The week in iron ore and oil: what you need to know

lunes 20 de julio de 2015

Against the backdrop of Rio Tinto lowering its production forecast, BHP flagging a $2.8bn asset writedown and oil and gas producers reporting quarterly revenue drops last week, we take a look at the forces driving Australian commodity markets. 

Oil

Last week the International Energy Agency (IEA) released its oil market report for July, predicting continued oversupply for the rest of 2015 and 2016.

After sliding sharply from September of last year, the oil price had shown signs of recovery in the early stages of 2015 before slumping again this month.

In its report, the IEA said higher output from both OPEC and non-OPEC producers saw global oil supply surge 550,000 barrels a day in June to reach 96.6 million barrels a day, with demand for the first quarter peaking at 1.8 million barrels a day.

60 secound guide: OPEC

The prospect of additional supply on the back of an agreement between world powers and Iran, which should see sanctions affecting the Islamic Republic’s oil and gas exports eased, saw the oil price fall lower last week.

While the IEA anticipates non-OPEC supply growth to “grind to a halt in 2016 as lower oil prices and spending cuts take a toll”, OECD industry inventories are at record highs. 

What does the low oil price mean for energy investors?

The combination of large volumes of US production and slowing global growth has also contributed to the oversupply of oil which has led to the recent price pressure.

How are low oil prices affecting shares?

China’s economic rebalancing

A big part of the demand story is the flow-on effect from both the economic situation in Europe and slowing growth in China.

Australia faces tough rebalancing act as China’s growth slows

China’s demand has been a big driver of commodity prices over the past year. As China has moved to rebalance its economy, commodity intensive sectors such as industrial production and fixed asset investment, manufacturing and property development have slowed.

This has translated to lower levels of demand for commodities at the same time as investment in increasing supply has come to fruition, resulting in a surplus which has seen commodity prices go backwards.

Iron ore

Senior Associate, Mining & Energy Commodities at Commonwealth Bank, Vivek Dhar says that regardless of the slowdown in demand, a number of iron ore projects are still slated to come online, such as Vale’s new expansion project in Brazil, S11D, which is due to start production in 2016, adding 90 million tonnes of supply a year.

“They’ll come through at a time the market doesn’t need it,” Dhar says.

“Who’s going to absorb the excess tonnes? At the end of the day if it’s China then prices are going to have to give.” 

Indications are that the current state of oversupply is going to persist for some time, particularly given crude steel output is contracting in China.

Iron ore, oil prices slide in offshore trading

Industrial metals

Dhar says that industrial metals are in a better position than iron ore because if there were to be an uptick in demand, these metals are better placed to go into shortage than the bulk commodities, which could potentially push prices higher.

Nickel shot up at the start of 2014 when the Indonesian ban on exports of unprocessed ore was introduced, but has fallen since then to below pre-ban levels.

Is nickel the metal to back in 2014?

But Dhar says that stockpiles which were built up ahead of the ban are expected to dwindle this year with prices then likely to respond, so if there were to be any increase in demand then that price response could be amplified.

The recent weakening price is again linked to the China demand story, with China’s stainless steel exports dropping over the past 12 months.

In the aluminium market, China’s production has rapidly increased in recent years, accounting for nearly all the market growth since the GFC and pushing the metal into surplus across the world, putting pressure on prices. 

Adding to this is pressure as a result of activity by metals traders trying to capitalise on changes between the spot, or cash, price and the forward price.

In the below interview, Dhar speaks to CommSec’s Tom Piotrowski about what he will be taking into consideration in his upcoming trip to China in view of the country's recent stock market downturn and changing macroeconomic conditions.

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