Back

Supply cuts needed to curb falling commodity prices

London, 01 Oct 2015

Falling prices and global volatility are likely to continue in commodity markets until supply is curbed by producers.

Overcapacity has become the norm in recent years and throughout 2015 steeply declining prices have attracted publicity and concern across the world.

A slowing global economic growth environment coupled with weaker industrial production has also led to future demand forecasts being further reduced, with the exception of oil and gas.

A slowing global economic growth environment coupled with weaker industrial production has also led to future demand forecasts further reduced, with the exception of oil and gas.

Macquarie Group’s Global Head of Commodity Research, Colin Hamilton, believes that supply cuts are “the only way to encourage a price rebalance in the sector.

In a Commodities Compendium released by Macquarie's Commodities Research team in October, Hamilton says reducing supply is difficult for producers in the current market conditions. There have been no permanent supply cuts since the global financial crisis began in 2008.

In a world of cheap money, it is cheaper for producers to fund new capacity, but it is also easier to keep existing marginal assets going.

Oversupply hurts margins and future investment, which in turn hurts emerging markets.

"The result of this is consistently lower demand for commodies and lower costs curves, with the result that the pain cycle will continue until there is a suitable circuit breaker,” says Hamilton. “Demand trends fall outside the control of the commodity sector itself, but supply does not."

Commodities is a naturally cyclical sector, says Hamilton, and companies will always try to restructure to cut costs and keep assets viable. “Given this, the recent commodity sell-off might be a blessing in disguise," he says.

"Despite challenges for the industry, ongoing volatility is likely to drive companies to think a little bit more about their business mode and in this case it may mean the growth confidence factor is weaker." 

"This is not only true for companies; it also applies to the financial markets that fund them."

In the short term, China’s ever prominent push to support growth is the only positive for the commodities industry.

"We may see a period of upside demand surprise in China, with copper having potential to outperform industrial metals peers."

"One of the biggest questions in commodity markets at the moment is how much downside risk is yet to be built into demand expectations for 2016–17.  While we feel comfortable that Chinese demand may have hit a cyclical low, outside of China concern remains for other emerging economies."

Hamilton also predicts that oil will move through the cycle faster than other commodities. This recovery in the oil price, forecasted to happen in 2017, will help all commodity markets through the return of cost inflation.

With China set to export its overcapacity of refined products for the foreseeable future, Hamilton remains cautious of urea, steel and aluminium. Falling Chinese demand expectations are also likely to disproportionally hurt potash, natural rubber and thermal coal into 2016.

Learn more about our Research expertise