Expect nickel and gas prices to be lower for longer

Every student of the commodity market soon learns the industry’s main axiom: “Low prices cure low prices, and high prices cure high prices.” That’s why commodities are known as a boom-and-bust industry: Periods of over-investment lead to gluts and low prices, which trigger under-investment, which ultimately curbs supply and sends prices up. What many aren’t taught is that this self-evident principle is often misleading, if not completely false.

The latest examples: the global nickel and US natural gas markets, where the accepted truth that low prices cure low prices isn’t working out as the axiom claims.

That’s a boon for the energy transition because both nickel and gas are key in the fight against climate change. Nickel is a must-have for electric vehicle batteries, while gas is seen as a bridge fuel between coal and renewables.

But low prices – and the prospect that they could remain low for an extended period – are terrible for the producers that are already curtailing output or even abandoning entire projects.

Two moves have caught the attention of the market. First, Glencore Plc, the world’s largest commodity trader, put its flagship multibillion nickel mine into “care and maintenance” on Feb 12, a first step before selling it or closing it for good. Second, on March 4, EQT Corp, the largest US natural gas producer, said it was cutting its output by about 6 percent this quarter after USgas prices fell close to a 25-year low.

Glencore and EQT are paradigmatic – but other companies are taking actions in both markets, and the prospect of some firms going bankrupt is a distinct possibility.

First, a quick 101 in commodity economics. The theory says that low prices force producers to reduce investment, curbing supply; they also incentivise consumers to use more stuff, perhaps in new applications, lifting demand. Over time, both forces rebalance the market, bringing prices to their so-called mean reversion, aka, the average. But that stylised supply-and-demand model assumes a fixed environment that doesn’t consider technological changes.

For most of the time, the static model works, but occasionally, technological developments shift the cost of production curve lower – permanently. That’s what has happened to both nickel and US gas. And it’s why producers are struggling to rebalance the markets, even when taking actions that in the past would have worked quickly.

Consider the case of nickel, the metal used to make stainless steel and, increasingly, EV batteries. Two decades ago, China’s Tsingshan Holding Group Co pioneered the large-scale use of so-called nickel pig-iron, a semi-refined product that’s a low-cost alternative to pure nickel, to produce stainless steel.

The major technological innovation was the rotary-kiln furnace, which allows ore to be processed, smelted and channeled into stainless steel furnaces in a continuous hot flow. Moreover, Tsingshan built mine-to-metal hubs in Indonesia, grouping all steps of the production in a single location (Sulawesi), further slashing costs. More recently, the company developed a new system to turn pig-iron into pure nickel, further flooding the market. The upheaval can be seen better through the lens of Indonesia’s share of global nickel output; it jumped to about 50 percent last year from 10 percent a decade ago.

The gas market has also seen its own disruption in the form of shale fracking. Shale was historically seen as an unlikely source of hydrocarbons, but two technological advances changed that. First, US wildcatters learned to drill vertical wells and then turn the bit around 90 degrees to proceed horizontally, first only a few yards but, nowadays, for miles. Then, they blasted the rock with water, sand, and chemicals – the process popularly known as fracking – freeing oil and gas molecules from the otherwise non-porous shale.

The result was a staggering increase in production, making the US the biggest exporter of liquefied natural gas last year. Over time, the process has become cheaper and cheaper, lowering overall costs. Despite years of low prices, US gas output has nearly doubled since 2010.

Barring a massive geopolitical disruption, it’s difficult to see how nickel and US gas prices can revert to the average price levels of yesteryear, regardless of the actions that producers are taking. True, neither commodity is completely immune to the law of “low prices cure low prices.” But the shift in their production costs means that the markets won’t mean revert – a lower-for-longer period is ahead. It may be bad news for producers – and their shareholders — but cheap nickel and US gas are good news for the planet.

Javier Blas is a Bloomberg Opinion columnist. Views do not represent the stand of this publication.

Credit: Bloomberg