Yves here. Yours truly is not alone in comparing the weird period we are in to the phase of a tsunami when the ocean pulls far further back from the shore before the monster wave rolls in, relentlessly overpowering everything in its path. Unless you are familiar with the pattern, the retreat of the water simply looks unusual, as oppose to a dire warning of a need to find high ground as fast as possible. This article describes why the deceptively calm economic phase, here as shown by limited volatility in commodity prices relative to widely expected shortfalls, is set to end, and not well.
By CityAM.com. the online presence of City A.M., London’s first free daily business newspaper. Cross posted from OilPrice
- Governments and industry have softened the impact of energy and commodity supply disruptions by releasing reserves, reducing inventories, and increasing operational flexibility.
- These measures are temporary, and continued inventory drawdowns are pushing oil and metal markets toward historically tight conditions.
- Once inventories become critically low, higher prices may become the primary mechanism for balancing supply and demand, leading to weaker economic growth and lower consumption.
Commodity markets have spent the past three months performing an extraordinary balancing act. Despite one of the most significant disruptions to global energy flows in decades, the global economy has continued to function remarkably smoothly. After an initial spike, prices for several key commodities have stabilised or even eased. Yet this apparent calm is deceptive. The reason the system has held together is due to governments, producers and consumers drawing down the buffers that normally protect the global economy from disruption. Those buffers are now approaching dangerous limits.
Inventories are being depleted at a remarkable pace. Global oil stockpiles have fallen to levels that senior industry executives describe as unprecedented. Aluminium markets are facing a similar squeeze. Bloomberg recently calculated that combined stockpiles tracked by the London Metal Exchange, CME Group and the Shanghai Futures Exchange would cover less than five days of global supply.
The surprising resilience of commodity prices reflects the fact that the global economy has proved far more adaptable than many expected. Strategic reserves have been deployed on a large scale. The United States and Japan have both released oil from emergency stockpiles to cushion the loss of supply. American jet fuel output has reached record levels. Even China has managed to reduce crude imports without any obvious drawdown of its strategic petroleum reserves, which a recent report from the Oxford Institute for Energy Studies suggests is due to changing refinery yields and industrial flexibility. In effect, China has been extracting greater flexibility from its industrial system rather than relying solely on inventory releases.
All of these developments demonstrate a market responding exactly as economic theory would predict. When a critical input becomes scarce, producers seek substitutes, inventories are drawn down and existing capacity is pushed harder. These adjustments can be remarkably effective. They buy time. But time is ultimately what inventories represent. Every barrel released from a reserve, every tonne withdrawn from a warehouse, and every industrial workaround implemented today simply postpones the moment when supply and demand must once again be reconciled.
The US Strategic Petroleum Reserve is a case in point. The United States entered this crisis from a significantly weaker position than prior energy shocks. Having peaked at more than 700 million barrels in 2010, the SPR had already been reduced by roughly a third before the disruption in the Middle East began. Recent releases have helped stabilise markets, but they have done so by consuming the very buffer that exists to absorb future shocks. The critical question is not whether the SPR can technically be depleted. It cannot. The more important question is whether markets begin to doubt that policymakers possess sufficient reserves to continue cushioning disruptions indefinitely. Once that confidence disappears, the existence of barrels underground becomes less important than the perception that the shock absorbers are running out.
At some point, the arithmetic becomes unavoidable. The world cannot permanently consume more commodities than it produces. Strategic reserves can only be released once. Inventories can only be drawn down once. Refineries can only be reconfigured so far. Eventually, the familiar supply-and-demand framework begins to reassert itself, and a new equilibrium must emerge between available supply and desired consumption.
Demand Destruction
Economists have a sanitised term for this process: demand destruction. The reality is more painful. Demand destruction occurs when prices rise to a level that forces consumers and businesses to reduce their consumption. Households spend more on fuel and less on everything else. Airlines reduce routes. Manufacturers delay investment. Energy-intensive industries curtail production. Consumption falls not because people choose to consume less but because higher prices leave them no alternative.
This is why inventory levels matter so much. As long as stockpiles remain available, markets can postpone the adjustment. Once they are exhausted, prices become the primary mechanism through which balance is restored. Neil Chapman, senior vice-president at ExxonMobil, recently described the situation with unusual candour. Oil prices, he argued, have remained relatively contained because inventories have been drawn down. Yet those inventories are now approaching levels rarely seen in modern markets. Once those buffers disappear, the economics change rapidly. As Chapman put it, “a model would say Brent will shoot up” towards $150 or even $160 per barrel.
Many governments will inevitably seek to shield consumers from the consequences. Price caps, subsidies and emergency fiscal packages are politically attractive when energy costs surge. Yet such measures do not eliminate the underlying economic loss. They merely redistribute it. If consumers are protected from higher prices, then taxpayers, bondholders or currency holders must absorb the cost instead.
