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May 30, 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 (2008). All rights reserved.
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The Markets at a Glance -
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Energy - Crude Oil
Are we reaching breaking point?
Since the start of May, WTI has powered on to new records. The benchmark contract for light sweet oil sky-rocketed from US$112/bbl on May 1st to over US$126.6/bbl on May 29th. A high of US$132.78/bbl was reached on May 21st. Brent followed in WTI’s footsteps, moving from under US$110/bbl to US$129/bbl. The spread between both contracts has narrowed from about US$5/bbl to a negative US$2.4/bbl, mostly due to the recent increase in stocks at Cushing, WTI’s delivery point.
The latest CFTC data for the period from April 29th to May 20th shows that speculators are not to blame for the latest price rally. Long non-commercials rose marginally, but shorts actually increased faster, taking the net non-commercial position from 3.9% to 3.7% of total open interest. If it had come down to non-commercials only, the price of oil would have decreased in May. Besides, 3.7% remains a very low level of fund involvement compared to highs over 8% last summer, when WTI was below US$80/bbl.
US crude stocks data hardly surprised the market, apart from a massive 8.88mb drop for the week ended May 23rd – the largest drop since September 2004. However this was apparently related to temporary unloading delays on the Gulf Coast, not to a drop in actual imports. Besides, US crude stocks remain well ahead of the 5 year average. Gasoline stocks kept declining, while distillates stocks started rebounding, as can be expected for this time of the year.
Just like last month, crude oil prices were pushed upwards by a very strong market for middle distillates: ICE gasoil futures, for instance, increased to over US$1,240/tonne in May – a massive 50% rise year to date, well above WTI’s 30% jump. Very strong worldwide demand for heating oil, gas oil and kerosene is pushing up prices: Chinese diesel demand for example has surged 13% in 2008 ytd vs. the same period in 2007. There are fears that demand will increase there as the Olympics loom and extra power has to be generated after this month’s Sichuan earthquake. The onset of winter in South Africa and Chile, two countries with severe power generation problems, could also lead to a surge in consumption of distillates. Even though current demand growth for gasoline is considerably weaker than for distillates, refineries lack the flexibility to produce distillates beyond a certain percentage of total output.
On the geopolitical front, more disruption in Nigeria, combined with an increasingly tense situation in the Middle East, fuelled bullish sentiment and added to supply worries. In the case of Nigeria, recent data shows that the average production rate in April fell to a lowly 1.18mb/day, down from 2.21mb/day at the start of the year and well short of a 2.45mb/day official target for 2008. Production in Mexico is also declining, although the reasons are different. The 13% yoy decline for April production surprised the market on the downside.
As the “speculative bubble” hypothesis becomes discredited, the big question has to be about demand. Indeed, production capacity is well known and quite inflexible – for instance, Saudi Arabia’s recent decision to increase output by 300,000b/day in June will do very little to offset tightness.
So when will demand drop to the point where prices have to correct sharply? The IEA has once again downgraded its forecast for 2008 global demand, now seen at 86.8mb/day vs. 87.2mb/day estimated last month. However, subsidies in emerging countries are still making world demand somewhat insensitive to price signals. So the real question should be: when will oil prices force governments to rethink their subsidy policies?
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Energy - European Refining Margins
Refining margins still supported by skyrocketing middle distillates crack spreads
During the past five weeks, refining margins evolution did not show significant changes. Volatility stayed at incredibly high levels, but quarterly averages remained basically unchanged. Our NWE Brent cracking gross margin indicator has varied from USD 5.4 on April 24th up to USD 7.7/bbl on April 30th and back to USD 2.6/bbl on May 7th. Then, it skyrocketed to USD 8.8/bbl on May 20th before tumbling to USD 4.7/bbl yesterday. Our Urals cracking gross margin indicator followed the same path albeit a little bit smoother (USD 3.6/bbl, USD 5.4/bbl, USD 1.7/bbl, USD 6.1/bbl and USD 4.0/bbl). At the same time, our NWE Brent hydroskimming indicator stayed most of time in positive territory, plunging below zero for only two days (USD 1.6/bbl, USD 5.3/bbl, USD -0.7, USD 5.4/bbl and USD 0.6/bbl).
Since the end of April, refining margins volatility has fundamentally reflected crude oil prices erratic variations. in the very short term, crude oil prices increases are not translated to refined products prices, which tends to instantaneously erode refining margins. But, within a few days, refining margins recover as products prices also increase.
During the past month, the refining margins complex accentuated its previous trends supporting high levels on average. Middle distillates crack spreads increased further, reaching a new historical high on May 23rd: USD 418.9/mt for Jet fuel (FOB barges NWE); USD 359.7/mt for ULSD (FOB barges NWE) and USD 281.7/mt for heating oil (FOB barges NWE). Gasoline crack spreads remained depressed, staying in the USD 100-150/mt range when they were permanently above USD 250/mt last year. Heavy products crack spread tumbled further, experiencing new lows: USD -368.6/mt for LSFO 1% (FOB barges NWE), USD -433.8/mt for HSFO 3.5% (FOB barges NWE) and USD -429.6/mt for bunker oil 380 cst (FOB barges NWE).
Gasoline crack spreads were still undermined by declining US consumption and surging US ethanol availability. According to US DOE revised data, domestic gasoline demand would have dropped by 1.3% yoy in Q1. Preliminary data showed a modest 0.3% yoy rebound in April, but the last available data pointed out a new 0.4% yoy decline (last four weeks ending May 23rd). At the same time, US ethanol production capacity has now reached 0.567 mbd, a yearly increase of more than 0.16 mbd (+40%). Ethanol demand for blending lags production capacity, but the last available data showed a strong yearly increase of 0.13 mbd (32.2%) last March. Gasoline market crack spreads should not recover any time soon and could even drop during the driving season: high oil prices reduces gasoline demand and ethanol capacity should still increase by more than 0.2 mbd before the end of the driving season.
