The excellent new Spielberg movie, Bridge of Spies, vividly captures the building of the Berlin Wall in 1952. It also reminds us of the excitement when the Wall fell, and European borders reopened after 47 years.
Now, Europe’s borders are closing again, pressured by vast Syrian refugee movements and terrorist massacres. France, Germany, Austria and Sweden have all “temporarily” reimposed border controls within the Schengen passport-free travel zone, whilst Hungary’s fences, as the photo shows, even resemble those of the old Iron Curtain.
Even more worrying is that the European Union will today discuss suspending the Schengen zone for 2 years – essentially confirming the return of national borders between major countries such as Austria and Germany. In addition, it will increase the pressure on Greece to leave Schengen – whose financially crippled administration has been swamped by the arrival of 700k refugees and migrants this year.
It is only 3 months since I was interviewed by the BBC on the threat posed to business by a Schengen breakdown. Since then, the threat has become even more serious, with the President of the European Commission warning:
“A single currency does not exist if the Schengen fails.”
The problem is Europe’s failure to agree a centrally-organised mechanism to enforce its border. This parallels its failure to implement a centrally-organised system of banking supervision, which is at the heart of the ongoing Eurozone debt crisis:
- National governments will not work together to establish both mechanisms as quickly as possible
- Thus the problems get worse, and allow euro-sceptic parties across the EU to claim exit is the only solution
Of course, Europe is not alone in trying to avoid tackling difficult issues. One of its problems is that these twin crises are taking place at a moment when the cracks are showing in key parts of the global financial system – Emerging Market debt, and the high-yield Western “junk bond” market.
As Carl Icahn warned recently, the central banks’ policy of low interest rates forced investors to take on more risk – but also meant investors became involved in markets they didn’t understand
- They all wanted to believe in the concept of the Commodity SuperCycle: but now commodity exporters in a wide arc from Brazil through S Africa, Australia, Asia, Middle East and Russia are suffering as this myth is exposed
- The Institute of International Finance has warned their $27tn of debt means companies “in many emerging markets will face difficulties in servicing their debts and in incurring new debts to support economic growth. It is another headwind adding to the slowdown in growth that emerging markets face.“
- A similar problem is affecting US energy investors: they bet $1.2tn on the idea that oil prices would always stay at $100/bbl, but now defaults are becoming common
- High yield, triple-C rated debt has fallen 6% so far this year, whilst double-B debt now yields 8% – its price has fallen by around a half in the past 2 years (bond prices move inversely to yields)
Of course, one could argue that these investors simply got what they deserved, and simply illustrate the principle that “a fool and his money are soon parted”. But the big money is being lost by pension funds and other major investors.
Thus the problems in debt markets add to the social and economic problems created by the Eurozone debt and refugee crises. Unless these are quickly resolved, they threaten to overwhelm the progress made since the fall of the Berlin Wall. It could be a very difficult 2016, if policymakers continue to duck discussion of the key issues.
The chemical industry continues to be the best leading indicator we have for the global economy. Whilst stock markets were continuing to move higher during H1, its depressed level of capacity utilisation was signalling that the economy was far more fragile than generally realised.
Company results for Q2 reflect this concern. Of course some, tied to specific market sectors or geographies, produced relatively good results. Others, however, were already cutting back in anticipation of harder times ahead.
Yesterday’s relatively weak US Q2 GDP report confirms this mixed picture. Q1 GDP was revised up to 0.6%, but Q2 disappointed at only 2.3%, meaning that H1 growth averaged just 1.5%. And GDP growth between 2012 – 2014 was revised down to an average annual rate of just 2%.
In turn, this means the recovery since 2009 has been the weakest since World War 2, with growth averaging 2.2%.
As we move into Budget season, companies may be tempted to assume that “all will eventually come right”. But this, I fear, would be a triumph of hope over experience. The fault-lines created by central bank policies are opening wider and wider:
- Clearly China’s economy is in a lot worse shape than many people had wanted to believe
- The Eurozone debt crisis over Greece is on hold for the holiday period, but not solved
- Oil prices look set to continue weakening as demand growth slows and Iran re-enters the market
- And, of course, the US Federal Reserve probably has to start raising interest rates in September (before the 2016 Presidential primaries begin), risking further volatility in exchange and interest rates
Looking back to my Budget Outlook for the 2015-2017 period, its 3 Scenarios still seem robust – as does its Base Case of a demand-constrained world. Similarly its forecast of deflation has come true, with prices for oil, commodity and the major petrochemicals all well down on a year ago.
More details of my usual survey of Q2 results are below.
Air Products. “Income rose on lower sales on higher pricing and volumes”
Air Liquide. ” positive currency effect was partly offset by the negative impact of energy prices”
Akzo Nobel. “Global economy remains challenging and shows a very mixed picture with different dynamics per region and customer segments”
Arkema. “Positive currency effects and earnings contributions from newly-acquired subsidiary Bostik”
Ashland. “Unfavourable exchange rates and lower demand from North American energy producers”
BASF. ““For the full year 2015, we now expect somewhat weaker growth for the global economy as well as global industrial and chemical production than was foreseen six months ago”
BP. “Stronger operational performance, improved margins and the benefits of our simplification and efficiency programmes”
Bayer. “Benefited from lower raw material prices due to the oil crude price decrease and improved demand, together with a positive currency exchange”
CP Chem. “Improved olefins and polyolefins cash chain margins as ethylene costs decreased on the crude oil price fall”
Celanese. “Growing uncertainty in the economic outlook of China”
Chemtura. “Reduced customer demand for certain products and a stronger US$ contributed to the fall in net income”
Clariant. “Expects the challenging environment characterized by an increased volatility in commodity prices and currencies, to continue”
Croda. ” Conditions remain uncertain in Europe”
Dow. ““This is not yet a [peak of the] cycle discussion but it’s starting to mimic one with outages. That’s what we saw in 1995… where supply outages created a mini cycle on the up”
Dow Corning. “Significant growth in its most profitable silicones segment product lines”
DuPont. “industry challenges in the agricultural sector and persistent currency headwinds”
Eastman. “Increase in sales, as well as relatively flat cost of sales”
ExxonMobil. “Performance underscored the resilience of the integrated business model”
Honeywell. “Sales were down 1% year over year because of delays in customer projects and lower catalyst shipments”
Huntsman. “Currency headwinds from a stronger dollar and the extended maintenance outage”
INEOS. “Strong, feedstock-advantaged North American markets and a weaker euro; markets in Asia have generally remained subdued”
Lanxess. “Making good progress with our realignment program”
LyondellBasell. “A spate of production outages in the industry added to tailwinds from abundant oil and natural gas supplies”
Methanex. “Drop in its revenue and average realized price”
Mexichem. “Difficult conditions on volumes and pricing in certain markets”
Olin. “Benefited from insurance recoveries for property damage and business interruption”
OxyChem. “Improved margins across most product lines on the back of lower ethylene and natural gas costs”
PKN Orlen. “Better PX/PTA and polyolefin sales volumes after production limitations and improved market demand”
PolyOne. “Euro remains very weak against the dollar and demand appears to be slowing in Asia”
PetroRabigh. “Lower margin on petrochemicals due to price decline”
Praxair. “Slowdowns in China and Brazil and weak metals, energy and manufacturing sectors”
Reliance. “Petrochemicals business recorded a strong quarterly performance supported by high operating rates and margin strength in the ethylene chain”
SABIC. “Lower average sales prices despite the reduction in cost of sales”
Sahara. “Decline in demand and product prices”
Sherwin-Williams. “Improved operating results in the company’s paint stores and consumer groups”
Shell. “Supported by improved intermediates market conditions which more than offset lower base chemicals industry conditions”
Siam Cement. “Improved margins and inventory gains”
Tasnee. “Lower product prices and higher expenses”
Technip. “Launched a major restructuring plan across the Group to address the challenging market outlook we anticipate”
Tosoh. “Increased sales volume and decreased feedstock prices”
TOTAL. “Petrochemical margins were also higher, notably due to limited production capacity as a result of numerous shut downs in the industry”
Unipetrol. “Much lower crude oil prices combined with solid market demand”
Univar. “Significantly lower chemical demand in upstream oil and gas markets in the US and other regions”
Versalis. “Stronger margins, shortages of some products on the back of industry outages, and the restart of its Porto Marghera plant”
Yansab. “Lower production and sales volume from turnaround activities … and lower average sales prices”
“We should not forget the historic nature of what is at stake.
