Volatile geopolitical conditions, simmering energy markets and commodity prices

commodity

In a world grappling with heightened geopolitical uncertainties, the recent Middle East conflict has emerged as a significant catalyst, introducing risks that could echo across commodity markets.

In its Commodity Outlook report released last month, the World Bank has shed light on a complex landscape marked by a 5 percent increase in the commodity price index. This surge is primarily attributed to an 11 percent spike in oil prices due to fears of the OPEC member nations making a strategic production reduction decision.

Various studies suggest a significant negative correlation between energy prices and farming margins. A study by the Food and Agriculture Organization (FAO) found that energy costs account for about 10 percent to 30 percent of the total costs depending on the commodity and the region. The study also found that the agricultural sector in developing countries is more vulnerable to energy price increases.

Turning to the manufacturing and services sectors, a recent study by the European Commission found that energy costs account for a significant share of total costs in the manufacturing sector, ranging from 10 percent to 30 percent, depending on the industry. The study also found that the services sector is less energy-intensive but that some services, such as transportation and logistics, are more vulnerable.

It indicates that oil prices are vital to managing inflation, which the central banks worldwide are trying to tame with higher rates. However, emerging from the pandemic, supporting growth is as essential as managing inflation, especially for emerging economies leading to conflicting economic narratives and central bank policies.

 Oil Market Dynamics

The Middle East conflict has cast a shadow over oil market stability, with potential disruptions looming. The World Bank Outlook Report underscores a decline in crude oil production and the floor for Russian oil exports, resulting in a price surge as the OPEC+ coalition implements concerted efforts to regulate the global oil supply. The intricacies of the oil market are critical in understanding the broader economic landscape. Not only does the conflict in the Middle East impact the supply chain but it also triggers a chain reaction across various sectors. The rapid ascent of energy prices, a linchpin for many industries, has burdened businesses and consumers.

Regional Responses And Shifts

Against this backdrop, regional dynamics have come into play. The Americas have responded by increasing oil output, partially offsetting the decline in overall crude supplies. This strategic move not only mitigates the impact on the local economy but also highlights the adaptability required in the face of global disruptions.

Simultaneously, the European Union has strategically diversified its energy sources, substituting the depleted supply of Russian pipeline gas with liquefied natural gas (LNG) and piped natural gas from Norway and North Africa.

This shift in strategy ensures energy security and underscores the need for flexibility in adapting to changing geopolitical landscapes. Understanding these regional responses and adapting to changing circumstances is a hallmark of resilience in the face of economic uncertainties.

Impact on Agricultural Commodities

The ripple effects of the conflict extend to agricultural commodities, where prices of staples worldwide have experienced a decline, helping global policymakers address the persistent challenge of food insecurity in various least developed countries (LDCs). The impact on agricultural commodities extends beyond the immediate price fluctuations. The reduction in food costs, while seemingly positive on the surface, and emerging geopolitical conditions deepen the challenge of food insecurity arising out of connecting available supplies with demand and the cost of doing it. Understanding the nuances of this impact is crucial for policymakers crafting responses to alleviate the plight of LDCs, helping them to remain resilient as they emerge from the pandemic.

Historical Context

The market response to events such as the Arab oil embargo from 1967 to 1973 and the imposition of oil export sanctions serve as reminders of the far-reaching consequences that geopolitical events can have on the global commodity landscape. These posed significant challenges to policymaking in driving the global economy away from the impact of the high oil price induced economic crises of the past. Drawing parallels between past and present allows for a more nuanced understanding of the challenges and opportunities that emerge after geopolitical conflicts. The ongoing conflict in the Middle East adds a layer of complexity, making the global oil market a subject of significant analytical interest from the perspective of its echoes across the commodity ecosystem. While metallic commodities have experienced a marginal 1 percent decline due to challenges to Chinese growth, gold prices have surged by 8 percent, reflecting the economic uncertainty and investors seeking refuge in safe-haven assets.

The Outlook

Looking ahead, the fragility in commodity prices during 2024 is attributed by the Outlook report (Q3:2023) to the underwhelming state of global economic expansion and the high-rate financial conditions. Baseline projections ignoring the current Gaza conflict indicate lowering overall commodity prices until 2024 due to the Chinese slowdown—any anticipated resurgence in commodity prices in 2025 hinges on strengthening global growth and recovery.

However, the report highlights the importance of strategies to expand renewable energy infrastructure to counter energy price volatility. Geopolitical risks, notably stemming from the Middle East conflict, pose a substantial upside risk to commodity prices, according to the scenario analysis of the report – an escalation could lead to significant supply disruptions, causing oil price surges of 56 percent to 75 percent.

The cessation of the Black Sea Grain Initiative to provide for Ukrainian exports and disruptions in transport and power could elevate food and energy prices. The report notes that weaker global growth, especially in manufacturing and trade, presents a downside risk, potentially leading to lower industrial commodity (metal) prices.

V Shunmugam is Adjunct Faculty with National Institute of Securities Markets. Views are personal, and do not represent the stand of this publication.