The chemical industry is the best leading indicator for the global economy. And my visit to Singapore last week confirmed that the downturn underway in the Asian market creates major risks for developed and emerging economies alike.
The problem is focused on China’s likely move into recession, now its stimulus policies are finally being unwound. And the result is shown in the above chart from The pH Report, updated to Friday:
- It confirms that the downturn began before oil prices peaked at the beginning of October, confirming that companies were responding to a downturn in end-user demand
- Since then, of course, the oil price has – rather dramatically – entered a bear market, with prices down by nearly a third
The question now is whether finance directors will choose to aggressively destock ahead of year-end results, to mitigate the volume decline with a decline in working capital. This would be a bold move given continuing geo-political uncertainty in the Middle East, and would also conflict with the more upbeat guidance that was given earlier with Q3 results.
But a review of ICIS news headlines over the past few days suggests they may have little choice. Inventories are described as “piling up” in a wide range of major products, including polyethylene – the biggest volume polymer. Indian producers are even offering “price protection” packages on polypropylene, to safeguard customers from losses if prices fall further.
Asian countries and their major partners (eg Argentina, S Africa, Turkey) were, of course, the first to be hit by China’s downturn. But Q3’s fall in German GDP shows the downturn has now spread to the Western economy that most benefited from China’s post-2008 stimulus bubble. As The Guardian noted:
“Goods exports make up 40% of German GDP – a much bigger proportion than for the next two biggest eurozone economies, France and Italy.”
OIL MARKETS CONFIRM THE RECESSION RISK
Of course, consensus opinion still believes that the US economy is sailing along, regardless of any problems elsewhere. But the chart of oil prices relative to recession tells a different story:
- The problem is that oil prices have been rising since 2016, with the summer proving the final blow-off peak. As always, this meant consumers had to cut back on discretionary spending as costs of transport and heating rose
- The cost of oil as a percentage of GDP reached 3.1% in Q3 – a level which has always led to recession in the past, with the exception of the post-2008 stimulus period when governments and central banks were pouring $tns of stimulus money into the global economy
- In turn, this means a downturn is now beginning in US end-user demand in critical areas such as housing, autos and electronics
Oil markets have therefore provided a classic example of the trading maxim for weak markets – “Buy on the rumour, sell on the news”.
- Prices had risen by 75% since June on supply shortage fears, following President Trump’s decision to exit the Iran nuclear deal on November 4
- As always, this created “apparent demand” as buyers in the US and around the world bought ahead to minimise the impact of higher prices
- But the higher prices also negated the benefit of the earlier tax cuts for his core supporters just ahead of the mid-term elections, causing Trump to undertake a policy u-turn
- He is now pushing Saudi Arabia and Russia to maintain production, and has announced 180-day exemptions for Iran’s 8 largest customers – China, India, S Korea, Japan, Italy, Greece, Taiwan and Turkey.
Understandably, oil traders have now decided that his “bark is worse than his bite“. And with the downturn spreading from Asia to the West, markets are now refocusing on supply/demand balances, with the International Energy Agency suggesting stocks will build by 2mb/d in H1 2019. In response, OPEC are reportedly discussing potential cuts of up to 1.4mb/d from December.
CHINA’S SHADOW BANKING COLLAPSE IS CREATING A NEW FINANCIAL CRISIS
Unfortunately, as in 2008, the collapse in oil prices is coinciding with the end of stimulus policies, particularly in China, as the chart of its shadow bank lending confirms. This has hit demand in two ways, as I discussed earlier this month in the Financial Times:
- Just 3 years ago, it was pumping out an average $140bn/month in mainly property-related lending *
- This created enormous demand for EM commodity exports
- It also boosted global property prices as wealthy Chinese rushed to get their money out of the country
- But during 2018, lending has collapsed by more than 80% to average just $23bn in October
China’s post-2008 stimulus programme was the growth engine for the global economy – with the efforts of the Western central banks very much a sideshow in comparison. It was more than half of the total $33tn lending to date. But now it is unwinding, prompting the Minsky Moment forecast a year ago by China’s central bank governor:
“China’s financial sector is and will be in a period with high risks that are easily triggered. Under pressure from multiple factors at home and abroad, the risks are multiple, broad, hidden, complex, sudden, contagious, and hazardous.”
