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The onset of the COVID-19 pandemic in the first two months of 2020 created a global economic and financial shock the like of which had not been seen in nearly one hundred years.

Saad Rahim, Chief Economist and Head of Research

Record volatility brings commodity traders to the fore

The onset of the COVID-19 pandemic in the first two months of 2020 created a global economic and financial shock the like of which had not been seen in nearly one hundred years. The resulting dislocations of economic activity and trade were a severe test for global commodity markets. For Trafigura, these dislocations were an opportunity to demonstrate the relevance and resilience of its services to clients, and its capacity to help balance commodities supply and demand.

The pandemic, government measures to curb its spread and the consequent sharp reduction in global economic activity impacted almost all the commodities Trafigura trades - either on the supply side, the demand side or, in most cases, a combination of the two. In the oil market, we saw, for a time, prices and curves moving from backwardation (where forward prices are lower than spot prices) to contango (the reverse) and back again. Volatility broke all records.

These conditions are in a sense what physical commodity trading firms are built to handle. The role of commodity traders is to address and rectify disconnects between supply and demand in global commodities markets, and the past few months have seen the largest-ever disconnect in the oil market, as a glut in supply collided with a drastic drop in demand. Those firms that operate on a global scale, with access to infrastructure, ample credit and a broad network of counterparties, were able to stabilise the market by storing various commodities, and then working to bring those inventories back into the market as demand has picked up.

Oil markets

The oil market has experienced a change of fortunes that is truly extraordinary. In calendar 2019, average crude oil prices were USD64.15 per barrel (Brent) and USD57.04 per barrel (WTI), about 10 percent below their averages for 2018. But the market expected a somewhat stronger 2020 on the back of the apparent truce in the US-China trade conflict, OPEC+ production cuts and other relatively positive news. Instead, prices are currently about 50 percent below 2019 levels and the year-to-date average is about USD20 below expectations.

 

The first signs of trouble came as China began exhibiting signs of a new viral pandemic gripping the country. A week after the city of Wuhan went into lockdown on 23 January 2020, prices had fallen 15 percent from their pre-quarantine peak. Chinese refining runs dropped by approximately 3.5 million barrels per day, close to 25 percent. By mid-February, as cases proliferated in South Korea, Iran and Italy, fears grew over global demand and prices dropped again by 20 percent in a week. The slide became a rout when Saudi Arabia, Russia and other members of OPEC+ abandoned production quotas and embarked on a battle for market share. The day after that decision, prices saw their second-largest one day drop ever with prices falling by almost a third at the market open.

The advent of quarantines and lockdowns in Europe and the US then took an unprecedented hammer to demand. Normally in a crisis it is a slowdown in economic activity that creates a drag on oil demand; this time, oil demand was hit first, as movement literally came to a halt. Demand for jet fuel suffered especially, with 80 percent or more of the market disappearing virtually overnight as airlines grounded their fleets. Gasoline use also collapsed in many areas. The US, which accounts for approximately one-third of global gasoline demand, saw demand fall by 45 percent, approximately 4.5 million barrels per day. Diesel use did not fall by quite as much but was also clearly impacted by the drop in trade and manufacturing, with global demand off by 25-30 percent.

As excess production met collapsing demand, storage began filling up at previously unimagined rates and market players started booking oil tankers to hold unwanted barrels. So-called floating storage is significantly more expensive than holding oil onshore and is economically unviable in all but the most extreme circumstances. Remarkably, on this occasion, floating storage was activated well before onshore storage tanks were actually full. Rather, they were “virtually full” in that the space had already been booked and was not accessible to new players. The result was the previously unthinkable emergence of negative crude prices. While the fall below zero and the consequent rapid curtailment of production occurred after our fiscal six-month period closed, the conditions were already building at the end of March.

Metals markets

Metals markets followed a different path, but were also heavily affected, not least because China consumes about 50 percent of most major metals, and in some cases much more. In the oil market, by contrast, China accounts for less than 15 percent of global demand. A major slowdown in China has an outsize impact on metals demand, so metals prices reacted earlier than oil. Similarly, as China started to emerge from COVID-19 quarantine much sooner than other regions, prices rebounded relatively quickly. One of the key themes in metals markets has been that the supply side has been impacted as much as the demand side, and more in some cases. This duality has helped balance these markets much more quickly than oil markets.

 

Copper had a particularly volatile ride. As the virus spread in China, prices plummeted by almost USD1,000 per tonne in two weeks (13 percent). The closure of auto plants and other manufacturing facilities was a problem, but there were issues on the supply side as well. Given the restrictions on movement, smelters were unable to move the sulphuric acid that is a by-product of smelting. At the same time, copper mines were hit hard by the virus, particularly in Latin America, with about four million tonnes per annum of production capacity offline at the end of March.

As demand picked up with a resumption of Chinese economic activity, inventories were drawn down. By the end of March, prices had rebounded by more than seven percent to just below USD5,000 per tonne. This more positive outlook looks set to continue, with demand outpacing supply, especially given the major stimulus programmes being rolled out across the globe, including infrastructure, grid buildout, 5G rollout and electric vehicles. One major risk to this positive outlook for copper and the other metals is the possible resurgence of trade issues between the US and China.