Asian Chemical Connections

European LDPE spot prices at their lowest level since January 2010 

By John Richardson

THE EU Summit results might have bought a little more time, but as John Authers points out in this article in the Financial Times, "the result was the latest politically driven bounce for risk markets (including crude-oil prices and equities), continuing a pattern that has persisted for 30 months, since Greece's crisis erupted in early 2010."

In other words, initial euphoria, creating an opportunity to make quick profits from a commodity and equity markets bounce, will give way to sober reflection and the realisation that the summit has, essentially, solved nothing.

At the core of the problem, adds Authers is that "moves to pool borrowing and banking regulation among the Eurozone members, which would solve the crisis, continue to require the kind of ceding of sovereignty that could take years to negotiate, and that electorates may not accept."

He further points out that government finances continue to be weakened by austerity policies and Greece remains at risk of bankruptcy.

As the dust settles on the summit, it will be interesting to observe whether the European chemicals industry trade group, Cefic, sincerely feels that significant progress has been made.

In a strongly worded letter to EU leaders, which was published last week, Cefic wrote: "Only a more united and integrated Europe, with a common currency, will provide future generations with peace and prosperity. We look to you now for clear leadership."

It asked politicians, "to pursue the deeper integration of Europe; to undertake structural reforms to boost growth and employment; to establish a budgetary union, based on sound national accounts and integrated control of public finances; to begin a gradual harmonisation of fiscal policy."

A tall order, indeed, and one that, as Authers says, could take years to fulfil, if it can be fulfilled at all, during which time the EU economy will continue to struggle.

Why would chemicals companies remain anything but extremely cautious  in the current climate?

Evidence of the impact of the Eurozone crisis came in Cefic's mid-year report, released on June 14. The trade group says that chemicals output growth will be at a standstill in 2012 after a weak 1.3 percent gain in 2011.

And it adds that chemicals output will be stuck 5 percent below the 2007 peak for the rest of 2012 with only 2 percent growth next year.

It expects petrochemicals production to grow by 1.0 percent in 2012 following a 0.9 percent decline last year. It forecasts no growth for polymers following a drop in output of 0.2 percent in 2011.

In a reflection of the weak polymer markets, European low-density polyethylene (LDPE) spot prices last week fell to their lowest level since January 2010, according to ICIS news.

By John Richardson

Getting on with politicians is always pretty useful for doing business anywhere.

And in China right now, it is a case of working key relationships with the right set of senior politicians who are set to take control of the Politburo later this year, after the once-in-a-decade leadership transition has taken place. Xi Jinping (see picture on the right) is, for example, expected to become the country's new president.

It is also important to be aware of the political sensitivities surrounding the leadership transition, and to be supportive of government policies that are likely to remain in place regardless of who takes charge of the Politburo.

Chemicals and polymer companies need to not only be successful in working the politics themselves, but must also align their sales and marketing efforts with the right set of customers. This was evident from a discussion the blog held with a senior polyolefin industry executive.

"There is a group of converters run by people who moved off the land in the 1950s-1960s and attended university, thanks to educational reforms," he told us.

"They started out life with very little and now they have built absolute fortunes - some of them are literally billionaires.

"They have been told, in the clearest possible terms, that they must give back to society in order to help keep the Communist Party in power.

"This involves visiting their rural home towns in order to act as role models, to show people 'this is what can be achieved under the current system'. They are also required to donate money to fund local schools, infrastructure etc.

"These companies are successfully playing the game and, as a result, receive discounted land, tax breaks and other financial benefits."

The owners of these companies, in order to win government support, must also guarantee that they won't move their wealth offshore to Hong Kong, Singapore or elsewhere, he added.

"Capital flight has become a major concern of the central government. Many of the super-rich have been shifting their wealth overseas because they are worried about where their relationships will stand after the leadership transition," he said.

Surveys released last year by rich list publisher Hurun Report and Bain & Co, the management consultancy, both estimated that 60% of about 960,000 Chinese people with assets of over Rmb10m ($1.6m)) had already begun the process of emigration or were considering doing so.

By John Richardson

THE "luxury end" of China's polyethylene (PE) market is being heavily targeted by overseas producers and the results so far have been pretty spectacular, according to one of the producers.

"The annual growth in demand for higher value grades has been tremendous - two times GDP," said a senior executive with this producer.

"What we are, in effect, doing is destroying commodity demand by going to a processor and explaining the value of what we do," he added.

"As people get wealthier in the southern and eastern provinces, they are demanding higher-value packaging material, just as some rich people are moving from buying Hondas to BMWs."

He believes that the potential for further growth is very good as only 7-8 percent of China's total PE film market comprises what he categorises as higher-value packaging material, compared with 75 percent in the US.

But there are risks for companies who focus too heavily on the luxury end of the PE market, as is also the case with other "differentiated" polymer and chemical producer.

(It is very important to stress that this does not apply to the PE producer we have referred to above. It has put in place a strategy to profit from all segments of China's market and much of the thinking that follows is thanks to this company.)

The risks include China's annual GDP growth falling to as low as 3 percent over the next decade or more because of the difficult transition from an investment to a domestic-consumption driven economy.

China's growth could also fall well below most companies' base-case scenarios due to the disastrous impact of China's one-child policy.

In a later post, we will also explore how a slowdown in urbanisation, due to the one-child policy and other demographic factors, threatens comforting assumptions about China's economy.

If growth slows then, of course, so will the increase in per capita income levels.

Another issue, which we discuss in chapter 6 of our e-book, Boom, Gloom & The New Normal, is that the vast majority of Chinese remain exceptionally poor by Western standards.

Middle income in China is people who earn just $2/day-$20/day. The rich are those earning over $20/day, and are just 4% of the population.

And as the chart above illustrates, per capita consumer spending in China, and in other developing countries, was way behind Western levels in 2010.

Even in the best of economic circumstances, therefore, it would take many years for luxury goods markets to approach the size of those in the West.

Evidence for this view emerged in a Citi report released last month on autos.

"Interestingly, although 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," wrote Citi.

"This is similar to Brazil levels, and compares with around 40 in Europe or Japan. Given development variance between China's 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."

