Itaú BBA - Oil: How low can it go?

Commodities Monthly Report

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Oil: How low can it go?

June 29, 2017

Commodity prices continued to decline in June. We have reduced our year-end oil price forecasts for both 2017 and 2018.

For the full report, see enclosed file

• Commodity prices continued to decline in June, led by energy and agricultural prices.

• We have reduced our year-end WTI price forecasts to USD 45/barrel for both 2017 and 2018, and our year-end Brent price forecasts to USD 47/barrel for both years.

• We expect the ICI to remain broadly stable from its current level by the end of 2017.

The Itaú Commodities Index (ICI) has retreated by 2.5% since end of May, dragged down mainly by lower oil prices. In this period, the energy ICI has dropped 6.9%, the agricultural ICI has fallen by 2.2% and the metals ICI has risen by 3.7%.

We have reduced our year-end WTI price forecasts to USD 45/barrel for both 2017 and 2018 (from USD 52.5/barrel in 2017 and from USD 50/barrel in 2018), and our year-end Brent price forecasts to USD 47/barrel for both years (from USD 54/barrel and from USD 51/barrel in 2018). Despite the OPEC production freeze, oil inventories have failed to adjust as fast as anticipated. This oil oversupply appears to stem from better productivity by U.S. shale oil producers. However, with WTI approaching USD 40/barrel, it has now started to hurt U.S. high yield energy credit spreads, which in turn is likely to bring discipline to the shale industry and hence to global oil supply. Still, in the short term, there is a risk that prices may have to dip below USD 40 to force a faster adjustment.

Firmer global manufacturing will limit metal price declines, but lower oil prices are a short-term risk. Strong demand will limit the downward adjustment in metal prices. The main risk is that lower oil prices in the short term may reduce metal production and distribution costs. Iron ore prices may be already close to their target (USD 55/mt), but we still foresee a 7.0% decline in the broader ICI Metals by year-end.

Our broad agricultural price index declined by 2.2% last month, led by sharp declines in sugar and coffee prices. The drop in sugar prices has been caused by strong supply coupled with lower ethanol demand as gasoline prices decline. International food commodities had more mixed price performance in June. Soybean prices fell by 0.5%, while wheat prices rose by 5.6%.

We expect the ICI to remain broadly stable from its current level by year-end.

Metals: A temporary recovery

Iron ore and copperprices have recovered some momentum since the end of May. We now forecast a 7.0% decline in ICI Metals from its current level by year-end 2017. Specifically, we expect iron ore prices to remain close to USD 55/mt and copper prices to decline to USD 5600/t by the end of the year.

Oil: A positive supplyshock

WTI crude prices have fallen since the end of May, to USD 43/bbl from USD48/bbl, and Brent prices have fallen to the same degree, but have gained some momentum over the last couple of days.

The oil-price slide was drivenby supply factors. Oil inventories remain high even after OPEC’s production cut. This oil oversupply appears to stem from better productivity by U.S. shale oil producers. However, we note that the recent fall in oil prices has started to affect credit spreads in the U.S. energy sector, which in turn is likely to bring more discipline the shale industry and hence to global to oil supply. Still, in the short term, there is a risk that prices may have to dip below USD 40 to force a faster adjustment.

We have reduced our year-end WTI price forecasts to USD 45/barrel for both 2017 and 2018 (from USD 52.5/barrel in 2017 and from USD 50/barrel in 2018), and our year-end Brent price forecasts to USD 47/barrel for both years (from USD 54/barrel and from USD 51/barrel in 2018).

Grains: Soybean prices fall in response to higher-than-expectedsupply

Wheat prices have risen by 5.6% since the end of May, while corn and soybean prices have fallen by 3.4% and 0.5%, respectively, over the same period.

Expectations of higher supply triggered a drop in soybean prices, despite the prospect of an increase in demand. However, as the U.S. export sales have been stronger than was projected by U.S. Department of Agriculture (USDA), the oilseed beginning inventories for the next crop may be lower, supporting prices.

We maintain our YE17 price forecasts for corn (USD 3.75/bushel), soybeans (USD 9.5/bushel) and wheat (USD 4.8/bushel).

The probability of an El Niño-like weather anomaly has decreased and this is no longer our base-case scenario for the second half of the year. For U.S.crop producers, an El Niño cycle in 2H17 would increase the risks of excessive rainfall, possibly delaying/jeopardizing the harvest.Those risks have decreased significantly, pointing to higher production in the United States.

Sugar/Coffee: Lower prices

International contracts for raw sugar and coffee have dropped by 14.9% and 6.8%, respectively, since the end of May. 

The recent drop in sugar prices may be explained by the oversupply of sugar in the market, coupled with diminished demand for ethanol as a result of falling gasoline prices. The oversupply of sugar was caused by a weak consumption in Brazil and a larger than expected harvest in Thailand, combined with disappointing import demand from China and India.On the other hand, with the decline in oil prices, gasoline prices in Brazil plummeted, increasing the demand for this fuel. This led to a reduction in the consumption of ethanol, affecting ethanol prices.

Sugar prices in Brazil have already reached ethanol price levels. As Brazilian millers can shift their production from sugar to ethanol, thisshould prompt the mills to start producing more ethanol than sugar, balancing the supply with the demand and raising sugar prices. However, with the further decrease in ethanol prices, the reference price for sugar is now lower.

Our YE17 coffee price forecast is unchanged at USD 1.40/lb, and we have reduced our YE17 sugar price estimate to USD 0.146/lb.


 

Paula Yamaguti

Laura Pitta


 

For the full report, see enclosed file


 

 



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