By John Richardson
IF you had presented this chart to your board of directors as a margins forecast at the beginning of this year, it is quite likely that you would have been laughed out of the boardroom. Nobody expected these kind of stellar results.
The thing is that this has never felt right, right from the outset of the upswing in margins which actually began in Q4 of last year. This is because the fourth quarter of last year marked the point when the world began to wake up to serious problems with the most-important demand growth engine of all: China. One of the symptoms of this broader understanding was the collapse in oil prices.
But “don’t look a gift horse in the mouth” is the old saying – in other words, the approach in these circumstances has long been to enjoy the strong profitability whilst it lasts without asking too many awkward questions in public. When it comes to investors, no company ever wants to raise doubts in case investors punish its share price and nobody else’s. Why be the first, and perhaps the only, company to suffer by being up-front about your concerns?
So we have seen companies and analysts come up with various theories about why margins have been so stellar, including:
- We are in the midst of a polyethylene (PE) mini super-cycle. The reason is that until the big wave of new US capacity starts coming on-stream from around H2 2017, there is too little new supply chasing too much demand. It therefore doesn’t really matter that demand growth is weaker.
- And we shouldn’t even obsess so much about demand being weak because even if China’s GDP is these days only growing at 6-7%, these are still great numbers and the size of PE markets is so much bigger than a decade ago. So, growth of “just 6-7%” is from a much higher base, which means that the industry is enjoying much-greater volumes of new demand compared with ten years ago. Plus, there are millions of people in the rest of the emerging world moving out of poverty for the first time, and so they will need lots more PE.
Let’s deal with this first point. Granted, relatively speaking there might not be that many new reactors starting-up over the next couple of years. But a few weeks ago, one very senior industry source said to me, “there is no shortage of PE at the moment, just the perception that things are tight”.
And when something cannot be afforded by your customers, you should be very worried. I have seen no evidence that today’s PE prices in Asia, which I think have been essentially driven by the rebound in oil and expensive ethylene, can be afforded by most converters. Now, of course oil prices are coming down, and ethylene and PE supply is lengthening on the end of scheduled and unscheduled shutdowns. So I strongly suspect that the struggling buyers of PE will attempt to claw-back the advantage.
On the second point, 6-7% growth in China isn’t actually 6-7% growth at all. Real growth is likely to remain in low single digits for several years, and will even be negative in some provinces as the great rebalancing gathers pace. As for the rest of the developing world, sure, progress on poverty alleviation has been tremendous over the past 20 or so years. But now, as the New further Normal develops, many millions of these people might be pushed back into poverty – for reasons including ageing populations in the West and climate change.
Very importantly, also, as people have put forward this second theory, they haven’t addressed what happens after H2 2017. You have to ask yourself why PE should be any different to oil, iron ore, copper and all the other commodities that are already severely oversupplied.
PE will, of course, be the same because the petchems business in general is not uniquely wise. It has got its longer term demand-growth forecasts wrong, along with the oil, iron ore and other commodities producers because it used same flawed, out-of-date ways of looking at the global economy. Too much PE supply will end up chasing too little demand because of a failure to get to grips with the New Normal.
What does the future hold? It holds the need to take a wholly different approach to selling PE, and all other petrochemicals, which I shall address in future blog posts. This will involve finding out how PE etc. can satisfy the basic needs of mobility, sustainability, sanitation, education, and sufficient decent food and water supply in the developing world.
Why? Because as demand growth will be much weaker in the future, people will not always be clamouring for your material, as was the case in the past. They instead will be asking these questions: “Do I really need to use PE or can I use another polymer to meet our basic needs? And if I do decide to buy PE, can I find ways of buying it in smaller volumes and at a cheaper price?” This will require a whole different approach to sales and marketing, which is an approach that most people will not be familiar with.
But let’s finish on a positive note. The margins so far this year have, as I have already said, been a fantastic, unexpected windfall. So I agree that petrochemicals companies should not look this gift horse in the mouth. What they should do is re-invest this unanticipated money in their businesses in order to prepare for the new Normal.