Boom, Gloom and the New Normal

As promised, the blog looks today at the performance of US polyethylene (PE) exporters in Brazil.

It was the fastest-growing of the major markets in 2011, as the wider economy benefitted from China’s demand. Since 2008, Brazil’s PE net imports have grown 78%, from 445KT to 793KT in 2011. But as the chart shows (based on data from Global Trade Information Services):

• NAFTA (red square) has seen its market share decline from 40% to 38%, despite its growing cost advantage since 2010 due to shale gas
• The reason is that China’s changing market dynamics (as discussed yesterday), has led to greatly increased competition

USA net exports have grown 51% over the period, from 171KT to 258KT. Canada’s exports have also increased from 6KT to 32KT. But at the same time, many more players have entered the market:

• Latin American exporters (blue line) have been the big losers
• Their share has dropped from 42% in 2008 to 24% in 2011
• The Middle East (dark blue) has jumped from 2% to 13%
• Europe (green) has maintained its position, rising from 8% to 10%
• SEA (brown) has jumped from 1% to 6%
• NEA (dark green) has increased from 3% to 4%
• India (purple) has gained a 1% share

In turn, this has led to a decrease in relative profitability. GTIS data also shows that Thailand, for example:

• Sold in 2008 at an average $1825/tonne, $100/t above USA levels
• But in 2011 it sold at $1546/t, $50/t below USA levels

Brazil’s market dynamics therefore highlight the increasing challenge being faced by US exporters. Countries no longer able to sell their output to China will not simply reduce production. Instead, they will target new markets, increasing competitive pressures around the world.

US petchem producers are planning a major boost to ethylene capacity. They now have the 2nd cheapest feedstock in the world, due to ethane from shale gas. The only question is, where will they sell their product?

Ethylene, of course, is very expensive to export. So derivatives such as polyethylene (PE) are the main way to tap export markets. Today, using trade data from Global Trade Information Services, the blog looks at the outlook for PE in the US’s largest export market, China.

China should present a wonderful opportunity. Market growth has slowed to normal rates following the end of stimulus programmes. But its production is largely based on crude oil, and so is far more expensive than NAFTA’s. Yet, as the chart shows:

• China’s net imports from NAFTA fell 53% between 2009-11
• This was despite a major increase in their cost advantage
• The USA saw its net exports fall 51%, from 947KT to just 461KT

The reason is that China does not focus on profitability as a major driver for business. Instead, it emphasises social and political factors:

• Social. Sinopec continues to increase its own production, even though its total chemicals EBIT between 2000-10 was just Rmb84bn, compared to total chemicals capex of Rmb166bn. No Western company would invest on this basis. But Sinopec’s role is to act as an utility, providing reliable supplies of raw materials to China’s factories to keep people employed.
• Political. China is, however, increasing its PE imports from the Middle East (up 69%) and SE Asia (24%). The ME and China operate a ‘strategic corridor’ which balances China’s need for energy imports with the ME’s need for markets. Whilst SEA has a free trade area with China.

The result is that producers in NAFTA, NE Asia and Europe have all seen a major decline in export volumes since 2009. In turn, of course, this has led to greater competition for the USA in other markets.

Tomorrow, the blog will analyse how has impacted US exports to Brazil, currently the world’s fastest-growing major market for PE.

Russia has been the great exception in regional chemical markets.

Normally, production growth starts at a high level, often 15% a year or more, and then slows as markets become more mature. But in Russia, output collapsed with the Berlin Wall after 1989, and growth was actually negative until the mid-2000s.

Since then, there has been a strong recovery. This makes sense from a feedstock perspective, as Russia was the world’s largest oil producer in 2009-10 (as Saudi operated OPEC quotas). Oil is now setting new post-Soviet records at 10.3mbd, with gas output also increasing.

