Author Archives: Stuart Burns

Brexit

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After four and a half years and unprecedented social and political discord, it has finally happened: the United Kingdom has left the European Union with the bare bones of a free trade agreement.

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Bare bones free trade agreement

It took until Christmas Eve — ahead of the Dec. 31 deadline exit date for both sides to make the final compromises necessary to reach an agreement.

However, to Prime Minister Boris Johnson’s credit, after all of the lies and disinformation around the benefits of leaving the E.U., he did finally get it done. Even the normally neutral and sober Financial Times acknowledges it is but the bare bones of a deal, with much left uncovered and much still to be agreed.

The deal covers goods, exports to the E.U. of which make up just 8% of U.K. GDP. However, the deal leaves out services. According to The Guardian, services account for around 80% of the U.K.’s economic activity and about 50% of its exports by value to the E.U.

There will be a lengthy process of ongoing negotiation around how much access the City of London is allowed to E.U. business. Similarly, there will be discussions regarding what constitutes the required “equivalence” for which the E.U. is looking.

This means the previous passporting agreement allowing automatic access to the E.U. is replaced by so-called equivalence. That is, each side unilaterally permits companies from the other to conduct certain financial activities in its territory.

That’s hardly a stable position. E.U. countries like France and Germany have made no secret of their desire to challenge the U.K.’s historical dominance in financial services post-Brexit.

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The oil price is caught between a short-term recovery and the medium-term prospect of peak oil, as countries ramp up programs to decarbonize by switching power generation sources and banning internal combustion engines (ICE).

The oil price has been seesawing between vaccine optimism and pandemic pessimism. Yet, it has managed a gradual recovery from its lows last year to around $50 a barrel now.

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Oil price recovers … but outlook remains muted

However, the oil price is nowhere near where most OPEC+ members would like it to be. It’s also not where shale producers need it to be to sustain capital raising for a return to growth.

However, the oil price could arguably have been a lot less. The price owes its current position to stoic management by OPEC+’s leading producers, Saudi Arabia and Russia.

Consumption still hasn’t recovered to a pre-pandemic level. Furthermore, it doesn’t have any prospect of reaching the levels projected for 2021 global consumption this time last year.

Demand destruction

Demand destruction has come from three main areas, the Financial Times notes, none of which are likely to turn around anytime soon.

The first factor is jet fuel. Air travel is severely depressed and is unlikely to fully recover for several years. Current consumption is some 2.5 million barrels per day below pre-pandemic levels.

Meanwhile, the second factor is gasoline and diesel consumption, which will likely recover more quickly. Even so, it will likely not see 2019 levels this year.

The final hit is from a wider loss of industrial activity and lower levels of goods shipped by sea.

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coronavirus

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Could the coronavirus pandemic bring about more reshoring in the U.S.?

The question is not just of interest in the U.S. By many measures, Europe has been hit as severely by the pandemic. If anything, Europe is even more reliant on global supply chains than the U.S.

The political philosophy that underpinned the Trump administration’s efforts to slow China’s advance — that is, to bring jobs back to the U.S. and “level the playing field” — is also prevalent in Europe. However, in the more fragmented political environment of the E.U., that philosophy is arguably taking longer to come into focus.

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Supply chains, reshoring and a ‘great reset’

Disruption to supply chains due to lockdowns was a relatively short, albeit very sharp, shock.

Automakers temporarily shut down Japanese production lines due to a shortage of parts from China in Q1. Furthermore, there is ongoing chaos at European, particularly U.K., ports due to a host of pandemic-related factors.

Supply chains far and wide have struggled during 2020. These challenges are prompting many to ask: is this the jolt needed to stimulate a great reset?

As The Economist notes, there can be a business case for it, too.

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There has been quite a bit of analyst chatter about the likely impact of China’s return to the steel scrap market next year.

In 2019, the authorities essentially banned steel scrap imports. The move came, in part, because many of the grades were classified as waste. However, of late the rumor is China will be moving to reclassify ferrous scrap as a recyclable resource and could lift the import ban (probably in Q1 2021).

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Steel scrap imports plunge

According to Platts, China has 184 million tons of EAF steelmaking capacity at the end of 2020. Furthermore, the country will likely have 197 million tons by end of 2021.

The totals are up from 175 million ton at the end of 2019, when scrap imports had plunged to just 180,000 tons due to the ban.

Domestic steel scrap production has been on the rise, generating some 240 million tons in 2019. As such, the 2014-18 average annual imports figure can be seen as minuscule by comparison.

But while they may be small, they are not insignificant.

Normally, imports rise and fall relative to the premium arbitrage of domestic prices over world prices. Currently, domestic steel scrap prices in China are said to be about $60/mt or Yuan 400/mt over Southeast Asian seaborne scrap prices on like-for-like grades (when freight and taxes are included).

