness in the Chinese economy has emerged via the polyolefins market.

In an excellent Insight article, my ICIS colleagues Chow Bee Lin and Peh Soo Hwee say that China's plastics processors are resisting additional price increases because their customers, the manufacturers of finished goods, are struggling. The combined retail sales values of China's top 100 home appliance manufacturers rose by just 1.11% in January-February, on a year-on-year basis, which was 16.68 percentage points lower compared with the same period in 2011, said China's Ministry of Industry and Information Technology.

But in early March, integrated Northeast Asian high-density polyethylene (HDPE) margins fell to their lowest level since ICIS records began. Integrated Northeast Asian low-density PE (LDPE) margins were just $91/tonne in Q1, their lowest since Q4 2000.

This suggests that producers, waving the spurious stick of tight supply in certain grades, will push for more price increases.

China's economy is undergoing its biggest economic upheaval in a generation. This is likely to negatively impact growth for the rest of this year at least.

A further factor behind affordability for converters, and their customers, both in China and Southeast Asia, is the high price of oil.

Expensive crude is damaging economic growth as gasoline and diesel prices increase.

High food-price inflation in China is also a result of the rise in the cost of oil.

By John Richardson

Wen Jiabao has been at it again. His extraordinarily strong comments on Tuesday follow those he made last month about the risks of a return to the economic chaos of the Cultural Revolution.

On this latest occasion, he has taken aim at the state-owned banks. China's premier, who is to relinquish power later this year, believes the banks make money "far too easily", and that their monopoly control of lending is starving private enterprise of financing.

We saw this last year as small and medium-sized enterprises (SMEs), which make up the bulk of chemicals and polymer buyers, struggled to obtain official lending. They were forced to increasingly turn to the "shadow bank system," thus paying exorbitantly high interest rates, as the central government reduced the amount of money the state-owned banks could lend in order to tackle inflation.

A tight rein on official bank lending has continued into 2012. This is one of the main reasons why chemicals and polymer buying continues to be "hand to mouth".

Wen's comments follow the announcement in March of a trial scheme in Wenzhou. Private investors in the eastern city will be encouraged to buy into local banks and to set up financial institutions, such as loan companies and rural community banks, said the State Council.

But resistance to further reforms is inevitable because of strong "vested interests", which we discuss in chapters 6 and 10 of our e-book, Boom Gloom & The New Normal.

The misappropriation of funds flowing from the state-owned banks to the state-owned enterprises (SOEs) has made some individuals very, very rich. Between 16,000-18,000 government officials and executives from the SOEs stole $123bn of public funds between the mid-1990s and 2008, says The Economist, quoting data from the People's Bank of China.

Successful financial-sector reforms are essential if China is to escape the "middle income trap".

SOEs need to be made to work harder to obtain financing. No longer should they be allowed to add industrial capacity, easily funded through their cosy relationships with the state-owned banks, that fails to add sufficient value to the economy.

Private companies must also have greater access to finance. It is this sector of the economy that has the potential to be the main driver of the innovation necessary for China to escape the middle income trap.

But can any of this realistically happen given that politics in China, like everywhere else, is the art of the possible?

And even if China's new leaders are as reform-minded as Wen has attempted to be during his decade in office, they will take time to settle in. They might need several years to build-up the confidence, and the political muscle, to take on the vested interests.

Can China afford to wait that long? 

By John Richardson

CONFIDENCE is a strange thing. It can be derived from solid reasons for optimism over the future or from temporary factors that can rapidly disappear.

And what is the value of publicly-expressed confidence? Is it often politically motivated rather than being based on the genuine belief that the future holds tremendous promise?

Right now in the petrochemicals industry, it is easy to make the case that the recovery in sales volumes in Europe and the US during Q1 mainly represented stock-building by buyers.

Inventories were exceptionally low down many value chains in December 2011, when it looked as if the Eurozone was about to collapse.

Once the immediate danger had been averted, therefore, some restocking was inevitable.

This was given further impetus by rising oil prices. Petrochemicals end-users "bought forward" in order to hedge against crude and petrochemical prices going even higher.

The Eurozone crisis was put on hold rather than resolved in December last year. This has become clear over recent weeks as the focus has switched to the next economy facing a potential sovereign debt default - Spain.

Will the direction of crude remain as clear in the second quarter? Quite possibly not, given the evidence of demand destruction caused by expensive oil and the determination of Saudi Arabia to lower prices.

