Boom, Gloom and the New Normal

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.”

The blog will publish its fifth annual Budget Outlook next weekend. As usual, it is therefore time to review last year’s Outlook. Past performance may not be a perfect guide to future outcomes. But it is one of the best that we have.

The blog’s 2008 Outlook ‘Budgeting for a Downturn’, and its 2009 ‘Budgeting for Survival’, meant it was one of the few to forecast the Great Recession.

2010′s ‘Budgeting for a New Normal’ was then more positive than most forecasts, suggesting “2010 should be a better year for the chemical industry, as demand grows in line with a recovery in global GDP”.

The 2011 Outlook was titled ‘Budgeting for Uncertainty’. This argued “Scenario planning will give businesses the chance to adopt the wisdom of the Scouting movement. Its motto, ‘Be Prepared’, seems the best possible approach in today’s increasingly uncertain New Normal environment.”

It described its Base Case as being “the classic ‘muddle through’ Scenario”. This suggested we might see 3% global GDP growth, oil in the $60-$80/bbl range and continued financial market volatility. It was broadly similar to the consensus chemical company forecast.

But the blog then suggested that companies should also consider an Upside Scenario based on global GDP growth of >3.5%, “causing oil prices to rise above $80/bbl” and inflation to become a major issue.

It also suggested that plans should be tested against a Downside Scenario, where countries instead “put their own interests first and adopted beggar-my-neighbour policies”. It suggested this could cause “the banking system to come under major strain”.

It looks as though 2011 will see all 3 Scenarios occur at different times.

Equally, the blog’s concern in the Outlook about the potential for ‘currency wars’ has proved well-founded:

• The US QE2 stimulus programme did force China and the other BRICs to allow their currencies to rise, and supported US export growth
• But as the blog warned, “when elephants fight, those around them need to be cautious”. And we have seen increasingly violent swings in major currency values in recent months

The blog’s aim is to ‘share ideas about the influences that may shape the chemical industry over the next 12 – 18 months’. It hopes that its 2011 Outlook again helped readers to better prepare for today’s increasingly difficult economy.

Its underlying viewpoint remains the same as in 2010′s ‘Budgeting for a New Normal’ when it forecast that:

“We will start to see a rebalancing of the global economy. The West will see lower consumption, as people rebuild their savings, and borrow less. In turn, this will mean lower export demand for the emerging economies. The outcome will be a more sustainable world economy, but it will be a difficult journey.”

The 10000 readers who downloaded the blog’s first Budget White Paper in December 2009, ‘Budgeting for a New Normal’, will remember the issues highlighted in the triangle above.

At the time, they were being widely ignored, as policymakers assumed that the economy would soon return to its previous SuperCycle.

Today, this optimism has been revealed as wishful thinking.

Instead, much as the White Paper feared, we have learnt that “Extended downturns are difficult times. We would all like the certainties of future growth to return. And I believe they will in time, but probably not as quickly as the financial community currently expects. Disappointment is part of the experience of extended downturns.”

The lack of attention has meant these issues have since become worse. And they highlight how the world is now moving away from the economic certainties that dominated the BabyBoomer SuperCycle:

• Then, steady economic growth led companies to focus on financial targets. The Shareholder Value concept was widely adopted
• Now, we are relearning that businesses cannot ignore the impact of politics and belief factors, when they come to make decisions
• Politics has led to the current impasse over the Eurozone crisis, and to lack of US progress on debt market issues
• Beliefs have driven geo-political issues such as the Arab Spring to the top of the agenda

All this means that the world is becoming ever more complex. New concepts such as Shared Value seem likely to become the main driver for future economic growth.

Equally, forecasting the future now requires robust scenarios to be developed, rather than simple straight line forecasts. As the White Paper also noted:

“Harold Macmillan, the former UK prime minister, summed up this dilemma when asked once about “his greatest worries”. He famously replied, “Events, dear boy, events”. This might be a good watchword for all of us, as we progress through the uncertainties of the current downturn towards the ‘New Normal’.”

