Plastics recycling paradigm shift will create Winners and Losers

My new analysis for iCIS Chemical Business highlights the paradigm shift now underway in the plastics industry.

A paradigm shift is underway in the plastics industry as public concern mounts over the impact of plastic waste on the oceans and the environment.

For 30 years, plastics producers have primarily focused upstream on securing cost-competitive feedstock supply. Now, almost overnight, they find themselves being forced by consumers, legislators and brand owners to refocus downstream on the sustainability agenda. It is a dramatic shift, and one which is likely to create Winners and Losers over a relatively short space of time.

The pace of change is startling. In January, 11 major brands, including Coca Cola, Unilever, Wal-Mart and Pepsi (and since joined by Nestlé) announced they were committed to working towards using “100% reusable, recyclable or compostable packaging by 2025“. Then in April, a UK government-led initiative saw 42 companies, responsible for over 80% of the plastics packaging sold in UK supermarkets, promise to “transform the plastic packaging system and keep plastic in the economy and out of the ocean”.

Tesco, the UK’s largest retailer, added to the pressure by beginning the move to a “closed loop system”. Clearly seeing the issue as a source of potential competitive advantage, they announced plans to remove all “hard to recycle” plastics – such as polystyrene, PVC and water-soluble bio-plastics – by the end of next year. Then last month, the EU Commission adopted new rules that will mean a minimum of 50% of all plastic packaging waste will be recycled by 2025. In addition, it has proposed drastic action, including bans, to reduce the use of the top 10 single-use plastic items found on EU beaches by 2021.

Understandably, many companies and CEOs have failed to keep up with these developments. Others have simply ignored them on the assumption they will prove to be all talk and no action. But nobody who attended the Circular Economy Forum at the recent ICIS World Polyolefins Conference could have come away believing that “business as usual” was a viable option for the future. As Borealis, Europe’s second largest polyolefin producer, explained, their vision is instead to “establish plastic waste as just another standard feedstock as the new normal” for the industry.

As the second chart shows, major plastics including polyethylene and polypropylene are now under major threat.

More than 50% of PE demand, and nearly a third of PP demand goes into single use packaging. Following the World Economic Forum’s ‘New Plastic Economy’ report in 2016, and Sir David Attenborough’s ‘Blue Planet 2’ series for the BBC, it is clear that this application is under major threat.

PARADIGM SHIFTS CREATE WINNERS AND LOSERS
The third chart highlights how business models are already starting to change. The current model was highly successful during the BabyBoomer-led economic supercycle, when demand grew on a constant basis. Companies could choose to compete via cost leadership or value-added strategies, or via a focus on premium products or service-orientation. But now the middle ground is starting to disappear: as demand growth is slowing and profits will be squeezed as competition intensifies. We are instead going back to the polarised model that existed before the 1980s:

  • Upstream-integrated companies can choose to adopt a Feedstock Focus and roll-through their margins to the well-head (in the case of ethane) or refinery (in the case of naphtha) as margins come under pressure
  • Those without this ability, however, need to instead adopt a Market Focus, as intensifying competition will squeeze non-integrated companies without the safety net of an upstream margin
  • Market Focused companies have the opportunity to respond to brand-owner and legislative pressure by basing their feedstock needs on recycled plastic rather than naphtha, ethane and other virgin feedstocks
  • They will need to develop new metrics to measure their progress as they start to build their capability to use recycled feedstocks and create long-term relationships with brand-owners and other stakeholders

Paradigm shifts generally produce winners and losers. In this case, the winners will be those plastics producers who adapt to the new opportunity created by the need to produce recycled plastic. This will clearly require investment in recycling facilities, but the sums involved are small compared to the cost of building new olefin crackers or refinery capacity. And in many countries, producers can even expect to be paid to take the recycled plastic as a feedstock, when the alternative is the cost of sending it to landfill.

The losers, of course, will be existing feedstock suppliers:

  • Many oil majors have assumed that rising demand for petrochemicals will help to compensate for demand lost to electrification in the transport sector
  • OPEC’s World Oil Outlook 2040 saw petrochemicals as providing “significant growth” for the future
  • The International Energy Agency will also need to revisit its assumptions about future demand growth as the impact of the new paradigm becomes more apparent.

As National Geographic has reported, the world has produced around 8.3 billion tonnes of plastic over the past 60 years, and only 9 per cent of this has been recycled. This is a shocking waste of a valuable resource. The paradigm shift now underway is well overdue and should prove very profitable for those companies prepared to seize the opportunities it creates.

