Material Matters: Coal, Steel, Oil And Platinum

This story features SOUTH32 LIMITED, and other companies. For more info SHARE ANALYSIS: S32

A glance through the latest expert views and predictions about commodities. Cyclone Debbie looms; Chinese coal policy; steel strength; iron ore outlook; oil's impact on commodities; platinum issues.

-Abbot Point and major miner Glencore the most at risk with Cyclone Debbie
-Iron and steel output surges as Chinese steel demand stays healthy
-Ord Minnett upgrades outlook for iron ore miners
-Diminished oil prices impact bulks and metals prices, despite intact fundamentals
-Deutsche Bank finds platinum starting to look cheap and a relative value proposition
 

Cyclone Debbie

As Tropical Cyclone Debbie hits the Queensland coast, Macquarie assesses the increased production risk for Queensland coal miners. The cyclone was a category four and, therefore. there is a risk of damage to port infrastructure as its trajectory is very close to the Abbot Point Coal Terminal.

Abbot Point terminal is owned by Adani and boasts capacity of 50mtpa, although the port is currently shipping 26-27mtpa. Macquarie estimates that thermal coal accounts for 87% of total coal exported through Abbot Point. Limited impact on global prices is expected, unless rainfall severely affects mine production in the Bowen Basin, immediately inland of Abbot Point.

Glencore is the major miner most at risk of production losses from the cyclone. South 32 ((S32)) may be a beneficiary, as it has NSW operations which will be unaffected. If there are material effects on the mine production in the northern Bowen Basin Macquarie expects to see near-term strength in spot coking coal prices.

A 10% move higher in coking coal prices translates to 6-9% upgrades to the broker's forward estimates for South 32 and 9-10% for BHP Billiton ((BHP)). There remains some risk to New Hope Corp's (NHC)) New Acland operation should rainfall head further south in Queensland.

Thermal Coal

Deutsche Bank suspects the Chinese government agency, National Development and Reform Commission (NDRC), may be reluctant to intervene further in the thermal coal market. Either that or there is a lack of viable policy options, or both. The government has stated that no measures will be taken to reduce production quantities as long as prices remain in, or above, a reasonable range.

Nevertheless, the broker notes there was also no suggestion that a further loosening of supply would be undertaken to bring prices back towards the RMB535/t mid point of the range. The reason perceived for this is that the NDRC expects coal prices to fall after the end of the heating requirements of the winter. Near-term momentum may still push prices higher, the broker believes.

Steel

Credit Suisse observes the NDRC scored early success in its attempt to talk down the steel price, as steel futures led the ferrous complex down with a 13% fall. The broker suspects it would probably be unwise to take an opposing view to a powerful agency so speculators probably cleared out.

Falling futures caused uncertainty for the steel mills and they stopped buying iron ore. Iron ore, as the result of the buyers strike, fell -8%. However, physical steel has declined only -3% because the construction season is under way and demand is still real. Therefore, Credit Suisse doubts the NDRC can hold the steel price down through the construction period.

The broker expects iron ore prices will recover while physical steel prices are firm and steel margins remain wide. Relatively, Chinese steel inventory is depleted as traders wind down inventories after the winter months.

Macquarie notes iron and steel output is booming. World steel data revealed that steel output growth slowed to 7.8% in February from 8.1% in January. If nothing else, from this base the broker expects to witness a sharper slowdown in the growth rate over the second quarter. The main question is whether this reverts to a year-on-year decline in the second half.

The key is Chinese construction activity, where Macquarie expects some signs of weakening to emerge during the next few months, but not a collapse. The broker considers the Chinese steel industry is in a healthy state at the moment and will continue that way for as long as demand holds up.

Iron Ore

Ord Minnett upgrades 2017 and 2018 forecasts for iron ore prices to US$82 and US$65 a tonne respectively, because of more constructive estimates of Chinese steel demand. These latest changes to steel demand estimates have driven earnings upgrades of 13-17%, along with significant improvements expected in the balance sheets, for major producers.

The broker notes the large iron ore miners are in the best financial shape in years. Ord Minnett retains a preference for Rio Tinto ((RIO)) over BHP Billiton, while reiterating an Accumulate recommendation for Fortescue Metals ((FMG)). The broker notes the latter's balance sheet is strong and a material uplift in dividends is expected in the near term.

Ord Minnett does not expect Fortescue to waste capital on large-scale mergers & acquisitions. The broker suggests, as the stock is not well held across large institutions, there is room for marginal buying as fund manager confidence improves.

For the two big players the broker expects Rio Tinto (Accumulate) will generate excess cash and continues to expect its US$500m buyback will be topped up progressively over the medium term, along with higher dividends. BHP (Hold) is slightly less compelling, although the metrics are considered still reasonable in isolation.

Oil Impact

Morgan Stanley suspects the re-start of US shale oil capability is a bearish inflection point for oil, following the lift to prices in January from the OPEC agreement. The shift to a US shale focus appears sufficient to limit prices for now, the broker believes. Meanwhile, the drag from weak oil prices on other commodities is by way of a general decline in the cost of production/delivery of metal and bulks.

This, in turn, undermines equilibrium prices in these commodities via a competitive supply-side response. Morgan Stanley contends that bulks are probably more exposed to changes in energy prices than the metals.

Beyond fundamentals, there is another bearish impact of a capped/weak oil price. Even though recent price performance in oil largely reflects a step-change in US supply, any price slide will likely deter investors. The broker cites an example where, in the fourth quarter of 2014, an investor exodus halved crude oil prices, which prompted a collapse in excess of 20% in metal/bulk prices despite the trade flows across all markets being intact.

Deutsche Bank observes the market share of OPEC remains well above the 2014 level, even after the production cuts. Today OPEC produces 40.2% of the world's crude oil, down from its recent peak of 41.3% in August 2016, but still considerably higher than the November 2014 level of 38.8%.

Projecting current levels of production into the next two years, the broker believes a continuation of supply discipline implies the OPEC share falling to 39% by 2019. While the broker believes market share may re-emerge as a concern, levels are not currently at a critical point for this to occur.

Platinum

Deutsche Bank continues to believe the platinum in market will be in modest industrial surplus at around 200,000 ounces in 2017. Labour relations issues in South Africa may mean that mine supply could disappoint on the downside but the broker already builds in a disruption allowance into estimates.

Also, the high grading of spent automobile catalyst substrate during 2015, when scrap steel prices were low, has meant that the current batch being recycled now has lower grades. This is reducing the amount of platinum being recycled, despite an increase in the volume is being processed.

The broker concedes that investment demand may change the supply/demand balance tilt but continues to believe that, with the exception of Japan, investment demand is very much linked to underlying fundamentals.

In this instance, the broker believes the underlying fundamentals for platinum are not strong enough to break away from the influence of gold. While the fundamentals are uninspiring, Deutsche Bank considers platinum is starting to look cheap on several metrics and makes a tempting relative value proposition.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms