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South32 Depends On Manganese (And Vice Versa)

Commodities | May 01 2015

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-Oversupply for next few years
-Less available vs iron ore
-More market discipline vs iron ore

 

By Eva Brocklehurst

Manganese, an essential input to most steel making, has been overshadowed in broker analyses by the travails of the iron ore and coal markets. Manganese prices have slumped this year by around 30% on concerns about surpluses, reflecting expanding supply from committed projects and slowing crude steel output.

Morgan Stanley observes too much supply has entered the market over the past five years in response to an optimistic outlook for steel consumption and, with the fall in steel output growth, has meant a surplus of ore similar to that faced by iron ore, nickel and zinc. Still, Morgan Stanley believes, if the supply side fundamentals are superior, the commodity can outperform, although it will take time for the market to re-balance. The broker expects the surplus to persist in 2016 but, significantly, there are no new projects coming to market and, with producers restricting supply growth, the trade can tighten over the medium to longer term.

Commonwealth Bank analysts are more bearish and expect oversupply will keep prices depressed for the next several years. The analysts contend most of the incremental new supply out to 2020 will come from around eight projects, with BHP Billiton's ((BHP)) Groote Eylandt, soon to be part of the South32 de-merger, accounting for 85% of the increase in supply.

The analysts believe the manganese surplus will peak in 2018 before reducing by 2020. Manganese prices are expected to bottom in 2018. The analysts expects prices to fall 31% year on year to US$137/t in 2015 and a further 6.0% to US$129/t in 2016 – a price in line with manganese prices before China's boom took place.

With the likely spin off of South32, the manganese assets will now represent a significant driver of South32's earnings, incorporating the GEMCO operation in Australia and the Hotazel operation in South Africa. Hence, Macquarie takes a closer look at the potential market drivers and costs for manganese. While a global surplus is expected to remain in place, the broker expects further cuts to Chinese and Australian output in the medium term will mean supply does start to fall over the next couple of years.

The demand environment appears better, although the market first has to first pare back oversupply and run down inventories. Macquarie expects the process may take time, with a draw on global inventories not expected until 2018. At that stage the broker expects the price to steadily appreciate.

Morgan Stanley believes it is wrong to draw too many parallels with the global seaborne iron ore market. The broker makes three distinctions. Firstly, there are less than 10 manganese producers globally and they operate less than 20 assets, ex China. This tends to encourage a more disciplined management of supply growth. Secondly, there is no substitute for manganese in steel applications whereas iron ore faces increasing pressure in China from scrap. For example, around 80% of US raw material input is steel scrap while China's ratio is only around 15%. Hence, while iron ore's share of total input may shrink, the share of manganese will likely remain stable.

The third distinction is that China cannot rely on domestic manganese supply as it can for iron ore. China's mines are generally situated far away from end users and its ore is not high grade. Macquarie also observes the removal of the boron-added steel rebate has made Chinese material less competitive internationally.

Manganese is an alloying element for steel production, bonding with iron. It reduces brittleness and enhances steel's strength. The ore is abundant but rarely found in concentrations sufficient for a commercial deposit. Morgan Stanley notes it is the fourth most employed metal in terms of tonnage, after iron, aluminium and copper. The other uses for manganese are in alloys with aluminium and copper and in batteries. Manganese is also used in fertilisers and as a colourant for vehicle paint, bricks, glass textiles and tiles.

Major global producers are China, South Africa and Australia. Together, South Africa and Australia deliver around half of global production. Gabon, Ukraine and Brazil are also significant producers. South32 will be the world's largest manganese producing company and Macquarie attributes 21% of South32's earnings to manganese. Having a major listed company with significant manganese exposure should boost investor interest in the ore.

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