Chemicals & The Economy

The blog continues to go from strength to strength.

It is now read in 130 countries and 3680 cities, up from 111 countries and 2088 cities a year ago. Its readership is truly global, with the Top 10 countries including Benelux, China, France, Germany, India, Italy, Singapore, Turkey, UK and USA.

It has also expanded its activities. ICIS has hosted two successful webinars, whilst the American Chemical Society now offers webinars every 6 months to their 100,000 members. Blog readers can join the next one on Thursday (they are free), by registering here. The introduction of YouTube interviews with ICB's Will Beacham has also proved popular.

Another exciting development has been the White Papers launched with ICIS. Over 2000 copies of the 1st White Paper were downloaded in 24 hours after its publication. The Mid-Year Update, just released, seems to be equally popular. Click here if you have not yet got your free copy.

In addition, the blog has been invited to speak at a number of major company, industry and sector events.

Thank you very much for your continued support.

In May last year, the blog was hopeful that the major decline in Russian chemical production might start to reverse. And recent ACC regional production figures have indeed shown a welcome improvement in Central and Eastern European output, which was badly hit by the 2008-9 collapse.

Once again, the blog is grateful to Sergei Blagov of ICIS news for the data in the above chart, and further insight into some key areas:

• Polymers (red line) has been the best performer, as domestic demand has risen along with the economy. Growth was up 5% overall last year.
• In January-May this year, production improved further. Polyethylene was up 20% versus 2009, whilst polypropylene was up 12%, PVC was up 18% and polystyrene up 16%
• Fertiliser production (blue), however, fell further to 13.4 million tonnes in 2009. It was down 12% after a 6% decline in 2008.
• Fibre output (green) was also down 18%, after a 24% fall in 2008.

When things are going well, potential problem areas get brushed under the carpet. Its only when the economy gets difficult, that tensions surface.

Comments by General Electric CEO, Jeffrey Immelt, reported today by the Financial Times, are therefore a worrying sign of the uncertainty at the top of leading global businesses about the economic outlook.

Here is Immelt on China: "I really worry about China. I am not sure that in the end they want any of us to win, or any of us to be successful."

And he went on to add, "China and India remain important for GE but I am thinking about what is next," he said, mentioning what he called "most interesting resource-rich countries" in the Middle East, Africa, Latin America plus Indonesia. "They don't all want to be colonised by the Chinese. They want to develop themselves".

Then there is Immelt on the USA, and President Obama, where he claimed that "Business did not like the US president, and the president did not like business. We [the US] are a pathetic exporter...we have to become an industrial powerhouse again but you don't do this when government and entrepreneurs are not in synch."

These comments expose major concerns. A GE statement has since tried to limit the damage, noting that "Mr Immelt's comments at a private dinner focused on the relationship between business and government in general and did not single out President Obama. Mr Immelt also discussed the attractiveness and importance of China as a market for GE."

However, as denials go, this is pretty weak, and it didn't stop the FT running the story on the front page. Coincidentally, the FT's main headline today is "Global alert over faltering economy". Immelt's comments demonstrate just how real is this concern.

The pension funding crisis is causing problems for companies, as life expectancy increases.

So the blog was interested to learn that drinks giant Diageo is to hand over whisky worth £500m ($750m) to its pension fund, to help bridge the deficit.

Apparently the pensioners won't be expected to drink it, in lieu of their pension. Instead, it will act as collateral, and help to reduce funding costs.

Would this work in the chemicals sector? Sadly, a barrel of industrial grade alcohol probably wouldn't carry the same allure. We're obviously in the wrong industry.

Each US auto sale is worth $2973 to the chemical industry, according to American Chemistry Council research. And as the chart above shows, current sales remain well below the levels seen in the Boom years.

In June 2007, for example, 1.5m autos were sold (black line), in line with 2006 and 2006 performance. They were worth $4.5bn in chemical sales in today's money. Even in 2008, as the Crisis developed, 1.2m were sold. Yet although June 2010 saw a welcome improvement to 983k sales (versus 859k in 2009), the chemical sales value was still only $2.9bn.

June also saw a continuing swing towards smaller, cheaper, vehicles, with Hyundai volumes up 35% at 51k. And sales to private buyers slowed, with volume supported by lower margin sales to government and companies. This will keep pricing pressure on parts suppliers, already struggling to pass on the impact of higher oil and polymer prices.

Overall, annualised sales dipped to 11.2m, compared to the 15m-17m level seen between 1995-2007. The auto companies still expect a rebound when new models are launched, but with US employment numbers very weak, H2 could easily disappoint.

The latest IeC Boom/Gloom Index © is showing a further rise in its austerity reading (red line). This is not good news for likely future chemical sales. It is one of a number of leading indicators - housing and auto sales, unemployment, bank lending etc - which are all pointing to a potentially sharp slowdown in demand during H2.

