Material Matters: Aluminium, Rare Earths & Coal

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A glance through the latest expert views and predictions about commodities. Iron ore; aluminium; oil; rare earths; and thermal coal.

-Iron ore prices expected to hold up until December quarter
-Bearish outlook for aluminium prevails
-Trade tensions fuel choppy oil market, amid indications of broader economic slowdown
-What are the potential implications if China restricts US access to rare earths
-Thermal coal prices lose buoyancy, now trading into the cost curve
 

By Eva Brocklehurst

Iron Ore

Ord Minnett upgrades forecasts for iron ore to US$89/t and US$75/t for 2019 and 2020 respectively. The broker expects strong prices to remain in place through the balance of the June quarter and into the September quarter. The broker's revised 2019 shipment estimates from Brazil are at the lower end of Vale's guidance and the global supply/demand deficit is now estimated at 85mt. Moreover, Chinese steel output has surprised to the upside, up 11% in April.

The broker expects the Brucutu mine will ramp up in 2020 and chances for a full re-start should improve once the risk of the Gongo Soco pit wall slippage fades. Coupled with decelerating global growth and a recovery in shipments to China, prices are expected to retrace into the US$80/t region by the December quarter.

The impact is not material for forecasts with estimated earnings per share rising 1-3% for BHP Group ((BHP)) and Rio Tinto ((RIO)). Fortescue Metals ((FMG)) earnings estimates are now 4-5% higher. Given the leverage to an elevated pricing environment, Ord Minnett maintains a Buy rating for Fortescue Metals.

Aluminium

Macquarie found the mood bearish at the Harbor aluminium conference in Chicago. The broker assesses the accelerating US/China trade war and the prospect [now resolved] of escalating tariffs being applied to Mexico appear set to harm global growth rates and demand. The lifting of Canadian tariffs on aluminium also raises a question of whether the premium for US midwest product will hold.

Already underperforming the LME complex, Macquarie notes aluminium has move much lower since the trade talks between the US and China started to unravel. High-level economic data from China has started to deteriorate although this is not yet bad enough, the broker points out, for stimulus measures.

Factors in favour of higher aluminium prices include investors being very short as well as a lift in alumina prices. Business continues regardless, with active buying of primary aluminium in Asia ex-China, the broker understands. Meanwhile, Europe remains weak and automotive segments continue to be a drag on that market.

Oil

ANZ analysts note the market is finding it difficult to form a consensus view on the oil outlook. Sentiment is being affected by trade tensions and weak economic growth, although supply outages have increased and there are risks of further disruptions. To test the market resilience against a global recession, the analysts' modelling indicates that world GDP growth below 3% would mean global oil consumption falls by -1%.

While under such a scenario the call on OPEC (Organisation of Petroleum Exporting Countries) crude drops to only 30m b/d in 2019 the risks around supply issues are higher. Iran and Venezuela are likely to exceed bearish estimates while US supply is unlikely to fill the gap, the analysts contend. All up, base case forecasts show a tightening market in the second half of 2019.

Morgan Stanley also observes a rise in trade tensions,amid indications of a broader economic slowdown and fears this will overtake supply outages. Brent declined -12% during three trading days recently, a relatively rare and significant fall for a three-day period, the broker points out.

Morgan Stanley lowers forecasts for oil demand and now envisages Brent peaking at US$65-70 in the second half. The broker has growing evidence of a sharper-than-expected slowdown in demand as well. Data from eight early-reporting countries, which collectively account for around 50% of global oil demand, reveal year-on-year growth ground to a halt over March and April.

Moreover, refining margins and product crack spreads have recently been falling, even as crude prices were falling. Weaker demand growth is consistent with a broader economic slowdown, the broker suggests, reflected in a range of indicators, including recent inversion of the US yield curve and weaker purchasing manager surveys.

Rare Earths

China, the dominant supplier of rare earth metals, has hinted it may be about to restrict US access. Citi sizes up the potential implications, noting it is China's dominance in processing rare earths that makes the supply chain so reliant on its product. Of the 50,000t mined ex-China last year 41,400t still went via China. Lynas Corp ((LYC)) is currently the only major ex-China integrated minor/refiner.

However, several mining and processing projects could reduce China's dominance in coming years, although this will need more government and investor support. The broker observes a blocking by China of US direct metal/alloy exports is manageable if ex-China processing is built swiftly, but becomes more serious if China attempts to impose restrictions across the supply chain. China provided 80% of US rare earth imports in 2018 and this is unlikely to be fully replaceable, Citi asserts.

Thermal Coal

Macquarie observes thermal coal, after a short lived bounce in mid April, is now trading into the cost curve. At current prices, a fifth of seaborne trade is out of the money. In Australia, small marginal mines, accounting for around 40mt of supply, are affected.

A structural headwind, the LNG surplus, amid slowing power demand in Asia and high coal inventory across the globe make it hard for the broker to envisage when the market will turn around. Higher grade indexes, which outperformed in 2018, have fallen the most and are now approaching 2016 levels.

While thermal coal power generation remains healthy, in most markets it is being displaced by other sources, namely hydro in China and gas in Europe. In China, Macquarie notes growth in thermal power generation fell to zero in March & April. In Europe, LNG imports are on track to double in 2019 while gas prices have fallen to multi-year lows.

While demand is expected to revive over the northern summer, Macquarie finds it hard to assess how this could provide a lasting boost to prices. Cuts in supply have been few and far between and generally confined to the Atlantic market, Macquarie notes. Total seaborne thermal coal supply, nevertheless, is growing, mainly from Indonesia.

Australian exports are also growing, although a moderation in exports is considered likely now that more thermal producers are switching to the semi-soft coking coal market. The main bullish offset is underperforming Chinese supply, as authorities have stepped up supervision of domestic mines after deadly accidents while new capacity additions have slowed.

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