Asian Chemical Connections

Picture: US shale gas worker

Source: Image Broker/Rex Features

By John Richardson

SHALE-GAS exploration in northern Saudi Arabia shows tremendous promise, said an industry observer on the sidelines of last week's seventh Gulf Petrochemicals and Chemicals Association (GPCA) conference in Dubai.

"The main purpose of the Saudi Aramco project is to generate methane for power generation that would reduce the need to use fuel-oil for electricity production," the source added.

"However, it is possible that the project could also yield additional ethane supply for petrochemicals."

Bloomberg reported in early November that SABIC was planning to invest in shale-gas technology in the US and elsewhere.

"SABIC'S venture capital arm is looking for opportunities in the US, Europe and China to buy stakes in start-up companies that can turn shale gas into petrochemicals, according to Ernesto Occhiello, SABIC Ventures' executive vice president for technology and innovation," wrote the wire service.

The industry observer added that with 80% of Saudi Aramco's capital expenditure on hydrocarbons exploration in the Kingdom devoted to gas exploration, the future will not necessarily remain the same as the present: Constrained ethane supply that is limiting SABIC and its competitors from further expanding basic petrochemicals capacity in Saudi Arabia.

SABIC, however, isn't expected to add ethylene capacity at home for at least the next five years because of the shortage of ethane.

And, even if more ethane does become available, projects would still have to involve more than just basic petrochemicals production in order to obtain an allocation, the source added.

"In return for being given ethane to make hugely profitable downstream polyethylene (PE) and mono-ethylene glycol (MEG), any project would have to also include substantially less profitable 'value added' derivatives,' " he said.

As we discussed last week, this is part of Saudi's job-creation agenda.

The shale-gas revolution took the petrochemicals industry by surprise and so the question foremost in the mind of the blog as it visited the GPCA event last week was, "What might be the next game changers?"

Could one such game changer be a return to ample ethane supply Saudi Arabia in the longer term?

What would this mean for, perhaps, an overconfident US petrochemicals industry? It seems to have become convinced that, thanks to its own abundant and very cheap feedstock ethane supply, it has the field pretty much to itself.

And, as we continue to argue, demand is the thing that everyone needs to worry about.

By John Richardson

ONE interpretation of the rise in the HSBC China Purchasing Managers Index to a 13-month high in November is that next year promises a strong recovery in the world's most-important chemicals market.

"People have taken considerable cheer from not only the HSBC report, but also other data points that might be interpreted as indicating that the Chinese economy has finally bottomed out," said a chemicals industry analyst.

"But I tend to think that the problems in China are far too deep-seated and structural for anybody other than someone with a very short-term perspective to gain any real confidence from the recent data."

We agree.

It could be that the improved HSBC index reflects a politically-motivated surge in bank lending during May-September.

During that period, the Communist Party was eager to shore-up support ahead of last month's leadership handover.

Now that the handover is obviously over, this might explain why bank lending declined by 14% in October. 

And so it is possible that the improved HSBC index reflects money that flowed into the economy prior to the October slowdown in lending.

Petrochemicals markets are showing no signs of renewed confidence.

This is likely to be partly because the back end of the year is traditionally quiet as producers and buyers wind-down their inventories in order to beautify their financial results.

But we tend to think that an important other reason is recognition that China is in an economic bind, although many people remain reluctant to publicly admit this.

"The mood remains very depressed out there. There has been no significant pick-up in demand," said a market intelligence executive with a leading Middle East producer on the sidelines of last week's Gulf Petrochemicals and Chemicals Association (GPCA) conference in Dubai.

This is reflected in the key polyethylene (PE) market. While some Asian prices edged-up by $5-20/tonne for the week ending 30 November on restocking and attempts to repair margins, other prices declined by $10/tonne (see the above chart).

"Many buyers and suppliers remain concerned that downstream demand may not pick up significantly in the next few months," wrote ICIS pricing in its 30 November Asian PE report.

We might get a clearer idea of the real state of China's economy in January next year, when the May-September lending surge and the year-end slowdown effect have worked their way out of the system.

But even then, any short-term bounce will have to be put into the context of the big structural problems - not least China's bad-debt problems, which is a subject we shall revisit in a series of posts over the next few days.

By John Richardson

A detailed study of some of China's positive economic data for November adds a lot more weight to the point we made yesterday: The "recovery" is unlikely to last into 2013.

November marked the first time in over a year that both the official China manufacturing PMI and the final HSBC/Markit Economics PMI were above 50 (see the table below). Anything above 50 marks economic expansion.

(The indices were released earlier this week. HSBC/Markit Economics released a "flash", or preliminary, PMI for November a few weeks ago.).

