US ethylene spot prices are tumbling as the major new shale gas expansions come on line, as the chart based on ICIS pricing data confirms:
- They began the year at $617/t, but have since more than halved to $270/t on Friday
- They are only around 10% higher than their all-time low of $240/t in September 1998
- WTI crude oil was then $15/bbl and ethane was $0.15c/gal
- On Friday, WTI closed at $70.5/bbl and ethane was $0.25c/gal
The collapse in margin has been sudden, but is hardly unexpected. It is, of course, true that downstream polyethylene plants associated with the crackers were delayed by the hurricanes. So ethylene prices may recover a little once they come online. But unfortunately, that is likely to simply transfer the problem downstream to the polymer markets.
The issue is shown in the second chart, based on Trade Data Monitor data:
- It shows annual US net exports of polyethylene since 2006
- They peaked in 2009 at 2.6 million tonnes as China’s stimulus programme began
- China’s import demand doubled that year to 1 million tonnes, but then fell back again
- Net exports have actually fallen since 2016 to 1.9 million tonnes last year
The problem, of course, was that companies and investors were fooled by the central bank stimulus programmes. They told everyone that demographics didn’t matter, and that they could always create demand via a mix of money-printing and tax cuts. But this was all wishful thinking, as we described here in the major 2016 Study, ‘Demand – the New Direction for Profit‘, and in articles dating back to March 2014.
Unfortunately, the problems have multiplied since then. President Trump’s seeming desire to launch a trade war with China has led to the threat of retaliation via a 25% tariff on US PE imports. And growing global concern over the damage caused by waste plastics means that recycled plastic is likely to become the growth feedstock for the future.
In addition, of course, today’s high oil price is almost certainly now causing demand destruction down the value chains – just as it has always done before at current price levels. People only have so much money to spend. If gasoline and heating costs rise, they have less to spend on the more discretionary items that drive polymer demand.
COMPANIES HAVE TO REPOSITION FAST TO BECOME WINNERS IN THIS NEW LANDSCAPE As I suggested with the above slide at last month’s ICIS World Polymers Conference, today’s growing over-capacity and political uncertainty will create Winners and Losers:
- Ethylene consumers are already gaining from today’s lower prices
- Middle East producers will gain at the US’s expense due to their close links with China
- Chinese producers will also do well due to the Belt & Road Initiative (BRI)
As John Richardson has discussed, China is in the middle of major new investment which will likely make it a net exporter of many polymers within a few years. And it has a ready market for these exports via the BRI, which has the potential to become the largest free trade area in the world. As a senior Chinese official confirmed to me recently:
“China’s aim in the C2/C3 value chains is to run a balanced to long position. And where China has a long position, the aim will be to export from the West along the Belt & Road links to converters / intermediate processors.”
The Losers will likely be the non-integrated producers who cannot roll-through margins from the well-head or refinery. They need to quickly find a new basis for competition.
Luckily for them, one does exist – namely the opportunity to develop a more service-led business model and work with the brand owners by switching to use recycled plastics as a feedstock. As I noted in March:
“Producers and consumers who want to embrace a more service-based business model therefore have a great opportunity to take a lead in creating the necessary infrastructure, in conjunction with regulators and the brand owners who actually sell the product to the end-consumer.”
Time, however, is not on their side. As US ethylene prices confirm, the market is already reacting to the reality of over-capacity. H2 will likely be difficult under almost any circumstances.
The industry made excellent profits in recent years. It is now time for forward thinking producers – integrated and non-integrated – to reinvest these, and quickly reinvent the business to build new revenue and profit streams for the future.
The post US ethylene prices near all-time lows as over-capacity arrives appeared first on Chemicals & The Economy.
Global demand is continuing to slow, yet chemical industry capacity is continuing to ramp up. As a result, supply gluts are likely to appear in many key areas as we move into the second half of the year. That is the key conclusion from the latest American Chemistry Council data for global chemical capacity and production.
