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Material Matters: Oil, Diesel, Lithium & Steel

Commodities | Mar 07 2018

A glance through the latest expert views and predictions about commodities. US shale oil; diesel; lithium; and China steel.

-Infrastructure constraints may impede growth in US shale oil production
-Outlook for diesel usage remains strong despite decline in diesel cars
-Morgan Stanley underscores its call for downward pressure on lithium price
-Chinese steel mills closely following their order books


By Eva Brocklehurst

US Shale Oil

Attractive oil prices have stimulated the US shale industry while the recent jump in US drilling activity has raised concerns about the impact on US output. ANZ analysts suggest actual growth in production will be lower than the drill rig numbers indicate, given rising infrastructure constraints and crew shortages.

The US rig count has risen sharply over the past couple of months and the upward trend is expected to continue, particularly if West Texas Intermediate crude remains above US$60/bbl.

Yet the list of constraints to production is growing, as investors are pressuring producers to focus on profitability and returns. The analysts note many producers are struggling to attract people back to the industry after the job losses in the past couple of years.

Pipeline capacity is also likely to constrain the growth in completed wells. In the past, the industry has been highly sensitive to price, as even small changes have a considerable effect on the economics, and output, of an operation.

The analysts sense some hesitancy in bringing wells on line until prices are well established above US$60/bbl. Still, they revise up forecasts for US shale oil output to 6.2mb/d by the end of 2018.


Despite the passing of the “golden age” of diesel as a passenger car fuel in Europe, Morgan Stanley suggests the strong outlook for global road freight and higher industrial usage remain supportive of the product. Global oil demand was just under 98m bpd in 2017 of which passenger cars made up 26%.

Europe, where diesel cars have had the highest penetration, constituted just 1.6% of global demand. This is the market that is at risk from the clamp-down on diesel emissions. Yet global road freight is 18% of global oil demand, second only to passenger cars, and in this environment diesel dominates.

Moreover, industrial activity, powering tractors, trucks and generators at construction and mine sites, also makes diesel more linked to GDP and less linked to price than petrol demand. As global GDP growth is expected to be strong and synchronised in 2018 diesel demand is likely to be supported.

The other issue pertains to the displacement of some fuel oils as, in 2020, the sulphur content in bunker fuel for shipping will be capped at 0.5% versus 3.5% currently. Morgan Stanley suggest most shippers will likely switch to compliant fuels rather than install scrubbers to clean emissions or switch to LNG. Hence, refiners will need to pull on their middle distillate products to meet the estimated demand.


Morgan Stanley addresses some of the key points raised in opposition to its recent bearish call on lithium. Regarding the view it is underestimating the penetration of electric vehicles, the broker suggests any forecast above its 9.2% penetration rate for battery electric vehicles by 2025 is highly ambitious.

This is based on the requirements for building supportive infrastructure, the rolling back of subsidies and the cost of implementation and capital investment that is required by automobile producers. While accepting China and Europe will lead the way and may reach 15-20% penetration by 2025, Morgan Stanley suggests other regions will lag and lower the global average.

On the other side of the demand/supply equation, the broker suggests the focus on 2025 also ignores the near-term surplus in the lithium market. Moreover, accepting that lithium brine deposits have long lead times to develop and many underperform market expectations, the broker suggests it is still taking a conservative view of the supply pipeline.

The vast premiums currently occurring in some areas will normalise as the market moves into oversupply, Morgan Stanley suggests, and the current arbitrage is already encouraging China's battery makers to seek supply from lower-cost sources.

The broker concedes China's privately-owned lithium industry is difficult to track but has heard that domestic lithium supply is coming on strongly and battery makers expect to be able to reduce their dependence on imported material in the near future.

China Steel

Macquarie observes sentiment in China's steel market is positive and while orders continue to decline because of subdued construction activity, a recovery is expected after Chinese New Year.

The rate of increase in trader steel inventory has begun to slow. While steel mills intend to boost inventory, the rate of re-stocking is tied closely to growth in order books, Macquarie suggests. Orders have fallen over the past month or so and only the automotive sector has grown.

Chinese steel exports are expected to remain soft in the near term but if domestic supply recovers strongly from April, when there may be some downside pressure on demand growth, exports may lift from current low levels.

The broker notes the industry's average profit margin remains substantial and steel mills are incentivised to maximise output, providing there is no policy disruption. The mills, reportedly, plan to commence re-stocking of raw materials soon, but Macquarie suggests the scale and duration of this depends on the demand and price outlook for steel.

The broker believes the mills will wait for the order books to improve before engaging in the raw materials trade, so the near-term re-stocking momentum may not be very strong.

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