Asian Chemical Connections

By John Richardson

NOBODY saw the shale gas technological breakthroughs coming and thus the revival of the US petrochemicals industry took everybody by surprise.

Today the accepted wisdom is that the US industry will remain a license to print money for many years to come.

But as we have discussed before, the substantial amount of ethylene derivatives exports that will result from the capacity expansions will have to find a home in an increasingly uncertain and volatile global economy. There will be no return to the economic golden era of the late 1990s through to 2007 where, barring a few minor recessions, all that producers had to do was build and sufficient demand was virtually guaranteed.

Equally uncertain is the outlook for natural-gas availability and therefore, of course, ethane feedstock costs in the US. The US faces a choice of whether to allow huge amounts of gas surpluses to be exported in the form of liquefied natural gas (LNG), or to use gas as a means of achieving Mitt Romney's promise of energy independence.

"In North America, there is some 150 million tonnes/year of new LNG projects being planned of which, perhaps, 30-40 million tonnes/year will actually go ahead," said Tony Regan, oil and gas consultant with Singapore-based Tri-Zen International. (see above table of US projects only). 

"Many projects, for energy security reasons, might not receive US Department of Environment approval to export to countries that don't have free-trade deals with the US. This would weaken their viability."

But even if Regan is right, the shale gas industry, as recent asset writedowns have indicated, is very unprofitable.

In an extraordinary collection of emails gathered by the New York Times, industry observers and participants variously describe shale gas as a "giant Ponzi scheme", and as another example of Wall Street talking up investment returns, just as was the case with the dot com bubble. An unprofitable industry will need to consolidate in order to make money, resulting in a long term increase in gas pricing.

The shale gas technological breakthroughs of a few years ago demonstrate how quickly competitive advantage can shift.

Source: http://www.economist.com/

 By John Richardson

RISING China labour costs are compounding weakness in the manufacturing sector and thereby, of course, damaging chemicals and polymer markets.

The country's garment exports fell by 0.2 percent in the first seven months of this year, compared with a 24 percent increase in January-July 2011, says the Association of Chinese Textile Exporters.

China's garment exports totalled $250bn in 2011, which could well mark an all-time peak as China tries to move up the manufacturing value chain - a key objective of its 12th Five-Year-Plan (2011-2015).

Meanwhile, the association estimates that Japan's imports of garments from Southeast Asia rose 22 percent in H1 2012. What is China's loss is a gain for countries such as Vietnam, Indonesia and Bangladesh that have lower labour costs.

But, of course, the timing for China could not be worse. The impact of higher labour costs is occurring at a time of weak global growth. This was reflected in the final reading of the HSBC August China purchasing managers' index, which fell to its lowest level in three years.

As China's textiles industry struggles, a great deal of new domestic purified terephthalic acid (PTA) capacity is being brought on-stream. Eleven new plants are due to start-up over the next three years, with a total capacity of 18.5m tonnes/year. The country's total PTA capacity is due to reach 39m tonnes/year in 2015 - double that of 2011, according to ICIS.

These new plants will benefit from low-cost local supply of paraxylene (PX), and are likely to have also benefited from cheap financing.

The outlook for exporters of PTA to China is therefore not good.

By John Richardson

A barrel of Brent crude oil cost $88.49 a barrel in June. Yesterday, it was trading at $116.55 a barrel.

In the intervening period the global economy has substantially weakened, most notably in the case of China, as the problems that have been identifiable since late last year have become widely recognised.

China's official GDP (gross domestic) product growth is likely to be around 7 percent this year, close to the government's targets, says Glenn Maguire, chief economist at the Sydney-based economic consultancy, Asia Sentry Advisory, in this video.

But he warns that real, underlying GDP growth could fall to 3-5 percent in 2012, reflecting what the polymer markets are telling us.

And yet the oil price has rallied, resulting in the Group of Seven industrially advanced nations urging oil producers in late August to "increase their output to meet demand".

The problem, as China illustrates, however, is that the oil-price rally has little to do with demand. As we discuss in Chapter 3 of our book, Boom, Gloom & The New Normal, oil prices are about speculation. The increases over the last few days are, for example, about excitement that the Fed might be about to give speculators another free lunch to gamble with even more stimulus money.

Source of chart: Morgan Stanley

By John Richardson

CHINA might soon raise export tax rebates, as it did during the 2008-2009 global economic crisis.

Some chemicals and polymers exporters to China would welcome the increase in export tax rebates (this would make re-exports of finished goods from China more competitive).

But on this occasion, overcapacity across several of China's industries is greater as a result of the investment splurge of 2008-2010.

Western economies are also burdened by deep structural problems.

The worst of possible outcomes, that needs to be built into scenarios for next year, is a global trade war as China exports deflation.

And what might further subsidies for exports indicate about China's economic direction?

Would raising export tax rebates merely represent a stop-gap measure designed to shore up growth during and immediately after the once-in-a-decade leadership transition?

Or could it indicate a retreat from the economic rebalancing of the 12th-Year-Plan (2011-2015)? This involves a movement away from exports and investment as a driver growth towards greater domestic consumption.

