The wisdom of Sir Robert Walpole, the UK’s first premier, seems the only possible response to this weekend’s headline from the Wall Street Journal. How can a National Emergency ever be the basis for a major rise in stock markets?
Of course, we all know that stock markets have become addicted to stimulus. But the problem with stimulus is that the patient needs more and more of it, to keep markets moving higher:
But the headlines surrounding the National Emergency clearly did the job as far as the High-Frequency Traders were concerned. They still dominate equity and other major markets, and Friday afternoon was exactly the kind of bumper payday that they adore.
The only problem is that neither stock markets, nor even the Federal Reserve, can cure coronavirus. And if the pandemic continues as the experts expect:
- Between 160 million and 214 million Americans will become infected
- Between 2.4 million and 21 million people could require hospitalisation
Clearly, no hospital system in the world could cope with the higher end of this range, particularly if they all come at once. And although the US system is easily the most expensive in the world, its performance is relatively poor by comparison with other major Western nations.
One key issue, of course, is testing. Nobody can know the actual size of the problem until we know how many people are already affected. And yet, as the WSJ reports from the President’s speech on Friday:
“By early next week, Mr. Trump said, there would be a half-million additional tests available, with 5 million tests available within a month.”
By comparison, China already has the capacity to do 1.7 million tests a week, according to the World Health Organisation.
This, of course, is why the experts are talking about trying to ‘delay’ the pandemic, rather than ‘contain’ it, as the chart based on US Centers for Disease Control and Prevention analysis (interpreted by Vox) confirms.
The US lack of a proper social support system is also a major disadvantage. Around 34 million American workers have no access to paid sick leave, for example, and 27 million don’t have health insurance. These people may well feel they have to keep working even if infected in order to pay the rent.
Hopefully, the new support package agreed on Friday night will help solve these problems. But who knows how long it will take to actually roll out the measures, and how many people will benefit?
The essence of populism, of course, is that it supplies simple answers to complex problems. And coronavirus is likely to prove a classic case of this weakness in action:
- Experts suggest the virus will keep returning unless ‘herd immunity’ can be established
- They estimate this means around 60% of the population therefore need to be infected
Data from China and Italy confirms that the main risk from coronavirus is to people over the age of 70, as the chart shows. The CDC also recommend that people with serious chronic medical conditions such as heart disease, diabetes and lung disease need to take special precautions.
But their voice is being drowned out. People are understandably frightened, and they need wise and well-informed leaders to give them clear messages. Leaders should be focused on aiming to manage the pandemic and on taking the obvious steps to protect those most vulnerable. Unfortunately, the opposite is happening as former UK Finance Minister, Lord Darling has noted:
“There is a striking lack of global cooperation in dealing with coronavirus”.
The issue is that effectively closing down large parts of the economy in response to coronavirus is a very high risk strategy:
- Millions of businesses could well go bankrupt around the world, and tens of millions lose their jobs
- And as watchdog the Institute of International Finance already warned on Thursday:
“Global growth is potentially approaching 1% this year (anything below 2.5% is essentially recession). The multitude of shocks in the system now risks a global “sudden stop”. Falling oil prices potentially accelerate mounting credit stress in the US. Vulnerable emerging markets are already seeing large outflows”.
Friday saw Wall Street celebrating its latest “fix” of easy money. But as Bloomberg also noted:
“For context, this was the S&P 500’s best day since Oct. 28, 2008. At the end of that day, the bottom was more than 4 months away, and there was a 29% fall before hitting the intraday low.”
We may well all come to regret, as we wring our hands in the summer, that the bells rang too soon.
Four serious challenges are on the horizon for the global petrochemical industry as I describe in my latest analysis for ICIS Chemical Business and in a podcast interview with Will Beacham of ICIS.
The first is the growing risk of recession, with key markets such as autos, electronics and housing all showing signs of major weakness. Central banks are already talking up the potential for further stimulus, less than a year after they had tried to claim victory for their post-Crisis policies.
Second is oil market volatility, where prices raced up in the first half of last year, only to then collapse from $85/bbl to $50/bbl by Christmas, before rallying again this year. The issue is that major structural change is now underway, with US and Russian production increasing at Saudi Arabia’s expense.
