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June 27, 2008
Disclaimer -
The information published in this document has been obtained from public sources believed to be reliable. BNP Paribas does
not make any representation or warranty, express or implied, in connection with the accuracy of the opinions or statements
contained herein. The information provided by this document is only indicative, not to be relied upon as substitution for the
exercise of judgment by any recipient, and subject to change without notice. BNP Paribas shall not accept any liability
whatsoever for any direct or consequential loss arising from any use of material contained in this document.
This document is not intended as, and does not constitute, an offer or a solicitation to buy or sell any instrument or to enter
into any transaction. Any reference to past performance should not be taken as an indication of future performance. This
document should not be reproduced (in whole or in part) without BNP Paribas’ written consent.
© BNP Paribas (2003). All rights reserved.
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The Markets at a Glance -
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Energy - Crude Oil
In the balance…
WTI initially dipped to the lower 120s in June, before rebounding and trading in a US$130-140/tonne for much of the month. It then surged suddenly, closing at a record high of US$139.6/tonne on June 26th. Brent largely followed WTI on its bullish ride, closing at US$136.87/bbl on June 26th.
The spread between both types of crude was quite volatile, reaching US$6.7/bbl in the second half of June after having dipped to a negative US$3.7/bbl – the lowest level since July 2007. Brent’s relatively poor performance towards the end of the month was due to bearish prospects for the July North Sea loading program, which is expected to produce about 14,000b/day or 9% more crude oil than in June.
CFTC data for WTI futures is not consistent with recent increases to record highs. In the May 27th – June 17th period, the net non-commercial position as a percentage of open interest decreased from 1.93% to 0.95%, the lowest ratio since February 2007. Longs decreased in this period, hitting a 21 week low at almost 200,000 lots, while shorts remained roughly unchanged at just over 190,000 lots.
Meanwhile, US crude oil stocks initially kept decreasing, giving the bulls ammunition when they dropped close to the 300mb level on June 13th. On the following week, they appeared to stabilize at that level. The sharp drop in the last 2 months has now taken inventories well below the 5 year average, as well as last year’s levels. In the meantime, distillate stocks continued their seasonal increase while gasoline stocks trended only mildly lower. Weak product demand appears to be still weighing on refinery utilization rates: at under 90% they still stand below seasonal levels.
Concerning the short term outlook, the market seems to be increasingly confronted with mixed signals: on the one hand, demand growth appears to be weakening by the day, while on the other hand supply issues persist. Are we getting closer to the “breaking point” we mentioned last month?
On the demand side, the news was expectedly bearish, as has been the case for many months already. However, whereas recent months had highlighted demand weakness in developed countries, recent news focused more on emerging markets where oil prices are heavily subsidized. India, Indonesia, Taiwan, Sri Lanka, Pakistan and Malaysia all decided to loosen price control. But the hammer blow came later in the month when China announced it would increase gasoline and diesel prices by 18%. The impact of these policies on demand is still unclear so far, but further “de-subsidization” in the coming weeks seems likely if prices remain close to these levels.
On the supply side, the market was confronted with bearish news from Saudi Arabia on the one side, and bullish news from Nigeria on the other. At a large meeting on June 22nd between oil producers and consumer countries, the Middle-Eastern Kingdom decided to increase output by 250,000b/day in July, taking total output to 9.7mb/day. This comes on top of a 300,000b/day rise in June and takes Saudi production to the highest level in almost three decades.
However, Saudi Arabia appeared very isolated as no other OPEC country followed suit. Besides, a series of supply disruptions in Nigeria is still preventing the country from achieving its 2008 target rate of 2.45mb/day. Most recently, production in the Western African country was estimated at around 1.77mb/day, down from 1.86mb/day in May. The recent blowing up of an oil pipeline at Chevron’s operations, a strike, and an attack on Shell’s Bonga oilfield all contributed to outages.
Apart from supply/demand considerations, monetary policy also played an important part in price moves. The massive US$10/bbl increase on Friday June 6th was unrelated to fundamentals and came after the US unemployment rate grew the most in 20 years, prompting ideas that the US$ would weaken.
Price movements in the short term remain uncertain. Clearly, any supply disruptions on a significant scale, such as a devastating hurricane in the US, will drive prices to all-time highs. However, the more prices increase from here, the more they will eventually cause demand destruction and subsequently correct. It bears reminding that most people have been saying this since oil reached US$100/bbl…
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Energy - European Refining Margins
Middle distillates crack spreads put margins under pressure
During the past four weeks, despite still high volatility, the refining margins evolution indicates a clear drop. Our NWE Brent cracking gross margin indicator tumbled from USD 7.2 on May 26th to USD 1.8/bbl on June 26th. During this period, our Urals cracking gross margin declined from USD 5.4 to USD 1.8/bbl. Our NWE Brent hydroskimming indicator dropped into negative territory, declining from USD 3.4 on May 26th to USD -0.1/bbl on June 26th. Our NWE Urals hydroskimming indicator stayed in negative territory, increasing its losses from USD -2.0 to USD -6.7/bbl.
Quarterly averages are still at very high levels, notably for simple refining margins which would have performed their best quarter since Q1 2003. However, the premium versus last year has waned quite rapidly during the past month.