A 3 December post from the FT Alphaville blog says, referring to data from the final HSBC/Markit PMI: "While output was strong (up from October's 48.2 to 51.3 flash), more forward-looking indicators were less encouraging than in October.

 "Finished goods inventory edged up from 48.4 to 48.8 (flash 49.5), signalling that inventories are being run down at a slower rate. New orders weakened from 51.2 to 50.8 (flash 50.1).

"So the 'new orders' are not as bad as in the flash, and still on the right side of 50 - but they are down quite a bit from October.

 "This is not helping the drawing down of inventories, which had built up to problematic levels around the middle of this year, but were beginning to abate in the past few months.

"Input inventories remained in contraction with the latest reading of 47.9 (versus. 47.3 in October), while finished goods inventories were run down at a slower pace (48.8) than in the previous two months (48.1 in October and 47.9 in September).

"Perhaps worse though, is the absence of any sign of improvement in employment manufacturing."

The table below is from the official PMI shows that the employment situation has worsened. It also indicates a build-up in raw material and finished-goods inventories.

                   Source of table: FT Alphaville

Rising unemployment also reflects the ageing of China's labour force and increasing automation, adds the FT Alphaville post. 

A further factor could be that the May-September economic stimulus was more of the "same old, same old" - money channeled from official state-owned lenders to the state-owned enterprises (SOEs) and local government infrastructure projects, rather than the private sector.

China's small and medium-sized enterprises (SMEs), which are responsible for an estimated 60% of economic activity and 75% of employment, dominate the private sector. The bulk of buyers of chemicals and polymers in China are SMEs.

(As tomorrow's blog post shall detail, the SME's have become increasingly dependent for their financing on the "shadow banking system", which could be China's equivalent to the US sub-prime crisis.)

In order for the recovery to be sustained, China's new leaders would have to launch another big stimulus package in 2013.

But that would lead to further inventory problems, and might do nothing to lower unemployment if the money continues to mainly flow to the well-connected SOEs. This seems highly likely as the reform process is in its early stages.

Inflation would also become a bigger problem. The consumer price index (CPI) index, even without another big surge in bank lending, is set to once again rise above 4% by mid-2013. 

China battled against inflation at above 4% throughout 2011 and during the early part of this year. The rate of food-price inflation is of particular importance for economic activity, and for social stability, as China remains a poor country. 

This indicates that monetary policy in 2013 is likely to become neutral or will involve a tightening of credit conditions.

More big stimulus would also set back economic rebalancing while worsening the bad-debt crisis, as the IMF indicated last week.

What is more, the leadership transition is over and so there is less of a need to buy public support.

We therefore think there will be no new big stimulus package in 2013 - barring an economic collapse in the West that causes Beijing to panic.

As a result, growth is likely to slow again as China confronts a very painful and prolonged period of economic adjustment.

By John Richardson

IN the best of all possible worlds, more than a billion people in the emerging markets will become a great deal richer over the next few decades.

As a result, they will be able to much more easily afford all of the things made from, or containing, chemicals and polymers - such as plastic wrapping for their food, refrigerators, automobiles and homes.

This was the assumption underlying many of the discussions the blog had with industry executives at last week's Gulf Petrochemicals and Chemicals Association (GPCA) conference in Dubai last week. Yet again, as we have heard so many times before, it was widely assumed that "if we take care of feedstock advantage, and other key elements of cost efficiency, all we have to do is build capacity in basic petrochemicals and demand will take care of itself."

Perhaps this upside scenario will prove to be correct. But what if it proves to be wrong? How smooth will the process of emerging-market personal wealth growth ultimately turn out to be?

An example of the increasing complexity of the demand environment - China's shadow banking system - has gained more attention this week.

"Shadow banking is flourishing in China, helping to make non-bank institutions as big a source of credit as banks themselves since July - something that has never happened before," wrote the Financial Times, in this article.

"Chinese bankers, leading rating agencies and the International Monetary Fund have all warned about risks from the surge in loosely regulated lending, with some even pointing to parallels with developed economies before the global financial crisis. But the Chinese government itself has taken a permissive stance," added the newspaper.

The FT said that:

*Estimates about the size of shadow banking vary widely depending on how it is defined. Tying together various threads of official data, UBS economist Wang Tao believes it is no smaller than Rmb13.6tn ($2tn), or about one quarter of this year's gross domestic product, and could be as big as Rmb24.4tn, or nearly 50% GDP.

*Trusts, the backbone of the shadow sector, had Rmb6.3tn of assets under management at the end of the third quarter, up 54% from a year earlier and five-times more than at the start of 2009 (see the chart below for another estimate of the growth in trust funds).

A problem is that, just as was the case with sub-prime, people are investing in the shadow-banking system on the assumption that asset prices will always increase in value. In tomorrow's post, we will explore why this idea might be flawed.

