Commodity Roundup: December 2014

 

Commodity prices mostly fell in December, led by losses in crude oil.


Crude oil prices plunged further as influential OPEC member Saudi Arabia hinted that it would not trim oil production even if price fell to as low as USD 20/bbl. Nevertheless, steadily falling oil prices pose a risk to profitability of oil extraction in US shale fields and Canadian oil sands. Expected slowdown in oil sector investment should eventually lead to narrowing in the supply-demand gap for crude oil. Consequently, we expect crude oil prices to recover in the second half of 2015 and pencil Brent to average USD 70/bbl in 2015.


Gold swung between gains and losses in December amid conflicting cues. Safe-haven demand (amid political uncertainty in Greece and global growth concerns) aided prices in the first half of the month. However, bullion came under pressure post the US FOMC policy meeting, which signalled that the Fed is on track to hike rates next year. The yellow-metal is poised to end the year on a flat note, around the USD 1,200/oz mark.


Industrial metal prices fell in December amid concerns over China’s growth prospects. A top Chinese government think-tank said that GDP growth is expected to slow down to 7.0% YoY in 2015 from estimated 7.3% in 2014. Nickel and lead fell by more than 7% each, while copper edged slightly lower (-1%) in December.


Agricultural commodities gained in December. However, on an annual basis, agri commodity prices are down, amid a comfortable supply scenario. Cotton has been one of the worst performers in this space, with prices down ~30% amid expectation of lower imports from China (the world’s largest importer), following the revision to its cotton stockpiling policy earlier this year.

Market Summary

Energy: Crude Oil

Global crude oil prices have fallen consistently since mid-June and touched 5-year lows in December

Review of December: Crude oil prices continued to fall

Crude oil prices continued to fall in December, extending their downward trend since mid-June. Both Brent and WTI fell more than 15% in the month of December, following 18% plunge in November. The front-month Brent contract has fallen to around USD 58/bbl, near the lowest levels in five years. Meanwhile, the WTI was last seen at around USD 54/bbl. 

OPEC has refrained from curtailing oil output despite falling prices. It seems more focussed on preserving its market share and does not seem inclined to provide any floor to oil prices

OPEC seems to be interested in preserving market share

The OPEC, in its November-2014 meeting, decided against any production cut and kept the collective oil output target unchanged at 30 million barrels per day (mbpd). In the past, OPEC had often intervened (by raising or trimming output) to provide stability to crude oil prices. However, in the current episode, it seems OPEC members are trying to preserve their market share and therefore have made peace with lower oil prices. Recent comments from Saudi Minister Al-Naimi indicated that the country will not cut output even if oil fell to USD 20/bbl. Apparently, OPEC members hope that their lower costs of oil extraction will help them to compete against newer oil production (viz. high cost US shale oil and Canadian oil sands).

Lower oil prices likely to affect future investment in costlier sources of crude oil, viz. US shale and Canadian oil sands

Implication of falling oil prices: negative for non-OPEC oil supply

Lower oil prices will pose risks to profitability of new sources of crude oil like shale and oil sands (refer to chart below). US Bakken shale oil reportedly costs USD 58-70/bbl to produce, much higher than Saudi Arabia’s costs of USD 5-7/bbl. With prices falling, there remain risks that future investment in shale oil (and oil sands) will slow down. Meanwhile, Russian officials have also acknowledged that Russian crude oil production volumes might decline in 2015 owing to inadequate investment amid tightening of Western sanctions. 

In the near-term, Brent oil price is expected to stabilize around marginal costs, i.e. around USD 65/bbl. In the slightly longer-term, oil prices should correct upwards as low oil prices will slow the pace of rise in oil supply

Oil price outlook: Rebound expected in late-2015

Near-term: Brent to stabilize around marginal costs, i.e. ~ USD 65/bbl
The latest OPEC meeting has revealed that the cartel is focussed on preserving its market share and it does not seem inclined to provide any floor to oil prices. In the absence of an “OPEC floor” to prices, the market is expected to stabilize near the marginal costs of supply. At present, US shale oil (technically ‘tight oil’) constitutes around 3 mbpd of US aggregate oil production of 9 mbpd. Meanwhile, the global oil market surplus is estimated at around 2 mbpd currently. Thus, in effect US shale oil is currently acting as the marginal producer (with estimated marginal costs in the range of USD 50-70/bbl). Consequently, Brent is expected to stabilize around USD 65/bbl and remain there till around Q1’ 2015.


Medium-term: Upward correction
Lack of investment in US shale and Canadian oil sands is expected to reduce the oil market surplus gradually in 2015. Consequently, we expect oil prices to trend higher in H2’2015, with Brent expected to hover near USD 75/bbl in Q4’2015. Hence, we expect Brent to average USD 70/bbl in calendar year 2015 (compared to USD 99/bbl in 2014).

 

Precious Metal-Gold

December was a volatile month for gold

December was a volatile month for gold. Prices started the month on an upbeat note, rising to USD 1,230/oz levels on safe-haven demand as concerns over China and Greece emerged. However, prices declined in the latter-half of the month, post the US FOMC policy meet. Gold is poised to end the month and the year at ~USD 1,200/oz.

