Asian Chemical Connections

The failure, and quite possibly the death, of the Doha round of trade negotiations earlier this week could create a very confusing and erratic regulatory landscape for the chemicals industry.

This excellent entry in the New Scientist environment blog by Fred Pearce, senior environment correspondent, makes the point that if the world cannot agree on further trade liberalisation, what hope for global climate-change legislation?

As Fred points out, John McCain, if elected, has made it clear that he won't accepted emissions caps if China and India do not follow suit.

Obama. however, is prepared to let the US take the lead ahead of the Asian giants. He warns, though, that if they don't agree to fall in line at some point, import tariffs could be imposed equivalent to the energy content of finished goods.

The European Union is also understood to be considering the same safeguards as it looks to extend its cap-and-trade system. Industry, including at least one of the oil-to-chemicals majors, is lobbying hard for safeguard provisions of taxes on imports if no global agreement is reached.

Chemicals and other producers would obviously shut up shop in the EU and move to countries where there was no price set on emissions or if there was no effective import-tax system or some other kind of economic disincentive.

Despite the few remaining climate-change scepticis - quite rightly derided in the same New Scientist blog - climate change as a result of human acitvity is accepted by most scientists and governments as a reality.

A global agreement on a price mechanism for carbon - whether its a cap-and-trade system and/or a tax - would be the best outcome for the chemicals industry. It would enable producers everywhere to accurately assess the cost of investment in better processes and new technologies.

They could also make reliable and predictable income through trading credits globally and from operating and licensing new technologies.

Piecemeal legislation wouldn't provide the same degree of clarity, leading to equally piecemeal strategies from company to company and region to region.

The lawyers might also make a lot of money out of disputes over carbon import taxes.

And, of course, companies might still look to move their investments elsewhere by searching for loopholes in US and EU carbon import-tariff rules.

Just look at the money being made out of "splash and dash" in the US as an example of how rules can be exploited.

As the effects of climate change accelerate, you could also see knee-jerk nonsensical regulations introduced by governments out of sheer panic. This could make life very difficult, if not impossible, for chemical producers in certain countries.

So let's hope the Doha round can be rescued - and that it serves as a confidence builder towards the much bigger job of a new global agreement on emissions.

In my previous post, I talked about the collapse of the Doha round of trade negotiations and how this didn't auger well for a new global agreement for setting greenhouse gas-emission limits and a worldwide price on carbon.

The chemicals industry needs clarity. A global price for carbon would enable companies to plan R&D investments over the long term.

I also discussed how it seems more than likely that if no global agreement on carbon prices was reached, countries and regions with pricing mechanisms already in place would have to impose import tariffs based on carbon content. The tariffs would be levied on intermediate and finished goods from places where there were no carbon-pricing mechanisms.

But in this thoroughly globalised world, who should bear the blame for CO2 and other emissions?

Christopher L Weber from the Carnegie Mellon University in Pittsburg, Pennsylvania and his colleagues have concluded that one-third of China's CO2 emissions are the result of exports. This is up from only 12% in 1987 and 21% in 2002.

Could proof of collective blame for emissions made through the WTO or other international bodies result in icarbon mport tariffs becoming unworkable?

You could spend fruitless years and millions of dollars in lawyers' fees trying to determine what percentage of tariffs to levy on companies at different points of production and logistics chains.

Shouldn't anyone who exports to China - whether for re-export or domestic use - carry the can for the country's emissions?

Might unworkable import tariffs force the EU to scrap or limit its cap-and-trade system out of fear of an investment drift?

The next US president could also be deterred from introducing a price on carbon, especially if the economic crisis drags on. Protectionist sentiment has risen since the slump began.

It is very easy assume that Asia ex-Japan will eventually catch up with the West and become as good at "solution" chemicals as the West. I am excluding Japan because it has long been a major speciality player.

All the money that China, for example, is pouring into its state-run research institutes would seem to suggest that eventually, the country will produce a BASF - or at least a collection of companies that come close to matching the German giant's innovation.

But this report from Deutsche Bank - in a theme I will be touching on a lot over the next few weeks - points out that despite the great drift east, Europe has has held its own.World_chemicals_market_Asia_gaining_ground.pdf">

I've created a new category "Analysts' Reports" which you will hopefully find useful.

The Deutsche Bank report concludes that the West has a great opportunity - and has already made an excellent start - in the green chemistry race.

"In 2007, Europe accounted for 31% of global chemicals turnover; in 1997 the share was 32%." write its authors.

Here's another important statistic from the study: BASF's turnover in 2007 was Euro60bn - the same as the entire Indian chemicals industry.

Knowledge retention, which I talked about yesterday, will be crucial for the West if it is to maintain this lead.

Constant innovation through a willingness to fail many times before succeeding might also be important. As Winston Churchill said: "Sucess is the ability to go from failure to failure without losing your enthusiasm."

It's going to be fascinating to see how the new Dow and Rohm & Haas entity raises its game to meet the challenge of responding to the need for clever new products that must also be sustainable.

Finally, here are a couple of examples of Western innovation, the credibility of which I cannot vouch for.

Ford claims to have developed a way of sequestering VOCs from paints for conversion into fuel for fuel cells.

The clever Germans say they have found a way of producing self-healing nanotech anti-corrosion coatings as an alternative to the toxic chromium.

These serve to illustrate one of the other points I made yesterday - the need to navigate all the information out there to keep up-to-speed with a rapidly changing chemicals world.

I'm bewildered. I don't know about you

China and the environment might not be only about rivers changing colour several times a day and factories belching out air pollution that kills hundreds of thousands of people prematurely every year.

Elizabeth Economy outlined the extent of China's environmental problems in her book, The River Runs Black.

In what could turn out to be the ultimate irony of ironies, the very economic system which has caused the crisis in the first place could end up resulting in China becoming the world's leader in clean technologies.

Ample evidence already exists to this effect, according to the Climate Group - a London-based non-profit organisation, the members of which include BP and Dow Chemical.

The group's latest report - China's Clean Revolution - claims that China's transition to a low carbon economy is already well underway. This is the result of supportive government policies which are driving innovation in low carbon technologies and diverting billions of dollars into energy efficiency and renewable technologies.

The huge energy that was poured into industrialisation, once Deng Xiaoping declared that getting rich was glorious, seems to have now been turned to wind, solar and other forms of renewable energy - along with conservation.

China now ranks fifth behind Germany, the US, Spain and India with six gigawatts of wind turbine capacity, says the Climate Group. Some experts believe that this could climb to 100 gigawatts by 2020.

As was the case with industrialisation, State backing might overcome that nasty burden of capitalism - the need to return short-term profits, or even any kind of profits at all.

Lending from China's big banks is still largely directed by the government and the banking system is awash with liquidity - a drastic contrast with the Western credit blight.

Incentives are in place to boost wind power, but have yet to be introduced for solar energy. China. however, is second only to Japan in the global solar photovaltaic market.

Research is taking place in to carbon capture and storage and integrated gasification combined cycle technology.

China is also introducing fuel efficiency standards for cars which are 40 per cent higher than those in the US. Twenty one million electric bicycles and 1.64 million energy efficient compact cars were sold in 2007, the report adds. Clearly, the Chinese are doing a great deal more than just praying for lower gasoline prices.

This all sounds fantastic, but the old story about China is that what works at a central government level might not necessarily be implemented evenly across the country.

Arthur Kroeber of the China Economic Quarterly, however, believes that this old tale about China is total nonsense when the central government decides to take something seriously. The environment is one problem that Beijing is taking exceptionally seriously as it tries to build a more "harmonious society", he says.

But the task remains huge. According to The New Scientist magazine, if China's emissions continue to increase at 8 per cent per year, its per capita CO2 emissions will be double those of the European Union by 2020. While China's emissions keep on rising, EU member countries are making big reductions. For example, Germany reduced its greenhouse gas output by more than 19% between 1990 and 2003.

The problem for China is that it still has to create lots of new jobs of a rapidly urbanising society, whereas many of the rich people in the EU are desperate to return to the rural life.

But, of course, the Europeans are hardly likely to return serfdom. Instead it's all about four-wheel drive gas guzzlers, centrally-heated converted barns, and conveniently located supermarkets stocked with food and booze from the four corners of the Earth.

What planet are we all really on? We rich-world people are all desperately trying to get rid of that tiresome leftover venison as we insist on Afghan melon, to quote the Big Yin.

When I looked in the fridge the other day, my wife had bought Sicilian lemon juice. For pity's sake...

A very interesting report by McKinsey (you can sign up free for their online newsletter which only takes a minute) expands on the theme of reverse globalisation which I talked about last week.

The cost of shipping a standard 40-foot container has tripled since 2000 and labour cost increases have risen by average of 19% per year in China compared with just 3% in the US.

The consultancy makes the point that you have to do very thorough input-by-input calculations for each product and grade of product before making any decisions. And, of course, you need some reliable forecasts of where the economics of offshoring versus onshoring are heading - including predictions on crude-oil prices. Predicting crude, as I discussed earlier on today, is where I fall short.

You also need to take a view on the direction of environmental legislation - i.e. will there by carbon taxes and/or cap and trade systems introduced globally that penalise producers for extended global supply chains?

If history is anything to go by, McKinsey has worked out that manufacturing a "midrange" product in Asia will cost you an extra $16 today compared with the US when all landed costs are included. In 2003, Asia had a $46 advantage.

Add to this the likelihood that more petrochemical feedstock will become available in the US thanks to declining gasoline demand and perhaps, as again I talked about last week, the industry in the states might be set for a revival. It has been comparatively higher feedstock costs and the drift of downstrean customers overseas that has caused so much damage to the US industry.

For anyone who subscribes to ICIS news, you might find this artice of interest. Allen Kirkley of Shell discusses some of the new emerging feedstock options and converging economics between the West and the Middle East.

Back in the heady days of 2006, I asked a group of five like-minded nerds what their favourite business book was.

They unanimously voted for The World Is Flat: A Brief History of the 21st Century by Thomas Friedman.

I rushed out and bought a copy. It has sold by the truck load and was quoted by Mohamed Al-Mady of SABIC during his speech at the Asia Petrochemical Industry Conference in Thailand in 2006.

Back then everybody was talking about a new paradigm of growth, driven by the relentless rise of emerging market consumption. Nobody mentioned that other book, The Limits To Growth, published in 1972 by the Club of Rome, during those heady days of the economic boom.

I ploughed my way through most of The World Is Flat (it is overwritten - all the points worth making could have been made in considerably less than 488 pages) and was profoundly irritated by Friedman's relentless enthusiasm for globalisation.

At that time I must confess I hadn't heard of the Club of Rome book, nor did I give any consideration to the idea that Friedman might be dead wrong for any reason other than a gut reaction to his seemingly boundless optimism.

Now he has woken up to the fact, 36 years after The Limits To Growth was published, that indeed this might be the case with his new book Hot, Flat And Crowded.

In a review in the Financial Times, Rahul Jacob makes the point that we should have all seen the weaknesses behind Friedman's flat earth theory.

Friedman was entranced in his earlier tome by the rise of India, particularly the booming IT hub of Bangalore.

"I have lost count of the times friends or relatives in India have forwarded by email Mr Friedman's comment that, while his parents told him to finish his dinner because there were people starving in India and China, he told his daughters to finish their homework because there were people there eager and willing to take their jobs," writes Jacob in his review.

As Jacob points out, the very roads that Friedman travelled along to get to the headquarters of the IT giants point to the limits to India's particular form of middle class, elitist growth; they are pockmarked and hugely congested with ancient patched-up vehicles pumping all sorts of foul fumes into the air.

India suffers from a self-inflicted limit to how far it can grow without creating unsustainable social and environment pressures - because of a political system that has created virtual development paralysis.

How can a country with terrible infrastructure, poor irrigation and very low literacy rates ever hope to create sustainable economic growth?

According to the CIA Factbook, India's female literacy rate was only 47.8% in 2001. This compares with 86.5% in China, based on the country's 2000 census, adds the Factbook.

The speed limit on Indian and, of course, also global growth is resources - so presciently highlighted by the Club of Rome back in the 1970s.

I've only just woken up to this reality. Back in the dim and distant 2006, all I cared about was riding the global property and share boom while consuming immense amounts of carbon in pursuit of my career. This involved writing my own much-shorter tomes that encouraged others to do likewise.

Many of us became so enamoured by globalisation that we ignored the fact that there are simply not enough resources available to allow all of us to consume as much as the typical Texan, or more latterly a middle class Indian in Mumbai.

Friedman gets excited in his new book, according to Jacob, about China's potential to lead the way in solving the environment crisis.

I agree that China has potential, but some huge challenges lie ahead.

Idealistic enthusiasm (the ungenerous might use the phrase "gormless enthusiasm", which has applied to many of us over the last few years) might have its place in generating the individual energy to make a difference: Each of us need to find new ways of individual and corporate behaviour if we are to prosper in a world threatened by Peak Oil and catastrophic climate change.

This type of enthusiasm needs to result in more than just further consumption of trees through higher book sales (and when do we have the time to read books like The World is Flat? When we're flying, that well-known environmentally friendly form of travel).

We need to radically change the way we lead our lives.

The smarty pants at BASF seem to have got it right again with their $6.1bn bid for Ciba Specialty Chemicals and rumours that they might also be after Clariant.

Talking about counter-cyclical investment is one thing, but doing it is quite another. You need to have built up the cash reserves to execute the obvious - and, of course, need the right product portfolio already in place to earn the money in the first instance.

BASF has made and continues to make a packet from its oil and gas business. It's oft-repeated focus on integration and on getting out of the more cyclical commodities is also paying dividends. It was walking the talk about reducing exposure to such commodities long before a certain US-headquartered company jumped on the bandwagon.

Talking about stating the obvious of buying low and selling high, McKinsey does this - but with some useful numbers - in its report, M&A Strategies In A Down Market. Again this is from the consultancy's excellent monthly newsletter, which is free once you have signed up.

The report's authors have also written a book, The Granularity of Growth. It includes a database of 200 global companies that decomposes the most important sources of growth (market momentum, mergers and share gains). Sectors that suffered big upturns or downturns were then analysed in order to rank the importance of these growth sources - with the study also extending to individual companies strategies.

"Two sets of results stuck out," write the authors.

"First, (I wish consultants would learn to write shorter sentences - my comments in italics) of the potential strategic moves companies can take to grow in a downturn - divest acquire, invest to gain a share - an effective acquisition strategy (defined as growth through M&A at a rate higher than 75 percent of a company's pears) created significant value for shareholders (you can pause for breath now).

"During an upturn, on the other hand (surprise, surpirse), divestments created slightly more value that acquisitions did (this presupposes you can find some mug to buy your business at some ridiculously inflated price on the belief that the economic boom will last forever).

"Second, companies often behave in counterproductive ways. Fewer than half as many companies in the segments we studied made acquisitions in downturns rather than in periods of economic growth. Significantly more divested businesses in those market segments in downturns than in upturns."

The global credit crisis and volatility in stock markets "could temporarily disrupt M&A activity and add risk to existing deals," said Scott Anderson, senior economist at Wells Fargo - the US financial services company. He was speaking at the ICIS Chemical Purchasing Summit, which is taking place in Boston, Massachussets.

He added, however, that conditions were right for further consolidation in the chemicals industry as manufacturing customers become larger.

The Middle East has the cash, of course - as do the Chinese if they can be bothered. Sovereign wealth funds could be the vehicles, as well as the petrochemical companies themselves, for a wholesale shake-up of industry ownership.

And as I've already said, those clever people at BASF look likely to be involved. Being right and having senior executives with brains the size of a small planets is very annoying for those of less able (especially if they are also nice to children and animals, actively care about the environment, give a large proportion of their incomes to charity and are good at football when World Cups come round).

As delegates gather for this year's European Petrochemical Association meeting in the unreal world of Monaco (unreal for the 99.9 per cent recurring of us who don't own Ferraris), I thought it was worth summarising some of the issues discussed on this blog over the last few months.

We've dealt with:

*Oil-price volatility and the likelihood that high and volatile crude is here to stay. Crude at or around $100 a barrel seems to be a new long-term level with the strong possibility that geopolitical shocks could send costs much higher. Supply and demand balances remain tight and as soon as global economic growth recovers we will see much higher prices - meaning that the recovery could be nipped in the bud. Are we heading for a new economic climate where recoveries are constantly set back by rising energy costs? For every one barrel we are discovering, we are consuming three.

*The new credit environment that might well emerge from tougher banking regulations. No longer will it be possible for a truck driver from Iowa earning $20,000 a year to borrow at ridiculous multiples of his salary and at "teaser" interest rates. How these regulations will effect emerging markets his harder to read as Asian governments and consumers are in far better financial shape than those in the West. Many of the banks in Asia have been more prudent. But the events in the US will surely lower the appetite for risk globally - and there is no guarantee that the financial-rescue package will work. Ask your consultants or inhouse researchers you use whether their demand-growth predictions factor in the possiblility of lower growth because consumers no longer have access to as much credit.

