Sadly, my July forecast that US-China tariffs could lead to a global polyethylene price war seems to be coming true.
As I have argued since March 2014 (US boom is a dangerous game), it was always going to be difficult for US producers to sell their vastly increased output. The expansions were of course delayed by last year’s terrible hurricanes, but the major plants are all now in the middle of coming online. In total, these shale gas-based expansions will increase ethylene (C2) capacity by a third and polyethylene (PE) capacity by 40% (6 million tonnes).
ICIS pricing reports this weekend confirm my concern, following China’s decision to retaliate in response to President Trump’s $200bn of tariffs on US imports from China:
Even worse, as the chart above confirms, is that US ethane feedstock spreads versus ethylene have collapsed during 2018, from around 20c/lb to 5c/lb today. Ethane averaged 26c/gal as recently as May, but spiked to more than double this level earlier this month (and even higher, momentarily) at 55c/gal.
The issue appears to be that US producers had calculated their ethane supply/demand balances on the basis of the planned US expansions, and never expected large volumes of ethane to be exported. Yet latest EIA data shows exports doubling from an average 95kbd in 2016 to 178kbd last year. And they are still rising, with Q2 exports 62% higher at 290kbd.
The second chart from the latest pH Report adds a further concern to those of over-capacity and weak pricing power.
It focuses attention on the weak state of underlying demand. Even the prospect of higher oil prices only led to modest upturns earlier this year in the core olefins, aromatics and polymers value chains as companies built inventory. Polymers’ weak response is a particularly negative indicator for end-user demand.
This concern is supported by recent analysis of the European market by ICIS C2 expert, Nel Weddle. She notes that PE is used in packaging, the manufacture of household goods, and also in the agricultural industry and adds:
“Demand has been disappointing for many sellers in September, after a fairly weak summer. “I don’t see a big difference between now and August,” said one, “for both demand and pricing. Customers are very very quiet.” All PE grades were available, with no shortage of any in evidence.
“The market is generally quieter than many had expected, and the threat of imports from new capacities in the US looms large – particularly with the current trade spat between the US and China meaning that product may have to find a home in Europe sooner than expected.”
US producers, as would be expected, remain optimistic. Thus LyondellBasell CEO Bob Patel has suggested that:
“Trade patterns are shifting as China sources from other regions and [US producers] are shifting to markets that are vacated. Supply chains are adjusting but there is a bit of inventory volatility as a result. Where product has landed [in China] and has to be redirected, there is price volatility. But we think that is [transitory].”
But the detail of global PE trade suggests a more pessimistic conclusion. Data from Trade Date Monitor shows that China was easily the largest importer, taking a net 11.9 million tonnes. Turkey was the second largest importer but took just 1.7 million tonnes, around 14% of China’s volume. And given Turkey’s economic crisis, it is hard to see even these volumes being sustainable with its interest rates now at 24% and its currency down 60% versus the US$.
As the 3rd chart confirms, the US therefore has relatively few options for exporting its new volumes:
- Total net exports have increased 29% in January-July versus 2016, but were still only 1.8 million tonnes
- Latin America remained the largest export market at 939kt, taking 52% of total volume
- China volume had doubled to 524kt, but was only 29% of the total
- Europe was the next largest market at 369kt, up 40%, but just 20% of the total
- Other markets remain relatively small; S Africa took the largest volume in Africa at just 12kt
China’s US imports will now almost certainly reduce as the new tariffs bite. And the onset of the US trade war is likely to further boost China’s existing aim of increasing its self-sufficiency in key areas such as PE. Its ethylene capacity is already slated to increase by 73% by 2022, double the rate of expansion in 2012-2017 and from a higher base. The majority of this new volume will inevitably go into PE, as it is easily the largest derivative product.
Back in May, I used the chart above to highlight how the coming price war would likely create Winners and Losers in olefin and polymer markets. Unfortunately, developments since then make this conclusion more or less certain. I fear that complacency based on historical performance will confirm my 2014 warning about the dangers that lie ahead.
