Chemicals & The Economy

The blog's quarterly look at company results raises more questions than answers about the outlook. This is very typical of turning points.

Back in May 2010, for example, companies also expressed mixed feelings, as the blog noted:

"Q1 has seen the forecast seasonal boost. But Asia, particularly China, remains the real focus of growth. PetroChina, Reliance and Sinopec all see a continuing boom underway, with Sinopec highlighting the importance of 'state stimulus measures'.

"Equally, Akzo Nobel seems typical of the majority when noting it remains 'cautious about the strength of the recovery'. BASF also notes that 'recovery is not certain'. And several companies, including Rhodia, worry about the 'uptrend in raw material and energy costs".

Today, Dow 'anticipate that global growth will gain momentum', whilst Unilever warn the 'external macroeconomic environment remains difficult.'

This divergence suggests that Scenario planning, based on Dow's Upside case and Unilever's Downside view, could prove a very valuable exercise for companies to undertake over the next few weeks.

Air Products. "Business activity did not pick up as much as we expected"
Akzo Nobel. "Our concerns are focused on the risk of recession in Europe, delayed recovery of the US property market and the potential for a slowdown in China,"
Arkema. "Positive about market conditions"
BASF. "Increased raw material costs could not be fully passed on in all business areas, which put pressure on margins."
Bayer. "Strong performance in its CropScience operations offset the sharp decline in its MaterialScience business"
BP. "Expected pethem margins to remain subdued given the difficult economic conditions"
Borealis. "Difficult market conditions, especially for the European polyolefin business segment"
Celanese. "Challenging economic environment in certain geographies and industries"
Clariant. "Economic headwinds, an unfavourable currency development and the absence of restocking activities"
Dow "Anticipate that global growth will gain momentum as we move through Q2 and into H2"
Dow Corning. "Demand improved slightly over last year, prices were depressed globally"
DSM. "Cautiously optimistic for 2012 despite the uncertain macro-economic situation"
DuPont. "Expect further sequential volume improvements"
ExxonMobil. "Weaker margins decreased chemical earnings"
Huntsman. "Certain economic challenges in various parts of the world"
Idemitsu Kosan. "Decreased demand for petchem products, particularly from China"
INEOS. "Demand for olefins in the quarter continued to be solid"
LG Chem. "Sluggish demand from China squeezed margins"
LANXESS. "Expects the performance in Q2 to be similar to Q1"
LyondellBasell. "Much weaker Europe, Asia and International olefins & polymers results"
Mitsubishi. "Drastic decrease in the sales volumes of basic petrochemicals due to the influence of the 11 March 2011 earthquake and a decline in demand"
OMV. "Significantly lower margins"
OxyChem. "Lower export volumes and higher raw material costs"
PKN Orlen. "High costs of feedstock led to lower margins"
PPG. Strengthening demand in the US in most end-use markets and growth in emerging regions, which offset weaker European activity,"
PTT. "Concerns over the uncertainty of economic situation in Europe and US, along with the more cautious economic policy in China, led to softened demand and continuously put pressure on product spreads"
Praxair. "Growth was strongest in North America and Asia"
Reliance. "Weaker demand for polyester products"
SABIC. "Lower prices for some products and an increase in some of our feedstock"
Shell. "Chemicals earnings were in line with the first quarter 2011"
Sherwin-Williams. "Higher paint sales volumes and price increases"
Siam Cement. "Chemical margins fell to their lowest as a result of excess global supply and slower demand".
Solvay. "Continue to operate a strict financial discipline with a strong focus on cash"
TOTAL. "Strong deterioration of the environment for petrochemicals in Europe"
Unilever. "External macroeconomic environment remains difficult and higher input cost headwinds persist,"
versalis. "Demand tracked a recessionary environment",
Vopak. "Optimism in the chemical sector in North America and increasing consumption of petrochemicals in Asia"

The new chapter of our free 'Boom, Gloom and the New Normal' ebook sets out a road map to success for companies in the New Normal. It also identifies 5 key areas where major change is already underway.

Demand-driven. Markets have essentially been supply-driven in recent decades, with growth being forecast on the basis of ratios to expected GDP growth. Companies have focused on increasing their efficiency via a 'one size fits all' business model. As we transition to the New Normal, they will need to refocus on being effective. Innovative strategies, flexible implementation planning, plus a commitment to local techno-commercial support and long-term R&D will be required

Market focus. New worldscale plants will still be needed during the transition. But companies operating in the West will also need to reposition their businesses to focus on the needs of the ageing 55+ New Old generation, if they wish to drive future growth. Those operating in the emerging countries will need to develop mechanisms to sustain growth in the domestic economy, particularly in the rural areas.

Affordability. Consumers have less money to spend, and so the highly profitable middle ground of the past couple of decades is disappearing. Instead, the focus will be on the megatrends of food, water, shelter, mobility and health. These products must be affordable, as they must meet basic 'needs' rather than supplying mere 'wants'.

Shared Value. Consumer values are changing quite dramatically, away from the materialism of the recent past. Concerns about sustainability and carbon footprint are rising up the agenda. Social stability is also becoming an important concern for governments. Companies who continue to operate on purely financial metrics will find the environment ever-harder to understand.

The VUCA environment. The transition to the New Normal is a sea-change for the global economy. Its full impact will take years, if not decades, to become clear. Meanwhile, the world will face much greater uncertainty, as conflicting views of the world play out on a day-to-day basis. Companies therefore need to plan for a VUCA environment: Volatility, Uncertainty, Complexity and Ambiguity will be the order of the day.

This VUCA landscape is creating winners and losers. No longer will the rising tide of affluent Boomers provide an effortless route to increased sales and revenues. Instead, companies need to create their own VUCA as they develop strategies and implementation plans. Vision, Understanding, Clarity and Agility will be their road map to success.

FREE DOWNLOAD OPTIONS FOR CHAPTER 11
Click here to download a 2 page summary of the Chapter .
Click here to download the full Chapter
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The story of the past 5 years has been how global economic growth moved from a dependency on the West's housing boom to a dependency on China's housing boom. Today's only problem is that history suggests such booms are unlikely to have a happy ending.

But who hasn't indulged in a little wishful thinking, from time to time?

And wouldn't it have been nice if the US housing boom could have continued forever? After all, as we noted in chapter 2 of Boom, Gloom and the New Normal, the US Federal Reserve estimated it allowed homeowners to withdraw $564bn/year between 2001-5, as the value of housing was doubling from $10tn to nearly $20tn. This provided a powerful boost to demand for autos and other chemical industry products.

Equally, wouldn't it be nice if China's housing boom could now continue forever? As the IMF note, housing's share of GDP rose from 2% in 1997 to 7% in 2009. It then jumped to nearly 10% last year, under the influence of China's massive stimulus programme. By comparison, it was just 6% in the US at the height of the sub-prime boom in 2005.

Polyethylene (PE) markets, like those for PTA, are trying hard to alert us to the potential problems that now lie ahead in China.

As the chart shows (based on ICIS production data and GTIS trade data), Q1 demand was down 4% (red column) versus 2010 (blue).

Contrary to popular belief, PE demand is not growing at 1.5 or 2 times GDP, but has actually gone ex-growth. 96% of China's population earn less than $20/day, and rising inflation and oil prices reduce their ability to afford the discretionary items that drive chemical demand.

Equally, N American PE exports to China were down 61% versus 2010.

China's ruling communist party does not care that the US cost base is the 2nd cheapest in the world, due to shale gas. Instead, it knows it must maximise job creation to remain in power. It therefore continues to increase China's own production, up 7% over the period.

Nobody knows what will happen next in China. All we do know is that PE markets are warning us that the risks of a 'hard landing' are very much higher than any of us would like to contemplate.

EU policymakers like to pretend that the Eurozone debt crisis was resolved by the adoption of last March's new Treaty. An even more disturbing thought is that they might even believe their own propaganda. Who knows?

But on the ground, it is crystal clear that the problems continue to multiply. Latest data from the Bank for International Settlements (the central bankers' bank) shows lending within Europe continues to slow, as the blog will discuss on Saturday. This is not good news for the global growth agenda.

Meanwhile, the blog's own Boom/Gloom Index remains stalled for a 3rd month at the 4.0 level (blue column) that has historically divided boom from gloom. And the austerity reading (red line) continues to rise.

The Index's paralysis seems to mirror rising political uncertainty:

• Next Sunday sees the final round of the French presidential election
• Greece votes the same day for a new government
• Ireland votes later this month in its Eurozone treaty referendum
• The USA is entering presidential elections

Equally, jostling for power continues in Russia (after its recent election) and in China (ahead of the politburo changes in October).

On 7 September 2008, in its now famous warning that a financial crisis was imminent, the blog noted that "'Deleveraging' is an ugly word, and it has ugly implications".

The chart above shows just how ugly these implications are becoming for the PIIGS countries (Portugal, Italy, Ireland, Greece, Spain).

It is based on data produced since 2009 by the Bank for International Settlements (the central bankers' bank), and shows the major EU lending flows to the PIIGS. It includes data just published for December 2011:

• Lending to Italy (a G7 group member) has fallen 37%
• Lending to Spain (the world's 12th largest economy) has fallen 40%*
• Lending to Greece (now in default) is down 54%
• Lending to Portugal is down 32%, and to Ireland down 41%

Major countries simply cannot continue to operate 'as normal' when these vast sums of money are being withdrawn from their banking systems:

• Italy has lost $352bn, equal to 32% of its GDP
• Spain has lost $$313bn, 21% of GDP
• Greece has lost $99bn, 33% of GDP
• Portugal has lost $75bn, 32%: Ireland has lost $203bn, 93%

Overall, $1.04tn has been withdrawn, a 39% reduction since December 2009. This is equal to 23% of the PIIGS' combined GDP.

These numbers, of course, explain why the European Central Bank (ECB) made its emergency €1tn ($1.4tn) loans at the end of December. It says it was seriously concerned "a dangerous loop involving low economic activity, funding stress for banks and a reduction in lending" might occur. This is central bank-speak for saying that the European banking system might well have collapsed.

But the ECB's lending under the Long Term Refinancing Obligation was just that, lending. It dealt with the immediate cash-flow problem in December. But it did not deal with the solvency issue. Many of these loans will never be repaid, as the assets behind them are now worthless.

* Netherlands lending to Spain is estimated in line with June 2011 levels, as the data is not yet available

The blog fears the storm discussed last month is getting closer.

Oil prices have weakened, with Brent falling $7/bbl last week to $113/bbl as Iran worries reduced. Attention is thus refocusing on the fundamentals, where US oil inventories are now at 21-year highs. We may therefore be about to discover that high oil prices have once again led to recession.

