US Treasury benchmark yield heads to 4% as 30-year downtrend ends


The US 10-year Treasury bond is the benchmark for global interest rates and stock markets.  And for the past 30 years it has been heading steadily downwards as the chart shows:

  • US inflation rates finally peaked at 13.6% in 1980 (having been just 1.3% in 1960) as the BabyBoomers began to move en masse into the Wealth Creator 25 – 54 age group
  • Instead of simply boosting demand, as during the 1960s-1970s, they began to work and create new supply
  • This meant supply/demand began to rebalance and interest rates then peaked at 16% in 1981

By 1983, the average Western Boomer (born between 1946-1970) had arrived in the Wealth Creator cohort, which dominates consumer spending, and the economy really began to hum.  There was a final inflation scare in 1984, when US inflation suddenly jumped from 3% to 5%, but after that the trend was downwards all the way.

The Boomers were the largest and wealthiest generation that the world had ever seen.  Their move to become Wealth Creators completely transformed the inflation outlook, as more and more Boomers joined the workforce.  And they transformed the economy by moving it into the NICE era of Non-Inflationary Constant Expansion.

Central bankers took credit for this move, claiming it was due to monetary policy.  But in reality, people are the key element in an economy, not monetary policy.  You can’t have an economy without people.  And sadly, the idea that the US Fed Chairman Alan Greenspan had somehow become a Maestro, blinded everyone to 2 key issues for the future:

  • Life expectancy was rising rapidly, meaning that the Boomers would not normally die just after retirement.  Instead, they would likely live for another 15 – 20 years after reaching age 65
  • From 1970, fertility rates had fallen below replacement level (2.1 babies/woman) across the Western world

This combination of a rise in life expectancy and a collapse in fertility rates was creating a timebomb for the economy.

THE RISE IN LIFE EXPECTANCY AND COLLAPSE OF FERTILITY RATES CREATED AN ECONOMIC TIMEBOMB

Western economies are based on consumer spending.  And spending declines once people reach the age of 55 – they already own most of what they need, and their incomes decline as they approach retirement, as the second chart shows:

  • There were 65m US Wealth Creator households in 2000, who spent an average of $62k ($2017)
  • There were only 36m in the 55+ cohort, who spent just $45k each
  • In 2017, there were 66m Wealth Creators (almost the same as in 2000) who spent $64k each
  • But there were now 56m in the 55+ cohort, who spent just $51k each

The rise in 55+ spending was also only temporary, as large numbers of Boomers have just reached 55+ and have not yet retired.  Spending by those aged 74+ was down by nearly 50% versus the peak spending 45-54 age group.

BELIEF IN MONETARISM LED TO THE DOTCOM AND SUBPRIME DISASTERS 
The dot-com crash in 2000 should have been a wake-up call for the failure of monetarism.  It also, after all, marked the moment when the oldest Boomers began to join the 55+ cohort.  But instead, policymakers thought monetarism could solve “the problem” and cut interest rates to boost the housing market – causing the subprime crash in 2008.

One might have thought – as we wrote in Boom, Gloom and the New Normal in 2011 – that this disaster would have destroyed the monetarism myth.  But no.  Abandoning monetarism would have led to a difficult conversation with voters about the need for everyone to retrain in their 50s, and prepare to take on new, and less physically demanding, roles.

Instead, policymakers tried to replace lost BabyBoomer demand by printing vast amounts of free money via the Quantitative Easing and Zero Interest Rate Policies.  Their aim was to avoid deflation, as inflation had fallen to just 0.6% in 2010 – although why this was a “bad thing” was never explained.  But in reality, they were running uphill, and the pace of the climb was becoming more vertical, as the average Western Boomer joined the 55+ cohort in 2013.

Of course, flooding the market with cheap money boosted asset prices, as they intended.  Stock markets and house prices soared for a second time. But it also created a major new risk.  More and more investors began to panic as they hunted through the markets, trying to obtain a decent “return on capital”.  They assumed central banks would never let markets fall, and so gave up worrying about the risk of making a dud investment.

