Asian Chemical Connections

The new chapter of our free 'Boom, Gloom and the New Normal' ebook sets out a road map to success for companies in the New Normal. It also identifies 5 key areas where major change is already underway.

Demand-driven. Markets have essentially been supply-driven in recent decades, with growth being forecast on the basis of ratios to expected GDP growth. Companies have focused on increasing their efficiency via a 'one size fits all' business model. As we transition to the New Normal, they will need to refocus on being effective. Innovative strategies, flexible implementation planning, plus a commitment to local techno-commercial support and long-term R&D will be required

Market focus. New worldscale plants will still be needed during the transition. But companies operating in the West will also need to reposition their businesses to focus on the needs of the ageing 55+ New Old generation, if they wish to drive future growth. Those operating in the emerging countries will need to develop mechanisms to sustain growth in the domestic economy, particularly in the rural areas.

Affordability. Consumers have less money to spend, and so the highly profitable middle ground of the past couple of decades is disappearing. Instead, the focus will be on the megatrends of food, water, shelter, mobility and health. These products must be affordable, as they must meet basic 'needs' rather than supplying mere 'wants'.

Shared Value. Consumer values are changing quite dramatically, away from the materialism of the recent past. Concerns about sustainability and carbon footprint are rising up the agenda. Social stability is also becoming an important concern for governments. Companies who continue to operate on purely financial metrics will find the environment ever-harder to understand.

The VUCA environment. The transition to the New Normal is a sea-change for the global economy. Its full impact will take years, if not decades, to become clear. Meanwhile, the world will face much greater uncertainty, as conflicting views of the world play out on a day-to-day basis. Companies therefore need to plan for a VUCA environment: Volatility, Uncertainty, Complexity and Ambiguity will be the order of the day.

This VUCA landscape is creating winners and losers. No longer will the rising tide of affluent Boomers provide an effortless route to increased sales and revenues. Instead, companies need to create their own VUCA as they develop strategies and implementation plans. Vision, Understanding, Clarity and Agility will be their road map to success.

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Click here to view the 4 minute video with Paul Hodges

By John Richardson

CHEMICALS analysts, and some senior company executives, are telling us that growth in China will bounce back in the second half of 2012. 

To give these forecasts some historical context, the recovery was supposed to happen in January, then February, then March, then April and now at some point in the second half of the year (most commentators and company executives now believe that the second quarter, as a whole, will be difficult).

The longer that the recovery is delayed the more that 2012 earnings forecasts will be under pressure for downward revisions.

We think that the structural changes taking place in China's economy, and the weak external environment, make these revisions highly likely.

Petrochemicals markets point to a very weak first quarter. Our colleagues at ICIS pricing have detected no signs of a recovery since the end of Q1.

In the case of polyethylene (PE), as the chart above illustrates, Q1 demand was down 4% (red column) versus 2010 (blue). Contrary to popular belief, PE demand is not growing at 1.5 or 2 times GDP, but has actually gone ex-growth.

North American PE exports to China have fallen 61% since 2010.

"China's ruling communist party does not care that the US cost base is the second cheapest in the world, due to shale gas," says fellow blogger, Paul Hodges.

"Instead, it knows it must maximise job creation to remain in power. It therefore continues to increase China's own production, up 7% over the period."

By John Richardson

THIS fascinating slide from Accenture, in a new study that the consultancy is about to release on the rebound in North American manufacturing competitiveness, quantifies the steep rise in relative labour costs in China between 2001 and 2011.

And this process is likely to accelerate as China attempts to narrow the gap between the very rich and everybody else, and as it also tries to rebalance its economy towards more domestic consumption.

The implications for the petrochemicals business include:

*Declining growth in demand for basic petrochemicals that are shipped to the eastern and southern provinces of China to be processed into low-value manufactured goods for export. Higher wages in these provinces mean that China has to move up the manufacturing value chain, which it is attempting to do. However, as we discuss in chapter 10 of our free e-book, Boom Gloom & The New Normal, success is far from guaranteed.

*The chance to replace these lost petrochemical volumes with greater sales inland, as China moves its basic manufacturing away from the coast to its less-developed regions in order to create jobs. But this assumes that foreign importers can get over logistics barriers and thus compete with rising domestic inland capacities.

The wider debate over the recovery in North American competitiveness will be the subject of later blog posts.

But just to point out here, labour costs are not the only factor in spurring this revival. Intellectual property-right concerns over China, and well-developed "innovation clusters" in North America, are encouraging the rebound in manufacturing investment, according to Accenture.

This underlines the argument in chapter 10 of our book: That China has a long to go before it can become a trusted manufacturer of branded goods. Please click here to download the chapter.

By John Richardson

THE above chart is a further illustration of what we believe is the wrong consensus view over China.

Q1 2012 mono-ethylene glycol (MEG) imports surged by 30% compared with the same period last year, as traders bet on a sharp rebound in China's economy. They believed all the talk of more local economic stimulus and a stronger global economy.

But as of last week, inventory levels in China's coastal storage tanks totalled 860,000 tonnes compared with the usual 400,000 tonnes.

Not surprisingly, therefore, MEG pricing has been declining, while ethylene feedstock costs have increased on higher oil and therefore naphtha prices:

MEG spot pricing edged-up slightly this week, by $22-27/tonne to above $1,000/tonne CFR China Main Port, reports my ICIS colleague Judith Wang.

This is the result of turnarounds, some of which, according to Becky Zhang - another of my ICIS colleagues - are prompted by the poor market.

For example, a major Middle East producer is shutting down during the peak textile manufacturing season (April-June) to fix mechanical problems.

