Boom, Gloom and the New Normal

The blog fears the storm discussed last month is getting closer.

Oil prices have weakened, with Brent falling $7/bbl last week to $113/bbl as Iran worries reduced. Attention is thus refocusing on the fundamentals, where US oil inventories are now at 21-year highs. We may therefore be about to discover that high oil prices have once again led to recession.

Petchem markets are, as usual, providing leading indicators of this potential change in sentiment. ICIS pricing reports on polyethylene this week capture the position:

• China. “The market outlook remained bleak… the deteriorating eurozone debt situation continued to weigh on orders from export-oriented converters.”
• AsiaPacific. “Relentlessly weak downstream demand, coupled with softer upstream ethylene and naphtha prices.”
• ME. “Slowdown of buying momentum in Asia, Europe and the Middle East for May cargoes.”
• Europe. “Several (producers) say that they will cut output rather than jeopardise margins but converters say it is already too late for that.”
• USA. “April demand was much weaker than expected, according to suppliers and some buyers.”
• Latin America seems the only exception. “Markets remain relatively tight with some production problems affecting supply.”

The big danger is now to cash-flow, particularly for the vast number of small/medium-sized firms who depend on the banking system for loans:

• Buyers rushed to buy forward in Q1 to protect their margins against rising oil prices, and so inventories are high all down the value chain
• But today, the reverse pattern is in place. Buyers are scared to buy, as they fear prices might be lower tomorrow.

In European polypropylene markets, for example, ICIS news reported that “buyers are being cautious when placing orders for May, with smaller ones buying truck by truck, and for the week rather than the month“.

Thus today’s inventories will take time to work down, particularly as we will soon enter the seasonally-weaker summer season. In turn, CFOs will become increasingly worried about their high levels of working capital.

The chart shows price movements since the April 2011 launch of the IeC Downturn Alert, with latest ICIS pricing comments below:

Naphtha Europe (blue), down 16%. “Participants expect the European market to lengthen further ”
PTA China (red), down 13%. “Buying interest from Chinese polyester makers was weak as their polyester yarn inventory remained high”
HDPE USA export (purple), down 11%. “Buying interest is limited as buyers are expecting prices to fall further in the next few weeks”
Benzene NWE (green), down 4%. “Restricted availability within the ARA region for May kept upward pressure on prices”
Brent crude oil (blue dash), down 6%
S&P 500 Index, no change

On 7 September 2008, in its now famous warning that a financial crisis was imminent, the blog noted that “‘Deleveraging’ is an ugly word, and it has ugly implications“.

The chart above shows just how ugly these implications are becoming for the PIIGS countries (Portugal, Italy, Ireland, Greece, Spain).

It is based on data produced since 2009 by the Bank for International Settlements (the central bankers’ bank), and shows the major EU lending flows to the PIIGS. It includes data just published for December 2011:

• Lending to Italy (a G7 group member) has fallen 37%
• Lending to Spain (the world’s 12th largest economy) has fallen 40%*
• Lending to Greece (now in default) is down 54%
• Lending to Portugal is down 32%, and to Ireland down 41%

Major countries simply cannot continue to operate ‘as normal’ when these vast sums of money are being withdrawn from their banking systems:

• Italy has lost $352bn, equal to 32% of its GDP
• Spain has lost $$313bn, 21% of GDP
• Greece has lost $99bn, 33% of GDP
• Portugal has lost $75bn, 32%: Ireland has lost $203bn, 93%

Overall, $1.04tn has been withdrawn, a 39% reduction since December 2009. This is equal to 23% of the PIIGS’ combined GDP.

These numbers, of course, explain why the European Central Bank (ECB) made its emergency €1tn ($1.4tn) loans at the end of December. It says it was seriously concerned “a dangerous loop involving low economic activity, funding stress for banks and a reduction in lending” might occur. This is central bank-speak for saying that the European banking system might well have collapsed.

But the ECB’s lending under the Long Term Refinancing Obligation was just that, lending. It dealt with the immediate cash-flow problem in December. But it did not deal with the solvency issue. Many of these loans will never be repaid, as the assets behind them are now worthless.

