Chemicals & The Economy

The above chart presents an excellent snapshot of the development of Asia's chemical industry over the past 20 years. It comes from the American Chemistry Council's global production report, and shows volume growth in each country/region, with a base of 100 in 2002.

• China (blue line) has seen the largest growth over the past 20 years. Its output has risen 18-fold since 1989. Since 2004, its growth has accelerated, with volume doubling by 2009.
• S Korea (black) and India (pink) have been the other big winners, with 4- and 3-fold growth since 1989. Both have also continued to grow output through the current downturn.
• The smaller producers (yellow) have also seen 3-fold growth. But their combined volumes have fallen 4% since 2007.
• Taiwan (brown) and Singapore (green) have seen slower growth since 1989, and are now also seeing volumes slip. Taiwan saw output fall 8% last year, whilst Singapore fell 13%.
• Japan (red) and Australia (light blue) were the largest producers in 1989. But their growth rate has been much slower, and their output in 2009 was only c20% above 1989's level.

Most Asian countries have pursued an export-driven development model over the past 20 years. China, India and S Korea have grown remarkably as a result, along with other NEA/SEA countries.

But with export growth now slowing as a result of the downturn, competition within Asia is now starting to increase. This can only intensify, as the major new import volumes start to arrive from the Middle East.

A year ago, Ben Bernanke (head of the US Federal Reserve), startled financial markets with his claim that "green shoots" of recovery were now visible. This helped to lead to a major stock market rally, based on the sentiment that the US and other western economies would quickly bounce back to 2003-7 growth levels.

Observers such as Nouriel Roubini suggested that Mr Bernanke was confusing signs of restocking with real recovery. Sadly, as the chemical company Outlook comments show, Roubini has been proved right.

The new IeC Boom/Gloom Index above shows that sightings of 'green shoots' (green line) in the Financial Times have reduced to almost zero. In turn, the Boom/Gloom Index itself (blue column) remains below its highs of Q2 last year, and well below its highs prior to the Crisis in 2008.

The good news is that global chemical production (the blue diamond line) grew during H2 2009. At the end of H1 2009, it had been equal to the level at the start of 2006. The bad news is that as the chart shows (based on data kindly supplied by Kevin Swift at the American Chemistry Council), it was only back to the level seen at the end of 2006.

At its peak in Q2/Q3 2008, production had been 9.5% above the Q1 2007 level. But at the end of December 2009, it was only 3.5% above this level. So the world essentially lost 6% growth over the interim period. And it seems unlikely that this will be recovered quickly, given the deleveraging underway by consumers and governments.

Different regions continue to perform at different rates:

• N America (red line) was the weakest performer, in spite of its Asian exports, with volume at 89.5% of the Q1 2007 level.
• The Middle East (brown) continued to run hard on the basis of its advantaged feedstocks, and its volume was up 20.7% versus Q1 2007.
• Asia (blue) recovered strongly following China's stimulus programme, and was up 18.1%.
• W Europe (purple) also recovered due to stimulus programmes, and production was up 4.1%.
• Latin America (green) also recovered, and was up 2%.
• Central Europe (light blue) remained weak, with volume at 93.4% of the 2007 level.

The blog was recently interviewed by ICIS' Anna Jagger at Vienna Airport, on its way back from the World Refining Conference. The conversation covered the need for companies to focus on innovation, as well as on survival, during the downturn. It also highlighted specific examples of opportunities that could be pursued today, within the context of strategies being pursued by leading companies such as BASF and Shell..

A year ago, the Dow Chemical stock price was below $6, giving the company a total market capitalisation of just c$7bn.

Since then, Dow has regained the initiative in a very focused way.

First, it sold Morton Salt for $1.7bn, then it sold $2.25bn of new equity and refinanced $4.65bn of long-term debt. Next, it sold the calcium chloride and refining businesses for $925m. And now Tuesday saw the disposal of the Styron business to Bain for $1.63bn. Plus Dow puts a $400m value on the long-term supply/purchase deals attached to the sale.

