China’s used cars put a dent in global industry

China is now developing a used car market for the first time in its history.  This means the end of global auto sales growth, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

Autos Top 7 Aug17

China’s car market has been key to the recovery in global auto sales growth since 2009, as the chart shows.

Its passenger car sales in the first half of each year have risen threefold between 2007 and 2017, from 3.1m to 11.3m today, while sales in the other top six markets have only just managed to recover to 2007 levels.

But now major change is coming to China’s market from two directions.

The first sign of change is the fact that H1 sales rose just 2.7% this year. This is the lowest increase since our records began in 2005 (when sales were just 1.8m), and compares with an 11% rise last year.

Official forecasts for full-year growth have also been revised down, to between 1% and 4%, by the manufacturers’ association. A further sign of the slowdown is the rise in price discounting, with Ford China suggesting prices were down 4% on average in the first half.

The second change may be even more important from a longer-term perspective. It seems likely that China’s used car market is poised for major growth. As the second chart shows, only 10m used cars were sold last year, versus 24m new cars.

Yet used car sales are typically between 2 and 2.5 times new car sales in other large markets such as the US, where 2016 saw 39m used car sales versus 18m new car sales.

China autos Aug17The background to this unusual situation is that China’s new car sales were relatively small until the government’s stimulus programme began in 2009. Their quality was also poor, as most cars were produced domestically and only lasted an average of three years. As a result:

 The auto market only really began to take off in 2009 under the influence of the stimulus packages, when annual new car sales jumped 53% from 6.7m to 10.3m. About 200m Chinese were able to drive a car in that year, and the stimulus programme suddenly provided them with the cash to buy one
 Used car sales were much slower to develop, as it took time for the introduction of western manufacturing techniques to gradually extend the average life of a car from 3 years in 2012 to 4.5 years today. But now the pace of change is rising, and it is expected to reach 10 years by 2020

The chart also shows our forecasts for the used car market out to 2020, when we expect used car sales to equal new car sales at 23.5m. This would still only represent a 1x ratio, but the forecast is in line with a new report from Guangzhou-based analysts Piston, who told WardsAuto:

“The used-car market in China is expected to have an explosion in the coming decade, because the ratio of used to new is [the opposite of that in] the US.

One sign of the change under way was seen last month, when Guazi.com, China’s largest used car trading site, was able to raise a further $400m from investors to expand its service.

Guazi, like BMW and others, have seen that the used car market offers very favourable prospects for growth prospect — as long as attention is paid to boosting buyer confidence by providing sensible warranties and service packages.

Local governments have also played their part under pressure from central government. The state-owned China Daily reports that 135 local authorities have now removed barriers that prevented used cars from one province being sold in another. The effect of these changes is having an effect, with used car sales in January-May jumping 21% versus 2016.

Such strong growth rates, and the slowdown in new car sales, suggest China’s auto market may have reached a tipping point.

All good things come to an end eventually, and it seems prudent to assume that China will no longer be the main support for global auto sales. We expect China’s new car sales to plateau because of the combined impact of the end of stimulus (as discussed here in June), and the rise of used car sales, as these will inevitably cannibalise their volumes to some extent.

Clearly this is not good news for those western manufacturers that have made China the focus of their growth plans in recent years. And there may be worse news in store, given the government’s determination to combat urban pollution by promoting sales of electric vehicles and car-sharing.

Yet it will be good news for those prepared to develop new, more service-related business models. Used-car sales themselves can be highly profitable, while servicing and spare parts supply are likely to become equally attractive opportunities.

Paul Hodges publishes The pH Report.

Oil price weakness will unmask reflation and recovery myth

Brent Jun17Oil markets have been at the centre of the recent myth that economic recovery was finally underway.  The theory was that rising inflation, caused by rising oil prices, meant consumer demand was increasing.  In turn, this meant that the central banks had finally achieved their aim of restoring economic growth via their zero interest rate policy.

