Boom, Gloom and the New Normal

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%

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 blog is quite surprised at the mainstream media’s lack of interest in the fact that average Brent oil prices were at record levels in 2011 in real terms (adjusted for inflation).

The annual average of Brent prices recorded by the US Energy Information Administration was $111.26/bbl, well above even 2008, when Brent prices peaked near $150/bbl in nominal terms. Yet a Google search of ‘record annual oil prices in 2011′ reveals only the blog’s own entry.

The statistic itself certainly seems newsworthy and important. 2011′s high oil prices took 5% of global GDP from consumers’ pockets. By comparison, oil costs averaged less than 3% during the economic SuperCycle years of 1982-2007. It is no wonder that spending is reduced, and retailers around the world are facing hard times.

However, the blog suspects this lack of awareness is about to change, as its impact becomes clearer:

• Tesco, the world’s 3rd largest retailer has reportedly had its worst UK Christmas performance for decades
• Nigeria is about to see major strikes over fuel subsidies
• Refiner Petroplus has seen its credit lines frozen, and has already been forced to shut 3 of its refineries.

Petchem markets are caught in the middle, as usual.

Producers have no choice but to try and protect margins by posting higher prices – especially with crude now rising further due to worries over Iran’s policies. But buyers find it extremely difficult to pass through any increases to cash-strapped consumers.

In addition, economic concerns have helped make markets treacherous:

• Inventories are low due to demand worries, and cash constraints
• Mid-tier companies are finding credit tight, as the banking sector cuts back (especially in China and Europe)
• Crude oil markets remain supply-driven and unpredictable
• Currencies are very volatile, with the €:$ rate down 3% during the week

The chart shows product price changes since the IeC Downturn Monitor’s launch on 29 April 2011, with ICIS pricing comments below:

HDPE USA export (purple), down 18%. “Trading was thin, with very little interest in US material”.
PTA China (red), down 14%. “Surging feedstock PX prices exerted major upward pressure on PTA prices”.
Naphtha Europe (brown dash), down 14%. “Petchems and gasoline have shown minimal interest in naphtha”.
Benzene NWE (green), down 13%. “Downstream demand had yet to pick up following the holiday season”.
Brent crude oil (blue dash), down 10%
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%

High oil prices are a bad thing for the global economy, and for the chemical industry,

2011 was therefore a very bad year indeed.

Brent oil prices, the global benchmark, averaged $111/bbl in 2011. This is higher even than in 1979 and 1980, after adjusting for inflation.

The chart shows the history since 1970, based on BP’s annual Energy Statistics. The red columns mark official recession periods in the US economy. They show that recession followed every time oil prices sustained a level of $50/bbl or more in $2011 (red line).

Of course, ‘this time may be different’. But in the past, oil costs above 3% of GDP have always led to a recession. 2011 saw them at over 5% – the highest level since the major downturn in the early 1980′s:

• The problem is caused by the drop in consumers’ discretionary income
• They have to buy gasoline, and heat/cool their homes
• So they have less money to spend on everything else
• Initially people buy forward to avoid higher prices
• But then demand falls away, as soon as the oil price stops rising

The ageing of the Western BabyBoomers, who drove the economic Supercycle between 1982-2007, makes it even more difficult for the global economy to sustain this burden.

The New Old generation of those aged 55+ are now 29% of the Western population. It is extremely hard for the economy to grow, when the needs of this major segment of the population are being largely ignored.

The other side of the short-term volatility in oil markets, as discussed yesterday, is that price movements are still trapped in their long-term triangle pattern.

As the chart shows, Tuesday’s $3/bbl move was not part of a break-out to new high ground. In fact, Brent’s prices remain within the same $99/bbl – $127/bbl range they have occupied all year.

The triangle highlights the continuing battle between the bulls, led by the high-frequency traders, and the bears, led by those who focus on fundamentals of supply and demand.

The bulls are making ever-more desperate efforts to push prices higher. But news that OPEC was maintaining current output quotas was clearly bearish. So is the fact that demand is clearly slowing in all major regions.

Of course, some major event might well arrive to force prices higher. If Iran blocked the Strait of Hormuz, they might reach $200/bbl, given the importance of those shipping lanes for world crude oil movements.

The blog will continue to monitor developments very closely, given the importance of the outcome.

ExxonMobil’s annual energy review is always a fascinating read. This year’s issue looks out to 2040 for the first time. It thus forecasts the relative share of the major fuels over the next 30 years.

Interestingly, it also shares the blog’s belief, as set out in our ‘Boom, Gloom and the New Normal‘ eBook, that demographics will play a critical role in changing demand patterns over this period, noting that:

• “Demographics and economic expansion drive energy demand”
• “Population growth is slowing. In some places – many OECD countries plus China – populations will change little by 2040″
• China will see “a steep drop in its working age group”
• “India and Africa become some of the strongest areas of GDP growth”

EM also provide the above historical chart showing how fuel use has changed over the past 300 years.

Biomass, mainly wood (brown), was the main fuel from 1800. It began to be replaced by coal (light brown) from 1850. Then oil (green) began its reign from 1900. More recently, gas (red) has begun its rise. EM expect a 60% growth in its use by 2040. Hydro (light blue), nuclear (dark blue) and other renewables (yellow) are at an early stage of growth.

EM make the useful point that the variability of wind and solar power can be balanced by ‘on-demand’ sources. This will add to gas’s more obvious advantages such as its relative abundance and low price.

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.

By now, companies should be reordering for the New Year. CFOs have achieved their working capital targets for year-end. And the commercial people should be planning Q1 sales.

So far, however, it seems that this restocking has proved rather weak. This parallels September’s disappointment, when the return from the summer holidays also failed to produce a major recovery in order flow.

Business managers have indeed been increasing their list prices, in preparation for a wave of orders. And China’s PTA producers have postponed planned commercial shutdowns. But DuPont, often a bellwether company for the global industry, summed up the general nervousness in their profit warning on Friday, when CEO Ellen Kullman noted:

“We are seeing slower growth in certain segments during Q4, driven by global economic uncertainty. This uncertainty is contributing to ongoing conservative cash management in some supply chains. The earnings revision reflects destocking across polymers and certain industrial supply chains that has accelerated during the fourth quarter. Consumer electronics demand has further softened, and housing and construction markets remain weak. Other markets remain as expected.”

Kuhlman went on to add that “with customer inventories at very low levels, we are staying close to our customers to assure that we are ready to respond when demand returns”. But she prefaced this with a reference to DuPont’s “aggressive productivity initiatives“. Companies expecting a quick recovery are not usually focussing their efforts on cost reduction.

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:

Benzene NWE (green), down 23%. “Market firmed though fundamentals still weak”.
HDPE USA export (purple), down 22%. “Producers began to implement price increases but with falling Asian and Middle Eastern prices, trade to Asia was all but impossible.”
Naphtha Europe (brown dash), down 21%. “Oversupply eases slightly on demand from Asia.”
PTA China (red), down 18%. “PTA producers had initially planned a large-scale production cutback because of negative margins, but have not done so yet as they expect margins to improve in December”
Brent crude oil (blue dash), down 12%
S&P 500 Index (pink dot), down 8%