Petchem markets are, as usual, providing leading indicators of this potential change in sentiment. ICIS pricing reports on polyethylene this week capture the position:

• China. "The market outlook remained bleak... the deteriorating eurozone debt situation continued to weigh on orders from export-oriented converters."
• AsiaPacific. "Relentlessly weak downstream demand, coupled with softer upstream ethylene and naphtha prices."
• ME. "Slowdown of buying momentum in Asia, Europe and the Middle East for May cargoes."
• Europe. "Several (producers) say that they will cut output rather than jeopardise margins but converters say it is already too late for that."
• USA. "April demand was much weaker than expected, according to suppliers and some buyers."
• Latin America seems the only exception. "Markets remain relatively tight with some production problems affecting supply."

The big danger is now to cash-flow, particularly for the vast number of small/medium-sized firms who depend on the banking system for loans:

• Buyers rushed to buy forward in Q1 to protect their margins against rising oil prices, and so inventories are high all down the value chain
• But today, the reverse pattern is in place. Buyers are scared to buy, as they fear prices might be lower tomorrow.

In European polypropylene markets, for example, ICIS news reported that "buyers are being cautious when placing orders for May, with smaller ones buying truck by truck, and for the week rather than the month".

Thus today's inventories will take time to work down, particularly as we will soon enter the seasonally-weaker summer season. In turn, CFOs will become increasingly worried about their high levels of working capital.

The chart shows price movements since the April 2011 launch of the IeC Downturn Alert, with latest ICIS pricing comments below:

Naphtha Europe (blue), down 16%. "Participants expect the European market to lengthen further "
PTA China (red), down 13%. "Buying interest from Chinese polyester makers was weak as their polyester yarn inventory remained high"
HDPE USA export (purple), down 11%. "Buying interest is limited as buyers are expecting prices to fall further in the next few weeks"
Benzene NWE (green), down 4%. "Restricted availability within the ARA region for May kept upward pressure on prices"
Brent crude oil (blue dash), down 6%
S&P 500 Index, no change

Friday's weak US jobs report seemed to surprise most of those Wall Street analysts who are supposed to understand this key subject. The reason is that they ignore the major demographic changes now underway.

The chart above shows official US employment numbers since 1939 (blue column) and per capita disposable income since 1969 (red line), when records began. It highlights how employment patterns have changed over the past decade, whilst income levels have been flat since 2006.

In the past, the jobs market could be relied on to recover very quickly after a recession:

• In 1974/5, jobs declined from 78m to 77m, but were 80m in 1976
• In 1981/3, they fell from 91m to 90m, but were 94m in 1984
• In 1990/2, they fell from 109m to 108m, but were at 111m by 1993

But since 2001, the position has changed quite dramatically. April's jobs number at 133m was only 770k higher than in April 2001. Similarly, Q1's $32.6k disposable income was unchanged from Q4 2006.

This is the background to the blog's argument in 'Boom, Gloom and the New Normal' that the ageing of the Western BabyBoomers (those born between 1946-70) is creating major changes in demand patterns. The first Boomer became 55 in 2001, an age when people typically start to save more and spend less, as the kids have often left home.

Today, 29% of the Western world (272m people), are now in this New Old 55+ generation. And they are uncomfortably aware that they have to save more, and spend even less, as they now have to finance an extra decade or more of life expectancy, compared to previous generations.

But Wall Street simply doesn't care about this longer-term issue. Instead it encourages companies to cut jobs as demand slows. This further reduces overall incomes, just at the time when they are already under pressure, creating a vicious circle.

The latest EU olefin operating rates (OR%) were very disappointing, even though they were not a surprise. As the chart shows, ethylene rates were just 81% (based on APPE data). They were far below the 90%+ rates that were normal before the crisis began.

These rates would normally have left the industry in crisis mode as regards profitability. But they were "rescued" by the parallel collapse in refinery runs, and the shortage of propylene/butadiene caused by the major shift to ethane feeds in the USA.

The second chart, from the International Energy Agency, highlights the truly startling change in German refinery runs since the financial crisis. Germany is the EU's largest and most prosperous country. Its refinery runs hardly ever fell below 2.1mbd before 2008. Since then, they have never reached this level, and were just 1.8mbd in February.

This average 18% fall in refinery runs gave major support to effective olefin OR%, as almost all EU crackers are based on refineries - either for naphtha or LPG. The high co-product values for propylene/butadiene were also critical in enabling the industry to deliver strong profitability.

Brent oil prices are still within the triangle formed by movements over the past 4 years. As the chart shows, they tried to break-out on the upside last month, based on Iran supply worries. But since then, they have retreated again.

Interestingly, there are now signs that fundamentals rather than sentiment are starting to drive oil markets. For the past 2 years, prices have been driven higher by the investment banks, with their continued forecasts of strong demand growth in China, plus reduced supply.

The only problem is that neither argument has proved correct. China's demand growth is slowing fast, as it moves to a more domestically-driven economy. Whilst record oil price levels have encouraged new supply to come onstream.

Of course, rising prices helped originally to create the perception of strong demand, as buyers rushed to protect margins by buying forward. But today, this process is reversing as companies try to reduce inventory levels and working capital.

Usually, the end of a triangle formation leads to a major move upwards or downwards, as either the bears or the bulls give up their argument. Back in March, the blog suggested that:

If prices fail to break higher, then the next step might instead be (for companies) to use today's higher prices as a platform for opening new hedges to guard against the downside risk.

