Commodities | Jul 08 2013
-Thermal coal market could re-balance
-Steel oversupply to persist
-CIMB likes copper
-Nickel, aluminium expansion curtailed
By Eva Brocklehurst
Volatility has been the name of the game in commodities over recent months as investors take on board the scaling back of the US Federal Reserve's quantitative easing program as well as the credit squeeze in China. Expectations that US interest rates will be tightened sooner rather than later have led to pressure on commodities, coupled with a stronger US dollar. National Australia Bank analysts find global financial markets are not ready for tighter monetary policy settings and prices, particularly for mineral commodities, have fallen in June.
Despite this scenario, West Texas Intermediate (WTI) crude oil continued to firm relative to Brent and Tapis. The WTI to Brent gap narrowed to its lowest point since the beginning of 2011 to be around US$5. The expansion of capacity to divert inventory away from the US distribution hub of Cushing to the refineries on the Gulf Coast reduces the cost of transporting crude oil to refiners. This has been instrumental in closing the price gap. Most of these projects are expected to be operational by 2014. On the Brent side, there continues to be very little impetus to prices. This is because of a fragile global economic recovery which is suppressing demand as well as current supportive supply conditions.
In line with other bulk commodities, prices for thermal coal have eased and NAB analysts note the global market is well supplied, despite considerable margin squeeze. Something that could reverse this situation is the move by the Indian government to allow some power companies to pass on the costs of foreign coal to customers. Imported thermal coal could surge as a result. CIMB notes recent import volumes in India have been very strong, up 120% year on year for the March quarter, and, if this continues, the market could re-balance very quickly.
Meanwhile, it seems increasingly apparent that Chinese authorities are intent on addressing some of the overheating sectors of the economy, so prospects for an acceleration in steel demand are fading. CIMB suspects, with strong supply growth coming over the next six months, iron ore and coking coal prices may come under further pressure this year. NAB analysts find downstream demand for steel remains sluggish and, while there have been production cuts at some steel mills, there continues to be an oversupply that is expected to persist for some time.
Falling steel prices have in turn forced producers to push for lower raw material costs. Consequently, coking (met) coal prices continued to come under pressure in June. June also witnessed the commencement of negotiations for coking coal contract prices for the September quarter. It has been reported that Nippon Steel and BHP Billiton ((BHP)) settled the Q3 contract price for premium coking coal at US$145 per tonne (FoB), slightly below NAB analysts' expectations of US$150 per tonne and 16% lower than the June quarter contract. There are two sides to this. Quarterly contract prices have fallen to their lowest-ever levels (quarterly pricing commenced in 2010) but appear to have settled at a premium to prevailing spot prices.
A number of factors have combined to create a liquidity squeeze in China and interest rates are up sharply. Moreover, authorities seem willing to allow tighter credit conditions to remain. Chinese demand is an important driver of base metals prices, so the emergence of credit concerns has directly had their effect. While average prices over June increased for some of the metals, NAB analysts observe a clear down-shift in prices of all of the metals over the second half of the month. In aggregate, base metals prices on the London Metals Exchange (LME) fell by 2% over June, consolidating a 1% decline over May, to be around 5% lower over the year.
CIMB has noted that the low prices are beginning to curtail expansion of nickel, thermal coal and aluminium supply and this, in turn, should relieve the downward pressure on prices. The analysts believe there are several opportunities in commodities, driven by supply-side issues. Copper is CIMB's stand-out commodity. There has been some heavy selling but with prices well below cost-support levels, the extent of the selling is considered unwarranted. NAB analysts also note that the average price of copper was off 3% over the month but this could partly reflect increased supply projections, following the re-opening of Freeport's Grasberg mine in Indonesia after a tunnel collapse towards the end of May.
The average price of nickel for June was around 4.5% lower than its May average. The sharp deterioration in price largely reflects the global supply glut that is forming as a result of a lack of demand from Japan. Furthermore, a surge in the production of nickel pig iron, a substitute for low-grade ore, means Chinese stainless steel makers lowered consumption of nickel. Aluminium and zinc prices were little changed over the month. The price of lead actually strengthened and was up 3% compared to its May average. While the supply of lead is currently in surplus, NAB analysts expect the lack of available scrap metal will tighten market balances over the forecast horizon, and this appears to be helping to support prices at current levels.
NAB analysts believe that the downside risks to metal prices that abound are potentially mitigated by a moderation of Chinese credit growth, because this could lead to less likelihood of a sharp correction in the Chinese property market. Furthermore, CIMB expects China to grow by 7.5-7.8% this year and easing inflation and weak economic data bolster the case for lower interest rates and more fiscal spending to support growth. Chinese authorities are expected to accept more modest growth around 7% per annum before stimulating the economy back into action but are also mindful of re-balancing the economy towards consumption and away from investment-led growth. Financial stability is seen by CIMB as the priority for Beijing, maintaining an eye on property prices, local government borrowing and shadow banking.
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.
