19 February 2019
Six months ago, at the time of our full year results for the 2018 financial year, an air of prudent caution was beginning to permeate commodity markets. On balance, events in exchange traded markets since then have justified that caution; while bulk commodities, have, in the main, been more resilient.
The result has been a mixed price performance by our key commodities.
We revised our near-term world growth mid–case downwards six months ago to reflect the negative impact of rising trade protection, partially offset by more expansionary domestic policy settings.
The net impact on key end–use sectors was expected to be modestly negative.
We retain those forecasts in this update.
For the year ahead, we assess that directional risks to prices across our diversified portfolio are mixed. We anticipate average benchmark prices for steel making raw materials are likely to remain above long run marginal cost. Prior to the recent tragedy in Brazil, we felt a somewhat lower outcome for iron ore than in the year just gone would not have surprised. That position is now highly uncertain. Metallurgical coal is expected to be able to sustain above long run marginal cost deeper into the cycle than iron ore. Quality differentials in both commodities are expected to remain favourable, albeit narrower than the extremes of recent history.
Oil and copper prices remain susceptible to swings in global policy uncertainty. We consider the commodity–specific fundamentals of both oil and copper markets are sound, although we estimate their forward looking short-term fair value ranges are lower than the same time a year ago.
In the medium-term, we see the need for additional supply, both new and replacement, to be induced across most of the sectors in which we operate.
In many cases, this could lead to higher–cost supply entering the cost curve.
This projected steepening of cost curves can reasonably be expected to reward disciplined owner–operators with high quality assets.
On the demand side, we continue to see emerging Asia as an opportunity rich region. China, India, ASEAN and the global impact of China’s Belt and Road initiative are all expected to provide additional demand for our products.
As the true economic costs of trade protection are progressively recognised by global consumers, we anticipate a popular mandate for a more open international trading environment will eventually emerge.
Looking even further ahead, the basic elements of our positive long–term view remain.
Population growth and rising living standards are likely to drive demand for energy, metals, and fertilisers for decades.
New demand centres will emerge where the twin levers of industrialisation and urbanisation are still developing. Emerging themes, such as sustainable and ethical end–to–end supply chains, will become even more important for competitiveness and consumer acceptance.
Technology will advance, creating both opportunities and threats, and climate change policy, technology and market responses will evolve.
Against that backdrop, we are confident we have the right assets in the right commodities in the right jurisdictions, with attractive optionality, with demand diversified by end–use sector and geography.
Table of contents
|World GDP >||China >|
|Major advanced >||India >|
|Steel >||Iron ore >|
|Met coal >||Copper >|
|Crude oil >||Global gas >|
|Eastern Aust gas >||Aust power >|
|Energy coal >||Potash >|
|Nickel >||Freight >|
|Inflation >||EVs >|
Global economic growth
World economic growth is likely to be around 3¾ per cent in real terms in calendar year 2018, similar to calendar year 2017. In 2018, stronger outcomes for the US and India have offset slower growth in China, Europe and Japan.
Global trade growth slowed from around 5¼ per cent in calendar year 2017 to around 4 per cent in calendar year 2018.
Looking ahead, we expect world GDP growth to fall in the range of 3¼ to 3¾ per cent in both calendar year 2019 and 2020, which is unchanged from six months ago. World trade volumes are expected to expand at a similar pace to GDP. The IMF’s January forecast update now positions them in the middle of our GDP range. They had previously been at the top of our range.
While we stress that an increase in trade protection alone is not a recessionary level shock for the global economy, it is an exceedingly unhelpful starting point for the pursuit of broad based growth across regions, expenditure drivers and industries.
That observation highlights the importance of continued advocacy for free trade and open markets by corporations, governments and civil society.
Financial conditions have tightened somewhat in the United States, with higher policy interest rates and a stronger exchange rate partially offset by a relatively flat Treasury yield curve. In emerging markets, financial conditions have tightened more appreciably, particularly for those with large hard currency external financing requirements and a reliance on portfolio inflows to service their deficits.
The US dollar strengthened over the last twelve months. On a real, trade–weighted basis, it is around 7 per cent higher YoY. The wide ranging impact of the US Federal Reserve’s policy tightening cycle and balance sheet unwinding, conducted against a backdrop of fiscal expansion, tariff–induced price increases, full employment at home, skittish global investor sentiment and pockets of financial fragility abroad, remains a key source of uncertainty.Back to top ↑
While we stress that an increase in trade protection alone is not a recessionary level shock for the global economy, it is an exceedingly unhelpful starting point for the pursuit of broad based growth across regions, expenditure drivers and industries.
China’s economic growth is expected to slow modestly in coming years. We expect real GDP to register between 6 per cent and 6¼ per cent in both 2019 and 2020, with 2019 closer to the top of that range. These estimates are unchanged from six months ago. They reflect the likely impact of US trade protection on the export sector as well as an appropriately calibrated countervailing domestic policy response.
News–based measures of policy uncertainty1, which tend to lead swings in economic activity, show trade tensions have had a material impact on the views of Chinese people.
In calendar year 2019, we anticipate that infrastructure will rebound somewhat after a disappointing 2018; housing will be resilient; and the automobile market will improve after a very weak calendar 2018. We feel the pronounced strength seen in the machinery sector in recent years will dissipate. Exports will undoubtedly slow in response to rising protection in the United States, as well as softening momentum in other major markets, such as Europe and Japan.
Within the above construct we anticipate that national level housing policies and rhetoric will remain directed towards limiting speculation, building rental markets and fine–tuning the shantytown redevelopment programme. However, at a local level, we sense that there is now an emerging willingness to loosen the reins slightly.
In terms of more enduring frameworks, China’s policymakers are expected to continue to seek a balance between the pursuit of reform and the maintenance of macroeconomic and financial stability. We anticipate a continuation of current efforts to address excess capacity; further encouragement for the financial system to focus on supporting the real economy; and additional measures aimed at improving both sectoral and aggregate balance sheet health, including that of local government.
Nevertheless, China is expected to remain the largest incremental contributor to global industrial value–added and fixed investment activity through the 2020s even as its growth rates mature.
One objective of China’s Supply Side Reforms has been to return highly–indebted heavy industrial sectors to profitability, thereby reducing systemic risk in the financial system. This objective is roughly on track, in our view.
A second objective of China’s Supply Side Reforms has been to improve urban living standards by tightening environmental regulations and improving the enforcement of those regulations. This objective is being pursued with considerable resolve.
Over the longer-term, our view remains that China’s economic growth rate should moderate as the working age population falls and the capital stock matures. China’s broad production structure is expected to continue to rebalance from industry to services and its expenditure drivers are likely to shift from investment and exports towards consumption.
Within industry, we expect a concerted move up the manufacturing value–chain; and a concerted move outwards, with an emphasis on South–South cooperation along the various Belt–and–Road corridors. More broadly, we anticipate environmental concerns will become an even more important consideration in future policy design than they are today.Back to top ↑
Over the longer-term, our view remains that China’s economic growth rate should moderate as the working age population falls and the capital stock matures.
Major advanced economies
After a very strong performance in 2018, the US economy is expected to decelerate in calendar 2019. It should, however, remain the fastest growing of the major advanced economies.
With the nation close to full employment based on traditional measures, inflation close to target and domestic demand still enjoying the tailwind of fiscal stimulus (but some cyclical sectors and financial indicators showing signs of fatigue), the US Federal Reserve’s forward policy guidance of at most two 0.25 per cent rate increases in calendar year 2019, patiently applied, seems reasonable.
Long-term nominal bond yields in the US remain below 3 per cent at the time of writing. That partly reflects the growing unease in some quarters about the “use by date” of the current expansion, which at ten years, is already three years longer than the historical average.