As always, the blog is grateful to Sergei Blagov of ICIS news for the data in the above chart, and further insight into some key areas:

• Production growth slowed during 2011 from 2010′s very high levels
• Fertiliser output (blue line) grew 5% to 19m tonnes
• Polymers output ( red) grew 9% to 5m tonnes
• Synthetic rubber output (green) was up 5% at 1.4m tonnes

These were still strong rates by historical standards. Polypropylene was particularly robust, up 12% at 722KT: polyethylene was up 8% at 1.65MT; polystyrene was up 14% at 348KT; and PVC was up 6% at 636KT.

Last April, China’s polyester market provided an early warning signal that the current downturn was about to start. Now, it is flagging an important change in relative positions within the value chain.

9 months ago, the divergence between crude oil prices and those for the C8 chain highlighted slowing end-user demand. The chart above updates the picture since then:

• Brent (purple line) is ~150% above its January 2009 level
• PTA (red) peaked at ~130%, but is now only ~75% above this level
• PET (blue) peaked at ~110%, but is also now ~75% above this level
• PX (green) has been relatively stronger, and is 100% above this level

This, of course, is very bad news for those who have invested in PTA and PET. They are suffering value leakage in relation to paraxylene (PX) prices, rather than adding value.

The reasons are probably three-fold:

• Slow end-user demand means products close to the oil barrel have greater pricing power than those downstream
• Lower Western refinery operating rates are reducing mixed xylene production, and increasing the differential necessary to justify extraction
• A massive jump in Asian PTA capacity (primarily in China) is not being accompanied by a similar increase in PX supply

The jump in Asian capacity repeats the pattern seen in the early 2000s, when China first boosted PTA production. Fellow-blogger Malini Hariharan noted last month that nearly 11.5MT of new capacity is expected in Asia this year, whilst only 1.4MT of new PX supply is scheduled.

Major shortages, and considerable market disruption, could therefore occur if the new plants all bid for the same few available feedstock parcels. This wouldn’t happen in the West, where issues of profitability would take priority. Producers would instead optimise margins by selling PX and covering their PTA commitments by purchases.

But China’s philosophy is not so profit-oriented. Instead, due to the often close linkages between companies and government, the need to maximise employment can have priority. This is especially true in a year when major politburo elections are underway, and the need for social stability is strong.

The global economy is moving into a difficult period, as it transitions to the New Normal. Debt levels are high, and incomes are under pressure, particularly for the large numbers of people moving into retirement.

Cost must be the key criteria when examining the opportunities for new product development and research. Chapter 8 of our free ‘Boom, Gloom and the New Normal’ ebook examines the application of this philosophy to the 4 megatrends that we have identified as being key to the future of the chemical industry:

• Improving water availability
• Improving food production
• Increasing life expectancy
• Reducing carbon footprint

It suggests that the key need is to be practical. Companies should focus:

• In the fields of water/food, on reducing the amount of waste, and the output that is lost when product is moving to market
• In developing new products and services for the over 55s, on core needs such as food, water, health, shelter and mobility
• In turn, this will enable them to ‘do more with less’. Carbon footprint will be reduced, and products will be more affordable

This philosophy is quite different from that seen during the 1982 – 2007 economic SuperCycle. Then, companies competed for the middle ground, as we saw in chapter 7. They added features, and pursued the concept of adding value in order to boost profits. Over time, they focused more and more on the wealthier parts of the global population, and became increasingly disinterested in those outside this privileged group.

Today, however, it is no longer viable to focus in this way.

The Western BabyBoomers are joining the New Old generation of those aged 55+, and they face the prospect of much lower incomes as they transition from salaries to pensions.

Similarly, incomes in emerging economies are dramatically lower than those in the West. It is wishful thinking to imagine that these regions can therefore somehow replace the demand for added value products that is disappearing in the West.

Doing more with less is therefore our motto for future success. The chapter contains, as always, a wide range of practical examples to help stimulate ideas within your own business. We are convinced that those who accept its challenges will benefit for many years to come.