The blog will discuss these issues in more detail in its annual Budget Outlook, to be published on 22 October. On Saturday, as usual, it will review the performance of its October 2010 Outlook, ‘Budgeting for Uncertainty’.

Yesterday’s Scenarios hopefully provided valuable insight into the challenges ahead for companies and individuals. They also suggest some Critical Success Factors for achieving a successful transition to the New Normal, as set out in the chart above:

1. Flexibility. This involves adapting to new circumstances and being willing to compromise rather than battling for an impossible nirvana.
2. Change management. The next 20 years will likely see rapid and unpredictable change in the business environment in contrast to the remarkable stability of recent decades.
3. Scenario Planning. Companies need to adapt their planning processes to cope with the greater uncertainty that will come from operating in a more ‘events-driven’ world.
4. Real needs. Over the past 20 years, Westerners have often confused ‘wants’ with ‘needs’. In the New Normal, mere ‘wants’ are unlikely to be reliable market drivers for the future.
5. Action orientation. Uncertainty can breed a loss of energy, and so companies will need to encourage their employees to experiment creatively if they are to move forward.

The positive news is that most Boomers are likely to lead active and healthy lives well into their 60s and 70s. So the opportunities to capture their interest and their business are very large indeed. We will highlight some valuable case studies to help with this process in Chapter 7.

Companies focusing on the emerging economies face similar challenges, as we will discuss in Chapter 6 next month. Their core market will also consist of a currently underserved demographic, those just moving out of poverty and able to afford a bar of soap, or a bra and pair of panties, for the first time.

But the Beatles provide a reliable guide, if we are prepared to listen to their message from ‘When I’m Sixty-Four’. The megatrends such as an ageing population and the need for improved food production provide the key to future success.

The blog will be happy to provide any support or advice that may be helpful to readers as they develop their Action Plans.

International eChem/ICIS are also running three training courses in Houston, Singapore and London during Q4, to help with detailed implementation issues. Please click here for further details.

The transition to the new Normal is likely to be painful and long-lasting.

Future demand growth will be slower as the ageing Boomers spend less and save more.

More regular and deeper recessions are likely to become a feature of the global economy once more, in contrast to the relatively smooth growth seen during the Boomer-led Super Cycle.

Successful companies will also have to venture into the unknown, as until recently the 55+ generation had no real existence as a separate economic unit.

Previous generations usually found their needs at this age were focused on health-related issues – the Zimmer frame of popular mythology.

So as we venture into the unknown, Action Plans can’t be too prescriptive about what we might expect to see over the next 20 years. Chapter 5 of the blog’s free ‘Boom, Gloom and the New Normal’ eBook, co-authored with John Richardson, aims to help with this process.

As discussed yesterday, the Chapter outlines some potential Scenarios to highlight the key variables that need to be considered:

‘All’s Well that Ends Well’. In this scenario, the key dynamic is that there is a rapid adaptation to the New Normal. This may be driven by the observation of the major pain being suffered in countries already at the sharp end of some most unwelcome restructuring – Greece, Portugal, Ireland and Spain, for example. This gives Western politicians the courage to talk seriously about the issues that society now faces, whilst the wider population becomes prepared to listen to their messages and to accept that major changes need to be made.

‘Muddle Through’. In this scenario, there is no rapid adaptation to the New Normal, and although a higher quality of dialogue takes place between policymakers and the electorate than in the past, no firm agreements are reached on key policies and objectives. However, and importantly, social cohesion is retained, and so society does not fragment into warring groups.

‘If You Don’t Know Where You’re Going, Any Road Will Do’. A third scenario is based on the potential for politicians to remain more focused on sound-bites than on formulating policies that will drive long-term success for their populations. In this Scenario, the current dysfunctional state of many Western political systems, and their alienation from the wider electorate, is not a temporary phenomenon but a sign of the future.

‘Don’t Worry, Everything will be Just Fine’. This is the scenario under which the West had been effectively operating for the past few years, ignoring the demographic changes which are taking us in a new direction. It is characterised by an increasingly desperate belief that everything is just about to ‘return to normal’ (i.e. the former SuperCycle), via the magic elixir of either tax cuts or yet more stimulus.

