Oil consumption growth has slowed as prices have stayed high

BP energy Jul14

As promised yesterday, the blog looks today at the impact of today’s high prices on oil consumption growth.

As the chart, based on BP data shows, the ‘easy money’ policies of the central banks have only partially mitigated the impact of the oil price rally since 2009.  Consumption growth has not fallen to the 0.8%/year level since during the second oil crisis after 1979.  But nor has it regained the 1.7%/year level seen during the Boomer-led SuperCycle.  Then prices averaged $27/bbl in money of the day, and $41/bbl in $2014.

Overall, the big winners over the period since 2009 have been the traders (including the commodity desks at the investment banks) and oil producers.  Consumers have paid the bill.

Oil proved a fantastic money-making opportunity from 2009 onwards.  A totally new trading product was developed titled ‘contango crude’.  This was crude that was stored in tanks all around the world to take advantage of pension funds’ sudden desire to buy crude on the futures markets.

For a cost of only $1/bbl per month, the early deals made total returns of $30/bbl – sometimes after as little as 3 months.  Storage companies also loved the story, and rushed to build more tanks to support it.

But today, the ‘contango trade’ is dead and buried.  Brent oil for supply next month closed Friday at $109.66/bbl.  The price for delivery in August 2015 was actually lower at $105.86/bbl.

In addition, the investment banks are now busy exiting the business, as their costs of capital are rising.  Many have either closed down their commodity trading businesses, or are reducing them in size.

Producers have been laughing all the way to the bank.  They have kept a very careful eye on the broken Brent pricing mechanism, and have ensured that it has remained steady at around today’s levels.  That was not very difficult to achieve in the over-heated conditions of the past 5 years.  There are, after all, no laws to stop producers buying in distressed cargoes to avoid disturbing the market.

But whilst the influx of financial players added excess speculative demand, it also encouraged new production – most obviously in the US, but also around the world.  It takes time to finance and find new sources of supply.  But 5 years has proved more than long enough to create supply gluts in many major markets.

High oil prices above $50/bbl have always led to recessions in the past.  The impact has been mitigated this time by the easy money policies and giant stimulus programmes.  But real incomes, adjusted for inflation, have mostly been falling in the West in recent years, causing higher oil prices to crowd out other more discretionary spending.

Equally, consumers have been looking to use more fuel-efficient vehicles, or to otherwise cut back on energy usage.  Again, as with exploration, these developments take some time to impact the market.  But they are now having an increasing effect in virtually every major market.

H2 may therefore prove to be the end-game for the post-2008 oil price market rally.  What happens next may not be pleasant, as the blog will discuss tomorrow.

Lower earnings, pensions, hit US consumers

US earnings Oct11.pngWall Street analysts have their bonuses to consider at this time of year. So it is no surprise that they are talking up the prospects for the Christmas season – the peak shopping period of the year in the West.

But those involved in shipping goods don’t see the same rosy picture:

• In August, Bloomberg reported that container shipping rates from Asia to Europe were suffering “the longest stretch of near-zero rates in its half-century history”, as retailers cut back on orders
• Now, the New York Times reports that imports via the 5 busiest US container ports “were lower in August than, or even with, 2010 volumes”.

This should be no surprise, given the above chart, again from the NYT. It shows that median US incomes fell 9.8% between December 2007’s start of the Great Recession and June 2011, according to new Census Bureau data. This includes a 6.7% fall since the official end of the recession.

The Census Bureau describe this as the largest decline “in several decades”. They add that it evidences “a significant reduction in the American standard of living.” And if this wasn’t enough to restrain Holiday spending, Western BabyBoomers (those born between 1946-70) are also becoming aware that their pensions are under increasing threat.

Most US public pension funds use an 8% assumption when they come to assess likely returns on their investments. But as the Wall Street Journal warns, this figure is now hugely over-optimistic:

• It was reasonable during the Boom-led SuperCycle after 1980, when demand for assets like stocks and housing soared
• But as we note in Chapter 5 of the free Boom, Gloom and the New Normal eBook, the key S&P 500 Index actually fell between 2000 – 2010
• None of the large US state pension funds with >$20bn saw more than a 4% annual return for the decade through June 2010

The pension funds are now between a rock and a hard place. Either they cut promised benefits to pensioners, or they increase taxes/employee contributions. Both mean US consumers will have less cash to spend.

One example from the Centre of Retirement Research highlights the scale of the crisis. It suggests that states with large unfunded liabilities might see pension costs rise from 3.8% of state and local government budgets in 2008 to 12.5% by 2014.

Any business managers who believe the analysts’ forecasts could face a difficult New Year, if these prove to have been wishful thinking.

