Chemicals & The Economy

Wall Street may be paying out $bns in bonuses. But in the rest of the USA, rising unemployment and foreclosure are having a major impact.

In a new analysis, the New York Times reveals that the Federal food stamp programme "now helps feed one in eight Americans and one in four children".

Renamed the Supplemental Nutrition Assistance Program, it enables families and individuals to buy groceries, and averages $130 per recipient each month. Around 90% of those helped live below the poverty line ($22k for a family of 4). Blacks are worst hit, with 25% receiving aid. 15% of Latinos are being helped, and 8% of whites.

These are worrying statistics for chemical companies. Many products that we produce are discretionary rather than essential. And people who need help to buy food are focused on 'needs' rather than 'wants'. This will hold back the recent recovery in industry sales.

The momentum-driven rally in financial markets has slowed recently, with many now in temporary trading ranges. And this is reflected in December's IeC Boom/Gloom Index (above). The Index (blue column) has been steady since June.

Underlying fundamentals show no sign of improvement. The 'green shoots' index (green line), which tracks expectations for a quick economic recovery, peaked in June. It has now fallen for 5 months, and is almost back to February's level.

Equally, the frugal index (red line), has been rising slowly since May. This probably reflects consumers' increasing focus in the real economy on 'needs' rather than 'wants'.

The American Chemistry Council's excellent weekly report contains some potentially good news on the outlook for Q1 demand.

Its detailed analysis of US polymer markets (above) suggests customers are currently reducing their inventories. CFO's presumably assume that the main impact of the housing/auto stimulus programmes is now finished, and are no doubt keen to keep working capital under control for year-end.

Thus October's end-user demand (blue line) was around 100kt higher (230 m lbs) than actual product supplied (red line). This continued the Q3 trend, when consumers reduced inventory by c70kt (150 m lbs) a month. It is quite likely this destocking will continue through December. But then the situation could change, as consumers should need to restock ahead of the usual Q2 demand peak in autos/construction.

In turn, 2010 might therefore see the industry return to its normal seasonal pattern, with a strong H1, followed by a slow Q3 holiday season, and then a final burst of activity in October/November before the Xmas break. Demand forecasting would become easier, and inventory levels could be better aligned with market needs.

The main risk to this scenario lies in crude oil markets. The blog continues to worry that today's $80/bbl price is driven by the 'correlation trade' (sell US$, buy oil and the S&P 500) and not supply/demand fundamentals. If financial markets tire of this trade, and oil prices weaken, then renewed destocking in the value chains is a real possibility.

The blog has recently noted a major change of mindset in the financial community. As the Financial Times commented this week:

"For the first time in a long time, banks seem to be in control of their lending policies. During the credit boom, the banks were held hostage by companies and private equity groups, as they chucked their balance sheet behind deals almost for free, in exchange for higher margin investment banking products such as advising on mergers and acquisitions. Today, the banks are controlling their lending decisions."

A rare interview today with INEOS CEO, Jim Ratcliffe, in The Times confirms this trend. It notes that INEOS's covenant waivers in the spring came at a high price in terms of interest charges. And Ratcliffe comments that "Under our agreement with the banks, we need to generate levels of cash which it is difficult to imagine the business doing. At some stage there has to be an asset sale".

The Times reports that "the total sum that must be raised is €700 million in two "bullet" repayments". And it says that Ratcliffe "thinks that a sum of €250 million due in January 2011 is manageable 'with a fair wind', but the second tranche in July of €450 million is 'quite a large slug'".

As Ratcliffe notes, Ineos could reasonably expect in the Boom period to make €2bn EBITDA. But this target will be hard to achieve in the future, if we are moving to a 'new normal' of slower growth and less debt, as the blog set out in its 2010 Budget Outlook. With INEOS debt at €7.3bn, the risk is that the banks will become increasingly hard taskmasters.

UK Finance Minister Alistair Darling is widely reported today as being about to announce a 'super-tax' on bonuses paid to bankers working in the UK.

The government's argument, notes the BBC's Robert Peston, is that "Investment banks are making exceptional profits, as a result of the intervention of government and the Bank of England to limit the economic damage from the mess caused by those very same banks. So it would be outrageous if they paid those profits to employees and bonuses. We are determined to prevent that."

Darling was the first western minister to warn of the likely end of the Boom period in August last year. He was widely derided at the time for suggesting that the downturn "will be more profound and long-lasting" that most people had expected. But he was, of course, proved right by events.

Similarly, it will be argued that bankers can easily retain their bonuses by moving abroad. But those who relocated last year to Dubai might now regret their decision. And given popular anger at the mess caused by the banking crisis, and the need to raise taxes, the blog suspects that other countries may well follow his move in coming months.