*Innovation will be the key as the environment becomes a bigger and bigger issue for the chemicals industry. You need right technologies and the right kind of staff. As there is a possibility of a global carbon tax or carbon cap-and-trade system, do estimates of what this might cost need to be factored into feasibility studies? How feasible will it therefore be - given both high energy costs and the possibility of a price on emissions - to continue building plants long distances from major consumption markets?

*One of the big areas of innovation will be attempts to break the link between the refinery and petrochemical industries. BASF is claiming it could be as little as five years away from breakthroughs in catalyst technology that could change the industry forever, enabling highly competitive petchems to be produced from biogass, natural gas or coal.

And finally, other theme I haven't blogged on yet but will do are plant and energy efficiency. Some very interesting research projects are taking place at the National University of Singapore chemical engineering department into monitoring the exact output of plants in differennt climate conditions and a model that might enable producers to much more accurately predict changes in yields from switching feedstocks. Much more later...

Meanwhile, have a great meeting - and let's hope the economic conditions improve.

I grew up in a small town called Bingley in West Yorkshire in the UK, where there are two major employers - the head offices of a building society (or what was once a building society, but became a failed bank - see picture above) and a clothing business.

My late parents worked most of their working lives for the B&B and I worked there during the summer when I was student, to pay off debts built up through excessive drinking (I was an arts student, thank goodness - none of this obsessive "grow old too young" nonsense of MBAs and other business degrees that are serving very little purpose at the moment. You'd be better staying at home and writing poetry).

In the financial maelstrom, you might have noticed that the B&B has been partially nationalised by the British government.

This used to be a dull but worthy lender that became more aggressive and, like most of the rest of us, didn't believe that there was a down as well an upside when we were all caught up in the economic supercycle.

Before the nationalisation occurred 370 jobs were axed last week - which will greatly affect Bingley's economy, from the direct job losses, of course, to the shops and the restaurants. More jobs are at risk among the remaining 3,000 employees.

My dad worked down a coal mine, fought in the Second World War in North Africa and Italy in an artillery regiment, returned from the war to work on the railways and then spent the rest of his working life as a caretaker (or a janitor as the Americans have it) at the building society. If he had been still around, he could have been out of work - but exactly what portion of the blame for the crisis would you have apportioned to him, Mr Paulson?

Multiply the impact of job losses around the world as other banks and businesses fail and this means much less chemicals demand - from the plastic packaging used in restaurants to cancelled bigger ticket purchases such as automobiles and TVs. Again, we need to be looking hard at demand-growth numbers in an attempt to contemplate what this will mean for all our businesses - whether we work directly in the chemicals industry or as service providers.

But the bigger tragedy is that real people, not those with fantastic salaries and parachute payments who are responsible for this financial mess, will suffer greatly.

These are real people who deserve protecting because they had no idea, and had no chance of gaining any kind of idea, of the potential scale of the crisis we are now confronting.

Yes, indeed, with all the talk of the collapse of capitalism and with liberal economists running for cover, dear old Karl might once again be the flavour of the month.

Oh how I remember those dewy-eyed days, standing on the picket lines in the pouring rain during the 1984-1985 Miner's Strike in the UK, believing passionately in the noble cause of the downtrodden working man as he (and she, of course - sorry sisters for putting you second) fought against the evil forces of Thatcherism.

Oh how I remember on one such occasion, a miner asking me what I did, to which I replied "a student in English Literature", to which he replied "what do you produce? Essays? You useless............(followed by two unmentionably rude words).

And how I remember when the forces of Thatcherism won and the miners were forced to march back to work I waited for some noble and great workers' song as they marched, some stirring ditty speaking of the struggle against the oppressor and the honour and dignity of honest toil as opposed to the grubby and slimy pursuit of evil money.

Instead all I heard coming out of the TV during the Look North programme was a rendition of that great brain-dead football chant, "here we go, here we go, here we go".

How our illusions can be shattered and how the illusion that pure capitalism works is also now in ruins.

This is still not The End of History as history never ends.

So why not a sensible compromise between socialism and capitalism - a workable system of regulations versus freedom to innovate? How about the Japanese model, may be, or that which is pursued in Singapore?

Mr Obscenely Rich Got Out In Tiime Banker, please look into these eyes, see the pain from the last Great Depression and maybe you will give some of your obscenely huge bonus towards poverty relief.

And perhaps also you'll be willing to pay for all the counselling that the children of this new Great Depression will need when they grow up into adults. As a rich an educated breed, you should be aware that the first few years of a child's life, how secure and encouraged they feel, determines their entire future.

Anyway, see below for my take on the state of the crisis and its implication for chemicals, written for a good friend and contact.

Chemicals demand is being affected by frozen credit markets and the fall in export trade of finished goods to the West.

The credit markets are showing signs of easing thanks to all the government intervention.

But as you can see from this article, the feedback effect on the consumer, and therefore, manufacturing companies, could get a great deal worse before it gets better. Bad corporate results caused the declines in stock markets yesterday (Wednesday 23 October) and as more consumer loans turn soar and unemployment rises globally, corporate earnings will deteriorate even further - at least for the 12 months, I think.

The good news from the financial is that the much-feared credit-default crisis may not be severe as people had expected.

However, the chemicals industry will remain under severe strain for at least the next year, even if the credit crisis eases enabling letters of credit to be more easily obtained (a global shortage of LC's has left commodity shipments, including chemicals, stranded).

The reasons are:

1.) The export dependency of some economies. China's GDP growth will be around 9% this year compared with 11.9% last year, for example, largely due to the slowdown in export trade. Delegates at the APPEC conference in Singapore this week were talking about very quiet demand for fuel products and chemicals at a time when China should be ramping up manufacturing for exports to the West in time for Christmas. Economies such as Singapore are even more vulnerable
2.) The volatility in energy and chemicals pricing. You could probably produce a graph these days linking crude-oil price movements with the equity markets. So until everyone reaches a consensus that the bottom has been reached, we are going to see constant dramatic day-to-day fluctuations in equities and therefore crude. OPEC might cut production at its next meeting, but this will just mean the volatility is within a higher band ($70-90 a barrel is the prediction instead of the current $60-80 a barrel. You cannot rule out the possibility, even if OPEC does make cuts, of a lower range than today - $40-60 a barrel. This would indicate that the real economy has become a great deal worse). Volatility creates the danger of being caught on the wrong side of the deal for sellers, buyers and traders (e.g. high cost raw materials purchased one day that cannot be passed on in higher-cost finished product because of a sudden fall in crude). For resin buying patterns, the uncertainty over the direction of crude is a crucial factor - in a bull market they stock up and in a bear market they de-stock. Crude is in no-man's land and so, combined with LC issues, worries about the overall economy and cancelled orders from customers buyers are remaining firmly on the sidelines.
3.) Last but certainly not least, is the huge wave of new capacity. Polypropylene was supposed to lead the downturn this year but didn't because of start-up delays. Equipment-delivery problems are being blamed, but market reasons seem likely to be another factor. The problem is that with markets showing no signs of turning, producers with heavy debt commitments can only hold back for so long and so will have to commission capacity soon - even if at operating rates lower than planned. For the Middle East producers, now that there is no immediate sign of markets turning, start-ups might as well take place because at the very least on a cash-cost basis contributions will still be achieved on a cash-cost basis (because of low and fixed feedstock costs), just about no matter how low crude goes - and with it petrochemical pricing.

Conditions could get dramatically worse very quickly. One factor not included above is the run on Asian currencies, and possibly even some banking systems, because of the dollar ironically being used as a "safe haven investment".

In the medium term, (the next 12-18 months) the only upside I can see is short-term recoveries in chemicals buying on signs that government interventions are working (with more likely to happen). But these recoveries, as I said, could be short-lived as more evidence emerges of the delayed effect on the real economy (e.g. further falls in corporate earnings).

To be frank, all bets are off on demand-growth forecasts - (so I am sorry this is not going to help you much in coming up with firm numbers!).

Everyone has been wrong and so it's best to err on the side of extreme caution and with a bit of luck we might be pleasantly surprised.

To give you an example of how quickly things can change, a Chinese PTA producer had been forecasting overall polyester growth in China at 12% are recently as July; now it thinks the market will be lucky to get away with zero.

I'd suggest looking at your forecast numbers, going back to those who have supplied the numbers, and asking them if these take into account their worst-case scenarios. Any forecast that predates September cannot be trusted at all.

Hope this helps!

Best Regards
John

Chemicals demand still exists, believe it or not, but the new economic order -one that could last as long as six years - requires new approaches.

Purchasing managers need to start acting locally as well as globally.

Who would want to be a financial controller if you work for a big company or the jack-of-all-trades managing directors of a small or medium-sized enterprise? Every purchase order and every invoice, literally every single transaction, needs to be reviewed by whoever understands overall credit availability.

One small step out of line, one tiny error by an over-enthusiastic purchasing manager or sales executive and bang, you've exceeded your credit limit. Even if you have a sound business model, your bank might have no option but to say "sorry, but that's it - we are withdrawing all your credit". But is there really such a thing as a sound business model these days?

This new economic order could have major implications for how chemical pricing behaves. Old understandings on how to read the direction of markets might need to be revised.

"There have always been two kinds of demand in the confectionary industry - long and short term," said a plastics-wrapping manufacturer on the sidelines of the ICIS World Polymers Conference, which took place in Bangkok, Thailand, earlier this week.

For the next few paragraphs, the confectionary industry and upstream to polyolefins will be used as an example of how purchasing managers need to act differently. The same rules could also apply to other product chains.

"Nothing has changed when it comes to your big 1b bar of chocolates. You can still ship large volumes of packaging material economically from, say, China to the US as these slow-moving items will sit on the shelf for months," the manufacturer added.

But for your fast-moving confectionary - for example, discounted big bags of miniature chocolate bars placed in toddler-reach on shelves near supermarket checkouts - shipping wrapping material from China no longer makes sense.

"A big percentage of a confectionary manufacturers' revenue comes from fast-moving and short-term promotional offers. The trouble is that these promotional offers are no longer as fast-moving because consumers are cutting back on spending."

Much smaller quantities of wrapping material are needed and so for logistics reasons, buying locally adds up. If you make chocolate in a developed markets, these small suppliers might have previously been ruled out because of their high labour costs and low capacity.

"It's not economic to half-fill a container and ship it all the way from China. Local suppliers can also much more quickly respond to small day-by-day changes in demand," the manufacturer added.

There are other reasons to buy in small quantities (and therefore locally).

Oil prices move in an almost perfect relationship with equity markets these days. Stock markets rebound as investors clutch on to some fleeting good news and crude rallies by a few dollars a barrel, only for the reverse to occur the following day.

So nobody at any point in any product chain wants to sell or buy big in case they end up on the wrong side of a shift in highly erratic energy prices. For example, why buy a big quantity of resin today only to see the WTI price tumble the next?

Your equally hard-pressed customers, even the ones you've worked with for years, will not be able to do you any favours if you plead that you made a mistake on crude.

Shortage of credit is a further reason to keep orders at a minimum.

"My MD is signing off every purchase order. You need to make your credit stretch. The other problem is that you need to very carefully monitor the credit situation of your suppliers and your customers. Make sure you have enough of each in every region where you operate in case some of them go bust," said the manufacturer.

Buying locally also extends up this chain to polyolefins.

"Polyethylene (PE) and polypropylene (PP) exports from the States have declined because of the weaker dollar and the collapse in pricing that closed-off arbitrage," said a polyolefins producer on the sidelines of the same conference.

"Another factor is that end-users prefer to buy local because retailers are placing smaller orders."

A further reason to keep inventories low is the huge economic uncertainty out there. Nobody knows how deep this recession will be and how long-lasting.

"We keep looking further and further back into history for parallels," said Matthew Sullivan, Director of Energy Structuring and Origination for Standard Chartered Bank, in a speech during the conference.

First it was the dot-com bubble crash of 2001, then the Asian financial crisis and next the global economy downturn of 1980-82. Now all the talk is of the Great Depression.

"Vehicle sales in the US, on a population-adjusted basis, have fallen to their lowest level since World War II," he added.

"I hate to give you the bad news, but I think it could take 5-6 years to get through this. Most of the iceberg is still beneath the water."

The dreaded consumer confidence feedback mechanism may have only just begun.

Banks might, theoretically, be in a better position to lend thanks to all the rescue packages - but at ground level in the chemicals industry trade finance remains desperately hard to obtain.

Inventory write downs are huge because of raw materials bought before the crash in demand and pricing. This will affect financial results in Q1 next year.

This will in turn lead to more job cuts in chemical and other companies. When you are worried about losing your job, if you haven't lost is already, you don't spend; and as Japan found out during the 1990s, consumers are even less likely to spend if they think that prices will be lower tomorrow.

As consumers make even deeper cuts into their spending, this leads to even worse corporate results, more business failures and more job losses and so on and so on....

"People are reviewing their retirement plans (because of the collapse in equity markets). They feel a lot poorer, which is another disincentive to spend - and they will have to add 5-6 years to their working horizons," Sullivan added.

The next big banking scare just around the corner might be further write downs on credit-card losses

In the midst of economic calamity and the resulting shift in buying patterns, what does this mean for how chemical pricing will behave?

Chinese buyers used to periodically withdraw from markets en-masse, in the case of polyolefins.

This would lead to big price declines because the volume of lost trade was big.

The guessing game would then begin over inventory levels and demand - meaning when they would need to re-stock.

When they did return, of course, volumes on the positive side were equally big, resulting in big price rallies.

Bu increments are these days as low as $20 or $30 a tonne a time because of small-volume sales. Prices then quickly fall back.

When prices retreat, even more ground can be lost than had been gained because of worsening economic news.

Nobody can be sure when chemical-pricing markets will bottom out for good in this current cycle - just as nobody has any clue when the economic recovery will arrive.

Yes, that's my target for the truck above, which is actually for 4-11 year olds and my son is only 22 months - but what the hell, don't we all deserve a second or, in my case probably a tenth or perpetual, childhood? And I am trying to teach him the value of recycling (the above picture is of a recycling truck) - even more bad news for the conventional chemicals industry.

The truck was S$249 (Singapore dollars) two weeks ago, has fallen to S$199 and surely has much further to go as the deflationary spiral begins to bite. My target is S$100, provided, of course, it hits this level before Santa sets off with his reindeer and his elves etc (poor old reindeer - less carrots this year, and I imagine Santa will be laying off some of his little helpers and moving those he retains to flexible short-term contracts with less healthcare and other benefits. Do the elves have a union, though? Not sure...answers, please).

But the serious point is that the deflationary vicious spiral - delayed purchases and higher savings rates leading to worsening corporate results, more unemployment and further delayed purchases - may have only just begun.

I remember reading an article in The Economist a few months ago which concluded that the US would not suffer a Japan-style decade-long slump because it had inflation. Not now.

Down every product chain, in the case of lego from crude oil to the plastic (acrylonitrile butadiene styrene) to the finished goods, inventory has been manufactured using high- cost raw materials. Remember when crude was above US$100/bbl? It seems almost a distant memory.

So this means everyone - from the retailer in Singapore selling my boy's truck right up to the ABS producer and the cracker, aromatics and refinery operators - will have to endure lots of hair cuts in this first circle of the deflationay spiral.

Volker Trautz of LyondellBasell is right to say that destocking of this nature is a big cause of weak demand at the moment - and that the true nature of underlying demand might not emerge until Q1 next year (see below for interview).

But by the time the first quarter comes around, we could be into the second loop of a deflationary spiral that might push is into something as bad as the Great Depression, or a global version of Japan's long and painful economic paralysis.

What's your strategy to survive this?

18 November 2008 17:45 [Source: ICIS news]

HOUSTON (ICIS news)--Petrochemical customers have cut purchases as they expect prices to continue falling - a trend that has masked the true level of demand during the global economic slowdown, the CEO of LyondellBasell said on Tuesday.

Starting in the third quarter, customers reduced purchases on the expectations that prices would fall in upcoming weeks, said Volker Trautz, LyondellBasell CEO, during a conference call.

Such destocking accelerated in the fourth quarter, Trautz said.

At the same time, demand has dropped because of the global economic slowdown, he said. "The economy has clearly slowed."

LyondellBasell will not have a clear picture of underlying demand until the first quarter, he said.

As it is, LyondellBasell has idled an olefins plant and reduced operating rates as a result of the slowdown, Trautz said. The company has also shut down polymer plants.

The company has reduced its 2009 capital expenditures programme to $800m (€632m), the minimum deemed necessary to meet safety and environmental standards, Trautz said. LyondellBasell has also adopted a cost-cutting programme.

In the upcoming months, LyondellBasell may consider selling off noncore assets, such as real estate, the company said.

In all, the company should generate cash in the fourth quarter, which should allow it to reduce its net debt, Trautz said.

In other news, LyondellBasell expects to remain in compliance with its covenants in the fourth quarter and in 2009, the company said.

($1 = €0.79)

By: Al Greenwood
+1 713 525 2653

It's all about hoarding cash over the next few years, but survival might not even be possible for even the best managed of companies if Martin Wolf's worst-case scenario comes true. The Financial Times columnist writes of the unravelling of globalisation into the protectionism that characterised the Great Depression years if the Obama stimulus package fails.

