Chemical industry data shows reflation remains hope, not reality

ACC Jul17Western central bankers are convinced reflation and economic growth are finally underway as a result of their $14tn stimulus programmes.  But the best leading indicator for the global economy – capacity utilisation (CU%) in the global chemical industry – is saying they are wrong.  The CU% has an 88% correlation with actual GDP growth, far better than any IMF or central bank forecast.

The chart shows June data from the American Chemistry Council, and confirms the CU% remains stuck at the 80% level, well below the 91% average between 1987 – 2008, and below the 82% average since then.  This is particularly concerning as H1 is seasonally the strongest part of the year – July/August are typically weak due to the holiday season, and then December is slow as firms de-stock before Christmas.

FMs Jul17

The interesting issue is why these historically low CU% have effectively been ignored by companies and investors. They are still pouring money into new capacity for which there is effectively no market – one example being the 4.5 million tonnes of new N American polyethylene capacity due online this year, as I discussed in March.

The reason is likely shown in the above chart of force majeures (FMs) – incidents when plants go suddenly offline, creating temporary shortages.  These are at record levels, with H1 2017 seeing 4x  the number of FMs in H1 2009.

In the past, most companies prided themselves on their operating record, having absorbed the message of the Quality movement that “there is no such thing as an accident”. Companies such as DuPont and ICI led the way in the 1980s with the introduction of Total Quality Management. They consciously put safety ahead of short-term profit and at the top of management agendas. As the Chartered Quality Institute notes:

“Total quality management is a management approach centred on quality, based on the participation of an organisation’s people and aiming at long-term success.”

  Today, however, the pressure for short-term financial success has become intense
  The average “investor” now only holds their shares for 8 months, according to World Bank data
 This time horizon is very different from that of the 1980s, when the average NYSE holding period was 33 months
  And it is a very long way from the 1960s average of 100 months

As a result, even some major companies appear to have changed their policy in this critical area, prioritising concepts such as “smart maintenance”. Such cutbacks in maintenance spend mean plants are more likely to break down, as managers take the risk of using equipment beyond its scheduled working life. Similarly, essential training is delayed, or reduced in length, to keep within a budget.

ICIS Insight editor Nigel Davies highlighted the key issue 2 years ago as the problems began to become more widespread around the world:

“The situation in Europe has exposed underlying trends and issues that will need to be addressed. Companies appear not to have sustained an adequate pace of maintenance capital expenditure. That has been for economic as well as structural (cost) reasons. Spending in high feedstock and energy cost Europe has certainly not been considered de rigeur….Having maintained plants to run at between 80% and 85% of capacity, suddenly pushing them hard does little good. Sometimes, they fail.”

The end-result has been to mask the growing problem of over-capacity, as plants fail to operate at their normal rates. This has supported profits in the short-term by making actual supply/demand balances far tighter than the nominal figures would suggest. But this trend cannot continue forever.

THE END OF CHINA’S STIMULUS WILL HIGHLIGHT TODAY’S EXCESS CAPACITY
Shadow Jul17The 3rd chart suggests its end is now fast approaching.  It shows developments in China’s shadow banking sector, which has been the real cause of the apparent “recovery” and reflation seen in recent months:

  Premier Li began a major stimulus programme a year ago, hoping to boost his Populist faction ahead of October’s 5-yearly National People’s Congress, which decides the new Politburo and Politburo Standing Committee (PSC)
  Populist Premier Wen did the same in 2011-2 – shadow lending rose six-fold to average $174bn/month
  But Wen’s tactic backfired and President Xi’s Princeling faction  won a majority in the 7-man PSC, although the Populist Li still had responsibility for the economy as Premier
  Li’s efforts have similarly run into the sand

As the 3-month average confirms (red line), Li’s stimulus programme saw shadow lending leap to $150bn/month. Unsurprisingly, as in 2011-2, commodity and asset prices rocketed around the world,funding ever-more speculative investments.  But in February, Xi effectively took control of the economy from Li and put his foot on the brakes.  Lending is already down to $25bn/month and may well go negative in H2, with Xi highlighting last week that:

“China’s development is standing at a new historical starting point, and … entered a new development stage”.