We note that the true costs of protectionism, particularly diminished consumer purchasing power, have not yet been fully felt by US households and businesses. Weakening domestic consumption and sales, and declining international competitiveness, are the inevitable medium-term outcome of such a turn inwards. It is very unlikely the current policy mix in the US will lower the nation’s trade deficit, which seems to be a core, if misplaced, objective of the current administration. The US’ [non–oil] deficit is essentially a joint function of its low relative national savings rate and the US dollar’s role as the world’s principal vehicle currency2.
In Europe and Japan, business confidence, particularly among manufacturers, has been softening since early in calendar 2018. The flaring of trade tensions in the June quarter amplified the shift in sentiment. Since then, softening growth momentum, a material slowdown in the bellwether auto sector, and in Europe, rising political and policy uncertainty, at both a national and regional level, have enshrined the trend.
For both regions, where the limits of monetary policy effectiveness may have been reached and public sector finances are stretched, we gauge that any upside to growth in the medium-term will have to come from external demand sources.
Shorter-term, the possibility of the US instituting global auto tariffs – the US Commerce Department is presently studying the matter – would clearly be a damaging development for Europe and Japan.Back to top ↑
India’s economy is on a healthy medium–term growth trajectory, notwithstanding the typical emerging market difficulties it experienced in calendar 2018. Reform signposts have been positive, in general, underscoring the nation’s long run potential. We note in particular its ascent as the number one destination globally for announced greenfield foreign direct investment; the introduction of a nationwide goods and services tax; an improved institutional setting for infrastructure planning and project execution; large scale efforts to bring rural residents into the formal identity and banking structure; and the determined efforts of policymakers to address non–performing loans in the banking system, particularly in the strategically important steel and power industries. On a less positive note, following a period of marked improvement in the country’s monetary and macro–prudential policy frameworks, we feel that the risk of some regression is expected to be high based on recent developments.
The upcoming general election, which will run from April through May, is an important inflection point for India’s medium-term outlook. Polling suggests that the incumbent government of Narendra Modi is the favourite, but it is very likely that its current parliamentary majority will be decreased significantly.Back to top ↑
Steel and pig iron
Global crude steel production growth was healthy in calendar 2018, building on the strong rebound in the prior year. Output increased by 4.5 per cent YoY. Pig iron output growth has been slower than that of total steel production for the year as a whole, with annual growth registering at 2.2 per cent YoY, although pig iron had stronger momentum late in the calendar year. Chinese output of pig iron increased by 3 per cent YoY to 771Mt.
Rising demand from key end–use sectors across all major regions and the ongoing impact of Supply Side Reform measures in China have led to higher capacity utilisation rates globally. This has translated into wider margins and much improved profitability for mills. Global utilisation has been hovering in the mid–to–high 70 per cent range, the highest since calendar year 2012. That is more than ten percentage points higher than at the cycle trough.
In China specifically, the lift in profitability has allowed for a promising trend of improvement in sector–wide balance sheets.
Around 40 per cent of the targeted reduction in the liability–to–asset ratio (–10 percentage points from 70 per cent to 60 per cent) has been achieved to date. So while there is clearly much more to do on this front, the direction of travel is heartening for both the financial sustainability of the steel industry and systemic financial system risk.
As we foreshadowed, a slowdown in construction and autos, and the intra–year constraints imposed by environmental policies, saw China’s production run–rate moderate in the second half of the 2018 calendar year.
In calendar 2019, we anticipate a shift in the demand contribution coming from each of the key end–use drivers. The net impact of the various moving parts points towards total demand being close to flat. Machinery, one of the strongest major downstream sectors of the last two years, and the most exposed to the trade conflict, is likely to decline. Infrastructure is expected to bounce back from a weaker than expected 2018 due to well publicised policy support. Housing will be resilient; while automobile production should improve after an uncharacteristically weak 2018, assisted by the pro–consumption bent to recently announced counter–cyclical policies.
We estimate that 80 per cent is the long run equilibrium crude steel capacity utilisation rate, consistent with the stated objectives of China’s steel industry Five Year Plan (2016–2020). That compares to slightly less than 70 per cent at the cycle trough and upwards of 85 per cent at the height of policy induced disruptions.
We firmly believe China will ultimately double its accumulated stock of steel in use, which is currently between 6 to 7 tonnes per capita, on its way to an urbanisation rate of around 80 per cent3, and living standards around two–thirds of those in the United States, at mid–century.
China’s current stock is well below the current US level of 11.8 tonnes per capita. German, South Korea and Japan, which all share points of commonality with China in terms of development strategy, economic geography and demography, have even higher stocks than the US. However, the exact path to this end point for China has become less certain due to increasing protection and aggressive capacity removal actions.
Among the range of possibilities we consider, our base case is that Chinese steel production has entered a plateau phase, with the literal peak to occur by the middle of next decade. Our low case4 assumes that we will immediately enter a multi–decadal decline phase in pig iron output.
Notably, where the “peak steel” debate is concerned, the annualised crude steel production run–rate in China hit a record of 984 Mt in August 2018, with the full calendar year hitting 928 Mt. That represents growth of 6.6 per cent over the 2017 calendar year outcome of 871 Mt, although we caution that the two figures are not directly comparable due to sampling changes that led to marked upward revisions to recent history over the last two years.
The recovery in the rest of the world continued in calendar year 2018. Based on figures from worldsteel, global crude steel production excluding China was 2.3 per cent higher than in 2017. Global pig iron, ex China, expanded by 1.0 per cent YoY during the period.
India saw crude steel output growth of 4.9 per cent YoY in calendar year 2018, with pig iron output growing by 7.0 per cent YoY.
During the year, India’s output passed Japan’s, making India the second largest steel producer globally.
India’s demand uplift was balanced across the infrastructure, construction and automobile sectors.
Steel production elsewhere in Asia has been mixed. Japan, saw output contract by –0.3 per cent YoY (to 104Mt), while South Korea saw production expand by 2.0 per cent YoY (to 72 Mtpa) during calendar 2018. Southeast Asia increased steadily, led by Vietnam (+23 per cent YoY) amid a rapid build–up of blast furnace capacity in the region.
Europe has seen a marked slowdown (–0.1 per cent YoY), following on from the strong, broad–based growth performance across steel–using sectors observed in calendar 2017. In calendar 2019, Eurofer is predicting slower growth in apparent consumption, with the slowdown spread across most major steel–using sectors, in line with the direction of the broader economy. Growth in North America was a healthy 4.1 per cent YoY in calendar 2018, with a 121 Mtpa run–rate (with the US producing 87Mt). The CIS (Commonwealth of Independent States), which has been a laggard region through most of the upswing, retained that status, with basically flat output in the year just concluded.
Higher steel tariffs in the United States has raised costs sharply for end–users, with negative implications for the competitiveness of downstream sectors. Hot–rolled coil (HRC) prices in the United States have been sitting around $250/t and $400/t above those in northern Europe and China respectively. A safeguard mechanism, which was designed to discourage the wholesale re–direction of exports from the US to Europe, was instituted by the EU in July 20185.Back to top ↑
We firmly believe China will ultimately double its accumulated stock of steel in use, which is currently between 6 to 7 tonnes per capita, on its way to an urbanisation rate of around 80 per cent, and living standards around two–thirds of those in the United States, at mid–century.
Iron ore prices (62 per cent, CFR) ranged between $63/dmt and $77/dmt over the second half of the calendar year, averaging $69/dmt (+1 per cent YoY). Demand for high and medium grade mainstream iron ore remained firm in the context of the attractive steel margins created jointly by steel Supply Side Reform, healthy end–use demand and periodic production curbs aimed at air quality improvement. Seaborne lump premia trended steadily upwards in the first half of calendar 2018, before settling above $0.30/dmtu for most of the second half.