This is in sharp contrast to last year, when the Index was highlighting a growing belief in the investment community that the 'green shoots' of recovery were becoming visible. As noted last month, this belief has now totally disappeared, and it therefore no longer features in the chart.

The Boom/Gloom Index (blue column) is still, however, in the same range that has held for over a year. Many investors are dangerously complacent, believing that the major falls now taking place in global stock markets, are only a necessary 'correction'. Sentiment has clearly not yet adjusted to the rapidly deteriorating fundamentals.

But in the blog's view, the odds that we are entering the 3rd stage of the downturn, where we suffer a drawn out fundamental downtrend, are now rising quite sharply.

Two months ago, on 8 May, the blog suggested that 'Sell in May and Go Away" was likely to prove good advice this year. Since then, most major stock markets have fallen dramatically, with the S&P 500 down by 9%.

The proximate cause of the blog's pessimism then was the onset of the Greek/eurozone crisis. And this, of course, is still getting worse not better. But from a chemical industry viewpoint, it is the chart above, and its implications for H2 demand, that is the real worry at mid-year.

China has been the mainstay of chemical industry demand for over a year. Now, it appears that both of its key drivers are reversing:

• The government is cutting back on its stimulus programme, with lending down 31% versus 2009 levels, as it worries about soaring property prices and social unrest
• Speculators are slowly realising that oil markets are over-supplied, and crude oil prices are now off 12% from their early May peak.

In turn, these two events have caused problems for Asian polyolefin markets. Speculators had taken full advantage of China's lax lending policies to invest in oil-related product areas. As a result, trading in linear low density polyethylene (LLDPE) had soared on the Dalian futures market.

This can be seen in the above chart. It highlights how WTI crude prices (blue line) and LLDPE (red dotted line) had, most unusually, been trading virtually in parallel. Now, however, this relationship has broken down.

And now it is emerging, as long feared by the blog and other observers, that polyethylene (PE) inventories have indeed been driven by this speculation in crude. As my fellow blogger, John Richardson, notes this week, "Sinopec's stock levels are reported to be at 700,000-800,000 tonnes compared with the usual 500,000 tonnes".

He adds that this is due to Q1's high level of PE imports, which reached 865KT in March, versus a 2009 average of 610KT. And this was in spite of a 100KT increase in China's domestic production to 800KT.

With China's auto sales falling 5% in June versus May, it seems unlikely that the torrid pace of stimulus-inspired demand growth will continue into H2. Equally, even the doziest pension fund will start to ask itself whether its 'investment' in crude oil futures has really provided the hoped-for diversification versus equity markets, when both are down similar amounts.

Some Iranian PE has already been re-exported from China, as the smarter traders seek to cut their losses. And if crude oil continues to fall towards the blog's expected $60/bbl, then a further slowdown in demand can be expected, as the value chain destocks. As they say in football, 2009 could then easily become a 'year of two halves', where the seasonal upturn in H1 gives way to a much more difficult H2.

Coal was the original source of most chemicals.

It was then replaced in the 1960's by oil-based feedstocks. Their lower cost of manufacturing led to the boom in applications and volumes seen over the past 50 years.

More recently, biomass' potential is now being explored.

At the same time, major companies such as BASF, Dow, TOTAL and Eastman, as well as engineering company Uhde, have been looking again at using coal or natural gas as sources for olefins and polymers. Whilst Shenhua Baotou Coal, in China, plan to produce 300 KT of ethylene and propylene from coal, along with PE and PP, later this year.

This week, ICIS news report that TOTAL's Methanol to Olefins (MTO) process, developed with Hydro and UOP, is working well at pilot stage. Based on the Feluy, Belgium site, the 45KT plant converts methanol into ethylene, propylene and heavier olefins. The UOP/TOTAL Olefin Cracking Process (OCP) then converts the heavier olefins to propylene.

TOTAL have produced on-spec polypropylene from the propylene, and plan to produce polyethylene over the next few months. And they add a key benefit of the process is that "more than 85% of the carbon entering the unit will come out as ethylene and propylene".

TOTAL will now start to "develop MTO/OCP projects with potential partners in coal or gas rich countries that are looking for developing their petrochemical industry based on their own raw materials," according to Francois Cornelis, TOTAL VP responsible for the area.

Unprecedented changes are taking place in the relative prices of the main 'building block' petrochemicals. In turn, these could have major implications for downstream users, all along the key value chains.

Today's post looks at the changes taking place in ethylene's relative price to the other olefins, propylene and butadiene. On Monday, the blog will look in more detail at ethylene pricing versus propylene. On Tuesday, it will look at benzene, and at paraxylene on Wednesday.

