Reviews & Outlooks | |
Reviews & Outlooks | |
5807 VIEWS | |
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Wednesday,
January 17, 2018 /3:30 PM /ARM Research
We
maintain a mixed outlook for commodity prices over 2018. Our expectation for
barley and cocoa prices remain bullish buoyed by wider deficit while outlook
for CPO, sugar,
and wheat are bearish underpinned by favorable weather conditions which guides
to higher production, elevated inventory levels as well as persisting market
surplus.
The
weakness in commodity prices, that began earlier in the year, continued for the
rest of the year as major commodities faced supply glut. Consequently, the
S&P GSCI Agricultural
Index posted a decline of 9%, largely driven by surplus positions in Wheat,
Rubber, Crude, Palm Oil (CPO), Raw Sugar and Cocoa, excluding barley where a
deficit picture stimulated the rally in prices.
Market rebalancing props up Barley prices
Output decline in Turkey and Morocco reflected smaller planted area as
well as low yield in the review season while poor weather conditions in France
and Belgium impacted the supply of the commodity in the Euro area. While on the
demand side, global barley consumption expanded by 1.1% YoY to 149MT, largely
underpinned by rising demand in Euro area, Russia and China2. The modest uptick
in consumption was driven by increased usage of barley for feed as consumers
switched away from other alternative feed ingredients such as wheat and corn.
For the 2017/2018 season, despite expectation of lower demand,
production, which is expected to fall faster than demand translates to a wider
deficit in the barley market. Based on USDA estimate, global barley production
is projected to contract by 3.7% YoY to 141.7MT, hinged on decline in
production from Australia, Canada, and US. Unfavorable weather condition in
Australia, return to normalized yield in Canada from abnormal high in prior year,
as well as lower acreage in major planting regions in US are the drags to
production.
On the other side, global barley consumption is estimated to decline
marginally by 1.4% YoY to 147MT on the back of lower consumption in China
(-9.2% YoY to 8.9MT) as well as Saudi Arabia and Ukraine3. China’s lower
consumption of barley is attributed to favourable prices for domestic corn
which is an alternative ingredient for feed. On balance, the wider deficit
picture (5.5MT) and consequent decrease in inventory (-22.5% YoY to 18.8MT)
creates scope for a sustained bullish price outlook over the 2017/2018 season.
CPO shakes off the lasting effect of El-Nino
Accordingly, CPO prices declined by 5.2% over the second half of 2017.
Going into 2018 (2017/2018 season), CPO prices are expected to be subdued as
post El- Nino production growth will likely persist. USDA projects a 7.3%
increase in production to 66.9MT while demand is projected to rise at a slower
pace of 4.9% to 62.9MMT, thus indicating a record surplus of ~4MT (+70% YoY). On supply, Indonesia and
Malaysia are expected to increase production by 6% and 8% relative to prior
season to 36MT and 21MT respectively largely underpinned by favorable weather
condition. On the demand side, the growth will largely stem from India (+4.3%
YoY to 9.8MT) as the economy recovers from the impact of demonetization. Also,
demand in Indonesia and Malaysia is expected to pick up by 5.6% and 30.5% to 9.1MT and 3.6MT respectively.
Sugar deficit narrows on higher production
Also, higher output in Russia reflects the impact of favorable weather
conditions, high yields, improved processing, and storage technologies as well
as high prices for imported raw sugar7. On the demand side, consumption was
marginally flat over the season (+1.5% YoY to 174.2MT) hinged on lower
consumption in India and China8 which neutered higher consumption from other
key buyers – Indonesia, Nigeria, and Pakistan.
Looking further ahead, global sugar production is estimated to expand by
8% to 184.9MT in the 2017/2018 season. The expansion will stem from forecasted
rise in production from India, Euro area, and Brazil with a combined increase
of 88.0MT to bring combined output to 184.9MT. In terms of the drivers,
favorable weather and production maximization are the propellers of Brazil and
India’s growth in sync with prior season. For the Euro area, common
agricultural policy reforms – which will, among other things, lift restrictions
on production and exports imposed on sugarcane growers – will drive higher
production. On the other leg, global sugar consumption is estimated to increase
slightly by 2% YoY to 174.2MT underpinned by higher demand from India, UAE, and
Pakistan.
Higher demand in these countries is hinged on economic rebound, robust
consumer spending, and a fast-growing domestic food processing sector. On
balance, the supply and demand projection indicate a transition to a surplus
market in this season of 10.8MT relative to a deficit of 0.2MT in prior year
which underpins our bearish outlook on the commodity.
Wheat prices take a pounding from surplus market
The increase in demand for wheat as feed ingredient largely supported
higher demand in China and Russia, while India’s sale of wheat at subsidized
prices to local millers through the Open Market Sales Scheme (OMSS) and public
distribution system (PDS) underpinned the demand picture. Elsewhere, the
increase in global wheat production was underpropped by output expansion in
Russia, Australia, and US with a combined increase of 29.4MT to bring their
cumulative output to 168.9MT.