The bigger opportunity in China, and in other developing countries such as India, is the hundreds of millions of people, who, for the first time, are earning enough money to be able to afford basic, low cost consumer costs.

Only in their wildest dreams do these hundreds of millions of people picture themselves owning a Honda, let alone a BMW.

In reality, they are only ever likely to own a motor scooter.

By John Richardson

POLYETHYLENE (PE) and polypropylene (PP) offer prices were reportedly on the rise across Asia earlier this week on increasing geopolitical tensions over Iran that led to a hike in crude prices.

"Butene-grade linear-low density (LLDPE) offers have increased by $40-50/tonne," said a source with a major producer.

September LLDPE futures contract prices on the Dalian Commodity Exchange also increased on Wednesday in response to the Tuesday rise in oil prices.

This all followed a very slight uptick in pricing for the week ending 29 June. For instance, some grades of PP edged up by $10-30/tonne, according to ICIS, as this slide illustrates:

But as the source wisely pointed out, "We should make hay while the sun shines as I don't think it will last."

In the case of oil, for instance, the rally was very short-lived: By the end of trading on Wednesday, prices had fallen back again as traders once again focused on the grim economic backdrop.

The news from China also continues to deteriorate. Only Yuan700bn of new loans were likely issued in June compared with earlier estimates of Yuan1trillion. Lower-than-expected borrowing was the result of lack of demand for credit, even though the supply and affordability of financing has improved.

Lending growth has also been slowing down in 2012.

Reports of disappointing demand for loans came at the same time as the release of the China HSBC services purchasing managers' index for June. The index fell to 52.3 from 54.7 in May,  with services firms growing at their slowest pace in ten months.

Meanwhile, unconfirmed reports suggest that the Saudi Polymers plant has come on-stream. This comprises two 550,000 tonne/year high-density polyethylene (HDPE) plants and a 440,000 tonne/year polypropylene (PP) facility.

And in June, QAPCO brought its 300,000 tonne/year low-density PE (LDPE) facility onstream.

By John Richardson

SOME commodity chemicals companies still assume that, if they build new supply, demand will always eventually catch up with supply.

The risks of not building new capacities, at times of easy financing and feedstock availability, are also viewed as too great. These include deteriorating economies of scale and loss of market share.

Thus in the US, for instance, the American Chemistry Council estimates that around $25bn (€20bn) is being invested in about 30 expanded or new US production facilities.

Companies are often also at the mercy of events because of their failure to predict major shifts in supply and demand dynamics. For instance, the current global tightness in butadiene appears to have caught producers by surprise.

A lot of money can be made or lost through sheer luck, therefore. To again use butadiene as an example, $10bn in earnings before interest, taxes, depreciation and amortisation (EBITDA) were transferred from the world's butadiene consumers to its suppliers during 2011, estimates Rafael Cayuela, butadiene commercial manager for Styron, the global plastics, latex and rubber producer.

Because the industry has always been run in this way and because, as the example above illustrates, this reactive approach can deliver outstanding profitability, the risk of inertia is substantial.

Speciality chemicals companies such as BASF and Bayer Material Science (BMS) are very different. For several years, they have been developing new processes and products to serve what they predict will be the major demand drivers over the next 30 years or more.

These new demand drivers are the megatrends: ensuring there is enough food and water to sustain global growth, the impact on economies and societies of changing demographics, such as ageing populations in the West and the impact of China's one-child policy, and the need to reduce carbon footprints.

Commodity chemicals companies argue that this only applies to the likes of BASF and BMS because they are "innovation" companies and so must constantly develop new products for new markets.

BASF and BMS also benefit from the somewhat more patient and longer-term approach of European investors compared with those in the US.

Further, neither of these two European majors have access to low-cost feedstock. Basic commodities, therefore, make no strategic sense for them and for other speciality players in a similar position.

And unlike the constant innovation that is taking place in specialities, the last commodity polymer to be invented was linear low-density PE (LLDPE) in the late 1950s (LLDPE didn't gain widespread commercial acceptance until the early 1980s). Old, well-established products encourage adherence to old and well-established ways of running businesses.

But the megatrends are reshaping the global economy and so have huge implications for chemicals companies in both the commodity and speciality sectors.

For example, 272m Westerners are now over 55 years (29 percent of the population), according to UN population data. Further GDP growth will be limited by reduced spending as people save for their retirements.

And the one-child policy in China will result in the ratio of workers to retirees (presuming workers continue to retire at 60) dropping from roughly 5:1 today to just 2:1 over the next 20 years, says Wang Feng, director of the Brookings-Tsinghua Center for Public Policy in Beijing. Between 15-25 percent of the country's 1980-2010 GDP growth was the result of a favourable age structure, he adds.

Commodity chemicals companies need to accept that building capacity on the assumption that demand will always catch up with supply no longer works.

In our Monday blog post we will discuss these megatrends further and provide examples of how companies can proactively develop new markets using polymers that were invented many decades ago. New applications do not necessarily require new products.

Instead of being reactive to market fluctuations in demand beyond their control, companies will thus be able to create and virtually dictate levels of demand.

Source of picture: BBC

By John Richardson

By 2050, the world's 10 biggest river basins by population are expected to produce a quarter of global GDP, according to a report commissioned by HSBC, which was released in June.

The figure is greater than the combined future economies of the US, Japan and Germany - and would a be sharp increase from a current contribution of a tenth,

Seven in 10 of these river basins face significant or severe water scarcity by 2050 without a considerable improvement in water resource management, the reports adds.

Respondents to the World Economic Forum's latest Global Risks Survey consider a water supply crisis to be the most likely and most severe societal risk for the next ten years. Governments are increasingly acknowledging that unsustainable water usage constrains economic growth.

And In China, the World Bank estimates that water-related inefficiencies may already be curtailing GDP growth by over 2 percent.

As we discussed on Friday, guaranteeing sufficient water supply to maintain the health of the global economy is just one of several megatrends that present an opportunity, as well as a threat, for the chemicals industry.

The other megatrends are ensuring sufficient supply of food to maintain growth, the impact on economies and societies of changing demographics, such as ageing populations in the West and the impact of China's one-child policy, and the need to reduce carbon footprints.

