January 18, 2023 | 15:54
Calmer Year in Store for Commodities?
Quarterly Forecast Update Edition
Commodity Forecast Highlights: [Quarterly Commentary Starting on Page 2]
Quarterly Forecast Update
Energy: With the sharp correction in recent months, one might be wondering whether crude oil’s bubble has popped, which would be music to the ears of consumers and central bankers. However, we think it’s too early to declare that crude oil prices have been effectively tamed. The oil market remains in a tremendous state of flux, given uncertainty surrounding the path of both global demand and supply. Although fears of a global recession continue to dictate the direction of crude oil prices, this factor may not dominate for long. The global supply picture remains ominous, as Russia could still end up shutting in production and OPEC+ could curtail output further. Thus, there is a likelihood that benchmark West Texas Intermediate crude (WTI) will end up trading at higher levels, which is why our average annual forecast remains at US$90/bbl in 2023 (vs. $95 in 2022).
A look back at major recessions (excluding the COVID-led meltdown in 2020) suggests that we would need to experience a downturn similar to the 2008-09 Great Recession or 1981-82 Volcker-driven U.S. recession before global oil demand would contract significantly. In these two cases, global oil consumption fell by 2.1% and 2.7%, respectively. A similar decline today, say around 2.5%, would roughly translate into a 2.5 mb/d fall. Meanwhile, we are of the view that the reopening in China (the world’s second largest consumer) should help offset weaker demand in the U.S. and Europe, resulting in a modest rise in global oil demand of around 1.0 mb/d in 2023. The IEA is even more optimistic and is projecting a pickup of 1.9 mb/d to 101.7 mb/d.
The bigger source of uncertainty facing the oil market still lies on the supply side, which means the overall market balance is likely to remain very tight. We still do not know what impact EU sanctions and the price cap will have on Russian oil exports. Moscow has maintained that it would rather cut output than sell oil to countries that impose the cap. As a result, Russia could be forced to shut in 0.5-1.0 mb/d of production. More problematically, one cannot dismiss the risk that OPEC+ could feel emboldened to rein in output further. The cartel surprised the oil market in early October when it cut its production target by 2.0 mb/d—a move the cartel no doubt considers to have been wise considering the recent slide in prices.
OPEC+ would prefer to see higher crude oil prices than current levels, but not too much higher. WTI between $90-100 over an extended period would arguably fulfill a few key objectives: (1) Help maintain comfortable budget surpluses for key members, notably Saudi Arabia. Riyadh is keen to diversify its economy, as per its Vision 2030, which will require lots of money to successfully develop new industries (e.g., food, medicine, tourism, etc.). (2) Avoid significantly worsening global inflationary pressures and forcing central banks to tighten to a point that results in a deep global recession and drop in oil demand. (3) Prevent a surge in non-OPEC+ production. Indeed, the recovery in U.S. crude oil output began to stall after WTI peaked at just over $120 in the middle of 2022. It appears that U.S. producers are not only under pressure to maintain capital discipline but are also facing fracking equipment shortages and soaring labour costs.
In Canada, it appears that it will take time before the discount of Western Canada Select (WCS)—a blend of heavy oil produced in Alberta—relative to WTI, which has blown out to US$25-30/bbl, returns to its historical norm of $15. The two main refining regions in the U.S. (Midwest and Gulf Coast)—typically the key buyers of WCS, accounting for roughly 90% of Canada’s crude oil exports—remain awash with heavy crude supply. The Biden Administration’s decision to release 1.0 mb/d from the Strategic Petroleum Reserve (SPR) last spring is still reverberating. Weaker U.S. demand has forced Canadian producers to look further abroad, namely to Asia. However, rerouting exports to Asia (via Houston) comes at a hefty cost that extends beyond the extra transportation expense. Asia is also awash with crude, as Russia has been forced to reroute its Urals crude exports, which are of a similar quality to WCS, from Europe to India and China at a heavy discount. Greater Urals supply combined with weaker China demand due to last year's COVID-driven disruptions help explain why WCS now needs a large discount to find a new home.
Thanks to an unexpectedly mild winter thus far in the Northern Hemisphere, global natural gas prices have fallen below pre-Russian invasion levels. The European benchmark Title Transfer Facility (TTF) is currently hovering around US$17.50/mmbtu, well below the peak of nearly $75.00 in August. Henry Hub—the North American benchmark—has dipped below US$3.50/mmbtu in recent days, compared to an average of nearly $9.00 in August. However, we think it’s too early to conclude that natural gas prices will remain low.