With Saudi Oil Minister Naimi again warning that prices are 'too high', the blog sees no reason to change this analysis.

Petchem markets continue to fulfill their role as leading indicators for the global economy. The chart shows the benchmark products in the IeC Downturn Monitor since January 2011:

• PTA prices in Asia (red line) have remained weak throughout, clearly signaling the major slowdown that is now underway
• US polyethylene export (purple) prices managed a recovery early this year, due to tight ethylene markets, but have since reduced
• Benzene (green) managed even less of a recovery in early 2012, despite lower cracker operating rates reducing supply
• Naphtha (brown dash) was supported by higher oil prices, but has recently fallen quite sharply

The problem is the convergence of two factors:

• High oil prices have destroyed demand, just as at previous times when they rose to take 5% or more of global GDP. Consumers simply don't have any spare cash, and borrowing is more difficult since the financial crisis began
• Buyers were forced to buy forward earlier this year as oil prices rose, in order to protect margins. Now they are scared to buy as oil prices weaken, and they worry about having high inventory levels ahead of the slower summer period

Price movements since the April 2011 launch of the IeC Downturn Monitor, with latest ICIS pricing comments below:
Naphtha Europe (brown), down 17%. "Less than expected improvement in demand for naphtha"
HDPE USA export (purple), down 16%. "Interest remains weak as buyers are expecting more price drops in the next few weeks "
PTA China (red), down 14%. "Polyester demand in China remained weak despite the traditional peak season in April-May."
Benzene NWE (green), down 6%. "Cracker operators veer toward lighter feedstock, resulting in less pygas and benzene production"
Brent crude oil (blue dash), down 10%
S&P 500 Index (pink), down 1%

China's leadership remain preoccupied with the transition to a new politburo in October, and the continuing fallout from the Bo Xilai affair. Equally, April's 7% rise in food price inflation remains a major issue for a country where 96% of the population earn less than $20/day.

Data for April bank lending and electricity consumption highlights the growing scale of the problems, as the chart shows:

• Lending (red column) was the basis for China's massive stimulus programme in 2009-10, when it reached 1/3rd of GDP. Most of this money went straight in property development and other speculative investments, which helped give cities like Shanghai some of the world's highest home prices
• It also fuelled inflation, as demand soared ahead of supply. So the government has since been forced to cutback. There are still occasional jumps, as in March when banks rushed to fulfil their loan quotas. But April's lending was down 8% from 2011 at Rmb682bn ($108bn)
• Similarly, the government's need to slow growth means electricity consumption growth is slowing. It was down 1.3% in April versus 2011 at 372bn kWh. This confirms the wider slowdown underway in the economy.
• The housing market looks particularly weak. A People's Bank of China survey showed only 14% of people were considering home purchases. This is the lowest level seen since the market first opened up to private buyers after 1998.
• 10%-20% price cuts are common for new properties, and average apartment prices in the 10 largest cities (including Beijing and Shanghai) fell for a 4th consecutive month - but they are still unsustainably high at $2443/square metre.

The blog has warned since December 2010 that "the risk is rising that we may discover, too late, we have simply been in the middle of yet another China 'boom and bust' scenario".

It sees no reason to change that view today.

For 25 years, Western policymakers coasted to electoral success on the back of an economic Supercycle. The BabyBoomers' arrival in the Wealth Creator 25 - 54 age group meant there was just 16 months of recession between 1982-2007. Politics and policy thus hugged the middle ground.

Political debate became based on focus groups, rather than principle. The need for the vision and implementation skills of people such as Adenauer in Germany, de Gaulle in France, or Thatcher in the UK seemed to belong to a distant age.

The Eurozone project reflected this new era. It allowed anyone to join the club, if they passed a few simple tests. So Greece - with a GDP/capita of just $11k in 1999 - became a member, having carefully manipulated its national accounts and gained the pass mark for entry.

Equally, the founders explicitly ruled out a clause to establish how a country might leave. Instead, membership was said to be 'irrevocable'. An initial study by lawyers at the European Central Bank over possible departure rules in 2009 concluded it was ''so challenging, conceptually, legally and practically, that its likelihood is close to zero.''

Today, of course, the chances of Greece leaving have risen so high that London bookmakers have stopped taking bets on the outcome. This should be no surprise, given that Greece's GDP has fallen ~20% since 2008. Voters will not continue to vote for economic suicide forever, as the recent election results showed.

Yet policymakers learnt their economics in a different age. They still think a few well-crafted sound-bites will somehow make a difference. And if that fails, they imagine an extra €1tn ($1.3tn) of lending will resolve the issue.

The problem is that they continue to treat symptoms, not causes. Greece is bankrupt because it borrowed too much and cannot repay. Equally, Germany and France don't want to tell their own voters that they are likely to take the hit, when the money fails to be repaid.

The cash involved is not small change, either. Bloomberg estimates that Greece owes a total of $510bn. That's equal to the GDP of Poland, Belgium or Norway, ranked 22-24 in the world economy.

The tragedy is that today's Greek problem was totally avoidable, if policymakers had faced up to the issues 3 years ago, when S&P first downgraded Greek debt. It was clear in January 2009 that the core issue was whether Greece, and others, might have to leave the Eurozone.