Third, there is the unsettling impact of geo-politics and trade wars. The US-China trade war has set alarm bells ringing around the world, whilst the Brexit arguments between the UK and European Union are another sign that the age of globalisation is behind us, with potentially major implications for today’s supply chains.
And then there is the industry’s own, very specific challenge, shown in the chart. Based on innovative trade data analysis by Trade Data Monitor, it highlights the dramatic impact of the new US shale gas-based cracker investments on global trade in petrochemicals.
The idea is to capture the full effect of the new ethylene production across the key derivatives – polyethylene, PVC, styrene, EDC, vinyl acetate, ethyl benzene, ethylene glycol – based on their ethylene content. Even with next year’s planned new US ethylene terminal, the derivatives will still be the cheapest and easiest way to export the new ethylene molecules.
The cracker start-ups were inevitably delayed by the hurricanes in 2017. But if one compares 2018 with 2016 (to avoid the distortions these caused), there was still a net increase of 1.7 million tonnes in US ethylene-equivalent trade flows.
This was more than 40% of the total production increase over the period, as reported by the American Chemistry Council. And 2019 will see further major increases in volume with 4.25 million tonnes of new ethylene capacity due to start-up, alongside full-year output from last year’s start-ups.
The problem is two-fold. As discussed here in 2014 (ICB, US boom is a dangerous game, 24-30 March), it was never likely that central bank stimulus policies could actually return demand growth to the levels seen in the Boomer-led SuperCycle from 1983-2000:
“Shale gas thus provides a high-profile example of how today’s unprecedented demographic changes are creating major changes in business models. Low-cost supply is no longer a guarantee of future profitability.”
This was not a popular message at the time, when oil was still riding high at over $100/bbl and the economic impact of globally ageing populations and collapsing fertility rates were still not widely understood. But it has borne the test of time, and sums up the challenge now facing the industry.
Please click to download the full analysis and my podcast interview with Will Beacham.
There were only two winners from the past 3 months of OPEC’s “Will they?, Won’t they?” debate on output cutbacks.
Iran wasn’t one of them – although the talks did emphasise its renewed ability to control the OPEC agenda. Nor was Saudi Arabia, forced to accept the lion’s share of the proposed cutbacks.
Instead, the US shale producers were big winners, with some saying they were “dancing in the streets of Houston” when the “deal” was announced last week. Who can blame them, given that production costs according to Pioneer now range between $2.15/bbl – $12.27/bbl in the vast Permian Basin field.
But the really big winners were the owners of the futures markets. As the head of the NYMEX commodities business boasted – “the OPEC talks have been great for our business“. Looking at the data, one can see what he means:
More than 1.7 million contracts traded just on Brent futures on ICE last Wednesday
Each contact represents 1000 barrels, so that is an astonishing 1.7bn barrels of oil – around 18x daily production
The NYMEX WTI contract traded 2.4m contracts – around 26x daily production
In total, therefore, volume on the major Western futures markets was a record 44x daily production
And, of course, last week was no exception in highlighting the dominance of the futures market is setting oil prices. As the chart above shows, their trading volume has rocketed since the central banks began their stimulus programmes. It averages nearly 12x physical volume so far this year, versus just 3x in 2006 – and just 1x in 1996.
As one observer rightly noted, the trading had all the signs of a buying frenzy. For in the real world, it is highly unlikely that the production agreement will achieve its promised goals:
Russia has never, ever, participated in an OPEC quota, and is very unlikely to actually cut production this time
Equally important is that OPEC production itself is likely to rise as Nigerian and Libyan output continues to recover
And, of course, oil inventories are already at record levels, and will likely rise further as production increases in the USA, Brazil, Canada and Kazakhstan
Unsurprisingly, most of the selling was being done by producers, delighted at being able to hedge their output into 2019. They sold so much, the forward curve moved from being in contango (where tomorrow’s price is higher than today’s), to backwardation (where tomorrow’s price is lower than today’s). This confirms that analyst talk of shortages and cutbacks is pure wishful thinking.
Even more worrying for the oil bulls is that the rise in the US$ is also reducing demand in the major Emerging Markets. Oil is priced in US$, and this has risen by 10% or more against many currencies in the past few months. And any recession in 2017, which seems likely based on the chemical industry outlook, will further weaken demand.
