Chemicals & The Economy

The oil market rally seems finally to be running out of steam. For months now, it has been driven by the 'correlation trade', whereby Wall Street traders sell the US$ and buy crude oil. But as the chart shows, the two lines have now begun to diverge.

Fundamentals have clearly started to affect the €:$ rate, as real-world concerns about the Greek economy no longer make the euro a one-way bet. The blog suggested in November that traders would find it difficult to push the euro above $1.50 : €1.00. As the blue line shows, it has since retreated quite significantly, and is now around $1.39.

The monthly average crude oil price (black line) is now at the $80bbl resistance level. And in futures markets, where Forward supplies trade, a major change has taken place. In H1 last year, the contango between the current month and the future month was extraordinarily high at $20/bbl.

This gave traders the ability to store oil offshore and make a certain profit. But now, the contango has almost disappeared. Forward prices for May are only $1bbl higher than the current month, not enough to allow traders to store oil offshore profitably. So they may now start bringing all 150mbls of floating oil back onshore again. If they do, there seems little to stop oil moving back to $40bbl, apart from geopolitical events.

As the blog has argued before, this kind of volatility is exactly what the chemical industry does not need, with the economy already so fragile.

There has been no New Year recovery for the IeC Boom/Gloom Index. It (blue column) slipped again last month, and is now back at September's level. A further fall in February would take it close to the levels seen before the dramatic rally in financial markets that began last March.

Equally, the Green Shoots spotted by US Fed Chairman Ben Bernanke last March, which sparked the rally, have now disappeared from view. Whilst the Frugal Index (red) has shown a small increase.

Its nearly 18 months since the US government nationalised the 2 home loan giants, Fannie Mae and Freddie Mac, at the start of the September 2008 financial crisis.

Today, their current obligations amount to $3.7trn - larger that the total UK economy. And the Wall Street Journal notes that their cumulative losses on home loans had reached $291bn by the end of 2009.

Yet even this support for the housing market has not been able to reverse the tide of foreclosure. According to the Mortgage Bankers Association, 4.5% of all US homes were in foreclosure in Q3, the highest percentage ever seen. 1 in 10 mortgages was at least one payment overdue. And 4.5m homes were worth less than 75% of the mortgage value.

A further worrying trend is the rapid rise in bank-owned homes for sale. These do not appear in the figures reported by the National Association of Realtors, as no realtor is involved. Equally, no accurate figures are available on the size of this 'shadow market', although the Financial Times estimates it is now larger that the 'official' market.

Tellingly, the Obama administration missed its own deadline for revealing its future plans for Fannie and Freddie on Monday. Instead, it made a one-line statement that "The administration continues to monitor the situation closely and will continue to provide updates on considerations for longer-term reform of Fannie Mae and Freddie Mac as appropriate." Whilst an assistant Treasury secretary noted that "we haven't yet found a way of dealing with this (housing issue) that would be practical on a large scale."

In August, Toyota (red line) briefly replaced GM (blue) as the US industry leader. Last month, however, its recall problems meant its sales fell 16% versus last January, an even worse performance than Chrysler (purple).

Toyota's problems are generally bad news for the industry, as they will inevitably impact overall public perceptions. Some will suspect that hard times have caused auto manufacturers to cut back on vital spending. This is particularly disturbing as Toyota was one of the Japanese companies who pioneered the development of Total Quality programmes, and helped export them to the west.

Overall (black line), US auto sales ran at a 10.8m annual rate. This is better than last year's actual total of 10.3m. But it is still a long way from the steady sales picture during the 1995 - 2007 period, when the chemical industry could count on a minimum of 15m sales, worth c$45bn in terms of chemical sales (in 2010 money).

SOURCE: WWW.CHARTOFTHEDAY.COMUS consumers were responsible for 16% of total world GDP in 2008. But their spending is taking a battering from the combination of high unemployment and high oil prices. Both are reducing end-user demand for chemical products.

