Things have not looked this good economically for a long time,and they continue to improve. On several occasions over the past six years, the global economy seemed to be taking off on a strong growth path only to slow once again due to an unforeseen constraint. Presently,global economic growth looks to be on track to be the strongest since 2011. Several positive factors contribute to this: strengthening growth in the Eurozone, a bounce-back in the US economy, a sustained rate of expansion in Japan, and economic recovery in important emerging markets like Russia and Brazil.

Barring any major unforeseen events or major policy errors, IHS Markit's moderately optimistic outlook is unlikely to change very much. The recent IHS Markit Purchasing Managers Indices (PMI) and other surveys of consumer and business sentiment remain positive. We observe steady improvement in the growth of world trade. The slight acceleration in growth from 3.0% this year to 3.2% in 2018 assumes that the United States will enact fiscal stimulus. The good news is that even if there is no growth boost from US fiscal policy, the underlying dynamics of the global economy will support a rate of expansion of around 3.0% next year.

Yet, in spite of all the positive news, the potential negative impact on petrochemical demand of geopolitical developments should be considered,when thinking about potential scenarios for our industry. In the following text, we highlight three of the most important ones.

Great Britain falls off a cliff

The UK economy has lost some of its resilience and the recent election has thrown the Brexit process into disarray. We have revised down 2017 growth from 1.7% to 1.5% and 2018 growth from 1.2% to 1.1%. Heightened political and policy risks could mean further downward revisions. At the same time, the rest of the European Union seems to be gathering economic momentum.

Whatever the British negotiators are currently claiming,there is the distinct possibility that Great Britain could fall off a cliff in 2019, if no agreement is made with the European Union in the next year and a half. If there is no deal, Britain will simply fall out of the EU in March 2019, which would mean that Great Britain would spend years entangled in lawsuits about payments and liabilities, EU citizens in Britain would lose their rights as would British citizens on the Continent. There would not be a free trade deal and businesses would virtually run up against a trade wall.

Nevertheless, the impact on the global petrochemical industry will likely be minimal. The UK produces less than 1% of global petchems and the UK is neither a major importer nor exporter of chemicals. The much larger effect would be the result of a much weaker UK economy and disruptions to product and service trade flows in and out of Great Britain. Much depends on the extent of the trade agreements the United Kingdom reaches, not only with the European Union but also with other countries and regions, how much access the United Kingdom will have to the EU single market.

China's future lost decade

The IHS Markit baseline economic growth scenario for China in the medium term is around 6%, but it is also possible that China's growth could be much lower, resulting in what in the future could be known as China's lost decade. If this should happen, the impact on the global petrochemical industry would be enormous, as will be discussed later.

China's economy in the medium term faces sizable challenges. Export growth will likely be subdued in the future, as demand from China's major markets of the United States and Western Europe will not likely return to high 2008/2009 pre-crisis levels. In addition, China's expansion as the export factory of the world has plateaued, which means Chinese exports will no longer be able to outgrow world import demand as it did before. At the same time, Chinese household demand weakness is structural in nature and will unlikely be corrected quickly. Without buoyant exports or consumer demand, business conditions in China will make it difficult to support robust growth in private investment.

Other downside risks to consider include:

• An isolationist approach to international trade policy by the USA could trigger a trade war, which would severely damage China's export sector and erode business confidence
• Chinese commercial banks' poor health could lead to a collapses the banking sector
• The Chinese real estate market could crash again. Such a market collapse would destroy substantial sums of household wealth and depress consumer demand
• Lack of political will to implement serious economic structural reforms could lead to prolonged economic growth slowdown in China, even stagnation.

As would be expected, any slowdown of Chinese economic growth would have a major impact on petrochemical production, demand and trade flows.China is currently responsible for an estimated one-third of total petrochemical production globally,and Chinese chemical demand is expected to grow at a rate slightly higher than GDP growth in the near to midterm. Preliminary estimates indicate that 20% of global demand growth for petrochemicals over the next five years would simply disappear, if China's economic GDP growth rate drops from 6% to 3%. The result would be a tremendous oversupply of basic petrochemicals and polymers and very poor margins for the global industry. This dependency on China is the single biggest risk to
the petrochemicals industry in the near future.

OPEC loses it

Oil markets have largely shrugged off the 25 May 2017 OPEC agreement to extend productions cuts through the end of March 2018. Oil prices fell after the meeting and have remained soft in the following weeks. The challenge facing OPEC is rising US tight oil production.Partly as a consequence, the price of Dated Brent is projected to average in the low $50s per barrel, but at times both below and above this price level. Price volatility is to be expected.

On 15 June 2017, Daniel Yergin, IHS Markit vice chairperson, was a guest on CNBC's "Squawk Box" and offered two reasons to explain why oil prices are "back to the past". First, oil inventories are now 10 percent higher than they were in the past, and second, the remarkable rebound in US shale oil production.

Until recently, common belief was that US shale oil companies needed a crude oil price of roughly $60 to $70 per barrel to survive, but due to new processes and technology advances, the minimum price level has now dropped to a range of $40 to $45 per barrel.

OPEC members and Russia were anticipating that production cuts would move oil inventories lower,and thus boost prices in the near term. However, the problem for OPEC members is that the growth in US production is already set for 2017, so the possibility of any relief will be difficult this year.

If crude oil prices stay at current levels, or drop even lower, what will this mean for global petchems? Overall, the global economy has and will continue to benefit from lower crude prices; certainly in energyimporting markets, such as Northeast Asia, India and Europe. At lower energy prices, plastics and polymers (also at lower prices) will continue to replace other materials (and recycled polymers), simply because they are typically viewed as a lower cost alternative for use in non-durable applications where performance standards are lower compared to durable applications. On the other hand, at low crude oil prices, some investments in new capacities could be postponed or cancelled, inevitably leading to tighter markets and overall better profitability for crude oil/naphtha-based petrochemical plants.

As can be seen from this short analysis, the world is fraught with uncertainty. However, this has always been the case. The prudent business executive factors in these and other geopolitical uncertainties when planning investments, acquisitions or forays into new markets. Certainly, a balanced portfolio, both geographically and product wise will be crucial elements in any risk management strategy. IHS Markit Energy and Chemical teams are positioned to support clients with a multitude of tools and consultancy services based on fully integrated forecast data, extensive market expertise and scenario planning capabilities to help mitigate some of these risks.

Posted 27 September 2017