Commodities User Guide

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Commodities User Guide

  1. 1. Commodities Research Deutsche Bank@ July 2006 A User Guide To Commodities Global Markets Research Table of Contents Introduction .................. 1 Energy .......................... 4 Metals ........................ 20 Agriculture .................. 48 Commodity Indices .... 64 Exchanges & Turnover65 Conversion Factors..... 68 London Michael Lewis Global Head of Commodities Research Hong Kong Amanda Lee, CFA Strategist Johannesburg Gary Pearson Strategist Melbourne Peter Richardson Chief Metals Economist Joel Crane Strategist New York Adam Sieminski, CFA Chief Energy Economist Paris Mark Lewis Strategist IMPORTANT: All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research is David Folkerts-Landau available to customers of DBSI in the United States at no cost. Customers can access this IR at Managing Director http://gm.db.com, or call 1-877-208-6300 to request that a copy of the IR be sent to them. Global Head of Research DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN THE BACK OF THIS REPORT.
  2. 2. Deutsche Bank@ A User Guide To Commodities July 2006 Table of Contents Introduction......................................................................................................... 3 Energy ..................................................................................................................... 4 Crude Oil....................................................................................................................... 5 Oil Products .................................................................................................................. 8 US Natural Gas ........................................................................................................... 10 Liquefied Natural Gas ................................................................................................. 12 US Power ................................................................................................................... 13 Coal............................................................................................................................. 15 Ethanol........................................................................................................................ 16 CO2 Emissions ........................................................................................................... 18 Metals .................................................................................................................... 20 Precious Metals Gold ............................................................................................................................ 21 Silver........................................................................................................................... 23 Platinum...................................................................................................................... 25 Palladium .................................................................................................................... 27 Other Platinum Group Metals: Rhodium, Iridium, Ruthenium.................................... 29 Industrial Metals Aluminium .................................................................................................................. 31 Copper ........................................................................................................................ 33 Lead............................................................................................................................ 35 Nickel.......................................................................................................................... 37 Tin............................................................................................................................... 39 Zinc ............................................................................................................................. 41 Iron Ore ...................................................................................................................... 43 Steel ........................................................................................................................... 44 Other Metals: Cobalt, Molybdenum, Uranium ........................................................... 45 Agriculture ......................................................................................................... 48 Coffee......................................................................................................................... 50 Corn ............................................................................................................................ 52 Cotton......................................................................................................................... 54 Lumber ....................................................................................................................... 56 Soybeans .................................................................................................................... 57 Sugar .......................................................................................................................... 59 Wheat ......................................................................................................................... 61 Deutsche Bank’s Commodity Index Suite .................................... 63 Commodity Exchanges & Turnover ................................................. 64 Conversion Factors ...................................................................................... 67 2 Global Markets Research