China, as the chart illustrates, has become far-more heavily dependent on investment to drive growth.

Source of graph: http://www.businessspectator.com.au/ 

By John Richardson

"Candide, the classic novel of the great French writer Voltaire, is a satirical description of a young man who has been taught that 'everything is for the best in the best of all possible worlds'," wrote Paul Hodges in this blog post last week.

Thus, we have been told while the world looks gloomy right now, China's average polyethylene (PE) growth rate from 2008 until 2012 has been excellent.

And we keep being reassure that China will return to trend-growth next year and beyond, thanks to rising urbanisation and the growth in the country's middle class.

Dr John Lee, Michael Hintze Fellow and adjunct associate professor at the Centre for International Security Studies, Sydney University, wrote in this article:

"Much of the optimism is based on the decade-long orthodoxy - popular with executives and investment analysts hardwired into talking up the China story - that Chinese urbanisation has a long way to go. As China-bulls point out, half of the population is still classified as rural and will need modern housing and other infrastructure over time. According to the narrative, this effectively guarantees strong demand for commodities such as iron ore for the next couple of decades, while Beijing has several economic tools with which to arrest any immediate dramatic slowdown.

"All of this is true, but the analysis is still incorrect. Timing for dramatic changes in commodity prices is impossible to predict. But the reality is that China's voracious consumption of commodities over the past decade has remarkably little to do with the genuine demands of urbanisation, makes little economic or commercial sense, and cannot continue.

"Since the mid-1990s, urbanisation has been advancing at the rate of less than 1.5 per cent each year. Yet fixed investment has been growing at 20 to 40 percent each year for the past decade. Fixed investment as a proportion of GDP increased from 38 percent in 1999 to 45 per ent in 2003 and over 50 percent currently.

"During the periods of rapid industrialisation in Japan, Taiwan and South Korea, fixed investment did not rise above 33 percent of GDP. That China is dangerously embarking on a unique and unprecedented economic path is further confirmed by the fact that formal bank loans increased from $750 billion in 2008 to $1.4 trillion in 2009. In the two years from 2008-2010, the amount of outstanding loans on the books of the country's banks increased by 58 per cent.

"Obviously, and much to Australia's delight, fixed investment needs steel, and steel making needs iron ore. Chinese steel production jumped from about 100 million tonnes in 2000 to over 400 million tonnes in 2005, to around 850 million tonnes currently. Analysts and forecasters need good data - which isn't available in China - and rely on models based on key assumptions about economic rationality. The problem then is that these dramatic increases make no sense.

"Since governments cannot force their populations to consume, and Beijing has little direct control over consumption levels for its exports in advanced American and European Union economies, the only available policy response to a slowdown was to ramp up fixed investment levels - in short encouraging eager state-owned-enterprises to build things for the sake of it.

"In other words, Chinese levels of fixed investment, and levels of steel production specifically, over the past decade have been predominantly driven by politically-motivated stimulus policies rather than market-determined demand.

"The result of the unprecedented reliance on fixed investment to maintain jobs, stimulate economic growth in urban areas (which is vital for regime security) and as a way for ambitious provincial officials to exceed growth targets in a personal quest for political promotion are the increasingly well-documented ghost cities, tens of millions of uninhabited high-end apartments that are bought as speculative capital assets rather than as investments based on rental yield, and world class infrastructure projects that will be never be adequately utilised. Estimates by Chinese state-backed researchers suggest that still empty apartments built over the past four years could house over 200 million Chinese."

Voltaire's Candide found that the world was, after all, not the perfect place that he had imagined.

By John Richardson

THERE was much talk last week about $158bn worth of new infrastructure projects in China that have received fast-track approval from the central government.

But is this just a lot of noise to boost financial and commodity markets? Can anybody be 100 per cent certain that these projects are genuinely new, and that they can be adequately funded?

If they are new and can be afforded, how quickly will they deliver a boost to economic growth and therefore chemicals and polymer demand? Will this new wave of building work be good for the economy in the long run?

Complicating the stimulus picture is a rebound in inflation. Overall August inflation accelerated to 2 percent from a year earlier after a 1.8 percent rate in July.

Food inflation accelerated for the first time in five months, rising 3.4 percent from a year earlier. Consumer prices increased 0.6 percent from the previous month, the biggest rise since January, while food prices increased 1.5 percent from July.

"A renewed inflationary trend could prove to be a further complication to policy makers' growth-inflation trade-off," Glenn Maguire, chief economist at Sydney-based economics consultant Asia Sentry Advisory told Bloomberg.

"China will have enormous difficulties in crafting a policy response to these divergent price and activity trends."

Meanwhile, industrial production in August fell to a three-year low (see above chart) - underlining the severity of the economic slowdown.

By John Richardson

THE chart above indicates the extent to which polyethylene (PE) price rises over the last few weeks have failed to adequately compensate for higher feedstock costs.

Last week saw prices edge up by a further $10-40/tonne, according to ICIS pricing.

"The majority of buyers have accepted higher September offers, but we know that we cannot push the envelope too far because demand is so weak," said a source with a global PE producer.

Oil prices have rallied on the ECB bond buying decision and the anticipation that the Fed might take more action this week.

