The Goods
July 11, 2024 | 09:32
Summertime Lull
Quarterly Forecast Update Edition |
Macroeconomic Developments:
|
|
Commodity Forecast Highlights: [Quarterly Commentary Starting on Page 2] |
|
Quarterly Forecast UpdateEnergy: Crude oil’s rollercoaster ride continues. Benchmark West Texas Intermediate (WTI) crude oil has been bobbing in the US$80-$85/bbl range of late after it had sagged below $75 in early June following OPEC+’s surprising decision to begin rolling back 2.2 mb/d in voluntary production cuts at the beginning of October. The latest rebound in prices appears to be driven by a combination of factors, but mainly: (1) the start of the U.S. summer driving season, and (2) greater recognition that the oil market (i.e., global oil supply/demand balance) remains quite tight. |
Looking ahead, we expect the rollercoaster ride to continue, which is why we remain comfortable with our average WTI forecast of just over US$80/bbl in 2024H2 and $80 in 2025. Prices could receive a temporary lift if concerns over supply disruptions reemerge in the Middle East or Russia, or if there is an acceleration in global monetary policy easing. On the flip side, news of slower demand from China (i.e., electric vehicle adoption), a pickup in U.S. crude production or an intensification of intra-cartel tensions could unnerve oil market participants. Looking further ahead, we expect crude oil prices will remain heavily supported by OPEC+. The cartel is currently holding back 5.7 mb/d or 5.2% of total global oil supply, with Saudi Arabia accounting for nearly half of the total. In our view, OPEC+ remains a fairly cohesive unit anchored by Riyadh’s increasing need to keep crude oil prices at elevated levels to boost its fiscal revenues. As we have often mentioned, the Kingdom has embarked on an ambitious economic diversification plan (Vision 2030), which is composed of many costly "giga projects" with a total contracted value of between 75% to 125% of GDP. Though there have been numerous media reports this year suggesting that Riyadh is considering scaling back some of these projects, in reality the opposite is occurring. There is greater pressure on the Saudi authorities to accelerate construction given limited progress so far. Such pressures explain why Riyadh unexpectedly abandoned its medium-term fiscal consolidation plans this year, as it will need to provide surrounding infrastructure to the giga projects. Meanwhile, the Kingdom’s main sovereign wealth fund, the Public Investment Fund, which is largely responsible for financing and building the projects, has been ramping up external debt issuance this year. Thus, the prospect of Riyadh suddenly pulling the plug on the cartel like it did back in 2014 (to regain market share and undermine U.S. shale producers) and in the very early days of the pandemic (over a disagreement with Moscow) is quite limited. Intra-cartel tensions are likely to persist as some members would clearly like to expand production, namely Iraq and the UAE. However, the cartel’s successful efforts at keeping prices elevated for the past few years suggests that it is likely to stick with its current strategy of ‘constantly recalibrating’ production cuts rather than abruptly abandoning them. Separately, the discount of Western Canada Select (WCS)—the country’s key heavy oil blend—to WTI has narrowed significantly, averaging around US$13.50/bbl in Q2, compared to just over $20 in the prior two quarters. A big reason for the decline is the opening of the Trans Mountain pipeline expansion—TMX— in early May, which makes it cheaper to transport oil (vs. by rail to the U.S.) and, moreover, allows Canadian oil to command higher prices on the international market due to direct shipments to overseas destinations (e.g., Asia). It’s difficult to gauge exactly where the WTI-WCS spread will ultimately settle but the $10.00-to-$12.50 range remains feasible, which would be below its long-run average of $15. |
Global natural gas prices have also experienced a tremendous amount of volatility this year. Benchmark Henry Hub averaged US$2.54/mmbtu in June after it plumbed new lows in March on an abundance of North American supply, posting the lowest monthly average since the early 1990s, at $1.49. The Q2 rebound appeared to be largely driven by LNG-related supply disruptions in the U.S. and Australia along with an outage in a key pipeline in Norway. However, prices have since begun to soften as disruptions have eased and the market is expected to remain sluggish until we approach winter. Thus, Henry Hub is still projected to gradually trend up over the forecast horizon, averaging nearly $2.90 in 2024H2 (vs. $2.11 in H1) and $3.25 in 2025. |
