The result is a challenged outlook for global growth – even in the US where a high frequency GDP tracker monitored by the Federal Reserve is now pointing towards increased risk of zero growth in the second half, potentially resulting in a technical recession which occurs when growth turns negative in two consecutive quarters. In addition, the World Bank this past week slashed global growth, warning of 1970’s-style stagflation.
These developments have naturally raised the question of when the phenomenal rally in commodities since the 2020 Covid bottom will pause. Under normal circumstances, elevated commodity prices tend to drive a response from producers in the shape of rising production, which eventually would support lower prices through increased supply. In addition, the prospect of growth and demand slowing would normally solve the problem of high prices.
The reasons why, in our opinion, we may not see these market reactions play out are driven by several factors – the most important being a reduced focus on investment from major producers of energy and metals. Other factors include sectors seeing some producers close to being maxed out on production, demand towards the green transformation, ESG investor and lending restrictions and increased focus on reducing dependence on Russia – a country increasingly seen as untrustworthy.
Crude oil trades near a three-month high, with the front month contracts of WTI and Brent both trading above $120 per barrel. The recent upside extension is being driven by China’s latest attempt to reopen major cities following Covid-19 lockdowns, a development which is likely to increase demand from the world’s biggest importer at a time where the global supply chains remain stretched due to the war in Ukraine. In addition, the OPEC Secretary-General said most members are ‘maxed out’, a comment that helps explain why the recent OPEC+ decision to raise production by 50% was ignored by the market in the knowledge the group (already 2.5 million barrel per day below target) will continue to struggle raising production.
In its monthly Short-Term Energy Outlook, the US Energy Information Administration left 2022 production unchanged at 11.91m b/d, in line with current levels, while boosting next year by 120k b/d to 12.97m b/d. In addition, they warned Russia’s production could drop by 18% by the end of next year. Refineries across the world are running at close to capacity to replace sanctioned barrels from Russia, and with supply being this tight, prices will likely need to go higher in order to kill demand, thereby supporting the painful process towards balancing the market.