Commodities Forecasts: The Long and Winding Road

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Commodities Forecasts: The Long and Winding Road Connection Series

Source: Credit Suisse

Modest 4Q Rally Before Supply Weighs in 2014 The near-term outlook for many industrial commodities has brightened since our last forecast update, with global economic growth finally beginning to recover over recent months, after consistently disappointing for 2½ years. We expect better demand to see most industrial commodities rally a little further in 4Q, although the gains are likely to be relatively modest.

Historically, demand growth (IP is the best proxy) has been the main driver of near-term pricing, while supply tends to have an impact over a longer time period; the inventory cycle means that demand tends to be much more volatile than supply, absent major weather events, etc.

Given this, it is a little surprising that the rebound in global IP in recent months has not seen a bigger bounce in industrial commodity prices.

While prices may possibly be lagging demand, we believe the disappointing response primarily reflects EM growth that continues to underperform.

With global IP growth likely to peak in 4Q and Chinese growth unlikely to improve further, it is likely that much of the bounce has already happened.

Following the near-term rebound, we expect increasing supply and a modest slowdown in IP growth to see prices under pressure once again in early 2014, with prices for those commodities where supply is improving (e.g., iron ore and copper) likely falling further, while those where supply remains tight (e.g., oil) likely to perform better. Despite the "no-taper" shock from the Fed, the "gold bubble" is likely to continue to deflate once the US fiscal debacle is resolved.

03 October 2013Securities Research & Analytics

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03 October 2013

Commodities Forecasts: The Long and Winding Road 2

Table of Contents

Editor’s Summary: It’s a Bounce Jim, but We Don’t Expect it to Last ... 4

IP growth still in the driving seat …........................................................................ 4

Recent data suggest near-term upside risks ......................................................... 7

So will the OECD recovery lift all ships? ............................................................... 8

Summary of Individual Commodity Forecasts 10

Price forecast summary tables ............................................................................ 14

Macro Outlook: Recovery Finally at Hand? 16

The slowdown looks to have come to an end at last ........................................... 16

The US post the Fed ............................................................................................ 17

China: As good as it gets? ................................................................................... 18

But won't policy continue to support? .................................................................. 21

Europe on the mend but 3Q data could disappoint ............................................. 21

Modest global recovery underway but EM is yet to bounce decisively ............... 22

Petroleum: 23

Balanced fundamentals and shifting tail-risks ..................................................... 23

Overview: A near-term soft-patch leads to familiar terrain .................................. 23

Supply – the bigger and less predictable deltas .................................................. 26

Demand: Global growth stays close to trend in 2013 .......................................... 30

Inventories and positioning .................................................................................. 33

Natural Gas: 38

Global LNG .......................................................................................................... 38

US Natural Gas .................................................................................................... 41

The broader fundamental view ............................................................................ 43

UK (NBP) prices: too high to burn, too low to import ........................................... 52

Steel: 55

Out of sync ........................................................................................................... 55

Bulk Commodities: 60

Iron Ore: Freight accompli ................................................................................... 60

Metallurgical Coal: Better but not good ............................................................... 67

Thermal Coal: Taking the low road ...................................................................... 73

03 October 2013


Base Metals: The Good, the Bad and the Ugly 80

Macro influences mask fundamental differences … ............................................ 80

Consumption growth better than we expected … ................................................ 80

…But supply continues to rise too ....................................................................... 80

Copper: Tipping the balance ................................................................................ 81

Aluminum: Reasons to be cheerful? Not really ................................................... 90

Alumina: From bad to worse ................................................................................ 97

Nickel: Saddled by supply (with a caveat) ......................................................... 105

Zinc: Light at the end of the tunnel? .................................................................. 114

Lead: Turning point ahead? ............................................................................... 121

Tin: Managing supply in a constrained world .................................................... 130

Gold & Silver: 134

Gold: Downward pressure likely to resume soon .............................................. 134

Silver: equilibrium looks achievable if investors stay long ................................. 140

Forecasts: .......................................................................................................... 144

PGMs: Addressing the inventory concerns 145

Platinum: a long road uphill ............................................................................... 146

Palladium: hold on tight to your dreams ............................................................ 149

Forecasts: .......................................................................................................... 153

Mineral Sands 154

Both zircon and TiO2 feedstocks to strengthen in 2014 .................................... 154

High grade TiO2 feedstocks .............................................................................. 154

Chinese ilmenite market .................................................................................... 158

Zircon demand steadying at normalized level ................................................... 158

Normalized zircon sales volumes ...................................................................... 160

Uranium: Spot-Term Price Dichotomy Reflects Inventory-Driven Factors ........ 166

Financial Flows 172

3Q 2013 summary of commodity-linked flows ................................................... 172

Technical Analysis 175

Precious metals stay bearish ............................................................................. 175

Base Metals remain range bound ...................................................................... 176

Energy stays within broad multi-year ranges ..................................................... 177

Contributors 178

03 October 2013


Editor’s Summary: It’s a Bounce Jim, but We Don’t Expect it to Last ... As outlined in The Setting of the Sun, we feel that the “glory days” of the commodity bull market are well behind us, with prices likely to continue to revert to more normal levels over coming years. However, while the complex is likely to remain under pressure, history suggests that within secular bear markets there are still clear up-cycles.

As shown in Exhibits 1 and 2, despite trending down from 1980 to 2002, real prices actually increased in nine of those 23 years.

Exhibit 1: Commodities appear to be at the beginning of a secular bear market

Exhibit 2: But within structural bear markets, there will still be cycles …

Real CRB Index Real CRB Index, yoy change, monthly

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1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

IP growth still in the driving seat … Unsurprisingly, during the last bear market, prices tracked broadly with changes in global industrial production, with trend monthly changes in global IP exhibiting a strong correlation with trend changes in the CRB from 1990 to 2002.

This of course suggests that despite the secular headwinds facing commodities, developments in the global business cycle will continue to drive near-term pricing.

While supply increases can push prices lower over time, the inflection points continue to be driven by the industrial cycle.

RESEARCH ANALYST

Commodities Research Ric Deverell

[email protected] +44 20 7883 2523

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mailto:[email protected]

03 October 2013


Exhibit 3: Industrial production growth drives the commodity cycle even during secular bear markets ... Percentage change

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1990 1992 1994 1996 1998 2000 2002

Global IP (annualised trend change) CRB (real annualised trend change, rhs)

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Commodities live in an EM world

Notably, however, it is also clear that there was a structural shift in the drivers of global commodity prices in the early 2000s.

In the 1980s and 1990s global IP growth of an average 3.7% p.a. saw commodities fall by an average of nearly 4% a year.

However, from the early 2000s commodity prices began to trend up (that is, the average growth rate picked up), despite average IP growth remaining relatively stable (Exhibit 4).

Exhibit 4: There was a structural shift in the relationship between global IP and commodity prices in the early 2000s Percentage change

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Global IP (annualised trend change) CRB (real annualised trend change, rhs)


Unsurprisingly, in large part this shift appears due to the increased importance (and growth rates) of the EM economies. In addition, the increase in prices was due to the poor response of supply to better demand – note that after many years of low prices investment had fallen to historically low levels.

03 October 2013


The relatively tight relationship between developed market IP and commodity prices seen in previous decades broke down in early 2000.

Exhibit 5: Developed market IP growth has become less important for commodities Percentage change

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1986 1990 1994 1998 2002 2006 2010

DM IP (annualised trend change) CRB (real annualised trend change, rhs)


In contrast, it is clear that after showing a relatively poor fit up until the new millennium, EM IP growth has correlated very well with changes in broad measures of commodity prices over the past decade.

This relationship has held very well over the past couple of years, suggesting that the dramatic slowdown in EM IP growth has been the main factor dragging commodity prices lower in the past few years.

Exhibit 6: The emerging market business cycle seems to be driving industrial commodity prices Percentage change

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1986 1990 1994 1998 2002 2006 2010

EM IP (annualised trend change) CRB (real annualised trend change, rhs)


Notably, in trend growth rate terms EM appears to be the key driver for both basic materials and oil, with Exhibits 7 and 8 showing that there has been little difference between trend price changes for Brent Oil and Copper in recent years.

03 October 2013


Exhibit 7: EM IP moves very closely with copper prices

Exhibit 8: While it also explains much of the recent cycle in the price of oil

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1997 1999 2001 2003 2005 2007 2009 2011 2013

EM IP (annualised trend change) Copper (trend change, rhs)

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EM IP (annualised trend change) Brent (trend change, rhs)

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

Given this, the next near-term leg in the commodity cycle is once again likely to be dominated by the emerging market demand, while the "average level" of prices over the coming 18 months or so will rely heavily on developments on the supply side.

Exhibit 9: EM growth drives commodity prices...

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93 95 97 99 01 03 05 07 09 11 13

24 month rolling correlation of changesin EM IP and Copper

24 month rolling correlation of changesin DM IP and Copper

Source: Credit Suisse , the BLOOMBERG PROFESSIONAL™ service

Recent data suggest near-term upside risks With the survey data suggesting that global IP is in the process of rebounding, it is likely that industrial commodities will rebound over coming months; however, despite the more positive near-term prognosis, we expect the bounce to be relatively subdued – similar to that seen late last year rather than anything more substantive.

Historical relationships would have suggested that commodities should have already rallied substantially, whereas after a bounce in August most basic materials (oil continues to be driven by geopolitical issues) have actually fallen over recent weeks.

In large part this reflects the fact that the rebound in global IP has, to date, been very much a developed world phenomenon, with the bounce in EM IP to date very modest.

03 October 2013


Exhibit 10: EM IP growth is lagging that in the developed world Index

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DM PMI NO EM PMI NO

Source: Markit, Credit Suisse

So will the OECD recovery lift all ships? For commodities, perhaps, the key near-term question is to what degree growth in the emerging markets will benefit from the developed world rebound? While historically we would assume that the rebound would quickly flow through to an EM rebound, it is notable that the correlation between EM and DM growth has collapsed in recent years, as the emerging countries deal with the structural issues caused by the large stimulus in 2009 and continued soft exports.

Exhibit 11: EM and DM IP have diverged … Exhibit 12: With the correlation between the two falling noticeably

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DM IP (annualisedtrend change)EM IP (annualisedtrend change, rhs)

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24 Month Rolling Correlation of TrendMonthly Change in DM and EM IP

Source: Markit, Credit Suisse Source: Markit, Credit Suisse

While we expect EM growth to recover somewhat, we suspect the period of substantial EM economic outperformance (led by the export and investment model) is behind us, with these economies likely to have to rely more on domestic demand for some time.

While global trade looks to have troughed, we think it is highly unlikely that we return to the heady growth rates seen in the early 2000s.

03 October 2013


We also suspect that the rebound in OECD IP is in large part an inventory adjustment, with US final demand growth actually slowing in recent months, while the euro area is flat at best (see macro section).

This suggests to us that although many industrial commodity prices are likely to move modestly higher in 4Q, increasing supply, the ongoing struggles in the EM world, and the peak in the developed world cycle will begin to weigh more heavily as we move into 2014.

03 October 2013


Summary of Individual Commodity Forecasts While the commodity complex is likely to remain under pressure in 2014, as has been the pattern in recent quarters, there is likely to be a substantial divergence among individual commodities, with those that face increasing supply likely to fall, while those where prices are already below long-run averages should see supply growth slow.

Over the coming year we expect three commodities to fall substantially (iron ore, copper, and gold), four commodities to be essentially flat (tin, silver, Brent and nickel), while eight commodities should increase modestly, with the PGMs and lead leading the charge.

Exhibit 13: The commodity outlook remains mixed – with substantial intra-commodity divergence likely Change from current spot to 4Q 2014 forecast

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Copper

Gold Tin

Silver

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Brent

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Aluminium

Thermal Coal

U.S. N

at Gas

U.K. N

at Gas

Zinc

Palladium

Lead

Platinum

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Crude Oil – Balanced fundamentals

Oil markets should remain in balance, with most risks manageable in the near to medium term. We expect global benchmark Brent oil futures to keep on trading within a $100-$120 per barrel (b) range. Oil demand has been growing at a moderate 1% + pace, slightly better than consensus expectations, but supply-side upsets drove most of the recent surge in oil prices: third quarter Brent prices averaged $108.29/b, ~3% above our 3Q forecast.

Over the next couple of quarters, our base case is for the gradual return of a portion of the ~3.2 Mb/d of lost MENA barrels, loosening the global oil supply/demand balance and helping to reduce the current call on Saudi Arabia by ~1.5 Mb/d. As such, we are revising down our 4Q 2013 forecast to $105/b, but acknowledge that risks seem skewed to the upside. Additionally, we are shifting our quarter averages for 2014, putting the year’s $105/b low point into 1Q and the seasonal high of $115/b into 3Q.

Global Gas – Tight LNG supplies stay tied to oil and Asia

Global LNG prices remain fully oil-linked and at a large premium to both continental European and North American gas markets. In North America, the ongoing "shale-revolution" keeps a lid on prices, which remain the lowest of any large market. Meanwhile, European natural gas prices continue to price at levels too high to spur local power sector demand, but too low to attract LNG away from higher-priced Asian markets. With little new supply expected until 2016 and beyond, any supply disruptions or demand surge can tighten the LNG balance. And its price should stay historically high (see Global LNG Sector - Later and longer).

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03 October 2013


US Natural Gas – Revised prices down again

We revised our US natural gas price deck modestly lower, in large part because the ongoing shale gas boon will keep on adding surplus supply. Aside from a little upside this winter, most risk remains skewed to the downside.

While we expect quite significant growth in US natural gas demand in coming years, it remains difficult to argue that at some point supply will fail to keep up with those demand gains. In fact, the latest well results from the next “exciting” shale play, the Utica, rival those of the best wells in the former most exciting play, the Marcellus. Consequently, beyond the odd tactical or weather-driven upside risk for US gas prices, we see mostly downside risk to the longer-term part of the curve as well.

UK Natural Gas – NBP prices stay too high to burn, too low to import

UK NBP (National Balancing Point) natural gas prices have remained range bound (within a 4 pence/therm range) since we last updated our forecast. Much of the supply-driven bullish bias still prevails, particularly with storage levels trending near five-year lows. The current supply mix is expected to remain mostly unchanged until Asian LNG price premiums subside or the availability of uncommitted spot cargoes increases – which we think will not happen until 2016, at the earliest. We leave our outlook, which calls for slight upside to the current futures curve through the forecast period, unchanged.

Iron Ore – Starting to ease lower

After a strong run in 3Q, we expect iron ore to feel the drag of increased supply in the final quarter of 2013, with prices easing back accordingly. Rio Tinto has begun its build-up toward 290 Mt/y, FMG’s efforts to reach 155 Mt/y continue apace and BHP Billiton should also start up its 35 Mt/y Jimblebar expansion before the quarter is out. Furthermore, seasonally stronger Brazilian volumes should add additional weight to the market’s offer. The usual host of 1Q supply disruptions, coupled with a likely move higher in steel production run rates, should tighten the market briefly at the start of 2014 but, after that, the completion of major Australian expansion projects will likely present the market with its first period of more prominent seaborne surpluses.

Thermal Coal – Downgrading prices

Prices have stagnated around $80/t, weighed down by a surfeit of supply. A continued lack of producer discipline makes any material near-term recovery very unlikely and, with many consumers also highly price sensitive, it is hard to see any immediate catalysts for a turnaround. Over time, a slowing of supply growth should allow prices to edge higher but thermal coal remains structurally challenged, particularly when one considers the long-run competition from unconventional gas that should emerge more forcefully at the back end of this decade. We downgrade our long-term real price to US$95/t.

Base Metals – A very mixed bag

Base metals have been provided with a degree of stronger support than we originally expected largely because of better-than-expected demand. Despite some concerns, China’s stabilization and reduced fears of a marked fade to growth in 2H have kept rises in apparent uses of industrial commodities in the country in the 7%-8% range for CY2013. However, both cyclical and seasonal factors have also played a hand and this makes us cautious about over-extending our projections. The boost is generally unlikely to create lasting physical tightness.

For copper, we hold to our view that mine-through-refined supply expansion growth will steadily eclipse demand, albeit this transition may not become apparent until 1H 2014. Moreover, this year’s apparent tightness owes much to the way in which Chinese smelters/refiners have reacted to growing supplies of concentrates; stocks have been

03 October 2013


accumulated, forcing up TCRCs at a critical point in the negotiation season; ultimately these inventories will be converted into refined metal. Shortages of scrap have also contributed to stronger demand for refined copper than at the semis level and this relative strength will be more modest in 2014. We still expect copper prices to be US$1,000 cheaper at this time next year.

In contrast, we are cautiously a little more optimistic about zinc and lead (or at least less pessimistic). The metals appear balanced to swing the other way and, after years of supply excess, market deficits could emerge in 2014. In the case of zinc, a hefty overhang of inventory, for now largely tied up, may defer the point at which prices gain stronger traction but 2013’s lean levels are providing no incentive to invest in new supply, let alone maintain existing production capability. In each instance too, uncertainty over Chinese supply merits a degree of caution.

The prospects look anything but rosy for aluminium and nickel. For both, supply growth looks set to swamp demand, principally at the hands of Chinese suppliers. We think these two metals are structurally in the weakest shape; we see little scope for sustained price rises over much of the course of the next 12-18 months. The caveat here is uncertainty over Indonesia’s pending ban on ore shipments from next January, but we consider downside prices risks to have grown in the absence of meaningful supply cuts.

Gold – Downward trend expected to resume, forecast unchanged

For gold, the main premise of our bearish outlook hasn’t changed:

A slow improvement in global growth.

The ongoing gradual normalization of real interest rates.

A lack of inflationary pressure in developed markets.

Less investor demand for tail-risk protection in the form of zero-yielding gold.

The fiscal headlines generated in the US may provide a modicum of support to gold above the key resistance level of $1,270 a little while longer. However, we do still expect the Fed to begin withdrawing stimulus in the not-too-distant future, while key budget decisions are likely to be deferred until after US mid-term elections in 4Q 2014. So with physical demand out of Asia having moderated from the 1H surge and the Indian market still struggling to get to grips with new import restrictions, we are comfortable in retaining our bearish forward price deck, expecting the metal to average $1,150 in 12 months’ time. Of course there will be rallies within the downward trend, but we continue to believe the correct strategy is to sell those rather than buy dips.

Silver – Equilibrium may be achievable, forecast unchanged

Our economists expect global IP to resume above-trend growth next year (5.0%) after two years of below-trend expansion in 2012 and 2013. That is in line with their somewhat cheerier global growth outlook for 2014: they forecast 3.8% global GDP growth for next year, which would be a significant improvement from this year’s rather disappointing 3.0% expected rate (see Forecasting the Elusive Speed-Up for 2014). Taken in isolation, that should spell good news for silver demand and potentially prices.

However, the silver market is awash with inventory, and price gains depend primarily on the metal being able to attract continued investor flows. ETF holders and the retail segment of the market are still net buyers but institutions have been much less active on the buy side via Comex futures since April.

Net/net we expect the effect of a lower gold price but more positive global outlook and improving rate of industrial demand growth to be broadly neutral for silver over the next 12 months. Consequently we have kept our 4Q 2014 average unchanged at $21.30.

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03 October 2013


Platinum Group Metals – Patience is a virtue

We think platinum is a metal that is more likely to grind its way steadily higher over the next several years than surge upwards in a repeat of 2008. The sector needs to see more mining capacity taken off-line in South Africa and a clear turn in European economic activity to become a more compellingly bullish story – both may happen in 2H 2014. In the interim we still think it is worth building a core long position when the metal is trading close to or below $1,400. At those levels there is substantially more upside than down for patient longs in our view and we retain our 4Q 2014 forecast of $1,630.

Are investors who are long palladium playing a risky game of “the greater fool” – hoping that the supply of fresh investment money is not yet exhausted on the back of flawed supply/demand analysis? It is a question some in the market have begun to ask. On the one hand we do not subscribe to the view common among a number of industry observers that the palladium market is and has been running 1 million oz per year plus deficits. On the other, we also recognize that there are substantial and in some cases rather opaque above-ground inventories of metal. But we do think there are grounds to believe the metal can get back to the 2011 highs around $850 over the next 18 months to 2 years.

That positive outlook depends on a benign growth outlook for the global automotive industry, and Chinese car sales in particular – an unforeseen macro shock (such as a China credit event) would likely see a rush to the exits. For now, however, we are content to retain our positive forward view of price and keep our 4Q 2014 average forecast of $820/oz.

For trading recommendations related to this note, please see Trading Recommendations: The Long and Winding Road

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Price forecast summary tables

Exhibit 14: Global commodities research – price forecast summary 2015 2016 2017 LT

Yr Avg (f) Q1 (f) Q2 (f) Q3 (f) Q4 (f) Yr Avg (f) Q1 (f) Q2 (f) Q3 (f) Q4 (f) Yr Avg (f) Yr Avg (f) Yr Avg (f) Yr Avg (f) (real)

EnergyBrent (US$/bbl) 111.70 113 103 108 105 107 105 110 115 110 110 100 95 95 90

previous 111.70 113 103 105 110 108 115 110 110 105 110 100 95 95 90

WTI (US$/bbl) 94.20 94 94 104 101 98 101 106 107 102 104 92 87 87 82

previous 94.20 94 94 97 102 97 105 100 100 95 100 90 85 85 80

U.S. Natural Gas (US$/MMBtu) 2.83 3.35 4.09 3.60 3.75 3.70 4.10 3.80 4.00 3.75 3.90 4.20 4.40 4.50 4.50

previous 2.83 3.35 4.09 4.20 4.20 4.00 4.10 3.90 4.00 4.10 4.00 4.40 4.70 4.60 4.50

U. K. NBP (GBp/Therm) - 58.49 66 68 64 68 67 72 65 64 70 68 67 65.50 65.00 61.00

previous 58.49 67 68 62 68 66 72 65 64 70 68 67 66 65 61

Iron Ore

Iron ore fines - 62% (China CFR) US$/t 128 148 125 131 115 130 115 110 100 90 104 90 93 95 90

previous 128 148 125 105 100 120 105 95 95 90 96 90 90 90 90

Iron ore fines - (China CFR) US¢/dmtu 206 239 202 211 185 209 185 177 161 145 167 145 149 153 145

previous 206 239 202 169 161 193 169 153 153 145 155 145 145 145 145

Coking Coal (contract)Hard coking coal (US$/t) 210 165 172 145 152 159 160 160 165 165 163 173 178 180 165

previous 210 165 172 147 150 159 160 160 165 165 163 173 180 185 165

Semi soft coal (US$/t) 139 116 120 105 105 111 112 112 116 116 114 121 124 126 115

previous 139 116 120 103 105 111 112 112 116 116 114 121 126 130 125

PCI coal (US$/t) 154 124 141 116 121 125 126 126 130 130 128 136 140 142 125

previous 154 124 141 110 113 122 120 120 124 124 122 129 135 139 130

Thermal CoalThermal Coal (Newcastle FOB) US$/t 95 91 87 77 80 84 85 85 85 85 85 88 95 100 95

previous 95 91 87 80 85 86 90 90 90 95 91 100 102 105 100

Thermal Coal (ARA CIF) US$/t 92 86 80 76 79 80 84 84 84 84 84 87 94 99 95

previous 92 86 80 77 82 81 89 89 89 94 90 99 101 104 100

Thermal Coal (RBCT FOB) US$/t 93 85 80 72 76 78 83 83 83 83 83 86 93 98 95

previous 93 85 80 78 82 81 88 88 88 93 89 98 100 103 100

UraniumUranium spot (US$/lb) 49 43 40 35 36 39 38 40 45 50 43 55 60 70 65

previous 49 43 40 43 45 43 48 52 56 60 54 65 70 65 65

201420132012

Source: Credit Suisse Commodities Research

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Exhibit 15: Global commodities research – price forecast summary 2015 2,016 2,017 LT

Yr Avg (f) Q1 (f) Q2 (f) Q3 (f) Q4 (f) Yr Avg (f) Q1 (f) Q2 (f) Q3 (f) Q4 (f) Yr Avg (f) Yr Avg (f) Yr Avg (f) Yr Avg (f) (real)

Base MetalsCopper (US$/t) 7,971 7,958 7,200 7,070 7,400 7,407 7,000 6,750 6,500 6,250 6,625 6,750 7,250 7,750 6,600

previous 7,971 7,958 7,200 7,000 6,800 7,240 6,600 6,300 6,100 5,900 6,225 6,750 7,250 7,750 6,600Aluminium (US$/t) 2,030 2,040 1,875 1,825 1,900 1,910 1,800 1,850 1,900 1,900 1,863 2,000 2,100 2,200 2,250

previous 2,030 2,040 1,875 1,800 1,750 1,866 1,800 1,850 1,900 1,900 1,863 2,000 2,100 2,200 2,250Alumina spot (US$/t) 319 340 330 327 317 329 320 320 330 330 325 330 350 380 400

previous 319 340 330 340 340 338 350 350 350 350 350 360 400 400 400Nickel (US$/t) 17,548 17,376 15,250 14,000 13,750 15,094 14,250 14,500 14,500 14,500 14,438 15,000 16,000 18,000 20,000

previous 17,548 17,376 15,250 14,500 14,000 15,282 14,500 15,000 15,500 16,000 15,250 17,000 18,000 20,000 20,000Lead (US$/t) 2,064 2,307 2,050 2,100 2,150 2,152 2,200 2,250 2,300 2,350 2,275 2,400 2,500 2,750 2,000

previous 2,064 2,307 2,050 1,950 1,900 2,052 1,900 1,900 1,900 1,950 1,913 2,200 2,300 2,500 2,000Zinc (US$/t) 1,954 2,054 1,850 1,880 1,950 1,934 1,900 1,950 2,000 2,050 1,975 2,250 2,500 2,650 1,900

previous 1,954 2,054 1,850 1,800 1,750 1,864 1,800 1,800 1,750 1,700 1,763 1,900 2,000 2,200 1,900Tin (US$/t) 21,047 23,230 20,500 21,150 23,500 22,095 21,000 21,500 22,000 22,500 21,750 23,000 25,000 25,000 20,000

previous 21,047 23,230 20,500 19,000 18,500 20,308 19,000 19,000 19,000 20,000 19,250 23,000 25,000 25,000 20,000

Precious MetalsGold (US$/oz) 1,670 1,630 1,410 1,310 1,250 1,400 1,220 1,190 1,150 1,150 1,180 1,200 1,250 1,340 1,300

previous 1,670 1,630 1,410 1,310 1,250 1,400 1,220 1,190 1,150 1,150 1,180 1,200 1,250 1,340 1,300Silver (US$/oz) 31.30 30.10 23.40 22.20 21.20 24.20 21.40 21.60 20.90 21.30 21.30 22.60 23.10 24.40 22.80

previous 31.30 30.10 23.40 22.20 21.20 24.20 21.40 21.60 20.90 21.30 21.30 22.60 23.10 24.40 22.80Palladium (US$/oz) 640 745 730 720 750 740 760 780 780 820 790 850 870 850 850

previous 640 745 730 720 750 740 760 780 780 820 790 850 870 900 850Platinum (US$/oz) 1,560 1,630 1,490 1,500 1,480 1,525 1,550 1,580 1,580 1,630 1,585 1,660 1,750 1,820 1,800

previous 1,560 1,630 1,490 1,500 1,540 1,540 1,550 1,580 1,580 1,630 1,585 1,700 1,770 1,850 1,800Rhodium (US$/oz) 1,320 1,200 1,130 1,150 1,350 1,210 1,600 1,700 1,800 1,900 1,750 2,080 2,300 2,500 2,500

previous 1,320 1,200 1,130 1,150 1,350 1,210 1,600 1,700 1,800 1,900 1,750 2,080 2,300 2,500 2,500

MineralsZircon bulk (US$/t) 2,250 1,230 1,250 1,300 1,350 1,283 1,400 1,600 1,600 1,600 1,550 1,650 1,650 1,625 1,500

previous 2250 1,230 1,250 1,500 1,500 1,370 1,700 1,700 1,700 1,700 1,700 1,650 1,650 1,625 1,500Rutile bulk (US$/t) 2,333 1,350 1,250 1,250 1,250 1,275 1,350 1,450 1,450 1,450 1,425 1,300 1,100 1,075 1,000

previous 2333 1,450 1,450 1,450 1,500 1,463 1,550 1,550 1,350 1,350 1,450 1,175 1,100 1,075 1,000Synthetic Rutile (US$/t) 1,659 1,250 1,200 1,150 1,150 1,188 1,250 1,350 1,300 1,300 1,300 1,200 1,000 975 890

previous 1659 1,300 1,300 1,300 1,350 1,313 1,450 1,450 1,250 1,250 1,350 1,075 1,000 975 890Ilmentite - sulphate 54% (US$/t) 313 255 230 200 200 221 250 250 250 250 250 225 225 225 200

previous 313 285 275 225 250 259 250 250 250 250 250 225 225 225 200Titanium Slag - SA Chlor 86% (US$/t) 1,688 1,050 1,050 1,000 1,000 1,025 1,050 1,150 1,150 1,150 1,125 1,000 850 825 760

previous 1688 1,150 1,150 1,250 1,250 1,200 1,100 1,100 1,100 1,100 1,100 925 850 825 760

201420132012


03 October 2013


Macro Outlook: Recovery Finally at Hand? The slowdown looks to have come to an end at last Those forecasting the global economy have had their forecasting mettle tested over the past couple of years, with activity at a global level consistently coming in weaker than expected by the consensus of economic forecasters.

As an illustration of this phenomenon, after starting above 4.5% in early 2011, the latest IMF forecast for global GDP growth in 2013 has now fallen to around 3.1%.

Exhibit 16: Global growth expectations have continually fallen for 2½ years … Percentage change

2.9%

3.1%

3.3%

3.5%

3.7%

3.9%

4.1%

4.3%

4.5%

4.7%

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul

IMF's 2013 GDP growth forecast

2011 2012 2013Source: Credit Suisse, IMF

One of the techniques of macro forecasters is that updates are mainly motivated by the mark to market of the past quarter (the one for which we have data), which then in turn informs the chosen path back toward what is considered a long-run or trend growth rate.

With quarter-over-quarter saar global growth slowing consistently from nearly 6% saar in early 2010 to around 2.3% in 1Q this year, it is little wonder in our opinion that those calling a bottom were proven wrong.

