SOURCE: Scotiabank


March 26, 2014 07:30 ET

Scotiabank: Energy Prices Jump in February

TORONTO, ON--(Marketwired - March 26, 2014) - Scotiabank's Commodity Price Index strengthened further in February -- jumping 7.2% month-over-month (m/m) after a 5.7% gain in January. The All Items Index climbed above year ago levels (+3.0%) for the first time since August 2013, with stronger oil and gas prices leading the way. 

"The Oil and Gas Index leapt 16.6% m/m and 34% above a year earlier amid frigid winter weather across North America and stronger U.S. refinery demand for Alberta bitumen," said Patricia Mohr, Scotiabank's Vice President of Economics and Commodity Market Specialist. "Western Canadian Select (WCS) heavy crude oil prices posted the largest gain -- up 24.2% m/m to US$81.54 per barrel. Propane prices in Edmonton and Sarnia also soared to a new record high in February, averaging US$94.70 per barrel -- well above US$71.29 at the top of the commodity price cycle in July 2008."

Highlights in the report include:

  • Oil price outlook 2014-15: Rising supplies of U.S. 'light, tight' oil pose risk to light oil prices across North America by mid-2015; heavy oil prices for Alberta bitumen producers should hold up well, with Houston refineries requiring a heavy oil slate. This accounts for the growing interest of Western Canada's light oil producers in diversifying markets to Asia/Pacific through new oil export pipelines to 'tidewater'.
  • China's copper demand will remain strong in 2014 -- supported by massive investment in the State Electricity Grid.
  • Developments in the Ukraine -- the world's fifth-largest wheat and third-largest corn exporter -- have lifted wheat, corn and nitrogen fertilizer prices in March.

Read the full Scotiabank Commodity Price Index below or find a copy online at,,3112,00.html.

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Scotiabank's Commodity Price Index strengthened further in February -- jumping 7.2% m/m after a 5.7% gain in January. The All Items Index climbed above year ago levels (+3.0%) for the first time since August 2013, with stronger oil & gas prices leading the way.

The Oil & Gas Index leapt 16.6% m/m and 34% above a year earlier amid frigid winter weather across Canada & the United States and stronger U.S. refinery demand for Alberta bitumen -- linked partly to the start-up of a new 200,000 b/d coker at BP's massive Whiting, Indiana refinery. Western Canadian Select Heavy crude oil prices (WCS) posted the largest gain -- up 24.2% m/m to US$81.54 per barrel -- pushed higher by a rally in WTI oil prices over US$100 as well as a decline in the discount off WTI to US$19.14 from US$29.22 in January and an enormous US$39.13 in December. Light oil prices in Edmonton also rose to a more normal US$96 per barrel in February from US$80.89 in January and a low of US$77-78 around the turn of the year. Start-up of TransCanada PipeLine's Gulf Coast Project (700,000 b/d), linking Cushing, Oklahoma to Nederland, Texas (originally planned as the southern leg of Keystone XL), drained oil inventories in Cushing, contributing to the rally in WTI oil prices. TransCanada delivered the first batch of heavy oil from Alberta to Texas in late February (via the existing Keystone and Gulf Coast pipelines).

Propane prices at Edmonton & Sarnia also soared to a new record high in February, averaging US$94.70 per barrel -- well above US$71.29 at the top of the commodity price cycle in July 2008. Canadian natural gas export prices jumped to US$6.83 per mcf in January and likely approached US$7 in February -- the highest level since September 2008 (just before the U.S. 'Great Recession'). While NYMEX prices have eased back in late March to US$4.27 per mmbtu with the approach of spring, prices are likely to stay relatively high over 2014:Q2 and Q3. U.S. gas-instorage has largely been depleted and is exiting the winter heating season at less than 1 tcf (953 bcf on March 14 or 47.9% below the 5-year average). It will take some time before the industry is able to ramp up drilling and refill storage, with inventories likely to enter the next heating season lower than last year.

The Metal and Mineral Index edged up in February (+0.4% m/m, -18.9% yr/yr). Fertilizer-related minerals (sulphur & potash) picked up and gold moved back over the US$1,300 per ounce level more than offsetting weaker base metals (excepting nickel). LME nickel prices (currently at US$7.36 per pound) were boosted by the Indonesian ban on the export of all unprocessed nickel-containing ores, implemented on January 12, 2014.

