Material Matters: Energy, Coal And Nickel

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Oil & gas outlook; coal pricing and demand; nickel outlook in the wake of the Philippines review of its nickel mines.

-LNG markets to be well supplied until 2021
-Proposed LNG projects need to be highly cost competitive
-Seaborne coal demand to remain robust
-7% of Philippines nickel production forced to close
 

By Eva Brocklehurst

Energy

A moderate recovery in oil prices will support the energy sector but Deutsche Bank maintains the main differentiator among stocks will be an ability to demonstrate production growth and low-cost expansion opportunities.

New LNG project opportunities in Australia are challenged and this means Deutsche Bank emphasises a preference for Oil Search ((OSH)), given its exposure to expansion opportunities in PNG.

Wood Mackenzie forecasts robust oil demand growth in 2016, driven by China and India. The reduction in oil prices since late 2014 is finally expected to result in a reduction in oil supply in 2016, driven largely by US tight oil. As a result, demand is expected to surpass production from the December quarter onwards.

Wood Mackenzie has downgraded Asian LNG demand estimates for 2025, led by downward revisions to Japanese demand, largely because of LNG displacement in the power sector from nuclear, renewables and coal.

LNG markets are expected to be well supplied until 2021 and Wood Mackenzie calculates new LNG capacity that needs to be sanctioned to meet 2025 Pacific basin demand is around 55mtpa. In the near term, well supplied Asian markets are expected to keep spot LNG prices below US$5/mmbtu out to 2021.

Given the narrowing market opportunity for pre-final investment decisions (FID) on LNG to meet 2025 demand, Wood Mackenzie believes proposed projects will need to prove highly cost competitive to proceed to FID. PNG LNG expansion involving Oil Search and Santos ((STO)) is considered to be one of the most cost competitive proposed LNG projects globally, with break-even prices around US$7.50-8.00/mmbtu.

Deutsche Bank acknowledges the rising level of onshore drilling activity is beginning to call into question the assumption total US liquids production will fall again in 2017, on the back of a decrease in tight oil production, offset by natural gas liquids growth and Gulf of Mexico offshore production growth.

Several factors that could sustain these assumptions, if growth in drilling activity does not accelerate, include rig counts, which have lagged the rising price of oil and should mirror the sluggish pace of last year after oil prices rose 42%. Deutsche Bank also observes, even when drilling activity has risen quickly in the past, declines in productivity have been observed.

The broker expects drilling activity will stop rising in 2017 as the West Texas Intermediate price of US$53/bbl is reached, as this threshold makes economic sense only in a portion of the US onshore tight oil resource.

Coal

The price surge of recent weeks aside, Citi still expects long-term thermal coal prices to fall to the mid US$50/t range with metallurgical coal prices in the high US$80/t range as seaborne demand declines structurally in the years to come.

That said, the broker suspects seaborne thermal coal demand may remain more robust than previously expected because of production cuts and resilient consumption. Citi expects the structural shift out of coal could be slow, as demand won't decline as rapidly as some expect. Natural gas prices ex US still do not compete effectively with coal on an economic basis.

For now, cost deflation, partly driven by aggressive producer cost cutting, may mean the days of US$100/t thermal coal are over, while a more robust cost curve could now provide support in the mid US$50/t region.

Citi expects coking (met) coal prices to remain range bound in the near term, averaging US$87/t in 2016, as improved Chinese import demand, in the wake of domestic production cuts, is met primarily by Australian production growth.

Nickel

ANZ Bank analysts observe the threat from the Philippines in terms of a broad review of its nickel operations, involving nearly a quarter of the world's nickel mine supply and key supply to the Chinese nickel pig iron industry, has come just as the market moves into substantial deficit.

Already Berong Mining and Benguet Coro have been forced to close operations, which make up 7% of the country's nickel production. While the likelihood of the Filipino nickel industry being completely shut down is low, the amount of supply sources at risk warrants a substantial premium. Hence, the analysts expect nickel prices to push towards US$12,000/t.
 

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