eureka report recommendation, page-3

Here is top part of report by Charlie Aitken. Demonstrates the problems faced by China in trying to produce 'pig-iron Ni'. Also shows probs faced by all laterite producers as cost of Sulphur has increased 8 fold! All-in-all report illustrates depth and strength the high grade sulphide deposit gives WSA.

Thursday, August 14: The triple macro headwinds of slowing Chinese GDP growth, the northern hemisphere seasonal manufacturing slowdown, and the massive unwinding of the long commodities/short US dollar trade by hedge funds with redemptions, has undermined both commodity and base metal prices in the short-term.

While I firmly believe all will prove to be short-term events in a long-duration commodity cycle, the hedge fund liquidation of long commodity positions has supported significant weakness for gold, oil, base metals and the Australian dollar. Although the unexpectedly strong rebound in the US dollar has accelerated the sharp sell-off in gold and oil, the correction for some base metals such as nickel and zinc, began over a year ago.

However, I genuinely believe the current US dollar-driven selloff will prove to be a climatic low and support a bottoming process for both base metals.


Nickel pig iron

The continued fall in the nickel price from the all-time high of over $US20 a pound in May 2006 has confounded many industry analysts, particularly me. There is no doubt the switch by the Chinese mills to processing nickel pig iron as a feedstock for stainless production has changed the short-term supply dynamics of the global nickel market. However, it is worth noting that nickel pig iron is a low-grade laterite and a high-cost alternative to primary metal.

In addition, industry costs have escalated rapidly, particularly with the massive increase in coke prices, which is undermining the cost-effectiveness of nickel pig iron substitution. Despite the contrary view, nickel pig iron will not undermine the positive long-term fundamentals for the lower-cost nickel sulphide producers. Industry figures from the Commodity Research Bureau reveal that 8–10% of global nickel production is sourced from low-grade, laterite nickel pig iron supply. Recent statistics also suggest that nickel pig iron is now providing 15–20% of China's current primary nickel requirements.

However, I do not envisage this will become a long-term trend. Industry estimates are hard to quantify, but the consensus supports a view that the current cost of Chinese nickel pig iron production is $US9–11 a pound but probably closer to the top of the range, depending on the nickel/iron ratio. Therefore at the current spot price, the vast majority of nickel pig iron producers are operating below the marginal cost of production.

This view is supported by recent Chinese customs statistics, which reveal a significant increase in port stockpiles of low-grade laterite ore, sourced from Indonesia and the Philippines, which has become uneconomic to process. As a result, my sources reveal that once again Chinese stainless mills are beginning to buy primary nickel metal.

In the past this trend has invariably confirmed that the high-cost marginal producers are underwater, which has supported a recovery in the spot price.


Minara, marginal cost producer

In this context, the 80% fall in December-half profit for Minara (MRE) has highlighted the industry cost pressures for the high pressure acid leach (HPAL) laterite producers. The 400% rise in the sulphur price, and the flow-on effects for the cost of sulphuric acid, have resulted in a severe first-half margin squeeze as the nickel price has plunged this year to about $US8.50 a pound.

As a result, a substantial revenue shortfall, and the suspension of the heap leach (HL) expansion, has resulted in a significant rise in the costs of nickel production. Consequently with the expected rise in second-half production costs to about $US8lb, or about the current spot price, Minara has unfortunately now become a marginal cost producer, which has been reflected in its dramatic share price fall.

In addition, unless management can reduce plant costs, or the price of sulphuric acid falls, Minara will remain a break-even producer.


Spot price support

It is ironic, but I believe the trading action for nickel was indicative of physical buying support between $US9 and $US10 a pound until the broad base metal selloff last week. In fact, Xstrata confirmed recently that continuing supply disruptions and delays have removed about 70,000 tonnes of metal from first-half global production. The result is a 6% fall in London Metal Exchange nickel inventories for the year to date.

I believe the current problems for Minara and other high-cost laterite producers highlight Xstrata's view for the potential of plant closures and further production cutbacks to support the spot price.


China: import dependent

China is the primary driver of global nickel demand. In addition, Chinese domestic nickel production is unable keep pace with demand. In 2006 China's share of global production was 10% compared to consumption of 23%, and with consumption forecast to grow at 6–7% pa for a decade, and limited reserves, this supply deficit is expected to increase.


Nickel: strong long-term fundamentals

There is little doubt nickel pig iron production will remain an important part of the Chinese stainless steel making process. However, considering it is low-grade, high-cost and very environmentally unfriendly, I believe it will merely serve to supplement primary nickel imports. Importantly, BHP highlights that China is the world's largest producer of iron ore but it very low grade and low quality.

However, large-scale Chinese iron ore production has not undermined the long-term iron ore price or the strong demand/supply fundamentals. I believe increased Chinese nickel pig iron production will prove no different. However, the disappointing Minara result highlights the risks for the high cost HPAL laterite producers with the recent fall in the spot price.

Consequently, I recommend investors rotate to the sulphide producers and the lowest end of the nickel cost curve. In this regard I strongly recommend Western Areas (WSA) with average production costs of $US3 a pound, yet with a share price down 40% from its recent highs.

Bottom of the cost curve: the place to be