Middle distillates crack spreads were supported by surging demand in China and the refineries maintenance season in the US and in Europe. Additional unexpected shut downs in some European refineries and low refineries utilization rates in the US reduced middle distillates availability. However, restarts of shutdown refineries and impact of the US slowdown on middle distillates consumption (-4.5% in Q1 2008 for distillate fuel oil) could rapidly change market mind.
Heavy products crack spreads were undermined by uncompetitive prices versus alternative fuel in the power industry.
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Energy - US Natural Gas
Still no relief in view
Over the period April 24th, 2007 (date of our last publication) to May 28th, 2008 Henry Hub gas prices have evolved in a range included between a maximum of US$ 11.85 /MMBtu (on May 27th) and a minimum of US$ 10.15/MMBtu (on May 21st), for an average price of US$ 11.12/MMBtu (46% higher than the average price of US$ 7.61/MMBtu over the same period in 2007).
Since the beginning of the year 2008, the average price has been equal to US$ 9.41/MMBtu, 27.6% higher than the corresponding period of 2007 (and 29.1% higher than in 2006).
Crossing the US$ 10/MMBtu threshold last month, Henry Hub spot prices climbed another step on May 6th when they jumped above US$ 11/MMBtu. Quick storage refilling, high drilling activity and weakening demand due to warmer weather could not make the balance versus record crude oil prices, dropping LNG imports and the Independence Hub outage protracted until June.
The Nymex futures curve gained more than US$ 1/MMBtu this month again, averaging US$ 12.11/MMBtu over the next 6 months. The June contract began the month at US$ 10.56/MMBtu, oscillated around US$ 11.3/MMBtu, and expired at US$ 11.76/MMBtu without crossing the US$ 12/MMBtu threshold. That was not the case for August to February 2009 contracts, with the first of them converging around US$ 12/MMBtu and January and February getting close to US$ 13/MMBtu.
Working gas in storage was 1,701 Bcf as of May 23, 2008, according to EIA estimates, 321 Bcf less than last year at this time and just 8 Bcf above the 5-year average of 1,709 Bcf.
The injection season began with a starting level of 1,234 Bcf as of April 4th. 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 slowly reaching 1,493 active rigs as of May 23rd, its highest level since last December. Unconventional gas plays have a key role in this activity and a further acceleration can be expected, as some companies disclosed the intention to put new rigs into service. Canadian drilling activity remained quite flat, with an increase of 4 rigs in May to reach 66 units as of May 23rd.
According to the Weather Research Center (WRC), the hurricane season should be quite active this year. Indeed, 11 named storms are expected, with 6 of them becoming hurricanes. Gas production could be significantly exposed to the risk as the Gulf of Mexico is estimated to have a 90% probability to be stricken. Moreover, the season might run a bit longer than usual, still according to WRC (usually, the hurricane season runs from June 1st to November 30th).
Through the first 4 months of 2008, US LNG imports totaled only 115 Bcf (versus 283 Bcf at this time last year), as higher prices were available to LNG suppliers in Asian and EU markets. In a context of globally tight liquefaction capacities, US LNG importers will probably have to pay higher prices – closer to the oil parity - in order to attract additional LNG supplies. We therefore reiterate our bullish stance of last month and we do not expect Henry Hub to move down the threshold of 10 US$/MMBtu in the short term.
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Energy - Emissions
Big money in the EUA markets?
European Trading Scheme
Albeit in a solid bull-run too, EUA markets seem to be completely lagging behind the European oil and gas markets. In particular, UK seasonal gas markets have soared so sharply that the UK summer coal-to-gas switching price now holds above 57 €/tCO2, more than twice the price of a DEC08 EUA. Still, in May, EUA markets have strongly headed North again, breaking through the 25 € mark, soaring from 23.56€ on the 1st of May to 26.59€ on May 29. Throughout the month, it appeared that fundamentals, German power prices and especially the UK coal-to-gas switching prices, have had renewed driving effects on EUAs (see the charts), although in absolute terms, CO2 prices failed to keep up with their impressive surge.
Even though it might not be straight forward when looking at a chart, the EUA forward curve significantly flattened in May, and especially during the second half of the month. It seems that the back end of the curve failed to keep pace with the sharp rise of the shorter maturities. According to our estimated cost-of-carry, the arbitrage opportunities now culminate close to 2.70 €/EUA on the Dec08/Dec12 spread. It means that shorting Dec08 and buying Dec12 may allow to cash in a 2.70 €/tCO2 cumulated profit in 2012. The question is why have the markets given rise to such a situation? Well, basically, to implement such a strategy one needs to own some EUAs and be willing to deliver at the end of 2008. In a regulatory point of view, it is feasible for EUAs can be banked and borrowed from one year to another. However, the position must be held over more than 4 years and portfolio management practices may not allow to do this. Also, the EU ETS industrials may prove to be reluctant to rely partially upon EUA borrowing to offset their actual CO2 emissions. These are probably some of the reasons why the back end of the forward curve has long been undervalued compared to the front-end.
CERs and ERUs markets
Despite a surge in the primary markets at the end of April and a steady rise of secondary prices from 16.1 to 17.73 €/tCO2e in May, CER markets failed to perfectly track the EUA markets. Actually, much news has come up in the last weeks, sometimes with contradictory effect on prices. While the post-2012 forward plan advocating a zero CER import limit compared to 2008-2012 (making the cumulated 2008-2012 import limit usable over 2008-2020) is still weighing down on CER prices, more pessimistic expectations on CER supply contributed to improve the bleak market mood. Also, the Lieberman-Warner bill proposes to allow US industrials to use Kyoto credits for compliance up to 5% in the planned future cap-and-trade system. This new demand for CERs and ERUs should bring some valuable support to the demand side. What is important to explain the growing spreads between CER and EUA markets is that both markets’ dynamics are drifting apart: the bulk of demand for CERs seems to progressively leak out from the EU ETS...
