Material Matters: Oz Labour Shortages, Iron Ore, Zircon And Oil

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-Miners need to address labour issues
-Iron ore price volatility returns
-Zircon demand set to improve
-Oil opportunity in dips
 

By Eva Brocklehurst

A shortage of labour is making life hard for miners. Volume growth has become the key to earnings as price gains flatten or stagnate. Goldman Sachs believes management has to raise productivity and control costs in this environment and the labour shortage will make this a challenge.

The practice of recruiting workers from large population centres to the middle of nowhere and providing travel and accommodation is growing. This fly-in fly-out, or FIFO, has become a sensitive topic in regional Australia, Goldman contends. FIFO can often upset the precarious social and economic balance in remote regions. FIFO also imposes additional costs on the mining sector in terms of airfares, accommodation and pay rates.

Goldman believes, in an environment of lower commodity prices and greater emphasis on cost control, these labour challenges will impact costs and productivity, particularly in iron ore and metallurgical coal. Management needs to reduce the risk of industrial action by addressing the misalignment of interests between FIFO and resident workers, and reduce turnover rates. In the end, the broker believes, management will have to find ways to reduce the reliance on FIFO and attract workers and their families to these regions.

With an eye on this added risk, Goldman notes volatility has returned to the iron ore market. Spot prices gained US$4.75/t after the Chinese New Year then lost US$8.50/t as sentiment turned on concerns about the Chinese property sector, where recently taxes have been added to reduce speculation. Port inventories for iron ore have increased by two million tonnes since early February and this suggests to the broker that the next leg of a restocking cycle may be under way.

Meanwhile, metallurgical coal prices have softened modestly in the run-up to the contract negotiations. Goldman believes spot activity will be subdued until settlements are announced. Prices are expected to recover in 2013 and in the second half Goldman expects US$185/t. On the thermal coal front, supply from Colombia remains constrained by industrial action and export restrictions, while a major fire has caused the indefinite closure of a large coal mine in the UK. This should not make much of a dent in demand as the European market appears well supplied and the broker finds the Atlantic/Pacific basin spread is largely unchanged.

JP Morgan has reviewed zircon price forecasts and reduced earnings estimates for major global producer, Iluka Resources ((ILU)), mainly because the broker previously underestimated the extent of de-stocking in 2012. Market conditions appear to be improving and a pick-up in prices could accelerate short covering in Iluka stock. The broker believes a return to long-run demand trends, and the largest suppliers curtailing production, will keep the market in tight supply over the medium term. Near-term zircon price forecasts have been lowered to US$1,438/t in 2013 and US$1,800/t in 2014. The zircon spot price is now US$1,275/t, down more than 50% from US$2,625/t in September 2012. Demand remains weak, highlighted by commentary not only from the producers but also traders. What may signal a turnaround is that Iluka's customer inquiries have been the highest in several months.

While de-stocking could be ending, JP Morgan also notes some in the market have focused on the potential impact of substituting zircon in Chinese tile manufacturing. This is only speculation at this stage, as Iluka has seen no concrete evidence of a structural change in the market. According to managing director David Robb, the company conducted detailed sampling of tiles manufactured in China to find out the amount of zircon they contained. The results showed a wide disparity between regions but no evidence of substitution. According to Iluka, the majority of structural changes that occurred in the zircon market were absorbed in 2011. For JP Morgan this implies the fall in demand in 2012 was more cyclical than structural. So, demand is expected to return to the long-term trend growth rate of around 2.5-3.0% but supply curtailments are likely to keep the market in tight supply. Moreover, it's the actions by producers that will likely keep the market in tight supply in the near-term and result in higher prices in 2013.

ANZ has found a short-term opportunity in being long Brent crude from a correction in oil markets. Indicators are pointing to a peak in the current cycle but the analysts expect the dip to be small and a seasonal uptick in oil demand in the second quarter should trigger a rebound in prices. Recent supply outages in the Middle East/North Africa and North Sea also support a price disruption premium. The analysts believe spot levels of US$110/barrel are a good entry point, with price target of US$118/barrel over the next two months. As major central banks should sustain accommodative policy this will offset any drag from concerns over US fiscal tightening.

A more resilient equity market also suggests oil prices are cheap compared with equities. While investment funds have been liquidating long positions near term, ANZ analysts suspect improving seasonal demand and economic data could be a catalyst for a short-covering rally. Prices should also improve as China builds stockpiles ahead of the seasonal pick up which occurs between June and September. There's another point. Government mandates to close Chinese refineries with capacity of less than 40,000 barrels/day, and the granting of licences to import crude oil supplies direct from the seaborne market, should underpin demand.

On the supply side, disruptions have grown in frequency in Libya.The analysts note, like Iraq, oil production in Libya still has not rebounded to pre-revolution levels of 1.6m barrels/day, with production closer to 1.0m barrels/day. Other OPEC countries have also underperformed production targets including Iraq, Nigeria and Angola. In addition, the analysts expect Saudi Arabia's supply tightening response and ongoing production issues in the North Sea will keep higher supplies elsewhere in check.
 

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