Asian Chemical Connections

Martin Brudermüller

Source of picture: BASF

By John Richardson

"THE struggle over China's future direction seems to be harder fought than we had imagined," said BASF vice chairman Martin Brudermüller last Thursday, in a German newspaper interview.

"There are very intensive discussions being held in China about the direction the country should take.

"For investors, the times when a project was unanimously rubber-stamped by politicians are over."

As fellow blogger Paul Hodges points out, when the world's biggest chemical company makes a statement as bold as this, one should sit up and take notice.

And so, here are our thoughts.

BASF might be right to worry about China's uncertain direction because:

*There are no guarantees that the 12th Five-Year-Plan 2011-2015), which involves a radically new economic blueprint, will be effectively implemented. This is a result of all the uncertainty over who will lead China following this year's leadership transition.

*Even if the plan succeeds, GDP (gross domestic product) growth could be a lot lower than many economists assume over the next decade, due to the painful process of weaning China off its addiction to investment.

*And if the plan fails, then China could end up pouring ever-more money into inefficient investments with ever-decreasing benefits as domestic demand remains relatively weak.

His comments on project approvals follow those made by Peter Huntsman, CEO of Huntsman Corp, during an investor call two weeks ago.

In the short term, the uncertainty over who will lead China might be making investors very nervous.

Relationships are important and if you end up building strong connections with the political faction that fails to gain control, then you have problems.

And even if companies choose the right faction, there is a big risk in these highly uncertain economic and political times that investment policies will be in constant flux.

Longer term, China might also become far-more self-sufficient in petrochemicals than some people have assumed.

On India, Brudermüller said: ""India is recording growth but the market is feeling the effects of home-grown problems, such as the backlog of reforms and the caution of foreign investors in reaction to questionable legislation.

"The political paralysis in certain areas does hold things up, and it's sad to see how the country is currently falling short of its potential."

India has muddled through in the past, but cannot afford to do so in the future.

Brudermüller, however, said that Southeast Asia (SEA) continued to perform well.

Indonesia alone, with its 240m people, was averaging stable growth of more than 5% per year, he added.

Meanwhile, Malaysia could become an even stronger export base, Vietnam was gaining in stature through its manufacture of shoes, textiles and printers, and Thailand was becoming increasingly important for international automotive and electronics value chains, Brudermuller said.

"We will also need to look more closely at Myanmar in the next few years, for example in the field of crop protection and the expansion of labour-intensive manufacturing," he added.

Geographical diversification is important at a time when growth so uncertain in India and China.

Even if reform in China is effective, there will be changes in the patterns of demand growth as low-value manufacturing migrates from the southern and eastern provinces either into inland China, or overseas to SEA and elsewhere.

By John Richardson

A collapse in the price of oil would expose petrochemicals producers, buyers and traders who have built- up stocks.

They built up inventories because oil was on the way up earlier this year.

And they were also encouraged to stock-up because of more confidence over the Eurozone, relative to Q4 last year, and the belief that China would bounce back after a disappointing 2011, as a result of stronger economic stimulus.

The US economy also looked as if it was in the midst of a reasonably strong economic recovery.

But the Eurozone is now in deeper crisis and China is slowing down far-more quickly than most people had expected.

US jobs growth in May was the slowest for a year, casting further gloom on the outlook.

Crude oil has responded. At one point last Friday, for instance, the Brent front month price fell by more than $4 a barrel.

"Ironically, a geopolitical crisis might help the chemicals industry as the price of crude would remain firm - thus enabling companies to avoid inventory losses," said fellow blogger, Paul Hodges.

But this would only be a temporarily relief as all the signs are that expensive crude has caused demand destruction. The economy is just too weak to support the current cost of oil, and so the longer it remains as high as it is today, the more the damage.

Last week's fall in the price of oil, and with it petrochemicals prices, further support the concern that companies who stocked-up in Q1 are heading towards significant losses.

Across-the-board price declines included a further 17 percent fall in US ethylene. The price of US C2s is now down by 44 percent over seven weeks.

The FOB Korea price of ethylene fell by a further $100/tonne last week, despite Taiwan's Formosa Petrochemical Corp announcing that it had shut its No 3 naphtha cracker at Maliao in Taiwan. The 1.2m tonne/year cracker is the largest of the company's three crackers at the site.

The weakness in Asian ethylene, of course, reflects problems downstream, which we will examine in further blog posts later this week.

And so, where do we go from here?

Small and medium-sized companies could face difficulties in obtaining working capital from banks, which will be concerned about losses on inventory.

This might occur at a time when the banks are already cutting their exposure to the smaller companies, because of the regulatory response to the 2008 crisis.

We are about to set out on a great journey as the world transitions to the New Normal.

The reason for the journey is that the world economy has changed irrevocably as a result of the financial crisis and the demand changes created by the ageing of the Western BabyBoomers.

There is no going back. In the 12th and final chapter of our free eBook, 'Boom, Gloom & the New Normal', we provide our view of how individuals, companies and politicians can prepare for the journey ahead.

We suggest that parents tell their children: "Go and take a degree that will allow you to work for the right kind of company. This type of company will be constantly innovating to make products which meet the needs of the future: The 55+ generation in the West and those emerging from poverty in the developing world. The firm that you work for must also be mindful of the other megatrends - food and water scarcity, carbon footprint - in everything it does and everything it makes."

We argue that companies should escape the tyranny of short-term financial metrics in order to once again plan for the longer term. They need to establish, and stick by, a set of values that will enable them to meet the needs of society and be successful - one and the same thing in the New Normal world.

In the political arena, Western politicians need to tackle unemployment in order to avoid wave after wave of social unrest further damaging already weakened demand growth. Good social policy is required, as without a healthy society there cannot be a healthy economy.

Many developing countries already have social policies in place that emphasize job creation over corporate profitability. But they face their own set of challenges as they transition from an export-orientation to a domestic focus. Thus their demand cannot inevitably replace lost demand in the West.

