Chemicals & The Economy

The blog's quarterly review of company results shows a considerable shift in mood since May.

Then, many analysts were completely fooled by the short-term support provided to margins by higher oil prices. And only Peter Huntsman warned about the risks of high oil prices, unemployment and economic fragility.

Q2 results show many more companies adopting his more defensive position.

The largest of them all, BASF, suffered a 5% fall in its share price as a result. The analysts who follow it had clearly believed their own propaganda. Oil prices at today's levels have always led to a global recession, and the risk of believing that 'this time is different' is rising all the time.

Most worrying was the change in tone from AkzoNobel. 3 months ago, they were still optimistic about the outlook. This time, CEO Hans Wijers warned about the risk of some "scenarios which are of course very scary". Wijers is a former economics minister in the Dutch government, and does not exaggerate.

Air Products. "See strong volume growth across a number of our businesses".
Akzo. "A very volatile world, with very little visibility, and there are scenarios which are of course very scary."
Arkema. "Repositioning in buoyant markets and the contribution of growth projects".
Ashland. "Significantly affected by steep raw-material cost increases".
BP. "Volumes were lower by about 8%, driven primarily by shutdowns".
BASF. "The economic risks remain".
Bayer. "Increase in raw material and energy costs was more than offset by higher selling prices".
Celanese. "We aggressively mitigated the impact of higher raw material and energy costs".
Clariant. "A more difficult but nevertheless solid business environment, characterised by softening demand".
ConocoPhillips. "Higher margins in olefins and polyolefins, and higher volumes".
Cytec. "Uncertain pace of global economic recovery, persistent high unemployment, fiscal constraints in the developed economies and inflationary concerns in the emerging markets".
Dow. "Our transformed portfolio, underpinned by our cost-advantaged and flexible operations, is now performing at a new level."
Dow Corning. "Uncertainty in the current business environment".
DSM. "Very solid results in materials sciences due to pricing strength and volume growth".
DuPont. "Compelling growth opportunities stemming from science-powered innovations and collaboration".
Eastman. "Higher raw material and energy costs, as well as strengthened demand".
ExxonMobil. "Improved margins...offset by lower volume sales".
Huntsman. "Given the sluggish global economic recovery, very pleased with the improving results".
INEOS. "Cracker margins have been at top of cycle levels", with chemicals EBITDA at a record €1923m for the past 12 months.
LyondellBasell. "Margins increased over already strong first-quarter levels".
Marubeni. "Rising prices of petrochemical products and increased volume".
Methanex. "Outlook is excellent."
Olin. "Bracing for softer demand in the third quarter because of anticipated chlorine customer outages and weakened vinyls exports".
Orlen. "Lower sales on the Czech market were partially offset by the increase in the Polish market".
Oxychem. "Strong export demand and higher margins."
Polimeri Europa. "High feedstock costs and lower demand".
PPG. "Anticipate the global economic recovery will continue, although at its uneven pace".
Praxair. "Strong growth in Asia and South America and moderate growth in North America."
Reliance. "Sales increase driven by higher volumes and higher prices".
Rhodia. "Solid levels of demand as well as excellent pricing power."
SABIC. "What keeps me awake at night is keeping the successes we have. This is about the 8.1 billion riyals ... How long can we sustain this? It is challenging."
Sherwin-Williams. "Domestic demand remains soft".
Shin-Etsu. "Domestic PVC sales suffered becuase of the temporary shutdown in quake-hit Kashima, while profits in the US improved".
Siam Cement. "HDPE-naphtha margin declined $60/t QonQ to its lowest since 2002".
Solvay. "Margins in plastics are currently above pre-crisis levels".
Syngenta. "Sales showed sustained volume momentum in all regions".
TOTAL "A generally favourable environment".

China's surging demand led the chemical world out of recession and into boom territory. Its 53% increase in polyethylene (PE) demand between 2008 - 2010 (up 6.2 MT), was typical of the support it provided.

But H1 2011 has not maintained this momentum, as the chart shows. Its PE demand was actually down 2.5% versus 2010:

• Domestic production rose 8% to 5.1MT
• Imports fell 11% to 3.5MT
• Exports doubled to 307KT

Equally, it is becoming more selective about its import partners, as trade data from Global Trade Information Services shows:

• Middle East imports were up 16% at 1.5MT
• SEA were up 10% at 679KT
• NEA were down 20% at 752KT
• NAFTA were down 53% at 293KT
• EU were down 44% at 130KT

Middle East imports would probably have gained extra market share, if Iran had been able to supply. Its volumes were down 18% at 368KT.

Of course, H2 may show some recovery, if the government decides to increase lending again. And in the short-term, there appears to be some tightness building up due to supply issues, particularly LLDPE.

But overall, China's main strategy is to increase its own production, where Sinopec aims to be global No 1 in ethylene by 2014.

It will also maintain the strategic corridor with the Middle East, to ensure energy supplies. But its interest in absorbing surplus production from NEA, NAFTA and the EU is likely to be low.

