Cygnet Commodity Market Update February 2022

Commodity Markets January 2022

Energy markets bounce back at the start of 2022, with volatility set to continue

Commodities markets ended 2021 on a mixed note, but bullishness returned in January 2022, despite a backdrop of weakness in equity markets and USD strength. Thermal coal prices led the way higher, with crude oil and natural gas prices also rallying sharply.

The turnaround in coal prices was dramatic. In Q4, prices were down 42%, but prices jumped 53% in January. One reason was that Indonesia – the world’s largest exporter – imposed a temporary ban on exports as it ramped up domestic requirements.

There were also reports about stockpiling of coal in Europe in response to Russia building up troops on the Ukrainian border. Russia supplies about 35% of European gas, and there are concerns that flows could be hampered by sanctions, forcing a move back towards coal.

China boosted its coal production in late 2021, but this was not enough to bring down prices, given the rapid growth in domestic power consumption. China’s coal production rose 7% y/y in December, but power consumption was up 10%.

Pursuing a green energy agenda is making China and Europe very vulnerable to power shortages arising from political shocks or unexpected changes in the weather.

Meanwhile, Brent oil prices rose by 16% in January, as a combination of resurgent demand and sluggish supply growth tightened the market once more. Oil demand growth was strong in Q4, with the IEA estimating an 8% y/y increase in November in the OECD area.

Lockdown measures are being lifted, and travel is rapidly normalising. Furthermore, some oil has been redirected into the power-generation market to tackle fossil fuel shortages. There is also upside potential for oil demand, given that it is still significantly below pre-pandemic levels for gas oil, gasoline and jet fuel.

Global Oil Market Balance

What has been surprising has been the limited response by OPEC to the latest rally in oil prices. The group had previously promised to keep raising production by 0.4mb/day every month through this year. However, three out of the past five months has seen the cartel falling short of this target due to technical issues and capacity constraints.

Recent weeks have seen both Nigeria and Russia struggling to boost production in line with quotas. Outside OPEC, Canada and the US were hampered in January by unusually cold weather. Estimates for OECD inventory levels for crude oil and products showed a drop to seven-year lows in late 2021, supporting the idea of higher prices.

The US will be a key factor to watch in the months ahead, as it is the world’s largest oil producer and still has spare capacity. Major corporates such as Chevron and Exxon Mobile are now generating large amounts of cash for stakeholders. Still, there is a reluctance to invest in oil, given the pressure from environmentalists and investors to avoid rapid growth in non-green energy units.

Rig counts are trending up, but only modestly. The US will probably boost supply by 5% this year, but this may not be enough to satisfy demand and rebuild depleted inventory levels, increasing the ability of the OPEC+ group to keep prices buoyant if it decides to do that.

Given the backdrop of strong demand and limited supply growth, the energy markets look set to remain high and volatile for the months ahead. Oil, in particular, looks very tight for the time being and remains highly vulnerable to supply shocks, given the limited buffers of inventory and spare capacity.

Dan Smith, Director – Special Projects