Making the transition to the New Normal could become very difficult, if our leaders fail to recognise the changes required. It might then involve moving through the "five stages of grief" identified by Elisabeth Kübler-Ross, the Swiss American psychiatrist. These are Denial, Anger, Bargaining, Depression and Acceptance.

We hope that the book has helped to highlight how we can all help to accelerate the transition to Acceptance where individuals, companies and countries work together in a search for solutions.

This will allow creativity to really flourish and encourage confidence to return. New opportunities will then emerge as we arrive in the New Normal.

FREE DOWNLOAD OPTIONS FOR CHAPTER 12

Click here to download the full Chapter

Click here to view the 4 minute video with Paul Hodges

By John Richardson

A SENSE of panic has gripped the fibre intermediates chain as a result of falling crude oil prices, an industry observer told the blog.

"Nobody knows where the bottom of the market will be, which, to me, feels a great deal like the crisis in late 2008," he said,

"Prices are in  virtual free fall. The only good news is that once they stabilise, they will recover as demand growth remains robust. But this, of course, depends on crude settling down."

He estimates that polyester demand in China will still grow by 6 percent this year, considerably down on last year's 8-10 percent growth, but nevertheless a decent performance when you consider that polyethylene (PE) is in negative growth territory.

The styrenics industry is an awful mess, also, as a result of the collapse in exports of finished products to the West.

"The good news for polyester is that it continues to gain ground over other synthetic fibres and cotton," he continued.

But while the long term outlook might, arguably, still be good, Becky Zhang, Asia ICIS pricing purified terephthalic acid (PTA) editor, wrote in her report for the week ending 1 June: "Cash is not a major issue with polyester producers in China, as the government has been relaxing its monetary policy to encourage liquidity and consumption since the beginning of the second quarter of this year, traders said.

"The main problem is the lack of market confidence, players said. The market is immersed in bad news including massive capacity expansions, the worsening situation in Europe, and a slowdown of economic growth in China and India."

This is the same shift in mood that we detected in the polyolefins industry two weeks ago. China's plastic converters have become reluctant to borrow money because of anxiety over the global economy, over domestic growth and over local politics.

And, as the industry observer said, prices are declining very rapidly: Paraxylene was down by $69/tonne - a 17 month low - and PTA fell by $37-40/tonne, representing a 19 month low, according to ICIS pricing. 

By John Richardson

MORE of the same won't solve China's problems.

"Economists worry that an influx of new cash (as part of China's new economic stimulus package) will exacerbate some of the market distortions in areas that are already heavily state-dominated," wrote the Financial Times, in an article on Tuesday.

The steel sector is an example of such distortions. Multi-billion dollar investments in new mills have been sanctioned by the government over the last two weeks, even through the steel industry's profits fell by 68 percent in the first quarter of this year compared with Q1 2011, continued the same article.

This latest economic stimulus package, however, does include efforts to boost domestic consumption, such as another subsidies programme for purchases of home appliances.

But as one steel analyst told the FT, the stimulus package as a whole is heavily skewed towards funding for state-owned enterprises.

"The state advances and the private sector retreats," he said.

China's leaders are probably panicking, given the weakness in the global economy.

This stimulus package, though, is smaller in scale than that which was introduced 2008, and is very probably only a stop-gap measure.

We won't have a clear idea of China's longer-term economic direction until after October, when the country's new leaders are set to take office.

Then we will know, broadly speaking and with lots of shades of grey, whether the new leadership will opt for:

*The status quo - i.e. more spending directed towards wasteful investment and state-owned companies. This would worsen China's bad debt problems and lengthen the process of rebalancing.

*A muddle- through halfway house: Some reforms, but nothing too quick and drastic, in order to keep the "vested interests" happy.

*A radical reform programme, in line with the 12th Five-Year-Plan (2011-2015) that could, ultimately, deliver enormous new growth, but will involve a painful adjustment process of several years of reduced economic expansion.

By John Richardson

THE blog has been attending the 25th World Gas Conference in Kuala Lumpur, Malaysia, this week where one of the themes repeated on numerous occasions has been the wonderful environment benefits of natural gas.

Poor old coal and crude-oil have received short shrift as presentation after presentation has stressed how gas is cleaner-burning.

But it occurred to us that:

*The age of natural gas abundance, thanks to shale gas, tight gas, coal-bed methane and improved technologies for accessing remote conventional reserves, such as in the arctic circle, might not be good news for the most effective means of lowering emissions: Conservation. There is now some 250 years worth of global natural gas reserves. Might not this tempt countries to guzzle their way through their reserves? This could especially be so in the US if it enjoys a manufacturing and therefore economic revival, given its history of energy profligacy.

*A typical shale gas field, we were told, contains more than 100 individual wells. As the shale gas revolution sweeps across the world, is it realistic to expect high production standards at every one of these many thousands of wells? If standards slip, which seems quite possible, we could see a big increase in the release of methane during natural-gas extraction and, of course, methane is a far more potent global-warming gas than carbon dioxide.

*The gas industry dismisses claims that fracking causes groundwater pollution. Nobody disputes, however, that the fracking process consumes a lot of water. If shale gas takes off in water-stressed countries such as China, the environmental consequence could be very severe.

*As the liquefied natural gas (LNG) trade expands, so will the emissions from moving these giant ships around the world, plus, of course, all the other energy required to refrigerate, regassify and distribute the gas.

Environmentalists are already going after the shale gas industry in a big way.

If the issues we have listed above are not convincingly addressed, one can imagine increasing pressure from environmentalists on the gas industry as a whole, which would also be applied to petrochemicals capacity downstream of gas production.

By John Richardson

CHINA surprised economists and markets with a 25 basis point cut in benchmark lending rates on Thursday. This was the first rate cut since the economic crisis of 2008.

The cut was seen as indicating that the economy is slowing down faster than had been previously thought.

