Itaú BBA - We forecast higher oil and lower iron ore prices

Commodities Monthly Report

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We forecast higher oil and lower iron ore prices

March 9, 2016

We lowered our corn and wheat price forecasts.

For the full report, see enclosed file

• Iron-ore prices rose to USD 60/ton from USD 40/ton, but fundamentals for the sector still point to the downside, and our scenario assumes a drop to USD 42/ton by 3Q16.

• We lowered our price forecasts for corn and wheat, after incorporating high carryover stocks and the outlook of stable planted area in the next crop. 

• We forecast a recovery in oil prices to USD 55/bbl by YE16, as the market finds a new equilibrium by 2H16, with a possible partial pass-through to prices of basic metals (via refining and transportation costs).

The Itaú Commodity Index has risen 6.9% since the end of January, driven by higher metal (18%) and oil-related (9.2%) prices. The ICI-agricultural fell 1.2% over the same period.

Metal prices advanced 17.6% year-to-date, with the improvement in investor sentiment and the replenishment of iron ore inventories in China. The latter is a temporary boost. Investor sentiment improved as fears of a global recession calmed.

Oil prices rose to USD 40/bbl, despite excess supply in the short term. In our view, this resilience was ensured by news related to (some) coordination between Russia and Saudi Arabia (which we doubt that will lead to an actual cut in supply) and signals of lower production guidance by several companies. This situation reinforces our assumption that lower U.S. output will offset rising exports from Iran, rebalancing the global market by mid-2016.

We expect Brent crude prices to climb to USD 55/bbl by YE16. The rebound may increase metal prices through higher refining and transportation costs.

On the other hand, we expect iron ore prices to decline, erasing recent gains. Macro and microeconomic factors drove prices to USD 60/ton recently, from USD 37/ton in mid-January. However, the global oversupply will likely get larger in 2016, with stable global output (higher production in Australia offsetting capacity cuts and reductions due to environmental issues in China) and lower global demand. We thus maintain our YE16 forecast at USD 42/ton, or almost 20% lower than current levels.

Lower price forecasts for corn and wheat. Agricultural prices fell slightly in February, due to favorable weather conditions in producing regions and signs that U.S. farmers will not reduce the planted area in the next crop year. We cut our price forecasts for corn and wheat by nearly 5%, as we acknowledged a combination of high carryover stocks and strong supply in the next crop year.

Our scenario for YE16 (higher oil prices, lower iron ore prices, small price increases for metals and agricultural products) implies a 10.7% hike in the Itaú Commodity Index (ICI) from current levels. 

Oil: End of oversupply in 2016, even without a reaction from OPEC

Oil prices rose to USD 40/bbl, despite excess supply in the short term. Weekly inventory changes registered by the U.S. Department of Energy show the oversupply. In our view, such resilience was ensured by news related to deals between Russia and OPEC, and indications of lower production by several companies throughout 2016.

OPEC/Russia coordination will not prompt the adjustment. Saudi Arabia and Russia agreed to freeze production at January levels, and Qatar and Venezuela committed to following the agreement. The deal will probably materialize and reduces the risk of further production increases by these countries, but will not deter countries that are likely to expand output (Iran and Iraq). Conflicts between Saudi Arabia and Iran represent headwinds to a broader agreement.

The adjustment is taking place in the rest of the world, particularly in the U.S. Global oil supply is adjusting and the main reasons that led to oversupply are being corrected. In particular, investments in shale oil in the U.S. plummeted and onshore output already fell to 7.63 mbpd in December from 8.24 mbpd last May.

We anticipate a partial recovery in prices in 2016, as oversupply vanishes in the middle of the year. According to our estimates, the global balance will transition from a seasonally-adjusted deficit of 0.2 mbpd in 3Q16 from a surplus of 2.2 mbpd in 4Q15 – even without coordinated reaction by OPEC.

This transition will take place as the decline in U.S. output offsets rising exports from Iran after the end of sanctions, without significant shocks on demand or on the remaining supply. We assume that i) demand will follow a path that is consistent with global growth and with price drops seen in the past two years, ii) the other OPEC members will sustain current production levels and iii) other producers in the world will remain on the trend seen in recent years, as production does not yet react to lower prices (and investments).

We forecast Brent crude prices at USD 55/bbl at YE16. 

Agriculture: Waiting for the next crop in the Northern Hemisphere

International prices (first due date) for corn and wheat have fallen since late January, while soybean prices have been relatively stable.

Weather forecasts indicate that 2Q16 will be marked by an increasingly weak El Niño. In Brazil, this outlook is favorable for the winter corn crop, but may hinder the beginning of sugarcane processing. There are no clear signs for the rest of the year yet.

The focus is changing to the 2016/17 crop. Overall, the outlook for corn, soybeans and wheat is still for large global carryover stocks into the 2016/17 crop.

No signs of reaction to low prices by U.S. farmers. The market is beginning to anticipate figures in the report that address planting intentions in the U.S., to be released in late March. So far, there is no expectation of a reduction in the planted area, although prices are below total production costs. This is because the share of the cost related to “fair” compensation for the land does not affect decisions of whether or not to plant.

Migration of planted area to soybeans from corn in the U.S. should be less intense in the 2016/17 crop. The ratio between soybean and corn contracts for the next crop is less favorable for soybeans than the average of the past three years (see chart).

We lowered our YE16 price forecasts for corn to USD 3.75/bushel from USD 4.0, after incorporating expectations for strong supply next year. We lowered our forecast for wheat to USD 5.15/bushel from USD 5.3, for the sake of consistency with the new scenario for corn.

We forecast soybean prices at USD 8.8/bushel at YE16.


Artur Manoel Passos
Ivan Lasaro


For the full report, see enclosed file

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