Commodities market likely to be volatile until early next year

The commodities market — mainly industrial metals, coal and soyabean — is likely to be volatile for the remaining part of the year as also at the start of the New Year due to the power crunch and the Evergrande crisis in China, according to analysts.

This is in view of China being the world’s largest consumer and producer of industrial metals and coal, making up over 50 per cent of the global demand. “While China largely determines the physical demand of metals and coal, news coming out of the country also affects speculative demand,” said Fitch Solutions Country Risk and Industry Research (FSCRIR) in its note on weekly commodities strategy.

Economic recovery

China’ strong economic recovery and government-led stimulus towards the construction industry supported metal demand and prices since April 2020, leading to rally in the first half of this year. It pushed iron ore, copper and tin to historical new highs,” said Fitch Solutions.

“The power crunch and supply woes are dominating the metals complex. The power shortage in China continues to escalate and hit producers along the supply chain disproportionally,” said Dutch multinational investment bank ING’s economic and financial analysis arm Think.

Fitch Solutions said it sees a sharp rise in risks to metal price forecasts as it continues to monitor the situation in China,especially the two biggest developments being Everrande's financial issues and the acute power shortage being faced by the country.

Double-edged sword

ING Think said the power issue could be a double-edged sword. “This is positive for metals prices. However, it is also affecting semi-fabricating and downstream consumers, which is negative for prices,” it said.

Evergrande and power crunch crises in China have resulted in metals such as nickel, tin and zinc sliding this week. But metals such as aluminium and steel have been gaining. The London Metal Exchange Index has declined 3.75 per cent this week to 4,161.

Fitch said financial difficulties faced by China's second largest real estate developer, Evergrande, momentarily led base metal prices to plunge in the initial hours of the news. “Uncertainty surrounding the matter continues to stoke volatility despite prices having recovered since then.” FSCRIR said.

Evergrande is having problems repaying its investors, suppliers and contractors, and is behind schedule on delivering houses that households have already paid for. The company directly affects demand for metals used in construction and consequently metal prices.

Long-term effects

“Prices of most metals have bounced back, due to both the power shortage issue dampening production, and markets pricing in the fact that the Chinese government will act to the extent necessary to prevent Evergrande’s troubles from spreading to the wider economy,” Fitch Solutions said.

However, FSCRIR said it expects metals price volatility to remain until the Evergrande issue is officially resolved. “Beyond short term price volatility, there are a number of ways the Evergrande situation will affect metals demand and prices in the medium to long term,” it said.

The Evergrande episode could spark a contagion effect on other Chinese property developers and could ultimately affect demand for metals used for construction. The realty firm’s attempts to sell off properties at discount could lower property prices and thus again cut into construction metals demand.

In the long term, this could affect construction activities and metal demand, FSCRIR said, adding that the episode could lead to a dampening outlook for construction and its metal demand for five years as more regulations on credit and local governments spending may be imposed.

Repercussions on metals

Fitch Solutions said the acute power shortage in China is having repercussions in global metals markets with prices of aluminium — the most-affected by the crunch — rallying and other metals gaining support such as steel and copper over the past week.

Rising demand for power, supply side issues such as low inflow of water into major reservoirs, less wind, drop in Chinese coal production and Chinese ban on coal from Australia have all led to the current power crisis.

Though China has increased imports from Indonesia, Russia and the US to make up for the Australian coal, it has had a negative impact as Moscow is currently trying to ease power crunch in Europe, while Indonesian exports have been affected by rains and government curbs on exports, Fitch said.

This has resulted in thermal coal prices rallying in the past few months, making it uneconomical for many coal-fired power plants, FSCRIR said, adding that coal prices at Qinhuangdao port in China (5,500 kcal/kg) are hovering around $146 a tonne currently compared with $65 in May 2020, with inventory being low stocks.

Aluminium, steel gain

Fitch Solutions said the power crunch was acting like a double-edge sword. “On one hand, metals producers (mostly aluminium smelters and steel mills) in a number of regions have been ordered to halt production altogether, to reduce the pressure on the power grid. This has led to an actual decline in physical metals production since June, coupled with speculation of significant metals supply shortages,” it said.

Prices of aluminium could breach their historical high of $3,271/tonne (reached in 2008) in the coming days, it said. Currently, aluminium three-month contract is quoted at $2,867.

Chinese steel prices have also edged higher despite falling iron ore prices,” Fitch Solutions said. Shanghai steel futures have zoomed to about $875 a tonne.

ING Think said the power crunch in particular has affected smelters, affecting supplies.

Downstream sectors also hit

“Rising energy prices combined with Beijing’s efforts to curb pollution and enforce environmental regulations have created power shortages across the country. These shortages have affected various industries including aluminium, steel and now food processing,” it said.

FSCRIR also said the power crisis has affected downstream activities, resulting in lower offtake of metals in recent months.

“Prices of metals used mostly in sectors affected by the power crunch have been pressured. These are mainly nickel (used in stainless steel production affected by mill closures), tin (used in consumer electronics hurt by power rationing) and zinc (used to galvanise steel affected by mill closures),” it said.

Fitch Solutions said the Chinese power shortage could be temporary, though it could extend into the New Year particularly since demand for winter heating would set in.

China is trying to resolve the issue by releasing national reserves in batches, increasing imports and curbing pollution, rationing power even to households and encouraging higher domestic production of coal.

China could now bring online the capacity that was previously shut despite high costs to tide over the current problems. Beijing could ensure “energy security” before winter heating demand sets in, though it remains to be seen if the higher cost of electricity will be passed on to the consumers.

China is unlikely to lift the ban on Australian coal imports, Fitch Solutions said, adding that it would diversify its sources of power, away from coal into renewables, which will aid in its climate goals. “But, we believe this will take time,” FSCRIR said.