What goes up, comes down

Economic growth

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D'turn 1Jun12.pngDon’t panic is the blog’s suggestion, after last week’s market collapse.

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

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

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

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

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

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

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

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

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

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

The chart shows benchmark price movements since the IeC Downturn Monitor’s 29 April 2011 launch, with latest ICIS pricing comments below:

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

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