What could markets learn from previous El Niño episodes?

We’ve talked about the increasing likelihood of El Niño appearing for some time, highlighting its potential impact on commodity prices (agricultural ones in particular, but also others like nickel). The latest El Niño prediction comes from the European Centre for Medium-range Weather Forecasts (ECMWF). “It is very much odds-on for an event,” according to the group, considered one the most reliable of the 15 or so prediction centres around the world. What is less clear is how strong it will be, when it will occur and then finally how it could affect commodity markets.

Related article: Are agricultural commodities underestimating the risk from El Nino?

Back in May Barclay’s reported that commodity markets were underestimating the probability of El Niño. Given the inherent uncertainty in forecasting perhaps that is unsurprising. But what could investors, producers and consumers learn from previous El Niño episodes? Looking back over the last 30 years eight episodes occurred and after each one there was lag of several months between El Niño peaking in intensity and agricultural markets spiking.

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Related article: The commodity most affected by El Niño is…Nickel

Europe has little to fear as Ukraine prepares for gas cutoff on Monday

The Ukrainian Prime Minister has ordered his nation’s authorities to prepare for a cut-off of natural gas flows from Gazprom tomorrow (16 June) as Russia rejected its latest price proposal. The EU suggested an interim price of $326 per 1,000 cubic meters ($8.25 a million British thermal units), which Ukraine would accept, compared with Gazprom’s final price offer for Ukraine of $385 per 1,000 cubic meters. Ukraine must pay for gas delivered in November and December and some of its bill for April and May by 10 am Moscow time (6 am GMT) on Monday or risk being moved to a system of advance billing, with supply dependent on payments made.

Whatever happens in the negotiations there seems little prospect of an immediate supply shortage in Europe however. Although the EU relies on Russian gas piped through Ukraine for 15% of its natural gas needs, the region’s storage facilities are currently well equipped to cope with a disruption being about 64% full compared with about 38% a year earlier and the highest for this time of year since 2011. Meanwhile Gazprom keen to ensure that its European customers get all required volumes appears ready to increase supplies through the Nord Stream and Yamal-Europe pipelines.

Russia has extended its deadline twice in the past few weeks to allow more time to reach a deal but has made clear it will not do so again. Final talks are underway today (Sunday).

Oil market sanguine about Iraqi insurgent advance

The outbreak of violence in Iraq by Sunni rebels belonging to Islamic State of Iraq and the Levant (ISIL) has introduced a new event risk for global oil markets. So far the escalation in geopolitical risk in Iraq has so far been confined to the north of the country with the only oil related casualty being the 250,000 b/d Kirkuk-Ceyhan pipeline – out of action since March. Geopolitical risk does not yet pose a significant threat to the country’s oil production since the northern region represents only a small proportion of total Iraqi oil production.

Current options market pricing reflects this sanguine view with oil markets attaching a low probability of an oil price spike over the coming 12-months ~ less than 20% probability of Brent rising over $120 per barrel. Brent crude futures rose $3 per barrel over the past week to around $113 per barrel, a nine month high. The last time oil prices were this high it was the threat of military action against Syria and the risk of wider conflict in the region that the oil market was focused on.

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Related article: Oil prices caught in a vice

But what if Iraq’s infrastructure is compromised and the 2.5 million b/d currently exported is shut-in? In the short-term the oil market could call on the 2.75 million b/d of spare Saudi capacity. However it is very doubtful whether Saudi Arabia could sustain anywhere near this level of output for any sustained period. The only other oil producer capable of putting significant additional volumes of crude onto the world market is Iran. According to the country’s oil minister Iran could boost its oil exports by 500,000 b/d immediately if sanctions were lifted and by a further 200,000 b/d within two months of sanctions being lifted. Meanwhile over the weekend Iran’s president has given the clearest hint yet that Tehran is prepared to cast aside 35 years of hostility in an alliance of convenience with the US to combat Sunni militants in Iraq. Even more incentive to conclude negotiations over nuclear facilities with Iran ahead of the 20 July deadline.

The US and the IEA could also release oil from its strategic stocks into the market. The IEA has coordinated a global stock release on only three occasions before. In the early stages of the Gulf War in 1991, after Hurricanes Katrina and Rita struck the US in 2005 and in response to the prolonged disruption of oil supplies from during the conflict with Libya in June 2011. The US could threaten to release oil to dampen further price hikes, a move it made during tensions with Syria during the summer of 2013.

Related article: Oil supply outages are becoming more common and difficult to predict