July 15, 2021 | 15:40
Commodities Running Out of Steam
Quarterly Forecast Update Edition
Commodity Forecast Highlights: [Quarterly Commentary Starting on Page 2]
Quarterly Forecast Update
Energy: Crude Oil: The outlook for crude oil prices remains promising as OPEC+ has reportedly resolved an internal rift following a breakdown in talks at its July 2 Ministerial Meeting. As a result, we remain comfortable with our recently revised forecasts for WTI to average US$65/bbl and $70, respectively, in 2021 and 2022.
According to media sources, Saudi Arabia and the United Arab Emirates (UAE) have reportedly been able to find a preliminary solution to their recent conflict, which prevented the cartel from increasing production at the last meeting. Thus, the three key decisions that will likely be discussed/finalized are as follows: (1) The cartel lowering the current production cut target of 5.8 mb/d by 400 kb/d per month (or a slightly higher amount) until the end of year. (2) Extending the cartel’s current pact to manage production from April to December 2022. (3) Increasing the UAE's crude oil production baseline to 3.65 mb/d (or by a slightly higher amount) from 3.17 mb/d in May 2022, which will effectively allow the country to increase its overall output.
It’s important to note that until this reported compromise is agreed upon at the next Ministerial Meeting, for which a date has yet to be announced, there is still a risk that things could head off track. Members could end up maintaining the status quo, keeping the current production cut of 5.8 mb/d in place until April 2022. This would likely provide a temporary lift to crude oil prices but could eventually result in heavy downward pressure if it appears that there will be no extension of the cartel’s production cut strategy. Worse yet, the oil cartel could begin to break down. Members may decide to no longer comply with mandated quotas and raise production to grab as much market share as soon as possible. This would likely lead to a rapid escalation in global supply and place heavy downside pressure on crude oil prices.
Nonetheless, recent developments highlight the difficulties that the cartel will face in maintaining cohesion and also provide valuable insight into the current thinking behind its production cut strategy, its view on future global oil demand and its comfort level with crude oil prices. First, the desire to gradually increase production (rather than maintain its current output) suggests OPEC+ remains focused on managing the level of crude oil prices. Or put another way, just as much as the cartel doesn’t want to see the price of crude sink back into negative territory, it is also worried about it rising much higher (say to US$90-100/bbl) which on a sustained basis could fast-forward the move to renewable energies (i.e., electric vehicles) and/or revive U.S. output. It bears mentioning that U.S. crude oil production edged up to 11.4 mb/d during the second week of July, which was the highest since May 2020.
Second, the proposal to extend the current OPEC+ agreement beyond April 2022 suggests that members are not entirely convinced that global oil demand will necessarily return to its pre-pandemic level of 100.7 mb/d (Q4/19) by end-2022. Thus, the cartel wants to ensure it has the flexibility to effectively control global oil supply for an extended period. That said, we think that the debate over when global oil demand will peak and at what level is likely to intensify, especially considering that the global decarbonization push continues to pick up steam.
The outlook for the price of Western Canada Select (WCS) – a blend of heavy oil produced in Alberta – also remains encouraging due to the recovery in 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 widened in recent weeks to the $14-15/bbl range as crude oil exports to the U.S. have picked up given its rapid re-opening. The differential is expected to remain at similar levels in the next few months as demand for gasoline from the U.S. is likely to remain elevated as we have reached the peak driving season.
Natural Gas: The outlook for natural gas remains very favourable, particularly in the short-term, as the global heat wave has boosted demand for power and pushed the price of Henry Hub above US$3.50/mmbtu in recent days. We are forecasting Henry Hub to average just over $3.00 for the rest of the year, $3.20 for the whole of 2021, and $3.00 in 2022, which is much better than the 2020 average of $2.03.
