By John Richardson
WE are in entirely uncharted territory because the West looks as if it is about to abandon the economic and geopolitical policy consensus that has been in place since the Second World War.
There is, for example, the collateral damage that might well result from the president-elect’s domestic stimulus policies – a stronger dollar leading to an emerging markets debt crisis.
Another consequence is that China ends up being blamed for manipulating its currency downwards, when in fact it will the stronger dollar that will be behind a much weaker Yuan. This increases the chances of a global trade war.
Risks for 2017 also include the success of populist politicians in elections in Holland, France and Germany. Italy, too, could be going to the polls next year because of Prime Minister Matteo Renzi’s resignation. Renzi has resigned, and has been replaced as Prime Minister, following his defeat in this month’s referendum on constitutional reform. It is no exaggeration to say that by this time next year, the Euro currency may no longer exist.
And what about China’s economy? Can it manage its debt crisis? Managing the crisis will be an awful lot harder in the event of a trade war and the collapse of the Euro.
The negative impact on demand for oil, and all the things made from oil including chemicals, will obviously be huge if all, or even just some, of these worst-case outcomes are realised.
In a weak demand growth environment, the only sensible response from oil producers would be to intensify their market-share battle. If any producer instead stuck to the recently agreed OPEC and non-OPEC cuts it would still be unable to reverse the fall in oil prices, whilst also losing market share.
But here is another wildcard: The impact on geopolitical stability of the incoming Trump administration’s approach to foreign policy.
Mr Trump earlier this month accepted a congratulatory call from the president of Taiwan. This caused panic amongst the foreign policy establishment as it appeared to put in doubt US policy that has been in place since 1979. Since that year, America has been aligned with Beijing’s “One China” policy, which stipulates that Taiwan is part of mainland China.
Over the weekend, Mr Trump went a step further when he said: “I fully understand the ‘One China Policy’ but I don’t know why we have to be bound by a ‘One China Policy’ unless we make a deal with China having to do with other things, including trade.”
China might welcome dealing with a pragmatic businessman, and may understand that positions like this are merely a way of opening negotiations.
Alternatively, we could end up with a geopolitical crisis between the US and China that drives oil prices a lot prices higher.
We also don’t know what the geopolitical implications will be of the incoming Trump team’s new approach to Russia.
Scenarios for Linear-Low Density Polyethylene
Oil prices could average $30/bbl or $90/bbl over the next 12 months. $50/bbl is also possible, but this “comfortable middle” scenario is the least likely outcome.
You must, as a result, “stress test” the profitability of your chemicals business using this broad range of outcomes.
Here I am going to use linear low-density polyethylene (LLDPE) as an example of what could happen to pricing and profitability under these three very different oil-price assumptions. Note that if you need scenarios for other products, contact me at john.richardson@icis.com.
LLDPE is of course used in many applications such as heavy duty industrial bags, film applications (e.g. stretch cling film, silage film), carrier bags, liquid paper board coatings, wire and cable and pipes. The above charts show what could happen to average pricing and profitability for LLDPE in December 2016-November 2017.
Here are the details behind my assumptions detailed in the chart at the beginning of this post:
In Scenario 1, Brent crude averages just $32.50/bbl in December 2016-November 2017. This leads to an average cost for naphtha for $292/tonne CFR Japan.
We always calculate the price per tonne of naphtha as a multiple of the price of oil per barrel. This multiple historically ranges around 8-9 times crude. In all three scenarios, I use an average multiple of 8.99, taking into account our view of supply and demand of naphtha over the next year.
In Scenario 1, I then assume an average spread, or gap, between naphtha and CFR LLDPE butene film-grade prices of $373/tonne. This would be line with the actual spread in 2011 of $374/tonne, when the LLDPE market was quite weak.
Also taking into account historical seasonal month-by-month variations in LLDPE prices, the end-result is an average LLDPE price of $663/tonne in December 2016-November 2017.
Average LLDPE integrated variable cost margins are $329/tonne. This would compare with an average margin in January-November 2016 of $675/tonne. But margins in 2009-2015 averaged $229/tonne and so this wouldn’t be a disastrous collapse.
Note that in all of these scenarios, I have also adjusted propylene, butadiene and aromatics prices and spreads based on the different market conditions. Co-product credits from selling propylene, butadiene and aromatics give us estimates of integrated variable cost LLDPE margins, which are calculated by our proprietary margins model.
Scenario 2 assumes an average Brent price of $52.94/bbl (the US Energy Information Administration’s estimate for the calendar year 2017 is $52/bbl). This leads to an average naphtha price of $471/tonne.
I then assume a naphtha-LLDPE average spread of $700/tonne – the same as the actual spread so far in 2016.
This results in an average LLDPE price of $1,172/tonne and an integrated variable cost margin of $519/tonne in December 2016-November 2017.
This, as I mentioned earlier, is the “comfortable middle” scenario where oil prices are higher on, but not too much higher, on effective production cuts and a reasonably healthy global economy.
In Scenario 3, though:
- Oil prices average $89.11/bbl and naphtha $801/tonne
- Spreads fall to $280/tonne on demand destruction caused by the surge in oil prices.
- LLDPE prices average only $1,115/tonne as margins slip to just $90/tonne, with some months during the forecast period seeing negative returns.
Scenario 3 is of course where geopolitics drive crude higher as the global economy enters a new recession.
This just scratches the surface. Any number of different outcomes are possible. For example, why not both a collapse in oil prices, and a collapse in LLDPE demand that also leads to very low margins under Scenario 1? You need to model many different outcomes, which is where the ICIS Consulting team can help.
This kind of work is essential as nobody really knows where we could be this time next year. 2017 will present a set of challenges that none of us have experienced before.