2018 Metal outlook in China

 2017 was another stronger than expected year for metals markets, with pricing ending the year in a bullish mood. We see 2018 as a year of consolidation for most metals, as a slowing pace of demand growth in China prevents most metals from seeing more tightness. Please see below for an overview of our forecasts for the year, and more detail can be found in our forthcoming annual reports on each of the major metals to be released in coming days.

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After two years of generally strong price performance led by a strengthening global economy and Chinese supply side reforms, what will 2018 bring for metals prices?
While China is normally the driver of commodity prices, ex-China factors appear to be the stronger lead in recent weeks. Continued strength in global macro as evidenced by multi year highs in many PMI’s, further US$ weakness, and bullish energy prices have all been supporting rising metals prices, meaning we start the year with exchange prices for many metals at quite elevated levels.
However looking at physical spot markets in China, it’s hard to find much support for further moves higher in the near term. Physical discounts have generally been narrowing as the traditional year-end credit squeeze has passed, and the majority of market players have an optimistic outlook for the year ahead. However on the China macro front, it’s hard to see a clear driver for demand to see a strong move higher this year. 
Financial conditions look set to continue the mild tightening bias seen through much of last year, and the trajectory of property sales continues to slow, though the push for more social housing and low housing inventory in many areas should limit declines in housing construction this year. Infrastructure spending on the other hand looks set to be pared back as the economy requires less support, for example last weeks railway investment target for the year was issued at 702bn RMB, down from the 801bn RMB spent in 2017. However with a backdrop of improving ex-China demand, a stable China should still be enough to keep some metals markets tight in 2018.
In terms of our preference, it’s the supply story which drives the differences in our price expectations.  For markets where we see minimal supply growth, such as steel and copper, prices and margins should remain elevated, though they will still struggle to maintain the highs at which we start the year.  For markets with clear supply growth however, such as aluminium and nickel, we would look for prices to be ease through the year, though both metals have stronger stories in the medium term. 
Supply side reforms and Chinas drive to improve its HSE (Health, safety & Environmental) standards have been a clear contributor to higher metals prices, and the pricing outlook for 2018 will clearly be influenced on what comes next in these areas. The winter cuts policy has been very successful for improving the air quality in targeted areas, with Beijing and its surroundings seeing the cleanest winter air in decades.  The question now is what happens in future winters, and now the key focus looks like being on trying to move much industrial capacity out of the heavily polluted North Eastern region.
Cuts to existing net supply look to have little further to go for steel and aluminium, with the focus now shifting to capacity swaps to enable upgrading and also spread capacity more efficiently around the country. Essentially we can say that capacity for steel and aluminium in China has successfully been capped, and while we still have another year or so of ramp up in aluminium output, the structural story for both metals is clearly healthy for the long term, especially with a backdrop of rising ex-China demand.
However for aluminium it’s too early, in our opinion, for the market to justify sustained excess returns. Indeed the Chinese aluminium market will remain comfortably supplied this year, on top of the already high inventory levels in China. We see 4.23mt of new smelting capacity potentially to be commissioned in 2018, and while this may be reduced to under 3mt on licensing issues, supply growth clearly looks set to keep pace with demand near term, making us bearish on the price outlook in both the short and medium term.
Recent Aluminium price performance especially has been at odds with the physical market. After prices in China corrected sharply in November, falling from over RMB16,000/t to under RMB14,000/t, they have since rallied back to RMB14,700/t at the start of 2018. LME price performance has been even stronger meanwhile, as for now the ongoing draw in LME inventory seems to be getting more attention from global Aluminium market players.
However the bullish story on Aluminium through 2017 was mostly focused on expectations of significant winter production cuts in China which would cause supply to tighten and inventory there to draw. Seven weeks into the winter cuts however and aluminium smelter curtailments total little more than 1mt on our data, while inventory in China is still growing, recently touching 10 year highs (See our recent Aluminium weekly for more).
While cost push has been one argument given for supporting prices, we do not see this lasting, and alumina capacity restarts post winter will be key to how quickly alumina prices ease back. So far we estimate 4.19mt of alumina refining has been curtailed for winter, and as this comes back in March, prices should fall back.
Copper on the other hand looks set for a tighter year, as evidenced by the recent fall in spot TC’s to below $75/t following the recent TC/RC annual settlement at US$82.5/t, down 11% from 2017. There are many new smelter additions planned in China for 2018, potentially as much as 1.45mt, while we see only 81kt of additional domestic mine output this year, meaning demand for concentrate imports will remain strong. However we still do not see a deficit in refined copper for the year as a whole, and thus expect prices to move lower from current elevated levels.  Ex-China copper mine performance, as usual, will remain a key swing factor for copper prices for the year.
Zinc remains tight, and while inventory moved higher in the last couple of weeks as refined imports rose sharply in late 2017, physical premiums have been strengthening in the last couple of weeks. However there is much zinc concentrate supply set to come on-line in 2018 also, though for China the 150-160kt we expect for this year remains at risk of environmental inspections and licensing issues, as happened over 2H17. With the demand environment for zinc less attractive than other metals on slowing auto sales in China, we see prices easing from current highs and averaging under $3,000/t for the year.
SMM expects the global lead market to remain tight in 2018, as rising secondary lead supply is insufficient to meet the shortfall in concentrate supply which will continue to be limited by environmental protection measures. Demand will be solid but not quite enough to move the market into deficit for the year however. We forecast LME lead prices to fluctuate in a range of $1,980-2,650/mt in 2018, and average $2,250/t for the year.
Nickel prices are set to see further volatility this year. We expect the bottleneck seen in supply of nickel cathode, pellet and briquette, to continue in the short term, which should support nickel prices in H1 2018. However there is a clear supply threat from rising NPI output, which we see increasing to 32% of global primary nickel output this year. Indonesian NPI output is set to rise by another 100kt over the next two years to 266kt, and with 16mt of nickel ore export licences already issued, Chinese NPI output is likely to rise strongly too as Indonesian ore imports increase through the year and strong margins incentivize output. We believe the abundance of NPI supply will drag refined nickel prices lower in the second half, especially given Indonesian costs under $8,000/t.
In the ferrous space meanwhile, steel inventory continues to be drawn to very low levels, and the steel market continues to look genuinely tight outside of the usual winter demand weakness.  This has been supporting higher raw material prices too, despite rising supply of both iron ore and coking coal per inventory and import numbers. Looking at supply and demand to try to forecast prices has been less and less useful in the ferrous raw material space in recent quarters, and I expect steel mill margins to remain the overwhelming driver for these prices at least into the middle of the year.
Indeed for iron ore last year the market looks oversupplied by as much as 80mt on paper, which has driven iron ore port inventories to record highs in the new year. Iron ore concentrate supply in China rose 12% last year on our numbers, to 258mt, while iron ore imports were also up around 60mt. However we believe total iron ore consumption last year was barely higher yoy as the increase in scrap availability from the IF closures accounted for most of the increase in reported steel production, and pig iron production for the year was little changed. For 2018 supply is set to continue to outstrip demand for iron ore, but prices will remain high for premium products as Chinese steel profit margins remain strong. We forecast iron ore prices to trade around a $60-65/t range for the year.
The MIIT (Ministry of Information and Industry Technology) issued a new steel industry policy yesterday, which detailed plans for significant capacity swaps and an emphasis on EAF capacity buildout in regions of China which are short of steel, namely the central and southern areas. We’ve already seen 131mt (on our numbers, 121mt officially) of the targeted 100-150mt closures announced under supply side reforms for the 2016-18 period, implying very little further closures. Industry M&A is also likely to see more of a push this year, as consolidation has always been emphasized as the second step in supply side reforms after outdated capacity elimination.
Indeed the improvements in Chinas scrap processing industry and preparing metals industrys for a strong growth in domestic scrap generation in the years ahead is likely to become an increasingly hot topic for commodities this year.  China has already curtailed imports of low quality scrap across many commodities, not just metals, and while this is depressing prices for some scrap materials outside of China which can no longer find a home, eventually new areas will emerge to process scrap which can no longer enter into China. 
On the consumption side, utilizing domestic scrap has clear environmental and economic benefits over importing raw materials for many metals, and given China’s scrap pool has been growing strongly over the last two decades, obsolete scrap generation will continue to accelerate in the years ahead.  Steel raw materials are most at risk from this trend, but eventually all metals will see a greater proportion of Chinese production coming from domestically generated scrap.