Asian Chemical Connections

China's National People's Congress

Source of picture: Rex Features

By John Richardson

The focus of next week's National People's Congress (NPC) meeting in China - the country's annual "parliamentary" meeting - is likely to be on the quality rather than the quantity of growth.

This is reflected in the fact that almost half of China's provinces are setting lower growth targets for 2013, according to this Bloomberg article.

"Fourteen provinces have set lower targets for GDP expansion this year than in 2012 and the other 17 left their goals unchanged," added Bloomberg, quoting research from Nomura.

Interestingly, a new generation of local political leaders with different objectives appears to be emerging.

"The [provincial] GDP targets may damp previous optimism that China's economic growth would get a boost this year thanks to the traditional rush of new projects from officials appointed as regional leaders," added Bloomberg.

"Instead, rising political stars including Hu Chunhua in Guangdong and Sun Zhengcai in Chongqing have set lower goals, supporting incoming President Xi Jinping's focus on 'quality and efficiency' of growth."

Local leaders were previously measured on how rapidly they could raise growth, regardless of the potential longer term social, environmental and economic damage. The focus was on "jobs, jobs and more jobs"in the dash for export-focused expansion.

China's shifting demographics, its rising income levels that have changed public expectations, and the end of the babyboomer-driven growth dividend in the West make a new approach essential.

The NPC, which begins on 5 March, will comprise an equal proportion of deputies from urban and rural areas, with more delegates from farming regions and fewer from big cities like Beijing or Shanghai, said the Xinhua wire service report.

The delegate list shows a 'marked increase' in the number of front-line workers, migrant workers, farmers, professional and technical personnel and women, added the official government news service.

More ethnic minorities and younger delegates, in their 20s and 30s, as well as fewer party and government officials would be present, continued Xinhua.

The presence at the NPC of more rural residents reflects the major policy agenda of improving the lot of rural residents.

"Reforming rural land laws to better protect farmers' rights and changing the draconian system of urban residence to give migrants better access to social services are both high on the policy agenda," said The Wall Street Journal in this article.

"Changes promise to raise households' share of national income - a crucial component of rebalancing China's economy toward stronger consumption.

"The reforms will be costly. The State Council's Development Research Centre estimates turning one rural migrant into an urban citizen, with access to education and subsidised housing, has an upfront cost of 24,000 yuan ($US3857). With about 260 million migrants, the initial price tag for turning just 10 per cent of them into urbanites is 630 billion yuan ($100bn) - equivalent to 1.2% of 2012 gross domestic product.

"At the same time, stronger protection for farmers will make it more difficult for local governments to seize and sell land - a key source of revenue. Land transfers generated 2.7 trillion yuan of revenue for local governments last year, or about a quarter of their total income."

Another big priority is tackling nothing short of horrific environmental problems that are causing a rising wave of Internet-fuelled public anger. Embarrassingly for the new leaders, the air quality in Beijing once again became chronically bad immediately ahead of the NPC.

The NPC is also expected to underline efforts to tackle a rising bad-debt problem, which is connected to an out-of-control shadow-banking system.

"The Chinese shadow banking system - credit flows beyond traditional bank loans - has quadrupled in size since 2008 to about Rmb20tn ($3.2tn), or 40% of economic output. These flows were crucial in reviving the country's growth last year," said the Financial Times, in this article.

The parliamentary meeting is also likely to emphasise the need to, once again, deflate the property bubble.

"China's property market is rife with speculation - both about rising house prices and about what the new government may do to curb them once it takes office next week," said Reuters in this article. {The new government formally takes office during the NPC meeting.]

"Asset prices have whipsawed as investors first bet that government-mandated infrastructure spending would boost real estate prices, only to then fret about new measures to cool a market that has seen double-digit annual price rises in cities like Beijing and Shenzhen.

"Markets appear more nervous than the government about the pace of price rises revealed by official January housing data issued last week, and economists at influential state-run think-tanks reckon investors are right to be worried that the new government is preparing to widen a pilot property tax as part of a broader reform of land and fiscal policies."

All of this points to a major and irreversible policy shift, starting from now.

We have long argued that rebalancing would mean lower growth in the short and medium-term.

By

John Richardson

Methanol-to-olefins (MTO) projects in China are subject to more disagreement over viability than any other group of petrochemicals investments, said HSBC in a report released last month.

HSBC, for example, takes a pretty negative view of the economics of MTO projects. This applies both to planned investments based on locally-sourced coal - which would be first gasified into syngas and then converted in to methanol and on to olefins and polyolefins - and those that would depend on imported methanol to make olefins and polyolefins.

This contrasts with Singapore-based methanol consultant Mark Berggren's view that the returns will be good for coal-based projects versus naphtha cracking.

Underling our point, a former petrochemicals industry executive is in agreement with Berggren.

He told us:

"The MTO coastal projects employ local Dalian Institute of Chemical Physics technology. It is similar to the UOP process in that it yields a higher a percentage of higher olefins and less of the lower olefins and fuel oil etc than some of the other technologies. This gives them one advantage.

"Further, the project proponents are looking at virtual integration through taking shares in overseas natural gas-based methanol projects in the Middle East, Africa and North America, where the gas has low alternative value or is stranded. As a result, this would make the imported methanol very competitive.

"Plus, the coastal projects have better economies of scale than coal-based facilities.

"The Chinese also have a good habit of learning very effectively as they build and operate projects and so there is every chance that capital costs will fall for these and all MTO projects over time, along with lower running costs.

"I would be less bullish over inland projects because of the possibility of China taking more of a serious approach to the environment, leading to a cost on CO2 emissions and further restrictions on approvals because of the large amount of water required in the syngas step (water supply is lower inland than on the coast).

"But the big advantage of inland projects over those on the coast is feedstock costs. Coal is as little as $25/tonne."

We think the second-to-last point is extremely important because China's approach to economic growth is evolving. The focus is on the quality rather than the quantity of growth.

As little as 12 months ago, the political and social drivers of petrochemicals projects (see the chart above) remained job creation and the dash for growth via industrial development.

Now, because rebalancing has begun, everything has changed.

