Chemicals & The Economy

Human beings are by nature optimistic. Otherwise our ancestors wouldn't have bothered to climb out of the swamps, all those years ago, in the hope there was 'something better' to be found.

Equally, we don't usually give up at the first sign that something has gone wrong. We assume that a way will be found to get past the problem. This means we don't waste time on temporary problems.

But every now and then, the paradigm does shift. If we don't recognise these moments, we will instead spend our time banging our heads against a brick wall. No matter what we do, our world will not return to how it was.

The blog strongly believes today is one of those moments.

The regular IeC Boom/Gloom Index chart above is a small illustration. It shows:

• The Index (blue column) remains in negative territory
• It is back at levels seen when the crisis began to develop in 2008-9
• The reading for Austerity (red line) continues to climb

Change is not necessarily a bad thing. It may be uncomfortable at the time, but it also brings opportunities. And there are major opportunities ahead:

• 29% of the rich Western population are now in the New Old generation of 55+ years. Yet just a century ago, Western life expectancy was only 46 years. It was still only 66 years in 1950. Today, these 272 million people can expect to live until they are 80.
• Billions of people in the developing world are emerging from poverty for the first time. They need the essentials of life - food, water, hygiene, shelter and transport. A century ago, their life expectancy was just 26 years. It was only 44 years in 1950. Today, it is 64 years, and still rising.

The blog's New Year outlook is very simple. It believes it is a waste of time and energy to keep hoping that things will 'return to normal' in another 6 months. They won't, and we might as well recognise this.

Instead, as we discuss in 'Boom, Gloom and the New Normal', demographics drive demand and the global economy.

The Western BabyBoomers (those born between 1946-70) drove the Boom years as they moved into the Wealth Creator 25 - 54 age group. But now they are leaving it. The average Boomer will be 54 this year.

Nor can we expect China or India to easily replace their demand. Their 'middle classes' have an income of just $2-$20/day. They would be below the 'poverty line' in the West.

This is why the paradigm has changed.

Yet very few companies have recognised this shift. Even fewer have begun to develop products and services for Westerners in the New Old generation, or for those emerging from poverty in the developing countries. These two groups of people are dramatically under-served in today's economy.

Great companies focus on the future, not the past. This enables them to survive wars, depressions and periods of near-disaster. The blog passionately believes that the great companies of tomorrow will be those who focus on these new opportunities.

The chart above shows how the benchmark products in the IeC Downturn Monitor moved during 2011. The yellow shaded area covers performance since 29 April, when the Monitor launched.

It shows a year of two halves:

• The period to the end of April was the last time that governments embarked on major 'stimulus efforts'.
• These cost at least $5trn, but failed to deal with the real problems - the US housing market; China's over-dependence on exports; the Eurozone debt issues
• They also made the problems worse, by providing liquidity to the 'high frequency traders' to drive oil prices up to recession levels

Financial crises such as today's usually follow a predictable pattern. Markets see a sharp fall, then a temporary rebound, followed by a long-drawn out fundamental downturn.

The downturn marks the period where the world readjusts to changed circumstances. It only ends when policymakers and companies refocus on looking forward, rather than on returning to the previous 'normal'.

Sadly, there are currently few signs that this forward-looking approach is yet being widely adopted.

ICIS pricing movements for the benchmark products since the Monitor's launch are below:

HDPE USA export (purple), down 22%
Benzene NWE (green), down 20%.
Naphtha Europe (brown dash), down 20%. "
PTA China (red), down 18%.
Brent crude oil (blue dash), down 14%
S&P 500 Index (pink dot), down 7%

High oil prices are a bad thing for the global economy, and for the chemical industry,

2011 was therefore a very bad year indeed.

Brent oil prices, the global benchmark, averaged $111/bbl in 2011. This is higher even than in 1979 and 1980, after adjusting for inflation.

The chart shows the history since 1970, based on BP's annual Energy Statistics. The red columns mark official recession periods in the US economy. They show that recession followed every time oil prices sustained a level of $50/bbl or more in $2011 (red line).

Of course, 'this time may be different'. But in the past, oil costs above 3% of GDP have always led to a recession. 2011 saw them at over 5% - the highest level since the major downturn in the early 1980's:

• The problem is caused by the drop in consumers' discretionary income
• They have to buy gasoline, and heat/cool their homes
• So they have less money to spend on everything else
• Initially people buy forward to avoid higher prices
• But then demand falls away, as soon as the oil price stops rising

The ageing of the Western BabyBoomers, who drove the economic Supercycle between 1982-2007, makes it even more difficult for the global economy to sustain this burden.

The New Old generation of those aged 55+ are now 29% of the Western population. It is extremely hard for the economy to grow, when the needs of this major segment of the population are being largely ignored.

The world enjoyed an economic SuperCycle between 1982-2007. Its largest economy, the USA, suffered just 16 months of recession during the whole 25 years.