Japan offers an early illustration of this dynamic. The government has proposed additional fiscal support while simultaneously insisting that it will not require higher borrowing over the calendar year. Markets appear sceptical. Yields across the Japanese government bond curve have risen as investors attempt to identify where the cost of these interventions will ultimately fall. The pressure has not disappeared; it has simply been transferred elsewhere within the system.
This is the uncomfortable reality confronting policymakers around the world. There is no financial engineering solution that can replace missing barrels of oil. No accounting adjustment can create aluminium inventories that do not exist. No subsidy can transform a scarce commodity into an abundant one. The shock emanating from the Middle East is real, and while the global economy has responded impressively through substitution, efficiency gains and inventory drawdowns, these measures are temporary expedients rather than permanent solutions.
When inventories become critically low, markets force a new equilibrium. And a new equilibrium in a poorer world means exactly what it sounds like: higher prices, lower consumption and lower living standards. The commodity markets are not forecasting a poorer world. They are enforcing one.
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1 To illustrate:
Thank you, Yves.
A surprisingly good article from the rag that I often read on the tube to the City.
The article and Yves’ pithy introduction echo what Aussie economist Steve Keen says. Steve can be found on X and sometimes Al Jazeera.
“This is the uncomfortable reality confronting policymakers around the world. There is no financial engineering solution that can replace missing barrels of oil. No accounting adjustment can create aluminium inventories that do not exist.” Spot on! It’s not just oil, but its derivatives and food. Trading and the prices and related commentary cited on air and in print do not take into account the physical.
Readers in the United Kingdom may be reading the Mandelson e-mails, some, but not all, of the messages exchanged. Have readers noticed how the concerns of ordinary people just do not feature in these exchanges? It’s the reality. If 2008, Brexit and covid were not enough to shake off the complacency of the people running the show, may be a replay of 1929 – 45 will, but I’m not holding my breath.
As soon as the war on Iran started, meetings were held in Whitehall to discuss the impact. The politicians were warned that, by the autumn, there could be civil unrest due to shortages of food, fuel and medicines and a rise in unemployment. Rationing and restrictions on media, including social, are on the table.
It’s really hope for the best in Whitehall. A wartime mobilisation is beyond the comprehension and managerial ability of ministers and officials. This is also why talk of mobilising industry and even forces to take on Russia is cheap. I echo Aurelien’s frequent comments on the matter.
(By the way, the Whitehall based officer who told me that over lunch a couple of days after the fighting started said the career military and diplomatic views are the US did not plan for this war, but Iran has for decades, an invasion of Iran would be “suicidal” (a word used in the voice over, not the written briefing), Iran is unlikely to lose and (at the time) “Tel Aviv (short hand for Israel) is burning”. Starmer was felt to be indecisive and shallow. It was not said, but was implied that the differences playing out in DC between military and diplomatic professionals versus think tanks, lobbies etc. are taking place in Whitehall, too.)
It says another thing which i believe it is real, very real, though not very much explored in Western countries probably because Neoliberalism. There is some flexibility in demand for oil and other commodities. It is being exploited mainly in China, if one is to believe what is written in the article, to reduce demand. It should be done in the CW too. With “flexibility” you can reserve oil products for the most essential activities and reduce tsunami damage. Some rationing would be required now, not tomorrow or the day after. Tighten speed limits, more workdays at home where it can be done, make freight transport more efficient, forbid private flights, etc. There are plenty of things that can help to reduce the impact. Forget free markets and go for it! Pretending that everything is all right is not helpful.
Thank you.
I don’t disagree.
I can’t comment about overseas and won’t.
The British government won’t implement such measures until it’s too late. It’s like covid in late 2019 and early 2020.
In any case, it’s not enough. The Bank of England is itching to raise interest rates. The Treasury does not want to increase spending, reduce the cost of living for individuals and begin a programme to mitigate the storm that’s coming.
the coming July reveal of reality will reverberate through daily lives. Will emergency services have fuel to dispatch ambulances and fire trucks? Will crops get harvested and seeded? How crowded will public transit be? Used EV’s are a buy now, will get snapped up like yesterday’s half off deals. How bad will the resession be? Will price spikes find a new level of value? Sea change coming.
corn inventories are surprising low according to the last USDA survey and new crop is off to good start, so harvest will be torturous, E15 will be debated increase, significant price increase just to get the crop to market, exports boom even with much higher transport costs. HRW harvest a total bust, expensive imports to the east coast, futures mkts confused until painfully obvious no wheat feeding, poor quality for milling and skyrocketing costs curb planted acres severely curtailed. thinking out loud here, oil price spikes drive all fut mkts higher near term, cash lags but commercials realize they better buy now to secure supplies. lazy, late to the party thinkers get steamrolled, gonna be brutal. again thinking out loud
You may be thinking out aloud but what you said is more reality-orientated and astute than anything coming out of the markets right now which is frankly delusional. Wheat crops here in Oz are going to be down about 50% so who knows what the state of US wheat crops are going to be like. Will there be the diesel to bring in all those crops? As I said before, we had better hope that the Russians have a bumper wheat crop this year. The world will need it.