Commodity as well as speciality chemicals companies have an opportunity to tap into these megatrends and thus virtually dictate demand growth.

The alternative is to sit back and hope in vain for the world economy to return to where it was before the Babyboomers started to retire in record number, and before the growth in emerging markets, such as China, became a great deal more uncertain.

The companies need to also proactively develop new markets, often using chemicals and polymers that were invented many decades ago. New applications do not necessarily require new products.

In the case of water, cotton production alone accounts for more than 3 percent of all agricultural water use. Traditional cultivation processes such as field flooding are obvious targets for reducing water use.

This challenge has led to the development of a programme organised by the Better Cotton Initiative and including companies such as Levi Strauss, to provide technical know-how to Indian farmers.

Over three years, this has enabled a 32 percent drop in the use of water and pesticides. The farmers' profits are 20 percent higher as a result, thus also helping to stimulate economic development.

The key is to use drip irrigation systems, essentially plastic veins that can direct water to each plant's root system.

This not only spreads water and fertilisers more evenly than traditional pumping, but also means less water is available to encourage weed growth around the plants.

In addition, electricity consumption is reduced, as drip irrigation requires less pumping.

These plastic pipes, the demand for which could be huge, are made out of good old fashioned polyethylene (PE).

By John Richardson

A management consultancy has gone on the record to warn about what the blog has been warning about for months: That the US petrochemicals industry is in danger of pushing itself into oversupply.

KPMG, in a report released late last month, said that the success of planned US expansions, including as much as a 33 percent addition to existing ethylene capacity by 2017-2018, was almost entirely dependent on the ability to export.

"Failing that, the US [chemicals] market is destined to fall back into the historic cycle of oversupply followed by rationalisation," said KMPG.

"This (need to focus on exports) will require a significant transformation of operating models for US chemical companies who have traditionally been focused on the US marketplace," it continued.

"Success in the emerging markets will also require a very sophisticated understanding of the pros and cons of each individual market. This must include considerations such as growth prospects, business environment, infrastructure maturity and tax implications, as well as a slew of regulatory and legal considerations such as investor protection, contract enforcement and ease of doing business."

As we discussed last week, successfully navigating the China market requires an intimate understanding of the needs and objectives of customers.

One senior business manager we know has built-up this understanding over more than 20 years.

He has stayed close to customers who he has watched, and helped, grow from small businessmen struggling to survive to multi-millionaires, and even billionaires. Such relationships matter as much, if not more, than technical service and the ability to compete on price with the lowest-cost producers.

Sure, many US producers have vast experience in selling into markets such as China.

But will they have enough of the right people in place to deal with the large volume of ethylene derivatives that will likely have to be exported?

In addition, building capacity on the assumption that demand will always eventually catch up is no longer the right approach, given all the macro-economic uncertainties, as the senior business we referred to above told us in a recent discussion.

He said: "China's economy could go either way. Contradictions in the system could tip it the wrong way - including the local authorities that don't want the system to be reformed because they make money from land sales, and the state-owned enterprises that get preferential loans.

"For petrochemicals, this means that all the projects being planned in the US should and hopefully will not go ahead.

"There are too many uncertainties over China for every company to take the risk, and if they do all commit to their planned investments, by 2016-17 we are going to see a big oversupply problem.

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

Ben Bernanke. Source of picture: Wikipedia

By John Richardson

OUR next three blog posts will examine some of the threats to a recovery in China's chemicals and polymer demand growth over the next 12-18 months.

We will look at:

*Debt. Is China already confronting a Ben Bernanke moment? (In November 2007, the Fed chairman told Congress that estimates that set the total losses from US subprime mortgages at about $150bn were probably "in the ballpark".)

*Deflation. Only a few months ago we were talking about the inflation threat in China. Now the concern is over deflation as a disincentive to consumer spending and investment. What latitude might deflation give to the government to re-stimulate the economy, given the counter-pressures of debt and the economic reform process?

*Will China export deflation in response to overcapacity in some of its domestic industries, creating further international trade tensions? Tensions are already on the rise, as a result of China's competitive devaluation of the Yuan during 2012, which late last year we warned was a possibility, and its VAT rebate policy.

*Politics. What are some the scenarios for government policy post-October, following the leadership transition, and what could these outcomes mean for the medium-term future of China's economy? BASF flagged up some of the uncertainties surrounding the leadership transition in June. 

This is, of course, not all-inclusive list (we would have to be amazingly arrogant to pretend otherwise) and our coverage of each of these issues can only scratch the surface, as China has now reached a VUCA stage (Volatility, Uncertainty, Complexity and Ambiguity).

In the past, to a large extent, all you needed to be successful as an exporter was to hand over your chemicals and polymers to a trader and they would be guaranteed to sell every molecule at decent margins. The only real debate was the size of positive demand growth as a multiple over GDP growth.

This is no longer the case.

In the first of a series of blog posts on the major challenges facing China's economy over the next 12-18 months, we look at bad debts.

High stakes in Hangzhou. Source of picture: Wikimedia  

By John Richardson

A fascinating blog post by Patrick Chovanec makes this very worrying observation about China's bad debt problem:

"The web of interlocking, often incestuous, and sometimes circular credit arrangements is reminiscent of Wall Street in the lead-up to the subprime crisis, in which a relatively small amount of mortgage losses, which most people believed could be contained, triggered a chain reaction that brought down major banks and froze credit across the entire global economy."

He is referring to "credit guarantee companies" that are in danger of collapsing as a result of the slowdown in the real-estate sector.

Chovanec's analysis focuses on a "mini financial meltdown" in the city of Hangzhou where 62 companies, from furniture makers to import-export traders, have been affected by the collapse of the property developer, Tianyu Construction Co.

He makes the point that these circular credit arrangements extend well beyond Hangzhou to many other cities and towns.

And he adds that even if everyone in Hangzhou is eventually bailed out by the amply-funded central government, companies with almost no access to working capital or investment funds will no longer be contributing to GDP growth.

"Bailouts, when they do happen, don't make losses go away, they just impose them on someone else - the drag on growth remains," he writes.