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This is the Labor Day weekend in the USA – the traditional start of the mid-term election campaign. And just as in September 2016, the Real Clear Politics poll shows that most voters feel their country is going in the wrong direction. The demographic influences that I highlighted then are also becoming ever-more important with time:
“Demographics, as in 1960 and 1980, are therefore likely to be a critical influence in November’s election:
- Median age in 1960 was just 30, and 29 in 1964. Young people are by nature optimistic about the future, believing anything can be achieved – and their support was critical for the Great Society project
- Median age was still only 30 years in 1980. The Boomers were joining the Wealth Creator 25 – 54 generation in large numbers. They were keen to join the Reagan revolution and eliminate barriers
- Today, however, median age is nearly 50% higher at 38 years, and the average Boomer is aged 61.. The candidates are not mirroring Kennedy/Johnson and Reagan/Bush in focusing on the need to remove barriers. Indeed, Trump’s signature policy is to build a wall”
2 years later, the median age is still increasing, and the average Boomer is aged 63.
But there is one major change from 2 years ago. Then, President Obama had a positive approval rating at 50.7%. But today, President Trump has a negative approval rate of 53.9%.
This has clear consequences for the likely outcome of the mid-terms, with the latest FiveThirtyEight poll suggesting the Democrats have a 3 in 4 chance of winning control of the House. In turn, of course, this increases the risk of impeachment for Trump and makes it even more difficult for him to stop the Mueller investigation. We therefore have to assume that Trump will do everything he can to reduce this risk over the next few weeks.
Americans are not alone in feeling that their country is heading in the wrong direction, as the latest survey (above) for IPSOS Mori confirms. And they have been feeling this for a long time – as I noted back in November 2016:
- “China, Saudi Arabia, India, Argentina, Peru, Canada and Russia are the only countries to record a positive feeling
- The other 18 are increasingly desperate for change“
Today Malaysia, S Korea, Serbia and Chile have moved into the positive camp. But Argentina, Peru and Russia have gone negative. And if we narrow down to the world’s ‘Top 10’ economies:
- 7 of them are negative – 53% of Italians, 59% of Americans, 63% of Japanese, 66% of Germans, 67% of British, 73% of French and 85% of Brazilians
- Only 3 are positive – 91% of Chinese, 67% of Indians and 52% of Canadians
There is a clear message here, as the median ages of the ‘Unhappy 7’ are also continuing to rise:
- Median Japanese age is 47.3 years; Italy is 45.5; Germany is 43.8; France is 41.4, Britain is 40.5; US is 38.1, (Brazil is unhappy because of economic/political chaos, and is the exception that proves the rule at 32 years)
- By contrast, China’s media age is 37.4 years, India is 27.9 (Canada is the exception at 42.2 years)
The key issue is summarised in the 3rd slide from a BBC poll, which shows that 3 out of 4 people in the world believe their country has become divided. More than half believe it is more divided than 10 years ago.
There is also a clear correlation with the demographic data:
- 35% of Japanese, 67% of Italians, 66% of Germans, 54% of French, 65% of British, 57% of Americans and 46% of Brazilians see their country as more divided than 10 years ago
- Only 10% of Chinese, 13% of Indians and 35% of Canadians feel this way
POLITICIANS ARE INCREASINGLY FOCUSED ON ‘DIVIDE AND RULE’
One might have expected that politicians would be working to remove these barriers. But the trend since 2016 has been in the opposite direction. Older people have historically always been less optimistic about the future than the young. And the Populists from both the left and right have been ruthless in exploiting this fact.
This trend has major implications for companies and investors. As long-standing readers will remember, very few people agreed with my suggestion in September 2015 that Trump could win the US Presidency and that political risk was moving up the agenda. As one normally friendly commentator wrote:
“Hodges’ predictions are relevant to companies, he says, because of the likelihood of political change leading to political risk:
- The economic success of the BabyBoomer-led SuperCycle meant that politics as such took a back seat. People no longer needed to argue over “who got what” as there seemed to be plenty for everyone. But today, those happy days are receding into history – hence the growing arguments over inequality and relative income levels
- 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
“Of course a prediction skeptic like me would say this, but 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.” (my emphasis)
Yet 3 years later, this has now happened on a major scale – impacting a growing range of industries and countries.
