We are living in a New Normal world. Populists such as Nigel Farage, Donald Trump, Marine le Pen and Beppe Grillo are gaining support as economic growth slows and social/political unrest becomes common. My presentation at our annual conference last week in Vienna highlighted some of the key issues, as Jessie Waldheim of ICIS news reports.
VIENNA (ICIS)–Markets face a period of increased volatility as political and demographic changes result in a paradigm shift from globalisation to sustainability as the driver for chemical markets, the chairman of consultancy International eChem said on Tuesday.
“The world is at a tipping point,” said International eChem chairman Paul Hodges. “Everything we’ve known, everything we’ve lived with for the last 50-70 years is now changing.”
In 1987, then US president Ronald Reagan stood in front of the Berlin Wall in Germany and demanded that it be torn down. In 2017, US president-elect Donald Trump is expected to build a wall. In Europe, the Brexit vote for the UK to leave the EU and the upcoming referendum in Italy could cause further turmoil for the EU.
These political changes are being driven by demographic changes which are also going to effect petrochemical and other markets. Essentially, as life expectancies have increased and birth rates have lowered, a larger percentage of populations are older.
For example, as the second chart shows, the number of US households in the 25-54 age bracket has been steady while the number in the 55-and-up age bracket has risen by nearly 50%. The older households tend to spend less money, having already made most major purchases.
This is in contrast to recent decades, when major population growth in the younger age brackets drove global demand. ”We don’t have lots of young people, so you don’t need as much stuff,” Hodges said, speaking at the 15th annual World Aromatics & Derivatives Conference in Vienna, Austria.
According to figures from the American Chemistry Council, we’re seeing a drop-off in capacity utilisation, which is the “best single predictor we have” of global GDP, Hodges said. With the capacity utilisation numbers in September 2016 nearly as low as in 2009, we’re likely to see a global recession next year, he added.
Our economy has not yet adapted to the new demographics. This adaptation will mean uncertainty and political risk. ”We’re seeing the rise of protectionism. Sustainability is replacing globalisation,” Hodges said.
Trump has said he has plans to declare China a currency manipulator and to withdraw from or renegotiate trade deals. The Brexit vote is part of this same paradigm shift. “We need to be planning for this,” Hodges said.
Specifically for aromatics markets, benzene price spreads have already come down. Benzene is a byproduct and refineries don’t increase production when benzene is tight and won’t slow production if less benzene is needed. ”We’ve seen benzene below naphtha before. We could see benzene trading below naphtha again,” Hodges said. “We have to accept the volatility is there.”
Companies will need to consider how trade flows will change with China no longer the major importer and manufacturing capital of the world. And companies will need to consider inter-polymer competition from lower polypropylene prices. Businesses models will have to change and restructuring will be inevitable.
Key chemical hubs will have to be made more robust, and being near customers may become more important, Hodges said. With the change comes opportunities. For instance, businesses could focus on designing solutions with new materials or by repurposing materials already in the market.
“Aging populations are an opportunity. Why are we not developing new services and products for them?” Hodges said.
Capacity 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.
2013 has seen 3 types of markets develop for the blog’s IeC Downturn Monitor portfolio as the chart above shows:
- Financial assets such as the S&P 500 (purple) have soared, as did the US$ against the yen (orange)
- Crude oil (blue) and naphtha (black) tried to follow, but found it difficult to pass though the higher prices
- Benzene (green) and PTA (red) have struggled with weak demand and high feedstock prices
The anomaly has been US polyethylene (yellow), where prices have stayed relatively strong as producers chose to focus on margin rather than volume.
This might seem a strange decision, given they enjoy a major feedstock cost advantage on ethylene due to shale gas. But it makes perfect sense when seen against the limited potential for selling additional export volumes. As the charts above show, based on trade data from Global Trade Information Services, there is really little scope for selling more PE or PVC (the main derivatives):
- Total PE net volumes are up 16% (blue column) versus 2011 (red) this year due mainly to a 26% increase to Latin America
- This region now takes three quarters of US net exports, as the percentage of sales to Asia has halved
- Total PVC net sales are up just 7% this year versus 2011, and flat versus 2012 (green)
- Exports are focused on Turkey, Mexico, Russia and Egypt: Asian volumes have also dropped versus 2011-12
This message does not yet seem to have got home to investors. They look at the raw data, and see just rising volumes and high margins. So they imagine that the world, and Asia in particular, are just waiting for additional volumes to appear.
