West faces “demographic deficit” as populations age

Rising life expectancy, and falling fertility rates, mean that a third of the Western population is now in the low spending 55-plus age group.  Given that consumer spending is around two-thirds of the economy in developed countries, the above charts provide critically important information on the prospects for economic growth.

They show official data for household spending in 3 of the major G7 economies in 2017 – the USA, Japan and the UK:

  • Each country reports on a slightly different basis in terms of age range and headings, but the basics are similar
  • US spending peaks in the 45 – 54 age group: Japanese spending peaks at age 55; UK spending peaks at age 50
  • After the age of 75, US spending falls 46% from its peak and UK spend falls 53%: after the age of 70, Japanese spending falls 34%

The data confirms the common sense conclusion that youthful populations create a potential demographic dividend in terms of economic growth.  Conversely, ageing populations have a demographic deficit and will see lower growth, as.older people already own most of what they need, and their incomes go down as they enter retirement.

The Western world has been, and still is, a classic case study for this demographic effect in action, as the second chart shows:

  • In 1950, only 16% of Westerners were in the New Old 55-plus age group; 39% were in the 25-54 age group that drives economic growth and wealth creation; and 45% were under 25 as the BabyBoom got underway
  • But by 2015, the percentage of New Olders had doubled to 31%, whilst the percentage of Wealth Creators was virtually unchanged at 41% and only 28% were under 25 (as fertility rates collapsed after 1970)

The Boomers were the largest and wealthiest generation that the world has ever seen, and as they joined the workforce they created an economic Super-Cycle. This was turbo-charged by the fact that, for the first time in history, Western women began to re-enter the workforce after childbirth:

  • In the US, for example, women’s participation rate nearly doubled from 34% in 1950 to a peak of 60% in 1999
  • And after the Equal Pay Act of 1963, their earnings rose to 62% of men’s by 1979 and to 81% by 2005 (since when it has flatlined)

But since 2001, the oldest Boomer, born in 1946, has been leaving the Wealth Creator age group.  By 2013, the average Boomer had left it.  And since 1970, Western fertility rates have been below replacement levels (2.1 babies/woman).  So the Western economy now faces a double squeeze:

  • The Boomers who created the SuperCycle are no longer making a major contribution to economic growth
  • The number of new Wealth Creators is now relatively smaller, due to the collapse of fertility rates

In the past, very few Boomers would have lived beyond retirement age, as the 3rd chart confirms based on UN Population Division data.  So, sadly, they would have been irrelevant in terms of economic growth.  But, wonderfully, this is no longer true today:

  • In 1950, average US life expectancy for men was just 66 years and 72 years for women.  UK men died at age 67, and women at age 72.  Japanese men died at age 61, and women at age 65
  • Today, US men are living an extra 11 years and women 9 years more.  UK men are living an extra 12 years and women 11 years more.  Japanese men are living an extra 19 years and women 22 years more
  • By 2030, the UN forecasts suggest US men will be living 20% longer than in 1950, and women 16% longer.  In the UK, men will be living 23% longer and women 18% longer.  In Japan, men will be living 35% longer, and women 37% longer

By 2030, 36% of the Western population will be New Olders, almost equal to the 37% who are Wealth Creators.

Clearly there is no going back to SuperCycle growth levels.  I will look at this critical issue in more detail next week.


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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.

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6 impossible things not to believe about oil before breakfast

Brent Sept16a

 ”Sometimes I’ve believed as many as six impossible things before breakfast.”

Oil traders know how the Queen felt in Lewis Carroll’s famous book, Alice Through the Looking-Glass.  The list of impossible things that they are being asked to believe grows almost by the day:

  Last week, prices jumped 4% on the basis that strong demand meant US inventories had fallen 14.5 mb in a week.  But the drop was more likely due to offshore rig shutdowns and oil import delays caused by Hurricane Hermine
  They were also asked to believe that Russia and Saudi Arabia would agree a deal to “rebalance oil markets” – even though the deal would not involve any production cuts, and would allow Iran and Nigeria to increase output
  Equally impossible was the earlier claim that China’s domestic demand would drive major price rises – when in reality some of this demand was one-off filling of strategic storage, and the rest was to increase diesel and gasoline exports from its teapot refineries into the Asian market, where margins are crashing as a result
  Before this was the claim that falling US drilling rig counts would collapse domestic oil production, even though cost-cutting meant industry major Pioneer said its Q2 production costs ranged between $2.25/bbl – $12.25/bbl
  Plus there is still a widely held view that Russia will have to cut output due to low prices, when in fact it is producing record volumes due to its production costs being less than $20/bbl
  And, of course, “everyone knew” earlier this year that Iran would never be able to boost oil production to its forecast levels after a nuclear deal – yet its current production is already only 200kpd below its year-end target of 4mbd

There are 100 other “stories” that have appeared in recent years to justify the myth that the world is running out of oil, and that prices need to be much higher than their median value for the past 150 years of $23/bbl.

These “stories” have helped fuel a speculative mania, which has proved highly profitable for commodity brokers and trading exchanges.  $51bn has so far moved into speculative commodity trading so far this year – the most since 2009.  And central banks have been very happy to supply free cash to support the speculation, in the hope this might help to create inflation and so reduce the cost of the debt created by their stimulus policies.

But, of course, those who actually use the oil – individual consumers, chemical companies etc – then have to pay the higher prices created by the mania.  So the end result is to reduce demand and weaken the global economy.

This clash between reality and illusion has created the near-record levels of volatility that we are seeing in oil markets so far this year.  But as the chart above confirms, each rally has only produced a pattern of “lower highs and lower lows” – each rally has been weaker than the last one, and prices go lower once it fails.

High levels of volatility are normally a sign that a mania is coming to an end.  Oil prices will then be left to find their own value, on the basis of real market fundamentals of supply and demand.  That, after all, is the key role of any market, to provide “price discovery”.


My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 54%
Naphtha Europe, down 53%. “Prices rise sharply on Brent hike”
Benzene Europe, down 53%. “US production as well as a lack of Asian imports earlier this year have strengthened US benzene prices into September.”
PTA China, down 40%. “High demand seen in July and August would likely not appear again, in the face of upcoming holidays and shrinking seasonal usage.”
HDPE US export, down 27%. “PE exports rose as the domestic market slackened, with production and sales figures for the month down by low single digit percentages, according to industry data.”
S&P 500 stock market index, up 9%
US$ Index, up 17%

A VUCA world of Volatility, Uncertainty, Complexity, Ambiguity

VUCAaA week is a long time in politics” was the insight of former UK premier Harold Wilson.  It is tempting to think that the events of the past week – a terrorist massacre in France: an attempted army coup in Turkey: a fatal US sniper attack: the overnight emergence of a new government with new policies in the UK – confirm Wilson’s remark.

But sadly, these were not just isolated, once-off incidents.  They are just the latest examples of the increasingly volatile, uncertain, complex and ambiguous world in which we now live.  Instead, the comment of Russian revolutionary leader VI Lenin seems more relevant:

There are decades when nothing happens and there are weeks when decades happen”

LaLa landOne super-critical issue is that for the past 20 years, policymakers have chosen to ignore today’s unprecedented level of demographic change – the fact that a New Old 55+ generation is emerging for the first time in history.  Instead they have claimed that the arrival of 1bn people in this cohort between 2000 – 2030 is simply “business as usual”.  Similarly, they have greeted the collapse of fertility rates – now well below replacement levels in most major economies – with just a shrug of the shoulders.

They have effectively created a fictional “La-La Land” where central banks believe they can create economic growth simply by printing money and reducing interest rates.  But now, this fiction is being exposed for all to see:

  • If the economy is going well, social and political issues tend to be downplayed
  • People don’t want to risk losing what they have, and hope their lives will improve
  • But when the economy starts going badly, then people have less to lose

The core economic issue is that the fundamentals of the global economy have been undermined by debt.  The alchemists at the central banks have promised NICE decades stretching out into the future, offering us Non-Inflationary Constant Expansion.  But today, it is becoming increasingly obvious that all the debt they have created – already 3x the size of the global economy – can never be repaid.

Trust in our political elites is therefore falling.  And more and more people are becoming uncomfortably aware that there will be many more Losers than Winners in the coming years – many pensioners, for example, will find that the promises they were made, will not be fulfilled.  And we all hope to live to be pensioners, one day.

VUCAA reader wrote to me recently asking the following question, which highlights just one of the many areas of major uncertainty in today’s world – currency volatility:

“I was wondering if you could talk more about what you think the effect will be on different world currencies as central banks continue to print money. Do you think the dollar will strengthen? Will it collapse with the S&P 500? What will happen to the euro and pound as Brexit intensifies? If the dollar collapses, will that change your outlook on the oil price?  I’d also love to hear your opinion on gold and whether it is commodity or a currency – and what do you see happening to it as the Great Unwinding occurs?”

This is a key issue, with major implications for governments, companies and ourselves as individuals.  The fact that questions like this are now being asked so often, by so many people in so many different parts of the world, tells us something very important is happening.

It confirms we are now living in a VUCA world, where Volatility, Uncertainty, Complexity and Ambiguity dominate – and where politicians’ focus on “soundbite analysis” fails to recognise there are no easy answers to the problems we face.

The issue of currency values is particularly important, as these are supposed to “take the strain” of balancing supply and demand in today’s economy.  I will return to it in a future post.  And please do let me know at phodges@iec.eu.com about other questions that you have.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 55%
Naphtha Europe, down 55%. “Naphtha market is over-supplied.  US gasoline blending demand poor”
Benzene Europe, down 54%. “Healthy derivative demand and balanced regional availability was keeping numbers buoyant into August”
PTA China, down 40%. “PTA ops rate at operational units remain high ahead of G20 shutdowns”
HDPE US export, down 33%. “Chines market players’ confidence was dampened amid continuous weak demand and sparse deals in the market. Thus, prices are expected to soften in the following week as some traders might need to lower their offers in a bid to move more cargoes.”
US$ Index, up 19%
S&P 500 stock market index, up 11%

IMF’s Greek memo confirms VUCA world has arrived

VUCAaThe good news was that the Eurozone leaders did realise, at the last moment, that Sunday was a “moment of truth” for the currency union and for Europe.  They spent 17 hours negotiating through the night as a result.  But reports suggest it wasn’t an easy time:

  • The BBC carried live reports of arguments between key players and shouting matches
  • At one point German Finance Minister , Wolfgang Schäuble apparently shouted “I’m not stupid” at the Governor of the European Central Bank, Mario Draghi
  • One participant described the meeting as being like “a kindergarten – the emotions have completely taken over

And since the meeting, a new IMF report has warned that ”Greece will need debt relief far beyond what euro zone partners have been prepared to consider, due to the devastation of its economy and banks in the last two weeks:

“The dramatic deterioration in debt sustainability points to the need for debt relief on a scale that would need to go well beyond what has been under consideration to date – and what has been proposed by the ESM,” the IMF said, referring to the European Stability Mechanism bailout fund.

“European countries would have to give Greece a 30-year grace period on servicing all its European debt, including new loans, and a very dramatic maturity extension, or else make explicit annual fiscal transfers to the Greek budget or accept “deep upfront haircuts” on their loans to Athens, the report said, adding.

“Greece’s debt can now only be made sustainable through debt relief measures that go far beyond what Europe has been willing to consider so far.”

It thus looks as though this may well be another of those “one step forwards, two steps back moments“.

I fear we will see many more of these moments in the future, as our leaders are finally forced to confront the problems of the real world – and can no longer pretend everything has been solved by printing money.  As we wrote in chapter 11 of Boom, Gloom and the New Normal:

“The transition to the New Normal is a sea-change for the global economy. Its full impact will take years, if not decades, to become clear. Meanwhile, the world will face much greater uncertainty, as conflicting views of the world play out on a day-to-day basis. Companies therefore need to plan for a VUCA environment: Volatility, Uncertainty, Complexity and Ambiguity will be the order of the day.”

The Greek crisis thus highlights the insight of Unilever CEO, Paul Polman:

I use the term VUCA to describe the world – Volatile, Uncertain, Complex and ambiguous.  It is very difficult for people to get a total picture.”

