Chemicals & The Economy

Last month, the blog introduced its new Boom/Gloom Index, designed to track sentiment in financial markets. The chart above now updates it to reflect the whole of June.

The Index has continued to move up, and is close to the levels last seen in October 2007. Equally remarkable is the performance of the Green Shoots Index, which has hit another all-time high. There is little doubt that the performance of the two indices is related. Investors clearly want to believe that recovery is 'just around the corner', even though there is little hard evidence to support this belief.

Chemical companies have done well in exploiting this improved sentiment. Dow managed to raise nearly $10bn to repair its balance sheet, via asset sales and equity/debt issues. Ineos are well on the way to agreeing new covenants with their lenders. Neither looked easy to achieve before the market began its March rally.

Now, of course, comes the hard part. Will the current restocking process turn into a real recovery? The blog maintains its doubts, and fears the green shoots may wither to become yellow weeds.

Capacity closures are always hard to achieve in the petchem industry:

• First, these are a 'zero sum game' - if I shut my plant, then other producers gain in terms of overall operating rates and margins, at my expense
• Secondly, there is the integration issue. Closing a consuming plant also impacts output from an upstream plant, and may make it unviable

Dow Chemical's announcement of US capacity closures reflects this underlying logic. By shutting downstream consuming plants, and an ageing cracker, Dow will align its overall US ethylene balance. It will no longer purchase ethylene in the merchant market. Dow is therefore passing on the pain of any necessary upstream closures to its suppliers.

But Dow also added a wholly new dimension to the debate, when Brian Ames, Global Hydrocarbons Business director, spoke to ICIS' Nigel Davis. His comment, no doubt carefully prepared, was that US capacity had to shut because "demand overall is lower than it used to be".

The blog shares Ames' view. US exports must suffer, in spite of the Gulf Coast's ethane advantage, as major new capacity arrives in the Middle East and Asia. Equally, there must be doubts about underlying US demand, unless housing and autos recover quickly to their former levels.

Dow's moves are therefore likely to prompt further debate about how to best manage capacity closures during depressed market conditions.

The good news from the latest reports on US house prices and auto sales was simple - things have stopped getting worse. US house prices saw "some stabilisation in some regions" according to the S&P/Case Shiller Index for April. Whilst auto sales are clearly bouncing along the bottom, down "only" 29% in June versus May's 35% decline.

The bad news in terms of house prices was that the decline is really only just getting underway in some key markets. Chicago and New York, for example, "posted record annual declines in April", and are now down 19% and 13% respectively. By comparison, Phoenix, the worst market, was down 35% versus last April, and 54% from the 2006 peak.

Anecdotal evidence from the blog's recent New York visit certainly suggested that the city's bankers are only now beginning to sell up. Initially, those newly unemployed in Q4 had held on to property, believing that they would quickly find new employment. But now cash is getting tighter, and H2 may well see more homes up for sale.

The auto market is also showing diverging trends. Ford seems to be on a bit of a roll, as the chart shows, even though its sales were down 11%, and it claims to be reducing price incentives. Other producers fared less well, with Chrysler having to increase its incentives by up to $750.

The other good news is that auto inventories are also coming down, due to the recent plant closures. Ford is actually increasing Q3 production by 25k vehicles, having dropped inventory by 214k since last June. GM has also reduced stocks by 206k over the same period. This should certainly help hard-pressed chemical and polymer suppliers.

The chemical industry has benefited from a benign paradigm over the past 25 years:

• Demographics in the west have encouraged consumption, as the baby-boom generation reached middle age
• Globalisation meant this could be achieved at lower cost, by outsourcing production to lower-wage countries in the east
• Workers in the east saved their money, which allowed banks to make good profits by lending it back to consumers in the west

Now, all three pillars of this paradigm are under threat:

• The baby-boom generation is starting to retire and a new, more frugal, type of consumption is emerging in the west.
• Asian countries are trying to rebalance their economies, to promote more domestic demand and replace lost exports.
• And many banks are amongst the ranks of the walking wounded, unable to resume lending at previous levels

What happens next, is therefore a key question. The Bank for International Settlements (BIS), the central bankers' bank, suggests that "A financial crisis bears striking similarities to medical illness. In both cases, finding a cure requires identifying and then treating the causes of the disease."

Its analysis, in its newly-released Annual Report, suggests that investors, consumers and policymakers have been "fooled into thinking that trend growth was higher than it really was". And the BIS's conclusion is that "countries have been left with bloated financial sectors, the ability to build more cars than their populations need and, in some cases, surplus housing stocks."

Housing and auto demand have, of course, been a key support for chemical demand in the past few years. If the BIS are right, then considerable downsizing awaits the industry over the next few years, as it adjusts to the new realities.

After yesterday's post, Edwin Pang of Credit Suisse in Hong Kong has raised an interesting question over the likely rationale for China's massive increase in petchem imports, such as polyethylene (PE), in 2009.

As the chart shows, its monthly PE demand (production plus net imports), was very steady in 2007-8. It averaged 980kt in 2007, and 970kt in 2008. Yet in 2009, it has soared to record levels, averaging 1270 kt/month.

This makes no sense at all in terms of real demand. China's total exports are down 26% so far this year. And it defies belief that the government's fiscal stimulus could have caused such a massive increase in domestic demand, in so short a time.

The blog's view is that the rise is instead due to traders':

• Desire to bet on the rising oil price, and a global economic recovery
• Ability to access cheap credit, as part of the fiscal stimulus

This creates a serious risk that a vicious circle could develop, if the oil price continues to slip, and global demand does not recover in H2.

The blog therefore continues to worry, as it noted back in March, that "China may well end up having to dump this inventory on world markets, at whatever price they will fetch".

Sometimes, the blog gets lucky with its timing. A week ago, it wrote bearishly on crude oil markets, and suggested that "chemical companies need to keep a close eye on changing sentiment in financial markets". By Friday, oil prices had tumbled 11%, as the US S&P 500 index continued to weaken from its 12 June peak.

The blog does, however, feel able to give itself another pat on the back for its underlying analysis. Back in May, it thought there was a good chance that oil prices (then $60/bbl) could well see a "move towards $80/bbl by the summer, if investors remain confident". And it also cautioned that if financial market "sentiment begins to change", then a downwards move towards "$40/bbl could happen very quickly".

The driver for the changing sentiment in financial markets seems to be changes in the US$: € rate. The evidence for this is as follows:

• The US$ hit a high of 1.26 versus the euro on 3 March
• The S&P 500 bottomed 3 days later at 666.
• The euro then rallied strongly, peaking on 3 June at 1.43 versus the US$
• The S&P 500 also rallied strongly, peaking on 11 June at 956.

And as the updated chart above shows, WTI continues to track the S&P very closely. It also peaked on 11 June, at $72.69/bbl.

The blog will keep a close eye on future $:€ developments. It would welcome readers' insights as to why these might currently be so crucial.

If you want a loan, go to China. That's the message from the chart, courtesy of Credit Suisse, which shows the staggering growth in bank lending since the start of the year. Now, even the People's Bank of China is starting to get concerned.

Lending so far this year has reached $1trn, equal to a quarter of the country's annual economic output. $223bn was lent in June alone, as local banks scrambled to meet government targets by the end of the quarter.

This is not an academic issue, as far as the global chemical industry is concerned. As a senior executive from a N American company told my fellow blogger, John Richardson, "I keep returning to the fundamentals and cannot understand why prices have risen so steeply since mid-February."

But what would you do, if the government offered you a cheap loan, and you saw the oil price was rising? Would you buy polymer, and store it? Just as US homeowners took subprime loans at cheap rates and bought houses they couldn't afford, on the basis that prices couldn't fall?

The blog hates to be a party-pooper. But it is growing increasingly worried by the 'China story', and continues to fear that it will all end in tears.

Any improvement in the troubled auto sector is extremely good news for the chemical industry, after the battering of the past few months. Thus the blog welcomes news, as the chart shows, that European sales increased 2.4% in June, the first rise for over a year.

Government support for scrapping older cars has led the way. The German market is up 41% versus 2008, and may hit 4 million sales in 2009. Italy was up 12% and France 7%. But the UK and Spain were both down 16%, as homeowners worry about negative equity.

Analysts JD Power warn that the market could collapse again, if the schemes are not renewed for 2010. They suggest Germany, for example, could see a 35% fall to 2.6 million sales. But for the moment, at least, government action on both sides of the Atlantic continues to keep chemical and polymer sales moving through the auto supply chain.

In 2007, Sweden was the largest private equity market in Europe, as a percentage of the country's GDP. And the local banks lent freely, as elsewhere, to fund investments. Now they, and other Nordic banks, are struggling to minimise their losses.