Global contestable iron ore demand is estimated to have increased 2 per cent YoY (+34 Mt) in calendar year 2018, to 1,589 Mt (62 per cent Fe equivalent, dry basis) –easily the highest level on record. Chinese imports of iron ore declined to 1,065 Mt in calendar 2018, –0.9 per cent lower YoY. However, after accounting for inventory changes at Chinese ports, the implied consumption of imported iron ore edged up by 2 per cent YoY. Asian developing countries also posted a solid year for pig iron production and iron ore imports, notably India and Vietnam.
In aggregate, the seaborne majors delivered an additional +50 Mt (dry) to the seaborne market in the calendar year, up 5.7 per cent YoY. Logistical disruptions and other unplanned outages were a key factor constraining industry–wide performance. These constraints were most pronounced in the seasonally weak March quarter and the seasonally strong December quarter. Furthermore, reductions by swing suppliers such as India, juniors in traditional basins and the temporary closure of Minas Rio combined to displace –48 Mt of supply over the year.
Price sensitive seaborne supply fell away despite attractive benchmark prices as lower grade, higher impurity ores continued to attract steep discounts. Chinese domestic iron ore concentrate production tallied 196 Mtpa in December 2018, +2.6 per cent higher YoY. The small gain partly reflects base effects related to the asymmetric application of winter restrictions YoY, as well as a mild response to favourable market conditions from some non–captive operations. Going forward, we expect that, in addition to structural market based drivers, safety and environmental inspections are likely to have a material influence on the average level and seasonal volatility of Chinese domestic iron ore production.
Our blast furnace customers in China are currently experiencing reduced margins to those they enjoyed in 2017 and for much of 2018. This has encouraged an increase in commercial blending arbitrage, and a reduction in the very high level of lower grade port inventories that had built when margins were exceeding US$100/t. Logically, this has led to a reduction in both the 65 per cent minus 62 per cent, and the 62 per cent minus 58 per cent spreads. Discounts for products with specifications lower than the 58 per cent index have also narrowed, by a handful of percentage points.
Prior to the tragedy in Brazil, we felt that it would not be a surprise to see lower average benchmark prices in the 2019 calendar year versus 2018. That view was built on two pillars: a moderation in steel demand and a lower rate of disruption in seaborne supply. Seaborne supply conditions are now highly uncertain, both in aggregate and in terms of quality profile.
In the medium to long-term, the on–going Supply Side Reform, the expected migration of steel capacity to the coastal regions and more stringent environmental policies are all expected to underpin the demand for high quality seaborne iron ore fines and direct charge materials such as lump. The South Flank project, which was approved in June 2018, will raise the quality of our overall portfolio, in addition to increasing the share of lump product in our total output.
We remain of the opinion that around two–thirds of the movement in product quality differentials since the introduction of Supply Side Reform will be durable. The recent narrowing of differentials is an anticipated development on the path to this gravity point.
We continue to contend that the long run price will likely be set by a higher–cost, lower value–in–use asset in either Australia or Brazil.Back to top ↑
We remain of the opinion that around two–thirds of the movement in product quality differentials since the introduction of Supply Side Reform will be durable. The recent narrowing of differentials is an anticipated development on the path to this gravity point.
Metallurgical coal prices6 over the last six months have ranged from a low of $172/t FOB Australia on the PLV index in July 2018 to a high of $236/t in December 2018. MV64 has ranged from $151/t to $196/t; PCI has ranged from $118/t to $135/t; and SSCC has ranged from $116/t to $132/t. Approximately three–fifths of our tonnes reference the PLV index.
For the calendar year as a whole, the PLV index averaged $207/t, 10 per cent higher than in calendar 2017. The differential between the PLV and MV64 indexes averaged 15 per cent in calendar year 2018, an equivalent outcome to the prior year.
Similar to our view on iron ore, our technical and market research, in addition to extensive customer liaison, indicate that the premia presently being attracted by high quality coking coals are predominantly a structural, as opposed to cyclical phenomenon, although there is certainly a transitory component to them that will fade with time.
Pig iron production in contestable met coal markets is estimated to have increased by 0.9 per cent –in calendar 2018.
On balance, the seaborne markets for coals referencing the PLV and mid–volatile indices still feel relatively tight. We have been pleased to see further growth in the met coal derivatives market, with traded turnover relative to the physical market rising at a faster pace than iron ore futures did at a similar stage of development.
Demand growth has been reasonably broad based by region, with India leading the way. Blast furnace restarts in India have driven a 14 per cent YoY increase in import volumes (across all met coal categories). Longer term, we anticipate that India and south–east Asia will be the main sources of incremental growth in seaborne demand for metallurgical coal. Traditional markets in North Asia were down –1 per cent YoY, to 102 Mt. On the supply side, coal throughput and vessel queues at the major Queensland ports did not normalise to the extent that was hoped in calendar 2018, following the major disruptions of calendar year 2017. As a result, Australian exports rose just 3 per cent YoY to 178 Mt, which is somewhat less than anticipated at the start of the calendar year. This was partly due to a fire at a major mine in Queensland, as well as uncertainty with respect to mine–to–port logistics.
Met coal exports from the United States and Canada have responded to attractive seaborne prices, expanding by 14 per cent (to 56 Mt in total) and 9 per cent (to 32 Mt in total) respectively over the year. Exports from Mozambique and Mongolia have been lower than expectations. Domestic Chinese coking coal supply has contracted marginally (–2.4 per cent YoY) against a background of safety and environmental pressures; while China’s total coking coal imports were down by –7 per cent YoY to 65 Mt. Shipments from Australia to China were down –9 per cent YoY to around 28 Mt.
The continued policy focus on environmental considerations7, should increase the competitiveness of high quality Australian coals into coastal China, at the margin. Uncertainties in this regard are the future level of Mongolian exports (mainly mid volatile, low sulphur) and US–China trade relations (US met coal imports are on China’s retaliatory tariff list). Further, while there also remains potential for intra–year import curbs during lower demand periods, our view is that in the future, as in the past, these curbs will tend to mostly impact upon energy coal and lower grades of met coal with higher sulphur content, and on cargoes destined for lower tier ports. The vast majority of premium met coal cargoes are destined for tier one ports. Strained geopolitical relationships beyond the US–China trade issue are a further source of uncertainty.
We maintain a constructive medium term outlook for metallurgical coal prices. The Supply Side Reform and heightened environmental, safety and water controls in China are all supportive of the market. In the medium term, enhanced value–in–use realisation for low impurity, high coke–strength after reaction products and Chinese supply-side discipline are both expected to pertain. So while prices will always be volatile within and across years based on both cyclical and idiosyncratic influences, it seems reasonable to suggest that met coal prices can sustain above long run marginal cost, on average, for some time to come.Back to top ↑
Demand growth has been reasonably broad based by region, with India leading the way.
Copper prices ranged from $5,823/t to $6,595/t ($2.64/lb to $3.00/lb) over the second half of the calendar year, averaging $6,139/t ($2.78/lb)8. Prices never recovered from the shock of the US–China trade confrontation, which escalated in early June and helped push copper down from well above $7000/t to less than $6000/t over the course of July and early August.
We assess that forward looking fundamentals for calendar 2019 support an approximate trading range of $6000/t to $6,500/t, based on an average rate of disruption to primary supply (i.e. an outcome closer to the historical 5 per cent loss, up from the preliminary estimate of around 3 per cent in calendar 2018). A durable peace on the trade front would provide upside to that range. Without a visible reduction in trade uncertainty, the likelihood of the price being anchored in the bottom half of the range is high.
Chinese end–use demand has been solid, but on a somewhat narrower base than in calendar year 2017. Real estate has provided good support, but the auto sector softened, notwithstanding rapid growth off a low base in ‘new energy vehicles’. Machinery has continued to grow at a healthy pace, while air conditioners and refrigeration also performed well. Power infrastructure has been a soft spot, while electronics was flat.