"It has begun to get to a degree like we saw in the financial crisis in the west. Products are being created that regulators don't fully understand, banks don't fully understand and customers don't fully understand," a commercial banker, who used to work as a regulator, told the FT.

We also worry that the small and medium-sized enterprises' continued reliance on the shadow-banking system indicates the difficulty in increasing their economic role at the expense of the over-dominant, economically-damaging SOEs.

And in general, the opacity and complexity of the shadow-banking system suggests to us that the government will struggle to prevent further misallocation of capital and asset bubbles.

What do these latter two points mean for economic rebalancing?

By John Richardson

THE China bulls will no doubt claim that the shadow-banking system isn't a systemic risk to the country's financial system and thus, of course, the world economy and the investment strategy of many chemical companies.

They might be right. Or they might be wrong. Assuming they are right is dangerous.

"The economic slowdown does not seem to be the only cause (of the rise in non-performing loans), and, in many cases, not even the major one," said Wei Yao, China macro strategic at Societe General, in August.

"The common mistakes include involvement in speculative activities (eg property speculation or commodity trading), massive capacity expansion (eg shipbuilding and solar panel manufacturing), outsized commitments to complicated webs of mutual loan guarantees and high exposure to underground banking (eg many small and medium-sized enterprises in Zhejiang).

And as the FT Alphaville blog wrote, again in August: "While previous financial crises don't show a very consistent relationship between the scale of credit growth-to-GDP and the scale of the subsequent crisis, research compiling 42 crisis episodes shows that average annual credit growth to GDP was 8.3% preceding these events.

"China's (credit growth) growth was 27.9% in 2009 and 20% in 2010 (see the above chart)."

The latter statistics might not fully take into account the scale of China's shadow lending, given the huge difficulty in making such an assessment.

And so now let's think about what's happening in China's property sector, the target of a great amount of speculative investment.

Chinese apartment values actually fall when someone moves into a building, so instead they are being kept empty and unused.

Here is one interpretation of how the property market boosts the economy:

*Land is obtained at a low price, or even for free, from rural communities.

*Local governments sell the land to the property developers.

*The developers then sell the apartments, which never get occupied, but they do get traded and are used as collateral.

"This explains why you can get current price: earnings ratios of 14:1 in China's Tier 1 cities, compared to a maximum of 5:1 at the peak of the US subprime bubble," said a keen observer of China.

"China has lots of land, and so theoretically the game can continue for years more. But only if there is still cash to fund the system," he added.

House prices have picked up, thanks to official lending via the May-September economic stimulus package.

This has helped to keep the bubble inflated.

Plus, as the FT pointed out in the article we linked to yesterday, the official lenders are making money from wealth management products (WMPs).

The WMPs fund the shadow-banking system from which some property developers are getting their money.

What happens if economic reforms, including a reduction in speculative lending, take the air out of the bubble?

Beijing might even end up being frightened of reforms as fixing the problem could be a systemic risk.

Not fixing the problem kicks the can down the road, inviting a bigger crisis later on.

A lot more than just the standard Model T.,,,

Source of picture: cCSU Archv/Everett/Rex Features

By John Richardson

THE question on my exam paper this Monday morning is what this outstanding article by the author, Charles Fishman, in The Atlantic magazine, means for the petrochemical industry.

We have all become used to the idea of the constant "hollowing out" of manufacturing in the Western world - a theme that the blog has discussed on many occasions during ICIS training's Petrochemicals I - An In-depth Introduction course.

Our slides are being adapted. What's clear from Fishman's article, and from plenty of earlier evidence about the recovery in US manufacturing, is that the old outsourcing model is changing.

Innovation in finished products will enable US companies to re-discover the lost skills of constantly improving the design of products made impossible by the tyranny of geographic distance - a big fault with outsourcing.

It will also become much easier to create niche products to serve ever-smaller groups of customers, as a result of the absence of long supply chains and the advent of 3D manufacturing.

For components suppliers, such as plastic processors, this will require an equal amount of innovation.

They, too, will take increasing advantage of 3D manufacturing to help with constantly improving the design of products, and to make much-smaller batches of products to suit niche groups of customers.

If the mass-manufacturing model for plastic processing is now under threat, what does this mean for petrochemical producers in the US?

Will they also need to also re-consider the current model of building huge million tonne-plus petrochemical complexes to serve homogenous "plain villa" manufacturing industries?

The enticement for all the cracker projects in the US - which is also helping to drive the overall recovery in the country's manufacturing industry - is of course the shale-gas boom.