New government estimates suggest US employment has fallen by 8.4m jobs since the downturn started in December 2007. Total unemployment was 1.4m higher in December 2009 than previously reported.

These are staggeringly bad figures, particularly when one considers the major financial stimulus programmes that were put in place in early 2009. And as the chart shows, from ChartoftheDay, job losses in this downturn are far worse than the average during recessions. They are 3 times worse than the average loss (blue line).

Equally, downturns between 1950-2000 had typically already begun to actually add new jobs again, and had already recouped all the jobs that had been lost. This is a major contrast with today (red line), where the most optimistic interpretation is that the job loss total may have peaked.

Sadly, this was all predictable, although politicians seem to have preferred to ignore the evidence. Back in December 2008, the blog noted detailed Bank of England analysis of 33 banking crises between 1977-2002 which concluded:

• The average length of each crisis was 4.3 years
• The median loss of GDP was 7.1%
• Major crises (such as today's) caused GDP losses of at least 10%.
• GDP losses can double if the banking crisis leads to a currency crisis

And their forecast of the likely course of today's crisis still seems valid:

• Governments have initially found it easy to borrow, but now face the risk of a currency crisis if foreign lenders begin to suspect they will never be able to repay the money borrowed.
• Companies continue to find it more difficult to borrow, as banks "de-risk" their balance sheets.
• Consumers face an increased risk of unemployment, and are tending to save more, thus further reducing demand.

ICIS have now published the blog's 2010 Budget webinar as a White Paper. Please click here if you would like to obtain a free copy.

My thanks go to Nigel Davis for his editing skills, and to Jamie Barnes for masterminding publication.

One can only feel sorry for China's government leaders. A year ago, they faced 23m unemployed, as their export markets collapsed in the West. In order to avoid major social unrest, they opted to unleash what the Wall Street Journal called "one of the biggest credit expansions in history". $1.4trn was lent during 2009, in a total economy of only $4.2trn. In addition, there was a stimulus programme worth $580bn.

Of course, some of this money will have been spent wisely. But it is unlikely that the required number of financially sound projects could have been found in such a short space of time. A considerable amount must have gone to fund speculation. As the above chart shows, the statistics from the Dalian futures exchange confirm this suspicion, as LLDPE volume (blue line) rose from 20m tonnes to a peak of 80m tonnes by April.

More recently, volumes have begun to slow as the government now tries to reverse course and avoid major asset price inflation. January saw only 28m tonnes traded. And this month's volume may be lower, with the Lunar New Year holiday beginning 3 weeks later (14 February). Yet there is still little evidence that China's main Western export markets (which accounted for 37% of GDP in 2007) are about to stage a full recovery.

Anti-dumping duties (ADDs) are on the rise, as countries seek to protect their own manufacturers.

The most publicised ADDs so far, of course, were those by the US on Chinese tyres in September. In retaliation, China hit companies such as BASF with duties on US produced nylon 6. Separately, India imposed an ADD on caustic soda.

Now, the whole issue is revving up again. Last week, Europe imposed ADDs on Chinese shoes. And, as ICIS news reported , China imposed ADDs on PTA imports from Korea and Thailand - both long-standing suppliers to the country. Yet it is only a month since the new free trade agreement between China and Asean came into force. Today, India has taken action against phenol imports from Japan and Thailand.

These ADDs are likely to be only the start of the story. As China's new petchem capacity comes online, its demand for imports will greatly reduce. Equally, India is unlikely to want to see these volumes move into its domestic market, just as it is also expanding capacities. Whilst Western countries are unlikely to want to encourage imports, when their own unemployment is at high levels.

As John Richardson notes today, the combination of the global economic crisis and big increases in petchem/polymer capacity is a lethal cocktail. As a result, those without a strong domestic market will likely find it increasingly hard to move their traditional export volumes.

Iran has begun storing crude oil offshore again, according to Bloomberg, as demand in its major market, Japan, enters a seasonal slowdown. It has 6mbd on ships in the Persian Gulf (equal to 19% of current storage for the WTI contract at Cushing in the USA). Another 2 ships also seem to be being used for storage off Malta and Benin.