Taiwan's Nan Ya Plastics is to begin a turnaround at its 720,000 tonne/year No4 plant at Mailiao in Taiwan in mid-May, which will last for 40-50 days. The shutdown was originally due to take place in April, was then delayed until July because of good margins at the start of the year, and has now been brought forward to May because of the weak market.

Another reason given for this week's slight uptick in pricing is anticipation of stronger demand after the 29 April-1 May Labour Day holidays in China.

We have heard that story before! The recovery in China is always just around the corner.

If supposedly structurally tight MEG continues to struggle, this further underlines our argument that DEMAND is the thing, and that conventional ways of looking at markets need to be revisited.

By John Richardson

Francois Hollande, who has the won the French presidential election, talks about cutting the retirement age to 60 from 62 for people who have worked for 41 years.

This is a handy slogan for an election campaign.

But European pension liabilities suggest that people should be working until they are older, rather than retiring earlier.

The record number of over-55s in the West, as a result of the Babyboomer demographics, is also a huge opportunity for governments and companies.

If people work well beyond 60, which they are now able to do because of better healthcare and diets, their experience and expertise will be invaluable. The extra tax revenues will also help solve the pensions crisis.

Older people will be able to help manufacture the "products of the future", needed for serving the three big emerging customer groups we discuss in chapter 9 or our free e-book, Boom Gloom & The New Normal.

These three groups are:

*The increasing size of the New Old 55+ generation in the West.
*The number of young Westerners struggling with higher unemployment.
*The increasing number of people moving out of poverty in the developing world.

Hollande also talks about trying to help young people through growth rather than austerity - for example, by employing 60,000 more teachers.

Growth will only be sustainable if it involves a partnership between governments and industry in making the products and services of the future. We discuss how these partnerships might work in chapter 10 of our book.

The European petrochemicals industry is heavily focused on managing costs.

It is also constantly adjusting operating rates in a weak and volatile demand-growth environment, as the chart below illustrates:

 What more can the industry do? We would be delighted to hear your views.

By John Richardson

THE total value of export orders at the latest Canton Trade Fair, which finished this weekend, declined by 4.8% compared with the previous event in October last year.

This is the first decline in the value of orders at the bi-annual fair since May 2009, when the world was in the midst of the global financial crisis.

Orders from Europe and the US were down, although more transactions took place with buyers from India, Brazil and North Africa.

The export environment is clearly doing China no favours as it struggles with a major domestic economic adjustment.

European demand for China's exports looks likely to weaken even further as a result of the worsening Eurozone crisis.

Disappointing US jobs-growth numbers also suggest that America's recovery is, at best, anaemic. As Janet Yellen , vice chair of the US Federal Reserve, pointed out in a recent speech, job vacancy rates are worse than during the 1970s and 1980s downturns. Does this sound like an economy returning to good health?

Not surprisingly, therefore, there were few signs last week of the expected recovery in petrochemicals markets.

The story is very similar, no matter what product you examine.

For instance, in acrylonitrile butadiene styrene (ABS), ICIS pricing reported last Friday that "end-users are hesitant to commit to large volumes as they expect prices to slip further.

"The weak economic conditions in the US and eurozone and the slowdown in the Chinese economy dampened sellers' sentiment further."

As the chart below shows, pricing has declined this year.

The second half of the year is going to be very difficult for the petrochemicals industry in all regions.

By John Richardson

SOME polyolefin companies continue to present an optimistic picture of markets to investors.

They point to positive factors such as renewed economic stimulus in China and a recovery in auto production in Thailand following last year's floods.

But, as we said yesterday, those involved in the day-to-day grind of trying to sell a wide range of petrochemicals, including polyolefins, paint a very different picture.

A source with one producer we spoke to this week was notably pessimistic.

Here is what he said, with a few of our own additions in brackets:

"A lot of the speculators have gone short on the Dalian Commodity Exchange's futures contract in linear-low density polyethylene (LLDPE).

"This is on the assumption that prices will fall by the end of May, when they will need to go in to the physical market to honour their contracts. They are therefore betting on a price correction.

"By the end of this month, I am concerned that LLDPE will have fallen to around $1,240/tonne CFR China (last week ICIS accessed LLDPE film at $1,330-1,400/tonne CFR China).

"There are two factors driving the market at the moment - the lack of Chinese demand and the approach of the Middle East producers.

"Chinese demand continues to really surprise everyone on the downside and we are all frequently looking for explanations about what is happening.

"A theory I heard the other day was that many of the polyolefin traders have either directly invested in property through their own real-estate companies, or are indirectly exposed through investments in other people's real-estate companies.

"As bank lending has become harder to get hold of, and as property prices have declined, they have been forced to cover their obligations by selling polyolefins at low prices - thus driving the whole market down.

"I think the blog's earlier assessment of the other factors shaping growth this year was a very good summary.

"The buyers are very cautious and continue to wait for prices to bottom out, but there is no sign of this happening because the Chinese economy is weaker than anyone had expected.

"The Middle East producers have so far held the line on price reductions, as they have a responsibility to their naphtha-based joint ventures in Asia. As a result, they have yet to aggressively reduce prices.

"But the concern is that if the market doesn't recover by the end of May, they will be forced to lower their offers because of more Middle East supply pressure. Several turnarounds in the Middle East have just finished."

(Saudi Polymers is also due to bring on stream two 550,000 tonne/year high-density PE plants and a 440,000 tonne/year polypropylene facility by the end of Q2 this year).

By John Richardson

THE possibility that China's economy may not expand as rapidly in the future as in the past is never discussed in public by resources-company CEOs, said an Australian-based stockbroker.