3 months ago, the blog highlighted that for the first time ever (as the chart above shows), ethylene prices (blue line) had dipped below propylene (red) and butadiene (green). This is due to a number of different factors:

• Ethane-based crackers are now coming online in the Middle East. This, together with the shift to lighter feeds in the USA and Europe, is reducing operating rates for liquids-based crackers. These, of course, are major sources of propylene, butadiene and benzene. And so the volume of these 'co-products' is reducing.
• Separately, declining gasoline demand in Europe and the USA, caused by the shift to diesel in Europe, and the higher use of ethanol in the USA, is reducing refinery operating rates. Refinery volumes are an order of magnitude larger than chemical volumes. And so in turn, this is also reducing propylene, benzene and paraxylene production.

This combination has created a counter-intuitive result. During a downturn, one would normally expect petchem supply/demand balances to weaken. This is happening to ethylene, although it is being mitigated by lower liquids-feed availability from refineries.

But for propylene, butadiene and benzene (and paraxylene to some extent), supply has reduced ahead of demand. The most extreme example is butadiene, where markets have become extremely tight, in spite of the downturn in the key demand area of autos, due to its lack of alternative production routes.

Our forecast, as originally set out in our 2008 Feedstocks for Profit Study, is that butadiene will see an extended period of tightness. It suggested that a Global Downturn scenario would lead to a tight supply position 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".

As promised on Saturday, today's post looks in more detail at the major change taking place in the relationship of propylene to ethylene prices.

When the blog joined the chemical industry in the 1970's, propylene was often regarded as a disposal problem by many cracker operators. They ran their plants to produce ethylene, which was both the highest volume and the highest priced product.

Accurate historical pricing data only goes back to 1978, and is European-based. The chart (based on the annual average propylene price versus ethylene) shows that then, propylene was only priced at around 60% of the ethylene price. This value-leakage led producers to focus development effort on propylene derivatives, particularly polypropylene.

Their effort paid off in the 1980's. The combination of propylene's lower price relative to ethylene, and its increasingly higher quality, led to better volumes. And so propylene was normally able to sell at between 70% - 85% of the ethylene price on an annual average basis.

But in the mid-2000s, propylene's relative price increased again. This was due to increasingly tight ethylene and benzene markets, which prompted some converters to seek alternatives to polyethylene and polystyrene. In turn, this helped propylene's growth rate to move to 1.2 x global GDP, versus the 1.0 x level of ethylene.

Now 2010 has seen propylene move to parity pricing with ethylene. This raises important questions for both producers and consumers:

• Should producers invest in more on-purpose production, such as metathesis and propane dehydrogenation? Some major volumes are now coming online in the Middle East and Asia, but perhaps more is needed.
• What will happen to refining rates? Around 30% of propylene is currently produced from this source, and so volumes have been reduced by the reductions in operating rates discussed on Saturday. Will these volumes return? And what might be the impact of China's heavy investment in new refinery-based propylene production?
• Will propylene derivatives be able to compete successfully at today's higher prices? Moves to higher auto efficiency in the USA, for example, will mean replacing steel and glass with lighter weight products - so perhaps polypropylene and polycarbonate won't need to be very price-sensitive in such applications?
• Can converters afford to change their machinery to use less propylene? Undoubtedly the new Polymer Parks in the Middle East will focus on polyethylene, as this is the main product from the local crackers. But with today's lower margins, the financial basis for a purchase of new equipment may not be sufficiently robust for current users to justify a move.

As noted on Saturday, this is an unprecedented situation, and we have no guide from history as to how these issues will resolve themselves. But the blog believes it would be very dangerous for companies to ignore them, and simply assume that the world will soon return to the pricing basis of the 1980s - 90s.

As promised, the 3rd of the blog's series on the changes underway in the pricing of the major 'building block' chemicals, looks at benzene.

The chart above shows its 'spread' versus naphtha, the key dynamic from a price and margin perspective. As can be seen, this was normally in the $80/t - $200/t range until the early 2000s.

This was because considerable on-purpose capacity existed in the form of HDA (hydrodealkylation) units. And when the price of toluene dipped, or benzene's price rose, these units stabilised supply/demand balances.

But since then, refining dynamics have increasingly come to dominate benzene markets. In 2000-1, they had caused benzene to go into surplus, and the spread to dip towards zero, as European refiners extracted more benzene from gasoline to meet new regulations.

Then in 2004, the removal of MTBE in the USA led to an extreme tightness, as toluene was sucked into the US gasoline pool. On-purpose HDA became very expensive. Equally, paraxylene's growth (PX) meant more MSTDP plants (disproportionation units) were built, with an increasing bias to PX output rather than benzene.

The spread jumped to a record $700/t level, and product remained tight until 2008. But in a dramatic reversal, spreads then fell to a negative $40/t level, as petchem demand slumped at the start of the Crisis, whilst refining rates proved more robust due to refiners' need to extract benzene to meet gasoline regulations.

