The litmus test for the global economy

China’s plastic ban and recycling launch marks end of ‘business as usual’ for plastics industry

Paradigm shifts start slowly at first, and it is easy to miss them. But then one day, they suddenly become obvious, and it becomes a scramble to catch up. That’s what happened on the waste plastic issue last week, when China decided to take action. As official news agency, Xinhua, reported:

  • “The policy measures proposed in this opinion basically cover the entire process and various links of plastic product production, circulation, use, recycling, and disposal, reflecting a system of full life cycle management
  • “Policy adjustments target both traditional areas and emerging areas such as e-commerce, express delivery, and takeaway
  • “(They focus on) plastic products that are currently in large use, relatively prominent, and strongly reflected in society, and take the lead in prohibiting or restricting production, sales, and use in some areas and regions
  • “It is important to point out that implementation will inevitably affect the production of some industries and the convenience of residents’ lives”

My former company, ICI, invented polyethylene (PE) back in 1933. PE is now the largest single polymer with volume close to 100m tonnes. More than half of this goes into single-use applications.  Yet in a major failure of the imagination, very few of us in the industry ever thought until recently about the waste this caused.  As the BBC reported after China’s decision:

“China has for years been struggling to deal with the rubbish its 1.4 billion citizens generate. The country’s largest rubbish dump – the size of around 100 football fields – is already full, 25 years ahead of schedule.”

And we are all still ignoring the economic waste involved.  Crude oil costs $60/bbl, and it costs lots more dollars to refine it/ship it/process it. And then we simply throw away the single- use plastic bags and packaging that we bring home from the shop or unwrap from the internet delivery.

Plus, of course, there is the marine waste problem, so vividly brought to life in the photo from Sir David Attenborough’s ‘Blue Planet 2 television series.

THE PLASTICS INDUSTRY MUST NOW TAKE UP THE CHALLENGE

China uses around 1/3rd of all the PE produced today. So its decisions are a game-changer for the entire global industry.

Nobody wants to do away with plastics themselves.  They are unique materials – lightweight, resilient, usually non-reactive and waterproof. They have much lower carbon intensity than competing materials such as metals, and they play an incredibly valuable role in our daily lives. Food packaging, for example, is proven to reduce food losses, wastage and health risks from contamination.

But the business model for producing plastics is broken, and needs to be challenged:

  • Does it really make sense to keep producing more oil and gas, with all the CO2 emissions this involves, and then throw away the end product?
  • If not, why aren’t we investing the necessary dollars to set up Resource Centres (as pictured) around our cities and towns, to recycle this waste plastic back into usable products?
  • And at the same time, why aren’t we developing robust contingency plans for optimising the legacy issues from the old business model

As I noted here a year ago, There’s a great future for the European plastics industry in recycled plastic, this opportunity is not just about China. Last month, new EU Commission President Ursula von der Leyen launched the EU’s Green Deal, noting:

“I am convinced that the old growth-model that is based on fossil-fuels and pollution is out of date, and it is out of touch with our planet. The European Green Deal is our new growth strategy – it is a strategy for growth that gives more back than it takes away. And we want to really make things different. We want to be the frontrunners in climate friendly industries, in clean technologies, in green financing.”

The key issue is summed up by new BP CEO, Bernard Looney. He warned at the weekend that the oil industry has to start:

“Going beyond small, ineffectual bets on low carbon investments.”

The plastics industry similarly has to step up from today’s relatively “small, ineffectual bets”. Otherwise it will run out of time to meet the 2025 recycling deadlines being set by an increasing numbers of brand owners and governments.

All paradigm shifts create Winners and Losers.  Losers will focus on recession risks and the potential impact of the corona virus. But Winners will know they need to do more than focus on these risks, if they want to generate long-term revenue and profit growth.

They will be the ones who start investing realistic sums of money, today, to turn the concept of the circular economy into reality.

Contingency planning is essential in 2020 as “synchronised slowdown” continues

The IMF has now confirmed that the world economy has moved into the synchronised slowdown that I forecast here a year ago. Its analysis also confirms the importance of the issues highlighted then, including “rising trade barriers and increasing geopolitical tensions”, a sharp decline in manufacturing, contraction in the auto industry and structural forces such as the impact of ageing populations.

