Weekly Commodity weekly Update 24.02.2011


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What began as a food crisis in North Africa entered the danger zone this week as oil rallied while Libya began to bleed. Rising energy costs are compounding the effects of already elevated food prices with the combined effect being a negative impact on global growth forecasts for 2011.

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Weekly Commodity weekly Update 24.02.2011

  1. 1. Modest supply shock lifts oil 20 dollars – what’s next?Since the unrest in North Africa began the price of crude has risen strongly despite only arelatively small disruption to oil supplies. A lack of confidence, verging on a state of fear, isnow hitting markets across the board.What began as a food crisis in North Africa entered the danger zone this week as oil ralliedwhile Libya began to bleed. Rising energy costs are compounding the effects of alreadyelevated food prices with the combined effect being a negative impact on global growthforecasts for 2011.The U.S. stock market, which up until now had been very resilient amid improved economicdata and ongoing quantitative easing, has run into its first major reversal since August, asfear of oil supply disruptions has begun to hurt confidence. Higher energy costs reduce thepurchasing power of households and increase companies’ production costs, thereby hurtingtheir profitability. JP Morgan has calculated that a 10 percent increase in the price of oillowers global growth by about 0.25 percent, with emerging economies being more exposed.Crude oil rose to thirty month highs this week with Brent racing towards USD 120 per barrelwhile WTI broke back above USD 100. Such a rapid ascent over such a short period of timehas lead to calls for oil potentially reaching USD 150 or even USD 220. The market hasbegun pricing in the effect of the current crisis spreading to the Middle East with SaudiArabia and Iran the main concerns as they represent 15 percent of global production.Meeting oil shortfallSo far supplies from Libya are being disrupted and the 1.6 million barrels per day itnormally produces could be lost for the foreseeable future. This has the potential of creatinga short-term bottleneck as the shortfall will have to be met by Saudi Arabia and the UAE,which hold most of the OPEC spare capacity of four to five million barrels per day. Thequality of North African oil however is better than that produced in the Middle East and assuch cannot directly be substituted on a one for one basis.
  2. 2. Tapping into spare capacity at this rate would reduce OPEC’s ability to offset any additionalsupply disruptions in the Middle East. But global inventories and spare capacity levels are ina much better shape than back in 2008, when prices spiked above USD 150. Back then thedollar was nearly 15 percent weaker versus the Euro but 25 percent stronger versus the yenmaking the impact being felt this time around the globe quite different.While the effect of higher prices over a prolonged period of time will impact variouscountries quite differently, analysis shows that countries like India, Indonesia and SouthKorea will begin to feel the sting when prices move above USD 110 dollars, while others likeGermany, China and Japan would first be impacted above USD 120. Back in 2008 crude oilstayed above USD 110 for five months, averaging 125 dollars during that period.Commodity performancePerformances across other commodities has been very mixed with the Reuters Jeffries CRBup 3.5 percent over the past week, driven higher by the energy sector which weighs heavilyin the index. Investors have been moving their money to safer assets and in the processhave reduced their exposure towards the agricultural and soft sectors. Copper, being aglobal indicator of growth, is suffering on the prospect of reduced economic activity.Silver outshines goldsince the unrest began the big winner in terms of price gains has been silver. It has gained23 percent during the last month reaching a 30-year high in the process and outperforminggold by 18 percent. Gold has been rallying but still finds itself below the highs from 2010, asflows out of ETFs continue amid a general sentiment of reducing exposure. Gold holds 59percent of all funds invested via commodity exchanged traded products and as such couldbe on the receiving end should risk aversion escalate further, thereby making furtherprogress somewhat slow.
  3. 3. Agriculture suffers on risk aversionThe agricultural sector, which rallied strongly during the first phase of the North Africantensions in Egypt, has done the opposite now as it’s all about energy rather than foodstability. Why is that?In order to understand this we have to look at the long positions, or bets on price gains, byhedge fund managers and other large speculators. As of last Tuesday the combined longfutures positions across wheat, soy contracts and corn were close to the record of onemillion lots from early February. As the crisis spread to the energy complex and thesubsequent impact on stock markets these positions began to be scaled back as part of anoverall move towards risk reduction.
  4. 4. The fundamentals that drove these markets to near records recently have not disappeared,but for the time being is just being ignored. Once this round of risk reduction ceases buyersare likely to return, given the supply outlook for 2011.A drought in northern China may worsen, thereby affecting wheat production while frostthreatens to hurt crops in Russia. Weather problems and the subsequent risk of supplydisruptions are going to stay with us for a while and will ultimately be the deciding factorimpacting prices. Meanwhile, corn prices are supported by the lowest stocks in 34 yearscombined with increased demand for ethanol, as gasoline prices rally.On a positive note, talking about food security it is worth pointing out that the price of ricehas now fallen 16 percent from the highs seen back in early February. India, the world’ssecond largest rice producer, said it was considering lifting a ban on exports as it preparesfor bumper harvests.ConclusionCurrent levels of excess oil capacity should help alleviate the fear of supply disruptions fromLibya. Major players like the U.S., OPEC and the IEA have all been trying to “pour oil on thewater” in an attempt to calm the seas. For now though the risk of contagion and riskreduction is driving sentiment so a period of increased volatility can be expected.
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