Asian Chemical Connections

Fed up with receiving those obscenely large bills from trendy management consultants populated by wet-behind-the-ears Harvard graduates? Ever thought that a great deal of commonsense is all you need to run a business rather than theoretical nonsense? These guys, as the Financial Times reveals in its article about the Japanese mob, have restructured without the need for a six-figure consultancy bill. Perhaps the yazuki will themselves to turn management consultancy, minus the gobbledegook jargon, the flash suits and the annoying chit-chat about yachts, apartments in Monaco and flying everywhere First Class when your company shoves you in cattle class. But if the Japanese mob ever do go into consultancy, please don't let your accounts department sit on the invoices.

Paul Cherry of Basell gave an excellent paper at the recent ICIS Olefins Conference - Download file
Paul offers some hints on how to survive the next downturn, and provides some sobering predictions on operating rates.
I bet that after 2009-10, or whenever the next downturn arrives, South Korea, Taiwan and Japan will further restructure. And what about Thailand? Is it building too much capacity based on the mistaken belief that it can become a major finished-goods manufacturing hub?
And as for China, its dominance will grow and returning a profit from China will not become any easier.

Japan's fourth quarter GPD growth of 4.8%, which was released today, exceeded economists' expectations. However, although consumer spending rose by 1.1% on an annualised basis, this merely compensated for the 1.1% decline in Q3.
In addition, wages rose by only 0.2% last year, barely up from a decade-long decline. Companies are preferring to pay down debt and invest in new machinery to raising salaries.
A further worry is the yen, which has been at a 20-year low in real terms. If the yen were to strengthen, exports would, of course, decline. In Q3 last year, the contribution of net exports to growth was 1.7%. Without these net exports, the economy would have shrunk by 0.9%.
Let's hope the Bank of Japan doesn't rush into an interest-rate rise on the back of the 4.8% rise in GDP, thereby snuffing out any hope of consumer-led growth.

The Bank of Japan has decided to raise interest rates - from 0.25 to 0.5%. This could weaken the yen, thereby damaging the country's export-led recovery. For the petrochemical players, the benefits of a 21-year low yen have been offset by the increased cost of importing naphtha.
The bank is also banking on last summer's consumer spending slump being only temporary, meaning that it can afford a rate rise needed to both strengthen the yen and slow what's also to being also an industrial investment-led recovery (to provide all the products for booming exports).
But what if the consumer spending slump is long term? If so, a rate rise is hardly the right medicine.

This was the warning from Bob Bauman of Nexant ChemSystems at last week's 25th Annual Petrochemical Conference in Houston, Texas.

Read below for some rather gloomy predictions of where markets could be heading in 2011-12

Quite possiby says International e-Chem and Wood Mackenzie in a new study which predicts that by 2015, China could have a deficit of as much as 35m tonnes.

When you consider that total global output is around 300m tonne/year, this is quite staggering.

On paper, China should be balanced on naphtha because of a huge refinery construction wave. However, the consultants argue that the refineries will be run primarily to make gasoline. The importance of gasoline supply to China as a means of stimulating economic growth, thereby maintaining social stability, was illustrated yesterday when the government raised fuel prices by 10%. The hope is that the price hike will end shortages through boosting refinery production as a result of improved refinery margins.

And globally, will there be enough naphtha to supply China? Many of the 700 or so refinery projects being built could be delayed or cancelled because of rising construction costs and tight contractor and raw material markets.

Even if there is enough supply on paper, will refiners want to make the naphtha that China and the rest of the world needs? Quite possibly not as naphtha only accounts for around 5% of total refinery output.

Therefore, globally, as in China, refineries exit primarily to maintain supply and make money from the transportation sector.

Quite possibly not, according to a Deutsche Bank report.

However, as the report makes the clear, the same types of imbalances are building in the Chinese economy which led to Japan's "Lost Decade" of the 1990s.

Time to take stock and have a contingency plan?

Yet more gloom - the world's second-biggest economy appears to be slowing down as the effects of the sub-prime crisis spread.

What will this mean for Japan's chemical industry, which in the first half of the current financial year suffered badly from the highly cylical electronic chemicals sector?

All will, of course, hinge on the extent of the slowdown in the US economy.

What's clear is that nobody will envy Shinetsu's position next year, when it's due to bring on stream new PVC capacity in Louisiana.

I sincerely hope not, but all the signs are there because of:

*A financial crisis which nobody again saw coming, this time with global implications

*What could prove to be too much spending on new equipment and capacity. This time high equity prices have paid for these investments rather than US dollar-denominated bank loans, as was the case in 1997.

The fundamentals are still strong, as today's article from ICIS news on share-price collapses points out. Asian demand is at much higher levels now than 11 years ago.

But the power of sentiment should not be underestimated.

It's too early to read the long-term effect on petrochemical pricing. More volatility seems certain with sentiment driving shifts in pricing on every piece of negative or positive economic and stock market news.

Lower feedstock costs on cheaper oil will also play a role, but as the extended article below points out, the impact on the real economy will take time to assess. It is this impact that will set the long-term direction and determine whether we the downturn has, finally, arrived.

The mood at the recent NPRA International Petrochemical Conference in San Antonio, Texas, was mixed, despite all the economic gloom.

Some producers said they were still making money - especially those selling into manufacturing sectors benefiting from a rise in exports due to the weak dollar.

What's certain, of course, though is that things will get worse regardless of the health of the global economy. The down cycle is just around the corner.

But we could quite easily see, as this extended article below speculates, another period of under-investment following all the over-investment that markets will need to absorb over the next 3-4 years.

Plus ca change, plus c'est la meme chose.

Back in the 1980s, before Japan's "Lost Decade" of stagnant growth, management gurus lined up to praise the country's collective spirit as the basis of a sustainable economic miracle.

Since then, of course, the West has been consistently espoused as the best.

And even the Japanese wish they could break free of their consensus shackles, according to this week's issue of The Economist -- hence, the huge popularity of management hero Kosaku Shima of conglomerate Hatsubishi Goya Holdings.

He thinks outside the box, acts decisely, is not scared of telling people what he thinks and has been successful even though he has always sat outside political factions within his company.

And in June, Shima (see picture above) truly broke the mould when he was promoted to shacho (president) of his company at the tender age of just 60 - very young by Japanese standards.

There is one slight problem: he is a manga or cartoon character.

"Shima is influential - business people want to be like him but can't," says Yuko Kawamoto, management professor at Waseda Uniiversity in Tokyo.

"Maybe there is hope for Japanese society. We want to change, but do not have the courage."

The grim reality for the average salaryman, according to The Economist, remains a life of drudgery and of stifled opinions because of the dreaded fear of causing a superior to lose face. As a result, bad decisions go unchallenged and become ingrained policy.

Japan's chemical companies have often broken the mould through innovative technologies - and were talkiing about and acting on energy efficiency long before the current oil and environmental crises.

Sumitomo Chemical is also about to start-up a huge petrochemical complex in Saudi Arabia - along with Saudi Aramco - and is talking about a major second wave of investment at the same site. This also involves breaking the mould as it's the first occasion that a Japanese chemicals company has invested on its own in a big overseas cracker project.

But the perception remains, fair or otherwise, that the chemicals industry could and should have undergone more restructuring.

Fair or unfair?

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?

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.

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.

"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?

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.

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.

"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.msnbc.msn.com/id/23512037/

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

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

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

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

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

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

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

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

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

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

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

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

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

The EU removed similar safeguard duties in December 2007.

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

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

Restocking and crude oil have been important factors.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

It's the same story for Indonesia.

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

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

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

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

This is also especially true of China.

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

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

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

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

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

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

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

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

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

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

By Malini Hariharan (Malini is now joint blogger for Asian Chemical Connections)

Japanese chemical majors have raised their sales and profit forecasts for the second half of the fiscal year ending 31 March 2010, but the revisions are marginal and companies are still holding a conservative outlook.

Earnings in the first half of this fiscal year have been better than expected but the stock market is not impressed. It appears investors are being guided by the cloudy outlook for H2.

A Tokyo-based analyst highlighted three major risks that Japanese companies foresee:

• Inventory adjustments in China for petrochemicals and globally in the auto and LCD sectors
• A rise in naphtha prices led by higher crude oil prices
• Rising availability of product from new petrochemical capacities in the Middle East.

Mitsui Chemicals has forecast sales of Yen1,210bn as compared to Yen1,487.6bn in 2008-09. Operating loss is expected to narrow to Yen15bn from Yen 45.5bn last year.

Sumitomo Chemical expects to post petrochemical sales of Yen500bn in 2009-10, down 9.6% from the previous year. Total sales are projected at Yen1,620bn, down 9.4%.

At an analyst meeting yesterday Sumitomo Chemical disclosed that operating rates at its joint-venture PetroRabigh complex in Saudi Arabia are still quite low, especially for polyethylene (PE). Although the situation is improving the company expects full operations only at the end of this year.

PetroRabigh has posted losses yet again. Third quarter losses had widened to Riyals844.7m from Riyals155.9m in the same period last year.

Japanese companies are continuing their efforts to widen their footprint in China. Mitsui Chemicals and Sinopec have agreed to proceed with a joint venture for production of phenol and ethylene, propylene diene terpolymer (EPT). At a recent analyst meet, Mitsui's ceo disclosed that the project would be a 50:50 joint venture. Asked if the jv would be expanded to include ethylene and propylene production, the ceo said there was no immediate plan but there was some potential.

Mitsui's ceo is also reported to have said that the company was interested in acquisitions in agro-chemicals or speciality chemicals. Among the Japanese majors, Mitsui is most exposed to commodity chemicals and is under greater pressure to diversify if product portfolio.

By Malini Hariharan (Malini is now joint blogger for Asian Chemical Connections)

Sumitomo Chemical and Saudi Aramco appear to be in a generous mood. After successfully launching the first phase of their joint venture and starting work on the second phase the two are willing to welcome others to the Rabigh party.

Pic source: Saudi Aramco

Ziad Al-Labban, president and ceo of the joint venture Petro Rabigh, is reported to have said that discussions are underway with companies, including Japanese firms, to invest in production synthetic fibre and other products at Rabigh. He expects a total of 50 companies, including some from Japan, to eventually set up operations at the site.

The product slate for PetroRabigh's second phase, due to be completed in 2013-14 includes aromatics, synthetic rubber, nylon 6 and speciality chemicals. What more can be produced and what makes Rabigh so attractive?

There is of course the feedstock that will be readily available from the PetroRabigh complex and the benefits of shared world class infrastructure. But local markets are small with not very exciting growth prospects, especially for products like synthetic fibres. I certainly can't see a big textile industry developing in Saudi Arabia or the GCC.

I have often heard that the attractiveness of the Middle East fades as you move down the product chain. The closer you are to the cracker the more profitable it is as you then get full advantage of cheap feedstocks.

But Saudi Arabia's plans for a diversified chemical industry are slowly but steadily progressing. And Abu Dhabi is also working on a similar model. What incentives are being offered to make these countries an oasis for downstream chemical production?

By Malini Hariharan (Malini is now joint blogger for Asian Chemical Connections)

The 17 Nov public hearing arranged by the Indian government at Delhi to discuss provisional anti dumping duties levied on PP imports from Saudi Arabia, Singapore and Oman was postponed at the very last minute causing a great deal frustration among lawyers and industry executives who had flown in from out of the country.

The hearing was postponed because of bereavement in the family of the government bureaucrat heading the hearing. Efforts to get another bureaucrat proved to be futile. A new date has yet to be set but I am told it should be soon.

And I have received some information from Japan on the likely candidates for the Rabigh party. One of the products being considered by Petro Rabigh for its second phase is superabsorbent polymers (SAP). As Sumitomo Chemical does not have technology for this product, it is rumoured that Nippon Shokubai or Sumitomo Seika could be joining Petro Rabigh for this project.

By Malini Hariharan

Japan's largest chemical company Mitsubishi Chemical Holdings has been actively restructuring this year but more needs to be done to complete its transformation.

High on the list is reorganization of its cracker operations at Mizushima. Mitsubishi and Asahi, which also has a cracker at the same site, have been talking since 2007 about unifying operations.

The two had even made an announcement in June that a study on this would be completed within two months. But that deadline has passed and it is uncertain if they can start joint operations at the site from the earlier target date of April 2010.

The official line from the two companies is that the study is still in progress.

Industry players in Japan acknowledge that 1-2m tonnes of ethylene capacity in the country will need to close given the rising competition from the Middle East. But while companies have announced plant closures for derivatives they have been hesitating when it comes to crackers.

The biggest reason for the slow pace is culture, says one industry analyst. In addition to this, cracker structure at most Japanese sites is complicated with many companies involved in offtake contracts. It is difficult to move quickly, he adds.

Mitsubishi's other challenge will be to digest the proposed merger of Mitsubishi Rayon Co (MRC). The Yen228bn ($2.57bn) deal, due to be completed in March 2010, gives Mitsubishi access to the methyl methacrylate (MMA), polymethyl methacrylate (PMMA) and carbon fibre businesses.

Mitsubishi's aim is to achieve a cost synergy of Yen3bn and operations synergy of Yen7bn by fiscal 2012-13.

But analysts are not convinced about the synergies especially as buying into MMA takes Mitsubishi away from its strategy of expanding in specialities. Even carbon fibre, they say, is not very exciting.

Carbon fibre is a value added product and demand is quite promising. But competition is likely to be intense," says a second analyst.

Analysts say that the merger was driven by financial reasons and pushed through by Bank of Mitsubishi-Tokyo which had funded MRC's $1.6bn acquisition of Lucite earlier this year.

In a recent research report analysts at Nomura said that while major synergies are unlikely, the merger gives Mitsubishi an opportunity to reconfigure its business portfolio for higher growth.

"If Japanese chemical makers are to capitalize on growing overseas demand, we think they will need to create a portfolio of businesses that are among the global leaders in terms of market share. The merger will make Mitsubishi the world leader in MMA and could facilitate major progress in compiling a full line of LCD [liquid crystal display] materials, leveraging comprehensive strengths in carbon fibre, and going on the offensive in water-treatment products. We think the merger is really aimed at leveraging MRC's strengths more fully than it can do on its own."

They pointed out that MRC did not have the capital to scale up its carbon fibre business on its own.

But they also emphasised the need for further restructuring at Mitsubishi.

"If the company can put together an all-Japan team comprising olefins, polyolefins, terephthalic acid, phenol, and polycarbonate resin, we think it could see sharp cost reductions and a business platform capable of competing worldwide."

By Malini Hariharan

Companies executing projects at Map Ta Phut in Thailand have finally received a notice from the government to stop construction work. The notice comes after the Thai Supreme court's ruling in early December to suspend 65 projects on environmental concerns.

Mitsubishi Rayon has confirmed it has stopped work at its 90,000 tonnes/year methyl methacrylate (MMA) joint venture project with the Siam Cement Group. A company source says the plant is almost 'built up' and they are still hoping for start up to take place as scheduled in the second quarter of 2010. But he admitted that there was no information on when work can restart.

PTT says that construction work at its No6 gas separation plant is nearly over and it is still discussing with government agencies on whether this project can be exempted.

The Thai prime minister Abhisit Vejjajiva reiterated yesterday that he would like to have new environmental rules by the end of the year. The deputy prime minister has also been assigned to work with the four-party panel, headed by former Thai prime minister Anand Panyarachun, in speeding up the resolution of complex legal issues.

The Bangkok Post reports that the panel has been asked to prepare its recommendations this week and forward them to the cabinet for consideration next week.

But not everyone is convinced in the government's ability to find a quick solution.

Chainoi Puankosoom, ceo and president of PTT Aromatics and Refining is reported to have expressed concern that "legal clarity will not be seen within the next twelve months due to the lengthy process involved". He would instead like a special framework that would allow affected companies to proceed with their projects

He said construction of most of the 65 suspended projects was 50-100% complete and also pointed out that suspension of construction work would not ease the pollution problem.

"It is going to take a lot more time to solve than people think," says a Bangkok-based industry analyst.

But how much more time is still not clear.

Meanwhile, I heard that the head of the four-party panel was confronted with an unpleasant smell on his recent visit to the Map Ta Phut industrial estate. He is now fully sympathetic to the plight of local residents.

By John Richardson

CHINA'S capacity expansions in industries including steel, aluminium and petrochemicals continue to astound.

Take polyvinyl chloride (PVC) for example., where, according to a new report by ChemSystems, "capacity (in China) has expanded from 5m tonne/year in 2003 to over 15m tonne/year in 2009, almost 90 percent of total global capacity expansion over the period.

"Despite legitimate environmental concerns, relating both to massive carbon emissions and mercury pollution, the development of acetylene-based capacity in China shows no sign of slowing.

"The government's effort to restrict the construction and expansion of less efficient, environmentally hazardous plants has had little impact on the overall pace of development, although has perhaps prevented some sub-scale projects from moving ahead."

 This makes one wonder whether the huge increase in bank lending in 2009 and the first few weeks of this year has further added to the capacity-building momentum.

As China's coal/acetylene feedstock advantage is mainly located in under-developed Western China, it hardly requires an enormous leap of imagination to figure out that local authorities will have cashed-in on the opportunity while they had the chance.

