The Goods
April 07, 2022 | 13:15
War Continues to Reverberate in Commodities
Quarterly Forecast Update Edition |
Macroeconomic Developments:
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Commodity Forecast Highlights: [Quarterly Commentary Starting on Page 2] |
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Quarterly Forecast UpdateEnergy: Crude Oil: Crude oil prices will likely remain extremely volatile until we have a better idea of how the war is going to conclude. For now, our baseline view is that the conflict is going to drag on in the coming months and that official sanctions and self-sanctioning are likely to remain more or less the same. As a result, we remain comfortable with our current forecast for West Texas Intermediate (WTI) crude to average US$100/bbl in 2022 and US$85 in 2023. The lower projection for next year essentially reflects the view that the oil market will become somewhat more balanced (i.e., a smaller deficit/small surplus) due largely to increased supply. |
The other possible scenarios that we need to be mindful of are (1) a sudden end to the war with a long-lasting peace agreement, which would lead to lower oil prices immediately, or (2) the conflict worsens and leads to more severe sanctions on Russian energy, which would lead to much higher oil prices. Irrespective of how long the war lasts, it will have a long-lasting impact on the global energy market, as the West will undoubtedly accelerate its efforts to reduce reliance on both Russian oil and gas. However, it’s not going to be an easy task. The International Energy Agency’s (IEA) 10-Point Plan to cut oil use, which includes measures such as reducing speed limits on highways, car-free Sundays, promoting car sharing, working from home more, promoting walking and cycling, reducing business travel, hastening the adoption electrical vehicles, etc., highlights that curbing global oil demand is not going to happen overnight. The world’s existing capital stock that relies on crude oil as an input (such as internal combustion engine automobiles and petrochemical plants) will not be quickly abandoned. It also seems reasonable to assume that muted demand from China, which has played a role in dampening prices in recent days, will eventually rebound once COVID-related lockdowns are loosened. Meanwhile, boosting the supply of crude oil remains challenging. OPEC+’s resolve to keep a tight lid on global supply has not been shaken by Russia’s invasion of Ukraine. The scope for the West to expand supply remains limited despite the surge in prices. This is best highlighted by the muted response of U.S. shale oil production, which just a short time ago was considered to be one of the world’s major swing producers due to the ability to quickly drill and extract oil. However, U.S. production, at 11.8 mb/d as of April 1 (vs. 11.6 mb/d pre-war, 10.9 mb/d a year ago and 13.0 mb/d two years earlier), has remained essentially flat. The latest Dallas Fed Energy Survey (conducted March 9-17) highlighted that “investor pressure to maintain capital discipline” continues to be the dominant factor (cited by nearly 60% of 132 firms surveyed) in suppressing the recovery in U.S. crude oil output. The survey indicated that U.S. producers can drill profitably on average with WTI at US$56/bbl. We suspect that the labour shortages and the high degree of uncertainty over the direction of crude oil prices may also be holding back production. Otherwise, the potential for other major Western producers (Brazil, Canada, Guyana, Norway, etc.) to ramp up production this year, say by over 500 kb/d individually, is limited. It bears mentioning that the Canadian federal government just approved a small offshore project (Bay du Nord), which could end up pumping 200 kb/d further down the road. The only countries that could rapidly lift global oil production lie within OPEC, as the UAE, Iran and Saudi Arabia are estimated to have spare capacity in the order of roughly 1.0, 1.5 and 2.0 mb/d. It bears emphasizing that if the West were to completely prevent Russia from exporting crude oil, the upside for prices would be immense. IEA statistics show that Russian crude oil production (including refined products) stood at 11.2 mb/d in December 2021, or 11.4% of global oil supply. Of this, Russia exported 7.8 mb/d, with crude and condensates accounting for 5.0 mb/d. These figures explain why the Biden Administration’s decision to tap America’s Strategic Petroleum Reserves (by releasing 180 mb or 1 mb/d), which has been supplemented by the release of another 60 mb by other IEA members, is unlikely to materially reduce prices for an extended period. More importantly, Russia’s ability to continue to export, though at a discount, to major markets such as China and India is preventing global crude oil prices from increasing further. The price of Western Canada Select (WCS)—a blend of heavy oil produced in Alberta—has continued to piggyback off WTI. The discount of WCS to WTI has averaged roughly US$12/bbl since the war began and is likely to remain at similar levels amid strong demand from U.S. refineries. Though Canadian production is likely to increase and some Canadian oil may need to be shipped by rail, the risk of a surge in output leading to a significant widening of the differential is low. Canadian producers have essentially moved toward smaller incremental expansions and optimization of existing projects rather than large greenfield projects given the lack of pipeline access. |
