Commodities | Jun 21 2012
– Weak steel prices impacting on coal
– Thermal coal price forecasts lowered
– Iron ore market reviewed
– Oil refining balance impacted by rising US production
– Premiums supporting aluminium smelters
By Chris Shaw
International steel prices remain on a downward trajectory, RBS noting steel prices were down 6% and ferrous scrap prices down 7% over the past week. The falls have been matched by weaker thermal coal prices, which also declined by 6% in week-on-week terms.
Citi suggests part of the problem for thermal coal prices in particular is high inventories and weak demand, which is limiting China's ability to soak up excess inventories. As Citi points out, while Chinese thermal coal imports have been strong year-to-date, inventories at power plants are now at a record 26 days of consumption.
Given electricity consumption is falling, Citi suggests current stock levels could be enough to keep thermal coal prices subdued for the foreseeable future, especially given the level of supply from the Americas in particular.
This means buyers have little reason to rush back into the market. As an example, Citi notes Chinese power demand growth decelerated to 3.7% year-on-year in April, its lowest rate since May of 2009. But inventories have typically stood at around 15 days of consumption, so the current high inventory levels suggest buyers will be opportunistic in coming months. Such activity will weigh on prices in Citi's view.
Macquarie agrees and has cut its seaborne thermal coal price forecasts for the remainder of 2012 in the expectation current oversupply will take some time to be addressed. This implies it remains too early to call a bottom in the market.
Medium-term, Macquarie's view is the current oversupply situation is not serious, as the supply side should adjust to current pricing. A pick up in prices is expected in the final quarter of this year, as China should enjoy a cyclical pick-up and coal burn in that market around year end should be 10-20% higher than current levels. US exports are also considered unlikely to remain at current levels.
To reflect its views, Macquarie has lowered forecasts for Newcastle coal in the June quarter to US$97 per tonne from US$103.50 per tonne previously, while September quarter forecasts fall to US$90 per tonne from US$105 per tonne previously. The broker's 2012 average price forecast for Newcastle coal falls 6% to US$108 per tonne.
Cuts to forecasts for Richards Bay prices have been similar, through larger for the June quarter, while long-term forecasts for Macquarie are unchanged. This implies prices form a solid base around US$100 per tonne before gradually adjusting higher.
Still on bulks, Macquarie has also reviewed what it sees as the most likely drivers for iron ore prices in coming months given the market is currently trading at the top end of the cost curve.
Major drivers in coming months start with the impact of the Indian monsoon period, as this impacts on tonnages from that market. This year the effect is expected to be even greater given increasing dependence on material from Goa, which typically is greatly impacted by the monsoon rains. Macquarie estimates Indian exports could drop by as much as 50 million tonnes in annual terms, which implies lower incremental Chinese imports.
Chinese inventory levels will also be important as this market is one of the few where overall inventory levels have fallen since the start of the year. The lack of material from Goa increases the risk inventories fall further in coming weeks, while steel production is tipped to increase through the end of the September quarter. This implies steel mills may have to enter the market more aggressively over the next few months in Macquarie's view.
Chinese steel prices have not kept pace with production, as the lower demand growth environment has put pressure on realised prices and profitability. Macquarie suggests steel price moves should be the single largest catalyst for iron ore, so until there are signs of an improvement in steel demand iron ore prices are likely to struggle.
Finally, Macquarie notes Australian iron ore exports continue to run at record levels, this at the same time as Brazilian exports are stagnant and Indian exports are falling. This combination puts more pressure on Chinese domestic ore production.
For Macquarie, current iron ore fundamentals point to upside, with US$130 per tonne appearing a relative floor for prices. For prices to fall to levels closer to US$100 per tonne the suggestion is there would need be a strong correction in Chinese output in particular. Given monetary policy is moving to the pro-growth side in that market, such an iron ore price outcome would be a major shock in Macquarie's view.
As Standard Bank notes, the perceived wisdom in oil markets is the world remains tight on sweet or low sulphur crude, which stems from a distillate crunch in 2008 when global refineries struggled to produce enough low sulphur fuel from high sulphur crude.
But this market view is being thrown off course by the rapid pace of growth in US shale oil production, which is similar to conventional sweet crude. With domestic US oil production hitting its highest quarterly level in 14 years in the March quarter, the US is now importing less crude oil and in particular sweet crude.
This is weakening the premium sweet crude typically commands in the market, with Standard Bank expecting this trend will continue for some time. This implies a number of refining investments won't generate the returns that had been promised.
A slight positive in the view of Standard Bank is refineries typically find it easier to replace sour crude feed with sweet crude than to do the opposite.
With respect to the base metals, Commonwealth Bank argues aluminium smelters may be being held afloat by current market premiums. As CBA notes, between January 6 to last week LME aluminium prices have fallen 7% to US86c per pound.
Over the same period, the average aluminium premium has risen by 59% to US9.4c per pound. Rising premiums and weaker prices reflect the difficulty market participants are having in obtaining metal from warehouses, as significant tonnage is tied up in financing trades and cancelled warrants.
In CBA's view some producers may be generating part or all of the premium in addition to the spot price for new sales of the metal to buyers looking for prompt delivery. This wold help explain how some smelters are continuing to operate, given the current aluminium spot price implies around 70% of smelters are losing money at present.
This figure would fall to around 40% of smelters losing money if aluminium premiums were added to the spot price.
