China Update

China Commodities Weekly for the Week of December 14 – December 18, 2009

■ So far this week, China's base metals, flat steel products, iron ore, corn, fertilizers, ethylene, methanol, and coal prices have been up; while long steel products, soybean, and oil products prices have been flat. In early December, China's pulp & paper markets were flat to firmer, with pulp, waste paper, and fully coated freesheet leading the gain.

Molybdenum – A Tax Cut and a Price Uptick

■ On Wednesday, the Ministry of Finance announced a cut in the export tax in 2010 for molybdenum oxide and hydroxide to 5% from 15%; for molybdates to 5% from 10%; for molybdenum powder to 5% from 10%; and for unwrought molybdenum to 5% from 15%. The ferromolybdenum export tax remains at 20%.

■ As China is now a net importer, we believe the lower export tax will only show its impact when China has a local surplus. In recent days, however, the Chinese local molybdenum market has been actually experiencing a modest rebound due to some increased purchases by steel mills.

■ We note that since December 1, molybdenum concentrate is trading up by RMB50-RMB70/mtu, to 1,920 RMB-1,950 RMB/mtu this week. Prices for ferromolybdenum have gone up RMB4,000-RMB5,000/tonne, to RMB130,000-RMB132,000/tonne after several major stainless steel mills increased purchases. The market seemed to be stabilizing at current levels during the past three sessions, as activities have not picked up further ahead of the holiday season.

■ At current local price levels, we note that exports out of China are not economically feasible even with the lowered export taxes.

Potash – Settlement Speculations

■ It has been a confusing time for the potash market. After some long waiting on the part of the potash bulls, the local Chinese spot prices finally turned up in recent weeks, amid sharply lower port inventories, now below 1.3 million tonnes (although producer inventories remained well over 2 million tonnes). However, there was a sudden drop in Brazilian prices to US$400/tonne, dampening market sentiment.

Higher Local Prices

■ We had been cautious on the Chinese potash settlement for a long time until last week, when we raised our China contract price projection to over US$400/tonne FOB. Admittedly, this new projection is much higher than market consensus now, which is probably in the range of US$320-US$370/tonne. To be sure, we were fully aware of the prevailing local market prices when we made the raise. This is what we wrote last week: “Average retail prices rose to RMB2,890/tonne (US$423), up about RMB150/tonne week over week. Port quotations rose some RMB60-RMB100/tonne to RMB2,700-RMB2,800/tonne (US$395-US$410)…. We expect the local Chinese price will climb some RMB200/tonne more (or US$30/tonne more) to top RMB3,000 at ports (US$439/tonne). As such, we have decided to raise our forecast for the 2010 China import contract price to US$410/tonne FOB, up from US$395/tonne.”

■ Therefore, our new projection was not based on the current market prices. We were trying to be forward-looking and base our projection on a seasonally strengthening price trend in China.

■ The local market move this week supports our views on local price direction. On December 11, Salt Lake Potash, China largest potash producer, hiked ex-factory prices by RMB100/tonne to RMB2,500/tonne for 60% MOP. On December 15, Sinochem hiked its port offers by RMB100/tonne across product lines. Russian 60% pink and white MOP were offered at RMB2,950/tonne, Canadian pink offered at RMB3,050/tonne, and Canadian white offered at RMB3,150/tonne. After the hike, mainstream port prices have been offered at well over RMB3,000/tonne (US$439/tonne), although real transaction prices have been somewhat lower.

But Suppliers Seem Ready to Give Up on Lower Brazilian Prices

■ In fact, we made the seemingly abnormal projection raise last week on purpose: as we have repeatedly written recently, we believe that any China settlement could trigger a tradable rally in the potash sector as the Chinese settlement would be perceived as market bottom. It would remove perceived downside risk and prompt buyers in other regions to increase purchases.

■ In our opinion, if suppliers can hold back for another month, waiting for the Chinese local market to firm up further, we think the settlement will still have a chance to top US$400/tonne FOB as we projected. But if suppliers give up before year-end, as the Brazilian prices recently indicate, the settlement will likely be well below US$400/tonne as the current market consensus expects. Judging by recent comments from major suppliers, the latter might well turn out to be reality, which is good for the Chinese importers and users (and which is in line with our old views before last week).

■ Jim Prokopanko, CEO of Mosaic, said on December 8 that he expects China will agree before Christmas, or shortly after the New Year, to buy potash for less than US$400 per tonne.

■ Overnight, BPC’s sales chief Oleg Petrov said talks with Chinese buyers would take place next week and that a deal could still be struck by year-end. “It’s important to have a contract with China in place, because the first quarter is the most active period of consumption in China,” he said. He declined to specify a target price, but said it could possibly be lower than the current global spot price. He confirmed to Reuters the recent Brazilian sales by stating: “We are currently selling to Brazil at US$400 per tonne CFR and we see no reason why this price should erode.… There will not be a full recovery in 2010, but the market will be much better than this year. The Chinese contract will be extremely important for this recovery, as it will help restore market confidence and help to boost volumes.”

■ BPC also said it may look to settle deals with China on a spot basis from 2011, replacing annual contracts, to reflect the growing influence of Brazil and India in world markets. “The role of China as the price-setter for the world is changing. This (potential 2010 settlement) could be the last year,” Petrov told Reuters. “With (Chinese) domestic production growing, it will not buy as much potash as India or Brazil.… The increasing role of Indian and Brazilian markets might prompt BPC to give up long-term contracts with China and switch to spot deliveries, starting from 2011.... China will always lack material. It will continue to buy potash, but it will not be the biggest market for imported potash. It is already going head-to-head with Brazil and India.”

■ Petrov estimated Chinese potash inventories had fallen to about 3.0 million tonnes from between 4.5 million and 5.0 million tonnes a year ago. In peak years, China consumed 10 million to 11 million tonnes of potash annually. It can now produce about 5 million tonnes domestically and could potentially raise this to 6 million to 7 million tonnes, he said. Brazil, on the other hand, expects a demand boom in 2010. Of the approximately 7 million tonnes that could potentially be consumed, about 6.3 million tonnes may be imported, Petrov said.

Macro – November Data

■ Last Friday, China released its November macroeconomic data. Interestingly, although most of the data are not in line with consensus, the overall market impact was quite neutral.

■ On the growth side, industrial production (IP) grew 19.2% YOY in November, higher than economists’ consensus of 18.2% and October’s 16.1%. This stronger-than-expected IP number is offset by weaker-than-expected retail sales growth and fixed asset investment growth. In November, retail sales grew 15.8% YOY, weaker than economists’ consensus of 16.5% and October’s 16.2%. Fixed asset investment grew 32.1% year-to-November, lower than the 33% growth seen in year-to-October.

■ On the inflation side, both CPI and PPI are higher than expected. In November, CPI increased 0.6% YOY, compared with -0.5% in October and economists’ consensus of 0.4%. It is worth noting that this is the first positive CPI reading in 10 months. We note that the Chinese government has recently added “managing inflation expectations” to its top policy priorities, in addition to “maintaining economic growth” and “making adjustments to economic structure.”

■ Monetary data show that Chinese banks issued RMB294.8 billion of new loans, higher than market expectations of RMB250 billion. M2 money supply grew 29.7% YOY year-to-November, also higher than economists’ consensus of 29%. These monetary data show that liquidity is ample and flowing in China.

Commodities – November Data

■ On the commodities side, both output and import data were very strong in November. This combination has dual implications: on one hand, it implies that underlying demand remains robust; on the other hand, however, it shows that local supply is very ample.

■ Base metal output is extremely high, with copper, aluminum, and zinc output all hitting new monthly records. China produced 420,700 tonnes of refined copper in November, up 5.4% month over month (MOM) and 20.4% year over year (YOY); 1.355 million tonnes of aluminum, up 7.5% MOM and 33.5% YOY; 444,800 tonnes of refined zinc, up 9.8% MOM and 40.8% YOY; and 21,606 tonnes of refined nickel, up 13.3% MOM and 0.8% YOY.

■ In November, China produced a record 288.94 million tonnes of coal, up 5.8% MOM and 26.8% YOY. The strong coal output is absorbed by the even stronger electricity output. In November, China’s power generation surged 26.9% YOY, the sixth yearly rise in a row and the fastest YOY growth in nearly four years. The exceedingly strong power generation was entirely attributable to output growth from thermal power plants. Coal-based generation surged 38.8% YOY in the month while output at hydropower plants dropped 23.3% YOY. We note that the severe snowstorm in November must have had a very big impact on China’s heating demands, power generation, and coal consumption in the month. The good news for the coal bulls is that the damage had already been done – as a result of the snowstorm, coal inventories at major power generators had been drawn down to relatively low levels (on average 12 days of use) and will likely remain low into the winter, unless the weather warms up unexpectedly. We note that thermal coal prices have continued to move higher so far this week.

