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Will oil prices rally under US Fed’s emergency rate cut?

2020-03-05 www.cofeed.com
The US Federal Reserve announced to slash its benchmark interest rates by 50 basis points Tuesday in an emergency move to protect the economy from the negative impact of the coronavirus outbreak. It was the largest cut since the 2008 financial crisis. And the Fed also cut the interest rate on excess reserves by 50 basis points to 1.1%. Michael Feroli, chief U.S. economist at JPMorgan Chase, said Monday he saw a 50% chance the Fed would cut rates this year to zero, up from a 33% in the previous week, according to Wall Street Journal. 

Three US major stock indices posted an uptrend after the news, but then they all pared gains to fall. Dow Jones were down 2.94% to close at 25917.41, NASDAQ down 2.99% to close at 8684.09, and S&P down 2.81% to close at 3003.37.


It was nearly twelve years since the last emergency cut for the financial crisis in 2008. Definitely, the COVID-19 (novel coronavirus pneumonia) is wreaking havoc.

On China’s Dalian Commodity Exchange, soybean oil rose moderately in early trading, but then failed to extend the rebound. As of 9:52 (Beijing Time), soybean oil May contract was traded lower by 10 yuan at 5,662 yuan/tonne, and palm oil May contract was down 34 yuan at 4,976 yuan/tonne. The trend of palm oil has been weaker than soybean oil in these two days. As a contrast, on January 10th 2020, soybean oil May contract was 6,950 yuan/tonne and palm oil May contract was 6476 yuan/tonne. In just more than a month, soybean oil has declined by 1,294 yuan/tonne and palm oil by 1,510 yuan/tonne.


Fig.: Soybean Oil on DCE

 
Fig.: Palm Oil on DCE

The major factor is the epidemic which has drastically reduce the oil consumption in China. In spite of an increase in household consumption, it still fails to offset the sharp decline in demand from schools, hotels, catering services and factories. 

According to Cofeed, since February, the trading volume of bulk soybean oil has totaled 44,460 tonnes, with an average of 2,021 tonnes per day, which is far below a normal level of 20,000 tonnes. This has directly reflected how much the epidemic has impacted the oil consumption.
 
Oil futures were sharply higher, although hitting the limit-down on the fist session after the festival. DCE soybean oil May contract was even traded at 6,250 yuan/tonne, which was attributed to the peak of the epidemic. At that time, there was a blockade in road across the country, and oil mills were neither unable to resume work nor to transport goods. But after few days, the government introduced policies to stabilize grain and oil supply, so that oil mills began to resume production and to pick up utilization capacity. As February 28th, soybean crush rose to a very high level of 1,927,200 tonnes.
 
Oil mills have picked up operation rates to a very high level, so soybean oil stocks continue the sharp increase this week. In the week ending February 28th, China’s commercial inventory has totaled 1,344,200 tonnes, up 146,400 tonnes by 12.22% from 1,197,800 tonnes last week, up 495,200 tonnes by 58.33% from 849,000 tonnes last month, and up  6,200 tonnes by 0.46% from 1,338,000 tonnes of the corresponding period last year. And the five-year average at the same period is 1,168,300 tonnes. Currently, an increasing number of mills are facing swelling stocks, and among them are state-owned and foreign-owned leading mills. In this case, soybean oil price basis keep declining under pressure. 
 

Fig.: Soybean Crush in China


Fig.: Soybean Oil Stocks in China

On import front, DCE gross margin for South American soybeans is still handsome, of which it is 200-280 yuan/tonne for Mar-Jun Brazilian soybeans. Chinese importers bought a few cargoes again on Monday after 11 cargoes last week. China’s soybean arrivals may total 29.13 mln tonnes from March to June, according to estimates by Cofeed, which will be a 3% increase compared to 28.25 mln tonnes a year earlier.

In palm oil market, the news of an output reduction has been overshadowed. According to SPPOMA, Malaysia’s palm oil production grew by 39.75% on Feb 1st-29th against the same period in January. And data by other agencies also post a 8-12% increase in the production. Calculated by the percentage, February palm oil production in Malaysia is predicted to increase to around 1.30 mln tonnes from 1.17 mln tonnes. Moreover, its exports have posted a month-on-month decline of 11.8-12.8%. BMD palm oil will continue to come under pressure. 
 
Meanwhile, as of March 2, China’s edible palm oil stocks totaled 925,600 tonnes at ports, down 0.07% from 926,300 tonnes last Friday yet up 5.8% from 875,000 tonnes a month earlier. The same period in the previous years: 776,800 tonnes in 2019, 670,300 tonnes in 2018, 579,800 tonnes in 2017, 919,400 tonnes in 2016, with 5-year average at 774,300 tonnes. 
 
In the shadow of bearish fundamentals, domestic and foreign oil futures both suffered a setback , and oil spots also remained weakening. After testing the bottom for over a month, oil prices are low at present. And as domestic and foreign policies work along, there is support in the market. The demand will pick up with the epidemic under control gradually in China. The demand has been better now, according to local dealers in Rizhao, Shandong. And data surveyed by Cofeed showed that, soybean arrivals at ports are forecast to be 74 cargoes or 4.825 mln tonnes for March in China. Some oil mills will suspend production in the next two weeks for a lack of soybeans, so soybean crush is predicted to be about 1.63 mln tonnes this week and 1.65 mln tonnes next week. Therefore, soybean oil stocks will also follow to slow down the growth for some time. In addition, Malaysia’s new administration said they would work to improve relationship with India, a move that brought upbeat sentiment to the market and might help limit further declines in oil market.

Going ahead, global demand for edible oils may be affected by the rapidly-spreading coronavirus, which will then be negative the market. The Fed’s decision last night also triggered concerns over a setback in the US stocks market, and the commodity market is even more threatened by the epidemic. Therefore, the oil market is forecast to be little changed in its weakening trend, even if there are some short-term slight bounces driven by policies. 

(Cofeed’s editor on Mar 4, 2020)