Chemicals & The Economy

The US Senate thinks the Amaranth hedge fund increased the costs of natural gas futures contracts last year. Any pension funds invested in Bear Stearns' hedge funds might want to check on the current value of their holdings.

Housing and autos have always been key drivers for the US chemicals industry. We should be concerned if the housing market weakens further.

Yesterday’s "swings in financial derivative prices were so extreme that they implied scenarios in which the core of the global liquidity system suffers a serious assault", according to JP Morgan, the investment bank. Watch out, if current US sub-prime mortgage problems turn into a more general “flight from risk”.

Bill Gross runs PIMCO, the world’s largest government bond managers with assets of nearly $700bn. In a new commentary, he pulls no punches about what he sees as the ‘gluttony’ of the super-rich amongst the private equity and hedge fund elite. He also takes aim at the lenders who, in his view, have been ‘too meek and too passive’. He sees the end of the era of cheap debt financing, and with it the boom in M&A that has sustained equity markets in recent years.

Normally a 275 point fall on Wall Street, and a 600 point fall in Hong Kong, would make for some headlines. But this time, the media coverage has been very muted. Presumably everybody thinks it will be another '9 day wonder', and believes with Chuck Prince of Citigroup that one simply has to keep ‘dancing'. But equally, there are some quite worrying opinions now being expressed about the underlying risks that might impact us later in the year or in 2008. I thought you might like to see them:

‘What we saw last month was a toy trainset model of what is in store for us with the unwinding of the great credit bubble’. John Dizard, Financial Times markets commentator.

(NB the first and last quotes are from the Financial Times, which unfortunately has a subscription only policy for its stories, so I haven't included the link details in order to avoid frustration if you tried to click through).

I mentioned PetroChina in the very first blog entry, when the stock was trading at $155 in New York. It seemed to me to typify the new mood of confidence that I was finding as I travelled in Asia on the 10th anniversary of the Asian financial crisis. Little did I think that just 3 months later, it would be trading at $260.

This meteoric rise in the Chinese stock market has left me feeling more than a little uneasy, as to whether confidence has now turned into pure speculation. And this concern has been amplified by news this week that legendary investor Warren Buffett has sold his entire 11% holding in PetroChina, for a $3.5bn profit. Agreeing that, as usual, he sold ‘a little too soon’, he told Fox Business News yesterday that the sale was due to his concern over valuation.

Buffett clearly feels that the best of the China stock market run is behind us, at least for the moment. It will be interesting to see how much longer the present surge can last, and what the impact will be if (when?) it tumbles back to reality.

And in the meantime, it was also interesting to see that in the same interview Buffett denied that he had ever been interested in buying troubled investment bank, Bear Stearns. He added that he was still steering clear of the housing market and US housing stocks, as ‘prices still didn’t seem low enough’. As Buffett tends to buy and sell early, this is a salutary warning that there may well be more trouble ahead for this critical area of chemicals demand.

CFOs are paid to worry, but their worries seem to be increasing quite rapidly, according to the results of the quarterly CFO survey by Duke University/The Economist. This showed:

• Record pessimism about the US economy, with US CFOs worrying about ‘weak consumer demand, high fuel costs, rising labor costs and credit markets’.
• European CFOs are ‘dramatically more pessimistic’, and expect employment to fall 0.6%
• Asian CFOs are still optimistic about growth, but almost all CFO’s with Western multinationals said they were being told to increase revenue growth to compensate for slower Western growth.
• A third of Asian CFOs see Chinese growth as likely to slow, whilst 61% of Chinese CFOs expect a US recession to hurt their firms.

Credit market worries are particularly painful for US CFOs, with around half saying that credit has become less available, and that they have experienced an increase in the cost of credit. A third of European CFOs have seen the same impact. US CFOs also noted an increase in ‘hardship withdrawals’ by employees from their 401K savings account, as a result of a need to make mortgage payments or avoid personal bankruptcy.

Housing, as we know, is an absolutely key market for the chemical industry, both directly and indirectly. Directly, each new house accounts for $16k of chemical demand, whilst indirectly, years of rising western house prices has allowed consumers to cash out their gains to spend on Asian imports.

Now this virtuous circle has turned with a vengeance. And the subprime mortgage crisis is turning into a game of very big numbers. Earlier this week, the European Central Bank handed over €349bn, not too many questions asked, to 390 banks. It was also revealed that the Bank of England was now liable for around £50bn in respect of the continuing Northern Rock debacle.

Now the Financial Times reveals that the US is ahead of them both, handing out $746bn in Q3, on an annualised basis. Apparently the reason the US hasn’t (yet?) suffered a major bank run is that an obscure body called the Federal Home Loan Bank (FHLB) system has stepped in to replace the lack of liquidity in mortgage-backed loans.

The sums lent by now may be even higher, because like all government bodies, data releases tend to be delayed. But we do know it raised $210bn in November alone, presumably to fund loan commitments already made, on top of the Q3 lending. Its top 3 borrowers have been Citigroup. Countrywide and Washington Mutual – and one wonders what would have happened to their balance sheets without this infusion of federal money?

The Chairman of the FHLB, Ronald Rosenfeld, summed up the dilemma facing central banks and governments across the Western world. Asked by the Financial Times what would happen to the FHLB portfolios if house prices fell by 20 or 30 per cent, he replied: "I do not know the answer, but I can tell you I do not want to hear the news’.

But, he added, if the loans weren’t being made, and ‘if house prices were to depreciate 20% to 30%, you would simply have enormous problems in this country.’

Right at the start of the crisis on 2 August, I noted that Jochen Sanio, head of Germany’s financial regulator, had warned that we were facing ‘the worst banking crisis since 1931’. Since then, public statements from the world’s central bankers have remained calm. But actions speak louder than words. And it is clear from their actions that they too must share Herr Sanio’s fears.

I have often wondered how the major investment banks arrive at their forecasts for long-term crude prices. Last night I found out how it is done at the biggest player, Barclays Capital.

Dr Paul Horsnell, Head of Commodities Research, said that when he started in the role in 2003, he began by keeping close to the mainstream with a forecast of $24/bbl. Since then, as the market price has risen, he has simply doubled the previous price, deducted $1/bbl, and this number has become his new long-term forecast.

