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Material Matters: Demand From Brazil And China, Coal And Oil

Commodities | Jun 29 2011

– Brazil increasingly important to commodities demand
– Chinese commodity trade data still solid
– Support for thermal coal prices
– Some positives in Chinese steel market 
– Release of strategic oil reserves only a short-term solution

By Chris Shaw

Among the BRIC economies of Brazil, Russia, India and China, Brazil is traditionally viewed as a key commodity supplier. But as Barclays Capital points out, the country is now becoming established as an important demand driver as well, thanks to rising economic growth and incomes levels and an increase in infrastructure spending.

This combination is boosting domestic commodity usage, Barclays noting over the past five years demand growth for copper, aluminium and oil has been 3-5% higher than for the preceding five years. This reflects a wealthier population gaining access to metals and energy intensive end-use products typically associated with higher income levels. 

Expected large infrastructure investment demand should keep Brazil's commodity consumption at high levels, especially given the momentum provided by new investment associated with the 2014 World Cup and 2016 Olympic Games. 

Barclays is forecasting an increase in the investment to GDP ratio to 22% by the middle of this decade, up from a current level of 18.5%. This implies a solid medium-term outlook for commodities demand.

Across in China, Barclays suggests trade data for May indicates commodity demand remains robust, even allowing for recent monetary policy tightening measures. Energy commodities offered the brightest news, with net crude imports jumping and net gasoline exports the weakest since February.

Thermal coal imports were also their highest since January, the May numbers representing a sharp turnaround from the past three months. Numbers for the metals were not as strong, but Barclays points out price signals continue to suggest tight domestic conditions across a number of key markets. 

Taking a broad view of commodities, Barclays suggests while headwinds are currently stronger, so too are the upside risks for prices. This is because if China can achieve a soft landing for its economy, the demand outlook continues to look strong. 

With inventory levels and spare capacity wearing thin in some markets there continue to be supply risks, especially given ongoing geopolitical and weather related events. Barclays suggests degrees of supply constraint will be the main differentiators of performance in commodity markets in coming months. Favoured to perform the best in the third quarter are crude oil, copper, corn and gold.

Short-term, Goldman Sachs suggests price direction is increasingly tough to call, as the market remains nervous given the Greek bailout and the fact fundamental market-related news is presently having a very limited impact on prices.

Thermal coal prices have been relatively stable of late, but as Macquarie notes this has been despite some surprising swings in both demand and supply. The biggest changes in terms of export and import flows have been a large increase in US thermal exports and a similarly large increase in imports by India.

While the increase in US exports had been expected, Macquarie still sees the magnitude as a surprise, as for 1H11 exports are likely to be more than double the previous corresponding half year. Much of the increase has gone to European and Atlantic buyers, though there have been higher shipments to Korea as well.

This increase in US exports would have been bearish for the market, states Macquarie, had it not been for lower Russian exports. If Russian tonnes fail to recover by the northern winter, Macquarie sees scope for pricing to move sharply higher into the end of the year.

Imports into India appear on track to increase by around 13Mt year-to-date in year-on-year terms, Macquarie suggesting this may be due to stocking ahead of the commencement of some new projects. This increase has so far been achieved without a strong increase in prices, Macquarie putting this down to higher supplies of material from Indonesia.

While further increases in both Indonesian and Australian exports are expected by the end of the year, Macquarie takes the view the increase may not be able to ramp up fast enough given more Indian units will be ramping up and Japanese demand should be back to more normal levels.

Chinese demand is also a big risk, as Macquarie expects power demand growth is likely to be much stronger than was the case last year. This sets the stage for prices similar to, or higher, than were experienced at the start of this year in Macquarie's view.

In steel, Macquarie sees signs of a two-speed market emerging in China as construction steels continue to enjoy solid margins while flat products are struggling at break-even levels. Looking ahead, Macquarie expects utilisation rates for flat products should improve to levels allowing for some margin expansion by the second quarter of 2012. There also appears to be a need for more long product capacity than is currently planned.

One trend to emerge in the Chinese steel market recently is the relative strength in non-residential construction. Commercial and office real estate is now running ahead of residential, Macquarie noting this is correcting several years of relative under performance. This trend is expected to continue for the next 2-3 years.

Medium-term, Macquarie also expects the Chinese auto sector to present a compelling demand story, as car ownership rates remain low and much of urban China is starting to enter the GDP per capita bracket that has triggered strong demand increases in other economies. 

On the supply side, Macquarie expects a slowing in capacity additions will lead to improving utilisation rates for both flat and long products. For long products, Macquarie currently estimates utilisation rates will grow to more than 100% in both 2012 and 2013, which means additional capacity will need be added or China will be forced to lift imports of construction steels.

Still on bulks, Commonwealth Bank notes spot iron ore prices have dropped below US$170 per tonne for the first time since June 2, closing at US$168.70 per tonne at the start of this week. In CBA's view, the falls reflects caution on the part of buyers given a thin market of late as well as recent weakness in steel prices.

Turning to oil, Deutsche Bank notes the International Energy Agency (IEA) has announced a coordinated drawdown of 60M barrels of strategic oil stocks. The move is in response to the oil price remaining stuck at a level seen as a significant drag on the global economy.

Deutsche also notes the move is viewed by the IEA as a way to give Saudi Arabia more time to gear up output, which would help offset the loss of supplies from Libya. Deutsche's view is the move is a risky one, as while it offers a short-term fix to the issue of higher oil prices, there remain a number of long-term components that still need to be addressed. 

One is that OPEC will still need to lift output sharply in 2012 given expectations of stronger demand. So while the IEA move may show some short-term success, Deutsche Bank takes the view eventually a fundamentally tighter oil market will force the IEA to accept higher prices for oil.

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