Industrial production for May, due to be released on Saturday, is now expected to show a faster deceleration than had been forecast.

Interestingly, economist Donna Kwok, in this article from CNBC, says that there is a lot more to the rate cut than meets the eye.

The discount that banks will be allowed to offer on lending rates, relative to the benchmark, has been more than doubled, she said. China strictly controls the interest rate at which banks can lend money and pay depositors.

"The discount that banks were previously allowed to offer on lending rates relative to the benchmark rate has been doubled, from 10 percent to 20 percent, which means that the lowest official lending rate has effectively been cut by 63 basis points, not just 25 basis points," she added.

A 63 basis point cut suggests the government has become very, very worried about the slowdown in global growth.

Questions the chemicals industry needs to ask about the rate cut include:

*Will it be enough to restore the confidence of chemicals and polymer buyers, who have become reluctant to borrow money, regardless, seemingly, of the cost and availability of finance?

*What more can China's senior leadership do before the end of the year to boost growth, given that the make-up of the Politburo is about to change?

*Could a panic stimulus package do more long-term harm than good?

By John Richardson

THE notion that Asian polyethylene (PE) markets would soon bottom out, which was widely expressed at the Asia Petrochemical Industry Conference (APIC) last month, seems to have been discredited.

There was a slight recovery for the week ending 1 June, when prices had crept up by $10-20/tonne on improved confidence amongst traders, according to ICIS.

Confidence was boosted by the belief that China would launch a huge new economic stimulus package.

"But then, everyone began to realise that economic stimulus would not be on the same scale as in 2008," said a Singapore-based polyolefins trader.

Even last Thursday's decision by China to cut interest rates by 25 basis points failed to lift the renewed negative sentiment. As a result, pricing for the week ending 8 June was assessed $10-50/tonne lower by ICIS.

Volumes are substantially down because few end-users want to commit to anything more than hand-to-mouth purchases, until or unless macroeconomic and political uncertainties are resolved. In thinly traded markets, pricing tends to bounce around, and so a few more mini recoveries, followed by further declines, seem likely.

This is not a "business as usual" scenario, as some major Asian producers insisted was the case during APIC. China's buyers haven't just tactically retreated until pricing has bottomed out.

Instead, we face the biggest crisis since 2008, which was further underlined by the release of weak economic data by China over the weekend.

           Chinese govt poster promoting the one-child policy  

By John Richardson

IF all you can remember is strong emerging markets growth, then it is easy to be misled into only building into your scenarios the notion that China and India are merely pausing for economic breath.

Conventional wisdom remains that this is, decidedly, the Asian century - and that the demand for chemicals will continue to boom on the rise of the continent's wealth.

But, as we shall discuss in several blog posts over the next few weeks, nothing is guaranteed as the New Normal evolves. Chemicals and other companies that fail to build the downside risks into their planning processes are failing in their responsibilities.

This applies across all sectors, of course, including liquefied natural gas (LNG). There are some Aus$200bn of projects in Australia alone being planned, all of which, we were assured yesterday, would be successful because of "strong population growth" in China and India.

But when we raised the issue of China's one-child policy, we were told "that's (just) high-level stuff. Demand will always be there in Asia. Just look at Malaysia, Indonesia and Thailand."

Hold on, though, isn't Southeast Asia heavily dependent for growth on China?

China will see its population shrink, rather than expand, according to Guo Zhigang, professor of sociology at Peking University.

"At China's current total fertility rate, the country's population will shrink to just 800m by the end of this century," he wrote in the June issue of the China Economic Quarterly (CEQ).

"Even if China adopts a pro-birth policy (there are no signs of this at the moment), experience from other developed countries suggests that reversing the downward spiral is very difficult."

The economic consequences both of this overall decline in population and the ageing of the population will be huge, as we discuss in chapter 6 of our e-book, Boom, Gloom & The New Normal.

"China's rapidly ageing population will have enormous economic and social implications. The demographic dividend China enjoyed over the past 30 years - especially in 1980-2000 - is now largely exhausted," wrote Wang Feng, director of the Beijing-based Brookings-Tsinghua Center for Public Policy, in the same issue of the CEQ.

"In 1980-2010, the effect of a favourable population age structure accounted for between 15 percent and 25 percent of per-capita GDP growth.

"As China's demographic fortunes reverse, the economy will slow down regardless of other factors driving growth. Since China's economic and political governance model is premised on near double-digit growth, this will require substantial policy change."

There are surely no guarantees that all the right policies will be adopted and that, even if they are adopted, they will be effectively implemented.

And there are no guarantees that, even with the best of possible policy outcomes, China will overcome such a big demographic challenge.

"Over the next 20 years, the ratio of workers to retirees (presuming workers continue to retire at 60) will drop precipitously from roughly 5:1 today to just 2:1," adds Wang.

The same issue of the CEQ also argues, in separately authored articles, that China's demographics will deliver some benefits as well as problems. For example, Tom Miller, managing editor of the CEQ, says that China's army of single children, doted on and heavily subsidised by their parents, will create more consumerism.

But clearly, chemicals and other companies cannot, and must not, assume that growth will just happen - and that, therefore, their capital investments will easily be justified.

Macro-economic analysis is not something that can be outsourced to the International Monetary Fund and the World Bank etc. It has to be conducted in-house.

As fellow blogger Paul Hodges points out in this post, spread sheets might be telling you all is right with the world, but spread sheets alone cannot model the future - especially if they involve "garbage in, garbage out" data.

By John Richardson

CHINA'S 15.3 percent increase in exports in May, far greater than most analysts had expected, is being interpreted as a sign of the country's enduring economic strength.

This is certainly good news for China amidst all the other negative news. But to what extent is it good news for the US, the main destination for most of the increase in China's exports? China's exports to the US surged by 23 percent in May, compared with just a 3.2 percent increase to the European Union.

