Industry Research Rubber Industry

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1 Rubber Industry Rubber Industry Industry Outlook: Negative Executive Summary 1 December 2014 Onnicha Lertsachanant onnicha@trisrating.com Ruangwud Jarurungsipong ruangwud@trisrating.com Natural rubber or NR is a commodity used around the world as a raw material for many products, but primarily vehicle tires and latex gloves. The price of natural rubber is tied to the supply of rubber, the demand for the end products, and the price of substitutes for NR. Oil prices also shape supply and demand because crude oil is used to make synthetic rubber. The health of the global economy, especially the automotive industry, also affects natural rubber prices. During the past three years, the prices for natural rubber have been weak because the Chinese economy has been growing more slowly. China is the world s largest user of natural rubber. NR prices have also stayed low due to a rapid increase in the supply of natural rubber from Thailand, the world s biggest producer. Natural rubber prices were rising until The Thai government introduced measures in to support the NR industry, such as programs designed to boost the planting of natural rubber plantations. As a result, farmers expanded the area under natural rubber cultivation and some new growers entered the market. A natural rubber plantation takes approximately seven years to develop from seedlings into harvestable trees. The supply of natural rubber began climbing in 2012, and inventories of rubber started rising as well. As a result of the increase in supply, the export price of natural rubber (RSS3) declined from Bt114 per kilogram (kg.) in January 2012 to Bt52.8 per kg. in October Rubber prices did not find a bottom in The International Tripartite Rubber Council, comprising representatives from Thailand, Indonesia, and Malaysia, agreed to intervene the market, in an effort to shore up prices. The area under cultivation or plantation area will be regulated. In addition, farmers in Thailand can receive subsidies and soft loans from the government. The Thai government recently announced a Bt6 billion buffer stock scheme to help stabilize the market price of rubber.

2 Thousand Tons Industry Research Primary use for natural rubber is vehicle tires Natural rubber (NR) is used widely, in products ranging from household goods to industrial products. Tires and latex gloves are the major finished products that require rubber as the main raw material. Demand for NR is related to demand for vehicle tires, as automobile tire manufacturers use 60%-70% of all NR produced. Synthetic rubber is a near substitute for NR in many applications. Synthetic rubber is made from crude oil. As oil prices drop, tire manufacturers decrease their demand for NR and substitute synthetic rubber. Tire manufacturers make replacement tires and original equipment (OE) tires. TRIS Rating estimates that replacement tires account for approximately 75% of the tires sold in the world. Demand for replacement tires is generally more stable than demand for OE tires. Demand for replacement tires is less sensitive to economic cycles than demand for OE tires, since demand for OE tires is driven mainly by the sales of new automobiles. Economic conditions affected vehicle production and sales in 2013 and 2014 The state of the world economy affects the automotive industry worldwide. Worldwide demand for autos has grown steadily, but demand can slump during the periods of economic crisis. According to the Organisation Internationale des Constructeurs d Automobiles (OICA), 87 million automobiles were produced in 2013, a 3.7% year-on-year (y-o-y) rise. Nearly half of the autos sold were sold in the Asia/Oceania regions; the Americas and the European region comprised 21% and 20%, respectively. Chart 1: Production and Consumption of Natural Rubber Worldwide 14,000 12,000 10,000 8,000 6,000 4,000 2, World Production World Consumption Source: International Rubber Study Group (IRSG) TRIS Rating 2 1 December 2014

3 Auto production is expected to grow moderately in The US market is recovering after six years of economic stagnation. Demand for vehicles from emerging market nations is expected to grow at a steady rate. The OICA reported that worldwide vehicle sales in 2013 reached 85 million vehicles or a 3.9% y-o-y rise from the 2012 level. Production figures show a similar trend. However, the OICA forecasts that worldwide vehicle sales will grow by approximately 2% in The projection is based on forecasts of good demand in China and the EU. Automobile and tire industries drive rubber consumption According to the International Rubber Study Group (IRSG), worldwide use of NR in 2013 reached 11.4 million tonnes, up 3.2% from the 2012 level. In the first six months of 2014, NR use grew by approximately 4.2% y-o-y to 5.8 million tonnes as the US economy gained strength. Demand for NR in 2014 is expected to grow moderately, in line with the growth in vehicle sales. China is the world s largest NR consumer, because Chinese companies make most of the tires sold worldwide. In the first six months of 2014, China used 35.5% of the total amount of NR used worldwide, followed by the European Union (9.9%), India (8.7%), the US (8.2%), and Japan (6.1%). In Thailand, domestic consumption of natural rubber was 0.27 million tonnes in the first six months of 2014, a 5.4% y-o-y rise. Synthetic rubber is a substitute and complementary product for natural rubber Natural rubber and synthetic rubber are substitutes and complements. Both materials are used to produce the desired properties needed in rubber end products and tires. Natural rubber possesses qualities which are not possessed by synthetic rubber, such as low heat absorption and the ability to regain its original shape. These unique properties mean synthetic rubber cannot be a perfect substitute for NR. Over the past decade, NR comprised 38%-50% of the amount of all rubber consumed worldwide. Only about 10% of the amount of NR can be substituted by synthetic rubber. TRIS Rating 3 1 December 2014

