Updated Base Metals Price Forecast Slower start to 2012 before prices regain traction Commodities Research, 7 December 2011 Bombed out aluminium prices to prevail for a while longer before supply cuts improve balance

Copper prices expected to average above USD 8,000/tonne amid continued supply deficit

Nickel market continues to struggle with oversupply, but supply risks remain to the downside

Table 1. New base metals price forecast USD/tonne 2011E 2012E 2013EAluminium 2,400 2,375 2,500 Copper 8,850 8,250 8,500 Nickel 22,800 20,000 21,000

Source: Nordea Markets Table 2. Old forecast (31 August 2011)

USD/tonne 2011E 2012E 2013EAluminium 2,460 2,500 2,600 Copper 9,200 8,500 8,500 Nickel 23,600 21,000 21,000

Source: Nordea Markets Our updated economic forecasts for global GDP growth of 3.2% (from 3.3%) in 2012E and 3.7% (from 3.8%) in 2013E entail a mild recession in the Euro area but with limited spill-over effects to the global economy, which will grow slightly below trend next year. Our forecast for Chinese GDP growth is left unchanged at 8.5% and 8.1% for 2012E and 2013E, respectively. The first half of 2012 is expected to be slightly weaker than antici-pated in September and our base metals price fore-casts have been adjusted to reflect both this sub-dued growth outlook and supply-side developments since then (see tables 1 and 2 above). Aluminium prices to rebound from depressed levels The slowdown in economic growth this year has resulted in a worsening of expected fundamentals in the aluminium sector through lower expected future economic and thus aluminium demand growth. The price of aluminium at the London Metals Exchange has tumbled 24% from its recent peak in April 2011

to levels around USD 2,000-2,100 per tonne (Chart 1). In the current market, aluminium producers are feeling the pinch from poor prices and rising costs, which paves the way for production cuts. Accord-ing to industry consultants Harbor Intelligence and Brook Hunt, marginal1 cash output costs in the aluminium industry are currently estimated between USD 2,400-2,500 per tonne. Average cash costs are estimated at around USD 1,950 per tonne for 2011. China, the largest producer and consumer of alu-minium, is among the highest cost producers with average cash costs currently standing at USD 2,670 per tonne according to Harbor Intelligence. Domes-tic aluminium prices in China are also significantly higher than LME prices, but roughly 40% of the industry is losing money on a cash cost basis, nev-ertheless. Chart 1. Aluminium prices and exchange inventories

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1 Marginal cash costs are defined as the cash costs of producers at the 90th percentile on the supply curve.

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Robust demand growth to be driven by China Global end user aluminium demand has stalled, but demand for primary aluminium has remained firm. The exception is in Europe where physical premi-ums have started to come down from elevated lev-els. We have lowered our aluminium demand growth forecast for 2012E to 5.7% (7.7%) but leave our 2013E growth forecast unchanged at 6.5%. The decent demand outlook is underpinned by robust demand growth from China of around 10-11%. Demand is expected to be boosted by aluminium price competitiveness and penetration in the trans-portation sector. Growing urbanisation, income and market share in automotive, aerospace, electrical, electronics and solar energy support robust demand growth in the coming years, albeit at a slower pace than previously estimated. Supply under pressure by poor profitability Global aluminium output has come under intense pressure from poor prices and sticky production costs. However, historically high physical premi-ums paid on top of LME prices provide some offset for producers. Output fell to a 6-month low in Oc-tober according to official figures from the Interna-tional Aluminium Institute (IAI) as production in China decreased sharply. The pipeline for capacity expansions outside China looks relatively dry and is heavily dependent on expansions in India where output has disappointed already. Chinese planned expansions are decent, but could be hurt by poor profitability and power-related constraints amid China’s recurring power shortages. According to China Electricity Council, the current power short-age could last until next spring, but may be allevi-ated by the recently announced hike in power prices and cap on coal prices from January. This neverthe-less puts upwards pressure on Chinese production costs by an estimated USD 60 per tonne for smelt-ers without self-generated power. Although current prices incentivise production cuts, especially in China, we expect that prices must remain at current depressed levels for a while before we see cuts. Shutting down and restarting production is costly, high premiums provide offset, costs can come down further and history has shown that prices must trade at current levels on the cost curve (50th percentile) for a sustained period before cuts are made. Bottom line: Capacity is expected to expand at a slightly higher pace than demand next year, with the opposite being true for 2013E. We see a largely

balanced aluminium market for the next couple of years, with risks to the outlook largely balanced. Current aluminium prices are considered too low compared to current operating costs and to our ex-pectations for the global operating rate, which should remain in the 85-87% range. Prices are therefore expected to average higher than current forward prices over the next two years. We pencil in average prices of USD 2,375 (USD 2,500) per tonne and USD 2,500 (USD 2,600) per tonne for 2012E and 2013E, respectively. Chart 2. Aluminium forecast versus market