Tomorrow’s post will provide its view of the Critical Success Factors against which Action Plans need to be measured.

The blog will be happy to provide any support or advice that may be helpful to readers as they develop their Action Plans.

International eChem/ICIS are also running three training courses in Houston, Singapore and London during Q4, to help with detailed implementation issues. Please click here for further details.

Today’s economic situation is getting worse, not better. The blog believes this is because most policymakers still refuse to accept the wisdom contained in the Beatles’ ‘When I’m Sixty-Four’ song on their iconic Sgt Pepper album.

The Western BabyBoomers (those born between 1946-70) are the largest and richest generation that the world has ever seen.

But last year, the oldest Boomer reached the age of sixty-four. And ageing Boomers simply don’t need more housing or new cars, as they no longer have to provide for growing families.

So demand patterns are changing, radically, just as they changed in the 1970′s. This was when the arrival of the Boomers set off the economic SuperCycle, as they entered their peak consumption years between the ages of 25 – 54.

Chemical companies are therefore not only facing an imminent economic slowdown, as the blog has chronicled over the past 5 months with its IeC Downturn Alert. They also need to change their business models, to adapt to this New Normal.

This month’s Chapter 5 of the blog’s free ‘Boom, Gloom and the New Normal’ eBook, co-authored with John Richardson, aims to help with this process. The first step is for CEOs to establish a high-powered team, operating with the support of their Board and line managers, to quickly put in place the necessary Action Plan.

The team needs to answer the 4 key questions required for any successful plan:

• Why. The Board needs a clear view of the likely impact of an economic downturn, combined with the demand changes caused by the ageing of the Boomers.
• What. The team needs to highlight the key issues which its plan aims to tackle. Speed is essential, and only the really super-critical issues can be addressed short-term.
• How. Implementation plans are critical. Resources need to be available, and key managers must ‘buy-in’ to the process, otherwise it will fail.
• When. Timing is also critical. Short-term priorities (credit control, working capital) have to be balanced with the business model changes needed to adapt to the New Normal.

The outlook is very uncertain. Tomorrow’s post will discuss the relevant Scenarios that need to be addressed. And on Thursday, it will highlight the Critical Success Factors against which plans need to be measured.

The blog will be happy to provide any support or advice that may be helpful to readers as they develop their Action Plans.

International eChem/ICIS are also running three training courses in Houston, Singapore and London in Q4, to help with detailed implementation issues. Please click here for further details.

The chemical industry has a turnover of $3.4trn, and is the world’s 3rd largest industry. It matters to the global economy.

Many of its leaders are about to meet next weekend in Berlin for the annual European Petrochemical Association (EPCA) meeting.

The blog strongly believes that this should not be seen as a ‘business as usual’ meeting. We cannot simply assume that the global economy is in fundamentally good shape:

• IMF head, Christine Lagarde, has warned the global economic situation is entering a “dangerous place”
• World Bank president Robert Zoellick has described world finances as being in a “danger zone”

These are not sound-bites being made for effect.

The danger signs have been building for months. The blog, after all, introduced its IeC Downturn Alert nearly 5 months ago, on 2 May.

Coincidentally, this matched the peak of the US S&P 500 Index, since when financial markets and crude oil prices have fallen dramatically, as shown in the chart above.

Every week since then, with the help of ICIS news and ICIS pricing, the blog has chronicled the approach to today’s Downturn:

• First we saw customers around the world buying ‘hand to mouth’. They tried to run down inventories built up during the 50% rise in crude oil prices between December-April
• Then everything went quiet during the summer. The retailers destocked after seeing end-user consumption fall due to the impact of higher oil prices
• Then it became clear that China’s economy, the previous motor of the global economy, was slowing fast, as the government reduced credit to combat high inflation
• Now, in September, it is clear that demand has not returned after the holidays. And the wider economic outlook is getting worse, not better.

