It is incredible to think that a little over a year ago WTI oil prices were trading at negative $30/bbl. in the front and today spot is trading close to $125/bbl. There was a time when one could not give oil away, it was literally flowing out of pipes and there was no storage to put it in. People were willing to pay you to take their oil off their hands!
Today, it is literally the opposite where one is willing to pay whatever price just to get their hands on oil. With commodities, it is all about physical settlement. At time of delivery or expiration of the contract, the buyer of the contract has a contractual obligation to buy that amount of the commodity and the seller the obligation to sell. If the seller does not have the commodity then it needs to do whatever it has to find it to be able to deliver it.
This is what happened in the Nickle market today as it opened up 100% to $97,000/oz., up more than 200% in two days! This is because of margin calls of Chinese entrepreneur Xiang Guangda, who amassed a massive short position in nickel futures now faces billions of dollars in mark-to-market losses and faced margin calls. This is why LME has suspended Nickle trading as this has moved way beyond circuit breakers.
Commodity financing is quite complicated as it is built upon a layer of financing structures, a bit like the MBS/ABS bonds whereby if one of the factors moves violently, it causes a shake-up of the entire structure. Commodity markets had been tight prior to the Russian invasion of Ukraine as aggregate demand proved to be so strong with limited supply in a short period of time, thanks to the Fed and global central banks liquidity induced stimulus boom.
We all know supply takes time to catch up, it does not happen overnight. Russia's invasion of Ukraine changed the entire landscape. If we were debating stagflation or recession before, this war has just accelerated us on that path in just a week! Slow gradual moves in commodity prices are good, but not parabolic price spikes as consumers and producers cannot manage nor monetize.
Russia produces about one-third of oil globally. Following its invasion of Ukraine, the entire world has united in stopping them by putting self-embargos on trading with them. Some Russian banks have been banned from the SWIFT system, aimed at crippling Russian finances. The large oil/gas Russian companies have collapsed 90% as sanctions will eat all their profits. But so far Russian oil and gas flows had been removed from this sanction list. Europe is highly reliant for more than 40% of its gas needs from Russia and about 2.5 mbpd of oil. But for the U.S., Russian imports made up only 3% of crude shipments, according to the EIA.
Overall, imports of Russian oil and petroleum products represented about 8% of the U.S. total. U.S. imports of Russian crude in 2022 have dropped to the slowest annual pace since 2017, according to the intelligence firm Kepler. So, as the U.S. bans Russian crude imports, it is not the same thing as Europe or the rest of world banning Russian imports. We know China is certainly not banning their imports. The market is currently trading as thought 3-4 mbpd of Russian oil is out of the market.
Today, U.S. domestic oil production is around 11.6 mbpd from highs of 13.2 mbpd, when it lost production permanently post the Covid slump. President Biden is trying to coerce, rather beg, OPEC and other producers to pump more to avoid catastrophic consequences. It is true that OPEC+ has been slow to bring back that oil back with increases of just 400k bpd every month, leaving them short of 2 bmpd of oil to get back to pre Covid levels. But the increase for now is only coming from UAE, Saudi Arabia and Kuwait. The other members are unable to produce and it is the former that is making up the slack. OPEC+ spare capacity is deemed to be around 2 mbpd for now. But they too don't believe this is sustainable nor will the market care if they release more for now.
It is too difficult to try and predict when this invasion with Ukraine will end as it seems Putin will not stop till he wins and takes hold of Ukraine with a firm mandate to make sure they do not join NATO. It will not stop at anything less. The commodity markets are a function of demand and supply. In the oil market, the price is now moving to a tipping point where demand destruction happens to cool down prices.
Daily moves of 200% in UK nat gas or coal going from $80 to $400/tonne or wheat in excess of 300% are not healthy in any way. Cross asset markets are showing signs of distress as we have seen a breakdown in VAR models in the credit, rates and FX market. All these asset markets are connected and when one blows up, the others follow as margin unwinds and liquidation takes hold. What was supposed to be an inflation scare is now turning into a financial liquidity funding crisis, a combination of 2008 to 2019 mixed with a bit of LTCM from 1997 - a toxic cocktail of collapses.
It seems the U.S. is running out of options but other than ban imports or send more fighter planes to Ukraine, perhaps it should focus on their own domestic policy, they have the fastest growth of oil possible in the world via shale, which is economically feasible at prices of just $45-$50/bbl. It is shocking that they haven't mandated their U.S. producers to pump more who seem to be hiding behind the investors' promises of higher shareholder returns.
All eyes will be on the Powell Fed next week. If the Fed had a dilemma whether or not to raise rates prior to this commodity price squeeze, it certainly will be even more perplexed now. Of course, their erroneous policy mistakes will be blamed on Russia and not on their endlessly irresponsible MMT experiment over the past decade. The irony is that financial markets are already collapsing before they have even started tightening. It seems the U.S. economy and the Fed can only survive from one crisis to another, each time printing even more and lowering rates further. However, this time rates are close to 0% and the balance sheet is closer to $9 trillion. There is no margin of error.