So from a starting point of $24/bbl, he then moved to a $47/bbl forecast, and is currently forecasting $93/bbl. When he next revises the forecast, he expects it to go to $185/bbl.

The interesting thing was that in a room full of eminent energy economists, as well as many senior oil industry people, nobody took issue with his methodology.

I had the opportunity last night to learn current thinking within the oil industry on the current outlook for oil markets, by attending the annual lecture of the British Institute of Energy Economists, kindly hosted by BP.

A year ago, at the same event, the crude price was $51/bbl. Last night, the headlines were ‘major fall in oil price to $91/bbl’. This captures the extreme volatility that now exists in oil markets, and which makes life an absolute nightmare for anyone who buys or sells oil-based chemicals.

The consensus emerging from the discussion was that markets will remain strong, and that the activity of speculators will continue to create volatility. High oil prices are not likely to stimulate new supply in the short-term, as most reserves are in areas that are difficult to access due to politics or geography. Equally, demand will continue to grow in the Middle East and Asia, due to massive government subsidies on domestic prices.

Stock markets are usually good indicators of future economic conditions. Their savage downturn since the start of the year suggests that investors now feel a growth slowdown is almost inevitable.

Barrons (the major US investment paper) today highlights another very worrying development. It notes that ‘selling rallies aggressively is (now) more fruitful than buying every little dip’. This marks a complete change of behaviour by investors. Barrons suggests that the rationale is that now ‘overshoots tend to occur on the downside’ rather than on the upside.

The basis for the argument can be seen in the chart, which plots the relative performance of 5 main indices (the German DAX, UK FTSE 100, Shanghai Composite, US S&P500, Japan Nikkei) over the past month. All are down by around 15%, with Japan down over 20%.

These are major losses by any standard. Particularly at this time of year, when seasonal influences are strongly positive. And although rallies have taken place, these have soon given way to further falls. Last Friday, for example, news of the Bush stimulus package led to a major intra-day rally in the US, but the market still closed down. And today, more selling has taken place in Asia and Europe.

Unless something changes quickly, this synchronised downturn would imply that we are now in a fully-fledged global bear market. Strong rallies do occur in bear markets, just as corrections happen during bull markets. But they cannot disguise the fact that the overall trend has become negative.

In turn, this would suggest that chemical companies should not expect either that consumer demand will recover quickly, or that Asia will successfully ‘decouple’ its economy from western markets. They should also be very careful about credit risks, as if the economy does go into a slowdown, company defaults will rise.

Its now a year since the blog started. Since then, 213 postings have appeared. It is now read in 72 countries and 620 cities (shown above). Most encouragingly, readership continues to steadily increase. Since January, it has risen a further 301%.

The blog's aim is to identify 'the influences that may shape the chemical industry over the next 12 - 18 months', and to 'develop useful insights into the key factors that will drive the industry's future performance' . So a first birthday is a suitable moment to assess its success:

The G-20 was created in 1999, after the financial crises that had hit emerging countries from 1997 onwards. It includes the G7 group of major industrial companies, plus the main emerging economies, including the BRIC countries (Brazil, Russia, India, China). Its ministerial meeting this weekend became a preparatory session for its first-ever Heads of State meeting in Washington on Saturday, with the aim of developing "concrete policy outcomes".

Encouragingly, China used the occasion to announce a $586bn stimulus package, to be spent by the end of 2010, focusing on rural development and infrastructure programmes. As Zhou Xiaochuan, governor of the People's Bank of China, noted "if China can maintain domestic demand, its helpful for global stability". The BRIC countries also announced measures to promote trade flows between themselves, in an effort to compensate for lost exports to the West.

The background to these efforts is a forecast from the International Monetary Fund that world growth in 2009 will be at a recession level of 2.2%, and less than half the 5% seen last year. The IMF also forecasts that "output in the advanced economies (US, Europe, Japan) will contract" next year. This would be the "first annual contraction since 1945", and be "broadly comparable" to the major recessions of 1975 and 1982.

The blog's forecasting record is reviewed in ICIS Chemical Business this week. Click here if you would like a copy. The blog's aim is to "highlight relevant information for the busy executive, and to provide relevant and actionable analysis of key issues". The article particularly notes the blog's willingness to challenge consensus forecasts.

The blog has warned for over a year that the chemical industry faced a global downturn. It has developed a good track record on forecasting movements in oil prices, and it also forecast the global financial crisis in early September under the heading 'the price of all assets will go down'.

Current market conditions are causing problems for everyone in the chemical industry. But as the blog has long feared, they are particularly testing those companies with higher debt levels. On Friday, Moody's announced a downgrading of the Corporate Family Rating of Lyondell Basell Industries to B3 to B1, and said the outlook "remains negative".

Yesterday, INEOS asked for "a waiver on its covenants". As the Financial Times reports: "The highly indebted chemicals group is struggling with a loss on its large inventory of oil following the decline in petrochemicals prices. It is also feeling the knock-on effects of a rapid deterioration in the housing and automotive sectors, two big users of its products."

The FT says that INEOS currently has €7.3bn in net debt. Q3 EBITDA was reportedly 20% down at €402m, causing INEOS to ask for the waiver for the next 6 months "whilst we wait for the mists to clear". The FT adds that INEOS will present a new 5 year business plan to its bankers by April, and could consider selling assets to reduce leverage.

An interesting note from PetroMatrix highlights the close linkage that has now developed between changes in the Dow Jones Industrial Average and WTI crude oil prices.

The chart, showing market action on Thursday, makes the point very clearly.

PetroMatrix's analysis suggests that "the correlation across asset classes remains very strong and there is little diversification of sentiment or of asset fundamentals".

Surprisingly, our 7th European conference this week in Cologne (co-organised with ICIS), was one of our most successful. Delegate numbers were down, as companies cut travel budgets. But those attending said they had gained much more, than if they had stayed in the office.

For a start, there was the opportunity to share experiences, and put today's problems in context. My colleague, John Keeley, focused on the scary nature of today's demand slump when opening the conference. But he also reminded delegates that one must remain pro-active. His "yes, we can" approach became the key theme of the event:

• Pierre-Emmanuel Goffinet of GTIS showed how companies could use trade statistics to better understand what is happening in their markets
• Phil Allen of GEMS outlined new marketing tools to maximise profit by better understanding customer needs
• Wood Mackenzie suggested that the coming gasoline glut created an opportunity for producers to obtain cheaper feedstocks

Delegates also came away with a real insight into current problems in financial markets. Nigel Davis of ICIS insight analysed the factors behind the current collapse in demand. Whilst Paul Satchell of ING, who had correctly warned last year that the crisis had hardly begun, focused this year on the problems caused by lack of visibility down the value chain.

