Commodities | Jun 25 2021
This story features WOODSIDE PETROLEUM LIMITED, and other companies. For more info SHARE ANALYSIS: WPL
A glance through the latest expert views and predictions about commodities: Coking coal, thermal coal, oil and gas, and copper
By Mark Story
-Despite the ban on local coal, the prices China is paying are filtering through to Australia
-Oil could exceed US$85/bbl later this year before rebalancing lower
-Double-digit upgrades to Macquarie’s copper price forecasts for 2022-25
-Possible 20-40% upgrade valuations to energy producers if oil prices stay circa $US74/bbl over mid-term
Credit Suisse suspects the 46% rise in Australia’s premium low volume (PLV) coking coal price last month to A$178/t may have been initiated by the rise in the Newcastle thermal coal price, and then exacerbated as rising cost-and-freight (CFR) prices in China motivated traders to buy PLV for swapping.
If so, the broker believes it opens the prospect PLV may remain strong at A$150-$190/t for the year as both thermal and China’s seaborne coking coal demand are unlikely to collapse.
If Credit Suisse is correct and PLV prices are now responding to the arbitrage China is offering for non-Australian seaborne coking coal, and thermal prices, the broker concludes it is a positive outlook for PLV. As long as there is an arbitrage on offer, the broker believes traders will want Australian PLV for swapping, and China is reportedly tight in coking coal.
Credit Suisse suspects the prices China is paying are filtering through to Australia. While China is not buying Australian coal, the broker notes it is buying hard from every other region, and there are finite global resources.
As a result, the broker speculates that the sideways shuffle of global coal demand has lifted demand for Australian coal. Consequently, Credit Suisse suggests there may be a way that the higher prices China is paying are filtering through to Australian coal prices.
For example, traders are actively taking Australian cargoes for swapping with US and Canadian cargoes that they can send to China to enjoy the bumper prices China is paying. Credit Suisse highlights that the most recent jump in Chinese CFR prices coincided with the rise in Australian prices, suggesting the China price jump further incentivised traders.
The broker also notes cargo swapping and demand for replacement Australian coal may have become more frenzied in late May, which is when the Australian price started to rise.
Overall, Credit Suisse believes the demand for cargo swaps and price-push from thermal coal look like the most compelling reasons for prices to have risen. The broker suspects thermal coal push started the rise and then the arbitrage took over and kept coking coal running above A$170/t.
Now that the swap trade is underway and steel mills are getting used to Australian PLV and enjoying the profit, the broker expects the trade to be sustained as long as it’s profitable.
While exports of thermal are down in Australia, Indonesia and Colombia, power demand is surging around the world, driving the (USD) thermal coal price to US$120-130/t. Credit Suisse notes Indonesia is restocking coal ahead of summer demand and there are few alternatives to Newcastle coal as Chinese prices attract all seaborne coal other than Australian.
While Credit Suisse doesn’t expect thermal prices to rise higher, the broker also doesn’t expect a major pullback. The broker expects the low in autumn this year may be US$100/t, which might put a floor under PLV at US$130/t. But it wouldn’t test that level unless coking coal demand gave way, which Credit Suisse does not predict.
Credit Suisse would expect the thermal coal price to relax from current prices, but most likely after peak northern summer electricity demand in August. Soon thereafter, buyers in Indonesia will start to look towards winter, so the broker expects any weakness in prices to be quite short-lived.
Oil and gas
Citi is raising forecasts for Brent crude oil prices by US$4 to US$72/bbl this year and by US$8 to US$67/bbl next year, US$5 below year-before levels. Increases are due to more bearish supply and demand factors weighing on market balances next year.
The broker is also forecasting a narrower spread between Brent and WTI due to changing global market conditions, largely in the US.
In particular, Citi now expects Brent crude oil prices averaging US$77/bbl over third quarter FY21 and US$78/bbl in fourth quarter FY21, US$4 and US$9 higher than the broker’s previous forecast.
While Citi has revised its oil price deck higher, the broker still does not buy into the view that the world is on the verge of a new commodity super-cycle. Post-pandemic recovery in the works for India, and evidence of higher demand in China, the US and Europe, provide ample support for Citi’s view that by August 2021 global oil demand may exceed the record 100.8-mb/d reached in August 2019 on pent-up leisure demand.
Citi notes this year the normal summer inflection point for crude oil and refined product markets has looked to be stronger than normal, with refinery throughputs increasing ahead of a seasonal upsurge in end-user demand. As a result, the broker now sees Brent oil prices averaging in the high US$70s for the rest of the year, with a high probability of touching US$85 before subsiding with markets rebalancing.
A further telling sign that oil demand is improving, notes Wilsons, is a run-down in global inventories, which have fallen -15% from the 2020 highs and are now almost in line with 2017-19 levels.
Citi has revised its expected Brent crude oil average price for 2022 to US$67/bbl from US$59. But a combination of factors is driving the broker’s longer term outlook. These include a marked slowing of demand growth as the recovery’s go-go phase fades, potential higher production from Iran and the US, plus a full return of OPEC crude to the market.
Meanwhile, Australian energy equities have lagged the oil price more so than global energy equities, hence from a valuation perspective, Wilsons believes this leaves Australian energy equities trading at an historically wide discount relative to the market that will prove unsustainable.
