Podcast Summary
Navigating the Complexities of the Volatile Commodities Market: In the volatile commodities market, a 360-degree perspective and the ability to navigate complexities are crucial for identifying investing opportunities. Traders face intense price volatility, physical availability issues, uncertainty around financing and settlements, and geopolitical events like the ongoing war in Ukraine.
The current commodities market, particularly oil, is experiencing unprecedented volatility due to a combination of geopolitical events and a tight market. Principal Asset Management, a real estate manager, emphasizes the importance of a 360-degree perspective in identifying investing opportunities. Meanwhile, in the commodities world, traders like Pierre Onderand of Onderand Capital Management are dealing with intense price volatility, physical availability issues, and uncertainty around financing and settlements. The situation is further complicated by the ongoing war in Ukraine and its potential impact on oil and sanctions. This volatile market is unlike anything traders have seen in recent decades, with historically low inventories, low spare capacity, and high expected demand. It's a stressful and emotional time for those in the industry, but also an opportunity for those who can navigate the complexities.
Oil market's physical tightness and significant backwardation: Low inventory levels and geopolitical tensions cause oil price increases, with investors using futures and options to bet on price movements
The current oil market is experiencing extreme physical tightness due to strong fundamentals and significant backwardation, which means the price of oil for immediate delivery is much higher than for future delivery. This situation is driven by low inventory levels and geopolitical tensions, and it could lead to even more significant price increases as disruptions continue. The speaker's investment strategy involves studying the fundamental supply and demand dynamics of the market to make informed bets on price movements, whether bullish or bearish. They use futures and options to express their views, with more leverage and less risk through options when expecting large price moves in a short time. The speaker's fund has held both long and short positions throughout various market conditions, including during the financial crisis and the COVID-19 pandemic.
The physical aspect of oil trading impacts prices significantly: Low inventories can cause prices to soar, while oversupply can lead to negative prices. Regulatory restrictions and high production costs limit supply response in the oil industry.
The physical aspect of commodity trading, specifically oil, plays a crucial role in determining prices. When inventories are low and there's a need for delivery, but no oil is available, prices can skyrocket. Conversely, when inventories are full and there's an oversupply, prices can go negative. Speculators help keep prices within a range to prevent the market from running out of inventories or storage capacity. Despite the ongoing debate about why there hasn't been a more aggressive supply response in the oil industry, particularly in the US context, Principal Asset Management believes there are two reasons: regulatory restrictions and the high cost of production. Understanding the physical aspect of commodity trading is essential for making informed investment decisions.
US oil industry plateaus, pressure to address climate change: Despite pressure to transition to renewable energy, traditional oil and gas will still be needed in the short term due to energy demand and infrastructure limitations.
The US oil industry has reached a plateau in terms of production growth, with many fields becoming more mature and some companies still recovering from financial losses. Producers are under pressure from shareholders to maintain profits rather than increase production, and there's also pressure to address climate change by not increasing supply too quickly. However, there's a looming energy crisis as the world transitions to renewable energy sources and electric vehicles, as the electricity to power these new technologies may not be readily available, especially in Europe. Renewable energy sources, such as solar and wind, cannot ramp up quickly enough to replace lost fossil fuel supply, and it will take time to build the necessary infrastructure to support the transition. In the short term, traditional oil and gas may still be needed to meet energy demands. The Russian situation has further complicated the issue by disrupting oil and gas supplies from that region. While there is a long-term plan for a transition to renewable energy and electric vehicles, it cannot happen overnight and will require significant investment and time to build the necessary infrastructure.
Metal supply challenges due to geopolitics and ESG concerns: Geopolitical tensions and ESG concerns are causing metal supply crunches, with potential long-term impacts. Prices may need to increase significantly to incentivize new supply, while the loss of Russian oil further complicates the situation.
The current global situation, including geopolitical tensions and the push towards renewable energy and electric vehicles, presents significant challenges for the supply of necessary metals. The miners have been under pressure due to ESG concerns, which could lead to a metal supply crunch in the long term. Replacing lost Russian oil in the short term is also a challenge, as it takes time to increase production from other sources. The long-term view is that metal prices will likely need to increase significantly to incentivize enough supply growth to decarbonize the world. The loss of Russian oil, which is not likely to return soon due to geopolitical tensions, further complicates the situation. The situation is complex and uncertain, and it depends on various factors, including geopolitical developments and the pace of transition to renewable energy and electric vehicles.
Russia-EU conflict could cause global energy crisis: Europe may need to find alternative sources for oil and gas, implement demand reduction measures, and work together to conserve energy and accelerate the energy transition to mitigate a potential energy crisis due to reduced Russian supply.
The ongoing geopolitical situation between Russia and the EU could lead to a significant reduction in the supply of Russian oil and gas to Europe, potentially triggering a global energy crisis. This could result in the need for Europe to find alternative sources of oil and gas, as well as implement measures to reduce demand. The IEA's strategic reserves could provide some relief, but releasing large quantities would leave them empty in a few years, requiring resupply. Demand destruction through government mandates or higher prices could help offset the supply shortfall, but it may not be enough to completely replace the lost Russian supply. Ultimately, finding a solution will require a collective effort from all countries involved and a commitment to energy conservation and the acceleration of the energy transition.
