Material Matters: Thermal Coal, Iron Ore, Palladium, And Alumina

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SUMMARY

– Thermal coal, fertiliser fundamentals remain favourable

– Short-term support for iron ore prices

– Palladium, alumina tipped to go higher

 

By Chris Shaw

In a not surprising outcome, Australian thermal coal export shipments were weak in January as those in the market had to deal with the impact of significant flooding in Queensland in particular. Macquarie notes Queensland shipments in January are likely to come in below 30 million tonnes on an annualised basis.

Shipments for New South Wales in contrast remained steady at an annualised rate of around 102 million tonnes in both December and January. Combining the two implies total annual shipments of around 130 million tonnes, which compares to total thermal coal shipments in 2010 of 141.3 million tonnes. 

While the impact of the floods is fading, Macquarie suggests one constraint that may continue to linger is the incentive to switch from thermal coal production to production of semi-soft/PCI coal where possible. 

Macquarie notes recent semi-soft contract negotiations were settled at US$180 per tonne for the first quarter of 2011 and will be set at 80% of hard coking coal (HCC) prices in the second quarter. With HCC contracts to be settled at around US$290-$300 per tonne in this quarter, producers who can wash thermal coal into semi-soft coal may be able to take advantage of prices of US$230-$240 per tonne. This is well above the US$119.75 per tonne for the second quarter currently priced into Newcastle swaps.

This suggests some switching is likely to occur, leading Macquarie to forecast total Australian thermal coal exports in 2011 will be in the order of 148 million tonnes. This, plus signs the market for spec coal is likely to be tighter than that implied by export growth from Newcastle, leads Macquarie to suggest there is upside risk to what is being priced into coal futures markets at present.

This view fits in with that of Citi, who expects continued strong thermal coal prices as strong demand and supply restrictions continue to support the market. Citi estimates the rains in Australia will see about five million tonnes of thermal coal supply lost given the Queensland rail system remains closed, while it too picks up on the fact some producers are now giving priority to higher priced products such as semi-soft coal.

Production in Indonesia has also been hampered by heavy rains, while a shortage of rail wagons is impacting on the Russian market. An easing in some of these restrictions saw thermal coal prices come back from recent highs, but Citi remains positive on price prospects in the market.

One reason is if European demand for thermal coal was to recover, the global market would tighten significantly as coal from South America and South Africa is at present being delivered to Asia rather than its more traditional European markets. 

As well, Citi expects China will remain a net importer this year, as while domestic production continues to grow it is not increasing fast enough to keep pace with demand. India should also see significant increases in the amount of thermal coal it imports in coming years, as urbanisation and increasing electrical intensity continue to push up demand. 

Elsewhere in the bulk commodities space, Goldman Sachs notes the seaborne spot iron ore market has started the Chinese New Year strongly, prices either at or near record highs. This price strength had been expected and has been met by higher steel prices through Asia.

Goldman Sachs expects this rally has further to run in the short-term, as steel demand from China improves and as major suppliers continue to deal with constraints. Longer-term though Goldman Sachs is more cautious, as scrap prices have fallen and steel price gains appear more a function of cost push from higher raw material prices than evidence of significantly stronger demand. 

Any weakening in underlying demand will see steel prices fall and as this would impact on margins Goldman Sachs suggests it could be a precursor to weaker iron ore prices. This is unlikely in coming weeks, but remains a distinct possibility in the second half of this year in the broker's view.

Deutsche Bank in contrast sees scope for iron ore to remain somewhat scarce for the next two years, thanks largely to bottlenecks as mining companies build infrastructure and source equipment needed to handle the amount of material has to be transported over long distances. 

There is also potential for some structural issues in iron ore markets, Deutsche suggesting these include the Indian steel industry attempting to ban iron ore exports and a slow recovery in Brazilian export levels. Cost inflation in China may also emerge as an issue, pushing the marginal cost of production in that market to around US$115 per tonne.

Deutsche expects steel production growth this year will decelerate after increasing by a double-digit rate next year, something that is likely to limit demand for iron ore. But with supply expected to continue to struggle to meet demand, the broker sees iron ore prices averaging US$175-$180 per tonne over the next two years.

Turning to palladium, Standard Bank notes the metal continues to enjoy good price support on the back of solid industrial demand. Contributing here are auto sales, where numbers for major manufacturers were up in January. This follows steady improvement in 2010.

Using adjusted sales numbers, Standard Bank suggests auto sales appear much more supportive for palladium than at the start of last year and more supportive than similar figures for platinum. A further seasonal pick-up is expected in February and March.

On a six-month view Standard bank expects both palladium and platinum prices will head higher, but current market conditions suggest palladium is favoured to perform the better of the two metals.

In the base metals, Goldman Sachs notes a recent recovery in primary aluminium production has driven an equally sharp improvement in demand for metallurgical grade alumina. The stockbroker estimates demand in 2010 was 87.6 million tonnes, forecasting this will increase to 111.2 million tonnes in 2015.

Based on current estimates for refining capacity, Goldman Sachs estimates this would imply a steady increase in refinery utilisation rates in the low 90% range in 2014 and 2015, so as legacy metal-linked contracts expire in coming years it is expected the average contract price will converge with the spot price.

This improvement in utilisation, along with increasing cost pressures, should be enough in Goldman Sachs's view to generate gradual price improvement. From levels of around US$340 per tonne (FOB) in 2010, the broker is forecasting alumina prices of US$371 per tonne this year and US$455 per tonne by 2015. 

Alumina Ltd ((AWC)) is the primary pure play on the Australian market, the FNArena database showing the company is rated as Buy twice, Hold five times and Sell once with a consensus price target of $2.70.

Turning to the agricultural commodities markets, BA Merrill Lynch notes the USDA has lowered is 2010/11 global grain inventory estimate by 24bps to 19%. The change saw inventory estimates lowered for all crops.

BA-ML suggests falling grain supplies should continue to support grain prices at elevated levels, so giving farmers encouragement to invest in agricultural inputs this year. This implies good news for fertiliser plays such as Incitec Pivot ((IPL)) and Nufarm ((NUF)), enough for BA-ML to rate both stocks as Buy at present.

BA-ML is not the only one to pick up on this theme as the FNArena database shows Incitec Pivot is rated as Buy five times, Hold twice and Sell once with a consensus price target of $4.60, while Nufarm scores four Buys and four Sells and has a consensus price target of $4.82. 

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