                                                       Regional PVC Capacity Additions

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Source of graph: ChemSystems

The consequences of big feedstock and capital-cost advantages will be felt very keenly in Japan, South Korea and Taiwan. If these projects in China couldn't repay their loans would anyone have the ability or desire to attempt foreclosures?

Japan, South Korea and Taiwan have a collective PVC surplus of 2.4m tonne/year which used to be shipped to China, said ChemSystems.

The search for other overseas markets - where greater distance is likely to create freight-cost and delivery-time disadvantages - could be made extra difficult by ongoing North American capacity expansions.

New projects in North America will be targeted for exported as, of course, the region's construction industry is in major crisis, the consultancy added.

Shintech, part of Japan's Shin-etsu Group, Westlake Chemical and Georgia Gulf were all scheduled to have expanded capacity by this year, according to ICIS news.

Taiwan's Formosa Plastics Corp is due to bring on-stream an 180,000 tonne/year capacity increase in Point Comfort Texas in Q1 2010, says the ICIS Plants & Projects database.

US PVC exports were 202,438 tonnes in November, more than double the 91,859 tonnes a year earlier, ICIS news reported yesterday - quoting the United States International Trade Commission (ITC).

For the first 11 months of 2009, US PVC exports were up 54% from the year-earlier period at 1.914m tonnes, the ITC added.

There are yet more problems for Japan, South Korea and Taiwan: Natural gas prices which remain very low relative to naphtha could give ethane-based US ethylene-to-PVC producers an export edge, along with further weakness in the US dollar.

By John Richardson

MORE evidence that China will not remain as easy a sink for surplus polyolefin volumes - especially in the case of the higher-cost importers - is emerging.

"There are plans to open a bonded warehouse in Guangdong province to sell RMB material converted into US dollar product," a Singapore-based polyolefin trader told me yesterday.

Those who want to buy polyolefins for re-export as finished goods always prefer to buy overseas material priced in US dollars, as this is exempt from the full 17.5% rate of value-added tax (VAT).

The importers deliver this stuff into bonded warehouses ahead of collection for processing and re-export.

"If the manufacturers involved in the re-export trade were to buy RMB material they would only be exempt from 13 percentage points of the VAT," the trader added.

"As a result, it's always more expensive to buy local material for this purpose."

But if there are now plans to deliver Sinopec and PetroChina-sourced product into a bonded warehouse, the competitive landscape might have started to shift.

"How it works is once you have converted RMB-priced product into resin priced in US dollars, which has to involve the use of a bonded warehouse, it becomes exempt from the full rate of VAT - the same as the imports," continued the trader.

"The only drawback is that you cannot then re-price the polymer back into RMB."

China is rapidly increasing its polyolefin capacity, therefore making the option to supply into this re-export market more viable as it is no longer as dependent on overseas suppliers.

The country's polyethylene (PE) capacity is due to increase by 1.99m tonne/year in 2010 to 11.1m tonne/year, while its ability to produce polypropylene (PP) is to set to rise by 2.74m tonne/year to 12.7m tonne/year, according to Shanghai-based commodity information service, CBI.

It's easy to imagine much more local volume being delivered into bonded warehouses as China's capability to produce polyolefins continues to improve.

China's producers are able to minimise costs in ways not open to some of the higher-cost importers, such as those in South Korea and Japan who operate sub-world-scale naphtha-based cracker and derivative complexes.

Some exporters from Europe would also be vulnerable, while the US ethane gas advantage might be able to buy a number of its PE players a little more time.

The commodity-grade end of the business could end up even more firmly in the hands of the local Chinese producers and the Middle East players.

By Malini Hariharan

The China market appears to have started the year of the tiger on a strong note. We are not yet hearing a roar but at least it is not a whimper.

Pic source: Xinhua

A polyolefin market participant says that traders have started making enquiries after the Lunar New Year holidays. End-users are not yet coming up to buy but there has been a recovery in exports. "The order book scenario is getting better," he says.

There were some concerns before the holidays that inventory levels may be too high but he believes that they are not alarmingly so especially with the first line traders. "They look high considering the reduced number of working days [in February] but on a volume to volume basis they are at a normal level," he says.

Another polyolefin trader described the market as stable to tight. "International producers are waiting and watching. But the feeling is that local prices are getting better."

And there was positive news from the Dalian lldPE futures market which delivered a surprise yesterday moving by up 3%. The rise was attributed to higher crude oil values and a firm physical market. The rise in values contradicted earlier expectations that China PE prices would collapse after the holidays, market participants told ICIS news.

ICIS news also reports that offers for PVC edged up by $20/tonne after the holidays. While buyers had expected a fall in offer levels given the recent decline in feedstock costs producers said that strong seasonal demand would exert upward pressure on prices.

In a report released today Woori Investment & Securities says that prices of PE, PP, MEG and PTA moved up yesterday as the Chinese market reacted to the rise in crude prices during the holidays. And demand was firm on concerns of a supply shortfall due to maintenance shutdowns South Korean and Japanese plants over February-April. It has forecast petrochemical prices to remain solid through April.

It might still be too early to draw a clear picture of the next few months. Turnarounds will certainly constrain availability but a lot will also depend on the volumes that come out from the Middle East, especially from the plants that had faced operating issues in December-January. And not to forget there is also the influence that China's recent credit tightening moves will have on speculative activity and demand for petrochemicals.

By Malini Hariharan

And Sumitomo Chemical has discovered this.

The company recently said that PetroRabigh, its joint venture with Saudi Aramco in Saudi Arabia, has managed to secure fresh ethane allocation of 30m scf of ethane for a second phase of projects.

Ethane is running short in Saudi Arabia and getting an allocation, even a small one, is an achievement. But the second phase will need to use naphtha - about 3m tonnes. This will come from PetroRabigh's phase one which includes a refinery.

For phase one PetroRabigh had received an allocation of 95m scf of ethane sufficient to support a 1.25m tonnes/year cracker.

Details about the second phase are still sketchy. A feasibility study is due to be completed in the third quarter of this year and if viability is confirmed the projects will start up in Q3 2014, says Sumitomo

Pic source: PetroRabigh

The products being studied include ethylene propylene rubber, thermo plastic olefin, methyl methacrylate monomer (MMA) and poly methacrylate (PMMA), low-density polyethylene (ldPE), ethylene vinyl acetate (EVA), caprolactam, polyols, cumene, phenol, acetone, acrylic acid (AA), superabsorbent polymer and nylon 6.

But PetroRabigh phase two does not figure in Sumitomo's three-year plan, unveiled recently, as the plan runs only till fiscal 2012.

The plan does not have any surprises in terms of company strategy but Sumitomo has set some very tall sales and profit targets which might be difficult to achieve.

Despite an uncertain global economic outlook the company has set a sales target of Yen2,400bn and operating income of Yen190bn in fiscal 2012. This would mean a return of equity of 20%, up from the 1.8% projected for 2009-10.

"The numbers are too aggressive. Sumitomo has large exposure to cyclical businesses such as petrochemicals and information technology (IT); it will be quite difficult to achieve [the targets] if the recent price trend continues. The price assumptions for ethylene and polyethylene are very optimistic. A recovery in domestic petrochemicals is a dream story," says a Tokyo-based analyst.

To achieve its overall targets Sumitomo has said that it will quickly maximize profits and cash flows from major investments including its PetroRabigh cracker and derivatives joint venture with Saudi Aramco.

In petrochemicals, the company's policy is to ensure sustained profitability by establishing global operations. To achieve this Sumitomo plans to establish a worldwide marketing operation built on globally standardized products.

Profitability of operations in Japan would be strengthened, says the company without giving specific details on how this will be achieved.

"The issue of [improving] petrochemical competitiveness in Japan has been discussed for a decade; many people are sick of the discussion. The product mix is important. There should be more high performance chemical products. Sumitomo and Mitsui Chemicals have to change its business structure and not rely on ethylene derivatives," says a second analyst.

Sumitomo too is thinking along the same lines.

"We will increase the proportion of value-added petrochemical products we produce domestically from the current 70-80%," says a company spokesman. All options are being explored including new technologies and feedstocks and alliances.

A recent example of activity in this area is the new 150,000 tonnes/year propylene demonstration facility, a 50:25:25 joint venture by Idemitsu Kosan, Sumitmo and Mitsui.

Each company will contribute C4 fractions to the new unit and offtake propylene in proportion to their investment.

Sumitomo is unwilling to give details on what it plans to do with the extra propylene and would only say that it would be used for downstream production.

These and other initiatives are expected to help Sumitomo achieve petrochemical sales of Yen785bn and operating profit of Yen30bn in fiscal 2012, up from forecasted sales of Yen500bn and an operating loss of Yen9bn in the current financial year.

But the share of petrochemicals and basic chemicals in total sales is projected to shrink in the future from 43% in 2009-10 to 30% in fiscal 2020 as Sumitomo's priority is to achieve a balanced business portfolio.

Pharmaceutical and agrochemicals would contribute about 30% of total sales in 2020 almost unchanged from the current level, while the share of information and communications technology (ICT), battery and fine chemicals portfolio would expand to 30%, up from 21%.

Investments will be made to ensure this balance. The petrochemicals and basic chemicals segment would draw only about 20% of the company's investment dollars through 2020 while the other two segments would each draw 40%.

The Risk Of Exhausted Optimism

Source of picture: http://www.thedigeratilife.com/blog/double-dip-recession/

By John Richardson

Global polyethylene (PE) oversupply will be "challenging but manageable" over the next year-and-a-half provided there is no double-dip economic downturn, said Joe Duffy, consultant with DeWitt & Co.

"My analysis suggests that if economic growth continues into 2011 at the same rate as 2010, 2009/2010 expansions should be absorbed by the market with only 300,000 tonne/year of overhang," he added.

"However, more expansions are planned for 2011 which will maintain the overhang into 2012.

"On paper, conditions should start picking up in 2013/14 - but I would expect this to begin in mid-2012, as buyers seek to restock in anticipation."

He estimated that Asian demand growth would be 2.4m tonne this year versus 3.2m tonne/year of new production in Asia and 2m tonne/year in the Middle East.

This would leave oversupply on paper at 2.8m tonnes this year - but Duffy said that this would be reduced by lower European, Japanese and US operating rates as their exports decline.

"These three big industries enjoyed strong exports in 2009, mainly to China. They took advantage of a window of opportunity provided by the strong economic rebound and delays to Middle East start-ups," added a Singapore-based source with a global polyolefin producer on Tuesday.

"Last year was a big relief to all us. Even the marginal-cost producers in Japan and elsewhere could make money."

The US doubled its exports to China last year, but its export volumes could dip very sharply from the second half of 2010, continued Duffy.

And so when you take away what he characterised as the "low hanging fruit" of exports being easily displaced by higher production in the Middle East - and also Asia - this reduces the 2010 surplus by 1m tonnes to 1.8m tonnes.

On the upside more production problems in the Middle East - which has been beset with difficulties in starting-up and stabilising production at new plants - seem very possible.

Linear low-density PE (LLDPE) production might also remain constrained by the shortage of butene-1 co-monomer, the result of lower liquids cracking operating rates on cheaper ethane feedstock in the US.

Higher cost liquids cracker production is also under pressure from the new Middle East capacity, he said.

"Delays to start-ups of alpha olefins facilities (which produce butene-1) have also contributed to the shortage," he said

"Around 1.8m tonne/year of swing LLDPE/high density PE (HDPE) is being commissioned this year, but LLDPE is tight because of the butene-1 shortage.

"It is also more difficult technically to produce LLDPE and so while the commercial guys might want the right mix of grades, from a production perspective - i.e. achieving close to 100 per cent operating rates - it is easier to only produce HDPE."
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Source of picture: the truth about cars

By John Richardson

WHEN my fellow blogger Malini Hariharan once asked a particularly unhelpful individual who used to track polyethylene (PE) markets what was going on, his only response was "conditions are volatile".

And so as you kick-off this fine and sunny morning (at least it is here in Singapore), here is some further useful advice for you: Conditions are becoming even more volatile.

But unlike the individual referred to above, in a series of blog posts over the coming weeks we will endeavour to explain exactly why pricing markets have become even harder to predict. We believe that old tools of analysis need to be revised and old assumptions challenged.

We are going to start with liquefied petroleum gas (LPG) and how unexpected shortages have curtailed the length of the usual propane and butane "cracking season".

Every summer, when demand for LPG for heating in the northern hemisphere falls, cracker operators that have invested in the flexibility to change feeds often reduce naphtha consumption in favour of LPG. Cracker operators in Japan, South Korea and Singapore have, for example, invested in this flexibility.

But as these two recent graphs from the ICIS pricing Ethylene Margin Report show (click below to view), earlier this summer LPG cracking didn't make economic sense

LPGslide.ppt.

So we talked to oil, gas and refining consultants Purvin & Gertz and they gave us the following reasons why this happened:

1.) Refinery operating rates globally are constrained due to weak oil-product demand, despite the story the financial industry is spinning about booming demand
2.) Asian refineries were undergoing heavy maintenance programmes
3.) The economic crisis resulted in delays to liquefied natural gas (LNG) projects, thereby reducing the extra availability of propane and butane co or by-product that needs to be extracted from the LNG before it is shipped
4.) The well-documented OPEC oil quotas that have limited availability of associated ethane gas have also done the same for associated propane and butane
5.) Petrochemicals demand for LPG has increased due to the increased cracking of propane and butane resulting from ethane shortages, and the start-up of the three propane dehydrogenation (PDH) to polypropylene (PP) projects in Saudi Arabia. This is only a small part of the overall picture, BUT constrained LPG supply in Saudi Arabia - evidence of which came from a recent analysts report about Yansab - is one reason why it is over-simplistic to talk about new supply flooding the market without adding a few important qualifications

The LPG season has belatedly begun thanks to Asian refineries returning from turnarounds and LPG exports from a new gas-separation plant in Abu Dhabi, which is feeding the Borouge II cracker complex with ethane, add Purvin & Gertz.

But clearly there are some new variables for flexible-feed cracker operators that look as if they are here for the long-term and therefore need further study.

An example of how Lexan solar control IR sheets (made by SABIC Innovative Plastics) can be put to use

Source of picture: SABIC

By John Richardson

SAUDI ARABIA is busy reshaping its petrochemical industry to reflect a drastic shift in priorities.

Such is the change in the kingdom that commentators are going so as far as to say that major capacity additions of commodity petrochemicals will soon become a thing of the past.

The Saudi government is only supporting new investments downstream of the basic cracker derivatives in an attempt to diversify the economy and create more jobs (as you go further downstream, labour intensity increases).

To some extent, this also applies to other countries in the Gulf Cooperation Council (GCC). But what happens in Saudi Arabia is important, as this is where most of the project activity is in differentiated, or value-added, chemicals.

A separate but very important theme worth more exploration is where the new commodity capacity to serve voracious emerging-market demand growth will be added - as what is being planned in Saudi Arabia and elsewhere in the GCC is unlikely to be anywhere close to sufficient.

China is an obvious candidate. So is Singapore, as it takes advantage of spare refinery-based feedstock.

Malaysia is another strong possibility. It has very competitive ethane-gas feedstock, and the petrochemicals division of Petronas will have a much bigger motive to expand once its listing takes place, the current schedule for which is the fourth quarter this year.

But returning to Saudi Arabia, the shift downstream will leave the smaller, private producers that have a limited or even a single-product portfolio in a weak position, according to an industry source.

"Even if future allocations of natural-gas feedstock were readily available - and we all know they are not because of supply constraints - the government will only give them to companies moving up the value-chain," says the source.

It is a classic chicken-and-egg situation, according to an HSBC report on Middle East petrochemicals.

"Access to feeds that can be used for downstream development is likely to be limited to companies that [already] have a broad product portfolio and can therefore integrate internally," says the report.

Companies involved in refinery-based petrochemicals, such as Saudi Aramco, are also likely to emerge as winners, the report says: some of the downstream chemicals being planned require oil-based rather than gas feedstock.

So the strategy for these smaller, marginalised producers is likely to be mergers, acquisitions and diversification into plastics processing, adds the industry source.

It is important to stress, though, that larger and more diversified private companies are in a different position - most notably, Saudi Arabia International Petrochemical Co (Sipchem).

Sipchem brought its methanol plant on stream in 2004 and has since commissioned acetic acid and vinyl acetate monomer (VAM) facilities.

Last month, Sipchem announced a joint venture with Rhodia to build the Middle East's first ethyl acetate plant.

This is exactly the kind of "access to feeds" integration that HSBC is talking about, as Sipchem has acetic acid raw material for the ethyl acetate project.

SABIC, along with Saudi Aramco, is, of course, ideally placed to cash in on the diversification strategy because of its own access to feedstocks.

But to what extent will these two giants make money?

What is certain is that returns will be less than the massive margins generated by a relatively simple ethane-based cracker and downstream polyethylene (PE) and monoethylene glycol (MEG).

How much is made depends on what Saudi Arabia decides to build, says HSBC.

The bank carried out an internal rate of return (IRR) study of 40 basic and differentiated commodity chemicals that could be produced across the Middle East with a 10% hurdle rate for project viability.