Price increases have been essential for naphtha cracker operators as they attempt to repair squeezed margins. The increases have been made possible by deep operating-rate cuts in Europe during Q4, and maintenance work and outages in both Europe and the US in the first quarter.

By John Richardson

CHINA'S mono-ethylene (MEG) market was supposed to be very strong this year.

But instead, to date we have seen persistently weak market conditions that few people, least of all the traders, seem to have anticipated.

The traders appear to have been taken in by the hype and booked cargoes for delivery to China that they are struggling to sell. A few weeks ago, 800,000-850,000 tonnes were reported to be in storage tanks on the east coast compared with the usual 400,000 tonnes.

"MEG buying interest remained low because of soft polyester sales," wrote my ICIS pricing colleague, Becky Zhang, in her MEG price report for the week ending 6 April.

MEG market participants expressed hope that more government economic stimulus might be on the way, resulting in a recovery in demand and pricing.

This hope has been frequently expressed down many petrochemical chains throughout this year. But the central government is hamstrung. It cannot afford to boost lending by too much, or aggressively cut interest rates, because of food-price inflation. A big new round of fiscal stimulus would also hamper its reform agenda, made more difficult by the leadership transition. 

MEG was supposed to be the "shining star" of 2012.

The accepted wisdom at the start of this year was that the market would become tight as global capacity additions were lagging demand, with China the main driver of demand.

Two new world-scale plants were said to needed every year - about 1.5m tonnes/year of capacity. Feedstock constraints in the Middle East and lack of investment in Asia had led to a big shortfall in investment, claimed industry observers.

Demand would also continue to boom in China, growing at around 12 percent in 2012, the observers believed.

But China's demand growth, as we have seen, is the big problem. It may now only grow at around 8 percent, say some commentators.

The pricing chart above indicates that as the price of ethylene has risen, the price of MEG has fallen.

Ethylene has increased because of production cutbacks resulting from margin pressure exerted by high naphtha and oil prices.

But MEG producers have, quite clearly, failed to pass-on these higher costs to their customers, reflecting the weakness in demand.

If the "shining star" of 2012 continues to perform as badly as this, what are the prospects for other products where supply is not supposed to be as tight?

By John Richardson

THE importance of reliable market intelligence on China was further emphasised on Monday with the release of the March inflation data.

Last week a sales and marketing executive with a polyolefins producer told us: ""Although the overall inflation rate has fallen to 3.2 percent (the February number), this is very misleading as it doesn't reflect conversations we are holding with our customers.

"If you go to any plastics processor in China they will tell you the same thing - that real inflation is more like 8-9 percent per year as a result of double-digit increases in food prices."

In March, the overall inflation rate rose to 3.6 percent.

Overall food-related costs were up by 7.5 percent, vegetable prices jumped 20.5 percent and the cost of meat and eggs was 11.3 percent higher.

One of the reasons why food has become much-more expensive is bad weather damaging crops, say economists, and so therefore only temporary.

But if oil prices stay high, this will maintain upward pressure on the cost of food.

And higher wages costs will, without doubt, continue to exert upward pressure on inflation because of the structural changes in the economy. Prices for clothing and shoes rose 3.8 percent in March, a sign of underlying wage pressures, Paul Cavey, a Hong Kong- based economist with Macquarie Securities told Bloomberg. This compares with a 0.8 percent rise in March 2011.

Petrochemical market participants have been hoping for over a month now that more economic stimulus is on the way, as was the case with mono-ethylene glycol (MEG) last week.

But the rise in inflation gives the government less flexibility to cut interest rates and further lower bank-reserve requirements.

By John Richardson

THE recent investigation by the US-based Fair Labor Association into Foxconn is a further indication of how China is transforming its economic model.

It was found that Foxconn breached several Chinese regulations, including a maximum working week of 49 hours. The company is China's biggest private-sector employer and manufactures 40 percent of the world's electronics.

The association being allowed into Foxconn by the Chinese authorities is significant, as is the fact that the investigation was initiated by Apple. Apple was no doubt responding to bad publicity earlier this year over working conditions at Foxconn. The US company has already agreed to raise wages in response to the report.

Back in the 1980s, around 5 percent of China's GDP was generated by exports. Now the figure is closer to 40 percent as a result of China deliberately stacking the competitive-advantage cards in its favour.

