• TRADE FINANCE, MACRO AND MARKETS

    Greening the supercycle

February 2021

Are we heading for another commodities supercycle? One could be forgiven for thinking this was just around the corner given some of the bounce-backs in prices, but ESG priorities and liquidity shortfalls bring different nuances, flow’s Clarissa Dann reports

When the commodities boom of the 2000s evolved into what was heralded as a “supercycle”, it was not hard to see how rising demand from China, together with concerns over long-term access to supplies, had created it.

Almost 20 years on, in early 2021 we look to be on the cusp of another, but rather different period of sustained above-trend movements in a range of commodity prices.

“We do seem to be entering into something of a commodities supercycle, but this is more the consequence of supply and demand factors aligning temporarily resulting in significant spikes in prices" said Chris Midgley, Head of S&P Global Platts Analytics on 18 January1.

Carefully avoiding the word “supercycle,” Deutsche Bank commodities analysts declared in their Commodities 2021 Outlook: Cyclical recovery meets a green tipping point (13 January): “We expect recovering demand in the West, sustained demand strength in China and potential further USD weakness to remain positive underpins to the cycle through 2021. We continue to anticipate a cyclical peak in commodity consumption growth rates and prices around mid-2021.”

Path of the supercycle

It would appear that the upward trajectory of a supercycle has, over the decades, aligned with economic shock recovery. “Analysis shows that the current supercycle is following the average path of these historic supercycles, pointing to a turn in commodities through the 2020s,” reflected Daniel Sullivan, Head of Global Natural Resources at investment managers Janus Henderson in August 2020.2 His chart (see Figure 1) would indicate that he has a point – although a US index, it is nevertheless helpful given the fact the US is the world’s largest importer.

Figure 1: US commodity price index 1795 to present

Source: Stifel Report June 2020 as published in the Janus Henderson article here

After months of economic contraction and shutdowns as a result of Covid-19, it would be no surprise that the various bounce-backs around the world, together with government stimulus measures have had an effect on supplies (and therefore prices) of certain commodities. After all, we are only 10 months on from 20 April 2020 when the May contract West Texas Intermediate (WTI), the US oil benchmark, which had started the day at US$17.85/bbl traded at –US$39.55/bbl, remaining in negative territory for around six hours before recovering to US$1.43 the next morning.3

By contrast, by 8 February 2021, the spot price for April 2021 was US$58.6/bbl, according to Bloomberg.

In its article Commodity prices are surging: Is a new supercycle beginning? (16 January) The Economist predicted “the roll-out of vaccines across the world’s largest economies will eventually inspire higher levels of travel and trade. And a big spending bill by a Democratic American government, together with continued loose monetary policy from the Federal Reserve, would stimulate economic activity and therefore commodity consumption.”

In the newspaper’s view, this could weaken the dollar, making oil and other commodities denominated in dollars “cheaper for buyers in emerging markets, lifting demand and pushing commodity prices even higher”.4

But there is more at play here than Covid-19 recoveries. As the world moves into a state of energy transition and the new US administration joining the Paris Agreement on 21 February 2021,5 fossil fuels will become harder to finance, impacting investment, and ultimately the price. It all depends how quickly renewable alternatives can come on stream to mop up demand – overall energy demand is not reducing.

Surge or splurge?

As one of the global banks supporting commodity traders moving huge volumes of commodities around the world all the time, feedback, according to Willem Calame, Head of Natural Resources Finance Flow EMEA at Deutsche Bank has indicated, they are “quite bullish” about sustained price rises because of the challenges throughout the supply chain “such as failed harvests and structural increasing demand for food, storage capacity, geopolitical tensions, trade wars, banks/insurance/investor views on oil and gas – and ESG.”

In other words, the level of industrialisation as the world goes into post-Covid recovery stimulation mode could be on a par with China’s earlier trajectory – which drove the 2000s supercycle. “This is a lot of infrastructure projects consuming a lot of commodities in years to come,” explains Calame.

However, both he and Sandra Primiero, Deutsche Bank’s Global Head of Natural Resources Finance agree that once commodities production normalises after Covid lockdowns, prices will normalise as well. In addition, “core traditional industries such as automotive and aviation will need less steel because of their reduced production levels”.

“It is far too early to say we are at the actual beginning of a supercycle,” states Primiero. She and Calame point out that supercycles by definition are “years and years of a high price environment” and it would take the equivalent of China going into an industrial boom all over again to drive another one. Post-Covid-recovery does not equate to any kind of equivalent demand surge.

What we could be seeing at the moment is more of a short-term surge in 2021 that will not be sustained. Part of the reason for this is lack of bank lending as banks prioritise domestic borrowers.

Sandra Primiero, Global Head of Natural Resources Finance, Deutsche Bank and Willem Calame, Head of Natural Resource Finance Flow EMEA"We do see the potential for a supercycle of those commodities that fit to products of the future"
Sandra Primiero, Global Head of Natural Resources Finance, Deutsche Bank
Willem Calame, Head of Natural Resource Finance Flow EMEA

Fuelling the future

Demand for batteries metals and other commodities aligned with energy transition is rising and looks set to continue its upward trajectory. “Batteries metals – such as lithium – are in a boom and we do see the potential for a supercycle of those commodities that fit to products of the future,” agree Primiero and Calame.

