Hurricane Harvey: lack of insurance will hit Houston’s recovery

Buffalo Bayou

“By Monday, the third straight day of flooding, the aftermath of Hurricane Harvey had left much of the region underwater, and the city of Houston looked like a sea dotted by small islands.  ’This event is unprecedented,’ the National Weather Service tweeted. ‘All impacts are unknown and beyond anything experienced.’”

This summary from the New York Times gives some idea of the immensity of the storm that struck large parts of Texas/Louisiana last week, including the 4th largest city in the US.  And this was before the second stage of the storm.

I worked in Houston for 2 years, living alongside the Buffalo Bayou which flooded so spectacularly last week.  The photo above from the Houston Chronicle shows the area around our former home on Saturday, still surrounded by water.  Today, as the rest of America celebrates the Labor Day holiday, the devastated areas in Texas and Louisiana will be starting to count the cost of rebuilding their lives and starting out anew:

  Some parts of the Houston economy will recover remarkably quickly. It is a place where people aim to get things done, and don’t just sit around waiting for others to do the heavy lifting
  But as Texas Governor Abbott has warned, Harvey is “one of the largest disasters America has ever faced. We need to recognize it will be a new normal, a new and different normal for this entire region.”

The key issue is that the Houston metro area alone is larger in size than the economies of Sweden or Poland.  And as Harris County Flood Control District meteorologist Jeff Lindner tweeted:

An estimated 70% of the 1,800-square-mile county (2700 sq km), which includes Houston, was covered with 1½ feet (46cm) of water”

Already the costs are mounting.  Abbott’s current estimate is that Federal funding needs alone will be “far in excess of $125bn“, easily topping the costs of 2005′s Hurricane Katrina in New Orleans.  And, of course, that does not include the cost, and pain, suffered by the majority of homeowners – who have no flood insurance – or the one-third of auto owners who don’t have comprehensive insurance. They will likely receive nothing towards the costs of cleaning up.

SOME PARTS OF THE ECONOMY HAVE THE POTENTIAL FOR A QUICK RECOVERY
Companies owning the large refineries and petrochemical plants in the affected region have all invested in the maximum amount of flood protection following Katrina, when some were offline for 18 months

  Oil platforms in the Gulf of Mexico are used to hurricanes and are already coming back – Reuters reports that only around 6% of production is still offline, down from a peak of 25% at the height of the storm
  It is hard currently to estimate the impact on shale oil/gas output in the Eagle Ford basin, but the Oil & Gas Journal reports that 300 – 500 kb/d of oil production is shut-in, and 3bcf/d of gas production
  ExxonMobil is now restarting the country’s second-biggest refinery at Baytown, and Phillips 66 and Valero are also restarting some operations, whilst ICIS reports that a number of major petrochemical plants are now being inspected in the expectation that they can soon be restarted

Encouragingly also, it seems that insurance companies are planning to speed up inspections of flooded properties by using drone technology, which should help to process claims more quickly.  Loss adjusters using drones can inspect 3 homes an hour, compared to the hour taken to inspect on roof manually.  But even Farmers Insurance, one of the top Texas insurers, only has 7 drones available – and has already received over 14000 claims.

RECOVERY FOR MOST PEOPLE AND BUSINESSES WILL TAKE MUCH LONGER
For the 45 or more people who have died in the floods, there will be no recovery.

Among the living, 1 million people have been displaced and up to 500k cars destroyed.  481k people have so far requested housing assistance and 25% of Houston’s schools have suffered severe or extensive flood damage.

These alarming statistics highlight why clean-up after Harvey will take a long time.  Basic services such as water and sewage are massively contaminated, with residents being told to boil water in many areas.  The “hundreds of thousands of people across the 38 Texas counties affected by Harvey” using their own wells are particularly at risk.

And as the New York Times adds:

Flooded sewers are stoking fears of cholera, typhoid and other infectious diseases. Runoff from the city’s sprawling petroleum and chemicals complex contains any number of hazardous compounds. Lead, arsenic and other toxic and carcinogenic elements may be leaching from some two dozen Superfund sites in the Houston area”

FEW IN HOUSTON HAVE FLOOD INSURANCE
Insurance Aug17Then there is the issue that, as the chart from the New York Times shows, most of those affected by Harvey don’t have home insurance policies that cover flood damage.  Similarly, a survey in April by insurer Aon found that:

“Less than one-sixth of homes in Harris County, Texas, whose county seat is Houston, currently have active National Flood Insurance Program policies. The county has about 1.8 million housing units.”