By John Richardson

IF China's decade-long focus on coal-fuelled heavy industry is really coming to an end, as this article in The Sydney Morning Herald suggests, then the prospects for further approvals of coal-to-olefins (CTO) projects seem very bleak indeed.

"In the first 12 years of this millennium, China increased annual coal use by a staggering 2.4 billion tonnes, or 163%, accounting for more than four-fifths of global coal consumption growth," wrote The Sydney Morning Herald.

China now, however, plans to cap coal production at 4bn tonnes per year by 2015, just slightly above the 3.9bn tonnes that it consumed last year (see chart below).

CTO projects, as they are less of an economic priority than new coal-fired power plants, seem likely to face the administrative chop by local officials.

Previously, local officials were measured by their ability to deliver growth for growth's sake at huge environmental cost.

But now, Beijing is giving indications that regional administrators will be evaluated on their ability to deliver better quality growth, including, perhaps, helping to meet the ambitious coal-capping target.

Cynics will rightly say that they have heard it all before: China issuing bold promises about dealing with its atrocious air and water quality, only for policies to flounder on vested interests and corruption.

This time seems different as the attempt to cap coal consumption has backing from the State Council - China's highest administrative.

And the blog gets the impression that China's new leaders are serious about dealing with the environmental crisis. They have to be as political pressure is building.

This is further evidence of what we discussed yesterday: A redefining of what represents social good in China, and therefore a political priority. This, we think, will have implications for all chemicals projects in China - and for existing chemicals production.

As for coal-to-chemicals in general, the Tianji Coal Chemical Industry Group pollution incident will have done it no favours.

Tianji Coal officials, reportedly, delayed letting local authorities know about an aniline spill for five days.

"After sending a team to Handan in January, Greenpeace East Asia issued a report on the spill. It said that there were about 100 coal-to-chemical factories on the upper reaches of the Zhuozhang River," wrote the New York Times in this article.

"'There is a history of clashes between heavily water-consuming coal-to-chemical factories and citizens downstream who are trying to compete for water to drink,' the report said.

"Larger factories like those of Tianji use 2,000 to 3,000 tons of water per hour, equivalent to the amount of water that more than 300,000 people use in a year "

By John Richardson

POLYETHYLENE (PE) prices in China fell by $5-10/tonne for the week ending 1 March, according to ICIS pricing.

"It is increasingly clear that Chinese growth will slow from the second quarter onwards and this will limit potential recovery for Asia," say analysts at Credit Agricole.

The Shanghai Composite Index dropped 3.7% on Monday, its biggest daily loss since November 2010, as a result of efforts to rein-in surging property prices and data released on Sunday that showed the country's service sector expanded at its slowest pace for five months.

This followed disappointing HSBC purchasing managers' index for February

We have consistently warned over the last few monthhs that the Chinese recovery, if it can be even called a recovery, would not be sustained.

By John Richardson

COST cutting and disciplined operating rates have been two of the factors that have helped maintain European cracker and polyethylene (PE) profitability at pretty healthy levels since the onset of the global financial crisis in 2008.

So too has the European cluster concept, where producers can share ethylene via pipelines and where there is close integration with refineries. The stand-alone European cracker is a dying breed.

This is all marvellous news for European petrochemical margins (see above), but what about the industry's customers?

"Life is really tough," said one plastics converter who spoke to the blog during its current trip to Amsterdam for the 8th ICIS World Olefins Conference.

"We are in a low margin business and have very little ability to resist prices rises from our suppliers who have all the power. It feels like death by a thousand cuts."

One could argue that buyers are always going to plead poverty.

But the macro-economic fundamentals have been so bad for so long in Europe that what this downstreamer said seems likely to be close to the truth

And if Europe's economic malaise does, indeed, last another decade, one wonders how many converters will still be around in 2023 to voice concerns about their weak profitability.

Europe can avoid a lost decade if politicians quickly realise that demographics drive demand.

But, sadly, there is no sign of this type of political leadership. The focus is instead on short-term economic fixes in the hope that Europe's long-term problems will somehow, magically, disappear.

Meanwhile, the petrochemicals industry is equally short-term focused as it worries about the next round of quarterly results and individual bonuses.

It is time for some new thinking.

The course of true love never runs smooth.....Happy China couples get divorced and then plan to remarry in order to avoid new property tax

Source of picture: Quirky China News/Rex Features

By John Richardson

China will see "large inflation pressure in the second half of the year," said a People's Bank of China official on the sidelines of the National People's Congress (NPC).

But he believed that the official target of 3.5% inflation for 2013, lower than the 4% target set for last year, could be met if swift action was taken to control money supply.

To this end, outgoing premier Wen Jiabao announced during the NPC that a 13% growth target for money supply had been set for 2013 compared with 12% last year.

The NPC was thus used to further underline what Beijing made clear last week: A new tightening phase.

The renewed battle against inflation is not expected to any time soon require an increase in interest rates or bank-reserve requirements.

This is, perhaps, good news given that both of the above measures badly dented petrochemicals demand growth from April 2011 until Q2 2012.

A problem, however, as The Wall Street Journal points out is that "central banks around the world are easing policy and keeping interest rates at extraordinarily low levels. Many Chinese commentators argue that this global easing is pushing up inflation in China as speculative capital flows in, chasing higher returns."

The policies of the Federal Reserve, the European Central Bank, and more recently the Bank of Japan, are all odds with China's renewed battle against inflation.

The developed world seems likely to throw more, rather than less, liquidity at its economic growth problem.

This could force China to take more severe measures to bring the rising cost of living under control. Plus, of course, there is a risk to international relations.

Meanwhile, the clampdown on the 10,000 lb inflationary gorilla in the corner of the Chinese room - the property sector - has led to a jump in the divorce rate.

The 20% property tax is to apply to second properties bought by married couples. But, if the couples separate they can buy one home each and thus avoid the tax. They can then remarry.

Property sales have also jumped ahead of the introduction of the tax because, as the Financial Times points out, property is central to the Chinese economy "with vast amounts of the population's wealth tied up in the values of their homes".

There are two risks here, which are:

1.) The government fails to rein in the property sector because of other innovative efforts to avoid new regulations This might be good news for growth in the short term, but will worsen inequality and the scale of the potential correction if the bubble eventually bursts.

