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Material Matters: Copper, Steel & Manganese

Commodities | Jun 17 2019

A glance through the latest expert views and predictions about commodities. Copper; steel; manganese; iron ore miners; Queensland petroleum royalties.

-Supply-side disruptions in copper unlikely to affect price in current environment
-How long can property drive apparent steel demand in China?
-Manganese continuing to perform poorly, lacking supply constraints
-Strong upgrade cycle for iron ore miners as supply still constrained
-Petroleum royalties review to the fore in Queensland's budget


By Eva Brocklehurst


Risks are mounting for copper on the supply side in terms of outages, although prices are also being trampled by the US/China trade war. Macquarie is fielding investor queries as to what is required in terms of supply outage/reductions to overcome the increasing negative sentiment regarding global industrial activity.

The broker assesses copper is holding at US$5800/t but the impact of the US/China trade conflict on demand will need to now be factored in, as costs rise and business confidence takes a hit.

Supply remains weak and Chilean miners are talking of strikes, while grades are slipping. Zambia, meanwhile, appears to be repelling all future investment and the recently re-started Katanga asset in the Democratic Republic of the Congo is under review.

Furthermore, Macquarie adds, another scrap import restriction is increasingly likely in China as well. Supply-side disruptions need, at the very least, a neutral market tone in order to affect the price, the broker suggests. If the market is bearish, particularly amid global growth fears, incidents such as strikes will simply be ignored.


Macquarie notes a healthy demand for steel still seems to exist in China, as supply growth has been strong and exports subdued. Steel margins have, nevertheless, fallen to their lowest point in the year. Flat exports, when production is booming, generally suggest more domestic demand and/or rising stockpiles.

Macquarie observes China's property sector has clearly outperformed with investment rising at even higher rates than last year. Construction machinery, white goods and shipbuilding are also very active. However, the broader manufacturing sector in China is weak, particularly automotive industries.

How long can property drive apparent steel demand? As land purchases have fallen by nearly -34% in January-April, new building starts that are in evidence are more likely a lagged development, in the broker's view, rather than a reflection of positive sentiment and looser liquidity.

There is some offset from infrastructure, although Macquarie believes a peak is likely at the end of the September quarter or early in the December quarter. Steel inventory draw down has also begun to slow. Steel net exports only take 6-7% of China's steel production and exposure to the US is low. Hence, if it were not for property, China's steel demand would likely be slowing and this is bearish for prices and margins.

Citi expects stimulus measures globally will boost steel market sentiment and, with cash spreads now well below historical averages, there is potential for supply responses to emerge while Chinese exports trend down. Recent weak macro data and escalating trade war tensions have triggered stimulus efforts from central banks and governments globally.

Elsewhere, raw material costs have begun to ease. For the scrap producers, the broker expects new US and Chinese electric arc furnace (EAF) capacity will underpin scrap demand.

With steel profitability now below long-term averages, the broker believes the bottom of the market is near and upgrades Sims Metal Management  ((SGM)) and BlueScope Steel ((BSL)) to Buy as the risk/reward turns favourable. The broker believes consensus downgrades are more than priced in for these two stocks.


Manganese has performed poorly this year, Macquarie points out. Spot prices are now down -10-18% in the year to date. The broker notes the growth trend in imports to China has reversed in 2019, after constantly rising since 2017.

This appears odd, given very strong crude steel production rates. The explanations the broker offers are a surge in China's domestic manganese ore production (considered unlikely), de-stocking across the value chain or a drop in the intensity of use. On the latter, Macquarie notes a spectacular drop in vanadium, a sister product, which suggests a relaxation of the environmental standards that pushed usage of both metals higher last year.

On the supply front, South African export growth has slowed but there is still material coming from non-core suppliers which have contributed to a fall in seaborne prices. Macquarie observes the manganese ore industry lacks the supply constraints that have supported the prices of other bulk commodities

As the price declines, questions are being asked about the cost structure of the industry. Macquarie reiterates a mildly bearish view on manganese ore prices and expects more downside risk if the squeeze on upstream profitability continues amid plentiful stocks.

Iron Ore Miners

Citi notes the iron ore benchmark price is back over US$100/t as China's steel production has peaked and iron ore supply remains constrained. The broker finds China's steel mill margins are now very thin and supply of property is outstripping demand. Hence there is a genuine risk of steel production cuts in the second half of 2019, and the broker retains an iron ore forecast for 2020 of US$70/t.

Citi notes iron ore stocks are in the midst of a strong upgrade cycle, as estimates for both BHP Group ((BHP)) and Rio Tinto ((RIO)) have been revised up around 25% in the last three months. Consensus estimates for Fortescue Metals ((FMG)) have been revised up by around 100%. The broker notes, this upgrade cycle exists just for iron ore as, in way of contrast, earnings estimates for South32 ((S32)) are essentially unchanged over the period.

Rio Tinto has strong valuation support and Citi maintains a Buy rating. BHP is expected to generate a return on equity of 18% at a price of US$60/t for iron ore with net profit margin of 22%. Fortescue Metals can generate returns of 11% at US$60/t for iron ore for a net profit margin of 17%. The share price implies a long-run growth in earnings per share of 10.7% and Citi suggests the valuation metrics are becoming stretched.

Queensland Petroleum Royalties

Queensland's government budget paper has proposed increasing petroleum royalties to 12.5% from 10.0%, effective July 1. Ord Minnett notes, unsurprisingly, there has been a backlash from industry groups and LNG producers.

For the broker, the bigger issue centres on the flow-on effect that these costs would have on domestic gas and electricity prices on the east coast. Higher-cost gas supply from Queensland is increasingly setting spot domestic gas prices, as supply from traditional sources in Victoria decline.

Ord Minnett suggests the immediate effect of a direct hike in royalties would be reduced profitability from the east coast LNG plants: Australia Pacific LNG (APLNG), Queensland Curtis LNG (QCLNG) and Gladstone LNG (GLNG). All these have embarked on additional upstream drilling campaigns.

The state budget has also indicated there will be additional reviews into strengthening domestic supply through royalty regime settings, and simplifying the royalty regime more generally. The broker points out the former could raise the possibility of a different pricing regime for domestic gas, while the second has been more broadly welcomed.

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