Setting the stage for the next oil bull market?

While history never repeats, so the saying goes it often rhymes. Recent developments in the oil market may hark back to an earlier time – the period from 1999 to 2002. According to a recent report from Goehring & Rozencwajg highlighting the similarity between the two periods oil prices and oil related equities in particular are seriously undervalued.

But before looking at where we are today first a recap.

Oil prices fell to a low of $10.72 per barrel in December 1998, in a spasm of near panic selling. The Economist magazine published an edition titled ‘Drowning in oil’ in March 2009 argued that given productivity gains and the poor outlook for the economy that, “$10 might actually be too optimistic. We may be heading for $5.”

A month later OPEC agreed to cut production and oil prices rallied strongly to $37 per barrel by September 2000; the rise in prices that year prompting OPEC to agree to two production increases. Oil prices gradually pulled back to $25-$30 per barrel range over the next 12 months on higher OPEC and non-OPEC supply combined with fears of a slowdown in growth.

After the 9/11 terrorist attacks oil prices dropped over 40% driven by fears of collapsing global demand. Oil prices eventually bottomed at $17 per barrel in November 2001. This then set the stage for the boom that followed with oil prices rising almost 8 fold over the next 7 years.

So how does the past few years compare? Here’s what Goehring & Rozencwajg have to say:

Oil prices bottomed in panic selling back in the first quarter of 2016, just as they did back in 1999…And just like the pullback of 2001, the pullback in oil in the second half of 2018 created a huge surge of bearish market sentiment. In 2001, the underlying fundamentals in global oil markets had improved dramatically from 1999. Oil demand, led by the non-OECD world, was about to surge and non-OPEC oil supply was about to hugely disappoint. Few energy analysts anticipated these huge changes about to take place.

In many ways we are again in the same position as 2002. Because of the temporary imbalance in global oil markets, prices pulled back, and have now stabilized some 60-65% above their 2016 cycle-lows, (just as they did in 2001). Because of the US Federal Reserve quantitative tightening, Trump trade wars, and worries over potential debt problems in China, investors and energy market [commentators] believe we will to see significant downward revisions in 2019 and 2020 global oil demand (also similar to 2001). Finally, we believe we’re going to see a significant overestimate of future non-OPEC oil supply, just as we did back in 2001.

IF history does rhyme then the potential for an asymmetric setup looks very promising. Especially since energy stocks as a proportion of the overall S&P 500 are lower now than they were in 2002/03!

So where could the unanticipated demand growth come from to propel the next bull market in oil? In previous notes we’ve highlighted the strong oil demand growth potential in countries like India (see below) as energy infrastructure and road networks are rolled out. Meanwhile, the growth in electric vehicles may also prove to be much slower than forecast. Up until now demand has been supported by generous subsidies, which in many cases are being gradually removed. Finally, although the risk of a recession or at least a slowdown is much higher that it was a year ago the experience of the early 2000’s may point towards a much quicker rebound in activity and so growth in oil demand.

And what about non-OPEC supply growth? Why might that continue to underwhelm? Most oil companies are still budgeting on a lower-for-longer basis and so the oil majors’ overriding focus is on cost containment rather than engaging in ambitious projects. Big energy companies are focusing on US shale and other short-term efforts over the long-term mega-projects seen in years past, all of which spells bad news for longer term non-OPEC supply stability.

Related article: How electric cars may end up supporting the next bull market in oil

Related article: Curve ball: How the ‘S’curve can help investors focus on the long term

Related article: Drowning in oil? In defence of The Economist’s oil price articles
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Charge of the lithium brigade: Solid state batteries and metal demand

A recent Bloomberg article highlights the challenge facing the car industry if it is to deliver an electric vehicle that’s inexpensive, safe and capable of traveling 500 miles on a single charge. That quest has zeroed in on solid-state technology, an overhaul of a battery’s internal architecture to use solid materials instead of flammable liquids to enable charging and discharging.

If it can be mastered, the article suggests solid-state technology could help speed the demise of the combustion-engine car and potentially slash electric vehicle charging times to about 10 minutes from as much as several hours.

The challenges are enormous, but the opportunity is potentially enormous for investors betting on the right metal before the bullish narrative is born, and are swift enough to know when the narrative is getting tired.

But which metal? George Heppel from CRU had this to say on LinkedIn in response to the article (my highlight in bold):

The massive growth in interest in electric cars has prompted widespread speculation on what form the next-generation battery will take – but for now, conventional battery technologies are here to stay for the next 10 years at least. Nickel, cobalt and lithium will continue to be the key EV battery materials. Cobalt may continue to be thrifted out in exchange for higher nickel content, but it is unlikely that it will be removed entirely – and any thrifting will be more-than made up for by an increase in battery demand.

Looking further forward (10+ years), I broadly agree with the article that solid-state batteries are the most likely next major step in battery technology. This would result in a decrease in nickel and cobalt demand and a corresponding increase in lithium demand as graphite anodes are replaced with lithium metal. Interestingly, this additional lithium demand will most likely take the form of lithium metal as opposed to lithium carbonate or hydroxide. Major investments into lithium metal refining capacity will need to be made in order to meet demand.