Demand growth from the rest of the world was softer than anticipated, particularly in the second half of the calendar year. Housing starts in the United States, which had been strong, have weakened noticeably, although business investment remains solid. Upstream electronics demand growth has decelerated, with global semiconductor sales growth down from a pace in excess of 20 per cent at the end of calendar year 2017 to the mid–single digits at the end of calendar 2018. Auto sales weakened noticeably in the second half of the calendar year, with the United States, Europe, Japan and Brazil all experiencing negative momentum. Purchasing managers’ index readings in Europe and developed Asia presaged this softening, having peaked in the March quarter of calendar 2018.
The growth in Chinese end–use demand is likely to slow from around 3½ per cent in 2018 to around 2 per cent in calendar 2019. Obviously weak prospects for indirect exports, working through the machinery and consumer durables sectors, is a major swing factor. Elsewhere, we see stronger or steady outturns than last year for power infrastructure, rail, autos and domestic consumption of consumer durables, led by replacement demand in rural areas, in line with the focus of policy support.
Turning to supply, along with the Chinese ban on the import of low grade copper scrap, expectations of impending disruptions to primary supply gave a bullish tone to market commentary a year ago. The reality turned out to be the reverse. Rather than being a year marked by above average disruptions, the loss of primary supply was only around 3 per cent, versus the historical average of 5 per cent (the average being equivalent to around –1000 kt). A major factor in this performance was that the majority of labour negotiations in South America were concluded relatively amicably and in basically timely fashion.
Treatment and refining charges (TCRCs) for copper concentrates were higher YoY in calendar 2018, despite the introduction of new smelting capacity in China, with the enforced closure of the smelter at Tuticorin, India, being the decisive factor. The Metal Bulletin TC index has ranged between a high of just over $89/dmt and a low of $83/dmt. That compares to the 2018 benchmark settlement (in which we do not participate) of $82.25/dmt. The Tuticorin re-start is widely expected to push TCRCs back down, as reflected in the lower 2019 benchmark settlement of $80.8/dmt. Shanghai Grade A cathode premia were higher on average in calendar year 2018 as China’s scrap ban led to a stronger than previously expected requirement for cathode imports (up 18.5 per cent YoY).
Turning to the outlook, the global copper market is expected to remain roughly balanced for the next few years. Solid demand growth is expected to be matched with a combination of committed green and brownfield supply, restarts and rising scrap availability. Even so, the market looks to be finely, rather than comfortably balanced over this period, and it will be vulnerable to supply shocks throughout this phase, particularly in the concentrate segment.
Developments in China will continue to be vital for the copper market. Major themes include the evolution of the regulatory environment for scrap imports; the scale of investments in scrap processing capability; lifecycles of copper intensive capital stock; technical standards for aluminium usage in power cables; and the evolution of policies towards the production and uptake of electric vehicles.
Looking at the first of these questions in more detail, China’s curbs on low grade scrap imports, which were phased in from the beginning of calendar year 2018, should be positive for primary demand, for a time. But beyond an inevitable adjustment phase, we do not believe this development is likely to sustainably alter longer run market balances, the incentive to invest in scrap processing capacity globally, or mine inducement dynamics. The recent announcement that category 6 scrap (~80 per cent copper contained) will be more closely monitored by the Chinese authorities is a new potentially bullish watch point for the primary market.
Subject to the above caveats on precise timing, a structural deficit is expected to open in the early–to–mid 2020s, at which point we see some sustained upside for prices. Grade decline, resource depletion, increased input costs, water constraints and a scarcity of high–quality future development opportunities are likely to result in the higher prices needed to attract sufficient investment to balance the market.
It is these parameters that are critical for assessing where the marginal tonne of primary copper will come from in the long run and what it will cost. We estimate that grade decline could remove –2 Mt per annum of mine supply by 2030, with resource depletion potentially removing an additional –1½ and –2¼ Mt per annum, depending upon the specifics of the case under consideration.
Our view is that the price setting marginal tonne in ten years will come from either a lower grade brownfield expansion in a low risk jurisdiction, or a higher grade greenfield in a high risk jurisdiction. Neither source of metal is likely to come cheaply.Back to top ↑
Without a visible reduction in trade uncertainty, the likelihood of the price being anchored in the bottom half of the range is high.
We assess that Crude oil prices spent time in both over and under–valued territory in the second half of calendar 2018. Our view is that the fair value range over this period was roughly $65/bbl to $80/bbl. With the fundamentals positioned less favourably in early calendar 2019 (a starting point of global surplus, a softer demand picture in prospect) the fair value range in the current year will be lower. The front–month Brent minus WTI spread ranged from a low of around $4.30 to a high above $10 in the half year, averaging just over $8.
The sustained uptrend of the oil price between early calendar 2017 and the September quarter of 2018 surprised us in scale, but not in direction. Robust demand conditions, aggregate production discipline by the Vienna Group9, and unplanned outages elsewhere were able to offset a sharp acceleration in US onshore production and drag the market back into balance.
Once the market turned, the shift was abrupt. Prices fell sharply as concerns shifted from a potentially tight market to oversupply in the December quarter, the US softened its stance towards importers of Iranian crude and macro investor sentiment deteriorated. Against this background, additional evidence of a re–commitment to curtail supply was required to stabilise prices. This was duly provided, with Saudi output falling by –0.42 Mbpd month–on–month in December.
A broad based under–estimation of US supply potential in the second half of the year was the major swing factor for calendar year 2018 fundamentals. With perfect foresight of the US supply surge, the major players in the Vienna group would have presumably been more cautious in their move to increase production to offset Venezuelan declines and the prospective loss of Iranian exports. Lest we forget, the major players in the Vienna group executed on an announced lift in output around mid–year in a professed attempt to forestall excessive market tightening.
On such narrow margins does the short-term oil price rest.
Global oil demand has closely followed the broader trend in economic activity. After a strong and broad based uplift in calendar year 2017, which spilled into the early part of calendar year 2018, a slowdown began to emerge in the June quarter. This pattern was most evident in the OECD ex the US, led by declines in Germany, Japan and Korea. Chinese demand growth has remained robust overall though, and is on track for an outcome between 3½ and 4 per cent in calendar year 2018. India closed the calendar year 2017 with some momentum, and this has spilled over into calendar year 2018. India is on track for an outcome between 4½ and 5 per cent in calendar year 2018. The IEA forecasts 5 per cent growth in India’s crude demand in 2019 as well. Transport demand continues to be a significant driver of its growth.
Vehicle miles travelled in the US, as reported by the Federal Highway Administration, are +0.3 per cent higher year–to–date YoY. That represents a slowdown in growth from last year, and aligns with an observed decline in gasoline consumption. US diesel demand, however, continued to expand, consistent with anecdotal evidence of a buoyant trucking sector. Highway freight traffic in China expanded by 7.4 per cent year–to–date YoY as of December 2018, down from around 10 per cent at the same time a year ago, while passenger car sales declined. India’s demand for gasoline expanded by a robust 8.8 per cent YoY, while diesel demand grew at a solid 4.5 per cent. Overall, global gasoline demand increased by 0.5 per cent YoY up to the end of the September quarter (~26.5Mbpd), while global diesel increased by 0.2 per cent YoY (~28.3Mbpd).
Elsewhere in transport, domestic air traffic growth10 has been strong in the world’s three most populous economies, although growth rates have decelerated in recent months, partly due to challenging base effects. In the latest data, China expanded by around 7 per cent YoY; India expanded by around 13 per cent; and the US increased by around 5 per cent.
