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Material Matters: China, Coal, Nickel, Zinc & Copper

Commodities | May 29 2023

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A glance through the latest expert views and predictions about commodities: low confidence in China impacting demand; thermal coal price forecast; nickel costs vary across producers; positive outlook for zinc & tax changes for copper in Chile.

-Commodities caught in a Chinese confidence trap
-How low can thermal coal prices go?
-Why rising nickel costs vary across producers
-UBS positive on the medium-term outlook for zinc
-Greater tax clarity for copper miners in Chile

By Mark Woodruff 

Commodities caught in a Chinese confidence trap

Formerly, Citi had recommended commodity investors be patient to allow time for economic growth in China to gather momentum, yet weakness persists.

Ongoing subdued macroeconomic data now suggest the economy could be stuck for a while, believes the broker, and unable to overcome a current downturn in confidence for both consumers and business.

Boosting confidence is a longer-term issue, suggests Citi, and while short-term fixes such as government support could assist, they may only serve to stabilise the macroeconomic environment.

Moreover, the impact of prior (substantial) policy support measures could be limited by the elevated debt burden in the country.

Some of the recent strength in commodities imports into China may have been a false dawn, suggest the analysts, and more due to inventory replenishment or favourable import arbitrage opportunities.

A rebound in iron ore prices has faded, as weakness in major end-use sectors continues to weigh on steel demand, while copper prices have fallen.

Iron ore imports by China declined by around -10% month-on-month in April, due to a combination of poor steel mill appetite because of low/weak margins, and delays in Australian shipments owing to cyclones.

Citi expects more voluntary cuts from steel mills in the coming weeks as steel demand remains weak, and the seasonal construction lull during summer is expected to further weigh.

These views held by Citi build on last week's FNArena article on disappointing growth out of China. Please refer to

How low can thermal coal prices go?

As China's import demand for thermal coal may not maintain recent strength, and low gas prices weigh, Morgan Stanley ponders: what is the floor for thermal coal prices?

The Newcastle benchmark price is still at US$160/t, an elevated level from a historical perspective, though remains under pressure due to high inventories, suggests the broker. However, it’s felt strong import demand from China is preventing a full-blown collapse.

During prior China pullbacks, the Newcastle price failed to push below marginal cost levels, and the analysts don’t expect this will occur. 

The current seaborne marginal cost comes in at just under US$100/t, which the broker believes is not an unrealistic level for the Newcastle price to (temporarily) reach.

When Europe passes peak gas storage by October, it’s thought more price support may emerge, especially when current coal stocks are further depleted.

There is currently a -US$45/t discount for European versus Newcastle coal, which comes as no surprise to Morgan Stanley given the coal-equivalent title transfer facility (TTF) gas price (a virtual trading point for natural gas in the Netherlands) is now US$80/t versus the Amsterdam-Rotterdam-Antwerp (ARA) coal spot price of US$115/t.

In a further headwind for the commodity, coal-to-gas switching is now more likely in Europe, according to the analysts. Risks to the TTF price are still considered skewed to the downside in coming months.

More promisingly, the Newcastle coal benchmark still sits -US$15/t below the coal-equivalent JKM LNG spot price, point out the analysts.

Why rising nickel costs vary across producers

Global production costs for nickel been rising in the 12-months to the end of March.

However, these costs vary markedly for different companies, highlights Macquarie, depending on their method of nickel production and amount of revenue derived from by-products. The latter is typically deducted from gross production costs.

In the case of nickel sulphide producers, significant credits accrue from copper, platinum group metals (PGM) and cobalt, while for high-pressure acid leach (HPAL) producers, cobalt is a material offset.

Macquarie notes a significant rise in energy prices (e.g. for coal, coke, diesel and electricity) for the year to March. For HPAL producers, a significant cost element has also been sulphur, used in the making of sulphuric acid.

The rise in costs has occurred while nickel prices have shown a significant decline year-on-year, with the single exception of the LME nickel price, point out the analysts.

However, LME prices have recently dipped below US$21,000/t compared with the 2023 first quarter average of US$26,000/t.

In the case of producers of nickel pig iron (NPI) and ferronickel, the cost of nickel ore is linked to the LME price.

Unfortunately, as NPI prices fell sharply, elevated LME prices have started to squeeze margins of Indonesian NPI producers, explains the broker.

