A year of recovery, reopening and reflation
2021 was a year marked by recovery and reflation due to COVID-19 resurgence and supply chain bottlenecks resulting in record high pricing. The global economy continues to operate in a multi-speed fashion, with each region rising or falling depending on the impact of COVID-19’s successive variant waves, the amount of fiscal and monetary support, and the level and type of exposure to commodities.
While the spread of the Delta variant threatened for some time to derail the economic rebound that had been underway during our financial year, the world has generally been able to recover and move past the worst of that wave, albeit with some significant losses in India, Southeast Asia and parts of the US. Eventually however, as the number of countries imposing lockdown policies that forced the closure of their economies for prolonged periods dwindled, the world economy resumed its upward path out of the short but very sharp recession it experienced in the first half of 2020.
Demand recovery has in many cases exposed and/or exacerbated significant issues in the global supply chain, across manufacturing, transportation and commodities. As reported in our FY2020 results, the impact of the COVID-19 pandemic on the supply of commodities was equal to or in many cases even worse than the hit to the demand side. This was particularly true on the metals side, whereas oil producers acted to cut production voluntarily. Other commodities were also affected by demand outrunning supply, including lumber, tin and coal.
And while COVID-19-related impacts also undoubtedly further weakened supply-side logistics – as in shipping, where record delays in shipping times and order backlogs are at least partly due to COVID-19-induced port shutdowns and ship quarantines – many of the contributing factors to supply-side constraints have been several years in the making. In some cases, these issues are causing a domino-like effect, for example the lack of semiconductors has in turn led to a lack of available trucks, causing chokepoints across a range of other supply chains.
Taken together, this unprecedented mismatch between the supply and demand of commodities has resulted in some historic price movements. It should be noted that these price movements have been the direct result of the state of physical markets, given the lack of deliverable supply when needed.
The higher commodity prices and continuing supply chain bottlenecks, along with recovering labour markets, reopening of economies and significantly higher personal wealth and incomes, are all combining to create sharply elevated inflation levels around the world. These in turn are leading to rising interest rates and expectations of central banks tightening their accommodative monetary policies. However, as of now and barring a widespread new variant, the strong underlying growth momentum appears to have carried over from our last financial year into this one.
Oil prices (Brent) rebounded by almost 94 percent over the course of our financial year, rising by approximately USD38 per barrel. The rise in prices came despite a brutal second wave of COVID-19 infections and lockdowns over the northern hemisphere winter, followed by another sharp hit from the Delta wave in late summer which meant that oil demand had not yet fully recovered to 2019 levels, as at the end of September.
Demand has recovered more quickly in the US than most places, recovering to its average pre-pandemic level by mid-summer 2021, and even briefly went above it to an all-time high for total products demand. This was driven in particular by a strong recovery in gasoline demand, which is critical for global oil demand given almost one in every ten barrels of oil consumed globally goes into US gasoline engines. This more than offset the lag in jet fuel demand. Similarly, domestic air travel in the US had almost fully recovered by early summer 2021, before taking another hit as a result of the Delta wave. Indeed, given that international travel remained significantly restricted, especially on the busiest transatlantic routes, the recovery in overall US travel points to domestic travel being some way above pre-pandemic levels, despite continuing weakness in the business travel segment.
The significant movement of people from higher tax states and densely populated cities to lower-tax, lower-density areas has also created a level of structural demand growth.
Demand in other areas lagged behind the US recovery, at least initially. Europe slowly recovered but jet fuel demand remained subdued, while a full recovery in road transport was hampered by successive COVID-19 waves and slower than expected vaccine roll-outs. China’s road transportation demand had already exceeded pre-COVID-19 levels by late 2020, but was again hit when the world’s second-largest oil consumer enacted various lockdowns as part of its zero-COVID-19 policy. Demand also suffered as the result of power cuts and efforts to curb energy usage and emissions, all of which led to lower industrial production.
Other major markets saw demand gains retreat at various times as they grappled with the Delta variant wave. India was the first to feel the pain in March 2021. Transportation demand fell precipitously, albeit for a matter of weeks rather than months this time around. Southeast Asia on the other hand struggled from Q2 2021 onwards through to the end of our financial year in Q3 2021, but demand and industrial activities were rebounding strongly into Q4 2021.
On the supply side, OPEC+ continued its supply curtailments, slowly starting to bring back some volumes in Q3 2021, but maintaining a measured rate of increase given the uncertainties around further COVID-19 outbreaks and the pace of demand recovery. Nonetheless, some OPEC+ producers are struggling to match even lower output targets as a direct result of significantly lower investment in recent years.
