Material Matters: Copper, Tin, Oil And Iron Ore

This story features OZ MINERALS LIMITED, and other companies. For more info SHARE ANALYSIS: OZL

-Citi is bullish on copper
-Indonesia is key to tin
-Risk that crude rally falters
-Protracted iron ore surplus?

 

By Eva Brocklehurst

Copper

Citi is bullish on copper, believing market participants are underestimating the extent of the interruptions to supply which have already occurred in 2015. Longer term production growth is likely to be squeezed by a collapse in copper mine capital expenditure and the broker expects prices may reach US$8,400/t in 2018. Investment in new copper capacity has declined since 2013 and is expected to fall to US$6bn in 2018, down from a peak of US$33bn in 2012. Citi note that with the prospect of lower returns, miners prefer to boost operational efficiency at existing mines rather than risk capital in new capacity.

In analysing operating and capital costs for the global industry, Citi takes a closer look at the main projects for Australian producers. The weighted average incentive price for the global group is calculated at US$6,540/t, modestly above the broker’s long-term price of US$6,200/t. Brownfield projects require a price of US$6,500/t while greenfield projects require a little higher average at US$6,600/t.

OZ Minerals’ ((OZL)) Carrapateena project has an incentive price of US$5,605/t for copper in order to realise a 15% return on investment over 10 years, based on a US$3bn investment and including a three-year construction period. The project has high capital intensity at US$28,400/t of annual copper production over 10 years.

PanAust‘s ((PNA)) Frieda River is on par with Carrapateena in terms of scale, in Citi’s view. Both projects offer more attractive qualities than at least half of the other global projects in the peer group. Frieda River has a lower capital intensity, faster pay-back but higher operating expenses compared with Carrapateena. The incentive price is calculated at US$5,357/t. Beyond 10 years Carrapateena is ahead of Frieda River because of these lower operating costs and it has a more favourable jurisdiction, that being South Australia versus PNG. This is the reason Citi prefers OZ Minerals to PanAust.

[Note that PanAust has subsequently been made an increased takeover offer which the board has unanimously recommended – Ed]

Tin

2015 has been poor for tin, with the London Metal Exchange cash price down 18%. Macquarie observes this is the continuation of a move that began mid last year. The main reason is oversupply, as mine output from Myanmar rises while exports from Indonesia have remained resilient. The price is near five-year lows and some market analysis suggests this is an attractive entry point for new long positions. For now, Macquarie does not consider this is the case.

Supply has started to slow in Myanmar and, if the trend continues, should help rebalance the market. Meanwhile, cease-fire talks have commenced regarding the conflict in north eastern parts where tin mining takes place. However Indonesia is the largest exporter of tin and this is the region where Macquarie is looking for a supply response. The broker suspects producers are cutting costs and hunkering down to await an improvement. There is talk of reductions to exports but the broker finds no concrete evidence. At present, there is little material change in volumes.

Another indicator to watch is tin inventories at the LME. The drawing down of stocks in the absence of a meaningful supply adjustment is likely to be construed as an improvement in demand. This is inconsistent with the data and thus, while drawing down of inventories may be interpreted as a positive, Macquarie suspects it will not continue.

Crude

A recovery in oil prices since January may look significant but the gains are not extreme, in Deutsche Bank’s opinion. History suggests the rally will start to fatigue. Deutsche Bank does not believe this cycle, unlike others, will be accompanied by significant OPEC production cuts or aggressive monetary easing by central banks.

The broker suspects that the next phase of the recovery process, to begin mid year, will be much less predictable. OPEC production cuts have always been a feature of the oil market after a significant correction in the price, which Deutsche Bank defines as prices falling in excess of 40% over six to nine month period. Without an OPEC response and significant monetary easing by central banks there are no tailwinds to an oil price recovery.

In terms of physical stocks, Deutsche Bank is expecting a decrease in the build-up of inventory in the US. The latest bullish reversal from a December-March trend rate is well in excess of what is likely to occur in the near future. That drawdown was influenced by a large drop in the weekly imports of crude which, given the cause, the broker does not expect to be maintained. Inventories are expected to resume building, albeit at a slower rate, before peaking at the end of June.

Iron Ore

UBS believes supply needs to be rationalised to re-balance the iron ore market, as demand growth appears set to fall dramatically. Yet new supply under construction suggests the market is moving into a protracted surplus. A recent rally in the price reflects a slight improvement to sentiment, as there are some indications that rationing is underway. Atlas Iron ((AGO)) has lowered output by around 5mt and BHP Billiton ((BHP)) has announced a more incremental path in its expansion. Meanwhile, Brazil’s Vale has hinted that 30mtpa of its higher cost capacity could be taken out of the market.

UBS has calculated that the average price the equity market is implying for iron ore is US$51.50/dmt, which suggests a continued discount to spot. At the top end, Fortescue Metals ((FMG)) is reflecting US$54.91/dmt while BHP is implying US$47.45/dmt. The broker’s Neutral recommendations for Mount Gibson Iron ((MGX)) and BC Iron ((BCI)) reflect its confidence that low gearing and net cash positions should sustain them. Sell ratings on Fortescue and Atlas Iron reflect higher leverage and net debt, hence greater risk, given that break-even estimates are in line, or above, second half 2015 forecasts for iron ore. Of the majors, the broker prefers BHP in the near term, expecting oil to re-balance sooner than iron ore. BHP will also benefit from the upcoming South32 listing.
 

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