There is a good chance it will fail, fears the Federal Reserve in the notes released from its December meeting.

At a chemicals company level, leverage is obviously out and the private equity model thoroughly discredited - perhaps for good.

You can argue that the biggest mistake of the biggest casualty so far, LyondellBasell, was timing as the acquisition of Lyondell Chemicals took place in December 2007. Asset prices were then at their peak with many believing that the boom would continue forever, despite the already rapidly deflating US housing bubble. As recently as March last year, The Economist was talking of Asia's decoupling as the potential saviour of the global economy.

But leverage is itself the problem because of how the extraordinary multiples over tangibe, realisable assets were generated through the shadow banking system, creating the climate for deals such as the Basell takeover of Lyondell to occur. It is this badly regulated, free-for-all system that's brought the global economy down.

Maybe we will never again see the break up chemical companies for sale to private, or public, companies burdened by enormous amounts of debt.

Perhaps the well-integrated chemicals company with sufficient diversification to provide compensating cash flows when a particular subsidiary is struggling is the way forward. Is this yet another case of back to the future?

In an even better position are the state-owned giants in the Middle East and China. They are in the enviable position of cash in hand, and government ownership structures that guarantee funding if that cash was to ever run scarce. These are the only companies I can see able to make the acquisitions the industry now needs.

I am reading Charles R Morris's The Triillion Dollar Meltdown at the moment, having also recently cheered myself up with Paul Krugman's update of his classic, The Return Of Depression Economics.

As the private equity model implodes, Morris's following words ring so wonderfully true:

"The leveraged-buyout business, after a highbrow restyling as private equity, came roaring back. A typical deal: Put up $1 billion, borrow $4 billiion more, snap up a healthy company for $5 billion (after making a rich deal with its executives), vote yourselves a "special dividend" of $1 billion, all the while taking no risk. 'People talk about a wall of money,' one banker said. Private equity funds didn't have to raise capital; it was chasing them."

I am sure, of course, that such unscrupulous and whollly dishonourable practices have never, ever applied to any private equity deal involving our great and wonderful, wise and so superbly well-run chemicals industry that has always taken a long term and measured view of how to run its operations in the most financially-optimal way and for the benefit of humanity as a whole in its caring and compassionate pursuit of higher and principled ideas for a sustainable, warm and cuddly future where everyone sits around the campfire and sings "Well be coming round the mountain" (enough waffle, stop - please!).

As a very wise man once said, everything goes in and out of fashion like long skirts and short skirts.

Hence, my very capable colleague Malini Hariharan has offered some analysis of South Korea. Its companies, having being brutally hammered by the West post Asian Financial Crisis (which I had pointed out at the time ignored their strengths) are now at the front of the proverbial cat walk because they have low levels of debt.

Of course they have significant competitive disadvantages, but they might at least survive the crisis.

At the moment, a shell-shocked chemicals industry is still recovering from the impact of destocking following the huge inventory write downs in Q4.

The next step will be to measure the state of genuine, end-user demand and how this compares with the fantastic growth we saw in 2003 right through until the end of H1 2008.

Comparisons will inevitably look bad, even if, as some hope, recovery arrives in the second half of this year. This is bound to have a pyschologically dampening effect on markets.

Plus, chemicals and plastics markets are about to be roiled by large amounts of new capacity.

Recent price rises in the aromatics and olefins chains might, therefore, be reversed.

And so cost will remain King in the second of 2009, and perhaps for several more years.

The rise of private equity in chemicals, which I examined in a previous post, resulted in claims that the sector's more efficient management techniques would result in money being made "even at the bottom of the cycle".

But key to survival may no be longer innovative financial engineering and cutting costs social and bureaucracy costs incurred by previously much bigger, listed companies.

It might instead be all about chemical engineers getting every last cent of value out of production processes through optimising "every pipe and every valve," says my colleague Nigel Davis - editor of the Insight section of ICIS news.

It will be fascinating to watch how this plays out - and what becomes of chief financial officers.

Herein begins an occasional series where I offer advice on how to make a little cash.

By the way, is it me or do I get the sense that a lot companies haven't woken up to the severity of the crisis we are in? A recovery this, and I think quite probably next year, is out of the question. We need to find new sources of growth to replace the US consumer who isn't going to start spending money again in the same volumes as before for a good many years.

Anyway, here is my handy tip: purely by coincidence discover one day that quite fortuitously you have priced your local product so high - way above international levels - that this has attracted competitively priced imports. Take advantage of this wonderful, joyouous happenstance, this glorious instance of serendipity and lodge an antidumping petition.

A recent briefing by The Economist Intelligence Unit warned that because of the mess the West has made of the world economy, managers in Asia might face unrealistic targets.

Does this sound familiar? All answers will be treated in the strictest of confidence.

This excellent article from The Economist about vertical integration got me thinking that if, say, auto makers start buying up parts suppliers in developed markets (in developing markets the plastics processing industry is too fragmented) we could end up facing a whole new set of industry dynamics.

Buying up your supplier, or at least offering them strategic advice and financing in the way that Toyota does, could end the days of the poor and relatively small converter squeezed between the big petrochemical producers and the giant finished-goods manufacturers. Resin producers might suddenly find themselves facing heavy rather than lightweight opponents.

Petrochemical markets, as is the case with stock markets, are I believe in the midst of a bear-market rally.

As chemicals consultant Paul Hodges predicted on his blog last year, restocking in Q1 was inevitable after the great inventory run-down of the fourth quarter.

Paul has consistently made the right calls on the economic crisis and on its implications for the chemicals industry. His accuracy in predicting the major events - from crude-oil pricing to the collapse of Bear Stearns - can be demonstrated by visiting his blog.

Read his post today which provides are summary of how we got we are and where the global chemicals industry appears to be heading.

Petrochemicals benefited from the Q1 restocking, of course.

We have also seen an across-the-board price rally sustained by a lot of speculation in China made possible by ample availability of credit. The question now is whether credit will be restricted as China becomes concerned over inflation.

Petrochemicals pricing has also been supported by stronger naphtha due to firmer crude, first of all because of refinery rate cuts when the Q4 crisis occurred and more latterly a huge programme of refinery turnarounds in Asia. According to oil and gas consultancy Purvin & Gertz, this turnaround programme is due to come to an end around June.

Naphtha supply will increase in H2 on more exports from India, higher production from one condensate splitter in the Middle East and the start-up of another splitter. Supply could increase in Asia by 20-30%.

I think crude is likely to trade around the $50/bbl mark for the rest of this year so this will set a floor for liquid-feedstock costs.

However,I don't believe that petrochemical producers will be able to use tight naphtha as a justification for maintaining current price levels because of the increased supply.

Petrochemicals supply will also lengthen when Asias' big cracker turnaround season ends after June.

Middle East project delays are likely to continue, but some further extra supply in polyolefins, MEG, aromatics and propylene oxide (PetroRabigh is in the process of starting up the region's first PO plant) can be expected in H2.

The second half of the year could also see the start-up of lots of capacity in China. But how much volume actually hits the markets will have to be closely tracked.

Demand will be better this year than in 2008, but hey, so what?

Last year was exceptional bad because of the destocking, and all the economic uncertainties will not be compensated for by the boost from government stimulus packages.

So, in short, expect feedstock-price support to weaken and for petrochemical supply to lengthen in a persistently weak demand-growth environment.

The big unanswered question is to what extent the recent price prices were also the result of speculation in China. In methanol, an incredible two-thirds of Q1 imports were for speculation on futures markets.

As Paul again points out on his blog, the volume of contracts being traded on the Dalian Commodity Exchange is nothing short of staggering (an average of 1Om tonnes a day during the first quarter!).

Has this contributed to LLDPE prices trading above LDPE over the last few weeks for the first time in two years?

How much of the chemicals and polymers that have been imported into China recently, or purchased locally, and are being held in inventory for speculation purposes? To what extent has this speculation been made easier by increased credit?

With as many as 30m migrant workers laid off in China and export-focused factories operating at only 50% of capacity, how can all this increased chemicals trade be justified by an improvement in the final demand for finished goods?

China's economic stimulus package is kicking in. Over the last few days I hear of improved sentiment in China that the worst might be over.

But given that 10-30% of China's economy (depending on who you believe) is dependent on exports, it would take a heck of an effective stimulus package to boost domestic growth sufficiently to replace all the lost export trade in the second half of this year.

We've also picked up anecdotal reports that factories are being kept running by soft loans from banks for social stability reasons.
It's unlikely that the total extra production will replace all the volumes lost through factory closures.

But at the end of certain product chains you could see China exporting deflation in H2 to relieve inventory - another reason to believe that chemicals pricing will decline in the second half.

However, it might not be in China's interests to flood oveseas markets with goods at bargain-basement prices if this triggers international tensions and a further rise in protectionism.

Overseas chemicals players seem to have benefited from the relative strength of China's market with volumes of benzene and polystyrene, for exampe, being shipped from Europe.

Large increases in polyolefin shipments from the US to China are also being reported, in the case of PE the result perhaps of comparatively cheaper ethane versus naphtha.

The word on the street, from our price-reporting team, is that nobody can really say for certain whether the recent price rises are the result of improved demand or speculation.

But add all the above factors together and it seems a sharp correction from June onwards remains very likely.

And the more uncertain that price direction remains the closer the correlation might be between oil and naphtha and chemicals pricing on a daily, weekly or perhaps even a longer-term basis.

In the absence of clear direction, crude and equities might end up as the only guides available (or perhaps chemicals might even move in the opposite direction to equities in China as a lot of traders traditionally move their money between the two - and also property - depending on where they think the next gains can be made).

For the traders in China and those who know know how to play the domestic markets extremely well, it's also a question of maximising returns from micro-price movements.

On a weekly basis, one trader estimates that domestic polyolefin prices have fluctuated by $50-100/tonne in 2009 compared with $40-50/tonne in 2007. Last year can be discounted as an exceptional year because of the inventory building and the H2 collapse so, hence the comparison with 2007.

The Dalian exchange must also be adding to this volatility.

Bear-market rallies are better than no rallies at all, of course, and we could several more rises and sudden dips in chemicals pricing before this crisis is over.

Could the chemicals industry be in danger of wanting to believe something so much that ignores overwhelming evidence to the contrary?

The widespread perception is that China's economy has reached a turning point.

"The worst of the crisis is over and the world is entering the time when things will gradually get better," wrote former US presidential adviser John Rutledge in an article on the Chinese news service, Xinhua.

According to The Economist, it wasn't the collapse in exports that triggered slower growth in China.

It traces the origins of the downturn to tightening of credit in 2007 that led to a collapse in property prices in China's first-tier cities and a decline in construction.

"If the collapse in domestic demand led China's economy down, it can also help lead it up again. Not only is China's fiscal stimulus one of the biggest in the world this year, but the government's ability to 'ask' state-owned banks to spend and state banks to lend more means that the government's measures are being implemented more rapidly than elsewhere," writes the magazine.

The huge spending on infrastructure will hugely benefit rural communities as two-fifths of villages lack a paved road to the nearest market, it adds.

A large increase bank lending also appears to be behind a 36% rise in housing sales by value in the year to March after sharp falls in 2008.

If construction picks up this should help reduce unemployment as half the job losses among migrant workers have been in the building industry, the magazine continues.

But The Economist concedes that a misallocation of capital is a concern.

However, the article continues: "China is one of the few countries in the world where bank credit has fallen relative to GDP over the past five years. Banks have an average loan-to-deposit ratio of only 67%, low by international standards, and less than 5% of banks' loans are non-performing, down from 40% in 1998."

So in other words because the Chinese banks are awash with cash a major Western-style financial crisis seems unlikely, no matter how much money is wasted.

But if money is being misallocated, the boost to growth might be less than some people are forecasting.

There are strong rumours that easy bank loans have fuelled speculation.

"When we are selling to a trader in China they have no interest in our letters of credit because they can borrow so cheaply and so easily from their local banks. They are even prepared to pay 20% up front by telegraphic transfer," said a Singapore-based polyolefins trader.

"I used to sell 80% to end-users and 20% to other traders in China, but now those percentages have been reversed.

"I think a lot of traders in China have taken risky long positions because lending terms were so easy."

Money has even been borrowed and then made or lost on domestic stock markets, some sources claim.

The same might apply to the Dalian Commodity Exchange, which has seen a huge increase in trading in linear-low density polyethylene (LLDPE) over the last few weeks.

Large of inventories of steel, aluminium and concrete are being built as a result of speculation and perhaps an anticipation that demand will get better in H2. The same might apply to chemicals and polymers.

But Michael Pettis, a professor at Peking University's Guanghau School of Management, makes some worrying observations about the economy in his blog.

It is worth reading the lengthy posts for 20 April and 13 April.

In summary, he talks about:

*Private companies - the main engine of economic growth - struggling to get financing as the state-owned enterprises receive a flood of loans

*A poor return on money spent versus jobs creation - for example, CNY1trillion which is being spent in Henan province to create 650,000 jobs. He has calculated that if this same sum had been spent on giving workers salaries of CNY3,000 a month (more than twice the average salary of migrant workers) this would have been enough to pay the wages of 650,000 people for 43 years

*A boost in industrial production, "leaving the unresolved question of who is going to absorb the excess capacity if the US is no longer willing to play the role"

*Signs that China is trying to export its way out of oversupply. The trade surplus was $62.6bbn in Q1 this year, up from $41.7bn for the same period in 2008. "Although lower than the astonishing heights of January and late last year, the trade surplus is still much higher than this time last year. That means China's export of overcapacity is increasing," he writes

*A much larger vulnerability of GDP (gross domestic product) to exports than some economists have calculated. He quotes a Wall Street Journal article, quoting a working paper prepared for the International Monetary Fund. The paper estimates that for every 10% fall in exports, GDP will decline by 2.5%. Exports fell by 20% in the first quarter

*Government subsidies and tax distorting demand - for example, state-owned enterprises bringing forward vehicle purchases which was of the major reasons why auto sales rose by 10% in March. JD Power, the car consultancy, is forecasting flat Chinese passenger car sales in 2009

It would be nice to start the weekend with a little cheer, but I'm afraid no amount of gormless optimism would work.

DuPont, as you can see from this excellent piece from my colleague Nigel Davis at ICIS, has revised its forecast for 2009 global growth down to minus 2.5% from minus 0.6%.

Every chemicals end-use segment you can think off from automobiles to construction to electronics looks a lot weaker than in H1 2008.

We need a new way of thinking to get through this, but as I head for a weekend with my family where the plan is to avoid reading any financial news, I am short of any ideas - other than maybe working for an NGO and accepting a much-reduced standard of material liviing.

Making money in this climate remains extremely hard - although from a business journalist's perspective, it is of course a fascinating time.

The first stage of the 105th Canton Trade Fair - which involves electronic and electrical appliances, hardware and tools, machinery, vehicles and spare parts, building materials, lighting equipment and chemical products - concluded this week. Sales totalled $13.03bn - a 20.8% fall on the same stage last year.

I also read this other report about a surge in job creation in China's cities in Q1 over the the fourth quarter last year. What are all these extra workers doing?

Are they building dangerously high inventories of semi-finished and finished goods?

China's economy is showing signs of recovery, but not enough to replace the 20% fall in exports during the first quarter.

......all the right reasons than to be wrong altogether?

Sounds a dumb question, perhaps - unless you take particular pride in being one of those know-it-alls.

The point I am trying to make (and assuming that chemicals pricing doesn't collapse beforehand on a broader retreat in crude and equites on maybe panic over swine flu or the realisation that a global economic recovery is a long way off) is that I have thought for a while that the fundamentals point to a major price correction from June-July onwards because of:

*New supply from the Middle East. Surely, yes surely, there will be more capacity hitting the market in H2 as PetroRabigh ramps up output - even if YanSab, Sharq and perhaps even the new cracker in Qatar - are effectively pushed into next year

*A lot of new supply in China. My colleagues at CBI Research & Consulting are working on an update of the subtantial amount of additional capacity due on stream in H2, including Fujian Petrochemical & Refining (the latest world on the start-up of which is July)

*The end of the May-June petrochemical turnaround season in Asia

*An increase in naphtha supply (as much as 20-30% in Asia, according to Purvin & Gertz) as a result of higher production from two new condensate splittlers in the Middle East and greater naphtha exports from India

*A I said, my belief that everyone will have to wake up to the fact that the global economy, including China, will not enter recovery in 2009 or perhaps even in 2010. I remain worried about the quality of China's growth (is it too production rather consumption-driven?), how much stimulus-package money has been wasted on speculation, including in building chemicals inventory, and the possiblity that China - directly or indirectly - might start exporting deflation

But today I spoke to some goods contacts and friends at a leading petrochemicals trading company who gave the following additional reasons for their long-held view that prices would tank in July:

*US and European producers upping operating rates in response to strong arbitrage opportunities. The Europeans have already raised rates, apparently, and the US more recently. In the case of propylene, though, stronger demand for refinery-based C3s from several derivative producers might, perhaps, make further US PP shipments unworkable

*Strong interest in shipping petrochemicals from the US and Europe to Asia for arrival after May (all May business was concluded around 20 April). Cargoes could be at sea and uncommitted just as the shift in fundamentals listed earlier starts to take effect. Big quantities have already been shipped from the West to East during Q1, including very large amounts of BTX and polyolefins. Around 200,000 tonnes of US and European benzene is heading for Asia for March and April arrival, according to DeWitt & Co. China imported 114,000 tonnes of benzene in March alone, which compares with just 328,000 tonnes for the whole of 2008 - an average of 2,733 tonnes per month. The surge in toluene shipments from the West to China is equally dramatic: China received 66,000 tonnes in January, 77,000 tonnes in February and 94,000 tonnes in March compared with a 2008 total of 273,000 tonnes.

