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Oil Prices, Chemicals Markets Face Steep Declines

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By John Richardson on 27-Jul-2016


By John Richardson

THERE are three things you need to know about today’s global chemicals markets:

  1. Oil prices are now retreating back to quite probably below $30/bbl, and so of course there will be a chemicals destocking process.
  2. But the good news, if you can call it that, is that the destocking process won’t be that dramatic because of a lack of restocking during the February-July bull-run in crude. This is confirmed by the above chart, which shows anaemic global chemicals operating rates up until May this year.
  3. Let’s get serious, though. The real takeaway from this chart is that if the global economy had been genuinely strong, chemicals operating rates would have been a lot higher as oil prices went up.

Let’s now look at these three points in detail before then discussing what this means for your planning process for the rest of 2016 and into 2017. 

Oil Prices Return To The New Normal

The rally in oil prices had very little to do with the fundamentals of supply and demand. Sure, there were some temporary supply shortages resulting from wildfires in Canada more sabotaging of Nigerian pipelines.

What really drove the rally in crude, though, was the weakness in the US dollar. Now that the dollar is strengthening, financial players realise they can no longer make money from buying oil as an alternative “store of value”, and are they are selling-off their long positions.

This financial deleveraging is occurring as US shale-oil producers ramp-up production because a.) Their production costs keep falling, and b.) This year’s oil-price rally has enabled them to hedge at $50/bbl. And here is a very important statistic:  In February this year, only 3.5% of global oil production was cash-negative at $35/bbl – just 3.4mbd. Today’s figure is likely be even lower, as production costs keep falling not in the US but in other regions as well.

Meanwhile, the crude market is at last waking up to the long-standing reality that OPEC was never going to agree on production cutbacks, thanks to last week’s comments from Russia.

Adding further downward momentum to oil is the equally belated realisation that in gasoline, too – as well as diesel – China is greatly adding to global deflation in refinery product markets.

Weak Global Chemicals Operating Rates

The above chart shows that since the 2008 Global Financial Crisis, global chemicals capacity utilisation has risen to a peak of just 85.7% in March 2011, based on IeC analysis of American Chemistry Council data. This was below anything seen in the 1987–H1 2008 period, when the lowest CU% level was 86.3% in H1 2002.

And in May of this year, global chemicals capacity utilisation was at 79.3% versus 81% during the same month last year.

These weak operating rates have occurred despite not only the run-up in crude, but also the vast amounts of monetary stimulus that has been pumped into the global economy by the world’s central banks. Chemicals production levels are an excellent barometer of the overall economy because, of course, chemicals and polymers go into so many manufacturing and services value chains.

So what’s gone wrong? It is demographics. Ageing populations make all of this monetary stimulus a waste of both time and money.

What has also gone wrong is that China has changed direction. Whilst the Western central banks are likely to continue with their failed stimulus policies, China has changed direction. After a pause in Q1 when bank lending surged, economic reforms in China are now back on track.

What Happens Next

As oil prices fall below $30/bbl, chemicals buyers will hold back on purchasing decisions. There will thus, as I said, be a destocking process, even if it is historically quite mild.

Buyers of chemicals will also exercise caution because of social and political uncertainties that are resulting from the end of the Economic SupercycleBritain’s recent Brexit vote is one such uncertainty that will continue to add to the caution amongst some buyers. So will the outcome of this November’s US Presidential election.

How should chemicals companies respond? They should:

  • Build scenarios of very weak sales volumes, and deteriorating profitability, during the rest of 2016 and into 2017.
  • Resist pressure to cut costs in the wrong areas. The right kind of R&D and product development work that take advantage of the new demand drivers needs to continue.
  • Cancel the wrong kind of project, where the for the case for an investment has been based only on advantages in feedstock costs, access to cheap financing and exporting basic commodity chemicals and polymers to China.  Doing what worked so well in the past no longer works.