Its conclusion is that intermediate chemicals - but not all the way downstream into specialities - Is where Saudi Arabia, and the Middle East in general, should be positioned.

These include acrylics, acetyls, epoxy resins, polyacetals and the polycarbonate (PC) and nylon chains.

SABIC has announced a polyacetals joint venture with Celanese, which is due to start-up in 2013.

Saudi Kayan Petrochemical Co (Saudi Kayan), which is 35% owned by SABIC, will become the region's first PC producer when it brings its plant on stream at Al-Jubail, Saudi Arabia, next year.

And the second phase of Saudi Arabia's PetroRabigh - the joint venture between Saudi Aramco and Sumitomo Chemical - could include other intermediate petrochemicals such as ethylene propylene rubber (EPR) and thermoplastic olefins.

The second phase might also include paraxylene (PX), purified terephthalic acid (PTA) and polyethylene terephthalate (PET), which HSBC identified as other products suitable for the region.

A feasibility study into PetroRabigh's second phase is due to be completed in the third quarter of this year, with a start-up targeted for the third quarter of 2014.

What will not work in the Middle East is production of water treatment chemicals, plastic additives, construction chemicals, catalysts, oil-field chemicals and speciality coatings and adhesives, adds HSBC.

This is the result of low demand for these products in the region and the importance of locating plants in countries where the consumption is big, such as China.

This assumes, though, no heavy government subsidies, with plastic additives quite possibly part of slow-to-get-off-the-ground plastics-processing parks in Saudi Arabia and Abu Dhabi.

A big question is to what extent western and Japanese companies will be willing to license technologies.

The returns for licensors are solid enough, as they include marketing and distribution fees at 5-8% of revenues and licensing fees at a further 1-2% of revenues, says HSBC.

Access to low-cost finance is another temptation, with interest rates at just 2-3% - well below what the foreign majors would have to pay in their home countries.

The evidence to date is that a fair number of overseas players have been prepared to license technologies, although a great deal more deals need to be struck if Saudi Arabia is to fulfil all its ambitions.

But a second industry source adds: "The western and Japanese speciality chemicals market is highly fragmented...so for the smaller players, going to Saudi Arabia makes every bit of sense.

"These smaller players are in a bind when you think about it. It is a choice of no growth at home or going overseas to sometimes less-than-ideal returns."

Saudi Arabia also has the money to acquire companies that own these technologies. An historic case in point was SABIC's purchase of GE Plastics, and with it a distribution network.

Ownership of distribution networks becomes important as you go downstream.
Where there is money, there is usually a way around most obstacles.

 Tokyo at nightSource of picture: liveworldtours.com

By Malini Hariharan

it is easy to write off the Japanese petrochemicals industry which has for long struggled to find a solution to the dual pressure of rising global competition and an anaemic home market.

Japanese companies, once at the forefront of the Asian industry, have already given way to newer players from countries such as China, India and Thailand. Product portfolios have been trimmed and alliances formed to ensure profitable operations.

"The names of the companies may have not changed but their product mix has changed remarkably," says senior executive adviser at consultancy Accenture Japan, Ryota Hamamoto.

"Some companies have relocated their production facilities overseas and reassigned their Japanese employees to new smaller but sophisticated high-end specialities business without laying them off as their counterparts in Western countries usually do."

And more restructuring appears inevitable.

"The new ethylene capacities in the Middle East and China will result in Japanese producers losing market share. It is possible that 1.5-2.0m tonnes/year of Japanese ethylene capacity, or 3-5 less competitive plants, will be dismantled in the coming 5-6 years, " Hamamoto predicts.

The remaining crackers will need to operate as companies need hydrocarbon feedstocks to maintain their lucrative speciality chemicals businesses.

However, companies can delay the inevitable as long as markets such as China remain robust.

Hamamoto points out that Japanese ethylene production nosedived to 6.8m tonnes in 2008 from 7.8m tonnes in 2007.

"At that time some pessimistic analysts had forecast that output would fall further to 6.1m tonnes in 2009 as a fall in domestic demand seemed inevitable. But to our surprise, production hit 7.1m tonnes mainly as a result of strong demand from China and other Asian countries," he explains.

Hamamoto cautions that it would be unwise to dismiss all Japanese crackers as being uncompetitive.

"Most of the crackers are 30-40 years old and rather small; so one would think that their cost competitiveness is poor. However, the major producers are quite competitive as their plants are fully depreciated and are run at high operating rates with minimum accidents.

"Additionally, the plants are fully automated and companies have invested in energy saving technologies to compensate for the small size, old design and high cost of feedstock.," he says.

One example is Showa Denko.

A Showa Denko source explains that the company has attempted to raise its competitiveness to a higher level by making changes to its 695,000 tonnes/year Oita cracker.

Earlier this year, Showa Denko recently replaced seven small furnaces at the cracker with two high-efficiency furnaces; improved the waste heat recovery system and renovated the pre-distillation system.

The new furnaces give greater feedstock flexibility as they can crack liquefied petroleum gas (LPG), natural gas liquids (NGL), kerosene and light oil. The company says that the changes will improve energy efficiency by 5.3% and reduce carbon dioxide emissions by 6%.

Showa Denko, says the source, is looking at further improvement in production efficiency with an aim to reduce costs and does not have plans for further plant shutdowns other than those announced.

Japanese companies are also investing time and money to develop alternative production routes and make value-added products.

Mitsubishi Chemical has built a pilot plant to make propylene using methanol/dimethyl ether (DME) and other olefins from a naphtha cracker. It has also tested a new butadiene technology that uses butene as a feedstock although a decision to commercialise the technology has yet to be taken, says a company source.

Idemitsu has successfully developed metallocene polypropylene (m-PP) and is constructing a 40,000 tonnes/year plant at Chiba scheduled for completion in Q4 2011.

Prime Polymer, a joint venture between Mitsui Chemicals and Idemitu Kosan, is also strengthening its presence in metallocenes.

A 240,000 tonnes/year metallocene linear low density polyethylene (m-lldPE) plant at Ichihara will be expanded by 60,000 tonnes/year by November 2011.

And there are plans for a new 200,000-300,000 tonnes/year m-lldPE plant overseas for start up in 2014. Possible locations include Singapore and China with a final decision due to be made in H2 2011.

Random copolymer m-PP is currently being test marketed for food packaging and there are plans to start produce around 50,000 tonnes/year at an existing PP plant at Osaka by end of fiscal 2010, says a company source.

Homopolymer m-PP and block m-PP are also being developed at a pilot plant although a decision has yet to be made on commercialising these grades.

These efforts show that while Japanese companies no longer dominate the Asian petrochemicals landscape they still have the capacity to teach a few lessons to other regional players.

Here is another article on the liquefied petroleum gas (LPG) market, a subject we have covererd several times on the blog over the last few months.

Below we discuss how the temporary supply constraints that have kept LPG tight this year look set to end, creating a very attractive feedstock option for higher-cost Asian cracker operators as they attempt to compete in an ever-more difficult environment.

By John Richardson

THE world is about to be hit by a flood of new liquefied petroleum gas (LPG) (propane and butane) supply, creating a big opportunity for higher-cost Asian cracker operators as they seek to survive in an ever-more competitive world.

An additional 20-30m tonne/year of LPG is due to come on-stream globally in 2008-2012, according to the Singapore-located cracker operator, Petrochemical Corp of Singapore (PCS).

This could lead to 5-10m tonne/year of extra LPG consumption by the petrochemicals industry if the pricing incentives are right, the company added.

"Europe has gone as far as it can in taking advantage of the LPG opportunity, but Asia is only just waking up to the need to be more flexible with some investments in the region taking place over the last 18 months," said Paul Hodges, chairman of UK-based chemicals consultancy, International e-Chem.

 Source of picture: Bombayharbor.com

Some South Korean, Japanese and Singapore cracker operators have already invested in the furnace adaptations and storage facilities necessary to make use of LPG - but many other producers lag behind.

"LPG normally becomes attractive as a cracker feed when its price is around 90% of the naphtha price," added Hodges.

Traditionally, this has been in the summer months in the northern hemisphere when LPG pricing falls due to lack of demand for heating.

The anticipated oversupply of LPG is the result of the ramp-up in liquefied natural gas (LNG) and condensate capacity in the Middle East, said oil and gas consultancy, FACTS Global Energy.

The capacity flood should have, in fact, already arrived by now, but this year has seen a surprisingly tight global market.

Lower LPG production by refineries - the result of oversupply in refinery capacity - is one factor behind the tightness.

Middle East petrochemicals demand for propane and butane has also increased due to a change in feedstock mix.

Recently commissioned gas crackers are running a higher percentage of LPG feedstock than plants that were brought on-stream earlier on because of shortages of ethane.

In addition, Saudi Arabia has seen the start-up of three propane dehydrogenation-to-polypropylene (PP) complexes over the last 18 months.

But by far the biggest factor behind delays in the LPG supply surge is reduced operating rates and maintenance shutdowns at LNG plants, added FACTS.

"It should be noted that this will be temporary and in the longer term, the LNG mega-trains will be strongly required to ramp-up their production to avoid any damage to project economics," wrote the consultancy in a recent report.

LNG production has been reduced because of the same problem afflicting the refinery sector: A lot of new capacity came on-stream just as the economic crisis happened, with the LNG industry facing the added problem of the shale-gas revolution in the US. This has left the States unexpectedly self-sufficient in natural gas and even, possibly, in a position to export rather than import gas.

In Qatar alone, total LPG and condensate production will surpass that of crude oil by 2012, added FACTS in the same report.

Of course, though, cheap feedstock for the smaller, older and therefore more marginal cracker operators in Asia won't by itself be a game-changer.

"Cracking propane and butane changes cracker yields," said a Southeast Asian cracker feedstock purchasing manager.

"As a result, a careful balancing act will need to be performed between savings on raw-material costs and what these different yields will mean for polyethylene (PE), polypropylene (PP) and other olefins derivative production.

"One obvious opportunity from using LPG is increased propylene yields. This might help what could be tight C3 markets over the next few years."

Propylene supply has tightened in recent months as a result, of again, lower availability from refineries.

Other factors have been low liquids cracking operating rates in Europe on lack of naphtha availability (again because of problems in the refinery industry) - and US cracker operators switching to lighter feeds due to the collapse in natural-gas pricing.

A further reason has been the boom in polypropylene (PP) production due to strong demand growth for the polymer.

The shortage of C3s is seen by some industry sources as a serious and long-term problem. Unless it is addressed they worry that PP could suffer from demand destruction.

We are deeply ashamed of ourselves....

By John Richardson

AT the risk of boring you completely senseless let us once again return to the subject of liquefied petroleum gas (LPG) and its likely usefulness as a cracker feedstock over the coming years.

The reason why we keep going on and on about this subject is because an extra bit of raw material flexibility could make all the difference for the marginal producers in Asia, such as those in Japan.

Even assuming you subscribe to the sunny uplands theory, if you are far to the right of the cost curve it cannot do any harm at all to look at ways of improving your returns.

Our other big motive for being a little obsessed with LPG is that as gas feedstock is short in the Middle East.

This is helping support the argument for tight supply in 2012-2013, resulting in Asian cracker operators with no current feedstock advantage searching for ways to justify ramping up their capacities.

We know of one cracker project in China which could be 80% dependent on Middle East LPG imports with the remaining 20% comprising naphtha sourced from local refineries.

And putting two and two together and maybe making five, Qatar Petroleum took a stake in Petrochemical Corp of Singapore (PCS) last November and there are plans to build an LPG receiving terminal on Jurong Island.

Qatar is where most of the LPG surplus is supposed to come from and Singapore wants to eventualy raise its ethylene capacity from 4m tonne/year to 6-8m tonne/year. QED a grassroots cracker based on LPG?

LPG markets have been unexpectedly tight this year for a variety of reasons - but as we blogged about on Monday, oil and gas consultancy FACTS Global Energy thinks this will change from 2011 as the great supply flood finally arrives.

But a South Korean industry source we spoke to earlier this week vehemently rejected any notion that LPG would be so oversupplied that it would be a good feedstock choice for green field crackers

"If you look at history the maximum LPG cracking season in any one year has been eight months and this year it's made good sense for about 8-10 days because of all the unexpected demand and supply issues," he said.

"I am convinced that this is not going to change. Supply is going to increase in a big way, sure, but it is going to be easily eaten up by incremental demand from countries such as Indonesia, India and Vietnam."

This is where a little bit of knowledge might be dangerous. What the blog wasn't aware of is the drive to use LPG rather than kerosene and wood for domestic fuel in all the above countries for health reasons.

In Indonesia, the motive behind switching from kerosene to LPG is also to end black-market profiteering from the illegal resale of kerosene. In theory, you could do the same with LPG but this would require a lot more investment in storage and distribution.

"A problem with LPG is you get slightly less propylene and fewer C4s and pygas (propylene and C4s are in tight supply) and so this also weakens the case for it as a cracker feed," our source continued.

Apologies are in order here. We had been told by other contacts that LPG cracking can produce MORE propylene. The blog has donned a dunce's hat and is sitting in the corner in shame.

"LPG will remain a useful alternative feedstock at certain times of the year, but with all the uncertainties over surpluses, why invest in even more flexibility?" our source added.

"In South Korea, Taiwan and Japan, for example, there is the capability of producing around 500,000 tonne/year of ethylene via LPG which hasn't made economic sense in 2010. Why spend money to raise this number any higher?"

Patrick Thomas

Source of picture: Bayer Material Science

By John Richardson

SUCCESS in chemicals - whether you are into commodities or specialities - is largely about eking out maximum value from every single molecule in all the important markets.

The almost obsessive focus on China and other emerging markets might give the impression that "all the important markets" relegates the economically ailing West to the second or third division.

But any truly global chemicals company worth its salt needs to balance investment across each of the big consuming regions.

And so, after all the fanfare of last month's announcements by Bayer Material Science (BMS) of a further $1bn of capital spending in China, the company has also been keen to stress what it is doing in Germany and the US.

The chemicals major plans to invest a total of €3.5bn ($4.5bn) in these three countries over the next five years. This will involve commercialising a new technology, upgrading existing plants, building new production facilities and a lot more work on research and development (R&D).

"Our further expansion plans in Germany include growing our coatings facility in Leverkusen that produces aliphatic isocyanate, hexamethylene di-isocyanate (HDI) and isophorone di-isocyanate (IPDI) coatings," said the company's chief executive officer, Patrick Thomas, in an interview.

"This investment should be sanctioned by the board in the next 12 months and completed in two years."

Next he detailed an example of molecule-value stretching: plans to build a commercial-scale demonstration plant that will use the company's oxygen depolarised-cathode technology for producing chlorine. Start-up is scheduled for later in 2011 or the beginning of 2012.

This will involve the conversion of BMS's last remaining mercury cell chlor-alkali process unit in the world, which is located at Uerdingen in Germany, and result in big savings on electricity costs and reduced CO2 emissions.

In effect, hydrogen fuel cells are integrated in the chlorine cell as part of this new process, lowering electricity consumption (the main cost component in chlor-alkali production) by 50% compared with mercury or diaphragm cells.

Thirty per cent less electricity is required when facilities are converted from the membrane technologies.

The company will eventually convert all of its plants to this new breakthrough process, Thomas added.

And he said: "We have signed a memorandum of understanding (MOU) with China BlueStar (the mainly state-owned Chinese speciality chemicals giant).

"BlueStar, which is the technology supplier and builder of just about all the chlor-alkali units in China, plans to use our new technology across the country. The first step is to build a pilot unit in Caojing."

BMS will also invest in Baytown, which is near Houston, Texas, and the site of company's largest US production facility.

Polycarbonate, methyl di p-phenylene isocyanate (MDI) and toluene di-isocyanate (TDI) facilities will be upgraded at the site, involving debottlenecking and technical improvements to boost reliability.

Work will also be carried out on improving logistics, such as building a chlorine pipeline from feedstock supplier Oxyvinyl, which is 20km away. This will take chlorine transportation off roads and railways.

"These investments in both the US and Germany illustrate that they are still very important markets for us," said Thomas.

In volume terms, the US and Germany remain as big as China for BMS - even if they are eclipsed in terms of percentage growth-rates.

So, of course, because growth is booming in China, the big investments in new plants are taking place in that country.

Thomas provided a great deal more detail about what BMS wants to build at its big production site in Caojing, Shanghai, compared with what was reported last month.

"Our plan for MDI is to reach 1m tonne/year of capacity between now and 2016," he said
"This will involve a debottlenecking of our existing plant to 500,000 tonne/year from 350,000 tonne/year and building a new unit of 500,000 tonne/year."

The new polycarbonate plant being evaluated for Caojing will be an "economic copy paste" of the existing 200,000 tonne/year facility at the same site.

So it will initially also be 200,000 tonne/year and then the company wants to debottleneck both the old and new plants by 50,000 tonne/year to get to a total capacity at the site of 500,000 tonne/year.

"Capital equipment for the new plant has already been pre-ordered and our target is to bring the new plant on-stream in 2013. The debottleneckings will then take place 12-18 months after that."

Thomas stressed that the decision to move the BMS polycarbonate global headquarters to Shanghai from Germany would not mean any redundancies.

