Asian Chemical Connections

Sorry for the corny headline; we couldn't resist it.

By John Richardson

THE argument that the switch to natural gas from coal and oil is good for the environment has been further undermined by reports earlier this week of the big increase in the amount of gas-flaring in the US.

When the blog visited the World Gas Conference in Kuala Lumpur, Malaysia, last June it felt very suspicious of the "isn't gas wonderful for reducing global warming" hype that dominated the event. We raised the concern over the rise in fugitive methane emissions as natural gas production continued to climb.

The focus has now switched specifically to the US and the 50% increase in flaring at the giant Bakken field North Dakota that occurred last year compared with 2011.

"Flaring in North Dakota increases by about 20% the greenhouse gas emissions resulting from the state's oil production, refining and transport compared with the US average," said the Financial Times in this article.

The volume of gas flared in the US as a whole has tripled in just five years and is now the fifth highest in the world, behind Russia, Nigeria, Iran and Iraq, according to World Bank estimates.

The photo at the top of this post, taken by NASA's Suomi NPP satellite, shows the glow being emitted from hundreds of flares at the Bakken formation.

The picture compares the Bakken glow from space with those from Chicago and the twin cities of Minneapolis-St Paul.

(Apologies for the blurriness of the picture. Anybody reading the post in Bakken is likely to find the image even more blurry than the rest of us, as the smoke could well be in their eyes.) 

The reason for increased flaring at Bakken and other fields is the shale gas Ponzi scheme, which has reduced gas prices to record lows.

Because gas is so cheap, producers are being forced to waste hydrocarbons.

From a national perspective this seems an almost criminal waste of resources.

"Oil companies at the heart of the US shale oil boom are burning off enough gas to power all the homes in Chicago and Washington," adds the FT. 

As long as gas prices remain where they are now, investment in extra storage and pipelines needed to reduce flaring is unlikely to occur.

What does this mean for the petrochemicals business?

Longer term, gas prices seem likely to go up as the financially under pressure US shale gas industry consolidates.

The glas flaring row could more immediately exert further environmental pressure on gas producers and petrochemicals companies.

Ultimately though, milllions more jobs will be created by the US energy boom, provided it is combined with education and immigration reform, and investment in better roads, rail and other infrastructure

Another key element for the success of re-shoring will be manufacturing new types of finished goods, and adapting existing products, for an ageing population.

We therefore think that the US general public is likely to accept the overall environmental cost of the shift towards energy independence.

Source of picture: Imaginechina/Rex Feature

By John Richardson

ONE can interpret last week's release of January purchasing manager's indices for January just about any way you like.

Thus, Reuters wrote on 2 February: "China's official PMI released by the government's statistics bureau showed factories grew slower-than-expected in January, with a reading of 50.4, easing from December's 50.6 and below forecasts for a nine-month high of 50.9.

"The official PMI has been above the 50-point level demarcating growth or contraction from the previous month since August 2012, though its failure to break above 51 indicates that the economic expansion it signals is only moderate.

"A private sector PMI released by HSBC, on the other hand, rose to a two-year high of 52.3 {This was the HSBC final PMI for January following the release of a preliminary reading a couple of weeks ago}."

"Trade prospects in China, the world's biggest exporter, appeared darker than those elsewhere," continued Reuters.

"The twin Chinese PMIs showed export orders either grew marginally or shrank in January as shoppers in the United States and Europe, the two biggest buyers of Chinese goods, cut back spending."

Contrast this with Bloomberg, which said on 3 February: "China's services industries grew at the fastest pace since August as gains in retailing and construction aid government efforts to drive a recovery in the world's second-biggest economy.

"The non-manufacturing PMI rose to 56.2 in January from 56.1 in December, the Beijing-based National Bureau of Statistics and China Federation of Logistics & Purchasing said in a statement yesterday {this is the official government PMI).

"The Shanghai Composite Index last week posted the biggest weekly gain since October 2011 on optimism that Communist Party leader Xi Jinping can sustain the nation's expansion and control the risk that inflation will accelerate in the second half.

"Strength in services may assist a shift to a consumption-driven economy as the government targets more sustainable growth and factory output contributes to record pollution."

Regular readers of the blog will hardly be surprised to discover that this latter news article has led us to be a little sceptical.

The official PMI tends to focus more on big state-owned enterprises rather than private companies as opposed to the HSBC alternative, which looks more at private-sector companies.

Thus, to what extent does the apparent growth in services genuinely represent economic rebalancing compared with more gains by monopolistic, inefficient state-owned giants?

And, as Sydney University's Dr John Lee points out, China's retail statistics lump unsold goods in warehouses together with sales to the final consumers.

Further, the growth in construction, highlighted by Bloomberg, has largely been driven by the economic stimulus package in May-October of last year, which was designed to shore up popular support ahead of the leadership handover.

The package has poured more money into inefficient construction projects and has re-inflated the property sector, according to another Reuters article, published on 20 January.

"China's average annual urban disposable income in 2012 was 24,565 yuan. Home prices meanwhile averaged 20,700 yuan per square metre in Beijing last year," said the article, which indicates that China's recovery has made the already difficult job of economic rebalancing a lot harder.

In addition, although December's retail sales rose by 15.2%, which was an eight-month high, UBS argues that the strong figure was largely the result of an increase in property transactions and spending on furniture and household goods {never mind the distorting effect of unsold goods in warehouses}.

HSBC adds that investment growth is making the biggest contribution to growth since 2009 - the year that China injected $640bn into the economy to compensate for the global financial crisis.

The 2 February Reuters article also says: "Price pressures were shown to be building in China, with both surveys indicating input prices at their highest since mid-2011."

We still think this "recovery" might have some more legs as money from last year's stimulus package continues to slosh around the economy.

But inflationary pressures, as Reuters and others have argued, are building. This suggests higher interest rates and the withdrawal of stimulus in H2.

Plus, Beijing continues to give every indication of a strong commitment to economically disruptive restructuring efforts, now that its new leaders are in place.

For instance, it is setting a target of growth in industrial production at just 10% for 2013, compared with an actual increase of 13.9% in 2011.

Even this 10% target would be difficult to achieve because of weak external demand and constraints on domestic demand growth, a government official told the China Daily on 24 January.

Wall Street rounding up investors?

Source of picture: Rex Features

In a guest blog post, Joseph Chang, the global editor of our magazine, ICIS Chemical Business, echoes our own concerns that it is getting very frothy out there. The "this time it will be different" school of thought sems to be controlling the sentiment of the US petrochemicals industry.

By Joseph Chang

US petrochemical companies and Wall Street analysts are getting more bullish on the outlook for the US petrochemical sector.

Buffeted by widening margins on low natural gas liquids (NGLs) feedstock costs as a result of the shale gas boom, and a tightening market, Dow Chemical CEO Andrew Liveris sees a "double peak" in the cycle before the flood of capacity in the form of new worldscale crackers comes on in 2016-2017.

