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Material Matters: Energy, Iron Ore And Base Metals

Commodities | May 14 2020

This story features FORTESCUE METALS GROUP LTD, and other companies. For more info SHARE ANALYSIS: FMG

A glance through the latest expert views and predictions about commodities. Energy, iron ore and base metals.

– Oil demand projected to fall -9% in 2020 with prices stabilising after 2021
– India’s economic weakness to aggravate the issues facing coal and LNG
– No material impact on iron ore demand with steel not being so lucky
– All base metals facing surpluses due to demand contraction and different strategy by China

By Angelique Thakur

Crude Oil

Crude oil prices have plummeted -55-60% to date due to weaker demand with transportation, accounting for almost two-thirds of global oil consumption, inflicting the maximum damage.

This was exacerbated by the OPEC-Plus fallout with the subsequent truce, while arresting the price slide, not enough to offset the huge demand loss, note Commonwealth Bank analysts.

The International Energy Agency (IEA) predicts oil demand will fall -9% in 2020, effectively bringing it back to levels seen in 2012.  Further, the agency expects oil demand to fall -30%, -26% and -15% for the months of April, May and June.

Commonwealth Bank analysts expect stockpiles to peak by June/July with Brent prices recovering to US$40/bbl by December, moving to US$55/bbl by the end of 2021 and stabilising at US$60/bbl beyond that.

Credit Suisse highlights a near term risk for the sector on the ASX, stating Brent may not be the best price indicator for Australia with energy producers here receiving a lesser price for their oil than indicated by Brent.

Downside risks include bleak demand conditions for the rest of the year along with a second wave of infections renewing lockdowns worldwide.

India and energy markets

Analysts at ANZ Bank point out that, while recovery in China’s industrial activity is critical, a prolonged weakness in commodity demand from India, one of the biggest coal and LNG consumers, cannot be ignored.

India’s import demand has been hit considerably due to the lockdown and consequent economic slowdown. What is worrying ANZ analysts is infrastructure spending is taking a back seat in the wake of fiscal constraints, with the government focusing more on providing social assistance.

This would delay a return back to ‘normal’, comment the analysts, hitting import demand for coal and LNG.

India’s power generation declined by -25-35% during the first week of the lockdown along with an increase of 10% in domestic coal production during the first quarter, which together would put pressure on imports. This is significant as India represents about 20% share of the global thermal coal trade.

Prospects might even be worse for the metallurgical (coking) coal market, of which India consumes about 20% of global demand, well above China’s 14%. The lockdowns have led to a decline in steel production with mills deferring imports earmarked for the second quarter.

The LNG market, in which India’s demand contribution is second only to China’s, has seen imports dropping -25% over the first three weeks of April.

Overall, ANZ analysts do not see much upside for prices of coal and LNG in the short term.

Iron Ore and Steel

The iron ore market, supported by stronger demand in China, has not been materially impacted from the pandemic with prices trading above US$80/t. Analysts at ANZ Bank expect exports from Brazil and Australia to pick up strongly in coming months.

JP Morgan analysts remain concerned about short term demand destruction, anticipating a surplus amounting to 100mt in 2020, most of it expected to be absorbed by China.

China’s steel output forecast for 2020 has been cut -1.5% by JP Morgan, the first contraction since 2015, due to high inventories and a slump in export demand. Data excluding China is even worse with steel production down -10.6% year on year and 2020 output forecasted at -8.3%.

The analysts also point out the Pilbara operations of Fortescue Metals ((FMG)) are unaffected by covid-19 with the group upgrading guidance.

In terms of 2022 earnings forecast, Citi is positive about both BHP Group ((BHP)) and Rio Tinto ((RIO)), expecting high return on equity (ROE), even while expecting the iron ore price to decline to US$60/t in 2022.

The same cannot be said about BlueScope Steel ((BSL)) and Sims Metal Management ((SGM)) with Citi expecting low ROE and a low margin for both.

Commodity analysts at Citi anticipate higher prices but not much to cheer for Australian producers as the AUD is expected to rise in tandem.

With the AUD expected to strengthen in 2022 to US$0.71, the predicted 16% improvement in the Citi Commodity Index would not translate to much on the ground with any benefit from higher commodity prices effectively eroded by the stronger AUD.

On Citi’s assessment, sector performance will have to be driven by dividend growth and capital management rather than relying on earnings momentum alone.

Base Metals

Credit Suisse analysts do not foresee a V-shaped recovery in base metals once the global economy comes out of lockdown.

Rather, plummeting consumer confidence, unemployment and withdrawal of investment by companies point towards creation of a demand gap and the analysts believe the world will enter global recession.

China’s copper-intensive ‘new infrastructure’ projects which include 5G networks, industrial internet and data centres among others are expected to offset any copper demand reduction in 2020. But Credit Suisse foresees copper surplus of more than 1mt per annum in the first half of FY21 with demand contraction expected to play spoilsport.

Nickel has a better outlook with analysts at Credit Suisse expecting prices to be around US$5.50/lb for 2020 and, unlike other base metals, expected to increase to US$6/lb in 2021 due to some surplus and rebounding demand.

Overall, the analysts expect huge volume surpluses for all metals this year, predicting a contraction in metal demand similar to that seen during the GFC.

The difference this time would be the strategy adopted by China, which, instead of bailing out commodities like it did during GFC, is resorting to measures like targeted spending, low interest corporate loans, tax relief and consumption vouchers, among others.

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