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.
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Polymer markets face two major challenges in coming months. The most immediate is the arrival of the major US shale gas-based ethylene and polyethylene expansions. The longer-term, but equally critical challenge, comes from growing public concern over plastic waste, particularly in the ocean.
The EU has set out its vision for a new plastics economy, where:
“All plastic packaging is reusable or recyclable in a cost-effective manner by 2030”.
Similarly, China has launched a ‘War on Pollution’, which has already led to all imports of plastic waste being banned.
Together, these developments mean there is unlikely to be a “business as usual” option for producers or consumers. A paradigm shift is under way which will change business models.
Some companies will focus on being low-cost suppliers, integrated back to the well-head or refinery. Others will become more service-led, with their revenue and profits based on exploiting the value provided by the polymer (virgin or recycled), rather than just the value of the virgin polymer itself.
The next 18 months are therefore likely to see major change, catalysed by the arrival of the new US production, as I discuss in a new analysis for ICIS Chemical Business.
The second chart indicates the potential impact of these new capacities by comparison with actual production since 2000, with 2019 volume forecast on basis of the planned capacity increases. But can this new PE volume really be sold? It certainly won’t all find a home in the US, as ExxonMobil Chemicals’ then President, Stephen Pryor, told ICIS in January 2014:
“The domestic market is what it is and therefore, part of these products, I would argue, most of these products, will have to be exported”.
And unfortunately for producers, President Trump’s new trade policies are unlikely to help them in the main potential growth market, China. As John Richardson and I noted a year ago, China’s $6tn Belt and Road Initiative:
“Creates the potential for China to lead a new free trade area including countries in Asia, Middle East, Africa and potentially Europe – just as the US appears to be withdrawing from its historical role of free trade leadership”.
The task is also made more difficult by the inventory-build that took place from June onwards as Brent oil prices rose 60% to peak at $71/bbl. As usual, buyers responded by building inventory ahead of price increases for their own raw materials. Now they are starting to destock again, slowing absolute levels of demand growth all around the world, just at the moment when the new capacity comes online.
SUSTAINABILITY CONCERNS ARE DRIVING MOVES TOWARDS A CIRCULAR ECONOMY
At the same time, the impact of the sustainability agenda and the drive towards the circular economy is becoming ever-stronger. The initial catalyst for this demand was the World Economic Forum’s 2016 report on ‘The New Plastics Economy’, which warned that on current trends, the oceans would contain more plastics than fish (by weight) by 2050 – a clearly unacceptable outcome.
Last year’s BBC documentary Blue Planet 2, narrated by the legendary Sir David Attenborough, then catalysed public concern over the impact of single use plastic in packaging and other applications. Even Queen Elizabeth has since announced that she is banning the use of plastic straws and bottles across the royal estates, as part of a move to cut back on the use of plastics “at all levels”.
Single use plastic applications in packaging are likely to be an early target for the move to recycling and the circular economy. This will have a major impact on demand, given that they currently account for more than half of PE demand:
- Two-thirds of all low density and linear low density PE is used in flexible packaging – a total of 33 million tonnes worldwide
- Nearly a quarter of high density PE is used in packaging film and sheets, and a fifth is used in injection moulding applications such as cups and crates – a total of 18 million tonnes worldwide
Virtually all of this production is potentially recyclable. 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.
Please click here to read the full analysis in ICIS Chemical Business.
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Global smartphone sales have seen major growth until recently as consumers fell in love with going mobile, as the chart shows:
- In the critical Q4 period they jumped from 290m in 2013 to 380m in 2014, 405m in 2015 and 439m in 2016
- But they then fell 9% in Q4 last year, according to Strategy Analytics data. They note that:
“It was the biggest annual fall in smartphone history (and) …. was caused by a collapse in the huge China market, where demand fell 16% annually due to longer replacement rates, fewer operator subsidies and a general lack of wow models.”
Even more revealing was that only Xiaomi of the Top 5 vendors increased their volume. Apple lost 1m sales, Samsung lost 3m, Huawei lost 4m, whilst even OPPO only managed to maintain its volume. And Xiaomi only did well because they were recovering from their 2016 collapse, when their share crashed to just 3.35% from 5% in Q4 2015.
