A zinc market constricted by high energy prices and war is setting the stage for nickel-like market shocks at one of the world's largest industrial metal exchanges.

High power and natural gas prices, sparked by the Russian invasion of Ukraine, have idled some zinc production in Europe, the region responsible for one-fifth of refined zinc supply. Scarcity of available zinc, which is heavily used by automobile and construction sectors, has pushed up prices and catalyzed massive stock drawdowns, potentially exposing the London Metal Exchange to another round of volatility.

The LME three-month zinc price climbed to $4,136 per tonne on March 8, reaching highs not recorded in 15 years. The LME three-month zinc price closed April 11 at $4,305/t, far above the $3,645/t on Feb. 9.

The world could face a 321,000-tonne zinc deficit in 2022, according to S&P Global Market Intelligence forecasts.

Similar fears of limited nickel supplies sent nickel prices skyward in the days after the invasion. A short seller trying to cover its bets in March drove a historic price run-up, triggering the LME to suspend trading of its nickel contract. Though a suspension of the LME zinc contract appears unlikely, zinc's grim supply and pricing outlook could be a big headache for consumers, including carmakers, already struggling to meet their raw material needs, industry analysts said.

"After the nickel debacle, the LME is much more sensitive to market tightness and positions, and they will look to move early to avoid a repeat," said Stuart Burns, founder and editor-at-large at MetalMiner, a metal pricing and analysis platform. "But even so, zinc prices are looking strongly bullish, and the stage is set for a potential run-up in prices over the coming couple of months."

"Hold onto your wallets," Burns said.

Electricity guzzler

Zinc prices were already heating up well before Russia launched a war in Ukraine and sent energy prices sky-high.

European zinc producers need a lot of electricity to power their smelters and were weighed down by inflationary pressures. Companies idled or pulled back production at several zinc facilities across Europe.

The war in Ukraine has only exacerbated supply chain bottlenecks and geopolitical uncertainty. Natural gas prices have risen on fears of curtailment of Russian supplies.

"The growing fear of further curtailed zinc smelter outputs due to the worsening European energy crunch has led to the drawdown of zinc stocks," Mitzi Sumangil, an associate commodity analyst for S&P Global Commodity Insights, said in an email. "This leaves a thinner cushion for the market should refined supply continue to underperform and provide support for the price to reach higher levels."

Stock drawdowns

Following a pattern similar to other metals, zinc's exchange and trade inventories also plummeted in 2022.

LME zinc warehouse stocks fell 49% between Jan. 3 and April 11, and prices rose at the same time. The landscape is eerily similar to the nickel market in the weeks before its historic price spike in March. LME's opening zinc stocks sat at 123,675 tonnes, but the exchange reported having just 45,925 tonnes of live warrants April 11.

"Any environment where you have very low stocks, you always have the potential for more volatility in the market," said Tom Mulqueen, head of research at Amalgamated Metal Trading Ltd., a U.K.-based metal derivatives broker and dealer. "Prices can move up quite a lot, and there can be a bit of a chain reaction."

Still, key differences exist between zinc and nickel markets, Mulqueen said.

"I think the big difference between zinc and nickel is that when you had the big runup in nickel prices last month, there was a really dominant hedging position in nickel on the Chinese side obviously driving a lot of that," Mulqueen said. "I don't think you have a similar thing in zinc."

Possible relief from China

The energy crisis in Europe "opened the export window for China," which could help ease the rise in inventory drawdowns, analysts at Horizon Insights said in an April 11 note.

China produced 47.8% of the world's refined zinc in 2021, according to Market Intelligence estimates. While the country experienced energy shortages of its own in 2022, China has been largely insulated from the latest rise in natural gas prices.

"It is currently economic to move material out of Asian warehouses using breakbulk shipping given the very high premiums," Macquarie strategists said in an April 7 note and confirmed with S&P Global Commodity Insights. "If the material is physically delivered into Europe or the U.S., then this should help ease the current tightness in the market due to lower smelter output, and we should see premiums ease over the next few months."

S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.