This article examines the status quo, driving forces, and market expectations.
The price of oil and response
Following the start of the invasion on February 24, Brent crude prices briefly rose above their 2014 highs, reaching $129.10 per barrel on March 7.[1]
Some attribute this to a temporary shock, as sanctions by the U.S. and its allies against Russia have avoided the energy sector directly.
The International Energy Agency (IEA) has released 60 million barrels of oil from its strategic reserve to offset the immediate supply constraints. But this is just equivalent to just one day of global consumption,[2] and would not counter a persistent squeeze on supply.
The broader context
Irrespective of sanctions, financial institutions providing key trade finance for the commodity markets in Europe, such as Dutch banks ING Groep NV and Rabobank, have reduced their lending exposure to deals involving Russia and Ukraine (including crude oil and wheat), owing to the increasing difficulty in settling transactions with Russian counterparties.[3]
This collapse in financing activity for commodities in Eastern Europe is driving up demand for varieties of crude oil from elsewhere in the globe, including suppliers in the Middle East. OPEC+ countries have not only demurred to commit to increases in production, but are still lagging behind their stated production targets following the rebound in global demand following the COVID-19 pandemic.
This is on top of supply chain difficulties, as Maersk and other companies such as BP and Shell have made independent moves to restrict or temporarily halt dealings with Russia.
The market response
Supply constraints are a genuine concern in secondary markets, at least for the immediate future.
The chart below shows the premium that purchasers will pay to receive a barrel of West Texas Intermediate (WTI) crude now as opposed to one month later (“prompt” contracts). The spike in this premium to $3.50 indicates that severe supply constraints are expected in the short term.
Source: Nymex
Brent and WTI spot and futures contracts show a similar story. The chart below shows a “super-backwardation” pattern, where prices of contracts settled in the future get progressively cheaper.
Both charts imply a gradual normalization of oil prices as supply and demand adapt over time.
Beyond the energy markets
Increases in the price of “safe-harbor” assets, such as gold, imply that investors are seeking protection against inflation.
Gold prices had increased 7.7% ($146 per troy ounce)[4] by March 8 to $2,049.85[5]. Holdings in gold exchange traded funds (ETFs), which simulate ownership of an underlying asset pool, also rose over January and February, topping 100 million ounces (see chart below).
Source: Bloomberg
Inflation expectations reflect the disruption of supply in other key commodities as the conflict continues.
Russia and Ukraine comprise 25% and 20% of global wheat and corn supply, respectively (12% of all calories supplied).[6] With Ukrainian ports closed, and the flow of Russian exports congested due to sanctions, buyers must find alternative sources of supply. This has naturally caused prices to rise. The Bloomberg Agriculture Spot Index, which tracks key commodities such as wheat, corn, and coffee, reached a record $485.05.
Conclusion
To summarize, the markets are deeply concerned that the crisis may prolong the disruptions in the supply chain.
Commodity prices may remain elevated for an indefinite period. Rapidly rising oil prices have coincided with recessions in the past,[7] and it is difficult to predict how long the situation will continue.
In such times of great uncertainty, investors should seek sectors that have proven to be resilient to recessions historically and those that benefit from inflation.
[1] Trading Economics - https://tradingeconomics.com/commodity/brent-crude-oil
[2] Reuters - https://www.reuters.com/business/energy/oil-prices-climb-market-weighs-release-reserves-vs-russia-disruption-2022-03-01/
[3] Bloomberg - https://www.bloomberg.com/news/articles/2022-02-24/ing-curbs-commodity-lending-after-russia-attacks-ukraine
[4] A unit of weight used to measure precious metals.
[5] Business Insider - https://markets.businessinsider.com/commodities/gold-price
[6] Bloomberg - https://www.bloomberg.com/news/articles/2022-03-02/russia-s-war-with-ukraine-could-devastate-global-grain-markets
[7] CNBC - https://www.cnbc.com/2020/01/03/spiking-oil-prices-have-led-to-recessions-in-the-past-and-thats-why-the-stock-market-is-on-edge.html