“Follow the money” is always a good option if one wants to survive the business cycle.  We can all hope that the IMF and other cheerleaders for the economy are finally about to be proved right.  But the CU% data suggests there is no hard evidence for their optimism.

There is also little reason to doubt Xi’s determination to finally start getting China’s vast debts under control, by cutting back on the wasteful stimulus policies of the Populists.  With China’s debt/GDP now over 300%, and the prospect of a US trade war looming, Xi simply has to act now – or risk financial meltdown during his second term of office.

Prudent investors are already planning for a difficult H2 and 2018.  Companies who have cut back on maintenance now need to quickly reverse course, before the potential collapse in profits makes this difficult to afford.

Force majeures hit new record high as safety loses out to profits


Just when you think something really can’t get any worse, it does.  Sadly, that’s the story on chemical industry force majeures since my last half-year review.  As I noted then:

“There is no such thing as an accident. The chemical industry, like others, has known this for over 30 years, since the adoption of Quality Management techniques. Yet it seems that over the past 18 months either this important fact has been forgotten or, more likely, I fear, has simply been ignored.

The evidence for this worrying statement is in the chart, which shows the number of monthly references to “force majeure” in ICIS News:

□  Until recently, this has shown 20 – 40 references a month, too high, but at least stable
□  Since 2015 there has been an alarming increase, with the range now 40 – 80 references
□  And there is no consistency on a month-by-month basis, suggesting that nothing is being done to improve the position

As the chart shows, force majeures have since climbed to new all-time highs, with October showing a new monthly record of over 200 reports. The average for 2016 was 75/month, even higher than the 2015 average of 65/month.

What is to be done?  Part of the problem is undoubtedly that plants are getting older, and so more likely to break down.  Part of the problem is that preventive maintenance and training has been cut back to save money.

But the main problem in too many companies is more fundamental – too many senior managers now see profits as being more important than safety.

IEA Feb17This is something quite new.  In the past, force majeures would have led to lower profits – companies who were unable to supply would lose sales, and have to sell afterwards at a discount to compensate for their unreliability.  But with today’s lower demand levels and growing capacity surplus, this discipline no longer applies.  As the second chart shows from the International Energy Agency:

□  European and Asian refineries have been running well below pre-2009 levels due to lack of demand
□  They have therefore been producing less naphtha as a feedstock for petrochemical plants
□  Only N America has seen good refinery rates – and, of course, most of its olefin production is gas-based, so the higher rates do not translate directly into more product

The result is that companies have been under no pressure from their feedstock suppliers to sell more petchem products in order to use more naphtha.  Instead, this slowdown in feedstock availability has balanced today’s weak levels of demand growth in major petchem markets and, counter-intuitively, led to relatively high levels of profitability.

The real question therefore is perhaps how long today’s abnormal market conditions will continue.  When they end, and customers once more penalise unreliable suppliers, attitudes will change.  One can only hope that today’s downgrading of safety consciousness doesn’t, in the meantime, lead to a major incident somewhere.

 

Force majeures at all-time highs even before downturn begins

FMs Jul16There is no such thing as an accident.  The chemical industry, like others, has known this for over 30 years, since the adoption of Quality Management techniques.  Yet it seems that over the past 18 months either this important fact has been forgotten or, more likely, I fear, has simply been ignored.

The evidence for this worrying statement is in the chart, which shows the number of monthly references to “force majeure” in ICIS News:

  • Until recently, this has shown 20 – 40 references a month, too high, but at least stable
  • Since 2015 there has been an alarming increase, with the range now 40 – 80 references
  • And there is no consistency on a month-by-month basis, suggesting that nothing is being done to improve the position

The realisation that all accidents are preventable occurred in the 1980s, with the introduction of Total Quality Management in major companies such as DuPont and ICI.  Safety was put at the top of management agendas, ahead of profit, and companies adopted international standards which became the basis for Responsible Care programmes.