European cracker margins are currently "at top of cycle levels" according to INEOS last week. But as the above chart shows (based on APPE data), they remain supported by supply issues rather than demand. Operating rates actually slipped to 81% in H1, a figure more normally associated with a downturn.

Detailed output figures for Q2 tell the story (excluding 2009, when the industry was still in recovery mode):

• Ethylene output at 4992KT was the lowest since 2001
• Propylene output at 3714KT was the lowest since 2003

The only exception was butadiene, where soaring margins encouraged producers to maximise available extraction capacity. Output at 520KT was the highest since 2006's 561KT.

Lower European refinery runs have been a great support to margins. German refiners, for example, ran at just 1.8mb/d in May. Until 2009, they were rarely below 2.2mb/day. Refiners had to cut rates, due to lack of gasoline export demand to the USA, and so cracker feedstock supply was also reduced.

Effectively, therefore, European operating rates have been in the mid-90% level, particularly when one includes the higher level of force majeures. These also provide strong support for margins, as consumers have to go into the market at short notice to obtain material

In addition, of course, the greater use of ethane feed in the USA and the Middle East has helped to keep propylene and butadiene tight. Prices for both products have been at record levels, providing further support for European producers.

The past 18 months have been a fabulous period to be a cracker operator. But the blog, like most of its friends in the industry, would have preferred the success to have been more due to strong European demand, rather than supply-side factors.

On Friday, the US government announced that GDP grew just 0.8% in H1. This, of course, was far below the US Federal Reserve's confident estimate of 3.5-4% for 2011, given only 4 months ago in March.

We are indeed in a New Normal. But the consensus simply refuses to recognise the impact on demand of the ageing BabyBoomers (those born between 1946-70), as these stop spending and start saving.

The government also issued revised GDP data going back to 2003. As the chart shows, this produced the startling result that US GDP today is still lower than the peak of the cycle in Q2 2007. The last time this happened was in 1980-82, when the economy went back into recession.

With oil prices at current levels, today's situation is very similar to those dark days - particularly given the dysfunctionality seen in politicians' response to the US debt ceiling, the Eurozone crisis, China's rail crash and Japan's earthquake/tsunami.

The H1 GDP data thus confirms Prof Martin Feldstein's fears that the US is now close to recession. Shipping markets are also very worrying. The main Asia-US shipping index has fallen 9% since April, as US retailers cut back on orders. Last year, it surged 56% in this key period.

The government also reported that US oil product demand in Jan-May was lower than in 2009. As Olivier Jakob of Petromatrix notes:

"Buying crude oil at $120/bbl is buying oil in the demand destruction zone, and if it can be a short term trading play, we do not consider buying demand destruction to be a sound investment strategy."

Meanwhile, petchem markets were quiet, with many major players on holiday. Traders took the chance to create some volatility, but it remains to be seen whether this move will be sustained with real buying interest, as we move into August.

ICIS pricing commentary, and price changes since January, are below:

Brent crude oil, up 24%.
Naphtha Europe, up 15%. "The market is balanced to long".
HDPE USA export, up 9%. "Trading appeared thin, with participants taking a wait and see approach."
Benzene NWE up 8%. "Traders actively buying to cover short positions."
PTA China down 5%. "Cargoes actively changing hands among traders"
S&P 500 Index, up 2%.

There's "a 50% chance that the US could slide into a new recession", according to Harvard's Prof Martin Feldstein. He sees the economy as "really balanced on the edge", with housing still depressed and consumer spending flat.

The blog's own IeC Boom/Gloom Index is flagging similar concerns. As the chart shows, the Index for July (blue column) was very close to 4, which has marked the divide between growth and recession in the past. Equally, the US S&P 500 Index (red line) seems to have peaked in Q2, and to now be weakening.

This is unsurprising, given policymakers insist on viewing current problems as only being related to liquidity. As the blog argued in detail last month, they are about solvency. Providing more liquidity, as announced in the weekend G7 statement, buys time. But it does not tackle the fact that the PIIGS debts will not be paid back in full. Equally, this means many of those banks who made these loans are possibly also bankrupt.

The real worry may be that there is so little discussion of this very obvious risk. Many companies, just like most investors, seem to have convinced themselves that 'all news is good news'. This has uncomfortable echoes of 2007-8, when it was also widely believed that policymakers could always avert a crisis.

Chrysler CEO, Sergio Marchionne, has issued a wake-up call to Western auto companies about the growth of China's exports. He warns that they "can't count on dramatic growth in Asia to drive prosperity", and suggests that China's plans to increase auto exports pose an "enormous" risk.

Meanwhile, US auto sales disappointed again in July. As the chart shows (red square), they have been back below the 1.1 million/month level since May. And optimism over a seasonal pick-up in August is fading.

Annualised sales this year are only 12.2 million. This is 27% down versus 2000-7's average of 16.8m. And thus the industry is getting ready to cut prices from current record levels in an effort to stimulate sales.