Similarly, recent lower refinery operating rates have reduced benzene supply from this important source, even though demand has been supported by government stimulus programmes. Spreads thus jumped again, to the $300/t level. And this increasingly volatile behaviour raises a serious issue for buyers. It demonstrates that there is really little flexibility for benzene supply to balance demand.

When benzene demand is low, this means they benefit from lower spreads. But as with propylene and butadiene, lower upstream operating rates will not increase merely because benzene demand improves. The blog therefore believes there is a clear need for consumers to examine their sourcing strategies, to cope with this potentially difficult situation.

Paraxylene (PX) has been a great petchem success story over the past 30 years. This 4th post in the blog's series looks back at its history, and discusses how its future may develop.

It is hard to remember that back in the 1970s, DMT (dimethyl terephthalate) was the main polyester material. But the superior properties of PTA (terephthalic acid) led to dramatic growth for polyester and hence in PX demand. More recently, major growth in the use of PET (polyethylene terephthalate) for bottles has further increased demand.

This growth was even more remarkable when set against the sourcing problems associated with PX. It required xylene (or toluene for MSTDP), to be 'bid away' from gasoline, and the octane pool. This was very difficult, as refiners would never allow gasoline stations to run short, whatever the alternative value into PX.

The blog spent several years experiencing these problems at first hand with ICI, then the No 2 PTA producer - first in the UK and then in Houston, Texas. A period of low prices often meant refiners simply stopped xylene extraction. This led to PTA producers placing a high priority on security of supply issues, rather than absolute price.

More recently, however, the blog suspects that markets are moving more in favour of PX producers. As the chart above shows, PX normally trades at a spread of $200/t - $350/t versus naphtha. And whilst the spread continues to have 10 year 'peaks', it has recently been far less volatile than benzene.

Lower Western gasoline demand should lead to improved toluene and xylene availability. And so, whilst benzene is becoming less of a genuine market, PX is moving in the opposite direction. It may, after all these years, finally develop a genuine supply/demand balance of its own, only partially related to gasoline.

The blog's major series this week has focused on the changes that seem to be taking place in markets for the petchem 'building block' products, particularly ethylene, propylene, benzene and paraxylene.

These changes in relative price and availability are of vital importance to a wide range of downstream chemical products. They may well prove to be secular in nature, rather than cyclical.

If so, they would fit with the blog's belief that we are in a transition to a New Normal, as set out in its recent White Papers, rather than a quick return to the high demand levels seen in the 2003-7 Boom period. They can be summarised as follows:

• Lower growth rates for refined products such as gasoline, diesel etc could dramatically change supply/demand balances for the building block products.
• These changes may be accentuated for some products by the move to lower output from liquids-feed crackers, and higher output ex-gas feeds.
• As a result, ethylene and paraxylene may become more freely available than in the past.
• Equally, propylene and benzene may become more difficult to source.

Changes of this magnitude present great challenges to both producers and consumers. We certainly cannot be sure that they are happening, and it will take time for their full impact to become apparent - maybe 3 to 5 years. In this timeframe, temporary reversals back to the previous status quo are almost certain, making firm forecasts even more difficult.

The blog therefore suggests that prudent buyers and sellers might want to develop a Scenario-based approach, that includes further development of the analysis set out this week. This need not be a central Base Case, but could be used to provide a suitable way of testing current strategies on a "what if?" basis.

The blog will be happy to support you in this process, if this would be helpful. And, as always, it will welcome your comments, either privately or in the Comments section.

The latest in the American Chemical Society's 6 monthly 'Chemicals and the Economy' webinar series took place last week. It was moderated by former ACS President, Bill Carroll, of Occidental Chemical, and again proved very popular.

ACS reported high levels of satisfaction from participants. Comments included: "This speaker is one of my favorites." "This was a very useful topic!" "Very informative, very interesting, very sobering, very good presentation. " "Presentation had great depth, in short time. Easy to understand graphics w/ presenter's help." "Excellent seminar, very up to date. Thanks!"

If you would like to view the 1 hour webinar (you can fast-forward!) please click here.

The US Institute for Supply Management (ISM) has also released an article summarizing the content of the latest White Paper for their chemical industry members. Please click here to read it.

The US Federal Reserve and the American Chemistry Council (ACC) have joined the blog in expressing concern about the outlook for the US economy. And as the chart above of the US S&P 500 shows, financial markets have continued to weaken since the blog's advice on 8 May to "sell in May and go away".

The latest minutes from the Fed's monthly meeting show it worries that the economy may take up to 6 years to fully recover:

"Participants generally anticipated that, in light of the severity of the economic downturn, it would take some time for the economy to converge fully to its longer-run path as characterized by sustainable rates of output growth, unemployment, and inflation consistent with participants' interpretation of the Federal Reserve's dual objectives; most expected the convergence process to take no more than five to six years."

