Itaú BBA - Some relief in the Crude-Oil Market

Commodities Monthly Report

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Some relief in the Crude-Oil Market

February 11, 2015

Volatility has set the tone for the commodities market since late December

• Oil prices have rebounded somewhat since late January, in a move that we see as consistent with fundamentals (signs of lower capital expenditures in production) and our scenario. We maintained our year-end Brent forecasts at USD 70/bbl, with a slight upward revision to average prices in 1H15 (to USD 55.6/bbl from USD 52.5/bbl).

• We reduced our forecasts for iron ore and copper prices. We believe that the short-term impulse brought by the recovery in oil markets is not enough to offset the outlook of lower demand growth in China.

• Other commodities will not follow the partial recovery in crude prices.

Volatility has set the tone for the commodities market since late December: the Itaú Commodity Index (ICI) fell 10% between the end of December and January 29, but has risen 6.1% since. Oil was the driving force behind both moves, as the ICI-Energy sub-index dropped 13.3%, then climbed 14.9% during these periods. Agricultural and metallic commodities also advanced from their recent lows, but are accumulating losses year-to-date (ICI-Agriculture:
-4.9%, ICI-Metals: -8.9%).

The rebound in crude prices to USD 57.0/bbl from USD 50.0/bbl is consistent with signs of declining investments in non-conventional production in North America. The weekly Baker Hughes count of oil rigs has declined by 28% since October, and several companies already report a delay to new investment plans. Finally, the rise in oil prices came despite a strike that is affecting oil refineries in the U.S. (lowering demand for crude oil in the short term). We are increasing our forecasts for average Brent prices in 1H15 to USD 55.6/bbl from USD 52.5/bbl, recognizing that the increase is based on fundamentals. Our year-end scenario remains at USD 70/bbl.

We lowered our year-end forecasts for the ICI in 2015 and 2016 by 1.4 p.p. and 1.7 p.p., respectively. We cut our estimates for iron ore, copper, cotton, natural gas and cocoa. In our scenario, the ICI will go up 11.8% in 2015 from current levels and rise 3.1% in 2016.

A partial and sustainable recovery in crude prices could help other commodities in the short term. The move will likely increase allocations in risky assets, as it improves the situations of producing countries, companies in the sector and banks exposed to these agents.

However, the pass-through of lower oil prices to production and transportation costs for the other commodities is not yet fully priced in, in our view. Downward pressure through cost deflation is set to continue, even if oil climbs to USD 70.0/bbl, given that prices will still be much lower than their previous equilibrium levels (USD 110.0/bbl).

Additionally, the outlook for oversupply continues to prevent any sustainable price hike for the other commodities. 

Metals: Cost deflation and weak demand 

Metal prices are down year-to-date, with iron ore and copper falling 11.8% and 8.5%, respectively.

The boost in risky assets following some recovery in oil prices was not enough to outweigh the outlook for slower demand growth in China. Several indicators show that economic growth will decelerate further in 1Q15, and the government is signaling that it will accept slower growth as long as the labor market remains heated.

Freight costs for iron ore between Brazil and China are an example of the aforementioned “cost deflation.” This cost fell to USD 11.0/ton by the end of last year, from USD 20.0/ton in 2013. Lower costs led to lower equilibrium prices for commodities, with a quicker impact on markets in which supply is not scarce. Finally, it is worth mentioning that cost deflation mitigates the impact of falling prices on the profitability of commodity producers.

We lowered our forecasts for iron ore and copper. The revision seeks to incorporate the recent slide, cost deflation and slower demand growth. Our forecast for iron ore dropped to USD 67/ton from USD 70/ton, while our scenario for copper slid to USD 5,600/ton from USD 6,100/ton.

Grains: Unfavorable weather in Brazil offset by improvements in Argentina

Corn, soybean and wheat prices have fallen year-to-date. The most-traded international contracts for corn, soybeans and wheat are down by 2.1%, 8.3% and 10.0%, respectively.

The slide is consistent with the outlook for oversupply for the three commodities. In particular, recent estimates for supply and demand by the U.S. Department of Agriculture (USDA) reinforce the expectation of oversupply in the wheat balance, which had not been as sound as for corn and soybeans.

Dry weather in Brazil in January was unfavorable to agricultural production, especially in Goiás state and in the Northeast region, and will likely reduce estimates for corn and soybean crops in the nation.

But the return of rainfalls improved the outlook for the harvest in Argentina, offsetting the decline in Brazil.

In the absence of significant changes in global supply, we maintained our year-end forecasts for corn, soybeans and wheat at USD 3.8, USD 10.0 and USD 5.4 per bushel, respectively.

Sugar: Upward adjustments in Brazil are not enough to raise prices

International sugar contracts were unable to support an increase this year, and remain at the same level as at the end of last year, falling 8.8% from a recent peak on January 21.

The hike could not be sustained, despite several upward factors in Brazil, all of which could potentially reduce the availability of sugarcane to produce sugar:

  • Increase in the share of anhydrous ethanol in the gasoline mix, which allocates more sugarcane for the production of anhydrous ethanol.
  • Higher domestic prices for gasoline, which increase equilibrium prices for hydrous ethanol, encouraging fuel production.
  • Below-average rainfalls in São Paulo state (the main region for sugarcane production), intensifying the risk of new crop losses.

Prices failed to recover due to depreciation in the Brazilian real against the U.S. dollar during this period and to high inventories among producers and consumers. 

As the year goes by, producer inventories will eventually go back to normal, and that, combined with the adjustment by Brazilian producers, may trigger some recovery in prices. We maintain our year-end forecast for sugar at USD 0.17/lb.


Artur Manoel Passos

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