As I warned then:
“Companies and investors should not ignore the warnings now coming out from Beijing about the change of strategy. China’s lending bubble – particularly in property – is likely coming to an end. In turn, this will lead to a bumpy ride for the global economy.”
The bumps are getting bigger and bigger as we head into recession. Asia’s downturn is now spreading to the rest of the world, and is a major wake-up call for anyone still planning for “business as usual”.
* Lending has major seasonal peaks in Q1, so I use rolling 12 month averages to avoid distortions
China is no longer seeking ‘growth at any cost’, with global implications, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
A pedestrian covers up against pollution in Beijing © Bloomberg
China’s President Xi Jinping faced two existential threats to Communist party rule when he took office 5 years ago.
He focused on the first threat, from corruption, by appointing an anti-corruption tsar, Wang Qishan, who toured the country gathering evidence for trials as part of a high-profile national campaign.
More recently, Mr Xi has adopted the same tactic on an even broader scale to tackle the second threat, pollution. Joint inspection teams from the Ministry of Environmental Protection, the party’s anti-graft watchdog and its personnel arm have already punished 18,000 polluting companies with fines of $132m, and disciplined 12,000 officials.
The ICIS maps below confirm the broad nature of the inspections. They will have covered all 31 of China’s provinces by year-end, as well as the so-called “2+26” big cities in the heavily polluted Beijing-Tianjin-Hebei area.
The inspections’ importance was also underlined during October’s five-yearly People’s Congress, which added the words “high quality, more effective, more equitable, more sustainable” to the Party’s Constitution to describe the new direction for the economy, replacing Deng’s focus from 1977 on achieving growth at any cost.
It is hard to underestimate the likely short and longer-term impact of Mr Xi’s new policy. The Ministry has warned that the inspections are only “the first gunshot in the battle for the blue sky”, and will be followed by more severe crackdowns.
In essence, Mr Xi’s anti-pollution drive represents the end for China’s role as the manufacturing capital of the world.
The road-map for this paradigm shift was set out in March 2013 in 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”.
The report focused on the need for “improvement of the quality of growth”, based on development of “broader welfare and sustainability goals”.
However, little was achieved on the environmental front in Xi’s first term, as Premier Li Keqiang continued the Populist “growth at any cost” policies of his predecessors. According to the International Energy Agency’s recent report, Energy and Air Pollution, “Average life expectancy in China is reduced by almost 25 months because of poor air quality”.
But as discussed here in June, Mr Xi has now taken charge of economic policy. He is well aware that as incomes have increased, so China is following the west in becoming far more focused on ‘quality of life issues’. Land and water pollution will inevitably take longer to solve. So his immediate target is air pollution, principally the dangerously high levels of particulate matter, PM2.5, caused by China’s rapid industrialisation since joining the World Trade Organization in 2001.
As the state-owned China Daily has reported, the Beijing-Tianjin-Hebei region is the main focus of the new policy. Its high concentration of industrial and vehicle emissions is made worse in the winter by limited air circulation and the burning of coal, as heating requirements ramp up. The region has been told to reduce PM2.5 levels by at least 15% between October 2017 and March 2018. According to Reuters, companies in core sectors including steel, metal smelting, cement and coke have already been told to stagger production and reduce the use of trucks.
The chemicals industry, as always, is providing early insight into the potentially big disruption ahead for historical business and trade patterns:
- Benzene is a classic early indicator of changing economic trends, as we highlighted for FT Data back in 2012. The chart above confirms its importance once again, showing how the reduction in its coal-based production has already led to a doubling of China’s imports in the January to October period versus previous years, with Northeast and Southeast Asian exporters (NEA/SEA) the main beneficiaries
- But there is no “one size fits all” guide to the policy’s impact, as the right-hand panel for polypropylene (PP) confirms. China is now close to achieving self-sufficiency, as its own PP production has risen by a quarter over the same period, reducing imports by 9%. The crucial difference is that PP output is largely focused on modern refining/petrochemical complexes with relatively low levels of pollution
Investors and companies must therefore be prepared for further surprises over the critical winter months as China’s economy responds to the anti-pollution drive. The spring will probably bring more uncertainty, as Mr Xi accelerates China’s transition towards his concept of a more service-led “new normal” economy based on the mobile internet, and away from its historical dependence on heavy industry.This paradigm shift has two potential implications for the global economy.
