Soft Commodities post fledgling resistance on narrower gluts


Monday, July 27, 2015 14:46 PM / ARM Research

ARM Research continues with the serialisation of her core strategy document – the Nigeria Strategy Report. Today, they conclude their review of the global economy and markets with a discussion on trends across other commodities in H1 2015 and their outlook for prices in the second half of the year.

The decline in commodity prices that began four years ago continued into Q1 2015, however, prices rallied through the second quarter with both the Jefferies CRB and S&P GCSI indices slightly up at 1.7% and 2.8% respectively in the first half of 2015(-27.2% and -34.3% YoY). Upon closer examination, the uptick appears driven by recovering soft commodity and energy prices, with the SPGCSI Agriculture and Energy sub-indices up 1.3% and 11.7% respectively, in the first half of 2015. Generally speaking, prices remained at relative lows, driven by a persistent supply glut cutting across most commodities, and exacerbated by relatively weaker global demand. On the whole, grain prices have been the most affected by the supply overhang. Wheat output has exceeded consumption again in H1 15, further weakening its price, while falling Barley output has helped it find some support. Sugar and Crude Palm Oil (CPO) prices have also shown resilience in the first half of the year and look promising for the remainder of it. 

Figure 1: Jefferies CRB and S&P GSCI Indices performance

Wheat oversupply to persist amid favourable weather
Winter wheat harvest for 2014/15 season is currently under way and CBOT Wheat prices are down 6% in 2015 to $5.72/bushel . The trend confirms our projections in our last report and our reasons, namely: continued oversupply relative to demand.  On the supply side, favourable weather conditions in major planting regions over the season have resulted in record levels of global output. Although the US (8% of global supply) witnessed lower output on account of crop switching for better priced cash crops and excessive rains in some wheat producing states, this reduction was offset by improving yields in other major regions, specifically Ukraine and Russia. In the EU, poor harvests induced by prolonged dry weather in Spain did little to hamper regional output as favourable weather boosted yields in the UK and France. Unsurprisingly, the US Department of Agriculture (USDA) estimates global output for 2014/15 season to have increased 9.5 million tonnes to 726 million tonnes (+1.4% YoY), close to the International Grains Council’s (IGC) 721 million estimates. On the demand side, the USDA estimates wheat consumption for the 2014/15 season at 716 million, 12.1 million tonnes higher YoY. Whilst this narrows the supply gap, markets remain in surplus as global inventories climbed 10.43 million to 200 million tonnes.

Figure 2: CBOT Wheat Prices

Over the coming season, the National Oceanic and Atmospheric Agency (NOAA) predicts good growing conditions in wheat growing regions across Europe which will boost crop yields in Russia, Ukraine and the EU. Nonetheless this is expected to be offset by lower output for the US, Argentina, much of the Middle East and North Africa. Consequently the USDA forecasts global output for 2015/16 to decline by 4.8 million tonnes. On the other hand, driven by increased demand for wheat based feed for livestock farming in Asia, Middle East, and North Africa, global demand in the new season is projected to grow marginally by 4 million tonnes –further narrowing the supply gap. Hence, we expect wheat prices to find some support in the near to medium-term, though likely capped by large inventories. 

Barley prices begin recovery on account of declining output
At $3.80/bushel, Barley prices are flat (-0.7%) in the first half of 2015 as a 5.4% decline in Q1 15 was mostly offset by a 5.2% increase in Q2 15. Relative to other grains, the better performance of barley prices is a result of supply falling below demand levels. Both the IGC and USDA estimate 2014/15 Barley output at 140.7 million bushels, 3.2% lower than the previous season. Boosts in output in EU and Russia (57% of global output) were insufficient to offset weather induced declines in output in other major producers like Canada, Argentina, US, and Turkey.  In contrast, global consumption for the season remains unchanged at 141 million –as our prior expectation of a decline in demand for Barley-feed failed to materialize. Accordingly, global inventory levels dropped 1% to 25 million bushels.