Further momentum to crude was added by reports last week that China's central government has launched a $158bn infrastructure stimulus package.

But as this article in the New York Times points out:

*China's fixed-asset investment grew 20.2 percent in the first eight months of this year compared with the same period last year. It was the second-lowest pace since December 2002; only May of this year was marginally lower. Even this number could have been exaggerated by double-counting and replacement of existing factory equipment and buildings.

*Local government investment spending in August rose at its slowest pace since December 2001 -- and local government investment spending in China is 18 times as large as central government investment spending. (Local authorities are strapped for cash because their main source of revenue, land sales, has declined and they are heavily in debt from profligate spending during the boom years). The importance of local versus central government spending suggests that even if the central government $158bn stimulus package is real, it won't make that much of a difference.

*Manufacturers are retreating from ambitious central and local government production goals as they struggle with bloated inventories of unsold goods. Even the service sector, still underdeveloped and widely seen by economists as full of potential, is showing signs of distress.

A further worry is that as China confronts real GDP growth that could fall to as low 3-5 percent in 2012, it will resort to attempting to relieve its manufacturing surpluses through increased subsidies for exports.

This could lead to greater international trade tensions.

The China Daily, the government-run newspaper, has added significant further weight to earlier reports that export tax rebates could be increased.

"The Chinese government is expected to launch a package of measures to support the nation's struggling exports in mid-September, the first such move since the global financial crisis, two sources from the Ministry of Commerce told China Daily," wrote the newspaper.

"The measures cover a wide range of issues including tax rebates, insurance, credit, taxes, customs clearance and other tools to facilitate foreign trade, said the two sources."

Source of graph: Reuters

By John Richardson

THE Federal Reserve has got it badly wrong, and could compound its mistake by launching a third round of quantitative easing (QE3), warns Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley.

"The first two rounds of quantitative easing fuelled a commodity bubble, increased income inequality and set a bad example for the rest of the world," wrote Sharma, in this article in the Financial Times.

"During the 16 months of round one, up to March 2010, the CRB (Commodity Research Bureau) commodity price index rose 36 percent, while food prices rose 20 percent and oil prices surged 59 percent.

"During round two, in the eight months up to June last year, the CRB rose 10 percent, the CRB rose 10 percent, with food up 15 percent, while oil prices rose 30 percent."

And now stock and commodity markets have responded in anticipation of QE3. They have also reacted positively to the European Central Bank bond-buying decision, which, in effect, amounts to quantitative easing.

For example, as crude went higher, by last Friday the September ICIS Petrochemical Index (IPEX) had rebounded 2.6% from the year-low in August to 307.77, driven mainly by an almost 10% gain in Europe. The US component edged up by 1.6%, while Asia experienced stagnant growth.

Out of the sub-indices, olefins gained the most by 5.7%, followed by aromatics at 5.2% and then polymers at 3.9%.

Sharma identifies exchange traded funds, and other financial products, as being at the core of the problem. Commodity prices tend to now move in lock-step with equities. This is the point we made in chapter 3 of our e-book, Boom, Gloom & The New Normal, when we explained the dysfunctional nature of oil markets.

For most people, especially those in emerging markets who are very poor by Western standards, higher oil and food prices act as an effective extra tax on their spending.

As Sharma points out:

*When the price of oil hits $120 a barrel, consumer spending on oil reaches 6 percent of total worldwide income and starts to cut into spending on other goods.

*Estimates suggest that in the US, every $10 a barrel increase in the price of oil shaves 0.3 percent from GDP, and adds 0.3 percent to inflation.

*Illustrating the point about the poor getting poorer, in the US again he adds that families in the bottom 20 percent of income earners spend 8 percent of incomes on petrol and 30 percent on food, while the top 20 percent spend just 2 percent on petrol and 5 percent on food.

Fellow blogger Paul Hodges, and co-author of our e-book, also argues in this post that quantitative easing has failed.

He makes the point that in China, a very poor country by Western standards, oil prices are close to record-high levels.

Inflation in China rebounded in August as a result of more expensive food and fuel. This is limiting economic stimulus options.

And because demand is so weak in China, the polyethylene (PE) industry is struggling to fully pass-on higher raw-material costs to the converters and fabricators. Northeast Asian integrated PE margins are in deep negative territory.

One group of people that have benefited from quantitative easing are those who are lucky enough to own equities (Sharma adds that 75 percent of all stocks in the US are owned by the top 10 percent of income earners).

And the other beneficiaries are the bankers who got us into this mess in the first place.

The ability of these few people to buy extra yachts, Gucci handbags and luxury Manhattan apartments, isn't going to get the world economy going again.

By John Richardson

CHINA'S new local currency lending rose to 703.9 billion Yuan ($111 billion) last month, way ahead of July's 540.1 billion Yuan.

If a you are trader in the Dalian Commodity Exchange's futures contract in linear-low density (LLDPE) you can take this ostensibly encouraging number, and premier Wen Jiabao's speech earlier this week about shoring up growth, as a reason to go long. And sure enough, the Dalian rose by 0.82 percent on Wednesday.