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Energy - Coal
CIF ARA hostage to freight and Pacific market
CIF ARA thermal coal followed through on last month’s bullishness, climbing from the mid US$140s/tonne at the start of May to US$171/tonne on May 29th.
Freight rates were a key driver of CIF ARA prices, as the Baltic Dry Index soared past its previous record to over 11,000 points. The Richards Bay-Rotterdam and Bolivar-Rotterdam Capesize freight rates now stand at US$60/tonne. A general shortage of vessels and port congestion were the main reasons for the sudden increases in freight.
FOB prices have also risen: Richards Bay stands now at US$126.5/tonne, a US$14/tonne increase since our last publication. FOB Bolivar – at US$128/tonne – and FOB Russian Baltic – at US$138/tonne – have risen by the same amount.
Interestingly, the implied freight in CIF ARA prices has barely changed, from US$34/tonne at the start of the month to US$37/tonne today. What this means is that slow physical demand is impeding coal traders from charging European utilities the full cost of FOB + freight, which would currently amount to US$178/tonne for Richards Bay coal.
The increase in FOB Richards Bay itself is puzzling, considering Indian demand is reportedly weakening due to the onset of monsoon season. One theory is that Richards Bay is only following Newcastle, which still commands a premium over its South African counterpart. FOB Newcastle is now at US$135/tonne, up from US$127/tonne last month due to high demand and logistical problems. Reflecting the tight Pacific situation, recent data shows China was a net importer of coal in Q1 2008, importing about 1mt more than it exported. At 144mt, Chinese coal stocks at the end of Q1 were 3.6% lower than last year.
On the coking coal market, Xstrata is reportedly aiming for a hard coking coal contract price as high as US$360/tonne, well above the US$300/tonne that was agreed upon by other companies in earlier deals. Negotiations for semi-soft coking coal contracts are also ongoing, and here Xstrata is reportedly shooting for US$250/tonne.
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Energy - European Power
Uneventful month on the continent
May, like April, is traditionally a month of low demand in Europe: temperatures rise but generally not to the point where air conditioning and fans have to be used. Therefore, power prices are expected to hit relatively low levels compared to winter. As we saw last month, this didn’t happen in April due to unusually late cold spells and supply problems. In May, a softening in prices finally occurred in France and Germany; however they remained elevated in the UK. Compared to previous years, European power is still very expensive (roughly 60-90% higher in France and Germany, higher yet in the UK).
German baseload remained largely at or below the 60euros/MWh level with peakload consistently priced around 15 euros higher. National holidays on May 1st and May 12th caused predictable and momentary drops in prices, much like in France. The German power grid remained comfortably supplied throughout the month, thanks notably to adequate wind generation and imports from France.
French power mirrored German moves in May. Prices dropped sharply on national holidays; other than that volatility was exceptionally low both for baseload and peakload. Nuclear maintenance is continuing – 27% of nuclear generation was offline in week 21 – but there were no unexpected outages, and the system remained well supplied.
In the UK, baseload prices remained stable around 90euros/MWh for much of the month before shooting up to 150euros/MWh in the last couple of days. Peakload reached above 200euros/MWh, the highest since the July 2006 heatwave. Climatic anomalies were not the problem this year, in fact the weather was largely average compared to previous years. Power prices were mostly supported by concerns over coal-fired generation: there are worries that coal-fired plants that opted out of the Large Combustion Plant Directive (LCPD) – and therefore have to restrict operations – will reduce generation now and instead burn coal towards the latter part of the year, when it is more profitable.
Forward prices increased to record highs on all markets due to recent increases in the prices of oil and coal. If those increases prove to be sustained, there is every reason to think that power prices will increase sharply over the coming seasons.
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Metals - Non-Ferrous Metals \ Alumina
Dead calm for now
Alumina prices have been stable since our last release, both in China at RMB3,575/tonne and internationally at US$410/tonne.
Nalco’s latest alumina tender went to Standard Bank at US$425.28/tonne FOB Vizag, slightly lower than the previous one which had sold for US$427.77/tonne.
In industry news, BHP Billiton has approved an expansion of its 3.5mtpy Worsley refinery to 4.6mtpy. Production is scheduled to begin in 2011 and the upgrade is estimated to cost around US$1.9 billion. Approval for the expansion was finally given after a 2 year delay, even though alumina prices have significantly declined since 2006.
We expect international alumina prices to start weakening in the short term as large surpluses have been forecast by all major study groups, both for this year and the following ones.
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Metals - Non-Ferrous Metals \ Aluminum
Aluminum softens after quake concerns fade
Cash aluminum initially retreated to almost US$2,800/tonne in early May before bouncing right back close to the US$3,000/tonne level. On May 29th it closed lower at US$2,860/tonne. The 3mth-cash spread is quite stable around US$40-50/tonne.
Aluminum’s initial fall towards US$2,800/tonne was mostly due to a strengthening US dollar and a dearth of fresh news. Besides, there is evidence that the aluminum market remains well supplied in the short term: premiums aren’t increasing – they have actually softened in the US – and LME stocks are still rising, reaching 1,077,175 tonnes on May 29th. In China, aluminum production appears to have strongly recovered after February’s snowstorms: according to the National Bureau of Statistics, April production reached 1.14mt, about 14% higher than in February and roughly similar to December levels.
The Sichuan earthquake in mid-May momentarily gave some bullish impetus to prices, even though the earthquake didn’t cause much damage to smelters. A 20,000tpy potline at Aba Aluminum’s operations was destroyed, and the opening of a new 100,000tpy smelter will be postponed until next year. However, aluminum being the most power intensive base metal, prices rose on reports that dams were damaged and that hydropower supply may be curtailed in the near future. Besides, most smelters in Sichuan are affected by logistical difficulties related to infrastructure destruction.
