Material Matters: Critical Minerals, Met Coal & Oil

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A look at critical minerals and how they can help diversify Australian exports; met coal prices expected to fall below US$100/t in the short term; Oil prices may recover sooner than expected

-Demand for critical minerals expected to shoot up
-Coking coal demand outside China remains sluggish
-Oil markets: Time to Tango?

By Angelique Thakur

Critical Minerals: How to diversify Australia’s export basket

According to Geoscience Australia, critical minerals are metals and non-metals deemed vital for the well-being of economies. They include lithium, cobalt, manganese, rare earths, magnesium, vanadium, tantalum and titanium.

Supply of these minerals may be at risk due to factors like scarcity, geopolitical trouble and trade policies.

A lot of these minerals are used to make components for the renewable energy sector and in new technologies and with the world turning towards these two areas, ANZ Bank expects demand for these minerals will rise in coming years.

Some examples include lithium and cobalt which are used in ion batteries (for laptops, smartphones and electric vehicles). Rare earths are used in wind turbines and electric vehicles, while rutile and ilmenite are titanium minerals used in paints, paper and textiles.

High-end and new technologies like 5G are mineral-intensive, needing not only major metals like copper, aluminium and nickel, but also critical minerals.

ANZ Bank highlights the importance of these elements for Australia.

Australia is a leading producer and exporter of resources, which accounted for around 60% of the country's total exports in 2018-19. Its export basket was heavily skewed towards three commodities; iron ore, coal and natural gas, representing around 70% of total resource exports.

Such heavy reliance on a select few commodities leaves export revenue exposed to price volatility. The global shift to lower-carbon fuel sources also implies the share of coal will fall in the future.

Australia equally needs to diversify its export markets. Almost 80% of Australia’s iron ore exports are destined for China, along with about a third of LNG and more than 20% of coal. Japan is the largest importer of Australian coal and LNG.

This over-reliance on Chinese and Japanese markets makes Australia vulnerable to any changes in trade policy or geopolitical tensions.

Critical minerals can certainly help here, states the report. They will also allow the country to penetrate into different markets, diversifying its customer base and reducing vulnerability to export shocks.

Australia is the largest producer of lithium and rutile in the world. It is also one of the top-three producers of manganese, ilmenite and rare earths. Australia has considerable shares of global reserves of tantalum, vanadium and antimony.

ANZ Bank suggests investing in critical minerals – including exploration, extraction and processing – could help diversify Australia’s export markets.

While prices for commodities like lithium, cobalt and manganese have fallen materially over the last few years, ANZ Bank expects them to improve due to demand recovery in electric vehicles, renewable energy and high-end technologies.

Some covid-19 stimulus measure in China and Europe target the electric vehicles sector and renewables and will boost demand, while supply disruptions for some minerals could lead to a tighter market.

A number of concerns arising from the mining of these minerals need to be taken into account. These include environmental impact, plus social impact including indigenous Australians’ rights.

Coking Coal: Chinese demand expected to fall

Australia's hard coking coal prices have held steady since late May, ranging between US$106-116/t. Opposing forces at play are responsible for the range-bound price, according to a report by Morgan Stanley.

China’s coal buying spree, given the US$60/t arbitrage opportunity with domestic coking coal, offset subdued import demand outside of China (due to falling steel output).

The country's coal imports are up 57% year on year in the first half, a large proportion of which was hard coking coal. This has had the effect of keeping the price well above the 2015 low of US$80/t.

The current price, around US$111/t is near cost support level. This is not enough to warrant a meaningful supply response.

Blast furnace utilisation rates have been picking up outside China, point out Morgan Stanley analysts, but there is still a lot of uncertainty around China’s seaborne imports. This may render a quick recovery unlikely.

China’s strong first-half imports are not expected to repeat in the second half. One of the reasons are China’s coal import quotas. There are reports of southern China having used up 70-80% of its quota by late-July.

