5 May 2015, Stockholm, Sweden | News
Oil prices have recently gained support from a rapid decline in the number of active rigs in the United States. But this decline in production may be temporary, believes Handelsbanken's commodity analyst Martin Jansson. In the long run shale oil companies are likely to increase their activity again.
Continued price pressure is also expected on base metals as demand in China has peaked.
Martin Jansson describes the position of oil cartel OPEC as being stuck between a rock and a hard place. The oil market, which more or less ran itself at the start of this millennium, meant that the organisation could sit back and relax. But high prices have led to increased production elsewhere in the world, and once US shale oil was industrialised on an increasing scale Opec had to let the oil flow in order to not lose market share.
"Where we are now is that the price has decreased sharply and US producers have closed active rig numbers at the fastest pace ever. US output growth has levelled off in recent weeks, which means that oil prices have found good support and rebounded sharply," says Jansson in a conference call with Catella Fonder's Mikael Wickbom.
According to Jansson, production decline in the US is temporary and will probably come to an end in a couple of months. He expects that the focus on costs in the US shale oil industry will result in contracts under negotiation being signed at lower levels, which means that production can occur at a significantly lower price than before. A large proportion of producers are profitable with crude prices at around USD 65 a barrel.
"The industry will become more competitive in the long term, which means that the price of oil has a downside even from today's relatively low levels," says Jansson.
Other production sources, such as Canadian oil sands or deep-water discoveries off Brazil, are burdened by the very large initial investment for production to begin. But if, and when, they are in operation the costs change considerably. Jansson says that the oil sands in Canada require prices of up to USD 100 a barrel to justify a project getting underway, but once production has started a price of USD 30 a barrel may be enough to keep it profitable.
"This is why shale oil production in the United States is being targeted, because the initial investments are not as onerous. The shale fields will be the new swing producers that deviate from the market when prices fluctuate. I do not believe that we will see the stable oil market that many people are expecting – oil may fluctuate in a corridor of perhaps USD 15-20, which is quite a large percentage movement," he says.
The strengthening of the dollar has pushed down commodity prices generally. According to Jansson, this correlation is historically very strong. When the dollar experiences a large rise, commodity prices tend to fade, and vice versa. If you expect a weaker dollar going forward, commodities could be expected to gain support.
On the other hand, Jansson does not believe that the recent unrest in Yemen, and the Saudi attacks against targets in the country, will have any major impact. At least not in the form of production disruptions. However, the situation could make it even less likely that OPEC will reduce its production to make way for Iran if sanctions against the country are lifted. The reason is that OPEC leader Saudi Arabia sees Iran as its enemy, and hostility has been reinforced as the fighting in Yemen is largely a battle between Saudi and Iranian interests.
Martin Jansson is not one of those people who expect an upturn in commodity prices this year and next year. He instead foresees continued pressure on prices generally.
"Commodity prices have come down because China's commodity intensity peaked several years ago. There is no doubt that China's growth will decline further, so the short-term stimulus measures from China will have only a temporary impact. The past 15 years of high commodity prices have created new raw material production, not only in oil but also for virtually all metals, especially iron ore which also dropped 50 percent last year," he says.
Since this new production is out in the market and the ongoing costs to keep it running are relatively low, it will, according to Martin Jansson, be kept going even with low commodity prices. Unless demand suddenly increases dramatically there is no sharp rise in commodity prices on the horizon. This of course benefits the world economy as a whole and, not least, the US economy, which is largely consumer driven.
Martin Jansson points to natural gas and coal, which are also under pressure because the coal left over in the US is now being exported and is contributing to lower prices in Asia and Europe – not least cheaper electricity.
When Jansson about a year ago took part in a conference call with Catella Fonder, he highlighted oil, copper and iron ore as the three inputs that had not been under the same price pressure as others. Since then, prices of oil and iron ore have plummeted, and when it comes to iron ore the main reason is that China's demand peaked at the beginning of 2014 – ten years earlier than the market had anticipated. The major iron ore companies, which are Brazilian Vale and the three Australian behemoths BHP Billiton, Rio Tinto and Fortescue, still have expansion plans, which means that the price outlook remains bleak.
"If one of the four major decides that enough is enough, and quenches its expansion plans, then immediately one of its three competitors will take that share of the market. It's a very tricky game. I believe that eventually Australian politicians will have to intervene and cut back the expansion," says Jansson.
Of the commodities he a year ago predicted would decline, only copper remains. The metal has fallen back somewhat, but not as much as the others. One reason may be that copper, unlike the iron ore used to produce steel, comes in at a later stage of the construction process. A majority of the copper used in building projects is required in the final phase because copper is used in white goods, air conditioners, cabling and piping.
"The demand scenario for steel in China last year, which slashed the price of iron ore by 50 percent, will be experienced by copper in China this year," says Jansson, who however points out that copper is different in a number of ways. It is more difficult to find large new deposits of copper, and those that exist are often in politically difficult areas such as Mongolia.
"But I find it very difficult to see that copper is the only commodity that would resist gravity and not fall back to its production cost. I still see a downside in copper, but it may take a little longer than we thought," continues Jansson.
For other base metals like zinc and nickel, expectations have been raised for different reasons. In the case of zinc the closure of large mines has had an influence, and in the case of nickel the export ban in Indonesia raised hopes of a sustained rally. Jansson believes that zinc prices may well rise slightly since the large Century mine in Australia is exhausted and several major mine closures are expected next year.
"I absolutely believe that there will be a zinc rally and this will affect Boliden at home, but expectations are perhaps too high. A range of small mines will of course take the opportunity to increase their production in order to take market share as the big players exit. So after another 10 percent price rise the end of the road may be reached," he says.
As for nickel, expectations have already been lowered. Simultaneously with the export ban in Indonesia, demand slowed for stainless steel in China and, because stainless steel is the principal application for nickel, the lower demand meant that the rally stalled early.
Finally, the precious metal gold is, according to Jansson, currently just a play on when the US Federal Reserve will raise interest rates. Once the central bank shifts to tighter monetary policy the price of gold will fall, and much of this seems to have already been factored in.
"In the short term there may be some expectation that the Fed will act too late, so that inflation begins to rise in the United States. In this case gold may gain some support as a pure inflation hedge. But viewed in the longer term, if you anticipate a Fed hike, then short positions in gold or silver are probably a very good bet."