Material Matters: Iron ore, Lithium and Oil & Gas

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A glance through the latest expert views and predictions about commodities: large forecast decline for the iron ore price; lithium price forecasts and preferred stocks; three reasons to have an energy sector exposure.

-Macquarie predicts big fall for the iron ore price
-Broker forecasts for lithium prices
-Preferred ASX-listed lithium stocks
-Three reasons to have an energy sector exposure

By Mark Woodruff

Big iron ore price fall looming?

So far this year the iron ore price has remained steady as the market has focused on Chinese stimulus for a depressed property market, which accounts for half of the country’s steel demand.

However, Macquarie believes stimulus will be hard to implement while the Chinese zero approach to covid is maintained.

Without improvement in finished steel demand, the iron ore price may suffer an ugly reversal at some point, suggests the broker.

Despite current weakness in finished steel demand, the iron ore market has tightened since the Chinese New Year, driven by an impressive recovery in hot metal production, explains the analyst. This recovery is partly attributed to a reduction in scrap consumption in both electric arc furnace (EAF) and basic oxygen furnace (BOF) steelmaking as covid lockdowns disrupted collection and logistics across the country.

While Chinese blast furnaces are now approaching full utilisation, the broker feels current market dynamics are unsustainable and hot metal is being overproduced.

Nonetheless, iron ore prices may rise in the short term as the market focus shifts back to underperforming supply and falling iron ore inventories, explains Macquarie. This view assumes current margins and the same level of Chinese hot metal production.

Extra upside impetus for prices may result from the Indian government’s recent decision to impose large export duties on iron ore, suggests JP Morgan. The country’s highly-price-sensitive exports to China, the majority of which are low grade, were not previously taxed at all. 

JP Morgan estimates the impact on global supply from the Indian tax could be -20Mt. When combined with a potential -45Mt reduction in supply from Ukraine and the broker’s recently reduced production forecasts for Rio Tinto ((RIO)) and and Brazilian miner Vale of -20Mt apiece, further support for prices can be envisaged.

Forecasts for lithium prices and preferred exposures

Demand for copper and aluminium doubles every 25-30 years and 15-20 years, respectively, points out Citi, while lithium demand is expected to double every three years over the coming decade, underpinned by rising electric vehicle (EV) production.

The spot lithium price is currently trading around -8% below all-time highs after a mini-correction in the last few weeks, though both battery grade carbonate and hydroxide are still up on average by 90% for the year to date.

As lithium is the most exposed metal to EV sales (70% of lithium demand coming from the sector in 2022), the broker feels the recent price fall emanates from concerns around demand for EVs/batteries being impacted by lockdowns in China, especially in the key automotive hub of Shanghai.

Nonetheless, the broker forecasts lithium prices will average around $35k/t through to 2025 compared to average prices of $13k/t over the 2017-2021 period. These prices contrast with marginal production costs of circa $5-10k/t. The long-term price forecasts for lithium carbonate and lithium hydroxide remain at US$15k/t and US$17k/t.

Meanwhile, Barrenjoey upgrades its near-term EV sales forecasts and adjusts for a slower lithium supply ramp-up, which drives its 2022 lithium spodumene and hydroxide price forecasts around 20-70% and 30-50% higher, respectively. Five-year forecasts for lithium (spodumene, carbonate and hydroxide) are also raised materially.

As a result of these revised price forecasts, the broker raises its 12-month target price for Overweight-rated IGO ((IGO)) to $14.50 from $13.50. The Western Areas acquisition is also now included in forecasts.

The analysts believe IGO is well-placed to benefit from a step-change in demand for lithium and nickel (from rising EV demand), due to its low-cost operations for both commodities and potential for expanded production.

Barrenjoey also initiates coverage on four lithium names, with Overweight ratings for both Allkem ((AKE)) and Liontown Resources ((LTR)), while Mineral Resources ((MIN)) and Pilbara Minerals ((PLS)) are handed Neutral and Underweight ratings respectively.

The broker highlights Allkem’s geographic and product diversity, as well as exposure to spot pricing, and sets a $15.00 target price. The recent Galaxy Resources acquisition provides both carbonate/hydroxide and spodumene production across Australia and Argentina, while Sal de Vida in Argentina and James Bay in Canada lend production expansion potential.

Meanwhile, the analyst sets a $1.80 target price for the almost-fully-funded Liontown Resources as it begins the development of its underground spodumene project in WA.

In the eyes of Barrenjoey, Mineral Resources (target price $64) gains credibility for its partnership with Albermarle (the world’s largest lithium producer), and its Wodgina spodumene mine and the Kemerton hydroxide facility are soon to start up. However, it’s thought another layer of complexity is added by the company’s existing iron ore exposure.

Finally, Pilbara Minerals is the least preferred among the four new lithium stocks under the broker’s coverage for a number of reasons, including the smallest valuation discount and the lowest compound volume growth. A target of $3.00 is set.

Three reasons to have an energy sector exposure

Wilsons paints a bullish picture for ASX-listed energy stocks and believes a current discount to global peers may unwind over the next 12 months.

Apart from the Energy sector’s historical usefulness as an inflation hedge, the broker’s view is mainly predicated on a significant industry tailwind following Russia's invasion of Ukraine. It’s estimated around 3% of the world's production has been effectively removed from the global oil market due to the loss of Russian exports, resulting in one of the largest shortfalls in supply since the 1970s.

Supply losses could expand to around -3mbd during the second half of 2022 from nearly -1mbd in April, as Europe starts to wean itself off Russian fossil fuels, estimate the analysts. Russia formerly comprised 14% of the yearly global oil supply, and any attempts to increase production in other regions is expected to take some time.

Wilsons points out Australian energy company share prices have lagged offshore peers by over -30%. Over the last two years share prices for Santos ((STO)) and Woodside Energy ((WDS)) have risen by 57% and 27%, respectively, despite a 213% rise in the Brent crude oil price.

The broker prefers Santos and expects a re-rating over the next year from several catalysts including the potential sell-downs of 10% of its PNG LNG asset and 10-51% of its Pikka oil project in Alaska. A final investment decision on the Dorado field for the company’s project off Western Australia is also expected to create value.

The starting point is favourable, even prior to any catalysts, as Wilsons points to a share price trading at the lowest implied oil price in the sector of US$63/bbl. In addition, the company recently announced a new capital management framework targeting higher shareholder returns.

Woodside is also expected to flourish over the next year from high leverage to oil prices and the spot Japan/Korea marker (JKM) for LNG, as well as upside from the merger with BHP Group’s ((BHP)) Petroleum division.

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