“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.
It is now 8 years since John Richardson and I published our 10-year forecast for 2021 in Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again’. Remarkably, its core conclusions are very relevant today, as the summary confirms.
Unfortunately, as we feared, policymakers refused to junk their out-of-date models, despite the lesson of the 2008 financial crisis. Instead, they doubled down on their failed stimulus policies.
- Yet nearly 1/3rd of the world’s High Income population are in the Perennials 55+ age group and are a replacement economy
- As a result, and as we suggested in 2011, central bank policies have not, and cannot, produce sustainable growth or inflation
As a result, they have created record levels of government, corporate and individual debt – which can never be repaid. Even the IMF has now started to recognise the timebomb that has been created:
“We look at the potential impact of a material economic slowdown – one that is half as severe as the global financial crisis of 2007-08. Our conclusion is sobering: debt owed by firms unable to cover interest expenses with earnings, which we call corporate debt at risk, could rise to $19tn. That is almost 40% of total corporate debt in the economies we studied.”
Already we are starting to see the unwinding of some of the most extreme examples of the bubbles that have been created in asset prices:
And if the IMF are right, which is almost certain, we must expect major bankruptcies to take place over the next few years. Over-leveraged businesses go bust very quickly when profits decline, as they can no longer pay their interest bills.
As with the run-up to the 2008 crisis, the signs of trouble are already building. The Fed has had to provide $200bn of support to overnight money markets in New York over the past 6 weeks, and is having to add another $60bn/month into next year.
Companies now face a binary choice as they finalise their Budgets for 2020-2022.
They can choose to ignore what is happening in the real world and continue to hope ‘business as usual’ will continue? Or they can start contingency planning by working through the implications of our forecasts for their Downside Scenario?
One key issue is that our 2021 predictions included paradigm shifts as well as economic forecasts. And as the chart above shows, the transitions associated with paradigm shifts are now accelerating:
- It took decades for the telephone, electricity, autos and even the radio to reach most Americans
- But it took only years for the microwave, computer, cellphone and internet to become mainstream
It is clear that a whole series of major paradigm shifts are now underway, as I noted 2 weeks ago:
- Climate change is finally being taken seriously by legislators and many companies
- This will lead to dramatic declines in the use of fossil fuels for both transport and petrochemicals
- It highlights how sustainability is now the key issue for corporate strategy, replacing globalisation
- Affordability is also moving up the agenda, and will become critical as the debt crisis starts to impact
The problem is that incumbents, as we have seen with central banks, are usually very slow to notice what is happening in the real world outside their office or factory. The reason is simple – they forget what they have discussed with their friends and family once they go to work. Group-think instead takes over, and everyone goes blindly on believing their own propaganda until it is too late.
German car company VW was a classic example of a blinkered strategy. As top executives now recognise, it was only the “dieselgate” emissions disaster that enabled new management to introduce the Transform 2025 strategy based on a transition to Electric Vehicles.
Most companies don’t face the near-death challenge faced by VW in 2015. But they do face major challenges over the next 2-3 years, which will require them to implement major shifts in their strategy if they want to continue to grow revenue and profits in the future.
The good news is that these challenges can be turned into opportunities with hard work and imagination. Please let me know if I can help you to achieve the necessary transformation.
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.
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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Good business strategies generally create good investments over the longer term. And so Aramco needs to ensure it has the best possible strategies, if it wants to maximise the outcome from its planned $2tn flotation. Unfortunately, the current oil price strategy seems more likely to damage its valuation, by being based on 3 questionable assumptions:
- Oil demand will always grow at levels seen in the past – if transport demand slows, plastics will take over
- Saudi will always be able to control the oil market – Russian/US production growth is irrelevant
- The rise of sustainability concerns, and alternative energy sources such as solar and wind, can be ignored
These are dangerous assumptions to make today, with the BabyBoomer-led SuperCycle fast receding into history.
