Boom, Gloom and the New Normal

There is much discussion of countries such as Greece being likely to leave the Eurozone.

Some even believe it is inevitable.

But on a practical basis, how would it happen?

This is a question that has been bothering the blog for some months.

But with another crisis summit meeting about to start, it is no nearer finding an answer.

In previous generations, a currency consisted of coins made from brass, copper, silver and gold. These had a value, depending on their weight.

But today’s currencies have no value in themselves. So if Greece, say, left the Eurozone tonight, how would its citizens buy food and other essential tomorrow morning? Equally, would euro coins (see Wikipedia picture) that had been issued in Athens suddenly become worth less than those issued elsewhere?

Of course, today’s currencies have great advantages for commerce and travel, particularly in our computer age. But replacing one currency with another can’t be done overnight. It took 2 years to happen prior to the Eurozone launch in 2002, for example. Banks had to prepare to exchange newly minted euros for the former national currencies.

If any reader has the answer to the question, the blog would be glad to share it.

6 months ago, when reporting Q1 results, the blog strongly disagreed with the rosy outlook being offered by most analysts. It warned then that:

“The history of the past 40 years shows high oil prices have always led to:

“Sadly, many analysts have only focused on the immediate short-term benefits. Some even upgraded their forecasts, on the assumption that good times are here to stay. The blog hopes they may prove correct, and that ‘this time is different’, but would not invest its own money on this basis.”Today’s survey of Q3 results shows markets have since slowed considerably. Companies operating in the Middle East and China still expect their growth to continue, but this is due to the different context in which they operate.

The level of caution is also rising. Those companies who reported at the end of October were relatively more confident than those reporting in recent days. The EU’s problems are a particular concern, as it represents 26% of the global economy.

Air Products. “Near-term economic outlook is for continued slow growth, and is clouded by global economic and policy uncertainties”.
Akzo Nobel. “”The crisis has also taken far longer and hit far worse than many of us feared.”
BASF. “”We remain cautious … as economic growth is likely to slow further. In particular, credit restrictions in China, as well as the debt crises in Europe and the US will adversely impact economic growth.”
BP. “Strong refining feedstock optimisation in the US due to accessing WTI-priced crude grades”.
Bayer. “Earnings diminished by higher energy and raw material costs”.
Borealis. “We are planning with a low-growth scenario for next year”.
Braskem. “Oil market volatility and reduced demand for petrochemicals continue to affect the scenario”.
Celanese. “Higher pricing across all operating segments and favourable currency impacts”.
Clariant. Expect “further softening demand, volatile currencies and stable raw material costs”.
ConocoPhillips. “Earnings rose 49% because of higher ethylene margins”.
Croda. “Sales growth and margin improvement in our core businesses”.
Dow. “We expect high-cost crackers in Asia and western Europe to begin to feel the margin compression in the very near term”.

Long-standing readers will remember that then-UK Finance Minister Alastair Darling was the first Western politician to recognise in August 2008 the disaster that was about to hit financial markets.

Now out of office, his warning today therefore deserves the widest possible discussion around the world:

“I despair of the way in which EU leaders are constantly behind events. I do not think enough people realise how serious this crisis is, and how hard it is going to hit us.

“I know of no one in private who thinks the solution proposed for Greece will work. Any solution that will leave Greece with debts of 120% of GDP in 2020 is simply not credible. Everyone knows there is going to have to be a larger cut than the 50% write-off”.He termed last week’s G20 Cannes summit last week a “disaster” and added that the EFSF (European Financial Stability Fund) “‘rescue fund’ does not exist.

“The ECB has been buying Italian bonds in the markets for months, and now they have to recognise they have to be the lenders of the last resort, and they must say they will do everything possible to protect the euro. Unless they do that, the markets will continue to have a go at any weak economy.”

Darling described bank recapitalisation as being “like a fire that starts under the floorboards – before you know where you are, the whole building is in flames and burnt down”.

“We are seeing government after government introducing austerity programmes to protect themselves from the markets, but if there is no growth there is no way that the austerity can be enough. That is why the G20 should have been focusing on how to achieve growth – but it did not, and we may now pay a very heavy price.”

