Commodities | Dec 04 2013
-Iron ore heading for excess
-Chinese power demand rebounds
-Copper oversupply to fade
-Zircon prices still under pressure
-Titanium dioxide to gradually improve
By Eva Brocklehurst
Australia and China are the most relevant countries when it comes to the iron ore market and they are diverging. Goldman Sachs notes, on the demand side, China has demolished 10 blast furnaces in Hebei, signalling a peak is imminent in steel-making capacity. On the supply side, Australian iron ore capacity is expanding. While the analysts are not suggesting capacity is equal to production, the divergence of the two sides of the market signals a growing imbalance. Moreover, the mining sector's focus on productivity and efficiency will result in volumes that gradually converge on, and in some cases exceed, nameplate capacity. Goldman Sachs believes, with 20:20 foresight, miners would have stopped new projects for some commodities as early as 2010 but this sort of foresight doesn't exist and the seeds of further oversupply have been sown.
Iron ore prices have traded in a narrow range during the month of November and remain in line with the year to date average of US$135/t. Goldman thinks the iron ore market will move over the next two years from a state of high prices and seaborne balance to low prices and excess supply. The market is expected to overshoot and sustain a period of below trend pricing up to 2015, before stabilising at around US$85/t, which is the analysts' long-term estimate of cost support. As further evidence of the peaking of steel, Goldman notes metallurgical coal prices have continued to decline as ample supply is met with limited buying interest and high inventories at steel mills. Spot prices are now US$12/t below Goldman's US$150/t estimate of cost support and barely US$2/t above the iron ore price.
Meanwhile, demand from the Chinese power sector is rebounding, with output from conventional plants up 19% in October, year on year. Domestic coal prices have posted the first recovery since the collapse of prices in the second quarter of 2012. This should provide some opportunity for higher seaborne prices, in Goldman's view. Nevertheless, upside potential is modest as the analysts consider the Chinese market remains well supplied. The import price differential between seaborne and domestic thermal coal has widened to US$6/t, suggesting some near term upside for seaborne import volumes and prices.
Global refined copper supply should end the year in balance, according to Morgan Stanley. The analysts think it unlikely that significant market surpluses will emerge between now and 2015. This contrasts with consensus expectations of a substantial oversupply. Morgan Stanley thinks it was an acute copper scrap shortage that was behind the prevailing tight market conditions, most prevalent in China where many scrap consumers were forced to supplement with other forms of copper. Caution may be warranted regarding the coming supply. Having examined 11 projects, or 60% of total capacity additions for the next two years, Morgan Stanley thinks start-up has slipped on a number of these developments. This is likely to affect new supply going forward. Morgan Stanley has increased copper demand forecasts by around 2% for 2014 and 2015. The models are showing a nearly negligible surplus in 2014 and just 76,000t in 2015.
Macquarie has also reviewed another copper conundrum. Mine output is growing at the fastest rate in a decade and refined production is rising – all indicating the copper market is in surplus. What doesn't fit that scenario is the visible stocks of copper, which have continued to be drawn since the LME announced plans for warehouse consolidation, suggesting the market is in deficit. Much of the stock has ended up in China amid a combination of consumer re-stocking plus tight credit that supported demand for copper financing, some of which has appeared in bonded warehouses. Nonetheless, this does not fully account for the draw in exchange stocks. Following the chain of sales, Macquarie finds that the global copper surplus appears to have been exported to Vietnam, with that country's imports this year roughly triple annual consumption. Vietnam does not have LME warehouses. Based on the trade statistics, exporters ship only very small volumes to Vietnam. Hence, this "invisible" inventory should serve to cap the upside in the copper price and could add momentum to the downside if the position is unwound.
Zircon demand has been weak and is likely to stay erratic under spot pricing. Credit Suisse has been alarmed by the extent of the collapse in demand in the September quarter. Chinese tile production, which appears to mirror zircon demand, has fallen since June. Credit Suisse finds this hard to explain, unless there is a delay in fitting out houses, or the intensity of use of tiles in China is sliding. Both these factors provide some reason for the weakness. At any rate, Credit Suisse expects restrictions to production by the major producers will need to be in place for another two years and price rises for zircon in 2014 are considered unlikely.
Titanium feedstock is also soft and prices are unlikely to rise until pigment margins are positive. This requires an end to de-stocking. Credit Suisse notes the northern winter brings a seasonally weak period for demand and so increases to feedstock price forecasts have been scaled back for next year. Citi thinks the titanium dioxide outlook will improve and is on track for gradual recovery by 2016. The analysts thinks the downturn was related to inventory rather than just demand, or lack thereof. Demand growth of around 3.2% should outpace effective supply growth of around 2.5%, particularly considering a US housing recovery and improving Chinese demand. This broker also expects prices to bounce along the bottom before recovering. While the end to de-stocking and a cyclical recovery should be positive for feedstock producers the recovery is expected to be predominantly volume driven. Prices are expected to be capped by a combination of feedstock supply growth and Chinese pigment producers running at lower utilisation rates.
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