ICG Commodity Update – October 2020
The ICG Commodity Update is our monthly published comment on energy, industrial metals and precious metals market.
Oil prices slid 10% last week, their largest weekly drop since April and have fallen to their lowest level in 5 months. Analysts worry that slumping demand will combine with higher production to again oversupply the market, prompting outsize moves in both directions. Indeed, the European measures are set to shave ~2mboe/d of oil demand in Nov-Dec, said GoldmanSachs. That equates to 2% of pre-coronavirus global demand and would take European oil demand back to levels last seen in May, when much of the continent was emerging from lockdown. On the other side, supporting much of the surge in EM Asia’s nominal GDP growth has been China’s strong recovery, as the IMF noted. This partly explains China’s surge in crude oil imports during the COVID-19 pandemic, which, given their parabolic trajectory, exceed pre-COVID-19 levels. China’s crude imports for 1Q-3Q20 are up 13% YoY, and average 11.1mboe/d. Turning to the supply side, most analysts continue to expect that OPEC will do whatever it takes to ensure prices resume their upward trend as demand picks up in 2021. Therefore expectations increase for a delay to quota easing in Jan 2021 by 3 months. Therefore to sum up, the oil market is in a delicate balance. Prices are being pulled up by the strong oil demand recovery in China and India, high compliance by OPEC and its allies, and hurricane disruptions to US Gulf of Mexico production, and pulled down by regional restrictions across Europe and recovering oil production in Libya. However, the long awaited oil and gas consolidation wave has finally arrived on the oil patch! The 6 largest US producers now account for half of Permian production, up from just 35% in early 2020 and the highest level of concentration since 2002. Indeed, low commodity prices and tightening financing conditions have historically led to consolidation and market repair in the oil and gas sector, with the late-1990s a good example. History is starting to repeat itself, with 4 material M&A transactions announced over the past 3 months (the ECF participated in two of them). However, this time the M&A drivers are different but the outcome will be similar: consolidation driven by cost-cutting and capital efficiency, repairing the sector’s damaged returns from a 50-year low and rebuilding investor confidence. 3Q20 results may start this healing process as the group should generate post-dividend FCF, which hasn’t been achieved on an annual basis since 2005, while holding oil production flat. In general, the valuation of oil companies and the overall market sentiment versus the oil industry is at its lowest point in decades. However, the oil business has always been full of booms and busts. Nevertheless, we think the oil age is far from over. It may be in decline, and for the long-term health of our planet that may not be a bad thing, but oil as a commodity will be needed for the foreseeable future – as an absolutely necessary part of providing energy to the world.
Copper stayed relatively flat in October as fresh lockdowns in Europe cast doubt over the economic recovery and the upcoming US election fueled uncertainty in broader markets. Large swathes of Europe are entering lockdown as governments conclude tougher action is needed to counter the coronavirus. Concern that economic growth will be hampered by further restrictions dragged crude prices and commodity currencies lower. The virus concerns are overshadowing a brightening outlook from manufacturing activities in China. Both private and official Chinese gauges beat estimates to show the country’s economic recovery is going strong. Especially in focus is iron ore as data on China’s economy and the nation’s mammoth steel industry pointed to a brighter outlook. Steel companies from China expecting robust demand for steel and steel products to last, underpinned by the auto and home-appliances sector. According to investment bankers, lots of conversation about takeovers are going on in the mining space. Miners are engaging in plenty of takeover talks despite a tepid year for acquisitions, but few deals will get done without greater clarity on the economy and an ebbing of Covid-19. For years, mining executives have been saying that consolidation in the industry is inevitable given the abundance of companies and increasing difficulty of finding new high-grade deposits. Mining companies have been involved in about $52 billion of acquisitions this year, according to Bloomberg data. That’s less than half the value of deals seen during industry consolidation in the mid-2000s and following the end of the financial crisis. The inability of companies to undertake due diligence amid Covid-19 restrictions and huge price volatility in the metal markets have hampered this year’s activity, Barclay said. According to the Bank, if an economic recovery takes hold and strengthens demand for commodities, a very busy year is anticipated. On another note, industrial metals are poised to rally mid- to long-term, as the world enters the age of “critical metals”. Mining has a key role to play in decarbonizing tomorrow’s world. The green electrification sector has received a material boost from new policy developments so far in 2020. A combination of Europe’s Green Deal, China’s 2060 neutrality goal and Biden’s clean energy plan (if elected) will all require significant investments in both the renewable energy (solar, wind,etc.) and EV-related sectors (charging infrastructure, cars) – all these sectors rely heavily on industrial metals. Independent Capital Group has published an extensive fundamental analysis about this megatrend on it’s blog, which can be accessed via www.independent-capital.com/die-bedeutung-der-energiewende-fur-die-nachfrage-nach-industriemetallen-ein-unterschatzter-megatrend
Gold has given up ground during the presidential race’s closing stages, dropping for a third straight month in October, the longest losing run for the traditional haven since April 2019. Still, while prices have pulled back from the record set in August, holdings in bullion-backed exchange-traded funds remain close to an all-time high as investors track the US contest, the course of the coronavirus pandemic, and central bank action. According to analysts, the risk of prolonged political uncertainty following the US presidential vote this week could likely benefit gold if there is no clear winner announced on election night. On the company side, AngloGold joins other gold miners in increasing dividends. The company will double its dividend pay-out ratio after gold prices surged this year and the company’s borrowings fell to the lowest in nearly a decade. AngloGold, the world’s third-largest gold producer said it will now return 20% of free cash flow before growth capital to shareholders. Newmont, the world’s largest gold miner, increased its dividend by 60%. The company is planning to pay out 50% to 60% of its incremental free cash flow generated from gold prices above $1’200 an ounce. It’s current dividend yield stands at 2.7%, which is above the S&P 500’s yield of about 1.7%. The club of dividend increasing gold companies is also joined by Yamana Gold, which hikes dividend by 50% before listing on London Stock Exchange, Agnico Eagle Mines with an increase of 75% and Kirkland, which increases its quarterly dividend by 50%. It often has been hard for gold mining companies to appeal beyond a dedicated group of commodity-oriented investors because of the perception that they are wasting assets with mediocre management and poor capital discipline – this perception should slowly change over time as gold companies prove that they are cash-flow generating and dividend paying. Analysts expect that a growing gold price presents significant upside to dividends and the first hikes could be one of many to come.