The commodity markets are not forecasting a poorer world. They are enforcing one.
Yes! And IMO it is by design. Forced degrowth, so the US/Western Empire can keep a proportionally larger share, even if the pie is much smaller. It’s economic warfare vs China, which believes in the mantra of endless growth (something impossible at this stage, there’s no Planet B).
It’s a very risky bet, because it will unleash mass unrest and quite possibly revolutions. However the Dark Lords of Wall Street believe that they will manage, as they did before. I don’t think so.
As Mark Blyth once said, ‘the Hamptons are not a defensible position. The Hamptons are on a low-lying beach. Eventually the people will come for you.’
Back in 2008 and on, the Dark Lords had a competent and popular “front man” in the White House, Obama.
I do not see anyone today with nearly the amoral efficiency and suavity of that literal “Dark Horse” politico. He may have “saved then from the pitchforks” back then, but I doubt anyone now practicing politics in America could pull off the same trick.
Stay safe. Prepare Ye for the End.
Thank you, Ambrit.
I hope both of you are well.
I’m preparing for the end of days and having a house built on farm land with its own water and electricity supply somewhere tropical.
Let’s pause for a few days and enjoy Epsom on Friday and Saturday. If you don’t have access to the racing, please try this free Greek one, https://horseraces.pamestoixima.gr/en/live-stream. Unfortunately, it no longer shows French racing.
I disagree.
Trump has no plan, he got sold a bill of goods, was high on Venezuela and launched a war expecting Iran to collapse in 3 days. He doesn’t want “de-growth.” Israel doesn’t care about “de-growth,” they want hegemony in the ME and Iran is in the way of their regional aspirations. Trump wants to walk away, but he can’t because unless the SOH is re-opened without Iranian control, it will go down as a big “L,” further, Israel doesn’t want him to walk, so he is stuck playing chicken with Iran and praying for a miracle, while doing his best to prop up financial markets in the meantime.
If SOH remains shut, and especially if the Red Sea is shut-down as well, its not clear how that improves “relative power.” The “Western Empire,” e.g. Europe, is completely dependent on oil and gas imports, and will be wrecked. Russia will do quite well, and Europe will have to come begging to the Russians if they want to heat and cool their cities. China has a massive petro reserve, has links to Russia and has the most advanced renewable and nuclear infrastructure in the world, so whatever hardship, they are in a good position to pivot. US has light crude, but not a lot of heavy necessary for diesel and industrial uses, so prolonged closure is likely to de-industrialize, and forget about trade. If the plan is “forced degrowth” to preserve relative power, it is as ill-conceived as it is as a “regime-change” war.
Another problems for this view: the SOH and the Red Sea (potential) shut-down are strategic weapons wielded by Iran in response to US aggression. The US did not expect Iran to shut-down the SOH. Iran controls the SOH. If closure was going to make the US world hegemon, and weaken Iran’s friends, then it doesn’t make sense that Iran would close it, or alternatively, keep it closed if it results in a strategic victory for the Yanks. If your analysis were correct (I don’t think it is), then the US would end up winning the game of chicken and Iran would re-open Hormuz before they destroyed Russian and China.
here’s more confirmation of what’s coming https://themerchantsnews.substack.com/p/exxon-just-said-160-oil-my-book-is?r=wh9r
and Russias spring wheat sowing behind schedule
I experienced a tsunami in California that was triggered days before by the huge 2010 Chilean earthquake (scaled at 8.8) I was sitting on walkway overlooking the Santa Barbara, CA harbor and the water level began to drop slowly but perceptibly and then rise again, several times. Each event getting lower and then higher over a span of 15 minutes. Eventually, the water level in the harbor rose 3+ feet with some boats beating against their dock. When this high water departed the narrow entry of the harbor, it created a powerful seaward current that ripped barges from their moorings and slammed them in the the famous Stearn’s Wharf. Extensive piling damage occurred. All from a tsunami that originated in South American Pacific; thousands of miles away.
In Western Samoa in 2009, the only person at one of the beaches who saw the ocean recession and correctly understood the reason was a 10 year old girl who had learned about it in school. She ran along the beach yelling at people to run for higher ground, and saved a lot of lives.
Sadly I don’t think current world leadership are as willing to listen to reason as the people on the beach were.
Andaman Islanders also avoided the tsunami by instinctively going to higher ground…
You get the idea that those in harms way in the PNW would be sitting ducks were a tsunami to hit there.
This is really interesting… I wonder if this was recorder at all and could be used to predict large earthquakes? I don’t even know what the mechanism would be there
Hoo Boy.
A reminder that Denial isn’t just a river in Israel.
I see what you did there