Boom, Gloom and the New Normal

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.

As promised, the blog looks today at the performance of US polyethylene (PE) exporters in Brazil.

It was the fastest-growing of the major markets in 2011, as the wider economy benefitted from China’s demand. Since 2008, Brazil’s PE net imports have grown 78%, from 445KT to 793KT in 2011. But as the chart shows (based on data from Global Trade Information Services):

• NAFTA (red square) has seen its market share decline from 40% to 38%, despite its growing cost advantage since 2010 due to shale gas
• The reason is that China’s changing market dynamics (as discussed yesterday), has led to greatly increased competition

USA net exports have grown 51% over the period, from 171KT to 258KT. Canada’s exports have also increased from 6KT to 32KT. But at the same time, many more players have entered the market:

• Latin American exporters (blue line) have been the big losers
• Their share has dropped from 42% in 2008 to 24% in 2011
• The Middle East (dark blue) has jumped from 2% to 13%
• Europe (green) has maintained its position, rising from 8% to 10%
• SEA (brown) has jumped from 1% to 6%
• NEA (dark green) has increased from 3% to 4%
• India (purple) has gained a 1% share

In turn, this has led to a decrease in relative profitability. GTIS data also shows that Thailand, for example:

• Sold in 2008 at an average $1825/tonne, $100/t above USA levels
• But in 2011 it sold at $1546/t, $50/t below USA levels

Brazil’s market dynamics therefore highlight the increasing challenge being faced by US exporters. Countries no longer able to sell their output to China will not simply reduce production. Instead, they will target new markets, increasing competitive pressures around the world.

US petchem producers are planning a major boost to ethylene capacity. They now have the 2nd cheapest feedstock in the world, due to ethane from shale gas. The only question is, where will they sell their product?

Ethylene, of course, is very expensive to export. So derivatives such as polyethylene (PE) are the main way to tap export markets. Today, using trade data from Global Trade Information Services, the blog looks at the outlook for PE in the US’s largest export market, China.

China should present a wonderful opportunity. Market growth has slowed to normal rates following the end of stimulus programmes. But its production is largely based on crude oil, and so is far more expensive than NAFTA’s. Yet, as the chart shows:

• China’s net imports from NAFTA fell 53% between 2009-11
• This was despite a major increase in their cost advantage
• The USA saw its net exports fall 51%, from 947KT to just 461KT

The reason is that China does not focus on profitability as a major driver for business. Instead, it emphasises social and political factors:

• Social. Sinopec continues to increase its own production, even though its total chemicals EBIT between 2000-10 was just Rmb84bn, compared to total chemicals capex of Rmb166bn. No Western company would invest on this basis. But Sinopec’s role is to act as an utility, providing reliable supplies of raw materials to China’s factories to keep people employed.
• Political. China is, however, increasing its PE imports from the Middle East (up 69%) and SE Asia (24%). The ME and China operate a ‘strategic corridor’ which balances China’s need for energy imports with the ME’s need for markets. Whilst SEA has a free trade area with China.

The result is that producers in NAFTA, NE Asia and Europe have all seen a major decline in export volumes since 2009. In turn, of course, this has led to greater competition for the USA in other markets.

Tomorrow, the blog will analyse how has impacted US exports to Brazil, currently the world’s fastest-growing major market for PE.

China’s bank lending fell 7% in 2011, following a 17% decline in 2010. As the chart shows (red column), the government is clearly trying to stabilise the position, after the panic increase in lending in 2008/2009. (January lending, impacted by Lunar New Year, was down 29% vs 2011).

Electricity consumption growth (blue line) also seems to be stabilising. It is a lagging indicator, as it takes time to expand electricity production. But the ending of subsidies for rural home appliances helped to push their sales down 33% in January versus 2011.

The reason for the government’s caution is that food price inflation remains out of control. It was up 10.5% in January, reversing recent declines. In a country where 96% of the population earns less than $20/day, food prices matter a great deal.

Those analysts with a purely financial outlook seem to have missed this critical point. They have been forecasting further stimulus programmes for some months. But very little has yet happened. Instead, the government remains focused on maintaining social stability.

This is particularly important in the run-up to the major changes that will take place in politburo membership this year. Thus, instead of reductions in interest rates, the government has instead announced minimum wages will rise 13% a year until 2015:

• In Beijing, it is currently $200/month, and $140 in urban Chongqing
• The aim is for it to be at least 40% of average wages by 2015
• At present, it varies between 20%-30%, depending on region

This will boost domestic spending power. But, as we argue in our Boom, Gloom and the New Normal eBook, affordability will be the key factor. Those companies who focus on meeting the population’s basic needs for food, water, shelter, health and mobility should do very well indeed.

Over the past 18 months, the main investment analysts have argued that high oil prices would have no impact on the global economy. Now, new forecasts suggest their optimism has been misplaced.

