Chemicals & The Economy

The Red Queen in the classic book, Alice in Wonderland, would have recognised today's financial markets when she boasted "Why, sometimes I've believed as many as six impossible things before breakfast."

Fellow blogger Doris de Guzman noted one great example last week, when questioning whether Facebook could really be worth the combined value of Dow, DuPont and ADM.

Another is the widespread myth that says China is now a 'middle-class' country, and can easily replace any loss of demand in the West. Unfortunately, 96% of its population has an income of less than $20/day, well below the poverty line in the West.

Readers can no doubt compile their own lists of myths very easily. And as we are seeing with Facebook, those who invest of the basis of them can easily lose a lot of money.

Belief in such myths can also blind us to what is happening in reality. Convergence is indeed taking place between Western and emerging markets, but in the opposite direction.

As the blog noted in March, automakers such as Renault, Ford and Datsun are all focusing on the low-cost market in the West. Renault are the most successful, with low-cost models such as the Dacia now seeing more sales in Europe than in their original Indian target market.

Equally, as Unilever's European marketing head notes in the Wall Street Journal:

"With around one in five people now officially living beneath the poverty line in countries like Spain and Greece, it's critical that we find new solutions to ensure that people across the region continue to enjoy our brands, while keeping in control of their household budget."

Similarly, food giant Nestlé is seeing strong growth in sales of cheap, smaller package-sized products. One example is packs of 25 single-serve Nescafé instant coffee sticks, which sell for €2 in France - less than the price of an espresso in Starbucks.

These examples are further evidence for our argument in Boom, Gloom and the New Normal that affordability, not value-in-use, will be the key to future profitability.

We are about to set out on a great journey as the world transitions to the New Normal.

The reason for the journey is that the world economy has changed irrevocably as a result of the financial crisis and the demand changes created by the aging of the Western BabyBoomers.

There is no going back. In the 12th and final chapter of our free eBook, 'Boom, Gloom & the New Normal', we provide our view of how individuals, companies and politicians can prepare for the journey ahead.

We suggest that parents tell their children: "Go and take a degree that will allow you to work for the right kind of company. This type of company will be constantly innovating to make products which meet the needs of the future: The 55+ generation in the West and those emerging from poverty in the developing world. The firm that you work for must also be mindful of the other megatrends - food and water scarcity, carbon footprint - in everything it does and everything it makes."

We argue that companies should escape the tyranny of short-term financial metrics in order to once again plan for the longer term. They need to establish, and stick by, a set of values that will enable them to meet the needs of society and be successful - one and the same thing in the New Normal world.

In the political arena, Western politicians need to tackle unemployment in order to avoid wave after wave of social unrest further damaging already weakened demand growth. Good social policy is required, as without a healthy society there cannot be a healthy economy.

Many developing countries already have social policies in place that emphasize job creation over short-term profitability. But they face their own set of challenges as they transition from an export-orientation to a domestic focus. Thus their demand cannot inevitably replace lost demand in the West.

Making the transition to the New Normal could become very difficult, if our leaders fail to recognise the changes required. It might then involve moving through the "five stages of grief" identified by Elisabeth Kübler-Ross, the Swiss American psychiatrist. These are Denial, Anger, Bargaining, Depression and Acceptance.

We hope that the book has helped to highlight how we can all help to accelerate the transition to Acceptance where individuals, companies and countries work together in a search for solutions.

This will allow creativity to really flourish and encourage confidence to return. New opportunities will then emerge as we arrive in the New Normal.

FREE DOWNLOAD OPTIONS FOR CHAPTER 12
Click here to download the full Chapter
Click here to download the 2 page ICB summary
Click here to view the 4 minute video with Paul Hodges

BASF opened its first China plant 20 years ago. Its Asian strategy focuses on China, Japan, S Korea and India.

Thus yesterday's comments by vice chairman Martin Brudermüller deserve careful study by any company or investor who is interested in the outlook for the region.

The background was an unexpected 5% fall in BASF's regional sales in Q1. Of course, Q1 2011 had been very strong, as buyers built stocks whilst crude oil prices rose. But crude also rose in Q1 this year, so clearly something else has been happening.

