Boom, Gloom and the New Normal

An excellent new report from Citi’s commodities team suggests the US supply/demand balance for crude oil is undergoing fundamental change.

Importantly, they also argue that the concept of ‘peak oil is being buried’, and add:

“The belief that global oil production has peaked, or is on the cusp of doing so, has underpinned much of crude oil’s decade-long rally”.

US OIL MARKETS
As Citi note, the arrival of shale oil in the USA and the associated liquids from shale gas, is now “leading the US to be the fastest growing oil producer in the world“.

The Citi chart above provides dramatic evidence for the first assertion. It shows that the US has become a net exporter of refined oil products (gasoline, diesel, jet fuel etc) for the first time in 60 years. The scale of the turnaround is also important. The US imported 2.5mbd in 2005, but exported 360kpd in H2 2011.

Citi argue there is little reason to expect this trend to change. Not only is more oil being produced all the time, but US demand is also declining:

• On production, the key is developments in states like N Dakota, where companies are applying shale gas drilling techniques to shale oil deposits
• On demand, Citi share the blog’s view that higher prices reduce the ratio of oil demand growth to global GDP growth. Higher auto fuel standards, the attractiveness of shale gas, and increasing use of ethanol will also reduce oil demand

Citi thus expect the US “to achieve energy independence this decade”. This has been long-delayed since the goal was announced by then President Nixon in reaction to the 1973 oil crisis. But not only are the tools to achieve it now available, but also the political will.

PEAK OIL DOUBTS
The concept of ‘peak oil’ was originally invented in 1956 by a Shell geologist, M King Hubbert, and gained credibility from its accurate forecast that US oil production would peak between 1965-70. However, as the blog noted last year, Hubbert’s other forecasts were less successful. The USA produced 7.5mbd in 2011, rather than just the 1.5mbd he expected.

The major influence of the peak oil story has been in commodity markets.

As we noted in chapter 3 of ‘Boom, Gloom and the New Normal’, pension funds and others have been sold the idea that oil and other commodities represent a ‘store of value’ whose prices will always keep rising. Thus they have continued to buy, even though demand is falling and inventories are comfortable.

The major impact of the Citi argument is initially on US markets. They therefore expect the recent disconnect between WTI and global markets to continue.

Yet now the ‘peak oil’ theory is being challenged, the door is also opening for other countries to exploit the large deposits of shale gas and shale oil that exist outside the USA.

January was not a great month for auto sales in the 3 major markets of the USA, EU and China. These amount to over 50% of global auto sales, and are a key indicator of underlying consumer demand.

As the chart shows, sales were just 3m (red square), down from 3.2m (green line) in 2011:

• China’s volumes were down 17% to 1.2m from 1.4m
• EU fell from 1.04m to 0.97k
• Only the USA saw a rise to 0.9m from 0.8m

Of course, China’s sales were much slower than last year due to the Lunar New Year taking place earlier than in 2011, and combining with the Spring Festival. But even so, China’s auto industry is only forecasting 8% growth this year – in line with the 6% seen in 2011. This is well down on the 33% and 49% increases seen during the stimulus period.

It is also difficult to be optimistic about EU sales, with auto companies forecasting sales declines of 6% or more this year. Whilst sales growth forecasts in the USA will be tested by today’s high gasoline prices.

This time last year, the petchem industry stood on the edge of an unseen precipice. Life seemed good. Prices were racing ahead and demand appeared buoyant. But in reality the buyers were only buying forward to protect margins, whilst end-user demand was slowing fast.

This year, the blog fears, we may be about to take one step forward.

As last year, the evidence comes from ICIS market reports. The highly experienced Linda Naylor last week reported buyers commenting as follows in European polyethylene and polypropylene markets:

“‘We expect an increase for ethylene in March, so we are buying our full contracted volumes in February, and also in January, even though our demand is poorer than we expected. That way, we won’t have to buy so much in March.”

“‘Our demand is below what we expected but we are taking our full contracted volumes to be able to have a buffer next month.”

Similar warning signs are reported by Becky Zhang in China’s ethylene glycol markets, and Helen Yan in Asian butadiene:

“‘The market is full of offers and this [has worsened the] bearish sentiment’, a major regional trader said. China’s port inventory reached a historic high of over 750KT, with increased import volumes arriving from all over the world. This is almost exceeding China’s maximum storage capacity of around 800KT.”

“‘BD prices are higher than BR and this is not sustainable,’ another synthetic rubber producer said.”

The chart shows how prices for the benchmark products have seen 3 major rallies since 2009. These followed the 3 major stimulus packages.

Today’s rally began with Q4′s US Federal Reserve’s $400bn Operation Twist programme. It is clearly much weaker than those which followed the March 2009 and August 2010 quantitative easing programmes.

Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 11%. “Offers for re-exports from China were heard at lower prices than offers from the US Gulf”
PTA China (red), down 11%. “The current supply and demand balance as well as volatile external markets did not support a solid upturn”
Naphtha Europe (brown dash), down 7%. “Vitol continued its naphtha buying spree, taking 5 cargoes after it bought eight cargoes last week”
Brent crude oil (blue dash), down 5%
Benzene NWE (green), down 4%. “Continued buoyancy on crude and energy numbers counterbalanced by lower demand.”
S&P 500 Index (pink dot), no change

Greece’s debt default saga seems never-ending. And it is tempting to hope that it only matters to those suffering in Greece and the PIIGS countries (Portugal, Italy, Ireland, Greece, Spain).

But a look at auto sales trends since 2005 gives a different picture. As the chart shows, based on ACEA data, sales in the 5 PIIGS countries have seen a sharp decline since the crisis began:

• 4.8m autos were sold there in 2007, 31% of total EU sales (blue column)
• Only 2.9m were sold in 2011, a fall of 39%
• Italy’s sales (green line) were down 30% to 1.7m
• Spain’s (red) were down 50% to 0.8m
• Portugal’s (orange) were down 24% to 0.2m
• Greece’s (purple) were down 65% to 0.1m
• Ireland’s (brown) were down 52% to 0.1m

It is also clear that further declines are inevitable, as earlier stimulus such as ‘cash for clunkers’ is replaced by austerity programmes. Those losing their jobs in the public sector, or seeing their pensions reduced, will suffer a permanent loss of purchasing power.

Even more worrying is that a vicious circle is now underway. Jobs are starting to go in the private sector within the PIIGS, and amongst EU companies who supply there, further damaging the sales outlook:

• Italian auto maker, Fiat, sold 928k cars in 2011, versus 1.2m in 2007
• France’s PSA, the EU’s 2nd largest manufacturer, sold 1.6m versus 1.9m
• Renault COO, Carlos Tavares, has suggested current price wars could lead to a major bankruptcy
• He added “you cannot continuously be in the red. Somebody some day has to pay for it.”

Already PSA has announced 6000 job cuts, and said that production needs to be cut short-term to conserve cash-flow. Whilst
Fiat CEO Sergio Marchionne has warned that Europe needs to “cut 10% – 20% of its car manufacturing capacity”.

As promised, the blog looks today at the performance of US polyethylene (PE) exporters in Brazil.

It was the fastest-growing of the major markets in 2011, as the wider economy benefitted from China’s demand. Since 2008, Brazil’s PE net imports have grown 78%, from 445KT to 793KT in 2011. But as the chart shows (based on data from Global Trade Information Services):

• NAFTA (red square) has seen its market share decline from 40% to 38%, despite its growing cost advantage since 2010 due to shale gas
• The reason is that China’s changing market dynamics (as discussed yesterday), has led to greatly increased competition

USA net exports have grown 51% over the period, from 171KT to 258KT. Canada’s exports have also increased from 6KT to 32KT. But at the same time, many more players have entered the market:

• Latin American exporters (blue line) have been the big losers
• Their share has dropped from 42% in 2008 to 24% in 2011
• The Middle East (dark blue) has jumped from 2% to 13%
• Europe (green) has maintained its position, rising from 8% to 10%
• SEA (brown) has jumped from 1% to 6%
• NEA (dark green) has increased from 3% to 4%
• India (purple) has gained a 1% share

In turn, this has led to a decrease in relative profitability. GTIS data also shows that Thailand, for example:

• Sold in 2008 at an average $1825/tonne, $100/t above USA levels
• But in 2011 it sold at $1546/t, $50/t below USA levels

Brazil’s market dynamics therefore highlight the increasing challenge being faced by US exporters. Countries no longer able to sell their output to China will not simply reduce production. Instead, they will target new markets, increasing competitive pressures around the world.

US petchem producers are planning a major boost to ethylene capacity. They now have the 2nd cheapest feedstock in the world, due to ethane from shale gas. The only question is, where will they sell their product?

Ethylene, of course, is very expensive to export. So derivatives such as polyethylene (PE) are the main way to tap export markets. Today, using trade data from Global Trade Information Services, the blog looks at the outlook for PE in the US’s largest export market, China.

China should present a wonderful opportunity. Market growth has slowed to normal rates following the end of stimulus programmes. But its production is largely based on crude oil, and so is far more expensive than NAFTA’s. Yet, as the chart shows:

• China’s net imports from NAFTA fell 53% between 2009-11
• This was despite a major increase in their cost advantage
• The USA saw its net exports fall 51%, from 947KT to just 461KT

The reason is that China does not focus on profitability as a major driver for business. Instead, it emphasises social and political factors:

• Social. Sinopec continues to increase its own production, even though its total chemicals EBIT between 2000-10 was just Rmb84bn, compared to total chemicals capex of Rmb166bn. No Western company would invest on this basis. But Sinopec’s role is to act as an utility, providing reliable supplies of raw materials to China’s factories to keep people employed.
• Political. China is, however, increasing its PE imports from the Middle East (up 69%) and SE Asia (24%). The ME and China operate a ‘strategic corridor’ which balances China’s need for energy imports with the ME’s need for markets. Whilst SEA has a free trade area with China.