Thankfully, however, it does appear that 2Q of 2013 was something of a turning point, with global growth picking up noticeably for the first time in several years, suggesting that the downward drift may have finally come to an end.

With growth returning to around normal in the middle of this year (c.3.5% saar) the normal historical relationship suggests that the downward pressure on many commodity prices should begin to abate.

Our economists expect growth to the elusive speed-up should finally come to pass in 2014 (Forecasting the Elusive Speed Up for 2014)

RESEARCH ANALYST





03 October 2013


Exhibit 17: But in 2Q growth finally started to rebound Percentage change

-4%

-2%

0%

2%

4%

6%

8%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Global GDP QoQ SAAR Average Since 1970 = 3.6%


The US post the Fed The US remains the bedrock of the global recovery. However, over recent months higher interest rates and tight fiscal policy have seen the pace of growth moderate a little, forcing the FOMC to delay its much-anticipated tapering of asset purchases.

Housing (the epicenter of the recovery) has slowed as higher interest rates "bite," although as rates have recently dipped on the new dovish Fed, it is likely that this important sector will resume its rebound through year-end.

Exhibit 18: US monetary conditions have tightened, despite the Fed's no taper decision …

Exhibit 19: With housing beginning to show the impact

Percentage change Thousand homes

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

2010 2011 2012 2013

200

400

600

800

1000

1200

1400

2005 2007 2009 2011 2013

New Home Sales (k)


Similarly final domestic demand growth has slowed in recent months.

Business investment appears to have stalled.

Real consumption growth has slowed.

The pace of growth in payroll employment has moderated.

03 October 2013


Exhibit 20: Business investment has stalled Exhibit 21: And consumption is slowing Percentage change Percentage change

-40%

-30%

-20%

-10%

0%

10%

20%

2006 2007 2008 2009 2010 2011 2012 2013

Core Capex Shipments,qoq annualised

-6%

-4%

-2%

0%

2%

4%

6%

2005 2006 2007 2008 2009 2010 2011 2012 2013

US Personal Consumption Expendituresa, annualised trend mom


Thankfully, industrial production looks to be recovering strongly. While weaker domestic demand should put a cap on this rebound (it was notable that the ISM and PMI suggested that the pace of growth has already peaked), the inventory rebound underway should see IP momentum remain solid over the coming month or two before beginning to moderate around the turn of the year.

Exhibit 22: The labor market has also softened Exhibit 23: Thankfully IP is rebounding but, with demand soft, this is likely to prove transitory

Thousand jobs Percentage change (lhs), Index (rhs)

-100

0

100

200

300

400

2010 2011 2012 2013

NFPs 3MMA

QE 3 announced: Sep'12

QE 2 announced: Nov'10

40

45

50

55

60

65

70

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2008 2009 2010 2011 2012 2013

US IP 3MMA Average Markit and ISM new orders (rhs)


China: As good as it gets? Listening for clear signals through the China noise

As our economists and global strategists have shown in recent weeks, interpreting the Chinese data is becoming increasingly difficult.

For a long time part of the challenge with China was the fact that it did not release sequential data for either IP or for GDP.

03 October 2013


When the government began to release data in this form back in February 2011, we felt that it would be a boost to our ability to study the higher frequency movements in the business cycle.

Unfortunately, after over two years of releasing monthly IP data it has become clear that this official series is highly misleading, with the volatility in the monthly print too low to be credible.

As our strategy team showed in Global Strategy: China accelerates, the standard deviation of the monthly release in China is dramatically lower than seen in even the most advanced nations, and far below that suggested by the year-on-year releases.

Exhibit 24: Reported IP exceptionally smooth … Exhibit 25: … in contrast to other major economies Percentage change, mom annualized, 3mma Basis points, 18-month standard deviation of mom IP

-5%

0%

5%

10%

15%

20%

25%

30%

35%

2005 2006 2007 2008 2009 2010 2011 2012 2013

China Industrial Production Pre-2008 Average

0

20

40

60

80

100

120

140

160

180

China US Japan Euro Area

Source: Credit Suisse, China NBS, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

And as illustrated in China: Growth has bottomed, when we back out a monthly growth rate from the year-on-year official releases it gives us a much more volatile series, with the new data lining up well with the HSBC PMI and our strategists' growth measure that takes the first principal component of 13 of the key partial indicators of Chinese growth.

Noticeably both these series line up well with the HSBC-Markit PMI, but not so well with the official PMI.

Exhibit 26: The HSBC PMI appears to provide the best snapshot of the Chinese industrial cycle Percentage change, mom annualized, 3mma (lhs); 3m/3m PCA Z-Scores

40

45

50

55

60

65

-5%

0%

5%

10%

15%

20%

25%

30%

2005 2006 2007 2008 2009 2010 2011 2012 2013

CS China IP Indicator Markit PMI NO (rhs)

Source: Credit Suisse, China NBS, the BLOOMBERG PROFESSIONAL™ service

https://plus.credit-suisse.com/u/aU1HZS

https://plus.credit-suisse.com/r/aljOfF

03 October 2013


So how are things tracking?

As seen in Exhibit 26 the recovery in Chinese IP looks to have continued in September, although the HSBC PMI is beginning to show signs of reaching a near-term peak.

This is a positive, but we note that the components of the PMI continue to suggest that much of the recovery has once again been driven by domestic stimulus, which we believe will prove relatively short lived now that growth has stabilized.

China's export performance also appears to have stabilized; however, we do not expect a large uptick in coming months. Indeed, partly because a large part of the current growth in the US is housing (which is not import intensive) it is noticeable that imports to the North Atlantic remain very weak.

Exhibit 27: Exports have recovered after the post-HK distortion crack down

Exhibit 28: While also benefitting modestly from an improving external environment

Real natural log, monthly, sa USD billions, monthly, sa

3.0

3.2

3.4

3.6

3.8

4.0

4.2

4.4

4.6

4.8

5.0

2002 2004 2006 2008 2010 2012

CAGR: 18%CAGR: 8%

CAGR: 38%

HK export distortion

5

10

15

20

25

30

35

2005 2006 2007 2008 2009 2010 2011 2012 2013

Exports to US Exports to EU Exports to JPN

Source: Credit Suisse, China Customs Source: Credit Suisse, China Customs

Exhibit 29: North Atlantic imports remain very weak Percentage change

-2%

-1%

0%

1%

2%

3%

4%

08 09 10 11 12 13

EA27 non-oil imports,trend monthly change

US non-oil imports,trend monthly change

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

03 October 2013


But won't policy continue to support? Events of the past couple of months have shown that the Chinese authorities retain the capacity to quickly boost growth. From here on, however, we do not expect a further stimulus.

As shown in Exhibit 30, the authorities remain highly focused on the labor market (a proxy for the much discussed "social stability," with their tolerance for weaker growth coming to an end in June as the labor market softened noticeably.

In GDP terms this looks to correlate with around 7%.

With growth now back between 7% and 8% and the labor market recovering, we feel that the authorities will once again begin to focus on structural issues and that they will be very reluctant to boost growth further.

Note that despite all of the talk, to date, there has been very little "rebalancing," with the latest stimulus once again boosting housing and investment.

Exhibit 30: China's leadership still mainly cares about the labor market – the dip in June-July was beyond its near-term tolerance Index, Employment component of HSBC-Markit PMI

4647484950515253545556

2005 2006 2007 2008 2009 2010 2011 2012 2013

July 2013


Europe on the mend but 3Q data could disappoint Perhaps the largest positive to emerge over the past couple of months has been in Europe, where the long recession appears to have finally ended. Most importantly, after contracting substantially over recent years, final domestic demand in Europe has finally stabilized, suggesting that the drag from Europe on the rest of the world may now be fading.

While the outlook for Europe is slowly improving, we caution that recently the surveys have diverged substantially from the hard economic data, suggesting some caution in extrapolating the 2Q recovery into 3Q – IP is currently falling heavily.

03 October 2013


Exhibit 31: European IP Is currently falling Exhibit 32: Demand has finally stabilized Index (lhs), percentage change (rhs) Index

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

30

35

40

45

50

55

60

65

70

05 06 07 08 09 10 11 12 13

Eurozone IP mom (rhs)Eurozone Manufacturing PMI NOIP mom 3mma, annualised (rhs)

94

95

96

97

98

99

100

101

102

103

104

2008 2009 2010 2011 2012 2013

Euro area

US

Japan


Modest global recovery underway but EM is yet to bounce decisively Notwithstanding the recent divergence between the surveys and the hard data, it does appear that global IP growth is rebounding as we enter 4Q, which should support industrial commodity prices. That said, to date, the rebound is very much centered on the developed world with the all-important EM countries continuing to lag (see Editor's Summary).

Exhibit 33: Global IP is recovering Exhibit 34: But with EM lagging the DM rebound Monthly. percentage change, 3MMA (lhs); index (rhs) Index

40

45

50

55

60

65

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Global IP MoM 3MMA

Global PMI New Orders (rhs)

40

45

50

55

60

65

2005 2006 2007 2008 2009 2010 2011 2012 2013

DM PMI NO EM PMI NO


It is also notable that the most recent PMIs suggest that global IP growth may be in the process of peaking as we enter 4Q.

03 October 2013


Petroleum: Balanced fundamentals and shifting tail-risks We still think the characterization of “manageable uncertainty” best describes the current and near-term state of oil markets. Oil supply and demand seem relatively well balanced, but there was far more tension this summer than most had anticipated. Nearly all of that pressure emanated from the supply side, which is also where we believe most near-term risks reside. That said, in our view, most s/d balance swings should remain manageable.

From a forecasting perspective all this means that we are keeping our forecast for global oil benchmark Brent futures within the range that it has traveled in for the last two or so years – i.e., between $100 and $120 dollars per barrel.

Our full year 2014 forecast for Brent is unchanged at $110/b. We see a marginal increase in prices, compared to our 2013 forecast, which would make it the fourth year in a row with prices averaging less than +/- 2% from $110/b. Our view remains more bullish than consensus, we maintain that prices will turn in 2015 and, thus, have left our FY2015 target of $100/b in place. That being said, we do see more upside risk building around that 2015 target.

Within this price range we have really only tinkered with our quarter average price forecasts and tweaked our view of the WTI – Brent spread.

Marking to market, the third quarter, Brent spot futures averaged $108.29, or 3% above our forecast. Similarly WTI averaged $106.0, 8% higher than expected.

Shifting around quarter averages for 2014: We put the year’s low watermark (of $105/b Brent) in the first quarter, and the seasonal high ($115/b), in 3Q 2014.

Lastly, we halved the projected discount of WTI to Brent from -$8/b to -$4/b through the first half of 2014, after which that spread should widen to approximately -$8/b, reflecting growing surpluses in the US Gulf Coast refining centers, and the cost of transport to other coastal markets.

Overview: A near-term soft-patch leads to familiar terrain Another quarter (and year) of historically high oil prices, set against the fundamental disruption of many MENA societies, including Syria and Libya, has underscored that the shale revolution playing out in the US has had an only limited impact on global oil markets, thus far; this is in sharp contrast to the enormous changes that this supply revolution is driving in natural gas as well as in other sectors in the US and elsewhere, (see The Shale Revolution II).

RESEARCH ANALYSTS

Commodities Research Jan Stuart


Johannes Van Der Tuin [email protected]

+1 212 325 4556

Supply Model Contributors

Equity Research

Edward Westlake [email protected]

+1 212 325 6751

David Hewitt [email protected]

+65 6212 3064

Exhibit 35: Credit Suisse oil price view (Brent)

Actual, forecast, futures and "consensus"

PeriodActuals &

CS ForecastPrevious

Fcst FuturesBBG

Consensus*

FY11 (a) 109.97$ 1Q12 (a) 118.28$ 2Q12 (a) 108.99$ 3Q12 (a) 109.42$ 4Q12 (a) 110.11$

FY12 (a) 111.70$ 1Q13 (a) 112.57$ 2Q13 (a) 103.35$ 3Q13 (a) 108.29$ 105.00$

4Q13 105.00$ 110.00$ 106.63$ 106.47$

FY13E 107.30$ 107.73$ 107.71$ 107.67$ 1Q14 105.00$ 115.00$ 104.42$ 106.47$ 2Q14 110.00$ 110.00$ 102.78$ 104.43$ 3Q14 115.00$ 110.00$ 101.31$ 105.90$ 4Q14 110.00$ 105.00$ 100.00$ 105.73$

FY14E 110.00$ 110.00$ 102.13$ 105.64$ 1Q15 105.00$ 105.00$ 98.73$ 2Q15 100.00$ 100.00$ 97.40$ 3Q15 100.00$ 100.00$ 96.26$ 4Q15 95.00$ 95.00$ 95.22$

FY15E 100.00$ 100.00$ 96.90$ 106.51$ FY16E 95.00$ 95.00$ 93.26$ 103.30$ FY17E 95.00$ 95.00$ 90.98$ 96.73$

Long-Term 90.00$ 90.00$

Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service

The commodity price

forecasts mentioned in this section have been provided

by the Commodities Research analysts above.

https://plus.credit-suisse.com/r/dPG87i





03 October 2013


To be sure, in our view the very near-term global oil supply and demand balance looks decidedly looser this winter than it has recently (Exhibit 41). But when looking at 2014 as a whole, we once again find ourselves in a familiar position, relative to the consensus, represented by the International Energy Agency (IEA), which sees at once more demand growth and less supply growth than we do.

In our view, the call on Opec and inventories should not shrink materially, if at all, next year (Exhibits 36 and 37).

Exhibit 36: Fundamental demand shifts in 2014, the CS view versus “consensus”

Exhibit 37: Once again we see no large changes in the "Call on Opec," while most expect a deep cut

Yoy, Mb/d Yoy, Mb/d

(0.5)

0.0

0.5

1.0

1.5

2.0

2014 Global OECD Non-OECD

Credit Suisse Consensus (IEA)

(1.0)

(0.5)

0.0

0.5

1.0

1.5

2.0

Non-Opec Call on Opec crude + inventory

Credit Suisse Consensus (IEA)

Source: Credit Suisse, IEA Source: Credit Suisse, IEA

Below we will highlight the latest data and the degree to which it mostly confirms our 2013 forecast for modestly growing oil demand (~1.3-1.5%, yoy) and US centric below consensus non-Opec supply growth (less than 1 million barrels per day, Mb/d). Additionally, we outline supply risks in MENA, all within the context of what we expect to change (or not) in 2014 and touch upon some of the work we are doing on longer-term demand trends in emerging markets. Lastly we outline the state of inventories, positioning of speculators and other risks to our outlook.

In the shorter term – relaxing some tensions on the supply-chain

As we have discussed repeatedly, much of the outperformance of oil prices in 3Q had a lot to do with a host of planned and unplanned supply outages (e.g., Libya, Nigeria, extended field maintenance in the North Sea, etc.), which coincided with seasonal peaks for both refiner demand for crude oil as well as end-user demand for gasoline (in the US) and middle distillates (Mideast, Latam) (see Oil Sense: Back to School).

In our view, it is commercial actors’ ongoing positioning around real, near-term shifting supply/demand risks that has driven recent market shifts, as opposed to just Syrian headline risks driving paper "speculators" to buy insurance.

Within this context, our monthly global supply and demand model indicated that the call on Saudi crude oil and global inventories rose to a new five-year high last quarter (Exhibit 41) and that this peak coincided with a rally in Brent oil prices and a fierce steepening of its futures curve (Exhibits 38 and 39).

https://plus.credit-suisse.com/r/fIFD6g

03 October 2013


Exhibit 38: Recent Brent price rally in context Exhibit 39: Brent time-spread backwardation spiked$/b CO1 – CO6 ($/b)

$80

$90

$100

$110

$120

$130

$140

J-12 M-12 S-12 J-13 M-13 S-13

Breaking through the ~$105/b then ,

temporarily, the ~110/b ceiling on lost Libyan

barrels

$(4)

$(2)

$-

$2

$4

$6

$8

Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13

Backwardation = spot shortage = bullish

Contango = spot surplus = bearish


It’s also interesting to us that early/preliminary data show that Saudi production rose to new highs not seen since the late-1970s/early-1980s, while crude oil inventories in China, Europe, Japan and the US trended lower.

Exhibit 40: Saudi Arabia continues to play the role of swing producer

Exhibit 41: “Call on Saudi + inventories,” our near-term base case and two plausible scenarios

$/b (lhs); kb/d (rhs) Kb/d, Call on Saudi + inventories = Global Demand – Non-Opec Supply – Processing Gains – Opec ex-Saudi Arabia – Saudi Arabian non-crude production

7,000

7,500

8,000

8,500

9,000

9,500

10,000

10,500

$60

$70

$80

$90

$100

$110

$120

$130

$140

$150

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13

Saudi Production (kb/d, right axis) Brent front month ($/b)

Increased output to compensate for disruptions

from first Libya and then Iran ... and when Brent price

Lower production in the wake of the GFC

Lots of room to cut back from this winter

8,000

8,500

9,000

9,500

10,000

10,500

11,000

11,500

12,000

J-13 M-13 M-13 J-13 S-13 N-13 J-14 M-14

Base Case

Lower Demand

Extended SupplyDisruptions

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse Commodities Research

Why a softer balance this winter

Normal seasonal demand patterns, set against leading indicators, supply-side maintenance data, new field start-ups and assumptions about events in MENA, drive our projections. In our base case, the call on Saudi oil plus inventories should decline by some 2.5 Mb/d and reach a trough low early next year.

While this decline is fairly large and somewhat steep, it is also eminently manageable for Saudi Arabia – which last winter cut production and prevented global inventories from ballooning, driven by a very similar dynamic in underlying fundamentals.

This year’s “required” Saudi production cut is bigger, but comes from a higher base.;

03 October 2013


We therefore expect only a modest retracing of benchmark Brent prices, quarter over quarter of ~5%, to a ~ $105/b winter average.

At the same time we expect Brent and WTI futures curves to remain backwardated.

As for price direction on WTI; we expect that the longer-dated part (six-months plus) of its futures curve to remain neatly aligned with Brent (see Oil Sense: Where has all the WTI gone?).

Prompt WTI prices, however, should prove quite volatile and occasionally at odds with Brent, as more infrastructure segments connecting the inland delivery hub to Gulf Coast import markets are completed in the next several months – and as important shifts in demand in the US mid-continent materialize, perhaps as early as December.

In general, we expect risks around the near-term part of our forecast to be roughly in balance: on the supply side significant disruptions (e.g., Libya, Iraq) could persist; conversely, non-Opec growth may accelerate faster than we assume. Furthermore, there is obviously risk to either side of the macro-view driving our demand outlook, but more on those risks later.

Supply – the bigger and less predictable deltas If nothing else events in 2013 underscore that production growth outside of the United States still matters. As we keep emphasizing, the North American shale-oil revolution alone cannot change the global oil balance as quickly as many want to believe. Outside of the US key supply-side themes remain the pace and success of investments as well as instability across MENA.

Failure to grow: Time and again we project that non-Opec oil production (outside the US) should grow, and equally often since 2011 those projections have proven too optimistic. At its root, the cause is simply an underappreciation of what we loosely call “decline rates on aging fields.” In addition, we tend to take company development plans at close to face value, not factoring in the cost and time overruns that typically accompany such large capital investments.

Exhibit 42: Outside the US, which grows very fast indeed, non-Opec growth lags expectations

Exhibit 43: Non-Opec oil production (ex-US and ex MENA) trends sideways at best

Non-Opec, ex-US, oil production deltas, by quarter yoy, in kb/d All liquids, outside Opec, US, Syria, Yemen, Sudan and Egypt. Monthly in Kb/d, single month sa + t-13 Henderson trended and its forecast.

-1200

-800

-400

0

400

800

1200

1600

(1200)

(800)

(400)

0

400

800

1200

1600

Q1-'12 Q2-'12 Q3-'12 Q4-'12 Q1-'13 Q2-'13E Q3-'13E Q4-'13E

Non-Opec ex. USA expectations Non-Opec ex. USA Non-Opec

kb/d kb/d

Non‐Opec (ex‐US) production disappoints, yet again.

38000

39000

40000

41000

42000

J‐08 J‐09 J‐10 J‐11 J‐12 J‐13 J‐14

Source: Credit Suisse, IEA, EIA, JODI Source: Credit Suisse, IEA, EIA, JODI

This year’s story illustrates that once again the bump in other non-Opec growth has been pushed into the future (Exhibit 42).

https://plus.credit-suisse.com/r/KlTi2I

https://plus.credit-suisse.com/r/KlTi2I

03 October 2013


In fact, strip out the US as well as MENA instability, related non-Opec supply disruptions and growth have been flat for approximately three years running (Exhibit 43).

Of course the old advice of “follow the money” helps explain some of the problem. In big broad figures, every year more than $750 billion of capex is invested on oil and gas related industry. Of that global capex, ~$200 billion is currently spent in the US, with another ~$250 billion on LNG. That leaves a mere ~$300 billion of capex to be spread across the rest of the world, including the mid- and down-stream. Thus, it shouldn’t be a mystery as to why the US, and secondarily Canada, are outperforming the rest of non-Opec.

Exhibit 44: Yoy supply growth by key producing regions and countries Kb/d

Base

2012 1Q13 2Q13E 3Q13E 4Q13E 1Q14 2Q14E 3Q14E 4Q14E 2010 2011 2012 2013E 2014EGlobal Oil 91,130 -250 190 820 810 1,380 1,430 2,400 1,870 2,555 990 2,100 390 1,775Opec all oil 37,690 -860 -1,050 -570 -140 -120 -50 880 870 1,230 695 1,490 -655 400Non Opec 50,970 560 1,190 1,340 900 1,420 1,430 1,470 950 1,230 200 560 995 1,320

North America 17,380 1,140 1,170 1,370 1,040 1,090 1,170 1,210 1,010 640 605 1,275 1,175 1,125US 10,090 860 1,120 1,160 900 1,100 1,020 1,060 850 505 405 1,050 1,010 1,010Canada 3,760 280 100 250 200 20 220 230 240 130 195 235 205 175

Mexico 2,910 -10 -70 -60 -70 -50 -80 -90 -90 -20 -20 -20 -50 -80

South America 8,090 -260 50 160 140 340 270 140 60 115 55 -40 25 200Venezuela 2,750 -100 10 -30 40 90 70 70 60 -130 -25 -5 -20 70Brazil 2,530 -210 -10 90 30 180 160 50 -40 120 -20 -40 -25 85Argentina 680 -30 -10 0 0 -10 -10 -20 -20 -10 -40 -15 -15 -15

Europe 4,440 -370 -290 -110 -280 -190 -200 -170 -170 -310 -330 -245 -260 -185Norw ay 1,920 -250 -160 -10 -160 -90 -110 -110 -100 -220 -105 -100 -145 -105United Kingdom 920 -140 -130 -100 -100 -110 -100 -80 -90 -105 -240 -170 -115 -95

FSU 13,820 180 320 110 200 200 190 240 170 335 195 85 200 200Russia 10,640 140 210 80 90 160 40 40 40 315 270 110 130 75Kazakhstan 1,630 60 90 80 30 60 170 190 150 60 10 -20 65 140Azerbaijan 880 -40 0 -60 70 -30 -20 10 -10 -20 -100 -45 -5 -15

Middle East 28,440 -700 -940 500 510 350 210 0 130 1,170 2,070 155 -160 175Saudi Arabia 11,570 -490 -720 440 -140 -720 -710 -870 -350 725 860 280 -225 -660Iran 3,540 -640 -230 40 100 280 390 610 490 15 35 -735 -180 445UAE 3,390 340 170 190 240 140 80 -40 -110 65 405 120 235 15Kuw ait 3,210 -170 -30 60 240 260 70 20 -40 75 365 300 25 75Iraq 3,120 300 40 -150 60 270 210 230 150 30 350 280 60 215

Africa 9,980 -290 -260 -1,120 -680 -400 -140 930 700 235 -1,475 760 -585 275Nigeria 2,670 -30 -180 -360 -160 -130 -80 50 10 340 -80 20 -185 -35Algeria 1,760 -240 -90 60 90 170 0 -50 -60 -145 65 20 -45 15Libya 1,510 220 -50 -870 -740 -690 -230 770 620 60 -1,285 1,030 -360 120Angola 1,770 0 50 10 40 60 50 70 60 -35 -125 80 25 60

Asia 8,990 40 140 -100 -120 -10 -80 50 -30 370 -130 110 -10 -15Indonesia 890 -40 -30 -30 0 0 -10 0 -10 -5 -40 -45 -30 -5China 4,150 110 160 -40 -80 -20 -60 50 0 285 -5 45 40 -10India 890 -10 -20 0 10 30 30 10 20 80 20 0 -5 20

Y-o-Y Grow thY-o-Y Grow th by quarter ('000 b/d)

Source: Credit Suisse, EIA, IEA, Jodi, Petrologistics

Not much is changing in broad investment terms:

The US still has very good rocks (geology) and its investment climate is the friendliest, and among the most stable in the world.

We also do not think that oil prices will rally suddenly to produce a significantly larger pool of investments.

While there is a large slug of projects, delayed and others, in the pipeline we don’t expect that operations will suddenly become easier and/or less prone to "unplanned" events.

In our base case we expect non-Opec oil production to grow by 1.3 Mb/d, roughly 30% more than last year. IEA and other balances, however, project growth of 1.6 Mb/d, which we think is an un-realistic 60% acceleration. Despite the fact that our base-case non-Opec forecast may appear a little too pessimistic, recent history (three years and counting) suggests that we have tended to be too optimistic.

The largest differences between our base-case and other forecasts involve Canada, Norway and the UK; for all production deltas in the section below please see Exhibit 44.

03 October 2013


Canada’s production, other forecasts say, "should" grow by as much as 450 kb/d, on the assumption that in 2014, surely, operators manage to run to capacity and install new kit on time. We observe, however, that this projected average annual increment is fully two times as large as the largest annual increment in any of the past nine years.

In our base case, we allow for some improvement, including a large 10% qoq surge in the fourth quarter of this year. Our projected growth for 2014 is roughly 2x the nine-year average and very close to the average per annum (pa) pace achieved since 2010. But we stick to our view that downtime this year was not exceptional in the context of the industry’s performance over the last three to five years. In addition, we see still more downside risk if pipeline capacity constraints hinder activity.

The biggest single delta is Norway – consensus projects actual growth, after 12 years of consecutive declines averaging 6% pa. We’ve seen projections of as much as 12% growth in Norway’s oil production next year. New fields, and, we assume, the absence of “exceptional, extended and unplanned” outages, help underpin this hoped for U-turn.

In our base case, however, we assume that like super-tankers, an oil province with some 60+ mature fields and only a smattering of significant developments due on line in 2014 cannot turn around that quickly. In our base case we project a -6.0% decline in 2014 – after a fall of -7.5% in 2013.

UK offshore – confronts a situation similar to Norway. There are ~120 mature offshore UK fields, which in aggregate have not grown since 1999. Our current forecast is for an -11.9% yoy production decline in 2014, roughly in line with the five- year average of approximately -11.7%.

Exhibit 45: Our base-case reflects low expectations for yoy supply growth from non-Opec

Exhibit 46: MENA oil supply disruptions spiked in 3Q, but will likely roll going forward

Yoy, Mb/d Production losses relative to pre-crisis base-lines, kb/d

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14

CS Base Case Consensus (IEA)

0

500

1000

1500

2000

2500

3000

3500

Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sept-13E Jan-14E May-14E

Libya Iran Sudan Egypt Syria Yemen

Forecast through 2Q14

Too optimistic?

Source: Credit Suisse, IEA Source: Credit Suisse, IEA, Petrologistics

Dealing with MENA instability

Ongoing political instability and sanctions across MENA have led to numerous supply outages, most recently peaking at a ~3.2 Mb/d average production loss for the month of August. Going forward, we again risk being too optimistic. Since we cannot get around applying some version of a “rational actor” model to the many issues at play in the region, in our base case we assume some return of volumes to markets in the short and long term, including next year (Exhibit 46). The assumptions and observed trends in four of the more critical countries are as follows:

03 October 2013


Iran – Biting sanctions have lowered Iranian exports by over 1 Mb/d. Going into 1H 2014 our base case is for a certain amount of slippage in the sanctions regime, leading to a ~300 kb/d increase in Iranian crude exports. Though generally, we are skeptical that negotiations will lead to an unwinding of those parts of sanctions that matter for oil flows, in the foreseeable future. In fact, there is a strong possibility that we are still too optimistic.

Oil markets could sell off in a limited way on any sign of rapprochement between the US and Iran, but such a market move would likely be moderate, as it would only stem from speculative flows.

Iraq – This is mostly a story of unfulfilled promise. Production was down sharply in September, by ~400 kb/d, due to significant maintenance in southern Iraq. However, the real problem has been a flat lining of overall supply growth. As of now, production peaked at ~3.37 Mb/d in September 2012 and has been moving sideways ever since. To date, the only real progress has been in northern Iraq, where tangible headway is being made toward developing and exporting volumes from territory administered by the Kurdish Regional Government (KRG).

As the political and security situation remains uncertain, at best, we worry that even our below-consensus forecast for 200kb/d of growth in 2014 may prove too bullish.

Libya – Mounting "labor actions" and civil unrest have held the country’s oil infrastructure hostage since mid-summer, causing supply to plunge by ~1.12 Mb/d. As we’ve written previously, the government’s inability to consolidate power, particularly in the east of the country, and to ensure order has become manifest.

Consequently, while exports have resumed around Zawiya, close to Tripoli, we have little confidence that resolving disputes in western Libya in a sustainable manner will be as easy.

Syria – While it is not a major oil exporter, and the majority of what little production it did have has been offline for quite some time, there does continue to be a degree of headline risk associated with the Syrian conflict.

While US strikes no longer appear likely, the danger remains that the conflict might escalate or spread in such a way as to destabilize production in the greater region.

