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Material Matters: Oil, Iron Ore, Aluminium & Lead

Commodities | Oct 14 2022

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A glance through the latest expert views and predictions about commodities: Higher oil price forecasts; iron ore prices remain in bubble territory; US sanctions on Russian aluminium and lead prices unfairly marked-down.

-OPEC increases the risk of a global recession
-Are iron ore prices still in a bubble?
-The effect of US sanction on Russian aluminium
-Macquarie suggests lead prices have been unfairly marked-down

By Mark Woodruff

OPEC increases global recession risk

Cost increases resulting from the recently announced large OPEC production cuts will make a zero-growth global recession more likely.

Citi also makes the point that no country dependent on oil export revenue wants to facilitate an international effort to establish a price cap on oil, in response to the Russia-Ukraine crisis.

As such, the broker considers the production cuts of -2mbpd, effective from November, are at least partly motivated by political considerations. The November timing comes only days before the US mid-term elections, and a month before Europe imposes additional sanctions on purchases of Russian oil.

It’s thought further economic policy reactions may result, with consequent global market impacts.

In reaction to OPEC’s move, Citi raises its forecast December quarter 2022 Brent average price to US$97/bbl from US$85/bbl, while increasing its 2023 forecasts to US$88/bbl from US$75/bbl. The medium-term price forecast is raised to US$75/bbl in 2024, and toward US$65/bbl thereafter.

In the broker’s hard-landing scenario, global economic growth will fall to zero in 2023 from a base case of 2.1% growth, while global oil demand growth could fall to zero from 2.2mb/d.

The economic impact on oil demand is more exaggerated because of the typical macro-induced slowdown in oil consumption, as well as a slower recovery of the aviation sector, which was supposed to super-charge oil demand growth in 2023, explain the analysts.

Recessions normally result in falling commodity prices, leading to surpluses, which then require a further fall in price. However, Citi suggests further production cuts by OPEC may limit price declines to around the US$70/bbl mark.

China, US dollar and recession to drag down iron ore prices

The iron ore price is currently in the midst of a deflating bubble, according to Longview Economics.

As risk assets are currently oversold, Longview suspects the price will rally from current chart support levels, before resuming a negative trend in three to six months’ time.

Policy tightening by central banks is ongoing, and according to Longview, will result in further US dollar strength, which historically is inversely correlated to the iron ore price.

Such strength deflated similar iron ore price bubbles in 2008, in the global financial crisis, and from May 2021 during the pandemic. All bubbles are inflated by cheap money, observes Longview, and those bubbles always burst when the cheap money is removed.

Two other catalysts to burst the iron ore price bubble are the increasing likelihood of a US/global recession and the ongoing pursuit of a zero-covid policy by China, which will reduce investment and construction activity, suggests Longview.

The US/global recession is likely to arise from an over-tightening of interest rates, believes Longview, resulting in significantly weaker home building and steel demand. 

In addition, iron ore prices will fall on excess iron ore supply. Longview Economics expects ongoing closure of steel mills in Europe courtesy of high energy prices, and weaker Emerging Market economies, weighed down by the strong US dollar.

How America can exert maximum pressure on Russian aluminium?

Morgan Stanley believes sanctions on United Company Rusal, Russia’s only aluminium producer, would have the largest global impact of the three alternatives currently under consideration by the US administration.

The other options being contemplated to restrict Russian aluminium are higher tariffs or a total ban by the US. While these measures could tighten up the US domestic market, from a global perspective the broker believes Russia would be able to redirect flows over time.

In analysing Rusal's recent revenue breakdown by region, Morgan Stanley points out America was responsible for a much smaller share of revenue than Europe and the Commonwealth of Independent States (CIS).

The placing of sanctions on Rusal would likely create more challenges for other buyers of Russian aluminium outside of the US and provide more upside for aluminium prices, according to the analysts. 

When Rusal was previously placed under sanction in 2018, aluminium prices jumped by 25% and industries reliant on aluminium were significantly disrupted.

Lending additional perspective, Morgan Stanley notes Russia accounts for 6% of global aluminium supply and is the second largest global producer after China.

Lead prices have been unfairly dragged lower by wider base metal falls

Around 90% of lead demand is for batteries, of which circa 65% is for cars. Drilling down further into the statistics, approximately 78% of auto battery demand is because of replacement.

On these figures, particularly for replacement, Macquarie asserts demand for lead is well supported for at least the next few years, by comparison to other base metals.

The broker feels lead prices have been unfairly dragged down in sympathy with the rest of the metals complex, which has been impacted by a stronger US dollar, inflationary pressures and concerns over Chinese growth.

Unlike other base metals, explains Macquarie, there is little need to motivate new lead mine supply, though the price does need to remain high enough to enable the continued economic recycling of lead acid batteries.

Mine supply is forecast to grow by just 0.7% per year over the period 2021 to 2026, and that is primarily due to the Abra project in Australia, which commences next year.

The Abra project is a globally significant lead-silver mine located in the Gascoyne region of Western Australia and is 60% owned by Galena Mining ((G1A)).

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