Please click here if you would like to download the article.

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Apple, Xiaomi squeeze smartphone mid-market as sales plateau

The global smartphone market has finally gone ex-growth as China’s slowdown continues.  In turn, the market is starting to polarise – with Apple pushing further up-market whilst Chinese brands such as Xiaomi focus on volume.  Samsung’s middle market positioning looks increasingly under threat:

  • The chart shows Q1 sales for Samsung, Apple, the 3 top Chinese brands and Others (Strategy Analytics data)
  • The 3 Chinese brands (Huawei, OPPO, Xiaomi) have collectively taken top position with 27% of the market
  • Samsung has slipped into 2nd place with 23%, whilst Apple is at 15%
  • Total volume at 345m was down 2% versus 2017 and back at 2015 levels, as Strategy Analytics note:

“Samsung is holding steady in its core markets of North America, Western Europe and South Korea, but the company is facing intense competitive pressure in China and India from rivals such as Xiaomi. Apple volume grew 3%.

“Huawei grew 14% despite headwinds in North America (whilst) Xiaomi doubled marketshare versus 2017 as its growth soared 125%. Xiaomi is expanding like wildfire across Asia, particularly in India.  OPPO has been hit hard by Xiaomi’s rapid retail expansion and Huawei’s much-improved Android device portfolio.

CHINA’S PREVIOUSLY HOT MARKET HAS GONE COLD

The key to Q1’s decline was the collapse in China’s market, where sales fell 19% to 91m, and were back at 2013 levels according to Canalys data.  And as the chart shows, the 4 main players are consolidating their position:

  • Huawei grew market share to 24% from 18%; OPPO grew from 17% to 19%
  • Vivo grew from 15% to 17%, whilst Xiaomi jumped 8% to 13%.  And as Canalys note:

“There is a sense of fatigue in the market. The level of competition has forced every vendor to imitate the others’ product portfolios and go-to-market strategies.  But the costs of marketing and channel management in a country as big as China are huge, and only vendors that have reached a certain size can cope.”

Xiaomi’s growth is due to its focus on the sub-RMB1000 level ($160).  Its recent launch of cheap up-market phones will put more pressure on competitors and further drive consolidation in the market.

SMARTPHONE MARKET’S POLARISATION CONFIRMS THE GLOBAL TREND

It is, of course, no accident that China’s downturn has ended global market growth.  Its vast stimulus programme after 2008’s financial crisis meant that it became the growth engine for the global economy.  But now President Xi’s resolve to make “deleveraging” one of his “3 tough challenges” is changing the rules of the game, again:

  • As the chart shows, the Boomer-led SuperCycle created a new and highly profitable mid-market
  • Before then, companies had competed on the basis of price or perceived value
  • But from the mid-1980s onwards, the mid-market became the most profitable sector
  • Now, with the Boomers retiring and stimulus programmes ended, we are going back to basics again
  • The vastly different strategies of Apple and Xiaomi highlight the new world ahead

Apple CEO, Tim Cook, has deliberately turned his back on the mid-market, positioning the new iPhone X at the $1000 price point, where it has consistently outsold the cheaper iPhone 8 and iPhone 8Plus. In turn, this led profits to jump 25%.  As a result, Apple is the clear leader in the high-end sector with its relatively niche products and high margins. As the Financial Times reports:

“iPhone unit sales of 52m were up only 3% by volume but the product’s revenues jumped 14%, as the iPhone X drove its average selling price up by $73 compared with a year ago, to $728.

Apple’s performance highlighted the new strategy:

  • Its China revenues rose 21% and the iPhone X was the top selling smartphone
  • It also benefits from the growth of the used-phone market, now around 10% of the total
  • Around a quarter of US consumers sold their old smartphone when upgrading last year
  • iPhones will likely hold their value well, making them more valuable when resold

Similarly, Xiaomi’s success in China highlighted the opportunity in the mass-market.  Its market share jumped to 13% as it aimed to make a net profit margin of just 5% on its $100 – $160 phones.

INVESTORS NEED TO WATCH FOR BANKRUPTCIES AS CONSOLIDATION REVS UP
The free money provided by the central banks since 2008 has had two key effects:

  • It has prolonged the reign of the mid-market as consumers have been able to borrow cheaply
  • It has allowed mid-market companies to borrow heavily and build up major debt

Now, both of these trends are reversing.  Consumer spending is increasingly being driven by income, rather than borrowing.  Companies are seeing interest rates rise on their debt: even worse, those who borrowed to take advantage of low US rates are seeing repayments rise as the US$ rises again.

