By
Jom Jacob

Besides a favourable demand-supply fundamental, natural rubber market during 2017 is expected to gain from anticipated trends in crude oil market and improvement in commodity prices. However, possibility of rubber prices taking a substantial jump in 2017 is bleak unless global economy shifts to a much faster track than the anticipated rate

The year 2016 has passed witnessing a rebound in natural rubber prices in the fourth quarter despite the fact that uncertainties clouding the market remain. As the New Year begins, players in rubber industry across countries are cautiously watching on potential developments in the market during 2017.
This is an attempt to review the factors which drove the prices up during the fourth quarter and examine the prospects of the market in the new year.
During the period from mid-September to December 2016, prices of block rubber rose by 46.2% in Kuala Lumpur and 51.9% in Bangkok (Table 1). For sheet rubber, while prices jumped 40.2% in Bangkok, it rose only 11.7% in Kottayam, India. In India, trading in rubber was affected from November onwards due to acute shortage of cash following demonetization of currencies announced by the Indian Government on November 8. Traders in India, by and large, reportedly abstained from buying rubber from farmers. As a result, the market could not gain from the momentum in overseas markets.

FACTORS THAT IMPACTED PRICE RECOVERY

OPEC decision to cut oil output

Recovery in rubber prices during the fourth quarter of 2016 was driven by a host of factors which include uptrend in crude oil prices, improved US economic outlook and supply concerns mainly caused by flood in South Thailand. Crude oil prices had improved from end of September 2016 in response to the initiative by the OPEC to curtail oil output and the consequent agreement it reached on November 30 to cut output by 1.2 million barrels per day (bpd). As non-OPEC producing countries led by Russia also joined the move, oil prices rose by 23.6% from US$ 44.50 per barrel at end of September by to US$ 55.0 per barrel at end of December. Synthetic rubbers being petroleum-derived products, the rise in oil prices led to speculation of a possible substitution of synthetic rubbers by natural rubber. Although it is a fact that substitution based on relative prices is insignificant, especially for the short-term, natural rubber prices gained strength as speculators by and large made bet on a possible substitution from synthetic rubbers to natural rubber. Against 23.6% increase in Brent crude oil price during the period from end of September to end of December 2016, the price of SMR-20 grade of natural rubber rose 43.2% in Kuala Lumpur market.

Forecast of faster economic recovery

Recovery in rubber prices during last quarter of 2016 is partly attributed to an improvement in the commodity’s demand prospects in the context of post-election developments in the US and renewed expectations of a faster global economic recovery.  The US economy grew 3.2 per cent in third quarter of 2016, the strongest quarterly growth in two years. The US consumer confidence rebounded in November to its highest level in nine years.  Adding to it, the IMF in its World Economic Outlook released in October 2016 had suggested a 3.4 per cent growth in global economy during 2017, higher than the preliminarily estimated 3.1 per cent in 2016.

Speculations of supply shortfall

A reported shortfall in supply, and reactions of speculative investors to the same, have also contributed to the uptrend in rubber market. During the 3-year period from 2014 to 2016, global supply grew at the average annual rate of 0.2% only whereas the demand grew at 3.5 per cent average rate. According to preliminary estimates, global supply in 2016 was short of demand by 320,000 tonnes. Supply remained either deficit or closely matching with demand from 2014 to 2016 (Table 2).

