January 14, 2017/ARM Research
We continue discussions on the commodity section of our core strategy document – the Nigeria Strategy Report. In today’s piece, we review developments in the global soft commodities market over H2 16 and delineate our outlook for 2017. In contrast to recent years, when an oversupply picture across most agricultural commodities underpinned price declines, impact of one-off weather shocks (which hurt CPO output) and market rebalancing across rubber and sugar combined to drive a rally across soft commodities in H1 16. However, as the El Nino phenomenon receded, the S&P GSCI Agricultural Index declined 5% over H2 16. Nonetheless, largely reflecting the strong H1 16 rally, soft commodities posted a 2.6% gain over 2016. Across soft commodities markets, surplus positions in Wheat and Cocoa drove price declines while a deficit picture across Rubber, Crude Palm Oil (CPO) and Raw Sugar spurred price rallies. For 2017, our expectations for rubber and barley prices remain bullish, buoyed by adverse weather conditions, depressed inventory levels, persisting deficit picture as well as favourable legislations aimed at providing price support for commodities. In terms of CPO, we remain cautious on prices given expectations for the market’s transition to a surplus from the deficit recorded in 2016 while thinner deficit in the sugar market should taper the scale of price upside for the commodity. In terms of wheat, the global supply-demand picture reveals tighter supplies which could drive higher prices. Nonetheless, China’s elevated inventory levels tempers our bullish outlook. Rounding up our covered commodities is cocoa, where we expect prices to remain bearish given the prevailing surplus in the market. Overall, we maintain a guardedly optimistic outlook for commodity prices over 2017.
Commodities decline as fundamental imbalances offset reclining weather concerns
In contrast to recent years, when an oversupply picture across most agricultural commodities underpinned price declines, impact of one-off weather shocks (which hurt CPO output) and market rebalancing across rubber and sugar combined to drive a rally across soft commodities in H1 16. However, as the El Nino phenomenon receded, the S&P GSCI Agricultural Index declined 5% over H2 16. Nonetheless, largely reflecting the strong H1 16 rally, soft commodities posted a 2.6% gain over 2016. Across soft commodities markets, surplus positions in Wheat and Cocoa drove price declines while a deficit picture across Rubber, Crude Palm Oil (CPO) and Raw Sugar spurred price 
wheat market raises prospect for price upswingExtending the bearish run in H1 16 (-5%), wheat prices slid 13% over H2 16 as persisting concerns over supply glut deepened with United States Department of Agriculture (USDA) data showing that global wheat supply exceeded demand by 23.8million MT while ending stocks remained at elevated levels of 241.0million MT (+10.9% YoY). On the supply side, global wheat production for the 2015/ 2016 season rose 10.2million MT (+1% YoY) to 735.5million MT, underpinned by higher output from China (+3.98million MT) and EU (+3.09million MT). The increase in Chinese production reflects impact of the high state wheat purchase price (~1.5x higher than global average) as part of moves towards self-sufficiency. In addition, higher EU wheat output largely reflects impact of favorable weather conditions in France and increased acreage in Italy and Spain. Elsewhere, favorable weather conditions also buoyed domestic output in Eastern Europe as wheat output in Ukraine and Russia expanded 3% and 10% YoY to 61.0million MT and 27.3million MT respectively.
These gains offset the impact of adverse weather conditions which drove production declines in India (-10% YoY) and Canada ( -6% YoY). In addition to the continued increase in production, wheat prices grappled with the high inventory levels fueled by rising Chinese stockpiles which rose 27.5% YoY to 97.04million MT, a natural fall-out of the state wheat purchase program.
On the demand side, global wheat consumption expanded by 5.9 million MT (+3% YoY) to 711.7 million MT driven by higher demand from EU (+5% YoY to 131 million MT) and Eastern Europe (+4% YoY to 78.2 million MT). The higher consumption in both regions largely reflected increased utilization of wheat in domestic feed and food industries. Overall, the picture across wheat markets over 2016 is broadly similar to the trend over the last four years as bearish concerns persist due to subsisting supply glut.
