Material Matters: Oil, Coal, Lithium & Nickel

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A glance through the latest expert views and predictions about commodities. Oil; shale; metallurgical coal; lithium; and nickel.

-Sharp retracement in oil expected if OPEC disappoints on production cuts
-US shale-directed rigs need to increase to deliver on expected 2018 call on shale
-Opportunity to buy coking coal may emerge later in the March quarter
-Canaccord Genuity increases demand forecasts for lithium
-Significant percentage of nickel in operations needed to benefit from battery demand
 

By Eva Brocklehurst

Oil

Citi notes the fundamentals for oil appear solid for the northern winter ahead. The next move in prices is expected to be driven by investor flows and, in turn, these are likely to be driven by OPEC's November 30 production quota decision. The broker suggests geopolitical risks have been overlooked and under-priced this year and developments (and the potential for disruptions) over the last week in Saudi Arabia, Nigeria, Iraq and Latin America underpin this belief.

Countering this idea, to some extent, is the potential for the November 30 meeting to disappoint. Citi notes the market is factoring in a nine-month extension of the OPEC oil production cuts. Anything short of this is likely to disappoint speculators that have gone long on oil with this as a base case. Hence, the broker envisages a sharp retracement if OPEC disappoints.

Shale

In a world where OPEC output is restrained, oil demand continues to grow and there is little growth elsewhere Morgan Stanley observes this increases the reliance on shale, just when limits are becoming apparent. The broker estimates that US shale will need to produce 7.0mb/d in 2018 to balance the market, up from previous estimates of 6.6mb/d. The majority of this increase comes from assumptions that the current OPEC/non-OPEC agreement will be extended to the end of 2018.

Yet Morgan Stanley notes actual oil production growth over the last three quarters in the US has slowed to just 1.0%, as inflation and operating inefficiencies start to take a toll. US oil-directed rig counts have fallen at a rate of 14 per month since mid August and, to deliver on the broker's estimate of the 2018 call on shale, this will need to revert back to growth of 8-10 rigs per month.

In turn, this requires 12-month forward West Texas Intermediate to be around US$55/bbl. This puts the front month Brent at US$63/bbl, where Morgan Stanley expects it to average throughout 2018.

Metallurgical Coal

Raw material inputs to the steel industry remain at the mercy of reductions to steel production in China over the winter, with metallurgical (coking) coal and iron ore both vulnerable. Macquarie envisages metallurgical coal prices are on a downward trajectory over the next three months, but an opportunity to buy might emerge later in the March quarter, as pent-up demand leads to a re-stocking cycle when the restrictions are lifted.

Hard coking coal prices have fallen by -14% to US$181/t since the beginning of September. Taking China's winter policy at face value, Macquarie estimates that a reduction of around -31mt of crude steel production between November and March may result in the loss of -27mt of coking coal demand and -4mt of PCI (pulverised coal injection) demand.

Still, recent price volatility shows there is a lot of uncertainty around reductions to steel production and the extent to which this is already been priced into spot iron ore and coking coal prices. Moreover, Macquarie notes China tends to lift overall coal production during the heating season and many of the safety and environmental checks which have constrained production in the September quarter have started to ease.

Rising domestic output will add to inventory levels among the steel mills and independent coking plants. Imports are, therefore, expected to ease in the December quarter. The drop in imports cannot be offset by other seaborne importers as, while China accounts for only 20% of the seaborne coking coal market, it is the most volatile importer and marginal buyer.

On the supply side, prices are vulnerable to a pick up in exports from both Australia and the US. Hence, Macquarie believes metallurgical coal is a safer short bet than iron ore over the next couple of months and on a downward trajectory towards US$140/t over the next three months.

Lithium

Canaccord Genuity updates forecasts for lithium, resulting in an increase in demand expectations to 827,000t by 2025. The revisions include minor adjustments to modelled sales of electric vehicles as well as upward revisions to average battery size assumptions. The broker expects tight market conditions to persist through 2018 and potentially into 2019, subject to the success of new projects.

Canaccord Genuity continues to anticipate a transient market surplus from 2019-23 before deficits return in 2024. Based on updated demand assumptions, Canaccord Genuity estimates that by 2025 the lithium market will require 23 new projects with an average capacity of 25,000tpa of lithium carbonate. Revised pricing forecast call for increases of 16% and 13% in 2018 and 2019 respectively. Long-term forecasts increase by 6% to US$11,806/t.

Nickel

Near to medium term fundamentals of the nickel market are underpinned by the stainless steel cycle yet Canaccord Genuity is bullish for nickel over the longer term as well, given the expected structural change in the sector and an expected deficit materialising from the demand for lithium ion batteries. The analysts suggest that, while demand is growing faster than supply, there is no immediate shortage of suitable nickel for batteries.

Moreover, the nickel demand/supply chain is complex and dynamic. The broker adjusts assumptions to reflect current pricing, derived from buoyant market sentiment. Long-term nickel price assumptions increase to US$8.00/lb, a level envisaged necessary to entice an additional supply response.

Canaccord Genuity believes the main criteria for benefiting from the battery revolution include a significant percentage of revenue from nickel operations, Class I final or intermediate products, a preference for Class I refinery capacity, and long mine life. First movers in the market among the Class I producers include Sumitomo and BHP Billiton ((BHP)).
 

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