Thursday's Market Minute: Geopolitical Escalations: A Greater Risk Than Inflation

Inflation data will capture the attention of traders as commodity price advances concern the market. The market hopes shelter costs will begin to crack to offset such concerns. But the real threat to the marketplace is one of the hardest things to price: geopolitical tensions. A lot of events have occurred over the last two months that have provided commodity prices the momentum needed to advance. 

Last month, Russia pulled out of the “Grain Deal” which allowed Ukraine and Western partners to continue grain shipments to trade partners within the region. In particular, the Middle East and African nations. The degradation of the deal was by no means peaceful. Russia targeted strategic grain silos, impacting critical ports that will impact global trade for years to come. As for the underdog Ukraine, they have targeted key Black Sea ports as well, reflecting their depth of influence when it comes to global trade.

The price of Chicago wheat quickly spiked 21% before receding back to its lows. Luckily, it’s harvest season for wheat which has come several weeks earlier than normal thanks to the abundance of rainfall, coupled with an abnormal balance of sunlight, and the tactical grace of Mother Nature to shield much of the crop from damaging hail like we have seen in the western plains. But this trend is far from over.

Let’s put wheat aside and bring it closer to home, energy. Now, when we talk about energy the masses tend to immediately focus on oil, so let’s walk down that path. Oil has seen gains since June after completing the textbook definition of a consolidation pattern from May to June. Now, the breakout has occurred, but it’s more than just the technical trends; it’s fundamental. The fundamental setup for crude consists of a market where producers are ramping down oil supply by putting rigs offline, maximizing refinery capacity to exhaust existing inventory, reflected by Wednesday’s EIA report of 93.8% refinery utilization rates, and consumers are rounding out their summer travel ambitions while leveraging credit markets. But that’s a story for another time.

Byproducts of oil like gasoline, which has seen over a 20% increase since the end of June, or heating oil, which has seen a 36% increase in the same timeframe, are experiencing a shortage in supply that a rapid change in the refining mix cannot fix. Energy companies, after decades of dealing with latent supply adjustments to meet demand, are now trying to imitate the impeccable supply chain structure that grocery chains have perfected over the years, using a 'just-in-time' inventory approach.

The backwardation in the oil market's price structure, following a year and a half of unexpected supply shocks due to the Russia/Ukraine conflict, reflects a determination to minimize, if not eliminate, storage costs, streamlining profitability and returning cash to shareholders. This structure makes sense in most markets but as we have seen over the last 4 years, a “bump in the road” can escalate prices at a moment’s notice, squeezing the consumer, pressuring inflation, and boosting cashflow for energy producers. Just something to keep your eye on.

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