Tire Industry Monthly

How sustainable are current rubber prices? Take a guess!

David Shaw
Contributor: David Shaw
Posted: 11/04/2014

Today I am going to talk about the impact of low natural rubber prices. I make no apology for this column – it is something I feel strongly about. On one level it is a simple topic, but at another, immensely complex, covering global geo-politics; the rural poor in the developing world and, of course, tires.

Natural rubber (NR) is a traded commodity, like oil, or gold or pork bellies. The price of NR is defined by the balance of buyers and sellers in a number of markets around the world, principally in Tokyo (TOCOM), Singapore (SICOM) and Shanghai (SHFE).
It is my personal opinion that most of these markets are broken due to lack of liquidity and volume, but since I cannot offer a better model for pricing NR, I'm not going to discuss that opinion. Instead, I want to look at the 'sustainability' of the current prices.

The reality of rubber production costs

Most of the world uses the SICOM six-month price on TSR-20 as its reference price. That's just a particular grade of NR. TSR stands for Technically-Specified Rubber, and the 20 is a measure of the impurities in the rubber – higher numbers mean more impurities. The 6-month price means what you can expect to pay for delivery six months hence (in April 2015). The precise grade is not important, But the price on the SICOM exchange at the close of business on 31 October was $1.60/kg. That's significantly below the cost of production. In fact the cost of production is not an easy number to get hold of. I was fortunate to be at a seminar organised by the International Rubber Research and Development Board (IRRDB), in Malaysia last month where we discussed cost of production. As you might imagine, the cost varies depending on the local cost of land, labour, fertiliser and other things.

When people calculate the cost of NR production, they usually refer to the cost to the farmer; they tend to exclude the cost of transport to the processing house and the dealers who perform that function. They also ignore the cost of converting the rubber to bales of TSR-20. In some cases they ignore other factors.

So all the data I give below under-estimate the true costs. One of the decisions from the IRRDB seminar was to set up a much-needed programme to evaluate the real cost of production in different parts of the world. Kerala, in Southern India is the most prosperous region in the world where they still grow rubber. Costs there are around $2.50/kg. In China the Authorities recently gave data on production costs. In Hainan – a relatively wealthy Province – it is $2.34/kg. In the less-wealthy Yunnan Province, that falls to $2.08. As we look to less prosperous areas in South-east Asia, such as Cambodia. Laos, and more remote parts of the two largest rubber producers in the world: Indonesia and Thailand, the figure falls to about $1.80.
But that is still more than the world price of $1.60.

Traders and Speculators dominate the rubber market

The impact has been severe. Sales of motorcycles in Indonesia have halved; the same with consumer products; bad debts are increasing across the rubber growing regions; families can no longer afford to pay for education and so on.
Free-market economists would argue that this is a simple case of supply-and demand. When there is over-supply, prices fall. In the world of synthetic rubber (SR) there are periods of over-supply and one or more of the main supplies chooses to close factories and re-balance the equation. That's all true.

The difference with NR is that there is a 7-year period between planting trees and production beginning, so capacity needs to be predicted on a 7 – 10 year cycle, which is difficult, at best. The second difference is that cutting production in NR means a smallholder or farmer deliberately cutting off his source of income for an extended period. That's not going to happen.

Most NR goes into truck tires. A typical truck tire consumes around 20kg of NR. If we say the average cost of production of NR is $2.10 (probably an under-estimate), then those 20kg of rubber represent a payment from the developing world to tire makers of $10 for each tire. Multiply that by 150m truck tires made each year and the deficit is $1500 million or more. As governments subsidise their rubber tappers – who are also voters – this means the tax-payers of Indonesia, Thailand, Vietnam and other developing countries are subsidising tire makers around the world to the tune of billions of dollars each year. There are no easy solutions to this. We cannot fight the markets; we cannot — in the short term — develop new pricing mechanisms; we cannot introduce subsidies or other market distortions. These have been tried in many commodities in many different guises. The only ones to win from such measures are the traders and speculators who dominate the international markets.

Probably the most worthwhile is for tire makers to repay that debt by funding schools, healthcare projects and other social welfare schemes. Tire makers do this, but not on the scale that is needed or justified by the current low price of NR. These corporate social responsibility projects fund a few millions of USD, but not billions every year, that are needed and justified by the economic arguments. And then what happens when the prices rise again — as they did in 2010 and 2011 — well above $4. Above around $3 the growers are rewarded for their efforts. But of the tire makers were to pull the plug on those CSR projects, it would be a disaster.

A future dialogue takes two sides

As I said, it is far from simple. I believe the key to this is education, transparency and dialogue. Many tire engineers have no idea of the impact that the low price of NR has on families in South-east Asia; meanwhile few in the NR-producing communities have much idea about the realities of tire production. I'd like to see more discussion of these topics within the tire industry. I was at the Global Rubber conference in Sri Lanka earlier this week and we made a start, but the dialogue takes two sides.

Consumers such as the ETRMA and producers such as ANRPC need to talk, but I'd also like to see increased dialogue between tire technical departments and the Rubber Research Institutes to see how the NR community can respond to the needs of the tire industry for new materials for Winter tires; truck tires and other products where the properties of NR remain among the best in the world.

David Shaw
Contributor: David Shaw
Posted: 11/04/2014