Commodities pare gains as Russian energy market avoids sanctions

Markets were volatile in response to the news from Ukraine. Gains earlier in the week were pared back as commodities were spared direct sanctions.

The fears of supply disruptions following Russia’s invasion of Ukraine waned on Friday, but the energy sector remained on edge given the evolving nature of crisis. The US State Department confirmed our initial thoughts that disruptions to crude oil supply is unlikely. The department’s senior energy advisor, Amos Hochstein, warned that sanctions may only curtail Russian exports by half. This could be offset by the doubling of prices, ultimately having very little impact on Russia. In the meantime, high gasoline prices would hurt US consumers. After trading as high as USD105/bbl in the immediate aftermath of the incursion, Brent crude oil fell back below USD100/bbl. US President Biden said that any potential restrictions on currency clearing would also include carve-outs for energy payments. He said the US is working with other major consuming nations on a coordinated reserves release. Crude oil buyers remained cautious, with Russia’s flagship Urals grade trading at a discount of USD11.60/bbl, the deepest in 11 years. The shipping industry is also ensnared in the conflict. Merchant ships have been reportedly hit in the Black Sea. Insurers have subsequently refused to cover vessels in the region or are demanding huge premiums. Russia’s Black Sea oil port of Novorossiysk handles around 2mb/d.

European natural gas futures also gave up Thursday’s initial gains. With spot prices surging to record highs, utilities started ordering more gas under long term contracts with Gazprom which was significantly cheaper. The threat of further restrictions on Russian entities hastened their efforts to secure supply while they are able. Gazprom reiterated that gas transit via Ukraine is running as normal and is increasing in line with customer requests. The Ukraine is a transit route for several of Russia’s gas flows into the continent. Even so, flows have consistently fallen in recent years. Of the 155bn m3 of gas piped to Europe from Russia in 2021, 40bn m3 went via Ukraine. Military escalation there could disrupt that supply (see article linked above). North Asian LNG future followed European gas lower on Friday, with the Japan-Korea Market futures for April falling back below USD30/MMBtu. Europe’s ability to import more LNG may also be constrained. Western Europe’s regasification capacity was already operating at 100% in January, which suggests there is limited capacity to accommodate a future increase in import volumes. Southern Europe has some spare import capacity but is unconnected to the north.

Aluminium and nickel led the base metals sector lower on Friday as the sanctions against Russia proved less severe that initially feared. Still, risks to supply from energy hungry smelter remains high, with electricity prices at elevated levels. There are also concerns that sanctions against Russian banks may impact physical commodity markets. Russia is the world’s third largest producers of aluminium and nickel. It also supplies 10% of USA’s total aluminium imports. Demand for safe have demand also waned, with gold prices extending their declines on Friday. Meanwhile Fed officials signalled they remain on track to raise interest rates next month despite the conflict.

Iron ore appeared un-impacted by the conflict. This is despite Ukraine exporting 38m tonnes in 2021, which is 2% of global trade. However, prices were under pressure following weaker than expected construction demand in China. Mysteel estimates the restart rate of construction firms was down 17%?y/y following the Lunar New Year holiday.