Commodity markets in a post COVID-19 world
By John Baffes, Senior Economist, Macroeconomics, Trade & Investment, World Bank
Recent developments in commodity markets
Almost all commodity prices experienced a sharp decline since January 2020 as the COVID-19 pandemic worsened. Mitigation measures have significantly reduced transport, causing an unprecedented decline in demand for oil, while weaker economic growth is expected to reduce demand for most commodities. Price forecasts for most commodities have been revised down, with most risks remaining tilted to the downside and dependent on the speed at which the pandemic is contained, and mitigation measures are lifted.
Crude oil prices fell nearly two thirds from January to April 2020. The fall was initially driven by worries about the impact of COVID-19 on oil demand in China, the world’s second-largest consumer of oil, and subsequently deepened during the quarter as the virus spread and more countries imposed travel restrictions. The decline was exacerbated by the breakdown of OPEC+ talks in early March, and a new production agreement announced on April 12 failed to boost prices.
Some oil benchmark prices have seen even more dramatic declines. On April 20 the WTI Cushing contract for delivery in May fell to negative territory. The magnitude of the collapse was due to both fundamentals—weak demand and limited storage capacity—and technical factors associated with the futures market. On the technical side, the drop reflected the fact that the May contract expired on April 21, and there was very limited storage capacity available for physical deliveries for the contract. Although prices rebounded next day, subsequent price movements confirm that the fundamentals of weak demand and limited storage capacity are becoming increasingly severe across the crude oil market.
“Contrary to energy commodities, most agricultural commodity prices have been broadly stable.”
“There are numerous downside and upside risks to the price forecasts, emanating mainly from the duration and severity of the pandemic, and how quickly mitigation measures can be lifted.”
Contrary to energy commodities, most agricultural commodity prices have been broadly stable. In some markets, however, numerous factors began exerting pressure toward the end of 2020Q1, most importantly the widely adopted mitigation measures to contain the spread of the COVID19 pandemic.
“Traditional” factors included multi-year high stocks levels (the third highest level in recent history) and record production for some grains due to favorable weather conditions in key producing regions. The spread of the COVID-19 pandemic, however, added an entirely different set of factors: weaker demand, a sharp reduction in input costs (energy and fertilizer), trade restrictions, disruption in supply chains (on both the input and output side), a much stronger U.S. dollar, and panic buying.
The World Bank’s Agricultural Price Index gained a little more than 1 percent in 2020Q1 (q/q) and stands at 3.1 percent higher than a year ago. Prices of grains, oils and meals, and beverages increased in the quarter, while agricultural raw materials declined. Following a projected drop of about 1 percent in 2020, the index is expected to gain 2 percent in 2021, representing a small downward revision from the October forecast. There are numerous downside and upside risks to the price forecasts, emanating mainly from the duration and severity of the pandemic, and how quickly mitigation measures can be lifted.
Although the fertilizer price index has remained broadly stable, some of its components have experience changes. For example, a fall in potash and urea prices, owing to a slump in demand, pushed the index lower. However, phosphate prices increased as the COVID-19 outbreak in China severely hampered production and disrupted supply chains.
In 2020, the index is projected to fall by 9.9 percent as global fertilizer supply remains plentiful. Risks to this outlook are broadly balanced. Upside risks include prolonged widespread supply disruptions, while downside risks include a slower-than-expected recovery in demand.
Fertilizer prices—measured by World Bank’s Fertilizer Price Index—dropped nearly 5 percent in the first quarter of 2020 (q/q). That marked the seventh consecutive quarterly price decline for the index. While the index was pushed down due to a fall in potash and urea prices, phosphate prices increased as the COVID-19 outbreak in China severely hampered production and disrupted supply chains.
