Commodities | Mar 07 2019
A glance through the latest expert views and predictions about commodities. Iron ore; copper; Queensland gas; and Oz gold assets.
-Iron ore strength likely to continue over 2019, but outlook beyond is unclear
-Macro issues may play a part in pushing copper prices higher, despite easing tightness
-Opportunities for production growth in Queensland CSG could offset other sources
-Which miner is likely to run the ruler over Barrick/Newmont Oz gold assets?
By Eva Brocklehurst
Iron ore exports recovered in February with the big four Australian producers exporting 65.6mt, up 4% year-on-year. UBS notes all operators lifted monthly volumes and are within their annual capacity target bands.
The broker has downgraded Rio Tinto ((RIO)) to Neutral from Buy as the stock is now trading at a premium. Rio Tinto stock has rallied 23% over the year to date, supported by the strength in the iron ore price.
The risk to its view, the broker acknowledges, lies with the iron ore market and further disruptions in Brazil. UBS calculates the stock is pricing in a long-term iron ore price of US$56/t against the spot price of US$88/t, and the latter is not sustainable. UBS envisages an average 2019 price of US$74/t.
Morgan Stanley raises its iron ore price forecasts by 30% because of the tightness in the market caused by the dam failure at Vale's Brazilian iron ore mine. Price forecasts are raised to US$81/t for 2019 and US$68/t for 2020.
The broker observes there is still 140mt of iron ore in China's ports, cushioning the market and, by the time these excess stocks are diminished, supply should recover. Vale's mine is expected to recover to 386mt in 2020.
Citi is more pessimistic and believes low-cost iron ore spare capacity in Brazil will be wiped out for years to come, and the market is likely to remain highly vulnerable to disruptions going forward.
Citi also turned bullish on iron ore earlier in February, raising its 2019 average price forecasts to US$88/t and the spot target to US$100/t. The broker perceives the implications of the disruption to Brazilian supply are yet to be fully priced.
The broker estimates the global market is losing around -81mt per year of Brazilian supply, accounting for around 4% of the market. This supply is hard to replace with either spare capacity from Brazil and Australia or high cost supply from China, India and elsewhere. Although Citi concedes it is not impossible at the right price.
Still it is questionable whether traditional swing suppliers will respond at current or higher prices. A major decline in mining expenditure in past years and tighter environmental restrictions are likely to limit supply in China.
Morgan Stanley, on the other hand, expects supply outside of Brazil to respond to current market tightness and elevated prices, but suspects other major iron ore suppliers will be keen to limit the spike in prices and avoid high-cost supply returning to the market. However, the broker does not envisage significant volumes of idled supply will be available for a quick re-start neither in nor outside of China.
Morgan Stanley also suggests the market is ignoring the iron ore leverage of Mineral Resources ((MIN)), likely because of a lack of detail in the reporting for the mining services division. The upgrade to the broker's iron ore price outlook substantially lifts earnings estimates for the business. Morgan Stanley maintains an Overweight rating on the stock with a $20.80 target.
Chinese copper consumption appears to be improving and Citi notes exchange inventory is at 10-year lows. Citi suspects that Chinese demand may not be fulfilled that easily from imports, noting reduced production. China relies on a sizeable surplus outside of its borders to feed its consumption of copper.
Despite an easing of market tightness, Citi suspects prices may still head higher because of macro issues, such as the ongoing frictions over the China/US trade deal and a continuation of Chinese stimulus.
Demand is expected to rebound both seasonally and with stimulus measures in the next few months, and raise the threshold for ex China demand to compete for trade flows. President Trump has also confirmed he will delay the US tariff increase that was scheduled for March 1.
Citi remains constructive on copper, expecting prices to reach US$6800/t by the end of the year. The broker has a long-term target of US$7500/t. The share prices of global copper companies remain down year-on-year and offer potential upside, in the broker's view.
Citi points out copper is highly leveraged to macro sentiment and equities offer significant potential. The broker highlights Antofagasta in Europe, Southern Copper in the Americas and OZ Minerals ((OZL)) in Australia as top picks.
Queensland coal seam gas assets have significantly more gas than any other source on the east coast, with the majority exported through the Curtis Island facilities near Gladstone.
Ord Minnett envisages opportunities for production growth that could offset the declining supply elsewhere and keep the market balanced. Assuming total exports remain at current levels, the broker assesses increased upstream production should mean more gas available for domestic use, and there could be more than 200PJ per annum available by 2023. Ord Minnett forecasts total Queensland gas production to increase to 1627PJ by 2025 from 1341PJ in 2018.
The broker also calculates that current extraction costs will rise materially over time, as well productivity diminishes. The broker estimates that by 2025, more than 25% of Queensland CSG wells will need prices above $12/GJ to recover capital invested. Queensland's gas output is expected to grow 4% per annum and upstream gas production has increased materially over the last three years since LNG export facilities came online.
Many of the process plants are still underutilised and, now that Santos ((STO)) is less capital constrained, incremental investment in well development should result in higher production. Of the three facilities APLNG, 37.5% owned by Origin Energy ((ORG)) and QCLNG, operated by Shell, are at capacity. Gladstone LNG (GLNG), 30% owned by Santos is operating at around 80-85%.
While Ord Minnett envisages most of the growth will come from GLNG and QCLNG, APLNG has the lowest cost of production because it has the highest average well flow rates. Low flow rates, meanwhile, are expected from the Western Surat fields of Senex Energy ((SXY)) which makes economic the project appear particularly challenging. Ord Minnett recently downgraded Senex Energy to Lighten.
Ord Minnett has assigned a value of US$5.6bn to the combined Barrick/Newmont Australian assets, having reviewed the likely options for local gold miners to bid for these assets should Barrick's hostile takeover of Newmont be successful. This local portfolio produces around 2m ounces of gold a year versus Newcrest Mining's ((NCM)) production of 2.4m ounces.
The broker notes gold provides a natural diversification from growth-focused commodities such as iron ore and copper and, as its economists recently pointed out, the chance of a US recession within 12 months has risen to 45%. Being long on gold is considered one of the best late-cycle trades.
The broker suspects BHP ((BHP)), Rio Tinto, South32 ((S32)) and Fortescue Metals ((FMG)) could run the ruler over these assets. The main difference is that gold miners would need to raise equity whereas those mentioned could largely fund acquisitions from existing balance sheets.
The least likely is BHP, as the broker suspects the company's focus on tier 1 assets prevented from considering precious metals. The assets would be strategically sound for South32, but here again the broker assesses the company's appetite is likely to be low.
Meanwhile, gold assets could help Fortescue trade on high multiples and could be more material in terms of scale, while the Australian location would be a good strategic fit. Adding gold in order to diversify could possibly re-rate the business. Meanwhile, an offer may make sense coming from Rio Tinto but Ord Minnett suspects the company is likely to be too conservative in terms of valuation.
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