  3. 3. July 2006 A User Guide To Commodities Deutsche Bank@ Introduction July 11, 2006 To Deutsche Bank’s Clients: The nationalisation of energy resources in Bolivia provides an example of how highly st prized commodities have become in the 21 Century. For many emerging market economies, commodity exports constitute more than 60% of total exports. To address the growing importance of global commodity markets we are publishing the Deutsche Bank User Guide To Commodities. It is the second in our Commodity Guide series following the publication of the Deutsche Bank Investor Guide To Commodities in April 2005, which examined the properties of commodities as a distinct asset class. This report is divided into the four broad sections: energy, precious metals, industrial metals and agriculture. It covers over 30 commodity markets and identifies, among other things, the key producer and consumer nations, the commodity’s major uses and, where applicable, the commodity exchanges on which they are traded. I hope you, our clients, find this guide instructive. Michael Lewis Global Head of Commodities Research (44 20) 7454 2166 michael.lewis@db.com Figure 1: Commodity exporters by country Figure 2: Top 25 commodity futures Iraq W TI Crude Oil (NYMEX) Nigeria No. 1 Soybeans (DCE) Venezuela Soy Meal (DCE) Kuwait Chile Alum inium (LME) Zambia Corn (CBT) Saudi Arabia Brent Crude Oil (ICE) Russia Corn (DCE) Iran Soybeans (CBT) Peru Copper (LME) Ecuador Natural Gas (NYMEX) Bolivia Gold (TOCOM) Brazil Gasoline (TOCOM) Colombia Gluten W heat (ZCE) New Zealand Gold (NYMEX) Australia Gasoline (NYMEX) South Africa Heating Oil (NYMEX) UAE Sugar #11 (NYBOT) Egypt Major energy Copper (SFE) Argentina exporting countries Gasoline (CJCE) Annual turnover in 2005 (m ilion lots) Canada Major agricultural Gas Oil (ICE) Indonesia exporting countries Energy future Non-GMO Soybean (TGE) India Major metal Agricultural future United States Cotton (ZCE) exporting countries Mexico Zinc (LME) Metal future Malaysia Mixed portfolio of W heat (CBT) commodity exports China Fuel Oil (SFE) 0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 Commodity exports as % of total exports (2005) Source: DB Global Markets Research, National Sources Source: NYMEX, DCE, LME, ICE, TOCOM, CJCE, TGE, SFE, CBT, ZCE Global Markets Research 3
  4. 4. Deutsche Bank@ A User Guide To Commodities July 2006 Energy Energy security and the effects of burning fossil fuels on the environment are st considered two of the most pressing issues facing the world economy in the 21 Century. To some, global warming and its effects on the environment pose more dangers to mankind that the rise in terrorism. At the same time, the surge in oil prices during this decade is encouraging the development of alternative energy sources such as nuclear, bio-fuels, fuel cell technology as well as renewable energies such as wind and hydro power. This is consequently increasing the strategic importance of many commodities such as uranium, platinum, ruthenium, water, sugar and possibly even corn. Even so, the world economy still remains heavily dependent on crude oil. Although OPEC oil production as a share of world oil production has fallen from 50% to approximately 35% over the past 30 years, this ratio is expected to rise in the years ahead. This reflects OPEC’s control of 75% of proved global oil reserves, of which 80% are located in the Middle East. Energy markets, and specifically crude oil, are the deepest and most liquid of all the four broad commodity sectors. The NYMEX WTI crude oil futures contract is the most actively traded commodity future anywhere in the world. Annual turnover in 2005 reached 60 million lots, twice as liquid as its nearest rival the ICE Brent futures contract. Figure 1: Global oil reserves by country Figure 2: The world’s energy futures contracts Estimated world oil reserves Saudi Arabia OPEC-11 Contract Exchange Turnover (million lots) 1201 billion barrels (end 2005) Iran 17% Iraq WTI Crude Oil New York Mercantile Exchange 59.65 23% Kuwait Brent Crude Oil Intercontinental Exchange 27.41 United Arab Emirates Natural Gas New York Mercantile Exchange 19.14 Venezuela 2% Gasoline Tokyo Commodity Exchange 17.45 Libya Nigeria Unleaded Gasoline New York Mercantile Exchange 13.17 6% Qatar Heating Oil New York Mercantile Exchange 13.14 Algeria Indonesia Gasoline Central Japan Commodity Exchange 11.97 11% Russian Federation Gas Oil Intercontinental Exchange 10.97 3% USA Fuel Oil Shanghai Futures Exchange 9.81 Other 3% Kerosene Central Japan Commodity Exchange 9.79 Kerosene Tokyo Commodity Exchange 7.30 7% 10% Crude oil Tokyo Commodity Exchange 1.98 8% Brent New York Mercantile Exchange 0.99 8% Natural Gas Intercontinental Exchange 0.44 Source: BP Statistical Review, DB Global Markets Research Source: NYMEX, ICE, TOCOM, SFE, CJCE (2005 data) 4 Global Markets Research
  5. 5. July 2006 A User Guide To Commodities Deutsche Bank@ Crude Oil History & properties Petroleum, or crude oil, is a complex mixture of various hydrocarbons found in the upper layers of the Earth’s crust. The word petroleum derives from the Greek petra meaning rock and elaion meaning oil. In ancient Mesopotamia around 4000BC, a tarry crude was used to make ships watertight as well as being used as an adhesive. Crude oil was also used in the construction of the pyramids, embalming by the Egyptians and as a body paint by native Americans. It was believed to have medicinal th benefits in ancient Persia and Sumatra. The first oil wells were drilled in 4 Century China using bits attached to bamboo poles. However, the commercial drilling of oil began in Titusville, Pennsylvania by Edwin Drake in 1859. There are over 130 different grades of crude oil around the world. Their grades are mainly a function of sulphur content and gravity. The highest quality crudes are those with low sulphur content and a high specific gravity. Specific gravities measure the weight of the oil relative to water. The higher the API gravity (measured in degrees, º), the lighter the compound. Figure 2 identifies the main benchmark crude oils according to specific gravity and sulphur content. On this basis West Texas Intermediate (WTI), the US benchmark crude oil and Malaysia’s Tapis are the best quality crude oils in the marketplace. The heavier, sour crudes from the United Arab Emirates and Mexico