inflection point for nickel

Nickel: a stainless idea
By Charlie Aitken



It is rare for inflection points to be identified at the precise moment of their occurrence. They are usually obscured by unrelated events, or often overlooked as unimportant at the time. It is usually on reflection only, that the important turning point for a recovery is confirmed. The inflection point for the domestic equity market was the unexpected closure of the SPI futures market resulting in the lunchtime meltdown in equities. However we believe an inflection point for the nickel price occurred the next day in the madness of a massive liquidation of base metals by hedge funds and commodity traders.

On the day of that base metal liquidation, despite nickel falling 5.2%, it outperformed the copper price (–8%), zinc (7.5%), and lead (5.2%).The outperformance of nickel was surprising considering the universally negative view of the demand/supply fundamentals. As a result, we believe that day represented the inflection point for the nickel price. Subsequently it has rallied strongly.

Perfect storm

There is no doubt that the nickel price has experienced a very volatile period. In a spectacular rally from the low point last year, nickel peaked at an all-time high of $54,300t on May 16 this year. Subsequently over the last 3 months, the price collapsed by 53% to the recent low of $25,055t. However we believe the outlook has changed and the nickel demand/supply fundamentals have turned positive.

A confluence of factors creating a perfect storm resulted in the unprecedented rise in nickel over the last year. Global stainless steel production increased by over 30% yoy at the end of last year, well in excess of world demand. The supply glut was largely driven by the ramp up of 4mt of new capacity, which increased Chinese stainless steel production by almost 100% over the same period.

The huge increase in stainless production created a massive nickel shortage, with LME stockpiles falling to 2900t, or just a few days consumption. The supply shortage was exacerbated by low inventory levels and production disruptions from the major producers. The result was an unprecedented increase in the stainless steel and nickel prices, culminating in the May high.

Nickel pig iron

Unsurprisingly, the massive increase in the nickel price resulted in global stainless steel producers switching from high grade, to low grade production. In addition, Chinese producers switched to processing low grade nickel pig iron for stainless steel production.

Nickel pig iron is a ferronickel pig iron produced from low grade nickel laterite ore sourced primarily from Indonesia and the Philippines. Nickel pig iron generally contains less than 5 per cent nickel (compared with 25–40 per cent in conventional ferronickel) and has a higher phosphorous and sulfur content than conventional ferronickel.

Nickel pig iron’s use is limited by high concentrations of phosphorous and carbon and is primarily used in the production of the 200 series stainless steels, which have a lower nickel content than the 300 series.

As a result, nickel pig iron substitution supplemented the supply deficit and undermined the rampant nickel price. Consequently sentiment deteriorated and stainless steel demand collapsed as consumers postponed buying orders. The subsequent de-stocking cycle, and hedge fund short selling, prompted a self-perpetuating downward spiral. The result was a dramatic fall of over 50% in the nickel price to the recent trading low.

Nickel pig iron part 2

There is no doubt that the growth in Chinese nickel pig iron production has changed the short term supply dynamic in the global nickel market. Industry figures estimate that 8%-10% of global production is sourced from this low grade supply. Our figures suggest that nickel pig iron is providing about 15-20% of China’s primary nickel requirements. In addition nickel pig iron cost of production is estimated at $US11-12lb.

Despite the fears of analysts we do not believe that nickel pig iron will significantly reduce long term Chinese imports of primary metal for a number of reasons.

Firstly nickel pig iron production costs are high compared with primary nickel. Secondly the low grade laterite nickel raw material is heavily dependent on unreliable locations and unsustainable long term supplies. Thirdly, this process is very environmentally unfriendly, and considering the Chinese Government’s commitment to the reducing industrial pollution, the long term production from small mills is unlikely. Finally, low grade laterite ore prices are rising sharply as suppliers respond to the strong increase in demand. In the last 12 months laterite ore prices have risen from $US30t to $US80t currently.

