Profitable themes over the past month have been expectations of weakness in crude oil prices, in China’s economy, and in the financial sector; plus positive views on long-dated government bonds in the JUUGS (Japan, UK, US, Germany, Switzerland).

90% of market players probably dismiss most, if not all, of these trends. And they certainly would not accept there is any risk of a repeat of 2008.

The blog agrees with them on this. If there is a serious downturn, it could well be far worse than 2008:

• Oil prices at today’s levels have always led to recessions. This time, prices have been above $100/bbl for longer, and actually higher in Europe/China
• Debt levels are higher. US sub-prime was the 2008 focus, but since then policymakers have added $tns of debt in the US, Europe and China
• Lehman was at the eye of the storm last time. Now it is JP Morgan Chase with reportedly $150bn of trading positions in areas where they are now the only buyer
• Political uncertainty is much higher. Nobody knows how the eurozone crisis will end; nor do we know who will rule China next year

Petchem markets are also doing their best to alert us to the potential problems ahead. Nel Weddle and Linda Naylor’s recent reports capture the position as seen by major market players:

“We are trying to avoid even mentioning 2008 – we are risking to get to that point, but there has to be actions in Europe”.
“Unless China picks up and the eurozone problems are resolved, it’s a bad market environment which won’t be resolved any time soon.”

“The market is beset by concerns over demand, credit, keenly-priced imports and weakening upstream prices. Several large creditworthy buyers have been offered spot lots that they say they cannot take, as it would mean displacing material from other sources. “‘I just don’t need 500t extra at the moment. I am working my stock down to a minimum and expect lower prices again in June’,” said one. Another said: “‘The price would have to be very low indeed for me to take extra material’.”

As the chart shows, benchmark prices have fallen further below the 29 April 2011 launch of the IeC Downturn Monitor. Latest ICIS pricing comments are below:

Naphtha Europe (brown), down 22%. “Demand remained mediocre. The Asian market is weak, while in Europe, there has been little interest from petchems and gasoline”
PTA China (red), down 18%. “Weaker downstream polyester demand exerted additional downward pressure on prices”
HDPE USA export (purple), down 17%. “Prices would have to fall to the high 40s c/lb ($1050/t) before sales volumes would pick up, traders said”
Benzene NWE (green), down 10%. “Many players were anxious about the outlook moving into June”
Brent crude oil (blue dash), down 12%
S&P 500 Index (pink), down 5%

Shale gas developments in the US have sparked a wave of euphoria about the opportunity for a renaissance of its domestic manufacturing base. Petrochemicals should be one of the main beneficiaries, as the ethane produced from shale gas discoveries now provides the US with some of the cheapest feedstock in the world.

Major producers including Dow Chemicals, Shell and Chevron Phillips have already announced plans to build new ethane-based capacity. Others are likely to join them. Current estimates suggest total US ethylene capacity could therefore increase by 25 to 30 percent from today’s 27 million tonnes.

However, one key factor has the potential to spoil the story – much of this new capacity will need to be exported in the form of polyethylene (PE) and other major plastics. Yet as the chart shows, based on data from Global Trade Information Services, US net PE exports have actually been declining since 2010, even though its cost advantage from shale gas was increasing.

This is quite a different picture from the 2006-09 period, when US exports rose from 700KT to 2.6 million tonnes (MT). China’s demand surged in 2009, due to its major stimulus programmes, enabling US exports to jump from 267KT to 900KT. But since then, US exports to China have dropped back to 2006′s level, and its total exports have fallen 39 percent to 1.6MT.

Analysis of recent market developments in China highlights the root cause of this dramatic shift. As the second chart shows, based on Q1 data for 2010-12:

• China’s demand has fallen 4%, as stimulus programmes have ended
• Meanwhile, its own production has increased 7%

This, of course, makes no sense in economic terms. China has some of the highest cost production in the world, being based largely on imported oil. But it values social stability above economics. So it is unlikely to shut plants and increase unemployment in order to access cheaper US imports. Instead, it is already planning further increases in its own capacity.

In addition, China is now taking a strategic view of its remaining import needs. Middle East imports were up 34% over the period, due to the ‘strategic corridor’ under which China provides access to markets in exchange for energy supplies. South East Asia imports were also up by 22%, due to the free trade agreement now in place. Imports from other regions thus suffered major falls. North East Asia imports were down 38%, with US imports down 62% and EU volumes down 68%.

Thus PE highlights the major challenge facing the USA as it seeks to use the shale gas bonanza to reinvigorate its manufacturing base. It has the feedstock, and the cost advantage. But it needs to increase its exports, if it is to move the additional volume.

