Chemical company CEOs need to act on high oil prices

Distillates Jan10.JPGPity your poor Purchasing Director this week. They know the West is having a cold winter, but they have done their analysis and can show you slides, such as the one above from Petromatrix, that indicate the US has the highest stocks of distillates since 1999. In addition, the world has 75mb of distillate in floating storage. So there is no shortage of product.

So why are oil prices above $80/bbl?
• Is it because crude oil is somehow short, or gasoline? No. We have high stock levels for these as well, plus plenty more in floating storage.
• Is it instead because higher prices are needed to justify sufficient E&P investment in finding more oil for the future? Perhaps, but then we have to ask the related question, namely ‘what level of global GDP growth can be maintained if oil is going to be $80/bbl or higher’?

Or to put the issue another way, can industries such as chemicals successfully pass through such prices, and maintain previous growth levels? We all know, after the experience of 2007-8, that the perception of today’s high prices being easily absorbed is not the same as reality. Purchasing managers are virtually forced to buy forward, if they see higher prices round the corner. But this doesn’t mean their sales colleagues can sell the same volume, or maintain the same margins.

And in reality, as will likely become clear as and when prices fall again, high oil prices (as we first saw in 1973-4, and 1979-80), in fact cause demand destruction. They effectively act as a tax on the general population, who have to heat their homes, and travel to work and the shops. This gives them less to spend on other products and services.

So, then, why are oil prices so high? The answer is very simple – ‘money talks’. As the Wall Street Journal notes this weekend, banks “including Citigroup Inc., Bank of America Corp., J.P. Morgan Chase & Co. and Morgan Stanley are offering levels of borrowing–known as leverage–that they haven’t provided in more than two years“. But this money is not flowing into loans to industry.

Instead, its going straight into trading activity in financial markets. And in so flowing, it has the remarkable effect of creating the illusion of recovery, as outsiders look at high oil prices, and assume that demand levels must have recovered. This could become a very dangerous assumption indeed, if it becomes shared by policymakers.

CEO’s are now preparing their comments on 2009 performance, and the 2010 Outlook. It would be very helpful indeed, if they included a paragraph that noted what is happening in oil markets, and questioned why this is being allowed to continue.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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