According to Bloomberg, Sweden's second-biggest bank, Handelsbanken, "seized parts of Plastal Group and Plastal Holding AB on July 2, after a cash infusion from Stockholm-based private equity firm Nordic Capital failed to save the plastic-parts maker from bankruptcy".

75-year old Plastal had sales of €1.3bn in 2007, and 6000 employees in 10 countries. But since then, it has been badly hit by the downturn in its core automotive market. Now "Handelsbanken, which loaned the company 2.1 billion kronor, plans to merge Plastal's Belgian, Norwegian and Swedish units into a new company".

Sadly, Plastal is unlikely to be the only company whose ownership moves from private equity to their bankers, as the downturn continues.

As expected, Ineos have today confirmed that their proposed new covenants have now been accepted by their lenders.

For those unfamiliar with the mechanisms used in the world of high-yield debt, this does not involve any new money, or a refinancing. Instead, it means that the lenders have agreed to provide Ineos with more head-room in terms of its day to day operations. Thus the company have confirmed that there will be a "reset of the Leverage, Interest Cover and Debt Service Cover covenant levels, effective from September 2009".

This sounds like financial small print. But it means Ineos and their lenders have agreed to make an adjustment to the conditions of existing loans, rather than to change the whole capital structure of the business. So Ineos employees, as well as their customers and suppliers, will no doubt be very reassured that everything has now been finalised.

The blog is rather pleased with the performance of its new Boom/Gloom Index©, as financial markets continue to respond positively to any suggestion of "good news".

The Index is based on Ben Graham's famous concept that markets are:

• A voting machine in the short-term but
• A weighing machine in the long-term

It is therefore meant to identify whether positive or negative sentiment is driving short-term performance. And clearly, market sentiment is indeed still remarkably positive, in spite of the fact that there is no sign of any real improvement in the underlying fundamental position.

One example of the continuing influence of positive short-term sentiment can be seen in the positive reaction to the news that US housing starts rose 3.6% in June to an annualised rate of 582k. Yet as the above chart from the American Chemistry Council shows, the long-term fundamentals still remain dreadful:

• Last month's starts were 46% down on June 2008 levels, and were worth just $9.3bn in terms of chemicals sales (each house uses c$16k of chemicals) on an annualised basis.
• This compares with sales worth $35bn of chemicals during the boom period, when starts were running at a 2.2 million level in 2006/7.

The blog is very mindful of Keynes' insight that "markets can remain irrational for longer than most investors can remain solvent". It will therefore be keeping a close eye on the Boom/Gloom Index©, to identify when today's positive sentiment starts to wane.

California's Governor, Arnold Schwarzenegger, has now made a provisional agreement to reduce the State's soaring budget deficit.

Its main features are a $9bn temporary cut in the education budget, plus multi-$bn cuts in welfare and health programmes.

The only good news is that it clears the way for oil drilling to resume off the Santa Barbara coast. The ban, aimed at preserving California's beaches, had clearly become an expensive luxury for the US's most populous state.

In another sign of the economy 'bouncing along the bottom', US drivers appear to have returned to the road in recent months. Latest figures from the US Highway Administration show a 0.1% rise in vehicle miles travelled during May, the second consecutive month of positive growth since 2007.

But this is unlikely to provide much support for increasingly hard-pressed refiners. European players saw crack margins tumble 62% in Q2 to $1.20/bbl, versus an already low $3.20/bbl in Q1. Weak demand is leading to low refinery operating rates, whilst normally strong diesel margins have failed to keep up with higher crude oil prices.

US refiners are also worried, with new government proposals for carbon 'cap-and-trade', likely to increase their costs significantly. Plus, of course, new CAFE standards aim at raising average auto mileage by 42%, at the same time as legislation to promote ethanol usage is also effectively reducing oil product demand.

Last August, we published a major Study, 'Feedstocks for Profit', with refining experts Wood Mackenzie, which forecast that "competition is likely to increase within the main regions, as exporters find life much more difficult." This scenario now seems to be coming true.

In terms of chemical sales, the increased competition comes at a time when demand is already weak. But on the positive side, refiners' problems could well provide chemical companies with an opportunity to mitigate their problems, by accessing feedstocks at distressed prices.

The excellent weekly report from the American Chemistry Council (ACC) has a number of interesting insights:

• As the chart shows, global chemical production seems to have bottomed. All regions are, however, now showing a decline versus 2008.
• Separately, the ACC has updated its valuable survey of the state of inventories down the US polymer chain. This suggests that these were finally being rebuilt in May and June, for the first time in a year.
• Equally, they note that total inventory of existing US homes reduced to 9.4 months, with sales stable at similar levels to June 2008.

The latter is a critical leading indicator for chemical sales. But according to the US Realtors Association, the housing market is now seeing 2 quite different sets of drivers:

• Homes priced under $250k are selling fast, often via foreclosure, and inventories are down to 6 months
• But homes priced over $1m are seeing very little activity, with inventories now at 20 months.

The question, of course, is what happens next? The risk is that rising unemployment starts to force owners of more expensive homes to sell on a distressed basis. This would clear inventories, but would also cause further problems for the financial system, as lenders would then have to go through another round of debt write-offs.

Hopefully, these owners will be able to hang on. But even then, the chances of a V-shaped recovery remain low. As the ACC note, it is likely that "headwinds from massive deleveraging and lingering fallout from housing will offset the typical inventory bounce".

Source: Chartoftheday.com
There are "lies, damn lies, and statistics" according to Mark Twain, the famous American humorist. His argument was that statistics are often (a) untrue* and (b) used without the necessary context.

Last week provided a perfect example of the latter. As the blog's own Boom/Gloom Index© shows, sentiment is currently very positive in global financial markets. And so US markets rallied 4%, on the basis that reported company earnings were "above estimates".

Yet in context, this "outperformance" disappears. The above chart from ChartOfTheDay.com (COTD) shows 12-month, 'as reported' S&P 500 earnings, adjusted for inflation. And COTD highlight that these are now down over 98% since peaking in Q3 2007. Equally, they say this is "by far the largest decline on record (the data goes back to 1936)".

Also ignored last week was S&P's own report on Friday that forecasted total S&P 500 earnings for the 12 months to September "to be negative ($-1.01 EPS), for the first time in index history". Howard Silverblatt, S&P's senior equity analyst noted that any recovery in earnings will depend on a recovery in sales, as "you can only cut so much, and for so long".

*The blog carefully checks all those it uses with reputable sources

Its not only the blog (and fellow blogger John Richardson), who worry about the speculative frenzy underway in China, and its impact on global polymer and chemical markets.

Wu Xiaoling, former deputy governor of the central bank, has called the growth in new lending "excessive", and warned it is creating "bubbles in the property and stock markets".

Wu says China's bank lending in 2009 will be "a staggering increase of 40% of the entire stock of outstanding loans". The blog had to read this statement several times to fully grasp its importance.

It does not mean that bank lending will increase by 40% in 2009 versus 2008 - which would still be a very large increase. It means that the total value of all bank lending at the end of 2008 will have been increased by 40% during 2009.

Equally, Stephen Roach, chairman of Morgan Stanley Asia, and a long-time China bull, says he "is starting to worry" about the direction of current policy. The blog likes Roach, particularly for his accurate analysis in December 2007 that "decoupling (of China's economy from the West) is a good story, but it's not going to work going forward". He notes:

• In 2007, premier Wen Jiabao warned the economy was becoming "unstable, unbalanced, uncoordinated and ultimately unsustainable"
• Roach claims that current policies "compound the very problems the premier warned of: aiming a massive liquidity-driven stimulus at its most unbalanced sector"
• He adds that they "leave little doubt as to how bad it was in China in late 2008 and early 2009", to cause the government to react in this way

But Roach warns the loan growth is "ultimately a recipe for failure".

This week, the government began to respond to its critics, with regulators starting to insist that its Rmb 7400bn ($1080bn) of loans so far this year, be "used to bolster the real economy and not to speculate". But as we know from recent experience, bubbles on this scale don't usually subside gently. And when they burst, a lot of innocent people can get hurt.

Natural gas is a major feedstock for US chemical producers. So the problems caused by the rush to buy a fund that "invests" in the natural gas futures market, are a concern.

Olivier Jakob of Petromatrix has been warning for some time that the UNG fund was becoming too large. Investors have been so keen to bet on rising commodity markets, that it now represents 70% of open interest in the nearby futures contracts! As a result, the market itself has become dysfunctional, and UNG is being forced to close some of its positions.

The UNG problem is another example of rampant speculation in financial markets. When this happens, it usually ends in tears

This week's company results have been keenly awaited, as the industry seeks to form a view on what happens next to demand and profits.

