Asian Chemical Connections

Imagine having to sack two of your senior management team after unauthorised takeover discussions.
And then imagine just a few weeks later being forced to announce a 20% reduction in first quarter earnings.
Andrew Liveris, Dow CEO (continuing our Dow theme - see below), is having a hard time of it. Mind you, life is supposed to be tough at the top and this is what he is paid for.
The likeable Liveris has come out fighting, as this article illustrates. Shareholders, though, in the US in particular, are not famed for the patience.
I am not sure about the reference to Rugby: Liveris, an Aussie, should remember that England beat Australia in the last Rugby World Cup Final.
Don't mention the cricket......

At least the US is on board, but the pact to reduce emissions by 25-40 per cent by 2020 might well not be sufficient to prevent the 1.5 centigrade rise in global temperatures that will be disastrous for the planet.

In another excellent article from George Monbiot of The Guardian, he argues that we need to "decarbonise our society" in order to achieve reductions of 95.9 percent in the UK and 98.3 per cent in the US by 2050.

Impossible? Maybe, but as the effects of climate change become more evident, pressure on the chemicals industry will mount. A great deal more investment in new technologies to reduce emissions will surely be necessary - to put more substance behind some of the right noises industry leaders are making.

The old saying "there's no such thing as a free lunch" has at last been proved true with the virtual collapse of the global financial system - and with it, quite possibly, the world's economy.

But for the last decade or more, the chemicals industry, like every other industry, gorged itself on an easy credit-fuelled property boom that's swept the globe.

In Singapore until very recently, real estate was red hot. Surprise, surprise, oversupply beckons, the market is flat and a pricing collapse cannot be ruled out.

Property bubbles come and go and so cyclical downturns were inevitable in Singapore, Thailand, India, China and Australia.

But perhaps the long-term fallout of the crisis - a much more prudently managed banking sector - might have negative implications for chemical demand-growth multiples over GDP.

As the problem rests mainly with US lenders, though, it's hard to say whether credit will also become much harder to obtain for good in Asia and other emerging markets.

But the appetite to lend money to average and below-average earners at high multiples of annual incomes - and with incredibly low "teaser" interest rates - will at the very least take a few years to recover.

Mohamed El-Erian, co-CEO and co-chief investment officer for Pimco, analyses the implications of this tighter credit climate in today's Financial Times.

It is worth asking your friendly neighbourhood consultant or in-house researcher whether any of their growth scenarios take into account the possibility of much tighter lending conditions for many years to come.

As the American Chemistry Council points out, $16,000 of chemicals are consumed when an average home is built in the states.

On a global basis, this alone means an awful lot of demand without counting consumption by real estate in other countries.

As if the problems confronting China's polyolefin markets were not enough, sales have apparently been further hit by the tainted food scares which began with baby's milk.

A wide range of products are now affected with Cadbury becoming the latest global confectionary brand to withdraw some of its products.

The China market was already facing the potential for negative or even flat polyethylene and polypropylene growth in 2008 because of the collapse in export trade to the West due to the global financial crisis.

The problem now, according to a leading Western PE producer, is that just about every exported Chinese food product is being subject to closer scrutiny by regulatory authorities - along with the negative impact on sales of all the product withdrawals. This is making China's converters even less willing to buy resin.

Long term, lower growth in China means it will of course take longer to absorb the new capacities.

The Chinese government also faces the task of rebuilding confidence in its food industries - not only for the sake of export trade but to also tackle local anger. Civil unrest over health concerns surrounding air and water pollution is already a major threat to social stability.

But for those focusing on immediate prospects, the good news is that there are strong rumours of substantial delays to the start-up of two major PE plant sin the Middle East.

The longer that late equipment delivery and technical (or maybe market?) issues push back start-up, the more likely it is that the global economic downturn will at least have reached the bottom of the trough before the big flood of volumes hits supply.

The industry has been very lucky. First came the Iranian delays, which in effect mount to the cancellation of 3-4 crackers all due on stream in 2010-12.

Then we have seen up to three crackers in Qatar delayed to beyond 2012.

And for those projects where building work is almost complete, continued technical and equipment delivery issues have left buyers with the same feeling that Manchester Utd fans had during the 1980s and early 1990s, which was: "Maybe we'll win the championship next year." Sadly, or rather tragically, things changed.

This year was supposed to mark the big ramp-up in PP production, but it hasn't happened.

I am taking a well-earned break in Perth, Western Australia until early next week so this blog will be quiet until then.

And no, I am unlikely to find out anything interesting on feedstock issues surrounding the Australian cracker as I'll be too busy, hopefully, lying on the beach.

I've just returned from a wonderful few days in Perth, Western Australia, where the motorists don't as a rule try to kill you (unlike in most of Asia) and if you are a tourist at least, you can come away with the false impression that the cork-hatted people have got the balance between work and other things that matter more sorted out.

Anyway, to the point after that ridiculously long sentence. I failed the Koala Bear test in the gift shop in Yanchep National Park .

On sale was a stuffed Koala Bear toy made in Australia at $11.80 in Australian dollars. You could also opt for an "Inspired in Australia" version (I tried to establish what this meant with the shopkeeper, but she hadn't a clue. What Koala Bear is not inspired by the Antipodese, for goodness sake?) at $5.50.

Or you could for the Chinese version at a staggeringly cheap - and no doubt nasty in some horribly chemically polluting and toxic way - $2.50.

We all might want to save the planet by lessening our carbon footprint (blah, blah, blah) but in these straitened times with my investments plummeting in value, I went for the Chinese version on the grounds that my 21-month-old son would very quicky lose the thing anyway (sorry, another long sentence).

Ten minutes out of the shop Mr Koala Bear ended up face down in a puddle.

This was the wisest investment decision I've made for the last two years.

The grass will increasingly seem greener in the other field with, of course, little opportunity to hop over the fence because of downsizing and other vile euphamisms for wrecking the security of families needed to compensate for the naked and unregulated greed of the evil bankers.

So there will be time to dream of the perfect company (life can look very different on the inside of these compared with the public images that they portray, again of course).

One such dream employer could be Virgin Blue, if a recent interview with their chief executive officer, Brett Godfrey, in the Australian Financial Review magazine is anything to go by.

Unfortunately, I can't give you a free link to the article because it's behind a subscriber wall and I doubt very much whether my boss would sign-off the Aus$1,038 annual fee in the current financial circumstances.

But here are a few highlights from a hard copy of the magazine I found abandoned an a seat in Perth airport (yes, in these straitened times why pay for newspapers and magazines?)

"As a result of the JP Morgan furore (a highly critical and inaccurate analysts' report), Godfrey pencilled in his diary a series of 30 roadshows designed to reassure staff about the future. Over the past four months, with chief operations officer Andrew David in tow, he talked to 1600 of the company's 5000 staff in Sydney, Melbourne, Adelaide, Auckland and Christchurch."