Going into 2017, USDA projects continued expansion in global wheat production (+9.2MT) due to higher output from US (+6.74MT) and Russia (+10.96MT)— higher Russian acreage (+6% YoY) should see output exceed the record 61.0million MT in 2016 placing it a key global producer. On the demand side, the USDA forecasts a faster expansion in global consumption (+25MT) largely driven by India (+7.6million MT) and China (+5million MT) to offset lower consumption in EU (-2.28 million MT). The higher projected consumption from India reflects sentiment over the removal of 10% import tax duty on wheat imports which has driven domestic wheat prices lower as well as accelerated consumption. In the case of China, higher projected demand is hinged on fungal toxin problems associated with old corn stocks which has led farmers to a switch to wheat for livestock. Overall, the global supply-demand picture reveals tighter wheat supplies (-66% YoY to 8.2MT) which raises scope for northward trajectory in wheat prices over 2017. That said, as in prior years, bearish sentiment surrounding elevated inventory levels (+3% YoY to 241.03MT) particularly by China should moderate the bullish optimism—the shrinking surplus picture supports scope for modest price upswing in 2017.
Deficit picture underpins bullish outlook for Barley prices
Despite USDA data showing global production outweighing consumption by 1.1million MT, barley prices extended the gains in H1 16 (15%) to return 15% over H2 16. In the 2015/2016 season, global barley production rose 5% YoY to 148.7MT underpinned by higher output from Turkey (+ 85% YoY to 7.4MT) and Morocco (+106% YoY to 3.5MT). Strong production from Turkey and Morocco reflects the impact of improved weather conditions which reflected in bumper harvests reaped by both countries with Morocco’s output at a record high. These strong gains in production offset the impact of declines in Russia’s harvests (-15% YoY) which occurred on the back of adverse weather conditions and lower acreage plantings.
On the consumption side, global barley consumption tracked higher by 4% YoY to 147.6MT buoyed by Saudi Arabia (+ 20% YoY to 10.2MT) and Turkey (+29% YoY to 6.9MT). Robust Saudi demand stemmed from government subsidy on imported barley which made the commodity more price competitive relative to other feed alternatives while strong demand in Turkey was buoyed by livestock feed grains particularly ruminants. These gains offset the impact of lower Chinese consumption which prevailed in the season as higher sale of corn from state reserves lowered prices to a decade low which shifted demand for barley to corn.
Going into the 2016/2017 season, USDA forecasts lower barley production (-3% YoY to 144MT) on the back of lower output from Turkey (-36% YoY to 4.7MT), Argentina (-26% YoY to 3.7MT) and Morocco (-69% YoY to 3.5MT). The downtrend in Turkey’s production can be attributed to adverse weather conditions in prime planting regions which is expected to impact on yields adversely. For Argentina, the decline in barley output is linked to elimination of 23% export taxes on wheat which is expected to encourage some farmers to switch towards wheat production. In the case of Morocco, lower output can be attributed to severe drought which prevailed during the entire planting season. In the same vein, USDA forecasts consumption to decline by 3.1% YoY on the back of lower demand from Turkey (-20% YoY to 5.5MT) and China (-10% to 7.1MT). Turkey’s lower projected consumption is attributed to decline in domestic production which is expected to drive local barley prices higher. Overall, the global barley market is expected to post a deficit of 2.25MT which underlies our outlook for prices to remain bullish over 2017.
El Nino aftershocks underpin bullish run in CPO prices
CPO prices continued the uphill climb rising 34% in H2 16 as sentiment swung bullish following the emergence of a 1.1MT deficit for the current crop cycle (vs. a surplus of 3.2MT in 2014/2015). The deficit stemmed from contraction in global CPO production (-5% YoY to 58.8MT) – a fallout of drought related yields losses in South- East Asia due to the El Nino event in planting season which crystallized into lower output from Indonesia (-3% YoY to 32MT) and Malaysia (-11% YoY to 17.7MT). Furthermore, output was hampered by Indonesia’s anti-deforestation drive which resulted in a presidential moratorium on new palm oil concessions in select provinces which lowered the new plantings. On the other hand, global CPO consumption trended upwards (+2.7% YoY to 59.9MT) largely on the back of higher demand from Indonesia (+15% YoY to 8.6MT) which offset declining demand from China (-16% YoY to 4.8MT). Strong demand in Indonesia was buoyed by increased usage of CPO in the government’s B-20 biodiesel program while the decline in China’s demand stemmed from release of rapeseed oil stocks from state reserves which served as an alternative to CPO. Unsurprisingly, given the weak CPO output in the 2015/2016 season, inventories declined 26% YoY to a three year low of 7.2MT.