This has involved low salaries and poor working conditions, lax environmental standards, cheap energy, cheap land, excellent infrastructure and tremendous tax incentives, particularly post-2001 after China joined the World Trade Organisation.

China is now trying to create a more equal society, hence its determination to raise minimum wages. Minimum wages are being raised by 13 percent under the 12th Five-Year-Plan (2011-2015), but total wage costs, when extra social benefits are taken into account, are reported to be increasing by 15-20 percent per year.

And the Foxconn investigation could result in a "race to the top" by contract manufacturers in general as working conditions are improved, said Auren van Heerden, president and CEO of the Fair Labor Association. This would, of course, add to costs.

Here are some implicatioons for the chemicals industry:

*A China plus one strategy, in response to these rising costs, has long been the policy of the big Western retailers and branded-goods manufacturers. This process is likely to accelerate with countries such as Vietnam, Indonesia and Bangladesh likely to benefit. This will result in the relocation of some chemicals demand.

*For reasons of infrastructure, logistics and the availability of skilled labour, some low-value manufacturing will stay in China.

*Suppliers of commodity chemicals and polymers to Western branded-goods manufacturers forced to stay in China will, as a result, be under more pressure to keep prices down. "We used to be able to raise our polymer prices by $100/tonne or more and Apple didn't really care," said a source with a former Apple plastic-resin supplier. "This might no longer be the case for Apple, and probably more so for other companies where margins on their finished products are not as spectacular."

By John Richardson

THE shale gas advantage, along with the revival of the US economy, made for a euphoric atmosphere at last week's International Petrochemicals Conference (IPC)* in San Antonio, Texas.

China was only a blip on the corner of the radar screen because the talk was so domestic-focused.

The only doubts expressed were over whether regulatory restrictions over permitting for fracking, and the risk that the US will become a major exporter of liquefied Natural Gas (LNG) thereby reducing feedstock supply for petrochemicals, might spoil the party. There was obviously a political sub-text here with the US presidential elections just around the corner.

Contrast this with a discussion the blog had in Singapore recently with a senior polyolefin industry executive, who said: "All the projects being planned in the US and elsewhere will not go ahead.

"There are too many uncertainties over China, and over the global economy in general, for every company to take the risk. If all of them do commit to their planned investments, by 2016-17 we are going to see a big oversupply problem.

"The US will not be able to export all the surplus volumes that are being planned. They are already facing tougher competition in Latin America from displaced Middle East and South Korean volumes from China, and this is going to get worse.

The traditional approach has been "if we have the feedstock advantage let's build, and let's build big as demand will take care of itself".

Most US chemicals companies laid-off their in-house economists during the 1990s and early 2000s because growth seemed so assured, we were told by a US management consultant.

"They just had to take growth estimates from the International Monetary Fund, or another official body, and could rightly assume that the numbers would be roughly right," he said.

"It would certainly be the case that the general direction would be right of these estimates from official bodies - i.e. upwards."

But we argue in our e-book, Boom, Gloom & The New Normal, that we have entered a period of great economic uncertainty.

China is an excellent example of this. Few people predicted the weakness in its petrochemicals markets over the last 12 months.

And who can say with any degree of certainty that the US economy, which will have to soak-up most of this extra petrochemicals volume, will enjoy a strong and sustained recovery?

Pause for thought, at least.

*The IPC was organised by the American Fuel and Petrochemical Manufacturers (AFPM).

By John Richardson

ECONOMISTS think China's growth has bottomed out, thanks to unexpectedly strong March bank lending.

They also think that interest rates will stay low for a long time, even if rates cannot be cut because of the inflation problem. 

New loans in March totalled Rmb1trn ($159bn), more than banking analysts had expected.

This renewed economic stimulus might be behind month-on-month improvements in retail sales and industrial production figures during March.

Further optimism was drawn from comments by Wen Jiabiao, China's premier. He said there was "a need to "strengthen our back-up plans and make room for contingency policies", in light of Friday's announcement that Q1 GDP growth was 8.1 percent - the lowest in nearly three years.

But weak March export growth is an indication that there is, quite obviously, nothing that China can do about the external environment.

Plus, the blog remains concerned that domestic policy responses to weaker growth are limited both by inflation and by the need to press ahead with economic reforms.

Old-style huge stimulus, on the scale of 2009-2010, would place the economic reform process at risk as the speculators would once again benefit, thereby increasing income inequality. Wen, in his comments on the property market, has made it clear that this will not be allowed to happen.