03 October 2013


Demand: Global growth stays close to trend in 2013

Exhibit 47: Global oil demand, SA Exhibit 48: Global oil demand, SA, momentum Ln scale Mom and yoy 3 mma % change

11.25

11.30

11.35

11.40

11.45

J-08 J-09 J-10 J-11 J-12 J-13 J-14

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

-1%

0%

1%

2%

3%

4%

5%

J-11 M-11 S-11 J-12 M-12 S-12 J-13 M-13

3 mma mom % change 3 mma yoy % change

Source: Credit Suisse, IEA, EIA, Jodi Source: Credit Suisse, IEA, EIA, Jodi

Data confirm oil demand growth well north of consensus … again

Global oil demand is on trend for ~1.4% yoy growth in 2013, materially higher than consensus expectations and in line with our end 2012 forecast (Exhibit 47).

That said, there was a marked 2Q slowdown in EM, which judging from the July data is slow to recover – though the same data also suggest that decline rates have bottomed.

In the OECD, it was tempting to put too much significance into the 2Q “improvement.” But we are glad that we did not, as July data indicate much of the European 2Q upswing was weather driven, not a structural or cyclical improvement (Exhibit 49).

Demand momentum, rolled in July, after turning up in April/June (Exhibit 50). As of now, we expect that 3Q oil demand growth will remain flattish, at around 0.2% yoy.

Exhibit 49: OECD oil demand, SA Exhibit 50: OECD oil demand, SA, momentum Ln scale Mom and yoy 3 mma % change

10.65

10.70

10.75

10.80

10.85

10.90

J‐08 J‐09 J‐10 J‐11 J‐12 J‐13 J‐14

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

-3%

-2%

-1%

0%

1%

2%

3%

J-11 M-11 S-11 J-12 M-12 S-12 J-13 M-13



03 October 2013


Weaker growth across EM, particularly in key oil-consuming economies, pulled down non-OECD oil demand momentum in 2Q (Exhibit 52). Thus far, while some EM economies appear to be bottoming out, notably China, at only 2.1% yoy in July, demand growth remains somewhat tepid.

Exhibit 51: Non-OECD oil demand, SA Exhibit 52: Non-OECD oil demand, SA, momentum Ln scale Mom vs. yoy 3 mma % change

10.40

10.45

10.50

10.55

10.60

10.65

10.70

10.75

10.80

J‐08 J‐09 J‐10 J‐11 J‐12 J‐13 J‐14

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

0%

1%

2%

3%

4%

5%

6%

7%

J-11 M-11 S-11 J-12 M-12 S-12 J-13 M-13


Source: Credit Suisse, JODI, NBS, ANP Source: Credit Suisse, JODI, NBS, ANP

If we eliminate China from the EM Asia picture, the continent’s oil demand growth momentum profile still appears to be flagging, year-over-year demand is growing, but at an incrementally slower rate (Exhibits 53 and 54).

Exhibit 53: Non-OECD Asia ex-China oil demand, SA Exhibit 54:EM Asia ex-China demand SA momentumLn scale Mom and yoy 3 mma % change

9.1

9.2

9.3

9.4

9.5

J‐08 J‐09 J‐10 J‐11 J‐12 J‐13 J‐14

-1.5%

-0.5%

0.5%

1.5%

2.5%

3.5%

-3%

-1%

1%

3%

5%

7%

J-11 M-11 S-11 J-12 M-12 S-12 J-13 M-13


Source: Credit Suisse, JODI Source: Credit Suisse, JODI

Looking out into 2014

We are not making grand assumptions in our forecast. In our base case, oil demand continues to grow by ~1.3 Mb/d yoy, in line with 2013 (Exhibit 47).

Drilling down, our current expectation is for a continued, slight, trend decline of OECD oil demand on the order of ~0.3 Mb/d; a hair more than in 2013, but slightly less than 2011-2012.

At the same time non-OECD oil demand, the engine of global growth, should increase by ~1.6 Mb/d, within recent trends.

03 October 2013


Exhibit 55: Global oil demand – 2012 base and yoy change by key economy kb/d and yoy % change

1,000 b/ d Base by year (2010-14)2012 1Q13 2Q13E 3Q13E 4Q13E 1Q14E 2Q14E 3Q14E 4Q14E 2010 2011 2012 2013E 2014E 2008-12

Glo bal 90 ,550 1.8% 1.4% 1.9% 1.2% 1.4% 1.1% 1.6% 1.9% 4.1% 1.1% 1.1% 1.6% 1.5% 0.9%

OECD 46,190 -0.9% 0.0% 0.4% -0.2% 0.0% -1.1% -0.5% 0.0% 1.4% -0.9% -0.8% -0.2% -0.4% -1.6%

Emerging M arkets 44,350 4.7% 2.8% 3.4% 2.6% 2.8% 3.4% 3.8% 3.7% 7.3% 3.5% 3.2% 3.4% 3.4% 4.0%

OEC D A mericas 23,650 1.4% 0.6% 1.5% 0.9% 0.7% -0.6% -0.5% 0.3% 2.0% -0.8% -1.3% 1.1% 0.0% -1.7%

Canada 2,290 4.1% 1.2% 0.3% -1.9% -0.7% -1.5% -1.0% -0.8% 4.7% 0.1% 0.9% 0.9% -1.0% 0.1%

M exico 2,140 0.8% 0.5% -1.1% -3.2% -0.7% -2.2% -0.4% 0.4% 0.5% 1.6% 1.5% -0.8% -0.7% -0.2%

USA 18,560 1.3% 0.3% 1.8% 1.9% 1.0% -0.3% -0.4% 0.4% 2.2% -1.2% -2.1% 1.3% 0.1% -2.1%

So uth A merica 6,610 3.5% 3.3% 3.1% 2.7% 2.1% 2.2% 2.9% 2.5% 7.3% 3.7% 3.0% 3.1% 2.4% 4.0%

Brazil 3,160 4.1% 3.3% 4.4% 3.5% 2.3% 2.6% 3.8% 3.0% 9.7% 3.8% 4.4% 3.8% 2.9% 5.3%

Venezuela 820 2.0% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 9.9% 2.6% 3.4% 2.1% 2.1% 6.2%

Argentina 740 8.3% 7.0% 4.0% 3.8% 3.6% 3.8% 4.2% 4.0% 7.5% 2.4% 3.3% 5.7% 3.9% 3.7%

Euro pe 14,680 -4.0% -0.4% -0.5% -0.9% 0.2% -2.0% -0.3% 0.0% -0.3% -2.6% -3.3% -1.4% -0.5% -2.3%

France 1,740 -3.3% 2.3% -0.3% -0.9% 1.1% -3.1% -1.6% -0.8% -1.9% -2.2% -2.9% -0.6% -1.1% -2.5%

Germany 2,390 -0.8% 5.3% 3.3% -1.3% 1.7% -6.5% 0.1% 2.0% 0.7% -3.0% -0.3% 1.6% -0.7% -0.2%

Italy 1,350 -4.6% -6.1% -1.4% -0.1% 0.2% -0.1% -0.1% 0.0% 0.0% -3.3% -9.4% -3.0% 0.0% -4.7%

UK 1,500 -3.0% 2.1% -1.4% -0.9% -0.9% -1.2% -0.8% -0.8% -0.9% -2.3% -5.1% -0.8% -0.9% -3.0%

Oth Europe 7,700 -5.3% -2.2% -1.4% -0.9% -0.3% -0.8% -0.1% -0.3% -0.1% -2.6% -2.8% -2.4% -0.4% -2.3%

F SU 4,300 2.6% -2.7% 3.1% 3.1% 3.1% 3.1% 3.1% 3.1% 2.5% 3.6% 0.4% 1.5% 3.1% 0.9%

M ideast 7,380 4.5% 1.6% 4.5% 4.1% 4.7% 4.8% 5.0% 4.9% 5.2% 2.5% 3.0% 3.7% 4.9% 4.0%

Saudi Arabia 2,980 7.1% 0.8% 5.7% 6.1% 6.2% 6.1% 5.9% 6.1% 7.8% 5.0% 4.9% 4.9% 6.1% 7.1%

Iran 1,750 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% -1.4% -2.4% -0.1% 0.0% 0.0% -1.7%

Iraq 619 4.5% 7.1% 8.4% 5.0% 5.0% 5.0% 5.0% 5.0% 11.3% 9.2% 9.6% 6.3% 5.0% 13.2%

A frica 3,600 6.5% 4.2% 0.1% 1.0% 1.1% 1.2% 0.9% 1.1% 4.4% -1.6% 2.8% 2.9% 1.1% 3.6%

A sia-P ac 30,330 3.2% 2.7% 2.4% 1.1% 1.4% 2.6% 2.8% 2.9% 7.8% 4.0% 4.5% 2.3% 2.4% 3.5%

China 10,120 5.6% 4.2% 4.7% 1.7% 2.2% 4.5% 4.8% 4.8% 14.0% 4.9% 3.9% 4.0% 4.1% 6.4%

India 3,530 4.4% 0.9% 0.5% 0.5% 0.6% 1.5% 3.0% 3.1% 5.7% 4.7% 4.8% 1.6% 2.0% 4.3%

Indonesia 1,660 2.6% 1.9% 1.3% 2.4% 2.5% 2.5% 2.0% 2.3% 4.7% 9.4% 2.3% 2.0% 2.3% 4.7%

Japan 4,930 -3.2% -3.4% -2.1% -3.7% -3.6% -1.4% -2.4% -2.0% 1.5% 2.6% 8.0% -3.1% -2.4% -0.3%

South Korea 2,300 -1.1% 2.1% 0.3% 0.3% 0.3% -1.1% 0.2% 0.2% 3.7% -0.5% 1.9% 0.4% -0.1% 0.6%

Australia 1,130 1.5% 1.1% -2.0% -3.0% 0.5% 0.5% 0.5% 0.5% 1.7% 4.2% 1.9% -0.6% 0.5% 1.4%

Thailand 1,230 8.8% 3.5% 1.2% 1.2% 1.2% 3.3% 4.6% 4.6% 6.4% 4.8% 7.0% 3.6% 3.4% 3.7%

by quarter (2013 - 2014)

Source: Credit Suisse, IEA, EIA, Jodi, NBP, ANP

Longer-term trends in emerging markets

The effect of non-OECD demand has become increasingly dominant within oil markets. As such, we begin looking at the many drivers of EM oil demand.

Here are just a couple of intriguing observations that have begun to raise our confidence in the notion that existing growth trends may indeed prove much more resilient than what is commonly assumed.

Exhibit 56: EM oil demand has drawn level with that of the OECD, but on a per capita basis there is a lot of room to grow

Exhibit 57: As non – OECD nations become wealthier, the growth in vehicle ownership will be one factor driving increased oil demand

Level oil demand in kb/d (lhs); per capita oil demand in gallons/year (rhs) Vehicles per 1000 people (x-axis) vs. per capita GDP (y-axis) by country

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

1995 2013E

Non OECD OECD

‐

100

200

300

400

500

600

kb/d gal/yr

Maximum per capita consumption growth potential ?

2013E

Algeria

Australia

Chile

China

Czech

Estonia

Germany

Greece

Hungary

Israel

Italy

Japan

Kenya

Korea

Kuwait

MalaysiaMex.

Netherlands

New Zealand

Pakistan

Poland

S. Africa

Spain

Thailand

Turkey

Ukraine

US

0

10

20

30

40

50

60

0 100 200 300 400 500 600 700 800

GD

P p

er c

apita

(20

10 c

urre

nt '0

00s

$)

Vehicles per 1000 people (2010)

?

?

Source: Credit Suisse, IEA, World Bank Group, EIA, Jodi Source: Credit Suisse, World Bank Group

03 October 2013


DM and EM oil demand are now roughly equal, but not on a per-capita basis. While this is an obvious statement it is not often understood how much room demand in emerging market countries has to grow (Exhibit 56).

As oil has become primarily a transportation fuel, the link between per capita vehicle ownership and fuel demand is clear. By this measure, the non-OECD market for fuel demand still lags the OECD, but the likely growth trends are clear, Exhibit 57.

Granted, much of the expected non-OECD demand increase depends on the wealth-effect and as such requires ongoing global economic growth (north of ~3% pa).

Inventories and positioning Back to more near-term concerns, a few brief comments about inventories and futures market positioning.

Inventory levels and recent trends are supportive of our above-consensus oil price views.

On-land OECD crude oil inventories fell significantly since May, and shifted to the lower end of the five-year range. At end August, the ~950 million barrels (Mbs) in commercial storage was still modestly short of the five-year average (Exhibit 58).

It is interesting to us that reported crude oil inventory actually fell during the last few months, even as Saudi produced at 30-year record highs, as that supports our observation that tight markets more so than headlines about Syria, drove late-summer price strength.

Further downstream, the middle distillate complex (mostly diesel and jet fuel) remains quite tight. At last count its inventories remain some 50 Mbs (~-10%) below their five-year average (Exhibit 59).

Exhibit 58: OECD crude oil inventories Exhibit 59: M. distillate inventories vs. five-year meanMb Mb

880

910

940

970

1000

1030

1060

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

5y Max Min 5yr avg 2013 2012

-60

-20

20

60

100

140

180

220

Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13

Surplus onland floating storage


Risks and positioning

Given fundamental uncertainty and the still prevailing lack of conviction in direction, it is perhaps odd that speculative net length, and open interest, in Brent and WTI linked futures contracts are at historical highs.

One hypothesis is that much of the speculative length represents a wide variety of relative value trades as well as the hedging of exposure in other asset classes (e.g., energy sector equities). Either way, however, current positioning represents a bearish risk to today’s ~$110/b Brent (and ~$104/b WTI) oil-price levels, supporting our sense that prices are likely to drift lower into year-end.

While speculative net length has come down over the last few weeks, it remains relatively high, and leaves oil markets vulnerable to bearish catalysts.

03 October 2013


Exhibit 60: Speculative length remains high Exhibit 61: Open interest is still going up MM net length as a percentage of total OI (rhs) vs. flat price in $/b (lhs) Open interest in thousands of contracts

$75

$100

$125

$150

0%

2%

4%

6%

8%

10%

12%

14%

16%

J-12 A-12 J-12 O-12 J-13 A-13 J-13

MM Futures Net Length Brent Price

800

1000

1200

1400

1600

1800

2000

Brent OI(contracts)

WTI OI(contracts)

2000

2200

2400

2600

2800

3000

3200

3400

3600

Total Crude OI(contracts)

Current

Hi

Low

Average

Source: Credit Suisse, CFTC, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse, CFTC, the BLOOMBERG PROFESSIONAL™ service

Balancing risks to our fundamental views

While risks to our s/d balance view have continued to migrate to the bullish side for both supply (e.g., supply disruptions) and demand (e.g., less tail risk to the downside), in the bigger picture, next year we see risks around our base case as being fairly even:

On the demand side, tail risk seems concentrated in the US, debt-ceiling and budget talks are the key near-term worry, but in China and Europe negative risks have receded.

Despite China’s growth deceleration, in the near term the economy runs less risk of derailing than the consensus feared earlier this year.

In Europe, the re-election of Chancellor Merkel has pushed acute euro-crises risks further into the future.

Indeed, in our view, there is a chance that oil markets may be ignoring the opposite demand risk: that of suddenly accelerating demand growth in the wake of a relatively more sustained global economic recovery (larger than any of the recoveries witnessed in the last five years).

That said, near term, the recovery is fragile. A more prolonged cyclical downturn in certain emerging markets and another wobble in the US remain worries.

Around our base-case “call on Saudi Crude and Inventories” line in Exhibit 41, a lower oil demand-growth line reflects the aforementioned downside risk, while the upside risk derives mostly from the supply side.

Simply put, any projection factoring a rational-actor model of dispute resolution into the multiple crises playing out in many MENA oil-producing countries, has proved too optimistic. And yet, in our own base-case forecast, we have to assume that things relatively improve, in Libya, Nigeria, Iraq and Iran – the key sources of supply disruptions and production disappointments during the summer of 2013.

Therefore, on balance, our base case is very generous to sovereign oil producers/exporters and somewhat pessimistic in the case of our non-Opec production forecasts (relative to consensus).

03 October 2013


Balances tables:

Exhibit 62: Demand Mb/d unless otherwise stated

Demand 2010 2011 Q1-'12 Q2-'12 Q3-'12 Q4-'12 2012 Q1-'13 Q2-'13E Q3-'13E Q4-'13E 2013E Q1-'14E Q2-'14E Q3-'14E Q4-'14E 2014E 2015E

Global 88.5 89.5 89.4 89.9 91.0 91.9 90.55 91.0 91.1 92.7 92.9 92.0 92.3 92.2 94.2 94.6 93.3 94.7

YoY Grow th, net mb/d 3.5 1.0 0.4 1.5 0.6 1.5 1.0 1.6 1.2 1.7 1.1 1.4 1.3 1.0 1.5 1.7 1.4 1.3

YoY Grow th, % 4.1% 1.1% 0.4% 1.7% 0.6% 1.7% 1.1% 1.8% 1.4% 1.9% 1.2% 1.6% 1.4% 1.1% 1.6% 1.9% 1.5% 1.4%

OECD 47.0 46.6 46.5 45.7 46.1 46.5 46.2 46.1 45.7 46.3 46.4 46.1 46.1 45.2 46.0 46.4 45.9 45.6

YoY Grow th, net mb/d 0.6 -0.4 -0.6 0.3 -0.9 -0.3 -0.4 -0.4 0.0 0.2 -0.1 -0.1 0.0 -0.5 -0.2 0.0 -0.2 -0.3

YoY Grow th, % 1.4% -0.9% -1.3% 0.6% -1.9% -0.6% -0.8% -0.9% 0.0% 0.4% -0.2% -0.2% 0.0% -1.1% -0.5% 0.0% -0.4% -0.7%

Americas 24.1 24.0 23.4 23.6 23.8 23.8 23.6 23.7 23.8 24.1 24.0 23.9 23.9 23.6 24.0 24.1 23.9 24.0

YoY Grow th, net mb/d 0.5 -0.2 -0.7 -0.1 -0.4 -0.1 -0.3 0.3 0.1 0.4 0.2 0.3 0.2 -0.1 -0.1 0.1 0.0 0.1

YoY Grow th, % 2.0% -0.8% -2.9% -0.4% -1.5% -0.4% -1.3% 1.4% 0.6% 1.5% 0.9% 1.1% 0.7% -0.6% -0.5% 0.3% 0.0% 0.5%

Europe 14.9 14.5 14.0 14.1 14.1 13.9 14.0 13.4 14.0 14.1 13.8 13.8 13.5 13.8 14.0 13.8 13.8 13.6

YoY Grow th, net mb/d 0.0 -0.4 -0.5 -0.3 -0.8 -0.4 -0.5 -0.6 0.0 -0.1 -0.1 -0.2 0.0 -0.3 0.0 0.0 -0.1 -0.1

YoY Grow th, % -0.1% -2.8% -3.2% -1.9% -5.5% -2.9% -3.4% -4.1% -0.3% -0.5% -0.8% -1.4% 0.3% -2.0% -0.3% 0.1% -0.5% -1.0%

Asia Pacific 7.9 8.1 9.1 8.0 8.2 8.7 8.5 8.9 7.9 8.1 8.5 8.4 8.7 7.8 8.0 8.4 8.3 7.9

YoY Grow th, net mb/d 0.2 0.1 0.6 0.6 0.3 0.2 0.4 -0.2 -0.1 -0.1 -0.2 -0.2 -0.2 -0.1 -0.1 -0.1 -0.1 -0.3

YoY Grow th, % 2.1% 1.9% 6.5% 8.7% 3.8% 2.6% 5.3% -2.0% -1.1% -1.3% -2.4% -1.8% -2.0% -1.0% -1.2% -1.0% -1.3% -3.7%

Non-OECD 41.5 43.0 42.9 44.2 44.9 45.4 44.4 44.9 45.4 46.4 46.6 45.8 46.2 47.0 48.2 48.3 47.4 49.1


YoY Grow th, % 7.3% 3.5% 2.4% 2.9% 3.4% 4.1% 3.2% 4.7% 2.8% 3.4% 2.6% 3.4% 2.8% 3.4% 3.8% 3.7% 3.4% 3.5%

Former Soviet Union 4.1 4.3 4.1 4.4 4.5 4.2 4.3 4.2 4.3 4.7 4.3 4.4 4.4 4.4 4.8 4.4 4.5 4.5

YoY Grow th, net mb/d 0.1 0.1 0.1 0.0 -0.1 0.0 0.0 0.1 -0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.0

YoY Grow th, % 2.5% 3.6% 1.5% 1.0% -1.3% 0.6% 0.4% 2.6% -2.7% 3.1% 3.1% 1.5% 3.1% 3.1% 3.1% 3.1% 3.1% 0.7%

China 9.3 9.7 9.8 9.9 10.1 10.7 10.1 10.4 10.3 10.5 10.9 10.5 10.6 10.8 11.0 11.4 11.0 11.6


YoY Grow th, % 14.0% 4.9% 2.4% 1.3% 3.7% 8.1% 3.9% 5.6% 4.2% 4.7% 1.7% 4.0% 2.2% 4.5% 4.8% 4.8% 4.1% 5.4%

Other emerging Asia 10.7 11.2 11.6 11.6 11.6 12.0 11.7 12.2 12.1 11.9 12.4 12.1 12.6 12.5 12.4 12.9 12.6 13.1


YoY Grow th, % 7.2% 4.7% 3.6% 3.8% 5.9% 4.2% 4.4% 5.4% 3.9% 3.2% 3.1% 3.9% 3.2% 3.3% 3.9% 4.0% 3.6% 4.2%

South America 6.2 6.4 6.3 6.6 6.7 6.8 6.6 6.5 6.8 7.0 7.0 6.8 6.7 6.9 7.1 7.2 7.0 7.2


YoY Grow th, % 7.3% 3.7% 3.0% 3.6% 1.0% 4.4% 3.0% 3.5% 3.3% 3.1% 2.7% 3.1% 2.1% 2.2% 2.9% 2.5% 2.4% 2.9%

Mideast 7.0 7.2 6.9 7.5 7.9 7.2 7.4 7.2 7.7 8.2 7.5 7.7 7.5 8.0 8.6 7.9 8.0 8.3


YoY Grow th, % 5.2% 2.5% 2.1% 5.1% 4.6% 0.3% 3.0% 4.5% 1.6% 4.5% 4.1% 3.7% 4.7% 4.8% 5.0% 4.9% 4.9% 3.4%

Africa 3.6 3.5 3.6 3.5 3.5 3.8 3.6 3.8 3.7 3.5 3.8 3.7 3.9 3.7 3.5 3.8 3.7 3.9

YoY Grow th, net mb/d 0.1 -0.1 0.0 0.1 0.1 0.2 0.1 0.2 0.2 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.1

YoY Grow th, % 4.4% -1.6% -0.2% 1.7% 3.7% 5.9% 2.8% 6.5% 4.2% 0.1% 1.0% 2.9% 1.1% 1.2% 0.9% 1.1% 1.1% 3.6% Source: Credit Suisse, IEA, JODI, EIA, NBP, ANP

Exhibit 63: Stock changes Mb/d unless otherwise stated

Balance, stocks 2010 2011 Q1-'12 Q2-'12 Q3-'12 Q4-'12 2012 Q1-'13 Q2-'13E Q3-'13E Q4-'13E 2013E Q1-'14E Q2-'14E Q3-'14E Q4-'14E 2014E 2015E

Implied inventory change -0.5 -0.5 1.8 1.2 -0.3 -0.4 0.6 0.0 0.2 -1.1 -0.6 -0.4 0.2 0.6 -0.2 -0.4 0.0 0.0

Reported oil inventory:

OECD stock change 0.0 -0.2 0.5 0.4 0.5 -0.7 0.2 -0.1 -0.1 0.0 -0.6 -0.2 -0.3 -0.1 -0.1 -0.4 -0.2

OECD inv entory (billion barrels) 2.67 2.60 2.64 2.68 2.72 2.66 2.66 2.65 2.64 2.64 2.58 2.58 2.56 2.55 2.54 2.51 2.51

Cov er, day s demand 56.6 55.9 57.9 58.1 58.6 57.6 57.6 58.0 57.1 57.0 56.0 56.0 56.6 55.4 54.9 54.4 54.4

'Call on Opec & stocks" 30.5 31.0 29.8 31.0 32.2 31.6 31.1 30.7 30.8 32.2 31.5 31.3 30.4 30.4 32.2 32.2 31.3 31.8

YoY Grow th, net mb/d 1.7 0.5 -0.4 0.6 -0.1 0.4 0.1 0.9 -0.2 0.0 0.0 0.2 -0.3 -0.4 0.0 0.7 0.0 0.5

YoY Grow th, % 6.0% 1.5% -1.3% 2.1% -0.3% 1.4% 0.5% 3.1% -0.5% 0.1% -0.1% 0.6% -1.0% -1.4% -0.1% 2.2% -0.1% 1.6% Source: Credit Suisse, IEA, JODI, EIA, NBP, ANP

03 October 2013


Exhibit 64: Supply Mb/d unless otherwise stated

Supply 2010 2011 Q1-'12 Q2-'12 Q3-'12 Q4-'12 2012 Q1-'13 Q2-'13E Q3-'13E Q4-'13E 2013E Q1-'14E Q2-'14E Q3-'14E Q4-'14E 2014E 2015E

Global 88.0 89.0 91.2 91.1 90.7 91.4 91.1 91.0 91.3 91.7 92.3 91.6 92.4 92.8 94.1 94.2 93.4 94.7

YoY Grow th, net mb/d 2.6 1.0 2.0 2.9 2.1 1.3 2.1 -0.3 0.2 0.9 0.9 0.4 1.5 1.5 2.4 1.9 1.8 1.3

YoY Grow th, % 3.0% 1.1% 2.3% 3.3% 2.4% 1.5% 2.4% -0.3% 0.2% 1.0% 1.0% 0.5% 1.6% 1.6% 2.6% 2.0% 2.0% 1.4%

Non OPEC 50.2 50.4 51.3 50.5 50.3 51.8 51.0 51.8 51.7 51.8 52.7 52.0 53.3 53.2 53.3 53.7 53.4 54.2


YoY Grow th, % 2.5% 0.4% 1.2% 1.2% 0.5% 1.5% 1.1% 1.1% 2.4% 2.9% 1.9% 2.0% 2.9% 2.9% 2.9% 1.8% 2.6% 1.5%

North America 14.9 15.5 16.5 16.5 16.6 17.5 16.8 17.7 17.6 18.0 18.6 18.0 18.8 18.8 19.2 19.6 19.1 19.9


YoY Grow th, % 4.3% 3.9% 8.6% 8.4% 7.5% 8.2% 8.1% 6.8% 7.1% 8.8% 6.3% 7.2% 6.6% 7.0% 6.7% 5.4% 6.4% 4.0%

South America 4.6 4.6 4.7 4.5 4.5 4.6 4.6 4.5 4.6 4.7 4.7 4.6 4.7 4.7 4.7 4.6 4.7 4.8

YoY Grow th, net mb/d 0.2 0.1 0.1 0.0 -0.1 -0.1 0.0 -0.2 0.0 0.2 0.1 0.0 0.2 0.1 0.0 -0.1 0.1 0.1

YoY Grow th, % 5.5% 1.3% 1.6% -0.2% -2.6% -2.4% -1.0% -3.6% 0.6% 3.4% 1.2% 0.4% 4.0% 3.3% 0.9% -1.2% 1.7% 2.2%

Europe 4.5 4.2 4.2 4.1 3.7 3.8 3.9 3.9 3.8 3.6 3.5 3.7 3.6 3.6 3.4 3.3 3.5 3.5

YoY Grow th, net mb/d -0.3 -0.3 -0.2 -0.1 -0.3 -0.4 -0.3 -0.4 -0.3 -0.1 -0.3 -0.3 -0.2 -0.2 -0.2 -0.2 -0.2 0.0

YoY Grow th, % -6.8% -7.6% -4.8% -2.2% -7.4% -9.8% -6.0% -8.9% -7.3% -3.3% -7.5% -6.8% -5.4% -5.6% -5.1% -5.1% -5.3% 0.5%

FSU 13.3 13.5 13.6 13.5 13.5 13.7 13.6 13.8 13.8 13.6 13.9 13.8 14.0 14.0 13.8 14.0 14.0 14.0


YoY Grow th, % 2.5% 1.4% 0.8% -0.1% -0.1% 1.7% 0.6% 1.3% 2.3% 0.8% 1.4% 1.4% 1.4% 1.3% 1.7% 1.2% 1.4% 0.3%

Russia 10.3 10.5 10.6 10.6 10.6 10.8 10.6 10.8 10.8 10.7 10.9 10.8 10.9 10.8 10.7 10.9 10.8 10.8


YoY Grow th, % 3.2% 2.7% 1.7% 0.4% 0.2% 1.8% 1.0% 1.3% 1.9% 0.7% 0.8% 1.2% 1.5% 0.4% 0.4% 0.4% 0.7% -0.2%

Africa 2.6 2.6 2.3 2.1 2.1 2.1 2.2 2.1 2.2 2.2 2.2 2.2 2.3 2.3 2.3 2.3 2.3 2.3

YoY Grow th, net mb/d 0.0 -0.1 -0.3 -0.4 -0.4 -0.4 -0.4 -0.2 0.0 0.1 0.1 0.0 0.2 0.1 0.1 0.1 0.1 0.0

YoY Grow th, % 0.5% -2.1% -11.8% -14.5% -17.4% -16.7% -15.1% -9.7% 0.1% 2.6% 4.1% -0.9% 8.9% 5.7% 4.5% 3.0% 5.5% 1.8%

Mideast 1.7 1.7 1.4 1.5 1.5 1.5 1.5 1.4 1.3 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4

YoY Grow th, net mb/d 0.0 -0.1 -0.3 -0.2 -0.2 -0.1 -0.2 0.0 -0.1 -0.1 0.0 -0.1 0.0 0.1 0.0 0.0 0.0 0.0

YoY Grow th, % 1.2% -4.1% -19.3% -11.1% -11.3% -4.5% -11.7% -0.1% -9.5% -6.9% -3.0% -4.9% 1.5% 8.4% 2.9% -0.7% 2.9% -1.5%

Asia 8.5 8.3 8.4 8.3 8.5 8.6 8.4 8.5 8.4 8.4 8.4 8.4 8.4 8.4 8.4 8.4 8.4 8.2

YoY Grow th, net mb/d 0.3 -0.2 0.0 0.0 0.2 0.3 0.1 0.0 0.1 -0.1 -0.1 0.0 0.0 -0.1 0.0 0.0 0.0 -0.2

YoY Grow th, % 4.3% -1.8% -0.3% -0.2% 2.3% 3.1% 1.2% 0.3% 1.5% -1.3% -1.5% -0.3% -0.4% -1.1% 0.5% -0.4% -0.3% -1.9%

Processing gain 2.3 2.4 2.4 2.5 2.5 2.5 2.5 2.5 2.5 2.6 2.5 2.5 2.5 2.6 2.6 2.6 2.6 2.6

OPEC 35.5 36.2 37.5 38.1 37.9 37.2 37.7 36.7 37.1 37.3 37.0 37.0 36.6 37.1 37.3 37.0 37.4 37.9

YoY Grow th, net mb/d 1.2 0.7 1.4 2.3 1.8 0.5 1.5 -0.9 -1.0 -0.6 -0.1 -0.7 -0.1 0.0 0.0 0.0 0.4 0.5

YoY Grow th, % 3.6% 2.0% 3.8% 6.3% 5.0% 1.4% 4.1% -2.3% -2.7% -1.5% -0.4% -1.7% -0.3% 0.0% 0.0% 0.0% 1.1% 1.2%

Opec Crude Oil 30.0 30.5 31.6 32.2 31.9 31.2 31.7 30.7 31.0 31.1 30.9 30.9 30.5 31.0 32.0 31.8 31.3 31.8

YoY Grow th, net mb/d 0.8 0.4 1.2 2.0 1.5 0.2 1.2 -0.9 -1.2 -0.7 -0.2 -0.8 -0.1 0.0 0.9 0.9 0.4 0.5

YoY Grow th, % 2.8% 1.5% 4.1% 6.8% 4.8% 0.8% 4.1% -3.0% -3.7% -2.3% -0.7% -2.4% -0.4% 0.0% 2.9% 2.8% 1.3% 1.6%

Opec 11 27.6 27.7 28.8 29.1 28.6 28.0 28.6 27.6 27.9 28.0 27.7 27.8 27.2 27.7 28.7 28.5 28.0 28.2

YoY Grow th, net mb/d 0.8 0.1 1.2 1.8 1.0 -0.1 1.0 -1.2 -1.2 -0.6 -0.3 -0.8 -0.4 -0.2 0.7 0.7 0.2 0.2

YoY Grow th, % 3.0% 0.3% 4.3% 6.7% 3.6% -0.4% 3.5% -4.3% -4.2% -2.1% -1.0% -2.9% -1.4% -0.7% 2.4% 2.5% 0.8% 0.7%

Opec non-crude 5.5 5.7 5.9 6.0 6.0 6.0 6.0 6.0 6.1 6.2 6.1 6.1 6.0 6.0 6.2 6.1 6.1 6.0

YoY Grow th, net mb/d 0.4 0.3 0.1 0.2 0.3 0.3 0.2 0.1 0.1 0.2 0.1 0.1 0.0 -0.1 0.0 0.0 0.0 0.0

YoY Grow th, % 8.2% 4.7% 2.4% 3.9% 6.1% 4.6% 4.3% 1.4% 2.3% 2.8% 1.4% 2.0% 0.1% -1.0% -0.3% 0.3% -0.2% -0.6% Source: Credit Suisse, IEA, Petrologistics, EIA, NBP, ANP

03 October 2013


Exhibit 65: Brent forecast comparison Exhibit 66: Brent historical price and forecast $/b $/b

$80

$85

$90

$95

$100

$105

$110

$115

$120

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14

CS Forecast Forward Curve Bloomberg Forecast Mean

$20

$40

$60

$80

$100

$120

$140

$160

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Brent front month Quarterly avg forecasts

Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service

Exhibit 67: WTI forecast comparison Exhibit 68: WTI historical price and forecast $/b $/b

$70

$75

$80

$85

$90

$95

$100

$105

$110

Q4 13 Q1 14 Q2 14 Q3 14 Q4 13


$20

$40

$60

$80

$100

$120

$140

$160

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

WTI front month Quarterly avg forecasts



03 October 2013


The commodity price forecasts mentioned in this section have

been provided by the Commodities Research

analysts above.

