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Budgeting for the unknown: Part 2

Last month we discussed the volatile energy market, considering what processors may expect in the coming months. However, energy prices are only one of the many costs for which producers must routinely budget. Another major expense is resins. While much of a resin''s price is often directly linked to the cost of oil and gas, the markets are not identical.

As the petrochemical and resin producers at long last emerge from their prolonged period of stagnation, the market is again experiencing significant capital investment. Nowhere is this more apparent than in the oil-and-gas-rich Middle East. As described in a March 2004 report by the European Chemical Council (CEFIC), Middle Eastern petrochemical capacity is again set to explode in the coming years.

Already the Middle East is set to become the world''s largest producer and exporter of petrochemicals and plastics in 2005, with exports predicted to exceed 40 million tons by year-end, with almost 80% of this production being exported. You can count on this top ranking continuing in the coming years as massive new development projects come online.

In Iran, for example, the National Petrochemical Company (NPC) plans to have nine new crackers with a total ethylene capacity of almost 10 million tons per year operational by 2010, a feat that will help to more than double the region''s total ethylene production.

U.S. resin production is also on the rise. After jumping 6.4% year-over-year in 2004, production levels in 2005 are expected to continue to grow by 2%. Furthermore, increased investment is not limited to the Middle East and the U.S.

In China, three multibillion-dollar, world-scale petrochemical complexes are at last due to come online in 2005 and 2006, a development that is expected to boost China''s ethylene capabilities from 6.8 million tons per year to 9.5 million tons per year. Looking at a few of the specific resin markets, Asian Chemical News and Sinodata Consulting predict that domestic production of expandable polystyrene (EPS) will grow by 200,000 tons; PVC production will jump 700,000 tons; ABS output by 70,000 tons; PP production by 300,000 tons; PE output by 200,000 tons; and PS by 100,000 tons.

The other side of the equation... demand

These new investments in future capacity will inevitably help to tame some of the supply-driven price jumps that newly developing goliaths like China and India helped spur in 2004. However, the processing market should not expect to reap much benefit in 2005.

Short-term prospects continue to suggest tight supplies through 2007, as both chemical and resin producers struggle to make up for years of underinvestment, and as growing demand in key markets like China continues to outpace new production capabilities.

A closer look at the growing appetites of the Chinese market makes this point clearer. As such, processors should budget for continued but gentler price increases for chemicals and resins in 2005, an upward trend that should peak in early to mid-2006 with the introduction of new global capacity, especially in China and Iran, then slowly cool off through 2010.

Of course, a major crash in China could dramatically affect this forecast. If, for example, rising interest rates were to push a significant number of China''s underperforming manufacturers out of business, the country''s consumption rates would likely plummet, curbing global demand.

However, processors should realize that although many analysts are predicting a hard landing for China, it is most likely that the government would intervene to save these faltering companies, which employ so many of China''s otherwise restless citizens.

A look around the globe

The Organization of Economic Cooperation and Development has forecast that the overall economic growth among its member states will slow from 3.6% in 2004 to 2.9% in 2005. The World Bank says this trend will also occur in the larger global marketplace, which it predicts will see growth rates fall from 3.5% to 2.7% this year.

Mexico Mexico''s state-run energy company, Pemex, the two Mexican chemical firms Indelpro and Grupo Idesa, and Canada''s largest petrochemical company, Nova, have officially agreed to team up to develop a $2 billion U.S. ethylene and polyethylene plant in either northern or southern Mexico. The plant is scheduled to be operational by 2009 or 2010, and will help meet the growing PE demand in North America, which is estimated to continue to grow by 4% annually. Mexico currently imports around 60% of its petrochemicals despite the country''s natural abundance of oil and natural gas.

China According to the China Automotive Industry Informational Network and Asimco Technologies Ltd., a foreign-owned automotive parts supplier, in 2004 vehicle manufacturers and suppliers in China imported $11.3 billion in components, a 21.5% jump from 2003 numbers. Although still far behind their Asian and European counterparts, U.S. suppliers increased their market share in 2004 by capturing 4.3% of sales, or $490.1 million, up from 2.9% in 2003.

During its March session, the National Peoples Congress (NPC) addressed the topic of reforming China''s corporate tax codes so as to level the field between foreign investors, who have traditionally been favored, and local businesses. Current corporate taxes on foreign-owned businesses generally stand at 14%, compared to 24% for domestically own corporations. One suggestion was to only extend this favorable tax bracket to high-tech investors, or other high-value-added or socially desirable industries like those focused on environmental protection.

Other issues said to have been discussed include codifying private property rights and reducing the amount of initial capital required to start up a new company. All of these measures are meant to encourage greater domestic investment by Chinese citizens.