Summing up the 2 days, I said that I hoped the New Year would see a welcome recovery in demand. Factories will reopen downstream, and customers will need to rebuild inventories. But I warned that this would provide only temporary relief, with housing and autos in recession.

My advice was therefore to use the next few weeks to develop, and implement, robust plans to survive an extended downturn.

There is now general agreement that we are in a global recession. The World Bank's new 'Global Economic Prospects' report expects global GDP growth of only 2.5% this year, and just 0.9% growth for 2009.

This is well below the 3% level that signals recession. And the Bank also forecasts that world trade will contract in 2009, for the first time since 1982.

The key question is therefore how long this recession will last? The blog's research has highlighted 4 main scenarios:

V-shaped. The optimistic view is that recovery is just round the corner. But this seems unlikely, given the headwinds of the credit crunch and looming over-capacity in many key chemical products.

U-shaped. This is the blog's base case. It implies the recession bottoms in 2010/11, and then begins to recover. Early decisions to close high-cost plants, and cancel unnecessary new capacities, would also be required.

W-shaped. This is often seen in serious recessions. Severe destocking leads to an apparent early recovery, as the value chain restocks. But demand then slips back again, before properly recovering.

L-shaped. This is the worst case scenario, as it implies demand could fail to recover by 2011, and might instead remain at a low level. This would mirror Japan's experience post-1990.

The blog's view is that it would be very optimistic for companies to plan on the basis that this recession will be V-shaped, as in 2002/3 and 1997/8.

Instead, it shares the view of a senior BASF executive, who has reportedly said he had "hoped it would be a U-shaped recovery (as in the early 1980's and 1990's), but now thinks it could become L-shaped".

The blog has been searching the websites of the major central banks, such as the IMF, World Bank, Federal Reserve and Bank of England, for research on the history of credit crises. Several readers, including Paul Noble of Parsons Brinckerhoff, have also kindly forwarded helpful studies.

The most comprehensive study that it has found analysed 33 banking crises between 1977-2002 and concluded:

• The average length of each crisis was 4.3 years
• The median loss of GDP was 7.1%
• Major crises (such as today's) caused GDP losses of at least 10%.
• GDP losses can double if the banking crisis leads to a currency crisis

The studies also suggest that lack of effective government action (eg depositor guarantees and liquidity support) causes even greater GDP losses. The US Depression led to 30% of GDP being lost.

Another key message from the research is that even "successful" government intervention comes at a high price. This is because it causes banks to lower their risk profile in two key ways:

• They prefer to hold government debt rather than make corporate loans
• They only lend to the very safest borrowers

This change in risk profile means that government intervention has the side-effect of breaking the process by which banks provide credit for the real economy. Inevitably, therefore, credit crunches are deflationary.

History's lessons on the likely course of today's crisis are thus not encouraging. Governments will initially find it easy to borrow, but face the risk of a currency crisis if foreign lenders begin to suspect they will never be able to repay the money borrowed. Companies however, will find it more difficult to borrow, as banks "de-risk" their balance sheets.

Consumers therefore face an increased risk of unemployment, and so will tend to save more, rather than spend money. In turn, this will reduce demand - further pressuring companies, and government's ability to provide fiscal stimulus.

The blog is now 2.5 years old. Readership continues to grow, both within the chemical industry and its investment community. It is now read in 121 countries, and 2735 cities, versus 89 countries and 1244 cities a year ago. Readers are also very loyal, with 23% reading it twice a week.

Its readership covers all the major areas of chemical production. The UK, USA, Germany, Netherlands, Turkey, China, India, France, Singapore, Belgium make up the Top 10 countries, with Japan, S Korea, Italy, Brazil, Saudi Arabia and Russia all featuring in the top 25. English is a 2nd language for most readers, who speak 55 different first languages.

The blog aims "to share ideas about the influences that may shape the chemical industry over the next 12 - 18 months", and so it focuses on:

• The major companies
• Key consumer industries, including housing and autos
• Economic data such as GDP, industrial production and exports
• Developments in oil and financial markets

698 posts have been made in total, with 142 written in the past 6 months.

The blog's annual Budget Outlook continues to attract strong interest. This year's, 'Budgeting for a New Normal', was also the subject of a well-supported Webinar, and will shortly be published as a White Paper.

Thank you very much for your continued support.

Blog readers have a wide range of interests.

That is clear from the list below of the Top 10 posts in 2009.

It also confirms the complexity of the chemical industry, and its fascination.

In alphabetical order, it is as follows:

• Bubble, bubble, toil and trouble
• Companies remain cautious on the outlook
• "Green shoots" likely to be "yellow weeds"
• IEA warns on economic downturn, lower oil demand
• 'It's the price that matters': Wal-Mart and Tesco signal a major change in consumer priorities
• New US auto fuel standards provide chemical companies with major opportunities
• OPEC worries about weak oil market fundamentals
• Rotterdam oil storage running out of space
• Russia's chemical production tumbles
• The nudist beach on Wall Street

Interestingly, the list includes 2 'classic' posts from 2007 and 2008, which are obviously still valued by many readers as reference points:

• The insight from Tesco and Wal-Mart which pinpoints the moment at which consumer priorities began to shift from 'wants' to 'needs'
• Warren Buffett's then controversial views on financial markets, just before they began to implode.

"Crude oil is (now) more than just a physical product", according to NPRA Chairman William Klesse. As he noted, "Today there is ample crude in the world, and crude is not at $80/bbl because of physical markets".

This was a strong statement from the head of the US National Petrochemical & Refiners Association, at the start of the annual meeting in San Antonio. As he added, the reason behind the price hike is that crude has become "a financial product".

The chart, from the Financial Times, shows the reason for his concern. Last year, European pension funds alone "invested" €21bn ($29bn) into commodity funds, particularly oil. This was a 145% increase on the 2008 figure, with minimum 60% growth expected this year. This flood of money hiked oil prices 78%, even though demand growth was poor.