What they miss is that Asian and LatAm countries are busy expanding their own production as fast as possible, so as to create jobs. They also forget that China’s slowdown is also now impacting Latin America’s demand. Equally, they overlook the fact that Brazil’s vast increase in PVC imports (double 2011 levels) and in PE (up 34%), is mostly a one-off bonus due to preparations for the soccer World Cup and the Olympics.
The operating managers with whom the blog talks understand all this very well. Some have special grades of PE that currently cannot be supplied by domestic competition in the importing countries. But most appreciate there is little point trying to sell additional volume, as this would merely lead to a price war and lower margins. They also know, unlike investors, that exporting additional volumes – if major new capacity is built – will be very hard indeed.
The chart shows latest portfolio price movements since January 2013 with ICIS pricing comments below:
PTA China, red, down 17%. “Downbeat market outlook for the downstream polyethylene terephthalate (PET) and polyester fibre demand”
Benzene Europe, green, down 14%. “Players are generally in the midst of running down inventories ahead of year-end rather than building stock.”
Brent crude oil, blue, down 1%
Naphtha Europe, black, up 3%. “European arbitrage window to Asia is well and truly shut, but domestic petrochemical demand will continue to prop up prices as crackers minimise the use of the more expensive alternative feedstock propane”
HDPE USA export, yellow, up 13%. “Limited trade in the week shortened by the US Thanksgiving holiday.
US$: yen, orange, up 16%
S&P 500 stock market index, purple, up 23%
Crude oil markets long ago lost their role of price discovery. Since early 2009, they have instead been dominated by pension funds seeking to find a ‘store of value’ as the US$ weakened, along with hedge funds enjoying a money-making ‘momentum play‘. The reason has been the $tns spent by western central banks in their liquidity programmes. As the chart of Brent prices shows, each new programme has pushed oil prices higher:
• The G-20 meeting in April 2009 stopped them stabilising in their historical $10-$30/bbl range, to which they had just returned after the 2005-8 financial bubble
• QE2 stopped the downturn underway in the summer of 2010 and sent prices higher again
• Twist in 2011 and then the European Central Bank (ECB) in 2012 had the same impact
• Now the Bank of Japan (BOJ) has launched its own, equally large programme
However, the BOJ has a slightly different agenda. It aims to devalue the yen, not the US$. And the yen has already fallen close to $1: ¥100 compared to $1: ¥93 before the new policy was launched on 4 April. If it succeeds, then clearly US pension funds will have no further reason to buy crude oil. And so prices could easily start to reconnect with fundamentals. At the same time, the S&P 500 could continue to rise, as yen-based investors seek their own ‘store of value’.
The fundamentals are dreadful, as the blog will discuss in more detail tomorrow. So without pension and hedge fund support, prices could easily return to $50/bbl, and then decline back to their historical trading range. This would also return them to the traditional relationship with US natural gas prices. Whilst this is currently regarded as ‘impossible’, the blog has always seen ‘reversion to the mean‘ as its favourite investment strategy.
Meantime, of course, chemical markets are locked in ‘wait and see’ mode. Q2 has not seen any major increase in demand, so buyers are reluctant to push purchase prices lower as this would merely devalue their own inventory. Similarly producers long ago abandoned hopes of gaining market share, and are content to maintain the status quo.
If oil prices start to slide, however, these dynamics will clearly change. Naphtha fell a further 6% last week, and is now down 14% on its high a month ago. This is an astonishing move, at a time of supposedly peak demand, and highlights the potential weakness ahead as we go into the quieter summer months.
Benchmark price movements since the IeC Downturn Monitor’s April 2011 launch and latest ICIS pricing comments are below:
Naphtha Europe, down 28%. “1-1.1MT of deep-sea naphtha supply will land in Asia in May”
PTA China, down 20%. “Downstream polyester yarn, fibre and PET bottle chip demand are at their peak season in April-May”
Brent crude oil, down 16%
HDPE USA export, down 13%. “One trader believed that prices would begin to fall soon as producers realize their prices are attracting little interest from global buyers”
Benzene NWE, flat. “Domestic market was still relatively quiet and thin”
S&P 500 stock market index, brown, up 17%
The blog is extremely concerned about recent market developments.