This could well apply to many of the small and medium-sized enterprises which make up most of China's chemicals and polymers buyers.

"For the past several years, higher property prices led to more lending, which led to even higher property prices (and more and now less chemicals demand) and onwards and upwards," he adds. 

"Now that the market has turned, lower property prices are undermining the basis for both past and future lending, and shutting down China's engine of investment-led growth."

Premier Wen Jiabao reiterated over the weekend that China must "unswervingly" continue to implement property controls to stop prices from rebounding. He is also in favour of changes to real estate taxes and wants to set up a long-term policy to control the property market, said the official Xinhua news agency.

"Tianyu was one of a handful of relatively small real estate developers that were allowed to go bankrupt recently, presumably because they weren't seen as worth rescuing," continues Chovanec.

"Yet allowing even that small thread to be pulled unraveled a whole web of credit relationships that put numerous banks and businesses in danger. Now think what could happen if a developer like Evergrande (one of China's ten largest, which was recently accused of hiding the fact that it is actually insolvent via massive accounting fraud) went bust."

One can take comfort in official data that suggests that China's bad debt problem is containable.

But can you trust the data?

Even the accuracy of electricity statistics, widely viewed as one of the few reliable measures of economic growth in China, is being questioned by HSBC and Standard Chartered.

And as Chovanec points out, just as was the case with sub-prime in the US, it is not just the data that counts, but also the hidden interconnections.

The second of our series of blog posts on China's economic challenges over the next 12-18 months focuses on deflation.

By John Richardson

DEFLATION has now become a major concern for the Chinese economy following the release of official data earlier this week that showed a 2.1 percent decline in producer prices in June compared with the same month last year. Month-on-month, producer prices fell 0.7 percent.

And June consumer prices were 0.6 percent lower over May, the largest month-on-month decline in two years.

"This reflects what our customers in China have been telling us for several months now," said a source with a global PE (see our foot note on current PE pricing trends).

"While they have seen their costs increase as a result of higher wages and, until recently, more expensive fuel costs, they have been losing pricing power because demand is weak as plastic-product markets are oversupplied."

This article in the New York Times points out that deflation:

*Makes it much harder for businesses to sell enough goods to repay loans that they took out, usually on the expectation of rising prices, potentially making worse the bad-debt crisis we discussed yesterday.

*Falling prices also discourage investment, which has also slowed sharply over the last few months, and give consumers an incentive to delay purchases until prices fall further.

Deflation has raised the hope that the Chinese government might launch further economic stimulus.

But Wen Jiabao reiterated at the weekend that controls on the property market will stay in place, and could even be stepped up. The government cannot afford to allow the gap between the super-rich, and the rest of China, to continue to widen.

In addition, a big new stimulus package could easily result in a return to inflation. The big worry is a resumption of food-price inflation in a country that remains very poor by Western standards.

In an excellent post earlier this week, fellow blogger Paul Hodges makes some very valid points about the long-term implications of rising China auto exports.

More immediately, as China's auto and other manufacturers struggle with deflation, the temptation will be to increasingly export their surpluses at aggressively low prices. This could result in an increase in international trade tensions.

Another article in the New York Times (see above chart) says that China's auto exports rose by 21 percent in the first five months of this year over the same period in 2011. May year-on-year exports rose 43 percnet. 

Asian PE Prices

Last week, we said that Asian PE prices could be on the rise. This was confirmed by ICIS, which assessed pricing for the week ending 6 July at $10-60/tonne higher. (polypropylene prices were also $20-50/tonne higher).

"I doubt if this will last as this is mainly a result of stronger inter-trade buying," added the source with the global PE producer.

And, indeed, yesterday the important gauge of short-term sentiment, the Dalian Commodity Exchange's futures contract in linear low-density PE (LLDPE) fell by 1.05 percent.

The blog, sadly, remains of the view that PE demand growth in China will likely be in minus territory this year. What applies to PE applies to many other chemicals and polymers.

In the last of our series of blog posts on some of the major challenges facing China's economy over the next 12-18 months, we look at politics.

By John Richardson

THE outcome of the battle over China's economic direction is, of course, of crucial importance to the world economy.

It would be comforting to assume that all you have to continue to do to predict chemicals demand growth in China is to gather and input historic data into a spread sheet and trust that this largely reflects what is going to happen in the future.

The "big picture stuff" is quite often ignored because thinking through and compiling scenarios based on different political outcomes is an immensely complex, difficult, uncomfortable and even risky process.

Thus it is easier to ignore the bigger picture on the assumption that China's politicians "always get it right".

But, as the country approaches its once-in-a-decade leadership transition, which takes place from October this year, there is a huge risk of China getting it wrong.

Chemicals companies must, therefore, do this kind of analysis, as BASF indicated in June.

Major economic reforms, vital to wean the country of a wasteful addiction to investment, may fail if politicians follow the path of least resistance. Implementing the reforms outlined in the extremely ambitious 12th Five-Year-Plan (2011-2015) would involve tackling well-entrenched "vested interests", such as the state-owned enterprises (SOEs) and many of the politicians themselves who have benefited from corruption.

In February, the World Bank, in a major report on China warned: "China's growth is in danger of decelerating rapidly and without much warning. That is what has occurred with other highflying developing countries, such as Brazil and Mexico, once they reached a certain income level, a phenomenon that economists call the 'middle-income trap'. (see the above chart on the middle income challenge, which we also discuss in chapters 6  and 12 of our free e-book, Boom, Gloom & The New  Normal). 

The report outlined reforms that need to take place, including a transparent financial sector (no more 'soft loans' for favoured SOE projects) and more innovation in areas such as green energy.

It therefore seems very worrying that Beijing's response to the global economic slowdown has involved sanctioning more industrial capacity, including in the already oversupplied steel sector.

This might deliver a short-term boost to growth through, for example, more jobs in building these factories, but adding to oversupply will likely increase bad debt and deflation problems, while raising international trade tensions.

Another risk is that China will be tempted to take the brakes off the housing sector, in response to an ever-weaker world economy.

