Issue Date: January 12, 2009
AS RECENTLY as August, the mood in Asia was euphoric. The world was dazzled by China's extravagant Olympics, and the Asian chemical industry was in the midst of five years of uninterrupted prosperity. Since then, conditions in the region have rapidly deteriorated. For chemical makers, the situation is the worst in memory.
Things are particularly bad in the petrochemical sector. Because of sharply reduced demand, producers in China, Japan, Taiwan, Thailand, and South Korea have cut operating rates, closed facilities, and performed maintenance shutdowns earlier than scheduled.
The forecast is not universally so dismal. For example, the outlook for butadiene, caustic soda, polysilicon, and carbon fiber producers is favorable. And each of the region's three largest economies has something to be optimistic about. China's economy is projected to grow by a still hefty 8.2%; in Japan, suppliers of display materials expect growth in the second half; and in India, industry leaders are confident about near-term prospects.
These positive factors are mere drops in the gloomy bucket, however. Overall, 2009 will be an extremely difficult year.
"Demand has dropped so dramatically in the fourth quarter that roughly 25% of capacity has been shut down, give or take 10% depending on the chemical," says Steve Zinger, managing director for Asia at the consulting firm Chemical Market Associates Inc. (CMAI). "It's really unprecedented to see that much shut down."
In Singapore, where the chemical industry is export-oriented because of the city-state's small market, production of petrochemicals dropped nearly 32% in November 2008 compared with the same period in 2007, according to the Singapore Economic Development Board. Production of specialty chemicals fell 28%. EDB attributes the declines to a drop in export orders and an increase in maintenance shutdowns.
Asia's production cutbacks are due in part to an effort by chemical makers to reduce inventories, Zinger says. But even after inventories are drawn down, he expects that producers in the region will not operate their facilities at much more than 85% of capacity.
The petrochemical industry's output cuts have restored the balance between supply and demand for the time being, Zinger adds. But he notes that those firms still operating are for the most part just barely covering their production costs. "Profit margins have fallen to zero on a cash basis," he says.
One of the main factors in the falling chemical demand is that China's export-oriented industries, which include clothing and toy manufacturing, are producing fewer goods because orders from customers in the U.S. and Europe have shrunk or even evaporated entirely. Hundreds of export-oriented factories have closed down in southern China in recent months. The clothing and toy industries are major users of petrochemical products such as polyester fiber and polyvinyl chloride resin.
The near-term outlook in Asia is, if anything, worsening. In December 2008, economists at the Asian Development Bank revised downward the economic predictions they had made just two months earlier. "As the global crisis spreads to Asia, the risk is on the downside," Jong-Wha Lee, ADB's head of regional economic integration, said in Hong Kong at a press conference at the Foreign Correspondants' Club in December. He added that the economic picture has been shifting, forcing ADB economists to revise the assumptions in their forecasts.
BUT THERE IS a limit to how bad conditions in Asia will become, Lee predicted. He said the region is in much better shape than just before the onset of the Asian financial crisis of 1997–98 because Asian banks now boast much stronger balance sheets than they did back then. On an even brighter note, Lee added, the current regional slowdown will provide some space for fast-growing Asian economies to take steps toward making their growth more sustainable.
And developing countries such as China have plenty of space to slow down. Despite its ebbing exports, China's economy will grow by a substantial 8.2% this year, ADB predicts, just slightly less than the sizzling 9.5% the agency says the country achieved in 2008. ADB contends that the $600 billion stimulus package the Chinese government announced in November "is a significant proactive way to counter the economic risks from deteriorating global and domestic growth prospects."
By contrast, the Japanese economy, which is about one-third larger than China's, will shrink by 0.2% this year, ADB expects. The Japanese Ministry of Economy, Trade & Industry says industrial output in Japan fell more than 8% in November 2008 compared with October 2008. The contraction is mostly due to lower global demand for Japanese goods.
In these conditions, chemical companies in Japan are exceptionally pessimistic about their near-term future. Diversified producers Sumitomo Chemical and Mitsubishi Chemical both expect their net profit in the fiscal year that ends on March 31 to be only about one-quarter of what they achieved during the previous fiscal year. The companies produce a wide range of basic chemicals, petrochemicals, electronic materials, crop protection products, pharmaceutical ingredients, and finished drugs.
But they may not be able to achieve even their modest financial targets. The two firms issued their downbeat profit forecasts before auto manufacturers—big consumers of chemicals and plastics—announced they would be cutting production to cope with mounting inventories of unsold vehicles. Japan's car output in November 2008 was 20% lower than it was in November 2007, and the carmaker Toyota is expecting its first financial loss in 70 years this fiscal year.