Investors need to be very careful about where they place their bets for the future.  And companies need to check out their business partners’ strategies.  Falling volumes and higher interest/debt costs will lead to a wave of bankruptcies.

Most analysts are ignoring the changes underway in China.  As with subprime, they will soon argue that “nobody could have seen this coming”.  But in reality, there are always warning signs.  The global smartphone market has been the great success story of the stimulus era.  Its paradigm shift is highlighting the likely “surprises” that lie ahead.

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2018 will see Winners and Losers appear in plastics markets

Two major challenges face petrochemical and polymer producers and consumers in 2018:

  • The likely disruption created by the arrival of the ethylene/polyethylene expansions in the US
  • The growth of the circular economy and the need to dramatically increase recycling capacity

My new interview with Will Beacham, deputy editor of ICIS Chemical Business, focuses on both these key issues and suggests they will create Winners and Losers.

The new US product will likely change the global market. Its ethane feedstock is essentially a distressed product, which has to be removed to enable the shale gas to be sold.  It is also clear that this 40% expansion of USA polyethylene capacity, around 6 million tonnes, cannot be sold into the US domestic market, which is already very mature:

  • US net exports have actually been in decline in recent years, so it will also be a challenge to export the volumes
  • President Trump’s apparent wish to start a trade war with China will make that market difficult to access
  • It is likely, therefore, that a significant volume will end up arriving in Europe, causing a price war

We have seen price wars before, and the “Winners” are usually the integrated producers, who can roll through margins from the well-head or the refinery into ethylene and polyethylene sales.

The economics of this are relatively simple.  In the US, producers will have to absorb lower margins on the small percentage of shale gas that is used as ethane feed into the cracker.  Similarly in Europe, refinery-integrated producers will have to absorb lower margins on the small percentage of oil that is used as naphtha feed into the cracker.

As the chart shows, this development will be good news for ethylene consumers.  As Huntsman CEO, Peter Huntsman noted a year ago:

“There is a wave of ethylene that is going to be hitting the North American markets quite substantially over the next couple of years. I’d rather be a spot buyer than a contract buyer. I can’t imagine with all of the ethylene that is going to be coming to the market that it’s not going to be a buying opportunity.”

In turn, of course, this will pressure other plastics via inter-polymer competition

Non-integrated producers clearly face more difficult times.  And like the integrated producers, they share the challenge being posed by the rise of sustainability concerns, particularly over the 8 million tonnes of plastic that currently finds its way into the oceans every year.

This issue has been building for years, and clearly consumers are now starting to demand action from brand owners and governments.

In turn, this opens up major new opportunities for companies who are prepared to realign their business models with the New Plastics Economy concepts set out by the Ellen MacArthur Foundation and the World Economic Forum.

The New Plastics Economy is a collaborative initiative involving leading participants from across the global plastic packaging value chain, as the second chart illustrates.  It has already prompted action from the European Union, which has now set out its EU Strategy for Plastics in the Circular Economy.  This aims to:

“Transform the way plastics and plastics products are designed, produced, used and recycled. By 2030, all plastics packaging should be recyclable. The Strategy also highlights the need for specific measures, possibly a legislative instrument, to reduce the impact of single-use plastics, particularly in our seas and oceans.”

Clearly this represents a paradigm shift for the industry, both producers and consumers.

It may seem easier to do nothing, and to hope the whole problem will go ahead.  But the coincidence of the arrival of all the new US shale gas capacity makes this an unlikely outcome.  Companies who do nothing are likely instead to become Losers in this rapidly changing environment.

But as I discuss in the interview, companies who are prepared to rethink their business models, and to adapt to changing consumer needs, have a potentially very bright future ahead of them.  Please click here to view it.

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Goodbye to “business as usual” model for plastics

Polymer markets face two major challenges in coming months. The most immediate is the arrival of the major US shale gas-based ethylene and polyethylene expansions. The longer-term, but equally critical challenge, comes from growing public concern over plastic waste, particularly in the ocean.

The EU has set out its vision for a new plastics economy, where:

“All plastic packaging is reusable or recyclable in a cost-effective manner by 2030”.

Similarly, China has launched a ‘War on Pollution’, which has already led to all imports of plastic waste being banned.

Together, these developments mean there is unlikely to be a “business as usual” option for producers or consumers. A paradigm shift is under way which will change business models.