The PE market however suggests that potential customers, such as China, are no longer playing by the old rules. Social and political factors are instead becoming increasingly important in dictating global trade patterns, at the expense of pure economics.

Auto sales are the most obvious example. As the chart shows, they have recovered from the very slow period over the Lunar New Year holiday, but are still only up 2% (red diamond) versus 2011 levels (green line).

Even this growth has only been due to price cuts. Whilst the head of the dealers association warned “unsold cars are crowding dealer lots in cities from Guangzhou in the south to Xi’an to the west.”

This pattern is confirmed by other key markets. Investment in real estate has been 13% of GDP in recent years, a clear sign of China’s unbalanced economy. It was growing 20%/year in the 2009-11 boom period. A key area is construction of new residential floor space:

• This grew 16.2% in January-April last year versus 2010
• This year, it fell 4.2% in the same period
• The slowdown is even worse when one remembers that growth had still been 5.1% in the first two months of this year

This, unfortunately, is what happens when credit bubbles start to implode.

Air is starting to rush out of the balloon, even faster than it was pumped in during the government’s 2009-10 lending boom. Home prices have now been falling for 8 months in China’s top 100 cities.

Political debate became based on focus groups, rather than principle. The need for the vision and implementation skills of people such as Adenauer in Germany, de Gaulle in France, or Thatcher in the UK seemed to belong to a distant age.

The Eurozone project reflected this new era. It allowed anyone to join the club, if they passed a few simple tests. So Greece – with a GDP/capita of just $11k in 1999 – became a member, having carefully manipulated its national accounts and gained the pass mark for entry.

Equally, the founders explicitly ruled out a clause to establish how a country might leave. Instead, membership was said to be ‘irrevocable’. An initial study by lawyers at the European Central Bank over possible departure rules in 2009 concluded it was ”so challenging, conceptually, legally and practically, that its likelihood is close to zero.”

Today, of course, the chances of Greece leaving have risen so high that London bookmakers have stopped taking bets on the outcome. This should be no surprise, given that Greece’s GDP has fallen ~20% since 2008. Voters will not continue to vote for economic suicide forever, as the recent election results showed.

Yet policymakers learnt their economics in a different age. They still think a few well-crafted sound-bites will somehow make a difference. And if that fails, they imagine an extra €1tn ($1.3tn) of lending will resolve the issue.

The problem is that they continue to treat symptoms, not causes. Greece is bankrupt because it borrowed too much and cannot repay. Equally, Germany and France don’t want to tell their own voters that they are likely to take the hit, when the money fails to be repaid.

The cash involved is not small change, either. Bloomberg estimates that Greece owes a total of $510bn. That’s equal to the GDP of Poland, Belgium or Norway, ranked 22-24 in the world economy.

The tragedy is that today’s Greek problem was totally avoidable, if policymakers had faced up to the issues 3 years ago, when S&P first downgraded Greek debt. It was clear in January 2009 that the core issue was whether Greece, and others, might have to leave the Eurozone.

Now, the Eurozone train crash is becoming a serious concern for the whole global economy. Policymakers have continued to live in their dream world, bearing out the Financial Times’ warning in August 2008 that:

“In economic crashes there are pauses before the next carriage hits the one in front. This explains how we have since moved from crisis to crisis, with rallies in between, as participants persuade themselves that the worst is over.”

Disaster is not yet certain. But the Greek people will almost certainly vote for anti-austerity parties if new elections have to be held next month, unless the troika of the IMF, EU and ECB change their policies.

Policymakers now have to accept you cannot get blood from a stone. They must also recognise that the lack of any formal Eurozone exit arrangement may well lead to chaos in financial markets worldwide.

After all, since December nobody has been able to answer the blog’s very simple question: what will Greeks use for money in the days after it leaves the euro? How will people buy food and other essentials, and pay their debts to foreigners?

We desperately need industry leaders and others to challenge the wishful thinking that now passes for EU policy. Such debates were common before the Supercycle, as when ICI Chairman John Harvey-Jones took on Margaret Thatcher over industrial policy.

Painful decisions can be postponed no longer.

