2022 was undoubtedly an eventful year for the global natural resources complex, marked by scarcity of supply and volatile markets. As we look ahead to 2023, we do not expect these conditions to improve much in the near term. However, as we focus on the underlying fundamentals, we maintain our high conviction in the robust cyclical and secular support of the natural resources sector. As the market backdrop remains uncertain, we believe active managers should look to global natural resources for attractive opportunities amid this multi-year commodity upcycle.
In our view, the agricultural sector should be one of the most noteworthy natural resources markets in the upcoming year and beyond. Structurally, agriculture and food demand tend to be more resilient during the peaks and valleys of economic cycles. Despite tightening monetary policy worldwide, the global population continues to rise, and likewise food demand should continue to grow unabatedly. However, unstable growing conditions across various parts of the world could impede food production.
A look back at historical corn yields provides a depiction of these possible changes in food production. Corn - a component in many food and industrial products and a key ingredient in livestock feed - is the most commonly produced feed grain in the United States. Corn production rose substantially from the 1970s through the early 2000s, with the number of bushels per harvested acre doubling from 80 bushels to over 170. However, corn yields plateaued in 2014, and yields have remained in the 170s through present day. The most recent season’s estimated yield fell near the low end of the plateau, and prices of corn stocks are expected to slip to 10-year lows.i
There is also a considerable risk of future volume disruptions from the Black Sea region, as the war between Russia and Ukraine has jeopardized the upcoming spring planting season. To add insult to injury, global spring plantings may also be less fertilized, as natural gas and coal shortages have curtailed the production of nitrogen-based fertilizer.
Within energy, we believe the fundamentally tight supply-and-demand dynamic should continue in the coming year. In 2022, recessionary fears, Covid-19 lockdown policies in China, and demand destruction all took a toll on the demand for energy commodities. However, contrary to what headlines may suggest, there is more to the story than doom and gloom. For an accurate representation of the energy market, it is necessary to separate hearsay from reputable research and data.
According to fundamental analysis, US demand (particularly for gasoline and distillates) hovered near the five- to 10-year average. As US consumers saw gasoline prices rise over $5 per gallon, demand softened somewhat but quickly normalized as prices moderated. In our view, the pace of the price increase contributed more to the sticker shock effect than the actual retail cost for the average consumer. Data from China also contradicts the dismal market narrative, as Chinese import numbers remained near historical averages despite the government’s zero-Covid lockdown policy.
Oil demand is perhaps not as sensitive to economic downturns as consensus would suggest. Excluding the pandemic-induced recession, global oil demand actually increased during two of the last three recessions. Moreover, during the 2008-09 downturn, while demand for oil fell 2.3% from peak to trough, the post 2009 rebound was strong. It is also worth noting that over recent decades, oil has steadily comprised a smaller and smaller piece of global gross domestic product (GDP) growth.
The current oil cycle is one that is supply driven, as demand has recovered and normalized from the drop spurred by the Covid-19 pandemic. Oil supply, however, continues to spark concerns. The Organization of the Petroleum Exporting Countries (OPEC) has worked effectively to regulate supply. Its recent oil production cut of 2 million barrels per day effectively and pre-emptively offset approximately half of the oil demand destruction seen during the Global Financial Crisis.
Russian oil supply is still at risk of further sanctions and disruptions, and an Iran nuclear deal is not likely to happen soon. It is also important to consider the different role that US shale is taking in this cycle. While management teams within the US shale complex continue to exercise a great deal of financial and operating discipline, they are beginning to see real physical constraints to increasing production. Years of underinvestment have resulted in various infrastructure, labor and oilfield services bottlenecks. It will take several years to adequately address these bottlenecks; however, the specter of demand destruction induced by global energy transition efforts, in addition to ambiguous policies, continues to deter necessary investments. We continue to believe there are attractive opportunities in high quality management teams with top-tier energy assets, as well as areas like oilfield services where near full capacity utilization has translated into positive earnings revisions.