One is that China will no longer need to maintain its vast stimulus programme, which has served as the engine of global recovery since 2008. Instead, we can expect to see sustainability rising up the global agenda, as Xi ramps up China’s transition away from the “policies that served it so well in the past”.
A second is that, as the chart below shows, China’s producer price index has been a good leading indicator for western inflation since 2008. Its recovery this year under the influence of the shutdowns suggests an “inflation surprise” may also await us in 2018.
Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.
The post Anti-pollution drive hits China’s role as global growth engine appeared first on Chemicals & The Economy.
China’s strategies for oil, refining and petrochemical production are very different from those in the West, as analysis of Sinopec’s Annual and 20-F Reports confirms. As the above chart shows, it doesn’t aim to maximise profit:
□ Since 1998, it has spent $45bn on capex in the refining sector, and $38bn in the chemicals sector
□ Yet it made just $1bn at EBIT level (Earnings Before Interest and Taxes) in refining, and only $21bn in chemicals
As I noted last year:
“Clearly no western company would ever dream of spending such large amounts of capital for so little reward. But as a State Owned Enterprise, Sinopec’s original mandate was to be a reliable supplier of raw materials to downstream factories, to maintain employment. More recently, the emphasis has changed to providing direct support to employment, through increased exports of refined products into Asian markets and increased self-sufficiency in petrochemicals”.
Commentary on China’s apparent growth in oil imports confirms the confusion this creates. Western markets cheered last year as China’s oil imports appeared to increase, hitting a record high. But they were ignoring key factors:
□ China’s crude imports were indeed 14% higher at 7.6 million bpd – nearly a million bpd higher than in 2015
□ But 700 kbpd of these imports were one-off demand as China filled its strategic storage
□ And at the same time, China’s refineries were pumping out record export volume: its fuel exports were up around one-third during the year to over 48 million tonnes
As Reuters noted:
“This broadly suggests China’s additional imports of crude oil were simply processed and exported as refined products.” In reality, ”China’s 2016 oil demand grew at the slowest pace in at least three years at 2.5%, down from 3.1% in 2015 and 3.8% in 2014, led by a sharp drop in diesel consumption and as gasoline usage eased from double-digit growth.”
The issue was simply that Premier Li was aiming to maintain employment in the “rust-belt provinces”, by boosting the so-called “tea-pot refineries”. He had therefore raised their oil import quotas to 8.7 million tonnes in 2016, more than double their 3.7 million tonne quota in 2016. As a result, they had more diesel and gasoline to sell in export markets.
The same pattern can be seen in petrochemicals, as the second chart confirms. It highlights how Operating Rates (OR%) for the two main products, ethylene and propylene, remain remarkably high by global standards. This confirms that Sinopec’s aim is not to maximise profit by slowing output when margins are low. Instead, as a State Owned Enterprise, its role is to be a reliable supplier to downstream factories, to keep people employed.
□ Its OR% for the major product, ethylene, hit a low of 94% after the start of the Financial Crisis in 2009, but has averaged 102% since Sinopec first reported the data in 1998
□ Its OR% for propylene has also averaged 102%, but has shown more volatility as it can be sourced from a wider variety of plants. It is currently at 100%
Understanding China’s strategy is particularly important when forecasting demand for the major new petrochemical plants now coming online in N America. Conventional analysis might suggest that China’s plants might shutdown, if imports could be provided more cheaply from US shale-based production. But that is not China’s strategy.
Communist Party rule since Deng Xiaoping’s famous Southern Tour in 1992 has always been based on the need to avoid social unrest by maintaining employment. There would therefore be no benefit to China’s leadership in closing plants. In fact, China is heading in the opposite direction with the current 5-Year Plan, as I discussed last month.
The Plan aims to increase self-sufficiency in the ethylene chain from 49% in 2015 to 62% in 2020. Similarly in the propylene chain, self-sufficiency will increase from 67% in 2015 to 93% in 2020.
It is therefore highly likely that China’s imports of petrochemicals and polymers will continue to decline, as I discussed last month. And if China follows through on its plans to develop a more service-based economy, based on the mobile internet, we could well seen exports of key polymers such as polypropylene start to appear in global markets.
