Cooling global commodity prices forces them to defer projects.
Indian commodity-linked companies are realigning hedging strategies, deferring projects and contemplating production cut as global commodity prices soften. Still, the tide could turn swiftly in favour of such companies.
After more than an eight-year boom in commodities, a slowdown in the global economic growth is pulling down prices. Little wonder then that the commodity-related stocks have taken a beating on the bourses. Shares of Tata Steel, Hindalco and other commodity-related companies have dropped by more than 76 per cent in the past 12 months.
Unlike the previous occasions, the global credit crisis seems to be the main cause for the downturn in the commodity cycle, and not a shift in demand.
"It is not the demand-supply balance, which has got impacted. It is the impact of the credit crisis because banks have stopped lending. People have sold asset classes across the board and not specific to commodities," said Gnanasekar Thiagarajan, director, Commtrendz Research, a Mumbai-based consultancy firm.
A study of the credit crisis and resultant slump in the commodity prices clearly establishes the linkages. The worst sector to be hit by the credit crisis seems to be base metals. Airline companies, which are reeling under the impact of falling passenger traffic, have slashed or postponed aircraft purchases leading to a slump in demand for aluminium. Consumption of fewer food processed items by the developed countries, including the US, has also added to a softening in demand for the metal.
Aluminium prices have now declined to below the production cost of $5,500 on the London Metal Exchange. The impact will certainly be felt at the mining companies, which in response to the demand, are bound to cut production to maintain prices and profitability.
More From This Section
Similarly, auto companies, which have witnessed slowing sales, are consuming lesser steel, forcing steel companies to cut prices and curtail production.
Tata Steel, the country’s biggest steel maker in the private sector, has said it will cut prices by Rs 4,000 by December, reflecting the market trend. The company’s UK unit, Tata Corus, has announced a 20 per cent cut in production over the next few months.
Arvind Parakh, director for strategy and business development, Jindal Stainless, said, "We are going slow on everything from expansion projects to acquisition."
Metal manufacturers and linked-products, including raw material suppliers, are now likely to be severely hit because of a shift in hedging strategies.
Most companies hedge for six months to a year for their products. But, a prolonged hardening of prices led several firms to keep as much as 40 per cent of the position open. These companies will now have to book sales at lower prices.
Sadly, exporters are likely to be the worst hit as they will be also impacted by a sharp drop in the rupee. Most exporters had earlier sold their dollar or overseas earnings in the forward market in anticipation that the local currency may appreciate.
Still, the cycle could turn quickly. Since emerging economies, including India and China, are in the growth phase, their demand for products may reverse the softening of commodity prices.
"Prices may drop in the short-term, but in the long-term demand will remain strong because of growing economies," said Navin Vohra, partner at Ernst & Young. "Any dramatic drop in prices will lead to consolidation in the industry to maintain profitability."
Demand for energy and related products will continue to remain strong, fuelling demand for related metals and raw materials. Also infrastructure demand in emerging economies are expected to stabilise prices of steel and copper.
Others believe that the downturn in the commodity cycle will be clearer after the dust on the credit crisis settles and some semblance of order is resumed in the financial markets.
"Demand has not contracted to the extent that is being portrayed. One needs to wait and watch for the impact of the credit crisis to blow over," Vohra added.