In addition, the government's determination to further low real estate prices will surely act as a drag on economic growth. Beijing property prices fell by 21 percent in Q1.

A big new economic stimulus would also, crucially, weaken the credentials of the "reformist" faction within China's senior leadership. This faction faces a tough job in ensuring a smooth leadership transition later this year, as the events surrounding the arrest of Bo Xilai have illustrated.

Despite the optimism of the economists, chemicals and polymer markets were showing no signs of recovery last week. For example:

*Asian polyethylene (PE) prices were assessed $10-20/tonne lower by our colleagues at ICIS pricing. Demand remained weak.

*Polyester demand was also weak as concerns persisted that there would be no peak manufacturing season for textiles this year, which normally runs from April until June.

*Upstream of polyester, mono-ethylene (MEG) inventories in China remained high. This is the result of traders anticipating a strong post-Lunar New Year demand recovery that has yet to happen. One purified terephthalic acid (PTA) end-user was rumoured to have resold his paraxylene (PX) raw material because of the weak demand.

By John Richardson

NEW banking regulations could severely restrict the ability of small and medium-sized (SMEs) companies to access trade finance. This would hit Asia particularly hard, as the majority of chemicals and polymer business involves SMEs.

Under the Basel III regulations, due to be phased in from next year, a three-month trade finance loan will be treated the same as a one-year loan. This will force banks to hold more top quality capital against this type of lending, according to the Financial Times.

This is deterring some banks from staying in the trade-finance business and could increase the cost of letters of credit by 300 percent or more, adds the newspaper.

Some French banks have already decided that the extra regulatory burden is not worth it, and so they have withdrawn from the trade-finance business, says the FT.

"Basel III's implementation could have unintended consequences for trade financing through the proposed leverage ratio, which would require banks to set aside 100 percent of capital for any off-balance-sheet trade finance instruments, such as letters of credit," says the World Bank.

"This is five times more than the 20 percent credit conversion ratio used for trade finance in Basel II. New capital regulations would also require banks to set aside capital for one year for any instrument, even though that security may carry a maturity of under a year. Most trade finance instruments have maturities of about 90 days; this would triple the capital cost of such instruments."

Trade finance volumes could fall by 6 percent, representing a $270bn a year reduction in global trade and a 0.5 percent decline in global gross domestic product, the World Bank adds.

'Eighty-five per cent of all letters of credit will have Asia at one end or the other," said Andy Dyer, managing director of transaction banking in Asia Pacific for ANZ, in this article in Singapore's Business Times.

By John Richardson 

THE higher that oil prices go the more the US petrochemical industry's margins have expanded.

Petrochemical prices are oil-driven and, therefore, have to go higher as crude becomes more expensive, whereas the cost of shale gas-based ethane keeps on falling due to rising supply. US petrochemical producers are cracking increasing amounts of ethane.

A further benefit for the US is that its overseas naphtha-based competitors are being forced to cut operating rates as their margins are, in contrast, being squeezed.

But there is growing evidence that expensive crude is damaging the US economy, which, of course, will ultimately hurt petrochemicals demand (if it hasn't done already...).

"US economic activity is still pushing oil demand growth into the negative," wrote OPEC in its monthly oil report for April.

Latest firm consumption figures, for January, showed a 4.3 percent year-on-year contraction in consumption, the second-highest since July 2009, the report added.

Preliminary data for February and March also indicate contractions.

"The usage of some industrial and transportation fuels, especially distillates and gasoline, accounted for the bulk of this contraction," continued OPEC.

As transportation costs for industry have risen, so has the cost of petrochemicals, because, as we mentioned above, pricing is linked to the crude-oil price.

Pricing in the US has been further boosted by up to five crackers, 10 percent of US ethylene supply, being off-line in March-April.

US petrochemical industry executives were full of optimism during the International Petrochemical Conference (IPC)*, which took place in San Antonio, Houston, earlier this month.

They talked of both the shale-gas bonanza and the strength of the US economic recovery.

But if the US is in such a great shape, why was it that industry was unable to absorb higher fuel costs during the first quarter?

A further factor that should have boosted overall economic activity, and therefore the affordability of crude, was the warmest winter in 50 years.

This suggests that a big driver of petrochemicals demand during Q1 was consumers "buying forward" to hedge against more expensive crude and impending cracker turnarounds.