"Underpinning China's export success is a combination of long-term investments in automation and short-term depreciation of the currency," wrote the New York Times, in this article.

Increased automation is the reason why imports in the US are becoming less expensive. Data from the Bureau of Labor Statistics in the US show that average prices of goods imported from China fell in April for the first time in two years.

Automation has been forced on China's manufacturers by rapidly rising labour costs. Moving up the value chain to more sophisticated forms of manufacturing is also a key part of Beijing's 12th Five-Year-Plan.

It seems likely that investments in automation have been funded by soft loans, via the state-owned banks, as this is such an important part of central government strategy.

China's export trade has been further boosted by the government allowing the Yuan to depreciate in value against the dollar by 1 percent in May, its largest drop since the Chinese currency was unpegged from the dollar in 2005.

And so? Yes, this is an election year in the US and both Mitt Romney and Barack Obama will be under a lot of pressure to do something about the "unfair advantages" enjoyed by China's manufacturers.

The focus could well be on all those soft loans from the state-owned banks, with more noise about the Yuan being undervalued.

We might therefore be in for more trade disputes between China and the US, if the May export figures really do point to a major shift in the composition of China's exports.

Longer term, China still has a long way to go to catch up with the US in terms of investment robotics, research and development and intellectual property-right protection, according to the consultancy, Accenture.  

But with ample state funding available, how long will it be before China catches up, assuming it can avoid the middle income trap?

What might this mean for the US manufacturing revival, which is helping to justify plans for a 33 percent increase in the country's ethylene capacity?

By John Richardson

POLYESTER producers, and their raw-material suppliers, enjoyed a huge boost to their profitability between October 2008 and March 2011 when cotton prices increased by 468 percent from 40 cents/lb to $2.27/lb.

This led to polyester being substituted for cotton, and helped inspire a big capacity build in purified terepthalic acid (PTA) and polyester.

But since March of last year, cotton prices have been declining - and have fallen by 18 percent so far in 2012.

Of course, as with all commodities, market players are always trying to anticipate the point at which prices might bottom out. Thus, the I.C.E. Futures US contract for July delivery jumped by 3 percent earlier this week to 75.09 cents/lb on the theory that weak returns for farmers would result in less planting during H2.

And, interestingly, just as rising labour costs have eaten into the profitability of China's chemicals and polymers buyers, so too is the case with its farmers. Cotton planting in China's major growing regions has fallen by 10 percent this year on the higher cost of labour, according to the China Cotton Association.

But exceptional demand weakness could be the real issue for cotton prices in H2.

The historic surge in cotton prices in 2008-2011 was the result not just of supply constraints caused by flooding, and farmers switching to other more lucrative crops, but was also "a barometer of advanced economies' consumer sentiment and appetite," according to this article from Worldcrops.com.

"Even though countries like China and India are top producers and importers, their populations aren't the end consumers," continues the same article.

"In fact, domestic consumers in emerging markets generally appear quite prepared to switch to cheaper substitute textiles.

"International cotton prices don't reflect emerging market demand for cotton, but rather advanced economy macroeconomic sentiment."

Worldcrops.com believes that prices might have found a floor, well above their 40 cents/lb low of October 2008.

But how weak might Western demand for textiles become if the Eurozone crisis isn't resolved?

The problem is that with cotton, and with every other commodity, we are in uncharted territory.

And what applies to cotton also applies, to a large extent, to polyester - its substitute.

China is due to shutter 2.5m tone/year of polyester capacity between now and July, according to our ICIS colleague, Becky Zhang.

Polyester yarn and fibre makers in China have further reduced operating rates at plants to 68-73% this week, from 70-75% seen a week ago.

Overall inventories of Chinese polyester yarn plants swelled to 15-32 days' worth this week, compared with 11-26 days a month ago.

Purified terephthalic acid (PTA) plants are also being shuttered as PTA producers seek to reduce their off-take of paraxytene (PX) feedstock, according to Bohan Loh, also of ICIS.

By John Richardson

ASIAN polyolefin traders have little else to do apart from betting on the Euro 2012 soccer championships because of dismal demand, said a Singapore-based trader.

"This is the worst I can remember in 10 years in this business, and it is definitely now worse than in 2008," he added
.
"The shock of 2008 was more sudden, more dramatic, but more short-lived. What we have seen in 2011-2012 has been longer periods of depressed demand where prices have been flat or declining, with very brief periods of recovery. These recoveries have followed improvements in equity markets and crude oil.

"Take the last few days as an example. Last Friday morning, after China had announced its 25 basis points cut in interest rates, the Dalian Commodity Exchange rallied and there was a slight uptick in interest for physical cargoes."

(The Dalian Commodity Exchange operates a futures contract in linear low-density polyethylene).

"But by the afternoon, people were asking themselves 'will the interest rate cut make that much of a difference?' They decided no, and so the Dalian retreated again and what appetite there was for acquiring physical cargoes disappeared.

"On Monday this week, the recovery at least lasted all day, thanks to the rescue package for the Spanish banks. But on Tuesday, the futures and physical markets fell back again.

"The problem is that there is absolutely no visibility out there - nobody knows when the market will bottom out, and nobody is prepared to take any risks."

During 2011, lack of liquidity held the market back as the Chinese government increased bank-reserve requirements and raised interest rates, he added.

This forced polyolefin buyers to either cut back on activity or turn to the shadow-banking system, where they paid very high interest rates.

"Over the last couple of months there has been a very significant sea change," the trader added.

"Our customers no longer want to borrow money, even though financing is more available and cheaper. There is no demand out there, so why would they borrow money?"

The market was so bad that the prospect of new supply, from start-ups in Saudi Arabia, Qatar and Singapore, had not caused panic, he added.

"The attitude towards this new supply is, 'bring it on because it, surely, cannot make the demand any worse.' "

By John Richardson

HOW long will the relief rally last in oil and equity markets following the Greek election results?