The longer-term outlook for global natural gas is still considered to be quite bright, given its role in the energy transition and the fact that Europe is still in the midst of an energy crisis. Note that the big pickup in LNG supply, thanks to the construction of floating storage terminals, has not completely offset lost Russian imports. This explains why the European price benchmark—Title Transfer Facility (TTF)— remains well above the pre-pandemic level, currently hovering around US$10.50/mmbtu (vs. average of $5.50 between 2015 and 2019). Meanwhile, the average front-month futures price for LNG cargoes in East Asia averaged just over US$12.60/mmbtu in late June. Higher prices in Europe and Asia should continue to benefit North American producers due to the upcoming completion of new LNG export terminals (expected beginning in late 2024). The eventual completion of LNG Canada, in Kitimat B.C., which is expected to start operating by mid-2025, should help resuscitate Western Canadian natural gas prices. The new terminal should allow Canadian natural gas producers to tap higher prices overseas, particularly in Asia. Recently, the price of AECO (Western Canada’s natural gas benchmark) has been suffering from excessive supply, averaging around US$0.55/mmbtu in recent weeks. Thus, the Henry Hub-AECO spread has blown out to the US$1.50-2.00/mmbtu range, compared to a historical average of $1.00 (the cost of transportation to Henry Hub in Louisiana). The spread is likely to take some time before it eventually normalizes but could narrow significantly (<$1.00) once LNG Canada is fully operational, as it will draw heavily on production from the Western Canadian Sedimentary Basin. |
Metals: Metals markets have backed off from recent highs after the sudden swell in financial market interest in Q2 proved temporary. Still, most precious and base metals are sitting well above last year’s averages and estimated long-term equilibrium levels. Commodity-specific factors such as raw material constraints (e.g., in copper, zinc) and de-dollarization (gold) continue to lend support, but the broad outlook remains clouded by economic, interest rate and geopolitical uncertainties. Global industrial activity has failed to gain traction after registering some modest improvement at the start of the year. The global manufacturing PMI remains in expansionary territory, but only slightly, and the relevant indices for both the U.S. and China have contracted in recent months. In China, the property market has continued to weaken, defying authorities’ repeated efforts to stabilize the sector. |
Nevertheless, the longer-term energy transition theme remains intact and has been augmented by recent hype around AI and data centres, owing to the vast amounts of metals needed for electrification. Meanwhile, several central banks have begun to loosen monetary policy, with the Fed and Bank of England expected to join those ranks in the coming months. However, policy is expected to remain relatively tighter for longer amid sticky inflation and economic resiliency—with potentially higher end-points in this easing cycle than previously expected. On the geopolitical front, trade relations have deteriorated between Western countries and China, reflected in a slew of new tariffs imposed on Chinese imports, including electric vehicles and solar panels. Given that consumers are unlikely to absorb the added cost of imports and the lack of domestic options available at similar (low) price-points, such trade barriers could dampen purchases of the affected products and thus demand for the metals used to make them. Meantime, uncertainty will continue to ramp up as the U.S. presidential election approaches in November, bringing a tailwind to safe-haven assets like gold. The picture for industrial metals is more complex, as increased global protectionism would threaten industrial activity in the near term but could lead to more segmented commodity supply chains and thus higher prices over the longer term. Beyond the safe-haven support fueled by election uncertainty, war-related risks and trade frictions, gold is continuing to benefit from central bank buying. Rather than ebbing in the face of higher real interest rates and record spot gold prices, the de-dollarization push appears to be broadening to other countries, though it’s worth noting that China’s central bank did not add to its gold reserves in the last two months. In fact, whereas the correlation between gold and real rates (10-year inflation-indexed USTs) has traditionally been negative, since 2021 it has turned slightly positive. Gold’s recent lustre is also reflective of rising market concerns around increasing government debt burdens, particularly in the U.S. where neither presidential candidate is expected to materially improve the fiscal trajectory. Finally, global gold ETFs saw net inflows in both May and June, ending a year of declines. Thus, even with a potentially slower pace of monetary easing, in this environment gold is likely to continue to trade comfortably above US$2,000/oz. We now expect prices to average $2,250 in 2024 (previously $2,200) and $2,200 in 2025 (previously $2,100). Silver is subject to many of the same macro forces, with an added boost from its role in the energy transition (i.e., solar panels, communications). Mine supply growth has also failed to keep pace with physical demand, pushing the market toward a steeper deficit this year. As a result, silver has picked up nearly 30% year-to-date, roughly double gold’s gain, and in May notched its highest levels (over US$31/oz) in over a decade. We have raised our silver forecasts to US$27/oz in 2024 (from $26) and $26 in 2025 (from $25). Although now down roughly 