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James Williams, Hedgeweek

Commodities outlook for 2015: The four key sectors


Oil – According to the US Energy Information Administration (EIA) US oil production increased by 1.2m barrels per day last year to 8.7m barrels per day: the biggest annual change in US field production of crude oil in over a century. This supply glut caused crude oil prices to drop off a precipice last year, falling from USD107 per barrel in June to USD45 per barrel in March this year. Despite this, production has continued unabated. 

On 25 March 2015, for example, the EIA announced that US crude production had risen to 9.42m barrels per day: the highest level since 1973. 

Mike Wittner is Global Head of Oil Market Research and Head of US Commodities Research at Société Générale in New York. In his view, WTI will continue to see downward pressure for the next few weeks (although prices have climbed to USD48.35 at the time of writing) but the house forecast is that WTI prices will be USD45 per barrel for Q2 2015. 

“WTI has been under severe downward pressure because of the stock builds in the US, in particular Cushing. It’s approaching capacity and getting tight. The weak point for Cushing is in the next few weeks because in April, as plant refinery maintenance starts to wind down, US refinery crude runs should increase and start to take the pressure off WTI; we would expect the pace of US stock builds to start to ease and by May, US inventories should top out for the season. 

“We are expecting a 1.9m barrel per day oversupply for Q2. I think WTI will still see downward pressure for the next few weeks but then it will start to shift more to Brent crude as stock builds in Europe and Asia increase when refinery runs go down in April and May,” says Wittner, noting that their maintenance season comes after the US. 

Wittner believes that WTI is getting close to a price floor. This is not to say that the market won’t set new lows for both WTI and Brent in this current cycle “but I think Q2 2015, as a whole, will be the low point. That is because in the second half of the year two things happen: we will see a broadly balanced market and, more importantly, we think that some time in 2H15 we will finally see an impact on US crude supply as a result of the oil rig cuts,” comments Wittner. 

The potential for Iran to bring on stream an additional 1m barrels per day if nuclear negotiations continue to proceed and sanctions are lifted represents a downside risk but in Wittner’s view this will be a late 2015 issue at best, and more likely a 2016 issue. 

Since October, the number of oil rigs engaged in horizontal drilling to “frack” shale oil has dropped nearly 50 per cent to 813. Independent oil companies have cut spending this year by 35 to 40 per cent according to Wittner. That production has yet to reduce clearly indicates the time lag involved. That said, in Wittner’s view the needle will start to move in April and May. 

What investors and speculators are looking to get their heads around is where crude oil prices will be headed over the mid-term. 

To start with, the OPEC meeting in June is not going to result in any reversal of decision by Saudi Arabia to cut production. The oil-rich kingdom has made a fundamental strategic shift in response to a fundamental supply shift, which is US shale oil. It will let the market balance itself and let price dynamics do the work. 

“If you look at total non-OPEC supply growth over the last four years it has been totally dominated by US shale oil. That kept the global demand for OPEC crude flat to declining last year and the simple fact is that the consensus outlook is that shale oil will continue to grow into the middle of the next decade. There’s no room for OPEC crude production to grow. It is being dominated by US shale oil production. That’s precisely what the Saudis responded to last year. 

“Could they have cut production in November by 1.5m barrels per day in conjunction with Kuwait and the UAE? Yes. At the time Brent was at USD80 per day. If they’d done that it would have rebalanced the markets and instead of prices dropping USD10 after the OPEC meeting they would have gone up USD10 and we would have been in a USD90 Brent market,” explains Wittner. 

The point is, the Saudis would have had to make another one or two big cuts this year, and next year. While that might have succeeded in keeping Brent prices at USD90, the volume would have fallen and as Wittner stresses: “This is not about price or volume, it’s about revenues. 

The strategy of cutting production numerous times just doesn’t work. It’s precisely what happened in the 1980s.”