Should imports be relaxed, there is, therefore, the potential to suck in considerable imports.

Platts suggests this would not top the record 13.7 million tons imported in 2009. Some, however, disagree, saying it could reach 20 million tons.

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person fueling up diesel engine car

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Recognizing the direction of flow and going with it is certainly a good survival tactic, particularly with respect to diesel engines.

So the move by European truck makers to tackle the challenge of a continent-wide commitment to decarburization should be seen as a refreshing attempt to mold the narrative and future landscape rather than refusing to acknowledge the direction of travel.

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Diesel engines, electric vehicles and lower emissions

The European Union has plans to reduce CO2 emissions by 50% by the end of the decade.

Transport will play a big part in that.

Automotive car manufacturers, driven by challenging targets, have and continue to invest billions to develop viable electric vehicles. In some cases, they are also exploring alternatives such as fuel cells.

However, the truck industry has so far concentrated on producing ever more fuel-efficient, lower-emission diesel engines.

2040 pledge

As the Financial Times reports, though, an alliance of Europe’s largest truck makers has now pledged to stop selling engines that emit emissions by 2040.

Daimler, Scania, Man, Volvo, Daf, Iveco and Ford have signed a pledge to phase out traditional combustion engines and focus on hydrogen, battery technology and clean fuels.

The report says the industry will spend between €50 billion and €100 billion on new technologies to achieve this goal. First, they plan on introducing biofuels, which have a carbon capture and storage component. Having already taken CO2 out of the atmosphere, they are said to be more carbon neutral than fossil fuels. However, they will migrate over the next twenty years to hydrogen fuel cells and batteries — or, likely, a combination of both depending on how technologies and investment in infrastructure develops.

Under the coordination of the E.U. carmakers’ association ACEA, they are working with the German-funded Potsdam Institute for Climate Impact Research to consider the best technologies and approaches to follow – and, no doubt, where to lobby for state support to aid the process.

Carbon tax disincentive

One key area already identified is a higher carbon tax in the E.U. The industry says that to realistically incentivize investment they have to disincentivize the advantages currently enjoyed by internal combustion engine (ICE) systems. “If politicians continue to subsidize fossil fuels, it will be very difficult for us, we need to change the behavior of our customers, and of our customers’ customers,” Scania chief executive Henrik Henriksson told the Financial Times.

It goes without saying that, in the meantime, the customer is going to end up paying for this. A higher carbon tax will be borne by the trucking industry and its users, not by truck manufacturers.

As costs rise for ICE engine systems (e.g., diesel), the industry will find demand will fall for ICE engines. In turn, demand will rise for EV or fuel cell alternatives. Of course, that will only happen if they are deemed viable in terms of range, reliability and speed of refueling.

As a trucker observed to me the other day, “I covered 250,000 miles in the last three years, if I went electric it would currently take me six years because I would spend half my time sitting in truck stops recharging!”

That’s why many believe the future for heavy transport will be hydrogen fuel cells with battery back-up or support.

Challenges ahead

However, two challenges need to be resolved.

The first is an adequate infrastructure of refuelling stations, at least on major roads and motorways.

The other is the development of clean energy electrolysis splitting water. Currently, most hydrogen comes from natural gas making it essentially a fossil fuel.

Still, as we have seen with auto EVs, first technology needs to be developed. Then, costs have to be reduced. Gradually, the most viable solutions emerge.

At least Europe’s truck makers are trying to coordinate investment and agree on a common direction — that’s an encouraging sign.

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commodities

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When Jim O’Neill, former chairman of Goldman Sachs Asset Management and a former U.K. treasury minister, posts his thoughts on what 2021 may bring for equities, commodities and the dollar, it is worth taking a few minutes to listen.

Few economists have his level of both academic and practical experience in global financial markets. Over the decades, he has been proved more right than wrong.

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Bull or bear for commodities, equities

The premise of his post is simple: will 2021 prove to be a bull or a bear market?

Spoiler alert: he believes it will be a bull. However, he says it won’t be with the same trajectory as the recovery in 2020 has seen.

To the downside, he sees risks from a slow rollout of vaccines. After huge hype, the vaccines have raised expectations of an early end to the pandemic.

Countries that have struggled to cope with testing and tracing, such as the U.K., may struggle to roll out an effective vaccination program. Organizationally, the two are not so very different in their challenges.

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sanctions

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Aluminum buyers will have read a recent announcement in Bloomberg with a sense of panic, if not déjà vu, as the specter of Rusal sanctions reportedly looms again.