As ever its important to know that any bet on a particular energy metal is a bet on innovation. Technological developments of all sorts involve a large dose of serendipity and its impossible to say for certain how innovation in batteries will evolve. The lesson from history is that metal price spikes (of all kinds but particularly minor metals like lithium and cobalt) tend to be spectacular, but ultimately brief.

Related article: Electric dreams: If you thought predicting oil prices was tricky, try cobalt or lithium

Related article: What lessons does rhodium have for commodity investors?

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Tin prices: The top 10 most important drivers

1) Low liquidity

The LME tin contract is simply too illiquid to be on the radar of most funds. Unlike the major base metals such as copper whose price is heavily driven in the short term by funds eyeing macro-related factors like currencies and trade flows, the tin market is just too small in terms of volume. That means its price can be volatile and driven by obscure tin related factors that maybe hidden from all but the most seasoned tin market observers.

2) Concentrated, volatile supply

Three countries account for 66% of global mined tin supply; China with one-third share of total supply, followed by Indonesia and Myanmar both with a 17% market share.

Indonesia has traditionally been the wildcard, and thats a problem given that it is also the largest global exporter of tin. Earthquakes, monsoons and regulatory battles with major producers have frequently curtailed production from the exporter. That being said, any hit to exports in the past have tended to be brief.

Myanmar emerged as a major new source of tin around 2013, when significant tonnages of mine concentrate first started being imported by China. The sustainability of the tin mines in Myanmar’s Wa region has been the question of much debate in the tin market, with suggestions that reserves are being depleted rapidly.

3) Soldering demand the primary driver

The main application for refined tin is for soldering (accounting for 47% of demand in 2017). Electronics component miniaturisation and economisation remain the greatest threat to tin use in solders – an ever-decreasing amount of metal is being used to achieve the same performance. This is offset by market expansion and the opening of new markets such as robots, e-bikes and electric vehicles.

Chemicals and tinplate account for 18% and 14% respectively, followed by lead batteries with an 8% market share leaving 13% for other uses.


Photo by Chris Ried on Unsplash

4) New technologies

According to the International Tin Association there were more than 5,000 scientific papers and patents on tin related technologies published in 2017 demonstrating a strong future for this versatile element. Energy uses and technologies are the strongest new use drivers, with tin additions to lead-acid batteries and solder used for joining solar cells already benefiting. Over the next decade tin has many opportunities in lithium-ion and other batteries, solar PV, thermoelectric materials, hydrogen-related applications and carbon capture.

The challenge for investors (as with nickel) is understanding the impact that new technology demands could have on the metal versus the established end markets.

5) Stock levels

In theory rising tin stock levels should be indicative of a weak market, as supply exceeds demand. It is normal for prices and inventory levels to generally move in opposite directions. When tin producers don’t like the market price and think that they can get a better one by waiting, they put their production into warehouse storage and wait for better times. When prices rise up to or above a price level that the producers like, tin starts coming back out of inventory and onto the market. So watching tin inventory levels can give us insights about where the producers think a fair price is.

Both the LME and the Shanghai Futures Exchange (ShFE) report tin stocks. Traders should monitor the change in tin inventories at both exchanges for clues about tin supply and prices.

6) US dollar

Like most internationally traded commodities tin is priced in US dollars. At its most basic a decrease in the value of the US dollar relative to a commodity buyer’s currency means that the purchaser will need to spend less of their own currency to buy a given amount of the commodity. As the commodity becomes less expensive demand for the commodity rises, resulting in an increase in the price and vice versa.

A weaker dollar can also act as a disincentive to producers to increase output. The prospect of a lower profit margin acts as an incentive to decrease the supply of the metal.

7) Conflict minerals

Under the Dodd Frank Act of 2010 companies are required to investigate their supply chains for tin, tantalum, tungsten or gold mined and then sold to finance insurgent militia groups in the DRC and surrounding central Africa region. Tin may pose the biggest challenge for companies looking to rid their supply chains of “conflict minerals” blamed for funding violence in the Democratic Republic of the Congo.

8) Chinese demand

As families furnish their homes with large appliances the demand for tin typically increases. Since China is the largest global end user of tin (accounting for around half of refined tin use) the price of tin typically reacts in advance to signs of faster or slower growth in Chinese demand.

9) Input prices

Tin occurs in cassiterite ore bodies, and breaking down these ore bodies to extract the metal expends energy. Producing tin requires ample supplies of coal, electricity and crude oil. Mines and blast furnaces utilize energy to extract tin ores from the ground and process it into tin. These costs can have a big effect on primary production. Similarly, the costs of scrap tin can impact the price of secondary production.

10) Political interference

In the past the Indonesian government has attempted to tighten its grip on the country’s independent tin sector. Meanwhile, China has cracked down on illegal mining operations in a bid to improve environmental standards.

Related article: Copper prices: The top 10 most important drivers

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