Material Matters: Copper And Oil Outlooks Still Favourable, Minor Adjustments In Steel

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By Chris Shaw

Arbitrage opportunities between the Shanghai Future Exchange ((SHFE)) and the London metals Exchange (LME) can impact on copper prices as traders move between the two markets, but as Barclays Capital notes this arbitrage remains closed at present (little price differential).

As well, Barclays notes the cash to three month spread has now flipped into contango for the first time since early June, contango meaning futures prices rising into time. This implies current spot market conditions in China are now not as tight as was previously the case.

What it also means according to JP Morgan is it's the same Chinese merchants that drove the recent rally in copper who are now causing prices to fade as they react to the new pricing outlook in the market.

Looking at the supply side of copper, JP Morgan suggests the bulk of the production reports from major producers offer nothing to suggest the market will be anything other than in deficit in 2011 and balanced in 2012 and 2013.

Antofagasta in Chile delivered a soft June quarter report, while Escondida also disappointed on the refining side by enough to offset a modest improvement in concentrate production. JP Morgan notes production performance at Codelco also appears to have flat-lined in recent months.

While producers are spending to stabilise head grades and boost reserves, JP Morgan notes this is not preventing operations from underperforming what are already low expectations. While greenfield projects are being developed, the broker doesn't see any significant supply boost prior to 2013 at the earliest.

This means risk is to the downside to the extent JP Morgan sees scope for supply to continue to undershoot expectations. So rather than the essentially balanced market being forecast through to 2013 there could instead be four years of deficits in the broker's view.

This is enough for the broker to remain most positive on copper among the base metals, even as Chinese merchants are de-stocking and robbing the rally of some of its upside momentum. While a move through US$7,800 per tonne could force some buying in China, JP Morgan sees this as unlikely shorter-term as it expects the physical market will stand back from current price action.

In summary, JP Morgan suggests the fundamentals in the market mean any weakness in copper prices will need to come from the demand side, something it sees as unlikely given current healthy demand levels. The broker estimates copper demand globally will grow by around 7% this year, driven by an expansion in Chinese consumption of 9.5%.

Copper prices should therefore be well supported in JP Morgan's view, the broker expecting prices will probably hug the US$7,000 per tonne level through 2011 with upside if the market proves to be even more constrained than expected.

Turning to oil, Barclays Capital notes in the US the Petroleum Supply Monthly and Petroleum Supply Annual publications have been released, the former showing a downward revision to May demand and the latter an upward retrospective revision to 2009 demand, as helpful as that may be.

While lower demand in May is disappointing it isn't a great concern according to Barclays, as original figures for the month were never seen as sustainable. The group's estimate for the half year is unchanged following the release of the monthly publication.

This implies a steady recovery in demand is still likely, helped by a turnaround in demand for distillates to a strong positive in the June quarter from negative growth in the March quarter. Barclays continues to expect moderate growth in US oil demand for 2010 as a whole, with this tightening in fundamentals expected to support oil's new found price range above US$80 per barrel.

Elsewhere in the energy market, Commonwealth Bank notes more US drill rigs are now being used to target oil plays than gas, a reflection of poor gas pricing at present. The implication in the bank's view is new oil production capacity should outstrip gas capacity in coming years, something that should eventually help to tighten the US gas market.

In steel, Deutsche Bank suggests current spot prices imply some minor downgrades to earnings for BlueScope Steel ((BSL)) in FY11 from higher iron ore prices and some upgrades to forecasts for OneSteel ((OST)) from lower scrap and coal costs. To reflect this, Deutsche prefers OneSteel coming into results season, in part because guidance for the period was reiterated back in May.

A short-term positive for OneSteel is recently announced steel price increases of 11%, combined with scope for the company to announce an iron ore reserve upgrade when it reports this month. Medium-term Deutsche prefers BlueScope though, as its earnings are more skewed to international demand and markets and this offers greater scope for upside from FY11.

Deutsche suggests both BlueScope and OneSteel are cheap relative to international peers, so both stocks are rated as a Buy by the broker. The FNArena database shows Sentiment Indicator readings of 0.8 for BlueScope and 0.5 for OneSteel.

For Sims Group ((SGM)), Deutsche suggests there is some downside risk to consensus estimates for FY11 as scrap prices have weakened in recent months. To reflect this the broker is below consensus with its earnings estimates for the company in FY11.

The potential for cuts to market earnings estimates enough for Deutsche to retain its Hold rating on the stock, while the FNArena database Sentiment Indicator reading for Sims stands at 0.4. 

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