Commodity Blog

Current credit market woes could further stunt commodities supply growth especially from small producers seeking to develop high-cost projects in ”risky” regions like the Democratic Republic of Congo and Zambia, says Lehman Brothers in its 2008 commodities outlook.
Lehman notes that lack of available supply has already limited global consumption of particularly copper, nickel and iron-ore.
It puts this down to a long list of non- cyclical factors, including depletion of high- quality resources in low-risk regions.
The study warns that inventories can get worked down to ”very” low levels when underlying demand is greater than production.
It points out that London Metals Exchange nickel inventories fell to five hours of supply in 2007, and copper and zinc inventories to very low levels as well.
With low inventories and insufficient supply growth to meet underlying demand, commodity prices can soar to levels far above the marginal cost of production, the report says.
Lehman says that recent data suggest that the long-awaited economic slowdown is upon the world, but with the probability of a recession in 2008 is still below 50%.
It believes that the recessionary impact on the mining sector could be muted if demand for metals and bulk commodities in emerging eco- nomies continues to be strong.
If decoupling proves to be a reality, it believes that the mining sector outlook for 2008 should once again be good, with mining equity valuations inexpensive.
Lehman’s global economics team does not completely buy the decoupling thesis, however, and is therefore forecasting a modest slowdown in Chinese economic growth from 11,3% in 2007 to 9,8% in 2008, and 8,8% in 2009.
Lehman expects mining costs to rise by at least 5% on average in 2008 as a result of persistent supply-side constraints.

Copper
Lehman finds that the lead time to bring new copper supply on line has significantly lengthened.
In general, it expects supply constraints to continue to be a major factor in the copper market.
It puts China’s copper consumption at 26% of global consumption and US consumption at less than 12% of global copper consumption.
It says copper inventories in China are low, with the London Metals Exchange-Shanghai price differential slightly favouring Chinese imports, owing, in part, to the Chinese government waiving a 2% duty on copper imports.
One significant negative in the copper market in 2008 should be the shift in production at the Grasberg mine in Indonesia from the low-grade walls in the pit to the high-grade bottom of the pit, which should result in a 2,4% increase in global copper supply in the third quarter, an increase of 202 000 t. This shift is the primary reason why Lehman sees the copper market softening modestly in 2008. Its 2008 copper price forecast is $3/lb.

Nickel
Lehman expects stainless steel inventory destocking to come to an end this year and nickel demand to rebound. On the supply side, it says the emergence of nickel pig iron in China, in 2007, has significantly changed the nickel industry and esti- mates that nickel pig iron pro- duction costs of $9/lb and $15/lb support nickel prices of at least $11/lb. Its 2008 nickel price forecast is $13/lb, versus a current price of $13,25/lb, with the average at $10/lb-plus until “at least” 2010.

Zinc
It sees zinc moving into surplus in 2008. Zinc production has increased at Antamina, in Peru; Lennard Shelf, in Australia; San Cristobal, in Bolivia; Cerro Lindo, in Peru; and from mines in Kazakhstan. Chinese refined zinc production increased 19% year-on-year and Lehman expects Chinese refined zinc exports to increase in 2008 as China still has excess zinc smelting capacity. As the zinc market heads into surplus and 2008 inventories build, there is the risk that zinc prices will drift down to Lehman’s estimated marginal cost of production of $0,90/lb.

Aluminium
Lehman describes aluminium as this cycle’s base-metal laggard. Despite global aluminium demand increasing by 9%-plus from 2006 to 2007, its price has been range-bound between $1,06/lb and $1,33/lb. Lehman cites the reason as the abundance of bauxite resources in low-risk Australia, bauxite mining’s technically unchallenging nature and the quick coming on line of new alumina refining and aluminium smelting capacity.
It notes that most of the world’s aluminium producers are racing to get to the bottom of the cost curve by building new smelting capa-city in the Middle East and Iceland, where there are large volumes of cheap, stranded energy. Chinese production increased by 35% year-on-year and Chinese aluminium smelters are the marginal producers. Lehman says that if prices go far above $1,30/lb, a supply-side response could drive them down. Its below-consensus aluminium price forecast for 2008 is $1,10/lb.

