Material Matters: Aluminium, Iron Ore & Nickel

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A glance through the latest expert views and predictions about commodities

-Tight supply underpins aluminium yet unlikely to persist
-Material slump in iron ore required before earnings downside
-Nickel could be in surplus till mid decade
 

By Eva Brocklehurst

Aluminium

Morgan Stanley finds reason to be cautious about aluminium, noting China's production has hit a fresh high and supply growth elsewhere exists. Also, automotive production has been disrupted and the price of alumina is falling.

Still, the aluminium spot price has held up close to US$2150/t. The broker assesses speculation and a high price for copper are partially responsible for the resilience but there are also indications of a shortage of metal.

Restocking activity has largely supported the price and as 2021 got underway production was largely committed to contract agreements, making spot tonnage hard to find.

The broker notes scrap is in short supply as well, being affected by freight disruptions. Container freight rates have eased slightly from the highs but remain elevated and this has contributed to tight supply across the market for aluminium.

Morgan Stanley points out a large volume of the 69% of total inventory on the London Metal Exchange held in Port Klang is tied up in rent share agreements. China has also re-opened to scrap imports, reducing availability elsewhere.

Many of the drivers of the squeeze in the market are unlikely to persist through the second quarter of 2021, in the broker's view. Prices should then fall as restocking wanes, supply grows and freight constraints are lifted.

Morgan Stanley also suspects China's decarbonisation policies could have longer-term implications. The message from governments across the country has made it clear that new investment in coal-fired smelting capacity is unlikely to be approved and coal-fired power costs are going to rise.

On this basis demand could overtake primary supply growth by 2023 and China will have to consider importing aluminium, growing secondary supply and/or pushing coal-fired smelter costs up sufficiently to ensure a shift towards renewables.

Steel & Iron Ore

Since late February air quality around Beijing has been poor and a new air pollution control plan has been put in place by the Tangshan local government. The policy includes the phasing out of outdated equipment along with emission controls.

These environmental restrictions have created some uncertainty in the price of iron ore. UBS is unperturbed, noting Tangshan produced 144mt of crude steel in 2020 and the new restrictions are unlikely to affect global production in 2021 as reductions in Tangshan will be offset elsewhere. Moreover, Chinese policies still support steel demand.

Macquarie suspects steel production cuts in China could reduce exports and lead to an increase in production outside of China. If the reduction in Chinese steel production outweighs growth elsewhere then this could be bearish for iron ore demand.

On the other hand, while there is a risk prices may soften, the free cash flow of iron ore miners remains significant.

Macquarie calculates, at US$100/t, the major miners have free cash flow yields in FY22 of 7-8%, although points out the free cash flow yields of Mineral Resources ((MIN)) and Champion Iron ((CIA)) are negative because both are undertaking expenditure for growth.

In sum, Macquarie considers iron ore prices would require a material slump before there is downside to the earnings outlook. Goldman Sachs is now more convinced that BHP Group's ((BHP)) Pilbara business will widen the capital expenditure, margin and cash flow to peers.

BHP's free cash flow is expected to average around US$10/t higher than Rio Tinto ((RIO)) and US$15/t higher than Fortescue Metals ((FMG)) over the next five years, underpinned by lower capital intensity and higher grades/margins.

BHP has no plans for major mine replacement for at least five years after the South Flank is completed in mid 2021. On the other hand, not only does Rio Tinto have the highest number of mines to replace, Goldman Sachs envisages greater production and expenditure risk from the Juukan Gorge incident centring on current and future heritage approvals.

BHP already has the highest operating earnings margins and the broker forecasts a long run margin of 60% compared with Rio at 56% and Fortescue at 47%. Goldman Sachs retains a Buy rating for BHP and Neutral rating on Rio and Fortescue.

Nickel

If Tsingshan expands according to plan Credit Suisse assesses nickel may be in surplus by over 300,000t until the middle of the decade. The company intends to lift output by around 700,000t to 1.1mtpa by 2023 which could undermine prices.

This volume is around 40% of global consumption on the broker's estimates and, while some will be supplied to the growing battery market, ferronickel for stainless steel will be dominant until the battery market becomes a significant consumer in the second half of the decade.

Tsingshan is also the world's largest stainless steel producer so, in Credit Suisse's opinion, its strategy is puzzling. If Tsingshan floods the market with nickel and drives down prices it would reduce its own raw material cost advantage over rivals.

Ore supply is currently the greatest constraint on Tsingshan and Credit Suisse notes another 60mtpa of wet saprolite ore is required over the next three years, which is more than the total currently supplied.

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