Beyond the temporary impact of the global heatwave, there are two key developments that are expected to support Henry Hub for the rest of the year. First, U.S. dry natural gas production is expected to remain suppressed due to weaker associated gas production from shale oil output. Indeed, the latest U.S. Energy Information Administration projections show gas output rising just 1.3% to 92.6 bcf/d in 2021 (vs -2.5% in 2020).
Second, U.S. exports of LNG, roughly 10% of total natural gas production, are expected to remain supported by the recent surge in benchmark prices in Europe (Title Transfer Facility – TTF) and Asia (Japan-Korea Marker – JKM). TTF is now hovering over US$12.00/ mmbtu (up ~600% from a year ago), while JKM is averaging around US$13.00/mmbtu (up ~450% in the same period). Both benchmarks have reached levels that make them attractive for U.S. producers to export to these markets, when accounting for liquefaction and shipping costs. Demand from Europe should remain steady from a medium-term perspective, supported by the planned retirement of a large number of coal and nuclear power generation plants. Furthermore, the decarbonization push has picked up steam this year as carbon prices have surged in Europe, which is helping to fast-track the switch from coal to gas-fired electricity. Meanwhile, LNG demand from Asia, particularly China, has picked up this year due to robust industrial demand for electricity.
In the meantime, the price of AECO—Western Canada’s natural gas benchmark—should be able to continue piggybacking on higher Henry Hub and slightly lower domestic production (-0.2% in the first four months of 2021) in the coming quarters. As a result, we are projecting AECO to average US$2.55/mmbtu in 2021, up from $1.67 in 2020. Alternatively viewed, the Henry Hub-AECO differential is expected to average roughly US$0.65/mmbtu in 2021, compared to $0.36 in 2020 and $1.21 in 2019.
Metals: With the price of many base metals recently hitting multi-year or record highs, the prospects for the mining sector appear fairly bright. This has spurred talk that commodities could be on the cusp of another supercycle, similar to what occurred in the early 2000s to the early 2010s. At present, we do not think there are strong enough drivers to replicate the last supercycle for base metals, which was propelled by massive demand from China‘s twin industrialization and urbanization drive.
Nonetheless, the price of most metals should continue to benefit from favourable supply/demand dynamics; that is, a pandemic-driven boost in demand versus a limited increase in new supply. The pickup in demand appears to be largely driven by two key factors: a surge in goods-related demand and much stronger-than-expected demand out of China, notwithstanding recent signs its economy maybe cooling. Or put another way, the current global economic recovery remains metal intensive. Some metals like copper and nickel may also be benefitting from a pickup in the global decarbonization drive (e.g., demand for electrical vehicles), particularly in China. On the flip side, Beijing recently released some of its strategic reserves of key base metals, which has likely contributed to an easing in copper, zinc and aluminum prices. Nickel has bucked the trend, which has resulted in us revising up its forecast, but we have maintained our existing forecasts for other base metals.
Nickel is expected to hold up better than its base metal peers in H2/21 on the back of robust demand for stainless steel and batteries coupled with the underperformance of existing mining operations and a decline in Chinese nickel pig iron (NPI) output. 2021 has been a stellar year for stainless steel due to durables demand, while supply, which has already seen disruptions at two of the major global hubs, has also come under considerable pressure. Accordingly, we have increased our annual nickel forecast to US$7.80/lb for 2021 (previously $7.65) and $7.50/lb for 2022 (previously $7.45).
Aluminum also appears to be benefiting from similar China-driven supply/demand dynamics. Some Chinese provincial authorities (Inner Mongolia and Yunnan) have intensified their efforts to tackle pollution, which has led to production curbs. The dysfunctionality of the London Metal Exchange’s warehousing system has also limited supply available to the wider market. As a result, we have maintained our annual forecasts for aluminum at US$1.00/lb in 2021 and $0.95 in 2022.