And even better, continues the author of the article, Fiona Carruthers: "Employees are guaranteed a response to their bright ideas within seven days, unless he is travelling" (a note from an anonymous reader of my blog to his business-division director: "Dear....I sent you an email three years ago with some restructuring ideas and I am still waiting for an acknowledgement. Happy to see that some of those ideas have been successfully implemented by a colleague, though, who as you know has been subsequently promoted. But I'm not bitter about this." His redundancy cheque is in the post)

Godfrey, rather than laying new staff off, also sent them on a free holiday paid for by Virgin (although this was unpaid leave) when a strike at Boeing delayed a new service.

This is the stuff that dreams are made of.....

Is my colleague in London a cat lover? I am, but did not take offence at the analogy.

If I knew when chemicals prices were going to rebound, I would tell you - but only for some hefty fees.

By Nigel Davis
LONDON (ICIS news)--Beware the 'dead cat bounce'. Global chemical market intelligence service ICIS pricing editors are seeing some spot prices in Asia moving up from recent lows although contract prices remain severely depressed.
Are these the first signs that feedstock-to-product price differentials are recovering?
A dead cat bounce is a "figurative term used by traders in the finance industry to describe a pattern wherein a spectacular decline in the price of a stock is immediately followed by a moderate and temporary rise before resuming its downward movement, with the connotation that the rise was not an indication of improving circumstances in the fundamentals in the stock," according to Wickipedia. It is derived from the notion that "even a dead cat will bounce if it falls from a great height".
As with the world's stock markets, it is too early to call the upturn with anything approaching a degree of certainty. Chemical prices globally are falling because of much weakened feedstock costs.
Oil prices this week have dipped below $50/bbl which is hardly a position from which chemicals prices might be expected to recover.
But looking beyond that, it is the global demand slowdown that is giving the worlds' chemicals markets the jitters.
Industry economists work with real data and they have little visibility. Their forecasts make salutary reading.
The American Chemistry Council's (ACC's) chief economist, Kevin Swift, for instance this week told the New York Society of Security Analysts (NYSSA) that chemicals production in the US could fall by as much as 5.7% next year. This is a forecast for the sector excluding pharmaceuticals.
In the ACC's 2008-year end analysis and outlook Swift notes that forecasting now involves considerable uncertainty.
The general consensus, however, is that recession is spreading across the globe and this is affecting the business of chemistry worldwide.
"Global business of chemistry growth has essentially stalled since earlier in the year, with outright decline in the developed nations and slowing growth in most developing nations," the ACC's report says.
"As a result, global output will moderate significantly in 2008 and will further slow in 2009 before a recovery emerges in 2010. For the business of chemistry in the US the recession will adversely affect demand into 2009, resulting in lower production volumes."
Other sector economists point to slowed growth in the US and a sharp slowdown in Europe, Japan and elsewhere. The outlook is hardly bright, whichever way you look at it.
Analysts have continued to talk about the lack of visibility for the sector which is battling the demand slowdown, or rather consumer disinterest, against the backdrop of lower feedstock and product prices.
Demand has all but ground to a halt in December across great swathes of the sector. The (multi) million dollar question is when will it return.
Producers widely believe that demand will return once price/feedstock cost ratios have stabilised. There will be a new floor from which producer might expect to see greater interest in their products and from which they could hope to drive prices higher.
But we have yet to find the floor in relation to feedstock costs. And the chemical industry's customers themselves are not exactly overwhelmed with new orders.
The situation could change but is unlikely to do so rapidly and certainly not before the start of the New Year.
Swift suggests that the indicators for the US economy will become more negative as consumers retrench, sales fall, inventories rise, and production falls, which is hardly good news for chemicals.
A similar patter of reduced payrolls, mderating incomes and a "viscoious self-reionforcing cycle" is seen across other major global economies.
It pays to look forward, certainly, but it is too early yet to be overly optimistic. "Things will get worse before they get better," Swift says in his latest ACC report, "but eventually they will get better when confidence returns".

The timing of when to strike the ball is everything in the wonderful sport of cricket - and also, apparently, in the American pastime of baseball.

An Australian banker is fond of reminding the English how much better his country is at playing cricket.

But his gloating doesn't extend to how well he's been timing dipping in and out of equity markets of late. Like a lot of other "cashed up" people he is suffering from the "if only" syndrome.

"A lot of money seems to be pouring into stock markets because it has nowhere else to go. I didn't expect this run to last as long," he said.

All the moving indicators are pointing upwards with crude above $55/bbl on Thursday where he thought there would be very tough resistance.

"There's so much crude in storage which has been acquired by the financial traders who perceive the economic recovery is just around the corner. This is a big risk.

"Equity markets are also responding as if a recovery is only three months away. They usually price in a recovery about a quarter ahead of when it actually happens, but I believe that the recovery - or rather the bottom of the market - is at least six months away."

And in his view, you have to be very careful how you measure "recovery" in the context of the worst economic downturn since possibly the Great Depression.

The first important measure is the effect of inventory adjustments on GDP (gross domestic product) growth.

In the US, for example, total inventory reductions subtracted $50bn from growth in the fourth quarter of last year, he said.

The first quarter adjustments will see a further $100bn or so of production cuts and the second quarter possibly in excess of $150bn.

The collapse of liquidity in Q4 2008 forced companies across all sectors to make much quicker operating-rate cuts and plant closures than occurred at the start of previous recessions.

"There was simply no re-financing available so the companies had no choice."

BASF has reduced is global production by 25%, Bayer Material Science has taken 300,000 tonne/year of polycarbonate (PC) capacity temporarily off-line and Dow Chemical's average operating in the fourth quarter was just 64%.

"I expect some inventory replenishment down many of the production chains in Q3 in the US, and probably elsewhere," he added.

"This could give the false impression that we have reached the bottom of this crisis and recovery has begun."

Inventory building in Q3 would need to be measured against consumer spending, he said.

Retail sales on big-ticket durable items such as autos and homes might take longer to bounce back in the West than in Asia. Cost consciousness could also extend for some time to clothing, food and tourism.

Individual wealth has been badly dented by the fall in stock markets relative to their peak and the collapse in housing.

"Savings rates are likely to continue increasing as a result of this loss in wealth - even more so if unemployment keeps on rising."

Recoveries in GDP growth in the third quarter of this year would also need to be measured against the same period in 2007 rather than 2008, he added.

"This will give us a measure of how far we are away from returning to the boom conditions of 2004-07."

The crisis began in the third quarter of 2008.

Any comparison between Q4 2009 and Q4 2008 would be even more misleading as the global economy ground to a virtual halt during the last quarter of last year.

Comparing 2007 with 2009 is crucial for the chemicals industry as new capacity was planned on the belief that growth would continue at levels close to the great boom years.

"Even if were still in a global boom we would still need capacity to shut down," said Paul Hodges, chairman of UK consultancy International eChem.

"In most building block products we are now faced with 20% oversupply."

It could be a very long time before the world economy enjoys another period like 2004-07.

Consumer and corporate credit is likely to remain much more restricted because of financial-sector reforms.

"You also have to look at the potential for credit-card debt going bad to undermine consumer spending and the stability of the banks," the banker added.

"The first quarter results of the Western banks were very misleading. They looked good because of a reduction in competition due to consolidations and bank failures.

(Also, the banks could hardly fail to make money as governments were practically giving money away)

"But behind the numbers you could see warnings over just how much bad debt could result from credit-card defaults.

"As much as 25% of the revenues of some commercial banks come from credit-card transactions."

Consumers who are not in danger of default will be eager to pay off their plastic debts rather than incur 20% interest charges, he said.

The other big risk is the rate of recovery on corporate debt that's gone bad. Optimists think it could be as high as 40%, whereas others are warning of returns of as low as just a few cents on the dollar.

There appears to be the risk of a least a double-dip recession - perhaps even three dips.

Commodity chemicals prices started going up before the current equity-market rally.

This followed the deep global production cuts in aromatics, olefins and derivatives and a rebound in feedstock costs.

It's a moot point whether the cuts, combined with delayed start-ups in the Middle East, created genuinely tight markets or just the perception that they were tight.

In the end, though, the result was the same - raising the age-old conundrum of whether sentiment or fundamentals are driving markets.

A danger is that rising crude prices and the stock-market rally could lead to chemicals production being ramped up (if it hasn't happened already), despite the uncertain outlook for consumption.

Confidence can be a dangerous thing.

It's a great deal easier to off-load shares when you think the market has turned than a warehouse full of polyolefins.

No, I can't do this

Source of picture: perthperth.com/surfing/bodysurfing

Dear Reader,

Off to Australia for a week's leave so no more entries and so will post again from 31 August.

Fair Dinkum

Back from less-than-sunny Perth to discover that the prediction from my good friend and colleague Paul Hodges at International eChem has come true: Benzene has headed south because of:

1.) The rise in its pricing seems to have been out-of-kilter with what has happening downstream in styrene

2.) Traders credit might well have stampeded for the exit after building very high stocks in China in July

3.) Overall reformer economics appear to have been much-improved of late, perhaps encouraging over-production of benzene

See this slide from ICIS pricing which illustrates the point.

View image,

The conclusion has to be, again, that apparent chemicals demand is a long way from underlying demand, despite all the macro-economic confidence.

Expect many more mini disruptions like this - if not the dreaded overall collapse.

Source of picture: www.msnbc.msn.com/id/23512037/

CHINA is making export gains at the expense of other higher-cost competitors that might not be sustainable because of reasons including rising trade protectionism and economic rebalancing.

Chemical companies need to factor in this risk - and take into account how overall demand might merely be shifting location rather than increasing.

Knit apparel is a good example where, according to this article by David Barboza in the New York Times, American imports from China jumped by 10% in July this year compared with the same months in 2008.

This was as US imports from Mexico, Honduras, Guatemala and El Salvador fell by 19-24%. Barboza was quoting data from Global Trade Information Services.

It is not just emerging markets that are suffering as a result of China's increasing dominance in textiles.

The beleaguered European industries are also in the firing line with the EU evaluating extending antidumping duties on imports of shoes from China and Vietnam.

"Reductions in raw-material import tariffs and increases in export-tax rebates have helped Chinese apparel producers push their prices down," said said Ying Min Ye, president of Beijing-based Chem1 Consulting at the Downstream Asia Roundtable Asia oil and gas event in Kuala Lumpur. Malaysia.

The conference, organised by the World Refining Association, took place earlier this month.

You can add to these advantages a Yuan which is now being pegged to the US dollar, resulting in steep depreciations against other Asian currencies. Between March and September, the Yuan had fallen in value by 10% against a basket of Asian currencies, said Barclays Capital.

A further huge advantage is, according to Nicholas Lardy of the Peterson Institute for International Economics (quoted in the same Barboza article), flexibility in labour markets.

This means the ability to cut wages without worrying about troublesome trade unions or restrictive employment legislation.

The biggest comparative boost of all might well be the flood of cheap lending. China has pump-primed its economy through a huge increase in bank loans.

The US removed safeguard duties against imports of several categories of Chinese clothing last December, according to a new report from Textiles Intelligence, providing China with another edge.

The EU removed similar safeguard duties in December 2007.

Both sets of duties were the result of damage caused to local industries when The Agreement on Textiles and Clothing (ATC) came into effect on 1 January 2005

Here, therefore, could end some of the head-scratching over steep increases in fibre-intermediate pricing in 2009.

Restocking and crude oil have been important factors.

What might have also benefited the market are China's gains at the expense of others.

The country's yarn output grew by 9% in the six months to June 2009 over the same period last year, Yin added at the same event.

Fibre output rose by 10% and polyester production by 13%. Click here for a copy of his full presentation - .5 Yingmin Ye 1.pdf

It's not just in low-end clothing where China is making gains, but also in electronic goods - at the expense largely of the Japanese.

Japan has seen its share of electronic-good exports to the US fall by 18% in 1999 to 7%, added Barboza.

In the last year alone, China's market share of the US electronics goods market has doubled from 10% to 20%.

Sales of electronic materials to China were up by 15% in Q3 over the second quarter, said Andrew Liveris, CEO of Dow Chemical, when the company's third-quarter results were released last week.

Coatings and infrastructure sales rose by 16%, polyethylene (PE) 10% by and the automatic sector 5%, he added.

From a Dow perspective, if it's taking sales away from Japanese electronic chemicals companies all well and good.

But displaced demand doesn't necessarily add up to greater overall demand.

Another important point is that when all is said and done, China's exports as a whole are still down on the first half of 2008.

China exported $521 billion worth of clothes, toys, electronics, grains and other commodities in H1 2009, according Barboza.

Although lower than declines suffered by other exporters such as Japan and Germany, this figure still represented a 22% fall over the first half of last year.

Returning to the theme of winners and losers from China's boom, Australia - despite seeing its currency rise in value by 40% against the Yuan in March-September - has made big net gains through a surge in commodity exports.

It's the same story for Indonesia.

"Commodities and high-tech goods have gained [because of the recovery in China]. But anything in between, China can often produce itself, so countries in these areas are under more pressure," said Tai Hui, an economist at Standard Chartered in Singapore in this article from the Financial Times.

Malaysia and the Philippines were losing out because they competed directly with China in many export markets, he added.

"Market stability has improved, but we continue to remain cautious about the ability of some economies to sustain growth," continued Liveris when the Q3 results came out.

"This is especially true of the US and Europe, and until these economies return to 'normal', we believe global growth will be muted."

This is also especially true of China.

Last week we discussed how domestic consumption was much less than investment as a driver of January-September GDP (gross domestic product) growth.

The relatively high investment component of GDP points to several risks and concerns:

*An increase in export-based industrial capacity. Now that it's on the ground, China will be tempted and able to keep this capacity running, even in very weak market conditions

*At the moment the US seems to be more worried over China's willingness to keep on funding its huge deficits than damage to jobs caused by aggressively cheap imports. But how long will this last as unemployment climbs towards 10%? Could we see a big increase in trade protectionism?

