Itaú BBA - Lower price forecasts for oil and metals due to a weaker China

Commodities Monthly Report

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Lower price forecasts for oil and metals due to a weaker China

September 9, 2015

An unfavorable environment for commodity-exporting nations.

• We revised our price forecasts downward for Brent crude (to USD 55/bbl from USD 60/bbl by YE16) and base metals, as we incorporated an outlook for slower global growth. 

• Our forecasts are below what the futures markets are pricing in, implying an unfavorable environment for commodity-exporting nations. 

• Despite the forecasts of an intense El Niño weather pattern, its peak is expected in 4Q15, so the impact on global grain production may be mild. Still, there are risks to the summer harvest in the U.S. and to the sugarcane crop in India.

The Itaú Commodity Index (ICI) has fallen further since the end of July (-4.1%), as the outlook for lower growth in China (and its impact on other countries) worsens expectations for future demand. All three index components posted declines: Agriculture (-5.3%), Metals (-2.2%) and Energy (-4.0%).

Slower growth in China hurts demand for base metals. The year-to-date drop for Metals (-21.6%) is sharper than for the other components (Agriculture, ‑14.8%; Energy, -10.7%), reflecting a sharper slowdown in demand.

We reduced our price forecasts for Brent crude (to USD 55/bbl from USD 60/bbl by YE16) and base metals, as we incorporated lower global growth, due to China’s influence. The combined effect is a decline of 5.1 p.p. in our estimate for the ICI by YE16, in addition to the 8.2 p.p. reduction in our previous revision.

The slide in agricultural prices is consistent with our scenario, so these forecasts remain constant. Importantly, we see upside to our scenario for sugar prices, given the risks for global supply and for changes in the gasoline market in Brazil.

Previous cycles suggest further downside to commodity prices. In August, average prices were 6.4% below their long-term trend[1], and our scenario suggests a return to the trend in 2016. However, history shows that previous upward cycles have been followed by long periods in which prices were over 20% below their long-term trend, so there is room for further declines.

Oil: Absence of equilibrium factors boosts volatility

Oil prices remain at low levels, with intense volatility. Brent crude fell from USD 50/bbl to as low as USD 42, rebounded to USD 54 and now trades close to USD 49.

This volatility seems to be caused by: i) instability in the macro scenario; and ii) lack of an equilibrium factor in the market, which magnifies macro shocks.

Absence of equilibrium. Until mid-2014, OPEC adjusted supply when prices moved too far from USD 110/bbl. Since then, the focus has turned to U.S. shale oil producers, which face high costs and a shorter lag between investment and output than other producers. The equilibrium price would be close to a representative production cost for that output. However, the price slide observed since May has not prompted another response from producers, raising uncertainties about production costs. With excess supply, the uncertainty about costs translates into greater volatility in oil prices, intensifying the impacts of the Chinese economy or the monetary policy of advanced economies.

Producers are keeping oil under the ground after successful drilling. Weekly data on U.S. shale oil show stability in the number of exploration wells and rising productivity per well. Data also show a drop in total oil production since May. These seemingly contradictory facts suggest that producers are maintaining exploration/drilling activities but not extracting oil, using wells as a form of storage (fracklog).

Fracklog may lead to a quick production boost in response to any price increase, limiting the potential for sustainable gains.

We reduced our forecast for Brent prices to USD 55/bbl from USD 60/bbl, incorporating the outlook for slower global growth in 2016. Even though China accounts for the biggest reduction and may sustain a strong increase in crude imports (+10.4% yoy in the year through July), slower growth in China affects other nations. Lower growth in demand in 2016 delays the equilibrium between supply and demand to the end of 2016.

Grains: Intense El Niño may not affect production so much

International prices for corn, wheat and soybeans fell in August, extending the declining trend started in July. Corn, soybean and wheat prices fell 2%, 12% and 6%, respectively, under near-normal weather conditions.

Corn’s outperformance seems consistent because its balance has less “slack” than soybeans and wheat do. This difference was reinforced in the latest revision for the balance between supply and demand published by the U.S. Department of Agriculture (USDA), raising yields for soybean crops in the U.S. (lowering risks of a significant impact from rainfall in June) and showing high availability of wheat around the world.

Incorporating recent information, we revised our forecast for the soybean crop in the U.S. to 103 million metric tons from 101 million, while keeping the forecasted crop for corn at 338.7 million tons.

El Niño is expected to be more intense, but its impact on the grain supply may be mild. Forecasts for El Niño are being updated and point to an intense anomaly (the largest since 1998) and indicate that the pattern will last until 2Q16. However, the period of greater intensity (4Q15) does not bring significant risks to crops in Asia, which will be finishing harvesting. Nevertheless, the pattern may pose risks to the harvest in the U.S. (excessive rainfall) and for the sugarcane crop in India.

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 is consistent with a small decline in U.S. production and no additional losses in other producers.

Sugar: Risk of a turnaround

International sugar contracts have climbed 7.0% since August 24, breaking the correlation with prices for hydrous ethanol in Brazil converted into U.S. dollars. 

The hike and broken correlation may be explained by several risk factors that arose recently:

- Firstly, news related to risks of crop losses in China and India.

- Secondly, news of another interruption in sugarcane crushing in the Center-South region of Brazil. Depending on the intensity, these adjustments may be offset by higher usage of sugarcane for sugar production (and less for ethanol), but there are limits to the mix change, and a sudden reduction in expected output may cause prices to decouple from the “floor” provided by hydrous ethanol converted into sugar for the rest of the year.

Furthermore, an increase in the CIDE tax on gasoline in Brazil is being discussed again, and may raise domestic prices for hydrous ethanol.

We maintain our year-end forecast for international sugar prices at USD 0.11/lb., but acknowledge upside if one or more risk factors materialize.

Metals: Affected by weakness in China

In August, metallic commodities traded around the same level, not recovering from the sharp declines seen in July. Spot iron ore prices remained near USD 55/ton, while copper traded near USD 5,250/ton. Aluminum and tin also traded sideways, while nickel, zinc and lead fell further during the month. Our Metals index is down by 20.7% year-to-date.

We lowered our price forecasts for metallic commodities, incorporating the outlook for slower global growth. Importantly, the slowdown in China has been sharper in sectors which are heavy users of metallic commodities. Factors that recently led expectations to deteriorate also reinforce a scenario in which these industries will not recover, so the outlook for demand will probably remain unfavorable. 

These are our adjusted price forecasts by YE16 (prices per metric ton):

- Copper: to USD 5,150 from USD 5,562

- Aluminum: to USD 1,600 from USD 1,730

- Zinc: to USD 1,800 from USD 2,060

- Nickel: to USD 9,460 from USD 12,050

- Lead: to USD 1,700 from USD 1,810

- Tin: to USD 14,065 from USD 16,250

Our estimate for iron ore remains at USD 50/ton.

Our scenario considers an additional decline of 1.3% until year-end and a drop of 1.1% in 2016. 


Artur Manoel Passos




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