Although supply remained considerably in excess of demand during 2012 and 2013, the period from 2014 onwards has seen rebalancing of demand and supply. Furthermore, floods in South Thailand during November and December 2016 brought added concerns over global supply in the short term. Supply from South Thailand has special significance because Thailand accounts for 37% of the global supply of natural rubber and an estimated 65% of the country’s supply comes from the South.
Exodus of speculative hedge funds
Natural rubber also gained from an exodus of speculative hedge funds, particularly in China where speculative investors by and large shifted from steel and copper to rubber. The last quarter of 2016 saw steel and copper losing attraction among hedge funds in anticipation of their robust supply and slowing demand from infrastructure and construction sectors in China. Huge inflow of speculative funds fuelled rubber futures at the Shanghai Exchange to touch 19,825 yuan renminbi per tonne, up 49.6% from the rate prevailed at the end of September 2016.
Depreciation of currencies in China & Japan
Yet another major factor which supported natural rubber market during the last quarter of 2016 was the sharp depreciation of China’s yuan renminbi and Japan’s yen due to strengthening of the US dollar in anticipation of potential hike in the US policy interest rate. During the period from September 30 to December 30, 2016, the Japanese yen suffered a 13.5% loss against the US dollar. The devalued yen made rubber futures at TOCOM economically more attractive to the overseas investors. Driven by the favourable rate of yen, along with a set of other factors, TOCOM rubber futures surged 73.9% to 283.9 yen per kilogram on December 16, from 163.3 yen per kilogram on September 30.
Strikingly, the recovery in prices during the last quarter of 2016 was partly driven by factors external to the rubber sector which include developments in crude oil market and currencies besides investment position taken by speculative funds. While the rebalancing of demand and supply contributed much in taking market momentum up during the last quarter of 2016, there are concerns over demand-supply fundamental staying favourable in 2017.

SUPPLY & DEMAND ANTICIPATED FOR 2017

Projected global supply

Global area occupied by tappable rubber trees is expected to expand by 350,000 ha in 2017 due to large-scale planting undertaken across countries seven years ago (2010) in response to the favourable prices prevailed during the year. Trees planted seven years ago are expected to be opened for tapping by May 2017 when farmers resume tapping on expiry of the leaf-shedding season. During 2017, global production of natural rubber is anticipated to increase by 4.6 per cent to 12,846 million tonnes from 12.280 million tonnes in 2016.
Demand to exceed supply
Global consumption of natural rubber grew at 3.5 per cent average annual rate during the period from 2014 to 2016. As suggested by the IMF in October, global economy may grow at 3.4 per cent during 2017 as against the preliminarily estimated 3.1 per cent rate in 2016. The IMF is likely to slightly upscale its outlook in view of further improvement of conditions, especially in the US and Europe. Demand for rubber is expected to gain from the anticipated further improvement in global economy. Although demand from China may slowdown, faster growth in demand from the US, Europe and countries in Southeast Asia is expected to offset it. In view of new investments in auto-tyre manufacturing, demand for natural rubber is anticipated to grow relatively faster in Thailand, Indonesia, Malaysia, Vietnam and Sri Lanka. Moreover, crude oil is expected to rule above US$ 50 per barrel during 2017 suggesting increase in synthetic rubber prices during the year. This also can contribute to the demand for natural rubber through substitution.
Taking the various factors into account, global consumption of natural rubber is anticipated to grow at a rate ranging from 3.5 per cent to 3.9 per cent during 2017. Taking the medium level growth of 3.7 per cent, global consumption during 2017 is anticipated at 13.066 million tonnes which is 220,000 tonnes more than the supply. Precisely, global supply of natural rubber in 2017 is anticipated to be in short of demand by 220,000 tonnes. The shortfall will be more severely felt till end of April. Tightness in supply is expected to ease after April coincident with the reopening of trees for tapping on expiry of annual leaf-shedding season in major producing countries. Moreover, the vintage of trees planted seven years ago will be newly opened for tapping after April. This can expand the mature area by 350,000 hectares.

Risk factors

The projected figures of supply and demand in 2017 are subject to upside and downside risk factors. In the event of global economy registering a faster-than-expected growth, demand for natural rubber can register a corresponding faster growth. The resultant momentum in the market may enthuse farmers to unlock more supply. More attractive prices can prompt farmers in Malaysia, India and other countries to resume harvesting of mature trees which have been left untapped for the past few years. Untapped mature trees occupy 356,000 hectares in Malaysia and 145,000 hectares in India. Favourable price may also enthuse farmers to adopt proper farm management leading to improvement in average yield. On the other hand, a lower-than-expected economic growth can bring down expectations on demand and send negative sentiments to the market. This
can bring down expectations on supply.

