Material Matters: Platinum, Aluminium, And China’s New Export Markets

This story features SANTOS LIMITED. For more info SHARE ANALYSIS: STO

 – Barclays estimates 50% of all platinum production is loss-making
 – Outlook for aluminium prices remains grim
 – Changes to oil and metal price forecasts
 – China's growing exports to Africa and South America
 – Citi expects further weakness in coal prices

By Chris Shaw

The platinum market has experienced a number of production cuts and disruptions to output in recent months, including lost output of 120,000 ounces for Implats as the result of a strike at its Rustenburg operation.

Despite this and lower production from the likes of Anglo American Platinum and Eastern Platinum, Barclays Capital suggests the platinum market remains in surplus of around 89,000 ounces. Barclays notes around half of production in the platinum market is losing money at current price levels after accounting for sustained capex, a figure which drops to around 20% when capex is excluded. 

For Barclays this implies while cuts to production have started to emerge, prices remain too low to support current production levels. 

Turning to aluminium, Barclays notes in markets in oversupply situations prices will continue to eat into the cost curve as the market sends signals to participants to cut production levels. 

But Barclays also points out this relationship breaks down when non-market forces are introduced, something which is happening in the aluminium market at present. In this market the majority of global production is currently loss making even when high physical premiums are factored in. 

At the same time there is increasing evidence of government intervention helping support loss-making smelters in China in particular but also in markets such as Australia where the Port Henry smelter has received some concessions from the Federal government.

In the view of Barclays this intervention disrupt efficient market mechanisms, the result being further distortions and dislocations to the market. This has bearish implications for market fundamentals and prices according to Barclays.

National Australia Bank has conducted yet another of its regular updates for commodity prices forecasts to account for changes to market conditions through June. For the bulks the bank notes prices were mixed for the month, with thermal coal prices falling given soft demand and improved supply, but tighter markets helping support coking coal prices.

While the Chinese economy continues to slow there are some signs of stabilisation for the economy in general and growth in some sectors following recent policy changes. The US also offers scope for a general pick-up in demand as that economy continues to strengthen slowly, leading NAB to suggest bulk commodity prices should hold up around current levels. 

This means no major changes to bulk commodity prices forecasts, NAB making only modest adjustments to estimates to reflect a slight cut to Chinese economic growth forecasts. For iron ore the bank expects prices will range from US$125-US$132 per tonne through the June quarter of next year, while hard coking coal prices are expected to trade in a range of US$210-US$225 per tonne for the same period.

Semi-soft coking coal and thermal coal prices are expected to trade in similarly narrow ranges through the June quarter of next year, prices ranging from US$147-US$160 per tonne for the former and US$105-US$115 per tonne for the latter.

While concerns over Europe have eased slightly following the recent EU leaders summit, NAB has trimmed its global growth forecasts slightly as a reflection of recent soft economic data. There is no change to the bank's view conditions will improve into 2013.

As macroeconomic events are expected to remain volatile so too are commodity prices, with the medium-term trend for a softening in prices in the view of NAB. In US dollar terms the NAB non-rural commodity price index is forecast to fall by around 11% over 2012 and by a further 4.5% in 2013. In Australian dollar terms this translates into a fall of 7.25% for the year to December 2012, then a further fall of 2.25% in 2013.

In NAB's view some of the recent falls in the gold price can be attributed to heavy falls in financial markets, as this has prompted some selling of the metal to cover losses elsewhere. At the same time, a steady US dollar and some emerging deflation worries have combined to limit demand for gold.

Near-term NAB expects gold prices will fluctuate around lower levels as Europe continues to deal with sovereign debt issues. Solid central bank buying should help support the market in the near-to-medium-term, but if physical demand remains weak there should be little support for higher prices in the bank's view.

Taking a longer-term view, NAB suggests as the current general economic uncertainty dissipates and as the US economic recovery picks up speed, there is likely to be a further moderation in gold prices. NAB's forecasts reflect this, as the bank expects the quarterly average price for gold will fall from US$1,610 per ounce in the June quarter to US$1,510 per ounce in the December quarter of this year, then to US$1,340 per ounce in the December quarter of 2013 and US$1,310 per ounce in the March quarter of 2014.

Deutsche Bank has similarly revised its oil price expectations, reflecting its view demand side fears have deflated the geopolitical risk premium in recent months. At the same time as physical markets have loosened, the global economic growth outlook has weakened and Saudi Arabia has increased production.

As a result of the changing market fundamentals, Deutsche has cut its 2H12 forecast for Brent crude to US$99 per barrel from US$116 per barrel previously. Long-term the broker's price forecast for Brent declines to US$110 per barrel from US$125 per barrel, while for West Texas Intermediate Deutsche's long-term forecast stands at US$100 per barrel.

Adjustments to Deutsche's numbers also factor in the potential impact of US shale oil production and the potential for a reversal of the long-term downtrend in non-OPEC output as a result of this increased production from the world's largest oil consumer.

The changes to Deutsche's oil price forecasts have translated to cuts in earnings per share (EPS) forecasts for 2012 for large cap Australian energy plays of between 8-13%. Most impacted have been Oil Search ((OSH)) and Santos ((STO)), with Woodside ((WPL)) experiencing a less significant cut to estimates.

Despite the changes, Deutsche Bank continues to rate all three companies as Buy, with Oil Search the top sector pick given pure-play exposure to the PNG LNG project. Woodside has been elevated to Deutsche's second pick given strong near-term earnings momentum, while Santos continues to trade at an attractive discount to valuation.

By way of comparison, the FNArena database shows Sentiment Indicator readings for the three of 1.0 for Oil Search and Santos and 0.6 for Woodside.

Taking a broad view on China, DBS Group notes that nation's trade surplus has been falling ever since peaking at 7.6% of GDP in 2007. This trend is continuing, as DBS notes export and import growth this year to date has been 8.7% and 6.7% respectively, which compares to the 20.35 and 24.9% achieved in 2011.

As part of a process of reducing reliance on Western markets, DBS points out China has been strengthening its ties with Africa and South America. This has generated stronger export growth to both markets over the past decade than has been achieved in exports to both the US and Europe, though from a lower base.

As DBS notes, in 2011 11% of China's exports went to Africa and South America, which is more than double the number of a decade ago. This was also in excess of the 9% of exports that went to the ASEAN region.

Looking ahead, DBS suggests by 2020 Chinese exports to the EU and US could fall to 32.8% from 35.9% in 2011, while exports to Africa and South America could increase to almost 20% from around 10.3% last year.

The trend is for the Chinese to export more high and medium-skilled technology manufactured goods to the African and South American markets, which is helping build strategic partnerships in those regions.

In the view of DBS, this process will assist the Chinese to re-balance away from a long-term reliance on Western markets.

Further on China, coal inventory in that market remains at high levels observes Citi, who notes key Chinese power plants have around 27 days inventory at present. This is 74% above historical average levels.

In Citi's view this implies coal prices are likely to drop further in coming weeks, something that would be a positive for Chinese power companies as costs would come down. This would improve profitability, meaning further tariff hikes would not be necessary.

 
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms