Boom, Gloom and the New Normal

An excellent new report from Citi’s commodities team suggests the US supply/demand balance for crude oil is undergoing fundamental change.

Importantly, they also argue that the concept of ‘peak oil is being buried’, and add:

“The belief that global oil production has peaked, or is on the cusp of doing so, has underpinned much of crude oil’s decade-long rally”.

US OIL MARKETS
As Citi note, the arrival of shale oil in the USA and the associated liquids from shale gas, is now “leading the US to be the fastest growing oil producer in the world“.

The Citi chart above provides dramatic evidence for the first assertion. It shows that the US has become a net exporter of refined oil products (gasoline, diesel, jet fuel etc) for the first time in 60 years. The scale of the turnaround is also important. The US imported 2.5mbd in 2005, but exported 360kpd in H2 2011.

Citi argue there is little reason to expect this trend to change. Not only is more oil being produced all the time, but US demand is also declining:

• On production, the key is developments in states like N Dakota, where companies are applying shale gas drilling techniques to shale oil deposits
• On demand, Citi share the blog’s view that higher prices reduce the ratio of oil demand growth to global GDP growth. Higher auto fuel standards, the attractiveness of shale gas, and increasing use of ethanol will also reduce oil demand

Citi thus expect the US “to achieve energy independence this decade”. This has been long-delayed since the goal was announced by then President Nixon in reaction to the 1973 oil crisis. But not only are the tools to achieve it now available, but also the political will.

PEAK OIL DOUBTS
The concept of ‘peak oil’ was originally invented in 1956 by a Shell geologist, M King Hubbert, and gained credibility from its accurate forecast that US oil production would peak between 1965-70. However, as the blog noted last year, Hubbert’s other forecasts were less successful. The USA produced 7.5mbd in 2011, rather than just the 1.5mbd he expected.

The major influence of the peak oil story has been in commodity markets.

As we noted in chapter 3 of ‘Boom, Gloom and the New Normal’, pension funds and others have been sold the idea that oil and other commodities represent a ‘store of value’ whose prices will always keep rising. Thus they have continued to buy, even though demand is falling and inventories are comfortable.

The major impact of the Citi argument is initially on US markets. They therefore expect the recent disconnect between WTI and global markets to continue.

Yet now the ‘peak oil’ theory is being challenged, the door is also opening for other countries to exploit the large deposits of shale gas and shale oil that exist outside the USA.

January was not a great month for auto sales in the 3 major markets of the USA, EU and China. These amount to over 50% of global auto sales, and are a key indicator of underlying consumer demand.

As the chart shows, sales were just 3m (red square), down from 3.2m (green line) in 2011:

• China’s volumes were down 17% to 1.2m from 1.4m
• EU fell from 1.04m to 0.97k
• Only the USA saw a rise to 0.9m from 0.8m

Of course, China’s sales were much slower than last year due to the Lunar New Year taking place earlier than in 2011, and combining with the Spring Festival. But even so, China’s auto industry is only forecasting 8% growth this year – in line with the 6% seen in 2011. This is well down on the 33% and 49% increases seen during the stimulus period.

It is also difficult to be optimistic about EU sales, with auto companies forecasting sales declines of 6% or more this year. Whilst sales growth forecasts in the USA will be tested by today’s high gasoline prices.

Cars are now the largest single market for chemical sales, as housing markets have slowed globally. Each new US car is worth $3297, for example, according to the American Chemistry Council (ACC), making the US market worth $42bn in 2011.

2011 auto sales were ~59m, up 4% from 2010. The West (EU, USA, Japan) still dominates, with 50% of demand. Developing countries showed rapid growth until recently, but the BRICs (Brazil, Russia, India, China) are still only 35%.

The chart above shows performance in the 3 largest markets since 2007:

• China (blue column) remained in top spot at 14m. But its growth rate collapsed with the ending of stimulus spending – from 49% in 2009, and 30% in 2010, to just 5% in 2011. Q4 growth was only 1%, as the last subsidies were removed in September
• The EU (red) was 2nd at 13m, continuing its recent decline. Sales have now fallen for 4 successive years. Without Germany, whose sales rose 9% to 3.1m in 2011, the picture would be even worse
• The USA (green) remained 3rd with sales up 11% to 13m, hopefully having now bottomed, as the blog noted recently. But they are a long way from the 15 – 17m range enjoyed during the 1995-2007 boom years

• Japan was the next largest market at 4.2m, hit by 2011′s tsunami disaster. The other main markets are small by comparison – Brazil at 2.7m, Russia at 2.6m, India at 2m

Overall, growth in the 3 major markets weakened significantly last year.