Morgan Stanley thinks fresh import demand will likely be suppressed by a clearance backlog. Mongolian coal exports to China have also risen by 23% month on month. This leads Morgan Stanley to think a slowdown in China's import demand is but inevitable.

Outside of China, demand remains sluggish. Steel output increased by 10% in June versus April but is still down -21% year on year. India, the second-largest met-coal importer, has seen the most progress. Its June steel output has risen by 112% versus April (although is down -26% year on year).

However, this recovery is driven by met-coal free iron production, highlights Morgan Stanley, noting coking coal shipments from Australia to India remain subdued, down -21% Jan-May.

Morgan Stanley analysts suggest an increase in covid-19 cases in India along with the monsoon season will likely push any strong recovery in steel demand to the fourth quarter. Steel output from other key met-coal importers – Japan and South Korea – fell again in June (versus April). Production in these developed markets is expected to be back at 2019 levels by 2024.

Slowing imports by China have the potential to cause a lot of damage. The analysts fear prices may even fall below the cost support level if China were to cease taking in the excess supply.

Ex-China demand will take more time to gather pace and Morgan Stanley believes it is possible we may see met coal prices drop below US$100/t in the short term, before recovering.

Met coal prices in the second half are expected to average US$108/t, with US$125/t projected for the first half of FY21.

Recovering black gold prospects

Shaw and Partners is of the view the worst is over for oil markets, and a price recovery is well underway.

The Energy Information Administration (EIA) forecasts oil demand to grow by 12.5mmbbl/d between the second half of 2020 to 2021-end. This, it states, is larger than the combined production cuts by OPEC-plus and the US (11.8mmbbl/d).

Shaw and Partners is of the view this may indicate the world is heading into an oil supply crunch in the coming 18 months. Oil demand, led by the pandemic instigated lockdowns, came crashing down to 79mmbbl/d in April from about 100mmbbl/d at the beginning of the year. Demand currently stands at circa 91mmbbl/d.

Inventory levels started to decline from June and are currently being drawn at the rate of about -1mmbbl/d. A real-time indicator of crude oil inventories, the Brent oil forward curve, has seen a considerable reduction in the level of contango since May. This indicates a tightening market, further proof of recovery.

The drawdowns also correspond with a recovery in Brent oil price, trading in a US$40-45/bbl range since June.

The analysts expect oil inventories to decrease throughout the year. In fact, the swing producers of the world, OPEC-plus and US Shale, may have to increase production ahead of plans to play catch up to the rising demand.

Oil, more than any other commodity, needs continued re-investment and Shaw calculates oil prices need to be more than US$70/bbl to incentivise new production.

For LNG, Shaw fears the increasing number of new projects may put a permanent dent in prices. The broker’s long-term price slope stands at 11% or circa US$7.8/mmbtu. This is equal to about 65% of the Brent oil price and is down from previous circa 13.5% (A slope of about 17% means LNG prices are equal to crude oil prices, on an energy equivalent basis).

The supply glut has led to a decrease in US exports since the start of 2020, leading to a corresponding recovery in regional spot pricing from their June lows.

Looking at the asset quality, operating metrics and leverage to oil prices, Shaw analysts are bullish on Beach Energy ((BPT)), Santos ((STO)), Oil Search ((OSH)) and Woodside Petroleum ((WPL)). All these companies can continue their operations even with Brent oil at US$35-40/bbl, on the broker's calculations.

Beach Energy is one of the broker's favourites due to a strong balance sheet and the ability to capitalise on spare liquefaction capacity at the Woodside-operated Karratha gas plant.

Santos is preferred due to its leverage to any recovery in the oil prices. Santos' Dorado oil project is considered the best undeveloped oil and gas project in the whole of Australasia.

The stock which presents the highest valuation upside potential is Oil Search. The broker suggests conservative investors may prefer Woodside Petroleum with a strong balance sheet and least leverage to the oil price.

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