US shale gas – ‘its a demand thing’
on May 15, 2013

US PE trade May13.pngThe 25 years of the BabyBoomer demand supercycle between 1983-2007 cover the careers of most people in the industry. Over this quarter-century, we all grew to accept that low-cost and reliable supply was key to success. Demand would always take care of itself.

Today’s world is the opposite. Low-cost supply is no longer enough on its own, as growth has become hard to find. Instead, focusing on demand is now critical for success. And understandably, companies find it very difficult to adjust to this quite different world.

Developments in US shale gas provide the best example of the mindset change that is required:

• The US now has some of the lowest-cost ethylene supply in the world
• It also has all the necessary expertise and infrastructure to monetise this
• The problem is that it needs demand to increase
• And in today’s low-growth world, this is very hard to achieve

The chart of US polyethylene (PE) exports highlights this core issue. It is the largest ethylene derivative, yet Q1 net trade data from Global Trade Information Services shows export growth is very slow:

• 2013 exports (blue) have recovered from 2012’s slowdown (when outages reduced capacity)
• But they were up just 5% versus 2011 (red)
• The important Asian export market is also now much reduced
• China continues to invest in new capacity, as does SEA
• Latin America is the only real growth area, up 34%, but the outlook is uncertain
• It is building new capacity, whilst its growth is slowing in line with China’s slowdown

Of course, some argue that producers in high-cost regions such as China and Europe will shutdown and import product instead. But the blog has written many expenditure proposals in its time, and none have ever been dependent on competitor closures for success.

The reason is that experience shows existing capacity has a tendency to survive for much longer than anyone expects. Thus payback periods can become very hard to predict. And in the case of China, profit has never been the key driver for its own capacity expansions. As the blog’s study of Sinopec’s accounts since 1998 highlights:

• Its EBIT earnings have never covered its capital expenditure costs for chemicals
• Its role, being 76% state-owned, is instead to be a reliable supplier of raw materials to the factories to keep people employed
• In turn, this enables the communist party to ensure people’s living standards increase
• This then enables the party to remain in power

PE thus highlights the key issue as we transition to the New Normal. Ageing western populations cannot maintain the steady demand growth of the SuperCycle, when they were younger.

Of course, low-cost supply will always be important for profit. But as PE shows, the real key to success in the future will be understanding demand patterns.

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