Commodities rallied strongly in 2021 with the sector recording its best year since 2000. Years of ample supply with steady prices had reduced investments towards new production and once the post-pandemic growth surge unfolded, supply was left struggling to keep up. With energy from oil to gas and coal being the main input to drive the global recovery, these sectors witnessed increased tightness which ultimately resulted in the current energy crisis.
We see another year where tight supply and inflationary pressures will support commodity returns. The decarbonisation of the world will increasingly create so-called greenflation, where rising demand and prices of commodities needed to support the process will be met by inelastic supply—partly driven by regulations such as ESG—prohibiting some investors and banks from supporting mining and drilling activities.
Overall, the energy heavy S&P GSCI Total Return Index rose 40 per cent while the more broadly exposed Bloomberg Commodity Total Return index, which included a higher share of the struggling precious metal sector, managed a 27 percent return, both easily outperforming the gain of 23.3 per cent in USD terms in the MSCI World Index.
Energy: The strong recovery in global energy demand together with lack of investments—partly due to regulations and the push towards raising power production from renewables—have all helped drive a surge across all fossil fuels. The outlook for 2022 points towards continued tightness and with that elevated prices. The most visible imbalance between supply and demand was seen in Europe and Asia during the second half of 2021, when gas prices in Europe at one point in December reached $60/MMBtu—more than ten times the five-year average price.
In Europe, the fragility of an energy market focused on decarbonising energy production has become increasingly apparent during the past six months. The result has been greenflation, driven by punitively high prices of gas and power prices putting heavy energy-consuming industries at risk while hurting consumers’ propensity to spend and to keep the economic recovery on track. While gas is being viewed as the bridge between coal and renewables in Europe, Asia remains stuck with coal as a key source of energy, not least in China and India where surging power demand last year was met by increased demand for coal. As a result of this and despite the need to decarbonise the world, the amount of electricity generated worldwide from coal surged by an estimated 9 percent to a new record high in 2021. The International Energy Agency estimates that demand will reach a fresh record this year, at a level where it may stay over the following two years.
While the risk of blackouts in Europe due to lack of gas has more or less been averted following a mild winter spell during the holiday period along with strong supplies of LNG, the forward price structure points to continued pain for consumers and industries across the continent. Dutch TTF gas futures for February 2023 delivery are trading only 10 percent below the current price, still more than four times the long-term average.
Crude oil markets look set to tighten further in 2022, with several producers within the OPEC+ group already struggling to meet their allocated quotas. With that in mind and considering US production struggling to reach pre-pandemic levels, we maintain a long-term bullish view on the oil market. It will be facing years of likely underinvestment with oil majors losing their appetite for big projects, partly due to an uncertain long-term outlook for oil demand, but also increasingly due to lending restrictions being put on banks and investors owing to a focus on ESG and the green transformation.
Global oil demand is not expected to peak anytime soon and that will add further pressure on spare capacity, which is already being reduced on a monthly basis, courtesy of OPEC+ production increases. According to OPEC and the IEA, the early months of 2022 could see an oversupplied market, but with spare capacity starting to run low and demand reaching a pre-pandemic peak, we see Brent crude oil reach into the $90s, and potentially above $100 during the second half.
(The writer is the Head of Commodity Strategy at Saxo Bank)