Since the end of May, refining margins have been squeezed by the continuous crude oil prices increase and poor data on the demand side. It is now more and more difficult to translate the crude oil prices surge into oil products prices as demand is obviously undermined by the level of prices. Middle distillates crack spreads has begun to decline from their May peak: USD -100.5/mt to USD 308.4/mt on June 26th for Jet fuel (FOB barges NWE), USD -122.7/mt to USD 236.9/mt for ULSD (FOB barges NWE) and USD -186.0/mt to USD 195.7/mt for heating oil (FOB barges NWE). Gasoline crack spreads remained depressed, declining till USD 111.7/mt on June 26th. Heavy products crack spread have experienced new lows during this period, but have recovered slightly recently: on June 26th, USD -334.3/mt for LSFO 1% (FOB barges NWE), USD -415.6/mt for HSFO 3.5% (FOB barges NWE) and USD -409.8/mt for bunker oil 380 cst (FOB barges NWE).
Gasoline crack spreads were still undermined by declining US consumption. According to US DOE data, domestic gasoline demand would have dropped by 2.1% yoy during the four weeks ending June 20th. Evidences are accumulating that US drivers are adapting their behavior to the high oil prices environment: SUV’s sales collapsed by 19.4% yoy last May; US vehicle distance traveled declined by 4.3% last March yoy and by 1.8% last April.
Middle distillates crack spreads reacted to the US distillate fuel oil stocks continuous increase. US stocks gained 9.9 MMbbl during the past four weeks, approaching last year June levels. Middle distillates US demand also shows signs of weakness: jet fuel demand would have dropped by 3.6% yoy during the four weeks ending June 20th and distillate fuel oil consumption by 1.1%.
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Energy - US Natural Gas
Hot summer
Over the period May 28th, 2008 (date of our last publication) to June 25th, 2008 Henry Hub gas prices have evolved in a range included between a maximum of US$ 13.01 /MMBtu (on June 19th) and a minimum of US$ 11.48/MMBtu (on May 30th), for an average price of US$ 12.48/MMBtu (68% higher than the average price of US$ 7.43/MMBtu over the same period in 2007).
Since the beginning of the year 2008, the average price has been equal to US$ 9.90/MMBtu, 34% higher than the corresponding period of 2007 (and 39% higher than in 2006).
Despite high domestic production and the restart of the Independence Hub activity, Henry Hub spot prices kept on surging in June, with an increase of 13% through the month. Low storage levels, weak LNG imports and increased cooling load are responsible for this rally, along with record crude oil prices evolving above the US$ 130/bbl threshold in June. Furthermore, concerns about the possibility for the Gulf of Mexico to get hit by a hurricane underpinned prices significantly.
Averaging US$ 13.1/MMBtu over the next 6 months, the Nymex futures curve remained flat but gained around US$ 1.1/MMBtu in June. The July contract closed at US$ 12.75/MMBtu as of June 25th, but it reached a maximum of US$ 13.21/MMBtu as of June 18th. It was the highest price for a near-month contract since the January 2006 contract (US$ 14.27/MMBtu as of December 21st, 2005), as well as the highest price ever for a July contract.
Working gas in storage was 2,033 Bcf as of June 20th, 2008, according to EIA estimates, 382 Bcf less than last year at this time and 56 Bcf below the 5-year average of 2,089 Bcf. Storage rebuild is facing difficulties as injections started from a relatively low point, gas prices are at record levels for the season and LNG imports are very low. Yet, given that January 2009 contracts are traded more than US$ 1/MMBtu above the July contract, companies should be incited to increase stocks injections.
According to our simulation, gas storage levels at the end of the injection season should be in the region of 3300 Bcf (Base Case), some 200 Bcf under last year level.
US drilling activity kept on increasing and reached 1,514 active rigs as of June 20th, a level close to its August record of 1,523 rigs. Unconventional gas still played a key role in this rise. Canadian drilling activity started to exit the spring thaw this month: 118 rigs were in activity as of June 20th, in line with last year level.
LNG imports for 1H08 are estimated around 175 Bcf (versus 464 Bcf for 1H07). Cargoes have massively been diverted to European and Asian markets, as these places offered higher prices. Taking into account the tightness of the LNG market, the concerns about the storage rebuild and the hurricane threat, the market is likely to remain nervous. In such conditions, we do not expect Henry Hub spot prices to move down the US$ 12/MMBtu threshold in July.
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Energy - Emissions
EUAs still heading North
European Trading Scheme
Even though the European gas and Brent markets have completely outstripped the EUA markets since the end of Q1, the latter have smoothly pursued their way up, progressively breaking through all symbolic resistances, till hitting their 2 year high yesterday. Despite an erratic start of June, caused by more severe volatility on European oil & gas markets, the EUAs have climbed almost continuously as from mid-June. Overall, Dec08 EUAs gained 1.54 € or 6% over the month, rising from 26.3 to 27.9 €/tonne. On the back end of the forward curve, the surge is even sharper, as the Dec12 contract grew by 3€ (10%), starting at 29.3 before culminating at a strong 32.3€/tonne. This resulted in a steepening of the forward curve, moving deeper into contango, thus slashing arbitrage opportunities between short and late maturities.
While crude oil and gas markets have somewhat handed over some volatility to the EUA markets at the beginning of June, the steady sharp rise of coal import prices has boosted German power prices, which brought strong bullish momentum into EUA prices over the second half of the month. Yet, EUA markets did not capture the full run that spurred the German power markets, probably owing to a simultaneous slump of coal-to-gas switching prices in the UK, hit by thriving coal markets and front-summer UK gas prices which have levelled off since mid-June. These opposite signals have likely weighed down on EUA price gains.
