This Is Not Just Another Economic Downcycle

Business, China, Company Strategy, Economics, Naphtha & other feedstocks, Olefins, US


By John Richardson

ECONOMIC upcycles come and go, but in the end, the fundamentals don’t change. This is the message I have picked up from conversations with senior industry executives over the last two weeks.

“All we have to do is cut costs, wait this one out, and everything will be fine in 12-18 months. When all the panic has died down, we then need to focus on when and where to build new world-scale capacity. Nothing changes. It’s all about building big, using the right technologies and securing feedstock advantage,” was one comment I heard.

But this is sadly misleading advice and will get you into a lot of trouble.

Firstly, this is because of the scale of today’s problems. Take just one of many, measures – the multiple of earnings to house price ratios. At the height of the US sub-prime boom, they were 5:1; in China, during its real estate frenzy, they reached no less than 14:1.

Overinvestment as a whole in China has also been at all-time historic high, as the two IMF charts at the beginning of this post indicate.

Comparisons are often draw between China and countries such as South Korea and Japan, which also went through periods of investment-led growth that went badly wrong because of badly-spent money.

But the charts show that China’s reliance on building ghost cities and steel, aluminium, chemicals and other manufacturing plants as a driver of GDP growth is on a scale that the world has never seen before.

Coming down from these heights, to a new more sustainable growth model, will take years of painful adjustment.

Will the adjustment even be successfully made at all? It remains very much in the balance whether China can make the transition from an investment to a consumer-led economy. If it fails, it will fail to escape its “middle income” trap.

Old chemicals industry hands have also largely grown up in a period when Western demographics were very favourable. Put these two factors together – rich Babyboomers, and booming emerging markets in general led by China – and you had an economic Supercycle.

We are in an altogether different era of global economic and so social and political history when all the accepted wisdom upon which you have successfully built your career has been turned on its head.

Here is one headline change for you to contemplate amongst many, many others: Chemicals markets are set to become much more regional as a result of the need to preserve local jobs.

This spells the end of the linear thinking that the route to success in commodity chemicals is purely to build big with feedstock advantage. If you do this again, you will not be able to find a home for your surpluses because of, I said, more regional markets.

And here a further reason why the old model of saying building a big steam cracker complex based on cheap ethane feedstock in the US no longer works: Most of the evidence points towards China becoming self-sufficient in commodity chemicals and polymers.

The problem is that the majority of people in this industry have either spent their entire careers working in the Supercycle, or cannot remember life before the Supercycle. You have to go way back to 1989 to remember that.

But this is just a problem of Denial. We have to move very quickly beyond Denial to Acceptance.


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