The Slippery Slope of Declining Petrochemical Demand

I am back from South Africa where I spoke about my range-bound market thesis to South African Society of CFA in both Johannesburg and Cape Town. I’ve visited many countries over last few years, but none have amazed as much as South Africa. I hope to write my thoughts about South Africa soon. It is truly an amazing country.

"Gas use in Europe’s largest economies fell as much as 16% this winter despite unusually cold conditions, according to IHS Global Insight.” WSJ, April 6, 2009

It is hard to be bullish on commodities after reading these types of statistical data bits, especially when you consider that Europe is not the producer of things in the world (China is), and thus a predominant consumption of natural gas goes to heat homes. Of course there is another side to this story - Gazprom (GZPFY.PK) will be cutting capital expenditures to cope with lower demand and lower gas prices that it is about to face (natural gas prices lag oil prices).

Gazprom, despite being government controlled, is not a unique case. Oil and gas companies are facing lower demand and sharply lower prices. The resulting much lower free cash flows are causing them to slash production and capital expenditures. Capital expenditures are easier to cut out of the two - those are the future revenues and thus future problems which make them irrelevant at present.

Lowering production is a bit trickier for both oil and gas companies as that impacts current revenues. Oil and gas rich nations like Russia, countries in the Middle East, and Venezuela all face a similar problem. They stand on one leg - petrochemicals – and that leg is being undermined by global decline.

However, their social obligations have ballooned during time of prosperity – cutting productions lowers already declining revenues, while social obligation costs don’t decline. What does this all mean? Lower demand for petrochemicals in the short-run is becoming a certainty. Lower production in the short-term is not certain, though very possible (OPEC to my surprise did reduce production so far, but will it be able to maintain it?) In the longer run, supply of petrochemicals will not be robust; it will decline. It will take high oil and gas prices to cure that problem. As it does every time.

Comments

[epeon:]

Market economics. You raise prices, demand goes down. The worst part for Opec is that the west is making structural changes that will be irreversible. In the past, Americans switched to smaller cars which reduced demand. And, when oil went down, everybody bought bigger cars. Now, people are moving to hybrids. Soon, people will go to plug in hybrids. People have gotten burned enough that they do not want to take the risk of being vulnerable to oil prices. Also, governments don't want to be in that position either. So, western governments will subsidize plug-ins which will make a shift to electricity. This will displace oil with lower cost fuels. And, once this starts, it will be irreversible.

Apr 07 11:26 AM

[doubleguns:]

Epeon, I believe some where in the middle of this changeover we are going to get squeezed by MUCH higher oil and nat gas prices since oil/gas production is going to drop off long before the auto industry can replace all of those cars. We dont have enough money to replace all the cars in America anytime soon but I would LOVE for us to try. Think of the job creation making @200 million cars and trucks.

Apr 07 02:00 PM

[Karen Consumer:]

Unemployed people use less gas because they aren't able to go to work each day and the number of companies calling them in for interviews is small. Empty (foreclosed) houses in winter aren't heated by oil or natural gas. People who do have jobs just do necessary travel and wear more indoors or use their wood burning fireplaces. That's market economics.

And you can only have plug in hybrids if you can generate electricity. We still have a long way to go before more power plants are built (remember, Obama said 'you can try to build a coal power plant, but we're going to make it so expensive...'), and in the mean time there is still no nuclear plant that the environmentalists will tolerate, and now that the environmentalits have shown their hand with objecting to wind turbines in the deserts of California, and the recent declaration of the [endangered] status of the Sacramento and San Joaquin rivers in CA, where is this power going to come from?

As long as governments insist that market economics must be green and clean as well as "fair", we're screwed.

Apr 07 03:19 PM

[Fighting Yoda:]

We are in a Great Recession - commodity demand is obviously coming down. The supply will not come down as much - as suppliers will only cut slowly and reluctantly. Nat Gas has come down to $3.75, crude and copper etc will quickly follow.

China inspired commodity rally is over- Baltic index down 35% from its recent highs.

Apr 07 09:51 PM

[Stez:]

For the moment petro chemical demand will fall. Baker Hughes rig count has shown a strong contraction in the drilling market.

However the fact that exploration projects are terminated means that we will see prices increase as supply is limited. Oil sands will no longer be a viable supply source as the price of refinement is too high.

My view is the market will be range bound. However 18 months time we will return to 70 dollar oil.

Honda are doing amazing things with hydrogen cars however those developing economies like their oil and are going to retain their fossil fuels for a decade or more at the very least.

Apr 08 08:51 AM

[john s. gordon:]

karen - empty unheated houses in winter suffer major structural damage due to frost heaves (i'm from vermont). are the banks holding these foreclosed assets looking after their heating requirements?
> jack

Apr 08 09:16 AM

[The Greates...:]

Have you heard about the new VMT (Vehicle Mileage Tax) idea that is being studied right now. With GPS your government will be monitoring the mileage you drive and install a tax on those miles. Big Brother is closer then you think.

Apr 08 09:57 AM

[The Greates...:]

Oil needs to go the way of the dinosaur, it is a relic fossil of the past. New alternative fuels and energy sources are becoming more readily and affordable everyday and will replace oil as our energy source if we are smart as a species.

Apr 08 10:00 AM

[The Greates...:]

I leave you now with this thought, all the big bail outs are going to the big name finical institutions on Wall Street, the working class (middle) got to keep a little more of their checks. But that working class is shrinking everyday due to job loss. Job loss floods the job market, lowing working wages because of the competition in the labor fields, benefiting the larger companies that do hire. (Lower wages means a bigger bottom line) So, if your big enough, it is a win, win situation all around. An also hard times squeezes out competition, creating more monopolies in big business. The consumer loses all the way around, write, call, email and fax your representative today, let them know your watching. Have a nice day.

Apr 08 10:02 AM

[yank:]

over 85% of the total products manufactured in the world are petroleum-based. So much for your comment that oil will go the way of the dinosaur. Some advice for you. Think before you speak.


On Apr 08 10:00 AM The Greatest Rip Off of our Time wrote:

> Oil needs to go the way of the dinosaur, it is a relic fossil of
> the past. New alternative fuels and energy sources are becoming more
> readily and affordable everyday and will replace oil as our energy
> source if we are smart as a species.

Apr 08 10:14 AM

[RWCMom:]

Re: "over 85% of the total products manufactured in the world are petroleum-based...."

You, too, have some control over that: buy products with less packaging (if the product is dry there is no need for plastic), buy the largest container possible (lower container: product ratio), buy used and bring your own bag, buy products of recycled plastic, make it yourself, do without, be creative


On Apr 08 10:14 AM yank wrote:

> over 85% of the total products manufactured in the world are petroleum-based.
> So much for your comment that oil will go the way of the dinosaur.
> Some advice for you. Think before you speak.

Apr 08 01:30 PM

[Jade Queen:]

Hello Yank. People who were employed could afford to buy more of that 85% of stuff than people unemployed. I'm with RWCMom. People are changing their habits in major ways, and profits/losses reflect that. Exactly where we are on the change graph, I'm not sure, but we are getting pattern changes.

Apr 08 02:48 PM