Material Matters: Copper, Aluminium And Gas

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-Chile ships most raw copper to China
-Citi queries aluminium deficit
-APA, Origin Energy best placed in gas
 

By Eva Brocklehurst

The gap between mined and refined copper output in Chile, the world's biggest producer, has widened. Macquarie cites statistics which reveal Chilean mine output surged last year and broke out of a range that has endured for a decade. Despite this, a production downtrend is expected to continue as tailings dams are reduced and Radomiro Tomic comes to the end of its life. Macquarie thinks that maturing assets and a lack of attractive new projects signals that this year could see a peaking of copper output. The broker also notes a lack of new smelter developments, and increased environmental legislation, means that all growth in supply is being exported as concentrate from Chile rather than as cathode. The prevailing business model seems to be about shipping raw material to China for further refinement.

Emphasising this development, Macquarie notes Chile's copper cathode exports fell 7.4% in 2013 to be at the lowest levels since 2000, but concentrate exports to China rose by 50%. Macquarie suspects, with no new smelter capacity on the horizon, any expansion by Chile's Codelco is likely to add more supply to concentrate exports. Macquarie wonders if, given there is an incentive from a revenue standpoint, Chilean smelter output can rebound from current lows. Whether the current tightness in cathode markets remains prolonged, or eases through this year, hinges heavily on whether Chilean, and global smelter output for that matter, stage a rebound from current levels.

Weak aluminium prices are pointing to a major oversupply in the metal but Citi thinks the market indicators for aluminium are conflicting. The London Metals Exchange 3-month prices imply a market that's in significant oversupply, despite the closure of smelting capacity around the world over the last two years. Physical premiums are at record highs, resulting in full prices being seen in North America, whether they're up almost 20% since July 2009, in Citi's calculations, and even up by 5% since the beginning of this year. This has led to speculation there's a deficit. Citi thinks this is fanciful. Chinese smelting capacity is being built out and the country is increasing its exports of semi-refined aluminium. There's also significant growth in Middle Eastern production. According to the analysts, there's limited supply of readily available metal and a strong financing demand that's being wrongly seen as a signal of a developing deficit.

Citi suspects premiums were largely elevated in 2013 because of regional cuts to production and the impact of a resurgence in contango financing demand. This form of demand competes for physical metal with fabricators, limiting the availability and driving up premiums. Citi expects global aluminium production will grow by 4.9% in 2014, driven by a 10% increase in Chinese output. The analysts continue to expect a market surplus in 2014, albeit at a reduced level. They point to the fact that China's aluminium consumption tends to receive undue attention. This is typically first use consumption, such as the initial fabrication of semi-finished products. Hence, there is a statistical over-estimation of consumption, given that a significant volume of the aluminium semis are exported. This means that China's growing surplus will more than compensate for a Western world shortage, in Citi's view.

Goldman Sachs notes Queensland LNG exports are fast approaching, driving a tight, internationalised and less certain gas market. The analysts expect east coast gas prices to rise to $7.50/GJ by 2020. The new gas contracts are expected to be defined by LNG net-back pricing for the next 4-5 years and higher prices will weigh against domestic consumption by power generators and industrial users. The analysts expect this will reduce the competitiveness of gas-fired generators and production will be curtailed significantly.

The greatest risk is with generators such as AGL Energy's ((AGK)) Torrens Island and Origin Energy's ((ORG)) Darling Downs, Mortlake and Ladbroke Grove. These generators are at risk of closure by the end of the decade if the higher gas prices are realised. Goldman expects APA ((APA)) will benefit from increased gas transmission and storage demand, while Origin will be a net beneficiary of rising prices. Origin has a net long position in gas towards the end of this decade, which will only be partly offset by lower earnings from its base load, gas-fired generators. In contrast, AGL is expected to be negatively impacted as it has a short position in gas. Goldman has Neutral ratings on AGL and Origin and is restricted on APA, given it is acting as a financial advisor on a matter.

Goldman Sachs expects higher prices will force a contraction in domestic consumption of gas on the east coast out to 2020. Based on forecasts, this may provide incentives for some mass market gas customers on the eastern seaboard to switch fuels. The chemicals, glass and refining industries are expected to be the most sensitive to the price hikes. In the case of fertilisers, this is expected to weigh heavily on producer cost competitiveness. A material increase in wholesale gas prices could cause a number of the more structurally challenged industrials to curtail or even mothball production.

The analysts consider that, amid higher gas prices, Shell's Geelong refinery and ExxonMobil's Altona refinery may be compelled to close. In NSW, there'll be lower gas usage from the cessation of refining by Caltex's ((CTX)) Kurnell and Shell's Clyde refineries. Goldman thinks a number of glass manufacturers are also at risk. In Queensland, the analysts cite Incitec Pivot's ((IPL)) plant on Gibson Island as at risk, particularly following the expiry of the current gas supply contract in 2017. 
 

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