Brudermüller suggested that "the region is becoming more vulnerable", and highlighted two key issues, which will both be familiar to blog readers:

• China's political direction. He expressed a "certain amount of unease" over the leadership transition now underway, and added that "the struggle over China's future direction seems to be harder fought than we had imagined."
• India's slowdown. "The political paralysis in certain areas does hold things up, and its sad to see how the country is currently falling short of its potential."

BASF is not about to retreat from the Asian positions it has worked so long to develop. And it continues to consider further expansion in SEA, even into Myanmar, as part of its next leg of growth.

But when BASF worries about something, then the blog worries with it.

Don't panic is the blog's suggestion, after last week's market collapse.

Instead, the important thing is to plan for what might happen next. Scenario planning is absolutely critical to survival over coming months.

The blog's advice is to assemble your management team as quickly as possible, and ask everyone to come prepared to be honest and open about their views of the outlook. The time for wishful thinking is long past.

Then start by being clear about your collective assumptions. To help this process along, the blog's view is as follows:

• We are heading into a global recession, caused by oil prices having been well above levels which have always led to recession in the past
• In the short-term, demand is likely to be very weak, as inventories are high down the value chain, due to forward-buying as oil prices rose in Q1
• We are also now entering the seasonally weaker summer months, when demand should be expected to be slow

A key question for Scenario planning is to agree how low oil prices might go. A Downside Case would see them back at the $30-50/bbl range; a Base Case might put them in the $60-80/bbl range; the Upside case might be $90-125/bbl.

All of these outcomes will have different outcomes for your business. In particular, the risks increase tremendously as prices fall further. Too many companies currently have too much high-priced inventory. They will struggle with cash-flow even if prices remain around today's levels.

But the more prices fall, the greater the risk of bankruptcy. Small and mid-sized firms have to rely on bank lending, and many banks no longer want to lend. So they will use the excuse of increased working capital risks to cut back, leading to a potential for panic sales at firesale prices.

Businesses also have to remember that Middle East companies are unlikely to cut back their volumes. Oil production is near record levels, and so the volume of associated gas as feedstock is also high.

Similarly, US companies have very low feedstock costs, and will not feel any need to cut back. Many are also committed to major expansion projects, and so need to increase volumes to justify the investments. US ethylene prices are already down 44% over the past 7 weeks.

Nobody knows what will happen next. But running around like a headless chicken will not help. Instead, you might like to re-read the blog's 'The CEO's checklist for survival', published in ICB in January 2009. Not all is still relevant today, but its methodology may well be helpful.

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 32%. "Demand remained lacklustre, and the market lengthened from the previous week"
HDPE USA export (purple), down 25%. "USG export prices continued to spiral downwards, following feedstocks ethylene and ethane, sources said"
PTA China (red), down 23%. "Buying interest was low as persistently weak polyester demand and downbeat outlook curtailed buying activity"
Brent crude oil (blue dash), down 17%
Benzene NWE (green), down 6%. "Lower production rates and buyers operating on a hand to mouth basis amid wider economic instability in Europe"
S&P 500 Index (pink), down 6%

There has never been any fundamental basis for the rise in oil prices over the past 3 years:

• At no time has there been any actual shortage of product
• In fact, inventories have always been at comfortable levels

They rose only for two reasons:

• The investment banks found they could make a lot of money by persuading the pension funds that oil had become a separate asset class, and was not simply a part of the real economy
• Regulators allowed high-frequency trading to dominate energy markets, thus removing the impact of fundamentals in price discovery

Equally, there have been plenty of people lining up to claim 'this time was different'. Even last month, a new IMF paper claimed that high oil prices no longer mattered due to "fundamental changes in the workings of the global economy" and the ability of brilliant central bankers to "use macroeconomic policy to mitigate the effects of rises".

As we discussed in chapter 3 of Boom, Gloom and the New Normal, this combination can be very powerful. It has taken prices higher and for much longer than any reasonable person might have expected:

• If pension funds start to put 5% of their assets into oil futures, they dwarf fundamental market movements
• And then the high-frequency computers add their central bank-funded leverage to take prices even higher

This is why the blog has used the 'triangle formation' in the chart above to try and highlight when these forces might finally play out. As it noted last month, the banks and the computers had a last effort to try and push prices higher, towards their ultimate $200/bbl target.

And in failing, they provided an excellent opportunity for those chemical companies who agreed with the blog's analysis to hedge their positions against any future price collapses. Hopefully, many did.