China's Dalian polymer futures market continues to have a major influence on regional, and global, polyethylene markets. But November's trading volume was lower than a year ago, at 25 million tonnes. This is the first negative annual growth since volume took off in June last year.

Last month, the blog noted a comment from LyondellBasell COO, Ed Dineen, that China's polyethylene (PE) market seemed to be following crude oil prices. And the chart above certainly provides support for this theory. It shows LLDPE prices (red dotted line) beginning to shadow crude oil prices (blue line) from July 2008, just after Dalian volumes began their meteoric rise from 100kt/month to April's record 80 million tonnes.

Normally, one would expect LLDPE supply/demand balances to have their own separate impact on pricing. In H1 2008, for example, LLDPE prices fell, even though crude prices were rising. Thus the chart does highlight a clear risk that part of China's massive import demand this year for PE may be linked to speculation on crude oil prices, financed by the government's massive lending programme.

We will only find out for certain, if indeed crude prices do slip from today's levels. But if the blog was a major player in PE markets, it would certainly now try and hedge this risk as far as possible.

Q3 comments from Tesco, the world's 3rd largest retailer, confirm the picture of a more frugal consumer suggested by other majors.

On the positive side, they report "a material improvement" in sales "in both Asia and Europe". And Tesco expect "this trend to continue into Q4 and beyond".

But on the less positive side, CFO Laurie McIlwee said "competition was intense in the run-up to Xmas, with promotional activity at an 'unprecedented level'". Consumers seem increasingly focused on cut-price offers, and even then they seem to be cautious in their spending.

Chemical companies supplying directly into the retail sector have been feeling this pain for some months. It has become very difficult to pass on higher oil prices, particularly with Retail Price Indices now in negative territory in many countries.

The blog is delighted to see that the UK government has now allocated GBP30m to:

"Equip Teesside to move beyond traditional heavy industry to realise its potential to be part of our low carbon manufacturing base.

"It also includes investment to establish bio-based materials, to reduce energy use of industry in the area, for initiatives on carbon capture and storage and support for technology transfer and new business practices."

It is very good news that the skills of the chemical industry are being recognised as fundamental to the development of the low carbon industries and technologies of the future. The Teesside 10-point plan, and the leadership provided by key local figures and organisations, will now have some financial firepower behind them.

"The more things change, the more they stay the same". Or, as the blog's French-speaking readership might say, "plus ça change, plus c'est la même chose".

When the blog started work in the chemical industry, in 1978, it was possible to pay up to 114% of one's income as tax in the UK, if one was a very high earner. That regime was swept away by Margaret Thatcher after the 1979 election.

But now governments need to quickly increase their tax revenue. Thus the UK government has confirmed plans for a new 50% 'super-tax' on bank bonuses, in addition to the normal 40% top rate. Of course, it is described as a "one-off" tax. But then income tax itself was originally introduced as a "one off" tax in 1799 to pay for the UK's war with France.

Bankers are already muttering about leaving to go somewhere else. But where? The list of countries in severe financial trouble as a result of the financial crisis is rising all the time - last week it was Dubai, then Greece on Monday, and now Spain is having 'crisis' cabinet meetings.

For most of this year, the banks' trading houses have been earning vast sums of money promoting the "correlation trade" (sell the US$, buy crude oil, gold and equities). As a result, around 150mbbls of oil and oil products is now in floating storage, with much more on land.

Next year, the same traders and brokers might well decide there was more money to be made from promoting a different trade. They might argue, for example, that the world economy was still too fragile to afford $80/bbl oil, and instead suggest oil should be sold, not bought.

These things happen. But they can cause problems for those who have to budget forward. Governments dependent on oil revenues, for example, find it difficult to simply 'turn off the tap' on spending, just because prices on the NYMEX futures exchange have fallen.

This is behind Mexico's decision to hedge its entire crude oil output for 2010 at $57/bbl after costs. All 230m bbls have been hedged, as a follow-up to 2009's successful hedge at $70/bbl. This added $5bn to government revenues in H1, a critical sum for any organisation.

Hedging often gets a bad name, when it is used to describe a trading activity. But as Mexico's Finance Minister, Agustin Carstens, noted ""We want this as an insurance policy. If we don't collect any resources from this transaction, it's OK with us. That would mean the oil price had remained above $57 a barrel".

The blog suspects that Mexico's $1bn insurance premium for its hedging strategy may again prove money well spent in 2010.

"The most important 'fuel' of all, will be energy saved through fuel efficiency". That's ExxonMobil's (EM) latest view of the outlook for meeting world energy demand over the next 20 years.

And as Nigel Davis highlights in ICIS insight, this "will require materials and innovation - the backbone for the chemicals industry".

EM expect "40% of the world's electricity will be generated by nuclear and renewable fuels" by 2030. It also expects the carbon price to reach $30/t over the next decade, making natural gas the most economically attractive fuel for power stations. But whilst EM see wind, solar and biofuels growing at 10%pa till 2030, these will still only have a 2.5% share of global energy needs, as they start from a low base.