In the last oil price rally of 2016-18, when oil prices almost doubled, the Australian energy sector largely kept pace with the oil price. By comparison, Wilsons notes, during this time the three largest Australian oil producers, Woodside Petroleum ((WPL)), Santos ((STO)) and Oil Search ((OSH)) were all going through periods of strong prospective project growth.
Wilsons thinks part of the reason Australian energy stocks have dramatically underperformed US and European peers in this oil price cycle is that relative production growth rates have reversed. In short, Wilsons concludes that global energy companies are now offering higher prospective growth versus Australian equities.
Wilsons notes similar discounts are currently seen in companies such as APA Group ((APA)), AGL Energy ((AGL)), Aurizon ((AZJ)) and Origin Energy ((ORG)), all of which earn a significant proportion of the income of fossil fuel-related activity. The broker believes the discount is also partly due to perceived structural/ESG concerns, particularly fossil fuel-derived income.
In light of perceived structural/ESG concerns, industry leaders including Santos used the recently held Australian Petroleum Production & Exploration Association conference to emphasise Australia’s gas industry should strive for net-zero emissions to avoid being blacklisted by equity investors and lenders.
Cooper Energy ((COE)) noted that its position as Australia’s first carbon-neutral domestic gas producer from 2020 has benefited the company’s ability to retain certain ESG-focussed shareholders.
Beyond oil, Bell Potter notes a strategy of supplying carbon-neutral LNG is also being adopted by some Australian exporters. Their intention is to avoid losing market share from new low-cost LNG capacity expected to come online in Russia and Qatar over the next decade.
Wood Mackenzie research estimates that 75% of LNG demand is from countries that are focused on reaching carbon neutrality and highlighted “green LNG” as a strategic option for Australian LNG exporters.
Undervalued Australian oil producers
With regard to Wilsons aforementioned acknowledgment of Australian energy equities now trading at the widest discount to the market seen in over a decade, on a relative price/earnings basis the sector is at a -25% discount to its long-term average and a -50% discount when the sector last had the benefit of rising oil prices.
Wilsons questions whether this discount would be sustainable if oil prices were to move dramatically higher, something the broker is increasingly becoming more bullish on. The Wilsons Australian Equity Focus List is overweight the energy sector with exposures to Santos and Worley ((WOR)), and expects both stocks to benefit if the oil market is squeezed higher over the next 12-18 months.
Wilsons notes share prices of Australian energy producers currently imply a Brent oil price of $US55-60/bbl, a discount to the spot price of $US74/bbl. If oil prices stay at $US74/bbl over the medium term, the broker suggests the market will need to upgrade valuations of energy producers by 20-40%.
The broker believes higher prices into 2022 will drive a new round of “catch-up” spending across upstream projects, which could send Worley earnings 50%-plus higher within three years.
Wilsons disagrees with the view that Santos’ production growth will require additional equity capital. The broker believes Santos’ long-term production growth is sector-leading and expects the company to be successful with asset sell-downs that maximise value.
Amongst base metals, the most significant changes by Macquarie’s Commodities Strategy team are 13-14% upgrades to the copper price forecasts 2022-25. Despite expecting a cyclical pullback the June quarter highs as a slowdown in global industrial production took some heat out of industrial metals markets, Macquarie still forecast a circa -250kt deficit for 2021.
The broker is also expecting marginal surpluses between 2022 and 2024, a -450kt deficit in 2025 and structural deficits quickly moving above 1Mtpa beyond.
All base metal miners boast strong earnings upgrade momentum under a spot price scenario, and Macquarie has an Outperform rating on all the base metals stocks in its coverage. The broker prefers OZ Minerals ((OZL)) and Sandfire Resources ((SFR)) for copper, with the former remaining the broker’s preferred exposure, as the company is boasting several key organic catalysts headlined by the Prominent Hill Expansion update.
While Sandfire boasts the greatest leverage to copper prices for the next two years, over 50% higher than Oz Minerals, Macquarie notes OZ Minerals has the greatest by-product earnings leverage to stronger gold prices in the broker’s base metals coverage.
While Panoramic Resources ((PAN)) offers the greatest leverage on average to nickel prices for both FY21 and FY22, the broker also favours IGO Ltd ((IGO)), Nickel Mines ((NIC)) and Western Areas ((WSA)) for nickel production. However, with strong forecast free cash flow yields, which increase further in a spot price scenario, Nickel Mines is the broker’s preferred nickel exposure.
Mincor Resources ((MCR)) and Chalice Mining ((CHN)) are the broker’s key development and exploration plays, with the former offering significant leverage to nickel on a mooted resumption of mining, with the stock's net present value increasing 22% for a 10% change in nickel prices.
Macquarie note, earnings multiples remain attractive, with OZ Minerals enterprise value to earnings multiple for FY22 at 6.0x. Under a spot price scenario, multiples decline slightly to 5.2x. Sandfire and Western Areas show a similar pattern, with multiples of 1.4x and 5.5x for FY22 using the broker’s forecasts, but 1.2x and 5.0x under a spot price scenario respectively.
Mincor Resources also has attractive multiples on the resumption of operations at 3.1x and 1.8x for FY23 and FY24 on the broker’s forecasts and 2.3x and 1.3x at spot pricing. Macquarie notes Nickel Mines trades on spot forward multiples of 8.7x and 6.1x for FY22 and FY23.
While earnings margins range from around 30-50% using Macquarie's commodity price forecasts, Western Areas has the lowest forecast earnings margin in FY21 at 27%, while Sandfire has the highest at 56%.
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