It could be a very difficult H2 for anyone involved in the Asian oil and polymer markets. And given the global importance of these markets, everyone around the world will also feel the impact. The issue is that most business strategies have been based on 2 increasingly unlikely assumptions:
Companies all assumed that oil prices would stay at $100/bbl or higher forever
They also assumed that China’s economy would grow at double digit rates forever
It would have been hard enough if just one assumption had been wrong.
If oil prices had remained high, then companies based on natural gas might still have hoped to do well. If China’s demand had remained strong, then at least it would have been able to buy some of the planned new production. But as both assumptions seem likely to be wrong, companies have few places to hide:
China’s slowdown means that its gasoline and diesel exports are soaring. Gasoline exports rose 75% in H1 to 4.45 million tonnes, whilst diesel exports more than trebled to 6.6 million tonnes
The collapse of oil prices means that US polymer producers no longer have a major cost advantage versus oil-based producers in Asia and Europe
The end result of these two developments is likely to be chaos in oil and polymer markets.
Profits are already collapsing in Asian refining markets – they are down 83% since the start of the year and were just $2.21/bbl this week. And China is not the only country boosting its exports – India’s gasoline exports are up by nearly a quarter this year, whilst Saudi Arabia’s exports were up 76% between January – May.
Similar changes are taking place in China’s polymer markets, as the charts show. China’s polyethylene imports rose just 2% in H1 versus 2 years ago. Its polypropylene imports actually fell by nearly a quarter over the same period, as it ramped up new capacity based on very cheap imported propane.
And the underlying problems of too much supply chasing too little demand are likely to get worse, much worse, as we head into 2017, when all the new N American PE capacity will start to come online. Where will it all be sold is the big question? Can it all be sold?
Of course, the position might turn around if central banks do a mega-stimulus programme involving ‘helicopter money‘.
But the nightmare scenario for these producers is that the collapse of gasoline and diesel margins will now cause refiners to cut back production. In turn, this will further pressure oil markets – which are already struggling to cope with record high global inventories – and cause prices to return to parity with natural gas prices.
None of these concerns are new. I first raised them in a detailed analysis in March 2014, titled US boom is a dangerous game, when I warned:
“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. Any company sanctioning new investment without a firm guarantee of future offtake therefore risks finding itself landed with an expensive white elephant for the future.”
Unfortunately, however, consensus thinking preferred the analysis first described by Voltaire’s Candide – “that everything was for the best, in this best of all possible worlds“. Refiners and polymer producers could now find themselves in a very difficult situation as a result.
Difficult times lie ahead for global polymer markets, as I note in a new analysis for ICIS Chemical Business.
In the short-term it is clear that downstream users have, once again, been busy building stock in recent weeks as the oil price rose. But now, finance directors are getting calls from their bankers asking about working capital levels. It would be no surprise if demand soon slackened off again ahead of the seasonal summer slowdown, as this excess inventory is unwound.
Unfortunately, however, this is not the main problem facing us as we head into H2. There are more fundamental reasons for concern in the polymer markets themselves, as China starts to ramp up its own production of polymers, in line with the objectives of its new 5 Year Plan. This calls for 93% self-sufficiency in the propylene chain, and 62% in the ethylene chain, by 2020:
- Polypropylene (PP) highlights the change underway, as China’s capacity expands and its import needs reduce
- In turn, this is creating a chain reaction, as displaced export producers in NE Asia and the Middle East seek new markets
- The US market is one obvious target – and it is also starting to receive large volumes from Latin America, as the region’s economy heads into recession following China’s slowdown
- Europe has seen an even greater change in its trade patterns. It has now become a net importer, due to the arrival of displaced product from the Middle East and NE Asia, and a 9-fold increase in Latin American imports
These developments highlight the rapid shift that is taking place in demand drivers for the entire petrochemical and polymer industry:
- Until recently, the industry has operated on the “build it, and buyers will come” principle of Kevin Costner’s 1989 baseball movie ‘Field of Dreams’
- It profited from a 25-year economic SuperCycle, which caused business models to become supply-driven, based on the strength of BabyBoomer demand
- Today, however, we are going ‘Back to the Future’
- Feedstock cost advantage remains necessary, but it is no longer enough to guarantee profit in a world where demand growth is slowing sharply, as we describe in Denand – the New Direction for Profit’
Unfortunately, the post-Crisis meddling by central banks has increased the potential surpluses, by destroying price discovery in key markets. High oil prices were never justified by supply constraints. But, understandably, producers assumed new supply was needed, and rushed to expand production.
