CHINA March 12 2014 5:56 PM

NEW YORK (Scrap Register): Rising Chinese ore prices have already contributed to an increase in average NPI RKEF production costs to almost $1000 a ton. As this drives NPI prices higher, differentials with refined nickel prices should narrow and eventually boost refined nickel and FeNi imports, said Barclays in a research note.

The near-10% rally in LME nickel prices over the past month has confirmed the initial premise that the application of the Indonesia ore export ban early in 2014 could be a game changer for the metal’s fundamentals. From the consecutive record refined market surpluses in 2012-13 and a collapse in LME prices to five-year lows, the ban is expected, over the next 12 months, to effectively strangulate Indonesian ore-dependent NPI producers and boost Chinese nickel import requirements significantly (with a subsequent tightening effect on the ex-China market).

At the current juncture, the potential for additional price upside is now leveraged to evidence of the genuine physical market effect compared with initial expectations. To that end, we believe there are already clear signs of tightening in the Chinese nickel ore market.

Based on data from SMM, port ore stocks have fallen just under 2Mt, to close to 17.7Mt, since January, reflecting the lack of fresh Indonesian shipments, as well as some constraint on Philippine ore due to the monsoon season. Over the same timeframe, ore prices have risen close to 15%, which, in turn, has increased average NPI RKEF production costs by almost $1000/t. This is important because it lays a path for the substitution by the stainless steel sector of NPI units for higher grade nickel units, which should ultimately bolster import demand and provide an ever-increasing draw on LME units. There should also be a benefit for ex-China stainless producers, given that integrated RKEF-stainless steel plants account for as much as 30% of total domestic capacity.

The critical question is how fast that dynamic will play out, and in that respect, the key subquestions are: (1) how significant are ore stocks in China? (2) who holds the stocks? and (3) Is there much flexibility from the non-RKEF NPI producers limiting the immediate feed-through from lost RKEF units into imported nickel units? In terms of (1), we believe that approximately two-thirds of port stock is high-grade Indonesian ore. If we assume, somewhat optimistically, that this contains an average 2% nickel content and 30-35% water content, then, at current levels, it represents about 170Kt of nickel that could be used in RKEF production in 2014. In the context of 2013’s 220Kt RKEF NPI output (which relies exclusively on Indonesian ore) and 200Kt EAF NPI output (which relies heavily on Indonesian ore also), there is obviously a huge gap in current high-grade ore port stocks and the requirement just to keep RKEF/EAF production flat y/y. Moreover, if the majority of this ore lies in traders’ hands (as per question 2), a relatively constrained supply style would be expected, even if anecdotal evidence suggests that there is no single entity with significant pricing power.

However, it is important to acknowledge that NPI producers have also built ore stocks. Determining the size of those stocks is difficult in part because there are no official figures but also because it is unclear how long such stockpiling has been occurring. Based on specific anecdotes, we estimate producer stocks at 10-15Mt (high grade Indonesian ore), which, based on previous assumptions, would amount to at most 200Kt nickel contained. Combining the two figures, there is approximately 370Kt of nickel contained in ore stocks in China currently, which supports our expectation that RKEF output levels will not come under pressure until H2 of this year. In regard to (3), we believe that there is some potential upward flex for lower- to mid-grade NPI producers who use lower nickel content ore from the Philippines. This underlies our projection that total NPI output will be supported at 430Kt in 2014, representing a modest contraction (rather than collapse) from 2013 levels.

Overall, the dynamics in the ore market should eventually contribute to a tightening of the global nickel market. We caution, however, against being over optimistic about the pace at which tightening in the physical market will take place. Even with ore prices rising and NPI costs trending higher, there are few signs that the refined market is tightening. While Chinese refined-NPI differentials have narrowed from close to $5000/t a year ago to $2000/t for equivalent nickel content, NPI is still more attractive for stainless producers. The LME-Chinese price ratio remains below the arbitrage breakeven, and LME stocks continue to rise, even if cancelled warrant levels are now at record levels. It is only when some of these refined market indicators turn that another leg higher in LME prices will be justified, in our view, but we think it makes sense, for investors who are not already positioned, to buy on any dip, Barclays concluded.