Stock Market

Doha meet to make no difference to crude supplies: Citigroup

Doha meet to make no difference to crude supplies and India’s rapid growth would be counterproductive over a long period — these were the key takeaways of a discussion of CNBC-TV18’s Latha Venkatesh with Seth Kleinman, Head of Energy Strategy, Citigroup and Manoj Pradhan, Global Economist at Morgan Stanley.  

Seth Kleinman, Head of Energy Strategy, Citigroup, saw crude prices staying in the early USD 40- per-barrel range, but the rebound in steel prices, he said, is unsustainable.

On his expectations of crude supply cuts by oil producers, especially the Organisation of Petroleum Exporting Countries (OPEC), in the run-up to April Doha meet, Kleinman said, “I think what happens in Doha will change basically nothing in terms of actual barrels put up for sale.”

Kleinman sees the average price for liquefied natural gas (LNG) to hover around sub-USD 5 mmBtu for 2016 and around USD 4 mmBtu in 2017. “Unless you have some kind of big weather extremity, there is really no way of seeing how you can mop up the oversupply of gas,” he said.

He expects copper prices to stay firm on strong demand and there could be a widening of supply deficit in 2017.

On India-specific growth outlook, Pradhan of Morgan Stanley feels the economy will likely work around the impediments that have been there for a long time. “We are not expecting a robust pick-up or massive dynamic growth,” he said, adding he would be worried if India grew rapidly, as that typically proves counterproductive over a longer period.

Below is the transcript of Seth Kleinman and Manoj Pradhan’s interview with Latha Venkatesh on CNBC-TV18.

Intro: Hello and welcome to Indianomics. The key factor that changed the grammar of the world financial markets, over the past one week has been the Fed statement indicating that the number of rate hikes in the coming year will be two rather than four. Commodity prices which have already been gaining ground, gained further ground after that Fed statement which pushed the dollar down to a five-month low. So, is this a seminal troughing out of commodity prices, especially crude, that is the question we have to grapple with in the next few months and I have someone who is best placed to answer that question. Seth Kleinman, Head of Energy Strategy at Citi Research joins us.

Q: That really is the first question. Has crude troughed out for the moment, for this super-cycle?

Kleinman: Yes, I think it has. What we saw back very early in the year was crude oil price being pushed down to levels that you could see that the industry just could not take. Below USD 30 per barrel, the industry just does not work down there and you saw it most dramatically in terms of the response from US shale. But you are also seeing some fields getting shut in China. You have seen talk of fields getting shut in a whole lot of other countries. USD 30 per barrel was too low.

We have rebounded to a more sustainable level. We will see where we go from here. I do not think it is too much more upside from here, but we will see.

Q: That is exactly the next question really. There has been a lot of bullishness getting built in to the run-up to the Doha meeting of oil producers, especially the Organization of the Petroleum Exporting Countries (OPEC) countries. Do you expect that supplies will be cut in the run-up to April Doha meet? Where do you see crude trending and what are you expecting in Doha at all?

Kleinman: The market clearly wants to believe, but I am not really a believer at all. I think what will happen in Doha will change basically, exactly nothing in terms of actual barrels put on the water and barrels for sale. That is it; clearly the market wants to believe. But the reality is when you are at USD 30 per barrel, you could talk about some kind of joint action that would boost prices maybe by USD 10 per barrel and that might work. You can get up to USD 40 per barrel. You are not necessarily going to reactivate shale, you are not going to see a material – that is not going to increase production from elsewhere. But when you are at USD 40 per barrel, and you talk about some kind of action that boosts you to USD 50 per barrel, somewhere between USD 40 and USD 50, you are going to start to see the return of US shale production. So, there are options, there is room to manoeuvre. At USD 40, it is significantly much more constraint than it was at USD 30 per barrel.

Q: Let us talk about ranges now. In the run-up to April, what do you expect will be the range for crude and indeed for the rest of 2016?

Kleinman: We are in a USD 35-45 per barrel range. Above USD 40 per barrel, you are going to see one less buying from China because of the way their market is now structured and between USD 40-50 you start to see the return of US production. So, we are capped in the low USD 40s. If we overshoot that then you risk bringing on a bigger supply response and then you get according weakness later in the year. But we are now really in the low USD 40s to high USD 30s range.