Nobody minds higher prices, if they are a response to strong demand and can be passed through to customers. But today’s high prices have nothing to do with strong demand. On the contrary, in fact. Most consumers are actually reducing output.
Equally, the wider economic outlook continues to weaken:
• European demand is very weak in most key industries. Auto sales are already 7% below 2011 levels, and seem likely to fall further
• US demand is slowing, as monitored by the ACC’s new Barometer, whilst policymakers are focused on the upcoming Presidential election
• China’s demand for products such as polyethylene is below 2011 levels. Yet leadership changes underway have created a power vacuum
Financial markets, however, have once again bid up crude oil prices in the mistaken belief that demand is ‘about to recover’. Yet anyone on the ground could tell them this was mistaken. All that is happening is that buyers are again rushing to cover short-term needs as crude rises.
Another reason for concern is that these moves are taking place in very thin August markets. Many executives are either on the beach, or otherwise away from their desks. They will be horrified by what they find on their return. Hence the blog’s own concern.
Benchmark price movements since the IeC Downturn Monitor’s 29 April 2011 launch, with latest ICIS pricing comments, are below:
PTA China down 24%. “Supply shortage was caused by three typhoons which struck China’s east coast”
HDPE USA export down 22%. “Material remaining in short supply”
Naphtha Europe down 16%. “Between 500kt-700kt from NWE and the Med are set to arrive in Asia during August/September”
Brent crude oil down 10%
Benzene NWE down 3%. “The bullishness for benzene in recent months has seen styrene producers cut back operating rates due to poor economics”
S&P 500 Index up 3%
Trading volumes in financial markets are very low these days. Many ordinary investors are on holiday, and others are focused on the Olympics. So it is easy for the high-frequency computers to create major volatility – and large profits for their owners.
Thus they managed to create a 1.5% fall in the S&P 500 on Thursday,and a 1.9% rise on Friday. But there was no real ‘news’ to drive the market. Thursday’s fall was due to ‘disappointment’ over the lack of immediate action by the European Central Bank (ECB). But as Reuters had already noted, a number of key steps have to occur before the ECB can act:
• Spain has to formally request ECB help – something resisted till now
• Euro leaders have to allow the bailout fund buy bonds at auction
• The German Bundesbank must agree
• Germany’s Constitutional Court must also agree
The first 2 items are likely to occur. Spain will find it better to ‘lose face’ than go bankrupt. Whilst politicians see ECB action as ‘easier’ than making painful decisions on spending cuts themselves. But the German position is less easy to read, although the computers were optimistic on Friday.
The Bundesbank is so far resisting the proposed deal, whilst the Constitutional Court ruling on the legality of bond-buying is not due till 12 September. Neither can be taken for granted. The price of agreement is to effectively commit Germany to unlimited costs in defence of the euro.
This volatility also has real-world impact. As the chart shows, it is allowing the ‘correlation trade’ to continue to operate. The computers work on algorithms, and push up the prices of all financial assets together:
• S&P 500 (blue line) moves are mirrored by WTI (green) and Brent (red)
• Thus Friday’s S&P 500 rise also added $3 – $4/bbl to oil prices
In the real world, this simply makes life even worse for companies and consumers. Oil prices have been in the demand destruction zone for over 2 years now. When the reckoning finally comes, it could be very painful indeed.
Benchmark price movements since the IeC Downturn Monitor’s 29 April 2011 launch, with latest ICIS pricing comments, are below:
PTA China down 25%. “Production cutbacks in Taiwan, South Korea and Thailand, which began in early June, continued in August because of negative margins”
HDPE USA export down 22%. “Global demand was easing, with many countries buying only as much material as they need
Naphtha Europe down 19%. “Demand is still increasing from the petchem sector, as the propane-naphtha price spread currently favours naphtha.”
Brent crude oil down 15%
Benzene NWE unchanged. “An ongoing lack of material”
S&P 500 Index up 2%