Material Matters: Oil & Gas, Chinese Demand And Softs

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-Big year ahead for LNG
-Chinese demand to pick up
-Investors favouring quality
-Better outlook for Oz beef
-Thai gold demand decline
 

By Eva Brocklehurst

What can the market expect from Australia's oil and gas sector in the upcoming March quarter production reports? UBS expects the first signs of higher pricing for LNG from Woodside Petoleum's ((WPL)) Pluto facility as legacy contract prices are phased out. Exxon, operator of PNG LNG, recently confirmed ramp-up was running ahead of schedule and budget, which the broker thinks could prompt another production guidance upgrade from Oil Search ((OSH)). The first LNG production from PNG should benefit stakeholders Oil Search and Santos ((STO)). Meanwhile, Santos' Gladstone LNG project is expected to commission its pipeline soon.

From Beach Energy ((BPT)) and Drillsearch ((DLS)) the broker will be looking for confirmation that Western Flank oil production in the Cooper continues at plateau rates and whether recent drilling success will extend this plateau period. Similar confirmation is sought in the case of the Beibu Gulf from Roc Oil ((ROC)) and Horizon Oil ((HZN)). Over the March quarter the best performing stock in UBS' energy coverage was Aurora Oil & Gas ((AUT)), operating in the US shale fields, thanks to the Baytex takeover bid. In contrast, Karoon Gas ((KAR)) suffered from the failed Grace exploration well.

UBS is still expecting the WTI oil price to fall through the second quarter to US$100/bbl, because of weaker demand growth and increasing supply from the US and Iraq. UBS notes the market seems to have shrugged off concerns around Ukraine. The broker's bearish long-term view is forecasting the long term oil price at US$92/bbl from 2017. UBS has raised 2014/15 US natural gas forecasts to US$4.75/mmbtu and US4.50/mmbtu respectively and maintained the long-term gas price forecast of US$5/mmbtu, although there is upside risk as the broker is bullish on long-term gas demand.

Citi suspects Chinese commodity demand has reached a cyclical low and growth should pick up as the year progresses. The analysts note recent signals of increasing government concern and a desire to support infrastructure investment and social housing. That said, Citi does not expect a large stimulus package along the lines of 2012. Rather, just as the slowdown last November was driven primarily by credit tightening last April, some easing of policy in the current quarter suggests better industrial demand in the second half of the year. This should add up to a better performance for most commodities but the most leveraged to an improvement in Chinese demand, in the broker's analysis, are steel, iron ore, metallurgical coal, zinc, copper, soybeans, LNG, naphtha and fuel oil. Incorporating supply considerations, Citi thinks steel, zinc, copper and LNG provide the best exposure to an improvement in Chinese demand.

Morgans believes resource sector stock investment is being steered towards the quality names, noting a bounce in valuations. The sector has been tough to call recently because commodity prices have been volatile and valuation multiples, in some cases, are at historical lows. The broker thinks there are some good companies for which share prices have not increased significantly. Morgans concedes it is too early to move on unfunded developers or early exploration plays but the process of identifying these, and singling out those with good resources and good management, should be in train. One of the stocks that caught the broker's attention is MetalsX ((MLX)), which is looking to expand on a number of fronts. Morgans' suggests MLX's valuation, much lower than the company's peers, is due to a lack of clarity on mine life for the company's Kalgoorlie assets. Morgans suspects this will change as production is expanded in 2015 and new projects such as Central Murchison are brought on line.

ANZ analysts believe sentiment in commodity markets appears to be turning more positive after a first quarter fraught with tight liquidity, soft demand and oversupply. These analysts also think the Chinese authorities are trying to shore up confidence. New supply dynamics in some markets such as copper and iron ore could curtail the gains. In the case of iron ore, increased supply from Australia is expected to cap prices, despite a seasonal pick-up in demand through the second quarter. If Chinese steel inventories continue to decline, the analysts expect further short covering in the market and this could prompt higher iron ore prices down the track. The analysts are generally positive about base metals but there is a supply overhang in a number of markets. The decline in global copper prices has resulted in a squeeze on copper scrap and has, in turn, forced some refiners to source higher quality cathode, particularly in the US and Europe. The analysts think this will keep end-user demand robust but is unlikely to avert the fourth straight year of copper surpluses.

The analysts are most bearish about soft commodities and proteins. In sugar, a large crop in Thailand is a negative for prices over the next six months. In Australia it's the opposite. Yields for the June harvest are reduced and Cyclone Ita is likely to have reduced volumes in the far north. Low prices are inhibiting a rebound in Australian production with current prices providing a margin return for most producers. In cotton, the April US supply and demand report showed stocks at the lowest level in 20 years. Nevertheless, the analysts observe this tightness is already priced in and demand at the yarn and fabric stage is reported to be weak across Asia. Moreover, the widening disparity with synthetic fibre does not bode well for cotton prices, in the analysts' view.

The ANZ analysts believe the preferential tariff rates that Australia has recently negotiated with Japan should provide a boost to Australian beef prices in 2015. Australia is the first global supplier to gain preferential tariffs on chilled and frozen beef into Japan. This is likely to coincide with high global beef prices and a normal wet season in northern Australia, reducing Australian beef supply next year. US slaughterings are down 8% year to date with the profit incentive for US farmers to retain heifers and cows remaining high. The analysts expect Australian beef prices to dramatically outperform over the next 12 months, partly related to a weaker Australian dollar, which the analysts expect to fall to US84c by early 2015.

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