Steel-Making Materials： Banking On A Cyclical Recovery For Support

Deutsche Bank Markets Research Global Special Report Commodities Bulk Materials Industrial Metals Date 2 July 2014 Steel-Making Materials: Banking On A Cyclical Recovery For Support ________________________________________________________________________________________________________________ Deutsche Bank AG/London DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 148/04/2014. Grant Sporre Research Analyst (+44) 20 754-58170 grant.sporre@db.com  Global steel output continues to grow, with the latest data from the World Steel Association highlighting that May’s global steel production was the second highest on record at 141 Mt, up 3.5% vs April and 3.6% YoY. Production of 684 Mt for the first five months is up 2.4% YoY and annualizes to 1,654 Mt. Chinese steel output for the first five months is also up 4.9%, but given the high inventory levels in the property market, we expect output to slow in H2, to average 3.7% growth for 2014. Whilst this may be seen as bearish, we highlight the following: Although Chinese steel consumption is slowing, it is our view that it remains in positive territory. We also see the current downturn in the Chinese property market as cyclical, with price cuts likely to drive volumes towards the end of the year. A recovery in Europe and the US is well entrenched and is supportive from a global perspective.  In our assessment, c.330Mt of net (post high cost closures) new capacity will push the iron ore market into a significant surplus from 2014 onwards. In order to see an “orderly” increase of stocks at the Chinese ports, we estimate 250Mt of supply curtailments or project delays are required by 2016E. We have determined the price resistance levels at which sufficient capacity becomes cashflow negative using our adjusted cash charge iron ore curve. In our assessment, the resistance point in 2014 is USD105/t (this implies a lower H2 average of USD98/t), USD96/t in 2015 and USD90/t in 2016. We have identified four blocks of supply which will have to be displaced to restore the balance. These are further domestic Chinese mine closures, limited Indian ore into the seaborne market due to the current export tax structure, high cost Canadian and Australian juniors and project delays in a tight cash environment. So far the Chinese domestic producers have proved resilient, and their resilience is a downside risk to our forecasts. Although channel checks suggest that a number of producers are loss-making, Chinese iron ore production is up 9% Y/Y, before grade adjustments.  The supply side of the Coking Coal market has responded to the weak pricing environment, announcing c.18Mt of annualized closures. These announcements have been sufficient to stabilize prices, especially in the premium hard coking coal category. However, as pleasing as these announcements are, a further 10 – 15Mt of cuts are required to counter the weak demand environment. We forecast the seaborne demand to be flat y/y, not only due to weaker than expected Chinese steel consumption, but also due to strong domestic supply. We forecast imports to be down 10% y/y. Domestic producers have shown very little signs of closing capacity, but given that domestic and seaborne prices are at parity, we see little downside risks. Further closures in the US, Australian and potentially China, should spark a slow price recovery. However, given the weight of new Australian supply and the weaker than expected Chinese imports, we have downgraded price forecasts by 4% in 2014, and an average of 7% for 2015 – 2017E. Latest reports suggest that Q3’14 benchmark settlements between Anglo American and Nippon, for HCC are a rollover at USD120/t, USD5/t below our forecasts. 2 July 2014 Special Report: Steel-Making Materials: Banking On A Cyclical Recovery For Support Page 2 Deutsche Bank AG/London Steel outlook: Lower Chinese steel consumption...but near a cyclical bottom We recently our China steel consumption/production forecasts by 25Mt in 2014 and by 21Mt in 2015. Our China crude steel forecasts now stand at 808Mt in 2014 and 842Mt in 2015. Historically, China steel production (when measured on a Y/Y basis) has had a high correlation with China property sales (GFA), also on a Y/Y basis. This is unsurprising given that construction accounts for a third of Chinese steel consumption, and the property market has further secondary impacts on other demand segments. The relatively muted Chinese steel production growth YTD (especially versus a particularly strong year in 2013, with the daily output for CISA mills up 1.8% YTD) and the h