Cheaper fuel adds to longest commodities slump in a generation

Lower fuel prices are compounding the longest commodity slump in a generation.

Because energy accounts for as much as half the cost of producing food and metals, all sorts of commodities will keep dropping, according to Societe Generale and Citigroup.

With inventories ample and slowing economies eroding demand, cheaper oil lowers the price floor for mining companies and farmers to remain profitable. Corn may drop another 3 per cent, cotton 6.5 per cent and gold as much as 5 per cent, SocGen estimates.

Costs are falling as surpluses emerge in copper and sugar and as the economy slows in China, the top consumer of energy, metals, pork and soybeans. The Bloomberg Commodity Index of 22 items is heading for a fourth straight annual drop, the longest slump since its inception in 1991. Brent crude, gasoline and heating oil are the biggest losers as a rise in US drilling led to a price war with Organisation of Petroleum Exporting Countries (Opec) producers.

"There's been a structural change in oil, and there's more to come," said Michael Haigh, the head of commodities research at Paris-based SocGen.

Brent crude, the international benchmark, has tumbled 41 per cent since the end of June to US$66.19 a barrel as US output jumped to a three-decade high. The price this week touched US$65.93 - the lowest since October 2009.

The Bloomberg Commodity Index fell 12 per cent this year.

Falling oil prices would be a boon to consumers who could expect to pay less for food, said Citigroup's Aakash Doshi. About 45 per cent of the operating expenses of growing and harvesting rice comes from inputs such as fuels, lubricants, electricity and fertiliser, a US Energy Information Administration analysis of US Department of Agriculture data shows. Energy accounts for about 54 per cent of costs of corn and wheat.

Energy makes up 30 per cent to 40 per cent of operating costs for mining, says Citigroup, which estimates a further 20 per cent drop for oil, along with gains for the dollar, would cut thermal-coal costs by US$8 a tonne, or 13 per cent, and iron ore by US$4 a tonne, or about 6 per cent.

Crude is dropping because of too much supply, not because demand is weak, so better economic growth should mean buoyant consumption for other raw materials, said David Rosenberg, the chief economist at Gluskin Sheff & Associates in Toronto.

Opec last month kept its output target unchanged even after the steepest slump in oil prices since the global recession. The fracking boom has sent US output up 33 per cent in the past two years to nine million barrels a day, contributing to a global surplus that Venezuela last month estimated at two million barrels a day.

Corn is the most directly affected agricultural commodity when oil prices fall, and lower costs could spur farmers to increase plantings, while reducing the appeal of biofuels made from the grain, said Christopher Narayanan, a SocGen analyst.

The bank expects prices to fall to an average US$3.92 a bushel in 2015. Futures in Chicago have averaged about US$4.20 this year.

"What you see in a farm is tractors, trucks, pumps, fertiliser and chemicals, so everything is somehow linked to energy," said John Baffes, a senior economist at the World Bank. "If the decline in oil prices is sustained, or oil prices are even lower in the future, that will relieve a lot of pressure from agriculture."