But anybody with a perspective slightly longer than 24 hours needs to be concerned over these comments from Mark Williams and Qinwei Wang of Capital Economics.

"Any optimism should be tempered by the fact that borrowing by firms, as opposed to households, remains weak," they said in a research note.

"The further we dig into today's data, the more sceptical we become that they are particularly encouraging. It is hard to see how the economy can be turned around unless firms decide to invest. There is not yet much sign of that happening on a large scale."

Glenn Maguire of the Sydney-based economics consultancy, Asia Sentry Advisor, also points out in this video that the People's Bank of China has of late been reluctant to further reduce interest rates and bank-reserve requirements because:

*Average industry operating rates in China are now lower than they were during Japan's lost decade, and the "Volcker Recession" in the US, according to IMF data.

*Flooding the economy with more lending, resulting in even more industrial overcapacity, could thus drive China's operating rates even lower. China is already seeking to export its existing deflation.

Wen sought to defend his economic record during his speech earlier this week, along with promising more stimulus.

"His has been basically a caretaker government that was lucky enough to inherit the best growth period in modern Chinese history, but their stimulus package (2008-2010) spent too much money on the wrong things," an academic adviser to the government told the Financial Times.

"The next government will probably face the consequences of their mistakes in the form of an economic crisis and large-scale social unrest," he added.

By John Richardson

THE FED'S decision to launch quantitative easing 3 (QE3), a series of open-ended steps more radical than anything it has attempted before, is bound to drive petrochemicals pricing higher, in response to the surging cost of crude.

But as a corporate planner with a US polyolefins producer told us yesterday, before the Fed announcement: "The cost of crude is a major problem for us as it doesn't reflect real demand in the real economy."

As we discussed earlier this week, this is the problem with central bank action, which was further underlined by this post yesterday from fellow blogger Paul Hodges.

A sales and marketing executive with a North American polyolefins producer told us last week: "The issue today is that the majority supplier of polyolefins to Asia is no longer the regional producers. It is instead the Middle East which sits on much lower costs. It has the power to price according to market demand.

"The Asian naphtha-based producers are seeing great cost pressures in China and are therefore trying to export to better-priced markets such as Latin America, Africa and Russia.

"But this is offering limited help as long sailing times mean that Asian producers are not viewed as preferred suppliers.

"I am not sure if 2013 will be any different."

By John Richardson

THE blog has spent a great deal of time talking to lots of people, and reading everything it can get its hands on, concerning China's leadership handover and has reached one overwhelming conclusion: Nobody has a clue.

The comforting, easy analysis is that the once-in-a-decade handover will be handled smoothly - and that, therefore, in the "best of all possible worlds". China's economic boom will continue.

But this one-dimensional scenario would represent dangerous complacency for chemicals companies, similar to that which governed the planning process in late 2011, when the consensus view was that chemicals demand growth would bounce-back in 2012.

One scenario that has to be built into the planning process is that, despite the re-appearance of president-in-waiting Xi Jinping (pictured on the right), there is an intense political struggle still going on in China.

Some politicians may, for instance, be using the dispute over the ownership of islands with Japan to shore up their base, as they don't want to cede too-much power to Xi Jinping.

The problem could centre on the reported failure of the early August meeting of party leaders at the seaside resort of Beidaihe to resolve deep differences over who should hold power after the handover.

There is a strong possibility that the handover, which is supposed to take place in mid-October, will be delayed, creating a longer period of uncertainty over China's political and therefore economic direction.

"The current political malaise is likely to carry on for another 6-7 months, maintaining uncertainty among investors," said an Australian resources consultant.

This uncertainty has been one of the factors why, while bank lending picked up in August, corporate borrowing remains weak.

A political struggle appears to be taking place between the reformers and those who have, allegedly, done remarkably well out of the current investment-drive growth model. "Vested interests" might still be fighting hard against the reformers.

An in-house CIA article in 1975, entitled "The Art of China Watching", contained the sub-heading, "Does Logic Help?".

Since then, as The Economist points out, China has undergone a dramatic social and economic transformation.

But, underlining our point that nobody really has a clue, the magazine adds that politics "remains an intricate and frustrating puzzle to be tackled with crude techniques and unreliable sources".

By John Richardson

SINOPEC's remarkable rise in the petrochemicals business continued in 2011 as it jumped two places in the ICIS Top 100 ranking, compared with 2010, to finish second overall, behind BASF. This was the result of a 28.9% rise in chemicals sales in local currency and a 34.9% increase when sales were measured in US dollars.

The steep rise in sales reflects the Chinese government's strategy of boosting petrochemicals self-sufficiency. New cracker and derivatives capacity was commissioned by Sinopec in 2011. Between 2000 and 2011, the company's total production in all chemicals rose from 2m tonnes to 10m tonnes - a 14% increase per year.

Sinopec's operating profit also almost doubled in 2011 compared with the previous year.
But the problem is that this reflected a strong first half of 2011. By Q4 of last year, markets had weakened.

And 2012 has been an immense disappointment. Chinese demand growth in all the major synthetic resins is likely to be in the low single digits.

