“By Monday, the third straight day of flooding, the aftermath of Hurricane Harvey had left much of the region underwater, and the city of Houston looked like a sea dotted by small islands. ’This event is unprecedented,’ the National Weather Service tweeted. ‘All impacts are unknown and beyond anything experienced.’”
This summary from the New York Times gives some idea of the immensity of the storm that struck large parts of Texas/Louisiana last week, including the 4th largest city in the US. And this was before the second stage of the storm.
I worked in Houston for 2 years, living alongside the Buffalo Bayou which flooded so spectacularly last week. The photo above from the Houston Chronicle shows the area around our former home on Saturday, still surrounded by water. Today, as the rest of America celebrates the Labor Day holiday, the devastated areas in Texas and Louisiana will be starting to count the cost of rebuilding their lives and starting out anew:
Some parts of the Houston economy will recover remarkably quickly. It is a place where people aim to get things done, and don’t just sit around waiting for others to do the heavy lifting
But as Texas Governor Abbott has warned, Harvey is “one of the largest disasters America has ever faced. We need to recognize it will be a new normal, a new and different normal for this entire region.”
The key issue is that the Houston metro area alone is larger in size than the economies of Sweden or Poland. And as Harris County Flood Control District meteorologist Jeff Lindner tweeted:
“An estimated 70% of the 1,800-square-mile county (2700 sq km), which includes Houston, was covered with 1½ feet (46cm) of water”
Already the costs are mounting. Abbott’s current estimate is that Federal funding needs alone will be “far in excess of $125bn“, easily topping the costs of 2005′s Hurricane Katrina in New Orleans. And, of course, that does not include the cost, and pain, suffered by the majority of homeowners – who have no flood insurance – or the one-third of auto owners who don’t have comprehensive insurance. They will likely receive nothing towards the costs of cleaning up.
SOME PARTS OF THE ECONOMY HAVE THE POTENTIAL FOR A QUICK RECOVERY
Companies owning the large refineries and petrochemical plants in the affected region have all invested in the maximum amount of flood protection following Katrina, when some were offline for 18 months
Oil platforms in the Gulf of Mexico are used to hurricanes and are already coming back – Reuters reports that only around 6% of production is still offline, down from a peak of 25% at the height of the storm
It is hard currently to estimate the impact on shale oil/gas output in the Eagle Ford basin, but the Oil & Gas Journal reports that 300 – 500 kb/d of oil production is shut-in, and 3bcf/d of gas production
ExxonMobil is now restarting the country’s second-biggest refinery at Baytown, and Phillips 66 and Valero are also restarting some operations, whilst ICIS reports that a number of major petrochemical plants are now being inspected in the expectation that they can soon be restarted
Encouragingly also, it seems that insurance companies are planning to speed up inspections of flooded properties by using drone technology, which should help to process claims more quickly. Loss adjusters using drones can inspect 3 homes an hour, compared to the hour taken to inspect on roof manually. But even Farmers Insurance, one of the top Texas insurers, only has 7 drones available – and has already received over 14000 claims.
RECOVERY FOR MOST PEOPLE AND BUSINESSES WILL TAKE MUCH LONGER
For the 45 or more people who have died in the floods, there will be no recovery.
Among the living, 1 million people have been displaced and up to 500k cars destroyed. 481k people have so far requested housing assistance and 25% of Houston’s schools have suffered severe or extensive flood damage.
These alarming statistics highlight why clean-up after Harvey will take a long time. Basic services such as water and sewage are massively contaminated, with residents being told to boil water in many areas. The “hundreds of thousands of people across the 38 Texas counties affected by Harvey” using their own wells are particularly at risk.
And as the New York Times adds:
“Flooded sewers are stoking fears of cholera, typhoid and other infectious diseases. Runoff from the city’s sprawling petroleum and chemicals complex contains any number of hazardous compounds. Lead, arsenic and other toxic and carcinogenic elements may be leaching from some two dozen Superfund sites in the Houston area”
FEW IN HOUSTON HAVE FLOOD INSURANCE
Then there is the issue that, as the chart from the New York Times shows, most of those affected by Harvey don’t have home insurance policies that cover flood damage. Similarly, a survey in April by insurer Aon found that:
“Less than one-sixth of homes in Harris County, Texas, whose county seat is Houston, currently have active National Flood Insurance Program policies. The county has about 1.8 million housing units.”
