Material Matters: Coal, Zinc, Mineral Sands and Fertiliser

This story features ILUKA RESOURCES LIMITED. For more info SHARE ANALYSIS: ILU

-Coal production cuts yet to make a mark
-Indonesia coal shut-downs
-Chinese zinc output may be overstated
-Mineral sands outlook weak
-Challenges for urea

By Eva Brocklehurst

For coal, production cuts by miners are yet to make a mark on supply/demand metrics and it may be up to a cold US winter (demand) or wet Australian summer (supply)  to get prices off the floor, according to JP Morgan. Thermal coal stocks are historically high and US as well as Chinese utilities are not actively signing long-term contracts. Meanwhile, the broker has never seen utilities more active in the spot coal market. A pick-up in Chinese steel production should help coking coal, but there's been no significant recovery in the price as it continues to bounce along the bottom at around $153/t.

Hence, JP Morgan is lowering its price forecasts for 2013-2014 for both thermal and coking coal, believing that, without a robust pick up in demand, supply cuts alone will not lift coal prices. The broker has cut coking coal forecasts by 6% and thermal by 13%. Coking coal should recover as Chinese steel rebuilds inventory and JP Morgan expects Chinese steel production to grow by 5% in 2013. Chinese thermal coal remains well supplied but there may be near term support from seasonal factors.

Over in Indonesia the broker notes junior miners are shutting down operations and volume from the small miners could decline by 20% in FY13. The larger miners are facing a re-pricing threat as, at the current spot price, about 40% of their volume is loss-making. So, maybe even deeper production cuts are needed to underpin Asian coal prices. A factor that may have an impact is whether US producers continue to export coal into global markets. Excess US thermal coal was sold into global markets in the first half of this year, depressing prices. Now, US exports seem a little too expensive to price internationally but JP Morgan believes miners are still motivated to maintain markets. Meanwhile, India's outlook hinges on the outcome of the central government's proposed restructuring of debt from distribution companies and state agreement on sharing the burden. The broker believes this will be resolved and it should result in sharply higher Indian thermal coal imports by 2014.

Macquarie expects zinc demand to improve next year. After attending the Antaike conference in China the broker notes most delegates expect the Chinese economy has already bottomed out, with potential for acceleration in demand at the end of this year and continuing into 2013. Reasons cited for the improved demand are continuing investment in the infrastructure sector and expectations of modest recovery in the construction sector, which has been struggling from lack of confidence among property developers. In general, market expectations for 2013 are still cautious, especially for zinc as a result of the rapid and substantial ramp-up of zinc mine output.

Here's where it gets a bit interesting. Macquarie notes discussion at the conference was focused on the increase in zinc mine output reported this year in China. Most delegates believed zinc mine output had been overstated by upwards of 40,000-50,000 tonnes per month for contained zinc, attributed mainly to an overstatement of output in the Inner Mongolia and Guangxi provinces. Macquarie notes this could be because provincial governments were striving to reach economic growth targets, as well as possible mishandling of data on a gross-weight basis, for which estimates of contained metal may be erroneous.

Reported zinc mine output was up by 18% year-on-year (Jan-Sep) at 3.67mt contained zinc, according to the latest available data. However, Antaike estimates that production has probably risen no more than 12% and forecasts total output for the year to be 4.7mt. Antaike's forecast of refined production, by comparison, was around 4.8mt, which would be around 8% lower than in 2011. Macquarie says this would leave China with little need to import zinc concentrates and, although arrivals are down year-to-date, the total has not fallen far: evidence of a surplus in the market for zinc concentrates and why many are cautious about the price potential in 2013.

It's also not looking so good for mineral sands. Zircon will remain in oversupply as tile manufacturers reduce use, according to Goldman Sachs. Following a period of scarcity and high prices, ceramic tile manufacturers have learned to live with a lower amount of zircon. Based on industry sources, Goldman believes that the process of substitution (e.g. mixing zircon with alumina) and demand destruction (e.g. removing zircon from the tile body) is structural, and the zircon market will be oversupplied for an extended time. The outlook for titanium dioxide feedstocks is relatively better. Goldman expects demand to contract in 2012-13 but the contraction is likely to be milder and shorter relative to zircon demand. Again, China should account for most of the expected demand growth, and this will drive demand for sulphate grades in particular.

This doesn't augur well for Iluka ((ILU)), the largest zircon producer globally. Goldman says Iluka has to take the lead in reducing production to balance the market. The broker expects it will take a year or more before there is a substantial return to previous production levels of around 450,000t per annum. In the case of high-grade feedstock, Goldman expect the price of rutile and synthetic rutile to fall to reflect the “value-in-use” in comparison to chloride slag. Thus, Iluka's production and sales volumes for these products should recover moving into FY14. Goldman has derived its target price ($7.33) on a more heavily weighted near-term earnings multiple and moved the stock to a Sell. It's not just Iluka, the broker has lowered the expected 12-month returns on all the minerals sands producers and developers.

Macquarie also moved Iluka to Sell (Underperform) this week, balancing the five Buys and two Holds otherwise unchanged in the FNArena database.

Evy Hambro, chief investment officer of BlackRock’s natural resources equity team, has taken a much longer-term view of resources companies. He believes that many people underestimate the scale of demand in China that's here to stay. "In the face of even modest assumptions around demand, supply may struggle to keep pace, especially as mining companies defer growth plans," he noted."Indeed, looking forward a few years, it is possible to see deficits opening up in some metals markets. This is a sector that is rife with investment opportunities." Mr Hambro suspects current mines will be unable to meet global demand after 2015.

Citi has put the spotlight on the challenges facing urea producers in SE Asia. First, in India there's been a decision to cancel the planned 1.4mmt urea project in Kalol as the organisation could not secure commitments from the government for access to natural gas. Second, one of Pakistan's largest fertiliser companies, Fatima, is looking to Africa to build new urea plants, given challenging feedstock availability in the country. The two countries account for around 23% of global urea consumption. These developments should benefit producers in the Middle East and China, Citi maintains. Global fertiliser markets are weakening and seasonal pressure is likely to remain through the end of the year. Citi also notes a lack of certainty regarding potash contract signings is keeping pressure on prices. Trade publications report that China is pushing for a potash contract below $400/mt CFR (last contract was $470/mt), as domestic prices have fallen nearly 15% since the start of September. Citi prefers exposure to nitrogen, citing ample incentive for US farmers to plant another large corn crop in 2013, which is supportive of fertiliser and seed companies. 
 

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