China’s Market Woes and the Effect on Global Markets and Commodities

           Energy Markets

UK gas and power contracts for winter delivery (commencing 1st October 2015 and ending 31st March 2016) are now trading at five-year lows, creating a fantastic opportunity for buyers to secure their energy at record lows.

These record lows are a consequence of a number of factors that have created a perfect storm for the bear market we are currently experiencing. The Chinese stock market crash, which has suffered a 30% fall over the past five weeks, and the subsequent demand worries are weighing heavily on investor sentiment in equity and commodity markets. The uncertainties around prospective interest rate hikes in the US and the UK are also having a bearing as FX and bonds will be affected by the timing of these hikes. This has fed into the commodities market, which is not a surprise when you consider China is the largest importer of raw materials in the world. For instance, in 2012 China consumed half of all the metal produced globally (91 million tonnes), and there are similar stories regarding coal, copper, oil, soya bean, cotton, and rice. Chinese demand destruction is feeding into other economies who have come to rely on China’s insatiable appetite for commodities. An example of this is Peru, which supplies China with copper. In 2012-14 Peruvian GDP was around 7%. This has now fallen to 1% because of China’s reduction in imports and subsequent collapse in the price.

With Brent Crude falling by 20% in July, oil has also been affected, although Chinese demand is not the only reason prices have softened. Another factor is Iran, which has stated that it will be exporting a minimum of 500,000 barrels a day as soon as sanctions are lifted. Additionally, OPEC continues to pump record volumes and shows no signs of scaling back output to accommodate Iranian production. What’s more, Saudi production continues unabated, and the US rig count has risen again of late as producers innovate to cheapen the price of extraction. Global demand worries are weighing further, and the current level of around $50 for Brent is a level we may be seeing for the foreseeable future. Some commentators are expecting the January lows of $45 to be tested and, subsequently, broken.

If all of the above was not bearish for Continental Europe’s gas and power markets, there have also been a few supply fundamentals that have added to the downside. Gazprom announced they would auction up to 3.24 bcm of gas for winter delivery. This is very bearish for winter 15/16 as previously there were worries around storage levels across Europe in light of the Groningen production cut of 3 BCM. This additional supply source will negate the previous bullish sentiment around winter supply levels. An increase in the storage capacity at Rough (UK’s largest gas storage facility) was also announced. Furthermore, LNG imports are still steady in light of the reduction in Asian demand, a byproduct of a ramp-up in LNG production from Australia. Geographically, Australia is in a fantastic position to supply Asian markets as opposed to Qatargas whose shipping cost to the far east is eroding its profit margins, making the Atlantic basin a more attractive destination for spot cargoes. An increase in renewable generation and consumer sensitivity and awareness of energy usage are also having an effect. German renewables, for example, made up 78% of the daily energy supply mix, further reinforcing the Europe-wide shift to renewables.

In summary, the global energy supply-demand balance is shifting and at this juncture it is a fantastic time to be a buyer of any of the above commodities, with prices at multi-year lows. More so for buyers of gas and power who face non-commodity price hikes as green policies and infrastructure costs are factored into their invoices. The current price destruction in gas and power can now be offset against the aforementioned charges and in most cases total annual energy costs will be at their lowest for years if consumers take advantage of the current downside.

Wayne Bryan

Wayne has been working in energy for 12 years, moving into consultancy after beginning his career with a major international energy supplier. Wayne holds an MA in International Finance and manages some of Alfa’s corporate flexible client contracts. He is currently responsible for several of Alfa Energy’s publications. He has also appeared in many news media in his capacity as energy analyst, most notably Reuters, Bloomberg, and the BBC, among many others.