* Netherlands lending to Spain is estimated in line with June 2011 levels, as the data is not yet available

EU policymakers like to pretend that the Eurozone debt crisis was resolved by the adoption of last March’s new Treaty. An even more disturbing thought is that they might even believe their own propaganda. Who knows?

But on the ground, it is crystal clear that the problems continue to multiply. Latest data from the Bank for International Settlements (the central bankers’ bank) shows lending within Europe continues to slow, as the blog will discuss on Saturday. This is not good news for the global growth agenda.

Meanwhile, the blog’s own Boom/Gloom Index remains stalled for a 3rd month at the 4.0 level (blue column) that has historically divided boom from gloom. And the austerity reading (red line) continues to rise.

The Index’s paralysis seems to mirror rising political uncertainty:

• Next Sunday sees the final round of the French presidential election
• Greece votes the same day for a new government
• Ireland votes later this month in its Eurozone treaty referendum
• The USA is entering presidential elections

Equally, jostling for power continues in Russia (after its recent election) and in China (ahead of the politburo changes in October).

The story of the past 5 years has been how global economic growth moved from a dependency on the West’s housing boom to a dependency on China’s housing boom. Today’s only problem is that history suggests such booms are unlikely to have a happy ending.

But who hasn’t indulged in a little wishful thinking, from time to time?

And wouldn’t it have been nice if the US housing boom could have continued forever? After all, as we noted in chapter 2 of Boom, Gloom and the New Normal, the US Federal Reserve estimated it allowed homeowners to withdraw $564bn/year between 2001-5, as the value of housing was doubling from $10tn to nearly $20tn. This provided a powerful boost to demand for autos and other chemical industry products.

Equally, wouldn’t it be nice if China’s housing boom could now continue forever? As the IMF note, housing’s share of GDP rose from 2% in 1997 to 7% in 2009. It then jumped to nearly 10% last year, under the influence of China’s massive stimulus programme. By comparison, it was just 6% in the US at the height of the sub-prime boom in 2005.

Polyethylene (PE) markets, like those for PTA, are trying hard to alert us to the potential problems that now lie ahead in China.

As the chart shows (based on ICIS production data and GTIS trade data), Q1 demand was down 4% (red column) versus 2010 (blue).

Contrary to popular belief, PE demand is not growing at 1.5 or 2 times GDP, but has actually gone ex-growth. 96% of China’s population earn less than $20/day, and rising inflation and oil prices reduce their ability to afford the discretionary items that drive chemical demand.

Equally, N American PE exports to China were down 61% versus 2010.

China’s ruling communist party does not care that the US cost base is the 2nd cheapest in the world, due to shale gas. Instead, it knows it must maximise job creation to remain in power. It therefore continues to increase China’s own production, up 7% over the period.

Nobody knows what will happen next in China. All we do know is that PE markets are warning us that the risks of a ‘hard landing’ are very much higher than any of us would like to contemplate.

The new chapter of our free ‘Boom, Gloom and the New Normal’ ebook sets out a road map to success for companies in the New Normal. It also identifies 5 key areas where major change is already underway.

Demand-driven. Markets have essentially been supply-driven in recent decades, with growth being forecast on the basis of ratios to expected GDP growth. Companies have focused on increasing their efficiency via a ‘one size fits all’ business model. As we transition to the New Normal, they will need to refocus on being effective. Innovative strategies, flexible implementation planning, plus a commitment to local techno-commercial support and long-term R&D will be required

Market focus. New worldscale plants will still be needed during the transition. But companies operating in the West will also need to reposition their businesses to focus on the needs of the ageing 55+ New Old generation, if they wish to drive future growth. Those operating in the emerging countries will need to develop mechanisms to sustain growth in the domestic economy, particularly in the rural areas.

