Brazil, Russia, India and China disappoint as manufacturers face investment demands of EVs © Bloomberg
Less than a third of China’s 31,000 auto dealers were profitable in the first half of 2019, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
Auto markets in the Bric countries are facing two major challenges. The first relates to the downturn already under way in the two largest markets, China and India, where 2019 sales seem likely to be at least 10 per cent below the previous year’s levels.
The second is the need for manufacturers and parts suppliers to spend billions of dollars on the transition to electric vehicles in order to meet Chinese government production targets in 2021-23.
It therefore seems probable that winners and losers will emerge over the next 18 months, as companies along the value chain find themselves short of cash to fund the new investments required.
China’s downturn is particularly important as sales in Brazil, Russia and India have already fallen by 20 per cent since peaking in 2012, as the chart below shows (January-November basis). Chinese sales have been in a downturn for more than a year, and the impact is broadening along the supply chain.
As Automotive News reported: “We knew China had been in a prolonged auto sales slump, and we knew the market was under pressure from tougher municipal and provincial emissions standards. Now, we’re seeing how these factors are devastating dealerships, to the tune of half of them being sold and several hundred being driven out of business.”
Less than a third of China’s 31,000 dealerships were profitable in the first half of 2019. The downturn is particularly bad news for western manufacturers, whose global profits have depended on China volumes.
US brands are worst hit, with January-November sales down 23 per cent due to frictions caused by the US-China trade war. General Motors reported third-quarter China sales down 17.5 per cent, continuing their slide since the second quarter of 2018, with sales also hit by strong competition in the key mid-priced sport utility vehicle segment. Ford saw its third-quarter sales fall 30 per cent — accelerating the downturn that began at the end of 2017.
French brands are having a difficult time, with volume down 54 per cent in January-November. Seventy per cent of Peugeot, Citroën and Renault’s dealerships were lossmaking in the first half of last year.
Korean brands were down 15 per cent, and even German brands had no growth over the previous year.
The problem is magnified by the fact that China’s market has seen rapid growth since 2008. Many companies and dealerships therefore assumed that the sales ramp-up from 550,000 vehicles a month in 2008 to 2m a month by 2016 was somehow “normal”. They have no concept of a slowdown, or how to survive it.
The downturn is likely to intensify as the government continues to squeeze the shadow banking sector and hence the property market. As the chart below shows, shadow lending remains well down on its earlier peaks, averaging just $67bn a month in the 10 months to October. This means, as we noted here a year ago, that “buyers can no longer count on windfall gains from property speculation to finance their purchase”.
As Reuters notes, the scale of the previous stimulus-driven growth also means that today, “much of the urban middle class has already purchased a vehicle. Household ownership rates were nearing 50 per cent in the provincial-level cities of Beijing and Tianjin and the wealthy province of Zhejiang by the end of 2017… Pushing ownership further down the income scale in urban areas as well as out into the poorer countryside is harder without generous tax incentives, plentiful credit and fast growth in incomes.”
Sales in the other Bric markets are also slowing. India’s sales were down 13 per cent at the end of November, while in Russia the industry is now forecasting a 2 per cent decline. Even in Brazil, industry trade group Anfavea has reduced its growth forecast to 8 per cent, due to the slowing Latin American economy.
The downturn creates a major dilemma for the industry, as it coincides with the need to commit to major new investments in EV manufacture.
China is proposing to set a 14 per cent target for EV production in 2021, rising to 16 per cent in 2022 and 18 per cent in 2023. Similarly, the industry ministry has called for EVs to be 25 per cent of total new car sales by 2025, and announced that “regions with ripe conditions have our support if they establish trial projects to establish no-go zones for gasoline-powered vehicles and replace them with new energy vehicles in the urban public transport system”.
Companies therefore have to move forward with EV investments, even though their profits are under pressure from the sales downturn.
Volkswagen, for example, is planning to open two Chinese EV factories this year with total capacity of 600,000 cars, and aims to produce 11.6m EVs in China by 2028. Tesla is opening capacity for 250,000 cars and plans to double production in the future.
With other manufacturers following suit, some in the industry expect EV prices to fall below those for internal combustion engines within the next two years, which would further accelerate the transition.
The industry is therefore faced with a stark choice. The need to commit to EV manufacture means there is no “business as usual” strategy for either manufacturers or parts suppliers. Those who decide to conserve their cash risk finding themselves without the relevant products and services in the world’s largest auto market.
Paul Hodges publishes The pH Report.
On Monday, I discussed how OPEC abandoned Saudi Oil Minister Naimi’s market share strategy during H2 last year.