As a result, social and political issues took a back-seat. Politicians instead competed to occupy the middle ground. Former UK premier Margaret Thatcher's phrase 'you can't buck the markets', became received wisdom almost everywhere.

The blog suspects a major change is now underway, as the world enters another recession - just 3 years after the 18 month downturn between 2007-09. Politics may revert to discussion of policies, instead of image. And life may become more uncertain as a result.

2012 sees presidential elections scheduled in the USA, China, Russia and France:

USA. The first primaries are now underway
China's elections will see only 2 of the current 9-member politburo remain - Xi Jinping and Li Keqiang
Russia's election process seems more uncertain, after recent protests
France's election could be quite turbulent, given the Eurozone crisis

In addition, Germany will be preparing for major elections in 2013, whilst India's current government may not last until 2014's elections. Italy also seems overdue for an election, following Berlusconi's departure.

Political issues will therefore assume much greater importance. A year ago, in its Budgeting for Uncertainty White Paper, the blog suggested that:

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

"Now we have moved into a new stage, where countries try to maximise domestic employment by boosting exports via devaluation of their currencies."During 2011, we moved into a phase of competitive devaluations. Today, trade disputes are becoming much more common:

• Whirlpool, the world's largest appliance manufacturer, is asking for dumping duties on Korean refrigerators from Samsung and LG
• Meanwhile, the EU's new airline tax on carbon emissions is threatening a trade war with China, Russia, India and possibly the USA.

2102 may well be the year when politicians more openly adopt protectionist measures to improve their own chances of election or re-election.

Prof Daniel Kahneman is the blog's favourite living social scientist. He won the 2002 Nobel Prize for economics for his insight that:

• Economists are wrong to assume human beings are motivated by self-interest and make rational decisions
• In fact, human judgement may take short-cuts that systematically depart from basic principles of probability
• The avoidance of loss and disadvantage is a more important driver than the hope for gain and advantage

CMAI kindly allowed the blog to repeat Kahneman's most famous experiment on the day of his Nobel award, with an audience of 500 people. His insight was again proved correct.

Unfortunately, most policymakers ignored his work, although it could have helped them to avoid the current financial crisis. The blog only hopes they will now read his new book, 'Thinking, Fast and Slow'. It raises important questions about how we allow perception to dominate reasoned analysis, and could be a powerful tool for promoting global economic recovery.

The chart above is one of his examples:

• It appears that the top line is shorter
• But if you measure it, they are both the same

Now you know they are the same, does your mind accept this fact?

The answer, certainly in the blog's case, is 'no'. It wants to believe the top line is shorter, even though it drew the lines. This is Kahneman's point.

He argues that the mind has two ways of operating:

• One is fast and intuitive (System 1)
• The other is slow and analytical (System 2)

And as this example shows, they operate independently, so that "you cannot decide to see the lines as equal, even though you know they are. To resist the illusion, you must learn to distrust your impressions of the length of lines when fins are attached to them".

Politicians can't summarise Kahneman's work in 146 characters on Twitter. Nor can it provide a sensationalist headline for the mass-media.

But his work does explain why such 'sound-bites' can appear effective. They allow us to use System 1 and rush to instant judgement.

It also explains why current policies, mostly based on System 1 thinking, may appear to be rational, whilst taking us steadily in the wrong direction.

December's US auto sales provide a classic example of Kahneman's illusion, discussed on Saturday.

Initially they appear encouraging to our System 1 minds. As the chart shows (red line), they were the 2nd highest of the year, and one of the few months to top 1.1m sales since the start of the Great Recession. But analysing them with a System 2 approach gives a different picture.

The past 3 years have seen buyers trying to avoid purchases:

• Owners have been hanging on to old cars for as long as possible
• Vehicle scrappage rates are now only 4% of the US fleet
• The average age of the US fleet is nearly 11 years, a record
• They are driving less, with vehicle miles down 1.7% versus 2007 levels

Yet there are limits to everything. Life without a car is very difficult in many parts of the USA, due to the lack of public transport and the vast distances. So it would appear that we have finally got to the point where today's old cars simply can't run any more.

As a result, industry estimates suggest we may well see 13.5m sales in 2012. This would better the 12.8m in 2011, but would still be well down on the 15 - 17m range seen in the boom years from 1995 - 2007.

These new purchases will come at a cost, however.

• Buyers are cutting expenditure in other areas, such as personal care
• Some are having to pay 16% interest on 'near-prime' loans (10% above normal rates)

None of these reasons provide much support for Wall Street's System 1-type belief that recovery is finally underway. But they do highlight how companies need to conduct careful System 2 analysis, if they want to develop successful strategies for the transition to the NN.

ICB has just published the blog's annual New Year Outlook. The interview above summarises its key points. ICIS deputy editor Will Beacham opens the interview with the key question:

"A year ago, we were about the only people who didn't have unbridled optimism for the whole of 2012. Why do you think there was all this unfounded optimism?"

