Itaú BBA - Oil fundamentals suggest a rebound in oil prices starting by mid-year

Commodities Monthly Report

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Oil fundamentals suggest a rebound in oil prices starting by mid-year

February 3, 2016

Oil excess supply likely to vanish in 2016, even without OPEC action

For the full report, see enclosed file

• Oil prices stayed closed to USD 30/bbl as the market continues to be oversupplied. News suggesting a production-cut agreement involving OPEC and Russia, which we think is unlikely, had only a short lived impact on prices

• We expect the oversupply to vanish by the middle of the year (even without coordinated reduction by OPEC), supporting a recovery in oil prices to USD 55/bbl by YE16.

• We have reduced our price forecasts for sugar and coffee due to favorable conditions for the next crop in Brazil.

Aggregate commodity prices (as measured by the Itaú Commodity Index – ICI) have climbed by 5.0% since mid-January, driven by appreciating oil and metals. Agricultural commodities did not follow this trend but are still outperforming the other commodities this year to date because they were not affected by the risk aversion in the first two weeks of January. The recent aggregate gain was not enough to offset the losses of the beginning of the year, and the ICI is still down 2.8% YTD.

The oil market is in the spotlight this year, affecting not only other commodities and the exchange rates of oil‑producing countries but also stock prices and interest rates all over the world. Over the past 60 days, the daily correlation between changes in Brent crude prices and the S&P 500 was 0.43, compared with 0.19 in 1H15.

Brent prices stayed close to USD 30/bbl, compared to a low of USD 28/bbl in mid-January. Prices went up to USD 35/bbl supported by news of an eventual coordinated action by major producers and by not-so-bad economic data from the U.S. and China. The prospective supply cut would not involve countries that effectively reduced production in the past, so this news was not expected to have as strong of an impact as it did. Hence, the subsequent price increase suggested that there is an excess of short positions in the market (at least for now). The increase was not sustainable and prices remains in USD30-35 range. Gains in the oil market helped metal prices to reverse some of their recent declines.

In our view, a cut in production does not reflect the strategy of Saudi Arabia and its allies, countries which have a history of coordinated production cuts, so we do expect the combined market forces to eliminate the excess supply by mid-2016 (see chart).

We forecast an increase in crude prices to USD 55/bbl by YE16 (without counting on an adjustment by OPEC). Our scenario assumes that a decline in U.S. production will offset higher exports from Iran, while demand sustains its upward trend. Econometric/historical analyses suggest that prices will bottom out the quarter before the market shifts to a deficit (so in this case, the trough of the cycle would be reached in 2Q16). We have also maintained our price forecasts for metals, which project some gains from current levels.

We have reduced our YE16 price forecasts for sugar and coffee (to USD 1.28/lb from USD 1.25/lb) due to favorable weather in Brazil. Our forecasts for soybeans and grains have been maintained, as fundamentals have not changed.

Oil: Excess supply likely to vanish in 2016, even without OPEC action

Oil prices have recovered from their recent lows (USD 28/bbl), with the Brent crude trading in the USD 30-35/bbl range, but remaining lower than their sustainable levels. Economic data turned out to be better than had beem priced in and there was news of a prospective cut by OPEC (as discussed above). Notwithstanding this increase, prices remain much lower than their sustainable levels.

We anticipate a partial recovery in prices in 2016 as the excess supply in the market vanishes by the middle of the year. According to our calculations, the global balance will shift from a seasonally-adjusted oversupply of 2.2 mbpd in 4Q15 to a deficit of 0.2 mbpd in 3Q16 even without coordinated action by OPEC.

This transition will take place as a decline in U.S. output offsets an increase in exports from Iran due to the end of sanctions, and thus without major shocks to demand or the remaining supply. We believe that: i) demand will remain on a path that is consistent with global growth and with the drop in prices over the past two years; ii) other OPEC countries will maintain their current output levels; and iii) other world producers will remain continue their trends of recent years, as output does not react to falling prices (or declining investment).

We maintain our YE16 forecast at USD 55/bbl. 

Softs: Favorable weather in Brazil

Prices in international sugar contracts fell to around USD 0.13/lb in January from USD 0.15/lb at the end of December. The futures contract with the first due date is trading around BRL 0.128/lb in New York.

Sugar prices dropped due to favorable weather in the Center-South region of Brazil, which improved the outlook for the 2016-17 crop and may result in a smaller deficit for the crop year. Rainfall was heavier and better distributed than last year, which along with a likely decline in ethanol demand points to higher sugar output in Brazil in 2016.

Expecting a smaller deficit, we have lowered our forecast for average international sugar prices to USD 0.139/lb from USD 0.143/lb in 2016, in line with the futures curve.

International coffee prices (first due date in New York, Arabica) remained between USD 1.11/lb and USD 1.25/lb, showing little reaction to currency depreciation in major producing countries.

Weather in Brazil and the upward cycle in the biannuality of coffee plants in most producing states suggest that there will be a larger crop in 2016. Notwithstanding the recently favorable weather, the focus is on the evolution of weather conditions over the next months, which will define grain filling and size.

Our YE16 price forecast has been revised to USD 1.25/lb from 1.28/lb, in line with the futures curve. We maintain our assessment that these levels provide a good balance between downward drivers (favorable weather in Brazil and higher prices in local currency for the biggest producers) and upward drivers (the risk of crop losses).

Grains: No shocks for now

International prices (first due date) for corn, soybeans and wheat are little changed this year and still appear unaffected by macro concerns. The cumulative changes since the end of 2015 stand at ‑3.5%, 1.1% and 1.1%, respectively.

Overall, the outlook for these three commodities remains the same: a relatively loose global balance in 2016, assuming that crops in the Northern Hemisphere evolve under expected conditions.

We maintain our YE16 price forecasts for corn (USD 4.0/bushel), soybeans (USD 8.8/bushel) and wheat (USD 5.3/bushel).


Artur Manoel Passos

Ivan Lasaro


For the full report, see enclosed file


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