As the mid-term campaigning moves into its final weeks, we must therefore assume that Trump will focus on further consolidating his base vote. Further tariffs on China, and the completion of the pull-out from the Iran nuclear deal are almost certain as a result. Canada is being threatened in the NAFTA talks, and it would be no surprise if he increases the economic pressure against the US’s other key allies in the G7 countries, given the major row at June’s G7 Summit.
Anyone who still hope that Trump might be bluffing, and that the world will soon return to “business as usual”, is likely to have an unpleasant shock in the weeks ahead.
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Last week, the UK’s Foreign Secretary, its chief Brexit negotiator and several junior ministers, resigned. President Trump gave an interview attacking the UK prime minister, Theresa May, and suggesting her policies would “kill” any future trade deal with the US. And the EU 27’s main negotiator on the critical Brexit issue, Michel Barnier, warned:
“On both sides of the Channel, businesses… should analyse their exposure to the other side and be ready, when necessary, to adapt their logistical channels, supply chains and existing contracts. They should also prepare for the worst case scenario of a “no deal”, which would result in the return of tariffs under WTO rules.” (My emphasis)
It was quite a week. None of us know what may happen next, as I warned when Ready for Brexit launched last month.
WHAT ARE WTO RULES?
It is now less than 9 months until the UK officially leaves the EU on 29 March. Yet according to a ReadyforBrexit poll:
- Only around a quarter of businesses have begun to plan for what happens next
- Nearly three-quarters have so far done nothing
They could have a considerable shock ahead of them, as the Brexplainer video above explains.
Currently, the UK trades with the world on the basis of around 750 agreements negotiated by the EU. Trade between the current 28 EU members is covered by the Single Market and Customs Union. But as Barnier warns, if there is no deal agreed by 29 March, then WTO rules will apply:
- WTO rules would mean that a tax, called “Tariffs”, would be reintroduced for trade in goods between the UK and the EU27. Services, including financial services, could also be impacted by restrictions on market access
- Border controls and customs checks could add time to shipments and impact supply chains. This could be particularly important for highly regulated sectors such as chemicals
- Documentation and paperwork will increase, as businesses will need to be able to prove the nature and origin of their goods, especially if they use parts or components from several different countries
HAS YOUR BUSINESS PLANNED AHEAD FOR A ‘NO DEAL’ BREXIT?
Most major businesses have been planning for a ‘no deal’ scenario for some time:
- They are increasing warehouse space, in case deliveries are delayed
- They are checking their cash flow, as VAT could be payable up-front under WTO rules
- They are working out the possible ‘no deal’ impact in key areas such Customs & Tariffs, Finance, Legal, Services & Employment and their Supply Chain
Most smaller businesses have assumed they don’t need to do anything. Yet 29 March is now only 257 days away.
SURELY ITS CERTAIN THAT WITHDRAWAL AND TRANSITION AGREEMENTS WILL BE SIGNED?
After the Brexit vote in June 2016, the chief Brexit negotiator, David Davis, was confident that all the major trade deals would be finalised by July 2018:
“Be under no doubt, we can do deals with our trading partners, and we can do them quickly… So within two years, before the negotiation with the EU is likely to be complete, and therefore before anything material has changed, we can negotiate a free trade area massively larger than the EU.”
But by September last year, he had changed his mind and was instead warning as the Telegraph noted:
“Nobody ever pretended this would be simple or easy.”
And now, of course, Davis has resigned along with his fellow Leave campaigner, Boris Johnson.
