Material Matters: Thermal Coal, Oil And Oz Iron Ore and Nickel Markets

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the By Chris Shaw

The June quarter report from the Australian Bureau of Agricultural and Resource Economics (ABARE) was, in the view of Barclays Capital, most interesting with respect to market supply and demand forecasts for thermal coal.

The report showed ABARE has made upward revisions to demand estimates for most Asian consumers, the largest changes coming courtesy of China and India. For the former, Barclays notes demand estimates were lifted by around 13 million tonnes, while for the latter the increase was around 18 million tonnes.

When compared to the corresponding report in June of last year, Chinese import forecasts have now been increased by almost 60 million tonnes, while India's have increased by 21 million tonnes. ABARE has also increased its 2011 estimates, lifting its Chinese demand forecast by 16 million tonnes and its forecast for India by 22 million tonnes.

Barclays Capital is not quite as bullish with its forecasts, as the analysts see scope for growth momentum to slow. But the point they is even if growth slows it will be from much higher levels than previously expected.

Demand has also risen in some other markets, Barclays noting the ABARE numbers imply an upward revision to Japanese thermal coal demand of three million tonnes for 2010. In full year terms this implies an increase of demand of 2.6% to 120 million tonnes. This shows solid growth, as ABARE's March report had indicated Japanese demand would only reach such a level by 2013.

With demand coming in stronger than expected, Barclays notes there has been a supply response, with Indonesian exports in particular coming in strong in year-to-date terms. ABARE has lifted its estimate for Indonesian exports for this year by around 40 million tonnes to a total of 250 million tonnes.

Barclays notes the ABARE report shows Australian exports continue to underperform, to the extent expectations for 2010 have been revised lower. This reflects ongoing infrastructure issues, with bottlenecks and delays to expansion plans both ongoing issues.

The cuts to ABARE's 2010 thermal coal export estimates for Australia have been offset by an increase to expectations for thermal coal exports in 2011 but as Barclays cautions, risks for Australian exports remain to the downside at present.

Turning to oil, Commonwealth Bank takes the view the market's fundamentals remain soft at present. This suggests prices remain exposed to any shifts in perception with respect to the international economic outlook.

The US is not helping in this regard, Commonwealth Bank chief commodity strategist David Moore pointing out the recovery in demand in this key market remains uneven. Medium-term however the outlook remains more positive in Moore's view, as demand should grow steadily according to International Energy Agency (IEA) forecasts.

These estimates suggest global oil demand growth of around 1.6 million barrels per day this year, then 1.3 million barrels per day in 2011. Moore expects global demand growth may actually exceed this level. Non-OECD demand growth should be the main driver of demand growth, the IEA estimating Chinese demand growth should come in at more than 36% from 2009 to 2015.

Barclays agrees, taking the view global oil demand should reach an all-time high in 2010. According to Moore this means an increased reliance on OPEC supply, which implies some upside to prices as OPEC's effective spare capacity continues to decline.

Moore has retained his view oil prices should strengthen significantly through 2012, as from prices of a little below US$80 per barrel at present he is forecasting an increase to around US$90 per barrel by the end of next year.

Barclays Capital is similarly bullish on the outlook for the oil price. The group suggests while the June quarter has proven to be something of a lost one, prices should again move above the US$80 per barrel level in coming months as demand picks up in line with an improving global economic outlook.

China is expected to be a driver of global economic growth but recently there have been increasing concerns of the slowdown in that economy. But in the view of Commonwealth Bank commodity analyst Lachlan Shaw, any slowing in growth is most likely to just be to more sustainable levels.

Shaw points to growth in Chinese electricity consumption as supportive of this view, as the most recent data hows this measure rose 2.7% in April. Since May of 2009 electricity consumption is up almost 20%, which is consistent with robust industrial activity and commodity demand in Shaw's view (and consistent with ABARE's thermal coal forecasts).

While any comparison of figures with May of last year may be risky given 2009 numbers were impacted by the Global Financial Crisis (GFC), Commonwealth Bank's numbers show May power output this year was still 6.6% higher than pre-GFC peak production levels.

In the nickel market, Norilsk Nickel has advised it intends to offload some of its Australian assets. These potentially include the Black Swan, Lake Johnson, Cawse and Waterloo assets, with Credit Suisse suggesting the latter two are most likely to be sold in any deal.

This leads Credit Suisse to suggest there could be a buying opportunity for any Australian juniors with money on hand, with Independence Group ((IGO)) and Panoramic Resources ((PAN)) both noted to have net cash balances of more than $100 million at present.

As well, Credit Suisse notes both companies have operations in the same area as the Norilsk assets, while both also have a history of buying underperforming nickel mines from major global operators. Panoramic is seen to be in the better position with respect to a purchase given Independence is currently focussed on its Tropicana Gold deposit.

Consolidation among smaller cap nickel plays in Australia has been a long time coming according to Credit Suisse, so any asset sales by Norilsk may act as a catalyst for additional corporate activity in the broker's view.

In terms of the best exposure to nickel among the smaller Australian plays, Credit Suisse prefers Panoramic as it offers both a pure nickel exposure and has potential to pay special dividends to shareholders. Value has also improved in Western Areas ((WSA)) shares in Credit Suisse's view, as that company's share price has fallen 30% since early in April.

Panoramic is rated as Outperform by Credit Suisse, while Western Areas and Independence Group both score Neutral ratings. Sentiment Indicator readings for the three stocks according to the FNArena database are 0.6, minus 0.1 and 0.5 respectively.

Credit Suisse has also updated its view on the Australian iron ore sector in the wake of the Western Australian Government progressing approvals for Hancock Prospecting's Roy Hill Project. The project is seen as similar to the Chichester project of Fortescue Metals ((FMG)), given resource bases of around the same size and a relatively close geographical proximity.

For the sector in general, Credit Suisse suggests a go-ahead at Roy Hill is a slight negative for Fortescue Metals ((FMG)). The broker's argument is most of the value in Fortescue is associated with its infrastructure rather than its deposit, so the fact Fortescue cannot leverage this infrastructure to “assist” Hancock with the Roy Hill project is a disappointment.

Both will need rail lines and these would pass close to one another, Credit Suisse pointing out combining these lines would assist both companies given it would boost capacity and allow for a more streamlined operation as one line could carry loaded trains and the other empties.

In summary, if Roy Hill requires more infrastructure to be built in the Pilbara region it will mean the potential to extract value from existing infrastructure is reduced. On the flip side, this is good for other junior iron ore plays in the region as there are different haulage agreements in place with different companies.

Credit Suisse notes both BHP Billiton ((BHP)) and Rio Tinto ((RIO)) are required to provide haulage services for any third party access on their rail lines, while for Fortescue the agreement allows others to use their own trains on that company's lines.

No Roy Hill agreement has been announced but Credit Suisse suggests it may include haulage services, which benefits other junior players as they don't want to own their own train sets and would prefer to simply pay others to move their output.

Given this, if the Roy Hill project includes such a haulage agreement Credit Suisse sees upside risk for the junior iron ore plays as the existence of a fourth railway system in the Pilbara region offers them additional access and choice.

Among the juniors, Credit Suisse rates Atlas Iron ((AGO)) as Outperform with a $3.15 price target, while it doesn't cover FerrAus ((FRS)), Brockman Resources ((BRM)) and Giralia Resources ((GIR)). The broker also rates Fortescue as Outperform with a price target of $6.00.

The FNArena database shows Atlas Iron is rated as Outperform once and Hold twice with an average price target of $2.58, while Fortescue is rated as Buy four times and Hold five times with an average target of $5.56.

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