My new IeC colleague Paul Satchell reviews them, from the point of view of a highly-experienced financial analyst, in his 'Chemicals Viewpoint'. But the blog thought it would also be interesting to simply quote the actual words used by companies themselves, as reported by ICIS news:

Akzo Nobel, "With the exception of some emerging markets, we see little significant recovery of growth," CEO Hans Wijers.
BASF, "Capacity utilisation rose from below 60% in the first quarter to slightly above 60% in the second - there was no reason why the second half would show an improvement on the first, and could possibly be worse", CFO Kurt Bock
Bayer, "The bottom of the cycle has been reached, but there is still no sign of a sustained recovery in demand," CEO Werner Wenning.
BP Chemicals, "The outlook continues to be challenging"
Celanese, "We're not seeing signs of a widespread strong recovery," CEO David Weidman
Dow, "Second-quarter operating rate was c75%, with overall demand still below last year and excess capacity remaining", CEO Andrew Liveris.
Dow Corning, "global economic recession continues to dampen demand", CFO J Donald Sheets.
DuPont, "My concern is the true demand recovery. Are we going to be bumping along the bottom," CEO Ellen Kullman
ExxonMobil Chemicals, "Q2 prime product chemical sales fell 6.7% versus 2008."
Mitsubishi, "Ethylene production in the quarter fell 13% year on year"
Olin, "Precipitous decline in caustic soda pricing and the continuation of weak demand," CEO Joseph Rupp
Reliance, "Attributed its rising margins to the fact the industry was operating on a low level of inventory, and the depreciation of rupee against the dollar".
Rhodia, "Demand in emerging countries returned to 2008 levels and customer de-stocking in Europe and North America was essentially completed," CEO Jean-Pierre Clamadieu.
Shell Chemicals, "Reduced global demand for chemical products significantly impacted the chemicals manufacturing plant utilisation rate, which dropped to 68% from 84% in Q2 2008"
Siam Cement, Thailand, "It remains to be seen what path the recovery process takes and over what period."
Sherwin Williams, The "past three years have erased a decade of growth in the coatings market", CEO Chris Connor.
Sinopec, "Mainstream ethylene plants were running at full capacity from January to June 2009. We haven't seen signs of demand falls and will keep high production".
Wacker, "Customers are still cautious about placing orders. They are ordering smaller quantities or concluding contracts with shorter durations".

Sinopec is clearly still benefiting from the Chinese "bubble". But demand elsewhere shows no sign of returning to pre-2008 levels.

The blog was also interested to see Akzo Nobel's CEO Hans Wijers adopting one of its own mottoes for the crisis, that "We hope for the best, but we prepare for the worst."

Merrill Lynch's Bob Farrell was the doyen of sentiment analysts. He famously suggested that 'bear markets have three stages - sharp down, reflexive rebound, a drawn-out fundamental downtrend'.

So far we have certainly seen the 'sharp down' period, and the blog's new Boom/Gloom Index© seems to have signalled the current 'reflexive rebound', with July's Index correctly indicating that market fundamentals and sentiment would continue to diverge:

• The former remained neutral, as shown in the round-up of company statements, and fellow-blogger John Richardson's Asian review.
• But sentiment remained very positive, as the financial sector claimed to "look through" current fundamentals to a more positive future outlook.

However, August's Index suggests they may now be starting to realign. And this is supported by the 26% decline in the Green Shoots reading.

So far, investors have been willing to assume that the current restocking process is indeed becoming a real recovery. But if Farrell's analysis is correct, they may soon start to demand more evidence to support this belief. The clear risk is that this would then lead markets to enter his next phase of 'drawn-out fundamental downturn'.

Sales of most chemicals are down due to the recession. But US sodium silicate volumes could see a massive boost, according to the Wall Street Journal. The reason is that the government has mandated its use to destroy the engines of the old cars that it buys under the subsidy scheme.

Normally 'liquid glass', as it is otherwise known, is used to repair leaking gaskets. But now, mechanics around the US are apparently queuing up for the chance to "kill" the engines. The blog was intrigued to learn that older engines take longer to die - 1988 Dodge vans take 6 minutes, but a 1999 Jeep takes only 2 minutes.

As the downturn began In July 2007, leading retailers Tesco and Wal-Mart "signalled a major shift in consumer priorities".

And Tesco added a warning that "If you don't have the basic things right, you will be talking at the edge rather than at the centre".

2 years later Procter & Gamble, one of the world's major consumer companies, has learnt this lesson the hard way. Its sales last quarter were down 4%, and profits down 18%, as they tried to maintain a premium position against low cost 'value-based' competition.

But large, successful companies like P&G don't usually just disappear. They have learnt to adapt to a changing world. And P&G's response is the the product above. It is part of a totally new strategy, which includes the European launch of a new Pampers Simply Dry product.

The new product, 'Tide Basic' no longer seeks to focus the consumer's eye on the words 'new' or 'improved'. Instead, it is a response to the growing mood of frugality amongst consumers, as discussed in the blog last month. It is 'Basic'. It has no new features. In fact, P&G has deliberately reduced its performance.

From a chemical industry viewpoint, this means it offers no scope for value-added innovation. That's very bad news for those specialty chemical companies who would normally supply the innovation. And it is further confirmation of Wal-Mart and Tesco's warning two years ago that "coming down the road is a tougher time".

The blog's favourite financial journalist, Gillian Tett, has written an excellent article summarising the similarities between today's problems in the western banking system, and those of Japan's during the 'lost decade' of the 1990's.

Her point is that although central banks are pouring money into the system via 'quantitative easing', it is clearly not reaching the wider economy. In particular, small and medium sized enterprises (SMEs), find bank loans very difficult to obtain.

Tett says she observed exactly the same issue in Japan, when working there 10 years ago. As now, politicians were jumping and down, urging the banks to lend. The government even set quotas for SME lending. But Tett describes the results as "almost comical". Her research uncovered, for example, that some banks were meeting their SME quota via loans to Toyota subsidiaries; hardly the result that was required.

Fast forward 10 years, and it seems the same process is being repeated. Large corporates, seen as low-risk, can tap markets - Dow raised $2.75bn to repay borrowings this week. But as Tett notes, "numerous small or risky corporate ventures in the West complain they cannot get loans". Consumers also struggle. And she concludes that "the pipes (of the banking system) are badly clogged, if not broken".

As a result, Tett says we are seeing a "backflow" of the liquidity created by the central bank money. It is ending up back with the government, via purchases of government bonds. In Japan, this process caused long-term interest rates to fall to 1%. The blog suspects that the same outcome could occur in some western countries too, if the plumbing of the banking system remains blocked.

As regular readers will know, the blog believes benzene is a good leading indicator for chemical demand, due to its widespread use in the industry. Last November saw its price "on the floor", indicating a major downturn, and it remained there until March, before its price began to "surge" in early April as destocking ended down the value chain.

Since then, as the chart based on ICIS pricing shows, benzene (blue line) has risen 270%, twice the oil price increase. But benzene's main derivative, styrene (red dotted line), has only increased in line with oil prices. Thus the spread between styrene and benzene prices (dotted purple line) has been squeezed.

This suggests underlying levels of chemical demand are still weak. And my IeC colleague, John Keeley, has seen this picture before, when he ran Shell's European aromatics business. His judgement is simple, "go short benzene now, unless you think styrene is about to tighten".

Cerberus' timing was clearly not very good with its Chrysler acquisition in Q3 2007.

And Steve Feinberg, Cerberus co-founder, admitted this when he told the New York Times "we were too optimistic on timing. Maybe what we should have done was not bought it."

So far, they have lost $6bn of their original $7.4bn investment. But the interview makes clear that their mistakes were not just due to timing, or over-optimism at the top of the 2003-7 credit bubble. They are also a warning sign of how new influences are starting to shape the investment landscape in the 'new reality'.

Steve Lewandowski of Total Chemicals wisely pointed out to the blog recently that Political, Environmental, Societal and Technology (PEST) issues are moving up the agenda around the world. The blog shares his view that careful study of these should be high on the list, when companies look at producing SWOT (Strengths, Weaknesses, Opportunities, Threats) analyses.

Last week, Nissan said its new Leaf model had achieved 367 mpg (156 kpl) in city driving. And this week, GM said its Volt could get an average 100 mpg rating.

Pedro Spohr of Galp in Portugal was therefore clearly right last October, when he suggested to the blog that the new range of electric cars could help to change naphtha balances. Of course, prototypes are not the same as mass motoring. But given the success of the duel-fuel Toyota Prius, and the likelihood of government incentives to keep prices low for the new cars, the blog will continue to keep a close eye on developments.

The latest OPEC monthly oil report paints a bearish picture of the market. It expects OPEC to supply 28.4mbd in 2009, down 7.5% from 2008 levels. And it forecasts more of the same for 2010, expecting to supply just 28 mbd.

