V is for Volatility

Oil markets

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ethane v N May12.pngUnilever CEO Paul Polman suggests we are living in a VUCA world, as we discuss in chapter 11 of Boom, Gloom and the New Normal. Volatility, Uncertainty, Complexity and Ambiguity make planning for the future more difficult than for a generation.

This week, the blog will run a special series that examines how this VUCA world is impacting chemical companies, and complicating decision-making.

Oil prices are a classic example of increased Volatility. In the past, they would fluctuate according to changes in supply/demand fundamentals. Today, however, around 60% of trading is instead computer-driven.

At the same time, the US markets are seeing major changes take place in the availability of shale gas. Thus ethane prices have tumbled, even whilst oil-based feedstock prices have risen.

This is a recipe for confusion. The chart shows a 15 year history of naphtha prices in Rotterdam (the main global benchmark) versus ethane prices at Mt Belvieu in the USA:

• Historically, naphtha (blue line) and ethane (red) have moved together
• Ethane has usually been cheaper, as naphtha also has value in gasoline
• However the two lines have generally tracked each other closely
• During 2007-8, both surged to new highs and collapsed together

Today, however, naphtha prices are once again close to record highs, whilst ethane is much lower and within its traditional price range.

All olefin producers, and not just those planning ethane-fed expansions in the USA, now have to wrestle with the issue of whether current trends are sustainable. Some key questions include:

• Will oil prices stay at current high levels in future?
• Will ethane prices continue in the current range?
• Will ‘fracking’ technology transform oil production as well as natural gas?
• Will super-computer trading continue to dominate oil futures markets?

There are no ‘obvious’ answers to any of these questions.

Equally, each question has major implications in itself. For example, if oil prices do remain high, what will happen to consumer demand? Will it be reduced, as discretionary spending is reduced, thus hitting overall chemical and polymer demand?

The industry did, of course, face similar strategic issues in the 1960s-70s. Companies learnt to use judgement and experience when planning for the future, rather than simply assuming today’s world would continue forever.

Today’s rising Volatility suggests these skills are likely to become super-critical once again.

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