Two Main Forces Have Come Together to Pull Down Commodity Prices

Two main forces have come together to pull down commodity prices from the steep increases observed last year, BofA Global Research stated in a report sent to Rigzone this week.

“First, the Fed has increased interest rates at one of the fastest rates in decades in the past 15 months to contain the most pronounced spike in inflation in four decades,” BofA Global Research analysts said in the report.

“In turn, rapid rate hikes have led to a steep contraction in M2, triggered a banking crisis, and helped bring down inflation,” they added.

“Second, faced with the twin evils of inflation and the first war in Europe since 1945, the U.S. Treasury engineered a set of economic sanctions that have both minimized global commodity supply losses while also cutting tax revenues to Russia's government,” they continued.

Except for gold, beef, and sugar, major commodity prices are down year on year on ample supplies and a clouded macro-outlook, the analysts stated in the report.

“To fight downward price pressure, Saudi Arabia voluntarily cut one million barrels per day on Sunday and OPEC+ extended its output agreement into 2024,” the analysts noted.

Even so, oil remains at the heart of a fight between monetary and physical commodity market forces, the BofA Global Research representatives highlighted in the report.

“At their core, markets are witnessing a battle royale between Saudi Arabia and the U.S. Federal Reserve, pitting Prince Abdulaziz bin Salman against Chairman Jay Powell,” they said.

“Faced with a need to preserve financial resources to transform its economy, Saudi Arabia pledged to cut oil production volumes four times in the past year to support oil prices, aggressively levering its muscles as the world’s most powerful swing crude oil producer,” the analysts added.

“With macro headwinds moving from a tropical storm to a category 1 hurricane, OPEC+ volumes are once again declining, and oil balances should tighten as inventories fall in 2H23,” they continued.

“Yet, as physical oil markets face off with a monetary contraction, bearish asset allocators will keep clashing with bullish oil speculators,” the analysts warned.

Oil May Struggle to Rally

Oil prices may struggle to rally until the Fed eases money, according to the report.

“Fundamental commodity traders struggled to reconcile tighter balances ahead with falling oil prices, while multi-asset allocators instead followed the simple logic that tighter monetary policy will lead to weaker growth and falling inflation, shorting commodities along the way,” the BofA Global Research analysts said in the report. 

“OPEC+ scored a partial win with the surprise April oil cuts, spooking CTAs out of their shorts. Still, monetary forces are extremely powerful and trend followers are just a sleeve of the broader financial sector,” they added.

“Most importantly, the market is pricing in Fed rate cuts starting in December, a development that should support oil prices into 2024,” they continued.

Yet this rate path likely reflects not a central case but rather the average of two outcomes, the analysts noted in the report.

“1/ sticky inflation with a robust labor market that forces the Fed to keep rates higher for longer or 2/ a steep recession that forces the Fed to cut rates at 100bp clips,” the analysts said.

“In this battle royale, oil has the losing hand until money starts easing again, and we maintain our average $80 per barrel Brent forecast for 2023,” the BofA Global Research analysts added in the report.

Here and Now

In a separate report sent to Rigzone this week, Standard Chartered analysts noted that the oil market currently seems to be almost exclusively focused on the here and now and most comfortable with backward-looking indicators, “such as short-term physical differentials”.

“If that is true, the lags between producer actions and market responses may be long and may not happen until further physical market tightening occurs,” the Standard Chartered analysts said in the report.

“The market is currently trading as if it wants everything to happen at once and does not like lags. If something does not happen instantly, the implicit assumption seems to be that it does not matter much,” they added.

“We have already, within 48 hours of the OPEC+ press conference, seen market comments suggesting that the lollipop cut [Saudi Arabia’s one million barrel per day production reduction] has failed and has not tightened the market. The reality is that the cut does not start until July 1 and, allowing for transit times, the reduction in availabilities arising from the cut will not be felt in most refining centers until late July or early August,” the analysts continued.

The Standard Chartered analysts highlighted in the report that being subject to lag does not diminish the force of a supply change. The analysts also projected in the report that the price of Brent will average $91 per barrel this year. In the report, Brent is predicted to average $88 per barrel in the third quarter of this year and $93 per barrel in the fourth quarter.

Brent Price

On June 8, 2022, the price of Brent closed at $123.58 per barrel. Following that close, Brent dropped steadily over the rest of the year, closing at $76.1 per barrel on December 9, 2022. The commodity’s highest 2023 close, so far, was seen on January 23, at $88.19 per barrel, and its lowest 2023 close, so far, was seen on May 3, at $72.33 per barrel.

To contact the author, email andreas.exarheas@rigzone.com