Capacity Utilisation (CU%) data from the American Chemistry Council has therefore once again proved to be the best leading indicator for the global economy. It has been far more reliable than stock markets, where valuations continue to be massively distorted by central bank stimulus. And unfortunately, the latest data shows no sign of any improvement as the chart confirms, with November’s CU% now back at November 2012’s level at 81.7%.

Of course, it remains very easy to ignore the warning signs. ‘Business as usual’ is always the most popular forecast, as we saw a year ago when the consensus assumed a sustainable economic recovery was finally underway. And it would be no great surprise if, in a year’s time, consensus opinion starts to claim that “nobody could have seen recession coming”.

This is why it seems likely that businesses will now start to divide into Winners and Losers. As the IMF note in their analysis, the current situation is “precarious”, with a number of potential downsides starting to crystallise. On a macro view, these include the growing supply chain risks created by Brexit, where the UK expects to leave the EU at the end of this month.

Anyone with experience of trade negotiations knows that these normally take years rather than months to complete. No Deal is therefore the most likely outcome in a year’s time at the end of the transition period.

This will have a major impact on industries with complex and highly integrated downstream value chains like autos, chemicals and aerospace. Contingency planning is therefore on the critical path for any company that currently relies on product flowing seamlessly and tariff-free across the UK-EU27 border.

Of course, potential Losers will continue to nurse the hope that the UK government might reverse its refusal to accept the 2-year extension offered by the EU. But anyone who followed the recent UK election campaign knows this is an unlikely outcome.

The chemical industry also has its own specific challenges to face, given the growing impact of US shale gas-based expansions in the polyethylene area. This is no great surprise, as I have been warning about the likely consequences of these supply-led expansions since they were first announced in 2014 . But unfortunately, the combination of stock market euphoria over the shale gas revolution and the Federal Reserve’s easy money policy meant that the core assumptions were never properly challenged.

Euphoria remained the rule even after the oil price collapse at the end of 2014 disproved the assumption that prices would always be above $100/bbl. And it continued despite President Trump’s election. As a self-confessed “tariff man”, his policies were always likely to upset the idea that plants could be sited half-way across the world from their markets.

Warning signs were also obvious around the assumption that China’s growth would remain at double-digit rates, creating an ongoing need for major imports. And more recently, concerns over climate change and plastic waste issues have created further question marks over the outlook for single-use plastic demand.

Incumbents are often slow to understand the likely impact of potentially disruptive developments on their businesses. Business discussions around the boardroom and water cooler can often take place in a parallel universe to those that happen outside the office with friends and family.

The upstream oil industry is currently providing a classic example of this phenomenon as it promotes the idea that despite mounting concerns over the role of fossil fuels in climate change, chemicals can somehow replace lost oil demand into transport. Yet as former Saudi Oil Minister Yamani warned back in 2000, “the Stone Age didn’t end for lack of stones, and the Oil Age will end long before the world runs out of oil”.

Unfortunately, therefore, it seems likely that 2020 will see today’s synchronised slowdown continuing to challenge consensus optimism. Contingency planning around recession risks should therefore be top of the agenda, particularly for companies with high debt levels.

But at the same time, better placed companies have a once in a generation opportunity to take advantage of the paradigm shifts now underway, as adoption rates accelerate up the typical S-curve. These Winners are likely to discover that their best days still lie ahead of them, given the range and scale of the new opportunities that are emerging.

Please click here to download my full 2019 Outlook (no registration necessary).

Polyethylene’s crisis will create Winners and Losers

Polyethylene markets (PE) are moving into a crisis, with margins in NE Asia already negative, as I have been forecasting.  Scenario planning is now a matter of potential life or death for companies likely to be impacted over the next 12-18 months.

The collapse in margins is already quite dramatic as the chart based on ICIS data shows:

  • NEA margins were $657/t in January 2017, and are now -$100/t; SE Asian margins have fallen from $909/t to $103/t
  • NW Europe margins  are down from $739/t to $300/t; US Gulf margins are down from $965/t to $603/t: Middle East margins are down from $1125/t to $833/t

The same pattern is also true for the other main grade, High Density PE (HDPE).