Of course, the banks and the computer traders will not give up easily. They have made a lot of money over the past 3 years, and they don't care about, or even understand, the damage they have caused to the global economy.

But as the chart shows, a clear breakout has now occurred on the downside. This provides at least the potential for prices to start reconnecting with fundamentals. $60-80/bbl seems a sensible target Base Case for this first phase.

After all, on the fundamental side, US oil inventories are now at a 22-year high, OPEC production is at a 23-year high, whilst demand growth in Asia, Latin America, Europe and N America continues to slow.

As Shell CEO Peter Voser told Reuters yesterday:

"Global demand is softening, we have got recessionary elements in Europe, a small slowdown in Asia Pacific. At the same time, some of the geopolitical elements of price volatility over the past few months have kind of receded, and therefore we see a softening of prices which I expect to go well into the second half of this year."

The blog's Boom/Gloom Index (blue column) reaches its 3rd anniversary this month.

It was introduced to help monitor sentiment in financial markets, on the basis that "many markets are clearly being ruled by sentiment". It has since done a good job in identifying peaks and troughs:

• Peaks have been focused on periods when central banks have rushed to provide liquidity via quantitative easing and other stimulus programmes
• Thus the Index was strong from June 2009-June 2010, and from September 2010-June 2011
• The main trough has been seen since August 2011. This highlights the key flaw in the central banks' thinking
• Their Quantitative Easing and bank lending programmes wrongly assume that markets face liquidity problems, rather than solvency risks

The Austerity measure (red line) in the chart highlights this issue. It shows how governments are increasingly being forced to abandon stimulus programmes, due to lack of cash. Investors increasingly worry that countries such as the PIIGS (Portugal, Ireland, Italy, Greece, Spain) will never repay their debts.

Thus June sees a sharp jump in the Austerity reading, back to levels last seen in May/June 2010 when the Eurozone crisis first properly erupted. In turn, this has pushed the Index below its neutral 4.0 reading and back into Gloom territory.

This highlights how the stimulus policies have been able to create short-term economic growth and major asset bubbles (oil/commodities prices, China real estate etc). But they have not created the conditions for sustainable long-term expansion.

The story of the 1989 US movie Field of Dreams summed up the happy days of the economic supercycle that was then getting underway. Starring A-list players such as Kevin Costner and Burt Lancaster, its theme that "if you build it, they will come" came to define the era.

In the world of manufacturing, companies stopped worrying about end-user demand. Instead, they became convinced that growth was a constant, and that demand for their product could be modelled on a spreadsheet as a ratio to GDP.

Similarly in financial markets, banks abandoned the use of personal judgement and experience. Instead, they hired maths and physics graduates to build black-box computer models. Risk became managed via spreadsheets and complex 'value-at-risk' models.

The blog rather likes spreadsheets itself. But 'garbage in, garbage out' is a good definition of their limitations. Equally, it worries that the models only use relatively recent data, often from just the past 5 or 10 years. This is not long enough to capture the trends of even a single generation.

Now, of course, the models are starting to misfire left, right and centre. Demand no longer follows GDP growth, as we demonstrate in Boom, Gloom and the New Normal. Whilst JP Morgan's $2bn+ trading loss is only the latest in a long sequence including US subprime and Lehman.

Field of Dreams was a great film. But it is time to make a break with its message of wish fulfilment. The hard truth today is that 'if you build it, they may not come'. Nor can banks continue to run their business via computer models.

This is why the blog believes Unilever CEO Paul Polman's message about today's increasingly VUCA environment is so important. Volatility, Uncertainty, Complexity and Ambiguity are likely to be the theme for at least the next few years.

The US Federal Reserve has provided a wonderful new example of the problems with spreadsheets.

It also shows how a naive belief in the credibility of any computer-generated output has come to over-ride common sense. In turn, policy can become based on myth, rather than reality.

The chart above from the Wall Street Journal shows a new revision by the Fed of the amount of cash being held by US companies. It turns out that companies have a massive $500bn less cash (blue line) than previously believed (red line). As the WSJ comments:

"More significant than the number itself, however, is how the revision affects the trend. Before the revision, the Fed showed corporations continuing to accumulate cash, with liquid assets rising nearly every quarter since the recession ended and reaching a record $2.2 trillion at the end of last year. Now, however, it appears corporate cash piles grew rapidly through 2009, then levelled off. Companies aren't spending their cash, but they aren't holding more of it, either."