Its analysis suggests that "the market is still fundamentally weak amid ample stocks of crude and products". And it notes that "US oil consumption is still showing a massive reduction". However, it says China saw "strong growth" in June "after a devastating contraction in Q1", and India is seeing "significantly higher growth".

OPEC notes that recent high levels of oil price volatility "indicates the increasing sensitivity of oil prices to conflicting economic signals". Its own view is cautious, suggesting that "expectations for a strong recovery (in the US economy) may still be premature".

Companies normally have 3 ways of pleasing investors:

• Meet or better expectations for revenue and earnings
• Cut costs to meet earnings if revenues disappoint
• Focus attention on a more favourable earnings definition

When things are going well, the first option is preferred. But under the pressure of a sustained economic downturn, it is understandable that some companies might investigate other options.

According to Paul Marson in the Financial Times, the third option is very popular at the moment. More companies than ever are focusing attention on 'operating earnings' rather than 'reported earnings'. These sound much the same, and 'operating' even seems more 'hands-on' than 'reported'.

But 'operating' earnings allow companies to exclude items that have to be included in 'reported' earnings, under GAAP accounting standards. And Marson notes the gap between the two is now at an all-time record of $54/share. Today's 'reported earnings' for the S&P 500 companies are just $7.20/share, versus $61.20/share 'operating earnings'.

Of course, if recovery were just around the corner, then companies might be right to highlight this to investors. But there is little evidence to support this argument: last month's US retail sales were down 8% versus 2008, and even retail giant Wal-Mart saw a 4% decline, reporting that "customers around the world are forced to do more with less".

Leading retailers such as Wal-Mart are an excellent leading indicator for the world economy. And as US head Eduardo Castro-Wright noted, the outlook is weak as "more people are concerned about unemployment".

In fact, Q2 saw many companies following Wal-Mart's reaction to falling sales revenues by taking the second option of cutting costs. In turn, of course, this creates a vicious circle by increasing unemployment.

At the same time, US foreclosures continue to climb. July's record volume saw 360k properties receive a foreclosure notice last month - a scary 1 in every 355 households. And of course, the consumer accounts for c70% of US GDP, and 16% of total global output. So a problem for the US consumer is a problem for the global economy.

Budget season is about to start, when chemical companies start to take a view on the outlook for 2010. Although the blog would like to be optimistic, it doubts that the optimistic view portrayed by 'operating earnings' is reliable evidence of a real recovery in the US economy.

Henry Mintzberg is one of the blog's favourite management gurus. The reason is that he understands the constraints under which most managers operate. His view is that the best managers aren't Superman or Superwoman, but "are simply ordinary, healthy people who aren't too screwed up".

In an interview with the Wall Street Journal, he outlines the 3 ways in which managers make things happen:

• Direct action. "Sometimes managers manage actions directly. They fight fires. They manage projects. They negotiate contracts."
• Via other people. "Managers build and motivate teams, and they enhance the culture and train them and do things to get people to take more effective actions."
• Via influence. "Managers manage information to drive people to take action--through budgets and objectives and delegating tasks and designing organization structure."

Mintzberg's view is that today, we "have much too much managing through information. It doesn't take genius to say: Increase sales or out you go. That's the worst of managing through information. The alternative is to give more attention to the people plane and the action plane. Even when you're managing information, you can manage in a much more nuanced way than just shooting a bunch of figures around."

Mintzberg's new book, 'Managing' has one further tip for managers. In his view, interruptions are a major cause of failing to manage properly, and "email--and especially BlackBerries in the pocket and all that--really makes it much worse".

Some 20 years ago, the blog launched ICI Watercare - which became the largest water treatment business in the chemical industry. So it has kept a close eye on opportunities in the water industry ever since.

The weak monsoon season in India highlights one such opportunity. As a new report from the UN Food and Agriculture Organisation (FAO) notes, Asia's vast irrigation systems were built 40 years ago, at the time of the 'Green Revolution'.

It says they have become "underused, poorly maintained and inefficient", and calls for major investment to finance their modernisation.

This is clearly a multi-billion dollar opportunity for the chemical industry. Such investment will not only require polymers, sealants and other products for the irrigation systems themselves. It is also an opportunity to provide much-needed expertise, to ensure the rebuilt infrastructure operates more efficiently in the future.

Many western governments have not seen manufacturing as a major priority in recent years. Instead, they have favoured moves to boost services, particularly the financial sector.

US manufacturing employment, for example, has fallen from 19.6m in 1979 to just 11.8m today - the lowest level since 1941. Over the same period, China has taken the opportunity to become the manufacturing capital of the world. Understandably, companies have preferred the more welcoming environment there, and in other emerging economies.

Now, however, there are signs that the politicians' love affair with financial services is coming to an end. British deputy prime minister, Lord Mandelson, has said the UK "needs an economy with less financial engineering and more real engineering". And according to Bloomberg, President Obama is considering the appointment of a new manufacturing "czar" to oversee the development of new policies.

The question that Boards need to consider is whether this new interest will be benign, or disruptive. The blog's worry is that the politicians will not just focus on support for the low carbon economy, and green technology. Instead, they may move to disrupt current patterns of world trade by encouraging companies to repatriate jobs to western countries.

Already the President's economics head, Larry Summers, has called for the US to become "export-oriented". And as Fred Bergsten notes in the Financial Times, Summers is sowing the seeds of future conflict by effectively arguing that "China can no longer behave like China, because the US intends to behave much more like China".

The blog is very interested to see the different outlooks being proposed by central bank heads. US Fed Chairman Ben Bernanke claimed Friday that the financial crisis was due to "panic", rather than fundamental problems such as reckless lending. As a result, with the "panic" over, he now saw the potential for securing "a sustained economic recovery".

But at the same meeting, European central bankers were more cautious, believing that the world economy still faced major problems:

• Germany's Bundesbank President Axel Weber said it was "too early to say it won't be a bumpy road ahead."
• Whilst European Central Bank President Jean-Claude Trichet was "uneasy when I see that because we have some green shoots here and there, we are already saying, 'Well after all we are close back to normal".

The underlying issue is shown in the chart from thechartstore.com, which shows "official" recessions in grey. And these are much shorter than the "real" recessions faced by industries such as chemicals. This is because the end of the destocking process produces a statistical recovery, as GDP rises in response to a renewal of underlying demand.

Thus the "official" 1980's recession ended in 1982, and that of the 1990's lasted just 6 months. Yet in reality, the chemical industry had to wait 3-4 years before a real recovery took place. And even the minor downturn of the early 2000's was far shorter officially, than in reality.

The US housing crisis is still getting worse, causing the weekend collapse of Guaranty Bank, the 11th largest US bank failure. As the Wall Street Journal notes, this marks a "new stage" in the banking crisis. Guaranty Financial had bought low quality, "toxic" mortgage loans, and its woes illustrate the "boomerang effect" that is now hitting thousands of small to medium sized US banks.

The problem, as the Independent Community Bankers of America note, is that most low quality mortgage loans "have declined in value, and it is not clear when they are going to come back in value, if at all." Whilst the Mortgage Bankers Association warn that "more than one in eight homeowners (are now) delinquent or in the foreclosure process". And Deutsche Bank calculate that 27% of US homeowners (14m) now owe more on their mortgages that their homes are worth.

Thus it is not really good news that US sales of existing homes rose in July, as shown in the above chart (blue column). For new data shows that "two-thirds of (existing) home sales are either foreclosures or banks taking a loss on the mortgage". And the 13% rise in inventory (red line) since January suggests more forced sales are in the pipeline.

Financial markets continue to believe in a quick V-shaped recovery. But wishful thinking of this kind would be dangerous for chemical company Boards. Today sees the end of an important source of recent demand, as the US "cash for clunkers" auto stimulus programme finishes. And with US banks now failing at the fastest rate since 1992, the blog fears that the outlook for demand is unlikely to see much medium-term improvement.

Our 8th European Aromatics & Derivatives conference, co-organised with ICIS, has a number of distinguished industry speakers including:

• BASF, Jaroslaw Michniuk, Group VP, Styrenics Europe
• Reliance, Rajen Udeshi, President Polyester Chain
• Shell Chemicals, Jonathan Forbes-Lane, GM, Aromatics Europe

In addition, the blog will be presenting its thoughts on "5 Key Steps to Take in 2010" to help your business cope with the twin problem of increasing capacity and slowing demand growth.

It will be held in Amsterdam on 25-26 November. The 'early bird' discount on delegate fees ends this weekend on 27 September.

For more info on the agenda and booking, please click here.

The blog was asked to write an analysis for ICIS Insight on the growing concerns about the outlook for China's economy, and their potential impact on the global chemicals inustry.