INTEREST RATES ARE NOW HEADED HIGHER AS PEOPLE WORRY ABOUT RETURN OF CAPITAL
The end of the Bitcoin bubble has highlighted the fact that that risk and reward are normally related.  Most investments that offer potentially high rewards are also high risk – a lot has to go right, for them to make the possible return.  This process of price discovery – the balance of risk and reward – is the key role of markets.

Left to themselves, markets will price risk properly.  But they have been swamped for the past decade by central bank liquidity and their crucial role has been temporarily destroyed.  Now, the fact that the US 10-year bond has broken out of its 30-year downtrend tells us that markets they are finally starting to regain their role.

How high will interest rates now go?  We cannot yet know, and we can also be sure they will not move in a straight line as central banks will continue to intervene.  But as more and more investments, like Bitcoin, prove to be duds, so more and more investors will start to worry about return of capital when they invest.

4% therefore looks like the next level for rates, as we are now trading within the blue bars on the chart.  It may not take very long for this level to be reached, given the fact that the world now has a record $233tn of debt – 3x the size of the global economy.  After that, we shall have to wait and see.

 

FORECAST MONITORING
I strongly believe that forecasts should be monitored, which is why I always review the previous Annual Budget forecast before issuing the next Outlook, and always publish the complete list of Annual Budget Outlooks.

I now plan to begin monitoring my blog forecasts, using the percentage mechanism highlighted in Philip Tetlock’s masterly “Superforecasting” book.  The first forecasts relate to last week’s post on US polyethylene exports and today’s forecast for the US 10-year Treasury bond.  I will change confidence levels as and when circumstances change.

 

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US PE exports on front line as Trump changes trade policies

It is almost a year since Donald Trump became President.  And whilst he has not followed through on many of his promises, he has indeed introduced the major policy changes that I began to discuss in September 2015, when I first suggested he could win the election and that the Republicans could control Congress:

“In the USA, the establishment candidacies of Hillary Clinton for the Democrats and Jeb Bush for the Republicans are being upstaged by the two populist candidates – Bernie Sanders and Donald Trump….Companies and investors have had little experience of how such debates can impact them in recent decades. They now need to move quickly up the learning curve. Political risk is becoming a major issue, as it was before the 1990s.

Many people have therefore had to go up a steep learning curve over the past year, given that their starting point was essentially disbelief, as one commentator noted when my analysis first appeared:

“I have a very, very, very difficult time imagining that populist movements could have significant traction in the U.S. Congress in passing legislation that would seriously affect companies and investors.

Yet this, of course, is exactly what has happened.

It is true that many of the promises in candidate Trump’s Contract with America have been ignored:

  • Of his 174 promises, 13 have been achieved, 18 are in process, 37 have been broken, 3 have been partially achieved and 103 have not started
  • His top priority of a Constitutional amendment on term limits for members of Congress has not moved forward

Yet on areas that impact companies and investors, such as trade and corporate tax, the President has moved forward:

  • On trade, he has not (yet?) labelled China a currency manipulator or moved forward to fix water and environmental infrastructure
  • But he has announced the renegotiation of NAFTA, the withdrawal from the Trans-Pacific Partnership, his intention to withdraw from the UN Climate Change programme and lifted restrictions on fossil fuel production

These are complete game-changers in terms of America’s position in the world and its trading relationships.

Over the decades following World War 2, Republican and Democrat Presidents alike saw trade as the key to avoiding further wars by building global prosperity.  Presidents Reagan, Bush and Clinton all actively supported the growth of global trade and the creation of the World Trade Organisation (WTO).

The US also led the world in environmental protection following publication of Rachel Carson’s ‘Silent Spring‘ in 1962, with its attack on the over-use of pesticides.