Natural Gas: Global LNG Global LNG prices remain fully oil-linked and at a large premium to both continental European and North American gas markets. In North America, the ongoing "shale-revolution" keeps a lid on prices, which remain the lowest of any large market. Meanwhile, European natural gas continues to trade at levels too high to spur local power sector demand, but too low to attract LNG away from higher-priced Asian markets (Exhibit 69).

With little new supply expected until 2016, any unanticipated supply disruptions or sudden demand surge tighten the LNG balance and keep prices historically high even in shoulder seasons.

For instance, force majeure at Nigeria LNG and an unplanned shutdown of Australia’s Pluto LNG tightened the chain this summer and helped drive the ~$1.50/MMBtu (+11%) increase in JKM prices from July (which also $3/MMBtu higher than a year earlier).

However, when we look out to the end of the decade, our model shows supply and demand neatly balanced, i.e., no further project sanctions are required. Through the end of the decade, the 67 MT (8.9 Bcf/d) of already announced incremental supply projects should suffice to maintain a balance.

That is, unless a more bullish China demand story emerges or Japanese nuclear power stations fail to ever restart.

Overall, we see a broadly balanced (but tight) market through to 2017 with the potential for excess supply toward the end of the decade as projects from the US, Canada and East Africa near full output – if they come on-stream on schedule.

Exhibit 69: Global gas price benchmarks $/MMBtu

$2

$4

$6

$8

$10

$12

$14

$16

$18

$20

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13

JKM (spot LNG) US Henry Hub NBP (UK) JCC formula Jap LNG


Supply-demand: relatively tight to 2017—in a tenuous balance after

The base case forecasts, published within Global LNG Sector - Later and longer by Credit Suisse Equities analysts led by David Hewitt, shows a broadly balanced to slightly tight global LNG market through 2017 – in which regional in-balances persist and Asia continues to draw cargoes away from Europe.

The LNG market probably does not need any of the new and “possible” projects listed in our database to be sanctioned in a hurry, since there is only a 14 Mt/y (1.86 Bcf/d) shortfall versus expected demand if no projects are sanctioned from here.

RESEARCH ANALYSTS

Commodities Research Jan Stuart


Stefan Revielle [email protected]

+1 212 538 6802

Supply Model Contributors Equity Research Edward Westlake


David Hewitt [email protected]

+65 6212 3064

Arun Jayaram [email protected]

+1 212 538 8428

Mark Lear [email protected]

+1 212 538 0239

Dan Eggers [email protected]

+1 212 538 8430

Mark Freshney [email protected]

+44 20 7888 0887










03 October 2013


Put differently, to absorb the supply from any incremental project sanctions also requires more bullish assumptions on Chinese, Japanese or European import requirements to balance the global market (Exhibit 70).

Exhibit 70: Credit Suisse global LNG demand/supply forecast Mt/y

150

200

250

300

350

400

450

500

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Existing Under construction

Possible Speculative

LNG demand (base) LNG demand (Asia bull) Source: Credit Suisse

Demand – latest developments and near-term outlook

Following a decline in global demand for LNG in March and April, year-over-year demand growth resumed thanks to many of the same dynamics that have held true over the past 2+ years.

Exhibit 71: LNG imports by region Exhibit 72: Year-over-year LNG imports by region Bcf/d Bcf/d

15

17

19

21

23

25

27

29

31

33

35

Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13

Asia Pacific Europe Middle East North America South America

-4

-3

-2

-1

0

1

2

3

4

5

6

Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13

Asia Pacific Europe Middle East North America South America Total

Source: Credit Suisse, Wood Mackenzie Source: Credit Suisse, Wood Mackenzie

Asia Pacific LNG demand remained historically high in the absence of nuclear power-generation in Japan and rising import pressure from South Korea as well as smaller import markets.

The last Japanese nuclear reactor (the number 4 unit at Kansai Electric’s Ohi plant) went down for maintenance on 14 September. There is now serious doubt whether there will be enough power-gen capacity this winter.

03 October 2013


Newly developed Japanese nuclear regulations came into force in July. About one-third of Japan’s facilities, mostly located on the less exposed and unstable western coasts, should easily pass the associated new inspection regimes. However, overcoming mounting public distrust of all things nuclear, we believe, will prove well-near impossible.

In our base case we have only a smattering of Japan’s nuclear plants starting up, from late 2014 onward.

In South Korea, the discovery of fraudulent safety certificates for four of its nuclear reactors led to the shutdown of nearly 40% of available capacity. The lack of available capacity has left the country bumping up against reserve margins that are below industry minimums and should keep LNG imports elevated to meet winter demand.

South America continues to take an increasing share of LNG cargos. This increase has been led by Brazil and Argentina.

The North American wedge went from year-over-year declines to flat thanks to increased appetite for natural gas in Mexico.

PEMEX reportedly took delivery of ~200 MMcf/d of LNG at around $19.50/MMBtu from Nigeria this summer, which is nearly five times higher than US gas prices. While evidently keen to avoid the shortages seen in 2012, these import prices also illustrate the attractiveness of the Mexican market for US exporters.

Weak European gas demand and the desire to send the marginal LNG cargo to Asia continue to keep European LNG imports muted. Despite the surprising uptick in LNG imports shown in May import data, generation economics are now negative for natural gas power generators and should keep overall gas demand in check this winter.

Supply – everything’s getting pushed back, multiple new supply points

In 2013 Credit Suisse estimates only ~6 Mt/y (0.8 Bcf/d) of nameplate capacity will be added and just 11 Mt/y (1.5 Bcf/d) in 2014. Further out, momentum comes from the third and fourth US project approvals (Lake Charles and Cove Point – more on that in the US gas section), but activity in APAC is markedly lower, with only Phase 2 of APLNG and Petronas’ FLNG-1 announcing sanctions since our last Global LNG report.

Exhibit 73: Global LNG nameplate capacity: 2013- 2025

Exhibit 74: Capacity additions by year and by region/county

Mt/y Mt/y

0

100

200

300

400

500

600

700

800

900

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

Operation Construction Possible (CS base) Speculative

0

5

10

15

20

25

30

35

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Australia/PNG North/West Africa Indo/Malaysia US

Canada Russia East Africa

Source: Credit Suisse Source: Credit Suisse

In the US, the pace of LNG export project approvals seems to be picking up. And we should see more project sanctions in the next 36 months. In Canada and East Africa there are multiple projects jockeying for position, but we see the timeline for gas from these three new supply areas pushing back toward, and even beyond, the 2020 benchmark.

03 October 2013


US Natural Gas The ongoing shale gas boon should keep on depressing US natural gas markets. And as if that wasn’t enough, this past summer was unusually mild, which quickly undermined what little optimism we found three months ago (after a reasonably cold winter season).

Consequently we have to reverse course and revise our price forecasts modestly lower.

That said, in the very near term (specifically early this winter) it strikes us that markets are a little too bearish. We think the consensus is too aggressive about production gains in 4Q and 1Q of 2013. We think that supply growth in the Northeast may be more constrained than most think.

We anticipate a resumption of unbridled growth following winter, once more midstream infrastructure falls into place in the Northeast.

Key price revisions: adjusting lower across the board

We are revising average 2013 forecasts lower to $3.70/MMBtu. The weather (and perhaps efficiency) related underperformance of gas power demand during 3Q led our initial forecasts to be too high and is the contributing factor to our ~30 cent downward revision to average 2013 prices. Even still, we think there remains slight upside to 4Q 2013 prices once investors begin positioning for a potentially tighter start to the winter period we’ve outlined above. We are revising down our 4Q 2013 forecast by 45 cents, but place it 18 cents above current futures prices.

Our 2014 targets are also revised lower. We hold 1Q 2014 prices roughly 10 cents above current futures if our bullish thesis plays out and inventories hit sub five-year average levels. However, once Northeast pipelines and processing capacity (in both Marcellus and Utica) becomes available, supply growth should resume at the recent aggressive pace, with associated gas and Eagle Ford also adding incremental volumes. Our 2014 average supply growth forecast of 1.3 Bcf/d yoy (versus ~1 Bcf/d yoy growth in 2013) should weigh heavily on prices. To reflect a looser balance, particularly toward the back of 2014 (as demand should remain roughly flat yoy), we’ve revised 4Q 2014 lower to $3.75/MMBtu, sending 2014 year averages to $3.90/MMBtu.

The burgeoning supply overhang from low-cost gas continues from 2015 onwards while the industry awaits LNG exports. Due to the likelihood of continued improvement in basin efficiencies and an increasing share of supplies being met from plays that break even below $3/MMBtu, we are revising 2015-2017 lower by 20 cents, 30 cents and 10 cents, respectively. Additionally, we are placing an asterisk on our long-term forecast of $4.50/MMBtu as we think there will be further downside risks, particularly as Utica enters the picture in the next 12 months.

LNG exports remain the largest uncertainty to the long-term supply/demand picture, in our view. The latest non-FTA approval for Cove Point marks the fourth such project and brings the total of approved projects to ~6.37 Bcf/d, all of which are projected to begin operations by the end of the decade.

Exhibit 75: US natural gas price outlook$/MMBtu

PeriodActuals &

CS ForecastPrevious

Fcst FuturesBBG

Consensus*1Q12 (a) 2.77$ 2Q12 (a) 2.26$ 3Q12 (a) 2.81$ 4Q12 (a) 3.36$

FY12 (a) 2.80$ 1Q13 (a) 3.35$ 2Q13 (a) 4.09$ 3Q13 (a) 3.60$ 4.20$

4Q13 3.75$ 4.20$ 3.57$ 3.90$

FY13E 3.70$ 4.00$ 3.65$ 3.78$ 1Q14 4.10$ 4.10$ 3.81$ 4.08$ 2Q14 3.80$ 3.90$ 3.78$ 3.87$ 3Q14 4.00$ 4.00$ 3.85$ 3.94$ 4Q14 3.75$ 4.10$ 3.97$ 4.15$

FY14E 3.90$ 4.00$ 3.85$ 4.05$ 1Q15 4.10$ 4.40$ 4.16$ 2Q15 4.00$ 4.10$ 3.94$ 3Q15 4.20$ 4.20$ 4.00$ 4Q15 4.30$ 4.80$ 4.13$

FY15E 4.20$ 4.40$ 4.06$ 4.50$ FY16E 4.40$ 4.70$ 4.16$ 4.73$ FY17E 4.50$ 4.60$ 4.28$ 4.98$

Long-Term** 4.50$ 4.50$

*Bloomberg forecasts from previous three months only Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

03 October 2013


Latest twist and turns

Relative to our forecast, gas power demand this summer has been weak. Consequently our price forecast overshot by 60 cents (+15%) in 3Q.

Mild July and August summer temperatures sent cooling degree day totals 25% and 22% below recent 15-year averages, respectively. Meanwhile, average gas prices were $3.60/MMBtu, $0.79/MMBtu higher than the same period in 2012. Between weather and competitive fuel pricing, coal recaptured market share and gas power demand fell to four-year lows. Injections into storage for July/early August outpaced 2012 by a combined 263 Bcf, helping to significantly shrink the year-over-year storage deficit created during the winter of 2012-2013.

Despite the improved storage situation, we have grown tactically bullish on the first half of winter 2013-2014 but the window of opportunity is small. After 3Q prices bottomed in the $3.20 range, we have witnessed a gradual tightening of the S&D and issued a bullish thesis and trade in the report (Commodities: We're Back - Back in Black...). Specifically:

Gas demand, as reflected in pipeline flows, improved in late August/September as warmer-than-normal temperatures returned electricity consumption to levels not seen since the record-setting year in 2012. Meanwhile, industrial demand continues to add steady year-over-year growth through the completion of heavy gas consuming steel and chemical plants.

Net imports have fallen to five-year lows as new pipeline capacity to Mexico has become operational and Canadian import flows trickle in. Both trends are expected to hold.

Ahead of major Northeastern infrastructure completions in 4Q 2013, Northeast supply growth has flat-lined, as nearly all available export routes are full, particularly in the Northeastern PA dry Marcellus (see TGP line in Exhibit 76). To that end, pipeline constraints and a declining ex-Marcellus supply bucket have held production growth to just 1.0 Bcf/d yoy (versus 3.0 Bcf/d in 2012 and 4.3 Bcf/d in 2011).

Exhibit 76: PA gas production on TGP and Transco Exhibit 77: US dry gas production Bcf/d Bcf/d

0

0.5

1

1.5

2

2.5

3

Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13

TGP Transco 30 per. Mov. Avg. (TGP) 30 per. Mov. Avg. (Transco)

Lack of growth on TGP in 2013 indicates pipeline constraints

54

56

58

60

62

64

66

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13

2011 2012 2013

Source: Ventyx, Credit Suisse Source: Bentek Energy, Credit Suisse

With our supply growth of 1.4 bcf/d yoy from Nov 2013-March 2014, the S&D residual has turned negative (bullish) for the first time in a number of storage seasons. Under normal weather circumstances, this could bring inventories to 1.55 Tcf levels by March and below the five-year normal level (see storage section below).

Outside of this small window of opportunity for bullish gas investors, our view remains more bearish for the balance of 2014 and continues through 2017. Greater confidence that supply growth will be adequate to meet even aggressive industry demand forecasts (from power, industrial LNG exports, etc.) is even placing our long-term price forecast of $4.50/MMBtu into question.

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03 October 2013


The broader fundamental view Demand – two steps forward, one step back

Last year, the cornerstone for natural gas demand growth was the power sector. Specifically, through switching from costlier coal generation to natural gas, power demand for natural gas grew 20% yoy. But as indicated in our previous outlooks (and noted above), over 70% of the demand gains appreciated last year have been lost in 2013.

Exhibit 78: Power demand versus Henry Hub price Exhibit 79: EEI data show negative demand growth $/MMBtu and Bcf/d, forecast indicated by dark blue bars GWh

(7.00)

(5.00)

(3.00)

(1.00)

1.00

3.00

5.00

7.00

$(3.00)

$(2.00)

$(1.00)

$-

$1.00

$2.00

$3.00

Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14

yoy gas power demand yoy $/MMbtu

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

70,000

72,000

74,000

76,000

78,000

80,000

82,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Jan-Sept Elec. Demand yoy % change

Source: Bentek Energy, the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: EEI, Credit Suisse

Could there be more to lackluster demand growth? More important for longer-term demand trends may be the modest decline in total US electricity output data (EEI data are looked at to assess total demand growth, including all fuel types). Shown in Exhibit 79, if year-to-date declines hold, it would represent the third consecutive year of falling electricity demand. Weather-adjusted trends would look worse still.

That is to say, without overall electricity demand growth (due to energy efficiency, conservation, etc.) natural gas must capture market share from other fuel sources to show incremental year-over-year demand growth.

We forecast average natural gas power demand to remain flat year over year this winter and in 2014. As seasonal weather returns, higher prices year over year keep switching levels lower for the balance of 2013. Into 2014, 6.3 GW of announced coal retirements take place, but are mostly offset by a forecasted addition 12.5 GW of wind capacity, just shy of the 2012 record-setting year. Annual average power demand growth for 2014 is expected to be just 0.6 Bcf/d.

Nuclear and renewables add downside risk for gas demand from power-gen

As US power demand seasonally decreases into the winter months, generation from other fuel sources becomes increasingly important when deciding where the marginal MWh will come from. To that end, we think nuclear output and wind additions are two key areas of power demand that will have unappreciated impacts on gas demand for the balance of 2013 and 2014 (and beyond).

Higher expected nuclear output this fall/winter should negatively impact gas demand. Last November a series of atypical plant outages for uprates and operational issues sent nuclear output to ten-year lows, averaging just 76.3 GW during in November or 6 GW below previous ten-year norms (Exhibit 80). Assuming a more typical maintenance season is seen this fall, we estimate gas power demand could displace 0.5 Bcf/d in gas demand this winter.

03 October 2013


Exhibit 80: Upside to nuclear generation this winter?

Exhibit 81: Meanwhile, wind additions next year are expected to be large

MW MW

65,000

70,000

75,000

80,000

85,000

90,000

95,000

100,000

105,000

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13

Prior 10-yr Range Prior 10-yr average 2013 2012

Source: NRC, Credit Suisse Source: Ventyx, Credit Suisse

Wind generation will continue to displace gas demand in 2014. After the record-setting 2012 when 13.6 GW of wind capacity was added in the US, 2013 has slowed considerably. While activity is expected to pick up following the 3Q 2013 earnings season, 2014 is staging up to be a near-record year for wind additions (Exhibit 81). Credit Suisse Utilities research analyst Dan Eggers estimates that 2014 could see 12.5 GW of added wind capacity as developers look to add projects that qualify for production tax credits (PTC) before their expected expiration in 2015. All told, the 2013-2014 additions could collectively displace 2 Bcf/d gas demand by 2016 and remain an issue largely overlooked by energy commodity investors.

US industrial growth is alive and well, but big additions don’t come until 2015

Initially highlighted in The Shale Revolution, the US industrial “renaissance” has gained steam in 2013, and has only confirmed our optimisms that natural gas demand for industrial uses will show steady growth through the decade. Our industrial project lists have ballooned to 170, heavily weighted in the fertilizer and chemical industries. Through the end of the decade, the completion of all announced projects could add nearly 2 Bcf/d to industrial gas demand and back to levels not seen since the late 1990s.

Exhibit 82: Forecast industrial gas demand … Exhibit 83: … increments by Industry-sector Bcf/d Bcf/d

15

16

17

18

19

20

21

22

23

24

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

0

50

100

150

200

250

300

350

400

450

500

2013 2014 2015 2016 2017 2018 2019 2020

BioFuels Chemicals Fertilizer Industrial Gases Metals Petroleum Rubber

* Includes only projectsthat have been announced, approved, permitted or under construction

Source: Wood Mackenzie, Credit Suisse Source: Credit Suisse

EIA data through June peg year-to-date industrial demand growth at 0.8 Bcf/d yoy while pipeline data showed growth was mostly flat yoy from July through August. We forecast industrial growth at 0.4 Bcf/d in 2013 and 0.6 Bcf/d in 2014. Notable projects anticipated in 2013/2014 include the following:

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03 October 2013


The LyondellBasell 780 kt/y methanol plant in Channelview, TX is slated to restart in 2013. Once complete it could add nearly 61 MMcf/d to gas demand.

Nucor’s 114 kt/yr DRI steel plant is targeting to start before year-end in St. James Parish, LA. This plant could add 31 MMcf/d to gas demand. Nucor has planned a 273 kt/y expansion of this same project for 2014 and could bring total project gas demand to 62 MMcf/d.

In 2014, Methanex plans to restart a methanol plant in Geismar, LA that was previously located in Chile. Citing the low cost advantage of US natural gas prices, the plant was transported to the US gulf region. Once complete, the 990 kt/y plant could add 85 MMcf/d to industrial gas demand by 4Q 2014.

Beyond 2014, the industrial focus turns heavily to the fertilizer market. Notably, three brownfield projects by CF Industries (two in Iowa and one in LA) add significantly to the US ammonia and urea base, meanwhile adding ~200 MMcf/d to gas demand.

Exporting the shale gas revolution’s key benefit, i.e., lower natural gas prices: US LNG exports are becoming a reality

The US natural gas market has seen three non-free trade export approvals from the Department of Energy in 2013, sending the total number of approved projects to four with total export capacity of 6.37 Bcf/d. As highlighted in US LNG export: Take-two recent approvals have removed doubts that had arisen around possible misgivings in Washington about “exporting away the competitive advantage of low-cost natural gas.” Instead, there is now greater confidence about the export-approval process and criteria under Energy Secretary Ernest Moniz. Timing of approvals for individual projects now is the largest uncertainty, as is, of course, ultimately the question of what overall ceiling may be imposed.

Interestingly, the speed of the last two DoE approvals – coming just 11 and 5 weeks apart – has followed (even outpacing) our most aggressive case and is only adding upside to likely US LNG export levels by the end of the decade. We maintain our view for 8.9 Bcf/d of US LNG exports by 2020.

Supply: “Dirty Deeds Done Dirt Cheap”

We maintain our view that US natural gas production will continue to show annual average growth despite today’s deceivingly low rig counts. The unabated ability of US gas producers to reduce costs and improve the “science” behind drilling natural gas wells has turned exploration and production into something resembling a manufacturing process.

For example, better sweet spot identification, improved frac recipes and optimization of lateral lengths have sent average Marcellus expected ultimate recoveries (EURs) to increase 69% since 2010 (Exhibit 84).

If continued improvements are seen in areas like the Eagle Ford, Niobrara, and the upcoming Utica Shale, we have no reason to believe US gas supplies will turn over, irrespective of rig counts.

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03 October 2013


Exhibit 84: Marcellus EURs continue to get bigger Bcfe

0.29 0.15 0.29 0.390.75

1.64

3.93

4.72

5.51

6.565

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Bcfe

Source: Credit Suisse, Company reports

Infrastructure remains the only real impediment to supply growth. Significant amounts of pipeline and processing capacity are slated to be added to help bring new supplies to market over the next 12 months.

The Northeast alone will add ~2.9 Bcf/d of pipeline capacity in 2013 with another ~5 Bcf/d planned for 2014. In addition, gas processing capacity is expected to increase ~1.5 Bcf/d in 2013/2014 if all planned projects happen.

Outside of the Northeast, another ~5 Bcf/d of processing capacity through and 4 Bcf/d of pipeline capacity has been announced through 2014, focused mostly within the Southeast and Southwestern US.

In a perfect world, takeaway and processing capacity would lead drilling to allow for steady growth in US production. However, in the Northeast, this is proving to be more difficult than it appears on paper. This summer and fall we witnessed historically unusual negative basis pricing within the Appalachian region as Dominion South, TCO and Leidy Hub traded as lows between $0.20-$1.00/MMBtu under Henry Hub. Until the needed infrastructure catches up, we think there could be instances of choppy supply growth and severe basis pressure.

For this reason, the only change we have made to our supply forecasts is the introduction of a slightly less aggressive Marcellus scenario for the winter of 2013-2014. Thereafter, we believe many infrastructure issues will have been addressed, allowing for the resumption of Northeast production growth.

Pipelines flows indicate production so far in 2013 has grown on average ~1.1 Bcf/d yoy, with an overwhelming share coming from the Northeast. We expect 2013 average year growth to end at +0.8 Bcf/d above 2012 levels (Exhibit 86).

With Marcellus production likely adding 2.2 Bcf/d yoy, the remaining basins account for a decline of 1.2 Bcf/d.

03 October 2013


Exhibit 85: Natural gas production Exhibit 86: 2013 average year growth by play Bcf/d (Bcf/d

52

54

56

58

60

62

64

66

Jan Mar May Jul Sep Nov

4-year range 2013 2012 4-year avg

-1.3-1.0

-0.4 -0.4-0.1 -0.1

0.0 0.0 0.0 0.1 0.2

1.2

2.2

0.8

3.0

4.3

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Co

nven

tiona

l

Ha

yne

svill

e

Ba

rnet

t

GO

M DJ

Ca

na-W

ood

ford MS

Gra

nite

Was

h

Fay

ette

ville

Nio

bra

ra

Pe

rmia

n

Ea

gle

For

d

Ma

rcel

lus

Net

Impa

ct

201

2

201

1

Source: Bentek Energy, Credit Suisse Source: HPDI, Credit Suisse

After pipeline constraints are resolved in 1Q 2014, we think supply growth could be 1.2 Bcf/d yoy in 2014 for the following reasons:

US producers appear more hedged for 2014 than they were in 2013. US producers took advantage of a weather-driven rally during 2Q 2013 which saw calendar 2014 average prices reach $4.40 levels for the first time since 4Q 2012. Based on company reports, we estimate that producers were able to increase the amount of 2014 hedged production by 10% above the same period in 2013 (as was recorded after 3Q 2012 earnings).

Exhibit 87: Producers are 10% more hedged in 2014 Exhibit 88: But, average hedged prices are lower % of hedged annual production $/MMBtu

28%

19%

0%

5%

10%

15%

20%

25%

30%

Current (for 2014) Last year (for 2013)

$4.49

$4.18

$5.20

$4.81

$4.30

$5.80

$3.50

$4.00

$4.50

$5.00

$5.50

$6.00

Swap Price ($/Mcf) Collar Floor Price($/Mcf)

Collar Ceiling Price($/Mcf)

Current (for 2014)

Last year (for 2013)

Source: Company reports, Credit Suisse Source: Company reports, Credit Suisse

With average hedged swap prices at $4.49/MMBtu, producers will continue to be masked from periods of price weakness, both at Henry Hub and at local hubs (i.e., the Northeast). This fact alone could allow production growth in 2014 to occur at a steeper pace than 2013, in our view. With today’s Northeast Marcellus breakeven (for 15% IRR) at $3.02/MMBtu and $0.62/MMBtu in the Southwest liquids-rich areas, returns are likely to remain stout for some time to come (see Exploration & Production: US Upstream Deep Dive).

The inventory of non-producing wells has only increased in Northeast. Based on state data released this summer, we estimate that the total number of wells that have been either shut in or drilled but not completed is currently greater than 1500 wells. This number represents a ~100 well increase from the 2H 2012 and highlights the fact that ongoing production constraints, likely due to limited takeaway capacity, are having an impact on drilling operations.

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03 October 2013


For reference, 1280 wells went into production between the 1H 2012 and 1H 2013, adding 4.35 Bcf to daily production levels. We think the ultimate volume impact of completing today’s non-producing Marcellus wells could be even greater as today’s EURs are ~40% higher than those in 2011.

The Utica is real and will add incrementally to supply in 2014. Activity is growing within the Utica shale as gas rig counts have risen to 15 versus just 3 a year ago. The “core” of the play has been identified by Carroll and Harrison counties in the southeastern portion of Ohio. Average well IP rates have been roughly 8 MMcf/d (compared to 6 MMcf/d in the Northeast Marcellus and 10.3 MMcf/d in the core Haynesville). However, given the high-liquids content of the test wells to date, economics should rival the Southwest Marcellus, and rank among some of most attractive in the US shale arena.

However, like the Marcellus, supply growth in 2014 will be limited by available processing and pipeline capacity. We estimate that 1.8 Bcf/d of processing capacity has already been completed in the SW Marcellus/Utica shale, while another 1.1 Bcf/d is slated for 2014.