Some companies will focus on being low-cost suppliers, integrated back to the well-head or refinery. Others will become more service-led, with their revenue and profits based on exploiting the value provided by the polymer (virgin or recycled), rather than just the value of the virgin polymer itself.

The next 18 months are therefore likely to see major change, catalysed by the arrival of the new US production, as I discuss in a new analysis for ICIS Chemical Business.

The second chart indicates the potential impact of these new capacities by comparison with actual production since 2000, with 2019 volume forecast on basis of the planned capacity increases. But can this new PE volume really be sold? It certainly won’t all find a home in the US, as ExxonMobil Chemicals’ then President, Stephen Pryor, told ICIS in January 2014:

The domestic market is what it is and therefore, part of these products, I would argue, most of these products, will have to be exported”.

And unfortunately for producers, President Trump’s new trade policies are unlikely to help them in the main potential growth market, China. As John Richardson and I noted a year ago, China’s $6tn Belt and Road Initiative:

“Creates the potential for China to lead a new free trade area including countries in Asia, Middle East, Africa and potentially Europe – just as the US appears to be withdrawing from its historical role of free trade leadership”.

The task is also made more difficult by the inventory-build that took place from June onwards as Brent oil prices rose 60% to peak at $71/bbl. As usual, buyers responded by building inventory ahead of price increases for their own raw materials. Now they are starting to destock again, slowing absolute levels of demand growth all around the world, just at the moment when the new capacity comes online.

SUSTAINABILITY CONCERNS ARE DRIVING MOVES TOWARDS A CIRCULAR ECONOMY
At the same time, the impact of the sustainability agenda and the drive towards the circular economy is becoming ever-stronger.  The initial catalyst for this demand was the World Economic Forum’s 2016 report on ‘The New Plastics Economy’, which warned that on current trends, the oceans would contain more plastics than fish (by weight) by 2050 – a clearly unacceptable outcome.

Last year’s BBC documentary Blue Planet 2, narrated by the legendary Sir David Attenborough, then catalysed public concern over the impact of single use plastic in packaging and other applications. Even Queen Elizabeth has since announced that she is banning the use of plastic straws and bottles across the royal estates, as part of a move to cut back on the use of plastics “at all levels”.

Single use plastic applications in packaging are likely to be an early target for the move to recycling and the circular economy. This will have a major impact on demand, given that they currently account for more than half of PE demand:

    • Two-thirds of all low density and linear low density PE is used in flexible packaging – a total of 33 million tonnes worldwide
    • Nearly a quarter of high density PE is used in packaging film and sheets, and a fifth is used in injection moulding applications such as cups and crates – a total of 18 million tonnes worldwide

Virtually all of this production is potentially recyclable. Producers and consumers who want to embrace a more service-based business model therefore have a great opportunity to take a lead in creating the necessary infrastructure, in conjunction with regulators and the brand owners who actually sell the product to the end-consumer.

Please click here to read the full analysis in ICIS Chemical Business.

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West’s household spending heads for decline as population ages and trade war looms

As promised last week, today’s post looks at the impact of the ageing of the BabyBoomers on the prospects for economic growth.

The fact that people are living up to a third longer than in 1950 should be something to celebrate.  But as I noted in my Financial Times letter, policymakers are in denial about the importance of demographic changes for the economy.

Instead, their thinking remains stuck in the past, with the focus on economists such as Franco Modigliani, who won a Nobel Prize for “The Life Cycle Hypothesis of Savings”, published in 1966.  This argued there was no real difference in spending patterns at different age groups.

Today, it is clear that his Hypothesis was wrong.  He can’t be blamed for this, as he could only work with the data that was available in the post-War period.  But policymakers should certainly have released his theories were out of date.

The chart highlights the key issue, by comparing average US and UK household spending in 2000 v 2017:

  • In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, and 12.5m in the UK.  They spent an average of $62k and £33.5k each ($2017/£2017)
  • There were 36m US households headed by someone in the 55-plus New Older cohort, and 12.4m in the UK, who spent an average of $45k and £22.8k each
  • In 2017, the number of Wealth Creator households was almost unchanged at 66m in the US and 11.9m in the UK.  Their average spend was also very similar at $64k and £31.9k each
  • But the number of New Older householders had risen by 55% in the US, and by 24% in the UK, and their average spend was still well below that of the Wealth Creators at $51k and £26.4k respectively

Amazingly, despite this data, many policymakers still only see the impact of today’s ageing Western populations in terms of  likely increases in pension and health spending.  They appear unaware of the fact that ageing populations also impact economic growth, and that they need to abandon Modigliani’s Hypothesis.

