The litmus test for the global economy

2018 will see Winners and Losers appear in plastics markets

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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Goodbye to “business as usual” model for plastics

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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The return of volatility is the key market risk for 2018

We are living in a strange world. As in 2007 – 2008, financial news continues to be euphoric, yet the general news is increasingly gloomy. As Nobel Prizewinner Richard Thaler, has warned, “We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping.” Both views can’t continue to exist alongside each other for ever. Whichever scenario comes out on top in 2018 will have major implications for investors and companies.

It therefore seems prudent to start building scenarios around some of the key risk areas – increased volatility in oil and interest rates, protectionism and the threat to free trade (including Brexit), and political disorder. One key issue is that the range of potential outcomes is widening.

Last year, for example, it was reasonable to use $50/bbl as a Base case forecast for oil prices, and then develop Upside and Downside cases using a $5/bbl swing either way. But today’s rising levels of uncertainty suggests such narrow ranges should instead be regarded as sensitivities rather than scenarios. In 2018, the risks to a $50/bbl Base case appear much larger:

  • On the Downside, US output is now rising very fast given today’s higher prices. The key issue with fracking is that the capital cost is paid up-front, and once the money has been spent, the focus is on variable cost – where most published data suggests actual operating cost is less than $10/bbl. US oil and product exports have already reached 7mbd, so it is not hard to see a situation where over-supplied energy markets cause prices to crash below $40/bbl at some point in 2018
  • On the Upside, instability is clearly rising in the Middle East. Saudi Arabia’s young Crown Prince, Mohammad bin Salman is already engaged in proxy wars with Iran in Yemen, Syria, Iraq and Lebanon. He has also arrested hundreds of leading Saudis, and fined them hundreds of billions of dollars in exchange for their release. If he proves to have over-extended himself, the resulting political confusion could impact the whole Middle East, and easily take prices above $75/bbl

Unfortunately, oil price volatility is not the only risk facing us in 2018. As the chart shows, the potential for a debt crisis triggered by rising interest rates cannot be ignored, given that the current $34tn total of central bank debt is approaching half of global GDP. Most media attention has been on the US Federal Reserve, which is finally moving to raise rates and “normalise” monetary policy. But the real action has been taking place in the emerging markets. 10-year benchmark bond rates have risen by a third in China over the past year to 4%, whilst rates are now at 6% in India, 7.5% in Russia and 10% in Brazil.

An “inflation surprise” could well prove the catalyst for such a reappraisal of market fundamentals. In the past, I have argued that deflation is the likely default outcome for the global economy, given its long-term demographic and demand deficits. But markets tend not to move in straight lines, and 2018 may well bring a temporary inflation spike, as China’s President Xi has clearly decided to tackle the country’s endemic pollution early in his second term. He has already shutdown thousands of polluting companies in many key industries such as steel, metal smelting, cement and coke.

His roadmap is 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”.

But, of course, transitions can be a dangerous time, as China’s central bank chief, Zhou Xiaochuan, highlighted at the 5-yearly Party Congress in October, when warning that China risks a “Minsky Moment“, where lenders and investors suddenly realise they have overpaid for their assets, and all rush together for the exits – as in 2008 in the west.

Business as usual” is always the most popular strategy, as it means companies and investors don’t face a need to make major changes. But we all know that change is inevitable over time. And at a certain moment, time can seem to literally “stand still” whilst sudden and sometimes traumatic change erupts.

At such moments, as in 2008, commentators rush to argue that “nobody could have seen this coming“. But, of course, this is nonsense. What they actually mean is that “nobody wanted to see this coming“. Nobody wanted to be focusing on contingency plans when everybody else seemed to be laughing all the way to the bank.

I discuss these issues in more detail in my annual Outlook for 2018.  Please click here to download this, and click here to watch the video interview with ICB deputy editor, Will Beacham.

The post The return of volatility is the key market risk for 2018 appeared first on Chemicals & The Economy.