In terms of pipelines, PVR’s Utica project aims build 450 MMcf/d in gathering and associated infrastructure to tie gas production to TETCO and REX beginning in late 2014. In addition, two projects have been announced to export Utica gas to the Gulf as well as to Midwest and Eastern Canada. Neither project is slated until late 2015 or 2016.

Additionally, given high GPMs in the Utica, access to NGL takeaway capacity will be nearly as important as gas pipeline infrastructure in our view. Enterprise Products' ATEX pipeline will remain the most important project here, adding 190 kb/d of ethane takeaway in 1Q 2014 with expandable propane service in 1Q 2015. Two other projects, Bluegrass and the Kinder Morgan-MarkWest Energy, aim to expand raw-mix NGL takeaway by 400 kb/d, both terminating in the Gulf region where it can be more easily processed or fractionated.

Exhibit 89: Utica shale activity

Source: Gulfport Energy

03 October 2013


Downside risk to the marginal cost of gas production?

Simple math will tell you that as supplies from low cost shale basins continue to ramp and account for a higher percentage of total supply, the average weighted cost of producing gas is falling. Our view is that the lion’s share of supply growth through 2020 is likely to come from shale plays with economic breakevens below $3/MMBtu (i.e., Marcellus, Eagle Ford and Utica).

We track carefully the impact on upstream natural gas economics and have modeled in detail the reserves and productivity of the key conventional and shale basins in the US in a series of reports (see for instance The Shale Revolution", 12/13/2012). While it’s still relatively early days, several key trends have emerged. These should, we think, keep a lid on prices (near $4.50/MMBtu, annual average) through the end of the decade. Critically:

Costs keep coming down, as efficiencies rise and technology (e.g., completions technology of late) improves.

What’s more, as exploration risk has fallen to near zero, IRR premiums enjoyed by traditional E&P entities should come down to manufacturing and utility IRRs.

Nor do we think that we have to wait for oil and gas prices to converge before operators target dry-gas plays again. Instead we believe that a great many dry-gas targets will be drilled either by operators that don’t have a portfolio of liquids-rich targets or by entities simply looking for growth and decent returns.

In other words, we believe that the same factors that scaled up the shale production in places like the Marcellus will continue to rule the US upstream. And consequently there should be enough supply at sub $5 levels to meet our base-case demand scenarios by 2020, even when including LNG exports.

Exhibit 90: US supply cost curve – ample growth to meet bullish demand story $/MMBtu on y-axis and cumulative production (2020-2013) in Bcf/d on x-axis

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

-5.6 -3.6 -1.6 0.4 2.4 4.4 6.4 8.4 10.4 12.4 14.4 16.4 18.4

Mississippian Eagle Ford Fayetteville

Utica Granite Wash Barnett

Marcellus Cana Woodford Haynesville

Permian Niobrara

Needed to make up for base declines in conventional and GOM production

??

?


Storage paths and residuals

A materially looser natural gas balance this summer (we estimate by 3.4 Bcf/d yoy) has allowed inventories to rise dramatically after seeing the year-over-year storage deficit balloon to +800 Bcf under 2012 levels this April. Based on weekly storage data, we estimate that injections for July/August outpaced 2012 by a combined 263 Bcf, significantly helping to

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03 October 2013


reduce the year-over-year storage deficits. And with an 87 Bcf injection for the week ending September 20 and a likely mid-80 Bcf build for the follow week, storage levels should begin October just shy of 3.5 Tcf. For October we note the following:

Over the past ten years, October injections have averaged 251 Bcf with a high of 388 Bcf seen in 2011.

Using average builds, 3.75 Tcf by November 1 is certainly in sight, but reaching last year’s ending inventory of 3.93 Tcf now appears challenged.

Our normal-weather, end-of-season inventory forecasts (Exhibit 91) are now 3.80 Tcf. Weather, and the arrival of space heating demand, is the largest risk factor to our late September and October forecasts.

With our supply growth of 0.9 Bcf/d year over year from November 2013-March 2014, the S&D residual turns negative (bullish) for the first time in a number of storage seasons. Under normal weather circumstances, this could bring inventories to 1.55 Tcf levels by March and below the five-year normal level (Exhibit 92).

Exhibit 91: 3.8 Tcf is a forgone conclusion this fall Exhibit 92: While winter points to lower inventory Bcf Bcf

3.8 Tcf

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Apr Jun Aug Oct

Range 2012 2013 fcst 2013

(In Bcf/d) CS Base CaseProduction 1.0Imports/(exports)

LNG (0.1)Mex Exports (0.3)Canada (0.7)

DemandPower Gen (3.7)Industrial 0.2

"Residual" 3.4

Summer 2013 Residual

1.55 Tcf

600

1100

1600

2100

2600

3100

3600

Nov-13 Dec-13 Jan-14 Feb-14 Mar-14

10-yr range Winter 13-14 base

(In Bcf/d) CS Base CaseProduction 0.9Imports/(exports)

LNG (0.1)Mex Exports (0.2)Canada (0.4)

DemandPower Gen (0.1)Industrial 0.4

"Residual" (0.2)

Winter 2013-2014 Residual

Source: EIA, NOAA, Credit Suisse Source: EIA, NOAA, Credit Suisse

Exhibit 93: Henry Hub forecast comparison Exhibit 94: Henry Hub historical price and forecast $/MMBtu $/MMBtu

$3.00

$3.20

$3.40

$3.60

$3.80

$4.00

$4.20

$4.40

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

NYMEX Henry Hub Quarterly Avg Forecast

Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse Commodities Research

03 October 2013


Exhibit 95: US natural gas supply-demand forecasts Bcf/d

(Bcfd) 2012 Q1/2013 Q2/2013 Q3/2013 Q4/2013 2013 Q1/2014 Q2/2014 Q3/2014 Q4/2014 2014 Q1/2015 Q2/2015 Q3/2015 Q4/2015 2015

Marketed Gas Production 69.2 69.3 69.9 70.4 70.4 70.0 70.4 70.8 71.2 72.1 71.2 73.2 73.6 74.4 75.5 74.1Y-o-Y 3.4 0.5 1.0 1.2 0.5 0.8 1.2 1.0 0.8 1.7 1.2 2.7 2.8 3.1 3.3 3.0

Y-o-Y% 5.1% 0.7% 1.5% 1.8% 0.7% 1.2% 1.7% 1.4% 1.2% 2.4% 1.7% 3.9% 3.9% 4.4% 4.6% 4.2%

Dry Gas Production 65.7 65.8 66.3 67.0 67.1 66.5 67.1 67.4 67.8 68.7 67.8 69.7 70.1 70.8 71.9 70.6Y-o-Y 3.0 0.4 0.8 1.3 0.7 0.8 1.3 1.2 0.8 1.6 1.2 2.6 2.6 3.0 3.2 2.8

Y-o-Y% 4.8% 0.6% 1.2% 1.9% 1.1% 1.2% 2.0% 1.7% 1.2% 2.4% 1.8% 3.9% 3.9% 4.4% 4.6% 4.2%

Conventional 32.9 31.3 31.6 32.0 31.4 31.6 31.1 31.0 30.8 30.8 30.9 30.8 30.7 30.5 30.5 30.6Y-o-Y 1.7 -1.8 -1.2 -0.9 -1.2 -1.3 -0.3 -0.6 -1.1 -0.6 -0.7 -0.2 -0.4 -0.3 -0.3 -0.3

Y-o-Y% 5.5% -5.3% -3.8% -2.8% -3.7% -3.9% -0.9% -2.0% -3.5% -2.1% -2.1% -0.8% -1.1% -0.9% -1.0% -1.0%

Offshore (GOM) 4.3 4.0 3.7 3.8 4.1 3.9 3.8 3.5 3.5 3.9 3.7 3.6 3.3 3.3 3.7 3.5Y-o-Y -0.8 -0.6 -0.6 0.0 -0.2 -0.4 -0.2 -0.2 -0.4 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2

Y-o-Y% -15.1% -13.8% -13.9% -0.7% -5.0% -8.6% -5.0% -5.0% -9.1% -5.0% -6.0% -5.0% -5.0% -5.0% -5.0% -5.0%

Unconventional 32.0 33.8 34.2 34.6 34.9 34.4 35.6 36.3 36.9 37.5 36.6 38.7 39.6 40.5 41.3 40.0Y-o-Y 3.6 2.7 2.5 2.3 1.9 2.3 1.8 2.1 2.3 2.6 2.2 3.1 3.3 3.6 3.8 3.5

Y-o-Y% 12.5% 8.8% 7.8% 7.0% 5.8% 7.3% 5.4% 6.3% 6.6% 7.4% 6.4% 8.8% 9.1% 9.8% 10.2% 9.5%

Barnett 6.0 5.8 5.6 5.6 5.6 5.6 5.6 5.7 5.8 6.0 5.8 6.2 6.4 6.6 6.7 6.5Y-o-Y 0.1 -0.3 -0.4 -0.4 -0.3 -0.4 -0.2 0.0 0.2 0.5 0.1 0.6 0.7 0.8 0.7 0.7

Y-o-Y% 1.4% -5.0% -7.2% -7.3% -5.2% -6.2% -3.3% 0.2% 4.0% 8.1% 2.2% 11.3% 13.3% 13.2% 11.5% 12.3%

Cana-Woodford 1.1 1.1 1.0 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1Y-o-Y 0.0 -0.1 -0.1 -0.1 0.0 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Y-o-Y% 2.7% -5.4% -6.7% -5.7% -2.3% -5.0% 1.4% 4.3% 4.6% 3.7% 3.5% 3.2% 2.1% 1.4% 1.1% 2.0%

Eagle Ford 2.1 2.9 3.2 3.4 3.6 3.3 3.8 4.0 4.2 4.3 4.1 4.5 4.6 4.8 4.9 4.7Y-o-Y 1.1 1.3 1.3 1.2 1.1 1.2 0.9 0.8 0.7 0.7 0.8 0.7 0.6 0.6 0.6 0.6

Y-o-Y% 102.6% 80.0% 68.6% 52.5% 41.1% 58.1% 29.5% 23.7% 21.4% 19.4% 23.2% 17.5% 16.2% 15.2% 14.5% 15.8%

Fayetteville 2.7 2.9 2.8 2.7 2.7 2.8 2.7 2.7 2.6 2.6 2.6 2.7 2.7 2.7 2.7 2.7Y-o-Y 0.2 0.2 0.1 0.0 -0.1 0.0 -0.1 -0.2 -0.1 -0.1 -0.1 0.0 0.0 0.1 0.1 0.0

Y-o-Y% 6.5% 7.6% 2.5% -0.9% -2.2% 1.7% -5.2% -5.5% -4.3% -3.0% -4.5% -1.4% 0.2% 2.1% 4.0% 1.2%

Haynesville 6.0 5.2 5.0 4.9 4.9 5.0 5.0 5.1 5.1 5.1 5.1 5.2 5.3 5.4 5.4 5.3Y-o-Y -0.9 -1.6 -1.2 -0.7 -0.4 -1.0 -0.2 0.1 0.2 0.2 0.1 0.2 0.2 0.3 0.3 0.2

Y-o-Y% -12.8% -23.2% -19.9% -13.0% -8.0% -16.5% -3.8% 1.1% 3.6% 4.3% 1.2% 4.1% 4.7% 5.2% 5.7% 4.9%

Marcellus 5.7 7.4 7.8 8.2 8.3 7.9 8.6 8.9 9.0 9.2 8.9 10.3 10.7 11.0 11.4 10.8Y-o-Y 2.8 2.8 2.6 2.1 1.5 2.2 1.2 1.1 0.9 0.9 1.0 1.8 1.8 2.0 2.2 1.9

Y-o-Y% 100.4% 62.7% 48.4% 34.0% 21.9% 39.4% 16.3% 13.8% 10.4% 10.2% 12.6% 20.4% 19.8% 21.9% 24.1% 21.6%

Mississippian 0.2 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3Y-o-Y 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Y-o-Y% 25.1% 35.5% 19.8% 17.6% -5.3% 14.9% 2.0% 4.9% 6.2% 6.5% 4.9% 6.5% 6.0% 5.7% 5.4% 5.9%

Denver-Julesburg 0.8 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6Y-o-Y 0.0 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 0.0 -0.1

Y-o-Y% -2.5% -14.4% -13.0% -11.7% -10.6% -12.5% -9.7% -9.4% -9.2% -8.9% -9.3% -8.6% -8.2% -7.9% -7.5% -8.1%

Niobrara 0.1 0.2 0.2 0.3 0.3 0.2 0.3 0.4 0.5 0.5 0.4 0.6 0.6 0.7 0.7 0.6Y-o-Y 0.1 0.1 0.1 0.1 0.2 0.1 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2

Y-o-Y% 274.4% 92.3% 101.8% 110.9% 108.3% 104.3% 90.9% 83.0% 76.7% 71.2% 79.1% 66.0% 52.5% 49.0% 45.0% 52.0%

Permian 4.6 4.7 4.8 4.8 4.8 4.8 4.9 4.9 5.0 5.0 4.9 4.5 4.6 4.6 4.6 4.6Y-o-Y 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.1 0.1 0.1 0.2 -0.4 -0.4 -0.4 -0.4 -0.4

Y-o-Y% 3.8% 4.0% 4.1% 3.5% 3.6% 3.8% 4.2% 3.1% 2.8% 2.8% 3.2% -7.5% -7.5% -7.4% -7.4% -7.5%

Granite Wash 2.6 2.7 2.6 2.6 2.7 2.7 2.7 2.7 2.7 2.8 2.7 2.8 2.8 2.8 2.8 2.8Y-o-Y 0.0 0.1 0.1 0.0 0.0 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Y-o-Y% -0.5% 3.8% 2.0% 0.8% -1.0% 1.4% -0.2% 3.0% 3.7% 3.7% 2.6% 3.4% 2.7% 2.6% 2.6% 2.8%

Canadian Imports (Net) 5.4 5.0 4.9 5.4 4.2 4.9 4.7 4.7 5.1 4.1 4.6 4.2 4.4 4.8 3.9 4.3Y-o-Y -0.5 -0.4 -0.7 -0.7 -0.4 -0.6 -0.4 -0.2 -0.3 -0.2 -0.3 -0.4 -0.2 -0.3 -0.2 -0.3

Y-o-Y% -8.9% -7.7% -12.7% -11.3% -8.9% -10.2% -7.8% -4.1% -5.4% -4.1% -5.4% -9.0% -5.3% -6.1% -4.2% -6.2%

Mexican Exports (Net) -1.7 -2.1 -1.9 -2.2 -2.0 -2.0 -2.0 -2.1 -2.5 -2.2 -2.2 -2.2 -2.4 -2.7 -2.5 -2.4Y-o-Y -0.3 -0.7 -0.2 -0.3 -0.2 -0.3 0.1 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2

Y-o-Y% 24.5% 48.4% 10.8% 17.9% 12.9% 16.7% -3.5% 12.0% 10.4% 11.6% 11.6% 11.5% 10.9% 9.5% 10.5% 10.5%

LNG Imports (Net) 0.4 0.4 0.2 0.3 0.2 0.3 0.3 0.1 0.2 0.2 0.2 0.2 0.1 0.1 -1.0 -0.1Y-o-Y -0.4 -0.1 -0.1 -0.2 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 0.0 -0.1 -1.2 -0.3

Y-o-Y% -47.3% -25.0% -29.4% -38.6% -30.5% -31.0% -30.5% -32.4% -30.5% -30.5% -30.8% -30.5% -30.5% -30.5% -691.7% -174.5%

Total Supply 73.3 72.6 73.1 73.8 72.9 73.2 73.3 73.5 74.0 74.2 73.8 75.3 75.8 76.6 75.9 75.9Y-o-Y 2.1 -0.7 0.0 0.0 -0.2 -0.2 0.7 0.5 0.2 1.2 0.6 2.0 2.2 2.5 1.8 2.1

Y-o-Y% 3.0% -1.0% 0.0% 0.0% -0.3% -0.2% 1.0% 0.7% 0.3% 1.7% 0.8% 2.7% 3.1% 3.4% 2.4% 2.9%

Industrial 19.5 21.7 19.2 18.5 20.4 20.0 22.1 19.9 19.2 21.2 20.6 22.7 20.3 20.2 21.6 21.2Y-o-Y 0.6 1.0 0.5 -0.1 0.4 0.4 0.5 0.7 0.7 0.8 0.6 0.6 0.4 1.0 0.4 0.6

Y-o-Y% 3.1% 5.0% 2.6% -0.5% 1.8% 2.3% 2.1% 3.8% 3.5% 3.7% 3.3% 2.9% 1.9% 5.0% 2.0% 2.9%

Electric Power 24.9 20.0 21.0 28.2 19.6 22.2 20.1 21.6 28.8 20.1 22.7 21.2 22.8 29.9 21.3 23.8Y-o-Y 4.2 -1.7 -5.6 -3.3 -0.4 -2.7 0.1 0.6 0.6 0.6 0.5 1.1 1.1 1.1 1.1 1.1

Y-o-Y% 20.4% -7.9% -20.9% -10.6% -1.8% -11.0% 0.5% 2.7% 2.0% 2.9% 2.0% 5.7% 5.3% 4.0% 5.7% 5.1%

Res/Comm 19.4 40.1 13.7 7.5 27.5 22.2 35.0 12.9 7.5 27.3 20.7 35.4 12.8 7.4 27.2 20.7Y-o-Y -2.3 7.4 2.0 -0.5 2.3 2.8 -5.2 -0.8 0.0 -0.2 -1.5 0.5 -0.1 -0.1 -0.1 0.0

Y-o-Y% -10.4% 22.5% 17.6% -6.1% 9.2% 14.5% -12.9% -5.5% -0.4% -0.8% -7.0% 1.4% -1.0% -0.9% -0.5% 0.2%

Other (Lease Fuel, Pipeline Distribution) 5.9 6.4 5.6 5.9 6.1 6.0 6.6 5.8 6.0 6.3 6.2 6.8 5.9 6.2 6.5 6.4Y-o-Y 0.3 0.2 0.0 0.2 0.2 0.1 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2

Y-o-Y% 4.7% 3.6% -0.5% 3.0% 3.0% 2.3% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%

Total Demand 69.7 88.2 59.5 60.1 73.6 70.4 83.7 60.2 61.5 74.9 70.1 86.2 61.8 63.7 76.5 72.1Y-o-Y 2.8 6.9 -3.1 -3.8 2.5 0.6 -4.4 0.7 1.4 1.3 -0.3 2.5 1.6 2.2 1.6 2.0

Y-o-Y% 4.2% 8.5% -4.9% -5.9% 3.5% 0.9% -5.0% 1.2% 2.3% 1.7% -0.4% 2.9% 2.6% 3.6% 2.2% 2.8% Source: Credit Suisse, EIA, Bentek Energy, HPDI

03 October 2013


UK (NBP) prices: too high to burn, too low to import UK NBP (National Balancing Point) natural gas prices have remained largely range bound (within a 4 pence/therm range) since we last updated our forecast. Despite the modestly quiet spring/summer period, much of the supply-driven bullishness is still prevalent as prices are 6 pence/therm above equivalent 2012 levels. And with storage levels in the UK trending near five-year lows, year-over-year premiums should remain intact.

In our view, today’s near ten-year high NBP price is the result of the UK’s inflexibility of gas supply and growing reliance on continental (oil-linked) imports rather than LNG imports and continental shelf production. The current supply mix is expected to remain mostly unchanged until Asian price premiums subside or the availability of uncommitted LNG spot cargoes increases. Neither of which is forecast to come until 2017, at the earliest (see LNG section).

Meanwhile, natural gas demand continues to trend near five-year lows, providing little aid to today’s elevated price levels. During 2Q, UK clean spark spreads (the net revenue a generator makes from selling power fueled by natural gas) turned negative.

Leaving forecast unchanged as historical price premiums should hold

Marking to market 3Q. Prices averaged 2.45 p/therm higher than our forecast of 62 p/therm for 3Q 2013. UK injections failed to keep up with early season levels, keeping the year-over-year deficit intact. Today, storage levels at NBP are 87% full at 3914 Mcm, 10% less than year levels. Meanwhile, European gas storage levels have also lagged 2012 levels with aggregate EU stock levels 75% full versus 85% last year (Exhibits 97 and 98).

Exhibit 97: NBP storage remains notably low Exhibit 98: European storage levels Mcm

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000


5-yr Range 2013 2012

Hub Area Opening Stock

Capacity Max. Injection

Max. Withdrawal

Storage level %

Baumgarten 5,889,528 9,784,634 60,489 87,746 60.19

France 4,647,355 7,098,373 45,875 79,639 65.47

Germany 8,913,672 11,422,279 94,176 169,106 78.04

Portugal 77,413 97,431 734 2,642 79.45

Spain 1,087,694 1,348,002 6,716 10,093 80.69

NBP 2,362,136 2,709,677 36,083 49,413 87.17

PSV 7,253,041 9,053,716 49,824 84,557 80.11

TTF 799,697 1,182,777 6,459 29,360 67.61

ZEE 325,059 401,666 2,863 5,872 80.93

Totals 31,272,311 43,098,554 304,760 519,712 72.56


Exhibit 96: UK NBP natural gas forecastGBp/therm

PeriodActuals &

CS ForecastPrevious

Fcst FuturesBBG

Consensus*1Q12 (a) 57.97 2Q12 (a) 56.70 3Q12 (a) 55.11 4Q12 (a) 64.18

FY12 (a) 58.49 1Q13 (a) 66.04 2Q13 (a) 67.95 3Q13 (a) 64.45 62.00

4Q13 68.00 68.00 67.76 68.00

FY13E 66.61 66.00 67.25 67.33 1Q14 72.00 72.00 70.83 70.00 2Q14 65.00 65.00 63.70 63.33 3Q14 64.00 64.00 63.13 63.66 4Q14 70.00 70.00 67.98 72.30

FY14E 67.75 67.75 66.41 66.65 1Q15 71.00 71.00 70.94 2Q15 64.00 64.00 61.95 3Q15 63.00 63.00 61.37 4Q15 70.00 70.00 66.37

FY15E 67.00 67.00 65.16 67.00 FY16E 65.50 65.50 63.66 66.67 FY17E 65.00 65.00 63.08 64.18

Long-Term 61.00 61.00

*Bloomberg forecasts from previous three months only Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

03 October 2013


4Q 2013 prices are expected to average 6% higher than 4Q 2012 levels at 68 p/therm. Low inventory levels, declining UK continental shelf production and minimal LNG imports keep the reliance on continental (oil linked) imports high this winter.

2014 prices are expected to average 67.75 p/therm, 1.75 p/therm higher than the expected annual average price for 2013. Our global LNG outlook forecasts only 11 MTpa or 1.5 Bcf/d in 2014 with little of that targeting UK/European markets.

Demand – firmly stuck in the doldrums

UK natural gas demand stayed relatively unchanged yoy during 3Q, returning to reality after an extremely cold March/April 2013. Shown in Exhibit 99, average demand in 3Q was ~168 Mcm/d, just 1 Mcm/d above five-year lows witnessed during 3Q 2012.

The gas demand outlook is unlikely to change in the near term as generation economics still largely favor coal. In its 2013-2014 winter consultation, the UK Nation Grid mentioned that:

“for gas to become the preferred source of fuel for power generation this winter, the gas price needs to fall by c.50%, or there needs to be a doubling of the coal price, alternatively there needs to be a 10 fold increase in the carbon price to around €60/tonne.”

In fact, based on today’s UK clean spark spreads, UK gas generators are operating at a loss (Exhibit 100).

Exhibit 99: UK natural gas demand Exhibit 100: UK spark spreads Mcm/d GBp/MWh

100

150

200

250

300

350

400


5-yr range 2012 2013

-6

-3

0

3

6

9

12

15

18

21

24

27

30

Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13

UK Clean Dark UK Clean Spark Coal favored

Gas unfavored


Supply: pipeline imports will respond to price, winter demand but don’t look for LNG

In general, the UK has seen an trend of increasing reliance on imports from Norway and the Continent over the past three winters.

UKCS production has steadily fallen 33% from winter 2010-2011 to winter 2012-2013 as basin declines have clearly taken hold. This winter, however, new fields at Easington and Teeside and the return of the Elgin field could add upside to last winter’s levels.

Meanwhile, Norwegian and continental imports have increased a combined 35% or 7 bcm on average over the past three winters. Both import locations have remained very price elastic, with flows along the Interconnector UK increasing nearly 100% during 2012-2013 as prices reached daily highs of 74 pence/therm in March.

03 October 2013


Last, LNG imports have fallen on average 69% or 9 Bcm over the past three winters. This supply-side factor will remain subdued this winter as price incentives remain clearly pointed toward Asia where demand growth continues to climb.

Exhibit 101: UK winter gas supply by source Bcm

Source: National Grid, Credit Suisse

Exhibit 102: Monthly UK supplies by source Mcm/d

-100

-80

-60

-40

-20

0

20

40

60

80

Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13

UKCS Langeled BBL IUK LNG Send Outs


03 October 2013


Steel: Out of sync 2013 remains a China story for global steel production, with output in the Middle Kingdom having risen 8% year-on-year in the year to date, against a 2.3% decline for the rest of the world (RoW). The resilience of Chinese mills' run rates has exceeded our expectations but, with OECD acceleration yet to materialize, in aggregate we cut our 2013 global production forecast by 4 Mt to 1,571 Mt. For 2014, however, we raise our forecast to 1,651 Mt from 1,634 Mt, primarily on account of higher Chinese numbers, while also still reflecting the first stages of a RoW turn around.

A more stable macro backdrop, with tentatively improving industrial production, should be sowing the seeds of higher OECD output but this now looks to be more of a 2014 story than something likely to emerge in the immediate future. Our base case is therefore one of cautious optimism but the risk that a nascent developed market recovery is again derailed clearly cannot be ignored. Conversely, for China, having run above trend for much of this year, growth should slow to a degree over the next 12 months. That said, our 4.5% expected growth rate still exceeds that of many other nations.

The possibility that growth again matches close to 7% cannot be entirely ruled out, but it is certainly not our base case.

This year's demand has been aided by the bringing forward of previously announced infrastructure projects (see China Economics), as the government has sought to smooth growth. Absent wholly new projects being added to the current five-year plan, this recent additional demand growth should therefore be given back later in the cycle.

Higher China output has also filtered through to higher exports, putting RoW output under competitive pressure, particularly in the East Asian region. Without particularly strong demand at the aggregate global level, it would be very difficult to sustain both an OECD cyclical upturn and continuation of above-trend Chinese production.

Exhibit 103: Global crude steel output Exhibit 104: Crude steel production in major regionsMt, monthly, sa Mt, monthly, sa

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012 2013

25

30

35

40

45

50

55

60

65

70

3

5

7

9

11

13

15

17

19

21

2005 2006 2007 2008 2009 2010 2011 2012 2013

JKT EU27 USA China (rhs)

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

Chinese run rates yet to flag

Though down from peak run rates above 800 Mt/y, China's steel production is yet to show signs of the seasonal slowdown that has characterized 2H output over the past four years. Indeed, CISA's latest estimate for the middle ten days of September suggested a mild increase in aggregate output from 2.13 Mt/day to 2.14 Mt/day. In terms of the path taken by China's mills to get here:

RESEARCH ANALYSTS

Commodities Research Andrew Shaw

[email protected] +65 6212 4244

Marcus Garvey [email protected]

+44 20 7883 4787


Equity Research Michael Shillaker




analysts above.

https://plus.credit-suisse.com/r/gTbNWQ




03 October 2013


Output accelerated in 4Q 2012 (Exhibit 105) on the back of an upturn in both the infrastructure and construction cycles.

In turn, this was driven by the surge in social financing, China's broadest measure of credit, as non-traditional lending was allowed to balloon.

Despite this, production increases do appear to have been overdone, leading as they did to a dramatic build of finished steel inventories (Exhibit 106).

Rather than output then falling back, however, it maintained a steady, and high, level.

Instead, in order to facilitate this inventory destock, price played its role as the market's balancing factor – with rebar collapsing towards the lows of 2008-2009 (Exhibit 106).

Exhibit 105: China steel production has stayed strong Exhibit 106: And inventory has been worked down Mt/y, monthly Mt, weekly

300

400

500

600

700

800

900

2005 2006 2007 2008 2009 2010 2011 2012 2013

DAAR SAAR

4

6

8

10

12

14

16

Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13

Long (rebar, wire rod) Flat (HRC, plate, CRC)

Source: Credit Suisse, China NBS Source: Credit Suisse, MySteel

Exhibit 107: Price collapse cleared the market Exhibit 108: With better IP proving supportive RMB/t –Shanghai Rebar Percentage change (lhs), Index (rhs)

3000

3500

4000

4500

5000

5500

2007 2008 2009 2010 2011 2012 2013

40

45

50

55

60

65

-5%

0%

5%

10%

15%

20%

25%

30%

2005 2006 2007 2008 2009 2010 2011 2012 2013

CS China IP Indicator Markit PMI NO (rhs)

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse, China NBS

Now, with the inventory overhang removed and growth seemingly past its trough (Exhibit 108) the domestic market is on a firmer footing. However, in the very near term, production should still slow seasonally, allowing mills to build raw material inventory ahead of another 1Q upturn.

03 October 2013


East Asia tracking sideways

After a strong finish to 2012 and good first half of 2013, the waning of Abenomics' benefits on Japan's crude steel market has seen production fall 4.3% over the past three months. In June we flagged that Japan's year-to-date improvement then looked more a case of stealing growth from regional neighbors than something that would prove net additional at the aggregate level. Now, similarly, a stagnating yen has allowed for a recovery in South Korean and Taiwanese output – respectively up 6.5% and 3.3% over the same period.

Part of the region's failure to generate any consistent up-cycle can be explained by strong Chinese export volumes (Exhibit 109), which have been competitive on account of the low prices flagged above. However, the core problem to date has been the lack of a sustained acceleration in demand.

For 2014 specifically, a rising global tide should help to lift all ships and our equity colleagues (see Steel Sector Review) have also flagged the tentative stages of a demand recovery from both the domestic autos and construction sectors. An uptick should therefore be possible and, with Credit Suisse FX Strategy forecasting resumption of the yen's decline (targeting 115 to the USD in 12 months), Japan may also be able to relatively outperform.

