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Russia/Ukraine: Inside commodities markets
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By: David Chang, Commodities Portfolio Manager
The commodities markets have been in the crosshairs of the Russia/Ukraine crisis because both countries are major global exporters of critical commodities. Energy commodities (oil and gas) have been top of mind for many investors given these markets’ centrality to global inflation, growth, and monetary policies. But Russia and Ukraine also export significant amounts of other key commodities: nickel, steel, and other metals, along with agricultural staple commodities like wheat and corn.
I’d be hard pressed to find a historical precedent where a geopolitical event involving two commodity exporters of such size and breadth is impacting global markets to the same degree as Russia/Ukraine. For a little perspective, Russia is the world’s second-largest oil exporter. It contributes about a third of Europe’s total natural gas supplies. In aggregate, it’s the second-largest global exporter (behind the US) on a gross basis and the largest on a net basis. Ukraine is important in its own right, especially as an exporter of wheat and corn. (Much of Ukraine’s total global exports are concentrated in grains, whereas Russia’s are broader-based.) In fact, if you combine Ukraine’s exports of wheat and corn with Russia’s, they comprise about 25% of world exports of those two commodities.
And this tragic episode is occurring at a time when global commodity markets were already very tight. The structural supply-demand backdrop has rarely been more favorable for prices, with aggregate inventory levels across almost all commodity groups the lowest they’ve been since probably the 1980s. What typically happens when supplies are that tight and unresponsive is that commodity prices skyrocket, making us much more dependent on demand for commodities that people want or need having to be “destroyed” by the elevated prices. And the price levels that might trigger said demand destruction are often dramatically higher than what we’d call a “normal” price for any given commodity.
So, it’s no surprise that we’ve seen near-term volatility in the commodities markets since the conflict began earlier this year. Looking ahead, challenges may persist. On the supply side, Russia may struggle with its production, especially as it loses external financing, and could even opt to impose export bans on some commodities. Longer term, onshoring a country’s supply chains can be an expensive solution (i.e., inflationary) because it essentially means moving away from a very low-cost producer (for example, oil and metals production in Russia is among the cheapest in the world) toward reliance on much higher-cost domestic supply chains to produce those same commodities. And finally, there are still financial obstacles in the medium and long term to investing substantial capital in the energy transition. Time will tell.
For more on the transformational changes of the Russia/Ukraine situation, click here