Potash inched ahead to US$297.50 per pound (FOB Vancouver), after bottoming at US$295 in January (standard grade). Demand is reported to be strong in Latin America, including Brazil -- where Canpotex has announced a US$360 cfr granular price for April (US$350 may be achieved) -- and is good in China. Sulphur prices at the Port of Vancouver -- used in DAP fertilizers -- have also climbed from a low of US$55 last autumn to US$165.63 per tonne. Reduced supply from the Middle East, Russia and Western Canada (Syncrude) alongside restocking in China account for firmer prices. Tight international DAP supplies, amid strong spring application, have also lifted sulphur.

Gold prices (London PM Fix) touched a high of US$1,385 in mid-March -- catching a 'safe-haven' bid from developments in Crimea. A temporary fall in the yuan against the U.S. dollar, engineered by the People's Bank of China to introduce currency volatility into the foreign exchange market, may also have increased the attractiveness of gold (a US dollar asset) to Chinese investors. The S&P TSX Gold Index is up 34% since late 2013, with investors believing that gold prices bottomed at US$1,180 in late June, and taking advantage of over-sold share prices last year.

The Forest Products Index edged down in February (-1.1% m/m, -2.1% yr/yr). Western Spruce-Pine-Fir 2x4 lumber prices lost ground from US$373 per mfbm in January to US$364 in February and have only inched up in March (US$366). U.S. housing starts at 908,000 units annualized in January & February have been checked by severe winter weather. However, an increase in multiple-unit permits in February points to a pick-up in building activity this spring (1.2 million units forecast for 2014). Wood products prices could skyrocket, given today's low consumer stocks. NBSK pulp prices have climbed by US$20 to US$1,030 per tonne in March (the highest since June 2011), boosted by a pick-up in U.S. printing & writing paper demand.

Finally, the Agricultural Index inched ahead in February (+1.0% m/m, -14.6% yr/yr). Record cattle prices, firmer hogs and stronger barley prices (a feed grain) just offset slightly lower wheat and canola prices. Developments in the Ukraine, the world's fifth-largest wheat & third-largest corn exporter, have lifted prices in March. The recently signed Canada-South Korea Free Trade deal will provide improved access for Canadian beef & pork, though tariff elimination will be slow and South Korea will continue to accept beef only from cattle less than 30 months of age.

China's Copper Demand Will Remain Strong in 2014

LME copper prices have recently been pressured by jitters over China's growth prospects -- industrial activity slowed to 8.6% yr/yr in January & February and China has endured its first onshore corporate bond default. Prices have dropped from US$3.31 per pound in January to a low of US$2.92 on March 20. However, we believe the near-term decline has been overdone, with much of the slowdown reflecting China's one-week Lunar New Year holiday. A short-covering rally is expected soon, with copper snapping back over US$3 in 2014:Q2 to average US$3.08 in 2014 (yielding a still lucrative 25% profit margin over breakeven costs including depreciation) after last year's US$3.32. However, prices may drift lower again to US$3.00 in 2015, as the current wave of new mine supply continues.

China's refined copper demand will increase by a strong 9% in 2014 -- buoyed by a massive RMB 382 bn (US$61.4 bn) investment in the State Electricity Grid (+13% from 2013), accounting for 40-50% of China's copper consumption. Structural changes in the semis industry, with significant new wire rod capacity, will also underpin cathode demand in 2014. The scrap market will remain tight, with recently lower prices pulling back supplies, increasing demand for primary metal. Financial markets are concerned that record Chinese imports of refined copper in early 2014 (+47.7% yr/yr) partly reflected the 'carry trade', which could now be partially unwound, bringing more copper to market. (The 'carry trade' -- an importer opens a low interest-rate U.S. dollar Letter of Credit to purchase copper, converts US dollars to RMB and invests RMB in higher-yield investment products in China or re-lends RMB to a borrower in China at higher Chinese rates; at expiry of the L/C, the U.S. dollar loan would be repaid likely with fewer RMB given the long-term trend of RMB appreciation). The recent policy shift by the People's Bank of China allowing a wider 2% trading band for the RMB/U.S. dollar rate has introduced more currency risk and may discourage this kind of commodity-related financing going forward.