Critical Success Factors in the New Normal

CSFs.pngYesterday’s Scenarios hopefully provided valuable insight into the challenges ahead for companies and individuals. They also suggest some Critical Success Factors for achieving a successful transition to the New Normal, as set out in the chart above:

1. Flexibility. This involves adapting to new circumstances and being willing to compromise rather than battling for an impossible nirvana.
2. Change management. The next 20 years will likely see rapid and unpredictable change in the business environment in contrast to the remarkable stability of recent decades.
3. Scenario Planning. Companies need to adapt their planning processes to cope with the greater uncertainty that will come from operating in a more ‘events-driven’ world.
4. Real needs. Over the past 20 years, Westerners have often confused ‘wants’ with ‘needs’. In the New Normal, mere ‘wants’ are unlikely to be reliable market drivers for the future.
5. Action orientation. Uncertainty can breed a loss of energy, and so companies will need to encourage their employees to experiment creatively if they are to move forward.

The positive news is that most Boomers are likely to lead active and healthy lives well into their 60s and 70s. So the opportunities to capture their interest and their business are very large indeed. We will highlight some valuable case studies to help with this process in Chapter 7.

Companies focusing on the emerging economies face similar challenges, as we will discuss in Chapter 6 next month. Their core market will also consist of a currently underserved demographic, those just moving out of poverty and able to afford a bar of soap, or a bra and pair of panties, for the first time.

But the Beatles provide a reliable guide, if we are prepared to listen to their message from ‘When I’m Sixty-Four’. The megatrends such as an ageing population and the need for improved food production provide the key to future success.

The blog will be happy to provide any support or advice that may be helpful to readers as they develop their Action Plans.

International eChem/ICIS are also running three training courses in Houston, Singapore and London during Q4, to help with detailed implementation issues. Please click here for further details.

Scenarios for the transition to the New Normal

New Normal logo.pngThe transition to the new Normal is likely to be painful and long-lasting.

Future demand growth will be slower as the ageing Boomers spend less and save more.

More regular and deeper recessions are likely to become a feature of the global economy once more, in contrast to the relatively smooth growth seen during the Boomer-led Super Cycle.

Successful companies will also have to venture into the unknown, as until recently the 55+ generation had no real existence as a separate economic unit.

Previous generations usually found their needs at this age were focused on health-related issues – the Zimmer frame of popular mythology.

So as we venture into the unknown, Action Plans can’t be too prescriptive about what we might expect to see over the next 20 years. Chapter 5 of the blog’s free ‘Boom, Gloom and the New Normal’ eBook, co-authored with John Richardson, aims to help with this process.

As discussed yesterday, the Chapter outlines some potential Scenarios to highlight the key variables that need to be considered:

‘All’s Well that Ends Well’. In this scenario, the key dynamic is that there is a rapid adaptation to the New Normal. This may be driven by the observation of the major pain being suffered in countries already at the sharp end of some most unwelcome restructuring – Greece, Portugal, Ireland and Spain, for example. This gives Western politicians the courage to talk seriously about the issues that society now faces, whilst the wider population becomes prepared to listen to their messages and to accept that major changes need to be made.

Muddle Through’. In this scenario, there is no rapid adaptation to the New Normal, and although a higher quality of dialogue takes place between policymakers and the electorate than in the past, no firm agreements are reached on key policies and objectives. However, and importantly, social cohesion is retained, and so society does not fragment into warring groups.

‘If You Don’t Know Where You’re Going, Any Road Will Do’. A third scenario is based on the potential for politicians to remain more focused on sound-bites than on formulating policies that will drive long-term success for their populations. In this Scenario, the current dysfunctional state of many Western political systems, and their alienation from the wider electorate, is not a temporary phenomenon but a sign of the future.

‘Don’t Worry, Everything will be Just Fine’. This is the scenario under which the West had been effectively operating for the past few years, ignoring the demographic changes which are taking us in a new direction. It is characterised by an increasingly desperate belief that everything is just about to ‘return to normal’ (i.e. the former SuperCycle), via the magic elixir of either tax cuts or yet more stimulus.

Tomorrow’s post will provide its view of the Critical Success Factors against which Action Plans need to be measured.

The blog will be happy to provide any support or advice that may be helpful to readers as they develop their Action Plans.

International eChem/ICIS are also running three training courses in Houston, Singapore and London during Q4, to help with detailed implementation issues. Please click here for further details.

A 4-point Action Plan for chemical companies

Sgt Pepper.pngToday’s economic situation is getting worse, not better. The blog believes this is because most policymakers still refuse to accept the wisdom contained in the Beatles’ ‘When I’m Sixty-Four’ song on their iconic Sgt Pepper album.