Now, the Eurozone train crash is becoming a serious concern for the whole global economy. Policymakers have continued to live in their dream world, bearing out the Financial Times' warning in August 2008 that:

"In economic crashes there are pauses before the next carriage hits the one in front. This explains how we have since moved from crisis to crisis, with rallies in between, as participants persuade themselves that the worst is over."

Disaster is not yet certain. But the Greek people will almost certainly vote for anti-austerity parties if new elections have to be held next month, unless the troika of the IMF, EU and ECB change their policies.

Policymakers now have to accept you cannot get blood from a stone. They must also recognise that the lack of any formal Eurozone exit arrangement may well lead to chaos in financial markets worldwide.

After all, since December nobody has been able to answer the blog's very simple question: what will Greeks use for money in the days after it leaves the euro? How will people buy food and other essentials, and pay their debts to foreigners?

We desperately need industry leaders and others to challenge the wishful thinking that now passes for EU policy. Such debates were common before the Supercycle, as when ICI Chairman John Harvey-Jones took on Margaret Thatcher over industrial policy.

Painful decisions can be postponed no longer.

China's demand growth continues to be weak down the main value chains.

Auto sales are the most obvious example. As the chart shows, they have recovered from the very slow period over the Lunar New Year holiday, but are still only up 2% (red diamond) versus 2011 levels (green line).

Even this growth has only been due to price cuts. Whilst the head of the dealers association warned "unsold cars are crowding dealer lots in cities from Guangzhou in the south to Xi'an to the west."

This pattern is confirmed by other key markets. Investment in real estate has been 13% of GDP in recent years, a clear sign of China's unbalanced economy. It was growing 20%/year in the 2009-11 boom period. A key area is construction of new residential floor space:

• This grew 16.2% in January-April last year versus 2010
• This year, it fell 4.2% in the same period
• The slowdown is even worse when one remembers that growth had still been 5.1% in the first two months of this year

This, unfortunately, is what happens when credit bubbles start to implode.

Air is starting to rush out of the balloon, even faster than it was pumped in during the government's 2009-10 lending boom. Home prices have now been falling for 8 months in China's top 100 cities.

Unilever CEO Paul Polman suggests we are living in a VUCA world, as we discuss in chapter 11 of Boom, Gloom and the New Normal. Volatility, Uncertainty, Complexity and Ambiguity make planning for the future more difficult than for a generation.

This week, the blog will run a special series that examines how this VUCA world is impacting chemical companies, and complicating decision-making.

Oil prices are a classic example of increased Volatility. In the past, they would fluctuate according to changes in supply/demand fundamentals. Today, however, around 60% of trading is instead computer-driven.

At the same time, the US markets are seeing major changes take place in the availability of shale gas. Thus ethane prices have tumbled, even whilst oil-based feedstock prices have risen.

This is a recipe for confusion. The chart shows a 15 year history of naphtha prices in Rotterdam (the main global benchmark) versus ethane prices at Mt Belvieu in the USA:

• Historically, naphtha (blue line) and ethane (red) have moved together
• Ethane has usually been cheaper, as naphtha also has value in gasoline
• However the two lines have generally tracked each other closely
• During 2007-8, both surged to new highs and collapsed together

Today, however, naphtha prices are once again close to record highs, whilst ethane is much lower and within its traditional price range.

All olefin producers, and not just those planning ethane-fed expansions in the USA, now have to wrestle with the issue of whether current trends are sustainable. Some key questions include:

• Will oil prices stay at current high levels in future?
• Will ethane prices continue in the current range?
• Will 'fracking' technology transform oil production as well as natural gas?
• Will super-computer trading continue to dominate oil futures markets?

There are no 'obvious' answers to any of these questions.

Equally, each question has major implications in itself. For example, if oil prices do remain high, what will happen to consumer demand? Will it be reduced, as discretionary spending is reduced, thus hitting overall chemical and polymer demand?

The industry did, of course, face similar strategic issues in the 1960s-70s. Companies learnt to use judgement and experience when planning for the future, rather than simply assuming today's world would continue forever.

Today's rising Volatility suggests these skills are likely to become super-critical once again.

The blog's series on the emerging 'VUCA world' today looks at how companies have to manage increased levels of Uncertainty. This can be seen in key areas of demand, such as housing.

The above chart shows how US housing starts (blue line) have fallen from 2.1m in 2005 to just 0.6m last year. Housing permits (red line) have followed a similar trend.

Each new home contains ~$15k of chemicals and polymers (paint, furnishings, kitchen/bath fittings, adhesives, appliances etc), according to American Chemistry Council data. So the US market is now worth just $9bn, compared to $32bn then.

Housing markets have been equally key to demand growth in other major regions such as China, Europe and Latin America. So the question of what happen next is critical to anyone in the chemicals business.

The honest answer, is 'nobody knows'. Instead, Uncertanty abounds:

• In the USA, starts have never been this low since records began. Does this mean housing markets may now rebound strongly, or have rates of household formation changed direction?
• In China, investment in real estate has been 13% of GDP, and also a major source of chemical industry demand. But with 64.5m apartments empty, and prices now falling, will this continue?
• Europe has seen a collapse in housing markets in countries such as Spain and Ireland. Many construction projects are now being cancelled across the continent, as austerity programmes bite. Can demand recover?
• Latin American demand has been supported by an economy boosted by increasing exports to China. If China is slowing, will its growth also slip?

Uncertainty of this intensity in such a key market has a major impact on confidence. Even if a company wants to be bold, and bet on an upturn, it may find its bankers harder to persuade.