This is not the traditional meaning of a double peak consisting of a peak followed by a dip and then another peak - rather a doubly good peak!

And "supercycle" is once again entering the Wall Street lexicon, as Morgan Stanley analyst Vincent Andrews sees the "potential for an ethylene supercycle in the 2014-2016 timeframe".

This would benefit large ethylene players in the US such as Dow, LyondellBasell and Westlake.

Few would disagree that US shale gas is a game changer, [perhaps not?] and it looks like there could be more upside in these stock prices.

But especially in a cyclical business, beware "game changers and paradigm shifts". Too many players shifting in one direction can lead to extreme swings.

By John Richardson

THE above chart shows that China's polyethylene (PE) demand growth has been well below that of overall GDP for most of the years between 2006 and 2012.

This supports the argument that economic growth has been too heavily focused on investment rather than consumption, given that the majority of PE goes into packaging and agricultural film applications rather than construction.

Another big factor behind the sub-GDP growth performance has been the increasing use of imported scrap, or recycled, plastic during periods of high virgin polymer prices.

This was particularly the case during 2006-2008 when the surge in resin prices, on the back of expensive crude, forced many plastic processors in China to switch to recycled material and/or to increase the use of fillers. Most of China's plastic processors are small and medium-sized enterprises (SMEs) with limited cash-flows.

In 2009, however, the recycling market dipped on new regulations and reduced availability.

2009-H1 2010 saw a huge increase in apparent PE demand growth (imports plus domestic consumption), partly because of the decline in recycling.

But the main reason for the demand surge was China's giant late 2008 economic stimulus package, which was designed to mitigate the impact of the Global Financial Crisis.

Polymers in general were being used as collateral for circular trades in other commodities and even property, as a major component of the stimulus package was a jump in bank lending that made speculation easier. 

A trader would, for example, buy PE just to get the credit to trade in, say, copper or to buy a condo in Beijing.

There was also a large build-up in inventories of both resin and of finished goods made from PE, as the easy lending conditions made taking long positions seem like a one-way bet.

But then, from April 2011, credit conditions became a lot tighter as the government grappled with inflation.

The first to suffer were the SMEs because of their poor access to credit and so they began to buy resin on a hand-to-mouth basis.

SMEs have long struggled to access credit because the state-owned banking system is set up to serve the state-owned enterprises.

This became an even greater problem when credit was rationed from April 2011, leaving the SMEs last in the queue for state-owned bank lending. They were forced to either cut production or go to private lenders who charge very high rates of interest.

Big stocks of both PE and finished goods made from PE, thanks to the credit binge, further depressed PE demand growth.

Q1-Q3 of last year was largely the same as the April-December period of 2011: A shortage of credit amongst the SMEs, whilst demand growth continued to be depressed by the lingering inventory problem.

But from May 2012, Beijing launched another stimulus package, albeit on a much smaller scale than the one introduced in late 2008. This latest package was designed to shore up support for China's new leaders as they prepared to take office.

Up until Q4 last year, commodity and financial markets were full of the notion that China might be heading for a hard landing.

Markets then seized on the idea that China was on a sustainable path to stronger growth - thanks to this new package.

The problem is that the May-October 2012 rise in bank lending and government spending on infrastructure projects is the "same old, same old".

The extra money has gone into more inefficient infrastructure spending and has re-inflated the property bubble.

Meanwhile, the SMEs, which are still paying interest rates of around 15%, are once again struggling with higher resin and fuel costs because PE and oil prices have risen.

Commodity prices have increased due to greater confidence in both the Chinese and Western economies.

What is different about this current cycle to previous PE cycles in China?

We think the answer is "nothing", because, as in 2011:

*The new stimulus package has made rebalancing even harder, thus potentially further suppressing the growth of consumption as a driver of economic growth.

*Inflationary pressures are building. For instance, input prices for manufacturers are now at their highest levels since mid-2011. Higher interest rates and a reduction in access to credit seem likely, mainly at the expense of the SMEs - as they also struggle to cope with higher labour costs and reduced labour supply.

*There seems every chance that the current euphoria in China will lead to traders repeating the mistake of taking excessive long positions in PE. Manufacturers of finished goods might also be tempted to overproduce.

*A lot of new PE capacity is on the way, which the market will probably struggle to absorb.

By John Richardson

THE US petrochemicals industry is battling hard to block an explosion in liquefied natural gas (LNG) investments that they fear would result in a rise in ethane, propane and butane feedstock costs.

Andrew Liveris, CEO of Dow Chemical, raised this issue in December, but the pressure from the industry on legislators responsible for approving LNG projects now appears to have been stepped up. Peter Huntsman, CEO of Huntsman, has now joined the fray.

Overall gas markets could tighten if a substantial number of US LNG projects go ahead, thus pushing up the cost of raw materials for steam cracking, the petrochemical industry argues.

In addition, LNG exporters might find value in leaving ethane in shipments in order to increase calorific values. Some customers, such as those in Japan, have a preference for "wet" LNG, which contains a small percentage of ethane.

Petrochemical companies are very concerned about protecting margins that have soared thanks to the shale-gas dividend.

For instance, Dow Chemical has reported a $413m (€306m) decrease in purchased energy and feedstock costs in Q4 last year, compared with the same quarter in2011, thanks to the shale-gas boom.

ExxonMobil saw a 76% increase in Q4 2012 chemicals profits, largely thanks to higher margins on cheaper raw materials.

LyondellBasell's Q4 profits were 68% higher for the same reason.

But how likely is it the US will see a flood of LNG investments that will tighten the gas market?

Some 246m tonnes/year of LNG capacity is being planned in the US, 152.8m tonnes/year of which have firm start-up dates, according to ICIS data.

Peter Voser, CEO of Shell, thinks that only around 50m tonnes/year of  LNG capacity is likely to built in the States. 

And Toledo Ohio-based Teo Consultancy, in this article in the Oil & Gas Journal, contends that the viability of many of the LNG projects is very much up in the air.
The above chart rates several of the US projects based on structural and financial advantages or disadvantages.

And the consultancy also writes: "The projected financial performance of proposed US LNG export plants supports the building and commissioning of at least a few of them. The proposed plants, however, face large risks. Potential supply-demand shifts in both the US and destination markets could result in price shifts much greater than the 10% used in this article's sensitivity analysis.

"Competitors can also act to damage the financial viability of proposed US LNG plants by, for instance, changing their pricing approach so that US exports will no longer be attractive. The success of such defensive strategies will depend in part on growth in global demand for natural gas in comparison with growth in supply outside the US.