Even as OPEC+ begun to increase production, US production remained flat throughout our fiscal year. After falling some two million barrels per day from the pre-pandemic peak, down to just over 11 million barrels per day, US production has struggled to maintain this level due to repeated outages from hurricanes as well as the winter-related power shortages in Texas in February 2021. Shale production has moved from being “growth at any cost” to maintaining a committed focus on capital discipline. Although oil rig numbers have more than doubled from their low point, they are only now moving beyond the level needed to maintain production at around 11 million barrels per day.
Therefore, the industry remains focused on returning cash to shareholders rather than growing production, and at the current rate it will take some time before US production is back to pre-pandemic levels.
The combination of supply constraints from both OPEC+ and others, and the patchy but sustained recovery in demand, has meant that oil inventories globally have sharply reduced from record levels reached last year. Historically strong backwardation (Chart 1), global inventories below the five-year range and rapidly decreasing Chinese inventories all suggest that the strong momentum in prices that we have seen over the last financial year is set to continue depending any ongoing impact of COVID-19.
Natural gas prices in Europe reached all-time highs, with the European TTF benchmark trading at USD90 per MWh, including some of the highest volatility days ever in September 2021. TTF prices normally average just under USD20 per MWh, so the move up to levels that are more than four times as high has meant significant economic cost for Europe. In some EU countries, governments have had to subsidise prices, while in others industrial production has been curtailed.
Part of the reason for the rise in European gas prices has been stronger LNG demand from Asia due to low hydropower reserves this year in China and also lower coal production. LNG prices in Asia (JKM) reached a record level, rising to USD35 per MMBTU, as the region priced to attract cargoes from other regions, particularly Europe. Major supply disruptions in Russia, and across other gas producers in places such as Australia, Nigeria, Norway and South-East Asia, on the back of a cold 2020-21 winter, meant that European inventories were at extremely low levels coming out of summer 2021. This points to the potential for further disruptions if the continent sees another cold winter. Europe is not the only area that has had to deal with power-related curtailments, with China enacting production cuts, primarily in the energy-intensive steel and aluminium sectors but also in other base metals.
A relatively quick recovery in China, combined with the fact that most countries managed to maintain industrial production and construction even during lockdowns, meant that demand for metals stabilised quite quickly during the pandemic. Supply, however, was severely impacted by ongoing outbreaks and other disruptions to major producers, even as demand recovered. This resulted in strong price momentum over the course of the past 12 months as stocks drew down given the slower recovery in supply.
Copper was most affected by these dynamics for the majority of our financial year, resulting in prices hitting an all-time high in March 2021, closing at USD10,700 per tonne, before stagnating in the middle part of the year and then rebounding into the close of our financial year. Continuing outbreaks and mine lockdowns in Chile and Peru and ongoing disruptions to global logistics chains meant that supply was constrained. On the other hand, demand for appliances, vehicles, housing and electronics all rose as consumers spent savings and stimulus payments. As the scale of the economic impact of the COVID-19 crisis became clear, government-enacted stimulus measures supported industrial activity at a time when the service sector was facing severe headwinds. As a result, global industrial activity not only recovered quickly to pre-COVID-19 levels, but exceeded previous highs. Simultaneously, governments embarked on public infrastructure spending programmes, particularly targeting power generation and other metalsintensive sectors.
In China, smelter output started to be curtailed in Q3 2021 as power shortages began to materialise and these cuts accelerated as the scale of the energy crisis became clear. In the US, an accident at the Kennecott smelter, and disruptions at smelters in Australia, India, Japan and Russia, exacerbated an already tight market, with LME stocks reaching the lowest levels since 2005.
It was a similar story for zinc, as supply curtailments outweighed demand, with the latter picking up strongly over the course of the past 12 months, especially in the US and Europe. Zinc prices reached their highest level since 2018, rising from USD2,327 to just under USD3,130 per metric tonne. Before a shortage of semiconductors dragged the global auto sector to a near halt, Europe in particular saw strong activity in this sector, boosting zinc demand. Demand for vehicles remained very strong throughout the year, but supply chain shortages brought available auto inventories down to record lows. Manufacturers continued building vehicles to the extent possible, keeping demand for zinc robust when it might have been expected to fall. The stimulus plans put into place in Europe have also boosted demand significantly, with infrastructure investment picking up pace, in particular spending on electricity grids in Europe after almost a decade of decline. This is expected to continue as the continent undertakes significant changes to its power generation as part of the transition to cleaner energy.
The US also saw strong demand for zinc from construction, manufacturing and transportation. Housing construction increased by almost 60 percent versus the average over the previous decade. Infrastructure spending started to pick up as a result of various stimulus programmes and automotive production also contributed to solid gains. As a result, demand for metal from both the US and Europe meant that premiums rose to very high levels in order to attract inflows.