10% from May’s all-time high, copper remains the best-performing base metal in 2024, rising over 15% since the start of the year (matching gold’s performance). Investors’ net long positions have been trimmed, but are still significant, as the red metal remains the clearest beneficiary of global decarbonization/electrification trends and the market is currently experiencing a pronounced shortage of concentrate supply. Nevertheless, given still muted near-term demand conditions, we have only marginally lifted our average copper forecast for this year to US$4.15/lb (previously $4.10). Mine supply is set to ramp up in 2025 and 2026, which will likely result in some retracement, but we now expect prices to average US$4.00/lb in 2025 (previously $3.90). Aluminum has caught a bit of an uplift from copper’s rally, particularly as expectations for increased aluminum substitution for copper tend to creep up when the price ratio approaches 4 (it has averaged 3.85 so far in 2024 vs. 3.77 in 2023). But unlike copper, aluminum faces no material supply constraints, and the scrap recovery market is expanding strongly. Increased U.S. tariffs on aluminum from China will likely have a limited effect on domestic prices given the relatively small share of imports. As such, while we have bumped up our annual estimates, we continue to expect prices to remain below long-run equilibrium levels over the forecast horizon, averaging US$1.08/lb in 2024 (previously $1.05) and $1.10 in 2025 (previously $1.08). Perhaps even more so than copper, the zinc market continues to see a scarcity of raw material, which has reportedly led to negative treatment charges (paid to smelters by miners to convert ore into zinc metal) for the first time and smelter production cuts in China. As a result, the refined market is heading for a sizeable deficit this year and inventories will remain quite tight until supply additions come online later next year and into 2026. We have modestly raised our annual zinc forecasts to US$1.22/lb and $1.20 in 2024 and 2025 (from $1.20 and $1.18, respectively). Optimism faded more forcefully in the nickel market after prices surged above US$9.00/lb in May. Output of nickel pig iron and ferronickel (both used in stainless steel production) has been affected by supply disruptions, namely permitting issues in Indonesia and civil unrest in New Caledonia. However, inventories of Class I nickel (used in electric vehicles) continue to rise on the major exchanges and the demand picture remains subdued, exacerbated by the recently announced tariffs by multiple countries on Chinese EVs (i.e., EU, U.S., Brazil, Türkiye). It appears that the market is awaiting additional announcements of production cuts/closures before prices can move higher (such as BHP's recent decision to suspend its Western Australian operations). While we expect to see some recovery in prices later this year, we have trimmed our annual average forecasts to US$7.90/lb in 2024 (from $8.00) and $8.00 in 2025 (from $8.10). Forest Products: Lumber prices were dragged through the mud in the second quarter, continuing to underperform our expectations through the first half of the year. Price action has been dampened by a glut of supply in the southern U.S. and lacklustre U.S. housing demand, due largely to the persistence of high interest rates and a pandemic hangover for renovation projects. Benchmark Western Spruce-Pine-Fir (SPF) prices averaged just US$386/mbf in Q2, down 14% from Q1, but have managed to stay above longer-term levels (around $300) as production curtailments at higher-cost B.C. sawmills are providing some support. On the demand side, the spring U.S. homebuilding season largely underwhelmed as sticky inflation south of the border continues to push back the timeline for monetary policy easing. While U.S. 30-year residential mortgage rates have come off their late-2023 peak, they continue to run above 7% with no immediate relief in sight. Elevated rates have played a large part in the recent drop in U.S. home building. In May, U.S. housing starts fell to the lowest level (outside the initial pandemic plunge) since July 2019, though the direct impact on lumber has been somewhat muted by the better relative performance in single-family structures (versus condos). |
While lumber demand is expected to improve over the forecast horizon, the gradual pace of rate relief and the slow recovery in renovation activity following the pandemic-era surge are likely to remain headwinds. Thus, we expect lumber prices to remain relatively range-bound over the near term, particularly until there is more clarity on the interest rate outlook. We project Western SPF prices will average $400/mbf in 2024 (or ~$380 in H2), before seeing a modest recovery to $425 in 2025. |