The IEA estimates that global demand growth will edge upwards from +1.3 Mbpd in calendar year 2018 to +1.4 Mbpd in calendar year 2019. Six months ago, they were forecasting demand of +1.5 Mbpd in calendar year 2019, with risks to the downside.
After opening calendar year 2018 in rough balance, the oil market finished it in mild surplus. We anticipate that demand and supply will both advance +1.4 Mbpd in 2019, based on estimated voluntary restraint from OPEC producers of –0.9 Mbpd (with Saudi Arabia assumed to shoulder slightly more than one third of the collective burden).
US liquids production remains a key source of uncertainty. Our central case projects US supply to increase by almost +2 Mbpd in calendar year 2019 (1.3 Mbpd crude), down only slightly from the spectacular +2.2 Mbpd (16 per cent YoY) seen in calendar 2018. The 2018 jump was achieved despite pronounced take–away constraints in the Permian, which have led to a stark widening of regional price differentials. The key reasons why we think it is reasonable to expect the US to follow up its huge 2018 with another big year are (1) “Drilled but Uncompleted Wells” – DUCs – have increased 85 per cent YoY in the Permian (2) Takeaway constraints are expected to be progressively alleviated from the September quarter 2019; and the completion constraints that were a secondary contributor to the rising DUC inventory are unlikely to be as pronounced.
Investment in upstream oil is expected to increase by around 5 per cent in nominal terms in calendar year 2018, according to the IEA. That follows a 4 per cent increase in calendar year 2017. The value of investment remains around 40 per cent lower than at the peak in 2014. US shale led the way, with an estimated increase of 20 per cent YoY in 2018, increasing its global share of upstream capital spending to almost one–quarter. A little more than half of the growth in shale spending is due to rising costs. In the conventional space, an emphasis on brownfields is clearly evident, with around two–thirds of newly sanctioned projects fitting this description.
In the long-term, we continue to see compelling market fundamentals, underpinned by rising transport and industrial demand in the developing world in addition to a steepening cost curve underpinned by natural field decline.
We expect oil demand to grow by approximately 1 per cent per year over the next decade despite significant efficiency gains in the light–duty vehicle fleet. Our long run view on electric vehicles (EVs) is discussed below.
On the supply side of the market, with natural supply decline of at least 3 per cent per year added to the demand growth referenced above, by 2030 we see the need for new production equivalent to at least one–third of total global production today. We anticipate US tight oil production starting to plateau in the mid–2020s, at which point its role in setting global oil prices would begin to diminish. That observation, and the relative lack of exploration success and investment in the conventional sphere in recent years, points to the need for known but more costly supply to be induced to fill the long run gap to demand.
By the mid–2020s, the marginal barrel is expected to come from a higher–cost non–OPEC deepwater asset.
Looking beyond the 2020s, on the demand side we see an expected peak in the mid–2030s in our central case followed by a sedate trend decline. The annual loss of demand is not expected to approach the rate of systematic decline of existing fields, even based on a highly conservative estimate of the latter. Therefore, we expect that the industry will remain in a permanent state of inducement and reserve replacement even beyond the peak in demand.Back to top ↑
In the long-term, we continue to see compelling market fundamentals, underpinned by rising transport and industrial demand in the developing world in addition to a steepening cost curve underpinned by natural field decline.
US natural gas
The US natural gas price [Henry Hub] ranged from a low of around $2.50/MMBtu to a high of around $4.60/MMBtu (excluding the very short lived spikes observed at the start of the year) in calendar 2018, averaging $3.12/MMBtu.
Despite soaring US production, US gas storage levels continued to track below the five year average through 2018, ending the calendar year at around –17 per cent below the five year average. Strong power burn over summer, growth in US LNG exports and pipeline exports to Mexico, and a colder than normal start to winter have all helped keep storage levels in check, as the opening of North East pipeline capacity facilitated unprecedented growth in new supply.Back to top ↑
Liquified natural gas (LNG)
The Japan–Korea Marker (JKM) price for LNG averaged $9.76/MMbtu DES Japan in calendar year 2018, 37 per cent higher than the prior year, with the price ranging from $7.05 to $12.07/MMbtu. Prices were well supported for most of the year on robust demand growth, led by China, while a sweltering north Asian summer also boosted overall demand in the region. Chinese imports continued to surprise to the upside, surging more than 40 per cent year–on–year (after growing at a similar rate in the previous year). Slippage in the start date of new projects also contributed to the tighter market.
Uncertainties on the demand side, and vivid memories of the tight market from the winter of 2017/18, encouraged buyers to secure their volumes early ahead of the 2018/19 heating season. That led to favourable prices at the end of what is usually shoulder season, with JKM hitting a four year high in September. As it happens, a relatively mild winter has unfolded, which left end–user stocks higher than normal through December and January. This, coupled with new projects ramping up and a sharp decline in oil prices, weighed on LNG either side of the New Year.
Looking ahead, Chinese demand, along with the timing and scale of nuclear restarts in Japan (9 of 54 are currently operational) and energy mix policies in South Korea are key uncertainties for the LNG market.
On the supply side, we anticipate another large increment of new supply coming to market in calendar year 2019. We estimate that 4.2 bcf/d of additional nameplate capacity came online in 2018, in a global LNG market of around 41 bcf/d; an even larger increment of new supply is expected in calendar 2019. Despite the strong LNG demand growth that we project for the medium-term, current and committed capacity is likely to supply the market fully until the middle of next decade, with risks modestly skewed towards the market tightening sooner. Beyond this point new projects will be required in a global gas market where the marginal supply looks likely to come from US LNG exports under a range of scenarios.
Six of the nine new projects earmarked for calendar 2019 are US export facilities. That is a supportive signpost for the hypothesis that regional gas markets are on a path to harmonisation around a global benchmark.Back to top ↑
Eastern Australian gas
The East Australian natural gas market continues to evolve. The ramp up of Queensland LNG projects has altered the shape of the market. Longer-term, we expect the domestic market will become closely linked to the international LNG market. This assessment comes from the conclusion that southern demand centres will become increasingly reliant on the supply of gas from Queensland LNG resource holders, and potentially LNG imports to balance the market, due to declines from existing fields.
The domestic market remained tight throughout the 2018 calendar year. Competing demand from LNG export projects and declines in conventional supply have both contributed to this tightness.
We continue to believe that a more accommodative policy environment for on onshore gas development – both conventional and unconventional – has the capacity to provide significant additional supply to the market.Back to top ↑
Australian power market
The Australian Government has embarked upon a new approach to energy policy since August 2018. It maintains that the electricity sector is already on track to meet its share of Australia’s commitments under the Paris Agreement. The Government has shelved the National Energy Guarantee (which would have imposed an emissions reduction requirement on electricity retailers), and shifted its focus to improving the affordability and reliability of supply. In this context, the Government has worked with State governments to introduce a Retailer Reliability Obligation. It is also progressing plans to underwrite new dispatchable generation and to give the Treasurer new divestment powers (in relation to generator owners that are deemed to be manipulating the market or withholding contracts for anti-competitive purposes).
We recognise that the electricity sector has decarbonised significantly over the past decade and is likely to continue doing so. Nonetheless, in our view there is still a need for a national policy framework that provides predictability on emissions reduction and ensures climate and energy policy are considered on an integrated basis. As the Energy Security Board11 recently noted, the absence of such a framework is likely to encourage the continuation of ad hoc government decision––making, with adverse consequences for both the efficient operation of the market and investment in new and existing dispatchable generation.Back to top ↑
Energy coal prices have benefited from strong demand from China and India, healthy demand from mature North Asian markets and supply disruptions in key export jurisdictions.
Against this backdrop, the gcNewc 6000 kcal/kg FOB Newcastle index averaged $107/t over the 2018 calendar year, ranging from a high of $123/t in July to a low of $91/t in March. The 5500kcal index averaged $71/t over the same period.