2.) The government succeeds and in so doing, GDP growth is lower in 2013 than the official 7.5% target.

 Source of picture: China Daily

By John Richardson

The famous investor, Jim Chanos, warned three years years ago that the West places an inordinate amount of trust in "nine guys in a room" (i.e. China's Politburo Standing Committee) getting it right. Since last year's leadership transition that trust now needs to be placed in just seven guys in a room.

It is ironic that a great deal of plain vanilla analysis from chemicals companies and their investors continues to assume that these men will get it right, whilst both groups are very willing to criticise the shortcomings of Western politicians.

The blog hopes that this plain vanilla analysis is only for the sake of maintaining good relations with China, of giving the country's leaders adequate "face".

We would like to believe that at hidden, deeper levels, the chemicals companies have research departments carrying out immensely complex studies necessary to prepare for  many different outcomes over the next few decades.

If this is so, we have the right to access to this resarch if we are continue to place our trust in certain companies. 

One of the mantras that the blog has heard chanted by many companies over the last 16 years, as it has has shuffled from one conference presentation and press conference to another, is "urbanisation" - as if the word in itself, by itself, guarantees continued prosperity.

But what has urbanisation really amounted to since China's "economic miracle" began?

China's urbanisation rate is said to have reached 51% in 2011, but if you strip away migrant workers without hukou (residency permits) and homes, the real urbanisation ratio is closer to 36%, according to Bank of America's Ting Lu, who is quoted in this Business Inside article.

As China nears the Lewis Curve turning point, Ting adds that it is therefore "absolutely right" that China's leaders are focusing on how to unlock much greater real urbanisation during this year's National People's Congress meeting.

"Speeding up urbanisation could boost demand and improve efficiency and social harmony," adds Ting.

"China [has] experienced rapid industrialisation but rather slow urbanisation in the past decade, resulting in 150 million migrant workers living in urban areas without having urban residency permits," he adds.

"Most of those migrant workers cram in factory dorms, are excluded from urban public services and social welfare systems, and leave a total of around 58 million of their children in rural areas.

"It is true that for many small cities migrant workers can get urban residency permits by buying homes there, but it is hard for most migrant workers to accumulate enough wealth to do so.

"{This is] partially because they cannot sell (or capitalise) their cultivated land and residential land, and partially because home prices have risen too much as a result of limited supply," writes Ting.

"Surging home prices in China in the past decade are to a large extent due to the under-supply of residential housing, which in turn is the consequence of under-supply of land for property development."

He sees the solution as increasing supply of land for homes.

"Close to 200 million migrant workers don't live in their rural homes except during the Chinese New Year holiday.

"Urban residential land [totals only} 11,000km2, whilst residential land in the rural area is estimated at 92,000km2."

He therefore argues that the focus of land reform should be expanding the urban area from the current level of 39,000km2, "which is only 0.4% of {the} total national {land] area, versus 2.6% in the US and 4.0% in Japan."

China, as a result, needs to get rid of collective land ownership - one of the foundations of its political system. Did simple, eh?

And what about food security? Given China's history, this is surely hugely sensitive.

"Vested interests" have made a fortune out of rising property prices and millions of hard-pressed middle income people have overstretched themselves to buy homes.

Badly engineer this expansion of residential building to the extent that you end up with a property-price collapse and you, thus, end up with a lot of angry people.

Further, the health of a huge amount of speculative bank lending is tied-up in maintaining property prices where they are now.

The benefit, though, of giving millions of migrants the freedom to get rid of their hukou status would be that they would have access to health care services, pensions and free education.

But can China afford to give migrants this freedom, given rising social costs resulting from its one-child policy?

 Source of picture: http://whyfiles.org/ 

By John Richardson

MY colleague Nigel Davis has written an excellent Insight article which highlights how some chemicals companies are seeking to respond to changing patterns.

As we have discussed before, Bayer Material Science is adapting its portfolio of products in response to the megatrends - demographics, energy conservation, climate change and the challenges of providing enough food and water to sustain emerging-markets growth.

"There are many ways you can grow in chemicals but achieving anything like the growth rates of the past has become increasingly difficult," writes Nigel.

"In the short term {and in the long term, we think], chemical companies face the prospect of slower demand from China, lacklustre growth in the US and extreme weakness in Europe."

He uses the example of BASF and how the Germany-headquartered chemicals giant is working with Harvard University, MIT (the Massachusetts Institute of Technology) and the University of Massachusetts (UMass) Amherst.

The aim is to jointly develop new materials for the automotive, building and construction, and energy industries.

The research collaboration will involve chemists, physicists, biologists and engineers with know-how in different industries, BASF says. The trick will be to turn academic research into technically feasible products and processes.

"Topics already identified include micro- and nano-structured polymers with new properties, as well as biomimetic materials that emulate nature," BASF said.

"The scientists are working on lightweight construction materials for wind turbines and automotive construction and on new colour effects for cosmetic applications," it added.

"We need the creative spirit of the widest possible range of sciences to develop solutions to meet the needs of a growing world population for clean drinking water, secure energy supply and improved quality of life," president of BASF's Advanced Materials and Systems Research, Christian Fischer, said.

Such creative spirits will only prosper in companies that have top-line executives who both understand that the "rising tide lifts all boats" growth model of the past is over for good, and crucially, are prepared to act on that understanding.

Close collaboration with countries and local companies, as growth models evolve, is essential if companies are to adapt to the New Normal - as, of course, is the willingness to invest in R&D that will not always reap immediate share-market and quarterly profits-boosting results.

Carefully nurtured relationships with customers will also be a key ingredient for success.

"I have watched my customers grow for more than 10 years now, and as a result, have been able to grow with them," said a source with a global polyolefins producer.

"Many of my customers in China have gone from being commodity converters of standard-grade polyethylene (PE) to highly sophisticated producers of value-added film with, for example, high moisture protection."

If you haven't done the groundwork already, it is going be extremely difficult to play catch-up.

BASF, for instance, is already collaborating with 600 research institutions.

There is no more time left to lose.

Source of picture: Luxepost.com 

By John Richardson

CHINA'S industrial output has had the weakest start to a year since 2009 and retail sales growth has slowed, according to this article from Bloomberg.