“Quality management principles are a set of fundamental beliefs, norms, rules and values that are accepted as true and can be used as a basis for quality management.”

As the Chartered Quality Institute notes:

Total quality management is a management approach centred on quality, based on the participation of an organisation’s people and aiming at long term success (ISO 8402:1994)”

The key phrase is “long term success”.  Companies commit to training programmes that enable employees to understand the cultural and practical steps necessary to ensure that the company operates on the principle of “right first time”.  If an accident occurs, a team is established to understand what went wrong, and what needs to be done to ensure it is not repeated.  And management commits to paying the cost – because they know that they will save money over the longer term.

Of course, there is always a temptation to “cut corners” and save this cost by “taking a chance”.  And as I noted in my last 6-monthly review of the data, it seems that the short-termism of financial markets is causing more and more managers to adopt this “cross my fingers and hope” policy:

Many managers feel pushed to cut back on maintenance and training, and take the risk of using equipment beyond its scheduled working life – thereby saving money and boosting the share price in the short-term.”

The fact that this policy has been followed in the good times, when profits were high, is not a good sign as we now enter the downturn.  Essential training has already been reduced, and equipment is already running beyond its scheduled life.  So many companies will be very exposed as their profits begin to stall.

There is nothing more important than safety.

 

Force majeures at record level, despite high profits

FMs Jan16

All accidents are preventable.  This simple fact, which used to be top-of-mind for every chemical industry manager, seems to have been increasingly either forgotten or ignored in recent years.  The evidence is in the chart above: showing industry force majeures since 2008 (as reported on ICIS news):

  • They were at a record level in 2015, continuing the trend seen since 2012
  • They were up 25% in 2015, after rising 61% in 2014 and 30% in 2013
  • This means they were more than double 2008′s level

Why is this happening?

In the past, safety was the top priority of every Board and manager.  Profits came second.  Nobody wanted to be responsible for death or injury because they had taken a short cut to save money.  And, of course, if you put that statement to any manager today, they would still agree with it.  But the evidence of the rise in force majeures shows that in too many companies, safety is no longer such an absolute priority.

Yet safety management is an absolute.  You cannot be half-safe.  So if a valve has a working life of, say, 10k hours, you must replace it after 10k hours even if it might last another thousand.  Nor can you allow half-trained people to operate plants, and you must ensure that training is regularly updated and that management enforces the rules.

All this costs money.  And many shareholders these days don’t actually bother to understand the businesses in which they invest.  Instead, investing is a form of computer game for them, and they buy/sell on the basis of computerised “screens” – “X” is trading at a more attractive multiple to “Y”.  One very senior investor even told me last year that he “didn’t see the point of having a CEO, as the performance of the business was already captured on his spreadsheet“.

NYSE holding period Jan16As a result, the absolute priority of safety has been compromised.  The average investor only expects to hold their shares for a few months – the high-frequency traders for only milliseconds (and they do half of all trading).  So many have no interest in the long-term future of the business.  Their priority is to achieve the highest possible share price in the shortest possible time, and then sell out.  So they really don’t want to spend time discussing issues like this with the company, and they don’t care if their short-sighted approach leads to a problem after they have sold their shares.

Nor do they care if customers get upset.  They will have sold their shares long before this causes business to be lost.

Of course, there are still some fund managers who do think long-term:

  • They do believe that their job is to support companies to grow their business for the long-term
  • Their aim is to help it to increase its earnings, so that it will be able to increase its dividend payments
  • They know these dividends will then be available to pay out promised pensions to fund members when they retire

But they are no longer the majority, as the second chart confirms.

This is why many managers feel pushed to cut back on maintenance and training, and take the risk of using equipment beyond its scheduled working life – thereby saving money and boosting the share price in the short-term.

