Boom, Gloom and the New Normal

This time last year, the petchem industry stood on the edge of an unseen precipice. Life seemed good. Prices were racing ahead and demand appeared buoyant. But in reality the buyers were only buying forward to protect margins, whilst end-user demand was slowing fast.

This year, the blog fears, we may be about to take one step forward.

As last year, the evidence comes from ICIS market reports. The highly experienced Linda Naylor last week reported buyers commenting as follows in European polyethylene and polypropylene markets:

“‘We expect an increase for ethylene in March, so we are buying our full contracted volumes in February, and also in January, even though our demand is poorer than we expected. That way, we won’t have to buy so much in March.”

“‘Our demand is below what we expected but we are taking our full contracted volumes to be able to have a buffer next month.”

Similar warning signs are reported by Becky Zhang in China’s ethylene glycol markets, and Helen Yan in Asian butadiene:

“‘The market is full of offers and this [has worsened the] bearish sentiment’, a major regional trader said. China’s port inventory reached a historic high of over 750KT, with increased import volumes arriving from all over the world. This is almost exceeding China’s maximum storage capacity of around 800KT.”

“‘BD prices are higher than BR and this is not sustainable,’ another synthetic rubber producer said.”

The chart shows how prices for the benchmark products have seen 3 major rallies since 2009. These followed the 3 major stimulus packages.

Today’s rally began with Q4′s US Federal Reserve’s $400bn Operation Twist programme. It is clearly much weaker than those which followed the March 2009 and August 2010 quantitative easing programmes.

Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 11%. “Offers for re-exports from China were heard at lower prices than offers from the US Gulf”
PTA China (red), down 11%. “The current supply and demand balance as well as volatile external markets did not support a solid upturn”
Naphtha Europe (brown dash), down 7%. “Vitol continued its naphtha buying spree, taking 5 cargoes after it bought eight cargoes last week”
Brent crude oil (blue dash), down 5%
Benzene NWE (green), down 4%. “Continued buoyancy on crude and energy numbers counterbalanced by lower demand.”
S&P 500 Index (pink dot), no change

Over the past 18 months, the main investment analysts have argued that high oil prices would have no impact on the global economy. Now, new forecasts suggest their optimism has been misplaced.

The chart above gives the International Energy Agency’s latest forecast of likely oil demand growth this year:

• It has been reduced by a further 0.3mbd since January
• Total 2012 oil demand growth is forecast to be just 0.8mbd
• Global economic growth is now forecast at just 3.3%, down from 4%

Sustained high oil prices are indeed reducing economic growth, and oil demand itself, just as they have done every time in the past.

Even the idea that China would “inevitably” see strong demand growth has proved wishful thinking. The IEA forecasts just a 0.4mbd increase in China’s oil demand this year. And even that may turn out to be over-optimistic, given the clear slowdown now underway.

As the blog has long feared, the chemical industry will now have to pick up the pieces, after the damage has been done:

• Today’s oil and feedstock price levels mean that working capital costs are very high compared to historical levels. This reduces the cash available for product and market development.
• They also increase market volatility. The lack of inventory means small changes in demand can cause major swings in market prices, if producers or consumers have to cover supply chain problems.
• Even more critically, as we are seeing with the Petroplus refinery bankruptcy, there is a real risk of supply disruptions for feedstocks and raw materials, if key plants can no longer afford to operate.

Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 14%. “US spot export prices are still too high for large quantities to be sold in many markets”
PTA China (red), down 10%. “Buying activity slowed down clearly as compared with last week because the persistently weak downstream polyester sales curtailed buying interest”
Naphtha Europe (brown dash), down 7%. The Petroplus bankruptcy led traders to build inventory in anticipation of “stronger demand from both the gasoline blending sector and petrochemical end-users”
Brent crude oil (blue dash), down 6%
Benzene NWE (green), down 4%. “Price ideas edged up in line with stronger US and Asia numbers as well as steady-to-firm energy costs”
S&P 500 Index (pink dot), down 2%

Dow Chemical is usually optimistic. 6 months ago, for example, it reported that “our transformed portfolio, underpinned by our cost-advantaged and flexible operations, is now performing at a new level.”