As the Associated Press adds:
“Experts say another reason for lack of coverage in the Houston area was that the last big storm, Tropical Storm Allison, was 16 years ago. As a result, people had stopped worrying and decided to use money they would have spent for insurance premiums on other items.”
Even those with insurance will get hit by the low levels of coverage – just $250k for a house and $100k for contents. Businesses carrying insurance also face problems, according to the Wall Street Journal, as they depend on the same Federal insurance scheme, which:
“Was primarily designed for homeowners and has had few updates since the 1970s. Standard protections for small businesses, including costs of business interruption and significant disaster preparation, aren’t covered, and maximum payouts for damages haven’t risen since 1994.
The maximum coverage for business property is $500k, and the same cap applies to equipment and other contents, far below many businesses’ needs. And even those with insurance find it difficult to claim, according to a study by the University of Pennsylvania and the Federal Reserve Bank of New York after Hurricane Sandy in 2012:
“More than half of small businesses in New York, New Jersey and Connecticut that had flood insurance and suffered damages received no insurance payout. Another 31% recouped only some of their losses.”
Auto insurance is a similar story. Only those with comprehensive auto insurance are likely to be covered for their loss – and even then, people will still suffer deductions for depreciation. According to the Insurance Council of Texas:
“15% of motorists have no car insurance, and of those who do, (only) 75% have comprehensive insurance. That leaves a lot of car owners without any protection.”
In other words, around 1/3rd of car owners probably have no insurance cover against which to claim for flood damage.
HARVEY’S IMPACT WILL BE LONG-TERM
It is clearly too early, with flood waters still rising in some areas, to be definitive about the implications of Hurricane Harvey for Houston and the affected areas in Texas and Louisiana.
Of course there are supply shortages today, and the task of replacement will created new demand for housing and autos. But over the medium to longer term, 3 key impacts seem likely to occur:
It will take time for the supply of oil, gas, gasoline and other refinery products, petrochemicals and polymers to fully recover. There will inevitably also be some short-term shortages in some value chains. But within 1 – 3 months, most if not all of the major plants will probably be back online
It will take a lot longer for most people affected by Harvey to recover their losses. Some may never be able to do this, especially if they have no insurance to cover their flooded house or car. And those working in the gig economy have little fall-back when their employers have no need for their services
The US economy will also be impacted, as Slate magazine warned a week ago, even before the full magnitude of the catastrophe became apparent:
“For the U.S. economy to lose Houston for a couple of weeks is a human disaster—and an economic disaster, too….Given that supply chains rely on a huge number of shipments making their connections with precision, the disruption to the region’s shipping, trucking, and rail infrastructure will have far-reaching effects.”
China is now developing a used car market for the first time in its history. This means the end of global auto sales growth, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
China’s car market has been key to the recovery in global auto sales growth since 2009, as the chart shows.
Its passenger car sales in the first half of each year have risen threefold between 2007 and 2017, from 3.1m to 11.3m today, while sales in the other top six markets have only just managed to recover to 2007 levels.
But now major change is coming to China’s market from two directions.
The first sign of change is the fact that H1 sales rose just 2.7% this year. This is the lowest increase since our records began in 2005 (when sales were just 1.8m), and compares with an 11% rise last year.
Official forecasts for full-year growth have also been revised down, to between 1% and 4%, by the manufacturers’ association. A further sign of the slowdown is the rise in price discounting, with Ford China suggesting prices were down 4% on average in the first half.
The second change may be even more important from a longer-term perspective. It seems likely that China’s used car market is poised for major growth. As the second chart shows, only 10m used cars were sold last year, versus 24m new cars.
Yet used car sales are typically between 2 and 2.5 times new car sales in other large markets such as the US, where 2016 saw 39m used car sales versus 18m new car sales.