OUTLOOK ON CRUDE OIL

The recovery in crude oil market during the last quarter of 2016 was driven by the OPEC’s deal on 30 November to cut output by 1.2 million barrels per day (bpd) for six months from January 2017. Following OPEC’s decision, producers from outside OPEC, led by Russia, agreed to reduce output by 558,000 bpd, the largest non-OPEC contribution ever. But, OPEC’s members have the habit of not adhering to respective agreed targets. Moreover, higher oil prices raise the chances of other producers, particularly the US Shale operators, boosting output.  These factors raise concerns over possibility of oil prices gaining further momentum or even staying at the level of around US$ 55 per barrel realised at the end of 2016. In a long-term perspective, oil market faces threats due to falling cost of solar energy and battery storage, increasing sale of electric vehicles, and popularisation of energy-efficient ‘smart’ buildings. Number of battery and plug-in vehicles around the world has surged in recent years to one million from less than 20,000 in 2010. As car makers offer more electrical vehicles with a range exceeding 500 km, a shift in that direction will progressively take place. Presence of more battery-charging stations along with possible ban on gasoline and diesel cars in more number of cities can accelerate the shift.
Oil prices are likely to fall in the long-run in view of the above developments in the energy sector. However, in 2017, oil is anticipated to rule between US$ 50 and US$ 55. According to Short-Term Energy Outlook released by the US Energy Information Administration on December 6, Brent crude oil is anticipated to average at US$ 52 per barrel in 2017, up 20.9% from the average of US$ 43 per barrel in 2016. This implies possibility of synthetic rubbers becoming more expensive in 2017, compared to 2016, providing ample space for natural rubber prices to go up.

OTHER NON-FUNDAMENTAL FACTORS

Influence of currencies

As stated earlier, devalued currencies of China and Japan played a role in taking rubber futures up at Shanghai Exchange and TOCOM during the last quarter of 2016. The course of these currencies during 2017 largely depends on strength of the US dollar. The US Federal Reserve has raised policy interest rates by a quarter points in December 2016 and signalled a faster pace of rate increases during 2017. This suggests possibility of dollar gaining further strength in 2017 and thereby exerting downward pressure on China’s yuan renminbi and Japan’s yen vis-a-viz dollar.  Obviously, rubber futures at Shanghai Exchange and TOCOM can
expect a boost from the anticipated devaluation of respective currencies against the US dollar. However, influence of currencies on rubber futures is usually short-lived.
Role of hedge funds
Another important factor having potential influence on rubber market in 2017 is role of hedge funds. Due to dominant influence of hedge funds, commodities largely follow similar trends regardless of factors specific to each commodity sector.  As natural rubber also directionally tracks the general trends in commodities, its future course depends on the emerging trends in commodities. According to Commodity Outlook released by the IMF in December 2016, a 10%  rise is anticipated in the general index of all commodities in 2017 compared to 2016. In view of the improved global outlook and new developments in the crude oil sector, the IMF is likely to scale-up its outlook on commodities. Obviously, anticipated general trend in commodities is favourable to an improvement in price of natural rubber during 2017.

PRICE EXPECTED IN 2017

While demand-supply fundamental will continue influencing natural rubber market, a set of non-fundamental factors is expected to play an equally important role in setting the price trends during 2017. Based on the IMF’s outlook on global economy, global supply of natural rubber in 2017 will be short of demand by 220,000 tonnes. This is subject to downside and upside risks depending on emerging global economic conditions. The expected deficit in supply is likely to be more severely felt during the period up to April on account of seasonal factors affecting the supply. Besides a favourable demand-supply fundamental, natural rubber market during 2017 is expected to gain from anticipated trends in crude oil market and improvement in commodity prices. However, possibility of rubber prices taking a substantial jump in 2017 is bleak unless global economy shifts to a much faster track than the 3.4 per cent rate anticipated. Due to the presence of large extent of untapped mature area and the space available for increasing the average yield across countries, supply has the potential to increase much beyond the expected level if the prices scale too high. This may prevent the market from staying significantly high.