Boom, Gloom and the New Normal

Last May, the blog raised major questions about the sustainability of China’s petchem demand growth surge in 2009-10.

It suggested in an ICB article that “China’s 53% rise in PE demand is a warning sign in itself that its economy may be over-heating. Inflation is also rising – far too high for comfort“.

Now new data on China’s polyethylene (PE) production for 2011 provides clear evidence that a slowdown is underway. The chart updates that in ICB, showing 2005-11 history (based on Global Trade Information Services trade data and ICIS production data) and shows:

• PE demand grew just 1% last year (200kt)
• China’s domestic production grew 3% (300kt)
• Net imports fell, with NE Asia, NAFTA and the EU badly hit

This decline in import demand may well continue. ICIS’ Nigel Davis has highlighted how the government’s 12th Five Year Plan will see ethylene production expand to 24m tonnes by 2015, from 15.2m in 2010. The aim, as always in China, is to create jobs and maintain social stability.

Two important conclusions need to be considered:

• China’s demand surge between 2008-10 was almost certainly a one-off, not the start of a major new growth pattern
• China’s 58% rise in exports in 2011 may actually be the start of a new trend, and not a short-term response to an inventory build

As the blog’s co-author John Richardson noted last week, many of China’s new plants will be built inland, to serve local demand. The coastal plants will therefore need to find a new home for their output, if the export factories cannot buy it, due to lower Western demand for finished goods.

These conclusions are, of course, completely opposite to consensus thinking. This believes a new economic stimulus package, like that seen in Q4 2008, is just around the corner. The consensus may, of course, be proved right in the end. But at the moment, it looks like wishful thinking.

China’s demand surge stabilised the petchem industry after 2008. Prudent business managers will clearly want to assess whether this support will prove as strong in the future.

Q3 results showed chemical companies being cautious over the outlook. Q4′s results have now confirmed the external environment remains difficult. The reasons are not hard to find:

• Slow growth in the global economy – BASF expect 2.7% again in 2012
• Uncertainties over the Eurozone debt crisis and its wider impact
• Concerns over the impact of high oil prices on consumer demand
• Worries about the future pace of growth in the US and China

To some, these represent the typical ‘wall of worry’ that promises outsize gains for brave investors. To others, they represent real and so far unsolved challenges.

Chemical companies can do very little to influence these events. Instead, they need to ensure their Base Case strategies have been tested against both positive Upside and more negative Downside Scenarios. Then at least, they will know what they need to do, whatever occurs.

Air Products. “Economic growth continued to slow this quarter”.
AkzoNobel. “Challenging year against the background of weaker global economic conditions and unprecedented raw material price inflation”
BASF. “Customers were more cautious in their ordering, reduced their inventories and put off orders in expectation that the economy would decline and prices could possibly soften”
BP. “Weakening market conditions as additional Asian capacity has come on stream at a time of weaker demand”
Bayer. “Overall business development in Q4 showed a mixed picture”
Brenntag. “Expectation of slower but nevertheless growing world economy”
Clariant. “Strength of the business unit catalysis and energy ”
Dow. “Times like these demand a focused approach and strong resolve”
Dow Corning. “Prices softened in the face of global economic volatility”
DSM. “Challenging economic environment impacted most material sciences businesses”
DuPont. “Supply-chain inventories are low, and we expect demand to pick up slowly, starting late in Q1 or early in Q2″.
Huntsman. “Lower demand trends and aggressive customer destocking within Q4″
INEOS. “Offtake has picked up after heavy destocking at year end”
LyondellBasell. “We expect overall Q1 economic activity to remain slow in Europe and Asia”
Methanex. “Methanol demand growth is expected to significantly exceed new capacity additions over the next few years”.
OxyChem. “Higher caustic soda pricing more than offset higher feedstock costs”.
PPG. “Customers curtailed inventory and remained cautious with their ordering”.
PTT. “Earnings were negatively impacted by lower petrochemical margins”
Polimeri Europa. “Cracker margins were severely hit by higher supply costs of oil-based feedstock”
Praxair. “Higher volumes and prices also contributed to better sales figures”.
Reliance. “Weakness in economic conditions resulted in reduced earnings, particularly in our refining and petrochemicals businesses”
SABIC. “The decrease in net income is mainly driven by lower pricing environment in global markets for most of the products, despite increase in sales volumes.”
Solvay. “Significant slowdown in demand for vinyls in Europe, and to a lesser extent in its polyamide segment”
TOTAL. “Suffered from deteriorating margins in the second half of the year in Europe and in the US”

The New Normal involves three major transformations in the nature of consumer markets:

• The increasing size of the New Old 55+ age group in the West
• Too many young people struggling with higher unemployment
• Large number of people moving out of poverty in the developing world

These are the great opportunities for future growth, if our economy can be adapted to serve their needs. Chapter 9 of our new ‘Boom, Gloom and the New Normal’ e-book looks at the implications for chemical manufacturing.

Today, and in the future, we need to focus on the megatrends which will drive future demand growth.

In the fields of water and food, we should focus 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, we should focus on core needs, such as food, water, health, shelter and mobility.

This will enable us to ‘do more with less’. We will reduce carbon footprint, and enable output to be afforded by the maximum number of people.

These changes in market drivers will have a profound impact on how, and where, products are manufactured.

Manufacturing processes will need to change in many companies as we transition to the New Normal. Quality will matter more and more as we move away from the ‘throwaway society’ of the past couple of decades.

So will approaches such as Process Intensification. This involves reducing the size of chemical and plant equipment, and can often enable companies to lower capital and operating costs whilst reducing waste.

The chemical industry has long been an enthusiastic champion of the importance of Quality management. It was one of the first to appreciate the importance of the concept of the ‘learning organisation’ that was originally brought to the West from Japan.

But in the early 2000s, the Quality movement seemed to stall. Many of the people who had launched this revolution retired. More worryingly, some companies began to forget that Quality was a process, and had to be reinforced by senior management at every possible opportunity.

Now, we need to relearn that having the right corporate philosophy is the critical starting point. This includes a focus on benefiting wider society, good leadership, and on rooting out inefficiencies through getting everybody involved in processes and problem solving.

Chapter 9 will hopefully help companies to ensure that manufacturing delivers the competitive advantage that is required as we transition to the New Normal.

FREE DOWNLOAD OPTIONS FOR CHAPTER 9
Click here to download a 2 page summary of the Chapter .
Click here to download the full Chapter
Click here to view the 6 minute video with Paul Hodges

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.