are of a poorer quality and consequently trade at a discount to WTI. Sweet crudes are defined as those with a 0.5% sulphur content or less while sour crudes have a sulphur content of 1.5% or more. The area between 0.5-1.5% is sometimes referred to as intermediate sweet or intermediate sour. The reference to sweet and sour relates to the early days of crude oil production as one of the easiest ways to judge the sulphur content of crude oil and products was by taste and smell. Major producers Saudi Arabia is the world’s largest producer as well as exporter of crude oil. Although the US is the world’s third largest oil producing nation, it is also the world’s largest importer of oil, representing 26% of cross-border trade in oil. The largest oil reserves exist in Saudi Arabia, Iran and Iraq. In terms of annual production, OPEC’s market share has declined from about 50% in 1973 to around 35% today. However, this share is expected to rise as non-OPEC oil production flattens and given that the 11 OPEC member countries hold 75% of the world’s proved crude oil reserves. . Figure 1: Crude oil price since 1960 Figure 2: Different crude oil grades compared 80 4 Crude oil price (USD/barrel) Cheap 70 Maya (Mexico) 3 Arab Heavy (Saudi) 60 SOUR BCF-17 (Venezuela) Kuwait (Kuwait) 50 Dubai (UAE) SULPHUR CONTENT (%) Bow River (Canada) 2 Basrah (Iraq) 40 Mars (US) Saudi Lt (Saudi) 30 Urals (Russia) Expensive 1 Oman (Oman) ANS (US) 20 Brent (UK) WTI (US) 10 Bonny Lt (Nigeria) SWEET Tapis (Malaysia) Daqing (China) 0 0 15 20 25 30 35 40 45 50 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 HEAVY °API GRAVITY LIGHT Source: DB Global Markets Research, IMF (monthly data) Source: DB Global Markets Research, EIA Global Markets Research 5
  6. 6. Deutsche Bank@ A User Guide To Commodities July 2006 Figure 3: The world’s top 10 oil producers, consumers, exporters and importers in 2005 % of % of % of % of Producers mmb/d world Consumers mmb/d world Exporters mmb/d world Importers mmb/d world Saudi Arabia 10.89 12% US 20.66 25% Saudi Arabia 8.84 18% US 12.99 26% Russia 9.48 11% China 6.59 8% Russia 6.82 14% Japan 5.41 11% US 7.47 9% Japan 5.41 7% Norway 2.69 5% China 3.14 6% Iran 4.24 5% Russia 2.66 3% Iran 2.66 5% Germany 2.46 5% Mexico 3.76 4% Germany 2.60 3% Venezuela 2.40 5% S. Korea 2.17 4% China 3.62 4% India 2.59 3% UAE 2.35 5% France 1.87 4% Norway 3.06 4% Canada 2.26 3% Nigeria 2.35 5% India 1.70 4% Canada 3.01 3% Brazil 2.18 3% Kuwait 2.19 4% Italy 1.66 3% Venezuela 2.97 3% S. Korea 2.17 3% Iraq 1.82 4% Spain 1.57 3% UAE 2.88 3% Saudi Arabia 2.06 3% Algeria 1.71 3% Taiwan 1.00 2% World 84.3 100% World 83.7 100% World 50.0 100% World 50.0 100% Source: International Energy Agency, BP Statistical Review, DB Global Markets Research Major consumers The United States remains the largest consumer of oil, accounting for 25% of world consumption. In 2005, China overtook Japan to become the world’s second largest th oil consumer. Since 1995 India has moved from being the 13 largest oil consuming th nation to the world’s 6 . Brazil has also moved up the league table of oil consuming th th nations from 12 to 8 place over the same period. Looking ahead, China is expected to post the largest incremental increase in oil demand during the current decade and consequently overtaking the US from the previous decade, Figure 4. Major uses Fuel products constitute the vast majority of demand for petroleum. Gasoline is used to power automobiles, light trucks, boats, recreational vehicles and farm equipment. Kerosene is used for commercial aircraft, while distillate fuel oils such as diesel and heating oil are used to power buses, trucks, trains and machinery, heat buildings and fire industrial boilers. Liquefied petroleum gases (LPGs) such as propane, ethane and butane are used for domestic heating and cooking, farming and as a gasoline alternative. Petroleum is also used in the petrochemical production of solvents, lubricating oils, waxes, asphalt, fertilizers, pesticides, synthetic rubber and plastics. Figure 4: Oil demand growth in key consuming nations (million b/d) Country 1990-2000 Country 2000-2010E US 2.69 China 3.86 China 2.23 US 2.14 India 1.13 India 0.78 S. Korea 1.09 Saudi Arabia 0.50 Brazil 0.72 Iran 0.44 Saudi Arabia 0.67 Indonesia 0.39 Indonesia 0.45 Canada 0.36 Spain 0.42 Thailand 0.34 Japan 0.35 Russia 0.33 Thailand 0.32 Taiwan 0.31 Source: IEA, DB Global Markets Research 6 Global Markets Research
  7. 7. July 2006 A User Guide To Commodities Deutsche Bank@ Figure 5: The price of crude oil relative to income Figure 6: Crude oil turnover by exchange G7 per capita income divided by the price of oil 70 Annual turnover in m illions of lots for: 2500 Brent futures contract Oil price decline helps to 60 (ICE) boost the purchasing power W TI futures contract 2000 of a G7 consumer (NYMEX) Number of barrels of oil 50 1500 40 30 1000 Higher oil prices cut 20 the purchasing power 500 of a G7 consumer 10 0 0 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: DB Global Markets Research, IMF Source: NYMEX, ICE Exchange traded Crude oil futures and options are traded primarily on the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE). Brent crude is generally accepted to be the world benchmark, and is used to price two-thirds of the world’s internationally traded crude oil supplies. In the US, the West Texas Intermediate (WTI) crude oil is the benchmark. Price conventions & codes Crude oil is priced in US dollars per barrel. The Bloomberg tickers for the WTI and Brent crude oil generic one month futures contracts are CL1 <CMDTY> and CO1 <CMDTY> respectively. The Bloomberg ticker for the DB Crude Oil total returns and excess returns indices are DBRCLTR <INDEX> and DBRCL <INDEX> respectively. The Bloomberg ticker for the DB Crude Oil-Optimum Yield total returns and excess returns indices are DBLCOCLT <INDEX> and DBLCOCLE <INDEX> respectively. Global Markets Research 7