"The extent to which China and India shift from coal towards natural gas will play a large role in determining the future supply-demand balance. China depends on coal for about 70% of its energy requirements, and India on coal for more than 50% of its. In contrast, natural gas only meets about "4% of China's energy requirements and 11% of India's, according to the International Energy Agency's 2012 World Energy Outlook.

"Neither country is likely to implement energy policies that will put economic growth at risk, making a shift away from coal towards natural gas likely only once an adequate supply of gas is economically available. Any major shift from coal towards natural gas therefore will be a reaction to, not a driver of, the supply-demand balance.

"Proposed US LNG plants also face currency-driven risks. A major appreciation of the US dollar would damage prospects for the proposed plants, especially with respect to the other major countries in the Organization for Economic Cooperation and Development (OECD). Europe's ongoing financial crisis increases the likelihood the euro will depreciate against the US dollar.

"Japan would prefer the yen also depreciate against the dollar, given the structural challenges that country faces in light of an ageing and shrinking population (our italics and emphasis) and continued dependence on exports. By contrast, however, the US dollar will likely depreciate against the major non-OECD currencies, including the Chinese yuan, as these economies continue to develop."

And what goes for LNG projects goes to what we fear could be a headlong rush into an excessive amount of petrochemical investments in the US: The global economic consequences an ageing and shrinking population.

By John Richardson

THE Nikkei Index has risen by more than 30% since November (see the chart below). Earlier this week, the Nikkei was at its highest level since September 2008.

Global stock markets are, in general, of course, on a roll.

This is fantastic news for the day traders and the electronic traders, who, according to a Perth, Australia-based resources analyst, have played a much-bigger role in overall equity trading activities since the New Year.

"First of all, we had stock markets rallying on thin overall trading volumes over Christmas and early January. Because activity was so think it only took a relatively small number of players with a positive outlook to get the rallies going," he said.

"Even now, overall volumes are nothing to write home about. Also of concern to me is the large number of day traders, and also extremely short-term electronic trades, in all the markets. This suggests an even more short term view of the fundamentals than usual - and that's saying something, as markets have become incredibly short term in their outlook since 2008."

The rally may have some legs in yet. This would offer further support to equities and commodity prices, including petrochemicals. Asian polyethylene (PE) prices were, for example, up by as much as $100/tonne for the week ending 1 February, according to ICIS pricing.

But as far as the blog can discern, last week's PE increases were mainly driven by traders taking long positions, as demand amongst most end-users was weak due to the Chinese New Year.

A key factor, perhaps, remains the strength of real demand, and the extent of new supply, after the New Year.

Or maybe not. "You won't get much traction for your ideas at the moment as everyone wants to believe there is a ray of light. This could, in itself, maintain the petrochemicals recovery," said an executive with a global polyolefins producer. 

Returning to the subject of Japan, what has essentially changed about its economic outlook since November? Nothing....

All that has happened is Japan's commitment to drive down the value of the yen. This hasn't suddenly, magically, created lots of new babies to solve a demographic crisis (see chart below).

In 2012, for the third year in a row, the Japanese population, according to this article in The Diplomat. The total decrease was 263,727, or 0.21% of the total population, representing approximately a 50% increase in number of individuals lost over the previous year.

Japanese government projections have shown that if current trends continue, today's population of about 127 million will be halved by the end of the century.

The argument driving the rally in the Nikkei and export-focused company share prices is, of course, that a weaker Yen will boost exports. But many of the exports will be to Western markets, which are falling over their own demographic cliffs.

But it would unfair to only single out Japan's contribution to what could well be a global currency war. As Reuters said in this article: "Japan's plan to aggressively weaken the yen has been the most recent salvo. But that merely counters open-ended bond buying and dollar creation by the U.S. Federal Reserve, pound printing in Britain or even Swiss intervention to cap the franc."

Meanwhile, the European Central Bank is the only one of the big four central banks unable or unwilling to create new cash and put a lid on its exchange rate.

"The euro has now soared 20% against Japan's yen in just three months, 8 % on sterling and 7% on the dollar - the latter compounding gains against a host of dollar-pegged, emerging currencies," continued Reuters.

"Morgan Stanley economist Elga Bartsch said there is a risk of the euro 'overshooting' and derailing the zone's tentative stabilisation by sapping exports, capital expenditure and corporate profits.

The threat of further extreme appreciation has thrown the focus on the Euro zone's "one size fits all" currency weakness.

"For example, Morgan Stanley's estimate of euro/dollar 'fair value' - gleaned from relative inflation, growth, exports and labour costs - is $1.33 and only just below current levels," added Reuters.

"But that masks huge gaps between 'fair value' assumptions for each euro member - stretching from $1.53 for Germany to $1.26 for Spain, $1.19 for Italy and as low as $1.07 for Greece.

"And it highlights the daunting task facing the weakest euro members absorbing an exchange rate squeeze after years of back-breaking wage and fiscal adjustments to recoup competitiveness."

Please, please be careful out there.

By John Richardson

China announced last week that its state-owned banks had lent Rmb1.07 trillion ($172m) in January, which was more than double the amount in December.

Financial markets have taken as evidence that the economic recovery has gained momentum.

But when you combine January-February lending for 2012 in order to get rid of the Lunar New Year distortion effect (the Lunar New Year falls later this year and so there are extra working days in January 2013), the number doesn't look so astounding: In January-February 2012, Rmb1.4 trillion was disbursed.

(It is also important to note that bank lending in China always surges in January as state-owned banks start to fulfill their new quotas and companies dip into new budgets.)

This suggests that while the government might have gone hell-for-leather in boosting lending in May-October 2012 for political purposes, the supply of official new credit was kept at a relatively conservative level last month.

One reason could be that Beijing recognises inflationary pressures are building and so has instructed the state-owned banks to tread fairly cautiously, whilst the government also wants to press ahead with economic rebalancing.

For the time being at least, though, consumer-price inflation appears to be fairly benign as it fell to 2.0% in January from 2.5% in December.

Some economists expect inflation to gather steam during the first quarter, but they think it will stay below 3.5% for the full year 2013 - a figure that they expect the government to announce at its target. If inflation stays below 3.5%, the argument is that there will be no need for increases in bank reserve requirements or interest rate increases.

We think, though, that government concern might well be building over inflation because:

*Food prices were up by 2.9% in January. Food-price inflation matters a lot in China because it remains a poor country.

*Overall consumer prices were by 1.0 percent in January from December, the strongest monthly gain January 2012.

*"Apart from higher state investment as a potential source of inflation, the housing market is showing signs of strength once again as prices climb towards record highs despite curbs to try to cool the market," wrote Reuters in this article.

*Commodity prices are on a role as the ICIS Petrochemical Index (IPEX) for February indicates (see chart below). Northeast Asian prices rose by 3.2% on a 4.8% increase for olefins, a 3.1% increase for polymers and a 0.8% rise for aromatics. Olefins prices were lifted by a continued strengthening of butadiene.

