Commodities | Mar 05 2012
– Focus on geopolitical risk and commodities
– Supply side an ongoing issue for oil
– Weak demand suggests US gas prices may fall
– Copper supply outlook improving
– Commodity price expectations revised
By Chris Shaw
Geopolitical risk has been an ongoing issue for the energy market but as Barclays Capital notes, this risk has not been as obvious in the base metals market. The last few months has seen a number of examples of shifting political goal posts in countries significant to the metals and mining industry, so Barclays suggests risks are increasing in the base metals sector as well.
An example of changes to policy has been the Indonesian government signing an order banning exports of all raw ores from 2014, something which would impact on nickel ore, copper and bauxite. Elsewhere, countries such as Australia and the Philippines have proposed higher mining taxes, as governments look to raise revenues.
Such political issues are likely to have a bigger impact on future investment and project timings in the view of Barclays, especially as mining companies are being forced to look to more difficult projects and less accessible regions to grow production.
While shorter-term little impact is expected from such measures, Barclays expects they will prove to be another hurdle for supply growth given the industry is already dealing with higher costs, tougher environmental regulations and ongoing technical challenges.
Oil prices have been pushing higher on the back of geopolitical tensions in the Middle East, Citi noting there are again concerns over the potential impact of higher prices on the US economy. This reflects the fact oil remains a central part of US consumer spending.
Historically, Citi notes every postwar recession in the US with one exception was preceded by an oil price shock, while every major oil price increase except for one was followed by a US recession. Citi's data show when spending on oil moves to the range of 5-6% of GDP, economic growth in the US tends to contract and a recession could follow.
The impact of any oil price shock on US GDP growth depends on the form of the shock, its origin, and how quickly and by how much the price increases. On Citi's numbers, a 10% real oil price increase may generate a minus 0.2-0.7% decrease in economic growth in the US.
A 50% increase would cause a negative 2.3-4.3% impact on US growth, so with Citi currently forecasting 2.0% growth in 2012 and 1.8% growth in 2013 a gradual 50% increase in the real price of oil would be enough to cause a technical recession.
A similar 10% oil price shock would increase US unemployment by 0.1-0.2% on Citi's numbers, while a 50% increase would lead to a 1.2-1.4% increase in the level of jobless. As Citi notes, an oil price shock takes longer to impact the job market, so the full impact could take 12-18 months to become apparent.
Citi points out while higher oil prices have immediate negative repercussions, such a shock also reduces demand for oil both domestically and globally. This causes oil prices to weaken, though Citi notes demand destruction tends to be slow acting.
Macquarie's analysis of the oil sector dynamics suggests while the supply side is currently a mess, demand remains solid thanks to emerging market structural demand and transient oil demand for power generation. With the Iran situation likely to persist throughout 2012, the broker suggests a second release of strategic petroleum reserve volumes is becoming more likely if prices stay high heading into summer.
According to Macquarie, the status quo is the most likely path for crude oil supply and demand in relation to Iran, so a major challenge for the market remains spare capacity. At present this spare capacity is estimated to be around 2.5 million barrels per day.
This compares to as much as 10 million barrels per day of production considered to be at risk given the countries involved in production such as Syria, Iran and Libya. This supply disruption risks sees Macquarie suggest it will be difficult for crude oil prices to fall.
Still on energy, Barclays notes US gasoline demand remains weak and has fallen away significantly since the beginning of January. In contrast to last year when higher US retail gasoline prices contributed much to lower demand, Barclays points out this year's demand weakness comes despite steady improvement in US economic indicators.
This may in part be due to the use of ethanol, as the ending of the ethanol tax credit at the end of last year saw many refineries attempting to maximise the ethanol blend in gasoline, so reducing effective gasoline demand.
Another reason for the decline could be a change in methodology, as Barclays notes while the Energy Information Administration (EIA) underestimated US exports last year, there may be a level of overcompensation occurring at present.
Factoring this in, Barclays suggests while US gasoline demand is weak at present it is no weaker than was the case last year. Current gasoline prices do seen a bit high relative to demand dynamics, so Barclays expects gasoline prices will correct first before rising on any supply shortfalls.
In the metallurgical coal market, Macquarie suggests at US$205-$210 per tonne the settlement range for June quarter hard coking coal contract tonnages has surprised slightly on the downside. While the price remains above the top end of the cost curve, it represents the lowest level since the final quarter of 2010.
In the view of Macquarie, the current met coal price reflects the fact there is adequate supply for current levels of market demand. A slow recovery in China suggests a relatively dull price outlook this year, though Macquarie continues to see met coal as a structurally compelling commodity longer-term.
At current price levels, Macquarie suggests hard coking coal supply cuts are unlikely as prices remain above cost support, but the semi-soft end of the market may well come under pressure as the cost of production discount at present doesn't match what is being received for product in the market.
As Macquarie points out, the cost of the marginal semi-soft producer is around 85% of that of hard coking coal, while the contract price this quarter is likely to be around 65% of hard coking coal. This suggests either some semi-soft output is curtained or is pushed into the thermal coal market.
Macquarie continues to forecast met coal export prices will trade back to the US$225-$250 per tonne range by the end of the year. In part this will depend on a rebound in steel output by core buyers in Europe, Japan and Korea.
Citi continues to track the deviation of reported production volumes against forecasts for the companies under coverage, which accounts for 50-75% of global supply. The fourth quarter showed numbers were marginally better than had been expected, with iron ore and copper delivering strong results and coal disappointing.
In Citi's view, the data imply a less tight copper market in 2012, especially given a more robust and secure supply side response is expected this year. From 2% in 2011 Citi is forecasting copper supply growth of 5% in 2012, with 65% of this coming from the 10 existing, largest mines.
Supporting the expectation of a stronger supply side market are recent increases in treatment and refining charges. These are viewed as miners effectively admitting mine supply will improve through the year, something that would remove a key source of support for a strongly bullish copper outlook.
Finally, Goldman Sachs has revised its commodity price forecasts to reflect both changes to forex assumptions and recent commentary on the US interest rate outlook. The major impact is on the precious metals sector.
For gold, Goldman Sachs has extended a 4% escalation from a base of US$1,650 per ounce to mid-2014, the result being an increase in forecasts in 2013 to US$1,749 per ounce from US$1,714 and in 2014 to US$1,764 per ounce from US$1,573 previously. A forecast of US$1,681 per ounce for 2012 is unchanged.
Platinum and palladium estimates for this year have also risen to US$1,648 per ounce and US$699 per ounce respectively from previous forecasts of US$1,575 and US$675 per ounce. These changes reflect a marking-to-market of assumptions in relation to potential supply disruptions.
Changes to base metal price forecasts for Goldman Sachs have been modest, as have changes to coal and bulk commodity estimates. As a result of the adjustments, earnings estimates and price targets have been revised for companies under coverage, though there are no changes in ratings for any stocks.
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