Now, however, as the FT notes, there is growing "alarm" amongst the investment community about the relatively poor results they obtained. The "investors" who held the fund for a year made just 17% by December, not 78%. The reason was that they "invested" in futures markets, which were in contango (where the months ahead are priced higher than today's spot price).

Thus although oil prices rose, each month the "investors" lost most of the gain, as the future contract came closer to actual delivery. Instead, the bulk of the gain went to those who launched the commodity funds, or those who actively traded the futures markets.

These highly-paid "investors" failed to understand the simple truth that commodities trading is a zero-sum game - you win, I lose. Or as Goldman Sachs' CEO Lloyd Blankfein told the US Congress earlier this year 'when Goldman sells a security that subsequently goes up (i.e., on which the other party makes money), "we wish we hadn't sold it".'

Meantime, as Klesse noted, it is the petchem and refining industries that has to cope with the end result - an oil price that is currently very over-valued in relation to the laws of supply and demand.

Sell in May and Go Away" is the oldest rule in stock market investment. This week has certainly provided further support for it:

• The major Western stock markets are down c8%
• The major emerging markets are down between 4% - 13%
• Crude oil prices are down 13%

This May panic may well also mark the markets move into their 3rd, and most destructive phase. As originally identified by Merrill Lynch's analyst guru, Bob Farrell, "bear markets have three stages - sharp down, reflexive rebound, a drawn-out fundamental downtrend".

Greece, of course, and its debts, has been the catalyst for this week's panic. And the chart above (from the Bank of International Settlements), highlights the core problem. European banks have collectively lent $2663bn to the 5 euro countries at most risk of default, the PIIGS (Portugal, Ireland, Italy, Greece, Spain).

The vertical axis identifies the debt held by each country, showing that France has lent $79bn to Greece, and Germany $46bn. As my fellow blogger, John Richardson has noted, "if the whole of Greece suddenly vanished into the ocean, it wouldn't make that much of a difference to the global economy...including chemicals". Nor would Portugal, or Ireland.

But Spain and Italy combined are 6% of the global economy, with GDP of $3.6trn. Between them, they owe $1.8trn to banks in the rest of the EU. If markets become seriously worried about the prospects for economic recovery, then they will clearly be near the top of everyone's concerns. US banks, for example, have $3.6trn of loan exposure to Europe.

This suggests the world economy is now approaching a cross-roads:

• In one direction lies economic recovery, as argued by Larry Summers, US economics chief. His view was that government stimulus would provide, like a 3-stage space rocket, the "escape velocity" to stabilise the major economies and encourage consumers to begin spending again
• The blog, however believes with Pimco (the world's largest bond fund managers) that we face a "new normal" of lower spending and less debt.

As we move into Budget season, Boards will start to debate their outlook for 2011-3. Clearly they will hope, with Summers, for better times. But prudence suggests they should also plan for a less favourable, Pimco-type Scenario. Markets may well rally again short-term. But if Bob Farrell's analysis is right, the third phase of the Crisis still lies ahead.

Consumer spending is 70% of US GDP. And because US GDP is so large, this means the US consumer is 17% of global GDP. This is the same as the combined GDP of China and Japan, who rank 2 and 3 after the USA.

So a change in US consumer spending matters. And it particularly matters to the chemical industry, as our products are focused on consumer needs. Thus the blog is taking very seriously indeed comments from major US consumer companies, who suggest we can no longer rely on the "shop-till-you-drop American consumer" to support global demand. For example:

• Wal-Mart, the world's leading retailer, has seen its US same store sales drop for the last 5 quarters. This has not happened before. Wal-Mart also warned they expect consumers to "remain cautious about spending".
• Target, the leading discount store, confirmed the blog's view that March was the peak of the cycle, with CEO Gregg Steinhafel saying "its clear Q2 marked a change in trend. GDP growth softened considerably, and our sales trends levelled off as well".
• Procter & Gamble, the world's largest consumer products company, gave the same message. "Consumers day-to-day spending reflects an entrenched frugality that often means leaving P&G's relatively inexpensive products on the shelf."

This is serious stuff. And it links with major demographic changes taking place in the USA. The boom in chemical demand over the past 40 years is closely tied to demand from the 'baby boomer" generation (born between 1946 - 1964). They now own 80% of all US personal financial assets and are responsible for over 50% of discretionary spending power.

But they are getting closer to retirement, with a median age of 54 years. And so their need for 'new things' is reducing, as is their ability to afford them. Equally, as the above chart from thechartstore.com shows, their savings rate is starting to shoot up. They were let down by the stock market after the dot-com boom; then the housing market disappointed.

So now we seem to be seeing the start of a generational switch from spending to saving in the world's most important market. From close to zero, the savings rate has already jumped to 6%, as baby-boomers worry about how to afford their retirement, especially as they can expect to live longer than any generation in history.

Of course, if stock market and housing prices began to recover, then this trend might reverse again. But there is clearly a danger of a vicious circle developing, where fear replaces greed as the prime driver in financial markets, and drives a growing demand for yield.

The back-to-school season, now underway in the USA, is the second most important shopping period of the year. It will therefore be even more critical than usual for those wishing to forecast chemical demand.

If Wal-Mart, Target and P&G are right, then the US economy could easily see US GDP growth of below 2% in Q4.

This would not be good news for everyone in the chemical industry, dependent on the US consumer to drive future demand.

The blog has had a letter published in the FT this morning, which readers might like to see.

It focuses on the problem of using EBITDA measures when analysing a company's performance. It suggests that analysts should move away from their current reliance on this measure, which ignores the impact of important areas such as interest and tax payments. Hopefully, the letter may help to spark some debate in this critical area.

Sir, I was delighted to see Lex reminding readers that they should assess company profits after payment of all significant costs such as "staff or technology" ("Price/earnings multiples", August 24).

It would be excellent if Lex would return to basing its valuable analysis on a company's real bottom line. This would then help your readers to assess who is swimming naked, before the tide goes out.

Paul Hodges,
Chairman,
International eChem,
London N7, UK

With the Chairman of the US Federal Reserve saying the outlook is "unusually uncertain", its time to summon the chemical market genie.

Of course, rubbing the lamp is not always successful. And if the genie does arrive, one can only ask 3 questions.