His comments ring true for petrochemicals, also. The blog is struggling to find a senior executive willing to discuss this possibility on the record.

"The top management of iron ore, coal and other resource companies are burying their heads in the sand," added the stockbroker.

"The assumption is that iron ore prices will be at least $100/tonne. This would justify some of the higher-cost projects.

"And the more efficient producers are factoring into their financial forecasts the assumption that the higher-cost projects will be able to run at high operating rates, thanks to booming Chinese demand.

"In iron ore, as in petrochemicals, it is the marginal or highest-cost producer that sets the price in a strong market, maximising profits for those with lower operating costs."

To draw a parallel with petrochemicals, this is the equivalent of assuming that the smaller, naphtha-based cracker operators in Japan, South Korea and Taiwan will be able to consistently run at around 100 percent over the next few years. This would guarantee stellar returns for the ethane-based crackers.

But, perhaps, all will be right with the world if you are only interested on decent returns over the next few years.

"China's government could be tempted to kick the can down the road through another big economic stimulus programme, thus delaying the rebalancing of the economy away from investment and towards consumption," said the stockbroker.

"This would provide a temporary boost to GDP, which would perhaps be long enough for some of the heavily debt-burdened resources projects to pay-down their debts."

Michael Pettis makes a similar point in this article in the Business Spectator, the financial and economic news and analysis service.

China's GDP growth will average only 3 percent per annum in 2010-2020, as a result of the government efficiently managing the transition from investment to consumption-driven growth, he believes.

"If I am wrong and Chinese growth this decade is materially higher than 3 per cent, my prediction is that the 'lost decade' of much lower growth will stretch out over two decades," added Pettis, senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University's Guanghua School of Management. (He is also the author of this very thought-provoking blog).

Based on his assumption that the Chinese government will successfully rebalance the economy over the next decade, Pettis added: "Non-food commodity prices are set to collapse over the next three to four years.

"Collapse is not too strong a word. China's share of global demand for such commodities as iron, cement, copper, etc, is completely disproportionate to its size and almost wholly a function of its very high growth in investment. As investment growth drops sharply, as it must, global demand for non-food commodities will plummet."

This could also include a steep drop in demand for petrochemicals.

The reason he gives for China's need to rebalance its economy is "massive" misallocation of investment on infrastructure and industrial capacity. This has led to unsustainable debt levels.

Sounds familiar? It was debt that, of course, caused the financial crisis in the West.

We were sold the story that US house prices would always increase.

And now we have been sold the story that growth in China is a one-way bet.

By John Richardson

THERE is a lot of talk at the moment about on-purpose butadiene, via the butane dehydrogenation process, because of the recent extreme market tightness .

The tightness is the result of a shift to lighter cracker feedstocks and reduced operating rates at naphtha crackers in Europe.

Future feedstock patterns are also not expected to aid the availability of co-product butadiene.

The surge in ethane availability  in the US, via shale gas, has led to announcements  for up to a 29 percent addition to the country's ethylene capacity by 2017. Ethane feedstock for steam cracking, of course, yields very little C4s and therefore butadiene.

And in China, the rise of coal to chemicals - again replacing what would have otherwise been naphtha-based petrochemicals capacity - is no help. The coal-to-methanol-to-olefins and coal-to-methanol-to-propylene processes yield very little, if any, C4s.

Hence, Texas Petrochemicals is planning to bring a 270,000 tonne/year butadiene plant -based on its butane dehydrogenation process - onstream in Houston,Texas, by 2016.

"There are also two butane dehydrogenation projects in China that we know of, and perhaps a few more," said an industry source.

In addition, Asahi Kasei Chemicals plans to produce butadiene from butene, via its new BB-FLEX technology. The company is considering building a 500,000 tonne/year plant in Mizushima, Japan, based on the process, for start-up in 2014.

It is not only tight supply that is justifying all this interest in on-purpose butadiene, but also claims of booming autos demand.

"Autos demand is growing very rapidly and, of course, in countries such as China you now have a much bigger demand base for replacement tyres," said the industry source.

"And so even if you don't get much auto demand growth, which has been the case in China over the last two years, replacement tyres are still sufficient to ensure a lot of demand. Sixty percent of global butadiene demand is accounted for by the need to replace tyres."

Natural rubber supply has also been constrained over recent years because of the switch to more-profitable crops such as palm oil.

It takes 7-9 years for a rubber plantation to reach maturity, and so it will take a long time for the recent rise in butadiene prices to result in a compensating surge in natural-rubber availability.

The conventional wisdom, therefore, is that butadiene is a fantastic investment bet.

"At the moment, yes, I agree, but it would only take a few of these on-purpose plants to be built and the market would be oversupplied," said a synthetic rubber industry executive.

"And don't assume that that the Western mindset applies to China. It might continue to add capacity, even when the market is close to balance or already oversupplied, because of access to cheap capital."

By John Richardson

Asian polyethylene (PE) prices slumped by $90-130/tonne last week on the eurozone crisis, the fall in oil prices and the imminent arrival in China of large volumes of Iranian material, according to ICIS pricing.

A further factor dragging down the market was the start-up, expected by end-May, of Qapco's low-density polyethylene (LDPE) plant in Qatar, added ICIS.

Saudi Polymers is, in addition, due to bring on-stream two 550,000 tonne/year high-density PE (HDPE) plants and a 440,000 tonne/year polypropylene (PP) facility by the end of Q2 this year..

Asian polypropylene (PP) prices also fell last week, by $70-130/tonne, on the eurozone crisis and the decline in crude, said ICIS.

Disappointing economic data on China, which was released last week, is hardly going to help a market that has been struggling for months.