  8. 8. Deutsche Bank@ A User Guide To Commodities July 2006 Oil Products History & properties The commercial drilling of crude oil by Edwin Drake in 1859 was first seen as an opportunity for kerosene to compete with whale oil in the illumination market. However, technical progress in petroleum refining from simple distillation (boiling the crude oil in a vacuum) to the extraction of gasoline and other light products (via more sophisticated thermal and catalytic cracking and reforming) for transportation and heating purposes led to rapid demand growth for crude oil. The different types of oil products contained in a barrel of crude oil will each have their own boiling temperature. As a result, oil products are lumped into groups called fractions, which are determined according to that product’s boiling point, Figure 1. Figure 1: Refined products by type Boiling Point (ºF) Fraction Less than 90ºF Liquefied Petroleum Gases: Butanes, Propanes & Lighter 90-220ºF Gasoline 220-315ºF Naphtha 315-450ºF Kerosene, Jet Fuel 450-800ºF Diesel, Gas, Fuel & Heating Oils 800ºF and higher Residue Source: Petroleum Refining, William Leffler, DB Global Markets Research Since there are more than 130 different crude oil grades, refineries can be optimised to produce “cuts” or fractions that are best suited to the characteristics of the crude oil being run and the type of products that are most in demand in the local markets. Figure 2 outlines the proportion of the various petroleum products that are derived from a US and European barrel of crude oil. Figure 2: A barrel of US and European crude oil: the petroleum products spectrum 100% Light Propane/LPGs Gasoline/Naphtha Kerosene/Jet Fuel Yields in % volume on crude intake 80% Diesel/Heating Oil Residual Fuel Oil Other Oils 60% 40% 20% Heavy 0% US (WTI) Europe (Brent) Source: EIA, DB Global Markets Research 8 Global Markets Research
  9. 9. July 2006 A User Guide To Commodities Deutsche Bank@ Refined products by use Not surprisingly different parts of the crude oil barrel have different uses. The US tends to favour crudes with a high gasoline cut and favours complex refineries that can produce clean, light products. Also, the US emphasises liquefied petroleum gas (LPG). Propane is a liquid under low pressure, is easy to burn and is typically used in locations where natural gas is not available. It is also used as a chemical feedstock for making ethylene and propylene. Butane is used predominantly as a motor gasoline blending component as it is good for starting cold engines. Normal butane is also used as a chemical feedstock. Terminology for the other products can vary around the world. For example, heating oil in the US is referred to as “gas oil” in Europe. Jet fuel in the US and Europe is referred to as kerosene in Asia. The term gasoline is used globally in spark-ignited combustion engines although “petrol” is a more common term for gasoline in the UK. In the US, gasoline is often referred to as “gas” but should not be confused with natural gas. The term distillate normally refers to middle distillate fuels which incorporate the middle cuts of the refined barrel: jet fuel, diesel, gas oil, fuel oil and heating oil. Figure 3: Refined product futures turnover by contract 20 Annual turnover (futures only, m illion lots 2005) 15 10 5 0 G asoline G asoline H eating oil G asoline G as O il Fuel O il K erosene K erosene (T O C O M ) (N Y M E X) (N Y M E X) (C JC E ) (IC E ) (S FE ) (C JC E ) (T O C O M ) Source: TOCOM, NYMEX, CJCE, ICE, SFE Prices The Bloomberg tickers for the one month generic heating oil and gasoline futures contract are HO1 <CMDTY> and HU1 <CMDTY> respectively. The Bloomberg codes for the DB Heating Oil total returns and excess returns indices are DBRHOTR <INDEX> and DBRHO <INDEX> respectively. The Bloomberg codes for the DB Heating Oil-Optimum Yield total returns and excess returns indices are DBLCOHOT <INDEX> and DBLCOHOE <INDEX> respectively. Global Markets Research 9
  10. 10. Deutsche Bank@ A User Guide To Commodities July 2006 US Natural Gas History & properties Natural gas is a colourless, odourless, highly flammable gaseous hydrocarbon which gives off a great deal of energy when burned. Although it consists primarily of methane, it can also contain ethane, propane, butane and pentane. It is relatively clean burning, emitting relatively low levels of harmful combustion by-products. Although there is some evidence for the abiogenic existence of methane in the earth’s mantle, most geologists favour the view that gas, like coal and oil, was formed via the compression and decomposition of organic material over long periods of time. It is typically found in the same geologic formations below the earth’s surface that trap oil, that is, in permeable mineral layers that are capped by non- porous sedimentary rock. Natural gas seeps were first discovered in Iran between 6000 and 2000BC. These naturally occurring surface leaks could sometimes be ignited by lightning strikes. A similar ‘burning spring’ was found in Greece around 1000BC and became the site of the Temple of Oracle in Delphi. Around 500BC, the Chinese used natural gas to boil sea water to produce fresh water. The first gas well in the US was drilled in 1825, and connected by pipeline to users in Fredonia, New York. Like oil, natural gas is described as sweet or sour depending on, in the case of gas, its hydrogen sulphide content. Hydrogen sulphide is highly poisonous and is removed during processing. Because methane is odorless, natural gas distribution companies add a harmless, but, stinky chemical (mercaptans) to the gas prior to distribution to end-users so that consumers can more easily detect leaks. Gas is also described as wet or dry depending on the presence of natural gas liquids (NGLs) and other energy gases. If natural gas is greater than 90% methane then it is referred to as dry. Wet gas can be “stripped” of the NGLs (or LPGs) at facilities called gas processing plants. Finally, natural gas is described as associated or non-associated depending upon whether or not it is associated with significant oil production. In the US, only 20% of natural gas reserves are believed