Material Matters: Japan’s Disaster And Commodity Markets

This story features WHITEHAVEN COAL LIMITED, and other companies. For more info SHARE ANALYSIS: WHC

– Experts are trying to assess Japan's earthquake and commodity market implications
– LNG, Coal likely winners
– Long-term contracts to support uranium
– Oil price forecasts also lifted

By Chris Shaw

The full impact of the damage and losses suffered in Japan in the wake of the earthquake and tsunami that struck on Friday afternoon still cannot be accurately assessed, but with markets remaining open brokers have attempted to formulate some preliminary views on the implications for commodity markets from the tragedy.

Taking a broad view, Citi sees the combination of the Japanese earthquake and tensions in MENA are likely to generate an increase in risk aversion. This suggests a correction in commodity prices short-term. Longer-term this should be more than reversed.

According to Citi, short-term conventional thermal fuels such as oil, gas and coal should find some support as the shutdowns at its nuclear plants causes Japan to adjust its energy mix. The biggest impact is likely in thermal coal, Citi estimating Japan's demand could increase by 10% or seven million tonnes this year. Such an increase would add to existing upward pressures on prices.

Goldman Sachs agrees, pointing out about 10% of Japan's coal-fired power capacity is understood to be suspended at present, while stockpiles at a number of power stations have either been washed away or contaminated. 

Deutsche Bank takes the view the immediate impact on bulk commodity prices will be a weakening in line with the weakening in the Japanese economy. As activity recovers and the rebuilding process gets underway, the broker expects a meaningful pick-up in demand for coking coal.

In terms of Australian coal plays, Citi estimates Coal and Allied ((CNA)) has the largest exposure to Japan at 49% of its market, while Whitehaven Coal ((WHC)) has 31% exposure and Macarthur Coal ((MCC)) 25%. 

Estimates by Deutsche Bank suggest only minimal valuation impact for Macarthur and Whitehaven from any shorter-term fall in prices, so there is scope for volatility in markets to create an opportunity if share prices over-react. 

Both stocks are rated as Hold by Deutsche Bank, while the FNArena database shows Sentiment Indicator readings of 0.3 for Coal and Allied, 0.2 for Whitehaven and minus 0.1 for Macarthur.

Goldman Sachs also expects LNG demand will increase, though the magnitude of any increase will be limited by storage issues. Upward pressure on gas prices is expected to flow through to similar pressure on coal prices.

Short-term there may be some negative impact on the base metals in the view of Citi, this reflecting a temporary reduction in demand. But longer-term the need to rebuild should be a positive, with lead likely to receive the greatest boost in demand. The rebuilding process should also boost the steel, iron ore and coking coal markets, notes Citi.

In steel, Goldman Sachs estimates around 23% of Japan's steelmaking capacity has been affected by the disaster, while Deutsche Bank estimates as much as 40% of capacity is currently shut-in. This interruption to production opens up scope for some iron ore and coking coal contracted to Japanese mills to be diverted to the spot market.

Goldman Sachs expects this will put further pressure on spot iron ore prices. These have been trending lower in recent weeks in response to weaker Chinese demand.

On its numbers, Goldman Sachs estimates about 25% of Japan's installed nuclear capacity is currently offline. While longer-term China's response to the crisis is important given the intention to increase its nuclear power generation capacity, short-term Goldman Sachs expects spot prices will fall sharply.

Citi suggests uranium demand should only be slightly hit given most uranium producers have long-term price contracts in place. The broker agrees with Goldman Sachs that longer-term implications could be more serious if there is any significant public backlash against uranium as a source of power.

At present, JP Morgan notes International Energy Agency (IEA) forecasts are for Japan's nuclear power industry to supply 23% of primary energy demand by 2030, up from 13% in 2007. This compares to LNG's share increasing to 19% from 16%.

The earthquake means this expectation for nuclear fuel may prove overly ambitious, especially given likely community opposition stemming from the issues at nuclear plants in the wake of the earthquake and tsunami.

This suggests there is scope for LNG to experience an increased proportion of Japan's primary energy mix. If this is the case, JP Morgan sees a meaningful impact on global LNG demand given Japan is the world's largest LNG importer.

Macquarie agrees, estimating the need to replace the nuclear reactors that have been shut down will see additional call on other sources such as gas, fuel oil and diesel. Incremental LNG demand could equate to around 3.5% of global demand on Macquarie's numbers.

Short-term, JP Morgan expects greater Japanese demand for imported LNG and coal. This should benefit LNG producers with flexible capacity, which implies Woodside ((WPL)) among the Australian plays.

Longer-term an increase in Japanese gas demand should favour Woodside, Oil Search ((OSH)) and Santos ((STO)), which JP Morgan rates as Underweight, Neutral and Overweight respectively. Sentiment Indicator readings for the three companies stand at 0.1 for Woodside, 0.4 for Oil Search and 0.9 for Santos (the maximum is 1.0).

Macquarie also sees the most bullish impact of any long-term increase in LNG demand as applying to Woodside, which the broker rates as Neutral. Origin Energy ((ORG)), on which Macquarie is currently restricted, is also a likely beneficiary as the current situation could offer a good time to negotiate pricing terms on new LNG contracts. This should be a positive for Origin's APLNG project. 

Origin Energy has a Sentiment Indicator reading of 0.6 according to the FNArena database.

Most exposed in the uranium market among the Australian plays is Paladin ((PDN)) as Citi estimates the company only has around 60-65% of volume contracted. In contrast, Energy Resources of Australia ((ERA)) is essentially fully contracted for the medium-term. Sentiment Indicator readings stand at 0.0 for Paladin and minus 0.4 for ERA.

Elsewhere in the energy market, Macquarie has lifted oil price forecasts to reflect ongoing uncertainty with respect to supply across MENA countries. Supply disruptions are tightening the global supply/demand balance, Macquarie estimating spare capacity now stands at about three million barrels a day. This has come about a year earlier than the broker had expected just two months ago.

Lower spare capacity increases the risk OPEC is less willing to moderate prices aggressively in the second half of 2011, especially given underlying demand growth of around 2.5% is expected this year.

Given the changed market dynamics, Macquarie has lifted its average annual oil price forecasts to US$116.50 per barrel this year from US$97.10 previously and in 2012 to US$119.50 per barrel from US$115.50 previously. There is no change to Macquarie's long-term price forecast of US$88 per barrel.

The changes to oil price forecasts flow through to higher earnings for Australian oil plays, with the large cap exposures enjoying the largest benefit. Macquarie has lifted large cap earnings forecasts by an average of 31% this year and by 5% in 2012.

Higher earnings mean a boost to corporate balance sheets, while also supporting valuations in the sector. The changes have not generated increases in share price targets. 

In the sector, Macquarie rates Santos, Oil Search, Australian Worldwide Exploration ((AWE)), Beach Petroleum ((BPT)), Horizon Oil ((HZN)), Roc Oil ((ROC)), Molopo Australia ((MPO)), Tap Oil ((TAP)) and BHP Billiton ((BHP)) as Outperform.

Only Woodside and Nexus Energy ((NXS)) are rated as Neutral by Macquarie.

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