Material Matters: LNG Supply Expectations Lowered, Opportunities In Resources

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By Chris Shaw

LNG supply growth is surging around the world, Barclays Capital noting this reflects the commissioning in the latter stages of 2009 of 5.8 billion cubic feet per day of new capacity.

The expectation was this increase in supply, boosted further by new trains being commissioned this year, would see abundant spot cargoes forced into the US and European markets. But as Barclays points out, consumption has also been very strong in the first half of 2010.

A cold northern hemisphere winter boosted consumption in the early months of this year, which has been followed by economic recovery in key consuming markets. Barclays notes industrial activity in seasonally adjusted terms rose by 27% in both Japan and Korea in the first quarter, driving Asian purchases of LNG to record levels. European buying was also stronger in the March quarter, up 1.9 billion cubic feet per day from the same period last year.

The key for the rest of 2010 in the view of Barclays is the potential for the supply side to underperform expectations, as previously anticipated projects are now being delayed and outages are causing supply growth to come in lower than expected.

To reflect this, Barclays has cut its forecast for global LNG supply growth this year to four billion cubic feet per day from five billion cubic feet previously. While this remains a strong level of supply growth it is not a sellers' market in the group's view.

In the base metals, Commerzbank notes a number of Chinese pig iron producers have been forced to scale back production given the fall in the metal's price from US$27,000 per tonne in April to around US$18,000 per tonne this week.

Pig iron production is only profitable at relatively high nickel prices, which has not been the case in recent months. At the same time production costs in China have been rising thanks to higher electricity costs and restrictions on emissions, so bringing down pig iron production levels.

In Commerzbank's view, production should decline further in May and June given this combination of factors, an expectation supported by anecdotal evidence some end customers are currently deferring orders and reducing stocks.

Generally among the base metals Barclays sees scope for further price gains shorter-term, as inventories continue to trend lower. As examples, the group notes earlier this week aluminium saw a drawdown of 7,850 tonnes and copper of 2,375 tonnes.

Commentary by industry players is also turning more positive. Here Barclays refers to Aurubis, Europe's largest copper smelter, which sees the trend of declining copper inventories in the warehouses of the metal exchanges as a price supporting factor.

This trend is attracting little attention at present according to Aurubis, which points out warehouses are currently reporting inventories of 59,000 tonnes. Average monthly demand for copper is around 230,000 tonnes and monthly output of new copper stocks is around 160,000 tonnes.

With stocks reportedly low along the value added chain, Barclays suggests there is scope for copper to be in even shorter supply after the current Northern Hemisphere summer break.

Taking a medium-term view, Macquarie suggests the current uncertainty with respect to growth in Europe and China is creating an opportunity for investors as commodity markets are more likely to tighten into 2011.

Even allowing for the current issues in Europe, Macquarie expects global growth both this year and in 2011 will materially exceed the long-term trend rate of 3.6%. This is broadly positive for commodity prices and the group has adjusted its price forecasts accordingly.

The largest increase is in iron ore, where Macquarie has lifted its price forecasts by an average of 13% across the next five years. This includes an increase of 23% to its iron ore fines forecast this year and a 16% increase in 2011. For lump ore the increases are 16% this year and 9% in 2011.

Among the base metals, Macquarie has cut its copper price forecast for this year by 9%, for nickel and aluminium by 2% and for zinc by 10%. In 2011 the broker's nickel forecast has been increased 3%, while aluminium, copper and zinc forecasts are unchanged. Changes in coal are minor, ranging from minus 1% to plus 4% through 2011, while Macquarie has lifted its gold price forecast this year by 3%.

Factoring these changes into its respective company models means changes to earnings estimates, while preferred stocks for Macquarie remain Rio Tinto ((RIO)) in the diversified space and Equinox ((EQN)) in the base metals sector. BHP Billiton ((BHP)), Oz Minerals ((OZL)), Independence Group ((IGO)), Alumina ((AWC)) and Kingsgate Consolidated ((KCN)) are also rated as Buys.

There is less value among coal stocks but Macquarie has initiated coverage on Whitehaven Coal ((WHC)) this week with an Outperform rating. Coal & Allied ((CNA)) also scores an Outperform rating. Among the iron ore plays, Macquarie has upgraded Mount Gibson ((MGX)) to Outperform from Neutral, while it also rates both FerrAus ((FRS)), Northern Iron ((NFE)) and Giralia Resources ((GIR)) as Outperform.

Fortescue Metals ((FMG)) and Atlas Iron ((AGO)) are rated as Neutral, the latter having been upgraded from Underperform previously. Macquarie continues to rate Aquila Resources ((AQA)) as Underperform on valuation grounds.

Similarly in the oil sector, Macquarie has revised its forecasts, the changes reflecting growing uncertainty and short-term trading in the oil market. The result is a lowering of the broker's estimate for West Texas Intermediate by 7% this year to US$80.70 per barrel and in 2011 by 3% to US$87.50 per barrel.

These changes mean minor adjustments to valuations for companies in the sector, though Macquarie has not adjusted any recommendations as a result. Santos ((STO)), Oil Search ((OSH)), Beach Petroleum ((BPT)), Tap Oil ((TAP)) and Nexus Energy ((NXS)) are rated as Outperform, while Woodside Petroleum ((WPL)), Arrow Energy ((AOE)), Roc Oil ((ROC)), Innamincka Petroleum ((INP)) and Karoon Gas Australia ((KAR)) are all rated as Neutral.

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