The bad economic data included:

*Growth in imports of just 0.3 percent in April compared with the same month last year. This was against forecasts of an 11 percent increase. The average monthly growth rate in imports during 2011 was 25 percent.

* Exports grew by just 4.9 percent - half as much as economists had expected. This followed a disappointing Canton Trade Fair.

*Industrial production grew by 9.3 percent in April year-on-year, the weakest reading in three years and well below the 11.9 percent increase in March.

Financial markets, and maybe be the odd poyolefins trader, might take perverse cheer from the bad news on the grounds that it makes major economic stimulus by the Chinese government more likely. The fall in April inflation to 3.4 percent, from 3.6 percent in March, supports this view. This compares with the government's 4 percent annual inflation goal.

But fellow blogger Paul Hodges made the excellent point last month that Chinese politicians were too pre-occupied,  due to the biggest political crisis since Tiananmen Square in 1989, to spend much time focusing on the economy.

His comments were backed up by Jamil Anderlini and Robin Kwong in the Financial Times on Saturday.

They wrote that last month's purge of Bo Xilai had left Chinese politics in disarray, with "much of the bureaucracy unsure what the final outcome of the power struggle will be."

In theory, economic decisions to adjust interest rates are in the hands of the State Council, headed by premier Wen Jiabao, they added.

But in practice, major economic decisions, such as altering interest rates, are in the hands of the nine-member Politburo, which is too divided by the Bo purge to reach any consensus.

As a result, the FT believed that the most likely response to the weak growth figures was a further cut in the bank-reserve requirement, as this does not require top-level consent.

On Saturday, the reserve requirement was, indeed, cut - by a further 50 basis points.

But it is debatable whether even an interest-rate reduction, viewed as a more effective way to boost the economy, would make much difference.

"Our customers in China are very cautious and will, I think, remain so until the end of this year," said a source with a global PE producer.

"Even if the economic environment improves, uncertainty over the outcome of the leadership transition is going to limit their appetite for credit risk."

The once-in-a-decade leadership transition takes place at the end of this year.

By John Richardson

Here is the first of a three blog posts on what is happening in China's polyolefins markets.

SAUDI ARABIAN polyethylene (PE) producers have been forced to cut offer prices twice in the last few weeks, in response to exceptionally weak Chinese demand, the blog has been told.

A few weeks ago, offers were cut substantially for May cargoes compared with April with a further smaller reduction made last week across most grades, says a source.

This suggests that Middle East producers in general may no longer be able to "hold the line" against the pressure for deep price reductions.

Naphtha-based competitors, as a result of the lower Saudi offers and a general decline in the market, have therefore gained no benefit from the fall in naphtha costs - the result of weaker crude.

But even in Saudi Arabia, with its unbeatable feedstock-cost position, producers are worried about netbacks.

Further concerns have been raised by the start-up, due by end-Q2, of the Saudi Polymers plant in Saudi Arabia. This comprises a 550,000 tonne/year high-density PE (HDPE) plants and a 440,000 tonne/year polypropylene (PP) facility.

QAPCO is expected to start-up its 300,000 tonne/year low-density PE (LDPE) in Qatar by the end of May.

Saudi Kayan Petrochemical Co's 300,000 tonne/year LDPE is also due to come on-stream in Saudi Arabia in Q3, according to ICIS (as we shall discuss tomorrow, LDPE is in particularly bad shape).

The big debate in the Middle East, as is the case everywhere, is whether Chinese buyers will return in big numbers once they believe that pricing has bottomed out.

By John Richardson

In the second of a series of three blog posts, we gauge the reaction of the market to last week's sharp decline in polyolefin prices.

Yesterday, we focused on the Middle East. Today, we interview a source with a Western-headquartered global polyolefin producer.

He told us:

"I have a dreadful feeling that this is a repeat of 2008. Back then, the Chinese didn't buy for 4-5 weeks and everybody kept expecting them to, all of a sudden, return in big numbers.

"Low-density polyethylene (LDPE) is in a really bad way and I think that it will eventually fall to within $50//tonne of  linear-low density PE (LLDPE). This is the result of the arrival of lots of Iranian cargoes and the start-up, very soon, of a lot of new capacity.The new capacity comprise:

*QAPCO's 300,000 tonne/year facility, which is due on-stream in Qatar by the end of May.

*Saudi Kayan Petrochemical Co's 300,000 tonne/year plant, scheduled to start-up in Saudi Arabia in Q3.

By John Richardson

In our third post on the context behind last week's steep fall in polyolefins prices,and the prospects for a recovery, we look at inflation - one of China's numerous economic challenges.....I

NFLATION remains a major threat in China, hence the government is unable to make the cuts in interest rates necessary to adequately re-stimulate the economy, said a polyolefin industry source.

"The inflation problem hasn't gone away," he added, referring to how, despite the fall in overall inflation to 3.4% in April from 3.6% in March, April food-price inflation was still at a worryingly high 7%.

As we have been pointing out for several months now, and nothing has changed, the government is caught between a rock and a hard place.

If it re-stimulates the economy by too little, then the rest of the world's economy could be in a lot deeper trouble.

Too much stimulus and this could cause a steep rise in food-price inflation, thus hurting China's low-paid workers who spend a big proportion of their incomes on food. This would contradict one of the main objectives of the government's 12th Five-Year-Plan (2011-2015), which is to reduce income inequality.

Plus, even if China were to lower the cost of borrowing and further cut bank-reserve requirements, it might not make much difference, given the weak state of business confidence. Domestic companies, hit by falling exports, higher wage costs, a weakening global economy and uncertainty over the outcome of the October leadership transition, appear to be in no mood to borrow aggressively.