*Overall input prices are at their highest level since mid-2011, when China was last forced to tighten liquidity. Part of the reason is that Chinese manufacturers, which includes, of course, chemicals and polymer buyers, are once again in the midst of a strong restocking phase. They are attempting to hedge against further price rises whilst also preparing for the post-Lunar New Year demand recovery. 

*"As the economy transits into another stage of growth, economic controls need to always emphasize containing inflation risks," the People's Bank of China said last week, indicating a change of approach from accommodative to more cautious.

But if state-owned credit growth in January was indeed not that dramatic, where is all the money coming from to fuel increased industrial activity?

The answer lies in January's "social financing aggregate" which more than doubled from a year earlier, to Rmb2.54 trillion.

Social financing aggregate is a broader measure of liquidity in the economy, including state-owned bank lending, wealth management products, corporate bonds and unofficial lending.

This suggests to us that the small and medium-sized enterprises (SMEs) might have taken a gamble on by borrowing a lot of money from the unofficial lenders, who make up the shadow banking system, at high rates of interest. The SMEs have to borrow from unofficial lenders because the state-owned banks are biased in favour of the state-owned enterprises.

The rise in unofficial lending further supports our main argument: That Beijing is very worried about inflation, and also about the bad-debt implications of a collapse in commodity prices - as it was from April 2011, at the beginning of the last cycle of credit tightening.

Everything will be fine, of course, as long as commodity prices don't collapse.

But is anyone really convinced that some of the recent dramatic price increases are entirely justified by demand? Iron ore is, for instance, up by 79% since September, even though 33.8% of China's steel mills are loss-making and excess production was 160 million tonnes in 2012.

Economic problems in the US and Europe, which we will examine later this week, also suggest that China's recovery in exports of manufactured goods will not be maintained.

Source of picture: Rex Features

By John Richardson

WE are worried that the recovery in Asia's chemicals and polymer markets may not be sustained.

One of our biggest concerns is that China's small and medium-sized enterprises (SMEs), which make up 60% of the economy and are responsible for 80% of employment, are under more pressure.

They are being hurt by high borrowing costs and more expensive raw materials and fuel.

The SMEs can suffer on the way up, during commodity price rallies, and on the way down, when China is forced to tighten to reduce inflationary pressures. From April 2011, when liquidity was tightened during the last battle against inflation, the SMEs found it harder to access formal credit. This forced them into the expensive shadow-banking system.

As we discussed yesterday, China might soon face another cycle of monetary tightening as a result of rising manufacturing input costs.

If there is a sudden retreat in chemicals and polymer markets, China's SMEs could be left sitting on high-cost raw material inventories if they have "bought ahead" of demand.

Evidence of the squeeze on the SMEs was provided by this article in the Global Times newspaper.

"The average profit margin of many of the country's small businesses stands at around 1-3% in the current context; however, the figure was roughly 8-12% prior to the global financial crisis in 2008,' according to Zhou, also director of the Wenzhou Council for the Promotion of Small and Medium-sized Enterprises," said the article.

"'Rising labour costs are unavoidably a trend in the country, and thus for SMEs the way ahead is either to resort to mechanisation or to steer toward high value-added businesses,' Lu remarked, pointing to longer-term difficulties confronting the SME sector."

One of the key tests for the sustainability of chemicals and polymer pricing post-Lunar New Year will be the strength of export orders from the West.

January's export and import numbers looked very strong, even when the distorting effect of the Lunar New Year is stripped out (the Lunar New Year falls later this year and so there were more working days in January than was the case in 2012.).

But just over the horizon is the 1 March sequester in the US. It could well be that the Republicans and Democrats don't reach a deal to avoid the sequester, leading to renewed recession.

And in Europe, political upheavals in Spain and pressure from a "one-size-fits-all" currency are just two of its problems.

The SMEs could, thus, find export orders weaker than expected after the Lunar New Year.

They might also struggle to get the staff to run their factories.

Labour shortages have been a feature of the post-Lunar New Year landscape for several years now.

We suspect that demographic factors, rising income levels in the countryside, and the high cost of living in the eastern and southern towns and cities, could once again combine to persuade many migrant workers to stay back home.

Those who do return could well also be more prepared to demand higher wages and down tools if their demands are not met.

By John Richardson

The above chart is the most important indicator about why the current rally in equity markets is at high risk of a sharp correction.

Volumes in European markets (the blue line) and US markets (the red line) are significantly below levels in 2006-2012.

High volumes are always a bullish indicator as it means lots of people are involved; low volumes means movements are taking place without real conviction.

Low volumes encourage a trading mentality, as financial players need volume and so rumours start very easily.

Another concern is that in today's markets, interpreting complex political issues has become very difficult. As a result, different interpretations add to the volatility.

A further factor behind the volatility is the increasing role played by high-frequency traders.

The stock markets have also changed their focus. They no longer see their main role as being to provide capital for companies.

As Bill Gross of Pimco, the world's largest bond fund, has sad: "Credit is now funnelled increasingly into market speculation (instead of) productive innovation".

Central bank intervention, through stimulus packages, has provided great support for these speculators via ample and very cheap financing.

We discussed in chapter 3 of our e-book, Boom Gloom & The New Normal, how earlier price rallies in crude occurred because of some of the speculative factors listed above.

Everyone then sought to find a reason to justify increases in oil prices based on supply and demand when they had, in fact, been driven by speculation.

We are worried that history is in danger of repeating itself.

Today, the "real world" after-the-fact justification for rallies in equity markets, in commodities including crude and in chemicals pricing, is lagging economic indicators.

For instance, an increase in US government defence spending ahead of the presidential election and China's equally politically motivated stimulus package in May-October 2012 helped boost growth in the fourth quarter.

In the case of China, money from the stimulus package is still sloshing around its economy.

But post-Lunar New Year, stimulus seems more likely to be withdrawn as China has to rebalance its economy and deal with inflation problems.

As for the US, the 1 March sequester, which would involve deep cuts in defence and other spending, threatens renewed recession.

Numerous other negative macro-economic events could be the trigger for a significant correction in equity and commodity markets.

The risk for the customers of chemicals companies is that they are once again trapped in the cycle detailed below, because of rising raw material costs:

*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 six 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.

*End-consumers have all been reducing their purchases, due to the loss of discretionary income resulting from high oil prices. This creates a double whammy for profit margins.

As we keep stressing, please, please be careful out there.

The great news behind rising labour costs: Shan Dalin, pictured with his family, is a crane operator from Southwest China's Guizhou province who has worked in eastern Zhejiang province for 10 years. In 2012, Shan's monthly income rose to 2,800 yuan ($449) from lower than 2,000 yuan in 2008. [Photo/Xinhua]

By John Richardson

The shortage of workers in one of the manufacturing heartlands of China - Guangdong province - is expected to increase from 400,000 before the Chinese New Year (CNY) to 1 million-1.2 million once the holidays are over, according to the Guangdong Human Resources and Social Security Department, quoted in this China Daily article.