China's new leadership has just unveiled its plans for 'urbanisation' through 2020 -- key to economic growth and copper consumption. The plan aims to lift the country's 'urbanisation rate' from 54% to 60% by 2020, accompanied by a massive construction program of transportation networks (every city with over 500,000 people will be accessible by high-speed rail), urban infrastructure and residential real estate. Re-development of 4.75 million rundown 'social housing' units will be undertaken in 2014 (costing RMB 1 trillion).

The Oil Price Outlook for 2014-15 -- Impact of Rising U.S. 'Light, Tight' Oil

The United States has enjoyed a remarkable rejuvenation of oil production over the past two years -- from a mere 5.65 mb/d in 2011 to 7.46 mb/d in 2013 (+1.8 mb/d). This largely reflects the development of 'light, tight' oil in the North Dakota & Montana Bakken and the Eagle Ford & Permian Basins in Texas -- where reservoir engineers are becoming increasingly adept at using new multiple-fracture drilling technology. So far, roughly 10-12,000 wells have been drilled in the U.S. Bakken, with the potential for about 30,000 wells over time. The North Dakota Department of Energy expects output from the Williston Basin to increase from roughly 1 mb/d now to 1.5-1.6 by 2015-16, with production not levelling out until 2020-25, despite rapid decline rates. This will contribute to another large 935,000 b/d gain in U.S. oil output in 2014 and an additional 775,000 b/d in 2015. These estimates include growth in the federal U.S. Gulf of Mexico from 1.3 mb/d last year to 1.4 mb/d in 2014 and 1.6 mb/d in 2015, as eighteen new wells come on stream (including Mars B & Cardamom Deep).

So far, the increase in U.S. oil production has been readily absorbed by the market, with little fallout on either North American or international oil prices. While gains in U.S. petroleum consumption have been limited, U.S. net imports of crude oil have dropped by a huge 1.29 mb/d since 2011. The bulk of West and North African 'light' crudes have been backed out of the U.S. Northeast market and re-directed to Europe and China, offsetting the disruption of Libyan exports due to civil unrest. U.S. refiners (mostly on the Gulf Coast) have also stepped up their net product exports by 537,000 b/d to 2.15 mb/d since 2011, with gasoline, middle distillates & petroleum coke shipped to Latin America -- especially Mexico, Brazil, Chile, Panama, Honduras … and to major transshipment ports in Europe.

Going into 2014, there is still plenty of room to accommodate stepped-up U.S. oil production by backing out crude imports -- running at 7.57 mb/d in late 2013 or 5 mb/d excluding imports from Canada. However, with imports of West & North African 'light' crudes plunging to a mere 191,000 b/d in December 2013, the medium, sourer crudes of the Middle East may start to bear the brunt of import displacement -- increasingly into the US Gulf Coast. Imports from Venezuela are also likely to decline.

On a more concerning note for U.S. oil markets, the near-term potential for further growth in U.S. refined product exports is limited, with domestic refineries already operating at 88% of capacity and only 300,000 b/d of expansion planned for 2014-15. While refined product exports are permitted from the United States, crude oil exports are banned -- a national security initiative introduced in the early 1980s in the aftermath of the Arab oil embargo -- unlikely soon to be ended. Canada is the only country to which shipments are effectively exempted -- attracting stepped-up exports of U.S. oil into Eastern and Atlantic Canada last year, narrowing Canada's oil trade surplus. U.S. producers are increasingly viewing Eastern Canada as a potential oil export market.

U.S. dependency on net imports of liquid fuels (crude oil, NLGs & biofuels) has dropped substantially -- from a peak of more than 60% of U.S. consumption in 2005 to 33% in 2013 and a projected 25% in 2015. While a positive for the U.S. merchandise trade balance, the rapid development of U.S. 'light, tight' oil poses a risk for 'light' oil prices in 2015-16 -- especially in the United States and Canada. WTI oil prices could drop towards the US$90 mark by mid-2015 from today's US$99. This accounts for the growing interest of Western Canada's 'light' oil producers (e.g. Crescent Point Energy) in diversifying markets to Asia/Pacific and the west coast of India -- another development favouring proposed export pipelines to 'tidewater' -- the Northern Gateway Pipeline to B.C., Trans Mountain expansion and the Energy East Pipeline Project to Montreal, Quebec City and Saint John, New Brunswick. 'Heavy' oil prices for Alberta in-situ bitumen & conventional oil are expected to hold up relatively well due to the need for a heavy crude slate in Houston.

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