Going into the 2016/2017 season, USDA projects global CPO production at 64.5MT (+9.7% YoY) buoyed by improved weather conditions which is expected to drive recoveries in crop yields in Indonesia (+9.4% YoY to 35MT) and Malaysia (+13% YoY to 20MT). Similarly, global consumption is expected to trend higher (+5% YoY to 69.3MT) buoyed by higher demand from India (+13% YoY to 10.4MT) and Indonesia (+6% YoY to 9.MT). Higher Indian consumption reflects the surprise move to cut import taxes on crude and refined palm oil. In Indonesia, government’s decision to increase the proportion of palm oil used in biodiesel production to 20% from 15% recorded in 20161 underpins our positive outlook for demand. In sum, the global CPO market is expected to transition from a deficit to surplus of 1.5 million MT in the 2016/2017 season which poses downside risks to prices scope in the 2016/2017 season.
Narrowing sugar deficit caps scope for extended price rally
Bucking the bullish trend realized over H1 16 (+ 35%), sugar prices declined 9% in the second half of the year despite the emergence of a deficit of 6.7MT in the global market for the first time in five years. In the 2015/2016 season, data from USDA showed that global production declined by 7% YoY to 165.8MT on the back of lower output from Brazil ( -8% to 34.7MT), India (-10% YoY to 27.5MT), EU (-11% YoY to 16MT), China (-38% YoY to 8.8MT), and Thailand (-14% YoY to 9.7MT). Lower Brazilian output reflects increased diversion of sugar cane toward ethanol production on the back of government’s imposition of a cide tax on gasoline consumption (3cents/litre) which boosted demand for ethanol. Poor output from India and Thai production reflects impact of following adverse weather conditions which drove yields lower and discouraged new plantings. Elsewhere, the decline in EU’s output stemmed from lower plantings as lower demand for sugar in non-food uses in the 2014/2015 season drove record surpluses of unsold out-of-quota sugar which was carried forward into the 2015/2016 production quota. In the case of China, lower output stemmed from elimination of government support prices, widespread sugar smuggling and steep competition from cheaper imports which made domestic production unprofitable. On the flipside, global sugar consumption rose modestly (+1% YoY to 172.5MT) on the back of higher demand from Indonesia (+9% YoY to 5.9MT) and India (+3% YoY to 26.8MT). Higher Indonesian purchases originated from the Food and Beverage Industry and higher household consumption while India’s demand can be attributed to higher demand from bulk consumers (account for 65% of domestic consumption) in the Food and Beverage Industry and hotels.
Looking into the 2016/2017 season, USDA projects global sugar production to rise 3% YoY to 165.8MT due to stronger harvest from Brazil (+9% YoY to 37.8MT) and EU (+8% YoY to 16.2MT). In the case of Brazil, higher sugar prices will incentivize producers to divert a higher proportion of sugarcane towards sugar production (2016/2017 estimates: 43% vs 41% in prior season). Higher production in EU can be attributed to Common Agricultural Policy reforms coming into effect next year which involves lifting restrictions on production and exports imposed on sugarcane growers.
On the demand side, the USDA forecasts modest 1% YoY rise in global consumption to 173.6MT on the back of higher demand from India (+1% YoY to 27.2MT) and Russia (+4% YoY to 6.1MT). High consumption from India is linked to rising demand from the Food and Beverage Industry while the positive outlook on Russia springs from the ongoing economic downturn which is expected to support higher household sugar consumption for use in producing homemade jams, sweeteners, and alcohol. Overall, the deficit in the global sugar market is expected to narrow to 2.6MT while inventories is projected to decline by 19% to 30.8MT. Our expectation of a sustained tightness in the sugar market in the 2016/ 2017 season suggests that prices would bear its upward trend after cutback in H2 16. That said, the narrower deficit implies the scale of price upside should be confined.