2009 had equalled 2008 performance, as China’s massive stimulus balanced the US/EU slowdown. Then co-ordinated G20 stimulus led to 10% growth in 2010. But last year saw growth decline to 4%. Q4 growth was only 2%, versus 10% in Q4 2010.

The blog does not rule out a panic reaction by policymakers, as it becomes more apparent that the world has re-entered recession. Co-ordinated stimulus would work for a period, as it did in 2009/10. But the debt overhang afterwards would be even worse than today’s.

In the absence of further stimulus, it is hard to see much growth in 2012, particularly with oil prices at today’s record level:

• Germany’s economy is slowing fast, so EU volumes are likely to continue their decline
• China’s growth will remain slow, as its primary focus is now on controlling food price inflation, rather than boosting demand
• The USA will probably also see only slow growth, even with further stimulus ahead of the presidential election

It is not all bad news, however, as moves to reduce auto weight will boost chemical and polymer demand. The ACC estimates, for example, that 378lbs (172kg) of plastics and composites were used in the average light vehicle in 2010, up from 286lbs in 2000 and just 20lbs in 1960.

But clearly the days of steady SuperCycle growth are now behind us, as the Western BabyBoomers enter the New Old 55+ generation. With 29% of the Western population already in this cohort, their mobility needs now represent a new and potentially very attractive market opportunity.

We highlight these in more detail in Chapter 8 of ‘Boom, Gloom and the New Normal’, to be published next week.

December’s US auto sales provide a classic example of Kahneman’s illusion, discussed on Saturday.

Initially they appear encouraging to our System 1 minds. As the chart shows (red line), they were the 2nd highest of the year, and one of the few months to top 1.1m sales since the start of the Great Recession. But analysing them with a System 2 approach gives a different picture.

The past 3 years have seen buyers trying to avoid purchases:

• Owners have been hanging on to old cars for as long as possible
• Vehicle scrappage rates are now only 4% of the US fleet
• The average age of the US fleet is nearly 11 years, a record
• They are driving less, with vehicle miles down 1.7% versus 2007 levels

Yet there are limits to everything. Life without a car is very difficult in many parts of the USA, due to the lack of public transport and the vast distances. So it would appear that we have finally got to the point where today’s old cars simply can’t run any more.

As a result, industry estimates suggest we may well see 13.5m sales in 2012. This would better the 12.8m in 2011, but would still be well down on the 15 – 17m range seen in the boom years from 1995 – 2007.

These new purchases will come at a cost, however.

• Buyers are cutting expenditure in other areas, such as personal care
• Some are having to pay 16% interest on ‘near-prime’ loans (10% above normal rates)

None of these reasons provide much support for Wall Street’s System 1-type belief that recovery is finally underway. But they do highlight how companies need to conduct careful System 2 analysis, if they want to develop successful strategies for the transition to the NN.

November (red line) was a mixed month for auto sales, as the above chart shows. It updates the state of the world’s 3 largest markets:

• China remained the largest market with sales of 1.3m. Its Year To Date (YTD) sales are up 6% at 12.5m
• Europe is the 2nd largest market with sales of 1.03m, but YTD was down 2% at 12.1m
• The USA is 3rd, with sales of 1m, and YTD up 11% at 11.6m

In terms of total volumes, YTD 2011 was up 5% versus 2010 at 36.2m. This is a slowdown versus the 9% growth seen in 2010. But it is still respectable.

Interestingly, the USA is now leading the recovery, as both China and Europe have slowed. But its volumes are still a long way from the 15m-17m annual sales which were seen routinely until 2007.

China’s growth has slowed very sharply. Its sales were up 49% in 2009, and 30% last year. But the ending of the stimulus programmes has reduced demand growth very sharply.

Europe, however, is the weakest link. Its volumes have been lower every year since 2007. And it has become dangerously reliant on Germany:

1. Sales there were up 3% in November, as its economy continued to benefit from China’s demand.
2. But in the other major markets, the UK was down 4%, Spain down 6%, France down 8% and Italy down 9%.