And, of course, today is only the start of the problems. As the second chart shows, there are vast amounts of new product coming online between 2019 – 2021 in both LLDPE and HDPE:

  • LLDPE: China is adding 3.4 million tonnes; USA 1.8Mt; Russia and S Korea 800kt each; with India, Oman, Malaysia and Indonesia also adding capacity
  • HDPE: China is adding 4.4Mt; USA 1.9Mt, S Korea 900kt, Russia 700kt; with India, Oman, Malaysia, Indonesia, Philippines, Iran and Azerbaijan also adding

The problem is that the fundamental assumptions behind the shale gas investments were simply wrong:

  • Oil was most unlikely to always be >$100/bbl, providing a feedstock advantage with shale gas
  • China wasn’t likely to be growing at double-digit rates, and always importing more petchems
  • Globalisation was already ending, meaning that plants couldn’t be sited half-way across the world from their market
  • Plastics will not always be the material of choice for single-use packaging applications

Essentially what happened is that companies stopped planning for themselves and allowed Wall Street to set their strategy, as one CEO told me:

“You may be right, but every time I mention shale on an earnings call, the share price goes up $5.” 

It is now too late to wind back the clock.  The US product from the integrated players has to go somewhere as their ethane feedstock is essentially a distressed product. If they don’t use the ethane to make ethylene and its derivatives, they cannot produce the shale gas.

The result is shown in the charts above, based on data from Trade Data Monitor

  • 2019 has seen vast amounts of new US ethylene-based exports, and more is still to come
  • Most of it was exported as PE, where exports have risen 85% so far this year versus 2018
  • The trade war means exports to China have actually dropped, so Europe, SEA and NEA have suffered major disruption
  • US PE exports to these regions were up 98%, 240% and 246% respectively, causing margins to start their collapse

The world is therefore starting to divide into Winners and Losers, as the chart suggests.  Non-integrated ethylene producers around the world are particularly at risk:

  • They have to buy their feedstock at market prices, and they will have to sell into an increasingly over-supplied market
  • As a result, it is quite likely that their margins will become negative – as they have done before in periods of over-supply
  • At this point, integrated producers have the advantage as they are still making money upstream on oil/gas/refining

But there are also wider risks for European and Asian consumers down all the major value chains, as they will be impacted by lower cracker rates.

Scenario analysis must now be a top priority for potential Loser companies.  There really is very little time left, as the margins chart confirms.

Portugal shows the way to climate neutrality by 2050

“If you don’t know where you are going, any road will do”. The Irish proverb’s logic shows us the way forward on the greatest challenge that we face today, of achieving climate neutrality by 2050.

As the President of the European Petrochemical Association, Marc Schuller, highlighted last month when issuing a ‘call to action’:

“The Youth of the the world is calling for ambition and transformation. There is a new sense of urgency and as business leaders we should ensure that we embrace it and that our response as an industry is keeping up with this new pace of change and level of ambition.”

Governments also have a major role to play.  And it is important that they speak in language that ordinary people can understand.

This is why Portugal’s Roadmap for Carbon Neutrality 2050 is so important.  As the chart shows, it positions climate neutrality as an opportunity. Most people, after all, would prefer to be up with the peleton – challenging for the yellow jersey and the lead, not stuck at the back.

There is also very little doubt that climate change is taking place.  After all, as the chart on the right shows, the global population has more than trebled since 1950, from 2.5bn to 7.8bn today.  An increase of this size must have a major impact on the world in which we live.

The chart on the left shows one aspect of this impact in terms of the rise in surface temperatures from 1960, versus 1850-1900.  We have good data for both periods, and so the data’s reliability is high.

Of course, correlation doesn’t always equal causation. And no doubt there are a range of other factors involved – some positive, some negative. But given the observable risks of climate change today, it makes no sense to ignore the issue and hope it will go away.

This is why voters are telling their leaders that climate change is important.  After all, what is the point of a better standard of living, if at the same time you worry that you might get flooded out of your home – or it might be burnt to cinders?

