What is wrong with the natural rubber market? The Chief Executive’s View:

首席执行官Robert Meyer，合盛农业集团

When analysing the reasons behind the persistently weak prices for natural rubber, the most intuitive explanation is normally fundamental: either demand must be weak or the market must be oversupplied.

Those who are in the business know that demand is not weak. In fact, it hasn’t been for a while, largely because natural rubber demand tends to correlate to global GDP development – which is still going strong, trade tensions notwithstanding.

Supply, then?

To understand the supply conundrum, we need to differentiate China from the rest of the world.

China currently has the only significant inventory of natural rubber globally. The exact amount of inventory is not entirely transparent, but 550,000mt of WF grade on warrant in SHFE, and another 250,000mt or so of TSR grades largely in Qingdao is probably not too far off.

Considering that China consumes, at least until very recently, 400,000mt every month, the inventory does not appear excessive.

The devil lies in the detail:

Firstly, WF stubbornly remains at a premium to tire-grade TSR and therefore is not consumable by the tire sector at current price levels. The industrial, i.e. non-tire, demand for WF is less than 150,000mt annually.

Secondly, it appears that Chinese tire production may be slowing down quite dramatically due to the escalating trade tensions between China and its key markets in the West. China has a strong concentration of old tire plants in Shandong province, who used to face less competition from their more progressive and technology-driven peers as these mainly focussed on export. With the emergence of trade barriers, some of the export-designated quantities now compete locally, which has led to a build-up of tire inventory in China.

Then there is a third point: State Farms produce WF, mainly in Yunnan, Hainan and Guangdong provinces. Their farmers rely on the WF contract trading not only at a premium to TSR (this is why they produce WF), but also on the WF forward curve offering a steep contango. This has given rise to a successful game plan: sell the forward paper, produce the cargo, and deliver the latter against the former when it expires.

In aggregate, the 3 State Farms provide work to hundreds of thousands of farmers, who need to remain gainfully employed. Absent the WF product and contango premiums, the farmers have little chance of survival, as the productive tapping season in relatively short in China. Fundamentally, China is too far north for its lands to be able to compete with the tropical soils of Thailand and Indonesia.

Of late, there might even be a fourth point to consider. The Chinese government has long held a strategic buffer stock of natural rubber; the current batch hails from a time when rubber prices were much higher than today, which has caused much trouble within the agency in charge of managing this stockpile. In a world of trade tensions and enhanced risk of conflicts, it is conceivable that the excess domestic inventory is viewed as a welcome extension of the strategic buffer stock. Better yet, it is de facto free of charge and poses no positioning risk to the agency, as market participants own it. Tax and logistical considerations negate the idea of it ever leaving the PRC.

Finally, the excess inventory keeps a lid on prices – a welcome side effect that all rubber consumers benefit from globally. At least for the time being.

As to the rest of the world, the fundamental analysis is much less complicated.

August’s issue of the Global Tire Intelligence Report continues to paint a familiar picture: tire companies are expanding globally. Not so in China, but in Europe, the Americas, South East Asia. Habits persist across generations and cultures: humans enjoy mobility, and they consume more of it as they become more prosperous. These new tire factories are not only strategic, but given the trade tensions, they are timely and tactical. If China exports less tires, then the demand – which continues to expand with GDP – must be satisfied with new sources. This new trend in the rubber world will add to the looming supply side crisis:

In Indonesia, natural rubber output for 2018 is likely to drop between 7% to 10%. This is due to two factors: low prices (which afford the average farmer an income of less than half minimum wage!) and the White Root disease (Rigidoporus microporus) which appears to have spread throughout Indonesia. This disease may have its origins in the widespread flooding in H1 2016, nobody knows for sure. If that were the case, then this problem could surface in Thailand as early as next year. Thailand suffered from severe floods in H2 2016/ H1 2017.

Vietnam, and the broader Indochina region, have grown rubber output significantly over the last decade. The world’s third largest producer today, Vietnam is subject to harsh criticism from global NGO’s for having violated social and ecological terms of sustainable engagement. With the advent of the Tire Industry Partnership (TIP) as a global forum for supply chain stewardship, Vietnam has already become an outlawed origin for many global tire makers.

Thailand, the world’s leading producer of rubber, is heavily focussed on the Chinese market. The issues in China may bring about a significant reduction in the demand for new STR, at least in the short to medium term. Besides the issues already described, the flattened market structure has negated import margins of new cargo into China. Thai producers may find themselves having to re-orientate themselves to the global market. While technically possible, this would require a lengthy homologation and approval process for the newer factories. There is also the issue of elevated nitrate concentration in the soils of North-East Thailand, which has led several of the leading tire companies to ban supplies from this origin. Apparently, the elevated nitrate concentration affects certain plasticity parameters of the rubber grown in North East Thailand.

Vietnam and North East Thailand have been the key growth areas for rubber supply over the past 4 years. The rest of the world has remained largely constant, or may even have declined in response to lower prices and structurally changing economies.

In a scenario where out-dated Chinese tire production is partially substituted by new tire factories around the globe, demand for the aggregate output of circa 2.2 million mt from North East Thailand and Indochina may not be sustained. If this were the case, then the world would be facing an acute shortage of consumable natural rubber from eligible origins.

In summary, it is important to realise that we are facing many winds of change. The effect of low prices, agronomical differentials, rising standards of living (and by extension production costs) and trade barriers are not easy to predict.

It is time for the world to take note and for industry participants to develop new pathways for an industry that the world simply cannot afford to neglect any longer.

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Robert Meyer
合盛农业集团首席执行官