By John Richardson
TOMORROW’S winners will be those who recognise that oil, oil products such as gasoline and diesel and chemicals markets have changed for good.
They will understand that this has generated a whole range of new opportunities to make a profit and to sell huge volumes of product. These two things are obviously very closely linked in the commodities chemicals game, as shifting a million tonnes at a low margin is nearly always hugely better than shifting 400,000 tonnes at a high margin.
And, anyway, a standard new worldscale cracker is these days in the region of a million tonnes a year of ethylene capacity. So you simply must shift big volumes if you plan to start-up a brand new cracker complex and make your investment work.
The great news is that there is a very clear path to boosting your sales: Satisfying societal needs.
This will also help build the reputation of the chemicals industry, giving it the license to continue to produce in a world where permission to burn carbon is going to be increasingly rationed. In other words, if what we do helps get rid of huge shortfalls in the provision of basic needs in the developing world – such as water, sanitation and food – then legislators will be more willing to offset these benefits against the negatives of adding lots more carbon dioxide to the atmosphere.
Who as at risk of losing out? It will be those who resolutely stick to the old notions of how the oil production, refining and chemicals world works.
One of those old notions, as I shall explore in detail tomorrow when I look at polypropylene (PP), is that high oil prices are good news for the global chemicals industry. This thinking rests on the idea that crude in the region of $100 a barrel reflected a booming global economy, and so also had to mean healthy underlying supply and demand fundamentals.
Follow this idea through to its logical conclusion and you can end up thinking that the sooner oil gets back to that price level the better, as this will once again mean a strong global economy. If oil thus remains where it is today, or goes even lower, then this group of people may end up cutting back on their chemicals research, sales and marketing budgets, when, in fact, they should be spending more.
The only way we can get back to $100 crude is a major geopolitical crisis or another huge round of wasted Federal Reserve economic stimulus. Both of these events would be extremely bad news for the global economy, and so chemicals consumption growth.
What the real supply fundamentals of oil are telling us are as follows, as this excellent Seeking Alpha article points out:
- Oil supply will remain above demand over the next year because neither Russia nor OPEC will not agree to cutting production [This excess of supply over demand is a long term trend that will last long beyond 2016].
- US shale companies have increased the number of “DUC wells” – the fracklog I discussed earlier this year– so that they can quickly ramp up production if the price rises. Fracklog is oil held in storage, ready to be very quickly produced if crude prices marginally recover.
We have long known that OPEC is playing a “long game” and so, led by Saudi Arabia, it cannot and will not back down for several years. Saudi Arabia wants to avoid the 1980s mistake of cutting production only to still see prices and its market share collapse. It knows that it risks leaving oil in the ground if it cuts output.
On Russia, as Gary Bourgeault writes in his Seeking Alpha Post:
Russia’s way of producing oil is much different than OPEC’s, and it can’t simply shut down production quickly as producers in the Middle East can do. Russia’s cold climate also makes it difficult and slow to shut production down, and also takes time to ramp back up. Under that scenario, Russia would be giving up more than OPEC, and it’s not going to allow that to happen.
The other reason it won’t happen is Russia is so dependent on energy for its GDP, it would be devastating for it to give up market share without a fight, as it would have a dramatic impact on its people and the country.
The other side of the story is demand. Consumption of oil in the developed world is in long-term decline because of demographics.
Meanwhile, in the developing world it is all about China. To believe otherwise – that other individual emerging markets can consume as much oil and all the things made from oil as China in the foreseeable future – has always been a mathematical fallacy. Even if you lump together the consumption of many of the other emerging markets, your final total will still fall short of China.
China is undergoing its own long-term economic slowdown, so there goes your main source of incremental demand growth for crude. At the same time, consumption in the rest of the emerging world will taper-off because of its overreliance on China as a driver of its own economic growth.
The chart at the beginning of this post, from the Wall Street Journal, shows the impact of the slowdown in China’s economy on diesel and gasoline demand so far this year. But this is not temporary, this is structural as we know that a.) China is moving away from being a heavy manufacturing economy and so diesel demand will continue to moderate, and b.) For both economic and environmental reasons, new-car sales are in long-term decline.
China is in general firmly committed to a leaner, greener future as it seeks to clean up its environment, as shall become even clearer when full details if its 13th Five-Year-Plan (2016-2020) are released next year. This obviously also means lower demand growth for oil and coal.
But as I shall discuss tomorrow when I look in detail at PP, once you have accepted the realities of today’s oil markets, low oil prices over the next five and more years would be fantastic news for the global chemicals industry. This would stimulate demand by making all the products that we make very affordable in a world where affordability will be the No1 priority. The last thing that anyone should therefore be hoping for is for oil prices to return to anywhere near $100 a barrel.