The answer seems to be that the experience of the 25 year economic SuperCycle from 1982 - 2007, when the USA suffered only 16 months of recession, has led to the assumption that continuous growth is 'normal'. Unfortunately, it isn't, as we are now relearning.

In addition, as the Bank of England noted back in December 2008, even relatively small banking/financing crises take an average of 4.3 years to resolve. And they typically caused a 7% loss in GDP. Today's crisis was clearly set to be larger in scale, even if policymakers had pursued really wise and far-sighted policies.

The blog still sees major opportunities ahead, once policymakers begin to address the real issues.

4 of today's 5 major challenges are self-inflicted: Eurozone debt, US subprime housing, China's bank lending and the record level of oil prices.

The 5th, the demographic challenge of the ageing of the Western BabyBoomers, could become a really wonderful opportunity if policy makers would only open their eyes to new possibilities.

DOWNLOAD OPTIONS
Please click here to download the free 2 page ICB Outlook
Please click here to view the 4 minute YouTube interview

Interest rates are key to the direction of the global economy.

But not in the way that was true during the 1982-2007 economic SuperCycle. Then, there was a global surplus of savings, due to the vast numbers of people in the Wealth Creating 25 - 54 age group.

So interest rates reduced dramatically in most countries, with the USA leading the way. Its 10 year government bond rates reduced from 15% in 1982 to just 5% by 2007.

Today's market is increasingly dominated by the New Old generation of people aged 55+. As one would expect, older people are more concerned about security rather than growth. They value 'return of capital' more than 'return on capital.

Thus a new UK investor survey reports that "protecting the value of existing assets" was the main priority. In turn, this means that investors are very nervous about markets where governments are borrowing too much, and have no plan to repay their debts.

This is why investors now prefer the JUUGS (Japan, USA, UK, Germany, Switzerland) to the PIIGS (Portugal, Ireland, Italy, Greece, Spain). The chart above updates the position since the blog first launched the concept (today's interest rates = red line; August 2011 = blue column) :

• In August 2010, rates in the PIIGS averaged 5.9%: now they are 14.5%
• Rates in the JUUGS were 2.05%, now they are 1.5%

These demographically-driven changes have confused even the world's largest bond investors, PIMCO, who suffered a rare year of major under-performance in 2011. They worried (rightly, of course) about the rising level of debt in some of the JUUGS - but failed for a while to realise this was not investors' primary concern.

The key question at the start of 2012 is what happens next in the Eurozone. As the chart shows, Greece's interest rate has gone 'off the chart' at 38%. And now, the real threat is contagion to Germany. As the Financial Times warns:

"If the euro stays together, it will only be because Germany pays, one way or another - hurting their bonds. If the euro breaks down...German finances would be trashed by the need to rescue its banks".

Nobody knows how this very serious situation may play out.

We can all hope for good sense and wise policy to prevail. But hope is not a strategy, and can easily turn into wishful thinking. The blog will continue to keep a very close eye on developments.

The blog is quite surprised at the mainstream media's lack of interest in the fact that average Brent oil prices were at record levels in 2011 in real terms (adjusted for inflation).

The annual average of Brent prices recorded by the US Energy Information Administration was $111.26/bbl, well above even 2008, when Brent prices peaked near $150/bbl in nominal terms. Yet a Google search of 'record annual oil prices in 2011' reveals only the blog's own entry.

The statistic itself certainly seems newsworthy and important. 2011's high oil prices took 5% of global GDP from consumers' pockets. By comparison, oil costs averaged less than 3% during the economic SuperCycle years of 1982-2007. It is no wonder that spending is reduced, and retailers around the world are facing hard times.

However, the blog suspects this lack of awareness is about to change, as its impact becomes clearer:

• Tesco, the world's 3rd largest retailer has reportedly had its worst UK Christmas performance for decades
• Nigeria is about to see major strikes over fuel subsidies
• Refiner Petroplus has seen its credit lines frozen, and has already been forced to shut 3 of its refineries.

Petchem markets are caught in the middle, as usual.

Producers have no choice but to try and protect margins by posting higher prices - especially with crude now rising further due to worries over Iran's policies. But buyers find it extremely difficult to pass through any increases to cash-strapped consumers.

In addition, economic concerns have helped make markets treacherous:

• Inventories are low due to demand worries, and cash constraints
• Mid-tier companies are finding credit tight, as the banking sector cuts back (especially in China and Europe)
• Crude oil markets remain supply-driven and unpredictable
• Currencies are very volatile, with the €:$ rate down 3% during the week

The chart shows product price changes since the IeC Downturn Monitor's launch on 29 April 2011, with ICIS pricing comments below:

HDPE USA export (purple), down 18%. "Trading was thin, with very little interest in US material".
PTA China (red), down 14%. "Surging feedstock PX prices exerted major upward pressure on PTA prices".
Naphtha Europe (brown dash), down 14%. "Petchems and gasoline have shown minimal interest in naphtha".
Benzene NWE (green), down 13%. "Downstream demand had yet to pick up following the holiday season".
Brent crude oil (blue dash), down 10%
S&P 500 Index (pink dot), down 6%

This week's news provided more evidence to support the blog's fear that the global economy is close to recession:

• The German economy, Europe's motor, saw negative growth in Q4
• US retail sales grew just 0.1% in December, despite good auto sales
• China's auto sales fell in Q4, and house prices fell in 60 cities

Equally worrying is that many policymakers seem blind to the risks of recession. Germany's Chancellor Merkel, for example, remarked as recently as August that "I don't see anything which signals a recession in Germany". Yet only a month later, growth had already stalled.

