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Commodities Poised to Rebound in 2016


TOM BUTCHER: Commodities are having a difficult year and we've seen stories in the press attributing this to the slowdown in China, a possible hard landing, and slowing global growth. What’s the real story?


Serious Supply Response to Low Prices


ROLAND MORRIS: I agree that this has been a dominant theme in the press. Markets and investors are worried about the growth outlook, particularly for emerging markets and China. I think that hidden behind the scenes is a very serious supply response to low prices, occurring across several industries and sectors. In particular, we think that the capex cuts that have taken place in the energy and industrial mining sectors (recently in energy and over the last several years in industrial mining) is setting the stage for much tighter supply as we look ahead. Currently the market is focused on very serious concerns about global demand. What is being missed by the press is the tremendous cutbacks being made by industry, which we think will balance the markets faster than many investors realize.


Cutback in U.S. Oil Drilling


One of the things that I find has been underappreciated by investors is the cutback in U.S. drilling activity, which we've all seen with the sharp drop in the U.S. rig count that occurred in December, January, and February. The U.S. rig count was cut by more than 50%, resulting in a drop in U.S. production.


U.S. production peaked at 9.6 million barrels in April. By June, it was under 9.3 million. As we approach yearend, the weekly indicated numbers have it at 9.1 million, and we think the real production numbers in the U.S. will fall to 9 million or lower by yearend. That is a serious cutback in supply. On top of that, perhaps more importantly in the energy markets, there has been a complete cutback in deep water and oil sands projects; megaprojects by large integrated oil companies globally have collapsed to virtually zero. The way we look at it, almost 6 million or 7 million barrels of potential production that would've been available to the marketplace between now and 2020 have either been permanently canceled or pushed out past 2020.


Oil Demand Remains Strong


When you think about that supply-demand balance, even though we have Iranian oil coming into the market next year, you find demand is strong this year. This is underappreciated. With the press preoccupied with global growth, oil consumption this year is the strongest it has been in five years. Year-to-date, we're up 1.7 million barrels in demand over last year. Last year's demand was weak; it was only up 700,000 barrels. Demand has consistently been growing at about 1% or close to 1 million barrels a year.


This year is a very strong demand year because gasoline prices are low and consumers are responding by driving more. That is taking place not only in the U.S. and Europe, but also in China. There’s stronger-than-anticipated demand, lower prices, and cutbacks from industry because of lower prices. We think these factors will balance the market by the middle of 2016.


When we think about industrial metals, it's very similar. Capex reductions in industrial metals started in 2012. You’ve had a reduction in investment across the board by diversified miners. The peak of investment was 2011. Starting in 2012, diversified miners globally started cutting back on investment. Next year in 2016 coal investment will be down 63% from the peak, iron ore 50%, gold 27%, and copper 33%.


Industrial Metals Experience Similar Reduction in Investment


I believe those are meaningful reductions in investment and they can result in meaningful reductions in supply. Copper looks like it's going to be in deficit in 2016. That’s a big change. With any stability in global growth, we could see copper prices start to rise late this year, early next year. That’s a big change too. You think about a market such as industrial metals that has seen oversupply for three straight years. To suddenly have an inflection point because of a reduction in supply is notable. It is similar to the energy markets. Many copper mines around the world are older mines. When companies cut back on capex, they cut new investment in their reorganization and focus on cost. Additionally, they start to cut into sustaining capital cost of mines. That means they're hydrating their mines or just mining the easy ore bodies within those mines. That reduces the long-term potential of those mines; it shortens the mine life and sets up the market for disappointments on production. We’re already seeing disappointments in copper production globally, whether it's electricity outages in Zambia, labor actions in a country, or plain mine failures.


A Constructive, Long-Term Outlook


At the beginning of this year, industry thought that copper would be oversupplied by 800,000 tons in 2015. Now as we approach the end of the year, it looks like it's going to be 200,000 or less. By next year we believe we'll be in deficit because of production failures in mines around the world and reduction in investment. We don’t think underlying concerns about global demand, which are very understandable because of concerns about what the growth trend in China truly looks like, are not that terrible, in our opinion. Behind that story, which has been the lead subject of the press in terms of commodities, is a real supply story that we think is very constructive for the longer term outlook. When you have balanced markets and there is any kind of change in global growth trends, you could have tighter markets and significantly higher prices.


BUTCHER: Thank you very much.


MORRIS: You're welcome.


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