Base Metal Commentary

The base metal suite is on track to record a second month of declines, driven by concerns over high inflation, a quickening pace of rate tightening in the west and weak demand within China (which has been at the mercy of COVID-19 lockdown measures over the last two months). However, over the last week, a continued improvement in COVID-19 daily cases within both Beijing and Shanghai, in addition to a modest improvement in China’s May economic readings, could indicate that the worst may be over. Meanwhile, across in Europe, the EU agreed upon an altered 6th tranche of sanctions against Russia, which will see Russian crude imports into the EU cut by up to 90% by the end of the year. 

LME 3M PRICE PERFORMANCE (M/M Change)

Source: Bloomberg

Shanghai Daily Case Numbers
Standing at 67 on 29th May versus 122 on 28th May, with cases falling overall, although still occurring outside quarantine 

Beijing Easing Measures - Outbreak deemed under control; certain restrictions lifted
•    Public transport to resume in three districts including Chaoyang
•    Shopping centres outside controlled area to open with limits
•    Five districts on city’s outskirts to resume return to work

Shanghai Easing Measures - Raft of new measures to support economy
•    COVID-19 test requirements to be reduced to enter public places from 1st June
•    All manufacturing to restart from 2nd June 
•    Accelerate approvals for property projects
•    Car ownership quota is to move to 40,000 (this represents the total number of cars allowed to be purchased in one year by city residents)
•    Purchase tax for passenger vehicles to be reduced (+ subsidies for EV)
 

CHINESE PMI READINGS FOR MAY

Source: Bloomberg

The EU’s 6th Tranche of Sanctions
If we go back to 4th May, EC President Ursula von der Leyen gave a speech at the EP Plenary on the social and economic consequence for the EU of the Russia war in Ukraine, in which she laid out the proposed 6th package of sanctions against Russia. 

EC Proposed 6th Tranche of Sanctions 

-    “First, we are listing high-ranking military officers and other individuals who committed war crimes in Bucha and who are responsible for the inhuman siege of the city of Mariupol. This sends another important signal to all perpetrators of the Kremlin's war: We know who you are, and you will be held accountable.”

-    “Second, we de-SWIFT Sberbank – by far Russia's largest bank, and two other major banks. By that, we hit banks that are systemically critical to the Russian financial system and Putin's ability to wage destruction. This will solidify the complete isolation of the Russian financial sector from the global system.”

-    “Third, we are banning three big Russian state-owned broadcasters from our airwaves. They will not be allowed to distribute their content anymore in the EU, in whatever shape or form, be it on cable, via satellite, on the internet or via smartphone apps. We have identified these TV channels as mouthpieces that amplify Putin's lies and propaganda aggressively. We should not give them a stage anymore to spread these lies. Moreover, the Kremlin relies on accountants, consultants and spin doctors from Europe. And this will now stop. We are banning those services from being provided to Russian companies.”

-    “My final point on sanction: When the Leaders met in Versailles, they agreed to phase out our dependency on Russian energy. In the last sanction package, we started with coal. Now we are addressing our dependency on Russian oil. Let us be clear: it will not be easy. Some Member States are strongly dependent on Russian oil. But we simply have to work on it. We now propose a ban on Russian oil. This will be a complete import ban on all Russian oil, seaborne and pipeline, crude and refined. We will make sure that we phase out Russian oil in an orderly fashion, in a way that allows us and our partners to secure alternative supply routes and minimises the impact on global markets. This is why we will phase out Russian supply of crude oil within six months and refined products by the end of the year. Thus, we maximise pressure on Russia, while at the same time minimising collateral damage to us and our partners around the globe. Because to help Ukraine, our own economy has to remain strong.”
Please note however, that until the 31st May, no final deal had been agreed by the EU, with various member states (such as Czech Republic, Hungary and Slovakia) unwilling to sign a deal that would remove Russian crude supply given their high dependence on the raw material. Therefore, in order to provide some flexibility for these member states (which are landbound), the EU approved an altered 6th tranche of sanctions which would allow the continued use of Russian crude imports into the EU via pipeline (or at least temporarily). 

