October 13, 2021 | 15:30
Energy Boldly Goes Higher
Quarterly Forecast Update Edition
Commodity Forecast Highlights: [Quarterly Commentary Starting on Page 2]
Quarterly Forecast Update
Energy: Crude Oil: These are ‘happy days’ for OPEC+. Beyond the fact that both crude oil and, more so, natural gas prices have zipped upwards in recent days due to energy/power shortages in Asia and Europe, concerns over the clean energy transition (e.g., reliability of wind power) have also come to the fore. This is not to say the world’s decarbonization push is going to stall, but it has also become clear that the world will not be able to simply abandon fossil fuels overnight, which must sound very pleasing to the ears of the world’s major energy producers.
It therefore should have come as little surprise that OPEC+ sat tight earlier this month and stuck with its prior telegraphed decision to taper its production cut target by 400kb/d for the month of November. Recall OPEC+, after some infighting, had decided in July to increase production by 400 kb/d per month in August until September 2022. There had been some speculation that OPEC+ could surprise the market with a larger increase following calls from the United States to increase supply.
On the flipside, OPEC+ may be becoming less concerned that much higher crude oil prices could dramatically incentivize new exploration and production or fast-forward the move into renewable energy given developments over the past month. Meanwhile, it appears that the combination of rising ESG considerations and shareholder demands to maintain capital discipline may actually be working in favour of OPEC+, at least temporarily. A key gauge of whether capital discipline may be loosening is to watch the U.S. shale market, where production could quickly come online. Overall U.S. crude oil production recently sat at 11.3 mb/d on October 1, still well below the pre-pandemic peak of 13.1 mb/d, but had been steadily creeping upwards before Hurricane Ida struck.
For the time being, it appears that crude prices should be well-supported as new incremental supply is likely to remain fairly limited, while demand continues to improve amid shortages of other fossil fuels. As a result, we have revised up our near-term WTI forecast to US$75.50/bbl for Q4/21, which lifts the annual projection to $67.50 for 2021 (previously $65). We have also nudged up our 2022 forecast to $72.50 from $70.00.
The outlook for the price of Western Canada Select (WCS)—a blend of heavy oil produced in Alberta—will be able to piggyback off WTI, increased demand for Canadian heavy crude by U.S. Midwest refineries and declining supply from Mexico. The discount of WCS relative to WTI has averaged US$13.50/bbl the past few weeks and is likely to remain at a similar level in the coming months. As economic activity continues to normalize, we expect only slightly more Canadian crude oil to be transported to the U.S. by rail as Enbridge Inc.’s Line 3 pipeline replacement project recently entered into service, which adds new pipeline capacity. Note Line 3 will add 370 kb/d of new incremental pipeline capacity and thus increases Canada’s total pipeline capacity to just over 4.6 mb/d.
Natural Gas: The prospects for natural gas appear even more promising than that of crude oil as benchmark Henry Hub has surged above US$5.00/mmbtu over the past month. For comparison purposes, it had averaged roughly $3.40 in the first eight months of the year and just $2.65 the prior five years. Though we are not projecting prices to stay at current levels for an extended period, prices should remain at elevated levels compared to recent history, especially if the upcoming winter ends up being colder than normal. As a result, we recently revised the forecasts for benchmark Henry Hub natural gas to US$3.85/mmbtu for 2021 and $4.00 for 2022 (previously $3.50 and $3.00).
The price of Henry Hub should benefit from a combination of domestic and overseas factors. In the U.S., the projected demand/supply balance is expected to only modestly temper prices next year as supply outpaces demand. The EIA recently projected dry natural gas production to increase by 4.2% to 96.4 bcf/d in 2022 (vs an estimated rise of 1.2% in 2021), while domestic consumption is forecast to fall 0.8% (vs 0.0% in 2021).