The Western BabyBoomers (those born between 1946-70) are the largest and richest generation that the world has ever seen.

But last year, the oldest Boomer reached the age of sixty-four. And ageing Boomers simply don’t need more housing or new cars, as they no longer have to provide for growing families.

So demand patterns are changing, radically, just as they changed in the 1970’s. This was when the arrival of the Boomers set off the economic SuperCycle, as they entered their peak consumption years between the ages of 25 – 54.

Chemical companies are therefore not only facing an imminent economic slowdown, as the blog has chronicled over the past 5 months with its IeC Downturn Alert. They also need to change their business models, to adapt to this New Normal.

This month’s Chapter 5 of the blog’s free ‘Boom, Gloom and the New Normal’ eBook, co-authored with John Richardson, aims to help with this process. The first step is for CEOs to establish a high-powered team, operating with the support of their Board and line managers, to quickly put in place the necessary Action Plan.

The team needs to answer the 4 key questions required for any successful plan:

Why. The Board needs a clear view of the likely impact of an economic downturn, combined with the demand changes caused by the ageing of the Boomers.
What. The team needs to highlight the key issues which its plan aims to tackle. Speed is essential, and only the really super-critical issues can be addressed short-term.
How. Implementation plans are critical. Resources need to be available, and key managers must ‘buy-in’ to the process, otherwise it will fail.
When. Timing is also critical. Short-term priorities (credit control, working capital) have to be balanced with the business model changes needed to adapt to the New Normal.

The outlook is very uncertain. Tomorrow’s post will discuss the relevant Scenarios that need to be addressed. And on Thursday, it will highlight the Critical Success Factors against which plans need to be measured.

The blog will be happy to provide any support or advice that may be helpful to readers as they develop their Action Plans.

International eChem/ICIS are also running three training courses in Houston, Singapore and London in Q4, to help with detailed implementation issues. Please click here for further details.

Time for leadership at EPCA

D'turn 26Sept11.pngThe chemical industry has a turnover of $3.4trn, and is the world’s 3rd largest industry. It matters to the global economy.

Many of its leaders are about to meet next weekend in Berlin for the annual European Petrochemical Association (EPCA) meeting.

The blog strongly believes that this should not be seen as a ‘business as usual’ meeting. We cannot simply assume that the global economy is in fundamentally good shape:

• IMF head, Christine Lagarde, has warned the global economic situation is entering a “dangerous place
• World Bank president Robert Zoellick has described world finances as being in a “danger zone

These are not sound-bites being made for effect.

The danger signs have been building for months. The blog, after all, introduced its IeC Downturn Alert nearly 5 months ago, on 2 May.

Coincidentally, this matched the peak of the US S&P 500 Index, since when financial markets and crude oil prices have fallen dramatically, as shown in the chart above.

Every week since then, with the help of ICIS news and ICIS pricing, the blog has chronicled the approach to today’s Downturn:

• First we saw customers around the world buying ‘hand to mouth’. They tried to run down inventories built up during the 50% rise in crude oil prices between December-April
• Then everything went quiet during the summer. The retailers destocked after seeing end-user consumption fall due to the impact of higher oil prices
• Then it became clear that China’s economy, the previous motor of the global economy, was slowing fast, as the government reduced credit to combat high inflation
• Now, in September, it is clear that demand has not returned after the holidays. And the wider economic outlook is getting worse, not better.

The blog made similar efforts to alert the industry to the issue of demand destruction before the 2008 downturn, and was later awarded the title of ‘The Crystal Blog’. But sadly, its warnings were not taken seriously at the time when they could have had an impact.

The industry’s leaders need to ensure that ‘this time is different’ in Berlin. It is no exaggeration to say that the very future of some companies, and of important sectors of our industry, may be at stake.

Price movements since April, and ICIS pricing comments this week are below:

Benzene NWE (green), down 26%. “A swathe of imports coming into the ARA region were also keeping supply ample as demand struggled amid weak end user confidence.”
Naphtha Europe (brown dash), down 19%. “The impact of refinery run cuts is starting to show, and it is thought that the naphtha oversupply would have been more severe if not for these“.
HDPE USA export (purple), down 18%. “The Asian market has slowed down, in part because of a national holiday, and in part because of concerns about the global economy. Asian prices were expected to fall in China because of tightening credit rules.”
S&P 500 Index (pink dot), down 17%.
Brent crude oil, down 14%.
PTA China (red), down 4%. “Most buyers were adopting a wait-and-see stance because of the unclear market trend. Only a few end-users purchased cargoes on a need-to basis.