So rather than risk wasting them, the blog has learnt to spend the first question in asking him to decide the other two questions.

And this is what the genie said:

"They should be obvious, even to you, blog. Ask me what is happening to the US economy? It dominates the global economy, as you have written many times".

So I asked, and the genie answered, laughing:

" You have wasted a question. You already know what is happening to the US economy. It is heading back into the downturn, now the stimulus programmes are ending.

"In Q3 last year, GDP grew by 1.6%, and by 5% in Q4. But then it slowed in Q1 to 3.7% and now Q2 is estimated at just 1.6% again. But I can understand that you have been hoping a proper recovery might be underway, particularly after the industry has had such a strong H1."

Thank you, O genie, I replied, and so what should be my second question? The genie sighed, and I thought for a moment he was going to disappear back into his lamp.

"Ask me about the US housing market? You surely know that this used to be a $35bn chemical market in 2006, when there were 2.2m housing starts? But you can start by answering my two-part question:

"So, said the genie, the rich aren't buying. And as 23% of all homeowners owe more on their mortgage than the home is worth, and sales in July were an all-time low of just 276k annualised (worth just $5bn), then this major market will provide little support for future chemical sales"Chastened, I waited for him to reveal my 3rd question.

"Again, it is obvious", he replied. "Even you have been writing about it since February 2009. Ask me about the potential impact of deflation."

"But if I can interject, O genie, all the commentators suggest that we are in a 'bond market bubble' and that we should really worry about inflation?"

At this, the genie laughed for a very long time.

"You amuse me, blog", he finally replied. "So I will allow you this extra question. Ask all of your friends if they have read an article about this so-called 'bond market bubble'? And then ask them if their own pension fund is now even 50% in long-term G7 government bonds? You will find there is indeed a bubble in articles about a 'bond market bubble', but very few people actually own them".

So the genie then answered his 3rd question, reminding the blog of an analysis in Barrons, the US investment magazine.

"Today, if you're a Western baby-boomer (born between 1946-64), you now need to save $1.42 if you want to have $2 in 10 years time, with interest rates at 3.5%.

But when rates were at 7%, you only needed to save $1 to achieve the same result.

"Now, blog", he then added. "You wrote about the baby-boom generation only last week. You can surely see why they are beginning to panic about their future income level in retirement?

"If their baby-boomers stop spending and start saving, which they must do to protect their retirement income, then clearly global chemical market growth rates cannot go back to the levels seen before 2008."

And with that, the genie disappeared back into his lamp, leaving the blog to ponder on the implications of his answers for chemical sales in the rest of 2010, and in future years.

Anyone running a chemical company knows that the benefits of certain key decisions can take years to develop. Many companies had to support their nascent pharma businesses for 20 years, before steady profits began to flow. Whilst major complexes can easily take 10 years from inception to completion.

Yet in recent years, investors have become more and more impatient for quick results. We can see this in the above chart, from Andrew Haldane of the Bank of England, which shows that US investors' average holding time has reduced since the mid-1970's from 7 years to less than 7 months. Equally, the Financial Times has recently noted that:

"Today's markets are dominated not by long-term investors, but by speculators so busy with "burn and churn" buying and selling, that they have lost interest in what is surely the fundamental reason for owning shares: the fact that they either produce, or are expected to produce, an income."

The FT adds that "dividends have accounted for 90% of total return in the US market since 1871", and suggests that investors seeking to fund pension promises would do well to focus on companies whose future earnings will support steady dividend growth.

Haldane, in a very thoughtful and well-researched paper, goes on to question whether the West's financial system has been on the right track in recent years. He worries about its "tendency towards impatience and a demand for immediate gratification", and warns that "just as patience can ward off great disaster, impatience can ruin a whole life."

Coincidentally, this message is also supported by the Bank for International Settlements (BIS), the central bankers' bank, in its latest Quarterly Review. Its study of 20 recent financial crises leads it to conclude with the simple truth that "what goes up, tends to come down".

It goes on to argue that today's short-termist policies will only prolong the pain of the current Crisis, as was seen in Japan in the 1990's. Instead, it says the prime need is to "fix the banking system" via "the early full recognition of losses and the restructuring of bank balance sheets".

With shareholders seemingly ever-more short-term in their outlook, the blog will not be holding its breath for this to take place any time soon.

When elephants fight, those around them need to be cautious. And this is the prospect for 2011-13, as the Western countries try to force the BRICs (Brazil, Russia, India and China) to export less and import more, the so-called 'rebalancing' strategy.

Thus Budgeting for Uncertainty seems the right title for the blog's annual Outlook for the chemical industry.

Key factors that will contribute to this uncertainty include:

• The USA is aiming to rebalance the world economy by forcing the BRICs to reduce exports and instead focus on expanding domestic demand. This proposed rebalancing represents a major change from the past 20 years of export-driven development by the emerging economies, and will not be achieved overnight.

• Europe is making a 180 degree shift in policy, by abandoning previous efforts to stimulate its economy. It is instead planning to achieve budget balances by reducing spending and increasing taxes. It is also lining up alongside the USA in hoping to increase its exports to the BRICs, whilst reducing imports from them.

• The BRICs themselves are between a rock and a hard place. They were not the cause of the financial Crisis, but they are the ones on whom the major burden of adjustment may fall. The principal instrument of change will be the exchange rate, as the West aims to force China and others to revalue their currencies quite sharply.

These macro factors clearly raise more questions than answers. Even the issue of timescale is unclear, with the US suggesting it might take a full Budget cycle of at least 3 years for real changes to be observed. Plus, of course, there is absolutely no guarantee that the West will get its way, or that the whole exercise may not end in tears.

On the other hand, everything might go extremely well, with a renewed burst of co-operation as seen immediately after the Lehman collapse in Q4 2008. If the G20 Group of the major economies really worked together, then chemical demand could easily be stronger, rather than weaker.

The blog's view is that Scenario planning is the only solution when faced with so many different variables. The idea is to establish a Base Case, and then develop Upside and Downside Cases which are reasonable projections of what might happen if everything went very well, or very badly.

The blog's own effort to help kick-start this process is shown above:

BASE Case. This suggests we will see global GDP growth of 3%, with oil staying in the $60 - $80/bbl range of the past 18 months. We will still see financial market volatility, but no major collapses. It is the classic 'muddle through' type of Scenario.