The current supply/demand situation remains comfortable and there might be downside risk to cash aluminum prices in the coming weeks. Additional smelting capacity is being built rapidly in China: local consultant Antaike has recently revised its figure for the amount of annual capacity under construction that will come on stream in 2008, taking it from 2.2 to 3.8mt. Inventories remain low relative to consumption, but they probably have further to rise.
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Metals - Non-Ferrous Metals \ Copper
Strike premium fading, for now
Cash copper has declined since our last release, dropping from US$8,600 on April 25th to US$8,109/tonne on May 29th. Trading seemed to lack a clear direction however, as prices oscillated between a high above US$8,700/tonne and a low below US$8,200/tonne. The 3mth-cash spread is still in backwardation, reaching a negative US$120/tonne on May 29th.
The main supply side event this month was the official end of the strike at Codelco’s operations in Chile. Labor organizations voted to end industrial action on May 6th at the El Teniente, Andina and Salvador mines. It may take some time for full production to resume, however. Moreover, it is widely expected that the threat of industrial action in Chile isn’t over and we may witness more disruption during the summer.
There was more supportive news from elsewhere in the world: in Mexico, unions threatened to strike at Grupo Mexico’s Cananea mine while the DRC announced a ban on exports of unprocessed copper.
Chinese import data was ambiguous: imports of refined copper in April fell by 31% yoy to 128,000 tonnes. However, this marks a month-on-month increase even though SHFE copper is trading at a high discount to LME copper. Besides, last year’s level of imports was very high as China was actively restocking. Considering all this it is hard to tell whether US$8,000+/tonne prices are having a negative impact on Chinese demand.
However, there is no shortage of data to suggest that the front end of the copper curve may be overvalued: the International Copper Study group has recently estimated an 85,000 tonne surplus in 2008, while the World Bureau of Metal Statistics believes supply exceeded demand by 4,000 tonnes in Q1 2008. Market premiums have recently decreased in various regions such as the US and China. And finally, LME stocks posted an increase in May, building by about 16,000 tonnes to 126,400 tonnes. This is the first time this year that LME stocks start rising again.
Prices remain above US$8,000/tonne due to constant supply disruptions – and maybe more importantly, the threat of supply disruptions – at the mine level. However, this hasn’t translated into a shortage of refined material. As a result, we expect LME cash prices to decrease in the near term while TC/RC rates remain very low.
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Metals - Non-Ferrous Metals \ Lead
Free fall below US$2,000/tonne
Lead got hammered on the LME in May, with the cash price dropping over 20%. It settled at US$1,920/tonne on May 29th. The 3mth-cash spread is still in contango at around US$10-30/tonne.
The main reason for the sharp fall was the rise in LME stocks: they have increased by over 16% since our last release, climbing to 65,125 tonnes. A slowdown in Chinese demand for car batteries, due to the end of winter season, is starting to have a strongly negative impact on lead demand.
Data from the International Lead and Zinc Study Group (ILZSG) shows that the lead market was in a deficit of 7,000 tonnes during Q1 2008, down from 38,000 tonnes in the same period last year. Overall, the ILZSG predicts that 2008 will end in a small surplus of about 26,000 tonnes, after several years of deficits. Further Q1 data showed a slight yoy increase in refined production (+1.2%) and a 0.4% contraction in demand, driven by a massive 5.5% drop in Europe.
Reflecting low demand, lead premiums have declined both in the US and Europe. European premiums have been harder hit, plummeting from US$185/tonne at the start of the year to US$90/tonne. In the US, they were initially resilient but finally took a dive from US¢7/lb to US¢4.5/lb.
The market took no notice of the ongoing delay to the resumption of Magellan’s shipments in Australia. Ivernia – the owner of Magellan – has recently stated that it would take up to 4 months to ramp up to normal production once it gets the go-ahead from the Australian government.
Also in Australia, recent tests in the city of Mt Isa, where Xstrata produces lead, have shown high lead levels in the blood of local children. Further blood testing is being made to evaluate the impact of lead dust.
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Metals - Non-Ferrous Metals \ Nickel
Dropping close to 2 year lows
Nickel took a late-month beating on the LME, with the cash price dropping to US$22,047/tonne on May 29th. Prior to May 20th or so the price had looked well supported above US$26,000/tonne. The 3mth-cash spread is in a relatively stable contango, averaging US$160/tonne in May.
Paradoxically, LME stocks have retreated since our last publication, dropping by 6% to 48,522 tonnes. However, they remain close to 11 year highs, which remains a bearish factor.
Why has nickel suddenly dropped to a 22 month low, after having looked stable around US$25,000-30,000/tonne in the past 6 months?
The fact is that demand from the stainless steel industry continues to disappoint, particularly in China. Most analysts had expected a sharp upturn in Q1 and Q2 2008. Recent data shows that global stainless steel production fell by 1.5% yoy in Q1, while for nickel-bearing grades the fall amounted to 4.5%. Compared to Q4 2007 the data does look a little better, but there are doubts as to the continuation of this recovery.
There have been more encouraging signals outside of China, however. For instance, ThyssenKrupp claims that its stainless steel orders increased by 40% yoy for Q4 2007 and Q1 2008. Outokumpu has reported “normal” demand for standard stainless steel, with Q1 deliveries increasing 28% vs. Q4 2007.
Meanwhile, the World Bureau of Metal Statistics announced that the nickel market had been in a 9,300 tonne deficit during Q1. This could have had a positive impact on prices, but most analysts expect a balanced or a surplus market for 2008 as a whole.
