Base Metal Commentary - Feature Article

As we approach the start of the second quarter of 2022, in today’s commentary we will discuss the key bullish and bearish parameters surrounding the base metals, alongside a look at the change to the fundamental picture for the suite following the dramatic developments between Russia and Ukraine.  

 

Bullish 
•    Heightened metal supply risks over the developments between Russia/Ukraine (please see below)
•    China’s GDP growth target set at 5.5% for 2022 (expectation of further monetary and fiscal support over the year)
•    Low global base metal inventory levels (maintaining elevated prices)
•    58% of the global population have been fully vaccinated against COVID-19 

Bearish 
•    Rising COVID-19 cases (particularly in countries that practise zero tolerance like China)
•    Rising inflationary pressures (increased expectation of higher interest rates alongside stimulus pullback in the west)
•    Strengthening U.S. dollar
•    Continued elevated freight rates (negatively impacting industries such as automotive) 
•    Global GDP growth is set to pull back this year from 5.9% in 2021 to 4.4% in 2022 (based on IMF figures); however, we expect that the developments between Russia and Ukraine could see this figure further downgraded, due to higher inflation and extended supply chain pain. In addition to this, elevated commodity prices bring into question the topic of demand destruction

At the beginning of 2022, our expectations for the macro-outlook held a more bearish tint compared to 2021, on the back of stimulus pullback in the west, concerns over a slowdown in China’s economic growth and a prediction that global supply chains would start to ease in a meaningful way by H2 (improving global dislocations and lifting global inventories which would help bring down elevated base metals prices).

However, as it stands now, the impact of the Russia/Ukraine war has inflamed supply risks associated with our base metals, with supply chain pain set to last for most this year, while inflation concerns have been elevated, resulting in the prospects for global growth (particularly in the west) to be downgraded from current levels. 

In addition to this, the ongoing presence of COVID-19 (despite vaccinations) is expected to continue to impact both the supply and demand side of the equation for base metals this year, with countries that practise zero tolerance (such as China) most at risk. 

WHAT ARE THE DIRECT & INDIRECT IMPACTS ON THE BASE METAL MARKETS FROM THE RUSSIA/UKRAINE WAR? 

Directly
•    The flow of base metal material out of Russia has not stopped; although given logistical difficulties and reputational risk concerns (self-sanctioning), we do expect delays to delivery to ensue in the coming weeks/months. 

•    The supply of industrial machinery to Russia and alumina is in question. (Please note, roughly 2.5Mt of alumina supply is at risk, following a ban on alumina and bauxite exports out of Australia to Russia (from 20th March), in addition to the difficulties faced in shipping Ukrainian alumina to Russia). This total amounts to roughly 2% of global alumina production.  

Indirectly
•    Higher energy prices have resulted in delays to European smelter restarts (or capacity to be curtailed), altering market balances for certain base metals (aluminium, zinc and lead)

•    Elevated freight rates have exacerbated supply chain logistics (continuing to exacerbate regional dislocations between the west and east and their price differentials respectively).

To see the full list of updated sanctions (and self-sanctions), please see the section below from our Weekly Base Metal Macro Update: 

Metal Specific Sanctions
•    On 15th March, the UK officially denied Russia and Belarus access to ‘Most Favoured Nation’ tariffs for hundreds of exports (resulting in import tariffs increasing to 35% for Russian metals). The list of metals includes iron ore, steel, copper, aluminium, lead, iron and silver. 
•    On 15th March, the European Commission Council imposed a ban on Russian steel products (three-month transition period)
-    8.8Mt of semi-finished & finished steel were exported from Russia to the EU in 2021 (30% of total Russian exports and 22% of total European imports)
-    Please note this does not include slab or billets
-    On 20th March, Australia banned all exports of bauxite or alumina to Russia (~20% of total Russian imports of alumina ~1.5Mt)

Energy Sanctions
•    On 8th March, President Biden signed an Executive Order to ban the import of Russian oil, LNG and coal the U.S. (in 2021 the U.S. imported 700,000bbl/d of crude and refined petroleum products from Russia)
•    On 9th March, the UK announced that it will ‘phase out’ imports of Russian oil by the end of the year (Russia exports 44% of its crude oil to the UK ~ 8% of the UK’s total global imports)
•    On 8th March the EU has set a target to reduce the bloc’s natural gas imports from Russia by two-thirds by end-2022 (before becoming independent on Russian fossil fuels before 2030)

Nord Stream 2 Halted (Nord Stream 2 AG filed for bankruptcy on 2nd March)
•    Supporting higher near-term energy prices across Europe
•    Energy intensive metals to suffer (aluminium & zinc deficits to widen)
•    Stocks fraction of deficits
•    LME Prices & Premia to remain 

Commodity-Finance for Russian Banks Hit (reputational risk and difficulty in processing payments – self sanctioning)
•    The UK, the EU, Switzerland, France, Germany, Italy, Canada and the U.S. banned the Russian central bank (and five others previously sanctions Russian banks) from using SWIFT. Please note, this won’t stop transactions taking place but will increase the transaction period
•    The UK and the U.S. implemented sanctions limiting Russian bank transactions with their markets (and transactions involving domestic currency)
•    Two Chinese state banks (ICBC & Bank of China Ltd) restricted financing for purchases of Russian commodities (stopped issuance of U.S. dollar denominated letters of credit for purchases of physical Russian commodities, yuan denominated still available)
•    International lenders (ING Group NV, Rabobank, Société Generale SA, Credit Agricole SA & Credit Suisse Group AG) imposed restrictions on commodity-traded finance linked to Russia. 

