World automotive: EIU's quarterly rubber outlook

From the Economist Intelligence Unit

October 2nd 2006

Natural rubber: Demand

There has been little change over the past three months in the outlook for global demand for natural rubber: we continue to expect usage over the next two years to increase by almost 4% a year. Among principal markets, growth will be slightly weaker than forecast in China and North America and more sharply lower in Latin America (on top of a downward revision of estimated usage in 2005). Offsetting this, demand in Other Asia (ie outside China, Japan and India) will be stronger than forecast, on top of a slight upward revision of estimated usage in 2005.

The boom in China’s consumption of natural rubber is slowing

Efforts by the government to curb the massive growth in China’s economy are having limited success: we see further acceleration in 2006. The country’s rubber industry has been a major contributor to the boom, with strongly growing production and exports of tyres and other rubber manufactures. In terms of value, China's tyre production increased more than 23% in the first half of 2006, according to the Rubber Industry Association.

Even so, usage of natural rubber has been growing more slowly than expected, and manufacturers have complained about the impact of higher prices on profitability. We have accordingly made a slight downward revision in our forecast of Chinese consumption growth in 2006 (from 12% to 10%), followed by continued growth of 8% in 2007 and 7% in 2008.

Demand will continue to grow strongly in Japan and India

Together, Japan and India represent a market for natural rubber not much smaller than China. In both countries usage is growing strongly, by more than 5% in Japan and almost 6% in India. We expect both trends to continue this year and in 2007 and 2008, in line with expectations for the respective economies (although at differing ratios: in Japan, rubber consumption is rising much faster than GDP).

Growing demand for rubber in Other Asia

Collectively, Asian countries other than China, Japan and India account for more than 20% of global usage of natural rubber—not much less than China’s 21%. Demand arising from the development of rubber manufacturing among the rubber-producing countries of the region (especially Malaysia, Indonesia, Thailand and Vietnam) has been growing strongly, adding to the needs of established industries of South Korea and Taiwan. In the group as a whole, usage of natural rubber rose by almost 3% in 2005. We expect this to accelerate to 4% this year, followed by slightly slower growth in 2007 and 2008.

The US tyre industry retreats as imports advance

The US tyre industry continues to retreat in the face of booming imports of tyres and other rubber manufactures. Imports of car tyres from China, which are much cheaper than competing products, rose by almost 50% in 2005. The US domestic market for passenger cars has revived, but at the expense of gas-guzzling sports utility vehicles (SUVs). Sales of SUVs—together with deliveries of commercial vehicles generally—have fallen sharply, and deliveries of heavier tyres have accordingly been hit. There was little growth in US tyre imports in the first half of 2006, but deliveries of car and light CV tyres fell by about 7%. Our forecast of a slight (1.5%) fall in North American consumption of natural rubber in 2006 is unchanged, but we now expect this to be followed by steeper declines of 1.7% in 2007 and 2% in 2008, in line with forecast trends in the US economy.

Revival in EU25 economy will falter

The EU25 economy has been recovering from last year’s slowdown, but we expect some deceleration in 2007 and 2008. After a slow start to the year, usage of natural rubber has been running about 3% higher than in 2005. We have raised our expectation of growth in demand for natural rubber this year, from 2% to 2.5%, but take a less optimistic view of longer-term prospects.

Expectations of Latin American demand have been lowered

The International Rubber Study Group (IRSG) has lowered its estimate of Latin American consumption of natural rubber in 2005 and of resulting year-on-year growth, from 7.7% to 2.3%. From a lowered base, we now expect growth of 3% and more to follow in 2006 and beyond.

Natural Rubber: Supply

Production of natural rubber in South-east Asia, which accounts for almost four-fifths of global supply, is becoming less predictable. With global warming the incidence of El Niños has been rising, disrupting the normal seasonality of tapping and increasing the volatility of output. In the long term, the impact of climate change upon natural rubber yields in the region is likely to be adverse.

The military coup in Thailand will not boost rubber production

Thanks to political factors as much as to bad weather, since 2003 natural rubber production in Thailand has been falling, registering a decline of 5% last year. The fall has since continued, at a similar rate, aggravated by unseasonably heavy rain at mid-year. The political situation is uncertain, following the military coup in mid-September. The problems of the mainly Muslim southern provinces, which account for the bulk of natural rubber production, remain unresolved. We expect the decline in output to continue at least into 2007 before circumstances allow any return to normal. Over the longer term, new plantations in the north of the country should make a growing contribution to national production.

Strong growth in Indonesian production will continue

Offsetting the fall in Thailand’s output, Indonesian production has been rising strongly, to the extent that it now rivals that of Thailand. After a promising start to the year, unfavourable weather has hindered production, but we expect growth to resume, averaging about 8% this year and 5-6% in 2007-08.

Malaysian output has been erratic

Uncertain weather has also affected Malaysian production. Following last year’s 4% decline, there was a recovery of more than 23% (year on year) in the first quarter of this year. This has not been sustained, and we expect output over the year as a whole to register an increase of just 7%, followed by weaker growth in 2006 and 2007.

Self-sufficiency will remain out of reach in China

China supplies less than 28% of its own natural rubber needs. Even if, as China’s Rubber Industry Association perhaps optimistically assumes, national production were to reach 750,000 tonnes in 2010, self-sufficiency would still fall below 30%. We take a more pessimistic view of supply prospects: early indications point to a fall in production in 2006, albeit not as steep as last year’s 12%, followed by a gradual recovery.

Natural rubber: Stocks and prices

The heights which natural rubber prices have reached since 2004 undoubtedly owe something to the involvement of hedge funds in the market, as it has done with other major commodities. But the new higher level of rubber prices is not without support from fundamentals. As the table below implies, there is a real physical shortage of rubber, and one which will increase, reducing stocks to a record low in relation to needs.

The unprecedented shortage necessitates another upward price revision

Over the first three quarters of 2006 RSS1 in New York, roughly paralleled by SMR20 in Kuala Lumpur, has registered successive year-on-year increases of 50%, 69% and 44%. The unprecedented physical shortage of natural rubber (NR), and the likelihood that the price of NR’s synthetic competitor will remain high, calls for further upward revision to our price forecasts. We now expect RSS1 to average US$2,492/tonne in 2006 and US$2,753 in 2007, paralleled by hikes of SMR20 in Kuala Lumpur.

The coup in Thailand will exacerbate volatility

The increased liquidity that hedge funds have brought to the market and the agility with which they change position have enhanced the volatility of the spot market, evidenced by the sharp fall in spot RSS1 in the first week of September. The military coup in Thailand, which occurred as this issue of World Commodity Forecasts went to print, will have added to supply-side uncertainty and hence to volatility.