In the short term, nickel’s fortunes will remain heavily dependent on the stainless steel sector. What is perhaps more interesting is the rising discount of 27-month nickel relative to cash nickel, indicating an increasingly bearish mood for the long term. As a percentage of the cash price, the 27mth price has gone from roughly 100% at the start of the year to 93% today.
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Metals - Non-Ferrous Metals \ Tin
Soldering input soldiers on to new records before correction
Tin initially reached new highs in the first half of May, with the cash price soaring above US$25,000/tonne, before correcting to US$22,652/tonne on May 29th. The 3mth-cash spread first dipped lower into backwardation but reached contango again at the end of the month. The rapid rise in tin prices has led LCH.Clearnet to recently increase the margin call for tin on the LME. The new US$8,705/five-tonne lot margin stands 41% higher than previously.
Indonesian exports appear to have decreased in April: provisional data indicates 7,857 tonnes of exports, which would be lower than the 8,606 tonne March figure. The Indonesian government hasn’t made a decision yet concerning an official 100,000 tonne cap on annual production. In any event, exports are currently running at around that same rate on an annual basis, so it wouldn’t make much difference in the short term.
In China, recent data from the National Bureau of Statistics shows a 12% drop in refined tin production for the January-April period, compared to last year. It is the only base metal for which Chinese production is on the decline. A lack of concentrate supplies, combined with export restrictions, is believed to have caused this situation. However, domestic prices in China including duty and VAT are currently lower than on the LME, which suggests the Chinese market isn’t particularly tight. This situation may in fact encourage Chinese exports. As of March, China had been a net importer of tin for 8 successive months.
Meanwhile, LME stocks are still decreasing, but at a slower pace than previous months, dropping 5% to 7,435 tonnes. This is the lowest level since September 2005.
We expect the price to correct further as fundamentals, even though they are tight, do not justify tin at around US$22,000/tonne.
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Metals - Non-Ferrous Metals \ Zinc
Saved by the quake
Cash zinc on the LME has declined since our last publication, reaching US$2,015/tonne on May 29th. However, there have been ups and downs in May: a high of US$2,322/tonne was reached on May 16th. In spite of this month’s decrease, zinc is now trading above lead for the first time since last summer. The 3mth-cash spread is still in a contango, reaching US$30/tonne on May 28th.
Zinc could probably have fallen much further if it weren’t for the earthquake that struck China’s Sichuan province in mid-May. 500,000 tonnes of smelting capacity was shut down after the earthquake, sometimes as far away from the epicenter as Shaanxi province. Actual damage from the earthquake only affected about 100,000tpy, but other smelters had to close due to power shortages. Prices retreated when it became clear that in terms of actual production, only around 30-60,000 tonnes of refined zinc would be lost due to the quake.
Another supply side factor that supported prices was the strike at AngloAmerican’s Skorpion mine in Namibia. The strike started on May 10th and is still ongoing. Skorpion produced 150,000 tonnes of high-grade zinc last year.
However, these temporary disruptions aren’t making a significant dent into the current supply glut: as a reminder of the current state of surplus, zinc premiums fell both in the US and Europe. Besides, LME stocks increased once again in May: they reached 143,500 tonnes on May 29th, up 20,000 tonnes since the start of the month.
Confirming zinc’s bearish outlook, the International Lead and Zinc Study Group (ILZSG) recently released data showing a 72,000 tonne surplus on the zinc market in Q1 2008. The ILZSG expects a 215,000 tonne surplus for the year.
Zinc may drop further in the coming weeks, as prices probably haven’t bottomed out yet. At this stage, however, we believe most of the 2008 surplus has been factored into the price and it is unlikely that zinc will experience a sudden collapse.
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Metals - Ferrous Metals \ Iron Ore
Chinese iron ore prices to drop in the short term
Indian offers to Chinese customers for 63% Fe iron ore have reportedly dropped as low as US$170/tonne, down US$30/tonne from highs of US$200/tonne a few months ago.
Iron ore inventory levels in Chinese ports have increased dramatically in recent weeks, reaching 79mt in late May, up from an estimated 65mt last month. Normal inventory levels stand at 40mt or so. The Chinese Iron and Steel Association (CISA) has recently ordered a suspension of imports until stocks decrease.
The sharp inventory increase is partly due to lagging demand as several smaller steel mills are currently short on coke and can’t produce steel. Besides, Beijing is to issue a list of 23 mills which will have to suspend production for 3 months ahead of the Olympic games. Combined with tighter credit conditions, this is forcing many smaller mills to rethink their production strategy and act more cautiously.
In spite of lower demand, imports haven’t lagged: they totaled 42.85mt in April, 7.2mt higher than in the previous month. It is rumored that many traders had been anticipating price increases later in Q2, thus importing and stocking large quantities in spite of low demand.
Concerning negotiations between BHP-Billiton – Rio Tinto and Chinese steelmakers, no agreement has been reached yet. CISA has so far remained defiant in the face of Australian threats to start selling more iron ore on the spot market. However, if no agreement is reached within a few months, Chinese steelmakers will have no choice but to use the spot market.
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Metals - Ferrous Metals \ Steel
Above US$1,000/tonne
Except for CIS HRC export, all of the finished steel products we cover increased above US$1,000/tonne in May.
In the US, the price of HRC imports initially rose to US$1,137/short ton before dropping back to US$1,080/short ton. This remains higher than last month’s US$1,010/tonne. According to the American Iron and Steel Institute’s latest figures, steel import permit applications totaled 2.9mt in April, higher than the 2.5mt seen in the preliminary import data for the previous month. However, the pick-up in import activity appears to be restricted to long products due to domestic shortages: billets were up 55% from March, wire rod 89% and reinforcing bar 57%. High freight rates, booming international demand and a weak dollar are all keeping a lid on US steel imports: January-April figures remain 8% lower than last year.