As the Associated Press adds:

Experts say another reason for lack of coverage in the Houston area was that the last big storm, Tropical Storm Allison, was 16 years ago. As a result, people had stopped worrying and decided to use money they would have spent for insurance premiums on other items.”

Even those with insurance will get hit by the low levels of coverage – just $250k for a house and $100k for contents. Businesses carrying insurance also face problems, according to the Wall Street Journal, as they depend on the same Federal insurance scheme, which:

Was primarily designed for homeowners and has had few updates since the 1970s. Standard protections for small businesses, including costs of business interruption and significant disaster preparation, aren’t covered, and maximum payouts for damages haven’t risen since 1994.

The maximum coverage for business property is $500k, and the same cap applies to equipment and other contents, far below many businesses’ needs.  And even those with insurance find it difficult to claim, according to a study by the University of Pennsylvania and the Federal Reserve Bank of New York after Hurricane Sandy in 2012:

“More than half of small businesses in New York, New Jersey and Connecticut that had flood insurance and suffered damages received no insurance payout. Another 31% recouped only some of their losses.”

Auto insurance is a similar story. Only those with comprehensive auto insurance are likely to be covered for their loss – and even then, people will still suffer deductions for depreciation.  According to the Insurance Council of Texas:

15% of motorists have no car insurance, and of those who do, (only) 75% have comprehensive insurance. That leaves a lot of car owners without any protection.”

In other words, around 1/3rd of car owners probably have no insurance cover against which to claim for flood damage.

HARVEY’S IMPACT WILL BE LONG-TERM
It is clearly too early, with flood waters still rising in some areas, to be definitive about the implications of Hurricane Harvey for Houston and the affected areas in Texas and Louisiana.

Of course there are supply shortages today, and the task of replacement will created new demand for housing and autos.  But over the medium to longer term, 3 key impacts seem likely to occur:

  It will take time for the supply of oil, gas, gasoline and other refinery products, petrochemicals and polymers to fully recover.  There will inevitably also be some short-term shortages in some value chains. But within 1 – 3 months, most if not all of the major plants will probably be back online
  It will take a lot longer for most people affected by Harvey to recover their losses.  Some may never be able to do this, especially if they have no insurance to cover their flooded house or car.  And those working in the gig economy have little fall-back when their employers have no need for their services
  The US economy will also be impacted, as Slate magazine warned a week ago, even before the full magnitude of the catastrophe became apparent:

“For the U.S. economy to lose Houston for a couple of weeks is a human disaster—and an economic disaster, too….Given that supply chains rely on a huge number of shipments making their connections with precision, the disruption to the region’s shipping, trucking, and rail infrastructure will have far-reaching effects.

 

Sinopec’s results confirm China’s focus on employment and self-sufficiency, not profit

Sinopec May17China’s strategies for oil, refining and petrochemical production are very different from those in the West, as analysis of Sinopec’s Annual and 20-F Reports confirms.  As the above chart shows, it doesn’t aim to maximise profit:

□  Since 1998, it has spent $45bn on capex in the refining sector, and $38bn in the chemicals sector
□  Yet it made just $1bn at EBIT level (Earnings Before Interest and Taxes) in refining, and only $21bn in chemicals

As I noted last year:

Clearly no western company would ever dream of spending such large amounts of capital for so little reward. But as a State Owned Enterprise, Sinopec’s original mandate was to be a reliable supplier of raw materials to downstream factories, to maintain employment. More recently, the emphasis has changed to providing direct support to employment, through increased exports of refined products into Asian markets and increased self-sufficiency in petrochemicals”.

Commentary on China’s apparent growth in oil imports confirms the confusion this creates.  Western markets cheered last year as China’s oil imports appeared to increase, hitting a record high. But they were ignoring key factors:

□   China’s crude imports were indeed 14% higher at 7.6 million bpd – nearly a million bpd higher than in 2015
□   But 700 kbpd of these imports were one-off demand as China filled its strategic storage
□   And at the same time, China’s refineries were pumping out record export volume: its fuel exports were up around one-third during the year to over 48 million tonnes

As Reuters noted:

This broadly suggests China’s additional imports of crude oil were simply processed and exported as refined products.”  In reality, ”China’s 2016 oil demand grew at the slowest pace in at least three years at 2.5%, down from 3.1% in 2015 and 3.8% in 2014, led by a sharp drop in diesel consumption and as gasoline usage eased from double-digit growth.”

The issue was simply that Premier Li was aiming to maintain employment in the “rust-belt provinces”, by boosting the so-called “tea-pot refineries”.  He had therefore raised their oil import quotas to 8.7 million tonnes in 2016, more than double their 3.7 million tonne quota in 2016.  As a result, they had more diesel and gasoline to sell in export markets.

China OR May17

The same pattern can be seen in petrochemicals, as the second chart confirms.  It highlights how Operating Rates (OR%) for the two main products, ethylene and propylene, remain remarkably high by global standards.  This confirms that Sinopec’s aim is not to maximise profit by slowing output when margins are low.  Instead, as a State Owned Enterprise, its role is to be a reliable supplier to downstream factories, to keep people employed.

□   Its OR% for the major product, ethylene, hit a low of 94% after the start of the Financial Crisis in 2009, but has averaged 102% since Sinopec first reported the data in 1998
□   Its OR% for propylene has also averaged 102%, but has shown more volatility as it can be sourced from a wider variety of plants. It is currently at 100%

Understanding China’s strategy is particularly important when forecasting demand for the major new petrochemical plants now coming online in N America.  Conventional analysis might suggest that China’s plants might shutdown, if imports could be provided more cheaply from US shale-based production.  But that is not China’s strategy.

Communist Party rule since Deng Xiaoping’s famous Southern Tour in 1992 has always been based on the need to avoid social unrest by maintaining employment.  There would therefore be no benefit to China’s leadership in closing plants.  In fact, China is heading in the opposite direction with the current 5-Year Plan, as I discussed last month.

The Plan aims to increase self-sufficiency in the ethylene chain from 49% in 2015 to 62% in 2020.  Similarly in the propylene chain, self-sufficiency will increase from 67% in 2015 to 93% in 2020.

It is therefore highly likely that China’s imports of petrochemicals and polymers will continue to decline, as I discussed last month.  And if China follows through on its plans to develop a more service-based economy, based on the mobile internet, we could well seen exports of key polymers such as polypropylene start to appear in global markets.

Wrong assumptions on China growth and oil prices mean danger lies ahead for refiners and polymer producers

China PE, PP Jul16It could be a very difficult H2 for anyone involved in the Asian oil and polymer markets.  And given the global importance of these markets, everyone around the world will also feel the impact.  The issue is that most business strategies have been based on 2 increasingly unlikely assumptions:

  Companies all assumed that oil prices would stay at $100/bbl or higher forever
  They also assumed that China’s economy would grow at double digit rates forever

It would have been hard enough if just one assumption had been wrong.

If oil prices had remained high, then companies based on natural gas might still have hoped to do well.  If China’s demand had remained strong, then at least it would have been able to buy some of the planned new production.  But as both assumptions seem likely to be wrong, companies have few places to hide:

  China’s slowdown means that its gasoline and diesel exports are soaring. Gasoline exports rose 75% in H1 to 4.45 million tonnes, whilst diesel exports more than trebled to 6.6 million tonnes
  The collapse of oil prices means that US polymer producers no longer have a major cost advantage versus oil-based producers in Asia and Europe

The end result of these two developments is likely to be chaos in oil and polymer markets.

  Profits are already collapsing in Asian refining markets – they are down 83% since the start of the year and were just $2.21/bbl this week. And China is not the only country boosting its exports – India’s gasoline exports are up by nearly a quarter this year, whilst Saudi Arabia’s exports were up 76% between January – May.
  Similar changes are taking place in China’s polymer markets, as the charts show. China’s polyethylene imports rose just 2% in H1 versus 2 years ago.  Its polypropylene imports actually fell by nearly a quarter over the same period, as it ramped up new capacity based on very cheap imported propane.

And the underlying problems of too much supply chasing too little demand are likely to get worse, much worse, as we head into 2017, when all the new N American PE capacity will start to come online. Where will it all be sold is the big question?  Can it all be sold?

