‘Bubble, bubble, toil and trouble’ as China, West’s policy diverge

D'turn 21Jun14

Sometimes its good to take a step back from the day-to-day markets, and focus on the bigger picture.  Thus the chart looks at how markets have moved since the start of 2008 when the sub-prime bubble came to an end:

  • Prices peaked in June/July 2008 as oil peaked at $147/bbl (blue line) and naphtha at $1147/t (black);
  • Benzene peaked at $1400/t (green); HDPE at $1818/t (orange); PTA at $1185/t (red)
  • The US S&P 500 stock index had peaked in May at 1425, and was beginning a steady decline

Then the market bottomed at the end of 2008:

  • Oil fell to $41/bbl in December; naphtha to $235
  • Benzene fell to $190/t; HDPE to $683/t; PTA to $530/t
  • The S&P 500 kept falling, however, from 880 in December to 683 in March 2009

Demand was clearly recovering in Q1 2009, but the central banks were most concerned about the financial sector.  Thus we had the major G-20 stimulus programme in March 2009 (brown arrow).  And when this ran out of steam in 2010, we had the QE2 programme.

The biggest impact for the chemical sector, however, came from China.  Its vast lending programme got underway in November 2008, creating enormous increases in global demand as the then leadership focused on residential property as the key to the revival of the economy.

Until April 2011, the impact of the central bank programmes and China’s stimulus were very much the same.  All markets rose together.  However, in April 2011 they began to diverge:

  • Oil peaked at $125/bbl and has never managed to move past this level again
  • Naphtha peaked at $1100/t; Benzene at $1315/t; HDPE at $1642/t and PTA at $1523/t
  • However, the S&P 500 only stalled temporarily at 1364, whilst the $:yen value bottomed at  $1: yen 81

Global operating rates (OR%) in the chemical sector have also never recovered to 2011 levels.

Falling OR% means only benzene prices have since made new peaks. It is now a by-product, and so lower OR% mean less product is produced, particularly as US petchem crackers shift from oil feedstocks to ethane.  Benzene prices have thus hit $1527/t in December 2012, and $1535/t in January 2014 – both periods of low operating rates.

The real interest comes in the different performance of PTA and the S&P 500:

  • PTA has remained weak since 2011, with its decline accelerating since 2012
  • The S&P 500 has however been moving into bubble territory over the same period

The reason for the divergence is not hard to find.  China’s new leadership are slowly but surely reversing the previous policies.  Thus lending is being reduced as they aim to burst the property bubble.  In the West, however, central banks are panicking over the failure of their stimulus policies, and allowing the bubble in financial assets to grow, with margin debt at record levels.

The clash between these two policies is likely now to intensify.  Most financial observers hope and expect China to reverse course again, and provide more major stimulus.  They also expect the central banks to provide even more liquidity to push financial markets higher.

But what happens if they are wrong?  What happens if China maintains its current course, and continues to focus on tackling corruption, pollution and its housing bubble?  Can the central banks in the West create enough new liquidity to maintain the financial market bubble?

The modern world has never seen such policies implemented on such a scale.  So we have no idea how it may all play out.  But the general history of bubbles certainly suggests that they do not end well.

The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
PTA China, down 4%. “Operating rates at downstream polyester facilities are expected to dip to below 70% because of weak margins faced and poor downstream demand”
US$: yen, down 3%
Brent crude oil, up 4%
Benzene, Europe, up 6%. “Prices rose sharply through the week, mirroring price increases seen in the US and Asia. A number of reasons were given for this including the higher price of crude and the escalating tensions in Iraq”
S&P 500 stock market index, up 7%
Naphtha Europe, up 7%. “Prices have risen sharply to hit a new annual high, boosted by strong gains in upstream ICE Brent crude oil futures, but the upward trajectory belies underlying weakness in the market. Long supply in key export destinations in Asia, predominantly Japan, as well as the high prices in Europe, are discouraging arbitrage trade to Asia. Naphtha supply has become long as a result of the slow demand”
HDPE US export, up 7%. “Prices still slightly too high to really compete in the international market”

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