UPSIDE Case. This assumes that the G20 achieves a 'grand bargain' to rebalance the world economy, allowing GDP to grow at above 3.5%. Inflation would probably become a major issue under this Scenario, causing oil prices to move above $80/bbl.

DOWNSIDE Case. Instead of increased international co-operation, countries put their own interests first and adopt beggar-my-neighbour policies. GDP growth would probably fall to 2.5%, and the oil price below $60/bbl, with the banking system under major strain as Deflation took hold.

The slide also suggests a number of 'Jokers' that companies may want to consider. These include changing demographics, such as the ageing of the Western baby-boomers. And, of course, one can never ignore the potential impact of geo-political events, such as a bombing of Iran's nuclear plants, or new tensions with N Korea.

Of course, it would be possible to simply adopt a Base Case Scenario, and assume that this will work out. But the chances of this occurring are probably less than 50%, so it would be highly risky. Instead, the blog would strongly recommend businesses to adopt a version of the above framework, using their own ideas for Base, Upside and Downside Scenarios.

By adopting this process, businesses can then test out key assumptions in advance. They can also develop mitigation strategies, in case events begin to diverge from the Base Case view. As always, the blog will be very happy to advise on the process, if this would be helpful.

2010 has been a suprisingly good year for many companies. We can certainly hope that current performance will continue, but hope is not a strategy.

Scenario planning will give businesses the chance to adopt the wisdom of the Scouting movement. Its motto, 'Be Prepared', seems the best possible approach in today's increasingly uncertain New Normal environment.

Crude oil prices are now up 18% since the US Fed announced its QE2 Lifeboat policy at the end of August. This clearly justifies the blog's faith in the 'triangle pattern' in September. The rise is mainly due to financial players, with the Large Speculators dominating the buy-side on the futures markets.

But in turn, average US gasoline prices have now moved back over $3/gal, nearly double their lows in December 2008. And this highlights the key question, of whether the world economy can really prosper with oil prices at the $90/bbl level?

The evidence from history, in both 1979-80 and 2007-8, is that it can't. But there has been a suggestion recently that 'this time it is different' because demand has been growing quite strongly in Asia in recent months.

However, veteran crude oil market watcher Ed Morse of Credit Suisse has a different view. He suggests we have seen "a series of one-off reinforcing factors that, coupled with winter seasonality, have tightened product and crude oil markets":

• The Q3 heatwave in Japan and S Korea, which led to higher electricity demand for air conditioning
• China has shut 1355 coal mines to curb pollution, causing factories to run diesel generators instead
• Europe is having one of its coldest-ever November/Decembers, also increasing heating and fuel oil demand

None of these factors, sadly, are indicators of economic growth. Instead, with China poised for further interest rate rises, to cool inflation, the risk of slower economic growth there is clearly rising.

The blog has an incredibly loyal following around the world. 24% of its readers visit twice a week, or more.

They also recommend it to colleagues. Visitor numbers jumped 50% last month.

The issue is the rising uncertainty over the outlook for the world economy. This has clear potential to cause problems for the chemical industry.

The White Paper, Budgeting for Uncertainty, discusses this in more detail.

Now the blog is delighted to announce two major new developments. Both are with ICIS Asia director, John Richardson, co-author of the Asian Chemicals Connections blog:

• June 16-17 will see the 2nd New Normal seminar, in Frankfurt, Germany. This follows February's very successful Singapore launch. It will cover the major changes taking place in chemical demand patterns around the world. The focus will be on:

The Value Proposition for both initiatives is very clear. The past 20 years have seen managers able to focus on developments down their vertical silo. Demand growth has been very stable, as the vast Western BabyBoom generation moved into the 25 - 54 age group, when consumption peaks as people marry, settle down and have children.

This means that we cannot rely on consumption growth, in the developed and emerging economies, to continue in a straight line. Managers instead need to refocus on understanding developments up and down the chemicals Value Chain. This will enable them to identify the challenges ahead for their businesses, and exploit the opportunities that will arise.

Further details of the e-book will be available soon. Please click here for more details of the Frankfurt New Normal seminar in June.

The blog is delighted to announce the title of its new eBook, jointly authored with fellow blogger, John Richardson.

It explains how Western BabyBoomers are changing chemical demand patterns, again. We believe it will become vital reading for all those working in the global chemical industry.

The first chapter of the book will be published online by ICIS next week. John and I look forward to bringing you more details then.

Crude oil and commodities markets have lost touch with the fundamental realities. This didn't just happen yesterday, but began a decade ago.

That's the argument put forward by my co-author, John Richardson, in the latest chapter of our new free eBook, 'Boom, Gloom and the New Normal - how the Western BabyBoomers are changing chemical demand patterns, again'.

John highlights how the supposedly 'informed commentary' that gets widely reported in the media is often focused on boosting income for the trading houses, not market understanding.

I describe some of the issues this raises for chemicals in the above 3 minute interview with ICIS' Will Beacham.

We are delighted with the support we are receiving for the free eBook. Please click here if you would like to download Chapter 3.

Many readers have been taking a well-earned break over the past few weeks. The blog also continues to gain large numbers of new readers, as the financial crisis intensifies. As usual, therefore, it is highlighting key posts during August, to help you catch up as you return to the office.

Boom/Gloom Index suggests markets on the edge presciently forecast the recent volatility. Markets fall as politicians argue, US Fed policy may be going Back to the Future, Investors rush to save with the JUUGS, and US GDP still below 2007 levels explore the key issues

European cracker margins at 'top of cycle levels', China's PE market down 2.5% in H1 and Q2 chemical results raise concerns about the outlook look at the current state of chemical markets

China's power consumption hits new record looks at the strains now impacting China as it struggles to cope with an overheating economy. China's auto market goes ex-growth covers the same theme, as does China's bank lending nears its Minsky Moment

Policymakers remain in the Denial phase suggests the crisis is a long way from its end, as does Recession may now be very close and Towards a New Normal, not a new Supercycle whilst Goldman halves global ethylene growth estimate shows the analysts are slowly starting to recognise reality

Plus, of course, Chapter 4 of Boom, Gloom and the New Normal was published this week, and focuses on how the world may look in 2021

Next week, the blog publishes Chapter 5 of its 'Boom, Gloom and the New Normal' eBook, co-authored with John Richardson. This looks in detail at the major changes taking place in demand patterns as the BabyBoomers (those born between 1956-70) enter the 55+ age group.

