Material Matters: Emissions, Coal, Iron Ore And Nickel

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-Gas, nuclear likely beneficiaries
-Thermal coal oversupply prevails
-China to crack down on coal safety
-Risks of smaller inventories in iron ore
-Nickel buying expected to re-emerge
 

By Eva Brocklehurst

The emission reduction agreement between the US and China could be a catalyst for other countries to make an effort to address climate change and implement new greenhouse gas targets. The US has pledged to reduce emissions by 26-28% below the 2005 level by 2025, while China intends to achieve a peak in emissions around 2030 and increase the share of non-fossil fuels in its economy to 20% by 2030.

Even without these pledges, existing policies and current market dynamics in both countries could still affect oil, gas and coal demand, in Citi's view. Subdued conditions may lead to lower demand from 2015-2030 in the order of US$1.3 trillion for oil and as much as US$1.6tn for coal, on Citi's calculations. In contrast, the likely rise in demand for gas could be worth US$1.3tn. The US/China agreement has potential for a sharper reduction in carbon dioxide emissions as Citi estimates that along with the world's two major economies achieving their targets, global emissions could be flat lining before 2030 if annual growth rates of emissions in the rest of the world are cut in half.

All up, this is considered the least required to turn around the trend trajectory for emissions but falls short of the scenario that the International Energy Agency envisages is necessary to prevent average global temperatures from rising two degrees. Longer term beneficiaries of the targets would likely be gas in the US and nuclear energy in China, in Credit Suisse's view. The broker also notes major coal producers, BHP Billiton ((BHP)) and Rio Tinto ((RIO)) were unconcerned about the emission reduction agreement.

Glencore plans to shut all thirteen of its Australian coal mines for the three weeks over Christmas. Credit Suisse observes this is an unusual move to tackle price weakness but the company expects it will reduce the need to push incremental sales into an already weak price environment. The broker observes there is no speculative rise in the thermal coal price as yet and the thermal coal production cut is only 2% of Australia's annual exports, although 26% of the expected monthly rate. Credit Suisse suspects there may be some price increase towards the end of the year. While the decision was a surprise, Macquarie does not believe it will have a material impact on seaborne coal supply, or demand conditions. These are temporary cuts and, as such, will not alleviate oversupply. Nor does it mean exports will fall by an equivalent amount.

Macquarie does deduce some interesting messages from Glencore's decision. The announcement, in view of the carbon forum about to be held in Berlin, sends a signal to Glencore's customers that they should not take the oversupply situation and weak spot price for granted. Glencore may also be signalling that, as an industry leader, it is acting responsibly, highlighting the lack of action from its peers.

In wider terms, the Glencore Australia Christmas closure is insignificant compared with another recent coal-related announcement. Macquarie notes China has just announced the most stringent safety check of coal mines in its history. All projects operating illegally or unsafely will be closed between now and April 2015. This could result, if fully enforced, in production cuts of up to 400mt, 80 times that announced by Glencore, and equivalent to almost half the seaborne trade in thermal coal, on Macquarie's estimates. While positive for the price in the domestic market the question is whether or not it will translate to seaborne prices. China has acted as the market of last resort up until recently, taking excess seaborne tonnes which must price into the domestic market.

Potential tax cuts on exports and the recent imposition of a coal import tax mean uncertainty prevails regarding the impact of Chinese decisions on the global coal market. Credit Suisse remarks that metallurgical (coking) coal duties on exports from China are also likely to be reduced at the start of 2015 as, according to reports from Platts, a number of measures are being tested to support the struggling local industry.

Meanwhile, the cracking down on pollution in China has kept some sintering plants closed for longer than usual and iron ore spot lump premiums are nearing record levels. Credit Suisse observes, in a contrary move, the discount for low grade ore is falling. The broker still expects seasonal re-stocking in December will occur, but the risks stemming from the government's anti-pollution moves have increased. Steel mills are keeping smaller inventories in fear of more shut downs, after the government had such success in clearing Beijing's air for the APEC summit. The mills are aware the anti-pollution measures are serious, while there appears to be little concern about iron ore availability.

Nickel stockpiles at the London Metal Exchange appeared to have levelled off over the last week but this remains a record stockpile covering 10 weeks of consumption and Credit Suisse observes prices remain depressed. There are indications, too, that Chinese demand for stainless steel is soft, as nickel pig iron is carrying a discount to refined nickel of US$1100 per tonne of contained nickel. The broker believes the most efficient producers will be making only narrow margins while the less efficient operations will be losing money.

Macquarie observes nickel has confirmed its reputation for being the most volatile of the LME metals. Fund buying and selling may have driven prices to their extremes but fundamentals have also been important. At the ferroalloys conference in Barcelona the broker met many that were bearish in the short term, reporting a drastic weakening of the physical market indicators of nickel demand. Nickel in recycled scrap is now selling at 73-78% of the LME price, having been at 82-88% earlier this year.

Another fundamental consideration is that, when nickel prices rose sharply earlier in the year, stainless steel buyers over-ordered in anticipation of higher stainless steel prices. Now, the slowing in stainless steel orders and production is particularly severe in Europe where economic growth has stalled. Demand weakness is the most important reason for the slump in the price in recent weeks. What do current prices represent? Macquarie suspects that over 30% of existing producers are losing cash. Having been overly bullish earlier in the year the broker is now cautious and does not envisage any physical buying until the new year. Still, while de-stocking has been the game, whether it be nickel ore or stainless steel, Macquarie observes this can only be done once and, as prices appear to bottom, there could be another buying spree.

 

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