The blog's series on the VUCA world today reaches C for Complexity.

Interest rates are key to company profitability. They determine rates of return for new investments, and their affordability. They also have a major influence on consumer spending patterns.

The debate over their future direction is just one example of current Complexity:

• Financial investors mostly argue that rates will go higher, perhaps much higher, in the major economies
• The world's largest bond fund, PIMCO, even argued in January 2010 that UK bonds were sitting on a 'bed of nitro-glycerine'

The blog has never agreed with this view.

It argues that the ageing Western population means investors now focus on return of capital. They also need to save more and spend less, as they are uncomfortably aware that their pensions are too small to fund their extra decade of life expectancy compared to previous generations.

It also coined the term JUUGS to describe the countries whose bonds would be perceived to provide the greatest safety - Japan, UK, USA, Germany and Switzerland. It has since followed their progress by comparison with the PIIGS (Portugal, Ireland, Italy, Greece, Spain).

The chart above shows 10-year interest rates today (blue column) in the PIIGS and JUUGS versus May 2010 (red):

• Average rates in the PIIGS were 5.8%, double the 2.7% in the JUUGS
• Today, they average 12% in the PIIGS, and just 1% in the JUUGS
• Rates have risen in all the PIIGS, whilst falling in all the JUUGS

The blog originally set out its argument in the Financial Times in September 2010. It was then developed further as chapter 2 of Boom, Gloom and the New Normal last June.

It argues that Japan is the role model for what is happening today. The JUUGS' interest rates are only following the path taken there in recent decades. The reason for the correlation is that Japan's own babyboomer generation are ~10 years older than in Western countries.

Of course, it could be that the blog has simply been lucky so far with the results of its argument. And it agrees rates could certainly jump if demand ever returned to Supercycle levels, as expected by the market consensus.

Thus the debate over interest rates highlights the Complexity of the financial world. Those whose judgement turns out to be wrong may well lose a large amount of money as a result.

The blog's latest post for the new Financial Times FT Data blog has just been published, and is reprinted below. Please click here for the FT site.

Shale gas developments in the US have sparked a wave of euphoria about the opportunity for a renaissance of its domestic manufacturing base. Petrochemicals should be one of the main beneficiaries, as the ethane produced from shale gas discoveries now provides the US with some of the cheapest feedstock in the world.

Major producers including Dow Chemicals, Shell and Chevron Phillips have already announced plans to build new ethane-based capacity. Others are likely to join them. Current estimates suggest total US ethylene capacity could therefore increase by 25 to 30 percent from today's 27 million tonnes.

However, one key factor has the potential to spoil the story - much of this new capacity will need to be exported in the form of polyethylene (PE) and other major plastics. Yet as the chart shows, based on data from Global Trade Information Services, US net PE exports have actually been declining since 2010, even though its cost advantage from shale gas was increasing.

This is quite a different picture from the 2006-09 period, when US exports rose from 700KT to 2.6 million tonnes (MT). China's demand surged in 2009, due to its major stimulus programmes, enabling US exports to jump from 267KT to 900KT. But since then, US exports to China have dropped back to 2006's level, and its total exports have fallen 39 percent to 1.6MT.

Analysis of recent market developments in China highlights the root cause of this dramatic shift. As the second chart shows, based on Q1 data for 2010-12:

• China's demand has fallen 4%, as stimulus programmes have ended
• Meanwhile, its own production has increased 7%

This, of course, makes no sense in economic terms. China has some of the highest cost production in the world, being based largely on imported oil. But it values social stability above economics. So it is unlikely to shut plants and increase unemployment in order to access cheaper US imports. Instead, it is already planning further increases in its own capacity.

In addition, China is now taking a strategic view of its remaining import needs. Middle East imports were up 34% over the period, due to the 'strategic corridor' under which China provides access to markets in exchange for energy supplies. South East Asia imports were also up by 22%, due to the free trade agreement now in place. Imports from other regions thus suffered major falls. North East Asia imports were down 38%, with US imports down 62% and EU volumes down 68%.

Thus PE highlights the major challenge facing the USA as it seeks to use the shale gas bonanza to reinvigorate its manufacturing base. It has the feedstock, and the cost advantage. But it needs to increase its exports, if it is to move the additional volume.

The PE market however suggests that potential customers, such as China, are no longer playing by the old rules. Social and political factors are instead becoming increasingly important in dictating global trade patterns, at the expense of pure economics.

Today the blog ends its review of the VUCA world with A for Ambiguity.

The global economy often seemed to be on auto-pilot during the 25 years of the economic Supercycle between 1982-2007. The chart above shows US GDP since 1929 (when records began), with the pink columns showing the official dates for recession:

• Between 1929-82, the US was in recession for 23% of the time
• There were 11 recessions in total over the 54 years

• Between 1982-2007, it was in recession for just 5% of the time
• There were 2 minor downturns lasting 16 months over the 25 years

Policymakers claimed that this was because they had learned to 'manage' the economy. And they argued that the creation of more independent central banks was the key to success. This allowed the experts to manage things without political interference.

This argument may be correct. But we cannot turn back the clock and run a spreadsheet-like 'What If' analysis to test it. So we do not know what would have happened had central banks remained as they were.

This is a key example of the Ambiguity around today's key policy areas.

