Monday 9 November 2015

Commodities terrible year and future prospects

Commodities have been a hot topic this year with many plunging to lows last seen during the panic of the Financial Crisis. The two factors stirring problems within the sector is a stronger dollar and weaker Chinese demand with the former burying the dagger deep in the soul of most producers that have been grappling with the failure to export enough to in demand nations as the dollar hampers the affordability.

I wanted to deal with a few cases and commentary around widely followed commodities and see if there's a distinct trend emerging and whether producers need to prepare themselves for a more bleak 2016.

Coal

One of the key players throughout the world and probably the easiest prey for climate change activists, coals use in the generation of electricity largely contributes to industrialised economies that rely on a consistent supply of electricity to power energy demanding machinery that manufacture millions of consumer goods in a day.

Coal is the cheapest yet the dirtiest form of commodity to produce electricity which is why some nations opt to build coal power stations to relieve short term demand. China is one of those examples as the migration of many people to newly built cities has required the government to set up these power stations in a relatively short span of time allowing the spotlight to be shone  on the nation's contribution to climate change.

I don't think the dip in coal consumption we seeing out of China has much to do with policy enforcement regarding the transition from dirty to clean energy, a programme like that would likely take years before we start to see any real changes, however I do believe that it's been caused by an overestimated expansion in output that has resulted in millions of tonnes of coal being brought to surface with no buyer able to purchase it due to demand.

We saw a huge spike in demand as China electrification process took flight so much so mining houses were unable to keep up with demand, we are now placed in a predicament where there's simply too much coal. I have no doubts that once China starts to grow again we could see a surge in prices but how long that will take is anyone's guess.
Grains

We'd all like to think cheaper grains price means less hunger in the world but we need to take cognisance of the fact that climate change is affecting the output every year and with an ever increasing global population refusing to halt, that in itself is placing a massive burden on farmers and various roleplayers to come up with a sustainable soultion.

We can see from the chart above the southern hemisphere nations producing wheat and corn are currently experiencing adverse drought conditions that could throw the balance out and possibly push up the price of both commodities.

Oil

The biggest casualty of the downturn that started before the rest of the commodities rot set in, oil players have been playing tug of war with each other over supply. The US who delivered on a threat to become energy sustainable by producing its own oil by capturing shale gas and then converting it into fuel has had its efforts hampered by the actions of OPEC who is insistent on not cutting back production.

OPEC's thinking is if it can lower the price of oil to such an extent it would push out shale gas producers who have to grapple with a higher cost per barrel due to high capital layout in setting up new wells. So far OPEC is succeeding with most wells operating dropping every week in response to the supply shock.

But that doesn't stop other players from taking advantage, nations such as Russia. The former communist state has been sealing crucial deals with big buyers such as the likes of China whilst the bickering in the oil price war continues.  The combined contribution to oil supply by Russia and OPEC is equivalent to 50% with the former making up 10%.

Countries such as Venezuela and Nigeria who aren't particularly efficient in the production or capable of managing such a dramatic downturn have both called on Saudi Arabia, the leader of OPEC to called an emergency meeting due to be held in December with Venezuela asking that Russia be included however that suggestion was shot down.

I believe the oil industry is an interesting place at the moment with many players now posing a threat to global oil supply dominance. There's a lot of politicking behind each one's motive but the trade off is greener energy becomes more expensive relative to the downturn in oil prices with not much optimism heading into 2016.

Platinum

 Precious metals and most notably platinum have seen prices fall off the cliff as the world demand for cars crashed into expectations with no sign of revival. Even the drop in oil prices wasn't enough to push consumers from trading up or buying a new vehicle.

Again this comes down to China where most of the growth in car sales is seen however with the drop off in economic activity and a debt burdened consumer dealing with constraints there isn't likely a chance of seeing any vigour coming into the sector.

In South Africa where the majority of the world's platinum is produced, miners have faced an uphill battle with labourers demanding a living wage that has led to unrealistic wage increases to be passed through ramping up the costs of production so much that it's forced these mining houses to start the process of retrenchment.

But the SA government has stepped in on a few occasions and pressured these companies to not go down the route of mass retrenchment as it would stall the economy. The real problem here is the government doesn't want egg on it's face by promising employment for all when the situation on the ground is anything but.

This has led platinum producers to continue producing at levels that are not sustainable and if they had a chance to cut back on the supply it could help prop up the price but at what cost. Lonmin the world's third largest producers has battled as hard as it could and is now facing possible closure due to its debt exposure it took out to appease everyone else.

The SA government is sitting in a catch 22 situation, it's either you let the platinum producers die and no one has a job or renegade on your promise and allow retrenchment to start, really tough choice but priorities have to be weighed up.
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