Itaú BBA - Stronger Demand

Commodities Monthly Report

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Stronger Demand

February 4, 2013

Lower price volatility

Better demand indicators helped keep prices roughly flat in January (and December) despite improvements in the supply outlook. The Itaú Commodity Index (ICI) stood flat in January. Looking ahead, we maintain our year-end forecasts and continue to expect the ICI to increase by 0.8% yoy in 2013.

Grain prices were affected by the U.S. Department of Agriculture’s (USDA) January report. It showed a better than expected demand for corn in the U.S., more than offsetting upward revisions to global production. Although agricultural prices extended losses for the sixth month and averaged 1.3% lower than December, a 4.3% recovery has occurred since January 9. On the supply side, weather conditions in South America have been favorable to production, reducing the risks of having crops outlying official estimates.

Raw sugar prices traded below $0.19/lb in January, reaching new recent lows. Given the consensual view of global surplus in 2013, prices are set to remain around $0.19, only because of adjustments in the Brazilian ethanol market. However, these changes will only affect prices after the harvest in Brazil’s Center-South region begins, which is expected to occur by mid-March.

Base metal prices in January averaged 1.2% above December, still driven by the better outlook for the Chinese economy. The strong increase in iron ore spot prices, due to a new restocking cycle by mills in China, should revert throughout 2013 as higher prices provide an incentive for Indian and Chinese inefficient mines to increase production.

Energy prices rose 2.2% in January, driven by better demand and prospects of lower infrastructure bottlenecks in the U.S. (leading to lower discounts of WTI over Brent crude oil). Taking both current data and a better outlook into account, the International Energy Agency (IEA) revised upward its demand scenario for 4Q12 and 2013. In the U.S., a cold winter is leading to an increase in heating oil demand compared to last year’s mild temperatures. Meanwhile, Saudi Arabia and Iraq reduced crude output, leading to a lower supply from OPEC countries in December, and terrorist attacks in Africa pose a relevant short-term risk.

Weather: Lower Risks for the Brazilian Crop

Overall weather conditions remained favorable for agricultural production in Brazil throughout January. The highlight was rainfall exceeding the seasonal average in the producer regions of Bahia and Tocantins. The States of Mato Grosso do Sul, Paraná, Santa Catarina and Rio Grande do Sul received around 100 mm of rain, slightly below the seasonal average. Meanwhile, the states of São Paulo, Mato Grosso and Goiás received 200 to 300 mm of rain. The recent evolution reduces risks of soybean, corn and sugar crops outlying for current estimates[1].

Looking forward, two climatic conditions in the short term may have some negative impact on crops. First, crop yields may be negatively affected by dry weather in the Southern Region. Besides, excess rain in Mato Grosso may slow soybeans harvesting and reduce planted area for the winter corn crop. So far, the persistence of rain has been unable to delay harvest evolution, which was slightly ahead of last season as of January 24.

Switching the focus to hydroelectric power generation, late last year, reservoirs reached very low levels, due to i) below-average rainfall; ii) growth in electricity usage close to 4% (despite low GDP growth); and iii) possible restrictions and inefficiencies in the electric power system. With rising capacity in thermal plants and more transmission lines, Brazil is less reliant on hydroelectric dams than in the past. Still, falling electricity prices may lead to more growth in consumption than the country can meet without the risk of rationing, in a scenario of rainfall below the historical average (or within the historical average, but with inefficiencies in the system).

Water levels at reservoirs fell sharply throughout the year, and reservoirs ended 2012 with 30.5% capacity, way below the historical average (48.8%) and below the reading registered in late December 2000 (35.4%).

In January, rains in key regions (reservoirs and rivers with hydroelectric dams) have been close to seasonal historical average, after six months below average. As a consequence, reservoir levels increased to 37.6% capacity from 30.5% in the end of 2012. Such increase was lower than the average in January (by 10 percentage points), despite strong usage of thermal plants. This may be due either to lagged effect of low rains in November and December on Affluent Natural Energy (ANE) or the supposed inefficiencies in the system. See more details regarding the current situation in our report (Rationing: Risks Depend upon Rain and Prices).

In Argentina, overall conditions are better than last year, but not as favorable as implied by current USDA estimates (54 and 28.5 mi t for soybean and corn, respectively). Most fields have received lower rainfall than the seasonal average, while some farm regions suffered flooding.

Grains: Corn Demand Surprises on the Upside

Even though agricultural prices extended losses for the sixth month and averaged 1.3% lower than December, a 4.3% recovery has occurred since January 9. The main driver of this recovery has been the U.S. Department of Agriculture’s January Report (World Agricultural Supply Demand Estimate, or WASDE), showing a stronger than expected demand by the U.S. for corn. This upward adjustment to demand was greater than the increases to global production projections.

For year-end 2013, our forecasts for soybean and corn prices remain at 1400 cents/bushel and 638 cents/bushel, respectively. These projections assume crops close to current ranges in the Southern Hemisphere and a crop under normal weather conditions in the U.S. for the next crop year (October – September).