Portugal’s response is an excellent example of a government taking a lead, within the framework of the European Green Deal to be launched early next year. As the chart shows, it is focused on the key areas and aims to carry the population with it:

  • “Eliminating coal-based power generation by 2030 and achieving full decarbonization of the power generation system by 2050
  • Decarbonizing mobility by strengthening public transport, decarbonizing fleets and reducing the carbon intensity of sea and air transport
  • Expanding conservation and precision agriculture and reducing emissions associated with livestock and fertilizer use
  • Preventing waste generation, increasing recycling rates and reducing waste disposal in landfill
  • Applying carbon tax, changing consumption and production patterns, environmental education and awareness
  • Promoting skills development towards new economic opportunities” 

Of course, nobody likes change. But as the chart above shows, the world is already changing.

As I discussed last month,  the world’s population is now expanding because people are living longer, not because women are having lots of babies.

  • Nearly a third of the world’s High Income population, those earning at least $12k/year, are in the Perennials 55+ generation. Their incomes decline as they retire, and so Sustainability is critically important for them as a way of doing more with less
  • Younger people, the Millennials,  still want mobility, but owning a car doesn’t excite them. Similarly, they want the benefits provided by plastics, but they don’t want the waste and pollution generated from applications such as single-use packaging

As Portugal has realised, most people – given the choice – would like to be at the front of the pack. We all want to enjoy the opportunities that the rise of the sustainability agenda will provide.

Corporate leaders need to respond – unless they want to risk finding themselves on their own, at the back of the pack.

Day of reckoning approaches for US polyethylene expansions, and the European industry

Planning for future demand in petrochemicals and polymers used to be relatively easy during the BabyBoomer SuperCycle. The team would consult the latest IMF forecast for global and regional growth, and then debate the right ratio to use to calculate product demand.

For polyethylene (PE), the ratio was generally just above GDP at around 1.1x, on the basis that relatively more plastic was likely to be needed as the economy grew.

So when the US shale gas opportunity came along, producers were very confident that it would provide them with major cost advantage over most other Regions. And they were under major pressure to use the ethane that might be produced from the new natural gas production, as it is explosive when mixed with air in concentrations between 3% – 12.4%.

Essentially this meant the ethane was a distressed product, and had to be used in ethylene production, as there are no other major applications.

Since those early days, the US polyethylene expansions have been “an accident waiting to happen”, as I first argued when the plans were still being finalised in March 2014:

“US ethylene producers need to work out where all the new ethylene production is going to be sold before embarking on the planned frenzy of cracker construction”.

Unfortunately, the pressures from Wall Street to exploit the apparent opportunity were too great. One by one, companies gave in to peer pressure and announced expansion plans, as shown in the ICIS graphic – and were rewarded by sharp increases in their share price. As one CEO said to me at the time:

“You may be right, but every time I mention shale on an earnings call, the share price goes up $5.”

Our major Study, ‘Demand – the New Direction for Profit’, jointly produced with ICIS, took the analysis a stage further in March 2016, warning that:

“The supply-led business model – build capacity and wait for demand to catch up – will no longer work in today’s low- or-no-growth marketplace.”

And it really did seem obvious then that the key assumptions behind the expansions were wrong:

  • Oil prices were no longer above $100/bbl and so US gas-based producers didn’t have a major cost advantage
  • Global growth hadn’t returned to SuperCycle levels; China was starting to move towards self-sufficiency and would not longer need need vast import volumes
  • Globalisation was being replaced by protectionism, and plants could no longer be sited half-way across the world from their markets

But companies went ahead anyway, due to the pressure from upstream gas producers to dispose of the product, and the enthusiastic support provided by investors.

The terrible hurricanes in 2017 postponed the moment of reckoning, as plants were delayed for months due to the damage.  But then, construction picked up again and most of the new capacity is now in place – and linked to new polyethylene capacity.

Polyethylene is the largest volume polymer, and the expansions are adding 40% (6.5 million tonnes) to US capacity between 2017 – 2019.  Other Regions are of course also expanding – particularly China, as it seeks to become more self-sufficient as a result of President Trump’s trade war. The ICIS price charts therefore show a depressing picture:

  • Asian HDPE CFR prices have fallen from $1350/t to $900/t over the past year
  • US HDPE prices have fallen from 64c/lb to 53c/lb over the same period
  • And European HDPE prices have started to tumble, down from $1150/t in June to $950/t today

The reason is not hard to find, as the charts from Trade Data Monitor confirm.   Total H1 ethylene exports in the shape of PE, PVC, styrene, EDC, ethylene and other derivatives almost doubled to 4 million tonnes. And suddenly, Europe has become the main importer, with volume up from 420kt in 2018 to 1.05MT.  Most of the volume is in PE, which doubled to 3MT on a global basis.

