I had the opportunity to discuss the current situation with respect to some key commodities. Please click on the link below to access and watch the interview:
Whilst other sectors struggle in the shadow of China’s economic weakness and uncertainty over inflation and interest rates, energy is booming – whether it be uranium or crude oil. The key drivers are both immediate in terms of near-term demand, combined with the bigger picture around the need for longer-term energy security and independence.
Crude oil remains very well supported from a demand perspective, prices are up 20% YTD, which is only likely to intensify as we head into one of the key demand periods being the northern hemisphere winter. And it’s not just oil demand itself of course, but the price support that’s being provided by OPEC+ keeping a tight rein on crude supplies.
The current market shortfall will only get worse towards the end of the year, with estimates of a 3 million barrel per day shortfall during the final quarter of this year, which would represent the biggest shortfall in more than a decade.
The US has over the past decade represented the swing producer that the world could rely on to boost output to take pressure out of crude markets, but this is no longer the case. US shale producers have found it necessary to move away from the ‘barrels at any cost’ mantra that previously existed, as the cost of capital for well development has become more expensive. As a result, oil producers are channelling profits back to shareholders in the form of dividends, rather than boosting output for growth’s sake. This is reflected in reinvestment rates, which have been declining since 2017, mirroring a similar decline in cashflow from operations.
It’s a shift to maintaining, rather than significantly expanding, their production. This means US production cannot make up for the shortfall in OPEC+ production. There’s clear evidence of this with US production declining for three consecutive months, a 17% drop in drilling rigs over the past 52 weeks, and crude inventories at the nation’s biggest storage hub at Cushing, Oklahoma, now down to dangerously low levels of close to 22 million barrels.
Uranium prices are up 38% YTD and have reached their highest level since the Fukushima nuclear disaster in 2011, on the back of rising demand and a slew of supply challenges, with spot prices trading around $66 a pound, and futures even higher at around $73 a pound. Uranium fundamentals are the least exposed to China’s economic cycle and secular and cyclical challenges.
The rally has also been stoked by concerns over supply, with the recent coup in Niger disrupting shipments to European reactors, and key miner Cameco lowering its production targets due to challenges at its operations in Canada. The war in Ukraine has also upended trade flows from Kazakhstan, which accounts for more than 40% of global supply, and sparked efforts to ease reliance on Russian nuclear enrichment facilities.
At the same time the demand outlook is brightening, as governments re-embrace nuclear power to facilitate the shift away from fossil fuels. There have been unprecedented number of announcements for nuclear power plant restarts, life extensions and new builds, which in turn means that utilities are accelerating their purchases under long-term agreements, which are on track to exceed last year’s 10-year high. Increasing contracting from utilities, as opposed to financial entities, has been the primary driver for the rise in the uranium price year to date.
Copper, along with iron ore, is a commodity that’s highly correlated with China’s economy – and worryingly demand is slowing down at a time of the year when it usually picks up. Despite stimulus measures, end-user demand in China is muted. A quarter of China’s copper demand comes from construction, an industry that’s suffered due to the protracted crisis in the property market, whilst consumer goods account for 16%, another sector that’s suffered as Chinese households have conserved cash due to economic uncertainty. More aggressive stimulus from Beijing could change the equation, but over the longer term it’s likely that China’s economy will be consigned to a phase of slower growth.