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Five things to watch in the commodity space in 2017

Gold could surprise on the upside, while coal might be less buoyant.

The past two years in commodities have supplied countless moments of fascination and intrigue to the neutral observer, as first the market collapsed towards the end of 2015 and then it dramatically rebounded last year. For those invested, it has been a wild ride indeed.

So what will happen in 2017? Does anyone know? Instead of attempting to predict and forecast the future, ING Bank published a report last week identifying the top ten factors it suggests keeping a close eye on in 2017. (We have distilled this down to five in the interests of brevity.)

Oil

OPEC and non-OPEC members reached a formal agreement at the end of November last year to cut 1.8 million barrels per day from combined production. “We have seen a positive start to embracing it,” says Warren Patterson, a commodities strategist at ING. “A few have already reported cutting production, but moving further down the line there could be signs it could fall apart.”

OPEC oil production

screenshot-2017-01-09-14-44-50

With the Brent crude oil price trading at $56 a barrel at the time of writing, there is a strong incentive for cartel members not to stick to their production targets. Discipline by all members is vital to achieving the goals of the cartel, and this particular agreement was signed by 22 countries, each in varying states of fiscal health. Venezuela, as one of the most vulnerable, could be the first to move away from the reductions imposed.

Also, two large producers – Libya and Nigeria – were given exemptions and both are planning on increasing production by a combined one million barrels per day this year, which could negate the overall effect.

“The agreement has been positive for sentiment, but the time it has taken to get the deal done has allowed competitors to adjust,” says Patterson. Which bring us to the next item we think worthy of your attention in 2017: the continued resurgence of US shale.

US oil production and exports

In the time it has taken OPEC to forge an agreement, US shale producers have been able to lower the break-even cost of production to between $30 and 50 a barrel. According to Patterson, this has occurred through the renegotiation of service agreements and the wider adoption of technology that has improved oil recovery rates from 30% to as high as 80%. 

US oil production has since rebounded off its low of 8.4 million barrels a day in July 2016, to reach 8.8 million as per the last available figures. “We expect them to get back to the 9-million-barrel per day mark this year,” says Patterson.

US oil rig count

screenshot-2017-01-09-14-46-23

Chinese coal market

China endured a volatile coal market in 2016, owing largely to the policy of restricting production days (days a mine could operate) from 365 to 276 with the intention of removing surplus capacity from the market. “This had an immediate impact on the price of coal – prices began to rally locally and internationally,” says Patterson.

The government later reversed the policy when it realised there could be shortages heading into winter, so they scrapped the limits. This saw coal production increase from 280 million tonnes in October to 308 million tonnes in November following the decision. Patterson expects a further increase when figures are released for December.

China coal production

screenshot-2017-01-09-14-47-29

It is unlikely the policy will be re-implemented. “I think they will be careful with their policy moving forward, so I think they will take a coordinated approach to reducing excess coal and steel capacity, but I don’t think it will put any pressure on production in the short-term,” says Patterson.

While renewable energy is growing in China, the country is still highly dependent on conventional coal-fired power. So the threat of substitution by renewables is one that will only become more evident over the longer term.

Chinese steel exports

China’s gamble is now beginning to cost it. To utilise surplus domestic steel-making capacity as it transitioned its economy, the industry began to aggressively export steel at prices that have since been determined to be below cost (i.e. defined as ‘dumping’).

According to ING, exports jumped from 56 million tonnes in 2012 to above 100 million tonnes in 2016. But China’s major trading partners – that included the US, EU and India – began imposing tariffs on Chinese imports, (South Africa included.) Another 17 investigations are ongoing, and other types of contraventions are now being investigated – such as the US looking into indirect shipments of steel from China through Vietnam.

Consequently, ING expects lower production from China and, with steel prices rising as a result of the trade protection, less supply and lower prices for feedstock. “This will feed into the whole chain, and will affect demand for iron ore and coking coal,” says Patterson. 

Much of the same will follow for Chinese aluminium.

Gold and precious metals

“Well it’s fair to say everyone got the market wrong towards the end of the year – particularly since Trump got elected,” says Patterson. “Investors have been attracted to equities and away from safe haven assets like gold on the back of his election to the presidency.”

Spot gold price 2016

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Source: IRESS

But there was also poor demand for physical gold which affected the price. Demand declined in China in response to the high prices seen in the earlier part of the year, while in India the demonetisation programme (where monetary authorities removed the two highest-denominated notes from circulation) affected jewellery demand.

But Patterson thinks there is still room for the price to rise.

“The biggest positive risk for gold are the number of elections in Europe. (Elections are scheduled to take place in France, Germany, the Netherlands, Czech Republic, Hungary, and Norway in 2017.) Populist parties coming to power could see a shift back to precious metals. The one offsetting factor is the US Federal Reserve that looks set to continue raising interest rates, but we think two to three increases have already been priced in,” says Patterson.

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