The background to this unusual situation is that China’s new car sales were relatively small until the government’s stimulus programme began in 2009. Their quality was also poor, as most cars were produced domestically and only lasted an average of three years. As a result:
The auto market only really began to take off in 2009 under the influence of the stimulus packages, when annual new car sales jumped 53% from 6.7m to 10.3m. About 200m Chinese were able to drive a car in that year, and the stimulus programme suddenly provided them with the cash to buy one
Used car sales were much slower to develop, as it took time for the introduction of western manufacturing techniques to gradually extend the average life of a car from 3 years in 2012 to 4.5 years today. But now the pace of change is rising, and it is expected to reach 10 years by 2020
The chart also shows our forecasts for the used car market out to 2020, when we expect used car sales to equal new car sales at 23.5m. This would still only represent a 1x ratio, but the forecast is in line with a new report from Guangzhou-based analysts Piston, who told WardsAuto:
“The used-car market in China is expected to have an explosion in the coming decade, because the ratio of used to new is [the opposite of that in] the US.”
One sign of the change under way was seen last month, when Guazi.com, China’s largest used car trading site, was able to raise a further $400m from investors to expand its service.
Guazi, like BMW and others, have seen that the used car market offers very favourable prospects for growth prospect — as long as attention is paid to boosting buyer confidence by providing sensible warranties and service packages.
Local governments have also played their part under pressure from central government. The state-owned China Daily reports that 135 local authorities have now removed barriers that prevented used cars from one province being sold in another. The effect of these changes is having an effect, with used car sales in January-May jumping 21% versus 2016.
Such strong growth rates, and the slowdown in new car sales, suggest China’s auto market may have reached a tipping point.
All good things come to an end eventually, and it seems prudent to assume that China will no longer be the main support for global auto sales. We expect China’s new car sales to plateau because of the combined impact of the end of stimulus (as discussed here in June), and the rise of used car sales, as these will inevitably cannibalise their volumes to some extent.
Clearly this is not good news for those western manufacturers that have made China the focus of their growth plans in recent years. And there may be worse news in store, given the government’s determination to combat urban pollution by promoting sales of electric vehicles and car-sharing.
Yet it will be good news for those prepared to develop new, more service-related business models. Used-car sales themselves can be highly profitable, while servicing and spare parts supply are likely to become equally attractive opportunities.
Paul Hodges publishes The pH Report.
The global auto market is currently dominated by China, where sales have more than trebled over the past 10 years. But the other 6 major markets have not always done so well. Their total sales are up just 4.3% since they peaked before the Crisis began in 2007.
As the chart, showing January – August sales since 2006 confirms:
US sales are up just 0.5% v last year at 11.6m, and have clearly plateaued – they are also up only 3% v 2006
EU sales have been in recovery mode, up 8% v 2015 at 9.8m – but are exactly the same as in 2006
Japanese sales are down 2% v 2015 at 2.8m – and are down 11% v 2006
Indian sales are up 8% v 2015 at 1.9m – but have more than doubled v 2006
Brazilian sales are down 26% v last year at 1.3m – but are up 8% v 2006
Russian sales are down 15% v last year at 0.9m – but are up nearly 50% v 2006
This highlights the relatively weak impact of the various stimulus programmes in creating sustainable sales growth over time. Yet governments have spent billions since 2008 on “cash for clunkers” and other incentives. The problem is that they feel dependent on the auto industry for jobs, and so they are most reluctant to let the market operate in balancing supply and demand.
The EU is a good example of the distortions this has produced. A new scandal is just emerging, after the VW diesel problems, based on the common dealer practice of self-registering new car sales. As Bloomberg report:
“Manufacturers and dealers have been inflating car sales for years via a trick known as “self-registration.” The carmaker sells a vehicle to a dealer and books the revenue in its accounts. But, absent a customer, the dealer then effectively sells the car to itself. The vehicle often sits on the lot for a while — maybe it’s used as a test drive or loaner vehicle – and is later resold as “nearly new” at a steep discount to the list price. The carmaker can boast of higher sales volumes while avoiding the brand damage from steep discounts on new vehicles. Astonishingly, self-registrations are thought to account for more than 30% of new car “sales” in Germany.”
As the chart shows, Germany is not the only market where the practice is common. 15% of all new car “sales” in France are self-registrations, as are 10% in Italy and the UK. It is no surprise that these are also countries where auto manufacture is seen as a key part of the economy.
