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Material Matters: Oil, Coal And Oz Miners

Commodities | Dec 04 2017

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A glance through the latest expert views and predictions about commodities. Oil; coal; commodity outlook and Oz miners.

-Will OPEC-led production cuts reduce global oil stockpiles next year?
-Declining need for high cost, marginal coal supply perceived in 2018
-Chinese support expected to drive positive earnings revisions for miners

 

By Eva Brocklehurst

Oil

OPEC and allied oil producers have agreed to extend production cuts for a further nine months to the end of 2018. Production caps for Libya and Nigeria will also help reduce oversupply risks next year. Commonwealth Bank analysts note both countries account for around 2.8% of global oil supply and their inclusion in OPEC's decision is a surprise as both are producing below historical levels because of disruptions.

OPEC has also stated that production limits will be reviewed at the June meeting. The analysts suggest the inclusion of a review will appease Russian companies that are looking for an exit strategy. Saudi Arabia has suggested that when an exit is contemplated it will happen gradually to insulate the market from any shocks.

The CBA analysts maintain downside risks to estimates, amid concerns that OPEC-led production cuts may not reduce global oil stockpiles next year. Meanwhile, US supply growth looks more certain and there is increased hedging activity.

Morgan Stanley suggests, outside the US, there isn't much growth to be found. Moreover, despite impressive production numbers in September from US states where shale production dominates, growth to that extent is hard to sustain.

In aggregate, over the last 12 months, supply has fallen, outside of OPEC and associates, driven by Mexico and China in particular. Demand is growing and, with supply constrained, the broker suggests the burden on shale will increase. This should provide fundamental support to current oil prices.

Morgan Stanley believes the OPEC decision comes against a backdrop of a market that has already re-balanced. as inventories have been drawn down rapidly this year. US shale will need to contribute at least 1.1mb/d in 2018, a 20% increase, just to keep the oil market under supplied to the equivalent of 2017.

Coal

Macquarie finds some interesting trends amongst trade flows in coal. Demand from Asia is particularly evident in South African exports and the persistence of negative freight across the swap curves is considered a reflection of the strength of Pacific markets relative to the Atlantic.

South Korea has increased imports from South Africa, Canada, Colombia and the US. This is markedly different to Japan, which source most of the additional coal from its traditional Australian supply. For China, most of the additional imports come from Indonesia. India meanwhile has cut back on thermal coal imports in 2017 with the exception of the US.

Generally, Macquarie envisages a declining need for high-cost, marginal supply in 2018. Ex-China seaborne demand is still positive, driven by continuous growth in Asia that is only partly offset by a further decline in European imports. Additional supply from Australia and Colombia is expected to meet most of the demand in Asia.

The market in 2018 appears dependent on a further increase in Chinese imports and/or a rebound in Indian seaborne demand in order for prices to stay at their current elevated levels, in Macquarie's view.

Commodity Outlook And Oz Miners

Citi makes significant upgrades to commodity prices, ex-precious metals, with the largest upgrades being for bulks. A tight Chinese steel market is expected to support more sustainable steelmaking margins, in turn supporting demand for high-grade iron ore.

The broker upgrades forecasts for iron ore to US$64/t from US $53/t. Meanwhile, Newcastle thermal coal prices are expected to average US$78/t in 2018 and metallurgical (coking) coal is expected to average US$155/t.

Although there are near-term risks from seasonal and Chinese currency-related effects, that may be amplified by the shutting down of Chinese operations over the winter, the broker expects demand to recover and a re-stocking rally in the first quarter of 2018.

Chinese growth and supply-side reforms continue to provide support for the market, although Citi does not necessarily forecast significant gains in 2018. Consensus upgrades are expected to drive positive earnings revisions for the relevant companies as well as strong free cash flow. If companies remain disciplined, and there is a lack of viable acquisition targets or projects, this cash flow is expected to be distributed to shareholders.

The broker prefers the Australian diversified majors such as BHP Billiton ((BHP)), Rio Tinto ((RIO)) and South32 ((S32)), as they are expected to deliver cumulative free cash flow of US$56bn over the next three years on the broker's current commodity price forecasts. Citi upgrades BHP, Rio Tinto, South32, Fortescue Metals ((FMG)) and Alumina ((AWC)) to Buy from Neutral.

Citi has a positive outlook for copper and nickel in 2018/19, which drives upgrades to its targets for Independence Group (( IGO)), OZ Minerals ((OZL)) Sandfire Resources ((SFR)) and Western Areas ((WSA)). OZ Minerals remains the broker's preferred copper and base metal exposure.

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CHARTS

AWC BHP FMG OZL RIO S32 SFR

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For more info SHARE ANALYSIS: OZL - OZ MINERALS LIMITED

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For more info SHARE ANALYSIS: SFR - SANDFIRE RESOURCES LIMITED