“Its about whether a country can leave the euro zone and what that means for the future of an incomplete and flawed European Monetary Union.
“Its about whether there may soon be a failed state in southeastern Europe with all the geopolitical consequences that could entail in a fragile region.
“Its about whether the EU’s 58-year-old project of “ever closer union” goes into reverse, and whether the objective forces of economic divergence finally overwhelm the political will on which the euro was founded.
“The United States, China and Japan understand what’s at issue and all have expressed concern that Europeans should find a solution to keep Greece in the euro. Yet at this point, that does not appear the most likely outcome…..
“If European leaders effectively abandon a defiant Greece to its fate, neither the euro zone nor the European Union will be the same again. Some, notably among the growing ranks of Eurosceptics around the continent, will think that is for the better. The glee with which Nigel Farage, Marine Le Pen and Geert Wilders greeted the prospect of the unravelling of European integration may give euro zone leaders pause.”
This summary from Reuters’ vastly-experienced European Affairs editor, Paul Taylor, expertly sums up the real issues at stake in Sunday’s final Eurozone summit on Greece.
These have been largely ignored in the on-going arguments about Greece’s debt. Debate has instead focused, understandably enough, on the fact that the Greeks have managed to borrow large amounts of money, at least €322bn ($365bn), and cannot possibly ever repay it. Even worse, the various Greek governments appear to have done nothing to reduce their future spending, or indeed, even to raise a more sensible amount of tax.
It is no wonder that only 10% of Germans want to handover more money to the Greeks, given the history of previous loans. The word for debt in German, “Schuld“, also means “guilt” – and it is understandable that Germans and others across Europe now see Greece as a morality play, where the guilty need to be punished for their crimes.
Yet, with all apologies to my many German friends, this is not the real issue on Sunday:
- Last Saturday, 1600 Syrian refugees landed on the Greek island of Lesbos. Many more thousands are on their way. If Greece leaves the Eurozone on Monday, who will run the reception camps where these migrants now live? Nobody, is the likely answer. The Greek government will be unable to feed and protect their own population, so why should they devote precious resources to these people? Inevitably, therefore, Greece will become an open door for increasing numbers of Syrian/Libyan and other migrants into the European Union
- Equally important is the future of the Eurozone itself if Greece is to be abandoned to its fate. It will then be clear to everyone that it is no longer a currency union, bound together by treaty obligations. Instead, it will have become just another exchange rate mechanism, like its ill-fated predecessor the Exchange Rate Mechanism (ERM). Its fragility was summed up by the UK’s finance minister, who boasted that he went home that evening after leaving the ERM and “was singing in his bath”.
- The third reason why the Eurozone should pause is that Greece in many ways is just the ‘canary in the coalmine’, warning of the flawed construction of the Eurozone itself. As I have long argued, Eurozone leaders should never have set up economic and monetary union without political union. They knew this at the time, but they ducked the issue. Now it has come back to bite them, hard. And if Greece goes, we can be sure that others will follow them, if this fundamental flaw in the design is not now fixed.
Of course it will be difficult for resolve all the long-standing issues created by the Greek crisis on Sunday. But as the Chinese proverb says, “a journey starts with a single step”. And the facts are at least clear:
- Everyone knows that Greece will never pay its bills
- Everyone also knows that Greece will immediately default on its debt if it is forced to leave the Eurozone
- And everyone also knows that taxpayers in the richer Eurozone countries will end up paying the bill as a result – Germany will end up paying at least €86bn, and probably much more
So why take this pain for no gain? Why not instead deal with the cause of the problem – the lack of political union. Why not admit, as Paul Taylor argues, that the Eurozone is “incomplete and flawed”? And having recognised reality, then use the crisis to make a fresh start by agreeing a more sustainable basis for the Eurozone itself?
“Summit fatigue” is a real issue in long-running sagas like Greece. It can easily lead people to sleepwalk into a situation they had never dreamed could happen.
