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Material Matters: Met Coal, Iron Ore And Nickel

Commodities | Jun 03 2020

This story features SOUTH32 LIMITED, and other companies. For more info SHARE ANALYSIS: S32

A glance through the latest expert views and predictions about commodities. Met coal, iron ore and nickel.

– Supply glut in metallurgical coal to continue in the near future
– Copper shows resilience backed by strong fundamentals
– Hit to nickel supply along with a collapse in end-use demand
– Iron ore prices expected to reduce during the second half

By Angelique Thakur

Metallurgical-Coal: Current glut caused by weak demand

Seaborne metallurgical (coking) coal has a diversified demand base with 77% of demand from countries other than China, for example India, Japan, South Korea, Europe and Brazil.

Massive steel output cuts in these regions point to a -25-30% year on year output fall, impacting the demand for coking coal.

Since it is costly to idle coke ovens, most steel mills keep their ovens operating. This implies the decline in coking coal demand will not be as steep as that witnessed for steel, suggest Morgan Stanley analysts.

This was also seen during the global financial crisis when steel output for key regions (excluding China) fell by -38% year on year over February-April 2009 while met coal imports fell by just -13%.

Based on this logic, the analysts predict ex-China crude steel output to contract by -13% in 2020 and rebound by 8% and 5% in 2021 and 2022 – forecasting a V-shaped recovery.

Over the same time, seaborne met-coal demand is forecasted to decline by -11% in 2020 and increase broadly in line with crude steel production thereafter.

Morgan Stanley experts note hard coking coal prices are down more than -30% since mid-March. China, as influential as it is in driving iron ore prices, does not have the same effect on met coal prices as it imports 82% of its iron ore requirements while just 9% of its metallurgical coal needs.

Having said that, the country is still an important spot market buyer in the seaborne market, buying unwanted cargoes. However, the current glut in its thermal coal market may lead to tightening of import restrictions with met coal as collateral damage.

With many players still making money at the current price levels, the supply contraction of -7% expected by the experts for 2020 will mostly be led by disruptions in Mongolia and mine closures in the US and Australia. Once these are resolved, the experts expect met-coal supply to grow.

The analysts forecast prices to dip to US$105/t in the third quarter, gradually recovering to US$145/t by the second quarter of 2022. Overall, the revised price outlook implies prices lower than consensus for both 2020 and 2021.

Morgan Stanley analysts are Overweight on both South32 ((S32)) and Whitehaven Coal ((WHC)). They expect 12% of South32’s FY20 revenue to come from met coal.

Overall, the experts predict a -1% decline in Australia's exports this year which translates to 2mt.

Copper: A dip is just a blip

Strong buyer activity in China helped prop up copper’s price throughout the second quarter even as end-use markets contracted globally.

However, softening signals from China and an increase in supply raises the question of whether demand is strong enough to prevent a price fall. Morgan Stanley analysts answer in the affirmative.

They point out copper scrap inventories have not seen an excessive build-up with supply shortfall matching the demand decrease. This along with a relaxation of the lockdown measures and positive stimulus should ensure resilient copper prices.

However, the China-dependent immediate scenario presents some downside risk due to a slowdown in buying by the country along with supply running ahead of overall recovery in global markets.

The analysts report restarting of major mines but warn there will be no strong growth in the second half with low prices impacting capacity utilisation. The analysts peg the loss from this at -540kt year till date.

Backed by strong fundamentals, any dip in the price presents a buying opportunity, insist the analysts, who forecast a strengthening of the price during the second half.

They consider copper their preferred metal and expect it to play an important role in the post-covid-19 story.

Nickel: Supply dries up

Together, Indonesia, the Philippines and New Caledonia dominate global nickel ore exports. They accounted for 97% of nickel ore exports and about 55% of the global nickel supply in 2019.

With Indonesia’s nickel ore exports banned and closure of the Tawi Tawi mining operations in the Philippines due to the pandemic, global nickel supply is expected to decrease sharply, estimated by Macquarie analysts at around -150kt this year.

Indonesia’s nickel ore export ban will hit nickel pig iron (NPI) production in China to the tune of -164kt year on year in 2020, on the analysts’ estimate, while leading Indonesia to increase its NPI production by 188kt over the year.

Only New Caledonia expects its ore supply to increase due to new ore export licenses issued by the government. The increase is pegged at 225kt for the year but the analysts fear this might be impacted by covid-19 led disruptions in production.

However, the issue is not simply a supply squeeze as Citi analysts point out. Nickel is currently their least preferred commodity given a weak end-market due to the pandemic.

The team points out the metal has less exposure to bullish sectors with 23% of its end-use demand coming from the bearish oil and gas, aerospace and developed markets hospitality sectors. These sectors expect a demand decline of -10% this year itself.

As a result, Citi downgrades the price outlook to Underperform with an expected stock overhang further slowing down recovery.

On a positive note, Citi analysts admit an improvement in macroeconomic sentiment may potentially drive prices higher and are bullish for base metals (including nickel) in the medium-term.

Iron Ore: A year of two-halves

Macquarie analysts expect steel mills to be in for a tough year even as global steel demand shows signs of revival. Steel margins remain hammered with increasing inventories and sticky raw material prices – especially those of iron ore which have risen by 12% since the beginning of May.

A combination of these factors has put pressure on industry profitability. This has prompted mills to look for the lower grade 58% Fe ore over the higher grade 65% Fe ore.

Increasing demand for lower grade ore has led to a narrowing of discounts (price difference between higher grade 65% Fe ore and the lower grade ores) with Macquarie noting the spread narrowing to circa 10% in the first half of FY20 from 25% in the third quarter of 2017.

The analysts expect this to shrink even more, making this a time of exceptional profitability for low-grade miners like Fortescue Metals ((FMG)) and other small Australian producers.

However, rising iron ore prices are considered a temporary phenomenon by Credit Suisse analysts. Rising steel production in China, which stood at 319mt till April or 4mt ahead of 2019’s figures, has failed to impress these analysts who continue to expect iron ore prices to fall.

This forecast is mostly based upon an increase in shipments from Brazil, although Credit Suisse analysts acknowledge it is too early to call this a definite sign of improvement.

Steel production shutdowns in Japan and lingering doubts on economic recovery in Europe are also factors expected to impact demand for the ore.

Credit Suisse expects China’s iron ore demand to fall with producers moving towards scrap-based steel production. Scrap-based steel had taken a beating due to softer electric arc furnace (EAF) margins.

With EAF spreads widening now, producers are expected to move away from blast furnaces which are witnessing margin erosion due to rising iron ore and coke prices.

The experts term this year as a year of two halves for iron ore with a deficit in the first half followed by a surplus in the second.

All things considered; the iron ore price is forecasted to decline to US$77/t in the second half.

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