Brexit letter means end of “business as usual” for the UK

UK exports Apr17The UK economy set off into the Great Unknown on Wednesday, when premier Theresa May officially notified the European Union of the UK’s intention to leave (Brexit) by the end of March 2019.  In response, the EU released its draft guidelines for the negotiations:

   “The first phase of the negotiations should aim to agree on a divorce settlement on the rights and obligations of the UK.  It would have the goal of providing as much clarity and legal certainty as possible to citizens, businesses, stakeholders and international partners on the future
   “Once that political criteria is met, the EU would be open to talk about a future framework”

Critically, the guidelines confirm that the details of a future relationship and trade deal will only be discussed once the UK has left.  They also suggest that the terms of trade could be very different from today:

The future relationship as such can only happen when the UK becomes a third country“:

“Any future trade deal cannot amount to being a member of the single market.  It must ensure a level playing field in terms of competition and state aid, and must encompass safeguards against unfair competitive advantages through, inter alia, fiscal, social and environmental dumping.”

“Any future agreement will need to be ratified by national parliaments, which could take up to two years.  Therefore, the guidelines foresee a transitional phase to “bridge” the time between the divorce settlement and when the UK leaves the bloc in 2019, and a future trade deal, which can only be negotiated in detail when the UK is already out.

“Any such transitional arrangements must be clearly defined, limited in time, and subject to effective enforcement mechanisms.”

As I discussed in September, this means that the UK’s trade options – given its “third country” status – are now very limited.  Theresa May has already ruled out continued membership of the Single Market and Customs Union, and refused to accept the jurisdiction of the European Court of Justice.  Therefore, the only 2 options available from March 2019 are a Canadian-type deal, or a fall-back to World Trade Organisation (WTO) rules.

Critically, these alternatives mean there is no “business as usual” option.

Optimists had hoped that nothing would really change post-Brexit.  But today it is clear that the EU, like any club, will not allow non-members to have the same benefits as members. Instead, companies and investors are going to have to learn to live with growing uncertainty as the clock ticks down to March 2019

   A new free trade agreement (FTA) for goods and services might be finalised quickly after Brexit, by 2020-2021
   But it might take much longer, say to 2025 – Canada’s own deal, after all, took 7 years to finalise
   Spain’s move to link a deal to agreement on a new status for Gibraltar might make it impossible to do a deal
   Other EU members might follow, making Brexit a Pandora’s Box with trade held hostage to political issues

We can all hope for the best, but hope is not a strategy.  It therefore seems prudent to assume, as a base case, that the UK will be operating on the basis of WTO rules from March 2019.  It certainly won’t have any FTA deals in place outside the EU by then, given that the UK can’t start to negotiate these until Brexit takes place.

This is not good news as the chart from the Financial Times confirms, given that 50% of all UK goods’ exports and nearly 45% of services’ exports go to the EU:

   The WTO has arbitrary tariffs such as 10% for cars, 7% for plastics, 16% for cereals and 36% for dairy products
   These will increase costs for UK consumers, and reduce the UK’s competitive position in EU and other markets
   In many industries such as chemicals, products move in and out of the UK as part of global supply chains
   Almost inevitably, therefore, companies will start planning to relocate back into the EU, to avoid the tariff

This is the Great Unknown in action, and it will create Winners and Losers.  Winners will plan for a very uncertain future, and create options which will enable them to profit from whatever developments take place.  Losers will bury their heads in the sand, and refuse to prepare for any change.

On Thursday, I will look in more detail at Brexit’s likely impact on the UK consumer, which adds further complications to an already uncertain outlook.

2015 operating rates confirm chemical industry slowdown

ACC OR Feb16

Financial markets are becoming more and more chaotic, with prices regularly moving by 1% per cent or more in a day.  Prices have also started to suffer sharp reverses of direction within a day, as talk of new stimulus competes with the reality of mounting supply gluts.  These developments are classic red flags, warning of a potential major change in direction.  They also highlight the impact of the Great Unwinding of policymaker stimulus, as markets return to their core role of price discovery based on the fundamentals of supply and demand.

Commodity markets are the immediate cause of this chaos, as their collapse creates increasing numbers of forced sellers.  Speculators facing margin calls have been joined by sovereign wealth funds, needing to raise cash quickly so that their governments can pay the bills.  If the ratings agencies are correct, we will soon see bankruptcies and defaults intensify the downward pressure.