In this case, the risk is very clear and immediate. It is that large numbers of migrants start to pour into N Europe via the relatively safe route from Turkey to Greece. (The United Nations estimates there are now 4 million Syrian refugees, and report that total migrant crossings rose 80% in H1 versus 2015 to 137k). And in turn, their arrival leads within a short while to the triumph of nationalist parties in France, the Netherlands and elsewhere, all determined to exit not just the Eurozone but the European Union itself.
Sunday will be a critical day for all of us who live in Europe. And for the underlying stability of the political structures that have underpinned the world since World War 2.
The 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.
This morning, Greece introduced capital controls. People can only withdraw €60/day ($65) from their bank accounts. The government has also called a referendum on Sunday, after Eurozone talks on a new bailout package collapsed.
The key issue is that Greece will never be able to repay its debts. These are currently estimated at €322bn ($365bn) – far larger than its economy, which is only $238bn after having shrunk by 25% since 2008. Greece also needs new money to be invested in the country, if it is to make a new start and fund new growth.
If Greece was a company, everyone would know what needed to be done. The business would have to be put into bankruptcy; debt-holders would have to write off some debt and swap the rest for equity; and a new business plan would have to be developed to be funded with new money from existing and new investors.
But Greece isn’t a company, of course. And today’s politicians don’t like to take hard decisions or to deliver difficult messages to their electorates. This is why I feared 2 weeks ago that the “Slow motion Greek train wreck was getting ready to hit another buffer‘. The heart of the problem is very simple:
- Political union in the Eurozone was essential if economic and monetary union was to succeeed
- But although this was rejected by France in the 1990s, the Eurozone project still went ahead in 1999
Politicians instead pretended that political union existed, and banks have since lent vast sums to Greece. And although it has been clear since 2009 that these loans cannot be repaid, they failed to explain this to their electorates. Instead the Greek and Eurozone leaders decided to extend repayment to 2050.This policy of “pretend and extend” means Greece is now bankrupt on an epic scale.
None of us can now know what will happen next. But we can assume Eurozone politicians will continue to try and avoid telling their electorates what has been done in their name. The German part of the bill could easily be €86bn, and in a worst case could be the entire €322bn according to the respected IFO Institute.
But the game of “Pretend and Extend” is clearly complicated by the involvement of the IMF. It is not allowed to lend to countries who cannot repay their loan, and it has powerful members outside the Eurozone in Asia and Latin America, who want it to enforce this rule. Thus Christine Lagarde, the head of the IMF, told CNBC yesterday:
“Our objective is clearly to restore the financial independence, the stability of Greece – to make sure that growth can start again. And that Greece can be sustainable from an economic and financial standpoint. As I’ve said, it is a balancing act. There has to be measures taken by Greece, there has to be support by the Europeans. And they come in sequence. Measures have to be taken, they have to be implemented. And that triggers a different attitude and a willingness to look at both financing and debt sustainability.”
The IMF is thus coming out on the side of those who want realism to be injected into the debate. The Greeks have to develop a functioning tax system, and realistic social policies. In turn, the Eurozone governments have to agree to write off debt and finance the new start. That is the real meaning of Ms Lagarde’s emphasis on the need to look at “both financing and debt sustainability” in sequence.
This is why the concept of political union should have been agreed alongside economic and monetary union. But today, German taxpayers face a different decision – and one that has not yet been explained to them. This is simply that if they don’t refinance Greece, they stand to lose all the money that has been lent to Greece in their name.
Greece’s decision to hold a referendum highlights the impasse that has been reached:
- Greece can only implement one side of the necessary deal – reforming its taxation and spending policies. It cannot come up with the new money needed to reverse the current decline in its economic performance
- The Eurozone is in an equally bad position, as it cannot force Greece to undertake this restructuring. And so it may end up having to write off the Greek debt, and getting nothing in return
This is always the problem with ‘pretend and extend’ policies. In the end, reality has a habit of intruding.