This theory was first undermined in 2014, when oil prices began their fall.  There had never been a shortage of oil. Prices rose to $125/bbl simply because the hedge funds saw commodities like oil as a ‘store of value’ against the Federal Reserve’s policy of weakening the dollar.

The theory sounded attractive and plenty of people had initially made a lot of money from believing it.  But it didn’t mean that the global economy had recovered.  And by August 2014, as I highlighted at the time, oil prices were starting to collapse under the weight of excess supply.  As I also suggested in the same post, this meant “major oil price volatility is now likely”.  By luck or judgement, this has indeed since occurred, as the chart shows:

□  The 2009 – 2014 rally was dominated by “technical trading”, as oil markets lost their role of “price discovery”
□  August – December 2014 then saw prices crash to $45/bbl
□  Prices rose nearly 50% in early 2015 in a “failed rally”, as hedge funds assumed prices would quickly recover
□  Prices then halved to $27/bbl in January 2016 as the reality of over-supply swamped the market
□  Since then prices have doubled as OPEC combined with the hedge funds to try and push prices higher
□  This rally now seems to have failed, as US shale supply continues to increase

In reality, as I discussed last month, this final rally merely enabled new US production to be financed.  The US oil rig count has doubled over the past year, and each rig is now 3x more productive than in 2014.  At the same time, the medium-term outlook for oil demand in the key transport sector is becoming more doubtful, with China and India both now moving towards Electric Vehicles as a way of reducing their high levels of air pollution.

A measure of how far the market has moved was seen at last week’s Clean Energy Ministerial meeting, which:

“Set a collective aspirational goal for all EVI members of a 30% market share for electric vehicles (EVs) by 2030. It does so with the aim of taking advantage of the multiple benefits offered by electric mobility for innovation, economic and industrial development, energy security, and reduction of local air pollution.”

Already oil price targets, even amongst the optimists, are now being revised downwards.  Nobody now talks about a “quick return” to $100/bbl, or even to $70/bbl.  Instead the hope is that possibly they might return to $60/bbl at some point in the future – others merely hope that today’s $50/bbl level can be maintained.

Inflation Jun17Hope, however, is not a strategy.  And in the absence of major geopolitical disruption, it seems likely that the hedge funds will continue to withdraw from the market and leave supply/demand fundamentals to once again set the price. In turn, this will challenge the reflation and recovery myth that grew up whilst the funds were boosting their bets on the oil and commodity markets.

As the second chart shows, inflation has already begun to weaken in China as well as in the US and Eurozone economies.  China’s move away from stimulus will help to accelerate this move in H2, In turn, markets will likely return to worrying about deflation once more.

Japan is an excellent indicator of this development.  Its inflation rate completely failed to take off despite the major rise in oil and other commodity prices. As I have long argued, Japan’s ageing population means that its previous demographic dividend has now been replaced by a demographic and demand deficit.

The US and Eurozone economies are both going through the same process.  10k Americans and 18k Europeans have been retiring every day since 2011 as the BabyBoomer generation reaches the age of 65.  They already own most of what they need, and their incomes generally suffer a major hit as they leave the workforce.

Companies and investors therefore need to prepare for a difficult H2.  The failure of the latest oil price rally, and the return of deflation worries, will puncture the myth that reflation and economic recovery are finally underway.  Political stalemate will increase, until policymakers finally accept that demographics, not central banks, drive demand.

Oil prices under pressure as US oil/product exports ramp up

US oil exports May17

On Monday, I discussed how OPEC abandoned Saudi Oil Minister Naimi’s market share strategy during H2 last year.

Naimi’s strategy had stopped the necessary investment being made to properly exploit the new US shale discoveries. But this changed as the OPEC/non-OPEC countries began to talk prices up to $50/bbl. As CNN reported last week:

Cash is pouring into the Permian, lured by a unique geology that allows frackers to hit multiple layers of oil as they drill into the ground, making it lucrative to drill in the Permian even in today’s low prices.”