As towards the end of this year, as long as we do not overshoot to the upside now, then you will start to see more widespread supply declines outside of America. And that is enough to push us closer to USD 50 per barrel towards the end of the year.

Q: Do you see 2017 being bullish at all? I know it is too far out.

Kleinman: We will continue to grind higher into 2016, 2017 and even into 2018 as we start to see. There is a very long lead time. There is a long lag time in this industry. So, projects that got cut or cancelled or curtailed when we were down at USD 30 per barrel, that is going to take 6-12 months to show up but it will affect supplies. So, as long as the global economy keeps trucking along, it does not have some kind of hard-landing, demand will keep growing and the tightness in supplies will increase over the next couple of years and prices move higher as a result.

Q: Let me veer away from crude to its allied commodity, gas. How do you see gas prices trending in the west but more importantly in the east? One understands that Australia is on the verge of increasing its gas supplies considerably by 2017. So, lay out the gas price trajectory for us.

Kleinman: Gas prices look like they stay under heavy pressure here because it is not just Australia, it is also the United States. Between the two of them, you have a two pronged surge in supply that is coming online just as particularly Asian demand, Asia is always driver of energy and particularly gas demand growth. You have got slower economic growth in the region and you also see this continued exponential build out in renewables. And very cheap coal. Gas prices look like they could easily trade down to USD four LNG wise in Asia. They are already sub-USD five. Unless you have an incredibly hot summer or an incredibly cold winter, add some kind of big weather extremity, there is really no way of seeing how you can mop up the oversupply of gas which increases as Australia and the US continue to push more gas into global markets.

Q: So, the average gas price in 2016, more importantly in 2017?

Kleinman: Average gas price for LNG somewhere around the sub-USD five for here and probably closer to USD four in 2017.

Q: One question, not exactly your area of extraordinary interest but commodities other than crude have also seen a bit of a leg up. The chartists tell us that the copper chart has definitely troughed out. What is your sense about metals for this quarter and for this year?

Kleinman: We were expecting a rally to come in metals because you are starting to see, prices were low enough that you were starting to see supply curtailment. Meanwhile, demand actually was looking okay. We were expecting a rally later in the year. It has come a little bit earlier than we expected. But we still think that overall, the demand and supply for copper remains constructive. So, we think that by the end of this year, you are in deficit and that deficit can grow in 2017. So, we are optimistic in terms of prices on copper. We still think this rally has some legs.

But what is tricky is trying to figure out what is copper or metal specific and what price move came about just because of a massive unwinding of the biggest consensus short in the market which was short emerging markets, short everything China and commodity related. That trade en masse got unwound over the past four weeks. And so you have seen every commodity rally. You have seen everything from timber to coal to iron ore. Some commodities that are really in severe oversupply. Fundamentals have not changed at all. They have rallied right along with things like copper where you could paint a more constructive picture. So the question is has the whole market gotten ahead of itself and then sees a setback or do we start to see some differentiation on the part of how these commodities really start trading?

Q: That is interesting to distinguish, but perhaps what worries us more is steel price. Not exactly a commodity, but a value added one. A lot of dumping still happens from China and from the far-east into countries like India. That perhaps is another story, but do you have a view there? Do steel prices also stabilise at a slightly higher level? We saw them fall all the way to USD 250. Do they stabilise closer to USD 400 for the rest of the year?

Kleinman: Steel is really the perfect example. There is really nothing fundamentally bullish that has changed in the steel story. You are still talking about a severe glut that is difficult to manage. When you talk about overcapacity in the various industries in China, with steel, it is a chronic overcapacity. There is really no sign of it getting rationed here and yet, prices have rebounded. So, steel is one of the commodities where this rebound is looking really unsustainable.

Latha: So, the message quite clearly is that crude stays in the early USD 40 per barrel. So, the Indian fiscal math does not go terribly awry. But on the other hand, the other higher commodity prices does not mean the pressure on steel prices or lenders to steel companies in India are going to see any relief. That is the message a global commodities expert.