Overseas demand is likely to remain more supportive even though U.S. exports of LNG roughly absorbs only 10% of total natural gas production. The lack of export/LNG capacity helps explain why the price of Henry Hub has not risen at the same pace as global LNG prices. Indeed, benchmark European (Title Transfer Facility—TTF) LNG prices are now hovering around US$30.00/mmbtu (over 5x vs end-2020), while Asian (Japan-Korea Marker—JKM) prices are closer to US$35.00/mmbtu (3.5x vs end-2020). Looking beyond the impact of lower-than-normal inventories and weather (winter and wind), European LNG demand should remain steady from a medium-term perspective, supported by the planned retirement of a large number of coal and nuclear power generation plants. This decarbonization push is likely being fast-tracked by rising carbon prices, which should encourage a quicker switch from coal to gas-fired electricity.
Meanwhile, it’s clear that demand from Asia, particularly China, is playing a greater role in supporting global LNG demand/prices. Or put another way, there is rising global competition for LNG, and it may persist in the short-term. Indeed, China’s increasing reliance on natural gas may have also contributed to reportedly low inventories in Russia and its inability to ramp up supply to Europe. Moreover, demand in China has boomed due to strong pandemic-driven industrial demand for electricity, weaker coal supply and the increasing push to decarbonize the economy. This explains why the Middle Kingdom’s power grid has been under extreme stress this year, which has led to curbs on industrial, retail and household usage in recent weeks. Though it’s difficult to predict when China’s power crisis will ease, we suspect that three developments would likely need to occur beforehand—robust pandemic-driven demand for goods will need to ease; domestic coal supply which has been constricted due to safety concerns, will need to pick up; and, power prices will need to rise. Indeed, the authorities have responded, urging coal miners to ramp up production and lifting retail power prices to curb usage in the past week.
In the meantime, the price of AECO—Western Canada’s natural gas benchmark—should be able to continue tracking higher Henry Hub prices and, more specifically, strong U.S. LNG exports, which support demand for Canadian exports of natural gas south of the border. As a result, we are projecting AECO to average US$3.00/mmbtu in 2022, up from our projection of $2.85 in 2021. Alternatively viewed, the Henry Hub-AECO differential is expected to average US$1.00/mmbtu in both 2021 and 2022, compared to $0.36 in 2020 and $1.21 in 2019.
Metals: Base metal prices have held up well in the face of large supply/demand-driven shocks emanating from China. Concerns that weaker demand from China's housing sector due to the Evergrande crisis so far appear to have been offset by the emergence of a local/global power crisis. The latter has resulted in power rationing and forced output cuts in energy-intensive industries such as aluminum and steel, which had been intensifying throughout the year driven by Beijing’s great desire to tackle decarbonization. Nevertheless, we expect base metal prices to ease modestly as the unexpected effects of the pandemic, which have led to a big spike in demand for durable/metals-intensive goods, supply-chain shortages and bottlenecks in global logistics slowly reverse course. On the flipside, base metals are likely to continue benefitting from a pickup in the global decarbonization drive (e.g., demand for electrical vehicles and greater installation of solar and wind turbines), which reduces the downside risk to prices of copper and nickel.
Aluminum has jumped to the front of the pack as prices recently hit their highest level since before the Global Financial Crisis. Aluminum has benefitted from China’s aggressive power-related production cuts this year, which have intensified on the back of the power crisis. We anticipate the cuts will remain in place for the balance of 2021 and the market to remain tight until mid-2022. Regional authorities in crucial smelting hubs (Yunnan, Xinjiang, Guangxi, and Inner Mongolia) are under heavy pressure to reduce emissions targets, with over 20 Chinese smelters facing some form of curtailment. The coup in early September in Guinea, a major supplier of bauxite, has contributed to the recent runup in aluminum prices. We have raised our annual forecasts for aluminum to US$1.10/lb in 2021 (vs $1.05 previously) and $1.05 in 2022 though risks next year are skewed to the upside.
Zinc prices have also held up well as power rationing in both China and Europe has led to a reduction in smelter production. Meanwhile, despite concerns that China’s power crisis is beginning to affect end-use zinc consumption, ex-China refined zinc consumption growth is expected to remain strong in the balance of 2021 and in 2022 as global galvanized steel production (main source of demand for zinc) continues to recover, particularly in Europe. In the medium-term, the increasingly stringent enforcement of power consumption targets could constrain Chinese refined zinc output and support prices. We are maintaining our annual zinc forecast at US$1.25/lb in 2021 but raising it to $1.10 (vs $1.05 previously) in 2022.