And there is still more volume to come, with ExxonMobil now starting its new 650kt plant and LyondellBasell starting its new 500kt plant in Q4. That’s more than 1MT of new  PE output which will have to be exported into an already over-supplied market.

In addition, it is clear that public opinion and the new EU Circular Economy directive are already starting to have a major impact on demand for single use plastics. Unfortunately, over 50% of  PE output goes into this application, along with nearly a third of polypropylene.

Volume is already disappearing as consumers make the shift to more sustainable forms of packaging. It is clear that recycled material now has the potential to replace virgin product as the feedstock of choice in the future.

In turn, these paradigm shifts are creating Winners and Losers.  Next year is likely to prove very difficult for US PE exporters, as they face up to the fact that export demand has not grown as expected, and they do not have a major cost advantage.

As the picture of Fido the dog illustrates, polymer producers are the ‘flea on the tail of the oil/gas markets’:

  • Producers integrated into US natural gas production, or EU refineries, will be able to ‘roll through’ margins to the wellhead and refinery as prices go lower
  • But non-integrated European players have much less protection. Their margins will get squeezed, at the same time as demand patterns shift away from the use of virgin product

Now is therefore the time for these producers to start accelerating moves to using recycled feedstock for their production.  In another 12-18 months, if prices and margins keep on falling at current rates, it may well be too late.

Stormy weather ahead for chemicals

Four serious challenges are on the horizon for the global petrochemical industry as I describe in my latest analysis for ICIS Chemical Business and in a podcast interview with Will Beacham of ICIS.

The first is the growing risk of recession, with key markets such as autos, electronics and housing all showing signs of major weakness. Central banks are already talking up the potential for further stimulus, less than a year after they had tried to claim victory for their post-Crisis policies.

Second is oil market volatility, where prices raced up in the first half of last year, only to then collapse from $85/bbl to $50/bbl by Christmas, before rallying again this year. The issue is that major structural change is now underway, with US and Russian production increasing at Saudi Arabia’s expense.

Third, there is the unsettling impact of geo-politics and trade wars. The US-China trade war has set alarm bells ringing around the world, whilst the Brexit arguments between the UK and European Union are another sign that the age of globalisation is behind us, with potentially major implications for today’s supply chains.

And then there is the industry’s own, very specific challenge, shown in the chart. Based on innovative trade data analysis by Trade Data Monitor, it highlights the dramatic impact of the new US shale gas-based cracker investments on global trade in petrochemicals.

The idea is to capture the full effect of the new ethylene production across the key derivatives – polyethylene, PVC, styrene, EDC, vinyl acetate, ethyl benzene, ethylene glycol – based on their ethylene content. Even with next year’s planned new US ethylene terminal, the derivatives will still be the cheapest and easiest way to export the new ethylene molecules.

The cracker start-ups were inevitably delayed by the hurricanes in 2017. But if one compares 2018 with 2016 (to avoid the distortions these caused), there was still a net increase of 1.7 million tonnes in US ethylene-equivalent trade flows.

This was more than 40% of the total production increase over the period, as reported by the American Chemistry Council. And 2019 will see further major increases in volume with 4.25 million tonnes of new ethylene capacity due to start-up, alongside full-year output from last year’s start-ups.

The problem is two-fold. As discussed here in 2014 (ICB, US boom is a dangerous game, 24-30 March), it was never likely that central bank stimulus policies could actually return demand growth to the levels seen in the Boomer-led SuperCycle from 1983-2000:

“Shale gas thus provides a high-profile example of how today’s unprecedented demographic changes are creating major changes in business models. Low-cost supply is no longer a guarantee of future profitability.”

This was not a popular message at the time, when oil was still riding high at over $100/bbl and the economic impact of globally ageing populations and collapsing fertility rates were still not widely understood. But it has borne the test of time, and sums up the challenge now facing the industry.

Please click to download the full analysis and my podcast interview with Will Beacham.