*Bubbles in real estate and equities. Real-estate prices have risen by 73% so far this year. Confusing signals are emerging from the government over whether or not monetary tightening will occur in 2010. Leave it too late and these bubbles could get more out of hand; act too hastily and the economic rebound will be set back

*Assuming that the investment number reported for Q1-Q3 also includes money spent on stockpiling oil and other commodities, will the high levels of imports continue? Monetary tightening is a threat along with sudden dips in import demand as China starts running off inventories

*Meagre underlying growth in domestic consumption. Nominal GDP only increased by 4.7% in the first nine months of this year, indicating that deflation was behind the higher headline number of 7.7% Although a lot of people might have made theoretical and real money out of real estate and equities, this doesn't suggest a healthy state of affairs for the average worker.

A weaker currency, import tariff rebates, increases in export taxes and soft and plentiful bank loans for new capacity hardly suggest rapid economic rebalancing towards domestic growth.

Has China put in place the right policies to move quickly enough towards this rebalancing to keep the rest of the world happy?

Can it move any quicker given the country's social and economic pressures?

By John Richardson

Manufacturers yesterday reported rising output and improved employment prospects in the US, Europe and Asia.

China's Purchasing Managers' Index (PMI), involving a survey of more than 700 manufacturers, increased for the eighth straight month in a row - and is now back to where it was in May 2008. This is exactly the same length of time that China's chemical imports have been booming.

In the US, too, the Institute of Supply Management (ISM) survey for October showed that the employment index had expanded for the first time in a year.

But dig a little deeper and the same old doubts and muddle re-emerge.

New orders rose at a slower pace in October than in September, added the ISM. This could be an indication that the process of re-stocking is coming to an end, points out the Short View in the Financial Times.

The rate of bank lending to private companies has turned negative in the Euro Zone for the first time since the data was first gathered, according to this post on The Economist's Buttonwood blog.

Nobody in the chemicals industry is getting excited about the prospects for 2010, least of Jurgen Hambrecht of BASf on the release of the German giant's Q3 results..

He warned of the need for more concerted efforts by governments and industries, as there was no easy way out of the crisis.

One easy way might be China. But as we keep going on and on about, what are all the chemicals being shipped to China going into?

As long as this uncertainty lingers, so will the fear that it will come to a sorry and sudden end.

If you're selling in China and merely looking towards your year-end bonus, this endless head-scratching might not matter if China can hold its ground until end-December.

But anyone with a slightly longer-term perspective needs to be a little more worried.

Source of picture: www.prisonplanet.com

Misleading perceptions can be very dangerous - especially when they apply to the crude-oil futures markets.

"The price has more than doubled this year partly because of the belief that the recovery in Chinese oil-import demand is all about booming local consumption" said a source on the sidelines of this week's APPEC oil and gas conference in Singapore.

But China is adding around 25m tonne/year of refinery capacity in 2009, which, of course, requires a lot more oil to operate.

Liberalisation of fuel-price controls has raised refinery profitability, resulting in recent operating rates of more than 80%.

This high throughput hasn't been matched by an equivalent increase in gasoline consumption, despite the humongous increase in vehicle sales.

"People seem to be buying lots of new cars, driving them home to impress the neighbours but not driving them much after that," said Jason Feer, vice-president and general manager, Asia Pacific, of the Argus Media Group in a speech at the conference

Fuel-price liberalisation has pushed the cost of gasoline close to US levels, he added afterwards.

This miss-match between supply and demand could be a factor behind China becoming a bigger exporter of gasoline and diesel.

China exported 505,505 tonnes of gasoline in September - 153% higher than a year earlier, according to China Customs.

Diesel exports have also risen, reaching close to 400,000 tonnes in August and 293,759 tonnes in September.

This led to talk of overseas refinery margins being put under pressure for the long-term by China's exports.

But another source said: "This is just one of those conspiracy theories about China. Any company will export when it makes more economic sense.

"China's refiners are listed, remember, and so operate like listed companies. Exports are not a long-term strategic objective."

Another factor behind the rise in fuel exports was unwinding of big inventories built ahead of last year's Beijing Olympics, he said.

What's clear is that the rise in oil imports this year - expected to be around 5% - isn't just a sign of an immediate surge in domestic consumption.

And as we've already covered on this blog, China's overall growth story is not as straightforward as crude and equity markets appear to believe - another nail in the bull's coffin.

A further misleading view was that we were already in a V-shaped recovery, believed a number of delegates.

"I expect the recovery to be W-shaped," said Gati Al-Jebouri ,Chief Executive Officer of Lukoil, in a speech to the conference.

One of the economic threats he highlighted was fiscal tightening.

Australia has twice raised interest rates over the past few weeks, Norway recently raised rates and India has tightened reserve requirements for the country's banks because of inflation concerns.

A string of comments from US Fed hawks indicate a possible change in direction.

If fiscal tightening isn't timed properly, it might come too soon for a fragile recovery.

Higher interest rates could narrow the contango that's helped make storing crude, gasoline and diesel etc a low-risk option.

Very high storage levels don't fit with current crude prices.

On the New York Mercantile Exchange, light, sweet crude futures for delivery in December traded at $79.71 a barrel this morning, down 69 cents in the Globex electronic session.

December Brent crude on London's ICE Futures exchange fell 70 cents to $78.19 a barrel.

I found it hard to find any delegate who found much logic in today's price of oil.

"It could easily more or less half to $40 a barrel in the New Year. That's where it should logically be," said one delegate.

Admittedly, though, one tends to seek out those who support your biases - and I could be described as a tad pessimistic about this recovery.

By John Richardson

Inventories of copper, aluminium, lead and nickel have risen as prices for all these commodities have also surged, says this article in The Economist.

Source of graph: The Economists

Copper stocks total half a million tonnes in metals-exchanges warehouses in what HSBC analyst Andrew Keen describes as a market that's departed from fundamentals.

The reason behind high stocks and rising prices is the willingness of traders to take positions in the belief that demand for these commodities will get even better next year.

And surprise, surprise, a lot of these hopes rest on China's economy continuing to expand at or at least very close to the rates we saw in 2009 and in Q1 2010.

But pointers to significant further economic tightening in China are emerging every few days.

Last week, for example, the People's Bank of China issued three-year bills for the first time in about three years in order to reduce liquidity. Financial analysts told ICIS news that Beijing was becoming more creative as it attempted to keep a lid on inflation short of interest-rate rises.

And last week also, there were reports quoting unidentified sources that Shanghai is considering a property tax in order to clamp down on investment properties. The source of the original news story was Shanghai Securities News, affiliated to the state-owned Xinhua News Agency.

This suggests the government is at least thinking about such a tax, and maybe is using the news stories to sound-out market and public reaction.

A slowdown in China's overall growth would obviously mean that demand for metals would be less than is being anticipated, leading to a sudden unwinding of stockpiles.

If interest rates globally start to increase - a possibility as governments ease back on economic stimulus - this could give metals traders another reason to develop cold feet.

As the pricing of all commodities are so heavily interlinked these days, crude, chemicals and plastics pricing could also head south.

What's interesting and needs more research by this blog are the more direct links between trading in chemicals and plastics and other commodities, such as metals, which seems to be common practice in China.

Parallel trading contributed to a sharp rise in China's polyethylene (PE) stocks in March, which we talked about yesterday.

