Geopolitics and oil price volatility

Materials Risk has discussed the decline in commodity price volatility (and in oil prices in particular) a number of times over the past couple years. Macro factors such as monetary easing have helped with lower interest rates increasing the incentive to store commodities which, in turn increases the shock absorbing effect on prices. The oil market has been particularly interesting since despite the plethora of geopolitical concerns and significant supply outages oil prices have traded in a narrow range. A new chart from Bank of America Merrill Lynch shows that despite the interruptions to supply overall volatility in oil production growth has fallen to historic lows, suggesting that this may have been the main micro factor in dampening oil price volatility.


Related article: Oil prices caught in a vice

BofA Merrill Lynch go on to highlight the close relationship between conflict in energy producing countries (here measured by war casualties) and oil output. With war casualties in energy producing countries rising sharply in the past couple years they argue that this is likely to lead to more oil production outages in the future. However when you compare the chart of oil production volatility and the one below showing oil price volatility there appears to be little connection between the two. Oil production was significantly more volatile during the 1980′s and early 1990′s yet volatility remained low. While more recent spikes in oil price volatility are likely to have been caused by demand uncertainty as a result of the financial crisis than fluctuations in oil production (see more of BofA’s charts here).


Related article: Oil supply outages are becoming more common and difficult to predict

Related article: Is food price volatility about to return with a vengeance?

No sugar high in sight

Sugar prices have halved in value since mid-2011 as bumper harvests outpaced demand growth. Now sugar prices are currently trading near six-month lows, just below 16 cents per lb on the expectation that Brazilian farmers will again have a bumper crop with farmers reportedly harvesting their crop at a blistering pace. Brazil is the largest sugar producer, accounting for just over 20% of global production and almost 60% of global sugar trade flows.

Sugar cubes.jpg
Sugar cubes” by Uwe Hermann Licensed under CC BY-SA 3.0 via Wikimedia Commons.

According to Unica, mills in Brazil’s center-south region, which process 90% of the country’s cane have harvested 13% more sugar between April and mid-July than the same period in 2013. However, according to the investment bank Macquarie one reason for the rapid harvest is the dry weather following the drought that affected much of Brazil earlier in the year has enabled farmers to transport their cane from the fields much faster.

While the effects of the drought have inflated early crop indications by making it easier to harvest, there is also a suspicion that the drought also badly damaged the Brazilian crop with many forecasters predicting a lower harvest this year. Sugar output from other producers may also disappoint. India, the second largest producer (17%) has seen less rain than usual since the monsoon season began in June, although this may still be enough to cover domestic consumption.

However there are a number of factors, both and short and long term which might limit any potential upswing in prices, should the lingering effects of the drought reveal themselves in a poor crop.

First, Brazilian sugar farmers are suffering as current low prices are well below their cost of production. Although Brazil used to have the lowest sugar production costs in the world, levels have risen steadily over the past few years and now range between about 20 cents and 24 cents per pound, depending on the age and size of the mills. In addition farmers suffer from over-capacity, lack of storage and logistics and (unlike other producers supported by subsidies) unsupportive government policy. The mounting debt that has resulted has forced many mills to close but is also proving a bottleneck to restructuring, with many local banks owning the debt. All of which means that it may take some time for there to be a supply response to low prices.

Second, the Brazilian government has capped fuel prices in a bid to control inflation (up to 6.5% in August from below 4% back in 2007), but which also squeezed ethanol margins. To recap, sucrose extracted from sugar cane can be manufactured into either raw sugar or ethanol. In Brazil, typically 48% goes into making ethanol and 52% goes into producing raw sugar, which is then processed into refined sugar. According to sugar and ethanol cooperative Copersucar, ethanol demand in Brazil could increase by 8 billion litres to over 30 billion litres a year if the government were to allow state-owned oil major Petrobras to sell gasoline at market prices.

Third, high stock levels. According to Commerzbank high stocks thanks to previous years’ surpluses “should continue to prevent major price jumps.” The bank suspects that even if world production for 2014-15 falls 2-3 million tonnes short of consumption, as forecast by many observers, that this ” would not lead to a genuine scarcity” of supplies, after four successive seasons of production surplus.”

Related article: Excess sugar consumption leaves a bitter aftertaste


Resource nationalism risk seen down as ‘shale boom’ changes perception of scarcity

Some interesting comments from Antoine Halff, from the International Energy Agency (IEA) on how the shale boom in the US has changed oil-producing nations perceptions of scarcity and their ability to negotiate (read impose) better terms for them with oil companies.

In an interview with Bloomberg he said “Back in 2008, we were at the peak of a cycle of resource nationalism among producing countries. Now we’re in a completely different situation, where some of the very same countries that had indulged in resource nationalism are back-pedaling, and making their investment terms more attractive to foreign companies,” Going on to say “Many countries feel threatened by the unconventional revolution in the U.S. There’s competition for investment, competition for technology.”

This view contrasts with those expressed by Dambisa Moyo (author of Winner take all: China’s race for resources and what it means for the world) who believes that the slowing growth in some emerging markets will be one of the main drivers of government action towards resource nationalism, fearing that “…we will continue to see much more talk and much more action around natural resources in the years to come.”

And despite the apparent correlation between resource disputes and crude prices depicted in the chart below Jaakko Kooroshy from Chatham House believes that “…conflicts with governments will not disappear because prices have fallen. Governments will continue to look to get a good deal, and where they feel they’re not getting that…they may act on this.”