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Material Matters: Crude, Cobalt & Lithium

Commodities | May 16 2018

A glance through the latest expert views and predictions about commodities. Crude oil; iron ore; cobalt; and lithium.

-Upside for energy equities should oil prices stay at current levels
-Changes in marine fuel standards will concentrate demand for oil
-Cost pressures increasing for iron ore producers
-Retracement in cobalt prices considered a buying opportunity
-Morgan Stanley remains bearish on lithium as SQM asserts its dominance


By Eva Brocklehurst

Crude Oil

Morgan Stanley raises its oil price forecasts to US$90/bbl by 2020. The broker believes there is significant upside for energy equities should oil prices remain at current levels. The broker retains a Overweight ratings for Woodside Petroleum ((WPL)), Beach Energy ((BPT)), WorleyParsons ((WOR)) and FAR ((FAR)).

Morgan Stanley now expects Brent to average US$76/bbl in 2018 and US$80/bbl in 2019 and believes Beach Energy is the way to play the theme, as those companies that focus on free cash have been outperforming in North America and Australia is experiencing the same trend.

Upside risk to the sector remains, given the significant underinvestment since 2014 at the same time oil demand has stayed resilient. Expansion opportunities, nonetheless, depend largely on LNG markets, which appear to be strengthening.

Morgan Stanley also points to upcoming changes in marine fuel standards that will concentrate the demand for oil into a narrower part of the complex. This should drive both middle distillate and crude demand, requiring refining margins to rise.

The broker notes the shipping industry accounts for around 5% of global oil demand but remains responsible for 40% of oil-based sulphur emissions. The broker cites, for context, sulphur emissions for one cruise liner are the same as around 380m cars.

New regulations by the International Maritime Organisation that kick in at the start of 2020 are targeting this factor. Installing a scrubber to clean exhaust gases is one option that may allow shippers to use high-sulphur fuel oil but this is capital intensive.

Alternatively, they can convert to LNG but this option suffers from a limited distribution network. So far, shippers plan to use lower-sulphur fuels such as marine gasoil or very-low-sulphur fuel oil (VLSFO) blends.

Morgan Stanley suggests the new regulations could displace 2.5-3mbpd of high-sulphur (HSFO) demand and shift some of this into the middle distillate pool, creating a severe oversupply of HSFO and an equally tight market for middle distillates.

Middle distillate demand is growing strongly and inventory is approaching five-year lows, the broker observes. The new IMO regulation should add another 1.5mbpd to demand by 2020. Morgan Stanley expects the scramble for middle distillates will drive crack spreads higher and drag oil prices along.

Oil supply growth is dominated by condensate and LNG, from which refiners cannot make middle distillates. Middle distillates require crude oil in a ratio of 1.8 barrels for every one barrel of middle distillate. On current trends, therefore, crude oil supply would need to increase 5.7mbpd by 2020 and Morgan Stanley suggests this is unlikely.

Hence, the broker argues that middle distillate prices will need to rise to a level where demand slows, suspected to be the case when gasoil reaches US$850/t, ie around 25-30% above the current level.

Iron Ore

UBS observes cost pressures for iron ore producers are on the increase from rising oil prices, although transportation is a big differentiator between regional iron ore producers. The March quarter produced some hits to price realisation.

Fortescue Metals ((FMG)) reported price realisation of 62% in the quarter, down from 66% in the December quarter and from 71% in the September quarter. The broker notes, while discounts remain high for Fortescue, steel mills are prepared to pay a premium for high-quality iron ore, pellets and lump. Compared with September 2017, UBS assesses iron ore producers have had their break-even costs increase to US$30-$70/dmt from US$27-67/dmt.

Meanwhile, Vale's costs have reduced because of a weakening of the Brazilian real and ramp up of the lower-cost S11D asset. Conversely, costs for both BHP Billiton ((BHP)) and Rio Tinto ((RIO)) have increased because of a fall in the lump premium since September.

Numerous factors are affecting the market in the spreads between low and high quality iron ore. These include the restructure of the Chinese steel industry as the government cracks down on pollution. New supply from Australia and Brazil in the higher quality range of iron ore means less high-grade iron ore to blend and less low-grade iron ore being sought.

There has also been an increase in port stocks, specifically of low-grade iron ore and, in order to shift these stocks, large discounts are being offered.

Macquarie notes iron ore shipments from Western Australia have increased significantly over the past six weeks, although the increase may not be enough for either BHP or Fortescue to hit their FY18 shipment guidance.

In the June quarter a combined shipping rate of over 800mtpa is expected for the first time from the three big WA exporters. Any miss to guidance by the major producers is expected to present a positive catalyst for the broader iron ore market.

Macquarie suggests the recent rally in share prices has captured a significant proportion of the upside to price targets. Macquarie retains a preference for BHP over Rio Tinto and Outperform ratings for both Fortescue and Mt Gibson Iron ((MGX)).


The recent retracement of cobalt prices to US$89,000/t is a buying opportunity, Citi believes. The broker expects cobalt prices to rise by 20% over the next two years on the back of a sustained deficit, amid a build up in stocks, given high levels of supply risk. The broker expects prices will average US$100,000/t by the December quarter and US$110,000/t by 2020.

Even without the supply risks from the Democratic Republic of Congo materialising, the broker suggests cobalt will remain scarce and stockpiling continue. The DRC accounts for more than 60% of global supply and the majority of incremental supply in the next two years.

Battery producers and car manufacturers are observed to be signing deals or in talks with various producers to secure their future supply. Substitution is an issue but unlikely to be a game changer, in the broker's opinion, until 2020. Key applications susceptible to substitution are metallurgical, chemicals and super alloys, accounting for around 46% of global demand.


Sociedad Quimica y Minera de Chile (SQM) has unique assets and leads the lithium market. Morgan Stanley estimates the company will double its lithium production in 2019 and double again by 2023. This will be positive for the company but negative for lithium prices.

The broker suggests the company is attempting to catch the jump in demand and expansions will come faster and larger than many suspect. The main bottlenecks to the company's intentions are the industrial plant licenses, which take around six months to be issued, while capacity then needs to be added to the industrial plant.

Nevertheless, arriving at an estimate of 200,000t capacity by mid 2023 does not require additional brine extraction or pond capacity. The broker suggests the company's expertise in lithium production is crucial for Chile to recover its global leadership in the product.

As a result, Morgan Stanley reiterates a bearish call on lithium, expecting an inflection point to come in the medium term. In 2019 the broker expects significant new capacity to begin placing prices under pressure, amid a continued de-rating of lithium-related equities.

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