to be oil associated. Major producers The US and the countries of the former Soviet Union are the largest producers of natural gas. The Russian natural gas industry is dominated by Gazprom, which controls 95% of production. In the US, Texas, Louisiana, Alaska, New Mexico and Oklahoma hold more than half of the country’s reserves. Other major producers include Canada, the United Kingdom, Algeria, Iran and Norway. World natural gas reserves are estimated at 5,210.8 trillion cubic feet (Tcf). Europe and the former Soviet Union together hold 42% of world reserves, while 34% is located in the Middle East. Figure 1: The world’s top 10 natural gas producers, consumers, exporters and importers in 2005 % of % of % of % of Producers bcf/d world Consumers bcf/d world Exporters bcf/d world Importers bcf/d world Russia 57.9 22% US 61.3 23% Russia 18.7 27% US 11.4 16% US 49.9 19% Russia 39.2 15% Canada 9.1 13% Japan 7.8 11% Canada 17.9 7% UK 9.2 3% Norway 7.8 11% Germany 6.8 10% UK 8.5 3% Canada 8.8 3% Algeria 6.2 9% Italy 6.4 9% Algeria 8.5 3% Iran 8.6 3% Turkmenistan 4.1 6% Ukraine 5.2 7% Iran 8.4 3% Germany 8.3 3% Indonesia 3.6 5% France 4.4 6% Norway 8.2 3% Japan 7.8 3% Trinidad 2.8 4% S. Korea 3.2 5% Indonesia 7.4 3% Italy 7.6 3% Qatar 2.7 4% Spain 3.1 4% Saudi Arabia 6.7 3% Ukraine 7.0 3% Malaysia 2.4 3% Turkey 2.6 1% Netherlands 6.1 2% Saudi Arabia 6.7 3% Netherlands 2.3 2% Mexico 1.0 1% Total 266.4 100% Total 266.0 100% Total 69.8 100% Total 69.8 100% Source: BP Statistical Review, DB Global Markets Research 10 Global Markets Research
  11. 11. July 2006 A User Guide To Commodities Deutsche Bank@ Figure 2: World natural gas reserves by country Figure 3: US natural gas price since 1990 16 US natural gas price (USD/mmBtu) Russia 25% 27% 14 Iran Qatar 12 Saudi Arabia 10 UAE 8 US 3% 6 Nigeria 3% Algeria 4 3% Other 2 16% 4% 4% 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 15% World total: 6,112Tcf Source: DOE/EIA, (2005) Source: DB Global Markets Research, Bloomberg Major uses Burning natural gas is relatively clean, producing 30% less carbon dioxide than petroleum and 45% less than coal. The major use for gas is in homes, businesses and factories for heating, cooking and cooling. Natural gas is increasingly used as a source of energy for electricity generation via gas turbines and steam turbines. Compressed natural gas is used as a vehicle fuel for public transport buses. In addition, natural gas is used as a base ingredient in the manufacture of ammonia, anti- freeze, fabrics, glass, steel, plastics and paint. Regulatory matters Natural gas was originally considered an undesirable by-product of oil production. As a gas, it is more difficult to transport than oil and it was often flared-off, or burned at the wellhead as a disposal method. Gas flares are still common in Africa, the Middle East and parts of the Former Soviet Union that do not yet have the infrastructure for the utilisation of gas. Rules that prohibit flaring are now becoming increasingly common. Around 1950, the development of high-strength steel pipelines made it possible to transport natural gas over much longer distances and this, combined with the development of offshore drilling, has resulted in a significant increase in the use of natural gas. Gas tends to be much more highly regulated than oil (in many countries) because of the tendency for natural gas transportation and distribution to be concentrated in the hands of fewer suppliers. Exchanges & prices Natural gas futures are traded on the New York Mercantile Exchange (NYMEX) in units of 10,000 million British thermal units (mmBtu), for delivery via the Sabine Pipe Line Co. Henry Hub in Louisiana. There is also a natural gas futures contract listed on the ICE, but turnover in 2005 was negligible. The Bloomberg ticker for the one month generic US natural gas futures contract is NG1 <CMDTY>. Global Markets Research 11
  12. 12. Deutsche Bank@ A User Guide To Commodities July 2006 Liquefied Natural Gas (LNG) History & properties Liquefied natural gas, or LNG, is a clear, colourless liquid formed when natural gas is cooled to -162°C. It is odourless, non-toxic and non-corrosive. Liquefaction takes place in independent units called trains, and begins by removing impurities which would freeze at low temperatures. The gas is then cooled under high pressure, condensed, and then reduced in pressure for storage. The resulting liquid is 1/600th of the volume of natural gas, and about half as dense as water. Purified LNG is usually composed of 90% methane and small amounts of ethane, propane, butane and heavier alkanes. The history of natural gas liquefaction dates back to Michael Faraday, who th experimented with the process in the 19 Century. The first compressor refrigeration machine was built in 1873 in Munich by German engineer Karl Von Linde. Subsequently, LNG plants were built in West Virginia in 1912 and Cleveland, Ohio in 1941. The first LNG tanker, the Methane Pioneer, transported LNG from Louisiana to the United Kingdom in 1959, demonstrating the viability of long-range transport. In 1964, Algeria became the first continuous large-scale exporter. Major producers The world’s largest LNG producers and exporters are Indonesia and Malaysia, with exports going to Japan, South Korea and Taiwan. Algeria supplies Europe and the US, while Qatar exports to Spain and India in addition to Japan and South Korea. Russia and Iran possess the world’s largest proved gas reserves, but do not yet have liquefaction capability, although there are LNG projects currently underway in both countries. Major uses LNG’s primary benefit is its ease of transportation and density of storage. It can be transported efficiently over long distances where pipelines are not an option. Specially designed seagoing vessels incorporate double hulls and specialized storage tanks. At the receiving terminal, LNG can be stored or reheated into gaseous form and distributed via pipeline. Exchange traded The trade in LNG is conducted via long-term sale and purchase agreements (SPA) which typically extend for over 15 years. Figure 1: Major exporters & importers of LNG Figure 2: US LNG natural gas storage Exporters bcf/d Share of world total (%) Importers bcf/d Share of world total (%) bcf/d 1995 2000 2005 2010E 2015E Indonesia 3.05 17% Japan 7.39 40% 25 Malaysia 2.76 15% S. Korea 2.95 16% Qatar 2.62 14% Spain 2.12 12% 20 Algeria 2.49 14% US 1.73 9% Australia 1.44 8% France 1.24 7% 15 Trinidad 1.36 7% Taiwan 0.93 5% Nigeria 1.17 6% India 0.58 3% 10 Oman 0.89 5% Turkey 0.47 3% Brunei 0.89 5% Belgium 0.29 2% 5 UAE 0.69 4% Italy 0.24 1% Total 18.28 100% Total 18.28 100% 0 Atlantic Basin Demand Pacific Basin Demand Source: BP Statistical Review, DB Global Markets Research (2005 data) Source: US DOE/EIA, DB Global Markets Research 12 Global Markets Research