Inventory pressures in the West have been relieved and some of the big losses suffered in Q4 have been recouped (and some of the traders seem to have done very well indeed).

So batten down the hatches once again.

Any excuse to make a reference to the late, great and wonderful Ian Dury.

I sent the following email to my friend in response to the stock market rallies and the green shoots of optimism seemingly turning into beautiful May flowers:

"I take it nothing can has fundamentally changed? The confidence couldn't possibly be so self-fulfilling that all the consumer and corporate debt somehow vanishes into a great big black hole?"

His response, justifiably caustic, was:

"Of course, that's the answer. We wake up on May 1, and its all been a nightmare.

"Suddenly houses are still worth what they were there years ago, and are still increasing in price on a monthly basis.

"None of the banks have been nationalised, and the shadow banking systems is still the same size as the normal banking system.

All is fine with the world, and neither Chrysler nor GM are close to bankruptcy."

Quite. Enjoy it while it lasts.

"Nobody can see until the end of the month - never mind into the third quarter," commented an olefins trader recently.

"The reason is that very senior managers are too busy micro-managing everything, from getting involved in trying to track commodity chemical price direction to insisting on signing off every expenditure over a few hundred dollars.

"The problem with these senior guys when they track markets is that they are so out-of-the-loop - assuming that they have ever actually been in the loop - that they don't know what they are doing."

I heard of one big company where the CEO has even insisted on signing off travel authorisation to next week's APIC conference in South Korea.

In these days of tight credit and collapsed sales, it's understandable that much tighter control on spending is essential.

And during the boom years, can we all honestly say that every single trip we made was entirely commercially justified - and that we were always sufficiently foused on the bottom line to get maximum value out of each trip? Look back at your old expenses forms and count up the number of genuine "drinks with Mr Kim" entries.

It will be interesting to see how the lessons being learnt today will be remembered when the economy has fully recovered.

But from a HR perspective, a tough sign-off regime needs to be well-communicated.

So does the senior guys tracking shifts in chemicals pricing - whether competently or incompetently - otherwise the workers on the ground are likely to become demoralised.

They are unlikely to be able to leave in this current climate, but will surely perform far worse if they feel their opinions are being ignored for no good and well-explained reasons.

Off-the-record, of course, how does your company measure up?

And did you fiddle your expenses during the good times?

One of the new skills being learnt in this current crisis is how to run plants efficiently at low operating rates.

"It's funny that for years now, we've worried about how to scale up profitably. Now industry is faced with just the opposite, how to scale down profitably," says Mark Matzopoulos, chief operating officer at UK-based Process Systems Enterprise in this article in ICIS Chemical Business.

A friend of mine has just graduated from university with a very good degree in chemicals engineering and has managed to land a job with an engineering company. His fellow graduates have not been as lucky in their search for jobs with chemical companies.

At least somebody is making money out of this crisis

It's easy to get caught up in the excitement over the rebound in the Chinese economy and miss underlying weaknesses which point to some major problems ahead.

To some extent, in a desperate effort to compensate for collapsing export trade, China might have borrowed from the future in order to achieve a swift recovery.

"The (Chinese government's economic) stimulus programme borrows from a future investment cycle," writes the online research publication, the China Economic Quarterly (CEQ), in its Q2 report.

"Since 1978 China has run relatively regular five-year investment cycles followed by five years of retrenchment."

Spending by the State on infrastructure and industry boomed in 2003-07 and so the following five years were supposed to involve the reductions in expenditure necessary to repair a big hole in the national balance sheet.

But, of course, the reverse has happened with infrastructure and industrial projects scheduled for the next 5-10 years now set to be completed over the next 3-4 years. This includes speeding up investments in the refinery and petrochemical industries.

"China could be in for some rough times after the stimulus money runs out in 2011," the CEQ adds.

Repair work to the national budget might not be the only reason why longer-term prospects could be a lot bleaker than many expect.

China might also fail to boost domestic demand sufficiently to compensate for export trade which might take many years to recover.

"For the first time in the 30-year reform era, China faces an extended period - five years or perhaps longer - in which exports will provide no significant contribution to growth," says the CEQ.

The reason is the well-documented collapse in the West's debt-financed consumption binge.

On the surface, it looks as if China is making great headway towards realising more of its enormous domestic-growth potential: retail sales grew by 16% in Q1 this year, up from 15% in the first quarter of 2008.

If you dig deeper, though, as the CEQ again does, you discover that retail sales include many "institutional" purchases, meaning those by state-owned enterprises (SOEs).

The government has increased military salaries by 50% and is providing rebates of 13% and 10% respectively off rural purchases of household appliances and automobiles.

Despite all this cash sloshing about, however, when you take away the institutional purchases from the retail sales figures, the CEQ concludes that there is little evidence of a pick-up in consumption.

Longer term, this can be fixed if efforts to create much better pension and healthcare systems lead to more spending and lower savings levels.

Compared with the West, and particularly the US, the Chinese keep an awful lot more of their money bank deposits.

But here's another potential pitfall: all that money sloshing around (the CEQ estimates the total stimulus will be worth Yuan5-6 trillion, or 15-18% - much bigger than the originally announced Yuan4 trillion) could end up creating another non-performing loans crisis similar to that of the early 1990s.

This could force China's banks to lower interest rates on deposits in order to repair their balance sheets, warns Peking University finance professor Michael Pettis on his blog, China Financial Markets.As bank deposits are such an important method of saving money in China, lower interest rates could lead to more money being saved as compensation, leading to damaged consumer growth, he adds.

Numerous economists are also warning that too much of the stimulus is in the form of loans to the SOEs, which can be less efficient in boosting the economy than private companies.

The private sector, hammered by the collapse in export trade, is in contrast reported to be struggling for finance.

An inevitable slow down in bank lending, the result of the huge rise in loan growth during Q1, could also be put yet another brake on the economy.

"RMB (Yuan) net lending fell sharply to YuanB592bn in April from YuanMB1.9tn in March, broadly consistent with our expectation," writes Jun Ma, Chief Economist Greater China for Deutsche Bank, in a report.

"We believe this reflects the success of the window guidance by the PBOC (People's Bank of China) and the CBRC (China Banking Regulatory Commission) that advised banks to "appropriately control loan growth"; the decline in new project approvals; as well as the slower pace of equity capital injections from the central government budget.

"Going forward, the continuation of these factors will likely lead to a further decline in net lending to about Yuan300-400bn per month in the remainder of this year."

A further worry remains the potential global deflationary effect in H2 of China stockpiling raw materials, including perhaps chemicals and polymers.

Imports of polyethylene (PE) and polypropylene (PP) have, for example, been at record levels in Q1.

However, it's impossible at this stage to say whether this involves major stockpiling or is more the result of better demand and big production cutbacks by Sinopec and PetroChina earlier this year.

In the case of iron ore and copper, though, the steep rise in Q1 imports (iron ore was up by 33% and copper by 62%) are being widely attributed to state-backed inventory building and strong investment demand.

"China is stock piling commodities - everything from metals to oil," said a chemicals industry source.

"The argument is that it's better to store financial reserves in commodities rather than US dollars."

"There has also been some stock piling of gasoline and diesel in anticipation of price increases by the government."

Gasoline and diesel prices were indeed increased from early June - the first time since March.

But if you put five economists in a room, goes the old adapted saying, you are likely to get at least ten different opinions.

It can be just easy to interpret some of the recent data in a much more positive way, and it might just be possible that the current euphoria will create a self-fulfilling prophecy of a sustained recovery.

It's worth being aware, though, that a 50% rise in the local stock markets since the start of the year and lots of positive macro-economic news might not tell the full story.

Cartoon: Peter Brookes, The Times

Yes, this blog has gone staggeringly quiet over the last few weeks as I gained a life: I went home to the UK and mixed with some people who had no interest in or desire to know anything about polypropylene. Do you realise that there are some people out there who have never even heard of catalytic reformers? Amazing....

Anyway, before I return to my sad little petrochemicals bubble, here are some reflections on the political chaos gripping good old Blighty caused by MPs' expenses.

The pleasure the Brits are deriving from their fuming indignation over some upper-class twit claiming the cost of cleaning out his moat, and other such extraordinary fiddles, almost makes up for the misery inflicted by collapsing house prices.

But as I kept saying over many a pint of wonderful British real ale during my leave: "Corruption? Call this corruption. If you want real, decent corrupt politicians then go to India or the Philippines, to name but two Asian countries affected by this problem.

"The good people there would be delighted if all that their political leaders did was claim the odd household plant or a bit or mortgage tax relief off the State."

It's good fun to have a go at politicians, though - God knows they all deserve it.

And there is never any excuse to fiddle your expenses and quite obviously, all the journalists enjoying the hunt have never, ever over claimed or falsely claimed for anything (you can be probably tell, except if you are American that is, that this is intended to be sarcastic).

I had a friend many years ago who worked on a national newspaper who received a major telling off for not claiming enough fraudulent lunches, dinners and gallons of alcohol, the reason being that if the accountants saw one person managing on less everyone else might have been forced to follow suit.

Most national newspaper journalists, certainly in the 1990s anyway and so this may have changed, could double their salaries by being on the fiddle.

But in the row over MPs' expenses perhaps not enough focus is being placed on a much bigger issue. This is how Britain is going to repair its government finances without creating major inflation problems or interest-rate hikes that will limit inflation but nip the recovery in the bud. The same applies, of course, to the US.

I don't pretend to understand Bond yields etc.

Perhaps nobody understands, nobody has control, nobody has a flipping clue and so in the absence of any clarity the only debate worth having is over why the former Home Secretary's husband, working as a government-paid political assistant, claimed porn movies on his expenses (still my favourite of all the scandals).

Toodle pip. I promise you in my next post that I'll write about polypropylene for all you fellow sad people out there.

As I've been warning on this blog for some time, the explosion of credit in China has created a great deal of paper-bottomed optimism over the recovery.

Fitch, the ratings agency, has just raised its macro-prudential risk indicator ffor China from category 1 (safe) to category 3 (Iceland et al) because of the lending surge and public debt.

China's Banking Regulatory Commission warned last week: "The top priority at the moment is to stop explosive lending. Banks should carefully monitor the process of credit approval and allocation, and make sure that loans flow into the real economy."

And Andy Xie, the often-quoted Sino-bear, says in the same article I've linked to above from The Daily Telegraph: "Commodity speculators have been using cheap credit to play the arbitrage spread between futures and spot on the oil markets. They have even found ways to trade lumber to iron ore by sheer scale of leverage. "They've made everything open to speculation."

This is probably one of the main factors behind the boom in speculation in linear-low density polyethylene (LLDPE) futures on the Dalian Commodity Exchange. PVC futures were also recently launched on the exchange.

As my fellow blogger Paul Hodges points out on his blog, Chemicals & The Economy, China is at risk of repeating the mistakes of the West: an unsustainable rise in credit.

The obvious danger, as has been flagged up before, is a sudden collapse in chemicals demand and pricing as inventories are unwound (built up with too-easy) as tougher lending conditions are imposed. This could be an even more dramatic bursting of the current equities and commodity price bubbles if it occurs at the same time as sharp fall in crude (which seems likely if equities are hammered.

Source of picture: gilesbowkett.blogspot.com

The excellent daily energy and shipping report, The Schork Report said today that the bottom had "fallen out of the entire (energy) complex."

With the Bulls on the defensive, the authors believe that crude could retreat towards $60/bbl.

Natural gas markets are so oversupplied that prices in the region of $2/mBTU are possible, it adds.

Back in March, the report offered what I think is the best summary of the denial of fundamentals that's taken over equity and commodity markets recently:

Our concern is this: with each passing session it appears more traders are encouraged to "participate", hence, the market keeps moving higher. That happens enough times and soon you have $100 oil and Matt Simmons all over the tube alleging the Saudis are doctoring their books and that Petrobras and ExxonMobil didn't just find all of that oil in Brazil. Then, just like we saw last spring, when the price path of the market decouples from the fundamentals, perception trumps reality and high prices become the justification for higher prices. All because the
smart money [sic] doesn't want to "miss out".

Since March, August WTI prices on the NYMEX have rallied from $58.07/bbl to a $73.48/bbl high (+26½%).

Despite some recent headlines pointing to tighter oil supply (for example, more civil unrest in Nigeria and US dollar weakness) the energy-market mood has changed.

Until last week greed seemed to be chasing greed. "The market was going higher...and they (the speculators) went on a buying spree because once again, high prices justified high prices," wrote Schork on July 6.

So what began as a bear-market rally ended up as a growing consensus - which perhaps too few dared challenge - that the recovery would be V-shaped. Doesn't this sound an awful lot like the consensus views of decoupling and ever-rising energy costs which prevailed during H1 last year?

What changed last week was a fall in June US consumer confidence and a sharper-than-expected rise in unemployment. The employment-to-population ratio also fell to its worst level since 1984 and average hourly earnings have remained stagnant in two out of the last three months.

An indication of just how far we are away from a consumer-led US recovery is that US gasoline prices fell last week - for the second week in a row. This was the first consecutive weekly decline this year and occurred even though this is the peak driving season.

Chemicals pricing has increased in line with energy costs - as this chart from ICIS pricing shows. Naphtha, ethylene and polyethylene (PE) have been chosen as examples.

View image

Global production cutbacks and delays to Middle East start-ups have also helped sustain a chemicals price rally which began in February.

Efforts are being made to push through further prices rises. European PE and polypropylene producers are, for example, bidding for 10% July increments. These are aimed at recovering higher upstream costs and improving margins.

But the new capacity won't be delayed forever. China's import demand has already started to weaken on anticipation by buyers of extra volumes in H2 and resistance to price hikes.

This is bad news for the US and European producers. They have enjoyed strong exports to Asia in Q1 and during some of the second quarter, which has helped them keep domestic markets tight.

As I said last week, chemicals companies that have continued to manage inventories well during this paper-bottomed boom will be in a better position than those who have been taken in by the markets.

Picture: The China Daily

"I've given up trying to read the polyolefin market in China. I just can't figure out what's going on," said a senior source with a major North American producer late last week.

"I keep returning to the fundamentals and cannot understand why prices have risen so steeply since mid-February."

Him and me both; we are perplexed by statistics which show a rise in domestic polyethylene (PE) production and imports, despite, as my colleague Paul Hodges points out, a sharp in exports of finished goods.

Where is all this stuff going? Into inventories of finished goods, perhaps, as factories are kept running for social reasons?

Paul, on his blog Chemicals & The Economy, says today that there has been a strong correlation between stockmarket strength and rising crude .

Oil is another reason why chemicals pricing in general has gone up by so much.

Now it looks as if equity and oil markets are heading in the other direction.

But as a second source told me by email this morning: "I've stopped worrying about this; I am just making money while it lasts."

Quite, but to return to the North American producer and his theories for these weird numbers, he added the following:

(Anybody else out there - your views as always are more than welcome).

"Dalian (the LLDPE commodity exchange) is now leading the market - i.e. people are pricing off it.

"The Chinese government has apparently also tightened up regulations on scrap imports after concerns were raised over health risks."

The scrap factor could be important as over the past 2-3 years, the steep rise in recycled material has taken around 4-5 percentage points a year off virgin polymer growth.

Also, once polymer prices go past $1,000-1,200/tonne it becomes economic to ship in scrap polymer and convert, according to one source.

Take away this automatic price-capping mechanism and you could have another reason why prices have risen by so much since mid-February - and why production and imports are both up.

Source of Picture : purchasing.com

In his own words, here is how one contact describes the current situation with a couple of extra points added by yours truly (with links)

"We've seen arbitrage close from Europe on polyolefins with no new business since April-May. Some material was delivered in June but this was merely May deals.

"The reason is delays to new capacity and re-stocking. We haven't seen a new PE plant in China for over a year with the next ond due on stream in July-August - Fujian.

There has also been substantial China petrochemical turnaround programme in April-June as our re-launched World Ethylene Plant Report illustrates.

In addition, deep cutbacks were made earlier in the year for market reasons.

"I think the reasons for the project delays have been that EPC (engineering, procurement and construction) resources have been severely overstretched.

"The fall in crude by $10/bbl is clearly also going to have an effect and buying patterns will change as everyone holds back rather than brings forward purchases."

Chemical companies as a whole displayed "dangerously complacent" views about second-half 2009 prospects when they released their Q2 results late last week, argues chemicals analyst Paul Satchell in his blog.