Clearly, today, these priorities no longer matter to President Trump.  And already, US companies are starting to lose out as politics, rather than economics, once again begins to dominate global trade.  We are returning to the trading models that operated before WTO:

  • Until the 1990s, trade largely took place within trading blocs rather than globally – in Europe, for example, the West was organised in the Common Market and the East operated within the Soviet Union
  • It is therefore very significant that one of the President’s first attacks has been on the WTO, where he has disrupted its work by blocking the appointment of new judges

Trump’s policy is instead based on the idea of bilateral trade agreements with individual countries, with the US dominating the relationship.  Understandably, many countries dislike this prospect and are instead preferring to work with China’s Belt & Road Initiative (BRI, formerly known as One Belt, One Road).

US POLYETHYLENE PRODUCERS WILL BE A CASE STUDY FOR THE IMPACT OF THE NEW POLICIES
US polyethylene (PE) producers are likely to provide a case study of the problems created by the new policies.

They are now bringing online around 6 million tonnes of new shale gas-based production.  It had been assumed a large part of this volume could be exported to China.  But the chart above suggests this now looks unlikely:

  • China’s PE market has indeed seen major growth since 2015, up 18% on a January – November basis.  Part of this is one-off demand growth, as China moved to ban imports of scrap product in 2017.  Its own production has also grown in line with total demand at 17%
  • But at the same time, its net imports rose by 1.8 million tonnes, 19%, with the main surge in 2017.  This was a perfect opportunity for US producers to increase their exports as their new capacity began to come online
  • Yet, actual US exports only rose 194kt – within NAFTA, Mexico actually outperformed with its exports up 197kt
  • The big winner was the Middle East, a key part of the BRI, which saw its volume jump 29% by 1.36 million tonnes

Sadly, it seems likely that 2018 will see further development of such trading blocs:

  • The President’s comments last week, when he reportedly called Africa and Haiti “shitholes” will clearly make it more difficult to build long-term relationships based on trust with these countries
  • They also caused anguish in traditionally pro-American countries such as the UK – adding to concerns that he has lost his early interest in the promised post-Brexit “very big and exciting” trade deal.

US companies were already facing an uphill task in selling all their new shale gas-based PE output.  The President’s new trade policies will make this task even more difficult, given that most of it will have to be exported.

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The return of volatility is the key market risk for 2018

We are living in a strange world. As in 2007 – 2008, financial news continues to be euphoric, yet the general news is increasingly gloomy. As Nobel Prizewinner Richard Thaler, has warned, “We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping.” Both views can’t continue to exist alongside each other for ever. Whichever scenario comes out on top in 2018 will have major implications for investors and companies.

It therefore seems prudent to start building scenarios around some of the key risk areas – increased volatility in oil and interest rates, protectionism and the threat to free trade (including Brexit), and political disorder. One key issue is that the range of potential outcomes is widening.

Last year, for example, it was reasonable to use $50/bbl as a Base case forecast for oil prices, and then develop Upside and Downside cases using a $5/bbl swing either way. But today’s rising levels of uncertainty suggests such narrow ranges should instead be regarded as sensitivities rather than scenarios. In 2018, the risks to a $50/bbl Base case appear much larger:

  • On the Downside, US output is now rising very fast given today’s higher prices. The key issue with fracking is that the capital cost is paid up-front, and once the money has been spent, the focus is on variable cost – where most published data suggests actual operating cost is less than $10/bbl. US oil and product exports have already reached 7mbd, so it is not hard to see a situation where over-supplied energy markets cause prices to crash below $40/bbl at some point in 2018
  • On the Upside, instability is clearly rising in the Middle East. Saudi Arabia’s young Crown Prince, Mohammad bin Salman is already engaged in proxy wars with Iran in Yemen, Syria, Iraq and Lebanon. He has also arrested hundreds of leading Saudis, and fined them hundreds of billions of dollars in exchange for their release. If he proves to have over-extended himself, the resulting political confusion could impact the whole Middle East, and easily take prices above $75/bbl

Unfortunately, oil price volatility is not the only risk facing us in 2018. As the chart shows, the potential for a debt crisis triggered by rising interest rates cannot be ignored, given that the current $34tn total of central bank debt is approaching half of global GDP. Most media attention has been on the US Federal Reserve, which is finally moving to raise rates and “normalise” monetary policy. But the real action has been taking place in the emerging markets. 10-year benchmark bond rates have risen by a third in China over the past year to 4%, whilst rates are now at 6% in India, 7.5% in Russia and 10% in Brazil.