New local-currency loans for February were also lower than the estimates of 27 out of 28 analysts in a Bloomberg News survey.

China's leaders are trying to undo the damage of 2012 by reducing liquidity in the financial system - hence, last month's lower-than-expected new lending.

Industrial output is likely down because credit is tighter - and because demand has been weakened by rising inflationary pressures.

And as for weaker retail sales growth this, of course, also reflects higher inflation.

Standard Chartered estimates inflation will average 4% this year, above the government's target of 3.5%. This suggests that more credit tightening is on the way, with an interest rate rise now expected in Q4 (we think possibly earlier).

Weaker retail sales growth is also probably the result of a dip in demand for luxury goods.

Luxury goods sales are down because China's new leadership is anxious to show that it is serious about dealing with government officials showing-off their ill-gotten wealth.

One wonders how many sales-growth estimates have been based on the assumption that China's elite would be able to carry on buying huge volumes of luxury handbags and Kweichow Moutai Co (600519) white spirit etc.

We think that that the clampdown on corruption - part of which is the pressure on government officials to cut back on "bling" - is here to stay.

Why? Because it will help make the majority of Chinese who still earn less than $10 a day a little happier.

Plus, it gives the new Politburo Standing Committee a chance to visibly take on the "vested interests" who are keen to maintain the old growth model, as these have been the people benefiting from graft whilst stocking-up on luxury goods.

Equally likely is that the air around major cities, such as Beijing and Shanghai, will be cleaned-up by closing-down highly-polluting chemicals and other factories (perhaps this is already also a factor in lower industrial output?) and limiting the growth in car ownership.

A healthier environment will help make China's middle-income netizens more content.

The renewed battle against inflation, the corruption crackdown and efforts to deal with air pollution are just three of the many reasons why 2013 will play out very much like 2012: Another year where the commodity end of the chemicals industry will have to deal with demand growth lower than during the previous decade's "economic miracle".

But innovative chemicals companies are a different matter entirely. They could see growth rates at healthy multiples over increases in GDP as they help China deal with water shortages, wasteful use of energy and pollution.

Being part of China's solution is infinitely better than being part of its problem.

By John Richardson

CHINA'S demand for polyethylene (PE) is lower than immediately ahead of the February Chinese New Year (CNY) break, said a Singapore-based polyolefins trader.

"For demand to be less than just before the New Year, when most traders had already pulled out of the market to avoid cargoes being stranded at ports during the holiday period, is remarkable. In the ten years I've been in this business, this has never happened before," the trader added.

"Trading has come to a virtual halt. Re-exports have increased." (Re-exports comprise resin shipped to China and held in bonded warehouses that has failed to find a home in the domestic market, which, as a result, is shipped to other countries).

"I got it wrong as I thought there would be a strong recovery after the holidays, but it didn't happen because of policy uncertainty. Most other traders are in the same position. We all thought monetary conditions would remain favourable," he said.

"Restrictions on the property markets, reduced liquidity in the banking system and lower new lending in February, have reduced PE buying.

"People are worried that Beijing will have to take more measures to cap property prices, as what has happened so far is unlikely to work. They all think that eventually interest rates will have to be increased because overall inflation is also rising. This is further dampening activity."

Asian PE pricing fell by in $20-40/tonne for the week ending 8 March, mainly because of weak demand, according to ICIS pricing (see above chart).

The People's Bank of China (PB0C) is keen to take a more aggressive stance on inflation, whereas government agencies, such as the National Development and Reform Commission, are eager to maintain the recovery, according to this Reuters article.

But February inflation was at 3.2%, up from 2.0% in January, with the February rate close to the government's maximum annualised target of 3.5%.

The risk is that if the cost of living continues to rise at this pace, the PBOC will win the battle, leading to an increase in interest rates earlier than Q4 - the current consensus forecast.

"A rise in interest rates would be a major blow to the market," said the trader.

And even if pro-growth government agencies get their way for most of this year, the PBOC looks set to continue its policy of reducing liquidity as a tool to fight inflation.

A further reason to expect less credit in the system is that overall lending for January-February is ahead of the central bank's annualised target, according to Reuters.

"Take January and February together and new loans are being extended at a 10 trillion RMB rate for the year [on an annualised basis), well above the RMB 8.5-9 trillion that Wang Jun, senior economist at the well-connected China Centre for International Economic Exchanges, believes the PBOC is tasked with for 2013," wrote the wire service.

Measures to control the shadow-banking system also seem likely, as total new credit in 2012 hit an all-time high.

Rising inflation is partly China's fault as a result of its politically motivated economic stimulus in May-October last year.

Another factor behind the rising cost of living - the surge in global oil prices - is beyond China's control (unless China introduces emergency measures to raise subsidies on fuel prices).

"Today, gasoline is at RMB 9630/t and diesel at RMB 8810/t, compared to June 2008's peaks of RMB6980/tonne and RMB 6520/tonne," wrote fellow blogger Paul Hodges, in this post.

"China's gasoline price for 90 RON is thus $4.60/US gallon ($1.20/litre), compared to current US prices of $3.75/gal. European prices are even higher at $8.00-$9.00/US gallon."

By John Richardson

ALTHOUGH overall Chinese polyethylene (PE) demand, as we feared would happen, has fallen back to Q1-Q3 2012 levels (current sentiment suggests that it could be even lower), higher-value segments of the industry continue to do very well.

It is, therefore, worth reflecting again in more detail on comments made by a source with a global polyolefins producer last month.

They tell us that:

*Polyolefins producers with the right technologies, and crucially with the right long-standing and carefully nurtured customer relationships, stand to do very well this year.

*But the higher-value segment comprises only around 10% of China's market. The remainder will be a battle for profitability and market share which the Middle East producers, and perhaps the US if there are arbitrage opportunities, are sure to win. Overly upbeat comments made by certain Asian naphtha cracker operators to chemicals analysts earlier this year are going to ring very hollow.

*Higher-value plastic processors in Europe and elsewhere will be under more pressure from competitors in China. At the moment, it seems as if antidumping or safeguard duties are not an option for the Europeans. But if the Eurozone economy worsens, which we think is highly likely, this might well change. "Unfair" Chinese government financial support for manufacturers in general is likely to attract a lot more attention. We like the slide above, from management consultants Deloitte, which neatly summarises the challenges Eurozone businesses. Converters we spoke to in Europe last week explained how difficult conditions have become.