One problem is that Americans' love affair with autos has faded. High prices led to a 1.9% reduction in July's gasoline sales versus 2010. And vehicle miles travelled January-May were the lowest level since 2004.

The move towards the New Normal is also having a major impact. Americans are already spending less, and saving more, as the BabyBoomers (those born between 1946-70) enter the 55+ age group.

The US savings rate was 5.4% in July, versus ~0% by the end of the 1982-2007 supercycle. Sales are therefore likely to remain lower. especially as lending criteria become stricter and fears over job security rise.

We have another strong speaker line-up for our 10th European Aromatics & Derivatives conference on 22-23 November in Amsterdam, co-organised as usual with ICIS.

Patrick Thomas, CEO of Bayer Material Science, will talk about the outlook from the viewpoint of a major global aromatics consumer.

Alexander Farina, GM strategy for Shell Chemicals, will give his views on the prospects for the C6 chain.

Other leading speakers including Bob Young from refining analysts Wood Mackenzie, Pierre-Yves Francois from Rhodia, and Matthew George from Indian Oil will give their views on the major issues along the value chain.

In addition, the blog will discuss the likely impact of the New Normal, whilst its blogging colleague and co-author, John Richardson, will question whether China's growth story is coming to an end.

For more details, and to enjoy the Early Bird Discount, please click here.

The blog's IeC Downturn Alert is now 3 months old. The aim was to provide enough time for readers to develop robust contingency plans, as a new global downturn became more and more likely.

A key issue is that dysfunctional political systems in the eurozone, USA and China seem unable to deliver sensible solutions to today's problems:

• In the 1980s, leaders such as Reagan, Thatcher and Deng succesfully adapted their economies to the rise of the Western BabyBoomers (those born between 1946-70).
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• Today their heirs, such as Obama, Merkel and Wen seem unable to recognise the importance of the ageing of the Boomers for future global demand

S&P's downgrade of US debt from its AAA rating is just one example of how their inability to lead is destroying confidence around the world.

Reuters poses the issue very well in relation to financial markets. They comment that:

"If one thinks:
• "We really are going to enter a double-dip recession, then stocks are not remotely attractive at these levels
• "Wise and proactive economic policy in the US and Europe can help prevent such a thing, then likewise it's a good idea to stay on the sidelines right now: there's no chance of that happening any time soon.
• "Less government is better government and that the private sector, left to its own devices, will create jobs and economic growth, then maybe what you're seeing right now is a buying opportunity."

Most investors, like most chemical company executives, would like to believe that governments could implement "wise and proactive economic policy". They are not at all used to the idea that the private sector might be on its own, left to 'sink or swim' by governments.

Equally, it is hard to see what the private sector can achieve on its own.

The Financial Times' Gillian Tett, one of the few to forecast the 2008 downturn, suggests that the parallels with that terrible time are growing. But instead of Bear Stearns and Lehman, its Greece and Spain who are going bust.

Oil markets are also looking weak. A major fall in prices looks increasingly likely, and would certainly panic those Chinese traders and others, who have been busy buying in recent days, in anticipation of a strong September.

The detailed moves since the IeC Downturn Alert launched at end-April, with ICIS pricing commentary on market sentiment last week, are below:

Naphtha Europe (brown dash), down 17%. "Buyers are in no hurry to purchase material while sellers are under pressure "
HDPE USA export (purple), down 15%. "Producers increased the price to traders and brokers, based on increasing global prices and improved demand ".
US S&P 500 Index (pink dot), down 12%
Brent crude oil (blue dash, right hand scale), down 9%.
PTA China (red), down 6%. "Prices rose on the back of PX prices after a fire hit Taiwan Formosa group's refinery complex ".
Benzene NWE (green), down 2%. "Mounting macroeconomic concerns saw lower offers that were not met with any firm corresponding bids."

China's auto market has gone ex-growth, as the above chart shows. Monthly sales in July (red square) were the 2nd lowest since July 2010.

The problem is the continuing fall-out from the end of China's great credit bubble. Inflation hit a new high of 6.5% in July. More importantly, food prices rose by 14.8%, up from 14.4% in June.

This would be bad enough in the West, where average incomes are ~$40k/year. But China is a relatively poor country:

• Average urban household income was $2810 last year
• Average rural household income was just $870

Food and energy costs therefore take up a very high proportion of ordinary people's income.

This means China will have to do more to control inflation. Bank lending, the main agent of growth since 2008, will have to be further reduced. In turn, the government will therefore likely aim to preserve jobs via increasing exports again.

This is already emerging as a key risk in auto markets, as the blog will discuss tomorrow.

A year ago, a panicked Federal Reserve introduced its QE2 programme. One of its key aims was to kick-start US growth via driving down the value of the US$ and boosting exports.

