Natural Rubber Bounces All Around

Background

Natural rubber is produced from the latex sap obtained from rubber trees—Hevea brasiliensis. Before it became the ubiquitous eraser, rubber was used to create elastic balls in a game called tlachtli in pre-Columbian mesoamerica. Natural rubber hit the road in the mid-1800s with the manufacture of solid rubber tires. Pneumatic tires were patented in 1845 followed by the Michelin brothers pioneered their use in automobiles, leading to the creation of Michelin & Cie, the leading producer of tires in Europe at the time. Following their lead, Goodyear Tire and Rubber Company was formed in 1898 followed by the Firestone Tire and Rubber Company in 1900, with other tire companies to follow.

Brazil’s reign as the top producer of natural rubber, beginning with the first boom in 1910, was mired by environmental destruction, corruption, and unsafe work conditions. Natural rubber was gathered from the Amazon forests in a costly and inefficient process that saw countless foragers die from starvation, dysentery, and other diseases while rubber barons enriched themselves. Even with the development of synthetic rubber, considered an inferior subsitute to natural rubber, the source of rubber continues to be latex sap from rubber trees. In 1912, Brazil exported $30 million worth of rubber—the equivalent of $500 million in 2017. Attempts to domesticate wild rubber in Brazil failed, but the collapse of the rubber industry in the country may have been the result of a single individual.

British explorer Henry Wickham smuggled 70,000 seeds to London. These seeds were then cultivated in the Royal Botanic Gardens as part of a process to determine their viability outside of the Amazon. The experiments were successful and soon the seeds were exported to Asia. Wickham’s actions sparked a chain reaction that would lead to Asia becoming the leading global producer of natural rubber.

While rubber was first cultivated in Asia in 1877, it was the growth of the car industry and the high prices commanded by natural rubber that strengthened the plantation-style farming in Asia. By 1920, Southeast Asia was responsible for 90 percent of the 400,000 tons of natural rubber produced globally.

The auto industry is the single largest consumer of natural rubber. As such, these industries are inextricably linked. Any rise in demand for automobiles leads to increased demand for natural rubber, while a downturn in demand would see a decline for the respective industries.

Production and Supply

The top 5 producers of natural rubber are Thailand, Indonesia, India, China, and Malaysia. Combined, these countries produce more than 75 percent of global supply of rubber. Of these countries, China and India are net importers of natural rubber while the rest are net exporters.

Thailand accounts for approximately 40 percent of the global supply of natural rubber. For such a significant global supplier of rubber, it should come as no surprise that any weather events hindering production would also affect the price. Weeks of flooding in the southern parts of Thailand, starting in December 2016 and continuing through the start of 2017, have prevented tapping of rubber trees for latex. As a result, natural rubber prices reached a four-year high in January 2017 on the Tokyo Commodity Exchange (TOCOM). With Thailand going to the wintering period (February to May), production will not cover reduced supply due to the floods.

For a worst case scenario, severe drought in Thailand in 2009-2010 led to production shortages. Coupled with a surging demand, rubber prices skyrocketed to, at the time, a record high of $3,948 per metric tonne on the Singapore Exchange. Some relief was felt in July when prices dropped to $3,274 per metric tonne, but it was short-lived. A combination of factors, including demand and speculation, would lead to an all-time high price of $6,259 per metric tonne in February 2011. While natural rubber pricing has not seen a repeat of such volatility since, the days of prices in three-digit prices are over, in part due to China’s rapidly expanding auto fleet.

Driving Demand

China is one of the top rubber producing countries and the largest consumer of natural rubber. Increased demand for automobiles in China has led to a similar surge in natural rubber demand. Because production of natural rubber in China has not kept pace with consumption, imports have risen. With GDP growth rising rapidly, demand for automobiles has yet to slow down.

China’s GDP per capita has been increasing rapidly since the beginning of the new millennium—increasing 8 times between 2000 and 2015. The country’s burgeoning middle class has led to an increased demand for automobiles. Between 2005 and 2015, the registration or sales of new vehicles increased from 5.8 million to 24.6 million between 2005 and 2015.

Import quantity of natural rubber in China has increased steadily with the demand for new vehicles. In fact, import demand growth, at 14.2 percent, surpassed the annual growth of GDP per capita, 11.7 percent, in 2013, based on the most recent import data. As the largest consumer of natural rubber, any shocks to consumption creates ripples across the entire industry.

China reduced the tax rate on small passenger vehicles from 10 percent to 5 percent in September 2015. That decision spurred an increase in sales of small passenger vehicles followed by an increased demand for natural rubber, which would then lead to increased prices for rubber.

Would-be automobile owners, expecting a tax hike back to 10 percent, spurred increased sales in 2016. When China only raised the tax rate to 7.5 percent, sales remained strong. The multi-year growth of automobile sales in China led to increased demand for natural rubber, which lifted the industry from a 7-year low in January 2016. Governments have formed national reserves of natural rubber to ease market volatility, or to simply create a safety net against increasing prices.

Absorbing the Shock

Producers and consumers of natural rubber create stockpiles as a preventative measure. With a glut of rubber leading to depressed prices, many governments purchased natural rubber from farmers above market prices to form these reserves. Thailand had 310,000 tonnes of natural stockpiled to start 2017. The country sold 98,000 tons from its reserves as part of a state auction in January as part of an effort to stabilize prices after tapping was temporarily halted due to severe flash floods. Likewise, China often holds stockpiles of natural rubber to stabilize prices or help rubber farmers in the country.

When prices fall, these governments sometimes decide to sell off the stockpiles to avoid any further losses. Of course, that could lead to a domino effect of adding to the surplus and depressing already depressed prices. At other times, the sell off is to offset surging storage costs. When Thailand announced that it had auctioned off 98,000 tonnes of natural rubber, benchmark rubber futures on the TOCOM slid. Thailand’s planned auction of a further 125,000 tonnes in March could lead to another drop in natural rubber prices as would its goal of selling off its entire stockpile by the end of the year.

Fears of dwindling supply, leading to bare coffers, have propelled natural rubber prices upward. Stockpiles on the TOCOM fell to a six-year low March 1, which sparked concerns of a depletion of reserves. The already low supply, as a result of flooding in Thailand, along with speculation led to increased prices on the Shanghai Futures Exchange, which affected trading in China. Thai auctions will help reign prices in, but the higher cost of rubber could be passed on to consumers.

Conclusion

The vacillating nature of the natural rubber industry is attributed to many factors that can influence prices. Speculation in Shanghai Futures Exchange or potential stock depletion in the TOCOM can affect perception of price movements. Often the reaction is disproportionate to the factors affecting prices, which can lead to short-term spikes followed by periods of stability.

While the impact of Thailand’s floods on supply could be short-lived, Thailand Meteorological Department forecasts heavy rains in the south of the country where much of the rubber is produced. India, which so far has been a less significant player in the natural rubber market because of the country’s near self-sufficiency, could play a pivotal role in determining prices.

At least, that’s according to India. The country stated production has increased, but industry players are calling India’s bluff. Kerala, where much of India’s rubber is produced, is facing one of the harshest droughts in a century. It remains to be seen which way the rubber bounces in response to these shocks. How high the ball that is surging prices rises remains to be seen, but it’s likely to soar higher due to speculation, short supply, and continued demand for new vehicles.