The spread between the spot indexes for gcNewc 6000 and Newc 5500 averaged 52 per cent in the 2018 calendar year, which compares to 25 per cent over calendar year 2017. The spread between the spot indices for semi–soft coking coal (SSCC) and gcNewc 6000 averaged 16 per cent in 2018, versus 22 per cent in 2017.
The calendar year averages tell a part of the story, but they hide the extremes. Both the gcNewc 6000–5500 and SSCC–gcNewc 6000 spreads established records over the period: one for width and one for narrowness. This was due to the extremely tight market that emerged in gcNewc 6000, with strong demand for higher quality energy coals over a very hot north Asian summer allied to a constrained supply situation in Australia and South Africa.
Chinese energy coal imports grew by +8 per cent YoY in calendar 2018, backed by a 6 per cent YoY increase in thermal generation. India also saw strong growth in imports (15 per cent YoY), as domestic production (8 per cent YoY) was unable to keep up with the strong recovery gradient in key end–use sectors.
The Chinese government continues to urge domestic coal miners to execute more long-term contracts with end–users to stabilise prices within the “green zone” ($64–73 5500kcal CFR or RMB 500–570/t locally), or more recently, the “yellow zone” (up to RMB 600/t). The equivalent seaborne price (API8) traded comfortably above this range in the 2018 calendar year.
The Chinese authorities also demonstrated their determination to cap inbound volumes for calendar 2018 at no more than 271 Mt (the total from the previous year). This led to lengthy vessel discharge queues and delayed custom clearances in the December quarter as the threshold was approached. It is unclear exactly how attitudes towards controlling imports will unfold in the medium–term, but it seems likely that some form of flexible quota system, favouring end–users over traders and higher calorific value, low ash, low sulphur energy coals, and premium metallurgical coals, will be in place for the next few years. That is a pragmatic policy. A move towards a less pragmatic alternative would be worrying. An alternative might feature a “first come, first served” approach in tandem with an inflexible ceiling. While this would benefit from the advantage of simplicity, it would be inconsistent with the nation’s steadfast resolve to improve environmental outcomes for its citizens.
Longer-term, we see total primary energy derived from coal (power and non–power) expanding at a compound rate slower than that of global population growth. Coal is expected to progressively lose competitiveness to renewables on a new build basis in the developed world and in China. In our view the cross over point should have occurred in these major markets by the end of next decade on a conservative estimate. However, coal power is expected to retain competitiveness in India, where the coal fleet is only around 10 years old on average, and other populous, low income emerging markets, for a much longer time.Back to top ↑
Longer–term, we see total primary energy derived from coal (power and non–power) expanding at a compound rate slower than that of global population growth.
Muriate–of–potash (MOP) prices have been on an improving trend since mid–calendar year 2016, with a further step–up achieved in calendar 2018. Suppliers have successfully implemented higher prices across all major markets. Brazilian gMOP12 prices reached $350–355/t CFR in early calendar 2019, up around 24 per cent YoY. South East Asia sMOP saw slightly smaller percentage gains (17 per cent YoY), while the US cornbelt saw average pricing of $358/t for gMOP, up around 23 per cent YoY. Annual CFR contract prices for China and India stand at $290/t. Early in calendar 2019, the average free–on–board standard grade Vancouver benchmark was up by around 22 per cent YoY to $275/t, with producer returns up by a similar proportion.
Demand has been robust. Data already to hand indicate that there was YoY growth in global shipments in calendar 2018 following on from the record volumes of the previous year. Canadian exports (Jan–Nov) increased 13 per cent YoY to a record 19.9 Mt, boosted by volume from K+S Bethune (commissioned May 2017) and Nutrien Rocanville (expanded October 2017). Exports from Belarus (Jan–Nov) are up around 3 per cent YoY, to 10.1 Mt, but Russia and Chile have seen export shipments decline13. Brazilian import volumes (Jan–Dec) increased 9 per cent YoY to 10.5 Mt. Indonesia, the largest market in south–east Asia, saw imports (Jan–Nov) rise 4 per cent YoY,– despite a ten–year low for palm oil prices. Imports into China and India declined by around –1 per cent YoY.
Sustained strong demand, allied to idle capacity within Canpotex, has enabled price gains despite the ongoing introduction of substantial capacity additions in Canada, Russia and elsewhere, although admittedly ramps–ups have not been smooth in most of these cases.
Problems with product quality have reportedly slowed down the ramp–up at Bethune, while EuroChem has only recently achieved commercial production at its Usolskiy mine. A new mine in Turkmenistan has produced minimal quantities and is reportedly struggling with brine inflow and technical difficulties. Looking ahead, further announced additions to capacity are scheduled out to 2021, notably EuroChem’s second greenfield project and two new mines in Belarus.
Turning to the long-term, demand for potash stands to benefit from the intersection of a number of global megatrends: rising population, changing diets and the need for the sustainable intensification of agriculture. While potash demand can be volatile year to year, we anticipate trend demand growth of 1.5–2.0 Mt per year (between 2 and 3 per cent per annum) through the 2020s. The pace of demand growth is important, because the need for new supply to be induced will only arise once both the spare capacity held by incumbents and capacity additions that are under construction have been absorbed by the market.
There is some scope for greenfield additions in the former Soviet Union, and for brownfield expansions in existing basins, but this is limited given the scale of such investment over the last decade.Back to top ↑
Nickel prices ranged from $10,595/t to $14,620/t over the second half of the calendar year, averaging $12,374/t. Along with other exchange traded metals such as copper, nickel prices were a casualty of the rise in trade tensions, which eroded investor confidence in pro–growth assets from the June quarter forward.
Nickel end–uses are dominated by the stainless steel sector. It comprises more than two–thirds of primary demand today. China produces a little more than half of the world’s stainless steel and is far and away the major consumer of nickel. Despite intense interest in the impact of electric vehicles on battery raw materials, we note that nickel demand from batteries is less than 5 per cent of consumption today. Nevertheless, with a rapid and prolonged drive towards the electrification of transport in prospect, there are plausible long run paths14 where batteries and stainless steel will become equally important consumers of nickel.
There are three key questions for the nickel market in the longer run. The first is how fast will electric vehicles penetrate the auto fleet? The second is what mix of battery chemistries will power those vehicles? The third is what will be the “steady state” marginal cost of converting the abundant global endowment of laterite ores to a high grade nickel product suitable for use in battery manufacturing.Back to top ↑
The dry bulk freight market remains in modest over–supply, but it seems evident that the absolute trough in freight rates is well behind us. Policy–led dock capacity rationalisation in China is one factor in this assessment. Sustainably higher global steel prices, generated by China’s industrial reform, will also help prevent new build costs falling again to the lows of a few years back15. Balancing that, there is still an overhang of shipbuilding capacity globally; and steady increases in average vessel size continue unabated. A wave of new deliveries are also scheduled for calendar 2019. And on a final point, the downward vulnerability of freight rates when the bulk trade is temporarily disrupted, as it was in the December quarter, is not indicative of a market on the precipice of a sustained period of tightness.
The route from Western Australia to Qingdao traded an approximate range of $6 to $10/t in calendar year 2018. Rates on C5 averaged $8.39/t in the second half of the calendar year, 19 per cent higher than in the first half. For the full calendar year, C5 was 14 per cent higher YoY.
Panamax and Supramax rates have traded in a much narrower range than Capesize, while lifting solidly YoY. They averaged $11,500/day in the 2018 calendar year, up from $9,500/day in 2017.
BHP chartered vessels will be fully compliant with IMO 2020. There are three compliant responses. (1) Use compliant very low sulphur fuel oil (VLSFO). (2) Install scrubbers. (3) Retrofit or new–build for LNG.