Naimi’s strategy had stopped the necessary investment being made to properly exploit the new US shale discoveries. But this changed as the OPEC/non-OPEC countries began to talk prices up to $50/bbl. As CNN reported last week:
“Cash is pouring into the Permian, lured by a unique geology that allows frackers to hit multiple layers of oil as they drill into the ground, making it lucrative to drill in the Permian even in today’s low prices.”
Private equity poured $20bn into the US shale industry in Q1
Major oil companies were also active, with ExxonMobil spending $5.6bn in February
US oil/product inventories have already risen by 54 million barrels since January last year and are, like OECD inventories, at record levels. And yet now, OPEC and Russia have decided to double down on their failing strategy by extending their output quotas to March 2018, in order to try and maintain a $50/bbl floor price. US shale producers couldn’t have hoped for better news. As the chart shows:
US inventories would be even higher if the US wasn’t already exporting nearly 5 million barrels/day of oil products
It is also exporting 500 kb/d of oil since President Obama lifted the ban in December 2015
Nobody seems to pay much attention to this dramatic about-turn as they instead obsess on weekly inventory data
But these exports are now taking the fight to OPEC and Russia in some of their core markets around the world
None of this would have happened if Naimi’s policy had continued. Producers could not have raised the necessary capital with prices below $30/bbl. But now they have spent the capital, cash-flow has become their key metric.
The second chart confirms the turnaround that has taken place across the US shale landscape, as the oil rig count has doubled over the past year. Drilling takes between 6 – 9 months to show results in terms of oil production, and so the real surge is only just now beginning. Equally important, as the Financial Times reports, is that today’s horizontal wells are far more productive:
“This month 662 barrels/d will be produced from new wells in the Permian for every rig that is running there, according to the US government’s Energy Information Administration. That is triple the rate of 217 b/d per rig at the end of 2014.”
Before too long, the oil market will suddenly notice what is happening to US shale production, and prices will start to react. Will they stop at $30/bbl again? Maybe not, given today’s record levels of global inventory.
As the International Energy Agency (IEA) noted last month, OECD stocks actually rose 24.1mb in Q1, despite the OPEC/non-OPEC deal. And, of course, as the IEA has also noted, the medium term outlook for oil demand has also been weakening as China and India focus on boosting the use of Electric Vehicles.
The current OPEC/non-OPEC strategy highlights the fact that whilst the West has begun the process of adapting to lower oil prices, many oil exporting countries have not. As Nick Butler warns in the Financial Times:
“Matching lower revenues to the needs of growing populations who have become dependent on oil wealth will not be easy. It is hard to think of an oil-producing country that does not already have deep social and economic problems. Many are deeply in debt.
“In Nigeria, Venezuela, Russia and even Saudi Arabia itself the latest fall, and the removal of the illusion that prices are about to rise again, could be dangerously disruptive. The effects will be felt well beyond the oil market.”
OPEC and Russia made a massive mistake last November when when they decided to try and establish a $50/bbl floor for world oil prices. And now they have doubled down on their mistake by extending the deal to March 2018. They have ignored 4 absolutely critical facts:
Major US shale oil producers were already reducing production costs below $10/bbl, as the Pioneer chart confirms
The US now has more oil reserves than Saudi Arabia or Russia, with “Texas alone holding more than 60bn barrels”
At $30/bbl, US producers couldn’t raise the capital required to exploit these newly-discovered low-cost reserves
But at $50/bbl, they could
Former Saudi Oil Minister Ali Naimi understood this very well. He also understood that OPEC producers therefore had to focus on market share, not price, as Bloomberg reported:
“Naimi, 79, dominated the debate at OPEC’s November 2014 meeting, according to officials briefed on the closed-door proceedings. He told his OPEC counterparts they should maintain output to protect market share from rising supplies of U.S. shale oil.”
Naimi’s strategy was far-sighted and was working. The key battleground for OPEC was the vast Permian Basin in Texas – its Wolfgang field alone held 20bn barrels of oil, plus gas and NGLs. By January 2016, oil prices had fallen to $30/bbl and the Permian rig count had collapsed, as the second chart confirms:
Naimi had begun his price war in August 2014, and reinforced it at OPEC’s November 2014 meeting
Oil companies immediately began to reduce the number of highly productive horizontal rigs in the Permian basin
The number of rigs peaked at 353 in December 2014 and there were only 116 operating by May 2016
But then Naimi retired a year ago, and with him went his 67 years’ experience of the world’s oil markets. Almost immediately, OPEC and Russian oil producers decided to abandon Naimi’s strategy just as it was delivering its objectives. They thought they could effectively “have their cake and eat it” by ramping up their production to record levels, whilst also taking prices back to $50/bbl via a new alliance with the hedge funds, as Reuters reported:
“OPEC and some of the most important hedge funds active in commodities reached an understanding on oil market rebalancing during informal briefings held in the second half of 2016…. OPEC effectively underwrote the fund managers’ bullish positions by providing the oil market with detail about output levels and public messaging about high levels of compliance”.
