Boom, Gloom and the New Normal

As regular readers know, the blog regards benzene as an excellent leading indicator for petchem markets and the global economy. Its track record since the start of the crisis in 2008 has continued to be strong.

The reason is probably two-fold:

• It is one of the oldest, and widely used, chemicals. In many ways it is therefore a proxy for industrial production.
• It is close to the feedstock end of the value chain. So it also responds to ‘correlation trade’ activity by the high speed computers that now dominate financial markets

As the chart shows, it provided early warning in December (yellow highlight) that another feedstock price surge was underway. This drove up other petchem markets as cost increases began to be passed through. The correlation trade also led to a major rally in global stock markets.

But the crucial issue with bear-market rallies is that the volume of trading usually fails to increase as prices rise. Instead of more and more buyers jumping into the market, activity remains subdued.

This has been the pattern of recent weeks. Equally, both crude oil and the US S&P 500 have stalled at the top of their trading range. Brent is still at $124/bbl, and the S&P 500 is at 1370. Neither has found new buyers willing to support the rally.

Meanwhile, ICIS pricing reports continue to suggest that end-user demand is slowing. Buyers seem to be simply protecting downstream margins by buying forward. There is no surge of new demand.

Thus benzene’s price fall last week (second highlight) is worrying. So are the reports from China on PTA demand. It never recovered after the Lunar New Year holiday, and now seems to have slowed further.

The blog would like to be wrong. It may be that this week’s slowdown will be quickly reversed. But for the moment, it suggests that – just as in 1973/4, 1979/80, 1990/1 and 2007/8 – today’s sustained high level of oil prices is leading to demand destruction on an increasing scale.

ICIS pricing comments and price changes since the IeC Downturn Monitor launch on 29 April are below:

PTA China (red), down 10%. “PTA demand is likely to drop as a number of downstream polyester yarn/fibre chip producers in China have either shut their plants or lowered their operating rates by 5-20%, starting from last week, to ease high inventory pressure and balance weak demand”
Benzene NWE (green), down 8%. “The market has grown increasingly detached from oil and energy movements, with supply/demand dynamics playing a larger role in driving direction”
HDPE USA export (purple), down 5%. “US Gulf export offers were higher, as producers continue to try to implement an increase of about 3 cents/lb for March. However, traders said they are purchasing very little material, because the prices are too high to work in other regions”
Naphtha Europe (brown dash), down 2%. “Demand for naphtha remains unexceptional, with no shortage of offers but little in the way of bids.”
Brent crude oil (blue dash), no change
S&P 500 Index (pink dot), no change

The March IeC Boom/Gloom Index confirms the blog’s sense that markets are sitting on a fence, waiting for something to happen. As the chart shows (blue column), it has risen back to 4.1, just at the point which divides strong from weak markets.

Similarly the US S&P 500 Index (red line) is stuck at 1369, at exactly the 1370 line which would mark a major breakout. Meanwhile oil markets are also trapped, with Brent at $124/bbl remaining at the top of its triangle.

Interestingly, a number of major institutions now seem close to accepting the blog’s long-standing argument that high oil prices lead to
recession. Christine Lagarde, head of the IMF, is the latest, warning that “higher oil prices” are a major risk for “still fragile financial systems”.

A reader has also kindly drawn the blog’s attention to a paper by Prof James Hamilton of the University of California, San Diego. It notes “All but one of the 11 postwar US recessions were associated with an increase in the price of oil, the single exception being the recession of 1960.”

ICIS pricing comments confirm the supply-driven nature of current markets. Upstream prices are close to the levels at which the IeC Downturn Monitor originally launched on 29 April. But downtream PE/PTA have so far failed to pass today’s increases through to their customers:

PTA China (red), down 10%. “Activity was limited as persistently weak downstream polyester sales continued to weigh on market sentiment”
HDPE USA export (purple), down 9%. “Globally, PE prices increased on mounting energy and feedstock ethylene cost pressure”
Benzene NWE (green), down 3%. “Sources believe that the current bullishness on crude and naphtha numbers will continue to support price levels in March”
Naphtha Europe (brown dash), down 2%. “Interest in naphtha remains mediocre”
Brent crude oil (blue dash), down 1%
S&P 500 Index (pink dot), no change

The Wall Street Journal carried an interesting opinion piece on Friday, assessing current market conditions from the viewpoint of the film character, Forrest Gump. Gump’s key insight is that “Stupid is as stupid does”. Thus the Journal noted:

“Oil staged its last price surge along with other commodity prices when the Fed revved up its second burst of “quantitative easing” (QE) in 2010-2011. Prices stabilized when QE2 ended. But in recent months the Fed has again signaled its commitment to near-zero interest rates first through 2013, and recently through 2014. Commodity prices, including oil, have since begun another surge.” And it went on to add:

“Fed officials….want to take credit for easy money if stock-market and housing prices rise, but then deny any responsibility if commodity prices rise too, causing food and energy prices to soar for consumers. They can’t have it both ways, as not-so-stupid Americans intuitively understand when they buy groceries or gas. This is the double-edged sword of an economic recovery “built to last” on easy money rather than on sound fiscal and regulatory policies.”

ICIS’ Truong Mellor sums up the consequences as far as petchem markets are concerned when he notes with regard to benzene that:

“The push and pull of opposing factors – the upstream bullishness versus the slower end-use demand as well as the sense that the market is currently overheated – is also adding to the confusion.”

Europe and the USA are not the only regions where the Fed’s QE policies are destroying demand. China has record retail prices for gasoline and diesel, and ICIS reported a polyester producer commenting this week:

“General demand is not recovering as well as expected. We are at a very difficult position now: sales are slipping while inventory are increasing”.

All the key sentiment indicators are telling us that financial markets are at a cross-roads. The critical number is 1370 on the US S&P 500. This was the peak of the last rally, and coincided with the blog’s launch of its Downturn Alert on 2 May. Friday’s close was 1366. A rise above 1370 would also mark a recovery to market levels not seen since June 2008.

The chart shows product price changes since then, with ICIS pricing comments below. It shows how stock and oil markets continue to move together, whilst downstream markets have proved increasingly unable to pass through the higher prices due to demand destruction:

HDPE USA export (purple), down 11%. “PE prices were stable in Asia, amid weak demand and high feedstock costs”
PTA China (red), down 11%. “Mounting polyester inventories have restricted the purchasing power of polyester makers in the physical and futures markets”
Benzene NWE (green), down 5%. “Sentiment has softened this week with lower demand from the phenol and cumene sectors.”
Naphtha Europe (brown dash), down 4%. “Reduced supply, resulting from refinery maintenance and shutdowns, is easily able to meet soft demand”
Brent crude oil (blue dash), down 2%
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%

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.