Material Matters: Commodity Outlook, Electricity, Iron Ore And Nickel

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-Market less bearish but not bullish
-Diversity in China's grid gaining pace
-Steel, iron ore prices not reflecting demand
-More new low-cost iron ore output ahead
-Oz iron ore output eases in Jan-Feb
-Nickel prices remain depressed
 

By Eva Brocklehurst

Commodity Prices

The worst may be over in terms of the downside risk to commodity prices, ANZ analysts contend. Sentiment has improved and, technically, many markets are bouncing off support levels. The stronger US dollar and volatility in equity markets may also be subsiding.

Nevertheless, the analysts are not completely convinced there is no more weakness to come. Chinese PMI data in February suggests manufacturing activity is unlikely to bounce in the short term.

In some areas further supply growth could to push markets into surplus but the analysts note the speed at which each market is adjusting is varied. Supply growth in industrial metals is slowing while the analysts observe the financial pressures on US oil producers are encouraging a sizeable reduction in output. Bulk commodities are expected to sustain a long drawn out re-balancing process.

In summary, the analysts believe this more a market becoming less bearish rather than one that is fundamentally being driven higher. For the fundamentals to be better, economic data in emerging markets needs to stabilise.

Electricity in China

New data from China's electricity sector shows consumption was up 0.3% in the January-February period, coal imports fell 10.2% and coal production declined 6.4%. Thermal power generation (coal and gas) was down 4.3% and hydro electricity production was up 22.6% to a new record high.

All this suggests to Tim Buckley, at the Institute for Energy Economics and Financial Analysis, that slowing economic growth and reduced energy intensity in China, as well as a rapid diversification towards renewables, nuclear and hydro generation, are unwinding the country's historical dependence on coal.

Two trends are in evidence, he maintains. Electricity consumption has decoupled from economic activity, as the Chinese economy moves towards greater reliance on less electricity-intensive service sectors. Secondly, a record 32 gigawatts (GW) of wind installations and 18GW of solar installations in 2016 alone are showing that attempts to diversify the grid are gaining momentum.

Iron Ore

Several questions come to the fore for Goldman Sachs as iron ore prices rebound strongly from their recent lows. The current rally and a period of mine closures and production reductions suggests a closer look is required at steel prices. These should reflect the cost of raw materials and level of industry profitability, but instead the broker notes the causal relationship is currently reversed.

Goldman Sachs believes steel prices have rallied because the market was in deficit and better margins were required to increase production ahead of the peak demand season. This is a key indicator to watch as higher steel prices encourage idled blast furnaces to start up again.

Macquarie notes extensive short covering in iron ore was largely propelled by expectations for better steel demand in China and near term, the market appears well supported by seasonal factors and improved sentiment.

Still, the broker remains bearish on iron ore and expects the current rally to be short-lived in the absence of a material lift in Chinese steel demand, and raw materials should once gain drive steel prices rather than the other way around. Production cuts are expected to return in the months ahead.

The broker remains nervous with iron ore prices above its forecasts of US$50/t , at around US$55.50/t, suspecting there is little upside to be had. The broker reiterates a view that, while 2016 appears fundamentally well supported, the industry is still facing challenges and more new low-cost supply needs to be absorbed by the market.

The broker lifts expectations for iron ore supply from Australian juniors and India in response to the recent price performance and expects seaborne iron ore supply to decline by 11mt this year as opposed to previous forecasts of a decline around 20mt.

The broker's Indian materials analyst has signalled that India has turned into a net exporter of iron ore since October 2015. Higher prices may push Indian exports up to 15-20mt this year, the analyst suspects. While Macquarie has a forecast for iron ore prices that is ahead of consensus, the upside is considered capped by the potential return of Chinese mines, and the risk of stronger export volumes from India.

Structural issues are expected to remain large in 2017 and 2018. The broker continues to expect iron ore prices will fall back to US$45/t in 2017, as this is the level that is considered low enough to force the required supply to exit from China.

Meanwhile, Australian iron ore shipments hit a peak of 830mtpa ex Western Australia in late 2015, Macquarie notes. The most recent data suggests a decline of an average 50mtpa this year versus the second half 2015 average. The wet season has had an impact on production rates for BHP Billiton ((BHP)) and Rio Tinto ((RIO)) despite the weather being relatively benign.

Macquarie notes a material decline in WA shipping rates and the loss of the Samarco product is the key contributor to the recent rise in iron ore price. The broker expects BHP will miss its target of 270mt per annum and downgrades expectations to 260mtpa.

Rio Tinto, meanwhile, has run down stockpiles and is now the number one global shipper of iron ore. Still, in the last two months the Pilbara shipping rate has fallen to around 310mtpa, 5-10mtpa below Macquarie's previous expectations. In comparison Fortescue Metals ((FMG)) has consistently shipped at a 160-165mtpa rate and the broker expects another solid result which may even beat its 165mtpa guidance range.

Nickel

Macquarie observes the nickel market is moving into deficit with global nickel supply expected to fall by 6.5% this year. Price rises will be limited by a large inventory overhang, nonetheless. The analysts estimate Chinese stainless steel production will fall further this year, driven by lower exports and weaker demand.

On a global basis, Macquarie assumes no growth in nickel usage in 2016. A significant deficit is expected as the year progresses. The broker expects a deficit of around 80,000t this year and a further 65,000t deficit in 2017. At current nickel prices, around US$9.000/t, 70% of supply is loss making and the broker believes price will have to move above US$10,000/t or else mine closures will continue.

Pricing upside will be limited for a number of years, given the inventory levels. One aspect of the outlook that may jeopardise an eventual price recovery would be if the Indonesia government lifted its ban on exports.

Macquarie suspects any easing of the ban would actually be partial and its impact limited at current prices, as Chinese nickel pig iron producers would remain loss making even with access to higher grade ore from Indonesia.
 

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