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Commodity Weekly Analysis
Industry and commerce are facing several problems over the coming months, including a highly likely continuation in rising wholesale energy costs and the possibility of a colder than usual winter.
It has been well documented across the mainstream media that since the start of 2021 energy prices have risen. Looking at the front-month contract for Dutch TTF, a European natural gas benchmark, we see where the concern lays as the front-month contract has increased 400% this year to trade at €98, having started at a modest €20 in January 2021.
The main result of these extraordinary rises in global energy costs is that manufacturing is being slowed down, especially in energy-intensive industries such as any that process chemicals, and metals.
These higher energy costs and lack of supply also result in higher input costs for farmers, which is made worse with the recent decrease in the availability of CO2 for food production, and a shortage of fuel additives. Headlines were dominated by the CO2 shortage as it is used in the end-of-life process for a lot of livestock. A shortage of carbon dioxide could prevent the traditional British Christmas dinner from having its centrepiece this year. CO2 is used when removing the air from the turkey bag by blowing carbon dioxide into it, which also acts as a bacteria growth suppressant, which extends the shelf life.
Assuming we get through the winter with no unexpected disruptions, which will include a rising COVID-19 variant disruption, there is light at the end of the tunnel for rising energy prices. Already we have heard from Russia who have stated they can, and will, supply more Natural Gas. The Nord Stream 2 is primed ready to deliver. Traders have already started pricing in a 50% drop in the Dutch TTF Ice Endex futures contracts through Q2 2022 which is partly seasonality but also on the possible increase in supply.
It has been reported that natural gas inventories are still 5% below the seasonal norm, and overall energy prices remain vulnerable to tight markets. Natural gas prices in the US are expected to fall over the next three months having possibly overshot to the upside. On the downside for the economy analysts also predict natural gas prices in the US could double, and oil prices could increase by 5% if the winter is just one standard deviation colder than usual so we could see some multi-year highs still.
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The crude markets are slightly lower today amid recent reports of rising US crude stockpiles and an uptick in production. Later this afternoon we receive the Energy Information Administration (EIA) inventory numbers. The market is expecting the EIA report to show a build in crude stocks by around 1.85 million barrels.
Higher energy prices and a break in the weather have enabled US producers to restore production to its pre-Hurricane Ida level. For the week ending October 8, the EIA estimated oil production in the United States at 11.4 million barrels per day, down 100,000 barrels per day from pre-Ida levels. Despite this, there are signs that the US shale producers are back in action as US crude prices rise above $80/bbl for the first time since 2014 support the higher costs of shale producers. In the latest drilling report, production from the seven major shale formations is expected to increase by 76,000 barrels per day to 8.29 million barrels per day.
US oil rig count rose to 445 last week, which is the largest increase since April. The stronger price of oil has forced producers to complete their backlog of unfinished wells and the latest Drilling Productivity Report from the EIA shows that the US had 5,385 drilled but uncompleted wells (DUCs) in September 2021, the lowest since February 2017 and down from nearly 8,900 at its 2019 peak. As old wells become less efficient these new completed wells will pick up the production.
EIA forecasts that total US crude supplies will average 11.59 mbpd in 1H22, up from 11.5 mbpd in its previous estimate. Over the course of 2022, US crude production will expand by 710,000 bpd, which is a sharp increase compared to this year. This projected increase in US oil production will still not be enough to stem rising crude prices or fill the global short fall, this ultimately relies on OPEC+.
There is a growing demand issue though concerns about Chinese growth and falling industrial output in Japan and the USA, are taking a back seat to fuel shortages during the seasonal demand increase. But if supply does increase and the winter months are quite mild, we’re then left with the possibility of dealing with decreasing demand. The US GDPNow model from the Atlanta Fed is showing that US GDP could be 0.5% which may as well be 0% considering it has fallen from 6% in the last 3 months.
The ActivTrader sentiment indicators for Nat Gas and Brent oil could be the easiest way to decide on a trade selection. Currently the NGasNov21 contract is extremely bullish on the sentiment indicator as prices are falling, possibly to do with the supply coming on stream as discussed earlier. Whereas the Brent contract is extremely bearish on the indicator which to a contrarian like myself suggest that the lack of OPEC+ supply increases is likely to see these traders get squeezed out of their short positions.