Barring a major geopolitical crisis involving the West and Iran, the demand and supply fundamentals point to weaker crude.

As petrochemical buyers destock we might, as a result, see a very different second quarter.

*The IPC was organised by the American Fuel and Petrochemical Manufacturers (AFPM).

 By John Richardson

EVERY time you come back to the subject of China, it becomes ever-more complex and uncertain.

An excellent example is an article published in the academic journal, Eurasian Geography and Economics, in February, by University of Washington professor Kam Wing Chan.

It questions to what extent China's economy will benefit from further urbanisation because of the harmful impact of the hukou residency system that was introduced in 1958.

The system, designed to ensure that enough people remain on the land in order to keep the country sufficiently fed, has created a two-tier society.

Tier one comprises urban residents eligible for unemployment benefits and pensions.

Hundreds of millions of former rural residents, who have moved to the cities and towns in order to find work, but without being able to officially change their residency status from rural to urban, occupy the second tier. They are ineligible for welfare payments, and even for free public education as hukou status is hereditary.

Chan, who studied population statistics from China's National Bureau of Statistics and the Ministry of Public Security, discovered that 460m people had urban hukou status in 2010 compared with a total 666m city-dwellers.

The remaining 206m were therefore caught in an economic no man's land, creating "a pool of super-exploitable labour," he wrote.

New rules have been introduced by the central government, which allow migrants, under certain conditions, to apply for a change of residency status after they have moved to small and medium-sizes cities. But the majority of employment is in the big cities, such as Beijing and Shanghai, argued Chan.

If much of this increased urbanisation is going to involve former rural residents trapped in severe poverty by Western standards, they will hardly be rushing out to buy BMWs and Louis Vuitton handbags.

This, of course, has major implications for the nature of chemicals demand growth.

By John Richardson

THE majority of chemicals analysts have yet to wake up and smell the coffee, according to an industry observer.

"South Korean stocks have come off by 15-30% since their big recovery in January, but it is only the timing rather than the overall sentiment that has changed," said the observer.

"The theory had been, and this is clearly not going to happen, that there would be strong restocking immediately after the Lunar New Year.

"Now the expectation is instead for a strong second half of the year. This sentiment, ironically, improved when the Q1 GDP number was released. Because this was the lowest growth that China had seen in nearly three years, everyone is assuming that more economic stimulus, through interest rate and bank-reserve requirement cuts, and more bank lending, is on the way.

"They have also interpreted the rise in March bank lending as an indication that more stimulus is already happening.

"But I think there is more downside yet, before any potential upside.

"If you look at a lot of the chemicals analysts, their earnings forecasts for a lot of the Northeast Asian stocks remain very bullish despite a disappointing first quarter and what seems likely to be a fairly weak Q2.

"The assumption among these analysts is that there will be a very strong pick-up in earnings during the second half that I just don't see happening.

"All the upbeat earnings estimates for Northeast Asia are based on synthetic resins demand growth in China of 8-12 percent for 2012.

"But up until end-February, the latest figures I have, growth was only 3 percent. This was a slight improvement on the 2% growth in January-February 2011, but still a long way short."

An indication of just how bad economic conditions have become came with the release of LG Chem's first-quarter results yesterday.

The South Korean company reported a 42 percent decline in net income. Operating profit, or sales minus the cost of goods sold and administrative expenses, dropped 45 percent to Won459.5 billion The petrochemical division, which accounts for 78 percent of sales, had an operating profit of Won369 billion, half that of a year earlier.

LG, which is major acrylonitrile butadiene styrene (ABS) and polyvinyl chloride (PVC) producer, has been hurt by what's happening in the China market.

The blog believes that some analysts, and companies, have yet to factor in the major structural changes taking place in the Chinese economy, which will dampen growth for the rest of this year at least.

There is also the political challenge, and the weakness of the export environment for manufactured goods.  

By John Richardson

THE nature of demand in China is changing, despite the belief among some chemicals analysts, and companies, that everything will soon return to normal.

Here is a summary of our key arguments. Please print off and pin to your office, or boardroom, wall for discussion - and let us know if you disagree:

*THE late 1990s and first decade of this century were remarkably straightforward for measuring chemicals and polymer demand growth in China. As China became the workshop of the world, and as the West enjoyed a credit-fuelled economic boom, one could reliably predict constant double-digit annual growth rates for all chemicals and polymers. Everyone was a winner, even the higher-cost producers, as China's appetite for all kinds of raw materials seemed insatiable.

