Boom, Gloom and the New Normal

Financial markets continued their start of quarter rally last week. But their volatility amazes even seasoned observers. The US Dow Jones Index has moved at least 100 points in 57 of the last 58 days, for example, whilst crude oil jumped $3/bbl on Friday alone.

Of course, the continued correlation between stock and oil markets is ultimately contradictory. Higher oil and feedstock prices can only do further damage to the prospects for economic recovery in the real economy, in which we all operate. The blog discusses this in the above short interview, recorded with ICIS’s John Baker at EPCA.

But the volatility is likely to continue, as long as markets remain dominated by the high frequency traders and their computer games. Reassuringly, though, there are signs that next month’s G-20 meeting might ban at least some of this dysfunctional trading activity. The blog will tip its hat to Andy Haldane at the Bank of England, and his colleagues, if this can be achieved.

The blog was also reassured by news that German chemical firms are studying “scenarios for a recession” as a result of the current financial market turbulence. Henrik Meincke at Germany’s VCI chemicals trade group told ICIS that “Germany’s chemical industry would be prepared” should a recession occur.

ICIS pricing comments this week, and price movements since the IeC Downturn Alert launched on 29 April, are below:

Benzene NWE, down 28%. “An air of nervousness was compounding the softer sentiment across the benzene market, as was the strict inventory management currently in place across the aromatics chain and downstream markets.”
HDPE USA export, down 25%. “Prices continued to fall during the week. One source suggested some prices have been so low, producers might be trying to sell into China.”
Naphtha Europe, down 16%. “Demand remains poor from both the petrochemical industry and the gasoline sector.”
Brent crude oil, down 13%.
S&P 500 Index down 10%.
PTA China, down 8%. “Buyers had no confidence to purchase cargoes because of poor downstream sales.”

The great film comedy Groundhog Day saw Bill Murray doomed to repeat the same day in his life, until he learnt to become a better person. Sadly, financial markets have yet to learn from his example.

Every quarter, the investment banks produce new stories aimed at pushing stock/oil markets higher. Then high-frequency traders make $millions in seconds by bidding prices higher.

This week saw the same pattern yet again as Q4 began.

Reuters, not known for its sensationalism, carries a detailed account of how the computers pushed prices 4% higher in the last hour of Tuesday’s New York trading. Those who haven’t yet read our own account of the process in Chapter 3 of ‘Boom, Gloom and the New Normal’, may well be amazed by the report.

Yet 3 days later, the Governor of the Bank of England, not normally an alarmist, told the BBC that: “This is the most serious financial crisis we’ve seen at least since the 1930s, if not ever.”

It is a measure of the dysfunctionality of our financial systems that the two events could occur so close to each other.

The real world in which chemical companies operate confirms the Governor’s outlook. The chart above shows price movements since the beginning of the year. It highlights the complete change of direction since the IeC Downturn Alert’s launch on 29 April.

ICIS pricing comments this week are below:

Benzene NWE (green), down 17%. “Benzene players continue to struggle with softening demand and overall bearish sentiment.”
S&P 500 Index (pink dot), down 9%.
PTA China (red), down 7%. “Market remained unchanged because of China’s National Day holiday from 1-7 October.”
Naphtha Europe (brown dash), up 3%. “Demand from the petrochemical industry remains poor, while from the gasoline sector it is mediocre.”
HDPE USA export (purple), up 5%. “Prices trending lower based on plentiful supply and low feedstock costs.”
Brent crude oil, up 9%.

Petchem markets are continuing to act as leading indicators for the global economy. The IeC Downturn Alert shows there was no September rebound in orders after the holiday period.

October will have to bring a sudden, and powerful reversal of the downward trend. Otherwise Q4 could be very difficult indeed. Benzene, the blog’s favourite market indicator, is now down 27% since the Alert began 5 months ago.

Equally, crude oil prices are looking very weak, and seem to be heading towards the blog’s $60/bbl target. The damage they have already created to demand means prices could end up much lower.

Meanwhile, financial markets have become dysfunctional under the influence of the super-computers. These now control 60% or more of trading in most markets. They are programmed to:

• Read and interpret financial market headlines in real time
• Issue thousands of buy or sell orders in response to these
• Then close their positions after micro-seconds, and start again

The computers are fine when it comes to reading numbers. But they completely fail when interpretation is required:

• Thus markets soared on Thursday, after German Chancellor Merkel won her parliamentary vote to support the European Financial Stability Facility
• But they then reversed direction on Friday, when new headlines suggested the vote had not resolved any of the Eurozone’s problems.

This demonstrates how financial markets have lost touch with their real purposes – of raising funds to allow companies to expand, and of allowing producers to hedge commodity price risks. High-frequency trading instead simply creates unhelpful market volatility for the profit of those owning the most powerful computers.

