Attention, Commodity Managers: Here’s What You Need to Know About Steel, Copper and Aluminum in Q1 2017

Pavel Ignatov/Adobe Stock

The latter half of 2016 has seen a recovery of sorts for certain flat steel products compared to the first half of the year, while many base metals have spent 2016 making higher highs. The price of oil has been a huge story, with other sectors, from plastics to natural gas and beyond, directly feeling the effects.

For a couple base metals specifically — copper and aluminum —the bullish stories have taken a hit in December, with buyers and investors interested in what’s coming next.

On the other side of the Spend Matters Network, Raul de Frutos, MetalMiner’s metals procurement specialist, has been closely analyzing ferrous and base metals markets for the past couple weeks, with his short-term eye on this month and Q1 — while connecting to a longer-term sensibility for the rest of 2017.

Here we mostly channel Raul’s original analysis, in addition to some insight from other sectors, that may be useful for procurement practitioners, namely commodity managers and buyers that have exposure to metals and, as a bonus, energy.

Steel and its Raw Material Inputs

Chinese coking coal prices have been quite volatile over the past few months. Despite the recent decline, prices are well above last year's levels.

On the bullish side, we saw a big increase in flat products prices, both domestically and internationally. Hot-rolled coil and cold-rolled coil prices in U.S. have risen 13% and 17%, respectively, since they hit bottom in mid-November. MetalMiner’s North American Carbon Steel Index overall, as an example, has spent the year on an elevator:

metalminer-carbon-steel-index-2016

Concurrently, construction and labor costs continued to rise in December, according to the IHS PEG Engineering and Construction Cost Index:

ihs-construction-index-dec16

Source: IHS Markit and the Procurement Executives Group (PEG)

Steel prices in China also continued to climb in December — but that country’s steel supply could be under fire.

China’s pollution-curbing efforts may prove to affect the 2017 picture. In December, authorities asked 23 cities in northern China to issue red alerts as inspection teams scoured the country. The scale of the red alert measures show that the Chinese government is taking air pollution seriously.

China has previously applied stricter anti-pollution rules and supply-side reforms designed to cut capacity in the coal and steel sectors, which helped push prices up. Now that the situation is getting unbearable for citizens, China has no choice but to get tough in its self-declared “war on pollution.” The result is that we could see significant supply disruptions in China’s metal production sector, particularly in steel.

What This Means For Steel Buyers

  • The expected boost in infrastructure spending in U.S. will help support steel prices. However, the main driver to steel prices continues to be China. In 2017, steel buyers need to monitor if China is able to spur demand growth rates and whether its steel supply falls amid pollution issues.

Copper

Although copper has lost some of its post-election gains, it still managed to end 2016 with decent yearly gains, suggesting that sellers are not totally in control.

One of the key factors supporting copper prices is the earlier-than-expected supply deficit. While most analysts were previously projecting the copper markets to move into deficit by the end of the decade, many of them are now expecting a deficit as early as this year.

Another factor supporting copper prices is higher energy prices. Oil prices retook the $50/barrel level in December. Saudi Arabia said it could be ready to cut output more than originally agreed upon at the latest OPEC meeting. Non-OPEC countries, including Russia, also agreed to an output cut north of 500,000 barrels a day. For copper, energy can represent almost 20% of the production costs.

Trump’s proposed infrastructure investments are also positive for copper prices. However, the key demand driver continues to be China, by far copper's largest consumer. China’s Caixin Manufacturing Purchasing Managers’ Index (PMI) rose to 51.9 in December from 50.9 in November and beat market expectations. The figure marked the sixth straight month of growth and the strongest upturn in Chinese manufacturing conditions since January 2013.

Further appreciation of the U.S. dollar could negatively impact copper prices. Higher interest rates in U.S. are among the factors contributing to a stronger dollar. In December, the Federal Reserve raised interest rates by a quarter point, as expected, but policymakers signaled a likelihood of three increases in 2017, up from prior expectations for two moves.

What This Means For Copper Buyers

  • A strong dollar and a possible slowdown in Chinese demand are factors that could bring prices down. Until now, China's demand looks strong and the dollar hasn't had a big of an impact on metal prices.

Aluminum

After surging in November, base metals fell across the board in December. That selling pressure spread into aluminum markets, limiting any upside moves into the year-end. Prices however didn't give that much ground as aluminum's fundamental story remains rather bullish:

metalminer-aluminum-index-2016

Learn more about MetalMiner's North American Aluminum Index here: http://agmetalminer.com/metal-prices/aluminum/

The auto industry is a key driver of aluminum demand. Auto sales in U.S. and China (the world's biggest car market) finished the year on a strong note. Total vehicle sales in the U.S. hit an 11-year high in December, aided by a fourth-quarter surge in demand that exceeded expectations. In China, car sales hit an all-time record in November, up 17.1% year-on-year.

Although the figures came in strong, they should be taken with a pinch of salt. In the U.S., cars were sold at an average 10% discount off the original asking price and that's an incentive level not seen since the beginning of the financial crisis. Similarly, in Q4, China announced a 50% cut in its sales tax on automobiles with small engines. The tax cut was effective only until the end of 2016 although some analysts expect China to extend the tax cut into next year.

One of the factors supporting higher aluminum prices has been that there were fewer smelter restarts than expected in China. In addition, we foresee limited additional restarts this year due to rising production costs and pollution issues in China.

What This Means For Aluminum Buyers

  • The massive existing overcapacity and questions regarding China's ability to maintain its rate of growth are the main factors that could spoil the party for aluminum bulls. However, for the reasons explained above, it seems early to make a call on that. We still see upside potential in aluminum prices.

Bonus Round: What's Up With Natural Gas?

What’s up is that U.S. natural gas production is down annually — for the first time since the shale gas revolution began in earnest.

IHS Markit recently reported that U.S. natural gas production “averaged 72.1 billion cubic feet per day (Bcf/d) in 2016, which reflects a 1.8 percent (1.3 Bcf/d) decrease from 2015 averages.”

“Despite an increase in U.S. drilling rigs operating in the second half of 2016, a rebound in energy prices and improvements in drilling efficiencies, natural gas production in the remainder of the lower-48 combined for a 6.6 percent (3.5 Bcf/d) year-on-year decrease,” said Warren Waite, manager for analytics at PointLogic Energy, a business unit of IHS Markit, according to their release.

Coupled with the United States becoming a net exporter of natural gas for the first time in 2016, this trend has interesting implications for the year to come — namely for rising prices — as many U.S. steel producers use natural gas as a key energy feedstock.

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