On the flip side, copper and zinc prices are facing some downward pressure as China has intensified its efforts to tackle domestic commodity speculation. Also, new projects are about to come online, notably Kamoa-Kakula and Grasberg. However, mining companies, which typically build copper projects intensively when the outlook for prices is favourable, have yet to announce any new major investments. As a result, we are maintaining our forecast for copper prices to average US$4.00/lb in 2021 and $3.50 in 2022 as fundamentals for copper remain strong due in large part to decarbonization demand (electrical vehicles and solar panels).
Zinc has been able to participate in the resurgence in demand for base metals despite concerns of oversupply. Zinc, which is mainly used to galvanize other metals such as iron and steel to prevent rusting, has been propelled by a pick-up in construction/infrastructure activity, where a lot of galvanized steel is utilized, and, to a lesser extent, a rebound in automobile production, especially compared to depressed levels in 2020. Nonetheless, the zinc market remains in surplus this year amid the strong gains in global smelter output, which we expect to eventually weigh on prices. We are maintaining our annual zinc forecasts at US$1.25/lb in 2021 and $1.05/lb in 2022.
The outlook for precious metals is relatively subdued because of less-dovish tones from the world’s major central banks. Nonetheless, despite nervousness in the gold market around the rotation out of ETF holdings, we are not expecting to see aggressive outflows in 2021-22 given negative real yields, amplified geopolitical tensions and potential for wider market volatility. Hence, we are maintaining our annual forecasts of US$1800/oz for 2021 and $1700 for 2022. The picture for silver is more encouraging as it continues to benefit from the wider global industrial recovery, electronics demand and rising solar photovoltaic investment. This likely explains why ETF holdings of silver have proven to be more resilient than gold this year. Coupled with a slow recovery in mine output, this implies a tighter balance for the silver market. We are maintaining our forecast for silver prices to average US$27.00/oz in 2021 and $26.00 in 2022.
Forest Products: Lumber prices have finally come back down to earth, or at the very least have re-entered the planet's atmosphere following the unprecedented bout of volatility experienced since the onset of the pandemic last year. In May, signs of waning lumber demand began to emerge, setting in motion a foundation-rattling correction with prices plunging from all-time highs of close to US$1700/mbf to about $700 by mid-July. While the declines have decelerated in recent weeks, benchmark Western Spruce-Pine-Fir (SPF) prices still remain well above the longer-term average of $350-400.
Despite still-strong fundamentals supporting U.S. homebuilding (i.e., low mortgage rates and historically low resale inventories), the rebalancing of the lumber market has taken place primarily on the demand side. Notably, U.S. housing starts and permits, which had soared to well above pre-pandemic levels by the end of last year, have stalled in recent months amid waning, albeit still elevated, homebuilder optimism. While lumber supplies have become more plentiful, homebuilders have cited shortages in other building materials (i.e., osb/plywood) and products (i.e., windows and doors), not to mention the continued shortage of skilled workers, which together are a drag on overall construction activity. High prices themselves have also likely been a factor, with median new home prices running a staggering $57k above year-ago levels in May, deterring some would-be buyers.
Meantime, renovation and repair (R&R) demand appears to have taken a slightly earlier-than-expected hit as many states accelerated economic reopening plans, pivoting funds away from home-related projects. While a stabilization in lumber prices will support a recovery on this front, the general stickiness of retail prices on the downside are likely to weigh on R&R demand in the coming months.
On the supply side, modest new capacity additions over the next couple of years and improved efficiency at current mills should keep supplies relatively steady over the forecast period. Nevertheless, risks from transport issues and wildfires continue to warrant monitoring as the movement of lumber remains at the mercy of rail bottlenecks, while extreme heat and dry conditions increase risks of severe wildfires that could disrupt logging and sawmill operations. Furthermore, the combination of falling prices and elevated Canadian stumpage fees could result in capacity reductions at higher cost sawmills.
Longer-term we believe fibre supply issues in B.C. will help support a higher floor for Western SPF prices than the historical average. In any event, given the faster-than-expected rebalancing over Q2, we now expect lumber prices to average US$950/mbf in 2021 (down from $1100), but have maintained our call at $700 for 2022.
