Material Matters: Aluminium, Nickel And Energy Stocks

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-Aluminium premium reflecting deficit
-Bell Potter picks Sirius in nickel
-M&A theme emerges in energy
 

By Eva Brocklehurst

The outcome of years of producer restructuring in response to price has now surfaced in the aluminium market. The market is moving towards the first annual deficit in six years. Production cuts and delays to ramp-ups in new smelting capacity has led to JP Morgan changing views on the 2014 primary aluminium balance. The analysts have lowered the 2014 forecast to a deficit of 176,000t from a surplus of 435,000t. They maintain a surplus forecast for 2015, but envisage it will be small. Outside of China, Africa and the Middle East, production is flat or falling, as producers idle higher cost capacity. Middle Eastern production of aluminium was up 14% in the March quarter with expansions in Abu Dhabi and Saudi Arabia. This was not enough to offset declines elsewhere.

JP Morgan now expects aluminium production, ex China, to rise by 1.7% this year compared with a prior forecast of 3.6%. Deficits in both the US and Europe are expected to increase and Brazil is also expected to book a domestic deficit this year. In China, the analysts maintain that new capacity is coming on stream with lower costs and is being built faster than demand is growing. This is likely to result in a continuation of weakness in domestic aluminium prices. Given the differential with London Metal Exchange prices the analysts expect Chinese imports of primary aluminium to drop sharply and exports of fabricated products to rise.

JP Morgan is making no changes to forecasts for cash prices. One of the reasons is that production cost support continues to move lower, with 2013 global average cash costs around US$60/t below 2012. Inventories are expected to be more important for price formation in the early stages of the move to a deficit, involving a net draw down on those stocks. The analysts expect increases in total delivered prices to work through an increase in physical spot premiums rather than through an increase in cash prices.

The nickel price has risen around 30% so far in 2014, mostly because of supply concerns associated with the export ban in Indonesia, the potential for sanctions to affect Russian supply and delays in commissioning of large laterite projects. Bell Potter assumes nickel prices will average US$7.22/lb this year and US$7.75/lb in 2015, with upside risk.

Bell Potter estimates that, prior to the ban, Indonesia was probably supplying around one third of China's nickel metal units. Russia accounts for around 15% of global supply and two thirds of global supply in 2013 was provided by the top 10 nickel producers. Large nickel laterite projects, such as those operated by Glencore, Xstrata and Vale, are currently operating at around 50% of capacity and this low utilisation rate is expected to increase to just 60% in 2014. Hence, the broker expects consolidation among nickel sulphide producers as laterite sources of supply remain at risk.

Further to this theme, BHP Billiton ((BHP)) has signalled divesting its non-core Nickel West business and Bell Potter believes this could be a catalyst for consolidation in the Western Australian nickel sector. Nickel West sources over 35% of its upstream nickel units from third parties. To Bell Potter, this makes Western Areas ((WSA)) and Sirius Resources ((SIR)) the best positioned to participate in any consolidation. Sirius Resources is the broker's top pick in terms of value and corporate appeal, while Western Areas has strategic appeal but is considered fully valued. The other key Australian nickel stock is Independence Group ((IGO)). The stock is more diversified, with a precious metals business accounting for half its value, and Bell Potter also considers the stock fully valued.

The theme that emerged in the March quarter production reports from the mid cap energy sector was not exploration results or production growth but rather mergers and acquisitions, according to Macquarie. In this the broker names the Baytex proposal to acquire Aurora Oil & Gas ((AUT)) and the proposed merger between Horizon Oil ((HZN)) and Roc Oil ((ROC)). Average Brent crude prices were in a tight range, around US$108/bbl in the quarter. Macquarie continues to expect demand will be led by emerging markets and remain flat in developed markets.

Production challenges in the mid cap sector were felt by Drillsearch Energy ((DLS)) and Senex Energy ((SXY)), while Aurora delivered its eighth consecutive quarterly increase and Carnarvon Petroleum ((CVN)) a 28% increase. Total development spending fell 17% in the quarter with most companies recording a fall. Roc Oil and Horizon Oil cut spending by 66% and 46% respectively, as Beibu Gulf construction rolled off. Beach Energy ((BPT)) and Senex Energy cut spending by 37% and 58% respectively. Macquarie still expects developments capex will increase by 10% in 2014 and that the March quarter lull may simply be a timing issue. Exploration activity rose by 20% in the quarter and Macquarie also thinks the sector's exposure to exploration is set to increase.

Macquarie considers the sector still offers value, although it has become a little more expensive. For those with oil exposure, the broker estimates the sector is discounting an oil prices of just US$67/bbl which compares to spot Brent at US$108.5/bbl and the broker's long-run forecast of US$107/bbl. The broker's preferred exposures are AWE ((AWE)), as management targets a doubling of production and tripling of operating cash flow, Horizon, as the granting of the Stanley licence will de-risk the next leg of growth, and Senex, as, despite the early onset of decline at Growler, the company has encouraging results elsewhere.
 

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