Volatility in commodities continues
May was a volatile month for commodities with no clear overall trend. Westpac’s Export Price Index is best described as flat but there have been big swings within this.
The following text is an updated version of the Commodities Update in the June Market Outlook (PDF 405KB)
For more details on our longer-term commodities price forecasts please see June Commodities Forecasts (PDF 40KB)
May was a volatile month for commodities with no clear overall trend. Westpac’s Export Price Index is best described as flat but there have been big swings within this. The most extreme was the 27% rise in thermal coal and the 21% fall in met coal which left met coal trading below lower grade thermal coal, a sign of a market well out of equilibrium. Crude oil prices have firmed with Brent lifting 11% while base metals are down 2%. Even gold has moderated, dipping 1% with iron ore flat.
Westpac’s Export Price Index is best described as flat, lifting just 1% in the month. But there have been big swings within this. The most extreme example is the 27% rise in thermal coal prices to US$423/t and the 21% fall in met coal to US$371/t – yes met coal is trading below lower grade thermal coal, a sign of a market well out of equilibrium. Crude oil prices have firmed with Brent lifting 11% to US$119/bbl while base metals are down 2% with copper now trading at US$9,684/t. Even gold has moderated, dipping 1% to US$1,853/oz with iron ore flat at US$146/t.
Needless to say, the seaborne coal market has entered a very interesting phase now that thermal coal is trading at a significant premium to higher grade met coal. Even the top end premium low vol met coal was traded at a US$407/t average in the last week, a meaningful discount to thermal coal and something that has never been seen before. Various market sources have cited the different fundamentals in these markets, along with sub-optimal downstream steel demand and poor steel mill margins as reasons for the inversion. This is captured by the reversal of the recent trend for Australian met coal to trade at a premium to Chinese met coal In the last week mid vol HCC cfr China was +US$4/mt or 2% compared to -US$44/mt or -11% for mid vol HCC fob Australia, on Chinese restocking demand as the COVID restrictions were eased.
The lift in thermal prices reflects: 1) tight supply from Indonesia (export bans were introduce in January) and Australia (Q1 was much wetter than usual due to an extended La Niña); and 2) geopolitics, as Russian coals faces bans. Met coal prices were largely demand-driven until the Russia-Ukraine conflict, and resulting embargo, saw prices surge higher. But there is something specific to the Australian thermal coal market. In the past month Newcastle prices are up +US$96/t or 32% compared to +US$25/t or +12% at Richards Bay (South Africa) and a fall of -US$10/t or -7% at Kalimantan (Indonesia). The Australian thermal coal market is extremely tight as post-pandemic demand recovers strongly. This year’s Japanese reference Price talks occur against a backdrop of significant price volatility fanned by the Ukrainian conflict, an extended La Niña wet season in Australia, and a March earthquake off Japan. The supply side constraints from widespread flooding and under investment have collided with the better-than-expected demand. In the last few weeks the shipping queue at Newcastle has risen to 16 from single digits at the second half of May. However, it may not just be a demand issue as cargo assembly is taking longer than usual with many producers facing production issues due to the recent wet weather.
Chinese COVID lockdowns and related restrictions hit hard in April. Transport and logistics started to improve from mid-April but to date progress has been slow. Consumer movements remain restricted in multiple cities and property sales continue to drop. The government has ramped up policy support recently, and we expect more as indicated by the Politburo meeting at end-April, including tax rebates, faster bond issuance and easier local government financing to support more infrastructure investment and more explicit support for property. As noted on page 16 we see the Chinese economy readying itself for strong rebound in the second half of year. Overall, we believe the administration’s target of near 5.5% growth in 2022 is still attainable but with two clear risks: 1) further significant outbreaks and lock downs; and 2) the global economy slowing under the weight of higher interest rates and weak real incomes which may hit Chinese exports harder. For the near term we will be closely monitoring the Chinese recovery, steel production and rising seaborne supply (for both coal and iron ore).
The above China optimism lifted iron prices which saw the largest weekly increase since March, up ~US$10/t to $145/t, with demand optimism returning after Shanghai ended its two month strict lockdown and Beijing confirmed it will resume public transport in most districts, restart dine-in restaurant services and allow workers to return to offices. Construction sites have gradually resumed work over the last few days and demand (as well as prices) for rebar has picked up. We acknowledge the risk of further lockdowns (with China adhering to the zero-COVID policy) and the recent pledges to lower steel output in 2022 compared to 2021.
We now expect modest growth in Chinese crude steel demand and production of around 1% y/y in 2022 with weak property partly offset by higher infrastructure spending. This should see demand for seaborne iron ore flat in the year. You would expect a modest improvement in the second half of the year as the lockdown eases and construction activity picks up. However, noting the above pledge to lower steel output in 2022 in 2022 on a year-on-year basis would suggest that output is set to moderate in the second half of the year versus the first half.
For the near term iron ore signals remain supportive with China iron ore and steel inventories falling, China pig iron production holding strong, while global iron ore shipments still disappoint.
Looking further out seaborn iron ore supply is expected to grow on average by around 3% per year 2022 to 2024, or around 100Mt, with most of the increase in supply from Australia and Brazil with Rio Tinto and Vale normalising supply after recent investments. Simandou in Guinea is set to add up to 100Mt from 2025/26. Given the history of how the major behave when ore prices fall below US$70/t, and most of the new supply over next 3 years come from the majors, if prices fall do fall below US$70/t the Big 4 are likely to slow expansion projects and prioritise "value over volume".
The EU has agreed to further sanctions including a ban on Russian seaborne crude and oil products, phased in over six and eight months respectively. A ban on shipping insurance for Russian oil by EU companies would be included in this package. European refiners representing >55% of the region’s capacity had already stopped buying from Russia or announced intentions to stop purchases by year-end. Russian exports to the EU are already down ~1Mb/d. Nearly 20% of exports, or ~750kb/d, transit via the excluded Druzbha pipeline, but both Germany and Poland have said they would stop pipeline imports by year-end. This leaves Hungary, Slovakia and Czech Republic with an exemption and they typically import ~250kb/d. When the embargo comes into effect 97% of Europe’s refining capacity will be banned from Russian oil and less than 10% of normal Russian exports will flow into the EU.
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