Material Matters: Alumina, Aluminium, Steel, Iron Ore, Coking Coal And Nickel

This story features ALUMINA LIMITED. For more info SHARE ANALYSIS: AWC

-Steel demand in sharp decline
-Growth in China’s aluminium exports
-Iron ore inventory seen building
-How to turn coking coal prices around
-Nickel upside seems to be waning
 

By Eva Brocklehurst

Alumina

Credit Suisse suspects the market has not witnessed the end of the slide in prices. The Chinese alumina price impacts the Australian price through import arbitrage, and the ex-works price has been falling faster than the Australian price because of over-production. Credit Suisse observes there is a lot of cargo looking for a buyer in the Pacific market and this is a catalyst for prices to go lower. The broker recently downgraded Alumina Ltd ((AWC)), the world’s largest third-party producer, to Neutral from Outperform amid concerns about the downtrend in prices.

Commonwealth Bank analysts also note the pressure on alumina prices and blames declines in bauxite and aluminium pricing for guiding it lower. China’s alumina market remains in deficit, the analysts note. Headwinds are expected to continue in the short term but the analysts maintain alumina is one of the few commodities in which investment is occurring at the top end of the cost curve. China plans to build out capacity that is reliant on local low-quality bauxite deposits. This should help support alumina prices in the longer term.

Aluminium & Steel Producers

To Macquarie, it seems increasingly the case that steel and aluminium producers are playing a game of bluff when it comes to production cuts. Global output of both metals is holding up despite price pressures. Oversupply relates mostly to elevated Chinese exports. Macquarie observes producers both outside and inside China are reluctant to make further production cuts. Figures for global crude steel output in May reinforced the weak trend seen so far this year, as output was flat month on month and down 2.1% year on year. Despite the softer supply Macquarie claims demand is much worse.

There is a risk of a full year of global steel consumption decline. For steel, Macquarie expects utilisation rates will increase over time owing to a lack of capacity additions globally and China is likely to rationalise some capacity, driven by economics. Aluminium production also appears to be running ahead of demand and with Chinese supply growing, the situation, Macquarie suggests, is getting worse. There is pressure to take supply offline. The analysts believe up to 1mt of ex China aluminium capacity will have to be cut in coming months as prices fall further. Given the cost-competitive nature of new Chinese capacity, growth in export volumes in coming years is expected.

Iron Ore

The latest data on freight at major iron ore terminals in Brazil and Australia signals to Goldman Sachs an increase of 10% in export volumes relative to the January-May average. Some weakness in April/May exports was likely caused by weather events and, on that basis, should have limited implications for future performance. Hence the analysts expect that in the weeks ahead Chinese inventories will recover and prices will return to a level where marginal producers are again under pressure.

Goldman Sachs also observes the divergence between falling steel prices and higher iron ore prices has driven mill profitability to a multi-year low. Unless steel demand and prices improve in the short term there is the likelihood the iron ore rally will end.

Metallurgical Coal

Macquarie notes a quarterly hard coking (metallurgical) coal contract settlement of US$93/tonne FOB Australia was recently reported, the lowest settlement since 2004, when the market was only 60% the size it is today. Then Chinese net imports were zero and contracts were set annually. Macquarie’s base case is that prices will only recover gradually from 2016 and will not get back to 2013 levels until the end of the decade.

What are the factors that could turn metallurgical coal prices around? Cost inflation needs to re-emerge. Deflation has occurred on the back of a stronger US dollar, a fall in the oil price and productivity gains. The best potential for upside pressure is a reversal of miner productivity gains, which have mostly come from attrition. The analysts make the point that there is a limit to the extent labour reductions can be made. Macquarie also notes high-grading gains at the mines can also only be sustained for some time.

Another factor is weather. Australia represents over 60% share of seaborne supply and this mostly comes from Queensland, where floods are prevalent. The broker, however, is not sure that floods in the future are likely to be quite as bad as in the past, as miners have increased investment to mitigate for damage while buyers are now more flexible in terms of what they can purchase. Another issue that prevents prices rallying is that balance sheets in the US coal industry are more distressed than the assets, which means assets continue to operate and volume reductions are not guaranteed even if companies are seeking relief from creditors or facing bankruptcy.

Some consolidation in China’s coal industry may help prices rally but Macquarie queries whether this could flow through to the global market. A ramp-up in China’s metallurgical coal supply since the middle of last year means China has returned to being a net exporter. The analysts find it hard to imagine the government would restrict supply to turn this situation around. Another factor which may support prices is if the market is too bearish about Chinese demand. Peak steel expectations in China have shifted to this decade from next decade. Macquarie suspects China’s capital stock of steel is still only around 40% of that in the US on a per capita basis and such “peaking” could actually be a long process.

Nickel

UBS suspects the case for a substantial lift in the nickel price is waning. Prices were expected to rise sharply on the back of a delayed reaction to Indonesia’s export ban, which caused China’s stainless steel industry to turn to alternative nickel products amid a surge in ore exports from the Philippines. Softer economic momentum also added a dampener to prices.

China’s latest trade data signals renewed imports of conventional nickel products and UBS expects a short-term rise in the nickel price to US$8.25/lb by the first half of 2016, which compares to spot at US$5.80/lb. Nevertheless, the broker believes the magnitude of the expected lift in prices is waning as inventory has built up relentlessly on the London Metal Exchange. While some signs of outflow is occurring, inventory needs to be drawn down further in order to elicit a price response. China’s move to source more conventional nickel products may be a catalyst. UBS has calculated the equity market is factoring in an average implied price of US$6.39/lb, around 11% above the current spot price.

Citi finds little support for nickel prices after a brief rally in late April/early May and believes a downtrend has resumed. Moreover, the weaker-than-expected pricing has removed any incentive for stainless steel consumers to rebuild inventory levels. Global stainless steel production rates remain soft and Citi suspects the expectation of an imminent listing of Norilsk full plate cathode on the Shanghai exchange may have been behind large deliveries of nickel into LME warehouses in Singapore.

If Norilsk metal receives approval over the northern summer, Citi suspects this could prompt significant drawdown from Singapore as the metal is transferred to China. Despite this, support could be short lived as the broker suspects the fundamentals in the market will cap any upside before the end of the northern summer.
 

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