The EU Approved 6th Tranche of Sanctions

•    Russian seaborne oil to be banned by the end of the year, with a temporary exemption for pipeline oil. (Please note, this will cover two-thirds of Russian crude imports).

•    Pledges by Poland and Germany to stop importing pipeline oil by the end of this year. (Please note, this will result in 90% of Russian crude imports being sanctioned by end-year).

•    Russia's largest bank, Sberbank, to be cut off from the SWIFT payment system.

•    Three more Russian state-owned broadcasters banned. 

•    More restrictions on "individuals responsible for war crimes in Ukraine".

As it stands, this will leave ~10-11% of Russian crude imports without EU sanctions, with namely the Druzhba pipeline remaining open to provide crude oil imports into landlocked Czech Republic, Slovakia and Hungary. This exemption will be revisited “as soon as possible” based on comments from EC President Ursula Von der Leyen. 

MAIN CRUDE PIPELINES BETWEEN RUSSIA & EUROPE

Source: Bloomberg

The reaction of the base metal suite was suite muted, given that the markets had been pricing it in for some time, with gains for both natural gas and brent crude oil on 31st May (which jumped by 7% and 1% respectively), being short lived. However, as the year goes on, a focus on fundamentals will increase for the energy sector, especially given that new trade routes will need to be established within Europe, with price volatility perhaps on pause for the moment, rather than being ruled out. Returning to the outlook for the base metal suite, zinc and aluminium will remain the most vulnerable to future energy prices given their high energy intensity in production, although in our view, the expectation for the EU to include sanctions on Russian natural gas supply, remains low. Please note, the EU has 40% reliance on Russian natural gas, with crude oil reliance at 26%. 

How Have Zinc’s Fundamentals Changed Over the Course of 2022?

Supply
Global refined supply is set to remain flat on a Y/Y basis, driven by forecast continued smelter curtailments over the year, particularly in Europe. It is forecast that close to 60-70,000t of disruption to European production occurred in Q1 2022, with up to 40,000t expected for each quarter over the remainder of the year (based on CRU data).  

Demand
Global demand for zinc has been downgraded this year, forecast to remain almost flat, driven not only by base effects, but largely by inflation pressures driven by the Russia/Ukraine war and the unexpected spread of COVID-19 in China (alongside a weak property sector), which has hurt the outlook for both the automotive and construction sectors. Meanwhile, with supply chains likely to remain stretched for months ahead, demand on a global basis has been constrained.  

Market Balance
Zinc is forecast to record a deficit close to 250,000t in 2022, which is a sizeable change from the start of the year, in which it was forecast to be a balanced market. The key driver here has been the unexpected decline in ROW production, driven by high energy prices in Europe making smelter profitability largely unfeasible. 
How Have Aluminium’s Fundamentals Changed Over the Course of 2022?

How Have Aluminium's Fundamentals Changed Over the Course of 2022?

Supply 
The outlook for supply has improved over the year, largely on the back of a faster than expected pick up in Chinese output (with close to 2.5Mt of capacity coming online this year), supported by healthy coal production and water reservoir availability, in addition to the Government re-focusing its effort on economic growth in the near-term over environmental policy. Please note here, we refer to no energy intensity target for 2022 being established in the Two Sessions gathering in March. Meanwhile in Europe, production has been affected by smelter profitability, with up to 600-800,000t of capacity having been impacted since the start of Q4. The extended threat of production being cut in Russia due to a lack of alumina supply (given Australian’s export ban and the shutdown of Ukraine’s Nikolaev factory which amounted to 2.5-3Mtpa of supply coming offline), has been reduced on the back of Chinese exports filling the gap (at lease for the moment). 

Demand
Global demand has been downgraded over the year, given the longer than anticipated lockdowns within China and inflation related demand destruction in the west. It is forecast that total consumption will rise around 1.2% Y/Y. 

Market Balance
Aluminium is forecast to record a slightly smaller deficit than in 2021, which is a change from the start of the year, in which it was forecast that a new record deficit would be recorded. This change has been driven by a downgraded global outlook for consumption, in addition to an improved outlook for supply, particularly in China. 

TOTAL CHINESE EXPORTS OF ALUMINA 

Source: Bloomberg