Commodities | Oct 06 2014
-Chinese met coal also in oversupply
-Iron ore at US60-70/t may be needed
-India, China slowing will weigh on crude
By Eva Brocklehurst
China's economy is gradually shifting. Domestic steel consumption is growing at a fraction of its historical average as liquidity diminishes and credit tightens. Despite the fact seaborne metallurgical (coking) coal prices are at 5-year lows Chinese imports are, in the year to date, down 18%. Goldman Sachs does not envisage any obvious catalysts for a recovery in the price in the near term. Faced with a depressed market, many loss making mines have delayed production cuts in the hope of a recovery but these operating losses cannot be sustained indefinitely. The broker notes the closures are now equivalent of 10% of annual seaborne demand.
In principle, cuts of this scale should be sufficient to bring the seaborne market back into play but this is undermined by the completion of new projects and cost deflation, particularly in Australia, while any recovery remains highly dependent on Chinese demand. In this case the broker notes the Chinese domestic market is also suffering oversupply and demand growth has struggled to absorb the output. China sets the price ceiling for the seaborne market by virtue of its size and the broker now expects a more protracted recovery in the price.
Goldman expects an eventual return to its US$140/t estimate of marginal cost by 2017 but the pace of recovery will be gradual. The broker downgrades spot price forecasts for 2015, 2016 and 2017 by 10%, 4% and 3% respectively and, over that period, producers with weak balance sheets and/or with limited scope to improve the competitiveness of their assets are expected to remain vulnerable. That said, cost deflation is shifting the cost curve lower and Australian producers are benefitting from a weakening of the currency.
Iron ore supply also continues to overwhelm demand alongside a supply chain wary of overstocking. Commonwealth Bank analysts observe limited structural catalysts on the scene for a price recovery and expect iron ore prices will continue on a prolonged down cycle pushing well into the cost curve. Supply is still expected to grow this year, albeit at a slower pace, as loss making supply slowly departs. Loss making miners appear to be delaying decisions to stop producing and this is partly because Chinese mine costs are falling. This reduction in costs is attributed to a lower cost of diesel, balls for grinding mills, salaries, taxes and maintenance costs. These cost cuts translate to a US$5-8/t reduction in costs and cost curve support for iron ore prices, in the analysts' calculations.
Prices should receive a lift in the seasonal re-stocking ahead of the Chinese winter and move back towards US$90/t by the end of the year. Nevertheless, ultimately, a price around US$60-70/t may be required to re-balance the markets, in the analysts view.
CBA analysts have also downgraded crude oil benchmark forecasts by 10% for FY15 and by 1% for FY16 on mounting concerns regarding a surplus. An increase in US crude output reflects a lift in US oil rigs to near record highs thanks to hydraulic fracturing and horizontal drilling in shale oil deposits. OPEC has also conveyed a similar message to the market, currently pumping more than it is required to produce in 2015. Saudi Arabia and other OPEC members are considered likely to compete for market share and serve to further the oversupply. Nevertheless, the analysts are wary that lower oil prices over a longer period of time might instigate a reversal towards price maximisation and not market share, given OPEC member countries' fiscal break-even was in the US$90-100/bbl range in 2013 and is likely to be rising.
If geopolitical risk is being factored into current prices -stemming from tensions in Ukraine, Iraq and Libya – then the analysts believe there are other potential downside risks to crude oil prices should global tensions ease. In this instance, Libya, in particular has potential upside for output if violence abates. Meanwhile, economic growth trends are weighing on demand. OECD demand is largely unchanged from a year ago and world crude demand growth is being driven primarily by non-OECD countries, such as India and China. The analysts believe these two countries are witnessing the greatest threat to trend economic growth in the short term and this is expected to weigh on crude demand over the coming year.
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