Oil prices have now fallen $50/bbl since I forecast their collapse in August. But it is only recently that companies and investors have begun to realise this price fall is real, and not just a minor blip. As a result, few have yet recognised the extent of the collateral damage that is likely to appear in H1.
Of course, low oil prices are generally good for the economy, as they help to boost consumer spending on discretionary items. But it takes time for these positive effects to come through, as we saw in the 1985 and 2008 oil price collapses:
- People who lose money from the oil price fall stop spending immediately
- Those who gain money take time to accept it is safe to spend more
- And this time, there is another factor – namely that oil prices will now trigger deflation in Japan and Europe
- Deflation means people pay down debt as it becomes more expensive, and delay discretionary purchases as prices will be cheaper tomorrow
Chemical markets, as always, are the leading indicator for this behaviour, as the chart shows for the two most important products – ethylene and propylene – where annual price histories exist since 1978 and 1979 respectively:
- It shows prices for N Sea oil on the vertical axis in $/bbl, and product prices in $/tonne on the horizontal axis
- Prices are shown by annual average by decade – 1970s, brown; 1980s, red; 1990s, green; 2000s, pink
- This also highlights just how unusual recent price levels have been in the historical context
- The trend line shows European prices for both products have a greater than 95% correlation to oil
- Contract prices are 96% correlated for ethylene, and 97% correlated for propylene
Oil prices averaged $99/bbl in 2014 versus average ethylene contract prices of $1544/t and propylene prices of $1481/t in Europe. At today’s Brent oil price of ~$50/bbl, the equivalent price is $900/t for ethylene and $775/t for propylene.
This represents a loss of nearly $650/t for ethylene, and $700/t for propylene in less than 6 months. Multiply this by total inventory, and the hit to working capital is enormous.
This is why, as we have seen in recent months, buyers all down the value chain disappear very quickly very quickly when prices fall. They have to run down inventory as fast as possible to avoid bankruptcy.
In addition, of course, many companies will now have to write off capital investments made on the false assumption that oil would remain above its relative energy value to gas.
Of course, these developments are still only the early stages of the Great Unwinding of policymaker stimulus now underway. Companies and investors therefore need to move quickly to respond to this changed world.
‘Business as usual’ is, unfortunately, not an option for 2015 – especially as oil prices probably still have another $20/bbl or more to fall.
WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 53%. “Falling global prices, sluggish derivative demand and a bearish macroeconomic outlook saw the European benzene market drop below $600/tonne by mid-December 2014, the lowest point spot prices have been since May 2009”
Naphtha Europe, down 46%. “Crude oil futures remained on their downward trend amid the ongoing oversupply of physical crude around the globe.”
Brent crude oil, down 45%
PTA China, down 39%. ”Market sentiment was largely bearish because of weaker sales in the downstream polyester markets”
¥:$, down 18%
HDPE US export, down 12%. “A trader had heard of extreme discounts being offered to move material offshore”
S&P 500 stock market index, up 5%