The stock price has, of course, responded to these successes. It is now trading at c$29, giving a market capitalisation of $33bn. The blog congratulates those responsible in Dow for this major turnaround, at a time when market conditions have remained difficult.

The financial crisis has highlighted the need to move away from the simplistic approach of the "shareholder value" cult, where short-term targets dominate company thinking.

Even Jack Welch, former GE CEO and original instigator of the approach, now agrees that the concept was "a dumb idea".

The blog therefore welcomes DSM's new approach to the question of Board pay:

• The key principle is value creation for People, Planet and Profit
• It takes into account the company's long-term strategic goals
• It also aims to create more external transparency

Of course, one still wants companies to manage the short-term effectively, whilst remaining focused on longer-term objectives. So it is sensible for DSM to base 50% of short-term and long-term incentives on financial targets. The other 50%, however, will be based on "measures such as the introduction of 'green' products, energy consumption reduction, reduction of emissions of greenhouse gases and the engagement of the company's workforce".

The proposals go to shareholders for approval at the end of the month. Those interested in quick "in-and-out trading profits" will no doubt be dismayed. But those interested in a company's ability to generate robust profit streams - to be used for the payment of pensions, and other long-term goals - will hopefully give their support.

By coincidence, the blog's 6-monthly review of global stock markets takes place in March/September, so its review last March took place just as the market rally began. This week is therefore a good time to review developments since then.

Russia has been the the best performer (up 160%) and India up 100%. Brazil, another BRIC country, is in 3rd place (up 85%). But China, the fourth BRIC, is last, with a rise of 'just' 40%, behind Japan (up 45%). The US, Germany and UK are up c60%.

The blog maintains its view that this is a typical bear market rally, however, with a further decline to come. And the chart above provides some evidence for its belief. Even after these rallies, all the major markets are still down versus their 2007/8 peak. The best performer remains Brazil, down just 6%.

China and Japan are the worst performers, down 50% and 43% respectively since their peak. Russia is still 39% down, in spite of its recent rally. Then come Germany and the US, down 27%, with India and the UK in 2nd place, down c18%.

More evidence is emerging of the real estate bubble that China's easy money policy has created over the past year. Wen Jiabao, China's premier, has described property markets in some cities as now being like a "wild tiger". And new figures explain his concern, with the government reporting property sales rose an astonishing 80% last year, to a value of $560bn:

• Shanghai is the epicentre of the bubble, with prices 150% above their 2003 level
• The average apartment now costs $200k, although average wages are just $5k
• Luxury apartments cost 20% more than in New York's Manhattan district
• Outside Shanghai, Tianjin has built a $3bn "floating city" on a reservoir
• It is about to add the world's largest indoor ski resort

Property bubbles can be fun whilst they last. But after they burst, the hangover can be very painful for chemical companies, due to housing's importance as a key sector for demand. As we saw in the 2003-7 Boom period, a bubble leads to over-optimistic forecasts of future demand. And the new plants built to meet this perceived demand remain online, to depress prices and margins, long after the original bubble has collapsed.

Further evidence that the West is moving into a 'new normal' can be seen in the rising number of Napa Valley wineries facing foreclosures.

The concept, adopted by the blog for its recent 2010 Outlook White Paper, suggests that the 'conspicuous consumption' seen in the West during the 2003-7 Boom is being replaced by more budget-conscious consumers, and slower growth.

Napa Valley, long the most expensive of US wines, provides strong evidence in favour of the theory. According to Bloomberg, "2010 may be a vintage year for foreclosures in the Valley, as a result of falling land values and a consumer shift to cheaper brands".

Land values have already fallen 15% since the 2007 peak. Whilst last year saw a 15% fall in the sales of $30/bottle wine, and a 10% fall for $15/bottle product. Even some former high-rollers are cutting back from $750/bottle wine to $40/bottle.

The main problem causing foreclosure is excess leverage. As buyers pay less for wine, so a vineyard's land is worth less. And those who bought at the peak, when average prices jumped above $200k/acre for top properties, are now finding the banks are unwilling to refinance.

Experts suggest that winners from the shakeout will be those who "don't compromise quality, and manage their wines and land better" than competitors. Meanwhile, Napa's problems do mean that those of us in the chemical industry will find it cheaper to "drown our sorrows" with wine.

The blog sends its very best wishes to Ralf Kuhlmann of ExxonMobil, who retires this week as Business Director, Basic Chemicals Europe.

The phrase "a pillar of the industry" might have been invented to describe Ralf. He was President of APPE (Assoc of Petrochemical Producers in Europe) until recently.

He was also an EPCA Board member, President of the "European Science & Engineering Program" foundation of Exxon Chemical Europe, and a member of "European Industrial Research Management Association" and of the Energy, HS&E and Logistics Program Council (CEFIC).

The blog has known Ralf for 15 years. It joins everyone in the European hydrocarbons community in wishing him and his family "all the best" for the future.

The above chart is a real labour of love by ICIS' Sue Royse. It comes from the indispensable monthly ICIS Worldwide Ethylene Plant Report. This tracks global operating capacity (except Russia/CIS), and details both planned and unplanned shutdowns. It highlights a number of key issues:

• Total nameplate capacity was basically flat during 2008 at c10500kt/month. It began to rise sharply at the end of 2009, and is now at 12000kt/month. ICIS currently expect it to increase to 13000kt/month by the end of 2012.
• This is a c25% capacity increase. Yet demand historically increases in line with global GDP. So even if we return to Boom period growth of c4% (most unlikely in the blog's view), operating rates will remain well below those 2003-7 levels.

The chart also further explodes the myth that new Middle East/Asian plants have had major delays in starting-up. It is unclear where this myth began, but it seems to have been fed by wildly optimistic expectations in the financial community about the time taken to actually build new cracker complexes.

The chart shows scheduled maintenance as blue columns, and unscheduled as yellow column. The latter rose to historical highs in Q4 2008- Q1 2009, during the great destocking period. But since then, the combined total has reverted to its historical 7% level (left column), in line with the industry norm that maximum operating rates are c93% of nameplate capacity.

The apparent rise in China's crude oil imports has been a major factor behind the doubling of oil prices in the last year. Yet a detailed analysis by Petromatrix illustrates that reality is a little different from the headline:

• China has been importing more oil, as its new refineries come online (alongside its new petchem capacity).
• But domestic oil demand has not been increasing at the same level.

Petromatrix estimate that China's "refinery runs are growing at double the pace of Chinese oil demand growth". The result is shown in the above graph, which shows how China has "turned into a significant exporter of oil products" in recent months.

There is no doubt that China's own demand has grown over the past year. But Petromatrix's analysis suggests the underlying picture is more complex. When this will be recognised by oil markets is an open question. In the meantime, other Asian refiners are clearly paying the price for China's refinery expansion.

A week ago, the BBC carried a report that PetroChina had completed "preliminary work" on a possible bid to buy a stake in Ineos' Grangemouth refinery.

The BBC quoted Ineos as confirming it was in talks with "a number of parties" over the future of Grangemouth, whilst cautioning that "the discussions with interested parties are exploratory and it would be premature to speculate on whether any might lead to investment in the site. The Grangemouth petrochemical and refining facility remains a strategic part of the Ineos Group and the company is committed to its long-term development."

The BBC report came after a rare interview in The Times last December with Ineos chairman Jim Ratcliffe, who noted 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".

This still seems a sensible strategy, even though the blog understands that Ineos doubled EBITDA to €1222m in 2009, versus €594m in 2008, and is currently trading ahead of its business plan. Its liquidity has also improved by c€100m via the Ineos ChlorVinlys divestment, whilst the $350m fluorochemicals sale should complete later this month.

Then 2 days ago, the Sunday Times newspaper reported "that Ineos has recently held exploratory talks with Sabic, and Kuwait's Petrochemical Industries Company." It added that Ineos CEO Tom Crotty had refused to disclose the identity of the potential suitors, but had said "we are in talks with several parties that may lead to us bringing someone in, either as an equity partner in the group or on certain assets".

Yesterday, the Daily Telegraph added that the "proposals discussed with the Middle Eastern players are thought to have included the possibility of the company hiving off its petrochemical commodities business." It quoted an Ineos spokesman as saying that the company had been open about its plans to "further strengthen its balance sheet", although it had "no pressing need to do any deals given our current performance".

Morgan Stanley, the investment bank have reportedly been advising Ineos on Grangemouth since last June, when 'The Scotsman' newspaper suggested that "PetroChina could buy the refinery, while Ineos would retain the polymer and petro-chemical processing plants located on the same site". Perceptively, however, the paper had also quoted PetroChina as saying that "talks can take a really long time".

European auto sales continue to depend on the influence of government stimulus programmes. The main feature of February's results was the sharp decline in Germany's sales. They were down 30% versus February 2009. This supports the fears of those who saw stimulus programmes as simply bringing forward new sales, not creating new demand.

Overall, European sales were up 3%, due to the continuing stimulus programmes in Spain, up 47%; the UK, up 26%; Italy, up 21%; and France, up 18%. But it seems doubtful that these sales gains will continue beyond the end of government intervention.

Most worrying are the continued problems in Central Europe. In Hungary, for example, the government cannot afford a stimulus programme, and has instead had to increase VAT (sales tax). Sales went into freefall during 2009, and were down 78% in August. Last month they fell a further 58% versus February 2009. Only 3042 autos were sold - in a country whose population is 10m.

OPEC's meeting wrapped up quickly yesterday, with Saudi oil minister Ali al-Naimi once again saying oil prices today were "beautiful".

This highlights sentiment's ability to take prices in the opposite direction to fundamentals. For certainly, on fundamentals, OPEC should have had a difficult session:

• Quota compliance is now down at c50%, with Bloomberg estimating OPEC production at 26.8mbd last month, versus the target of 24.9mbd.
• Global oil stocks are 15% above normal levels at c60 days, versus the typical historical level of c52 days.
• OPEC's own analysis suggests that 2010 is likely to see "a decline in the demand for OPEC oil for the 3rd consecutive year".

But financial markets remain convinced a strong V-shaped economic recovery is underway. They also believe that China's oil demand will increase for domestic consumption, in spite of data showing China's oil imports are increasingly being used as the basis for exporting oil products - which is a zero sum game within the Asian market.

Interestingly, however, blog's own sentiment indicator, the Boom/Gloom Index, has been stable now for c6 months. And this parallels the oil bulls' own inability to push prices much above today's $80/bbl level, in spite of continued talk that they should be nearer $100/bbl.

Will this stability continue? The key issue, perhaps, is now the one of demand destruction. US gasoline prices are at $2.80/gal, their highest level since Q4 2008. And high energy prices also typically reduce consumer's discretionary spending - which in turn usually lowers chemical and polymer demand.

On a fundamental basis, such a combination of lower demand and high stocks would not normally be a recipe for rising or even stable prices.

Major changes are underway in the US petchem and polymer market:

• Middle East/Asian production will likely eliminate the US Gulf's historical position as 'exporter to the world'
• The arrival of cheaper gas, and the impact of shale gas, is changing cracker feedstock slates quite dramatically
• The continuing decline in domestic gasoline demand creates potential problems, but also opportunities

I look at these issues in an article published this week in ICB, to coincide with the NPRA meeting in San Antonio, Texas. I also summaries the key points in the above video interview with Will Beacham. Please click here if you would like a copy of the article.

Last June, the blog noted research by Profs Eichengreen and O'Rourke that compared the current Crisis to the Great Depression. They have now updated their work to February 2010, 22 months after the Crisis began.

The positive news is that the stimulus measures taken by governments have caused world industrial production to recover. As they say, this is a cause for congratulation - although it is still not clear whether this recovery will continue as stimulus measures are removed.

In fact, the Profs emphasise that we are still 6% below the previous peak, and "considerable excess capacity remains in a number of important economies". They therefore advise that stimulus measures continue.

But in their other 2 focus areas, World trade and Equity markets, the news is less positive. The current Crisis saw a sharper decline than post-1929, and the recent recovery has only brought us back to the trend seen in the Great Depression.

Their chart above of world trade volume highlights this, with today's position (red line) clearly in line with the Depression trend (blue line). This is disappointing, given the size of the recent stimulus programmes.

It is also worrying, as the chemical industry is a major beneficiary from growth in world trade. China's increasing use of anti-dumping duties, and growing US pressure to term China a 'currency manipulator', are worrying signs of the fragility of the current economic recovery.

US housing used to be a $35bn chemicals market, with 2.2m housing starts in 2006, each with a $16.7k chemicals value.

Last year, total housing starts were just 550k, for a value of only $9bn. And as the chart above shows, from the American Chemistry Council, the annualised rate (blue line) was just 575k in February. Building permits (red), an indicator of future building activity, increased 11% to 612k.

The depth of the current downturn is shown by the fact that it would take a 35% increase from 2009's level just to get back to the lowest level of housing starts seen between 1959-2008. Optimists argue that a major downturn leads to a strong recovery, but with 15% of Americans either in foreclosure, or at least one mortgage payment overdue, the blog fears this optimism is misplaced.

"Crude oil is (now) more than just a physical product", according to NPRA Chairman William Klesse. As he noted, "Today there is ample crude in the world, and crude is not at $80/bbl because of physical markets".

This was a strong statement from the head of the US National Petrochemical & Refiners Association, at the start of the annual meeting in San Antonio. As he added, the reason behind the price hike is that crude has become "a financial product".

The chart, from the Financial Times, shows the reason for his concern. Last year, European pension funds alone "invested" €21bn ($29bn) into commodity funds, particularly oil. This was a 145% increase on the 2008 figure, with minimum 60% growth expected this year. This flood of money hiked oil prices 78%, even though demand growth was poor.

Now, however, as the FT notes, there is growing "alarm" amongst the investment community about the relatively poor results they obtained. The "investors" who held the fund for a year made just 17% by December, not 78%. The reason was that they "invested" in futures markets, which were in contango (where the months ahead are priced higher than today's spot price).

Thus although oil prices rose, each month the "investors" lost most of the gain, as the future contract came closer to actual delivery. Instead, the bulk of the gain went to those who launched the commodity funds, or those who actively traded the futures markets.

These highly-paid "investors" failed to understand the simple truth that commodities trading is a zero-sum game - you win, I lose. Or as Goldman Sachs' CEO Lloyd Blankfein told the US Congress earlier this year 'when Goldman sells a security that subsequently goes up (i.e., on which the other party makes money), "we wish we hadn't sold it".'

Meantime, as Klesse noted, it is the petchem and refining industries that has to cope with the end result - an oil price that is currently very over-valued in relation to the laws of supply and demand.

The death of Sir James Black, Nobel Prize winner and one of the giants of the modern pharmaceutical industry, has been announced this week.

He began work at the blog's former company, ICI after the War. The idea was to build on the success seen with drugs such as penicillin. It was, as we know today, a good decision. But it took 20 years before the pharma business made money. Even in 1978, when the blog joined ICI Petchems, numerous executives would complain that "ICI Pharma was spending all our profits", whilst we were not able to build more crackers.

Black's great discovery was beta blockers - the first effective therapy for high blood pressure, and still widely used today. He then moved to what is now GSK, where he invented Tagamet to treat stomach ulcers. In turn, this led to the development of Zantac, the best-selling drug in history.

Black's death is a reminder, if one was needed, that finance is not the be-all and end-all of the chemical industry. The real driver is the quality and the effectiveness of the products that we make, that help to create a better life for people around the world.

A remarkable thing happened this week in European olefin markets. Contract prices for butadiene and propylene were finalised for April/Q2 at higher levels than for ethylene. This has never happened before, in Europe or other regions.

The chart, based on ICIS pricing data, shows how ethylene (blue line) has normally been the highest priced olefin. Butadiene (green) has often been relatively tight during downturns. And in 2005/6, propylene (red) and ethylene were sometimes similarly priced. But we have never before seen both "co-products" higher than ethylene itself.

The rationale for the changes is the arrival of the ethane-based crackers in the Middle East, and greater use of lighter feedstocks in other regions. This is significantly reducing the amount of propylene and butadiene co-produced on steam crackers. Low refinery operating rates are also temporarily reducing propylene production from this source.

Propylene should return to better balance over the next few quarters, as more new capacity comes on stream via propane dehydrogenation and metathesis, as well as from the new Asian refining capacity. Equally, lower prices for ethylene will start to improve polyethylene's (PE) competitive position versus polypropylene, after an extended period when PE supply has been relatively tight.

Butadiene, however, may well remain tight for some time. This was a key conclusion from our 2008 Feedstocks for Profit Study, when we warned that a Global Downturn scenario would lead to shortages of butadiene as Europe's steam crackers "will turn down relatively harder than auto production, due to Middle East production taking a relatively higher share of C2 demand, and thus reducing the supply of butadiene".

In December, the blog suggested that "2010 might 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".

The chart above, from the excellent American Chemistry Council's weekly report, provides welcome evidence that this may indeed be happening. The red columns show destocking/restocking down the main polymer value chains. Clearly Q4 saw destocking for year-end reporting reasons, with consumers drawing down inventories by 110kt (250m lbs) a month.

But January and February saw this trend reversed, as customers restocked in advance of expected better demand from key industries such as auto and construction. The ACC estimate this led to inventory builds of 75kt (165m lbs) in January, and 25kt (55m lbs) in February. As a result the trend line (black) has become positive for the first time since 2006.

Much is now riding on Q2 demand. We cannot expect a V-shaped recovery of demand back to levels seen in the 2003-7 Boom. But we should hopefully see an improvement versus Q2 last year, even though today's high levels of crude prices will act as a "tax" on discretionary expenditure by causing consumers to focus on higher transport/heating costs.

The blog congratulates Brenntag, the leading distribution company, on its successful flotation yesterday.

Its shares were issued at €50, and rose to €52 in early trading, giving it a market capitalisation of €2.7bn ($3.6bn). New private equity owners BC Partners sold 4.45m shares to raise €223m, and now own 71% of the company.

Brenntag itself also raised €525m by selling 10.5m shares. This enabled it to repay expensive mezzanine debt, and will also finance potential acquisitions in Asia and Latin America.

As distribution industry expert Marc Fermont of DistriConsult noted in a recent speech, the "IPO is a major industry event whose success was essential for the whole sector". He added that Brenntag was a relatively safe investment, as "distributors tend to bring regular cash flows measured as EBITDA, including in period of crisis (whilst) financial risks are limited as very few bankruptcies are reported in the sector".

Prof Nouriel Roubini, one of the few to forecast the current Crisis, is very positive about the opportunities for growth in India over the next 20 years. Speaking in Mumbai, he argued that:

• "While the economies of India and China are not large enough to lead global growth, emerging markets remain 'bright spots' compared with the U.S., Europe and Japan, which all face deflationary pressures".
• "The size of the emerging markets is going to become larger and larger, and it's going to become greater than the GDP of the United States. It may take 20 to 30 years, depending on relative economic growth, but the process will occur (and) we should get used to it."
• "China might be facing a greater challenge in maintaining its double-digit growth rate than India", as stimulus measures are withdrawn.
• "China has been a hare and India a tortoise, but growth is accelerating in India. The positive aspect about India is that its economy is less dependent on exports compared with China."