Commodities | Oct 19 2011
– JP Morgan revises oil price expectations
– Solid fundamentals to support tin prices
– China under-reporting steel production
– Iron ore price correction underway
By Chris Shaw
While the global economic outlook worsens and even with Libya expected to make a rapid return to oil production, JP Morgan continues to see pricing pressures for the oil market. These issues have become more apparent with the broker extending its oil market model to 2013.
On the supply side, the ongoing impact of declining output from mature oil fields is eating into supply side increases in both North America and Brazil. According to JP Morgan this means producers will need to produce at close to flat-out levels for at least the next two years.
While OPEC has a buffer to stabilise the market in the event of any significant shock to either supply or demand, there remain price risks to the global oil market in the broker's view. On JP Morgan's estimates supply constraints will be hit by the end of 2013, which is supportive of higher prices longer-term.
For 2013 an average price of US$121 per barrel is expected, while by the end of that year the quarterly price could be around US$130 per barrel. Shorter-term the view is spot market tightness will see prices remain in a US$20 per barrel range between US$100-US$120 per barrel through 2012.
For JP Morgan, the primary downside price risk is not just a global recession but the re-balancing argument for the oil market. It is assumed Kuwait, the UAE and Saudi Arabia will adjust production to account for additional output from both Libya and Iraq, but if this is not the case or if market re-balancing occurs at a price other than the level expected, there is risk of a global economic slowdown weighing on the oil price.
If there were to be a global recession JP Morgan estimates front month ICE Brent crude prices could drop to US$50-US$70 per barrel. Such a price slump would be expected to be temporary given the ability for producers to respond by lowering output.
While the current economic environment makes upside risk harder to imagine, JP Morgan sees the risk as a higher probability than more bearish assumptions, partly because of the lack of global spare capacity and the potential for currency shifts to impact on prices.
Looking at the global oil market, JP Morgan notes non-OPEC supply growth has averaged just 0.4 million barrels per day over the past five years. This is despite oil averaging US$76 per barrel over that period.
For JP Morgan this weak supply growth number highlights why historically high oil prices are needed to spur the growth in supply necessary to match growing emerging market demand. Even with the higher prices of recent years, non-OPEC supply growth is only expected to hit 0.6 million barrels per day through 2013. This will mean an increased market share for OPEC producers.
Challenges to production growth are significant and include rising service sector costs, while access, taxes and administrative burdens also act as a restraint on supply growth in key areas such as the Gulf of Mexico, notes JP Morgan.
This suggests any fall in prices will see the cancellation of some investment decisions. JP Morgan estimates prices of around US$100 per barrel are needed to generate the supply growth required to match emerging market demand.
The stockbroker suggests the key oil market lesson of the past five years is unless emerging market growth rates are severely dislocated, any dip in the oil price is likely to be quickly met by stronger emerging market demand and a rapid retrenchment in supply.
Across in the base metals, while tin is the smallest of the LME traded base metal markets the deficit relative to market size is the largest in the sector, observes Macquarie. This suggests the tin price should probably be stronger than is the case at present.
As Macquarie notes, tin demand has been solid over the past 18 months, largely reflecting ongoing demand from the electronics sector given tin's use in the manufacturing of solder alloys. Tin demand in this sector is price inelastic since there are no easy substitutes.
Shipments of semi-conductors offer a reasonable guide to tin demand and here Macquarie notes global shipments are still running at all-time record levels. This suggests prospects for tin demand appear positive, so supply will be a key for prices.
Behind China, Indonesia is a major supplier and has been lifting output to meet the growth in demand in recent years. But Macquarie notes Indonesia's tin exports have recently started falling sharply as prices have dropped.
A lack of new projects in other nations prior to 2013 leads Macquarie to suggest world tin mine and metal output will struggle to rise 5% this year, which implies the market will again run at a significant discount.
This has the potential to leave the ratio of reported stocks-to-consumption at very low levels, something Macquarie suggests should be supportive for the tin price.
In April of this year steel industry consultant MEPS noted China's steel production in 2010 had been under-reported. Further analysis of the market suggests to MEPS this under-reporting has continued into 2011.
As an example, in August MEPS estimated Chinese crude steel output for the first six months of 2011 had been 363 million tonnes. This compares to the official figure of 353 million tonnes. For this year as a whole MEPS expects total under-reporting by the Chinese of 28 million tonnes.
MEPS expects total apparent consumption of finished steel in 2011 of 677 million tonnes, which would be an increase of 10% from year ago levels. While this is above the figure of Worldsteel, the steel-maker's association, MEPS has built further under-reporting of crude steel output into its forecasts for the Chinese market.
Still on the bulks, Westpac notes spot iron ore prices have fallen quite sharply over the past two weeks, losing 8% to US$158 per tonne. In Australian dollar terms the fall has been even more pronounced, prices for Australian spot fines falling almost 12% on a landed in China basis.
On Commonwealth Bank of Australia's numbers, spot iron ore prices are now into the very top of the seaborne cost curve. The bank suggests the next level of cost support is around the US$145-US$150 per tonne level, as this represents the cost of marginal Chinese domestic supply.
Westpac expects while December quarter iron ore contracts will be broadly in line with contract prices in the September quarter, if current spot prices were maintained through the final quarter then contracts for the March quarter would fall by around 13%.
What is also of significance is Brazilian prices have fallen by a larger 16%. Westpac notes from a historical sense, where Brazilian prices go Australian prices tend to follow.
What supports the potential for some further correction in the iron ore market is evidence of further easing in Chinese steel demand. As Westpac points out, rebar prices have fallen almost 5% this month, while hot rolled coil has fallen by around 6.3%.
The price weakness has spread further, with Westpac noting Chinese steel scrap prices are down 5% for the month, while Chinese domestic iron ore prices have fallen by almost 6% relative to last month.
As inventory levels have risen by a greater than normal 12% over the past six months, Westpac has been forecasting a correction in iron ore prices for some time. This correction now appears to be underway, with Westpac expecting a low in spot iron ore prices of around US$140 per tonne by the middle of next year.
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