Material Matters: Citi Lifts Iron Ore Forecasts, Plus NatGas, Aluminium and Zinc

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

By Chris Shaw

Citi has found some good news for the iron ore market, noting delays to planned supply increases and higher steel production forecasts have pushed back the timing of an expected supply surplus in the global market.

The surplus is now expected to bite in 2014-15 rather than 2013-14 as Citi had previously expected, its forecasts calling for a surplus in 2015 of 180 million tonnes. This equates to around 14% of the global market.

What will eventually kill the golden goose that is current iron ore prices, according to Citi, are the economics of projects, as at around three years the average payback on an iron ore project at present is shorter than for most other commodities.

Australian producers such as BHP Billiton ((BHP)), Rio Tinto ((RIO)) and Fortescue ((FMG)) are currently ramping up production and Citi expects this will eventually force out high cost Chinese production. It will also lead to an oversupply in the market however, so Citi expects prices will eventually return to levels around US$60 per tonne.

To reflect the changes to timing of the likely market surplus, Citi has revised its iron ore price forecasts in both spot and contract terms. For the final quarter of this year the broker now expects spot prices to average US$146 per tonne and contract prices US$132 per tonne, both up from previous forecasts of US$130 and US$113 per tonne respectively.

For 2011 and 2012 prices are expected to remain fairly steady, Citi's spot price forecasts now standing at US$145 per tonne in both years compared to previous estimates of US$130 per tonne in 2011 and US$120 per tonne in 2012. Contract price forecasts for the two years are US$135 per tonne and US$128 per tonne for 2011 and 2012, up from US$113 and US$103 per tonne respectively.

The changes in forecasts become more significant in percentage terms from 2013, Citi's spot prices increasing to US$130 per tonne that year and US$100 per tonne in 2014 from US$90 and US$80 per tonne respectively. Forecasts for contract prices have risen from US$73 per tonne in 2013 and US$63 per tonne in 2014 to US$113 and US$83 per tonne respectively.

There are no changes to Citi's iron ore forecasts in 2015, which stand at US$80 per tonne for spot prices and US$69 per tonne for contract prices. There are also no changes to Citi's ratings for the major Australian iron ore plays, the broker retaining Buy ratings on BHP, Rio Tinto and Fortescue.

Other Australian-listed companies with exposure to the iron ore market include Grange Resources ((GRR)), Mount Gibson ((MGX)), Murchison Metals ((MMX)), Atlas Iron ((AGO)), Gindalbie Metals ((GBG)), Sundance Resources ((SDL)), Australasian Resources ((ARH)), Brockman Resources ((BRM)), Sphere Minerals ((SPH)), BC Iron ((BCI)), Flinders Mines ((FMS)), Alkane Resources ((ALK)), Territory Resources ((TTY)), Strike Resources ((SRK)), Admiralty Resources ((ADY)), Western Plains Resources ((WPG)), Indo Mines ((IDO)) and Carnavale Resources ((CAV)).

Turning to natural gas, Citi notes US LNG imports have fallen in a trend counter to the typical spring/summer up-tick. Fourth quarter imports are expected to improve slightly but to remain at subdued levels.

To reflect this, Citi has cut its full year US LNG import estimate to 1.2Bcd/d from 1.7Bcf/d previously, with 2011 expected to show a modest rise to around 1.5Bcf/d. This partly reflects stronger global LNG demand as Citi points out the US typically acts as the reserve market for absorbing LNG once demand is sated elsewhere.

The fact the global LNG supply/demand balance has tightening this year means there has been less excess for the US to absorb, though Citi does suggest some factors tightening the market recently are non-recurring in nature.

There should still be some unpredictable factors impacting on the global LNG market next year, which supports Citi's view US imports are likely to experience only a modest up-tick in 2011.

Worries continue to circle the US economy, the latest stemming from weak new home sales for July that were at a record low. Durable goods orders also fell by the most in 18 months. Goldman Sachs notes such data continue to chip away at investor sentiment with respect to commodities, while some increases in LME inventories for the likes of nickel at present are also not helping prices.

Aluminium prices weakened last week despite a modest draw on stocks as news emerged China was a substantial net exporter of the metal in July. This supports the analysis of Goldman Sachs that China continues to reduce its dependence on imported alumina by raising domestic production and importing more bauxite for refining.

This means China's dependence on imported alumina has fallen from around 46% in 2004 to about 14% in 2010. By comparison, Goldman Sachs notes China's overall dependence for raw materials has not changed nearly as much, standing at about 52% in 2010 against 49% in 2004.

RBS notes the northern summer vacation period is coming to an end in the coming week, meaning a return to what remains an uncertain market for commodities generally. While underlying supply and demand fundamentals have often been overwhelmed by broader market risk this year, though in general the precious metals have outperformed the base metals.

Zinc has been the worst performer of the base metals group, RBS putting this down to worsening fundamentals for the metal. While demand rose in the first half by 20% in year-on-year terms to 6.065 million tonnes, refined output also rose 17% to 6.241 million tonnes.

Zinc inventories on the London metals Exchange have also risen by 27% since the end of 2009 and they are now at their highest level since January of 2005. If Shanghai and total exchange stocks are included, zinc inventories are at their highest level since April of 1995.

The last time LME inventories were this high RBS notes zinc prices were around US$1,245 per tonne, which equates to around US$056 per pound. This is about 40% lower than the current price in nominal terms, which offers a clear reason why zinc prices have struggled of late in the broker's view.

Click to view our Glossary of Financial Terms