  13. 13. July 2006 A User Guide To Commodities Deutsche Bank@ US Power History & properties The origins of the US power industry date back to 1882 and the establishment of the Pearl Street electricity generating station in New York city. Electricity is measured in watts and watt-hours and unlike other commodities can not be stored. The market for electricity involves three activities: production, transmission and distribution. The US operates approximately 10,000 power plants with an average thermal efficiency of 33%. Efficiency has not changed much since 1960 due to the long life of a power plant. The average age of a power plant in the US is 30 years. In terms of transmission, the US operates 275,000 miles of high voltage power lines arranged in three networks. The average loss in transmission is around 5-7%. Distribution involves the handoff from high voltage lines to low voltage distribution networks to deliver power to the consumer. In 1940, 10% of the US’s total energy consumption was used to produce electricity. Today it is 40%. Annual revenues for electrical utilities are around USD350bn or 2.5% of GDP. Electricity is also one of the most capital intensive sectors in the US with current assets valued at USD1.3tn. The US power market is fragmented along regional lines and according to Regional Reliability Councils. The move towards deregulation of the US power sector began in the 1970s. Trust in the industry was damaged by the Three Mile Island accident in 1979. Moreover the 1970 Clean Air Act as well as the subsequent two oil price shocks encouraged the more efficient use of fossil fuels as well as the development of alternative energy source. Technological improvement in power generation also occurred at a time when there were large price discrepancies in electricity prices across the US, suggesting that price discrimination was occurring in the industry. Figure 1: The US power market by region ECAR Region is dominated by coal power (83%) MAAC Region has a relatively high nuclear component (38%) SERC Region has more natural gas capability (12%) than other regions Source: DOE/EIA, DB Global Markets Research Global Markets Research 13
  14. 14. Deutsche Bank@ A User Guide To Commodities July 2006 Today there are three types of utility companies in the US: 1) Publicly owned utilities These are owned and operated by municipalities, states or the federal government. They produce electricity and sell it to consumers or other utilities at cost. 2) Investor Owned Utilities (IOUs) These are owned by private shareholders. Most IOUS are beginning to divest their energy production and focus on distribution. Around three-quarter of the US power grid is owned by these companies. 3) Cooperative utilities These were created by the government to provide electricity to rural areas deemed unprofitable by the IOUs. They are government subsidised non-profit entities free from state or local taxes. There are two basic types of power generators today and they can be distinguished by the type of load they handle namely base or peak load. Baseload plants are typically steam driven. These must be run at full capacity and are difficult to start up and shut down. Peak load plants usually use gas turbines. They operate at a lower efficiency, but can be started up and shut down rapidly. Exchange traded In February 2003, the Commodity Futures Trading Commission (CFTC) approved NYMEX’s monthly, weekly and daily Pennsylvania/New Jersey/Maryland (PJM) electricity futures contracts. The monthly contract started trading on April 11, 2003 and is based on the electricity prices in the Pennsylvania/New Jersey/Maryland (PJM) Western hub at 111 delivery points, mainly on the utility transmission systems of PPL Corporation and FirstEnergy Corporation. This contract is priced in US dollars per megawatt hour. At the beginning of this year, NYMEX launched a further five electricity futures contracts. The new contracts are: ISO New England peak daily futures, NYISO A peak daily futures, NYISO G peak daily futures, NYISO J peak daily futures and Cinergy hub peak daily futures. The PJM Interconnection administers the largest electricity market in the world serving more than 44 million customers in Delaware, Illinois, Indiana, Kentucky, Maryland, New Jersey, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and Washington D.C. The power companies within PJM operate more than 1,000 generating units, representing more than 137,000 megawatts of capacity fuelled with coal, natural gas, oil, nuclear and hydro power. This generating and distribution network is also tied to the power grids of the Midwest, New York State and other areas in the mid-Atlantic states. 14 Global Markets Research
