Commodities Update June 2024
The last month has seen a broad-based softening of commodities outside of met coal and LNG. This issue we continue our exploration of the base metals market, with a view to understanding their role in the transition to a low carbon economy. This month we focus on alumina, the raw material for aluminium (accounting for 30-40% of the primary cost of aluminium production). Here, constrained Chinese production, and rising demand look set to see prices remain elevated and volatile.
The following is based on text from the Westpac June 2024 Market Outlook
For more details of our longer-term forecasts see Westpac June 2024 Commodity Forecast
Our broad commodities index, the Westpac Export Price Index, (WEPI) soften in the month (-2%) as robust met coal and LNG prices were offset by softer iron ore, thermal coal, crude oil and most base metal prices. We have done a bit of ‘marking-to-market’ for our near-term forecasts, but our long-held profile is broadly unchanged. We still expect iron ore prices to weaken this year, down to US$85/t by end 2024, ‘ditto’ for met coal (US$230/t by end 2024) and thermal coal ($120/t by end 2024). We are expecting crude oil to hold around current levels (US$80/bbl) through to late this year when lacklustre demand sees prices dip below US$80/bbl. While we hold a constructive medium-term view for metals associated with the transition to lower carbon emissions, we believe the current rally in base metals is overextended and expect a correction to take copper down to US$9,300 and nickel down to US$17,000/t by the end of the year. All-up we are looking for the WEPI to fall around 10% by the end of the year.
Crude oil
We were surprised by the extent of recovery in crude markets from the recent two-month lows. There have been some signs of softening post the EIA report of US crude inventory lifting by a larger than expected 3.7mb while gasoline stocks gained 2.56mb and distillate rose 882kbpd. In addition, the IEA released its monthly Oil Market Report and cut its change in demand forecast for 2024 by 100kbpd, taking it down to a rise of just 960kbpd. The EIA also noted that “oil’s subdued outlook is expected to carry forward into 2025, with a modest increase of 1mbpd reflecting lacklustre economic growth, an expanding EV fleet and vehicle efficiency gains”. The IEA then released its annual report on crude oil “Oil 2024” which forecast “peak oil demand” later this decade. In the report the IEA outlined “a major supply surplus emerging this decade, suggesting that oil companies may want to make sure their business strategies and plans are prepared for the changes taking place”. The IEA is forecasting oil demand to peak at 105.59mbpd in 2029 – this is the first time the IEA has put out a forecast for peak oil demand. The report highlights that OECD demand peaked in 2023 due to declining demand from Europe, US demand is forecast to peak in 2025 while the pace of increase in African demand peaks in 2026.
OPEC, quite naturally, had a strong response to the report producing their own report Energy Aspects quoting the OPEC General Secretary HE Haitham Al Ghais that “peak oil is not on the horizon” stating that “IEA’s narratives for oil are dangerous, especially for consumers, and could lead to unprecedented volatility”. There is some merit to OPEC’s argument as we note that in the commodities space, where investment in new production requires significant capital deployment and requires very long timelines, it is possible for production to fall faster than demand when investment in new production is not possible due to an observed (or even widely expected) trend decline in demand. In this situation prices will be higher, and more volatile, than you would expect given declining demand.
This is all consistent with our overall view on the crude oil market and points to rising inventories as we move through the second half of the year. As such, Robert Renne continues to expect crude prices to be capped by waning demand and rising supply, and while a near term bounce could extend as far as US$84.44/bbl he would be surprised to see it much above that level.
Iron ore
We see little reason to change our view that rising supplies and softening demand will see iron ore prices move lower through the second half of 2024. There were record Australian exports for the months of March and April, record Brazilian exports for the month of April and China record records for iron ore imports in January, February and April. Combine that with declining Chinese steel production, which is down around 4% year to date to April (down almost 7% through the year to April), it is little wonder that Chinese iron ore port inventories continue climbing hitting a fresh 2-year high, they are 2 standard deviations above seasonal average levels and are at the highest level against imports since February 2023 and compared to steel production, the highest since July 2022. As such, we are not at all surprised to see iron ore get as low as US$103/t was we were drafting this report and cannot rule out a potential further dip down towards $100 or even lower.
Base metals and the global transition
Base metals are showing signs of stabilising after the recent dramatic falls with aluminium down around 10% from the May highs, copper down 12%, zinc down 13% and nickel down a not insignificant 18%.
Regular readers may have noticed that this year we have focused more on the base metals group than usual. That is because we recognise the need to understand the longer-term dynamics for the critical minerals associated with the transition to net zero carbon emissions. (For a quick backgrounder in regard to this longer-term view see: Future prospects for Australia’s transition minerals). So far, we have covered copper, and aluminium while back in March we looked at the quintessential boom-bust mineral, nickel. The key theme unfolding from this research is that while the longer-term outlook remains particularly bright for these minerals (e.g. recent research suggests that under a net-zero scenario the global energy sector’s need for critical minerals will increase six-fold by 2040) that does not mean we have seen the end of two-way price volatility for this group. Overall, the transition to net-zero presents a positive outlook for Australia’s resources sector given our strong leadership in mining technology and services.
Copper
Our colleague Robert Rennie has been consistent with his view that copper was in a delivery squeeze/bubble. He saw prices being capped around $US12,000/t to US$15,000/t then once we pass this squeeze, prices should drop back through US$10,000 (our end-2024 forecast is US$9,300/t). As such, he was not surprised to see an around 10% slump over the last two weeks to below $10,000 as we went to press. The last week of May saw another huge rise in Shanghai copper inventories taking us to levels that have only been exceed three times before which set the market up for a break below US$10,000/t. However, more recently Rob noted that he still sees the risk that prices could extend lower given that copper inventory at SHFE warehouses continues to surge and are now 3.5 standard deviations above the 5-year average for this time of year. He also noted a Bloomberg report that Chinese refiners were set to export a total of between 40kt and 50kt of refined copper to LME warehouses in Asia. Chinese fabricators have been reluctant to pay up for copper as prices advanced toward US$10,000/t. This should continue to weigh on near term copper prices.
However, he again noted that Chilean copper production for the month of April was the lowest for that month all the way back to 2005 emphasising a supply problem for the months ahead. On top of this, Bloomberg noted that rising smelting capacity inactivity may be starting to filter into refined copper production “with satellite analysis from Earth-I showing a fifth of smelting capacity for the key industrial metal was offline in May”. An average of 20.8% was inactive last month, up 3.4% from May 2023 according to a statement from the company. Point being, once copper is done on this correction, it remains a strong buy on dips.
Aluminium and alumina
As we noted last month there has also been a lot of action in the aluminium market and we expect this metal to continue to outperform after the Chinese government stated in a work plan for 2024/25 that it would cut CO2 emissions by 3.9% and will implement far stricter limits for new aluminium output capacity.
This month we turn to the recent spike in alumina prices and find reasons to believe higher prices can be sustained for longer than we had previously anticipated. Alumina typically accounts for 30-40% of primary aluminium production costs. While most aluminium producers are vertically integrated (in electricity and alumina), marginal smelters are more exposed to volatility in alumina and power prices.
Over the past decade or so the aluminium industry has seen significant overcapacity resulting in prices generally tracking the cost curve. Price spikes in alumina/power lift the marginal cost of production and are supportive for the aluminium price (which is why aluminium is often described as ‘solid electricity’). Chinese overcapacity led to an oversupplied market with aluminium prices falling deep into the cost curve from 2021 to 2023. Then in early 2024 Alcoa curtailed output from the Kwinana refinery, removing around 1.4mtpa of alumina output. Combined with bauxite curtailments/shortages in China, this closure dragged alumina prices up out of the cost curve from around US$325/t at the end of 2023 to around US$375/t. This move was more likely due to the elimination of an oversupplied situation rather than the evolution of genuine tightness in the alumina market. Then a Rio Tinto declaration of force majeure on contracts with the Australian Yarwun & QAL refiners, due to fires affecting natural gas supplies, created market fears that real tightness would emerge in the alumina market. These refineries have a capacity of 7mtpa or around 4.5% global supply, 10% ex-China supply. The event saw prices push up through US$450/t.
China has excess alumina capacity (the industry is currently running at around 80% utilisation) and acts as the swing producer if seaborne prices are high enough. At least for the medium term, we expect this to remain the case. However, so far this year a series of safety stoppages have restricted the ability to lift alumina output and these issues appear unlikely to be resolved near term. Overall, for at least the medium term, a combination of constrained domestic alumina and increasing domestic alumina demand due to the resumption of smelter production in Yunnan are likely to limit China’s ability to materially lift exports to address tightness in the seaborne alumina market. As such, alumina prices are likely to remain elevated and potentially volatile.
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