LME Primary Aluminium probability rangeBased on implied volatilities in the options market

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Source: Bloomberg, Nordea Markets Copper prices to reflect continued deficit Copper prices peaked in early February this year at prices above USD 10,000 per tonne as the funda-mental outlook pointed to an increasing supply deficit. However, lack of seasonal restocking by Chinese buyers during the spring, who instead turned to drawing on inventories amid historically high prices, tight credit conditions and a closed “ar-bitrage window” to import LME based copper, re-sulted in prices trending lower. Meanwhile, global economic growth slowed, reducing actual and ex-pected copper demand from China and the rest of the world. LME copper prices tumbled 33% from the February peak to the recent low in early Octo-ber (USD 6,785 per tonne), but currently trade around USD 7,800-7,900 per tonne (Chart 3). The industry marginal (90th percentile) cash cost is estimated by consultants Brook Hunt at USD 4,000 per tonne while the most expensive mine operations require almost USD 8,000 per tonne. Prices above this “threshold” should therefore only be justified in a market characterised by deficit, ie refined supply falling short of refined usage resulting in stock draws. According to the latest data from the Inter-national Copper Study Group (ICSG), the market was in a production deficit of 161k tonnes (1%) for

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the first eight months of 2011 versus a deficit of 339k tonnes for the same period of 2010. World demand grew by 1% during this period, while mine production continued to underperform relative to capacity with production during the first eight months of 2011 practically unchanged from last year. Production at three of the four largest produc-ers (Chile, Peru and the United States) fell by an aggregated 4% despite record high copper prices (Chart 4). Chart 3. Copper prices and exchange in-ventories

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Source: Bloomberg, Nordea Markets Chart 4. Chilean copper ore and concen-trates production continues to disappoint

Chile Copper ore and concentrates production

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5y range 2011 2010 5 year avg Source: Bloomberg, World Bureau of Metals Statistics, Nordea Mar-kets Demand to pick up from low 2011-levels World copper refined usage is expected to grow by 1.5-2% y/y this year after 2010’s strong 7.1% y/y growth. China will continue to be the driver of de-mand growth in the coming years as urbanisation and industrialisation continue. China will have to import roughly one-fourth of its copper needs, meaning that Chinese stocking cycles will remain a key price driver for the foreseeable future. We also expect China’s current 5-year plan to support cop-

per consumption as the power and construction sec-tors constitute more than half of total consumption. We expect Chinese consumption to grow at around 7% p.a. the coming two years and expect consump-tion per capita to reach levels above those of Eu-rope and North America as early as 2013E. Histori-cally, world real GDP growth of 1% corresponds to copper consumption growth of 1.2% (see Nordic Metals & Mining, 5 October 2011, Nordea Equity Research). We expect demand to converge to this historical relationship after a break-out on the up-side in 2010 and to the downside in 2011E, imply-ing around 4% y/y global demand growth in both 2012E and 2013E. Supply expansions look comfortable in theory Repeated labour strikes, adverse weather condi-tions, operational problems and lower ore head grades have become the norm rather than the ex-ception for copper supply in recent years. 2011 has been no exception to this “rule” and the ISCG ex-pects a production deficit of about 200k tonnes for 2011. The project pipeline looks, on paper, rela-tively comfortable, with expansions at existing mines (brownfield) and new plants (greenfield) planned to come on stream the coming few years. Copper mine production is highly concentrated given that Americas (mainly Chile, Peru and the US) and Asia constitute roughly 75% of global out-put. Of the 10 largest copper mines in the world, six are Chilean. Judging by production plans for the Chilean mines alone, they would manage to meet the expected demand increase by themselves. How-ever, copper output tends to fall short of guidance levels and we expect history to repeat itself. Bottom line: ICSG expects an increase in refined copper production of 3.4% in 2012E compared to the producers’ expansion plans of roughly 9% growth (1.5m tonnes). We share the view of the ICSG and expect a production deficit to emerge also in 2012E for a third year in a row. We expect a nearly balanced market in 2013E. Due to a slightly weaker economic development in the start of 2012, we have lowered our average price forecast for 2012E from USD 8,500 per tonne to USD 8,250 per tonne, but keep our forecast for 2013E at USD 8,500 per tonne.

