Crude prices could surge to around US$150 per barrel: TD

Key Concepts

• Negative Supply Shock: A sudden decrease in the supply of goods (energy/commodities) leading to higher prices and potential shortages.
• Floating Inventory: Crude oil stored on tankers at sea, currently being depleted to critical levels.
• Demand Destruction: A market phenomenon where high prices force consumers to reduce consumption because they can no longer afford or access the product.
• Stagflation: An economic condition characterized by stagnant economic growth, high unemployment, and high inflation.
• Carry Costs: The costs associated with holding a financial position, such as interest payments on margin or storage costs for physical commodities.
• Real Rates: Interest rates adjusted for inflation; a critical factor in the performance of non-yielding assets like gold.

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1. The Energy Crisis and Supply Shortages

Bart Melek, Global Head of Commodity Strategy at TD Securities, warns of a severe negative supply shock in the energy sector.

• Physical Shortages: The market is experiencing a dichotomy between futures prices and physical availability. Melek notes that while futures markets are volatile, the physical market is facing actual scarcity.
• Global Impact: Real-world examples include farmers in Australia unable to plant crops due to diesel shortages and fishing fleets in Thailand remaining docked due to fuel constraints.
• Projections: Crude oil prices could reach $150 per barrel. Global shortfalls are estimated between 6 to 8 million barrels per day. Even after stabilization, the market expects a structural deficit of a few million barrels, leading to a "race" to satisfy demand while simultaneously attempting to rebuild depleted inventories.

2. Commodity Interdependencies

The crisis extends beyond crude oil into essential industrial and agricultural inputs:

• Fertilizer Components: Prices for nitrogen, ammonia, and sulfur are at "sky-high" levels.
• Industrial Chemicals: Sulfuric acid, critical for metal production, is also facing supply constraints, which will likely lead to prolonged inflationary pressure across multiple sectors.

3. Impact on Canada

Canada, as a major energy producer, is experiencing a net benefit from the current environment:

• Differential Erosion: The gap between Western Canadian Select (WCS) and West Texas Intermediate (WTI) is narrowing, resulting in higher revenues for Canadian producers.
• Capacity Constraints: Melek notes that while Canada is benefiting, the lack of expanded export capacity limits the country's ability to fully capitalize on the global supply vacuum.

4. Metals and Gold Outlook

• Copper: While there is a structural deficit of 300,000 to 400,000 tons, Melek warns that if stagflation takes hold, lower global growth could dampen demand, potentially moving the market toward a balance or even a surplus.
• Gold: Melek argues that gold’s performance is not driven by inflation in isolation, but by the Federal Reserve’s reaction to it.
  • The "Volcker" Lesson: Referencing the 1979–1982 period, Melek explains that when central banks aggressively hike interest rates to combat inflation, gold prices can fall because "real rates" become high, making interest-bearing assets more attractive than non-yielding gold.
  • Current Risk: If the Fed chooses to hike rates rather than cut them, the resulting increase in carry costs and bond yields will make holding gold less attractive.

5. Synthesis and Conclusion

The current commodity crisis is characterized by a genuine, physical disruption in supply rather than mere market speculation. The combination of depleted floating inventories, refinery damage, and geopolitical instability suggests that elevated energy prices are likely to persist for the foreseeable future.

Melek’s core argument is that the market is entering a period of "demand destruction" where prices must rise high enough to force a reduction in consumption, as behavioral changes cannot happen quickly enough to offset the physical shortages. Investors are cautioned that while commodities are traditionally an inflation hedge, the aggressive monetary policy responses from central banks create significant risks for assets like gold and industrial metals.