Last week, however, Dow reported that Q4 operating rates were down from 81% in 2010 to 72%, and warned it faced “headwinds” in all segments apart from agriculture. Dow added that “times like these demand a focused approach and strong resolve, and Dow’s firm operating discipline, cost control and productivity will continue throughout 2012.”

Yet next day, financial markets turned euphoric, with the S&P 500 and oil prices jumping 1.5% in response to the monthly US jobs report.

Demand, as always, will determine whether markets are right to climb today’s ‘wall of worry’. So far this year, it has been relatively subdued, and gives no indication that either Western or Asian consumers are feeling full of confidence about the year ahead.

The chart shows market developments over the past year. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 14%. “US spot export prices are too high for most markets”
Naphtha Europe (brown dash), down 11%. “Demand from both the petrochemical industry and the gasoline sector have declined”
PTA China (red), down 10%. “Chinese fibre market has yet to resume full production after the holiday”
Brent crude oil (blue dash), down 10%
Benzene NWE (green), down 5%. “There had been an expectation that buyers would enter the market, but this has so far failed to materialise”
S&P 500 Index (pink dot), down 1%

‘Would you buy, or would you sell?’ is always an interesting question in any market. Petchems provide a particularly balanced answer today.

• Buy arguments include – China’s buyers will return from holiday, and will need to restock; gasoline markets are tightening after the Petroplus bankruptcy; bad weather is causing some disruption
• Sell arguments include – US GDP data disappointed with inventories showing a big rise; a blockage of the Strait of Hormuz seems less likely in the short-term; European demand remains slow for the time of year

The ‘safe’ answer to the question would therefore be to buy. And this is what has been happening, especially as consumers need to build inventory ahead of proposed price increases. They cannot pass these on downstream, so their profitability depends on buying forward.

The second question, of course, is ‘would you therefore go long?’ And today the ‘safe’ answer would be to simply maintain prudent inventory levels. Markets have been driven by supply-side constraints for many months now, not by strong levels of demand.

The ‘sell’ arguments above create justifiable concern that one day, perhaps not too far away, fundamentals of demand will come back into play. Going ‘long’ would require either a strong belief that demand is returning, or confidence that supply will remain disrupted.

The blog suspects that crude oil market moves may prove decisive in the end. The bankruptcy of European refiner Petroplus is yet another warning sign about the impact of demand destruction at today’s record prices. But equally, oil is still trading in its ‘triangle’ pattern, so it would be premature to anticipate its future direction.

The chart shows market developments over the past year. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 16%. “Trading was thin, with the Chinese New Year holiday keeping Asian markets at a standstill”.
PTA China (red), down 13%. Markets were closed for Lunar New Year
Brent crude oil (blue dash), down 11%
Naphtha Europe (brown dash), down 11%. “Restocking, delays in the Mediterranean, and higher propane prices which have finally encouraged buyers back to naphtha”.
S&P 500 Index (pink dot), down 4%
Benzene NWE (green), down 3%. “Some key European producers have been aggressively purchasing benzene instead of pygas”.

There is no arguing with markets when they are being driven by sentiment, either positive or negative. Last week’s news of China’s slower GDP growth gave rise to opposite interpretations in Asia and the West – but news media reported both were seen as firmly positive:

• In Asia, markets “jumped… after news that Q4 economic growth in China had beaten forecasts eased fears of a sharper slowdown there”
• Western markets “rose to a 10-week high…after China’s slowest economic growth in more than 2 years bolstered expectations for easier monetary policy”

News analysts, however, were more cautious, with CBS noting:

“This is the smallest GDP increase in a decade and the consensus opinion is that it indicates China is heading for a soft landing as its economy slows. That would be a reasonable conclusion if there was any chance this number wasn’t a complete fabrication. The actual number is certainly lower, quite possibly by a huge amount”.

