Geopolitics And Inflation Move Commodity Markets—For Better Or Worse

Geopolitical news is driving continued price volatility

Crude Oil

Unless you are actively involved in the crude oil trading pits, you can guess daily oil price moves by just following the news. Oil prices have become more volatile in the past month given the war between Russia and Ukraine. Who would have thought when it started in late February that a month later it would still be going on?

Screen Shot 2022 05 19 at 12.08.31 PMNews about the war is driving oil prices. Russian troops are bogged down. Ukraine troops scored a major victory. Russia to pull back troops, but rockets keep coming. Peace discussions are underway. Negotiators are making no progress. Each headline will move oil prices. With a 24-hour news cycle, it is not surprising oil price volatility has increased. War means less Russian oil, while peace signals Russian oil might soon be welcomed back onto the world stage. Traders read the headlines to judge whether global oil markets will remain tight and prices high and react accordingly.

Adding to war news is economic news. What is happening with inflation? How high will interest rates rise to squash rising prices? Final 2021 fourth quarter data confirmed a 6.4 percent year-over-year increase for the Federal Reserve’s favorite inflation measure—a 40-year high! Taming rising living costs means the Federal Reserve will be boosting short-term interest rates six more times this year. Substantially higher interest rates translate into reduced economic activity and lower energy consumption.

Screen Shot 2022 05 19 at 12.08.45 PMOther global issues are roiling the oil market. Will U.S.-Iranian nuclear talks lead to its oil gaining access to the world’s market, easing tightness? But China is now battling a new COVID outbreak, and it has locked down Shanghai, the nation’s largest and wealthiest city. COVID and China equates to slower economic growth, and that means oil use will be lower for the foreseeable future. Elsewhere, governments are struggling to reduce energy and power bills for their citizens, as security of supply is supplanting climate change worries. Politicians are trying everything from increased financial subsidies to cutting fuel taxes, let alone trying to find cheaper fuels. The U.S. government will release one million barrels of oil a day for 180 days from its Strategic Petroleum Reserve to counter rising gasoline costs, but the reprieve may be transitory. States are granting gasoline sales tax holidays—another short-term fix. Elections and unhappy consumers drive political stunts, rather than serious structural solutions.

We have no idea when or how the Russia/Ukraine conflict will end. We also have no idea whether Russian energy, currently a pariah in the world market, will suddenly be desirable. Will major countries experience recessions—or possibly the entire world? Will oil producers abandon the financial discipline demanded by their shareholders under government pressures for more supply and sink prices by creating a glut? Strap yourself in and get ready for continued price volatility.

Natural Gas

iStock 1147246065 2LNG tankers continue to haul U.S. gas to Europe

Right now, the natural gas market is all about helping Europe avoid a human disaster. The continent is captive to Russian gas supply and haunted by the threat of a supply cutoff, possibly due to the demand for payment in rubbles and not dollars. For several months, an armada of LNG tankers have hauled U.S. gas to Europe, nearly abandoning the Asian market. Choosing where to sell LNG is easy when Europe pays more than Asia and seven-times Henry Hub prices. We will see how long Asian buyers are benevolent, especially when the calendar dictates time to refill storage for next winter.

Screen Shot 2022 05 19 at 12.08.56 PMThe U.S. and Europe have pledged to get an incremental 15 billion cubic meters of gas to the continent by the end of the year and an incremental 50 bcm by 2030. No one knows how it will get done or where the extra supply will come from. U.S. LNG exporters are running at capacity, although the industry was able to ship 4.3 bcm to Europe in January, a hefty increase over year-ago shipments.

The additional LNG came from the two newest U.S. LNG terminal expansions this year, but there will be no further volumes available before 2024. A tight global gas market exists, as there are few new LNG export terminals being built anywhere. Therefore, for more gas to get to Europe requires redirecting it from other customers. A potential incremental supply source could be China, as it takes more gas from Russia and displaces LNG volumes it currently anticipates importing. Forget the political implications of such an arrangement.

Screen Shot 2022 05 19 at 12.09.07 PMFor U.S. gas consumers, the LNG market will operate at capacity keeping demand up and prices elevated. The world finds its gas storage volumes at historical lows, which will need to be rebuilt before next winter. This is also true in the U.S. As the world’s largest exporter of gas, high domestic natural gas prices will be sustained. High prices signal the market wants more production if we do not want to enter next winter with low storage volumes, which could mean power supply challenges if weather is colder than normal.

It is still shocking how geopolitical events, the current U.S. administration’s anti-fossil fuel governance agenda, and producers responding to the demand of their shareholders to exercise greater financial discipline and return more cash to investors have combined to transition the world’s gas industry from chronic oversupply to sustained undersupply. Americans’ electricity and gas bills are going up and will stay elevated into next year. Politicians who attack the gas industry and then beg for it to deliver more supply are finding that this hypocritical attitude is extending the industry’s typical response time to commodity price signals. That delay is and will continue to create hardships for consumers. This situation could have been avoided if all parties had handled their roles differently.

By G. Allen Brooks, Expert Offshore Energy Analyst & ON&T Contributor

This article was featured in ON&T April 2022.

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