Itaú BBA - Oil: where is the bottom?

Commodities Monthly Report

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Oil: where is the bottom?

January 14, 2015

The Itaú Commodities Index (ICI) has retreated 16.2% since the end of November, once again affected by oil prices.

• We believe that the adjustment of oil prices will take a few months, so we are reducing our forecast for prices for the first half (from USD 70.0 to USD 52.5 per barrel). We maintain our end-of-year outlook at USD 70.0/bbl.

• Low oil prices are affecting other commodities through cost deflation, an increase in risk aversion and substitution (from ethanol or natural gas). We have reduced our forecast for base metals by incorporating a slower recovery in oil. 

The Itaú Commodities Index (ICI) has retreated 16.2% since the end of November, once again affected by oil prices. The breakdown by component illustrates this impact: the agricultural ICI with a slight decrease of 1.9%, the metals ICI with a drop of 7.6%, and the energy ICI with a drop of 32.2% during the same period.

The drop in oil is affecting other commodities, especially the base metals, through three channels:

  1. The drop in energy prices translates into lower commodity production and transportation costs.
  2. Even though lower oil prices will increase global GDP growth, the sharp decline generates losses to key producing countries, to O&G companies and to banks exposed to these agents. These losses create risks of sizable credit events and are leading investors to risk-off behavior, affecting other commodities.
  3. Ethanol loses competitiveness against gasoline, potentially lowering corn demand for ethanol production in the U.S. (which was above the minimum quota established by the government).

We still believe that Brent prices at USD 70 per barrel will eventually balance supply and demand, but the adjustment could take a few months and prices may remain low until then. Therefore we are forecasting average Brent prices in 1H15 at USD 52.5/bbl (previously: USD 70/bbl). We expect prices to recover in the second half of the year, reaching USD 70/bbl by year-end.

We lowered our year-end 2015 ICI forecasts by 1.2 percentage points and the average 2015 by 6.8 p.p. In addition to the change in the average price for the Brent, we reduced sugar and base metals prices. With these adjustments, our year end ICI forecast is 17.3% above current levels. Advancing to 2016, we expect the ICI to rise 3.4% yoy.

Oil: reaction to low prices will take some time 

Brent prices plunged to USD 48.0/bbl and have already posted a drop of 55% in relation to the previous equilibrium point (at USD 110.0). WTI prices have accompanied the move, retreating to USD 45.0 per barrel during the same period.

Still no reaction in supply and demand to the low prices. OPEC’s supply has remained practically stable, without a relevant reaction to low prices. The most recent estimates suggest that a decline in Libyan production was offset by other countries in the cartel. In the U.S., weekly data on implicit demand for gasoline and other oil products have yet to show a significant increase, and production continues to climb.

Metals: feeling oil’s effect

Base metals have retreated since the middle of November, in a move that can be attributed to the strength of the dollar relative to other currencies and to the other causes that have led to the drop in oil.

We revised our forecast for base metals, especially aluminum and copper, taking into account a scenario of slower oil price recovery and further strength of the dollar. We cut our forecast for aluminum prices to USD 1,860/ton from USD 2,050/ton and copper to USD 6,100/ton from USD 6,500/ton by the end of 2015.

Iron ore stable at USD 70/ton. After numerous drops in 2014, prices have been practically stable since the middle of November, little affected by the movements in exchange rates and other effects of the drop in oil prices. We maintain our forecast of USD 70.0/ton for the next two years.

Agriculture: unfavorable weather in Brazil 

The USDA’s latest WASDE[1] did not confirm expectations of some market participants of lower harvested area in the 2014/15 U.S. crop. The final estimate for the soybean crop rose a bit to 108.1 million tons, leading to an unprecedented surplus in the U.S. market. Unexpected lower yields have led to an unexpected downward revision in the corn crop to 361.1 million tons. Even with the drop in corn crop, the report consolidates the prospect of strong surplus in the U.S.

Despite the consolidation of surpluses in the U.S., dry weather in Brazil in January is preventing a sharper decline in international corn and soybean prices. The unfavorable weather condition in the country also creates risks for sugarcane and coffee crops, but the negative effect can be offset by the normalization of rainfall and temperature in the coming months.

We maintain our year-end 2015 forecasts for corn, soy and wheat at USD 3.4, USD 10.0, and USD 5.4 per bushel, respectively.

Sugar prices remain low, with futures contracts in NY operating below USD 0.15 per pound. Unexpected deliveries at the end of the year and a weakening of the currencies of leading sugar producers help explain this weakness.

We cut our forecast for sugar prices from USD 0.18 to USD 0.17 per pound at the end of 2015, taking into account a stronger dollar and a stronger effect of large stockpiles on prices.


Artur Manoel Passos


[1] Monthly report from the U.S. Department of Agriculture containing supply and demand estimates for agricultural products.


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