Global Commodities: The ways of water

Natasha Kaneva (0:03)

Hello, and welcome to another episode of At Any Rate. I'm your host, Natasha Kaneva, and I head JP. Morgan Global Commodities Research. We're pleased to be back on the air as we have much to discuss in the commodities markets. Since our last episode, almost more than a month ago, oil prices have climbed to 23 percent, peaking at $110.

Energy is only part of the story, though, as rising fertilizers and record high diesel prices have trickled down to agricultural markets, which are up about 20 percent. To make matters even more complicated, the world is bracing for El Nino event that has rapidly intensified into a super El Nino, with a high likelihood of becoming one of the strongest on record. To help me untangle all of that, I'm happy to have Tracey Allen back on the podcast. She heads our Agricultural Commodities Strategy. Tracey, welcome back and thank you for being here.

Tracey Allen (0:54)

Great to be back, Natasha.

Natasha Kaneva (0:56)

Tracey, let's start with oil, just to set up the theme.

First of all, I think it's very fair to notice that there is no shortage of risk for the market to price. Over the past week, we see that the conflict has opened new pressure points across the regions. For example, Hooties' advances along the Yemen's Red Sea Coast and into the Bab al-Mandeb have put another critical shipping route at risk, while an attack on Saudi Arabia's East-West pipeline temporarily shot a key alternative route for crude exports. Nor is the volatility contained in the Gulf, despite President Trump's assurance that there is an energy truce between Ukraine and Russia. Ukrainian drones struck Russian refiners on Saturday. Even in a more significant display of rich, there was a hit on the refinery in Tatarstan, which is more than 1200 kilometers from the Ukraine-Russia border on Sunday, and there were two more attacks on Monday and on Tuesday. Meanwhile, Russia launched attacks on the Ukrainian capital and other cities. There is no clear signal from either the US or Iran that they are prepared to escalate. We're watching very closely the meeting between President Trump and President Xi Jinping on September 24th. They're set to meet in DC.

So there could be some diplomatic breakthrough, but otherwise the assumption that the disruption is temporary is becoming increasingly difficult to sustain in the oil markets. So then, what if it's not? The answer depends less on how long the conflict lasts than on how the physical oil market continues to clear while the conflict continues. So for example, at the start of the US-Iran war, we expected the world to draw rapid inventories. So when the inventories go down, it sends a very strong signal to the market that the market is in the deficit that pushes the oil prices higher. We believe that that would be enough to keep the prices at around $100 even after the Strait reopens. But in practice, the markets actually clear it very differently. It appears that faced with uncertainty over how long the conflict might last, the governments and the consumers largely chose to preserve inventories, keeping the barrels in reserve for tougher days ahead. Stocks, oil inventories fell very sharply through May, but then they leveled off in June and July before resuming more modest draws in August and so far in September. But in total, when we look at the numbers, the draws of crude oil and refined products amounted to only about 550 million barrels, which is about one-third of what we had expected. And so instead, the policymakers shifted far more of the adjustment burden on demand. Since March, for example, our numbers show that demand is running around 4.4 million barrels per day below last year's levels. That's about one and a half times larger than the adjustment implied by the inventory draws of about 2.9 million barrels per day. This distinction is critical for the price formation because falling inventories tend to lift prices while fading demand tends to depress them.

So by leaning more and more on the demand destruction, much less on the stock draws, the market was able to absorb the extraordinary supply disruption without the sustained rise in crude prices. And in fact, since the conflict began, Brent Oil has averaged just $94.

So it also suggests that the fears of inventories being close to depletion as a balancing mechanism are premature, at least for now, we believe there is still an ample inventory to cushion a prolonged disruption before operational stress levels are reached, which limits the need for crude prices to move materially higher from the current levels. However, having said all of that, if Middle Eastern flows were to remain at current levels, our framework would imply that fourth quarter of this year and December exit price around $7 and $8 above our current forecasts, respectively. So Tracey, this is the view on oil and that's how we view the markets. So moving to agricultural markets, clearly Middle East crisis is affecting your markets as well. We know that 30% of fertilizer, for example, are moving through the Strait of Hormuz. Prices are up about 20% since the start of the war. So what are you watching?