Hurricane Harvey will turbocharge move to the circular economy

Harvey Oct17a

300,000 homes and half a million cars have been destroyed by Hurricane Harvey.  And in terms of business, it is often forgotten that Houston is home to more Fortune 500 companies than any other metro area than New York.  The damage will take years to repair, as families have to regroup and re-establish their lives – as I describe in my new feature article for ICIS Chemical Business, and in the above video interview with ICB Deputy Editor, Will Beacham.

The hurricanes are also likely to have a longer-term impact on the chemicals industry.  Regulatory concerns may well be increased, given the prominent reporting of the potential for toxic run-off from the two dozen Superfund sites in the area. There will also be increased pressure on the industry to rethink its basic business model and increase the priority given to sustainability.

Even before the hurricanes, consumer concern was mounting over the impact of plastic waste on the oceans and the environment. Now, the devastation they have caused will likely turbo-charge the move towards renewables and the circular economy. Fear is a strong motivator, and millions will take another look at climate change.

This development will, of course, create opportunities as well as challenges for farsighted companies. It is never easy to move away from a “business as usual” mind-set. But the increased need to adopt key elements of the circular economy agenda creates an opportunity to develop major new sources of revenue and profit for the future.

In a decade’s time, therefore, we will not simply remember today’s devastation. We will likely also recognise that it marked the moment when sustainability stopped being simply an item in the Annual Report, and instead opened the door to a new era for the industry and those who work and invest in it.

Please click here to download the feature article for ICIS Chemical Business, and click here to view the video interview.

Plastics demand is peaking as circular economy arrives

Plastic waste Jul17The Stone Age didn’t end because we ran out of stones.  Similarly, coal is being left in the ground because we no longer need it any more.  And the same is happening to oil, as Saudi Arabia recognised last year in its Vision 2030:

“Within 20 years, we will be an economy that doesn’t depend mainly on oil“.

And so now the debate is moving on, to products such as plastics that are made from oil.

The move began several years ago with the growing concern over plastic bags.  Consumers decided they no longer wanted to live in a world filled with waste bags.  Now, in a landmark new Study*, the debate is evolving to focus on the question of ‘What happens to plastic after we have used it?’   As the chart shows:

  The world has produced 8.3bn tonnes of plastic over the past 60 years
  Almost all of it, 91% in fact, has since been thrown away, never to be used again
  But it hasn’t simply disappeared, as plastic takes around 400 years to degrade
  Instead, the Study finds, 79% is filling up landfills or littering the environment and “at some point, much of it ends up in the oceans, the final sink

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.

RT Jul17
The good news is that potential solutions are being developed.  As the video shows, Recycling Technologies, for example (where I am a director), is now trialling technology that will recycle end-of-life plastic into virgin plastic, wax and oils.  Other companies are also hard at work on different solutions.  And more and more effort is focused on finding ways of removing plastic from the sea, as I noted last year:

 “95% of plastic packaging material value is currently lost after just a short first-use cycle
  By 2050, there will be more plastics in the ocean than fish by weight, if current policies continue
  Clearly, this state of affairs cannot be allowed to continue.”

SUSTAINABILITY IS REPLACING GLOBALISATION AS A KEY DRIVER FOR THE ECONOMY
But there is another side to this debate that is just about to move into the headlines.  That is the simple question of “How do we stop putting more and more plastic into the environment?”  Cleaning up the current mess is clearly critically important.  But the world is also starting to realise that it needs to stop creating the problem in the first place.

As always, there are a number of potential solutions potentially available:

  The arrival of 3D printing dramatically reduces the volume of plastic needed to make a finished product.  It operates on a very efficient “additive basis”, only using the volume that is needed, and producing very little waste
  Digitalisation offers the opportunity to avoid the use of plastics – with music, for example, most people today listen via streaming services and no longer buy CDs made of plastic
  The ‘sharing economy’ also reduces demand for plastic – new business models such as car-sharing, ride hailing and autonomous cars enable people to be mobile without needing to own a car

The key issue is that the world is moving to adopt the principles of the circular economy as the Ellen MacArthur Foundation notes:

“Underpinned by a transition to renewable energy sources, the circular model builds economic, natural and social capital.”