But the OPEC meeting did highlight one critical development. For the first time since the 1980s, Saudi Arabia sided with OPEC in terms of agreeing cutbacks. This has only happened twice before in history – during the 1973/4 Arab Oil Boycott, and the 1979/85 Oil Crisis.
Both times, Saudi was worried that its critical Oil-for-Defence deal with the USA might not deliver promised support:
In 1973, President Nixon was facing impeachment over the Watergate scandal, and the Arab world was up in arms over US support for Israel in the Yom Kippur War
In 1979, President Carter was facing defeat in his re-election bid, and the Iran hostage issue meant US support again became unreliable
Today, the 1945 pact between President Roosevelt and King Saud (pictured above) is effectively dead. President-elect Trump no longer sees the USA as the “leader of the free world”, and it is most unlikely that he would send military support to Saudi if it was attacked. The fact that the US is now on the way to becoming energy self-sufficient by 2021 means it has no real need for Saudi oil any more, as I suggested 2 years ago:
”Suddenly the Saudis face a critical question – does the US still need the 1.3 million barrels/day they supplied in 2013?
And if not, will the US still be prepared to defend Saudi from attack, as it did during the first Gulf War in 1990-1991?
This is the question that keeps senior Saudi officials and Ministers awake at nights in Riyadh”
This the New Normal world in action. Old certainties are disappearing, and we do not yet know what will replace them.
New data from the International Monetary Fund confirms that last year’s collapse in global GDP was even worse than first reported.
As the chart shows,the fall when measured in current dollars was a record $4.7tn, versus $3.3tn in 2009. And it was 6% in percentage terms versus 5.3% in 2009:
- Even more worrying is that the IMF have now revised down their 2016 outlook
- They now expects GDP this year to be just $0.8tn higher than in 2015 – only 1%
- And they don’t now expect GDP to recover to the 2014 level until 2018 at the earliest
This highlights the headwinds now hitting the economy as we arive at the “demographic cliff“. The World Bank’s country director for Indonesia, Rodrigo Chaves, noted this week:
“No country becomes rich after it gets old. The rate at which you grow [with] a whole bunch of old people on your back is much lower than the rate of growth at which you can grow when people are active, are educated, are healthy.”
This is simple common sense, of course. But the IMF and most policymakers still refuse to accept the obvious conclusion – that an ageing global population cannot possibly grow at the same rate, as when everyone was in the peak Wealth Creator 25 – 54 age group. The problem with their obstinacy is two-fold:
- It means they persist in adding more stimulus, arguing that this will quickly “flush the blockages”
- It also means companies are encouraged to invest in extra capacity, for which there is no market
That is why the US is now spending $164bn on building new shale gas-based petrochemical capacity. Producers were assured by policymakers that growth would return to previous levels. So they felt they did not need to obtain binding “letters of intent” from potential customers. The result, sadly, is that next year will likely see major over-capacity.
It is not too late to rescue the situation. It just needs companies and investors to abandon their reliance on policymakers’ guidance. It is 8 years since the Crisis began, and clearly their policies have failed to produce the promised results. Instead, we all have to focus on developing new areas of growth, as I discussed on Friday.
The critical issue is that we have now returned to the demand-led markets that predominated before the SuperCycle. So we need to focus on finding new customers, and on helping existing customers to grow their demand. This will require greater resources – technical and commercial – to be successful.
But doing nothing, and hoping that everything will somehow turn out alright, is becoming a certain recipe for major pain in the future as demand continues to disappoint.
Global markets are becoming ever more complex as the Great Unwinding of stimulus policies continues. This means that each blog post is now taking much longer to write. It therefore seems sensible to focus on writing 3 posts each week – on Monday, Wednesday and Friday – in order to continue to provide the highest possible quality of analysis.
It is exactly a year since I forecast that the Great Unwinding of stimulus policies was about to begin:
- Brent oil prices were then at $104/bbl and had been above $100/bbl level for over 3 years
- The US$ index against the world’s major currencies was at 81, continuing its 30-year downtrend since 1985
Last Friday, as the chart shows, Brent oil prices were 54% lower at $49/bbl, and the US$ Index was 19% higher at 96.
These are massive moves over such a short space of time. Most worryingly, it seems that most commentators never even dreamt that they could take place. Thus it is only very recently that the consensus has begun to accept that oil prices might stay “lower for longer”. Even China’s devaluation last week appeared to come as a complete shock to most experts. This highlights the problems caused by policymakers’ refusal to accept that demographic change is creating a New Normal world.
