Material Matters: Thermal Coal, Steel, Base Metals

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 – Thermal coal prices likely to be capped
 – Deutsche Bank reviews Australian steel sector results
 – Citi updates views on non-ferrous metals
 – Barclays reviews copper and nickel market outlooks

By Chris Shaw

US thermal coal exports fell by 6.8% in month-on-month terms in June but were up 125% in year-on-year terms to 5.3 million tonnes. Commonwealth Bank notes this is the second highest level of thermal coal exports in recent history.

The strength in exports is being driven by the fact domestic US utilities continue to switch to natural gas-fired power stations. This reflects not only cheaper gas prices as well as pressure being applied to the power industry to find cleaner fuels.

CBA suggests the month-on-month decline in US thermal coal exports was due to stronger US power demand from a warmer than average summer. Thermal coal exports from the US should remain high in the next couple of months, CBA seeing this as driving seaborne coal supply higher.

Given such an outlook, CBA expects thermal coal prices will be capped heading into the northern hemisphere autumn.

Standard Bank notes thermal coal stockpiles at Chinese pots have declined significantly in recent weeks, though this decline has been from very high levels. At the same time as Chinese port stocks of thermal coal have declined prices have moved slightly higher, rising from US$86 per tonne in June to US$91 per tonne in mid-August.

With total electricity production growth in China weak at present and with hydro accounting for an increased proportion of the electricity being generated, Standard Bank suggests the recent pick up in thermal coal prices cannot be due to rising demand.

For Standard Bank the price gains reflect supply issues in Columbia and potentially some short-covering by traders. The demand outlook remains weak and this will cap upside for thermal coal prices in the view of Standard Bank, with prices for API4 coal expected to approach US$80 per tonne.

Further on the bulks, Deutsche Bank has reviewed profit reporting season for the Australian steel sector. The review highlighted several key themes, including ongoing pressure on both volumes and manufacturing and distribution earnings, the significant level of restructuring underway to improve cost positions and the focus on balance sheet strength.

Following the sector's profit results, Deutsche notes forecasts for steel sector earnings for FY13 were cut by 15% on average. Sims Metal Management ((SGM)) enjoyed the smallest average cut at around 5%, while the largest was the 30% cut to forecasts for BlueScope ((BSL)). 

Post results, Deutsche Bank continues to favour Sims and BlueScope within the sector, rating both as a Buy. For Sims the attraction is leverage to a recovery in the US economy and additional benefits from a cost out program being undertaken.

BlueScope also offers leverage but this is weighted more to a recovery in the Australian economy, which improved balance sheet strength indicated in the result should attract renewed investor focus in the view of Deutsche.

Arrium ((ARI)) is rated as a Hold by Deutsche Bank, this as iron ore is a major driver of earnings at present and the stock continues to be the most highly geared in the sector. While expected cost cutting is a positive, forex moves will continue to impact on earnings and sensitivity to iron ore prices is a further concern. 

As a means of comparison, Sentiment Indicator readings for the three stocks according to the FNArena database stand at 0.8 for Arrium and 0.4 for BlueScope and Sims. 

Moving to the non-ferrous metals market, Citi suggests fundamentals should improve in the final quarter of this year but any pick-up may prove to be a modest one as it will be driven primarily by the restocking cycle.

Citi doesn't expect strong stimulus from China as policy is more likely to be aimed at consolidating domestic demand, so facilitating restocking later on. Copper is most likely to benefit from a restocking cycle in the view of Citi, this assuming copper demand normalises after summer shutdowns of manufacturing plants have run their course. 

The one uncertainty for copper relates to inventory currently held in bonded warehouses in China, as the risk is this material may be used to meet any increase in demand. Citi expects this risk will mitigate in coming months given the expectation of higher rate financing and other requirements for bonded warehouse stocks.

Domestic supply trends will continue to generate tougher market conditions for zinc and aluminium. Both metals have less attractive market fundamentals and so prices may struggle in Citi's view, this given the ongoing ramp-up of new smelting capacity in aluminium and solid growth in Chinese domestic supply of zinc.

In terms of price forecasts, Citi expects copper will average US$8,200 per tonne in 2013, which compares favourably to recent prices of just under US$7.500 per tonne. For aluminium, prices are expected to average US$2,115 per tonne next year against recent levels of around US$1,800 per tonne, while zinc forecasts stand at an average of US$2,300 per tonne next year against prices of around US$1,800 per tonne now.

Looking more closely at copper, Barclays notes International Copper Study Group (ICSG) data for May was surprising in that it showed global mine production was strong but consumption was weak. 

Total production for the month came in 44,000 tonnes higher than Barclays had forecast, which implies some upside risk to the full year mine supply estimate of 16.3 million tonnes. This is despite recent producer statements indicating the need to moderate the degree of improvement in copper output expected in the current half year.

This reflects supply losses from technical issues and lower ore grades being processed. Longer-term Barclays continues to expect new mine start-ups will deliver strong copper mine supply growth, though much of this growth will come from markets with greater political and operational risks. 

Greenfields projects are forecast to deliver almost all supply growth in 2014, Barclays noting these projects will need to not only grow output but offset the losses experienced by more established projects. 

On the demand side, Barclays notes the ICSG data showed ex-China copper usage was weaker than expected and although the pace of contraction shown in May is not expected to be sustained in coming months, there is some downside risk for 2H consumption expectations. Overall, Barclays suggests the ICSG data for May supports a narrowing of this year's refined copper market deficit.

While nickel has for some time been regarded as having the weakest fundamentals of all the base metals, Barclays Capital notes following recent price weakness the are questions being asked as to the potential for any further downside in prices.

Adding weight to the suggestion nickel price downside may be limited is eroding supply expectations. Nickel pig iron output is being cut back and some key mines continue to outperform, to the extent Barclays has revised down its forecast 2H12 market surplus of refined nickel to 32,000 tonnes from 45,000 tonnes in June and 53,000 tonnes in February.

While nickel supply is tightening, Barclays notes LME prices are yet to react as sustained weakness in the Chinese stainless steel sector remains an issue. As nickel pig iron production has declined so too has stainless steel output, though Barclays sees scope for a seasonal rebound in activity levels from September.

For Barclays, the shifts in the nickel market fundamentals support a stabilising in prices around the US$16,000 per tonne level. Any sustained rebound would require a pick-up in stainless steel market conditions.

 
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