Equally, the new data shows that cash is just 5.7% today as a percentage of companies total assets, versus 6.3% at the end of 2009.

Errors of this kind matter greatly for policy. Policymakers wanted to believe that companies had great piles of cash, but were reluctant to spend it. Hence they hoped quantitative easing and stimulus programmes would build confidence and in turn persuade them to spend it.

However, this wishful thinking has proved to be exactly that. The reason companies aren't spending money is simple - they don't have it to spend. Common sense, rather than an obsession with computer models, would have given this answer long ago.

Petchem markets are doing an excellent job in their role as a leading indicator for the global economy. But as we warn in Boom, Gloom and the New Normal, policymakers remain in Denial about their message.

The chart above spells it out clearly.

Volume leads pricing. Since January, China's demand growth has collapsed. So its PTA prices (red line) have collapsed by 42%. Similarly, slow US demand means polyethylene producers have to chase volume in export markets, and so their prices (purple) are down 27%.

Equally in Europe, demand is extremely weak. Oil demand was down an astonishing 4.4% in March. Thus naphtha prices (brown dotted line) are down 33%, whilst Brent prices (blue) are down 20%.

Meanwhile, spot benzene pricing (green) highlights how today's low volumes have created a vicious circle for purchasing managers:

• Buyers kept inventories low, as prices fell down the value chain
• But markets were then hit by supply problems, and prices soared
• Now the benzene/naphtha spread is $631/t, a near record level

Some commentators, such as former EPCA speaker Martin Wolf, do get the message however. As Wolf wrote last week in the Financial Times:

Before now, I had never really understood how the 1930s could happen. Now I do. All one needs are fragile economies, a rigid monetary regime, intense debate over what must be done, widespread belief that suffering is good, myopic politicians, an inability to co-operate and failure to stay ahead of events."

The blog can only repeat its warning from last month:

"If there is a serious downturn, it could well be far worse than 2008"

Benchmark price movements since the IeC Downturn Monitor's 29 April 2011 launch, with latest ICIS pricing comments, are below:

Naphtha Europe (brown), down 33%. "Demand from the petrochemical industry remains poor"
PTA China (red), down 30%. "The 10% fall in PTA prices caught most players off guard"
HDPE USA export (purple), down 28%. "US Gulf prices are workable into South America"
Brent crude oil (blue dash), down 20%
S&P 500 Index (pink), down 3%
Benzene NWE (green), up 5%. "Continued availability restrictions for prompt material kept upward pressure on the European benzene market "

US auto sales maintained a steady pace in May. As the chart shows (red square), they were 1.3m in the month, and are now up 13% versus 2011 (green line).

The key driver remains the need to replace old vehicles. It is impossible to work or shop in many parts of the US without a car, given the lack of public transport. And the average age of the auto fleet has hit a new record of 11.1 years. So owners simply have to replace their vehicles.

Equally, high fuel prices mean that buyers are trading down in quite significant numbers when they do purchase. Sub-compact sales are increasing rapidly - although the blog would certainly think twice about driving one on most US freeways.

The other driver is a loosening of credit standards. Credit agency Experian reports these are back to pre-Crisis levels, meaning more people are eligible for loans:

• Poorer people drive the oldest cars, and need credit to replace them
• Similarly, loan terms have been extended, to make repayments lower
• Interest rates at 4.56% are also helping those with good credit scores

In addition, of course, Japanese manufacturers are only now returning to the market with normal volumes, after last year's tsunami disaster.

Even so, full recovery is a very long way off. Auto sales were still lower in May than in the 2005-8 period. And the annualised sales rate actually dropped to 13.78m, easily the lowest so far in 2012.

China's auto sales picked up in May at 1.18m. This was the highest-ever sales rate in May, and meant 2012 sales are now up 5% versus 2011 (green line).

Beneath the surface, however, China's Automobile Dealers Association reported that inventories of new cars continue to build. They now average a record 2 months, versus 45 days in April, as China continues to ramp up its production levels. And in China retail sales are measured by when cars are sold to the dealers - not when they are bought by a customer.

As a result, dealers' margins have seen a major squeeze. They are just 1%, compared to normal levels of 4% - 6%. Essentially, dealers are now simply running for cash - they have to sell cars, at any price, in order to meet their bills.

