Material Matters: Bulks, Base Metals, Silver And LNG

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 – Bulk commodity forecasts revised
 – Lead and nickel market outlooks updated
 – PV demand may not support silver
 – Threat of US LNG exports assessed
 

By Chris Shaw

Bulk commodity prices have been mixed in recent weeks, with recent signs of improvement in the Chinese economy generating better performance in the iron ore market but coal prices generally stabilising around recent lows.

National Australia Bank notes growth in global crude steel output is still subdued, this as Chinese GDP demand has slowed for seven consecutive quarters. Despite this, the average spot price for iron ore rose in October to around US$114 per tonne,ending the month close to US$120.00/t, up from below US$90 per tonne in September. Thermal coal prices in October fell 7%, this after a 1% decline in September.

The pick-up in iron ore reflects improving sentiment with respect to the outlook for Chinese steel demand, as well as a restocking phase by Chinese steel mills after inventories were drawn down in July and August as mills ran down stockpiles to drive spot prices lower.

While there are signs the recent restocking process is now slowing, NAB sees scope for a pick-up as demand conditions in a number of markets have started to improve and leading into the northern winter. This is expected to support the iron ore prices in coming months. 

With premium hard coking coal contracts for the December quarter being confirmed at US$170 per tonne FOB, NAB expects some additional purchases in the spot market. Adding in the delayed impact of investment stimulus in China leads the bank to suggest prices should move back towards US$180 per tonne late next year.

Signs of a delayed supply response should also prove somewhat supportive to met coal prices according to NAB, while there is potential for further industrial disputes to further tighten the market if prices rise noticeably. 

Weak US demand continues to impact on the thermal coal market, while Chinese imports have also declined in recent months. With prices around US$80 per tonne NAB expects demand should improve, which in turn should support prices. 

While coal prices estimates are largely unchanged, NAB has lifted iron ore price estimates to account for the faster than expected price recovery in the market. Still positive longer-term fundamentals should keep prices at elevated levels, though the bank suggests downside risks remain significant.

In recent months the lead market has experienced a number of developments of note, including a dramatic rebound in LME stocks over the past week to 325,000 tonnes and a spike in the cash/3-month spread to more than US$10 per tonne.

As well, Deutsche Bank notes there are indications from a number of market sources that physical lead is in very short supply, as recyclers are producing less. This has meant premiums in Europe have hit levels of US$100-$140 per tonne, the highest since 2008. US premiums are also at all-time highs.

Deutsche Bank notes lead demand generally picks up at this time of year given increased demand for batteries, but even allowing for this the supply squeeze has surprised many in the market. 

A key element of the supply shortage in Deutsche's view has been the build in LME tonnages. Much of the lead is being held in financing deals, meaning it can take several months for a tonne of lead to exit. Deutsche sees potential for this financing impact to be long-lived, which implies premiums will remain high and the perceived scarcity of available metal may also support LME prices.

On the demand side of the market Deutsche sees potential for some improvement in growth in the final quarter of this year, particularly as economic data are showing signs of stabilising. The broker remains cautious though, as any new threat to global economic growth could see a reversal in lead demand.

In the nickel market, Standard Bank suggests there remains the risk of potential disruptions to the supply side, and nickel to date has underperformed the bank's expectations. The bank's numbers imply as much as 800,000 tonnes per year of nickel capacity is potentially at risk of some sort of disruption over the next 12-18 months. 

To reflect this Standard Bank has revised its forecasts for nickel market balances for both 2012 and 2013, this year moving down to 48,000 tonnes and next year to 35,000 tonnes from previous forecasts of 59,000 tonnes and 42,000 tonnes respectively.

This reflects further delays and disruptions to most of the new generation of nickel projects. With potential for supply to continue to underperform expectations, the bank forecasts it would only take the unplanned loss of an additional 30,000-40,000 tonnes of nickel to bring the market back into balance.

The demand side of the market remains weak, so Standard Bank notes some producer discipline is required to help bring the market closer to balance. Increased warehousing and financing demand could also help absorb the surplus, something the bank suggests could potentially benefit premiums in the future. This would likely be at the expense of current prices.

Turning to silver, Standard Bank notes demand for the metal for industrial applications fell from 500 million ounces to 487 million ounces in 2011, highlighting weakness in global manufacturing. 

One sector of the silver market to still perform strongly last year was photovoltaic (PV) demand, which Standard Bank estimates increased to around 75 million ounces in 2011 from about 50 million ounces in 2010. This suggests without the increase in PV demand, overall industrial demand for silver would have fallen by 7.7% I year-on-year terms rather than the 2.7% fall experienced.

Looking forward, Standard Bank suggests it is unlikely PV demand can continue to support industrial demand for silver. While solar energy capacity building continues, the outlook for European solar energy is worsening and this is an important market.

European Union PV build accounted for 74% and 79% respectively of total world new build in 2012 and 2011, this in large part to government support such as feed-in tariffs. New austerity measures suggest these support measures are now at risk, something Standard Bank suggests would result in a significant drop in silver demand.

Standard Bank's forecasts are for PV demand for silver to fall to 52.3 million ounces in 2012 and 53.2 million ounces in 2013, which would be down nearly 20 million ounces from 2011 demand levels. This leads the bank to suggest any upside in silver into next year will rest primarily on investment demand.

Standard Bank forecasts an average price for silver in 2013 of US$33 per ounce.

Turning to the LNG market, Deutsche Bank suggests while the risk US exports place substantial downward pressure on pricing is real but is being overplayed in the market. There are three factors in support of this, the first being Australia is dominated by LNG projects with existing contracts, which will limit any impact.

Another factor noted by Deutsche is the Pacific Basin LNG market is not homogenous, which offers scope for different pricing benchmarks in different regions. As well, brownfield expansions are less exposed to any threat from the US given better project economics and the potential to leverage existing production and customer relationships.

At present, Deutsche expects the US could export between 30-50mmtpa of LNG by 2020, with prices likely linked to Henry Hub pricing. This would price US LNG exports at a meaningful discount to existing contracted Australian LNG prices.

This has some significance given Asian buyers continue to talk up the benefits of diversification and cheaper LNG sources, but Deutsche argues Henry Hub prices are currently subdued and any recovery to historical levels occurs the cost advantage of US LNG could quickly dissipate. 

As well, Deutsche suggests Asian buyers are likely using the spectre of cheaper US LNG as a bargaining tool for better contract prices with Australian suppliers. This could also help narrow the gap between current Australian LNG prices and potential US prices. Given the global LNG market is primarily a long-term contract market there is likely to be little impact on existing projects.

While there are at least 16 identifiable North America LNG export proposals Deutsche takes the view exports may prove problematic, as no projects to date with the exception of Sabine Pass have made much progress with LNG buyers and the regulatory environment remains uncertain.

As a result, Deutsche continues to take a positive view on Australian companies exposed to the LNG market, rating Oil Search ((OSH)), Woodside ((WPL)), Santos ((STO)), Aurora Oil and Gas ((AUT)), Karoon Gas ((KAR)) and Drillsearch ((DLS)) as Buy, while Origin Energy ((ORG)) is rated as Hold.

Sentiment Indicator readings for these stocks according to the FNArena database stand at 1.0 for Santos and Karoon Gas, 0.9 for Origin, 0.6 for Oil Search, 0.4 for Woodside, 0.3 for Drillsearch and minus 0.2 for Aurora.
 

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