Material Matters: Oil, Coal, Copper & Nickel

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A glance through the latest expert views and predictions about commodities. Oil; coal; steel; copper; nickel; and miners.

-Crude prices remain in the doldrums
-China working to reduce volatility in coal power
-Chinese steel price may soften but unlikely to slump
-Tight copper market expected to continue for several months
-Fundamentals continue to underpin nickel
-Room for mining sector to grind higher in the short term
 

By Eva Brocklehurst

Oil

UBS observes September quarter oil prices have failed to recover to the extent expected. Despite global inventories falling, price recovery has been held back by a number of factors. These include a recovery in output in Libya and Nigeria, uncertainty around the future of the OPEC/non-OPEC agreement beyond the March quarter of 2018 and recovering US production.

The broker now envisages the global oil market will be undersupplied to the tune of 0.5-0.6mmbbl/d in the second half 2017. Moreover, US production is unlikely to balance the market in the medium to longer term.

The broker believes prices over US$60/bbl are required to incentivise mainstream offshore activity and project sanctions in the past two years are exceptional and unrepresentative of the market.

The broker lowers near-term crude price forecasts to US$54/bbl for Brent. 2018 Brent is expected to average US$55/bbl versus US$60/bbl expected previously and 2019 US$63/bbl versus US$65/bbl. The decrease in the broker's oil price estimates prompts a reduction in earnings forecasts for Oil Search ((OSH)), Santos ((STO)) and Woodside ((WPL)) by -4-24% from 2017-19.

Coal

Macquarie observes coal miners globally have benefited from the Chinese government's "276 working days policy" that was introduced in April 2016. This year the policy was relaxed, although safety inspections were becoming more frequent and increasingly stringent.

As prices rose, the government increased the speed of its approvals for new capacity and expansions for some existing mines. Macquarie now expects effective coal mining capacity in China to reach more than 3.8bn tonnes/annum by the end of 2017.

On the demand side, the broker expects thermal coal consumption to be lower now as the peak season for demand passes, yet there is potential upside from a re-stocking. The government has recently notified coal miners of its intention to smooth the stocking cycle and lower price volatility. Macquarie believes the main impact will be on power plants.

During the winter the broker expects coal consumption will be negatively affected by government efforts to cut air pollution. Furthermore, if power plants build up coal inventory before the winter, in line with the government's plans, seasonal demand is unlikely to be lower, and this means a market will not tighten as it did over the summer.

Steel

Macquarie suggests, after recent meetings with Chinese mills, miners and smelters, that local governments are serious about implementing central government policies regarding capacity closures, safety and environmental inspections. The broker observes a shift in attitudes from "economic growth at all costs".

The main policy this year has been the closure of induction furnaces, affecting the balance in the steel market. This has led other mills to ramp up output to fill the gap. A tightness in supply and low inventory has made the market attuned to any disruptions, highlighting the need for re-stocking ahead of the peak season in September and October.

Strong profitability has, therefore, prompted the mills to delay scheduled maintenance work to maintain high output. Macquarie believes a trend for strong steel production will continue in September and the mills will try to produce as much as they can before the winter curtailments happen.

Macquarie suspects that over coming months the steel price may correct, to reflect a softer balance, but it will not collapse and the market may become interested again when the winter reductions start. After the closure of 65mtpa of capacity in 2016 and 50mtpa targeted 2017 there is 25mtpa capacity in the closure target left for the next three years. Macquarie understands this may occur next year and after that the government will focus on industry consolidation.

Copper

UBS considers the current spot price for copper fair, as supply disruptions have proven greater than expected while demand indicators remain robust. Over the next 12 months productivity at mines is expected to improve, while China's property cycle may weigh on demand growth. The broker, as a result, envisages modest upside risks to forecasts for US$2.80/lb in 2018 and US$3.00/lb in 2019.

It appears mine disruptions have continued, so metal markets may be tight for several months more. Exports from both Chile and Peru, 40% of mine supply, were very weak in July. An improvement in mine productivity should alleviate tightness in the months ahead. Meanwhile, Chinese activity and spending on the grid has increased. UBS suspects non-visible inventory in China has been run down and speculative buying has played a large role in the recent appreciation of the copper price.

Nickel

The nickel price continues to be supported by currency trades via a persistent US dollar sell-off, which has lifted all commodity prices. In nickel's case, Morgan Stanley observes this has coincided with improving fundamentals. These include a re-stocking of stainless steel in China and growing market awareness of the new end-use in electric vehicles, as well as policy shifts in Southeast Asia.

A new mining bill in the Philippines has ended the notion that the country might be softening its approach to mining. The latest bill proposes a ban on ore exports and mining in all watersheds and legislative approval to be obtained for all mining permits.

Meanwhile, Indonesia supply is stepping up and the number of companies authorised to export ore has increased. Following this, the country's smelter/nickel pig iron production has dropped because of low nickel prices and discontent over the reversal of policy.

The net result, Morgan Stanley observes, is there is no shortage of nickel in the near-term although the policy changes in both Indonesia and the Philippines are generating uncertainty around future sources of supply. This lends upside risks to the broker's price outlook with expectations of an average US$4.88/lb in 2017.

Miners

Ord Minnett continues to envisage value in selected exposures in the mining sector. There is room to grind higher in the short-term and the broker recommends investors retain exposure to the sector. Balance sheets are in good shape and a large part of the broker's coverage is either net cash or close to being un-geared. This means capital management should stay on the agenda.

The broker believes consensus estimates are too low following the broad-based rally in commodities. That said, valuations are not yet that stretched and the broker is aware the current prices sit above the cost curve support and may incentivise new supply. The broker's preferred stocks are Rio Tinto ((RIO)), Fortescue Metals ((FMG)), South32 ((S32)) and Alumina Ltd ((AWC)).
 

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