Only now are they starting to realise they were fooled. A new Study by Rystad Energy highlights the extent of the problem – it shows that the US now has larger oil reserves than either Saudi Arabia or Russia. And as the charts show, the US is also seeing a vast increase in propane production, as the Wall Street Journal describes:
“In a first, U.S. oil-and-gas companies are on track this year to export more propane than the next four largest exporting countries combined—OPEC members Qatar, Saudi Arabia, Algeria and Nigeria, which have long dominated the trade… U.S. exports already account for more than a third of the overall market for waterborne shipment”.
In essence, a chain reaction has developed, which is expanding in scope all the time:
- The US is exporting low-cost propane to China
- This means that China can cheaply expand its own propylene and polypropylene capacity via PDH technology
- It is now 81% self-sufficient in PP, with H1 output up 37% since 2014, dramatically reducing its import need
- NEA and the Middle East therefore need to send their newly-surplus production to the US
- This reduces the need for US domestic PP production, freeing up more cheap propane for export to China
And, of course, cheap PP can often replace polyethylene and other polymers in certain applications. So in turn, this will further pressure all the new PE capacity now about to come online on the US Gulf Coast, by reducing potential demand for the new product.
Please click here to read the ICB article. And please do contact me at email@example.com if you haven’t yet ordered the Demand Study, and would like further details.
Difficult times lie ahead for global polymer markets. It would be bad enough that downstream users have been busy building stock in recent weeks as the oil price rose, as Linda Naylor reports on polypropylene (PP) for ICIS:
“PP demand is slow, slower than many expected, and the strong growth of recent months is now considered to be partially down to stock building. “The market appears to have gone long quickly,” said one buyer. Some sources thought that inventories along the chain were higher, and concerns over working capital were leading to destocking.”
Now these stocks are likely to be unwound, as oil prices return to more normal levels with Iran and Iraq (and probably others) ramping up production just as demand weakens seasonally.
But there are more fundamental reasons for concern in the polymer markets themselves. As the chart above shows:
- China’s PP production is up 38% in January-April versus 2014 levels, and its imports are down 28%
- NE Asia and the Middle East have been badly hit, with their volumes down 10% and 38%
In turn, this is now starting to pressure the US market, as these producers seek to replace lost volumes. US imports from both regions have jumped to 25kt this year from 9kt in January-March 2015 (US Customs data is a month later than China’s). There are likely to be further increases through the year as China’s imports continue to reduce.
A further problem was a further 25kt of PP imports from Latin America – up from just 1kt in 2015 – as China’s slowdown forces LatAm producers to seek new markets. Unfortunately, US demand is also slowing, and so US inventories are now back at April 2013 highs.
As suggested 3 months ago, a major battle for market share is now developing, with US prices for PP starting to tumble. Contract prices fell 4c/lb ($88/t) in May after a 3c/lb fall in April, and ExxonMobil have told customers its prices will reduce by 3c – 5c/lb in June.
Europe is seeing a similar reversal of trade patterns, with Middle Eastern and NE Asian imports each up 20kt in January-February versus 2015 (Europe’s trade stats are even slower to appear than the US). And worryingly, many market players have failed to understand the extent of the downward pressures, with respondents to the latest ICIS sentiment index expecting a “sustained period of bullishness”. I fear they have a nasty shock ahead of them.
The problem goes far deeper than just PP, of course, as the second chart shows. European contract propylene prices have fallen sharply in H1 versus ethylene, averaging just 69% of the C2 price – a level last seen nearly 20 years ago. Already, as I found when giving the keynote presentation at last month’s World Polyolefins Conference, convertors are starting to think about switching from other polymers to PP in certain applications.
This is bound to put further pressure on polyethylene (PE), where China’s import volume has also fallen so far this year. It was down 3% versus 2015, whilst China’s production was up 6% – and overall demand up just 1%. The slowdown couldn’t be worse timed, as the first of the major new US capacities will be online in less than a year.
Unfortunately all my warnings have been lost in the recent euphoria – understandably, everyone wanted to instead believe that demand was returning to pre-2008 SuperCycle levels. But hope is not a strategy.
The good news is that our new Study, Demand – the New Direction for Profit, is now available to guide you through the difficult times that likely lie ahead. I honestly believe that buying it could be the best decision you make all year.