The key issue for the chemical industry is EM's forecast "that efficiency gains of about 300 quadrillion Btu a year can be achieved by 2030, equal to twice the growth in energy demand over the period". A potential $30/t CO2 price makes it essential for companies to reduce carbon footprint from a cost point of view. But, as Nigel comments, this could also position them "to tap into growing markets for energy efficient materials and the demand for more energy efficient products".

The blog continues to believe that the current downturn is a transition period, at least in the West, towards a more frugal way of life. And its theory has received a boost from a New York Times feature which suggests this might be happening in the bastion of consumerism, New York.

The NYT suggests the key question is whether middle class Americans "Can change their mind-sets and lifestyles in order to accumulate capital and work down debt?" And rather than focusing on upwardly-mobile lifestyles, it provides tips on how to be more frugal.

It says half-way measures might be to "make an effort to live off cash, not credit cards", as "your spending may seem more real when green pieces of paper disappear, than it does when you swipe a card". And it notes that previously "upwardly mobile Americans (are becoming prepared) to defer gratification, another necessary mind-set change".

It also reports a Pew Research Center survey found that since 2006, Americans have begun to separate "need" from "wants". Only 47% now think microwave ovens are a necessity, vs 68% in 2006: 54% now "need" air-conditioning vs 70%; 66% "need" clothes dryers vs 83%.

Currently, US consumer spending accounts for 16% of global GDP, and is the single most important driver for chemical demand. Companies therefore need to keep a very close eye on the potential implications of such a major shift in US consumer culture.

EU auto sales continued to improve in November versus 2008, with total volumes up 27%. But as the chart from ACEA (EU Automobile Manufacturers Assoc) shows, they were still lower than in 2007.

The difference between sales in W Europe, and in the new EU Central European states (EU CE), was quite dramatic. Sales in the former rose 31% in November, whilst they fell 17% in the latter.

Overall, total EU sales are now down 2.8% versus 2008. W European sales are only down 1%, thanks to the major stimulus programmes adopted in many countries. But EU CE sales are down 27%.

The key question, of course, is the 2010 outlook? Many fear that subsidies have only brought forward planned sales, and not created genuinely new demand. If they are right, and governments prove unwilling, or unable, to further subsidise sales, then chemicals volumes in this important market may well come under further pressure.

Financial crises take time to mature. Yet until the end is nigh, apologists will insist that nothing needs to change. Thus valuable time is wasted.

Last year, Iceland was the obvious example of this problem. Now it is Greece, a eurozone member.

Back in January, S&P had downgraded Greece's bonds, due to debt concerns. And they were already yielding record amounts versus the German benchmark. Since then, nothing has really changed, and there is talk that Greece may soon need a rescue package from the International Monetary Fund (IMF).

Will Greece now move to tackle its high debt, low growth problem? Probably not, as the government is already facing major social unrest. But as Germany's Budget spokesman, Norbert Barthie notes, Greece is just "the tip of the iceberg" within the eurozone. Portugal, Ireland, Italy and Spain all face similar problems, whilst Austria had this week to nationalise its 6th largest bank following losses in E Europe.

The concern, as the Wall Street Journal notes, is "that the Continent's economic recovery could be derailed." Already, it says, the growing crisis is forcing "financially stronger countries to think about how to shore up other members of the euro zone against a potential financial-market rout". This may still be a relatively small risk, but it is no longer one that can be safely ignored by the chemical industry.

Paul Volcker was the last US Federal Reserve chairman who believed that a key part of its role was "to take away the punchbowl just when the party starts getting interesting".

He successfully brought inflation back to single figures during the 1980's downturn, setting the scene for the major economic recovery that followed.

Now head of President Obama's Economic Recovery Advisory Board, he is warning that regulators '"have not come anywhere close to responding with necessary vigor" to the worst economic crisis in 70 years'.

Volcker bases his argument on the belief that "we need to produce more, finance less". He also highlights the fact that "some banks have "pervasive conflicts of interest". And his core argument is that "this isn't any time to go back to business as usual."

As Bloomberg notes, Congress took 4 years from the 1929 Crash to enact meaningful banking reform. So it is no surprise that nothing has yet been achieved. Yet since 2007, the 4 largest US banks have got bigger, rather than smaller. They now hold 35% of all US deposits versus 27%. Globally, the world's top 10 banks hold 26% of assets, versus 18% in 1999.

Similarly, as Barrons notes, the US housing crisis - the core of today's financial problems - is still unresolved. 1 in every 8 mortgages is now in either foreclosure or delinquent, and foreclosures themselves are forecast to reach 3.9 million in 2009, versus 3.2 million last year. Equally, debt problems continue to raise concern in the eurozone and elsewhere.

