Itaú BBA - Still-challenging scenario but sugar rebounds

Commodities Monthly Report

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Still-challenging scenario but sugar rebounds

November 10, 2015

The scenario for commodity prices remains challenging, but the sugar market is rebounding due to specific factors.

For the full report, see enclosed file

• The scenario for commodity prices remains challenging. Excess supply and concerns over China tilt the risks downward.

• The sugar market, however, is rebounding. We revised our price forecasts for this commodity upward because the balance requires high prices to boost the global output in the coming years.

• Recent oil stability masks the risk of sharp price movements. In addition to the risks related to storage bottlenecks, the situation in the Middle East has become more complex and creates upside potential that may not be priced in.

The Itaú Commodity Index has fallen 3.0% since the end of September, dragged by metals, natural gas and grains. Meanwhile, international sugar prices climbed 15% during the same period. Finally, crude oil traded near the levels registered in September (Brent crude at USD 48-50/bbl).

We revised our average sugar price forecast for 2016 up to USD 0.149/lb, from USD 0.116/lb, to reflect the transition to a deficit in the market as well as the need for higher prices in order to boost the output over the next few years.

We also adjusted our price forecasts for natural gas and some metals, partly offsetting the impact of the revision of our sugar estimate. The net effect was a 0.3 pp increase in our YE16 forecast for the ICI.

We continue to see a challenging outlook for commodity exporters. The ICI is expected to advance 9.3% by YE16 from current levels. However, this is below the level being priced in by futures contracts, and the partial rebound in crude prices is responsible for approximately 60% of the aggregate rise. Furthermore, this is a relatively small increase when compared with the declines registered over the past six-month (-16.6%) and 12-month (-29.8%) periods.

Excess supply and concerns over China represent downside price risks for nearly all commodities; perhaps with the exception of Oil, given that geopolitical instability — potentially intensified by the macroeconomic scenario in Saudi Arabia and other producing nations — may affect regional output and prompt sharp price increases.

Metals: Demand & costs overshadow announced production cuts

The drop in metal prices in October underscores a particularly unfavorable scenario. Our forecasts assume just a small price hike from late October, as slowing metal demand in China and lower producer costs overshadow recent announcements of production cuts.

Adjustments in our YE16 price forecasts:

- Iron ore maintained at USD 50/ton;

- Copper maintained at USD 5,150/ton;

- Aluminum reduced to USD 1,550/ton, from USD 1,600;

- Zinc maintained at USD 1,800/ton;

- Nickel reduced to USD 9,700/ton, from USD 9,460;

- Lead maintained at USD 1,700/ton;

- Tin raised to USD 14,300/ton, from USD 14,065.

Recent stability of crude oil masks risks

Oil prices remain low, with Brent crude trading at around USD 49/bbl and WTI around USD 46/bbl.

The latest rig count and output  figures suggest that the U.S. may once again reduce production, but the adjustment seems insufficient in light of the oversupply. 

Our scenario assumes an oversupply until 2H16, sustaining the downward pressure on prices. Our YE16 estimates remain at USD 55/bbl for Brent and USD 50/bbl for WTI.

However, this scenario and the recent price stability mask a broad range of possibilities for oil prices, with reasonable assumptions that could drive prices down to USD 30/bbl or up to USD 90/bbl.

On the downside, the storage bottlenecks cited in our previous report are a prime example.

On the other hand, the situation in the Middle East stands out among the possible drivers behind a potential sharp increase in prices. Several ethnic/religious conflicts bring risks to the region, which accounts for 40% of global oil output.

Risks related to the Middle East were aggravated by two recent changes:

- First, the slide in oil prices led to a macro deterioration among producing countries. Saudi Arabia, for instance, will deal with a current account deficit equal to 10% of GDP and a budget deficit equal to 20% of GDP if crude prices remain at around USD 50/bbl. Government assets can only cover four to six years of deficits of this magnitude, thus requiring fiscal adjustments. Given that oil production has already been nationalized – which means no gains from raising oil taxes – the adjustments must include cuts in public spending. Public spending in turn plays an important role in the conflicts in the region and in maintaining social welfare. In a nutshell, there is no easy decision for Saudi Arabia.

- Second, Russia is increasing its involvement in geopolitical issues. An active engagement of a net oil exporter increases the likelihood of interventions that may affect oil production and transportation infrastructure.

Given the small global oversupply (less than 2% of global output), any oil-production-related issues in the region could cause a sharp price increase – a risk that may not be priced in at the moment due to the high production levels in the Middle East despite the abovementioned conflicts.

Sugar: Market turnaround

International sugar contracts continued to rise in October. The futures contract with the first due date is trading at around USD 0.15/lb in New York – significantly above the mid-August low of USD 0.104/lb. Sugar prices have sustained the hefty premium over hydrated ethanol in Brazil, favoring a higher utilization of the sugarcane crop to produce sugar toward the end of the harvest in the country’s Center-South region.

After many years of excess supply and inventory accumulation, the global balance is finally showing a deficit. Despite the high global inventories, the 2% expected annual increase in demand requires high prices to maintain the market equilibrium.

We revised our forecast for average international prices in 2016 up to USD 0.149/lb, from USD 0.114/lb, following the incorporation of a deficit this crop year and expectations of sustained high prices to encourage greater output going forward.

Grains: Focus shifts to summer crop in the southern hemisphere

International prices (first due date) for corn, soybeans and wheat resumed a downtrend in late September, falling 5.4%, 2.9% and 1.2%, respectively.

Focus shifts to the Southern Hemisphere. The corn and soybean harvests in the U.S. enjoyed favorable conditions and are virtually over. Notwithstanding some uncertainties regarding the corn crops in Eastern Europe, the supply drivers are now in the Southern Hemisphere, particularly in Brazil and Argentina.

Barring any shocks in the Southern Hemisphere, the global balance for these three commodities remains relatively comforable, with the highest risk concentrated in the corn market. We maintained our YE16 price forecasts for corn (USD 4.0/bushel), soybeans (USD 9.1/bushel) and wheat (USD 5.3/bushel).

Coffee: Neutral balance amid upward and downward drivers

International coffee prices (first due date in New York, Arabica) flirted with an increase, but fell back to USD 1.20/lb in late October, showing little response to FX depreciation in major producing countries.

Our YE16 forecast for coffee stands at USD 1.28/lb – near the futures curve. This level seems to provide a good balance between the downward drivers (favorable weather in Brazil and higher prices in the local currencies of the largest producers) and the upward drivers (risks of crop losses in Central America).


 

Artur Manoel Passos

Pedro Schneider


 

For the full report, see enclosed file


 



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