Global debt has risen by $57tn since 2007 to $199tn, as they tried to restore growth to the SuperCycle levels seen when the BabyBoomers were in their peak income and spending period. In the process, they destroyed the price discovery mechanism in most major financial markets. In turn, of course, this means that most people under the age of 40 have never known a world where markets fulfilled their fundamental role of balancing supply and demand.
Over the past year, however, markets have begun to rediscover their role. Oil prices have therefore been falling, and the US$ has been rising. And this process will likely continue. As the International Energy Agency reported last week, “global supply continues to grow at a breakneck pace“. As a result, it suggests that “2H15 sees supply exceeding demand by 1.4 mb/d, testing storage limits worldwide”.
US markets are already waking up to reality, with storage tanks at the key Cushing terminal expected to overflow within 2 months. And already the force majeure at BP’s Whiting refinery has caused Western Canada Select crude to trade at just $22.75/bbl on Friday. Brent prices are also weakening, of course, as Iraq production hits record levels and Iran prepares to return to the market – at a time when Chinese and Asian demand is slowing fast.
I therefore doubt that it will be too long before Brent prices hit my forecast level of $30/bbl. And they will quite possibly go much lower, due to the long-term surpluses that have now developed in all major energy sources – coal, gas and oil. This will create great opportunities for those who are light on their feet. But it will also create major challenges for those who cling to the idea that policymakers and the consensus know best.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 52%
Naphtha Europe, down 51%. “Asian arbitrage window closed because of high freight rates”
Benzene Europe, down 48%. “Supply is expected to lengthen into September, with improved cracker operating rates and lower downstream production”
PTA China, down 41%. “The traditional pick-up in demand between August and September had also not been seen so far”
HDPE US export, down 27%. “Domestic export prices dropped during the week as suppliers and producers lowered prices to keep their ties open to international markets.”
¥:$, down 21%
S&P 500 stock market index, up 7%
I spent most of last week in New York and Boston, meeting with major investors. One key topic on all their agendas was the major downturn underway in the global mining industry. The connection with my visit was that some have already begun to worry that the planned US ethylene expansions may lead to a similar outcome.
The reason is that mining companies were a few years ahead of the US in rushing to boost their capacity by record amounts. They were convinced that China’s growth would be sustained at double-digit levels forever. Now they are paying the price. As the Financial Times reports:
“Commodity prices roared up during the past decade because of voracious demand from China, which single-handedly transformed the mining industry. But prices have come down virtually across the board as China’s economic growth has slowed, and the country moved away from a multi-year construction boom.”
Equally sobering is the assessment of Mark Cutifani, chief executive of leading company, Anglo American,
“It is a pretty tough market. The news from China hasn’t been good . . . It has deteriorated more than we expected and we think it is going to be tougher in the next six months“.
Investors are now worrying they may have encouraged US ethylene producers to make the same mistake:
- They are currently helping to fund a 40+% increase in US ethylene capacity, at an estimated cost of $145bn
- Yet as the chart above shows, the US has been unable to raise its demand above the levels of 10 years ago
- Ethylene, PVC, styrene and ethylene glycol output peaked in 2004, and polyethylene output peaked in 2007
Equally worrying is that net exports of ethylene’s major derivative, polyethylene, have been in decline since 2009, as the second chart based on data from Global Trade Information Services confirms,
Investors are also worried that many of these investments are apparently proceeding without the security of signed off-take contracts, backed by major bank guarantees. This also mirrors developments in the mining industry, where euphoria over the outlook for China was the key driver.
These concerns are now being brought into sharp focus by the renewed weakness in crude oil prices since the Iran nuclear deal was finalised. Investors are now concerned that if this decline continues, a return to lower oil prices could remove today’s US cost advantage versus other regions. China’s stock market collapse adds to their concern.
These developments highlight the way that investors’ rose-tinted glasses led to them falling in love with the shale gas story, just as they had with mining. They had encouraged both industries to expand by bidding up share prices for the companies involved, and rushing to provide the necessary finance. Now they are realising, too late, that different Scenarios were also possible.
There is, of course, no easy escape from the current commitments, given the up-front costs that have already been incurred. But the example of the mining industry suggests cancellation may well end up being the lowest cost option in the long run.