Analysts JD Power report only 63% of dealerships made a profit last year, down from 81% in 2010. Presumably this level will be even lower in 2012, if current trends are maintained.

The problem is that manufacturers are expanding total capacity to an expected level of 31m vehicles by year-end. This was planned in the euphoria surrounding China's lending and stimulus boom, when vehicle sales jumped 46% in 2009 and 32% in 2010. But they then rose just 2.5% in 2011, to 18.5m.

Presumably these cars will still be made, as China will always prioritise employment over profit. And if they can't be sold in China, as seems likely, then exports will be the only alternative. This will not be good news for other Asian manufacturers in H2.

Wenzhou in coastal Zhejiang province was the first city to encourage private enterprise when China began opening its economy in 1978. Its growth accelerated after China joined the World Trade Organisation in 2001, attracting 2.8 million migrant workers to join the city's population.

Now its 9 million people are at the forefront of China's slowdown, according to an on-the-ground report from Bloomberg, which notes:

• "The once bustling city centre is in decline"
• "Businesses are suffering because of weak demand, higher raw material costs and rising wages"
• "70% of businesses rely on exports...leaving it vulnerable as Europe's crisis crimps expansion"

City centre roads, once packed with traffic are now empty. Shopping areas are also quiet, with shops already advertising 40% sales, a month ahead of the usual timing.

Bank lending has now entered a vicious circle. Wenzhou once had a thriving private lending sector, which powered the city's sustained expansion. But the downturn in demand caused 60 business owners to flee in January/February, as they couldn't make the repayments due. So now lenders are sitting on their hands, causing more businesses to close.

The effect on ordinary people is stark:

• Mr Liu, a taxi driver, used to earn Rmb 5000/month ($750)
• Today he earns just Rmb 3000/month from his 12 hour shifts
• Food takes half his earnings, Rmb 1500/month
• After other costs, he has just Rmb 400/month for rent

Similarly, the city's former property boom is collapsing:

• Prices fell 14% in May, the fastest drop in the country
• But apartments still cost Rmb 30000/sq metre ($3950/sq yard)
• This is equal to the average annual per capita disposable income
• High end prices have fallen from Rmb 70000/sq metre to Rmb 40000

This is not like 2009, when the government could pump up the system with easy lending. Instead, policy remains effectively on hold, until the selection of the new Politburo is finalised in October. Meanwhile, as the official China Daily notes, local governments are instead often focused on meeting their GDP targets via a 'make and break' construction policy.

In Shenyang, for example, it reports that the city has just blown up a 9 year-old indoor sports stadium, which cost $126m and was the largest in Asia when it was built. Its reporter, Huang Xiangyang adds:

"I don't know how much of our GDP comes from this make-and-break game played by some local officials. But I do know it not only wastes resources and causes irreversible environmental damage, it also inevitably provides a hotbed for rampant corruption.

"But it is a game some officials like to play because it boosts local GDP, which has long been a key criteria for promotion, despite Beijing's repeated calls for green growth." In the past, where Wenzhou had led, the rest of China has followed. Its current troubles may therefore turn out to be a forerunner of wider problems in China's economy.

Another month, and another downturn in the European car market.

It was the largest regional market in the world as recently as 2009, when 13.3m cars were sold But as the chart shows. May (red square) saw sales down 9% versus 2011 (green line). This is the 8th consecutive month in which sales have fallen.

Even more worrying is that sales have now begun to fall in Germany. Its economy had been supported by the strong export position with emerging economies such as China and India. But now these are slowing fast, and German sales were down 5% in May.

In other major markets, sales were equally depressing:

• Spain was down 7%
• France (facing a key election tomorrow) was down 17%
• Italy was down 19%

Greece, also voting tomorrow, saw its sales down 47%.

Brent oil prices have just finished a record sequence of 240 days above $100/bbl. This was longer than the 170 days in 2008. And longer, on an inflation-adjusted basis, than in any previous period of high oil prices.

In Europe, prices were actually higher than in 2008 due to the lower value of the euro versus the dollar. Prices averaged €85.06 at their peak in June 2008. But in 2012, they were above this level continuously from January - May, and peaked 12% higher at an average €94.99 in March.

UK prices have seen similar peaks, due to the weaker £. Tesco are the world's 3rd largest retailer, and as CEO Philip Clarke noted last week, when revealing disappointing Q1 growth figures:

"A tank of petrol still cost about £70, compared with £45 two years ago. That is an amazing dent in household budgets."