Data for April bank lending and electricity consumption highlights the growing scale of the problems, as the chart shows:

• Lending (red column) was the basis for China’s massive stimulus programme in 2009-10, when it reached 1/3rd of GDP. Most of this money went straight in property development and other speculative investments, which helped give cities like Shanghai some of the world’s highest home prices
• It also fuelled inflation, as demand soared ahead of supply. So the government has since been forced to cutback. There are still occasional jumps, as in March when banks rushed to fulfil their loan quotas. But April’s lending was down 8% from 2011 at Rmb682bn ($108bn)
• Similarly, the government’s need to slow growth means electricity consumption growth is slowing. It was down 1.3% in April versus 2011 at 372bn kWh. This confirms the wider slowdown underway in the economy.
• The housing market looks particularly weak. A People’s Bank of China survey showed only 14% of people were considering home purchases. This is the lowest level seen since the market first opened up to private buyers after 1998.
• 10%-20% price cuts are common for new properties, and average apartment prices in the 10 largest cities (including Beijing and Shanghai) fell for a 4th consecutive month – but they are still unsustainably high at $2443/square metre.

The blog has warned since December 2010 that “the risk is rising that we may discover, too late, we have simply been in the middle of yet another China ‘boom and bust’ scenario“.

It sees no reason to change that view today.

• PTA prices in Asia (red line) have remained weak throughout, clearly signaling the major slowdown that is now underway
• US polyethylene export (purple) prices managed a recovery early this year, due to tight ethylene markets, but have since reduced
• Benzene (green) managed even less of a recovery in early 2012, despite lower cracker operating rates reducing supply
• Naphtha (brown dash) was supported by higher oil prices, but has recently fallen quite sharply

The problem is the convergence of two factors:

• High oil prices have destroyed demand, just as at previous times when they rose to take 5% or more of global GDP. Consumers simply don’t have any spare cash, and borrowing is more difficult since the financial crisis began
• Buyers were forced to buy forward earlier this year as oil prices rose, in order to protect margins. Now they are scared to buy as oil prices weaken, and they worry about having high inventory levels ahead of the slower summer period

Price movements since the April 2011 launch of the IeC Downturn Monitor, with latest ICIS pricing comments below:
Naphtha Europe (brown), down 17%. “Less than expected improvement in demand for naphtha”
HDPE USA export (purple), down 16%. “Interest remains weak as buyers are expecting more price drops in the next few weeks ”
PTA China (red), down 14%. “Polyester demand in China remained weak despite the traditional peak season in April-May.”
Benzene NWE (green), down 6%. “Cracker operators veer toward lighter feedstock, resulting in less pygas and benzene production”
Brent crude oil (blue dash), down 10%
S&P 500 Index (pink), down 1%

Back in May 2010, for example, companies also expressed mixed feelings, as the blog noted:

“Q1 has seen the forecast seasonal boost. But Asia, particularly China, remains the real focus of growth. PetroChina, Reliance and Sinopec all see a continuing boom underway, with Sinopec highlighting the importance of ‘state stimulus measures’.

“Equally, Akzo Nobel seems typical of the majority when noting it remains ‘cautious about the strength of the recovery’. BASF also notes that ‘recovery is not certain’. And several companies, including Rhodia, worry about the ‘uptrend in raw material and energy costs”.

Today, Dow ‘anticipate that global growth will gain momentum’, whilst Unilever warn the ‘external macroeconomic environment remains difficult.’

This divergence suggests that Scenario planning, based on Dow’s Upside case and Unilever’s Downside view, could prove a very valuable exercise for companies to undertake over the next few weeks.

