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Commodities to price in new supply risks

Edward Bell - Senior Director, Market Economics
Published Date: 11 March 2022


  • Commodity markets will endure considerable volatility in the wake of the war in Ukraine. Geopolitical risk premiums will be needed across all markets, not just in energy.
  • Fundamentals will be in the process of rebalancing as markets find ways to accommodate the absence of Russian supplies thanks to restrictive sanctions placed on the country.
  • Oil prices in particular will show elevated volatility and will remain high. We now project an average of USD 112/b for Brent and USD 108/b for WTI in 2022.
  • Metals prices will also move higher thanks to security of supply concerns and changing risk appetite. Gold prices will be able to withstand in the near-term at least the impact of higher rates from the US.

The war in Ukraine has pushed commodity prices substantially higher as markets try to find the appropriate levels for  geopolitical risk premiums. Economies that have relied on secure and cheap sources of energy and raw materials will now need to value those supplies at a much higher level, even if only the risk of disruption hangs over them, rather than a material disruption to flows. We noted earlier in response to the war that energy prices will need to include a new geopolitical risk premium and that baseline prices will adjust upward for a new equilibrium in the market to be set. At present, oil markets and other commodities appear to be in search of those new balancing levels and with the enormous risks affecting markets the swings are wide.

In oil markets, prices have swung in a range of USD 27/b from highs to lows in the week of 7-11th of March. In the whole year of 2019, prices moved USD 22/b from bottom to top. Volatility is historically more of a defining characteristic of commodity prices than stability but the moves in the market at present are extreme and short-lived. This week’s gyrations were prompted by commentary from the UAE’s ambassador to the US that the country supported increasing oil production at a faster pace than the OPEC+ targets, although that view was quickly tempered by the UAE’s own energy ministry, while the US also announced its ban on imports of Russian oil and other energy commodities

How then can we set an oil price assumption among such wide swings in prices driven by a variable exogenous to conventional macroeconomic analysis, namely the war in Ukraine. We have little visibility over how the conflict will progress but in the near term, or the next several months at least, it shows little sign of de-escalating or returning to conditions ex-ante. Thus, oil prices will be high and they will be volatile. We assume Brent prices will oscillate in a wide range either side of USD 120/b, likely with more upside risks than downside, for three to six months. After that the trajectory for oil is even more uncertain but for now we would expect them to ease as balances begin to improve. That will bring our annual average price assumption to USD 112/b from closer to USD 80/b previously. For WTI the path is roughly similar with trading around USD 115/b for Q2-Q3 before easing off at the end of the year to bring the annual average to USD 108/b. We stress that these are assumptions that will be subject to market conditions and fundamental rebalancing, dynamics that are both in flux at present and substantial revisions in our oil outlook may be more par for the course this year.

Emirates NBD Research oil price assumptions

Source: Bloomberg, Emirates NBD Research

Oil markets will now be in the process of rebalancing. With the degree of sanctions that have been imposed on its economy, a recession in Russia is almost a near certainty, the question is more of what severity. Regardless, oil demand in Russia is going to drop sharply as trade, air travel and private consumption decline. Russian oil demand was estimated at around 3.75m b/d in Q4 2021. During the Covid-19 pandemic, oil demand dropped by around 0.5m b/d between Q1 and Q2 2020 so a similar, if not larger, drop should be expected during a prolonged period under sanctions.

In the European Union, efforts to wean itself off Russian oil supplies will be underway. In the short term this can be achieved by finding alternative suppliers but also by limiting demand. The IEA, which counts 75% of the EU as members, has policy procedures for cutting energy demand in the face of supply shocks. In 2018 the IEA estimated that reducing commuting/supporting remote work as an energy saving measure would cut oil demand by 0.5m – 1m b/d. The evidence from the Covid-19 pandemic shows precisely the kind of drop in oil demand that can be achieved while economic activity can still be maintained, to a degree.

What the supply response to the war will be is even more uncertain. So far OPEC+ has resisted officially committing itself to higher production volumes, citing that there had been no change in oil market fundamentals following the Russian invasion. Now that the US, UK and a few others have legally blocked Russian oil and energy products, the market will be questioning if that qualifies as a change in fundamentals that will allow OPEC+ to increase production at a faster pace. We are skeptical that we will get new higher targets when the producers’ alliance meets later this month (March 31) even as voices of dissent, such as the UAE, push for OPEC+ to alleviate the tightness and volatility in markets.

Outside of OPEC+ we would expect to see output increase from producers in the US, Canada and elsewhere to take advantage of historically high prices. But those flows won’t be immediate, nor can they necessarily flow to international markets as easily as Russia’s. The US is still a net oil importer of around 4m b/d and while seaborne crude oil exports are rising, they remain well below Russian flows.

US crude exports not at a level to offset drop in Russia's

Source: Bloomberg, Emirates NBD Research

With Russia’s influence on raw materials stretching beyond energy, commodity markets as a whole are pricing in new sustained periods of disruption. Wheat prices have moved to record levels and the LME has been forced to suspend, momentarily, trading in nickel forwards given the intense volatility in the market. We thus assign more upside risk to our commodity price views as a whole.

Where we see a further substantial change in the outlook is on gold prices. We had expected that gold prices would suffer in 2022 as the Fed prepares to normalize policy and move rates higher while financial conditions, while tight, probably wouldn’t substantially derail performance in equity markets. We still expect that the Fed will carry out rate hikes but the economic passthrough from the war in Ukraine—higher global inflation, uncertain supply chains, investor demand for havens—is a departure from our baseline and thus sets up a positive case for gold as a haven asset. We now expect gold prices at an average of USD 1,960/troy oz this year.

Source: Bloomberg, Emirates NBD Research. Note: average of quarters