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Material Matters: Iron Ore, Oil And Tin

Commodities | Jan 24 2017

A glance through the latest expert views and predictions about commodities. Iron ore optimism; oil market re-balancing; and a rally in tin.

-tight steel market expected to support iron ore prices
-observable down-trends in oil production and inventory needed
-semiconductor growth sees demand for tin surge

 

By Eva Brocklehurst

Iron Ore

Optimism in China's steel industry is the main driver of iron ore prices over the short term but the domestic iron ore industry could also have an impact on prices, keeping these around current levels in 2017, ANZ analysts contend. Iron ore is expected to be affected by the country's policy on industrial over-capacity. China's State Council announced last year it would reduce steel production capacity by 150m tonnes by 2020.

China is also intent on eradicating illegal steel making capacity as it battles pollution and emissions in its major cities. Hence, tightness in the steel market should support iron ore prices and the analysts expect underlying Chinese steel demand to remain robust in 2017. Steel production growth is expected to contract this year, although be matched by a similar fall in growth the net exports from the major exporters.

Growth in exports of iron ore from the Australian producers, Rio Tinto ((RIO)), BHP Billiton ((BHP)) and Fortescue Metals ((FMG)) is expected to fall to its lowest level in five years. Another indicator underscoring this expectation is the forecast from Australia's Bureau of Meteorology for an above-average number of cyclones during the local season, which lasts from November to April. This, the analysts suspect, could impact exports by as much as 15% quarter on quarter.

Still, the main potential game changer for iron ore is the Chinese domestic industry. Since iron ore price highs of US$180/t were encountered in 2009-14 Chinese output has fallen by more than 60%, as the high cost producers shut down when the price fell below US$100/t.

As iron ore prices have pushed above US$80/t in recent weeks, the analysts observe this raises the possibility of a recovery in Chinese iron ore production. If supply pushes up to when prices were last at this level, another 50mt of iron ore capacity could potentially be reactivated in China, in turn sending prices back below US$60/t.

Yet, the analysts believe the probability of this occurring is relatively low, as exporters have established strong relationships with buyers in China and now provide nearly 90% of the country's total iron ore consumption.

Oil

UBS has reduced its long-term oil price assumption to US$70/bbl from US$75/bbl. This reflects a view regarding the cost of developing a marginal barrel outside of the US, although the ultimate range could vary from US$60-80/bbl. Assuming reasonable compliance with OPEC output cuts, the physical oil market appears under-supplied for the second quarter of 2017.

The speed of a US response to the OPEC production cuts suggests significant tightening is most likely a 2018 event. The main uncertainties, the broker envisages, revolve around US shale and its capacity to ramp up quickly and be the marginal producer as conventional supplies decline globally. Other variables include the return of Nigerian supply and whether annual demand continues to grow at over 1mmbbl/d.

The reduction in long-term oil prices has reduced the broker's forecasts for earnings per share for the oil stocks. The broker expects oil companies to be conservative regarding organic investment in 2017 and mergers and acquisitions are again likely to feature.

UBS retains a preference for Woodside Petroleum (( WPL)) with its modest gearing and low-cost LNG production as well as Origin Energy ((ORG)), with its ramp-up of APLNG and and rising electricity prices. The broker has reduced its rating on Santos ((STO)) to Neutral after the recent equity raising and and downgraded Horizon Oil ((HZN)) to Neutral after a 35% rally in the share price.

Shaw and Partners also expects the market to rebalance if OPEC delivers on its supply cuts. The trends are already under way with non-OPEC supply falling and demand remaining robust. If OPEC delivers then this should underpin an oil price recovery in 2017. The analysts note inventory levels are still near historical highs and, without OPEC cuts, it would take around two years for the oil market to rebalance.

With oversupply, the value of marginal production is zero, and there is no reason to spot prices to rally. The analysts believe, for the current rally to continue, observable down-trends in production and inventory data are needed. OPEC and non-OPEC cuts, if delivered, should eliminate up to 1.8m bpd of supply and result in deficits through 2017.

The analyst expect this would result in meaningful reductions in inventories throughout the year, for the first time in four years. Assuming demand remains robust the market should "normalise" by the end of the year, Shaw and Partners estimates.

Tin

The lowest volume metal of the base metals traded on the London Metal Exchange, tin, was second only to zinc in terms of its recovery in 2016, rallying 45% to trade at US$21,000/t by the end of the year, Macquarie notes. Refined stocks of the metal in warehouses are at low levels, although producer inventories have lifted and mine supply appears to be improving, notably in Indonesia.

Key reasons behind the recovery in the tin price include low visible levels of stock on exchanges and reduced export volumes from key producer Indonesia, as well as lower production in China and Myanmar. The broker estimates Indonesian mine production was down 13% in 2016 after price-related mine closures at the start of the year.

While Indonesian production looks to be improving, Macquarie suspects Myanmar production growth is slowing. Meanwhile, Chinese metal output was affected from July by environmental shut-downs and data up to October implies there has been no real recovery.

The supply developments are not that dynamic and the broker concludes the 2016 rally was mostly driven by one factor that did change dramatically, demand. There was a surge in end-use semiconductor shipments in the second half of 2016 while tinplate production was boosted by stronger-than-anticipated demand from the Chinese steel sector. Together these two features account for around two thirds of global demand.

Moreover, Macquarie's semiconductor analysts are projecting global sales growth of 9% in 2017 on a continued recovery in the sector, particularly with wafer fabrication capacity being added aggressively. The broker upgrades its outlook for demand, which should push tin into a deeper deficit over the next few years. Accordingly, price forecasts are raised on average by 5-21% out to the end of the decade.
 

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