Sadly, the answer is not long, because difficult discussions lay ahead for the New Democracy party as it tries to form a government. Greece, also, remains broke and so the Euro crisis is far from being resolved.

The underlying fundamentals mean that nothing has essentially changed in oil, equity, and, of course, petrochemical markets following the election results. In petrochemicals, because of these underlying fundamentals, we expect aversion to risk to remain the dominant mood.

Meanwhile, petrochemical prices continue to decline. In Europe, for instance, polyethylene (PE) prices fell by €20-50 with Asian prices down by a further $20/tonne for the week ending 15 June, according to ICIS.

Monthly June PE prices in Euope are down by €150/tonne.

And even Jim O'Neill is now worried about emerging market growth.

Eleven years ago, the chairman of Goldman Sachs Asset Management said that the BRICs (Brazil, Russia, India and China) would drive the global economy, but last week he warned that his thesis faces "a more challenging test".

By John Richardson

SIGNIFICANT volumes of US polyethylene (PE) are heading to China as the States attempts to compensate for weaker domestic sales, understands the blog.

Despite the fall in US prices, margins remain strong, creating arbitrage opportunities.

US May contracts for polyethylene (PE) settled down by 7 cents/lb ($154/tonne, €125/tonne) from April, following weak domestic and export demand and a drop in feedstock prices, according to ICIS.

Producers had initially sought a 7 cent/lb increase for May contracts. By mid-month, several producers had offered a 4 cent/lb decrease.

However, after ethylene prices fell by 44 percent in around seven weeks, producers eventually agreed to a 7 cent/lb reduction.

Buyers are seeking a further 7 cents/lb reduction in contract prices for June as ethylene prices and demand continue to head south.

At one point last week, US ethylene for prompt delivery fell to a 20-month low, before regaining some ground on firmer feedstocks prices and slightly improved demand.

In January-May this year, North American Free Trade Agreement exports to China declined by 61 percent compared with the same periods in 2011 and 2010.

"This was the result of stronger local demand and limited supply due to turnarounds and outages," said an industry source.

An increase in US exports would exert further pressure on the already hard-pressed naphtha-based Northeast Asian producers.

"Long-term cracker shutdowns are needed in Northeast Asia to balance the market. Closing down the odd cracker for a few weeks, as with Formosa, and cutting operating rates will not be enough," continued the source.

Meanwhile, as the weakness in the China market continues, unconfirmed reports have emerged over the last few days of delays in the start-ups of new Middle East and Asian capacity.

Source: ICIS pricing Weekly Asian PE Margin Report

By John Richardson

The slide above shows how Northeast Asian naphtha-based polyethylene (PE) producers are struggling as a result of the weak China market (dark blue bars).

And it confirms what we were discussing yesterday: The US, with its ethane advantage and with reportedly high producer inventories, is in a very strong position to export to China (light blue bars).

Northeast Asian operating rate cuts have clearly not been enough to restore profitability.

"One Japanese producer, for instance, is talking of overall PE production cuts of as much as 30 percent, but I still feel that this is not enough," said an industry source.

"Formosa closed its No3 1.2m tonne/year cracker down for market reasons, but that was only for a couple of weeks. I feel we need long-term closures," he added.

And he said that Chinese state-owned producers continue to lose money.

"They are still running their plants as utilities to guarantee supply to downstream industries and are, thus, matching Middle East import prices at $300-400/tonne beneath their costs."

The chart also shows the improving margins of European producers (purple bars).

"European margins are good on low naphtha costs and favourable exchange rates for exports," said the ICIS European polyolefins editor, Linda Naylor.

"A lot of PE and polypropylene (PP) is being exported - for example, one producer plans to double its PP exports.

"Some producers have been considering production cutbacks, but for most of the producers, margins are too good to curtail production.

"But everyone is expecting a fall in July ethylene and propylene contract prices, which, I think, will impact margins and prompt cutbacks.

"Buyers are concerned that production cuts in July/August, along with increased exports, will tighten the market and drive prices up again in September and October."

By John Richardson

A NEW report from HSBC supports our argument that China's synthetic resin market has yet to bottom out.

Big structural changes in China's economy are an additional factor, in our view, to the slowdown in China not covered in the comments below.

The bank highlights, of course, the weak business environment as a major factor behind the slowdown.

What is of more interest, however, is its analysis of inventory levels.

"Despite over a year of weak apparent consumption growth (production plus net imports), the cumulative levels of inventory within the system are well above their average of 1.5m tonnes over the last decade," said HSBC.

This was the result of the huge amount of stock that had been accumulated during 2009-2010, when China implemented a Yuan4trn ($628.93bn) stimulus package, along with an estimated Yuan9.6trn of new bank lending - equivalent to around one-third of the country's GDP (gross domestic product). This was designed to offset the impact of the global economic crisis.

"While it is amply clear that while there has indeed been a destocking cycle since Q1'11, the real key is the massive restock that occurred post Q4'08. This was driven, in our opinion, by the large stimulus undertaken by the Chinese government and the environment of cheap credit," added the bank.

"The data also illustrate the mini restocking cycle in Q1'12, which drove expectations around a demand bounce but was quickly followed by another round of destocking, which continues to date."

HSBC said that while converter inventories are low, this is the not case with the traders.

"While traders have been influential within the Asian resin markets for a while, we can trace the shift to a predominantly trader-led resin market in terms of influence back to the early days of the post-stimulus period in 2009," said HSBC.

"Key points to bear in mind are that the big departure of apparent consumption from GDP growth only started in 2009, post-stimulus.

"This correlates with the spike in futures volumes of linear-low density PE (LLDPE) on the Dalian Commodity Exchange and, anecdotally, with what one hears about Chinese traders using commodity imports as a source for financing.

"It also correlates with what we know of commodities where inventory data is readily available - for copper for example.

(The problem with the synthetic resins market in China is that there is no reliable measure of inventories).