This would further add to bad debts when the re-inflated real-estate bubble eventually goes pop. It would also widen the gap between the rich and the poor, thus undermining another key part of the 12th Five-Year-Plan, and would represent a major threat to social stability.

The current leadership might be just playing for time by doing just enough to get to the end of their terms in office without major mishaps, suggests fellow blogger Paul Hodges.

This would place a great deal of pressure on the new leaders to press ahead with reforms, assuming that they are so minded.

OUR last four blog posts have focused on some of the big challenges confronting China's economy over the next 12-18 months.

Today we again switch our focus to how major changes in demographics could adversely impact longer-term growth prospects.

By John Richardson

CONTINUING high rates of urbanisation are constantly cited by chemical industry executives as a reason to be bullish over China's long-term demand-growth prospects.

But urbanisation appears to be slowing down as a consequence of the huge shift that has already taken place of China's rural population to its towns and cities.

"The number of workers migrating from the countryside to the cities peaked at 18m in 2008 and has averaged around 14-15m a year in the ten years that we have the data for," said Dr Clint Laurent, general manager of Global Demographics - the Hong Kong-headquartered demographic and socio-economic forecasting service.

"The big surge in migration has involved 15-34 year olds as this age group has moved from planting rice to earning three times as much in the cities and the towns," he added.

"This has decimated rural communities, dramatically reducing their fertility rates and therefore the number of new 15-year-olds coming through.

"As a result, the rural-urban migration will fall to just 4 million by 2032 - an insignificant number in a workforce the size of China's."

The disastrous one-child policy is China's much-bigger demographic challenge.

"China needs to make the right policy choices in order to compensate for its one-child policy. There is, of course, a risk that it will make the wrong decisions," continued Laurent.

One of the big challenges will be to meet the pension, and healthcare, liabilities of a rapidly ageing population.

"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," wrote Wang Feng, director of the Beijing-based Brookings-Tsinghua Center for Public Policy in the June 2012 issue of the online economic research publication, the China Economic Quarterly.

"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," he added.

Between 15-25% of the country's 1980-2010 GDP (gross domestic product) growth was the result of a favourable age structure, he said.

"As China's demographic fortunes reverse, the economy will slow down regardless of other factors driving growth," continued Wang.

And as Laurent also points out, chemicals and other companies need to respond to the changing nature of demand resulting from China's huge demographic shift.

"If you're the marketing director of Coca-Cola, Nike, Pepsi and Disney, or any other child brand, you have a problem over the next decade as the size of the market is going to shrink," he said.

This also applies to the chemicals and polymer companies that supply raw materials to companies such as Coca-Cola, Nike, Pepsi and Disney.

As the population ages, there will also be a surge in demand for health and wellbeing products, added Laurent - creating a big opportunity for the chemicals industry.

Source of graph: http://thinkprogress.org/ 

By John Richardson

DANIEL Yergin's superb book, The Prize, describes how the history of the 20th century was shaped by oil and gas.

Now we are entering a new era.

Some 600,000 jobs have already been created by the US shale and oil gas revolutions, leading to hopes of a much more broad-based US manufacturing revival, including in petrochemicals.

In 2008, the US imported 60 percent of its oil for vehicles and industry. Imports have since fallen to 45 percent, largely because of the shale oil boom, according to this excellent article in The Australian newspaper.

Oil production has increased by 1.3 million barrels a day in three years, more than double that of Russia.

And an even bigger prize is being eyed, to add to the abundance of hydrocarbons emerging from shale gas fields such as the Marcellus in West Virginia, New York State and Pennsylvania and the Bakken shale oil formation in North Dakota, continues The Australian.

This is the "Green River Formation" which stretches across Colorado, Utah and Wyoming and represents the world's biggest shale oil formation.

About half the deposit could be extracted - 1.5 trillion barrels of oil - according to the US-based research group, the Rand Corporation, which was quoted in the same article in The Australian.

This is equivalent to the world's entire proven oil reserves, creating discussion that the US might become energy independent in 15 to 20 years.

"In collaboration with Canada and Mexico, the US could - and should - forge a broad pro-development, pro-export policy to realise the benefits of our hydrocarbon resources," writes Mark Mills from the American think tank, the Manhattan Institute.

Greater access to energy might lead to an overall US economic recovery. It could also reshape geopolitics through reducing the US dependence on the Middle East, including a change in its relationship to Saudi Arabia, which, as Daniel Yergin pointed out in The Prize, helped shape 20th Century history and politics.

But the US might easily squander its energy bonanza through failing to use cheaper oil and gas as the basis for a wider manufacturing revival (the "Dutch Disease"). We discuss some of the policy challenges confronting the US in chapter 10 of our free e-book, Boom, Gloom & The New Normal.

A parallel with what might happen in the US is already happening in Australia through its government policy, or lack of policy, regarding its natural-gas reserves.

Dow Chemical Australia and New Zealand managing director, Craig Arnold, highlights some of the problems facing Australia and natural gas in this article.

This blog post cannot, of course, come close to covering every potential outcome of the new energy revolution.

But here are four more thoughts:

*Other countries have big shale gas reserves, including Europe and most notably China. BASF said last week that subtantial development of European shale gas reserves could be as long as a decade away. But China has the capability of surprising everyone by pressing ahead with exploiting its shale gas reserves, if it feels its economic and geopolitical position is under threat. Prospects for shale oil outside the US are the greatest in again, China, Russia and Argentina.

*Overcoming technological challenges will play a pivotal role. In the US, for example, the Green River Formation confronts the difficulty that the bulk of material being extracted from its wells is kerogen. This requires expensive heating treatment to yield small amounts of commercially useful oil and gas. In China, Peter Voser, CEO of Shell, highlighted in June that much of China's shale-gas reserves are geologically challenging.

*Access to technology will therefore be crucial and could become a highly sensitive political issue with broader implications for international trade relations. Politicians might come to believe that avoiding"Dutch Disease" involves barriers to technology transfer.

*The environmental challenges surrounding fracking will continue. But we think that money and jobs will always overcome most environmental objections.

By John Richardson

THE economic slowdown throughout Asia became more apparent last week with the release of disappointing data, prompting interest rate cuts in China, Vietnam and South Korea.