Since then:

• The US$ has fallen, and US exports have increased
• But other major countries have become alarmed about the impact of this policy on their own exports and growth
• Japan and Switzerland now aim to drive down the value of the yen and the Swiss franc

The blog discussed this risk in its January White Paper 'Budgeting for Uncertainty'. Its analysis still seems valid today, particularly in the light of Chrysler's comments this week:

"Rising Western unemployment does not help the domestic population to repay the debts incurred during the final stage of the Boom after 2002.

"This would have a particularly bad impact on the chemical industry, which has been a major beneficiary of the globalisation trend and accompanying movement to free trade."

Goldman Sachs today halved its estimate for global ethylene growth to ~2.5%, and slashed its earnings estimates for some major US companies. Analyst Robert Koort warns:

"Our outlook for earnings growth has decelerated substantially in recent weeks ... Our economists now expect US GDP to grow only 1.7% in 2011 and 2.1% in 2012 vs. consensus estimates of 2.5% and 3.0%. ...

They assign a one-in-three risk of renewed recession in the next 6-9 months. We also expect fallout from the recent US sovereign credit rating downgrade by S&P and the associated stock market weakness to erode business confidence, further decelerating growth prospects."

And he adds:

"Based on our prior global GDP growth assumptions we estimated NTM ethylene demand growth at close to 5%, but our current less-robust GDP growth outlook suggests ethylene demand will grow at roughly half that rate."

China's credit bubble is one of the largest the world has ever seen. This is true not only of its total size, but also in relation to GDP.

The history of credit bubbles is very clear about what happens next. Anyone who has followed the US subprime lending disaster will know the script already. But the blog worries that too few companies seem to be learning from history, and making the necessary contingency plans.

The great analyst of credit bubbles is Hyman Minsky. We described his insights in Chapter 2 of 'Boom, Gloom and the New Normal':

• Long periods of stability lead to complacency
• Lenders no longer check whether borrowers can repay the loan
• They are instead convinced that capital values will always rise
• They therefore believe foreclosed assets can be sold at a profit

China is now going through the late stages of this cycle. The 'Minsky Moment' is therefore getting closer. This is when prices begin to fall, and lenders suddenly panic about the real value of their assets. Liquidity dries up, and there is a sudden rush for the exits.

The chart shows how monthly borrowing has grown since 2008. The big jump began in Q4 2008 when the government ordered banks to increase lending, to compensate for the loss of exports:

• Monthly lending averaged RMB 386bn ($57bn) in Q1-Q3 2008 (red line)
• It then jumped 24% to RMB 477bn in Q4
• 2009 saw it jump a further 67% to RMB 796bn (brown line)
• 2010 saw a small decline to RMB 660bn (green line)

Latest figures for July show very little change in 2011 (purple line). Monthly lending has so far averaged RMB 667bn.

The sums involved are huge. Lending doubled in 2009 to $1.4trn, around one third of total GDP. Most of this money went into housing, in the belief that 'the government would never let property prices fall'.

The rise in lending was great news for the chemical industry. Demand for the most basic polymer, polyethylene, jumped 53% between 2008-10.

But just as Minsky would predict, the government is now worried about what happens next. Bloomberg reports it is introducing new restrictions "to guard against the risk of bad loans should property prices fall".

Coincidentally, the Financial Times notes that "China's debt burden is far higher than it likes to admit". It adds that "people forget that it undertook its fiscal stimulus package through the banking system, rather than by issuing public debt".

Credit bubbles are like balloons. They expand whilst more air, or debt, is pumped into them. But as soon as this stops, they begin to deflate.

Of course, 'this time may be different'. But companies cannot afford to plan on the basis of wishful thinking.

China's own central bank is now planning for a possible property market downturn. Prudent chemical company Boards would be wise to follow its example. The risk of a downturn in China's chemical demand growth is becoming too great for comfort.

The blog was almost alone at the end of April, when it launched the IeC Downturn Alert. Today, its fear that we are close to a global downturn has become mainstream.

As the American Chemistry Council report, "fears of another global recession are rising with several noted forecasters raising the chances of another recession to one‐in‐two".

The disfunctionality of financial markets is clearly a major factor in boosting chances of a downturn:

• 75% of US equity trading in August was High Frequency Trading
• This is traders playing computer games, in micro-seconds.
• It has no value whatsoever, and clearly destabilises markets
• But Wall Street-friendly regulators continue to excuse it

In terms of chemical markets, most players have sensibly retreated to the sidelines, as ICIS pricing comments note. The chart shows how prices have moved since April, when IeC Downturn Alert launched:

Naphtha Europe (brown dash), down 16%. "Factors dampening activity include the ongoing summer holiday season, and crude oil price volatility".
Brent crude oil, down 15%.
S&P 500 Index (pink dot), down 14%.
HDPE USA export (purple), down 13%. "Prices were assessed notionally higher based on price ideas from traders".
PTA China (red), down 7%. " Most buyers were pessimistic about the market outlook."
Benzene NWE (green), down 3%. "Benzene has been incredibly resilient to the volatility seen for crude."