  • Volatility.  Nobody, including the key players, had forecast the twists and turns of the crisis over the past few months.  Crisis Eurozone summits followed each other in quick succession, Greece held a referendum on a week’s notice.  And we still don’t know if a final deal can be agreed.
  • Uncertainty.  The focus on the drama now shifts back to Athens.  Will the Syriza government gain approval for the package?  Will it survive as a government, or be replaced by different leaders?  Will there be new elections in the autumn?  We simply cannot know the answers to these critical questions
  • Complexity.  The Greek crisis was supposed to have been settled in 2010, and then in 2012.  Each time the bailout figure was higher, and now a 3rd bailout of €86bn ($95bn) is discussed.  But nobody really believes this will finally put Greece back on the road to economic sustainability
  • Ambiguity.  After all this time, there is no agreement within the Eurozone on objectives.  Greece wants to “end austerity”, Germany wants Greece to cut spending and increase taxes, other countries (poorer than Greece) don’t understand why they should handover yet more cash to Greece

And Greece is only a very small economy, its GDP was just $238bn last year.  What will happen when it becomes clear that one or more G20 countries cannot pay their bills?  As I wrote in my 2014 – 2016 Budget Outlook:

“The key is for each company to develop its own VUCA for success:

  • “Volatility.  Developing a road-map requires Vision
  • “Uncertainty.  A strategic Understanding of the changes underway is essential
  • “Complexity.  The planning process requires Clarity over implementation
  • “Ambiguity.  Unforeseen events will place a premium on Agility

“Nobody said business was meant to be easy.  But companies who take on the challenge of today’s VUCA world will be increasingly successful as we move through the 2014 – 2016 budget period.”


Chemical companies highlight increased uncertainty and volatility in Q1 results

Question markVolatility creates uncertainty.  And uncertainty can easily lead to paralysis, if a company hasn’t planned ahead for the range of potential scenarios that might develop.  This is the risk highlighted in my usual analysis of quarterly results.

A key warning sign is the divide that has developed recently in performance in different regions and industry sectors, as the detailed reports below confirm:

  • Several companies use words such as “challenging”, “volatile” and “uncertainty” to describe the outlook
  • Middle Eastern companies focused on their lower profits due to the fall in global market prices
  • And PPG, industry leader in paint and coatings, mirrored Akzo Nobel in highlighting a more difficult world.

But US petrochemical companies have, on the contrary, been encouraged by the recent rebound in crude oil prices to believe their shale advantage might continue.   And China’s majors happily reported further expansions in production, despite confirming weak demand in their domestic market.

Nobody can be sure what the rest of Q2, and H2 will bring.  We can all hope that it will finally bring the sustained recovery promised by policymakers for the past 6 years.  Stability in feedstock prices would be very welcome too.

But what happens if, as I suspect is more likely, Phase 2 of the Great Unwinding gathers momentum – causing interest rates to rise, and stock markets to weaken?

We have already seen some remarkable increases in Western interest rates.  And the increase in stock market volatility would normally be a warning sign that a change in trend was underway.

Knowing that we don’t know the answer, and planning ahead for a range of potential scenarios, is likely to be the best strategy for survival.