This cohort already includes 272 million people, 29% of the Western population, and it is growing every day.

The book argues that the over-55s simply do not need to buy new houses, or extend their present homes. Equally, they no longer want to buy new autos every few years. So it is hard to imagine that these key sources of chemical and polymer demand can recover to earlier SuperCycle levels.

Stimulus programmes and tax cuts cannot force people to buy things that they no longer need or want.

This seems plain common sense. But our discussions with central bankers and policymakers over the past few months have made it clear that this is not a consensus view, as the blog discussed recently.

Equally, the chapter highlights the very real financial problems facing the over-55s as they reach pension age. The chart above gives an example of the mountain that has to be climbed.

It is based on official US earnings statistics, starting from 1979. Over the period to the end of 2010, a worker on median wages would have earned a total of $811,096, and have a pension fund of $242k by the end of 2010 (purple line), based on the assumptions that they:

• Earned median wages from 1979 - 2010 (blue line)
• Saved a regular 10% of this income (red line), a total of $81110
• Achieved the average S&P 500 Index growth as a return on their investment each year.

This employee would have earned $39k in 2010 on median earnings. Yet their pension fund would provide an annual pension of only ~$10k/year, with inflation proofing.

Of course, no one chart can cover all circumstances. Some people will have managed to save more, and will have been more successful with their investments. But saving 10% of income each year is a stiff target. And US earnings are generally higher than elsewhere in the West.

Clearly a pension of $10k/year will not fund the prosperous retirement that most people are expecting. In turn, it provides another reason why chemical companies should assume that demand patterns will change in the West, as we transition to the New Normal.

The chemical industry has a turnover of $3.4trn, and is the world's 3rd largest industry. It matters to the global economy.

Many of its leaders are about to meet next weekend in Berlin for the annual European Petrochemical Association (EPCA) meeting.

The blog strongly believes that this should not be seen as a 'business as usual' meeting. We cannot simply assume that the global economy is in fundamentally good shape:

• IMF head, Christine Lagarde, has warned the global economic situation is entering a "dangerous place"
• World Bank president Robert Zoellick has described world finances as being in a "danger zone"

These are not sound-bites being made for effect.

The danger signs have been building for months. The blog, after all, introduced its IeC Downturn Alert nearly 5 months ago, on 2 May.

Coincidentally, this matched the peak of the US S&P 500 Index, since when financial markets and crude oil prices have fallen dramatically, as shown in the chart above.

Every week since then, with the help of ICIS news and ICIS pricing, the blog has chronicled the approach to today's Downturn:

• First we saw customers around the world buying 'hand to mouth'. They tried to run down inventories built up during the 50% rise in crude oil prices between December-April
• Then everything went quiet during the summer. The retailers destocked after seeing end-user consumption fall due to the impact of higher oil prices
• Then it became clear that China's economy, the previous motor of the global economy, was slowing fast, as the government reduced credit to combat high inflation
• Now, in September, it is clear that demand has not returned after the holidays. And the wider economic outlook is getting worse, not better.

The blog made similar efforts to alert the industry to the issue of demand destruction before the 2008 downturn, and was later awarded the title of 'The Crystal Blog'. But sadly, its warnings were not taken seriously at the time when they could have had an impact.

The industry's leaders need to ensure that 'this time is different' in Berlin. It is no exaggeration to say that the very future of some companies, and of important sectors of our industry, may be at stake.

Price movements since April, and ICIS pricing comments this week are below:

Benzene NWE (green), down 26%. "A swathe of imports coming into the ARA region were also keeping supply ample as demand struggled amid weak end user confidence."
Naphtha Europe (brown dash), down 19%. "The impact of refinery run cuts is starting to show, and it is thought that the naphtha oversupply would have been more severe if not for these".
HDPE USA export (purple), down 18%. "The Asian market has slowed down, in part because of a national holiday, and in part because of concerns about the global economy. Asian prices were expected to fall in China because of tightening credit rules."
S&P 500 Index (pink dot), down 17%.
Brent crude oil, down 14%.
PTA China (red), down 4%. "Most buyers were adopting a wait-and-see stance because of the unclear market trend. Only a few end-users purchased cargoes on a need-to basis."

Today's economic situation is getting worse, not better. The blog believes this is because most policymakers still refuse to accept the wisdom contained in the Beatles' 'When I'm Sixty-Four' song on their iconic Sgt Pepper album.

The Western BabyBoomers (those born between 1946-70) are the largest and richest generation that the world has ever seen.

But last year, the oldest Boomer reached the age of sixty-four. And ageing Boomers simply don't need more housing or new cars, as they no longer have to provide for growing families.

So demand patterns are changing, radically, just as they changed in the 1970's. This was when the arrival of the Boomers set off the economic SuperCycle, as they entered their peak consumption years between the ages of 25 - 54.

Chemical companies are therefore not only facing an imminent economic slowdown, as the blog has chronicled over the past 5 months with its IeC Downturn Alert. They also need to change their business models, to adapt to this New Normal.

This month's Chapter 5 of the blog's free 'Boom, Gloom and the New Normal' eBook, co-authored with John Richardson, aims to help with this process. The first step is for CEOs to establish a high-powered team, operating with the support of their Board and line managers, to quickly put in place the necessary Action Plan.

The team needs to answer the 4 key questions required for any successful plan:

• Why. The Board needs a clear view of the likely impact of an economic downturn, combined with the demand changes caused by the ageing of the Boomers.
• What. The team needs to highlight the key issues which its plan aims to tackle. Speed is essential, and only the really super-critical issues can be addressed short-term.
• How. Implementation plans are critical. Resources need to be available, and key managers must 'buy-in' to the process, otherwise it will fail.
• When. Timing is also critical. Short-term priorities (credit control, working capital) have to be balanced with the business model changes needed to adapt to the New Normal.

The outlook is very uncertain. Tomorrow's post will discuss the relevant Scenarios that need to be addressed. And on Thursday, it will highlight the Critical Success Factors against which plans need to be measured.

The blog will be happy to provide any support or advice that may be helpful to readers as they develop their Action Plans.