This is as we suspected and flagged up a couple of weeks ago.

Post-CNY labour shortages seem likely to affect other coastal export-focused manufacturing provinces.

Part of the reason is simply delays in workers returning from their homes in the hinterland to eastern and southern China due to the huge logistics challenge of moving so many people in such a short period of time. For instance, more than 10 million migrant workers, or 61% of the total in Guangdong, have left the province, says the China Daily.

Longer-term reasons for the expected squeeze in labour supply include the high cost of living in the coastal provinces and the success of government efforts to raise living standards in inland China.

Thus, increasing numbers of migrant workers, as has been the case over the last few years, are likely to decide to remain at home when the New Year is over.

Labour shortages, which are also the result of the beginning of the end of China's demographic dividend, place the workers who do return to their jobs in a very strong position.

If they don't get what they want, there will be more industrial disputes after the New Year, which would, obviously, also restrict the ability of manufacturers to fulfil orders.

And so the manufacturer who are, of course, the buyers of chemicals and polymers, will need to further raise wages and improve working conditions in an attempt to secure enough workers.

This is likely to further squeeze the margins of the small and medium-sized enterprises (SMEs), which, as we discussed earlier this week, have reportedly fallen to 1-3% compared with 8-12% before the Global Financial Crisis. Since December, rising fuel and chemicals and polymer costs have exerted a great deal of pressure on China's SMEs.

There might well be a post-New Year bounce in chemicals and polymer markets on the inevitable uptick in industrial production.

Placing this bounce in the right context is going to be difficult.

Will underlying demand be stronger than before the New Year or weaker, and how will the SMEs cope with increasing cost pressures and, quite possibly, reduced access to credit as the Chinese government deals with renewed inflationary pressures?

Our concerns for the second quarter are growing.

By John Richardson

THE consensus view is that Chinese growth will be fine at the very least for the first half of this year, and possibly for the whole of 2013, thanks to all the money still sloshing around the economy.

An additional $19.1bn of infrastructure spending, which was announced by Beijing earlier this week, is a drop in the ocean compared with the $1.1 trillion allocated last year. But the latest spending might well be viewed as a sign that China's new leaders are prepared to do "whatever it takes", to borrow a European phrase, to maintain the recovery.

The latest OECD leading economic indicators, which show a weakening of the Chinese economy (see above chart), could also be used by financial and commodity markets to support the notion that the central government will further open the spigot (the OECD indicators attempt to predict turns in the business cycle nine months ahead).

Once again, therefore, we could be in the surreal world of the "worst things get, the better they are".

But how much time do China's new leaders really have?

In this wired age, the government faces rising dissent. An increasingly informed public is demanding less pollution, better working conditions, more equal income distribution and an effective crackdown on corruption.

This all points to the pressing need for economic rebalancing, as inflationary pressures also build. 

Let's assume, though, that the majority opinion is right.

Strong headline GDP growth will not necessarily deliver strong chemicals and polymer demand growth, as 2006-2012 taught us.

The small and medium-sized enterprises will continue to struggle throughout this year, even if GDP growth is greater than in 2012.

We are also worried that a significant global, downward correction in financial and commodity markets is a possibility by as early as Q2.

And stronger headline growth, based on more fiscal stimulus, will only make the eventual, inevitable rebalancing more painful.

Source of picture: Rex Features

Today, we are running a guest blog post from Brian Spero,who is a financial contributor for the online resource, Money Crashers Personal Finance, where he writes about economic policy, real estate, and home improvement. 

As the chemical industry keeps a watchful eye out for tangible proof of an improving economy, recent reports on the US housing recovery have been heavily scrutinised.

While it's welcome news that prices are on the rise and the economy seems to be stabilising, many remain sceptical.

There has been no shortage of enthusiasm for the housing market's apparent recent rebound, buoyed by reports that prices are up 4% to 5% over the last year.

Many agree the biggest factor behind the turnaround has been enduring low mortgage rates, and with percentages projected to stay down for the foreseeable future, growth is expected to continue well through 2013.

Freddie Mac recently released information suggesting that prices could rise as much as 10% over the next 12 months, while experience dictates that when interest rates finally do start to inflate, it will drive real estate sales even further, as would-be homeowners scramble to capitalise on historic lows.

Another prominent factor has been the influence of cash investment purchases. Those who would throw cold water on the positive signs remind us that as prices rise steadily investment will diminish, leaving the real estate market stagnant once again.

A clue in determining if this recovery truly has traction is if the percentage of cash sales decreases from its current level of 20% to around 10%, which would indicate a sustaining element that individuals are purchasing.

While mortgage applications have been up in recent months, nearly a third of those currently paying mortgages owe more than their homes are worth.

Many have scoffed at the relatively small rise in prices, pointing to how much more ground there is to make up before housing prices approach their peak in 2005, but it's important to recall the volatile factors that created the unrealistic boom.

The simple fact is that when people's houses are worth more, their confidence as consumers goes up, creating a domino effect that serves to fuel economic growth.

It's not just the housing market that's on the upswing. Reports reveal related industries such as construction, lumber, and architecture are also experiencing a bump. The buying, selling, and building of homes has a powerful influence on construction, retail, and financial services. This creates jobs and generates profits as people spend on everything from moving and storage, to furniture, appliances, and landscaping.

As the staunchest naysayers fairly point to lingering concerns over job growth, high unemployment, and unresolved questions relating to the national debt, the momentum (at least for the moment) is in recovery's favor.

Will the housing market continues to rebound, taking the greater economy with it, or will it level off - or worse yet, begin to flounder?

There is currently real reason for optimism. Foreclosures are down, which means a decrease in supply that will result in not only rising prices, but also a further boost to the construction industry. Plus, according to a report by CNBC, about one-third of U.S. homeowners own their homes outright without mortgages, which serves to balance out the discouraging data on mortgage debt.

Things are better than last year, and according to sources ranging from Forbes to Fannie Mae, we can expect another year of growth in 2013.

By John Richardson

CHINA's new leaders are under increasing pressure to do something about the dreadful pollution that blights the lives of hundreds of millions of people.

One Shanghai resident told the blog, "The air quality is so bad here I have taken up smoking again. I figured that as my health was already in jeopardy from simply breathing in, I might as well get some pleasure out of the process".

But a government scheme promoting the virtues of smoking probably wouldn't cut it.

And so Sinopec could be required to do its bit to clean up the air.

"China's new leaders, ever wary of anything that might cause unrest, have promised to clean up the pollution quickly. Among their targets are the country's antiquated, filthy oil refineries," writes The Economist in this article.

