Commodities Update November 2023
Commodities rallied 3% through October as the gains in iron ore, LNG and copper more than offset the fall in coal (both met and thermal) and crude oil. Crude oil inventories have declined, despite softening demand, as OPEC+ maintains production cuts but the risk premia for the Middle East conflict has faded. Chinese scrap steel consumption fell as economics continues to favour blast furnaces but the introduction of an ETS should turn this around in favour of electric arc furnaces in 2025/26.
The following text is from the Westpac November 2023 Market Outlook (PDF 402KB)
For more details on our longer-term forecasts see Westpac November 2023 Commodity Forecasts
Through October the broad commodities index for Australian exports lifted 3% (still down 11% in the year) but, as always, there was quite a bit of diversity in individual commodity performance. Iron ore prices lifted 7% (up over 50% in the year) to be trading a touch under US$130/t as we went to press. The other standout in the month was gold which lifted 8% in the month (up 20% in the year) while copper prices had a modest rally of 2¼% (up 6% in the year). Crude oil prices have eased back from the recent highs, down –4½% in the month to be 12¼% lower in the year; and while the week average as we publish is US$82/bbl, overnight Brent closed at US$79.9/bbl. As a result, we have lowered our end 2023 forecast to US$82/bbl and March forecast to US$83/bbl.
Despite softer crude oil prices LNG landed in Japan firmed, lifting 6% in the month but this is still 38½% lower from last year’s Ukrainian invasion boosted level. This unwinding of the Ukrainian energy shock is also being seen, quite dramatically, in thermal coal markets where prices fell –16½% in the month to be down –68¼% in the year. However, at around US$127/t, thermal coal prices remain elevated compared to longer run historical prices. Contrast this with met coal, which China has not been able to lift production of in the same way they boosted the production of thermal coal, fell –4% in the month and is down just –10½% in the year. At US$258/t, met coal is still trading at a historical premium associated with significant Chinese demand from blast furnaces and limited supply in the seaborne market.
Westpac closely follows crude oil production, demand and inventories and observe that crude oil inventories have dropped sharply around the world because of the aggressive production cuts from Saudi Arabia and Russia. Our measure of OPEC+ production has dropped by 2.7mbpd over the last year with Saudi Arabia accounting for 2mbpd of that. If those production cuts by OPEC+ can be maintained into 2024, then this should underpin crude markets from an inventory perspective. However, demand for liquid fuels appears to be correcting. Diesel sales have fallen 13.4% in the year to September in France with the IEA noting that Europe’s diesel fuel demand in 2023 is set to be down by about 380kbpd compared to the 2019 pre–pandemic levels. For naphtha the results are even more stark, with consumption set to be about three quarters of what it was in 2021; this would the lowest EU diesel demand in 48 years according to the IEA.
China is providing something of an offset, importing the equivalent of 11.56mbpd of crude in October, up 13.5%yr and 13.4%ytd versus the 5 year average. However, Chinese exports of gasoline, diesel and other fuels fell to the lowest in four months as refineries came close to exhausting export licences. So, with chatter that the Chinese SPR has stopped refilling, private inventories are set to rise sharply, pointing to a likely significant slowdown in imports into the end of the year. As such, we have left our end 2023 forecast at US$90/bbl but note that recent events suggest the risk to that forecast lie to the downside. We feel that OPEC+ will do what it can to keep prices above US$80/bbl, hence our forecast for US$85/bbl through the first half of 2024, before the rate cuts in the US kick in to boost demand, plus weaken the US dollar, lifting Brent to US$92/bbl by end 2024.
We also closely watch Chinese consumption of scrap steel as it is a substitute for iron ore. As the Chinese economy matures, more scrap becomes available as steel infrastructure and products age. Over the last three years, China has consumed less scrap steel and, as a result, more iron ore. This is somewhat surprising as we would expect the supply of scrap to be lifting and the resulting increase in iron ore demand has resulted in a tighter iron ore market. This has resulted in a greater reliance on blast furnaces (BF–BOF), compared to electric arc furnaces (EAF), which is at odds with President Xi’s pledge in 2020 “to have CO2 emissions peak before 2030” and with the announced targets in the steel industry’s 14th 5Yr Plan. The Chinese steel industry accounts for around 15% of China’s total emissions and EAFs (which consume far more scrap than BF) emit around 0.5t CO2 per tonne of steel vs. BF–BOFs at around 2t of CO2 per tonne of steel.
It appears to us that the driving force behind lower scrap steel consumption is mainly economics, as it is currently more efficient in China (where there is a modern fleet of BF–BOFs) to produce steel from iron ore and met coal than from scrap steel and electricity (EAFs have been negatively impacted by high power and scrap steel prices plus softer rebar demand). As such, we expect demand for scrap steel to lift materially when the relative economics improve; this is likely to happen after the steel industry joins China’s Emission Trading System (ETS). When China set up its ETS in 2021 it indicated that the steel industry would join the ETS by the implementation of the 14th 5Yr Plan (expected by 2025). Is this likely to still happen? With the EU’s CBAM (Carbon Border Adjustment Mechanism) coming into effect from 2026 there will be much greater pressure on the Chinese steel industry to lower the carbon content of the steel it exports to the EU. It is likely that on joining the ETS, China’s steel industry would receive free allocations of carbon that, over time, would be reduced thus driving up the cost of carbon for BF–BOFs and increasing the appeal of EAFs. This would see the relative competitiveness of scrap steel improve. While scrap consumption is likely to be stable through 2024 it should start to lift around 2025/2026.
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