In the CIS, the export price for HRC FOB Black Sea still stands at US$970/tonne even though international demand hasn’t weakened. Domestic prices, on the other hand, have been steadily increasing, with reports of deals as high as US$1,050/tonne ex-works. Meanwhile, Russian oil companies are believed to be lobbying for a 20% export tax on steel products in order to decrease domestic prices – oil companies use steel for pipelines and extraction infrastructure. It is not clear yet what the government will do: some believe that it may encourage more imports, others that it will apply an export tax to certain product categories only.
The Chinese export price for HRC is now at US$1,025/tonne, up from US$910/tonne last month and taking the gap with domestic prices to almost US$200/tonne. There haven’t been many deals at this level, as regular customers aren’t willing to buy large quantities. Meanwhile, preliminary data shows Chinese exports increased by 15% from March to April, reaching 4.78mt. This is 30% below 2007 levels but the rapid month-on-month increase may lead to further export restrictions. In defense of Chinese steel mills, it could be argued that the increase was only related to the exceptional rise in international prices.
The export price for Turkish rebar has made strong gains since our last publication, reaching almost US$1,300/tonne. European demand has been weakening at these price levels, but customers in the Middle East, particularly Dubai and Qatar, are reportedly buying regardless of the price.
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Soft Commodities - Fibers \ Cotton
Late month drop below US¢70/lb
Cotton futures in New York weren’t very volatile for much of May, trading in a narrow US¢69-72/lb band. However, they declined sharply in the last week of the month, dropping to US¢66/lb on May 29th.
Fund activity was very muted in the first part of the month: CFTC data shows net non-commercials as a percentage of open interest moving from 11.22% on April 29th to 11.41% on May 20th. Both long positions and shorts essentially remained static. However, although there is no official data yet to back this up, funds apparently exited the market in the last week of May, causing prices to drop.
On the physical market, the US¢70/lb threshold appears to be important, triggering Chinese demand whenever prices drop under it. The reverse is also true.
The USDA’s May supply/demand report was bearish for the 2007-8 season: world production is now seen above 120m bales, with mill use revised slightly lower and ending stocks at 61.55m bales. At 49.5%, the stock-to-use ratio would be almost unchanged from last year’s 51.1%.
Concerning the 2008-9 season, the International Cotton Advisory Council (ICAC) predicts that cotton production will increase by over 3% - in spite of significantly lower US plantings – but cotton use should rise by 1.3% and exceed production once again. Ending stocks would drop by 5.5%. This implies a slightly more bullish situation. Besides, there might be significant downside risk to the consumption estimate as the macroeconomic situation could deteriorate more than expected: demand for clothing is relatively elastic.
In light of these fundamentals, current prices still remain quite high in our view.
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Soft Commodities - Fibers \ Pulp & Paper
Solid April data justifying higher prices
Since our last publication, BEKP pulp delivered to W. Europe has increased slightly to 525euros/tonne. NBSK CIF W. Europe has also increased, rising US$30 to US$910/tonne. The spread between both remains around US$90/tonne. World pulp data for April was supportive of higher prices.
Indeed, world shipments were up 7.4% year-on-year and are now up 6.4% year-to-date. The increase in shipments was driven by China (+38%). Demand in Europe (+6%) and Latin America (+19%) was also strong and helped counterbalance a decrease in shipments to North America (-5%). Hardwood shipments continue to increase faster than softwood, at +14% vs. +4%. The shipment to capacity ratio increased 2 percentage points from last month to 94% but remains flat yoy.
The main difference with previous months is that this time the inventory data was also bullish, with inventories dropping by an estimated 150,000 tonnes. In days of consumption, this translates to a decrease from 34 to 32. A market is generally considered to be in balance at 30-32 days. The decrease in inventories may reflect spring maintenance or a concerted effort by producers to reduce stocks: operating rates were at 90% vs. 95% for Q1 2008.
Pulp producers have the intention to implement further price hikes in June. If world demand remains surprisingly strong as appears to be the case, increased hardwood capacity in Latin America might not cause a supply glut. The risk of a supply glut appears even smaller when taking into account the drop in European supply from last winter and the sudden shutdown of Pope & Talbot’s pulp mills.
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Soft Commodities - Grain and Oilseeds \ Corn
Cold shower for US corn crop, not for prices
Corn futures on the CBOT are still hovering around the US$6/bushel level, closing at US$5.98/bushel on May 29th.
CFTC data shows a clear increase in bullish sentiment over the period from April 29th to May 20th: longs stayed put at around 465,000 lots but short positions were cut by more than a third to just over 100,000 lots. As a result, net longs as a percentage of open interest rose from 21.8% to 25.7%.
Widespread concern over excessive rain in the US Midwest caused corn to spike up to US$6.30/bushel in the first part of the month: by the middle of May, only half of the corn crop had been planted, versus 75% normally. It is accepted that corn seeded after May 15th is more prone to damage from the summer heat, and consequently this has the potential to reduce yields.
Besides, corn was supported at high levels by crude oil prices, which continued their bullish journey above US$130/tonne. Combined with the US Congress decision to extend import tariffs on ethanol, the crude oil price rally helped alleviate fears over US ethanol demand.
Looking to the 2008-9 season, the USDA predicts that world production will marginally fall by 2mt to 778mt: an increase in non-US production won’t match a 7% decrease in US output of the coarse grain. Consumption is seen growing strongly from 771 to 787mt. Ending stocks should total 99mt, down from 110mt in 2007-8. This would leave the stocks-to-consumption ratio at an alarming 12.6% - this year it stands at 14.3%.
In the short term, corn, like other grains and oilseeds, will transform into a “weather market”: weather developments over the summer will affect US yields and weigh on prices. In the longer term, we anticipate tightening fundamentals to support prices at very high levels, but they will remain capped by crude oil and ethanol prices.