"Sinopec is not like a Western oil firm. As an arm of the state (and a more powerful one than the environmental-protection ministry) it has a lot of say in writing its own rules," continues The Economist.

"That is perhaps why in much of China regulations allow the sulphur content in petrol to be as high as 150 parts per million, whereas European standards cap it at 10 ppm!!!!" said the same article. [Our quadruple exclamation marks].

"The ruling State Council announced earlier this month that it will unveil new standards for diesel in June and petrol in December that will cap the sulphur content at 10 ppm, to be implemented nationwide by 2017. Refiners must upgrade facilities, or else."

Politicians might make an example of Sinopec in an attempt to prove that they are serious about reforming the state-owned enterprises (SOEs) in general.

The SOEs are accused of exerting an excessive and harmful influence on the economy.

They have made excessive profits because of poor environmental standards and access to cheap finance and land etc, it is widely argued.

Suppressed savings rates - which have allowed the state-owned banks to lend to the SOEs very cheaply - have dampened domestic consumption.

Lots of low-cost cash has also resulted in an over-reliance on big-scale, and often inefficient, manufacturing investment as a driver of economic growth.

Sinopec might well continue to argue, though, that it is hugely disadvantaged compared with its overseas peers. It has to buy crude at international prices while selling gasoline, diesel etc at prices that are kept artificially low by the government (see the above chart).

The answer could be to fully liberalise fuel prices, giving Sinopec the revenues to introduce cleaner fuel standards.

But allowing Sinopec to earn the money to get rid of foul air risks creating another problem for Beijing: People taking to the streets over more expensive fuel, at a time when there is already a great deal of tension over the high cost of living in China's big cities and towns.

And so it possible that, if the anti-pollution drive is indeed genuine, Sinopec will see its margins squeezed, as The Economist argues.

It could thus have less cash to become a global giant in exploration and production - and perhaps one day in refining and petrochemicals, also - which some commentators see as its destiny.

Equally, it might find it harder to fund petrochemicals capacity expansions at home.

Or the government might be persuaded just to give Sinopec money to pay for higher fuel standards.

But such financial support could be viewed as the government maintaining unfair, economically-distorting support for the SOEs.

The Sinopec story is one example of the many complexities surrounding China these days.

Any number of outcomes are possible.

By John Richardson

ONE should be careful about reading too much into the above margins for February as, of course, there was very little trading activity because of Chinese New Year (CNY), whilst oil and therefore naphtha prices increased.

But the poor performances in December and January in Southeast and Northeast Asia, despite the rally in global equity and commodity markets, suggest that the real economy has yet to fully reflect the new "risk on" sentiment.

Middle East and US producers will have made good or very good money in January-December as a result of their feedstock advantages. They always do. 

But in a genuinely tight market the higher cost producers benefit as well, which is why the above chart is significant.

This week will be crucial as activity picks up post-CNY. Improvements in pricing, along with perhaps margins, seem likely as there is often a post-holiday bounce.

But we worry that:

*The weak performance in December-January occurred despite a big loss of PE production due to turnarounds and outages. This indicates that demand was lower than the financial markets want us to believe. PE production is expected to be 1.5m tonnes higher in 2013 compared with last year as turnarounds and outages end and new capacity comes on-stream.

*Post-CNY, China's small and medium-sized enterprises (SMEs) could struggle to ramp-up production as a result of labour shortages.

*The SMEs are likely to have to accede to demands for higher wages in an attempt to relieve labour shortages. This will further squeeze their margins, which are already under pressure from more expensive oil and therefore fuel and resin prices.

It will take a while to put any post-CNY markets recovery into the proper context.

Proper context is crucial because influential people have put an awful lot of money, and their reputations, into the notion that we have entered a sustained recovery. They will, as a result, keep making a great deal of noise about how everything is back on track.

We suggest noise reduction headphones.

By John Richardson

A NEW report from HSBC backs up our concerns that the post-Chinese New Year polyethylene (PE) will be weaker than in December-January.

The bank is with us in thinking that the stronger markets over the last two months have been driven by:

*Lagging indicators such as strong export and import data and purchasing manager's indices (PMI) for December-January. The PMIs were also open to different interpretations, we think.

*Restocking ahead of the Chinese New Year as converters sought prompt cargoes (see above chart of China resin inventory levels).

*Turnarounds and outages that signicantly tightened markets. "Over the course of Q4'12/Q1'13, over 5 million tonnes of annualised capacity in the region (c30% of the region's installed capacity base) was hit by shutdowns," says HSBC.

But now:

*The turnarounds are coming to an end with a great deal of new capacity coming on-stream. "The peak period for these outages was the first 3-4 weeks of January when PetroRabigh, Saudi Polymers and Borouge 2 were all down at the same time. Supply this year is being added in Asia (China, Singapore), the Middle East and the US. China is adding four new crackers over a 15 month period from Q4'12 to Q4'13, with effective capacity growth of 1.8 million tonnes/year, or 12% of the existing capacity base," adds HSBC.

*It is very unlikely that Chinese growth will be able to do the "heavy lifting" to support all this new capacity because of economic rebalancing in China and a weak export environment. "While it is certainly possible to see Chinese demand grow at a rate of 10%, given a reaccelerating Chinese economy - the CAGR over 2006-12 was 9.8% - it is unlikely that growth will be strong enough to absorb the 1.8m tonnes/year that China is adding and also absorb the c2.2m tonnes/year of capacity being added in Saudi Arabia, Singapore and the US. In order to absorb all of the domestic supply, as well as the new Middle East and US supply, Chinese demand growth would need to average over 15% in 2013, a situation we believe is highly unlikely," says HSBC. The bank's base case for growth is 8%, but adds that growth lower than this is possible.

Thus, the best of the year for spreads, and perhaps therefore margins for the higher-cost producers, is over, according to HSBC.

Margins in December-January were hardly worth writing home about.

By John Richardson

"People are tired of being depressed and looking for any little source of light to feel positive. Even companies are resorting to this and forecasting margin and earnings recovery though there is no strong data to show this is going to happen," said a chemicals industry source.

Take the US housing market and this post from Jim Quinn of the Burning Platform Blog.

"Everywhere I turn I'm hearing about the strong housing recovery that is propelling our economy, generating jobs and spurring a resurgence in retail spending by the millions of deleveraged consumers," writes Quinn.

"I challenge anyone to show me the tremendous housing recovery on the new home sales chart below.

"New homes sales have 'surged' to an annual pace of 369,000, only 74% below the 2006 peak (see the above chart) and about 50% below the long term average. New home sales fell in December at the fastest rate since February 2011.

"Existing home sales also fell in December, are pacing at 1999 levels, and are still 30% below 2006 levels. In a country of 115 million households, with mortgage rates at all-time lows, there were a total of 26,000 new homes sold in December, and only 10,000 of them were actually built.

