2008 has not ended well for the chemical industry. First there was the collapse in demand, as the various value chains destocked in response to slowing consumer demand and lower oil prices. Then INEOS, the world’s 3rd largest chemical company, had to seek covenant waivers from its lenders. Now, according to the Wall Street Journal, LyondellBasell, the 4th largest chemical company, may be about to file for bankruptcy.
The underlying issue is that petrochemicals has always been a highly cyclical industry. A typical 7 year cycle involves 2 years of stunning profitability as demand recovers after a downturn, 3 years of average returns as supply and demand rebalance, and then 2 years of horrendous losses as new supply comes online just as demand slows.
We are now 5 years into the current cycle, which started in 2003. So a downturn should not therefore come as a surprise. And, of course, it follows a lengthy period when central bankers had completely failed to do their job, and had allowed personal and corporate debt to reach record levels. As I noted in a letter to the Financial Times back in March 2007, they had proved totally:
“unwilling to implement the famous dictum of William McChesney, the long-serving Fed chairman in the 1960s, that “the job of the Federal Reserve is to take away the punch bowl just when the party starts getting interesting”. Instead, they seem to confuse being market-friendly with being friendly to markets.”
Thus they allowed demand to continue accelerating between 2005-7, by actively promoting ever-higher levels of leverage. This benefited housing and auto demand – prime markets for petchems – whilst also encouraging companies to increase their own levels of debt. But as the blog has warned many times:
“The seeming genius of many private equity funds in recent years has been due to nothing more than the application of high leverage during the ‘up’ part of the business cycle. As and when we go into the ‘down’ cycle, leverage will exert its same impact on the downside.”