Natural Gas: Global natural gas prices are likely to remain elevated compared to pre-war levels as the EU attempts to reduce its reliance on imports from Russia. We have nudged our 2022 forecast for benchmark Henry Hub up to US$5.00/mmbtu (previously $4.50), as U.S. producers should benefit from increased demand for LNG from the EU and a relatively sluggish recovery in domestic supply. In tandem, the price of AECO—Western Canada’s natural gas benchmark— has also been revised higher, to US$4.00/mmbtu (previously $3.75) for 2022. We are expecting the Henry Hub-AECO differential to average US$1.00/mmbtu, which effectively accounts for the cost of transporting natural gas to the U.S. from Canada. |
The U.S. Energy Information Administration’s (EIA) latest supply/demand projections reinforce these expectations. While domestic natural gas consumption is forecast to rebound by 2.0% in 2022 (vs. -0.3% in 2021), LNG exports are expected to lead the charge, climbing 16.2% (vs. +49.5% in 2021), maxing out liquefaction capacity. In contrast, dry natural gas production is forecast to rise just 3.1% to 96.7 bcf/d in 2022 (vs. +2.3% in 2021). Overall, the focus of the natural gas market will remain squarely on the EU’s plan to quickly lower its imports from Russia, which account for 45% of total imports. It’s a tall order, as the EU is looking to reduce its Russian imports by nearly two-thirds (or 100 of 155 bcm) by the end of the year. In particular, there are limits to the potential for ramping up LNG imports this year from Australia, the U.S., the Middle East and North Africa (which could add a combined 50 bcm), given terminal capacity constraints in Europe and elsewhere. The capacity of the other three pipelines (Algeria, Azerbaijan and Norway) is even more limited (10bcm). The rest of the reduction will need to be made up by accelerating the EU’s ‘Fit for 55’ plan, which targets reducing net greenhouse gas emissions by at least 55% by 2030. This will mainly involve speeding up the switch to renewable energies such as wind and solar (20 bcm), promoting energy efficiency (14 bcm), and diversifying to other gases such as biomethane and green hydrogen (6 bcm). A key spillover from the plan, whether the near-term target is met or not, is that the cost of energy for Europe is likely to remain much higher than in the past. The good news for consumers, at least in the near term, is that natural gas prices have benefited from relatively favourable weather conditions of late, particularly in China. This has helped cap some of the upside pressure, as benchmark European (Title Transfer Facility—TTF) LNG prices averaged US$40.15/mmbtu in March (vs. $27.26 in January and February). If the EU decides to ban coal imports from Russia, power prices are likely to rise further. |
Metals: Russia’s devastating invasion of Ukraine and retaliatory sanctions by the West have significantly altered the landscape for metals markets, which were already tight after the strong rebound in industrial demand and myriad supply constraints last year. The war has exacerbated the energy crisis in Europe and generated new supply-chain disruptions, further stoking inventory strains and propelling metals prices to record highs. Russia is a key global supplier of nickel, aluminum, precious metals, steel, iron ore, coal, uranium and potash. While exports of these raw materials have not yet been directly sanctioned or banned by Russia, they are becoming increasingly difficult to transport. Affected commodity trade flows will eventually be rerouted, but this process will be neither smooth nor quick. |