Air Liquide. “Growth in the next few years will be supported by the recent major new contract signings”
Air Products. ““Despite economic uncertainty, we remain laser focused on the things we can control and are maintaining our full-year guidance”
Akzo Nobel. “Overall market conditions remain challenging”
Arkema. “Positive foreign exchange will remain a key determinant”
Axiall. “Lower PVC prices and lower ECU values for the combined value of the caustic soda and chlorine”
BASF. “In a volatile and challenging environment, BASF aims to perform well and slightly increase sales in 2015″
BP. Resetting and rebalancing BP to meet the challenges of a possible period of sustained lower prices”
Bayer. “Raising its group sales forecast to between €48bn-49bn from €46bn previously, largely on account of positive exchange rate development”
Braskem. “Restocking trend in the plastics processors chain and strong demand from the domestic consumer goods and agribusiness sectors”
Brenntag. “Macroeconomic environment characterized by moderate recovery”
CP Chem. Margins fell because of lower polyethylene prices, as well as planned turnarounds”
Celanese. “Lower expenses and taxes led profit upwards”
Clariant. “Growth in Europe is expected to remain weak due to the appreciation of the Swiss franc with the weakening of the euro”
DSM. “Impairment charge following announced partnership with CVC and restructuring and related expenses”
Dow. “Looking ahead, we expect geopolitical and economic uncertainty throughout 2015″
Dow Corning. “Despite the headwinds caused by the strengthening US dollar we saw significant growth in our most profitable product lines”
DuPont. “Income fell by 28% year on year as negative currency effects and portfolio changes impacted sales”
Eastman. “We face increasing challenges including global economic uncertainty, the strengthening US dollar, and the impact of volatile oil prices”
Evonik. “Positive business trend in Q1″
ExxonMobil. “We remain focused on business fundamentals and competitive advantages that create long-term shareholder value”
Honeywell. “We will continue to plan conservatively as the global economic environment continues to evolve”
Huntsman. “We have taken aggressive self-help measures to deliver $175m of expected incremental synergies and restructuring savings by the middle of 2016″
Indorama. “Predicted inventory gains for Q2 on the back of stronger pricing for PTA and MEG
LG Chem. “Profit fell by 14% amid a double-digit decline in sales”
Lanxess. “Costs and exceptional charges caused by the ongoing restructuring of the business”
LyondellBasell. “Planned and unplanned industry downtime has continued to support polyolefins pricing”
MOL. “A much better petrochemicals contribution due to the smooth operation of Slovnaft’s units”
Olin. “Income fell by 56% on chlorine and caustic soda sales and costs related to a planned acquisition”
Oxychem. “Margin improvement across most of OxyChem’s product lines”
PKN Orlen. “Constraints on suppliers in western Europe having opened up market opportunities”
PPG. “A weak overall global economy and unfavourable currency effects”
PTT. “Prices of petrochemical products slumped in tandem with crude oil”
Perstorp. “A combination of positive currency effects, positive effects from improved margins and increased volumes”
PetroChina. “Production of ethylene grew by 8% and that of synthetic resins was up by 12%
PetroRabigh. Lower profit margin on petrochemicals, despite the relatively stable operations”
Polyone. “The sharp drop in prices for raw materials caused customers to destock their inventories”
Praxair. “Growth headwinds persist from the strength of the U.S. dollar and the impact of lower commodity prices on our customer base”Reliance. “Profit fell 7%, while sales at the division declined 18%”
SABIC. “Decrease in net income is attributable to lower average sales prices despite the reduction in cost of sales”
Saudi Kayan. “Swung to a net loss due to a drop in prices, production and sales”
Shell. “Chemicals earnings were buoyed by improved conditions in the intermediates industry which were more than offset by the impact of unit shutdowns at the Moerdijk chemical site in the Netherlands and weaker base chemicals industry conditions”
Sherwin Williams. Sales increased 3.5%n due primarily to higher paint sales volume in the groups Paint Stores and Consumer Groups, but unfavourable currency translation rate changes decreased consolidated net sales 3.1%”
Sinopec. “Ethylene production during the quarter rose 7% year on year while synthetic resin production expanded by 7.6%”
Sipchem. “Increased production volumes and sales”
Solvay. “Better margins and favourable foreign exchange development”
Slovnaft. “Demand was supported by lower product prices”
Synthomer. “Asian nitrile business continued to be the strongest performer as margins firmed and demand increased throughout the quarter”
Tasnee. “Decline in product prices outweighed the increase in the quantities produced and sold”
TOTAL. “Structural overcapacity in Europe is expected to weigh on margins in the medium term”
Trinseo. ““We are pleased to report break-even results for the first quarter, driven by our restructuring efforts”
Unipetrol. “very high market demand for polymers due to favourable GDP dynamics, limited imports to and higher exports from Europe (a weaker euro against the US dollar and a lower crude oil price were factors here) and force majeures at several European players”
Wacker. “Higher sales volumes, especially for solar silicon and semiconductor wafers, and the weaker euro helped boost sales”
Westlake. “Sales prices were negatively impacted by the significant decline in crude oil prices”