Material Matters: Oil & Gas, Silver, Zinc And Iron Ore

This story features BEACH ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: BPT

-AWE bid a positive for sector
-Bullish oil likely short term
-US gas prices lower for longer
-Speculative push on silver
-Zinc entry point ahead?
-Pull forward in iron ore demand seen
 

By Eva Brocklehurst

Oil & Gas

The read on the unsolicited proposal for AWE ((AWE)) from Lone Star Japan, – which was rejected – is positive for Australia's small cap E&P sector, Credit Suisse asserts. The broker considered the bid reasonable although the board maintained it was opportunistic.

Still, the bid may bring attention to the value opportunities in a sector which has suffered from weak commodity prices. The broker finds value in the sector and has Outperform ratings on Beach Energy ((BPT)), Senex Energy ((SXY)) and FAR ((FAR)).

Morgan Stanley questions why the oil price is not higher, given the muted price action over the past 1-2 months suggests that an inventory buffer may be preventing a full recovery and/or the market is rightly nervous about the sustainability of outages and possible producer responses.

Bullish oil trends are expected to continue through May but the broker suspects the risks may skew to the negative in the second half. A number of worrying data points have emerged in recent weeks, which makes the broker suspect Chinese demand is slowing already.

Any renewed concerns in emerging markets could be particularly problematic for oil. The broker also notes India, Argentina and China have, or are planning, new regulations on oil trade which may have significant impacts on imports, production and investment.

Goldman Sachs observes the oil market has gone from enduring storage saturation to being in deficit earlier than expected. Hence, the broker is pulling forward its price forecasts with second half West Texas Intermediate now forecast at US$50/bbl.

The reason the broker believes the market shifted to deficit in May is driven by evidence of strong demand and sharply declining production. Stronger vehicle sales, and a larger crop harvest lead Goldman Sachs to raise its demand forecasts emanating from India and Russia, while reducing US and EU forecasts.

The broker expects some outages will recur, as well as higher production from Iran and Iraq, and this should eventually more than offset the higher demand. As a result a more gradual decline in inventories is expected with a return to surplus in the first quarter of 2017. Goldman lowers 2017 forecasts, with prices expected to only reach US$60/bbl by the fourth quarter of 2017.

Morgan Stanley also suspects cheaper Canadian gas may flood the US market in the northern summer. AECO prices traded to 5-week lows last week and the broker notes average discounts to Henry Hub prices are in excess of US$1/mmbtu for both May and April.

AECO sourced gas is currently the lowest cost option for many regions of the US. If this continues the added supply may keep prices lower for longer. Morgan Stanley observes record high inventories have occurred in Canada, given a very mild winter on top of supply growth.

Silver

A sharp rise in the price of silver over the last six weeks has made it a top performer in the year to date, Morgan Stanley observes a corresponding lift in the metal's non-commercial CFTC long positions and Comex futures, suggesting speculators are behind the move up in price.

The broker answers the question of why silver has not tracked gold this time: speculators prefer silver over gold, largely because it is cheaper and the latest speculative push has been driven by a credit surge in China and perceptions of emerging risk around China's expanding debt.

Silver's production rates are higher, delivered predominantly as a by-product of zinc-lead operations. Favourable market conditions exist as well, as mine supply fell 6.4% in 2015 and is forecast to shrink further. Morgan Stanley forecasts silver this year at around US$14.55/oz, capped by persistent low inflation.

Zinc

Macquarie suggests that zinc stocks are more than ample to cover any spot requirements, despite a definite improvement in European demand sentiment. The situation is similar in North America. Premiums have been flat in both regions and some analysts are expecting a downward move in prices.

The tightness in concentrates is yet to feed down the chain, the broker observes, and a short-term move down may occur. Macquarie agrees this could provide an entry point as into the second half its view on prices is strongly positive.

September and December quarter prices are expected to range between US$1,900/t and US$2,200/t as metal production slips on an emerging feed deficit. The broker believes mine reductions are obvious enough to envisage production falling around 8.0% this year, forcing metal output to fall and tightening up markets.

Iron Ore

Macquarie has upgraded its outlook for iron ore over the near term. This comes on the back of stronger Chinese steel demand and supply disappointments. The broker upgrades forecasts for 2016 iron ore prices by 1.0% and 2017 by 11%. Chinese steel demand growth is forecast to rise slightly in 2016 after the broker previously expected it to fall.

Pulling forward near-term demand expectations and the delays to supply has meant the broker's outlook for 2018 and 2019 is more precarious. Macquarie now estimates 50mt of high-cost seaborne supply needs to be removed in these years.

The new outlook has driven upgrades to miner earnings estimates for the next 18 months but then downgrades for the following 18 months. The broker's preferences are unchanged but sustained strength in iron ore prices over the next 18 months could mean Fortescue Metals ((FMG)) de-gears at a much faster rate than current estimates imply.
 

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