The reason for this myopia is probably fairly simple. The global economy grew more or less continuously during the 1982-2007 period, and so policymakers are making the fatal assumption that this is 'normal'.

As a result, their wishful thinking is creating additional risks for the economy as we move into 2012:

• On the Downside lie the risks of a Eurozone break-up, a hard landing in China, and a further downturn in the US housing market
• None of these risks is minor from a chemical industry viewpoint. They all have destabilising potential, particularly in terms of political risk
• Protectionism would be a very strong possibility if any of these areas went seriously wrong
• On the Upside, policymakers might panic if these events occurred
• They might undertake further stimulus efforts, on a massive and perhaps co-ordinated scale
• In terms of scale, they might each do a minimum of $500bn, making $1.5trn in total

None of us can judge the likelihood of the above events. They are like leaving a series of banana skins at the top of the stairs, and wondering whether anyone will fall and break their leg as a result.

The best response is perhaps to continue with a Base Case scenario that is based on the arrival of recession. A Downside scenario would then reflect the risks above, just as would the Upside scenario.

It is all a very long way away from the comforting consistency of the Supercycle days. But to do nothing in the face of the banana skins around, could also prove to be wishful thinking as well.

Markets are worryingly quiet for the start of a New Year. There is some restocking underway, but the main interest lies in the crude oil market.

Since Brent peaked in April, there has been a clear pattern each month:

• Prices have peaked at the start of almost every month
• The only exceptions have been July and October
• They have then slipped lower by the end of the month

So players have been busy 'talking up' the market since New Year, to see if they can catch unwary buyers. If the pattern holds, they will then 'talk down' the market in the 2nd half of the month.

Actual price movements since April have been minimal - with a range of $103 - $118/bbl. So this type of tactic is the only way for players to earn a decent bonus. Their aim is simple - to buy at the end of each month, and then resell at the start of the next month.

Meanwhile, back in the real world of petchems, uncertainty rules.

Some hope that China will boost demand once Lunar New Year is over. Others, particularly in the USA, hope that consumer demand might be improving. But in Europe, there is little optimism. France and Austria lost their AAA ratings on Friday, and Greece moved closer to default.

The chart shows market developments over the past year. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 18%. "The delta between China and US prices was still too wide to generate much interest in US product".
Naphtha Europe (brown dash), down 16%. "Low activity levels, with high prices still having an impact on demand".
PTA China (red), down 14%. "Surging feedstock paraxylene (PX) prices supported PTA prices".
Brent crude oil (blue dash), down 10%
Benzene NWE (green), down 9%. "Upward movement was primarily crude driven, as demand from key sectors such as styrene and phenol has so far remained sluggish to average ".
S&P 500 Index (pink dot), down 6%

Saturday's blog post highlighted the risk of a hard landing in China.

This risk is very real, and is centred on the government's need to achieve a difficult balance between reducing today's high rate of food price inflation, whilst not collapsing the property market.

House prices are now falling in 60 Chinese cities. An excellent report by the Financial Times highlights the key issues, which are summarised in the chart above. As in the USA during the sub-prime bubble, we may well have reached the point where China's credit bubble can expand no longer.

The key is the country's relative poverty. It is only 90th in the world in terms of GDP/capita at just $5184. This is a long way from the USA at $48147 or Germany at $44558. Yet as the FT's chart above shows:

• Beijing property prices average 17300 Rmb/sq metre ($2700)
• Shanghai property sells at 14300 Rmb/sq metre ($2200)

As a result, the house price to income ratio in China's Tier 1 cities has reached 14:1. It is 10:1 in Tier 2 cities, and 8:1 even in Tier 3 cities. By comparison, the US ratio at the peak of its housing boom was only 5:1.

The problem is our old friend, unrealistic expectations. As the FT notes:

"It is easy to forget that the market is just over a decade old and, apart from a brief dip in the midst of the 2008 financial crisis when transactions dried up, most Chinese have only seen prices double every couple of years and never seen them fall."

Before 1998, all urban housing was built and allocated by the state. There was no word even for 'mortgage', as there was no such thing as private residential property. Even in rural areas, peasants built their homes on land allocated by the state or the collective.

Another key factor behind the rise in prices has been China's lack of a proper system of social security. As a result, most women believe owning a home is essential for any man wanting to get married.

