Mining and Metals commodity briefcase - EY · Mining and Metals commodity briefcase ... Iron Ore, Nickel, Steel, Platinum October ... hard coking coal contract registered its second

Mining and Metals commodity briefcase

Coal, Copper, Iron Ore, Nickel, Steel, Platinum

October, 2016

Coal

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended tobe a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member ofthe global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining fromaction as a result of any material in this publication. On any specific matter, reference should be made to the appropriateadvisor.

EY coal commodity briefcaseJuly – August 2016

Price Chart

Industry Snapshot

Thermal coal prices recovered in July-August 2016 as the enforced supply cuts started to take effect in China. This trend is not sustainable in longer term as thermal coal power generation is in structural decline.

Global thermal coal demand is forecast to decline 2% in 2016 followed by a 1-2% decline over 2017-2019, as nations strive to increase the use of renewable forms of energy.

The metallurgical coal market is progressing towards balance supported by closure of capacity globally. This has resulted in consecutive increases in the quarterly benchmark prices.

Demand for met coal is expected to remain weak as steel production is forecast to decline.

Sector Review

Thermal coalThermal coal prices rebounded as supply cuts start to take effect. Richards bay FOB prices surged 34% in August, from lows of below $50/t in January 2016.1 The recovery in prices is largely due to:

Supply disruptions Threat of further disruptions from the emergence of La Niña in Australia and Indonesia Declining Chinese production as the Government implements initiatives to close capacity Increases in demand in several regions or markets

The Chinese Government’s enforced production control and the lowering of utilization at existing mines is supporting prices in the near-term. Thermal coal output has already declined by 10% over Jan-May 2016 and mines are operating at a lower utilization of 276 days as compared to the typical 330 days.2 This initiative has led to tightening of China’s domestic market and higher prices are attracting more imports. The price of high-grade Australian thermal coal, benchmark for the Chinese market, rose 20% from a low of $49/t in January to over $59/t in July 2016.3 Rising prices are also likely encourage unprofitable miners to continue producing coal and may also lead miners to bring idled production will be back online at a time when it is least needed. In the longer term higher prices are also not sustainable as thermal coal power generation is in structural decline. Weakening global demand led by the shift to cleaner forms of energy will keep a cap on prices. More permanent production closures will, therefore, be needed to balance the market as demand declines by 2% in 2016 and a further 1-2% over 2017-2019.4

Metallurgical coalRecent quarterly benchmark increases for metallurgical coal suggest that the market is finally moving towards balance. The hard coking coal contract registered its second consecutive increase in Q3 2016, the first time since 2011, to $92.5/t, up $8.5/t q-o-q. Metallurgical coal has benefited from capacity closures in China. About 45mt of global production has been closed over the last four years and 14mt has been closed in 2016 already, mostly in Australia, Canada and the US.5 In addition, metallurgical April-May coal output in the Shanxi region alone declined 21% y-o-y as China enforced lower operating capacity utilization.6 Falling Chinese production has seen metallurgical coal imports into China increase, up 28% year to date.7 Despite these positive signs the market remains in oversupply. Demand fundamentals remain weak as global steel production is estimated to decline by 0.5% in 2016. What is clear is that whilst the worst may be over, volatility will remain and any recovery will be very gradual.

1 IHS McCloskey2 Metals Quarterly Q3 2016, HSBC, 11 July 20163 “Thermal coal price hits 10-month high as Chinese buyers snap up cargoes,” Mining.com, 11 July 20164 Metals Quarterly Q3 2016, HSBC, 11 July 20165 Commodities Quarterly, Deutsche Bank, 6 July 20166 Metals Quarterly Q3 2016, HSBC, 11 July 20167 Commodities Quarterly, Deutsche Bank, 6 July 2016

Copper


EY copper commodity briefcaseJuly – September 2016

Price Chart

Industry Snapshot

Weak seasonal activity in China has kept copper prices lower and as a result any activity in the market, however slight, is resulting in price surges and volatility.

Chinese copper demand grew by an unexpected 2.1% in 1H16, led by increased demand from the power sector. However, a surge in Chinese exports suggests that there is sufficient concentrate availability and demand may not be as robust as it seems.