*Then came the 2008 economic crisis, which brought the credit boom in the West to an end. Europe and the US is still coping with the aftermath of the end of that boom, making future demand for China's finished-goods exports very uncertain.

*Temporarily, though, in 2009-2010, when the Chinese government threw money at the problem of high unemployment among factory workers in export processing zones, all seemed right again. Chinese demand for chemicals soared, in response to the economic stimulus.

*But from April 2011, the country's chemicals markets have struggled as the stimulus has been withdrawn in an effort to tackle inflation and growing income inequality.

*A further complication is government efforts to re-focus the economy away from an over-dependence on exports towards greater domestic consumption. As early as mid last year, petrochemical industry executives were seeing the effects of these efforts. In the south and east, the government had started to actively starve "low-value" plastic processors of credit in order to force them to either relocate inland or move overseas. Increasing wage, energy and environmental-compliance costs also began to squeeze the margins of these processors in the south and the east - the developed regions of China. This process of re-balancing continues, eating into chemicals and polymer demand - confounding predictions of a strong 2012 recovery.

*The other big uncertainty is politics. As China faces perhaps its biggest political crisis since 1989, in the short-term, policy options to deal with any worsening of the external environment could be limited. Longer term, the economic reforms might fail.

 By John Richardson

The consensus view on China remains that we have reached, or are near, the bottom of the decline in GDP (gross domestic product) growth.

This was how yesterday's release of the preliminary HSBC China Manufacturing Purchasing Managers Index for April was interpreted.

Although the index contracted for the sixth month in a row, the rate of contraction had slowed down, in response to greater economic stimulus, said HSBC.

"The modest improvement in April's flash PMI results, plus March's better than expected new lending and industrial production growth numbers, suggests that Beijing's earlier easing measures are starting to work. This, in turn, should help ease concerns of a sharp growth slowdown for China," wrote the bank in a research note.

"In addition to the most recent (overall bank) reserve requirement ratio cut, delivered at the end of February, the People's Bank of China has also since suspended bill issuance in open market operations, and lowered the reserve ratio for some rural financial institutions.

"Fiscal spending is also picking up, with its growth rate accelerating to 33.6% year-on-year in 1Q from 11.5% in 4Q last year."

Another reduction in the reserve requirement is expected over the next few weeks.

But, as we discussed yesterday, the changes in the management of China's economy are so fundamental and so extensive that any recovery in growth can only be modest.

Politics also remain a big issue. Fellow blogger Paul Hodges believes that the political crisis in China is such that the country's leaders will be too pre-occupied to focus on the kind of economic stimulus package sufficient to achieve a big economic rebound.

And, as far as the Asian chemicals industry is concerned, 2012 earnings estimates will need to be revised down.

"Sure, there should be a recovery in profitability later this year, but a lot of this would be to do with a 'base effect', as Q4 was exceptionally bad in 2011," said an industry observer.

Chemical product markets are also still telling us that demand remains weak. For instance:

*Monoethylene glycol (MEG) inventories in China rose by 20,000 tonnes last week, according to Becky Zhang of ICIS pricing. Stocks totalled 870,000 tonnes compared with the usual 400,000 tonnes. More than ten vessels were waiting off the coast of China to unload further cargoes. Some ships had been waiting for more than two weeks for tank space so that they could discharge their cargoes. This was supposed to be a bumper year for MEG.

*Purified terephthalic acid (PTA) prices recovered slightly in the early part of last week, added Becky. However, sentiment weakened towards the end of the week on a decline in buying interest from end-users. Polyester sales were not as strong as had been expected, despite this being the peak production season, which runs from April until May.

By John Richardson

Word for word, see below what an Asian polyolefins trader told us yesterday:

"This year has been absolutely terrible, the worst I can remember in eight years in this business, and even worse than 2008. There is just no demand out there.

"There was supposed to be a recovery after the Chinese New Year, everybody seemed to be banking on that, including us, but it just didn't happen and isn't going to happen, I don't think.

"Any activity that's taking place at the moment is almost entirely between the traders - the end-users in China are just not interested.

"What's worrying is that the negative mood has started to spread from China to Vietnam and Indonesia, which have been better markets so far during 2012. End-users in Vietnam and Indonesia have started to pull back from orders.