Meanwhile, Morgan Stanley (MS) have confirmed the blog's suspicion last week that traders might start to bring more offshore crude onshore, as the contango narrowed. MS suggest as much as 25% of floating storage might now be coming ashore. This was no doubt partly responsible for the dramatic 8% fall in crude prices towards the end of the week.

The contango reflects buyers' willingness to speculate on higher prices in future months. But the future price has to be high enough to cover the costs of storage, and the time value of money. As of today, the trade looks unattractive, with March futures contracts selling at $74bbl, and August at just $76bbl. Thus the blog continues to suspect that prices could easily move lower, if more traders decide to cash in their current profits. As Petromatrix comment, US stocks are now 15mb above last year's high levels, whilst demand is down, and yet oil prices have doubled.

The Toyota problems, with over 9 million autos being recalled around the world, has set the blog thinking about how to spot corporate disaster in the making.

One excellent source of insight is Prof Jim Collins' book, 'How the Mighty Fall', published last year. This suggests that doomed businesses pass through 5 key stages.

Encouragingly, Toyota's management are apparently using Collins' analysis below to help identify the root causes of their problems:

• Hubris born of success. This is when people begin to believe their own propaganda, and assume that they will always achieve their goals.
• Undisciplined pursuit of growth. Getting bigger becomes confused with being good, and business models get pushed beyond the actual capability of the people involved.
• Denial of risks. The top people refuse to accept that things are going fundamentally wrong, and instead re-organise.
• Grasping for salvation. Management begins to panic, but still resist making changes to their, by now, clearly flawed business model.
• Bankruptcy or downsizing. Nothing can now be done to rescue the situation, and the business is broken up, or closed down.

As Collins notes, decline is a disease that develops in small stages. He says it is "harder to detect but easier to cure in the early stages; easier to detect, but harder to cure in the later stages'. Sadly, Toyota is unlikely to be the only such example that we witness during this current downturn.

The blog is delighted to learn from ICIS that thousands of copies of its new White Paper, 'Budgeting for a New Normal', have been downloaded in the first week of publication.

Please click here if you would like to obtain a free copy.

The blog was in Vienna this week for a World Refining Association conference on the Global Petrochemical outlook. It had the privilege of chairing a very distinguished panel of industry leaders in a discussion about managing through the downturn.

One of the key inputs came from Anton de Vries, LyondellBasell SVP, who had earlier shown the above slide illustrating the close relationship between polyolefins demand and GDP/capita. The vertical axis shows consumption of polyolefins/capita, and the horizontal axis GDP/capita. It highlights a number of key factors:

• The developed Regions (eg EU, USA, Japan) have GDP/capita of over $40k, and use over 40kg/capita of polyolefin.
• Emerging countries (China, India) have GDP/capita of less than $5k, and use only c10kg/capita.
• Total demand (the size of the circle) in emerging countries is therefore much less than in the developed world, even though they have much larger populations.

The blog has added a trendline to the chart, in order to highlight the relatively gradual way in which higher GDP/capita leads to higher polyolefin consumption. As Anton noted, the emerging countries can expect to see major increases in demand as their populations become richer. But it will probably take decades for them to reach the current level of per capita demand in developed economies.

CFO's have a lot to think about currently. Volatility is rising in currency and oil markets. Plus credit risks on previously safe 'sovereign' debt markets are also increasing.

Today, for example, there are new concerns that investors in Dubai World's $22bn debt may lose 40% of their investment.

Equally, current problems in the eurozone over Greece's debt may well spill over into Spain, Portugal and even Italy - where debt levels are also high.

Recent history would suggest these problems represent a one-way bet for speculators. Ever since George Soros famously 'broke the UK£' in 1992, it has been assumed that markets rule. But this is only a recent development. When the blog started work in 1976, for example, it was only allowed £50 for each business trip abroad, due to capital controls.