Sector Update

Will China keep up with its past performance?China has retained its importance in the copper market, with other emerging markets failing to capture higher shares of demand either due to weak economic activity or a ramp up in domestic supply. Chinese copper demand grew by an unexpected 2.1% in the first half of the year led by demand from the power sector.While positive signals exist, a surge in exports from China indicates a different story. The increase in LME headline exchange inventories to a record 271,575t in August 2016 broadly corresponded with a decline in Shanghai inventory levels. Although weak seasonal activity manufacturing activity in China was under pressure, stock rebalancing suggests that the Chinese market is more than sufficiently oversupplied in the absence of demand pick-up.1 In line with this, the demand outlook for 2H16 remains cautious, though still fuelled by a growing real estate market, could drop back to 0.8%.2

The medium term outlook is clouded by uncertainty regarding future supply on the copper market. An extended period of low prices has led to limited capital for exploration and development, in turn deferring onset of new supply.

The Chilean mining sector increases use of seawaterSeawater consumption across Chile's copper industry has been growing steadily. In 2015 it grew 33% to 2.3m3/s in comparison to a marginal growth in freshwater consumption. Since 2012, the use of both desalinated and non-desalinated seawater, has surged 130% from 1.0m3/s, according to Cochilco. Seawater consumption is set to account for 50% of all water consumption in the mining industry by 2026. In line with growing demand there are a number of desalination plants that will come online over the next couple of years.

Chinese copper imports decline on weak domestic demandChina's August copper imports fell 2.8% from July to 350,000t, the lowest in a year on slow seasonal demand and higher Chinese refined production. Contrasting this China's copper ore and concentrate imports increased 34.6% for the first eight months of 2016 to 10.86mt.3

1 Copper is waving a red flag for China's economy, Business Insider, 8 August 2016What do surging LME copper stocks say about China?, Reuters, 30 August 2016

2 CHINA COPPER DEMAND PICKS UP AFTER SUMMER LULL, Reuters News, 12 September 20163 CHINA AUG COPPER IMPORTS SINK TO ONE-YEAR LOW OF 350,000 T, Reuters News, 8 September 2016

Iron Ore


Price Chart

Industry Snapshot

Prices relatively stable: Prices have defied forecasts, stabilizing through July and August between $55 and $60/t,however few expect long term recovery

Samarco: Report into dam disaster blames liquefaction and less efficient drainage as a result of design changes in2011/12.

Sector Overview

Prices remain disconnected from fundamentalsThe iron ore sector is somewhat baffled by the recent strength in prices, which have defied both logic and forecasts. Iron ore has been one of the best performing commodities this year with a 54% increase in prices (as at 31/8/16) from their December 2015 lows of $38.30/t. A variety of operational challenges and stable demand in recent months rather than a shift in strategy or fundamentals has led to comparative price strength. However the majors remain real about prices, confirming their expectations for longer term iron ore price decline.

Demand remains firm from ChinaIncreased iron ore imports into China have continued despite forecasts to the contrary. A slower than expected contraction in steel production (1.8% in 2015, compared to a forecast 3% decline) has skewed the previous outlook.1 China's domestic iron ore production dropped in July, down by 3.3% y-o-y. Imports increased during the month by 2.7% y-o-y, the second highest in history.2 Strong stimulus measures have supported new infrastructure and house prices in China and this has increased demand for iron ore.3 It's clear that China's efforts to rationalize overcapacity in its steel industry are proving difficult to implement and sustain, especially when higher prices provide an incentive to keep producing.4 However, demand for steel is still expected to fall again later in the year once these incentives wear off, which will consequently impact demand for iron ore imports.

1 “Iron ore should be on a downtrend, not an uptrend,” Mining Journal, 29 August 2016.

2 “China's iron ore output falls 3% in July despite higher price,” Metal Bulletin, 18 August 2016.

3 ““Rio Tinto and BHP’s strategy of raising production to force lesser-quality producers out of business appears to be paying off,” Mining Journal, 9 August 2016.

4 “Iron ore volatility masks positive shift in fundamentals: Russel,” Reuters, 18 July 2016.