The company also wants to build a new coatings plant in Shanghai. Like the coatings investment in Germany, this new facility will produce solvent-free, water-based aliphatic coatings.

Capacity of this new plant would be 50,000 tonne/year with start-up scheduled for 2013-2014.

The existing 30,000 tonne/.year plant at Caojing is to also be debottlenecked.
"All our projects at Caojing have reached the Memorandum of Cooperation (MOC) phase," said Thomas.

"The MOC phase is a step along from an MOU and means that the local Shanghai authorities will now move on to studying our proposals.

BMS is to begin environmental impact assessments and feasibility studies as part of a local approvals process that involves about 20 different steps.

"Once these steps have been completed, some aspects of our overall plan for Shanghai will need to be submitted to the central government's National Development and Reform Commission (NDRC) for final approval.

"Other elements of the expansions can go ahead with only local government backing."
Further product development work in China includes building a large-scale PC automobile-glass demonstration hall in Shanghai.

R&D development work in the auto and appliances industries mainly occurs in China, as does manufacturing.

But the electronics industry is slightly different.

"The know-how is in the US, Japan, South Korea and Taiwan with the manufacturing - because of the low labour costs - in China," said Thomas.

This is why BMS opened a functional films research centre in Singapore in June last year as the city state is "an international hub for the development of technology, drawing on expertise for the whole region".

The functional films centre focuses on research into coated high-tech films and nanotechnology for electronics.

Stand still in this business and you end up being overtaken, and, quite probably, kicked off the running track altogether.

The opportunities are huge, but as the BMS announcements indicate, so are the difficulties in making sure you both keep pace with competitors in China while not losing focus on all the important markets.

By John Richardson

THE earthquake and tsunami that hit Japan on Friday afternoon is still hard to take in. We send our sympathy to everyone connected with this disaster and just hope and pray that the rescue efforts go exceptionally well.

As Japan returns to work this morning it will confront the huge cost of rebuilding at a time when its economy is struggling with slowing growth and lack of confidence in the government.

But this is a country that has overcome huge obstacles in the past and we are sure that history will repeat itself.

It seems almost in bad taste to talk about the impact on refining and petrochemicals, but of course life has to go on.

And so we have been trying to piece together the impact on these two industries both in Japan and elsewhere.

Petrochemicals plants at Ichihara, Chiba prefecture, and Sendai, Miyagi prefecture were reported to be still on fire 15 hours after the disaster occurred.

Chisso Corp's Goi Complex, which includes polyethylene (PE) and polypropylene (PP) plants, is at Ichihara.

Maruzen Petrochemical shut down its 480,000 tonne/year crackert at Chiba, east of Tokyo, after the earthquake.

Keiyo Ethylene shut is 690,000 tonne/year cracker at Chiba.

Keiyo Ethylene Co is 55 percent-owned by Maruzen Petrochemical and 22.5 percent each by Mitsui Chemicals and Sumitomo Chemical.

Idemitsu Co, Showa Denko and Mitsubishi Chemical are also reported to have closed down plants in order to carry out test.

Some 1.7m tonne/year of ethylene capacity is thought to be off-line.

There was also a fire over the weekend at the chemical factory of JFE Chemical in the Chuo ward in the city of Chiba, Chiba prefecture.

JFE Chemical produces coal tar, benzene, toluene and xylene and industrial gases including oxygen, nitrogen and argon.

JX Nippon Oil & Energy shut its paraxylene facilities in Kashima, Ibaraki prefecture, with a combined capacity of 600,000 tonnes/year, and in Kawasaki with a combined capacity of 350,000 tonnes/year.

Around 1.2m tonne/year of refinery capacity is thought to be also shut down. These include three JX Holdings refineries, one refinery operated by Cosmo Oil, another by TonenGeneral Sekiyu and a final one run by Kyokuto Petroleum.

The 220,000 tonne/year Cosmo refinery, which is at Ichihara, was reported to be on fire.

Japan is a major importer of naphtha and so crack spreads elsewhere will be under downward pressure due to the drop in demand.

Ten naphtha vessels were said to be heading from Europe to Japan when the disaster happened.

This could add further length to a European market that was already struggling to cope with oversupply.

By John Richardson

OUR sympathies again go to the people of Japan. The main focus should be on providing as much support as possible to the rescue efforts and let's hope that petrochemical companies globally step forward.

But as we said yesterday, life goes on. The Japanese stock market was down around 5% this morning in early trading, suggesting fears about serious damage to the economy. There is anxiety that another earthquake could occur over the next few days.

Here is a research note from UBS, which as you can see, estimates that 20% of Japan's refining capacity and 27% of its ethylene capacity and 30% of its aromatics production is shut down.

As we said in our post on Sunday, Japan is a major importer of naphtha and so some refiners will struggle to place their volumes. However, UBS sees an upside for Asian refining margins.

In the immediate term Formosa Plastics Corp, Formosa Chemicals & Fibre and LG Chem are expected to benefit the most from the outages as a result of their product mix, adds UBS. They should be able to gain market share in China.

The lost production might also help to rebalance what has been a weak polyolefins market in China.

The supply disruptions, which seem very likely indeed to be long-term .In the confused situation at the moment seems possible that major structural damage has been caused to refineries and petrochemical plants.

This is the UBS note in full:

Impact on Japan refining industry
The devastating earthquake and tsunami in Japan that took place on 11 March has resulted in 20% of refining capacity loss in Japan (900-950K bpd) or 3.5% and 1%of Asia and global refining capacity respectively. While some refineries are shut for safety concerns, Cosmo Oil has shut its 220K bpd refinery in Chiba due to fire

.

Implications for Asia refining market
Singapore complex refining margin jumped from US$7-8/bbl to US$15/bbl after
Hurricane Katrina hit the US Gulf coast in late Aug 2005, which resulted in 1.4mn bpd refining capacity loss. We believe Asia refining margin should see more upside in the near-term and major refiners in the region such as GS Holdings, SOi and Thai Oil are best-positioned in Asia.

Impact on Japan petrochemical industry
Around 2mn tpa ethylene capacity in Japan have been affected by the earthquake,
which translates to 27% of total ethylene capacity in Japan or 4% and 1.4% of Asia
and world ethylene capacity respectively. It has been reported that total aromatics
capacity being affected should be around 5.7mn tpa, or 30% of Japan production.

Implications for Asia petrochemical market

We believe any supply disruption in Japan could potentially impact South Korea and
Taiwan as these two are the main competition in China petrochemical market.
Looking at Japan's major export products, we believe FPC and FCFC in Taiwan and
LG Chem in South Korea are best-positioned to gain market share in Asia.

By Malini Hariharan

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

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

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

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

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

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

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

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

By John Richardson

ASIAN paraxylene (PX) and styrene markets look set to be the most affected by the loss of Japanese exports as the slide below from Bob Townsend at the UK-based consultancy, International eChem (Iec) illustrates. 

Japanese Exports.ppt

My fellow blogger Paul Hodges, also of IeC has analysed the data behind the charts to produce a breakdown of Japan's 2010 exports across the olefins, aromatics, fibre intermediates and polymers chains.

There are unconfirmed reports a 10% increased in Asian PX prioce as a result of the loss of production at JX Nippon Oil.

ICIS asessed pricing at around $1,740/tonne (€1,253/tonne) CFR (cost & freight) Taiwan and/or China Main Port (CMP) earlier today.

JX along with fellow Japanese producer Idemitsu Kosan and global major ExxonMobil are crucial to the Asian market as they nominate the monthly Asian Contract Price.

The nominations are then negotiated with the big five big buyers, two of which are Mitsubishi Chemical and Mitsui Chemicals.

The loss of Japanese PX production comes during a heavy turnaround period. Polyester producers in China are already complaining about squeezed margins and so it will be interesting to see whether the higher PX costs can be passed on down the chain.

A good article from my colleagues Peh Soo Hwee and Felicia Loo at ICIS news neatly summarises both the impact on naphtha of the loss of Japanese production and details of exactly which petrochemical plants are down across the major product chains. Our post from earlier today provides more detailsl these shutdowns.

The Kashima and Sendai ports have also been closed as a result of the disaster - meaning that even where chemicals plants are still operating, shipments may not be possible.

Again our sympathies go out to everybody caught up in this tragedy. We pray and hope that the rescue efforts go well and that Japan is soon able to focus on the rebuilding efforts.

By Nigel Davis

For some, life goes on. For others, everything is lost.

An email to the BBC on Tuesday from a resident in Mie, Japan, 350 miles from the stricken nuclear power plants on the east coast of the country, described a relatively normal day.

Utilities are available but people are feeling nervous and there is some stockpiling. "It feels as if there are two Japans at the moment," the correspondent, John Stephenson, said.

So, one question among so many at this particularly difficult time is: how are the two Japans coping, indeed surviving, in the face of such adversity?

The impact of the earthquake and tsunami on Friday 11 March, and now the aftershocks, can still only slowly be pieced together.

The world's eyes are on the damaged nuclear reactors. But the Nikkei stock market index had crashed by 10% at the close on Tuesday, reflecting the sharply negative economic outlook. Oil prices plunged.

Assessing the impact of the disaster on the petrochemical industry, and on regional markets, so far is difficult to say the least, although some headway is being made.

Reports suggest that important crackers and other production units are not operating.

We know for certain that ethylene and aromatics production is hit. ICIS has reported the closure of ethylene, benzene, paraxylene (PX), propylene oxide, propylene glycol, polyvinyl chloride, titanium dioxide and polyether polyols plants, and reduced output at others. It could take weeks or months for these units to come back on stream.

Paraxylene prices have climbed following a supply force majeure announcement by the world's largest PX exporter, JX Nippon Oil.

Three of its PX plants, with a combined capacity of 950,000 tonnes a year, located in the devastated Miyagi prefecture, are shut down.

Five refineries have shut down in Japan - a Cosmo oil refinery continues to burn - and port activities have been disrupted, putting further strain on foreign trade.

But many plants are operating normally, and others that shut down automatically as a precaution might be expected to restart soon.

However, the damage caused by the disaster is unimaginable, as is the hardship being suffered by so many people.

Production plants have closed automatically, while chemical company offices have been closed, giving staff time to come to terms with recent events.

According to reports, all of Japan's 12 automobile makers closed their assembly lines, for the first time ever. Some of them will not reopen until Wednesday.

Japan's chemical industry has been dealt a severe blow from which it will no doubt recover, but that recovery will take time.

For some in this business, life goes on as normal, but for others the disruptions to production capability and to trade will take time to come to terms with.

By Malini Hariharan

More companies are reporting damages to facilities after last week's earthquake and tsunami.

Mitsubishi Chemical said in a statement that berths, roads and infrastructure around the plant area at its Kashima site have been damaged and delivery or shipment of cargo "would be next to impossible".

"Restoration of capabilities will take quite some time," it added.

Infrastructure at its subsidary Japan Polypropylene's facility at Kashima has been hit.

"Basic infrastructure at the site is badly damaged and we'll need time to restore that, but damage at the PP plants may not be as serious," a company source informed ICIS news.

The company has a total PP capacity of 346,000 tonnes/year at the site. It has also had to shut down its PP plants at Goi after a fire in a neighbouring refinery run by Cosmo Oil.

Mitsubishi Gas Chemical said the building and equipment at a plant in Fukushima prefecture has been damaged by the earthquake and that operations have been suspended. The plant produces materials for printed wiring boards for use in smartphones and other consumer electronics and makes up to 60% of the global market for wiring-board materials.

Major Japanese electronic companies are said to be struggling with power blackouts and production has been suspended at a number of plants across the country.

Worries about supply-chain disruptions are mounting especially in the electronics and automotive sectors and some Asian businesses have slowed down production.

The impact of this should work its way up to petrochemicals in the coming weeks.

By John Richardson

Dear Reader

Below we take a break from our own coverage and focus on another topic - some thoughts on the future competitiveness of the European petrochemicals industry.
A widely-held assumption has been that a lot of European petrochemicals capacity will have to shut down as a result of lower-cost capacity elsewhere, particularly in the Middle East.

But the European industry enjoyed tremendous profitability in 2010 as a result of production being carefully aligned to demand.

More important reasons for these stellar results were probably the age of the plants and lack of investment in maintenance as a result of the 2008 global economic crisis. This led to a high number of force majeures.

Perhaps the biggest reason of all, though, was lack of naphtha from refineries. The collapse of demand in 2008, a long-term decline in US gasoline demand and the start-up of state-of-the-art "full conversion" refineries in Asia put the older European refineries under a lot of pressure.

Plant reliability should now improve as a result of the strong 2010 earnings.

But these earnings will give the Europeans a greater capacity to hunker down and wait for another fly-up in margins if the next 2-3 years prove difficulty because a weaker macro-economic environment.

Barring another major global recession that effects demand for all petrochemical products, Europe's use of naphtha as its main feedstock could continue to deliver very strong co-product credits.

The lightening of feeds in the US, as a result of the shale-gas bonanza, has helped tighten butadiene, benzene and propylene markets.

So has the most recent wave of new capacity which was predominantly in the Middle East and gas-based.

A further factor behind the C3s tightness has been polypropylene (PP) demand growth above the expansion in global GDP and in excess of that for other competing polymers.

This is the result of PP gaining market share from these other competing polymers, such as polystyrene (PS), and a lot of focus on application development.

Producers have therefore been lured into adding substantial amounts of PP capacity, in excess of feedstock availability.

Another even bigger bonus for European petrochemicals could be greater, rather than less, availability of naphtha over the next few years.

More than 50% of new vehicle registrations in Europe are of diesel vehicles.

European refiners might have to run harder to make diesel which will result in greater naphtha production. Exporting naphtha and gasoline to the US is going to get even harder because of the country's continuing decline in gasoline consumption.

Refining capacity in Europe might, in theory, be shut down in if the losses on naphtha and gasoline exceed the money to be made from diesel.

But the same mentality applies to refining as petrochemicals: Why be the first, and maybe the last, company to close capacity when there could be another fly-up just around the corner? (The global refining industry fairly recently made tremendous amounts of money as a result of the Hurricane Katrina disaster. The disaster left the gasoline market very under-supplied).

Environmental clean-up costs and contract obligations with customers may also continue to act as barriers to closure (as is again also the case with petrochemicals).

And if more overseas companies such as PetroChina - which recently acquired Ineos refinery assets - buy into the European industry they are unlikely to want to shut down.

The big oil companies are divesting refining assets in order to concentrate on more profitable exploration and production (E&P). A good example was Chevron's sale last week of a refinery in Wales, the UK, to Valero Energy.

Smaller companies such as Valero seem unlikely to want to buy-in and close-down assets.

A further factor preventing capacity being scrapped could be the intervention of governments anxious to maintain national fuel supplies.

If European petrochemical producers, therefore, do not shut capacity down as expected who might be the losers if there is another major economic crisis?

We are going to explore this theme in later posts, but the losers could be the South Koreans and other Northeast Asian producers.

They are facing much-tougher competition for import volumes into China from the Middle East. China's import growth could also slow down due to structural shifts in the economy and greater petrochemicals self-sufficiency.

South Korea, Japan and Taiwan are also entirely dependent on imported oil and heavily dependent on imported naphtha.

Like all scenarios there are a few caveats. Here are a few:

1.) The European economic crisis deepens, forcing further closure of manufacturing industry
2.) The Japanese earthquake and tsunami leads to major changes in the global economy, the scenarios for which are laid out in the post from Paul Hodges - which have linked to above
3.) The high price of propylene results in strong growth of on-purpose production, thereby reducing co-product credits for the liquids cracker players
4.) Continued tightness in C3s leads to PP demand destruction and, as a result, eventual weaker demand for propylene
5.) Co-product credits remain so good that the US makes a major switch to heavier feeds (This won't be naphtha as "heavier" in the US means moving from ethane to propane and butane). This weakens the competitive position of the Europeans

By Malini Hariharan

The paraxylene (PX)-purified terephthalic acid (PTA) market appears to be bearing the brunt of the Japanese earthquake and tsunami. Spot supplies of PX have dried up following the shutdown of three Japanese plants with a total capacity of 950,000 tonnes/year.

Spot PX prices surged to a record high $1,815/tonne CFR Taiwan last week as JX Nippon Oil & Energy declared a force majeure on supplies. PTA prices also rose to a 16-year high of $1,500-1,517/tonne CFR China main port, reports ICIS news.

And further price hikes are likely as a number of PTA plants in China and Taiwan are due to shut down for maintenance in the coming weeks. Additionally, some Chinese companies are planning to bring forward turnarounds following a tightening of PX availability from Japan.

Meanwhile, PTA demand is expected to strengthen in the coming months with around 2m tonnes/year of new downstream polyester capacities starting up in China, writes my colleague Becky Zhang.

She estimates that 1.9m tonnes/year of PTA capacity in Northeast Asia is due to shut down in March and 5.35m tonnes/year of capacity in April.

With cotton prices still running at record highs there appears to be room for polyester to digest the latest price increases. And with peak textile production season approaching, transaction volumes at the China Textile City in Shaoxing rose to 5.1m-5.2m metres/day early last week.