Of course, the position might turn around if central banks do a mega-stimulus programme involving ‘helicopter money‘.

But the nightmare scenario for these producers is that the collapse of gasoline and diesel margins will now cause refiners to cut back production. In turn, this will further pressure oil markets – which are already struggling to cope with record high global inventories – and cause prices to return to parity with natural gas prices.

None of these concerns are new.  I first raised them in a detailed analysis in March 2014, titled US boom is a dangerous game, when I warned:

“Shale gas thus provides a high-profile example of how today’s unprecedented demographic changes are creating major changes in business models. Low-cost supply is no longer a guarantee of future profitability. Any company sanctioning new investment without a firm guarantee of future offtake therefore risks finding itself landed with an expensive white elephant for the future.”

Unfortunately, however, consensus thinking preferred the analysis first described by Voltaire’s Candide – “that everything was for the best, in this best of all possible worlds“. Refiners and polymer producers could now find themselves in a very difficult situation as a result.

 

Oil heads back to $30/bbl and probably lower

Brent Jul16b

There was never any fundamental reason why oil prices should have doubled between January and June this year. There were no physical shortages of product, or long-term outages at key producers. But of course, there was never any fundamental reason for prices to treble between 2009 – 2011 in the Stimulus rally, or to jump nearly 50% between January – May last year.

 Instead, prices once again rose because financial players expected the US$ to decline
 They realised this meant they could make money by buying oil on the futures market as a “store of value”
 Now, as the US$ has started to recover, they are selling off these positions
 And so oil prices are falling again

The problem is that the financial volumes swamp the physical market – they were 7x physical volume at their 2011 peak- and so they destroy the oil market’s key role of price discovery based on the fundamentals of supply/demand. As I worried in an interview back in March:

“Now the central banks are doing it again. And so, once again, oil prices have jumped 50% in a matter of weeks, along with prices for other major commodities such as iron ore and copper, as well as Emerging Market equities and bonds. In turn, this will force companies to buy raw materials at today’s unrealistically high prices, as the seasonally strong Q2 period is just around the corner. Some may even build inventory, fearing higher prices by the summer.

If this happens, and prices collapse again as the hedge funds take their profits, companies will … be sitting on high prices in a falling market in Q3 – just as happened in January. Only Q3 could be worse, being seasonally weak, and so it may take a long time to work off high-priced inventory.”

Today, just as I feared, the hedge funds are indeed now unwinding their bets and leaving chaos behind them. As Reuters reports, they have already “slashed positive bets on US crude oil to a 4-month low”:

Russia has confirmed the myth of an OPEC/Russia oil production freeze is now officially dead
US oil and product inventories hit an all-time high of almost 1.39bn barrels
China’s gasoline exports have doubled over the past year, and its diesel exports tripled in H1
Saudi Arabia’s Oil Minister has warnedThere are still excess stocks on the market – hundreds of millions of barrels of surplus oil. It will take a long time to reduce this inventory overhang

Even worse is that the world is now running out of places to store all this unwanted product, as Reuters reported earlier this month:

Storage tanks for diesel and heating oil are already so full in Germany, Europe’s largest diesel consumer, that barges looking to discharge their oil product cargoes along the Rhine are being delayed”.

Similarly, the International Energy Agency has reported a major backup of gasoline tankers at New York harbor, due to storage being full, whilst Reuters added that tankers are being diverted to Florida and the US Gulf Coast to discharge.

Plus, of course, the recent rally has proved a lifeline for hard-pressed oil producers, who have been able to hedge their output at $50/bbl into 2017. As a result, companies have started to increase their drilling activity again, and are expected to open up many of the 4000 “untapped wells” – where the well has been drilled, but was waiting for higher prices before it was sold.

Yet wishful thinking still dominates oil price forecasts. $50/bbl has always been the “Comfortable Middle” scenario, as we noted in the Demand Study – and most companies and analysts are most reluctant to break away from this cosy consensus. Yet even in February this year, only 3.5% of global oil production was cash-negative at $35/bbl – just 3.4mbd. Today’s figure is likely even lower, as costs continue to tumble.

And in the real world, oil prices have already fallen more than 10% from their $50/bbl peak. Unless the US$ starts to fall sharply again, it seems highly likely that prices will now revisit the $30/bbl level seen earlier this year. Given the immense supply glut that has now developed, logic would suggest they will need to go much lower before the currently supply overhang starts to rebalance.