Source of picture: anahoyhanioblogspot.com

By John Richardson

THE blog will be taking a few days off this week as 'tis the season to be Merry', regardless of what you may think is our rather cynical and often-times pessimistic view of the chemicals industry.

We will come roaring back towards the end of this week by the 28th European time and the 29th in Asia to tackle more on the extent of the US shale gas advantage. In the meantime, happy festive season to all our readers as we look forward to what we hope, despite or cynicism and occasional pessimism, will be another prosperous year.

By the way, 50% of the blog (John Richardson) is in the process of relocating to Perth, Western Australia - hopefully in time to gloat about England retaining the Ashes.

By Malini Hariharan

News is slowly trickling in on the status of Japanese petrochemical plants. Only four of the country's 14 crackers have shut down while a few are running at reduced rates, reports ICIS news.

JX Nippon Oil & Energy has shut its 460,000 tonnes/year cracker at Kawasaki while Maruzen Petrochemical has shut its 520,000 tonnes/year cracker at Chiba. And Mitsubishi Chemical has shut two crackers, with a total capacity of 828,000 tonnes/year at Kashima after a power outage. Mitsubishi has also shut its phenol plant at the same site.

And Japan Polypropylene has had to stop operations at its two polypropylene (PP) plants with a total capacity of 669, 000 tonnes/year.

Nearly 22% of the country's refining capacity of 4.52m bbl/day is estimated to have shut down. This includes JX Nippon's refineries in Sendai, Kashima and Negishi, as well as the Chiba refineries of Cosmo Oil and Kyokuto Petroleum.

A fire at JX Nippon's storage tanks at Sendai has yet to be put out and storage tanks at Cosmo Oil's in Chiba, were also still ablaze.

JX Nippon has also shut its benzene plants and is likely to declare force majeure on paraxylene (PX) supply

Shutdowns extend beyond petrochemicals across a wide range of sectors. For instance, Suzuki Motors is reported to have halted production at six of its factories while Toyota Motor has halted operations at all its 12 plants.

But Asian petchem markets were largely stable on Monday with players still assessing the impact of the shutdowns.

By John Richardson

THE global growth outlook grows ever murkier as a result of credit tightening in China (or is the problem instead continued strong growth in lending?), inflation problems throughout Asia, possible monetary tightening in the West, the direction of oil prices and the Japanese tsunami-earthquake.

We feel that this is making the rest of 2011 and next year perilously hard to forecast.

What follows is a brief summary of these key challenges, which we will examine in more details over the coming days and weeks.

As always we are working closely with fellow blogger Paul Hodges in an attempt to provide valuable support to chemical industry planners.

We don't want to get above ourselves here - this particular blog is run by journalists. But we hope that what follows helps you to challenge any blithe comments you come across about guaranteed continued strong expansion of the world's economy.

Here goes:

1.) We have picked up anecdotal reports from polyolefin traders and producers that credit tightening in China is making it harder for small -and medium-sized businesses, including the plastic converters, to access working capital. But does China's shadow banking system mean that, in fact, credit continues to expand? How does one then explain what appears to be flat polyolefins demand in China right now? Is this just a temporary lull due to overstocking? If Beijing cannot control credit growth, and thereby inflation, what does this mean for the battle against inflation and the long-term health of the economy? If property values continue to increase because of easy lending what will this mean for social stability and the struggle to create a more equitable society?

2.) Inflation, mainly driven by higher wages and oil and food prices, is a problem across Asia. Central banks are being criticised for being too slow to lift interest rates and allow currencies to appreciate. A repeat of the 1997 Asian Financial Crisis seems unlikely because of big foreign currency reserves. But Richard Martin, the managing director of strategic consultancy IMA Asia, was recently quoted in this article in the Australian Financial Review as saying: "Everything you buy is increasing 20 per cent year-on-year - labour, materials. Margins are down. In the second quarter companies will need to lift prices that will lead to a significant shift to inflation. The pace will step up each quarter to 2012. At that point inflation pressures within the production system will be strong enough for central banks to lift rates for a mid-cycle slowdown." His comment on weaker margins is interesting and could well be one of the reasons why Asian cracker operators are struggling compared with their western competitors

3.) Inflation in the West is also an issue, though more muted than in Asia. The Fed may decide on no further major boost to liquidity - i.e. it will complete QE2 but there will be no QE3. There are also indications that US interest rates could be increased by the end of the year. The European Central Bank is talking about rate rises while maintaining funding support for banks. Austerity programmes across Europe represent another danger to growth

4.) Once there are definite indications that there will be no QE3 this will likely result in some unwinding of the oil price, provided problems in the Middle East do not escalate. Speculators have indulged in a one-way bet on the Fed maintaining exceptionally high levels of liquidity. This has helped drive the oil price up and the dollar down. The reverse could now occur. What should this danger mean for chemical company raw-material purchasing strategies?

5.) Paul Hodges' excellent posts on the effects of the Japanese tsunami-earthquake are well worth reading. We would add that in the short term rolling electricity blackouts, as a result of the nuclear crisis, will continue to disrupt chemicals and downstream production for the next few month. New suppliers may, as a result, be sought for some of the chemicals that Japan makes for high-end goods such as printed circuit boards. An estimated 70% of one particular grade of epoxy resins for all the world's circuit boards is made in Japan, for example, with around 90% of Japanese production reported to be down two weeks ago. It might not be, of course, that easy to replace highly specialised chemicals technology at such short notice, leading to economic problems that will linger and continue to spread beyond Japan. This could mean further disruption for the rest of this year, for instance, in auto production in the US and final assembly of electronic goods in China. In the longer term, will procurement managers seek to move away from such a heavy reliance on one Japanese supplier because of the risk, however statistically remote, of another major earthquake in the next 5-10 years?

By John Richardson

THE fascinating, but also at the same time frustrating, complexity of the Chinese economy has been thrown into further relief this week in the debate over the implications of the June 6.4% inflation rate.

The rate, the highest in close to three years, was seen as especially worrying by some economists because it included the highest "core" increase in the cost of living for at least five years.

Two thirds of the increase in overall Chinese inflation has, however, been attributed to food prices (food prices rose by 14.4% from 11.7% in May), creating the hope that the heat will soon be taken out of inflation when food prices moderate.

The cost of pork, for example, has risen by 57% in the past year and is often subject to boom-and-bust cycles. So the hope is that once pork and other highly volatile food prices moderate during the next down cycle, everything will be fine.

But the June core inflation rate of 3% has increased the concern that the huge 2009-2010 economic stimulus has created strong underlying inflationary pressures that won't easily be solved.

"Since Q4 2008, China has created the largest credit bubble in history," writes fellow blogger Paul Hodges in this post.

"First, it doubled bank lending to $1.4trn in 2009 (one third of GDP), and then maintained it close to this level. Secondly, it added a stimulus package worth another 13% of GDP ($580bn), focused on providing cheap electrical goods and autos."

As we discussed earlier this month, some of these stimulus packages are being unwound - for example, in autos - with important implications for chemicals and polymer demand growth.

But still, with all this money left over from the stimulus package sloshing around in the economy, some economists are becoming increasingly worried that inflationary pressures are going to persist.