Last year, Warren Buffett paid only $7m taxes, just 17.4% of his income.

Now he says rich Americans, including himself, should pay more, in order to help reduce US debt. He notes that:

• In 1992, the wealthiest 400 Americans paid 29.2% tax on $16.9bn income
• In 2008, they paid just 21.5%, on incomes of $90.9bn

And he adds:

"People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what's happened since then: lower tax rates and far lower job creation."

Buffett says the US should "raise tax rates immediately on taxable income in excess of $1 million, including of course dividends and capital gains".

This would have impacted just 236,883 households in 2009. He would also like an extra tax on the 8274 households who earn $10m or more.

It will be interesting to see if Congress follows his advice.

The blog is a great believer in the predictive power of the retail sector.

Wal-Mart and Tesco were the first to spot the downturn in the summer of 2007, a year before it became obvious to everyone else.

Now Wal-Mart's problems are providing some important messages about how companies need to adjust their strategies to survive as we transition to the New Normal:

• Financially-driven strategies are a dead end
• Focusing on Gross Margin loses sales

As the chart from the Wall Street Journal shows, Wal-Mart has increased Gross Margin consistently since the Great Recession began. But it has also suffered 9 quarters of declining US same-store sales. This is the key metric for any retailer.

As Wal-Mart's COO, Bill Simon has told analysts, "I think the gross margin could be an impediment to sales growth." The financial focus meant less attention was paid to customers' changing needs:

• Wall Street loved Wal-Mart's removal of low-priced, low-margin items
• But customers simply went elsewhere for their bargains

In turn, this has led to a bigger problem.

Many consumers are now living from pay-check to pay-check. They simply can't afford to buy large sizes, even though these offer better value. As a result, they prefer the 'Dollar Stores', where they can cover their basic needs for the week ahead.

Wal-Mart is still the world's largest retailer. But it will now have to move quickly, to catch up. Chemical company boards need to review their own strategies, to ensure they are not making the same mistake.

A year ago, the blog feared we were "still towards the beginning of the crisis", not at its end. Sadly, its judgement seems to have been correct.

2 weeks after that post, the US Federal Reserve launched its now infamous $600bn QE2 programme. The aim was to provide further massive stimulus to the global economy. Previous efforts had clearly not worked, and it feared the economy was already weakening.

Unfortunately, QE2 not only failed to stimulate a recovery, but actually made it more difficult to achieve. This was because it provided the high frequency traders with the liquidity they needed to push up food and energy prices on commodity markets:

• Recovery was already difficult with oil at $60/bbl
• It became almost impossible when it moved above $100/bbl

Clearly also, the Eurozone debt crisis has since got worse, not better. A year ago, Greece was the main problem. Now it is Italy, a G7 country.

The key issue is that policy makers are still in the Denial phase of the crisis, as the chart shows. This uses Elizabeth Kübler-Ross' famous 'Paradigm of Loss' model as a guide on how the crisis is developing.

Investors, and some company managements, also remain in Denial. The hype surrounding QE2 led to a false sense of euphoria about the outlook. Even today, there is a clear lack of realism, and a focus instead on 'onwards and upwards' to peak earnings in 2015.

Q2 showed growth has stalled in both the USA and Europe. Yet many investors still believe the central banks will somehow be able to ride to the rescue and enable the world to avoid a seemingly inevitable recession.

Worryingly, though, we can see that the wider population is now moving into the Anger phase. Social unrest is building in many countries. Also, political systems have become more dysfunctional in the USA, Eurozone, Japan and even China.

Today's 419 point fall on the Dow Jones Average, and $6/bbl fall in WTI crude oil prices, may not be just another example of the wild volatility that has come to seem normal in financial markets.

It may also mark the end of an era.

Since 1994, the US Federal Reserve has used all its resources to support the stock market in times of strain. This took it well beyond its official mandate of fighting inflation and supporting employment.

Instead, it meant interest rates were lowered, and liquidity provided, any time the market experienced a major sell-off. It created the dot-com bubble in 1999-2000; the subprime housing disaster; and more recently the bubble in energy and commodity markets.

Today, for the very first time in 15 years, 2 senior US Federal Reserve Governors have spoken out against this policy:

• Philadelphia Fed chief Charles Plosser said taking action after stocks tumbled "signalled that we are in the business of supporting the stock market."
• Richard Fisher, the Dallas Fed chief, said the Fed "should never enact such asymmetric policies to protect stock market traders and investors."

It remains to be seen whether this change of policy becomes permanent. There are very powerful forces, not only on Wall Street, ranged against it. Will the Fed really do nothing, if today's falls continue next week?