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

Further evidence of the trend towards a more frugal consumer comes from L'Oreal, the world's largest cosmetics company.

Like Procter & Gamble, it was slow to react to the trends identified by the major retail chains some 2 years ago. As a result, its profits fell 14% in H1, after decades of 10% annual increases.

And like P&G, it is undertaking a fundamental reassessment of its product portfolio and mission statement. As CEO Jean-Paul Agon notes, its new focus is on "affordable innovation" rather than "premium-isation".

Until recently, its aim was "more performance and higher prices". Now, Agon says the drive is to "create affordable ranges".

Agon also casts doubt on the idea that lipstick sales increase during a recession, as consumers seek "an inexpensive indulgence". He says this is no longer true, and that instead women want their "skin to look perfect". No doubt readers, as well as my fellow-bloggers Barbara, Malini and Doris, will be able to provide global insight on Agon's new theory?

There are clear signs in the above chart that the inventory cycle has turned positive again, as customers restock. Globally, data from the American Chemistry Council shows chemical production now down 10.5% versus last year, after being 13.4% down in March, in line with signs that GDP in the west is now stabilising.

But will we go back to the levels of demand seen in the 2003-7 Boom period? This seems unlikely. Moody's economy.com, for example, has produced interesting new data that shows the average US household's wealth has reduced from a peak of $540k to $421k in Q1. And Moody's note that consumers are becoming more frugal, due "to a general uneasiness about the future".

Of course, some argue that Asian consumers may be more extravagant. But total Asian consumption is worth just $5trn, half that of the USA. It is hard to see them spending enough to make up for slowing western growth, especially with 50% of Asia's GDP based on exports.

Many readers have been out of the office during August on a well-deserved break. As usual, the blog is therefore highlighting below the main postings over the past month, in the hope this will help you to catch up quickly on key developments - please click on the highlighted title if you want to read the original posting:

Demand has stabilised, but companies saw no sign of major upturn when reporting HI results. More questions were asked about China's apparent boom. The manipulation of 'operating earnings' to meet analyst expectations reached a new peak amongst S&P 500 companies. GDP in the west made a statistical recovery, as destocking ends, although a weak monsoon is hitting India's GDP.

End-user industries have also stabilised. Auto sales rebounded due to government subsidies, but capacity cutbacks continued, whilst a rise in foreclosures has increased US house sales.

Oil markets remain sentiment-driven and out of line with fundamentals. Benzene prices have dropped $300/t since the blog suggested they were signalling a chemical market peak. The Boom/Gloom index turned cautious, whilst US natural gas markets remain confused.

Bank lending is greatly reduced versus the Boom period, and Gillian Tett suggested their plumbing systems were still blocked. China's banks started to worry about a speculative bubble.

Consumption trends are focusing on cost and sustainability rather than innovation, with P&G introducing a Basic brand. Auto makers drive for higher fuel efficiency creates a feedstock opportunity for chemical companies, as does the need for improved irrigation systems in Asia.

Political issues will need careful attention when companies produce SWOTs in future, as politicians start to focus on real rather than financial engineering.

Prof Mintzberg had good advice for managers on coping with interruptions.

A key rule for any successful trader is that high volume is always bullish, and low volume is negative. The blog first learnt this when trading oil products in Houston, on secondment from the UK in the 1980's. And it has proved an invaluable guide ever since, in a wide range of markets.

The rationale for the rule is simple, namely that (a) more people join in a rally as it strengthens and (b) the end of a bear market is signalled by a "give up phase", when volume rises as people finally lose faith in recovery. In turn, this sets the scene for a new trend to emerge.

Thus the chart above carries a fairly clear message. Trading in linear low density polyethylene (LLDPE) on China's Dalian futures exchange leapt earlier this year, just as benzene prices also surged. By April, Dalian was trading 80 million tonnes - 4 times total annual world production. But August's trading was down 58%, whilst benzene prices have also fallen.

Clearly, the "smart money" feels that it is now time to move on, having made a healthy profit. In turn, this confirms the blog's growing sense that the speculative price rallies of the past 6 months, in commodity and financial markets, may now be coming towards an end.

One of the blog's major themes is that it fears the idea of a quick V-shaped recovery will prove wishful thinking. New figures from the Bank of England seem to bear out its caution.

The slightly complex chart shows that net UK lending for mortgages (yellow line, then red diamond) has been falling steadily since the beginning of 2008. And provisional data (not included in the chart) suggest it actually fell in July, for the first time since records began in 1993.

Overall, mortgage holders paid back £418m ($681m) more than they borrowed. This was in spite of approvals for new mortgages reaching a 17-month high. As the Guardian notes, "cautious consumers and strict lending criteria kept net lending low".

The UK's housing bubble created major demand for most chemicals. If consumers and lenders remain cautious, as seems likely, it will prove very difficult to quickly replace these volumes with other applications.

Today is Labor Day holiday in the USA. But sadly, the latest news on jobs remains deeply worrying. As the chart from the New York Times shows, jobs are still being lost (blue line), long after recovery had begun in downturns from 1974 - 2000. And far more jobs have already been lost.

Total jobs lost since the downturn started now amount to 7.4m, the largest decline in any slump since World War 2. Unemployment rose to 9.7% in August, with 14.9m Americans out of work. And a further 5m were out of work for over 26 weeks (and not counted in the 9.7% rate).

These job losses have continued even with major stimulus programmes in place. And the Financial Times reports that 40% of the 35m Americans now on food stamps (worth c$290/month) are also working part-time, which suggests that wages outside the financial sector are starting to fall.

The figures make it seem very unlikely, to the blog at least, that any "recovery" in official GDP figures will lead to a rapid rise in consumer spending. And that, at the end of the day, is the key factor that will determine chemical company sales and profits next year.

China was the first major country to feel the impact of the financial crisis. In August 2008, it noted that "the era of low costs and high growth has come to an end for China, and an economic restructuring is inevitable".

Since then, of course, China's export-dependent economy has meant it has been one of the worst-hit economies. GDP growth fell to 0% in Q4 last year, when 23m jobs were lost. Thus the blog was fascinated to read a detailed status report on the government's recovery efforts by Premier Wen Jiabao in today's China Daily.

Wen says China has so far only replaced 6.66m of the lost jobs, and warns that "to counter the global financial crisis is a long-term and arduous task". He adds that "the impact of the crisis is as strong as ever and is unlikely to disappear anytime soon". And he worries that "the stabilization and recovery of the Chinese economy is not yet steady, solid and balanced. With many uncertainties remaining in the prospects of the world economy, we still face tremendous pressure of the decline in external demand".

Last year, exports represented 37% of China's GDP, and these are still down over 20% versus 2008. Just replacing this volume is itself a major task. Wen is therefore only being realistic when he suggests that "perseverance" is required as boosting "domestic demand is a long-term strategic policy", and not the 'quick fix' assumed by financial markets.

Any executive whose business depends on China, directly or indirectly, would probably find the full speech well worth reading, for the perspective it provides on the government's current ambitions and future goals.

Globalisation flourished whilst economic growth was strong. Jobs lost in Western countries were replaced by new jobs. Whilst cheaper production offshore kept consumer prices low, as well as bringing more people into the world economy.

But today's economic downturn means this virtuous circle is turning vicious. Western countries are becoming more protectionist and hope to repatriate offshore jobs. Thus the USA, with nearly 10% unemployment, has now imposed a 35% import duty on Chinese tyres.

The justification is the 3-fold increase in China's US market share to 17% between 2004-8, whilst 4 US tyre factories shutdown. Such "market disruption" allows punitive duties to be imposed under World Trade Organisation rules. Thus. as we forecast in our landmark 'Feedstocks for Profit' Study last year, regionalism is now making a comeback.

Chemical companies supplying the tyre industry will be amongst the first to have to consider relocating their plants back home. But with high oil prices also increasing the cost of extended supply chains (as P&G have noted), many others will need similar debates as the downturn continues.

After destocking, and then restocking, what next?

The blog is a great believer in following the insights of the major retailers, who have been consistently "on the money" in their analysis. Thus it takes very seriously the comments of Wal-Mart CEO, Mike Duke, who has joined the camp of those who believe we face a "new normal" - not a return to the levels of demand seen in the 2003-7 boom period.

Interviewed by the Financial Times, Duke was quite clear about the challenges ahead. "The 'smart' shopping, the customer that really looks at price and value and quality, the deferral of purchases ... this is something that will be with us for a long, long time."

Whilst chain-store JC Penney, which targets middle- America, told investors that "consumers are acting rationally, they are paying down their debt, they are spending for things they need. And for the more discretionary thing, they are being more cautious." US Federal Reserve data confirms this trend, with consumers repaying $21bn of debt in July, the largest amount ever seen since records began in 1943.