The chart above gives the International Energy Agency’s latest forecast of likely oil demand growth this year:

• It has been reduced by a further 0.3mbd since January
• Total 2012 oil demand growth is forecast to be just 0.8mbd
• Global economic growth is now forecast at just 3.3%, down from 4%

Sustained high oil prices are indeed reducing economic growth, and oil demand itself, just as they have done every time in the past.

Even the idea that China would “inevitably” see strong demand growth has proved wishful thinking. The IEA forecasts just a 0.4mbd increase in China’s oil demand this year. And even that may turn out to be over-optimistic, given the clear slowdown now underway.

As the blog has long feared, the chemical industry will now have to pick up the pieces, after the damage has been done:

• Today’s oil and feedstock price levels mean that working capital costs are very high compared to historical levels. This reduces the cash available for product and market development.
• They also increase market volatility. The lack of inventory means small changes in demand can cause major swings in market prices, if producers or consumers have to cover supply chain problems.
• Even more critically, as we are seeing with the Petroplus refinery bankruptcy, there is a real risk of supply disruptions for feedstocks and raw materials, if key plants can no longer afford to operate.

Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 14%. “US spot export prices are still too high for large quantities to be sold in many markets”
PTA China (red), down 10%. “Buying activity slowed down clearly as compared with last week because the persistently weak downstream polyester sales curtailed buying interest”
Naphtha Europe (brown dash), down 7%. The Petroplus bankruptcy led traders to build inventory in anticipation of “stronger demand from both the gasoline blending sector and petrochemical end-users”
Brent crude oil (blue dash), down 6%
Benzene NWE (green), down 4%. “Price ideas edged up in line with stronger US and Asia numbers as well as steady-to-firm energy costs”
S&P 500 Index (pink dot), down 2%

Last April, China’s polyester market provided an early warning signal that the current downturn was about to start. Now, it is flagging an important change in relative positions within the value chain.

9 months ago, the divergence between crude oil prices and those for the C8 chain highlighted slowing end-user demand. The chart above updates the picture since then:

• Brent (purple line) is ~150% above its January 2009 level
• PTA (red) peaked at ~130%, but is now only ~75% above this level
• PET (blue) peaked at ~110%, but is also now ~75% above this level
• PX (green) has been relatively stronger, and is 100% above this level

This, of course, is very bad news for those who have invested in PTA and PET. They are suffering value leakage in relation to paraxylene (PX) prices, rather than adding value.

The reasons are probably three-fold:

• Slow end-user demand means products close to the oil barrel have greater pricing power than those downstream
• Lower Western refinery operating rates are reducing mixed xylene production, and increasing the differential necessary to justify extraction
• A massive jump in Asian PTA capacity (primarily in China) is not being accompanied by a similar increase in PX supply

The jump in Asian capacity repeats the pattern seen in the early 2000s, when China first boosted PTA production. Fellow-blogger Malini Hariharan noted last month that nearly 11.5MT of new capacity is expected in Asia this year, whilst only 1.4MT of new PX supply is scheduled.

Major shortages, and considerable market disruption, could therefore occur if the new plants all bid for the same few available feedstock parcels. This wouldn’t happen in the West, where issues of profitability would take priority. Producers would instead optimise margins by selling PX and covering their PTA commitments by purchases.

But China’s philosophy is not so profit-oriented. Instead, due to the often close linkages between companies and government, the need to maximise employment can have priority. This is especially true in a year when major politburo elections are underway, and the need for social stability is strong.

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.

There is no arguing with markets when they are being driven by sentiment, either positive or negative. Last week’s news of China’s slower GDP growth gave rise to opposite interpretations in Asia and the West – but news media reported both were seen as firmly positive:

• In Asia, markets “jumped… after news that Q4 economic growth in China had beaten forecasts eased fears of a sharper slowdown there”
• Western markets “rose to a 10-week high…after China’s slowest economic growth in more than 2 years bolstered expectations for easier monetary policy”

News analysts, however, were more cautious, with CBS noting:

“This is the smallest GDP increase in a decade and the consensus opinion is that it indicates China is heading for a soft landing as its economy slows. That would be a reasonable conclusion if there was any chance this number wasn’t a complete fabrication. The actual number is certainly lower, quite possibly by a huge amount”.

The Washington Post added a more detailed warning:

“Real estate accounts for 13 percent of China’s economy, and it has been growing at ~20% a year…The run-up in real estate prices has allowed for massive government spending, as provinces and localities sell land and use land as collateral for large loans, raising the specter of a debt crisis similar to the debt crisis in the United States and Europe.”

Meanwhile petchem markets remained in their recent range. The current optimism in financial markets, even though these also remain range-bound, makes it prudent to restock inventories regularly.

The chart shows how markets have moved since 2009′s rally began, with the recent downturn highlighted in yellow. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 18%. “Even with higher global prices, US prices were still too high to generate much interest”.
Naphtha Europe (brown dash), down 14%. “Some seasonal restocking, a recent open arbitrage to the US and the current loading of European vessels booked in December for Asia”.
PTA China (red), down 13%. “Transactions were subdued as most market players were away for the upcoming Lunar New Year holiday”.
Brent crude oil (blue dash), down 11%
Benzene NWE (green), down 5%. “Values buoyed by a firming Asian market as well as crude and energy gains”
S&P 500 Index (pink dot), down 4%

Saturday’s blog post highlighted the risk of a hard landing in China.