This is a view shared by producers. Keith Phillips, CEO of Piedmont Lithium told S&P Global Platts that car manufacturers will not be able to produce electric vehicles (EVs) at a rate that satisfies demand, and chemical companies will not be able to provide adequate amounts of lithium for batteries. "There is probably enough lithium in the world in terms of quality projects that are being pursued to get us to about 10% or 15% EV penetration, but the resources haven't even been discovered yet to pass that [and to] incentivise the production of these critical materials and development of these assets”,6 he reports. The other complication is traditional the process of mining lithium takes its toll on the environment; hence the quest for alternative methods such as geothermal extraction.7

If it is feasible to produce high volumes of hydrogen from solar and wind, convert this to liquid hydrogen and ship it or even use it as renewable marine or jet fuel, this could be a supercycle all by itself, predicts Primiero, although she admits this event is some way off in the future. Existing networks for liquefied natural gas (LNG) – which enjoys lower CO2 emissions than oil (or coal) – can be used for hydrogen. LNG prices have been rising steadily and look set to continue doing so in 2021, according to the International Energy Agency. In its 13 January 2021 Short-Term Energy Outlook (STEO), the U.S. Energy Information Administration (EIA) forecasts that the annual natural gas spot price at the Henry Hub will rise 98¢ per million British thermal units (MMBtu) to average US$3.01/MMBtu in 2021.8

In January 2017, the Hydrogen Council – an industry-led initiative formed at that year’s World Economic Forum to develop the hydrogen economy – explained its role in the energy transition and emphasised the need for significant infrastructure investment. “Electrolysis produces hydrogen by using (excess) power supply and enables to valorise it either in other sectors (transport, industry, residential heat) or to store it for future re-use,” stated its launch document.

“Hydrogen has the potential to improve economic efficiency of renewable investments, enhance security of power supply and serve as a carbon-free seasonal storage, supplying energy when renewable energy production is low and energy demand is high, e.g., in European winter.”9

Green hydrogen production (which uses wind and or solar power to produce carbon-free fuel from water by splitting hydrogen molecules from oxygen molecules) is gaining traction because of its potential to power energy-intensive industries such as concrete and steel manufacturing. Yale University’s helpful article, Green Hydrogen: Could It Be Key to a Carbon-Free Economy? (5 November 2020), explains progress so far and why “why the focus for now is on the 15% of the economy with energy needs not easily supplied by wind and solar power, such as heavy manufacturing, long-distance trucking, and fuel for cargo ships and aircraft”.10

As clarified by the European Reconstruction and Development Bank, “The hydrogen that the world uses today is made from either coal or natural gas. This hydrogen is carbon-intensive, it’s not a green fuel. It’s called grey hydrogen if it comes from gas, while the hydrogen produced from coal is called black. Then there is blue hydrogen, an upgrade of the grey, where the CO2 emitted is captured upstream, so the system doesn’t emit CO2 in the atmosphere.”11

Deutsche Bank Research Analyst Luke Templeman makes the point that “large investors are relatively uneducated about hydrogen compared with other forms of renewable energy” and that “the industry needs the support of financial institutions”.12

Adds Primiero “When you build a plant to produce hydrogen you need a lot of steel, so iron ore could stay high.” She goes onto explain that prices or any form of supercycle are difficult to forecast, “because we are in transition away from one natural resource (fossil fuels) to a new natural resource (renewables)”.

March of the renewables

BP’s Statistical Review of World Energy (2019) published in June 2020 noted that fossil fuels still supplied 84% of the world’s energy, but that renewable energy had continued its growth streak with the largest increase in consumption on record.12

Figure 2: Energy mix consumption 2019

Source: Statistical Review of World Energy 2019 (BP)

“The world will need oil for years to come, but clearly there is momentum for fuels for the future,” concludes Calame. And with systemically important global banks displaying sharpened appetites for ESG-related lending, that momentum looks set to accelerate.

Deutsche Bank report referenced

Commodities 2021 Outlook: Cyclical Recovery meets a green tipping point (13 January 2021)

The tough choice to create a hydrogen economy by Luke Templeman (Konzept: What we must to to rebuild, November 2020)


Sources

1 See https://bit.ly/2N9sSZa at spglobal.com
2 See https://bit.ly/2NopM3o at janushenderson.com
3 See Covid-19 and commodities at flow.db.com
4 See https://econ.st/3am1j7X at economist.com
5 See https://bit.ly/3tY1Lkp at news.un.org
6 See https://bit.ly/3dfP0vC at spglobal.com
7 See https://bbc.in/2Nx9C7J at bbc.com
8 See https://bit.ly/2MYOqb9 at eia.gov
9 See https://bit.ly/3dndhQm at hydrogencouncil.com
10 See https://bit.ly/3u2HbQ7 at e360.yale.edu
11 See https://bit.ly/37ga2qg at ebrd.com
12 See https://on.bp.com/3qmA4zv at bp.com

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