International eChem/ICIS are also running three training courses in Houston, Singapore and London in Q4, to help with detailed implementation issues. Please click here for further details.

The transition to the new Normal is likely to be painful and long-lasting.

Future demand growth will be slower as the ageing Boomers spend less and save more.

More regular and deeper recessions are likely to become a feature of the global economy once more, in contrast to the relatively smooth growth seen during the Boomer-led Super Cycle.

Successful companies will also have to venture into the unknown, as until recently the 55+ generation had no real existence as a separate economic unit.

Previous generations usually found their needs at this age were focused on health-related issues - the Zimmer frame of popular mythology.

So as we venture into the unknown, Action Plans can't be too prescriptive about what we might expect to see over the next 20 years. Chapter 5 of the blog's free 'Boom, Gloom and the New Normal' eBook, co-authored with John Richardson, aims to help with this process.

As discussed yesterday, the Chapter outlines some potential Scenarios to highlight the key variables that need to be considered:

'All's Well that Ends Well'. In this scenario, the key dynamic is that there is a rapid adaptation to the New Normal. This may be driven by the observation of the major pain being suffered in countries already at the sharp end of some most unwelcome restructuring - Greece, Portugal, Ireland and Spain, for example. This gives Western politicians the courage to talk seriously about the issues that society now faces, whilst the wider population becomes prepared to listen to their messages and to accept that major changes need to be made.

'Muddle Through'. In this scenario, there is no rapid adaptation to the New Normal, and although a higher quality of dialogue takes place between policymakers and the electorate than in the past, no firm agreements are reached on key policies and objectives. However, and importantly, social cohesion is retained, and so society does not fragment into warring groups.

'If You Don't Know Where You're Going, Any Road Will Do'. A third scenario is based on the potential for politicians to remain more focused on sound-bites than on formulating policies that will drive long-term success for their populations. In this Scenario, the current dysfunctional state of many Western political systems, and their alienation from the wider electorate, is not a temporary phenomenon but a sign of the future.

'Don't Worry, Everything will be Just Fine'. This is the scenario under which the West had been effectively operating for the past few years, ignoring the demographic changes which are taking us in a new direction. It is characterised by an increasingly desperate belief that everything is just about to 'return to normal' (i.e. the former SuperCycle), via the magic elixir of either tax cuts or yet more stimulus.

Tomorrow's post will provide its view of the Critical Success Factors against which Action Plans need to be measured.

The blog will be happy to provide any support or advice that may be helpful to readers as they develop their Action Plans.

International eChem/ICIS are also running three training courses in Houston, Singapore and London during Q4, to help with detailed implementation issues. Please click here for further details.

Yesterday's Scenarios hopefully provided valuable insight into the challenges ahead for companies and individuals. They also suggest some Critical Success Factors for achieving a successful transition to the New Normal, as set out in the chart above:

1. Flexibility. This involves adapting to new circumstances and being willing to compromise rather than battling for an impossible nirvana.
2. Change management. The next 20 years will likely see rapid and unpredictable change in the business environment in contrast to the remarkable stability of recent decades.
3. Scenario Planning. Companies need to adapt their planning processes to cope with the greater uncertainty that will come from operating in a more 'events-driven' world.
4. Real needs. Over the past 20 years, Westerners have often confused 'wants' with 'needs'. In the New Normal, mere 'wants' are unlikely to be reliable market drivers for the future.
5. Action orientation. Uncertainty can breed a loss of energy, and so companies will need to encourage their employees to experiment creatively if they are to move forward.

The positive news is that most Boomers are likely to lead active and healthy lives well into their 60s and 70s. So the opportunities to capture their interest and their business are very large indeed. We will highlight some valuable case studies to help with this process in Chapter 7.

Companies focusing on the emerging economies face similar challenges, as we will discuss in Chapter 6 next month. Their core market will also consist of a currently underserved demographic, those just moving out of poverty and able to afford a bar of soap, or a bra and pair of panties, for the first time.

But the Beatles provide a reliable guide, if we are prepared to listen to their message from 'When I'm Sixty-Four'. The megatrends such as an ageing population and the need for improved food production provide the key to future success.

The blog will be happy to provide any support or advice that may be helpful to readers as they develop their Action Plans.

International eChem/ICIS are also running three training courses in Houston, Singapore and London during Q4, to help with detailed implementation issues. Please click here for further details.

Wall Street analysts have their bonuses to consider at this time of year. So it is no surprise that they are talking up the prospects for the Christmas season - the peak shopping period of the year in the West.

But those involved in shipping goods don't see the same rosy picture:

• In August, Bloomberg reported that container shipping rates from Asia to Europe were suffering "the longest stretch of near-zero rates in its half-century history", as retailers cut back on orders
• Now, the New York Times reports that imports via the 5 busiest US container ports "were lower in August than, or even with, 2010 volumes".

This should be no surprise, given the above chart, again from the NYT. It shows that median US incomes fell 9.8% between December 2007's start of the Great Recession and June 2011, according to new Census Bureau data. This includes a 6.7% fall since the official end of the recession.

The Census Bureau describe this as the largest decline "in several decades". They add that it evidences "a significant reduction in the American standard of living." And if this wasn't enough to restrain Holiday spending, Western BabyBoomers (those born between 1946-70) are also becoming aware that their pensions are under increasing threat.

Most US public pension funds use an 8% assumption when they come to assess likely returns on their investments. But as the Wall Street Journal warns, this figure is now hugely over-optimistic:

• It was reasonable during the Boom-led SuperCycle after 1980, when demand for assets like stocks and housing soared
• But as we note in Chapter 5 of the free Boom, Gloom and the New Normal eBook, the key S&P 500 Index actually fell between 2000 - 2010
• None of the large US state pension funds with >$20bn saw more than a 4% annual return for the decade through June 2010

The pension funds are now between a rock and a hard place. Either they cut promised benefits to pensioners, or they increase taxes/employee contributions. Both mean US consumers will have less cash to spend.

One example from the Centre of Retirement Research highlights the scale of the crisis. It suggests that states with large unfunded liabilities might see pension costs rise from 3.8% of state and local government budgets in 2008 to 12.5% by 2014.

Any business managers who believe the analysts' forecasts could face a difficult New Year, if these prove to have been wishful thinking.