Material Matters: Copper, Oil & LNG

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A glance through the latest expert views and predictions about commodities. Sanctions; copper; energy; and LNG.

-US sanctions on Russia could spread to nickel and copper
-Copper market expected to become short from 2019
-Forward curves suggests current oil prices may not be sustainable
-Could US/China trade wars provide opportunity for Australian LNG?
 

By Eva Brocklehurst

Sanctions

Sanctions announced by the US on Russian individuals and companies, such as Rusal, could have an ongoing material impact on the global commodities trade. UBS notes, at present, sanctions are relevant to aluminium, of which Russia produces 6% of global supply.

If the scope of sanctions was expanded there could be an impact on nickel, as Russia produces 10% of global supply, and to a smaller extent on copper, where Russia generates 4% of global supply.

If sanctions are expanded to include copper, Sandfire Resources ((SFR)), OZ Minerals ((OZL)), BHP Billiton (BHP)), Independence Group ((IGO)) and Rio Tinto ((RIO)) are expected to benefit. If nickel is affected, Western Areas ((WSA)) and Independence Group would be the main stocks to consider.

Copper

Macquarie is positive about copper on a two to three-year view as there are limited capacity additions envisaged beyond 2019, when the market is expected to become short after enduring a substantial surplus. A recent sell-off of the metal was driven by a slower than expected recovery in China's activity post the new year.

Physical premiums have been rising while spot treatment charges remain low. Another bullish development is that around 25% of contracts globally are still up for renewal this year and the risk of strikes remains a possibility.

The broker also points out that for many of the diversified miners, copper has become the most important, or second most important, metal in terms of profit sensitivity to commodity price moves.

Copper is not easy to find and mine economically and the broker observes there is little available in terms of greenfield projects that compare to the current field of tier-1 assets. Hence, many large copper miners are actively pursuing brownfield expansions.

Macquarie notes a wide range of attitudes, from Glencore's preference to acquire assets rather than develop, to BHP's desire to find more copper resources while conducting drilling campaigns in remote regions. Those Australian copper producers most sensitive the copper prices as a percentage of profit include Sandfire Resources and (unlisted) MMG.

Oil

Recent increases in spot oil prices have lifted the front end of the forward curve, Ord Minnett observes, and lower forward prices suggest the current oil price may not be sustainable. The broker upgrades Brent price forecasts to US$66/bbl for 2018 and US$60/bbl for 2019 and retains a long-term forecast of US$55/bbl.

The research team generally adopts the forward curve as a basis for its oil & gas price estimates and then assumes a normalised US$55/bbl for Brent from 2020. Ord Minnett retains a preference for Oil Search ((OSH)) because of its long-term growth and attractive valuation as well as the potential in Alaskan assets. Origin Energy ((ORG)) is also preferred because of de-leveraging of the balance sheet.

The least preferred is Beach Energy ((BPT)), as the stock is trading at a sizeable premium to valuation. The broker acknowledges that management is developing the recently acquired Lattice assets, which should extend production and increase output, and the valuation has the most leverage to both short and medium-term Brent assumptions.

LNG

China is becoming the world's largest LNG importer, expected to overtake Japan by 2022. At the same time, the US is emerging as the new low-cost supplier, with multiple plans to export LNG production in the next few years.

While a lot of the US capacity remain speculative, by 2020 it is expected to meet Australia and Qatar as a world's largest exporter of LNG. The question for Shaw and Partners is what the impact of a trade war would have on this "logical" trade with China.

LNG projects are capital intensive, have long pay-back times and require a predictable fiscal regime. The threat of a trade war may impede this trade and impose additional costs. The analysts note US sanctions imposed on Iran more than 15 years ago prevented the development of multiple LNG export projects in that country and, as a consequence, delivered Australia a large market opportunity.

Can this happen again? Almost all Australian LNG is sold to Japan, South Korea, Taiwan and China and Asian gas consumers have a large appetite for Australian gas. Moreover, the expanding LNG trade and enhanced market opportunity that exists for local companies to sell LNG into Asia means investors in the industry with deep pockets have the incentive to finance the large amount of gas resources that remain in the ground.

Shaw and Partners notes there is a very large gap in Australia between commercial reserves and actual resources, which flows onto the enterprise value of stocks. These macro events support a positive view on the domestic gas & export industry and the broker retains a preference for Woodside Petroleum ((WPL)) as its large cap exposure.

The analysts note Oil Search and its partners Exxon and Total continue to advance plans to expand the low-cost PNG LNG project, while the Harbour Energy offer for Santos ((STO)) highlights the undervaluation that exists for stranded fields in offshore Northern Territory and Western Australia in addition to unconventional gas in the Cooper Basin.

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