The upshot? Probably that the crude oil market is entering a new structural price paradigm. In the old world, the supply balancing mechanism was the Saudis. In today’s new world, that supply balance mechanism is no longer the Saudis and OPEC. It is the interplay between prices and production costs. 

“That’s what sets the market. I think we could end up in a USD75 Brent world. The bottom line is we had a three-year real world experiment with Brent at USD110 and the result of that experiment was too much supply and too little demand. Equally, I think if we found ourselves in a USD50 Brent world for an extended period we’d have the opposite problem. So I think we’ll end up somewhere in the middle,” concludes Wittner.

Soft commodities: cocoa – Fundamentally, there are some good reasons for the market to support higher cocoa prices than historical levels. Over 60 per cent of cocoa production comes out of the Ivory Coast and Ghana in West Africa. In both countries, the trees are getting older. Clearly, if anything happens in that region, it can heavily impact prices. The average age of the cocoa bean trees is 15 to 20 years old. Many are past their maximum yielding timeframe. As such futures prices, over the longer term, should be higher.

London cocoa futures rose by more than 13 per cent in 2014 on expectations that production would fall in West Africa. Currently, however, there are no obvious signs that futures should be trading as high as they have been; consistently above USD2,900 a tonne over the last six months.

The International Cocoa Organisation (ICCO) last month revised estimates of a surplus to a global cocoa deficit of 17,000 tonnes in 2014/15. As a result, prices rallied 10.8 per cent in February although they have since fallen back to USD2,695 per tonne. 

Asked whether cocoa presents a short selling opportunity over the near-term, Nicole Thomas, Commodity Analyst for McKeany-Flavell responds: “A 17,000 tonne deficit might sound like a lot but it really isn’t. As far as short selling opportunities go, in my humble opinion I would have to say it could be. It feels like futures are too high in relation to the fundamentals. To have maintained prices above USD3,000 per tonne over the last six months perplexes me because there is nothing out there that says the situation is that bad. However, I’d caution the short seller as due to the persistence of elevated futures, current levels may appeal to commercial users and add support to values.

“What would be a more reasonable level based on fundamentals would be a price of somewhere between USD2,400 and USD2,800 per tonne; similar prices to those seen in 2013.”

Indeed, from a demand side chocolate consumption has dropped off in Europe. As the Wall Street Journal reported on 22 March 2015, the ICCO expects demand in Europe and the Americas to fall 2 per cent in each region, with demand in Asia potentially falling by 4 per cent. 

“Where you need growth is in less mature markets like Asia where demand has primarily been for cocoa powder – and you need that demand to lean more on the side of chocolate. That would help balance the profitability for cocoa products. The bigger story right now with cocoa is the amount of speculation in that market and the need to plant fresh trees in West Africa,” says Thomas. “It’s hard to justify today’s prices based on demand.”

Precious metals – “At the start of the year our expectations were that the Federal Reserve would raise rates in June but we’ve recently revised that to September, which in the short-term is marginally more positive for gold,” notes Suki Cooper, Precious Metals Analyst at Barclays. 

This should present less downside risk for gold. A June rate hike would, in Cooper’s opinion, have exposed a weak floor for gold prices but the rate hike potentially not happening until September should support seasonal buying in India. 

“Gold faces a battle between a rate hike and seasonal strength; the rate hike is likely to be the more dominant of the two. 2015 is likely to see lows for the gold price and perhaps present good buying opportunities longer term. 

“We forecast a Q3 price of USD1150 per ounce,” confirms Cooper. The house forecast is for gold prices to average USD1183 per ounce for 2015.

At the time of writing spot gold was trading at USD1185 per ounce.

Silver prices in the near term are also expected to soften. Currently trading at USD16.71 per ounce, Cooper confirms that the house forecast is for prices to test lows below USD15 per ounce this year. 

