Russia-Ukraine tension may give rise to a new commodity world order

The Russian invasion of Ukraine has the potential to establish a new commodity world order that tilts reliable supply toward North America, Bloomberg Intelligence says in a research note.

Analyst Mike McGlone argues that should oil and gas prices continue to spike amid the increased geopolitical tension, it could very well be the catalyst for a global recession.

“The conflict is unique, but in 2008, the severe risk-asset reversion was aggravated by a sharp rally in West Texas Intermediate crude oil to its peak around US$145 a barrel,” said McGlone.

The analyst believes the crude oil market will likely mirror past reversion patterns from elevated prices. Brent crude has dropped about 80% on three occasions since the 2008 peak. “It’s possible that Russia’s invasion of Ukraine triggers a global recession and accelerates electrification and decarbonization trends,” said McGlone.

According to Bloomberg, should prices sustain near end-of-February levels, it should be a boon for energy and agriculture producers. Crude oil and most grain prices are currently trending well above US production costs.

However, it becomes a question of sustainability of 2022’s elevated price levels, and the inability of copper to breach the US$10,000-a-ton resistance level may indicate similar reversion risks as 2008. “We expect the metal is sniffing out demand-destruction risks due to the potential for a global economic slowdown. If copper continues to back down, so should US Treasury bond yields, which would buoy gold if past patterns repeat,” said McGlone.

While a new world order is likely to shift liquid fuel flows (Russia to China) rather than cut supply, Bloomberg is more confident that North American producers are gaining “plenty of impetus.”

According to McGlone, commodities have proved their value as a portfolio hedge in 2022. However, they risk a similar ebbing-tide outcome as in 2008. In his view, precious metals are gaining the upper hand in 2022.

“Strong industrial metals at the start of 2022 risk reversion in-step with crude oil and set the stage for gold to breach US$2,000 per oz. resistance. Copper’s inability to breach last year’s highs along with the US Treasury long-bond yield may indicate a bigger slog of risk-asset underperformance necessary to alleviate inflation,” he said.

Markets may be facing an extended risk-off reversion period, which Bloomberg views as essential to reduce inflation pressures. Gold stands to be a primary beneficiary, potentially with US Treasury long bonds and Bitcoin.

The flattening US Treasury yield curve, China in decline and a gold-to-copper ratio at “good support” may tilt performance toward the precious metal. Up about 4% in 2022 to February 23, gold is in the early days of resuming its enduring uptrend versus copper.

Despite sharp rallies in some industrial metals such as aluminum and nickel, fueled by Russia-Ukraine tensions, copper is up less than 2% in 2022 and hasn’t been able to sustain above the critical resistance level.

“To outpace gold’s tendency to appreciate in terms of fiat currencies with unlimited supply, copper needs outsized demand from China, which we see as mostly past tense,” said McGlone. “The metals sector is well poised for enduring outperformance versus most commodities as spiking energy will incentivize supply and accelerate decarbonization trends.”

Meanwhile, market analysts at Wood Mackenzie are tracking spiking coal prices.

Buyers in markets including Europe, Japan, South Korea, and China are scrambling to address their exposure to Russian supply. Although sanctions announced to date have expressly excluded energy exports, coal buyers react to two main areas of concern.

One is performance – will Russian coal actually be delivered? Russian metallurgical coal producer, KRU, had already declared force majeure on cargoes to Western Russian ports before the escalation of the Russia-Ukraine crisis due to a deterioration in rail transport availability.

Some other major Russian coal producers are also rumoured to have declared force majeure on shipments due to rail delivery delays.

The second concern relates to counter-party risk. Financial restrictions on Russian banks and other entities may prevent some buyers (and their banks) from trading with Russian suppliers. Add to this the concern that sanctions could be expanded in the future, and the impact on coal markets is hardly surprising.

“European thermal coal prices have surged to record highs with futures prices above US$400 per tonne until Q4 2022. Some buyers in Japan and Europe have already indicated they are looking to replace Russian supply, and non-Russian thermal coal in Europe is attracting a significant premium over Russian material,” said principal analyst Rory Simington in a press note.

“Prices in the Asian market have also responded with Newcastle physical prices reaching US$400 per tonne. Metallurgical coal, used in coke production and injected into blast furnaces, spiked with PCI prices – a key Russian export – leaping to an unprecedented level and nearing towards US$400 per tonne.”

However, Woodmac expects relatively normal import activities would remain the most likely outcome. Together, Europe, Japan and South Korea imported around 90 million tonnes of Russian thermal coal and 25 million tonnes of Russian metallurgical coal in 2021. These coals are predominantly high-energy thermal coal and PCI and cannot conceivably be replaced in the currently tight global supply market, in Woodmac’s view.

Further, power plants are specifically designed to run on a high-energy coal and cannot switch coal types. Steel mill operators would be challenged to replace Russian PCI and met coals given the current global spot supply shortages, especially out of Australia.

Conversely, Woodmac believes Russia would not be able to quickly make up for a loss of European demand by pivoting to Asia (China) due to limited eastbound rail capacity.