We see only moderate upside risks to commodity prices from the ongoing Crimea crisis. Our core view is that significant sanctions on Russia by Western powers are unlikely, as we do not expect EU officials to pursue this course. For Russia's part, Putin has already toned down the belligerent rhetoric and we do not expect further military provocation. However, given the importance of Russia as a global commodity exporter, we have examined the potential implications for commodity prices of a deterioration in diplomatic relations and a slide towards more punitive measures by Western powers on Russia. Our conclusion divides key commodities into three categories depending on the degree of upside price risk. We see natural gas, wheat, nickel, platinum and palladium as most at risk. In each case, upside risks would get priced in ahead of sanctions upon indication that policy was moving in that direction.
|Central To The Commodities Global Supply Chain|
|Russia - Share & Rank Of Global Exports By Commodity (2012 unless otherwise stated)|
What Could Sanctions Look Like?
Should Western powers pursue harsher sanctions on Russia than laid out in our core scenario above, these would likely take to form of financial sanctions aimed at inflicting pain on the country's oligarchs and banking system. Indeed, outright trade sanctions on Russia's commodity exports are extremely unlikely. Key European states such as Germany, Italy and Netherlands would be significantly exposed to a disruption of Russian energy exports and thus we expect EU policy makers to try and avoid such a scenario at almost any cost.
Nonetheless, even a mild version of economic sanctions on Russia could disrupt commodity exports. First, there is the risk of Russia intentionally curbing commodity (particularly energy) exports as a retaliatory measure. Second, sanctions on Russia's financial system could hamper the ability of banks to facilitate Russian exports through their trade finance operations. This second risk is less pronounced in Russia, which has several large national banks, than would be the case in a country that relied predominately on foreign banks. Below, we assess the risk of such factors resulting in a price spike for the commodities in question.
|Germany Heavily Reliant On Russian Gas|
|Russia - Largest Gas Exports Markets in 2012 (excluding LNG), bcm|
Energy: Gas Most At Risk
Russia's dominance as a gas supplier to Europe and Ukraine's importance as a transit route for this gas mean that European natural gas and oil prices are at risk should diplomatic measures to resolve the Crimea crisis break down. In particular, a more belligerent Russia could utilise its considerable leverage over Ukraine through the gas it supplies to the country and indirectly tighten European gas supplies.
|Minimal Reaction So Far|
|Front-Month Brent Crude & German Day-Ahead Natural Gas Prices, Rebased|
While this is certainly an upside risk to European energy prices, we do not see potential for a major price spike for two key reasons. First, the precarious state of Russian balance of payment dynamics mean that the country cannot afford to willingly curtail energy exports for a sustained period. Second, the situation for most European states is different than during the 2006 and 2009 gas supply disruptions: European gas storage inventories are high and the current mild weather is resulting is weak gas consumption. In addition, the Nord Stream pipeline pumping gas from Russia directly into Germany means that Central Europe has alternative delivery options.
Grains: Wheat Exports At Risk
There are upside risks to wheat and therefore other grain prices should western powers ratchet up punitive measures on Russia. Admittedly, we see it as extremely unlikely that Western sanctions would directly target Russian wheat exports, as the main customers for Russian wheat are countries in the MENA region. Nonetheless, a knock to Russian banks' ability to facilitate wheat exports over the coming months resulting from financial sanctions could tighten the global market. This is particularly due to the fact that Russia wheat export volumes are set to be at a seasonal high in the next three months as the country clears a backlog from the 2013/14 harvest.
|Close To A Break|
|Front-Month CBOT Wheat, USc/bushel (weekly, with RSI)|
A secondary risk is the potential for any associated rise in military tensions around the key Ukrainian Black Sea ports of Odessa and Illichivsk. Even in the absence of sanctions on Russia, a disruption to exports from Ukraine from these ports could ensue should the stability of the region deteriorate. Should the Crimea region be declared a conflict zone by insurance companies, the insurance premium on shipping companies operating at Ukrainian ports (and even Russian ports if the entire Black Sea region becomes involved) could discourage trade out of the concerned ports ( see: 'Global Wheat Outlook: Black Sea Focus', March 5).
Nickel: Chinese Demand Could Play Swing Factor
We believe moderate upside risk exists for nickel prices due to Russia's dominance as a global exporter and the potential for stronger Chinese demand in the coming months. Russia accounted for 37% of global refined nickel exports in the first ten months of 2013 and is home to the world's largest nickel producer, Norilsk Nickel. Nearly all of the country's refined and unwrought nickel is exported to the Netherlands, making its way to LME warehouses in Vlissingen and Rotterdam. Concurrent events in Indonesia are likely to further exacerbate any supply issues from Russia. The Asian country continues to restrict exports of unprocessed nickel ore until miners establish domestic smelting capacity. While our core view remains that the export ban will eventually be moderated due to economic headwinds and export revenue losses, the short term may see further refined nickel price increases as Chinese producers draw down nickel ore inventories used in nickel pig iron (NPI) production. In such a scenario, a drawdown in ore inventories is likely to lead to increased Chinese consumption of refined nickel.
|Russia Dominates Refined Market|
|Refined Nickel - Exports And Russian % Of Total|
Platinum & Palladium: Concentrated Supply Raises Risks
Platinum and palladium prices would face upside risks in the event that supply from Russia is even moderately threatened. In fact, palladium prices have already surged into a new trading range since March 3 despite no obvious deterioration in supply prospects since then. In our view, palladium prices face the greater upside risk of the two metals.
|Already Breaking Into A New Range|
|Spot Palladium, US$/oz (Weekly Chart)|
Fundamentally, the picture for palladium is bullish due to a troubled supply outlook. Together Russia and South Africa account for roughly 78% of global palladium production. In Russia, supply is closely managed by the state and thus shipments are hostage to government policy. In the event of Western sanctions on Russia, palladium shipments could therefore be hit. This is against a backdrop of strike action across the platinum belt in South Africa that shows no sign of a wage agreement being reached. Currently 40% of South African platinum supply has been halted by the strikes, which has a direct impact on palladium supply as the two precious metals are mined together.
Coal: Europe To Find Solace From US Flows
In our view, any pullback in Russian coal supplies from the seaborne market would not lead to a significant uptick in thermal coal prices. The global coal market is currently well supplied and exports from the US should help to fill the void left by Russia in key coal-consuming regions such as Germany, Poland and the UK. A growing number of US coal miners are seeking to increase export volumes in a bid to alleviate the pain caused by falling domestic consumption, which could buffer the impact of a possible decline in Russian exports. Furthermore, shipments from Canada and Colombia could also be directed towards Europe as a pipeline of production and port expansion plans come online over the coming quarters.
|Europe To Remain Top Destination|
|US Coal Exports - Total ('000 short tonnes, LHS) & By Region (2013, RHS)|
Iron Ore: Healthy Supply To Cap Price Upside
We see limited upside risk to iron ore prices even in the event of significant disruption to Russian exports. Healthy supply in the seaborne market should offset the price-supportive impact of any dwindling of exports from Russia (which accounted for 5.0% of global iron ore exports in 2012).
|No Respite From Ukraine Crisis|
|China Iron Ore Import Price, 62% Grade (US$/dry metric tonne, CFR)|
Despite the economic slowdown in China, major iron ore miners in Australia and Brazil are undertaking a series of expansion plans aimed at lowering their sitting in the global cost curve. With the bulk of the iron ore export base lying in the hands of these two countries (at 70% of seaborne supply in 2012), we expect iron ore prices to continue heading downhill over the coming quarters due to market oversupply and slowing Chinese import growth.
|Only A Small Slice From Russia|
|Global - Iron Ore Exports By Country (2012)|
Potash: Uralkali's China Focus Reduces Risks
Even if the EU and US were to approve sanctions on Russia, we believe they will have little impact on the country's potash exports. Russia's dominant export, Uralkali, currently mainly sells to China, Latin America and South East Asia. From a logistics point of view, Uralkali has few operations via Black Sea ports and uses mainly ports on the Baltic sea to ship potash to different locations across the globe.
|Potash Shipments Are China Focussed|
|Uralkali - Sales By Country (2012, %)|
Steel: Abundant Global Supply To Limit Risk For Higher Prices
In the event of sanctions against Russia or disruption to export routes in the region, supply of steel from both Ukraine and Russia could be impacted. Given that Ukraine is the world's third-largest steel net exporter (22.3mnt in 2012) and Russia the world's fourth-largest (19.8mnt in 2012), the impact would be significant as existing Western consumers of Eastern European steel would be forced to look elsewhere to meet their demand. Nevertheless, the glut of steel available on world markets means that this scenario would be unlikely to precipitate significantly higher global steel prices.
|Global Crude Steel Production Balance (mnt) & Stocks-To-Use Ratio (%)|
The global steel market remains heavily oversupplied. As a consequence, other major steel producing countries including China, Japan and South Korea would have little difficulty filling a gap left by Russia and/or Ukraine. Moreover, steel stockpiles remain extremely elevated, thus consumers could rely upon stocks to satisify short-term demand.
In terms of regional differences, since 40% of CIS steel exports are delivered to European countries, we highlight short-term upside risk to benchmark European steel prices. However we reiterate our view that this uptick would be insufficient to provide major tailwinds for the global benchmark and would likely be temporary. Meanwhile, the 38% of CIS steel exports that go to the Middle East, Africa and Asia would likely be unaffected by events in Russia and Ukraine as these countries are unlikely to participate in sanctions.
|Diversified Portfolio Of Clients|
|CIS - Exports of Steel Mill Products By Destination, 2012, (mnt)|
Aluminium: Surplus Offers A Buffer
We see little upside risk for aluminium prices given both continued price weakness and elevated inventory levels. Regarding the former, three-month LME aluminium contracts have continued to face resistance around the US$1,800/tonne level and are unlikely to see imminent gains. While a global average of regional aluminium premiums remains at historic highs, it has ticked down in recent weeks, potentially indicating short-term market tightness is waning. On the inventory side, LME inventories remain at record multiyear highs at approximately 5.3mnt. Furthermore, Russia only supplied 8.4% of global refined aluminium in 2013, far less than China, which supplied around 46% and which continues to suffer from productive overcapacity.
|No Shortage Of Supply|
|Global - LME Inventories (tonnes)|