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 40%
Naphtha Europe, down 40%. “Values are coming down gradually from recent highs as the product is long and its use in summer gasoline blending is limited”
Benzene Europe, down 39%. “There is still a steady stream of imports moving into the region from the Middle East and India. As a result, some traders believed that this would readjust the current supply/demand dynamic before long”
PTA China, down 29%. “The two major producers Yisheng Petrochemical and Hengli Petrochemical currently have no plans for any run rates reduction in July. This was largely to faciliate cash flow, several market participants added”
HDPE US export, down 19%. “Domestic export prices slipped during the week on oversupply, verified by industry data released on Friday.”
¥:$, down 21%
S&P 500 stock market index, up 8%
“Central banks have to be mindful that too long a period of very low interest rates can have undesirable consequences in the context of ageing societies. For pensioners, and those saving ahead of retirement, low interest rates may not be an inducement to bring consumption forward. They may on the contrary be an inducement to save more, to compensate for a slower rate of accumulation of pension assets.” Mario Draghi, President, European Central Bank
It is now exactly 4 years since we published Chapter 1 of Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again. When writing it, John Richardson and I thought our basic premise – that demographics drive demand – was simply a statement of the obvious. We didn’t write the book to make this argument. We wrote it with the aim of helping companies and investors to develop the new business models needed to profit from these new demand patterns.
How wrong we were! Very few policymakers took us seriously, with the exception of Governor Shirakawa of the Bank of Japan. He had already made the same argument when taking office in December 2008.
Instead, they maintained that the stimulus provided by Quantitative Easing (QE) was already returning the global economy to “normal” levels of economic growth. And when, as was inevitable, this first round of QE failed, the US Federal Reserve simply did QE2 and then QE3, whilst China and the UK followed. Even worse, new premier Abe replaced Shirakawa in 2012 as a prelude to QE in Japan, and Mario Draghi followed at the ECB this year.
But of course, there has been no sustained recovery. And finally, on Friday, Draghi half-conceded that there just might be some downside to the policy in a world of ageing societies. His statement above thus stands as the first faint recognition by a Western policymaker of the fact that stimulus has been exactly the wrong policy since 2008.
Unfortunately, however, this recognition on its own is “too little, too late”. The Great Unwinding of these stimulus policies began 9 months ago, and we are already seeing rising volatility in the 4 key markets of oil, the US$, interest rates and stock markets. These are the warning tremors of the debt-fueled Ring of Fire created by the central banks.
China, the world’s 2nd largest economy, has been moving away from QE since the new leadership took office in 2013, due to the dangers that it creates. As premier Li warned last month:
“It is quite easy for one to introduce QE policy, as it is little more than printing money. When QE is in place, there may be all sorts of players managing to stay afloat in this big ocean. Yet it is difficult to predict now what may come out of it when QE is withdrawn.”
The chart highlights the problem, based on Bloomberg data. It shows that the G7 group of the world’s major economies can now be best described as the Ageing and High Debt group. Their gross government debt per person ranges from a minimum of $36k/person in Germany to $100k/person in Japan. It is hard to believe all this debt will be repaid. As I noted in February, after the Greek election:
“We all learnt one crucial lesson from Syriza’s victory in the Greek election last week – voters can halt the European Central Bank (ECB). Or in other words, protest coalitions can trump elite consensus. In places like Spain and France, this effect may not work through immediately, but it is being absorbed.”
Draghi has realised very late that the economic rules change in an ageing society. Older people already own most of what they need, and their incomes decline as they near retirement. They also have to save more. None of them ever expected that average life expectancy at age 65 would double during their lifetime, from 10 to 20 years.
There are only 3 ways that the debt burden can be resolved – by major rises in taxation, cuts in services, or default. Greece has shown that electorates will not support the first two options forever. The recent tremors in government bond markets are thus a first sign that investors are realising the 3rd option may eventually prove inevitable.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 45%. “Prices have moved lower this week with excess product in Asia and the US said to be the key causes”
Brent crude oil, down 37%
Naphtha Europe, down 34%. “The naphtha arbitrage window from Europe to Asia is only marginally open but is described by traders as the best money-making option this week”
PTA China, down 27%. “Domestic prices were largely on a downtrend, attributed mainly by weaker downstream polyester conditions.”
HDPE US export, down 18%. “Domestic export prices remained stable during the week, though there were reports of increased trading”
¥:$, down 18%
S&P 500 stock market index, up 9%