Darling has no need to exaggerate for effect. And his track record is excellent. The blog therefore takes his warnings very seriously indeed.

As promised, the blog looks today at the USA’s trade position in polyethylene (based on data for the January-August period from Global Trade Information Services, the leading global supplier).

The chart shows US net trade (exports less imports). This peaked in 2009 (green column), with net exports of 1.6 million tonnes. Volume had risen 69% versus the 2007 level of 0.97MT (blue). But volume in 2011 has been just 1.03MT (light blue), only up 6% versus 2007.

The main reason is an overall decline in export volumes from 3.3MT in 2008 to 2.9MT in 2011:

• Mexico peaked in 2009 at 734KT, but is 679KT in 2011
• Latin America has been volatile, but peaked at 771KT in 2008
• China peaked in 2009 at 585KT, but is 192KT in 2011
• NEA peaked in 2008 at 178KT, but is 107KT in 2011
• SEA has been volatile, but 2011′s 292KT is a new high

Meanwhile, net imports in 2011 at 1.85MT are equal to 2007′s 1.83MT. These come mainly from Canada, whose volume of 1.19MT in 2011 is also similar to 2007′s 1.17MT.

Of course, many Western readers would have expected the USA’s exports to have risen since 2008, not fallen. Its cost position has improved remarkably since then, due to its new source of advantaged ethane from shale gas. The reason is that many of its major competitors do not share its financially oriented approach.

As the blog highlighted last week, most emerging economies also prioritise social and political criteria, whereby employment and strategic geo-political issues have an important role.

The blog’s own research on China’s Sinopec demonstrates how it effectively operates as a utility, supplying raw materials to the factories to keep people employed. Employment is also a key driver for the Middle East and many other Asian countries.

This is why an understanding of Prof Michael Porter’s Shared Value approach is so important for the future. Western companies can no longer rely on the use of purely financial criteria to guide their strategy, as the world transitions to the New Normal.

Financial markets have become increasingly nervous in recent weeks, since the blog last reviewed developments in global bond markets.

Its conclusion then was that investors are worrying more about return of capital, than return on capital, as we transition to the New Normal. This is because 272 million westerners are now over 55 years old, and they need security of income as they prepare for retirement.

The chart above updates market moves in the JUUGS (Japan, UK, USA, Germany, Switzerland) and the PIIGS (Portugal, Ireland, Italy, Greece, Spain). Since August (blue column), the 2 groups have seen very different interest rate trends for 10-year government bonds (red line):

• Rates in the JUUGS have been extremely stable. UK and Swiss rates have edged down 0.1%, whilst German rates moved up 0.1%. US and Japanese rates are unchanged.
• The PIIGS have been much more volatile. Greece is now paying 34% vs 22% in August: Portugal’s rate is 12% vs 11%: Italy’s is 6.4% vs 5.7%: Spain’s is 5.5% vs 5.3%: only Ireland’s reduced, from 8.8% to 8.3%.

This suggests Portugal will also need to default on its debts, alongside Greece. Otherwise the burden of interest payments will simply become too large, particularly as austerity programmes lead to recession.

Italy, of course, is the real problem child. It is a rich and large G7 country. But its interest rate is now also close to being unaffordable. Two key questions are looming on the horizon:

• Will it really now allow the IMF to dictate its economic policy?
• What will happen to French and German banks if investors start to question Italy’s ability to repay its debt?

Italy currently owes $416bn to French banks, and $162bn to German banks. It owes a total of $788bn to European lenders. This is the concept of ‘contagion’:

• If Italy’s rates move into the 6.5%-7% area, and remain there, then its default becomes almost certain.
• France, another G7 member, would then be in the firing line.
• Its 3.3% interest rate is already 50%+ higher than those of the JUUGS. This suggests underlying nervousness amongst investors.

The blog will continue to monitor the situation closely.

The brave new world of modern finance continues to amaze the blog.

It still has problems with the idea that the answer to having too much debt is to borrow some more. But last week’s Eurozone summit not only did this (as noted by the German central bank), but added a new element.