  15. 15. July 2006 A User Guide To Commodities Deutsche Bank@ Coal History & properties Coal is a fossil fuel. It is combustible, sedimentary, organic rock which is composed mainly of carbon, hydrogen and oxygen. Coal is classified into four types, lignite, sub- bituminous, bituminous and anthracite according to their carbon and water content. The harder the coal, the less moisture it has and the more efficient when it is used as a fuel. Lignite has the lowest carbon content and heating value and alongside sub- bituminous coals are used primarily for electricity generation. Anthracite has the highest carbon content with the lowest amount of moisture and hence has the highest energy content of all coals. It is used in high-grade steel production. Bituminous, which is sub-divided into thermal and metallurgical coal, is used for both electricity generation and for making coke in steel production. Historians believe coal was first used commercially in China for smelting copper and th for casting coins around 1000BC. The demand for coal surged during the 19 Century during the industrial revolution and at the end of that century, the development of the coal industry became closely tied to electricity generation when the first coal-fired electrical power plant came into operation in New York in 1882. Major producers The largest coal producing countries are China, USA, India, Australia and South Africa. China is not only the world’s largest producer, but, also the largest consumer of coal. Two-thirds of the worl’s coal reserves are located in Europe, Eurasia and the Asia Pacific. On current technologies, there is enough coal to last for another 200 years. Major uses Coal is primarily used to generate electricity, accounting for almost forty percent of electricity production worldwide. Large quantities of coal are also used in the manufacture of steel. It is also used in cement manufacturing as a liquid fuel. Exchange traded Coal futures are traded on the New York Mercantile Exchange (NYMEX). The contract trades in units of 1,550 tons and is priced in dollars per ton. The two main coal price contracts are the Tradition Financial Services (TFS) API#2 and API#4 Coal Indices. The API#2 is the arithmetic average of the McCloskey Coal Information Services (MCCIS) NWE Steam Coal Marker, which tracks steam coals used for electricity generation and the International Index compiled by Energy Argus in its COAL Daily index. This tracks shipments of coal to northwest Europe. The TFS API#4 price is the arithmetic average of three prices: the FOM Richards Bay price published in the McCloskey Fax, the Spot Coal Price Index published in the South African Coal Report and the FOB Richards Bay published in Energy Argus’s COAL Daily. Figure 1: The world’s top 10 coal* producers, consumers, exporters and importers in 2004 Tonnes % of Tonnes % of Tonnes % of Tonnes % of Producers (Mn) world Consumers (Mn) world Exporters (Mn) world Importers (Mn) world China 1,956 42.2% China 1,428 30.7 Australia 219 29.0 Japan 183 24.2 US 933 20.1% US 885 19.0 Indonesia 107 14.2 Korea 79 10.5 India 373 8.0% India 343 7.3 China 86 11.4 Taiwan 60 7.9 Australia 285 6.1% S. Africa 158 3.4 S. Africa 67 8.8 Germany 39 5.1 S. Africa 238 5.1% Japan 143 3.0 Russia 65 8.6 UK 36 4.8 Russia 210 4.5% Russia 142 3.0 Colombia 52 6.9 Russia 27 3.6 Indonesia 129 2.7% Poland 73 1.5 US 43 5.7 India 27 3.6 Poland 100 2.1% Korea 71 1.5 Canada 27 3.6 US 25 3.3 Kazakhstan 83 1.8% Germany 58 1.2 Kazakhstan 22 2.9 Netherlands 23 3.0 Ukraine 62 1.3% Australia 56 1.2 Poland 19 2.5 Spain 23 3.0 Total 4,629 100% Total 4,646 100% Total 754.3 100% Total 754.9 100% Source: World Coal Institute (* includes both steam and coking coal) Global Markets Research 15
  16. 16. Deutsche Bank@ A User Guide To Commodities July 2006 Ethanol History & properties Ethanol also known as ethyl alcohol, grain alcohol or simply alcohol, is a clear, colourless, flammable liquid. The natural production of ethanol occurs through the fermentation of carbohydrates. Archaeological evidence of alcoholic beverages has been found in 9,000-year-old pottery remains from northern China. However, th distillation was developed in the Middle East in the 8 century and pure ethanol was first prepared in 1796 by Johann Tobias Lowitz by charcoal filtering. Ethanol’s chemical formula was determined by Nicolas-Théodore de Saussure in 1808, and it was first created synthetically in 1826. Attention in recent years has been focused on the use of ethanol not just as a pollution-reducing additive to gasoline, but, also as an alternative renewable fuel. In Brazil, ethanol is made mostly from sugar while corn is the main feedstock for ethanol in the US. Major producers & consumers The United States and Brazil are the dominant producers of fuel ethanol, each producing approximately 4,200 million gallons, equivalent to 70% of world production in 2005. Brazil leads the world in the use of fuel ethanol, where it can be produced competitively as long as oil prices stay above USD30 per barrel. Brazilian gasoline is required by law to contain at least 25% ethanol. As of 2005, 80% of all new cars in Brazil have flexible-fuel engines, which can run on any combination of gasoline and ethanol. Figure 1: The world’s top 10 ethanol producers in 2005 Millions gallons % of world US 4,264 35% Brazil 4,227 35% China 1,004 8% India 449 4% France 240 2% Russia 198 2% Germany 114 1% South Africa 103 1% Spain 93 1% UK 92 1% World 12,150 100% Source: Renewable Fuels Association Major uses The largest single use of ethanol is as a motor fuel and fuel additive. The increasing use of ethanol as a gasoline additive in the US was enhanced in 2006 by government action to ban the use of methyl tert-butyl ether (MTBE) as an oxygenate fuel additive, which has been responsible for groundwater and soil contamination. Ethanol produces fewer emissions of carbon monoxide and oxides of nitrogen, and can be produced at lower cost than gasoline. In the US, all vehicles can run on a 10% ethanol blend, E10, but it is commonly available only in the US Midwest. However, ethanol production is heavily subsidised by up to USD0.51 per gallon yet ethanol only has 66% of the energy content of gasoline. Other countries requiring various ethanol blends include Argentina, Thailand and India. Brazil is the most efficient producer of ethanol, by virtue of the fact that its primary feedstock is sugar cane rather than corn. For each unit of energy used in production, sugar cane yields 8.3 units, while corn yields only 1.3 units. One difficulty with ethanol is that it cannot be transported by pipeline due to its chemical volatility. 16 Global Markets Research