But if it does, then financial markets will be quite different in 5 years time:

• Markets will not be protected from their own follies
• Investors who cannot evaluate credit risk will lose money
• Commodity prices will be driven by fundamentals of supply and demand
• Computerised high frequency trading will disappear

Unfortunately, it is almost certain that the path back to reality will be extremely painful. 15 years of Fed 'bubble-blowing' will take a long time to put right. But if Plosser and Fisher really mean what they say, then Fed policy is indeed headed Back to the Future.

Most of us have now heard of the PIIGS countries (Portugal, Ireland, Italy, Greece, Spain). They are the ones causing the Eurozone debt crisis.

Today, the blog introduces the JUUGS (Japan, UK, USA, Germany, Switzerland). These are the major countries that investors now love.

If you are worried about return of capital, rather than return on capital, these are the countries for you. They have deep and liquid debt markets, are politically stable and highly likely to pay their bills. Importantly, they are not reliant on flows of foreign money to fund government spending. 85% of US Treasuries, for example, are owned by Americans.

This is becoming mission critical for many investors.

The chart above shows the difference between interest rates for 10 year government bonds in the PIIGS countries (left) and the JUUGS (right). It also shows how rates have moved between August 2010 (blue column) and today (red line):

• Rates have shot up in the PIIGS
• Greece is now paying 16%. Even Spain and Italy are paying 5%
• But rates have dropped to historic lows in the JUUGS
• Japan/Switzerland are paying just 1%, and the others only ~2%

This is another clear sign that we are indeed entering the New Normal. It also supports the blog's argument that changing demographics, particularly the ageing of the Western BabyBoomers, are leading to major changes in global demand patterns.

We explore this argument in more detail in Chapter 2 of our new free eBook, 'Boom, Gloom and the New Normal'. We believe its argument needs to be better understood and debated, if the chemical industry is to reposition itself successfully for future growth.

Please click here if you would like to download a copy.

The blog was in a minority of one when it launched its IeC Downturn Alert at the end of April.

But today, only a very few diehard optimists are still arguing the issue. GDP reports in Europe and the USA have shown virtually no growth in Q2, whilst China is clearly also slowing fast.

It is also hard to believe that until very recently, many analysts were arguing that a new Supercycle was already underway.

The blog remains convinced that we are in transition to a New Normal, not a new Supercycle. Next week sees the publication of chapter 4 of its new eBook, 'Boom, Gloom and the New Normal', co-authored with John Richardson.

This Chapter is titled 'Where we are Headed'. It offers 10 predictions about how the world will look in 2021. We believe it will become essential reading for anybody who is concerned about where we are headed in the next few years.

ICIS pricing is a very valuable resource, particularly at market turning points. It highlighted the start of the current downturn in April, when reporting that buyers had moved to operating on a 'hand to mouth' basis.

Now, its market editors are highlighting the fragility of demand due to 'economic uncertainty'.

This is the moment when buyers ought to need to order, as they return from the holidays:

• US retailers should be demanding rush orders for Thanksgiving/Xmas
• Auto companies should be seeing a flood of consumer enquiries
• Construction should be surging before the winter arrives

So far, the opposite is happening. US consumer confidence hit a 30 year low this month. Europe's debt crisis is getting worse, and has spread to Italy. China and India are seeing more social unrest, with inflation far too high for comfort in both countries.

Of course, we still have 2 weeks to go, before September will reveal buyers' true position. But ICIS' Linda Naylor remains an excellent barometer of market conditions. And she reported a large PE buyer saying last week that "customers have been cancelling orders and everybody wants to sell."

The chart shows the major surge in prices since January 2009, and highlights in yellow the downturn seen since April when IeC Downturn Alert began, with ICIS pricing comments below:

US S&P 500 Index (pink dot), up 26% overall since January 2009; but down 18% since April.
PTA China (red), up 96% since 2009; down 6% since April. Major plant and feedstock issues have led to only minor price rises recently as "the fragile macro-economic environment is weighing down sentiment".
HDPE USA export (purple), up 97%; down 13%. "Buyers were waiting to make purchases amid the economic volatility".
Brent crude oil (blue dash, right hand scale), up 141%; down 13%.
Naphtha Europe (brown dash), up 203%; down 15%. " Demand remains poor from the gasoline sector and petrochemicals. The propane market is bearish with plenty of material available".
Benzene NWE (green), up 335%; down 9%. "Widespread uncertainty surrounding the global economy, and the potential impact of this on the market, once players returned en masse from their summer holidays".

The investment banks have maintained a consistent focus on oil market supply disruptions and demand surges in recent years, alongside forecasts of sharply increasing prices. We discussed their role in more detail in the recently published Chapter 3 of our new free eBook, 'Boom, Gloom and the New Normal'.

As the above chart from the Wall Street Journal shows, based on leaked confidential information from the US CFTC (Commodities Futures Trading Commission), the investment banks are also major players in the futures markets. It shows positions on the day studied by CFTC, 30 June 2008, when crude was at $140:

• The banks appeared to hold most contracts. more than energy companies, airlines, hedge funds or Others.
• The WSJ also reports that Goldman Sachs, one of the most prominent bulls on oil prices, held 451k long WTI contracts and 419k short contracts (a net length of 32k contracts).
• Analysts Petromatrix calculate that if the WSJ is correct, "Goldman Sachs, for its own and its clients positions, was holding 35.2% of the WTI Open Interest on June 30th 2008".

