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Nickel Downside Risk

Commodities | Jan 17 2017

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Indonesia’s decision to overturn its nickel export ban may have dire consequences for the nickel price, although uncertainty reigns.

– Indonesia lifts nickel export ban
– Downside nickel price risk may be material
– Impact is difficult to quantify

By Greg Peel

Last year the Indonesian government decided that the country’s exports of large amounts of low grade nickel to, in particular, the Chinese nickel pig iron industry, left Indonesia with a low margin industry and handed over the value-add to China. In order to secure the value-add for its own economy, the government instigated a ban on nickel ore exports in order to encourage the development of a local smelting industry.

The ban came as a blessed relief to global nickel miners given the world was facing a substantial nickel surplus, which had been placing significant downward pressure on the nickel price.

Enter Indonesia’s partly state-owned nickel miner and processor, PT Antam. Back in September, the miner appealed to the government to lift the ban given the company was stockpiling ore of a grade too low to suit its own processing, but sufficient for export to the Chinese. With revenue going begging, the relevant Minister was set to accede to PT Antam when in stepped members of Indonesia’s Smelting Associations, who pointed out a lifting of the ban would derail the development of Indonesia’s smelting industry, make Indonesia appear an unreliable jurisdiction into which to invest, and specifically threaten investment already made by Chinese companies in the country.

In the latter case, Chinese stainless steel company Tsingshan has spent US$6bn to date on building a smelter, port and power station in Indonesia, on the assumption the law would not be changed.

The minister thus backed down. As far as commodities analysts were concerned, that was the end of the story. In the meantime, the new Philippines government also instigated a ban on nickel ore exports by companies deemed to be environmentally damaging. It all looked good for the nickel price heading into 2017, and for the share prices of nickel miners. At the very least, the bans would serve to clear out the global nickel surplus and bring the market back into balance.

While the news out of the Philippines was positive, the reality is that the environmental audit being undertaken by the government is proving a slow process. Until shut down, “dirty” Filipino nickel miners continue to export. While this had provided some strain on the nickel price recovery, nobody was prepared for what was to transpire last week.

Indonesian Flip-Flop

The Indonesian government has changed its mind, again. Nickel ore exports will be allowed to resume, but only from those companies who can satisfy strict requirements regarding the planning of and progress towards the construction of smelting facilities on the ground in Indonesia. PT Antam has won the day. As have Chinese nickel pig iron smelters, who since the bans have all but been shut down by a lack of global ore supply. One saving grace for Tsingshan is that it, too, can export to its own smelters in China. Indonesia’s Smelting Associations are not happy.

So what does this mean for the nickel price? Analysts are unsure, other than to note there is no upside unless the Indonesian government again changes its mind. As to the extent of downside, analysts agree this could be material, but it will depend on certain factors.

Just how much nickel will suddenly be released onto the market? This depends on how many Indonesian producers can or will satisfy the government’s rigorous smelter investment requirements. PT Antam alone, analysts note, has the capacity to release enough nickel ore onto the market to restart the Chinese pig iron industry and severely damage the price of processed nickel. But is this in PT Antam’s interest?

It is more feasible that the company would drip-feed ore onto the market in order to restrain price falls, lest it shoot itself in the foot by losing on the price swing the revenue it gains on the export roundabout.

Focus On Downside Risks

Analysts are therefore in a difficult position, and as yet reluctant to definitively adjust nickel price forecasts until more is clear. One thing is for certain nonetheless – those adjustments will be to the downside, and perhaps materially so. Prior bullish theses are now out the window.

To date, only Macquarie (among the eight major brokers in the FNArena database) has downgraded its recommendation and target prices for Australia’s two leading listed nickel miners, Western Areas ((WSA)) and Independence Group ((IGO)), cutting each to Neutral from Outperform pending greater clarity.

Among the database brokers, Macquarie had been decidedly bullish on the nickel price, while other brokers had otherwise decided the nickel price had run too far, too fast.

Citi and UBS both already had Neutral ratings on Independence Group, with Deutsche Bank on Sell. Credit Suisse upgraded Independence to Outperform last month on increased reserves at the company's Tropicana mine but will no doubt now reassess.

As for Western Areas, all of Citi, UBS, Deutsche Bank and Ord Minnett (Lighten) had Sell ratings in place prior, with Credit Suisse having downgraded to Neutral last month.

The share prices of both stocks took a hammering on Friday when the Indonesian government made its announcement. Western Areas fell -19% and Independence -10% and fell again yesterday before finding some support later in the session.

As to where to from here, that is unclear.

It should be noted, however, that as of late last year Western Areas was the third most shorted stock on the ASX, at over 13%, and Independence was also heavily shorted, in excess of 8%. Short-covering, therefore, may well be in play as the share prices of both companies currently consolidate.

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