Favorable weather condition and acreage expansion were the drivers for
the rise in output. Going into the 2017/2018 season, USDA estimates a
relatively unchanged global wheat production picture (-0.3% YoY to 752MT) as
expectation of tight supply in US, Australia and Canada (-32.2MT to 95.9MT) is
expected to offset high-yield induced output growth in the Euro area, India,
and Russia (+27.9MT to 332.9MT). The forecasted decline in Australia is
predicated on poor rainfalls and high temperature in Australia while output
decline in US and Canada is hinged on lower acreage relative to the prior year
as well as poor weather conditions. On the demand side, the USDA also estimates
wheat consumption to remain unchanged (+0.1% YoY to 740 million MT).
Increased usage of wheat for feed is expected to support demand in India
and Russia (cumulative: 5.0% YoY to 144MT) while China’s demand is estimated to
decline by 2.1% YoY to 116MT amidst abundant corn supplies driving a switch to
corn as a feed ingredient. On balance, with production of 752MT and consumption
of 740MT, the surplus picture looks set to shrink, albeit, modestly to 11.9MT
(prior year: 14.3MT). The foregoing leaves scope for moderate gains in prices.
However, bearish sentiment trailing the growing inventory level (+4.7% YoY to
267 million MT) may limit scope for a rebound, as seen in previous years, and
thus extend the bearish run in the price of the commodity.
Cocoa prices set for a bullish H1 18
Following the bearish trend over H1 17, where cocoa prices declined by
10.5%, prices have rebounded to a modest growth of 0.7% over H2 17. The
marginal rebound came amidst concerns about the current wet weather conditions
in West Africa which may cause the spread of black pod disease into the
2017/2018 season and restrain output. Nonetheless, at the end of the 2016/2017,
the International Cocoa Organization (ICCO) estimates a faster rise in global
cocoa production (+18.5% YoY to 4.7MT) than consumption (+5.4% YoY to 4.4MT), implying
a surplus of 0.3MT (2015/2016: 0.2MT deficit).
The robust output was largely driven by conducive weather conditions in
Cote D’Ivoire – world largest supplier of cocoa – where output rose 18.1% YoY
to 2.0MT. From the consumption side, in the third quarter of the review season,
data from ICCO showed a broad-based increase in cocoa grindings across Europe,
North America, and Asia11. The double-digit growth in Asian markets was the
direct result of depressed domestic cocoa prices in the region which boosted
demand for the commodity.
According to ICCO, the 2017/2018 season started off slowly as excessive
rains impacted on output supply. The organization noted that production in the
first 50 days from Cote D’Ivoire contracted by 9% YoY to 0.3MT. The build-up in
inventory by cocoa grinders is forecasted to drive demand lower, albeit, at a
slower pace than production. This guides to a deficit and underpins our outlook
for cocoa prices to sustain its bullish trend in the first half of the
2017/2018 season.
ITRC’s push for production quota underpins for bullish
outlook for rubber
Going forward, International Tripartite Rubber Council (ITRC) comprising
top rubber producers in Asia have agreed to cut exports of natural rubber
starting from December in a bid to address declining global prices. That said,
bearish sentiment surrounding muted demand from major consumers should moderate
the expected increase in prices.
Mixed outlook for commodities portend varied impact
for Nigeria
Tying it all together, our expectation for barley and cocoa prices
remain bullish buoyed by wider deficit in the market as unfavourable weather
implies constrained production and lower inventory levels. Similarly, we are
cautiously optimistic on our outlook for rubber prices premised on ITRC’s decision
to support prices by imposing a quota on production.
Elsewhere, our outlook for CPO, sugar, and wheat are bearish underpinned
by favorable weather conditions which guides to higher production, elevated
inventory levels as well as persisting market surplus. Overall, we maintain a
mixed outlook for commodity prices over 2018.
Dissecting the impact of trends in global soft commodity markets on
corporates in the Nigerian FMCG sector, our bearish price outlook for wheat in
2018 should be gross margin positive for Flour millers including Flour Mills of
Nigeria, Dangote Flour and Honeywell Flour Mills, given that they import a
sizeable portion of their raw wheat input.
Similarly, higher rubber prices should be positive for Okomu’s revenue
from exports while lower sugar prices should support Dangote Sugar’s gross
margin. On the other hand, our expectation of further upticks in barley prices
suggests gross margin pressures for brewers including Nigerian Breweries,
Guinness Nigeria and International Breweries while higher cocoa prices in 2018
should be negative for Cadbury’s gross margin. Rounding up our coverage, lower
CPO prices should be negative for revenue of palm oil producers (Okomu and
Presco).
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