Agriculture: Wheat prices, like those of most other crops, remain below longer-run inflation-adjusted norms. Although wheat rallied through the spring due to growing challenges in top-exporter Russia, recent reports have suggested that the country’s crop will be larger than previously thought, which has pulled the market back to recent lows. This year's crop is also shaping up well across the rest of the Northern Hemisphere. In the United States, farmers are more than halfway done harvesting a large winter wheat crop, and with the spring crop also in good shape, the U.S. Department of Agriculture (USDA) expects total production to reach the highest level in five years. The severity of the drought on the Prairie Provinces has also eased, which suggests a decent rebound in Canadian production this year. With global supply still running strong, wheat prices are now expected to average US$5.80/bushel this year, down from $6.45 last year, though the market should recover to around $6.50 in 2025 if yields revert to trend. |
Corn prices have also been under pressure, as a record harvest in South America has padded stockpiles and conditions across the U.S. corn belt suggest another strong crop on the way. The U.S. Drought Monitor (USDM) now estimates that just 6% of acreage in the Midwest is experiencing drought, down from 47% at the start of the year. Growing conditions are especially strong in Iowa, the top corn-producing state. As a result, the USDA currently rates 91% of the national crop in “fair” or better condition and expects U.S. stockpiles to increase again this year. With supply still outpacing demand, corn prices are now expected to average around US$4.40/bushel in 2024, down from $5.65 last year, though firm oil prices should bolster ethanol-related consumption and help put a floor under the market. Prices should trend gradually higher to around $5.10 in 2025. Soybeans have dipped in tandem with corn over the past few months, reflecting the strong crop in South America and increasingly supportive conditions in North America. In the United States, favourable weather across the Midwest has left 92% of the national crop rated “fair” or better by the USDA, which together with a jump in acreage, is likely to drive near-record production this year. Conditions have also remained supportive in Southern Ontario, a hub of soybean production in Canada, which should keep production near last year’s all-time high. Given the strong supply outlook, soybean prices are expected to average around US$11.80/bushel in 2024, down from about $14.20 last year, but should recover to around $12.30 in 2025 if global yields normalize. Canola prices have also trended lower over the past few months, primarily due to better growing conditions across the all-important Prairie Provinces (the world’s top exporting region). The Canadian Drought Monitor currently estimates that 35% of the country’s agricultural land is experiencing abnormally dry weather, which is elevated but still an enormous improvement from 81% at the start of the year. With the weather delivering better yields and an above-average amount of acreage devoted to the crop, production in Canada is likely to increase significantly this year. The canola market is also being affected by broader abundance in the soybean space, which has provided an amply available substitute. As a result, canola prices are now expected to average US$460/tonne in 2024, down from $560 last year, before recovering to around $530 in 2025. Hog prices have moved effectively sideways over the past few months despite a tailwind from the summer barbeque season. The tepid pricing environment has partly reflected sluggish demand, with protein consumption being squeezed by elevated interest rates and the generally higher price of household necessities. But supply has also become more abundant, as producers have reacted to the favourable feed price environment by shifting into expansion mode. The USDA now estimates that headcount of the North American hog herd will increase by around 1% this year. The USDA has also revised its U.S. herd estimate significantly higher, indicating greater supply than previously thought. Overall, hog prices are likely to average around US$83/cwt in 2024, little changed from $81 last year, but should improve to around $91 in 2025 as herd expansion tapers off and due to continued scarcity in the cattle space. Cattle prices reached yet another record in June, though the market has taken a breather over the past couple weeks. At this stage, pricing is being steered by herd rebuilding efforts across much of the United States, as the drought previously afflicting much of the country has dissipated. In Texas, easily the top-producing state, the USDM estimates that around 13% of acreage is currently experiencing severe drought, down from 60% last fall. In Oklahoma, the number-two state, just 4% of pasture is grappling with severe drought, down from around 30% last fall. With more producers now holding back animals for breeding, the near-term supply of animals available for slaughter has declined meaningfully. As a result, cattle prices are expected to average US$180/cwt in 2024, up from $173 last year, but should ease to $165 in 2025 as expansion begins to increase marketable supply. |
Technical NoteThe BMO Capital Markets Commodity Price Index is a fixed-weight, export-based index that encompasses the price movement of 20 commodities key to Canadian exports. Weights are each commodity’s average share of the total value of exports of the 20 commodities during the period 2012-21. 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. |