But will building big, based on cheap feedstock, be of less importance in this new environment than providing speciality grades of polymers in order to serve constant innovation in manufacturing? By their nature, the profitability of such grades is driven as much, if not more, by technology rather than feedstock advantage.

Or are we oversimplifying this? Perhaps we shouldn't get too carried away into thinking that the revival of US manufacturing signals an end to the whole outsourcing model.

Low-value manufactured goods will likely continue to be made in the developing world, increasingly maybe in South America, even if China has become too expensive. The US manufacturing revival will probably only be in mid and high-level products where labour costs are less of an important element of overall costs.

Thus, there could be plenty of room for lots of feedstock-advantaged new US crackers that can export their surpluses of basic polyethylene (PE) around the world, while making a few speciality grades to serve local markets.

But what about the total demand picture? We still worry about demographics and what this means for the US, and many other economies. We are concerned that there will simply not be enough demand to absorb all of these new crackers.

And further - the Chinese might build a lot more capacity than some people think, in order to boost their self-sufficiency in petrochemicals, and take advantage of their own cheap feedstocks. The Middle East could also find a great deal more ethane.

Where will the US place of all it surplus perrochemicals? 

Let's finish on a really positive note, though: The return to innovation in local manufacturing in the US could help make all the products that don't even exist today, that will be needed by the Babyboomers as they get older.

This should also provide lots of meaningful work for young people in manufacturing industry.

Please let us know our grade for our answer to this morning's exam question.

South Korea and its consumer-driven economy

Source of picture:  KeystoneUSA-ZUMA/Rex Features

By John Richardson

MEASURING demand growth cannot involve merely assuming that the future will be the same as the past, as this increasingly complex world continues to tell us.

There are a myriad of social, political and environmental factors that will determine the rate of chemicals and polymer consumption-growth, now that the Supercycle is over.

In chapter 10, of our e-book, Boom, Gloom & The New Normal, we compared 1960s-1980s South Korea with China. Back then, South Korea used investment as a driver of growth.

It limited freedom of expression, the development of a civil society, and the innovation crucial for any country to escape the middle-income trap.

It wasn't until the election of Roh Tae-woo in 1987 that South Korea removed the last remnants of authoritarian rule. This seems to have been a significant in South Korea becoming a consumer-driven economy, and in being able to manufacture world-beating branded goods.

Support for our arguments is provided by an article by Tom Miller, managing editor of the China Economic Quarterly (CEQ) and author of China's Urban Billion (Zed Books, 2012). 

China could be at a similar crossroads today, but as Miller points out in the December issue of the CEQ: "Investment's share of GDP (in China) shot up from 35% in 2000 to 49% in 2010, while household consumption's share shrank from an already measly 46% to just 34%.

"No other country has ever grown with such a high share of investment and such a low level of consumption - not even South Korea or Taiwan, whose experience of economic take-off China most resembles.

"China's investment-driven model of economic development is widely viewed as wasteful, and even the country's leaders agree that it is unsustainable. Over the coming decade, investment growth must slow."

Miller's comparison is with how Taiwan has developed over the last two decades.

He writes: "For all its enormous development, China still lacks genuine civil society - a space where people can form associations and, should they so wish, spend their money together.

 "Public events in China, such as music festivals, are routinely cancelled because they fail to meet official stipulations. "Chinese cinema is bland and unappealing because films must pass the censor.

"Private charities do not exist, because they are deemed a threat to government authority. In Taiwan, by contrast, citizens may associate freely.

"In October 2012, 50,000 people marched through Taipei in support of gay rights; the city has many bars and shops, even bookstores, specifically catering to gay customers.

 "In China, non-mainstream interests--especially those without official approval--struggle to exist at the margins.

"Taiwan's experience shows how political liberalisation helps to nurture private consumption. China's rigid political system is no barrier to much greater consumption: as its citizens grow wealthier, they will spend more.

"But by reducing the opportunities to consume, social repression is a drag on consumption's full potential. Like self censorship, it is insidious and hard to spot--yet the economic impact is considerable. China's consumer economy will remain stunted."

By John Richardson

CHINA's polyethylene (PE) demand growth was up just 4% in January-October of this year compared with the same period in 2010, as the chart above from Global Trade Information Services (GTIS) indicates.

And yet in January, many of the people the blog spoke to were confidently predicting double-digit demand growth for 2012.

What has gone wrong?

Few people recognised the painful transition process that China is undergoing. We can expect low petrochemicals demand growth in general for several years to come as this process plays out.

Meanwhile, further evidence has emerged that China's economic "recovery" might amount to little more than a temporary, unsustainable dose of government stimulus designed to make the leadership transition easier. Total exports were up by just 2.9% in November, compared with analysts' expectations of a 9% increase.

By John Richardson

Is the Chinese financial system on the brink of its equivalent of the US sub-prime crisis?