Hong Kong The South China Morning Post reported in late March that the Environment Minister, Dr. Liao, was considering introducing a $1 tax on every plastic bag used. The discussed tax would be initially paid by wholesalers, and then passed on to the consumer if he or she requests a plastic bag.

Currently, supermarkets in Hong Kong pay back $.10 for every bag not used, however the government estimates the average person still uses five plastic bags per day-more than 33 million bags, or 1064 tons of plastic waste each day total. If enacted, Hong Kong''s tax would be only the latest bag tax imposed by a government struggling with plastic waste.

United States The Ohio-based Bemis Co. finalized its deal to acquire majority ownership of the Sao Paolo, Brazil-based Dixie Toga packaging company. Dixie Toga is one of South America''s largest packaging companies, with more than $300 million in sales during 2004.

Plastic plates, cups, and utensils, once reserved only for children and backyard barbeques, are picking up steam. A recent report by Home Furnishing News (HFN) says that 2004 sales of plastic beverage-ware and melamine dinnerware grew by 4% and 5% respectively as these products gain more acceptance in less casual markets.

  • The Iowa Corn Promotion Board (ICPB) and Battelle (the firm that operates the Dept. of Energy''s Pacific Northwest National Laboratory) signed a commercial license to produce a new plastic additive made from corn. The compound, isosorbid, has several hoped-for advantages. The additive reduces the amount of petroleum necessary to produce plastics while also improving the strength and rigidity of plastic bottles.

  • The most recent trade data for 2005 doesn''t offer U.S. processors much hope that a cheaper dollar will help improve falling trade balances. During the first two months of 2005 the U.S. deficit for plastic products grew by 178.8%, compared to the same period last year; a particularly troubling picture considering the 2004 deficit itself rose 69.7% to a record high of more than $2.3 billion.

    U.S. plastics manufacturers saw rising deficits with the EU and Canada, markets where the falling U.S. dollar should have benefited American exports.

    In the first two months of 2005, U.S. plastic products deficits with Canada grew by 27.3% passing $138 million; deficits with the EU 15 and EU 25 rose by 565% and 308.5% respectively. Deficits with China jumped 45%, topping $701 million.

    Meanwhile, plastics materials and resins remain a bright spot for the U.S., as surpluses continued to grow, rising 18.4%. In 2004 surpluses for resins passed $8.47 billion, a 27.7% jump over 2003.

  • Standard & Poor Rating Services (S&P) issued a report in March that claims the credit-quality status in 2005 for key U.S. plastic packaging companies will continue to be hurt by high raw material costs. The report, "Elevated Oil and Natural Gas Prices Continue to Exert Pressure on Plastic Packaging Companies, Leading to Credit Quality Decline," suggests that low-value-added industries like plastic film and flexible packaging will have a more difficult time passing on materials costs than rigid plastic packaging producers.

    Indonesia Both Japan and India are petitioning Indonesia''s Batam Industrial Development Authority for special trade status in this state-sponsored industrial zone near Singapore. The petitions are reported to request permission to create separate industrial parks on the island, which would most likely focus on automotive component manufacturing.

    While Japan has already established several industrial footholds on the island, the move by India is seen as an attempt to establish a beachhead for the continued expansion of India''s businesses into this regional market.

    OPEC In March, OPEC members agreed to increase petroleum output by 500,000 barrels per day to help meet growing global demand and cool rising prices. However, prices should not be greatly affected by this jump as a Reuter''s survey in February of this year showed that 10 of OPEC''s 11 members were already pumping 600,000 barrels per day more than the 27-million barrel-per-day ceiling.

    Oxford Economic Forecasting believes that if the price of Brent crude remains at $50 a barrel, it will knock .5 points off of U.S. GDP growth, .3 points off Europe''s, and .4 points off Japan''s.

    European Union The European Union leaders met in Brussels on March 22 and 23 to discuss the current state of the EU economy and to amend its 1997 Stability and Growth Pact.

    Much to the dismay of the European Central Bank and other financial analysts, the revisions make it easier for members to borrow money while maintaining deficits greater than 3% of GDP. The revisions now allow member states to exceed previous deficit limits, and permit governments to enact numerous "temporary spending" measures, which cover the gamut from pension reforms to allowances like "fostering international solidarity" (peace-keeping operations) and advancing European policy goals.

    These amendments help members avoid politically unpopular budget and labor reforms deemed necessary by growing numbers of business leaders, and serve to increasingly distance the commission from the more liberal goals established in Lisbon five years ago.

    Agostino von Hassell [email protected], and Mark Bella [email protected], of the Repton Group LLC (New York).

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