By John Richardson
PEOPLE do what they have to do to get by and so how we behave largely depends on the incentives that are set for us.
To give you just one example, the route to “getting by” – or rather the way to apparently make lots and lots of money now and in the future – has been very clearly laid-out for the US polyethylene (PE) producers over the last six years.
The shale gas revolution, which vanishingly few people predicted, created a bonanza of cheap raw materials. So you would have been seen as crazy not to lighten the feedstock slate of the crackers that fed your PE plants. We have thus seen lots of producers switch from naphtha and propane and butane to ethane at their existing facilities.
Financing these changes in feedstocks was incredibly easy because of the Fed’s quantitative easing programme that pushed-down borrowing costs to record lows.
It would equally have seemed crazy not to plan major capacity expansions because of again these feedstock advantages, bond investors falling over themselves to lend you cheap money, and these four long-standing broader business realities:
- The petrochemicals business has long been seen as all about running harder just to stand still – i.e. producers need to always be thinking ahead, to the next capacity expansion.
- Most of us have grown up in an era of almost constant global economic growth, give or take a few short lived even if at times brutal recessions. So this obviously translates into the need for ever-greater volumes of PE.
- What is defined as “world-scale” in all petrochemicals is also always increasing as engineers constantly find ways of building ever-bigger individual plants. If you don’t keep up with what is world-scale then your economies of scale – your unit costs of production – will fall behind your competitors.
- If you are say the world’s third-biggest PE producer, if you don’t keep on expanding in line with what your competitors are also doing you might end up being pushed-down to being only the fifth-biggest PE producer in the world. Lose market share in this way and you will not be able to charge as much for your PE because you are no longer as critical a global supplier.
We have rarely, if ever before, seen such a strong set of incentives line-up in this way before in the history of the petrochemicals business. So you would have been seen as foolish, and might even have lost your job, if you had turned your back on this overwhelming expansion logic.
Now that everything is going badly wrong, you will increasingly see people in the US petrochemicals business pointing fingers at those who set the wrong incentives. This might help shape better future monetary and fiscal policies in the US.
But finger-pointing won’t solve the immediate problem of where to place all the extra US PE volumes when they start to hit global markets after H2 2017.
Step One to getting there is to accept that the four “business facts” I have outlined above simply no longer apply in the New Normal. It is time to to question many of our long-held assumptions.
Step Two is to wherever possible postpone, or even cancel, US PE expansions.
A close look at charts such as the one above will help with Step Two. It shows how we believe that China’s linear-low density PE (LLDPE) demand will grow from 8.6 million tonnes in 2015 to 12 million tonnes in 2020 and 16 million tonnes in 2025. But these are our “base case” assumptions around which we can build downside scenarios for you, based on China’s difficult and likely very prolonged economic rebalancing.
Regardless of its consumption growth, China may anyway end up being pretty much self-sufficient in LLDPE much sooner than many people think. You can again need to build scenarios around this strong possibility.
Essentially take away China and the rest of the global industry is in trouble, as in 2015 China will account for no less than 28% of global demand. We see this rising to 33% by 2025. This is obviously a very extreme assumption with lots of grey areas in between. But do you have sufficient understanding of the new China to be able to respond to all of these potential grey areas?
And Step Four is about how to sell extra LLDPE and other PE volumes to regions and countries other than China.
If China disappoints that still leaves the West. But we know that in the US and Europe, PE demand growth will be very limited over the next ten years because of ageing populations.
Other emerging markets then? Yes, let’s hope that Africa will, for example, grow much better than our base case assumptions for LLDPE. We see Africa’s demand rising from 1.1 million tonnes in 2015 to 2 million tonnes in 2025.
But even if growth in Africa, Latin America and developing Asia ex-China ends up being much greater than all our base-case assumptions, do you have the right knowledge of these markets in place to guarantee that you end up as a winner?
“Markets such as Southeast Asia, India and even Africa, these will become more important going forward and will add a lot of complexity (lots more offices, different cultures, smaller orders, etc.),” said a former executive with a major polyolefins producer.
“I reckon some companies will finish up passing on the complexity (and therefore the margin) to traders, which I think will finish up being not very smart,” he added.
If you feel that you have already lost valuable time in preparing for the New Normal, there is no more time to lose.