Essentially this is Europe’s way of keeping car production at higher levels than justified by actual demand. In the USA, the same result has been achieved by extending loan terms to an average of almost 6 years, and allowing sub-prime loans to become 1/3rd of all car loans. But as one leading consultancy warned yesterday:
“The problem the industry has created across Europe is that dealers, supported by manufacturers, have been using this as a way to get ultra-low mileage, very young cars at a transaction price which is more competitive than a brand new vehicle.”
Automakers know they are playing a dangerous game, but feel trapped by Wall Street pressures to show ever-higher sales each month – no matter whether these sales levels are sustainable in the longer-term No wonder many of them are trying to change their business models towards “mobility” as fast as possible.
It is 15 years since Goldman Sachs coined the word BRIC to highlight their argument that growth in the global economy would, in future, be led by the major emerging economies rather than the developed world. The core concept was that China and India would become the dominant suppliers of manufactured goods and services, whilst Brazil and Russia would become dominant suppliers of raw materials.
The idea was, of course, mainly a marketing venture for Goldman, who hoped to use it to stimulate investment activity at a time when many were in a state of shock after the 9/11 tragedy. And their timing was excellent, as the Note was published just before China joined the World Trade Organisation in December 2001:
China’s declared aim of becoming”the manufacturing capital of the world” provided good collateral for their argument
India’s 2002 launch of its “Incredible India” marketing campaign was equally supportive
With this support, the idea of Brazil and Russia moving closer to developed country status, via increasing their role as commodity suppliers, did not seem so far-fetched
The other great virtue of the BRIC concept, as a marketing venture, was that it was impossible to disprove the theory. Anyone who argued that these countries were too poor to really replace the G7′s economic leadership were simply told they “didn’t understand” or were “stuck in the past”. But 15 years is long enough to test the strength of the analysis, particularly in a key area such as autos. The chart above, showing January – August auto sales in the 4 countries since 2006, enables us to focus on some of the key issues:
China has been a qualified success. Its auto sales have risen more than four-fold from 3.2m in 2006 to 14.4m today. But it seems unlikely that this growth will continue in the future, as used cars are now set to become the main growth driver. This market has only developed recently, as auto quality was very poor before Western manufacturing techniques were introduced from 2009 onwards. It is also clear that government policy over the past 2 years has shifted to focus on increasing China’s self-sufficiency in auto production. The main tactic has been to halve the purchase tax on small cars (engines up to 1.6l), as these are primarily Chinese made. This tax reduction expires in October, but it has achieved its objective, boosting the market share for Chinese brands cars to 42.5%.
India has been successful on a smaller scale. Its auto sales have more than doubled from 800k in 2006 to 1.9m today, but the market for motor vehicles is still dominated by motorbikes – which have a 2/3rds market share, with cars at just 12%. Ford’s experience highlights the problem, as it has been forced to repurpose its major car manufacturing investment in India away from the domestic market into exports – which now account for 2/3rds of sales. Ford is also now moving away from pure manufacturing to become “an auto and mobility company”, with its investment in Zoomcar highlighting its new focus on becoming a “full service mobility company”
Brazil, unfortunately, has been a major disappointment. Its auto sales had doubled to 2.5m by 2012, but are back at 1.3m this year. 2013 was, of course, a turning point in the Chinese economy with the appointment of President Xi, and the subsequent development of his New Normal policies, which have taken the economy in a new direction. Xi’s policies are not based on China being the “manufacturing capital of the world”. Instead, he is focused on building a more service-driven economy, based on the mobile internet and greater self-sufficiency. As a result, Brazil is now left with an economy that is dangerously exposed to commodities, in a world where over-supply has become endemic.
Russia has also unfortunately proved a disappointment. Its auto sales doubled from 900k in 2006 to 2m in 2009, but then collapsed back to 1m after the financial crisis. China’s stimulus programme then took them to 1.9m. But 2015 saw a major decline to 1.1m, and 2016 has been worse, with sales back at 900k again.
