Material Matters: Iron Ore, Oil, Coal and Lithium

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A glance through the latest expert views and predictions about commodities: upside for the iron ore price; oil glut; potential effects from Russian coal ban and top ten emerging lithium producers.

-Morgan Stanley remains bullish on iron ore
-A global glut of oil by mid-2023?
-Effects of a potential ban on Russian coal
-Top ten emerging lithium producers

By Mark Woodruff

Further upside for iron ore prices

Morgan Stanley remains bullish on iron ore though believes further price strength is more likely to align with a further recovery in China’s steel production.

While the broker’s China economist sees headwinds for GDP growth, steel demand is still expected to accelerate in the second half of 2022 by comparison to the first half.

A key headwind for Chinese GDP growth, which the broker expects to lessen by the end of the year, is the transition to living with covid. Towards year-end, robust infrastructure stimulus is also expected to negate weakness in the Chinese property sector.

The analysts disagree with commentary suggesting China's stimulus is responsible for recent iron ore price strength. It’s believed the main cause is supply disruption from the Russia/Ukraine conflict. Hence, further iron ore price upside is expected when the China stimulus is eventually factored in.

Also, since mid-February, Morgan Stanley notes China's overall blast furnace utilisation rate has crept up by 10% to 85%, which is supportive of iron ore demand. While China’s steel output is still down for the year-to-date, supply has also shrunk, mostly due to declines in volumes from Brazilian miner Vale and Rio Tinto ((RIO)).

Finally, while some investors believe a looming seaborne deficit in 2022 may be covered by inventories sitting at Chinese ports, the broker points out those inventories are largely comprised of low-grade ore.

A global oil glut by mid-2023?

Longview Economics expects global oil supply growth to exceed global oil demand by mid-2023.

Should oil prices remain at current levels, the research house expects a significant supply response in the coming 12-18 months.

While there’s a possibility of further sanctions against Russian energy, the largest marginal impact has probably already occurred, according to Longview, and yet a stable/strong price environment remains for Russian energy producers.

Even before the invasion of Ukraine, Russia signed deals with China and India to increase energy relationships, and Longview expects an ongoing switch to eastern consumers.

On top of this, OPEC production should continue to increase through to the end of 2023, assesses the analyst. Six key OPEC members are still estimated to have capacity to increase production.  Meanwhile, oil production is recovering in both Iran and Venezuela, two countries that typically suffered from weak production growth.

Outside of OPEC, Longview expects US oil production growth to continue, driven by rising capital expenditure and smaller private producers. The latter have been incentivised by the near doubling of the oil price from 12 months ago. Given the traditionally quick response time of shale production, a supply response from the US could potentially be rapid and significant.

In addition to rising supply estimates, Longview’s demand forecast doesn’t account for rising recession risks from monetary policy tightening, which would result in a sharper deceleration in global oil demand growth.

Thermal versus metallurgical coal prices

Additional Australian coal may be required by Europe, according to Morgan Stanley, should the European Commission proceed with a proposed to ban Russian coal imports to Europe, as part of a new round of sanctions.

While South Africa, Colombia and the US are considered the natural suppliers to what the broker terms the Atlantic basin, the volume of coal required may be difficult for those countries to fill and it also may take time to exit existing customer contracts. It’s estimated around 62% of European thermal coal imports in 2021 came from Russia.

As for the Russian coal, Morgan Stanley expects some of the potential exports could be lost due to the logistical challenges of redirection. As a result, the already undersupplied seaborne market may remain tighter for longer and it’s felt price risk for thermal coal is skewed to the upside.

Morgan Stanley sees less impact upon metallurgical coal with only around 17% of Europe’s imports originating from Russia in 2021. It’s also felt that a full redirection of trade flows would be more easily achieved, compared to thermal coal.

Lithium price forecast and top 10 emerging producers

To reflect current tightness in the lithium market (with no signs of easing), UBS lifts its 2022 spodumene forecast by around 17%, while its longer-term price forecasts are under review.

The broker expects the industry to gravitate closer to spot pricing in the future and cites the precedent set by the breakdown of the annual iron ore price contract many years ago. In that market, dynamics evolved to a point where the price difference between spot and contracted pricing made long-term fixed price agreements untenable.

The ability of a producer to realise prices closer to (a rising) spot is a key factor in picking relative outperformance in the sector, note the analysts.

Meanwhile, Petra Capital identifies ten emerging lithium producers ranging from Liontown Resources ((LTR)) with a market capitalisation of $4.3bn to Lithium Power International ((LPI)) at $325m. 

To enable comparison of the ten companies, the broker converts Resources and Reserves to lithium carbonate equivalent (LCE). This is necessary as reporting methods for Resources and Reserves include brine deposits, hard rock and sedimentary lithium.

The largest resource base is held by AVZ Minerals ((AVZ)), followed by Liontown Resources. Firefinch ((FFX)), which has operations in Mali, and AVZ Minerals (operations in the Democratic Republic of the Congo) are thought by the analysts to suffer from a sovereign-risk valuation discount. Meanwhile, Galan Lithium ((GLN)), is assessed as the cheapest in the group of ten emerging producers, based on attributable LCE Resources.

Meanwhile, companies nearest to production like Core Lithium ((CXO)) and Argosy Minerals ((AGY)) have the highest valuations. The former has the Finniss project in the Northern Territory, while Argosy commences production in mid-2022 from the Rincon project in Argentina.

In terms of the capital expenditure required to bring projects online, and contrasting that with the incremental production added, Sayina Mining ((SYA)), Firefinch and Core Lithium all enjoy very low capital intensities.

Other companies listed among the ten emerging producers are Lake Resources ((LKE)) with its flagship Kachi Project in Argentina, and Piedmont Lithium ((PLL)) with its operations centred on the Carolina Tin-Spodumene belt in the US.

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