Material Matters: Ongoing Positives For Coal, Copper, Gold, Crude Oil

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By Chris Shaw

Coal is centre stage on commodity markets today as ongoing wet weather has forced a number of Australian producers to declare force majeure thanks to flooding of their mining pits. Force majeure clauses excuse a party from liability if an unforseen event beyond the control of that party prevents it from meeting its contractual obligations. It is for this reason that force majeure clauses are often loosely translated as "an act from God".

Those most impacted include Macarthur Coal ((MCC)) and Aquila Resources ((AQA)), with Credit Suisse estimating around nine million tonnes of annual production has been affected.

The news creates some uncertainty, Credit Suisse pointing out it is not yet clear for how long operations will be impacted. The final impact could be relatively minor as production could be re-started within a week, while the broker notes the other end of the spectrum is further extreme bad weather, that in 2008 caused BHP Billiton's ((BHP)) production to fall by 30%.

In the view of Credit Suisse, the uncertainty with respect to production means coal pricing remains unsettled, especially for PCI and semi-soft coal. The broker suggests the non-producing and non-Queensland based metallurgical coal stocks are the best positioned to benefit if the poor weather continues.

For Credit Suisse this implies the best-placed companies are Aston Resources ((AZT)), Riversdale Mining ((RIV)), Whitehaven Coal ((WHC)) and Coal and Allied ((CNA)). The broker rates Aston as Outperform, Whitehaven and Coal and Allied as Neutral and Riversdale as Underperform.

Goldman Sachs has also responded to the bad weather by cutting its production forecasts for producers such as BHP Billiton ((BHP)), Rio Tinto ((RIO)), Macarthur and Whitehaven Coal. This reflects a more cautious view with respect to production and shipments in both the current quarter and the March quarter of 2011.

Given uncertainty as to just how much production will be affected, Goldman Sachs has not adjusted its coal price forecasts at this stage. The broker does point out lower production increases the potential of a tighter market and therefore a spike higher in coal prices. Longer-term Goldman Sachs remains positive on coking coal, noting its positive view here has some positive implications for pricing for both semi-soft and PCI coal as well.

Further on coal, Citi notes European market demand has jumped higher thanks to extremely cold weather, which has pushed API2 thermal coal prices to US$144 per tonne. Demand is also expected to pick up in Asia, with forecasts predicting a colder winter in China than is usually the case.

This demand boost comes at the same time as supply problems remain in the market, with Russian supply being held back by a shortage of rail wagons and, as with Australia, heavy rains impacting on output in Colombia.

These market conditions suggest to Citi the European price rally is not over, this despite price gains of more than 15% in November. Implied freight differentials lead Citi to suggest South African prices may also get dragged higher thanks to the strength of rising European demand.

Commonwealth Bank is also positive on coal prices shorter-term, taking the view ongoing cold weather in the northern hemisphere, supply disruptions in Australia and some switching by producers able to do so should support thermal coal prices.

But not all is good in coal markets according to RBS, which notes there are reports in the market China's National Development and Reform Commission (NDRC) has ordered a freeze in 2011 thermal coal contract prices.

The goal of the move, according to RBS, would be to lower the burden on power producers given coal prices are rising faster than electricity tariffs. If the reports prove to be true, the broker sees downside risk to market estimates, as forecasts at present are for price increases of about 5%.

While coal companies could push increased volumes to the spot market, RBS suggests this may not be enough to fully offset the impact of no price gains in the coming year.

Deutsche Bank has looked more closely at the energy market, the result being increases to its oil price forecasts and cuts to natural gas estimates. For the former, improving demand and potentially lower OECD inventory cover should be supportive for prices, while for the latter the potential is for high levels of storage next spring to pressure prices lower.

Deutsche estimates oil demand growth in 2010 has risen by about 2.3mmb/d in year-on-year terms, while further growth of around 1.5mmb/d is expected in 2011. While non-OPEC supply is slowly moving higher, production discipline by OPEC members means inventories are falling.

OECD forward demand cover could fall to 57 days by the end of 2011 according to Deutsche Bank, down from a current level of 60 days. This implies OPEC spare capacity is being eroded, something Deutsche sees as supportive for prices in coming years. To reflect this, the bank has lifted its 2011 (average) price forecast to US$87.50 per barrel, up from US$80 per barrel previously.

With respect to natural gas, Deutsche Bank notes in 2009 proved reserves in the US rose by 11% to 284 trillion cubic feet, the highest level since 1971. Given US gas production continues to increase despite lower natural gas prices, the outlook is for storage to hit excessively high levels by March of next year.

Deutsche argues the only way for the market to fix current low prices is for a period of even lower prices and to reflect this it has cut its forecasts. For the first half of 2011 Deutsche's forecast now stands at US$4.25/mmBtu, down from US$4.70/mmBtu previously. The forecast of US$5.25/mmBtu in 2012 is unchanged.

With respect to base metals, Goldman Sachs suggests aluminium premiums could rise further in the short-term, this following a recent tender by India's National Aluminium Co Ltd for 9,000 tonnes of ingot at prices above LME cash levels.

Goldman Sachs also sees some positives for copper in that the market is showing signs of an uptake of cathode on contracts for 2011. To date the improvements have come from Europe and Asia,and the broker suggests the fact Codelco has left some tonnage uncontracted reflects a view the market will tighten next year.

Morgan Stanley is also bullish on copper, agreeing with the view the market is likely to tighten further in 2011. Recent negative production guidance from Rio Tinto highlights the broker's view the copper market could run a larger deficit in 2011 than is currently expected.

This suggests possible material upside to consensus market estimates for both copper and earnings for copper companies listed in Australia, which sees Morgan Stanley lift its price targets across the sector. Morgan Stanley now has a target on Ivanhoe Australia ((IVA)) of $4.26, up from $3.69, while its target for PanAust ((PNA)) increases to $0.89 from $0.69.

For Oz Minerals Morgan Stanley has lifted its price target to $1.78 from $1.46, for Equinox Minerals ((EQN)) the target increases to $6.31 from $5.05 and for Citadel Resource Group ((CGG)) the target has risen to $0.56 from $0.49.

Currently Morgan Stanley rates Ivanhoe, PanAust and Oz Minerals as Overweight, the latter two being upgraded from Equal Weight previously. Both Equinox and Citadel Resource Group are rated as Equal Weight, Equinox having been upgraded from Underweight and Citadel downgraded from Overweight.

Finally on gold, Standard Bank notes Chinese gold investment demand continues to rise at a rapid pace, with Shanghai Gold Exchange data indicating China imported 210 tonnes of gold in the first 10 months of this year. This compares to imports of 45 tonnes over the same period in 2009.

The stronger demand reflects increased jewellery and investment demand in Standard Bank's view, the former now expected to total as much as 420 tonnes this year, up from 350 tonnes in 2009. Assuming this forecast is close to correct it implies Chinese investment demand of as much as 180 million tonnes of gold in 2010, which Standard Bank notes would be a rise of 70% in year-on-year terms.

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