US oil prices have been slightly weaker than Brent in recent months, but still averaged over $100/bbl from January into May. The reversal of natural gas prices back to long-term averages also helped to support consumer spending.

But even in the US, as the above chart from the American Chemistry Council shows, the damage has been done. Inflation-adjusted sales (orange line) have dropped quite sharply in recent months. As the ACC note:

"The report provides further evidence that the recovery is softening and consumers are again holding back, constrained by persistent unemployment and low wage growth."

Petrochemical markets continue to provide plenty of warning signs about the deteriorating state of the global economy. As the above chart shows of price movements since January, even benzene is now weakening as supply disruptions fade.

The obvious conclusion is that downstream users have simply been unable to pass through recent increases. Instead, these further weaken demand.

The outlook for Q3 is therefore not very good. Players down the value chain still hold too much inventory. This was bought during crude oil's earlier upward run to $125/bbl, when players had to panic buy to protect their margins. Equally, political uncertainty in the Eurozone and China adds to the general lack of confidence.

Yet financial markets remain ever-hopeful that central banks will step in with a magic wand, and remove all their problems. Thus Wall Street rallied on Thursday and Friday, gaining 2.4%. This is understandable, as the current leadership of the US Federal Reserve continues to confuse being 'market-friendly' with being 'friendly to markets'.

Not for them the hard logic of previous chairmen such as Paul Volcker, who would put the interests of the real economy first. And this change in central bank philosophy has important implications for chemical markets and consumers. As US investment magazine Barrons notes:

"Quantitative easing is losing potency in lifting asset prices and the economy but remains just as powerful boosting commodities." And it adds, "there is a great irony about monetary policy these days: investors and politicians would like it do more and more when it is apparent it can accomplish less and less."

If central banks do resume their mistaken policies, then oil prices will almost certainly rise again, fuelled by the increased liquidity. This will further destroy demand in the real economy, even while the speculators and high-frequency traders celebrate their profits.

Benchmark price movements since the IeC Downturn Monitor's 29 April 2011 launch, with latest ICIS pricing comments, are below:
Naphtha Europe (brown), down 33%. "Outlook for the European market is uncertain, with petrochemical requirements for naphtha reduced in both Europe and Asia, and gasoline demand lower than in previous years"
PTA China (red), down 32%. "Polyester production cuts continued to increase in China. Around 1.7MT of capacity has been idled since early June, and another 1.5MT is to be taken off line."
HDPE USA export (purple), down 28%. " Mexico's Pemex reduced prices due to declining prices of imported material and low demand for all grades"
Brent crude oil (blue dash), down 22%
S&P 500 Index (pink), down 2%
Benzene NWE (green), up 1%. "Market appears to be easing off as imports from both Asia and the US Gulf arrive"

Global bond investors have found a new worry. 10 year interest rates in Spain, the world's 12th largest economy, have risen alarmingly in recent weeks. As the chart shows, they are now above 7% (blue column) compared to 4% when the blog first focused on the Eurozone crisis (red).

7% is a critical level, as it marks the point at which countries can usually no longer support the burden of interest cost involved. During the current crisis, it has also marked the moment when countries such as Ireland and Portugal have had to receive a bail-out.

This is why the blog has continued to argue that there are sound reasons for the current record differentials between interest rates being paid by the PIIGS (Portugal, Ireland, Italy, Greece, Spain) and the JUUGS (Japan, UK, USA, Germany, Switzerland).

Interestingly, some major bond fund managers have recently begun to express similar views. Thus Jeffrey Rosenberg, chief fixed income investment strategist for Blackrock (who have $3.7tn under management), noted recently in respect of the low interest rates in the JUUGS:

"You're not talking about a bubble because a bubble is about greed. That's not a reflection of 'I expect prices to go higher and I have to jump in,' that's a reflection of 'I want to preserve my principal.' Negative yields reflect fear."

Oil markets have weakened significantly since they fell out of their major 'triangle' formation earlier this month. WTI is already within the forecast $60-80/bbl range although, as the chart shows, Brent still maintains a $10/bbl premium at $90/bbl.

Of course, charts can only display the change in sentiment and direction. They cannot explain why it is happening. Usually, this only becomes clear after the change has begun to take place.

