ICG Commodity Update – September 2023
The ICG Commodity Update is our monthly published comment on the energy, industrial metals and precious metals market.
Crude oil prices posted its largest quarterly rally since the initial shock caused by the conflict in Ukraine. The markets are currently grappling with the impact of OPEC+ production cuts, which are resulting in tightening conditions for the foreseeable future. In fact, Russia is selling its oil to India at $80/bl, which is roughly $20 higher than the Western price cap. This price premium can be attributed to the tight global oil market dynamics, as reported by Reuters. In the United States, stockpiles at the Cushing hub have dwindled to critically low levels, particularly affecting refinery markets. This tight supply situation is having a direct impact on consumers at the gas pump. Indeed, oil demand growth has outpaced the increase in refinery capacity since 2021, and this will continue through 2027, according FGE. Global refinery processing rates this year are near record highs. Russia just decided to halt diesel exports next month in order to reduce domestic prices. The move sent European diesel futures prices higher again. Although some analysts say oil prices could soon hit $100/bl, US shale companies are not rushing to increase drilling activities. In the Permian Basin the number of rigs drilling for crude declined by about 12% to 314 since the end of April, according to Baker Hughes. Exxon cut its working US drilling rigs down about two this year to 17, well below the 65 it had running before a pandemic-induced oil downturn in 2020. Many oil executives anticipate that most shale companies will continue with their current strategies, even as global oil prices rise. These companies have committed to returning their profits from high energy prices to investors through share buybacks and dividends, all while facing challenges from inflation and high interest rates. Nonetheless, the US remains an oil and gas superpower. Rystad forecasts that American crude production is on track to hit a record 13mboe/d in September. However, the industry’s recovery from the pandemic was relatively slow as it last achieved this production level in November 2019. On another note, there are reports suggesting that Saudi Aramco is planning on a secondary offering to raise as much as $50bn by the end of this year. While this is speculative, such a move could put pressure on the nation to support higher oil prices for an extended period to bolster the success of the offering.
Recently, industrial metals from copper to iron ore slumped as investors reacted to the ongoing weakness in China’s property sector and inflationary pressures that could keep global monetary policy tighter for longer. With some of the Chinese economic uncertainty concerns that dominated in the third quarter of 2024 easing, analysts have seen some signs of improving sentiment returning to the base metals sector. Looking at China’s renewable generation capacity installed to date, a trend which could replace or exceed potential demand weakness in real estate, installed solar and wind capacity is up 134% year-over-year in the first eight months, representing 71% of the 200GW targeted for the full year – China appears to be on a good track to achieve or even surpass its renewable energy targets this year. Looking at Copper, prices have been under pressure since they peaked in January as global monetary tightening hurt the outlook for demand. Copper stockpiles immediately available to withdraw from the world’s top metals bourse hit the highest in almost two years – that’s a sharp turnaround from just three months ago when stocks fell to critically low levels. China’s CMOC Group shipment of its previously stranded copper stockpiles in the DRC has contributed to rising supply on the market, according to market participants. For mining companies, the last two quarters of the year are typically a stronger period for production. Analysts are seeing an even more exaggerated than usual H2 weighting this year for many miners – achieving expectations for the second half of the year should help underpin stronger financial results and could provide a tailwind into year-end. Further, companies have strong balance sheets and continue to prefer pursuing selective and generally lower-risk growth options with strong cash flow for shareholder returns. All in all, Bloomberg calculates that mining majors are currently pricing in a 5-10% pullback in commodity prices, despite having rallied about 7% off a mid-August low. This may provide some protection if prices cool for raw materials. More recently, the union of supervisors at Chile’s Escondida copper mine, the world’s largest, rejected a contract offer from mine owner BHP, paving the way for another strike. The proposed contract was rejected with 99% of the vote according to the union which counts over 900 members.
Investment demand for gold waned as SPDR Gold ETF holdings, the world’s largest gold-backed ETF, plummeted to their lowest levels in four years. High US yields and a strong Dollar continue to act as headwinds against the metal as investors see the US Federal Reserve sticking to its high-rate regime for a duration longer than previously expected. Gold and the U.S. dollar often have an inverse relationship. When the dollar strengthens, the price of gold in dollars typically falls, and vice versa. This inverse correlation is because gold is priced in U.S. dollars worldwide. When the dollar rises in value, it takes fewer dollars to buy the same amount of gold, leading to a decrease in the gold price. There are hopes of significant physical demand from key market drivers like India and China though. Due to anxiety over the economy, there are reports of a surge in gold demand from China. Although gold has been under pressure in recent weeks, cash flows from precious metals producers remains strong as metals prices remain elevated – historically speaking. Adding to the optimism, inflation brought on by the pandemic appears to have peaked. Amongst smaller producers and developers, the removal of logistic challenges has expedited project advancement and is helping to reduce the backlog of maintenance. This has resulted in a progressive increase in production coupled with lower operating costs. This trend is expected to continue into 2024. In general, the industry has had a lower-than-expected appetite for M&A, with investors preferring companies looking to streamline current portfolio or divestment of non-core assets. Looking at PGM equities, the sector has had an underwhelming 2023 so far. Given that South Africa is a major player in the PGM market, most PGM producers have been impacted by several operational challenges including power supply disruption, strikes, and logistical challenges. However, the biggest impact to PGM producers’ performance has been driven by the collapse in palladium and rhodium prices. Continuing PGM supply challenges from South Africa and Russia (due to sanctions) are expected to be supportive of PGM prices alongside stronger than-expected light vehicle production data so far. Some analysts see a potential rebound in PGM prices, but the market hasn’t seen a sustained move upwards yet.