The only concern appears to be the slow buying in the Chinese polyester market as inventories have yet to be depleted.

By John Richardson

CHINA'S polyethylene (PE) market is in such a bad state that re-exports are now being considered to Europe.

The wide disparity between a flat China market and strong pricing in European has created this exceptionally rare arbitrage opportunity, which, according to an industry observer "has happened before, many moons ago, but not on this scale."

Click here for a slide showing an example of this disparity -

EuropeAsiaHDPE23March2011.ppt

Traders left with too much material on their hands have been re-exporting resin for several weeks now to other destinations such as Vietnam, Turkey and Latin American.

What is remarkable, and worrying, is that PE in China has remained flat despite surging raw-material costs on the high price of crude.

This is despite the facts that we are in the midst of a major cracker turnaround season in Asia and a large percentage of Japanese production is down because of the earthquake and tsunami.

So what's going on?

We have already written about the reduction in available credit, a particular problem for small -and medium-sized enterprises, as a result of increased bank-reserve requirements.

Reduced liquidity must have surely also hurt the levels of speculation among traders that has helped pump up the market over the last couple of years.

Two producers, however, argue that while official credit growth had slowed down, off balance sheet lending made the real total of available financing a great deal higher.

Fitch, the credit ratings agency, has said that banks have shifted money off their books through, for example, packaging loans into securitised products. This has allowed them to sustain high levels of lending.

These kind of practices resulted in Rmb11 trillion of new loans in 2009, way ahead of the official figure of Rmb7.9 trillion, according to Fitch.

"The flat China market is more likely to be the result of a general lack of confidence in future lending conditions," said one of the producers.

"Tougher restrictions on property speculation and the end of tax incentives for auto purchases are other factors."

If the government continues to struggle to control inflation for the rest of this year and into 2012, more measures might have to be taken to cool the economy down.

China's Premier Wen Jiabao also recently said: "China will resolutely press ahead with controls on the property market to curb speculation".

He added that the government will "'severely punish" irregularities in the real-estate market, implement differentiated credit and tax policies, and hold local officials accountable for maintaining stable home prices".

Demand in Japan has, of course, also been hit by the earthquake and tsunami.

And here is something else to worry about: Crude oil production in Saudi Arabia has risen to 9.4m barrels a day from 8.4m barrels a day as part of OPEC's efforts to calm troubled markets, said an industry observer.

This could well be turned into more PE for shipment to China, further depleting the market share of the higher cost producers.

OPEC only officially abandonded quotas ten days ago and so it might take a while longer before we see these extra volumes. But given that Saudi Arabia can make money in any market conditions they will run surely run harder once they receive the extra feedstock.

By Malini Hariharan

Japan's benzene supply is expected to drop by 10% following plant shutdowns and diversion of product for gasoline blending, reports my colleague Mahua Chakravarty.

This works out to about 40,000 tonnes/month, which is lower than the initial estimate of 100,000 tonnes/month made immediately after the earthquake.

Traders have started booking cargoes from South Korea to meet the shortfall. But this has not had an impact on benzene prices which have eased slightly this week on poor styrene markets.

Five benzene plants with a total capacity of 1.13m tonnes/year remain shut while some plants are running at reduced rates.

In polyolefins, Japan is likely to import product as plants continue to remain shut.

A Taiwanese producer sold around 2,000 tonnes of linear low density polyethylene (LLDPE) at $1,530-1,535/tonne CFR Japan this week for April shipment, reports my colleague Bee Lin Chow.

Chinese re-export offers to Japan have also surfaced although a gap in price ideas appears to be hindering business.

But it is unlikely that Japanese buying will prop up the current weak Asian market.

Meanwhile, Mitsubishi Chemical has confirmed that it will take a few more weeks to restart its plants at Kashima. Plants at the site include two crackers with a total capacity of 828,000 tonnes/year.

"We are doing all in our power to rebuild, but we calculate it will take at least two months for the plants to go back on line," said the company.

Mitsubishi has started inspecting the plants and also commenced some rebuilding activities. But infrastructure at the site has been badly damaged and that is likely to constrain resumption of operations.

This shutdown is likely to affect operations of other companies at Kashima that rely on feedstocks from Mitsubishi.

Shin-Etsu Chemical said that all operations at Kashima, where it make polyvinyl chloride (PVC), have been halted and inspection has yet to be completed.

Besides damage to facilities that power and water supply at the site has been hit.

"At present, it is still unclear how long it takes to re-start the operations at the Kashima plant," said Shin-Etsu

Kashima Vinyl Chloride Monomer's 600,000 tonnes/year vinyl chloride monomer (VCM) remains shut.

"The plant is likely to remain shut for two to three months as it was quite badly damaged by the earthquake," said a source from the company, which is a subsidiary of Shin-Etsu.

By John Richardson

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

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

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

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

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

Here goes:

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

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

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

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

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

By Malini Hariharan

A question that every butadiene buyer has been asking for a long time is when will prices ease?

There are no signs yet although buyers are threatening to cut production.

Butadiene rose by more than $200/tonne last week to $3,080-3,120/tonne CFR Northeast Asia, reports my colleague Helen Yan on ICIS news.

Prices have been driven up by a number of cracker outages and turnarounds in Asia, Europe and the US. Butadiene supplies have tightened over the last year and the more recent shutdowns at two Iranian plants (Jam Petrochemical and Amir Kabir) and Shell's cracker in Singapore have not helped matters.

Butadiene prices have risen by around 50% since January.

But buyer resistance is on the rise and some are planning cuts in production.

Kumho Petrochemical, Asia's largest synthetic rubber producer, will shut a 70,000 tonnes/year styrene butadiene rubber (SBR) plant and cut operating rates at a second 100,000 tonnes/year plant in May.

Other SBR producers in Asia too are reportedly contemplating production cuts. Additionally, a few SBR producers have planned maintenance shutdowns in the coming weeks.

However, the production cuts may not materialise if high butadiene costs can be passed on. And there are signs that this is happening.

SBR prices in India have crossed $4000/tonne and are likely to remain firm in May, reports ICIS news.

Tyre producers are willing to pay high prices as they expect SBR availability to remain constrained because of production disruptions in Japan.

"We have received enquiries from some tyre producers in Japan. Their suppliers in Japan were not able to deliver their contract cargoes because of power outages and extensive damage to infrastructure after the earthquake," said a Korean SBR producer.

If this continues, SBR and butadiene can continue their upward march and provide much -needed relief to Asian cracker operators who have been hit by weak pricing for other derivatives.

Today, the blog is proud to announce the publication the first Chapter of its new eBook:
'Boom, Gloom and the New Normal: how Western BabyBoomers are changing global chemical demand patterns, again'
It is co-authored with Paul Hodges of International eChem - author of the Chemicals & Economy blog.
A new chapter will be published each month. Please click here for Chapter 1. We hope this will help to build discussion about its key messages.
These are as follows:
• It is most unlikely that we will quickly return to the Golden Age of chemical consumption between 1990-2008
• This was driven by the enormous purchasing power of the Western BabyBoomers (those born between 1946-70)
• They were the richest, and largest generation that the world has ever seen. But they are now moving into the 55+ age group, when people typically save more and spend less
• This is already impacting key sources of chemical demand, including housing and autos. These will not recover to previous peaks
• Equally, the age of outsourcing production to the emerging economies is also coming to an end
• Western demand is reducing, not growing, so there are no longer any capacity constraints to be overcome
• Instead, Western and emerging economies need to adapt to the New Normal, and its very different demand patterns
The eBook argues that the next wave of global growth will not be a simple replica of the past 25 years. Instead, it will require major innovation in business models and technology.
The industry will need to develop a sustained focus on key megatrends such as increasing food supplies, water availability and life expectancy, whilst reducing carbon footprint.
These represent major challenges. But the industry faced similar challenges in the 1970's, and overcame them to launch the Golden Age.
We hope the new eBook will prove valuable for everyone currently working in the global chemical industry. Please click here to download a free copy of Chapter 1. Paul and I look forward to your comments.

Chapter 2 of Boom, Gloom and the New Normal is published today.

In a completely new and challenging analysis we argue:

• The Western BabyBoomers boosted chemical demand for housing, autos and electronics during their peak consumption years between 1980-2000. But this demand is unlikely to be sustained, now they are entering the 55+ age group. A new SuperCycle is therefore extremely unlikely.

• Demographics ultimately drive chemical demand. Japan's BabyBoom took place around a decade earlier than the West's, and may therefore provide useful insight into the likely future course of events.

• Japan's experience post-1990 seems to indicate that stimulus programmes cannot counter the impact of an ageing BabyBoom generation over the medium and longer-term.

• Equally, it suggests interest rates in the major economies could well fall significantly, as the 55+ generation starts to save more and spend less, to fund their potentially lengthy retirement.

• This means funding should be available to tackle the key megatrend issues that will drive the next wave of global growth: ageing populations, increasing food and water supply, and reducing carbon footprint.

Please click here to download this free Chapter. You can also click here to download the 2 page summary article in ICIS Chemical Business.

By John Richardson

THE consequence of either a failure by the US to raise the debt ceiling and/or a downgrading of the country's Triple A debt rating would have obviously have serious consequences for the Asian and global chemicals industries.

Just how serious nobody really knows as we are in uncharted waters.

At the very worst we could be talking about a global recession, even a multi-year depression, according to this excellent article from my ICIS news colleague Joe Kamalick.

"A short suspension of principal or interest payments on the Treasury's debt obligations would cause severe disruptions in financial markets and the payments system," Daniel Meckstroth, chief economist at the US Manufacturers' Alliance, was quoted as saying in the article.

Banks, money market mutual funds and many other financial institutions use the liquidity of short-term Treasury securities to manage cash needs.

"A default would (therefore) suddenly make the market value of Treasury securities difficult to determine, potentially destabilising the financial sector and creating panic", he added.

Even if a default is avoided at the 11th hour, and depending on how the debt limit is raised, the US government's credit ratings may very well be downgraded. Mekstroth warned that this "would hasten the decline of the dollar's role in the international financial system".

A ratings downgrade or an outright default would "call into question the status of Treasury securities as a safe haven for foreign investors", he said, noting that more than one-third of Federal debt is held by foreign governments, the largest being China and Japan.

Analysts at High Frequency Economics (HFE) have warned that a US default or credit downgrade would sharply reduce the value of Beijing's Treasury securities holdings.

If the US - China's top trading partner - had to as a result drastically cut spending, China too could slip into recession.

"We have no doubt the world economy would fold with it," HFE said.

A credit downgrade would drive interest rates up globally, reducing business investment - and in the US, deepening economic problems left over from the sub-prime crisis.

"This debt debate is already further entrenching the pressured US consumer," a US-based chemicals analyst told the blog.

"Businesses aren't hiring and consumers aren't spending.

"The global economy is largely based around the developed world's consumption of goods. Asia is seen as the growth market while the developed nations are the foundation.

"You take away more consumer spending, which would happen if there is a default or downgrade, and it is just a ripple-down to Asia.

Demand for Asian products would drop significantly from US consumers."

China is due to enter its peak manufacturing season in August - when factories making finished goods traditionally ramp-up production ready for the Christmas sales season in the West.

Polyolefin traders have partly justified recent prices rises, and their long positions, on the manufacturing season.

A US default and/or downgrade could therefore lead to a much-weaker manufacturing season and end the polyolefin price recovery, as we have discussed before.

At the very least, until or unless the debt crisis is resolved, the converters are likely to stay largely on the sidelines, leaving the traders with substantial stocks of resin.

"Asian petrochemical producers are high cost producers," continued the chemicals analyst.

"What will US producers do with all their excess material as local demand weakens? Shipping the product to Asia and cratering the market sounds likely."

The US polyethylene (PE) sector has benefited enormously from cheaper feedstock, as a result of shale gas, and the weaker dollar.

A debt default or downgrade is likely to weaken the dollar further, as well as, as we've already said, seriously weakening local demand.

"I don't think the US PE industry has yet to fully realise the opportunity it has to take market share away from their higher-cost Asian competitors," a senior executive with a global polyolefins producer told the blog late last week.

The obvious losers in Asia will be the South Koreans, who, according to a recent Nexant ChemSystems report, are already suffering from margin compression.

Other losers will include the Japanese and non-integrated producers which buy ethylene.

The debt crisis - along with the problems we have highlighted in China - should lead to a re-evaluation of the "2014-2015 peak of the cycle" theory.

Some of the numerous shale gas-based petrochemicals projects that have been recently announced in the US might, as a result, be delayed or even shelved (an industry euphemism for "cancelled").

The good news is that US politicians might have a little longer to reach a deal beyond the widely-publicised 2 August deadline, according to US-based wealth management and private equity company Robert W Baird & Co.

Inflows to the Treasury have been greater than forecast with expenditure lower than anticipated, said Robert W Baird in a fixed income investment note released earlier this week.

"The August 10 date (when it expects the Treasury to run out of money) is not much of an extension but it could provide the White House and Congress valuable additional time to come to an agreement," continued the note.

"However, we do not feel it will be enough to allow the 'warring parties' to come to an agreement on deficit reduction to avoid a ratings downgrade."

A downgrade would raise US long-term interest rates by 25-50 basis points and would also cut GDP growth by 25-50 basis points, it added.

The vast majority of analysts agree with Robert W Baird & Co that a default is unlikely because politicians realise the consequences would catastrophic.

"It would be Lehman Bros crisis times five," added the chemicals analyst.

But, as we have said, a downgrade is bad enough.

"My guess is that they have a triage plan to cut some less consequential payments in the short-term to avoid a default," added a UK-based chemicals consultant.

"But what does this say to the rest of the world about the dysfunctionality of the system?

"It is no longer just waiting weeks to find out who's been elected because Florida couldn't count its hanging chads.

"This is being unable to write a simple letter to the bank manager, asking for the loan to be extended. They've spent the money, so they have to have the loan.

What kind of planet do they think they are living on?"

Hear hear......

By John Richardson

Confidence among Middle Eastern petrochemical producers remains high because they obviously now that as long as oil prices do not collapse they will continue to make excellent money, said a chemicals analyst.

The blog believes that there is a very strong chance that crude will collapse to as little as $25 a barrel as we enter a new global recession. This would result in even the likes of SABIC being forced to think again as petrochemical pricing in turn collapses.

The mood in the Middle East is not only being buoyed by good margins.

"Market share is being gained thanks to the ironing-out of production problems," the analyst added.

As we have reported before on the blog, frequent technical issues at new plants is one of the reasons why petrochemical supply was tight in 2009-2010. New supply was drip-fed into markets rather than arriving in a sudden flood as many observers had predicted, with demand during the recovery from the late 2008 crisis bolstered by government stimulus packages.

Many of the technical problems look as if they have been resolved, resulting in a substantial surge in exports from the Middle East, the analyst added

"Overall petrochemical exports from the port of Dammam in Saudi Arabia were substantially higher in August compared with July," he said.

"We have seen a steady improvement in output throughout 201l with no one notable exception - Saudi polypropylene (PP).

Technical problems at the 450,000 tonne/year Al-Waha Petrochemical plant forced a shutdown on 1 July with production resuming in August, according to our colleagues at ICIS news.

Operating rates at National Petrochemical Industrial (NATPET), a 400,000 tonne/year operator, were reduced in July in order to resolve problems at the plant.

And Petro Rabigh - the 700,000 tonne/year producer - underwent an extended turnaround in an effort to resolve issues at its deep catalytic cracker that ended in August, ICIS news was also told.

PP output is up at all three plants as demand in China takes a battering from a sharp slowdown in auto sales.

An overall increase in Middle East petrochemical output is occurring as governments pull back on economic stimulus - most importantly in China.

Polyethylene (PE) trade data from China for H1 of this year show the big gains made by the Middle East as overall demand fell by 2.5 per cent.

The rest of this year does not look good for the higher cost producers in Japan, South Korea and elsewhere as there are no indications of China easing back on its battle against inflation,

And for everybody, including even the Middle East, it is hard to find reasons to be optimistic about 2012.

By Malini Hariharan

The going has been good for the refining industry this year but analysts are predicting a weaker 2012 and 2013.

UBS for instance, expects complex refining margin in Asia to fall 20% in 2012 from the average $8/bbl forecast for 2011. And it expects 2013 to be even weaker with average margin of $6/bbl. The key reasons for the downtrend in margins are:

* Addition of new capacities mainly in China and India. UBS expects nearly 1.1m bbls/day of capacity to be brought onstream in 2012-13

* Full recovery in operating rates in Japan after the March earthquake and tsunami. UBS estimates that around 470,000 bbls/day of refining capacity was lost in Japan in 2011 which is around 10% of the country's total refining capacity. Most of the affected refineries have restarted but two (Cosmo Oil in Chiba and JX Nippon at Sendai) are expected to resume operations only in the first quarter of 2012.

* Depressed demand growth as a result of a weaker global economy. UBS projects that Asian demand is likely to increase only by 900 000 bbls/day during 2012-13.

The average operating rate in this region is projected to decline yo 85.9% in 2012 and 85.3% in 2013 from 86.6% in 2011.

