The End of “Business as Usual”

In my interview for Real Vision earlier this month, (where the world’s most successful investors share their thoughts on the markets and the biggest investment themes), I look at what data from the global chemical industry is telling us about the outlook for the global economy and suggest it could be set for a downturn.

“We look at the world and the world economy through the lens of the chemical industry. Why do we do that? Because the chemical industry is the third largest industry in the world after energy and agriculture. It gets into every corner of the world. Everything in the room which you’ll be watching this interview is going to have chemicals in it. And the great thing is, we have very good, almost real time data on what’s happening.

“Our friends at the American Chemistry Council have data going back on production and capacity utilization since 1987. So 30 years of data, and we get that within 6 to 8 weeks of the end of the month. So whereas, if you look at IMF data, you’re just looking at history, we’re looking at this is what’s actually going on as of today.

“We look, obviously, upstream, as we would call it, at the oil and feedstocks markets, so we understand what’s happening in that area. But we also– because the chemical industry is in the middle of the value chain, you have to be like Janus. You have to look up and down at the same time, otherwise one of these big boys catches you out.

“And so we look downstream. And we particularly look at autos, at housing, and electronics, because those are the big three applications. And of course, they’re pretty big for investors as well. So we see the relative balance between what’s happening upstream, what’s  happening downstream, where is demand going, and then we see what’s happening in the middle of that chain, because that’s where we’re getting our data from.

“As the chart shows, our data matches pretty well to IMF data. It shows changes in capacity utilization, which is our core measurement. If if you go back and plot that against history from the IMF, there is very, very good correlation. So what we’re seeing at the moment– and really, we’ve been seeing this since we did the last interview in November— is a pretty continuous downturn.

“One would have hoped, when we talked in November, we were talking about the idea that things have definitely cooled off. Some of that was partly due to the oil price coming down. Some of that was due to end of year destocking. Some of that was due to worries about trade policy. Lots of different things, but you would normally expect the first quarter to be fairly strong.

“The reason for this is that the first quarter– this year, particularly– was completely free of holidays.  Easter was late, so there was nothing to interrupt you there. There was the usual Lunar New Year in China, but that always happens, so there’s nothing unusual about that.

And normally what happens is, that in the beginning of the new year, people restock. They’ve got their stock down in December for year end purposes, year end tax purposes, now they restock again. And of course, they build stock because the construction season is coming along in the spring and people tend to buy more cars in that period, and electronics, and so on.

“So everything in the first quarter was very positive. And one wouldn’t normally be surprised to start seeing stock outs in the industry, particularly after a quiet period in the fourth quarter. And unfortunately, we haven’t seen any of that. We’ve seen– and this is worth thinking about for a moment– we’ve seen a 25% rise in the oil price because of the OPEC Russia deal, but until very recently we haven’t seen the normal stock build that goes along with that.”

 

As we note in this month’s pH Report, however, this picture is now finally changing as concern mounts over oil market developments – where unplanned outages in Venezuela and elsewhere are adding to the existing cutbacks by the OPEC+ countries. Apparent demand is therefore now increasing as buyers build precautionary inventory against the risk of supply disruption and the accompanying threat of higher prices.

In turn, this is helping to support a return of the divergence between developments in the real economy and financial markets, as the rise in apparent demand can easily be mistaken for real demand. The divergence is also being supported by commentary from western central banks.  This month’s IMF meeting finally confirmed the slowdown that has been flagged by the chemical industry since October, but also claimed that easier central bank policies were already removing the threat of a recession.

We naturally want to hope that the IMF is right. But history instead suggests that periods of inventory-build are quickly reversed once oil market concerns abate.

Please click here if you would like to see the full interview.

US-China tariffs could lead to global Polyethylene price war

I was interviewed on Friday about the likely impact of President Trump’s trade wars on the global chemical industry by Will Beacham, deputy editor of ICIS Chemical Business. His interview is below.

The introduction on Friday of trade tariffs by China and the US is the first step in a trade war that could turn into a global polyethylene (PE) price war as the wave of new US production is sent to new markets, likely Europe.