In the early part of 2008, one bright spot in Japan was strong global demand for electronic materials, particularly display components. In the first half of the fiscal year, Sumitomo Chemical improved its margins on sales of electronic materials even as the profitability of its other businesses deteriorated. But the outlook is darkening for this segment as well. The flat-panel display industry has been experiencing boom-bust cycles spaced roughly two years apart.
Nitto Denko, the world's leading supplier of polarizers used in liquid-crystal displays (LCDs), says that demand for its products is weakening and that the situation will last at least until the spring. The company, which exports a substantial portion of its output, expects its yen-denominated profit to decline because of the strength of the Japanese currency.
Conditions for Nitto and other suppliers of display components could improve in the second half of the year, however. The consulting firm iSuppli expects production of LCD television sets to increase by more than 20% in 2009. Much of the growth will take place in the second half, iSuppli predicts, as consumers are enticed by falling prices for flat-screen TVs.
IN INDIA, the third largest Asian economy after Japan and China, industry leaders are relatively optimistic about the near-term outlook. Generic drug manufacturer Ranbaxy Laboratories, which in November was acquired by the Japanese pharmaceutical company Daiichi Sankyo, is confident that it will boost sales in emerging markets. It lost some U.S. business after the Food & Drug Administration deemed that a few of its facilities did not comply with current Good Manufacturing Practices. Petrochemical giant Reliance Industries expects to maintain profit margins despite weakness in demand.
Moreover, Asia offers a few rays of hope for companies that make certain types of products or that are positioning themselves to grow after this downturn.
Looking at the Asian petrochemical industry beyond 2009, analysts at the financial research company Macquarie expect that oil and chemical producers Sinopec, PetroChina, and Reliance will emerge from the downturn in a stronger position than their rivals in the rest of Asia. This is because, the analysts say, the three giants are building new low-cost facilities that will put them at a competitive advantage when demand in Asia starts to rebound.
And in a weird way, collapsing Asian chemical demand has improved conditions for certain products, CMAI's Zinger notes. For instance, the outlook for butadiene pricing is relatively good. Butadiene is made by petrochemical complexes that use naphtha as a feedstock, something that almost all Asian petrochemical complexes do. The lower cost producers in the Middle East, in contrast, use natural gas as a feedstock and don't produce much butadiene. Faced with lower global demand, Asian producers will be forced to cut back before the Middle Eastern firms, leading to a relatively tight butadiene market, Zinger says.
Similarly, the outlook for producers of caustic soda, or sodium hydroxide, is rather positive. This is because most caustic soda is coproduced with chlorine at plants dedicated to the polyvinyl chloride market. In recent months, these firms have cut output of chlorine, taking caustic soda production down with it. But caustic soda is a less cyclical product that goes into a wide variety of applications. Users of caustic soda have been bidding up prices as a result, Zinger says.
And the solar industry is still experiencing growth in Asia, just as it is in the rest of the world. Japan's Tokuyama, a leading producer of polysilicon, will invest $535 million to build a 3,000-metric-ton-per-year plant in Borneo that will begin production in 2012. Tokuyama says that demand for polysilicon used in making photovoltaic cells is growing rapidly and that it is receiving many orders.
Japan's Toray Industries, meanwhile, is confident in the strength of demand for car parts made from carbon fiber. In December, it acquired a 21% stake in Advanced Composite Engineering, a German producer of advanced composites. Toray expects that concern about global warming will induce car manufacturers to reduce the weight of vehicles to improve mileage. Using carbon fiber composites is one way to get there.
But beyond these bright spots in a few sectors of the chemical industry, the overall picture for 2009 is unmistakably bleak. One piece of evidence is a profit warning that Japan's Shin-Etsu Chemical issued in mid-December. Shin-Etsu is the world's largest producer of both silicon wafers and polyvinyl chloride resins.
The company did not announce a new profit forecast, but it warned investors that it was unlikely to meet the profit targets it had made at the end of April 2008. "The effects of the severe downturn in market conditions since November have gone far beyond the limits of the company's management efforts," Shin-Etsu stated.
The warning is significant because the company had been delivering record profits uninterruptedly for the past 12 years, through the ups and downs of both the electronics and the petrochemical industries. And until December, it was working toward another year of record profits. That even a well-oiled corporate machine like Shin-Etsu is faltering at this time is a bad omen for the rest of the chemical industry in Asia.
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