Noil! How Oil Prices Impact other Commodities

Despite an unrelenting focus on the recent rout in oil, there have been a number of other significant swoonings across commodityland™ which have also been rather noteworthy. This played out naturally in my head as ‘noily’ (aka, ‘not about oil’…although, as we know, everything is interlinked).

As it turns out, noil is actually a word – meaning a short fiber left over from spinning silk. Trying to find an istockphoto image of said noil, this picture of a gnarly alpaca showed up instead. I then looked up ‘no oil’, and an alpaca image showed up again. Fate it would seem. So here is a post which is not about spinning silk, gnarly alpacas, or oil.

First up, I present the Baltic Dry Index –  which measures the cost of shipping dry bulk commodities. The index has just fallen to an all-time record low This drop is in part due to a shipping glut, with shipping capacity rising by 85% since 2008 while demand has been dropping.

Another key element has been the ailing economic health of emerging markets such as China, who lead demand for raw materials such as coal, iron ore and steel. With the impending Chinese new year (February 19th) pointing to a period of inactivity in the world’s largest commodity importer, the Baltic Dry Index is likely to come under further downward pressure in the coming weeks:

Next up we look at Asian LNG prices, which have just dropped below European prices for the first time in over four years. Asian LNG prices initially charged higher in early 2011 after the Fukushima nuclear disaster in Japan meant nuclear reactors were gradually taken offline for safety checks, then never restarted (this June appears the earliest time for a restart).

Prior to the disaster, nuclear power accounted for about a third of Japan’s electricity needs. Afterwards, LNG imports were relied upon to account for the lion’s share of the shortfall. This was no mean feat, given Japan’s status as the world’s third largest economy. To put this all in context, Asia accounts for ~75% of the world’s LNG demand, with South Korea and Japan accounting for ~50% of global demand on their own.

But a combination of lower winter demand due to warmer-than-normal weather, rising global production and lower oil prices (I know I said ‘noil’, sorry about that…) have meant that Northeast Asian LNG prices have plunged from close to $20/MMBtu last winter to currently below $7/MMBtu.

This is changing global dynamics, as Europe is now seeing an influx of LNG cargoes after being shunned for a number of years. Given that just over a quarter of global LNG (~10.6 Tcf) is based on spot and short-term prices, the UK (the largest LNG consumer in Europe) is suddenly being seen as a much more attractive destination than in prior years – or as some have said, a dumping ground:

China remains the best hope for Asian LNG demand, with its LNG imports rising 10.3% last year to 2.7 Bcf/d as it maintains its shift away from coal. That said, increasing domestic output and a slowing economy could mean it experiences a hugely huge 23 Bcm (2.2 Bcf/d) surplus of supply by 2017 (h/t Barclays).

China’s waning appetite for coal is an opportune segway into our final falterer. For global coal benchmarks have also participated in a plodding path lower as global oversupply persists. Key coal-exporting nations such as Colombia and Australia have maintained output in recent years, in the hope that higher-cost production will be squeezed out of the market (sound familiar?).

Meanwhile, US coal prices have reached a six-year low due to a triple whammy: not only is a stronger dollar making its coal less competitive abroad, but domestic demand is waning as falling natural gas prices encourage coal-to-gas switching. All the while, EPA rulings are pressuring coal-fired generation into retirement.

Foreign coal producers, however, have seen a huge benefit from the stronger US dollar, helping to mitigate the price drop of coal in local currencies. Accordingly, Deutsche Bank predicts the global glut of seaborne coal to triple this year. Supply is expected to outpace demand this year by 30 million tons, with absolute demand falling from both China and Europe while total global supply ticks higher.

Well, that’s all folks. What started out as a ‘noily’ rant has only served to highlight the latent impact that falling oil prices have had across the whole of commodityland™. LNG prices have experienced downside in part due to contracts being oil-indexed in nature. Meanwhile, some dry-bulk ships are being converted to tankers, to take advantage of booming oil chartering rates amid the price fall.

And finally, the drop in coal prices has been in sympathy with other commodities such as iron ore and copper, as part of the reason for falling oil prices is mirrored across commodities – tempering demand due to a slowing global economy. As always, thanks for playing!

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