The blog, in the 'Boom, Gloom and the New Normal' eBook, puts forward an alternative argument, that 'Demographics drives Demand'. It suggests instead that the arrival of the Western BabyBoomers (those born between 1946-70) into the Wealth Creating 25 - 54 age group, was the key stabilising effect.

It argues that the Boomers are the richest and largest generation in the history of the world. And as they reached their Wealth Creator period, when people typically settle down and have children, they inevitably stabilised demand patterns.

The world got used to the concept of 'pent-up demand'. If central banks raised interest rates for a year or two, the children still kept on growing, and new Boomers kept joining the Wealth Creator cohort. So demand jumped, as soon as interest rates fell again.

But since 2000, the Boomers have been joining the New Old 55+ generation, when people typically save more and spend less. And the Boomers have to save more, as they also have the longest life expectancy in history. It is therefore no surprise that growth has slowed.

Most economists and central bankers, with the exception of the Bank of Japan, ignore this analysis. They refuse to accept that demographics has anything to do with demand. And, of course, they may be right.

But the debate matters enormously. If the blog is right, then the $trillions of stimulus and quantitative easing since 2001 simply gave the economy a 'sugar-high'. Demand jumped temporarily, but then fell back when the stimulus ended. Whilst debt levels rose still further.

Masaaki Shirakawa, the Governor of the Bank of Japan, supports the demographic argument. He has argued for some time that Japan's "low growth was mainly attributable to demographics, or more specifically, a rapid aging of the population". And he noted recently that:

"The implications of population aging and decline are also very profound, as they contribute to a decline in growth potential, a deterioration in the fiscal balance, and a fall in housing prices. Given that other developed countries will face the same problems despite some differences in timing and magnitude, the economic effects of demographics deserve further study."

This exactly summarises our view, and is one of the major factors behind the decision to publish 'Boom, Gloom and the New Normal'. It would clearly be nice to believe that making central banks independent meant recessions became a thing of the past.

But it may also be wishful thinking. Today's financial crisis seems never-ending. And it may well be that central bankers are unwittingly making the situation far worse, by their refusal to consider alternative viewpoints.

Equally, in Unilever's view, today's VUCA world is not going to go away.

Companies therefore need to develop their own VUCA if they are going to prosper in the transition to the New Normal. Vision, Understanding, Clarity and Agility will be their keys to success.

Financial markets are telling us something important about the outlook.

Profitable themes over the past month have been expectations of weakness in crude oil prices, in China's economy, and in the financial sector; plus positive views on long-dated government bonds in the JUUGS (Japan, UK, US, Germany, Switzerland).

90% of market players probably dismiss most, if not all, of these trends. And they certainly would not accept there is any risk of a repeat of 2008.

The blog agrees with them on this. If there is a serious downturn, it could well be far worse than 2008:

• Oil prices at today's levels have always led to recessions. This time, prices have been above $100/bbl for longer, and higher in Europe/China
• Debt levels are higher. US sub-prime was the 2008 focus, but since then policymakers have added $tns of debt in the US, Europe and China
• Lehman was at the eye of the storm last time. Now it is JP Morgan Chase with reportedly $150bn of trading positions in areas where they may now be the only buyer, and already $2bn of declared losses
• Political uncertainty is much higher. Nobody knows how the eurozone crisis will end; nor do we know who will rule China next year

Petchem markets are also doing their best to alert us to the potential problems ahead. Nel Weddle and Linda Naylor's recent reports capture the position as seen by major market players:

"We are trying to avoid even mentioning 2008 - we are risking to get to that point, but there has to be actions in Europe".
"Unless China picks up and the eurozone problems are resolved, it's a bad market environment which won't be resolved any time soon."

"The market is beset by concerns over demand, credit, keenly-priced imports and weakening upstream prices. Several large creditworthy buyers have been offered spot lots that they say they cannot take, as it would mean displacing material from other sources. "'I just don't need 500t extra at the moment. I am working my stock down to a minimum and expect lower prices again in June'," said one. Another said: "'The price would have to be very low indeed for me to take extra material'."

As the chart shows, benchmark prices have fallen further below the 29 April 2011 launch of the IeC Downturn Monitor. Latest ICIS pricing comments are below:

Naphtha Europe (brown), down 22%. "Demand remained mediocre. The Asian market is weak, while in Europe, there has been little interest from petchems and gasoline"
PTA China (red), down 18%. "Weaker downstream polyester demand exerted additional downward pressure on prices"
HDPE USA export (purple), down 17%. "Prices would have to fall to the high 40s c/lb ($1050/t) before sales volumes would pick up, traders said"
Benzene NWE (green), down 10%. "Many players were anxious about the outlook moving into June"
Brent crude oil (blue dash), down 12%
S&P 500 Index (pink), down 5%

Nobody ever bothers to deny something that is plainly impossible.

So when CEOs of a major bank deny something, the blog always worries.

The 'Interesting quote' series began in August 2007, when the blog noted Chuck Prince (then CEO of Citgroup) as saying:

'We see a lot of people on the Street who are scared. We are not scared. We are not panicked. We are not rattled. Our team has been through this before.' We are 'still dancing'.

We all know what happened next.

Now Jamie Dimon (JP Morgan Chase CEO) has told shareholders:

"There's no outcome that would be a disaster for this company. I am not sitting here worried about the ultimate loss on this thing".

The blog hopes his confidence is well-placed.

China's slowdown is continuing to gather pace.