FREE DOWNLOAD OPTIONS FOR CHAPTER 8
Click here to download a 2 page summary of the Chapter .
Click here to download the full Chapter
Click here to view the 4 minute video with Paul Hodges

Latest data from the IMF shows that the EU remains the world’s largest economic unit. Its GDP in 2010 was $16.2tn, 26% of the global economy. The USA was next with $14.5tn, and China 3rd with GDP of $5.9tn.

So what happens in Europe matters greatly to the global economy.

Equally, petchems are one of the best leading indicators that we have for monitoring the health of the broader economy. So the chart above of ethylene production in the EU 15 (plus Norway), based on APPE data, provides good insight into what lies ahead:

• Q4′s 4.4MT output (red line) was the lowest since 1995, excluding 2008
• Total 2011 output of 19.6MT was the lowest since 2000, excluding 2009
• Q4 operating rate was just 72%, and H2 only 77%

This is not good news, by any standard.

Another way of interpreting the data is to average 2010-2011 volumes. This takes account of 2010′s stock-build as crude oil prices rose, and then 2011′s destocking. It gives an average volume for the 2 years of 19.9MT. This would be the lowest volume since 2001, excluding 2009.

The conclusion is obvious. Demand destruction is underway in the world’s largest economic region. It also seems unlikely that things will improve short-term with oil prices at a sustained record level, and with EU governments committed to an austerity approach.

Producers and consumers have done a superb job over the past few months in reducing output in line with demand. In the short-term, they should hope for a reward in terms of a bounce in orders. H1 should be the seasonally strongest part of the year.

But only an extreme optimist will regard this as a sign that the economy itself is turning the corner. And policymakers’ continuing inability to finalise Greece’s inevitable default is a reminder, if one were needed, of the banana skins that now litter the world’s economic outlook.

The blog’s 6 monthly review of force majeures (FM) reveals worryingly little improvement in performance. As the chart shows, H2 was slightly better than H2 2010. But realism suggests it was flattered by Q4′s low operating rates, which probably reduced the actual need for FMs.

The chart is based on the number of FM mentions in ICIS news. It shows FM reports in H2 by year since 2005. Clearly there was a great improvement between 2005-7. But since then, the momentum for change seems to have disappeared.

The industry’s near-record profitability over the past 18 months should really have led to a much greater reduction in outages.

This is very disappointing for anyone who remembers the pioneering work on this issue by the then giants of the industry, DuPont and ICI. They taught us that ‘all accidents are preventable’, and instilled a culture which led to safety reporting being the first item at Board meetings.

Many companies, of course, still follow these rules, and focus on continuous improvement. They benefit not only from ‘doing the right thing’, but also from better profitability and customer relationships.

But procurement professionals around the world line up to tell the blog about their frustration at the problems they encounter on a day-to-day basis. The blog only hopes their continued pressure will lead to it being able to show a better performance in July.

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.

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%

The blog celebrated its 100,000th visit during 2011. Its readership also continued to increase, and now covers 142 countries and 5992 cities. The map shows the major centres of readership, which include all the main petchem hubs.

Readers also remain very loyal, with 40% visiting at least once a week during 2011. Over the past 6 months, they have become even more loyal, with 54% visiting at least once a week.

The highlight of the blog’s year was the launch of its ‘Boom, Gloom and the New Normal’ eBook, co-authored with John Richardson. This argues that demand patterns are changing, due to the ageing of the Western BabyBoomers. Its key messages have been receiving increasing attention from companies and policymakers.

Generous sponsorship from Vitol also meant that a hard-cover version of the first 7 chapters could be circulated at our European conference in November. The online PDF version is also still available, if you would like to click here.

The other notable feature of the year was the launch of the IeC Downturn Alert at the end of April. Its aim was to help ensure that the industry did not fall into the same trap of over-optimism that created such problems at the end of 2008. The blog hopes that its reports have helped to ensure that inventories remained under control in recent weeks.

The blog has also greatly valued the opportunity to speak at a number of industry conferences, and to share ideas with many individual companies and their management teams.

Thank you very much for your continued support.