A key factor this time may be Iran:

• The West is determined to stop Iran's nuclear development, and has put in place a comprehensive oil and sanctions policy to achieve this
• This means traders know strategic stockpiles will be used to balance markets if required, and so relieves price pressure on the upside

• The Saudis blame Iran for the unrest in the oil-rich Eastern Province and for October's alleged attempt to assassinate their US ambassador
• They are pumping near-record volumes at 10mbd, which has led to speculation they may be aiming to pressure Iran by reducing oil prices

The latter argument is covered in more detail in an interesting Foreign Policy article kindly forwarded by a blog reader in the Middle East.

Today's weaker market means we are now suffering the reverse of Q1's panic-buying when crude prices were rising. Buyers are instead trying to reduce inventory to avoid being caught in a falling market.

This is also making life difficult for CFOs, due to the working capital risk. And they worry this may take some time to reduce, as we reach the seasonally slow Q3 holiday period.

The critical question is where oil prices go next:

• Some still believe that a commodities supercycle is underway, which will take prices back to $120/bbl en route to their $200/bbl target
• But the consensus now sees prices keeping closer to today's levels, which also fulfil the budget needs of leading OPEC producers
• However, if the geo-politics argument is correct, Saudi might well be prepared to take prices much lower, to really pressure Iran

Lower prices would certainly help the global economy, and would kick-start consumer spending again, as in the past.

But the recent record period of high oil prices has already pushed the economy into near-recession. And if prices were to fall below $60/bbl, this would then cause major cash-flow issues for many companies.

The global economy is now in the middle of its 3rd downturn in the past 4 years. The chart above shows how the blog's benchmark products have acted as leading indicators on each occasion (yellow highlight):

• In 2008, naphtha (red line) PTA (purple), benzene (green) and polyethylene (PE, blue) all peaked around the middle of July, and fell sharply for the rest of the year
• In 2011, benzene and PTA led the downturn, peaking in March. Naphtha and PE followed, causing the blog to launch the IeC Downturn Alert
• This year, the downturn again began in March. And as in 2008, all 4 benchmark products peaked at the same time

In 2008 and 2011, policymakers assumed that the world faced a cash-flow shortage. So they reacted by flooding the markets with borrowed money. Many governments also introduced major stimulus programmes to enable the economy to reach escape velocity again, and return to the steady growth of the 1982-2007 supercycle.

Unfortunately, as is now becoming clear to a wider public, they made a terrible mistake. The real problem in the world economy is excess debt. And one cannot solve a debt crisis by adding more debt. The short-term 'sugar high' that it creates soon disappears.

The best guide to what is happening comes from Hyman Minsky. As the blog wrote in September 2008, when the crisis began to unfold, a long period of stability, such as that seen during the supercycle, leads investors to become complacent about risk:

"They believe that a new paradigm has developed, where high leverage and 'balance sheet efficiency' should be the norm. They therefore take on high levels of debt, in order to finance ever more speculative investments.

"Eventually, however, a 'Minsky moment' occurs. Earnings from the new investments prove too low to pay the interest due on the debt. Confidence in the 'new paradigm' disappears and, with it, market liquidity. Investors find themselves unable to sell the under-performing asset, and suddenly realise they have over-paid. In turn, this prompts a rush for the exits. Prices then begin to drop quite sharply, as 'distress sales' take place."

If policymakers had dealt with the debt issue in 2008, we would by now be in recovery mode. Instead, as the benchmark products indicate, we are back on the same path as in 2008. The only difference is that the economy is suffering from even more debt.

The risk from a second Minsky Moment is thus even higher than in 2008.

Benchmark price movements since the IeC Downturn Monitor's 29 April 2011 launch, with latest ICIS pricing comments, are below:

Naphtha Europe (brown), down 38%. "Prices fell to their lowest level since September 2010"
PTA China (red), down 30%. "Production cutbacks in China's polyester sector continued, as producers needed to offload inventories with high feedstock costs"
HDPE USA export (purple), down 28%. "Producers unwilling to drop prices further with weak global demand "
Benzene NWE (green), down 4%. "Market is totally detached from movements in the value of Brent crude because the market is so tight"

China's polyethylene (PE) demand continues to highlight the slowdown underway in the wider economy. As the chart shows for the January- May period, based on data from Global Trade Information Services:

• Overall demand (red column) was down 5% versus 2010 (blue)
• China's production continued to increase, up 1%
• Imports were down 9%, and exports up 95% (from a low base)

Thus it also looks as though PE demand in 2012 will be well below GDP levels for the 2nd year running, as it was up just 1.3% in 2011.