This is a concern we raised last week in this first post, and a second post, on China's shadow-banking system.

This article from the Wall Street Journal provides more evidence of the risks ahead.

The chart below shows the rapid growth in wealth-management products (WMPs) issued by the state-owned banks anxious to boost their deposit ratios. WMPs are linked to the shadow-banking system.

At the end of every year, when regulatory reviews are imminent, there is usually a race to boost deposit ratios, says the WSJ.

"But what makes this year different is that "competition is fiercer because banks are facing tighter funding conditions," the article adds.

"The rapidly growing WMP market is causing concern among regulators. WMPs are pools of stocks, bonds, currencies or loans, repackaged by banks and marketed to their customers, much as mortgages were repackaged into securities for investors in the US before the financial crisis."

We interviewed a senior petrochemicals industry executive a few months ago who told us everything was fine in China because it had a strong government that "gets things done".

This is not the case, we think, because of the way the system works, as we shall explore tomorrow. There are many competing interests pulling in different directions. For instance, in some cases the state-owned banks and state-owned enterprises have more power than the government ministries which are supposed to control them.

Source: The Economist

By John Richardson

ONE of the blog's Indian friends said last week, as he worries about his country's political failings: "I sometimes wish were more like China, where, when the Politburo says 'do this' it is done.

"Here we, perhaps, have an excess of democracy. If we want to get a bridge or a power plant built it can take decades."

But the blog is beginning to think that this might not be that straightforward a comparison.

During the supercycle, when all the economic stars were aligned in China's favour, the various actors in China's political system maybe found that it was in their interests to pull in the same direction.

Local governments, for instance, made a fortune from acquiring land for free or for next to nothing from rural residents, as state-owned enterprises (SOEs) made equally big piles of cash from strengthening their hold over the economy.

Now, though, China is at a crossroads as it seeks to reform its economy.

The problem is that the "vested interests" have strong motives to keep things as they are; and because of an opaque and complex political system, they could have a great ability to do so.

"Central ministries rank equal to provincial governments. So do many large SOEs, a fact which, according to a study by America's Congressional Research Service, leads to vast regulatory difficulties," writes The Economist in this article.

"SOEs, it said, sometimes outrank party and state leaders in their locales, and so are not bound by their orders. China's five largest banks have comparable rank to the banking regulator, allowing them to resist oversight."

(See the above chart explaining the power relationships between various different levels of government).

Local authorities may, therefore, be able to continue to build wasteful and inefficient infrastructure, while continuing to seize land to sell to property developers.

And the SOEs might add more wasteful industrial capacity, while continuing to channel money to companies set up on the side. SOE officials routinely carry several business cards, one for their official jobs and the others for their private businesses.

All of these scenarios seem likely to persist if Beijing, as it did in May-September, launches more economic stimulus packages because of worries about growth slowing due to economic reforms.

Meanwhile, China's big state-owned banks, as we discussed yesterday and last week, may successfully resist efforts to reign-in financial speculation. This could substantially add to China's bad-debt problems.

Much of the focus during the leadership handover was about which faction within the Politburo would gain the greatest control, as this was thought to be an important indication of China's economic direction.

Was this the wrong focus?

By John Richardson

CHINA'S polyethylene (PE) market is enjoying a mini-rebound on improved confidence in the ability of politicians to turn the economy around, the blog has been told.

There seems to be a feeling out there that more help is on the way for the small and medium-sized enterprises (SMEs). The SMEs, which make up the bulk of the country's polymer buyers and account for most of China's economic and activity and employment, have struggled since April 2011.

"As a result, restocking is taking place in what is traditionally a quiet time of year," said a source with a global polyolefins producer.

"This is partly because stocks were low in October, but is also due to the belief that Xi Jinping and the rest of the Politburo really mean business, which was underlined during Xi's tour of Guangdong last week.

"The new leaders are talking about serious economic reform, which will involve raising the role of the private sector in the economy, and have already started a major crackdown on corruption.

"When Hu Jintao came to power ten years ago, he talked about dealing with corruption but it was all talk - nothing happened. This time it seems to be different."

And he added that Xi's Guangdong tour further helped to boost sentiment because he dispensed with heavy security during his walkabout, giving the impression that he is a "man of the people".

But while cost-advantaged US and Middle East were reaping the benefits, he cautioned that substantial further price rises would have to occur for Asia ex-China producers to feel the benefit.

As we discussed last month, Northeast Asian (NEA) integrated naphtha-based high-density polyethylene (HDPE) margins were recently at their lowest point since 2000.

Let's not look a gift horse in the mouth, though: Last week saw integrated NEA HDPE margins increase by $54/tonne, thanks to a $20/tonne increase in prices and lower feedstock costs, according to the ICIS pricing Weekly PE Margin Report.

