Demand for mined commodities continues to be dominated by strong imports from the emerging markets, and from China and India in particular, with improving but still weak fundamentals from the industrialized countries. For the past year, China has been the major source of increased demand for commodities as it deployed a more effective stimulus program and more constructive credit policies. However, the China economy is primarily driven by exports to the United States, Europe and Japan, and continued growth in commodity demand from China requires the return of industrial production in the industrialized countries.
Industrial production outside of China has improved more recently as inventory de-stocking reaches completion. However, demand growth beyond the de-stocking effect remains sluggish. Trends in U.S. steel production can be indicative of broader ex-China industrial trends, and steel production in the United States bottomed at just under 40 percent capacity utilization in April. By July, extensive de-stocking had reduced steel inventories by over half to about 2.2 months of supply. Since the completion of de-stocking, steel production has improved to above 60 percent capacity utilization as sales out of production replace previous sales out of inventory. Beyond the effect of completed de-stocking, end use demand in the U.S. remains soft.
Seaborne metallurgical coal and iron ore demand remains strong as China steel production continues at high levels and imports are starting to move into other steel producing regions. Total China met coal imports were almost 30 million metric tons through ten months, about six times higher than last year. As a result, the seaborne met coal spot market is thin, with some producers already sold out for 2010. China imports, plus an increase in global steel production have pushed met coal spot prices well above this year’s benchmark of $129 to as much as $180 (thats why ANR hit new highs today) per metric ton. Iron ore is under similar demand pressure, and its spot prices are above $100 per metric ton, up from $92 in October and a low of $60 in February.
The thermal coal outlook varies dramatically between the seaborne markets and the U.S. market. China and India are major factors in the seaborne market. China imports this year are already 100 million metric tons through ten months, double last year. Imports increased significantly this year due to rapidly improving electricity demand and the process of restructuring small mines in the Shanxi (we've identified a potential play on this consolidation) and Heibei provinces. Much of the increase is considered structural, with the electricity generators along the southeastern coast expected to rely increasingly on imported coal to avoid rail capacity constraints and because strong domestic prices are making imports competitive.
India’s coal imports also continue to increase. India’s coal imports could reach 50 million metric tons in 2009, up 28 percent from 2008, and are expected to increase to above 60 million metric tons in 2010. Coal India expects this trend to continue, and has projected that imports could increase to 200 million metric tons by 2014. (Some of the first signs that India demand could really hit supply)
Based on this continued strong emerging market demand, seaborne thermal coal spot prices have risen above $80 per metric ton. Supply shortages are expected to continue, with seaborne thermal coal being contracted for 2011 and 2012 at even higher prices. (now why has the CLD IPO been so weak. These prices will flow to them)
The thermal coal markets in the U.S. continue to be weak, with demand from coal-fired electricity generation down 13 percent year to date. There has been some seasonal improvement, and the most recent data shows coal-fired generation up more than 20 percent from its low in April. As a result, generator stockpiles were reduced in both tons and days in the most recent report. However, stockpiles remain at historically high levels, and will delay recovery in the U.S. thermal coal market for 12 to 18 months. On the positive side, higher natural gas forward-month prices are reducing the economic incentive to dispatch natural gas-fired plants, and 22 gigawatts of new coal-fired plants should add 70 to 80 million tons to thermal coal demand by 2012. (again the domestic market is picking up and the surging nat gas prices should make CLD more attractive)
Copper demand has been increasing as China has strategically restocked, but with inventories high copper imports are expected to moderate. However, China imports are expected to remain above their import levels of 2007 and 2008. Based on a continued healthy demand from China and the expectation that demand from the rest of the world will turn positive later this year, the 2010 price forecast for copper has been revised up several times and is now well over $3.00, with the expectation of further supply shortages and price increases in 2011. (basically as the US starts using more copper, world supplies will be scarce. FCX or SLT in India are the plays we like. FCX seems to trade more off gold of late)
Seaborne traded commodity prices are strong and improving based on the strength of current demand from the emerging markets, the start of demand improvement from the industrialized countries, and the realization that mining will run out of excess capacity well before the industrial sector reaches its full capacity. Mining companies see the need to restart expansion projects and have been announcing significant increases in their capital expenditure budgets for 2010.
“We see 2009 as the cyclical floor for incoming orders based on consistency of the order rate over the past four quarters, the continuation of strong commodity demand from the emerging markets complemented by improving commodity demand from the major industrialized countries, and the limited upside in current mining capacity,” continued Sutherlin. “Our customers are increasing their capital expenditure budgets for 2010, and are also validating equipment specifications and confirming production slots to enable them to reactivate some of the projects they previously put on hold. As such, we expect 2010 to be a year of improving order rates.”
“We expect original equipment orders to return to their typical lumpy pattern due to the timing and size of each project. Based on commodity fundamentals and discussions with customers, we expect that copper, international coal, iron ore and oil sands to have the greatest potential for original equipment orders during 2010. Original equipment orders for the U.S. coal market will be limited to met coal demand and otherwise to machine replacements based on the higher productivity of new technology. Aftermarket orders in our second half of fiscal 2009 were up 6 percent from the first half, and we expect this trend of steady improvement to continue as our international customers bring production back on line during 2010.”
“We have previously stated that our revenues in 2010 would converge to the rate of incoming orders, which has been relatively stable at an approximate $2.8 billion run rate for the last four quarters. We do not expect significant upside potential to revenues in 2010 because original equipment orders booked in 2010 will primarily become 2011 shipments and because the aftermarket will be limited by its more steady rate of improvement.”
“We have previously indicated that we were targeting decremental operating leverage for 2010 to be in the lower 30 percent range. Although we anticipated pension expense increase in 2010, we subsequently determined that pension expense would increase by $36 million, or $0.23 per share more, due primarily to a lower discount rate. Our guidance will reflect decremental operating leverage of approximately 33 percent despite the added pension impact on earnings, and it dips into the 20 percent range without this added expense. Either measure represents extremely good cost control as we enter a lower revenue year.”
“With those explanations, we are guiding our fiscal 2010 to have revenues of $2.8 to $3.0 billion and earnings per fully diluted share of $2.65 to $3.05. We expect cash flows to be stable, and are budgeting capital expenditures of $100 million as we reactivate strategic projects to get their benefit early in the up-cycle.”