Material Matters: Oil, Iron Ore And Base Metals

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-Will OPEC cut production?
-Cooper unconventional still prospective
-Aluminium benefitting from US demand
-Forward demand for nickel a concern
 

By Eva Brocklehurst

Oil markets continue to face downward price pressure. Libyan production has increased and global economic concerns are weighing on demand. Recent commentary from Saudi Arabia has suggested to Deutsche Bank that there is little likelihood of cuts to OPEC production in November. Kuwait and Iran have also signalled a near-term reduction in production is less likely. Deutsche Bank analysts suspect recent declines in the differential between Saudi Light and Oman/Dubai signal Saudi Arabia may be reducing the price in order to expand market share.

Nevertheless, the analysts do not fully discount the probability of production cuts, given the penchant of OPEC to support prices with production cuts, and believe the longer term outlook is more robust, with demand improving and reduced investment in new projects. They do not anticipate material reductions in US tight oil production from existing operations but do believe lower prices will lead to the deferring of new projects. Given the long lead times in the industry, a reduction in near-term investment has implications for longer-term supply and, hence, the price.

In Australia's Cooper Basin, Goldman Sachs notes two main issues are affecting sentiment. Western Flank oil production is now naturally declining and, coupled with lower oil prices, this is driving down earnings expectations. Some stabilising of production rates in the December quarter are expected and this should improve sentiment. The other issue is the slow progress on unconventional sources.

The market seems to have lost patience, in Goldman's view, ahead of the next round of flow results from Beach Energy ((BPT)) and Drillsearch ((DLS)) and Chevron's phase-2 decision in March. Here, lower oil/LNG pricing will not help. Goldman Sachs does not attribute significant value to unconventional sources but maintains the market is dismissing the prospect too hastily. The broker remains keen to dissect the long-term pilot testing results from the more prospective zones.

In the wake of its Perth resources conference, Morgans notes sentiment is buoyant in the resources sector while deals are being done, although investors are yet to get fully on board. The fall in equity valuations is making acquisitions more attractive and Morgan observes companies are considering it cheaper to buy exploration assets than do it themselves. Iron ore miners signalled a pressing need to renegotiate services in order to reduce costs, while base metals producers were ahead on this undertaking, having already trimmed contract costs around 12 months ago.

Iron ore miners expect another 15% of Chinese domestic capacity will shut down permanently over the winter months and this bodes well for Australian producers, albeit the benefits are unlikely to surface until the June quarter of 2015. Merger & acquisition appetite prevails, particularly from overseas entities and Morgans highlights Gold Road Resources ((GOR)) as the next potential candidate for a takeover bid, thanks to a large resource bases and exploration upside.

JP Morgan has returned from the London Metals Exchange week-long briefing conscious of the macro economic trends that are preoccupying both producers and consumers more than usual. For some metals, a broader consensus is needed on a firming global economy for prices to significantly appreciate. This is particularly the case for copper, for which prices have fallen by around 5% in recent weeks despite inventories at the lowest levels since 2008. The market appears worried about a slowdown in China, patchy US economic data and the possibility of a European recession.

Aluminium is seen benefitting the most from US demand while European demand is also expected to grow 2% next year. US copper demand is envisaged as growing 3-4% while European demand is likely to remain flat. China is considered reluctant to stimulate growth beyond its targets and this is seen delivering less support for metals prices in general so relatively more importance is being placed on growth outside of China.

JP Morgan remains constructive on both aluminium fundamentals and price after returning from London and expects the market will remain in deficit next year, forecasting the cash price to average US$2,125/t over 2015. The copper market is expected to remain balanced and JP Morgan is neutral on copper pricing for 2015.

From the JP Morgan analysts' perspective, both producers and consumers were extremely cautious about nickel. A 23% decrease in nickel prices has prompted some in the industry to rapidly temper bullish views on both price and inventories. Most producers are forecasting either a balance or a surplus next year. Furthermore, consumers are not forward purchasing significant volumes at current prices.

The major difference between the bulls and the bears is the view on forward demand. Demand was strong in the first half of this year but has tapered dramatically in the second half, with stainless steel mill operators being extremely pessimistic regarding demand in the current quarter. JP Morgan believes some of the recent tonnage increases in LME inventories are likely to be the result of producers delivering metal that was previously earmarked for spot transactions.
 

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