It also highlighted the real risk of deflation emerging:

"Some participants judged the risks to the outlook for inflation as tilted to the downside, particularly in the near term, in light of the large amount of resource slack already prevailing in the economy, the significant downside risks to the outlook for real activity, and the possibility that inflation expectations could begin to decline in response to low actual inflation. A few participants cited some risk of deflation."

As Al Greenwood notes in ICIS news, this week's data also showed that "US capacity utilisation for manufacturing fell to 71.4% in June, down from 71.7% in May. From 1972-2009, the average was 79.2%."

The American Chemistry Council has also raised a yellow warning banner in its latest weekly report. Chief Economist Kevin Swift notes:

"The economic reports were generally negative this week. Retail sales, industrial production, trade, and the regional business surveys all disappointed. There was potentially good news, however, in that initial claims for unemployment insurance fell to a two-year low."

"Overseas, the recovery of industrial production appears to be slowing, with the year-earlier comparisons in the Eurozone, China and India, for example, still strongly positive but moderating. This confirms earlier signals emanating from the purchasing manager reports and composite leading indicators. A second half slowdown or soft patch is clearly in order. It's not clear yet if this is a metamorphosis into a double-dip or not. The risks, however, are clearly rising."

The blog would strongly advise Boards to consider developing a Downside Scenario in respect of their Budgets for H2. It hopes, like the ACC, that the economy will maintain H1's improvement. But there are growing signs of renewed economic weakness in all major Regions. Companies without a detailed contingency plan could be badly hit.

China's chemical demand is clearly starting to slow, as my fellow blogger John Richardson has been reporting recently. This has big implications for the global chemical industry, which has relied on China to balance declining sales in the West.

The slowdown comes as the government rolls back the stimulus measures introduced in Q4 2008, when 23 million Chinese lost their jobs as exports collapsed. These measures have done the job in terms of creating employment, by subsidising domestic demand and financing major infrastructure investment.

But they have come at a cost in terms of rising asset prices, particularly in housing. Labour unrest has also increased, as workers find themselves unable to afford apartments. In turn, this has led to outspoken criticism by young writers such as Qing Tong, whose book 'From the Wolf's Burrow into the Tiger's Den' became an instant bestseller last month.

The result is shown in the chart above. Bank lending (red column) fell 37% in H1 versus 2009, and is on course to meet the annual target of a 21% decline. And power consumption (blue line) probably peaked in May, as China Daily reported it "rose at a slower pace last month because of weakening demand from heavy industries".

Chemical companies face a clear risk of a synchronised slowdown in demand in all 3 major Regions during H2.

• The US is hitting a 'soft patch' at best, if not a full 'double dip'
• China's demand seems to have already slowed.
• Europe, sadly, seems to be following the same path.

Not only are its governments increasingly focused on austerity measures and reduced spending. But fear of unemployment is making consumers nervous about major expenditures (autos and housing), which drive chemical demand.

EU auto sales (red line) fell again in June, for the 3rd month running, as shown in the above chart from ACEA (Europe's Auto Manufacturers Association). France joined the list of declining markets, whilst Germany was down 32% and Italy 19%.

The UK (up 11%) and Spain (up 26%) were therefore 24% of total EU sales in June. But this support seems unlikely to continue, as their major government stimulus programmes are replaced by austerity measures. In Spain, for example, the €100m ($130m) scrappage scheme is now out of funds, and the sales tax on autos rose 2% on 1 July.

The business climate for Western firms in China is getting worse.

2 weeks ago, the CEO of General Electric, Jeffrey Immelt, caused a stir when he told a private dinner that "I really worry about China. I am not sure that in the end they want any of us to win, or any of us to be successful."

Today, BASF CEO, Jürgen Hambrecht, has publicly hit out at restrictions on foreign business. In a meeting with Wen Jiabao, China's premier, he complained about "foreign companies being forced to transfer business and technological know-how to Chinese companies in exchange for market access", and concluded "that does not exactly correspond to our views of a partnership."

Replying, Wen apparently told Hambrecht to "calm down", and went on to add, "currently, there is an allegation that China's investment environment is worsening. I think it is untrue."

Hambrecht has been a staunch defender of China in the past, even criticising German Chancellor Angela Merkel for her meeting with the Dalai Lama in 2007. His public concern is therefore a clear sign that China's relationships with Western firms are deteriorating.

As the chart above from Petromatrix shows, total US stocks of crude, gasoline, distillate and jet kero this year (red line) remain very over-supplied in the short term, by comparison with previous years.

A major reason for this is the move by pension funds to adopt long-only positions in the commodity future markets, in the belief that crude markets are fundamentally tight.