"Furthermore, we are increasingly seeing large re-export offers from China of Saudi and other Middle Eastern product, which almost certainly implies large levels of trader inventory."

This all helps to explain a conundrum: Demand growth well below the increase in overall GDP.

Polyethylene (PE), polypropylene (PP), polyvinyl chloride (PVC), polyethylene terephthate (PET) and acrylontrile butadiene styrene (ABS) demand growth had averaged just 2.7% since the first quarter of last year, compared with a 9.1% increase in GDP, said HSBC.

Asian chemical share prices, despite steep declines over the last few months, are still overvalued by around 20 percent, said the bank. Some investors are, perhaps, still holding on to the Supercycle theory.

"Despite the weak business environment, the spread of stock ratings and earnings estimates are still highly skewed towards the bullish view," added the bank.

"We believe that consensus expectations are far too high, particularly in the case of the Northeast Asian names where year-on-year earnings growth in 2012 is likely to fall well short of expectations."

By John Richardson

IT is the demand for loans that matters in China these days more than their supply, as chemicals markets have been telling us for over a month now.

And now, statistical back-up for our anecdotal evidence, that China's economy has turned an important and worrying corner, has been provided by a new Citi Investment Research report on the auto market.

"China growth has slowed sharply in recent quarters - from an annual GDP (gross domestic product) growth rate of almost 11% to just 8.5% currently, with the FY12 official target coming down to 7.5%," wrote the bank.

"China money supply has slowed sharply, and official loan targets, so easily exceeded in previous years, are now being missed on a monthly basis. It seems the demand for loans and investment in the Chinese economy has slowed sharply. Without this investment, China GDP should continue to slow."

China money supply growth growth

Source: Citi, Bloomberg

The construction market, one of the main reasons why chemicals and polymer demand growth was so strong in 2009-2010, continues to slow, said Citi. Growth in chemicals and polymers has now entered negative territory. 

"China April construction data was weak. Although home sales declined a bit less than in previous months, sales of commercial property fell much more sharply, as did new starts and land sales," added the bank.

"Given that construction accounts for a large slice of the Chinese (or any emerging market) economy, these declines suggest GDP remains under pressure.

"The question is whether China policy stimulus (reserve requirement cuts and more) will once again save the day. We would be cautious for now."

And on the main theme of the report - autos - Citi said that sales in China had slowed sharply over recent months, driven by lower sales of commercial and light vehicles and by falling sales of locally produced vehicles.

Source: Citi, CAMA

"Generally speaking, mass OEM JV sales have remained flat year-on-year, and premium brand sales have sharply beaten the market. BMW has performed best of all.

"However, especially given the housing data, we fear that the best months are behind us on this front."

Interestingly, also, Citi raises a question mark over the conventional wisdom that there is still huge potential for further auto-ownership growth, particularly in the developed eastern region of China.

"Although (nationwide) ownership penetration in China remains low, at 60 cars per 1,000 drivers, annual sales have doubled since FY09 to around 24 per 1,000 drivers," continues Citi.

"This is similar to Brazil levels, and compares with around 40 in Europe or Japan.

"Given development variance between China east and west, this suggests China eastern annualised sales per 1,000 drivers are getting very close to Western levels already - even if the fleet remains small relative to the population."

               Mitt Romney would declare China a currency manipulator

               Source of picture: Wikimeda

By John Richardson

China's practice of providing value-added tax (VAT) rebates for importers of raw materials who then re-export finished goods is the subject of a new US Department of Commerce ruling.

And a leading international trade lawyer has warned that US companies are becoming increasingly impatient with Chinese trade practices in general.

We warned earlier this month that, as the global economy weakened, trade tensions between the two countries could build. 

The VAT rebates apply to chemicals, polymers, fibre intermediates and other raw materials that are imported to manufacture finished goods for re-export.

In other countries with VAT, exporters receive the full refund of VAT paid on inputs.

In China, however, exporters receive varying amounts of VAT refunds, depending on the products involved. Producers of value-added goods tend to get higher VAT rebates, encouraging exports, whereas producers of basic materials get lower VAT rebates, thus discouraging exports.

The selective rebates were reduced in 2007 as part of China's drive to lower dependence on exports while boosting domestic consumption.

But as the economic crisis worsened, China's rebates were increased for some products.

Simon Evenett, a professor at the University of St Gallen in Switzerland, estimates that 71% of Chinese exports were affected by a change in rebates in 2010, compared with just 4% in 2007.

"Given that China's VAT rates vary between 13 percent and 17 percent, and that parts and component imports account for half the value added in many Chinese sectors, even small variations in these rebates can have a big impact on the profitability of exporting," wrote Evenett in an academic paper, which was quoted in this article in the Financial Times.

In 2010, Beijing paid out the equivalent of a fifth of total annual Chinese government spending in VAT rebates, added Evenett, who also runs the monitoring service, Global Trade Alert.

"What's more, all of this is World Trade Organisation (WTO) legal," he said.

In response to the VAT rebate scheme, the US Department of Commerce announced on June 19 that it had changed how it will calculate antidumping duties.

"The department will now deduct the un-refunded VAT from the export price to the US. This, of course, increases the dumping margin because the net export price is lower," said Edmund Sim, partner in the Singapore practice of law firm, Appleton Luff, and an expert in international trade legislation.

"And in anti-subsidy duty cases against China, the US claims that raw materials in China, when purchased from state-owned companies, are subsidised by the state, particularly in the case of some polymers and steel," he added.

"The US Department of Commerce will thus value the amount of subsidy by comparing the Chinese domestic price with the world price for the raw materials.

Dumping, under international trade law, is defined as when a manufacturer in one country exports a product to another country at a price which is either below the price it charges in its home market or below its cost of production.

Winning anti-subsidy, or countervailing, duties involves proving that an exporter has used a tax break, free land or another type of investment incentive intended to support domestic business.

