Commodities Update - Week Ending 26 June 2022

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Macro Pivots

Tightening Supply

European Emergency

Ukraine will withdraw its troops defending Severodonetsk, the embattled eastern city that is the locus of Russia’s war effort. The withdrawal comes after weeks of Russia massing artillery fire in eastern Ukraine, after narrowing its earlier war aims of seizing the capital city of Kyiv.

That being said, Ukraine’s loss of Severodonetsk and Lysychansk “will not represent a major turning point in the war,” as said by the Institute for the Study of War (ISW), a Washington-based think tank. Furthermore, the narrative that Russia’s military resources are continuing to run dry continues with Russia’s reported deployment in Ukraine of retired military personnel who are now private contractors suggesting?it?does not have enough trained service members, according to the British Defense Ministry.

On Thursday, the European Union decided to grant Ukraine membership candidate status — a first step in a lengthy process, but a move President Volodymyr Zelensky nonetheless welcomed as “historic.” U.S. Secretary of State Antony Blinken is in Berlin, where he will join talks on food security — an issue that has been exacerbated by the war in Ukraine and Russia’s blockade of key ports.

Sanctions

The table on right details all current sanctions. New developments are bolded. Note that the list is not exhaustive.

The US, UK, Japan and Canada plan to announce a ban on new gold imports from Russia during a summit of Group of Seven leaders that’s getting underway Sunday. Shipments between Russia and London have already collapsed to almost zero since western countries imposed sanctions on Russia for its invasion of Ukraine. The?London Bullion Market Association, which sets standards for that market, removed Russian gold refiners from its?accredited list?in March. As such, the ban simply formalize what the gold industry has already done.

Depending on when you read this update, Russia is hours away from or has technically defaulted on its debt. A grace period on about $100 million of missed bond payments -- blocked because of wide-ranging sanctions -- ends on Sunday night. There won’t be an official declaration, and Russia is already disputing the designation, but if investors don’t have their money by the deadline, there will be an “event of default” on Monday morning, according to the bond documents.

Trade Flows

Oil Flows

Total Russian crude oil loadings came in just above seasonal average. Russian loadings towards Europe continued to sink to new seasonal lows of 1.9 mmbpd vs. seasonal average of 2.8 mmbpd. Appetite from India and China remained strong at new seasonal highs of 1.6 mmbpd vs the seasonal average of 0.6 mmbpd.?Russia has now overtaken Saudi Arabia as China’s top oil supplier.

Gas Flows

The International Energy Agency (IEA) has warned that?Russia could cut gas supplies to Europe entirely?in order to boost its leverage against the West following Moscow's invasion of Ukraine. Russia has severely restricted gas flows to Europe in recent days. The Kremlin blames a delay in servicing equipment caused by European Union sanctions, while Europe accuses the Kremlin of playing geopolitics.

11 European countries are beginning to or have taken measures?to manage gas supply and even ration power in case Russian gas flows stop after?supply through the Nord Stream 1 pipeline were curtailed. Most have declared a?state of emergency.?Norway has already responded by agreeing to increase gas supply to the EU.

The?uncertainty is already starting to eat in sentiment?with?German business confidence taking a big hit. Munich-based Ifo Institute president commented that “The likelihood of a recession is clearly increasing… There’s a lot of pessimism about the gas situation...?But if Russia does reduce gas supplies further, what our forecasts say is that we will get a recession, but in 2023 -- not before that”.

Note that Germany will cut supplies in this order:?Companies with so-called “interruptible contracts” would be the first to see their gas supply cut if rationing is enforced, followed by gas power plants that are not essential for grid stability. Next in line are large industrial customers, which accounted for about 37 percent of the country’s gas demand in 2021.

Agricultural Flows

Infrastructure owned by two major agriculture traders was damaged in Russian attacks at one of the biggest crop-handling ports in Ukraine. Agricultural trader Viterra’s terminal and one of Bunge Ltd’s facilities were struck. Infrastructure damage risks prolonging the loss of Ukraine’s agricultural supplies on global markets, which has accelerated global food inflation this year.

With Ukraine's seaports blockaded or captured by Russian forces, neighboring Romania's Black Sea port of Constanta has emerged as a main conduit for the war-torn country’s grain exports amid a growing world food crisis. But?port operators say that maintaining, let alone increasing, the volume they handle could soon be impossible without concerted European Union support and investment. The solutions discussed in Kyiv, Romanian president Klaus Iohannis said, included speeding up Danube barge shipments, increasing the speed of their unloading at Romanian ports, new border crossings for trucks with Ukrainian grain and reopening a decommissioned railway linking Romania with Ukraine and Moldova. Nothing concrete has developed yet.

Green Wave – Structural Underinvestment

Years of underinvestment in exploration and production continue to haunt the global economy. World rig count pushed higher in May 2021 with much of the increase from the Middle East and the US. There are some encouraging signs at least, with the decline in DUCs in the US slowing down precipitously as we see new drilling activity catching up to well completions.

OPEC

OPEC and allied producing countries including Russia will likely stick to a plan for accelerated oil output increases in August, sources said, hoping to ease surging oil prices and inflation pressure as U.S. President Joe Biden plans to visit Saudi Arabia and the Middle East.