Equally, the data continues to provide worrying evidence of the decline in demand for NAFTA imports, despite the increasing shale gas advantage. They were down 58% from 2010 levels.

The reason is that China aligns its imports with overall strategic interests, rather than economics. It has some of the highest cost production in the world, but operating the plants keeps people employed. The social stability that this provides is more important to the ruling communist party than any potential cost saving.

The only exceptions are with the Middle East, where China's need for energy means its imports from there are up 36%. Whilst SEA imports were up 12%, as it also values the export markets provided by the free trade agreement.

This is the world of the transition to the New Normal.

Morgan Stanley's head of emerging markets seems to share the blog's belief that the current oil and commodity 'supercycle' is simply a speculative frenzy.

Writing in the Financial Times, Ruchir Sharma notes:

"The daily news about falling oil prices is the beginning of a major shift in the global economy: the end of the "commodity supercycle", the idea that the rise of emerging markets led by China would continue to drive up prices for oil and other commodities, from copper to corn....

"The oil bulls build their forecasts on the assumption that the mass, rapid rise of the big emerging markets will continue for another decade or two. But their boom was unprecedented - almost freakishly unusual - and is now breaking up, with Brazil, Russia, India and China all slowing markedly."

He also confirms our argument in chapter 3 of Boom, Gloom and the New Normal that markets have become dominated by speculators:

"The commodity mania spawned a new industry of investment funds that allow even lay people to trade in commodities. The total invested in commodity funds has more than doubled over the past five years to more than $400bn in 2011. The daily volume of trades in energy futures is now a staggering 25 times higher than daily global demand for energy. Speculators rule the markets"

The problem is, of course, that the damage has already been done. As the blog worried back in October 2010:

"But once the party has ended, and the computers have been shut down for the night, it will be the real world of the chemical industry that will have to pick up the pieces."

Brazil's economy has soared in recent years, as its raw materials have supplied China's infrastructure boom. China now accounts for 17% of total exports, and has replaced the USA as its largest trading partner.

In turn, of course, this led to major growth in Brazil's own chemical demand. Its polyethylene (PE) imports grew 78% from 445KT in 2008 to 793KT in 2011. But as the chart shows, based on Global Trade Information Services data, the position has changed quite dramatically this year, as China has slowed:

• Brazil had become a marginal net importer in 2011 (green column)
• But this year it has become a net exporter again (red)

In terms of the key regions:

• ME and SEA have maintained their increased volumes in 2012
• But NAFTA imports are down 27% versus 2010 (blue)
• Brazil's net exports within Latin America are up 20% versus 2010
• Its exports to Europe are up 24%, whilst NEA imports are down 43%

This highlights how China was the key driver for global chemical demand since its stimulus programme began in 2009. Now it is slowing, competition is increasing again as producers fight for market share in export markets.

The blog today celebrates its fifth birthday. Its 1400 posts since the June 2007 launch have covered a wide range of subjects. And one thing is certainly true. There has never been a shortage of topics to cover.

Readership has also continued to grow very steadily. As the map shows, the blog is now read in 145 countries, and 6433 cities. And one of its great pleasures is meeting readers all over the world, when it travels to meetings and is invited to speak at conferences.

Reader loyalty is also incredibly strong. 54% now visit at least once a week. And 42% visit at least twice a week. This loyalty has supported a wide range of related initiatives:

• Its Budget Outlooks at the start of the year remain extremely popular
• Chemicals and the Economy webinars are organised every 6 months by the American Chemical Society. The next is on 12 July
• ICIS Chemical Business regularly features its analysis of key topics
• Workshops are also held in all major regions for readers and companies

Over the past year, of course, the blog has also been publishing its new eBook, 'Boom, Gloom and the New Normal' with fellow-blogger John Richardson:

• This describes the impact of changing demographics on the global economy and chemical demand patterns. And it presents clear strategies for success in the transition to the New Normal that is now underway
• 15,000 readers have already downloaded the book. Whilst several major companies are using its analysis to develop winning strategies for their future business

The blog would like to thank all its readers for your continued support.