Looking forward, many of the major supports highlighted in recent months for today's high oil prices by the banks are disappearing:

• Libya's 1.6mbd output should start to return to markets during H2
• China's demand January-July was only up 300kbpd vs 2010
• Saudi pumped 9.8mbd in June, up 918kbpd versus May
• Crude oil stocks in the US Gulf are close to record levels

Plus, of course, economic slowdown reduces likely future demand growth.

Yet as Petromatrix note, large traders known as the "Large Speculators (remain) very exposed to the long side of WTI" in US futures markets.

Thus the potential for further oil price declines back to the blog's expected $60/bbl is clearly quite high, even though the banks will no doubt remain highly bullish.

China's growth in electricity consumption is a much better guide to its economic growth than the published GDP figures. This was confirmed by likely next premier, Li Keqiang. It has been a major reason for the blog's long-standing focus on this key area.

The problem with GDP is that it is a target for local Party members, not an output. As Li noted, it is for "guidance" only.

Thus GDP has been reported at ~10% since the stimulus programmes went into effect from Q4 2008. But as the chart shows, electricity consumption (blue line) has far outpaced this level of growth:

• It reached a record 435 kWh in July
• The January - July total was 15% above the 2010 level
• Similarly, Jan-July 2010 was 15% about the 2009 level

15% GDP growth would ring warning bells in any country. It would highlight potential overheating, and a rising risk of a banking crisis.

Exactly on cue, such worries are now emerging. As the Wall Street Journal reports, local government has been the main driver of the lending:

• Loans to local government for highways and other infrastructure projects are estimated at RMB14.4trn ($2.25trn)
• They represent a third of all loans in China
• Banks often received land as collateral for these loans

But for the past year, the central bank has worried about whether these loans will be repaid. It has pushed up reserve ratios, causing China's publicly traded banks to raise RMB 595bn ($93bn) of new capital.

But in turn, of course, this is making new loans harder to obtain, as the chart also shows (red column). So the credit bubble is beginning to burst. Bank of China, for example, recorded RMB 135bn of bad loans in H1, more than the RMB 123bn it reported for the whole of 2010.

Most analysts, of course, are convinced that China will avoid a banking crisis. But most analysts also failed to spot the US sub-prime crisis.

The blog's friends at the American Chemical Society are running some interesting free webinars this week on 30-31 August, and have invited blog readers to join:

Navigating the Global Industrial Job Market with Richard Connell, Pfizer; Scott Harbeson, Concert Pharma; Jos Put, DSM

Entrepreneurship + Innovation = Jobs with George Whitesides, Harvard University; Joseph Francisco, Purdue University

From Scientist to CEO with Randall Dearth, LANXESS Corp CEO

Simply click on the links to get further information and register.

All of us would love to be able to see into the future.

Chapter 4 of our new free eBook, 'Boom, Gloom and the New Normal', does just this.

It offers 10 predictions about how the world will look in 2021:

1. Young and old will be focused on 'needs' rather than 'wants'.
2. A major shake-out will have occurred in Western consumer markets.
3. Housing will no longer be seen as an investment.
4. In emerging economies, companies will have recognised that the phrase 'middle-class' doesn't define people with Western income levels.
5. Chemical markets will have become more regional.
6. Western countries will have increased the retirement age beyond 65 to reduce unsustainable pension liabilities.
7. Taxation will have been increased to tackle the public debt issue.
8. Social unrest will have become a more regular part of the landscape.
9. Consumers will look for value-for-money and sustainable solutions.
10. Investors will focus more on 'return of capital' than 'return on capital'.

The New Normal offers the potential to restore a greater balance to society if companies refocus their creativity and resources on real needs.

There is also an urgent need for companies to focus on basic research to tackle these needs, rather than simply taking government grants to deploy old technologies.

The transition to the New Normal will be a difficult time. The world will be less comfortable and less assured for many millions of Westerners.

The wider population will find itself following the model of the ageing boomers, consuming less and saving more. Rather than expecting their assets to grow magically in value every year, they may find themselves struggling to pay-down debt left over from the credit binge.

More engineers and more scientists are going to be required to create the new products that will serve needs arising from the megatrends.

We will also need to find politicians with sufficient vision to sell the need for hardship and long-term struggle. This will be difficult, given that voters have become used to having all their wants met via quick 'fixes' of increased debt.

We could instead decide to ignore all of this potential unpleasantness.

But doing nothing is not a solution. It will mean we miss the opportunity to create a new wave of global growth from the megatrends. And we will instead end up with even more uncomfortable outcomes.

