Following a volatile 2021, we examine the 2022 outlook for Oil, Iron Ore, Copper, and Aluminum.
Commodities are an important asset class to consider when assessing the broader macro backdrop. They help inform our inflation view and can give us additional insight into global sentiment, while also serving as an important input in evaluating Emerging Markets (EM) credits.
Through November 2021, we saw oil prices rise 66% and then fall 20%, while Iron Ore rallied 56% before plummeting 66%. Copper and Aluminum were also volatile, before ending the month up 21% and 32% respectively. All in all, it was a wild ride!
Consistent with our view of a global reflation, oil, copper, and aluminum should enjoy a strong start to 2022. Iron ore is likely to remain in the doldrums until we see either a recovery in demand or a normalization of inventory.
Despite the volatile backdrop, we will attempt to chart the likeliest price trajectories for 2022. Covid remains an overarching risk and difficult to predict, with the capacity to quickly move us away from the base case scenarios we summarize below.
Brent Crude Oil
Supply is likely to be the more important driver for prices in 2022, with continued OPEC+ cooperation and a US shale ramp-up the key factors to monitor. OPEC+ held to their plan over 2021 and have reaped the benefits through higher oil prices. Assuming they can continue cooperating, the group will likely provide a strong floor to oil prices and limit downside. The swing factor for oil will come from any increases in US shale production. At the moment, we are not seeing any signs of a substantial increase, with shareholders continuing to prefer getting their cash back rather than investing in growth. The recent global Strategic Petroleum Reserve (SPR) release, led primarily by the US, will add barrels to the market over December and Q1 2022, but should have a limited medium-term effect, as it will eventually need to be bought back. On demand, we expect a supportive backdrop, and assume that even if covid cases remain high, major developed market (DM) economies should remain largely open. As a result, we see jet fuel consumption, the last remaining sector lagging pre-covid levels of utilization, to improve over the year as new infections abate and global tourism resumes. Taken together, prices should rally in 1H 2022 when inventories are low and demand is improving, before stalling in 2H 2022 when additional supply from the US and OPEC+ comes online. Whether or not we spike as high as $100 will be determined by any deviation from the OPEC+ plan and the strength of the demand recovery.
The key risk remains new Covid variants. While known, their impacts are difficult to predict and can emerge with little warning to push the market lower. Furthermore, the low global inventory position of the oil market exacerbates price action, with small changes in the supply/demand balance leading to relatively large changes in prices.
The main challenge for iron ore will come from higher-than-normal inventory levels and our expectation of a surplus balance in 2022, which will need to be worked through either by a sustained period of lower-than-average prices or by a pickup in demand. The demand outlook for the metal remains challenged with Chinese consumption under pressure because of a slowdown in property investment, modest growth in infrastructure spending, and a decline in steel production to fulfil carbon neutrality goals. Furthermore, we see limited capex and capacity growth for steel output in China in the medium term. On the production side, we expect more supply coming online in 2022; iron ore producers are not yet responding to the lower prices because of low production costs. Given the relatively weak outlook, we think that sustained lower prices, particularly in 1H 2022, are needed to bring the market back to balance.
The key risk is a faster-than-anticipated pickup in demand and/or any signal of policy loosening in the Chinese property sector. We view the latter as unlikely because the Chinese government has been reiterating it will not use property as a stimulus tool.
Demand for copper is expected to be robust, driven by continued investments in the green economy globally. From a supply perspective, there are no major new projects that are expected to come online. In addition, we are seeing blockades and protests, as well as drought-induced constraints on water access, which is likely to affect near term production and could exacerbate the supply deficit. As a result, all factors are pointing to a continued strong environment for copper prices with risks skewed to the upside.
The key risk is that copper is a consensus bullish trade and positioning in the metal is prone to get extended, with macro market volatility impacting copper more than most commodities. However, the fundamental outlook provides a strong backstop to the metal’s price. The other risk to monitor is scrap supply, which was impeded during Covid when China altered regulations by shifting collection to other countries. How this dynamic evolves over 2022 could cause additional volatility in both directions.
Demand for aluminum is expected to remain strong over 2022 with recovery in auto demand, growth in the power grid, and green spending expected to offset the impact from the slowdown in property investment in China. Note that aluminum is typically used at the end-of-construction cycle. Therefore, Chinese property developers have a strong incentive to complete projects under construction so they can deliver the home and (1) fulfill their government objective to complete construction, (2) recognize revenue, and (3) use the cash trapped in deposit and escrow accounts to repay debt. Hence, we believe the slowdown we are seeing in property construction in China has a higher impact on cement and steel demand, which are used at the beginning of new construction, as opposed to aluminum and copper, which are used in the later stages. On the supply side, production ceilings will remain in place in China in order to fulfill the country’s carbon neutrality plan, providing a supportive backdrop for the metal. We see capex as muted and strictly applied to capacity swap programs only. The spike in prices we saw in Q4 2021 because of power rationing in China is likely to unwind, but the aluminum market is still expected to be in deficit for 2022. Taken together, we are bullish Aluminum in 2022 with risks skewed to the upside.
The key risk is power constraints in China, which affect downstream demand.
Forecasts, projections and other forward looking statements are based upon current beliefs and expectations. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecasts, projections and other forward statements, actual events, results or performance may differ materially from those reflected or contemplated.
The information herein is for illustrative purposes only and does not necessarily reflect current estimates. The purposes of the above is to provide background on the types of analysis performed by JPMIM's research group, as an investment advisor. The inclusion of any investment mentioned above are not to be interpreted as recommendations to buy or sell. A full list of firm recommendations for the past year is available upon request. There can be no guarantee that the above have been or will be profitable in the future.
Commodity Risks: The value of commodity related securities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. The energy sector can be significantly affected by changes in the prices and supplies of oil and other energy fuels, energy conservation, the success of exploration projects, and tax and other government regulations, policies of the Organization of Petroleum Exporting Countries (“OPEC”) and relationships among OPEC members and between OPEC and oil importing nations. The metals sector can be affected by sharp price volatility over short periods caused by global economic, financial and political factors, resource availability, government regulation, economic cycles, changes in inflation or expectations about inflation in various countries, interest rates, currency fluctuations, metal sales by governments, central banks or international agencies, investment speculation and fluctuations in industrial and commercial supply and demand. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.