Price movements since the Alert’s launch, and ICIS pricing comments this week are below:

Benzene NWE (green), down 27%. “Market values have eroded throughout the past month on continued macroeconomic bearishness as well as slower downstream demand.”
Naphtha Europe (brown dash), down 20%. “Refinery run cuts are reducing supplies…demand remains weak”.
HDPE USA export (purple), down 18%. “Traders said US inventories were building….but very little export activity was yet taking place.”
S&P 500 Index (pink dot), down 17%.
Brent crude oil, down 17%.
PTA China (red), down 10%. “Sellers were forced to offload their cargoes to take in cash ahead of the National Day holiday in China.”

The chemical industry has a turnover of $3.4trn, and is the world’s 3rd largest industry. It matters to the global economy.

Many of its leaders are about to meet next weekend in Berlin for the annual European Petrochemical Association (EPCA) meeting.

The blog strongly believes that this should not be seen as a ‘business as usual’ meeting. We cannot simply assume that the global economy is in fundamentally good shape:

• IMF head, Christine Lagarde, has warned the global economic situation is entering a “dangerous place”
• World Bank president Robert Zoellick has described world finances as being in a “danger zone”

These are not sound-bites being made for effect.

The danger signs have been building for months. The blog, after all, introduced its IeC Downturn Alert nearly 5 months ago, on 2 May.

Coincidentally, this matched the peak of the US S&P 500 Index, since when financial markets and crude oil prices have fallen dramatically, as shown in the chart above.

Every week since then, with the help of ICIS news and ICIS pricing, the blog has chronicled the approach to today’s Downturn:

• First we saw customers around the world buying ‘hand to mouth’. They tried to run down inventories built up during the 50% rise in crude oil prices between December-April
• Then everything went quiet during the summer. The retailers destocked after seeing end-user consumption fall due to the impact of higher oil prices
• Then it became clear that China’s economy, the previous motor of the global economy, was slowing fast, as the government reduced credit to combat high inflation
• Now, in September, it is clear that demand has not returned after the holidays. And the wider economic outlook is getting worse, not better.

The blog made similar efforts to alert the industry to the issue of demand destruction before the 2008 downturn, and was later awarded the title of ‘The Crystal Blog’. But sadly, its warnings were not taken seriously at the time when they could have had an impact.

The industry’s leaders need to ensure that ‘this time is different’ in Berlin. It is no exaggeration to say that the very future of some companies, and of important sectors of our industry, may be at stake.

Price movements since April, and ICIS pricing comments this week are below:

Benzene NWE (green), down 26%. “A swathe of imports coming into the ARA region were also keeping supply ample as demand struggled amid weak end user confidence.”
Naphtha Europe (brown dash), down 19%. “The impact of refinery run cuts is starting to show, and it is thought that the naphtha oversupply would have been more severe if not for these“.
HDPE USA export (purple), down 18%. “The Asian market has slowed down, in part because of a national holiday, and in part because of concerns about the global economy. Asian prices were expected to fall in China because of tightening credit rules.”
S&P 500 Index (pink dot), down 17%.
Brent crude oil, down 14%.
PTA China (red), down 4%. “Most buyers were adopting a wait-and-see stance because of the unclear market trend. Only a few end-users purchased cargoes on a need-to basis.“

Europe is at the eye of the storm when it comes to energy pricing. This is the last thing required by its struggling economy.

As the chart shows, Brent in euros (green line, RHS) is now back at the same level as June 2008, whereas WTI is 35% cheaper (black line, LHS).

Such a divergence has never happened before, and is due to two factors:

• Brent is now at $25/bbl premium to WTI, vs its usual $1/bbl discount
• The euro has fallen 12% from $1.60 to $1.40

Brent’s unprecedented premium is clearly not due to strong levels of European demand. But an excellent article by Javier Blas in the Financial Times highlights one potential cause – the growing lack of liquidity in the Brent market:

• The Brent contract includes 4 fields (Brent, Forties, Oseberg, Ekofisk)
• But their output is declining and is forecast to be <1mbd by next year

The result, as the Oxford Institute for Energy Studies notes in a major new study is that:

“While the volume of production is not a sufficient condition for the emergence of a benchmark, it is a necessary condition for a benchmark‟s success. As markets become thinner and thinner, the price discovery process becomes more difficult. Oil price reporting agencies cannot observe enough genuine arms-length deals.

Furthermore, in thin markets, the danger of squeezes and distortions increases and as a result prices could then become less informative and more volatile thereby distorting consumption and production decisions.Brent’s current $25/bbl premium to WTI seems to provide prima facie evidence that such “squeezes and distortions” may now be taking place.

Brent’s premium also creates a further problem for Europe’s economy. Unlike the USA, its prices for natural gas are closely linked to oil prices. So today’s high premium for Brent creates a double whammy for consumers, and intensive energy users such as the chemical industry.

The IeC Downturn Alert has hopefully done the job for which it was intended.

It was launched at the end of April, when the blog became convinced that the global economy was highly likely to enter a new downturn. It also realised from its experience in 2007-8, when it later became known as ‘The Crystal Blog’, that this view was probably not widely shared.

