Commodities Update February 2024
Prices in aggregate moved lower over the past couple of months, but fortunes varied by commodity. Iron ore prices have been surprisingly resilient, as supply remains constrained. We also note that crude prices have surprised by weakening of late, but as global conflict and tensions persist, risks remain to the upside.
The following is based on text from the Westpac February 2024 Market Outlook. (PDF 381KB)
For more details on our longer-term forecasts see Westpac February 2023 Commodity Forecasts
Since our last commodities update in mid–December, there has been a broad weakening of commodity prices but, as always, not all commodities performed in the same way. Our broadest commodities index (Westpac Exports Price Index) is down close to 5% over the last two months with thermal coal leading the way, falling 20% over that period. LNG prices have fallen 12% while met coal is down 6%. But not all energy prices have fallen since December, Brent crude is up almost 7% on the back of the broadening conflict in the Middle East with Houthi attacks in the Red Sea disrupting shipping activity. Iron ore prices are also down 7% but at US$126/t are still surprisingly resilient compared to wide held expectations for prices to weaken though 2023. The base metals complex is broadly flat, but this was driven by a 5% rise in aluminium and lead contrasted with a 3% fall in nickel. Meanwhile gold has rallied 2%.
Given the ongoing troubles in the Chinese residential property market and construction industries, there is quite a bit of head scratching on why iron ore prices remain so robust. We have seen the number of foreclosed homes in China rise 43% in 2023 with 389,000 units impacted according to the China Index Academy. More recently, the Chinese administration had instructed heavily indebted local governments to delay or halt some state–funded projects as Beijing is trying to manage debt risks as it attempts to stimulate the economy. To top off 2023, the latest update on Chinese steel production was very disappointing with December output almost 11mt below our ‘forecast’ at just 67.44mt that was based on CISA data. We do note this is consistent with smaller, less efficient steel mills being shuttered, meaning the industry will hit the ‘just over 1bnt’ steel production cap that was imposed in 2023. Backing this up, the NDRC has noted that China will “continue to promote supply–side structural reform in the steel industry this year with a focus on high–end operations” and “will strictly control the increase in new steel capacity ... (and) speed up a green transition” suggesting that this story should continue through 2024.
On the 2024 outlook for iron ore, it does appear that China continues to focus on shutting down smaller, less efficient, higher polluting steel production. However, through the first half of 2023, steel production was well above forecast levels based on CISA data with inventory coming in modestly above the seasonal norm. Inventory levels dropped back towards seasonal norms through the end of last year which is not what you would expect to see if steel producers were indeed cutting back to meet official targets. Given this structural downward shift in steel production you must question why iron ore has been so robust.
We suspect there are two factors here. The first is iron ore supply is prudently managed by the major producers, and secondly, the Chinese steel industry restructuring with a focus on smaller mills, the larger coastal based mills are far more depended on imported ore.
As it has been the case for some time now, the major iron ore producers (in particular BHP and Rio Tinto while Vale production has been in the doldrums for some time) have been adept at matching shifts in demand with a corresponding adjustment to output. As you can see in the chart above, Chinese imports of Australian ore peaked in 2020 and have been tracking broadly sideways since then. This careful management of supply is, we think, providing a sound foundation under iron ore pricing. Total ore imports have been trending higher since 2021, as supplies from outside Australia have lifted, but total imports are still down from the 2020 peak.
As the charts above highlight so far this year we have seen steel input prices continue to drift higher while Chinese steel prices have been holding ground. As such, it is not surprising that the percentage of Chinese steel mills currently profitable is down to 26.4%, normally profitability improves as demand tends to lift at the start of each year but so far this year there is no sign of this and as input prices remain elevated, and steel prices suppressed, then this recovery is likely to be delayed for at least a few more months.
Utilisation of Chinese blast furnaces is cyclical hitting a peak around July and then again in October before hitting a low in late December or early January. The peak this October was stronger than the four-year average but is has since fallen aways as usual and was around average through January.
Electric arc furnaces (EAF) utilisation is a lot more seasonal than blast furnaces and not just because they are more expensive to run but also because they can be turned on and off as required whereas blast furnace must maintain a level of output to ensure the viability of the furnace. EAF utilisation tends to moderate though the start of the year as the economy goes into care and maintenance as the country heads into the Lunar New Year holiday then fires up as the holiday ends. In 2023 there was an unusual spike in utilisation of EAFs in December and so far, it has held up through January.
We know if there is a focus on pollution/emissions control the administration gives preference to EAFs over blast furnaces, but we are are still somewhat surprised by the strength of EAFs utilisation. Even more so given the pressure on mill margins.
On this question it is also surprising to see that local ore prices have not weaken more against imported ore if most of the adjustment in steel production is coming from the smaller, inland mills that are more dependent on domestic iron ore.
Turning to the crude oil market, we are somewhat surprised that prices dropped below US$80/bbl given the near-term upside risks for refined fuels (and refining margins or cracks) and thus crude prices due to the extreme cold weather in the US, a series of Ukrainian drone attacks on Russian refinery capacity, Houthi attacks on vessels in the Red Sea and growing risks that Iran could be pulled into more direct conflict with the US.
Clearly, the latter two risks remain potent drivers for crude markets in the short term, given how important the Suez Canal and Red Sea are to crude supply. During 2022, the number of tankers transiting the critical pinch–point between Yemen and Djibouti, the Bab al–Mandab Strait, which aptly translates as the Gate of Grief or the Gate of Tears, surged as Russian crude and products were forced to travel south to Asia due to EU sanctions and bans while Middle Eastern crude travelled north through the Suez canal and Sumed pipeline to replace that lost crude.
Daily transit calls for tankers through the Bab al–Mandab Strait in December 2022 were up 44% versus the average of the previous 3 years. However, in January 2024, daily transit calls slumped by 50%yr. Meanwhile, at the Suez Canal daily transit calls for tankers in December 2022 were up 46% versus the average of the previous 3 years but in January 2024, daily transit calls fell by 40%yr. Meanwhile transit calls round the Cape of Good Hope were up 82%yr in January 2024 emphasising where that disrupted traffic was flowing.
The IMF Port Watch data used here doesn’t allow us to differentiate between different types of tankers. However, Kpler notes that oil tanker transits through the Red Sea were down 23% in January compared with November, while the drop was much more pronounced for LPG and LNG which was down 65% and 73% respectively suggesting the impact has been more in fuels than crude markets. However, the longer the disruptions go on, the more structural the blockages become, and the more costs rise, and the greater the impact on crude plus liquids inventory. Hence our more positive near-term view on cracks and fuels, which is thus supportive of crude oil prices.
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