Sim added that in all the cases he had seen, the calculated amount of subsidy was large because the Chinese domestic prices for raw materials were lower than international prices.

"This is the result of the VAT rebate policy discouraging exports of basic raw materials, which increases domestic supply and lowers domestic prices."

This applies to polyvinyl chloride (PVC), where, despite local capacity being well in excess of demand, end-users still import substantial volumes.

"This new US approach effectively targets the VAT refund policy both in dumping and anti-subsidy cases, which can be viewed as double counting," said Sim.

"At some point, therefore, the US will have to drop one of the approaches if the Chinese go to the WTO."

Sim added that he also got the sense that American companies were becoming less tolerant over long-running problems in China, including intellectual property rights protection and cyber attacks which sometimes result in intellectual property being stolen.

"In addition, US companies are complaining more strongly about being denied access to Chinese markets," he said.

"What the US is finding particularly frustrating is that, despite the tremendous improvement in its energy cost position thanks to shale gas, it still feels it cannot sufficiently penetrate Chinese markets."

A further source of tension is the fall in the value of the Yuan against the US dollar by around 1% in 2012, following several years of appreciation. The appreciation, which occurred between 2005 and the start of this year, is also viewed as insufficient by the US.

"We recently had an audience with Mitt Romney's trade adviser in Washington DC," said Sim.

"He confirmed that, yes, on day one of him being President, Romney would declare China as a currency manipulator.

"But this would be a strategy to get China to negotiate rather than a statement of policy. The Obama approach has been to instead ignore the issue," added Sim.

"How would China react? Pragmatically, it might ignore the rhetoric during the first few days of a Romney administration.

"It might then recognise that, despite the change in government, there was still continuity.

"Some of the officials in a Romney administration would likely have also worked for the second Bush administration. Governments like continuity when dealing with other governments," he said.

By John Richardson

OIL prices could fall to as low as $35-40 a barrel or might slip no further than $60-70 a barrel, depending on which analyst you belief.

And we know of one global polyolefins company that is working on the assumption that crude, both West Texas Intermediate and Brent, will trade between $40-80 a barrel in the second half of this year.

What a difference a few months have made. If you remember, back in early Q1 the consensus was that crude, and commodity prices in general, had only one direction to go - and that was up.

Now, though, even Morgan Stanley, of all people, are admitting that the high cost of oil has caused demand destruction, as fellow blogger Paul Hodges has been pointing out for well over a year.

And we have consistently warned that China was at risk of severely slowing down because of structural changes in its economy and we've been proved right. What we didn't predict was the escalation of the Eurozone crisis.

So, if you're a purchasing manager for a chemicals and polymer consumer, why on earth would you want to do anything other than keep your acquisitions to absolute minimum?

As Hodges points out in the slide above, a virtuous circle of buying forward on the risk higher crude has become a vicious circle for the chemicals industry.

The risks to the global economy are also escalating, meaning that any chief financial officer with her or his salt needs to horde cash. 

Soe small and medium-sized companies are also likely to face a funding crisis.

This is all being reflected in numerous ICIS news stories that talk of falling prices down the value chains from crude, resulting in weaker demand.

Here just a few examples:

*Yesterday, Asia's isopropanol (IPA) prices had fallen to their lowest level in nearly six months amid persistently low demand in the key Chinese market and weak feedstock acetone and propylene prices.

*Last week, Asian ethylene prices fell to a two-year low as crude, and of course, naphtha declined, resulting in ample supply.

*And earlier this month in Europe, polyethylene (PE) buyers put their purchases on hold in anticipation of lower July ethylene contract prices.

By John Richardson

THE chart above, from data provided by Global Trade Information Services, further confirms that all hope of any substantial growth in China's commodity grade polyethylene (PE) market during 2012 needs to be given up. Companies, and chemicals investors, should further revise their expectations.

The five percent decline in apparent demand growth (imports plus domestic production) for January-May 2012 over the same periods in 2011 and 2010 is a slight improvement on the six percent fall in January-April.

However, it is a long way from expectations of strong growth during 2012, which was the consensus in early Q1.

In all probability, the best the industry can hope for is flat growth, with quite likely a decline over last year.

Nevertheless, following a slight improvement in pricing last week (our colleagues assessed some grades at $10 a tonne higher, although other grades fell by $10), there has been a moderate improvement in short-term sentiment.

"The market has stabilised in Asia a bit and all we need now is no more bad macro-economic news," said a source with a North American-headquartered producer.

"The Southeast Asians are benefiting from the ASEAN-China free-trade agreement and so are making pretty decent margins. It is the Northeast Asians who are really struggling."

This is again confirmed by the chart above, which shows a 12 percent rise in Southeast Asian exports to China compared with a 39 percent fall in Northeast Asian shipments.

"US prices are lower than those in Asia,"continued the source, as he discussed potential arbitrage to China.

US May contract prices fell by 7 cents/lb ($154/tonne) and June contracts could decline by as much as $7-8 cents/lb, although at least four producers are trying to limit the June fall to only $5 cents/lb.

"I expect a further fall in July by around $5 cents/lb on weaker demand as buyers hold back on purchases because of macro-economic worries," the source added.

But, as yet, he hasn't seen any signs of the anticipated surge in US exports to China as the States tries to regain lost market share: North American Free Trade Agreement exports fell by 58 percent in January-May, as the chart above once again shows.

"I don't think there is any US-China arbitrage at the moment. If you take the cents/lb per pound cost in Houston, including freight and handling charges for linear low-density PE (LLDPE), it comes to around $1,210/tonne and so arbitrage isn't quite there, but it is pretty close," he continued.

China CFR LLDPE prices were assessed at $1,190-1,220/tonne by ICIS for the week ending 22 June, $10/tonne higher than the previous week.

US PE contract pricesBy John Richardson

THE American Chemistry Council's Mid-Year Situation and Outlook Report, which was released this week, helps explain the background to the weakness in demand seen in the US polyethylene (PE) market.