As always, chemical company utilisation rates have proved an excellent leading indicator for these developments. Sadly, as the chart shows, latest data from the American Chemistry Council gives no sign of any major improvement taking place:

  • December saw rates at 81.7%, marginally down from 81.9% in December 2014
  • The average rate for 2015 fell to 81.7% from 82.3% in 2014
  • The average rate since the Crisis began in 2009 is 82.8%, versus 91.3% in the period to 2008

Individual regions saw a mixed performance in December:

  • N America was up 2% versus 2014, and Latin America was down 2%
  • W Europe was up 3.4% as consumers rushed to buy, expecting an oil price rise that failed to happen
  • E Europe was up 8.2% as Russian volumes jumped 11% with the weaker rouble
  • The Middle East/Africa was up 5%, and Asia up 4.8% – with China up 4.8% on lower imports

January will probably show a weaker performance, as consumers had to run down higher -price inventory bought in the pre-Christmas panic.  This month will also be slow, due to Lunar New Year, and March will be affected by Easter.

Of course, the central banks will keep talking of new stimulus.  But in the real world, more and more people have decided that stimulus simply increases the debt-load, and does nothing to increase underlying growth.  Chemical industry data doesn’t lie, and clearly shows that the post-2008 strategy simply doesn’t work.

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 68%
Naphtha Europe, down 66%. “Naphtha crack slips deeper into negative territory, closed arbitrages drag naphtha down”
Benzene Europe, down 59%. “There was some confusion about what was driving the upward movement towards the end of the week. Some sources believed that the market was simply following crude oil movements, while others cited stronger demand from the Mediterranean.”
PTA China, down 46%. “Restocking of cargoes were just about finished, with most companies expected to stop business activities from next week due to the Lunar New Year holidays”
HDPE US export, down 42%. “Domestic prices for export held steady, though there were reports of slightly lower prices by a penny or so.”
¥:$, down 14%
S&P 500 stock market index, down 4%

2015 operating rates confirm chemical industry slowdown

ACC OR Feb16

Financial markets are becoming more and more chaotic, with prices regularly moving by 1% per cent or more in a day.  Prices have also started to suffer sharp reverses of direction within a day, as talk of new stimulus competes with the reality of mounting supply gluts.  These developments are classic red flags, warning of a potential major change in direction.  They also highlight the impact of the Great Unwinding of policymaker stimulus, as markets return to their core role of price discovery based on the fundamentals of supply and demand.

Commodity markets are the immediate cause of this chaos, as their collapse creates increasing numbers of forced sellers.  Speculators facing margin calls have been joined by sovereign wealth funds, needing to raise cash quickly so that their governments can pay the bills.  If the ratings agencies are correct, we will soon see bankruptcies and defaults intensify the downward pressure.

As always, chemical company utilisation rates have proved an excellent leading indicator for these developments. Sadly, as the chart shows, latest data from the American Chemistry Council gives no sign of any major improvement taking place:

  • December saw rates at 81.7%, marginally down from 81.9% in December 2014
  • The average rate for 2015 fell to 81.7% from 82.3% in 2014
  • The average rate since the Crisis began in 2009 is 82.8%, versus 91.3% in the period to 2008

Individual regions saw a mixed performance in December:

  • N America was up 2% versus 2014, and Latin America was down 2%
  • W Europe was up 3.4% as consumers rushed to buy, expecting an oil price rise that failed to happen
  • E Europe was up 8.2% as Russian volumes jumped 11% with the weaker rouble
  • The Middle East/Africa was up 5%, and Asia up 4.8% – with China up 4.8% on lower imports

January will probably show a weaker performance, as consumers had to run down higher -price inventory bought in the pre-Christmas panic.  This month will also be slow, due to Lunar New Year, and March will be affected by Easter.

Of course, the central banks will keep talking of new stimulus.  But in the real world, more and more people have decided that stimulus simply increases the debt-load, and does nothing to increase underlying growth.  Chemical industry data doesn’t lie, and clearly shows that the post-2008 strategy simply doesn’t work.

