As our fiscal year began in October 2021, most COVID‑19 restrictions were being eased, and it looked like the world would begin re-opening fully, allowing the global economy to return to a modest but sustainable growth path.
Instead, the global economy has suffered multiple shocks starting with a gas crisis in Europe shortly after the beginning of our fiscal year. This was quickly followed by the outbreak of the Omicron variant of COVID‑19, the spread of which led to large parts of China’s economy going into lockdown, exacerbating the supply chain issues and weighing on commodities demand.
And then, the end of February saw the largest shock of all, the Russian invasion of Ukraine, which has disrupted energy and food flows to degrees that are coming in to clear focus, with significant upward pressure on prices and downward pressure on growth only expected to increase further.
In no small part due to these disruptions, inflation has reached levels not seen for 40 years in most regions. This is leading central banks around the world to tighten monetary policy more rapidly and more aggressively than expected only a few months ago. The result has been the strongest US dollar in 20 years, a surge fuelled by fears that disrupted Russian energy flows would lead to price spikes and lack of availability of supply in Europe would cause recession. The stronger USD, combined with higher interest rates globally, has been another headwind for the global economy, particularly for emerging markets.
The supply disruption from Russia and the demand disruption from China have affected our key markets differently. Base metals prices moved upwards initially, reaching all-time highs in some instances, and in the case of London Metal Exchange nickel prices, threatening to up‑end markets entirely. However, subsequently, prices have faltered as the impact of developments in China outweighed that of those in Russia. The pace of post‑lockdown recovery in China will be a critical factor in determining how metals markets perform in the second half of our fiscal year.
In energy markets, however, it has been a different story, as global demand has continued to grow strongly despite the drop in China, while supplies have been constrained, as a result of a lack of capacity due to under‑investment or by sanctions (Iran, Russia, Venezuela). In both energy and metals markets, inventories are extraordinarily low by historical standards and will struggle to meet any sustained rebound in demand.
Even before the Russian invasion of Ukraine disrupted global energy flows, energy markets were facing challenging supply and demand dynamics. For gas markets, Europe entered the winter months with storage at very low levels, while low hydropower reserves and constrained coal output in China, combined with a strong sequential year‑on‑year increase in power demand, meant that Asia, and particularly China, paid record-high prices to attract record amounts of liquefied natural gas (LNG). In Europe, already low gas stocks – depleted by lower injection into storage from Russia following lower exports in the summer months – were called upon earlier and to a greater extent than expected, due to low wind power output and reduced production in the Netherlands and Norway which reduced domestic supply. On top of those temporary issues, the decline of coal‑fired capacity, amounting to an over 40 percent reduction in the last five years, and reduced nuclear capacity, are structural trends that exacerbated the situation.
As a result, price pressures in European natural gas markets started to build through August and September, including periods of extreme intraday volatility. At the start of our fiscal year in October saw prices spike sharply upwards, increasing 78 percent (intraday peak) in just four trading days. At their peak, prices were about six times their normal average (EUR120/MWh vs. EUR20/MWh). The problem persisted through most of the European winter as Gazprom-owned storage in Europe was effectively empty. Prices spiked again in December, rising 85 percent in just seven days to make an all-time intraday high of EUR185/ MWh. A spell of warmer than normal weather from late December through January brought much-needed respite that allowed a path out of winter without reaching critical storage levels. At the same time, China’s ramp-up of coal production and usage freed up LNG imports into Europe.
Prices spiked again in the immediate wake of Russia’s invasion of Ukraine; this time more than tripling from EUR105/MWh to EUR335/MWh between the invasion on 24 February and 7 March. Since then, despite some minor disruptions, Russian flows to Europe have remained largely intact. This is despite some countries being cut off from gas due to non-compliance with Russia’s condition that gas imports must be paid for in Roubles. In the meantime, Europe has significantly increased LNG imports from the US, Middle East and elsewhere. This is in no small part due to the fact that high prices have led to a curtailment of price-sensitive imports into India and China, enabling those volumes to flow to Europe instead.
Increased supplies and seasonal reductions in demand have allowed inventories to build, and have led European benchmark TTF prices to return to pre-invasion – albeit still historically high – levels.
Oil markets began our financial year in relatively sedate fashion trading between USD80-USD85 per barrel for most of October and November. However, that was before Omicron hit, with the news of a significantly more transmissible variant in South Africa breaking the day after the Thanksgiving holiday in the United States, when market liquidity is substantially lower than normal, exacerbating the sharp sell-off. Prices tumbled by almost USD10 per barrel in one day, in total collapsing about USD20 per barrel (-21 percent) between 24 November and 2 December.
Initial concerns about the virulence of Omicron kept oil markets under pressure throughout December, but once it became clear by the start of 2022 that the global economy was not returning to widespread lockdowns, the constrained supply situation became increasingly in focus, with crude oil inventories (excluding-China) at extremely low levels compared with both the five‑year average and range. For example, in the United States, crude inventories began 2022 at some 40 million barrels below the normal five-year level.