Other major markets suffered declines at various times throughout the year as the Delta variant swept through. India was particularly hard-hit in the early part of 2021, and Southeast Asia followed suit soon afterwards. Activity declined both as a direct result of COVID-19 cases and lockdown measures implemented in various countries, with countries in South-East Asia initially attempting to follow China’s lead in adopting a zero-COVID-19 approach.
As seen in the copper markets, supply outages at zinc mines in Peru and Mexico helped keep the market tight, with the concentrates market following up 2020’s sizable deficit with another small shortfall in 2021. Unlike copper however, inventories of refined metal have risen from low levels, partly due to the fact that China’s State Reserve Bureau (SRB) released significant strategic stocks into the market. With further infrastructure spending coming in both the US and Europe, the shortage of microchips expected to ease in coming months and the required replenishment of housing inventory in the US, the zinc market is likely to remain relatively tight going forward.
Demand for aluminium suffered throughout the first wave of COVID-19 in 2020, particularly in markets outside of China where primary metal demand fell by -10 percent. Production however, remained unchanged over the same period and resulted in the first aluminium surplus market in over five years.
But as we entered 2021, the market picked up quite strongly, with demand outside of China rising by over 14 percent and Chinese demand growing by six percent compared to 2020 levels. Primary consumption remained strong despite an even stronger increase in scrap demand, which rose by 12 percent year-on-year. By the end of the 2021 financial year, aluminium prices had reached some of their highest levels since 2008, as a result of strong demand and capacity reductions in China due to energy and emissions curbs. Prices therefore climbed steadily from just under USD1,750 per metric tonne to close to USD3,000 per metric tonne.
The current issue faced by the aluminium industry is that almost all of the production capacity growth over the last decade has been in China. Global demand for aluminium rose by 80 percent during the 2007-2020 time period, while capacity outside China essentially stayed flat.
Chinese smelting capacity is now 3.5 times as large as it was in 2007, supplying well over half of the world’s output. But going forward, China has taken a policy decision to no longer be the world’s supplier and to stop building new smelting capacity after the current slate of projects is completed in 2023.
We have already seen the ripple effects of changes to China’s aluminium capacity, where there were production reductions as the result of attempts to curb both emissions and energy usage. As a result, the market has been very tight in China, again forcing China’s SRB to release tonnes into the market from strategic stocks. This has not prevented premiums for deliveries into the US and Europe from rising to decade high levels, in particular into the former.
As demand continues to rise globally, with, unusually for metals markets, ex-China demand outstripping China demand growth over the next decade, it is hard to see where the capacity will be found to meet demand. Demand is expected to grow by just under 40 percent to the end of the decade, driven in large part by increased use of electric vehicles and renewable energy, both of which are significantly aluminium intensive. However, even with sharply higher scrap usage, the lack of new capacity leaves a major deficit, much as we see in other metals.
Nickel markets had a bumpier ride than the other metals markets, although prices generally trended upwards throughout the year and ended significantly higher than the starting point, rising by circa 25 percent to just under USD18,000 per metric tonne by the end of September 2021, compared to just under USD14,400 per metric tonne one year earlier. However, at various points in the year nickel prices rose to around USD20,000 per metric tonne with sharp drops following these peaks. The first drop came at least partly as a result of Tesla indicating that it would be switching more of its batteries to lithium Fe/iron phosphate (LFP) battery technology given concerns around availability of nickel. Prices then fell over USD2,500 per metric tonne (-14 percent) on news that China’s largest stainless-steel producer, Tsingshan had pledged to ramp up supply of intermediate material known as nickel matte to some of the large Chinese battery manufacturers.
Going forward, market development will be led largely by the bifurcation of the market involving the different types of nickel. Class I supply, derived in large part from nickel matte, is generally the only type acceptable for usage in batteries, and increasing demand from this sector is pointing to significant deficits in the Class I market going forward. Meanwhile, Class II is derived from nickel pig iron, ferronickel and nickel oxide, and is used in the production of stainless steel. The announcement from Tsingshan, that it could provide nickel matte from nickel pig iron, which is much more plentifully available, would mean that the deficit in Class I would not be quite as material and that this availability would therefore loosen the market and pressure prices. However, the process is significantly more energy intensive and, relying as it does on coal for this energy, results in much higher carbon emissions as well as other environmental impacts. Given that the major use case for the Class I material is in electric vehicles, producing much higher carbon emissions to produce the material looks to be an unresolvable challenge for the auto manufacturers and therefore, it is unclear what the uptake of this process will be.