Commodities Update September 2022
Our forecasts are based on 3 principles: 1. A bulks supply recovery as the industry faces Chinese peak steel; 2. Aggressive monetary policy suppressing growth in ‘23 then a recovery in ‘24; & 3. Resource sector underinvestment, particularly carbon-based energy & base metals including ‘green metals'
The following text is based on the article in the Septemeber Market Outlook (PDF 423KB)
For more details on our longer term forecasts see September Commodity Forecasts
Commodity prices continue to be very volatile with a significant dispersion in direction, as well as magnitude, of price changes through August. Our broad index is 6.2% higher in month since the last report but this masks a wide dispersion in outcomes. At the upper extreme is the 44% increase in met coal and a 12.3% lift in thermal coal contrasted to the 7.9% fall in iron ore. Crude oil (Brent) fell 5.9% in the month and yet LNG is up 11.7%. Our base metals index is down 3.4% but this is composed of a 6.5% fall in aluminium, a 7.5% fall in zinc and lead, a 1.7% fall in nickel and a 0.4% increase in copper. Gold fell 3.4% in the month while rural commodities rose 2.3%.
With this ongoing volatility in commodity prices we have focused on three key principles in formulating our forecasts.
- Bulks (iron ore and met coal) are set to face an ongoing recovery in supply just as the global steel industry faces restructuring associated with China having hit peak steel seeing iron ore and coal prices, both met and thermal, continuing to trend lower through 2024.
- The aggressive tightening of global monetary policy is set to slow US and European growth in 2023 to 0.6% and 1.5% respectively. While Chinese growth is set to lift to 7.0% in 2022, from 3.0% in 2023, and this will support global growth of 3.4% the moderation in developed world demand will act as a brake on energy and base metal prices until we get a recovery heading into 2024 fuelled by loosening in monetary policy and a weaker US dollar. The will see crude oil, LNG and base metals lover through 2023 before recovering through 2024.
- Underinvestment in the resources sector continues, particularly for carbon-based energy and base metals including ‘green metals’, resulting in a further tightening in supply as we head into 2024 and a recovery in developed world demand. This will be an inflationary influence for the broader commodity matrix from 2024 with particular focus on the base metals and carbon based energy.
Due to base effects, there is a stronger profile for our overall commodities index but due to the above factors there is significant variation not just in the magnitude of price changes but also the direction. Westpac’s Export Price Index is now 9.6% higher at end 2022 and 9.4% higher at end 2023. But the variation between the commodities has been significant. At US$100/t at end 2022 iron ore prices have been revised down 4.8% but remain at US$90/t for end 2023. Contrast that with 13.4% upward revision for met coal at end 2022 (to US$240/t) and a 21.4% upward revision to thermal coal (to US$425/t). The pressure on met coal is likely remain due to tight supply condition hence the 4.5% upward revision to the end 2023 forecast to US$212/t. Thermal coal is face a more uncertain time give extended elevated prices, the potential lift in Australian supply to more normal levels and the ongoing significant discounts for South African and Indonesian coal so we have revised down the end 2023 forecast by 14.3% to US$150/t.
Crude oil prices have fallen recently as demand fears outweighed continuing tight supply conditions; our end 2022 Brent forecast has been lowered 8% to US$92/bbl. The new low in crude is US$87bbl in March 2023. From there the recovery though 2024, a lower US dollar and a continuing tight supply will see Brent prices back to US$92/bbl, 8.2% higher than we had in the August report. We are not seeing the usual lift in US crude oil production at current price levels while Russian production is in decline as their industry struggles with maintenance and capital investment as western companies exit the country and trade embargos prevent the importation of critical equipment.
The recent weakness in crude oil prices has been due, in part, due to the market focusing on the growth risks associate with rising interest rates and the European energy crisis. However, the Atlantic hurricane season is nearing its halfway point and so far, no hurricanes have made landfall on the coast of the United States, contributing to the recent downward pressure on oil and fuel prices. The Atlantic season lasts from June 1 to November 30, with half of the storms usually occurring before September 12; U.S. National Oceanic and Atmospheric Administration (NOAA). On average, four hurricanes made landfall on the Atlantic or Gulf Coasts by September 12 between 1851 and 2021 (“Hurricane database”, HURDAT2, NOAA).
Through August EU natural gas prices spiked to a record high of US$70/mmbtu, more than treble the US$20/mmbtu for LNG landed in Japan and seven times the around US$10/mmbtu for US natural gas (Henry Hub). The loss of Russian gas has had a significant impact on EU gas prices and while the increase in demand for alternative sources has put upward pressure of global gas prices so far the moves in Asia and the US have been more mute than that in the EU; since June 2021 EU gas prices have surged 580% compared to a 172% increase in US natural gas and a smaller but still significant 110% increase in Japanese LNG. As the EU continues to tap into the global LNG market, and the US is the only likely possible supplier of additional LNG, then this has the potential to draw both the US and Japanese prices higher even without an increase in EU gas prices or even crude oil prices.
Investment in new oil supply hit a high of US$700 billion in 2014. But spending has been well below that level since. Over on the downstream processing side, global refining capacity declined in 2020 and 2021. For both oil producers and refiners, increasing net zero aspirations around the world have increase the uncertainty about future oil demand. This lack of investment is set hold the crude oil market in a very tight position which leave the market more prone to react to upside demand surprise than downside surprises.
We expect to see a similar pattern in base metals with our Base Metals Index at end 2022 revised down 3.6% while the end 2023 forecast has been revised up 2.3%. However, for individual metals the outcomes are far more mix. Our end 2022 forecast for aluminium is down 10% (US$2,500/t), -8.5% for lead (US$2,050/t), -3.6% for nickel and just -1.3% for copper. In 2023 our year end forecasts for nickel are 6.1% higher (US$21,750/t), 5% higher for zinc (US$3,150) and 4.9% higher for copper (US$8,250) while our aluminium forecast was revised down -3.8% (US$2,600/t). As you can see in the chart below, since the market dislocation early this year nickel has maintained the relative a relative premium to the Base Metals Index since then.
Our forecast for the rural/softs index for end 2022 has been revised down 3.6% but it was lifted 8.4% for end 2023.
Cost inflation (driven by the higher energy, labour, and other consumable prices) will be an ongoing challenge for the resources sector. For the Australian sector, iron ore and coal remain in a relatively better position compared to other commodities due to some offset from FX and very high margins on the cost of production. As such, some of this windfall gain will be recycled into repairs and short-term investments lifting production and smoothing out some of the supply chain disruptions lifting export volumes as we head in 2023. As such, with steel prices under pressure from falling sales and rising inventories this increase in volume will come just as demand remains anaemic putting further downward pressure on iron ore and met coal prices.
It is also worth highlighting just what a massive impact the EU demand for Australian coal, and tight supplies out of Australia due to very wet conditions on the east coast, have had on Australian thermal coal prices. At close to US$450/t Newcastle thermal coal is trading at a very unusual and very large premium to the higher grade and traditionally higher value met coal (around US$250/t). Even low vol PCI, which is lower grade met coal which normally trade between thermal and met coal, is now trading at a premium to premium low volatility met coal.
The premium for Australian coal is also significantly extended compared the low grade South African Coal (Richards Bay around US$250/t) and Indonesian coal (Kalimantan around US$125/t). Indonesia in particular is hampered by much lower grade of more polluting coal which is being shunned by the EU and their traditional markets of India and China now have access to cheaper, higher grade Russian coal that is facing embargos in many developed markets.
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