China's key polyethylene (PE) market responded as trading volumes fell and sentiment weakened for the week ending 13 July, according to ICIS.

Market participants, however, expressed hope that in the case of China, the economy had bottomed out following the release of first half GDP growth of 7.6 percent.

But:

*Can anyone trust that 7.6 percent was the real number, given that Chinese officials are encouraged to under-report growth during boom times and over-report GDP when the economy is struggling? "Out of the black box comes a number, and that number doesn't always line up with the other numbers," Andrew Batson, Beijing-based research director at macroeconomics consultant GK Dragonomics, told Bloomberg. "I wouldn't be surprised if the GDP numbers this year are smoothed," he added. 

*Electricity consumption is seen as a much more reliable measure of real economic activity. The chart above shows that it rose by only 7 percent in H1 this year over 9 percent during the same period in 2011. 2010 growth was 21 percent, at the height of the economic stimulus package.

*Bank lending jumped by 16 percent in H1 as the government attempted to re-stimulate the economy, as the above chart again shows. But, as we have discussed over the last week, this could add to China's bad debt and deflation problems. And it seems likely that most of the lending has been taken up by the big corporations. The small and medium-sized enterprises, which make up the bulk of China's chemicals and polymers buyers, seem hardly in a mood to lend. This is the result of rising labour costs, less labour supply, weak exports and now the pressure from deflation.

Graph prepared by the http://www.thegatesnotes.com/Personal/2012-Annual-Letter

By John Richardson

RISING food prices resulting from adverse weather conditions in the US, South America and Russia represent yet another threat to global economic growth.

Grain prices could, for instance, increase by as much as 25 percent this year, warns Danske Bank.

Dry weather in the US has hit corn and soybean crops, and the drought has been particularly bad in the mid-west corn belt.

La Nina has reduced South American harvests.

Simultaneously, dry weather in the Black Sea region has raised fears of a repeat of the 2010 wildfires that destroyed large parts of the Russian wheat crop.

The good news is that wheat and rice harvests in China look set to be good.

But a problem, of course, is that agricultural commodity prices are set globally.

Extreme volatility in food prices, driven to some extent by speculators in futures market, will also remain a permanent feature of the global economy.

The speculators are also to blame for the dysfunctional nature of crude-oil markets.

For the chemicals industry food represents an opportunity, as well as a threat, as we outline in our e-book, Boom Gloom & The New Normal.

The industry has the opportunity to apply existing products, and to develop new products, which can meet the challenge of providing enough food to sustain healthy global growth - one of the four megatrends.

The threat comes from, as we have described, the damage to growth caused by sudden increases in the cost of food, particularly in developing countries, as the chart above illustrates.

The vast majority of people in developing countries are very poor by Western standards and so spend a big proportion of their incomes on food.

Every time food prices increase, this damages chemicals demand growth. The reason is that millions of low-income earners are forced to reduce their spending on the basic consumer goods that they can just about afford to buy in the best of economic times.

This year's surge in the cost of food further illustrates that we live in a VUCA world in which investment in innovation is crucial for chemicals companies. They can thus help dictate their own patterns of demand.

Mind the gap - India's rich and poor

Source of graph: http://www.business-standard.com/india/news/sonalde-desai-the-great-indian-poverty-game/469351/

By John Richardson

INDIA'S economy is expected to grow at its slowest pace for a decade as a result of political gridlock, tight monetary policy and the weak global economy, according to a Reuters' poll of economists.

As we discussed in March, when the economy was beginning to show signs of serious stress, many of the small and medium-sized companies and the "one man bands" that make up a big proportion of India's chemicals industry had not suddenly become overly negative. The reason was that they had not in the first instance been taken in by all the hype immediately following the Congress Party's re-election in 2009.

But sober long-term expectations are often not the best way to make money in financial markets and thus, India, along with China Russia and Brazil, was part of the "BRICS Version 1" story.

BRICS Version 1, which made some people a lot of money, failed to take into account:

*Unsustainable growth rates. India, as is the case with China, is struggling to deal with the economic distortions left over from its boom years, including the high inflation rate that has made the Reserve Bank of India very reluctant to cut interest rates.

*Failure to address underlying economic weaknesses. In India's case they include poor infrastructure and the huge incomes gap between the rich minority and everyone else.

"I think we need to replace the 'I' in the BRICS acronym with Indonesia," only half-joked a senior Indian petrochemicals industry executive recently.

In all seriousness, chemicals companies do need to work on "BRICS Version 2" in order to prosper in India and elsewere.

India's Version 2 probably nvolves accepting that political impediments to growth might never be resolved and that, therefore, recent GDP growth rates were the exception rather than the norm.

Version 2 also, without doubt, involves the realisation that behind the catchy headline, "India's booming middle classes", is a story of extreme price sensitivity among the vast majority of Indians who are likely to remain very poor by Western standards for many years.

Well-established players in the Indian market, who as we said didn't get carried away by all the hype beyond, perhaps, skilfully playing financial markets, have been running their businesses on Version 2 for decades.

By John Richardson

DEMAND remains "very weak" in China's polyolefins markets, said a sales and marketing executive with a major Western producer.

"I am having real trouble justifying higher prices to my customers, which are partly the result of naphtha having risen in line with stronger crude. What they cannot understand is why crude should be strong when the global economy is so weak."

We shall examine the subject of what's driving oil prices in another post later this week. Suffice to say here that the increases have little to do with the fundamentals of demand.

Another factor behind higher olefins, and therefore polyolefins, pricing has been a temporary reduction in olefins supply, according to my ICIS colleague Peh Soo Hwee in this article.

"Ethylene and propylene spot prices in Northeast Asia had been on the rise following the 20 June power outage at Taiwanese producer Formosa Petrochemical Corp's (FPCC) Mailiao complex," she wrote.

"However, FPCC's 1.2m tonne/year No 3 cracker resumed operations on 6 July while the 1.03m tonne/year No 2 cracker was back up and running on 30 June. Both plants are currently operating at full rates.

FPCC also runs a 700,000 tonne/year No 1 cracker that is undergoing scheduled maintenance from 20 June to 5 August."