We have seen some reprieve from the notable natural-gas rally during this year’s summer months. Soaring prices did exactly what they were supposed to do, signaling physical markets to send molecules to European storage ahead of winter. This was aided by the redirection of liquefied natural gas (LNG) shipments that China would have otherwise consumed if its Covid-19 lockdown policy was not in effect. Europe has had to take drastic measures in the wake of Russia’s suspension of gas supplies, as the continent has cut down industrial natural-gas consumption, adopted severe energy conservation policies, restored coal plants and deferred the retirement of nuclear power facilities. A critical question remains: what happens next winter, and the winters after that, as additional LNG supplies from the US, Middle East and Australia require capital and time to build up.
While the price spikes that occurred over the summer are likely outliers, we believe that we are in a “stronger for longer” environment. Natural gas should continue to gain recognition as an important bridge fuel for a decarbonizing world.
Metals and mining
Recession fears and lockdowns in China also rippled through the metals-and-mining complex. Our views on this space are more bifurcated and nuanced. While we believe that China is in the early stages of a reopening, the looming threat of a global recession poses a potential headwind for broader metals demand. There is a notable distinction about this current economic cycle. In previous recessionary cycles, there have typically been sizeable inventory buildups and an overabundance of supply. However, during this cycle, physical inventories across the metals sector have remained constrained, owing to production headwinds.
Select metals and materials have more upside leverage, both cyclically and structurally, and we continue to be most constructive in our outlook for copper. China’s demand for copper is certainly a significant factor. However, end uses for copper are diversified well beyond building construction and property markets. Major producers, such as Chile, have experienced persistent production setbacks in recent years, and supply has struggled to meet demand. Structurally, copper ore grade has fallen steadily over the past 20 years.
Energy transition, CAPEX and others
From a secular perspective, the global push toward decarbonization should drive a significant generational shift in the demand for copper (akin to, and perhaps even greater than, the emergence of Chinese demand in the early 2000s). We believe that in the next 10 years, demand for electric vehicles (EVs) will surpass construction as the most prominent use of this metal. Also, this generational shift is not limited to just copper; we see similar dynamics happening across various metals subsectors, and the worldwide initiative to create a decarbonized future could substantially boost demand. Additionally, with the emergence of this new structural demand, we believe we are at the cusp of a capital expenditure (capex) supercycle, and that companies that provide the equipment and services, such as engineering and construction, could benefit over the coming years.
We are also becoming increasingly bullish on our outlook for uranium. As nuclear power gains further acceptance as a critical fuel in the path to zero emissions, we believe uranium is in the early stages of an upcycle. After over a decade of power reactor closures following the Fukushima disaster, global utilities and governments are again recognizing the advantages of nuclear power and delaying plant retirements. However, as the supply side has been in a bear market for the past decade, close to 30% of annual refined uranium today is derived from secondary supplies controlled largely by Russia. As global utilities draw down their inventories, we believe a procurement cycle will follow, which should drive prices higher.
Are we there yet?
Commodity cycles rarely (arguably, if ever) last only two years; typical cycles last between five and 10 years, as this timeframe allows for physical supply to develop and correct any supply/demand imbalances. Consensus continues to overestimate how elastic commodity demand can be during economic cycles. Demand may soften during a recession, but oftentimes this response sets off a “coiled spring” effect. As we have seen in previous downturns (even one as severe as the Global Financial Crisis), demand for commodities recovers rapidly when economic conditions normalize. Supply, however, may be increasingly constrained as capital investments tend to be deferred during times of economic uncertainty. While the global natural resources markets continue to be volatile, we believe we are in the midst of a multi-year commodities cycle. In our view, themes such as decarbonization can extend the investment timeframes of these diverse assets as well as increase their upside potential.
i US Department of Agriculture. (n.d.). World Agricultural Supply and Demand Estimates (WASDE) Report. Accessed November 17, 2022.
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