An “inflation surprise” could well prove the catalyst for such a reappraisal of market fundamentals. In the past, I have argued that deflation is the likely default outcome for the global economy, given its long-term demographic and demand deficits. But markets tend not to move in straight lines, and 2018 may well bring a temporary inflation spike, as China’s President Xi has clearly decided to tackle the country’s endemic pollution early in his second term. He has already shutdown thousands of polluting companies in many key industries such as steel, metal smelting, cement and coke.

His roadmap is the landmark ‘China 2030’ joint report from the World Bank and China’s National Development and Reform Commission. This argued that China needed to transition:   “From policies that served it so well in the past to ones that address the very different challenges of a very different future”.

But, of course, transitions can be a dangerous time, as China’s central bank chief, Zhou Xiaochuan, highlighted at the 5-yearly Party Congress in October, when warning that China risks a “Minsky Moment“, where lenders and investors suddenly realise they have overpaid for their assets, and all rush together for the exits – as in 2008 in the west.

Business as usual” is always the most popular strategy, as it means companies and investors don’t face a need to make major changes. But we all know that change is inevitable over time. And at a certain moment, time can seem to literally “stand still” whilst sudden and sometimes traumatic change erupts.

At such moments, as in 2008, commentators rush to argue that “nobody could have seen this coming“. But, of course, this is nonsense. What they actually mean is that “nobody wanted to see this coming“. Nobody wanted to be focusing on contingency plans when everybody else seemed to be laughing all the way to the bank.

I discuss these issues in more detail in my annual Outlook for 2018.  Please click here to download this, and click here to watch the video interview with ICB deputy editor, Will Beacham.

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Anti-pollution drive hits China’s role as global growth engine

China is no longer seeking ‘growth at any cost’, with global implications, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

A pedestrian covers up against pollution in Beijing © Bloomberg

China’s President Xi Jinping faced two existential threats to Communist party rule when he took office 5 years ago.

He focused on the first threat, from corruption, by appointing an anti-corruption tsar, Wang Qishan, who toured the country gathering evidence for trials as part of a high-profile national campaign.

More recently, Mr Xi has adopted the same tactic on an even broader scale to tackle the second threat, pollution. Joint inspection teams from the Ministry of Environmental Protection, the party’s anti-graft watchdog and its personnel arm have already punished 18,000 polluting companies with fines of $132m, and disciplined 12,000 officials.

The ICIS maps below confirm the broad nature of the inspections. They will have covered all 31 of China’s provinces by year-end, as well as the so-called “2+26” big cities in the heavily polluted Beijing-Tianjin-Hebei area.

The inspections’ importance was also underlined during October’s five-yearly People’s Congress, which added the words “high quality, more effective, more equitable, more sustainable” to the Party’s Constitution to describe the new direction for the economy, replacing Deng’s focus from 1977 on achieving growth at any cost.

It is hard to underestimate the likely short and longer-term impact of Mr Xi’s new policy. The Ministry has warned that the inspections are only “the first gunshot in the battle for the blue sky”, and will be followed by more severe crackdowns.

In essence, Mr Xi’s anti-pollution drive represents the end for China’s role as the manufacturing capital of the world.

The road-map for this paradigm shift was set out in March 2013 in the landmark China 2030 joint report from the World Bank and China’s National Development and Reform Commission. This argued that China needed to transition “from policies that served it so well in the past to ones that address the very different challenges of a very different future”.

