Itaú BBA - OPEC reaches a deal

Commodities Monthly Report

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OPEC reaches a deal

December 8, 2016

Oil prices rise as OPEC delivered the deal. Metals with a better outlook, but the recent rally should partially fade in 2017.

For the full report, see enclosed file

• Coordinated action by the cartel will likely balance the oil market as early as January 2017. With falling inventories and rising prices, the response by U.S. shale producers will be the main driver acting against further oil price increases.

• We expect metal prices to decline in 2017 as China’s property sector cools off and marginal producers react to high prices. Nonetheless, prices will likely remain above their recent lows, benefitting the largest global producers.

• Agricultural commodity prices have fallen since late October due to the strengthening U.S. dollar and favorable weather conditions. Sugar and coffee prices have dropped more sharply due to their higher correlation with the BRL and because of an excess of long positions by hedge funds.

The Itaú Commodity Index (ICI) has gained 7% since the end of October, led by metals (+15%) and oil (ICI-Energy: +11%). The agriculture component, meanwhile, has fallen by 2%.

Our YE17 forecasts are unchanged. We expect the ICI to stabilize at current levels until YE16 and then slide downward gradually over the course of 2017, losing about 2% as metal prices decline – note, however, that on average the ICI is expected to be 11% higher than in 2016 throughout the year

Oil: OPEC cut balances the market. Crude prices climbed after OPEC announced an agreement to cut output by 1.2 mbd, the lower bound of the range of cuts suggested at a recent informal meeting. The cartel expects non-members to complement their effort with a 0.6 mbd cut, although Russia is the only viable source of such a cut (-0.3 mbd). Regardless of the reaction of other countries, the cartel’s cut will likely be enough to balance the market in January, when it is due to become effective. Global inventories should start to decrease from then on. We maintain our YE17 Brent price estimate at USD 54/bbl, a level that would allow an additional response by U.S. producers to partly offset the cartel’s action.

Agriculture: Strong dollar and favorable weather prompt price drops. Weather conditions remain favorable for growing crops in the Southern Hemisphere. Sugar and coffee prices have fallen by 9% and 15%, respectively, since the end of October. The underperformance was caused by these commodities’ greater correlation with the BRL, as well as an excess of long positions held by hedge fundsuntil mid-November. In our view, prices for these two commodities will rebound as the global deficit again becomes the main driver following the adjustment of technical positions.

Metals: Some drivers of the rally will dissipate in 2017.Metal prices rose sharply in 2016 (see chart) due to stronger demand (particularly in China), higher inventories and greater discipline among producers. We foresee falling prices in 2017, due to both demand- and supply-related factors. The Chinese property market has been the main driver of demand gains in 2016, but regulatory tightening will likely lead to a slowdown in 2017. As for supply, a stronger dollar and higher prices will likely prompt a reaction by marginal producers. Nevertheless, we expect prices to remain higher than their recent lows, benefiting the economies of the largest global producers.

Oil: OPEC cut balances the market

Brent prices have risen to USD 55/bbl from a low of USD 44/bbl in November. The increase in prices was a reaction to the agreement announced by OPEC on November 30.

OPEC’s cut was larger than anticipated and will likely be enough to balance the global market.OPEC members agreed to reduce their combined output to 32.5 mbd (from 33.7 mbd currently), with specific quotas for most members. The cut would reduce production to the lower bound of the range suggested at their informal meeting in Algiers. The reduction of 1.2 mbd from October levels will be implemented starting in January and will likely be enough to end the oversupply in the global balance.

The cartel also announced that non-members had agreed to cut an additional 0.6 mbd, although Russia is the only viable source of such a cut (-0.3 mbd, 50% of what is needed) and the extra amount agreed upon is not necessary to balance the market. In our view, only some help from Russia is priced in.

We maintain our YE17 Brent forecast of USD 54/bbl (WTI: USD 52/bbl), a level that would allow an additional response by U.S. producers to partly offset the measures taken by the cartel.

In the short term, we see a neutral bias,with a balance between downside (non-compliance) and upside (non-members joining the cartel; delayed reaction by U.S. producers) risks.

Deregulation in the oil industry after a new administration takes over in the U.S. may expand supply in the medium term. This potential is a downside risk for prices and should be monitored.

Grains: Favorable weather and strong demand

Corn, soybean and wheat prices have had mixed performance since late October(stable, +4% and ‑4%, respectively). Favorable weather (both for harvesting in the U.S. and planting in Latin America) and a strong dollar continue to put downward pressure on prices, but that pressure is being offset by robust demand indicators (U.S. export sales).

Corn and soybean export sales in the U.S.remain strong. Total contracted amounts for the 2016-17 crop are higher than in past years and apparently support a bottom for prices.

We expect international prices for these three commodities to remain at current levels until year-end. Our YE17 forecasts are:

  • Corn: USD 3.6/bushel
  • Soybeans: USD 10/bushel
  • Wheat: USD 4.7/bushel

Our scenario assumes that La Niña will last until the end of 1Q17 and will be followed by neutral weather.Hence, La Niña may affect the current crop in the Southern Hemisphere but will end before it can affect the next crop in the Northern Hemisphere or the winter corn crop in Brazil.

The planting of the summer crop in the Southern Hemisphere took place under favorable weather conditions, sustaining market expectations of increased production of soybeans (Brazil) and corn (Brazil and Argentina).

Sugar/coffee: Prices likely to remain high in 2017

International contracts for raw sugar and coffee have fallen by more than 9% since late October, underperforming other agricultural commodities. Sugar prices have plummeted 9%, to USD 0.1953/lb, and coffee prices have dropped by 15%, to USD 1.42/lb. Average prices for other commodities were flat over this period.

The underperformance of sugar and coffee is a consequence of the greater correlation between these two commodities and the BRL and of an excess of long positions held by hedge fundsuntil mid-November.

In our view, prices for both commodities will rebound as the global deficit comes back into focus following the adjustment in technical positions.

We expect sugar prices to average USD 0.215/lb in 2017. We expect a deficit of 3.6 million tons in the 2016‑17 crop year (after a deficit of 10 million in 2015‑16), followed by two consecutive years of surpluses that lead to lower prices in 2018.

Our YE17 price forecast for coffee stands at USD 1.70/lb.


 

Artur Manoel Passos, CFA
Tomas
Davidowicz


 

For the full report, see enclosed file



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