Commodities | Jun 25 2019
Gold preferred over base metals; LNG to remain weak; oil risks regional; no recovery in sight for lithium.
-Trade war drags on base metal miners, with gold exposure providing best protection
-LNG prices unlikely to recover while new projects pump it out
-Oil floats higher on fears of US-Iran tensions, but global shock unlikely
-Lithium finds it can’t defy gravity, or the laws of supply and demand
By Nicki Bourlioufas
Base metals miners caught in trade war cross fire; gold exposure best protection
Australian base metals miners are under pressure from the US-China trade war and the safest bets for investors could be exposures to gold, says Macquarie. Oz Minerals ((OZL)), Independence Group ((IGO)) and Sandfire Resources ((SFR)) are its key picks. OZ Minerals has some valuation exposure to gold through its 30% interest in the Tropicana mine, and OZ Minerals and Sandfire have exposure through gold by-product credits.
Almost all base metals are trading below Macquarie’s short and medium-term forecasts. The exception is zinc, which is trading above medium-term estimates. However, weakness in the Australian dollar has partially offset metal price weakness for miners that account for costs in the local currency.
Macquarie says higher-cost miners Western Areas ((WSA)), Panoramic Resources ((PAN)) and Metals X ((MLX)) have the greatest leverage to an eventual recovery in base metal prices. Western Areas offers the most significant leverage to an increase in Macquarie’s nickel price assumptions. “A +10% increase to our nickel price deck results in a +21% increase to our valuation for WSA and +61%-28% increases to our FY19-23 earnings estimates,” Macquarie notes.
In the short term, the Metals X is likely to be driven by improvements in operational performance at its Nifty copper sulphide mine, while Panoramic has similar potential at its Savannah nickel sulphide mine.
LNG prices to remain weak as output surges
Macquarie warns that the liquid natural gas (LNG) market is likely to remain oversupplied until the later years of the next decade. The warning, based on feedback from analysts and industry contacts in Singapore and Hong Kong, is a reversal of recent expectations that the market would come into balance by the early-2020s.
The forecasts of oversupply are based on approvals of unexpected projects, such as LNG Canada, and higher than expected production by new LNG projects. Macquarie says the projects are producing “above nameplate capacity” – that is, more than their intended full-load output. If Macquarie’s assumption holds, and this output continues at 110% of nameplate capacity, the market could remain fully supplied until the end of the 2020s.
Macquarie also reports that LNG contract slopes, which indicate how tightly LNG prices are indexed to the price of oil, continue to weaken. A slope of 16.67% represents approximately parity with oil. Medium and long-term deals are attracting slopes of about 11%, while even premium markets are securing slopes of only about 7%.
An 11% slope could mean downside to Macquarie’s valuations of the Scarborough field being developed by Woodside Petroleum ((WPL)) and Exxon Mobil’s PNG LNG project, in which Oil Search ((OSH)) and Santos ((STO)) are invested, because Macquarie analysts model the projects at a 12% and a 12.5% slope, respectively.
JP Morgan suggests Europe is set to become the key driver of global demand for LNG, with imports into the region potentially doubling by 2030. Production of indigenous LNG within Europe has peaked and regasification plants, which used to reconvert liquefied gas back into natural gas, are operating well below capacity.
JP Morgan concedes that LNG costs more than other types of imported gas, but says some European governments are looking for ways to reduce their dependence on Russian pipeline gas. As a result, the emerging geopolitical landscape should help to create “an incrementally positive outlook for LNG”.
Oil buoyed by OPEC cuts, US-Iran tensions, but risks to remain regional
Citi’s Commodities team note oil prices have been remarkably immune to the risk of disruption, but fundamentals, geopolitics, and financial positioning now all point to a possible price rise, with a potential price of US$75/bbl for Brent crude during the northern summer. There is a greater likelihood that OPEC and its allies may extend or even deepen production cuts for the rest of the year.
Tensions in several petrostates, including Venezuela, Libya, Algeria and Kazakhstan, complicate the mix, but the greatest risk is pressure on Iran by the US and possible retaliation by Tehran. However, in contrast to previous decades “these risks are likely to remain regional, rather than prompt a systemic shock”.
Macquarie has changed its view of the impact of new regulations by the International Maritime Organization. The rules require ships to use lower sulphur fuel from 2020, and Macquarie had predicted the changes would put pressure on prices of heavy and sour crude oil and send jet and diesel soaring, thus boosting overall refining margins.
However, Macquarie says, the combination of sanctions on Iran and Venezuela, supply cuts by OPEC, contaminated oil from Russia, and Canadian pipeline constraints “have pushed up heavy crude prices just as refiners were gearing up”.
Lithium unlikely to recover from crash anytime soon
Morgan Stanley analysts attended the 11th annual Lithium Supply & Markets Conference in Santiago, Chile, which attracted participants from the Chilean ministry of mining, as well as senior management in all relevant lithium players in Chile, Argentina, Australia and China.
Morgan Stanley reported that the consensus view at the conference put expected demand at 1m metric tons by 2025, but the analysts are more conservative, tipping demand of 0.7 m tonnes around that time. Morgan Stanley is also sceptical about the consensus view that the contractual price will trend towards US$10,000 per tonne and revert to US$13,000-14,000 per tonne by 2022-24.
This view is in conflict with the fact that there are a lot of lithium resources in the world, “most of which are very profitable at current prices” and, as with any other commodity, “supply should adapt to wherever demands decide to go from a volume and mix perspective”.
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