While prices would usually rise to incentivise increased output in the US and OPEC+, this time US shale producers have exercised significant capital discipline as pressure from shareholders to prioritise cash returns rather than new capital expenditure has significantly slowed US production growth. As at publication of this report, US production levels had recovered from their post‑COVID‑19 level of approximately 11.0 million barrels per day, reaching back up to 11.9 million barrels per day, but this remains well below the 13.2 million barrels per day level the US was producing at just before the pandemic. Even this recovery has in large part been made possible by the industry drawing down its inventory of half-completed wells and by high‑grading to focus primarily on the most productive acreage. To highlight the challenge, since the end of 2020, US rig count has increased by 115 percent but US production has increased only by eight percent indicating the need for significant further spending in order to raise production levels back to pre-pandemic levels.
OPEC+ members (including Russia pre-invasion of Ukraine), have nominally been adding about 400,000 barrels per day of production back in to the market each month since last summer, gradually reversing the cuts they had enacted in April 2020. However, due to years of under‑investment and also occasional political flare-ups in places such as Libya, the group has actually only been adding about half of their agreed amount per month. As such, pre-invasion, the group was under-producing its collective quota by at least one million barrels per day. The fact that they were doing so despite high prices (prices at the start of February 2022 were 60 percent higher than a year ago), and despite increasing pressure from oil consumer nations, the United States, the European Union and others, indicates that most countries were already producing at their maximum sustainable capacity well before the invasion. Indeed, it seems that, at the time of writing only Saudi Arabia, Iraq and the United Arab Emirates have meaningful capacity to increase. However, to keep adding barrels from here will mean going well below the critical threshold of two million barrels per day of global spare capacity. Should this happen, any unforeseen disruption would lead to a rapid tightening of oil markets.
On the day of Russia’s invasion of Ukraine, oil prices broke the USD100 per barrel level for the first time since 2014 and reached one of the highest levels ever at USD139 per barrel in early trading on 7 March. Since this date, oil prices have been very volatile, falling over 30 percent in just seven days from their peak, rebounding 30 percent in six days, and then trading in a range of USD100 to USD115 per barrel.
The volatility, not just in oil but gas, food products, freight and base metals, is the direct result of Russia being one of the largest commodity producers in the world – any disruption in export flows has further tightened markets that were already, in most cases, very tight or in substantial deficit to begin with. So far, outside of food and fertiliser, exports have witnessed less severe disruption than expected, as measures restricting Russian flows of oil have only recently started to come into force. As those measures and other countries’ restrictions take effect, Russian authorities are now indicating that oil production is likely to drop by over 15 percent this year, impacting global supplies of both crude oil and refined products such as gasoline and diesel.
Meeting increasingly tight supply and increasingly high demand in coming months presents a significant challenge. At some point, higher energy prices will start to mitigate demand growth, particularly as inflation is widespread across spending categories. Governments around the world are choosing to cushion demand as much as possible for the time being, via subsidies and tax cuts, so the full impact of higher prices may not be felt for some time yet.
While Russia is an important producer of many metals, both in terms of widely-used base metals (aluminium, nickel, copper) and more specialised metals (titanium, palladium), the impact of the war in Ukraine has not been as significant as it has been in the energy markets. The impact of COVID-19 in China has had a far greater impact over the period in review. Even beyond China, macro-economic drivers have affected prices the most, acting as a headwind as micro-level inventory balances for most metals remain historically tight. In general, metals have recovered faster from the initial impact of the pandemic than other markets primarily because the shutdown in China was relatively short-lived compared with other regions. That situation has, of course, reversed in recent months as China began to struggle with the outbreak of Omicron.
For copper markets, the start of our fiscal year in October coincided with rising awareness that inventories were historically very low in the face of robust demand as the world economy tried to replenish low stocks of everything from cars and houses to durable goods, all of which are metals intensive. This tightness was further exacerbated by rapidly expanding demand from the energy transition, in particular for electric vehicles and renewable power generation. In October alone, LME inventories drew by 86,000 tonnes, a 43 percent drop in available stocks. The combination of lack of available supply and strong demand led to LME prices reaching their second-highest level of USD10,452 per tonne. Even more tellingly, the spread between the first and second contract months spiked sharply upwards, rising to a record level of USD1,086 per tonne (for context, the long-term average is basically just above flat). That severe backwardation, when current month prices are higher than future ones, was a clear indicator that inventories were extremely tight, and that the market wanted as much material out into the physical market as possible.
The contraction in stocks continued through November, reaching the lowest levels recorded since 2005. Backwardation reduced from the October highs, but nonetheless remained very high by historical standards, between USD200-USD400 per tonne. Which in turn meant that material was delivered into the LME system, pausing the one-way trajectory of stocks before inventories started to rise again as the West and then China went into their respective holiday (and therefore slower activity) seasons.
