As many of the world’s governments continue pushing to a greener future, the energy transition is colliding with another challenge facing the world as it struggles to emerge from the pandemic: skyrocketing food prices.
Many energy companies plan to increase their biofuel capacity by 2030, mainly using crops like corn and soybean oil as a major feedstock.
But such a move is driving price inflation for a host of commodities and vegetable oils, including palm oil, canola and soybean oil. Meanwhile, corn, oil, copper, and gasoline futures prices have all doubled from a year ago while lumber has more than tripled.
Simply put, accelerating demand for renewable biodiesel fuels is directly responsible for a worrying commodity price inflation.
Food costs have been pushed to their highest in seven years in a price boom reminiscent of the China-led commodities supercycle which helped precipitate the world into a food crisis earlier this century. Demand for vegetable oils in North America is growing so fast that the region risks going from a surplus to serious shortfalls in less than a decade.
Low carbon fuels
A big reason why the demand for renewable biodiesel fuel has skyrocketed is California’s Low Carbon Fuel Standard (LCFS) rule. The rule is designed to lower California’s carbon intensity from transportation fuels and provide a range of low-carbon renewable alternatives.
Created in 2011, LCFS is a market-based program that focuses specifically on reducing the carbon intensity of fuels used in the state and aims to reduce greenhouse gas emissions throughout the state by 20% by 2030 and 80% by 2050.
To this end, Phillips 66 is in the process of converting its San Francisco area oil refinery into one of the globe’s biggest renewable fuel plants.
And, it’s clearly having a huge impact on food commodity prices.
“The entry of legacy petroleum companies has spun this industry on its ear. The market has tightened so much the food side was caught off guard,” John Jansen, vice president of strategic partnerships at United Soybean Board, has told Bloomberg.
JPMorgan Chase & Co estimates that under Biden’s Climate Plan, U.S. production capacity for renewable diesel will jump almost sixfold by the end of 2024.
Soaring commodity prices have raised serious doubts about whether the fiscal and monetary policies designed to buffer the economy during the pandemic are now working against it.
To be fair, the economic reopening has been bumpy due to factors such as depleted inventories leading to big restocking orders and putting premiums on near-term deliveries of raw materials. Jammed supply lines are creating pockets of scarcity and adding costs that are passed directly on to consumers.
Commodity bull market
But then again, the entire commodity market is experiencing a major boom thanks to the massive stimulus by the world’s major economies.
Factories are humming and consumers are spending again, helping to trigger a broad commodity rally thanks to the so-called reflation trade.
In fact, Wall Street is now predicting a new commodity bull market that will rival the oil price spikes of the 1970s or the China-driven boom of the 2000s. Market experts, including Goldman Sachs, believe the commodity boom could rival the last “supercycle” in the early 2000s that powered emerging BRIC economies (Brazil, Russia, India, and China).
These expectations are supported by the fact that the price movement of most commodities has historically been both seasonal and cyclical. Peering at the 10-year charts of leading commodities reveals a clear pattern of mean reversion where prices tend to oscillate backward and forward towards their mean or average.
And so far, Wall Street appears to be right on the money, with the Bloomberg Commodity Index (BCOM) up 11% in the year-to-date and nearly 40% over the past 52 weeks.
Here are 3 key commodities that can act as an inflation hedge and also as a nice play in the emerging commodity supercycle.
#1. Oil
After a historic slump, oil has also been on a tear, up 110% in a year. In a sharp turnaround from last year, the energy sector has emerged as one of the best-performing. Brent crude has been flirting with $70 per barrel, a level it last touched nearly two years ago.
The oil rally this year has been spurred by encouraging production discipline, including OPEC+ recently extending most output cuts to April and Saudi Arabia agreeing to voluntarily extend its output cut of 1 million barrels per day output cuts as well as the ongoing Covid-19 vaccine rollout that gives hope that a full reopening might not be far off. You can expect to see oil demand considerably in the coming months as more people begin to travel, especially with the EU now launching a “Digital Green Certificate” that will facilitate safe and free movement within the bloc for people who have been vaccinated.
Although the rally has lately taken a breather due to concerns that demand continues to be patchy, consumption is roaring back in notable regions, including the United States. A stronger dollar has also been curbing crude’s gains.
