Itaú BBA - OPEC surprises

Commodities Monthly Report

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OPEC surprises

October 7, 2016

The promise of production cuts reinforces our outlook for oil trading for USD 50-55/bbl in 2017.

For the full report, see enclosed file

• The promise of production cuts by the cartel reinforces our outlook for oil trading for USD 50-55/bbl in 2017, but increases the chances of price overshooting if the cut materializes and the reaction by U.S. producers takes longer to stabilize global markets.

 • We revised our price forecasts upward for iron ore (to USD 48/ton from USD 45) and some base metals, due to a better outlook for demand.

• We revised our price forecasts upward for sugar and coffee in 2017. In our view, supplier reaction to higher prices will only bring equilibrium to the global balance starting in 2018. The outlook for corn, soybeans and wheat remains the same: large inventories and strong supply in 1H17.

The Itaú Commodity Index (ICI) remained in an upward trend, climbing 7% since the end of August and 19% year-to-date. Most commodities gained in the period, with surprises in terms of supply (OPEC promising an agreement, mines closing in the Philippines) and demand (greater confidence in the Chinese economy, better manufacturing PMIs around the world). The two noteworthy exceptions were soybeans (stable) and iron ore (-7%), which are the most significant exports from Brazil.

Upward revision in metal forecasts. Notwithstanding a 7% slide since August, we increased our forecast for iron ore in 2017 to USD 48/ton from USD 45. In addition to prices currently trading much higher than our current scenario for the next year, we see a more steel-intensive growth in China in the short term due to more infrastructure investment, as well as weaker supply expansion.

OPEC announcement thins downside for oil prices. The cartel surprised the market by announcing a preliminary agreement to reduce crude supply. Details are still being worked out, and the actual adjustment will only materialize after a formal meeting on November 30, but the new strategy means upside for prices, which will probably trade near USD 50/bbl until the final statement. We maintain our YE17 call for Brent at USD 54/bbl, as the marginal cost for shale-oil producers will stand as the key factor to determine equilibrium, despite lower supply from OPEC. Nevertheless, the agreement will increase price overshooting risks in 1H17 and considerably reduce downside for prices for several months.

Upward revision in price forecasts for sugar and coffee. The ICI-Agriculture has climbed 8% since late August, led by additional gains for sugar, besides some recovery for corn and wheat after a sharp decline in August. We increased our price estimates for coffee (incorporating the effect of weather shocks on crops in 2017) and sugar. The scenario for grains and soybeans is unchanged: a huge crop in the U.S. in 2016/17, strong incentive to expand the planted area in Brazil and Argentina in the next crop, and high global inventories.  

Our scenario is consistent with stability in the ICI from current levels by year-end, and then a 3% advance throughout 2017.

Oil: OPEC reduces downside for prices

Crude prices were trading between USD 45 and USD 50/bbl until September 28 (date of the OPEC announcement). Prices reflected equilibrium between the outlook of oversupply for some time and risks of an agreement during the informal OPEC meeting in Algiers on September 26-28.

OPEC surprised the market by announcing a preliminary agreement. The cartel reached a preliminary agreement to reduce its combined production to a level between 32.5 and 33.0 mbpd after its next formal meeting, on November 30. The stated range represents a decline of between 0.7 and 1.2 mbpd from estimated output in August. Some details lead to questions about the size of the actual cut, but the baseline scenario now contemplates some reduction starting in December.

The OPEC cut again turns the focus to U.S. output. Even the minimal adjustment (to 33.0 mbpd, our new assumption in the baseline scenario) would be enough to push the end of excessive supply forward to 1Q17. After that, the global market will need an increase from unconventional sources in the U.S. and the debate goes back to the intensity, speed and price level needed to drive their reaction.

We maintain our YE17 scenario for Brent at USD 54/bbl (WTI: USD 52/bbl). In our view, prices between USD 50 and USD 55 would be enough to ensure a reaction by U.S. producers, which are the source of marginal output in international markets.

The announced production cut did not change our baseline scenario, but the downside for prices shrank. The news also created overshooting risks, as the reaction by U.S. producers may take longer to materialize.

Soft commodities: Coffee and sugar prices will remain high in 2017

International raw sugar contracts have gone through another round of gains since the end of August, advancing 15% to USD 0.231/lb (futures contract for first delivery traded in New York). In addition to the outlook for a deficit for two consecutive years, recent changes in the weather and in the crushing situation signal risks that sugar production in the Center-South region of Brazil totals less than 35 million tons in the current crop (our forecast: 35 million).

International coffee contracts remained around USD1.50/lb.

The two commodities post year-to-date gains (sugar: 52%, coffee 16%) due to lower supply. The output decline was caused by weather shocks and lower investments due to unfavorable profit margins in the past.

We revised our forecasts for average prices in 2017 upward, as supplier reaction to recent gains will only affect the balance in 2018. We adjusted our estimate for sugar by 7.5%, to USD 0.215/lb from USD0.2. Our revision for coffee amounted to 7%, to USD 1.5/lb from USD 1.4.

According to our calculations, the global sugar deficit will narrow down to 4 million tons in crop year 2016/17, from 10 million tons in 2015/16. This scenario assumes 1% growth in global demand (below trend, due to higher prices) and stable output in India and Thailand. The biggest risk is additional production declines in India and Thailand in the next crop.


Artur Manoel Passos, CFA


For the full report, see enclosed file

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