Autos are a critical market for the chemical industry. They also provide an important insight into the wider state of consumer demand. Currently they are flashing an amber warning light that difficult times may lie ahead in all the main regions.

Autos are now the single biggest market for petchem sales. They are also reported very quickly. So October’s EU auto sales provide the best real-time picture of the downturn now underway. As the chart shows:

• October’s sales (red square) were the lowest in recent years
• Total sales since January are also the lowest
• They are 16% below the 2007 peak

It is not difficult to write the script from here. People in the weaker economies such as Spain or Italy will not be buying many new cars in the next few months. Austerity programmes and rising unemployment do not encourage purchases of high cost items.

Equally, as Petromatrix report, consumers are cutting back on their driving, as they worry about high fuel costs. Germany’s diesel demand was down 6% in September versus 2010, whilst gasoline demand was down 3%. Data for the other 4 main markets (France, UK, Italy, Spain) shows similar trends.

Already the auto makers are starting to respond. GM said its results were “not sustainable and not acceptable”, adding that it was looking at ways to reduce costs. Others such as Peugeot have already announced production cuts and layoffs.

Q1 could be very difficult indeed, if current trends continue.

Auto sales in the key global markets of China, USA and Europe present a mixed picture as we look towards year-end (red square):

• China had a strong September, and sales are now up 6% versus 2010
• But the Auto Association claimed this was due to a last minute rush of orders caused by the ending of subsidies on smaller engines
• They forecast Q4 sales will be down 5% as a result, and expect the market overall to be up just 3% in 2011

• Europe’s September sales were steady, and down 1% in 2011
• Germany remains key, with sales up 11% so far in 2011
• In the other major markets, France is stable, whilst the UK is down 5%, Italy down 11% and Spain down 21%

• The US is up 11% versus 2011, but still adrift of the pre-2008 period
• In total, it should meet the blog’s forecast of 11m-13m for the year

Overall, however, these 3 regions, which account for two thirds of global sales, are likely to show only minor growth of perhaps 3% in 2011, if China’s sales fall as forecast. This is really not good news for a market which is of such key importance for the chemical industry.

The good news about US auto sales last month was that they were the highest September sales since 2007. The bad news was that they were still below the 1.1 million level, which was the minimum monthly sale from 2005 – August 2008.

The reasons for the slight increase in sales were also quite prosaic. The average age of autos on the road is now a record 10.7 years, and so people are being forced to replace older vehicles. And even so, a rise in incentives to an average $2716/auto was required to boost sales.

The blog’s EPCA meetings also revealed that the size of the average auto sold is getting smaller, as consumers cut back spending. This reduces the actual amount of chemicals and polymers used per car. In turn, it means the benefit from the impact of greater fuel efficiency standards may be less than the blog had hoped.

Auto sales in the world’s 3 main markets (China, USA, EU), saw much slower growth in the past 3 months.

The chart above shows how they have moved in 2011 (red square) versus previous years. It is clear that the stimulus-led boom seen since 2009 has come to an end:

• Overall, sales in the last 3 months were 9.2m, up just 2% on 2010
• Last year, China’s sales were soaring, and masked the West’s slowdown
• But now the need to fight inflation has ended its credit boom

Thus year to date sales in these 3 major markets were 26m at the end of August. This was only 5% higher than the 2010 level, and looks set to weaken further in Q4. By comparison, 2009 saw a very healthy 10% rise at this stage in the year, even though Q1 had been dreadful.

Last year, these three regions were nearly two-thirds of global auto sales. And it seems other global markets are also slowing: passenger car sales in India actually fell 2% in the April-August period versus 2010.

This slowdown was already evident back in July. Hopefully companies focused on these important markets have now had time to prepare their contingency plans, in case the slowdown continues.

Most of Europe goes on holiday in August, and so it is only now that auto sales for July and August have been reported.

As the chart above shows, the monthly sales figures continued the weak trend seen so far this year (red square):

• July’s sales of 1 million were the lowest in the 2005-11 period
• August’s sales of 750k were lower than any year except 2010
• Total sales of 8.9 million were down 1% versus Jan-Aug 2010

ACEA (Association of European Auto Manufacturers) also note that only Germany is showing any strength amongst the 5 main markets. It is up 11% in 2011, but France is at 0%, the UK down 6%, Italy down 12% and Spain down 22%.

This does not provide much confidence regarding the Q4 outlook for chemical and polymer demand in this important sector.