Its new bailout plan suggests that the European rich should now borrow from the emerging country poor, via the IMF. Thus the support of Italy (income per capita of $34k) depends on loans from China (income of $3k). Or, to put it another way, the world’s second wealthiest region aims to borrow from people who have some of the lowest incomes in the world.

Of course, President Sarkozy made some reference to ‘old style reality’ when he told the French people on Thursday night that “the problem is that we spend too much and we must work more.” But this is unlikely to be the message on which he campaigns for re-election next year.

Naturally financial markets rallied strongly at the news, with the US S&P 500 Index jumping 4% during the week. But in the real world, where those of us in the chemical industry work, markets failed to show similar enthusiasm, as this week’s IeC Downturn Alert chart above shows. Even Brent crude oil managed only a $0.85/bbl rise, whilst naphtha actually fell.

This caution was shared in the world of electical appliances, a key market for chemicals. Whirlpool and Electrolux, the two largest companies reported:

• “Sales gains in Asia and Latin America are slowing and aren’t sufficient to make up for sluggish demand in the U.S. and Europe”
• Electrolux estimate “N American appliance sales this year will be 25% below the 2005 peak; W European sales will be down 15% from 2006″
• Whirlpool’s CEO noted that the only “people who are buying, are people whose appliances break”.

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

Benzene NWE (green), down 30%. “Market remains under downward pressure this week, largely due to continued weak demand.”
HDPE USA export (purple), down 28%. “The window of opportunity for sales into China has basically closed as prices in Asia and the Middle East continue to fall.”
Naphtha Europe (brown dash), down 21%. “Demand from gasoline is reasonably healthy, while from petchems remains poor”.
PTA China (red), down 14%. “Demand remains weak on the back of limited procurement from the cloth and weaving sectors amid tight credit and higher inventory.”
Brent crude oil (blue dash), down 11%.
S&P 500 Index (pink dot), down 6%

The 2012-14 Budget period offers great opportunities, as well as great challenges.

Will companies continue to focus on short-term developments in financial markets? Michael Porter’s Shared Value concept instead offers us a powerful model for creating future growth.

Will policymakers stop focusing on the 24 hour news cycle and instead begin to set out the bigger picture? We need a vision for the future, and a clear idea of how to get there.

Are these decisions hard to take? No.

Has the world the resources to start in this new direction? Yes.

Would we enjoy the challenge? Yes

Can we start today? Yes.

We all know that companies are going to have to set difficult budgets for the next few years. They will also have to deal with continued uncertainty. We cannot rely on wise and all-seeing policymakers to lead us forward. They may well decide to do more of the things, such as Quantitative Easing, that will make the situation worse instead of better.

But larger companies, in particular, could also start to examine how to expand long-term R&D. And every company could add a future dimension to its Budget in respect of the opportunities that will arise from the new markets being created by today’s demographic and societal changes:

• Nearly a third of the Western population is now in the 55+ age bracket. They have the incredible benefit of an extra decade of life expectancy, compared to previous generations. And they have money – maybe not a lot, but enough to buy useful products and services. Yet they remain woefully underserved and often unrecognised by most companies.

• People in emerging economies are starting to move out of poverty in large numbers. This ‘bottom of the pyramid’ market represents a wonderful opportunity to develop new products and services. Millions now have some money to spend for the first time in their lives.

The great megatrends of the future also offer vast opportunities for future growth. These involve the need to increase food production, improve water availability and reduce carbon footprint. They are vitally important, and also offer the potential for profitable future growth. So, of course, do the opportunities associated with increasing life expectancy.

Companies therefore have a clear choice as we move into the Budget period. The blog believes a New Normal lies ahead, as it is describing in its new Boom, Gloom and the New Normal eBook, co-authored with John Richardson.

Winners will accept the challenges that it offers, and begin to move in a new direction. Losers, however, will remain frozen in the headlights, unable to take the first steps that will lead them to success.

Collectively, as the world’s 3rd largest industry, chemical companies have enormous potential to do good at this most difficult time. But progress depends on each of us as individuals being prepared to adopt a positive outlook in the face of the problems with which we are surrounded.

