Situation Report: It’s Time To Act
By Robert Meyer, Chief Executive Officer, Halcyon Agri Corporation Limited
The natural rubber sector is in unchartered waters. I don’t remember a time when fundamentals were as blatantly ignored by the universe of punters trading natural rubber futures as they seem to be today. Knowing that my colleagues (who collectively bring more than a century of rubber market experience to the table) are equally perplexed as to the recent price “discovery” offered by paper markets, I am going out on a limb to share my views.
Of top concern over the last weeks has been the emergence of the nCoV Wuhan virus. While the biology of the virus is not fully understood yet, statistics suggest that we are faced with a pathogen that is highly contagious and quite difficult to deal with: incubation can take up to 14 days, and some have suggested the virus can be transmitted without the infected person showing any symptoms of being sick. Whilst it is particularly virulent, nCoV seems to be less deadly than other respiratory pandemics of recent times with a fatality rate of about 2%.
Yet its effects have been far-reaching: on January 22rd, nCoV infected the Shanghai futures market before spreading to the Tokyo and Singapore markets. The Chinese New Year holidays in Shanghai and Singapore kept those markets closed for several days whilst Tokyo continued to trade, and the net result is best described as carnage. Peak-to-trough, natural rubber lost around 15% of its value in a week, at least according to the futures markets.
My position as CEO of Halcyon Agri gives me unrivalled access to information across the world of rubber. Halcyon’s global footprint is unique. Our origination and distribution activities literally span the globe and we hold pole position in all three major links in the physical value chain: we are the biggest planters, the largest processors and the leading distributors in the world. We don’t, however, have a big stake in the futures markets – our participation here is cursory at best.
In my previous notes, I have been transparent in my assessment of the natural rubber market fundamentals. The output from significant new-plantings of rubber – mainly in non-traditional origins such as the Mekong Delta and West Africa, but also in North and North-East Thailand – has come to market from 2013 to 2018. This new supply has brought market prices down and has masked a dearth of replanting in the traditional sources of rubber production – places like Indonesia, Southern Thailand and Malaysia. In these areas, farmers have overtapped their trees to combat low prices. Trees are living organisms: they need rest, and to be nurtured. Overtapped trees are more vulnerable to diseases, and overtapping implies accelerated use of available bark reserves thus shortening the useful life of a rubber tree.
Yet, the farmers have no choice but to overtap. A farmer’s income is price multiplied with volume: when one goes down, the other must go up in order to maintain income levels. Add consumer price inflation of 5 – 7% in these areas, and the plight these farmers have had to face becomes painfully obvious.
In late 2016, a new force emerged on the global natural rubber stage: Non-governmental Organisations (“NGO’s”) and Civil-Society Organizations (“CSO’s”) started to investigate the natural rubber industry, especially recent cases of deforestation and land-grabbing. Aided by modern satellite imagery, they very quickly concluded that the last rubber bull-market (which ended in 2012), had caused widespread deforestation in ecologically very sensitive areas such as the Mekong Delta and Central Borneo. Just as the automotive industry began pleading mea culpa on charges of rigging diesel exhaust emission tests, a couple of activist CSO’s shone the spotlight on the tire industry and its impact on the biosphere.
Fast forward to today, where stakeholders have joined forces in the Global Platform for Sustainable Natural Rubber (“GPSNR”). Why is this relevant? Because recent plantings of natural rubber in controversial areas have quietly been declared “off-limits” for conscientious purchasers of natural rubber, which includes many of the world’s leading tire makers. They simply cannot reconcile their sustainability policies and OEM supply contracts with the heavily scrutinised and penalised automobile industry with the notion of buying rubber from questionable origins.
Enter Ms Thunberg. Fridays for Future is a global campaign that has blindsided political leaders and captains of industry alike. Nominated for a Nobel Prize at the tender age of 17, Greta Thunberg has mobilised a generation to stand up and fight for climate change. Natural disasters have become more regular and possibly more devastating than 20 years ago. The Indian Ocean Diopole (“IOD”), a phenomenon where the eastern and western Pacific Ocean experience steep temperature differentials, has caused drought in Australasia and floods in Eastern Africa, and given rise to the worst-ever forest fire season in Australia on record. Driven by climate change, perhaps, but certainly a harbinger of severe drought in South East Asia. Recent reports suggest that the Mekong Delta is currently experiencing extremely low water-table levels, which has an immediate impact on the rubber that is planted there.
Back to the fundamentals of rubber: traditional origins are facing diseases that are new to this part of the world – leaf blight and white root disease. Much of newly planted rubber has a limited audience due to questions about its sustainability, and one of the world’s most significant rubber growing areas is facing unprecedented drought. The International Tripartite Rubber Council warns of a supply deficit of up to 1 million metric tonnes for 2020, which equates to a reduction in output of up to 7%.
The supply issues we face are structural. They cannot be remedied on the fly – there is no amount of money that can make rubber trees grow faster, or reverse their age. But what about demand? According to virtually all forecasts that are available, demand will do what it always does: track global GDP. The nCoV outbreak might dampen the outlook a little – I estimate a worst-case scenario of 250,000 metric tonnes reduction in Chinese demand for tire-grade rubber. This will be partially offset by a 50,000 metric tonne increase in the demand for natural latex, driven by the increased production of gloves and masks. Until yesterday, even I was not aware that natural rubber latex gloves offer significantly better anti-viral protection than nitrile-gloves, due to their superior shear-values (they don’t tear as easily). They also seem to be more resistant to water-borne pathogens due to the molecular structure of natural versus nitrile latex.
What can we conclude from all of the above? I believe the natural rubber market is poised to stage a cyclical and structural price recovery. In 2019, the prices of tire-grade natural rubber appreciated by USD200 per metric tonne to USD1450. The present market turmoil notwithstanding, I expect this rate of climb to continue, possibly reaching USD1650 later in the year. My calculation of living wage levels in the main rubber producing countries, and of minimum capital returns for mid-stream players, suggests that a price level around USD2200 is needed to stabilise the decline in future output – and prevent widespread natural rubber shortage from 2021 onwards. Runaway rubber prices might sound appealing for some, but their impact is temporary for the market, and disastrous for the planet. High prices cause widespread deforestation and new-plantings, which only serves to bring prices crashing back down a few years later. This feast-to-famine price cycle is the result of a futures market that doesn’t understand fundamentals anymore. Why? Probably – and this is speculation on my part – because the principal players in this market are algorithms that aren’t sufficiently well designed to take heed of slow-changing fundamental variables such as the human conscience.
For those in the know, there has never been a more pressing time to act: we need to decouple physical rubber prices from the vagaries of the futures markets. I hope that producers and consumers start to realise this, and that the GPSNR forum develops the chutzpah to launch an inquiry into alternative pricing models. The time to act is now.
Chief Executive Officer – Halcyon Agri Corporation Limited