2 key conclusions seem to stand out from this analysis:
The BRIC concept only appeared to work when China was operating as the “manufacturing capital of the world” following WTO entry. And even then, its success was more apparent than real, as Western demand for its production was inflated by the subprime policies pursued in the West – which then led to the 2008 Financial Crisis. China hasnow recognised under President Xi that this policy has reached its sell-by date, as the ageing of the BabyBoomers means that Western demand for manufactured goods has gone ex-growth
Ford’s experience highlights how India’s future is not going to be as a “China lookalike” focused on manufacturing. Instead, it will be more focused on services – not only due to reasons of affordability and sustainability, but also because of the new opportunities opened up by the mobile internet, as Mukesh Ambani has highlighted. The arrival of the smartphone is a paradigm shift, which will completely change demand patterns due to its ability to enable the “sharing economy”, and more localised producttion on demand via 3D printing.
The BRIC example is thus another powerful example of the dangers created by building an unthinking consensus on the basis of clever marketing by a major player. Goldman have done very well out of the BRIC thesis, as have those companies and investors who were agile enough to play the trend for their own benefit.
But others, who let their judgement be swayed by consensus thinking have, like Ford, made some expensive mistakes. Today, after all, it is very clear that Goldman’s core thesis was simply wrong. Emerging economies have not taken over economic leadership from the G7, and and are unlikely to do so in the foreseeable future.
“What a difference a day makes“.
Dinah Washington’s famous song could well be applied, with a longer timescale, to developments in China’s economy.
The shape of the above chart has changed completely since it was last featured here in January 2015, as volatility has increased in China’s economy. It shows the relationship between bank lending and auto sales on a monthly basis, segmented by years, and includes latest data for January – July 2016.
The rationale for the chart is that most Chinese auto sales are based on borrowed money, due to the low level of average incomes. But borrowing itself, based on incomes, wouldn’t have enabled auto sales to treble since 2008. It was the rampant property market speculation unleashed by former President Hu and Premier Wen, with their dramatic increase in lending, that made the surge in sales possible.
One key effect of this speculation was to further divide the country into two halves. Average incomes in the urban areas are already 3x those of rural areas – and, of course, rural areas offer little scope for property speculation:
□ Purple period, 2008, saw monthly auto sales of 600k and monthly official lending of Rmb 400bn ($57bn). Average monthly urban incomes were $189
□ Blue period, 2009, of panic stimulus saw auto sales increase 50% and lending treble, whilst incomes rose to $210
□ Grey period, 2010-2013, of consistent stimulus saw monthly auto sales stabilise at 1.4m and lending at Rmb 700bn ($108bn), whilst incomes reached $391
□ Black period, 2014-2016, has seen auto sales and lending become much more volatile. Auto sales have fluctuated between 1400 – 2100, whilst lending has varied between Rmb 600bn – 1500bn. 2015 incomes averaged $413.
The 2014-2016 data thus highlights the major political battle that has taken place within the Chinese leadership over the past 2.5 years. Stimulus has been the core policy of the Populist faction led by Premier Li Keqiang, who has been opposed by the Princelings under President Xi Jinping, as I discussed a year ago.
The battle has been intense. Li has marshaled support for further lending from provinces based on Old Economy industries such as steel, as in Q1, when the economy seemed to slow. Xi has then pushed back firmly on the basis that structural economic reform based on New Normal industries must be the key priority.
Overall, Xi has been winning since 2014, as the charts above from the Wall Street Journal confirm, although there has been major volatility along the way as Li and the Populists have managed to introduce new stimulus. As the Journal notes:
“A swath of economic activity—from factory output to investment and retail sales—slowed last month, reflecting renewed weakness in China’s economy as the effects of earlier government stimulus wane…
“Sheng Laiyun, a spokesman for the National Bureau of Statistics, acknowledged at a briefing Friday that many private businesses were reluctant to expand against a backdrop of cooling growth. “Economic performance in July was indeed slower as the domestic and global economies are still undergoing deep adjustment.”
The key issue is that Xi comes up for reappointment next year and it would therefore make no sense for him to hold back on reform now. He needs to be able to claim that he has tackled the worst of the problems that he inherited, and then point to the prospect of better times ahead, as his New Normal reforms – such as the One Belt, One Road initiative and the Shenzhen/Shanghai – Hong Kong Stock Connect financial linkages – start to produce results.