Regulatory Context and Carbon Balance
The EU parliament is now in the process of ruling on the European Commission’s proposal in its effort to give birth to a new regulatory framework for the post-2012 era. Although it is likely that the EU members of the Parliament will probably loosen some of the severe restrictions worked out by the Commission, these changes are expected to be cosmetic, especially with respect to CERs/ERUs import caps. The EU parliaments’ environmental committee is working on an additional 300 million tonnes on import caps, thus raising the limit from 1.4 bn tonnes over 2008-2020 to 1.7 Bn (130 million tonnes per year). Yet, some clauses aim at limiting the banking of these Kyoto-credits from Phase 2 to Phase 3. Also, they have come up with a proposal to restrain the conversion into EUAs of certain types of CERs/ERUs, which could be banned if the underlying projects do not comply with “Gold Standard” criteria.
With such stringent pending changes affecting the 2008-2012 period, especially on the CERs/ERUs import caps, it is likely that (if it is not already the case) the EUA prices will benefit from a risk premium, due to their growing “carbon credit-of-choice” status.
CERs and ERUs markets
The DEC08 CER contract has grown by 14% (2.5€/tCO2e), from 17.9 to 20.4€/tCO2e over June. However, the discount of the secondary DEC08 CERs against the DEC08 EUAs has somewhat stabilised within a 7€-7.50€ corridor, even though the CERs markets seem to lack sufficient momentum to fully catch up with the surge of the EUA markets. Nevertheless, as worries regarding the proper on-time delivery of CERs are rising, some expect the spread to narrow further in the coming months.
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Energy - Coal
Newcastle and Richards Bay scale US$160/tonne
CIF ARA thermal coal kept scaling new heights in June, adding more than US$30 to reach over US$200/tonne in the last week of the month.
As in the past few months, these price hikes seem unrelated to European demand. Utilities on the Old Continent are said to be well covered for the summer, and buying interest for thermal coal appears to be concentrated on Q4 and Q1 2009. Freight wasn’t bullish either in June: Richards Bay to ARA freight actually dropped sharply from around US$60/tonne at the start of the month to only US$42/tonne on June 26th.
The reasons for CIF ARA bullishness are to be found on the supply side. Richards Bay FOB surged to more than US$160/tonne at the end of June, but this is also puzzling considering weak European and Indian demand as well as stocks of 2.8mt at Richards Bay, which are relatively stable and close to normal levels.
In fact, it seems Richards Bay FOB has been dragged upwards by Newcastle FOB, which has jumped from US$135/tonne at the end of May to US$165/tonne on June 26th. As opposed to its South African counterpart, Newcastle is facing serious supply concerns. There are rumors that export allocations could be reduced by 1mt in Q3 in order to address vessel congestion at the Australian port. This could have dramatic consequences for the Pacific region considering China is still struggling with coal production – recent floods in Southern China and hydropower issues in Sichuan have only made matters worse.
Supply issues are also contributing to FOB strength in Russia and the US, where logistical issues may prevent production from reaching export markets this summer.
Concerning coking coal, Xstrata and its Japanese customers still haven’t reached an agreement on semi-soft coking coal prices for the 2008 contract year. Xstrata is said to be gunning for US$260/tonne while the Japanese are targeting only US$200/tonne.
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Energy - European Power
UK market still volatile
European power prices showed relatively little volatility in June, except in the UK. However, prices remain at very elevated levels compared to previous years, due to cost increases – the average French baseload price for the May 30th – June 25th period was a staggering 145% higher than last year, in spite of low demand. Prices across the board were somewhat higher than last month.
In Germany, baseload moved in a 60-90euros/MWh range throughout the month, in tandem with French baseload. Demand was weak for most of the month, apart from a heatwave at the start of June. Wind generation, meanwhile, increased in the second half of June and the system remained well supplied on the whole. Besides, alpine hydrostorage levels are increasing, after having reached very low levels earlier in the spring.
In France, soft demand helped ease concerns over potential supply shortfalls due to maintenance at nuclear plants. RTE frequently had to revise its estimates of nuclear capacity: at one point in early June, effective capacity ended up 5,000MW lower than had been forecast.
UK power prices were significantly more volatile than on the continent. Baseload peaked at almost 180 euros/MWh on June 3rd, and averaged over 100 euros/MWh throughout the month. The impact of the LCPD directive on UK coal combustion continues to make itself felt: an estimated 11,692MW of capacity has opted out of LCPD with an additional 4,000MW under derogation. At the same time, increases in gas prices and nuclear outages kept the market under bullish pressure.
Further out on the forward curve, prices remain under the bullish influence of surging oil, coal and gas prices.
The outlook for the summer is potentially quite bullish for spot prices: system margins could tighten very rapidly in the event of a heatwave. In France, there are concerns that hot temperatures could hinder water cooling at nuclear plants, further limiting supply.
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Metals - Non-Ferrous Metals \ Alumina
Price decline postponed, yet again
International alumina prices increased US$25 to US$435/tonne, while Chinese prices dipped further to RMB3,375/tonne. Since the start of the year, alumina sold on the Chinese domestic market has plunged by about 20%.
International prices were expected to start easing, due to ample availability of material. However, the market tightened when Alcoa was forced to declare force majeure because of a gas explosion at one of its Western Australian power suppliers, Apache Corp. It should take another month or so for Apache to resume operations. Even though Alcoa can buy gas from elsewhere in the meantime, it is estimated that 5% of output will be lost, totaling about 90,000 tonnes over 2 months.
A recent Nalco tender went to Standard Bank for US$457.57/tonne, much higher than a recent Vedanta tender at US$415/tonne and indeed, higher than Nalco’s latest tender at the end of May, which went for US$425/tonne. Traders attributed the price increase to the gas explosion in Western Australia.