Now, John Dizard in the Financial Times warns that "sooner rather than later, European officialdom will impose higher taxes, credit restrictions and transaction barriers aimed at global macro traders", and "shock measures that force the unwinding of politically undesirable trades".

Of course, such moves in defence of the euro are not on the agenda today. But Dizard has a record of being proved right over time. And if they did occur, CFOs might wake up one morning to find they now have significant amounts of money locked away in the wrong place.

Prudent CFOs will therefore no doubt want to consider the potential impact of capital controls, where they next update their risk management strategies.

The European Union was the leading auto market in the world in 2009. It sold 14.4m, versus 13.6m in China and 10.4m in the USA.

January has continued this promising trend, with volumes up 13% versus 2009. But it is likely to prove temporary, as government scrappage schemes end. This has already happened in the major German market, where January sales were actually down 4% versus 2009.

The chart also gives a good picture of the relative decline in volumes since the downturn began. Versus January 2008, EU volumes last month were actually down 17%. And between 2003 - 8, January sales ranged between 1.2m - 1.3m, versus only 1.06m this year.

No wonder alarm bells were ringing in China's central bank last week. The above chart (from China Daily) shows how total lending rebounded to $204bn in January, only 14% below the 2009 level.

Total lending doubled during 2009 to $1.4bn, an astonishing amount for a country with total GDP of $4.3trn. Of course, this enabled China to easily reach its target of 8% GDP growth. But it also led to higher inflation, and a surge in house prices, which rose 11%.

The government now aims to cut lending by 22% versus 2009, to help keep inflation under control. January's lending figure was clearly too high for comfort, causing the central bank to order an unexpected rise in banks' reserve ratios on Friday, just before the Lunar New Year holiday.

Further tightening is probably inevitable. Chemical companies therefore need to carefully reassess likely levels of Chinese demand for their products, given that key elements of last year's major stimulus programmes may now start to be removed.

The blog has been following the development of GM's new all-electric car, the Chevrolet Volt, with interest, ever since Pedro Spohr of Galp in Portugal highlighted its potential to impact naphtha balances.

Of course, it won't do this on its own - but GM's adoption of the technology makes it essential for other manufacturers to follow suit.

The Volt's launch is scheduled for next year, and now ICIS news reports that GM say it will run on E85 blend ethanol, as well as electricity. It is part of a trend that led BP's CEO, Tony Hayward to forecast last week that gasoline consumption in the western world probably peaked in 2007.

This has to be good news for the chemical industry, over the medium and longer-term, as it means the competition with gasoline for oil-based feedstock supply will become easier.

Wal-Mart, the world's largest retailer with $400bn sales, saw deflation in its core US market last quarter.

Prices were down minus 1.6%, even more than the -1% forecast. The cause was lack of confidence amongst shoppers, many of whom are now living "paycheck to paycheck".

The major retailers have an excellent record as forecasters of future trends for the chemical industry. So it is worrying, to say the least, to find CEO Mike Duke expecting that U.S. sales will be "more challenging" in the current quarter. The only note of optimisim was that he went on to add the hope that they might "improve as the year progresses".

One of the key conclusions in our 2008 Study, 'Feedstocks for Profit', was that butadiene had the potential to go very tight in a Global Downturn Scenario. And as the chart above shows, prices are now rising sharply in the 3 major Regions.

The rationale for the lack of supply is that the gas-based crackers in the Middle East are now starting up. In turn, this is causing liquids-feed crackers in other regions to reduce rates, as their ethylene production cost is much higher. Thus the supply of co-products is reduced. And whilst propylene and benzene, the other main co-products, can be obtained from refineries, butadiene supply depends on liquids-feed crackers.

In addition, of course, the sharp differential between natural gas/LPG and crude oil values is encouraging producers in other regions to maximise lighter-feeds. And so butadiene supply is further reduced. As ICIS news reports, ABS is now "short" in Europe, and "critically tight" in the USA. Whilst butadiene spot prices in Asia (green line) temporarily moved up over $2100/t in January.

