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Material Matters: Coal, Iron Ore & Oil

Commodities | Mar 19 2019

A glance through the latest expert views and predictions about commodities. Oz miners; coal; iron ore; and oil.

-Credit Suisse ascertains Oz miners are trading close to fair value
-Gap between high and lower quality thermal coal prices increasing
-Citi expects Chinese demand for iron units to decline over the next five years
-New cheaper oil projects creating dilemma for OPEC

 

By Eva Brocklehurst

Oz Miners

Credit Suisse expects commodity prices and steel production in China could move lower throughout 2019. The broker's modelling of risk appetite suggests this has now normalised. All up, when running a mid-cycle earnings approach, the broker considers large capitalised companies are trading broadly in line with historical multiples, although BHP Group ((BHP)) is slightly expensive. Iluka Resources ((ILU)) appears the cheapest.

The broker ascertains the sector is, in general, trading close to fair value and struggles to visualise a positive shock outside of stimulus in Chinese infrastructure. The main risk is that Chinese policy diverges from its current rhetoric. On this basis, Credit Suisse would not be overweight on the sector and would consider moderating its position slightly. The key pick on a relative basis is Whitehaven Coal ((WHC)) followed by Iluka Resources and Alumina Ltd ((AWC)).

Coal

Credit Suisse observes the price of Australian thermal coal being sold to China is being hit relative to competitors, at odds with assurances by the Chinese and Australian governments. Whether there is a ban or just restrictions, the price suggests importers are avoiding Australian thermal coal. The sharp improvement in the Indonesian price signals to the broker where Australia's market share may be headed.

National Australia Bank strategists point to Platts data, which has indicated that Chinese coal buyers are seeking increased volumes from Indonesia and Russia, which could lead to greater volatility for prices in the short term because of supply constraints. The analysts expect thermal coal prices to ease gradually to US$90/t in 2020.

However, 5500kcal coal is now looking so cheap it could attract Indian buyers, Credit Suisse believes. Most high-ash coal in Australia is produced by Glencore, Yancoal and BHP Group. The former two have options to blend up some of their high-ash coal while BHP has few options from Mt Arthur because of insufficient washing capacity.

Morgan Stanley also notes the frequently-quoted 6000 kcal thermal coal price on an F.O.B. Australia basis has dropped from its 2018 peak, but at US$92.60/t remains largely in line with expectations for 2019.

The broker observes the difference between high-quality benchmarks and lower-energy alternatives has started to increase, and one of the drivers is the controls in place in China on import of low-energy coal. Morgan Stanley agrees this, in particular, affects BHP and Glencore.

Meanwhile, Credit Suisse points out, metallurgical (coking) coal prices have remain strong and Chinese buying is continuing. Ultimately, steel mills have little choice as China is short of premium-grade, low-sulphur coking coal. National Australia Bank analysts expect hard coking coal prices to decline to US$158/t in 2020 amid weaker steel output in China.

Iron Ore

The risks around iron ore price forecasts are finely balanced, in Citi's view. The broker expects only a modest lift in global steel production in 2019-20 and continues to believe the market will lose around -80mtpa of supply in 2019 because of a net reduction of -40mt in Brazilian exports. The broker assumes the mine at the site of the tailings dam tragedy in Brazil will be off line for all of 2019.

2020 is considered more difficult to predict, although the three-year ramp up of capacity by Vale should enable exports from Brazil to regain some ground and reach around 370mt. The broker considers the downside case for iron ore prices at US$80/t in 2019 versus upside of US$95/t.

Citi notes Australian iron ore miners have been quick to point out there will be no change to their production targets, and  they do not plan to bring forward production as a result of the exit of Brazilian supply. Given uncertainty around the longer-term demand for iron ore in China, Citi is glad this has been confirmed. The broker assumes China's demand for iron units will decline over the next five years as steel production rates peak and more scrap is utilised.

Macquarie observes shipments from Brazil have started to decline but this appears more related to the weather than expected capacity reductions from Vale. Meanwhile, shipping rates from key Western Australian miners have recovered and are now broadly in line with expectations for the March quarter, although down -3% sequentially and -1% year-on-year.

Spot iron ore prices for all products have increased since the tailings dam tragedy but the gap between higher grades and lower grades has narrowed significantly. Macquarie notes high-grade premiums have fallen to 15% from 40% while discounts for lower grades have narrowed to -20% from -50%. The broker maintains Outperform ratings on all three major Australian iron producers, Rio Tinto ((RIO)), BHP and Fortescue Metals ((FMG)).

National Australia Bank analysts have noted spot iron ore prices have eased from recent peaks, although acknowledge these are still high by recent standards. The analysts expect a relatively balanced market over the short term, with a limit to downward pressure until output can be boosted from other sources besides Vale, along with an easing of Chinese demand. Forecasts are unchanged, with spot prices expected to ease across 2019 and average US$80/t before dropping to US$70/t in 2020.

Oil

OPEC (Organisation of Petroleum Exporting Countries) has a dilemma, Citi points out, as the cartel is trying to cut production to support prices but is losing market share to shale and deepwater oil. Citi highlights the outperformance of liquids production by the US and a strong pipeline of non-OPEC non-shale supply projects. New discoveries have accelerated and resource bases are being revised higher.

Citi also assesses offshore projects are becoming cheaper and faster to implement. The International Energy Agency estimates that upstream oil and gas investment will hit around US$500bn in 2019, up 4%. This remains around -US$300bn lower than the 2014 peak but costs are also down -30-40%.

Saudi Arabia appears to believe it can reduce price volatility by preventing global oil inventory from moving too high or too low. However, Citi suggests this reaction to observable stocks, and efforts to mobilise support on output cuts or additions, sparks volatility rather than suppresses it.

The broker suggests Saudi Arabia needs to act like a central bank to be more effective, and announce a target price range while acting on it rather than searching for elusive data on inventory. Still, the broker concedes the targeting of a price above the market equilibrium would lead to a loss of share to shale and other non-OPEC producers. National Australia Bank analysts envisage a very gradual uptrend for oil prices amid a range of geopolitical risks. Brent is forecast to reach US$70/bbl by the end of the year.

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