Here are the comments in full from the polyoefins industry source:

"The fundamentals of the high-end PE films business remain good. I can make money even if the rest of the business fluctuates up or down by 5-10%.

"The high-end film manufacturers in China first took on the Australians, the Malaysians and the Indonesians and now have switched their focus to Europe.

"The European film manufacturers are complaining but cannot launch anti-dumping or safeguard duty claims. The reasons are that the markets are not big enough to justify the legal fees or get government support.

"Conventional thinking is that strong growth in China has to come to an end up, but when you talk to any customer below 50, they see things very differently. They think that the Chinese government will continue to provide them with very good support.

"For the high-end film manufacturers in China, into applications such as high moisture-barrier film for food and toothpaste packaging, they have absolutely no problem in accessing financing from the state-owned banks.

Plus the big brand-name finished goods manufacturers that are state-owned are instructed to buy from them.

"I think a reason could be because 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.

"But the higher-value segment only comprises around 10% of the overall China PE market.

"The commodity end of the business is struggling though, for example, in the 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.

"Smaller converters are closing down in China, or are merging, as a result of higher labour costs and other costs and a relative lack of government support.

"But the big commoditised converters are fine - they have plenty of cheap access to financing."

By John Richardson

XI Jinping, who formally became China's president last week during the National People's Congress meeting, faces enormous challenges.

Life is, for example, pretty grim for hundreds of millions of people in China.

Many have lost out on the country's "economic miracle" because a hugely disproportionate share of the country's wealth has ended up in the hands of a poor, often corrupt, elite at the top of Chinese society.

Thus, supported by demographics that have swung in their favour, factory workers are no longer prepared to accept poor wages and bad working conditions. They are now much more willing to down tools.

As for the middle class, life, whilst economically a lot better, is blighted by food and air pollution (and, of course, this applies to the poor as well!).

Just imagine bringing up your kids in a world where you worry every day that they might be breathing in noxious air and eating contaminated food. OK, your apartment might have tripled in value since the early 2000s, but what's the point of money when you cannot guarantee the safety of your children?

As countries get richer it always happens that the quality of life becomes as important as material wealth.

What is different in China is the size of its middle class, or more accurately the middle income proportion of its population, and the presence of the Internet. The Internet enables public dissent to spread far more quickly than in the past.

Maybe the biggest of all of China's problems is the end of the demographic dividend, which we have already referred to above.

The slide at the top of this post neatly summarises the economically dangerous consequences of China's one-child policy. As you can see, China falls into the same category as only one other country, Russia, in being both poor and old at the same time.

The great news is that Xi shows every sign of recognising all the difficulties. We wish him, and his colleagues, every success.

China has done it before - i.e. the economic transformation achieved by Deng Xiaoping, which lifted hundreds of millions of people out of poverty. This was a colossal achievement.

Let's hope it can do it again.

Chart compiled by the China Real Time Report blog. 

By John Richardson

NOBODY should be surprised about what is happening in China's petrochemicals markets, as the signs have been there for many months that economic rebalancing would have to accelerate.

This could be marvellous news in the long term for domestic consumption growth, but it is grim news right now for China's lower-value small and medium-sized enterprises (SMEs) - the main drivers of petrochemicals consumption.

As we warned might happen, they are finding access to credit much harder following government efforts to rein-in credit growth, according to several chemicals traders we spoke to yesterday.

And, as the Wall Street Journal's China Real Time Report blog points out, wage costs are once again on the increase.

"After a pause in 2012, minimum wages have returned to rapid increases," writes the blog.

"Export hotspots Zhejiang and Guangdong hiked the minimum wage by 12% and 19% respectively in 2013.

"With the central government's inequality plan promising to lift minimum wages to 40% of the average, further steep increases can be expected in the years ahead.

"A survey of more than 300 factories in the Pearl River Delta by Stephen Green, China economist at Standard Chartered, found that wages for blue collar workers are set to rise 9.2% in 2013, up from a 7.6% increase in 2012.

"The survey also found that additional pressure is coming from stricter enforcement of social insurance contributions - which can add substantially to the wage bill - and higher demands from workers' representatives."

The problem is that unless higher wage are met by increased productivity, inflationary pressure will increase, making an increase in interest rates much more likely.

"A rise in interest rates would be a major blow to the market," a Singapore-based polyolefins trader told the blog last week.

Workers have demographics on their side and so they might well be in no rush to heed calls for better productivity.

By John Richardson

EUROPEAN olefins markets have turned decidedly bearish, according to my ICIS colleague, Nel Weddle.

"Although the lack of pre-buying in February ahead of a much talked-about increase for March contract prices had been deemed a bearish signal, the one positive was that, up until now, demand levels were fairly stable," wrote Nel, European ethylene editor for ICIS pricing, in her 15 March report.

"However, this seems to have changed this week amid further bearish news from Asia.

"Many market sources are disappointed about the turn of events. Lengthening [European] supply during what is supposed to be the seasonal high for demand, in spite of all the unplanned and planned cracker outages, is not what the market had expected."

Not what the market expected seems to be a pretty common theme. An important question to ask is: Which market - the real one or the virtual reality one? 

"Chinese economic recovery has not rebounded as fast as expected post the Lunar New Year and the managements of the companies attending our conference were somewhat surprised that the new Chinese political leadership has not taken more aggressive steps to stimulate the economy," said US chemicals analyst Don Carson. He was referring to the Susquehanna International Group's 2013 Chemicals Conference in Boston, Massachusetts, on 14-15 March.

A challenge for chemicals company executives, if they have fallen into the trap of overselling prospects for growth in Europe and China, is how they explain to shareholders  disappointing first quarter financial results.

By John Richardson

CHINA has to improve innovation if it is to avoid the middle-income trap.

Some people assume that success is a given because of China's great achievement of lifting hundreds of millions of people out of absolute poverty over the last two decades.

But rapid industrialisation and infrastructure spending, which were the methods of achieving the above, are perfectly suited to a heavily-controlled political system. Resources can be easily mobilised on a huge scale when the state controls both finance (the state-owned banks), and, to quote Marx, "the means of production" (the state-owned enterprises).

