Material Matters: Oil, Lithium & Thermal Coal

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A glance through the latest expert views and predictions about commodities: iron ore; crude; lithium; zinc; and thermal coal

-Iron ore succumbing to the vagaries of China's steel policy
-Should investors lighten positions in key iron ore stocks?
-Bearish signs on the horizon for oil despite firm fundamentals
-Lithium supply likely to struggle to keep up with demand
-Power demand likely to mean thermal coal pricing will remain strong
 

By Eva Brocklehurst

Iron Ore

On the issue of why iron ore prices are falling so quickly, it appears China is enforcing its target to maintain flat steel production in 2021. UBS highlights data that indicates daily pig iron production is down -6% in July compared with June while key steel producers have announced plans to cut production in the second half.

Steel mills have subsequently de-stocked and this has resulted in the sharp fall in iron ore prices in a thin spot market. While China's policymakers are attempting to control the leverage of developers and property prices they are also accelerating infrastructure construction.

This has meant steel prices rose while iron ore prices fell. UBS has noticed iron ore exports have not yet lifted materially, although guidance from producers, mainly Rio Tinto ((RIO)) and Vale, implies supply will lift around 60mt in the second half.

The broker expects China's steel curtailments will be targeted for the December quarter when demand also seasonally slow and air pollution returns to the fore. As a result, iron ore prices are expected to stabilise in September/October before continuing to ease back to less than US$100/t in 2022.

As far as dividends for the three large Australian iron ore miners are concerned, Morgans notes a trend has been building where the share price decline after the dividend payment is significantly more than the dividend itself.

The reverse could also be argued as there has been support when large dividends have been announced. Hence, Morgans suggests those investors looking to lighten positions opportunistically should consider waiting for full-year results then trim positions before these stocks go ex-dividend.

The broker acknowledges this a tactical move that is not appropriate for all long-term investors. Having already outperformed, the broker considers BHP Group ((BHP)) is the best placed, given diversification and the lack of operational or strategy issues.

Crude Oil

Citi ascertains there are bearish signs on the horizon for oil despite the firm market fundamentals. The broker expects Brent in the second half of 2021 will be in the range of US$75-80/bbl and upside is more likely than downside and the tightening of the market is far from over.

This is apparent in the term structure of both Brent and West Texas Intermediate. As prices fell, refinery margins continued an upward trend which was a sign of market strength, the broker points out. OPEC and associates are supporting the market in a credible way, Citi suggests, with a plan to bring all oil taken off the market in 2020 back by the end of 2022.

Yet fickle financial flows are reflecting significant concerns regarding the spread of the Delta variant of coronavirus along with a potential for the Chinese economy to stagnate. There are also signs of inflation around the world and some central banks may be considering higher interest rates. These are the bearish signals.

Lithium

JPMorgan believes lithium supply will struggle to keep up with demand, calculating a growth rate of 19% for the next 10 years based on its global automotive & battery assumptions. A perpetual deficit is therefore envisaged until 2030. This means unknown and potentially less economic projects may be required to fill the gap.

JPMorgan raises long-term estimates for the lithium spodumene price to US$850/t from US$650/t and believes this is the price required to generate a 20% return for a notional hard rock mine with 1% lithium dioxide grade and a 10-year life along with capital intensity of US$1075/t.

The lithium hydroxide price calculation for the long-term of US$14,000/t generates a 20% return for a notional conversion plant. Lithium carbonate prices at US$12,250/t represent a -$1750/t discount to hydroxide and reflects the conversion cost.

The broker highlights the tight market for the foreseeable future has led to an increase in its medium-term price forecasts. JPMorgan retains an equity preference for IGO ((IGO)) and Orocobre/Galaxy Resources ((ORE))/((GXY)) and upgrades Mineral Resources ((MIN)) and Pilbara Minerals ((PLS)) to Overweight.

Zinc

Macquarie has reviewed its forecasts for zinc mine supply, refined production and consumption. Forecasts for a zinc metal surplus in 2021 and 2022 have been reduced while the previously forecast deficit in concentrate has now moved to a balance/surplus. The broker, as a result, increases price forecasts by 4-6% for 2021 and 2022 and by 7% for the longer term.

This reflects the improved market balance which is largely because of stronger underlying demand for zinc. Zinc prices are underpinning strong earnings upside potential for stocks such as 29Metals ((29M)) where the broker has upgraded forecasts by 10% in 2021 and 24% in 2022, lifting the target to $3.30.

Thermal Coal

Thermal coal prices have rallied into the September quarter amid buying by all major consumers. Macquarie notes China in particular is very short of coal. Domestic thermal coal production was down -6% in June and while there is no July data available, weekly railway transport suggests the first half of July was even weaker.

One of the policies which was adjusted because of market tightness related to imports, with China importing 24mt of thermal coal in June, up 27%. Because of the restrictions on Australian imports thermal coal was sourced mostly from Indonesia but also from South Africa, Canada, Russia and Colombia.

Australian thermal coal shipments have improved since March as India took most of the increased volume in May and South Korea in June. Additional volumes now appear headed for Taiwan.

Macquarie notes, in theory, as China reduces Australian imports other countries should be able to buy the coal at a cheaper price. In practice, China's rush to buy has contributed to rising prices across the board.

Strong manufacturing activity in Asia has also boosted demand and, contrary to expectations, coal is back in fashion in Europe. Strong power demand and soaring gas prices have meant a moderate increase in coal burning across the continent.

The broker expects the tightness in seaborne thermal coal will remain well into the December quarter as the structural shortage in China appears hard to address and China's power plants require a rebuild of stocks ahead of the winter.

Macquarie does not envisage any scope for a significant correction in thermal coal prices as recent price action has been consistent with the fundamental tightness.

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