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Material Matters: US Energy, Coal, Chrome, Steel And Oz Miners

Commodities | Nov 17 2016

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Trump and US energy; coking coal's price surge; improved outlook for alumina, chrome and steel; positive trends for Oz miners.

-If Trump policies survive Raymond James estimates the US to have the lowest energy costs globally
-Supply response to higher coking coal prices not expected to impact until second half of 2017
-Macquarie more confident on upside case for alumina, chrome market remaining tight
-Credit Suisse envisages rapid de-gearing likely over 2017 for key Australian miners


by Eva Brocklehurst

US Energy

In assessing what a Donald Trump presidency and Republican-controlled Congress may mean for the US energy complex in coming years, researchers at Raymond James suspect the "attack dogs" that have waged war on the US oil and gas industry over the past years will be called off. This includes the Environmental Protection Agency, the Endangered Species Act, and numerous executive orders that have catered to the US environmental lobby.

Longer term, more access to federal lands and less government regulation should mean lower US energy costs. If these policies survive the next decade, the researchers expect the US to have the lowest energy costs in the world. Yet there are variables that influence short-term oil prices and who sits in the Oval Office, or controls Congress, is not one of them.

Given that one of Trump's hallmark issues is the Iranian nuclear deal there is the possibility that Iran's oil supply could be interrupted by a revival of US sanctions. That said, Raymond James observes this agreement was a multi-country arrangement and it may not matter if the US backs out. The sanction that impacted Iran the most was the European Union's oil embargo.

The researchers note Trump's deregulation agenda may prove to be a gusher for energy and petroleum companies. The possibility of a federal anti-fracking legislation is less likely and there are also other benefits that would trickle down from the relief of regulatory pressure on pipeline construction. Oilfield services also stand to benefit from more drilling activity.

The lower cost of production means that the market share gains in the US should increase versus the rest of the world as relative returns improve, and activity gains in the US are also likely to outpace those in offshore arenas. For the refiners a much more favourable regulatory environment is likely to emerge but quantifying this is difficult, the researchers assert.

Yet a return to substantial US oil and gas production growth over the medium term is likely to further cement the structural advantages of the US refining system. In terms of coal, its market share in the electricity mix has fallen to 33% in 2015 from 50% in 2005. Coal will see some relief from the lack of a federal de-carbonisation mandate, but Raymond James still expects coal to continue to lose share.

Cheap natural gas from fracking and increasingly cheaper wind and solar are expected to be too powerful for coal to go back to where it was a decade ago. In sum, the researchers believe the winners from Trump policies are the US economy, US consumers, US oil & gas companies, US oilfield services, US mid-stream companies, US coal, and US renewable power.

Coking Coal

Chinese policies on coal have prompted a significant surge in import demand at a time when the major exporters have been reluctant or unable to respond, resulting in a price spike. As a result, ANZ analysts upgrade coking (metallurgical) coal forecasts. The analyst expect contract prices to average US$178/t in 2017 and US$135/t in 2018.

Higher spot prices are expected to induce a global supply response, led by North America, but not until there is some sustainability in prices. The analysts do not expect this to occur until the second half of 2017 and do not envisage major exporters raising output immediately. Australian producers are already at capacity and are now being hampered by wet weather.

Chinese coking coal production is also expected to decline over the next two years and recent strength in steel production is unlikely to continue, which should help alleviate the tightness in coming years. The analysts suggest upgraded coking coal price forecasts have implications for the broader Australian economy. Their estimate of Australia's terms of trade is improved by 3% with a resulting small lift in nominal GDP.

India is expected to drive long-term demand for coking coal, with its government aiming to triple steel production by 2025. India's focus on infrastructure investment should underpin greater demand for coal imports for the remainder of 2016 and for 2017. Yet, the analysts observe a large fiscal deficit has restricted investment by the Indian government, while complicated project approval processes and land acquisition issues have made completing large-scale steel projects difficult.

As a result, they envisage only mild growth for Indian coking coal imports, rising to around 55mt by 2020, and accelerating more quickly after that. Australian metallurgical coal producers are likely to be the greatest beneficiaries of higher imports by India, with Australia supplying around 85% of that country's total import requirements.

Alumina, Chrome And Steel

Macquarie notes three commodities for which the price outlook in 2017 has improved markedly. The broker raises forecasts for alumina, ferrochrome and steel, upgrading alumina price estimates by 27% for 2017, ferrochrome contract prices by 33%, and steel prices an average of 17% for the next three quarters.

The broker has become more confident in the upside case for alumina as Chinese aluminium smelter re-starts are finally under way and this is resulting in accelerating growth in demand after a stagnant 2016. Meanwhile, Chinese alumina production re-starts are not keeping pace, hindered by environmental inspections and a shortage of caustic soda.

The issues may be transient but the broker still expects a Chinese market deficit in 2017 and 2018, a gap which will have to be filled by the international market. The broker reiterates its observation that significant ex-China supply is still coming to the market.

Macquarie notes rises in chrome ore pricing over October were most dramatic. Chrome is a clear raw material constraint in a market that relies heavily on South Africa for global supply and where China has no substantial domestic resource.

As stainless steel output continues to look strong in China, and growth in Indonesia is ramping up, tightness in the chrome market appears set to persist. With no chance of direct substitution in stainless steel, Macquarie is looking at an ever tighter chrome market in 2017 and beyond.

The broker notes steel makers are doing their best to offset the recent surge in raw material prices. Steel prices so far have not encompassed a full passing through of the cost push that has been exerted. Steel margins, therefore, remain under pressure, both in China and globally. While the expectation of strong infrastructure expenditure offers some hope for demand, the scale of over capacity in the steel industry signals to Macquarie that a sustained margin recovery will be difficult to achieve.

Oz Miners

Macquarie retains a positive stance on most of the bulk commodity producers. The broker envisages material upside to base case forecasts for coking coal, manganese, iron ore and thermal coal. Incorporating updated commodity price and exchange rate forecasts has translated into solid upgrades to earnings estimates for South 32 ((S32)), and Alumina Ltd ((AWC)) – upgraded to Neutral from Underperform – but more modest updates for most other stocks.

Marking to market the broker upgrades its iron ore price expectations for the December quarter, which leads to upgrades to FY17 forecasts for BHP Billiton ((BHP)), Fortescue Metals ((FMG)) and Mount Gibson ((MGX)), and to the 2016 forecasts for Rio Tinto ((RIO)).

Credit Suisse expects that commodity prices, led by coal, are unlikely to stay at current levels yet they may be materially higher than its current base-case forecasts suggest. This could have the effect of re-setting balance sheets and re-invigorating investor demand for capital management.

The broker is yet to revise its base case forecasts but envisages a rapid de-gearing in balance sheets and strong uplift to earnings. While South 32 is already under-geared, the broker envisages Rio Tinto, Whitehaven Coal ((WHC)) and BHP could all move to an under-geared position by the end of FY18.

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