"They believe that demand has bottomed. Although they can't see the upturn yet they believe the worst is definitely behind us," writes Satchell.

"This blog sees this as dangerously complacent, particularly as analysts and investors have returned to a positive stance on the sector."

When you look at the results themselves, the numbers look better but only on a sequential basis (and watch out for some misleading year-on-year numbers in H2 when performances are very likely to be better than the disastrous second half of 2008. A more useful comparison might be with H2 2007).

Most companies reported year-on-year volume declines in the low 20% range - better than reductions of more than 30% in the first quarter of 2009.

Margins were again lower than in the same quarter last year but up on Q1 2009.

In the case of basic upstream petrochemicals, producers have largely been playing catch up with higher crude prices in this year's second quarter.

The overall margin improvements are likely to be the result of stronger returns further down the product chains.

These relatively better downstream performance could well be the result of extraordinary increases in apparent demand for polymers and other commodity chemicals. These have occurred at a time of tight global supply (the result of market-driven deep production cutbacks after the Q4 2008 price collapses and turnarounds).

The true nature of the demand increases is at the heart of the complacency Paul is worried about.

Numbers emerging from China remain counter-intuitive.

In January-May over the same period last year high-density PE (HDPE) general trading was up by more than 130%, even though re-exports were down by 16%.

To repeat yet again, how can this happen while China remains so heavily dependent on exports and the global economy remains weak?

BASF, when it disclosed its Q2 results, said that it expected global chemicals output to fall by 8% this year.

This would mean that by the end of this year, production would be back to 2005 levels.

In other words, the global chemicals industry will have lost three years of growth.

The broad-based chemicals giant is signalled out by Satchell as one of the few companies that has acknowledged the risk of another downturn caused by overcapacities, bankruptcies and growing unemployment.

The end of the bubble in oil and oil-product prices might cause severe problems in H2 this year. This could be before new petrochemical capacities and/or a winding down of speculation in China start directing markets.

"The risk from a potential fall in oil is only being thought about in terms of raw materials pricing. People seem to have already forgotten what triggered the de-stocking from last summer," adds Paul Satchell.

How will this one run?

Source of Picture: chemicals-technology.com

In the 12 years I've been covering the chemicals industry I don't think I have come across a time of such exceptional market muddle.

The traders love it. As a wise man said to me the other day, "When I was a trader I only cared about the price today if I was cashing in and not tomorrow."

But for the producers and buyers there are so many more factors that will shape the outcome of the second half, requiring fortunately for me hopefully some more business for ICIS training (one should always live in hope)

Here is Part 1 of what I plan to try and piece together over the next few months. Let's try and keep cooperating on data and analysis - but at the outset, does this make sense to you?

The Impact of Operating Rates, Plant Closures and New Petrochemical Capacities

Production from existing plants

This will be determined by overconfidence versus realistic confidence in the economy. This comes down to your view on the sustainability of the rebound.

To what extent have operating rate and inventory-management lessons been learnt from the oil collapse of H2 last year?

How are imminent new capacities affecting the behaviour of producers and buyers? In the first half, the tightness in some markets (for example, PP and PE) was partly the result of producers and buyers maintaining low stock levels because they expected new-capacity start-ups that didn't happen. To what degree has this experience made them less cautious?

It might be helpful to analyse Q2 chemical company results to get a feel for what production levels might be for the rest of this year.

Do the numbers add up and do the content and tone of what's been said sufficiently take into account all the risks? (Note: there are some individual company numbers on plans for overall average operating rates in H2).

The pace of permanent shutdowns in the West to reduce domestic oversupply and weaker exports positions also needs to be tracked.

Last year sudden decisions to temporarily or permanently close whole complexes - which were not necessarily entirely loss making - were forced on companies.

This was the result of the collapse in oil, the credit crisis and steep falls in demand.

To use PP as an example again, 500,000 tonne/year of US capacity-closure announcements were made in 2008 to take effect in the first half of this year.

Oversupply is still big: US PP consumption totalled just above 7m tonnes in 2008, 8% lower than the previous year with capacity still at 9.4m tonnes. So far this year (as of July) there have been no further announcements of closures.

Further factors affecting the pace of permanent closures could be divestments.

Trade buyers for distressed Western assets now seem much more likely than further private equity players and so attitudes to running marginal, or clearly uneconomic, plants might be different.

You also have to take into account environmental clean-up costs and regulations - and contractual and labour commitments.

And next: How will petchem operating rates be affected by refinery economics?

Dealing with the US refineries first:

How will refinery economics affect availability of PP and aromatics in H2? In the first half we saw a big increase in shipments from the US to Asia due to the global rate cuts, production problems in the Middle East, the peak of the Asian refinery and petrochemical turnaround seasons between April-June and the unexpectedly strong Chinese demand.

But since May/June, PP arbitrage from the US has closed on lower refinery operating rates resulting from weak gasoline demand. Benzene trade flows seem to have also reversed - in July we have heard of cargoes moving from Asia to the US, whereas in H1 there were record-high shipments the other way.

What's the outlook for gasoline, middle distillate etc demand for the rest of the year? (gasoline and middle distillate stocks are high on speculation and weak demand)

Some of the same questions need to be asked about Europe with a few
important differences, which are:

*Europe is a major exporter of gasoline to the US and so the price and availability of naphtha, and therefore petchem economics, will also be affected by US demand for the fuel

*Fuel demand in Europe is heavily weighted towards diesel and how will the European economies perform in H2 and what affect will this have on demand for gasoline, more importantly diesel, and how the refineries run? (Note: most propylene in Europe is produced from steam crackers because of the lower gasoline demand. But there is still a big link as naphtha is the main steam cracking feedstock in Europe).

I don't follow currency or shipping and other logistics markets, but these are obviously also critical factors.

Next question: How will the new petrochemical capacities run?

It's worth considering that there could be many more start-up delays, and
problems with operating new plants already on-stream, because resources were so stretched when these projects were planned and they remain stretched.

There is a shortage of engineers with the right levels of experience. Many of the projects were also planned when raw material, equipment and other costs were sky-high.

Budgets were stretched and so choices had to be made - for example, "Do I focus on my PE debottlenecking using ethylene from my new cracker or do I prioritise starting up the cracker and its new plants on time?"

Another problem is "project bunching". There seem to have been attempts to start up too many projects at the same time, further stretching already-scarce resources (a few years ago there was a lot of fevered excitement over the global economy. There was a rush to take advantage of financing while it was available in order to cash in on this growth and to maintain economies of scale).

There is, reportedly, a lack of the right kind of experience. Even companies with long track records in petrochemicals are confronting start-ups of projects bigger in scale and more complex than ever before.

Source of picture: oxo.typepad.com

Leaving China aside for a change - where the speculative frenzy continues apace -Paul Satchell, chemicals analyst, has a four-step measure for assessing whether the US and Europe are really out of the woods.

"Purchasing behaviour is strongly influenced by a customer's confidence, and, in the current context, four distinct phases could usefully be examined," he writes on his blog.

These are:

1. Normal buying patterns - annual/quarterly indications and regular (say, weekly) off-takes
2. De-stocking by customers - sharp reduction of off-takes, well below indications
3. 'Hand-to-mouth' purchasing - small quantities to satisfy immediate needs (indicator of low stock levels and weak confidence)
4. Gradual return to normal buying patterns as in 1.

"We expect that many chemicals manufacturers have experienced at least stages 1, 2 and possibly 3 since mid-2008. A move by major customers into stage 4 would give producers confidence to return capacity from idling.

Only when normal purchasing behaviour becomes commonplace, accompanied by reasonable volume trends, will we be confident that a recovery is soundly-based."

Who is going to be the first to put his or her head above the parapet?

If you are a chief financial officer who has just spent months explaining away how you lost your company so much money in Q4, do you really want to take that risk?

It seems ironic that in the crazy scramble to protect itself from the consequences of the US collapse of the US debt-growth model, China has headed down the same path.

As my fellow blogger Paul Hodges pointed out last Friday, official concerns over the bubbles in equity and property markets are increasing.

Zhang Jianguo, president of the 2nd largest bank, China Construction, has announced a 70% cut in H2 lending to Rmb 200bn ($29bn), "to avert a surge in bad debt".

What's also alarming is that the government is getting increasingly alarmed that too much lending has gone into speculation rather than where it's supposed to go - investment in infrastructure.

This again raises the danger that chemical companies have made unrealistic assumptions about underlying demand.

And this article, by Chen Changhua writing in the Chinese newspaper, Cajing, includes the following point:

"How quickly a country can recover from an economic slump is determined by the productivity of the country. Japan has not been able to recover from the 1990s slump mainly because there are not enough competitive new-generation enterprises to replace old enterprises. "

He warns the same fate could befall China unless the state-owned enterprises, the beneficiaries of much of the huge amounts of new lending, face tougher competition from the private sector.

Never underestimate the power of vested interests.

What would would the great man have thought?

Source of picture: Newham Council, the UK

Four of the things my dear late father taught me were:

*Never vote for the British Conservative Party

*Keep believing in the common good of humanity in the face of all the evidence to the contrary

I plan to teach my son the same.

These words came back to me when a friend described the excitement of his colleagues when their company was unionised.

"It's great, isn't it? Think of the shopping benefits."

Take it way, Billy.

Go find the young men never to fight again
Bring up the banners from the days gone by
Sweet moderation
Heart of this nation
Desert us not, we are
Between the wars."

Confidence along all the chemicals value chains is always a key issue because of the ability to aggressively manage inventories, according to the London-based chemicals analyst Paul Satchell.

So there's the ever-present risk of sudden and very disruptive de-stocking. The longer the current rallies in commodity prices and stock markets continue, the greater might be the risk that confidence becomes excessive and mistakes made last year are repeated.

If the events of last year have taught is anything it's that markets don't behave rationally.

Those who arrive late for the party just as the punch bowl is taken away might suffer the most - along with those who've been there for a while but don't make an exit before the bar closes.

Inventory rebuilding
There's plenty of evidence of inventory building in Asia which might not always in response to strong underlying demand. For example:

*Polyethylene (PE) inventories in China at the second and third distributor levels were at very high levels in June, according to one industry report. Polypropylene (PP) inventories were, however, at normal levels.

*Benzene, toluene and monoethylene glycol (MEG) inventories were said by several sources to be also very high in July. Hydro-dealkylation (HDA) and toluene disproportionation (TDP) operating rates were also reported to have been raised - a long with benzene production from coal-based steel plants. Strong overall reformer economics, up until the end of the first half of August, could have lead wrong decisions on production levels

Polyester operating rates were said to be on the rise from H2 July as producers tapped into ample bank lending in order to increase rates. This was on the assumption that the September buying season for textiles and garments would be strong, leading to a big improvement in exports. The next Canton Trade Fair will also be a major indicator (the textile and garments phase of the fair takes place between 31 October-4 November). But there are already signs of improvement: The textile and garment industry exported $14bn goods in June, up 13% from the previous month, said the National Development and Reform Commission. But this was still 10% down on a year ago.

A big influence on confidence will be whether China can be successful in taking the air out of its current real-estate and stock market bubbles.

Supply of new loans in July dropped to $52bn from $197.5b in June - a 77% reduction.

(China might not want to do anything more to spoil the mood of the party before the 60th anniversary of the Revolution, which takes place on the 1 October).

But this bubble has yet to reach the scale of the last one which went pop in October 2007.

At its peak so far this year the Shanghai Composite Index has traded at 3.8 times its book value, barely half the 7.2 book multiple in October 2007, according to the Financial Times newspaper.

There's also plenty of caution
The inventory building we talked about earlier only applies to China and traders in just about every commodity everywhere in the world.

Chemicals companies outside China seem to be exercising extreme caution because of the huge inventory losses incurred in Q4 last year.

"Inventories are being kept low because there is very little visibility down the value chains," said a UK-based chemicals consultant.

"The credit crunch means that it remains difficult to finance inventories.

"Chief financial officers have just spent months explaining away large inventory losses from the fourth quarter. They are unwilling from a career point of view to risk having to go through the same performance again. "

The focus is cost control with market share taking second place.

As one Asian industry source put it: "Sixty per cent of our focus used to be winning on business in a broad range of markets and 40% on cost efficiency; now these percentages have been reversed and we would rather lose sales than break our tighter budgets."

The same applies to operating rates. US and Europe have maintained deep operating rate cuts - and have idled or permanently closed many plants - with the Northeast Asians also said to be showing very good discipline at the cracker level.

Middle Eastern players were in contrast reported to be running flat out in August following production problems in H1. These prevented them from taking full advantage of strong Chinese import demand.

The main focus in polyolefins is on selecting which grades to be produced based on pure economics rather than, again, on winning or maintaining market share.

But will this type of caution be enough to prevent a sudden reversal in petrochemical pricing?

The Oil Factor
The big danger is that any retreat could be driven by an unwinding of heavy speculation in crude.

At the moment the market remains in full-carry contango, meaning the combined cost of storage and borrowing (the full-carry cost) is below the futures price.

If this changes - or quite simply storage space runs out - there could be a sudden stampede for the exit.

What seemed counter-intuitive is that oil prices were at mid-August levels when estimates of demand kept falling.

This is unless you accepted that the oil market was again being speculator-driven.
Petroleum demand would be 1.8m barrels of oil per day lower than it had forecast in June, said oil, gas and refining consultancy Purvin & Gertz.
OPEC said in a report in August that the "market remains fundamentally weak". And it noted that US consumption is "still showing a massive reduction."

Could it all happen at the same?
This big worry is that Chinese growth could fall on less economic stimulus as oil prices collapse and much-delayed new Middle East petrochemical capacity hits the markets.

China is also due to start-up several major cracker projects in the second half of this year.

But the first half of this year was far better than anyone dared to expect. There was a strong recovery in petrochemical pricing with some reasonable spreads at the polyethylene end of the chain as this chart shows (the same applied to PP)

View image

Let's just hope that the traders in all the commodities, including chemicals, don't spoil the recovery before real demand has the chance to catch up with the improved confidence.

Garbage out, garbage in

Source of Picture: The Daily Telegraph

Here goes for the second part of this series.

Is there anybody out there who can help?

How will the ongoing availability of recycled material affect the pricing power of virgin resins? (We have the data to show that imports of scrap polyethylene (PE) and polypropylene (PP) fell in Nov-Feb, but have since heard anecdotal evidence that they have increased again. If so why?

Questions worth asking on recycling:
a.) Has there been a recovery in availability of recycled material? If so why? Is this because of stronger demand in the West for durable consumer goods wrapped in plastics, which are recycled and sent back to China?
b.) And/or is this the result of the rise in virgin resins since March. Has this resulted in a much harder global search for and new sourcing of the scrap material that is available?
c.) And/or has there been a relaxation in the govt regulations covering recycled material that's made imports easier?
d.) If recycled material is now more readily available, has this set a new pricing cap on virgin resins? At what price is it now economic for converters to switch to recycled material?
e.) Has the rise in virgin resins also led to more fillers being used again?
f.) What's the current state of distribution networks for recycled material? We have heard that lots of traders in recycled material went bust during the big price collapse last year as they were left holding high stocks of material that was more expensive than virgin resin. We also understand that remaining traders in recycled material were interested in trading in virgin plastics in Jan-May because the profits were greater. A further factor to consider might be that the Dalian Commodity Exchange (where linear-low density PE and polyvinyl chloride futures are traded - see later notes) is a lot quicker and less risky way of making money than trading in scrap. This might have also hampered the rebuilding of the scrap-supplier network
g.) We have focused on China. Is recycling also a major issue outside China?

All the questions above could equally apply to some of the other polymers. PS is hard to recycle, but what about the impact on, say, PET resin water bottles? We are not sure if this has even been economic, but could this be a factor behind the lack of an automatic recycling price cap down the fibres chain - or any other chains for that matter?

Source of Picture: ChinaMonthlyReview.Org

Polyester operating rates in China have started to rise on anticipation that the global economic recovery has arrived, according to Leonard DeGuzman, chemicals consultant with DeWitt & Co.

Is this another example of a dangerous price bubble or further proof that we are really emerging from the woods?

"The impact of more plentiful lending only started to affect polyester markets from the second half of July when the synthetic fibre makers started tapping into extra credit lines," he said.

"It's the result of greater confidence that textile and garment exports to the West will rise because the economic recovery is really here."

Polyolefin resin converters have been taking advantage of the huge increase in bank loans since as early as the first quarter.

But their polyester counterparts have displayed more caution because of the textile and garment industry's bigger export dependence.

"You have to realise that it's not just clothing exports that have been affected. Non-apparel going into automobiles and housing have also been hit hard," said DeGuzman.

He warned that the poly-condensation players have yet to see any actual improvement in demand.

"They are just making the assumption that the next big order season from the West for textiles and garments, which begins in September, will be much better than in the spring season."

Another key measure will be the third phase of the next Canton Trade Fair, which includes textiles and garments. This takes place between 31 October and 4 November.

The recovery in pricing and confidence in upstream markets arrived a long time ago.

Benzene was trading at or below naphtha on several occasions late last year.