The two key issues here are that nickel pig iron production is high cost and the end product is low quality stainless steel. As a result we think nickel pig iron as a feedstock is a short-term fix for stainless producers much the same as low quality Chinese iron-ore.

Import dependent

In the long term, China remains dependent on imports of refined nickel due to the huge increase in stainless steel demand. Figures from the official Chinese Stainless Steel Council reveal that in 2000, nickel demand was approx 75kt pa; however this increased to 260kt last year, representing an increase of nearly 250%. However Chinese domestic nickel production is unable keep pace with demand. As a result stainless steel producers are facing a major long term nickel supply deficit. Last year China’s share of global nickel production was 10% compared to consumption of 23%.

In addition, with limited domestic reserves and rapidly increasing demand, this supply deficit is expected to deteriorate. At the China Nickel 2007 conference in May, Government forecasts revealed nickel demand could rise to 400kt pa in 2010, compared to domestic production of just 124kt. Our view is that China will remain a major long term importer of refined nickel.

A trend change

As we previously noted, our view is that nickel has reached an inflection point and the main reason is the announcement that the Baosteel Stainless Steel Company has suspended purchases of nickel pig iron. Baosteel is the largest steelmaker in China so this is a very significant event. Baosteel consumed around 36kt of nickel pig iron in the first five months of this year. However despite long term contracts with domestic nickel pig iron producers, it now appears Baosteel are returning to refined nickel for stainless steel production. This is very big news and the ramifications should not be underestimated.

There has been much speculation by analysts that Chinese nickel pig iron substitution would undermine the long term nickel demand/supply fundamentals. However, Baosteel is saying at the current price it is cheaper to use refined nickel than the lower quality nickel pig iron. The falling knife has embedded in the floor. As a result we believe $US 11-12lb will be the low point for nickel and a level from which a recovery can take place. We think the Baosteel announcement has put a floor under the nickel price. However there are additional factors suggesting nickel is poised for a strong recovery.

As we noted previously, the free on board costs for low grade laterite ore imports have nearly tripled in the last 12 months. At the same time, freight costs have doubled over the same period, further increasing the landed cost of imported ore.

This suggests to us that nickel pig iron costs are increasing rapidly which is supporting a higher refined nickel price. Finally, July trade data reveals Chinese stainless steel producers have aggressively returned to the nickel market which suggests an end to the Chinese nickel de-stocking cycle. According to the latest Chinese custom statistics, nickel ore and concentrate imports surged 53% mom in July. As a result we think nickel is poised for a strong recovery.

There is little doubt nickel pig iron production will remain an important part of the Chinese stainless steelmaking process. However, considering it is low grade and high cost, we believe it will merely serve to supplement primary nickel imports. The long term nickel fundamentals remain very positive supported by strong Chinese demand and a chronic internal supply deficit. We think the recent weakness in the nickel price is a short term de-stocking correction in a long term bull market.

Remember copper

The recent correction in nickel reminds me very much of the doomsday scenarios for the copper price last year. After a 40% fall from $US4.00lb, and the end of the US housing boom, analysts predicted a collapse in the copper price back to $US1.50lb. However at $2.40lb, the Chinese returned as aggressive buyers effectively ending the de-stocking process and prompting a strong recovery. The result was a large Chinese drawdown of LME stockpiles and a 50% rebound in the copper price to $US3.70lb.

The clear message here is that the marginal cost of base metal production has risen significantly. The implication of the rebound in the copper price is that it is uneconomic for a major resource company to commit to a large greenfields copper project at $US2.40lb or lower. This has acted to put a floor under the copper price. Similarly at $US11-12lb it is more cost effective for Chinese stainless steel producers to use refined nickel than nickel pig iron. Consequently we believe there is now a base for the nickel price.

We strongly believe the nickel price has bottomed and the conditions are in place for a significant recovery. We believe it is time to aggressively re-weight back into domestic nickel stocks.

Hang in there. RAB