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Harvey Isn't Done Spiking Commodity Prices

Sept. 6, 2017
With the water receding comes the awareness that the recovery will take years and require substantial quantities of commodities.

Ranked as one of the nation’s most costly natural disasters, Hurricane Harvey shattered records for rainfall and flooding. With the water receding comes the awareness that the recovery will take years and require substantial quantities of commodities. The sprawling affected area of Houston is close to the size of Massachusetts and current expected costs of rebuilding the Texas city alone are $100 billion and could increase.

In addition to the damage to the energy, chemicals, shipping and rail industries, there are about 100,000 flooded homes, damage to tens of thousands of businesses and municipal and cultural buildings, along with the remains of lost or demolished vehicles, electronics, white goods and furniture.

The raw materials most imperative for the rebuild are iron ore and steel. One of the main reasons steel is used in construction is its durability; it has the highest strength-to-weight ratio of any building material.

There also should be increased demand for zinc because of its use in roofing and panels. Its anti-corrosive attributes make the metal ideal for coating or galvanizing iron and steel.

Copper should also see a demand boost. As a good conductor of electricity, it’s widely used in generators and motors and in wiring in radios, televisions and other electronic goods. Copper also conducts heat, and is used in motor vehicle radiators, air conditioners and home heating systems.

Oil and gas are the big economic engines of Texas, though the effects of the storm aren’t as clear there. In the short term, West Texas Intermediate crude oil will continue to face downward pressure, as the Texas Gulf Coast is home to more than 30% of the nation’s refinery capacity. As of Sept. 1, 10 refineries in the region were still shut, representing a combined refining capacity of 2.9 million barrels per day, equal to 30.1 percent of total Gulf Coast refining capacity and 15.8% of total U.S. refining capacity. Concerns for crude shortages due to pipeline closures were allayed when the secretary of energy authorized the Strategic Petroleum Reserve to provide 4.5 million barrels. Weaker WTI prices have caused the Brent-WTI spread to widen to well over $5 a barrel and will likely continue.

On the other hand, the prices of refined crude products and distillates including gasoline, fuel oil, heating oil, propane, butanes, sulfur and petrochemicals should continue to rise. While some refineries are coming back online or are operating at reduced rates, the larger ones are mostly offline, and could remain out of commission for two weeks.

Gasoline spreads have widened considerably, particularly for the October/November spread. Crack spreads -- the differences between wholesale petroleum product prices and crude oil prices -- also appear likely to widen further before reversing on global rebalancing.

And the impacts on energy are global. As the U.S. has become the refinery of the world, the distillate rallies are pushing up international prices of European gasoil and diesel.

Natural gas prices have been rising as output falls; however, Harvey has bearish implications for the market if the storm further weighs on demand. Power outages and businesses closures could offset the supply risks. The crucial industries of shipping, rail and chemicals have experienced major setbacks. Shipping for both domestic and international delivery is crippled.

Lumber prices will rally further as the housing industry and furniture provide important markets. In addition, cement will be in high demand as it serves as a binder in construction and is used to produce mortar for masonry and concrete for foundations.

The Lone Star State produces high volumes of cotton, wheat, rice and soy, and is a large exporter of crops from around the country. The ratoon rice crop could be a near-total loss in Texas and Louisiana. While about 98% of the region’s cotton had been harvested, floodwaters and wind increase the risk of damage and saturation to unharvested produce and stored crops. Cattle ranchers are now unable to use their destroyed acres for grazing any cattle that were rescued.

Politics play a bullish role, too. First, while the timing of this storm adds momentum to President Donald Trump’s infrastructure initiative, it’s unclear what, if any, portion of his $1 trillion 10-year proposal factored in reserve funds for the unexpected -- storms, floods, fires, industrial accidents and other unforeseen acts of nature or human influence. But even if so, it’s implausible that the cushion was sufficient for a storm of the degree and devastation of Harvey.

Second, Trump is pushing for tariffs averaging 20% on imported steel -- of which the U.S. is a net importer -- and a similar tariff on Canadian softwood lumber, affecting about $5 billion in lumber imports from Canada.

Bottom line, there are multiple ways to trade these markets. Commodity futures and options are recommended for highly experienced traders. One can alternatively trade commodity ETFs and ETNs. It’s advisable, however, to use them as short-term trading vehicles rather than investments, particularly if the commodity is trading in a contango (futures prices greater than spot price) as the roll yield could erode or even reverse any gains. Equities on commodity producers, while not a direct play, are advisable, particularly for non-listed commodities such as cement.

By Shelley Goldberg

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