  Private equity poured $20bn into the US shale industry in Q1
  Major oil companies were also active, with ExxonMobil spending $5.6bn in February

US oil/product inventories have already risen by 54 million barrels since January last year and are, like OECD inventories, at record levels. And yet now, OPEC and Russia have decided to double down on their failing strategy by extending their output quotas to March 2018, in order to try and maintain a $50/bbl floor price. US shale producers couldn’t have hoped for better news.   As the chart shows:

  US inventories would be even higher if the US wasn’t already exporting nearly 5 million barrels/day of oil products
  It is also exporting 500 kb/d of oil since President Obama lifted the ban in December 2015
  Nobody seems to pay much attention to this dramatic about-turn as they instead obsess on weekly inventory data
  But these exports are now taking the fight to OPEC and Russia in some of their core markets around the world

None of this would have happened if Naimi’s policy had continued.  Producers could not have raised the necessary capital with prices below $30/bbl.  But now they have spent the capital, cash-flow has become their key metric.

US rigs May17The second chart confirms the turnaround that has taken place across the US shale landscape, as the oil rig count has doubled over the past year. Drilling takes between 6 – 9 months to show results in terms of oil production, and so the real surge is only just now beginning.  Equally important, as the Financial Times reports, is that today’s horizontal wells are far more productive:

“This month 662 barrels/d will be produced from new wells in the Permian for every rig that is running there, according to the US government’s Energy Information Administration. That is triple the rate of 217 b/d per rig at the end of 2014.”

Before too long, the oil market will suddenly notice what is happening to US shale production, and prices will start to react.  Will they stop at $30/bbl again? Maybe not, given today’s record levels of global inventory.

As the International Energy Agency (IEA) noted last month, OECD stocks actually rose 24.1mb in Q1, despite the OPEC/non-OPEC deal. And, of course, as the IEA has also noted, the medium term outlook for oil demand has also been weakening as China and India focus on boosting the use of Electric Vehicles.

The current OPEC/non-OPEC strategy highlights the fact that whilst the West has begun the process of adapting to lower oil prices, many oil exporting countries have not.  As Nick Butler warns in the Financial Times:

“Matching lower revenues to the needs of growing populations who have become dependent on oil wealth will not be easy. It is hard to think of an oil-producing country that does not already have deep social and economic problems. Many are deeply in debt.

“In Nigeria, Venezuela, Russia and even Saudi Arabia itself the latest fall, and the removal of the illusion that prices are about to rise again, could be dangerously disruptive. The effects will be felt well beyond the oil market.”

US Permian’s shale oil surge highlights OPEC’s failed strategy

Pioneer May17
OPEC and Russia made a massive mistake last November when when they decided to try and establish a $50/bbl floor for world oil prices.  And now they have doubled down on their mistake by extending the deal to March 2018. They have ignored 4 absolutely critical facts:

  Major US shale oil producers were already reducing production costs below $10/bbl, as the Pioneer chart confirms
  The US now has more oil reserves than Saudi Arabia or Russia, with “Texas alone holding more than 60bn barrels
  At $30/bbl, US producers couldn’t raise the capital required to exploit these newly-discovered low-cost reserves
  But at $50/bbl, they could

Former Saudi Oil Minister Ali Naimi understood this very well.  He also understood that OPEC producers therefore had to focus on market share, not price, as Bloomberg reported:

“Naimi, 79, dominated the debate at OPEC’s November 2014 meeting, according to officials briefed on the closed-door proceedings. He told his OPEC counterparts they should maintain output to protect market share from rising supplies of U.S. shale oil.”

Permian rigs May17Naimi’s strategy was far-sighted and was working.  The key battleground for OPEC was the vast Permian Basin in Texas – its Wolfgang field alone held 20bn barrels of oil, plus gas and NGLs. By January 2016, oil prices had fallen to $30/bbl and the Permian rig count had collapsed, as the second chart confirms:

  Naimi had begun his price war in August 2014, and reinforced it at OPEC’s November 2014 meeting
  Oil companies immediately began to reduce the number of highly productive horizontal rigs in the Permian basin
  The number of rigs peaked at 353 in December 2014 and there were only 116 operating by May 2016

