Commodities | Nov 01 2017
A glance through the latest expert views and predictions about commodities. Coal; steel; energy; and copper.
-Spread between coking and thermal coal prices could narrow
-Macquarie suggests dip in Chinese steel demand no cause for alarm
-In the end, prices and financial markets driving oil production growth
-Sentiment for copper still positive in China amid growth in major consuming sectors
By Eva Brocklehurst
Coal
ANZ analysts suggest coal prices will diverge in coming months, as Chinese policy measures have a differing impact on the two main markets. Demand for coking (metallurgical) coal has already waned, as China restricts steel production for the winter, while domestic supply constraints keep thermal prices elevated.
Growth in electricity generation from China's thermal sector has also remained at elevated levels. Issues with nuclear reactors, as the South Korean government announces additional safety checks, have also supported demand for thermal coal.
The Chinese government remains committed to restructuring the coal industry and closing less efficient, more polluting capacity ahead of schedule. As a result, import demand for thermal coal has rebounded strongly recently.
Meanwhile, in India, recent monsoons have left many pits flooded and rails damaged. This has forced utilities to use up inventory and as power plants re-stock many are turning to the international market. The analysts expect thermal coal prices to remain around current levels of US$100/t for the remainder of the year.
In contrast, Morgan Stanley forecasts a correction to thermal coal prices over the northern winter, as well as in the longer term, as demand for coal-fired power is increasingly displaced by alternatives. The broker suggests demand is already weakening as winter pollution controls take hold and the seaborne market appears vulnerable to a correction.
Limitations on steel output that have been put in place in China will not only limit steel but also downstream industrial activity, in the broker's opinion. This will, in turn, reduce power demand. Morgan Stanley observes inventories are rising at both ports and plants and a further rise is expected once pollution controls are fully imposed. Indian tightness is considered only a small offset to the downturn in China.
Meanwhile, the ANZ analysts expect metallurgical coal, which has been reasonably tight as supply disruptions occurred in Australia amid strong demand from China, to respond to new Chinese policy. Chinese hot metal production is expected to be down around 40mt over November to March.
Chinese government policy is expected to be the biggest driver for international coal prices. Prices for coking coal are expected to push back below US$170/t and the analysts suggest the spread between coking and thermal coal could narrow to levels not seen since mid 2016.
Steel
Steel demand in China has dipped over the past month, Macquarie observes, despite October typically being a peak month for demand. The exception is automobiles, which have shown stronger sequential growth in line with improving vehicle sales.
Demand from construction has decelerated particularly sharply. In the survey, when asked about near-term intentions, the majority of the respondents reported an intention to modestly replenish iron ore but not coking coal in coming weeks.
The dynamics have been reflected in steel prices and, after months of underperformance, average hot rolled coil spot margins are now around US$40/t higher than rebar in the Chinese domestic market. Macquarie is not alarmed and considers this a normal correction to the front loading of demand which occurs over the summer.
The broker emphasises that the dip in capacity utilisation in October stems from Chinese government policy and is not driven by weakening profitability, which remains exceptionally good. Around 770mtpa of Chinese steelmaking capacity is unaffected by the winter curtailment policy and, if current margins persist, it is possible that these mills may try to take advantage of the opportunity and increase production.
Energy
There are suggestions the declines in non-OPEC oil production are accelerating, along with disrupted output from shale sources in the US. Citi considers this wishful thinking by OPEC, and believes it is wrong to project weaker US supply growth. While there is some evidence to suggest this might be the case for the next six months, the broker doubts it is the case for the longer term.
In the end, prices and financial markets will drive production growth. A focus on the -40% reduction in upstream capital expenditure since 2014 and an emerging supply gap by 2022-23 is misleading and wrong, in Citi's view, as it misunderstands the extent of extraordinary capital efficiency gains, solid production from deep water & oil sands and the number of projects that have finally reached an investment decision.
To the extent that falling estimates for 2018 US production growth have contributed to higher oil prices, Deutsche Bank is concerned that some reversal may be in store in the December quarter, acting as a downside catalyst. Additionally, the broker notes that US oil-directed rig counts may increase slightly in the December quarter because of modest misses in the prior quarter's production and the four-month lag in WTI prices.
OPEC and non-OPEC supply reduction agreements are expected to be extended to the end of 2018. Opportunistic producer hedging in the lead up to a decision over the course of the March quarter 2018 could mean such an announcement becomes bearish for the oil price, in the broker's opinion, unless OPEC were to surprise by over-delivering.
Deutsche Bank does not believe there is a clear case for a united front, because Ecuador has recently expressed an interest in an exemption and OPEC members would want to have Libya and Nigeria included in the agreement in exchange for any further cuts.
Citi believes the efforts of OPEC and Russia to insist that production cuts will remain in effect through to the end of 2018 creates uncertainty about whether this can actually be achieved and, hence, whether US$60/bbl Brent prices can be sustained for long. Again, the two have signalled their intentions long in advance to other countries capable of producing more oil, albeit with fewer countries this time able to sustainably raise output.
Non-OPEC producers are all more likely, therefore, to take action to ensure they grow production, not just through 2018 but for several years beyond, and this could tilt the market into oversupply again, Citi suggests.
Furthermore, even before the price-induced supply additions hit the market any prolonged price uplift could erode the commitment of either Russia or Saudi Arabia to maintain production cuts. The broker suspects Iraq is the most likely candidate to test the Saudi/Russian commitment to production cuts and a higher oil price increases its ability to do so.
Copper
Macquarie finds overall sentiment on the copper market still positive. Both fabricator and trader sales continued to rise over the last month, thanks to broader growth in the major copper consuming sectors such as power, white goods and construction. Nevertheless, official data has showed a downside risk to growth for many of these sectors in China.
Although refined copper production increased by 6.8% in September, Chinese smelters in Macquarie's survey report flat capacity utilisation rates and showed no indications that production will be raised.
The broker has learned that, while a few secondary copper producers are affected by tightening scrap supply and environmental inspections, indicators suggest concentrate supply remains abundant and can support refined copper production growth from other producers.
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