In China, the news is that sluggish demand is making it difficult for prices to break out of recent lows. Chalco decreased its listed price from RMB4,200 to RMB3,500/tonne at the start of the month. Chalco usually lags in adjusting its spot prices and this recent move only reflects the domestic market price decline that has been going on since the start of the year.
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Metals - Non-Ferrous Metals \ Aluminum
Weak supply, weak demand
Cash aluminum on the LME made gains in June, advancing from US$2,882/tonne at the end of May to US$3,024/tonne on June 26th. The 3mth-cash spread remains in contango, trending slightly upwards in a US$40-50/tonne range.
The market remains well supplied in the short term due to weak demand: physical premiums are dropping in most markets. In Europe, the duty-paid cash premium recently reached a 2 ½ year low at US$80-90/tonne. In the US, the Midwest premium indicator decreased in June from US$0.045-0.0475/lb to US$0.04-0.0465/lb. Demand remains sluggish in Japan, while in China, it is growing at a much slower pace than last year. The International Aluminum Institute recently released data showing that total world inventories increased to 2.93mt in May, from 2.86mt in April. Meanwhile, LME stocks increased marginally in June, reaching 1,091,325 tonnes.
Nonetheless, prices remain supported by supply-side issues, particularly power issues. In Great Britain, Anglesey Aluminum’s 145,000tpy smelter suffered a power outage at the end of the month, while Alcoa has announced that it will idle capacity by 50% at one of its smelters in Texas, representing 120,000tpy.
In China, production is still growing strongly, increasing to 108,300 tonnes in May, up from 107,300 tonnes in April according to the International Aluminum Institute. This is bearish for the short term. However, Beijing and provincial governments are increasing power prices, in an attempt to slow down production growth.
All in all, while power costs and availability are certainly a bullish factor for the medium to long term, we believe nearby prices have no reason to move above US$3,000/tonne, considering weak demand and adequate supply in the near term.
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Metals - Non-Ferrous Metals \ Copper
Which is weaker: demand or supply?
Cash copper on the LME spent the first half of June hovering around US$8,000/tonne, before a series of rises in the latter part of the month took it to US$8,550/tonne at settlement on June 26th. The 3mth-cash spread remains deeply entrenched in backwardation around - US$130-170/tonne.
LME stocks didn’t show much movement in June, ending broadly flat at 123,050 tonnes.
CFTC data for the May 27th – June 17th period is consistent with price movements, showing the net non-commercial position initially dipping close to 0 before recovering to 3.11% as longs suddenly increased.
Weak demand data from China had little impact on prices. Chinese May imports of unwrought copper and semi-finished products were 19% lower than in April, while January-May imports ended up about 12% lower than in 2007. Record high prices seem to be taking their toll on Chinese demand.
However, the market was much more impressed by a constant stream of bullish supply news. Peru was the star of the show in June, with hundreds of workers at Freeport McMoRan’s Cerro Verde mine going on strike. Last year, Cerro Verde produced 183,000 tonnes of copper concentrate. In other news, access to Southern Copper’s Ilo smelter was briefly blocked by protesters while miners at Cuajone also went on strike. None of these disruptions lasted very long, but there is a possibility of a nation-wide strike on June 30th.
In other bullish supply news, BHP Billiton’s Cerro Colorado operation in Chile was hit by a truckers’ strike in early June, while Zambian copper mines faced a 15% reduction in power supply.
We remain uneasy about copper at US$8,000+/tonne considering weak demand. The International Copper Study Group recently estimated that Q1 2008 ended in a 19,000 tonne surplus, which compares bearishly to an 80,000 tonne deficit in the same period last year. However, with stocks at very low levels, large supply disruptions could have an explosive impact on prices.
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Metals - Non-Ferrous Metals \ Lead
Inventory rise leads to more price decreases
Cash lead on the LME has dropped further since last month, dipping to US$1,797/tonne on June 26th. A 15-month low was reached in mid-June at US$1,738/tonne. The 3mth-cash spread looks to be in a stable contango at roughly US$20-30/tonne.
LME stocks have risen considerably in the last few weeks, skyrocketing from 67,300 tonnes at the start of June to almost 100,000 tonnes on June 26th. Stocks haven’t been this high since August 2006.
Recent ILZSG data was bearish, showing a gradual move from market deficit to surplus: in the January-April period, world lead demand only increased by 0.7%, while mine production grew 6% and metal production by 1.2%. As a result, the lead market remained in a deficit of 8,000 tonnes, but this is lower than last year’s 20,000 tonnes deficit. In April specifically, the market was in a deficit of 6,800 tonnes. A small surplus is anticipated for 2008.
It is expected that current price levels will trigger more demand, which could give prices a lift later on in 2008. After all prices have dropped almost 50% since their October 2007 highs.
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Metals - Non-Ferrous Metals \ Nickel
Supply disruptions help nickel stay afloat
Cash nickel on the LME has slightly declined since our last release. On June 26th, the price at closure was US$21,902/tonne, as opposed to US$22,127/tonne on May 30th. The 3mth-cash spread remains in contango, although it decreased very briefly into backwardation in mid-June due to short-term shortage fears. LME stocks have slightly declined since our last publication, losing about 2,000 tonnes to 46,128 tonnes.
Bullish supply-side news helped nickel reverse the downward price trend in early June, almost reclaiming the US$25,000/tonne level at one point. In Western Australia, a gas explosion at power supplier Apache Corp’s facilities jeopardized production at Minara’s Murrin Murrin operation. Minara eventually announced that full production would return by August, and only 2,000 tonnes of nickel production should be lost. More importantly, BHP Billiton’s closure of its Kalgorlie smelter – in order to rebuild a furnace – came equally unexpectedly and could reduce global production by up to 28,000 tonnes this year, or 2%.