NOBODY KNOWS WHAT WILL HAPPEN NEXT
The truth is that nobody knows what will happen next. After last week, any UK business that trades with the EU, or any EU business that trades with the UK, would be wise to start planning ahead for a ‘no deal’ WTO rules scenario:
- Have you asked your suppliers about their plans for a ‘no deal’ scenario?
- Have you asked your customers about their plans for one?
- Have you checked if your ‘just in time’ deliveries will still arrive?
- Have you checked if your insurance policies will still be valid?
As the UK’s main business organisation, the CBI, warned on Friday “It will be a make or break summer:
‘With three months left to go, it is now a race against time. The EU must now engage constructively and flexibly, as must politicians from all UK parties. This is a matter of national interest. There’s not a day to lose.’
We can all hope that negotiations are successful. But hope is not a strategy. And after the events of the last week, prudent managers now need to start start planning for ‘no deal’. Please click here to watch the Brexplainer video.
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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.
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The blog has now been running for 11 years since the first post was written from Thailand at the end of June 2007. And quite a lot has happened since then:
Sadly, although central banks and commentators have since begun to reference the impact of demographics on the economy, they have not changed their basic belief that the right combination of tax and spending policies can always create growth.
As a result, the world has become a much more complex and confusing place. None of us can be sure what will happen over the next 12 months, given today’s rising geo-political tensions.
In times of short-term uncertainly, it can be useful to take a longer-term view. It is therefore perhaps helpful to look back at Chapter 4 of Boom, Gloom, which gave “Our 10 predictions for how the world would look from 2021:
- “A major shake-out will have occurred in Western consumer markets.
- Consumers will look for value-for-money and sustainable solutions.
- Young and old will focus on ‘needs’ rather than ‘wants’.
- Housing will no longer be seen as an investment.
- Investors will focus on ‘return of capital’ rather than ‘return on capital’.
- The term ‘middle-class’ when used in emerging economies will be recognised as having no relevance to Western income levels.
- Trade patterns and markets will have become more regional.
- Western countries will have increased the retirement age beyond 65 to reduce unsustainable pension liabilities.
- Taxation will have been increased to tackle the public debt issue.
- Social unrest will have become a more regular part of the landscape.
“The transition to the New Normal will be a difficult time. The world will be less comfortable and less assured for many millions of Westerners. The wider population will find itself following the model of the ageing boomers, consuming less and saving more. Rather than expecting their assets to grow magically in value every year, they may find themselves struggling to pay-down debt left over from the credit binge.
“Companies will need to refocus their creativity and resources on real needs. This will require a renewed focus on basic research. Industry and public service, rather than finance, will need to become the destination of choice for talented people, if the challenges posed by the megatrends are to be solved. Politicians with real vision will need to explain to voters that they can no longer expect all their wants to be met via endless ‘fixes’ of increased debt.
“We could instead decide to ignore all of this potential unpleasantness.
“But doing nothing is not a solution. It will mean we miss the opportunity to create a new wave of global growth from the megatrends. And we will instead end up with even more uncomfortable outcomes.”
Most of these forecasts are now well on the way to becoming reality, and the pace of change is accelerating all the time. It may therefore be helpful to include them in your planning processes for the 2019 – 2021 period, to test how your business (and your personal life) might be impacted if they become real.
THANK YOU FOR YOUR SUPPORT OVER THE PAST 11 YEARS
It is a great privilege to write the blog, and to be able to meet many readers at speaking events and conferences around the world. Thank you for all your support.
The post The blog’s 11th birthday – and a look forward to 2021 appeared first on Chemicals & The Economy.
More people left poverty in the past 70 years than in the whole of history, thanks to the BabyBoomer-led economic SuperCycle. World Bank and OECD data show that less than 10% of the world’s population now live below the extreme poverty line of $1.90/day, compared to 55% in 1950.
