If 2015 was the year in which the growing oversupply of key commodities led to a rout in prices, will 2016 bring the point of capitulation, leading to consolidation and the start of recovery?
That would certainly be the hope of many beleaguered commodity producers, be they members of OPEC, shale gas drillers in North America or the big companies that bet their futures on what they thought would be China’s endless appetite for coal, iron ore, copper and liquefied natural gas (LNG).
But the problem with hoping for a rationalisation of supply is that everybody wants someone else to shut down or cut production.
Everywhere in commodity markets, producers are still following the tactics that have largely failed for the past few years.
That is to cut costs while increasing output, in order to keep, or increase, market share while lowering the unit cost of production.
Coal is probably the major commodity most advanced in this process, with 2015 representing a fifth year of declining prices that has seen the Asian benchmark Newcastle index lose almost two-thirds of its value since January 2011. Yet, despite this massive loss in the value of coal, output hasn’t declined significantly in major exporters such as Australia and Indonesia, with cost-cutting and weakening currencies allowing producers to keep mines open.
This dynamic is also playing out in iron ore.
Spot iron ore fell to the lowest since assessments began in 2008 earlier this month, dropping to $37 a tonne, about one-fifth of what it fetched at its peak in early 2011.
While Vale, BHP and Rio can still make profits at this price, it’s unlikely they can make enough to keep increasing the dividends to shareholders.
Another group of increasingly nervous producers are those in the Organisation of the Petroleum Exporting Countries (OPEC), as they also await the exit of higher-cost crude from the market.
Waiting for rivals While top OPEC producer Saudi Arabia still has sufficient financial reserves to weather another year of low prices, the budgets of other countries, such as Venezuela and Angola, are starting to look increasingly vulnerable.
Fiscal and economic turmoil generally leads to political upheaval, and if low prices persist, it is likely that the populations of many of the weaker commodity producing countries will become increasingly restless.
But like coal and iron ore, hopes for a rationalisation of crude supply may be optimistic, especially in the light of Iran’s likely boost to output as Western sanctions are lifted and plans for increased exports from neighbouring Iraq.
The coal and iron ore experience also make it likely that US shale oil drillers, and other higher-cost producers such as Canadian oil sands, will be able to cling on for longer than the market generally expects them to.
If many commodity producers are waiting for their rivals to go out of business, LNG producers will be dreading the arrival of new competitors, as both Australia and the United States ramp up output of the super-chilled fuel.
Oversupply also plagues beneficiated commodities, such as steel and aluminium, with too much capacity remaining online in China as loss-making companies are allowed to survive because politics trumps economics.
Like other commodities, this isn’t a new situation and oversupply has been building for some time.
While 2015 was the year that the excess capacity finally hit home, it is far from certain that 2016 will be the year of capitulation.