Iron-ore
Lehman says that the seaborne iron-ore market is benefiting from a combination of very strong demand growth in China, and a slowdown in supply growth from India and domestic Chinese mines. Iron-ore exports from Brazil and Australia have also failed to meet expectations owing to weather- related problems and infrastructure constraints, especially at Brazilian ports. After peaking at almost 68-million tons in June 2007, Chinese monthly iron-ore production has been stable at between 60-million and 65-million tons a month.
Chinese iron-ore imports from January to November increased 17% year-on-year and October and November imports by 29% year-on-year. The marginal cost of production of iron-ore has been increasing as higher quality Chinese iron-ore resources are depleted and an increasing portion of Chinese mine supply of iron-ore is coming from small, low-grade, underground mines.
This high-cost, nontraditional supply has been necessary to meet underlying demand. Lehman estimates the marginal cost of production is currently at least $85/t and rising. With the iron-ore market as tight as it is, the spot price for Indian iron-ore in China has surpassed $200/t for iron-ore fines with 63,5% iron content.
This record-high price compares with a delivered $85/t cost for Australian iron-ore bought under contract, assuming a spot freight rate of $35/t and a delivered cost for Brazilian ore of $135/t, assuming the spot freight rate of $85/t. The iron-ore spot price has increased by 150% since the beginning of 2007.
Lehman is forecasting a 50% increase in the benchmark iron-ore contract price for the calendar year beginning April 1, 2008.
The consensus forecast is for a 35% price increase. Based on its analysis, it believes the risk to its above-consensus price forecast is to the upside. The iron-ore market could be primed for a surprisingly high contract price increase in 2008.
Higher-than-expected iron-ore prices should be a positive for Rio Tinto and may put added pressure on BHP Billiton to either make a formal offer for Rio greater than its proposed three-for-one share exchange offer, or walk away from this potential merger altogether.

Thermal coal
The Asia-Pacific thermal coal market has strength- ened because of steady demand growth and a variety of supply problems. Lehman expects this market to remain “very tight” in 2008 and believes the risk to its own 2008 Australian thermal coal contract price forecast of $68/t is “significantly” to the upside.
Lehman would not be surprised if coal prices settle at $80/t. It says that many of the long list of supply problems affecting the seaborne thermal coal market in 2007 have not been solved, and other problems have emerged. In Australia, ongoing port capacity constraints continue to affect exports.
While the vessel queue at Newcastle has fallen to 30 ships from more than 50 ships, Lehman does not expect to see a signifi- cant increase in Australian thermal coal exports in the near term.
The spot price for Newcastle thermal coal is currently $91/t versus just $51/t a year ago. A very strong Atlantic coal market is supporting Asia-Pacific thermal coal prices.
Lower than expected supply from South Africa and Russia has affected the Atlantic market. It notes that inventories at South Africa’s Richards Bay Coal Terminal have fallen to 1,1-mil- lion tons owing to a five-day closure of the Richards Bay coal rail line and a series of logistical problems compared with a normal level of Richards Bay Coal Terminal (RBCT) invent-ories of three-million tons.
RBCT exported only 66-million tons of coal in 2007, well below its capacity of 72-million tons. Lehman does not expect the expansion of the coal terminal to 76-million tons a year in 2008 to affect supply as the bottleneck has not been at the port. RBCT is set to expand to 91-million tons capacity in 2009.
Russian coal exports to Europe have been less than expected owing to strong domestic demand as well as stronger than expected demand in Japan and Korea. As a result of this tightness in the Atlantic thermal coal market, the spot price of Richards Bay thermal coal is currently $101/t versus just $49/t a year ago.
Lehman expects bottlenecks in the seaborne coal market eventually to ease, but for it to remain very tight for ”at least the next two years”, owing to slow supply growth and strong demand growth from India, whose imports could increase by 25-million tons in 2008, and, possibly, China.
Coking coal Like the Asia-Pacific thermal coal market, the seaborne coking coal market has been affected by port capacity constraints. The coking coal market has also been affected by production shortfalls in China as many Chinese coking coal mines are small, illegal mines that the government is forcing to close.
Coking coal demand has been very strong as global steel production increased 6,3% from 2006 to 2007. Coking coal prices in the spot market have been as high as $200/t. Lehman believes the risk to its own $120/t hard Australian coking coal contract price forecast for the fiscal year beginning April 1, 2008, is significantly to the upside.
If the market continues to tighten, it would not be surprised if contracts are ultimately settled at closer to $150/t.

Platinum
Lehman sees platinum-group metals (PGMs), especially platinum and rhodium, having a ”very good” 2008 outlook. It expects Lonmin and Anglo Platinum to continue to have operating problems and foresees PGM mining costs in South Africa continuing to be pushed higher.
It expects PGMs to be less cyclical than base metals since PGM demand growth is as much a function of tightening environmental regulations as it is a function of global economic growth.
It sees the risk to its own $1 300/oz platinum price forecast and $6 000/oz rhodium price forecast for 2008 as being to the upside, against the current $1 552/oz platinum price and $7025/oz rhodium price. It sees palladium fundamentals as being far weaker, with the palladium market having been in surplus since 2001.
It is comfortable with its 2008 palladium price forecast of $350/oz, with palladium currently at $377/oz.

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