However, this week the Financial Times summarises a timely new study of commodity markets, by Prof Joelle Miffre of Edhec Business School. This argues that investors need instead to understand the difference between:

o Backwardation, "when commodity producers are more prone to hedge than commodity consumers", and the future price is lower than today's
o Contango, "when commodity consumers outnumber commodity producers, leading to excess demand", and the future price is above the current value

They recommend that "to earn a positive risk premium, investors should take long positions in backwardated markets and short positions in contangoed markets".

The team's research suggests this strategy would have earned the investor a commodity risk premium of 12% a year between 1992-2008. Whereas the long-only strategies currently followed by pension funds earned only 2% a year. Edhec therefore concludes that "passive long-only strategies as advocated by traditional indexers perform less well".

Our 9th European Aromatics and Derivatives Conference will be held in Berlin on 23-24 November. Co-organised as always with ICIS, it features a strong line-up of industry speakers including:

• Shell Chemicals, Sven Royall, VP Intermediates on 'What next for Aromatics'?
• Ralf Kuhlmann (former Business Director, ExxonMobil Chemicals and APPE Chairman) on 'European petrochemicals: on the right track for the future?'
• Dow Chemical, Andrew Jones, Global Business Director Aromatics and Derivatives, on 'The changing landscape in aromatics'.

In addition, there will be important presentations from companies including TOTAL, Polimeri Europa, Equipolymers, Wood Mackenzie, Nexant and China's National Petroleum and Chemical Planning Institute. The blog will also be presenting its thoughts.

Please click here for further details, and 'early bird' registration.

Over-capacity is going to be a major issue for the petchem industry over the next few years.

Asian producers, in particular, are likely to be worst impacted. The reason is that they have relied on exports to China taking up to 50% of their production.

But now China's own production is ramping up, reducing the potential for these imports. And, of course, Middle East exporters to China will have a clear cost advantage in gaining the remaining volumes, versus most Asian plants which run on liquid feeds.

Asian producers therefore only only two alternatives, to attempt to:

• Export to the West or
• Close other regional competitors

The third alternative, of course, would be to shutdown themselves. But this is likely to be a last resort given the social implications on employment, and the impact on associated refineries and customers.

Exporting to the West is also likely to prove difficult, due to logistic costs and the close linkage between local producers and their customers. It will undoubtedly happen as the downturn continues, but at this stage it makes good sense to focus on inter-regional opportunities.

Equally, attack is often the best form of defense. And the new move by S Korea's Honam to acquire Titan in Malaysia is clearly based on this strategy, as Honam seeks to realise their Vision of 'global leadership'. Titan will provide them with a strong local base from which to attack SEA markets. And as my blogging colleague Malini Hanrahan notes today, they are losing no time in considering major expansion of Titan's facilities.

Singaporean producers will be tough competition, given their close links with China. But other SEA producers will quickly find themselves in the firing line. They urgently need to update their own strategies for the future, in the light of Honam's move.

"There are 64.5 million empty apartments and houses in China's urban areas", according to Barrons, the US investment magazine.

The figure comes from a survey of the country's electricity meters, undertaken by China's Academy of Social Sciences.

To date, China's homebuyers remain convinced that home prices cannot fall, as shown by their willingness last year to buy apartments in the empty city of Ordos. But as Barrons notes, the empty stock is 5 times the current total in the USA, where prices have now fallen over 30%.

China's auto markets are also showing signs of weakness. Inventories rose to 55 days in June, from 41 days in February, according to the China Automotive Technology & Research Center (CATRC). And H1 production exceeded sales by 1.29 million vehicles.

As a result, price wars are beginning to develop. Bloomberg cites a Zhengzhou dealer offering 21.5% discounts on the cheapest autos, such as Matiz's $6k compact. It says luxury autos are holding their prices better, but 7% discounts are common on $15k autos.

And whilst manufacturers are still pushing sales, the head of the CATRC has suggested "automakers should reduce supply rather than getting into a price war". This may become inevitable in H2. Bloomberg notes that both Credit Suisse and IHS Automotive expect demand to actually drop in H2 compared to 2009 levels.

Last year, governments focused on stimulus measures, to support the global economy.

Now Jean-Claude Trichet, head of the European Central Bank (ECB), says that "with hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto 'stimulate', 'activate',' spend'!"

Writing in the Financial Times, he is effectively calling for a 180° change in policy. Instead of providing further support for auto and house sales, he wants governments to cut expenditure, and focus on "fiscal sustainability".

He forecasts that Eurozone government debt will rise by 20% between 2007-11, and by 35%-45% in Japan/USA, and warns that "the economy may be close to...a rapid deterioration of confidence among broad constituencies of households, enterprises, savers and investors", due to:

• Lower tax revenues as a result of the downturn
• The cost of the recent spending increases
• The "volume of taxpayer risks" created by the need to prevent financial sector collapse.