Therefore, the market could end up tighter than expected in H2 2008, particularly if stainless steel production is ramped up. For the time being, however, the stainless steel business looks stale, and any production increases seem to be focused on grades not containing much nickel.
Highlighting weak demand, recent INSG data shows a surplus close to 14,000 tonnes in April, compared to 5,400 tonnes in March – the March surplus might actually have been bigger if not for the long strike at Cerro Matoso.
Prices should trade range-bound in the following weeks and react to news from the stainless steel sector, which constitutes two thirds of nickel demand.
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Metals - Non-Ferrous Metals \ Tin
More bullish supply data
Cash tin on the LME has rebounded from a correction that took it as low as US$20,625/tonne on June 2nd, reaching US$23,102/tonne on June 26th. The 3mth-cash spread is quite volatile: it dipped to a spectacular – US$500/tonne on June 5th, before coming back into contango briefly and then slipping to a backwardation close to US$90/tonne.
Supply-side news have been supporting prices in the past month: Indonesian tin exports fell once again in May, dropping to 7,150 tonnes from 7,858 tonnes in the previous month. Besides, Indonesian authorities look close to setting a 100,000 tonne limit on annual tin production. Anyway, the current rate of exports suggests that production this year will probably end up even lower than 100,000 tonnes, due to restrictions on illegal mining.
In China, the 10% export tax on refined tin at the beginning of the year seems to have had quite an impact: total exports in the January-May period only totaled 386 tonnes, which is 97% lower than last year. China has all but disappeared from the tin export market. Meanwhile, in Peru, April production of tin concentrate was 3.3% lower than last year at 3,164 tonnes.
Reflecting recent supply data, LME stocks are still decreasing, dropping well below the 7,000 tonne mark at 6,695 tonnes, the lowest level since August 2005.
Even though Indonesian officials have recently stated that US$15,000/tonne would be “an ideal price”, it looks like tin will remain somewhat higher than that for the time being.
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Metals - Non-Ferrous Metals \ Zinc
Close to bottom
Cash zinc on the LME initially plunged even lower in June, reaching a 2 ½ year low of US$1,811/tonne on June 16th, before rallying to US$1,887/tonne on June 26th. The 3mth-cash spread is still in contango, moving in a US$20-40/tonne range.
With the strike at AngloAmerican’s Skorpion mine coming to an end, the zinc market was left staring at rising LME stocks – they have recently breached the 150,000 tonne mark – and a widening supply glut. Recent data from the ILZSG is straight forward: the zinc market was in a 78,000 tonne surplus in January-April 2008, up from 43,000 tonnes last year. Unsurprisingly, the data points to a strong increase in mine production (+9.2%) with metal production relatively sluggish (+1.5%) and world demand almost flat at +0.7%. Demand in developed countries was particularly weak: in Europe, it declined by 7.5%.
CRU International also released supply/demand data and estimates that the zinc market moved from a 18,000 tonne deficit in Q1 to a massive 171,000 tonne surplus in Q2. This would explain the dramatic price fall in May, coupled with the sudden LME inventory rise in the same period.
Considering this overcapacity problem, the market’s attention has inevitably turned to production costs and mine/smelter closures. There is little doubt that the current LME price is below the cost of production for smaller producers. In China, some small refineries have reportedly no choice but to import metal instead of producing it.
Although the market has yet to hear about major cutbacks or closures, we might not be far from the point where further price decreases are no longer sustainable.
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Metals - Ferrous Metals \ Iron Ore
Chinese-Australian negotiations finally over
The spot market for Indian iron ore has been very quiet in June. A drop in offers below US$180/tonne didn’t spark buying interest from Chinese customers: there remains almost 80mt of iron ore in port warehouses waiting to be cleared. Besides, a number of smaller mills face an uncertain future as Beijing will impose a series of shutdowns prior to the Olympics.
The fact that India has recently set a 15% export tax on iron ore – instead of a fixed amount previously at around US$7/tonne for high quality iron ore – will probably have an impact on prices later. But for the time being, weak Chinese demand, coupled with monsoon season in India, is prompting a temporary lull in the market.
Concerning 2008 contract prices, negotiations between Chinese steelmakers and Rio Tinto/BHP Billiton have finally ended. The Australian producers initially managed to score 85% average price hikes with smaller Chinese mills – FOB basis but significantly higher than Vale’s 65-71% and thus reflecting a freight premium. Baosteel appeared to resist the increase at first, but ended up accepting it. Indeed, the China Iron & Steel Association had asked for negotiations to finish by June 30th, leaving little time for Baosteel to negotiate a smaller increase. Pilbara blend lump will be sold 96.5% higher than last year, and Hamersley fines 79.9% higher.
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Metals - Ferrous Metals \ Steel
Still some bullish momentum
June proved to be a mostly bullish month for steel prices worldwide, particularly long products.
In the US, the price of HRC imports has increased slightly since our last publication, reaching US$1,125/short ton. However import activity remains very quiet – as it has for the last year or so. May import permit applications, at 2.4mt, were down 20% from the previous month which confirms that the April rebound was not sustainable. A gap between expensive world prices and cheaper US domestic prices has been widening in recent weeks, which, combined with a weak dollar and expensive freight, has reduced imports.
The price of HRC Black Sea FOB, meanwhile, has increased to US$1,053/tonne. Customer resistance didn’t last very long and producers secured a number of price hikes both on the domestic market and for exports.
