Energy price rally may spill over to other commodities

Most commodity prices increased this week. Optimism over electrification, which was a hot topic during LME Week, seemed to feed through into higher industrial metals prices. But the prices of energy commodities were the pick of the bunch. Brent crude rallied throughout the week and briefly breached $85 per barrel on Friday. OPEC’s monthly oil market report showed that output in September was still 390,000 barrels per day short of target. As prices rise, there are growing calls for higher OPEC production. But it seems doubtful that the group could raise output much faster, unless it abandons the current quota system. Meanwhile, a cold spell that has blown through China has compounded upward pressure on energy prices. That is in addition to the Chinese government allowing coal-fired power prices to rise by up to 20% from base levels from Friday. Looking to next week, China is set to publish its September activity and spending data and Q3 GDP on Monday. We suspect that China’s economy contracted in q/q terms. So far, commodity prices have largely shrugged off the slowdown in China’s economy. And we wouldn’t be that surprised if they continue to do so as currently elevated energy prices spill over to other commodity markets by substantially raising production costs of agriculturals and metals.
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Gas & coal surge to support other commodity prices

Natural gas and coal prices soared in September. In turn, this has raised the output costs of industrial metals, most notably those which are especially energy intensive such as aluminium and steel. At the same time, reports suggest that some electricity providers are starting to substitute natural gas and coal for oil. While we expect natural gas and coal prices to ease back from here, they are likely to remain high by past standards well into next year. Nevertheless, we doubt this will be enough to prevent industrial metals prices from edging lower in tandem with weaker economic growth in China.

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Commodity prices generally rose this week, but especially energy prices, which continued to surge on constrained supply, unseasonably high demand and low stocks. That said, we think the supply shortfalls will prove temporary and expect energy prices to come off the boil next year. By contrast, most metals prices were largely down this week, as Chinese PMI data indicated subdued demand. What’s more, those PMIs did not factor in recent power constraints. Weighing on all commodity prices this week was a strengthening dollar, with the US Dollar Index (DXY) hitting a one-year high. OPEC+ meets next Monday to review its output policy. We already forecast a large rise in OPEC+ oil production next year as the group winds down its earlier output cuts, but there have been growing calls for an even faster unwinding, which would weaken oil prices. Elsewhere, we expect stronger US non-farm payroll numbers for September (Friday), which would support commodity prices.

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Most commodity prices ground higher this week. And, stepping back, we think events this week highlight three key themes to watch in the months ahead. First, natural gas prices show no sign of easing back, and are likely to remain high until early next year. Prices continued to surge this week on the back of ongoing supply disruptions and unseasonably strong demand in Asia. And, even if both these tailwinds fade, a rebuilding of stocks from their current lows should continue to support prices. Second, the growing divergence between industrial metals prices and underlying demand could set the stage for a sharp correction before the year is out. Despite the weaker-than-expected activity data out of China, industrial metals prices were a mixed bag this week. Nonetheless, they still remain close to multi-year highs. And finally, calls for OPEC+ to fully unwind its output cut before the end of next year (as is currently planned) look set to grow louder. The Biden Administration has already called for this and China has announced crude sales from its strategic reserve in an apparent bid to stem the rise in prices. The main event for commodity markets next week will be the Fed’s FOMC meeting (Tuesday/Wednesday). While we expect the Fed will fall short of formally announcing tapering QE, they may prepare the ground for it at the meeting. A repeat of the June meeting’s hawkish surprise could set the tone and drive a dollar rally, which would weigh on the prices of all commodities but particularly on some of the precious metals, which have tracked the dollar closely this year.

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