The Washington Post added a more detailed warning:

“Real estate accounts for 13 percent of China’s economy, and it has been growing at ~20% a year…The run-up in real estate prices has allowed for massive government spending, as provinces and localities sell land and use land as collateral for large loans, raising the specter of a debt crisis similar to the debt crisis in the United States and Europe.”

Meanwhile petchem markets remained in their recent range. The current optimism in financial markets, even though these also remain range-bound, makes it prudent to restock inventories regularly.

The chart shows how markets have moved since 2009′s rally began, with the recent downturn highlighted in yellow. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 18%. “Even with higher global prices, US prices were still too high to generate much interest”.
Naphtha Europe (brown dash), down 14%. “Some seasonal restocking, a recent open arbitrage to the US and the current loading of European vessels booked in December for Asia”.
PTA China (red), down 13%. “Transactions were subdued as most market players were away for the upcoming Lunar New Year holiday”.
Brent crude oil (blue dash), down 11%
Benzene NWE (green), down 5%. “Values buoyed by a firming Asian market as well as crude and energy gains”
S&P 500 Index (pink dot), down 4%

The above chart would have seemed unbelievable at any time in the past 30 years. It shows the performance of propylene and butadiene relative to ethylene.

Not because it shows butadiene prices racing ahead relative to ethylene (green line). This happens routinely during a downturn, as tyre demand is more robust than for polymers. If people are not buying new cars, they still have to buy new tyres for existing cars – for legal and safety reasons.

But the record level of the butadiene premium to ethylene, an average of 170% in 2011, does give a clue to the dramatic nature of the disruption that has taken place.

The real shock, however, is that propylene sold at parallel prices to ethylene through the year (blue line). Not only has this never happened before. But it is also contrary to the main rationale for propylene sales, as this developed during the 1980′s.

The blog discussed this emerging trend back in July 2010, in a major series of posts that anticipated recent developments. They were also summarised in its ICB analysis of September 2010. New readers may like to refer to these for background detail by clicking the links:

• Major changes underway on relative olefin pricing
• Propylene prices reach parity with ethylene
• Benzene develops security of supply issues
• Lower Western gasoline demand helps paraxylene
• Major changes underway in chemicals markets

The key is that markets have become supply-driven. Oil production and refinery output have been reduced due to lack of demand. This has reduced ethane availability in the Middle East, and naphtha availability in the West.

Equally, the dramatic increase in the price of crude oil versus natural gas in the USA, due to financial speculation, has prompted a major switch from liquid to ethane feeds on the crackers.

Propylene supply has therefore been reduced both by lower refinery runs, and by the switch to ethane feeds, as these produce virtually no propylene or butadiene. Lower cracker operating rates have also helped to tighten markets, particularly for butadiene.

The question ahead is now twofold:

• Will buyers still be interested in using propylene for its commodity applications such as packaging, if it is no longer price competitive?
• Can crude oil really maintain its current premium to natural gas?

The answers to these questions are really a zero-sum game. Those who get them right, stand to make a lot of money. Those who get their analysis wrong, will likely lose a lot of money.

The blog itself would be extremely cautious about ignoring affordability issues, and simply assuming current trends will automatically continue.

Markets are worryingly quiet for the start of a New Year. There is some restocking underway, but the main interest lies in the crude oil market.

Since Brent peaked in April, there has been a clear pattern each month:

• Prices have peaked at the start of almost every month
• The only exceptions have been July and October
• They have then slipped lower by the end of the month

So players have been busy ‘talking up’ the market since New Year, to see if they can catch unwary buyers. If the pattern holds, they will then ‘talk down’ the market in the 2nd half of the month.

Actual price movements since April have been minimal – with a range of $103 – $118/bbl. So this type of tactic is the only way for players to earn a decent bonus. Their aim is simple – to buy at the end of each month, and then resell at the start of the next month.

Meanwhile, back in the real world of petchems, uncertainty rules.

Some hope that China will boost demand once Lunar New Year is over. Others, particularly in the USA, hope that consumer demand might be improving. But in Europe, there is little optimism. France and Austria lost their AAA ratings on Friday, and Greece moved closer to default.

