The commodity roller coaster

A guest blog by Corinna Olearo, Head of Commodity Research and Price Risk Management, Nestlé

All opinions expressed are solely my own and do not necessarily reflect the views of my employer.

An exceptional year has just ended for the commodity markets (agricultural and energy) not only in terms of the price level, as several commodities reached levels never recorded before, but also in extreme volatility.

In February 2022, for instance, the price of Arabica coffee reached US$5,700 per tonne, not seen in the previous ten years. Similarly, the US corn, soybean, powdered milk, and natural gas prices have hit record highs for the past 9-10 years. Palm oil, wheat, European natural gas, and aluminium reached unprecedented levels between March and August 2022.

These markets peaked around mid-2022 and have started a downward trend. They have lost between 20 and 70 per cent of the value from the maximum recorded in 2022. Nevertheless, their valuations are still above the average of the previous ten years.

Have the drivers behind what some analysts named the “commodity super-cycle” disappeared? Let’s take a step back to analyse the factors that determined recent commodity price inflation.

An unexpectedly sustained demand

Although some of the inflation drivers were present before the Covid-period, the global pandemic was the main trigger for the increase in market volatility.

With the onset and rapid spread of the pandemic in the first quarter of 2020, expectations of a fall in global GDP wrongly led people to assume that there would be a fall in demand for essential goods. On the contrary, consumers in lockdown shifted their demand from the services they could not benefit from (tourism, restaurants) towards consumer goods. They also took advantage of the increase in savings and the various fiscal support programs promoted by different governments (for example, Brazil’s Bolsa Familia and the USA’s American Rescue Plan). A drop in demand was recorded only for those commodities linked to out-of-home consumption or travelling – and limited to the period of strict lockdowns.

Since mid-2020 and throughout 2021, there has been substantial growth in Chinese imports. The increase is due to several factors, including post-lockdown demand, the easing trade barriers between the US and China, and the willingness of the Chinese government to build strategic food reserves in a period of supply uncertainty.

Finally, we should mention the phenomenon of green inflation, which accelerated in 2020 as governments and private companies increased their commitments to reduce carbon emissions. The resulting policies directly impact demand for the raw materials related to renewable energy. These include metals to produce batteries or solar panels (aluminium, nickel, copper) or the various commodities used to produce biofuels (ethanol from sugar cane and corn, soybean oil, rapeseed oil, etc.).

A series of Black Swan events

A sequence of unprecedented shocks hit commodity markets in 2020-2021.

Lockdown measures limited the availability of labour, particularly immigrant labour. They significantly impacted the palm oil industry in Malaysia – the second biggest palm oil producer after Indonesia – where immigrants make up 80-90 per cent of the workforce.

Combined with the limited availability of labour, the unexpected surge in demand for consumer goods contributed to a global logistics crisis, impacting both land and maritime transport.

But the pandemic wasn’t the only problem. In March 2020, a container ship got stuck in the Suez Canal, which carries 12 per cent of global trade, blocking its passage for five days.

Finally, various extreme climatic events hit in 2021, reducing agricultural production. Brazil – the world’s leading producer of coffee, sugar, and soybeans – recorded its worst drought in a century. In July, the worst frost in twenty years reduced Brazil’s Arabica coffee harvest. Unprecedented flooding hit China and Europe in the summer, negatively impacting crops.

2022 – the expected market rebalancing was disappointing

The year started with high commodity prices corresponding to reduced stocks in various markets, but most analysts forecasted a progressive rebalancing of supply and demand. After all, high prices cure high prices! Instead, Russia’s invasion of Ukraine in February – the most unexpected event along with the pandemic – upset those predictions.

The Black Sea region accounts for 30 per cent of world wheat exports, 15 per cent of corn, 75 per cent of sunflower oil, 15 per cent of fertilizers, 9 per cent of aluminium, 12 per cent of crude oil and about 20 per cent of natural gas. Russia’s invasion of Ukraine led to considerable uncertainty about the availability of these raw materials, which provoked reactions from various countries that further reduced supply.

About twenty countries imposed restrictions on exports of agri-commodities in an attempt to control domestic inflation. Indonesia banned palm oil export for about one month. Another consequence was the worsening of the energy crisis in Europe – already underway since 2021 – which impacted global energy markets and, indirectly, agricultural production. Natural gas represents the main production cost of fertilizer and aluminium.

Finally, Europe recorded its worst drought in history, reducing the availability of energy resources (hydroelectric and nuclear energy) and raw materials.

What to expect for 2023?

It is as difficult to predict the course of the war in Ukraine as it is to make weather forecasts. Weather is the primary variable of energy, and food matters.

However, most market analysts expect commodity prices to experience a continuous and gradual decline during 2023. On the supply side, they expect production to increase thanks to the positive margins obtained by farmers over the past year, despite the increase in their production costs. They expect slower global economic growth, if not a recession in some countries, to limit demand.

In addition, the supply chain congestion triggered by the pandemic has been resolved thanks to the reduction in global demand. Finally, the dollar appreciation of the last two years should also result in lower purchasing power by non-US importers—most agricultural commodities trade in dollars.

 Main “known unknown”

Among the main uncertainties of 2023 are the consequences of the unexpected reduction of Covid control measures in China and the evolution of the European energy crisis.

China surprised most analysts by reducing Covid control measures in recent weeks. It is difficult to predict the consequences of the impact of this decision on the Chinese economy. There has been a sharp increase in infections, which has delayed an immediate return to tourism and restaurants reopening, which would positively affect commodity demand.

The European energy reference price (TTF) is currently at levels last seen before Russia invaded Ukraine. The European Union has accumulated high stocks thanks to the flow of Russian gas, albeit reduced by 50 per cent, and imports of liquefied gas from the United States. However, the European energy crisis is far from resolved. Cold weather over the next three months could reduce gas stocks, and the main question is the extent to which the European Union can rebuild reserves before next winter.

Since the end of August, Russia has almost stopped gas exports to Europe. The European Union may again have to compete with China for liquefied natural gas exports from the United States.

Opinions expressed are solely my own and do not necessarily express the views of my employer.

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