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 68%
Naphtha Europe, down 66%. “Naphtha crack slips deeper into negative territory, closed arbitrages drag naphtha down”
Benzene Europe, down 59%. “There was some confusion about what was driving the upward movement towards the end of the week. Some sources believed that the market was simply following crude oil movements, while others cited stronger demand from the Mediterranean.”
PTA China, down 46%. “Restocking of cargoes were just about finished, with most companies expected to stop business activities from next week due to the Lunar New Year holidays”
HDPE US export, down 42%. “Domestic prices for export held steady, though there were reports of slightly lower prices by a penny or so.”
¥:$, down 14%
S&P 500 stock market index, down 4%

Market volatility jumps as Great Unwinding continues

GU 13Apr15

As I have feared, major volatility is developing in financial and chemical markets, as the Great Unwinding of policymaker stimulus continues.  The chart above shows the dramatic increase in the benchmark portfolio since the Unwinding began in mid-August:

  • There was very little volatility from January until August, with prices generally remaining within +/- 10%
  • Volatility then exploded, with prices for Brent oil (blue line), naphtha (black) and benzene (green) falling 50% within a matter of weeks
  • Prices for PTA (red) in China fell 40%, whilst US export prices for HDPE (orange) fell 20%
  • The value of the Japanese yen (brown) also fell nearly 20%
  • And even though the US S&P 500 Index (purple) appears stable, it moved >1% on nearly one-third of trading days in Q1 this year – twice the volatility seen in 2014

The issue, of course, is that markets are no longer anchored by previous certainties.

They still believe central banks will never let stock markets fall – and New York Fed Chairman Bill Dudley duly rushed to support the S&P 500 last week after the weak jobs report.  But in the wider world outside stock markets, companies and investors are not so certain.  Oil markets provide a good example of the contrary views on offer:

  • Shell’s $70bn bid for BG is based on the belief oil prices will return to $90/bbl by 2017
  • The latest forecast from the US Energy Information Agency is for $59/bbl in 2015 and $70 in 2016
  • Goldman Sachs cut their forecast in January from $80/bbl to $42/bbl for 2015, and are now at $40/bbl
  • Citibank and myself both believe over-supply and weak demand will cause prices to fall below $30/bbl

BASF typify the uncertainly surrounding this key issue.  CEO Kurt Bock forecasts prices at $60/bbl – $70/bbl, but cautions that:

Oil and raw material prices are volatile, as are currencies; the emerging markets are growing more slowly; and the global economy is being damped by geopolitical conflict.”

Companies and investors clearly cannot avoid taking a view on the issue.  And the difference between the forecasts is vast in terms of future profitability.

One way to resolve this impasse might be to test strategies against the 3 Scenarios I proposed in my 2015-17 Outlook last November, Budgeting for the Cycle of Deflation.  This could help avoid the risk of an unpleasant surprise in the future.

 

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 46%. “Slight upward movement over the course of the week, with some cracker turnarounds and recent exports on benzene and pygas helping to balance out regional supply”
Brent crude oil, down 45%
Naphtha Europe, down 41%. “Activity remains low after the Easter holidays with demand for gasoline blending seen to be weak
PTA China, down 34%. “Overall polyester demand in Asia was described as largely flat, with majority of buyers sitting on ample inventories.”
HDPE US export, down 23%. “Prices held steady because of ongoing logistical problems in Houston.”
¥:$, down 17%
S&P 500 stock market index, up 8%

Hedge funds moving away from ‘buy on the dips’ strategy

Brent Mar15aIn recent years, financial markets have believed that “everything is for the best in this best of all possible worlds“.  Good news has taken markets higher.  So has bad news – as investors assume policymakers will apply more stimulus.

As a result, a whole generation of managers and analysts has grown up without having to learn the fundamentals of supply/demand analysis.  And many of those in the older generation have gone bankrupt, as a result of failing to understand that central bank liquidity has destroyed markets’ prime role of price discovery.

But now the Great Unwinding of these central bank policies is underway.  And last week’s developments in oil markets provided a classic example of the bumpy ride now ahead, as investors adjust to the world of the New Normal.

1.  Saudi reaffirmed its market share policy.  Last weekend saw a clear statement by Saudi Arabia’s Oil Minister, Ali al-Naimi, that the Kingdom did not intend to cut production to support oil prices.  Announcing that production had increased to around 10mb/d, Naimi added:

Saudi Arabia cut output in 1980s to support prices. I was responsible for production at Aramco at that time, and I saw how prices fell, so we lost on output and on prices at the same time. We learned from that mistake.”