4 Chart 2: World Demand for Natural Rubber (NR) and Synthetic Rubber (SR) Source: IRSG The price of NR is influenced by climate change and seasons, while the price of synthetic rubber reflects changes in the price of crude oil. Most synthetic rubber is created from two materials, styrene and butadiene. Both are currently obtained from petroleum. Synthetic rubber consumption throughout the world grew by 3.1% to 15.4 million tonnes in 2013 and by 5.9% y-o-y to 8.1 million tonnes in the first half of 2014, according to the International Rubber Study Group (IRSG). In 2013, the consumption of synthetic rubber slipped to about the same growth rate as NR, due to the slide in natural rubber prices. In the first six months of 2014, synthetic rubber comprised 58.4% of the total amount of rubber used worldwide. NR made up the balance. The proportion of synthetic rubber as a percentage of rubber used worldwide has risen slightly, climbing from 57.6% in 2012 and Oversupply situation boosts natural rubber stocks and depresses rubber prices Worldwide, natural rubber production has exceeded consumption for more than three years due to the slow pace of the economic expansion in China, the world s largest user, and a rapid increase in supply in Thailand, the biggest producer. Several years ago, the Thai government encouraged NR farmers to grow more rubber. The area under cultivation has been increasing in the northeast and northern regions of Thailand. As a result, the supply of NR has increased and the market price has continued to decrease. The significant increase in the supply of NR began in 2012 when supply totaled 11.6 million tones. Demand came to 11 million tonnes that year. The excess continued in 2013, as supply amounted to 12 million tonnes while demand reached TRIS Rating 4 1 December 2014

5 just 11.4 million tonnes. NR stocks have increased worldwide, climbing steadily to 2.3 million tonnes in 2012 and 3 million tonnes in By comparison, NR inventories worldwide had stayed below 2 million tonnes for the previous 10 years. The oversupply situation may be easing. In the first half of 2014, worldwide inventories decreased to 2.5 million tones, a positive sign for the industry outlook. Table 1: Worldwide Balance of Natural Rubber Demand and Supply (Unit: Thousand Tonnes) Year Production Consumption Existing Inventory ,996 9,190 1, ,931 9,662 1, ,057 10,139 1, ,098 10,182 1, ,723 9,284 1, ,393 10,760 1, ,230 10,997 1, ,603 11,008 2, ,042 11,355 3,006 6M14 5,335 5,796 2,546 Sources: Rubber Research Institute of Thailand (RRIT) and IRSG Harvestable area expands and natural rubber production rises The area cultivated for NR increased by an average of 5.9% per year between 2006 and 2010.Two factors caused the rise in planted area include: supportive government policies starting in 2004, and a rise in NR prices. Natural rubber trees take seven years to grow from seedlings to harvestable trees. The result of the rise in planted area materialized in The area containing harvestable trees grew by an average of 7.5% per year in , compared with an average growth rate of 3.2% during Thailand is the world s largest natural rubber producer There are three main types of NR products manufactured in Thailand: ribbed smoked sheet (RSS), block rubber or technically specified rubber (TSR), and concentrated latex. According to the Rubber Research Institute of Thailand (RRIT), TSR accounted for 43.2% of total production in the first six months of The production shares of RSS and concentrated latex were 19.8% and 17.6%, respectively. TRIS Rating 5 1 December 2014

6 According to the RRIT, in the first six months of 2014, rubber production in Thailand amounted to 1.7 million tonnes. This is approximately an 8.1% y-o-y drop. The drop reflects weaker rubber prices during Most rubber produced in Thailand is exported Approximately 88% of Thailand s rubber production is exported, mainly to China, Malaysia, Japan, South Korea, and the US. Lower rubber prices have boosted exports. According to the IRSG, in 2013, Thailand exported 3.6 million tonnes of rubber, a rise of 20.6% from the volume of exports in Rubber exports from Indonesia, the second largest producer and exporter, grew by 9.7% to 2.8 million tonnes in In the first six months of 2014, rubber exports from Thailand grew by 8.1% y-o-y, and exports from Indonesia rose by 2.5% y-o-y. In Thailand, the market is dominated by the major NR exporters. The leading exporters are Sri Trang Agro-Industry, Von Bundit, Southland Rubber, Thai Hua Rubber, and Thai Rubber Latex Corporation. TRIS Rating believes that a recovery in the world economy will raise the revenues of Thai rubber exporters in Chart 3: Export Markets for Natural Rubber from Thailand in 2013 (By Export Quantity) U.S. 4.4% Korea 4.9% Others 19.3% China 43.9% Japan 8.4% Malaysia 19.2% Source: Ministry of Commerce TRIS Rating 6 1 December 2014

