ICG Commodity Update – April 2024

The ICG Commodity Update is our monthly published comment on the energy, industrial metals and precious metals market.

 

Energy

Despite heightened tensions in the Middle East, oil prices have seen only modest reactions. Brent crude reached a peak of $92/bl on April 12th but has since retreated to $84/bl, similar to levels seen at the beginning of the month. Historical patterns suggest that geopolitical risk premiums tend to dissipate without actual supply disruptions. Additionally, there is ample spare capacity held predominantly by a few key countries (like Saudi Arabia and the UAE) that could offset significant supply disruptions if they were to occur. On the demand side, the outlook has brightened with diminished recession concerns, though forecasts vary widely. Nonetheless, OPEC has not fully implemented its latest production cutbacks. According to a Bloomberg survey, Iraq and the UAE continue to exceed their agreed limits by several hundred thousand barrels per day. Although overall production, particularly in the U.S., is at record levels, the efficiency of oil recovery per foot drilled in the Permian Basin has declined by 15% from 2020 to 2023, matching levels seen a decade ago, as reported by Enverus. This drop is attributed to decreased fracking efficiency. However, recent innovations in oilfield technologies, increasingly adopted last year, promise faster, more cost-effective, and higher-yielding fracking operations. Analysts expect the adoption of new technologies, particularly simultaneous fracking, to accelerate. Despite declining productivity and a limited rig count, advancements in well length and fracking techniques are driving record oil production in the U.S. Notably, the ongoing earnings season underscores key trends, including capital return discipline, modest growth expectations for U.S. shale liquids, and cautious spending outlooks. Interestingly, TotalEnergies is considering a U.S. listing, potentially joining U.S. equity indexes. This move aligns with the fact that U.S. funds already constitute 47% of its shareholder base and are increasing their holdings compared to European investors, likely influenced by ESG and political considerations. Similar plans are rumored for Shell. However, the domicils are not up for debate. Overall, sector sentiment towards energy is improving, and this positive trend is expected to continue.

 

Industrial Metals

In April, the US announced new restrictions on trading in Russian aluminum, copper and nickel. The rules, which restrict the use of metals on global exchanges and in over-the counter derivatives trading, will apply to Russian metals produced on or after April 13. Metals produced before that date are exempt. The US is also banning Russian imports of all three metals. Analysts see this move as more symbolic, given its only for new material and expect the actual impact to be relatively limited. Nevertheless, it is also expected that this move might translate in premiums for aluminum and copper – given momentum in general prices currently, this might add more fuel to the rally. Looking at China, steel and iron ore futures have risen as the government vowed more action to tackle the real estate sector woes that have stifled construction activity and hampered commodities demand more recently. The central government said it would study steps to digest a huge glut of empty homes, while some major cities announced their own measures to support the steel-intensive property sector. One of the major developments in the commodity equity markets last month was BHP’s $39 billion bid for Anglo American. The proposed combination, which has been rejected by the smaller rival, would create the world’s largest copper producer, with about 10% of supply, and add heft to BHP’s already significant iron ore and coal operations. It would also require Anglo to divest South African subsidiaries. That’s more than enough to trigger intense oversight by regulators concerned about implications for market concentration and access to key minerals. According to analysts, Riot Tinto and Glencore are waiting on the sidelines to either make a bid or for opportunities to buy parts of Anglo American’s business. The biggest producers all want to increase copper output to take advantage of rising demand in electric vehicles, grid infrastructure and data centers. Production from existing mines is set to fall sharply in the coming years, and miners would need to spend more than $150 billion between 2025 and 2032 to fulfill the industry’s supply needs, according to CRU Group. Projects that are shovel-ready and in quality jurisdictions are at a record low as there was a dramatic under-investment in mining and development in the last decade – with rising costs and more complexity to get all the permits ready, analysts think that currently, its cheaper to buy projects that are almost completely built than to find and develop themselves.

 

Precious Metals

Gold has gained about 12% this year despite uncertainty over when the US central bank will reduce rates. The metal made a record-breaking rally that saw it hit a succession of all-time highs in April, with those gains linked to strong central-bank purchases, demand from Asian markets and haven buying. Central bank buying hit a Q1 record of 290t. China marked a 17th consecutive monthly increase while the Reserve Bank of India already exceeded last year’s annual net purchases. The World Gold Council was keen to highlight Industrial demand for gold which jumped 10% y/y to 79t. The AI boom is taking centre stage in discussion, for gold, this involves high-end communication chips. In past gold bull markets, gold equities typically showed 2-5x leverage. Currently, gold equities are rebounding from significant lows compared to gold and broader markets, still distant from their peaks. Analysts observe a phase of margin expansion, affirmed by recent annual and quarterly reports. While all-in sustaining costs rose by approximately 10% annually in 2021/2022, they remained steady in 2023 and are predicted to decrease in 2024. Early indications from Q1 2024 reports suggest controlled costs, with major players like Newmont surpassing expectations through effective cost management. Many miners are seeing expanding margins, maintaining a healthy AISC margin around USD 730/oz in 2023, expected to continue growing. This trend underscores miners’ capital allocation discipline, evident in robust dividend policies and selective M&A endeavors. Unlike the previous cycle, there’s scant evidence of overspending, with CAPEX forecasts suggesting restrained expenditure ahead. Limited availability of Tier 1 gold projects fuels the importance of M&A for maintaining or expanding production levels. Investing in precious metals equities offers the advantage of gaining beta exposure to increasing gold and silver prices. This operational leverage, realized as miners expand margins, leads to significant outperformance compared to physical gold during market rallies – a trend which has yet to materialized. Most analysts see the upside potential for precious metals equities, or mining equities in general, as substantial. The strong performance of Newmont is particularly significant to generate greater interest in the industry overall.