DAP prices gained 7.5 percent in 2020Q1, reversing a downward trend of five consecutive quarterly declines. The price increase reflects a sharp production contraction in China—the world’s largest phosphates producer. Production rates have fallen to around 20-30 percent of total capacity in Hubei Province, the epicenter of the COVID-19 outbreak. The lockdown in Hubei—which accounts for more than one-quarter of China’s DAP capacity—has caused severe supply chain disruptions due to a shortage of labor. Similar logistical issues have hampered supply in India amid quarantines and closed borders. However, global supply remains plentiful, especially in Morocco and Saudi Arabia, where capacity is expanding. Major consumers, including India and Pakistan, continue to reduce imports due to high inventories.
Urea prices fell by a further 2.7 percent in 2020Q1, following a sharp decline in 2019Q4. Demand in China has been weak as the COVID19 outbreak limited fertilizer application. Markedly lower input costs (natural gas) further added to downward price pressures. Brazilian demand, however, remained robust due to maize and soybean acreage expansions. On the supply side, production disruptions in Hubei had only a marginal impact on prices as the province accounts for only 2 percent of China’s urea capacity.
Potassium prices fell nearly 8 percent in the first quarter of 2020, the first quarterly decline since 2017Q2. The price weakness largely reflects subdued demand in China and Southeast Asia. A lockdown in Malaysia, a large importer of potash for palm oil production, heavily affected movement of workers and raw materials. In the United States, flooding in the Midwest also limited fertilizer use. On the production side, there have been limited cutbacks related to COVID-19 outside of China, except for a temporary suspension of mining operations in Spain.
In 2020, the fertilizer price index is projected to fall by 9.9 percent as global fertilizer supply remains plentiful. Risks to this outlook are broadly balanced. Upside risks include prolonged widespread supply disruptions, while downside risks include a slower-than-expected recovery in demand.
“Demand in China has been weak as the COVID19 outbreak limited fertilizer application. Markedly lower input costs (natural gas) further added to downward price pressures.”
“The mitigation measures implemented in many countries may lead to shifts in consumer habits and the exacerbation of existing trends.”
Long term implications of the pandemic on commodity markets
Moving forward, the impact of COVID-19 may lead to long-term shifts in global commodity markets, which will affect both commodity exporters and importers.
Increasing transport costs. Enhanced border checks arising from COVID-19 concerns may permanently increase the cost of transporting commodities, reducing trade flows. This occurred in the aftermath of the September 11 attacks, when additional border checks and security measures were introduced, increasing transport costs.
Unwinding supply chains. Disruption to companies dependent on global supply chains could encourage business to move operations back to the home country. This may be exacerbated by national security concerns regarding the reliability of supply of critical equipment, such as personal protective equipment, which would favor local production.
These shifts could result in the unwind of global value chains as corporations restructure their supply chains. For commodity markets, such a development could potentially lower transport demand if it reduces the average distance of imports. All else equal, this would result in permanently lower oil demand, as value chains are more transport-intensive than other forms of trade. It could also lead to shifts in the source of commodity demand as manufacturing hubs shift.
Increasing substitution among commodities. Transport cost increases could induce substitution between domestic and imported commodities. For example, a higher cost of imported commodities due to increased transport costs could promote the use of domestic resources. If exact replacements are costly or unavailable domestically, the use of substitutes may occur, such as the use of domestically produced glass in drinks packaging instead of imported aluminum.
Changing consumer behavior. The mitigation measures implemented in many countries may lead to shifts in consumer habits and the exacerbation of existing trends. The trend toward remote working is likely to accelerate, as the pandemic has forced companies to invest in the necessary equipment, infrastructure, and processes to enable remote work. Once mitigation measures are lifted, a greater number of workers may continue operating remotely, which would reduce commuter journeys and demand for fuel. Similarly, businesses may reduce foreign travel in favor of video conferencing and other remote alternatives. The reduction in pollution resulting from the current restrictions on travel may also lead to greater pressure to implement stricter environmental standards, as the benefits of lower fossil fuel consumption (and lower pollution) become more apparent.