“Aluminum Surges on Concern U.S. May Reapply Rusal Sanctions” ran the headline, reminding buyers of the chaos that ensued in 2018. At that time, the Trump administration applied sanctions against Oleg Deripaska, owner of En+ and, therefore, Rusal Aluminium. The decision effectively banned Rusal metal from the U.S. market. Furthermore, it banned, by extension, metal from any suppliers of product based on Rusal primary metal – much of Europe and parts of Asia.

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Rusal sanctions Part 2?

By way of context, Rusal is the largest aluminum producer in the world outside of China. The company accounts for some 6% of global supply.

The firm is the largest supplier in Europe and still retains the position of being in the top five to the U.S. market.

Back in 2018, when Rusal stood on the outside looking into the Western world’s metal markets. Physical delivery premiums, particularly the Midwest Premium, skyrocketed to nearly $500 per metric ton. (Although, it has to be said, the Midwest Premium was already somewhat elevated before the Rusal sanctions by earlier, more Chinese-focused tariff action.)

There appears to be a number of factors at play this time around.

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Brexit

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Among all the hullabaloo of COVID-19 infection rates and surging deaths, we may all be forgiven for having forgotten that a small but relatively important part of the European Union, Britain, formally leaves the bloc — that is, Brexit — in just over two weeks time with no formal separation agreement or coherent working plan for how the U.K. will trade with the EU from January onwards.

Public sentiment is resigned to the constant buildup and letdowns of every previous “deadline” that came and went in what has been a colossal failure of statehood on both sides.

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Brexit deal or no deal

No new deadlines have been set save the obvious one of Dec. 31, after which the two sides will have to start applying tariffs to each other’s imports and exports by reverting to WTO rules.

But even a Brexit “deal” is a pale shadow of the close cooperation that previous Prime Minster Theresa May’s government negotiated with Brussels, only to have it thrown out by Tory backbenchers and dysfunctional opposition parties who used the opportunity to bring the government down rather than try to secure the deal they said they wanted.

The remaining sticking points to a deal may seem bizarre to an outsider.

The E.U. was insisting that Europe retains the legal right to penalize the U.K. if it diverges from the E.U.’s state aid rules. It’s a bizarre principle for a conservative government to be fighting over, as conservatives by tradition are deeply averse to state aid for anything.

But the principle here for MPs is an even deeper aversion to the U.K. being subject to diktat from Brussels. Such control undermines the very principle of being a sovereign nation.

The fudge both sides may be moving towards is to agree any such sanction is not automatic. Furthermore, there would be an arbitration system, allowing both sides to agree on some success in the negotiations.

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Shipping

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The shortage of containers in Asia, which we reported in detail last month, has been ongoing, as has the continuation of port congestion across the U.K. and Northern Europe.

Combined, these problems are having a profound impact on sea freight services.

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Shipping lines navigate choppy waters

A number of shipping lines are suspending all freight bookings from Asia to Europe until the end of the month.

Heavy and sustained demand has overwhelmed the container supply chain, creating chronic shortages in equipment and driving rates up. Further increases are likely in January.

So far this year, sea freight rates have doubled on the Asia to European routes, an unprecedented rise that has caught importers off guard as they have incurred some substantial losses just as businesses are struggling to recover from or meet the ongoing demands of the COVID-19 pandemic.

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The gold price has been on the rise during the pandemic this year. As infections rise, vaccines loom on the horizon and economies gradually recover, what do we expect from the gold price in 2021?

Gold price bulls

The bulls are predicting a resurgence in the price to U.S. $2,300 per troy ounce in 2021.

Goldman Sachs stated last month they had a target of $2,300, as recovery from the the coronavirus-related recession fuels higher inflation next year. Goldman’s economics team sees inflation rising to 3% next year before weakening through year-end. Further fuel could be added from a recovery in demand from India and China.

Punchy, you may think.

The gold price rose strongly in the first half of 2020, in large part due to the fall in both nominal and real yields. An increase in safe-haven investment demand in the wake of the virus-induced economic slump also contributed, Capital Economics wrote recently. The research house explained the the price rise has been strong since the start of 2019, riding an 18-month surge in demand for ETF holdings as a safe-haven investment. That is a process that gathered pace in the face of the pandemic.

Gold price retraces after August peak

However, the gold price has dipped from its August peak. Investors rotated out of safe havens into riskier assets on hopes of a vaccine-induced economic boom next year.

The story here is more conflicting. Yes, vaccines appear to be coming faster than London buses in rush hour.

However, so are infection rates and hospitalizations.

It will be a dark winter, as actual vaccination rates fail to live up to expectations and people continue to die. However, markets generally look forward, not at the present. The expectation remains that, sooner or later, markets will recover as vaccinated immunity spreads through the population.

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