HRC FOB China, on the other hand, initially retreated back below US$1,000/tonne, before rebounding to US$1,030/tonne. Traders reported buyer resistance to elevated prices, particularly in Europe, and a slowdown in transactions. Domestic HRC prices kept rising, reducing the spread with export prices. At the end of the month domestic prices stood at around US$830-840/tonne. The price increases might have been larger, but the National Development and Reform commission banned price hikes on products destined for reconstruction in Sichuan.
Turkish rebar jumped about US$150/tonne to US$1,447/tonne, due to very strong demand from the Gulf States, particularly the United Arab Emirates. An increase in re-rolling capacity there is also prompting huge price hikes for Turkish billet, thus making it more expensive for domestic re-rollers as well. There appears to be no end in sight to the construction boom in the Gulf, and also no end to the pockets of steel buyers there. The Turks are actually offering small quantities of rebar at a lower price to other countries that can’t afford the Gulf prices.
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Soft Commodities - Fibers \ Cotton
Surge on weather concerns
Cotton futures in New York remained below US¢70/lb until mid-June, when they broke out, hitting US¢74/lb on June 26th.
CFTC data for May 27th – June 17th reveals a drop in long non-commercials from 61,670 to 55,743 lots; but shorts decreased at an even faster rate, from 39,629 to 34,092 lots. As a result, the net non-commercial position increased from 8.2% to 9.8% of open interest; but this remains very low compared to 26% last January.
The price spike came in reaction to hot and dry weather in Texas, which is hurting US crop prospects. Most US cotton is grown in Texas, and reports indicate half the sown areas there are under threat from unfavorable weather. The USDA predicts US output at 14.5m bales in 2008-9, down from 19.2m bales in the previous season. The sharp decrease is mostly due to lower acreage as farmers favor other crops, however the figure may have to be revised even lower if negative weather conditions persist. At the global level, the USDA forecasts 2008-9 demand at 124.2m bales, with production at 116.4m bales.
Chinese imports are seen higher than last year at 14.5m bales instead of 12m bales. India may reap the benefits from added Chinese demand as the Indians look on track to harvest a large crop. The USDA thinks it will reach 26.5m bales, up from last year largely thanks to the use of genetically modified crops. As a result, Indian exports are seen 20% higher than last year whereas US exports should only increase by 8%.
World ending stocks should decline by about 13% to 54.1m bales. The general expectation is that prices will remain well supported as a result of the widening supply deficit: the International Cotton Advisory Committee (ICAC) believes the Cotlook A index will average US¢79/lb during 2008-9, up US¢6 from this season.
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Soft Commodities - Fibers \ Pulp & Paper
Healthy demand fuelling price hikes
Since our last release, NBSK pulp delivered to Western Europe has remained stable at US$910/tonne while BEKP pulp, also delivered to Western Europe, has increased 15 euros to 540 euros/tonne. As a result, the spread between both grades has decreased to around US$70/tonne. May pulp data was mixed but still supportive of high prices.
World shipments increased 2.7% yoy but decreased 1.7% mom, to 3.49mt. Weak demand in developed countries (North America -6%, Western Europe -3%) didn’t quite counterbalance strong growth elsewhere (China +17%, Latin America +22%). As in the past few months, a strong increase in hardwood shipments (+10%) contrasts with weak softwood data (-1.1%).
However, indicating an increase in production capacity – particularly in Latin America – the shipment-to-capacity ratio dipped to 90%, from 94% in April and 93% a year ago. Meanwhile, inventories increased to 32 days of consumption, up 1 day from last month, with 30-32 days generally indicating a balanced market.
For the time being, it seems a number of supply bottlenecks are preventing supplies from reaching the market: a poor winter harvest in Northern Europe, as well as strikes in South Korea and Canada are all supporting prices. Pulp producers have announced price hikes for July, and they should be successful considering demand strength in emerging markets.
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Soft Commodities - Grain and Oilseeds \ Corn
Midwest flooding
CBOT corn prices skyrocketed in June, reaching US$7.5/bushel on June 26th.
Surprisingly, CFTC data for the May 27th to June 17th period does not reflect the bullish price trend. Net long non-commercials declined slightly as a percentage of open interest, from 25.15% to 23.15%. Longs remained basically flat at roughly 456,000 lots while shorts increased from about 106,000 to 126,000 lots. This suggests many funds believe the recent rally is overdone and prices are due for a correction.
Nonetheless, price increases seem justified in light of the extreme weather events in the US Corn Belt. Prolonged rains throughout May and most of June led to heavy flooding along the Mississippi. In Iowa for instance, up to 10-20% of corn production could be lost as farmers struggle to replant fields. Besides, corn that is planted too late becomes more vulnerable to hot and dry weather during the summer, which could lead to further yield losses.
The USDA’s June supply/demand report for the 2008-9 season was mildly bullish, but supposedly didn’t reflect the full extent of US flood damage. US production was seen clearly lower at 298mt instead of 308mt, but this was offset by increases elsewhere, particularly in China and Russia, leaving world production almost unchanged at 775mt. US consumption is forecast lower than last month, due to adjustments to the feed demand estimate – the USDA recently released 24m acres from the Conservation Resource Program for cattle grazing, meaning less feed will be required – but world demand is seen slightly higher. In terms of ending stocks, they should stand at 17mt in the US, the lowest level since 1996, and 103mt in the world, almost 20mt lower than this year. In terms of stocks-to-use ratio, that would represent 13% as opposed to 15.6% this year.