Young bachelors have thus routinely turned to their extended families for help with raising the finance for a home. And as prices were doubling every 2 years over the past decade, the 'bank of mum and dad, and grandparents, and cousins' has always been happy to help.

Equally, the local provinces are dependent on property development for up to 40% of their income, according to the FT. And they quote Prof Yi Xianrong of China's prestigious Academy of Social Sciences as warning

"Right now the high housing price is not due to limited supply - it is because of endemic speculation. But the government doesn't combat speculation because high prices keep GDP growth and revenues high."

Today. however, the government's main concern is reducing the inflation caused by the credit bubble it unleashed in Q4 2008. It therefore has to reduce bank lending, even if this weakens property markets. Food price inflation is its key concern, and this rose again to 9.1% in December.

96% of China's population earn less than $20/day according to the Asian Development Bank. So rising food prices inevitably lead to a risk of social unrest. In turn, this now makes it difficult for the government to support the property market.

Effectively, it may therefore be caught between a rock and a hard place.

Inflation and social unrest would increase if it launched another stimulus programme and allowed lending to boom again. But the current lending slowdown risks causing future unrest amongst all those who have bought into the market in the belief that prices would never fall.

The blog sees no easy way through this crisis. It can only repeat its warning of a year ago. We may be about to "discover, too late, we have simply been in the middle of yet another China 'boom and bust' scenario".

The above chart would have seemed unbelievable at any time in the past 30 years. It shows the performance of propylene and butadiene relative to ethylene.

Not because it shows butadiene prices racing ahead relative to ethylene (green line). This happens routinely during a downturn, as tyre demand is more robust than for polymers. If people are not buying new cars, they still have to buy new tyres for existing cars - for legal and safety reasons.

But the record level of the butadiene premium to ethylene, an average of 170% in 2011, does give a clue to the dramatic nature of the disruption that has taken place.

The real shock, however, is that propylene sold at parallel prices to ethylene through the year (blue line). Not only has this never happened before. But it is also contrary to the main rationale for propylene sales, as this developed during the 1980's.

The blog discussed this emerging trend back in July 2010, in a major series of posts that anticipated recent developments. They were also summarised in its ICB analysis of September 2010. New readers may like to refer to these for background detail by clicking the links:

• Major changes underway on relative olefin pricing
• Propylene prices reach parity with ethylene
• Benzene develops security of supply issues
• Lower Western gasoline demand helps paraxylene
• Major changes underway in chemicals markets

The key is that markets have become supply-driven. Oil production and refinery output have been reduced due to lack of demand. This has reduced ethane availability in the Middle East, and naphtha availability in the West.

Equally, the dramatic increase in the price of crude oil versus natural gas in the USA, due to financial speculation, has prompted a major switch from liquid to ethane feeds on the crackers.

Propylene supply has therefore been reduced both by lower refinery runs, and by the switch to ethane feeds, as these produce virtually no propylene or butadiene. Lower cracker operating rates have also helped to tighten markets, particularly for butadiene.

The question ahead is now twofold:

• Will buyers still be interested in using propylene for its commodity applications such as packaging, if it is no longer price competitive?
• Can crude oil really maintain its current premium to natural gas?

The answers to these questions are really a zero-sum game. Those who get them right, stand to make a lot of money. Those who get their analysis wrong, will likely lose a lot of money.

The blog itself would be extremely cautious about ignoring affordability issues, and simply assuming current trends will automatically continue.

Pensions were one of the great inventions of the past century. Now the European Central Bank (ECB) has issued a 'wake-up call' on the affordability issues that lie ahead.

The reason is very simple. As we note in 'Boom, Gloom and the New Normal', pensions were introduced first introduced in Germany in 1889, and then in the UK in 1908. The idea was to provide a small amount of money to a small number of people for a small period of time:

• Life expectancy then was 30 years lower than today
• Pensions only went to those who lived 20 years longer than average

Since then, we have failed to index pension age to rising life expectancy. In addition, Westerners have come to assume that pensions are a 'universal right'. We forget that younger people will have to pay the bill for this dramatic increase in costs.

The ECB's report summarises the result. It calculates state-funded pension obligations in 19 EU countries where sufficient data exists:

• They have combined obligations of €30trn ($39trn)
• By comparison, total EU GDP in 2010 was only $12trn

The ECB is not supposed to intervene in political issues. So it cannot publically state the obvious conclusion. But most people reading the report will be in no doubt about what this means. Put simply, future pensioners are most unlikely to actually receive the money that has been 'promised' to them. Younger generations cannot, and will not, afford to pay the bill.

In turn, this has enormous implications for the type and cost of the products and services that older people will require. Affordability will be the key criteria for them in future years, not 'value in use'.

Companies that grasp this challenge will not only help to cushion the transition for disappointed would-be pensioners. They will also build a robust platform for their own future growth.

