Material Matters: Lithium, Iron Ore, Oil And Alumina

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-Lithium producers holding back
-Timing is critical for new entrants
-Iron ore price momentum fading
-Low rates, weak AUD supports oil, utilities
-Alumina capacity set for low utilisation
 

By Eva Brocklehurst

Lithium

Lithium became a buzz word in commodity circles as the price surged in 2015 while other commodities were stymied. Macquarie notes the price is up 50% since the beginning of 2015 and lithium demand is up 8% overall and 22% for battery use. The market is now in deficit, aided by established producers consciously not lifting output to meet demand, the broker asserts.

Macquarie also highlights lithium demand is not just about electric vehicles. Up until this year batteries for portable devices consumed more lithium, as did ceramics and glass. The broker does not envisage demand destruction as the price rises either. Lithum comprises less than 2% of a rechargeable lithium ion battery with cobalt and nickel more important from a cost angle.

There is no capacity constraint in the market, with four entities accounting for 90% of global production. The largest miner, Talison, is operating at only 60% of nameplate capacity, Macquarie observes. The broker believes that the price increase since the start of the year is being driven by short-term supply side constraints and, in order to protect market share and keep new entrants at bay, existing producers will eventually be forced to raise volumes.

The market is expected to move back into balance within 18 months and, longer term, the broker remains positive for the sector outlook, driven by expectations for lithium demand in new energy vehicle batteries out to 2021, at which point they would account for one third of all lithium demand versus one tenth today.

Macquarie concludes that timing is the key for raw materials suppliers, and has initiated coverage of five Australian-listed lithium hopefuls.

The broker has set Outperform ratings for those most ready to be near-term producers, Orocobre ((ORE)) and Neometals ((NMT)).

Galaxy Resources ((GXY)) is rated Underperform, as Macquarie does not believe medium-term demand supports the development of Sal de Vida and, hence, the stock is fully valued. A similar issue exists with Underperform-rated Pilbara Minerals ((PLS)), as the broker currently foresees the Pilgangoora mine entering the market at a time of oversupply and declining prices.

Altura Mining ((AJM)) is proposing to build its own project adjacent to Pilbara Mineral's Pilgangoora, with lower capex and at a faster rate. Macquarie does not believe this is a superior project, or that it will achieve its aggressive timelines, and sets an Underperform rating on the stock.

Iron Ore

Morgan Stanley notes large miners recently moderated their guidance for iron ore production but the tonnage is still arriving. The lift in iron ore prices has invited the re-entry of smaller producers into the seaborne market, with exports from a number of countries all rising this year. India is also coming back into the market, annualising 11mt of exports to China versus just 2mt in 2015.

Collectively, Morgan Stanley observes these tonnages are meaningful, up 31% year on year. Meanwhile, Chinese domestic output is also ramping up in response to robust steel production rates, the broker noting output lifted to 103mt in April. Feedback from the broker's recent visit to China suggests that most remaining domestic mines are profitable at a seaborne price of over US$50/t.

Ord Minnett also observes Chinese steel production is rising, which should absorb some of the volume growth in iron ore, but positive iron ore price momentum is fading. Chinese economic data is now longer overwhelmingly positive and measures are being introduced to reduce speculative trading. The broker deems it critical for the data to remain relatively robust over the second half for sentiment towards iron ore prices to remain positive.

The broker forecasts iron ore prices at US$53 and US$48 per tonne in 2016 and 2017 respectively. Nevertheless, with a rise in supply forecast for the second half of 2016, price volatility should continue.

Analysis of port data suggests Australia's Roy Hill mine is running at a 22mtpa rate, around 40% of full 55mtpa capacity. On this basis the broker increases 2016 shipment expectations from the supplier. Ord Minnett makes no other changes to supply assumptions for Australian producers but also notes that non traditional supply to China spiked in April.

Oil

Ord Minnett considers the current macroeconomic environment is positive for the energy and utilities sectors, despite a reduction in oil price assumptions. Near-term Brent forecasts are lowered to US$45/bbl in 2016 from US$50/bbl previously and to US$55/bbl in 2017 from US$60/bbl previously.

Oil prices have been rising as demand strengthens and high-cost production comes out of the supply chain. Lower cash rates are also positive for those stocks offering yield, such as in the utilities sector. The broker expects a further reduction to the Reserve Bank of Australia's cash rate to 1.0% by June 2017. In conjunction, a further weakening of the Australian dollar is expected, descending to a low of US65c by mid 2017.

Over the medium term the broker expects oil prices to be driven higher by stronger demand growth from India, China and Russia, declining non-OPEC supply and tight OPEC spare capacity.

Alumina

Price rises since the start of the year have taken the alumina price to over US$250/t FOB, too high relative to fundamentals, Macquarie maintains, and the price is likely to be crunched soon, reverting to US$220/t FOB Australia.

This price increase has not been matched by the Chinese domestic price. Chinese alumina production accounts for around 50% of the global total so the domestic price is the most important benchmark, the broker asserts.

While the Chinese price is up over 20% from the start of the year, it has stagnated in the past month. As a result, the import arbitrage for alumina into China has been closed since January. Macquarie observes this comes against a backdrop where demand is not rising.

Chinese output is for aluminium is down on where it was six months ago and while the broker is confident smelters will re-start, as yet this has not been the case. Some of the strength in the alumina price is also likely to have been smelters sourcing material ahead of potential re-starts.

Meanwhile, given a recovery in the price, Chinese alumina production is also re-starting, ahead of aluminium. Longer term, alumina is considered one of the few commodity markets where new projects are being delivered in coming years and capital is still being invested. This is due to a positive demand outlook for aluminium and reasonable industry margins, the broker contends.

Still, there is the likelihood that the global alumina market will be set for relatively low utilisation rates and/or capacity closures towards the end of the decade. China will still increase its demand for aluminium raw material units but given the Chinese business model of purchasing raw materials and building more than enough process capacity, Macquarie suspects the growth opportunity will be in bauxite.
 

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