Paul Hodges, chairman at London-based International eChem, said that around 6m tonnes/year of new US PE capacity has to find a home and, with China largely out of reach, the obvious destination would be Europe, where the surplus production will put downward pressure on prices there and around the world.

“The main hit from a trade war is going to be the US PE expansions – clearly it is being targeted so the opportunity to export to China is sharply reduced,” said Hodges.  “But this won’t just be a US problem because they will still want to move their product – it has got to come to Europe as there is no surplus demand in Asia, the Middle East or Latin America.”

He added that this first wave of tariffs were a wake-up call to those who thought globalisation was going to continue as it did in the past.  “We have reached a tipping point where we have to expect that trade wars are more rather than less likely”, he said.

“If you assume the US production will come onstream, then where will those 6m tonnes of product go? It can’t go to China, it can’t go to Latin America as that is too small a market, the Middle East is in surplus, Africa is too small – so Europe is the only place,” said Hodges.

US PE producers that are integrated up to the wellhead need to extract ethane in order to monetise their gas production:

  • These producers will continue to export happily at whatever price because essentially the ethane is a distressed product and has to be sold
  • However, non-integrated players’ margins could come under pressure.

In Europe, there is a parallel to the US, said Hodges, as regional production is generally tied into refineries.

Naphtha is a relatively small part of the product flow from a refinery, so prices can go down quite a long way before you start to think about cutting back on refinery operating rates.

“The risk for the second half of this year and 2019 is that you have two heavyweights in the boxing ring – one integrated back to the gas wellhead in the US and the other refinery-integrated in Europe – and people get squeezed in between,” he added.

EUROPE VALUE CHAINS
Hodges pointed out that if cracker operating rates decline in Europe it will hit all the other product streams such as propylene, butadiene (BD) and pygas. There are tremendous knock-on risks across all the value chains, not just ethylene.

“This won’t happen this year, but if it continues and gets worse over the next 12-18 months, do you start to look at cracker shutdowns in Europe? What will the implications be for people relying on those crackers for feedstocks?” said Hodges.  “It’s a hornet’s nest of unintended consequences: people don’t send a ship load of PE to Europe expecting it to shut down a PP plant.”

Hodges urged the industry to make contingency plans now to manage these future risks.  European producers will have to think about how they protect feedstock supplies for value chains on a Europe-wide and country basis so that pipelines are not shut down.

“You’d have to focus on a number of core hubs and reinvest in those to give the infrastructure you need for the future. You need to do it now – while there is time to take action,” he said.  “You might end up spending money you don’t need to spend, but that’s much better than waking up and realising you don’t have a feedstock supply,” he said.

According to ICIS data, the US is forecast to export a total of 1.37m tonnes of low density polyethylene (LDPE), high density polyethylene (HDPE) and low linear density polyethylene (LLDPE) to China (see LLDPE map above).  Although HDPE is not included in the current tariffs, it could be added later, according to Hodges.

He added that a price war in PE would impact other polymers because of inter-polymer competition.  It may only be 5-10% that is substituted, but to lose that amount of volume at the margin would be quite significant.

He described the trade war as a paradigm shift for the whole global industry as the era of globalisation switches to regional and nationalism.  “I’m worried that a lot of people in this industry have grown up with globalisation and they assume that is how it is,” he said.

Trade policy and geopolitics are like a chess game with lots of moving pieces and the approach is that you give up something in order to gain more, he added. This has been a very successful approach by the US since the Second World War, when it implemented the Marshall Plan or ‘European Recovery Plan’.  Almost the equivalent of $110bn in today’s money was invested to rebuild the continent.

“This boosted the European economy in order to make it a bigger import market for US exports. Trade expands opportunities and the overall economy. There may be some short-term successes going into a trade war but ultimately the US economy will lose,” Hodges conclude.

The post US-China tariffs could lead to global Polyethylene price war appeared first on Chemicals & The Economy.

