The End of “Business as Usual”

In my interview for Real Vision earlier this month, (where the world’s most successful investors share their thoughts on the markets and the biggest investment themes), I look at what data from the global chemical industry is telling us about the outlook for the global economy and suggest it could be set for a downturn.

“We look at the world and the world economy through the lens of the chemical industry. Why do we do that? Because the chemical industry is the third largest industry in the world after energy and agriculture. It gets into every corner of the world. Everything in the room which you’ll be watching this interview is going to have chemicals in it. And the great thing is, we have very good, almost real time data on what’s happening.

“Our friends at the American Chemistry Council have data going back on production and capacity utilization since 1987. So 30 years of data, and we get that within 6 to 8 weeks of the end of the month. So whereas, if you look at IMF data, you’re just looking at history, we’re looking at this is what’s actually going on as of today.

“We look, obviously, upstream, as we would call it, at the oil and feedstocks markets, so we understand what’s happening in that area. But we also– because the chemical industry is in the middle of the value chain, you have to be like Janus. You have to look up and down at the same time, otherwise one of these big boys catches you out.

“And so we look downstream. And we particularly look at autos, at housing, and electronics, because those are the big three applications. And of course, they’re pretty big for investors as well. So we see the relative balance between what’s happening upstream, what’s  happening downstream, where is demand going, and then we see what’s happening in the middle of that chain, because that’s where we’re getting our data from.

“As the chart shows, our data matches pretty well to IMF data. It shows changes in capacity utilization, which is our core measurement. If if you go back and plot that against history from the IMF, there is very, very good correlation. So what we’re seeing at the moment– and really, we’ve been seeing this since we did the last interview in November— is a pretty continuous downturn.

“One would have hoped, when we talked in November, we were talking about the idea that things have definitely cooled off. Some of that was partly due to the oil price coming down. Some of that was due to end of year destocking. Some of that was due to worries about trade policy. Lots of different things, but you would normally expect the first quarter to be fairly strong.

“The reason for this is that the first quarter– this year, particularly– was completely free of holidays.  Easter was late, so there was nothing to interrupt you there. There was the usual Lunar New Year in China, but that always happens, so there’s nothing unusual about that.

And normally what happens is, that in the beginning of the new year, people restock. They’ve got their stock down in December for year end purposes, year end tax purposes, now they restock again. And of course, they build stock because the construction season is coming along in the spring and people tend to buy more cars in that period, and electronics, and so on.

“So everything in the first quarter was very positive. And one wouldn’t normally be surprised to start seeing stock outs in the industry, particularly after a quiet period in the fourth quarter. And unfortunately, we haven’t seen any of that. We’ve seen– and this is worth thinking about for a moment– we’ve seen a 25% rise in the oil price because of the OPEC Russia deal, but until very recently we haven’t seen the normal stock build that goes along with that.”


As we note in this month’s pH Report, however, this picture is now finally changing as concern mounts over oil market developments – where unplanned outages in Venezuela and elsewhere are adding to the existing cutbacks by the OPEC+ countries. Apparent demand is therefore now increasing as buyers build precautionary inventory against the risk of supply disruption and the accompanying threat of higher prices.

In turn, this is helping to support a return of the divergence between developments in the real economy and financial markets, as the rise in apparent demand can easily be mistaken for real demand. The divergence is also being supported by commentary from western central banks.  This month’s IMF meeting finally confirmed the slowdown that has been flagged by the chemical industry since October, but also claimed that easier central bank policies were already removing the threat of a recession.

We naturally want to hope that the IMF is right. But history instead suggests that periods of inventory-build are quickly reversed once oil market concerns abate.

Please click here if you would like to see the full interview.

Oil price fall creates major inventory risk for chemical markets

Olefins Jan15Oil prices have now fallen $50/bbl since I forecast their collapse in August.  But it is only recently that companies and investors have begun to realise this price fall is real, and not just a minor blip.  As a result, few have yet recognised the extent of the collateral damage that is likely to appear in H1.

Of course, low oil prices are generally good for the economy, as they help to boost consumer spending on discretionary items.  But it takes time for these positive effects to come through, as we saw in the 1985 and 2008 oil price collapses:

  • People who lose money from the oil price fall stop spending immediately
  • Those who gain money take time to accept it is safe to spend more
  • And this time, there is another factor – namely that oil prices will now trigger deflation in Japan and Europe
  • Deflation means people pay down debt as it becomes more expensive, and delay discretionary purchases as prices will be cheaper tomorrow

Chemical markets, as always, are the leading indicator for this behaviour, as the chart shows for the two most important products – ethylene and propylene – where annual price histories exist since 1978 and 1979 respectively:

  • It shows prices for N Sea oil on the vertical axis in $/bbl, and product prices in $/tonne on the horizontal axis
  • Prices are shown by annual average by decade – 1970s, brown; 1980s, red; 1990s, green; 2000s, pink
  • This also highlights just how unusual recent price levels have been in the historical context
  • The trend line shows European prices for both products have a greater than 95% correlation to oil
  • Contract prices are 96% correlated for ethylene, and 97% correlated for propylene

Oil prices averaged $99/bbl in 2014 versus average ethylene contract prices of $1544/t and propylene prices of $1481/t in Europe.  At today’s Brent oil price of ~$50/bbl, the equivalent price is $900/t for ethylene and $775/t for propylene.

This represents a loss of nearly $650/t for ethylene, and $700/t for propylene in less than 6 months.  Multiply this by total inventory, and the hit to working capital is enormous.

This is why, as we have seen in recent months, buyers all down the value chain disappear very quickly very quickly when prices fall.  They have to run down inventory as fast as possible to avoid bankruptcy.

In addition, of course, many companies will now have to write off capital investments made on the false assumption that oil would remain above its relative energy value to gas.

Of course, these developments are still only the early stages of the Great Unwinding of policymaker stimulus now underway.  Companies and investors therefore need to move quickly to respond to this changed world.

‘Business as usual’ is, unfortunately, not an option for 2015 – especially as oil prices probably still have another $20/bbl or more to fall.


The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:

Benzene Europe, down 53%. “Falling global prices, sluggish derivative demand and a bearish macroeconomic outlook saw the European benzene market drop below $600/tonne by mid-December 2014, the lowest point spot prices have been since May 2009”
Naphtha Europe, down 46%. “Crude oil futures remained on their downward trend amid the ongoing oversupply of physical crude around the globe.”
Brent crude oil, down 45%
PTA China, down 39%. ”Market sentiment was largely bearish because of weaker sales in the downstream polyester markets”
¥:$, down 18%
HDPE US export, down 12%. “A trader had heard of extreme discounts being offered to move material offshore”
S&P 500 stock market index, up 5%