Commodities | Oct 30 2018
A glance through the latest expert views and predictions about commodities. Iron ore; lithium; and oil.
-Tightness in iron ore market exacerbated by shortfall in global production
-Citi considers correction in lithium equities overdone, volatility short term
-Current weakness in oil prices likely to be temporary
-Yet demand growth appears to be slowing
By Eva Brocklehurst
Tightness in the iron ore market is expected to persist in the short term as China's reform measures on the supply side continue and demand for higher grade ore remains elevated. ANZ analysts expect demand from China's property and construction sectors to remain robust and benchmark prices to stabilise at around US$70/t over the next couple of quarters.
China's attempt to reduce the impact of heavy industry on the environment is likely to ensure some steel mills will close. The analysts estimate an additional -16mt of crude steel capacity could be cut in the December and March quarters. Meanwhile, tightness in the market has been exacerbated by a shortfall in iron ore production and the global seaborne trade is expected to grow by only 10mt in 2018, the lowest increase in exports for the past two decades.
Macquarie observes the rise in iron ore prices is occurring as global equity markets are selling off and this has created confusion among investors. The broker believes several factors are in operation, including a rush to boost steel output in China before authorities impose controversial winter controls. There is also an incremental shift to lower grade ore, as mills manage margins, while utilisation rates are being kept stable.
Macquarie asserts that odd things happen during China's winter and steel mills have a wider range of objectives than simply dealing with pollution and boosting productivity. The broker points out, in 2017, high-grade premiums peaked ahead of the heating season and weakened thereafter.
Following this, a sharp pullback in construction activity affected rebar prices so the premium for higher grade ore was halved in just a few weeks. This year, the latest inventory data from Mysteel shows a sharp rise in Brazilian ore at China's ports and a draw down in lower grade Australian ore.
A downturn in spot Chinese lithium carbonate prices has impacted lithium equities. While Citi acknowledges the deteriorating medium-term fundamentals because of surging supply the correction in equities is considered overdone. The volatility in commodity prices does not affect the broker's valuation of these equities, which are underpinned by long-life assets and low costs.
China's domestic brine carbonate supply has been stronger than expected and demand lacklustre because of changes in subsidies. Yet Citi expects spot lithium prices to recover in the December quarter to US$10,000/t, driven by higher seasonal demand and the winter impact on brine supply in China. Those major producers contracting prices for 3-5 years will be insulated from the correction and continue to deliver volume growth.
Citi expects the pipeline from marginal projects will be curtailed but ongoing surpluses appear inevitable because of those projects that are already financed. Citi maintains long-term price estimates of US$7500/t for industrial lithium carbonate, US$9000/t for battery grade and US$9500/t for hydroxide. The broker has Buy ratings for Orocobre ((ORE)), Galaxy Resources ((GXY)) and Pilbara Minerals ((PLS)).
Morgan Stanley expects a period of weakness will weigh on oil prices in the near term. Still, the medium-term outlook appears constructive and the broker envisages Brent reaching US$85/bbl by the end of the year. Demand growth for oil has been soft in several countries, such as India and South Korea, and refining margins have come under pressure, reaching levels in Europe where cuts typically take place.
Exports from Iran are expected to fall as US sanctions are applied and the pipeline capacity in the US Permian Basin remains restricted. Production continues to decline in Venezuela although several other OPEC producers and Russia continue to pump out oil at all-time high levels. Morgan Stanley envisages a deficit during the remainder of 2018 and 2019.
While the bull case for prices over US$90/bbl could be realised amid further supply disruptions, Citi expects prices to cool off and average US$79/bbl in the December quarter, ahead of further downside in 2019. The broker accepts inventory is low but suggests this time of year refineries enter deep maintenance and end-user demand also eases after the summer.
The broker suspects OPEC and the US are able to add significant supply to the market in the near term, while output from Brazil, after a slow 2018, is expected to surge. Moreover, demand growth has been slowing because of higher prices and diesel growth is moderating. The broker suggests trade tensions and a de-synchronising of global economic growth are contributing downside risk for oil demand.
Shaw and Partners agrees that the easing of oil prices recently is not the start of a bear trend. Saudi Arabia plans to increase output to offset the loss of Iranian supply and has been ramping up since June. How long the increase is sustainable is not known. What is more supportive of prices is the signs of exhaustion in the US shale business. Rig activity has also been flat.
The bottlenecks in the US Permian Basin may take 18 months to sort out, the broker points out. Moreover, the US shale boom was fuelled by debt and most of the debt was backed by reserves, which can only rise if operators drill more wells in a rising oil environment. Shaw and Partners notes, the moment oil prices and activity drop away, so does the ability of operators to bear debt.
Shaw and Partners believes valuations based on a US$80/bbl oil price in 2019 are reasonable, despite the current volatility. The broker considers Woodside Petroleum ((WPL)) good value while Oil Search ((OSH)) offers longer-term growth, with Buy ratings on each. The broker is more cautious about those stocks exposed to the domestic gas industry, with a Hold rating on Santos ((STO)) and a Sell rating on Beach Energy ((BPT)).
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