Plastics demand is peaking as circular economy arrives

Plastic waste Jul17The Stone Age didn’t end because we ran out of stones.  Similarly, coal is being left in the ground because we no longer need it any more.  And the same is happening to oil, as Saudi Arabia recognised last year in its Vision 2030:

“Within 20 years, we will be an economy that doesn’t depend mainly on oil“.

And so now the debate is moving on, to products such as plastics that are made from oil.

The move began several years ago with the growing concern over plastic bags.  Consumers decided they no longer wanted to live in a world filled with waste bags.  Now, in a landmark new Study*, the debate is evolving to focus on the question of ‘What happens to plastic after we have used it?’   As the chart shows:

  The world has produced 8.3bn tonnes of plastic over the past 60 years
  Almost all of it, 91% in fact, has since been thrown away, never to be used again
  But it hasn’t simply disappeared, as plastic takes around 400 years to degrade
  Instead, the Study finds, 79% is filling up landfills or littering the environment and “at some point, much of it ends up in the oceans, the final sink

Nobody is claiming that this waste was created deliberately.  Nobody is claiming that plastics aren’t incredibly useful – they are, and they have saved millions of lives via their use in food packaging and other critical applications.  The problem is simply, ‘What happens next?’  As one of the Study authors warns:

“We weren’t aware of the implications for plastic ending up in our environment until it was already there. Now we have a situation where we have to come from behind to catch up.

RT Jul17
The good news is that potential solutions are being developed.  As the video shows, Recycling Technologies, for example (where I am a director), is now trialling technology that will recycle end-of-life plastic into virgin plastic, wax and oils.  Other companies are also hard at work on different solutions.  And more and more effort is focused on finding ways of removing plastic from the sea, as I noted last year:

 “95% of plastic packaging material value is currently lost after just a short first-use cycle
  By 2050, there will be more plastics in the ocean than fish by weight, if current policies continue
  Clearly, this state of affairs cannot be allowed to continue.”

SUSTAINABILITY IS REPLACING GLOBALISATION AS A KEY DRIVER FOR THE ECONOMY
But there is another side to this debate that is just about to move into the headlines.  That is the simple question of “How do we stop putting more and more plastic into the environment?”  Cleaning up the current mess is clearly critically important.  But the world is also starting to realise that it needs to stop creating the problem in the first place.

As always, there are a number of potential solutions potentially available:

  The arrival of 3D printing dramatically reduces the volume of plastic needed to make a finished product.  It operates on a very efficient “additive basis”, only using the volume that is needed, and producing very little waste
  Digitalisation offers the opportunity to avoid the use of plastics – with music, for example, most people today listen via streaming services and no longer buy CDs made of plastic
  The ‘sharing economy’ also reduces demand for plastic – new business models such as car-sharing, ride hailing and autonomous cars enable people to be mobile without needing to own a car

The key issue is that the world is moving to adopt the principles of the circular economy as the Ellen MacArthur Foundation notes:

“Underpinned by a transition to renewable energy sources, the circular model builds economic, natural and social capital.”

This paradigm shift clearly creates major challenges for those countries and companies wedded to producing ever-increasing volumes of plastic.  OPEC has an unpleasant shock ahead of it, for example, as its demand forecasts are based on a belief that:

“Over one-third of the total demand increase between 2015 and 2040 comes from the road transportation sector (6.2 mb/d). Strong growth is also foreseen in the petrochemicals sector (3.4 mb/d)”

They are forgetting the basic principle that, “What cannot continue forever, won’t continue“.  After all, it took just 25 years for cars to replace horses a century ago.  More recently, countries such as China and India went straight to mobile phones, and didn’t bother with landlines.  And as I noted last year, underlying demand patterns are also now changing as a result of today’s ageing populations:

  In the BabyBoomer-led SuperCycle, the growing population of young people needed globalisation in order to supply their needs. And they were not too worried about possible side-effects, due to the confidence of youth
  But today’s globally ageing populations do not require vast new quantities of everything to be produced. And being older, they are naturally more suspicious of change, and tend to see more downside than upside

Services Jul17Of course, change is always difficult because it creates winners and losers.  That is why “business as usual” is such a popular strategy.  It is therefore critically important that companies begin to prepare today to be among the winners in the world of the circular economy. As we all know:

There is no such thing as a mature industry, only mature firms. And industries inhabited by mature firms often present great opportunities for the innovative”.