The blog made similar efforts to alert the industry to the issue of demand destruction before the 2008 downturn, and was later awarded the title of ‘The Crystal Blog’. But sadly, its warnings were not taken seriously at the time when they could have had an impact.

The industry’s leaders need to ensure that ‘this time is different’ in Berlin. It is no exaggeration to say that the very future of some companies, and of important sectors of our industry, may be at stake.

Price movements since April, and ICIS pricing comments this week are below:

Benzene NWE (green), down 26%. “A swathe of imports coming into the ARA region were also keeping supply ample as demand struggled amid weak end user confidence.”
Naphtha Europe (brown dash), down 19%. “The impact of refinery run cuts is starting to show, and it is thought that the naphtha oversupply would have been more severe if not for these“.
HDPE USA export (purple), down 18%. “The Asian market has slowed down, in part because of a national holiday, and in part because of concerns about the global economy. Asian prices were expected to fall in China because of tightening credit rules.”
S&P 500 Index (pink dot), down 17%.
Brent crude oil, down 14%.
PTA China (red), down 4%. “Most buyers were adopting a wait-and-see stance because of the unclear market trend. Only a few end-users purchased cargoes on a need-to basis.“

Many readers have been taking a well-earned break over the past few weeks. The blog also continues to gain large numbers of new readers, as the financial crisis intensifies. As usual, therefore, it is highlighting key posts during August, to help you catch up as you return to the office.

Boom/Gloom Index suggests markets on the edge presciently forecast the recent volatility. Markets fall as politicians argue, US Fed policy may be going Back to the Future, Investors rush to save with the JUUGS, and US GDP still below 2007 levels explore the key issues

European cracker margins at ‘top of cycle levels’, China’s PE market down 2.5% in H1 and Q2 chemical results raise concerns about the outlook look at the current state of chemical markets

China’s power consumption hits new record looks at the strains now impacting China as it struggles to cope with an overheating economy. China’s auto market goes ex-growth covers the same theme, as does China’s bank lending nears its Minsky Moment

Policymakers remain in the Denial phase suggests the crisis is a long way from its end, as does Recession may now be very close and Towards a New Normal, not a new Supercycle whilst Goldman halves global ethylene growth estimate shows the analysts are slowly starting to recognise reality

Plus, of course, Chapter 4 of Boom, Gloom and the New Normal was published this week, and focuses on how the world may look in 2021

The investment banks have maintained a consistent focus on oil market supply disruptions and demand surges in recent years, alongside forecasts of sharply increasing prices. We discussed their role in more detail in the recently published Chapter 3 of our new free eBook, ‘Boom, Gloom and the New Normal‘.

As the above chart from the Wall Street Journal shows, based on leaked confidential information from the US CFTC (Commodities Futures Trading Commission), the investment banks are also major players in the futures markets. It shows positions on the day studied by CFTC, 30 June 2008, when crude was at $140:

• The banks appeared to hold most contracts. more than energy companies, airlines, hedge funds or Others.
• The WSJ also reports that Goldman Sachs, one of the most prominent bulls on oil prices, held 451k long WTI contracts and 419k short contracts (a net length of 32k contracts).
• Analysts Petromatrix calculate that if the WSJ is correct, “Goldman Sachs, for its own and its clients positions, was holding 35.2% of the WTI Open Interest on June 30th 2008“.

Looking forward, many of the major supports highlighted in recent months for today’s high oil prices by the banks are disappearing:

• Libya’s 1.6mbd output should start to return to markets during H2
• China’s demand January-July was only up 300kbpd vs 2010
• Saudi pumped 9.8mbd in June, up 918kbpd versus May
• Crude oil stocks in the US Gulf are close to record levels

Plus, of course, economic slowdown reduces likely future demand growth.

Yet as Petromatrix note, large traders known as the “Large Speculators (remain) very exposed to the long side of WTI” in US futures markets.

Thus the potential for further oil price declines back to the blog’s expected $60/bbl is clearly quite high, even though the banks will no doubt remain highly bullish.