A question which might be asked in a many a boardroom is, "Will it last?"

By John Richardson

A MAJOR political battle is taking place in the US over the future of the booming natural gas industry which could well have major implications for the country's petrochemicals industry.

There was angry reaction from Dow Chemical CEO Andrew Liveris on 6 December over the contents of a Department of Energy (DOE) report on US liquefied natural gas (LNG) exports.

The report promotes the economic virtues of granting more approvals for LNG projects. It estimates that exports could deliver a $47bn boost to the economy.

But Liveris said that the report was "flawed, misleading, and based on outdated, inaccurate and incomplete economic data," and that it failed to give due consideration to the importance of manufacturing in the US economy.

"Manufacturing is the largest user of natural gas in the US, and creates more jobs and more value to the US economy from natural gas than any other sector," he continued

"The value of every unit of energy used by the manufacturing sector is multiplied by as many as 20 times from the production of thousands of high value products though the value chain. Compare this to the 1-time value created by exporting energy as liquefied natural gas.

"Furthermore, for every manufacturing job created on the factory floor 5-8 more are created in the larger economy."

He talked of a US manufacturing revival, spurred by lower US energy costs. There are other factors behind the revival, as we discussed last week.

The chart above provides visual support for Liveris's arguments about the benefits that cheap gas can deliver downstream of petrochemicals.

The New York Times newspaper, in this 15 December editorial, took a very different view to Liveris when it wrote: "While the (DOE) report dwells largely on economic issues, exports would also help to lower emissions linked to global climate change by giving countries like India, China, Japan and Germany access to a cleaner energy source than coal.

"Greater gas exports could also factor into American foreign policy. By offering countries like India and China access to cheap American gas, Washington could make it more palatable for them to join in supporting sanctions against Iran, for instance. And it could give the United States new leverage in trade negotiations."

Another geopolitical dimension has been added to the debate by US Senator Richard Lugar.

"Senator Lugar (Republican-Indiana) introduced a bill this week that essentially would establish an energy free trade agreement between the US and each of the 28 member nations of the North Atlantic Treaty Organisation (NATO)," wrote my colleague Joe Kamalick in this 13 December article.

"He said the legislation, titled the Liquefied Natural Gas for NATO Act (LNG-NATO Act), was needed to protect US security interests by insulating US European allies from energy blackmail at the hands of Russia."

If passed, the bill would make the 15 US LNG projects a great deal more viable.

This all adds to our argument that the viability of the numerous US cracker projects is far from being a slam dunk.

By John Richardson

AT LEAST one global polyolefins producer is rumoured to be shipping increased volumes of resin from the US to Europe in response to the shale gas-derived shift in competitiveness.

"Dow Chemical CEO Andrew Liveris is making a call on the global economy - one of multi-year slow growth - and adjusting the company's approach to maximise competitiveness in this environment," wrote my colleague Joseph Chang in this article.

"But with six world-scale crackers scheduled to come on line in the US in the 2016-2017 timeframe, the economy better grow out of its funk by then.

"Liveris expects global GDP growth of around 2.5% in 2013, with China growing at a 6-7% clip and the US at about 2.2%. All figures are below historical norms.

"It is still years away, but the prospect of massive amounts of US ethylene and derivatives capacity coming on in a slow-growth global environment is not something to be relished. Much of that derivatives production will be targeted for exports."

Dow is pushing ahead with heavy investments in the US, while also announcing the closure of 29 plants - many in Europe. This involves an 8% reduction in its workforce.

Ethylene contract margins, however, still remain in positive territory, as the chart below shows from the latest ICIS pricing European Weekly Ethylene Margin Report.

But it seems logical to us that there will be increasing pressure from downstream industries in Europe for more discounts. Europe is in the midst of a multi-year economic crisis, the resolution of which rests on policymakers recognising that demographics drive demand. Mark Garrett, COE of Borealis, has said that Europe has entered a "ten-year stagnation period". 

How much longer can Europe carry on running its crackers at what blogger Paul Hodges describes as recession level operating rates? As the second chart below shows, Q3 rates remained at 80%. 

It seems reasonable, therefore, to assume that more boardroom discussions are taking place about restructuring the European industry.

Unless, that is, European producers are betting on a substantial reduction in the US feedstock advantage.

By John Richardson

CHINA appears to be in the midst of a two-speed recovery as a result of stronger domestic growth, while the export environment remains very bleak.

"Our polyethylene (PE) sales to converters who sell into the domestic market have picked up very well in Q4," said a source with a global polyolefins producer.

But he added that sales to export-focused processors were at what he called "recession levels".