The last quarter was an unexpectedly strong period with complex refining margins at $9.2/bbl as firm demand from China and Japan coincided with unplanned shutdowns like the one by Formosa Petrochemical in Taiwan. The company was forced to shut its refinery in early August after an accident. It has since restarted production but operating rate is still below 100%.

The good times for Asian refiners are not expected to last very long. But the only consolation is that margins are not expected to fall to the bottom of the refining cycle experienced in 2009. This was the year when the average industry operating rate dropped below 82% and complex margins touched a low of $3.7/bbl.

By John Richardson

CONFIDENCE can be very relative. So, compared with late Q4 last year when global cracker and derivatives markets ground to a virtual halt, perhaps it was inevitable that January would see some kind of rebound in the industry's mood.

Deep operating rate cuts in Northeast Asia have been a factor behind this return in confidence. In late December, Northeast Asian crackers were said by one chemicals analyst to be running at 85 percent, including most significantly some of Sinopec's ethylene plants. If Sinopec had indeed cut back to such a level, this would represent a radical change in approach for a company that has always previously run at 100 percent, regardless of market conditions, in order to keep its customers adequately supplied.

"Rate cuts to the mid-80 percent range would give the Northeast Asians considerably market muscle as we enter the post-Lunar New Year period. Once you get below 90-92 per cent, this is when producers begin to wield control over markets," said a senior executive with a global polyolefins producer.

Producers need a strong price recovery to regain margins that slumped very badly last year, mainly because of a very bad Q4. Polyolefins demand in China was weak from March-April. However, margins were held-up by strong butadiene and propylene co-product credits until the fourth quarter, when butadiene and propylene prices declined very sharply. High crude oil prices have added additional pressure.

This "needs must" situation could therefore be behind the apparent improved confidence among producers.

Modest pre-Lunar New Year polyethylene (PE) and polypropylene (PP) price rises are also said to be mainly the result of increased buying by local traders in China. This suggests that the traders also have a motive to "talk" up the market.

Chemicals analysts are playing their part as they talk about strong price recoveries in China, resulting from restocking and the Chinese government's "pro-growth" approach. But while this might result in an improvement in chemical stock prices, this will not necessarily mean that their arguments stack-up.

In Asia, you need to also consider the following:

1.) The risk that hard-pressed naphtha-based crackers producers will, at the first sign of a strong price surge, rapidly increase operating rates to well above 90 percent. There is talk about a "new realism" among the Northeast Asians, but they might quickly return to the old approach of fighting to regain lost market share.
2.) Global capacity additions in the biggest of all the cracker derivatives, polyethylene (PE), are few and far between in 2012 - potentially below demand growth. But there is a substantial amount of new capacity due on-stream in Saudi Arabia in H1, and this year's Asian cracker turnaround season is lighter than in 2011
3.) "Pro-growth" in China will also be relative to 2011, when the government was forced to drastically restrict bank lending. As we have said many times before, Beijing has very little freedom to boost liquidity anywhere close-to the misleading levels of 2009-2010. This year's official bank lending is expected to be 5 percent higher than in 2011, but it also worth noting that most bank lending tends to take place during the first half of each year. And the export environment for manufactured goods looks set to remain weak.

In Europe, too, the cracker business benefited from deep operating rate cuts. Rates were as low as 75 percent in Q4 and have since returned to 85-90 percent, in response to stronger buying by end-users.

But in the European polyolefins business, there is no firm evidence that this stronger buying represents a real demand improvement versus restocking in anticipation of further price increases. February ethylene contract prices have been settled €99/tonne higher than in January, with propylene contracts up by €90/tonne. Attempts at further increases seem likely if the current mood persists.

By John Richardson

AS the US contemplates raising its ethylene capacity by up to 29 percent by 2017, we would be fascinated to know whether the companies involved in these proposed expansions, and the "cheer leader" chemical industry observers spurring them on, have ever considered a chart such as the one below: 

First used in workshops during our New Normal seminars last year, the slide illustrates the point that petrochemical projects outside the West are not always only about economics. They are also about the Michael Porter concept of  'Shared Value', which we discuss in our e-book, involving delivering wider benefits to society.  

The Japanese built petrochemical plants in the 1960s onwards to achieve security of supply of raw materials for auto and other downstream industries. Building these plants was not always, therefore, only about the economic efficiency of the plants themselves.

Then came the South Koreans who followed the same model, and to some extent Thailand through its petrochemical master plans in the 1980s and 1990s.

Now we have a new wave of projects, which are also at least partially "social and political" - i.e. they have a wider agenda beyond just making money.

China has aggressively expanded its petrochemical industry, again for security of supply reasons. Sinopec has a poor rate of investment return from it petrochemicals business, as making money is not its main objective. Instead, it has been tasked by the government with once again guaranteeing supply of plastics etc to the country's vast manufacturing industry. This is why, even when market conditions are bad, Sinopec still tends to run its plants flat out.

The Middle East petrochemicals industry has, up until now, been a license to print money, thanks to feedstock-cost advantages. But its new agenda is also social and political through cracking heavier feeds, including naphtha, enabling downstream diversification, as the region seeks to create jobs to deal with the challenge of youthful populations.

And finally, there is Petronas and its $20bn Refinery and Petrochemical Integrated Development (RAPID) project, which is set to include a 300,000 barrel a day refinery, a worldscale cracker and a wide range of derivatives, including speciality chemicals. We are not saying that the project, due on-stream at end-2016, will not make money. But is the objective entirely about profitability, or is this again partly to do with nation building? Strong government support might be one reason why foreign investors are reportedly queuing up to invest in RAPID.

If you are sitting in Houston, contemplating an expansion based on low-cost shale gas-based ethane, you need to think about how many of these social, or semi-social, projects will be built over the next decade. The assumption that you will always be able to export your surpluses to an ever-hungry booming Asia - and to Latin America where "nation building" is also on the agenda - has to be questioned.

Your assessments of whether or not a rival project is going to be built cannot just take into account supply and demand analysis.

Evaluations will have to be also based on your relationships with senior government officials, and other policy and agenda setters, and your understanding of what is driving their decision-making. If you don't develop this type of market intelligence, you are in for some nasty surprises when uneconomic projects go ahead. These are global markets, of course, and so what happens in Guangdong can matter as much, or even more, than what happens in Louisiana.

Further, when your new plant is up and running there will obviously be periods when markets are bad, leading to pressure for operating rate cuts.

How do you respond when your competitors in Asia, and in Latin America, are still running at 100 percent?

And in a broader sense, what does it mean to be confronting competitors who don't care about losing money?

Perhaps everyone in Houston has thought this through, but none of our discussions, and nothing that we have read, points this way. Apologies if we have missed something.

By John Richardson

EXACTLY the same scenario is playing out in European polyolefin markets, as in Latin America and possibly the US, my ICIS colleague Linda Naylor reported last Friday.

High polyethylene (PE) and polypropylene (PP) prices in Europe have led to increased offers for re-exported material from China, according to Linda - our European ICIS pricing polyolefins editor.

"Yes, there are imports at present, but I don't think they will ruin the European market," said a European PE producer in the same article. "It won't be European prices falling, but Asian ones going up. Chinese PE producers can't survive at this level. They will have to cut production."

Reports from one chemicals analyst, of heavier naphtha purchases by Asian cracker operators during January, which we discussed last week, suggest more rather than less supply.

Perhaps the naphtha cracker players believed stories of a strong post-Lunar New Year Chinese rebound, and/or stronger butadiene and the prospect of stronger propylene and PP on resumed auto production in Thailand persuaded them to buy more naphtha.

Whatever the reasons, the extra naphtha cannot sit in tanks forever and so, if our analyst is correct, Asian cracker operating rates might be set to increase.

On paper, we noted last Thursday that the Middle East, despite market comments to the contrary, was not undergoing a heavy turnaround season.

Now we understand that a high number of outages in January and February helped support pricing, as this article from another of my ICIS colleagues, Ong Sheau Ling, illustrates. These technical problems have come to an end, removing that support.

Plus, as we again said last week, the start-up the ChevronPhillips joint venture high-density PE (HDPE) and polypropylene (PP) plants in Saudi Arabia are imminent. Distributors and end-users are also aware that around 1m tonnes/year of PE from the new ExxonMobil complex in Singapore is scheduled to hit the market at some point this year.

As supply lengthens, the China market is still showing no signs of the strong post-Lunar New Year rebound that so many people had predicted. ICIS assessed pricing as flat last Friday, other than low-density PE (LDPE) which declined by $20/tonne. Labour and credit shortages, and concerns over the global economy, continued to affect sentiment.

Meanwhile, margins came under further pressure, according to the ICIS pricing Weekly PE Margin Report. Integrated HDPE margins for the typical Asian naphtha cracker in our model fell by $73/tonne for the week ending 17 February, on flat HDPE pricing and a rise in naphtha costs.

Eventually, perhaps, the European PE producer might be proved right once the Asian cracker operators have used-up their extra naphtha supplies. They might then make deep reductions in operating rates to bring the market into better balance.

But even during Q4 last year, when markets were exceptionally bad, Northeast Asian rates were only lowered rates to around 85 percent compared to 70-75 percent in Europe.

The Northeast Asians have a long history of chasing market share rather than keeping a tight lid on production during periods of market weakness - and in China, producers there tend to run for social as much as economic reasons. We have picked up no indications that this has changed.

The $64,000 question right now is whether European and US prices might be dragged down by Asia, rather than the other way around.

The New Normal involves three major transformations in the nature of consumer markets, which are:

• The increasing size of the New Old 55+ age group in the West.

• Too many young people struggling with higher unemployment.

• Large number of people moving out of poverty in the developing world.

These are the great opportunities for future growth, if our economy can be adapted to serve their needs. Chapter 9 of our new 'Boom, Gloom and the New Normal' e-book looks at the implications for chemical manufacturing.

Today, and in the future, we need to focus on the megatrends which will drive future demand growth.

In the fields of water and food, we should focus on reducing the amount of waste, and the output that is lost when product is moving to market.

In developing new products and services for the over 55s, we should focus on core needs, such as food, water, health, shelter and mobility.

This will enable us to 'do more with less'. We will reduce carbon footprint, and enable output to be afforded by the maximum number of people.

These changes in market drivers will have a profound impact on how, and where, products are manufactured.

Manufacturing processes will need to change in many companies as we transition to the New Normal. Quality will matter more and more as we move away from the 'throwaway society' of the past couple of decades.

So will approaches such as Process Intensification. This involves reducing the size of chemical and plant equipment, and can often enable companies to lower capital and operating costs whilst reducing waste.

The chemical industry has long been an enthusiastic champion of the importance of Quality management. It was one of the first to appreciate the importance of the concept of the 'learning organisation' that was originally brought to the West from Japan.

But in the early 2000s, the Quality movement seemed to stall. Many of the people who had launched this revolution retired. More worryingly, some companies began to forget that Quality was a process, and had to be reinforced by senior management at every possible opportunity.

Now, we need to relearn that having the right corporate philosophy is the critical starting point. This includes a focus on benefiting wider society, good leadership, and on rooting out inefficiencies through getting everybody involved in processes and problem solving.

Chapter 9 will hopefully help companies to ensure that manufacturing delivers the competitive advantage that is required as we transition to the New Normal.

FREE DOWNLOAD OPTIONS FOR CHAPTER 9

Click here to download a 2 page summary of the Chapter.

Click here to download the full Chapter.

Click here to view the 6 minute video with Paul Hodges.

By Malini Hariharan

The drama continues in the Asian butadiene market. Bids this week are about $100/tonne lower than sellers' price ideas, writes Helen Yan in an ICIS news report. Buying indications have dropped to $3,350-3,400/tonne CFR Northeast Asia.

Butadiene prices appear to be going through another downcycle, reflecting the fundamentals of a market that it is structurally tight over the long term.

Spot butadiene prices have fallen steadily, from a peak of $3,900-4,000/tonne in early February, on strong resistance from buyers who have been unable to pass on the price hikes.

The average butadiene price in February was $3,800/tonne CFR NE Asia, as against $3,700/tonne for polybutadiene rubber (BR). BR producers usually need a price delta of $600-700/tonne for profitable operations.

Several downstream styrene butadiene rubber (SBR) and BR producers in China, Japan, South Korea and Taiwan have already cut production, and this has started to affect butadiene markets.

Traders are also holding back purchases in anticipation of further decline in butadiene prices. A sale tender for a 2000 tonne butadiene cargo for March loading is said to have drawn little buying interest.

The shift in the butadiene market comes at the worst possible time for Asian naphtha cracker operators, as their margins have been squeezed by the rapid rise in feedstock costs.

As we discussed earlier this week, Northeast Asian integrated high-density polyethylene (HDPE) margins have fallen to their lowest levels since ICIS records began. Low-density PE (LDPE) margins in Northeast Asia slipped into negative territory for the first time since we started tracking the data.

The cost push has even forced Sinopec to trim operating rates at its crackers.

Polyethylene (PE) prices have inched up this week in China on improved buying sentiment. But the margin squeeze is unlikely to ease if naphtha continues to climb.

By John Richardson

NEW banking regulations could severely restrict the ability of small and medium-sized (SMEs) companies to access trade finance. This would hit Asia particularly hard, as the majority of chemicals and polymer business involves SMEs.

Under the Basel III regulations, due to be phased in from next year, a three-month trade finance loan will be treated the same as a one-year loan. This will force banks to hold more top quality capital against this type of lending, according to the Financial Times.

This is deterring some banks from staying in the trade-finance business and could increase the cost of letters of credit by 300 percent or more, adds the newspaper.

Some French banks have already decided that the extra regulatory burden is not worth it, and so they have withdrawn from the trade-finance business, says the FT.

"Basel III's implementation could have unintended consequences for trade financing through the proposed leverage ratio, which would require banks to set aside 100 percent of capital for any off-balance-sheet trade finance instruments, such as letters of credit," says the World Bank.

"This is five times more than the 20 percent credit conversion ratio used for trade finance in Basel II. New capital regulations would also require banks to set aside capital for one year for any instrument, even though that security may carry a maturity of under a year. Most trade finance instruments have maturities of about 90 days; this would triple the capital cost of such instruments."

Trade finance volumes could fall by 6 percent, representing a $270bn a year reduction in global trade and a 0.5 percent decline in global gross domestic product, the World Bank adds.

'Eighty-five per cent of all letters of credit will have Asia at one end or the other," said Andy Dyer, managing director of transaction banking in Asia Pacific for ANZ, in this article in Singapore's Business Times.

By John Richardson

THERE is a lot of talk at the moment about on-purpose butadiene, via the butane dehydrogenation process, because of the recent extreme market tightness .

The tightness is the result of a shift to lighter cracker feedstocks and reduced operating rates at naphtha crackers in Europe.

Future feedstock patterns are also not expected to aid the availability of co-product butadiene.

The surge in ethane availability  in the US, via shale gas, has led to announcements  for up to a 29 percent addition to the country's ethylene capacity by 2017. Ethane feedstock for steam cracking, of course, yields very little C4s and therefore butadiene.

And in China, the rise of coal to chemicals - again replacing what would have otherwise been naphtha-based petrochemicals capacity - is no help. The coal-to-methanol-to-olefins and coal-to-methanol-to-propylene processes yield very little, if any, C4s.

Hence, Texas Petrochemicals is planning to bring a 270,000 tonne/year butadiene plant -based on its butane dehydrogenation process - onstream in Houston,Texas, by 2016.

"There are also two butane dehydrogenation projects in China that we know of, and perhaps a few more," said an industry source.

In addition, Asahi Kasei Chemicals plans to produce butadiene from butene, via its new BB-FLEX technology. The company is considering building a 500,000 tonne/year plant in Mizushima, Japan, based on the process, for start-up in 2014.

It is not only tight supply that is justifying all this interest in on-purpose butadiene, but also claims of booming autos demand.

"Autos demand is growing very rapidly and, of course, in countries such as China you now have a much bigger demand base for replacement tyres," said the industry source.

"And so even if you don't get much auto demand growth, which has been the case in China over the last two years, replacement tyres are still sufficient to ensure a lot of demand. Sixty percent of global butadiene demand is accounted for by the need to replace tyres."

Natural rubber supply has also been constrained over recent years because of the switch to more-profitable crops such as palm oil.

It takes 7-9 years for a rubber plantation to reach maturity, and so it will take a long time for the recent rise in butadiene prices to result in a compensating surge in natural-rubber availability.

The conventional wisdom, therefore, is that butadiene is a fantastic investment bet.

"At the moment, yes, I agree, but it would only take a few of these on-purpose plants to be built and the market would be oversupplied," said a synthetic rubber industry executive.

"And don't assume that that the Western mindset applies to China. It might continue to add capacity, even when the market is close to balance or already oversupplied, because of access to cheap capital."

By John Richardson

The 6% decline in apparent polyethylene (PE) demand in China from January to April this year, compared with the same periods in 2011 and 2010, underlines what market participants have been telling the blog for many months.

The above chart also further emphasises how, in a weak market, the Middle East is gaining a bigger market share.

Its 33% increase in exports to China occurred as hard-pressed Northeast Asian (NEA) naphtha cracker operators saw their share of exports fall by 40%.

This was the result of:

*Increased Middle East production. What is worrying is that there is even more on the way.