7 Natural rubber prices drop sharply Rubber prices in Thailand are derived from various auction prices, such as unsmoked sheet (USS) Songkhla, and official noon prices, such as RSS Grade 3 (RSS3; F.O.B. Bangkok). Rubber is also traded in commodity futures markets, e.g., the Tokyo Commodity Exchange (TOCOM). The price of RSS3 (F.O.B. Bangkok) hit a historic high of Bt180 per kg. in After the peak, NR prices dropped in 2012 and The fall in rubber prices is due to the economic fluctuations worldwide, slower economic growth in China, falling prices of crude oil, and a rise in the supply of rubber. The average price of RSS3 (F.O.B. Bangkok) declined to Bt52.8 per kg. in October 2014, falling by 33.6% y-o-y. TRIS Rating expects rubber prices in the world market to weaken in 2015 due to excess supply and falling oil prices. However, rubber prices may rise if the global economy recovers, or if oil prices rebound, or if the Thai government can intervene to limit the supply of NR. Chart 4: Natural Rubber Prices (F.O.B. Bangkok) Source: RRIT Government intervenes to raise rubber prices for Thai rubber farmers Due to further drops in rubber prices during 2014, the Thai government launched measures in the third quarter of 2014 to stabilize, then raise, domestic prices. For example, the government announced four recent programs to raise farmers incomes. First, the government will subsidize rubber farmers at a rate of Bt1,000 per rai, but not exceeding Bt15,000. The subsidy will be disbursed through the Bank for Agriculture and Agricultural Cooperatives or BAAC. Second, a new soft loan program encourages small rubber growers with vacant land to grow other crops in TRIS Rating 7 1 December 2014

8 order to earn additional income. The growers can apply for a maximum loan of Bt100,000 per household. Third, another soft loan program, valued at Bt10 billion and distributed through commercial banks, supports the working capital needs of rubber manufacturers. Lastly, BAAC has provided a Bt6 billion loan to the Rubber Estate Organization (REO). The REO will use the money to fund a buffer stock scheme designed to shore up falling rubber prices. The government has set a target price of Bt60 per kg. for RSS3. Major rubber producing countries cooperate to limit supply Ministers from the world s top rubber-producing countries, Thailand, Indonesia, and Malaysia, gathered in Kuala Lumpur on 20 November 2014 at The Ministerial Committee Meeting of the International Tripartite Rubber Council (ITRC). The meeting produced a preliminary agreement to regulate the area under cultivation in and to manage the NR exports from Thailand, Indonesia, and Malaysia to the global market. The ITRC also pledged to set up a regional rubber market within the next 18 months. In conjunction with the Ministerial Committee Meeting, a meeting was also held with other ASEAN rubber-producing countries. Attendees at the meeting agreed to cooperate on measures to strengthen NR prices. Rubber processor rated by TRIS Rating (as of December 2014) Company Rating Outlook Sri Trang Agro - Industry A- Stable TRIS Rating Co., Ltd., Tel: ext 500 Silom Complex Building, 24th Floor, 191 Silom Road, Bangkok 10500, Thailand, Copyright 2014, TRIS Rating Co., Ltd. All rights reserved. Any unauthorized use, disclosure, copying, republication, further transmission, dissemination, redistribution or storing for subsequent use for any purpose, in whole or in part, in any form or manner or by any means whatsoever, by any person, of the credit rating reports or information is prohibited. The credit rating is not a statement of fact or a recommendation to buy, sell or hold any debt instruments. It is an expression of opinion regarding credit risks for that instrument or particular company. The opinion expressed in the credit rating does not represent investment or other advice and should therefore not be construed as such. Any rating and information contained in any report written or published by TRIS Rating has been prepared without taking into account any recipient s particular financial needs, circumstances, knowledge and objectives. Therefore, a recipient should assess the appropriateness of such information before making an investment decision based on this information. Information used for the rating has been obtained by TRIS Rating from the company and other sources believed to be reliable. Therefore, TRIS Rating does not guarantee the accuracy, adequacy, or completeness of any such information and will accept no liability for any loss or damage arising from any inaccuracy, inadequacy or incompleteness. Also, TRIS Rating is not responsible for any errors or omissions, the result obtained from, or any actions taken in reliance upon such information. All methodologies used can be found at TRIS Rating 8 1 December 2014