The price of coal (XAL1:COM) near an all-time high shows how circumstances in one region of the world can impact the global commodities market, Morgan Stanley says.
Liquefied natural gas, electricity and aluminum prices (LMAHDS03:COM) are also soaring, even though the global economy has yet to fully recover from the pandemic.
Energy (NYSEARCA:XLE) is the weakest sector premarket as S&P (SPX)(NYSEARCA:SPY), Nasdaq 100 (NDX:IND)(NASDAQ:QQQ) and Dow (INDU)(NYSEARCA:DIA) futures tumble.
And the story starts in China, according to Martijn Rats, Morgan Stanley equity analyst and commodities strategist.
"The combination of a post-COVID-19 recovery and unusually hot weather has increased consumption of electricity sharply this year," Rats says in a note. "Most of China’s electricity is produced from coal, but domestic coal production is increasingly struggling to keep up - the result of regulatory reforms, under-investment and more stringent HSE inspections."
"Another important source of electricity generation in China is hydropower, but because of droughts in key parts of the country, hydropower has failed to grow this year too," he says.
"Over the summer, this led to power crunches that forced regional governments to curtail consumption - street lights were even switched off at night in a number of regions," Rats adds. "Another victim of these measures was aluminium smelting, which is a particularly electricity intensive process. Normally, China supplies ~60% of the world’s aluminium. With its production curtailed and global demand continuing to grow, aluminium prices soared."
Morgan Stanley draws three conclusions:
"First, this sequence of events shows how inter-connected commodity markets are. One region impacts another and multiple commodities are eventually linked. A drought in China can drive up the price of electricity prices in Spain but also the cost of soft drink cans in the US."
"Second, this year has shown how difficult it can be to anticipate such moves. Even a few months ago, the common view was that practically all these commodities were abundant, and would become more so over time."
"Finally, it shows how little margin of safety there is in the world’s energy system, and this has important implications for the future."