EY iron ore commodity briefcaseJuly – August 2016

Nickel


Price Chart

Industry Snapshot

Price volatility: Nickel prices rallied more than 40% to trade at US$10,500/t in August, mainly on concern that strict implementation of environmental laws in Philippines will create a supply deficit in the nickel market in the short to medium term.

Mines closure in Philippines: The new mining ministry in the Philippines has suspended 7 mining operations in the country after an environmental audit found they were not in compliance with ISO standards. The Philippines currently accounts for around 20% of global mined supply.

Industry Developments

Indonesian Government plans to increase royaltiesThe Indonesian Ministry of Energy and Mining Resources (ESDM) plans to increase the royalties paid by mining companies. On nickel, royalties will increase from the current 0.9% to 2% and these changes will be applicable from next year to mines managed by contracts of work.1

Myanmar lifts ban on nickel exportsAfter recent rally in nickel prices, Myanmar has decided to remove the ban on ferro-nickel exports to China, which wasimposed in September 2015. This may increase nickel supply in China where NPI production has been suspended in InnerMongolia, Jiangsu province and Shandong province due to environmental issues. Tagaung Taung ferro-nickel smelter is theonly nickel smelter in Myanmar and has production capacity of 85ktpa of ferro-nickel, containing 27-30% nickel.2

Brazil temporarily reduces its nickel cathode import tariffThe Brazilian Foreign Trade Chamber reduced its import tariff for nickel cathode to 2% from 6%, in light of the current supplyshortage. The reduced tariff is valid until December 2016 and is limited to 3,600 tonnes. During January-May 2016, Brazilimported only 539 tonnes of nickel cathode as compared to exports of 5,540 tonnes which was mainly shipped from theVotarantim nickel plant. As a result of low nickel prices, however, the company halted its mining operations in February andits stock is expected to run down shortly, creating a deficit in the domestic market.3

1 “Indonesian government plans royalty rate increases on metals, coal,” Metal Bulletin,” 27th July 2016

2 “Myanmar lifts ferro-nickel export ban to China,” Metal Bulletin Daily,”21st July 2016

3 “Brazil temporarily reduces nickel cathode import tariff,” Metal Bulletin, 27th June 2016

EY nickel commodity briefcaseAugust 2016

Steel


EY steel commodity briefcaseSeptember 2016

Price Chart

Industry Snapshot

The sharp surge in met coke prices to $200/t will impact steel producers margins in the short-term as they may find it difficult to pass on the full cost to end customers.

During January-August 2016, China exported 76.35mt of steel, an increase of 6.3% y-o-y. For the first 8 months, the monthly average is 9.5 mt indicating an annualised estimate of about 115mt for 2016. In line with higher steel production, iron ore imports to China surged 9.3% y-o-y to hit 670mt during January- August 2016.1

Trade barriers are giving a boost to US steel players with steel imports down 25% in the first half, leading to higher utilization rates at 74.3% and improving margins.2

Industry Update

Global production updateDuring August 2016, global crude steel production rose 1.9% y-o-y to 134.1mt. Among major contributors, China, Japan and India registered an annual growth of 3%, 1.5% and 9.4% respectively, accounting for 85.6mt- equivalent to 64% of total global production. On other side, production in the US was down 3.4% y-o-y to 6.7mt, on account of ongoing capacity rationalisation in its steel industry. Overall rise in global steel production lifted capacity utilization for August to 68.5%, up 0.5% y-o-y.3

Restructuring of the Chinese steel sector

Capacity reductionThe Chinese Government does seem serious about capacity cuts with a 16.6% decline in coal production while steel production is down 1.1% in the first half. Baosteel has also announced it will cut 9.2mt or 25% of annual steel production.4

However, the pace of capacity cutting has not been fast enough. Hebei Province is apparently behind on its plan to reduce steel and iron producing capacity. Seven major iron and steel producers have cut their capacity by 3.18mt in the first seven months of 2016 by turning off 6 plants – but this is only 10% of the target for capacity cuts set by the Government. Hebei has pledged to close 31mt in 2016.5 As a result the National Development and Reform Commission (NDRC) has announced it will form inspection teams to help steer companies in the steel and coal sectors to cut more production capacity.6