The blog spent a fruitful afternoon last week, going through ICIS news reports of cracker start-ups in the Middle East and China. The chart above is the fruit of its labours, which shows that 4.8MT of ethylene capacity started up last year in the ME, and 2.1MT in China. Whilst latest estimates suggest that another 3.3MT will start up this year in the Middle East, and 3.95MT in China.

The problem, of course, is that these new capacities are starting up with demand much reduced versus the growth levels seen in the 2003-7 Boom period, when these plants were planned. And, of course, other crackers are also starting up in Asia and elsewhere. Thus global Operating Rates are likely to be c80% level this year, unless demand suddenly improves.

But not all regions will run at this average rate. The blog's view is that both the ME and China will run at maximum rates - the ME due to its cost advantage with gas-based feedstocks, and China because of national energy policy. Thus NEA ex-China and SEA will find it very difficult to run at the global rate, as their exports to China are reduced.

15% of Americans were either in foreclosure, or at least one payment overdue, according to the Q4 Mortgage Bankers Association survey. This is a record high, but the MBA sees some signs that the numbers may have peaked. It is concerned, however, over the rise in the number of long-term unemployed, now a record 40% of total unemployed.

US housing was a $35bn market for chemicals as recently as 2006, when housing starts ran at a 2.2 million rate. They are now 74% below that level. January's figures showed some sign of a bottoming, but were still just 591k. One sign of the current crisis is that, as shown in the above chart from thechartstore.com, they need to rise c35%, just to get back to the lowest level ever seen in the period 1959-2008.

Update: In later news today, the S&P Case-Shiller Index of house prices fell 3.1% versus December 2008. 11.3 million US households are now in negative equity (where the house is worth less than the mortgage). This equals 24% of all US properties with mortgages.

France's Carrefour is the world's 2nd largest retailer, with sales of €86bn ($117bn). Reporting 2009 results, CEO Lars Oloffson echoed Wal-Mart's CEO Mike Duke, saying he saw "challenging" times ahead.

And he added that "I don't see any improvement in the short term in the economic environment. That means very clearly that we have to rely on our own performance".

Carrefour also, like Wal-Mart, saw its home market sales drop, by 0.9%. Across Europe, they fell 2.8%, "affected by the economic environment and by deflation in Spain". In Asia, growth at existing stores "was negative in all countries, reflecting a generally challenging economic environment".

In China, despite its economic boom, Carrefour saw "deflationary pressure throughout the year", although Q4 saw some recovery. Latin America was the one bright spot, with sales up 17% due to strong growth in Argentina and Brazil.

The blog's quarterly survey of company Outlook statements shows CEOs remain very cautious. There has been a rebound after the destocking disaster of Q4 2008 - Q1 2009. But there seems little confidence that we will quickly return to the levels of demand and margin seen in the 2003-7 Boom period. China's stimulus and loan programme has certainly had an enormous impact in Asia, but NAFTA and Europe remain weak.

BASF CEO Jürgen Hambrecht perhaps best summarises the overall mood, with his view that "the worst is behind us, even though dark clouds remain ". He added that:

"Overall, there are no signs of a self-sustaining, long-term recovery. We are still significantly below the capacity utilisation rates that were seen ahead of the crisis. (We expect) the majority of growth to come from the emerging economies in Asia, especially China, and from South America. The economy is still sputtering in Europe and North America. Growth in Europe would not return to 2008 levels before 2012. Stimulus programmes are being wound down, credit is becoming tighter, excessive national debt is leading to austerity measures, the number of jobs is falling and overcapacities still exist. There are further risks associated with geopolitical tensions and a trend towards protectionism."