Ukrainian Specific Disruptions
•    Ukrainian iron ore producer Ferrexpo announced force majeure on 25th February
•    40% Ukrainian steel production suspended for a week
•    1.7Mt/y Nikolaev alumina refinery plant owned by RUSAL has “severely curtailed” production (accounts for 1.2% of global alumina capacity)

Freight Disruptions (No booking to and from Russia)
•    No booking to and from Russia – this includes MSC (the world’s largest shipping company), CMA CGM (the world's second largest shipping company), A.P. Moller-Maersk A/S (responsible for ~17% of global container fleets) and One Network Express Pte (Asia’s second largest container shipping line)
•    Markets awaiting EU ban on shipping from Russia (following European Parliament passing a similar rule on 1st March)
•    Freight rates jumping as a result will have a knock-on impact on the availability of inventories held in Asia

What’s Next?
•    Markets awaiting EU ban on shipping from Russia (following European Parliament passing a similar rule on 1st March)
•    Fifth round on sanctions from EU could include further names on the blacklist- meanwhile, EU opinions divided on a future ban on crude oil imports given high dependence
•    Market questions if the LME would consider banning material coming into warehouses from Russia (although the LME has repeatedly mentioned that it will move only in line with Government legislation)
•    Will Russia retaliate sanctions? (Here we allude to President Putin’s announcement that natural gas to the EU would be required to be paid in roubles)

 

THE FUNDAMENTAL PICTURE FOR THE BASE METALS

Aluminium

Impact of Russia/Ukraine War
•    2.5Mt of alumina supply to Russia is at risk due to shipment disruptions from Ukrainian Rusal plant (Nikolaev ~1.7Mty), in addition to Australian ban on all exports to Russia of alumina and bauxite (20% of total Russian alumina supply) 
•    750-850,000t of European aluminium smelter capacity has been impacted by high energy prices, limiting smelter profitability and pushing back restarts
•    As of yet, flows out of Russia have not stopped, although future delays in material delivery are likely

Market Balance 
•    Market balance has been altered since the Russian invasion of Ukraine, with the threats to supply (above) increasing the deficit for ROW production, while output within China is set to surprise to the upside (based on early smelter restarts in Yunnan on resumed power supply). We forecast that the aluminium market balance will remain in a deficit this year, although this may be just below the record level recorded last year. 

Zinc

Impact of Russia/Ukraine War
•    Up to 300,000t of European smelter capacity has been impacted as a result of higher energy prices, reducing forecast output in the region which is responsible for 20% of global supply (and 30% of
ex-China supply)
•    Exports out of Russia (which is a net exporter of zinc-in-concentrate) are unlikely to be impacted, with the majority of material flowing to China

Market Balance 
•    Zinc’s market balance has been altered since the invasion of Ukraine, moving from a balanced market (forecast at the beginning of the year) towards a deficit, given the reduced supply outlook in Europe. However, once again this is a regional story, with improving concentrate supply in China being currently demonstrated by rising TC/RC costs, which in turn will lift refined output within the country. Future price direction for zinc will be linked to energy prices within Europe and it remains a high-risk metal in our view.

Nickel

Impact of Russia/Ukraine War
•    As it stands no material out of Russia has been stopped;, in addition Nornickel (which is responsible for 100% of Russian nickel production) has its own shipping line (reducing the expected delays in shipments given that the world’s three largest shipping lines have stopped taking orders from Russia).

Market Balance 
•    The market balance for nickel remains in line with what we forecast at the beginning of the year, which is a balanced market. However, we do forecast that nickel is one of the highest risk metals regarding a change to its fundamentals, especially if we do see export of nickel banned from Russia in future sanctions. Indeed, Russia is responsible for ~15% of global class I nickel and 7% of global nickel overall. Furthermore, in our forecasts, while the class II market for nickel remains at lower risk (given expected NPI capacity expansions in Indonesia), the class I market is at higher risk given the historic delays we have previously recorded in the production of low-grade laterite nickel into high grade sulphide nickel (via either HPAL or NPI to matte conversions). 

Lead

Impact of Russia/Ukraine War
•    High European energy prices remain the largest threat to lead output in the region (with up to 220,000t of capacity at risk). 
•    Exports out of Russia are unlikely to be impacted, with the majority of material (lead-in-concentrate) flowing to China 

Market Balance 
•    Lead’s market to see a smaller surplus this year on reduced output ex-China. Expect lead to drag behind the base metal suite – with price risk to the downside when European Ecobat’s Stolberg plant reopens in summer (please note the plant has been idled since July 2021)

Copper

Impact of Russia/Ukraine War
•    As of yet, flows out of Russia have not stopped, although future delays in material delivery are likely

Market Balance 
•    The near-term supply outlook for copper remains healthy, with several projects coming online over the next few years; however, the demand profile for copper has been downgraded (given the forecast weakness within the construction industry in China). Current price levels for copper appear to be supported by low stocks (both in the west and east), while investor appetite remains robust given copper’s longer-term demand profile within the green revolution. In addition, sentiment out of CESCO - World Copper Conference (held this week in Santiago), appears to be concentrated on the topic of life-of-mine extension expectations given elevated copper prices, supporting the medium-term surplus market balance we forecast.