(We discussed on Monday how another global producer was also enjoying strong fourth-quarter sales in what is normally a quiet time of the year as exporters wind-down inventories ahead of the end of the financial year. Buyers in China are also usually fairly cautions in December as they have half an eye on the Chinese New Year, which falls on 10 February in 2013).

The weakness of exports of finished goods was underlined by this article in The Economist, which said: "The recovery remains stronger in heavy than in light industry. It is also stronger in China's central and western regions than on the coast, where exporters tend to cluster.

"At the Canton Fair, China's largest trade fair, held in the southern city of Guangzhou last month, export orders were 17.5% lower than a year earlier.

"Official figures show that exports to the European Union have fallen by an astonishing 18% over the past year. Europe's chronic failure to resolve its crisis continues to cast a pall on China's prospects."

The EU, as we discussed yesterday, isn't going to recovery anytime soon and the 2013 economic prospects for the US hang in the balance, as a result of the fiscal cliff.

The positive side of the story, as the chart below from The Economist illustrates, is that industrial production grew by over 10% in the 12 months to November, its first double-digit increase since March.

Electricity output also grew by 7.9% over the same period.

But, sadly, it's necessary to pour more rain on the parade: Forward indicators in the final HSBC/Markit Economics Purchasing Managers' Index for November were less encouraging than those for October.

Further good news, though, as we again discussed on Monday, and fellow blogger Paul Hodges highlighted in this post, is that China's new leaders are making all the right noises. If the confidence of China's small and medium-sized enterprises can be further improved, the recovery might just gather some momentum in 2013.

But what are the odds of a US sub-prime style financial-sector crisis in China next year? Perhaps a more likely scenario is that tackling the problem will be deferred in order to give China's new leaders more time to settle in.

This latest article, from The Wall Street Journal, is further evidence of the scale of problem.

........Significant Commercial Production "At least Ten Years Away"

By John Richardson

A US-China Shale Gas Training Programme has been launched by the independent White House agency, the US Trade & Development Agency (USTDA).

An initial $378,000 will be invested to enable the US industry to travel to China and "help introduce Chinese energy sector officials and project sponsors to US shale gas best practices, policies and technologies," said the USTDA.

This all part of a US-China Shale Gas Resource Initiative that dates back to March 2009, following a meeting between President Obama and China's former President, Hu Jintao.

So what does this mean?

The blog's first thoughts were that there could be something geopolitical here - for example, helping to make China more energy independent, thus lessening its needs to seek energy resources overseas, backed up by greater spending on defence. This would put a strain on the US as it, perhaps, tries to reduce its own defence spending as part of balancing the budget.

But before we get too carried away, this might be purely commercial, as the following interview with a gas consultant suggests.

US support is sorely needed, by the sound of it, because of challenges of developing China's huge shale-gas resources, which we have discussed before.

China's shale-gas industry, and with it any wet gas feedstock for petrochemicals, seems to be at least a decade away from significant commercial production.

The consultant told us: "There are a lot of government-to-government connections between the US and China over shale gas, but I don't think this is geopolitical.

"This is being driven by collaboration between, say, a university in the US, one France and one in China to develop new shale-gas techniques that will be commercialised and, hopefully make money for companies in all three countries, while solving China's shale-gas problem.

"One of China's shale-gas problem is that its shale has a high clay content, and so in the worst-case scenario, you would be pumping chemicals and water in order to produce nothing more than a frothy, blancmange-style mess that has no commercial value.

"The US is a much more fortunate position as its shale is impermeable, very hard, and so it is much easier to frack.

"Thus, solving China's problem will quite possibly require new fracking techniques, new drills and new fracking fluids.

"The objective of the Chinese is to develop these technologies for domestic applications, with the eventual aim to sell them overseas.

"There has been a lot of talk about China being on the fast-track in terms of shale-gas development, but it doesn't look much look like a fast track to me.

"There have been two auctions so far, the first one of which was closed to all but a few Chinese companies with the second widened-out to more Chinese companies. But neither auction has allowed in foreigners and they need the foreigners for the technology.

"And so, a Chinese company has to first of all win an auction, and then find a foreign partner, which slows the whole process down.

"China's Ministry of Land has come out with a very ambitious target of producing 80-90 billion cubic metres a year of shale gas by 2020.

"From first identification through to significant commercial production of any gas resource normally takes ten years. China shale is likely to take more than ten years because of all these impediments."

A March 2012 Barclays Capital report said that China had set itself a target of producing 6.5 billion cubic metres per year of gas by 2015, accelerating to 600-100 billion cubic metres a year by 2020. This suggests that China is banking on some major technological breakthroughs. 

By John Richardson

WE wish our readers a great festive season and wish them all the best for the New Year. We will take a break and resume the blog on 28 December.

