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Material Matters: Iron Ore, Oil & Lithium

Commodities | Aug 20 2021

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

A glance through the latest expert views and predictions about commodities: iron ore; oil; aluminium; and lithium

-Slowing steel end use in China heralds a slump in iron ore prices
-Delta wave of coronavirus casting a pall over the oil market
-Power shortages in China drive downgrades to Macquarie's forecasts for aluminium
-Lithium could tighten further; emerging spot market triggering price rises

 

By Eva Brocklehurst

Iron Ore

Iron ore prices have slid, down -29% over August matching a move in Chinese steel prices. Macquarie notes during August rebar futures have fallen -US$85/t.Spot iron ore prices are now down more than -US$100/dmt from a high of US$233/tmt on May 12, a fall of -44%. Lump prices have fallen further, down -46% from the peak of US$267/dmt.

Morgan Stanley believes the correction in the rebar price could point to a softening demand environment, as industrial production in China for July highlights a significant slowing of steel end-use, notably in property and infrastructure. Although China's steel demand could pick up as construction activity improves in September on a seasonal basis, a swift improvement is required to offset current market weakness.

Wilsons asserts forecasting iron ore prices is about as difficult as forecasting the gold price, noting specialty commodity forecasters at investment banks have dwindled over the years and the market is increasingly using a combination of spot and long-term estimates of US$65-75/t.

On the broker's aggregation of iron ore forecasts, the metal is gliding from current levels down to US$75/t by 2024, closely matching the Chinese iron ore futures strip, which implies US$120/t by the end of June 2022.

While not formally forecasting the iron ore price, the broker is increasingly worried about the risk to its view that prices would remain higher for longer, and asserts the Chinese administration's policy change is a "big deal".

A combination of 90mt of unwanted iron ore and 60mt of increased mine supply could mean the market is in balance in the second half of this year, representing a significant risk for the price. Australian and Brazilian portfolios, meanwhile, are yet to show any reaction to a change in China's policy.

Within the materials sector, Wilsons is underweight iron ore-exposed names and lowers its exposure further by reducing its BHP Group ((BHP)) percentage on the focus list to 8%. Yet BHP, with a more diversified asset base, should continue to outperform Rio Tinto ((RIO)) and Fortescue Metals ((FMG)), in the broker's opinion.

Macquarie estimates the share prices of BHP, Rio and Fortescue are factoring in flat iron ore prices into perpetuity a US$70/t, US$80/t in US$85/t, respectively. At spot prices these three are trading on FY22 free cash flow yields of 15%, 14% and 8%, respectively.

A material decline in the share prices over the past week has largely been on the back of the iron ore price, although relatively the stocks are outperforming. BHP Group has fallen more than the other two, largely, because of the pending removal of the dual listing structure.

The broker reiterates a positive view of the stocks, believing Rio Tinto is the cheapest and, having already traded ex dividend, is likely to outperform.

Morgan Stanley believes the sell-off in iron ore is accelerating, having just marked the fastest correction in the price on record when it shed -US$23/t in a day. The broker is surprised at the speed at which the normalisation of the price is playing out and, given China's weak steel end-use demand, still envisages further potential downside from the current US$130/t levels.

The broker calculates, if China's July steel output level of 87mt persists through the remainder of the year, steel output in the December half could decline by a around -7% half on half, implying an annualised decline in iron ore consumption of more than -100mtpa, half on half.

Oil

The Delta variant of coronavirus is casting a pall over the oil market, ANZ analysts observe, and concerns regarding the sustainability of the global economic recovery have been raised. A deteriorating situation across Asia has already meant mobility has dropped away while China's zero tolerance strategy means travel is restricted in several major cities.

As a result, the analysts revise September quarter oil demand forecasts for Asia down to 12.9mb/d. Asia accounts for around 35% of global oil demand, half of which stems from China.

Elsewhere demand is more robust. Mobility continues to improve in Europe and the US as governments rely on high vaccination rates. This should mean the market stays tight and a further drawdown occur in inventory in the second half of 2021. Rising vaccination rates should then lead to improvement in sentiment.

Aluminium

Market fundamentals have improved and Macquarie upgrades its outlook for aluminium. Still the fundamentals are challenging. Slower Chinese supply growth has combined with growing demand which means the market has move to deficit from surplus.

2021 is now expected to show a deficit of -700,000t compared with the previous estimate of a surplus of 700,000t. Undersupply is expected to persist through to 2025. Hence, the broker upgrades aluminium price forecasts 3-16% over the medium term. Power supply shortages in China have been a key driver of the downgrade to expected production in 2021.

Even after such shortages ease, Macquarie notes it will take 2-3 months for a full recovery. China is also expected to reach a capacity cap of 46-47mtpa from 2023 onwards. Macquarie believes it will be hard for the government to relax this cap given the carbon reduction determination, unless higher aluminium prices start to damage the downstream industry.

Ex China, primary aluminium demand has increased, amid a strong recovery in Asia and the Americas. Without new capacity, the broker currently projects a -1.4mt deficit in 2024 and -1.8mt in 2025.

Lithium

Macquarie upgrades its outlook for lithium to reflect a further tightening of the market fundamentals and the emergence of a spot market for spodumene and forward market for lithium carbonate. The emerging spot market has provided a positive catalyst for prices, which the broker notes were already rising from positive market fundamentals.

Previous peaks are expected to be reached in the next six months. Chinese chemical grade lithium carbonate prices have risen to RMB94,000/t over recent weeks and battery-grade lithium carbonate to RMB99,000/t. Meanwhile, spodumene prices have risen to over US$850/t.

Macquarie lifts forecasts for spodumene prices in 2022, 2023 and 2024 by 46%, 34% and 21%, respectively. Moreover, the decoupling of spodumene from lithium carbonate should enable spodumene to hit a new peak of US$1350/t in the September quarter of 2022.

That said, the broker still maintains a relationship between the two, increasing the ratio to 6.5% from 6.0%, which translates to a 13% upgrade to long-term price forecasts for spodumene of US$850/t.

New projects are progressing and early-stage equity funding is accelerating yet several projects have suffered minor delays. The main risks to the tightening outlook are new discoveries or faster advancing of developments, Macquarie suggests.

The potential for re-use and recycling of batteries could also affect the market balance, although this is more about reducing widening deficits from 2027 and beyond. Beyond 2027 the broker considers the supply deficit will widen significantly.

Macquarie maintains a preference for Australian producers with IGO Ltd ((IGO)) and Pilbara Minerals ((PLS)) key picks as both offer strong near-term production growth.  Meanwhile Orocobre ((ORE)) offers unique exposure to both lithium brine in South America and spodumene production in Australia.

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