Equally, the head of ING, the largest US thrift bank told US investment magazine Barrons that "a lot of the data is showing there's a fundamental shift in spending habits". CEO Arkadi Kuhlmann said demand for the critical Christmas sales will be relatively slow as 80% of people now believe that "having money in the bank" makes them happier than "buying something".

US private consumption is worth $10trn and accounts for 16% of total world GDP. So this change of spending habits carries enormous implications for chemical industry demand. The blog's annual Budget Outlook, due next month, will tackle the issue in more detail.

It might be interesting to see whether blog readers agree with the ING opinion poll results.  You can vote below, if you wish.

The above chart, from Moncef Hadhri's excellent monthly report from CEFIC (the European chemical industry association) provides an interesting snapshot of the state of the EU chemical industry.

On the positive side, it shows that recovery from the destocking period was well underway in June (the latest data available). Volume (green line), had risen 10% from November's low of 82. And versus June 2008, volume is now down 'only' 12.4%, versus November's 25% decline.

But on the negative side, EU volume is now down 18% versus the all-time peak of 110 seen at the end of 2007. Volume is also 10% below 2005's average level of 100. This figure will clearly improve as restocking continues down the chain. But even if we get back to the 100 level, this will still mean the industry has effectively 'lost' 3 - 4 years of growth.

US corporate earnings were down a record 89% in Q1 versus the previous 12 months at just $7. Q2 saw only a minor improvement with earnings at only $8. Its interesting, therefore, to see market expectations for 2010.

The chart is based on S&P analyst forecasts, and shows "reported earnings" (red line) are expected to recover to c$45 in 2010 as restocking continues. But this would still only take them back to 2003 levels.

Unsurprisingly, therefore, analysts are choosing to focus on "operating earnings" (blue line) which, as the blog discussed last month, exclude many negative items that have to appear in "reported earnings" under GAAP accounting standards.

This discrepancy featured in the 2000-2 downturn, but was not seen in the 1990-4 downturn. It thus usefully highlights the wide gap between those expecting a quick V-shaped recovery now restocking is underway, and those who (like the blog) fear a more prolonged U-/W-shape will develop.

Pity your poor CFO. As well as keeping cashflow positive, they are also coping with major US$ volatility. In July 2008 it was trading at $0.63: €1, but then rose 43% to $.80: €1, before declining 28% to $0.68: €1 today.

The catalyst for this volatility seems to be oil price movements. As the chart shows from a new report by the James A Baker III Institute (kindly forwarded by my fellow-blogger John Richardson), there has been an 82% inverse correlation between the US$ exchange rate index and changes in crude oil prices since 2001.

The reason is that tighter crude oil supply/demand balances have led to higher oil prices. As a result, US oil imports cost $331bn in 2008, and were 47% of the US trade deficit, versus just 19% in 2002. So last year's collapse from $147/bbl in July to December's $34/bbl was good news for the US$. But this year's recovery to $70/bbl has caused a further US$ fall.

Adding to the CFO's problem is that 2009's price movements have been purely speculative, as traders 'look through to economic recovery". OECD crude oil inventories have actually risen steadily, from 52 days in June 2008 to 57 days by December, and then to 62 days by July 2009. Equally, today's US distillate stocks are the highest since 1983, whilst European heating oil stocks are at an all-time record.

Nothing is certain in life but death and taxes. But with refining margins now only $3.42/bbl, a fall in crude prices back towards $40/bbl would not be too surprising. CFO's probably need to consider whether to hedge against this possibility, and the problems it could cause - not only with year-end inventory, but also via a "surprise rally" in the US$ as well.

ExxonMobil Chemicals was 6th in the ICIS list of Top 100 companies in 2002, during the last downturn. By last year, it had risen to 2nd place, according to the latest ICIS list.

One of the secrets of its success was set out in an interesting Bloomberg interview yesterday with Basic Chemicals SVP, TJ Wojnar. This made it clear that EM is focusing ever more intensively on optimising production along the refining/petchem interface. Thus Wojnar noted that "the company would only consider buying plants that can be connected directly to Exxon Mobil oil refineries", in order to ensure that "by-products of the refining process can be turned into chemicals when fuel demand and prices are low".

Wojnar also gave an interesting example of this strategy in action, revealing that over the past 3 weeks, EM has been increasing the amount of refinery-produced vacuum gasoil (VGO) used in ethylene/polyethylene production, due to slowing gasoline demand. As he noted, the rationale for this move was simple, that "VGO is in surplus", and so it made sense for the company to take advantage of the lower feedstock cost..

Last November, the blog suggested "4 tips for survival", based on a Financial Times series on recession survival strategy. A new article this week on 'Leadership beyond a Downturn' provides some key tips on how to manage next steps:

• Prepare for continuing downturn, but also for some growth to return.
• Look outside to see what's changed, don't rely on old strategies.
• Continue to keep a close eye on cash-flow, but loosen some constraints.
• Maintain clear and honest communication, acknowledging uncertainties.

The blog believes that the landscape has changed during the current downturn. We came into it on the back of a major boom in consumption, supported by reckless lending and borrowing. This mind-set seems unlikely to return quickly.

Instead, as the period of destocking/restocking comes to an end, we may face a "new reality". This probably involves a paradigm of higher savings, lower consumption, and global GDP growth of perhaps 2.5% rather than the historical 3.5%.

This scenario is more challenging than the consensus view of a quick V-shaped recovery. But if correct, it will also present a number of major opportunities for those companies who recognise that the basis of industry competition has now changed.

I outline some of the key issues in a new article for this week's ICIS Chemical Business. Please click here if you would like to read it. As always, I would welcome your insights on the points discussed.

China's perceived demand has been the major driving force behind the rallies in financial and commodities markets this year. It has also attracted large volumes of polymer imports. But this wishful thinking ignores the fundamental issue that China's economy is relatively small (just $4trn in a world economy of $60trn) and is 104th in terms of GDP/capita ($3k, versus $46k in the USA).

Instead, traders have focused on the opportunity to make easy money, with at least 50% of the government's $1trn lending package estimated to have been used for speculative purposes. As the blog has noted, the Dalian futures markets has been a focus for some of this activity - at its peak in April, 80 million tonnes of LLDPE was traded, versus total world annual demand of c2 million tonnes.

Since then, the bubble has begun to deflate, and September's volume continues this trend. It was down 63% from April, at 29 million tonnes, whilst PVC trading volumes crashed the same amount in just one month. Volume still has a long way to go to return to more "normal" levels, but the trend (blue line) in the chart is clear. No government, not even China's, can continue to lend 25% of its annual GDP every 6 months.

My first European Petrochemical Association (EPCA) meeting was in 1985. Since then, I have found that it provides an unique opportunity to look back over the current year, and focus on what might happen next.

Thus in October 2007, just after I began writing the blog, my discussions led me to warn that we were at "a turning point in the petchem cycle". Similarly, last year, it helped to convince me that we should expect "a multi-year downturn" of the type we had seen in the early 1980's and 1990's, and not a short V-shaped recession as in 1997-8 or 2001-2.

This year, however, I found myself sharing the consensus view. Very few people claimed to see any sign of a real upturn in critical demand areas such as housing and autos. In fact, visibility on future orders seems as low as ever, as companies focus on reducing working capital for year-end.

This led me to reflect on where we are in the industry cycle. As readers know, I have long argued that the 2007-8 period was paralleling 1979-80. Then, as recently, a major oil price rise led to a massive rise in inventory (as companies bought ahead to beat price rises), whilst end-user demand was collapsing. And the result was the same - a traumatic collapse in demand as people destocked, followed by modest restocking.

Thus I found myself thinking of parallels with 1981-2. And I was reminded of an excellent series of lectures that I attended many years ago at the IMD business school, given by Prof Casse. His summary slide, above, provides the clearest view I have ever seen of the "life-cycle" through which industries seem to pass. It features 6 distinct stages:

1. The industry enjoys some success and cautiously expands (eg 2003-4)
2. Emboldened by success, it then takes greater risks (eg 2005-7)
3. Sadly, it then hits problems, and failures occur (eg 2008)
4. It discovers there is no "quick fix" and begins to struggle (eg 2009)
5. Then, it begins to learn from its mistakes (2010 ?)
6. Finally, it discovers strengths and potentials (2011 onwards?)

This year in Berlin, I was reassured to find a number of companies, including many of the largest, starting to move into Stage 5. I found this very positive. Clearly we face major difficulties as an industry, with slow demand growth and growing over-capacity. But there will also be opportunities, for those who correctly identify the strengths that will be required to access them.