Moreover these producers have experienced a narrowing cost advantage over Chinese NPI producers, where ore prices have fallen more rapidly.

Cost of production is not the only factor complicating comparison between companies. 

A major change in relative pricing of different nickel products over the last year, observes Macquarie, results in widely differing revenue bases.

UBS is constructive on medium-term outlook for zinc

As zinc is not really an energy transition material, UBS is not structurally bullish on demand, yet has a constructive outlook for the metal in the medium-term due to various supply and demand fundamentals.

To place medium-term fundamentals for zinc in some perspective, the broker believes the metal sits somewhere between copper (mine supply the key supply constraint) and aluminium, for which smelter production is the key factor limiting supply growth.

In the near-term, smelter cuts in Europe and a tight refined market are likely to drive the zinc price, according to the analysts, while over the medium-term mine supply is expected to be the limiting factor.

The broker anticipates only modest supply growth for zinc over 2023-25 resulting in a transitory surplus that could replenish low inventory levels.

Zinc doesn’t have an 'exciting' demand outlook either, with growth expected to be lower relative to other base metals but slightly better than carbon steel.

Global mine supply growth of 2-3% is expected over 2022-24 on stable China mine supply. The pipeline of new projects is limited in the rest of the world (ROW), and a rapid acceleration of projects appears unlikely to the broker.

Refined supply is lifting in China and UBS expects some recovery in Europe as smelters restart. The economics for European smelters has improved and restarts are expected to lift ROW smelter output in 2023/24.

Higher smelter output in China has been driven by a surge in concentrate imports, due in part to concentrate switching to China from Europe, rather than higher domestic mine supply.

The economics for European smelters have improved after a sharp decline in European energy prices and a change in the fundamental outlook for gas, combined with higher treatment charges, explains UBS.

However, concentrate availability is expected to be a limiting factor in the medium-term.

Some demand recovery in 2023 is expected for zinc, yet the outlook is mixed and remains lacklustre with limited improvement anticipated from China construction, with UBS forecasting a -14% fall in housing starts.

On the flipside, tailwinds are expected via the infrastructure/autos sectors in China.

The broker forecasts China refined output will lift 3-4% in 2023/24 and ROW output will return to ‘normalised’ levels over that period.

Under its research coverage, UBS has a Buy rating for South32 ((S32)), which has only modest by-product exposure to zinc via it’s Australian-based Cannington operation.

Greater tax clarity for copper miners in Chile

Following negotiations between the copper industry and government, Chile’s Lower House has formally approved the much-anticipated new Royalty Bill for large-scale copper producers.

The new bill will apply from the beginning of 2024 and will cap the effective tax rate (ETR) for copper mines at 46.5%, compared to the prior 2021 bill with an ETR of well over 50%. 

While the overall tax burden has crept up, Goldman Sachs believes foreign companies now have greater clarity and confidence on future investments in Chile, which should clear the way for major copper expansions over the next decade.

By way of example, the broker cites BHP Group’s ((BHP)) concentrator and leach expansion at Escondida and the sulphide leach extension and concentrator expansion at Spence. There’s also potential for a new sulphide concentrator at Cerro Colorado.

Foreign companies are impacted in different ways, given several 15-year tax stability agreements were signed between mining companies and the Chilean state dating back over a decade in some cases. 

On top of the 46.5% tax rate for companies that produce over 80,000t of fine copper a year, a 1% ad valorem tax (based on an assessed value) on copper sales from companies that sell more than 50,000t of fine copper was also introduced.

An additional 8% to 26% tax may also apply, depending on the miner's operating margin.

For stocks under Goldman’s coverage with Chilean exposure (which are all Buy-rated) forecasts for BHP Group are most negatively impacted by the new legislation and its target price falls to $49.00 from $49.90.

Rio Tinto ((RIO)) endures less pain than BHP, as its share of Escondida is just 9% of net asset value (NAV) compared to BHP’s 16%.

Moreover, Rio is already closer to the new 46.5% cap due to withholding tax implications from their dividend withdrawals from Chile. The target is only reduced to $136.10 from $136.20.  

Future investments for the company include its share of the concentrator and leach expansion at Escondida.

Clarity over the new royalty opens the way for future investments at Sierra Gorda for South32 ((S32)), such as a fourth milling line and the oxide project, notes Goldman Sachs. The broker’s $4.80 target price is unchanged

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