It is tempting to blame this on misfiring algorithms at the high-frequency traders. Regulators have been asleep at the wheel, and allowed them to dominate energy markets (and most other major financial markets). They are now responsible for half of all energy trading each day.
But there is a bigger issue underlying this problem, and one that must greatly concern companies as they finalise Budgets for 2016-18. This is the Great Unwinding now underway of the policymaker stimulus that pushed oil and other prices higher after 2008 – and led to China’s property and other bubbles now being unwound by President Xi:
- They have given companies a completely false view of underlying demand
- This $35tn of stimulus has made it appear that poor people in emerging countries (earning $2/day – $20/day) had become middle class by Western standards
- It disguised the fact that 1bn people in the world are moving out of the high-earning, high-spending Wealth Creator generation (those aged 25 – 54), into the low-earning, low-spending New Old 55+ generation
As a result, the industry has vastly over-expanded its capacity. It always does this at market peaks, as executives – cheered on by investors – rush to build new plants on the basis that demand growth will continue forever. The post-2008 market cycle has been even worse than normal for 2 key reasons:
- Most companies knew very little about China before 2008, and were easily persuaded that it would continue to see double-digit growth. They were also fooled by consensus thinking into believing that 3bn people in the emerging economies were becoming middle class
- Companies also put on their rose-tinted glasses when it came to assessing the impact of ageing populations on demand. They wanted to believe that “this time would be different”, and 65-year-olds would suddenly start spending as if they were 20 years younger
Now the Great Unwinding of these policies is underway, and all this excess capacity will force companies to compete fiercely on price and battle for market share. Even worse is the risk that, unlike in the past, demand may never catch up with all this new supply. It will take decades for the supposed ‘middle class’ in emerging economies to actually become middle class – if all goes well. And it would take 25 years for new babies to grow up and become Wealth Creators, even if women suddenly started tomorrow to reverse the decline in fertility rates and have more babies.
And this is where the problem of those ‘flash crashes’ becomes serious. It seems very unlikely that policymakers outside China will suddenly realise the error of their ways, and abandon stimulus. Far more likely, as the European Central Bank suggested last week, that they will do more and more stimulus to try and hide the failure of their policies. So markets will be pushed higher by the lure of unlimited amounts of free money from the central banks, and then brought low by the return of reality in terms of slowing demand and increasing debt levels.
As the map above shows, stimulus has effectively created fault-lines throughout the global economy. Those connected to emerging economies which have lost Chinese markets, have already started to open (thick lines). The developed economies will follow as the impact of China’s slowdown spreads (dotted lines). It will be a bumpy ride for the next few years. And companies should plan for the bumps in the road to be particularly large next year:
- China accounted for half of all stimulus in the 2008 – 2012 period before President Xi took office
- Since then he has been focused on unwinding the lending bubble he inherited
- He has also been redirecting the economy into a services-led New Normal, based on the mobile internet
- This means that China’s Old Normal economy will slowly wither away, never to return
2016 is critically important for his policies. He is due to seek re-appointment for a second 5-year term in November 2017. And it would make no sense for him to do this with the job half-done. Political necessity suggests he must try to ‘take the pain’ of adjustment by the end of 2016. Then he can approach the November 2017 Plenum with a platform that can not only claim to have resolved the problems he inherited, but also point to the sunlit uplands ahead – as his major initiatives of the Asian Infrastructure Investment Bank and the ‘One Belt, One Road‘ start to become reality.
So 2016 will see China putting its foot hard on the brakes of the Old Normal economy – whilst Western policymakers compete to ramp up stimulus to compensate. It could easily prove to be as difficult a year as 2008. Companies owe it to themselves to plan ahead for this Scenario. ‘Flash crashes’ take place in a flash, not over months. It could prove too late afterwards to regret that you had failed to put the necessary contingency plan in place.
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WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 54%
Naphtha Europe, down 52%. “Petrochemical demand for naphtha softens”
Benzene Europe, down 58%. “The key fundamentals in the European market are largely steady”
PTA China, down 42%. “Sentiment continued to be depressed by limited buying intentions from end-users and soft Brent crude prices”
HDPE US export, down 35%. “Domestic export prices remained stable”
¥:$, down 19%
S&P 500 stock market index, up 6%