Chinese companies were, however, the real winners during 2017 as the price war intensified, as the second chart confirms:
- China’s top 3 vendors now supply a quarter of the global market – compared to less than a tenth in 2013
- Samsung have been the main loser, with their share falling from over a third of the market to less than a fifth
- They did well to recover from the Galaxy Note 7 problems, but seem unlikely ever to reclaim their dominance
The rise of the Chinese vendors is great news for consumers, but very bad news for their competitors, as the third chart confirms. It highlights how revenues are now being squeezed for most vendors as the Chinese ramp up their volume. Only Apple has avoided the carnage by heading defiantly up-market, with its average handset price now close to $800.
The issue is the very different nature of the smartphone market in the major emerging economies, where incomes are much lower than in the West and it is very rare for carriers to subsidise handset sales over the life of the contract. In India, for example, the typical smartphone sells for less than $200, whilst Apple has less than 2% of the market.
2017 therefore marked a crucial turning point in the market, as I forecasted when reviewing 2016 data a year ago:
“The issue is that 3.1bn people now own smartphones, and the other 4.2bn can’t afford them. So inevitably, the market is going to focus more and more on price. Of course, millions of people will still want to own an iPhone or Galaxy. But price will become the deciding feature for many people.”
2018 seems likely to see pricing pressure intensify, now that the Chinese market has gone ex-growth. India is likely to be a critical battleground after Xiaomi’s success there in 2017, which was key to its nearly doubling global sales. As analysts IDC noted:
“Brands outside the Top 5 struggled to maintain momentum as value brands such as Honor, Vivo, Xiaomi, and OPPO offered incredible competition at the low end.”
OPPO is likely to be particularly aggressive as it saw no growth in 2017 after doubling its sales in 2016, whilst Xiaomi is unlikely to risk a second slip-up on volume. In turn, this makes it likely that Samsung’s mid-market positioning will come under major pressure from Chinese competition in key markets such as China and India.
Apple must now intensify its efforts to move into application-based markets such as healthcare and other services. It has been building its position over the past 3 years, and has a vast cash-pile from its smartphone profits to fund the necessary shift away from hardware sales. Samsung’s future looks less rosy, however, given that Chinese vendors have been able to produce smartphones for as little as $20 for the past 2 years.
And as I noted back in May 2015:
“The smartphone market is not alone is facing these New Normal challenges. They are coming to the online and High Street stores near all of us, if they haven’t already arrived.“
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‘What is this block of waste plastic doing on an Arctic ice-floe’, thousand of miles from where it was manufactured? Even more worrying is the question, ‘what will happen to it next?’ As David Attenborough’s ‘Blue Planet II‘ programmes have shown, plastic can break down into micro-particles after it has been used. And these micro-particles can then enter the food chain and the water supply:
- Around 150 million tonnes of plastic “disappear” from the world’s waste stream each year according to the BBC
- The United Nations estimates each square mile of sea contains 46000 pieces of waste plastic
- In turn, this plastic breaks up into micro-plastics, which can be eaten by fish and birds, and absorbed by plankton
- And then, as well as harming wildlife, it may well enter the food chain
- Micro-plastics also enter the water supply, and have even been found in drinking water at Trump Tower in the US
Now governments are starting to take action, with last week’s UN meeting of environment ministers formally agreeing that “the flow of plastics into the ocean must be stopped”. As the official Conference statement noted:
“We have been so bad at looking after our planet that we have very little room to make more mistakes…. we are sending a powerful message that we will listen to the science, change the way we consume and produce, and tackle pollution in all its forms across the globe.”
As I noted back in July at the launch of a major Study on waste plastic:
“Nobody is claiming that this waste was created deliberately. Nobody is claiming that plastics aren’t incredibly useful – they are, and they have saved millions of lives via their use in food packaging and other critical applications. The problem is simply, ‘What happens next?’ As one of the Study authors warns:
““We weren’t aware of the implications for plastic ending up in our environment until it was already there. Now we have a situation where we have to come from behind to catch up.””
We also know how this story will end, because we have seen it played out many times over the past 75 years.
As the photo on the left shows from 1953, most major Western cities used to be covered in smog during the winter, with people routinely wearing masks to try and protect themselves. The same is still true today in China and many cities in the Emerging Markets, as the photo on the right confirms.
- The smog problem was caused by coal, and governments were forced by popular pressure to greatly reduce its use in the West. Too many people were dying, or developing major lung and other diseases
- Then there were similar environmental problems with lead in gasoline, and with pollution from cigarette smoke. Again, governments moved to ban the use of lead, and to ban or restrict smoking in public places
The simple fact is that as societies become richer, people become more demanding about the quality of their lives. It is no longer enough to tell them that they are lucky to be alive, and to have some food to eat and water to drink. We can see the same development in China today, where President Xi knows that he has to tackle pollution, if the Communist Party wants to stay in power. As I noted last week:
“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.”
