Multiple uncertainties will continue to create a volatile environment for most commodities ahead of the year-end. While the recession drums will continue to bang ever louder the sector is unlikely to suffer a major setback before picking up speed again during 2023.
This forecast for stable to potentially even higher prices will be driven by pockets of strength in key commodities across all three sectors of energy, metals, and agriculture.
With that in mind, we see the Bloomberg Commodity Index, which tracks a basket of 24 major commodities, hold onto its +20 per cent year-to-date gain for the remainder of the year.
It highlights the behaviour of commodities where supply and demand ultimately set the price. While we are seeing concerns about growth and demand, the supply of several major commodities remains equally challenged.
An explosive rally during the first quarter was led by war, sanctions, and the backend of a post-pandemic surge in demand for consumer goods and energy to produce them. The market then retraced sharply lower during June when the US Federal Reserve turbocharged its rate hikes to combat runaway inflation, while China’s zero-Covid policy and property sector woes drove a sharp correction.
During the third quarter, however, the sector has reasserted itself and while pockets of demand weakness will be seen, we see the supply side equally challenged developments that we see support the long-lasting cycle of rising commodity prices that we first wrote about in the start of 2021.
Crude oil has returned to pre-Russian invasion levels as the market continues to price in the prospect of an economic slowdown hurting demand. The result is lower spot prices and a flattening forward curve to an extent that is not yet backed up by a corresponding rise in inventories.
It raises the question of whether the macroeconomic outlook has driven prices down to levels that are not yet justified by current supply and demand developments.
There is no doubt demand has softened in recent months, especially following the end of the summer driving season, and continued but temporary lockdowns in China that are hurting mobility and growth.
In Europe, punitively high prices for gas and power have also helped drive a slowdown in fuel demand but the region is still importing around 3 million barrels per day from Russia.
The introduction of an import embargo on December 5 will likely tighten the overall market with Russia struggling to find other buyers.
We view the current weakness in oil fundamentals as temporary and side with the major oil forecasters of EIA, Opec and the IEA who, despite current growth concerns, have all maintained their demand growth forecasts for 2023.
During the final quarter prices are likely to remain challenged at times resulting in a potential lower range in Brent crude between $80 and $100 dollar-per-barrel. The main developments that could impact prices include:
• China’s continued battle with Covid versus additional stimulus to offset growth risks
• Gas-to-fuel switching supporting demand for distillate products
• EU embargo on
Russian oil potentially forcing a reduction in Russian production
• The US plans to begin refilling its strategic reserves
• Opec threat to lower production should prices drop further
• The direction of US inflation and the dollar — both key drivers of the general level of risk appetite
• US production growth, which is showing signs of stalling, thereby supporting prices
Oil majors swamped with cash, and investors in general, showing little appetite for investing in new discoveries suggest that the cost of energy is likely to remain elevated for years to come. This is driven by the green transformation which is receiving increased and urgent attention, and which will eventually begin to lower global demand for fossil fuels.
It’s the timing of this transition that keeps the investment appetite low. Unlike new drilling methods such as fracking where a well can be productive within months, traditional oil production projects often take years and billion-dollar investments before production can begin.
With that in mind, oil companies looking to invest in new production will not be focused on spot prices around $90 in Brent and lower in WTI, but instead at +30-dollar lower prices currently traded in the futures market for delivery in five years’ time.
(The writer is Head of Commodity Strategy at Saxo Bank)
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