This gave the shale producers the window of opportunity they needed. Suddenly, they could hedge their production at a highly profitable $50/bbl – and so they could go to the banks and raise the capital investment that they needed.
As a result, the number of rigs in the Permian Basin has nearly trebled. At 309 last week, the rig count is already very close to the previous peak.
The Permian is an enormous field. Pioneer’s CEO said recently he expects it to rival Ghawar in Saudi Arabia, with the ability to pump 5 million barrels/day. It is also very cheap to operate, once the capital has been invested. And it is now too late for OPEC to do anything to stop its development.
On Thursday, I will look at what will likely happen next to oil prices as the US drilling surge continues.
Mention India to many CEOs and investors, and they will smile broadly at the thought of its “demographic dividend”.
Two-thirds of India’s population are under-35,and are already swelling the numbers of those in the critical Wealth Creator 25 – 54 age group which drives economic growth. As the chart shows:
India’s median age is just 27 years today. It will still be only 31 years by 2030
The Wealth Creator cohort is already 523m, and will reach 652m by 2030, whilst the Under-25 cohort is over 600m
There are only 169m in the New Old 55+ generation. Although life expectancy in India is now 69 years, it was just 37 years as recently as 1950
Helpfully, a major new survey by India’s Centre for the Study of Developing Societies provides new evidence on the hopes and values of this vast younger generation. It aims:
“At understanding the social and psychological wellbeing of young people….because if the expectations of this growing mass of youth are not addressed on time, then the disappointments of this burgeoning population could translate into social unrest and even violence.”
Its key findings are critically important:
One-third of young people are classed as students, up from just 13% during the last survey in 2007. But many are apparently “studying further to delay entry into the workforce or perhaps as a means of ‘timepass’
There is also a clear caste divide in terms of access to education, with “42% of Upper Caste youth reporting themselves as students, compared to 25% of Dalit youth and just 16% of Adivasi.”
“Agriculture is the largest employer of India’s youth” – and 39% of these young people are lowly-paid hired workers
Unsurprisingly, given this background, nearly 1 in 5 young people are worried about jobs and employment, whilst 1 in 10 worry about inequality and corruption
India’s youth also tend to be conservative – 53% oppose dating before marriage, 45% oppose inter-religious marriages and 36% oppose inter-caste marriages. And the survey adds:
“We also ascertained the youth’s opinion on contentious issues which have been at the centre stage of the ongoing debate over liberty and progressive beliefs – banning of movies which hurt religious sentiments, beef consumption and death penalty. We find that 60% supported banning movies which hurt religious sentiments. 46% object to allowing beef consumption and 49% support retaining capital punishment. These figures clearly indicate that most youngsters remain averse to progressive beliefs on political issues.”
As the Financial Times notes in its comments on the survey:
“Religion retains a powerful grip. Nearly half give religion precedence over science when they clash, while just a third would privilege science over religion….more than half of youths believe women should always listen to their husbands. Nearly two-fifths feel it is inappropriate for a woman to work after marriage, while a significant 38% feel women should not wear jeans.”
Similarly, 40% of young Indian women “favoured the idea of an obedient wife”
The survey evidence confirms a critical paradox about India:
Most young Indians have smartphones and are style-conscious
Yet like most poor people, they are very conservative in their social attitudes, with patriarchy deeply-rooted
It is very easy for non-Indians – seeing television news or making an overnight visit en route to/from China – to simply see the smartphones and fashion, and assume India has now become a middle class society by Western standards. Of course, it does have relatively rich people. But fundamentally, as Indians all know, it remains a very poor country with average earnings just INR 272/day ($4.20) – and less than two-thirds of adults are literate.
There are vast opportunities in India, once one accepts these key facts. These are often focused on helping people to build a better life for themselves – one example, as premier Modi has highlighted, is in providing toilets for the 600m who currently lack access to them.
Hindustan Unilever has understood this basic truth for many years, and has become India’s largest consumer products company as a result. Their mission statement is simple and powerful – “doing well by doing good“.
It is hard to be optimistic about the outlook for 2017.
The good news is that policymakers are finally giving up on the idea that stimulus can somehow return us to the growth levels seen when the Baby Boomers were young. As the Bank of England note in a new Report:
”Economic theory suggests that a fall in interest rates should lead to higher household spending, because lower returns on savings decrease the amount of future consumption that can be achieved by sacrificing a given amount of spending today
But as the chart shows, “when asked about how they might respond to a hypothetical further fall in mortgage payments, households reported that paying off debt and saving more were likely to be a more common response than increasing spending”
45% said they would save more, 50% said they would use money saved on mortgage payments to pay down debt and only 10% said they would increase their spending.
Unfortunately, companies and investors will now pay the costs of this failed experiment, as markets return to being based on supply and demand fundamentals, rather than central bank money-printing. Five major risks face the global economy, as my new 2017 Outlook highlights:
□ Global recession: The American Chemistry Council (ACC) index of global capacity utilisation is the best indicator that exists in terms of the outlook for the economy. As I noted last month, it has been falling since December 2015, and its latest reading is close to the all-time low seen in March 2009
□ Populist policies are gaining support: Populists provide simple answers to complex questions, and 2016 saw them gain major success with the Brexit vote for the UK to leave the EU, Donald Trump winning the US Presidency, and Italy’s referendum creating the potential for the country to vote on leaving the euro
□ Protectionism is replacing globalisation: One key result of these changes is that countries are turning inwards. The Doha and Transatlantic Trade and Investment Partnership trade deals are effectively dead, and President-elect Trump has promised to cancel the Trans-Pacific Partnership deal on coming into office
□ Interest rates are rising around the world: Investors have begun to worry about return of capital, rather than just return on capital. Benchmark 10-year interest rates have doubled in the US since the summer. They have also trebled in the UK and doubled in Italy, while negative rates in Germany and Japan have turned positive again.
□ India’s economy is under major strain as a result of the currency reforms, and China’s debt levels remain far too high for comfort. Its housing bubble in the Tier 1 cities has reached price/earnings ratios double those of the US subprime bubble. Its currency is also falling as the economy slows, creating the potential for further trade friction with the new Trump administration
Please click here if you would like to read the full Outlook, and click here to view my 6 minute interview with ICB’s deputy editor, Will Beacham. You can also click here to download a copy of all my New Year forecasts since 2008, when I was warning of a coming financial crash.
2016 saw the Great Reckoning for the failure of stimulus policies begin to impact companies and markets.
The blog’s readership has increased significantly as a a result, as shown in the chart above, with its visits now totaling nearly 500k. Its readership includes 197 countries and over 11k cities. Readers also remain very loyal, with one in two reading it every week, and one in four reading it every day.
The key issue is that consensus wisdom has clearly failed – once again – to provide a reliable guide to the outlook. By contrast, the blog was one of the first to explore the attractions of Populist policies, and to suggest that the UK government would lose the Brexit vote, and that Donald Trump would likely become President.
Even today, however, most “expert commentary” continues to ignore these developments, and the later Italian referendum, and instead believes we will see “business as usual” in 2017. Yet developments in the world’s 2 most important economies, the USA and China, suggest that in reality, this is the least likely option:
In the USA, President-elect Trump continues to focus on the need to reshore jobs from overseas, particularly China, in order to “make America great again”. As Peter Navarro, head of Trump’s new White House National Trade Council, told the New York Times:
“Imposing steep tariffs on China was an essential step to begin to address the American trade deficit with China, which reached $365bn last year. He blamed Chinese trade practices for “destroying entire industries, hollowing out entire communities” and “putting millions out of work.” His colleague, Prof Greg Auty added:
“The Trump camp was dead serious about its threats to impose tariffs on China. The goal is to force manufacturers to come back to the United States as a condition of selling into the American market. A full-on trade war between the world’s two largest economies would cost American jobs in the immediate term, but eventually millions of new ones would be created as the United States again hummed with factory work.
“We moved our supply chain to Asia in about two decades,” he said. “You certainly can do it in the U.S. a whole lot faster. It’s going to take a few years, but it’s going to be a much better America.” (my emphasis)
In China, as Xinhua reports, bursting the property bubble has become the key target of government policy:
“President Xi Jinping highlighted curbing property bubbles at a meeting of the Central Leading Group on Finance and Economic Affairs on Wednesday, the fourth time asset bubbles were mentioned by Chinese leaders in the second half of the year.
“China will take a varied approach to regulating the property market, adopting financial, fiscal, tax, land and regulation measures to build a long-term housing mechanism that provides housing for all people, according to Xi. Thanks to policies introduced by local authorities in October, the property market in big cities continued to stabilize in the last month, gradually retreating from sky-high prices.
“Houses are built for living, not for speculation,” policymakers have agreed.”
In addition, of course, a number of major challenges exist in other parts of the global economy:
The recent Italian referendum means the collapse of the Eurozone has become a real possibility
The future of the European Union itself is also under threat given the Brexit votes and upcoming elections in The Netherlands, France and Germany
Oil markets will likely see further volatility as the inevitable cracks appear in the recent OPEC output cuts deal
India’s currency reforms pose a further threat to the outlook for the world’s 6th largest economy, as premier Modi’s 50-day deadline for resolving all the problems ends today
I will do my best to follow these and other critical developments in 2017. Thank you for your continued support.