Now the challenge is to foster the right degree of creativity essential for innovation within what some people warn are the "confines" of the political system.

One of Xi Jinping's tasks is to ensure that the system is flexible enough to allow small, start-up companies to spring from nowhere and become producers of world-beating brands, while  ensuring that reforms don't undermine the political system.

South Korea became a democracy before successfully escaping the middle-income trap, as we discussed in chapter 10 or our e-book, Boom, Gloom & The New Normal.

Bill Dodson, author of China Fast Forward: The Technologies, Green Industries and Innovations Driving The Mainland's Future*, provides a bleak analysis of China's current innovation environment.

"As Thomas Kuhn wrote in his seminal study of the work of scientists, 'The Structure of Scientific Revolutions', most often discoveries are resisted by peers who have vested interests, yet eventually 'the community of scientists adapts - typically in nonviolent ways - as the discovery becomes a fact that expands on previous understanding," he wrote.

"The scientific method is supposed to weed out wrong or misleading results and researchers to contribute to a base of standing knowledge upon which others may continue to build. The court systems in a civil society function similarly, with judgments passed based on a body of evidence that is indisputable in its objectivity and certainty.

"Both science and society in China are based on patronage, though. Patrons are typically political appointees with ties to the Chinese Communist Party. They are made department heads, school directors and research presidents.

"Often, political appointees have little or no experience in the fields they are charged to manage. Subsequently, patrons themselves dole out positions of responsibility to scientists, funding for projects, even living quarters for the families of researchers. Consequently, researchers learn not to 'bite the hand that feeds' if one wants to advance his or her career."

This "network of patronage" means that China is ill-equipped to develop the innovation necessary to deal with its huge environmental problems, said Dodson. 

China's economy has become increasingly dominated by the state-owned enterprises, which, according to Dodson, is bad news for innovation.

"The larger the enterprise and more closely aligned with national industrial policy, the fewer degrees of freedom of research & development interests and commercial viability the entity has," he added,

Yigong Shi and Yi Rao, deans of Life Sciences at Tsinghua and Peking Universities said in an editorial in Sciences Magazine: "It is an open secret that doing good research is not as important as schmoozing with powerful bureaucrats and their favourite experts. China's current research culture wastes resources, corrupts the spirit, and stymies innovation."

The Chinese themselves, according to a survey by the design agency, frog, think it will take some time for China to catch-up on innovation.

"Companies like Apple, Microsoft, Google and Samsung were regarded as more innovative than local businesses such as HTC, Huawei, Tencent and ZTE," wrote the marketing news and analysis service, Warc, in its report on the frog study.

"A third of respondents thought it would take more than ten years for Chinese companies to become as innovative as those in the West, while a further 25% felt it would take between six and ten years."

Is it, though, just a question of time?

By John Richardson

EVERYWHERE you look across China's petrochemical markets the story is the same as in polyethylene (PE): Exceptionally weak demand during a time of the year when demand should be good.

Take purified terephthalic acid (PTA) as an example.

"Asia's purified PTA spot prices fell in the week ended 15 March on reflection of lower discussion and transaction prices," wrote ICIS pricing's Asia fibre intermediates, Becky Zhang, in her 15 March report.

"A 1.6% fall in PTA futures on 12 March weighed on buying and selling indications to a 15-week low. Mild upward corrections in PTA futures on 13-14 March stabilised buying sentiment, but were not able to drive up prices back to the levels seen in the previous week because of weak demand."

High inventories were reported up and down the value chain.

Earlier this week, Asia's spot benzene prices fell to a 23-week low as a result of lower prices in both the US and China, according to Asia aromatics editor, Ong Sheau Ling.

Demand for overseas benzene in China was low because domestic prices were lower than those on international markets, added Ong Sheau. This pattern is common across many products.

Asia's toluene prices have also fallen to an eight-and-a-half month low on high stock levels in China.

Petrochemicals markets might take heart from the improvement in the HSBC Purchasing Manager's Flash Index for China. The March index rose to 51.7 in March from 50.4 in February. However, it remained below a two-year high of 52.3 in January.

But one should be very cautious about reading too much into this.

The blog had six discussions with chemicals traders yesterday, who trade in products ranging from speciality polymers to benzene, and they all said that demand was exceptionally weak. Commodities demand in general remains poor, according to this Reuters report.

Weak January and February electricity output figures mean that first quarter GDP growth is likely to be slower than the fourth quarter's 7.9%, said Capital Economics economists Mark Williams and Qinwei Wang.

"They also looked at a drop in domestic freight volumes, but conceded construction activity and port volumes have improved," the Reuters article added.

"Taken together, the signs are that 'economic growth is slowing in the current quarter, much sooner than most had expected,' " Williams and Wang concluded.

Capital Economics added that growth in (quarter-on-quarter) terms has dropped back to the pace seen in mid-2012, before the policy-driven rebound took effect.

This is consistent with evidence that China is withdrawing economic stimulus as it tries to deal with inflation and excessive credit growth.

"China's got a head cold, and it's going to take awhile to get going but it will," Stephen Pryor, CEO of ExxonMobil Chemical, said during a panel discussion at the IHS World Petrochemical Conference in Houston earlier this week.

We wish we could share his unequivocal confidence.

The excellent article below from Paul Taylor at Reuters, which with his permission we publish in full below, describes how the European crisis is far from over, despite the hopes of financial markets following Mario Draghi's pledge "to whatever it takes" last year. The crisis is, in fact, getting worse.

18 ‎March ‎2013, ‏‎20:39:26 | Paul Taylor
Paris( Reuters) -Grigoris Lemonis, a 73-year-old Athens pensioner, uses his 580 euro monthly state pension to support his wife and the family of his son, an unemployed cook with two small children and a wife who works occasionally as a cleaner. Three-generation families surviving on a single income are increasingly common across southern Europe as mass unemployment tears at the fabric of closely knit societies.

The continent's social shock-absorbers are creaking under the strain of a prolonged economic crisis that began in 2008 and engulfed the euro zone in a sovereign debt crisis from 2010. The welfare state that Europeans built after World War Two, and which many view as a defining achievement of their civilisation, is one reason why the Great Recession has not triggered a revolution or severe social unrest so far.