The report focused on the need for “improvement of the quality of growth”, based on development of “broader welfare and sustainability goals”.

However, little was achieved on the environmental front in Xi’s first term, as Premier Li Keqiang continued the Populist “growth at any cost” policies of his predecessors. According to the International Energy Agency’s recent report, Energy and Air Pollution, “Average life expectancy in China is reduced by almost 25 months because of poor air quality”.

But as discussed here in June, Mr Xi has now taken charge of economic policy. He is well aware that as incomes have increased, so China is following the west in becoming far more focused on ‘quality of life issues’. Land and water pollution will inevitably take longer to solve. So his immediate target is air pollution, principally the dangerously high levels of particulate matter, PM2.5, caused by China’s rapid industrialisation since joining the World Trade Organization in 2001.

As the state-owned China Daily has reported, the Beijing-Tianjin-Hebei region is the main focus of the new policy. Its high concentration of industrial and vehicle emissions is made worse in the winter by limited air circulation and the burning of coal, as heating requirements ramp up. The region has been told to reduce PM2.5 levels by at least 15% between October 2017 and March 2018. According to Reuters, companies in core sectors including steel, metal smelting, cement and coke have already been told to stagger production and reduce the use of trucks.


The chemicals industry, as always, is providing early insight into the potentially big disruption ahead for historical business and trade patterns:

  • Benzene is a classic early indicator of changing economic trends, as we highlighted for FT Data back in 2012. The chart above confirms its importance once again, showing how the reduction in its coal-based production has already led to a doubling of China’s imports in the January to October period versus previous years, with Northeast and Southeast Asian exporters (NEA/SEA) the main beneficiaries
  • But there is no “one size fits all” guide to the policy’s impact, as the right-hand panel for polypropylene (PP) confirms. China is now close to achieving self-sufficiency, as its own PP production has risen by a quarter over the same period, reducing imports by 9%. The crucial difference is that PP output is largely focused on modern refining/petrochemical complexes with relatively low levels of pollution

Investors and companies must therefore be prepared for further surprises over the critical winter months as China’s economy responds to the anti-pollution drive. The spring will probably bring more uncertainty, as Mr Xi accelerates China’s transition towards his concept of a more service-led “new normal” economy based on the mobile internet, and away from its historical dependence on heavy industry.This paradigm shift has two potential implications for the global economy.

One is that China will no longer need to maintain its vast stimulus programme, which has served as the engine of global recovery since 2008. Instead, we can expect to see sustainability rising up the global agenda, as Xi ramps up China’s transition away from the “policies that served it so well in the past”.

A second is that, as the chart below shows, China’s producer price index has been a good leading indicator for western inflation since 2008. Its recovery this year under the influence of the shutdowns suggests an “inflation surprise” may also await us in 2018.

Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.

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Difficult times ahead for US polyethylene exports as business models change

This wasn’t the chart that companies and investors expected to see when they were busy finalising $bns of investment in new US ethylene and polyethylene (PE) capacity back in 2013-4.  They were working on 3 core assumptions, which they were sure would make these investments vastly profitable:

  • Oil prices would always be above $100/bbl and provide US gas-based producers with long-term cost advantage
  • Global growth would return to BabyBoomer-led SuperCycle levels; China would always need vast import volumes
  • Globalisation would continue for decades and plants could be sited half-way across the world from their markets

The result is that US ethylene capacity is now expanding by 34% through 2019, adding 9.2m tonnes/year of new ethylene supply, alongside a 1.1m tonnes/year expansion of existing crackers. In turn, PE capacity is expanding by 40%, with supply expanding by 6.5m tonnes/year through 2019.

It was always known that most of this new product would have to be exported, as then ExxonMobil President, Stephen Pryor, explained in January 2014:

“The reality is that the US from a chemical standpoint is a very mature market. We have some demand growth domestically in the US but it’s a percentage or two – it’s not strong demand growth,” Pryor said, adding that PE hardly grew in the US in a decade. “That is not going to change…The [US] domestic market is what is it and therefore, part of these products, I would argue, most of these products, will have to be exported,” Pryor said.”