(If you would like a copy of Prof Casse's key slides, please click here)

The blog has argued for some time that the chemical industry is facing a "new normal" as growth returns to the economy. Now US Federal Reserve Governor Dan Tarullo has helpfully spelt out some important changes that he expects to occur. He notes that:

• "Just about everyone understands we will never return to the credit markets of the middle part of this decade"
• "The habit of building personal savings predominantly through appreciation of one's home is one that Americans will have to change.
• "The growth models of emerging market countries dependent on unshakeable American consumption and ever-increasing borrowing will not be sustainable even as recovery becomes more established."

Tarullo also highlights the fact that "very few people believe they understand what the "new normal" will look like once the crisis has fully passed and the economy is on a sustained recovery path." He adds that "I suspect that this uncertainty is itself an impediment to stronger growth, since it makes financial planning more difficult."

The blog will aim to answer some of these key questions, as they relate to the chemical industry, when it presents its annual Budget Outlook next weekend.

The blog is now preparing its annual Budget Outlook for 2010. Before this is published next weekend, it makes sense to assess the blog's credibility by looking back at last year's Outlook, to see how well it performed. Past performance may not be a perfect guide to future outcomes. But it is one of the best that we have.

The 2009 Outlook was titled "Budgeting for Survival". Once again, as with the 2008 Outlook, "Budgeting for a Downturn", the blog was in a small minority of forecasters who had the courage to go against the optimistic consensus. Its main forecasts were:

• "Survival, not growth, is the prudent objective".
• "2009 is likely to see global recession".
• "Chemical demand is likely to be badly hit, as it is focused on consumer spending, particularly housing/construction and autos".
• "These areas may begin to bottom during 2009, but any real recovery is unlikely before 2011".
• "Unemployment is likely to rise, and banks will be reluctant to lend".
• "Companies selling into more favoured sectors (agrochems/pharma) will probably see lower demand and pricing pressure".
• On oil prices, "the most likely outcome is that OPEC will cutback production and seek to hold $70/bbl".

The blog's aim is to 'share ideas about the influences that may shape the chemical industry over the next 12 - 18 months'. It therefore feels very proud of having correctly forecast these key areas correctly.

It hopes that its 2009 Outlook enabled readers to better prepare for today's more difficult economy.

Our major Feedstocks for Profit Study last year foresaw difficult times ahead for European refiners. Now it seems this forecast by our partners, refining experts Wood Mackenzie, is coming true.

Total, Europe's largest refiner, today reported that European refining margins fell 85% in Q3, to just $6.60/bbl, the lowest level for 7 years. And they note that demand for oil products is falling, as the economy remains slow and consumers cut back on travel.

Wood Mackenzie will give their latest insights at our European Aromatics & Derivatives Conference next month in Amsterdam, co-organised with ICIS. Attendees will also hear from several leading industry experts including speakers from BASF, Shell and Reliance.

Please click here for further details.

2010 should be a better year for the chemical industry, as demand grows in line with a recovery in global GDP.

But a quick V-shaped return to the 2003-7 Boom years in terms of volumes/margins seems unlikely.

Governments will worry about budget deficits, and may well scale down support for critical end-uses such as autos and housing. Equally, major amounts of new capacity, planned during the Boom years, will start to come onstream in the Middle East and Asia.

In effect, therefore, 2010 will be a year of transition to a 'new normal'. The blog expects global GDP growth rates to average around 2.5%- 3% for the next few years, the 1980-2000 average. This will be a significant reduction from the 3.5%-4% levels seen in the Boom years.

The rationale for this change is that we will start to see a rebalancing of the global economy. The West will see lower consumption, as people rebuild their savings, and borrow less. In turn, this will mean lower export demand for the emerging economies. The outcome will be a more sustainable world economy, but it will be a difficult journey.

Growth Forecasts. Most chemical markets are mature, and growth rates are therefore tied to GDP. The blog would therefore suggest that companies review their forecast growth rates for individual businesses in the light of their expectations for global GDP growth. One of the problems of the Boom years was that arbitrary growth rates (often of 5% or more), were assumed for many products. This also led to a perception that major amounts of new capacity were needed to meet this assumed demand. A more realistic view of demand would highlight potential problems of over-capacity, and perhaps encourage companies and governments to address the problems this will bring.

Demand. On a global basis, chemical output is now back at 2006 levels, having lost 3 years of growth. If GDP now grows as the blog expects, then demand from key sectors such as construction/housing, autos and electronics should improve next year. But the impact of government stimulus measures will make for a bumpy ride. The end of specific measures will cause major falls in perceived demand, whilst new stimuli will create short-term upward fluctuations. Excellent supply chain management will therefore be required, and Boards will need to keep a very careful eye on underlying trends.

Protectionism. Unemployment is set to become a key political issue in the West, as economies adjust to the 'new normal'. Hopefully, it should peak in 2010, but is unlikely to quickly return to previous levels. Arguments about the 'export of jobs' will therefore increase, and lead to a rise in anti-dumping activity. In turn this will cause job losses in emerging economies. Chemical companies will need to keep a close eye on the political arena, as they operate in a complex value chain, and may not otherwise appreciate the potential impact of a development in a key supplying or consuming industry.

Credit issues. A recovery in demand puts great strains on cash-flow, and many companies go bankrupt as a result. This could be a particular problem in the current recovery, given the underlying fragility of large parts of the banking system. CFOs will need to institute robust monitoring mechanisms, and be prepared to keep customers on 'cash before delivery' terms if they have grounds for concern. New customers represent a particular risk, if their credit history is weak, even though their promised volume may be attractive.

Oil prices. These are likely to remain volatile in 2010, as speculative price movements linked to traders' bets on the US$'s value will continue. Neither $100/bbl, nor a return to $40/bbl, would be a great surprise on a day-to-day basis. But underlying supply/demand balances may well remain weak in 2010, in spite of the expected economic recovery. Thus we might see prices coming under more pressure during 2010. $50/bbl might be an average price, in the absence of major geo-political events.

Overall, the blog expects 2010 to be a transition year. Full economic recovery is unlikely to take place much before the 2011/13 timeframe. But the return of economic growth will offer companies the opportunity to identify likely future market needs. Those that focus on this new reality, rather than simply hoping for a quick return to the Boom years, will position themselves for future success.

The blog's new Budget Outlook is an independent view of the key issues which will impact chemical sales and margins in 2010. Previous Outlooks have stimulated much debate within the industry. We are therefore proposing to run a free 1 hour Webinar next week for blog readers, on Thursday 29 October at 15:00 GMT (16:00 CET, 11:00 EDT, 19:00 Dubai).

The format will be a 30-40 minute presentation, followed by online discussion. The Webinar will be hosted using Microsoft Live Meeting. If you would like to join the Webinar for the presentation, please click above, and use entry code w@\!7{F For audio you will need to dial +44 1452 584201, conference code is 4389561610

If you wouild like to obtain a PDF copy of the presentation before the Webinar, please email either Simon.Robinson@icis.com or myself, adding 'Chemicals and Economy Group' in the subject line of the email. Colleagues and business partners are also very welcome to join the Webinar.

Protectionism continues to build, as unemployment rises around the world.

ICIS news reports China has imposed tariffs of up to 36% on nylon 6. BASF will suffer a 30.4% tariff on US exports, and Honeywell 36.2%. Last month, of course, the US hit China with a 35% tariff on tyres.

The threat of more duty barriers may well lead to a move to supply domestic markets with locally produced product. It therefore represents an increasing threat to the globalised business model adopted by many chemical companies.

Mid-week update. India plans 20% duty on caustic soda, ICIS news .

Protectionism will be one of the key issues discussed in the blog's free Budget Outlook webinar next week (details yesterday). If you would like to register, please email simon.robinson@icis.com or myself, with Chemicals and the Economy Group in the subject line.

"Never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform."
Bank of England Governor, Mervyn King,
proposing that banks should be split up.

He argues that high-risk trading activities should be split off from low-risk utility banking (eg payment systems). Then, next time the investment bankers go bust, only their shareholders will suffer. The blog imagines most people in the chemical industry would support the Governor's argument.

9 months ago, the blog reported on the resilience being shown at the UK's Wilton chemical site, one of the world's largest.

It noted that "the power of the teams being created there could be immense".

It is therefore delighted to see that the North East Process Industry Cluster (NEPIC) is now moving forward on a new initiative aimed at creating a framework to ensure the area's survival.

This is being led by the blog's friend and former ICI colleague, Bob Coxon, supported by all the major stakeholders. He has made it clear that "any initiative had to be private- sector led. But government also had a role to play in creating a framework that made that process easier."

Hopefully, government is starting to get the message. Lord Mandelson, UK Business Secretary, has recently repeated his call for "less financial engineering and a lot more real engineering." He has also recognised that the UK is the world's 6th largest manufacturer - something that has been rather forgotten in recent years.