*The ability of the Middle East, because of its tremendously strong feedstock-cost position, to cut prices sufficiently to meet the demands of China's struggling plastic converters. Meanwhile, of course, NEA competitors, confronted with high oil and therefore naphtha costs, have been unable to compete.

Further evidence of just how difficult life has become for China's small and medium-sized enterprises, which make up the majority of chemicals and polymers buyers, emerged late last week. Bloomberg reported that China's biggest banks may fall short of central government-directed lending targets for the first time in at least seven years. Last month, total bank lending declined by 33 percent compared with March, and May could be even worse.

The problem isn't the availability and cost of credit, but rather the unwillingness of businesses to borrow money. This suggests that unless business confidence improves, further reductions in the bank-reserve requirement and cuts in interest rates may not make much difference. Right now, it is hard to see how confidence can improve.

Interestingly, Southeast Asia, which is, of course, mainly a naphtha-cracker region, saw its PE exports increase by 16 percent. This is likely the result of the ASEAN-China Free Trade Area.

And very interestingly, North American Free Agreement (NAFTA) exports were down by a full 61 percent. To what extent was this the result of supply and demand being well-balanced in the US and Canada versus exceptionally weak markets in China? If the latter turns out to be the main factor behind the decline this just shows how bad conditions are, as NAFTA should on paper be in a very strong position because of very-low ethane costs.

Meanwhile, macroeconomic conditions just keep getting worse.

For example, real estate prices are now falling in more than half of China's top 70 urban areas. Fixed-asset investments have increased so far this year at their slowest pace since 2001.

The fall in fixed-asset investments supports our belief that major structural changes in China's economy are a significant drag on growth.

A Chinese cabinet adviser admitted, again late last week, that "a sharp slowdown in the economy" was taking place.

Asian PE prices were down by $10-60/tonne and polypropylene (PP) $20-50/tonne lower for the week ending 25 May, according to ICIS pricing.

Source: ICIS pricing Weekly Asian PE Margin Report

By John Richardson

The slide above shows how Northeast Asian naphtha-based polyethylene (PE) producers are struggling as a result of the weak China market (dark blue bars).

And it confirms what we were discussing yesterday: The US, with its ethane advantage and with reportedly high producer inventories, is in a very strong position to export to China (light blue bars).

Northeast Asian operating rate cuts have clearly not been enough to restore profitability.

"One Japanese producer, for instance, is talking of overall PE production cuts of as much as 30 percent, but I still feel that this is not enough," said an industry source.

"Formosa closed its No3 1.2m tonne/year cracker down for market reasons, but that was only for a couple of weeks. I feel we need long-term closures," he added.

And he said that Chinese state-owned producers continue to lose money.

"They are still running their plants as utilities to guarantee supply to downstream industries and are, thus, matching Middle East import prices at $300-400/tonne beneath their costs."

The chart also shows the improving margins of European producers (purple bars).

"European margins are good on low naphtha costs and favourable exchange rates for exports," said the ICIS European polyolefins editor, Linda Naylor.

"A lot of PE and polypropylene (PP) is being exported - for example, one producer plans to double its PP exports.

"Some producers have been considering production cutbacks, but for most of the producers, margins are too good to curtail production.

"But everyone is expecting a fall in July ethylene and propylene contract prices, which, I think, will impact margins and prompt cutbacks.

"Buyers are concerned that production cuts in July/August, along with increased exports, will tighten the market and drive prices up again in September and October."

By John Richardson

IT is the demand for loans that matters in China these days more than their supply, as chemicals markets have been telling us for over a month now.

And now, statistical back-up for our anecdotal evidence, that China's economy has turned an important and worrying corner, has been provided by a new Citi Investment Research report on the auto market.

"China growth has slowed sharply in recent quarters - from an annual GDP (gross domestic product) growth rate of almost 11% to just 8.5% currently, with the FY12 official target coming down to 7.5%," wrote the bank.

"China money supply has slowed sharply, and official loan targets, so easily exceeded in previous years, are now being missed on a monthly basis. It seems the demand for loans and investment in the Chinese economy has slowed sharply. Without this investment, China GDP should continue to slow."

China money supply growth growth

Source: Citi, Bloomberg

The construction market, one of the main reasons why chemicals and polymer demand growth was so strong in 2009-2010, continues to slow, said Citi. Growth in chemicals and polymers has now entered negative territory. 

"China April construction data was weak. Although home sales declined a bit less than in previous months, sales of commercial property fell much more sharply, as did new starts and land sales," added the bank.

"Given that construction accounts for a large slice of the Chinese (or any emerging market) economy, these declines suggest GDP remains under pressure.

"The question is whether China policy stimulus (reserve requirement cuts and more) will once again save the day. We would be cautious for now."

And on the main theme of the report - autos - Citi said that sales in China had slowed sharply over recent months, driven by lower sales of commercial and light vehicles and by falling sales of locally produced vehicles.

Source: Citi, CAMA

"Generally speaking, mass OEM JV sales have remained flat year-on-year, and premium brand sales have sharply beaten the market. BMW has performed best of all.

"However, especially given the housing data, we fear that the best months are behind us on this front."

Interestingly, also, Citi raises a question mark over the conventional wisdom that there is still huge potential for further auto-ownership growth, particularly in the developed eastern region of China.

"Although (nationwide) ownership penetration in China remains low, at 60 cars per 1,000 drivers, annual sales have doubled since FY09 to around 24 per 1,000 drivers," continues Citi.

"This is similar to Brazil levels, and compares with around 40 in Europe or Japan.

"Given development variance between China east and west, this suggests China eastern annualised sales per 1,000 drivers are getting very close to Western levels already - even if the fleet remains small relative to the population."

Source: New York Times

By John Richardson

INVENTORIES of finished goods are mounting in factories across China as manufacturers continue to run hard, according to this New York Times article - perhaps in the hope that in 3-6 months time, everything will be alright again.

"My supplier's inventory is huge because he cannot cut production - he doesn't want to miss out on sales when the demand comes back," Wu Weiqing, the manager of a faucet and sink wholesaler, told the NYT.

Here is another explanation, from Forbes:

"It is more likely that Wu's supplier has been told by the local government to keep production lines going no matter what.

"And why would city and municipal officials do that? For one thing, local officials don't want to deal with unrest that idle workers cause. Moreover, lower-level cadres are judged by growth in their districts. The value of a sink sitting in a factory's inventory, even if never sold, is counted as gross domestic product."

Carmakers have solved their inventory problems by forcing dealers to take autos they cannot sell, adds Forbes.

"Inventories at the dealers in the first six months of the year increased by 900,000 units. These retailers are now carrying 2.2 million cars in their showrooms. Even with dealers taking unneeded cars, the manufacturers are operating at around 65 percent of capacity when 80 percent is thought to be the breakeven point," continues the magazine.

And yet, underlining our argument about the difficulties in changing China's investment-focused growth model, auto production capacity keeps on increasing.

For example, over the next three years, auto production is set to rise by an amount equal to all the factories in Japan, and nearly all the factories in the US, says the central government's National Development and Reform Commission.

And what is Beijing's solution to the problem? Manipulate inventory data, according to both the NYT and Forbes as politicians try to understate the scale of the problem. This might well be motivated by the desire to keep a lid on social unrest during the leadership transition.

But the HSBC Flash PMI for August shows that inventories climbed by their fastest rate since the survey began in April 2004.

 By John Richardson

LET'S put this into context: China's polyethylene (PE) demand grew by 53 percent in 2008-2010.

Growth during the first seven months of this year was just 1.7 percent over Januuary-July 2011, according to Global Trade Information Services (GTIS).

And when compared with the same seven months in 2010 growth was flat, as the above chart illustrates.

Also compared with 2010:

*Middle East shipments to China surged by 40 percent, The big winners in the region included Iran (up 24 percent as more ethylene has been polymerised to avoid sanctions) and Saudi Arabia (23 percent higher). Saudi production has increased on greater availability of associated gas.

*New capacity in Thailand resulted in a 131 percent rise in the country's exports, as Southeast Asia as a whole gained 27 percent.

*South Korean exports were down by 21%, which further underlines the problems confronted by the region's higher-cost exporters. Overall Northeast Asian exports were down by 32%. 

There is something seriously wrong when demand is so much below GDP growth, which was 7.6 percent in Q2.

This reflects lingering inventory problems in all the synthetic resins (the demand growth story is likely to be very similar for the other resins).

And, as we discussed on Monday, stockpiles of finished goods are increasing as the economy slows down.

A further problem for the poylolefins business is that supply is set to increase next month, when the first on-spec shipments from the Saudi Polymers plant in Saudi Arabia are expected. The facility includes two 550,000 tonnes/year high-density PE (HDPE) units and one 400,000 tonne/year polypropylene (PP) plant.

Source: http://www.economist.com/

 By John Richardson

RISING China labour costs are compounding weakness in the manufacturing sector and thereby, of course, damaging chemicals and polymer markets.

The country's garment exports fell by 0.2 percent in the first seven months of this year, compared with a 24 percent increase in January-July 2011, says the Association of Chinese Textile Exporters.

China's garment exports totalled $250bn in 2011, which could well mark an all-time peak as China tries to move up the manufacturing value chain - a key objective of its 12th Five-Year-Plan (2011-2015).

Meanwhile, the association estimates that Japan's imports of garments from Southeast Asia rose 22 percent in H1 2012. What is China's loss is a gain for countries such as Vietnam, Indonesia and Bangladesh that have lower labour costs.

But, of course, the timing for China could not be worse. The impact of higher labour costs is occurring at a time of weak global growth. This was reflected in the final reading of the HSBC August China purchasing managers' index, which fell to its lowest level in three years.

As China's textiles industry struggles, a great deal of new domestic purified terephthalic acid (PTA) capacity is being brought on-stream. Eleven new plants are due to start-up over the next three years, with a total capacity of 18.5m tonnes/year. The country's total PTA capacity is due to reach 39m tonnes/year in 2015 - double that of 2011, according to ICIS.

These new plants will benefit from low-cost local supply of paraxylene (PX), and are likely to have also benefited from cheap financing.

The outlook for exporters of PTA to China is therefore not good.

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

By John Richardson

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

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

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

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

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

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

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

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

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

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

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

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

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

Marc Faber

Source of picture: http://www.cliffkule.com/2011_06_26_archive.html

By John Richardson

RECENT action by Western central banks will result in more hot money flowing into Asia, creating further asset-price bubbles.

Last week, the Fed launched QE3 and the previous week, the European Central Bank launched its bond-buying programme.

Equity markets in China could also surge by 10-20 percent, as they are relatively undervalued compared with the stellar-performing US market, says international investor Marc Faber, in this video.

Faber makes the point that the super-rich will search the world for undervalued assets, generating tremendous returns for themselves.

But he added that it was a "complete fallacy" that Western central bank action had already or would in the future benefit the average person in the street.

In fact quite the reverse will happen, as the super-rich become even richer at the expense of everybody else - until the world economy collapses, warns Faber.

For example, property markets could well take off again in China, as could speculation in chemicals and polymers, as all the hot money seeks strong returns.

The existing high cost of homes in China's major cities is already a cause of social tension, said to be one of the factors behind the anger being vented against Japan over the East China Sea islands dispute.

China might face a tough choice: Either allow all this hot money to further inflate and distort its economy, or impose restrictions on the flow of overseas funds.

Perhaps it might decide to "join the party" by launching a big new economic stimulus of its own, in an attempt to deal with its industrial slowdown.

Living with inflation in excess of 5 percent per year would carry significant political risk - because of increased resentment over an even wider gap between the rich and the poor.

At the moment, though, it seems as if China cannot take major economic policy decisions, as it is too wrapped-up in its highly contentious leadership transition.

At the level of petrochemicals markets in China, which, of course, reflect the real economy, rather than the surreal world of super-rich investors, the demand outlook remains incredibly bleak.

The commodity polyethylene (PE) market, in terms of profitability, is the worst it has been in 15-20 years, we have been told.

PE prices were this week said to be as little as $50/tonne above the cost of ethylene, reflecting the inability of producers to fully pass-on the surging cost of oil.

And, of course, oil has gone up not because demand has got better, but rather because of all of that hot money flowing into commodities.

Source of picture: Flickr

By John Richardson

"How do you put the genie back in the bottle?" asked China scholar Victoria Hui in this New York Times article, referring to the difficulty that China now faces in stepping away with something tangible from its dispute with Japan over the East China Sea islands.

Japan might not be able back down either and so the risk here, as we discussed last week, is that this could escalate into a military conflict with the US obligated to support Japan. Most other Asian countries could end up backing the US.

What is really motivating Beijing in all of this?

"For a long time, the legitimacy of the Chinese government has been based on two things," wrote Deng Yuwen, an editor at Study Times, a magazine run by the Communist Party's Central Party School.

"One is high-speed economic growth. The other is patriotism and nationalism,"

Now that economic growth is slowing, he added that "the Chinese government very possibly may become increasingly dependent on nationalism and patriotism."

Let's hope that both sides can find a face-saving compromise and that the crisis is, as a result, defused.

Meanwhile, as long as this political crisis rumbles on, everybody down all the petrochemical value chains might be well-advised to keep their raw material inventories at minimum levels.

The temptation, as oil prices rise, is to "buy forward", but one chemicals industry source told us: "If some kind of conflict did break out, oil prices and stock markets, which move together these days, would, I think, halve in value overnight.".

By John Richardson

THE collapse in Japanese auto sales in China, a result of the East China Island dispute, is just the first phase in what could be a very damaging economic war, the blog understands.

Phase two could be the imposition of trade barriers against Japan by an increasingly hard line Chinese leadership eager to divert attention from economic problems at home.

"China may make Japan an economic victim by keeping the Yen high. It has warned in the press that it might inflict another 20 years of economic hardship on Japan," said a chemicals industry source.

China has always sought primacy in the region, the blog understands. Its refusal to devalue the Yuan from 1994 onwards, when everyone was pressing for a devaluation, was meant to dethrone Japan.

And as long as the dispute continues, the risk of military conflict remains.

There is a further very worrying consequence: Hardliners in China are thought to be using the dispute to cement their position ahead of the upcoming Politburo leadership transition.

Hardliners are more than likely to be conservatives, anxious to prevent economic reform.

If economic reforms fail, the prospects for long-term growth do not look good.

 By John Richardson

THE Japanese economy is at great risk from the East China Sea  dispute which, if  unresolved, could result in a long and bitter trade war with China, said several chemicals industry sources.

Japanese electronics and auto companies could even be forced to leave China, they warned.

"If the Chinese kick Japanese companies out of China, which I think could well happen, the Japanese cannot take their land, their equipment, and, most importantly, their technology with them," said one source.

"China has been very clever. It has learnt technology and sales and marketing skills from Japan, and so if the Japanese companies were forced to leave, China could easily replicate their capabilities.

"The Japanese decision to nationalise the islands, which triggered the dispute, was therefore very unwise. China has the upper hand in this relationship.

"Japanese chemicals and polymer companies would suffer very badly in the event of a trade war as they are the preferred suppliers to many of the Japanese electronics and auto producers. "

The country's auto manufacturers are attempting to compensate for a decline in China sales through boosting volumes in India.

But India is very different market with a very different set of sales and distribution challenges. In addition, the size of the Indian market is dwarfed by that of China.

Meanwhile, concerns remain over the danger that the dispute could escalate into a military conflict.

If a war does break out, some industry sources forecast that oil prices would quickly jump to $120-150 a barrel and petrochemicals prices would go up in response, before retreating on further damage to already weak demand.

This may all sound a little sensationalist, but you can trust us that this is an accurate account of one of the many worries for 2013.

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

By John Richardson

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

By John Richardson

BEFORE we look at last week's political handover in China in more detail tomorrow, while on Friday we will return to our theme of Asian demographics, the above slide illustrates what the big picture has meant for the polyethylene (PE) industry.

As you can see, variable-cost margins for Northeast Asian producers fell into negative territory in September-October and have only slightly recovered in November, according to the ICIS Asian PE Margin Report.

"All of Asia's naphtha-cracker operators are losing money," said a PE industry source.

China's plastic converters ran their factories at low operating rates and were reluctant to invest in new capacity immediately ahead of the handover. This, of course, also applied to many other industrial sectors. This has been one of the reasons for the weak market.

A theory being put forward was that if the right "pro-growth" leaders were selected, China would return to its previous strong growth trajectory by as early as Q2 next year (once the new president and prime minister have formally taken office).

Traders live and die by volatility and so this kind of story can serve their short-term objectives.

But the long-term reality is that regardless of the composition of the new Standing Committee, we had long felt that China faced a protracted period of much-lower GDP growth because of its economic imbalances.

Nothing has therefore, of course, changed followiing last week's political transition.

And, as we shall discuss tomorrow, many commentators worry that China's new leaders will fail to deliver.

The country's ageing population is one of the new Standing Committee's many challenges.

This is one of the factors behind rising wage costs that have led to a low-value manufacturing drift away from China, thus weakening PE consumption.

Higher-cost producers always suffer in a weak market, as the chart above indicates. China's PE demand growth was just 4% in January-September this year.