There has, as a result, been a slight improvement in polyolefins buying over the last few weeks but end-users remain extremely cautious.

"I was told by one of my customers that some 2,000 factories are expected to have to close down this year in one city alone, Guangzhou, because of the collapse in exports of finished goods to the West," added the sales and marketing executive.

"We should get a good gauge of what the August market will be like today as two Southeast Asian producers are due to announce their offer prices for butene-grade linear low-density polyethylene (LLDPE). And then on Wednesday, Middle East producers are likely to make their announcements."

Rather curiously, some Asian cracker operators have raised operating rates in July, or are planning to do so, on what they say are better margins.

Thailand's Siam Cement Group, Malaysia's Titan Chemicals and South Korea's SK Energy are some of the producers which have upped production, according to ICIS.

But the latest ICIS Asian Ethylene and PE Weekly Margin Reports suggest that margins are on the decline.

"Ethylene margins (naphtha) in Northeast Asia plummeted by $111/tonne this week as naphtha rose by $47/tonne, increasing feedstock costs by 5.5 percent" said the ICIS Asian Ethylene Margin Report for the week ending 20 July.

"Naphtha prices have risen four weeks in a row. The margin fall was cushioned by a $15/tonne rise in ethylene prices and a 1.4 percent increase in co-product credits, mainly because of higher fuel values."

The PE report for the same week added: "Integrated margins in Northeast Asia weakened for the third consecutive week after plunging by $128/tonne for low density PE (LDPE) and by $108/tonne for high density PE (HDPE).

"The primary reason for the margin decline was almost a $50/tonne surge in naphtha prices which increased naphtha costs by 5.5 percent to their highest since mid-May."

This confirms that cracker operators are failing to fully pass-on higher crude and naphtha costs as a result of what remains an exceptionally weak market.

Extra supply from higher Asian cracker operator rates is hardly going to help.

And neither will volumes from the recently started-up Saudi Polymers plant that are expected to hit the market over the next few weeks.

By John Richardson

EARNINGS estimates for South Korean petrochemicals companies for the full-year 2012 remain around 30 percent above where they should be because "most financial analysts remain in denial", said an industry source.

A sign of how bad the times have become was that LG Chem's Q2 results, which were released last week, were viewed as mildly positive because year-on-year net income "only" declined by 40.1 percent.

"It could have been a lot worse for LG if it had not been for its technology business. LG is, for instance, a producer of lithium ion batteries and liquefied crystal display glass substrates," the source added.

But over the next few days, Honam Petrochemical and Hanwha Chemical are expected to announce Q2 net income reductions of more than 50 percent.

Honam is heavily exposed to the polyester sector due to its substantial mono-ethylene glycol (MEG) capacities.

MEG sentiment and pricing improved for the week ending 20 July on production losses and hopes for a demand recovery in China, said ICIS.

But MEG and polyester in general have been weak for most of 2012.

"And in Hanwha's case, it a significant polyvinyl chloride (PVC) exporter to China and PVC is really struggling," said the source.

Earlier this month, China's major PVC pipes and profiles producers were operating at 60 percent of capacity with small and medium-sized downstream producers running at even lower rates, according to ICIS

Bearish sentiment among end-users was reflected in January-May suspension grade exports to China that totalled 408,800 tonnes, a 13 percent drop from the previous year's 470,500 tonnes.

Again, though, as the chart above illustrates, PVC prices have shown some recovery on restocking.

"Most analysts are in denial for the second half of this year because they believe that China's government will ride to the rescue with more economic stimulus," continued the source.

"Ironically, the worst that the macro-economic data has become during H1 the more optimistic has been the mood of some analysts on the belief that Beijing will have to sort the problem out."

But even if the overall economy does pick up in H2, the industry source and the blog are concerned that:

*Petrochemicals will continue to under-perform overall GDP growth because of persistent inventory overhangs, particularly in synthetic resins.

*Low-end manufacturers in southern and eastern China will still struggle as a result of structural changes in the economy.

 By John Richardson

US chemicals production remains way below its pre-crisis 2007 level but production in Asia-Pacific, after a brief blip in 2009, continues to soar, according to these charts from the American Chemistry Council.

Whereas US producers have carried out few capacity expansions since 2007 and are runnning existing plants at lower operating rates, the Asia-Pacific industry has added a great deal of capacity. This has helped meet strong demand growth

Weaker US production reflects what is happening in the American economy.

Current macroeconomic indicators point to deep structural problems with the economy, from anaemic wage growth for the vast majority of Americans to a persistently high unemployment rate.

And the US might fall off a fiscal cliff early next year, when tax cuts for the rich could come to an end as spending cuts are also enforced.

Housing debt left over from the sub-prime crisis remains a drag on the economy and yet the White House is unwilling to push-through debt write-downs, writes Edward Luce in the Financial Times.

Demographics are holding back demand. And so, in the absence of another Babyboomer boost to the economy, which of course isn't going to happen, a major reduction in consumer debt seems a good way to get the economy going again.

Sadly, though, it seems unlikely that any future White House administration would be willing to compel the banks to take big losses on mortgages, given the close relationship between both the major political parties and Wall Street.

And yet the US chemicals industry is planning a major wave of expansions.

Cheap feedstock is a big motivating factor behind these planned investments.

But if the US economy fails to achieve a sustained recovery, where is the output from all the new plants going to go?

"Exports" is the answer that many an executive would no doubt give.

What happens, though, if Asia-Pacific chemicals production keeps rising? 

China will continue to add capacity, and run it hard, regardless of economics as Sinopec's strategy suggests.

Elsewhere in Asia-Pacific, and also in the Middle East, further capacity might well be added for social and political as well as economic reasons.

Assumptions about emerging market economic growth also need to be challenged.

By John Richardson

WHAT is happening in India's polyvinyl chloride (PVC) sector reflects some of the macro-economic challenges we discussed earlier this week.

An additional 8.5m tonnes of PVC pipes demand could be generated in the space of just five years if the government can get its act together on economic reform, said an Indian PVC industry source. This would greatly add to overall PVC demand that totalled 1.98m tonnes in the financial year ending 31 March 2012.

