The financial crisis began a decade ago, yet production of the key “building block products” for the European petrochemical industry has still not recovered to its pre-Crisis peak, as the chart shows (based on new APPE data):
Combined production of ethylene, propylene and butadiene (olefins) peaked at 39.7 million tonnes in 2007
A decade later, 2016 olefin volume was 4% lower at 38.1MT, and lower than in the 2004 – 2007 subprime period
Olefins are used in a very wide variety of applications including plastics, detergents, textiles and paints across the European economy. The data therefore highlights the slow and halting timeline of the recovery – despite all the trillions of money-printing by the European and other central banks, and all the government stimulus programmes.
Worryingly, new data from the American Chemistry Council suggests that a new downturn may be underway in W Europe, as the second chart shows:
Output had been growing steadily at around 3%/year from 2014 to early-2016
But then it began to slide. It was just 0.5% in May, and only recovered to 2% in January – normally one of the seasonally strongest months in the year
This report is confirmed by Q1 results from BASF, the world’s largest chemical company. It cautioned that volumes were only slightly up compared to Q1 2016, despite “a sharp increase in prices for raw materials” due to the rise in oil prices. This is particularly worrying as demand was artificially inflated in Q1, due to many companies building inventory as the oil price rose following November’s OPEC/non-OPEC deal.
The issue is that oil prices are a critical factor along the entire value chain. Even retailers follow the oil price very closely, and every purchasing department aims to second-guess its direction, whether upwards or downwards. They buy ahead when they believe prices are rising, and leave purchases as late as possible when prices are falling.
This behaviour has a counter-intuitive impact on the market. Instead of demand reducing when prices rise, it actually appears to be increasing as companies build inventory. Thus producers are lulled into a false sense of security as price increases appear to have no impact on demand. But when oil prices are thought to have stabilised, volume then starts to reduce as buyers reduce their inventory to more normal levels.
The impact over a full cycle is, of course, neutral. But on the way up, apparent demand can often increase by around 10% and then fall by a similar amount on the downside, accentuating the basic economic cycle.
The European economy already faces a number of major headwinds due to the rise of the Populists and the UK’s Brexit decision to leave the European Union. Now the APPE and ACC data suggests that overall demand has actually been slowing for the past 9 months. And it is likely that underlying demand today is now slowing even more as companies along the value chain destock again as the oil price weakens.
Prudent CEOs and investors will no doubt already be preparing for a potentially difficult time in H2 this year.
Cotton markets are poised for another testing month in April. The outcome will also have potentially major implications for the polyester chain – and in turn for commodities markets more generally.
The reason is that China has announced that its long-awaited cotton auction will take place in the second half of the month. Cotton stocks are at all-time record highs – enough to make 3 pairs of jeans for everyone in the world – following the disastrous impact of stimulus policies, and China currently holds 11 million tonnes in store.
A lot is hanging on this auction, which will also tell us whether President Xi Jinping has now taken full charge of economic policy:
- Last year, an auction was announced for 1 million tonnes, but prices were set so high that only 63kt was sold
- The problem was resistance from an army-owned company, Xinjiang Production and Construction Corps
- It produces around 30% of China’s cotton, and opposed policies that would reduce its income by lowering prices
- It is also an important employer in Xinjiang province, accounting for 17% of its GDP
- But recently, as I noted in January, there have been signs that Xi is determined to make progress on the issue
This will have important implications for the polyester chain, as the chart above confirms.
Retailers vary their blends of polyester/cotton depending on relative prices, and the oil price fall has helped to support PTA/polyester demand in recent months. But as we note in the new “Demand – the New Direction for Profit” Study, China now also has enough PTA capacity to supply total world demand. So lower prices on cotton will likely lead to major price pressure on polyester, and across the textile chain.
In turn, this will pressure commodity markets more generally.
China’s New Normal policies have burst the commodities bubble created by policymaker stimulus. There has been a brief respite in recent weeks, as hedge funds realised the central banks were about to panic, once again. They knew the stimulus policies weren’t working, and that more free cash would soon become available. Oil prices jumped 50% as a result, along with other commodities.
But China is the real key to the outlook, as it has been since Xi became President in 2013. His most logical policy is to take the pain of restructuring this year. He can then move towards reappointment in 2017 by stressing that he has dealt with the problems he inherited, and can promise a better future ahead.
The outcome of the cotton auctions will be a key indicator for the global economic outlook for the rest of 2016.
Outsourcing and offshoring took off in western industry during the 1990s. The babyboomers’ demand supercycle meant new manufacturing capacity was urgently needed. And the entry of East Europe, China and India into the global economy offered a seemingly cheap way of achieving this. But today, new factors are reversing this trend.
The tragic deaths of 1100 Bangladesh textile factory workers will clearly accelerate the process, as consumers pressure retailers to increase manufacturing standards. But the trend has been developing for some time, led by major companies such as GE, whose map above highlights their creation of 16k new US jobs since 2009.
A major MIT study last year highlighted several key reasons for the new approach:
• Desire to bring products to market faster, by making them in the West
• Need to respond more rapidly to customer orders
• Reduced costs for transportation and warehousing
• Better protection of IP
• Higher quality
As an important article in Atlantic magazine noted last December, GE expects 75% of its $5bn Appliance Division’s sales to come from US production by next year, up from 55% in 2012. It notes the real benefit comes from applying new thinking – particularly the concepts of lean manufacturing. Simply recreating old-fashioned assembly lines will miss the point:
“In the simplest terms, an assembly line is a way of putting parts together to make a product; lean production is a way of putting the assembly line itself together so the work is as easy and efficient as possible.”
GE trialled the approach with its dishwasher team and successfully eliminated 35% of the labour required. And once they had reshored assembly, they began to manufacture key parts as well.
The key, as the Reshoring Initiative argues, is to focus on the total cost of ownership, not just wage costs. This is because today’s manufacturing environment is quite different from 20 years ago. Companies who reshore using lean manufacturing models will often find they can achieve lower ‘delivered cost’, even if the initial ‘purchase cost’ appears to be cheaper.