Manoj Pradhan, Global Economist, Morgan Stanley

Q: The first two months of 2016 global market seem to worry about recession. What is your sense of the global economy this year? Is it at least better than last year in terms of gross domestic product (GDP) growth?

Pradhan: It is a difficult story. I think it is going to move sideways probably at best. The downside risk has certainly increased buy my take was that markets were a little too worried about recession risk earlier in the year.

What is happening is that the China and the emerging market shock that we have had from 2015 is affecting the advanced economies on the tradable side. So, import prices, exports wherever there has been energy particularly in the United States has been a big problem and that problem is transmitting itself to degrees into the local economy. So there are risks, there are domestic risks.

However, typically speaking these risks are not as high as markets were anticipating. What we have seen in the recent past is that the data has suggested these stories a little bit more clearly where the data has improved particularly in the United States, I think we have seen the Federal Reserve also acknowledging that saying that look we still want to hike the interest rate this year but not as much as we wanted to.

On the other hand, when you look at the euro area economy, core inflation over there in the near-term has ticked down, which is why they are a little bit worried. If you look at the structural risks in those economies, I think they reflect this differential as well of the risks of secular stagnation in the United States are much lower. They don’t have a domestic problem and on the euro area, that story is mixed and even from that rationale, the difference between those two central banks reflects that story.

Q: I don’t know whether to ask you the chicken or the egg question first. Let me start with China. Do you see China being less of a dampener on global commodities? Do you think it will be a growth story this year?

Pradhan: I think the commodities picture is very difficult because there are always two sides to it. There is a demand side and there is a supply side. I think clearly, what we have seen in the beginning of 2015 and the last part of 2014 was the decline in commodity prices because China’s manufacturing sector is going through a growth shock.

How the supply response to that also has a lot to do and frankly our commodity guys know a lot better than I do on the supply front but if you look at China itself, I think that China story is also evolved. What we have seen is there has been a dramatic change in the growth mix and the change in the growth mix implies that the manufacturing sector now is showing incredibly subdued growth and will probably continue to do so for a while and it is the consumption side of the story that has remained robust in the near-term but over a longer-term probably has downside attached to it.

So the way China slows down, and it will structurally continue to slow down, has changed. That has implications for global markets because it is the manufacturing sector in China that matters a lot for the global economy, it matters for trade, it matters for commodity prices and it matters for overall sentiment and the way China sees the rest of the world.

So, to the extent that that story has stabilised, I think what we are working through now is the China shock being transmitted to the advanced economies through the tradable sector, through imported inflation and now the advanced economies are working through how to digest this China shock.

It is a second largest economy in the world, emerging markets are much bigger than they have ever been in the past, it is no surprise that the digestion story is taking so much longer, this is what happens when the second largest economy in the world changes its growth mix.

Q: Before I come to the developed markets, what about the EMs itself? There was a demand shock or a growth shock for the commodity producing EMs. Is the worst behind them, would you say that EM especially commodity EM growth in 2016 will be better than last year?

Pradhan: I think that is a difficult proposition to make. There are two reasons for it. One is, we are struggling with low growth. Almost everywhere potential output growth has come down. That is true in emerging market, that is true in the advanced economies but the problem that commodity exporters are struggling with is the Dutch disease problem. Typically speaking what happens in the Dutch disease economy is that the commodity sector becomes strong, it can deal with the currency appreciation, it absorbs a lot of the employment. So the unemployment rate goes down, wages go up and consumers become very strong. When you have an unwind of the Dutch disease to a decline in terms of trade, all of those stories start working themselves backward.

What also happens in a Dutch disease problem is as the commodities and the consumers become stronger, the manufacturing gets weaker because real exchange rate makes them uncompetitive.

For the unwind of this Dutch disease there are two things to keep track of. One is that, the commodity sector and the consumer first needs to slowdown, wages need to decline, the unemployment rate needs to increase, real rates need to come down, the exchange rate needs to come down and then the manufacturing sector slowly starts getting more competitive.

