Material Matters: China, Coal And Iron Ore

Commodities | Jun 15 2021

This story features WHITEHAVEN COAL LIMITED, and other companies. For more info SHARE ANALYSIS: WHC

A glance through the latest expert views and predictions about commodities: China's emissions; thermal coal; coking coal; and iron ore

-Coal, steel, scrap and aluminium markets likely to become erratic
-Supply disruptions and surging demand keeping thermal prices high
-Peak coking coal prices unlikely to be maintained


By Eva Brocklehurst

China's Emissions

China is looking to limit coal consumption as well as the impact of heavy industry on the environment by encouraging the use of scrap metal in production processes. As a result, certain commodity markets are in for a bumpy ride, ANZ analysts assert.

Global steel and aluminium markets outside of China could tighten, pushing prices higher, while the use of scrap may weigh on some raw materials. Inflation could also be an outcome and this may increase concerns about tighter monetary policy.

China is facing a battle to curb carbon emissions as the world's largest contributor and the analysts cite international experience which indicates developed nations usually take 50-60 years to achieve neutrality after reaching peak emissions. Yet the impact from such a large country setting its targets will have an immediate an effect.

China will manage coal consumption over the next five years, aiming to have 20% of its energy needs met by non-fossil fuel sources by 2025. Regardless of whether the policy is one of self-reliance or improved energy efficiency this will reduce imports of energy products. The analysts point out this is already playing out in demand for LNG.

LNG imports to China are up 24.5% in the first five months of this year. Meanwhile, the steel sector, which accounts for nearly 46% of industrial emissions and 13% of total carbon emissions will be made more efficient and less energy intensive, and steel production limits have been imposed to 2020 output levels.

In aluminium, around 80% of capacity in China uses coal-fired power. The country is phasing out less efficient smelters and will stop approving new aluminium projects. Beijing is also adjusting its policy to encourage imports and discourage exports, which could ultimately reduce the amount of steel produced as steel mills will only be required to feed the domestic market.

Import duties on pig iron, crude steel and ferrous scrap have been cut to zero from May. Crude oil refining capacity in China has grown by 16% and copper smelting capacity doubled since 2010, the analysts point out. This should also lead to more imports of crude and copper concentrate.

Thermal Coal

Increased demand at power plants ahead of the peak summer season in the northern hemisphere have caused prices for thermal coal to rally. China's thermal power output is up almost 20% over the year to April and thermal imports up materially in the first half of 2021 compared with the prior half.

Demand has also been strong across Asia with JPMorgan noting global purchasing manager indexes are at 10-year highs as global growth rebounds. The main exception is India, where thermal import demand has been affected by the second wave of coronavirus.

JPMorgan notes spot thermal coal prices are at the highest level since 2018 and expects 2021 and 2022 average prices of US$101/t and US$94/t, respectively. Supply disruptions have also contributed to a stretched market after mines were flooded in Indonesia, rail maintenance occurred in South Africa, unrest broke out in Colombia and safety inspections were the go in China.

Credit Suisse assesses more and more power plants are being squeezed into the spot market to obtain their coal which has lent upside to prices. China is also competing with others for non-Australian coal. A tight market has potential to last through to the December half and linger into early 2022.

LNG prices are also trending higher and there are few other alternatives to keep up with surging demand. The broker believes, if thermal coal supply continues to be disrupted, the Newcastle price is likely to hit US$100/t over the next 12 months. The broker prefers Whitehaven Coal ((WHC)) as its pick of Australian coal producers.

Macquarie downgrades New Hope Corp ((NHC)) to Neutral because of a muted thermal coal outlook, despite there being significant earnings and valuation upside at spot prices, and also prefers Whitehaven Coal given its leverage to both thermal and metallurgical (coking) coal.

Coking Coal

Chinese steel production hit a record in April yet coal imports remain sluggish as domestic production ramps up to meet a shortfall. Coking coal prices have recovered, despite no Australian exports going to China. Demand ex China has made up for this.

The main risk JPMorgan envisages for seaborne metallurgical coal demand is extended disruptions from India's second wave of coronavirus. Consumption should recover in the second half of 2021 as infection rates stabilise and new coke ovens come on line.

Chinese domestic production is up 10% as producers try to fill the supply gap caused by the ban on Australian coal. JPMorgan notes Japan and India have become the largest purchases of this displaced coal, accounting for around 60% of total Australian exports. Forward curves show 5-8% gains in coking coal prices, which the broker believes is a reasonable outlook.

Australian hard coking coal has rallied since mid May, Morgan Stanley also notes, as China's coal shortage and elevated steelmaking margins push domestic coke and metallurgical coal prices to multi-year highs.

The expanding China-Australia price arbitrage has meant US coal cargoes destined for Europe and Brazil have been resold to China and in turn been replaced by Australian spot market coal. Morgan Stanley does not believe the Australian price of US$170/t can be maintained while China continues to ban Australian imports and there remains excess Australian coal in the market.

The futures market is assuming the full elimination of the current price differential between Australian and Chinese benchmarks by the end of 2022. As China's steel margins are under pressure from lower steel prices its output and/or raw material input prices will need to adjust lower, the broker adds.

Australian supply could be fairly easily absorbed through exports to India which is now the leading importer, with imports increasing by almost 60%. Still, the monsoon is looming in India and the restocking cycle is likely to come to an end. Hence, Morgan Stanley suspects that it could become harder to place all Australian coal at the current price over coming months.

Macquarie has upgraded metallurgical coal forecasts which drives a material upgrade to earnings and price targets for those miners. The broker is cautious about Coronado Global ((CRN)) as it requires metallurgical coal prices at above US$130/t for a sustained period of time in order to keep the balance sheet strong.

Iron Ore

Macquarie materially upgrades earnings forecasts for iron ore stocks. The 2021 price forecasts is lifted by 20% to US$158/t. Incorporating the increase requirement for higher-cost supply to balance the market means 30% and 26% upgrades to 2022 and 2023 forecasts, to US$120/t and US$95/t, respectively.

The broker continues to favour Rio Tinto ((RIO)) over BHP Group ((BHP)) and Fortescue Metals ((FMG)), although the gap has narrowed and all three are trading at similar free cash yields further FY22. Goldman Sachs reiterates a Buy rating for BHP Group for high-grade iron ore exposure and a Sell rating for low-grade producer Fortescue Metals.

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