First, there is no guarantee that favourable temperatures will persist for the rest of the winter, let alone the rest of the year. Second, China's abrupt decision to end its zero-COVID strategy could lead to a major rebound in LNG demand this year. The IEA estimates that Chinese LNG imports contracted a hefty 20% (~20 bcm) in 2022 due to rolling COVID lockdowns, which made it much easier for Europe to purchase LNG and fill its storage facilities to healthy levels. And, lest we forget, Europe still depends on natural gas imports from Russia (via both pipelines and ships), which could drop to zero depending on Russian geopolitical strategy. Thus, we still expect TTF to trade between $15-30 this year, well above the pre-pandemic average of $5.50 between 2015 and 2019.
Henry Hub may not mirror natural gas price movements in Europe, but will nevertheless be influenced by overseas developments. The U.S. has become a large net exporter of natural gas and its producers are keen to take advantage of elevated global LNG prices, particularly in Europe and Asia. This should be aided by the restart of the Freeport LNG terminal (15% of total U.S. LNG capacity) in the coming weeks, which has been offline since June to repair major fire damage. Further out, U.S. LNG capacity is set to expand by 50% in 2024-25 with the completion of three new terminals.
Thus, we are forecasting Henry Hub to eventually recover from current levels, but we have trimmed our 2023 average projection to US$5.00/mmbtu (previously $5.50). The price of AECO—Western Canada’s natural gas benchmark, which typically piggybacks off of Henry Hub quite closely—has rebounded after it collapsed in August due to extended maintenance on a key pipeline in Alberta. The Henry Hub-AECO spread, which had widened to over US$5.00/mmbtu in August, has fallen below $1.00 as pipeline operations have normalized and a few Canadian producers have shut in some production. Note that the spread historically averages around $1.00, reflecting the cost of transportation to Henry Hub in Louisiana.
Metals: Last year's financial market rollercoaster produced the most volatility in base metals prices since the global financial crisis. On top of the outbreak of war, massive rate hikes and an all-time high in the U.S. dollar, metals had to contend with China’s rolling COVID lockdowns and the ongoing slump in its property sector (the most important sector for global metals consumption). Still, looking back to the start of last year, most metals ended up outperforming our expectations for 2022. This largely reflects that despite myriad headwinds, global growth held up fairly well, coming in close to the long-term trend rate of around 3%. That seems fitting for the Year of the Tiger, which is often associated with courage and resilience. Markets now appear optimistic that rate hikes might be effectively reining in inflation without too much economic pain, suggesting 2023 could see the mythical ‘soft landing’. The Year of the Rabbit, after all, symbolizes serenity and good luck.
Indeed, there are several factors supporting a more positive view on metals and, on balance, we have shifted up our near-term price outlook modestly across the segment. For one thing, following China’s unceremonious reopening and latest round of policy stimulus, the property sector could finally be on the cusp of an upturn. Metals demand should begin to pick up following the typical slowdown around the Lunar New Year, bolstered by targeted public infrastructure spending, roughly offsetting waning developed-market industrial activity. Market balances also look a tad tighter, as power constraints, civil unrest and enduring supply chain strains (despite some unclogging since last spring) have prompted some downward production revisions. This comes as visible inventories are already hovering at critically low levels. Indeed, the acute inventory tightness that emerged in 2022 is likely to remain a key theme in base metals this year, with anxiety about material availability keeping a premium on spot prices.
However, there are reasons to remain cautious. Chief among them, the global economy still appears headed for a slowdown, with leading indicators and manufacturing PMIs pointing firmly lower and yield curves still inverted. The IMF expects as much as one third of the global economy to be in recession this year and, as a result, we are anticipating a contraction in global (ex-China) industrial production. There is also a risk that underlying inflation could remain stickier than recent softer readings suggest, forcing central banks to keep rates higher for longer. Finally, it’s worth noting that while the decarbonization story continues to play out, the scale of metals-related demand is still relatively small (albeit growing fast), dwarfed by traditional end-use sectors (which are slowing). And, the rate of adoption of renewables is subject to uncertainty as energy security concerns have come to the fore.
Aluminum prices were elevated at the outset of 2022, as the energy crisis was already taking hold; but after surging to a record high in the wake of the invasion of Ukraine, they spent most of the remainder of the year in retreat. Still, on an annual average basis, aluminum notched an all-time high of US$1.23/lb. Longer-term demand prospects related to the energy transition aren’t as strong compared with other metals, particularly as scrap availability is poised to expand. And with most developed economies headed for a slowdown, we expect prices to step back in 2023—averaging $1.05 before rising to $1.10 in 2024. However, there is an important caveat on the supply side; specifically, to what extent previously shuttered smelters in Europe and North America come back online as power prices ease. More permanent closures would lend greater support to prices.
Copper was likewise unable to maintain its early-2022 strength in the face of forceful monetary tightening, U.S. dollar strength and China’s lockdowns. Prices dropped sharply around the middle of the year after spending more than a year above US$4.00/lb, and did not reach that mark again until last week. Long-term copper needs are exceptionally strong, so much so that substitution and rationing of supply will ultimately be required despite some new mines coming onstream in the next few years. But from a shorter-term perspective, the weaker global economic backdrop combined with increased supply is expected to weigh on prices, constraining the red metal to $3.60 on average in 2023 and $3.50 in 2024. However, there are upside risks to these forecasts given the potential for further mine supply disruptions and smelter bottlenecks.
In terms of benchmark LME prices, nickel was the clear chart-topper in 2022, though not for purely fundamental reasons. It was the only base metal to end the year higher than it started and finished with a whopping 40% gain (albeit, not a record high) on an annual average basis. The supply-demand balance for LME-deliverable (i.e., Class 1) nickel is indeed tight, bolstered by strong demand for batteries and the potential for sanctions/self-sanctions on Russian supply. But for the majority of the world’s nickel supply that falls outside this classification, the market is in surplus amid softer stainless steel activity and nickel pig iron (NPI) capacity additions. Meanwhile, supply of lower-cost intermediate products is also ramping up specifically for use in the battery chain, curbing a key price support. We thus anticipate nickel to dip from US$11.71/lb on average in 2022 to $10.50 this year and $9.00 in 2024, with persistent volatility given the steep drop in liquidity in the LME contract since last March’s short squeeze.
Like aluminum, zinc ended last year well down from where it started, but still managed to average an all-time high of US$1.58/lb for the year. But for zinc, there is little if any compelling energy transition tie-in. Pricing last year was entirely driven by refined supply cuts and inventory drawdown as demand was already slackening. Refined inventory cover, in terms of weeks of consumption, is sitting at less than half the prior-decade average (see Chart 4) and the lowest in absolute terms since 1989. As smelter curtailments begin to gradually reverse, the market balance is expected to improve from 2022's deep deficit to a much smaller shortfall this year and a surplus from 2024. In turn, prices will trend lower over the forecast horizon, averaging an expected $1.25 in 2023 and $1.10 in 2024.
Precious metals have been propelled higher over the last couple months by hopes of a Fed slowdown and the accompanying retreat in the greenback. The late-2022 rally was enough to edge the full-year average gold price just above the 2021 level, marking a new nominal high of US$1,802/oz. This is despite eight consecutive months of net ETF outflows through December. We expect to see macro positioning shift back toward precious metals in the coming months as the Fed nears its terminal rate, but later in the year, prices will likely start to lose steam as inflation reverts closer to target levels. We expect gold to average a still lofty $1,750 in 2023 and $1,650 in 2024. As expected, silver took a major step back last year from 2021’s elevated levels. Jewelry-related demand—unlike in gold’s case—remained robust, along with most other sources of physical demand. But this was more than offset by a record drop in ETF holdings. Longer-term demand expectations from solar power remain quite strong, tempered somewhat by increasing thrifting and other technological advances that require less silver. Prices are projected to soften further from US$21.75/oz on average in 2022 to $21.00 this year before recovering to $21.50 in 2024.
Forest Products: Lumber price dynamics have shifted dramatically over the past twelve months as pandemic-era influences and supply disruptions have taken a backseat to the large upward lurch in interest rates. Recall that the turbulent pricing action experienced around the start of last year was largely due to the fallout from severe B.C. flooding, which damaged critical lumber supply linkages, as well as firming U.S. home building. These forces pushed the price of benchmark Western spruce-pine-fir (SPF) north of US$1,300/mbf in January 2022, or about triple the prior August lows. But lumber wasn’t the only price surging. Broader inflation had become too much to bear for the Federal Reserve, leading it to embark on an aggressive campaign of monetary tightening in March 2022.
The ensuing 425 bps of rate hikes weighed heavily on housing affordability, with 30-year mortgage rates rising above 7% for the first time in decades late last year. This dealt a major blow to residential home construction, with lumber-intensive single-family starts dipping to 828k annualized units in November (or -32% y/y), while homebuilder sentiment plunged back to pandemic lows. As a result, Western SPF slid to a multi-year low of $335 in early January 2023.
Lumber prices received some support from production curtailments around the turn of the year, which saw several major producers trim shifts (some temporary, some permanent) or extend seasonal shutdowns this winter. However, the near-term outlook has instead taken its cue from the evolution of inflation and interest rates. Headline CPI may have peaked, but persistent underlying inflation is expected to keep upward pressure on interest rates early this year and potentially push the U.S. economy into a mild recession.