“This cannot be true” will likely be your first reaction. After all, margins have been strong so far this year. But margins have been strong because the oil price has been rising – not because demand has been strong:
- Rising oil prices always lull the industry into a state of complacency
- Demand appears to increase as oil prices rise, and we assume this is because of a strengthening economy
- But in fact, it is almost always due to buyers building stock ahead of future price rises
- They know prices will be higher next month, so they rush to beat the inevitable increase
Oil prices have risen around 87% since mid-January, when Brent bottomed at $27/bbl. So there has been an enormous incentive for buyers to build inventory. But this rise has not been due to any shortages – inventories are in fact at near-record levels. Instead, it has been due to pension/hedge fund speculation over the outlook for US interest rates and hence the value of the US$.
This highlights, as the chart above shows, how the global chemical industry has been fooled for the past 5 years by the central banks. They have kept telling us that demand is about to return to previous SuperCycle levels:
- The industry has therefore kept building new capacity at the same rate as in the SuperCycle
- Capacity has therefore risen by around 15% since 2012
- But demand has only risen by 8% over the same period
This means that H2 could be very difficult indeed, if the pension/hedge funds decide to reverse their strategies:
- They guessed correctly the US Federal Reserve would give up on its promised interest rate rise in March
- As a result, they made good profits by reverting to the post-2008 “store of value” trend
- This involved selling the US$ and buying oil and other commodities on the futures markets
But now this game is likely over, as the Fed has recovered its nerve. Fed Chair, Janet Yellen, gave strong hints on Friday that interest rates were likely to rise in June or July. So we may well see the US$ rise again
In turn, buyers will then likely start to destock into the seasonally weak Q3 period, as oil and commodity prices fall. Prudent companies urgently need to develop plans to mitigate the impact of this reversal.
But this will not be easy – as the second chart shows, surplus capacity was already at 25.9% in April – more than twice the average 9.6% level seen in the SuperCycle.
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 53%
Naphtha Europe, down 52%. “France refinery strike has minimal impact on naphtha”
Benzene Europe, down 57%. “A steady flow of imports combined with less consumption in May has seen prices move lower”
PTA China, down 41%. “Plants within 50km of G20 meetings in Hangzhou have been confirmed to be reducing run rates or shutting down their units during that period, while plants within 100km of the meeting locations, such as those in Ningbo or Dalian, continue to be in discussions with authorities on operating statuses. Those within 300km of the meeting locations will shut or reduce run rates for a shorter period of time”
HDPE US export, down 29%. “China’s imported prices were continuing to drop in the week”
¥:$, down 8%
S&P 500 stock market index, up 7%
The decline in China’s electricity consumption growth highlights the remarkable slowdown underway in its Old Normal economy, as the chart shows:
- Consumption growth took off in 2009 under the influence of the stimulus programme
- It rose 6.5% in 2009, and then accelerated further in 2010 when it was up 14.7%
- 2011 growth stayed at double-digit level – meaning consumption was up by more than a third compared to 2008
- It then slowed to 5.5% in 2012 and 7.7% in 2013, before new President Xi introduced his New Normal policies
- Growth fell to 3.8% in 2014, and was barely positive in 2015 at just 0.5%
These developments mirror those seen for commodities such as oil and metals, and for polymers, during the stimulus bubble. The problem was that then-President Hu and Premier Wen panicked at the start of the financial crisis in 2008, due to the job losses being caused in China’s export factories. Fearing major social unrest, which could lead to the end of communist party rule, they doubled lending to $20tn in 2009 – 4x China’s GDP of $5tn. And they kept their foot on the accelerator till they left office in 2013, by when annual lending had reached $28tn.
Temporarily, China’s demand appeared to rescue the global economy. And at the same time, the story spread that this was due to a previously hidden secret – that China had somehow become “middle class” by Western standards, without anyone really noticing. In reality, of course, average incomes were still only $5k/year in 2015.
