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So Much For The Bonus From Cheaper Oil

Aromatics, China, Company Strategy, Naphtha & other feedstocks, Oil & Gas, Olefins

Naphtha2

By John Richardson

THE big turning point in Asian petrochemicals markets can be traced back to around the end of July for three big reasons:

• It was broadly accepted from then onwards that China wasn’t going to change its policies. There would be no “blinking” via a big, old-style economic stimulus package.

• The country’s peak manufacturing season, when most of China’s factories ramp-up production in order to deliver finished goods to the West in time for Christmas, looked like being disappointing. This was clear from widespread anecdotal reports of anaemic buying of a raw materials in general, including petrochemicals, by these manufacturers (the season runs from the end of July until September).

• Oil prices also, of course, started to collapse from around July of this year and are now down by more than 40% since then.

This impact since this turning point is illustrated by the slide above, which begins on 25 July (the last full trading week in July) and ends on 12 December (the end of the latest week of assessments by ICIS pricing). Similar to my chart on Monday, on this occasion it shows the wider upstream impact on naphtha cracker operators.

The trouble is that many petrochemicals companies are still not fully taking into account the long-term implications behind the three big trends that I highlighted at the beginning of this post.

Analysis is shifting, sure – it has to shift. For example, most companies now seem to recognise, far too belatedly, that China is undergoing major economic reforms. But they still prefer to wrongly believe that these reforms will not be that disruptive to growth.

Similarly, they like to think that there is not that much wrong with the global economy – even though the data on China’s export growth so far this year is pointing in the opposite direction. The country’s exports were up by just 3.4% year-on-year in January-November, according to China’s General Administration of Customs. China’s exports grew by 7.9% for the full year 2013 over 2012.

Fortunately, though, some people are on the right track.

“I am not surprised by these numbers. Our customers in China have been facing poor export orders for most of this year,” said a source with a global polypropylene producer.

“I think that this is due to a combination of a shortage of credit, which is making it harder for them to obtain working capital, and higher labour costs that have made some converters less competitive against other exporters in Asia,” he added.

“But for me the largest single factor seems likely to be the poor state of the European economy. The European Union is China’s biggest trading partner.”

On the whole, though, denial remains a lingering problem – particularly surrounding what lower oil prices really mean.

I find it worrying that we might be placing our trust in the same people who failed to predict the collapse in crude. Many of those same people are now telling us that, yes, they got it wrong, but not to worry, cheaper oil is a tremendous immediate bonus the global economy. Given their recent track record, should we trust them to be right on this occasion?

The latest monthly report from the International Energy Agency (IEA) suggests to me that the answer to the above question should be a very clear NO.

In the report, the IEA argues that:

• Lower oil prices are already slashing producers’ spending, but this is more likely to affect medium- and long-term output than short-term supplies.

• As for demand, oil price drops are sometimes described as a “tax cut” and a boon for the economy, but this time round their stimulus effect may be modest.

• For producer countries, lower prices are a negative:  the more dependent on oil revenues they are and the lower their financial reserves, the more adverse the impact on the economy and domestic demand. Russia, along with other oil-dependent but cash-constrained economies, will not only produce less but is likely to consume less next year.

• Demand lost to substitution or efficiency gains during prolonged periods of high prices will not come back in a sell-off.

• Several governments are wisely taking advantage of the price drop to cut subsidies. Consumers thus might not see much of the decline. The dollar’s strength and oil sale taxes in some countries will also limit the feed-through from crude oil to retail product prices. In the OECD, a tepid economic recovery, weak wage growth and – last but not least – worrying deflationary pressures will further blunt the stimulus of lower prices.

Crucially, also, oil is a symptom of the wider economic problems that I highlighted at the start of this blog post. We are at the beginning of a new global financial crisis.

What does mean for the petrochemicals business over the next six months? What should you plan for?

I will make some more suggestions for the key polyethylene market tomorrow.