We expect the majority of ship–owners will choose to bunker compliant, low sulphur fuel oils. There is a ceiling on the proportion of the fleet that will choose to install scrubbing capability (with the number limited by dry dock capacity, scrubber availability, and the economic challenge presented by the need to dry dock a ship that would otherwise be working). This subset may well have become even smaller with China and Singapore recently moving to ban open–loop scrubbers.
We estimate that IMO will add between $2–3/t to WA–China freight & $4–5/t to Brazil–China. An outward Brazilian voyage using ‘scrubbed’ high sulphur fuel oil will be more competitive than the $4–5/t cited above.
We continue to engage proactively with sovereign entities and other regulators to leverage technological developments and promote improvements in safety and sustainability standards. We engage bilaterally and through our participation in Rightship.
Back to top ↑
BHP chartered vessels will be fully compliant with IMO 2020.
Inputs and inflation trends
Over the last six months, the “uncontrollable” element of industry wide operating cost inflation in US dollar terms has increased on the back of higher raw and basic materials prices. Offsetting that to a degree, exchange rates in our key producing regions were lower than in the prior half year. Isolated pockets of inflation in controllable operating and capital costs have emerged in our businesses. Beyond these pockets, our high level assessment remains that general inflationary trends in both opex and capex are benign by historical standards. We are accordingly comfortable that our pipeline of high quality minerals and petroleum projects, which are costed based on conservative escalators, can be delivered within budget.
Regionally, we underline that the sequence in which our businesses have exited their respective cost troughs over the last two years has been onshore petroleum (pre the shale divestment), Minerals Australia, Minerals America and offshore petroleum.
The Australian dollar and the Chilean peso both depreciated in the second half of calendar year 2018. These movements occurred against a backdrop of slim, or negative, interest rate differentials to the United States, and a general move towards more cautious asset allocation in global financial markets as the year wore on.
In Australia, both consumer price inflation and local currency mining wage growth are running just below 2 per cent YoY, reflecting modest economy–wide price pressures and the presence of spare capacity in the labour market. The Reserve Bank of Australia expects headline inflation to be in the bottom half of its target range of 2 to 3 per cent until at least the middle of calendar year 202116. In its latest budget update17, the Australian Federal Treasury projected nominal national wage growth of 2½ per cent and 3 per cent in financial years 2018/19 and 2019/20. Both forecasts are –¼ per cent lower than in the May budget.
Mining sector wage growth at the national level in Australia has lifted slightly from a year ago, but it remains below the economy wide average of 2.3 per cent YoY, which is itself still at a historically subdued level. Increases in administered wage outcomes in the last two calendar years appear to have had little discernible influence on commercially negotiated outcomes. While wage outcomes embedded in newly settled enterprise agreements appear to have bottomed, the average agreement is still tracking around 1 per cent below the rate of administered wage increases.
Notwithstanding those general trends, we continue to observe some upward pressure in certain segments of our minerals business, most notably in niche skill subsets. Further, despite the uplift in infrastructure activity in New South Wales and Victoria, we observe that construction wages are still running below the national average as of the latest update from the Australian Bureau of Statistics.
In Chile and Peru, a large number of collective bargaining agreements across the industry have been relatively calmly re–negotiated over the last twelve months.
In Chile specifically, mining wage growth has been soft, with relatively flat numbers employed in the sector overall allied to a small rise in the nationwide unemployment rate. Migrant flows from within Latin America and the Caribbean, who cover most segments of the skill spectrum, have contributed to this latter outcome. Notably, immigrants have a very high labour force participation rate of around 80 per cent, some 20 percentage points above indigenous Chileans, and a higher rate of unemployment. That means that the recent influx has had an outsized impact on the surveyed unemployment rate, which may consequently be overstating the true level of slack in the system19.
In addition to subdued wage growth, general inflation in Chile has also been modest, with calendar 2018 registering at 2.4 per cent YoY. However, inflation did show some upward momentum late in the calendar year, encouraging the Banco Central de Chile to project it to accelerate towards 3 per cent YoY by the end of calendar 2019.
With respect to mining activity specifically, we note that the Banco Central de Chile have revised their two-year ahead forecasts for mining capex up recently, while also highlighting that imports of capital goods have picked up appreciably. Competition with other sectors such as construction for productive resources is also expected to rise from current low levels over this period.
The International Monetary Fund projects that Chilean inflation will remain subdued out to the early 2020s, with the average rate over the next five years projected to be almost 1 per cent below the pre–GFC average.
Pervasive indexation in the local contracting structure will delay the recognition of the underlying movement in prices beyond the true cyclical turning point in domestic services costs.
A number of uncontrollable cost drivers across our minerals business such as diesel, explosives and steel products have increased in price, in line with movements in underlying commodity prices. Our proxy indices for explosives costs in Australia and Chile rose 4 per cent and 1 per cent YoY respectively in calendar 2018. Earth-moving tyre raw material costs are down marginally YoY, with a large fall in natural rubber offset by gains in carbon black, synthetic rubber and steel wire. Sulphuric acid prices have increased 58 per cent YoY for Chilean end-users due to a number of smelter outages that have come at a time of robust demand. Chilean spot power prices in the northern grid has seen an approximate –4 per cent decline over the calendar year, while Australian NEM spot power prices fell by approximately –15 per cent following steep back–to–back increases in the two previous years.
We anticipate that the International Maritime Organisation’s low sulfur shipping fuel regulation will begin to impact the diesel market soon, as the various upstream and downstream players prepare for its formal introduction in calendar year 2020. We expect that the disruption will lead to an increase in refining spreads and higher diesel prices for end–users than would otherwise have been the case.
The heavy machinery sector as a whole is now almost three years removed from its sector–specific cycle trough, the recovery from which was due principally to a wave of replacement demand. In mining specifically, we anticipate that the bulk of the replacement cycle in mobile equipment will have been completed by the end of calendar 2020. The exact timing will depend in part upon industry wide efforts to increase equipment life to the productivity frontier.
Globally, earth moving equipment deliveries have increased strongly in consecutive years, with the 2018 calendar year unit total almost double that of the trough seen in 2016. Even so, we assess that ample spare capacity remains at major OEMs, which should allow for incremental volumes to be comfortably met from existing facilities. We note in particular that 2018 global deliveries represented only half of the activity that was sustained at the cycle peak. Breaking out trucks with capacity above 200 Mt, deliveries in 2018 represented just two–fifths of the cycle peak. We also note a prospective calendar 2019 slowdown in competing demands from other (non-mining) machinery categories, and a decline in the resource industry related order backlog at some major OEMs20. However, capacity may not be ample everywhere across their upstream supply chains. This impacts upon lead times and thus OEM competitiveness on a total–cost–of–ownership basis. The relevant US producer price indices for this category – “mining machinery equipment” and spare parts for the same – rose 2.7 per cent and fell –0.8 per cent respectively in calendar 2018.
In the petroleum business, deepwater capital costs remain close to all–time lows. Vendor competition remains intense; while ultra–deepwater drillship and semi–submersible utilisation rates remain very low at 55 per cent and 40 per cent respectively. However, our observations from recent activity in this segment implies that offshore costs have finally bottomed. IHS Markit estimates that deepwater capital costs rose in real terms for the first time in four years in calendar 2018, with a nominal gain of 3 per cent YoY. That leaves costs about 30 per cent short of the peak reached in 2014. That compares favourably to developments in North American onshore, where capital costs are now only around 15 per cent below their 2014 level.
We anticipate it will take a considerable time for the current spare capacity in the deepwater segment to be fully absorbed by a combination of increased activity and retirements. That implies the exit from the trough in day rates will be a cautious and protracted one.
