The great commodity surge – what’s next?

The outlook for commodities was bleak at the beginning of this year, with analysts predicting a particularly poor front half of 2016 for oil, and an even weaker performance for iron ore. However, the oil and iron ore markets and the wider commodities market as a whole has performed much better than expected; the iron ore index and Brent futures have increased by 42% and 55% respectively since the start of 2016 – but why?

Well, according to London-based broker and Baltic member Freight Investor Services (FIS), a focus on oversupply has helped. In a post, FIS says: “Iron ore continues to come out of the ground at an unprecedented rate, while the oil market was not due to find balance until the second half of 2016 – yet we continue to see the march of the bull.”

It points to the periods of excess back in 2001 where ships could not be built fast enough to cater to burgeoning Chinese demand, yet the need to import ore and coke had to be fulfilled.

But growth, be it economic or sector-demand driven, eventually slows down, FIS added. “Undersupply is usually followed by oversupply as the markets look to find equilibrium. It hasn’t found it in freight yet but it is happening as the unproductive shipping sector scraps younger and younger ships in the realisation that no matter how healthy demand is, the fleet is too large,” it says.

Iron ore will suffer a similar fate: as winter approaches and the construction season draws to a close, FIS predicts that prices for iron ore should ease.

It concludes: “Fundamentally, the market has changed, weaker economics and mass oversupply may have changed its dynamics. However, seasonality will remain, prices may be lower, as are the cost curves of the miners.

“Bull markets and bear markets will still present opportunities, and percentage moves will be noticeable, the only difference is that unless there is huge construction stimulus, $100 per tonne will be sadly consigned to the past.”

Standout growth

However, coal could retain its shine, as Southeast Asia countries including Malaysia, Thailand and Vietnam continue to rely on coal-fired electricity to fuel their fast-growing economies out to at least 2020.

In a 10-year outlook for the Asia seaborne coal market, Mark Gresswell, chief analyst at Australian mining consultancy group HDR Salva, revealed at the 11th Coaltrans Australia conference in Sydney that three-and-a-half billion people are living on electricity consumption below the level in Japan.

“Eight of the most populous countries are in Asia and 54% of the world’s population live in Asia,” he said. “To move these people to Japanese levels of power consumption will require an extra 4,300 TW of electricity generation.”

This step change in levels of power generation in Asia will require an 80% increase in global coal production, he added. Coal-fired power generation is a relatively cheap source of energy at $30 megawatts per hour. This is less than half the cost of generating electricity from gas at $65 megawatts per hour.

“This is why coal will have a big role to play in Asia,” he said.

Mr Gresswell characterised 2016 as a year of transition for the seaborne market for thermal coal, as it shifts from a supply surplus to a supply deficit that will likely lead to a recovery in prices.

Large tonnages of Colombian coal are being moved to Asia, said Mr Gresswell, adding that this new trade was emblematic of demand growth in Asia drawing tons to the region. In China, imported coal competes strongly with Chinese coal, and Beijing’s tough stance on capping domestic production is being supported by mine inspections that could result in closures of local mines, he said.

In his opinion, Mr Gresswell says that Southeast Asia holds the promise of becoming the next India as countries in the region seek to diversify their fuel supply arrangements for electricity generation, which is growing at a current rate of 12% per year.

Looking ahead

Meanwhile, in the steel sector, Moody’s Investor Services Steel – Asia: Lower Earnings Keep Outlook Negative report predicts a bleak outlook for the Asian steel industry as both production and earnings weaken.

“Our expectation that Asian steelmakers’ aggregate earnings will be lower in the coming 12 months keeps the industry outlook negative,” says Jiming Zou, Moody’s vice president and senior analyst.

“A continued decline in demand, driven by China, and increasing trade barriers around the world, which limit exports, will reduce steel production, and persistent overcapacity will keep prices and companies’ profitability low.”

Moody’s expects Asian steel demand to continue declining by a low-single-digit percentage over the next 12 months, mostly due to slowing demand from China’s manufacturing and property sectors. “Demand from India and Southeast Asia will increase, but will be insufficient to offset the decline in China, which accounts for about 70% of Asian steel consumption,” it says. “Chinese production will likely contract 3%-4% in the next 12 months.”

Moody’s adds that some loss-making small or inefficient steel companies in China have suspended production, and supply-side reform is driving industry consolidation. However, the supply reductions will have a limited impact in the next 12-18 months, says Moody’s, given the declining demand and substantial overcapacity in China.

The ratings agency did reveal that it would consider changing the industry outlook to stable if China’s Purchasing Managers’ Index looked set to stay above 50 and the EBITDA per tonne of major Asian steelmakers began to show signs of improvement in the next 12 months. However, “a change to a positive outlook is unlikely during the coming 12 months in view of the current environment”, it concludes.

Likewise, Melbourne-based mining company BHP Billiton foresees Chinese production peaking at between 835m tonnes and 985m tonnes by the middle of the next decade, but not before. It believes that global scrap availability will also increase over time and substitute pig iron as a steel making input.