Commodities | Jun 09 2016
-Prices diverge among coking coals
-Will Peru overtake Chile in copper?
-More nickel mine closures needed
-Cost deflation period ending for iron ore
-Excess capacity likely for Chinese steel
By Eva Brocklehurst
Metallurgical (coking) Coal
Prices are diverging among the different coking coals. Morgan Stanley explains the importance of hard coking coal in terms of its preferred application in steel production and the substitution via blending that underpins the usual positive correlation with other coking coals across seaborne pricing.
Sometimes the correlation breaks down. The price of hard coking coal is up 16% in the year to date while the prices of lower grades are flat to lower. The broker believes the higher hard coking coal price is likely to be a function of price elasticity in China, as traders or mills buy incrementally more hard coking coal whenever its price falls to US$80-85/t, FOB Australia, during the first three quarters of the year.
Essentially, if it is cheap enough, China will buy higher grade seaborne coal. Otherwise it will stick to using lower grades. Given the sharp rise in the price of hard coking coal in May, Morgan Stanley expects a strong lift in trade flows in June.
London Metal Exchange stocks of copper jumped at the start of the week as inflows were recorded in Singapore, Gwangyang, Busan and Chicago. Macquarie observes Asia witnessed most of this movement which implies the material was either Chinese exports or metal from vessels re-routed from Shanghai.
The broker suspects the main reason for the diversion is that bonded warehouse premiums have fallen far enough to support warehouse storage. China has been observed exporting metal, with evidence exports were strong in April and holding up in May. The issue of the latest inflow is the sudden appearance of copper in a number of locations on the same day.
This implies there are fewer players warranting the metal and Macquarie assumes the intention was to crush the spread and take advantage of steep backwardation – where the spot price of a commodity is higher than the forward price. The broker also suspects, given a flood of fresh warrants entering the system, the player was not that successful.
Peru is now the second largest miner of copper and zinc in the world as well as being a significant producer of lead, molybdenum and precious metals. Macquarie believes the vast geological potential of Peru suggests the country has the potential to take on Chile as number one copper miner. Chile's growth is now stagnating on falling grades and resource quality, the broker observes.
Hence, the broker is not surprised that Chinese investment in Peru has increased, with the biggest consumer of metal looking to secure future raw material supplies. Macquarie observes the successful ramp up of several projects, notably Cerro Verde's mill expansion and the greenfield mega mine, Las Bambas. Cerro Verde is now Peru's largest copper asset, with annual capacity at 500,000 tonnes of copper.
While the strong copper output is likely to be bearish for the metal's price, Macquarie observes zinc is doing the opposite. Output has been struggling and Peru's overall production is down 9.1% in the year to date, which the broker observes will put more strain on an already under supplied market.
UBS observes much of the nickel industry is losing money. In the light of the fact that cost curves can lag and exclude items such as sustaining capital expenditure, the broker analyses free cash flow per pound of nickel to get a measure of which operations are losing cash.
The broker's coverage produces around 1mt of contained nickel each year, about half the global trade. The largest missing segment is the China-Philippines-Indonesia nickel pig iron route.
UBS deduces that around half the individual operations accounting for about 300,000 tonnes per annum are losing cash. Many are within a corporate entity that has multiple mines so most are neutral or even positive in terms of cash flow at the corporate level. While cross subsidising may continue, UBS suspects some may seriously consider shutting down operations in the months ahead.
Shutting production is considered a key catalyst for the industry to return to a more sustainable footing. UBS bases much of its forecast price upside to US$5.00/lb for 2017 on the closures occurring in late 2016, early 2017. The broker prefers Norilsk and Independence Group ((IGO)) as these appear able to generate reasonable margins if a low-price environment is sustained for longer than expected.
Citi retains a bearish view on iron ore but envisages some short-term upside largely from better Chinese steel output. This hinges heavily on policy decisions such as short-term stimulus and structural reforms.
Chinese steel end user sectors and export volume have outperformed so far this year, because of an easing in credit conditions and strong fixed asset investment. Meanwhile, ex China curtailments and disruptions in iron ore have been partly offset by recent re-starts. Citi still expects curtailments to resume into 2017 as increasing low-cost supply drives the price down.
The broker also suspects the massive cost deflation experienced over the past two years may be coming to an end. Prices may, therefore, receive some support from cost inflation but Citi notes the seaborne cost curve has become flat for the large miners.
The broker upgrades short-term iron ore price estimates on stronger Chinese demand, expecting US$49/t in 2016 and US$42/t in 2017. In the medium term, the broker remains bearish, expecting the seaborne market will spend a longer time finding lows in price before re-balancing.
National Australia Bank analysts believe the iron ore price rally to US$70/t in late April is unsustainable. A short-term boost to profitability should not overshadow the significant long-term challenges that China's steel industry needs to address, the analysts maintain. Excess capacity in China's steel sector is seen exceeding 300mt and medium term trends for steel, both in China and globally, are considered subdued.
The analysts suspect that expectations for China's steel consumption to continue to decline in coming years will be a constraint on iron ore demand. Sub-trend economic growth elsewhere is providing little opportunity to offset this. Over the medium term the analysts expect prices to settle around US$40/t.
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