“However, silver looks to be an interesting market for the next couple of years. I think we are going to reach a turning point in terms of its fundamentals. Over the last couple of years mine supply has grown consistently to record levels since 2004. When we get nearer to 2017 we expect the market to switch to a supply deficit so although we think there’s downside risk in step with gold, and that the rate hike is likely to be equally as negative, we do think the market surplus that has capped silver’s price will become less of a burden. 

“We think silver is going to become much more interesting and will find more support but not before it tests further lows,” says Cooper.

For platinum, prices have been in steady decline since last year. Overall, it is still a market in deficit but above ground stocks have had the effect of capping upside price momentum. What has compounded the problem for platinum prices in 2015 is weak jewellery demand. Consumption out of China has been much weaker than anticipated. 

“At the margin the fundamentals for platinum are continuing to improve but having an annual deficit, on its own, isn’t enough to push prices higher. Our price forecast for platinum this year is USD1,239 per ounce,” confirms Cooper.

The outlook for palladium is far brighter. Indeed, out of the four precious metals it has the highest upside potential. Whilst it is currently trading at USD763 per ounce, Cooper says the price forecast for 2015 is USD805 per ounce. This is based on a sizeable supply deficit forecast for 2015 and 2016. 

“It is a market that remains structurally under-supplied on an annual basis. Even though we are expecting some supply growth it’s been weak this year: the South African strike has impacted supply. From a demand perspective, we are seeing growth in recycled metal and the auto story is much more favourable for palladium. We are seeing demand growth coming out of the US and China,” concludes Cooper. 

Base metals – “We’re quite positive on copper prices this year. Although they’ve had a weak start to 2015 a lot of that has been down to the timing of Chinese New Year and in some cases, the fact that prices have fallen has deterred Chinese buyers in case prices fall further,” comments Caroline Bain, Senior Commodities Economist at London-based Capital Economics. 

LME stocks for both copper and nickel have continued to rise since the beginning of February. Copper stocks, for example, have risen 85 per cent since the start of the year. 

There is a sense of optimism in the market about copper mine supply this year, which hardly grew at all last year. According to the International Copper Study Group (ICSG) in its March 2015 Copper Bulletin, world copper mine production increased by just 1.3 per cent in 2014 and had a production deficit of 475,000 tonnes. 

Despite the optimism, recent price falls for copper – which have fallen from over USD3.20 per pound in July 2014 to USD2.77 per pound at the time of writing – will potentially delay bringing new mine production projects on stream. 

“There’s a lot of overconfidence in the market with respect to mine supply and probably too much negativity about demand at the moment,” says Bain. “China’s economy might be slowing, but GDP growth of 7 per cent is still respectable by anyone’s standards. We think the market has become a bit swept up in the China slowdown and that the price weakness has been overdone.”

Based on Chinese government announcements on infrastructure spending by the state grid there should be some copper buying coming through anytime soon, says Bain.

“We are slightly more bullish on where copper prices could finish by the end of this year. As it becomes clearer that there isn’t going to be a massive glut of copper then we might see speculators reduce their short positions and that could act as an additional catalyst for higher prices,” says Bain.

As for other base metals, zinc stocks are falling. The market is expected to see a large number of mine closures over the next 12 months which could lead to stockpiling ahead of a tightening market. The nickel market looks like it will tighten significantly this year because Indonesia has a ban on ore exports. Once those stocks have been wound down there will be a lot of scope for nickel prices to rise. 

“We think both the zinc and nickel markets will see some significant tightening this year. The signs are that demand is there but supply is a bit more difficult. MMG Limited is closing its massive Century zinc mine in Australia in Q3, for example,” comments Bain. 

Bain agrees that zinc has more upside potential than copper “except that copper is more highly traded and when sentiment towards copper turns more positive we might see a higher price move”. 

Demand is expected to be weak for lead to the extent that Bain does not expect to see a marked lift in prices this year. “The medium term outlook on demand is quite poor. 

“We are also negative on both steel and iron ore prices because there are huge amounts of supply in the market,” concludes Bain. 

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