For the 2015/16 season, though the IGC projects barley consumption to decline a further 3% due to the substitution of feed wheat for barley in near-east Asia, it also expects output to decline by a wider margin of 3.5% due to crop switching in Canada and the US and lower harvests across Europe. Based on this, our outlook is for Barley prices to continue trending upward over the remainder of the year.

Sugar prices steeply depressed on high inventories, but promising road ahead
Sugar prices have declined by a steep 22.2% in the first half of 2015 to $11.93/lb. The bulk of the decline came in Q1 15 with prices down 19% over the quarter as the expectation of a fifth consecutive season of surplus weighed heavily on prices. The surplus continued into Q2 15 as prices slid further by 5.9% (-40% YoY) and global inventories rose 0.57% YoY to 44 million MT. According to the USDA, global sugar output for the 2014/15 season declined 0.7% to 174 million metric tonnes, as dry spells early in the planting season caused crop yields to suffer in Brazil, China, and the US (who collectively account for 31% of global supply). Nevertheless in confirmation of our expectations in prior reports, production levels remained above global consumption even as the latter rose 2.3% to 171 million MT in 2014/15– marking the fifth consecutive season of growth in global consumption.

By all indications the convergence between declining supply and increasing consumption bodes well for sugar prices as we go into the 2015/16 season. Output for the next season is projected to decline further as increases in Brazil and Thailand are expected to be more than offset by declines in other key regions: Water shortages in Maharashtra have cut output forecast in India, and low prices continue to discourage sugar farming in EU and US. On the other hand, growth in use of sugar for ethanol refining in Brazil, and in food processing in India and China are expected to keep consumption trending upwards over the next season. For these reasons, our outlook is for the decline in sugar prices to slow to a halt over the remainder of the year, and recover thereafter.

Figure 3: Global Sugar Production, Consumption and Inventories (million MT)

CPO down but perhaps not out…
In the first half of 2015, CPO prices have applied the brakes to their four year long decline and trended sideways. Nonetheless prices remain 23% lower YoY at $600/MT (-5.5% YTD). Having declined 9% in the first quarter of 2015 alone, prices fared better in Q2 by gaining 4%. The fall in demand for CPO as a source of biodiesel in India and China which pushed prices lower in Q1 15 was offset by renewed demand in both those markets for CPO to compensate for falling stocks of other edible oils, in particular vegetable oils.  Furthermore a string of regulatory decisions in key producing countries that came in Q2 helped prices recover and improved the scope for future uptick in demand. First, the US Environmental Protection Agency (EPA) announced new regulation requiring all diesels produced in the US to have a biomass content of 50% by 2017. Second, the US Food & Drug Administration (FDA) has placed a ban on hydrogenated (Trans) fats in food manufacturing processes.

Further regulations in key producing countries add to the upside for demand. In a bid to support the market for their key export, the governments of Malaysia and Indonesia, like the US, have respectively raised the biomass blend requirement of domestically refined fuels to 10% and 20% respectively. Though fraught with implementation difficulties, these policies are set to boost demand for CPO in the short to medium term. On the supply side, unusually dry weather patterns towards the end of May have raised concerns about the impact of El Nino activity on crop conditions in south-east Asia. Nonetheless, the USDA has left its supply estimates for the 2015/16 season the same whilst raising its projections for demand – output and consumption are respectively projected to grow 5.7% and 5.9% YoY in the 2015/16 season . The change in the fundamentals underpinning demand in the market underpins the reconsideration of our prior position on CPO prices. Now, our outlook is for prices to improve over the remainder of the year spurred mainly by higher demand.

Figure 4: Global CPO production and consumption (Million MT)

Locally, the bearish outlook for oil prices suggests government and personal spending will remain subdued, keeping the corporate space under pressure. Whilst the broad theme of convergence of supply and demand suggests softer commodities could be finding support, translating into higher input costs for some commodity processors and consumer goods, the net impact could yet be positive as the reflation allows better pricing and margin recovery.  Nevertheless, any potential boost from commodity prices will likely be insufficient to offset the general impact of oil prices on domestic consumer demand.

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