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Material Matters: Iron Ore, Copper & Urea

Commodities | Jul 15 2020

This story features SIMS LIMITED, and other companies. For more info SHARE ANALYSIS: SGM

China’s steel output expected to increase in 2021; Impact on scrap markets if China decides to re-import high-quality ferrous scrap; Global fertiliser prices are at 10-year lows

-Iron ore prices are at record highs due to higher steel output in China
-China may reimport high-quality ferrous scrap
-Urea application continues unabated aided by low energy prices

By Angelique Thakur

Iron Ore: Dizzying heights

JP Morgan reports a 4% year on year increase in China’s steel output in May to about 1.1bn tonnes per annum and even while the rest of the world saw a year on year decline of -24%, production still improved by 6% over the month of April.

This may be a turning point, thinks JP Morgan but is hesitant due to rising covid-19 cases in regions like India which adversely impact demand.

Looking at China’s performance, JP Morgan has revised its steel production forecast to 2% from 1.2% year on year while also upgrading 2021 estimates to 2% from 0.5%

Supply is also steady with the last two weeks of June seeing Brazil’s iron ore exports rise at the highest rate, highlights JP Morgan, culminating in a month on month gain of 39%.

Vale is maintaining its 310-330mt guidance, along with solid Pilbara exports. JP Morgan reports a slight rise in China’s port stocks in the last few weeks and expects a build-up in the coming months.

An iron ore price at US$112/t is at year-to-date highs and JPMorgan analysts expect prices to hover over US$90/t for the next two quarters. Rising steel output from China has led the analysts to upgrade the price forecast for 2021 to US$84/t from US$80/t.

Key downside risk to price is from a second covid-19 wave in China while upside risk stems from interruption to Brazil supply.

Possible reversal of China’s ferrous scrap import ban

UBS notes China may re-start its ferrous scrap imports in 2021. The country had announced in around 2017 the National Sword initiative which aimed at curbing scrap metal imports in a bid to reduce waste pollution.

This saw China’s ferrous scrap imports falling to zero in 2019, notes UBS. However, realising that not all scrap is waste, the policy itself has undergone modifications, with high-quality non-ferrous scrap reclassified to renewable metals this year so as to avoid being banned.

Ferrous scrap has also seen lobbying by industry participants to convince the Chinese government to reclassify high-grade ferrous scrap with the aim of creating a niche renewable steel category.

UBS thinks some other reasons for wanting to re-import ferrous scrap could be the higher-priced domestic scrap in China.

Between 2016 and 2019, Chinese steel demand grew by 23% while iron ore imports grew 7%. The gap then was filled by domestic scrap whose usage rose to more than 175mt in 2019 from less than 80mt in 2016.

The increase in domestic scrap usage was indeed one of the aims of the National Sword policy of China but even though volumes rose, prices still remained elevated at around US$400/t, translating to a circa US$100/t premium to global scrap prices.

Some other reasons for the move to reimport ferrous scrap could be to support electric arc furnaces which are more environment-friendly than other methods and to reduce high iron ore prices, believes UBS.

In the short term, UBS expects ferrous scrap imports to remain under or about 2.5mtpa.

Currently, the ferrous scrap seaborne trade is about 110mtpa but with China entering the market again, UBS thinks global scrap ferrous prices could face upwards pressure.

UBS points out Sims ((SGM)) is likely to benefit from the increased demand for seaborne ferrous scrap and higher expected prices and rates the stock a Buy. BlueScope Steel ((BSL)) is rated as Neutral.

Urea Euphoria

Not all have been adversely impacted by the fall in energy prices. Urea, for one, is benefiting quite a lot, aided further by favourable seasonal conditions and a supply chain not impacted yet by the pandemic.

A semi-annual report by Rabobank titled Global Fertiliser Outlook notes global fertiliser prices to be at or near 10-year lows due to a combination of plunging raw materials cost, rising production capacity and mediocre demand.

Falling natural gas and coal prices, both critical to urea and phosphate production, have also played an important role in keeping prices low.

Also, Rabobank expects Australia’s winter crop planted area to increase by 26% in 2020,12% above the five-year average, another factor increasing demand for urea. All of these have led to the unabated application of urea on Australian farms.

Rabobank analysts think the low cost of production coupled with low global demand will keep urea prices low in the coming times. They also see limited upside for phosphate prices on a global level for the next six months.

Potash prices are likely to be influenced by supply contracts in China and India. With the main demand season getting closer, prices are expected to stabilise at slightly elevated levels than the ones locked on contracts.

The report also points out covid-19 has increased the risk of isolated shortages which could potentially increase prices.

Any interruption to freight may impact urea availability during winter and spring and cause local prices to rise sharply.

Another point of concern is a weakening of the Australian dollar in the next six months which would take some of the shine off the global low prices for the Australian farmers.

Base metals: Copper and Nickel

A key risk to copper is the possible supply disruption in Chile due to the pandemic. Macquarie notes the market has already priced in some risk premia to the copper price, with the recent price movements attributed to momentum trades rather than discretionary investors.

While consumption rates of base metals are expected to decline by -1-7% year on year, Macquarie expects demand to increase in the medium-term.

The broker also expects earnings upside across its base metals coverage. For copper miners, Macquarie expects earnings upside for OZ Minerals ((OZL)) and Sandfire Resources ((SFR)) for FY21-22.

For nickel producers, IGO ((IGO)), Western Areas ((WSA)) and Nickel Mines ((NIC)) offer earnings upside for FY21-22.

The analysts favour exposure to nickel in the long-term with demand being driven by electric vehicle batteries.

Macquarie prefers Western Areas and Nickel Mines for nickel while recommending OZ Minerals and Sandfire Resources for copper. The broker also likes IGO and Mincor Resources NL ((MCR)) due to their strong balance sheets.

OZ Minerals is to report its quarterly results on July 22, followed by Western Areas on July 23, and IGO on July 29. Sandfire Resources will be reporting its results on July 30, with Nickel Mines announcing its results sometime in the third week of July.

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CHARTS

BSL IGO MCR NIC OZL SFR SGM WSA

For more info SHARE ANALYSIS: BSL - BLUESCOPE STEEL LIMITED

For more info SHARE ANALYSIS: IGO - IGO LIMITED

For more info SHARE ANALYSIS: MCR - MINCOR RESOURCES NL

For more info SHARE ANALYSIS: NIC - NICKEL MINES LIMITED

For more info SHARE ANALYSIS: OZL - OZ MINERALS LIMITED

For more info SHARE ANALYSIS: SFR - SANDFIRE RESOURCES NL

For more info SHARE ANALYSIS: SGM - SIMS LIMITED

For more info SHARE ANALYSIS: WSA - WESTERN AREAS NL