Commodities | Apr 18 2019
A glance through the latest expert views and predictions about commodities. Mining services; gas; iron ore; and lithium.
-Major mining/infrastructure contractors may face capacity constraints
-Potential for LNG supply shortages beyond 2024
-Iron ore price edges closer to US$100/t, likely to more than offset volume losses
-Increasing pressure on lithium producers to lower prices and improved product
By Eva Brocklehurst
Deutsche Bank acknowledges underestimating the extent of the competitive response from miners in addressing the risk of cost inflation. Iron ore replacement expenditure is providing many opportunities for tier-1 construction-related civil contractors.
Yet, it appears miners are attempting to address cost inflation by reducing the size and complexity of the contracts they offer, in order to attract smaller operators. Value remains most important consideration and the implication is that contractor margins will be kept in check.
One thing that is also evident to the broker is that there are far fewer tier-1 contractors available in Western Australia today compared with the 2012/13 boom. Moreover, the amount of work also emanating from transport infrastructure on the east coast enables tier-1 contractors to be selective, which could mean more certainty for order books and margins through better execution.
In FY20, work done on transport infrastructure is estimated to increase to around $17bn and to $22bn in FY21. Deutsche Bank suspects tier-1 contractors such as CIMIC ((CIM)), Monadelphous ((MND)) and NRW Holdings ((NWH)) may face capacity constraints. The broker expects short-term positive news flow from these three operators.
The broker has Buy ratings on Ausdrill ((ASL)), Imdex ((IMD)) and Seven Group ((SVW)). The latter provides good exposure to mining capital expenditure and infrastructure without execution risk, Deutsche Bank believes.
The Australian energy market regulator (AEMO), has downgraded its gas supply forecasts after input from producers. 2P reserves have also been downgraded by -6%. The regulator envisages potential further shortages from 2024 under a neutral scenario and, for the first time, has identified underperformance with CSG is a risk to the market.
Canaccord Genuity believes it is time to review the state of the market as spot LNG prices have weakened materially and are nearing multi-year lows in Asia. This has not affected Australian pricing to date but has impacted investor sentiment.
As LNG plants under construction are down -53% from their peak in 2015, the broker is not surprised that the market is expected to tighten in the early 2020s and that Asian buyers are locking in medium-term contracts.
The three LNG mega project's at Gladstone, Queensland, costing in excess of $50bn to construct, are yet to reach collective nameplate capacity. Reaching full utilisation, Canaccord Genuity asserts, remains the most value-accretive opportunity in Australian E&P.
While the sale of Ironbark to APLNG by Origin Energy ((ORG)) has reinforced the view of the value of gas to the LNG projects, the broker is wary that the ACCC is investigating the transaction. Given the potential for government to activate the domestic gas security mechanism the broker prefers volume growth over price leverage.
Rio Tinto ((RIO)) has downgraded its iron ore shipment guidance for 2019 to 333-343mt, with a recovery in the June quarter still subject to weather conditions. Credit Suisse suspects the lower end of this range is still a stretch, requiring around 88mt per quarter, despite only shipping at or above this rate twice in history.
Nevertheless, less tonnage into an already-tight market is likely to mean prices more than offset the lost volumes. BHP Group ((BHP)) has also downgraded its production outlook for iron ore so the broker expects the market could become tighter.
A downgrade to iron ore production in isolation may be disappointing but for both companies the cause (weather) was out of their control. With the iron ore price edging closer to US$100/t this is expected to more than offset volume losses.
Morgan Stanley notes the iron ore price is also being supported by a recovery in steel margins and demand in China. The impact of the decline in Vale's shipment is likely to be felt in China's ports by late April and it remains uncertain when production will recover, or whether some idled domestic Chinese supply will re-start later this year to ease the deficit.
Nevertheless, Morgan Stanley does not envisage a long-run structural change to the iron ore market and retains a bearish view. The broker's long-term price estimate is US$55/t, set by the marginal cost of production.
The bearish view is underpinned by a forecast for falling steel output in China, amplified by the rising use of scrap. India is a major growth market and Morgan Stanley assumes iron ore industry growth in line with the domestic requirement. Even if all of India's additional iron ore demand were to be imported, this will total just 100mt of extra demand by 2025.
Citi forecasts a lower-for-longer price scenario for lithium and reduces price forecasts by up to -23% over the medium term. On the back of these forecasts the broker reduces earnings estimates for Galaxy Resources ((GXY)), Orocobre ((ORE)) and Pilbara Minerals ((PLS)). The broker maintains Buy ratings on the three stocks.
The broker believes the current Galaxy Resources share price is ascribing no value to the Sal de Vida project, while potential partnerships can significantly unlock value. Pilbara Minerals is most exposed to price volatility because of its significant spodumene supply ramping up in a short period of time.
The broker is convinced that the industry is adjusting from a seller's market that has enabled producers to enjoy high sales prices and lock in prices at relatively robust levels under long-term deals. There is increasing pressure from customers to lower prices and improve product specifications. New supply coming to the market appears to have emboldened the customers of Chilean producers to seek better terms.
Demand for lithium hydroxide is also expected to overtake demand for lithium carbonate by 2023, thanks to development of high nickel, low cobalt cathode materials. The consultants the broker met suggest the market is moving increasingly to surplus but should tighten again from 2024.
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