But no country, not even China, can continue lending at such a rate. Its interest bill in 2015 was $1.7tn – almost equal to India’s GDP. And not only was much of the money wasted in building ghost cities and property speculation, but it also boosted corruption and pollution. Such a vast lending bubble created easy pickings for corrupt officials. And pollution rose to intolerable levels, as 2/3rds of China’s electricity production is based on coal.
Thus Hu and Wen’s 2008 panic ended-up by 2013 in creating an existential threat to continued party rule, as ordinary Chinese suffered the after-effects of the stimulus policy on a daily basis.
This is why President Xi had no choice but to cut back on stimulus, and abandon the idea of further growth in the Old Normal economy. But just as China still suffers from the legacy of pollution and corruption, so the global economy is still suffering from the vast supply gluts created in energy and mining markets, as well as chemicals and polymers:
- These gluts are actually getting worse, rather than better, as lead times mean that companies are still planning to bring new capacity online in the 2016-2018 time-frame
- And continued government stimulus policies outside China mean that companies and investors still find it easy to fund these “white elephants”
The story of China’s electricity consumption boom, and its recent collapse, will be a case study for future historians on the chaotic conditions created by the stimulus policies. For us, living today, it creates a more immediate issue – namely how to manage the supply gluts that they have created.
Business models will have to change as a result, as they are creating a paradigm shift in the global economy. Today’s supply-driven business models, based on the “build it, and they will come” principle, will have to be replaced by a new model focused on securing customer commitments to buy.
The red line in the above chart from the Financial Times shows how far Eurozone growth has diverged since 2008 from the previous SuperCycle trend (in blue).
Unfortunately, most companies failed to spot what might happen as a result of Europe’s ageing population. Instead they spent $bns on new capacity in anticipation of a strong economic recovery. Only now are they beginning to realise how expensive their mistake could prove.
Thus the CEO of major shipping line Maersk has revealed they spent $3.7bn in 2011 on 20 new container ships for the Asia-to-Europe trade route, the world’s busiest. But today, capacity is 10% above demand, and rates have fallen 30% to less than $1k/container. Thus he confessed to the Wall Street Journal:
“It’s pretty clear that when we look back to early part of 2011 when these ships were ordered, ours and everybody else’s view on growth was somewhat different than what it turned out to be and therefore the market will not be as quite as big in 2015 as we thought it to be.”
It is, of course, not true that ‘everyone else’s view on growth’ was similar to his. Sadly, like too many CEOs, he believed the hype from policymakers and the central banks. A quick read of the first chapters of Boom, Gloom and the New Normal (which began publication in May 2011) might have provided food for thought about alternative views on the outlook for growth.
The chart also highlights how Eurozone GDP is now 15% below its trend-line growth (dotted red line). Just as first discussed back in December 2008, we have seen an L-shaped recovery.
Sadly Western policymakers still insist their models are right, despite the evidence on the ground. But at least China’s new leadership are being more realistic, and now accept they will now have lower growth due to the loss of the previous ’demographic dividend’. As a leading member of China’s Academy of Social Sciences explained recently ahead of the November plenum:
“Over the past three decades, China’s economy saw an average annual growth rate of almost 10%. There are many reasons for the rapid growth, but a major one was the country’s favorable demographic structure.”
In early March, the blog described itself as feeling like “a lonely voice, focused on what is really happening in the real world”. But gradually since then, the consensus view on growth and commodities regulation has begun to shift in its direction. For example, a recent New York Times article on China by Nobel Prize-winner Paul Krugman could have been based on recent blog posts:
- He says China’s wasteful infrastructure spend means consumption as a percentage of GDP is half the US level
- He then references Sir Arthur Lewis and the lesson of the Lewis Curve
- And finally he even worries that China is now experiencing its Minsky Moment
Equally, former US economic chief Larry Summers has now followed the blog in suggesting that “Quantitative Easing (QE) in my view is less efficacious for the real economy than most people suppose”.
Even more encouraging is that regulators are finally waking up to the fact that commodity markets have completely lost their role of price discovery, due to the combination of central bank liquidity and investment bank speculation. As the New York Times reported:
”In 2011, for instance, an internal Goldman memo suggested that speculation by investors accounted for about a third of the price of a barrel of oil.”
