Material Matters: Iron Ore, Lithium & Cobalt

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A glance through the latest expert views and predictions about commodities. Iron ore; lithium; cobalt; and energy.

-Preference for higher grade iron ore to continue
-Lithium surplus building
-Reign of cobalt may be short lived
-Energy industry fundamentals improving

By Eva Brocklehurst

Iron Ore

Iron ore shipments from Port Hedland lifted 2.0% to 45.0mt in May, a new record for the month and only second to the record level of exports achieved last December. Around 80-85% of Port Hedland's iron ore exports are directed to China.

Commonwealth Bank analysts point to iron ore prices slipping in May because of this rising seaborne supply. Australian iron ore is particularly singled out in surplus, which helps explain why the 62% iron benchmark fell.

The analysts also note that lower steel prices are discouraging China's steel mills from procuring additional iron ore. China's steel demand is expected to slow to around 1.5% in 2018, from 2.5% in 2017.

The risk to the forecasts is to the downside, particularly if demand from China's property and infrastructure sectors slips further. Seaborne markets are expected to add more than enough to meet China's growth expectations.

The analysts expect iron ore prices to trend lower to US$55/t by the December quarter. Support should come from healthy steel margins and a structural preference is likely to be retained for higher grade ores.UBS also notes that steel prices and spreads remain high. The broker observes iron ore inventory at ports has lifted, despite another lift in steel output to all-time highs and this points to higher usage of scrap.

The broker expects seasonally stronger iron ore supply and an easing of seasonal demand could weigh on the market in the months ahead and a higher & steeper cost curve will come into play.

Benchmark prices have been range bound while low-grade discounts are stubborn at just above 40%, the broker points out.

Port stocks could lift further because of seasonally stronger iron ore supply as well as anecdotally stronger scrap usage. UBS considers the recent moderation in some of these iron ore signals warrants close monitoring.

Lithium

Citi has moderated its forecasts for the adoption of electric vehicles because of regulation, supply/infrastructure constraints and push-v-pull demand. This reduces expectations for lithium demand growth slightly to around 16% to 2025.

Meanwhile, the supply wave continues to build and prices are expected to fall further, to US$14,000/t in 2019 and US$12,000/t in 2020.

Unrisked supply from existing producers has potential to meet forecasts, so the question for Citi is how much market share will they be prepared to cede to new entrants, against defending prices. This is particularly relevant, given the low incentive price for additional production for some producers because of latent capacity.

On a risked basis the broker forecasts supply growth of 18% per annum which means a surplus will build over the next few years and then begin to tighten by mid next decade, as electric vehicle adoption rates gain momentum. Citi also notes a large divergence in price over 2018, with hydroxide holding up despite the fall in industrial grade.

The broker expects around 80% of the incremental lithium demand will emanate from electric vehicle batteries, which supports hydroxide producers. This could drive an increased premium for product quality and favour incumbent producers.

Cobalt

Hallgarten notes the surge in cobalt is based on the growth in electric vehicles, in the mistaken belief that cobalt is irreplaceable in the mix, and the fact there is a permanent shortage of the material because it has main source is in the Democratic Republic of the Congo.

The analysts suggest that while having an automobile industry made Japan and Korea into first world economies, the bankruptcy of various Western car companies in the last 20 years signals there may be less attraction for China to have an automotive industry than many imagine.

Hallgarten is more comfortable by the day with a short call on cobalt without paying any attention to the speculation. The broker accepts the chaos and lack of clarity in the DRC may signal higher prices but also suspects the reign of cobalt will be short lived, with yet more reasons ensuing to replace cobalt in battery formulations.

Energy

Morgan Stanley has upgraded its industry view for the energy sector to Attractive. The broker believes the downside risks that plagued the industry in 2017 are easing. Prices will likely remain volatile but the upside risk centres on the under-investment across the industry since 2014, combined with strong demand.

Energy cycles typically play out in years, not months, and the broker notes it is less than 12 months since the cyclical lows of mid 2017. At the same time, LNG fundamentals are improving.

This is considered to be good for the majority of the stocks Morgan Stanley covers, as oil prices drive cash flows from existing assets.

LNG fundamentals will also set up brownfield expansion opportunities, although risks continue, including the average contract tenure of new LNG contracts.

The average contract size is reducing, which means more buyers are required to underpin new projects. The broker expects established players like Woodside Petroleum ((WPL)) are best placed, given scale and long-standing customer relationships.

The broker's key Overweight energy stocks include Woodside, Origin Energy ((ORG)), Beach Energy ((BPT)) and FAR ((FAR)).

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