Commodities | Feb 28 2013
By Andrew Nelson
Analysts at Deutsche Bank note there is work ongoing to expand the coal-carrying rail capacity in China to at least somewhat address supply bottlenecks. This is expected to result in better utilisation levels, meaning the prospect of increased domestic coal production.
The broker notes that current rail capacity upgrade along with the construction of new routes from the main producing regions of Inner Mongolia, Shanxi and Xinjiang will likely result in an extra of 335mtpa of supply by 2015 and a further 300mtpa by 2020.
Increased Chinese domestic production would lead to decreased import demand. Given Chinese imports of internationally traded coal at coastal ports have increased at a rate of 35% annually in the last three years, the development could remove an important growth leg from under Australian exporters.
The good thermal coal news out of China comes from Macquarie, the broker noting the latest trade data show that January was the third month in a row that China imported more than 200Mt. It’s hard to gauge how positive this trend is, though, given Macquarie believes the huge increase in Chinese import volumes is all about an oversupplied seaborne market, so is not really indicative of better or worse Chinese demand.
Intangibles aside, the trade data do show that both Australia and Indonesia, the two largest seaborne thermal producers in the world, were exporting record volumes of thermal coal in Q4 2012. However, Chinese prices do suggest that Australian producers are selling at heavy discounts to the FOB Newcastle price.
What Macquarie does find surprising is that Chinese traders haven’t as yet started to displace Australian coal imports with cheaper domestic production. The broker notes FOB Newcastle prices for 6000NAR coal averaged US$92/t in December, or a US$10 premium to Chinese domestic coal on an adjusted basis. The broker sees this development as supporting the view that Australian producers are discounting a little, especially given off-spec coal sales increasing as a percentage of overall Australian supply.
Still, the current trends have Macquarie thinking that China will continue to provide strong support for Newcastle prices below US$90/t FOB given the marginal cost of China’s shipped coal is around US$95-US$100/t. Thus, should see seaborne prices fall below this level; China is likely to be quick in absorbing the surplus.
Commodity analysts at ANZ Bank are turning positive again on iron ore, noting the recent 9% pullback in iron ore swaps below US$140/t has provided a good entry point for longer term iron ore trade. While the bank admits news from China about a curb on property development has put a fly in them ointment, traders will still look to buy the dips given the view of a generally improving Chinese outlook and as a hedge against near-term supply disruptions in Australia. Like Cyclone Rusty, to name just one.
The broker is also positive on the 2Q price prospects given the increasing strength being shown in the Chinese economy in general. This week’s soft China flash PMI is seen as a New Year holidays-influenced blip, with expectations otherwise for much improved March and April reads.
Iron ore port stocks are also lifting given inventories fell last week to a low of 67m tonnes, down 31% from a high of 96m tonnes in early September 2012. This happened at the same time spot iron China CIF prices fell US$9/t toward US$150/t from recent highs. This simply confirms the banks view that traders are buying the dips.
Ultimately, ANZ thinks spot prices will range trade between US$130-150/t for 2013.
Conversely, analysts at Macquarie note that sentiment has now started to wobble a bit, although the broker sees very little potential for a sequential increase in seaborne iron ore supply, at least over the next 3-6 months. The problem is that at current prices, there is a significant amount of Chinese domestic iron ore supply that is incentivised to produce and not currently operating.
The broker expects this material to start making its way back to the market from March, once the winter passes and all the labour has returned post the new year. To absorb this added production, the broker thinks pig iron production across iron ore importing regions such as China, Europe, Japan, Korea, Taiwan will need to increase by around 6.5%-7%, from January levels into the second quarter.
It may seem like a lot, but the broker believes this isn’t too much to forecast given that over recent years production over this period has increased by between 5% and 10%.
Looking towards the end of the year, the broker sees a substantial increase in the volume of seaborne iron ore supply, with run rates expected to be roughly 100mtpa higher toward the end of 2013 than they were in 2012. The broker sees this as having a considerable impact on the he volume of high-cost Chinese domestic iron ore required, thus reducing cost support for prices.
This leads Macquarie to expect another round of tightening measures, which will see mills looking to reduce raw materials inventory in a push to lower risks. With this happening just as new supply is coming to market, purchasing managers will grow confident they can secure material easily and can thus afford to cut inventory to absolute minimum levels. This could see iron ore can prices utterly collapse, falling to way below cost support for a short period.
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