But now the plants are starting up, and sadly it is clear that none of these assumptions have proved to be correct:

  • Oil prices have fallen well below $100/bbl, despite the OPEC/Russia cutback deal, and US output is soaring
  • Companies were badly misled by the IMF; its forecasts of 4.5% global GDP growth proved hopelessly optimistic
  • Protectionism is rising around the world, with President Trump withdrawing from the Trans-Pacific Partnership and threatening to leave NAFTA

As a result, US PE exports are falling, just as all the new capacity starts to come online, as the chart shows:

  • US net exports were down 15% in the January – September period, confirming the major decline seen this year
  • Net exports to Latin America were down 29%, whilst volume to the Middle East was down 31%
  • Volume has risen by 40% to China, but still amounts to just 440kt – enough to fill just one new reactor

And, of course, PE use is coming under sustained pressure on environmental grounds, with the UK government suggesting last week it might tax or even ban all single-use plastic in an effort to tackle ocean pollution.

The same assumptions also drove expansion in US PVC capacity, with 750kt coming online this year.  US housing starts remain more than 40% below their peak in the subprime period, and so it was always known that much of this new capacity would also have to be exported.  Yet as the second chart confirms:

  • US net exports were down 6% in the January – September period, confirming the decline seen through 2017
  • Exports to Latin America were down 9%: volumes to NAFTA, the Middle East and China were at 2016 levels

PRODUCERS NEED TO DEVELOP NEW BUSINESS MODELS
These developments are also unlikely to prove just a short-term dip.  China is now accelerating its plans to become self-sufficient in the ethylene chain, with ICIS China reporting that current capacity could expand by 84%.  And the pressures from pollution concerns are growing, not reducing.

The key issue is that a paradigm shift is underway as the info-graphic explains:

  • Previously successful business models, based on the supply-driven principle, no longer work
  • Companies now need to adopt demand-led strategies if they want to maintain revenue and profit growth

We explored these issues in depth in the recent IeC-ICIS Study, ‘Demand- the New Direction for Profit‘.  It is the product of 5 years of ground-breaking forecasting work, since the publication of our jointly-authored book, ‘Boom, Gloom and the New Normal: how the Western BabyBoomers are Changing Demand Patterns, Again‘.

As we highlighted at the Study’s launch, companies and investors have a clear choice ahead:

  • They can either hope that somehow stimulus policies will finally succeed despite past failure
  • Or, they can join the Winners who are developing new revenue and profit growth via demand-led strategies

US export data doesn’t lie.  It confirms that the expected export demand for all the planned new capacity has not appeared, and probably never will appear.  But this does not mean the investments are doomed to failure.  It just means that the urgency for adopting new demand-led strategies is ramping up.

 

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Saudi Arabia’s ‘Vision 2030’ is looking a lot less clear

Saudi Arabia’s U-turn to revive oil output quotas is not working and fails to address the changing future of oil demand, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

Saudi Arabia’s move into recession comes at an unfortunate time for its new Crown Prince, Mohammed bin Salman (known to all as MbS).

Unemployment is continuing to rise, threatening the social contract. In foreign affairs, the war in Yemen and the dispute with Qatar appear to be in stalemate. And then there is the vexed issue of King Salman’s ill health, and the question of who succeeds him.

This was probably not the situation that the then Deputy Crown Prince envisaged 18 months ago when he launched his ambitious “Vision 2030” programme and set out his hopes for a Saudi Arabia that was no longer dependent on oil revenues. “Within 20 years, we will be an economy that doesn’t depend mainly on oil . . . We don’t care about oil prices — $30 or $70, they are all the same to us. This battle is not my battle.”

The problems began a few months later after he abruptly reversed course and overturned former oil minister Ali al-Naimi’s market share policy by signing up to repeat the failed Opec quota policy of the early 1980s.