As a result, they have spent trillions of dollars on stimulus policies in the belief that Modigliani was right.  Effectively, of course, this means they have been trying to “print babies” to return to SuperCycle levels of growth.  The policy could never work, and did not work.  Sadly, therefore, for all of us, the debt they have created can never be repaid.

This will likely have major consequences for financial markets.

As the chart from Ed Yardeni shows, company earnings estimates by financial analysts have become absurdly optimistic since the US tax cut was passed.

The analysts have also completely ignored the likely impact of China’s deleveraging, discussed last month. 

And they have been blind to potential for a global trade war, once President Trump began to introduce the populist trade policies he had promised in the election.  Last week’s moves on steel and aluminium are likely only the start.

Policymakers’ misguided faith in Modigliani’s Hypothesis and stimulus has instead fed the growth of populism, as the middle classes worry their interests are being ignored. This is why the return of volatility is the key market risk for 2018.

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Global smartphone sales slide 9% in Q4, as China tumbles 16%

Global smartphone sales have seen major growth until recently as consumers fell in love with going mobile, as the chart shows:

  • In the critical Q4 period they jumped from 290m in 2013 to 380m in 2014, 405m in 2015 and 439m in 2016
  • But they then fell 9% in Q4 last year, according to Strategy Analytics data.  They note that:

“It was the biggest annual fall in smartphone history (and) …. was caused by a collapse in the huge China market, where demand fell 16% annually due to longer replacement rates, fewer operator subsidies and a general lack of wow models.”

Even more revealing was that only Xiaomi of the Top 5 vendors increased their volume. Apple lost 1m sales, Samsung lost 3m, Huawei lost 4m, whilst even OPPO only managed to maintain its volume.  And Xiaomi only did well because they were recovering from their 2016 collapse, when their share crashed to just 3.35% from 5% in Q4 2015.

Chinese companies were, however, the real winners during 2017 as the price war intensified, as the second chart confirms:

  • China’s top 3 vendors now supply a quarter of the global market – compared to less than a tenth in 2013
  • Samsung have been the main loser, with their share falling from over a third of the market to less than a fifth
  • They did well to recover from the Galaxy Note 7 problems, but seem unlikely ever to reclaim their dominance

The rise of the Chinese vendors is great news for consumers, but very bad news for their competitors, as the third chart confirms.  It highlights how revenues are now being squeezed for most vendors as the Chinese ramp up their volume.  Only Apple has avoided the carnage by heading defiantly up-market, with its average handset price now close to $800.

The issue is the very different nature of the smartphone market in the major emerging economies, where incomes are much lower than in the West and it is very rare for carriers to subsidise handset sales over the life of the contract.  In India, for example, the typical smartphone sells for less than $200, whilst Apple has less than 2% of the market.

2017 therefore marked a crucial turning point in the market, as I forecasted when reviewing 2016 data a year ago:

“The issue is that 3.1bn people now own smartphones, and the other 4.2bn can’t afford them. So inevitably, the market is going to focus more and more on price. Of course, millions of people will still want to own an iPhone or Galaxy. But price will become the deciding feature for many people.”

2018 seems likely to see pricing pressure intensify, now that the Chinese market has gone ex-growth.  India is likely to be a critical battleground after Xiaomi’s success there in 2017, which was key to its nearly doubling global sales.  As analysts IDC noted:

“Brands outside the Top 5 struggled to maintain momentum as value brands such as Honor, Vivo, Xiaomi, and OPPO offered incredible competition at the low end.”

OPPO is likely to be particularly aggressive as it saw no growth in 2017 after doubling its sales in 2016, whilst Xiaomi is unlikely to risk a second slip-up on volume.  In turn, this makes it likely that Samsung’s mid-market positioning will come under major pressure from Chinese competition in key markets such as China and India.

Apple must now intensify its efforts to move into application-based markets such as healthcare and other services.  It has been building its position over the past 3 years, and has a vast cash-pile from its smartphone profits to fund the necessary shift away from hardware sales.  Samsung’s future looks less rosy, however, given that Chinese vendors have been able to produce smartphones for as little as $20 for the past 2 years.

And as I noted back in May 2015:

“The smartphone market is not alone is facing these New Normal challenges. They are coming to the online and High Street stores near all of us, if they haven’t already arrived.

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