ICG Commodity Update – February 2023
The ICG Commodity Update is our monthly published comment on the energy, industrial metals and precious metals market.
Energy markets remain lower this year as the prospect of tighter US monetary policy and rising inventories in the US have so far outweighed optimism that Chinese demand will strengthen as activity picks up. Indeed, China’s crude oil consumption is expected to hit pre-pandemic highs and might contribute to most of the global oil demand in 2023 according to most analysts. On the supply side, US shale growth could slow to 300kboe/d in 2023, which is half of the growth of last year on issues with labour shortages and supply chain bottlenecks according to the Fed of Dallas and the EIA. Further to that, Russian flows are also in focus as western sanctions and bans related to the war in Ukraine tighten. However, markets have generally overestimated the extent of Russian oil supply disruptions since the Ukraine war began. Nevertheless, Russia’s deputy prime minister Novak recently indicated that the country will cut its oil production by 500kboe/d in March. According to Goldman Sachs, after all, the bullish micro fundamental story is still very much intact. Even front-end oil time spreads have moved back into backwardation, a sign of physical tightness. Interestingly, products now exhibit higher implied volatility than crude prices, unprecedented since the mid-2000s “Golden Age of Refining”, highlighting that the most binding constraints exist in seaborne transportation and distillation, rather than well-head production. This has direct implications for crude differentials, where quality concerns (product netbacks) and seaborne transportation costs now govern regional swings in crude prices. On the natural gas side, several US companies recently announced they are pulling back on gas drilling as US gas prices have fallen by about 50% this year. February saw the most oil and gas rig drop since June 2020. The 4Q results for the oil and gas companies have proven what we have communicated for some time. The profit for the upstream industry reached a record high-level last year. Interestingly, a key observation from the quarter results is the change in strategy from some of the European majors. Companies like BP and Shell have reversed some of their aggressive energy transition strategies. The clearest case is BP, the company is now guiding higher future upstream investments and higher oil and gas production. This is evidence that energy security is probably becoming more important post-Russia’s invasion of Ukraine.
According to analysts, it appears that the market is looking through a patch of demand softness in the copper market with the focus on firmer cyclical Chinese offtake to come, less growth tail risks in the developed world, and structural demand trends staying resilient. Market participants expect a 3.1% growth in global copper demand this year, while on the supply side, more than 250kt of annualized mine output could be at risk due to protests in Peru. Some analysts also see longer-term implications, with companies potentially delaying the approval of new projects. Politics could put a brake on new supply. Countries with large reserves of metals such as Peru are pushing for a bigger share of the profits from mining, which could discourage investment. In Chile, the world’s biggest copper producer, mining projects have been held back by regulatory uncertainties. In Panama, one of the largest copper mines in the world is embroiled in a tax dispute and has currently suspended ore processing. Companies got burned in the past when the cycle turned, and they found themselves boosting output just as demand was falling. Since then, they have prioritized strong balance sheets and become more wary of investing in new projects. The specter of global inflation makes heavy capital spending even less palatable as it pushes up costs. What is more, rich copper deposits are getting harder, and more expensive, to find – just in time when expansion is needed as large supply shortages are expected in the near future. If supply shortages turn out to be as severe as some analysts predict, it would cause a surge in prices that risks damaging the economics of smart grids and renewables and slowing their adoption. Looking at companies, the results from the world’s biggest miners are so-far disappointing as they grappled with lower metals prices and rising energy and labor costs. 2022 was a volatile year for industrial metals, with record prices in the first half giving way to a second-half slump amid fears for the global economy. Rio Tinto slashed its dividend on lower profits, BHP’s half-year earnings fell from a record, while Vale was hurt by cost inflation. Glencore had a better outing, posting its best-ever profit thanks to a global coal boom. Even though inflationary pressures are softening as supply chains start to ease up and gas prices fall, the direct flow through to the cost base will take time. Nevertheless, the companies are optimistic about a turnaround in its biggest market China, after the end of Covid Zero.
Following a strong rally at the start of the year, rising US interest rates sparking growth concerns and a stronger US dollar have weighed on precious metals. Gold headed for its worst month since the mid-2021, after a slew of data saw traders pricing a higher peak for US interest rates this year. The metal was down close to 6% in February – strong inflation, home sales and jobs data have increased expectations for monetary tightening. The dollar and Treasury yields have risen last month, dimming the allure of non-interest-bearing gold. That’s triggered outflows from bullion-backed ETFs. Looking at companies, Newmont’s $17 billion push to buy Newcrest Mining comes as miners wrestle with the reality that gold deposits are small, costly and short in life – while making the case for more diversification. A tie-up with Newcrest would boost Newmont’s gold output by about a third, based on 2022 production, and give the added bonus of greater exposure to highly sought copper. Newcrest rejected the $17 billion proposal, with interim CEO saying the company was “worth a lot more”. Newmont said during an earnings call that they are still engaging with the company, adding that a combination would create an ideal mix of gold and copper. Newmont’s reference to copper is a sign of how precious metals producers are looking to diversify as margins and revenues take a hit from lower-grade and harder-to-access gold deposits. Some base metals are increasingly coveted as global demand surges for materials that play a crucial role in the global push to electrify transportation and build cleaner energy technologies. Looking at platinum, markets are expected to tighten according to Analysts. Power outages continue to plague South Africa. Last week, state-owned utility Eskom announced power cuts of 7,000 megawatts, aiming to prevent a total collapse of the national grid. South Africa is the largest platinum producer, accounting for more than 70% of the world’s platinum mining supply, and while miners have backup systems, these power disruptions are likely to weigh on PGM production. Palladium on the other hand is expected to be oversupplied this year due to slower economic growth, higher scrap supply and substitution in autocatalysts favoring cheaper platinum at the expense of palladium.