But prices soared to a ten-week high of $900/tonne FOB (free on board) Korea for the week ending 7 August, according to ICIS pricing - a $55/tonne increase. Naphtha was at $651-652/tonne CFR (cost and freight) Japan.

Overall, reformer margins looked very healthy with toluene at $905-915/tonne FOB Korea and mixed xylenes (MX) at $835-837/tonne FOB Korea.

"Target spreads are $150-180 and so this is a very good position," said DeGuzman.

"This is generally true when crude remains under $100/bbl. When WTI surpassed the $100/bbl mark, reformers expanded their target spreads to $200-220/tonne. They grew as high as $250-270/tonne when oil was above $130/bbl."

The rebound goes back to the deep refinery operating rate cutbacks in China in the fourth quarter of last year, which left the country short of benzene.

Imports, as a result, soared to approximately 507,933 tonnes in January-June compared with 327,982 tonnes for the whole of 2008, according to DeWitt.

Where is it all going? Could a substantial amount have gone into speculation and inventories given that the styrenics and phenol chains have been weak?

The phenol chain had improved in early August, however, although later fell back again on weaker crude prices, said DeGuzman.

"Total benzene inventories in China were at 43,500 tonnes in July which is considered extremely high," he said.

"At above 38,000 tonnes local producers started discounting ex-factory prices in order to move material. Prices start increasing when stocks are at 15,000-23,000 tonnes."

But as of the week starting 10 August, DeGuzman said that inventories had fallen to a "snug" level of 25,000 tonnes."

This is another example of persistently high levels of volatility and uncertainty, making operating rate and inventory mistakes all too easy.

A clear sign that confidence in benzene is high is that pricing is closely tracking crude, he said.

Hydrodealkylation and toluene disproportion units are running flat out in Asia, DeGuzman added.

China's economic recovery has also led to a big rise in coal-based benzene output - a co-product of steel production.

"Operating rates at the coal-based plants were 50-70% in March, but in May rose to 80-85%.

"Logistics have also improved because it's the summer season, making benzene buyers more willing to off-take from the steel producers."

Toluene inventories totalled around 95,000-100,000 tonnes in May and in June were at 90-95,000 tonnes.

At the beginning of August, however, they had fallen to 65,000 tonnes and last week to 53,000 tonnes. Normal inventories are 40,000 tonnes.

The drawdown could be because China's refineries are running harder on the July increases in domestic gasoline and diesel prices.

Moving back down the chain, the overall spreads between mixed MX and paraxylene (PX) look healthy

PX supply has also been tight on several delayed start-ups in China.

Japanese producers have been reluctant to raise PX rates on what they say are poor economics with availability from Japan further constrained by outages, said DeGuzman.

Purified terephthalic acid (PTA) producers seem to have had little trouble absorbing the cost push from PX.

PTA prices were $1,120-1,130/tonne CFR (cost and freight) China on 7 August, a $10/tonne increase over the previous week. Four weeks earlier they were at $1,085-1,095//tonne CFR China.

But, to repeat - what is the extent of the actual improvement in synthetic fibres demand?

There are genuine reasons to be a lot more cheerful than a few months ago.

Chinese manufacturers in general are seeing stronger orders from the West as global oil prices and stock markets remain infused with optimism.

But export improvements are on month-on-month bases.

The textile and garment industry, for example, exported $14bn goods in June, up 13% from the previous month but 10% down on a year ago, said the National Development and Reform Commission.

Positive comparisons are also being drawn with 2006.

This was before capacity in many product chains was ramped up in expectation that 2007 to first half 2008 demand-growth levels would be maintained; synthetic fibres were no exception to this.

The longer the commodity-price rallies continue the harder the potential hard landing.

Source of Picture: www.autospies.com

Not an easy answer and not one much suited to a few paragraphs of blogging.

But here's one thought as the competitive environment becomes a great deal more difficult due to new Middle East capacity and the potential for China to move towards self-sufficiency in polyethylene and polypropylene: Have a chat with one of those poor old European refiners facing big naphtha surpluses.

Perhaps the refiners will be willing to do deals on long-term offtake deals at very preferential rates in order to keep operating. While gasoline might be falling in value in Europe for both local consumption and exports, diesel certainly isn't.

The Canton Trade Fair

Source of picture: Blawg.lehman.com

This interesting article from Bloomberg says that while petrochemical output in China rose in August, textile production actually contracted.

We don't as yet have any breakdown for specific petrochemicals.

If the overall increase includes higher aromatics-to-synthetic fibres output then the gamble that the chain has taken on improved sales of textiles and garments will have so far failed to pay off.

As we discussed earlier on this blog, there is evidence of higher output down the entire synthetic fibres chain.

A key measure of improvement in exports to the West of textiles and garments will be the next Canton Trade Fair which takes place in October-November.

Deep in the heart of the great wealth gap

Source of picture: Blogmlive.com

....the more convincing seems to be the argument that financial and commodity markets have got way ahead of the recovery in the real economy.

Take a recent Credit Suisse report, for instance.

Its analysis of monthly apparent demand in China, up until June, for a few key commodities such as polyethylene (PE), asphalt, copper and iron ore show that they were above underlying real demand.

Are we about to be undone by what has undone is so often before, and as recently of course as Q4 last year?

By this I mean the banks and the speculators. Public money, used to bail out the banks, is being poured into oil and gas speculation, creating dangerous bubbles.

And to repeat yet again, there's all the hot money deceiving us over China. In this case its through state-owned banks which have been instructed to attempt to compensate for the mess made by Western lenders.

China, and indeed the rest of Asia, is busy trying to remake much of its economy in order to be less reliant on export trade which saw unsustainable growth.

The problem for the average worker in the US and Europe is that salaries have been stagnating, or even declining, in inflation-adjusted terms due to the great drift of manufacturing east.

Combine this with the loss of perceived wealth caused by recent harmful financial "innovation" (I'd say that's too flattering a word to use. How about manipulation or fraud now being paid for by the tax payer?), and real demand could take many years to recover to 2004-07 levels.

This article from the UK's Guardian newspaper asks whether we have learned anything from the financial crisis.

A new report from the United Nations Conference on Trade and Development (Unctad), referred to in the same article, concludes that we haven't.

"All these rises in markets are said to reflect economic recovery but it is just another bubble," Heiner Flassbeck, Unctad's chief economist, told the Guardian. "These markets are reflecting a recovery that is not there. Wage deflation is a huge danger everywhere and this is not being recognised.

"Banks have been rescued by the taxpayer and are just returning to casino-style speculation that brought us trouble in the first place. We need to focus banking on supporting investment in productive businesses."

This reminds me of a trip through rural Texas I made in March last year. No luxury condos, country-club memberships and multi-million dollar bonuses were evident there.

The US back-to-school buying season

Source of Picture: theglobeandmail.com

As regular readers will remember, last Friday I linked through to this article from the New York Times on the likelihood of a disappointing back-to-school sales season in the US.

I had promised some more thoughts on this article and so here goes....

......This is a sign of the belt-tightening in the US and Europe resulting from the long-term shift in consumer behaviour - as discussed before on this blog - which will lead to:

*Greater dominance of low-priced retailers such as Wal-Mart, which has started selling a Toshiba laptop for just $348. More outsourcing to the developing world seems inevitable as cost pressures increase. The squeeze will work its way up to marginally cost-efficient chemical and polymer producers

*A rise in protectionism: Western manufacturers are likely to respond with more anti-dumping petitions - and perhaps an increase in ex-WTO measures such as complaints over labour and environmental standards. If a cap-and-trade bill is passed in the US we could also see carbon-import taxes for imports from those countries with no comparable systems. Such measures can be politically popular

And what does a 17-inch laptop for $348 mean for innovation in the chemicals industry? Are companies going to bother with expensive R&D?

But to cut back on R&D would show a lack of vision by any company that cannot compete in pure commodities.

More rather than less differentiation is likely to be the key for survival as chemicals and polymers with marginal "added value" will face tougher scrutiny from buyers.

Source of picture: rateyourmusic.com

...steal a lot and they make you a King," wrote the great Bob Dylan in A Sweetheart Like You on his great 1980s album, Infidels.

This seems appropriatea as we commemorate exactly 12 months to the day since the West's financial system imploded.

Obama is talking tough on new regulations - and I am sure he sincerely means it - but Wall Street seems to control the overall Washington agenda.

Why does it matter for the chemicals industry? Because the distortions in energy, other commodity and equity markets are creating a false impression for the industry.

As the president says: "It is neither right nor responsible after you've recovered with the help of your government to shirk your obligation to the goal of wider recovery, a more stable system and a more broadly-shared prosperity."

Hear, hear.

Source of picture: millermmccune.com

How quickly is China shifting its economy away from exports towards stronger domestic consumption?

The answer to this question is, of course, critical to the global chemicals industry.

On the surface it looks good: Retail sales grew by 16.6% in the first half of 2009 and by a slightly more modest 15.4% in the year-to-date.

The problem is how retail sales are calculated as they include government purchases and shipments to retailers before any sales to actual consumers (could these healthy figures include, therefore, lots of unsold washing machines, fridges etc? China's government has introduced a huge subsidy scheme aimed at encouraging rural residents to buy more white goods, but is unsure of its success).

Michael Pettis - on his always-pessimistic China Financial Markets blog - believes this leaves retail sales as a poor proxy for overall consumption.

He quotes Jim Walker's 14 September issue of Asianonomics, where Walker points out that retail sales have grown at 13-24% over the last six years - well in excess of the increases in GDP (gross domestic product).

Real consumption has, in fact, being growing at only 8-9% over the past few years, concludes Pettis.

This would mean consumption as an arithmetical share of GDP has fallen as GDP has been expanding by 10-12% per year.

A lot of money is going into investment in more surplus capacity, much of which might be inefficient because of the low cost of capital, he warns.

Consumers are subsidising lending costs through low-wage growth and low deposit rates, he adds.

Low-wage growth is obviously no good for encouraging greater, genuine domestic spending.

But low deposit rates versus better returns on local equities and the property market have been partly behind the recent booms in both.

Pettis is gloomy about the long-term ability of China's government to re-balance growth.

The Chinese Economic Quartely's view, however, is "worry - but don't kill yourself" over the pace of and extent to which re-balancing will occur.

Temporary setbacks are possible, but the CEQ believes the government has the financial muscle to get there.

China never gets any easier.

Forget supply and demand, just record the index cards....

Source of picture: Heatusa.com

This amateur pundit is beginning to think he got it very wrong.

"I've been thinking the same thing - I was as gloomy as you a few months ago," said an oil-and-gas consultant friend of mine this morning.

"The Singapore property market is close to its all-time highs of 1997.

"The consumer-confidence indices have seen a complete about-turn from 12 months ago.

"Could the improved sentiment itself result in this being a U rather than a W-shaped recovery?"

"Maybe the Chinese government will continue spending as much as it can to stimulate the economy as a hedge against the US dollars.

"Why buy more Treasuries when dollar weakness seems to be a long-term factor with the risk that the dollar might also be replaced as the reserve currency?

"It could well be in China's longer-term interests to keep investing heavily in moving the economy from an export to a domestic focus.

"This will need to involve winding down policies that have provided temporary relief from the global crisis (i.e. huge increases in bank lending and other stimulus policies) in favour of reforms that will boost the pace of genuine, underlying consumption growth.

"These need to include better healthcare and pension systems, financial sector liberalisation and deregulation of distribution and logistics."

"It seems amazing that only a year ago we were talking about something as bad the Great Depression of the 1930s.

"Perhaps the problem is that we've been looking too much at fundamentals - at supply and demand from oil down to finished goods.

"The focus instead should perhaps have been on international capital flows.

"We need to more carefully study how money flows between borders and between different equitiy markets, commodity futures markets and over-the-counter (OTC) trading,"

Here are my views...

Electronic trading systems have revolutionised the speed of capital flows.

The IntercontinentalExchange website, for example, says that transactions on its wide and ever-expanding range of markets each take only two milliseconds.

You have dollar and oil markets sitting on the same exchange. Movements in both markets are presented in real time.

Has this contributed to the correlation between a weaker dollar and higher crude prices -along with the rise of index funds linking the two?

Energy prices have been virtually divorced from stock levels since 2003 and so recent historic-high storage of oil, refined products and natural gas is nothing new.

The current bull-run in crude might well last until real demand catches up.

It seems unlikely that interest rates will rise before then. The US government will want to avoid banks - which are benefiting from public fundingand less competition - in trouble again.

Ironic, isn't it? Bail-out money is being used to make more bets. The bigger the bets the less the risk for a financial institution.

And maybe even the speculators have done us a favour by pricing in future tight supply now.

An issue for chemicals companies is controlling their production and stock levels to reflect the genuine needs of their customers.

The task of separating market froth real and immediate demand would surely benefit from some harder thinking.

MOVING IN THE RIGHT DIRECTION (SORRY, OUCH....!)

Source of Picture: www.autospies.com

The automobile industry in the West has been bought more time by economic stimulus, as this article in The Economist points out.

But some of the discussions at the Frankfurt International Motor Show, which takes place on 15-27 September, will be about the future of the industry over the next few decades.

Producers face big economic, demographic and fuel-efficiency challenges - and capacity is way ahead of current and projected demand. (separate leader from The Economist with some more useful numbers).

So what might this mean for the polymer industry? Here are a few thoughts:

*Demand for smaller cars will increase. Automakers will need to focus on either ferocious cost cutting and/or adding more sophisticated features if they want to achieve anywhere near the same returns for these smaller vehicles compared with big, luxury lines

*This creates a big opportunity for innovation through both lighter plastics (with stricter fuel-efficiency regulations another motive) and plastics which deliver other design benefits. Added value will no longer be defined by a little bit of extra customer service and the odd clever additive. Breakthrough products will be needed

*Feedstock-advantaged producers will be in an even stronger position to meet what commodity-polymer demand remains

*The Western polymer industry's own cost-cutting will have to be accelerated in the search for higher R&D funding, and as auto plants close down (since this recession started, there have been no closures in Europe, according to The Economist). Those with their own advantaged-feedstock positions in the Middle East and/or strong footholds in China will be in a better position to generate enough revenues

*The decline in US and European gasoline demand might lead to short-term feedstock advantages as the value of light-ends declines. Longer term, though, refineries will be shut down - potentially pulling the proverbial rug from beneath even those polymer producers with the right technologies (Note: Western gasoline demand is expected to keep falling after the economic crisis is over on tougher fuel-efficiency regulations and ageing populations, etc)

Source of picture: zerohedge.blogspot.com

It might seem a little melodramatic (and it's a wonderfully melodramatic name), but what kind of threat do dark pools - and other off-exchange trading mechanisms - present to all our livelihoods?

You can see that the World Federation of Exchanges might have a financial motive in making their complaint to the G20 over the threat these mechanisms represent to their "macro-economic role".

But after the role that the shadow banking system played in the financial crisis you have to be worried.

The $64,000 dollar question has to be how you regulate dark pools etc.

And for the sake of melodrama: Unseen forces, unaccountable and anonymous, might start determining all our livelihoods.

Sudden and entirely unpredictable shifts in global commodity markets could push countries into financial ruin and even wars.

At least in the case of the exchanges, because pricing is transparent, you can challenge the logic of say the futures price of oil being way out of step with supply and demand fundamentals.

But the problem with these dark pools etc is that you won't have a clue on what might happen until it hits you.

SWIMMING IN OIL?

Source of Picture: fashionfunky.com

The threat posed by Iran test-firing its Shahab-3 missiles and a rally in US equities on increased M& activity in the drug and technology industries pushed crude slightly higher yesterday after last week's steep declines.

This is yet further evidence that the oil market is why out of sync with real demand for the black stuff and just about all its derivatives.

"July's Vehicle Miles Travelled (VMT) figures were released last week, with total miles driven clocking in at 263.4 billion miles, up 2.3% from July 2008," writes today's Schork Report, the daily online data and analysis service for energy and shipping markets.

"That is a solid increase but keep in mind: Gasoline prices have decreased by 38% since last year.

"Further, July 2008's VMT figure was 3.5% lower than July 2007. Therefore, this year's 'increase' was 1.3% below 2007 and 0.5% below the 2003-07 time-step, thereby continuing a steady VMT decline."

This is more evidence that we are miles away (excuse the pun) from the credit-fuelled demand levels of 2003-07 for everything from barrels of oil and gigajoules of natural gas to synthetic dog coats.

Chemicals demand in the UK might not return to pre-recession levels until as late as 2020, Oxford Economics has warned.

But don't bet against speculators pushing crude prices back up again, especially if conflict breaks out with Iran over the missile testing and the alleged development of nuclear-weapons capability.

This is despite weak demand, as the Schork Report has pointed out, and deeply oversupplied crude and crude products markets.

Such is the oversupply that even a disruption in Iranian production (Iran is the world's fourth-largest producer) might not make much of a difference, assuming that the conflict doesn't spread to elsewhere in the Middle East.

"Saudi Arabia was running just about flat out in 2007. Now it has 6m barrels a day of spare capacity," said an oil industry observer last week. 

Recent falls in gasoline mean that its pricing could be close to "meltdown", according to this report from Bloomberg.