The hiatus might, however, be temporary with eyes glued on U.S. inventory data when it comes out on Wednesday, which could show the first drop in crude stockpiles since mid-February. The Fed is also expected to release a policy statement later on the same day as attention on the pace of global inflation grows. Fed Chair Jerome Powell has promised to maintain aggressive support of the U.S. economy. The central bank’s quarterly economic forecasts will show how many of his colleagues share his commitment. The Federal Open Market Committee (FOMC) is widely expected to hold interest rates near zero at the conclusion of its two-day policy meeting on Wednesday, and keep buying bonds at the current $120 billion monthly pace.
So the current outlook is largely bullish for oil.
Which is just as well: Danielle Shay, director of options at Simpler Trading, has told CNBC that not only can oil perform even better in a reopening economy but can also be a really good hedge against inflation.
Indeed, with oil prices having surpassed even the most bullish projections on Wall Street, some punters are now imagining the seemingly impossible. Bank of America says oil prices could spike over $100/barrel in the coming years.
#2. Copper
Similarly, Danielle Shay has picked copper as the other commodity that can perform well in a reopening economy and also act as a good hedge against inflation.
The price of copper has doubled in the past year to over $9,000 a metric ton for the first time in nine years, driven by tight supply and strong demand for the industrial metal.
Copper is moving closer to an all-time high set in 2011 as investors continue to bet that supply tightness will increase as the world recovers from the pandemic. Spencer Barnes, associate vice-president of mutual fund and ETF strategy at Raymond James Ltd, says that thesis is mostly sound since copper is cyclical and driven by market expansion, and should see a surge in demand given the massive push to reopen the economy and the fiscal stimulus that could spur consumption.
Further fueling the rally is an anticipated ‘green’ shift in the post-COVID economy, which supports higher demand for copper and other base metals since EVs use about 4x more copper than gasoline-powered vehicles.
The International Copper Association estimates that the rapid rise of EVs will raise copper demand in EVs from 185,000 tonnes in 2017 to 1.74 million tonnes by 2027.
#3. Lithium
Lithium bulls are enjoying their best moment in decades, lithium prices already up 90% YTD thanks to robust demand for cobalt and nickel free EV batteries.
Bullish tech markets are rarely without curious dislocations. And right now, one of the biggest imbalances can be seen in the huge momentum behind EV stocks such as Tesla Inc. and the lithium market, which has remained in bear territory for years now.
Over the past couple of years, a cross-section of analysts, including Goldman Sachs, have tried calling a bottom on lithium prices, reckoning on a significant contraction in supply as persistently low prices limited production of one of the key commodities in the EV powertrain. That has not happened–until now.
Lithium’s moment to shine appears to have finally arrived, thanks to the massive electrification drive and robust demand for electric vehicles.
Specifically, lithium prices have been on a tear thanks to explosive demand for lithium iron phosphate (LFP) batteries, according to Benchmark Mineral Intelligence (BMI).
BMI says battery-grade lithium carbonate midpoint price (EXW China, ≥99.0% Li2CO3) for mid-March was a good 88% higher since the start of the year to over $12,600 a tonne, the highest level since March 2019.
Lithium hydroxide prices are up 20% over the timeframe, although a relatively deep discount to carbonate continues to exist.
Cobalt and nickel free vehicles are proving to be a runaway success.
According to BMI analyst George Miller, “…demand for durable, improved, and low-cost LFP cathode material has become rejuvenated in China – a very similar story to what we saw in lithium’s last price run of 2016 but with a much improved product for the 2020s.”
A year ago, Tesla Inc. surprised the electric car industry when it announced some Model 3s made in its Shanghai factory will be equipped with lithium iron phosphate (LFP) batteries.
In December, only its second full month of sales, Tesla Model 3 55KWh LFP-battery captured 5.9% of the global full electric car market in terms of battery capacity deployed despite not being for sale in the US. Strong demand in Europe saw LFP-powered Model 3s command 46% of all Model 3 sales in January.
The Democratic Republic of Congo (DRC) is home to over half of the global cobalt reserves and provides over 70% of the total cobalt feedstock production globally. Unfortunately, for many years, human rights groups have highlighted severe human rights issues in cobalt mining operations, including child labor, leading to buyers shunning supplies from the region.