The rest of this year is therefore likely to be particularly tough, as Xi “takes the pain” of reform. Companies and investors who have been expecting further stimulus may therefore find it prudent to develop contingency plans in case such stimulus does not appear.
Serious questions need to be asked about the likely level of future demand growth for oil and auto sales in Emerging Markets (EMs), as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
Oil market volatility has reached near-record levels in H1 this year, as the first chart shows. It has averaged nearly 10% a week, and over the past quarter-century its three-month average has only been higher during the Gulf War and the subprime crash. Yet there have been no major supply disruptions or financial shocks to justify such a dramatic increase. Instead, July’s report from the International Energy Agency reminds us that:
“OECD commercial inventories built by 13.5 mb in May to end the month at a record 3 074 mb. Preliminary information for June suggests that OECD stocks added a further 0.9 mb while floating storage has continued to build, reaching its highest level since 2009.”
The problem is two-fold:
- Financial markets are now reaching the hard part of the Great Unwinding of policymaker stimulus, which began nearly two years ago as we have described in beyondbrics. Their key role of price discovery has been subverted by the tidal waves of central bank liquidity, and today’s elevated levels of volatility suggest it will be a difficult journey back, as markets return to valuations that are instead based on the fundamentals of supply and demand
- Life has not stood still over the past few years, and so there will also be plenty of surprises along the way as players are forced to recognise that many of their core assumptions are either untrue or out of date. The excitement of the 2009–2014 stimulus period, for example, seems to have led many investors to ignore the 2012 warning from then Saudi oil minister Ali al-Naimi that “Oil demand will peak way ahead of supply”. Today, they are being forced to play catch-up, as they digest the implications of Saudi Arabia’s new National Transformation Plan. Yet its core objective that “Within 20 years, we will be an economy that doesn’t depend mainly on oil”, is clearly linked to Naimi’s earlier insight.
New data from the US Energy Information Agency (EIA) confirms Saudi Arabia’s need for a change of direction, as the chart shows. The EIA’s reference case scenario out to 2040 suggests that US energy consumption will increasingly be led by natural gas and renewables, and notes that
“Petroleum consumption remains similar to current levels through 2040, as fuel economy improvements and other changes in the transportation sector offset growth in population and travel.”
Nor are these trends confined to the US. As Nick Butler has argued recently in the FT, conventional forecasts of ever-rising energy demand driven by rising populations and rising prosperity in the EMs appear far too simplistic. Instead, as he notes: “Demand has stagnated and in some areas is falling.”
Developments in the transportation sector (the largest source of petroleum demand), confirm that a paradigm shift is now underway along the whole value chain. As Dan Amman, president of GM, highlighted in the FT last year, when discussing the value proposition for city dwellers of buying a new car:
“It’s the last thing you should do because you buy this asset, it depreciates fairly rapidly, you use it 3 per cent of the time, and you pay a vast amount of money to park it for the other 97 per cent of the time.”
China’s slowdown confirms the depth of the challenge to conventional thinking about future auto and oil demand. Many still assume that EMs will account for two thirds of global auto sales by 2020, and underpin future oil demand growth. But the China-induced collapse of commodity export revenues in formerly high-flying economies such as Brazil and Russia means that this rosy scenario is also in need of major revision.
As noted last November, Brazil was temporarily the world’s fourth largest auto market in 2013, whilst Russia was forecast to reach fifth position by 2020. But as the chart of H1 sales in the BRIC countries shows, volumes in both countries have almost halved since then. China’s own sales growth is also slowing, as the government’s need to combat pollution has led it to focus on implementing policies aimed at boosting the role of car sharing and public transport – while its focus on electric vehicles is a further downside for future oil demand.
As we move into H2, it therefore appears that the fundamental assumptions behind the $3tn of energy market debt – $100/bbl oil and double-digit economic growth in China – are looking increasingly implausible. And given oil’s pivotal role in the global economy, today’s near-record levels of oil market volatility may also be trying to warn us that wider problems lie ahead for financial and energy markets.