Material Matters: Energy, 2016 Commodity Outlook, Metals And Steel

This story features SANTOS LIMITED, and other companies. For more info SHARE ANALYSIS: STO

-Oil supply, capex cuts to feature
-Oil market re-balancing late 2016?
-Little demand growth for commodities
-Supply deficits but no price inflation
-Domestic housing, AUD supports steel
 

By Eva Brocklehurst

Energy

The market is concentrating on the future direction of the oil price as it breaches US$30/bbl for the first time in 12 years and UBS addresses the impact on the oil sector. Most companies, other than AWE Ltd ((AWE)), are expected to report declining quarter on quarter December revenue.

The broker suspects the quarterlies will concentrate on guidance for the upcoming results as well as cost reduction initiatives. Santos ((STO)) is expected to suffer a material impairment, while impairments for Woodside ((WPL)) and Oil Search ((OSH)) are likely to be restricted to mature assets.

All are expected to announce cost savings. The broker's key pick for investors willing to look through near-term weakness is Woodside and Santos in large cap stocks and AWE and Karoon Gas ((KAR)) among small caps.

A number of factors are weighing on the oil prices, including global oversupply, the expected increase in Iranian volumes and concerns over Chinese economic growth. Furthermore, UBS notes a lack of material supply decline in US shale, despite lower drilling rates. The broker expects the market will re-balance by late 2016 with a lack of investment in new oil supplies.

Deutsche Bank does not envisage a near-term re-balancing but expects 2016 US onshore supply will decline and, along with robust demand growth, support a second half rebound. Nevertheless, incremental Iranian export volumes are a headwind. The broker does not expect further non-OPEC supply declines until 2017, when oil markets should tighten.

While expecting low oil prices will not be sustainable for long the broker believes spot LNG will come under further pressure as new supply intensifies the oversupply situation in Asia. Key Asian LNG buyers have over contracted out to 2020. Balance sheet resilience is the key issue for oil stocks and the broker expects substantial cuts in capex to persist this year.

Commodities

Macquarie analysts are at the point where they suspect conditions will get worse before they get better. Assuming some macro economic stability in the second half oil could be the first to benefit while US gas could also make gains.

Among the metals, zinc and palladium offer the best hope of raw material constraint, in the broker's view. In contrast Macquarie recommends avoiding exposure to steel, aluminium, thermal coal, potash and nitrogen markets.

Something has to give, and the broker believes that something is supply. Despite barriers to exit, the supply response is starting, because of a lack of growth and sustaining capital. The broker cautions that supply reductions historically have only managed to stabilise cycles and demand growth is needed for more sustained recovery. With industrial production barely growing the year ahead offers little in that regard, Macquarie warns.

Metals

Ranking the demand for metals, Macquarie envisages in 2016 only cobalt and aluminium have demand growth above 2.5%. Cobalt benefits from its exposure to the lithium-ion rechargeable battery sector while aluminium has not had a sustained demand problem because its intensity of use is increasing in packaging and construction.

At the other end of the spectrum are tin, thermal coal, iron ore, steel and platinum. Of these, the broker suspects steel is now in a muti-year downtrend and could be at risk of matching the 3.5% decline seen over 2015. This means iron ore and metallurgical coal demand is likely to follow. Thermal coal's seaborne trade is expected to fall further in coming years and the broker believes the challenge is in displacing existing supply, which takes time, and during which margins are likely to be weak.

Platinum, meanwhile, is suffering from an “anti-diesel” effect, the broker observes. The majority of metals and bulks are expected to sustain significantly lower growth rates over 2016. The exception is gold, given the strong negative demand growth seen in 2014 from fund selling which has dragged down the five-year average.

Only aluminium is expected to be in surplus this year but Macquarie cautions, while deficits are expected and important for a market that is re-balancing, they alone do not convert to price inflation until excess inventories are drawn down.

Steel

Australian steel products are benefiting from earlier delivery of cost reductions and growth in domestic demand as well as a lower currency, Deutsche Bank maintains. These benefits should offset weaker steel spreads and deliver better underlying earnings for the half year reports.

The broker expects BlueScope ((BSL)) to benefit form the continued strength in the Australian housing market and the acquisition of the remainder of North Star, retaining a Buy rating. Deutsche Bank notes the company's coated products business in China is performing well.

Despite recent negative impacts from declines in scrap prices the broker also believes Sims Metal ((SGM)) is well positioned to benefit from upside in the US economic recovery. The company's recent downgrade to forecasts is considered largely the result of a competitive central region in the US and management has shown some evidence of delivering on planned improvements.

Meanwhile, Arrium ((ARI)) is not considered in breach of covenants at this stage but the broker is cautious, given the current volatility in the iron ore price.

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