Food, Fuel, and the Cost-of-Living Crisis
The recent decline in commodity prices has provided a rare respite for central banks trying to rein in high inflation. But are the energy and food crises afflicting the world actually easing?
Amid a backdrop of slowing global growth as central banks act ever-more aggressively to rein in high inflation, the recent decline in commodity prices that has begun to ease the global cost-of-living crisis has been a rare bright spot.
This decline is especially welcome given the tight correlation between gas prices at the pump and inflation expectations, which central banks are monitoring closely for signs of de-anchoring that would require even more forceful action — with potentially recessionary consequences.
But even as most commodity prices are off recent peaks, many physical commodity markets remain tight while Europe is facing an acute energy shortage with the curtailment of Russian gas flows that could have knock-on effects across the commodity complex.
So are the energy and food crises really resolving? Given their importance for inflation, growth, and even political stability, where commodity prices are heading from here is top of mind understanding the drivers of this year’s surge in commodity prices and whether prices have already peaked.
Some analysts have long argued that we’re only at the start of a new commodity supercycle — -akin to the prolonged periods of high and volatile commodity prices in the 1970s and 2000s — owing to severe underinvestment in commodity supply capacity that has left supply unable to meet rising demand induced by government policies around Redistribution, the Environment, and Deglobalization (RED).
Such analysts view claims that the war in Ukraine is largely to blame for the current crisis as spurious, arguing that, if anything, the causality runs the other way. Others, in contrast, reject the idea of a coming commodity supercycle — and even the existence of commodity supercycles at all — given estimates that inflation-adjusted commodity prices have generally declined since the mid-1800s.
The argument here is that commodity shortages are almost always short-lived because demand and supply responses to higher prices, as well as human ingenuity, have a track record of overcoming scarcity. And they view this year’s run-up in commodity prices as the result of a classic speculative binge that far exceeds what’s justified by short-term tightness in fundamentals resulting from pandemic reopening and the war in Ukraine.
It’s no surprise, then, that there is a fundamental disagreement on where commodity prices are headed. The latter group believes that they have further to fall due to a looming global economic recession that will dent commodity demand and a rise in commodity supplies in response to recent higher prices.
They see copper prices — a historical bellwether for the global economy — leading the way but also expect Brent oil prices to fall to $60–80/bbl in the coming months. This contrasts sharply with the first group’s view that fuel and food demand will prove relatively resilient even in the event of a recession — as it did in the 1970s — -and that this demand resilience on top of supply constraints skews energy and food price risk sharply to the upside near term, while industrial metals, and copper, in particular, are well-positioned for medium-term upside. They, therefore, believe that there’s no better time for investors to own commodities, while the commodities bears believe now is the time to short them.
Given that fuel and food sit at the core of the current crisis — and arguably the inflation and growth outlook — it is important to look into the European natural gas prices, which are likely to remain extremely high and volatile as Russia curtails supply, oil offers the best risk-reward in the energy complex given that oil inventories are at record-low levels, increased oil supply from OPEC, US shale producers, and elsewhere is likely to be limited, and oil is the cheapest source of energy today.
The market expects an already exceptionally tight physical oil market to tighten further, driving Brent prices to a new cycle high of $135/bbl in 2H22 and an average of $125/bbl in 2023.
On the food side, the global food crisis isn’t about food shortages, but rather food prices, with global wholesale food prices up about 25% YoY, as the cost structure of the global food system has risen sharply alongside the broader energy complex, YoYd as demand for animal products has risen as incomes have grown worldwide.
So it’s unlikely that a potential resumption of Ukrainian grains exports will provide much relief, and argues that investing in technologies that increase food production using less land, water, and costly inputs is the only way to solve the global food crisis.
Without stepping up to meet this challenge, and soon, political stability in many developing countries could be undermined — case in point: Sri Lanka.
Agricultural prices are likely to remain volatile as food’s unique place in the carbon cycle leaves it particularly exposed to ongoing decarbonization efforts, crop yield volatility is likely to rise as climate change increases the frequency of extreme weather events, and country conflicts arising from, and contributing to, agricultural scarcity becomese increasingly common.