His hope was that by including Russia, the new deal would “rebalance” oil markets and establish a $50 a barrel floor under prices. In turn, this would boost the prospects for his proposed flotation of a 5 per cent stake in Saudi Aramco, with its world record target valuation of $2tn.


But, as the chart above shows, the volte face also handed a second life to US shale producers, particularly in the Permian basin, which has the potential to become the world’s largest oilfield. Its development had been effectively curtailed by Mr Naimi’s policy.

The number of high-performing horizontal drilling rigs had peaked at 353 in December 2014. By May 2016, the figure had collapsed to just 116. But since then, the rig count has trebled and is close to a new peak, at 336, according to the Baker Hughes Rig Count.

Even worse from the Saudi perspective is that oil production per Permian rig has continued to rise from December 2014’s level of 219 barrels a day. Volume has nearly trebled to 572 b/d, while the number of DUC (drilled but uncompleted) wells has almost doubled from 1,204 to 2,330.


Equally disturbing, as the second chart from Anjli Raval’s recent FT analysis confirms, is that Saudi Arabia has been forced to take the main burden of the promised cutbacks. Its 519,000 b/d cut almost exactly matches Opec’s total 517,000 b/d cutback.

Of course, other Opec members will continue to cheer on Saudi Arabia because they gain the benefit of higher prices from its output curbs.

But we would question whether the quota strategy is really the right policy for the Kingdom itself. A year ago, after all, Opec had forecast that its new quotas would “rebalance the oil market” in the first half of this year. When this proved over-optimistic, it expected rebalancing to have been achieved by March 2018. Now, it is suggesting that rebalancing may take until the end of 2018, and could even require further output cuts.

Producers used to shrug off this development, arguing that demand growth in China, India and other emerging markets would secure oil’s future. But they can no longer ignore rising concerns over pollution from gasoline and diesel-powered cars.

India has already announced that all new cars will be powered by electricity by 2030, while China is studying a similar move. China has a dual incentive for such a policy because it would not only support President Xi Jinping’s anti-pollution strategy, but also create an opportunity for its automakers to take a global lead in electric vehicle production.

It therefore seems timely for Prince Mohammed to revert to his earlier approach to the oil price. The rebalancing strategy has clearly not produced the expected results and, even worse, US shale producers are now enthusiastically ramping up production at Saudi Arabia’s expense.

The kingdom’s exports of crude oil to the US fell to just 795,000 b/d in July, while US oil and product exports last week hit a new record level of more than 7.6m b/d, further reducing Saudi Arabia’s market share in key global markets.

The growing likelihood that oil demand will peak within the next decade highlights how Saudi Arabia is effectively now in a battle to monetise its reserves before demand starts to slip away.

Geopolitics also suggests that a pivot away from Russia to China might be opportune. The Opec deal clearly made sense for Russia in the short term, given its continuing dependence on oil revenues. But Russia is never likely to become a true strategic partner for the kingdom, given its competitive position as a major oil and gas producer, and its longstanding regional alliances with Iran and Syria. China, however, offers the potential for a much more strategic relationship, which would allow Saudi Arabia as the world’s largest oil producer to boost its sales to the world’s second-largest oil market.

China also offers a potential solution to the vexed question of the Saudi Aramco flotation, following the recent offer by an unnamed (but no doubt state-linked) Chinese buyer to purchase the whole 5 per cent stake. This would allow Prince Mohammed to avoid embarrassment by claiming victory in the sale while avoiding the difficulties of a public float.

The Chinese option would also help the kingdom access the One Belt, One Road (OBOR) market for its future non-oil production. This option could be very valuable, given that OBOR may well become the largest free-trade area in the world, as we discussed here in June.

In addition, and perhaps most importantly from Prince Mohammed’s viewpoint, the China pivot might well tip the balance within Saudi Arabia’s Allegiance Council, and smooth his path to the throne as King Salman’s successor.

Paul Hodges and David Hughes publish The pH Report.

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