■ In November, China produced 47.26 million tonnes of crude steel, or 1.575 million tonnes a day, down 5.6% from 1.669 million tonnes a day in October. The lower steel output in November confirms our view that construction activities moderated a bit in November due to the adverse weather. On the input side, in November China’s iron ore output grew 3.5% MOM and 16.9% YOY to a new record of 86.78 million tonnes while China’s coke output grew 59.6% YOY but down 0.7% MOM to 31.31 million tonnes.

■ On the trade side, China’s imports grew 26.7% YOY in November while exports dropped 1.2% YOY in the same month, resulting in a trade surplus of US$19.1 billion. It should be noted that the 26.7% YOY import growth put an end to the 12 straight months of import declines brought on by the global financial crisis.

■ Most commodities imports surprised on the upside. November copper imports, including semis, rose to 290,158 tonnes from 263,109 tonnes in October; aluminum imports rose to 120,674 tonnes from 86,611 tonnes in October, and iron ore imports rose to 51.07 million tonnes from 45.47 million tonnes in October. The only disappointment was on oil. China’s November crude oil imports totalled 17.12 million tonnes or 4.17 million barrels per day compared with 19.34 million tonnes (4.55 million bpd) in October.

News in Brief

Electricity – Adding 70 GW in 2010

■ China will add 70 gigawatts (GW) of new installed power capacity in 2010, the China Electricity Council (CEC) forecast on December 11. The CEC projected that 60% of next year’s new installed capacity will be thermal power. In particular, the Chinese provinces of Shanxi, Liaoning, Jiangsu, Fujian, Henan, and Guangdong will witness large increases in thermal power installed capacity.

■ Meanwhile, the water-rich provinces of Yunnan, Sichuan, and Hubei will see substantial increases in hydropower installed capacity. And wind power will make up much of the new installed capacity in the wind-rich provinces of Jilin, Liaoning, Jiangsu, Gansu, and the Inner Mongolia Autonomous Region, the CEC said.

■ The CEC estimated that China’s total power installed capacity will grow to 850 GW by the end of 2009, up 80 GW, or 10.39%, from that in 2008.

Urea and DAP – Lower Export Tax in Off-season

■ China lowered the off-season export tax for urea and DAP to 7% from 10% in 2010. The on-season (or planting season) export tax has remained at 110%. For urea, the on-season is now defined as: February 1- June 30 and September 16-October 15. For DAP, the on-season is now defined as February 1-May 31 and September 1-October 15. Compared with actual practice in 2009, the on-season, during which the high 110% export tax applies, is reduced by half a month for both urea and DAP in the second half of 2010.

■ We observe that these changes are only mildly negative for the urea and DAP sectors. The 3% reduction in the export tax for urea is too small to offset the much higher coal and natural gas costs over the near term. The extension of the export window will likely only show its impact in 2H/10.

Recap of Our Calls

■ Essentially, we are making four calls in our China Commodities Weekly: economic trends in China, our overall sector call, our individual commodity sector views, and our calls for the contract negotiations for certain commodities. We recap our calls as follows:

■ Economic trends: There are three intertwined trends for the Chinese economy – seasonal (the current and next few months), cyclical (the current and next few years), and secular (the current and next few decades). We are currently a seasonal bear, a cyclical bull, and a secular bull.

■ Overall sector call: Our overall sector call is to answer one question: purely from a China perspective, should investors in the Western world be overweight, market weight, or underweight in the global raw materials and energy sectors as a whole? To this question, our current answer is overweight.

■ Individual commodity sectors: On individual commodity sectors, we are now positive on the copper, steel, iron ore, thermal coal, coking coal, uranium, molybdenum, corn, DAP, and hardwood pulp sectors. We are neutral on aluminum, zinc, nickel, potash, urea, wheat, soybean, methanol, ethylene, and crude oil. We are cautious on paper products. Please note that our positive, neutral, or cautious views on individual commodity sectors are all on a relative basis from a China perspective.

■ Views on annual contract negotiations: We are looking for a 12.5% rise in the 2010 annual iron ore contract. We expect 2010 benchmark Australian hard coking coal price to settle at US$160/tonne, up from US$129/tonne in 2009. We expect the 2010 China potash contract price to drop US$166/tonne from its 2008 level, to US$410/tonne FOB.