Exhibit 109: JKT – taking tonnes from one another Exhibit 110: With additional pressure from China Mt, monthly, sa Mt, monthly, saar – China net steel product exports

5.0

5.5

6.0

6.5

7.0

7.5

8.0

7.0

7.5

8.0

8.5

9.0

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10.0

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11.0

2005 2006 2007 2008 2009 2010 2011 2012 2013

Japan South Korea + Taiwan (rhs)

‐10

0

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70

80

2005 2007 2009 2011 2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA Source: Credit Suisse, Customs Data

Europe yet to turn the corner

As detailed in Five Years After Lehman, Europe has proved the case in point for the failure of hard data to live up to the surveys (Exhibit 111), an issue which continues to be reflected in European steel volumes, where the slide in run rates has left them down 5.6% yoy ytd (Exhibit 112). However, in our view, they are now at or very close to trough levels.

In particular, the ongoing stabilization of final demand should provide the catalyst for a gradual turn in apparent demand and consequent restocking of inventories. In turn, production should reach an inflection point, with 2014 therefore presenting the possibility of a cyclical turnaround. This is not to call for anything of great magnitude, we are forecasting output of 175 Mt for CY2014 (still below 2011's total), but it should at least mark the end of Europe's role as a drag on global crude steel production.

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03 October 2013


Exhibit 111: EU PMIs and IP have diverged Exhibit 112: But steel may be arresting its slide Index (lhs),percentage change (rhs) Mt, monthly, sa

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2005 2006 2007 2008 2009 2010 2011 2012 2013

Eurozone IP mom (rhs)Eurozone Manufacturing PMI NOIP mom 3mma, annualised (rhs)

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2008 2009 2010 2011 2012 2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

Exhibit 113: As final demand appears to be stabilizing Index – Final domestic demand

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104

2008 2009 2010 2011 2012 2013

Euro area

US

Japan


Morning in America?

Outside of China, the US appears well placed to deliver proportionally higher volumes in the near future – we forecast CY2014 growth of 6.7% across NAFTA as a whole. Though higher rates do appear to have stalled the recovery in housing for now (see Another disappointing housing number), industrial production is again generating positive momentum (Exhibit 114), a factor which bears more weight in US ferrous markets, where construction only accounts for c.15% of demand.

Steel production has moved gradually higher, gaining 2.7% over the past four months, but has yet to truly follow suit. A pick-up of steel runs in line with IP should therefore offer reasonable upside to aggregate volumes.

In sum, there should be less reliance on China to do all the heavy lifting in 2014, as the year is likely to mark the beginnings of an OECD steel production recovery. This recovery will likely be dependent on improving final demand and, though generally moving in the right direction fragile improvements could still easily be derailed.

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03 October 2013


Exhibit 114: US IP is recovering Exhibit 115: But steel has yet to truly follow suit Index (rhs),percentage change (lhs) Mt, monthly, sa

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60

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70

-1.0%

-0.5%

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1.5%

2008 2009 2010 2011 2012 2013

US IP 3MMA Average Markit and ISM new orders (rhs)

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10

2008 2009 2010 2011 2012 2013

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, WSA

Exhibit 116: World crude steel production in 2006-2016 Mt

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016EU 27 207 210 198 139 173 178 169 167 175 178 184NAFTA 130 131 123 81 110 119 122 119 127 129 134China 424 493 499 574 624 684 717 770 805 835 860India 46 53 58 63 68 74 78 79 83 89 93Japan 116 120 119 88 110 108 107 109 114 116 117S Korea 49 51 54 49 58 69 69 67 70 73 75Taiwan 20 21 20 16 20 23 21 22 23 24 25Russia 71 72 69 60 67 69 70 71 75 78 80Ukraine 41 43 37 30 33 35 33 33 36 37 39Turkey 23 26 27 25 29 34 36 35 37 38 40Brazil 31 34 34 27 33 35 35 35 38 39 41RoW 90 92 93 61 66 66 64 64 68 70 72

Global Total 1247 1346 1329 1211 1392 1493 1519 1571 1651 1706 1760YoY 9.0% 7.9% -1.3% -8.9% 14.9% 7.3% 1.8% 3.4% 5.1% 3.3% 3.2%

ex-China 824 853 830 638 767 808 802 801 846 871 900

China YoY 19.7% 16.5% 1.1% 15.0% 8.8% 9.6% 4.8% 7.4% 4.5% 3.7% 3.0%ex-China YoY 4.1% 3.5% -2.6% -23.2% 20.3% 5.3% -0.7% -0.2% 5.6% 3.0% 3.3%

Source: Credit Suisse, World Steel Association

03 October 2013


Bulk Commodities: Iron Ore: Freight accompli As detailed in What goes up..., iron ore's price rally has outperformed our expectations on an aggressive raw material restock by Chinese steel mills (Exhibit 117), with the move in prices also exacerbated by a period of weak Australian shipments. This rally took prices back toward the top end of the $115-$140/t range in which they have traded for the better part of two years.

We then argued that prices should retreat from such highs, moving lower in the face of increased Australian export capacity, seasonally rising shipments from Brazil and a seasonal slowdown in Chinese steel production. To date, two of those three factors have begun to emerge, with iron ore prices starting to ease back. Nonetheless, the level at which we are entering 4Q leaves a clear need to mark our forecasts to market.

Consequently, we now expect 4Q prices to average $115/t, a 2014 calendar average of $104/t and a 2015 average of $90/t. We still expect iron ore to endure significant surpluses at times in both 2014 and 2015, with these prices – based on our proprietary cost curve analysis – required to trigger a sufficient market response. After this, the iron ore market should continue to be well supplied for some time but with prices gradually moving back toward our real long-term level of $90/t.

Exhibit 117: Mills' inventory cycle has again been key in 2013 Days inventory cover from imported ore (lhs); US$/t (rhs)

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130

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190

15

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45

Mar-11 Jul-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Sep-13

Avg Stock Days China CFR 62% Fe (rhs)

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, MySteel

Near-term market to loosen

In recent weeks, Australian shipments have not just recovered from their summer lull but appear to have moved materially higher, with Rio Tinto's ramp toward 290 Mt/y leading the way (Exhibit 118). Specifically, we expect it to ship 68.5 Mt in 4Q as compared to 56.5 Mt in 2Q. In addition, Brazilian exports have returned to levels not seen since 4Q 2012 and, while we still forecast a CY2013 decline of 6 Mt, in sequential terms we expect them to remain at similarly elevated levels through to the end of the year (Exhibit 119).

Such expectations are also being supported by the dramatic rally in Cape rates, with 4Q now trading close to $30,000 on increased iron ore fixings. To some degree, high freight rates can be supportive of CFR iron ore prices, though with a transfer of rents from miners to shippers. However, while iron ore and freight prices tend to move together when being pulled by demand, they generally head in opposite directions when being pushed by supply (Exhibit 120).

In our view, 4Q is setting up to be one of the latter occasions and we see little reason for the supply side of the equation to tighten the market's balance before the year is out.

RESEARCH ANALYSTS



Marcus Garvey



Equity Research Paul McTaggart


Matthew Hope


Martin Kronborg


Michael Shillaker


Liam Fitzpatrick


James Gurry


Ivano Westin


Nathan Littlewood


Neelkanth Mishra


Ishan Mahajan


Paworamon (Poom) Suvarnatemee


Ami Tantri




analysts above.

https://doc.research-and-analytics.csfb.com/docView?language=ENG&format=PDF&document_id=1021657921&source_id=emcmt&serialid=X20pSIwVobXt3a%2fn3HTNoiJs7vt0iWCGrPhqjl%2fW%2b4o%3d





03 October 2013


Exhibit 118: Australia's shipments taking a leg higher Exhibit 119: And Brazil's exports tracking seasonally Weekly, annualized run rate, Mt/y Mt, monthly, nsa

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2009 2010 2011 2012 2013

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35

2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Credit Suisse, Thurlestone Shipping Source: Credit Suisse, Customs Data

Exhibit 120: Freight and iron ore can move in opposite directions Prices in natural logs. Grey: freight rates driven by cargo supply. Pink: freight rates driven by cargo demand

4.4

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Baltic Dry Index Spot Iron Ore (rhs)


Turning to the demand side of the picture, Chinese steel production (see Steel section) has evidently held up better than we had expected. In light of this we still expect output to decline seasonally in 4Q but to a lesser degree than historical precedents would suggest.

On account of this, it is not our base case for rising supply to trigger an immediate and dramatic fall in prices. Rather, we think they will ease back as mills maintain or, taking advantage of such ample supply, slightly increase raw material stocks in preparation for their next output increase in 1Q 2014.

In terms of risks to this view, we see few potential catalysts for an immediate acceleration in run rates but, given the demonstrated resilience of mills' output, we have to consider the possibility that it could hold up close to current levels for the next three months. If this occurs, we believe that domestic steel markets would push into greater surpluses, furthering the sell-down of rebar, in which instance mills' margins would come under further pressure and there would be a real likelihood that they ran another destocking cycle; this they have already done twice in the past 18 months. This would then push iron ore prices lower on reduced apparent, if not actual, demand. Furthermore, were coking coal to continue its recent relative gains, this could provide the catalyst for iron ore to “catch down” to rebar prices.

03 October 2013


As with supply, we do not therefore see why demand would contribute to a tighter near-term market, even if good volumes are still being both purchased and consumed. Our base case is for prices to ease back but it would be short-sighted to dismiss the risk of an, albeit temporary, more dramatic downswing. Iron ore's volatility has been well demonstrated in recent years, with moves in either direction tending to overshoot.

Exhibit 121: Mills' margins coming under pressure Exhibit 122: As iron ore's outperformance continuesIndex Index

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130

Oct-11 Apr-12 Oct-12 Apr-13

Steel Raw Material Index Shanghai Rebar Index

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Oct-11 Apr-12 Oct-12 Apr-13

Iron Ore Index Shanghai Rebar Index HCC Index


2014 and 2015 – the key years to come

Once into 1Q next year we expect the market to tighten temporarily on reduced availability of domestically produced Chinese tonnage, as well as the usual weather disruptions to both Australian and Brazilian shipments. Thereafter, we believe the market will face its first true test of a period in surplus.

Against our base case steel projections we expect supply expansions, even after accounting for the loss of 40 Mt of domestic China output, to push the market into a 32 Mt surplus for 3Q and a 34 Mt surplus for 4Q, with this loosening of the market being driven primarily by the following:

Rio Tinto's completion of its ramp-up to 290 Mt/y, with quarterly run rates potentially exceeding this at times. Remember, the seasonality of shipping from Australia means shipments will almost certainly be below year-average rates in 1Q but above them in 4Q. Year-on-year shipment growth should total 40 Mt.

BHPB finishing the ramp of its 35 Mt/y Jimblebar expansion, taking nameplate capacity to 220 Mt/y. Year-over-year output growth should total 17 Mt.

FMG achieving a 155 Mt/y run rate as Solomon reaches 60 Mt/y capacity, as opposed to an expected 4Q 2013 operating rate of 20 Mt/y. Year-over-year output growth should total 49 Mt.

These three therefore account for 106 Mt of our 159 Mt increase in supply and underpin our view that sufficient, credible, expansion plans remain on course to move the market into surplus. In addition, the first throes of Vale's Northern System +40 Mt/y project should see it deliver an additional 12 Mt to market next year, while African Minerals should also ship a further 7 Mt on top of 2013 levels.

Also of note has been the nascent recovery of Indian exports, spurred on by the country's currency devaluation. Though we doubt that fresh production and shipments from Goa will be able to resume in advance of 4Q next year, East Coast volumes should hold close to this year's 12 Mt level and, if the ban on Goan exports is rescinded in late 4Q/early 1Q as expected, we believe they will follow Odisha's lead in liquidating existing inventory even before production has been brought back online. This should add a further 12 Mt of supply.

03 October 2013


Exhibit 123: Indian exports creeping back? Mt, monthly, sa

0

2

4

6

8

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12

14

2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Credit Suisse, Customs Data

2015 should then follow a similar pattern, with firmer pricing in 1Q before the remainder of the year provides iron ore with its second period of significant surplus. Again, the Australian majors should play a key role as BHPB de-bottlenecks its existing operation and Rio begins to take the initial steps on the path to 360 Mt/y capacity.

Brazil will also need to play a larger role here as Vale adds a further 28 Mt, Anglo finally starts the Minas Rio project, shipping 6 Mt, and Usiminas expands exports toward 6 Mt.

After allowing for a further 20 Mt reduction in Chinese output and on a more conservative timeline for Vale's expansions (for details, see Buy the management but short exogenous factors), we still believe the market will be required to make a 111 Mt adjustment in 2015.

Price falls required to balance the market

Were producers' aggregate behavior perfectly rational, on these base-case assumptions, prices would merely need to fall to the marginal cost of production, on which point it is worth noting that consensus price forecasts line up very well with the marginal cost of production on our proprietary cost curve (for details, see Iron Ore Cost Curves).

However, as has been demonstrated time and again, prices tend to reset costs. In the shorter term, many producers have high fixed costs and may often stay operational longer than supply cost curves might suggest. Prices invariably “undershoot” for a period of time before supply and demand come back into balance. Further, market-clearing is dominated by cargoes entering the market on nearer-term pricing, meaning sharper falls are likely as mills withdraw from purchasing volumes literally “at sea.”

On this basis, we believe that prices will average $104/t in 2013 and $90/t in 2015. This corresponds to cutting through the 83rd and 80th percentiles of our cost curve, respectively (Exhibits 125-124), against consensus prices sitting just below the 90th percentile.

Iron ore is unlikely to follow in the same pattern as thermal coal. Specifically, iron ore's supply cost structure, concentration of supply in essentially an oligopolistic market and point of single spot market liquidity, make a prolonged erosion of prices very unlikely. Rather, when in periods of surplus, we expect iron ore to experience a number of particularly sharp price corrections; higher cost supply should give way but not as a rigid edict – after all, every mine has its marginal tonne. Under conditions of excessive supply, the larger producers too are probably going need to withdraw volumes to rematch supply to demand.

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03 October 2013


Exhibit 125: Consensus prices line up well with 2014 MC

Exhibit 126: And 2015 too but we doubt this would trigger the requisite supply response

CS forecast – blue, consensus forecast – red, demand - black CS forecast – blue, consensus forecast – red, demand - black

BHP.AX CLF FMG.AX KIOJ.J RIO.AX VALE.N China Other Reported Cash Cost (FOB)

All-In Cash Cost (FOB)

All-In 62% IODEX equiv (CFR)

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0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400

US

$ pe

r dr

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etric

ton

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Million tonnes per annum

BHP.AX CLF FMG.AX KIOJ.J RIO.AX VALE.N China Other Reported Cash Cost (FOB)

All-In Cash Cost (FOB)

All-In 62% IODEX equiv (CFR)

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0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1500 1600

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Source: Credit Suisse, Customs Data, Company Data, China NBS Source: Credit Suisse, Customs Data, Company Data, China NBS

Upside risks to our base case

Inevitably there are a number of risks to our base-case scenario. First of these could be maintenance of growth rates closer to GDP parity, around 7%, for China's crude steel production. As discussed in the Steel section, we doubt the likelihood of this occurrence, certainly when coupled with our base case ex-China numbers; however, such an outcome would clearly tighten the forecast market balance.

Specifically, this would reduce our respective 2014 and 2015 market surpluses from 73 Mt and 111 Mt to 45 Mt and 42 Mt, respectively. In such a scenario, prices should still touch low levels on cyclical downdrafts but year-average levels would come in higher, likely around $115/t.

The second clear risk is for supply expansions, at least outside of the Australian majors, to fall well short of plans. To suggest a relatively extreme example, our market surplus would fall from 73 Mt to 25 Mt if major Australian expansions slipped back by an average of 20% and all other suppliers fell 50% behind our assumed rate of progress. This would leave a very similar surplus to that we postulate for 2013 but would still be unlikely to deliver quite such high realized prices, on account of fewer than our assumed 40 Mt of Chinese supply leaving the market.

In both these scenarios, prices would therefore be likely to exceed our base-case assumptions but still decline from 2013 levels. To achieve a higher annual average would probably require the double hit of both an upside surprise from demand and downside surprise from supply.

Downside risks to our base case

On the flipside of these scenarios there are also plausible outcomes that would lead prices considerably below our current projections.

First, a repeat failure to accelerate from OECD steel production or earlier move below trend growth for China would require a greater market adjustment, potentially forcing prices to fall well below US$100 for a more prolonged period.

The other major downside risk would be for Chinese domestic production to prove stickier than assumed. If prices below an average level of $104/t were required to remove our assumed 40 Mt of Chinese domestic production, 2H 2014 troughs would likely be lower and last for longer than we currently predict.

03 October 2013


We currently assume that China's output will have declined to 300 Mt/y by 2015; however, it should be remembered that 2009 output of 326 Mt was achieved against average prices of $80/t. A combination of inflation and depletion will have taken its toll on these respective levels, but there is a material risk that seaborne supply is forced to bear a greater share of the burden to cut back than we currently forecast.

Exhibit 127: Chinese production – price responsive but unlikely to disappear Mt, monthly, sa annualized (lhs), US$/t (rhs)

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300

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2006 2007 2008 2009 2010 2011 2012 2013

Domestic 62% Production SAAR TSI 62% China CFR (month avg. rhs)

Source: Credit Suisse, Customs Data

Exhibit 128: Iron ore forecast comparison Exhibit 129: Iron ore historical price and forecast US$/t US$/t

$80

$85

$90

$95

$100

$105

$110

$115

$120

$125

$130

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$50

$70

$90

$110

$130

$150

$170

$190

$210

2009 2010 2011 2012 2013 2014

Iron Ore (62% Fe CFR Tianjin spot) Quarterly avg forecasts

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Commodities Research

Exhibit 130: Forecast iron ore prices Units as indicated below, long-term prices based on 2012 real prices

2012 1Q-13 2Q-13 3Q-13 4Q-13f 2013f 1Q-43f 2Q-14f 3Q-14f 4Q-14f 2014f 2015f 2016f LT

Iron ore fines – 62% (China CFR) US$/dmt 128 148 125 131 115 130 115 110 100 90 104 90 93 90

Iron ore fines - (China CFR) US$/dmtu 206 239 202 211 185 209 185 177 161 145 167 145 149 145 Source: Credit Suisse Commodities Research

03 October 2013


Exhibit 131: Global iron ore supply/demand estimates and forecasts In millions of tonnes unless otherwise specified

2012e 1Q 13 2Q 13 3Q 13 4Q 13 2013f 1Q 14 2Q 14 3Q 14 4Q 14 2014f 2015f 2016fChina Crude Steel Production 717 192 197 195 186 770 201 210 201 192 805 835 860% Change 3.2% 10.0% 2.9% -1.2% -4.6% 7.4% 8.2% 4.4% -4.2% -4.4% 4.5% 3.7% 3.0%

World ex-China Steel Productio 802 199 210 195 197 801 210 218 208 210 846 871 900% Change 0.9% 2.8% 5.1% -7.1% 1.4% -0.2% 6.3% 3.6% -4.3% 1.1% 5.6% 3.0% 3.3%

World Steel Production 1519 391 407 390 383 1571 411 428 409 403 1651 1706 1760% Change 1.9% 6.2% 4.0% -4.2% -1.6% 3.4% 7.2% 4.0% -4.2% -1.6% 5.1% 3.3% 3.2%

Chinese statisticsTotal Chinese IO Demand 1088 285 296 293 279 1153 301 314 301 287 1202 1240 1270% Change 3.2% 7.7% 4.1% -1.2% -4.6% 5.9% 7.6% 4.4% -4.2% -4.4% 4.3% 3.2% 2.4%

Domestic Production (62%) 353 76 94 97 94 360 66 85 85 84 320 300 250% Change -15.6% -18.5% 23.9% 3.0% -2.4% 2.0% -29.7% 28.5% 0.0% -1.9% -11.1% -6.3% -16.7%

Iron Ore Inventories at Port 73 66 73 75 -- -- -- -- -- -- -- -- --% Change -25.7% -9.8% 11.0% 2.4% -- -- -- -- -- -- -- -- --

Seaborne demand (imports) 2012 2013 2014 2015China 746 187 198 202 206 793 223 212 218 229 882 940 1020% change 8.5% -3.5% 6.2% 2.1% 2.0% 6.4% 8.2% -5.1% 2.9% 5.3% 11.2% 6.6% 8.5%

Japan 131 32 34 34 34 133 34 35 36 35 140 142 143% change 2.0% -1.8% 5.2% -1.8% 0.0% 1.8% 1.3% 2.9% 2.0% -1.2% 4.6% 1.8% 0.9%

South Korea 66 15 14 16 17 62 16 16 16 17 65 68 70% change 1.8% -12.9% -2.7% 11.1% 6.3% -5.8% -6.0% 1.6% -2.8% 7.4% 4.5% 4.3% 2.7%

Taiwan 18 5 6 6 5 22 6 6 6 5 23 24 25% change -10.3% 42.0% 13.2% -8.3% -4.8% 19.5% 7.6% 0.8% 9.7% -12.2% 4.5% 4.3% 4.2%

EU 27 108 26 29 31 29 114 29 33 31 27 122 124 128% change -7.1% 1.2% 11.3% 6.6% -6.6% 5.3% 2.8% 13.7% -5.5% -13.1% 7.1% 1.7% 3.4%

World ex-China 404 97 105 107 105 413 106 112 112 106 436 447 457% change -8.7% -17.4% 7.7% 1.9% -1.8% 2.3% 1.3% 6.0% -0.5% -5.3% 5.6% 2.4% 2.3%

World 1149 284 303 309 311 1206 329 324 330 335 1318 1387 1477% change 1.8% -8.8% 6.7% 2.0% 0.7% 4.9% 5.9% -1.6% 1.7% 1.7% 9.3% 5.2% 6.5%

Seaborne supply (exports) 2012 16.9 2013 2014 2015Australia 494 125 142 151 159 576 156 173 176 179 683 720 779% change 12.5% -8.8% 13.5% 6.2% 5.6% 16.7% -1.7% 10.5% 1.9% 1.5% 18.6% 5.4% 8.2%

Brazil 327 68 77 87 90 321 76 80 94 95 346 404 437% change -1.3% -30.4% 12.8% 12.9% 3.6% -1.8% -14.8% 5.4% 16.9% 1.4% 7.8% 17.0% 8.0%

India 35 2 3 4 4 13 5 7 5 8 24 32 32% change -56.8% 198.6% 45.5% 25.0% -12.5% -63.3% 42.9% 30.0% -30.8% 77.8% 86.0% 33.3% 0.0%

Other LatAm 28 7 8 7 7 29 8 8 8 8 31 31 31% change 5.3% 7.3% 1.4% -6.7% 1.8% 3.3% 7.0% 0.0% 0.0% 0.0% 7.0% 0.0% 0.0%

South Africa 54 15 16 15 15 61 15 15 15 15 60 60 60% change 1.3% 14.1% 6.5% -11.0% 0.0% 12.9% 0.1% 0.0% 5.6% 0.0% -1.4% 0.0% -0.4%

Other Africa 20 6 7 8 8 30 10 10 11 11 43 52 59% change 65.8% -6.2% 16.4% 16.5% 0.0% 49.5% 23.9% 0.7% 6.8% 0.0% 43.3% 22.2% 13.4%

North America 36 8 10 12 12 42 11 11 11 11 45 41 40% change 4.9% -10.0% 33.3% 10.6% 0.0% 17.0% -1.1% 0.0% 0.0% 0.0% 9.2% -9.1% -3.9%

EU27 9 2 2 3 3 9 3 3 3 3 10 10 11% change 2.9% -29.8% 5.3% 20.8% 0.0% 0.0% 4.8% 0.0% 0.0% 0.0% 16.0% 0.0% 3.0%

RUK 73 18 17 19 19 72 18 18 18 18 74 73 73% change 0.3% -3.5% -1.7% 7.5% 0.0% -1.6% -0.9% 0.0% 0.0% 0.0% 2.3% -0.7% -0.7%

Other 74 20 20 20 20 81 20 20 21 21 76 73 70% change 5.1% 6.8% 0.0% 0.0% 0.0% 9.4% 0.2% 0.5% 1.2% -0.9% -6.8% -3.2% -4.1%

World 1149 272 303 324 335 1233 323 345 362 369 1392 1498 1591% change 1.8% -12.6% 11.5% 7.0% 3.4% 7.3% -3.6% 6.9% 4.8% 2.0% 12.9% 7.6% 6.2%

Required Market Adjustment --- -12 0 15 24 27 -6 21 32 34 73 111 114

Source: Credit Suisse, Customs Data, Company Reports, WSA

03 October 2013


Metallurgical Coal: Better but not good Met coal prices move off their lows

In the last couple of weeks, 4Q benchmark settlements for metallurgical coal have emerged. According to McCloskey, hard coking coal for 4Q 2013 delivery has been settled by BHP Billiton and Nippon at $152/tonne FOB for Peak Downs and $148/t for Goonyella. This compares to a 3Q benchmark for Peak Downs of $145/t and was in line with prevailing spot pricing for Peak Downs product.

Platts reports that Posco has agreed 4Q low vol PCI prices at $120.50/t (up from $116/t) with JFE agreeing semi-soft at $105/t (rollover on 3Q pricing). This represents a PCI HCC linkage rate at 79% of Peak Downs pricing compared to 80% in 3Q. The semi-soft linkage rate has moderated from 72.4% to 69%.

Exhibit 132: Premium hard coking coal prices have shown a very modest lift in latest settlements FOB Australia, US$/t

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Source: McCloskey, Credit Suisse Commodities Research

Too early to crack the champagne corks, very much a China drive move … and price arbitrage has now closed

At the time of our last quarterly, spot prices for HCC were languishing at $135/t and we were pointing to the expectation of production curtailments being required to allow for an eventual recovery. The good news for met coal markets is that since our last quarterly review, demand has surprised on the upside.

Word pig iron output was up 7.4% yoy in August, with China up 11.5% and world ex-China up 1.4%. Year to date, pig iron production in those countries fed by seaborne met coal is up 4.9%, with China up 7%. However, seaborne ex-China pig iron production is down 1.3%, so it is clear that China’s steel production strength is underpinning met coal markets (at least for now).

The fact that Japan’s and India’s steelmakers settled quickly this quarter is probably a reflection of the fact that China has been active in met coal markets, with reports of prices of $170/t CIF being offered by shippers in the lead up to price settlements. Exhibit 133 illustrates that export and domestic prices have now converged, with China demand closing the gap.

03 October 2013


Therein lies a risk. As we’ve noted before, China remains the only country capable of singularly adding meaningfully to seaborne demand and it remains ~85% self-sufficient in met coal. China’s imports of met coal will remain essentially a function of the price arbitrage between domestic and seaborne pricing.

Exhibit 134: World pig iron production (Mt) Seaborne

EU (27) Japan Korea, Taiwan China Seaborne (1) ex China World (41) World ex China2007 116.8 86.8 39.6 468.5 711.7 243.2 943.3 474.82008 108.0 86.2 40.8 468.4 703.4 235.0 924.0 455.62009 72.5 66.9 35.8 542.8 718.0 175.2 905.3 362.52010 95.3 82.3 42.5 583.6 803.7 220.1 1024.7 441.22011 94.7 81.0 54.0 627.8 857.6 229.8 1081.0 453.12012 91.0 81.2 54.1 648.0 874.4 226.4 1095.5 447.4

Jan-12 7.0 6.4 4.6 48.0 66.0 18.0 85.1 37.1Feb-12 7.5 6.4 4.3 53.4 71.6 18.2 89.2 35.7Mar-12 8.2 7.0 4.7 57.5 77.4 19.9 96.4 38.9Apr-12 8.0 6.7 4.5 56.8 76.0 19.2 94.3 37.6May-12 8.3 6.8 4.5 57.3 77.0 19.6 95.9 38.6Jun-12 7.9 6.8 4.4 55.7 74.8 19.1 93.4 37.7Jul-12 7.8 7.1 4.7 56.3 75.9 19.6 94.4 38.1

Aug-12 7.4 7.2 4.7 53.7 73.1 19.3 91.0 37.2Sep-12 7.5 6.7 4.5 52.9 71.6 18.7 90.0 37.1Oct-12 7.4 6.8 4.5 54.0 72.6 18.6 91.4 37.4Nov-12 7.2 6.6 4.2 51.4 69.4 18.0 87.1 35.6Dec-12 6.8 6.7 4.5 50.9 68.9 18.0 87.3 36.4Jan-13 6.8 6.7 4.5 50.9 68.9 18.0 87.3 36.4Feb-13 7.1 6.4 4.0 57.1 74.4 17.4 92.0 34.9Mar-13 8.0 7.2 4.2 61.6 80.9 19.3 100.4 38.8Apr-13 7.7 6.8 4.2 60.7 79.4 18.7 98.2 37.6May-13 8.2 7.2 4.5 61.1 81.0 19.9 100.1 38.9Jun-13 7.8 6.9 4.6 58.3 77.6 19.3 96.1 37.7Jul-13 7.6 7.3 4.6 60.0 79.5 19.4 98.1 38.1

Aug-13 7.4 7.1 4.5 59.9 79.0 19.0 97.7 37.82012 YTD 62.1 54.5 36.4 438.8 591.8 153.0 739.7 300.92013 YTD 60.5 55.5 35.0 469.6 620.7 151.1 769.8 300.2

Chge YTD -2.6% 1.9% -3.8% 7.0% 4.9% -1.3% 4.1% -0.2%2013 Ann'd. 90.8 83.3 52.5 704.5 931.1 226.6 1154.7 450.2

YoY -0.5% -0.7% -4.1% 11.5% 8.1% -1.4% 7.4% 1.4%

Note: (1) EU27, Japan, South Korea, Taiwan, China

Source: World Steel Association, Credit Suisse estimates

Australian exports recovered: BHP Billiton leads the way

The pick-up in China demand for met coal has also corresponded with the normalization of Australian export tonnes. Australian met coal exports are now running at around 14 Mt/m (168 Mt/y) compared to flood-impacted lows of 8-9 Mt/m. Looking forward, the key Australian producers are all aiming to lift met coal output in the next 24 months.