This seems to be why we continue to see record levels of force majeures, at the same time as the industry is continuing to report strong profits.  Its not because companies can’t afford to spend the money, but because we live in a world where the concept of short-term shareholder value rules.

 

H1 sees worst-ever number of chemical plant force majeures

FMsJul15The first half of 2015 was the worst half-year for force majeures in the chemical industry since reliable data became available via ICIS news in 2005.  As the chart shows, there were 479 reports of outages, more than double H1 2014 and well above the previous peak of 375 in H1 2011.

This is absolutely shocking result, especially as it came after a bad 2014.  As I wrote when reporting those numbers earlier this year:

2013 wasn’t a good year for chemical plant reliability.  Force majeures (when plants go offline unexpectedly) were close to a record level.  Very worryingly, 2014 turns out to have been far worse:

  • 2014 saw a total of 620 reports, far above the previous high of 495 in 2011
  • 2011 was, of course, the year of the Fukushima disaster in Japan
  • This caused an additional 31 force majeures, but these were “knock-on” effects from the disaster

“We all know that accidents don’t just “happen”, but are caused by faulty procedures, lack of maintenance or training, or other human error.  It was also clear a year ago that the trend was already deteriorating. The number of force majeures had been above 2012 levels since May, and had reached a then-record high in the June – August period.

ICIS Insight editor Nigel Davies highlights the key issue in an excellent analysis:

“The situation in Europe has exposed underlying trends and issues that will need to be addressed. Companies appear not to have sustained an adequate pace of maintenance capital expenditure. That has been for economic as well as structural (cost) reasons. Spending in high feedstock and energy cost Europe has certainly not been considered de rigeur….Having maintained plants to run at between 80% and 85% of capacity, suddenly pushing them hard does little good. Sometimes, they fail.”

That said, buyers also played their part in creating the shortages.  Many failed to notice the major oil price decline that took place in H2 2014, and then suddenly woke up to reality in early Q1.  Panic destocking at this point left the market very short of product, and they then had to chase the market higher as prices rallied.  As I discussed in the Financial Times last week:

The current situation is not simply an issue of producers pushing up prices… on top of the force majeures, the second quarter of the year is typically the strongest time for demand and the limited rally in the value of oil at the beginning of 2015 caused buyers to rush to build plastics inventory in advance of expected price increases.”

This is the VUCA world that we described in Boom, Gloom and the New Normal, where Volatility, Uncertainty, Complexity and Ambiguity dominate.  Hopefully the experience of the last few months will prove to be a wake-up call, and ensure we are properly prepared for whatever is next thrown at us.

Issues such as oil price volatility, China and Greece are not going to go away anytime soon, and may well be joined by others as H2 progresses.

2013 a bad year for force majeures

FMs Jan14

2013 wasn’t a good year for plant reliability.  The blog’s 6-monthly survey of force majeure reports in ICIS news shows:

  • There were 386 reports of force majeures in 2013
  • This was very similar to the 391 level seen in 2010
  • It also reverses the decline seen in 2012 after the record 495 reports in 2011

This is a worrying performance, given that the industry has been profitable over the period.  This meant there was very little excuse for companies not spending the necessary money on maintenance.  And, of course, the tools for improving reliability have been improving all the time.

Even more concerning, as the chart shows, is that force majeures in 2013 (red square) were above 2012 levels from May onwards.  They also reached a record high in the June – August period, and were close to previous peak levels for the rest of the year.

Companies may well come to regret this short-sighted attitude.  During periods of good profitability, customers usually don’t have too many choices.  But when demand slows down, as seems likely in 2014, then reliability becomes a critical factor for them.

Equally, companies who have economised on maintenance during the good times, will find it more difficult to increase their spending when profits slow.  Whilst their lower reliability will make it more difficult for them to exploit the opportunity to operate successfully during upturns.

In addition, of course, there is the core issue of safety.  Poor maintenance and lack of training has a direct correlation with an increase in safety incidents.  This can not only lead to tragic consequences, but also threaten a company’s license to operate.