The long-term prospects for nickel remain very promising as it continues to benefit from strong stainless steel demand and increasingly, the clean energy transition (through its use in batteries). However, prices are likely to remain relatively volatile in the short-term as global/Indonesian production of refined nickel is expected to rise in the next couple of quarters. Nonetheless (lower quality) nickel pig iron production in China is likely to be temporarily impacted as the authorities have ordered smelters in several provinces to curb supply. Meanwhile, there is a risk that Indonesia could implement an export tax on products with nickel content (<70%) as the country looks to develop a homegrown EV economy. If this happens, it would translate into higher prices globally as Indonesia accounts for almost 40% of mined world nickel supply. We have raised our nickel price forecast for 2022 to US$8.05/lb (from $7.70 previously), compared to our projection of $8.15 in 2021.
Meanwhile, we have raised our forecasts for copper prices to average $4.10/lb in 2021 (from $4.00 previously) while maintaining $3.50 in 2022 as fundamentals for copper remain strong (i.e., the market will remain in deficit as consumption continues to outpace supply) amid the green energy transition (EVs, solar panels, etc.). Moreover, the price of copper has so far shrugged off Evergrande-related concerns in China’s housing market as there is now growing unease that already-low copper stocks could fall further due to power-driven restrictions in smelter activity. From a longer-term perspective, new project approvals have been limited over the past couple of years, which is increasing the risk of a medium-term supply problem or multimillion tonne deficit by the end of this decade.
Precious metals prices have held up relatively well in 2021 but we see them easing in 2022. The recent downtrend in gold prices reflects a strengthening U.S. dollar, rising U.S. bond yields and an expectation of tapering before year-end to curb inflationary pressures. However, we view the risk of an aggressive rotation away from gold as fairly limited for now. As a result, we are maintaining our annual forecasts of $1800/oz for 2021 and $1700 for 2022. Silver has lost some of its lustre in recent months with ETF holdings struggling to gain traction since they peaked in February. However, we don’t expect the rug to be pulled from under silver’s feet given positive investor sentiment surrounding silver’s longer-term industrial uses, particularly related to the energy transition (i.e., rising solar photovoltaic investment). This should underpin the price over the near term. Nevertheless, we have revised our forecasts slightly lower for silver to an average of US$25.00/oz in 2021 and 2022.
Forest Products: Following the dramatic rise and fall of lumber over the past year, prices have regained some upward momentum in recent weeks amid still-strong housing demand and a constrained supply backdrop. After peaking at all-time highs of nearly US$1700/mbf in May, prices of benchmark Western Spruce-Pine-Fir (SPF) experienced a severe multi-month correction before reaching a bottom of around $450 in August. It’s worth noting that this trough occurred at a historically high level as elevated log costs (due in part to high and rising Canadian stumpage fees) led some B.C. sawmills to curtail production due to profitability concerns. Since then, prices have moved steadily higher, rising to nearly $600 by mid-October, or well above the longer-term average of $350-$400.
Lumber demand prospects remain strong and stem largely from the U.S. housing market. More specifically, low inventories of existing homes for sale are supporting lumber demand through two main channels. For one, potential buyers who are looking to move but can’t find a suitable listing can build from scratch. While homebuilders are still challenged by typical shortages of labour, lots and materials, U.S. housing starts have held firm, averaging nearly 1.6 million units (annualized) through the first eight months of 2021—up sharply from about 1.4 million last year. That is all the more impressive when broadening material shortages (i.e., windows, doors, appliances, etc.) and shipping delays are taken into account, which have led some homebuilders to ration projects.
On the other hand, instead of building a new home, some may choose to remodel their current living space to better suit their changing preferences and/or work-from-home needs—a key driver of previous pandemic-related lumber rallies. While the mad dash to secure lumber for repair and renovation activity has ebbed compared to the frenzies of the past year, there are now signs that falling prices are bringing customers back to the aisles of big box stores.
