After a buoyant year in 2022, commodity markets face a tougher environment in 2023. Demand for natural resources has historically ebbed and flowed with economic growth, which is creaking under the weight of higher interest rates, higher inflation and geopolitical tensions.
However, while commodities cannot be immune to falls in global demand, there are a number of reasons why they may not be as fragile in the current cycle.
A series of factors drove commodity prices higher in 2022. Most important was the war in Ukraine, which took supply out of the market and pushed prices up. There was a legacy of supply chain difficulties from the pandemic, which collided with rising demand as economies across the world reopened. These circumstances were unique, but there are still a number of factors in place that support commodities prices.
Demand and supply
Many of the supply problems that have pushed prices higher are still in place. Inventories for many commodities are at historic lows, while long-term underinvestment in new commodities supply means that there is still a mismatch with demand. Many energy companies are still choosing to return cash flow to shareholders via dividends and buybacks rather than investing in new production.
Demand is likely to fall if the economic environment weakens. While the US, eurozone and UK economies have proved more robust than many thought at the start of the year, there are signs that higher interest rates are hurting growth. The most recent US GDP data showed growth slowing to 1.1% in the first quarter of the year and growth in the eurozone remains anaemic.
However, it is important to balance this weakness against a reviving China. China remains the most important economy for mining, and is moving in the opposite direction to the rest of the world following a year of lockdowns and a strict zero-Covid policy. The most recent round of services data, for example, showed the strongest levels in more than a decade suggesting the recovery is on track.
The energy transition remains a source of structural demand for a number of key commodities. Decarbonisation is building momentum across the globe, with investment programmes such as the Inflation Reduction Act in the US and RePower EU in Europe accelerating growth. Energy security has become a top priority for many governments, driving investment into sustainable options. The IEA’s World Energy Report 2022 suggests annual clean energy investment will need to more than double by 2030 to US $4trn to achieve net zero targets.
There is a financial incentive as well. Renewable energy costs for onshore wind and solar have fallen and it now represents the most economic technology choice for power generation in many markets, which is driving rapid adoption. We see similar cost competitiveness trends in other areas such as energy storage solutions.
While 2022 saw some exuberance in the prices for key energy transition metals such as lithium, these have fallen back as demand has slowed and now look more realistic. Overall, there is growing recognition of the role mining companies will need to play in supplying the materials required for lower carbon technologies such as wind turbines, solar panels and electric vehicles.
The bounce in many commodity prices in 2022 was driven by Russia’s invasion of Ukraine. This forced a reappraisal of the way countries source and use energy. This reappraisal is still ongoing, with policymakers keen to ensure that energy supplies are not at risk next winter. This will continue to drive demand for specific commodities.
OPEC has also showed itself to be more reactive on oil prices. It announced plans to reduce production targets (on 5 October 2022 and 2 April 2023). It is keen to put a floor under the oil price, ensuring that the oil price is high enough to make profits, but not so high that it kills off economic activity.
Energy and natural resources markets will remain an exciting area to invest even if the global economy weakens. Structural shifts in the global economy mean they will not simply ebb and flow with global growth as they have done in previous cycles. For us as investors, the key is to retain a flexible approach, ready to respond to long-term social and economic shifts.
Mark Hume is the manager on the BlackRock Energy & Resources Income trust. The views expressed above should not be taken as investment advice.