Chemicals & The Economy

Yesterday the UK public had a rare view of what the government really thinks about future house price trends. Photographers snapped Housing Minister Caroline Flint arriving for a Cabinet meeting. And then journalists went to work on reading the notes in her hand.

Contrary to official statements, it seems that the government expects 'sizeable falls in prices later this year - at best down 5 - 10% year-on-year' (my italics). Her notes went to add that 'we can't know how bad it will get'. I noted last month that the UK was 'at risk of a US-style housing slump', and it now seems that the UK government shares my view. This is clearly not good news for future chemical sales, as housing is such a major source of demand.

Headline interest rates are set by central banks. But the ones that we actually pay, as consumers or companies, are set by the banks themselves. And most of these are based on LIBOR - the London Inter-Bank Offer Rate - which is the main benchmark for $62 trillion of borrowing around the world. Now it seems the LIBOR rate is likely to rise by 30 May.

The background to this is slightly complex (details below), but the implications are enormous. Lending rates for 6 million US homeowners are likely to rise as a result, for example. Today the LIBOR system was discussed in the UK Parliament, and it seems a new system is likely to emerge by 30 May. Based on the evidence so far, this could increase actual lending rates quite significantly, by up to 0.30%.

Continue reading "Interest rates to rise by the end of May" »

The chemical industry moves a lot of product by ship. Recent rises in freight rates have therefore had a major impact on costs for producers and consumers. But there was always the thought that rates would soon decline, once shipbuilders began delivering all the new ships on order.

But now Bloomberg is suggesting that 10% of these orders have already been cancelled due to the credit crunch. ‘A year ago, banks would finance as much as 80% of an order, with 12- to -15- year loans,’ according to Fortis Bank. ‘Now, financing usually doesn’t exceed 65%, and terms are 10 years or less’.

And the squeeze is not just affecting ship-buyers, but also those planning to build new shipyards. 20% of current orders are scheduled to be built by Chinese shipyards that are themselves not yet in operation. Equally, there are major delays on critical parts – the waiting time for main engines is now 4 years, and even for diesel generator is 2 years.

Supply chain managers must be starting to wonder whether globalisation and outsourcing will remain viable tools for cost-reduction.

A month ago, I suggested that oil prices ‘seem set to move higher in the short-term, with $125/bbl now being talked as a target’. Readers were hopefully not too surprised, therefore, to see prices for Brent and WTI close at this level on Friday night.

One of my longer-term forecasts also seems to be coming true. Back in October, I was a rather lonely voice when I suggested that the ‘consensus (chemical company) forecast is very optimistic...expecting oil will remain at $70/bbl, that debt market problems will be contained, and that petchem margins will remain at 2007 levels’.

I feel most analysts have done the industry a major dis-service by continually suggesting that oil prices were somehow being inflated by speculative activity. This has blinded CEOs and business managers to what is really happening in oil markets. I was therefore very pleased to see last week that Rohm & Haas has decided that ‘enough is enough’. The company kindly sent me details of their ideas for changing the way that ‘raw material and energy costs are handled during these unprecedented, turbulent times’.

They say that ‘We can’t ask for, and implement, selling prices fast enough ...and we can’t afford to continue to serve as a buffer between our suppliers and our customers and lose significant profitability in the process. This is an untenable position.’ As a result, R&H are introducing an ‘indexed raw material and energy surcharge’ from 15 May for all Specialty Materials products in most major geographical markets.

The aim is to enable prices to fluctuate in line with crude prices. Thus they will automatically reduce when prices fall. Of course, the critical test will be the response downstream. As R&H rightly say, it is too early to ‘speak to what customers will do'. One suspects that the answer will tell us a lot about the strength of underlying demand.

Mark Twain’s famous quote rather sums up my current feelings about the state of the US economy. This is the most important single indicator of future chemical industry sales. And a couple of months ago, I aligned myself with Warren Buffett in suggesting that the US was probably in recession. Last week, this looked like a bad call, when the US government reported GDP up 0.6%. One could argue that this was only due to a rise in inventories, which might be a sign of weakness, not strength. But a positive number was still a positive number. Or was it?

This week, Prof Martin Feldstein of Harvard has suggested that the GDP report was ‘very misleading’. He went on to add that ‘monthly data since January indicate that economic activity and GDP have been declining since the start of this year’. And Prof Feldstein is not your ordinary academic. His views carry enormous weight, as he is also President of the body that officially decides whether, or not, the US economy is in recession. So my call may turn out to have been right, after all.