So this happens in two stages and the second thing to keep in mind is not every commodity producer has the same degree of a shock or the same degree of the problem. For example, Indonesia and South Africa are very unique commodity exporters because they export commodities but they import oil. So, they never got all the upside from commodity increases and they never saw all the downside from commodity price declines. In other words, they don’t have as severe a Dutch disease problem, so it is understandable that Indonesia has turned around as faster, Russia has been hit with a bigger shock, so their turnaround has been faster but most commodity exporters are still working through how to get rid of the supply overhang that remains in their domestic economy.

Q: Have commodities stabilised or do you think this is just a bear market recovery and do you think that given your estimate of global growth, commodities are going to remain depressed?

Pradhan: Our houseview is that commodity prices have not necessarily shown a structural shift up. There could be some downside but given how much commodity prices have moved and how much China has stabilised over the last few months, it is completely understandable that commodity prices over here look a lot better than they have for the last year and a half. So it is a conditional argument and if you look at commodity prices as being kind of stable from here, then you get a little bit of impetus, it might get global growth moving a little bit more. So you get some stabilisation.

If there is further downside then I think that might be a difficult proposition for global markets to deal with. What is true, however, is that the commodity shocks so far has been big enough for commodity economies to go through the bulk of that adjustment. When I look at oil exporters having taken their budget prices down from USD 50 per barrel to about USD 30 per barrel and it happens in a lot of EM economies, it tells me that these economies have finally said, look this is the time for adjustments, I cannot wait for oil prices to come to USD 60-70 per barrel, I have to treat them as if they are going to be USD 30 per barrel and then let my economy adjust and we will see what happens after that.

Q: Tell me your growth numbers for the following economies, for US, for Europe, for India and China?

Pradhan: What we are expecting out of each of those economies is a very diverse picture. If we start with China, what we are expecting is that the recent stabilisation we have seen in China has been pushed through to a large extent also through monetary easing and some of the other stimulus measures that we have seen in place, property sales have been high, car sales have been come about. We don’t expect that this will be a theme that continues throughout the second half in fact of this year could see a slowdown in China. It is not going to be a dramatic one, but keep in mind from my first point that China is still on a path of a structural slowdown. So, whatever you are seeing in terms of near-term stabilisation is not going to trump those structural forces. I think the downside to that story remain in place. Importantly, it happens in a way that doesn’t necessarily create a huge demand shock for the rest of the world. It does create demand downside for economies that are plugged into China’s consumption.

For the US economy, things are a lot more benign. What we are already seeing is a kind of a convergence between the manufacturing and the non-manufacturing Purchasing Managers’ Index (PMI). The non-manufacturing PMI has moved down over the last few months, sideways on the last print, the manufacturing PMI has picked up a little bit and we are seeing some kind of consolidation. The big uncertainty over there is what happens to inflation. So, core inflation has picked up over the last few months but there are a lot of idiosyncratic factors in here and core inflation could move down before picking up again towards the end of the year.

In other word, what this implies is that there is enough uncertainty to keep the Fed guessing and our best bet is they come up with one rate hike in the year. The euro area, growth is already softening from the robust growth that we saw in the last year, core inflation has come down. So it is a less rosy picture.

In India, our view has not changed. We continue to see slow and steady progress, which is exactly what we like. We are seeing improvements in the things that are coming out of the current account, the improvement of capital goods is an interesting story. The way the economy is going to grow is through a removal of a lot of the impediments to growth that we have seen for a long time. We are not expecting the robust pick up, we are not expecting massive dynamic growth and as I have said to you before in our conversations, it would worry me. If India started showing a rapid burst of growth because those burst of growth are typically counterproductive over a longer period. What we are seeing gives me a little bit more confidence but the story can remain in place for a longer period of time.

Latha: That is ditto what Governor Rajan said at the last credit policy meeting. He said, 7-7.5 is a good rate of growth almost advising that it would be wrong to chase something that is not too good for the economy. Don’t run too fast for your own good seem to be the advice. So you seem to be echoing that sentiment.

So the key takeaways from our guest are that global growth will not be a lot better than last year. This is good news and bad news. Bad news for exporters, bad news for the manufacturing sector in India but the good news is also that the commodity prices that have risen are not going to see a runaway rally. That is exactly what we heard from Seth Kleinman as well. So, benign commodity prices even if they have bottomed out is the picture for 2016.