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Material Matters: Oil, Lithium, Magnesium, Coal

Commodities | Oct 28 2021

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A glance through the latest expert views and predictions about commodities: oil & gas, lithium, nickel, magnesium, steel, and coal

-Current tight market suggests support for oil and gas stocks
-Lithium sector a hive of activity as UN climate change conference looms
-Tightness in the nickel market likely to persist
-Acute shortage of magnesium to have significant implications
-Jarden anticipates heightened demand for US steel as China curbs production
-China's coal market expected to become more balanced

 

By Eva Brocklehurst

Energy

Morningstar suspects the market is underestimating the demand for oil over the medium term. Tight supply and high prices should underpin oil because of an underperformance of the OPEC alliance compared with stated targets, combined with a recovery in demand as economies normalise.

A mid-cycle oil price forecast of US$55/bbl for West Texas Intermediate and US$60/bbl for Brent is maintained. Over time, the analysts believe the upward pressure on oil prices will ease.

This will occur as sanctions on Iranin exports are modified or lifted, while OPEC should be able to build production levels up over time. US producers also plan to grow at low single-digit rates, which will be enough to bring new supply onto the market and keep it balanced after 2022.

Meanwhile, natural gas prices in Europe are extremely high, which is the result of a combination of factors. Inventory in Europe had been replenished over the summer, although production remains affected by the pandemic.

Electricity producers are trying to purchase natural gas in order to make up a power deficit before winter arrives and, on the supply side, there is not a lot of excess natural gas available. Europe has to compete with Asian buyers such as China, which is making its first steps to rely less on coal for electricity generation and more on natural gas.

The analysts believe the transition in the electricity market to renewables is likely to lead to greater variability in power generation and, as intermittency remains an issue for renewables, generators are resorting to natural gas.

In summary, while there is a lot of negative sentiment around investing in oil companies, many oil stocks have surged and, based on long-term forecast for prices and demand, the analysts believe these are undervalued.

Lithium

Activity is heating up in the lithium sector and Bell Potter runs the ruler over the major transactions that have occurred since the start of 2021. The broker expects heightened news flow for the sector, given the UN climate change conference will be held shortly.

Specifically, in just over the last two months, there have been purchases of stakes such as the Lilac Solutions earn-in to 25% of the Kachi lithium brine project, owned by Lake Resources ((LKE)), Sayona Mining's ((SYA)) acquisition of 60% of Moblan lithium project and the Zijin Mining takeover of Neo Lithium.

Pilbara Minerals ((PLS)) and POSCO have firmed the joint venture to develop a 43,000tpa lithium hydroxide plant in South Korea while Mineral Resources ((MIN)) and Albemarle will re-start the Wodgina lithium mine by the September quarter of 2022.

In other news, Suzhou CATH Energy has an agreement with AVZ Minerals ((AVZ)) to earn a 24% equity interest in the Manono lithium and tin project. And Ioneer ((INR)) has a 50-50 joint venture with Sibanye-Stillwater to progress the Rhyolite Ridge project.

Nickel

Morgan Stanley envisages persistent tightness in the nickel market. China may be curbing its stainless steel production yet supply disruptions and strong demand for electric vehicle batteries are overriding factors in determining the outlook for nickel.

The broker observes the current draw on nickel exchange inventory, at an average rate of 1000t/day since early September, has tightened the market and pushed the price to test a 10-year high of $21,000/t (last US$19985).

There has been a net reduction of -225,000t in nickel demand on an annualised basis from China, or 9% of global primary refined supply, the broker observes. Yet, these energy-driven cuts to stainless production are likely to be more temporary than the environmentally-related restrictions on carbon steel.

A healthy rebound in China's stainless output is also likely as power shortages ease after the winter. On the supply side, refined nickel supply is expected to improve once the rainy season in the Philippines has passed. Norilsk has also indicated its output was up 55% in the September quarter.

Morgan Stanley does not expect the nickel price will follow the lead of iron ore given a much tighter market. The broker also disregards the potential bearish view of Tesla's confirmation it will switch to nickel-free LFP battery chemistry in its standard-range models.

Magnesium

An acute shortage of magnesium has challenged several industries and Morgan Stanley suspects, without much of a buffer in the system, China's output restrictions are likely to weigh.

A shortage of magnesium could have widespread impact on the automotive, aerospace, beverage can and consumer goods sectors. China's smelters are facing strict controls and while there was some recovery in October, utilisation is capped at 40%. China makes up 87% of the world supply of magnesium.

Europe is considered the most challenged in obtaining magnesium as it has no supply of its own and relies on China. While the US has supply there are some risks to components coming from Canada and Mexico. Morgan Stanley also points out magnesium begins to oxidise after 3-6 months which means it is hard to store for a long period.

What will occur, in the broker's view, is that aluminium producers, being unable to secure enough magnesium to produce their major aluminium alloys, will instead switch to primary metal for delivery into LME warehouses.

The broker suggests the current shortage of magnesium is likely to mean end-users look for alternatives, and for in areas for which there are no alternatives it may not be possible for production, such as steering wheels, to recover completely.

Steel

Jarden considers the US steel market will experience growth in demand in 2022, albeit at a slower rate compared with 2021. The broker forecasts demand growth of 2.7% with potential upside stemming from infrastructure investment.

The swing factor could be automotive production, affected by semiconductor supply shortages, and China's curbs to steel production could mean steel prices are supported globally.

Jarden notes the global steel production utilisation rate has risen steadily to over 80%, which is high by historical standards. While the market is pricing in a mean reversion in the US steel price in 2022/23 the broker believes there is a risk for subsequent years as US steel production capacity expands.

Yet, as China restricts steel exports and cuts production capacity this should reduce the risk of the market being hit by oversupply. As a result, decarbonisation should mean rising demand for scrap metal and support ferrous scrap pricing.

Jarden has initiated coverage on Sims ((SGM)) with a Buy rating and BlueScope Steel ((BSL)) with an Overweight rating. The former has 6% of global market share of seaborne scrap that should benefit from rising scrap demand while expansion into e-cycling and repurposed data centre equipment should diversify earnings sources.

The broker forecasts BlueScope's North Star (US) FY23 pricing will be 58% above the average pricing since 2019, at around US$1173/t.

Coal

JPMorgan suspects, after an extremely volatile year for China's coal consumption, the worst of the shortage is probably behind the country, amid a change to the government's attitude towards domestic production.

New production should reach the market in November and growth in coal production will accelerate. Coal price momentum should therefore subside and lead to a de-rating of coal equities. Extreme coal volatility in China over 2021 was caused by both weather and government policy. Hydro production was extremely weak and increased the requirement to boost thermal coal power.

Tight import controls and mining restrictions also led to limited supply growth. A coal shortage has persisted over the past month which the broker suggests is because incremental supply could not cover the lack of Australian coal imports.

JPMorgan expects demand will moderate and lead to a normalisation of coal inventory. Supply tightness in the winter peak season is not expected to be as severe as summer given new domestic supply should enter the market.

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