It therefore wanted to monitor the situation on a regular basis. It decided to select benchmark chemical products from the key regions, as a way of linking its wider concerns with the evidence on the ground.

The role of ICIS pricing, and its network of editors, has therefore been crucial. This has enabled the blog to follow individual product markets, and provide an objective analysis of their weekly fluctuations.

The chart above is, of course, a key reason why the blog was convinced a new downturn was near. As it noted in June, history shows that recession (shaded area) has occurred every time oil prices (red line) have remained above $50/bbl in real (eg inflation adjusted) terms.

Sadly, it appears that this time is not going to be different.

The evidence for a renewed downturn is now all around us:

• The OECD says “economic recovery appears to have come close to a halt in the major industrialised economies” with likely H2 growth at • China’s economy is slowing fast. Ethylene demand growth tracks GDP, and was just 1.9% in H1, compared to ~10% in 2009-10.
• The American Chemistry Council (ACC) reported Friday that “we see an economy still near stalling speed“.

The blog hopes that the IeC Downturn Alert, coupled with its IeC Boom, Gloom Index, has helped to catalyse debate about the potential for a renewed downturn. We cannot avoid the severe problems that this will cause. But hopefully the Alert has provided companies with clear advance warning that problems lay ahead.

Equally concerning is the fact that Western central bankers and policymakers have so completely misread the underlying economic situation over the past 3 years. The blog will look at the likely reason for this terrible mistake over the next two days.

Price movements since the Alert launched, and ICIS pricing comments this week are below:

Benzene NWE, down 16%. “Values softened over the course of the week due to wider economic bearishness.”
S&P 500 Index, down 15%.
HDPE USA export, down 14%. “Prices are still too high to compete with Asian prices”.
Naphtha Europe, down 13%. “Demand from petchems remains weak”.
Brent crude oil, down 9%.
PTA China, stable. “Underpinned by firmer feedstock PX prices and pre-holiday restocking activity by end-users”.

Chemical markets are traditionally 6 months ahead of the wider economy, as they are so focused on consumer demand. September may therefore provide a ‘moment of truth’ for the IeC Downturn Alert, launched in April:

• The petchems downturn since April may now become apparent in the wider economy
• Alternatively, demand may recover strongly, signalling recovery remains on course

It would be unwise to jump to conclusions this early in the month. But the failure of the US economy to add a single job in August, for the first time since 1945, is not a good omen.

Equally, only one downstream market, PTA in China, is currently showing any pricing strength. And even this seems somewhat precarious, according to the latest ICIS pricing report below. Other ‘bellweather’ markets such as benzene and polyethylene seem potentially weak.

Bulls, however, will take heart from the fact that Brent crude oil prices and naphtha both managed a small increase, even though inventories remained high. Any resumption of demand could enable derivative prices to recover quite sharply from the falls shown in the above chart.

Price movements since April, and ICIS pricing comments this week are below:

S&P 500 Index (pink dot), down 14%.
HDPE USA export (purple), down 14%. “Lower Asian export prices are continuing to reduce interest in US material”.
Benzene NWE (green), down 13%. ” Wider economic jitters could potentially affect demand and pricing.”
Naphtha Europe (brown dash), down 12%. ” Market is again bearish, and has lengthened from the previous week due to poor demand”.
Brent crude oil, down 9%.
PTA China (red), down 3%. “Some players expect a downward correction, while others see prices continuing to rise amid firm PX costs”.

UPDATE. Worryingly, Swisss firm Clariant became the first chemical company to issue a profit warning today, due to “order sizes coming down and more insecurity in the supply chain” in Brazil, US and Europe.

Bloomberg quotes the blog adding “There appears to be no ‘seasonal surge’ in demand from Western retailers in advance of Thanksgiving and Christmas. This is further confirmation perhaps that consumer demand is taking a real hit.”

The blog was almost alone at the end of April, when it launched the IeC Downturn Alert. Today, its fear that we are close to a global downturn has become mainstream.

As the American Chemistry Council report, “fears of another global recession are rising with several noted forecasters raising the chances of another recession to one‐in‐two“.

The disfunctionality of financial markets is clearly a major factor in boosting chances of a downturn:

• 75% of US equity trading in August was High Frequency Trading
• This is traders playing computer games, in micro-seconds.
• It has no value whatsoever, and clearly destabilises markets
• But Wall Street-friendly regulators continue to excuse it

In terms of chemical markets, most players have sensibly retreated to the sidelines, as ICIS pricing comments note. The chart shows how prices have moved since April, when IeC Downturn Alert launched:

Naphtha Europe (brown dash), down 16%. “Factors dampening activity include the ongoing summer holiday season, and crude oil price volatility”.
Brent crude oil, down 15%.
S&P 500 Index (pink dot), down 14%.
HDPE USA export (purple), down 13%. “Prices were assessed notionally higher based on price ideas from traders”.
PTA China (red), down 7%. ” Most buyers were pessimistic about the market outlook.”
Benzene NWE (green), down 3%. “Benzene has been incredibly resilient to the volatility seen for crude.”