It is almost a year since Donald Trump became President. And whilst he has not followed through on many of his promises, he has indeed introduced the major policy changes that I began to discuss in September 2015, when I first suggested he could win the election and that the Republicans could control Congress:
“In the USA, the establishment candidacies of Hillary Clinton for the Democrats and Jeb Bush for the Republicans are being upstaged by the two populist candidates – Bernie Sanders and Donald Trump….Companies and investors have had little experience of how such debates can impact them in recent decades. They now need to move quickly up the learning curve. Political risk is becoming a major issue, as it was before the 1990s.”
Many people have therefore had to go up a steep learning curve over the past year, given that their starting point was essentially disbelief, as one commentator noted when my analysis first appeared:
“I have a very, very, very difficult time imagining that populist movements could have significant traction in the U.S. Congress in passing legislation that would seriously affect companies and investors.”
Yet this, of course, is exactly what has happened.
It is true that many of the promises in candidate Trump’s Contract with America have been ignored:
- Of his 174 promises, 13 have been achieved, 18 are in process, 37 have been broken, 3 have been partially achieved and 103 have not started
- His top priority of a Constitutional amendment on term limits for members of Congress has not moved forward
Yet on areas that impact companies and investors, such as trade and corporate tax, the President has moved forward:
- On trade, he has not (yet?) labelled China a currency manipulator or moved forward to fix water and environmental infrastructure
- But he has announced the renegotiation of NAFTA, the withdrawal from the Trans-Pacific Partnership, his intention to withdraw from the UN Climate Change programme and lifted restrictions on fossil fuel production
These are complete game-changers in terms of America’s position in the world and its trading relationships.
Over the decades following World War 2, Republican and Democrat Presidents alike saw trade as the key to avoiding further wars by building global prosperity. Presidents Reagan, Bush and Clinton all actively supported the growth of global trade and the creation of the World Trade Organisation (WTO).
The US also led the world in environmental protection following publication of Rachel Carson’s ‘Silent Spring‘ in 1962, with its attack on the over-use of pesticides.
Clearly, today, these priorities no longer matter to President Trump. And already, US companies are starting to lose out as politics, rather than economics, once again begins to dominate global trade. We are returning to the trading models that operated before WTO:
- Until the 1990s, trade largely took place within trading blocs rather than globally – in Europe, for example, the West was organised in the Common Market and the East operated within the Soviet Union
- It is therefore very significant that one of the President’s first attacks has been on the WTO, where he has disrupted its work by blocking the appointment of new judges
Trump’s policy is instead based on the idea of bilateral trade agreements with individual countries, with the US dominating the relationship. Understandably, many countries dislike this prospect and are instead preferring to work with China’s Belt & Road Initiative (BRI, formerly known as One Belt, One Road).
US POLYETHYLENE PRODUCERS WILL BE A CASE STUDY FOR THE IMPACT OF THE NEW POLICIES
US polyethylene (PE) producers are likely to provide a case study of the problems created by the new policies.
They are now bringing online around 6 million tonnes of new shale gas-based production. It had been assumed a large part of this volume could be exported to China. But the chart above suggests this now looks unlikely:
- China’s PE market has indeed seen major growth since 2015, up 18% on a January – November basis. Part of this is one-off demand growth, as China moved to ban imports of scrap product in 2017. Its own production has also grown in line with total demand at 17%
- But at the same time, its net imports rose by 1.8 million tonnes, 19%, with the main surge in 2017. This was a perfect opportunity for US producers to increase their exports as their new capacity began to come online
- Yet, actual US exports only rose 194kt – within NAFTA, Mexico actually outperformed with its exports up 197kt
- The big winner was the Middle East, a key part of the BRI, which saw its volume jump 29% by 1.36 million tonnes
Sadly, it seems likely that 2018 will see further development of such trading blocs:
- The President’s comments last week, when he reportedly called Africa and Haiti “shitholes” will clearly make it more difficult to build long-term relationships based on trust with these countries
- They also caused anguish in traditionally pro-American countries such as the UK – adding to concerns that he has lost his early interest in the promised post-Brexit “very big and exciting” trade deal.
US companies were already facing an uphill task in selling all their new shale gas-based PE output. The President’s new trade policies will make this task even more difficult, given that most of it will have to be exported.
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We are living in a strange world. As in 2007 – 2008, financial news continues to be euphoric, yet the general news is increasingly gloomy. As Nobel Prizewinner Richard Thaler, has warned, “We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping.” Both views can’t continue to exist alongside each other for ever. Whichever scenario comes out on top in 2018 will have major implications for investors and companies.
It therefore seems prudent to start building scenarios around some of the key risk areas – increased volatility in oil and interest rates, protectionism and the threat to free trade (including Brexit), and political disorder. One key issue is that the range of potential outcomes is widening.
