The commodity sector traded higher for a second week with strong gains in grains and energy more than offsetting another quiet week in metals, both precious and industrial. Overall, the Bloomberg Commodity Index headed for its best week in two months with grains, led by corn, surging after a US report showing U.S. farmers likely planted fewer acres than previously expected. In energy, OPEC+ supported another leg up in oil prices while gas prices continued higher across the world, most noticeable in Europe where tightness has increased the risk of a summer supply crunch. 

The rising cost of energy helped reignite inflation worries thereby potentially making it harder for central banks to ‘sell’ the transitory message which, following the hawkish FOMC meeting in mid-June, helped trigger a major gold correction. These developments probably help explain why gold managed a small bounce despite continued headwinds from a stronger dollar. 

Other markets traded calmly with stocks breaking higher while Treasury yields continued to drift lower amid a tsunami of liquidity supporting riskier assets while keeping a lid on yield developments, potentially until late-August when the annual Jackson Hole gathering of central bankers could provide some fresh input. With this mind, Friday’s U.S. jobs report was potentially the last report to trigger some volatility before traders and investors turned their attention to a well-earned break away from the markets. 

Gold suffered the biggest monthly drop in four and half years in June in response to the changed tone from the Federal Reserve with regard to its willingness to control inflation through higher rates. While real yields have traded quietly around pre-FOMC levels, it was the stronger dollar that helped trigger the June correction, but as July began gold managed to find a bid despite continued dollar strength. Possibly a reflection of a market where traders had by now adjusted their positions to reflect a more hawkish Federal Reserve, but also a market seeing inflationary pressures through the rising cost of energy, both oil and natural gas. So far, however, the bounce has been relatively shallow with a break above $1795 and more importantly $1815 needed to change the sentiment back to neutral from negative.  

Crude oil rose ahead of the monthly OPEC+ meeting in response to a price-supportive proposal from Russia and Saudi Arabia to increase production by 0.4 million barrels per day from August to December, while extending its supply management policy from April 2022 to the end 2022. An increase of this magnitude was less than the market had anticipated and if agreed would keep global markets artificially tight and ensure further price support over the coming months. 

However, while supporting the increase, the UAE, which has raised its production capacity since 2018 when the individual baselines were set, insisted on having its baseline lifted by 0.6 million bpd to 3.8 million bpd, thereby allowing them a unilateral production increase within the current quota framework. Especially the extension of the current arrangement to the end 2022 was a problem as it would leave 30% of the country’s capacity idle for longer than expected. WTI crude oil almost jumped 4% on the news of a smaller-than-expected increase before paring gains on the UAE objection. 

The continued rally in crude oil has to a large extent been led by WTI and as a result, its discount to Brent dropped to less than $1.5 per barrel. The reason being an ongoing and rapid slump in U.S. stockpiles. During the past four weeks, U.S. crude oil stocks, including those released from strategic reserves (SPR), have fallen by 1.15 million barrels per day, the largest rolling four-week decline going back to 1982. 

The problem is the lack of response from U.S. producers who, despite higher prices, have refrained from increasing production. Partly due to ESG, investor and lending restrictions, but also due to the fact that shale oil needs high deferred prices as a proportion of their production tend to get hedged six to twelve months out. Right now, the very tight market conditions have led to a very steep backwardated forward curve which basically means WTI in December 2022 trades close to 11 dollars or 15% below spot. A scenario that benefits most OPEC+ producers as they sell a vast majority of their oil-based on spot instead of the much lower forward prices.

European gas prices surged higher with the Dutch TTF benchmark rising to levels last seen in 2009. Since hitting a pandemic low in May last year at €3.6 per MWh, the TTF first month contract has seen almost a ten-fold increase to €35 per MWh. A combination of reasons has transpired to increase the risk of a supply crunch later this year. The main reasons being:

  1. Stock levels well below the five-year average;
  2. Above-average temperatures across southeast mainland Europe;
  3. Gazprom signaling no increase in supplies after opting not to book more capacity on the Ukrainian pipeline;
  4. Annual maintenance on two pipelines from Russia to Germany during July (Yamal and Nord Stream 1 );  
  5. Very little LNG coming into Europe as prices are even higher in Asia;
  6. Scheduled and unplanned outages affecting Norwegian gas supplies to Europe.

One of the side effects being higher coal and carbon prices. In addition, the TTF gas winter 2021 over summer 2022 has reached a record above €12 MWh on expectations that tight supplies will last into the winter month with limited prospect for storage levels receiving a boost before then. 

Gazprom and Russia’s unwillingness to increase supplies through the Ukraine pipeline system can potentially be viewed in the context of current geopolitical tensions, both related to Ukraine and the Nord Stream 2 pipeline currently under construction. 

U.S. traded grain futures staged a strong comeback this past week after two reports from the US Department of Agriculture raised the prospect for even tighter global supplies following the Northern Hemisphere harvest this autumn. The quarterly stock and annual acreage reports both came in lower than expected, and considering the U.S. is the world’s largest corn and second largest soybean producer, it highlights the risk to supplies at a time where weather developments remain quite volatile. 

The combination of lower planted acreage reducing the ability to replenish stocks, now at their lowest levels since at least 2015, will result in the market becoming even more weather-obsessed as changes up or down could still swing final production numbers by millions of bushels. Currently in the U.S., wet weather has hit parts of the farm belt while drought risks are rising in northwestern areas and Canada.

Why haven’t U.S. farmers responded to surging prices in recent months and gone all in to extract as much profit as possible following years of price disappointments? Perhaps the answer lies exactly in that, with farmers appearing to have become more disciplined in planting following a number of years with low prices and excess supply. In addition, the general commodity rally has also increased the cost of fertilizers and gasoline, thereby potentially deterring farmers from expanding sowings too far into marginal and less yielding areas. 

Ole Hansen, Head of Commodity Strategy, Saxo Group