Diego Thomazini
The price of oil and other commodities have been under pressure ever since the Federal Reserve started its aggressive interest rate hikes. Bart Melek, Global Head of Commodity Strategy at TD Securities, explains to Kim Parlee why the year ahead may not be as challenging as some expect.
Kim Parlee: Commodity prices across the board have been under pressure ever since the Federal Reserve started its aggressive interest rate hikes, which has been stoking recession fears, even so in a new report from TD Securities. My next guest says, when it comes to commodities in 2023, it likely won’t be as bad as advertised. Bart Melek is the Global Head of Commodity Strategy at TD Securities. He joins me now. Good headline, good headline, not as bad as advertised.
Bart Melek: Well, thank you very much. We thought long and hard about it, and it seemed to fit.
Kim Parlee: Yeah, well, tell me why, so why don’t you think it’s going to be as bad? Well, what do you think is the advertisement, and then why don’t you think it’s going to be as bad?
Bart Melek: Well, I think any time you talk recession, traditionally, that implies 40% to 60% decline in key commodities peak to trough. We think this time is going to be a little different, famous words, a little different, but we really believe that it is an environment that is full of supply-side challenges. And even though we do expect pretty significant declines in demand growth for oil, for copper, and other key industrial commodities, we don’t see a route as we would typically expect during a period when China is not performing well economically, when the Federal Reserve and other central banks are very aggressively tightening monetary policy. And I think there is broad talk of a recession next year. We are certainly forecasting it, and yet, commodities are doing fairly well by, I think, most metrics.
Kim Parlee: Yeah, well, let’s talk. Let’s dig into that then, because you just gave a whole litany of reasons why it should be much further down. Let’s talk with the supply side, and the one that’s in the headlines, of course, is Russia and with what’s happening with oil there. But maybe just take us through what you’re seeing on the supply side.
Bart Melek: Well, on the supply side, of course, there’s the obvious problem with less crude supply because of the sanctions levied against Moscow because of the war in the Ukraine. That certainly took an awful lot of supply out of the market, and demand has been fairly well. We’ve seen the spikes earlier in the year to the upside. We’ve seen corrections recently, but the fundamental problems remain. And one of the issues is OPEC plus, the major global producer cartel, can and has the latitude to behave strategically. A few weeks ago, they’ve made an announcement that they will reduce supply by some 2 million barrels, well, the quota anyway, and prices have been doing fairly well as a result. On the other hand, we have producers in the shale that are simply not responding to the recent price increases as we should. We’re seeing evidence that most of the money is being spent on dividends and debt repayment as opposed to moved into exploration and capital ex.
Kim Parlee: Why is that? I mean, because that is something we’ve heard, that they’re not plowing it back into the ground get oil out. They’re paying it out to investors. Is that just because investors won’t have it any other way? Is that part of the reason, or what is the reason we’re seeing that?
Bart Melek: I think there is a lot of truth to that. One, I don’t think there’s an awful lot of appetite in corporate boards to spend money on new projects. There are regulatory restrictions, and I think there has been a lack of positive valuation for these companies. Or there is, I think, a perception out there that they may not be rewarded in terms of equity price for the risk and the expenditures they may be taking to develop new oil supply or new energy supply if you like. It seems that the belief is out there that investors are happier when they get cash.
Kim Parlee: Yeah, and also, I mean, obviously, with the ESG mandates coming around and less of a focus on the fossil fuel side, I think I was seeing, even in Germany, I think, I believe, they were starting to tax the excess profits coming in from oil companies. So you’re not getting rewarded for doing more for these companies too.
Bart Melek: Well, you know, there’s that. I mean, that ultimately means that there will likely be less supply than you would expect given what we’re seeing on the supply side.
Kim Parlee: What about the demand side? I mean, you talked about all the reasons why that we could see demand come down, China being one of the big ones, I mean, the COVID zero policy. So what do you see maybe for China over the next little while? Like are you going to– how long will it take to get that engine revving up, again, do you think?
Bart Melek: Well, you know, that is a tough question. Of course, many of us believe that China was going to free up the COVID zero regulations a month ago or so. That really didn’t happen. We’re continuing to see infections at a rapid rate, and this is a country which is not necessarily using vaccines with huge amount of efficacy. And the proportion of the population that is vaccinated is not overly large, and then that ultimately means that there’s a lot of risk of people ultimately dying. Still, a small proportion of the population, but it’s a big country, 1.4 billion or so people. That could be potentially dangerous, so we don’t think those restrictions are coming off quickly. None of us are experts in infections, but reading of what other experts are saying, we would say that the return to normality there will likely be gradual.
Kim Parlee: Let’s bring up a chart of the oil prices. $77.94 is what, I think, we closed at today, a bit of a down day, I know, for oil prices. But where do you see it going, I mean, given, I guess, the underpinning of the supply side, I guess, I would say, and would protect us from the traditional downside we see in a recession?
Bart Melek: Sure, we do see demand not being as robust as many thought six months ago, where the consensus was talking about 2 million barrels of new demand. Plus we think maybe 1.3 or 1.4 million barrels, but we do think that, as the winter really gets us into a grip here, we will see demand for heating oil and distillates of all sorts increase, particularly since natural gas and LNG are in short supply. That means we’re going to be substituting wherever we can with petroleum products, and we think that the market can tighten up quite a bit. We suspect that it’s unlikely that Saudi Arabia and other OPEC members will materially increase supply as was mentioned recently in the press. I think certainly with today at $77 and continued worry– a market worry that we might be in excess supply situation, probably no new huge supply coming up soon. And we ultimately think that OPEC will be true to its word, and they will keep this market balance. And we think prices will go north of $90, $95 as we move into 2023, particularly after the Federal Reserve pivots and China starts opening up.
Kim Parlee: All right, well, great to have you here, and we’ll have you back to keep us honest in terms of what’s going on. Bart, always a pleasure.
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