He warns that potential liabilities in this latter area are now 27% of GDP in the Eurozone and the USA.

Trichet concludes that the ECB "expects governments to confirm their determination to consolidate their public finances". It is hard to under-estimate the potential significance of his comments for chemical industry demand in H2 and 2011.

The blog's quarterly look at US company earnings reveals a worrying trend. As Howard Silverblatt, Senior Index Analyst for S&P, puts it ""no sales means no jobs, means no recovery".

As the chart shows, Reported Earnings (red line) recovered strongly to $61 in Q1, and were back at Q1 2008 levels. Equally, as the Q2 earnings season begins, they are expected to be 43% above Q2 2009 levels. But companies remain cautious, with dividends (green line) back at 2005 levels and expected to show only a marginal increase.

This is probably due to the fact that Q2 sales growth is forecast at just 7%. Q1 sales for companies in the US S&P 500 were only 1.8% above Q1 2009 levels. Silverblatt's latest report summarises the key issues:

"Comparisons should focus on quarter-over-quarter results to determine the recovery's progress, as well as the underlying momentum of the economy. And since I believe jobs are number one, and that companies are generally in good financial shape with excess cash (so they can ride out any short term disruption), I look to sales as a future indicator.

"Until companies and consumers start to spend more, the job front will not get better. But they won't spend more until they believe things are getting better. The stimulus programs were suppose to jump start the economy and break the downward cycle, by convincing both groups that better times were here. But so far we're not seeing the sales or the jobs; but earnings are good, at least for now".

There are mounting signs that 2010 could prove a Year of 2 Halves in terms of economic growth.

Interviewed by Bloomberg last month, the MD of the Economic Cycle Research Institute (ECRI), Lakshman Achuthan, warned that their indicators showed "A real global downturn in the industrial sector is starting right here and right now". They saw Chinese exports looking particularly weak in H2, closely followed by industrial production.

Now the ECRI Index for the USA (above) is clearly forecasting a renewed downturn, with a reading of -10.5. As Dave Rosenberg of Gluskin Sieff notes, "its never been here before without there being a recession". And the indicator itself is very credible, having only once produced a false forecast in the past 40 years.

Whilst their colleagues head for the beach and a well-deserved summer break, prudent CFOs will be developing their contingency plans to ensure H1's gains are not lost during any H2 downturn.

India's economy continues to impress. It has been largely unaffected by the global economic crisis, due to its relatively 'closed' nature. This gives its central bank a more traditional role - reducing interest rates when economic activity slows, and increasing them as it recovers.

Currently, it is on the latter course, increasing rates to 5.75% this week. Its problem, unlike much of the developed world, is rising inflation, which is now around 10%. Thus the Governor of the Reserve Bank, D Subbarao, has made it clear that "we expect credit to be dearer, as credit demand picks up, we expect lending and deposit rates to go up."

The Bank also increased its GDP forecast to 8.5%. A good monsoon season, unlike last year, is helping the important agricultural sector. Whilst India's major companies remain full of confidence, given their low-cost position. Reliance's Jamnagar refining/petchem site is one of the world's largest and lowest cost, after its recent expansion.

The news reminded the blog of a slide (above) shown by its long-standing friend, R D Udeshi, President of Reliance's polyester chain, at our 2004 European conference. His argument was that China's economic development would have to change course in time, as it moved from primary production to labour intensive manufacturing.

The slide tracks 'years from beginning of economic progress' along the bottom, versus 'GDP per capita' on the vertical axis. And its analysis has stood the test of time, with China's labour costs increasing 25% in key regions such as the Pearl River delta in H1.

It suggests that, whilst there will be bumps along the road, India has a few more years of solid growth ahead before it reaches China's current turning point.

LinkedIn, the online network for chemical and other professionals, was valued at $2bn this week.

Reid Hoffman, its founder, gave a brilliant description of what is was like to be part of a technology start-up: his parallel was
"throwing yourself off a cliff and trying to assemble a plane on the way down".

As chairman of an excellent technology startup, NiTech Solutions, the blog recognises the description.

The blog is awarding itself a pat on the back this morning. Last December, it made the bold forecast (given the widespread gloom at the time), that chemical companies would see "a strong H1". Today's regular snapshot of Q2 chemical company results certainly seems to confirm its optimism.

Almost all companies reported stronger revenues and earnings. But there is an interesting divergence in outlook between those companies focused on solutions and innovation, and those where low-cost leadership in commodity markets is essential.

Thus Bayer claimed that "MaterialScience has left the crisis behind", whilst the new management at Clariant worried about "a weaker economy". BASF, the industry No 1, was relatively cautious, forecasting the recovery would "continue at a moderate pace".

