Commodities | Nov 02 2015
-Capital shortfall looms for east coast gas
-Tough winter ahead for steel
-Large rebound in nickel unlikely
-Demand recovery needed in copper
By Eva Brocklehurst
East Coast Gas
Credit Suisse takes a look at the capital needs of the LNG market, given funds are being pulled out of the domestic market and there is a large share of unsanctioned resources in the hands of those with no capital to invest. The broker suspects further mergers, equity and demand destruction may be needed to balance the market.
Based on the broker's assumptions of a drop in domestic demand and costs of developing new gas, the required capital needed from 2016-2020 falls short by $16.5-20.5bn. As a result the broker envisages four potential outcomes.
M&A may bring better capitalised businesses to eastern Australia, with equity raised to fund development by those retaining the assets. Also, domestic demand destruction could occur and/or LNG projects export less than contracted volumes. Lastly, gas could be brought from other regions, namely the NT pipeline.
Competition regulator, the ACCC, may be looking at whether there is adequate competition in the market but Credit Suisse maintains a market needs to be created before worrying about whether it is orderly. The largest issue, in the broker's view is the supply problem. The broker expects the NT pipeline will go ahead but will not provide enough gas to resolve the shortfall.
Clearly, if new volumes are not added the demand has to be removed. Ultimately, the broker believes the oil price trajectory, and whether it is mutually beneficial for both offtakers and sellers of LNG to agree on volume reductions, will be critical.
What is vexing is that all companies covered by Credit Suisse have competing areas for what limited capital they have and, on a national and global cost curve, the east cost market does not stack up well. Moreover, further impairments are likely to be unavoidable if crude stays lower for longer and debt levels will remain a constraint.
Chinese Steel
On most measures, Macquarie observes Chinese steel mills are sustaining the worst profit margins since the global financial crisis. A solvency and liquidity crisis is developing, the broker suspects. Moreover, there has been no sign of steel prices stabilising, or the rate of decline ebbing.
Macquarie acknowledges it may appear irrational for Chinese mills to continue producing, but concerns over the difficulty of resuming production or re-capturing market share, as well as expectations of a cyclical recovery as the government continue to pump the economy, are prevailing.
This could also mean that shut-downs are merely a matter of time, the broker contends. This northern winter may be particularly bleak because of cash flow difficulties. This also increases the likelihood of government intervention as a last resort for the industry. However, Macquarie observes the central government, in contrast to impressions, has not been that keen to prop up the steel industry, in that it has imposed various restrictive measures in the areas of environmental protection and financing.
Nickel
Nickel inventories are now very high after five years of surplus. Macquarie observes the market is getting back towards balance and a deficit may be looming for 2016. The broker calculates that nickel prices are now at levels where around 60% of global production is negative on cash flow.
Over the last month prices have stabilised and London Metal Exchange stocks have started to fall but, the broker contends, until China's growth rebounds, or a major cut to production is announced, the size of any deficit will be small. Macquarie concedes it was wrong regarding forecasts for a move to deficit in 2015. This was because demand remained very weak and there was ongoing high production of Chinese nickel pig iron.
Still, an end to de-stocking and reduced secondary nickel availability should lead to a small improvement in demand in the current quarter and further improvement early in 2016. Macquarie warns that a massive price recovery is unlikely although speculative re-stocking by stainless steel buyers is a risk factor, as that caused prices to overshoot in the previous rally in early 2014.
Copper
Freeport-McMoran will reduce copper mining at its Sierrita mine in Arizona by half and is considering a full shutdown of operations. Morgan Stanley estimates this equates to 45,000 tonnes per annum in 2016. By itself, the broker believes reduction will not make a significant impact on global supply/demand balances but adds to the tally of production cuts so far this year.
Around 825,000t of cuts or cancellations to production have been announced in 2015, which the broker notes has been largely driven by the 20% decline in the copper price.
If Glencore's Mopania and Kantanga operations and Freeport's American assets remain closed in 2016, a total of around 2.5% of 2016 forecast global production will be removed from the market. Yet, price related production cuts are not the only issues for copper supply. There is unrest at two of the largest new copper mines, in Peru, drought conditions affecting Ok Tedi, as well as power shortages in Zambia. Despite this, Morgan Stanley still forecasts copper mine production to grow by nearly 5.0% next year.
Declining output is likely contributing to the drop in LME stockpiles and in bonded warehouse stocks in Shanghai. While the production cuts and supply pressures support better market conditions, Morgan Stanley believes a recovery in demand is also required for a sustained lift in prices. The broker's base case 2016 copper price forecast of US$6,118t assumes just a modest recovery in demand.
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