Doubts are also growing over the long-term health of the Chinese economy. GDP (gross domestic product) growth could call to as low as 3% per year over the next few years, as China undergoes a painful rebalancing from investment to domestic consumption-led growth.

If it fails to rebalance quickly enough, there is a risk of a major non-performing loans crisis as a result of continued investment in unneeded infrastructure and industrial capacity.

This doesn't mean, however, that Sinopec will necessarily delay capacity expansions. The main role of the company , which is still 76% owned by the government, is to guarantee supply of raw materials to domestic downstream industries even if, at certain times, this means losing money.

China as a whole is scheduled to increase its ethylene capacity from around 15m tonnes/year in 2011 to 27m tonnes/year in 2015, according to ICIS data.

This puts some of Sinopec's overseas competitors, which have to answer to shareholders, in a very difficult position if the worst fears over China's economy are realised.

South Korea's Honam Petrochemical, however, had a tremendous 2011 as a result of a 47.6% increase in sales.

But the South Korean companies in general are expected to struggle to achieve full-year 2012 financial targets because they are so heavily dependent on China for exports.

At least in the case of Honam, though, its position has been strengthened by its 2010 acquisition of Malaysia's Titan Chemicals.

This has given it better access to the booming ASEAN (Association of Southeast Asian Nations) markets, and an edge in exporting to China through the ASEAN-China Free Trade Area.

The challenge for Thailand's PTT Global Chemical, also, of course, within the ASEAN region, is to maintain its 2011 progress in 2012. In 2011, it leapt into the top 30 of the ICIS ranking, thanks to its emergence from the merger of the former PTT Chemical and PTT Aromatics.

India's Reliance Industries, which saw its 2011 petrochemicals sales jump by 28.2%, faces the very different challenge of effectively executing the biggest "off-gas" cracker project of all time.

It is due to bring on-stream a cracker, which could eventually produce 1.6m tonnes/year of ethylene, and associated downstream capacities at its Jamnagar complex in Gujarat in 2015

The cracker will be entirely fed by off-gases from Reliance's 1.24m tonnes/year refinery capacity at the same site.

"The biggest previous cracker to run solely on off-gases had an ethylene capacity of only 100,000 tonnes/year," said a source familiar with the Reliance project.

Reliance is to spend a total of $12bn on new petrochemicals capacity, including not only the cracker complex, but also on new paraxylene (PX), purified terephthalic acid (PTA) and polyester plants.

This is a major play on a domestic Indian market that, even if GDP growth slows quite dramatically, should be able to absorb all of the new Reliance capacities.

This time last year, most people would have said the same thing about all the capacities added to serve China, but maybe not now.

Marc Faber

Source of picture: http://www.cliffkule.com/2011_06_26_archive.html

By John Richardson

RECENT action by Western central banks will result in more hot money flowing into Asia, creating further asset-price bubbles.

Last week, the Fed launched QE3 and the previous week, the European Central Bank launched its bond-buying programme.

Equity markets in China could also surge by 10-20 percent, as they are relatively undervalued compared with the stellar-performing US market, says international investor Marc Faber, in this video.

Faber makes the point that the super-rich will search the world for undervalued assets, generating tremendous returns for themselves.

But he added that it was a "complete fallacy" that Western central bank action had already or would in the future benefit the average person in the street.

In fact quite the reverse will happen, as the super-rich become even richer at the expense of everybody else - until the world economy collapses, warns Faber.

For example, property markets could well take off again in China, as could speculation in chemicals and polymers, as all the hot money seeks strong returns.

The existing high cost of homes in China's major cities is already a cause of social tension, said to be one of the factors behind the anger being vented against Japan over the East China Sea islands dispute.

China might face a tough choice: Either allow all this hot money to further inflate and distort its economy, or impose restrictions on the flow of overseas funds.

Perhaps it might decide to "join the party" by launching a big new economic stimulus of its own, in an attempt to deal with its industrial slowdown.

Living with inflation in excess of 5 percent per year would carry significant political risk - because of increased resentment over an even wider gap between the rich and the poor.

At the moment, though, it seems as if China cannot take major economic policy decisions, as it is too wrapped-up in its highly contentious leadership transition.

At the level of petrochemicals markets in China, which, of course, reflect the real economy, rather than the surreal world of super-rich investors, the demand outlook remains incredibly bleak.

The commodity polyethylene (PE) market, in terms of profitability, is the worst it has been in 15-20 years, we have been told.

PE prices were this week said to be as little as $50/tonne above the cost of ethylene, reflecting the inability of producers to fully pass-on the surging cost of oil.

And, of course, oil has gone up not because demand has got better, but rather because of all of that hot money flowing into commodities.

By John Richardson

SAUDI Arabia has offered its main customers in the US, Europe and Asia extra oil supplies until the end of the year as a result of concerns over the impact that expensive crude could have on the global economy.

This follows last month's call from the Group of Seven finance ministers for oil exporters to raise production.

Saudi Arabia initially appeared to have said no to the Group of Seven, but now appears to have changed its mind, no doubt in response to the alarming increase in oil prices. By last Friday, Brent had risen by 33 percent compared with mid-June.