China will pump loans worth $1.3trn into its economy this year, equal to 1/3rd of GDP. Equally, by tying the yuan to the US$, China has achieved a major devaluation against major currencies such as the euro.

The result has been that China's Q3 GDP rose less in "nominal" terms than in "real" terms. Normally one has to deduct inflation from the "nominal" figure. But in Q3, China's "nominal" GDP growth was just 4.7%, but rose to 8.9% in "real" terms as a result of massive deflation.

When one looks at specific chemical industry statistics, the result is just as alarming. As the blog noted back in February, China allocated $58bn to accelerate the implementation of petrochemical expansion plans. And as ICIS news has reported, the new capacity is clearly not being delayed.

The two big projects for 2009, PetroChina Dushanzi and Fujian are now online. And there seems little reason to expect 2010's big projects (Sinopec Tianjin, Sinopec Zhenhai) to be delayed. Including other smaller expansions, and PetroChina Fushun in H1 2011, China will have increased ethylene capacity by 6 million tonnes in 2.5 years.

The impact is shown in the excellent new ICIS Asian weekly polyethylene margin report above. The yellow bar shows regional ethylene margins (based on NEA export netback values into PE) are already down to just $105/t. As one experienced industry observer told the blog, "2002/3 conditions are beckoning" if Western demand does not recover quickly.

The blog has learnt to be sceptical when new political leaders announce new directions for their country, after winning elections.

But its Japanese friends emphasised at EPCA that real change might be taking place in Japan, after 50 years of LDP government.

This, of course, could have a major impact on Asian politics. Japan is also the world's 2nd largest economy, with GDP of $5trn, and a leading player in global chemical markets.

New prime minister, Yukio Hatoyama, certainly set out a new direction in his speech to parliament today, claiming that "we're standing at a crossroads whether to go down a declining path by holding onto traditional thinking or find a new road fostered by new aspiration and ideas."

He also played down hopes of a quick economic recovery, noting that "the financial and economic crisis has had a serious impact on the economy and unemployment, and things are still in an unpredictable state."

The purpose of liquidity in financial markets is to enable price discovery. But when super-fast computers take over the trading, that purpose disappears. Instead, we have today's "correlation trading".

Olivier Jakob of PetroMatrix demonstrates this with the above chart, which shows Tuesday's detailed trading patterns in WTI and the Dow Jones Index. Clearly, they are simply trading in tandem on momentum, with no regard for real fundamentals or market sentiment.

This creates a very high risk scenario for chemical companies. As Jakob notes, we are now in "a situation where no single market knows exactly what it is pricing". Real supply/demand balances for crude oil are irrelevant to these computers, and the traders who drive them.

But, at some moment, probably not too far away, fundamentals will reassert themselves. Higher oil prices destroy demand. Already, consumer confidence is falling, even whilst stock markets (normally a positive driver) move higher.

Prudent CFOs and business managers should be alarmed by what is happening, and take the necessary avoiding action. It will all end in tears.

The good news is that the stabilisation seen in Q2 has been maintained. But companies remain cautious on the outlook, to judge from Q3 reports.

CEOs are sceptical about the impact of government stimulus efforts in the West, and fear demand will fall back as these end. The only optimists are in China and India.

Akzo. "Overall we don't foresee a quick recovery."
BASF. "A very slow recovery and an uneven recovery at that."
Bayer. "Too early to speak of a self-sustaining upswing in industry".
Borealis. "We are seeing a slow grind upwards".
BP. "Margins under pressure in Q4 due to new capacity".
Bunge. "Fertilizer business pressured by weak pricing."
Celanese. "See modest recovery of global economies."
Croda. "Tough market conditions".
Dow. "Do not count on material improvements in market conditions."
Dow Corning. "Still feeling the impact of the global economic recession."
DuPont. "Seeing market stabilisation and early signs of recovery".
ExxonMobil. "Earnings down by 19%, mainly due to weak margins".
WR Grace. "Dynamic and challenging market conditions."
Henkel. "We see stabilisation in our markets".
Ineos. "Challenge is the slow return of domestic demand."
Lonza. "Environment of high volatility is expected to continue".
LyondellBasell. "Outlook weakened by signs of declining US PE exports."
Nalco. "Starting to return to a growth path as economies recover."
Occidental. "Continued weakness in the US economy".
PetroChina. "Ethylene output in the 9 month period rose".
Polimeri Europa. "Prolonged weakness in industry fundamentals".
Praxair. "Demand has yet to show meaningful signs of recovery".
Quaker. "Still a great deal of uncertainty in our end markets."
Reliance. "Demand for most petrochemical products remained strong".
SABIC. "Has maintained the same operational levels."
A Schulman. "Signs of economic recovery could prove misleading."
Sherwin-Williams. No real signs of "the rumoured economic recovery."
Shell. ""Affected by the weak global economy."
Sinopec. "Demand upturn of chemical products".
Solvay. "Continued to be affected by the difficult economic environment"
Trelleborg. "Demand in many segments remained weak".
Yara. "Distributors still unwilling to build inventories for the spring".
Yule Catto. "Uncertainty remained about the global economic situation".

"Buy on the rumour, sell on the news" is the classic indication of a weak market. A lack of follow-through buying reveals that market action is not supported by fundamentals, but only by sentiment and momentum.

Friday's 2.8% fall on the US S&P 500, in reaction to Thursday's positive US GDP number, was therefore a clear sign of underlying weakness. Equally, the new IeC Boom/Gloom Index (above) shows no increase in sightings of "green shoots". And the Frugal Index has actually risen.

This conclusion is supported by the generally cautious tone of recent company results. The chemical industry is a well-known leading indicator for the global economy. If a real upturn was underway, the major western companies would have noticed it by now.

This year's speculative boom in China's economy, created by major government lending and stimulus programmes, now seems to be ending.

The evidence for this is in the above chart, showing LLDPE futures trading on the Dalian exchange. This hit 80 million tonnes (MT) in April, versus total global output for this type of polyethylene of only 2MT a year.

But volume has since been falling steadily. Last month, it was back at 13MT. And prices failed to make new highs, even though crude oil prices hit a new 2009 peak at over $80/bbl.

The blog is changing its US auto sales chart, now that a year has passed since volumes collapsed last October. Year-on-year % changes become meaningless as a result.

Instead, it will now show monthly volumes, on a total US basis (blue line) and for the major producers (dotted lines). Key highlights this month are:

• The impact of the stimulus programme has now disappeared. Total US sales were 673k vs 1007k in August.
• Ford, GM and Toyota maintained the same volumes as in October 2008, but Chrysler was down 30%.
• Looking back 2 years to October 2007, total sales were down 30%. Toyota and Ford were down c25%: GM and Chrysler were down c50%.

US autos are a critical market for chemicals. Between 1995 - 2007, over 15 million were sold each year. Last month's annualised sales rate was just 10.5 million. This implies a total market worth only $29bn, versus over $40bn in 2007. This change is one indicator of the 'new normal' that the blog expects for the next few years, as Western consumers spend less and rebuild their savings.

In these circumstances, chemical companies with the best strategy and execution ability will be relative winners, like Ford and Toyota. Those who do not adapt well risk following the fate of GM and Chrysler into bankruptcy.

Recent comments from LyondellBasell's COO, and BASF's CEO, seem worth highlighting as we come to the end of the results season.

Ed Dineen noted that China's polyethylene demand seems partly linked to changes in crude oil pricing, "It turned down somewhat as we saw crude retreat a little, but as crude turned back up toward $80/bbl, we saw the Chinese market react strongly to that".

Secondly, Jurgen Hambrecht worried that although "business had stabilised at a low level", "little attention was being paid to structural overcapacities".

Hambrecht also warned that "the effects of stimulus packages are starting to peter out, many companies are dealing with financing problems, the number of bankruptcies is increasing and unemployment is rising".

Politicians and analysts often focus on selling dreams. Otherwise, we might not be tempted to buy their promises of better times ahead.

But those running businesses have to remain realistic. BASF's CEO, Jurgen Hambrecht, did exactly that in his comments on the outlook. And the above chart, from the UK's National Institute of Economic and Social Research, provides a visual example of the current economic position.

The black line shows the change in UK GDP during the 1930/34 recession. And the thick red line shows how uncomfortably close we are to following its path in the current downturn. Only the 1979/83 recession (green line) comes close to matching it in recent times.

Of course, some countries are currently seeing better economic performance than the UK. But it is still the world's 6th largest economy, and accounts for 3% of global GDP. As such, it is not a bad benchmark.

The blog does expect GDP to begin to recover in most major economies next year. But the chart is a good reminder that it may take some years for many countries to regain the 2007 peak in terms of actual size of GDP.