Material Matters: Lithium, Iron Ore, Oil & LNG

Commodities | Mar 28 2019

A glance through the latest expert views and predictions about commodities. Lithium; Chinese commodity demand; iron ore; oil; and LNG.

-China subsidy reduction may pull forward demand for lithium to first half of 2019
-UBS observes confidence in Chinese infrastructure activity offsetting weakness in other areas
-Vale will find it hard to procure iron ore pellet from third parties
-OPEC appears strongly determined to support oil prices
-November's fall in oil prices likely to start showing up in LNG contracts


By Eva Brocklehurst


China has provided its final 2019 new energy vehicle subsidy policy. A reduction in total subsidies amounts to -65-70% with central government subsidies reduced by -40-60% depending on type. Local government subsidies will be completely removed after a transition period.

Citi suspects this may pull forward the demand for electric vehicle batteries and lithium to the first half and, subsequently, it is possible there will be a decline in the second half. This does not change Citi's long-term forecasts for 11% penetration of battery electric vehicles and plug-in hybrid electric vehicles by 2025. However, the trajectory may be different.

The policy has a transition period from March to June 2019 which could buffer the negative impact over the full year, as incentives are increased for front-loading sales during this time frame. Nevertheless, the broker acknowledges these reductions in subsidies are the most significant there has been over the past few years so the impact on demand in the second half remains uncertain.

From the detail, Citi ascertains the subsidy for pure battery electric cars driving over 400km will be reduced by -50% to around US$3700 per vehicle. Battery electric vehicles with a range of less than 250km will no longer receive any subsidy, which is in line with expectations.

Plug-in electric vehicles subsidies are reduced by -55%. Meanwhile the battery density multiplier is capped at 1.0x for all batteries with density over 160Wh/kilogram. Citi suspects this will slow the industry's rush towards 811 batteries.

Morgan Stanley considers the reduction in subsidies negative for both lithium prices and related equities and suggests consensus expectations of EV penetration rates for China could be overly optimistic. The broker expects the production surplus of lithium over 2019 to begin to incorporate the price normalisation process, including a convergence of spot and contractual prices.

Morgan Stanley retains an Underweight rating on both Albemarle (Citi is Neutral) and Sociedad Quimica y Minera de Chile with Equal-weight ratings on Orocobre ((ORE)) and Galaxy Resources ((GXY)). The broker's preferred exposure at this point is Mineral Resources ((MIN)), as this shows significant value at current levels.

Chinese Commodity Demand

UBS has visited three major Chinese cities to gauge commodity demand and supply. The overall sentiment is more optimistic than the broker expected. Infrastructure activity is believed to be underway, offsetting weakness in steel demand from property, appliances and automobiles. Fiscal stimulus is also supportive as cuts of -3% to VAT are boosting confidence downstream.

Credit tightness appears less of an issue now than it was in 2018. Most steel mills believe demand will be flat to up 3%. EAF production and scrap use has fallen because of higher prices and low availability. Hence, iron ore demand is likely to be higher.

The broker found no consensus on the amount of iron ore supply lost from Brazil while domestic iron ore supply growth is seen limited by approvals. Most mills expect more supply from Southeast Asia, India and Africa.

Meanwhile there has been a three-year hiatus in new nuclear reactor approvals that has now ended. Existing approvals were being worked on but unapproved projects have stalled. Most power companies UBS met with suggested it would be difficult to lift the percentage of nuclear generation to the 10% target by 2030 from the current 4%.

Coal import restrictions remain opaque as customs officials have slowed imports of Australian coal to 40 days from 20 days. The broker received no clear indication of any change in policy.

Iron Ore

Of the 93mt in iron ore currently affected by production shutdowns, Vale expects around 53mt is likely to come back on board over 2019, while the 40mt impacted by de-commissioning of dams will be out for 2-3 years. The company's northern system and other commodities felt no impact as a result of the tragedy on January 25, 2019.

Vale's production tonnage is contracted, and any production lost outside of mines where force majeure has been declared will need to be procured from third-party tonnage. Importantly, as Vale produces around 60% of the pellet market it will be difficult to source this from third parties.

Latent capacity in China is also considered to be limited as the move to quality iron ore is expected to be a long-term structural change in the industry. Morgan Stanley finds it hard, given the uncertain situation, to extrapolate the medium-term supply/demand balance for iron ore.

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