KPC's chief executive Sheikh Nawaf Saud al-Sabah expressed confidence that?Kuwait can hit its Opec+ crude production target for July and will be able to meet any further increases requested of it?and Nigeria?hopes to meet its Opec+ production quota by the end of August, on the back of efforts to stabilise regional security. On Nigeria, Shell, Chevron and ExxonMobil have all?committed to additional offshore investment, while simultaneously seeking to?exit their onshore positions.

Iran

EU foreign affairs representative Josep Borrell is now in Tehran as the?bloc steps up its diplomatic efforts to restart talks?between Iran and the US to revive the 2015 Iran nuclear deal. Iran said Thursday that it remains "serious" about reaching a revived nuclear deal?with major powers that ends economic sanctions and to which the United States is again a party, having?dropped its condition that the Iranian Revolutionary Guard Corps (IRGC) be dropped from Washington's list of terror groups?in return for sanctions relief.

Non-OPEC

Upstream

Germany is pushing for Group of Seven nations to walk back a commitment that would halt the financing of overseas fossil fuel projects by the end of the year, according to people familiar with the matter. That would be a major reversal on tackling climate change as Russia’s war in Ukraine upends access to energy supplies.

For all the recent tension between the Biden administration and the sector, oil?and natural gas heavyweights emerged from a summit with Energy Secretary Jennifer Granholm using words such as “constructive” and “optimistic” to size up talks aimed at boosting production?in the face of tight global supplies. Energy Workforce & Technology Council CEO Leslie Beyer said “The?industry is doing its job?to increase production and refining?as capacity allows,” and that Biden “must?open more federal lands and waters for production,?invest in energy infrastructure,?encourage Wall Street investment?in oil and gas,?streamline the permitting processes?and?expedite approvals,”.

At the JP Morgan Energy Conference in New York, Olivier Le Peuch, chief executive of top oilfield firm Schlumberger (SLB.N) said that?spending in the global oil exploration and production industry is "poised to accelerate broadly" and drive an increase in output. Schlumberger is looking at the?offshore oil sector as a major driver of growth, pointing to an expected 50% increase in offshore investment over the next four years, compared with the period from 2016 to 2019.

Midstream

The German economy ministry is considering?expropriating the part of the Nord Stream 2 pipeline system?located on German territory and cutting it off from the rest of the pipeline converting it into a connection for a liquefied natural gas terminal on the Baltic Sea coast.

Algeria, Niger and Nigeria held talks this week on the?revival of a decades-old project to pipe gas across the Sahara, a potential opportunity for Europe to diversify its gas sources. The Trans-Saharan gas pipeline is an estimated $13 billion project that could send up to 30 billion cubic metres a year of supplies to Europe.

Downstream

President Joe Biden on Wednesday called on Congress to?suspend federal gasoline and diesel taxes for three months?— an election-year move meant to ease financial pressures that was greeted with doubts by many lawmakers. After all, it doesn’t solve the root cause that is inadequate supply growth.

Demand Uncertainty

COVID in China

COVID in China looks to be largely under control.?Beijing on Saturday said it would allow primary and secondary schools to resume in-person classes and Shanghai’s top party boss declared victory over Covid-19?after the city reported zero new local cases for the first time in two months. The number of provinces with cases in the past 7 days have continued to hold relatively stable.

China also appears to be quietly easing into a pivot away from zero-COVID with at?least eight cities in China (Nanjing, Wuxi, Changzhou, Beijing, Wuhan, Chengdu, Xiamen, and Ningbo) cutting quarantine times for international arrivals?from 14 to 10 or seven days. There were no noteworthy developments regarding China’s mRNA vaccine efforts this week.

Raging Inflation in the West

While a full recovery in Chinese demand would bode well for commodities, the tight commodity complex is already resulting in record high inflation which could result in a negative feedback loop into demand. Europe is hardest hit as they bear the first-degree brunt of debilitating sanctions on Russian energy.

Bonds rallied into the close this week but the uptrend in yields remain intact as persistent inflation continues to haunt the global economy.

Rate hike expectations took a nosedive following the 75 bps hike on heightened recession fears.

Powell himself admitted that a soft landing would be “very challenging” and a recession is “certainly a possibility” though he did not see the likelihood of a recession as particularly elevated right now. With the market beginning to price in easing in Q2 2023, further confirmation of this should prove to be strong support for gold prices going forward.

Looking Forward

No change in our forward views for now.

Persistent inflationary forces from broad tightness in the commodity complex as well as supply chain bottlenecks threaten the economic recovery from pandemic-related reopenings

We do not see any likely relief valve to the tight energy complex other than sanctions on Russia or Iran being lifted. The former is almost an impossibility and in fact, has the potential to be exacerbated even further if sanctions were to spread to gas flows. The latter is unlikely at best for the time being. With systemic underinvestment in exploration and production, and inflation raising the breakeven costs of new wells, we believe insufficient supply growth will continue to be structural in nature until we see a meaningful shift in CAPEX activities by producers.

As such, we believe much of the delta going forward will stem from divergences in demand. With inflation showing no signs of abating and consumer confidence tanking, demand in the back end of the curve will likely face some pressure. Meanwhile, China’s willingness to purchase cheaper Russian oil and gas as well as the availability of headroom for additional stimulus will likely mean that eastern demand will outperform western demand on a relative basis.        

-?Commodities Update - Week Ending 19 June 2022

Charts

Oil

OPEC

Work-in-progress.

United States

Crude

Gasoline

Diesel

Gas

Work-in-progress