Agriculture: Crop prices have staged a dramatic rally over the past year and a few major products approached decade-highs during the spring. Although key benchmarks have taken a breather over the past month or two, prices remain far above recent norms. With the economic recovery from the pandemic proceeding apace, crops are receiving ample support from the demand side, but the forceful gains posted over the past year have been driven primarily by supply concerns. Across the world, key growing regions are facing the most challenging conditions in years. Most notably, a scorching drought currently prevails across much of the U.S. northern plains and the Canadian prairies, and moderately dry conditions now extend through parts of the Midwest corn belt and into Southern Ontario. Drought with an intensity rated moderate or worse by the U.S. Drought Monitor now spans almost 50% of the continental United States – the most extreme reading since 2012, when the driest conditions in decades drove corn and soybean prices to record highs.
Since the driest weather has been focused in the plains, wheat crop prospects have degraded most severely. In the United States, 55% of the spring wheat crop is now rated poor or worse, compared to 8% at this time last year, and Canadian wheat is also struggling. The U.S. Department of Agriculture now expects the lowest North American wheat yield in six years. In the oilseed space, prospects for this year’s North American crop have held up somewhat better. Although canola producers are grappling with dry conditions in Canada, the much larger U.S. soybean crop remains in good shape. However, oilseed prices have still increased significantly this year, thanks in part to exceptionally strong export demand—especially from China, though high prices are now causing it to reallocate its purchases toward corn. The stronger energy sector has also supported crop prices across the board by bolstering demand related to ethanol production.
Today’s strong crop prices, though warmly welcomed by farmers, are likely to fade ahead—at least, under the assumption that crop yields move back toward trend over the next year or so. Demand growth is also likely to moderate ahead as consumer spending patterns normalize after the post-pandemic rebound. Futures markets, for their part, are pricing later contracts at a significant discount across most major products. Overall, wheat prices appear on track to average US$6.70/bushel in 2021 (up from $5.50 in 2020) but will likely retrace to around $6.00 by the end of 2022. A similar dynamic is expected to play out in the canola space, where prices will likely average around US$640/tonne this year (up from $372 last year) before returning below the $500 mark by the end of next year. However, a further deterioration in growing conditions would send prices further skyward.
Livestock prices prices have also staged an impressive rally over the past year, albeit from the depths induced by the pandemic. While extremely painful at the time, last year’s meatpacking shutdowns also led North American hog and cattle producers to meaningfully reduce the size of their herds. The smaller livestock herd, together with a normalization in processing capacity, has now yielded a far stronger livestock pricing environment—especially in the hog space, where prices are at their highest since the outbreak of PED virus in 2014. By comparison, the recovery in cattle prices has been somewhat tamer, in large part due to the widespread drought, which has weighed on pasture quality and forced distress selling in some areas. But even with the drought, seasonally adjusted cattle prices are now at a four-year high, and the herd reductions currently underway should underpin even stronger pricing ahead. Both hog and cattle prices are also receiving support from the demand side. In both Canada and the United States, strong household balance sheets and rapid household spending growth are benefitting meat consumption – both at home and in the steadily-reopening food services space. Export demand is also strong, especially purchases of U.S. pork products by China, which have increased sharply since last year’s Phase One trade agreement due to ongoing shortages in that country.
Looking ahead, hog market strength is likely to wane as China finishes rebuilding its hog herd, which is still down significantly due to the outbreak of African Swine Fever in 2019, and as North American producers resume expansion. Overall, hog prices are expected to average US$90/cwt in 2021 (up sharply from $60 in 2020) before backtracking to $83 in 2021, which would still be a solid price by historical norms. Cattle prices are expected to average US$118/cwt in 2021 (up from $106 in 2020) and should edge somewhat higher to around $122 next year due to drought-related herd restraint. In both segments, a key risk is the possibility of continued gains in crop and feed prices, which could eventually spur damaging distress selling.
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.