In what has been a closely fought contest, iron ore looks set to narrowly defeat crude oil as the worst performing major commodity of 2015.
Benchmark 62% iron ore fines have fallen by just over 42%, narrowly shading a decline of more than 36% for benchmark Brent crude. It’s been an ugly year, and one that has got many analysts asking just how severe the declines may be heading into the new year.
While there are divergent views across the marketplace, it’s safe to say the NAB’s economics team sits firmly in the bear camp when it comes to the outlook for both commodities.
In the bank’s “10 themes for 2016” report today, they suggest stubborn oversupply and weak demand conditions ensure risks remain tilted to the downside heading into 2016.
Here’s a snippet on what they expect, starting with iron ore.
For iron ore in particular, a sharper slowdown in global steel output (especially in China) could potentially drive iron ore prices closer to US$30/tonne – roughly the break-even prices for major Australian miners – compared with our current forecast average of US$42/tonne. Chinese iron ore production will also remain the swing factor – while production has fallen 8.5% so far in 2015, this remains stronger than previously anticipated despite its lower grade and higher cost of production (above the current spot price).
The chart below, supplied by NAB, reveals the troubling demand-side story for the iron ore price. Steel consumption in China – the world’s largest consumer – is now trending lower, leading to reduced steel output as a consequence.
This clearly had ramifications for the iron ore price, given it’s the chief ingredient used in steelmaking, particularly given the huge uplift in seaborne supply coming from the likes of Australia and Brazil.
As the NAB points out, in the absence of a sharp decline in Chinese iron ore production, weak demand and burgeoning supply could weigh heavily on theprice next year.
Like the iron ore market, they also suggest that increased supply and weak global demand could see the crude price slip even further.
The global oil glut is also expected to continue into 2017 as market competition becomes more decentralised, with major producers from the US and Middle East continuing to supply at a robust rate in a bid to defend market share and sustain revenue. There now appears significant downside risk to our forecast for oil prices in the high US$40s/bbl to low US$50/bbl in the first half of 2016. Significant upside risks to production from OPEC, accompanied by further expected appreciation in the USD, suggest that oil prices could go as low as in the US$20s in 2016 under a worst case scenario.
However, unlike the outlook for iron ore, the NAB suggests price declines of the magnitude outlined in their worst case scenario would not last for very long “given that they are significantly below the cost of production for most high-cost producers”.
Even so, if the risks outlined by the NAB come to fruition, it’ll likely have severe and wide-ranging ramifications for marginal producers, and those who hold debt and equity in those companies.