The International Energy Agency (IEA) confirmed the blog's worst fears this week, with its announcement that crude oil demand actually fell by 300kbd in Q4. Not only is this "quite rare" as the IEA noted, but they went on to warn:

"We're flagging that there are clearly downside risks to the global economy and to oil demand: the world could see zero demand growth if there were further downgrades to global GDP estimates".

The issue is simple. The world has never before had to live with Brent prices at over $100/bbl ($2012) for so long. Demand destruction is clearly taking place on a wider and wider scale. Even if prices fell sharply tomorrow, demand would now still take a long time to recover.

The IEA data shows that Western demand fell very sharply in Q4, by 700kbd. And Asia, despite all the bullish analyst talk about decoupling and perpetual demand growth, saw just a 400kbd increase. China's slowing economy meant its demand rose only 1.7% in November versus 2010.

Yet for the moment, prices remain at their record levels. They are supported not only by Iran's threat to block the Strait of Hormuz, but also by Saudi Arabia's comment that its "wish and hope is we can stabilize this oil price and keep it at a level around $100/bbl".

As a former feedstocks and oil product trader, the blog well remembers that the basic rule in oil markets has always been to assume Saudi will achieve its objectives:

• It has the largest reserves, and plenty of spare capacity (Oil Minister Naimi suggested in his interview it could easily produce an extra 2mbd)
• And usually Saudi prefers relatively low prices, as it is keen to be seen as a reliable supplier, helping to promote global growth
• It is equally dangerous to bet against Saudi when it wants higher prices
• It cut production between 1980 - 1985 from 10.3mbd to just 3.6mbd, in its effort to keep prices at ~$30/bbl ($65/bbl in $2012)

But today's position is less clear-cut. Saudi needs high prices, at least $80/bbl, to balance its budget, following its decision to increase subsidies and handouts following the Arab Spring. But it also (unlike the 1980s) needs high volumes. 3.6mbd at $100/bbl wouldn't provide enough income.

It is thus hard to see how both its objectives can be achieved:

• US demand is down 1.5mbd since 2007, and its domestic production is increasing rapidly, whilst European and Japanese demand is also reducing
• 2012 seems a bad year to try the experiment, with demand growth under threat from European austerity programmes
• Equally, China imports only 5mbd, so even a major new stimulus programme would not really create much extra global oil demand
• The outlook is even less promising. Spare capacity today is 4mbd, and this volume is already set to rise to 8mbd by 2015

And finally, of course, there is the growth of gas supply. The arrival of shale gas has pushed US prices down to $2.35/MMBTU. As the chart shows, this has led to a record ratio for crude oil prices versus gas of 34 today, when the energy equivalent ratio is only ~6.

This will further reduce oil demand in favour of gas, probably permanently. Whilst today's record prices mean that other major consumers including the UK, Poland and China, are all hurriedly jumping on the bandwagon.

The blog cannot remember a time in the past 30 years when oil markets have been so uncertain.

History suggests it would be extremely unwise to bet against Saudi, at least in the short-term. The Iranian situation makes this doubly risky. Yet building inventory would also be very risky, if prices did begin to fall. And it is also very expensive at today's prices.

Thus low inventories and increasing nervousness create the potential for continued price volatility, further adding to the uncertainty.

Cars are now the largest single market for chemical sales, as housing markets have slowed globally. Each new US car is worth $3297, for example, according to the American Chemistry Council (ACC), making the US market worth $42bn in 2011.

2011 auto sales were ~59m, up 4% from 2010. The West (EU, USA, Japan) still dominates, with 50% of demand. Developing countries showed rapid growth until recently, but the BRICs (Brazil, Russia, India, China) are still only 35%.

The chart above shows performance in the 3 largest markets since 2007:

• China (blue column) remained in top spot at 14m. But its growth rate collapsed with the ending of stimulus spending - from 49% in 2009, and 30% in 2010, to just 5% in 2011. Q4 growth was only 1%, as the last subsidies were removed in September
• The EU (red) was 2nd at 13m, continuing its recent decline. Sales have now fallen for 4 successive years. Without Germany, whose sales rose 9% to 3.1m in 2011, the picture would be even worse
• The USA (green) remained 3rd with sales up 11% to 13m, hopefully having now bottomed, as the blog noted recently. But they are a long way from the 15 - 17m range enjoyed during the 1995-2007 boom years

• Japan was the next largest market at 4.2m, hit by 2011's tsunami disaster. The other main markets are small by comparison - Brazil at 2.7m, Russia at 2.6m, India at 2m

Overall, growth in the 3 major markets weakened significantly last year.

2009 had equalled 2008 performance, as China's massive stimulus balanced the US/EU slowdown. Then co-ordinated G20 stimulus led to 10% growth in 2010. But last year saw growth decline to 4%. Q4 growth was only 2%, versus 10% in Q4 2010.

The blog does not rule out a panic reaction by policymakers, as it becomes more apparent that the world has re-entered recession. Co-ordinated stimulus would work for a period, as it did in 2009/10. But the debt overhang afterwards would be even worse than today's.