"For some perspective, new home sales are at the same level as they were in 1967 when the US population was 200 million."

The rest of Quinn's coruscating views on unemployment, the housing market, autos and education are worth considering.

By John Richardson

THERE has been a lot of interest in China's coals-to-olefins (CTO) industry, with arguments that it is a very economically viable method of production.

On paper, there is even more capacity due on-stream than in the US as it forges ahead with its shale gas-based expansions.

But, according to new study by HSBC, of the 6m tonnes/year of ethylene capacity scheduled to be added through the coal-to-methanol and then on to olefins process in China over the 2013-17 timeframe, less than 20% - 1.2m tonnes/year - is viable.

As a result, HSBC hasn't even included the capacities in its supply and demand balances.

Reasons given include logistics.

"The logic of having projects in these regions, instead of in Eastern China (where the bulk of the plastics producers are located) is fairly straight forward, and stems from the advantage achieved by locating CTO projects close to coal-producing regions, namely better access to coal and lower coal prices," writes HSBC.

"However, the location of projects in Central-to-Western China, leads to its own set of challenges and constraints. The Chinese plastic converters are concentrated in Eastern China, with the top four provinces (Guangdong, Zhejiang, Guangxi, Shandong) accounting for c50% of the production of plastic products in China, while c85% of the existing Chinese ethylene capacity, for example, is located in the Eastern region.

"The mismatch between the plastic producing regions of Eastern China and the CTO projects in Central-to-Western China leads to the issue of transporting the CTO-produced olefins/polyolefins and co-products to Eastern China.

"Although the transportation cost of polymers is high, it is still less than the cost of transporting the equivalent amount of coal in the opposite direction, given that it takes c6.2 tonnes of coal to make one tonne of olefins.

"The co-products, on the other hand, are a different story. The main co-products include fuel gas, heavier olefins and gasoline, and are produced in much smaller in quantities than the olefins - total co-product yields for the MTO/MTP processes are only 7% and 11% while olefins yields are 33% and 28%, respectively.

"The smaller quantities of the co-products produced, coupled with the far-off location of the coal-to-chemicals plants, makes it difficult for these products to be sold at their normal market prices.

"The co-products, as a result, are either sold at a discount to market prices or are consumed internally as fuel, realising their fuel-linked value only."

HSBC says that Eastern coastal MTO projects, which would be based on imported methanol, are unviable because of the amount of methanol that would have to be acquired.

"A 600,000 tonnes/year MTO/methanol to-propylene (MTO) project requires 1.8m-2.16m tonnes/year of methanol, respectively, which is significant in size compared to average annual Chinese methanol imports of c5.3m tonnes/;year since 2009," the study adds.

Well-documented environmental challenges are also a major barrier to investment.

For instance, 15-20 tonnes of fresh water is required to produce each tonne of olefins.

"Per capita water resources and water resources per sq m in China's key coal producing provinces, such as Inner Mongolia, Shanxi and Shaanxi [where many of the CTO projects are located], is only 1/10th of the national average, according to research published by Greenpeace and the Institute of Geographical Sciences and Natural Resources under the Chinese Academy of Sciences in August 2012.

"To put this in perspective, refining uses 0.80 to 2.17 tonnes of water for each tonne of crude oil processed.

"High carbon dioxide emissions are another concern (see above chart).

"While the Chinese Government is supportive of the move towards greater self sufficiency in polymer production, it is also keen to avoid a repeat of the excessive investment in subscale capacity as witnessed earlier within the coal to basic chemicals space," says HSBC.

"To this end, the National Development and Reform Commission (NDRC) has oversight of all project approvals and has set minimum scale guidelines in order to ensure viability.

"Under the new rules announced in the 12th Five Year Plan for coal to chemicals in 2012, a coal-based olefins plant must have a minimum capacity of 500,000 tonnes/year while 1m tonnes/year has been set as the bar for coal-to-methanol and coal-to-liquids facilities."

Only three of the 23 CTO projects listed have won approval from the NDRC, says the study, supporting the notion that all the fuss about the industry, might, in the immediate term at least, turn out to be a storm in a teacup.

"We see projects that do not have NDRC approvals as running the risks of closure - similar to what happened with the teapot refiners or small-sized coal mines in China," adds HSBC (apologies for the pun).

By John Richardson

BEIJING is clearly getting worried that its politically motivated 2012 economic stimulus programme has damaged the economy.

"Just when the world had bought into a Chinese economic recovery, along comes the government throwing proverbial spanners in the works," writes James Gruber, former fund manager and journalist in his latest Asia Confidential weekly financial newsletter.

"Actually, they're more like grenades. According to Bloomberg, China's central bank has drained Rmb910 billion (US$145 billion) from the banking system this week [last week as you read this], a record high weekly net drain.

"Reducing liquidity after Chinese New Year is normal, as is increasing liquidity prior to this holiday. But the extent of the liquidity reduction dwarfed the Rmb 662 billion added before the New Year.

"To put this in some context, the People's Bank of China has now drained a net Rmb548 billion from the banking system this year. This compares with a net injection of Rmb1.44 trillion last year."

"On top of this news came calls from outgoing Chinese Premier Wen Jiabao for local governments to impose home price restrictions and 'decisively' curb housing market speculation. He described house price gains as 'excessively fast' and also ordered major municipalities to publish annual price control targets."

This helps to explain a week of two halves in Asia's polyethylene (PE) market.

In the first half of last week there was quite a lot of activity as some end-users restocked, the blog was told.

But from Thursday, we also heard that buyers backed away on the liquidity drain, the expected renewed clampdown on the housing market and the realisation that PE supply will lengthen from March onwards.

The above chart illustrates why Beijing has been forced to act on credit.

As you can see, total credit as a percentage of nominal GDP was at an all-time high last year, when both Total Loans (formal lending via the state-owned banks) and Social Financing (the sale of Wealth Management Products by the state-owned banks and lending by privately-owned credit agencies - the shadow-banking system) were added together.

Last year's surge in credit was substantially down to the rise in poorly regulated, highly speculative Social Financing, say some economists, who add that the sector represents a systemic risk.

Formal bank lending now accounts for just 55% of total credit compared with what used to be 92%, according to Peking University finance professor Michael Pettis.

Further reductions in liquidity- especially within the Social Financing sector - seem probable, therefore, as the government attempts to restore some balance.

An increase in interest rates might also be necessary to bring inflation under control.

We warned on 6 February that China's PE history would repeat itself, at the expense of China's small and medium-sized enterprises.

It now appears that we were right.

By John Richardson

YET more problems with Chinese economic statistics have emerged, casting doubt over the idea that an economic hard landing was avoided in 2012 - and that there was a strong rebound in the fourth quarter.

