Commodity prices have abruptly reversed direction in 2023. European gas prices, for example, are down over 57% year on year, with oil, industrial metals and a range of agricultural commodities also seeing double-digit falls. Even the great hope of the energy transition – lithium – is down 56% on last year. Should investors see this as a compelling buying opportunity or a moment to ship out?
The latest ‘Pink Sheet’ commodity report from the World Bank for March shows how far-reaching these declines have been: “Energy prices declined 6.3% in March, led by natural gas in Europe (-16.5%) and coal (-9.8%). Non-energy prices dropped 2.2%, with all key components registering losses. Agricultural prices eased 1.6% in March…Fertilizer prices declined 3.6%, led by Urea (-12.3%) and MOP (-8.8%). Metal prices dropped 3.2% in March, led by nickel (-12.9%), tin (-10.7%), zinc (-5.3%), and aluminium (-5%).”
This weakness has been reflected in the performance of natural resources-focused funds. The average commodities and natural resources investment trust is down 6.2% for the year to date. Among the major sectors, only India and Infrastructure Securities have performed worse. That said, natural resources companies have proved notably more resilient than commodities prices.
What happens next?
Mild winter weather, high storage levels and swift actions by governments to source alternative supplies have pushed gas prices lower. Fears of gas shortages in Europe did not materialise and, as winter draws to a close, gas storage levels are around 65% full, according to trade group Gas Infrastructure Europe.
Oil prices have come down as demand has fallen. The International Energy Administration says: “The market is caught in the cross-currents of supply outstripping still-lacklustre demand, with stocks building to levels not seen in 18 months. Much of the supply overhang reflects ample Russian barrels racing to re-route to new destinations under the full force of EU embargoes.”
From here, producers of oil and gas are scrambling to reduce supply to shore up prices. OPEC announced reduced production targets in October, designed to stabilise the price. Equally, Mark Hume, manager of the BlackRock Energy & Resources investment trust, says that the US government’s announcement that it will buy oil at prices below $72 puts a floor under oil prices. Investment in new supply remains relatively constrained, and the IEA is forecasting a significant increase in demand as the world economy (particularly Asia) reopens.
David Lewis, co-head of strategy at Jupiter, says the Merlin team has used recent low prices to increase exposure to conventional energy companies. He adds: “We have invested in the BlackRock World Energy fund. We believe that conventional energy companies are trading at low multiples, increasingly cash generative because the ESG movement has pushed them into not investing in drilling more wells.”
He also believes that conventional energy companies are part of the solution to climate change: “The world is very reliant on fossil fuels and for us to move to a sustainable world, we’re going to need these hydrocarbons to get us there. They will become greener as they go along and they will become part of the solution rather than part of the problem.”
Nevertheless, there remain plenty of investors who believe it is a poor long-term strategy to align with fossil fuel companies, whose core markets will inevitably decline and may have significant capital expenditure ahead of them. The past 12 months may have accelerated the energy transition. Renewable energy stocks and infrastructure options are cheaper than they were a year ago, having seen their prices fall in 2022, but still look relatively expensive. As such, the arguments on both sides are finely balanced.
The China problem
Elsewhere, the slump in industrial metals prices and energy transition commodities such as lithium and copper is perhaps more surprising. Governments are directing vast amounts of capital towards infrastructure building, particularly renewable energy infrastructure. China’s improving economy should also bolster demand as infrastructure projects resume. These areas should also be supported by slow investment in new supply.
Recent weakness appears to have been caused by weaker manufacturing activity in China. The Caixin/S&P Global manufacturing purchasing managers’ index (PMI) fell to 50.0 in March, down from 51.6 in February. Investors had been expecting a pick-up in activity in response to the end of Covid lockdowns across China.
It is also weaker Chinese demand that seems to have hurt the lithium price. Electric vehicle makers had rushed to secure scarce raw materials in the preceding two years, which had pushed up the price by more than 17x between July 2021 and November 2022 (source: Trading Economics).
However, slowing electric vehicle demand in China, the world’s largest and fastest-growing market, and additional battery supply from China, Australia and Chile have brought prices crashing down. While the long-term demand picture for lithium appears in tact and it is difficult to bring on new supply, this is bringing volatility in the short term.
Food prices have been influenced by the war in Ukraine. They have tough comparison figures because prices spiked in the immediate wake of the crisis. Fertiliser prices have come down, and the UN-backed grain deal has helped keep prices lower. The deal was extended for a further 60 days in March, but the world’s agricultural markets remain vulnerable to climate problems and to any unravelling of the deal.
Commodities markets are always volatile, and the war in Ukraine and the energy transition has made them even more so. There has undoubtedly been some froth in certain energy transition commodities, while energy markets have been subject to unpredictable elements such as the European winter weather, and the ability of policymakers to change course.
The relative resilience of commodity stocks in the face of volatile energy prices shows that they remain well-valued and have not necessarily reflected the prices of commodities themselves. The hope would be that commodity markets are now on a more even keel and companies can start to make progress again.