"Daily life has become pure misery," said Lemonis, a former painter in the construction industry who owns his own house. "We are up to here with bills and once all that is paid there's nothing left to live a decent life," he said, adding that the family can only afford meat once or twice a month.

With more than 26 million unemployed in the 27-nation European Union, including nearly 6 million young people, the system is struggling, and in some places failing, to cope. Many of the jobless have exhausted their benefit entitlements.

"In many countries, the poor are getting poorer," says Laszlo Andor, the EU's Commissioner for Employment and Social Affairs, pointing to a growing North-South divergence. "Europe's social fabric is clearly under pressure and a stronger response at EU and national level is needed."

Social spending rose across the continent in the first phase of the crisis but states like Greece, Portugal, Ireland, Spain and Italy that were hardest hit have now had to cut outlays on pensions, healthcare, education and unemployment benefits. Countries that target social spending towards providing services such as childcare, vocational training, job-search assistance and accessible healthcare have better results than those that spend most in cash payments to pensioners and the unemployed, Andor told Reuters in an interview.

While Austria and Spain both spent about 15 percent of GDP on social welfare other than pensions, Austria achieved a 55 percent poverty reduction while Spain managed only 28 percent. Countries like Italy and Poland that spend a higher share of their social budget on pensions tend to be less effective in alleviating poverty because the working-age population most severely hit by the crisis is less well covered, Andor said.
But welfare systems breed their own interest groups and are fiendishly hard to transform.

AFFORDABILITY

Political leaders are fretting about the affordability of the European social model in an era of high public debt, low growth and ageing populations. "If Europe today accounts for just over 7 per cent of the world's population, produces around 25 per cent of global GDP and has to finance 50 per cent of global social spending, then it's obvious that it will have to work very hard to maintain its prosperity and way of life," German Chancellor Angela Merkel said in an interview with the Financial Times last December.

Social spending as a proportion of output is now at least 6 percent higher than in 2007 on average in the 34 countries of the Organisation for Economic Cooperation and Development, a club of industrialised democracies of which 21 are EU members. Moreover, ageing populations are set to drive up the costs of pensions and healthcare in coming years, the OECD said.

The majority of EU governments have used the crisis as a reason to raise the retirement age, bringing it more into line with increasing life expectancy, said Willem Adema, an OECD expert on employment, labour and social affairs. Social scientists distinguish three broad welfare models: Nordic, continental European and Anglo-Saxon.

Nordic countries offer a high level of "cradle to grave" welfare with an emphasis on pre-school childcare and education, designed to keep women and older people in the labour market.

The continental European model features contributory social insurance systems that offer strong protection to "insiders" with protected jobs, while continuing to regulate employment and the labour market. The Anglo-Saxon model tends to make welfare payments smaller and more selective and encourages private provision of healthcare, education and pensions for the better-off.

The Nordic model seems to have proven the most effective at reducing poverty without discouraging people from work, although it comes with the highest taxes. Britain and Ireland pay cash allowances to stay-at-home single mothers, contrary to the OECD and EU view that such money is better spent on providing public childcare. In Germany, Merkel's government plans to introduce such a benefit this year.

"It makes more sense to get people into work than to focus on paying benefit to stay home," the OECD's Adema said. "Yet amazingly, some countries are cutting pre-school childcare." European governments have found it easier to trim welfare systems at the edges than to reform them radically. In particular, spending more on young children and school-leavers to promote employment and skills and less on the elderly is politically difficult. Older people vote more than the young.

"In many countries, it is the middle class who are the direct beneficiaries of social security entitlements," policy analysts Patrick Diamond and Guy Lodge wrote in a paper for the Policy Network think-tank. "This makes pensions and welfare payments to older cohorts practically untouchable." The Netherlands, where retirees enjoy the highest purchasing power in Europe, provides an example. Its recently created 50PLUS party that campaigns on behalf of pensioners won two seats in the 150-member parliament for the first time last year.

Since the new coalition of centre-right Liberals and the centre-left Labour party agreed to raise the retirement age to 67 from 2021, support for the grey movement has soared. A poll this month showed 50PLUS would win 18 seats if the election were held now, making it the third biggest party.

Older voters may fight their political corner, but they also should grasp the need to leave resources for social spending for the young. Just ask Lemonis - the Athens pensioner supporting two younger generations on his dwindling monthly allowance. "At least we pensioners are old and we've lived our lives," he said. "I'm worried about our children. What will they do when we can no longer help them?"

Source of graph: Standard Chartered

By John Richardson

WORKING conditions matter as much as higher salaries for China's emboldened manufacturing workforce, according to this article in the Financial Times.

"As the number of available workers falls, factories struggle not only to find new hires, but also retain existing staff. A young and educated workforce demands more from employers," writes the newspaper.

Thus, family dormitories, and perhaps even workplace creches, will become essential investments for companies.

This is all very well if you are the Chinese equivalent of an Apple or Google (no such companies exist in China. Will they ever exist?), but if you are making cheap plastic garbage bags in a coastal province in China, you are pretty much finished.

Higher wage costs are in themselves also, obviously, a big problem.

Headline percentage wage rises underestimate the scale of the crisis, the FT article also points out.

"Workers don't care what the minimum wage is. They expect to be compensated at the market rate," one employer told the newspaper.

"Given the massive shortages [of labour] we are facing, I am not sure any method will work any more."

The post-Lunar New Year period has made the problem worse.

Before the New Year break, we flagged up that workers would be more likely to stay at home after the holidays because of rising living standards in the countryside. We were right.

The FT said that there was another factor at play here: Because of tight labour markets (see the above slide from the Standard Chartered 2013 China annual employment survey), workers are more likely to take protracted two-month Lunar New Year holidays while they assess their employment options.

Labour shortages help to explain very disappointing petrochemicals demand post-New Year.

The Standard Chartered survey found that a growing number of companies in the Pearl River Delta region could no longer absorb higher wages and so planned to relocate.

Wage increases are now running ahead of improvements in productivity, the survey suggests. Such is human nature.

Thirty per cent of companies surveyed said they would move to other parts of China, and 9% said they would go elsewhere, mostly to Cambodia, Bangladesh, and Vietnam.