"Official data on China's gross domestic product show the slowdown in growth in the last two years as moderate, and in line with government targets," wrote The Wall Street Journal in this article.

"A 7.8% increase in output in 2012 was narrowly down from 10.4% in 2010, and above the official target of 7.5% for the year. But the real situation may be a lot less rosy than the official data suggest.

"Stephen Green, China economist at Standard Chartered, says the official numbers reflect an underestimate of inflation, resulting in an overestimate of real growth. Using an alternative measure of service sector inflation, Mr. Green calculates GDP growth at 5.5% in 2012 - putting the world's second-largest economy in hard landing territory (see the above chart)."

And although there are other signs that the economy recovered quite strongly during Q4 (also see the above chart), the same article adds that overall retail sales and auto sales growth might have been exaggerated.

Plus, it continues: "The official data shows resurgent exports coming into 2013, with 14% year-on-year growth in December.

"But a growing discrepancy between data on China's exports to Hong Kong and Hong Kong's imports from China, suggest that might be an exaggeration. Louis Kuijs, China economist at RBS, says that export growth could be overstated by as much as 4 percentage points."

Positive economic data came at the right time for China's new leaders as they settled into office.

But the problem is that "cooked" data might have misled the chemicals industry into thinking that all would be well during 2013. One wonders whether this has led to the setting of overly aggressive sales targets this year.

Intuitively, the strong surge in exports in December didn't seem to make sense, given all the economic problems in the West.

It was, therefore, hardly surprising that weaker exports were the main reason why the flash HSBC purchasing managers' index for February, which was released yesterday, fell to 50.4 in February from a final reading of 52.3 in January.

"Thinking of buying the dip? In a report released yesterday, Nomura's Zhiwei Zhang and Wendy Chen offered five reasons to reconsider," wrote Barrons, the investment newsletter.

"Reason #1: China's policy makers are becoming increasingly concerned about financial risks in the world's second-largest economy {hence, last week's decision to reduce liquidity]. They've asked banks to scale back the risks in so-called fund pools, which lets banks pay off some wealth management products by issuing new ones, a practice the Bank of China has called a 'Ponzi game,' the strategists say.

"Reason #2: More energy and utility reform. China raised the tariff on railroad shipments by 13%, the largest increase since 2003, the strategists say. That may be a sign that it's ready to lift prices on other "administratively suppressed prices," including electricity and other utilities-and increase inflation.

"Reason #3: The real-estate rebound could force China to [further] tighten the amount of credit in the economy-which could cause the GDP growth rate to slow.

"Reason #4: The government may not act to boost economic growth during the second half of the year. Local governments, for instance, have lowered their growth targets for 2013 by an average of 0.5 percentage point from 2012.

"Reason #5: China's leaders might crack down on companies that pollute the environment. This is clearly a good and necessary issue to tackle, but will reduce economic growth in the short-term."

Rebalancing was always going to have happen, with the only question being "when?

We felt that the answer would be "very soon", as seems to be the case.

By John Richardson

POLYETHYLENE (PE) prices crept up by $10-50/tonne for the week ending 22 February, according to ICIS pricing.

But, as the above chart shows, integrated high-density PE variable cost margins in Southeast and Northeast Asia remained very weak, and were way below all the other regions - again, up until the week ending 22 February.

On an ethylene basis, the picture was slightly better (see below), but Asia was still performing far worse than the US and Europe.

The well-rehearsed story in the US is, of course, shale gas, whereas the highly disciplined European industry can to a large extent set its own profitability, regardless of the very weak macro-economic fundamentals.

Asia margins are therefore comparatively weaker because of the region's feedstock position versus the US (most of Asia's crackers run on naphtha).

Asia's petrochemicals industry is also more fragmented and less well integrated than is the case in Europe.

This is only part of the explanation.

The other crucial part of the story is that, despite very tight supply in December and January, Asian producers have lacked pricing power. In a genuinely strong market even the highest-cost producers do well - i.e. many of those in Northeast Asia. 

This once again underlines how the equity and commodity markets have run ahead of the real economy, pricing-in a sustained recovery in the key China market that we worry isn't going to happen.

PE supply is now lengthening and China has started to reduce liquidity in order to control run-away credit growth.

There also signs that the long-awaited rebalancing of China's economy has begun, which, according to Peking University professor, Michael Pettis, will mean, even in the best-case scenario, annual average GDP growth of only 3% up until 2020.

PE producers are busy trying to repair margins by pushing for further price increases.

But this could be merely an exercise in damage limitation. We are with HSBC in thinking that the best of the year is already over.

....In A Tale Of Three Markets.

By John Richardson

AS China introduces more measures to clamp down on an overheated property sector and the shadow-banking system, polyethylene (PE) traders regard this latest news cycle as yet another opportunity to go short.

"It used to be that the trading business was about supply and demand fundamentals of PE itself, but not anymore," said a Singapore-based trader.

"For the last four years, ever since the Dalian Commodity Exchange was launched, we just look at the macro-economic news and make a decision on whether to go long, short or sit on our hands on the futures market.

"To some extent the futures market effects daily trading volumes on the physical market.

"I am sure there will be some good news just around the corner that will lift sentiment temporarily."

But fundamentally, however, the trader admitted that he is "flabbergasted" as to how weak demand is post-Chinese New Year in the non-speculative world, where people have to buy resin to actually make things.

We are well into the second week of trading post-New Year and yet, according to the trader, converters remain exceptionally cautious.

"I expected that much more restocking would have taken place by now. The processors are sitting on reasonably low inventories, but are in no hurry to enter the market which suggests their orders must be weak.

"The traders are also reluctant to stock-up and as for the producers, they are also sitting on low inventories. As a result, they are able to stick to attempts to raise prices {because of very weak margins, we think], but they are having very limited success."

Increased supply could soon weaken the position of producers.

But it is not all doom and gloom for those producers selling into the higher-value segment of the market. They remain confident.

"For the high-end film manufacturers in China, into applications such as high moisture-barrier film for food, they have absolutely no problem in accessing financing from the state-owned banks," said a source with a PE producer.

"Plus, the big brand-name finished goods manufacturers that are state-owned are instructed to buy from these converters.

"I think a reason is that these higher-value film producers are exactly what the Chinese government wants to encourage: An industry that is move up the value chain as part of China's efforts to escape the middle-income trap.

"These higher-value producers are also highly automated and so are not as affected by higher labour costs and labour shortages."

"But the higher-value segment only comprises 10% of the overall China PE market. The commodity end of the business is struggling in, for example, lower-value applications of high-density PE (HDPE).

"The consolidation process amongst lower-value converters is already played out in the US and Germany, but is still taking place in China."

Fascinating stuff, but this is all a little nuanced for those in commodity and equity markets who continue to argue that the current rising tide will lift all boats.

We continue to think that as we move into the second quarter, their arguments will become increasingly ineffectual.