By John Richardson
COUNTING the deckchairs on the deck of the Titanic as it heads towards the iceberg is the exact equivalent of assuming that 2017 oil prices will almost be entirely determined by whether or not OPEC and non-OPEC comply with their production cutbacks.
We might of course steer around the iceberg, but, as I discussed on Friday, the prospects for 2017 do not look good. And there is actually not just one iceberg out there, there are multiple icebergs.
Here are therefore three scenarios that place the OPEC and non-OPEC cuts into the broader context:
- Oil prices average less than $30/bbl in 2017, falling to lower than $25/bbl in H2. OPEC and non-OPEC producers initially stick to their agreed production cuts, but US shale-oil producers quickly fill the supply gap. Eventually, therefore, OPEC and non-OPEC players abandon their cuts in an attempt to win back market share. Meanwhile, the global economy is in recession.
- Oil averages around $55/bbl, and remains stable at this level throughout the year. US shale oil fails to fill the gap created by the production cuts. The reductions as a result stay in place and the global economy is fine.
- Crude prices average $90/bbl with great levels of volatility on supply disruptions caused by geopolitics. The trouble is that the global economy is already in recession before these supply disruptions, and so unaffordable crude makes the recession deeper.
I see No1 as the far-more likely scenario. No2 doesn’t take into account the end of the Economic Supercycle, which is behind the risks for 2017 which I again highlighted on Friday. And whilst geopolitics might temporarily drive prices towards $90/bbl, existing demand will already be so weak that this level will not be sustained for more than a few weeks.
We all obviously hope that No2 will happen, but hope is not the sole basis for sensible strategic planning.
A similar focus on petrochemicals supply
As 2016 comes to an end, there is also a danger that the petrochemicals business will also spend too much time counting the deckchairs and not enough time planning for the icebergs.
For example, much of the focus right now is on when 2017’s new polyethylene (PE) capacity will effect global markets. Substantial start-ups are scheduled for Asia and the Middle East. But the biggest production story by far in 2017 will of course centre around US start-ups. The ICIS Consulting base case for the rise in US surpluses sees the following:
- The high-density PE surplus will rise to 1.1 tonnes in 2017 from this year’s 800,000 tonnes. Low-density PE will increase to 620,000 tonnes from 515,000 tonnes, and linear-low density PE will rise to 750,000 tonnes from 580,000 tonnes.
Delays to US start-ups do however seem highly likely, and so we will constantly update our estimates during 2017. History suggests that commissioning capacity on this scale always takes longer than expected.
But what could well be far more important than the actual schedule of start-ups will be the trading relationship between the US and China. If it deteriorates to the point of a global trade war then the bigger issue will be whether the US can export to China at all
Let’s assume, for argument’s sake, that nearly all of the extra US output scheduled for 2017 is pushed back into 2018. In the event of the US not being able to export to China, this would still leave existing export volumes from the US to China struggling to find a home. How would the displacement of this volume effect global operating rates and margins?
The next level of severity would of course be that most of the new US capacity comes on-stream on schedule and we end up in a global trade, where US PE ends up being just too expensive for the Chinese to import because of high tariff barriers. Or might US imports be banned all together?
Let’s take this further. There is an even worse scenario where US PE start-ups are just about on schedule and other countries join with China in either raising tariffs on US PE imports, or excluding them entirely. This could happen if some of the 65 countries that make up China’s One Belt, One Road initiative decide to align with China. They may see that their long term economic and geopolitical interests will in future be much better served by moving closer to China, now that the US looks as if it is about to retreat from its global role.
“Please ignore the rhetoric,” I can hear you say, though, “Trump is a businessman, and so many of the statements he makes are about opening negotiations to win a compromise, or a deal, with another country.”
This was the context in which was placed his recent decision to accept a congratulatory call from the president of Taiwan, and then his comments questioning whether the US needed to stick with the One China policy.
But just how dangerous this approach could be for US-China trade and geopolitical relationships was illustrated by China’s response in the state-run newspaper, the Global Times. A carefully, but strongly worded, editorial included the following:
The One China policy is not for selling. Trump thinks that everything can be valued and, as long as his leverage is strong enough, he can sell or buy. If a price can be put on the US Constitution, will the American people sell their country’s constitution and implement the political systems of Saudi Arabia or Singapore?
Trump needs to learn to handle foreign affairs modestly, especially the China-US relationship. More importantly, a hard struggle against Trump is needed to let him know that China and other world powers cannot be easily taken advantage of.
If Trump gave up the One China policy, publicly supported Taiwan independence and wantonly sold weapons to Taiwan, China would have no grounds to partner with Washington on international affairs and contain forces hostile to the US. In response to Trump’s provocations, Beijing could offer support, even military assistance to US foes.
A further example of the risk of miscalculation in the new US-China relationship was the issue over the weekend of the US drone in the South China Sea. This looks as if it might blow over, but who knows what will happen next?
Coming to terms with 2017
The work of the brilliant psychiatrist, Elisabeth Kübler-Ross, helps here. Her book, On Death and Dying, was where she first introduced her concept of the five stages of coming to terms with grief. This has very often been applied to the world of business and economics. In this context, here is how it can be applied:
- First, we want to Deny that anything is wrong – for example, by assuming that all that OPEC and non-OPEC has to do is effectively implement their production cuts to make oil prices trade within a “comfortable middle” of around $55/bbl. This overlooks the rising threat from ever-more efficient US shale oil production, the failure of OPEC and non-OPEC to stick to previous output cuts, and the challenges facing the global economy.
- Next comes Anger. We blame each other. For example, “Why didn’t my analysts warn me that oil prices might fall to below $30/bbl, and that the US would end up in a trade war with China?”
- This is followed by Bargaining. “If I just cut my PE operating rate by 10% then please, please let margins come back to where they were in 2016”. In other words, we hope that by making minor adjustments, things will return to normal.
- Further down the line is Depression, and so paralysis – an inability to do anything to correct the failings of your business because you think everything is loss.
- Finally, Acceptance is reached. You can then start to devise the strategies for your chemicals business that make sense in the New Normal.
We can help you get all the way from Stage 1 to Stage 5 very quickly by providing you with the right methodologies for the New Normal. You don’t have much time to lose.