Itaú BBA - Downside risks to oil prices; upside risks for grains

Commodities Monthly Report

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Downside risks to oil prices; upside risks for grains

July 14, 2015

We see upside risks to grain prices and downside risks to our oil scenario due to supply-side factors.

• Metal and oil prices have fallen sharply in recent days, reflecting both supply and demand factors (the latter related to Greece-EU and China). We have lowered our price projections for some metals and see downside risks to our current oil-price forecast (for Brent crude at USD 70.0/bbl at year-end).

• Unfavorable weather in the U.S. has intensified the risk of crop losses and led to a steep hike in grain and soybean prices, but the impact on output remains uncertain. We have not changed our forecasts for agricultural prices, but we recognize that the weather poses (upside) risks.

The Itaú Commodity Index (ICI) has fallen by 1.0% since the end of May, with mixed performance for its three components.The aggregate decline was driven by price drops for metals (‑11%) and energy (-8%) due to rising macroeconomic risks on Greece-EU and China. The move  outweighted a sharp gain in agricultural commodity prices (+15%) due to weather-related risks. With drops in May, June and early July, the aggregate index is down 4.7% year-to-date.

We have lowered our price forecasts for ICI-Metals, as we foresee no room for recovery in aluminum, nickel and tin prices. Our new scenario assumes a 5.7% increase in the ICI from current levels by year-end.

Grain (and soybean) prices climbed in response to supply risks in the United States. Excessive rainfall in the U.S. Midwest hampered soybean planting and the winter wheat harvest and will likely reduce yields for both crops (and for corn as well). However, it is difficult to estimate the overall impact on output. Hence, the recent price hike reflects a greater probability of a stressed scenario (with intense crop losses and price increases), but prices may slide back to low levels if the losses are not so significant. We have left our forecasts unchanged, but we acknowledge that there are upside risks if the stressed scenario materializes.

Metal and energy prices have plummeted in recent weeks, affected by macroeconomic risks. The demand outlook was affected by the turmoil in Greece, which may reduce eurozone GDP and strengthen the U.S. dollar. The steep decline in China’s stock market also affected hard commodity prices as the shock may impact the real economy (although this is not our base case).

Supply factors also helped to explain the decline.Iron ore shipments from Australia increased again, while higher-than-expected oil production in the U.S. and the nuclear agreement between Iran and the P5+1 intensified the slide in crude prices.

Grains: Excessive rainfall in the U.S. increases risks

Weather conditions evolved in line with the El Niño pattern in June and early July. Rainfall levels were excessive in the U.S. Midwest and in southern Brazil, while eastern Australia experienced below-average precipitation levels.

Heavy rains affected output expectations in the U.S., but the magnitude of the effect is uncertain. Rainfall delayed (or prevented) the completion of soybean planting and the winter wheat harvest and will likely reduce yields for both crops and for the corn crop as well. Still, one can only guess the magnitude of the impact on the harvest. In the rest of the world, there were no significant changes in the supply outlook.

The consequence was a hike in prices.Corn, soybean and wheat prices rose by 25%, 11% and 21%, respectively, since the end of May. The increase in soybean prices was milder because the surplus in the global balance for the product is larger than for the other two commodities.

We maintain our year-end price forecasts for corn (USD 3.8/bushel), soybeans (USD 8.8/bushel) and wheat (USD 5.1/bushel). This scenario assumes that the impact of the excessive rainfall was small, so that prices return to lows that are consistent with the surpluses in the global balance.

In the event of larger U.S. crop losses due to the excessive rainfall, prices may rise from current levels.

Sugar: Parity with hydrous ethanol prices in Brazil

Prices in international sugar contracts surpassed the equivalent producer price of hydrous ethanol in Brazilas the earliest due date shifted to October from July (see chart).

The recent evolution of the harvest in the Center-South region of Brazil reinforces the prospect of higher crushing volumes, a decline in total recoverable sugar (TRS) and a greater usage of sugarcane for ethanol production. All in all, sugar production will be slightly lower, despite the increase in the latest sugarcane crop compared with the previous one.

Looking ahead, we continue to forecast that international sugar prices will be at parity with ethanol producer prices in Brazil, acknowledging that the adjustment in the production mix in Brazil is the main factor driving equilibrium in the market. Our year-end sugar price forecast stands at USD 0.132/lb.

The biggest risk factors in this scenario are moves in the Brazilian currency and domestic gasoline prices in Brazil. Parity with hydrated ethanol prices in Brazil (denominated in local currency) transmits exchange-rate volatility to international prices. There is a risk of additional hikes in domestic gasoline prices (although this is not our base-case scenario), which would boost hydrous ethanol prices.

Oil: Downside risks from Iran deal and efficiency gains in the U.S.

Oil prices have fallen sharply since early July.Brent crude slid to USD 57/bbl from USD 64/bbl, while WTI crude dropped to USD 52/bbl from USD 59/bbl.

The Greece-EU crisis is likely behind some of this decline, affecting prices through two channels: lower expected growth in the eurozone (reducing forecasted demand) and the U.S. dollar’s appreciation against other currencies. Renewed concerns with China following the steep decline in stock prices also helped to explain the move.

However, a combination of two supply shocks is the more likely explanation for recent price moves. First, U.S. output is still on the rise, albeit at a slower pace than last year. There is growing evidence of efficiency gains in shale oil production, increasing output for a given price level. The second shock relates to a nuclear deal between Iran and the P5+1, which has the potential to increase global supply by 1 mbpd in the next 12 months.

These shocks may delay the reaching of equilibrium in the oil market, and make it happen at lower prices.

Hence, we see downside risk to our scenario for oil prices. We currently expect Brent crude to rebound to USD 70/bbl by year-end.


Artur Manoel Passos


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