BHPB’s Queensland coal operations have been back at 100% of supply chain capacity for some months, with exports (100% basis) of 51.4 Mt in FY2013, a level last achieved in FY2010 (with the last three years being weather impacted). BHP expects that in FY2015 Queensland exports will be ~66 Mt given the Hay Point port expansion.

In all, BHPB Coal is spending US$10 billion (100% basis) on eight discrete projects, five of which are complete. The major projects include the Daunia and Caval Ridge mines, Broadmeadow life extension, Appin Area (underground mine to sustain Illawarra capacity using existing long-wall equipment) and the Hay Point port expansion (from 44 to 55 Mt/y capacity).

Smaller projects (<$0.5 billion) include the South Walker Creek prep plant upgrade (increases yield by 9% points), Broadmeadow top coal caving (which could add 2-3 Mt/y to nameplate capacity), Kalimantan coking coal (now scaled back to a 1 Mt/y project with BHPB’s share of costs at $80M). BHPB’s new Daunia mine has commenced production and the company has reportedly tendered two new brands into the market (Woodlands and Windsor), believed to include tonnage from the new mine.

03 October 2013


In all, we expect Australian met coal exports to increase by 7 Mt (4%) and 12 Mt (7%) in 2014 and 2015.

Mongolia and Mozambique are the other principal sources of new tonnes but remain significantly less important that Australia.

US exports moderate but remain elevated

The US met coal producers have been going through a difficult period given the lower prices of the last 12 months. Exports peaked in (mid-2012) at rates over 70 Mt/y and have now moderated but remain elevated around 50 Mt/y. While lower, this level is still well above the pre-financial crisis levels of ~25Mtpa.

US producers have been curtailing production at higher cost mines, but expanded tonnage at lower cost operations has slowed the net reduction in export volumes. While in the last quarter, we estimate that around 6 Mt/y of production has been idled (driven by Arch Coal and Alpha Natural Resources), other met coal producers have been expanding met coal production (e.g., Walter Energy).

4Q price increases for met coal, albeit modest, should help to keep US tonnage in the market. With this backdrop, we still believe that North American met coal exports in 2014 and 2015 will be up modestly on 2013 levels.

China coke reforms won’t offset rising demand

In the seven months to end July of this year, China’s coke production has expanded by 7.1% to 276 Mt. Pollution has become a growing concern within China and the current five-year plan looks to close 42 Mt/y of outdated capacity, much of it targeted for Shanxi province, the main coal-producing region. That said, the government is looking to see the larger, more efficient producers expand production and has mandated building in Shanxi an aggregate 120 Mt/y of coking “parks” or conglomerates by 2015.

China has replaced much of the less-efficient coke batteries with stamp charging systems that allow the manufacture of better strength coke from domestic coal. Also, the slowing of steel production growth since 2007-2008 has lessened the pressure on exploiting deeper, higher sulfur-bearing coking coal as has a shift away from ever-larger blast furnaces (2,000m3 configurations seem to be preferred) which have provided greater flexibility in terms of use of coals and coke properties.

China’s exports of coke in the first seven months of this year were 2 Mt, an average of 285 kt/m compared to lows of 100 kt/m in 2012. The increase reflects the lifting of the 40% export tax introduced in 2012.

However, given our raised forecasts for China steel production (770 Mt in CY2013 reaching 860 Mt in CY2016), China’s demand for coke/coking coal is likely to outpace indigenous capacity growth, and we look for imports of met coal to reach 69 Mt in CY2013 (up from 61 Mt) and 89 Mt in CY2016 (up from 78 Mt).

Supply-demand balance improved, but US swing capacity to limit price growth

After reviewing our supply-side work, we have reduced our assumed met coal supply by around 2 Mt/y compared to our previous estimates. Weaker prices have already made their impact felt in the US. On the demand side, our higher global steel production forecasts have seen an improved market balance in our S&D modeling. Whereas we were forecasting a modest market surplus of 12-14 Mt/y over the period 2014-2016, we now see a largely balanced market.

The US will remain the swing producer, while China is swing demand. In the absence of supply disruptions – near- to mid-term met coal prices will likely be limited by (i) China price arbitrage (now closed) and (ii) US production that can likely return to the market should prices move up too aggressively.

03 October 2013


Forecasts unchanged

We have marked to market our 4Q prices for the recent settlements. Our 2014-2015 price forecasts are unchanged. While our S&D modeling shows an improved dynamic, the strength of China demand will remain an unknown. In particular, we do not have good visibility on China’s ability to expand domestic coke production in line with steel production. With this in mind, we think it prudent to hold our view that HCC prices can increase to $180/t over time, capped by US swing tonnage and China’s swing demand.

Exhibit 135: Australian exports – back on the rise Exhibit 136: US exports – ebbing but still present Mt, Monthly, SA Mt, Monthly, SA

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Source: Credit Suisse, Customs Data Source: Credit Suisse, Customs Data

Exhibit 137: OECD imports – a bit better than flat Exhibit 138: China and India imports – volatile Mt, Monthly, SA Mt, Monthly, SA

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Exhibit 139: Metallurgical coal forecast comparison Exhibit 140: Met coal historical price and forecast US$/t US$/t

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Hard coking coal spot Quarterly avg forecasts


Exhibit 141: Forecast metallurgical coal contract prices, FOB Australia Units as indicated below, long term prices based on 2011 real prices


Hard coking coal US$/t 210 165 172 145 152 159 160 160 165 165 163 173 178 165

Semi soft coal US$/t 139 116 120 105 105 111 112 112 116 116 114 121 124 115

PCI coal US$/t 154 124 141 116 121 125 126 126 130 130 128 136 140 125 Source: Credit Suisse Commodities Research

03 October 2013


Exhibit 142: Global metallurgical coal supply and demand estimates Mt, Surpluses or deficits show market capacity but actual imports/exports should balance at the time

Importing Country 2012e 1Q 13 2Q 13 3Q 13 4Q 13 2013f 1Q 14 2Q 14 3Q 14 4Q 14 2014f 1Q 15 2Q 15 3Q 15 4Q 15 2015f 2016f

China 54 17 18 13 17 69 15 19 19 22 75 17 21 22 25 85 89% change 20.0% 1.1% 5.6% -28.4% 27.7% 29.4% -10.3% 26.3% 3.2% 14.0% 8.5% -24.0% 26.3% 3.2% 14.0% 12.8% 432.4%

India 36 8 10 9 10 37 8 11 10 10 39 8 12 11 11 42 44% change 8.3% -12.5% 39.6% -9.8% 1.2% 3.7% -18.6% 43.0% -10.8% 1.2% 5.1% -16.9% 43.0% -10.8% 1.2% 7.2% 425.0%

JKT 78 18 21 22 21 80 21 21 22 21 85 21 21 23 22 88 89% change -3.5% 1.0% 14.0% 4.7% -2.9% 2.7% -1.8% 0.3% 7.4% -3.8% 6.8% -0.9% 0.3% 7.5% -3.8% 2.7% 319.2%

EU 27 37 9 10 10 10 37 10 9 10 11 40 10 9 11 11 41 42% change -5.7% -1.1% 4.3% -0.4% 3.1% 0.3% -3.6% -5.0% 14.0% 3.1% 7.6% -8.9% -5.0% 14.0% 3.1% 1.7% 328.9%

Turkey 7 1 1 2 2 6 1 1 2 2 7 2 2 2 2 7 7% change 60.2% -26.5% 0.2% 14.3% 18.7% -2.0% -22.5% 0.2% 14.3% 18.7% 5.3% -24.6% 0.2% 14.3% 18.7% 2.5% 367.2%

North America 7 1 2 1 2 6 1 1 1 2 6 2 1 1 2 6 6% change 6.0% -56.2% 92.6% -2.8% 6.4% -17.9% -3.9% -2.3% 1.6% 6.7% 7.0% -5.2% -2.4% 1.7% 6.8% 0.4% 307.0%

Brazil 11 3 3 4 3 13 3 3 4 3 14 3 3 4 3 15 15% change -6.0% 13.9% 6.7% 29.0% -23.3% 14.7% 2.9% 6.7% 29.0% -23.3% 8.6% -2.8% 6.7% 29.0% -23.3% 2.6% 379.7%

Chile 1 0 0 0 0 2 0 0 0 0 2 0 0 1 1 2 2% change 17.7% -7.8% 18.7% 5.4% 1.8% 15.4% -10.9% 18.7% 5.4% 1.8% 13.3% -12.2% 18.7% 5.4% 1.8% 11.8% 370.9%

RoW 48 13 13 13 13 53 14 14 14 14 57 15 15 15 15 61 63% Change -3.6% 8.9% 0.0% 0.0% 0.0% 8.9% 7.8% 0.0% 0.0% 0.0% 7.8% 7.6% 0.0% 0.0% 0.0% 7.6% 315.0%

World 278 71 79 74 77 302 74 81 84 86 325 78 86 89 91 345 358

% change 2.6% -1.3% 11.1% -5.3% 3.8% 8.7% -4.7% 9.6% 4.2% 2.1% 7.3% -9.1% 10.0% 4.1% 2.3% 6.3% 358.7%

Exporting Country 2012e 1Q 13 2Q 13 3Q 13 4Q 13 2013f 1Q 14 2Q 14 3Q 14 4Q 14 2014f 1Q 15 2Q 15 3Q 15 4Q 15 2015f 2016f

Indonesia 6 1 2 2 2 7 2 2 2 2 7 2 2 2 2 8 8% change 39.2% -7.7% 7.4% 7.8% 12.6% 6.3% -17.1% 7.4% 7.8% 12.6% 8.0% -17.1% 7.4% 7.8% 12.6% 8.0% 353.5%

Australia 144 38 42 39 40 158 38 41 43 43 165 41 44 46 46 177 182% change 8.6% -5.3% 11.5% -7.9% 3.9% 9.2% -5.1% 8.7% 4.0% 0.0% 4.6% -4.9% 8.7% 4.0% 0.0% 7.5% 345.8%

Russia 17 5 6 5 5 20 4 6 5 6 21 4 6 6 6 22 24% change 16.4% -7.8% 17.0% -12.7% -6.3% 18.2% -14.5% 44.3% -3.0% 11.6% 6.6% -31.7% 44.3% -3.0% 11.6% 6.6% 476.3%

South Africa 3 1 1 1 1 3 1 1 1 1 3 1 1 1 1 3 3% change 0.0% -15.8% -3.8% 15.5% 6.9% 0.0% -15.8% -3.8% 15.5% 6.9% 0.0% -15.8% -3.8% 15.5% 6.9% 0.0% 325.5%

Mozambique 3 1 1 2 2 6 2 2 2 2 10 3 3 3 3 12 18% change 99.4% 15.0% 4.3% 58.3% 0.0% 90.7% 25.3% 0.0% 0.0% 0.0% 54.0% 27.2% 0.0% 0.0% 0.0% 27.2% 482.9%

Colombia 1 0 1 1 1 2 1 1 1 1 3 1 1 1 1 3 4% change -9.7% -33.3% 150.0% 0.0% 0.0% 88.2% 24.5% 3.2% 0.4% -8.5% 47.1% 26.6% 3.2% 0.4% -8.5% 20.0% 368.5%

North America 94 25 23 22 23 93 22 24 24 25 96 23 24 24 25 97 97% change 3.8% 12.3% -5.7% -5.2% 5.5% -1.8% -3.2% 7.5% 0.0% 3.4% 3.5% -9.1% 7.7% 0.0% 3.4% 1.2% 327.0%

China 1 0 0 0 0 1 0 0 0 0 1 0 0 0 0 1 1% change -63.6% -19.2% -6.7% -10.7% 0.0% -23.6% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 300.0%

Mongolia 19 3 3 5 6 19 3 6 6 7 22 3 7 7 8 25 27% change -4.8% -58.7% 30.8% 61.5% 8.3% -0.4% -50.4% 97.0% 9.5% 8.3% 15.8% -51.4% 97.0% 9.5% 8.3% 13.6% 706.0%

World 288 73 78 76 79 307 73 82 85 87 326 77 88 90 93 348 362

% change 6.4% -4.9% 6.7% -2.9% 4.1% 6.4% -8.0% 13.3% 2.7% 2.6% 6.4% -10.9% 13.6% 2.8% 2.6% 6.6% 368.3%

Surplus / Deficit 10 2 -1 1 2 4 -1 2 0 1 2 -1 2 1 1 3 4As a % of exports 3.5% 3.3% -0.7% 1.9% 2.1% 1.4% -1.3% 2.0% 0.5% 1.1% 0.5% -1.0% 2.2% 0.9% 1.2% 0.8% 1.1% Source: Credit Suisse, World Steel, Customs Data, Company Reports

03 October 2013


Thermal Coal: Taking the low road Thermal coal has endured a quarter of Stagnation, very much in line with our expectations from June. A number of market drivers do appear to be past their most bearish nadir, but a lack of producer discipline and consumers' well demonstrated price sensitivity leave few catalysts for the market to stage anything other than an anemic recovery.

Many of the challenges facing thermal coal increasingly appear to be structural rather than cyclical (The Shale Revolution II) and, while there should be somewhat better times in the years to come, for now, the market's best days do look to be behind it. In consequence, we again downgrade our forecasts, expecting FOB Newcastle coal to average $80/t in 4Q, $85/t in 2014 and $88/t in 2015. We also cut our long-term price to $95/t from $100/t.

In terms of the immediate market outlook, we expect prices to trade in fairly range-bound fashion around current levels. The end of Drummond's strike does introduce a degree of downside risk, but we believe it will more cap upside possibilities than push things materially lower. The pressure from US exports has begun to ease, particularly as some of last year's term deals roll off, and Indonesian shipments are finally falling back from peak annualized rates above 400 Mt/y.

That said the rupee's collapse will almost certainly curb Indian buying and an open arbitrage remains the key to China's appetite for seaborne coal, meaning neither is likely to bid thermal prices higher. Outside of these two, Japanese demand remains elevated, and coal continues to place above gas in the merit order almost everywhere outside of the domestic US but, in our view, this remains insufficient to tighten the market much. There is still no obvious contender to be caught short of coal and then have to bid the spot market.

Exhibit 143: Seaborne thermal benchmarks US$/t

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An all too familiar supply-side story

A surfeit of available material continues to be the coal market’s main driver, keeping prices under pressure. To date, producers have shown little inclination to cut back on output, with Indonesian exports up 20% yoy ytd, while Australian volumes have also moved higher, rising 14% yoy ytd. Defying our expectation that junior miners would begin to take some volume out of the market this year, Indonesian producers have managed to cut operating costs by concentrating on areas within their mine sites that benefit from lower strip ratios.

We do, however, view this as a temporary rather than sustainable change and, on our current price outlook, believe 2014 will see volumes fall back 5% for the country’s juniors,

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https://plus.credit-suisse.com/u/DOak5c

03 October 2013


especially if margins come under further pressure from a revision to IUP contracts, which would increase tax rates from a band of 3%-7% to 10%-13.5%. Such changes should not impact the larger miners that operate under CCOW licenses. That said, a dispute between Bumi’s Arutmin subsidiary and the contractor Thiess is likely to see a drop in the miner’s output from 74 Mt this year to 65 Mt in 2014, resulting in a net decline of 10 Mt for 2014 Indonesian volumes, despite expansions elsewhere from Berau and Harum, among others.

After this, we expect volume growth to return from 2015, albeit at a slower pace than the 13% CAGR achieved from 2008-2013, given our outlook for only slow and incremental improvements in seaborne prices.

In the case of Australia, take or pay contracts have reinforced their role as the market’s bête noir, incentivizing the continuation of low margin production and exports. This, in combination with the expansion of lower cost operations and producers’ aggregate efforts to minimize average costs by maximizing output, has seen exports increase 14% yoy ytd. Far from being a short-term problem, some take-or-pay contracts extend beyond the next ten years. Moreover, with the cost of “paying” averaging around $20/t (port plus above and below rail charges), prices would need to be a similar distance below costs before the incentive not to produce clearly crystallized.

Exhibit 144: Indonesian exports Exhibit 145: Australian exports Mt, monthly, sa Mt, monthly, sa

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In contrast to the big two seaborne suppliers, Colombia’s volumes have been extremely weak this year, buffeted by a series of labor disputes. Most recently, Drummond's strike appears to have taken 3.5 Mt out of the market in 3Q and CY2013 total volumes should only now come in around 71 Mt, down from 80 Mt in 2012. This underperformance has evidently reduced the extent of oversupply and, in large part, is why we now only see a 5 Mt surplus for 2013. Conversely it creates the potential for a 21 Mt jump in Colombian volumes in 2014.

Given the regularity of labor disputes, however, we see a reasonable risk of a recurrence in future years and so add 20% slippage to the recovery and expansion of Colombian tonnes. If Colombia were to suffer no disruptions during CY2014 and Bumi to resolve its contractor dispute before the start of, or at least early within, the New Year our market surplus would be 21 Mt, rather than the currently projected 6 Mt.

One bright spot for prices has been the easing of US exports, down from a peak of 70 Mt/y, to a year-to-date average of 48 Mt/y. The US’ blow out from net exports of 1 Mt in 2009 to 44 Mt in 2012 was a key contributor to thermal coal’s move into surplus and, therefore,

03 October 2013


even a mild reversal of this move is positive for the market. That said, despite power plant burn rates improving from 47 Mt in April 2012 to 76 Mt by June of this year, the US domestic market remains in surplus and we expect shipments to stabilize close to current levels rather than diminish significantly further. Moreover, if the seaborne market were to tighten sufficiently for DES ARA prices to rally back towards $100/t, for example, we would expect to see a significant pick-up in the volumes of US coal being offered for export.

Many US producers are now structurally looking to the seaborne market as a source of solace from domestic competition from gas and this is an inescapably bearish supply-side factor for global thermal coal. Rather than being a mere swing supplier, US exports appear to be here to stay and their capacity to re-emerge in greater volume would likely act as a brake on any attempt by the market to stage a substantial and sustained rally.

Exhibit 146: Colombian exports Exhibit 147: US exports Mt, monthly, sa Mt, monthly, sa

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Demand: No one to the rescue

China continues to set the pace among importers of seaborne coal and year-to-date volumes are tracking in line with our 192 Mt forecast for CY2013. Though the recent IP rebound (see macro section) has added to electricity demand, much of the summer's strength appears to have come from increased air-con demand on account of particularly high August temperatures. However, even after this pick-up in coal burn, IPP inventories of 19 days’ cover remain high. Furthermore, as we have highlighted previously (for example, see Unabated Abundance), the growth of imports since 2009 has depended more on the open arb for seaborne coal into the domestic market than on particularly exuberant demand growth.

As Exhibits 148 and 149 illustrate, while imports have continued to grow apace this year, it has essentially been at the expense of marginal domestic producers. Domestic raw coal production has fallen back in recent months and the availability of cheap imports also appears to have weighed on domestic prices. Again, the requirement for this arb to be open is now a structurally bearish feature for the thermal market. Having been a swing buyer when the seaborne price dipped below domestic levels before 2009, China should now account for 21% of global imports in 2013. As such, were seaborne prices able to rally to the extent that the arb closed, we would expect the resultant waning of Chinese demand to curb further price gains in fairly prompt fashion.

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Exhibit 148: China imports of thermal coal Exhibit 149: China domestic output under pressure Mt, monthly, sa Mt, monthly, sa (lhs); US$/t, excluding export taxes (rhs)

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Source: Credit Suisse, Customs Data Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, SxCoal

Indian imports picked up strongly in 2Q, responding to thermal's continued price declines. However, the rupee’s recent troubles should retard the near-term pace of import growth, playing on importers' well demonstrated price sensitivity. As Exhibit 150 highlights, India’s aggregate purchases have lagged price moves in rupee-denominated seaborne coal, picking up significantly in 4Q 2012 after the price falls of 3Q, before waning in 1Q 2013 after prices had rallied back into the end of the year. Recent dynamics suggest a repeat of this pattern is now possible, with rupee prices for Richards Bay coal now returning to levels not seen since last December.

Indian imports should continue to play a key role in market demand growth, but this price sensitivity is likely to remain a key feature for some time. So long as electricity prices preclude the direct pass-through of higher imported coal prices, any seaborne market rallies are likely to result in clear demand destruction.

Japanese imports have been running around 140 Mt/y ytd and, if successful, the third arrow of Abenomics may see further incremental gains. However, at current burn rates above 5 Mt/month, Japanese utilities are already running an aging coal fleet around 90% utilization. This limits the extent to which consumption, outside of direct industrial use and the production of cement, can materially increase and raises the risk of outages for boiler maintenance.

Japan is slated to add 1.6 GW of new capacity over 2013 and 2014 but we only forecast an incremental 3 Mt of demand from this on account of it likely cannibalizing a small portion of older plants’ utilization rates. In sum, the country remains a very large part of seaborne demand but a rather constant one at that. Japanese utilities, with their preference for high quality coal, should continue paying premium prices to obtain it, but their limited demand upside effectively precludes them from being the primary source of a tighter market.

03 October 2013


Exhibit 150: India imports vs. rupee coal prices Exhibit 151: Japan imports Mt, monthly, sa (lhs), Rupees/t (rhs) Mt, monthly, sa

4200

4400

4600

4800

5000

5200

5400

5600

4

6

8

10

12

14

16

2011 2012 2013

India Thermal Coal Imports (Mt)

Richards Bay FOB Thermal Coal (INR/t), rhs

0

2

4

6

8

10

12

14

16

2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Source: Credit Suisse, Customs Data, the BLOOMBERG PROFESSIONAL™ service Source: Source: Credit Suisse, Customs Data

South Korea, on the other hand, after showing a decline of 2 Mt for 2012 imports, is now close to making a meaningful new demand-side contribution. Over the next four years, the country should install a net 11 GW of coal-generating capacity and, after allowing for a fall below 90% utilization for existing capacity, we forecast a 3 Mt increase for 2014 imports, followed by a further 5 Mt in 2015.

Exhibit 152: South Korean imports Exhibit 153: EU imports Mt, monthly, sa Mt, monthly, sa

2

4

6

8

10

12

2005 2006 2007 2008 2009 2010 2011 2012 2013

6

8

10

12

14

16

18

2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Source: Credit Suisse, Customs Data Source: Source: Credit Suisse, Customs Data

Again, however, we see this as insufficient to tighten the aggregate seaborne market and, in fact, it may not even be sufficient to offset the decline in demand that is already under way in Europe. The Credit Suisse European utilities team still expects a 5% aggregate fall in 2014 coal demand of across the UK, Benelux and central European region.

03 October 2013


In the UK, this is partially being driven by the introduction of a carbon price floor but more broadly results from a combination of the continent’s large combustion plant directive (LCPD) and ongoing competition from renewables. Having provided one of the market’s upside demand surprises in 2011 and 2012, primarily on account of coal’s cheapness giving it primacy over gas in the generating merit order, we continue to believe that 2013 will mark the first year of a slow but steady decline in European coal burn.

Exhibit 154: Thermal coal price forecast comparison Exhibit 155: Thermal coal price history and forecasts US$/t US$/t

$76

$78

$80

$82

$84

$86

$88

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$30

$50

$70

$90

$110

$130

$150

$170

$190

$210

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Newcastle coal front month Quarterly avg forecasts

Source: Credit Suisse Commodities Research, the BLOOMBERG PROFESSIONAL™ service,


In conclusion, thermal coal remains a supply-dominated market and is unlikely to escape this dynamic for some time. Upside surprises from Indonesian and/or Colombian supply in 2014 are key risks to our forecast for a slow road to higher prices and any rally is likely to be capped by both Chinese and Indian import price sensitivity.

Many bearish aspects of the seaborne market do now appear to be past their nadir, reducing the risk that prices collapse back to 2008 lows but stabilization should be as good as it gets for now.

Exhibit 156: Forecast thermal coal prices US$/t, long-term prices based on 2013 real prices


Newcastle FOB New US$/t 95 91 87 77 80 84 85 85 85 85 85 88 95 95 ARA CIF New US$/t 92 86 80 76 79 80 84 84 84 84 84 87 94 95

RBCT FOB New US$/t 93 85 80 72 76 78 83 83 83 83 83 86 93 95 Source: Credit Suisse Commodities Research

03 October 2013


Exhibit 157: Global thermal coal supply and demand estimates Mt, Surpluses or deficits show expected market balance but actual imports/exports should net out at the time

Importing Country 2012e 1Q 13 2Q 13 3Q 13 4Q 13 2013f 1Q 14 2Q 14 3Q 14 4Q 14 2014f 2015f 2016f

China 182 47 47 46 53 192 37 47 53 60 197 207 216% change 31.0% -11.1% 0.0% -1.3% 15.7% 6.0% -29.6% 26.3% 11.7% 12.7% 2.5% 4.7% 4.6%

India 122 33 42 33 33 141 35 40 38 40 153 170 187% change 31.8% -13.5% 25.7% -21.4% 0.0% 16.1% 6.4% 12.5% -3.2% 5.7% 8.4% 10.6% 10.5%

JKT 294 72 77 77 76 301 76 71 81 79 307 313 319% Chagne 0.7% -4.8% 6.7% 0.2% -1.8% 2.5% 0.3% -6.4% 14.7% -3.5% 1.8% 1.9% 312.4%

EU 27 158 37 36 35 38 146 36 32 33 38 139 134 125% change 11.5% -14.5% -3.7% -1.3% 9.1% -7.1% -5.6% -10.8% 0.9% 17.1% -4.7% -4.0% -6.4%

Turkey 22 5 5 6 7 23 6 6 6 7 25 26 28% change 13.5% -30.1% -0.6% 21.1% 18.7% 5.0% -23.8% 0.2% 14.3% 18.7% 6.0% 6.0% 6.0%

North America 19 3 5 4 4 17 4 4 4 4 16 16 16% change -13.8% -40.8% 53.9% -16.0% 2.5% -13.3% -13.6% 0.8% 8.5% 9.5% -3.7% -3.1% 3.2%

Brazil 7 1 1 2 2 8 2 2 3 2 10 10 10% change -18.2% -9.8% 12.0% 55.2% -23.3% 15.4% 20.0% 6.7% 29.0% -23.3% 26.7% 7.9% 0.0%

Chile 9 2 3 3 3 10 2 3 3 3 12 13 13% change 11.8% -3.7% 13.6% 5.4% 1.8% 15.3% -11.4% 18.7% 5.4% 1.8% 12.7% 13.0% 0.0%

RoW 74 19 19 19 19 77 20 20 20 20 78 81 84% change 1.2% 3.5% 0.0% 0.0% 0.0% 3.5% 2.3% 0.0% 0.0% 0.0% 2.3% 3.4% 3.0%

World 886 220 234 226 235 916 218 224 241 254 937 969 998

% change 11.4% -10.1% 6.5% -3.7% 4.3% 3.4% -7.4% 2.8% 7.5% 5.2% 2.3% 3.4% 3.01%

Exporting Country 2012e 1Q 13 2Q 13 3Q 13 4Q 13 2013f 1Q 14 2Q 14 3Q 14 4Q 14 2014f 2015f 2016f

Indonesia 341 97 97 88 92 374 80 86 93 105 364 380 395% change 6.9% -3.9% 0.8% -9.7% 4.6% 9.6% -12.7% 7.4% 7.8% 12.6% -2.6% 4.4% 3.9%

Australia 171 42 47 47 47 183 42 46 50 51 189 199 203% change 15.2% -14.1% 12.3% 0.9% 0.4% 6.7% -11.7% 10.0% 8.6% 2.7% 3.5% 5.3% 2.3%

Russia 112 28 28 29 30 115 26 30 29 31 117 119 121% change 16.9% -8.7% 0.4% 1.1% 3.1% 2.7% -12.2% 17.6% -5.4% 8.9% 1.9% 1.9% 1.9%

South Africa 74 17 17 20 21 75 18 17 20 21 77 80 81% change 8.1% -17.0% -2.2% 20.2% 3.9% 0.5% -13.5% -3.8% 15.5% 6.9% 2.7% 3.9% 1.9%

Mozambique 2 1 1 1 1 5 2 2 2 2 7 8 11% change 46.4% 20.8% 0.0% 60.7% 0.0% 100.9% 15.0% 0.0% 0.0% 0.0% 41.7% 19.9% 35.2%

Colombia 76 12 19 18 22 71 22 23 23 21 89 94 97% change -1.4% -40.3% 62.2% -4.7% 18.8% -5.5% 1.7% 3.2% 0.4% -8.5% 24.9% 5.4% 3.0%

North America 55 13 13 14 13 54 12 16 15 16 59 64 64% change 36.4% 5.6% -0.8% 7.6% -5.0% -1.2% -8.7% 33.1% -5.7% 1.4% 10.3% 8.4% 0.0%

Other 41 11 12 11 11 45 10 11 11 11 42 37 36% change -10.3% 8.0% 9.5% -7.4% 0.6% 10.6% -9.4% 4.8% 0.9% 0.8% -7.1% -12.2% 308.4%

World 876 220 234 229 237 921 212 231 242 258 943 980 1008

% change 10.2% -10.0% 6.3% -2.4% 3.8% 5.2% -10.6% 9.1% 4.8% 6.3% 2.4% 3.9% 2.82%

Surplus / Deficit - - - 3 2 5 -6 7 1 4 6 12 10As a % of exports - - - 1.3% 0.8% 0.6% -2.8% 3.0% 0.5% 1.5% 0.6% 1.2% 1.0% Source: Credit Suisse, Customs Data, Company Data

03 October 2013


Base Metals: The Good, the Bad and the Ugly Macro influences mask fundamental differences … LME commodities continue to be influenced overwhelmingly by broader macro factors. However, as our analysis in the following section demonstrates, the supply-demand dynamics for industrial metals differ quite markedly. At the time of our last forecast update in June we signaled that these individual differences would start to be reflected in varying price paths across the suite, with copper especially vulnerable to downward corrections as supply marched ahead of underlying needs.

In any event, the copper market has remained in tighter physical shape than we had expected and, with generally more positive economic momentum, the ingredients may still be in place for a further bout of price strength as we move into 4Q. However, we suspect any such advances run the risk of being relatively muted. The good news is largely “in the price” already.

A number of other features are worthy of brief comment and, while improving demand prospects have made a contribution, it is worth remembering that direction for industrial commodities is still overwhelmingly driven by emerging markets and especially activity in China.