Last year, for example, it was reasonable to use $50/bbl as a Base case forecast for oil prices, and then develop Upside and Downside cases using a $5/bbl swing either way. But today’s rising levels of uncertainty suggests such narrow ranges should instead be regarded as sensitivities rather than scenarios. In 2018, the risks to a $50/bbl Base case appear much larger:
- On the Downside, US output is now rising very fast given today’s higher prices. The key issue with fracking is that the capital cost is paid up-front, and once the money has been spent, the focus is on variable cost – where most published data suggests actual operating cost is less than $10/bbl. US oil and product exports have already reached 7mbd, so it is not hard to see a situation where over-supplied energy markets cause prices to crash below $40/bbl at some point in 2018
- On the Upside, instability is clearly rising in the Middle East. Saudi Arabia’s young Crown Prince, Mohammad bin Salman is already engaged in proxy wars with Iran in Yemen, Syria, Iraq and Lebanon. He has also arrested hundreds of leading Saudis, and fined them hundreds of billions of dollars in exchange for their release. If he proves to have over-extended himself, the resulting political confusion could impact the whole Middle East, and easily take prices above $75/bbl
Unfortunately, oil price volatility is not the only risk facing us in 2018. As the chart shows, the potential for a debt crisis triggered by rising interest rates cannot be ignored, given that the current $34tn total of central bank debt is approaching half of global GDP. Most media attention has been on the US Federal Reserve, which is finally moving to raise rates and “normalise” monetary policy. But the real action has been taking place in the emerging markets. 10-year benchmark bond rates have risen by a third in China over the past year to 4%, whilst rates are now at 6% in India, 7.5% in Russia and 10% in Brazil.
An “inflation surprise” could well prove the catalyst for such a reappraisal of market fundamentals. In the past, I have argued that deflation is the likely default outcome for the global economy, given its long-term demographic and demand deficits. But markets tend not to move in straight lines, and 2018 may well bring a temporary inflation spike, as China’s President Xi has clearly decided to tackle the country’s endemic pollution early in his second term. He has already shutdown thousands of polluting companies in many key industries such as steel, metal smelting, cement and coke.
His roadmap is the landmark ‘China 2030’ joint report from the World Bank and China’s National Development and Reform Commission. This argued that China needed to transition: “From policies that served it so well in the past to ones that address the very different challenges of a very different future”.
But, of course, transitions can be a dangerous time, as China’s central bank chief, Zhou Xiaochuan, highlighted at the 5-yearly Party Congress in October, when warning that China risks a “Minsky Moment“, where lenders and investors suddenly realise they have overpaid for their assets, and all rush together for the exits – as in 2008 in the west.
“Business as usual” is always the most popular strategy, as it means companies and investors don’t face a need to make major changes. But we all know that change is inevitable over time. And at a certain moment, time can seem to literally “stand still” whilst sudden and sometimes traumatic change erupts.
At such moments, as in 2008, commentators rush to argue that “nobody could have seen this coming“. But, of course, this is nonsense. What they actually mean is that “nobody wanted to see this coming“. Nobody wanted to be focusing on contingency plans when everybody else seemed to be laughing all the way to the bank.
I discuss these issues in more detail in my annual Outlook for 2018. Please click here to download this, and click here to watch the video interview with ICB deputy editor, Will Beacham.
The post The return of volatility is the key market risk for 2018 appeared first on Chemicals & The Economy.
The above chart is a major wake-up call for anyone who still believes that China will continue to import ever-increasing volumes of major commodities such as polyethylene (PE). It suggests demand and import growth are now at much lower levels than in the past, and may even have begun to peak.
The chart shows cumulative volumes in January-February 2015 (red column), versus 2014 (green), based on trade data from Global Trade Information Services:
- China’s overall demand has fallen 4% versus last year, whilst domestic production has risen 9%
- As a result, imports have fallen 20%, hitting all major Regions
- The Middle East is down 21%, NE Asia down 10%, NAFTA down 61%, Europe down 31%, and SE Asia was flat
There are a number of key messages that jump out from the data.
One key issue is the continuing increase in China’s own production. This is in line with my discussion yesterday of Sinopec’s 2014 results, which confirmed once again that China’s refining and petrochemical industry operates without the need to make Western-style returns on its investment.
A second is that it confirms my concern last year that China’s PE imports were then being artificially inflated by the “collateral trade“. This was a development in China’s shadow banking system, whereby imports of commodities such as PE, copper and iron ore were used as collateral for lending into the property sector*.
A third is confirmation, if confirmation were still needed, that China is unlikely to be very interested in taking additional imports from the planned US expansions. Slowing demand growth, and rising domestic demand production, means that China simply doesn’t need to buy from the US any more.
Instead, it is clearly aiming to increase employment in relatively high-paying industries such as petrochemicals and polymers. This neatly compensates for the loss of jobs in low-margin activities such as plastic film processing, and means that China retains most of the value-added..
This is clearly a difficult message for US producers. But it is better to face reality today, that to commit large sums of money to build new capacity for which there is no market.
* As described last June in my joint note with Polarwide of Hong Kong, Here today and gone tomorrow, a simple guide to China’s world of trade finance