The seasonal slow-down was compounded by the emergence of Omicron, raising fears of another round of global lockdowns, as well as a flight to safety in financial markets. This was clear from the fall in yields as investors flocked to the safety of US Treasury (USTs) securities, with the yield on the 10-year UST falling rapidly from 1.7 percent to 1.3 percent. On top of this, China had been enacting measures to address the growing indebtedness of the property sector, and as such real estate activity started to contract significantly.
Nevertheless, the tightening micro picture led to a slow grind higher in prices, reaching a pre-invasion peak of just under USD10,300 per tonne. The Russian invasion then caused a further spike to an all-time high of USD10,845 per tonne as concerns over possible supply disruptions grew. Other metals followed a similar pattern. Zinc prices rose in October to a high of nearly USD4,000 per tonne, levels last reached just before the 2008 financial crisis. Zinc inventories had been drawing in a near-continuous fashion since 2012 (late 2015 being the exception), hitting a low in early 2020 before starting to climb through the rest of the year and into 2021 as the auto sector slumped due to supply chain issues. But from October 2021, inventories started to fall again as demand picked up and supply remained constrained. Although mine supply did expand in 2021, those expansions have only just managed to bring global supply back to the same level as 2015, while demand grew by over 0.6 percent annually on average over the same period.
Aluminium inventories started 2022 well below their five‑year range, and about 500,000 tonnes below their five‑year average, despite substantial builds during the early stages of the pandemic and again in mid‑2021. Although auto demand was a drag, consumer demand and construction kept overall demand very strong outside of China, resulting in record-high premiums for material delivered into the US and Europe. Here too capacity growth is constrained, as China had been the only region globally that has added any meaningful smelting capacity since 2008 but has now placed a hard cap on growth in smelters.
Aluminium and zinc prices followed a similar pattern, to each other and to copper: higher in October, in all three cases reaching close to record highs, before retracing into the end of the calendar year and then starting to move higher as 2022 began, mainly on optimism that COVID‑19 was finally behind us. Nickel prices followed a similar path initially as well, although they remained well below the previous record high (over USD50,000 per tonne) for the most part.
However, once the Russian invasion of Ukraine occurred, prices of all metals spiked to all-time highs: Aluminium hit close to USD4,100 per tonne, copper to USD10,845 per tonne, zinc to just under USD4,900 per tonne. Nickel was the metal that really surprised markets as prices rose 60 percent in a single day, and then a further 100 percent the next day. The speed and magnitude of the move meant that many market participants faced significant margin calls, which further exacerbated the volatility. Eventually, the LME cancelled trades made on the second day of the spike to restore an orderly market: a consequence has been that the paper market for nickel has until very recently been stuck in limbo as price discovery has been hampered due to the small volumes being traded.
The sharp move higher in metals prices in early March was driven by fears that exports from Russia would be disrupted, further tightening already-constrained markets. In the event, not much supply has been disrupted so far; but thanks to the emergence of Omicron, China has had to undergo the most serious lockdowns since the early days of the pandemic. After significantly impacting Hong Kong, the spread of the virus on the mainland has led to an extended lockdown in Shanghai, and in many other provinces and areas. The result overall has been a sharp shock to economic growth, in some ways more severe than the initial 2020 outbreak.
Property in particular continues to be hit hard, with slumping sales and construction activity, in turn dragging on metals consumption. Furthermore, Shanghai and Jilin, one of the other provinces hit hardest, together produce some 22-25 percent of China’s cars, so the shutting down of manufacturing facilities in those areas has led to another curtailment of auto production, exacerbating the ongoing issues in that sector globally and weakening metals demand.
As such, metals prices (excluding nickel) have been trading some 15-30 percent off the highs as the market waits for China’s next steps in terms of re-opening. China’s strategy has shifted to vastly expanding testing capacity in order to be able to move to more rapid but more targeted lockdowns. This approach appears to be paying dividends outside of Shanghai, allowing areas such as Shenzhen and others to open back up after a short, sharp lockdown. However, cases in Shanghai and Beijing remained elevated, slowing their full re-openings, although at the time of writing, indications are of an improving situation.
In the meantime, China has reversed many of the policies it had put in place last year, designed to prevent certain sectors of the economy from taking on too much debt or overheating, and also to bring costs of living down in order to foster demographic growth. In addition, the government has undertaken major stimulus efforts, lowering interest rates, encouraging lending, cutting taxes, targeting consumption growth, and boosting infrastructure spending. So far, given the ongoing lockdowns, these measures have failed to kickstart growth. The expectation, however, is that once the economy is substantively re-opened, these measures, totalling some USD5.5 trillion, will lead to a strong second half of the calendar year.
A resurgent China might be good for global economic growth, but given that commodity inventories are already extremely, and in some cases unprecedently, low, it remains to be seen how prices might react from here. Inflation is already problematically elevated, but Chinese demand for commodity imports could further spur inflationary pressures.
Read our 2022 Interim Report here.