  17. 17. July 2006 A User Guide To Commodities Deutsche Bank@ Figure 2: Corn use in US ethanol production Figure 3: Ethanol price since 2005 4.5 1400 Corn use in US ethanol production Ethanol price (USD/gallon) (Bushels million ) 4.0 1200 3.5 1000 3.0 800 2.5 600 2.0 400 1.5 200 1.0 0 May-05 Jul-05 Sep-05 Nov-05 Jan-06 Mar-06 May-06 1980 1983 1986 1989 1992 1995 1998 2001 2004 Source: National Corn Growers Association Source: DB Global Markets Research, Bloomberg Exchange traded Ethanol futures contracts have been traded on the Chicago Board of Trade (CBOT) since 2005. Ethanol futures are also listed on the CME and NYBOT. The CBOT ethanol futures contract calls for delivery of 29,000 gallons of denatured fuel ethanol, and is quoted in US dollars and cents per gallon. There is virtually no liquidity in this contract. The Bloomberg ticker for the CBOT generic one month futures contract for ethanol is DL1 <CMDTY>. Global Markets Research 17
  18. 18. Deutsche Bank@ A User Guide To Commodities July 2006 CO2 Emissions History and properties CO2 is the molecular formula for carbon dioxide, an atmospheric gas comprising one carbon and two oxygen atoms. CO2 was first recognized as a gas distinct from air in th the 17 Century by the Flemish chemist Jan Baptist van Helmont, who noticed it as a product of combustion after burning charcoal. CO2 is one of the greenhouse gases (GHGs) that contribute to the natural greenhouse effect, the process by which solar energy is trapped within the Earth’s atmosphere. In recent decades, concern has grown within the international scientific community over the increasing concentration of GHGs within the atmosphere which is associated with the industrialisation process of the last 250 years. Antarctic ice-core samples indicate that CO2 concentrations in the atmosphere were fairly constant at around 280ppm (parts per million) until the Industrial Revolution, but that since 1800 there has been a steady increase in CO2 concentrations up to today’s level of 375ppm. This concentration continues to increase at the rate of approximately 1.5ppm per year, and a similar pattern has been observed with concentrations of other GHGs. The concern is that this increase in GHG concentration levels has intensified the natural warming effect of existing GHGs in the atmosphere, and increased the average temperature of the Earth by approximately 0.6°C between 1850 and 2000. The International Panel on Climate Change (IPCC), a UN body set up in 1988 to improve understanding of global warming, estimates that if the current rate of increase in GHG emissions in general, and CO2 in particular, is not arrested, the Earth’s average temperature will rise by between 1.4°C and 5.8°C by 2100, with increasingly severe and potentially catastrophic consequences for the planet. Emissions trading as a response to climate change The recommendations of the IPCC and UNFCCC (the United Nations Framework Convention on Climate Change) are to slow the rate of increase in and then reduction of GHG emissions. In adopting this stance the UNFCCC has identified six GHGs. It is these that the 1997 Kyoto Protocol commits the signatories to reducing relative to their 1990 emissions levels. The six gases are ranked in terms of an index that measures their global warming potential (GWP) relative to carbon dioxide. So, carbon dioxide has a GWP of 1, methane of 23, and so on, all the way up to sulphur hexafluoride, which is 22,200 times more powerful than carbon dioxide in terms of its impact on the Earth’s temperature, when released into the atmosphere, Figure 3. Figure 1: Annual CO2 emissions limits on EU Member States’ industries in Phase 1 (2005-2007) of the ETS Member CO2 Member CO2 Member CO2 State allowance % of total State allowance % of total State allowance % of world Germany 499.0 22.8 Belgium 62.9 2.9 Estonia 19.0 0.9 UK 245.3 11.2 Finland 45.5 2.1 Lithuania 12.3 0.6 Poland 239.1 10.9 Portugal 38.2 1.7 Slovenia 8.8 0.4 Italy 232.5 10.6 Denmark 33.5 1.5 Cyprus 5.7 0.3 Spain 174.4 8.0 Austria 33.0 1.5 Latvia 4.6 0.2 France 156.5 7.1 Hungary 31.3 1.4 Luxembourg 3.4 0.2 Czech Rep. 97.6 4.4 Slovakia 30.5 1.4 Malta 2.9 0.1 Netherlands 95.3 4.3 Sweden 22.9 1.1 Total 2,191 100 Greece 74.4 3.4 Ireland 22.3 1.0 Source: European Commission, Deutsche Bank estimates (units are million metric tons) 18 Global Markets Research
  19. 19. July 2006 A User Guide To Commodities Deutsche Bank@ Figure 2: Liquidity in emissions trading since Figure 3: Index of global warming potential of December 2005 GHGs relative to CO2 100 Monthly turnover in carbon credits (million tonnes) Greenhouse Gas Global Warming Potential (GWP) 80 Carbon dioxide(CO2) 1 60 Methane (CH4) 23 40 Nitrous Oxide (N2O) 296 20 Hydrofluorocarbons (HFCs) 12-12,000 Perfluorocarbons (PFCs) 5,700-11,900 0 Dec-04 Feb-05 Apr-05 Jun-05 Aug-05 Oct-05 Dec-05 Feb-06 Apr-06 Sulphur hexafluoride (SF6) 22,200 Source: RWE Source: UNFCCC Under the Kyoto Protocol, a global scheme for trading these GHGs in units of one tonne of CO2 equivalent (CO2e) will begin from the start of Phase 2 (2008-2012) amongst those countries that have ratified the Protocol. There will be four main types of carbon credits tradable under the Kyoto Protocol: Assigned Amount Units (AAUs), Certified Emissions Reductions (CERs), Emissions Reductions Units (ERUs) and Removal Units (RMUs). However, a European trading scheme for CO2 emissions (the ETS) has already been operating in the European Union since 2005, and the unit of currency in the ETS is European Allowances (EUAs). Exchange traded & price conventions EUAs are traded over the counter and on various European exchanges, for example, Powernext, the EEX, and Nordpool. CERs are traded over the counter and are already fungible with EUAs within the ETS. ERUs will also be fungible within the ETS from 2008 onwards. CO2 emissions-allowances are priced in euros per tonne. Global Markets Research 19

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