We can see no reason why next year will be any better.

By John Richardson

SOUTH Korea serves as another example of how demographics are reshaping Asian economic prospects.

"By 2018, 14% of its population will be over 65, making it officially an 'aged society.' That is six years sooner than Japan and more than a century before France, according to the Samsung Economic Research Institute," writes Reuters.

The above slide places South Korea in the context of the rest of the G20. By 2030, its total number of retirees is forecast to be approaching 40% of the population. Only Spain, Italy, Germany, and, of course, Japan are expected to have older populations.

The extraordinary increase in South Korea's retirees compared with 1970 illustrates how, as countries become rich, people stop having enough babies. China's problem is that it is ageing before it becomes rich.

South Korea's demographics will have severe implications for its healthy state finances, says Reuters in the same article 

"A report released by the Ministry of Strategy and Finance in July (2011) warned the national debt would jump to 138% of gross domestic product (GDP) in 2050 as pension and health insurance expenditures skyrocket, from around 34% last year," the wire service continues.

The labour intensive South Korean economic model is under threat from labour shortages and poor productivity.

Productivity is at risk of getting worse as the workforce ages and, as a result, slips further behind in IT and other modern manufacturing skills.

Training will have to be improved, retirement ages raised and women will need to be more readily accepted in the South Korean workplace.

This emphasises the key role that governments need to play in addressing demographic challenges, as we argue in chapter 10 of our e-book, Boom, Gloom & The New Normal.

The good news for South Korea is that has a tremendous record of economic transformation.

"In 1948, per capita income in South Korea was US$86, on par with Sudan's.'(South) Korea can never attain a high standard of living,' wrote a US military official," the blog said in a 2003 tribute to the country's transformation.

This far-sighted US official added that there were virtually no South Koreans with the technical knowledge and skills to take advantage of the country's natural resources.

In 2011, South Korea's per capita GDP was $31,220, according to the International Monetary Fund (IMF), just behind the European Union and Israel and ahead of countries such as Spain, Italy and New Zealand.

South Korea is, of course, the home of many world-beating brands following its successful escape from the "middle-income trap".

It also seems to have at least recognised that it faces a demographic problem.

We worry that in the West, policymakers have yet to even recognise their demographic crises.

.....For Now 

By John Richardson

RELATIVE to most of 2012 - when China's polyolefins market was in dire straits - November, December and early January have been excellent for traders who took the right positions. At least one producer has also reporting a strong recovery in sales.

"I thought there would be a mini-rebound in early November, and I was correct," said a Singapore-based trader.

"Prices then retreated slightly before a stronger rally began in late November (see chart below)."

The latest recovery is being driven by:

*Shutdowns in the GCC. The estimated production loss as a result of the confirmed plant turnarounds is 118,000 tonnes of linear-low density polyethylene (LLDPE), 353,000 tonnes of high-density PE (HDPE) and 238,000 tonnes of polypropylene (PP), according to ICIS.

*Outages at the PetroRabigh and Daqing petrochemical complexes in Saudi Arabia and China, respectively. The Daqing outage is expected to last until around February and includes the company's 300,000 tonnes/year HDPE/LLDPE swing plant and its 250,000 tonnes/year HDPE facility. The PetroRabigh complex is expected to restart in late January. Offline at the moment are the producer's 600,000 tonnes/year LLDPE plant, its 300,000 tonnes/year HDPE unit and its 700,000 tonnes/year PP facility.

*Reports that Northeast and Southeast Asian cracker operators have cut capacity utilisation from more than 90% in November to around 85% in December/January. But, as we have just said, these are just reports, and there are suspicions that some South Koreans are continuing to run hard.

*Confidence amongst converters that China's new leaders mean business on economic reform.

*Low stocks amongst the converters, especially those who need to fulfil orders before the Chinese New Year, which falls on 10 February.

*The fiscal-cliff fudge. This has caused a rally in stock markets, in oil (Brent crude was up by $3 a barrel last week) and commodity prices in general. Iron ore, for instance, is now more than $153 a tonne. "Prices are up by around 70% over the last four months, and the rally gained extra momentum in December. This is mainly the result of misplaced confidence in a sustainable Chinese recovery," said a Perth-based investment analyst.

"Is there a real improvement in polyolefins demand or is this the result of short-term tight supply and an improvement in sentiment?" queried the Singapore trader.

"Quite frankly, I don't really care as I've made good money since November and can now afford to play very cautiously over the next couple of months, without worrying about missing out on anything further."

Reasons to be cautious about the sustainability of the recovery include:

*The end of turnarounds in the GCC in February-April and the resumption of production at PetroRabigh and Daqing.

*Substantial amounts of new capacity. ExxonMobil is expected to ramp up production at its two 650,000 tonnes/year metallocene LLDPE plants and its 450,000 tonnes/year PP facility in Singapore, now that its 1m tonnes/year cracker is being commissioned. China is also set to bring on-stream significant amounts of polyolefins capacity this year, including Sinopec Wuhan Petrochemical Co at Wuhan in Hubei. "We have heard that the complex's 300,000 tonnes/year LLDPE plant and its 400,000 tonne/year PP plant will start-up in early Q2," the trader added.

*The fact that stock and commodity markets also rallied in 2009, 2010, 2011 and 2012, only for the rallies to peter out.

A key question for the blog is: When will stock and commodity markets start worrying about the likelihood of a bitter and prolonged fight between Republicans and Democrats over the need to raise the US debt ceiling?

The fiscal-cliff fudge has left the two political parties even further apart, with the Republicans also blighted by deep internal divisions.

By late February or early March, the Treasury Department will run out of options to cover US debt and could begin defaulting on government loans unless Congress raises the legal borrowing limit - the debt ceiling. Economists warn that a default could trigger a global recession.

As far as China's new leaders go, the blog feels they will attempt a "steady as she goes" policy over the next few months, possibly even the rest of this year, as they try to shore up their support.

Modest stimulus, along with more of the right noises about economic reform, might well be the desired approach. This doesn't necessarily mean that genuine reform will be sufficient to put China on the right economic path.

If the external environment weakens substantially, however, (for example because of a US debt default or a new crisis in Europe), Beijing may be forced into a big new stimulus package - adding to concerns about inefficient investments and bad debts.

More immediately, factor in a possible bounce in confidence when the official purchasing managers' index for January is announced in early February, as the December PMI is said to have been manipulated downwards in order to store up some more good news.

Returning to polyolefins, a source with a global producer told us: "From late February/early March, when the Chinese New Year is over, plants have returned from turnarounds and new capacities start to come on-stream and the debt ceiling issue has come to a head, we should get a real idea about the strength of demand."

Note that markets in China are expected to quieten down from 15 January, ahead of the New Year, until late February.

So far so good...lack of arbitrage in 2012

By John Richardson

Despite a strong recovery in China's polyethylene (PE) prices and sales over the last month-and-a-half, producers are viewing the coming year with great trepidation.

One of the wild cards is how the US producers behave in 2013, as we also discussed in November.

Faced with weak demand in their own market as a result of a failure to negotiate an increase in the debt ceiling, will US producers seek to export their way of out of difficulties?

While the Middle East sharply increased PE exports to China in January-October on new start-ups and more stable production at plants brought on-stream in 2010-2011, North American Free Trade Agreement exports declined by 42% on US production losses and a stronger home market.

"That pretty much saved us. I am worried about this year, though, as, of course, US producers have a big feedstock advantage," said a Singapore-based source with a global producer. 

My colleague Nigel Davis, in this ICIS news Insight article, neatly summarised the US outlook when he wrote "Olefins prices in the US rose towards the 2012 year end on a series on unplanned cracker outages.

"And planned maintenance shutdowns in the first months of 2013 are expected to underpin the higher prices.

"(But) North America's ethylene producers are planning significant new capacity additions to take full advantage of increased ethane supplies from shale gas extraction and a mood of optimism prevails in the sector.

"In 2013 more than 2bn pounds (more than 900,000 tonnes/year) of ethylene capacity will be added to the US total (a significant proportion of which could be turned into PE).

"This 3.3% increase in the US ethylene capacity total is expected to help stabilise prices which fluctuated wildly in 2012, as the impact of numerous scheduled maintenance shutdowns was amplified by a string of unplanned outages.

"Cracker operators are keen to take full advantage of North America's ethane advantage which has put the region second only to the Middle East in terms of feedstock cost competitiveness.

"Capitalising on that advantage, however, is causing disruption in a low demand-growth environment.

"US cracker operating rates have been estimated at 85% in 2012 compared to closer to 92% in 2011 but rates could push back up to above 90% this year with fewer turnarounds putting some downward pressure on prices."

If the US does export bigger quantities of PE to China, the losers will, of course, be the higher-cost naphtha cracker operators in Northeast and Southeast Asia.

By John Richardson

THE latest Northeast Asian high-density polyethylene (HDPE) chart from ICIS (see above) hardly suggests a tremendous increase in profitability, despite the improvement in sales volumes and sentiment in China that we first highlighted in December, and provided more details on last week.

At least the Northeast Asian producers have moved into slightly positive territory, though, and so they should probably be grateful for small mercies.

What might have limited their gains are reports that US PE producers shifted more export material in November and December in an effort to push through domestic January price increases.

We continue to worry that US PE capacity creep in 2013 might exert further pressure on the higher cost Northeast Asians as the year progresses, particularly, of course, if the China demand recovery proves to be short lived.

The overall increase in PE capacity, and also polypropylene (PP), capacity is another concern.

By John Richardson

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

By John Richardson

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Please, please be careful out there.

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

Source of picture: Quirky China News/Rex Features

By John Richardson

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

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

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

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

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

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

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

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

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

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

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

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

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

There are two risks here, which are:

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

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

By John Richardson

ASIAN higher cost polyvinyl chloride (PVC) producers are facing the twin squeeze of increased electricity costs and very competitive exports from the US, according to an industry source the blog met with in Taipei, ahead of tomorrow and Friday's 2013 Asia Petrochemical Industry Conference (APIC).

Such is the pressure on the Japanese, and perhaps even the South Koreans, that rationalisation of capacity might have to take place, he added.

"Electricity costs are 3 cents a kilowatt in the US because of shale gas, making chlor-alkali units there exceptionally efficient. And, of course, the US has very cheap ethylene, thanks again to shale gas, for ethylene dichloride (EDC) production," said the source.

"This compares with 10-12 cents a kilowatt power costs in Japan - much higher than used to be the case before the 2011 tsunami forced Japan to import much more liquefied natural gas (LNG) to meet its electricity generation needs."

This is illustrates why three major themes look set to dominate this year's APIC conference: US shale gas, US shale gas and more US shale gas.

"A couple of years ago, coal-to-olefins (CTO) in China were heavily featured in the discussions at APIC, but now people seem to recognise that CTO will have a limited impact," said a petrochemicals consultant, again in Taipei ahead of APIC.

Returning to the subject of PVC, we might perhaps see a great deal of overseas interest in investing in the US chlor-alkali and vinyls sector, which again of course would be linked to the foreign interest in building steam crackers in the States.

By John Richardson

LABOUR markets are tight in China and so on the surface there appears to be no great pressure on Beijing to attempt to export its way out of an unemployment crisis.

But what happens if, as we suspect, real GDP growth has fallen to 4% or even lower? The government, despite its firm commitment to economic rebalancing, might be forced to once again boost export competitiveness.

A hint that this might be on the cards appeared in the state-run Global Times newspaper earlier this week.

"The Chinese Yuan has limited room to appreciate further and may be depreciated to foster the country's struggling exports and the broader economy, according to experts and insiders," wrote the newspaper.

Aggressive monetary easing by the Federal Reserve and, more recently, the Bank of Japan, were cited as reasons why the appreciation of the Yuan might be reversed.

The massive stimulus programmes of both central banks have depreciated the values of the Dollar and Yen, and, as the Global Times also points out, have also caused capital inflows into China, thus pushing up the value of the Yuan.

The approach of Western central banks looks set to continue, even though there is no prospect of it reviving demand.

And so China, boxed into a corner, could be forced to respond, resulting in a global trade war as it exports deflation via its many heavily oversupplied industrial sectors, including chemicals.

By John Richardson

THE blog is often accused of being pessimistic. We are not. We are just realistic.

It was realistic last November to anticipate that China's new leaders would be dedicated to major economic reform. In fact, this was clear even earlier than that - back in February 2012 when the World Bank produced its landmark report on China - that a fundamental shift in economic policy was taking place.

This excellent article from Reuters highlights, as we have thought for a long time, that Xi Jinping and Li Keqiang, are firmly committed to a major overhaul of China's economy. They have cemented their power base and will present more details on a radical reform programme at the crucial third plenum of the 18th Central Committee of the Communist Party of China, which is expected to take place in October, adds Reuters.

Quick fixes are no longer possible. Chemicals traders and company executives expecting a return to the type of stimulus-fuelled growth we saw in 2009 are going to be disappointed.

But this should not be a reason for pessimism for anybody who is looking beyond the immediate value of their share options, or the money to be made on the next chemicals shipment to China.

If Xi and LI are successful the opportunities are enormous, as The Economist points out in this article.

These opportunities include a huge surge in the spending power of low-income workers, thanks to successful reform of the Hukou system that at present denies hundreds of millions of workers access to basic social services.

A surge in investment by innovative private firms, if bureaucratic hurdles can be reduced and the allocation of capital improved, is another great opportunity for the chemicals industry.

But, as the chart above illustrates, some essential reforms, such as higher utilities charges and a liberalised interest-rate regime designed to improve the allocation of capital, will have a negative short term effect on demand. Nobody should be surprised, therefore, if real GDP growth in China over the next few years falls to 4% or even lower.

Meanwhile, as this painful shift takes place, the mood music needs to change. Rather than asking China to "save the world" through returning to an economic model that no longer works, chemicals company CEOs and Western politicians and central bankers need to all get behind this make or break effort to transform China.

We worry right now, though, that the huge quantitative easing programmes unleashed first by the Federal Reserve and more recently by the Bank of Japan, will not be supportive of China's efforts.

There could instead be a "race to the bottom" as currencies are competitively devalued, including the Yuan. China might end up boxed into a corner and thus forced to export deflation.

By John Richardson

So far so good - everything is going to plan.

The flash Markit/HSBC China Purchasing Managers' Index (PMI) for May fell to 49.6, slipping under the 50-point level demarcating expansion from contraction for the first since October last year and sending Asian financial markets sharply lower.

But, crucially, as Reuters pointed out in this article, the PMI also indicated a stable employment market.

"Although Chinese media has reported that a record 7 million graduates will join the labour force this year, there are few reports of widespread discontent among job hunters," wrote the wire service.

The impact of the one-child policy, although creating huge long-term challenges for China, has given its new leaders the leeway to implement vital economic reforms.

Maintaining a healthy jobs market is crucial for the legitimacy of the Communist Party.

Demographics were very different back when in 2008/2009, when the working population was still on the rise. Thus, Hu and Wen, the previous president and prime minister, felt that they had little choice but to launch a huge economic stimulus package in response to the Global Financial Crisis, as some 20 million migrant workers had lost their jobs.

As long as employment is not threatened, the transformation of China's economy to one that is much more dependent on domestic demand can continue.

The blog does worry, however, that the situation could change if currency wars break out. China has already indicated that the Yuan might have to be weakened. Given its huge overcapacity across many industries, it might end up exporting deflation.

But, as we said, so far so good.

Everyone needs to get behind China, as the long-term opportunities which would be created by much-more sustainable, domestic-driven growth are enormous.

Take the proposed reforms of the Hukou residency system.

China plans to spend 40 trillion yuan ($6.4 trillion) to bring a further 400 million people to cities over the next decade, according to this second Reuters article.

There are also already 200 million rural residents who work in cities as migrants.

But the problem is that the Hukou system denies these migrants access to free, or heavily subsidised, healthcare and education. Thus, they spend much of their incomes on these services.

China's planned reforms of Hukou would give migrants much greater access to cheaper healthcare and education.

Do the maths. Two hundred million, plus a further 400 million, equals a huge increase in chemicals and polymers demand, if all of these migrants are given more disposable incomes to spend on consumer goods.

But China can only afford to change Hukou if it achieves overall economic reforms, including interest-rate reform and root-and-branch changes to the tax system and how local authorities raise money.

A panicked return to the failed stimulus policies of the past would be a disaster, as it would worsen China's bad debt, environmental, corruption and income-inequality problems. Policy reversal could, ultimately, even lead to economic collapse.

And so any chemicals and polymers company with a long-term vision should be careful what it wishes for over the short term, and should plan for lower growth if, hopefully, the adjustment process continues.

The crucial question, of course, remains: How much lower might growth be during the rest of this year?

"UBS this week downgraded its 2013 [GDP] growth target for China to 7.7% from 8%, and Societe Generale is in the midst of lowering its estimates. Bank of America-Merrill Lynch cut its China 2013 growth forecast earlier this month to 7.6% from 8%," added Reuters in the above first article.

"If the economy meets the government's growth target and expands 7.5%this year, it would still be its worst performance in 23 years."

But real, underlying growth could be even weaker, as electricity consumption has increased by just 5% so far this year, according to fellow blogger Paul Hodges.