Crude oil around $95 a barrel represents its highest level since August 2014 – a 7.5-year high. We know that markets hate uncertainty, and markets especially hate uncertainty with respect to the oil sector, given that it is remains the lifeblood of the world economy, in terms of transportation and industry of all descriptions.
Of course, this uncertainty relates to Russia-Ukraine political tension, but we must remember that these tensions have played only a more recent role with respect to escalating oil prices. Oil prices have been on a roll ever since their pandemic lows below $20 a barrel just under two years ago, and that has been driven by recovering demand and restricted supply chains.
We’re now at the point where world oil demand is set to eclipse pre-pandemic consumption levels, but supplies are under more strain as OPEC+ struggles to meet quotas and US shale production remains below pre-pandemic levels.
So, while markets are naturally focused on diplomatic tensions that could artificially push crude prices higher very quickly, we shouldn’t lose sight of the fact that it isn’t just about geopolitical tensions– oil is benefitting from very strong demand-supply fundamentals.
This is relevant because of what might happen next with respect to Russia. Currently, there’s probably a $5 – $10 barrel risk premium factored into the crude price, which means that even if the situation is resolved, oil is likely to be well supported around the $85 a barrel mark in the short-term, which is where it was trading prior to the flaring up of political tensions.
So where to now for oil prices? Well, it depends on what eventuates with respect to the Ukraine-Russia standoff. The worst-case scenario could see western sanctions imposed on Russian oil exports, taking output from the world’s third-biggest producer off the market. This would almost certainly see oil surge through the $100 a barrel mark and potentially beyond $120.
Financial markets are already spooked by inflation at 40-year highs in the USA, and so the ongoing escalation in crude prices will be worrying politicians and central bankers around the globe, as we head into the worst of the northern hemisphere winter.
The West therefore must weigh up the risk-reward scenario of implementing potential sanctions on Russian oil production, versus the impact those sanctions will have on world oil prices, inflation and the global economy.
Irrespective, due to robust demand-supply fundamentals,elevated oil prices are here to stay in the near-term.
The other major commodity that is an important to the world economy is copper, with consumption levels far greater than the other industrial metals, and it too is faced with its own supply-side problems.
These supply-side concerns have not yet translated into significant price action, as after a 26% rise during 2021, copper prices have so far struggled for direction this year. But things could change if supply-side worries don’t resolve themselves soon.
These supply-side worries relate to available copper metal that is available for delivery and stored in warehouses. For example, copper inventories on the London Metal Exchange have fallen to their lowest levels since 1974. And it’s a similar story on the world’s other major metal exchanges, with just ~200,000 tonnes of available inventory officially held by the LME, Comex and the Shanghai Futures Exchange.
To put this into perspective, this inventory barely covers three days’ worth of global consumption. Copper therefore, like all LME industrial metals, is trading in a situation of backwardation – which is where prices for near-term metal delivery are higher than those for later delivery. Not surprisingly, cash premiums for immediate copper delivery on the LME have hit an all-time high.
So, it’s reasonable to expect upside pressure on copper prices over the coming weeks and months, as buyers continue their search for physical metal.
The current gold price looks robust, although a potential resolution to the Ukraine situation would no doubt lead to some profit-taking.
Nevertheless, the metal has performed solidly so far in 2022, trading pretty much above $1800 per ounce for the entirety of the year so far. Prior to the recent escalation of the Ukraine situation, gold has reached $1840 per ounce, which was largely driven by safe-haven appeal in the wake of inflation and interest rate uncertainty. The Ukraine stand-off has simply built another layer of risk premium into the gold price.
What’s also interesting is that during cycles of rising interest rates, gold tends to outperform other key investment types, like US equities and the dollar. We’ve seen this clearly over the previous four rate-rise cycles, so if history repeats, we’ll see upside in the gold price.