Material Matters: Coronavirus Impacts Part 1

This story features BEACH ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: BPT

Coronavirus has implications across resources markets, including iron ore, crude oil, base metals & molybdenum.

-Investor views on the outlook for iron ore in 2020 polarised by coronavirus
-Oil prices likely to struggle until outbreak stabilises
-Slump in metal prices for major Chinese imports expected to reverse strongly
-More molybdenum supply from Rio Tinto, Freeport-McMoran cuts
 

By Eva Brocklehurst

Iron Ore

The price of iron ore has felt the impact of the appearance of coronavirus, dropping to US$83/t, as China absorbs around 75% of the seaborne trade in iron ore. Moreover, this risk came at a time when supply was seasonally tight and the outlook was becoming increasingly bullish.

As a result, Morgan Stanley observes investor views have polarised. Immediate concerns stem from logistics, as demand for steel is always low around Chinese New Year.

The broker's economists consider the virus will cause near-term pressure on growth but it will be transitory, with a recovery beyond the March quarter. Depending on when the virus peaks, the start of the construction season, usually underway by mid-March may be delayed.

Countering the impact on demand, shipments from Australia and Brazil are affected by seasonal disruptions. Australian shipments fell sharply in the second week of January and have only modestly recovered, while heavy rainfall in Brazil – not causing any major disruptions as yet – highlights elevated risks.

Morgan Stanley expects prices to remain volatile and acknowledges significant downside risks to a US$93/t forecast for iron ore in the first quarter.

Macquarie remains confident in the fundamentals for 2020. Coronavirus aside, bullish elements have emerged in the market, mainly centred around Brazilian supply. In the context of a tightening physical market as a result of pronounced slump in shipments from Vale, the risk created by coronavirus may present opportunities for investors, given strong market fundamentals.

Improving Chinese steel margins continue to drive positive sentiment for iron ore, the broker adds. In recent weeks, the rebar margin has contracted and the hot rolled coil margin is now around US$6/t above the rebar margin.

Macquarie suspects ongoing investigations on dam safety are causing Vale to be particularly careful with water management during the rainy season, affecting material movements at its mines. The high rainfall, forecast to continue, could potentially hinder logistics and impact around 130mtpa of iron ore capacity.

Crude Oil

JPMorgan notes prices for Brent crude dipped below US$60/bbl for the first time since early November amid fears coronavirus was spreading rapidly. The market appears to be pricing in a demand shock equivalent to the SARS outbreak in 2003.

Morgan Stanley also envisages further downside for oil, depending on how soon the coronavirus peaks. Oil prices may struggle to find sustained support until the situation becomes more stable.

The broker emphasises concerns are not unfounded as an increasing number of flights to China have been cancelled and travel restrictions are in place across many cities. The downward shift in oil prices across the forward curve follows six months of relatively stable prices.

Meanwhile, US crude production reached another record high in November at 12.88m barrels/day and imports were the lowest since 1992, amid falling volumes from OPEC.

Production growth from the 'shale states 'had reached a new record high, driven by Texas and New Mexico with 470,000 b/d and 270,000 b/d respectively. Offshore output was up 45,000 b/d year-on-year.

Morgan Stanley believes 2020 will be a big year for capital expenditure in the Australian oil industry and that could lead to a change in performance across its coverage, particularly given demand concerns regarding oil and the outbreak of coronavirus.

Beach Energy ((BPT)) has outperformed but the broker suggests this will be more difficult in 2020 and downgrades to Underweight. Investment will also rise meaningfully and reserve life and production growth likely lag for both Oil Search ((OSH)) and Woodside Petroleum ((WPL)).

However, the broker upgrades Senex Energy ((SXY)) to Overweight, as the stock has underperformed for a number of years and should experience progress with its gas assets.

Metals

Citi continues to urge caution be applied across the entire metals complex in the near term, given the outbreak of coronavirus and the related shock to Chinese demand. This is because when net imports from the world's largest consumer fall, commodity markets still have to clear stock and speculative appetite is unlikely to stockpile physical metal or buy futures.

Of interest, the degree to which commodities have sold off (excluding rhodium and gold) following the coronavirus outbreak is correlated with the degree to which China is a net importer and include iron ore, nickel and copper.

Although there are other idiosyncratic factors driving markets such as aluminium, where China is a net exporter, the falls have been much less.

Citi's base case continues to be that the ongoing pro-cyclical downward trend will reverse strongly by the second quarter of 2020. Copper will be leveraged to any change in sentiment as there is no mine supply growth this year and smelters are struggling because of low margins.

Citi recommends monitoring key variables for coronavirus such as the number of people under medical supervision and the number of close contact cases in China. Once the rate of growth slows to zero this may indicate that an effective domestic quarantine has been put in place.

Molybdenum

Molybdenum, a by-product of copper production, has outperformed in recent years as supply faltered and demand recovered amid more investment in the oil and gas sector. Prices had been supported previously by a sharp fall in supply but production has surged and hit a record high in December quarter 2019, Macquarie notes.

The largest increase in supply was from Rio Tinto's ((RIO)) Kennecott operations. Yet, in response to weak demand, Freeport-McMoran, the largest molybdenum producer, has adjusted supply downwards at its US operations.

This is unusual, Macquarie points out, as normally those with higher costs of production and not the market leader make the adjustment.

The main unknown is impact of the coronavirus on the Chinese and global markets. Macquarie assumes demand will bounce back in 2020 as de-stocking bottoms in sectors such as automotive. Supply growth is also expected to be minimal in China.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms