Material Matters: Lithium,Coal & Iron Ore

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A glance through the latest expert views and predictions about commodities: lithium, thermal coal and iron ore

-Improved sentiment for EV, green tech bodes well for lithium
-Volatile period ahead for thermal coal
-Iron ore resilient still, futures hit fresh highs
 

By Eva Brocklehurst

Commodities Outlook

Strong economic activity and accommodative monetary policies are keeping the commodity market buoyant, and while tightening Chinese financial conditions are becoming evident ANZ Bank analysts are not that concerned at present.

The firm conditions also bode well for industrial metal demand and prospects for oil have improved with the re-opening of economies and good progress on vaccinations. US refineries are back to processing nearly 50mbpd after dropping sharply in February.

Higher prices are also providing incentives for US shale oil production, although growth is expected to be modest. Meanwhile, retreating US ten-year bond yields have underpinned gold and, along with a reiteration by the US Federal Reserve of its dovish stance on monetary policy, the backdrop remains supportive for the yellow metal.

Physical demand for gold has also been robust with Indian monthly imports rising to 2013 highs. Strong automotive sales and higher loadings bode well for the platinum group, in the analysts' view, while supply is still struggling to keep up.

Lithium

Morgan Stanley notes sentiment has improved towards electric vehicles and a strong rise in Chinese sales is expected over 2021. Moreover, there is an increased focus on green technology following the US election and a continued push on this front from the EU quarter.

Over the year to date, China's battery grade lithium price has risen 70% and spodumene 56%. While still modelling a deficit in 2021 and a modest surplus from 2022 the broker, in assuming all brownfield projects are developed and applying utilisation factors, finds additional supply could be available to balance the market.

To offset additional brownfield supply in 2023, Morgan Stanley expects battery electric vehicle sales would need to rise by around 2.5m. This would equate to an increase in electric vehicle penetration of around 11.5 percentage points in China, 13 percentage points in Europe, or 15 percentage points in the US.

Any increase in sales ahead of these levels could cause tightness in the market, although there is also potential additional supply from greenfield sources where Morgan Stanley applies more conservative utilisation factors and where there is a timeframe of around 2.5 years for such projects to come online.

Thermal Coal

The Newcastle thermal (energy) coal benchmark is stuck in the US$90/t range as seaborne supply disruptions and a renewed shortage in China keep the market tight. Morgan Stanley notes tightness is most evident in the 6000 cal segment with the premium over the Australian 5500 calorie benchmark currently at 60% compared with the long-run average premium of 28%.

Although expecting supply disruptions to ease the broker believes strong Chinese and Indian demand could support current prices across the northern summer.

China's domestic supplies are struggling to keep up with stronger than usual demand. As long as this market remains tight and port stocks are low, Morgan Stanley considers it unlikely import restrictions on non-Australian coal will tighten any time soon.

Macquarie assesses supply to the Chinese thermal coal market is now linked to government policy rather than market forces as another rebound in prices attracts government intervention. After production ramped up during winter output is now relatively constrained, which the broker believes is consistent with a pick up in environmental inspections observed on the ground.

Now the central government is asking the large miners to increase output again, although a full relaxation of policy is unlikely in the broker's view because of the number of mine accidents recently. The other possibility is an increase in import quotas of non-Australian material.

Indonesian coal miners are now the dominant suppliers to China and there has been unseasonal heavy rain in that country recently. Along with covid-related restrictions and limited production quotas Indonesia's shipments are -25% below 2019 levels.

Morgan Stanley envisages scope for Indonesian exports to rise significantly over the balance of the year as the government has lifted the national production target for 2021 to 625mt, which compares with 2020 production of 563mt.

The broker envisages an increased likelihood for the price of thermal coal to move closer to its US$95/t bull case in the June or September quarters. Beyond this time horizon the price can be expected to move back to the US$70/t level as tightness eases.

Meanwhile, new pandemic-related restrictions are putting pressure on India's coal supply and there could be a boost to imports as demand from the power sector increases during pre-monsoon stocking.

Japanese demand is expected to be subdued as around 3GW of coal-fired capacity is off-line after the earthquake in February. Morgan Stanley notes supply is also struggling, with disruptions in Australia after floods in March and shipments from Newcastle only now approaching January/February levels.

Iron Ore

Among the mid-cap iron ore miners, Macquarie expects Champion Iron's ((CIA)) production will remain above nameplate and the stock is its preferred pick, as growth is imminent from the development of Bloom Lake phase 2. The broker suspects the company may be ramping up its growth aspirations beyond 20mtpa. There is also a benefit from increases in the premium for higher grades along with lower freight rates.

Macquarie reiterates an Outperform rating for Champion Iron, Deterra Royalties ((DRR)) and Mount Gibson iron ((MGX)). All these miners are displaying material upside to valuation in a spot price scenario.

Benchmark iron ore prices have increased 40% over the past year and while Deterra Royalties has been a laggard since its was spun out from Iluka Resources ((ILU)), the broker is positive about the stock, given the growth profile at Mining Area C and the ramp up of South Flank.

Free cash flow yields are attractive for all these miners and this improves in a spot price scenario. Following the stripping program at Koolan Island, Mount Gibson's multiples increase materially from FY22. Iron ore prices remain 27% above the broker's June quarter forecasts and 48% above September quarter. Further afield, spot iron ore prices are 69% above the broker's FY22 forecasts.

Hence, as iron ore prices remain strong and well above the forward curve, there are earnings upgrade risks across the market. Moreover, both Champion and Mount Gibson benefit from high-grade premiums and Deterra s exposed to ore from BHP Group's ((BHP)) operations in the Pilbara, which are expected to achieve close to the benchmark 62% price.

ANZ Bank analysts also note iron ore futures have hit fresh highs amid strong housing construction and loose monetary policy. The analysts assess many steel producers are making the most of a situation which should eventually abate, and there is downside looming.

If stimulus measures end later this year steel output is expected to weaken, exacerbated by environmental curbs on the industry. In turn, this could impact on iron ore prices.

The analysts calculate a 1% swing in crude steel production equates to roughly 15mt of iron ore which in turn equates to a US$15-20/t price movement, and believe it is worth watching credit growth in China as authorities look to tame inflation.

Growth in social financing has fallen and this could have implications for activity in the construction sector later this year. Nevertheless, the analysts do not expect China's steel production to decline significantly in 2021 and emphasise sentiment remains positive, with high probability steelmakers ride out 2021 in a positive way.

The wildcard remains government support for the new energy sector. Building out infrastructure to support usage of new energy will generate additional demand for steel but the volume consumed in the power generation sector remain low, the analysts point out.

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