Commodities | Jun 12 2015
-Disruptions pose LNG upside risk
-Will steel mills race to re-stock iron ore?
-Gradual recovery best for met coal price
-Copper processing costs support miners
-Does China need imported alumina?
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By Eva Brocklehurst
LNG
Spot prices for LNG have been affected by lower oil prices and weak demand. While high inventories and a surge in Australian production are likely to provide headwinds, ANZ analysts suspect supply disruptions will present upside risk for prices in the next 12 months. This is particularly the case if Yemeni production is curtailed for longer than expected. Yemen exported around 6.5-7.0mtpa to Asian customers over the past two years and the recent force majeure, because of the conflict, has halted these exports. The analysts assume exports will resume by 2016. Near term, demand in the main markets of Japan and South Korea appears weak and should weigh on prices over the northern summer, in the analysts’ view.
Iron Ore
The recent rally is on borrowed time. Goldman Sachs observes the industry continues to expand with the building of new mines while operating existing mines more efficiently. Spot prices are currently slightly above the broker’s estimate of marginal production cost, at US$60/t. Hence, prices must fall below the cash cost of marginal producers in order to force the closures that are required to balance the market. Macquarie also suspects the deficit that is currently the case in iron ore is unlikely to last. A sharp draw on inventories in May suggests the market is now looking tight but supply will build again in the second half of 2015.
Macquarie’s base case is that this will be negative for prices. Nevertheless, as was the case in 2013, mills may soak up the excess supply in a substantial re-stocking which could keep prices supported at surprisingly strong levels and the broker warns of the risk of an upside surprise if the right conditions prevail. Macquarie concentrates on the “contestable market” – seaborne iron ore, Chinese domestic iron ore and small volumes which travel overland to China. Spreads between demand and supply growth in iron ore are most pronounced in China.
The key question is whether the Chinese mills wish to re-stock or remain content to maintain inventories at low levels. Should mills get the idea that prices will rise more in more sustainable fashion and the availability of supply with low lead times is going down, re-stocking should occur.
Credit Suisse points out that Chinese steel mills cannot afford to pay more than US$60/t for iron ore. Affordability is deteriorating as steel prices slide further. The latest weekly Mysteel profitability survey suggests only 39% of China’s steel mills are profitable. Still, the broker notes port stocks are falling and mills are becoming nervous about supply. The situation is not considered critical but, unless cargoes increase in the next few weeks, the issue will heighten in importance.
Credit Suisse also cites the 2013 experience but does not expect a similar outcome this time because, if port stocks dry up, mills have no cash to bid up prices. Finance for unprofitable operations is becoming harder to obtain and the broker suspects that instead, demand will simply drop for iron ore as blast furnaces curtail output.
Metallurgical Coal
Cuts to metallurgical (coking) coal supply continue, with the most recent curtailment announced by Peabody at its North Goonyella mine in Queensland. Macquarie notes this reflects the steep decline seen in prices this year, with the spot premium hard coking coal down 21% in the year to date. The broker expects more reductions to materialise over the rest of this year. If this occurs it would help in establishing a price floor but oversupply is just one of the problems.
Macquarie observe the other is substantial cost deflation brought on by lower oil prices and a stronger US dollar. Barring a large reversal in oil and FX, the best case scenario for US dollar denominated metallurgical coal prices is likely to be a gradual recovery next year, so idled capacity does not return in a hurry.
Copper
Macquarie observes there is broad consensus the copper market will be inadequately supplied towards the end of this decade, as development of all but the most advanced projects has stalled since 2012. Macquarie takes a look at the largest copper miners on an equity-share-of-output basis, and perceives a shift in rankings between now and 2020. The to 10 copper miners are expected to produce just under half of global copper mine output, before disruptions, this year. The top 20 would take this share to 61.6%. This proportion remains relatively steady over the next five years.
Morgan Stanley observes copper concentrate processing costs are down 20% in the year to date because of disruptions. This in turn should weigh on smelter revenue and constrain supply. Spot treatment and refining charges – paid to smelters by miners that process their concentrates – are well below the corresponding annual contract rate. The broker observes this is good for the miners and bad for the smelters. investment in smelting capacity is set to slow and maintenance programs will be brought forward, maybe even shut. In turn this may reduce the amount of metal flowing to the market and offer some support to the global copper price.
Still, the other signal Morgan Stanley observes is that trade in copper is subdued. Physical premiums are soft in all key regions and there  is an emerging contango – where people are willing to pay more for a commodity in the future than the spot price – which is consistent with weakness. Custom copper concentrate supply is set to expand further in 2016-17, with the start up of Las Bambas in mid 2016 and higher production expected from Grasberg in the next two years. All up, Morgan Stanley suspects, along with ongoing tightness in copper scrap supply, that smelter demand growth will outpace global concentrate supply.
Alumina
Of the entire aluminium value chain, alumina pricing has held up the best this year, amid the market turmoil. Macquarie notes the foundations of the outperformance appear to be now coming under pressure, including a fall in the domestic price in China. A near-term price correction appears an increasing possibility. That said, the broker does not believe the price will fall aggressively. The main element, the London Metal Exchange price, is under pressure and as a result, China alumina is now trading at 23% of the LME three-month price, well above historical norms.
The main issue, in Macquarie’s view, is whether China needs, or wants, imported alumina. The broker continues to expects the country’s self sufficiency ratio will climb, as alumina capacity is built and bauxite continues to be purchased. Over coming years, China’s alumina capacity utilisation is expected to remain around 80-85%. To increase imports to China, global suppliers will have to start cutting prices. China’s cost structure will become crucial to setting the global price and, in the short term, Macquarie expects this to provide a floor. In the medium term, support will need to come from upward pressure on bauxite prices.
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