In the short term, prices will probably correct somewhat if the weather improves in the US. However, more unfavorable weather heading into the summer months – particularly a hot and dry spell – could prompt even sharper price increases.
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Soft Commodities - Grain and Oilseeds \ Rice
Supply-side relief from bumper crops
The export price of grade B Thai rice has dropped to US$800/tonne since our last publication.
The mood of panic which doubled prices in the space of a few weeks earlier this spring appears to be fading. Indeed, a number of Asian countries are awaiting bumper crops. Vietnam, for instance, is expecting a 6% year-on-year increase for its upcoming crop.
This is prompting a few countries to reconsider their export policies: Cambodia recently lifted its ban on rice exports, and Vietnam, the 2nd largest exporter, allowed new export deals but capped exports for the first 9 months of the year at 3.5mt. Pakistan followed suit by saying it will also permit new rice exports.
However, although a correction seemed inevitable, prices will probably remain at elevated levels. Apart from the traditional cocktail of high global demand and rising costs, forms of government intervention seem to guarantee a minimum price level. Vietnam, for instance, recently introduced a US$800/tonne minimum export price, while Thailand has recently implemented an intervention price in order to protect farmers. At US$427/tonne for paddy rice, the new minimum price is about US$60/tonne higher than previously.
Besides, India is still banning exports and the situation is not expected to change considering this is an election year and food security/inflation are crucial issues. Meanwhile, Egypt has extended its export ban from October to April 2009.
The Philippines recently purchased 600,000 tonnes of rice from Vietnam at an average price of US$940/tonne CIF, which is lower than recent tenders. It should be the Philippines’ last large tender for the remainder of the year.
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Soft Commodities - Grain and Oilseeds \ Soybean
Back to all-time highs
Soybean futures on the CBOT marched to record highs in June, reaching an all-time high of US$15.7/bushel on June 26th.
Contrary to corn, CFTC data for the May 27th – June 17th period shows a quick increase in long non-commercials from less than 150,000 to over 170,000 lots. In the meantime, shorts also rose, leaving net non-commercials as a percentage of open interest flat at around 25%.
Soybean raced to record highs for the same reason as corn: flooding in the US Midwest and along the Mississippi is a serious threat to the crop, with about 15-20% of Iowa’s crop reportedly “lost”. However, soybean production isn’t as concentrated in the Midwest as corn and besides, soybeans have a longer planting window, meaning replanted acres won’t be as vulnerable to subsequent hot and dry weather as corn.
Outside the US, there appears to be no end in sight to Argentina’s political troubles, as farmers keep disrupting transportation and exports. Not only does this make soybean a scarcer commodity in the short term, it also raises doubts as to Argentinean acreage next season. Indeed, farmers might switch to other crops or at least not expand soybean acreage if the government maintains a high export tax.
Meanwhile, the USDA’s first forecast for the 2008-9 season anticipates a significant increase in world production, from 219 to 241mt, narrowly exceeding demand. Global ending stocks are seen at 50mt, marginally higher than last season. The stocks-to-use ratio would remain roughly flat at a lowly 21%.
Heading into the summer, prices will remain very much sensitive to US weather, considering the low level of stocks – US old crop inventories stand 80% lower than last year. However, we note that the CBOT crush spread has recently turned negative, which, combined with soy oil’s high premium over palm oil, could lead to demand substitution in the coming months.
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Soft Commodities - Grain and Oilseeds \ Wheat
Are the production forecasts too good to be true?
CBOT wheat futures rebounded in June, surging from a low of US$7.5/bushel on June 3rd to US$9.24/bushel on June 26th. European wheat futures followed, rallying over the 200 euros/tonne level.
CFTC data for the period May 30th – June 17th shows little change in non-commercial positions, with both longs and shorts about flat at respectively 83,000 and 86,000 lots. As a percentage of open interest, the net non-commercial position has remained close to 0 since the end of May, standing most recently at a negative 0.66%.
Meanwhile, the USDA’s latest supply/demand report was mostly bearish, including an upward revision of both US and global production – the latter is now seen at 663mt, 7mt higher than in May – and higher global ending stocks, at 132mt instead of 124mt previously.
Why then did prices gain 20% in two weeks? There are a few explanations for this: first, the market has grown slightly more skeptical about optimistic production figures for 2008-9. Parts of Eastern Australia seem to be under the threat of yet another drought: a prolonged lack of rain in the autumn recently caused ABARE to trim its production estimate for next season, from 26mt to 23.7mt. Since then, the onset of rainy weather has eased concerns there, but the market remains a little nervous after the last two years’ catastrophes. In Argentina, much of the wheat belt is also too dry and raising doubts. Meanwhile in the US, massive flooding in the Midwest hasn’t damaged the wheat crop as much as corn and soybean, but the wet weather could cause quality to drop.
Besides, with corn and soybean rallying to all-time highs, the market expects some feed demand to be diverted towards wheat, which could cause consumption to increase more than expected next year.
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Soft Commodities - Tropical Products \ Cocoa
Meteoric rise in prices: 28-year highs
Liffe Cocoa futures increased sharply this month, surging through 28-year highs.
Liffe futures traded at £1,726/tonne on June 25th, posting a 20% rise compared to the end of May.
On the supply side, the market seems to be fuelled by opposite news:
Concerns over Ivorian quality surged in recent weeks after excessive rain last month. The International Cocoa Organization argued that quality in Ivory Coast had deteriorated because buyers were mixing under and well-fermented beans.