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Soft Commodities - Grain and Oilseeds \ Rice
More panic as rice scales US$1,000/tonne
The export price of grade B Thai rice has increased by another US$100/tonne since our last publication, reaching US$1,040/tonne on May 21st.
As we pointed out last month, there is no global shortage of rice. However, price hikes are being fuelled by export restrictions, hoarding, and a general mood of panic on export markets. In this context, cyclone Nargis couldn’t have come at a worse time as it devastated the Irrawaddy delta, which produces about two thirds of Myanmar’s rice. Before the cyclone struck, Myanmar was expecting to export 600,000 tonnes to neighboring countries Bangladesh and Sri Lanka. In the end, it may have to import up to 1mt of rice this season. The cyclone may also have a longer term impact on Myanmar’s production considering the extent of the damage.
Prior to cyclone Nargis it had looked like prices might soften a little: the Philippines floated a tender for 675,000 tonnes of rice at the start of the month. The tender failed – Vietnam would have been the only supplier – but the Philippines’ National Food Authority declared that there was no hurry to import more rice as domestic stocks were up 21% yoy. This confirms the idea that panic alone has caused several large importers to buy more than they need, and that there is no actual shortage.
The USDA’s initial projections for the 2008-9 season were also bearish: world production is expected to increase by 5mt to 432mt (milled basis), with ending stocks rising by 4mt to 82.6mt.
In the meantime, Thailand still remains the only large exporter to authorize private exports. So far, shipments are running extremely high: 4mt for the January-April period, up 74% yoy. This is well above the pace required to export 9mt for this year, but Bangkok doesn’t seem willing to restrict exports in the foreseeable future. Instead, the government is releasing part of its 2.1mt reserves on the domestic market.
Asian warehouses are full of rice and destocking will eventually have to happen before the next round of record harvests. There are already signs of this: Cambodia has recently allowed exports to resume and Vietnam is said to be considering similar measures. We expect prices to correct during the summer. Nonetheless, they should remain at elevated levels due to various factors: high grain prices in general, a strong baht and relatively low global inventories.
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Soft Commodities - Grain and Oilseeds \ Soybean
Argentinean trouble
CBOT soybean futures have traded somewhat erratically since our last publication, but ended up about US$1 higher at US$13.48/bushel.
CFTC data for the period April 29th to May 20th shows a sharp reduction in non-commercial shorts from over 40,000 to 32,000 lots. As a percentage of open interest, net non-commercials increased from 22.8% to 25.6%, a 14-week high.
A two week strike by Argentinean farmers lent support to CBOT soybean prices throughout the month of May. Besides, the situation remains tense even when farmers aren’t striking, as the government doesn’t seem willing to back off from its sliding export tax scheme. At current world prices, the tax would amount to over 40%.
The May strike had a strong impact on Argentinean export activity, as blockades paralyzed transportation and ports. On Tuesday May 13th, for instance, only two grain trucks arrived to the port of Rosario, as opposed to over 5,000 one year earlier. Traders have been coping by importing soybeans from neighboring Paraguay, or by drawing from emergency stocks created between two strikes. However, if strikes become recurrent, some exporting companies may have to declare force majeure. This is bullish in the short term for CBOT soybean as it would divert demand to the US – and Brazil.
Looking out to the 2008-9 season, the new export tax may lead Argentinean farmers to plant soybeans on fewer acres. This is bullish longer term as Argentina is the world’s third largest soybean exporter and 1st soy oil exporter.
Besides, the USDA’s latest report concerning the 2008-9 season was also seen as bullish. Even though US production is seen 20% higher than last year at 84.5mt, the USDA cautioned that extremely low ending stocks in 2007-8 mean total US supply will be little changed. Therefore, soybean prices will remain very sensitive to supply shocks and strong demand.
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Soft Commodities - Grain and Oilseeds \ Wheat
Case study: back to fundamentals but watch your weather!
CBOT wheat futures kept declining in May, plummeting from around US$8/bushel at the start of the month to US$7.5/bushel at the end, the lowest price since the end of August 2007. European wheat futures weren’t spared and dropped about 30 euros to 180 euros/tonne, a 10 month low.
CFTC data shows that the net non-commercial position, as a percentage of open interest, is dipping towards 0. Data from the last 4 weeks shows a very slight increase in longs, but a much larger increase in shorts, from 68,000 to 85,000 lots. Wheat may well be the first soft commodity this year to see short positions outnumber longs.
The market is now entirely focusing on the 2008-9 marketing season, which will begin next month. There has been no shortage of production forecasts, and all of them are bearish: the UN’s FAO believes output will reach 658mt, with ending stocks increasing 16% to 168mt. The USDA’s prediction is close to FAO’s at 656mt, while the IGC (International Grains Council) sees production of 645mt as likely. Some private forecasts have gone a bit lower, around 630mt.
European wheat futures dropped even harder than in the US, shedding about 30 euros to 183euros/tonne, a 10 month low. Farmers in France are reportedly struggling with old crop stocks: they had hoarded wheat in the winter, hoping for higher prices and demand from North African countries. However, those countries bought wheat from other origins earlier than expected. As a result, about 3.2mt of excess wheat is now sitting in French silos.
In other countries, news of low plantings in Argentina was counterbalanced by bearish data concerning Indian production. The Indians are expecting a strong crop of 76mt, which should make them self-sufficient. Besides, the Ukraine has recently lifted its export quota for grains. Many believe that Russia and Kazakhstan will follow suit.
As we roll into the 2008-9 marketing year, the wheat market enters its weather phase, where weather developments can “make or break” the coming Northern Hemisphere crops in the EU, Canada and the CIS. Growing conditions in the EU are good so far. However, in a reminder of weather’s potential disruptive effects, the Australian winter wheat crop is said to be suffering from draught.