Where do we go from here? Potentially, to a very difficult place when Chinese petrochemicals demand fails to grow at all this year. It might even, in fact, contract.

These were the kind of issues being debated on Wednesday ahead of the Asia Petrochemical Industry Conference (APIC) in Kuala Lumpur, Malaysia, which takes place on Thursday and Friday of this week.

The mood is sombre and anxious and everyone wants to know what on earth has gone wrong with China.

By John Richardson

THE more that China's economy weakens, the greater the hope of a recovery in the second half of this year.

This type of thinking was in evidence last week. The release of a raft of disappointing economic data for April boosted the confidence of some people in the petrochemicals industry that China's government would have to do something pretty drastic to solve the problem.

The release of the weak data contributed to further declines across a broad range of petrochemicals.

Polyolefins took the biggest hit. Asian polyethylene (PE) pricing was down by $90-130/tonne with polypropylene (PP) $70-130/tonne lower for the week ending 11 May, according to ICIS.

But China's top leaders seem to have other things on their minds along with the economy.
China, as it prepares for this year's once-in-a-decade leadership transition, is in the midst of its biggest political crisis since Tiananmen Square in 1989, say numerous commentators.

This is the result of the ouster of Bo Xilai, the former Chongqing Communist Party head.
The country's nine-member politburo was so divided over Bo that it could not even agree on an interest-rate cut, said the UK's Financial Times.

A 50 basis-point cut in bank reserve requirements was announced last Saturday, following the release of the bad April data.

But the FT made the point that adjustments to the reserve requirement did not require politburo approval.

"It is not only politics that is holding back a cut in interest rates. The threat of inflation is another factor," said a senior executive with a global polyolefins producer.

Overall inflation fell in April to 3.4% from 3.6% in March, well within the government's annualised target of 4%. However, food-price inflation in April was still high - at 7%.

Lower borrowing costs might add to food-price inflation, thus hurting low-paid workers who spend a big proportion of their incomes on food. This would contradict one of the main objectives of the government's 12th Five-Year-Plan (2011-2015), which is to reduce income inequality.

Implementation of the plan is also acting as a further drag on growth.

Another problem is that despite three reductions in the reserve requirement since late last year, which has released many billions more dollars into the financial system, small and medium-sized enterprises (SMEs) are reported to remain short of credit.

"The SMEs are still finding it difficult to get hold of financing and so the government needs to take further measures," added the polyolefins industry executive. SMEs buy the majority of chemicals and polymers in China.

But perhaps all this talk about the need for cheaper, more easily-available borrowing entirely misses the point.

The real issue could well be that companies are very reluctant to take-on debt because of exceptional levels of uncertainty over domestic politics and the global economy.

"Our customers in China have become cautious and will, I think, remain so until the end of this year," said a source with another global polyolefins producer."Even if the global economic

environment improves, uncertainty over the outcome of the leadership transition is going to limit their appetite for credit risk."

An improvement in the global economy, given recent events in Greece, appears highly unlikely right now.

China, despite all the talk about rebalancing, remains heavily dependent on exports - and Europe is its biggest trading partner.

Some of the bad economic data for April reflected the current plight of manufacturers in this difficult environment.

Overall exports grew by just 4.9% in April compared with the same month in 2011.This was half as much as economists had expected and followed a disappointing Canton Trade Fair.

Growth in industrial production was also only 9.3% in April year-on-year, the weakest reading in three years and well below the 11.9% increase in March.

"A Middle East solvents producer says his pace of orders in 2012 has been well below that of the previous two years. He sells mainly to customers in China, who then re-export finished products such as leather upholstery," said an industry observer.

And he added that Middle East producers in general have turned bearish over China.

"The Saudis say that Asian demand has become much weaker since the end of April," he said.

"The drop in energy prices, and hence the resulting expectation of lower derivative prices, is also keeping the customers at bay and they are only buying what they need.

"This is not atypical of Chinese buying behaviour. They don't buy when prices are falling, but instead start buying when prices turn upward."

But, sadly, all the evidence points to this being much more than the standard "China has stopped buying" story.

Something much more fundamental seems to be going on.

By John Richardson

FEEDSTOCK advantages in the US and the continued economic rise of Asia were some of the themes of last week's Asia Petrochemical Industry Conference (APIC) in Kuala Lumpur, Malaysia.

Steam crackers are being planned in abundance in the US. As much as 7.65m tonne/year of new ethane-based ethylene capacity could be on-stream in the States by 2017.

Old technologies are also being brushed-off and updated to take advantage of the shale-gas boom. For example, West Virginia-based Aither Chemicals is re-developing a 1980s Union Carbide technology for reacting ethane in the presence of oxygen, over a catalyst, to produce ethylene and acetic acid, the conference heard.

Several companies were also said to be working on commercialisation of technologies to make aromatics from methane.

The inexorable economic rise of Asia was said to revolve around increases in urbanisation and per capita incomes.

The China slowdown and the Eurozone crisis were also discussed.

But both in public, and privately, delegates said that we would soon return to strong overall economic conditions, thanks to Asia replacing lost growth in the West. 

On feedstock advantages, there is of course no doubt that the landscape has changed quite radically.

The US has enormous opportunities to become the United States of Gas, thus boosting both petrochemicals and downstream manufacturing industries, as it also benefits from a shift in relative labour costs.

But for us, demand remains a concern - both in the short and long-term. We worry that there are no guarantees that we will easily move beyond the problems in China and the Eurozone. 

By John Richardson

ANOTHER theme that emerged from last week's Asia Petrochemical Industry Conference (APIC) in Kuala Lumpur, Malaysia, was the shock at the extent of the price declines in the key China market.