Financial market positioning has also been a factor in recent price volatility. However, fundamental support is apparent as visible (on-exchange) inventories are currently running well below normal across the major base metals. Moving into the second half of 2022 and 2023, high prices and stimulus withdrawal are likely to cause some metal demand destruction – particularly in the event of a sharper slowdown in economic growth and industrial production – and we therefore expect recent price gains to reverse. Even so, by accelerating the drive toward decarbonization and mineral security, the conflict will likely serve to keep prices elevated relative to longer-term assumptions. The most dramatic moves of late have been in nickel – never a stranger to big swings – amid a combination of Russian supply fears, limited inventories and a dramatic short squeeze that resulted in a suspension of trading on the LME. On a monthly average basis, prices surged by over 40% in March. The Norilsk mines in Russia are among the world’s largest and lowest-cost producers of ‘Class 1’ nickel (15%-20% of global supply), which is particularly well suited for use in batteries. Even with new projects set to come online in H2/22, global supply is bound to take a hit. We continue to expect a return to market surplus next year, though supply projections were subject to a high degree of uncertainty even prior to the invasion. We have raised our 2022 average nickel price expectation to US$11.00/lb, while leaving our 2023 forecast at $9.00. After briefly spiking during the nickel turmoil, a subsequent buying-frenzy pushed zinc to new heights. By early April the spot price was around 20% above pre-invasion levels (vs. 35% for nickel and 3%-to-4% for aluminum and copper). Although the demand outlook is not as promising, the supply of refined zinc is increasingly tight as the power crisis forces more smelter curtailments (the concentrate market, on the other hand, is oversupplied). Lacking a strong link to the green transition, the risk of demand destruction is high in a scenario where customers are struggling to secure physical deliveries. Nevertheless, with refined stocks set to remain low for a few years, prices should remain fairly well supported. Zinc prices appear on track to average US$1.50/lb in 2022 before falling to $1.20 next year. Aluminum prices have retreated from a panic-induced record high in early March, but are still up over 20% year-to-date given strong gains before the invasion driven by low inventories, robust demand and high energy costs. The ongoing energy crisis has significantly raised marginal costs for energy-intensive aluminum producers, forcing several smelter stoppages across Europe and China. Supply fears have been compounded by the conflict and potential sanctions on Russia, with Australia recently banning shipments of alumina (a key input for primary aluminum production) to the country. Facing what could be a multi-year deficit in refined supply and a rising cost structure due to carbon pricing (after several years of deflation), aluminum prices are expected to remain well above longer-run norms, averaging US$1.40/lb in 2022 and $1.20 in 2023. The response in the copper market has been somewhat less extreme—although prices did spike to a record high, this was only slightly higher than previous peaks of the past year. Copper fundamentals are very strong from a long-term perspective, given massive demand from the ‘electrification of everything’ and insufficient capex in the pipeline. Copper is facing near-term headwinds, however, in that some supply will be coming online in the next few years, likely eclipsing demand growth for a period before the structural deficit sets in. More crucially, the red metal is most exposed to an economic slowdown stemming from protracted supply-chain disruptions, interest rate hikes, a new pandemic wave or a collapse in sentiment. While we expect prices to fade from current levels in H2/22, China’s policy-driven growth push could provide some offsetting support. Overall, we forecast a copper price of US$4.25/lb in 2022 (roughly in line with last year’s average) and $3.50 in 2023. Precious metals have not been immune to recent commodity market volatility, as supply risks (at least in the case of platinum and palladium) and investor demand for safe-haven assets have come to the fore. After briefly topping the US$2,000/oz-mark during the early-March LME panic, gold has settled in the $1,900-$1,950 range, well above last year’s (record) average of $1,800. ETF net inflows have resumed after last year’s pivot away from gold by macro asset allocators, and physical demand remains strong. While heightened uncertainty—war, pandemic and global growth-related—as well as high inflation will continue to support gold in the near term, we still expect that rising interest rates and U.S. dollar strength will eventually bite. However, risks are to the upside if monetary tightening fails to tame inflation. Accordingly, we have raised our gold forecasts for both 2022 and 2023, with projections now sitting at US$1,875/oz and $1,750, respectively. Silver typically doesn’t attract the same macro investor interest as gold during times of uncertainty, but the price has nevertheless kept pace with the yellow metal this year thanks to robust physical demand (i.e., jewelry, silverware, industrial applications). Silver has strong potential in the shift to carbon neutrality but so far demand from solar has been modest, in part due to thrifting. In tandem with the revisions to gold, we adjusted our silver forecasts up to US$23.50/oz this year and $22.50 in 2023. |