Upbeat prospects for Ghanaian harvests underlie bearish sentiments on cocoa
In contrast to the first five months in 2016, when prices rose 3% on concerns over weak harvests from Cote D’ Ivoire and Ghana—due to dry weather conditions in West Africa, cocoa prices slid 19% over H2 16 as improved rainfall across West Africa and increased bearish bets by fund managers turned the tide. Bloomberg, citing U.S. Commodity Futures Trading Commission, reported that hedge funds slashed net long cocoa position by 36% to 3,599 futures and options — the lowest since June 2012, when fund managers were net-short. In addition, stagnant demand growth with flat movement in global cocoa grindings (-0.3% YoY to 4.1MT) exacerbated sentiment regarding prices.
Going into the 2016/2017 season, ICCO (the International Cocoa Organization) expects dry weather and severe harmattan conditions to drive weaker harvests in Côte d’Ivoire relative to the 2015/2016 season. However, the organization is upbeat over Ghanaian output which its forecasts to rise 11% YoY to 850,000 MT buoyed by favorable government policy. On the demand side, grindings are expected to improve marginally by 0.2% YoY underpinned by Europe and the US where higher consumption is attributed to the Food and Beverage Industry (particularly chocolate producing companies) and the personal care industry where cocoa butter is popularly used in formulation of skin care products. Overall, the surplus theme in the cocoa market should drive a retention of the current bearish trend for the commodity over 2016/ 2017 season.
ITRC pulls an ‘OPEC’ on the rubber market
Rubber prices maintained an upward trajectory rising in 2016 (annual: +73%, H1 16: +22.7%)— first positive annual return in over three years. The gains were largely buoyed by commencement of the Agreed Export Tonnage Scheme by the leading rubber producing countries (Thailand, Indonesia, and Malaysia) under the aegis of the International Tripartite Rubber Council (ITRC) which resulted in the withdrawal of exports of 615,000 tonnes of natural rubber for six months from March to August. The export cull was further extended to December with an additional cut of 85,000 tonnes which helped shrink the global oversupply glut of the last five years.
The foregoing combined with a recovery in Chinese tyre demand(2) supported prices over H2 16.
Looking ahead, the Association of Natural Rubber Producing Countries(3) expect demand and supply dynamics to remain positive for prices as lower production output—a fallout of adverse weather conditions and maintenance of the ongoing quota system for rubber exports by the ITRC—should support market balancing over 2017. To add, recovering automobile sales in the China should buoy demand for natural rubber.
2 Vehicle sales improved following tax cuts on vehicles with smaller engines from 10% to 5%. In H2 16, Chinese car sales jumped 16.6% YoY to 2.9million in November which boosted demand.
3 An association of 11 countries which accounts for about 92% of the global natural rubber production in 2015. Member countries include Cambodia, China, India, Indonesia, Malaysia, Papua New Guinea, Philippines, Singapore, Sri Lanka, Thailand and Vietnam.
Currency pressures continue to nullify impact of price trends on Nigerian food producers
Tying it all together, our expectations for rubber and barley prices remain bullish buoyed by adverse weather conditions, depressed inventory levels, persisting deficit picture as well as favourable legislations aimed at providing price support for commodities. In terms of CPO, we remain cautious on prices given expectations for the market’s transition to a surplus from the deficit recorded in 2016 while thinner deficit in the sugar market should taper the scale of price upside for the commodity.
In terms of wheat, the global supply-demand picture reveals tighter supplies which guides to prospect for increasing prices, nonetheless, China’s elevated inventory levels tempers our bullish outlook. Rounding up our covered commodities is cocoa where we expect prices to remain bearish given the prevailing surplus in the market. Overall, we maintain a guardedly optimistic outlook for commodity prices over 2017.
Dissecting the impact of trends in global commodity markets on corporates in the Nigerian FMCG sector, our bearish outlook on cocoa prices should be favourable for Cadbury while the uptrend in wheat prices and the weak naira outlook should exert pressures on gross margins for flour millers including UACN, Honeywell, Dangote Flour and Flour Mills of Nigeria. Similar sentiments also apply for margins of sugar refiners and brewers. For CPO producers, elevated global prices, weak naira outlook alongside CBN’s FX proscription for imports should continue to provide a buffer for revenues. In addition, bullish rubber prices and weak naira guides to favourable price outlook for Okomu’s rubber division. Overall, similar to 2016, we expect weaker naira to remain the major driver of input costs prices relative to prevailing trends in the global soft commodity markets.
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