Material Matters: Lithium; Aluminium; Oil

This story features PILBARA MINERALS LIMITED, and other companies. For more info SHARE ANALYSIS: PLS

Lithium price upside; higher for longer aluminium; commodity prices and inflation; oil’s ongoing deficit.

-Opportunity to buy lithium producers/developers
-Hydro power issues drive higher for longer aluminium prices
-Commodities trading below real dollar peaks
-Supply-side ensuring elevated oil prices

By Greg Peel

Lithium Looking Attractive

Spot China lithium carbonate equivalent (LCE) prices are trading below US$23,000/t, which could be supported by non-integrated refineries which need to source ores from third-party, high-cost lithium refineries in China (with an estimated production cost of US$22,000/t), in Macquarie’s view. Some lithium refineries began cutting output recently, in line with the analysts’ expectations.

Macquarie believes this presents a buying opportunity for investors, especially those who look past short-term volatilities, to increase their exposure to a critical mineral at an attractive price level. Most lithium miners are trading with an implied lithium ore price close to the analysts’ long-term price assumption of US$1,500/t.

Despite softer market sentiment, Macquarie sees value in lithium developers underpinned by resource quality and/or favourable jurisdictions. Hence the broker suggests the short-term market trough creates an opportunity for strategic investors, who may enjoy value unlocked through business consolidation or offtake agreements.

Pilbara Minerals ((PLS)) is Macquarie’s preferred producer, with Patriot Battery Metals ((PMT)) presenting the greatest upside on exploration over the near term. The analysts see value in both Allkem ((AKE)) and Liontown Resources ((LTR)), with Allkem offering unique exposure to both lithium brine in South America and spodumene production in Australia.

Global Lithium Resources ((GL1)) also offers great near-term exploration upside, in Macquarie’s view.

Higher for Longer Aluminium

With over 80% of its electricity coming from hydro, China’s Yunnan province has expanded aluminum production capacity to some 6mt over the past few years representing 7% of global capacity, Morgan Stanley notes, and another 2mt is in the pipeline. However, hydro has struggled to keep up with rising demand for power, driving shortages and forcing aluminum production curtailments.

In the wake of a post-covid demand recovery and curtailments elsewhere, this has tightened global aluminum markets.

Aluminum's reliance on a stable source of power to keep smelters running creates challenges when rainfall is insufficient for hydro, the broker notes, and alternative sources of power are limited. Morgan Stanley’s analysis suggests power supply tightness will continue into 2025.

The broker sees Yunnan's power deficit rising to -20 billion kilowatt hours this year on weak hydro resources and limited contribution from renewables. In 2024 and 2025, the broker estimates, Yunnan will face power deficits of -23bnkWh and -2bnkWh, as a result of slow power capacity growth.

The situation in Yunnan highlights the difficulties of an industry dependent on a stable source of power trying to switch to renewables and deal with seasonality. With China's aluminum capacity cap fast approaching, Morgan Stanley believes aluminum production is likely to come up against limits by late 2024, regardless of where the aluminum is actually produced. This should push the global aluminum market into a structural deficit as the energy transition drives demand, keeping aluminum prices structurally supported.

Rio Tinto ((RIO)) benefits from a 25% revenue exposure to aluminum and the ability to add carbon-free production, the broker notes. South32 ((S32)) should also gain as its power prices are now independent of the aluminum price, and its aluminum revenue (35%) and valuation (40%) exposures remain high.

Commodities and Inflation

A correlation between commodity prices and inflation is, well, stating the bleeding obvious. Citi acknowledges this but points out commodities are trading below their previous peaks if measured in today’s dollars, and hovering around their 20-year averages.

The copper price is -39% below its previous peak in real terms, iron ore is -50% below and gold is -16% below, Citi notes.

Should commodities move towards their previous peaks at some point it would be favourable for the miners in the medium term, Citi says. Again, rather stating the bleeding obvious.

Oil’s Comeback

The Brent crude price has risen some 30% since the June low to over US$90/bbl – a ten-month high.

The resilience of major economies and the lifting of pandemic lockdowns in China have contributed to strong global energy demand this year, Wilsons notes, despite headwinds from elevated inflation and interest rate hikes.

Meanwhile, the supply side of the equation is also tight. OPEC has continued to cut production, with major oil exporters Saudi Arabia and Russia recently extending voluntary supply cuts of a combined -1.3 million barrels per day to the end of 2023.

The combination of resilient energy demand and a tight supply backdrop will lock in a market deficit through the December quarter, providing a tailwind to the global oil price and acting as a boon for companies operating in the energy sector, Wilsons suggests.

The broker prefers producer Woodside Energy ((WDS)) and contractor Worley ((WOR)) in the space.

If China's growth continues to slow with stimulus lacking, major producers might extend production cuts if they see China's demand risks growing, keeping oil supply tight, Wilsons suggests.

Underinvestment in the energy sector will keep global supply tight over the medium term. Energy markets were already tight before the war, with limited capital expenditure in oil and gas since 2014, the broker notes. The war has highlighted the fragility of the market and concentration of risk in terms of production.

In upstream oil and gas, the industry at the peak was spending US$800bn per annum, which troughed at US$350bn in 2020, but has only since recovered to US$400bn in 2022, even with a bounce in demand and price. Oil and gas investment should increase, Wilsons believes, however new supply will take time to come online, leaving a market that will likely be tight over the medium term.

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