Prof Feldstein went on to warn that, in fact, a ‘deep decline’ is in prospect. He notes that 8 million US households are now in negative equity, and ‘more than 15% of all outstanding mortgages’. With US house prices ‘falling at a 25% annual rate over the past 3 months’, he suggests that there could be ‘widespread defaults and foreclosures’. This would have a major impact on chemical sales, as housing is such an important source of demand.

In March, during NPRA, I wrote in ICIS Chemical Business that ‘recession was a real threat’, and forecast that ‘those companies with robust contingency plans will find themselves with a major advantage’. Now it seems that Prof Feldstein shares Warren Buffet’s downbeat assessment of current economic prospects. I hope that readers have taken action to ensure that their business is well prepared for a potential economic downturn.

Spare a thought for the plight of the world’s investment bankers. According to the Financial Times, some minor cutbacks are finally taking place in the extravagant lifestyle to which they have come accustomed:

• UBS, having lost $11bn in Q1, has now told its analysts to fly economy on short-haul flights.
• Merrill Lynch bankers have to work an extra 30 minutes before they are entitled to a taxi ride home after work.
• Goldman Sachs employees no longer have access to free bottled water

Deutsche Bank has gone one further, according to Der Spiegel, and will no longer ‘approve any adult entertainment’ such as hotel porn channels.

I noted back in February that China is no longer exporting price deflation, and is instead causing global prices for commodities and manufactured goods to rise. A reader has now kindly sent me an interesting report from Credit Suisse, commenting on the potential inflationary impact of new labour laws in China. This is particularly important for the chemical industry, given the volume of foreign investment that has taken place in China.

It features the above chart, showing how wages have increased by 70% since 2004. And its analysis claims that the new Labour Contract Law, in operation since January, will increase manufacturing costs by a further 15%-20%. CS argue that this under-reported measure raises China’s labour rights to international standards, requiring extra pay for overtime, employer contributions to social and pension funds, and severance pay.

CS note that the new law is part of a package of measures aimed at stimulating domestic demand and reducing export-dependency. VAT export rebates were lowered three times in 2007, whilst corporate tax rates for Foreign Direct Investors are being raised from 15% to 25%. They argue that as well as increasing global inflation, the new measures ‘will also affect margins of many listed foreign companies using China as a production base’.

Please contact me at phodges@internationalechem.com if you would like a copy of the report.

After a while, large numbers lose their power to shock. So Bloomberg and the FT have performed a service this week by reminding us of the scale of losses in the financial sector. They calculate that so far, US and European banks have had to raise $216.9bn of new capital. And, of course, whilst this phase of the current credit crunch is now coming to an end, the IMF estimates the total bill will be close to $1000bn.

As Warren Buffett told his Annual Meeting this weekend, ‘the worst of the crisis in Wall Street is over. In terms of people with individual mortgages, there’s a lot of pain left to come’. This warning adds to my caution over the outlook for the chemical industry.

Continue reading "$216.9bn and still rising" »

Anthony Bolton’s investment column this weekend contains another nugget of wisdom. Coincidentally, it is linked with Archie Norman’s ‘tip for management’ which I quote below.

Bolton is the UK’s most successful fund manager. And he certainly shares Norman’s sense about the need to be humble. In fact, he goes even further, commenting that in his experience, ‘On average, you will be wrong at least two times out of five – half the time because an investment thesis proves to be incorrect, and half the time because something changes’.

He goes on to list some of the main things that can change. All of them will be familiar to commercial people in the chemical industry: ‘movement in interest rates or currencies; a change at the industry level – such as increased competition or new legislation; a new product fails to work as well as expected; a price war breaks out in a key market’.

Bolton’s caution seems particularly sensible today. As I commented in ICB last month, contingency planning has gone out of fashion in recent years. But given the current high level of uncertainty in the world economy, focused on the issues that Bolton highlights, it probably needs to assume a high priority in any CEO’s agenda.

Archie Norman is one of the most successful CEO’s of recent years. When he joined ASDA in 1991, it was a struggling, nearly bankrupt, UK food retailer. 9 years later, it was sold to Wal-Mart, after he had transformed it. Shareholders benefited from an 8-fold increase in the share price over the period, whilst Norman earned just £300k ($600k) a year.

Looking back on the experience, Norman does not think he was treated unfairly. In an interview today with the FT, he comments:

• ‘It has never occurred to me that money would have any bearing on my pace of work. I don’t work harder or less hard depending on the amount of money I earn. You are only as successful as your last challenge. I regard the things I have done in my career as a preparation for the next project’.
• His tip for successful management is also refreshing. ‘You have to be humble. You have to be prepared to listen to people whether they are cleaning the floor or in management’.