US C2 Jul15I spent most of last week in New York and Boston, meeting with major investors.  One key topic on all their agendas was the major downturn underway in the global mining industry.  The connection with my visit was that some have already begun to worry that the planned US ethylene expansions may lead to a similar outcome.

The reason is that mining companies were a few years ahead of the US in rushing to boost their capacity by record amounts.  They were convinced that China’s growth would be sustained at double-digit levels forever. Now they are paying the price.  As the Financial Times reports:

“Commodity prices roared up during the past decade because of voracious demand from China, which single-handedly transformed the mining industry.  But prices have come down virtually across the board as China’s economic growth has slowed, and the country moved away from a multi-year construction boom.”

Equally sobering is the assessment of Mark Cutifani, chief executive of leading company, Anglo American,

It is a pretty tough market. The news from China hasn’t been good . . . It has deteriorated more than we expected and we think it is going to be tougher in the next six months“.

Investors are now worrying they may have encouraged US ethylene producers to make the same mistake:

  • They are currently helping to fund a 40+% increase in US ethylene capacity, at an estimated cost of $145bn
  • Yet as the chart above shows, the US has been unable to raise its demand above the levels of 10 years ago
  • Ethylene, PVC, styrene and ethylene glycol output peaked in 2004, and polyethylene output peaked in 2007

US PE Jul15Equally worrying is that net exports of ethylene’s major derivative, polyethylene, have been in decline since 2009, as the second chart based on data from Global Trade Information Services confirms,

Investors are also worried that many of these investments are apparently proceeding without the security of signed off-take contracts, backed by major bank guarantees.  This also mirrors developments in the mining industry, where euphoria over the outlook for China was the key driver.

These concerns are now being brought into sharp focus by the renewed weakness in crude oil prices since the Iran nuclear deal was finalised.  Investors are now concerned that if this decline continues, a return to lower oil prices could remove today’s US cost advantage versus other regions.  China’s stock market collapse adds to their concern.

These developments highlight the way that investors’ rose-tinted glasses led to them falling in love with the shale gas story, just as they had with mining.  They had encouraged both industries to expand by bidding up share prices for the companies involved, and rushing to provide the necessary finance.  Now they are realising, too late, that different Scenarios were also possible.

There is, of course, no easy escape from the current commitments, given the up-front costs that have already been incurred.  But the example of the mining industry suggests cancellation may well end up being the lowest cost option in the long run.