ICG Commodity Update – October 2021
The ICG Commodity Update is our monthly published comment on the energy, industrial metals and precious metals market.
The COP26 Conference has just begun in Glasgow. A critical opportunity for countries to make progress on their plans to reduce emissions. The easy work is the pledge, the hard work is following through. Nevertheless, the new energy economy will be more electrified, efficient, interconnected and clean. However, the rapid but uneven economic recovery from last year’s Covid-induced recession is putting major strains on parts of today’s energy system, sparking sharp price rises in natural gas, coal and electricity markets. For all the advances being made by renewables and electric mobility, 2021 is seeing a large rebound in coal and oil use. While the energy transition theme is likely to present enormous market and investment opportunity, it needs to be executed delicately. There is no doubt that energy transition presents a major go-forward challenge for the oil and gas industry, but it is not going to culminate overnight. First, the IEA in its most recent World Energy Outlook conceded that the world remains far off of a “net zero” trajectory, and the “Announced Pledges” of world governments to date do not translate to a meaningful decline in oil demand until after 2030. In addition, the world will require a lot more natural gas production to bridge the gap between now and a renewable future. Indeed, natural gas emits half as much carbon as coal and may smooth the switch-over to the likes of wind and solar energy. Second, we think, the energy sector has to be at the heart of the solution to climate change. Fossil fuel divestment, in our view, stands as a permanent negative call on an industry that may be more dynamic and innovative than some market observers expect. As the CEO of Shell recently said, the revenues generated by the oil and gas business is financing the investment in renewables. The energy sector as a whole was the second-highest producer of green patents! Investors who sell their shares pass up the opportunity to engage with management and use their leverage as long-term shareholders to push for ESG improvements, including energy transition plans. About 1’300 institutions across the capital markets have committed to fossil fuel divestment. The issue of fossil fuel divestment in some ways has become politicized and may pose difficult questions for fiduciary investors if the sector continues to outpace the market. We believe that energy companies are likely to continue to benefit over the short run from a favourable market environment driven by a combination of increasing global energy demand and potential crude oil and natural gas supply shortages stemming from unprecedented underinvestment. As the recent 3Q results showed, the positive trend we saw in the 2Q continues with record high revenues and profits. Allowedly, after years of poor returns, the oil and gas companies are trying to woo investors by giving most of the extra cash they’re making into share purchases and rising dividends. We like that!
In October, copper inventories available on the LME hit the lowest since 1974, in a dramatic escalation of a squeeze on global supplies that sent spreads spinking and helped drive prices. Copper tracked by LME warehouses that’s not already earmarked for withdrawal has plunged 89% last month after a surge in orders for metal from warehouses in Europe. Stockpiles have also been falling fast on rival bourses and in private storage, and LME spreads have entered historic levels of backwardation, with near-term contracts trading at record premiums. The slumping global stockpiles and resilient demand for copper stand in stark contrast to mounting worries over the macroeconomic outlook, and the risk that stagflation and power shortages could derail the world’s strong growth trajectory. Base metals took a breather on the race to record highs amid concerns the energy crisis could slow down a nascent global economic recovery. Soaring energy prices are raising production costs for metals producers and forcing smelters to close even as inventories are dwindle. Power shortages are also forcing manufacturers to cut production, meaning they’re using less metals, especially when it comes to energy-intensive ones like aluminum and zinc. The higher cost pressure for everything from power to raw materials are leading to fears of higher inflation and a slowdown in global growth. On the other hand, fears of inflation could also increase demand for metals as there is a perception that they are a hedge against inflation, which is especially true for gold and copper. The supply curtailments started in China as the country restricted power to energy intensive industries and have now spread to Europe as the region faces its own power problems spurred by record gas prices. For example, Glencore’s zinc cuts followed an announcement that Nyrstar, one of the biggest zinc producers, would reduce output at three European smelters by up to 50% due to rising power prices and costs associated with carbon emissions. Meanwhile, Matalco, the largest US producer of aluminum billet, warned its costumers it may curtail output and ration deliveries as soon as next year amid a magnesium shortage. Steelmakers, including ArcelorMittal, have also cut production. As most metals are in backwardation and physical demand high, the ingredients are there for materially higher prices across the board. According to Anglo American, the global energy crunch could be repeated in metals markets in future years as supply falls well short of demand during the transition to greener power. With an average lead time of about 15 years to bring a new mine online, supply is likely to undershoot demand. That could replicate the dynamic seen in global energy markets, where years of underinvestment have left producers ill-equipped to compensate for a drop in renewable power output. The looming shortages of metals are forcing miners to reconsider investing in riskier jurisdictions, with BHP considering buying into a project in the DRC. The world’s biggest miner has become more receptive toward riskier operating environments for growth projects that offer access to the best mineral deposits. Exploration budgets in general are slowly coming back with copper exploration being on the rise but the industry may need greater assurance that the market can hold at high levels before meaningfully expanding budgets. Producers have adopted a cautious approach after being squeezed by years of low prices at a time that deposits are getting trickier and costlier to find and develop. Overall mining exploration spending this year is still a little more than half the all-time high of 2012. Activity is expected to rise about 10% next year, as drilling increases for gold, copper, and battery metals, before plateauing in 2023 and declining in 2024, according to S&P.
Gold posted a monthly gain in October even as central banks globally prepare to rein in pandemic-era stimulus. There have been some recent signs of investor interest in gold ramping up. By the end of the month, hedge funds trading the Comex boosted their net long position the highest in 12 weeks, while exchange-traded funds had modest net inflows, snapping five weeks of outflows. According to analysts, rapid tightening cycles and unbalanced recoveries could trigger demand for gold over the coming quarters. Gold’s traditional role as a hedge against inflation has faltered all year but growing risks that the global recovery could stall as price pressure rise may signal turnaround for the precious metal. Energy shortages in some parts of the world, an associated sharp rise in energy prices, slowing industrial activity, and the delta variant disrupting the services recovery have raised the specter of stagflation. Indeed, inflation expectations are rising and growth expectations softening for the short run. According to UBS, these risks could support gold prices in the next month or two, particularly if concerns about stagflation persist—historically, gold has performed well during periods of stagflation. When most economists and investors talk about stagflation, they typically refer to the early 1970’s and then from 1975 to the very end of 1979 with the “Oil Shock”. During these two periods, gold prices rose +200% and +325% in nominal terms respectively and rose considerably in real terms as well. On the company side, Impala Platinum Holdings is in talks to buy its smaller rival Royal Bafokeng Platinum, in a deal that Implats said may create South Africa’s largest platinum-group metals producer. Flush with cash after higher rhodium and palladium prices, the company is seeking to expand by buying lower cost and mechanized assets as some of its deep-level operations near their end. A deal would help the producer exploit synergies from deposits adjacent to its sprawling Rustenburg mining complex. It should also extend the life of the mines and end royalties that Implats was paying to Royal Bafokeng. Stricter car-emissions rules have kept palladium and rhodium, key metals in autocatalysts, in tight supply and at historically high prices, increasing earnings for mining companies. Implats in September reported a record profit, prompting it to boost its dividend. Also, Sibanye Stillwater’s deal in October to pay $1 billion for nickel and copper mines in Brazil shows how miners are looking to use cash to expand. After buying up PGM assets from Zimbabwe to North America, Sibanye is now looking toward battery metals needed for a green revolution. The precious metals champions metals fund holds a stake in all of the three mentioned companies.