Chemicals & The Economy

Last month's IeC Boom/Gloom Index showing a worrying weakness in sentiment, particularly when the world's major stock markets had actually recorded good performances in July, albeit on low volume.

But as the chart shows, this month confirms the downturn reading, with the Index (blue column) below the 4.0 level. Further confirmation of this reading comes from the 4.7% fall in the US S&P 500 Index over the month. Crude oil prices, which have been strongly correlated with the S&P, have also weakened sharply.

The only positive is that the Austerity reading (red line) fell back to April's level. But, of course, this was still high by comparison with earlier months. And with the return of politicians from their summer holidays, the austerity message may well start to gain in volume again.

EU governments have spent enormous sums of money to support the economy over the past year. Yet in terms of a key indicator such as unemployment, the situation has got worse rather than better. This is bound to restrain consumer spending, a key factor for domestic EU chemical demand.

Eurozone unemployment hit 10% in February, and it has remained at this level into July. 16 million people are out of work, and 23 million people in the European Union. Both figures are up around 1 million since July 2009.

As the chart shows, Austria and The Netherlands continue to have the lowest rates, at 3.8% and 4.4%. Spain now has the highest at 20.3%, closely followed by the two Baltic countries, Latvia and Estonia. Youth unemployment remains a particular problem, with 20.2% of under-25s out of work in the EU. Shockingly, 41.5% were unemployed in Spain.

Many readers have been taking a well-deserved break over the past few weeks. As usual, therefore, the blog is highlighting key posts during August, to help you catch up as you return to the office.

August has been surprisingly busy:

Force Majeure reports show worrying increase highlighted the worrying rise in force majeures, which may be linked to cutbacks in training, and maintenance spend.

US consumer demand growth stalls. The US economy seems to be heading back into the downturn, as the stimulus programmes end, with unemployment still high, housing starts at all-time lows and GDP slipping.

5 tips for surviving a period of deflation covered advice from the Wall Street Journal on managing a personal investment portfolio.

Speculative mania continues to drive oil markets. The impact of futures market trading disguises the weak fundamentals of the oil market, and has also been driving speculative activity on polymers in China.

US junk bond issue hits record as GDP slows worried that investors were piling into high-yield corporate bonds, just as the slowing economy was increasing their risk.

Lower refining rates support EU petchem margins described how lower oil product demand, and hence refining rates, was reducing naphtha availability, and so helping to keep petchem markets tight.

The" real bottom line" in the Financial Times featured the blog's letter to the FT.

The Petromatrix report is currently a must-read for anyone seeking to understand what is really happening in crude oil markets.

Its latest issue analyses China's demand. It suggests this is not as strong as the bullish investment banks on Wall Street might wish.

China's refinery runs are certainly rising, as its new major capacity comes online. And its own oil production in July was up 250kpd versus 2009. But its oil imports appear to have peaked, with July's 1mbd lower than in June, and slightly below 2009 levels. In addition, oil product imports are now falling, as domestic production increases.

Thus, as the chart shows, China's total imports of crude oil and products were actually 441kpd less in July (blue line) than in July 2009 (red). They were only 640kpd higher than in July 2008 (yellow) and just 478kpd above July 2007 (green). Pretty clearly, this slow growth in total domestic demand does not justify today's very high crude oil prices.

The figures also suggest that China is keeping its own refinery operating rates at a high level by replacing imports with domestic production. As such, it poses a real threat to other integrated refiners/petchem producers across Asia. If they have to cut refinery runs to compensate for China's higher production, then petchem feedstock supply will suffer.

With the Chairman of the US Federal Reserve saying the outlook is "unusually uncertain", its time to summon the chemical market genie.

Of course, rubbing the lamp is not always successful. And if the genie does arrive, one can only ask 3 questions.

So rather than risk wasting them, the blog has learnt to spend the first question in asking him to decide the other two questions.