Affordability. Consumers have less money to spend, and so the highly profitable middle ground of the past couple of decades is disappearing. Instead, the focus will be on the megatrends of food, water, shelter, mobility and health. These products must be affordable, as they must meet basic ‘needs’ rather than supplying mere ‘wants’.

Shared Value. Consumer values are changing quite dramatically, away from the materialism of the recent past. Concerns about sustainability and carbon footprint are rising up the agenda. Social stability is also becoming an important concern for governments. Companies who continue to operate on purely financial metrics will find the environment ever-harder to understand.

The VUCA environment. The transition to the New Normal is a sea-change for the global economy. Its full impact will take years, if not decades, to become clear. Meanwhile, the world will face much greater uncertainty, as conflicting views of the world play out on a day-to-day basis. Companies therefore need to plan for a VUCA environment: Volatility, Uncertainty, Complexity and Ambiguity will be the order of the day.

This VUCA landscape is creating winners and losers. No longer will the rising tide of affluent Boomers provide an effortless route to increased sales and revenues. Instead, companies need to create their own VUCA as they develop strategies and implementation plans. Vision, Understanding, Clarity and Agility will be their road map to success.

FREE DOWNLOAD OPTIONS FOR CHAPTER 11
Click here to download a 2 page summary of the Chapter .
Click here to download the full Chapter
Click here to view the 4 minute video with Paul Hodges

The above chart reflects the weekly changes in the 4 benchmark petchem products that launched the IeC Downturn Alert exactly a year ago. PTA (red line) was the only product to ever rise above its price on 29 April 2011 – and then only by $10/t, and for just 1 week.

The original aim was to try and help avoid the problems seen in H2 2008, when operating rates remained high down the value chain whilst demand fell. More recently, it has hopefully provided business and commercial managers with an insight into the overall state of the global market.

The key question today, of course, is whether we are about to see a repeat of last year’s May downturn? Superficially, the two situations appear the same – crude oil prices peaked in recent weeks at $125/bbl and end-user demand is weakening. There are also some key differences:

• A year ago, the blog was very much alone in worrying about a downturn. Most expected Q1′s strong performance to continue
• Today, the overall mood is one of uncertainty. Few people are confident about Q2 performance, but some expect an H2 recovery
• Capacity utilisation globally has slipped to 86.8%, compared to 88.8% a year ago, according to the American Chemistry Council (ACC)
• The ACC also report that US railcar loadings are down 0.7% versus 2011, despite the stimulus from much lower natural gas prices

The blog would like to be optimistic, and it has been searching for possible bullish scenarios. Sad to report, it has failed. Instead, it worries that the impact of high oil prices is much worse today than a year ago:

• They have now been above $100/bbl for a record 200 days. Even in 2007/8, the run ended after 170 days
• Recession has followed every single time since 1970 when oil prices have risen above $50/bbl ($2012)

Equally, reviewing the current state of play with its New Year ‘banana skins’ does not increase confidence:

• The Eurozone debt crisis is becoming quite scary. Spain’s foreign minister was not exaggerating on Friday when warning “This is like the Titanic. If there is a sinking, even the 1st class passengers drown”
• China’s housing bubble is not only bursting, but is now accompanied by its worst political crisis since Tiananmen Square in 1989. Little seems likely to change in the run-up to the leadership changes in October
• US housing markets remain difficult, as discussed on Saturday

And on the ground, ICIS reporters paint a consistent picture of difficult markets, as captured below in the blog’s usual round-up of ICIS pricing comments this week, and price movements since 29 April:

PTA China down 13%. “A spate of plant shutdowns in South Korea, Taiwan and China did little to underpin prices.”
Naphtha Europe, down 10%. “Market has become more bearish. Propane stocks are said to be abundant”
HDPE USA export, down 10%. “Offers fell, along with other global prices. However, traders said prices for US material were still too high to work in most other regions”
Benzene NWE, down 4%. “Availability for the prompt market is being squeezed by restricted pygas supply”
Brent crude oil, down 5%
S&P 500 Index, up 3%

Since 2007, every spring sees a rush of forecasters to claim that – finally – the US housing market has hit bottom. Sadly, for those trapped in foreclosure, and for those in the chemical industry who depend on housing sales, there is little real evidence today for such optimism.