In polyolefins, the slump in pricing has been the most pronounced during a period when the consensus opinion was that both pricing, and demand, would be strong as a result of the "renewed fiscal stimulus" story. Asian polyethylene (PE) pricing was down by a further $10-40//tonne last week with polypropylene (PP) $20-40//tonne lower, according to ICIS pricing.

"The extent of demand weakness in the China market was unexpected. I have never known it as bad as this. We understand some of the reasons, but not all of them. We are still searching for a full explanation," said a sales and marketing manager with one major polyolefin producer.

Some producers and traders claimed that demand would, however, soon come roaring back.

 "This is just a classic tactic by the Chinese. As usual, they have stopped buying and are waiting for pricing to bottom out. The second half of the year will be strong," said a sales and marketing manager with a second polyolefin producer.

But when the producers and traders were asked to justify why H2 would be better than the first half, they were not able to offer any detailed explanations. The common belief was that the Chinese market had always been strong, in their memory at least, and would thus remain so.

We beg to differ. China is undergoing major economic structural changes and it more obviously confronts an exceptionally weak export environment for its manufactured goods.

It is time for some painful, but nevertheless essential, scenario planning.

It is not only China we have to worry about, of course. As fellow blogger Paul Hodges pointed out yesterday, global economic problems have put us in, potentially, a worse position than in 2008.

By John Richardson

Wen Jiabao re-emphasised at the weekend that China's economic policy would be tweaked rather than radically overhauled because inflation, despite declining further in April, remains a major threat.

Anybody hoping for a stimulus package on the scale of that which was introduced in late 2008 is therefore likely to be disappointed.

And China's premier also stressed that the clampdown on the property sector would continue.

This means that petrochemicals traders, who frequently dabble in real estate and other speculative assets, are likely to remain under pressure. The "froth" will remain out of demand - i.e. the speculative element that boosted consumption in 2009-2010.

Stock markets have rallied on further government announcements over approvals being brought forward for infrastructure projects.

But while this is, of course, good news in the short term, and might result in a temporary boost in petrochemicals prices, (a great trading opportunity for those with the courage to go "long" for a couple of weeks, or perhaps only days) one has to wonder about further misallocation of capital. Investment-driven growth has run its course.

The key for a sustainable recovery in both petrochemicals demand and pricing is to also tackle what industry sources tell us is weak business confidence. That will as much depend on what happens globally as on action by Beijing, as China remains too heavily dependent on the export environment.

By John Richardson

POLYOLEFIN markets are not going to bottom out until August-September at the earliest, according to several producers and traders who the blog spoke to yesterday.

And even if prices do eventually stop declining, confidence has all but disappeared that there will be any substantial recovery in either pricing or demand for the rest of this year.

We were also told that:

*A major Chinese trader is not taking positions anymore because it cannot predict where the market will go over the next week, never mind the next month. This is unprecedented. It is only buying from producers when it receives firm orders from customers.

*Middle East offer prices to China keep falling. For example, one Middle East producer has reportedly just offered linear-low density polyethylene (LLDPE) for end-May/early June delivery at $100/tonne lower than its previously contracted price.

*Even discounted Iranian material, mainly low density PE (LDPE), cannot find a final home in the China market. As a result, it is being re-exported from bonded warehouses to Indonesia, the Philippines, Australia and Vietnam - possibly even South America.

*We have received further confirmation that smaller traders in China have been buying and then immediately selling polyolefins at losses, in order to get the cash necessary to fund property deals. This is the result of restrictions on banks that prevent them from lending to the real-estate sector. For instance, PE and polypropylene (PP) was recently bought for Rmb9,800/tonne and immediately sold at Rmb9,600-9,700/tonne.

By John Richardson

THE feedstock landscape can change very rapidly as the shale-gas revolution amply demonstrates.

But the assumption, right now, is that the landscape will not undergo any further radical changes. As a result, as much as 7.65m tonne/year could be added to US ethylene capacity by 2017. That would represent a 29 percent increase on existing capacity.

But Lee Fagg, Bangkok-based consultant with Nexant ChemSystems said: "Not all of the proposed US capacity will happen before 2020, as it remains unclear as to what the total availability of ethane supply from shale gas will be.

"Furthermore the current attractiveness in US ethane pricing is due to a supply surplus that exists today. However, if all the proposed projects go ahead the ethane market would change considerably. The sustainability of current US competitiveness would become less certain as domestic ethane prices would increase.

"And because of the nature of shale-gas extraction, it is very hard to accurately predict long-term ethane availability. You need to sink lots of wells in each shale-gas field. This makes it very hard to forecast the exact percentages of methane versus natural-gas liquids that will be produced by each of the fields."

As a result, Nexant estimates that only between 4-6m tonne/year of new ethylene capacity will have started-up in the US by 2020.

Fellow blogger Paul Hodges, in this post, also raises these questions:

• Will oil prices stay at current high levels in future?
• Will 'fracking' technology transform oil production as well as natural gas?
• Will super-computer trading continue to dominate the oil futures markets?

"There are no obvious answers to these questions," he wrote.

Add to this soaring construction costs. "You can earn US$400,000 a year as a welder in the US because of the boom in the shale gas and shale-oil industries," added a senior source with a North American polyolefins producer.

Could the US go the same way as Australia, where liquefied natural gas (LNG) are now in doubt because of rising costs?

Further - there is China and its coal-based methanol-to-olefins (MTO) plans. As much as 50m tonne/year of capacity could, in theory, be eventually built.

On a cash cost basis, as we shall explore in a later post, these projects look very favourable when compared with naphtha crackers. Polymers made via these MTO plants, most of which are located inland, can be delivered cost effectively to coastal and southern regions, where the big consumption markets are.