We really do wish we could be a great deal more optimistic, particularly at this time of year.

2012 has been a difficult year and we worry that next year will be equally, if not more, challenging.

The challenges in 2013 may include:

*Political and social instability in China. There are no guarantees that China's new leaders will, or even can, get it right.

*Even if the reform process is smooth, China faces what is likely to remain a weak export market, overcapacity across many industries, including even excavators, and the possibility of a US sub-prime style financial sector crisis.

*Spain might well have to default on its debt in 2013. "They're going to have to ask for help, and they're going to look for all sorts of things to call the restructuring - something other than the word 'default,', but it's mathematical: they just simply can't pay for it. They're going to have to have major reformation. Mariano Rajoy is really in deep trouble because he has no easy solutions," writes John Mauldin, the economist and financial writer.

* Everything is connected in this globalised world, of course, and hence China will struggle to revive its flagging export trade unless Europe bounces back, but this isn't going to happen in 2013 as Europe's problems will likely take at least a decade to fix. Further, Mauldin points out: "One of the things that we don't think about is how important European banks are to world trade - especially the French banks. They finance a great deal of world trade. They finance a lot of the trade that our country uses when they go internationally. All of these things are connected, and we have to find new ways to do things." France faces deep economic problems, including a debt-to-GDP ratio of 89.2% and unemployment at 10.2%.

*The US is politically dysfunctional. Sadly, the Presidential election solved nothing. Even if it gets past the fiscal cliff, sensible policies necessary to balance the budget, involving sufficient tax rises and spending cuts, seem unlikely.

Underpinning all of this is demographics. The global economy has lost its suspension.

Demographics drive demand and until or unless policymakers deal with this, we will continue to struggle.

The chart above, from fellow blogger Paul Hodges, looks at the G-20 nations who comprise 79% of the global economy.

The Y axis shows GDP/capita in US$, with the X axis indicating the median age for each country. The blue bubbles are the size of each country's economy versus the US.

The countries fall into three distinct groups:

*Rich but Old. These wealthy countries have median ages mostly over 40 years.

*Poor but Young. These relatively poorer countries have median ages around 25 years.

*Poor but Ageing. China and Russia are in their own group: China because it has lost 400m babies due to the one child policy; Russia because of its high cigarette and alcohol consumption.

By John Richardson

MOHAMED Al-Mady, the CEO of SABIC, told the Financial Times yesterday that he worries about Europe losing out on petrochemical investments because of its reluctance to embrace shale gas.

"Some European companies already made the decision to go into shale gas, so naturally when they do not there will not be development," he told the newspaper.

"I think the trend you will see (is) more investors going to North America, China and the Middle East."

France has banned fracking because of concerns over the impact on water supplies and other environmental issues.

The UK only allowed fracking to resume earlier this month under new, much-tighter regulations. This was a year after exploration was suspended following two small earth tremors in Lancashire.

Poland is in contrast forging ahead with exploration of its shale-gas reserves, backed by a very willing public.

"Ever since the US Department of Energy's April 2011 announcement that Poland may hold enormous quantities of shale gas - 5.3 trillion cubic meters, enough for 300 years of consumption - hydrocarbon fever has swept the country," said Dimeter Kenarov in this blog post for the Foreign Policy magazine.

"Even when the Polish Geological Institute and the US Geological Survey reduced those figures by 90% in early 2012, the faith in shale remained unshaken.

"Nowhere else in Europe has shale gas generated so much enthusiasm among both politicians and the public.

"The government has already granted 111 exploration concessions on an area of 35,000 square miles, or about a third of the territory of Poland, while polls from last year suggest that 73% of the country's nearly 40 million people back developing shale."

However, in the same blog post, Cezary Filipowicz, the business development manager of United Oilfield Services, a Polish shale-gas service company, said: "For many reasons - resources, ecology, the areas where production is possible - the revolution in gas supplies that happened in America will never happen in Poland.

"Whoever expects that we'll be an exporter of gas for the European market is dreaming."

The US is, of course, pressing ahead with numerous petrochemical investments.

And, as we discussed earlier this month, you cannot write-off the Middle East as a source of future supplies of very competitively-priced ethane.

So where does Europe go from here? It faces both feedstock disadvantages in the case of ethylene derivatives and, quite possibly, a decade of economic stagnation.

But Europe's economic problems are global - and there are a myriad of other macro-economic issues threatening the world economy.

We continue to worry that companies will be undone by macro-economics in this ever-more volatile world, no matter how hard they work at the traditional routes to success of feedstock advantage and economies of scale.

The solution lies in also taking a pro-active approach to developing new sources of demand, which we will discuss in a series of posts next week.