The bad news for the Asian petrochemicals industry is that if Saudi Arabia pumps more oil, this means more associated gas and therefore even higher operating rates at the country's cracker complexes.

Saudi Arabia's previous attempt to bring the oil price down, which involved raising crude production to 9.9m barrels a day, contributed to a sharp rise in polyethylene (PE) and mono-ethylene glycol (MEG) shipments to China.

New polymer capacities in the Kingdom could exert further pressure on the Asian naphtha-based industry as it struggles with the weak China market.

Back in May 2011, we were being told that these new capacities would be easily absorbed. How the world has changed.

Good news would, of course, be success by Saudi Arabia in reducing oil prices.

But given all the hot money flowing into commodities as a result of QE3, how confident can we be that Saudi Arabia will succeed?

By John Richardson

CHINA'S manufacturing activity did, at least, stabilise in September after hitting a nine-month low in August, according to the latest preliminary HSBC manufacturing purchasing managers' index (PMI).

The PMI improved to 47.8% in September compared with 47.6% in August.

Elsewhere, as the chart above shows, Eurozone and US PMI indices declined.

The composite Eurozone PMI fell to 45.9 in September from 46.3 in August.

Meanwhile, US manufacturing closed out its weakest quarter in three years. The Markit PMI index averaged 51.5 Q3, below the 54.2 registered between April and June, for its worst showing since the third quarter of 2009.

Of the preliminary China September PMI reading, Qu Hongbin, HSBC's China chief economist, said: "Manufacturing activities remain lacklustre, thanks to weak new business flows and a longer than expected destocking process.

"This is adding more pressure to the labour market and has prompted Beijing to step up easing over the past few weeks."

"It's still soft," Shane Oliver, head of investment strategy at AMP Capital Investment, was quoted as saying in this article.

"The good news is it hasn't got any worse, the bad news is it's no better really. Statistically there's no change. It's telling us Chinese growth is not losing further momentum but recovery remains elusive."

The question remains whether Beijing has the time and/or the legitimacy to take firmer action to turn the economy around, because it so wrapped up in the leadership transition.

"Because China's current senior politicians are about to step down, they don't feel able to take any major policy initiatives on behalf of their successors," said an Australian-based resources consultant.

More stimulus would also risk higher consumer-price inflation and, in contrast, even worse producer-price deflation.

A connected political issue - the China-Japan dispute over the East China Sea islands - poses a further risk.

"China's government is trying to deflect attention away from weak economic growth by allowing demonstrations against Japan," said a chemicals industry executive.

"I think that one of the underlying causes of the expression of anger against Japan is the sense among working-class people that they have lost out during China's economic boom," he added.

"The gap between the rich and poor has widened since the 2008-2010 economic stimulus package, and the cost of living for the average worker earning around $200 a month is a major issue. Property in China's big cities remains way too expensive for most people."

The executive worries that a miscalculation by either Japan or China could lead to military conflict.

"The US is obligated to side with Japan, and I think that most other Asian countries would take sides with the US," he said.

Source of picture: Flickr

By John Richardson

"How do you put the genie back in the bottle?" asked China scholar Victoria Hui in this New York Times article, referring to the difficulty that China now faces in stepping away with something tangible from its dispute with Japan over the East China Sea islands.

Japan might not be able back down either and so the risk here, as we discussed last week, is that this could escalate into a military conflict with the US obligated to support Japan. Most other Asian countries could end up backing the US.

What is really motivating Beijing in all of this?

"For a long time, the legitimacy of the Chinese government has been based on two things," wrote Deng Yuwen, an editor at Study Times, a magazine run by the Communist Party's Central Party School.

"One is high-speed economic growth. The other is patriotism and nationalism,"

Now that economic growth is slowing, he added that "the Chinese government very possibly may become increasingly dependent on nationalism and patriotism."

Let's hope that both sides can find a face-saving compromise and that the crisis is, as a result, defused.

Meanwhile, as long as this political crisis rumbles on, everybody down all the petrochemical value chains might be well-advised to keep their raw material inventories at minimum levels.

The temptation, as oil prices rise, is to "buy forward", but one chemicals industry source told us: "If some kind of conflict did break out, oil prices and stock markets, which move together these days, would, I think, halve in value overnight.".

A major new report from BBC News suggests that "China's economic model is in danger" due to its rapidly ageing population.

It reaches exactly the same conclusions as in our Boom, Gloom and the New Normal ebook. Chapter 6, published in November 2011 was titled 'The Risks to China and India Growth'.

Now, what was often regarded as unthinkable is on its way to becoming mainstream. As the BBC website warns:

"Professor Cai Fang, a Chinese labour economist, estimates that the rapid decrease of the labour force will lower China's annual growth rate by 1.5 percentage points from now to 2015, and it will decrease a further percentage point during the period from 2016-2020.

"China's demographic dividend will end - the country's fast economic growth in the past three decades has been mainly led by exports, which are dependent on an abundant and cheap labour supply.

"A fast decline of the labour force will cause shortages and a rapid increase in wages. Such changes will weaken the competitiveness of China's export industries in the international market, affecting economic growth.

"China will need to undertake dramatic economic restructuring to deal with this problem.