Air Products. “Business activity did not pick up as much as we expected”
Akzo Nobel. “Our concerns are focused on the risk of recession in Europe, delayed recovery of the US property market and the potential for a slowdown in China,”
Arkema. “Positive about market conditions”
BASF. “Increased raw material costs could not be fully passed on in all business areas, which put pressure on margins.”
Bayer. “Strong performance in its CropScience operations offset the sharp decline in its MaterialScience business”
BP. “Expected pethem margins to remain subdued given the difficult economic conditions”
Borealis. “Difficult market conditions, especially for the European polyolefin business segment”
Celanese. “Challenging economic environment in certain geographies and industries”
Clariant. “Economic headwinds, an unfavourable currency development and the absence of restocking activities”
Dow “Anticipate that global growth will gain momentum as we move through Q2 and into H2″
Dow Corning. “Demand improved slightly over last year, prices were depressed globally”
DSM. “Cautiously optimistic for 2012 despite the uncertain macro-economic situation”
DuPont. “Expect further sequential volume improvements”
ExxonMobil. “Weaker margins decreased chemical earnings”
Huntsman. “Certain economic challenges in various parts of the world”
Idemitsu Kosan. “Decreased demand for petchem products, particularly from China”
INEOS. “Demand for olefins in the quarter continued to be solid”
LG Chem. “Sluggish demand from China squeezed margins”
LANXESS. “Expects the performance in Q2 to be similar to Q1″
LyondellBasell. “Much weaker Europe, Asia and International olefins & polymers results”
Mitsubishi. “Drastic decrease in the sales volumes of basic petrochemicals due to the influence of the 11 March 2011 earthquake and a decline in demand”
OMV. “Significantly lower margins”
OxyChem. “Lower export volumes and higher raw material costs”
PKN Orlen. “High costs of feedstock led to lower margins”
PPG. Strengthening demand in the US in most end-use markets and growth in emerging regions, which offset weaker European activity,”
PTT. “Concerns over the uncertainty of economic situation in Europe and US, along with the more cautious economic policy in China, led to softened demand and continuously put pressure on product spreads”
Praxair. “Growth was strongest in North America and Asia”
Reliance. “Weaker demand for polyester products”
SABIC. “Lower prices for some products and an increase in some of our feedstock”
Shell. “Chemicals earnings were in line with the first quarter 2011″
Sherwin-Williams. “Higher paint sales volumes and price increases”
Siam Cement. “Chemical margins fell to their lowest as a result of excess global supply and slower demand”.
Solvay. “Continue to operate a strict financial discipline with a strong focus on cash”
TOTAL. “Strong deterioration of the environment for petrochemicals in Europe”
Unilever. “External macroeconomic environment remains difficult and higher input cost headwinds persist,”
versalis. “Demand tracked a recessionary environment”,
Vopak. “Optimism in the chemical sector in North America and increasing consumption of petrochemicals in Asia”

These rates would normally have left the industry in crisis mode as regards profitability. But they were “rescued” by the parallel collapse in refinery runs, and the shortage of propylene/butadiene caused by the major shift to ethane feeds in the USA.

The second chart, from the International Energy Agency, highlights the truly startling change in German refinery runs since the financial crisis. Germany is the EU’s largest and most prosperous country. Its refinery runs hardly ever fell below 2.1mbd before 2008. Since then, they have never reached this level, and were just 1.8mbd in February.

This average 18% fall in refinery runs gave major support to effective olefin OR%, as almost all EU crackers are based on refineries – either for naphtha or LPG. The high co-product values for propylene/butadiene were also critical in enabling the industry to deliver strong profitability.

Interestingly, there are now signs that fundamentals rather than sentiment are starting to drive oil markets. For the past 2 years, prices have been driven higher by the investment banks, with their continued forecasts of strong demand growth in China, plus reduced supply.

The only problem is that neither argument has proved correct. China’s demand growth is slowing fast, as it moves to a more domestically-driven economy. Whilst record oil price levels have encouraged new supply to come onstream.

Of course, rising prices helped originally to create the perception of strong demand, as buyers rushed to protect margins by buying forward. But today, this process is reversing as companies try to reduce inventory levels and working capital.

Usually, the end of a triangle formation leads to a major move upwards or downwards, as either the bears or the bulls give up their argument. Back in March, the blog suggested that:

If prices fail to break higher, then the next step might instead be (for companies) to use today’s higher prices as a platform for opening new hedges to guard against the downside risk.

With Saudi Oil Minister Naimi again warning that prices are ‘too high’, the blog sees no reason to change this analysis.

The chart above shows official US employment numbers since 1939 (blue column) and per capita disposable income since 1969 (red line), when records began. It highlights how employment patterns have changed over the past decade, whilst income levels have been flat since 2006.

In the past, the jobs market could be relied on to recover very quickly after a recession:

• In 1974/5, jobs declined from 78m to 77m, but were 80m in 1976
• In 1981/3, they fell from 91m to 90m, but were 94m in 1984
• In 1990/2, they fell from 109m to 108m, but were at 111m by 1993

But since 2001, the position has changed quite dramatically. April’s jobs number at 133m was only 770k higher than in April 2001. Similarly, Q1′s $32.6k disposable income was unchanged from Q4 2006.

This is the background to the blog’s argument in ‘Boom, Gloom and the New Normal’ that the ageing of the Western BabyBoomers (those born between 1946-70) is creating major changes in demand patterns. The first Boomer became 55 in 2001, an age when people typically start to save more and spend less, as the kids have often left home.

Today, 29% of the Western world (272m people), are now in this New Old 55+ generation. And they are uncomfortably aware that they have to save more, and spend even less, as they now have to finance an extra decade or more of life expectancy, compared to previous generations.

But Wall Street simply doesn’t care about this longer-term issue. Instead it encourages companies to cut jobs as demand slows. This further reduces overall incomes, just at the time when they are already under pressure, creating a vicious circle.