Last year, 13% said they would relocate to other regions in China, and only 4% planned to move abroad.

Does your chemicals company have a strategy to deal with all, or even any, of this?

By John Richardson

Amidst all the continued excitement about abundant supplies of ethane in the US, some sceptics are still warning that all may not as it seems during petrochemicals company investor presentations.

"The US does not have 100 years of natural gas supply," said the author of this post on the Oil Drum blog.

"There is a difference between resources and reserves that many outside the energy industry fail to grasp. A resource refers to the gas or oil in-place that can be produced, while a reserve must be commercially producible.

"The Potential Gas Committee (PGC) is the standard for resource assessments because of the objectivity and credentials of its members, and its long and reliable history. In its biennial report released in April 2011, three categories of technically recoverable resources are identified: probable, possible and speculative.

"The President and many others have taken the PGC total of all three categories (2,170 prillion cubic feet (Tcf) of gas) and divided by 2010 annual consumption of 24 Tcf. This results in 90 and not 100 years of gas.

"Much of this total resource is in accumulations too small to be produced at any price, is inaccessible to drilling, or is too deep to recover economically."

"More relevant is the Committee's probable mean resources value of 550 (Tcf) of gas. If half of this supply becomes a reserve (225 Tcf), the US has approximately 11.5 years of potential future gas supply at present consumption rates.

"When proved reserves of 273 Tcf are included, there is an additional 11.5 years of supply for a total of almost 23 years.

"It is worth noting that proved reserves include proved undeveloped reserves which may or may not be produced depending on economics, so even 23 years of supply is tenuous.

"If consumption increases, this supply will be exhausted in less than 23 years.

"Revisions to this estimate will be made and there probably is more than 23 years but based on current information, 100 years of gas is not justified."

Oops. More support for the Ponzi scheme argument?

And further, in the same post, the author argues that major shale-gas fields, such as the Barnett, Haynseville and Marcellus fields, may have already reached peak production, despite the addition of lots of new wells, at current gas prices.

The Woodford shale field is already in decline (see the above chart), adds the blog post. 

"A painful adjustment is underway in the natural gas exploration and production industry," continues the author.

"Fewer jobs will be created and projects may develop more slowly. This development may expose the notion of long-term natural gas abundance and cheap gas as an illusion.

"The good news is that this adjustment will lead to higher gas prices in a future less distant than most believe. Higher prices coupled with greater discipline in drilling will allow operators to earn a suitable return and offer the best opportunity for supply to grow to meet future needs."

How much higher would gas prices need to rise before some of the seven announced cracker projects (10m tonnes/year of ethylene capacity) in the US come into question?

Hopefully, the threshold will soon be crossed, as we continue to worry that sufficient demand will be the problem if all these projects go ahead.

By John Richardson

THE blog turned 50 last week and so spare it some indulgence, as it is in a somewhat reflective mood.

Yesterday, it attended a Bruce Springsteen concert in Melbourne, Australia - the great song writer/social commentator in the fine tradition of Woody Guthrie etc. His iconic song, Youngstown - about the "former" steel town in Ohio - was part of Springsteen and the E-Street Band's fantastic set.

The great news is that "former" no longer entirely applies to the Youngstown steel industry, as The Economist pointed out in this article.

"In Youngstown, Ohio, a French firm, Vallourec, has spent $650m building an entirely new mill to make similar pipes," wrote the magazine.

"It began production in October, with a staff of 350. Thirty miles in the opposite direction, in Brackenridge, Pennsylvania, Allegheny Technologies is spending $1.1 billion on a new mill to produce stainless steel and other specialty metals. US Steel opened a new $100m mill in Ohio in 2011, also to supply the oil and gas industry. Timken, another steelmaker, is spending $200m on its mill in Canton, Ohio.

"The main reason for this flurry of investment lies a few thousand feet below the ground: the Marcellus shale, a geological formation containing huge reserves of natural gas trapped in tiny pores in the rock."

We hope that concerns over poor shale-gas economics, and therefore much-more limited supply than the consensus view claims, are totally unfounded. The American people do not deserve to once again fall victim to another example of financial-sector snake oil.

We equally hope that the necessary investment takes place in infrastructure, in R&D and in education essential to make the US manufacturing renaissance real for the unemployed, as Boston Consulting Group has pointed out. 

Manufacturing investment needs to also be tailored to meet the needs of America's ageing population.

As Springsteen has said, if your job is taken away, "this removes an essential part of you".

Making more plastic pellets and steel girders in the US is about more than just dollars and cents.

By John Richardson

THERE will, of course, be bright spots in petrochemicals markets as a result of factors independent of China's new economic direction.

For example, as an aromatics trader points out, there are huge paraxylene (PX) capacity additions in Asia that will provide a great deal of support to reformer economics. In 2010-2013, he estimates that the region's capacity will double from 12m tonnes/year to 24m tonnes/year.

And buyers of polyolefins will be in a very strong position over the next few months as new capacity is ramped-up in China and Singapore.

But the rest of this year will still be primarily about the new economic direction.

Demand growth is likely to remain depressed for the rest of 2013, and into next year which, we think, most petrochemicals markets participants are now coming to terms with.

Markets have, however, yet to factor into what we think, along with fellow blogger Paul Hodges, will be further measures designed to tackle the property-market bubble, corruption, over-investment and the environmental crisis. Such measures would further depress growth.

The above chart, from Paul's blog, illustrates the impact of the new policy direction to date. Electricity consumption has slowed down on reduced economic stimulus, including bank lending.

There will be occasional bouts of restocking, as occurred towards the end of last year in polyethylene (PE), when chemicals and polymer buyers in China find their inventories exhausted and/or regain their confidence in a strong economic recovery. These won't last long.

Watch out, though, for a sudden change of mood amongst China's leaders. If the West suffers another major economic crisis aka Lehman Bros, or the cumulative impact of slower Western growth shows up in a dramatic reduction in exports, China might once again panic and throw stimulus money at the problem.

Such a dramatic change of direction would be great short-term good news for traders and producers.

In the long run, however the net effect would be harmful as rebalancing would take even longer and would be even more economically disruptive than is the case today.