Material Matters: Copper, Oil And Bulks

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 – Tight copper market supportive for prices
 – Oil market expectations updated
 – Credit Suisse turns less bullish on iron ore
 – Thermal coal prices near 3-year lows

By Chris Shaw

At current copper price levels, Chinese copper consumers appear to be closer to increasing imports than reducing them and exporting copper, in the view of Macquarie. The significance is that at the present time, copper availability outside of China remains limited and there are signs of incremental improvement in the global macroeconomic outlook.

As Macquarie notes, the stocking/destocking cycle in the Chinese copper market is the most aggressive of any major copper market, as traders and consumer try to buy when prices appear cheap and de-stock and use more scrap when prices rise.

Since August the copper price has risen almost 13% and Macquarie suggests such a price gain would typically spark some sort of destocking in the Chinese market. But over the past two months Chinese copper prices have moved in line with LME prices, meaning the price differential between LME and SHFE prices has remained virtually unchanged.

To Macquarie this suggests sentiment in the Chinese copper market has improved significantly over the past six months. The arbitrage price is implying Chinese consumers won't destock unless LME prices are higher, Macquarie noting this offers significant upside for exchange prices and will underpin the copper price while ex-China stocks remain low.

Emphasizing the tighter copper market, Macquarie notes the lower Chinese copper imports of late have not led to any significant increase in stocks outside of China. LME stocks now stand at just over 220kt, which is 150kt less than at the start of this year. This is also supportive of copper prices.

Turning to oil, Goldman Sachs suggests supply from ultra-deepwater and shale projects will lead to a more balanced market over the medium-term. This is expected to have enough of an impact on the market to overcome the need for the market to be forced into balance by prices than see demand rationed.

Near-term Goldman Sachs suggests oil prices are likely skewed to the upside thanks to low OPEC spare capacity and a seasonal pick-up in demand, but non-OPEC supply growth from 2013-14 should see a well supplied market and so boost OPEC's spare capacity. This should help generate a softening in the market.

Price forecasts have been adjusted to reflect this view, Goldman Sachs now forecasting average prices for Brent crude in 2013 of US$110 per barrel (down from US$130) and in 2014 of US$105 per barrel.

Longer-term, which is from 2016 on, Goldman Sachs is forecasting a normalised oil price of US$85 per barrel. This compares to the broker's estimate of US$115 per barrel as the long-run price the global oil an gas industry needs to be free cash flow neutral after capex and dividends.

The high price needed by the industry highlights how returns have deteriorated over the past seven years, a trend Goldman Sachs expects will continue given ongoing deterioration in legacy asset bases across the sector.

In terms of how to play the sector, Goldman Sachs suggests Asian oil companies compare favourably to global peers in terms of returns and valuation relative to historical levels. Factoring in revised oil price assumptions, Goldman Sachs continues to rate Oil Search ((OSH)) and Santos ((STO)) as Buy under Australian stocks under coverage, while Origin Energy ((ORG)), AWE Limited ((AWE)), Drillsearch ((DLS)), Woodside ((WPL)) and Senex Energy ((SXY)) are rated as Neutral.

By way of comparison, Sentiment Indicator readings for these stocks according to the FNArena database stand at 1.0 for Santos, 0.9 for Origin, 0.8 for Oil Search, 0.7 for AWE, 0.4 for Woodside and 0.3 for Drillsearch and Senex.

In Standard Bank's view the latest Chinese oil import figures don't reflect signs of stabilisation in the Chinese economy, apparent from data such as strengthening monthly industrial production, retail sales and fixed asset investment numbers.

As the bank notes, over the last two quarters the improving quarter-on-quarter GDP growth has not been matched by improving crude oil imports, as Chinese oil imports actually fell by more than 14% in quarter-on-quarter terms in the September quarter.

One reason in Standard Bank's view is there has been a shift to alternative energy sources such as thermal coal, while the bank also points out the second and third quarters tend to be slower periods for Chinese oil imports in general.

Standard Bank's conclusion is while the signs point to a stabilising in the economy, there is a long way to go before the oil demand destruction seen over the past two quarters is undone. The combination of a weak demand environment and reasonably solid supply should push oil prices lower in the December quarter in the bank's view. 

Geopolitical risk and liquidity from QE3 should limit downside, Standard Bank continuing to forecast a Brent crude price of US$105 per barrel for the December quarter.

Credit Suisse has revised down its previous bullishness on the outlook for iron ore prices. Short-term the broker expects prices will increase to US$120 per tonne as Chinese steel mills reverse the destocking that has been undertaken.

From the second half of next year however the iron ore market is expected to move into oversupply, this as Chinese steel output moderates. As a result, Credit Suisse expects iron ore prices will fall sharply to move towards the broker's long-term forecast of US$90 per tonne by 2014.

If iron ore prices move as expected Credit Suisse would want to see capex among players in the sector move the same way, while low costs and higher received prices would also be attractive attributes under such an environment. Without such qualities, the likes of Gindalbie's ((GBG)) Karara project and the north Pilbara trucking operations of Atlas Iron ((AGO)) become challenging.

Many unfinanced projects will be threatened in Credit Suisse's view, the broker arguing it is now very late in the cycle for investing heavy capex in expansion plans. As an example, funding for Atlas's Roy Hill project now appears somewhat shaky 

Having factored in its new pricing outlook, Credit Suisse has adjusted earnings estimates across the Australian iron ore sector. This has impacted on ratings and price targets, as the broker has downgraded Atlas Iron to Underperform from Outperform and cut its price target to $0.80 from $2.70. This reflects the view the current share price for Atlas doesn't account for a more dour outlook for the iron ore price.

Credit Suisse continues to rate Gindalbie, Mount Gibson ((MGX)) and Fortescue ((FMG)) as Outperform, with price targets adjusted for both Fortescue and Mount Gibson.

Macquarie takes a positive view of the shorter-term outlook for iron ore, suggesting the end of Chinese steel destocking offers upside risk to prices over the next three months. Whether there is a full steel destock in China in the final quarter of this year or the de-stocking process ends now, Macquarie expects some modest restocking in iron ore.

More bullish assumptions for the Chinese steel market would suggest Chinese apparent demand for iron ore would rise to more than one billion tonnes per year, something Macquarie suggests would need the return of a large amount of marginal supply from both the Chinese domestic and seaborne markets. For this to occur prices would have to be around the US$130 per tonne level in Macquarie's view.

Finally on the bulks, Commonwealth Bank notes thermal coal prices have now fallen close to three year lows, as commodity prices in general weakened this week on concerns Euro leaders will fail to find a solution for the ongoing debt crisis anytime soon and on the back of weaker Chinese foreign direct investment numbers. 

 
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