And as my fellow blogger Paul Hodges pointed out last week, the historically high amount of oil in floating storage is now being delivered to refiners due to a narrowing of the contango.

So I am with those who believe we are heading for $45 a barrel before the end of this year. 

Still, a two-way bet might be advisable - just in case there is another rally.

.....said Mervyn King, governor of the Bank of England

Source of picture: northbriton45blogspot.com

ANY excitement over US house-price figures for July - which showed the biggest monthly gain for years when they were released yesterday - has to be put into the kind of context that undermines a lot of recent positive economic numbers.

The price recovery is partly the result of the $8,000 tax credit for first-time buyers and the Federal Reserve buying mortgage-backed securities. The tax credit expires at the end of November.

Inventory of unsold homes is at its lowest level in more than two years, according to The National Association of Realtors.

But there's a "shadow inventory" of delinquent or foreclosed mortgages of some 7m houses, according to Amherst Securities.

This matters to the global chemicals industry because of the large amount of chemicals and polymers which go into your average US home.

More importantly, without the return of some kind of "wealth effect" (this still seems a long way off in real-estate as the S&P Case Shiller Index is still 30% below its 2006 peak) it's hard to see a sustained rebound in US consumer spending.

"It's the level, stupid - it's not the growth rates. It's the levels that matter here," Mervyn King, governor of the Bank of England, was quoted as saying last month.

Levels to be concerned about include western consumer indebtedness that is still too-high relative to income expectations and credit availability, wrote Mohamed El-Erian in the FT yesterday. He is chief executive and co-chief investment officer of Pimco.

Bank balance sheets are also still too geared for the comfort of regulators and the managers of the banks, he added.

As my colleague Nigel Davis saidthis Insight article from ICIS news, real levels of lending to businesses, especially the small -and medium-sized ones, remain constrained.

Unemployment has also risen well beyond expectations and it will take years for the jobless rate in the US to return to its natural rate, El-Erian continued.

Yesterday I quoted the excellent Schork Report which put into context some more supposedly encouraging statistics: July's Vehicle Miles Travelled (VMT) figures were released last week, showing a 2.3% increase from July 2008.

But as the authors pointed out: "The July number was still down by 3.5% compared with July 2007."

This was a year when demand for just about everything under the sun was at historic highs.

Further - the modest improvement in July 2009 happened after a 38% year-on-year fall in gasoline prices.

Growth in urban VMT was less than that for rural travel, according to the latest statistics.

Urban driving is seen a stronger indicator of overall economic health as it includes travel work.

Unemployment was therefore a threat to the "nascent recovery", added the Schork Report.

The US Conference Board's latest index of consumer confidence, which was also released yesterday, seemed to support the Schork view: The index slid to 53.1 in September from 54.5% in August.

How should chemical companies respond to these challenges?

There will be more on this, and the implications for Asia, over the coming days and weeks.

Source of picture: Time.com

Yesterday I talked about lack of willingness by western banks to lend money because their focus was on rebuilding reserves.

But Steven Major, Global Head of HSBC's Fixed Income Strategy Team, puts a different spin on the problem.

In the Fragile Recovery video from the Financial Times' View From The Markets section, he said banks would dearly love to be earning 8-10% from loans rather than the paltry interest rates on leaving cash in reserves or on low-yield government bonds.

The demand for loans simply wasn't there because the "real economy" had yet to recover to the extent of financial markets, he added.

Stock markets have long been lead indicators, pricing in recoveries before they reach consumers and companies. The same has also become the case with energy markets where price discovery is now driven by futures contracts.

Equities had already priced in strong growth in consumption and company profitability in 2010-11, Major said.

Neither, of course, is guaranteed - meaning that investors entering markets now "are not being paid for the risk", he continued.

The same is true for oil, but fundamentals are set to catch up very soon with a dip to $45 a barrel on the cards before the end of the year.

Here are a couple of questions anybody attending this weekend's European Petrochemical Industry Association (EPCA) meeting in Berlin might want to put to chief executive and chief financial officers etc:

*How much of your recovery over the last few months has been the result of cost-cutting and restocking?

*When both come to an end (and this may well have already happened for restocking) how confident are you on a scale of 1-10 that you'll be able to continue delivering quarter-on-quarter improvements in 2010-11? In other words, can you grow volumes?

The answers could be very telling.

Britain's last generational shift: The 1980s Miners Strike:

Source of picture: www.wsws.org

My late parents hated even the concept of debt - let alone the insanely irresponsible error of actually borrowing money.

This is not surprising as my father could remember, when he was a boy, queuing for free food handouts during the Great Depression.

My mother was slightly less poor when she was a child (but still poor by any normal Western modern-day standards), but believed in thrift just as fervently.

Their attitudes were shaped both by the Great Depression and the deprivations of Great Britain during and immediately after the Second World War.

So when I ran up an overdraft of few hundred pounds Sterling when I was student they were less-than-impressed - especially as the bank manager phoned to ask for my cheque book and cheque-guarantee card back!

Their approach to debt, aside from an expensive passion for beer when I was a student, is ingrained.

Despite my fascination with commodity and financial markets, I would rather observe from the sidelines.

The question now - as the West still struggles to cope with high levels of personal debt left over from the current crisis - is whether we have undergone another generational shift.

Quite possibly, thinks Paul Hodges of International eChem.

A whole generation has grown up with easy and cheap money being the norm and markets and assets only heading, on the whole, in one direction - that's up, of course.

In Britain, the last big shift in attitudes to debt and spending began back in the 1980s with the Thatcher revolution.

Millions of council tenants started buying homes for the first time and dabbling in shares, as the very nature of British society moved away from collectivism towards a greater "me" culture.

Financial deregulation also took place on both sides of the Atlantic and bubbles were kept inflated by central banks.

The rest, as we know, is very painful recent history.

How will the children of parents now facing foreclosures, personal bankruptcies and long-term unemployment respond over the coming decades? Will they start keeping their money beneath the proverbial mattress?

Can we also expect a permanent shift to more prudent forms of banking?

What will this mean for growth in chemicals demand?

"THIS IS RIDICULOUS. I WAS SITTING AROUND UNSOLD FOR MONTHS AND THEN WAS FORCED TO JOIN A SANTA FLEET-HIRE SCHEME. HOW HUMILIATING"

Source of picture: www.diytrade.com

BEWARE the prophets of recovery in exports of Chinese manufactured goods during the current Christmas buying season.

Labour markets in the key export-processing provinces, such as Guangdong, are reported to be tight as production of everything from I-Pods to Barbie Dolls is ramped up.

It would be easy to misinterpret this as a recovery in Western demand, but how can this be when the real economic news remains bleak?

On a month-on-month basis there is bound to be an improvement because, of course, this is the Christmas buying season for the big retailers.

And any comparison with sales to the retailers in October-November is bound to look pretty stellar compared with the exceptionally bad same two months in 2008.

But will the retailers overstock only to find Western shoppers less-than-eager to empty the shelves? (Is this is a bigger-than-usual incentive to wait for the traditional January sales?).

And/or will too gung-ho manufactures in China be left with high inventories?

There have been plenty of extra incentives to import raw materials, including polymers and chemicals, to make finished goods in 2009 - from easy credit to increases in export-tax rebates.

This has contributed to the very high import volumes we've seen across a broad range of chemicals and polymers for the last 7-8 months.

China is in danger of only growing one export, therefore: Deflation.

Offsetting the risk of being over-optimistic?

Source of picture: thetradingpit.net

MAYBE there should futures contracts in realism versus recklessness. That way any senior company executive who wants to take a punt on next year being better than 2009 can offset the risk by going "realistic" on the futures markets - and, of course, vice versa.

How on earth you would design futures contracts around such abstract and subjective concepts as realism and recklessness is a challenge I feel only able to deal with this weekend - over a few beers.

This post is not all nonsense. Stories posted by my colleagues from ICIS news  indicated chemical industry leaders were going long on realism in physical markets during this week's European Petrochemical Industry (EPCA) conference in Berlin.

Margins will not be back to 2007-08 levels until 2011, said Tom Crotty, INEOS Olefins and Polymers CEO.

Europe has yet to feel the full impact of new Middle East capacity, much of which has so far been sucked into China, he added.

The capacity down cycle will hit very soon as China's broad-ranged overstocking leads to more of these Middle East volumes heading to Europe.

"Anyone who says that the industry is going to be in great shape in the middle of next year is fooling themselves," said Shell Chemicals vice president Graham van't Hoff.

"We're still waiting for the major impact of excess capacity from the Middle East that we have to be braced for and ready to manage."

Demand wouldn't return to earlier levels for 2-5 years, he added. 

Now that's what I call wide-ranging scenario planning.

ExxonMobil, as they often do, talked about feedstock innovation and cost savings; hardly surprising as they are rather good at both.

And Albert Heuser, president of petrochemicals for BASF, expects overcapacity in the market in 2010-11.

If only this realism had been around in sufficient quantities during the boom years.

Will the experience and knowledge gained from this recession be retained to prevent another down cycle of recklessness?

Flying the flag for Q3...

Source of picture: etftrends.com

Yes, Q3 earnings season is almost upon us with the usual headline-grabbing improvements in carefully selected reported numbers.

What this season might tell us about the overall direction of everything is, to start the week on yet another pessimistic note, hardly uplifting.

John Authers is once again worth quoting from his Long View column in this weekend's Financial Times.

The S&P 500 enjoyed bounces of 2-3% in 2000-2008 immediately after the first - to third quarter results were announced, according to a study by Andrew Lapthorne of Societe Generale in London.

But the index, when you take these increases out of the calculations, fell on an average annualised basis of 1.2% - suggesting some economy with the truth in company reporting.

This year's Q3 season might help to support equity markets until the end of the year if, again, the clever bean counters have been at work - and companies follow their usual practice of under-promising and therefore appearing to over-deliver.

Next year is the problem.

Price/earnings ratios on an operating profit basis are way ahead of where they were in any previous economic recovery since the Second World War, said David Rosenberg of Gluskin Sheff in Toronto.

In other words, companies will have to deliver spectacular profit and/or revenue growth next year to justify current valuations.

The mood in bond markets - where yields indicate expectation of a slow and non-inflationary recovery - is very different.

As we've said before on this blog, commodity and equity markets have priced in a recovery which might well not happen in 2010 or even 2011.

Companies across many industries, including chemicals, have made improvements mainly on re-stocking and cost-cutting this year.

It's hard to see how they can make similar gains in 2010 - particularly in commodity chemicals where we are only just beginning to reach the bottom of a prolonged supply-driven down cycle.

And when equities go in the New Year so could crude, potentially creating another mini de-stocking crisis. This will be nowhere the near the scale of Q4 2008, though, due to much-tighter inventory management policies.

Company performances might get worse never mind better, making current valuations seem far to premature.

"Take it from me, peripheral vision isn't all it's cracked up to be, especially if you want to get a decent annual bonus...."

Source of picture: www.whipnspurs.co.nz

Here's a rant for Tuesday - with thanks to Paul Hodges for informing some of the thinking (I'd like to lay credit to certain parts of this...)

Purchasing managers are professionally required to wear blinkers. All they care about is making sure that they are ahead of the game because of the way their performances are measured.

So up until Q4 2008 they ignored headlines such as "US auto demand slumps on surging gasoline costs and slowing economy" and "western house prices plummet on sub-prime mortgage crisis."

Oil prices seemed to be on the forever-up and liquidity was abundant. The result was purchasing in big volumes ahead of anticipated further price rises until the great unravelling post-Lehman Brothers.

Senior strategists - whose job it was to worry about the big picture - were also wearing blinkers, deluded in the belief that 2006-07 demand levels would go on forever.

Cracker operating rates were going to remain comfortably above 80% during the coming down cycle, was the consensus view in the first half of last year.

Now the industry is going to have to live with global averages of between 60-70% over the next few years.

The chemicals industry has lost three years of demand growth as global production is now back to early 2006 levels. It is unlikely to budge much in a favourable direction until at least 2011.

The reason is that real western growth, minus all the froth of commodity and equity markets, is going to remain weak on unemployment and high personal debt problems.

Another concern is unwinding government subsidies.

Too many people might have been misled by Chinese imports over the last 7-8 months.

The strength of these imports wasn't sustainable and was due to temporary factors that have now come to an end.

Banking on China as the leader of a global recovery is utter nonsense when you look at the country's low per capita chemicals consumption and its heavy export dependency.

Any Northeast or Southeast Asian producer high on the cost curve is likely to find it harder to penetrate western markets in 2010.

How can these producers - when they import crude oil - export, say, PE to Europe at fair market prices in the face of much-stronger Middle East competition?

Trade lawyers should do very well from anti-dumping cases in 2010.

This is a protracted supply-driven U-shaped downturn, and we are only just getting towards the bottom of the U.

Lots of Middle East capacity has been delayed - and the next big wave of Chinese start-ups is only just beginning.

Studying the tone of Q3 results statements will be a good indication to what extent senior execs have taken on board this new reality (actually it's not that new - we've been waffling on about this on this blog for months).

Source of picture: www.textually.org

The political sensitivity surrounding Iran is so great that US-based companies are not even allowed to attend presentations by Iranian officials at conferences, a source said.

"I witnessed a recent walk-out during a presentation by the National Iranian Oil & Distribution Company (NIODC)," he said.

But a European office of a US company is able to do business with the Middle Eastern country, provided an entire technology and project is developed by that office.

"If as much as one email passes Europe and the US headquarters, that's enough for an investment to become technically in breach of sanctions," the source continued.

These nightmarishly difficult restrictions come as Iran attempts to build no less than seven grassroots refineries in a attempt to rectify deficits in fuel products - one each at Shahriar, Anahita, Caspian, Khuzestan and Pars and two at Hormuz.

Numerous other expansions at existing refineries are being planned with the likely investment costs running into many billions of Euros.

Scepticism is easy following big delays in previous natural grass processing, refining and petrochemical investments due to sanctions that limit financing and technology and skills transfer.

Doubts have also been raised over the level of investment in maintaining output from the oil fields that would supply this new refinery capacity.

In the case of the two crackers finally brought on-stream at Assaluyeh, the slow pace of growth in gas-processing means that they suffer operating rate cuts and even shutdowns during the winter.  

All the gas being processed during the winter months has to be diverted to domestic use because of a big shortfall in supply.

Honest and hardworking company officials on both sides of the political divide deserve solutions.

"YES, I HEAR YOU - I'M LISTENING...."

Source of picture: New York Daily News

How ridiculous does crude-oil pricing have to become before regulatory reforms occur that limit the role of financial speculation in a helpful way?

This was the question being asked by a refining industry source today after he had read this story from the Financial Times.

Call options are about to kick in which could drive the price of oil even higher even though the fundamentals are "mildly bearish", according to the FT.

Put options, when they take effect in significant numbers, have the opposite effect.

Real demand is still a long way from catching up with oil markets so heavily influenced by the financial or non-commercial players.

"Whatever too ridiculous is, and I'd argue last year was a stupid as it can get, the Saudis are likely to get on the Bat Phone to the White House at some point and demand some changes. The US government will be obliged to listen," added the source.

Inability to plan an economy because oil is so out-of-sync with the fundamentals is playing havoc with the Saudi budget-planning process, he continued.

The same applies to every government. If the other major oil producers backed Saudi Arabia, we might seem some useful changes.

This year is a positive for the world's biggest crude producer - as we discussed on Monday. The Saudi government had budgeted for an average oil price in 2009 of $40 a barrel, but this is likely to be closer to $70 a barrel, giving more leeway for infrastructure spending.

But the unpredictability of a market skewed by short-term financial sector interests could just as easily work against the Saudis.

They are pursuing a hugely important economic and social agenda which requires constant and steady funding.

At a chemicals industry level, tracking activity on the Nymex, the International Continental Exchange and the Dubai Mercantile Exchange is critically important if you want to make meaningful financial forecasts.

These forecasts should influence chemicals pricing decisions. Why push for an increase that isn't in line with the fundamentals in your markets if you believe that a spike is entirely paper-trade driven and won't last?

The danger is that if you ignore what might be underlying weaknesses in your markets, you will suffer on the downslide as customers attempt to recover their losses.

I am still thinking, as we've also mentioned before, that this rally will continue until the New Year at least - when all the fund managers' bonuses will be in the bank.

Profit taking could take place in Q1. Positions could then be rebuilt when another bottom has been reached in crude and equities ahead of the 2010 bonus payouts!

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?

Source of picture: Businesweek

More evidence is emerging of the big rebound in Chinese exports resulting from government subsidies, including a Yuan now pegged to the dollar, soft and plentiful bank loans and export-tax rebates.

More than 9,000 quality control inspections of goods set for overseas shipment took place in Q3 this year - a 32% increase over the same quarter last year, said AsiaInspection, which carries out monitors these inspections.

Book and stationery inspections were up by 24%, toys 32%, shoes and fashion accessories 58% and textile apparel 63%, according to this news report on the latest AsiaInspection findings.