Globalisation has been a key element in enabling this progress, as countries and regions began to trade with each other. But now global trade is starting to decline, as the chart from the authoritative Dutch World Trade Monitor shows:
- After a good start to 2018, February saw trade fall 0.7% in February and 1.2% in March
- The major slowdown was in Asia, particularly China, as its lending began to slow
And then on Friday, President Trump confirmed the opening of his long-planned trade wars:
- He imposed 25% import tariffs on steel and 10% on aluminium from Canada, Mexico and the European Union
- Similar tariffs were already in place on imports from China, Russia and other countries
- America’s longest standing allies have since imposed their own sanctions in retaliation
- The stage is now set for a developing global trade war as more countries join in
PRESIDENT TRUMP IS IMPLEMENTING THE POLICIES ON WHICH HE WAS ELECTED
None of this should have been a surprise, as it simply follows the agenda that President Trump set out in his Gettysburg speech just before the election. His policy proposals then, which I featured here in depth in January 2017, were crystal clear about his objectives, as the slide shows:
- Those policies marked in red are now being introduced
- Only 2 of them – around China being a currency manipulator, and infrastructure – are still to be delivered
- Yet companies, commentators and analysts have preferred to ignore the obvious
It was clear then, and is even clearer today, that Trump intends to abandon the policies followed by all post-War Republican and Democratic presidents including Eisenhower, Reagan and Clinton, and summarised in President Kennedy’s 1961 Inauguration Speech:
“To those old allies whose cultural and spiritual origins we share, we pledge the loyalty of faithful friends. United there is little we cannot do in a host of cooperative ventures. Divided there is little we can do–for we dare not meet a powerful challenge at odds and split asunder.”
As I noted after Trump’s own Inauguration Speech in January last year, he broke very explicitly with these policies:
“We assembled here today are issuing a new decree to be heard in every city in every foreign capital and in every hall of power. From this day forward, a new vision will govern our land. From this day forward, it’s going to be only America first, America first. Every decision on trade, on taxes, on immigration, on foreign affairs will be made to benefit American workers and American families.”
BAD NEWS HAS ALWAYS LED TO MORE STIMULUS IN THE PAST
Unsurprisingly, financial markets have chosen to ignore this rise in protectionism. For them, bad news is always good news, as they expect the central banks to provide more stimulus via their money-printing policies. As the left-hand chart shows of Prof Robert Shiller’s CAPE Index (Cyclically Adjusted Price/Earnings ratio) since 1881:
- When Trump took office, the ratio was already at 28.5 – above the 1901 and 1966 peaks
- Since then it has peaked at 33.3, above the 1929 peak
- Only 2000 was higher at 44, when the end of the SuperCycle coincided with the Fed’s first liquidity programme to prevent any problems with the Y2K issue
The right-hand chart confirms the bubble nature of the rally:
- It compares S&P 500 developments with the level of margin debt in the New York Stock Exchange
- Until 1985, the Fed operated on the principle of “taking away the punchbowl as the party gets going“
- Since then, it has increasingly believed, as then Fed Chairman Ben Bernanke said in November 2010
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
As a result, the S&P 500 has risen along with margin debt, which peaked at $659bn in January ($2018).
FINANCIAL MARKETS HAVE AN UNPLEASANT “SURPRISE” AHEAD AS CHINA SLOWS
It is therefore no great surprise that financial markets have continued to ignore developments in the real world.
Yet a decline in world trade, and the rise in protectionism, will inevitably produce Winners and Losers. This will be quite different from the SuperCycle, when the rise of globalisation created “win-win opportunities” for countries and regions:
- Essentially the deal was that consumers in richer countries got cheaper, well-made, products
- People in poorer countries gained paid employment for the first time in history by making these products
History also suggests President Trump will be proved wrong with his March suggestion that: “Trade wars are good and easy to win”. Like all wars, they are easy to start and increasingly difficult to end.
So far, financial markets have ignored these uncomfortable facts. They still believe that any bad news will lead to even more central bank stimulus, and a further rise in margin debt.
But as I noted last week, China – not the Fed – was in fact the major source of stimulus lending. Now its lending bubble is history, the party in financial markets is inevitably entering its end-game.
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