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 56%
Naphtha Europe, down 57%. “Market fundamentals weak. US gasoline blending demand poor,”
Benzene Europe, down 51%. “Spot prices moving higher over the course of the week alongside some upward movement in the US market.”
PTA China, down 40%. “Major producers are understood to still be in discussions with provincial authorities on a confirmed stoppage timeline for their PTA lines during the G20 periods.”
HDPE US export, down 33%. “China’s current import prices are higher than domestic prices.”
S&P 500 stock market index, up 11%
US$ Index, up 20%

Chemical capacity utilisation continues to weaken

ACC OR Jan16Capacity Utilisation (CU%) is the best measure we have for the current state of the global chemical industry.  It doubles as an excellent proxy for the outlook for the global economy.  And as the above chart based on latest American Chemistry Council data shows, recovery still seems a long way off:

  • Global CU% was down to 81.4% in November, versus 82% in November 2014 and 82.4% in November 2013
  • The only bright spot was in Central/Eastern Europe, up 9.2% versus 2014: Russia was up 14%
  • Asia is showing some signs of recovery under the influence of cheaper oil, up 4.9% versus its 7.5% peak
  • Middle East is also recovering, up 4.4% versus its 6.1% peak, as countries focus on petchem exports
  • W Europe was up 2.8% versus its 4.1% peak, N America was up only 2.2% versus its 5% peak
  • Latin America remains in crisis, setting a new low at -3.4%, with Brazil at – 4.3%

Sometimes November can disappoint as companies reduce inventory before year-end, but there was little sign of this happening in 2015.  Many companies had in fact been convinced by the analysts that oil prices would rebound, and so there was actually some panic buying.  This has no doubt led to some regrets, with oil now back at 2004 lows and still weakening as US and Iranian exports ramp up.

Pressure is also rising in Asia from the increase in China’s oil product exports.  November data showed:

  • Gasoline exports up 10% so far this year at 5m tonnes; jet kero exports up 17% at 11m tonnes
  • Fuel oil was up 12% at 9.3m tonnes; and diesel up 64% at 6.2m tonnes

Naphtha and LPG saw imports rise; naphtha was up 79% at 5.7m tonnes and LPG up 69% at 10.6m tonnes.  But these increases effectively meant that  China was also boosting its own petchem production – not only reducing its potential need for polymer/PTA imports but also increasing its petchem export potential.

January will be a critical month as Western countries return from the holidays.  This will give us some insight into likely demand trends in Q1, which are normally very strong for seasonal reasons.  But Asia will, of course, be slowing ahead of Lunar New Year on 8 February.

 

World Aromatics and Derivatives Conference next week

Aromsa Nov14Our 13th annual World Aromatics & Derivatives Conference takes place in Berlin next week.  Jointly organised as always by International eChem and ICIS, it features a must-hear list of speakers:

  • ExxonMobil:  Europe Business Director Tim Stedman will give a global market overview
  • Dow Chemical: Global Business Director Pieter Platteeuw will discuss the future for benzene
  • BASF: Business Manager Klaus Ries will look at the styrene value chain
  • Shell: General Manager Elise Nowee will ask the question, “What about Europe?”

In addition, we will benefit from expert presentations on key issues:

  • International Energy Agency:  Analyst Fabian Kesicki will present the IEA’s energy outlook to 2035
  • BMW: Senior Researcher Peter Phleps will look at how Mobility trends will impact car markets
  • Nexant: Global Manager Stewart Hardy will focus on the outlook for paraxylene and polyester
  • VCI: Senior Economist Christian Buenger will analyse global economic megatrends
  • Biorizon: Business Development manager Florian Graichen will look at opportunities in the bio area
  • ICIS price reporters Rhian O’Connor and Rob Peacock will highlight toluene and phenol/acetone developments

I will also be giving a presentation discussing the likely impact of the Great Unwinding of policymaker stimulus on the industry.

As the chart above highlights, chemical markets suggest a major economic slowdown is underway, caused by China’s new policies.  We are therefore in the New Normal world of slow demand growth and deflation.  How can companies create new markets for the future?

Full details of the agenda and registration details can be found by clicking here.