After falling to 680 cents/bushel on January 4, corn prices rebounded to around 740 cents/bushel after the WASDE. The report revised upward corn demand in the U.S. for the current crop year, to 262.1 from 254.4 million tons. This revision was based on the observed inventories at the end of 4Q12, and overwhelmed the 3.2 million tons upward revision to global production (Brazil, Argentina and the U.S.). The estimate for Brazil was revised upward to 71 from 70 million tons, still lower than current CONAB’s forecasts (72.1 million tons). For Argentina, the estimate was increased to 28 from 27.5 million tons. Given the dry weather observed in Argentina during the last few weeks, this revision was not expected.

Soybean prices also reached a recent low on January 4 (1390 cents/bushel) and rebounded afterwards following the rebound in corn prices. The WASDE brought an upward revision to global demand to 262.7 from 261.2 million tons, more than offsetting the expected increases in global production (US, Brazil). Overall, the adjustments to the soybean balance were lower than the adjustments to the corn balance. Looking to crop projections in south America, the estimate for Brazil was revised upward to 82.5 from 80 million tons, close to the current CONAB forecasts (82.7 million tons). For Argentina, the estimate was lowered to 54 from 55 million tons. All adjustments to global production were in the expected direction.

As highlighted in our previous report, freight costs in Brazil may affect domestic and international prices for corn and soybeans. These costs may rise due to a new law that limits working hours for truck drivers, as well as a lack of investment in infrastructure. Higher freight costs are partially passed on to international prices and may also widen the discount faced by domestic prices.

Base Metals: Iron in the spotlight

During January, our ICI metal index averaged a 1.2% gain over December. The price movement, different from December, had a mixed performance, with tin increasing 7.5%, lead 2.5%, copper 1.1%, nickel 0.3% and aluminum and zinc falling 2.2%, and 0.3%, respectively. However, in January, the spotlight belongs to iron ore, increasing as much as 23% regarding the December average and its peak on January 9 ($158.5/ton), while closing on the first month of the year with a 17% average gain over December, mostly on higher demand by Chinese mills paying the spot price to rebuild their iron inventories.

The spike on iron ore spot prices for delivery in China that was seen in January can be justified by two main reasons. First, through a heavy presence on the spot market, Chinese mills rebuilt their iron stockpiles with the objective of maintaining enough supply for steel production. Second, the disruption on the Australian iron belt due to a category 1 cyclone, with wind gusts reaching 100km/h, affected iron ore mining and shipment to China, Japan and South Korea, big buyers of the Australian iron ore also created concern on the market of further supply tightness. This was a scenario we brought to attention in our previous report, where iron ore held at the Chinese major ports is at its lowest levels. In our view, restocking should normalize in the near term, with iron ore for delivery in China ending 2013 at $125/ton, driven by a surplus (greater supply than demand).

Aluminum closed at $2062/ton, presenting the worst performance among base metals. The sector has been achieving consecutive surplus for a few years with high inventories, which has held prices at low levels for a while. Picturing these numbers, mining companies acting on this market are revising their operations to reduce aluminum supply and, maybe, suspend some mining production. With this move of the companies, and a world displaying better demand indicators, we expect a lower surplus and prices to raise closing 2013 at $2200/ton.

Energy: Asia Fueling Up

Brent crude prices remained firmly above $110/bbl in January, averaging $112.30/bbl and ending the month at $115.55. Better demand indicators and lower supply estimates in December, as well as issues in the Africa, are helping maintain prices above $110/bbl. Looking forward, we maintain forecasting prices at $110/bbl by the end of 2013.

Amid better demand indicators, the highlights are: i) strong oil imports from China; and ii) increase in heating oil demand in the U.S. due to a cold winter compared to last year. Besides, lower tail risks in the advanced economies and better growth forecasts for China and Japan prompt for a better demand outlook ahead. On the supply side, OPEC lowered oil production in December to its lowest level in 2012, with reduced output from Saudi Arabia and Iraq. All these fundamental adjustments were reflected in the International Energy Agency’s last report.

In the Middle East, the situation in Iran remains unchanged, without advances to the negotiations regarding its Nuclear Program. Meanwhile, civil war in Syria continues to pose a threat to stability in the region. Even though Syria does not produce oil, the conflict could spill to Iraq, thus affecting up to 3.0 mb/d of oil supply.

The main source of geopolitical risk in January has been Africa. Terrorist activities in Mali may affect crude output in neighboring countries. The worst case is Algeria, which produces around 1.2 mb/d and suffered from terrorist activities in the last few weeks.

Finally, the WTI discount to Brent fell to around $17/bbl in January from $20/bbl in the previous month, with expectations of improved ways to transport crude oil from the producer regions to the refineries. Looking forward, the discount will depend on the growth of crude production in the U.S. and the pace of improvements to the transport infrastructure. We expect investments in infrastructure to be partially offset by a strong increase to crude production, leading the discount to $15/bbl by the end of 2013.

Artur Manoel Passos

Luiz Felipe Carvalho






[1]For instance, CONAB (Brazil’s food supply agency), projects soybean and corn crops of 82.7 and 72.2 million tons this season, respectively. Meanwhile, forecasts for the next sugar-cane crop in Center-South range between 560 and 580 million tons.


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