October’s 5-yearly National People’s Congress stepped up the enforcement measures:
“For those areas that have suffered ecological damage, their leaders and cadres will be held responsible for life,” said Yang Weimin, the deputy director of the Communist Party’s Office of the Central Leading Group on Financial and Economic Affairs. “Our people will be able to see stars at night and hear birds chirp.”
Smart companies and investors in the plastics industry already know “business as usual” strategies are no longer viable. Instead, they are starting to map out the enormous opportunities that these changes will create.
The issue is simply that plastic waste is no longer just seen as being unsightly. It is now recognised as a major environmental hazard. As the 3rd chart shows, 480bn plastic bottles were sold in 2016 around the world, but only 7% were recycled. This waste is becoming unacceptable to public opinion. As a result, the UK government is now considering a tax or ban on all single use items.
Equally important is that the momentum for change has been building for a decade, as one can see from a look back over some of my posts on plastic bags:
Globalisation was the great trend of the past 30 years, and it changed the world very profoundly. Today, the focus is on sustainability and the development of the circular economy.
It is an exciting time for people who want to solve the problem of plastics pollution by thinking “out of the box”, and developing the more service-driven businesses of the future.
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Suddenly, manufacturing and protectionism have become political issues across the Western world. President Trump has already formed a Manufacturing Council with the aim of “reshoring jobs” from outside the USA, and is threatening to introduce import duties of up to 45%.
The problem, however, as the chart shows, is that this will not help the people who voted for him. Manufacturing is not the key to future success for a High Income economy like the US. Its real importance has always been as the mechanism for Low Income economies to become Middle Income:
The US moved from being Low to Middle Income long ago and is now a High Income economy based on Services
High Income economies are 74% based on Services – Industry is just 25% of GDP (World Bank 2014 data)
By contrast, GDP in Middle Income economies is 35% based on Industry, with Services at just 56%
GDP in Low Income countries is only 48% based on Services, Agriculture is well ahead of Industry at 31%
The real problem facing the US and other developed societies is two-fold:
One is that the the wealthy developed world has moved into the fourth stage of the Demographic Transition. As the IMF noted 10 years ago:
“Industrial countries have largely completed what is called the “demographic transition”—the transition from a largely rural agrarian society with high fertility and mortality rates to a predominantly urban industrial society with low fertility and mortality rates”.
But this has never been explained to voters. Western political leaders didn’t want to have difficult debates about the the key issue raised by collapsing fertility rates and increasing life expectancy – how do we retrain people in their 50s and 60s to ensure they continue to contribute to economic growth? Instead, they preferred to hope that central bank stimulus could somehow replace the loss of babies.
Today, the voters’ patience is starting to wear out. They see little evidence of growth returning to the earlier SuperCycle levels, when most of the population were in the Wealth Creation 25 – 54 generation. And so they are looking for new leaders, who will do a better job of protecting their living standards.
This is where the second problem becomes critical. Unfortunately, Western education systems have not provided every voter with the Basic Skills they need to work successfully in a Services-based economy, as the second chart (from the new UK government Industrial strategy) highlights:
Sadly, 30% of US adults aged 16 – 65 lack basic numeracy and literacy skills to OECD Level 2 standard
Other major economies – Germany, UK, Poland, France, Spain, Italy – are also above the OECD average of 22%
It is therefore no great surprise that large numbers of adults, who have not voted regularly in previous elections, are now becoming more active. Populist policies have an obvious attraction for them, as they feel their country is heading in the wrong direction.
The third chart highlights an even more serious side of this issue, namely the very low levels of computer skills across the OECD. These are critical for an increasing number of jobs, but the OECD reported last year that nearly three-quarters of adults have poor (or lower levels) of computer skills. As they also noted:
“There is a strong positive relationship between problem-solving proficiency (in technology-related areas) on the one hand and literacy, and numeracy proficiency on the other.”
Education policy is not something that can be changed overnight. It will take years, if not decades, to replace today’s failing systems and to provide adults with the Basic Skills they have been denied.
Protectionism, on the other hand, appears to offer almost immediate prospect of change. Only later will it become apparent that its main role has been to turn back the clock on incomes and the economy.