Businesses and consumers are already feeling the impact of the rally in commodity prices of everything from crude oil to grains and metals. The year’s highly volatile commodity markets, roiled by the Russian invasion of Ukraine, are complicating real-world economic growth prospects and are raising food and energy prices for consumers globally. The surge in commodities, including crude oil, natural gas, wheat, soybeans, and industrial and precious metals, have already hit consumer prices globally, with inflation at a 40-year high. This has prompted the Fed to start raising interest rates to tame inflation, with more rate hikes expected in the coming months.
Commodity Inventories “Critically Low”
Globally, the supply of commodities of all kinds is lower than the demand.
“Inventories across energy, agricultural and metals are critically low everywhere,” Tracey Allen, commodities strategist at JPMorgan Chase & Co, told Ryan Dezember of The Wall Street Journal. JPMorgan sees commodity prices staying elevated through the end of next year.
The supply of commodities could head even lower if the Russian war in Ukraine disrupts more materially exports of energy products out of Russia and/or wheat and corn exports out of Ukraine, the so-called “breadbasket of Europe”, as it is one of the world’s top exporters of corn, wheat, and vegetable oils. Reduced exports of Ukrainian agricultural commodities could raise food insecurity in many countries in South Asia, Western Asia, and Africa, IHS Markit said last month.
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Over the past three years, Russia and Ukraine combined accounted for around 30 percent and 20 percent of global wheat and maize exports, respectively, the UN said last week when it noted that the war resulted in a fresh all-time high in global food prices. The FAO Food Price Index averaged 159.3 points in March, up 12.6 percent from February, when it had already reached its highest level since its inception in 1990, the UN Food and Agriculture Organization (FAO) said. The FAO Food Price Index tracks monthly changes in the prices of a basket of commonly traded food commodities. Last month’s prices were 33.6 percent higher overall compared to March last year.
“The prospect of continued supply disruptions from Ukraine this year together with US and South American weather concerns as well as the mentioned rise in the cost of fuel and fertilizers will likely lead to another year of tightening supply,” Ole Hansen, Head of Commodity Strategy at Saxo Bank, said in a weekly commodity market update last week.
The commodities sector overall saw the best quarter ever in Q1 2022, Hansen noted.
“During the first quarter, war and sanctions turbocharged an already strong performing sector, resulting in the Bloomberg Commodity Spot Index registering a 24% gain, its best quarter in living memory, thereby almost eclipsing the 2021 gain of 26.5%, the best annual performance since 2000,” he said.
Speculators Pull Out Of Oil & Gas Markets
“The war in Ukraine and increasingly tough sanctions against Russia have uprooted multiple supply channels from crude oil and gas to key industrial metals as well as food commodities such as wheat, corn, and edible oils,” Hansen says.
The market turmoil in commodities, the extreme volatility, and the futures exchanges raising initial margins significantly after Putin’s war in Ukraine began have led to an exodus of speculators from oil futures. The lower liquidity in the paper oil market exacerbated the volatility to the point of some traders saying in March that “the market is untradeable.”
The high margin requirements raised the liquidity needs of commodity trading firms, which trade physical barrels around the world. Via futures contracts in commodities, trading houses hedge against risks. Without commodity derivatives, many traders would not be able to move physical volumes of oil.
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“We need a fully-functioning commodities futures market and what we’ve observed is a decrease in open interest. Assuming the situation does not normalise, there will be consequences of this inefficient futures market into physical,” Christophe Salmon, CFO at Trafigura, said at the FT Commodities Global Summit last month.
The Global Price Index of All Commodities has more than doubled since its pandemic low in Q2 2020, pushing 62 percent higher than its average during the last business cycle, Jim Glassman, Managing Director and Head Economist for Commercial Banking at JPMorgan, said this week.
Even if peace is reached in Ukraine, markets are likely to price in political risks for commodities such as oil, wheat, corn, nickel, and palladium, according to the economist.
“Futures markets anticipate oil prices to remain elevated for years,” Glassman noted.
Consumers are already feeling the pinch from high energy prices because oil price spikes almost immediately lead to higher prices at the pump.
“For every $42 rise in the price of a barrel of crude oil, the average household will spend an extra $500 annually on gasoline,” JP Morgan’s Glassman says.
Businesses dependent on raw materials and transportation could find the coming months challenging. If the rising cost of commodities and oil starts to spill over into core inflation, this could compel the Fed to plan more interest rate hikes, which could cool the economy, the economist noted.
By Tsvetana Paraskova for Oilprice.com
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The underlying factors behind such surge was the fact that the global oil market has been in its most bullish state since 2014 whilst the global oil demand has entered a super-cycle phase of accelerating demand which is expected to last 10 years and take Brent crude to $120 in the next few years.
The Ukraine conflict added at one time a premium estimated at $25-$30 to the price of a barrel of oil. However, this premium has started to evaporate when the oil market realized that the conflict hasn’t resulted in a global disruption of oil and other energy products. But it did disrupt Ukraine’s agricultural products like wheat and maize for which Ukraine accounts for 20% of the world’s total. This led to a chain reaction causing price rises of all commodities.
Depending on how long these rises will continue, they are bound to feed into the global economy and cause a global recession if not a real decline in the growth of the global economy this year. They are also leading to inflationary pressure and the need for central banks around the world to raise interest rates to tame inflation in the coming months.
The global supply of commodities could head even lower if Russia decides to retaliate further against Western countries imposing sanctions against it by limiting the supplies of essential commodities to them. Russia accounts for 30% of global wheat and maize exports. It is also a top supplier of precious metals, fertilizers, process uranium and many key industrial metals that keep the global economy ticking.
The skyrocketing costs of commodities demonstrate without ambiguity the world’s reliance on Russian commodities including oil, gas and coal exports.
The conflict is costing the Western economies and the global economy far more than costing Russia’s. With a bit of statesmanship on the part of the West, the conflict could end immediately if the West agrees to address Russia’s security concerns thus helping reduce sky-high energy prices and enabling the global economy to grow in peace.
President Putin has invested so much in the Ukraine conflict. Therefore, he isn’t going to stop until he achieves his objectives. The reported fall of Ukraine’s port of Mariupol and the link up of the Crimea and Moscow-backed Donetsk and Lugansk regions could see the end of Russia’s operations in Ukraine and the start of a peaceful settlement confirming Ukraine’s neutrality status.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London