"There are a lot of re-exports of polyethylene (PE) from bonded warehouses in China because of the weak demand, which is reflected in the wide gap between import and domestic prices - around $150 a tonne. The re-exports are mainly heading to Indonesia and Vietnam. This is one of the reasons why sentiment there is weakening.

"A lot of re-exported polypropylene (PP) from China is heading to India and South America.

"I think the reasons for end-users in China remaining so cautious include rising labour costs, the lack of availability of labour and credit.

"I heard about bank lending being increased in March by more than the banking analysts had expected, but we are not seeing any evidence of that among our customers. They remain short of credit. I think this is probably because most of our customers are small and medium-sized enterprises and most of the extra lending has gone to the big companies.

"Uncertainty in general is still dominating the mood, whether it's over economic reforms and politics in China, politics in Europe and the US, the Eurozone debt crisis and US economic growth.

"Labour costs have gone up hugely over the past six years. It used to be you could employ a worker in a packaging plant, a low-skilled manual worker, for Rmb800-1,000 a month. Now it costs Rmb3,300.

"What is strange is that there is a real shortage of unskilled workers, but a greater availability of skilled workers - and with a skilled worker, when you take into account greater productivity, you get better value for money.

"I have noticed a change in attitude among the 1990s babies compared with their parents. They expect wages to increase every year, they expect better living and working conditions, and they expect not to have to work as hard.

"Another thing I am noticing among my customers is greater automation, as manual workers are harder to find and a lot more expensive. They would rather invest in machinery than in people."

By John Richardson

THE mood in European ethylene and polyethylene (PE) markets has changed over the last two weeks, according to my ICIS pricing colleagues, Nel Weddle and Linda Naylor.

"A drop in crude oil and naphtha values saw speculation over a decrease for the May (ethylene) contract build this week," wrote Nel last Friday.

"This would buck the uptrend of the past four months. Soft derivative demand has long been a concern, but this has increased over the past couple of weeks amid reports of building inventories and cheaper imports from overseas."

She stressed, however, that volatility in crude and naphtha markets meant that some cracker operators felt a decrease would be difficult. In addition, the producers were anxious to protect margins that, while improving since January, still remained low.

"Polyethylene (PE) prices are being settled up on most grades in April, but the mood has changed significantly," added Linda.

"Just as the market believed that February and March prices would increase, and buyers continued to buy, now, in April, market sentiment is for May pricing to decrease, or at most stabilise, so buyers are destocking and buying only what they need."

Should we be surprised? Definitely not, as the European "recovery" across most petrochemicals was relative to a very weak fourth quarter.

Inventories among the converters were stripped to a bare minimum during Q4 as fears grew that the Eurozone would collapse.

Cracker operators responded by cutting operating rates to 70-75 percent.

Tighter supply, rising crude prices and confidence that the worst of the Eurozone crisis was behind us combined to drive inventory rebuilding during the first quarter.

Now the high PE prices have attracted more imports, which will have acted as some compensation for the exceptionally weak China market.

Uncertainty over the direction of crude has also increased, given confusing economic data. In terms of supply, however, there is a growing belief that it is ample - and that is only the Iranian "fear factor" that has enabled the speculators to drive-up the price. Iran is now seemingly ready to do a deal with the West.

Demand destruction caused by expensive crude is another issue.   

But most importantly of all is the Eurozone crisis.

The European Central Bank's injection of around Euros1 trillion into the banking system in December and March merely improved the short-term sentiment.

This is a complex crisis that is going to take years to resolve.

Take the Spanish housing market as one just example of the complexity and depth of this crisis. Some Euros663bn of mortgages are at risk of default.

There is also politics. Austerity has led to a rise in politicians, some of the extreme left of or right, who are questioning the German-driven efforts to solve Europe's problems.

As for the petrochemicals industry, it is trapped in a constant cycle of cost reductions, and the frequent need to cut operating rates, in order to manage weak long-term European demand. A few months of restocking, as the first quarter has demonstrated, doesn't represent a real recovery.

A New Normal way of thinking will help, we believe.

By John Richardson

FIVE years ago everybody had written-off the US petrochemicals industry, but now the industry is incredibly gung-ho, thanks to shale gas - even if the issue of demand is somewhat more problematic.

In five years time, might the world once again look a very different place as a result of shale gas in China?