This was one of the points made in this article from the Wall Street Journal.

Out of a poll of 13 economists conducted by the Dow Jones Newswire last Thursday, however, eight said that they believed there would be no further interest rate rises this year as inflation would soon peak.

The poll was taken before the weekend release of the June inflation number, which was not only close to a three-year high but was also sharply higher from the 5.5% increase in May.

But several economists, even after the announcement of the June figure, were quoted in the same article as still believing that inflation would ease later this year.

Worryingly, though, these same economists had predicted in June 2010 that the rise n the cost of living would moderate. Instead, inflation jumped to 5.1% last November, stayed at a high level for several months, and has now started to accelerate again.

This perfectly illustrates the point we made at the beginning - that figuring-out what is really happening with the Chinese economy remains incredibly frustrating.

Lack of clarity means that every comment made by senior politicians is analysed, perhaps over-analysed, as it is assumed that only they have the real inside-track on what is really happening.

A great case-in-point occurred earlier this week.

"Those still holding out for a policy loosening found some cause for hope in comments from Chinese Premier Wen Jiabao the day before the (June industrial production and second-quarter GDP) data were released," wrote Aaron Back in another article from the Wall Street Journal.

"He declared that fighting inflation still is the government's top priority, but also paid lip service to slowdown fears by pledging to prevent any 'large fluctuations' in economic growth.

"The domestic stock market, which fixates on official pronouncements, clearly detected dovish hints in this language, rising in early morning trading even before the data were announced.''

But then came the release of the data.

Second quarter GDP showed the country's economy expanded 9.5% from a year earlier, down only slightly from the first quarter's healthy 9.7%, adds Back.

On a sequential, seasonally adjusted basis, GDP accelerated, rising an annualised 9.1% in the second quarter, compared with 8.7% in the first.

Industrial-production growth rebounded strongly, rising 15.1% from a year earlier in June, the highest reading since May 2010. Economists had forecast a 13.1% rise, after 13.3% in May.

Australia's ABC TV news last night interpreted these figures as a sign that China's economy had further decoupled from the West, rather than discussing the implications for inflation.

This followed a rally in the Australian stock market on the argument that China was still booming.

But why exactly did industrial production rebound so strong?

"To meet the central government's target of conserving energy and reducing emissions in the period of the 11th Five Year Plan (2005-2010), many factories were shut down, cut- off electricity or reduced production last year," wrote the China Daily in this article.

"Since the beginning of this year, however, China has witnessed a sudden revival of the production of the heavy industries."

(Apologies for the bad grammar as these are obviously direct quotes).

The China Daily adds that this is the reason for the power shortages that have afflicted China's manufacturing heartland.

And so why, if industrial production has rebounded so strongly, has chemicals and polymers demand been so weak?

We think that "buying forward" was the reason and subsequently, the pressure of high chemicals and polymers prices (a global phenomenon) in a much-more restricted credit environment.

HSBC, in a report released late last month, estimates that polyethylene (PE), polypropylene (PP) and polyvinyl chloride (PVC) were more expensive that any other point in history in March this year, when inflation is taken into account.

Returning to the point about expectations of further monetary tightening, they might have dipped after Premier Jiabao's statements - but have now increased following the release of the latest industrial production and GDP numbers.

But as the China Daily also points out in the article above, this year's power shortages are still forecast to be the worst since 2004, perhaps limiting further growth in industrial production during the scorching summer months.

Could this, along with the restructuring of heavy industries the China Daily also discusses, take some of the heat out of inflation? What might this restructuring of energy-efficient industrial production mean for chemicals demand?

A further complication to ponder is what the Chinese government will do if inflation continues to increase.

Officially, it has said that it will stick to the conventional tools of raising interest rates and bank-reserve requirements, writes Karen Maley in this excellent article in Business Spectator.

But she adds: "Analysts note that further rises in the reserve ratio penalise the banks even more, and will only encourage both lenders and borrowers to seek out new ways to sidestep the official banking system."

As we wrote last week, the small and medium-sized enterprises, which make up the bulk of chemicals and polymers buyers in China, have been increasingly forced to side-step the official lending system. This has greatly increased their cost of trade finance, restricting their purchasing.

The alternative of further interest-rate rises would not only hurt the SMEs even further; as Maley points out, it would also raise government financing costs.

A stronger Yuan might therefore be the only solution. China's currency has risen by only 2% against the US dollar so far this year and has fallen in value against other currencies, she adds.

Increasing the value of the Yuan woud inflict extra pain on the SMEs as they struggle both with more expensive credit and higher wage costs.

All of these complications illustrate that the straight-line growth we saw in chemicals and polymers demand over the last two-and-a-half years, post the 2008 economic crisis, is no longer guaranteed.

Anyone who tells you otherwise is either being disingenuous or is ill-informed.

The next 12-18 month are going to be very challenging.

By John Richardson

THE shale-gas revolution, which, of course, is already well underway in the US, could also have major implications for petrochemicals in China.

China has 1,275 trillion cubic feet of recoverable shale-gas reserves, according to the Energy Information Administration - more than the US.

As a result, the Chinese National Energy Administration has commissioned a development plan for shale gas.

However, a new report by Deloitte says that:

*The emergence of a major shale gas industry in China would create a struggle for water rights with farmers.

*There are technological constraints and China has traditionally not been very open to inviting-in the international oil and gas companies that own technologies for unconventional exploration and production.

*Coal accounts for 70% of China's electricity needs, whereas natural gas accounts for only 4%. Even though natural gas emits less CO2s than coal, Deloitte believes it is unlikely that China will stray too far from coal for power generation, as most of its modern coal-based electricity plants have been built over the last five years.

Nevertheless, the consultancy adds that China is becoming more open to doing deals with IOCs in order to get hold of hydraulic fracturing technology. Although Shell is the only company to have signed a deal to exploit the country's reserves, negotiations are taking place with ExxonMobil, ConocoPhillips, Chevron and Halliburton, adds Deloitte.

Developing shale gas could also, in the long run. prove cheaper than importing liquefied natural gas (LNG) from Qatar, Australia and Russia, says the consultancy.

Doubts have similarly been expressed over the extent to which China will be able and willing to exploit its coal reserves in order to make transportation fuels and chemicals.

But where there is a will to improve energy security, China is likely to find a way.

The coal-to-chemicals story, and the threat that it represents to companies planning new projects based on exporting to China, is already well-documented.

What if China was to also exploit its shale-gas assets to such a degree that it was left with lots of surplus, and therefore very cheap, ethane, propane and butane?

Right now, this might seem many years away, but never underestimate China's ability to step-up the speed of its investments.

By John Richardson

THE possibility that China's economy may not expand as rapidly in the future as in the past is never discussed in public by resources-company CEOs, said an Australian-based stockbroker.

His comments ring true for petrochemicals, also. The blog is struggling to find a senior executive willing to discuss this possibility on the record.

"The top management of iron ore, coal and other resource companies are burying their heads in the sand," added the stockbroker.

"The assumption is that iron ore prices will be at least $100/tonne. This would justify some of the higher-cost projects.