After all, even in the SuperCycle, OPEC’s attempt in the early 1980s to hold the oil price at around today’s levels (in $2018) was a complete failure. So the odds on the policy working today are not very high, as Crown Prince Mohammed bin Salman (MbS) himself acknowledged 2 years ago, when launching his ambitious ‘Vision 2030:
“Within 20 years, we will be an economy that doesn’t depend mainly on oil. We don’t care about oil prices—$30 or $70, they are all the same to us. This battle is not my battle.”
As I noted here at the time, MbS’s bold plan for restructuring the economy included a welcome dose of reality:
“The government’s new Vision statement is based on the assumption of a $30/bbl oil price in 2030 – in line with the long-term historical average. And one key element of this policy is the flotation of 5% of Saudi Aramco, the world’s largest oil company. Estimates suggest it is worth at least $2tn, meaning that 5% will be worth $100bn. And as I suggested to the Wall Street Journal:
“The process of listing will completely change the character of the company and demand a new openness from its senior management“.
MbS is still making good progress with his domestic policy reforms. Women, for example, are finally due to be allowed to drive in June and modern entertainment facilities such as cinemas are now being allowed again after a 35 year ban. But unfortunately, over the past 2 years, Saudi oil policy has gone backwards.
SUSTAINABILITY/RENEWABLES ARE ALREADY REDUCING OIL MARKET DEMAND
Restructuring the Saudi economy away from oil-dependence was always going to be a tough challenge. And the pace of the required change is increasing, as the world’s consumers focus on sustainability and pollution.
It is, of course, easy to miss this trend if your advisers only listen to bonus-hungry investment bankers, or OPEC leaders. But when brand-owners such as Coca-Cola talk, you can’t afford to ignore what they are saying – and doing.
Coke uses 120bn bottles a year and as its CEO noted when introducing their new policy:
“If left unchecked, plastic waste will slowly choke our oceans and waterways. We’re using up our earth as if there’s another one on the shelf just waiting to be opened . . . companies have to do their part by making sure their packaging is actually recyclable.”
Similarly, MbS’s advisers seem to be completely ignoring the likely implications of China’s ‘War on Pollution’ for oil demand – and China is its largest customer for oil/plastics exports.
Already the European Union has set out plans to ensure “All plastic packaging is reusable or recyclable in a cost-effective manner by 2030”.
And in China, the city of Shenzhen has converted all of its 16359 buses to run on electric power, and is now converting its 17000 taxis.
Whilst the city of Jinan is planning a network of “intelligent highways” as the video in this Bloomberg report shows, which will use solar panels to charge the batteries of autonomous vehicles as they drive along.
ALIENATING CONSUMERS IS THE WRONG POLICY TO PURSUE
As the chart at the top confirms, oil’s period of energy dominance was already coming to an end, even before the issues of sustainability and pollution really began to emerge as constraints on demand.
This is why MbS was right to aim to move the Saudi economy away from its dependence on oil within 20 years.
By going back on this strategy, Saudi is storing up major problems for the planned Aramco flotation:
- Of course it is easy to force through price rises in the short-term via production cuts
- But in the medium term, they upset consumers and so hasten the decline in oil demand and Saudi’s market share
- It is much easier to fund the development of new technologies such as solar and wind when oil prices are high
- It is also much easier for rival oil producers, such as US frackers, to fund the growth of new low-cost production
Aramco is making major strides towards becoming a more open company. But when it comes to the flotation, investors are going to look carefully at the real outlook for oil demand in the critical transport sector. And they are rightly going to be nervous over the medium/longer-term prospects.
They are also going to be very sceptical about the idea that plastics can replace lost demand in the transport sector. Already 11 major brands, including Coke, Unilever, Wal-Mart and Pepsi – responsible for 6 million tonnes of plastic packaging – are committed to using “100% reusable, recyclable or compostable packaging by 2025“.
We can be sure that these numbers will grow dramatically over the next few years. Recycled plastic, not virgin product, is set to be the growth product of the future.
ITS NOT TOO LATE FOR A RETURN TO MBS’s ORIGINAL POLICY
Saudi already has a major challenge ahead in transforming its economy away from oil. In the short-term:
- Higher oil prices may allow the Kingdom to continue with generous handouts to the population
- But they will reduce Aramco’s value to investors over the medium and longer-term
- The planned $100bn windfall from the proposed $2tn valuation will become more difficult to achieve
3 years ago, Saudi’s then Oil Minister was very clear about the need to adopt a market share-based pricing policy:
“Saudi Arabia cut output in 1980s to support prices. I was responsible for production at Aramco at that time, and I saw how prices fell, so we lost on output and on prices at the same time. We learned from that mistake.”
As philosopher George Santayana wisely noted, “Those who cannot remember the past are condemned to repeat it.”
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Two major challenges face petrochemical and polymer producers and consumers in 2018:
- The likely disruption created by the arrival of the ethylene/polyethylene expansions in the US
- The growth of the circular economy and the need to dramatically increase recycling capacity
My new interview with Will Beacham, deputy editor of ICIS Chemical Business, focuses on both these key issues and suggests they will create Winners and Losers.
The new US product will likely change the global market. Its ethane feedstock is essentially a distressed product, which has to be removed to enable the shale gas to be sold. It is also clear that this 40% expansion of USA polyethylene capacity, around 6 million tonnes, cannot be sold into the US domestic market, which is already very mature:
- US net exports have actually been in decline in recent years, so it will also be a challenge to export the volumes
- President Trump’s apparent wish to start a trade war with China will make that market difficult to access
- It is likely, therefore, that a significant volume will end up arriving in Europe, causing a price war
We have seen price wars before, and the “Winners” are usually the integrated producers, who can roll through margins from the well-head or the refinery into ethylene and polyethylene sales.
The economics of this are relatively simple. In the US, producers will have to absorb lower margins on the small percentage of shale gas that is used as ethane feed into the cracker. Similarly in Europe, refinery-integrated producers will have to absorb lower margins on the small percentage of oil that is used as naphtha feed into the cracker.
As the chart shows, this development will be good news for ethylene consumers. As Huntsman CEO, Peter Huntsman noted a year ago:
“There is a wave of ethylene that is going to be hitting the North American markets quite substantially over the next couple of years. I’d rather be a spot buyer than a contract buyer. I can’t imagine with all of the ethylene that is going to be coming to the market that it’s not going to be a buying opportunity.”
In turn, of course, this will pressure other plastics via inter-polymer competition
Non-integrated producers clearly face more difficult times. And like the integrated producers, they share the challenge being posed by the rise of sustainability concerns, particularly over the 8 million tonnes of plastic that currently finds its way into the oceans every year.
This issue has been building for years, and clearly consumers are now starting to demand action from brand owners and governments.
In turn, this opens up major new opportunities for companies who are prepared to realign their business models with the New Plastics Economy concepts set out by the Ellen MacArthur Foundation and the World Economic Forum.
The New Plastics Economy is a collaborative initiative involving leading participants from across the global plastic packaging value chain, as the second chart illustrates. It has already prompted action from the European Union, which has now set out its EU Strategy for Plastics in the Circular Economy. This aims to:
“Transform the way plastics and plastics products are designed, produced, used and recycled. By 2030, all plastics packaging should be recyclable. The Strategy also highlights the need for specific measures, possibly a legislative instrument, to reduce the impact of single-use plastics, particularly in our seas and oceans.”
Clearly this represents a paradigm shift for the industry, both producers and consumers.
It may seem easier to do nothing, and to hope the whole problem will go ahead. But the coincidence of the arrival of all the new US shale gas capacity makes this an unlikely outcome. Companies who do nothing are likely instead to become Losers in this rapidly changing environment.
But as I discuss in the interview, companies who are prepared to rethink their business models, and to adapt to changing consumer needs, have a potentially very bright future ahead of them. Please click here to view it.
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