In the absence of further stimulus, it is hard to see much growth in 2012, particularly with oil prices at today's record level:

• Germany's economy is slowing fast, so EU volumes are likely to continue their decline
• China's growth will remain slow, as its primary focus is now on controlling food price inflation, rather than boosting demand
• The USA will probably also see only slow growth, even with further stimulus ahead of the presidential election

It is not all bad news, however, as moves to reduce auto weight will boost chemical and polymer demand. The ACC estimates, for example, that 378lbs (172kg) of plastics and composites were used in the average light vehicle in 2010, up from 286lbs in 2000 and just 20lbs in 1960.

But clearly the days of steady SuperCycle growth are now behind us, as the Western BabyBoomers enter the New Old 55+ generation. With 29% of the Western population already in this cohort, their mobility needs now represent a new and potentially very attractive market opportunity.

We highlight these in more detail in Chapter 8 of 'Boom, Gloom and the New Normal', to be published next week.

There is no arguing with markets when they are being driven by sentiment, either positive or negative. Last week's news of China's slower GDP growth gave rise to opposite interpretations in Asia and the West - but news media reported both were seen as firmly positive:

• In Asia, markets "jumped... after news that Q4 economic growth in China had beaten forecasts eased fears of a sharper slowdown there"
• Western markets "rose to a 10-week high...after China's slowest economic growth in more than 2 years bolstered expectations for easier monetary policy"

News analysts, however, were more cautious, with CBS noting:

"This is the smallest GDP increase in a decade and the consensus opinion is that it indicates China is heading for a soft landing as its economy slows. That would be a reasonable conclusion if there was any chance this number wasn't a complete fabrication. The actual number is certainly lower, quite possibly by a huge amount".

The Washington Post added a more detailed warning:

"Real estate accounts for 13 percent of China's economy, and it has been growing at ~20% a year...The run-up in real estate prices has allowed for massive government spending, as provinces and localities sell land and use land as collateral for large loans, raising the specter of a debt crisis similar to the debt crisis in the United States and Europe."

Meanwhile petchem markets remained in their recent range. The current optimism in financial markets, even though these also remain range-bound, makes it prudent to restock inventories regularly.

The chart shows how markets have moved since 2009's rally began, with the recent downturn highlighted in yellow. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 18%. "Even with higher global prices, US prices were still too high to generate much interest".
Naphtha Europe (brown dash), down 14%. "Some seasonal restocking, a recent open arbitrage to the US and the current loading of European vessels booked in December for Asia".
PTA China (red), down 13%. "Transactions were subdued as most market players were away for the upcoming Lunar New Year holiday".
Brent crude oil (blue dash), down 11%
Benzene NWE (green), down 5%. "Values buoyed by a firming Asian market as well as crude and energy gains"
S&P 500 Index (pink dot), down 4%

The blog's 6 monthly review of force majeures (FM) reveals worryingly little improvement in performance. As the chart shows, H2 was slightly better than H2 2010. But realism suggests it was flattered by Q4's low operating rates, which probably reduced the actual need for FMs.

The chart is based on the number of FM mentions in ICIS news. It shows FM reports in H2 by year since 2005. Clearly there was a great improvement between 2005-7. But since then, the momentum for change seems to have disappeared.

The industry's near-record profitability over the past 18 months should really have led to a much greater reduction in outages.

This is very disappointing for anyone who remembers the pioneering work on this issue by the then giants of the industry, DuPont and ICI. They taught us that 'all accidents are preventable', and instilled a culture which led to safety reporting being the first item at Board meetings.

Many companies, of course, still follow these rules, and focus on continuous improvement. They benefit not only from 'doing the right thing', but also from better profitability and customer relationships.

But procurement professionals around the world line up to tell the blog about their frustration at the problems they encounter on a day-to-day basis. The blog only hopes their continued pressure will lead to it being able to show a better performance in July.

The blog's argument that there is no shortage of crude oil seems finally to be going mainstream.

Equally, its concern over the impact of today's high prices, especially by comparison with natural gas, is also now starting to be highlighted.

Thus the Wall Street Journal notes:

"Oil inventories in the Western world are now high.

"In Europe, at the sharper end of the (potential Iran) embargo, International Energy Agency data show a less benign, but hardly alarming picture. On a 12-month rolling average to take account of seasonal swings, stocks covered roughly 140 days of net imports in October. That is 10 days less than in mid 2010, but in-line with the average of the past five years."Meanwhile the New York Times reports:

"Nationwide, the average household using oil spent $2,298 on heat last year, compared with $724 spent by gas users and $957 spent by electricity users, according to the Energy Department. This year, heating oil users are expected to spend 3.7% more than last year, while natural gas customers are expected to spend 7.3% less and electricity users will spend 2.4% less."

Latest data from the IMF shows that the EU remains the world's largest economic unit. Its GDP in 2010 was $16.2tn, 26% of the global economy. The USA was next with $14.5tn, and China 3rd with GDP of $5.9tn.

