Material Matters: Oil, Iron Ore & Base Metals

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A glance through the latest expert views and predictions about commodities. Oil; iron ore; zinc; nickel & copper; and gold.

-Morgan Stanley expects slower growth in US oil production
-Deutsche Bank: dip in iron ore price a buying opportunity for BHP and RIO
-Demand likely to fall away and zinc prices expected to peak in March qtr
-Can electric vehicles renew interest in nickel and copper?
-Interest in gold expected to pick up as reflation theme fades
 

By Eva Brocklehurst

Oil

The US Energy Information Administration may be forecasting US oil production will reach 9.7mb/d by December, but Morgan Stanley doubts it will get to that. This would require a sharp acceleration from already strong recent growth, and there is a range of factors that could prove an obstacle.

The forecasts require an acceleration of the monthly growth rate of onshore Lower 48 production to 80kb/d for the next five months from the 50kb/d in the preceding five months. Yet, Morgan Stanley notes rig count has been decelerating and has declined since its peak in early August.

Furthermore, anecdotal evidence is increasing that suggests the market for fracking services is getting tight, to such an extent this is slowing down the rate of well completions. According to some company reports the broker finds there is a reduction in efficiency by as much as 20%. When something goes wrong, too, this impact can be exacerbated. Hurricane Harvey has also caused disruptions for several companies which will take time to correct.

Morgan Stanley suggests that investors are no longer rewarding growth at any cost and there are signs that companies are responding. Anadarko's 8% share price increase on the day it announced a share buyback sent a strong signal to the US market, with subsequent commentary from others indicating an increased focus on returns. Morgan Stanley expects slightly slower growth will help the oil market re-balance.

Iron Ore

Deutsche Bank expects 62%e fine iron ore prices to retrace to the US$50-60/t range. The broker now forecasts US$55/t for the December quarter and a following recovery to US$70/t by mid-2018. With recent restrictions on sintering capacity in China, the broker lifts lump premium forecasts to US$15/t in 2018 and for the long run to US$8/t.

China's industrial production restrictions through the winter heating season are expected to impact steel production over the four key months by -34mt under a moderate scenario or -42mt under a worst-case scenario. This translates to around 30mt or 57mt of seaborne iron ore demand, respectively.

Deutsche Bank believes high levels of lower grade 58% iron at Chinese ports and ongoing supply-side reform in China, along with a further 60-70mt of high-grade supply expected from major producers over the next two years, will mean price realisations remain under pressure. The broker calculates, on profitability and marginal cost bases, around 15% of global iron ore production loses cash at US$50/t.

Deutsche Bank increases 2017 and 2018 earnings estimates for iron ore stocks under coverage by an average of 9% and 11% respectively, despite lifting AUD/USD forecasts by 10%. As some stocks are already pricing in a lower iron ore price the broker considers any dip in price to be a buying opportunity for both BHP Billiton ((BHP)) and Rio Tinto ((RIO)).

Zinc

Zinc prices continue to surge, breaching US$3,300/t on the three-month LME contract. Macquarie observes the loss of mines that have reached the end of their lives, such as Century and Lisheen, and Glencore's sudden temporary mine closure have triggered a shortfall of around 900,000 tonnes, forcing a mass de-stocking of zinc concentrate.

Macquarie also observes that China's domestic response to this situation fell short. Official statistics imply that output has actually fallen. The broker suspects a rush to bring on mine supply in past years meant corners were cut and damage was done to the surrounding environment. Now in times of extreme shortage, Chinese smelters have to wear government-mandated closures while inspections are carried out.

The broker also dismisses the idea that a large amount of refined metal was available globally to meet any rally in price, as this has failed to materialise. Macquarie believes US$3,350-3,400/t is achievable for zinc in the next six months. From there substitution towards aluminium in certain building materials may come to the fore. The broker expects a real erosion in zinc prices will come from demand and reiterates a call for a cyclical peak in the March quarter.

Nickel And Copper

UBS suspects electric vehicles could offer a renaissance for the nickel market. Nickel is used in cathode in two out of the three dominant battery chemistries for electric vehicles, nickel-manganese-cobalt (Chevy Bolt) and nickel-cobalt-aluminium (Tesla). Nickel use is also thought to lift from China's migration to the former of these two technologies and a shift within towards more nickel and less cobalt.

The broker calculate that, in 2025, electric vehicle production would mean an additional 300-900,000tpa or an increase of 10-40% of incremental nickel demand. The supply side is proving interesting as well, as only around 50% of mines are able to service the battery market. In the nickel space the broker is drawn to longer mine life and balance sheet strength but believes much of the share price upside is already factored in.

In this instance UBS prefers Independence Group ((IGO)), given a lower break-even price at the Nova mine, versus Western Areas ((WSA)). UBS lifts nickel price forecasts for 2020 by 20% to US$7.50/lb.

Global electric vehicle sales are also expected to drive around 1.6mt of copper demand in 2025. This is about 5% of annual copper demand the broker forecasts for that year and is expected to lead to an acceleration in demand growth, sustaining above 3% per annum versus a long-term average rate of 2.5-3%.

UBS calculates that in 2025 this means electric vehicles could form around 50% of demand growth and the supply task becomes that much harder in the face of declining grades for copper. In the copper space the broker is drawn to OZ Minerals ((OZL)) over Sandfire Resources ((SFR)), given a longer life story at its mines.

Gold

UBS believes a benign interest rate environment, softer US dollar and broad macro uncertainty support the need for some gold exposure within a diversified portfolio. The broker expects interest to pick up as the unwinding of the reflation theme occurs and gold becomes increasingly attractive as a hedge against equity exposures.

The broker forecasts gold to lift towards US$1,400/oz over the next four years. The broker's preference in the large gold space is for Evolution Mining ((EVN)) and Northern Star Resources ((NST)). In smaller stocks UBS prefers Perseus Mining (( PRU)) and Alacer Gold ((AQG)).
 

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