Whilst the aluminium warehousing scandal has finally reached the US Senate Banking Committee. Evidence from MillerCoors suggested this cost consumers $3bn last year, whilst Bloomberg reported “the 10 largest Wall Street banks generated about $6bn in revenue from commodities in 2012.”
Friday’s news that JP Morgan will exit its physical commodity business is thus an important step in the right direction. It will hopefully soon be followed by the other major players.
But policymakers have still not yet taken the critical step, which is to ask why their policies have failed so badly? They cannot yet bring themselves to recognise the simple truth that demographics drive demand. They still want to claim credit for the 1983-2007 economic SuperCycle, rather than accepting it was mainly due to the vastly increased numbers of Western BabyBoomers arriving in the 25 – 54 Wealth Creating age group.
Lower growth is now inevitable in the West as a result of these ageing Boomers reaching their low-spending and low income years. Whilst China’s one child policy since 1978 means its growth is also slowing, as its population ages.
The result, as the blog will discuss in a special series this week, is that companies have heavily over-invested in major new capacity, on the assumption that SuperCycle growth would continue. Now, disappointment is looming. Thus BASF CEO Kurt Bock warned on Thursday:
“We expect the development of the second half to be rather flat compared to the first half of 2013. Achieving our earnings target is significantly more challenging today than we had expected at the beginning of the year”.
Whilst Dow CEO Andrew Liveris warned that “while growth continues in China, we all have to reset expectations below historical rates.”
The chart shows latest benchmark price movements since January with ICIS pricing comments below:
Benzene Europe, green, down 16%. ”While prices have been on a steady downward trend since the start of 2013, they are still historically and structurally high compared with oil and energy pricing, thus making them difficult for end-use markets to absorb.”
PTA China, red, down 8%. “Restocking activity from textile factories worried that polyester prices will increase further on the back of higher raw material prices”
Naphtha Europe, black, down 6%. “Europe is structurally long, and sellers need to export to US gasoline and Asian petrochemical sectors to keep stocks in balance”
Brent crude oil, blue, down 3%.
HDPE USA export, yellow, up 6%. “Export prices were generally stable.”
US$: yen, orange, up 12%
S&P 500 stock market index, purple, up 15%
Last April, China’s polyester market provided an early warning signal that the current downturn was about to start. Now, it is flagging an important change in relative positions within the value chain.
9 months ago, the divergence between crude oil prices and those for the C8 chain highlighted slowing end-user demand. The chart above updates the picture since then:
• Brent (purple line) is ~150% above its January 2009 level
• PTA (red) peaked at ~130%, but is now only ~75% above this level
• PET (blue) peaked at ~110%, but is also now ~75% above this level
• PX (green) has been relatively stronger, and is 100% above this level
This, of course, is very bad news for those who have invested in PTA and PET. They are suffering value leakage in relation to paraxylene (PX) prices, rather than adding value.
The reasons are probably three-fold:
• Slow end-user demand means products close to the oil barrel have greater pricing power than those downstream
• Lower Western refinery operating rates are reducing mixed xylene production, and increasing the differential necessary to justify extraction
• A massive jump in Asian PTA capacity (primarily in China) is not being accompanied by a similar increase in PX supply
The jump in Asian capacity repeats the pattern seen in the early 2000s, when China first boosted PTA production. Fellow-blogger Malini Hariharan noted last month that nearly 11.5MT of new capacity is expected in Asia this year, whilst only 1.4MT of new PX supply is scheduled.
Major shortages, and considerable market disruption, could therefore occur if the new plants all bid for the same few available feedstock parcels. This wouldn’t happen in the West, where issues of profitability would take priority. Producers would instead optimise margins by selling PX and covering their PTA commitments by purchases.
But China’s philosophy is not so profit-oriented. Instead, due to the often close linkages between companies and government, the need to maximise employment can have priority. This is especially true in a year when major politburo elections are underway, and the need for social stability is strong.