This paradigm shift clearly creates major challenges for those countries and companies wedded to producing ever-increasing volumes of plastic.  OPEC has an unpleasant shock ahead of it, for example, as its demand forecasts are based on a belief that:

“Over one-third of the total demand increase between 2015 and 2040 comes from the road transportation sector (6.2 mb/d). Strong growth is also foreseen in the petrochemicals sector (3.4 mb/d)”

They are forgetting the basic principle that, “What cannot continue forever, won’t continue“.  After all, it took just 25 years for cars to replace horses a century ago.  More recently, countries such as China and India went straight to mobile phones, and didn’t bother with landlines.  And as I noted last year, underlying demand patterns are also now changing as a result of today’s ageing populations:

  In the BabyBoomer-led SuperCycle, the growing population of young people needed globalisation in order to supply their needs. And they were not too worried about possible side-effects, due to the confidence of youth
  But today’s globally ageing populations do not require vast new quantities of everything to be produced. And being older, they are naturally more suspicious of change, and tend to see more downside than upside

Services Jul17Of course, change is always difficult because it creates winners and losers.  That is why “business as usual” is such a popular strategy.  It is therefore critically important that companies begin to prepare today to be among the winners in the world of the circular economy. As we all know:

There is no such thing as a mature industry, only mature firms. And industries inhabited by mature firms often present great opportunities for the innovative”.

As the 3rd chart shows, the winners in the field of plastics will be those companies and countries that focus on using their skills and expertise to develop service-based businesses.  These will aim at providing sustainable solutions for people’s needs in the fields of mobility, packaging and other essential areas. The losers will be those who bury their heads in the sand, and hope that nothing will ever change.

 

* The detailed paper is in Science Advances, ‘Production, use, and fate of all plastics ever made

Supply chains to shift from global to local

YouTube Jun17

We are living in an ever more uncertain world, where “business as usual” is becoming the least likely option for the future. Companies and investors need to adapt quickly to this new normal environment, if they want to maintain revenue and profit growth. One example comes from the American company 3M, which has become legendary for its ability to identify new trends. Their latest insight continues this tradition, as CEO Inge Thulin has explained:

Our strategy has changed. If you go back several years, there was a strategy of producing at huge facilities at certain places around the world, and shipping it to other countries. But now we have a strategy of localisation and regionalisation.”

As Thulin suggests, there is plenty of evidence that global supply chains have reached their sell-by date. Political pressures are just one example of the challenges they now face, with America’s President Trump leading the way in starting to redraw the global trade map:

  He has already withdrawn from the Trans-Pacific Partnership, aimed at linking the US and 11 Pacific nations
  He is also intending to renegotiate the North American Free Trade Agreement with Mexico and Canada
  This month, he announced his intention to withdraw from COP-21, the Paris Climate Change Agreement

Similar disruption to previous trade patterns is also underway in Europe, where the UK’s Brexit vote to leave the European Union (EU) means that at least 759 treaties will have to be renegotiated – covering not only trade, but also key areas for business such as air traffic rights and financial services. This process will not be easy in the UK’s febrile political atmosphere, given the Conservative Party’s failure to win an outright majority in this month’s election.

The move away from globalisation towards more local supply chains also highlights the growing importance of sustainability as a key driver for the future. Globalisation was a critically important dynamic during the Baby Boomer–led economic SuperCycle, when demand was rising on a constant basis. But this demographic dividend is now being replaced by a demographic and demand deficit.

Today’s globally ageing population means that economic growth is set to decline in many countries:

  Older people already own most of what they need, and their incomes decline as they move into retirement
  The younger generation are also owning less “stuff”, as streaming services such as Netflix and Spotify confirm

Digitalisation is playing a key role in enabling this aspect of the paradigm shift, and it seems likely that major markets such as autos will now be prime candidate for disruption. We cannot yet know whether car-sharing, or autonomous vehicles, or another yet-to-be-invented business model will eventually dominate the mobility market of the future. But we can be reasonably sure that major disruption lies ahead.

I discuss these issues in more detail in the above video interview with Will Beacham, deputy editor of ICIS Chemical Business, and in a new article for the magazine.  Please click here to download a free copy.