But then Naimi retired a year ago, and with him went his 67 years’ experience of the world’s oil markets.  Almost immediately, OPEC and Russian oil producers decided to abandon Naimi’s strategy just as it was delivering its objectives.  They thought they could effectively “have their cake and eat it” by ramping up their production to record levels, whilst also taking prices back to $50/bbl via a new alliance with the hedge funds, as Reuters reported:

“OPEC and some of the most important hedge funds active in commodities reached an understanding on oil market rebalancing during informal briefings held in the second half of 2016…. OPEC effectively underwrote the fund managers’ bullish positions by providing the oil market with detail about output levels and public messaging about high levels of compliance”.

This gave the shale producers the window of opportunity they needed.  Suddenly, they could hedge their production at a highly profitable $50/bbl – and so they could go to the banks and raise the capital investment that they needed.

As a result, the number of rigs in the Permian Basin has nearly trebled.  At 309 last week, the rig count is already very close to the previous peak.

The Permian is an enormous field. Pioneer’s CEO said recently he expects it to rival Ghawar in Saudi Arabia, with the ability to pump 5 million barrels/day. It is also very cheap to operate, once the capital has been invested.  And it is now too late for OPEC to do anything to stop its development.

On Thursday, I will look at what will likely happen next to oil prices as the US drilling surge continues.

 

London follows Paris with city-wide electric vehicles and car sharing

EU autos Jun15Greek auto sales have been racing ahead in recent weeks.  They are up 16% so far this year, as people seek ways to protect their money in the event of Greece leaving the euro.  April saw the strongest rise, with sales up an astonishing 47% versus 2014.  As The Telegraph noted:

“People living in a country gripped by financial turmoil often worry about the security of their money. If it’s in a bank, it can be caught up in capital controls or lost through insolvency. Better, then, to spend it. And the purchase of choice is often a car.”

Ironically, the main winners from this are German car makers, as Greeks buy more German cars than any other brand.

Across the reset of the continent, the picture is more mixed.  As ACEA comment:

  • France (‐3.5%) and Germany (‐6.7%) faced a downturn, whilst Spain (+14.0%), Italy (+10.8%) and the UK (+2.4%) saw positive growth
  • But demand was largely supported by the EU’s new members, especially Poland (+11.0%) and the Czech Republic (+17.6%)

In terms of the top 5 major manufacturers, only Renault showed an increase over the month, up 5%.  And this was despite increased discounts by majors such as Ford (14%) and Fiat (16%) in key markets such as Germany.

Overall growth is also slowing, as the chart above confirms.  Sales so far in 2015 are up 6.8%, but May was only up 1.3%.  And the market continues to highlight the change underway in consumer preferences.  Thus the biggest gainer has been sales of the Mercedes Smart car.  Designed for cities, its sales were up 84% in May, and 56% so far this year after an updated 2-seater version, and a new 4-seater model went on the market.

Meanwhile, my own London borough has joined Paris’ fight against diesel engines, charging a £96 ($150) premium for its street parking permit.  And an even bigger campaign is about to get underway, as London seeks to boost electric vehicles and car-sharing across the city:

  • The city plans to spend £100m to boost the use of electric vehicles and car sharing across the capital
  • The model is Paris,where 220k drivers now use its Autolib scheme – taking 31k private cars off the road
  • Cost, and the need to reduce air pollution are the key drivers

This is a big win for French company Bollore, which has pioneered this experiment in Paris and has now won the London contract.  It highlights how markets are moving towards a more service-led mentality, and away from a simple product focus.  As Bollore note:

”Lots of people aged 18 to 25 are using the cars to go out for the evening with their friends. They might use them to go to a nightclub, dinner or the theatre…. We expect London to be bigger than Paris. It won’t be quite the same as Paris as English people are different but we have four years’ experience in Paris and that will help us.”

Their success highlights the opportunities now being created as we move slowly but steadily into the New Normal.

Companies and investors who seize these opportunities will do very well – unfortunately, at the expense of those who cling to the supply-driven and product-based strategies of the past.