Material Matters: Oil Impact, Mineral Sands, Aluminium and Coal

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-Gold miners benefit from lower oil
-Oil stocks can still outperform
-Opportunity for sulphate feedstock
-No constraints on aluminium
-Cost falls add to thermal coal woes
 

By Eva Brocklehurst

Impact of Falling Oil Price

What impact does the fall in the oil price have on miners? Morgans observes it helps the bulk miners – iron ore and coal – by reducing their operating costs but diminishes the geographical advantage in seaborne freight markets in terms of bulk shipping costs. Lower transport fuel pricing changes the dynamics of sea freight, reducing Australia's natural advantage from its proximity to China. Gold miners are estimated to be enjoying savings of between 20-30% from diesel prices, with iron ore miners a close second. Nevertheless, processing infrastructure generally runs on gas/grid power so the savings are less direct for the bulks. The bigger losers in the bulks sector are considered the take-or-pay contracts of Australian coal producers.

Oil and Energy Picks

With the industry struggling to forecast a floor in the oil price, Deutsche Bank takes a punt on how long the weak pricing may last. The analysts suspect low prices will drive a supply response, particularly in US tight oil. Operating efficiencies should lower break-even prices, while a reduction in drilling will take time to have an impact on production. Hence, the analysts envisage weakness in the first half of this year ahead of modest improvements in the oil price in the second half. Deutsche Bank considers the oil price is unsustainably low at a spot price of US$50/bbl and driven as much by geopolitical issues as fundamentals. Longer term the analysts expect an improvement, but long-term forecasts have been lowered to US$90/bbl from US$100/bbl.

Despite the lack of optimism in 2015, the broker believes Australian oil stocks can still outperform. First production at both APLNG and GLNG is a significant catalyst, as will the news flow be on expansion at PNG LNG. Deutsche Bank continues to favour Oil Search ((OSH)) as the top sector pick with PNG LNG the most economically robust new project in the region. The broker considers Santos ((STO)) oversold on unfounded funding concerns, while Origin Energy ((ORG)) is now a preferred exposure as a positive news flow is envisaged from APLNG and the stock has a more defensive earnings profile from its utility business.

Mineral Sands

The biggest structural change in the global titanium dioxide pigment market has come with the emergence of Chinese capacity, which now represents 40%, and the move by China to become an exporter. JP Morgan suspects this could limit the ability of producers elsewhere to lift capacity utilisation. As a result, the broker has reduced high-grade feedstock price forecasts. China's capacity growth over the last decade was primarily driven by higher pigment prices which resulted in better margins. As prices are now substantially lower, JP Morgan believes there is less incentive for capacity growth. Still, with utilisation still only 70%, Chinese production and exports are likely to trend higher.

Conversely, the broker believes there is an opportunity for sulphate feedstock producers, as China is likely to become more reliant on imports given the majority of its domestic ilmenite supply is a by-product of iron ore. The government has recognised the high rate of pollution in this industrial process and has introduced new policies to encourage development of chloride plants. JP Morgan understands there are only two chloride producing plants in China and Chinese pigment production remains predominantly via the sulphate process. With the fall in iron ore prices, the economics of China's iron ore mines are being challenged and this could, in the medium term, increase China's reliance on imported feedstock.

Aluminium

After adjusting for the under-reporting by China of aluminium output, Macquarie notes global output looks to have been over 53mt in 2014, breaking through the 1.0 million tonnes per week barrier. Macquarie attributes this increase in output to a reaction to sustained strong demand. While China's capacity additions were pursued firstly to satisfy growing domestic consumption, the ongoing commissioning of new, lower cost capacity has resulted in a primary aluminium surplus. Elsewhere, Western Europe production was 24% below the 2008 peak and the lowest since 1996 and North America's was the lowest in its history, 26% below the 1999 peak. South America was also making history, 42% below 2008 levels.

As aluminium prices are higher there has no pressure to idle existing operations but Macquarie observes, in a market with high inventories, this is still a problem. Ex China, the broker suspects many of the smaller producers may be tempted to re-start operations, particularly if given certainty on premiums. Macquarie observes the big question mark is over Russia's Rusal, where costs have fallen swiftly with the rouble. Thus far the company has shown no sign of a change in strategy. In Brazil, given high power prices, Macquarie believes there is scope for capacity to be offline on a more permanent basis. Companies there are earning more by selling power back to the grid than they would by selling aluminium.

Thermal Coal

While the theoretical level of oversupply is falling, 2015 looks set to be another tough year for US-dollar denominated thermal coal prices. Macquarie observes cost curves continue to fall on the back of oil and freight declines, while the policies of China look likely to persist to the detriment of seaborne pricing. Macquarie lists the reasons why thermal coal prices went belly up last year: supply growth from key countries such as Australia and Russia remained strong while global demand was weak; seaborne and Chinese cost curves moved lower and the US dollar appreciated; cross-over tonnes were also moved from the metallurgical (coking) coal market to the thermal market; and China implemented measures to protect its domestic industry.

These factors are not expected to change much this year. Macquarie suspects the cost curve for seaborne thermal coal is down around 15% on six months ago. Falling costs are not conducive to large-scale supply cuts. The broker acknowledges global seaborne thermal coal supply fell 2.0% in 2014, the first decline in over a decade, led by Indonesia and the US. India remains pivotal in seaborne demand growth prospects. The Indian government has spoken about boosting to its state-owned production to 1bn tonnes by 2020 but Macquarie remains cautious about this target, given the amount of infrastructure required.

Macquarie expects Newcastle and Richards Bay spot prices in 2015 will average less than US$60/t, the lowest annual average price level since 2006.
 

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