As the 3rd chart shows, the winners in the field of plastics will be those companies and countries that focus on using their skills and expertise to develop service-based businesses.  These will aim at providing sustainable solutions for people’s needs in the fields of mobility, packaging and other essential areas. The losers will be those who bury their heads in the sand, and hope that nothing will ever change.

 

* The detailed paper is in Science Advances, ‘Production, use, and fate of all plastics ever made

The world of $100/bbl oil is unlikely to return

GU 31Jan15Chemical markets are continuing to signal that the world faces major economic challenges in 2015.  The chart above highlights developments since August, when I first forecast that oil prices would see major falls, and that the value of US$ would see ”a strong move upwards“:

  • Benzene, always my favourite indicator for industrial output, has suffered worst, down 56% (green)
  • Brent oil is down 53%, despite major buying by financial and physical players trying to ‘catch a falling knife’ (blue)
  • Naphtha, the major raw material for gasoline and petrochemical production is also weak, down 50% (black)
  • PTA. the raw material for polyester, confirms the weakness of China’s economy, and is down 44% (red)
  • Next we see the recent rapid collapse of US export prices for polyethylene, now down 26% (orange)
  • Then there is the weakness of the Japanese yen versus the US$, down 15% (brown)
  • And finally, there is the US S&P 500 Index, which has managed a 2% gain over the period (purple)

It is not hard to develop a narrative to explain these extraordinary movements.  Oil prices had been kept artificially high by the US Federal Reserve’s money-printing, which drove financial investors to buy oil futures as a ‘store of value’.

This effort had been supported by China’s vast stimulus, which created the illusion that the country had suddenly become middle class by Western standards overnight.  But since the summer, the growing impact of President Xi’s ‘New Normal’ has exposed this myth.

Yet even today, the vast majority of commentators are still arguing that oil prices – for some yet to be discovered reason – will soon return to the $100/bbl level.  This is very dangerous thinking, as it is delaying the necessary process of adapting to the real world of the New Normal.

The insights of double Nobel Prizewinner, Prof Daniel Kahneman can, however, explain what is happening:

  • The first issue is the one of anchoring, where the human brain relates to a number – and then judges subsequent developments in relation to this.  Kahneman has authored a fascinating YouTube video to demonstrate this process in action – it lasts just 1 minute 50 seconds, and is well worth the time spent
  • The second is our natural desire to make snap judgements.  Our ancestors had no time, if suddenly finding themselves alone in a cave with an angry bear, to sit and analyse the situation.  Today’s Twitter phenomenon, and the widespread use of sound-bites, continues this tradition

So everything combines to create the illusion that $100/bbl is normal and natural, as it has been the price since 2011.

Oil price Feb15Yet if we move from fast and intuitive thinking (Kahneman’s “System 1″) to a slower and more analytical mode (his “System 2′), we would immediately realise as the above chart shows, that high oil prices are exceptional, not normal.

 

WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:

Benzene Europe, down 58%. “sentiment in the European market remained sluggish amid ample availability”
Brent crude oil, down 53%
Naphtha Europe, down 50%. “market is tighter on certain grades following a pick-up in transatlantic and Asian demand, and good petrochemical utilisation in Europe”
PTA China, down 44%. ”operating rates were slowly lowered with the approach of the Lunar New Year holiday.”
¥:$, down 15%
HDPE US export, down 26%. “Domestic export prices kept falling during the week, in sync with dropping ethylene and energy market values.”
S&P 500 stock market index, up 2%

Why did nobody else forecast that the oil price would collapse?

Brent Nov14aBrent oil prices closed at $104.71/bbl on Friday 15 August.  On the following Monday morning, I published the first post in my Great Unwinding series, arguing that:

The Great Unwinding of the failed stimulus policies since 2008 has now begun…oil markets are starting to follow cotton and other commodities in refocusing on the fundamentals of supply and demand”.

A week later on Wednesday 27 August, I published the 2nd post in the series, under the title “Oil prices break out of their triangle – downwards“.   Brent prices had closed at $104.24/bbl the previous night.  And in the post, I explained why I thought prices were certain to fall, and forecast:

Logic would suggest they will fall to at least the 200-day exponential moving average, currently around $70/bbl, and probably lower”.

Last Friday night, as the chart shows, Brent prices closed at $70.15/bbl.

Of course, I am pleased that my forecast proved correct.

But I am greatly concerned that, as far as I am aware, I was the only commentator who gave due warning back in August (when there was still time to take mitigating action), that prices were just about to collapse.

This leads me to ask what seems to be a critically important question, namely: “Why did nobody else see this coming”?  And even more importantly, “Why did all the analysts and industry experts argue so strongly through September and October that I was wrong?” 

They have a great burden on their shoulders today.  At the very least, they owe their clients and the media a heartfelt apology for their colossal mistake.  They also need to explain why they were so wrong, and what they are doing to change their approach for the future.  This would be considered normal in any other industry:

  • They assured companies that it was impossible for prices to fall below $100/bbl
  • Investors in pension and hedge funds also put their cash to work on this basis
  • Now, all this money has been lost

Globally, companies and investors will have lost $bns as a result.  Some businesses may even go bankrupt, having believed the conventional wisdom that said such a collapse was impossible.

The scale of this failure demands an explanation, and a commitment to learn from the mistakes that have been made.

OUR ‘GREAT UNWINDING’ RESEARCH NOTE IS STILL AVAILABLE
If you would like to download our Research Note containing the full series of Great Unwinding posts, please click here. 

I also hope you will consider subscribing to our new ‘pH Report’.  It aims to guide clients through the Great Unwinding of policymaker stimulus now underway.

We hope it will build on our track record of being one of the few to forewarn of the 2008 financial crisis.

WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:

Benzene Europe, down 34%. “The outlook for the rest of 2014 is decidedly bearish. Downstream demand is limited due to inventory destocking ahead of year-end”
Naphtha Europe, down 32%. “Naphtha supply is still seen as long in Europe on high refinery run rates”
Brent crude oil, down 28%
PTA China, down 25%. ”Prices largely fell, despite production cutbacks in December.”
¥:$, down 16%
HDPE US export, down 5%. “US export prices began to drop during the week, though trading was thin because of the upcoming holiday”
S&P 500 stock market index, up 6%

Shell, Bayer, Tullow to speak at World Aromatics conference

BrusselsNext month’s World Aromatics and Derivatives Conference in Brussels has a range of top-name speakers discussing key issues for the markets.

Co-organised as always with ICIS, it features:

Shell:  Global strategy manager Herbert Le Lorrain will present Shell’s new scenarios for the future, ‘Mountains and Oceans’

Bayer MaterialScience: New procurement head Christian Buhse will provide his first impressions of global benzene and toluene markets

Tullow Oil: Oil marketing manager Ben Holt will share the insights of this fast-growing company on the crude oil market

Styrolution:  Global product manager Brian Torrez will outline challenges and opportunities for the styrene market

Equipolymers: Commercial Director Antonello Ciotto will describe how the PET industry is meeting new requirements from brand managers

Avestra: CEO Adam Popov will provide an overview of Russia’s phenol/acetone market developments

In addition, Andrew Horncastle of leading consultants Booz & Co will describe the impact of latest refining industry developments on the aromatics markets.  Whilst Stewart Hardy of industry experts Nexant will review the outlook for the paraxylene chain.

The blog will also present two papers.  ‘Life as a by-product’ will look at the benzene outlook.  Whilst ‘Aromatics and Derivatives in the New Normal’ will discuss how age range and income levels will be key to future industry success.

Sponsored by Integra, the Conference has become a key event for the global industry, and provides an ideal networking opportunity.  Please click here for registration, and the full agenda.