As always, of course, the blog will be delighted to help any company that wishes to accept the challenges that offered by the transition to the New Normal. It is confident that they will discover a potential to be successful beyond their wildest dreams.

Blog readers can choose their favourite leading indicator this week.

In financial markets, the US S&P 500 index continued its recent rally. If you believe the bullish analysts; a Greek default, lengthy arguments between Germany and France, and the need to expand the Eurozone bailout fund into the €1-2trn range ($1.4-2.8trn), are all good news.

As US Fed Governor Richard Fisher noted Friday, the Fed’s new Operation Twist stumulus package has “so far been of greater benefit to traders and large monied interests than to job-creating businesses.”

Meanwhile benzene, the blog’s own favourite indicator, is now trading at the same price as naphtha – $893/t versus $888/t. This has only happened twice before in history – in the 2001 and 2008/9 downturns.

Other benchmark petchem products are giving the same message:

• In polyethylene, US producers are now planning to use their cost advantage to sell into China, due to lack of other available markets. Whilst European producers are targeting Asia, Africa and Latin America due to lack of domestic demand
• In PTA, lower paraxylene prices have led to sharp falls. China’s Zhengzhou futures market went limit down (6%) on Thursday, a clear sign of weakness. India was already slow before the Diwali holiday, whilst China’s polyester producers are lowering prices to try and capture sales

The key issue, of course, is the level of inventory down the chain. This is probably still quite high, as wholesalers and retailers built stock in H1 ahead of price rises and expected strong sales in the pre-Xmas season. This could pressure petchem/polymer volumes over the next few weeks.

In addition, today’s crude oil prices are clearly out of line with fundamentals. Supply is good, with Libya coming back already at reasonable rates. Stocks are at relatively high levels compared to more normal times. And demand is suffering due to today’s high prices.

There is thus a clear risk that oil/feedstock prices could fall quite sharply, and prompt further efforts to destock, if financial markets ever decided to move back towards reality.

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

Benzene NWE (green), down 32%. “Several cargoes have been booked to the USA to prevent a glut of benzene building in Europe.”
HDPE USA export (purple), down 26%. “Prices continued on a downward trend, as global demand remained weak.”
PTA China (red), down 18%. “Most market players are pessimistic as prices continue dropping amid tight credit and a slowdown in demand.”
Naphtha Europe (brown dash), down 19%. “Demand from petchems remains poor, while from gasoline is moderate”.
Brent crude oil (blue dash), down 12%.
S&P 500 Index (pink dot), down 9%.

Its the ‘big picture’ issues that we need to watch these days, no longer detailed forecasts of individual product growth rates. They are driving chemical product sales in every major region.

The chart above from the Financial Times highlights Europe’s drive towards austerity. Long gone are the days of the 2009 G20 meeting, when everyone focused on stimulus spending. This year, austerity packages will hit household income in most countries:

• Greeks lose 14% of their income, €5600 ($7600)
• Ireland and Portugal lose 5%
• Spain loses 5%, and Italy 3%
• Even the average German household will lose 1%

And, of course, Europe will likely see bigger cuts next year, and higher taxes, to help pay for current deficits.

Equally, there are no easy ‘solutions’ to today’s crisis. Recapitalising Europe’s banks, the most urgent task, will mean banks lending less – as higher reserve levels will reduce their lending ability. That will push some businesses into bankruptcy.

Similarly, Greece’s default will hit French and German banks hard. So they will need even more capital. If they don’t have enough, then the market will worry more about their lending to Spain and Italy. But this could easily become a vicious circle – if France puts in a lot of capital to protect its banks, then it could lose its own AAA rating.

And, of course, there is also the political dimension. Instead of trying to lead the debate, France and Germany have tried to put off the hard decisions. President Sarkozy faces election next year, and Chancellor Merkel in 2013. They now fear, probably rightly, that voters will throw them out if they agree to pass more money to Southern Europe.

Equally, as with President Obama in the USA, neither leader really seems to understand the economic issues involved. Instead, they all continue to defer to the same advisers whose policies have led to the current crisis.

Sadly, therefore, it seems the only real area of doubt about the outlook is around just how bad the downturn will be, and how long it will last.

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.”