Economic recessions cause significant oil demand destruction: Large economic downturns lead to prolonged low oil demand and prices, while OPEC's role in the market is uncertain
Large economic recessions, not marginal factors like public transport or high prices, cause significant demand destruction for oil and lead to major price drops. For instance, the financial crisis in 2008 and the European sovereign crisis in 2011-2013 resulted in prolonged low oil demand and prices. The speaker believes that the market doesn't expect the current oil supply disruption from Russia to last long, and prices could potentially reach $200 a barrel before demand is significantly affected. The role of OPEC in the oil market has diminished, with the focus now on the shale response. Despite their impressive response in 2020, OPEC's behavior remains uncertain.
OPEC+ Cautiously Bringing Back Oil, Some Struggle to Meet Quotas: Saudi Arabia, Kuwait, and UAE have significant capacity to bring on additional oil supply. Iran may add a million barrels a day, but it will take time. US supply increase will also take 12 months. Shift from dollar as reserve currency overstated, strong rule of law and financial market essential for a strong currency.
OPEC+ has been cautious in bringing oil back to the market, respecting quotas and gradually increasing production. However, many countries, particularly those in Africa, have struggled to meet their quotas due to underinvestment and declining production. This has resulted in limited speculative production capacity, with only Saudi Arabia, Kuwait, and the UAE having significant capacity to bring on additional supply. The market expects Iran to bring back a million barrels a day, but it will take 12 months for the US to increase supply. Regarding the potential shift away from the dollar as reserve currency, it's overstated as countries could still be sanctioned even if their currency is backed by gold or cryptocurrencies. Strong rule of law and a robust financial market are essential for a strong currency. For now, the US, Europe, and Japan have these strengths, while China, which holds a lot of US treasuries, remains dependent on the US.
A strong economy leads to a strong currency and protection against inflation with commodities: Investing in commodities like energy, agricultural products, food, and metals can protect against potential high inflation. However, there's underinvestment in commodities, and new supply may take up to 15 years to come to the market, leading to higher prices and increased US and global oil production in the near term.
A strong economy with freedom, low corruption, entrepreneurship, and a strong rule of law leads to a strong currency. When people are concerned about potential high inflation, they should protect themselves by investing in traditional commodities such as energy, agricultural products, food, and metals. However, there has been underinvestment in commodities, and it could take at least 5 years before new supply comes to the market. This is especially true for metals and oil, where new projects can take up to 15 years to come online. The hesitation to invest in long-term projects today is due to uncertainty about future demand levels. As a result, we can expect more oil production from the US in the near term and from the rest of the world a bit later, but we will likely have to live with higher prices to keep demand in check and accelerate the energy transition.
Supply constraints shaping future economic growth: The current commodity market constraints, including potential metal shortages and high steel prices, can limit oil production growth and economic expansion over the next decade. Understanding supply factors is crucial for predicting future economic trends.
The current commodity market constraints, including the potential shortage of metals and high steel prices, can limit oil production growth and economic expansion over the next decade. The speaker emphasized that supply, not just demand, will be a significant factor in shaping future economic growth. Regarding the potential for oil prices reaching $200 per barrel, the speaker explained that people may need to gradually accept higher prices as they get used to them, and that the economy's decreased oil usage per unit of GDP also justifies higher prices in today's market. The process of adjusting to higher prices will be gradual, as demand doesn't decrease immediately, and there are limited alternatives to oil. The speaker also warned that if prices stay too low for too long, inventories could run out, leading to unpredictable price increases. Overall, the speaker emphasized that understanding the role of supply constraints in commodity markets is crucial for understanding future economic trends.
Money can't solve all economic problems, time is crucial: Money can't solve all economic issues, time plays a crucial role in addressing infrastructure, production and recovery processes
While money can help alleviate some economic problems, there are certain issues, such as the time it takes to build essential infrastructure or ramp up production of critical resources, that cannot be solved with monetary means. The ongoing crisis in Ukraine and Russia, and the potential for long-term disruptions to oil and other commodity markets, highlights this reality. Even if a conflict ends tomorrow, the consequences and recovery process could take years. Additionally, the possibility of physical delivery issues in commodity markets could lead to significant price increases. Ultimately, the importance of time as a non-negotiable resource in economics cannot be overstated.
American Express Business Gold Card: Flexible Spending and Annual Credits: The American Express Business Gold Card offers businesses flexibility in spending and potential annual statement credits of up to $395 on select merchants, making it a valuable tool for businesses.
The American Express Business Gold Card offers businesses flexibility with spending capacity and potential annual statement credits of up to $395 on select merchants. This card's benefits make it a powerful tool for businesses, backed by American Express. Additionally, for those interested in finance and Wall Street news, check out the new Money Stuff podcast featuring Matt Levine and Katie Greifeld, where they dive deeper into the topics covered in Matt's popular newsletter. Listen to Money Stuff on Apple Podcasts, Spotify, or wherever you get your podcasts.
