Notes from the FT's annual global commodities summit

Last month the Financial Times hosted its Sixth Annual Commodities Summit, where industry leaders gather to discuss the state of the markets.  The mood was slightly better compared to the previous year's summit, with the consensus among oil traders being "the worst has passed." However, consistent with my own arguments, most analysts believe oil prices will remain subdued, stating the re-balancing of the market will take quite some time, despite OPEC's production cut.

Two points worth mentioning.  The first relates to longer term prices.  Traders and analysts stated that low prices have significantly curbed long-term investment which could create a supply disruption 3-4 years down the road.  Much of the current investment in production is focused on shale and existing sources rather than new discoveries, which require higher prices to cover higher overall costs. I don't have a crystal ball to forecast medium and long term prices of oil, but prices will reflect the battle over alternative energy sources: will the rapidly growing impact from renewable energy countervail the declining sources of cheap fossil fuels?  I'd bet on the former.

The second issue relates to a point I made recently: oil traders stated that the increase in prices (WTI) above $50 a barrel has decreased counter party risk.  As I argued, bankers also have an interest in maintaining higher prices in order to reduce the risk of default on their loans oil producers. According to one of the FT articles, all commodity traders/producers came under increased scrutiny by banks due to the bankruptcy filing of a commodity trading house in December:

Transmar Commodity Group filed for Chapter 11 in the US last December, owing its creditors more than $400m. Its collapse has had an impact beyond “soft” agricultural commodities such as cocoa and coffee, with leading independent oil and metals traders facing increased questions about risk and compliance from their banks.

In a competitive, non-manipulated market, I believe oil prices would fall below $40 under the current market glut; however, there are too many vested interests who support maintaining prices near the current $50 WTI crude sweet spot: if prices go too low, bankruptcy risks rise; if prices go too high, the glut will be exacerbated. It's steady as she goes for the rest of the year at least.

A final point in order to toot my horn a bit. In perusing the FT articles from this year's commodity summit, I came across an article from the previous year's summit (April 2016) with a quote that supports my central thesis which is a series of speculative bubbles created the belief that higher commodity prices were the "new normal," creating false signals for producers who expanded production into riskier projects (across all commodity products).

According to Oscar Landerretche, chairman of Chile’s state-owned copper producer Codelco,

“Things might have to get a little bit worse before it gets better,” claiming too much output had been fueled by speculators boosting the price of the metal. The Codelco chairman said the spectre of non-commercial traders was haunting markets and compared them with drug dealers, arguing funds had inflated prices during the boom years and led mining companies into risky behaviour.

Speculative influences across the commodity spectrum, initially fueled by Commodity Index Funds, created a similar response in oil and grains. Given that financial traders continue to dominate markets, the shake out is taking much longer, and is more drawn out because they will not let prices fall far enough for long enough for markets to re-balance--when a new low is perceived, speculative money pours in, which pushes prices back up before the necessary reduction in supply can occur.

Maybe oil traders are right, and the worst is past them, but the "drug dealers" in the form of Hedge Funds and ETFs will continue to haunt the markets....