A further boost to China's textiles industry was the EU's removal of restrictions requiring companies to source a percentage of their textile business from within the EU in January 2009, the report added
.
But Q3 2008 saw the collapse of Lehman Bros and the virtual grinding to a halt of the global economy, so comparisons with the third quarter of this year were always likely to appear good.

Export trade has bounced back from its low point. It is widely recognised, though, that it could be a very long time before shipments to Western markets return to 2007 levels.

Still, the October Canton Trade Fair reported a 20% increase in electronics, hardware, tools, transport vehicle and building material exports orders from overseas buyers as against the April Canton Fair.

Together, these products account for around 60% of China's total exports.

And the damage done to China by the crisis is far less than elsewhere.

For example, the country's semiconductor market is expected to fall 6.5% by value to $68bn in 2009, down from $72.9bn last year, according to this report, quoting iSuppli.

This compares with a forecast 16.5% fall in the global chip industry.

Consumer electronics exports by volume are, however, expected to be down by 10% to 30% in all categories except LCD-TVs and Set-Top Boxes, where growth is expected.

What on earth does this all add up to then?

Here's what I think:

*China's exports have rebounded from their low points more quickly than other countries due to all the government support.

*Because of its ability to aggressively discount, China is gaining bigger market shares from other countries in certain export sectors - most notably textiles and garments.

*China is likely to be able to grow market share even further as it can cut costs by even more, notwithstanding a big increase in trade protectionism

But, as we have already said, demand in the West is unlikely to return to 2007 levels for a very long time and so China is only gaining bigger slices of a much smaller overall pie.

The country's export trade has also been boosted by cheaper raw materials as result of import tax cuts and lower pricing.

The dramatic increase in chemical import volumes is partly due to both the above factors - and, of course, stronger domestic demand.

Take methyl methacrylate (MMA) and polymethly methacrylate (PMMA) as examples. Pricing remains way down on its July 2008 peak, as this graph MMAPPMAPricing200809.ppt from ICIS pricing shows.

MMA imports have risen by 293% in January-September over the same month last year, according to China customs. In September, overseas shipments increased by 87% to 16,309 tonnes.

PMMA imports were up by 67% in January-September with September cargoes totalling 20,829 tonnes - a 22% increase.

By Malini Hariharan (Malini is now joint blogger for Asian Chemical Connections)

The Indian government has announced 17 November as the date for a public hearing to discuss the provisional anti dumping duties that it had imposed in June on imports of polypropylene (PP) from Saudi Arabia, Singapore and Oman.

The hearing will give a chance to all affected parties to present their case. Such hearings are usually a formality and do affect the end result which is a confirmation of the provisional duties.

But I have been told that it may be different this time as the Saudis, led by Sabic, are likely to put up a spirited defense. The Saudis have been busy pulling lots of government strings for the duties to be revoked.

Sabic and Advanced Polypropylene were hit the hardest - duties on their PP exports range from $440-$820/tonne. I was told that one of the reasons for the high level of duties was 'the lack of cooperation in sharing data' when the Indian government had sent its questionnaire earlier in the year. However, this attitude appears to have changed.

There's a lot at stake here and this is why the 17 November hearing is crucial. India is already in surplus and looks likely to be in this position for the next couple of years. So there's every reason for Indian PP producers, Reliance Industries and Haldia Petrochemicals, to check competition. On the other hand, many Indian processors are unhappy as the duties would force them to rely on local supply.

For the Saudis, and also other Middle Eastern producers, India is not such a big market for PP. But the ADD threat is a worrying global trend that they want to ensure does not take off.

Besides India, China is investigating methanol and 1,4-butanediol (BDO) imports from Saudi Arabia. And the European Union (EU) is investigating on polyethylene terephthalate (PET) imports from United Arab Emirates (UAE) and Iran.

The growing protectionist measures have provoked a long chain of protests with the most recent one being in October by the Gulf Petrochemicals and Chemicals Association (GPCA).
The GPCA Secretary General Dr. Abdulwahab Al-Sadoun has said that the association will strengthen coordination with Gulf Cooperation Council (GCC) Governments to ensure that exports of petrochemicals and chemicals from the Gulf region are not restricted by anti-dumping regulations and other trade restrictions
"The GCC industry and our governments will not accept the application of anti-dumping regulations against exports of petrochemicals and chemicals from the Gulf. We have seen a surge in protectionist actions brought by countries to block imports. These cases are baseless and violate international rules," he said.
The investigations may not sound fair to GCC producers but they face an uphill task in convincing the Indian and Chinese governments to ease protection to local producers. A lot will depend on what the GCC governments can offer or withhold.

It seems as if Lex of the Financial Times is finally catching up with this blog by questioning the validity of some of the official data coming out of China. We take this as a compliment.

In today's column it talks about how the total for first-half Gross Domestic Product (GDP) growth numbers for China's 31 provinces was almost 10% higher than the overall figure put out by the National Bureau of Statistics.

This suggests that provincial officials are being encouraged to report high numbers to help create the impression that everything is coming up roses. How can we trust micro numbers, on chemicals production and consumption, for example, if distortions in big headline numbers are taking place?

Retail sales growth of 16.2% in October was also questioned by Lex. These numbers are not a good proxy for real consumption growth because they include shipments to retailers and various types of corporate and government spending.

Strong year-on-year petrochemical production growth recorded for September might be believable because in the same month last year the world economy came to a halt as Lehman Bros folded. Ethylene output grew by 29.4% and polyester production by 33.9%.

The polyester sector might have benefited from market-share gains made in export markets as a result of the 2009 depreciation of the Yuan against other developing-world currencies.

This is the result of a re-pegging of the Yuan to the US dollar, which on Wednesday hit a 15-month low against a basket of trade-weighted currencies.

But China's Central Bank, ahead of a visit to China by President Obama, yesterday acknowledged there was a case for a stronger Yuan.

As if often the chase with the Chinese government, though, only a few days earlier commerce minister Chen Deming had called for the creation of currency stability in order to protect exports.

So it's far from clear if and when China will let the Yuan rise in value, which would likely reduce the volume of chemical imported to be re-exported as finished goods.

As we've said before, lack of clarity on real over apparent domestic demand-growth continues to prompt a nagging suspicion that re-exports are more important than some people think in the recovery story.

The International Monetary Fund (IMF) said at the weekend that the Yuan had become "significantly undervalued" since it was linked again to the dollar.

If insufficient ground isn't given on the Yuan to satisfy the West, how long before politicians start targeting other "unfair" advantages such as this year's reductions in raw-material import tariffs and increases in export-tax rebates?

On an individual industry level, pressure for anti-dumping and other trade measures is likely to only grow - a long with measures outside the control of the World Trade Organisation (WTO) such as safety and environmental standards - if developed economies don't achieve sustained recoveries.

Source of picture: www.walletpop.com

By John Richardson

In his own words Paul Hodges of International e-Chem - and also a fellow blogger - puts in a nutshell some of the dangers confronting the chemicals industry as we approach the New Year, with a few interspersed further thoughts from this blog:

"If crude were to fall back to $40 a barrel - where based on fundamentals it should be - this would further cloud visibility about the real state of end-user demand. It would become hard to distinguish between a fall in demand down the chain because of de-stocking and greater caution, and a fall in the final consumption of chemicals.

"Oil at its current price is hindering rather than helping the recovery because we are seeing demand destruction again. This is because we are already seeing greater caution on the part of those companies that recognise the risks of lower demand for chemicals. "For example, as the gasoline price has gone up, people are driving less to the shopping malls in order to buy stuff made from plastics - i.e. discretionary spending."

There are even reports of this happening in China as a result of higher crude and fuel-price liberalisation.

"In Our Feedstocks for Profit Study, and I think this still holds, we saw a green light for growth was $25 a barrel, an amber light $50 a barrel and red at $75-80 a barrel.

"It's generally accepted that demand destruction occurs at $80-100 a barrel."

The last US recession began in December 2007 when crude touched $100 a barrel. This came at the same time as the sub-prime crisis. An important question now is with real wages in the West in decline and unemployment rising are we talking about demand destruction much closer to the $80 a barrel level?

"The crude price is being driven by irresponsible bankers, who are simply focused on generating maximum short-term trading profits (and personal bonuses for themselves). The money to support these trading activities is effectively being provided by taxpayers, as a result of the bailouts that have taken place," continued Hodges.

"The strength in crude oil is directly correlated to movements in the value of the US$, often on a minute by minute basis. This is not about free markets. It is about bankers using the low interest rates now on offer in the US, caused by their earlier greed and reckless lending, to once again bite the hand that feeds them.

"Bankers need to behave more responsibly, especially at a time of crisis such as today. If they are not prepared to do so of their own will, we need effective legislation.

"When this unwinds you could see a big return to dollars, strengthening the currency significantly," Hodges continued.

"This is hardly going to help progress in the US government's effort to make the economy more export-based - part of the global rebalancing efforts."

"Today's oil prices are not the fault of chemicals companies, but they will suffer as a result."

The risk is that the unwinding of these trades causes further disruption. As oil prices fall, so will chemical volumes as everyone de-stocks.

"This is why chemicals companies need good hedging strategies," said Hodges.

"Another problem is the cost in terms of working capital. This will lead to a further problem as demand recovers. When demand is really weak, it's possible to conserve working capital by cutting operating rates and other costs - hunkering down until the recovery arrives.

"But when the recovery does arrive, the difficulty is estimating how much to ramp up rates at the expense of working-capital preservation.

"Demand visibility - even without as yet a collapse in crude - is already extremely poor, making planning very difficult. "

"More companies go bust in an upturn than a downturn, because of the inevitable increase in working capital. This is a major risk in 2010, given the fragile state of the financial system, and banks' unwillingness to lend."

 "They are so cheap, I might even buy one as a hedge against global warming"
Source of picture: www.formalwilderness.blogspot.com

This blog has spent a lot of time tormenting itself over the sustainability of China's extraordinary economic rebound during 2009.

"Just where are all those imports of chemicals and polymers (polymers up 50% year-to-date) going?" we keep on asking.

Perhaps we've got completely the wrong end of the stick, a source politely suggests.

"There's no real need to worry about where this stuff goes because as long as the government is solvent - and it still has massive cash reserves - it will keep GDP (gross domestic product) growth at a minimum of 8-9% per year. The reason is the need to create enough jobs to maintain social stability.

"Quite frankly, if they had to they had to bury polymers and unsold washing machines, fridges and autos etc in landfills, they would do it to keep industrial production moving along at the right level.

"And quicker than you imagine, they will wean the country off too much depedence on industrial production and exports towards better local consumption."

But in the meantime, he has heard of Chinese refrigerators, which contain polymers including polycarbonate (PC), acrylonitrile butadiene styrene (ABS) and polypropylene (PP), flooding export markets.

"It seems that some refrigerators were manufactured for domestic sales and so benefited from government subsidies - but still found their way on to container ships."

Reliance Industries has made an offer for LyondellBasell says an official statement released yesterday on the LyondellBasell website:

"LyondellBasell has received a preliminary non-binding offer from Reliance Industries Limited to acquire for cash a controlling interest in the company contemporaneously with the company's emergence from Chapter 11 reorganization.

"This offer is in addition to the previous non-binding equity financing proposals received by the company and represents a potential alternative to the initial plan of reorganization previously filed by the company."

This confirms months of rumours to this effect. According to an unnamed merchant banker quoted by the Times of India, Reliance would have to pay at least $12bn - double an earlier estimate by the Economic Times.

India could be playing a major role in the shift of basis chemicals ownership from West to East - along with the Middle East

After failing in its efforts to capture Innovene and then Dow Chemical's commodity petchems unit, this is Reliance's fresh attempt to move into the global top league. The ICIS top 100 places LyondellBasell at the No 4 slot of top chemical companies globally.

A marriage of the two companies would result in a formidable giant with an annual turnover in excess of $75bn, including Reliance's earnings from its growing oil, gas and refining portfolio. It would also create the largest PP producer and also a top player in PE and give Reliance access to LyondellBasell's profitable technology portfolio.

Reliance's offer is subject to due diligence and sufficient credit support. The company issued a very cautious statement: "This review is ongoing and there can be assurance of the outcome with respect to any of the opportunities under review."

Reliance, it appears, is evaluating other opportunities too in its core businesses.

LyondellBasell's statement confirms that Reliance had earlier placed non-binding equity financial proposals and the latest offer represented was a 'potential alternative to the initial plan of reorganization'.

LyondellBasell was the first petrochemical giant to stumble at the start of the crisis last year. And it looks like it could well be the first big ticket M&A deal in what promises to be a busy season ahead.

We have already heard of IPIC on the prowl for European and US chemical assets and then Mitsubishi Chemical confirmed that it is looking to acquire Mitsubishi Rayon for $2.5bn.

An investment banker said last week that it was only in the last few months that he has seen an interest in boards and ceos. Capital market conditions have improved substantially and money will not be a deterrent, especially for companies like Reliance which are already sitting on huge piles of cash.

Relaince's biggest problem in the past has been its conservative valuations which have seen the company lose out to other global bidders, except in a few instances (Trevira and Hualon). There are already reports of rival bids emerging for LyondellBasell from Chinese companies and private equity investors. And ICIS news reported last week that analysts believe that LyondellBasell would also be a good fit for IPIC.

So will Reliance change its mindset and be bolder this time?

Reliance Industries - which is attempting to buy LyondellBasell - is offering $10-12bn, according to this report from Reuters quoting two sources with direct knowledge of the deal. 

This would be one of the biggest-ever acquisitions by an Indian company. In 2007, Tata Steel bought Corus for $13bn.

Reliance raised $660m through a share sale in September.

It has $4bn in cash, $8bn in treasury stock that can be sold and if it doubles its current net debt-to-equity of 0.35x it can borrow another $10bn, the Reuters report adds - quoting a recent Macquarie research note.

Will growth spread quickly enough?

Source of picture: www.oraclemarketplace.co.uk

By John Richardson

Global chemicals production had returned to 2006 levels by October of this year, according to this slide ACCProduction09Versus06.ppt from the American Chemistry Council (ACC).

Worldwide chemicals growth rates might not return to 2008 levels until 2012, Jurgen Hambrecht, CEO of BASF, warned on the release of the company's Q3 results.

The overall picture is being made to look bad by structural overcapacities and deep-seated economic problems in Europe and the US.

Booming emerging markets, particularly China, matter more than ever to Western chemicals producers.

So the big question being asked as we approach the New Year is whether China's almost hard-to-believe growth in chemicals demand in 2009 - reflected in a big surge in imports - can be maintained.

High-density polyethylene (HPDPE imports rose by 73% with low-density (LDPE) imports up by 85% in January-September, according to Shanghai-based commodities information service CBI.

Total PE imports in 2008 were 4.5m tonnes, but had China imported 3.75m tonnes by the end of H1 of this year alone, added CBI.

"China will enter a long period of slower and more volatile growth in probably 2-3 years when fiscal stimulus runs out", warned Michael Pettis, former Wall Street trader and professor at Peking University's Guanghua School of Management

This would force the country to make adjustments it had so far tried to avoid, added Pettis on his blog, China Financial Markets.

These adjustments, accordinng to a Shanghai-based expatriate, involve a major shift away from export and industrial investment-led growth to a more broad-based rise in consumer spending.

"What's holding back consumption is the lack of a decent welfare system, forcing people to maintain high savings levels to cover education and health costs," he added.

A lot of the wealth generated by China's growth was concentrated in the hands of the state-owned enterprises, Pettis added.

Higher dividend payments to company shareholders (sometimes no dividends are paid at all) and broader financial sector liberalisation were needed, said the professor.

China's critics argue that the response to the global economic crisis has so far been mainly more of the same: Providing a huge increase in funding for a big build-up industrial capacity and infrastructure.

The infrastructure, including 120,000 kilometres in high-speed rail lines, has the potential to accelerate urbanisation.

"There is little doubt that China's hope for prosperity in the long run lies in transferring the majority of farmers into higher-productivity jobs in the cities," wrote the well-respected Beijing-based economic research publication, the China Economic Quarterly, in an article earlier this year

"But simply moving a farmer into a city does not make him an economically significant consumer."

Chinese households with annual expenditure of below $5,000 - i.e. about 90% of the population - spent most of their money on housing, food and clothing, the CEQ added.

Those with income levels high enough to be able to spend more than $5,000 per year, the so-called "consumption households", mainly live in three regions - the Yangtze River Delta, The Pearl River Delta and the Beijing-Tianjin corridor, the article continued.

Each of these regions surrounds megacities, whereas other "consumption households" are more thinly scattered across the rest of China.

"Although there are a growing number of these households dispersed across the rest of the country, they are not concentrated enough to justify a sales and distribution presence for many products and services," the research publication added.

"Research my MasterCard suggests that multinational consumer-goods companies require a concentration of at least 20,000 consumption households to establish a viable market."

Distribution costs remain a barrier for setting up in the hinterland, despite big improvements in transportation over the last decade, said the CEQ.

"Logistics costs account for 20% of average goods prices in China compared to 10% in the US, according to the US Department of Commerce," the CEQ added.

Plenty of reasons, perhaps, for chemicals companies to be a little cautious over their forecasted growth rates in China over the next few years.