So what happens in Europe matters greatly to the global economy.

Equally, petchems are one of the best leading indicators that we have for monitoring the health of the broader economy. So the chart above of ethylene production in the EU 15 (plus Norway), based on APPE data, provides good insight into what lies ahead:

• Q4's 4.4MT output (red line) was the lowest since 1995, excluding 2008
• Total 2011 output of 19.6MT was the lowest since 2000, excluding 2009
• Q4 operating rate was just 72%, and H2 only 77%

This is not good news, by any standard.

Another way of interpreting the data is to average 2010-2011 volumes. This takes account of 2010's stock-build as crude oil prices rose, and then 2011's destocking. It gives an average volume for the 2 years of 19.9MT. This would be the lowest volume since 2001, excluding 2009.

The conclusion is obvious. Demand destruction is underway in the world's largest economic region. It also seems unlikely that things will improve short-term with oil prices at a sustained record level, and with EU governments committed to an austerity approach.

Producers and consumers have done a superb job over the past few months in reducing output in line with demand. In the short-term, they should hope for a reward in terms of a bounce in orders. H1 should be the seasonally strongest part of the year.

But only an extreme optimist will regard this as a sign that the economy itself is turning the corner. And policymakers' continuing inability to finalise Greece's inevitable default is a reminder, if one were needed, of the banana skins that now litter the world's economic outlook.

'Would you buy, or would you sell?' is always an interesting question in any market. Petchems provide a particularly balanced answer today.

• Buy arguments include - China's buyers will return from holiday, and will need to restock; gasoline markets are tightening after the Petroplus bankruptcy; bad weather is causing some disruption
• Sell arguments include - US GDP data disappointed with inventories showing a big rise; a blockage of the Strait of Hormuz seems less likely in the short-term; European demand remains slow for the time of year

The 'safe' answer to the question would therefore be to buy. And this is what has been happening, especially as consumers need to build inventory ahead of proposed price increases. They cannot pass these on downstream, so their profitability depends on buying forward.

The second question, of course, is 'would you therefore go long?' And today the 'safe' answer would be to simply maintain prudent inventory levels. Markets have been driven by supply-side constraints for many months now, not by strong levels of demand.

The 'sell' arguments above create justifiable concern that one day, perhaps not too far away, fundamentals of demand will come back into play. Going 'long' would require either a strong belief that demand is returning, or confidence that supply will remain disrupted.

The blog suspects that crude oil market moves may prove decisive in the end. The bankruptcy of European refiner Petroplus is yet another warning sign about the impact of demand destruction at today's record prices. But equally, oil is still trading in its 'triangle' pattern, so it would be premature to anticipate its future direction.

The chart shows market developments over the past year. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 16%. "Trading was thin, with the Chinese New Year holiday keeping Asian markets at a standstill".
PTA China (red), down 13%. Markets were closed for Lunar New Year
Brent crude oil (blue dash), down 11%
Naphtha Europe (brown dash), down 11%. "Restocking, delays in the Mediterranean, and higher propane prices which have finally encouraged buyers back to naphtha".
S&P 500 Index (pink dot), down 4%
Benzene NWE (green), down 3%. "Some key European producers have been aggressively purchasing benzene instead of pygas".

The global economy is moving into a difficult period, as it transitions to the New Normal. Debt levels are high, and incomes are under pressure, particularly for the large numbers of people moving into retirement.

Cost must be the key criteria when examining the opportunities for new product development and research. Chapter 8 of our free 'Boom, Gloom and the New Normal' ebook examines the application of this philosophy to the 4 megatrends that we have identified as being key to the future of the chemical industry:

• Improving water availability
• Improving food production
• Increasing life expectancy
• Reducing carbon footprint

It suggests that the key need is to be practical. Companies should focus:

• In the fields of water/food, on reducing the amount of waste, and the output that is lost when product is moving to market
• In developing new products and services for the over 55s, on core needs such as food, water, health, shelter and mobility
• In turn, this will enable them to 'do more with less'. Carbon footprint will be reduced, and products will be more affordable

This philosophy is quite different from that seen during the 1982 - 2007 economic SuperCycle. Then, companies competed for the middle ground, as we saw in chapter 7. They added features, and pursued the concept of adding value in order to boost profits. Over time, they focused more and more on the wealthier parts of the global population, and became increasingly disinterested in those outside this privileged group.

Today, however, it is no longer viable to focus in this way.

The Western BabyBoomers are joining the New Old generation of those aged 55+, and they face the prospect of much lower incomes as they transition from salaries to pensions.

Similarly, incomes in emerging economies are dramatically lower than those in the West. It is wishful thinking to imagine that these regions can therefore somehow replace the demand for added value products that is disappearing in the West.

Doing more with less is therefore our motto for future success. The chapter contains, as always, a wide range of practical examples to help stimulate ideas within your own business. We are convinced that those who accept its challenges will benefit for many years to come.

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