The problem is that regulators continue to confuse being market-friendly, with being friendly to markets. Thus they fail to take the difficult steps that would make the financial system safer for its users. The blog believes Volcker when he says "I think I'm probably going to win in the end." It just hopes that further debt crises aren't required to finally force regulators to act.

Harvard's Prof Martin Feldstein is one of the very few economists who has correctly forecast the length of the current downturn.

Today, he questions whether the US recession is really over, and suggests that "2010 is going to be a very weak year". He believes that we are entering a more frugal economy, and notes that this new mood "as you come out of a recession is going to be a drag."

Feldstein also believes that the housing slump will "continue to push down house prices". He adds that in his view, the Obama administration's efforts to revive housing markets "was just not well enough designed (and has) ended up failing."

P&G's new CEO, Robert McDonald, has "warned of the risks to global growth posed by increased protectionism in the US and around the world, stemming from the global recession".

interviewed by the Financial Times, McDonald noted that 20% of P&G's jobs in the US depend on their international business, which accounts for 60% of P&G's annual sales of $79bn. And he went on to argue that "it is short-sighted for the US government to think they can create jobs at home by hurting our ability to compete internationally."

Interestingly, and in a positive sign for chemical industry recruitment, McDonald added that the downturn was changing the attitudes of potential recruits to P&G. He noted that "I'm finding from students that they want to live a life with meaning. Making products or marketing brands that improve people's lives is more meaningful than being involved in a financial transaction that creates no value."

OPEC's Angola meeting lasted just 70 minutes yesterday. Before the session, Saudi Oil Minister al-Naimi noted that prices were at their target level of $70-$80/bbl, and called this "a perfect price".

However, the underlying supply/demand balance remains fragile. As the chart from Nomura shows, current OECD oil/product inventories are well above normal levels. Whilst today's high prices have tempted many OPEC members to increase output above their production quota.

Quota compliance is now down to c60%, compared to 80% in H1, when prices were below $50bbl. Nigeria is pumping 1.96mbd (quota 1.67mbd), Iran 3.78mbd (3.34mbd), Venezuela 2.24mbd (1.99mbd). Equally, geo-political issues are less important, at least temporarily. Hostilities in the Niger delta are greatly reduced, whilst Iran's nuclear ambitions have also moved off the front pages.

OPEC's own statement also showed it remains aware that supply is well ahead of current demand levels, noting that "it is not yet clear how strong or durable the recovery might be" and adding that "the world (was) still faced by shrinking industrial production, low private consumption and high unemployment".

The blog is now 2.5 years old. Readership continues to grow, both within the chemical industry and its investment community. It is now read in 121 countries, and 2735 cities, versus 89 countries and 1244 cities a year ago. Readers are also very loyal, with 23% reading it twice a week.

Its readership covers all the major areas of chemical production. The UK, USA, Germany, Netherlands, Turkey, China, India, France, Singapore, Belgium make up the Top 10 countries, with Japan, S Korea, Italy, Brazil, Saudi Arabia and Russia all featuring in the top 25. English is a 2nd language for most readers, who speak 55 different first languages.

The blog aims "to share ideas about the influences that may shape the chemical industry over the next 12 - 18 months", and so it focuses on:

• The major companies
• Key consumer industries, including housing and autos
• Economic data such as GDP, industrial production and exports
• Developments in oil and financial markets

698 posts have been made in total, with 142 written in the past 6 months.

The blog's annual Budget Outlook continues to attract strong interest. This year's, 'Budgeting for a New Normal', was also the subject of a well-supported Webinar, and will shortly be published as a White Paper.

Thank you very much for your continued support.

China's bank lending has rocketed this year, as the government attempts to maintain employment in the face of a major collapse in vital export volume. New figures show it had reached $1.35bn by the end of November. By comparison, lending in the whole of 2007 was just $0.5bn.

As the Wall Street Journal notes, this has been "one of the biggest credit expansions in history". And it is all the more remarkable as a percentage of China's GDP ($4.23trn). In addition, of course, China also launched a $580bn stimulus programme, aimed at speeding up construction of new refinery/petchem plants, and major infrastructure programmes.

Yet in terms of virgin polymers, the impact has been quite variable. As the chart shows, based on an excellent ICIS analysis by Becky Zhang of CBI, the main feature in 2009 has been a 27% rise in PE consumption (blue line) versus 2007, and a 22% rise in polypropylene (red line), both after a flat 2008. But PVC volumes (black line) were flat versus 2007, whilst polystyrene (green line) and ABS (purple line) were 4% higher.

Equally, CBI's figures also show that China's domestic recycling sector has been rising strongly over the past 2 years. 2009's imports of recycled plastic at 6.95m tonnes were equal to 2007 levels, but domestic recycled volumes rose 24% to total 9.92m tonnes.