Improving efficiency and competitivenessThe NDRC (National Development and Reform Commission) has stated that Chinese steel exports are competitive globally. China now uses the most efficient, low energy consuming, and highly sophisticated steel manufacturing equipment in the world. This is cutting production costs remarkably and boosting steelmakers’ global competitiveness. The NRDC also noted that the Chinese Government is not encouraging steel exports and has actually taken some measures to control the exports of metal products. China has taken strong measures to cut excessive production and substantial effects are emerging.7

1 “Chinese mills exports 9m tonnes of steel in August.” Steel Guru, 9th September 2016 2 “Nucor profit soars on lower costs, improving steel prices,” Dow Jones Newswires, 21 July 2016; “Steel Dynamics – 2Q results above guidance; 3Q spread improvement expected,” Jefferies Equity Research, 19 July 2016. 3 “ World Steel Association,” https://www.worldsteel.org/media-centre/press-releases/2016/August-2016-crude-steel-production2.html, 21st September 20164 “Baosteel to slash 9.2mt of capacity in 2 years,” SNL Mining & Metals, 13 July 2016. 5 “Hebei Province lags behind on plan to cut steel capacity,” Reuters via Steel Guru, 25 August 2016 6 “Cutting capacity to be monitored,” ShanghaiDaily.com, 20 August 20167 “Chinese steel exports are high due to competitiveness –NDRC official,” Steel Guru, 10 August 2016

Platinum


EY platinum commodity briefcaseSeptember 2016

Price Chart

Industry Snapshot

Platinum is likely to attract greater investment demand in 2H2016 as investors identify it as undervalued relative togold. This should support prices.

Mine production is forecast to remain steady in 2016 after the rapid recovery in 2015 after the strikes in South Africa in2014. Producers have cut down capex which will limit production.

A deficit market is likely as modest investment and jewelry demand along with steady production will keep the markettight.

Sector Overview

Platinum prices recovered post the Brexit vote Platinum prices have recovered to US$1,143/oz in July 2016 as compared to US$843/oz in early January 2016. Prices rallied 16% in July as investment demand surged after the Brexit vote given the safe haven status of precious metals.1

The recent price rise was also a catch up on the significant price underperformance of the PGMs in 2015. PGMs were the worst performing precious metals in 2015 undermined by a notably strong US dollar, a rapid recovery in mine output after the 2014 South African strikes and falling commodity prices. Prices were also impacted by the diesel automotive emissions scandal which raised concerns that automotive demand will shift away from diesel vehicles consisting of platinum to the palladium-rich gasoline vehicles.

Global DemandPlatinum demand is expected to grow at a moderate rate supported by the following factors:

Investment demand: Recovery in investment demand is expected in 2H 2016 as investors recognize platinum’s steep discount to gold and tight supply/demand balances. Several new physical investment products are scheduled to be made available to the market this year. The availability of product type, size and supplier is expected to increase investments and boost retail investment volumes. Higher investment demand is expected to result in a tightened market.2

Automotive demand: growth is forecast to grow only marginally as European diesel vehicle sales decline after the Brexitvote, US automotive sales are likely to be lower and emissions technology changes. Nonetheless, long-term automotive demand growth in India and China along with heavy duty diesel and light commercial vehicle platinum demand should somewhat offset the declining passenger vehicle demand.

Industrial demand: Robust demand from chemical, refining and electronic manufacturers is likely to maintain overall industrial consumption.

Jewellery demand: Platinum’s discount to gold should support retail volumes in 2016 and 2017. The growth in Indian demand could offset the decline in China. China’s market share in platinum jewelry has reduced with total market share falling to 28% in 2014 and 25% in 2015 from 43% in 2013. The decline, in large part, is a result of the slowdown in the domestic economy, which affected personal wealth and reduced consumption sentiment.3

1 “Global Metals Playbook,3Q16”, Morgan Stanley, 27 June 2016 via ThomsonOne

2 Press releases, World Platinum Council, accessed 11 August 2016

3 “Platinum Group Metals: Turning deficits into rallies,” HSBC Global Research, 8 July 2016 via ThomsonOne

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Mining and Metals commodity briefcase - EY · Mining and Metals commodity briefcase ... Iron Ore, Nickel, Steel, Platinum October ... hard coking coal contract registered its second

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