Polyethylene (PE) demand has been a very reliable leading indicator for the economy. Its 50% growth between 2008-10 highlighted the overheating economy, as the government stoked a credit bubble, even whilst official GDP growth reports were reassuringly low.

GDP numbers, however are merely targets. Likely future premier Li Keqiang described them as "man-made and therefore unreliable" in 2007. But the message has not been widely understood by planners or analysts.

Instead, companies need to refocus their planning on the insights to be gained from the use of trade statistics. These are currently one of the most woefully underused tools for understanding today's market.

The data they provide is better quality than ever before and more timely. On PE, the combination of trade figures from GTIS with China's own production data has been telling a very consistent story.

As the above chart shows, PE demand is continuing to decline. It compares January - April 2012 (red column) with the same period in 2011 (green) and 2010 (blue):

• Overall demand is down 6% versus 2010
• Imports are down 12%, as domestic production continues to rise
• Middle East and SEA imports continue to have advantaged status
• NEA, NAFTA and EU imports are suffering major declines

Other key data tell the same story of a major slowdown underway. Bloomberg reports bank lending is expected to miss targets yet again in May. Whilst mining imports are also slow.

Of course, the government will still report Q2 GDP in line with its target of 7.5%. But the trade figures are painting a much more reliable picture of what is really happening to the economy.

Petchem markets provided a perfect case study of Volatility last week, confirming the blog's view that we are heading into a VUCA world where Volatility, Uncertainty, Complexity and Ambiguity will dominate.

This was also real volatility, where prices crashed downwards and surged upwards at the same time. And it involved 2 of the 'building block' products, butadiene and benzene, not small volume derivatives.

Butadiene saw the biggest moves. The blog has lost count of the number of analysts who have suggested that prices will remain at a 'permanently high level', and even justify on-purpose production. Instead, it appears that buyers have simply disappeared.

US butadiene contract nominations thus fell an astonishing 27% on Friday. Whilst in Europe, the June contract price fell €400/t (18%). Benzene, on the other hand, showed the risks of having low stocks in a falling market. Plant problems saw European spot prices jump 20% ($200/t).

The butadiene problem is twofold:

• Inventories are high down the value chain, as buyers bought forward when crude/feedstock prices were rising
• Now, demand is disappearing, as they fear that oil and feedstock prices will continue to weaken

As Dow's CFO Bill Weideman noted "quite a few (buyers) are holding off, I should say, to buy in anticipation of lower prices."

Benzene, as always, is highlighting the next round of problems. A sudden, 20% price increase cannot be passed on in today's market. So demand will be further reduced, creating the potential for even more volatility in the future.

UK statesman Harold Macmillan best summarised today's situation when asked in the 1960s what kept him awake at night. "Events, dear boy, events" was his reply.

None of us know what combination of political, social and economic events are ahead of us. The only certainty is that a return to the BabyBoomer-led economic supercycle between 1982-2007 is increasingly unlikely.

The chart shows benchmark price movements since the IeC Downturn Monitor''s 29 April 2011 launch, with latest ICIS pricing comments below:

Naphtha Europe (brown), down 24%. "Demand remained mediocre. The Asian market is weak, while in Europe, there has been little interest from petchems and gasoline"
PTA China (red), down 20%. "Most Asian plants have completed maintenance work in April-May. At the same time, downstream polyester demand remained slow. "
HDPE USA export (purple), down 18%. "Interest remains weak as falling crude and naptha prices have led global buyers to expect a significant price drop next month"
Brent crude oil (blue dash), down 14%
S&P 500 Index (pink), down 3%
Benzene NWE (green), up 8%. "Production problems with at least two aromatics units drove the prompt market up sharply"

April was another bad month for EU auto sales.

As the chart shows, based on ACEA data, sales were down 7% in April (red square) and down 8% versus 2011 (green line) in January - April.

The only bright spot remains Germany, were sales were up 2% in the Jan-Apr period. It is now 24% of total EU sales, up from 22% a year ago and 19% before the Crisis hit in 2008. Interestingly, though, last month's volume at 1.047m was just slightly lower than 2008's 1.053m - highlighting how the market has gone ex-growth over the period.

The German auto industry is also a major exporter, particularly to China. Worryingly, Bloomberg reports that market conditions there appear worse than shown by actual sales data. Su Hui, VP with China's Automobile Dealers Association noted that

"Unsold cars are crowding dealer lots in cities from Guangzhou in the south to Xi'an to the west. It's like a contagious disease that will spread."

Prices have already fallen each month this year. And automakers' inventories are at 16 month highs at 757k. This equals the size of the dealership inventories, according to the National Development and Reform Commission, the country's top economic planning agency.

The blog is changing its regular presentation of US house price movements, to mirror that used for auto sales. This should help to identify month-by-month changes.

It also means there is no need to use seasonally adjustmed numbers. These are guesswork at the best of times. And in Q1 they have been tested to the limit, due to the abnormally warm weather in most of the US.

The chart is based on the S&P Case-Shiller Index and shows:

• 2012 prices (red square) in Q1 were 3% below 2011 levels (green line)
• This is similar to 2011's 3.6% fall versus 2010 (blue)
• The 2010 average was 20.4% below 2006's peaks (black)

Equally, S&P note that prices "ended Q1 at post-crisis lows", and add:

"Since we are entering a seasonal buying period, it becomes very important to look at both monthly and annual rates of change in home prices in order to understand the broader trend going forward."

The blog hopes its new format will help readers to do this.