Itaú BBA - Drop in oil prices likely to be short-lived

Commodities Monthly Report

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Drop in oil prices likely to be short-lived

August 9, 2016

We forecast metal prices to decline ahead and lowered our agricultural forecasts.

For the full report, see enclosed file

• We expect oil prices to rebound to USD 50/bbl by year-end. Despite downside shocks, the market needs U.S. producers to respond to reach equilibrium, and a consistent U.S. response will only materialize with higher prices. 

• We have cut our price forecasts for corn, soybeans and wheat (in line with price movements), incorporating the outlook for a larger crop in the United States. 

• Fundamentals for metals suggest falling prices ahead. The recent hike will likely reverse.

The Itaú Commodity Index (ICI) has fallen by 4% since late June, dragged down by its agriculture (‑5%) and energy (-9%) subcomponents. Metal prices moved in the opposite direction, climbing by 6%.

We expect oil prices to recover by year-end (to USD 52/bbl for Brent and USD 50/bbl for WTI), because, in our view, the market has overreacted to recent news. The drop since mid-June has been driven by several adjustments in supply and demand which narrowed the global deficit seen in 2Q16. However, these shocks do not change our overall assessment that the market still needs an increase in investments in the U.S. to reach equilibrium by year-end. In our opinion, such a reaction will only materialize if oil prices approach USD 50/bbl.

Fundamentals suggest that metal prices will fall over the rest of the year, given sluggish demand and new supply capacity increases. Nevertheless, we have increased our year-end price forecasts for iron ore (to USD 45/ton from USD 42/ton) and other metals in view of the risk of supply disruptions in the nickel market (which could last a while and spill over to other metals) and higher-than-expected domestic absorption of steel in China.

Agricultural prices have fallen due to favorable weather in the U.S., which reversed expectations that a drought or heat wave would reduce corn and soybean crop yields. We have cut our price forecasts for corn, soybeans and wheat, incorporating an outlook for larger supply.

Our scenario implies a 2% gain in the ICI from current levels, driven by hikes in agricultural (1%) and energy prices (13%) that are partly offset by a drop in metal prices (-12%).

Oil: Price drop is likely temporary

Brent crude prices have fallen since mid-June, to USD 44/bbl from USD 52/bbl, while WTI prices have fallen to the same degree.

The slide was apparently driven by many downside factors. In terms of demand, Brexit reduced growth expectations (for GDP and oil demand) for advanced economies, and a gasoline inventory accumulation for several weeks in the U.S. was regarded by some as a sign of weaker demand in that country. In terms of supply, temporary output disruptions in Nigeria and Canada are starting to reverse, the agreement in Libya will enable higher production going forward, and there are signs that exploration investments in the U.S. are resuming at a modest pace.

In our view, the market has overreacted to this recent news flow. Gasoline absorption is always very volatile, and weakness in a given month is more likely to be noise than a sign of a new trend in demand. The agreement in Libya is fragile and does not include well regions (controlled by rebel forces). Even with the resumption of temporarily-disrupted production and some deceleration in global demand growth restoring the global balance still requires more investments in the oil industry in the U.S. (see chart), which in our view will only materialize when oil prices approach USD 50/bbl.

We maintain our year-end forecasts for oil prices (USD 52/bbl for Brent; USD 50/bbl for WTI). Our scenario assumes that Brexit will dent growth in advanced economies.

Grains: Favorable weather, falling prices

Corn, soybean and wheat prices have fallen sharply since late June (-11%, -17% and -6%, respectively).

The price slide reflected favorable weather during a decisive period for crop yields in the United States. Higher-than-average temperatures did not bring heat waves, as had been expected, and were offset by higher-than-average rainfall levels.

Due to the favorable weather, indicators of productive efficiency have pointed to similar or better yield levels than in the two previous crops (see chart).

Finally, given the recent weather pattern, the risk of an early transition to La Niña (early enough to affect the current U.S. crop) has been almost completedly discounted.

We have reduced our year-end price forecasts for corn, soybeans and wheat, incorporating larger supply estimates, to the following (all forecasts are in USD/bushel):

  • Corn: to 3.4 from 4
  • Soybeans: to 9.8 from 11
  • Wheat: to 4 from 5.1

Our scenario assumes a transition to La Niña only later in the year, affecting the next crop in the Southern Hemisphere but not the current U.S. crop.


Artur Manoel Passos


For the full report, see enclosed file

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