Housing also provides a good example of the way in which markets are becoming increasingly complex, as we discuss in chapter 11 of Boom, Gloom and the New Normal, to be published next week.

In the past, prices would usually ‘bottom-out’ when inventories of unsold homes were ~6 times the volume of those being sold each month. In March, the average ratio was 6.3 times. But this hides the real picture.

The scandal of ‘robo-foreclosure’, where unauthorised people signed documents to evict people from their homes, means that most foreclosures now suffer long delays whilst legal ownership is properly established. This means, for example:

• The average foreclosure process is taking nearly a year (348 days)
• In Florida, one of the worst-hit states, it takes 806 days
• In New York, it takes 1019 days

At the end of 2011, nearly 1.9m homes had some form of foreclosure filing on them. If all these foreclosures were on the market today, they would nearly double current inventory to ~11 months – in line with the level seen in the dark days of 2008.

Another feature of the robo-signing delays is that they have temporarily boosted US retail sales. Those facing foreclosure obviously stop making payments on their mortgage. Barrons, the US investment magazine, calculates this is currently adding 1.2% to US retail sales ($42bn). But as they add “soon enough, the ‘savers’ will have to spend on rent”.

The chart shows how the S&P Case-Shiller index of US home prices initially fell 34% from their peak to March 2009. They then plateaued, as apparent inventory began to reduce. But now they have started to fall again. Prof Robert Shiller of Yale University, the co-founder of the index, is not optimistic:

“I’m more concerned about the downside than most people. I could see it staying languishing and edging down for years.”

He notes that home values took eight years to reach a bottom during the Great Depression and 11 more years to regain their lost ground. Nominal US home prices fell about 30% from 1925-33 and didn’t return to their pre-crash peak until 1944, the year before World War II ended.

Housing is at the centre of the US economy, and was the principal cause of the current financial crisis. Yesterday’s disappointing 2.2% GDP growth is yet another reminder that true recovery will remain a distant dream until the housing crisis is resolved.

Since 2007, every spring has seen a rush of hopeful forecasts claiming that – finally – the US housing market has hit bottom. Sadly, for those trapped in foreclosure, and for those in the chemical industry who depend on housing sales, there is little real evidence today for such optimism.

Housing also provides a good example of the way in which markets are becoming increasingly complex, as we discuss in chapter 11 of Boom, Gloom and the New Normal, to be published next week.

In the past, prices would usually ‘bottom-out’ when inventories of unsold homes were ~6 times the volume of those being sold each month. In March, the average ratio was 6.3 times. But this hides the real picture.

The scandal of ‘robo-foreclosure’, where unauthorised people signed documents to evict people from their homes, means that most foreclosures suffer long delays whilst legal ownership is properly established. This means, for example:

• The average foreclosure process is taking nearly a year (348 days)
• In Florida, one of the worst-hit states, it takes 806 days
• In New York, it takes 1019 days

At the end of 2011, nearly 1.9m homes had some form of foreclosure filing on them. If all these foreclosures were on the market today, they would nearly double current inventory to ~11 months – in line with the level seen in the dark days of 2008.

Another feature of the robo-signing delays is that they have temporarily boosted US retail sales. Those facing foreclosure obviously stop making payments on their mortgage. Barrons, the US investment magazine, calculates this is currently adding 1.2% to US retail sales ($42bn). But as they add “soon enough, the ‘savers’ will have to spend on rent”.

The chart shows how the S&P Case-Shiller index of US home prices initially fell 34% from their peak to April 2009. They then plateaued, as apparent inventory began to reduce. But now they have started to fall again. Prof Robert Shiller of Yale University, the co-founder of the index, is not optimistic:

“I’m more concerned about the downside than most people. I could see it staying languishing and edging down for years.”

He notes that home values took eight years to reach a bottom during the Great Depression and 11 more years to regain their lost ground. Nominal US home prices fell about 30% from 1925-33 and didn’t return to their pre-crash peak until 1944, the year before World War II ended.

