Material Matters: Coking Coal, Energy, Iron Ore, Global Miners And Nickel

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Elevated coking coal prices; OPEC oil deal looking shaky; iron ore outlook; balance sheet metrics for global miners; nickel's bullish outlook dented.

-Coking coal prices expected to ease in 2017 but at slow rate
-High chance OPEC agreement fails to achieve price increases
-Weaker outlook for steel suggests Oz iron ore exports likely to slow
-Rio Tinto leader of the global diversifieds in de-leveraging
-Indonesian supply of nickel pig iron mitigating shortages from Philippines
 

By Eva Brocklehurst

Coking Coal

Coking (metallurgical) coal has stood out as the key performer among bulk commodities in the last quarter, with prices more than doubling, Commonwealth Bank analysts observe. While some factors are anticipated to be short term and spot prices likely to retreat, the analysts expect the coking coal price contract to be settled for the December quarter could range from US$120/t to US$200/t.

Supply-side reforms and the exit of loss-making capacity have helped reduce China's coal output by around 10% in the first eight months of 2016. National Australia Bank analysts expect that increased Chinese production and weaker steel output will put downward pressure on coking coal prices but at a slower rate than previously anticipated. They expect hard coking coal contract prices to average US$96/t in 2017.

Energy

The CBA analysts also question whether the surprising deal on oil production at OPEC (Organisation of Petroleum Exporting Countries) will really change prices. The accord implies a cut in production of 250-750,000 barrels per day from August levels but individual country quotas are still to be decided at the November meeting. Moreover, Iran, Iraq, Libya and Nigeria have all signalled plans to boost output before the agreement is in place.

In sum, the analysts suspect the agreement has a higher chance of failing and the US will probably deploy rigs and boost production at prices above US$50/bbl. Hence, an unintended consequence may become a reality – OPEC concedes market share to the US and prices remain subdued.

National Australia Bank analysts continue to expect a gradual decline in US production in coming months because of the lag between construction of rigs and eventual production from the wells, but note that production may not ease very much from current levels unless there is a negative price shock.

The analysts also note the ramp up in Australian LNG production is progressing slower than expected, particularly in Queensland, where two out of three terminals have been running well below capacity for much of the year. Prices are subdued but the analysts suspect they have reached a bottom and should slowly increase over the coming year.

Iron Ore

National Australia Bank analysts expect steel demand should soften in coming months as China's construction boom fades. The profitability of mills has improved since late 2015 when steel prices hit record lows in China. However, the analysts note that iron ore and coal prices have been trending higher since mid May which signals profitability has only recovered to the lower bounds of the trend between 2009 and 2014, meaning continued challenges for Chinese steel producers.

Imported iron ore has provided an increasing share of China's steel requirements in 2016 with domestic production contracting by 6.7% in the first eight months of 2016. The analysts expect that given a weaker outlook for the steel sector, in China and globally, Australian iron ore exports are likely to weaken.

Growth has already slowed, at 4.9% in the first seven months of 2016 versus double digit growth in the same period last year. Almost 82% of Australian iron ore was exported to China over this period. The analysts expect spot iron ore prices to average US$54/t in the December quarter and US$44/t in 2017.

Global Miners

Deutsche Bank examines major diversified miners as well as the pure plays in iron ore and copper, looking at the balance sheet metrics and ability to generate cash flow and dividends. Rio Tinto ((RIO)) is considered to be the furthest along the path to de-leveraging while Vale is at the other end of the range.

The broker expects BHP Billiton's ((BHP)) leverage will reduce by the largest amount in 2018. All stocks reviewed fall to ratios of less than twice net debt to EBITDA (earnings before interest tax depreciation and amortisation) apart from Freeport-McMoRan. This results in upside risk to credit ratings, in Deutsche Bank's view.

All companies make free cash flow in 2017 but South32 ((S32)), Fortescue Metals ((FMG)) and Vale are envisaged to have this fall in 2018 year on year. Both Teck and Fortescue are expected to be large beneficiaries if current spot prices for their key respective commodities persist.

Nickel

An environmental audit by the Philippines government instigated expectations that supply of nickel would be wound back, which would in turn increase deficits and the draw down of inventories to more reasonable levels, Deutsche Bank observes.

A more reconciliatory tone from the Philippines and a potential temporary lift in the Indonesian ore export ban has dented this bullish outlook. The broker suggests this means more, rather than less, supply will hit the market. There is a chance some of the Filipino mines will be able to continue should they present a credible plan to fix any environmental infringements.

Deutsche Bank mulls several scenarios, and in the one where Indonesia allows some low-grade exports in combination with a tough but fair closure program from the Philippines, envisages the market more balanced with inventories remaining high. This presents a downside risk case for the commodity and prices could fall below US$10,000/t once more.

CBA analysts observe that nickel pig iron (NPI) is a higher value product because it contains more nickel than nickel ore and therefore the re-emergence of Indonesia's nickel pig iron supply, as a result of Chinese investment, is mitigating some of the shortages after the closure of mines in the Philippines.

Most of the Indonesian supply to come online this year is already in production and therefore Chinese stainless steel mills will struggle to immediately replace any declines from Filipino imports with Indonesian imports. Still, the analysts believe there is scope for NPI imports to continue lifting in 2017.
 

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