article 3 months old

Material Matters: Oil & Gas, Copper And Thermal Coal

Commodities | Nov 27 2014

This story features SANTOS LIMITED. For more info SHARE ANALYSIS: STO

-What if OPEC maintains production?
-Copper demand to keep pace with supply
-China FTA coal benefit some time away

 

By Eva Brocklehurst

Oil & Gas

Tough conditions are in store for Australia's energy producers as oil prices continue to ease. In Credit Suisse's view, Oil Search ((OSH)) stands out as the only stock offering true long-term value at its current price. The OPEC meeting scheduled for November 27 is rivetting the attention of industry analysts. Should the oil producing cartel cut production in a meaningful way, then the broker believes Santos ((STO)) will be the best performer in the short-term. Running the numbers through spot FX and spot oil pricing means Credit Suisse's valuations fall for the three major producers – Woodside Petroleum ((WPL)), Santos and Oil Search.

The broker's modelling on Australian LNG stocks suggest that even at US$85/bbl for oil, cash margins are slim and any unsanctioned Australian capacity is dead in the current environment. PNG remains the clear winner relatively, with the lowest cost unsanctioned capacity and quality operators well ingrained in its projects. If OPEC does not cut production, and prices fall further, the whole sector will be in pain, in Credit Suisse's opinion.

Copper

Copper supply is set to accelerate in 2015-16, benefiting from the surge in capex in 2011-14, and UBS envisages surpluses for the next two years. Still, the broker has reduced the quantum of such surplus forecasts because of potential supply disruption, as strikes are a constant underlying theme in copper. Chinese demand is still expected to lift by around 9% this year and should grow a further 6.8% next year, mainly driven by investment in the electricity grid. Generally, copper demand is sustained longer in an economy's development than steel for this reason. Copper trade is sensitive to credit so the reduction in Chinese interest rate policy may also stoke interest, in UBS' view.

Elsewhere, while US and European economic growth is important, both regions consume less copper now than in 2000-2008. Surpluses weigh on the outlook for prices for the next two years but after 2017, the broker's model returns to substantial, and growing, deficits. The equity market appears to be factoring in lower copper prices long term but US expects robust demand and a move back to deficit will mean supply anxiety lifts, and prices should return to above US$3/lb from 2016.

Macquarie's survey of the copper market in China also highlights some resilience in demand, with sustained strength in orders from the power sector. The main issue the broker finds is a tight cash problem across the supply chain and this is dampening appetite for re-stocking. The broker also notes that cable producers are most bearish. They argue that a slowing in property and power consumption signals reduced demand for power grid infrastructure. Macquarie disagrees, believing that power infrastructure investment is mainly driven by policy rather than real demand and the infrastructure sector should be regarded as counter cyclical and a weapon for government when construction is dragging on the economy.

The biggest swing in the market outlook for the next three months emanating from the broker's survey is in copper smelters. Although the market is still, overall, bearish on copper prices next year, Macquarie observes there are some that are becoming less convinced. The majority of market participants agree that China needs to import less refined copper in 2015 and that demand will be met with a hike in concentrate imports instead. Hence, the ex-China refined copper market is likely to be under more pressure next year, in the broker's opinion.

Thermal Coal

Australian coal exporters will be on a level playing field with Indonesia if the promises in the free trade agreement, to remove the 6% tariff on China's imports, are fulfilled over the next two years. However for the time being, imports will be hampered by the re-imposition of a tariff last October and volume restrictions directed at imports that begin this year, with quality restrictions beginning in January. The thermal coal tariff is unlikely to be lifted until some time in 2017. Deutsche Bank observes Chinese efforts to support the domestic coal market are bearing fruit and this is at the expense of the seaborne market. The probability that such measures continue is high, with modifications to be based on market developments.

Reductions in cash costs have reduced the likelihood of further mass closures of capacity and this leaves the broker with the impression that the market will be oversupplied beyond 2015. That said, Deutsche Bank expects that price pressures will remain manageable for miners in 2015, with the Japanese contract settlement likely in the mid to upper US$60/t range.
 

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.

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms

CHARTS

STO

For more info SHARE ANALYSIS: STO - SANTOS LIMITED