FREE DOWNLOAD OPTIONS FOR CHAPTER 4
Click here to download a 2 page summary of the Chapter .
Click here to download the full Chapter
Click here to view the 4 minute video with Paul Hodges

German Chancellor Merkel's recent comment that "I don't see anything which signals a recession in Germany" is just one sign of the current complacency about the global economy within the Western political elite.

Long-standing readers will remember Profs Eichengreen and O'Rourke 2009-10 work comparing today's Great Recession with the Depression of the 1930s. Worryingly, the parallels seem to be increasing again, as the chart above shows from new research by Prof Nouriel Roubini:

"World trade (dark grey line) has stalled since the onset of the year and is falling in line with lower growth in the developed world. While global industrial production increased slightly in June, it is still down on the quarter. July data, coupled with leading indicators such as PMIs (Purchase Manager Indices), points to Q3 weakness. Chinese commodity demand began to weaken in Q2 and continued to fall in July."

JACKSON HOLE MEETING OF ECONOMIC POLICYMAKERS
There was less complacency amongst economic policymakers at the US Federal Reserve's annual Jackson Hole meeting last week. There was no mention of a new QE3 programme to try and boost stock and commodity prices. Instead, as the OECD's head noted, policymakers are now realising that "this consolidation effort is going to take a generation."

Fed Chairman Ben Bernanke warned that "The quality of economic policy-making in the United States will heavily influence the nation's long-term prospects". Whilst Christine Lagarde, new IMF head, said economic risks "have been aggravated further by a deterioration in confidence and a growing sense that policymakers do not have the conviction, or simply are not willing, to take the decisions that are needed."

Policymakers, if not yet the politicans, may therefore be finallly realising that we face a solvency crisis, not one of liquidity:

• Solvency is whether one is able to pay one's total debts
• Liquidity is simply whether one can pay today's bills

The risk is, of course, that 2 years of implementing the wrong policies have left them dangerously short of time, and money. With actual US GDP growth just 0.33% ($40bn) in H1, there is surely a strong risk that the US is now entering a new recession. Europe cannot be in much better shape, despite the politicians' denials, given Q2 data.

IeC DOWNTURN ALERT UPDATE
Hopefully the blog's April launch of its IeC Downturn Alert launch has enabled chemical companies to prepare robust contingency plans for what may lie ahead. Price movements since April, and ICIS pricing comments this week are below:

S&P 500 Index (pink dot), down 14%.
Naphtha Europe (brown dash), down 13%. "Most sources still believe an oversupply threatens in September ".
Brent crude oil, down 12%.
HDPE USA export (purple), down 13%. "Latin America has now turned its attention to Asian offers".
Benzene NWE (green), down 11%. "Shutdowns downstream are expected to soften demand next month."
PTA China (red), down 5%. "Expected to be underpinned by rising PX prices caused by limited supply".

The above chart, from the invaluable American Chemistry Council (ACC) weekly report, highlights the scale of Q1's inventory build in N American polymer markets (polyethylene, polypropylene, PVC).

This build took place as consumers down the value chain rushed to buy forward, as WTI oil prices surged 41% between November - April.

Their buying was not based on actual demand, but on their need to protect margins. Most companies set sales prices for 90 or 180 days ahead, so anyone who had not bought forward could have seen planned profits turn into losses:

• The orange line shows the 22% rise in thermoplastic inventories from 4.25bn lbs (1.93Mt) to 5.2bn lbs (2.35Mt). Q2 saw this start to be worked through downstream, as consumers reduced new orders.
• Worryingly, however, we seem now to be entering the second stage of the downturn. The blue line shows that consumers are now seeing lower demand, and the ACC note the 3 month moving average dropped to 4.56bn lbs in July.

This two-stage process is exactly in line with the experience of previous oil-price induced recessions, as the blog highlighted in mid-April.

September will therefore be a crucial month.

History suggests end-user demand will remain weak, as individuals worry about the state of their finances and rising job insecurity. But, of course, we can still hope that 'this time will be different'.

Readers will no doubt be pleased to see that Bloomberg have today published a major article on the likely changes in demand patterns due to the ageing of the Western babyboomers.

Its title, 'Aging Baby Boomers Shrinking Labor Force May Curb U.S. Growth for 20 Years', emphasises the parallels it makes with our analysis in Boom, Gloom and the New Normal.

Equally, it concludes that:

"This is not your mother's recovery.

"Women and baby boomers entering the American workforce after 1950 helped to supercharge expansions in 1975 and 1983 by filling an increasing number of jobs and purchasing more goods and services. Now as the share of women with jobs falls and older Americans age into retirement, the shrinking -- or, at best, slowly growing -- workforce will weaken economic activity for the next two decades." Clearly, mainstream investors and media organisations are now becoming aware of the critical link between future economic growth and the ageing of the Western babyboomers.

Our work looks in detail at how this will impact the chemical industry. You can obtain all four published chapters via free download by clicking here

You can also sign up for the next in our series of New Normal Workshops, and obtain further details, by clicking here