Forest Products: Lumber prices have had a strong start to 2022, though that strength has come alongside unprecedented volatility due to the persistence of shipping-related challenges. Despite the easing of disruptions related to the floods in late 2021, some B.C. mills have continued to struggle sourcing reliable transportation (i.e., railcars or trucks). This has caused some mills to curtail production, putting pressure on inventories further down the supply chain. As a result, pricing has swung dramatically since the beginning of the year, with benchmark Western spruce-pine-fir (SPF) reaching as high as US$1,400/mbf in March before finding some relief after the settlement of a short-lived railway dispute. |
U.S. homebuilding, a key driver of lumber demand, has remained supportive, with total housing starts reaching a 15-year high in February, at 1.77 million (annualized) units. Still, the share of single-family housing starts, which are typically three times more lumber intensive than multi-unit starts, has trended lower over the past year. Meanwhile, headwinds from rising prices and rents have strengthened. Furthermore, with the Federal Reserve poised to accelerate policy rate hikes to battle 40-year-high inflation, the recent surge in mortgage rates is sure to take a bite out of housing affordability and demand. Subsequently, homebuilder sentiment has taken a cautious turn. While downward pressure on homebuilding demand will be somewhat offset by record-low inventories of resale homes, household budgets can only be stretched so far. This is particularly true as excess savings accumulated during the pandemic and wage growth are increasingly eaten up by rising costs of everything from food to fuel. Household savings will also continue to feel the pull from the ongoing pivot to the recovering services sector, which could also chip away at price-sensitive home repair and renovation demand. As a result, we see Western SPF averaging US$850/mbf this year, before moderating further to $620 in 2023. Shipping concerns remain an important wild card and could cause further bouts of volatility until reliable transportation has been restored across the supply chain. |
Agriculture: Crop prices have jumped sharply in response to Russia’s invasion of Ukraine, as both countries are major grain and oilseed exporters and the conflict will weigh on already-lean global supplies. The impact of the war has been most noticeable in the wheat space, where Russia and Ukraine accounted for almost 30% of global exports last year. Benchmark wheat prices, which were already at eight-year highs due to the drought in North America, jumped almost 80% in the immediate aftermath of the invasion and even with some retracement, remain roughly 25% above pre-conflict levels. Canola prices, which were already at record highs due to the drought, have also increased due to the war and have largely held recent gains. Unfortunately for consumers, it will likely take time for crop prices to reverse course, as growing conditions remain poor across much of North America and farmers are facing significantly higher costs for fuel, fertilizers, pesticides, machinery, and other inputs. |
Overall, wheat prices are expected to average US$9.50/bushel in 2022, up from $7.02 in 2021, and will likely remain elevated at around $7.50 in 2023. Canola prices appear on track to average US$760/tonne in 2022, up from $694 in 2021, and are forecast to remain well above longer-run norms at around $600 in 2023. In the livestock space, cattle prices have remained range-bound at elevated levels over the past few months. The drought, which has parched pastures all the way from Alberta to Texas, has continued to weigh on the headcount of the North American cattle herd, which is on track to contract for a fourth straight year. Meantime, hog prices have trended higher despite stronger supply fundamentals, as substitution effects have helped push consumers into pork products. Generally strong consumer demand has also provided a lift to meat and poultry prices across the board. In both Canada and the United States, real consumer spending on groceries jumped sharply at the onset of the pandemic and has remained above pre-pandemic trends even as restaurant spending has returned to normal. Overall, cattle prices are expected to average US$137/cwt in 2022 and 2023, up from $122 in 2021, since it will take time to rebuild the herd even once the weather turns. Hog prices are expected to average US$92/cwt in 2022, which is little changed from 2021 but well above the average of $67 observed between 2015 and 2020. |
Technical NoteThe 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. |