Oversupply, Lower Demand to Impact Commodity-Sensitive Economies in 2015

The biggest story of the year in commodities has been the sustained drop in the price of oil. Last year gold made headlines for ending the year net-negative for the first time in 12 years. This time around, crude is under pressure as shale technology has increased global supply, while energy demand from emerging and developed markets has fallen.

Shale Oil Pushed OPEC out of the Driver’s Seat

The once mighty Organization of the Petroleum Exporting Countries (OPEC) did not foresee the impact of shale technology. Shale is now at such an accelerated production rate, when coupled with weaker global demand for energy, it has succeeded in driving the price oil to a five-year low.

Oil exporters, especially those where energy is the main national export, face an uphill battle as OPEC did not orchestrate a cut in production that would have sent the price higher. Ten out of the 12 OPEC members are currently underwater as the price of oil is lower than needed to balance their budgets. Non-OPEC members like Russia — who made energy a negotiation tool with Ukraine — have lost ground as it can hardly afford the western sanctions with decreasing revenue for energy exports.
The sustainability of shale in North America will come under pressure as the investment returns were made at a higher price point. New investment will be delayed and ongoing projects will lose their competitive advantage as OPEC oil could end up being cheaper to extract in the long term.

Market share is the new battleground as prices continue to drop because of excess production. Five years ago, OPEC members controlled 60% of world oil production. That percentage has plummeted to 40%. The difference between then and now is it is easier for OPEC to maintain a unified front when prices are rising, than it is when prices are falling like they have since last summer. OPEC’s members are clearly looking for different outcomes. For instance, Saudi Arabia is not willing to give up market share to non-OPEC members by cutting production on the hope the prices increase. The Saudis can comfortably afford to ride out this low price phase but counties such as Venezuela and Iran cannot, being highly dependent on the price of oil to balance their budgets. Yet numerical majority among OPEC members did not pressure Saudi Arabia to cut production and its position as the largest producer served to maintain the status quo.

Dismal Global Growth Numbers Are Bad News for Commodities

Global agencies and economic think tanks have issued reductions to their global growth forecasts as the economies of Japan, China, and Europe continue to struggle five years after the credit crisis. The Chinese slowdown is of particular concern and it has hit commodities the hardest. Other energy and agricultural products have also felt the brunt of sluggish global growth, as have some base metals.

Precious metals have managed to gather some safe-haven appeal to hedge against uncertainty, but the demand for the physical delivery is low. U.S. growth in 2015 with an almost certain interest rate increase by midyear could boost global growth, but in order for that to happen Europe, Japan, and China need to make changes to take advantage of the coming economic momentum.

Market Uncertainty Will Keep Gold Bid

Gold regained some of its luster this year after an abysmal 2013. Physical demand for the metal increased this year after the world’s former No. 1 consumer, India, dropped its import caps. It could regain the lost crown in 2015.

Europe and Japan are battling deflation and that decreases investor appetite in the yellow metal as an inflation hedge. Gold has continued to lose its place as a safe haven during armed conflict, but still retains some of its appeal when stock market shocks appear. The uncertainty about when the Federal Reserve will hike interest rates has kept the market for the yellow metal bid when there are signs of softness in the U.S., but it quickly retreats after strong economic data emerges. This back and forth has helped gold remain close to $1,200 for most of the second half of the year.

Commodities Decouple from Geopolitical Strife

Pre-emptive stocking of energy by Europe ahead of the winter as things heated up between Russia and Ukraine kept the price of natural gas in check. Oversupply meant that armed attacks in Libya, and the ever-present threat of ISIS in the Mideast, did very little to affect the price of crude. The worst implications of the Ebola virus thankfully never materialized to present a global threat.

Looking Ahead to 2015

High inventories of energy and commodities and central bank actions will continue to affect the market next year. Elections in the United Kingdom will keep the markets on edge as the results will have ramifications on the future of the British Isles in the European Union. Greek elections will also preview the showdown that will be played out all over Europe as anti-austerity movements gain traction.

Meanwhile, there are various initiatives to create new trade agreements such as the Trans-Pacific Partnership, and a new trade pact proposed by China this year dubbed the Free Trade Area of the Asia-Pacific. If successful, these free-trade agreements could erode barriers to trade, increase demand among partner nations, and benefit commodity producers. Of course, obstacles remain before the signing and ratifying of these proposed treaties would be realized. The main one being protection-based clauses from national commodity lobbies, notably those in the U.S. and Japan.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza