Which commodities are most affected by lower oil prices?

With oil prices down more than 50% since June its worth looking at what commodities are likely to be most affected by the slump and whats happened so far. The relationship is complex though and it may be too early to draw any firm conclusions. Given that energy accounts for up to 50% of the production cost of many commodities, a drop in the oil price reduces the price floor. In the longer term though all commodities could see higher demand (and prices) if the drop in the oil price eventually stimulates an increase in economic growth

In terms of agricultural commodities corn is most directly affected by lower oil prices as lower energy costs reduce the cost of production, increase margins and encouraging more planting. Corn is also used in bio-ethanol and so lower corn prices could see higher demand.

However, cotton has the largest per-acre energy costs of all agricultural commodities so it is likely to see the steepest falls. According to a recent report from Societe Generale the historical correlation between cotton and crude is the highest across all commodities at 0.45:1.

The impact on metals is more complex. According to Macquarie aluminum production has the highest energy-related costs at around 40%, copper the lowest at 18% with gold coming in second last with 22% of production costs related to energy prices.

While electricity accounts for 40% of the production costs of aluminum, the most energy intensive of the base metals, thermal coal is the predominant power-source rather than crude. However, during periods when crude prices are driven to extreme highs or lows the relationship between crude and thermal coal become much closer potentially leading to a higher correlation between crude and aluminium prices.

Gold also has a complex relationship with crude. Lower oil prices, if reflected in a decline in fuel prices could increase consumer spending on gold jewelry, particularly in countries like India who stand to benefit greatly from lower crude prices. However investment demand for gold could decline if lower oil prices lead to lower inflation.

Macquarie note that in in recent years platinum, silver and aluminum have had the highest correlation with oil prices but over the longer term platinum, copper and tin had the highest correlation with oil prices with palladium the weakest correlation.

Finally, the effect on natural gas prices is more direct, at least in the short term. With gas contracts linked to oil (particularly in Europe and Asia) a decline in the oil price will feed directly into gas prices. In the U.S. the decline in oil price could encourage shale drillers to use more gas rigs in preference over oil, increasing gas supplies and leading to a further drop in gas prices.

Of these commodities here’s what happened since crude began its plunge in mid-June – corn (down 12% ), cotton (21%), aluminium (unchanged), copper (down 7%), gold (down 8%) and US natural gas (down 37%). This would tend to support the previous analysis, particularly suggesting natural gas and cotton are the  most vulnerable to the fall in crude prices. However, it will be sometime before the full effect is felt, particularly the timing and scale of any demand side impact.

Related article: Oil price floor now $35-$40 per barrel

Related article: Oil market suffers “unprecedented speculative sell-off”

5 most popular posts on Materials Risk in 2014

Risk and uncertainty was a key theme in commodity markets during 2014. This is reflected in the 5 most popular posts of the year on Materials Risk. For the most part, decision-makers in commodity markets operate in an information vacuum where data is mostly estimated, incomplete and often out of date. In that vacuum Materials Risk hopes to help you make sensible decisions amid a welter of conflicting and often inaccurate information. As the year ends we are clearer on the extent of the impact on commodity markets for some factors. Others may have to wait well into 2015.

1) What risk does Ebola represent to commodity markets?


2) Gone unnoticed…rhodium prices surge

Rhodium powder pressed melted.jpg
Rhodium powder pressed melted” by Alchemist-hp (talk) www.pse-mendelejew.de
derivative work: Purpy Pupple (talk) – Own work. Licensed under CC-BY-SA-3.0-de via Wikimedia Commons.

3) The commodity most affected by El Niño is…Nickel


4) What happened to the nickel price boom?


5) How will shale oil producers react to the rout in oil prices?

Raising the stern

Oil price floor now $35-$40 per barrel

The marginal cost of production is often thought to be the floor for commodity prices, but in reality this may not be true, at least not in the short term. As a general rule of thumb, if prices start to fall below the 90th percentile in the cash cost curve (also known as the operating cost) then production is likely to be curtailed. Morgan Stanley estimate this price in the oil market at $35-$40 per barrel.

“In commodities without a cartel, existing production must be shut-in. If true, marginal cost of investment is not the relevant metrics, it’s variable operating cost, which is closer to $35-$40/bbl on the high end.”

Even if a particular oil well is operating at a loss, there is a good chance it will continue to operate. Once the initial investment has been made, the incentive remains to continue producing as long as the price remains above the project’s operating cost. This will usually be much lower than the break even rate or marginal cost of production.

If the oil market is now operating as a ‘real’ market, i.e. not being controlled by OPEC then this would provide more of a fundamental basis for their argument that Brent crude prices could fall to as low as $43 per barrel in 2015. However, as we saw in 2008 when prices fell to a similar level, oil prices quickly rebounded to cover the marginal cost of production.

Related article: Oil market suffers “unprecedented speculative sell-off”