However, some analysts point that there should be adequate moisture for the next main crop. The forecast for 2008/2009 production in Ivory Coast stands at 1.4m tonnes and 2.59m tonnes for the whole West Africa. The world cocoa production estimate stands at 3.76m tonnes, up from 3.62m tonnes.
Arrivals to Ivorian ports reached almost 1.3m tonnes from October 15th to June 15th 2007/2008, up from 1.16m tonnes the last season.
On the demand side, total grindings for 2008/2009 are forecast at 3.78m tonnes, up from 3.69mtonnes the last season.
This rally was also supported by higher speculative activity.
CFTC data show that funds continued to expand their activity on ICE. As a percentage of open interest, net-non commercials increased from 17.4% to 21.5%, a 6-week high.
In addition, the volume of non-commercial long positions has risen by 22.5%, reaching 68,267 lots on June 17th.
Short term price direction is uncertain since the recent rally seems to have been driven primarily by stronger funds commitments.
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Soft Commodities - Tropical Products \ Coffee
Price increases seemingly unrelated to production forecasts
Arabica increased in June, settling at US¢154/lb on June 26th, while Robusta initially declined before rising to around US¢116/lb. As a result of Arabica’s stronger performance, the Arabica-Robusta spread increased to US¢38.1/lb.
Fears that frost might hit some of Brazil’s coffee growing regions fuelled some price gains in June, but those concerns soon subsided when it became clear that most of Brazil’s Sudeste region would remain unaffected. The Arabica market is essentially trading sideways as the frost premium – which will probably last until August – and reports of very low carry-over stocks are canceling out the expectation of a very large crop in Brazil. In its most recent report, the USDA forecast output of 51.1m 60kg bags, significantly higher than the Brazilian Agriculture Ministry’s prediction of 45.5m bags. However, Brazilian stocks are said to be very low: a recent estimate puts them at 10.4m bags as of March 31st, down from 17.6m bags one year earlier.
CFTC data for Arabica futures in New York doesn’t show many surprises for the May 27th to June 17th period. Long non-commercials slightly decreased, but so did shorts, leaving the net non-commercial position as a percentage of open interest almost unchanged at 15.7%.
Trading on the Robusta market has been even more uneventful in recent weeks. The market is still being impacted by an influx of Vietnamese beans: exports from the South-Eastern Asian nation are said to have increased by up to 20% from April to May. Farmers who once hoarded coffee have become desperate to increase cash-flows in order to finance fertilizer purchases. Besides, the outlook for Robusta is quite bearish: although estimates still diverge by a large amount, the 2008-9 Vietnamese crop should be reasonably large. The USDA estimates it will total 21.5m bags, up 23% from last year. Similarly, the Indian Coffee Board believes Indian production could increase by 12% next year.
More generally, the USDA pegs total coffee output for the 2008-9 season at 140.6m bags, up 18.2m bags from last season. Ending stocks should increase by 6.7m bags to 39.2m. This contrasts sharply with last month’s ICO report which forecast a balanced market for 2008-9, and production at only 127m bags. Either way, the coffee market should not come under significant upward pressure in the medium term, unless weather conditions turn hostile.
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Soft Commodities - Tropical Products \ Sugar
Competition with ethanol drives prices upwards
Raw sugar futures in New York initially kept dipping in June, reaching a 9 month low at US¢9.52/lb on June 4th. The price then rebounded sharply, settling at US¢11.68/lb on June 26th. White sugar on the LIFFE experienced an even stronger rally which took it to over US$380/tonne, before correcting to US$376/tonne. As a result, the white sugar premium briefly increased to a 1 year high above US$130/tonne before easing.
Sugar was initially hurt by more fund selling. CFTC data from May 27th to June 10th shows the net non-commercial position dropping from 15.6% to 12.2%, both as a result of long liquidation and short selling. A few factors may have caused investors to turn more bearish: recent estimates for the 2007-8 season showed an even bigger surplus than had been expected a few months ago, with leading broker Czarnikow estimating 11.6mt, Kingsman at 11.3mt, and the FAO not far behind at 9.8mt. Moreover, Czarnikow forecast a surplus of 1.6mt for next season, which suggests production might not drop as much as expected, leading to a third consecutive supply glut.
However, sugar rebounded in the second half of the month. Non-commercials climbed back to 14.4% of open interest on June 17th as short covering largely exceeded long liquidation. A rally was somewhat predictable considering prices had dropped well below the marginal cost of production. Besides, reports suggest that cane crushing in Brazil is going largely to ethanol production instead of sugar. As of mid-June, a surprising 62% of cane had gone to ethanol due to the high price environment and the prospect of profitable exports to the US, where higher prices for corn have pushed ethanol values upwards. Most analysts had initially expected that about 55% of cane production would go to ethanol. Furthermore, wet weather is hampering the cane harvest and cane production could end up a little lower than expected.
We expect prices to remain range bound: even though there won’t be any sugar shortages in the foreseeable future, prices still have to cover production costs in Brazil and make sugar competitive versus ethanol.
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Statistical Appendix - Prices
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Statistical Appendix - LME Stocks
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Statistical Appendix - US Oil & Natural Gas Stocks
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Research Analysis Group -
Christophe Lhermitte; Electricity, Metals
Régis Collieux; Oil, Oil refining, Petrochemicals, Fertilisers
Marco Boeri; Natural gas, including LNG
Emmanuel Jayet; Soft commodities (grains, tropicals, fibers, paper pulp...), Biofuels
Sébastien Loison; Energy, Emissions & Product Development
Eric Louvert; Metals
Hélène Drouilly; Natural gas, including LNG
Rym Dekar; Soft commodities
Yves-Erik Paré; Commodity markets
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