Commodities | Aug 16 2016
Price outlook for coal; iron ore consumption; China's steelmaking restructure; impact of Philippines nickel supply cuts; aluminium demand; Canaccord Genuity upgrades Galaxy Resources.
-Coking coal price to be well supported in next couple of months
-Heightened thermal coal price not expected to last
-Short-term iron ore prices unlikely to fall back
-Re-stocking the next driver of the nickel price?
-Aluminium supply likely to be forced offline again
By Eva Brocklehurst
Metallurgical (Coking) Coal
Spot prices for hard coking coal are approaching US$110/t, Macquarie observes, and a point where the entire seaborne market is cash positive. The broker notes this is unusual in a market where demand growth is negative and there has been no meaningful cost inflation, highlighting the importance of China in price setting.
The broker expects prices to remain well supported over the next couple of months, given Chinese inventories are low and mills are looking to increase purchases. The fourth quarter is expected to be more of a challenge. Macquarie suspects the Chinese government will find it difficult to control output levels as margins improve.
The broker also suspects, on a relative basis, that coking coal is less vulnerable compared with thermal coal, as it is more dependent on Shanxi province where production restrictions have been best enforced, and because there is less flexible supply in the seaborne market.
Thermal Coal
Credit Suisse notes China has implemented a 276 work day reform ahead of the demand for power for air conditioning. Domestic coal became so tight that traders turned to Australia for cargoes and the Newcastle price rose steeply in July, with global benchmarks following suit.
The broker does not expect the US$67/t price to last. Already China’s independent power producers are cancelling coal tenders as demand is expected to drop by 8-12% after the summer and output is gradually increasing.
The broker’s analysts believe the new normalised cost for thermal coal in China will be RMB400/t. This is the estimated sweet spot where both coal mines and the independent power producers make margin. Credit Suisse increases thermal coal price forecasts to US$55/t for 6,000 calorie coal from the December quarter to 2019, the equivalent in price parity terms to RMB400/t.
Iron Ore
Since July 2015 the correlation between iron ore and Chinese steel prices has increased to over 63% from 11%, ANZ analysts observe. China has announced it will reduce its steel production capacity by 100-140m tonnes but to date there has not been much evidence the closures are accelerating. Steel production has remained at elevated levels for most of the year.
Still, this may start to ramp up with Baosteel and Wuhan Iron & Steel, the two largest steel producers, recently announcing plans to restructure. The analysts maintain the eventual large scale closure of steelmaking capacity in China is ultimately bearish for iron ore. Yet selective stimulus measures, including support for the housing market, have gone a way toward supporting steel demand.
The analysts are now forecasting steel consumption in China will only fall 0.5% in 2016 against forecasts for a fall of 4.9% at the start of the year. The potential for upside to this forecast is increasing, should infrastructure spending be boosted. Hence, the likelihood of iron ore prices falling back to US$50/t in the short term is rapidly diminishing, the analysts maintain.
Nickel
To date eight out of 27 nickel mines have been told to suspend operations in the Philippines since the nationwide audit began in July. UBS observes these are generally smaller mines and accounted for 10% of the Philippines contained nickel production in 2015 and 2% of global supply.
The Philippines supply contracts are from July to January each year so the broker suspects the real impact may not be felt until early 2017 when exports fail to ramp up as normal. The broker envisages the nickel price, which averaged US$4.78/lb in the past month, is not yet on a sustainable footing, with 20-30% of mines still losing cash, albeit less than a month ago.
Meanwhile, stainless steel production looks to be lifting again after two years of flat output. The broker believes re-stocking could be the next driver of upside to the nickel price.
Credit Suisse contends there is the real threat that nickel ore could be cut off in the Philippines. The new environment minister has stated that open pit mining wreaks havoc on the islands and the mining law must be revised. A ban on open pits would end nickel laterite mining in the Philippines, the broker maintains.
Other producers of nickel laterite ore are Indonesia and New Caledonia. Indonesia banned raw material exports in 2014 and New Caledonia has always favoured domestic ferronickel producers over exports. Credit Suisse finds it difficult to imagine, if Philippines supply ceases, that another nickel ore supplier will step into the breach for China’s nickel pig iron producers.
Aluminium
2016 may reveal the first primary aluminium deficit in a decade, Macquarie asserts. The broker suggests this may disguise the fact that a stronger China is pushing less aluminium into the global market while outside of China demand is weaker than expected and struggling to absorb inventories.
Macquarie suspects there will be a resurgence in Chinese output, given the expansion of capacity being witnessed in Shandong, Xinjiang and Inner Mongolia. Output ex China is also running at record levels and the broker calculates almost all smelters are making money.
As a result, Macquarie expects the price will return to a level at the end of 2016 and into 2017 where supply is once more forced to come offline. Production growth in China still drives the market and the broker acknowledges surprises can dramatically change the market balance.
Any expectations of raw material constraint have dissipated, the broker adds. Despite a temporary ban in Malaysia, bauxite is readily available from Guinea and the Chinese domestic market.
Galaxy Resources
Galaxy Resources ((GXY)) has completed the acquisition of General Mining, with the focus now turning to the ramp-up of production at Mt Cattlin. Canaccord Genuity expects other catalysts to be forthcoming soon, including the Sal de Vida definitive feasibility study.
Galaxy remains one of the broker’s preferred lithium exposures. The broker's valuation is revised on the back of increased share numbers resulting from the General Mining acquisition, consolidated ownership of Mt Cattlin and James Bay and the revised production ramp up at Mt Cattlin.
Canaccord Genuity upgrades to Buy from Speculative Buy and raise the target to 65c from 60c.
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