"The rapid ageing process will also bring with it political difficulties. The legitimacy of Chinese communist party as a ruling group of the country since the Tiananmen Square massacre in 1989 has been based on its maintaining rapid economic growth.

"An economic slowdown could prompt challenges to party's legitimacy."

The BBC is rightly recognised as an authoritative and independent voice on economic issues. Their website contains enormous detail on the challenges now facing China.

Any executive whose business depends on China really owes it to themselves to view the BBC video above, and to study the detailed analysis on their website.

By Nigel Davis

The ICIS Company of the year award goes to NOVA Chemicals, a company that has risen phoenix-like from near bankruptcy to produce a healthy set of financial results in 2011.

Underlying its performance is the backing of a strong investor - the Abu Dhabi International Petroleum Investment Company (IPIC) - canny management and a clear strategic drive.

But NOVA is also catching a wave that in North America is seeing an almost gold rush-like swing to ethane cracking as more ethane supply opportunities come into play and ethane prices are pushed down.

NOVA benefitted in 2011 from a combination of factors including the low ethane price, the tightness and price volatility in liquid cracker co-products, and what it called a "virtually sold out" North American polyethylene industry. It could have a relatively good few years if ethane prices stay low and its new ethane supplies come on-stream as planned.

It has re-vamped its Corunna, Ontario, largely liquids-fed cracker to take more natural gas liquids (NGLs) and has first mover advantage on a number of deals to supply feedstocks to its plants that may prove critical in the years to come.

It has also been pushing the ethane advantage hard downstream into the North American polyethylene industry.

Supply/demand balances for ethylene and polyethylene were tight in 2011 which helped lift profit margins and while the first half of 2012 has not been great, with pricing pressure in the second quarter, there are some signs of a recovery.

The company posted record net profits of $615m (€474m) from $263m in 2010, on 15% higher sales of $5.2bn. It managed to produce first-half 2012 net income of $380m, almost at the record level of $388m earned in the first half of 2011.

NOVA is driving its feedstock advantage directly into polyethylene and, according to CEO Randy Woelfel, wants to keep the focus on the North American market.

The company will be one of the first chemical players to start drawing on ethane associated with shale gas drilling in North Dakota in the US. It also has an agreement in place to take ethane from shale gas exploitation in the important Marcellus deposit in the northeast of the US.

It has been troubled by dwindling ethane supplies to its cracking furnaces in Joffre, Alberta, but an agreement with Williams Energy will see it take a mixed ethane and ethylene stream from the oil sands off gases that Williams pipes out of Canada.

NOVA has spent money on its cracker at Corunna, where it also has a refinery, to enable it to crack more NGLs. It is buying more WTI (West Texas Intermediate) marker crude price-linked barrels of oil for the refinery, moving away from an historic tie to crude from the Mediterranean.

Driving this advantage downstream into polyethylene is clearly the name of the game and NOVA has planned two significant polyethylene additions using its proprietary Novapol and Sclairtech technologies. Woelfel wants NOVA to concentrate on the North American polyethylene market which has been tight for some years now.

Having re-aligned the company since he took over in 2009, the year that IPIC made the astute move to buy at NOVA's lowest ebb, Woelfel has, with IPIC's help, restored confidence in the firm.

The 2020 strategic plan is being put into effect now but the CEO is already talking about NOVA 2030 and where the company goes next. The challenge is to put real meat on the bones of those ideas.

There is a great deal of money to spend in the interim - NOVA has identified a total of $1.75bn of potential capital expenditures in its filings to the US Securities and Exchange Commission (SEC).

The good thing, however, is that the company and its owners are building on existing infrastructure and not striking out on green field investments - with their accompanying costs. The trick when additional supplies of ethylene, polyethylene and other ethylene derivatives come on-stream in North America in a few years time will have been to have made the investments in new assets economically and quickly.

The ICIS Company of the Year award is described in this week's edition of ICIS Chemical Business, published on Monday.

And while NOVA was a clear winner in the analysis, it was by no means alone in reaping the benefits of lower priced ethane in North America and an improved feedstock mix.
The average gain in operating profit or EBIT (earnings before interest and tax) across the ICIS Top 100 Chemical Companies of 8.4% shows that 2011 was a good year for the sector as a whole.

The strongest performers in 2011 in the diverse group of companies that make up the Top 100 ICIS chemical players were those that were able to capitalise on low-priced gas feedstock, in some on cases emerging market growth and in the case of the dominant fertilizer producers, strong agricultural demand.

It is not only petrochemical players that stand out in the analysis but also some of the major fertilizer producers and certain companies focused on products that rose sharply in price on supply tightness or other factors, such as the white pigment, titanium dioxide.

The top five players in the ICIS analysis were NOVA Chemicals, US-based Praxair, Saudi Arabia's SABIC, Canada's Potash Corp of Saskatchewan and US-based Eastman Chemical.

By John Richardson

A NEW research note from our colleagues at International eChem discusses how central bankers have pledged to do "whatever it takes" to achieve a sustainable economic recovery. Click here for a full copy - Research-Note-24Sept12.pdf.