And this is what the genie said:

"They should be obvious, even to you, blog. Ask me what is happening to the US economy? It dominates the global economy, as you have written many times".

So I asked, and the genie answered, laughing:

" You have wasted a question. You already know what is happening to the US economy. It is heading back into the downturn, now the stimulus programmes are ending.

"In Q3 last year, GDP grew by 1.6%, and by 5% in Q4. But then it slowed in Q1 to 3.7% and now Q2 is estimated at just 1.6% again. But I can understand that you have been hoping a proper recovery might be underway, particularly after the industry has had such a strong H1."

Thank you, O genie, I replied, and so what should be my second question? The genie sighed, and I thought for a moment he was going to disappear back into his lamp.

"Ask me about the US housing market? You surely know that this used to be a $35bn chemical market in 2006, when there were 2.2m housing starts? But you can start by answering my two-part question:

"So, said the genie, the rich aren't buying. And as 23% of all homeowners owe more on their mortgage than the home is worth, and sales in July were an all-time low of just 276k annualised (worth just $5bn), then this major market will provide little support for future chemical sales"Chastened, I waited for him to reveal my 3rd question.

"Again, it is obvious", he replied. "Even you have been writing about it since February 2009. Ask me about the potential impact of deflation."

"But if I can interject, O genie, all the commentators suggest that we are in a 'bond market bubble' and that we should really worry about inflation?"

At this, the genie laughed for a very long time.

"You amuse me, blog", he finally replied. "So I will allow you this extra question. Ask all of your friends if they have read an article about this so-called 'bond market bubble'? And then ask them if their own pension fund is now even 50% in long-term G7 government bonds? You will find there is indeed a bubble in articles about a 'bond market bubble', but very few people actually own them".

So the genie then answered his 3rd question, reminding the blog of an analysis in Barrons, the US investment magazine.

"Today, if you're a Western baby-boomer (born between 1946-64), you now need to save $1.42 if you want to have $2 in 10 years time, with interest rates at 3.5%.

But when rates were at 7%, you only needed to save $1 to achieve the same result.

"Now, blog", he then added. "You wrote about the baby-boom generation only last week. You can surely see why they are beginning to panic about their future income level in retirement?

"If their baby-boomers stop spending and start saving, which they must do to protect their retirement income, then clearly global chemical market growth rates cannot go back to the levels seen before 2008."

And with that, the genie disappeared back into his lamp, leaving the blog to ponder on the implications of his answers for chemical sales in the rest of 2010, and in future years.

Recycling may not be reducing carbon emissions as much as had been hoped. This seems to be the finding of an interesting new report from consultants SRI on recycling of PET bottles.

It looks at the benefits of recycling 1.5 litre carbonated beverage bottles made from PET (polyethylene terephthalate). Stricter legislation has led to many European countries collecting 80% of these bottles. The blog, along with its neighbours, dutifully puts its bottles into a green bin every week.

Yet the study finds that such 'kerbside' collection leads to only 45% of PET actually being reused. The other 35% somehow gets 'lost' in the cleaning and sorting process. This is perhaps not surprising given the difficulties of separating PET from other polymers, especially when the initial sort is done in cold and wet conditions on the road.

It concludes that this inefficiency means that recycling PET at the kerbside 'is no better than land-fill' in reducing carbon emissions. And it suggests that if politicians are really serious about reducing emissions, they should focus on improving the yield when sorting and reprocessing PET.

This would likely involve more effort by consumers. The best model is apparently Switzerland's, where bottles are returned to supermarkets. This leads to a 70% yield, and a clear benefit in terms of reducing carbon emissions.

The blog has had a letter published in the FT this morning, which readers might like to see.

It focuses on the problem of using EBITDA measures when analysing a company's performance. It suggests that analysts should move away from their current reliance on this measure, which ignores the impact of important areas such as interest and tax payments. Hopefully, the letter may help to spark some debate in this critical area.