This risk is very real, and is centred on the government’s need to achieve a difficult balance between reducing today’s high rate of food price inflation, whilst not collapsing the property market.

House prices are now falling in 60 Chinese cities. An excellent report by the Financial Times highlights the key issues, which are summarised in the chart above. As in the USA during the sub-prime bubble, we may well have reached the point where China’s credit bubble can expand no longer.

The key is the country’s relative poverty. It is only 90th in the world in terms of GDP/capita at just $5184. This is a long way from the USA at $48147 or Germany at $44558. Yet as the FT’s chart above shows:

• Beijing property prices average 17300 Rmb/sq metre ($2700)
• Shanghai property sells at 14300 Rmb/sq metre ($2200)

As a result, the house price to income ratio in China’s Tier 1 cities has reached 14:1. It is 10:1 in Tier 2 cities, and 8:1 even in Tier 3 cities. By comparison, the US ratio at the peak of its housing boom was only 5:1.

The problem is our old friend, unrealistic expectations. As the FT notes:

“It is easy to forget that the market is just over a decade old and, apart from a brief dip in the midst of the 2008 financial crisis when transactions dried up, most Chinese have only seen prices double every couple of years and never seen them fall.”

Before 1998, all urban housing was built and allocated by the state. There was no word even for ‘mortgage’, as there was no such thing as private residential property. Even in rural areas, peasants built their homes on land allocated by the state or the collective.

Another key factor behind the rise in prices has been China’s lack of a proper system of social security. As a result, most women believe owning a home is essential for any man wanting to get married.

Young bachelors have thus routinely turned to their extended families for help with raising the finance for a home. And as prices were doubling every 2 years over the past decade, the ‘bank of mum and dad, and grandparents, and cousins’ has always been happy to help.

Equally, the local provinces are dependent on property development for up to 40% of their income, according to the FT. And they quote Prof Yi Xianrong of China’s prestigious Academy of Social Sciences as warning

“Right now the high housing price is not due to limited supply – it is because of endemic speculation. But the government doesn’t combat speculation because high prices keep GDP growth and revenues high.”

Today. however, the government’s main concern is reducing the inflation caused by the credit bubble it unleashed in Q4 2008. It therefore has to reduce bank lending, even if this weakens property markets. Food price inflation is its key concern, and this rose again to 9.1% in December.

96% of China’s population earn less than $20/day according to the Asian Development Bank. So rising food prices inevitably lead to a risk of social unrest. In turn, this now makes it difficult for the government to support the property market.

Effectively, it may therefore be caught between a rock and a hard place.

Inflation and social unrest would increase if it launched another stimulus programme and allowed lending to boom again. But the current lending slowdown risks causing future unrest amongst all those who have bought into the market in the belief that prices would never fall.

The blog sees no easy way through this crisis. It can only repeat its warning of a year ago. We may be about to “discover, too late, we have simply been in the middle of yet another China ‘boom and bust’ scenario”.

The world enjoyed an economic SuperCycle between 1982-2007. Its largest economy, the USA, suffered just 16 months of recession during the whole 25 years.

As a result, social and political issues took a back-seat. Politicians instead competed to occupy the middle ground. Former UK premier Margaret Thatcher’s phrase ‘you can’t buck the markets’, became received wisdom almost everywhere.

The blog suspects a major change is now underway, as the world enters another recession – just 3 years after the 18 month downturn between 2007-09. Politics may revert to discussion of policies, instead of image. And life may become more uncertain as a result.

2012 sees presidential elections scheduled in the USA, China, Russia and France:

USA. The first primaries are now underway
China’s elections will see only 2 of the current 9-member politburo remain – Xi Jinping and Li Keqiang
Russia’s election process seems more uncertain, after recent protests
France’s election could be quite turbulent, given the Eurozone crisis

In addition, Germany will be preparing for major elections in 2013, whilst India’s current government may not last until 2014′s elections. Italy also seems overdue for an election, following Berlusconi’s departure.

Political issues will therefore assume much greater importance. A year ago, in its Budgeting for Uncertainty White Paper, the blog suggested that:

“Rising Western unemployment does not help the domestic population to repay the debts incurred during the final stage of the Boom after 2002.

“Now we have moved into a new stage, where countries try to maximise domestic employment by boosting exports via devaluation of their currencies.”During 2011, we moved into a phase of competitive devaluations. Today, trade disputes are becoming much more common:

• Whirlpool, the world’s largest appliance manufacturer, is asking for dumping duties on Korean refrigerators from Samsung and LG
• Meanwhile, the EU’s new airline tax on carbon emissions is threatening a trade war with China, Russia, India and possibly the USA.

2102 may well be the year when politicians more openly adopt protectionist measures to improve their own chances of election or re-election.