China's main motive for exploiting shale-gas reserves would be for power generation, and perhaps even for gassifying its transportation system. But the resulting natural-gas liquids could also feed big new petrochemical capacities.

Some experts believe it will be well beyond 2017 before we see a shale-gas revolution in China because of the issues we discussed last month.

Others constraints, according to this article in the Financial Times, include:

*Shale deposits in China that contain more clay than the brittle "marine" shales of the US, making them harder to frack and less productive.

*A lack of the infrastructure that has made the shale revolution possible in the US, including an extensive gas pipeline network and oil workers trained in fracking.

But never underestimate the role of the central government in China to make things happen faster than most people expect.

Shell's Chief Financial Officer Simon Henry concedes that geology is harder in China than in the US.

But he adds that the government could overcome these geological difficulties to bring the cost of producing shale gas in China down to $2-6 per million British thermal units.

This would be well below the current cost of importing liquefied natural gas (LNG) - $16 per million British thermal units.

Another option could be to, perhaps, wait for the world to be flooded by new LNG production, pushing prices well below $16 a thermal unit. This may happen if the US becomes a major exporter of LNG as a result of its shale-gas revolution.

However, for China, energy security is the main priority.

Several countries in Western Europe, along with the US, have big shale-gas reserves. This is likely to give them more geopolitical influence as they become less dependent on the Middle East, and on Russia, for energy supplies. 

Why would China want to see its geopolitical influence diminish in this new world order?

China has a fifth of global shale resources, and has the world's largest technically recoverable shale gas resources, according to the US Energy Information Administration (EIA).

Thus it has the potential to greatly improve its energy independence - and, as a result, increase its global influence.

In the past, China has been very good at learning from foreign expertise, which, in the initial stages of development, has involved inviting-in foreign investors.

We have seen this in petrochemicals where some overseas companies have been allowed to build one joint-venture cracker complex and one joint venture only. The Chinese can now build their own crackers and downstream plants, have their own petrochemical technologies and have the necessary sales and marketing skills.

The pattern is being repeated in shale gas.

"China's drive to develop shale gas has also helped fund shale projects around the world," says Leslie Hook in the same Financial Times article we linked to above. 

"As Chinese companies seek to master the techniques of extracting gas from sources, such as shale gas and coal bed methane, they have invested billions in unconventional oil and gas projects overseas, particularly in the US."

He adds that China has made shale a cornerstone of its energy policy, resulting in incentives which include liberalising investment rules to allow private investment and plans to remove government controls on gas prices.

The Ministry of Land and Resources is also, reportedly, drafting rules that would allow it to seize blocks from companies that fail to invest at least 30,000 yuan ($4,758) per square kilometre annually. This would be three times the minimum per-kilometre investment floor set for crude oil.

Failure to read the direction of Chinese government policy has been a big mistake in estimating 2012 demand growth.

It would be unwise to repeat the same mistake when it comes to shale gas.

By John Richardson

DOW Chemical CEO Andrew Liveris said in an earnings call, following the release of the company's Q1 results: "China is stabilising and growth is likely to accelerate later this year as their government keeps shifting its policies to inspire and incentivise domestic growth."

An industry observer agreed, and added: "I'm still sticking with the view that even if growth in China, and the rest of Asia, is not spectacular, it will be sufficient to support reasonable levels of income growth for 3 billion consumers of basic petrochemicals - whether it is in the form of food/consumer goods packaging, or in autos and residential construction etc.

"And given that announced capacity additions are low, and some will be delayed, the petrochemicals market will naturally tighten. We are looking at a multi-year upcycle."

Dow's first quarter net income fell 27.8% to $520m on weaker operating earnings and a restructuring charge.

However, Liveris added that the company had captured the tenth consecutive quarter of volume growth in emerging markets as it exited Q1 with momentum.

"Our sales in the United States, Germany and China all grew double digits from February to March, excluding the seasonality of our agricultural business," he said.

"Importantly, this momentum is ahead of what we saw last year. We also saw sales grow double digits month-over-month in all of our operating segments."

But growth could decelerate in China because of government policies and political instability. Auto and housing markets are struggling because of these policies, even if they might be doing better elsewhere in Asia.

The evidence from petrochemicals markets suggests that the widely expected recovery in growth during the second quarter has yet to happen.

For instance for the week ending 27 April, ICIS pricing assessed Asian polyethylene (PE) prices $20-40/tonne lower on weak buying interest, both in China and Southeast Asia.