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Chart 5. Copper forecast versus market LME Copper probability range

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Source: Bloomberg, Nordea Markets Nickel prices threatened by supply glut Nickel has been the underperformer among base metals this year on expectations of steady supply additions this year and in 2012. Nickel prices peaked in February above USD 29,000 per tonne, but currently trades around USD 18,000 per tonne (Chart 6). As stainless steel production accounts for roughly two-thirds of global nickel consumption, the slowdown in stainless steel production in the second half of the year has put pressure on refined nickel demand. At the same time, China’s nickel pig iron (NPI) industry, an alternative nickel feed-stock for stainless steel production, churned out record-high amounts. Chinese net imports of re-fined nickel have therefore remained low this year, while imports of nickel ore and concentrates to feed the NPI production have skyrocketed. Recently, however, these producers are getting squeezed out of the market as nickel prices have fallen below the cost of NPI production, which is estimated by con-sultants Brook Hunt in the range of USD 19,000-20,000 per tonne. Moreover, 90% of global nickel supply operates cash positively at price levels around USD 15,000 per tonne. Despite the sluggish price development, record-high refined nickel production in September and NPI ramp-up in China, visible exchange inventories of refined nickel have declined steadily by a total of 33% since the start of the year (Chart 6). We expect that some of the excess material has been shipped into China and may be stored away in off-market bonded warehouses. Nevertheless, LME nickel stocks will begin 2012 at the lowest starting level in three years.

Slower demand growth in 2012E, but stronger 2013E Slower economic growth and industrial production in the first half of 2012 than previously forecast will most likely result in lower nickel demand growth next year. INSG’s late September forecast of 6% demand growth for both 2011E and 2012E is considered too optimistic, in our view. We factor in demand growth of around 5% this year, falling to 3% next year before climbing to around 9% in 2013E. Chart 6. Nickel prices and exchange inven-tories

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LME inventories LME Cash price (rhs) Source: Bloomberg, Nordea Markets Supply pipeline impressive on paper On paper, the expected nickel supply pipeline looks overwhelming, but disruptions and delays have been a constant feature for the industry. Production growth is partly dependent on highly complex pro-jects, which makes delays likely, in our view. The International Nickel Study Group (INSG) latest es-timates point to a supply increase of around 9% in 2012E, which is roughly in line with our own esti-mates. However, this figure does not include any general adjustment factor for possible disruptions, implying that risks to supply are skewed to the downside. Bottom line: Coupled with our demand expecta-tion, the strong supply pipeline translates into an expected supply surplus the coming two years. We therefore expect prices to continue to be determined by the costs of the marginal producers. Further-more, we pencil in a slightly lower price assump-tion for 2012E of USD 20,000 per tonne (USD 21,000 per tonne) due to weaker demand expecta-tions for the start of the year. We nevertheless keep our previous forecast of USD 21,000 per tonne for 2013E.

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Chart 7. Nickel forecast versus market LME Nickel probability range

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Source: Bloomberg, Nordea Markets Risks to our outlook Forecasting metals prices in the current environ-ment is very difficult as the macroeconomic uncer-tainty is perceived to be heightened. Industrial met-als demand is highly cyclical and sensitive to changes in economic growth prospects. The sensi-tivity of demand to GDP growth is highest for nickel and aluminium, and lowest for copper. Nev-ertheless, small changes to the economic outlook could have relatively large implications for ex-pected metals demand and thereby the expected market balance. Our forecast described above must therefore be viewed as our “best estimate” corre-sponding to our baseline forecasts for global eco-nomic growth. The largest downside risks to our outlook are pre-dominantly demand-side related. The debt crisis in the Euro-zone, if not properly contained, may have large spill-over effects to the global economy mainly through the financial sector. A so-called “hard landing” in the Chinese economy, for exam-ple instigated by a burst of the property and credit “bubble” is another known risk. Chinese residential floor space for sale has mushroomed lately as prop-erty demand has fallen markedly. Anecdotal evi-dence points to a liquidity crunch among property developers. If property prices fall sharply, private construction may be cut back and China’s demand for raw materials and industrial metals will drop substantially. Upside risks to our outlook include stronger eco-nomic growth than envisaged. Expectations are low

and business and consumer confidence has eroded, which could pave the way for an upside surprise to economic growth. There is also probably pent-up metals demand for instance in the United States where construction activity remains at depressed levels. Stronger monetary and fiscal policy easing by China would most likely boost metals demand growth from the world’s largest consumer. How-ever, implementation of substantial easing meas-ures is most likely to be reactive rather than pre-emptive, in our view, if growth should falter more than currently anticipated. Bjørnar Tonhaugen bjornar.tonhaugen@nordea.com +47 2248 7959

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