Still, thin sawmill inventories and slower lumber production have been the necessary ingredients for sudden price upswings in recent years. This could lead to some short-lived blips as the homebuilding season ramps up, but ultimately, restrictive monetary policy and slowing economic activity should limit any near-term upside. As such, we see Western SPF prices slipping from an average of US$781/mbf last year to $450 in 2023, before firming to $525 in 2024 as a recovery in homebuilding begins to take root.
Agriculture: Crop products, like most other commodities, went on a wild ride in 2022. Key prices began the year already in elevated territory and then surged in the spring after Russia invaded Ukraine, casting a pall over global supply. Subsequently, most crops lost ground during the second half of the year, in part because supply was bolstered by better growing conditions in Canada and the Russia-Ukraine grain shipment agreement, but also because of intensifying concerns about global demand. In the end, the overall crop index closed the year somewhat lower than where it started, but still about one-third above its ten-year average.
Wheat and canola saw an especially dramatic rally and reversal last year. Both soared to all-time highs as the war in Ukraine aggravated existing drought-related shortages, but then tailed off sharply in the second half. Ultimately, wheat ended the year not far from where it started, and canola ended somewhat lower, but ongoing scarcity has kept both elevated compared to longer-term norms. In the USDA’s final crop progress report of 2022, more than one-quarter of the winter wheat crop, which will be harvested this year, was rated in poor or very poor condition due to continued drought on the high plains. Kansas, the top wheat-producing state, remains particularly parched, with 84% of its farmland experiencing drought rated moderate or worse by the U.S. Drought Monitor. Dry conditions have also reasserted themselves on the Canadian prairies, which could leave soil moisture low when the growing season arrives. All of this suggests that lean inventories of wheat and canola will be replenished only gradually, which should keep prices relatively firm in the near term. On an annual average basis, wheat prices are expected to decline from an all-time high of US$9.00/bushel in 2022 to $7.50 in 2023 (roughly in line with current pricing) and $7.20 in 2024. Canola prices are expected to decline from a record of almost US$750/tonne in 2022 to $620 in 2023 (also in line with current pricing) and $570 in 2024.
Corn and soybean prices also rallied impressively during the first half of 2022, though not to the same extent as wheat and canola, reflecting more supportive growing conditions in the U.S. Midwest. Prices also held up better during the second half of the year, as crop conditions in the Midwest began to deteriorate and it became clear that La Niña would impede production in the Southern Hemisphere. On the demand side, generally strong energy prices have underpinned ethanol-related consumption of corn and soybeans, which has kept North American inventories lean despite a respectable harvest last fall. With supply running relatively lean, corn and soybean prices are currently 10%-to-15% above year-ago levels, but are expected to trend lower as demand ebbs and inventories improve. Growing conditions have also evolved favourably in recent months, as important parts of the Midwest have enjoyed ample precipitation and appear better positioned for the coming season. As a result, futures markets are now pricing post-harvest corn and soybean contracts at a substantial discount to spot. Overall, soybean prices are expected to decline from an average of US$15.50/bushel in 2022 (and more than $15.30 currently) to $13.80 in 2023 and $12.80 in 2024. Corn prices are expected to drop from an average of more than US$6.90/bushel in 2022 (and almost $6.80 currently) to $6.40 in 2023 and $5.70 in 2024.
In the livestock space, both cattle and hog prices enjoyed a strong year in 2022. On the demand side, recent strength has been supported by the solid labour market and spill-over demand associated with the recent outbreak of avian influenza. Supply developments have also been supportive. In the hog segment, where higher feed costs have had a big impact on producer margins, the headcount of the North American herd declined by 3.6% between the end of 2020 and the end of 2022. Moreover, cattle supply has continued to be constrained by the drought, which has degraded pasture quality across large swathes of North America. The U.S. Drought Monitor estimates that more than 50% of Texas is currently experiencing drought rated moderate or worse, as is almost 90% of Oklahoma, the number two state for beef cattle production. Facing such challenging conditions, the headcount of the North American cattle herd has declined 4.2% since the end of 2018 and the U.S. Department of Agriculture is calling for another 1% drop this year. Unsurprisingly, futures markets are pricing year-ahead cattle contracts at a significant premium. Overall, cattle prices are expected to jump from an average of nearly US$142/cwt in 2022 to a record $156 in 2023 before backtracking to $146 in 2024, under the assumption that supply begins to normalize. In the hog space, there are already early signs that herd expansion is resuming, driven by the recent reversal in feed prices. With demand also cooling, hog prices are expected to decline from an average of almost US$98/cwt in 2022 to $92 in 2023 before edging up to $94 in 2024.
The 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.