Sir, I was delighted to see Lex reminding readers that they should assess company profits after payment of all significant costs such as "staff or technology" ("Price/earnings multiples", August 24).

It would be excellent if Lex would return to basing its valuable analysis on a company's real bottom line. This would then help your readers to assess who is swimming naked, before the tide goes out.

Paul Hodges,
Chairman,
International eChem,
London N7, UK

Registrations are already building for our 9th European Aromatics and Derivatives Conference, to be held in Berlin on 23-24 November. Co-organised as always with ICIS, it features a strong line-up of industry speakers including:

• Shell Chemicals, Sven Royall, VP Intermediates on 'What next for Aromatics'?
• Ralf Kuhlmann (former Business Director, ExxonMobil Chemicals and APPE President) on 'European petrochemicals: on the right track for the future?'
• Dow Chemical, Andrew Jones, Global Business Director Aromatics and Derivatives, on 'The changing landscape in aromatics'.
• China, Yu Jing from China's National Petroleum and Chemical Planning Institute, on 'Developments in China's aromatics and derivatives markets'.

In addition, there will be important presentations from companies including TOTAL, Polimeri Europa, Equipolymers, Wood Mackenzie and Nexant. The blog will also be presenting its thoughts.

The 'early bird' discount expires next week, so its worth registering today if you can. Please click here for further details of the agenda and registration.

Sometimes every cloud does have a silver lining. And that's currently the case with the fall in demand for oil products.

The European petchem industry is based on feedstock from refineries such as naphtha and LPG. And as the chart above from the IEA shows, German refinery runs, like others elsewhere in Europe, are down 15% due to lower demand for most oil products.

This has proved very supportive for petchem margins. As the second chart shows, based on APPE data , European operating rates for ethylene were only 82% in H1. Back in the Boom period between 2004-7, H1 rates averaged 89%.

Producers have done a lot in terms of self-help to reduce fixed and variable costs. And the monthly contract price certainly gives more flexibility versus the old quarterly system.

Even so, an 82% rate would have normally hit petchem margins, as producers fought to maintain market share. But instead, the 15% cut in refining rates meant cracker feedstocks were also reduced. So effective operating rates were much higher than 82%.

Thus producers were able to pass through H1's higher oil prices, and spreads for ethylene versus naphtha actually increased to €422/t. Whilst lower overall production rates sent co-product prices for both propylene and butadiene above those for ethylene, for the first time in history.

How long will this silver lining last? The blog's friends in the refining industry suggest that poor competitiveness will remain a problem for the European refiners, and they do not observe great optimism amongst leading players that might suggest a quick recovery.

However, it is also clear that petchem consumers are finding it increasingly hard to pass on the higher prices to their customers.

But in the meantime, EU petchem producers have their silver lining.

Oil markets are an accident waiting to happen for the chemical industry. Oil inventories around the world are close to record levels, with the IEA (International Energy Agency) reporting they are over 61 days of demand. Equally, as the Petromatrix chart above shows, they are at record levels in the USA (the world's largest market), and still climbing.

The major investment banks, of course, are still able to make easy money by selling the story of "demand from emerging markets and limited growth in supplies" to gullible pension funds. So it is no surprise that sentiment in the futures market continues to ignore the fundamentals.

But the risk/reward ratio for a bet on oil at $90/bbl in Q4 is starting to look pretty thin. Prices peaked at $83/bbl in early August and in spite of another bullish report last Monday, were down $9/bbl (11%) by the end of last week. So the risk of a price collapse to $60bbl or lower is clearly increasing, and is certainly now above 25%.

If it happened, then clearly OPEC would quickly cut production again. But this would be shutting the stable door after the horse has bolted. So destocking, as we saw in Q4 2008 - Q1 2009 and in 1980, could again become a serious problem for the major chemical industry value chains.

Thus, if the investment banks lose their battle to support oil prices, then the chemical industry may well be left to pick up the pieces.