Commodities | Oct 29 2013
–US thermal coal exports at the ready
-Japan's thermal demand to plateau
-Canada's crude bottlenecks easing
-Aluminium in line for more pain
-Zircon picks up but subdued
By Eva Brocklehurst
The mood at the recent thermal coal confab in Berlin was not as bearish as one might have expected. Macquarie reports there were calls for a rally in short-term prices, as demand is seen improving along with some potential supply disruptions. On the other hand, fears of oversupply meant some think prices may have to go lower in the short run to force out the higher cost suppliers in the US and Indonesia. Macquarie also noted a lot of complaints about onerous take-or-pay agreements in rail and ports in Australia, which has kept the Australian supply in the market. The largest concerns were centred on cost cutting in China and the reduction in infrastructure bottlenecks, which may reduce the need for imports later in the decade.
The US is the swing supplier in the thermal coal market and Macquarie thinks the price at which US material starts re-entering Europe is still around US$85-90/t. Unprofitable US operations were idled rather than shut or still shipped coal to generate cash flow alongside metallurgical operations. Macquarie remains of the view that volume is ready to re-enter the international market when conditions are favourable. Despite this belief, US thermal coal export forecasts have been revised down for next year. The analysts expect exports to be around 4mt lower than 2013, which is forecast to come in at around 40mt, 4mt down on last year.
Macquarie ponders the implication on seaborne market pricing if China removes its coal export tax. The talk is of coal flows from north China being re-directed from the domestic market towards Japan, Korea and Taiwan, if the policy is enacted. Macquarie thinks export demand would only be for higher value Chinese product, thus is unlikely to be stockpiled or surplus material. Overall, Macquarie does not think the removal of the tax will have a major market impact. Feedback from China suggests that producers there are more worried about import competition than trying to export.
Continuing on the thermal coal theme, Macquarie notes Japanese demand has been very strong this year. The analysts believe this strength is unsustainable because of a lack of new capacity. Japan's thermal coal imports through the first eight months of 2013 were up 4% with consumption by utilities particularly strong. The primary reason is that low prices have made coal-fired generation the most attractive option in the absence of nuclear power. Macquarie takes a further look at why imports were up just 4% when consumption was up 14.5%. This is not because of large de-stocking. The answer is that the 10 regional utilities, while accounting for around just 40% of Japan's thermal coal consumption, have more favourable fundamentals than the overall coal demand suggests. Japan's two east coast utilities have led the consumption increase, up 93%, while the largest consumer, J-Power, has actually contracted over the same period.
Although the strong summer demand has come to an end, thermal dependency will remain significant after the only two operating nuclear units were taken off line in September for maintenance. Macquarie suspects there will be no nuclear generation in the fourth quarter and thermal coal will remain the fuel of choice over this period. Despite this, Macquarie thinks coal consumption will plateau in 2014 as capacity utilisation is already high and there's no new developments coming on line until the end of the decade.
Western Canada's crude oil has experienced large discounts compared with global pricing as robust oil sands production growth has overwhelmed the legacy infrastructure. Until now, the growth in Canadian production has been focused towards the US Midwest but, because of bottlenecks in the south, this market has received only a small quantity. This is set to change. At the end of June the newly built, expanded or reversed pipelines have allowed evacuation of a crude build-up in the US Midwest and the WTI price has rallied, but Canada's supply networks remained strewn with bottlenecks. Citi notes plans are underway for many pipelines, whether it be up and down the US or out to Canada's eastern shore.
Moreover, from 2018 there are options that could open up Canadian crude access to east Asia. What it all means is that the difficulties faced by Canadian producers should ease as realised prices improve significantly from the second half of 2014 onwards. The Keystone XL pipeline in the US is a major stumbling block and, if it doesn't receive approval, Citi thinks the pressure to get supply away would only last for two to three years, after which Canada's Energy East pipeline should allow more diverse destinations away from the US to which Canadian oil producers have been so captive. With the prospects for this scenario being unleashed, the differentials in price are improving and further projects are likely to be given the go ahead, keeping supply growth robust.
Aluminium is in line for more pain before a cure is found. This is the prognosis from Deutsche Bank. Prices should stay weak near term and enforce further discipline from producers. Having said this, the analysts think the outlook is starting to improve. The update on the closure of RUSAL's capacity went further than Deutsche Bank expected and, factoring this into demand assessments, means the market should be in just modest surplus over the next three years. Alcoa has not given a detailed impact assessment about the pot instability at Ma'aden, but the analysts have trimmed forecasts modestly for 2013 and 2014.
The aluminium market outside of China is experiencing a modestly increasing deficit but the Chinese market is still in a substantial surplus, with that surplus being exported. Although aluminium prices have increased by 4% since the middle of September, Deutsche Bank is sceptical of the view that the flat price will compensate for any declines in the physical premium without further production cuts. The correlation between aluminium prices and physical premium has been very low over the past two years. The analysts expect to see prices drift lower into the first half of 2014, which will trigger a final wave of plant closures before price support is found.
Macquarie has taken the pulse of the Chinese zircon market to gain some idea of the near-term term direction for prices. Chinese tile manufacturing capacity utilisation rates are subdued, with just 15% of respondents reporting 100% utilisation, down from 80% at the start of 2012. That said, plants are running harder than they were at the start of 2013. The reason for the subdued rates is that end market demand is still weak. Tile inventory levels continue to build, albeit at a slower rate than reported in February.
The pick up in tile products containing zircon coincides with lower input prices. Zircon-bearing tile production increased in the September quarter with 60% of respondents indicating more than 50% of product contained zircon, up from 45% at the start of 2013.Tile producers' zircon inventories declined in the September quarter relative to prior surveys. Manufacturers consider current inventory levels as normal, indicating there may have been a shift to lower stocks given the relative drawing down reported through 2013. The outlook for zircon purchases is soft over the next three months as 40% of manufacturers polled anticipate purchases will decrease towards year end, despite 50% of respondents reporting decreased zircon inventory.
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