 

Concerns over China and Greece boosted safe-haven demand

Concerns over China and Greece boosted safe-haven demand

Gold prices began the month on a positive note, rising above the psychological USD 1,200/oz –mark on safe-haven demand as concerns over China’s economic growth worsened (following weak economic data). Further, political uncertainty in Greece came to the fore, after the Government brought forward Presidential elections (parliamentary vote) to December (earlier scheduled for March). During this period, investment demand for gold also saw a pick up.

However, gains were reversed following the US FOMC policy meeting, which indicated that the Fed remains on track to hike rates next year

However, prices declined post US FOMC policy meeting

The bullion, however, reversed gains after the US FOMC policy meeting (December 16-17), which indicated that the Fed remains on track to hike rates next year. Gold price slipped by 0.6% in the session immediately following the FOMC decision. In subsequent sessions, gold continued to remain under pressure amid broad-based strength in the greenback. Outflows in the gold backed ETF space also resumed, with aggregate sell-off in December totalling 15 metric tonnes (MT).

ETF sell-off continued, totalling 15 MT in December. In an unexpected move, India scrapped the 80:20 gold import rule

Domestic update- India’s 80:20 gold import rule scrapped

In an unexpected move, India scrapped the 80:20 gold import rule, which was imposed in August 2013. The rule had helped limit India’s gold imports to ~660 tonnes in FY2014, as against the historical average of 1000 MT. However, with the rule now abolished, India’s gold demand is likely to return to earlier levels.

With the US Dollar expected to trade firm over the medium-term, we expect gold to trade with a bearish bias in 2015

Outlook: Gold to trade with a bearish bias in the medium-term

Gold’s stellar performance in the beginning of 2014 started to lose steam towards the end of the year as Fed wound up its QE programme and the Dollar advanced steadily. Gold price is now poised to end the year on a largely flat note, around USD 1,200/oz levels, in line with our forecast. (Our 2014 year-end price call was USD 1,200/oz).


Going ahead, we expect bullion to remain under pressure as the Fed initiates its interest rate hike next year. Recent macroeconomic data from the US have been upbeat and reinforce the view of an interest rate lift-off in 2015. However, losses might be limited as the easy monetary policy stance by the BoJ and ECB is likely to partially offset monetary tightening by the Fed. An upside risk to prices could stem from any unfavourable geo-political event(s) that would boost the bullion’s safe-haven demand.

 

Industrial Metal: Copper

Copper edged lower in December.

Copper continues to remain under pressure owing to persistent growth concerns relating to the largest consumer and importer – China

Copper prices edged lower in December

The benchmark 3-month LME copper price fell by ~1% in December, following a 5% decline in November. Copper continues to remain under pressure owing to persistent growth concerns relating to the largest consumer and importer – China. Sentiment around China continues to remain weak despite the latest efforts of the People’s Bank
of China (PBoC) to prop up growth (including interest rate cut in November). In the latest development, the PBoC has said that it will change rules on calculating banks’ loan-to-deposit ratio, which is expected to again increase liquidity in financial markets. Nevertheless, the long-term outlook for copper demand remains subdued owing to China moving towards a lower growth trajectory and more importantly rebalancing away from investment-led growth towards a more consumption-oriented approach. Copper is as yet holding on to most of this year’s losses (-14% YTD) and the LME 3-month copper price is currently hovering around USD 6,300 per metric tonne (MT), down from a peak of USD 7,175/MT witnessed in early July. 

Peru workers’ strike provided brief support to prices in early-December

Peru workers’ strike provided some support to prices in early-December

Workers in Peru’s Antamina copper-zinc mine begun an indefinite strike in early December, over issues related to pay and working conditions. The Antamina copper mine, being partly owned by BHP Billiton and Glencore, is the sixth largest copper mine in the world and produces around 30,000 tonnes of copper per month. Subsequently, the strike ended on 15th December, and copper prices resumed their downward trend.

Industry groups have criticized new legislation in Chile which seeks to bolster workers’ unions in mining sector. Concerns related to Chile’s labour reforms might provide some near-term support to copper prices.

Chile mining industry labour regulation to be in focus

Chile is the largest producer of copper In the world, accounting for almost a third of global mine production. Chile’s Socialist Government this week introduced a new bill which will bolster the power of workers’ unions in the mining sector. However, Chile’s mining industry representatives have reportedly expressed reservations against the proposed legislation as it might raise labour costs in an environment of declining commodity prices. Antofagasta Minerals (a large copper mining group in Chile) categorically said that the current economic environment was not suitable to implement a radical labour reform. Meanwhile, CPC (Cámara de la Producción y Comercio), Chile’s largest business association, has also expressed reservations.

Nevertheless, copper prices are expected to remain under pressure for most of 2015 amid
bearish fundamentals

Outlook: Prices likely to remain subdued in the near-term

In the near-term, concerns related to Chile’s labour reforms and the consequent (possible) increase in cost of copper production is likely to provide some support to copper prices in the near-term (until more clarity emerges on the legislation).

Nevertheless, copper prices are expected to remain under pressure for the most of 2015 amid bearish fundamentals. The International Copper Study Group (ICGS) expects the global copper market to post surplus of 400,000 tonnes in 2015, i.e. around 1.7% of total demand. Going ahead, copper demand is expected to remain subdued amid faltering demand from its largest consumer China. Notwithstanding recent efforts by Chinese policymakers, a top Chinese government think-tank – State Information Centre – said that GDP growth is expected to slow down to 7.0% YoY in 2015 from expected 7.3% in 2014. Meanwhile, CFTC data show that speculators remain net bearish on copper.