The result is that producers in NAFTA, NE Asia and Europe have all seen a major decline in export volumes since 2009. In turn, of course, this has led to greater competition for the USA in other markets.

Tomorrow, the blog will analyse how has impacted US exports to Brazil, currently the world’s fastest-growing major market for PE.

China’s bank lending fell 7% in 2011, following a 17% decline in 2010. As the chart shows (red column), the government is clearly trying to stabilise the position, after the panic increase in lending in 2008/2009. (January lending, impacted by Lunar New Year, was down 29% vs 2011).

Electricity consumption growth (blue line) also seems to be stabilising. It is a lagging indicator, as it takes time to expand electricity production. But the ending of subsidies for rural home appliances helped to push their sales down 33% in January versus 2011.

The reason for the government’s caution is that food price inflation remains out of control. It was up 10.5% in January, reversing recent declines. In a country where 96% of the population earns less than $20/day, food prices matter a great deal.

Those analysts with a purely financial outlook seem to have missed this critical point. They have been forecasting further stimulus programmes for some months. But very little has yet happened. Instead, the government remains focused on maintaining social stability.

This is particularly important in the run-up to the major changes that will take place in politburo membership this year. Thus, instead of reductions in interest rates, the government has instead announced minimum wages will rise 13% a year until 2015:

• In Beijing, it is currently $200/month, and $140 in urban Chongqing
• The aim is for it to be at least 40% of average wages by 2015
• At present, it varies between 20%-30%, depending on region

This will boost domestic spending power. But, as we argue in our Boom, Gloom and the New Normal eBook, affordability will be the key factor. Those companies who focus on meeting the population’s basic needs for food, water, shelter, health and mobility should do very well indeed.

Over the past 18 months, the main investment analysts have argued that high oil prices would have no impact on the global economy. Now, new forecasts suggest their optimism has been misplaced.

The chart above gives the International Energy Agency’s latest forecast of likely oil demand growth this year:

• It has been reduced by a further 0.3mbd since January
• Total 2012 oil demand growth is forecast to be just 0.8mbd
• Global economic growth is now forecast at just 3.3%, down from 4%

Sustained high oil prices are indeed reducing economic growth, and oil demand itself, just as they have done every time in the past.

Even the idea that China would “inevitably” see strong demand growth has proved wishful thinking. The IEA forecasts just a 0.4mbd increase in China’s oil demand this year. And even that may turn out to be over-optimistic, given the clear slowdown now underway.

As the blog has long feared, the chemical industry will now have to pick up the pieces, after the damage has been done:

• Today’s oil and feedstock price levels mean that working capital costs are very high compared to historical levels. This reduces the cash available for product and market development.
• They also increase market volatility. The lack of inventory means small changes in demand can cause major swings in market prices, if producers or consumers have to cover supply chain problems.
• Even more critically, as we are seeing with the Petroplus refinery bankruptcy, there is a real risk of supply disruptions for feedstocks and raw materials, if key plants can no longer afford to operate.

Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 14%. “US spot export prices are still too high for large quantities to be sold in many markets”
PTA China (red), down 10%. “Buying activity slowed down clearly as compared with last week because the persistently weak downstream polyester sales curtailed buying interest”
Naphtha Europe (brown dash), down 7%. The Petroplus bankruptcy led traders to build inventory in anticipation of “stronger demand from both the gasoline blending sector and petrochemical end-users”
Brent crude oil (blue dash), down 6%
Benzene NWE (green), down 4%. “Price ideas edged up in line with stronger US and Asia numbers as well as steady-to-firm energy costs”
S&P 500 Index (pink dot), down 2%

Mahathir Mohamad is one of the Grand Old Men of the Asian political establishment. He was Malaysian premier from 1981 – 2003, and led its rapid modernisation and economic growth. Over the period, which included the Asian financial crisis, the former colony’s economy grew four-fold in real terms, and it is now the 37th largest in the world.

His comments from an Asian viewpoint to the BBC on the problems facing Europe are thus well worth noting. He suggests that:

“Europe must face up to the new economic reality. Europe… has lost a lot of money and therefore you must be poor now relative to the past. In Asia we live within our means. So when we are poor, we live as poor people. I think that is a lesson that Europe can learn from Asia.”

“You refuse to acknowledge you have lost money and (that) therefore you are poor. And you can’t remedy that by printing money. Money is not something you just print. It must be backed by something, either good economy or gold. I think you should go back to doing what I call real business – producing goods, providing services, trading – not just moving figures in bank books, which is what you are doing.”Mahathir agreed “with a laugh” with the BBC, this was a tough message:

“We used to get tough messages from you before, remember? And now, what is the result? Sometimes you undermined our currency and we became very poor. Well, we learn from each other. We were Euro-centric before. I think it should be a little bit Asia-centric now.”