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Soft Commodities - Tropical Products \ Cocoa
Downward correction after the investor exodus taking place for the last three months
ICE cocoa futures prices marked a turning point this month. Prices fell by 8% in May, reaching their lowest level in five weeks. ICE futures traded at £1,403/tonne on May 28th.
The fall off in prices was supported by weaker fundamentals and less financial support.
On the supply side, between October 1st and May 26th, Ivorian arrivals at ports were 10% higher than the same period last season, reaching 1.13m tonnes.
On the short term, estimates put Ivorian output for the on-going mid-crop at 320,000 tonnes, 20,000 tonnes higher than the average recent years output.
Further, global estimates of production were revised upward by 3%, reaching 3.74m tonnes for the 2008/2009 season. ICCO forecasts that output in Ivory Coast could reach 1.4m tonnes and 2.59m tonnes for West Africa for the 2008/2009 season.
Concerns about the global deficit continue to fade: ICCO estimates the deficit to reach 41,000 tonnes the next season after 301,000 tonnes in 2006/2007.
On the demand side, there is incertitude on the pace of a slowdown in US chocolate consumption.
Funds exited the cocoa market sharply.
Non-commercials positions totalled over 26% of open interest on April 29th. On May 20th, positions amounted to 17% of total open interest.
In addition, net non-commercial positions dropped from 36,145 lots on April 29th to 26,073 lots on May 20th, 2008.
Over a month, the volume of non-commercial long positions has decreased by 7.8%, reaching 55,723 lots on May 20th, 2008.
Fundamentals are still bearish backed by good weather in West Africa. A good flow of cocoa to the market is announced for the next months.
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Soft Commodities - Tropical Products \ Coffee
Prices stable as we enter frost watch period
Arabica underperformed Robusta in May, finishing about flat at over US¢141/lb while Robusta gained 1 cent to US¢111.5/lb mark. Consequently, the Arabica-Robusta spread has decreased to US¢27.8/lb.
Arabica continues to find support at a high level, even though Brazil is harvesting its large 2008 crop. Conab has recently raised its crop estimate to 45.5m 60kg bags from a previous prediction of 41-44m bags. However, the latest forecast remains well below the market consensus, which is close to 50m bags. Many noted that Conab faces domestic pressure to keep estimates down: if it sided with the market consensus coffee prices could drop, decreasing returns for local farmers.
In spite of these bearish estimates, Arabica is getting support from low Brazilian exports: so far in May they are down 30% month-on-month. Another supportive factor is that the Brazilian government will probably guarantee a minimum price to coffee growers, which would prevent prices from collapsing once the large crop is harvested and export ready. Besides, a “frost premium” may have been factored into the price: Arabica could drop in case the weather in Brazil remains above freezing.
Robusta succumbed to downward pressure due to producer selling from Brazil, Indonesia and Vietnam among others. Less than 10% of Vietnam’s old crop is reportedly being held by farmers, as opposed to 20-30% several weeks ago. It appears that hoarding, which had a highly negative impact on Vietnamese exports earlier this year – down 25% yoy from October to April – is gradually ceasing. Market players also focused longer term on Vietnam’s next crop, which is forecast to be quite big: the USDA estimates it will reach 21.5m bags, up 23%. However, there is still a long way ahead as harvesting will only begin in November.
More generally, the ICO (International Coffee Organization) has recently forecast a balanced market for 2008-9, with both supply and demand at 127m bags. In the current season, the ICO believes that demand, at 125m bags, exceeds supply by 8m bags.
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Soft Commodities - Tropical Products \ Sugar
Long awaited slump materializing
Raw sugar futures in New York fell to 5 month lows in late May, settling below the US¢10/lb mark on May 29th. At the start of the month raw sugar was above US¢11/lb. On the other hand, white sugar futures on the LIFFE remained mostly flat at around US$320-25/tonne: consequently, the white sugar premium has rebounded to over US$100/tonne.
It is telling that sugar prices couldn’t remain at elevated levels even though crude oil made big strides: the relationship between crude oil and sugar, which had held good during Q1, appears to have broken down.
Could it be that sugar is finally reacting to fundamentals? This seems to be the case, as Brazil’s harvest of its large 2008 cane crop kicks into high gear. Many forecasts have been made in the past month, all of which point to ample sugar availability: the Sao Paulo Sugarcane Agroindustry Union (Unica) sees the Center-South crop at 498mt, up from 431mt last season. Even though ethanol’s share is expected to rise by a couple of percentage points to 58%, sugar exports are forecast 15% higher at 18.9mt. This increase would be caused by decreasing Indian exports and a larger Center-South Brazilian production, which the agriculture ministry sees at around 29.35mt, over 10% higher than last season. Sugar production at the national level is forecast close to 35mt.
Accentuating the bearish mood, cane production in Thailand looks like it will beat expectations and increase by over 12% yoy. Last year, Thailand produced about 63mt of sugarcane.
Besides, record high freight rates are said to be limiting international sugar demand. Russia, for instance, had been expected to import a large amount of raws as its seasonal import tariff of US$220/tonne drops to US$140/tonne on June 1st. However, it appears to be staying off the market.
CFTC data shows non-commercial longs as a percentage of open interest dropping from 17.5% on April 29th to 15.6% on May 20th. This is not a very large fall and shows that a majority of funds are still long on sugar, expecting a tighter market next year. In this view, it is instructive to look at longer dated sugar futures, which are currently trading above US¢14/lb and indicating the consensus of a much more balanced market next year.
An ISO (International Sugar Organization) senior economist recently forecast a 1-2mt deficit for 2008-9, but he cautioned that there would be ample carry-over stocks to draw from. Until then, we believe sugar prices won’t fall much further below US¢10/lb as that is below the cost of production for Brazilian farmers.
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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
Rym Dekar; Soft Commodities
Hélène Drouilly; Natural gas, including LNG
Yves-Erik Paré; Commodity Markets
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