Housing is at the centre of the US economy, and was the principal cause of the current financial crisis. Yesterday’s disappointing 2.2% GDP growth is yet another reminder that true recovery will remain a distant dream until the housing crisis is resolved.

The blog continues this week’s special series on chloralkali and PVC markets by looking at EU developments on PVC.

Historically the EU has had strong export positions into markets such as Turkey and Russia, which lack major local production. More recently, as in the USA, strong export demand for caustic soda and weak domestic demand for PVC into housing led to an increased focus on PVC exports.

This created direct competition with US exporters. And helpfully, the US switch to ethane as an ethylene feedstock provided a silver lining for EU producers. US output of propylene and butadiene has been reduced by the switch to ethane feeds, and so overall EU cracker margins have been supported by higher co-product prices for both products.

Thus as the chart shows, based on GTIS (Global Trade Information Services) data, the EU has also been able to increase PVC exports:

• EU net exports of PVC rose 24% from 508KT to 631KT between 2006-8
• They then grew a further 51% to 954KT by 2011
• Overall, net exports rose 88% between 2006-11

GTIS data also provides a fascinating picture of the main battlegrounds:

• The US maintained net exports of ~325KT into China between 2009-11 (yesterday’s post gives details). EU volumes have fallen from 108KT to 17KT over the same period
• The US has also boosted net exports to Russia from 30KT to 209KT, whilst EU volumes grew only 35KT
• But the EU has done better in Turkey. Its net exports more than doubled from 221KT to 494KT, whilst the US saw only a 60KT increase to 192KT

Overall, therefore, China’s stimulus programme has compensated for the downturn in US/EU housing markets. It created major demand for caustic into mining-based economies, as well as for PVC in their housing markets and in China itself.

Today, however, there are worrying signs that this virtuous circle is ending, as China’s economy slows. GTIS data shows EU 2012 PVC exports to the end of February were slightly down at 171KT. This confirms the slowing trend seen for US caustic and PVC exports discussed on Tuesday and Wednesday.

Yesterday the blog discussed caustic soda, and the recent importance of China’s metal demand. Today it focuses on chlorine and PVC.

PVC is the largest end-use for chlorine. It is also critical for chloralkali producers when caustic demand is strong, as recently. Chlorine itself cannot be safely stored in large volumes, and so instead they rely on being able to combine chlorine with ethylene to make EDC/PVC.

In turn, housing is the key market for PVC – being used in pipes, wiring and house cladding. Thus US producers have faced a major challenge since 2006. New housing starts have fallen from an annual rate of 2.2m to just 650k, dramatically reducing US chlorine and PVC demand.

Potentially, therefore, US producers could have been forced to cut back profitable caustic sales, if they had been unable to move chlorine into PVC. But shale gas, and the cheap ethylene it provides from ethane, has come to the rescue.

Currently a remarkable ~40% of US PVC production is being exported.

The chart shows the history of this growth, based on GTIS (Global Trade Information Services) data. Net US exports of PVC more than doubled between 2006 (red column) and 2008 (blue) to 1.2MT, and then increased still further to 2.7MT in 2011 (orange):

• China’s 2009-11 stimulus programme led to a surge in PVC imports to feed its housing bubble. US net exports grew four-fold from 77KT in 2008 to 334KT in 2011
• China’s boom also boosted Latin America’s mining exports (as discussed yesterday), and so supported the domestic economy. Net US PVC exports to the region thus grew 61% to 577KT between 2009 – 2011

US producers would have struggled to compete in export markets without the ethylene cost advantage provided by shale gas, especially since 2009. Equally, their ability to make profitable co-product caustic soda sales would also have been reduced.

Worryingly, though, latest GTIS trade data shows net US PVC exports now seem to have gone ex-growth. 2012 data to the end of February shows them similar to 2011 levels at 395KT.

There also seems little sign of any major recovery in US housing markets, as the blog will discuss on Saturday.