"We need a new breed of politicians able to push reforms through that would attract the domestic and foreign investment needed for a return to the GDP growth rates of a few years ago," said the source.

"Sadly, there is no such new breed of leaders around at the moment."

More investment in infrastructure is needed, he said.

"Without the infrastructure spending, which could trigger the estimated 8.5m tonnes of extra PVC pipe demand, we won't be able to tackle the inflation problem.

"Lack of efficient ports and roads and not enough electricity supply have caused steep cost increases," he added.

"This is preventing the Reserve Bank of India (RBI) from making the interest-rate cuts we need to return to the previous growth trajectory."

Better roads and power supply etc would also encourage more manufacturing investment and thus create more jobs.

More manufacturing jobs would narrow the big income gap between India's low and middle-income earners and the small, rich urban elite.

Some 70% of India's PVC demand is reliant on the pipes sector compared with a global average of 40%, the source added.

This reflects the heavy dependence on agriculture as a driver of economic growth, as the big demand for pipes is mainly driven by irrigation.

Thus, India remains extremely vulnerable to changes in weather patterns.

Last year, PVC demand was damaged by a too-much rainfall during the monsoon. Summer lasted only 45 days compared with the usual 145 days.

This year the concern is that there won't be enough rainfall. To date, the monsoon has delivered 22 percent less rainfall than in an average year.

Poor harvests, resulting in higher food prices, are likely to make it even harder for the RBI to cut interest rates which currently stand at 8 percent.

"And the big worry for PVC demand is that the farmers could be short of money when the planting season arrives at the end of 2012. This would damage demand for PVC pipes," said the source.

"My base case for financial year 2012-2013 is PVC demand growth of 8%, my worst case is 6-7% in the event of bad monsoon and the best case 10-11%."

By John Richardson

DOW Chemical's Andrew Liveris has changed his views on China as a result of an economic slowdown that seems to have taken many people by surprise.

"China's economy has continued to decelerate as European exports suffered," said Liveris, as the company last week announced a 34 percent fall in profits year-on-year in Q2 2012 to $649m (€526m) on 6 percent lower comparable sales of $14.5bn.

And he warned on China that "we will likely linger around the current level until broader measures taken by the government to inspire domestic growth in investment and consumption take hold.

"China will not snap back quickly. It may be late this year when it gets back to 8% growth. Right now it is probably 3 or 4, to 5% at best."

When the company announced its Q1 2012 results back in April, Liveris had said: "China is stabilising and growth is likely to accelerate later this year as their government keeps shifting its policies to inspire and incentivise domestic growth."

We warned at that time that growth looked as if it was decelerating.

BASF CEO Kurt Bock (see above), on last week's release of his company's Q2 results, said: "At the beginning of the year... we could not have anticipated that the Chinese growth engine would start to stall.

"In the second quarter our sales in Asia decreased in local currency terms - as they did in the first quarter of 2012."

(BASF reported a mixed set of financial results for the quarter. For example, overall sales volumes rose, but volumes in chemicals fell)

The company added: "The economic developments in the past months and a look in our order books have led us to become more cautious about our expectations for the global economy in 2012. This means that we now expect the following business environment for the full year (previous forecast in parenthesis):

• Growth of gross domestic product: 2.3% (2.7%).
• Growth in industrial production: 3.4% (4.1%).
• Growth in chemical production: 3.5% (4.1%).
• An average euro/dollar exchange rate of $1.30 per euro.
• An average oil price of $110/barrel in 2012."

BASF isn't quite spelling it out in capital letters and so we will: GLOBAL GROWTH OF 2.3 PERCENT WOULD BE ESSENTIALLY A RECESSION.

By John Richardson

ASIAN high-density polyethylene (HDPE) margins have improved in June and July compared with the rest of the year, according to the above chart from the ICIS Weekly PE Margin Report.

But the overall year-to-date trend illustrates how the industry has lacked pricing power as a result of persistently weak Chinese demand.

August offer prices for both HDPE and linear-low density (LLDPE) were increased last week in an effort to further improve margins.

LLDPE offers from a Middle East producer were, for instance, increased by $60-70/tonne, said a source with a major producer.

"Higher oil prices and the expectation of reduced production from the Middle East were used as justifications for the higher offers," he added.

Crude has rebounded by around 14 percent over the last month on greater geopolitical concerns and the hope that the Fed will announce another round of economic stimulus at its Jackson Hole at the end of this month. Hopes have also been raised that some kind of positive action will be taken by the European Central Bank, which also meets this week.

On the supply side for PE, producers are hoping that high temperatures during the Middle East summer might lead to technical problems that force a slight reduction in output, as has been the case in the past.

"But, sadly, nobody is attempting to justify these modestly-higher August offers on stronger downstream-demand in China because there hasn't been any significant improvement," added the source.

The outcome of pricing negotiations for September deliveries is likely to be viewed as much more important barometer of the health of the industry, he said.

"September is a peak manufacturing month in China, when factories should be running flat-out to make finished goods for export to the West in time for Christmas.

"I think that pricing will actually be flat in September, reflecting the weakness in the global economy."

European HDPE margins, as the chart again illustrates, fell to their lowest level in July since January of this year.

As in Asia, therefore, Europe's cracker operators are trying to claw-back lost margins through an increase in the August ethylene contract price.

"Producers were adamant that they would not be compromising for August, having seen previously high cracker margins wiped away so rapidly to as low as they were in January by the upstream developments in July," wrote European ethylene ICIS pricing editor Nel Weddle in her, as always, excellent report for the week ending 27 July.

"In hindsight, they said, the €170/tonne drop in July (the ethylene contract price) had been a mistake."

Producers were therefore pushing for €170-200/tonne contract price increases for August, with initial settlements €140/tonne higher.

But there was no great confidence in the strength of demand for PE and other ethylene derivatives, she added.

The US has been buoyed by the shale-gas advantage, but, as the chart again shows, July HDPE margins fell to their lowest level since January.

There are no prizes for guessing the reason why: A decline in PE demand on a weaker economy.

US PE producers have announced a 6-7 cents/lb price hike for August, but consensus on price direction is lacking, according to ICIS.