The chart shows market developments over the past year. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 18%. “The delta between China and US prices was still too wide to generate much interest in US product”.
Naphtha Europe (brown dash), down 16%. “Low activity levels, with high prices still having an impact on demand”.
PTA China (red), down 14%. “Surging feedstock paraxylene (PX) prices supported PTA prices”.
Brent crude oil (blue dash), down 10%
Benzene NWE (green), down 9%. “Upward movement was primarily crude driven, as demand from key sectors such as styrene and phenol has so far remained sluggish to average “.
S&P 500 Index (pink dot), down 6%

The chart above shows how the benchmark products in the IeC Downturn Monitor moved during 2011. The yellow shaded area covers performance since 29 April, when the Monitor launched.

It shows a year of two halves:

• The period to the end of April was the last time that governments embarked on major ‘stimulus efforts’.
• These cost at least $5trn, but failed to deal with the real problems – the US housing market; China’s over-dependence on exports; the Eurozone debt issues
• They also made the problems worse, by providing liquidity to the ‘high frequency traders’ to drive oil prices up to recession levels

Financial crises such as today’s usually follow a predictable pattern. Markets see a sharp fall, then a temporary rebound, followed by a long-drawn out fundamental downturn.

The downturn marks the period where the world readjusts to changed circumstances. It only ends when policymakers and companies refocus on looking forward, rather than on returning to the previous ‘normal’.

Sadly, there are currently few signs that this forward-looking approach is yet being widely adopted.

ICIS pricing movements for the benchmark products since the Monitor’s launch are below:

HDPE USA export (purple), down 22%
Benzene NWE (green), down 20%.
Naphtha Europe (brown dash), down 20%. ”
PTA China (red), down 18%.
Brent crude oil (blue dash), down 14%
S&P 500 Index (pink dot), down 7%

Whisper it softly, so as not to alarm the CEO. But the world is starting to look worryingly like the picture of mid-2008.

Official bodies such as the IMF are always cautious in forecasting a downturn. They rightly worry that they could help to cause the decline, by hitting confidence. But there comes a moment when saying nothing becomes the bigger risk.

This is what happened back in April 2008. As the blog noted then, the IMF threw caution to the wind and warned:

“It is now clear that the current turmoil is more than simply a liquidity event, reflecting deep-seated balance sheet fragilities, which means its effects are likely to be broader, deeper, and more protracted”.

Now, its new managing director, Christine Lagarde, has gone much further. She warned on Thursday that the global economy faces the prospect of:

“Protectionism, isolationism and what happened in the 1930s (the Great Depression). There is no economy in the world, whether low-income countries, emerging markets, middle-income countries or super-advanced economies that will be immune to the crisis we see not only unfolding but escalating.”

This, of course, has been the blog’s concern for some time. As always, petchems have been a leading indicator for the global economy. So far, oil prices and the major financial markets have ignored their trend. But this may not last forever.

In some ways, therefore, it is a hopeful sign that the IMF has spoken out. Lagarde may be able to burst the bubble of complacency that seems to surround most of the major governments. But equally, it also emphasises once again the very real risks facing the global economy in 2012.

ICIS pricing comments this week, and price movements for the benchmark products since the launch of the IeC Downturn Monitor on 29 April are below:
Naphtha Europe (brown dash), down 23%. “The market has tightened slightly from the previous week.”
HDPE USA export (purple), down 22%. “Globally, buying sentiment was weak, with China, Vietnam and SEA buyers not wanting to build inventories ahead of the Lunar New Year holiday.”
Benzene NWE (green), down 21%. “Renewed downstream styrene production pulled material and kept supply levels balanced to tight”.
PTA China (red), down 19%. “Demand dropped as textile factories have stocked up enough inventories in the past two weeks to cover their requirement for the rest of the year.”
Brent crude oil (blue dash), down 16%
S&P 500 Index (pink dot), down 11%

NOTE: This will be the last Downturn Monitor in 2011, due to the Christmas and New Year period. It will resume on 9 January.