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Material Matters: Crude, Coal, Iron Ore, Alumina And Nickel

Commodities | Oct 25 2016

Commodity demand rebound; crude challenges; thermal coal exports; blast furnace efficiencies; alumina price surge; nickel ore exports.

-Zinc market retains strong fundamentals and top pick for RBC Capital Markets
-Atlantic Basin crude loadings recover and oversupply risk persists
-Thermal coal pricing continues to be dictated by Chinese policy
-Iron ore pellet premiums at highest level since 2014
-Nickel ore tightness to emerge, likely spike in prices


By Eva Brocklehurst


RBC Capital Markets observes Chinese economic stimulus and a rebound in demand for steel production have underpinned a broad recovery in commodity prices. Specifically for zinc, permanent mine closures related to an exhausting of reserves have tightened that market and driven prices higher. A similar situation relates to coal production cuts in China that have caused coal prices to spiral higher.

The analysis suggests the zinc market still has the best fundamentals and remains the top pick. Based on 2016 price forecasts, RBC Capital Markets analysts prefer zinc, coking coal and palladium. Based on five-year forecasts the analysts prefer nickel, zinc, uranium and copper.

The analysts believe, in the absence of further production cuts, stronger economic growth and demand are required to balance most commodity markets and lead to a sustained rally in prices. With the exception of coal and uranium, the analysts make minor changes to forecasts. Average coking (metallurgical) coal price forecasts are increased 37% and thermal coal are increased 17%. The analysts' average uranium price forecast is lowered 24%. The analysts recommend investors increase exposure to non-precious metal mining shares.


The trend in US inventories is looking better for crude but Morgan Stanley observes signs of physical market stress. The broker contends recent inventory data is backward-looking and exports are more important than production as a signal for physical markets.

The main challenge is that Atlantic Basin loadings are recovering. While the backlog should clear with appropriate price signals an oversupply risk persists. The headline rig count may be understating upcoming US supply and the broker also believes the disruptive nature of US shale oil is underappreciated.

Moreover, while some are becoming excited about the longer-term bullish comments from Saudi Arabia, Morgan Stanley points to a large number of producers that are increasingly finding ways to survive in a US$50-60/bbl world.

Thermal Coal

ANZ analysts suggest exporters of thermal coal are struggling to react to the shifting dynamics in the seaborne market. With China's new-found reliance on the international market, import demand in the Asian region has surged in recent months. Despite efforts to limit the impact of capacity closures on utilities in China, the analysts expect import demand to remain strong. Japanese buyers have also played a part in the current price rally. A move to more spot purchases occurred just as Chinese imports surged and has caught some consumers short.

Prices may be making almost every producer positive in terms of cash flow but the analysts believe an immediate supply response is likely to be muted and prices are likely to continue being dictated by China’s policy measures. If coal output can be temporarily raised heading into the northern hemisphere winter, prices may ease over the next couple of months. Even so, spot prices are expected to remain above US$80/t over the winter.

Iron Ore Pellets

When coking coal prices surge, steelmakers try to adapt, and Macquarie observes a standard tactic is to maximise blast furnace efficiency. This can lead to increased use of iron ore pellets. At US$35/t, pellet premiums are now at the highest level since 2014.  At every time coking coal prices surged in 2005, 2008 and 2011 this was met with gains in pellet premiums. With Samarco still off-line for the foreseeable future and limited growth from other suppliers, further upside to pellet prices seems probable to Macquarie.

At present, the broker considers it unlikely Vale will re-start pellet capacity unless the pellet premium rises a further US$10/t. However, prices above US$45/t are considered unlikely. As the global steel industry settles into a very low, or negative, growth pattern, operational gains will prove a strong differentiator, in the broker's opinion. In developed economies, and perhaps even China, this is likely to be augmented by the stricter environmental constraints placed on sinter plants and, hence, lead to closures of some operations.


Alumina's spot price is up over 30% in the year to date, to almost US$280/t CFR China, but Morgan Stanley believes one cannot assume downstream metal production and demand growth is strong. Aluminium's global market is on track to expand just 1.3-1.9% in 2016, the smallest lift since the GFC.

Floods, industry reforms and reactivating of smelters are forcing a lift in China's alumina imports. Morgan Stanley estimates total alumina supply affected in 2016 by these events exceeds 10mt or 8-9% of global supply. Yet upside to the now-buoyant spot price is likely to be limited by the responses by refineries elsewhere. Morgan Stanley believes the recent reactivation of China's smelting capacity is alumina's sole short-term driver of demand. Slower northern winter trade will probably moderate price performance too.


The latest decision by the Indonesia government not to allow nickel ore exports to resume puts the attention back on the Philippines. Widespread mine closures are not expected in 2017 but Macquarie suggests extreme tightness is still likely to emerge for nickel ore supply in China and nickel prices could spike early in 2017.

As ore prices rise, the cost of making nickel pig iron (NPI) will also rise, while other NPI cost inputs are also rising strongly (coal and coke). The broker estimates that the break-even level for Chinese NPI producers is already close to US$10,000/t, and in early 2017 could well rise above US$11,000/t as ore and carbon prices rise.

Macquarie expects Indonesian nickel pig iron production to grow from 28kt last year to 98kt this year and then to 170–180kt next year. Demand, meanwhile, has risen strongly, driven by a sharp rise in Chinese stainless steel production, especially for high-grade nickel (8%) 300 series.  Macquarie's latest supply/demand balance estimates shows a deficit of 70,000t this year and 100,000t next year, even with the expected rise in combined nickel pig iron production in Indonesia and China.

Prices could easily move into the US$11,000–12,000/t range in the March quarter as nickel ore stocks fall to extremely low levels, the broker believes. Any major disruption to supplies from the Philippines would add to the higher price outlook. Macquarie would be a buyer into any price dips below US$10,000/t.

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