What does China's MTO investment wave mean for the ability of the US to export its petrochemical surpluses?

And, of course, none of this takes into account the other big uncertainty: DEMAND.

By John Richardson

The 6% decline in apparent polyethylene (PE) demand in China from January to April this year, compared with the same periods in 2011 and 2010, underlines what market participants have been telling the blog for many months.

The above chart also further emphasises how, in a weak market, the Middle East is gaining a bigger market share.

Its 33% increase in exports to China occurred as hard-pressed Northeast Asian (NEA) naphtha cracker operators saw their share of exports fall by 40%.

This was the result of:

*Increased Middle East production. What is worrying is that there is even more on the way.

*The ability of the Middle East, because of its tremendously strong feedstock-cost position, to cut prices sufficiently to meet the demands of China's struggling plastic converters. Meanwhile, of course, NEA competitors, confronted with high oil and therefore naphtha costs, have been unable to compete.

Further evidence of just how difficult life has become for China's small and medium-sized enterprises, which make up the majority of chemicals and polymers buyers, emerged late last week. Bloomberg reported that China's biggest banks may fall short of central government-directed lending targets for the first time in at least seven years. Last month, total bank lending declined by 33 percent compared with March, and May could be even worse.

The problem isn't the availability and cost of credit, but rather the unwillingness of businesses to borrow money. This suggests that unless business confidence improves, further reductions in the bank-reserve requirement and cuts in interest rates may not make much difference. Right now, it is hard to see how confidence can improve.

Interestingly, Southeast Asia, which is, of course, mainly a naphtha-cracker region, saw its PE exports increase by 16 percent. This is likely the result of the ASEAN-China Free Trade Area.

And very interestingly, North American Free Agreement (NAFTA) exports were down by a full 61 percent. To what extent was this the result of supply and demand being well-balanced in the US and Canada versus exceptionally weak markets in China? If the latter turns out to be the main factor behind the decline this just shows how bad conditions are, as NAFTA should on paper be in a very strong position because of very-low ethane costs.

Meanwhile, macroeconomic conditions just keep getting worse.

For example, real estate prices are now falling in more than half of China's top 70 urban areas. Fixed-asset investments have increased so far this year at their slowest pace since 2001.

The fall in fixed-asset investments supports our belief that major structural changes in China's economy are a significant drag on growth.

A Chinese cabinet adviser admitted, again late last week, that "a sharp slowdown in the economy" was taking place.

Asian PE prices were down by $10-60/tonne and polypropylene (PP) $20-50/tonne lower for the week ending 25 May, according to ICIS pricing.

By John Richardson

ISN'T it interesting how when you talk to someone involved in a petrochemicals project, either publicly or privately, their project is very often sufficiently to the left of the cost curve to gain a winning advantage over competitors?

Discussions are almost entirely about feedstock advantage, production and logistics efficiency and location etc. Thus was the case at the Asia Petrochemical Industry Conference (APIC) in Kuala Lumpur, Malaysia, earlier this month.

Demand over the long term is never seen as a problem.

A reason might be that many executives have forgotten the world before the economic golden era of 1982-2007, or are too young to have experienced anything different. During those years, the global economy was buoyed by the wealth of the Babyboomer generation.

Nobody had to worry about demand during that period as, during brief recessions, it was always lurking in the background, waiting to come roaring back. All that central bankers had to do, as we discuss in our e-book, Boom, Gloom & The New Normal, was to cut interest rates to bring Western economies back to immediate economic health.

A virtuous circle also existed between strong growth in the West and in China. From 2001 onwards, following China's accession to the World Trade Organisation, the country enjoyed enormous export-focused growth, thanks to strong demand in the West.

Increasing volatility, uncertainty, complexity and ambiguity (VUCA) in the global economy, described by fellow blogger Paul Hodges in an excellent series of posts last week, indicate that this has all changed.

In the past, it was a bit like driving a new car with good suspension. Global growth was so buoyed by demographics that we didn't as much feel the bumps in the road caused by short-term economic events.

Now the suspension is worn-out, and needs replacing by new routes to growth, and so we notice the bumps a lot more.

Some policymakers realise things have changed - for instance, those in China who are backing economic reform.

But there are no guarantees that when policymakers recognise the challenges, and put a reform programme in place, they will succeed, as China again illustrates.

By John Richardson

CHINA'S rising labour costs and a worsening regulatory environment had resulted in almost a quarter of European firms to consider relocating their activities elsewhere, said a survey by the EU Chamber of Commerce and Roland Berger Strategy Consultants.

Twenty-two percent of 557 respondents said they may move investment to other developing economies, including those in Southeast Asia and South America, where doing business is easier, according to the survey.

This is in line with what the chemicals industry has been telling the blog.

Low-value manufacturing in the developed provinces is being deliberately starved of credit, and is struggling with government-mandated wage rises and higher environmental compliance costs, as part of the 12th Five-Year-Plan (2011-2015).

Reformers in Beijing want to move up the value chain in the eastern and southern regions, while encouraging lower-value manufacturing to shift inland.

And as manufacturing costs rise, challenging China's position as the automatic outsourcing choice for Western companies, there are no guarantees that, in the long term, the reformers will win.

The Bo Xilai incident has exposed the divisions among China's senior leaders, as the country prepares for its first leadership transition in a decade.

The Chamber of Commerce survey supports our view that "vested interests" might get in the way of reforms, thus creating huge uncertainty over the business environment.

"There is an overwhelming lack of optimism among survey respondents for future positive reform, with many companies perceiving regulatory reform to have stalled," said the survey.

Peter Huntsman, CEO of US-based chemicals major Huntsman, also made the point during an investor call last week that China's permitting process for chemicals projects was taking much longer.

Previously, China had welcomed chemicals investors with open arms, but attitudes had changed as a result of rising self-sufficiency, he added.

By John Richardson

EARNINGS estimates for South Korean petrochemical companies will have to be cut by 50 percent for the full year 2012, said an industry observer.

"It is quite clear that the first quarter was dreadful for the South Koreans and the second quarter will probably be even worse," he added.

There was a brief flurry of excitement on Tuesday of this week, which no doubt made some short-term financial market speculators some money. This was the result of rumours of a big new economic stimulus package in China on the scale of the 4 trillion Yuan ($585bn) that was pumped into the economy from late 2008 onwards.

"The rumour was clearly a load of nonsense as the government is still struggling from the fall-out of that earlier stimulus package, including a steep increase in non-performing loans," said the observer.

The rumour was confirmed as nonsense on Wednesday when Xinhua, the official news agency, published an article saying that the government had no plans for economic stimulus on the scale of 2008.

The article was also in line with the views of mainstream policymakers, quoted in other Chinese publications, who dismissed the possibility of any repeat of the post-Lehman Bros rescue act.

Another 4 trillion Yuan, or anywhere close to that figure, of additional stimulus would have been almost equivalent to scrapping the 12th Five-Year-Plan (2011-2015).

Did anyone really think that policy abandonment on this scale was possible in a year when China is undergoing a leadership transition?

China's new leaders need social stability in order for them to be able to establish their authority.

Another gargantuan dose of stimulus would, once again, mainly benefit China's rich minority because of the way the banking system works. This would increase income inequality, giving rise to social instability.

"It was a good story while it lasted and was a classic case of buy on the rumour and sell on the fact," said the observer.

South Korean petrochemical stock prices rose by 5-10 percent when the rumour broke, but then declined again when it was rubbished, he added.

The South Korean industry is worth keeping a close eye on as it is one of the big losers in the current climate.

Its poor health, along with other Asian naphtha-based petrochemical industries, is an indication of just how bad demand is.

"The only producers making money right now are those in the Middle East, and even they have had to frequently reduce polyolefin and other prices to shift volumes," said the observer.

There is, perhaps, some good news, however: A stimulus package does appear to be in the process of being introduced, even it is likely to be far smaller than the one launched in late 2008. 

It includes building more roads and airports, and more investment in advanced equipment manufacturing and energy conservation.

There is also talk of another cash-for--clunkers programme, where auto owners would be given incentives to swap their big cars for small cars. In addition, some reports suggest that home appliance subsidies, introduced with such a dramatic effect in 2009, might once again be on the cards.

But it is a moot point as to whether such a package will be good for the Chinese economy in the long term, as Michael Pettis, finance professor at Peking University's Guanghua School of Management, argues in the article we linked to directly above. 

And equally debatable is whether the package will be sufficient to achieve the much-anticipated H2 recovery in petrochemical markets.

By John Richardson

ASIAN naphtha cracker operators have cut production in response to the exceptionally weak China market, according to ICIS.

Yeochun Naphtha Cracker Centre (YNCC) has, for instance, lowered operating rates to 90 percent from 100 percent at its three crackers in Yeosu. South Korea, from the end of May. The total capacity of its three crackers is 1.9m tonne/year.

The last time YNCC had cut production was during the global financial crisis in late 2008, added ICIS.

And in May, Taiwan's Formosa Petrochemical Corp cut the operating rate of its three naphtha crackers in Mailiao to 80 percent from 90 percent.

But when you still hear senior sales and marketing executives with Asian polyolefin producers talking as if this is just a brief tactical retreat by Chinese buyers from the market, one wonders whether some companies are sufficiently prepared for the hard times ahead.

A couple of weeks ago, it dawned on the blog just how serious conditions have become following a discussion with a sales and marketing executive who works for a Western polyolefin producer.

He described how business confidence had declined in China, resulting in reluctance among small and medium-sized enterprises to borrow money.

This suggests to us that unless confidence can be restored, the much-discussed new round of economic stimulus will have a limited effect. In our 15 years of covering the petrochemicals industry, we cannot recall a previous occasion when China's downstream industries lacked the conviction to borrow money.

And returning to the supply side of the story, operating issues in Saudi Arabia prevented the country's cracker complexes from running at high rates during Q1, said an industry observer.

These issues included a power failure at the Al-Jubail site in late January.

"Production was down by only a few percentage points in the first quarter, but, when you are as big a producer as SABIC, that is a lot of lost volume," he added.

If these problems are resolved, more shipments from the region to the key China market might well be the result, exerting further pressure on the Asian producers.

More volumes are also expected to soon hit the market from polyolefin start-ups in Saudi Arabia and Qatar.

The Saudi Polymers plant in Saudi Arabia was scheduled to be on-stream by the end of May. This comprises two 550,000 tonne/year high-density polyethylene (HDPE) plants and a 440,000 tonne/year polypropylene (PP) facility.

QAPCO was due to bring on-stream a 300,000 tonne/year low-density PE (LDPE) facility in Qatar by the end of May.

"We expect production at the QAPCO plant to be ramped up over a six-week period from early June," said the observer.

And Saudi Kayan Petrochemical Co's 300,000 tonne/year LDPE plant is scheduled to start-up in Saudi Arabia in Q3.

ExxonMobil is also due to commission its two new 650,000 tonne/year metallocene grade linear low-density (LLDPE) plants in Singapore in 2012, with some of this capacity already on line, said ICIS.