Material Matters: Industrial Metals, Iron Ore, Thermal Coal and Oil

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-Citi favours copper, nickel, PGMs
-No sign of large iron ore producer cuts
-Thermal coal inventories still elevated
-Oz oil producers likely to defer FIDs
-Dividend cuts probable too
 

By Eva Brocklehurst

Industrial Metals

The most significant indicator for industrial commodity demand is, of course, the pace of growth in China and Citi notes this pace has slipped from double into single digits over 2014 and with it the commodity intensity of the Chinese economy shifts lower. The broker expects Chinese commodity demand to weaken further in the first half of 2015, with the prospects for January and February considered especially poor. It is not all negative. Citi expects higher copper consumption rates in 2015 as a result of postponed projects from the state electricity grid coming to the fore, as well as a rise in residential and commercial construction activity emanating from government measures to support the real estate market.

Commercial construction should boost Chinese domestic nickel usage, mitigating expected stainless steel export weakness. Citi is relatively bullish on nickel, copper, palladium and platinum with in-line views on silver, gold, zinc and aluminium and a bearish view on iron ore.

Iron Ore

JP Morgan has downgraded iron ore price forecasts further, as the introduction of more capacity and lack of typical seasonal re-stocking puts the market under pressure. Low cost producers are continuing to bring on more capacity, while demand growth is moderating. Iron ore prices typically increase at the end of the calendar year as Chinese steel mills build stocks ahead of the winter as this requires some domestic iron ore production to shut down. This situation has not occurred in 2014, with buyers apparently unconcerned about availability. The broker estimates around 126mtpa of new capacity was introduced by the big producers in 2014, or around 6% of global supply.

A further 341mtpa is expected to come on line in the next five years from Vale, Rio Tinto ((RIO)), BHP Billiton ((BHP)), Fortescue Metals ((FMG)) and Hancock Prospecting. Hence, JP Morgan suspects oversupply will deepen in the near term. At this point there are no signs these producers will cut back on capacity growth targets. JP Morgan has reduced 2015 iron ore price forecasts to US$67/tonne and long-term price forecasts to US$75/t.

Thermal Coal

China's annual conference on long-term thermal coal contract negotiations has just been held in Xi'an. Terms will not be firmed up until the end of this year but the conference has signalled to Macquarie the climax of Chinese government and producer attempts to push up coal prices from the trough in late August. This government support and potential demand upside are positives but elevated inventories and untested production discipline could work to pressure prices. With prices below RMB550/t, government policy is the dominant factor in Macquarie's estimation, but once prices reach this level underlying fundamentals are likely to reassert.

Macquarie considers Chinese government policy seems more about preventing a deterioration than pursuing upside in the price. In order to boost prices the Chinese government has been implementing measures to restrict supply, vowing to bring down both domestic production and imports. Macquarie suspects producer discipline is unlikely to hold up in the face of rising prices but for now, as the production cuts have not been in place for long they are still seen as effective.

Another key issue is the housing market. Power consumption, a core component of thermal coal demand, is dependent on the industrial and construction sectors. A pick up in housing benefits thermal coal not only through higher power consumption but also through higher consumption of cement. Macquarie observes signs that recent interest rate cuts and the government's tinkering with property policy are providing the positive factors necessary for China's housing market.

Energy

Australia's energy producers are likely to re-visit their 2015 capital budgets in the near term and Goldman Sachs expects cost discipline tools will be sharpened, with deferrals and head count reductions to free up cash flow. The broker believes Oil Search ((OSH)) and Woodside Petroleum ((WPL)) have the flexibility and can defer Final Investment Decisions and, while Santos ((STO)) must complete the Cooper Basin and GLNG project, there should be still room to cut costs. Goldman pushes back the FID estimate for the Browse FLNG to 2018 and suspects Woodside could prioritise making a strategic acquisition in 2015. Santos is challenged on its credit metrics at spot oil and the broker expects discretionary capex cuts and an underwriting of the 2015 dividend reinvestment plan. Oil Search and partners are expected to take FID on a T3 expansion into 2016/17.

All three major companies are likely to consider cutting dividends, in Goldman's opinion.
 

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