A rigorous approach to bottom–up cost driver modelling and advanced analytics, leveraging synergies across our commercial businesses, are expected to drive increasing cost competitiveness as industry wide cost curves steepen in the medium-term.Back to top ↑
In the petroleum business, deepwater capital costs remain close to all–time lows. Vendor competition remains intense; while ultra–deepwater drillship and semi–submersible utilisation rates remain very low at 55 per cent and 40 per cent respectively.
Sales of light duty electric vehicles (EVs, the sum of battery powered [BEVs] and plug–in hybrids [PHEVs]) expanded by 67 per cent YoY in calendar year 2018, with two million unit sales achieved for the first time. The EV share of total sales increased to 2.3 per cent, up from 1.4 per cent a year ago. Approximately three quarters of these sales were BEVs (with this segment growing 75 per cent YoY). With traditional vehicles sales declining YoY overall while tailing off quite sharply in the December quarter, the “exit–rate” for the EV share at year–end was just short of 4 per cent – a striking gain.
Slightly more than half of all EV sales were in China, where consumers rushed to beat the reduction in subsidies. The EV fleet in China surpassed 2 million in calendar year 2018, with sales growth of 85 per cent YoY. Over the year China’s share of global EV sales increased by 5 per cent to 53 per cent.
Beyond the sales data, signposts over the year have been either supportive or neutral. More models are being introduced and planned, more OEMs are setting themselves EV sales targets, battery costs are declining, vehicle ranges are increasing and the group of nations and sub–national authorities either introducing future bans on ICEs, or establishing formal targets for EV penetration, grew in size. While EV charging availability continues to improve, it still remains insufficient for mainstream EV adoption. The first “ultra–fast” chargers have started to come online, but they remain very small in number. To reach a twenty minute, 80 per cent charging time, they must be matched with a battery with double the normal voltage. Today, vehicles containing such batteries come at a price point that is far removed from “people’s car” territory21.
A balanced reading of these signposts led us to revisit, and ultimately revise upward, the assumptions underpinning our low case. Accordingly, we have lifted the trajectory that defines the bottom of our plausible forecast range.
Our central case projection remains, that by 2035, EVs will constitute around 14 per cent of the light duty vehicle fleet and close to 30 per cent of annual sales. However, our low case fleet share for this time horizon is now 7 per cent, up from 5 per cent a year ago. Further, revised projections for the broader fleet mean that a 14 per cent share in 2035 now means 275 million EVs will be on the road – representing around 40 million additional units than previously expected.
The central case assumes that cost competitiveness without subsidies will be achieved for most vehicle segments around 2030, with an inflection point on mainstream adoption around 2025. This case is calibrated on a battery chemistry view that assumes that the current stability and cost issues are resolved, and a nickel–rich lithium–ion 8–1–1 battery pack ultimately provides the required energy density and range characteristics needed to power mass market EV models that are competitive on a stand–alone basis from the second half of the 2020s.
The latest average cost estimate for lithium–ion battery packs is now slightly below $180 per kwH, with $100 per kwH the target for cost parity with a standard ICE vehicle. The average cost was ~$210 per kwH a year ago.
The first 100 million EVs on the road are expected to displace around 1.3Mbpd of oil demand circa 2030, equivalent to around 1¼ per cent of annual demand today. Constructing those same vehicles will take around 600kt of copper annually, equivalent to approximately 2½ per cent of annual demand. Looking somewhat further ahead, in our central case, EVs are expected to consume almost 7 per cent of the world’s electricity in 2050, by which time they will constitute around half the fleet and comprise around three–quarters of annual sales.
Our long run range comfortably covers the mid–case estimates of the majority of reputable external forecasters. To stylise, “greener” organisations and financial institutions are projecting sales either close to our mid case, or just above it; while more traditional industry groups are positioned between our low and mid cases, with a cluster of such projections situated close to our upgraded low.Back to top ↑
Our central case projection remains, that by 2035, EVs will constitute around 14 per cent of the light duty vehicle fleet and close to 30 per cent of annual sales.
Historical prices and other data in this report are sourced from multiple public and subscription sources, including Bloomberg, Reuters, Platts, Argus, Integer, IEA, I.H.S, CEIC, CRU, Wood Mackenzie, Mysteel, Worldsteel, Baker Hughes, SMM, the ABS, the IMF and the LME. All monetary values are in US dollars unless otherwise specified. Information in this report is valid as of 12 February 2019.
1 The underlying data series referred to captures the relative frequency of references to policy and economic uncertainty in major media channels over time. They are available from www,policyuncertainty.com.
2 The link between trade deficits and reserve currency status is known as the “Triffin dilemma”.
3 We continue to see Chinese urbanisation as an opportunity rich trend for our Company. We are currently engaged with the Development Research Centre of China’s State Council to deepen joint understanding of how urbanisation may evolve in the context of the three parallel revolutions underway in energy generation, transport and information technology.
4 As highlighted here, the construction of plausible low cases for each of our commodities is a vital element of our Capital Allocation Framework.
5 A safeguard mechanism imposes a tariff on imports only after a certain level, or quota, has been reached. In the current example, for the 23 steel products in question, the EU will impose a 25 per cent tariff on imports only after they have exceeded the average level of the prior three years (first come first served basis). Initially put in place for 200 days, it has now been extended to 2021.
6 The abbreviations used in the metallurgical coal section are as follows – PLV: Premium Low–Volatile, MV64: Mid–Volatile 64, PCI: Pulverised Coal Injection, SSCC: Semi–soft Coking Coal, as published by Platts.
7 Before the “Blue Sky” plan we documented six months ago could be instituted, the accountability for designing and executing environmental plans was moved from central ministries to the local authorities. In the first round under this decentralised model, controls were looser than in the previous winter, partly due to pragmatic balancing with the full employment objective due to the trade war. Looking beyond this phase, it is likely that a “competitive spiral” between local officials will produce better outcomes (cleaner air) than would have been the case under one size fits all central edicts.
8 Settlement basis. Daily closes may differ slightly.
9 This term refers to all OPEC and non–OPEC nations that are participating in the current pact.
10 All air traffic figures measured as revenue passenger kilometres.
11 Energy Security Board (2018), Health of the National Electricity Market, December, available from http://www.coagenergycouncil.gov.au/publications/health–national–electricity–market
12 Fertilizer–grade MOP is commonly sold in powder (“standard”) or compacted “granular” forms, abbreviated as sMOP and gMOP respectively. gMOP typically sells at a premium of US$10–25/t. Major markets for sMOP include China and India, while gMOP is prevalent in the Americas..
13 Russia’s monthly export data should be treated with considerable caution.
14 These paths depend in part on our range of internal views on EV penetration rates, fleet size and battery chemistry evolution. These are addressed above.
15 Steel represents around one–quarter of the total construction cost. The exact share for Chinese shipbuilders has drifted up from 23 per cent in 2016 to 26 per cent in 2018.
16 Statement on Monetary Policy, February 2019, https://rba.gov.au/publications/smp/2019/feb/pdf/05-economic-outlook.pdf
17 Mid–year Economic and Fiscal Outlook 2018–19, available from https://budget.gov.au/2018–19/content/myefo/index.html
18 This data references ABS catalogue 6291.0.55.003 for November 2018, original basis.
19 Banco Central de Chile Monetary Policy Report December 2018, Table III.2. Available fromhttps://www.bcentral.cl/web/central-bank-of-chile/-/monetary-policy-report-december-2018-summary
20 See for example, the Q&A in Caterpillar’s December quarter 2018 results https://www.caterpillar.com/content/dam/caterpillarDotCom/releases/4Q18%20Caterpillar%20Inc%20Results.pdf
21 The Porsche Taycan, with a retail price between £60-70k or US$78-91k, is a good example of this. With an 800 volt battery, coupled to a 350kwH charger, it can reportedly achieve an 80 per cent change in 20 minutes – at a premium price point.