Their well-meaning efforts have failed, and are instead likely to do the exact reverse of what is intended as a result of the soaring cost of crude.

As the chart above illustrates, oil prices are now at levels that have historically always led to recession.

Quantitative easing, and other central bank efforts to rescue the global economy, have led to more expensive crude - and could lead to other asset bubbles in Asia.

The reason, in the case of oil, is that printing money has led to rising investor concerns over currency risk for both the US$ and the euro, and about inflation risks.

Investors see crude oil markets as a potential 'store of value'. Some now even believe oil markets should be seen as part of a broader commodities-based asset class, rivalling equities and fixed interest.

Oil markets have proved unable to absorb these one-sided flows of money. Those value investors who attempted to realign the market with the fundamentals of supply and demand were swept away.

And the effect on petrochemicals is that as crude has increased over the last few months, we are have been dragged into another "buying forward" cycle, which works as follows:

*Manufacturers cannot adjust their prices on a daily basis to reflect higher oil prices. They are locked into fixed price contracts with their end-user customers, often for 6 months or more.

*When oil prices start to rise, they cannot simply sit back and allow future margins to disappear. Instead, they are forced into the market to stockpile raw materials before prices rise.

*This process continues until it becomes apparent that prices have plateaued. Then companies seek to destock again, but find this difficult as their immediate customers are also destocking.

*At the same time end-consumers have all been reducing their purchases, due to the loss of discretionary income. This then creates a double whammy for profit margins.

By John Richardson

THE blog was in Amsterdam this week for an ICIS training event involving delegates who were European chemicals and polymer buyers.

They had one overriding question for us: "How on earth do we manage the extreme volatility in our raw-material costs?"

The answer we gave was to not confuse oil-price driven temporary surges in demand as a genuine improvement in economic fundamentals.

As we discussed yesterday, this is far easier said than done. The blog is grateful that it is not a purchasing manager.

We provided some market intelligence on where we thought "real demand" was heading, primarily, of course in China.

And we pointed delegates to chapter 6 of  our e-book, Boom, Gloom & The New Normal, published last November, where we raised the importance of good people on the ground, able to spot the shifts in final consumer markets that can often be masked by the extreme volatility of crude. As economies weaken, we think it would be a mistake to cut back on this cost.

We also quoted a Hong Kong-based polyolefins industry executive, who last month told us: "The key to success is to stay on top of developments in the economy, society and politics and constantly think how these are changing and how you need to reposition your business.

"You need lots of good people on the ground who can detect micro changes at the level of your customers that can become major economic and social trends."

And we hinted that the delegates should disregard the nonsense talked by financial markets - for example, after the August bond-buying decision by the European Central Bank. At that time, the view being peddled by investment banks was that the new ECB policy would give Europe more time to solve its problems.

But as this week's events in Spain have illustrated, the underlying social, political and therefore economic problems that are at the root of the European crisis haven't gone away.

Perhaps we should have also offered the delegates one other piece of advice: Lobby politicians in an effort to force through better regulation of oil and other commodity markets.

This week came the good news that Germany is planning to impose new legislation on high-frequency trading.

An example of extreme volatility in chemicals markets has been provided by events in European polypropylene (PP). As my colleague Linda Naylor wrote in this excellent article:

*European PP buyers paid increases of at least 9 percent in September, but are now waiting for lower October offers.

* PP volatility has been mainly down to movements in the naphtha market. During the week ending 22 June, naphtha slumped to a low of $683/tonne but it peaked at $1,005/tonne during the week ending 14 September. Its high point in 2012 was in the week ending 2 March when it reached $1,083/tonne.

*"I am seeing my suppliers next week," said one PP buyer, "but it's not to talk about pricing, it's to talk about volatility. We just can't manage like this."

Credit: Odysseas Gp Creative Commons BY NC SA

By John Richardson

WHEN the Fed launched its third round of quantitative easing (QE3), a Perth Australia-based investment analyst said:

"I get the feeling that people are waking up to the fact that the Fed has lost all ability to improve the real economy.

"The balance sheet expansion only goes to help banks and that is where it ends. The liquidity is not flowing into the broader economy and is certainly not helping the job market. I think this rally will be short lived.

"Gold and oil will run, I agree. Each QE-related equity rally gets shorter and shorter and this will be the shortest."

He was right. Just two weeks after QE3 was launched, and three weeks since the European Central Bank announced its bond-buying scheme, underlying and long-term economic problems have brought stock-market euphoria over further money-printing to an end.

In Greece and Spain, for example, social unrest over austerity has returned. This was always going to happen because, as the investment analyst pointed out, central bank money has done nothing to help the 99.9 percent who are not big-time investors in equities and commodities markets.

The Financial Times went as far as to warn that "austerity is a centrifugal political force" - hence, increased calls for Catalan, and possibly Basque, independence.

Western European, at the time of the break-up of the former Soviet Union, quite rightly claimed that this demonstrated the strength of the democratic model of government.

But now, because democracies are failing to help the 99.9 percent, Western European will face greater pressures for the creation of more independent nation states.

We need to work towards solutions through government policies that help the majority, including recognising that ageing populations in the West represent both a challenge, and a tremendous opportunity.