"And the more efficient producers are factoring into their financial forecasts the assumption that the higher-cost projects will be able to run at high operating rates, thanks to booming Chinese demand.

"In iron ore, as in petrochemicals, it is the marginal or highest-cost producer that sets the price in a strong market, maximising profits for those with lower operating costs."

To draw a parallel with petrochemicals, this is the equivalent of assuming that the smaller, naphtha-based cracker operators in Japan, South Korea and Taiwan will be able to consistently run at around 100 percent over the next few years. This would guarantee stellar returns for the ethane-based crackers.

But, perhaps, all will be right with the world if you are only interested on decent returns over the next few years.

"China's government could be tempted to kick the can down the road through another big economic stimulus programme, thus delaying the rebalancing of the economy away from investment and towards consumption," said the stockbroker.

"This would provide a temporary boost to GDP, which would perhaps be long enough for some of the heavily debt-burdened resources projects to pay-down their debts."

Michael Pettis makes a similar point in this article in the Business Spectator, the financial and economic news and analysis service.

China's GDP growth will average only 3 percent per annum in 2010-2020, as a result of the government efficiently managing the transition from investment to consumption-driven growth, he believes.

"If I am wrong and Chinese growth this decade is materially higher than 3 per cent, my prediction is that the 'lost decade' of much lower growth will stretch out over two decades," added Pettis, senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University's Guanghua School of Management. (He is also the author of this very thought-provoking blog).

Based on his assumption that the Chinese government will successfully rebalance the economy over the next decade, Pettis added: "Non-food commodity prices are set to collapse over the next three to four years.

"Collapse is not too strong a word. China's share of global demand for such commodities as iron, cement, copper, etc, is completely disproportionate to its size and almost wholly a function of its very high growth in investment. As investment growth drops sharply, as it must, global demand for non-food commodities will plummet."

This could also include a steep drop in demand for petrochemicals.

The reason he gives for China's need to rebalance its economy is "massive" misallocation of investment on infrastructure and industrial capacity. This has led to unsustainable debt levels.

Sounds familiar? It was debt that, of course, caused the financial crisis in the West.

We were sold the story that US house prices would always increase.

And now we have been sold the story that growth in China is a one-way bet.

By John Richardson

POLYOLEFIN markets are not going to bottom out until August-September at the earliest, according to several producers and traders who the blog spoke to yesterday.

And even if prices do eventually stop declining, confidence has all but disappeared that there will be any substantial recovery in either pricing or demand for the rest of this year.

We were also told that:

*A major Chinese trader is not taking positions anymore because it cannot predict where the market will go over the next week, never mind the next month. This is unprecedented. It is only buying from producers when it receives firm orders from customers.

*Middle East offer prices to China keep falling. For example, one Middle East producer has reportedly just offered linear-low density polyethylene (LLDPE) for end-May/early June delivery at $100/tonne lower than its previously contracted price.

*Even discounted Iranian material, mainly low density PE (LDPE), cannot find a final home in the China market. As a result, it is being re-exported from bonded warehouses to Indonesia, the Philippines, Australia and Vietnam - possibly even South America.

*We have received further confirmation that smaller traders in China have been buying and then immediately selling polyolefins at losses, in order to get the cash necessary to fund property deals. This is the result of restrictions on banks that prevent them from lending to the real-estate sector. For instance, PE and polypropylene (PP) was recently bought for Rmb9,800/tonne and immediately sold at Rmb9,600-9,700/tonne.

By John Richardson

THE feedstock landscape can change very rapidly as the shale-gas revolution amply demonstrates.

But the assumption, right now, is that the landscape will not undergo any further radical changes. As a result, as much as 7.65m tonne/year could be added to US ethylene capacity by 2017. That would represent a 29 percent increase on existing capacity.

But Lee Fagg, Bangkok-based consultant with Nexant ChemSystems said: "Not all of the proposed US capacity will happen before 2020, as it remains unclear as to what the total availability of ethane supply from shale gas will be.

"Furthermore the current attractiveness in US ethane pricing is due to a supply surplus that exists today. However, if all the proposed projects go ahead the ethane market would change considerably. The sustainability of current US competitiveness would become less certain as domestic ethane prices would increase.

"And because of the nature of shale-gas extraction, it is very hard to accurately predict long-term ethane availability. You need to sink lots of wells in each shale-gas field. This makes it very hard to forecast the exact percentages of methane versus natural-gas liquids that will be produced by each of the fields."

As a result, Nexant estimates that only between 4-6m tonne/year of new ethylene capacity will have started-up in the US by 2020.

Fellow blogger Paul Hodges, in this post, also raises these questions:

• Will oil prices stay at current high levels in future?
• Will 'fracking' technology transform oil production as well as natural gas?
• Will super-computer trading continue to dominate the oil futures markets?

"There are no obvious answers to these questions," he wrote.

Add to this soaring construction costs. "You can earn US$400,000 a year as a welder in the US because of the boom in the shale gas and shale-oil industries," added a senior source with a North American polyolefins producer.

Could the US go the same way as Australia, where liquefied natural gas (LNG) are now in doubt because of rising costs?

Further - there is China and its coal-based methanol-to-olefins (MTO) plans. As much as 50m tonne/year of capacity could, in theory, be eventually built.

On a cash cost basis, as we shall explore in a later post, these projects look very favourable when compared with naphtha crackers. Polymers made via these MTO plants, most of which are located inland, can be delivered cost effectively to coastal and southern regions, where the big consumption markets are.

What does China's MTO investment wave mean for the ability of the US to export its petrochemical surpluses?

And, of course, none of this takes into account the other big uncertainty: DEMAND.

           Chinese govt poster promoting the one-child policy  

By John Richardson

IF all you can remember is strong emerging markets growth, then it is easy to be misled into only building into your scenarios the notion that China and India are merely pausing for economic breath.

Conventional wisdom remains that this is, decidedly, the Asian century - and that the demand for chemicals will continue to boom on the rise of the continent's wealth.

But, as we shall discuss in several blog posts over the next few weeks, nothing is guaranteed as the New Normal evolves. Chemicals and other companies that fail to build the downside risks into their planning processes are failing in their responsibilities.

This applies across all sectors, of course, including liquefied natural gas (LNG). There are some Aus$200bn of projects in Australia alone being planned, all of which, we were assured yesterday, would be successful because of "strong population growth" in China and India.

But when we raised the issue of China's one-child policy, we were told "that's (just) high-level stuff. Demand will always be there in Asia. Just look at Malaysia, Indonesia and Thailand."

Hold on, though, isn't Southeast Asia heavily dependent for growth on China?

China will see its population shrink, rather than expand, according to Guo Zhigang, professor of sociology at Peking University.

"At China's current total fertility rate, the country's population will shrink to just 800m by the end of this century," he wrote in the June issue of the China Economic Quarterly (CEQ).

"Even if China adopts a pro-birth policy (there are no signs of this at the moment), experience from other developed countries suggests that reversing the downward spiral is very difficult."

The economic consequences both of this overall decline in population and the ageing of the population will be huge, as we discuss in chapter 6 of our e-book, Boom, Gloom & The New Normal.