One interesting juxtaposition of views (given alphabetically as always) contrasts Celanese's upbeat assessment of H2 demand, versus that of the China Petroleum and Chemical Industry Federation, which expects a slowdown.

Air Products. "Operating leverage across the company would continue to drive margin improvement".
Albemarle. "Global economic indicators, industry trends and customer order patterns pointed toward a strong Q3 with a typical seasonal contraction in Q4".
Ashland. "Expected sustained, gradual growth of the overall economy".
BASF. "Expected the economic recovery to continue at a moderate pace in the second half of 2010. We expect our sales to grow in 2010 and outpace global chemical production."
Bayer. "MaterialScience has left the crisis behind and saw business expand more strongly than expected. Volumes have returned to the pre-crisis level"
BP. "Chemicals production increased to 3.92m tonnes in Q2 from 2.83m tonnes in Q2 2009, and 3.81m tonnes in Q1 2010".
Celanese. "Optimism came from Celanese's order book in China, which was 'strong and stable'".
China Petroleum and Chemical Industry Federation. Demand was "expected to slow down in the second half of the year amid a deceleration in China's economy."
Clariant. "We predict a softening in demand compared to H1 as a result of a weaker economy and the traditional seasonal effects of our businesses."
Croda. "It was difficult to predict whether the trend would continue. We would normally expect to see volumes in the second half below those seen in the first half due to holiday shutdowns in our customers' operations".
Cytec. "Sales revenue grew among all segments as the company focused on higher profit-margin business. The company also benefited from the cost reduction plan which laid off 600 workers, shut plants and froze salaries."
Dow Chemical. "Expects a sustained global recovery led by Asia, which would be slowly helped by the US recovery, but with Europe lagging".
DuPont. "H2 growth rates would slow down from strong year-over-year growth in H1."
Eastman. "Expected volumes would reflect typical seasonal declines in the second half of the year and that raw material and energy costs would be less volatile."
ExxonMobil. "Prime chemical product sales were 6.5 million tonnes, up 3.7% from Q2 2009".
WR Grace. "Grace is well positioned to succeed in this challenging environment."
INEOS. "The Group has continued to focus on cash management and liquidity. Demand for olefins was strong, resulting in improved margins in the quarter, particularly in butadiene. Polymer margins also experienced some improvement from the first quarter."
Johnson Matthey. "Expect results will be lower than Q1 due to normal seasonal factors, an expected end to recent stock building by the car companies and the potential impact on consumer confidence of economic uncertainty, particularly in Europe".
Kemira. Expects "demand to develop favourably" this year.
LG Chemical. "Expected a positive Q3 result due to strong seasonal demand and an increase in sales due to product expansion in petrochemicals".
Lubrizol. "Further recovery in demand, underlying market growth and favourable order patterns".
Mitsubishi Gas Chemical. "Increased sales of methanol following the start-up of a new plant amid improved market conditions."
Mitsui. "Improved demand for PE and PP helped the company raise its petrochemical product prices which offset high feedstock costs."
Petro-Rabigh. "Total sales for June 2010 have significantly increased compared to previous months".
PPG. "Demand levels are more than 10% below 2008 pre-recession levels. We anticipate a continued, gradual, global economic recovery."
Quaker. "Earnings will continue to be strong but will be below the first half due to a softening in demand and the lag effect on margins as we recover higher raw material costs".
Rhodia. "A positive contribution of €66m from "strong pricing power".
Shell. "Saw higher volumes, margins and operating rates".
Sherwin Williams. "Remained "cautiously optimistic" about the stability of end market demand".
Sigma-Aldrich. "Market conditions were expected to continue the "modest improvement" seen in H1".
Solvay. "Saw better utilization rates in the context of a more sustained global activity than last year".
Sumitomo. "Increased sales due to improved market conditions overseas had allowed the company to raise the prices of its petrochemical products which offset the high costs of naphtha and other feedstocks."
Syngenta. "Demand for our products has increased significantly in 2010, following a 2009 season characterised by low pest pressure and credit constraint."
TOTAL. "An overall improvement in market conditions and benefits realised through cost-cutting measures".
Trelleborg. "Overall demand expected to remain in line with or "slightly better" than Q2".
Wacker. "Robust sales across all its business segments".

"China's future economic growth will definitely gradually slow down. The issue for China's economy is the quality of growth, which is why we now have to carry out structural adjustment and transform our development model. The true meaning of this is raising the quality and efficiency of growth. So we should change our attitude, and be calmer."

The above quote is from deputy Chinese central bank governor, Yi Gang. He is the latest Chinese leader to highlight that China's economic model is changing from export-driven development. It corresponds with a note from IMD, the leading Business School, that points out 2010 represents the peak year in demographic terms for China's working population.