Turning to the supply side, high log costs, due in part to elevated Canadian stumpage fees, are expected to keep prices elevated for Western SPF for the foreseeable future as price dips cause sawmills to pullback production. Furthermore, costs could also see further upward pressure in the months ahead if the Biden Administration follows through on the Commerce Department recommendations to increase duties in November. On the flipside, capacity additions could add as much as 3.5 bbf in new production through 2022 (~5% of North American production), though that will primarily take place in the U.S. South.
Bottom Line: After experiencing record-setting volatility over the past twelve months, the lumber price rollercoaster could encounter a few more twists and turns ahead, though they are likely to be less severe this time around given improved supply and demand dynamics. As such, Western SPF is expected to average US$850/mbf in 2021, before moderating to an average of $650 in 2022.
Agriculture: Crop prices remain elevated due to the severe drought spanning the Canadian prairie provinces, the U.S. Northern Plains, and the Pacific Northwest. The U.S. Drought Monitor now estimates that 62% of the continental United States is grappling with abnormally dry conditions, while in Canada, around 45% of the country and 80% of agricultural land is facing the same. The hot, dry weather has resulted in a significantly smaller harvest of wheat and canola, which are grown intensively in the hardest hit regions. The U.S. Department of Agriculture now projects that North American wheat production will decline 22% this year (even with a respectable winter wheat harvest earlier in the year), while canola production is likely to plunge 33%. Although corn and soybean production have held up well by comparison, reflecting generally accommodative conditions in the U.S. Midwest, continental stockpiles of all major crops are getting low, as shortages in wheat space are encouraging greater use of other products. Strong domestic and overseas demand are providing an additional lift to crop prices, amplifying the impact of reduced supply.
A decent growing season in the Southern Hemisphere and a return to more normal conditions in North America next year would go a long way to putting crop prices into reverse. However, it will take time to replenish stockpiles, especially in today’s solid demand environment, so prices are likely to remain above recent norms through the end of 2022. Under the assumption of average growing conditions ahead, wheat prices are likely to moderate from an expected US$6.90/bushel in 2021 to $6.60 in 2022, which remains well above the average of $4.90 observed between 2015 and 2020. Canola prices, which hit all-time highs this year, should ease from an expected US$670/tonne in 2021 to $570 in 2022, against an average of $370 between 2015 and 2020. Of course, there is a possibility that prices could retain current strength or begin a new leg up if growing conditions remain challenging.
Livestock prices are also elevated, reflecting bullish supply and demand fundamentals. In the cattle space, the North American herd turned lower before the pandemic, declined further in 2020 as meatpacker closures undermined farm-level pricing, and has remained under pressure this year due to the impact of the drought on forage availability. The hog segment has experienced similar supply dynamics. After a period of rapid expansion, last year’s meat processing shutdowns put hog producers decisively into herd reduction mode, and higher feed costs have kept pressure on the herd this year. Overall, the North American cattle and hog herds are expected to end the year between 2% and 3% smaller than their recent highs. Livestock prices are also being pulled higher from the demand side, with domestic grocery spending still significantly higher than pre-pandemic norms and China importing more meat products from the United States.
Although meat and livestock demand will likely remain robust in the near term, today’s pricing is expected to spur a return to herd expansion, provided that drought conditions moderate ahead. This should put a ceiling over prices. Overall, hog prices are likely to ease from an expected average of US$93/cwt this year to $84 in 2022, though this would be well above the average of $67 between 2015 and 2020. In contrast, cattle prices are likely to hold their ground near current levels, as a longer gestation cycle will slow eventual efforts toward herd rebuilding. Cattle prices are projected to increase modestly from an expected average of US$121/cwt this year to $122 in 2022.
The BMO Capital Markets Commodity Price Index is a fixed-weight, export-based index that encompasses the price movement of 16 commodities key to Canadian exports. Weights are each commodity’s average share of the total value of exports of the 16 commodities during the period 2012-16. Similarly, weights of sub-index components reflect the relative importance of commodities within their respective product group.
The all-commodities index and sub-indices consist of the following:
Unless otherwise specified, all indices reported in this publication correspond to prices in U.S. dollars.