2.  China has run out of oil storage.  On Wednesday morning, Sinopec told Reuters that:

China’s commercial and strategic oil storage is almost full, leaving little room for Asia’s top oil consumer to keep up its soaring import growth and adding downward pressure to an already oversupplied market.  China’s purchases to fill its strategic petroleum reserves was one of the main drivers of Asian demand since August of last year, with the nation’s importers buying cheap crude to fill oil tanks despite slowing economic growth.  But with storage capacities approaching their limits, China’s crude imports will likely stay flat or rise only slightly this year.

3.  US oil inventories at new record high.  On Wednesday afternoon, Reuters also reported that:

“U.S. crude inventories soared last week to extend their record build into the eleventh consecutive week.  Crude inventories rose 8.2 million barrels to  466.7 million last week, another 80-year high record, compared with analysts’ expectations for an increase of 5.1 million barrels.”

Yet on Thursday, as the chart shows, Brent prices suddenly soared by $4/bbl as Saudi launched air strikes into the Yemen. Excited analysts rushed to suggest this created a “geo-strategic premium” for prices and could mean the end of Middle East oil shipments.  This reaction highlighted the consensus view that prices will always trend higher.

Interestingly, however, Friday’s trading saw prices fall back to their starting point.

Oil positions Mar15The move thus confirms my fear that the world has a very bumpy ride ahead.  Until very recently, as the above chart shows, hedge funds have also consistently assumed that oil prices will always rise (red line).  This positioning has continued since 2006, even during the collapse of H2 2008.

US oil producers have taken the same view, with the Wall Street Journal suggesting many are effectively storing oil today by drilling thousands of wells in anticipation of higher prices, but not yet pumping from them.

The hedge fund logic has been simple, that it makes sense to ‘buy on the dips’.  But more recently, however, there are signs their thinking is finally changing.  More hedge funds are now negative on prices than ever before (green shading).  Last Thursday’s abortive rally may well cause more to rethink their positions in the future.

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 52%. “Sources are wary of crude oil pricing going forward, with building stocks in both Asia and the US likely to spark a sell-off in the coming weeks, according to some analysts. Any major shifts on crude oil would potentially have a massive impact on benzene pricing.”
Brent crude oil, down 46%
Naphtha Europe, down 39%. “Summer gasoline blending plus Asian and European petrochemical demand combined with spring refinery maintenance work have tightened prompt supply.”
PTA China, down 40%. “Excess PTA inventories in the key China markets continued to dampen market sentiment, with inventory levels likely to continue to build up in the near term.”
HDPE US export, down 23%. “US export prices remained unchanged this week”
¥:$, down 16%
S&P 500 stock market index, up 5%

US jobless dominated by Blacks, Hispanics and those without high school diplomas

US jobs Sept14Financial markets today only care about one thing – whether central banks will continue to provide more low-cost financing to support higher asset prices.  Thus markets liked last Friday’s weak US jobs report.  They hoped that the US Federal Reserve would slow its tapering process as a result.

This inverted logic explains why bad news for the real economy is seen as good news for financial markets.

But for those of us who live and work in the real economy, bad news remains bad news.  Thus it becomes important to understand why US employment has failed to recover since the Crisis began in 2008

US EMPLOYMENT CANNOT BE REDUCED VIA MONETARY POLICY
One answer lies in the number of full-time jobs, which remain 3.2 million below their 2007 peak of 123.2m.  And a key reason for this shortfall is shown in the official Bureau of Labor Studies charts above:

  • 12% of Black Americans (purple line), and 8% of Hispanics remain unemployed (green)
  • This compares with just 5% of Whites (blue) and Asians (orange)
  • 10% of those with less than a high school diploma are unemployed (blue), compared to
  • 6% of those with some degree (orange, green) and 3% of those with bachelor’s degrees (purple)

Blacks are 14% of the US population, and Hispanics are 17%.  So this racial divide in the jobs market makes it most unlikely that employment can quickly recover.  Similarly, low educational attainment cannot be changed overnight.

This, of course, is why it makes no sense for the Fed to think it can boost employment via the use of monetary policy.

Printing more money, or keeping interest rates low, will not change unemployment rates for Blacks and Hispanics.  Nor will they magically provide a college or bachelor’s degree for those who left high school without a diploma.

Sadly, today’s politicians prefer to avoid hard conversations with the electorate about these structural issues.  That would mean real debate, not sound-bites and Twitter-feeds.  Instead, they are happy to shift the headlines to central banks.

But, of course, this hands-off approach does nothing for real investors, wanting to think beyond the next quarter.  Nor does it help real companies to invest in growing markets for the future.