Akzo Nobel. "The recovery is fragile and will be slow."
BASF. "The worst is behind us, even though dark clouds remain".
BP. "The pace of global economic recovery would be slow and gradual".
Bayer. "Expected the impact of the 2009 global business downturn to continue to be felt for some time to come".
Clariant. "Saw no fundamental reason for growth to pick up".
Cytec. "Markets are funny right now. They improve for a couple of months, and then they go down for a bit."
Dow Chemical. "Growth will continue to lag in the US and Europe, however, as high unemployment persists and questions about the sustainability of government stimulus spending remain."
Dow Corning. It's still a volatile economic environment, but the year ended with many positive signs."
DuPont. "In step with a transition out of a recessionary environment".
Georgia Gulf. "This year is going to be a step-up in some areas, but to say robust would be an over-statement".
Idemitsu Kosan. "Demand for products improved during the nine months, led by the economic stimulus package in China."
Johnson Matthey. "Visibility remains limited in some of our end-user markets, the group is well placed to benefit from economic recovery."
Kemira. Cost-cutting "had proceeded faster than planned and would be completed by the end of 2010".
LG Chemical. "Demand from China was expected to be robust as the country continued its 'solid growth'".
Lonza. "Demand reflected a reduction in orders for life-science ingredients and large-scale biopharmaceutical projects in custom manufacturing."
LyondellBasell. "Olefins profitability would be subject to oil price movements, while the polymers outlook would largely depend on whether the US PE export window to Asia remained open."
Occidental. "Continued weakness in US housing, durable goods and agricultural markets."
OMV. "Performance was affected by lower volumes and realised margins in the fourth quarter of last year".
Polyone. "Government stimulus programmes may have helped the economy in the back half of 2009 and this may not continue this year."
Praxair. "Cautiously optimistic that growth in the US and Europe will continue to improve, but recovery would be slow and deliberate".
Reliance. "A substantial improvement in overall margins as the industry was operating on a low level of inventory, leading to higher domestic realisation."
Rhodia. "Global economic conditions had improved but growth in Europe remained uncertain."
SABIC . "As the global economy improves during the year, we expect to see demand for our products improve."
Shell. "We are not assuming that there will be a quick recovery, and the outlook for 2010 is uncertain."
Sherwin Williams. "Demand in most end markets remained weak and industry-wide volume was down significantly from peak levels".
Sinopec. "China's chemical market in 2010 would face challenges, such as intensified market competition, the rise of trade protectionism and overcapacity".
Solvay. "Prepared in case of a longer crisis. Market conditions remain challenging,"
Sumitomo. "Consumer spending remained sluggish amid worsening employment conditions and capital investment fell substantially against the backdrop of depressed corporate earnings."
Sunoco. "We continue to expect a challenging market due to ongoing economic weakness and excess global supply."
Unilever. "Face pressure on consumer spending power and heightened levels of competitive activity."
Unipetrol. "The petrochemical industry is recovering but at a slow pace. It is quite clear that we still have hard times ahead."
Vitol. "The global economic outlook and the dynamics of future oil demand remain uncertain".
Wacker. "The upturn in demand experienced since April 2009 continued through the fourth quarter, but did not offset the drop in sales caused by the economic crisis."

World trade fell 12% last year, its worst decline since 1945. First estimates also suggest global GDP fell 2.2%, according to Pascal Lamy, head of the World Trade Organisation. This confirms the World Bank's fears back last March, that the global economy might shrink for the first time since World War 2.

Lamy went on to add the following downbeat assessment of the current position:

• The "freefall in trade" has been due to the "simultaneous reduction in aggregate demand across all major world economies (and) the drying up of trade finance".
• "The positive impact of national stimulus packages is fleeting and worries are mounting over the huge budget deficits rung up by many governments."
• "The International Labour Organization estimate the number of jobless worldwide at over 200m."

Lamy also highlighted the importance of trade to national employment:

• "22% of total employment in Germany depends on exports".
• "20% of US employment relates to exports of manufactured goods".

The chemical industry is a major beneficiary from growth in global trade. So it is unlikely that we will see a full recovery in demand whilst international trade itself, and global employment, remain depressed.