No prizes for guessing which commodity has dominated headlines through 2015. There had been speculation in the lead-up to the recent Opec gathering in Vienna that Saudi Arabia might be prepared to bring oil markets back into equilibrium (with non-Opec help) in 2016. A senior Opec delegate was cited as saying that a production cut would only go ahead if non-members such as Russia, Mexico and Oman committed to joint action. In the event, the cartel is moving ahead with its production ceiling of 30m barrels per day (bopd) as Saudi Arabia and the Gulf States obviously take the view that production cuts at this time would result in further loss of market share in North America.
Most industry analysts expect that the Saudis are prepared to play hard-ball for the foreseeable future. Norbert Ruecker, Head of Commodities Research at Julius Baer, certainly wasn't convinced that Riyadh was prepared to acquiesce to those OPEC members that have been pushing for a reduction in Saudi output: "We expect no bold step beyond homeopathic pledges. We maintain our neutral view and see prices trading around the $50 per barrel range". Meanwhile, Christopher Wheaton, energy fund manager at Allianz Global Investors, said that "although there's much talk of conciliation, we can expect no change to oil production out of Opec this time".
Hedge funds remain as bearish as ever
The speculation over a potential softening in the Saudi position came as the US Energy Information Administration reported that US output fell by just 20,000 barrels per day in September to a rate of 9.3m bopd. US benchmark West Texas Intermediate duly sank to a forward rate marginally above the multi-year low set in August. A recent Commitments of Traders report from the Commodity Futures Trading Commission (CFTC) highlighted that hedge funds reduced their long positions to July 2010 lows for the week ending 24 November 2015, while short positions increased 6.2 per cent for the same period. This suggests that US hedge funds remain as bearish as ever.
The impact of the continued slump has been relatively muted where the FTSE 100 is concerned. The UK benchmark is down by just 3 per cent since the beginning of the year, despite oil and gas stocks accounting for 12.3 per cent of the weighted value of the constituents (miners make up another 4.7 per cent). Over the same period, the FTSE 350 Oil & Gas Producers index has lost 16 per cent of its value.
Markets at saturation point
Beyond the experience of the oil companies, it's difficult to assess the wider impact of the falls. In the first quarter of this year, PricewaterhouseCoopers (PwC) modelled a study of the issue employing three alternative scenarios. In a case where the oil price settles permanently around $50 per barrel, UK gross domestic product (GDP) increases by around 1 per cent on average relative to the baseline between 2015 and 2020.
The outlook for Brent crude in the year ahead is resolutely downcast, according to recent analyst comment from two of the world's largest independent oil traders - Vitol and Trafigura. With global inventories on the rise and physical crude markets saturated, there are no immediate price catalysts looming into view. The surplus is building through new production channels initiated when oil was trading at $100 a barrel. Most producers would settle for an average rate 40 per cent down on that figure over the coming year - but even that might prove elusive.
Any old iron...
Sentiment towards the global mining industry remains in negative territory as we move into 2016, according to latest analysis from Fitch Ratings. The agency believes that prices for key industrial inputs will remain under pressure as "as the Chinese economy undergoes a gradual deleveraging and transition from investment to consumer-led growth".
Earlier this month, benchmark iron ore for immediate delivery to the port of Tianjin in China briefly breached the $40 a tonne mark. Prices rose from $20 a tonne in the early 1990s to $180 a tonne by 2012 as heady assumptions on Chinese demand growth gave way to rapidly expanding leverage ratios. The end result is that prices are collapsing to the lowest marginal cost of supply.
On the face of it, that's bad news for the FTSE 100 heavyweights Rio Tinto (RIO) and BHP Billiton (BLT). But it could represent an existential crisis for many of their rivals. Scale benefits flowing through from their low-cost sites in Western Australia's Pilbara region have reduced both group's break-even cost on iron ore to around 25 per cent below the current spot price. Analysis from UBS suggests that there's little headroom on profits at current prices for Brazil's Vale SA, while some smaller rivals are running at a loss.
The last men standing
So while the outlook on Chinese demand remains negative, it's conceivable that capacity will be driven out the market, providing a degree of support for prices. Both Rio Tinto and BHP have been criticised by politicians in Australia for pursuing what has been described as "a last man standing" strategy, but those same politicians were oddly muted when the mining groups were pouring billions into the Western Australian economy in recent years. For investors, Rio is in a stronger cash-flow position than BHP, particularly in light of the costs that the latter miner will have to bear as a result of the recent Samarco tailings dam breach in Brazil.
However, anyone thinking that cuts in global production capacity automatically translate into a commodity price rebound may have to temper their views given recent analysis from Macquarie Research, which suggests that a sustained recovery is dependent on structural demand growth. According to Macquarie, "it is demand that tends to lead a recovery, while supply reacts". So without a specific catalyst it's likely that any mining/commodities rebound will depend on a cyclical global economic recovery. The Macquarie analysts point out that this year marks the fourth consecutive year of price declines for base metals. Since 1970, average base metal prices haven't fallen for more than five years in a row, which suggests that we're heading towards the bottom of the cycle. But given that we've witnessed an unprecedented expansion of the industry, it's quite conceivable that we could also witness an unprecedented rate of retrenchment.