"China's rapidly ageing population will have enormous economic and social implications. The demographic dividend China enjoyed over the past 30 years - especially in 1980-2000 - is now largely exhausted," wrote Wang Feng, director of the Beijing-based Brookings-Tsinghua Center for Public Policy, in the same issue of the CEQ.

"In 1980-2010, the effect of a favourable population age structure accounted for between 15 percent and 25 percent of per-capita GDP growth.

"As China's demographic fortunes reverse, the economy will slow down regardless of other factors driving growth. Since China's economic and political governance model is premised on near double-digit growth, this will require substantial policy change."

There are surely no guarantees that all the right policies will be adopted and that, even if they are adopted, they will be effectively implemented.

And there are no guarantees that, even with the best of possible policy outcomes, China will overcome such a big demographic challenge.

"Over the next 20 years, the ratio of workers to retirees (presuming workers continue to retire at 60) will drop precipitously from roughly 5:1 today to just 2:1," adds Wang.

The same issue of the CEQ also argues, in separately authored articles, that China's demographics will deliver some benefits as well as problems. For example, Tom Miller, managing editor of the CEQ, says that China's army of single children, doted on and heavily subsidised by their parents, will create more consumerism.

But clearly, chemicals and other companies cannot, and must not, assume that growth will just happen - and that, therefore, their capital investments will easily be justified.

Macro-economic analysis is not something that can be outsourced to the International Monetary Fund and the World Bank etc. It has to be conducted in-house.

As fellow blogger Paul Hodges points out in this post, spread sheets might be telling you all is right with the world, but spread sheets alone cannot model the future - especially if they involve "garbage in, garbage out" data.

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

By John Richardson

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

Now we are entering a new era.

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

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

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

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

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

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

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

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

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

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

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

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

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

But here are four more thoughts:

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

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

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

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

Source of table: The Economist

By John Richardson

WHEN you are an energy giant such as Shell you can afford to explore multiple avenues in an effort to profit from China's long-term energy needs.

Thus Shell re-affirmed last week that it plans to invest $1bn in a year in exploiting the country's vast shale-gas reserves, which are even bigger than those in the US (see above table), even though:

*A lot of the reserves are in mountainous regions, thereby requiring construction of new bridges roads, etc.

*Some of the reserves are in areas short of water, whereas other shale-gas fields are in Sichuan - where there is a big alternative demand for water for rice cultivation. The "fracking" process is water intensive, although engineers argue that this is just a cost issue as water can be treated and recycled.

*Peter Voser, Shell CEO, admitted in June that China's shale gas reserves are "geologically challenging". Shale gas fields in China are around 10,000 deep, twice as deep as those in the US, according to Tony Regan of the Singapore-based gas consultancy, Tri-Zen.

But as we discussed in March, China is becoming more open to doing deals with the IOCs which might already have the technologies, or might develop the technologies, to overcome these challenges. Shell revealed, in the same announcement last week, that China is to become its global research hub for unconventional oil and gas technologies. 

Shell also disclosed that it is move its global headquarters for coal-bed methane to China. China expects coal-bed methane to meet 15 percent of its energy needs by 2020.

This may not be comparable at all to China, but in Queensland in Australia the coal-bed methane industry has encountered problems as a result of what Regan says has been the "psychology" of assuming that it would be technically easier than shale gas. In reality, it has on occasions proved as technically challenging, leading to disappointing gas production from initial exploration work.

Meanwhile, construction work on the Qatar Petroleum, Sinopec and Shell refinery and petrochemicals complex in Taizhou, Zhejiang province is due to start this year, according to ICIS.

The project, costing an estimated $12.6bn, will make use of imported condensate feedstock and will include a worldscale cracker and a 300,000 bbl/day refinery.

Qatar Petroleum and Shell have what China needs - hydrocarbon reserves - in return for which they get to serve the government's desire to raise petrochemicals self-sufficiency.

The other prize is the refinery sector, provided price controls on refinery products, such as gasoline and diesel, are eventually lifted. At the moment, as the Sinopec first-half results revealed, refining is a very difficult business in China.

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

By John Richardson

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

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

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

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

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

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

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

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

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

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

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

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

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

THIS blog was once criticised for devoting too much time to the big picture - e.g. politics, economics and demographics - one of the major themes of our free e-book, Boom, Gloom & The New Normal.

By John Richardson

Demographics determine savings rates, drive investments and economic growth, while also affecting wealth distribution through the generations, says Julia Wang, Hong Kong-based economist with HSBC, in a 14 November report.

"That Europe is slowly ageing is well-studied. However Asia is also undergoing an especially big turn. Populations are ageing in Asia far more rapidly than anywhere else in the world," she adds.

The chart below, from the HSBC report, shows that the ratio of over 65s is set to triple in Asia, with the exception of Australia, New Zealand and Japan (in Japan, the ratio is already high).

In China for example, this ratio will rise from 9.9% to 30.8%, less than elsewhere, but still a significant increase, thanks to the disastrous one-child policy.

In South Korea, the over 65 ratio will jump from 13.8% currently to 40.2% in 2050. This implies that nearly one in two South Koreans will be over the age of 65, says Wang.

"Bear in mind that demographic projections are based on parameters such as fertility, mortality and life expectancy, which are largely known and unlikely to change short of major catastrophes or scientific breakthroughs," she adds.

We argue the same in our e-book, and believe that chemicals companies have to, as a result, run their businesses in very different ways.

"Across the region, including Australia and New Zealand, in less than four decades the number of people aged 65 and over will jump from the 300 million currently to 960 million. Forty five percent of them will be in China. The ratio of over 65 year olds to total population will rise from 1:14 currently to 1:6," she continues.

"Incidentally, the Chinese population will start to decline in 2035 as will its share of the Asian population. India will replace China as the most populous country in Asia."

The result of rising median ages (see the chart below) is a much larger elderly population dependent on an ever-shrinking workforce, says Wang.

"Over the next four decades, dependency ratios will more than double in Hong Kong, Japan, South Korea, Singapore and Taiwan," she adds.

"The ratio will be higher than 1:1 in Hong Kong, Japan, South Korea and Singapore. This will have a major impact on savings, consumption patterns and government finances," adds Wang.

"Currently, the region vastly under-spends on age-related social security and healthcare compared to developed markets, reflecting the relatively young populations and less comprehensive social safety nets."

This enables governments to prioritise other types of spending, such as infrastructure, she adds.

"However this advantage will disappear quickly. As working populations get older, richer and scarcer, demand for more comprehensive healthcare and social security will arise.

"Take pensions. In most Asian economies, coverage ratios are still low. This suggests that most governments have not yet adequately prepared for the rising tide of retirees in the coming years."

Pension coverage is 92% in Western Europe, but only 30% in China and 20% in Thailand. This will need to rise, and quite quickly in order to deal with ageing populations, she believes.

"Some governments are already starting work on this, most notably China. But there is still a long way to go. If coverage is expanded, this will likely push-up wage costs still further," she says.

"If coverage is not expanded, governments will suddenly be saddled with huge liabilities that are inadequately provisioned for."