What goes for PE will, of course, apply to the rest of the US petrochemicals business.

In the case of PE, the blog has heard of big inventories among US producers, whereas there is a widespread belief that stocks among Chinese converters are low.

But as HSBC has pointed out, overall synthetic resin inventories among domestic and overseas traders who serve the China market remain high, meaning that the destocking cycle, which began in the first quarter of last year, continues.

So we worry that if the US attempts to raise PE exports in Q3 in order to compensate for their high stocks, including the possibility of big volumes heading to China, the end result could be a price war in a market that is more oversupplied than some people believe.

Adding to this oversupply is confirmation by our colleagues at ICIS news that the 300,000 tonne/year Qatar Petrochemical Co No3 low-density PE (LDPE) came on-stream on 20-21 June.

"In the US, the recovery of key chemistry end-use markets has been mixed," wrote the ACC in its report.

"The manufacturing sector, which is the largest consumer of chemistry, was strong during the early part of the year. It has weakened, however, as export markets softened and because of renewed retrenchment from uncertain households and businesses.

"Despite gains in vehicles and housing, weakness in export markets and domestic manufacturing will likely limit gains in (US) chemical demand," continued the ACC.

(The ACC expects vehicle sales to rise to 14.4 million in 2012 before increasing to a 14.7 million pace in 2013.

"Production of chemicals, excluding pharmaceuticals, has eased as demand from both domestic and export markets have slowed. Improvements in capacity utilisation have stalled as the manufacturing sector cools," said the report.

But in terms of overall US chemical-industry inventories, the ACC estimates that they remain "roughly in balance", and that, therefore, an inventory correction on the scale of 2009 is not expected.

We sense, however, that in many respects we are in a similar place to late 2008, when the global economic crisis began.

Declining oil prices, and the great uncertainty over the global economy, are weighing heavily on chemicals buying patterns. Chief financial officers will want to horde capital in the current climate.

True, there has been, as yet, no sudden and cataclysmic event on the scale of Lehman Bros.

But doesn't the Eurozone's slow train wreck, and widespread failure to predict the degree of slowdown in China, amount to approximately the same thing?

Adding to the caution among chemical producers and buyers must be the possibility of a Lehman Bros-style shock in the Eurozone.

Source: Wang Feng, director of the Brookings-Tsinghua Center for Public Policy in Beijing, from an article published in the China Economic Quarterly.

By John Richardson

ONE of the explanations for China's disappointing petrochemicals demand growth during 2012 is that even where export-focused factories in southern and eastern China can find sufficient orders to run their plants at high operating rates, they are struggling to find enough workers.

Earlier this year, we were told that labour supply had gone beyond a tipping point when millions of migrant workers failed to return to from the countryside to China's cities and towns after the Chinese New Year.

"We have been talking about this type of labour-supply problem for three years, but only now has it become really significant. Workers are remaining in their rural homes because of the success of government efforts to boost income levels in western China," said a senior executive with a global polyolefins producer.

A further factor is the high cost of living in China first-tier cities.

The impact of China's one-child policy is another reason for labour shortages in the south and the east.

And now a survey by the Chinese Manufacturers' Association of Hong Kong, which was released earlier this month, reported that that 90 percent of respondents were struggling to hire workers. Fourteen percent also said that they were short of the number of staff they needed, compared with 11 percent in last year's survey.

"One reason is the Guangdong government's December (2011) decision to suspend a planned increase in the minimum wage," wrote the Financial Times in a post on its Beyond Bricks blog.

"At the time, that decision was cheered by factory owners who were already struggling to cope with a 21.2 per cent rise in minimum wage imposed in 2010," continued the post. 

"The flip side is that even fewer migrant workers now feel it's worth their while to work in the province, where the cost of living is among the highest in the country."

What is China's loss in low-value manufacturing is often said to be the automatic gain of countries such as Indonesia and Vietnam.

But as Stephen Moore, director of the Singapore-based chemicals and plastics consultant Interdecent Asia, points out, "re-shoring" away from China is more complicated for manufacturers than it at first might seem.

"The plastic toy industry is, for instance, pretty much stuck in southern China because the design and manufacturing is also located there," said Moore.

"Most of the design and manufacture of toys is located in Guangdong province, which means that the process of getting toys to market is highly integrated," he added.

"This makes it more difficult to easily shut down production and move to a lower-cost country, even though it now costs $400 a month to employ a manual worker in China, compared with less than $200 in Indonesia. Five years ago, labour costs in China were also less than $200 a month."

He said that many toy manufacturers were family-owned and their founders were reaching retirement age, and so they didn't want the upheaval of relocating production.

"Also, many of their sons and daughters, who are probably wealthy enough never to have to work, are not interested in continuing in the family business, which is adding to the inertia," he continued.

The footwear industry was very different, making it much easier to shift production to other countries such as Indonesia and Vietnam, he added.

"The reason is that when labour costs became too high to manufacture shoes in Taiwan and South Korea during the 1980s-1990s, production was shifted to China, but design remained in Taiwan and South Korea," said Moore.

"As a result, in theory it is pretty easy for the Taiwanese and South Koreans to not renew a contract with a contract manufacturer in China or shut down their own plants there and shift production to, say, Indonesia or Vietnam."

The footwear industry has been the subject of numerous media reports detailing the big shift in manufacturing away from China, but Moore said that it was important to keep the real extent of the manufacturing migration in context.

"In 2010, which is the latest figures we have available, 7.6bn pairs of rubber and plastic shoes alone were made in China (this includes training shoes)," he added.

"This compares with just 380m pairs in Vietnam, 5% of the total in China. Indonesia is the world's second-largest exporter of training shoes, but it probably made around 10% of the total number of plastic and rubber shoes as China in 2010."

The plastic toy and footwear industries in China are major consumers of domestically produced and imported chemicals and polymers.