Consumption growth better than we expected … China’s stabilization, coupled with a moderate strengthening of demand growth on a broader base (or at least less weakness), means that we have revised upward our demand projections for CY2013 and to a lesser extent 2014. For example, we expect copper demand to have risen by more than 4% globally this year and potentially to expand by more than 5% next year.

An advance of almost 8% in China this year is typical of uses across the complex. Inventory movements through the supply chain are also playing an important hand and it is this feature, as well as a strong degree of seasonality, that makes us guarded about over-extending our demand forecasts.

…But supply continues to rise too For copper, we retain our view that mine-through-refined supply growth will trigger a steady transition into surplus markets (especially as Chinese smelters convert concentrate accumulations to metal), with consequent erosion of the metals “scarcity premium” in 2014. This waning may have been pushed back a little, but we still expect prices to be US$1,000 cheaper at this time next year.

In contrast, we have a cautiously more favorable leaning toward zinc and lead, which appear to be poised to swing the other way; after years of supply excess, market deficits could emerge in 2014. In the case of zinc, a hefty overhang of inventory, for now largely tied up, may defer the point at which upward moves in prices gain stronger traction but 2013’s levels are providing no incentive to invest in new supply. In each instance too, uncertainty over Chinese supply merits a degree of caution.

The prospects look anything but rosy for aluminium and nickel. For both, supply growth looks set to swamp demand, principally at the hands of Chinese suppliers. These two metals we feel are structurally in the weakest shape; we see little scope for sustained price rises over much of the course of the next 12-18 months.

Of course, caveats abound, not least due to uncertainties over Indonesia’s looming ban on ore shipments from next January, but we consider downside price risks to have grown in the absence of meaningful supply cuts.

RESEARCH ANALYSTS



Marcus Garvey [email protected]

+44 20 7883 4787

Supply Model Contributors Equity Research

Paul McTaggart [email protected]

+61 2 8205 4698

Matthew Hope [email protected]

+61 2 8205 4669

Neelkanth Mishra [email protected]

+91 22 6777 3716



analysts above.






03 October 2013


Copper: Tipping the balance Copper’s twists and turns continue to perplex, with opinions on the next directional move evenly divided. The surprise delay in the Fed’s taper initially heralded a fresh break above US$7,300/t, but this uplift does not seem to have much steam. If there is to be a bout of further strength, we believe it will be a mild and relatively short-lived one, with a move perhaps to a band somewhere either side of US$7,400 in 4Q, before fading away in the earlier part of 2014.

Market is tighter than expected in 2013

Previously we highlighted the likelihood of a market gradually shifting to larger pronounced statistical surpluses as mine supply growth persisted in line with the improved achievements of 2013. However, after a surplus amounting to around 500 kt for 2012, we believe the physical market is in closer balance in 2013 than we had postulated in our 2Q update.

There are three main reasons for this shift:

Although mine supply growth has shown signs of improving following very modest advances in 2009-2011, consumption has held up better than expected – this comprises a slightly better profile in China and very basic first steps of recovery in the rest of the world (albeit still with some soft patches in important emerging markets).

Equally importantly, China’s smelters have opted to stockpile concentrate rather than hurry it into refined form. Smelter production has (temporarily) fallen behind the pace of mine supply growth (a move triggering sharp increases in spot treatment terms).

Relatively low availability of scrap has resulted in a greater call on refined copper. Refined copper production has therefore closely matched that of demand, at times falling short, much to the benefit of those able to hoard metal.

Next year will likely see a swing back to a larger surplus

We think prices will come under renewed downward pressure as 2014 opens up. We expect two major drivers will come to the fore, assuming steadily improving aggregate world demand.

Mine supply growth should continue at a pace of close to 4.5% pa, as in 2013, even after taking into account project deferrals, or cuts in supply elsewhere.

Importantly too, concentrate destocking will likely result in a greater rise in smelter and refinery supplies, with growth expected to exceed 6%, comfortably outpacing growth in consumption.

However, Chinese smelters in particular will try to juggle with the amount of metal they release to the market; on the one hand they will be keen to “monetize” concentrates subject to better term TCRCs or tolling deals, but on the other, they will not want large surpluses of unwanted refined copper to build in China, potentially depressing both base prices and premiums.

Prices to slip back closer to US$6,000/t by 4Q 2014

Despite the potential for a short-lived run-up in prices, the price today probably still sits US$1,000 above next year’s 4Q average low. Within the next 12 months we continue to expect copper to be trading at the bottom of the US$6,000-9,000/t range, in which the metal has priced on the LME since 2006.

Our forecast keeps us in the more bearish camp for 2014-2015, but this relative weakness does potentially sow the seeds for price recovery at a later stage; we acknowledge that persistent mine supply growth at current rates is hard to sustain and

03 October 2013


we think copper prices will claw back their interim losses in 2016-2017. By then, US dollar moves might also play a strong hand. Equally, the scale of surpluses we envisage does not put copper in the same ilk as zinc in recent years and even our trough prices are still relatively high historically.

Next year’s forecast price nadir is also a little bit higher than we had contemplated in June.

Capital and broader cost management is having a toll on copper producers. Though we caution about too much faith in “cost support” (costs follow prices), signs are there that reduced margins have started to hold back ambitions in the copper mining sector.

Rising TCRCs are a benefit to smelters, but a rising cost to miners; copper prices do not need to fall quite as far to illicit the same responses to curtail mine supply.

Exhibit 158: Copper prices are expected to fall to the lower part of the US$6,000-9,000/t range in which they have traded for much of 2006-2013 US$/t, LME 3-month copper price

2000

3000

4000

5000

6000

7000

8000

9000

10000

11000

2005 2006 2007 2008 2009 2010 2011 2012 2013


Price falls and rising TCRCs will start to show on mine supply growth

One of the challenges of analyzing copper mine production is working out the difference between plans to add new capacity and the production that eventually comes to the market. Many analysts apply a “disruption factor,” typically 5%-6% of planned supply, to reflect the historical difference between earlier forecasts and the tonnage that actually comes forth in any one year. While this is a useful approach, in reality prices through the various parts of the production chain have an impact on even the most “firmly committed” programs.

Ironically perhaps, unexpected supply disruptions have been relatively benign in 2013, but producers are under pressure to trim capital spending and, countering mine expansions, there are significant losses due to the sapping effects of depletion at aging mines.

This is the principal dynamic in Chile where the largest producer, Codelco, has struggled to revitalize production. Progress at mines such as Escondida has helped stabilize the country’s output. We forecast a relatively modest increase of around 280 kt this year and a larger rise of almost 500 kt in 2014 before growth moderates more sharply in the medium term.

Peru, we expect, will make gains in both 2014 and 2015 after decent advances this year. These are led by improvements at Antamina following problems with grades, but the biggest impact is the introduction of Glencore’s Antapaccay mine this year.

03 October 2013


The aggregate contribution from regions where planned delivery can far from be guaranteed includes a forecast of firm progress in the African Copperbelt, although we have allowed for some disappointments on achieving promoters’ targets under difficult operating conditions in the region. Nevertheless, the DRC and Zambia combined could achieve increases of 200 kt and 330 kt in 2013 and 2014, respectively.

Rio Tinto’s Oyu Tolgoi mine in Mongolia has commissioned on schedule and appears on track to close on 200 kt/y of copper from 2015, although the underground expansion to considerably larger scale has been put back.

More broadly, the contribution from individually relatively modest mine expansions is notable and weaker prices will likely hold back a large proportion of planned growth from these sources.

Exhibit 159: World copper mine production has grown very slowly since the 1990s, but this looks likely to change in 2013-2015

Exhibit 160: Chilean mine supply is edging ahead, despite the significant effects of longer-term depletion

kt copper (lhs), % annual change (rhs) Monthly mine production, kt contained copper

‐2

0

2

4

6

8

10

10,000

12,000

14,000

16,000

18,000

20,000

22,000

24,000 Mine Supply (without adjustment), ktMine Supply, ktIncrease, % (rhs)

350

370

390

410

430

450

470

490

510

530

550


2012 2011 2004-2010 Avg 2013

Source: Credit Suisse, Wood Mackenzie Source: Cochilco, Credit Suisse

Nevertheless, our forecast of more than 4% pa growth in mine supply in 2014 and 2015 also entails “adjustments” to intended supply of 1.4 Mt/y and 2.3 Mt, respectively. Lower prices, rather than deep-seated unexpected technical or operational disruptions, we think will trigger this moderation to plans. Obviously, the lower the prices, the less supply will (eventually) come forward.

Next year’s price decay sowing the seeds for recovery later?

It is worth noting what might happen if price-induced trims to project activity were not to occur on this scale, although the effects of depletion tend to show more quickly with prices on the decline. We believe we are reflecting the balance of risks between far higher supply, or far slower expansion growth, in a balanced way. Admittedly, tipping this balance one way or the other would not take huge changes to supply and demand totals, though the case for a bullish outcome would seem to require a fortuitous combination of factors which are difficult to rely on.

From 2014, as demand also falls back towards trend rates below 4% pa so too will refined production and the surpluses we envisage for 2014 will become more moderate moving toward 2016. At this point prices could step back up to eclipse our long-run average, moving above US$7,000 in the course of 2015. However, we doubt US$10,000 is on the radar screen in the next few years unless it is merely a reflection of US dollar moves.

03 October 2013


Exhibit 161: Major expansions to mine supply in 2013-2016 Credit Suisse forecasts for major increases in mine supply, kt contained copper (excludes China, and former CIS)

Mine Country Owner 2012 2013 2014 2015 2016Frontier DRC Eurasian 0 20 50 60 60Kamoto/KOV DRC Katanga Mining 107 135 190 275 290Mutanda/Kansuki DRC Glencore 82 83 100 100 100Tenke-Fungurume DRC Freeport 158 175 157 215 239Bisha Eritrea Nevsun Res. 0 18 85 80 35Kanshanshi Zambia First Quantum 265 265 335 379 400Konkola Deep Zambia Vedanta 5 20 65 100 155Sentinel Zambia Sentinel 0 0 0 86 229Batu Hijau Indonesia Newmont 71 85 137 250 200Grasberg Indonesia Freeport 327 433 547 665 762Oyu Tolgoi Mongolia Rio Tinto 0 70 165 190 180Salobo Brazil Vale 13 70 125 175 200Caserones Brazil Nippon/Mitsui 0 37 155 190 180Collahuasi Chile Anglo/Glencore 275 334 386 432 455Escondida Chile BHP Billiton 1077 1152 1205 1270 1287Mina Ministro Hales Chile Codelco 0 20 210 215 180Sierra Gordo Chile Quadra 0 0 73 108 119Antapaccay Peru Glencore 5 173 176 176 176Las Bambas Peru Glencore 0 0 0 50 300Toromocho Peru Chinalco 0 0 105 225 237Jabal Sayid Saudi Arabia Barrick Gold 0 0 25 50 60Mt Milligan Canada Thompson Creek 0 5 47 44 39El Boleo Mexico Minera Boleo 0 0 10 36 54Buenavista/Cananea Mexico Buenavista 200 190 305 399 493Bingham Canyon USA Kennecott 163 150 168 206 217Morenci USA Freeport 284 286 358 359 360Pinto Valley (restart) USA (BHP Billiton) 1 14 55 59 62

Source: Company reports, Wood Mackenzie, Credit Suisse

Major changes to our China forecasts

Our latest statistical reconciliations point to a well-balanced copper market in China in 2013. We thought this apparent tightness was partly artificial. However, stable demand through 2Q and into the third quarter, at a time of usual seasonal tepidness, appears to lie behind further drawdowns of stocks. Shortages in scrap availability are likely to underpin consumption growth of 8% for refined copper for the full year, equivalent to an extra 150 kt of copper use over and above our earlier projections.

Other points of note for the full year, taking into account year-to-date patterns, include the following:

Domestic mine supply growth at a 1.53 Mt level (we have taken into account some probable erroneous reporting).

Total refined production increasing in line with demand growth at 8% to 6.24 Mt.

Net refined copper imports down from 3.41 Mt to 2.85 Mt (we expect these volumes may turn out a little higher but a moderate rise in exports is possible as tolling activity gathers pace).

We continue to see copper imports settling at recent rates – these are below the peaks of 2011-2012 but should average 400 kt/m (including refined copper and copper semis products). Greater flows are now being delivered to the domestic market through normal trading business rather than bonded warehouse imports. Bonded stocks are believed to have fallen below 450 kt in September from a March level of around 850 Mt.

03 October 2013


We take into account: increases in traders’ stocks of around 160 kt; producer stock additions of 60 kt; a rise in stocks at fabricators of 120 kt; and a fall in SHFE inventories of just over 70 kt. The implied stock change since March is -133 kt. This is consistent with a regional market in close balance for the calendar year. However, smelters are currently sitting on large concentrate stocks and metal stocks too may be being held back in anticipation of a final price flurry for the year (we don’t think there are large “hidden” refined stocks though).

Smelters manage the market

China holds the key to how supply is “managed” in the months ahead; the country now accounts for almost one-third of world refined production (and 43% of global refined consumption). Moreover, a large portion of supply, and metal flow, is in the hands of a small number of large entities.

For smelters, the main challenge is to manage supply at a time when they are aggressively expanding capacity – there are approved plans to add 2.9 Mt/y of new primary smelting capacity in 2013. These additions make reading of operating rates problematical; SMM estimates utilization rates at 24 major domestic smelters fell by 1 pp in July to 85.6%, but calculations on capacity in place point to a rate of less than 75%. These operating rates appear to have increased again in August, suggesting demand has held up sufficiently well to prompt generating more cash flow.

In the run-up to October’s LME week and the height of the concentrate mating season, China’s copper smelters have already achieved many of their aims. Spot treatment charges have edged up to US$90-95 against a background of steadily rising world mine supplies.

Exhibit 162: China’s imports of copper concentrates on a rising trend but volatile month to month

Exhibit 163: China’s imports of unwrought copper have crept up steadily since April

kt, gross weight copper concentrate Kt

0

100

200

300

400

500

600

700

800

900

1000

0

50

100

150

200

250

300

350

400

450

500

Source: CEIC, Credit Suisse Source: CEIC, Credit Suisse

Smelters are thought to have eased back on their purchases in August, following July’s surge. Imports of concentrate climbed 37% in January-July, year on year, and inventories at plants are now believed to exceed the equivalent of three months of needs, dominated by higher-grade material. This has strongly improved the smelters’ hand in negotiations to set more favorable terms for TC/RCs in this year’s contracts. Nevertheless, we believe copper-in-concentrate imports will climb by almost 16% to 2.3 Mt this year, followed by further advances of around 17% next year.

03 October 2013


Exhibit 164: Refined copper production in China could accelerate again in 2014

Exhibit 165: Swings in the SHFE/LME price arb will also influence trade flows

Kt, monthly, sa US$/t

250

300

350

400

450

500

550

600

2008 2009 2010 2011 2012 2013

-850

-650

-450

-250

-50

150

350

550


LME Cheap

LME Expensive

Source: CEIC, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service , Credit Suisse

China’s demand on a stable footing

The seasonal lull over the summer months (namely June and July) does appear to have been more muted (in the extent of its downturn) than most players expected, in some sectors at least. This has allowed goods and products in some (but not all) copper end-use segments to be run down to a greater extent than manufacturers anticipated. However, we are wary about measuring seasonal, and for that matter month-on-month, effects too precisely.

Orders look to have held up reasonably well in core durables applications. Aircon manufacture, for instance, has been blessed with a longer seasonal run than most producers expected, helped by some improvement in export markets. In contrast, auto activity looks set for a return to moderated rates.

Demand for copper in the housing and construction sector has also benefitted from the earlier acceleration in starts, completions and (indirectly through product demand) in sales. However, this momentum looks about to fade as completed units have already incorporated wire and ancillary equipment.

Investment in power infrastructure is a much mooted point and power cable manufacturers expect this to provide solid support. However, the data are a mismatch to this outward optimism. The effects of overcapacity have not abated and sector activity by its nature will likely be “lumpy.” This is a highly competitive industry, and while some manufacturers are boasting double-digit growth, others are being displaced.

Copper also continues to suffer substitution at the hands of cheaper aluminium cable and has lost ground in important magnet wire applications.

03 October 2013


Exhibit 166: Aircon manufacture’s typical seasonal decay has been slower in 2013

Exhibit 167: Power cable production is steady but data suggest manufacture is not on a new trajectory

Thousand units, monthly, nsa Thousand km, monthly, nsa

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

0

1,000

2,000

3,000

4,000

5,000

6,000


Order activity may well provide price support into 4Q, a prospect we did not expect earlier in the year. However, we suspect a large element of China’s advance this year of almost 8% in refined copper use is explained not just by the “scrap phenomenon” but also by the fact that off-take was so much weaker for a large part of 2012. As we move into 2014 we expect growth rates will fall back into closer alignment with trend patterns at around 5%-6% pa.

Non-Chinese markets hardly exciting but at least more supportive

Elsewhere, outcomes are mixed, with improved off-take (on a previously poor base!) stemming from the North Atlantic economies but patches of notable weakness in key emerging markets, for example, India and Brazil.

To put the US’ contribution in perspective, net growth will likely amount to far less than 100 kt/y throughout our forecasting horizon, reflecting the extent to which “first-use” consumption, at the refined copper level, has been savaged in the country over the past decade.

Europe may mount a better defense of apparent uses in 2014 as could Japan after a poor year. The same is true of other Asian economies which may follow with 5% pa growth after stagnation in 2013. However, for copper, the demand story is remains very much one about China in 2013-2016.

03 October 2013


Exhibit 168: Copper forecast comparison Exhibit 169: Copper historical price and forecast US$ per metric tonne US$ per metric tonne

$6,000

$6,500

$7,000

$7,500

$8,000

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14

CS ForecastForward CurveBloomberg Forecast Mean

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

05 06 07 08 09 10 11 12 13 14

Copper 3MQuarterly Avg Forecast


Exhibit 170: Forecast copper prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

1Q-13 2Q-13f 3Q-13f 4Q-13f 2013f 1Q-14f 2Q-14f 3Q-14f 4Q-14f 2014f 2015f 2016f LT LME copper 3M New US$/t 7,958 7,200 7,070 7,400 7,407 7,000 6,750 6,500 6,250 6,625 6,750 7,250 6,600

New US$/lb 3.60 3.25 3.20 3.35 3.35 3.20 3.05 2.95 2.85 3.00 3.05 3.30 3.00 Old US$/t 7,958 7,200 7,000 6,800 7,240 6,600 6,300 6,100 5,900 6,225 6,750 7,250 6,600


03

Octo

ber 2

013

Com

modities F


inding Road

89

Exhibit 171: Global copper supply and demand estimates Thousands of metric tonnes (kt)

World Copper Supply & Demand Balance (kt Cu)2008 2009 2010 2011 2012 2013f 2014f 2015f 2016f 2008 2009 2010 2011 2012 2013f 2014f 2015f 2016f

MINE PRODUCTION STOCKSChile 5,408 5,457 5,481 5,307 5,520 5,800 6,289 6,505 6,283 LME+Comex 371 592 437 459 384 551 China 1,157 1,056 1,257 1,373 1,542 1,530 1,755 1,915 2,060 SHFE 18 96 132 93 205 152 Russia/Caspian 1,256 1,264 1,229 1,212 1,229 1,248 1,282 1,324 1,325 Total Ex change Stocks 389 688 569 552 589 703 Peru 1,229 1,225 1,204 1,201 1,260 1,316 1,572 1,871 2,208 Weeks Consumption 1.1 2.1 1.5 1.5 1.6 1.8 Australasia 1,034 1,012 1,020 1,068 1,047 1,183 1,181 1,127 938 Commercial Stocks 417 388 407 417 471 500 USA 1,339 1,200 1,132 1,136 1,168 1,176 1,340 1,397 1,402 Total Reported Stocks 806 1,076 976 969 1,060 1,203 DRC 284 330 424 530 647 802 940 1,090 1,195 Zambia 547 635 694 681 692 745 936 1,123 1,327 Price (US$/t) 6,932 5,149 7,547 8,813 7,956 7,395 6,625 6,750 7,250 RoW 3,460 3,738 3,709 3,674 3,670 3,777 4,619 5,086 5,154 Price (US$/lb) 3.14 2.34 3.42 4.00 3.61 3.35 3.01 3.06 3.29

World Mine Production (unadj.) 15,714 15,917 16,151 16,183 16,773 17,577 19,915 21,438 21,892 TC (US$/t) 45 75 47 56 64 85 85 80 75 Highly Probable Grow th 15 56 140 193 RC (c/lb) 4.5 7.5 4.7 5.6 6.4 8.5 8.5 8.0 7.5 Probable Grow th 11 28 128 219 Required Adjustment (conc.) - - - - - - 1,400 2,300 2,100 REFINED COPPER CONSUMPTION

Sx Ew (adjusted) 3,066 3,269 3,322 3,436 3,614 3,612 3,899 4,012 3,799 Africa 306 304 292 290 234 231 243 255 267 Concentrate (adjusted) 12,648 12,647 12,829 12,747 13,160 13,924 14,412 15,062 16,048 Asia 9,180 10,044 11,109 11,486 11,675 12,354 13,108 13,698 14,288

World Mined Copper 15,714 15,917 16,151 16,183 16,773 17,536 18,312 19,073 19,847 Europe 4,189 3,469 3,839 3,685 3,436 3,481 3,610 3,719 3,831 % Change 0.5% 1.3% 1.5% 0.2% 3.6% 4.5% 4.4% 4.2% 4.1% Latin America 564 484 635 578 600 619 656 684 713

Available Supply of Conc. 12,632 12,626 12,807 12,725 13,138 13,902 14,390 15,040 16,026 North America 2,513 2,057 2,188 2,199 2,230 2,283 2,412 2,462 2,513 Smelter Capacity 16,612 17,104 17,604 18,067 18,896 19,663 21,066 21,805 22,118 Middle East 380 437 546 555 596 617 636 664 688 Smelter Production 14,303 14,174 14,790 15,471 15,779 16,733 18,897 20,103 20,849 Oceania 151 130 131 120 113 105 109 112 113 Required Adjustment 500 1,500 2,225 1,900 Russia/Caspian 757 437 526 783 724 743 766 782 798 Scrap Use 2,072 1,992 2,626 2,993 2,998 3,003 3,131 3,218 3,316 World Consumption 18,039 17,362 19,266 19,696 19,608 20,433 21,540 22,376 23,211 Smelter Loss 486 439 473 464 442 438 470 465 493 % Change 0.8% -3.8% 11.0% 2.2% -0.4% 4.2% 5.4% 3.9% 3.7%Primary Feed Requirement 12,646 12,559 12,554 12,853 13,138 13,587 14,650 15,041 16,040 China 13.2% 24.3% 10.2% 8.4% 4.5% 7.9% 6.5% 5.2% 4.9%CONC. SURPLUS/(DEFICIT) (14) 68 253 (128) (1) 314 (260) (1) (14) World Excl. China -3.5% -15.2% 11.4% -1.4% -3.7% 1.6% 4.6% 2.9% 2.9%

Annual Substitution (468) (394) (450) (550) (450) (450) (400) (400) (400) REFINED COPPER PRODUCTION

Africa 596 711 850 932 1,017 1,385 1,655 1,811 1,844 SURPLUS/(DEFICIT) 214 918 (320) (35) 483 182 380 171 21 Asia 7,096 7,376 7,855 8,285 8,997 9,596 10,682 11,346 12,157 Europe 2,722 2,562 2,732 2,918 2,971 2,977 3,098 3,128 3,139 CHINA MARKET BALANCESLatin America 3,768 3,955 3,900 3,758 3,408 3,526 3,784 3,753 3,596 Total Mine Supply 1,113 1,230 1,382 1,545 1,530 1,755 1,915 2,060North America 2,011 1,743 1,646 1,687 1,643 1,567 1,877 1,986 1,983 Conc. Imports 1,649 1,628 1,973 2,282 2,678 3,000 3,220Oceania 501 449 427 498 465 490 498 495 479 Other Raw Material Imports 632 729 883 886 990 1,045 1,080Other 1,560 1,482 1,537 1,583 1,589 1,677 1,764 1,818 1,893 Smelter Production 3,038 3,255 3,595 4,077 4,394 5,206 5,629 5,973

Required Adjustment - - - - - 500 490 300 500 Refinery Scrap 754 787 1,030 1,060 1,120 1,200 1,325 1,530Scrap/Blister 884 837 835 754 699 812 870 894 947 Refined Production 4,061 4,532 5,136 5,765 6,242 7,110 7,748 8,363Electro Refined 15,186 15,010 15,625 16,226 16,478 17,003 18,021 18,535 19,433 Refined Copper Imports 3,185 2,924 2,833 3,408 2,480 2,525 2,408 2,269Net Sx Ew 3,066 3,269 3,322 3,436 3,614 3,612 3,899 4,012 3,799 Refined Copper Ex ports 73 42 155 277 368 400 350 350World Refined Production 18,253 18,280 18,945 19,600 20,028 20,615 21,920 22,547 23,232 Refined Consumption 4,995 5,998 7,164 7,764 8,115 8,754 9,325 9,806 10,282

% Change 1.3% 0.1% 3.6% 3.5% 2.2% 2.9% 6.3% 2.9% 3.0% Direct Use of Scrap 1,530 1,153 1,305 1,286 1,150 1,152 1,180 1,236 1,296of w hich China 4,532 5,136 5,765 6,242 7,110 7,748 8,363 Semis Production 6,525 7,151 8,469 9,050 9,265 9,906 10,505 11,042 11,578% Change 11.6% 13.3% 12.2% 8.3% 13.9% 9.0% 7.9% % Change n/a 9.6% 18.4% 6.9% 2.4% 6.9% 6.0% 5.1% 4.9%

Source: Wood Mackenzie, BGRIMM, company reports, Credit Suisse

03 October 2013


Aluminum: Reasons to be cheerful? Not really Aluminum prices have done very little since our last quarterly forecast update. Beyond improved demand, nothing else has changed that much to convince us to be anything other than bearish on the outlook for prices, at least up to the point that meaningful supply cuts are undertaken. So far they have not; curtailments put in place this year are patchy and insufficient to eat deeply into the mountain of stocks left as a legacy of years of supply surpluses.

In summary, we retain our view that aluminium prices run the greater risk of further deterioration before any significant recovery can be established. Although it sits outside our central case, there is a plausible scenario that entails a much sharper plunge in prices. Again, we highlight our view that markets rarely correct smoothly and that undershooting, and deeper invasion of short-run cost curves, is a stark possibility.

Reasons to be cheerful? Part one: Surely supply cuts must come?

We believe cuts must happen. The problem is that slowing down or halting expansion momentum in a market where demand is growing strongly is also a “cut,” but the path to rebalancing takes a lot longer than wide-sweeping shutdowns of plants and probably comes with an extended period of flat prices and paper-thin margins for suppliers. In short, capital (eventually) gets rationed from the business and the thirst for growth abates.

Wood Mackenzie has identified almost 2 Mt/y of capacity subject to voluntary cuts since the end of 2011. This is equivalent to 4% of annual consumption. To illustrate the sensitivity of these decisions to prices though, it is notable that the effective date of actions has lulled in 1H 2012, possibly because prices rose and almost certainly smelters will have found ways to trim costs.

Exhibit 172: Announced cuts to aluminium smelter production since 2011 (outside China) Aluminium output in kt/y

Smelter Country Owner Recent Cuts Effective CommentsOutput Date

Vlissingen Netherlands Klesch Group 230 230 Dec-11 Bankruptcy - smelter to be demolishedLynemouth UK Rio Tinto 178 178 Mar-12 Permanent closureKurri Kurri Australia Hydro 180 60 Mar-12NZAS New Zealnd Rio Tinto 355 45 May-12 Result of high spot power pricesKurri Kurri Australia Hydro 120 120 Jun-12 First phase of full shut downAviles Spain Alcoa 93 47 Jun-12La Coruna Spain Alcoa 87 43 Jun-12Mostar Bosnia Aluminij 130 17 Jul-12 High power prices/weak metal priceHannibal USA Ormet 270 90 Aug-12 Second potline offline due to weak pricesPort Vesme Italy Alcoa 150 150 Nov-12 Closure completed Nov 2Various Russia Rusal 0 50 Dec-12Various Various Alcoa 0 191 Jul-13 Last of announced cuts of 460 kt/yBaie Comeau USA Alcoa 390 105 Aug-13 Soderburg potlines to be demolishedHannibal USA Ormet 270 90 Aug-13 Cuts now total 180 kt/yMassena East USA Alcoa 125 40 Sep-13 Permanent closure of 40 kt/y linePocos de Cal Brazil Alcoa 96 32 Sep-13 Temporary haltSan Luis Brazil Alumar 447 92 Sep-13 Temporary haltShawingan Canada Rio Tinto 100 100 Nov-13 Permanent closureVarious Russia Rusal 0 250 Dec-13 Further cut of 250 kt/y pledged by end-2013

Source: Wood Mackenzie, Credit Suisse

Moreover, these announced cuts (and we do believe many of these have taken place) could well be offset by expansions. Some capacity additions took place this year outside China and steady increments, mainly at existing plants under expansion, could add an extra 1.7-1.8 Mt/y of capacity in each of 2014 and 2015. Further, cuts are by definition likely to impact higher cost plants while new capacity is typically lower down the cost curve. The supply curve is therefore flattening and this can be expected to drive real costs down, or at least stem increases.

What kind of cuts

will take place?

New capacity in the

West too

03 October 2013


Prominent announced primary aluminium smelter capacity additions this year and planned for 2014-2015 include the following:

The ramp-up at Ma’aden’s 740 kt/y smelter in Saudi Arabia (Alcoa has a 25% interest in this JV).

Potential contributions from a number of plants in India (led by Vedanta’s Jharsuguda and Khorba, which are already operating, and Hindalco’s Mahan). These smelters could take India’s primary aluminium production from 1.8 Mt this year to 3 Mt/y by 2016, although we feel some delays are likely, not least because of bauxite and power issues.

Emirates Aluminium’s plant in the UAE is earmarked to add an extra 500 kt of metal, with plans to take the world’s largest smelter from 800 kt/y to 1.3 Mt/y by 2015.

Russian plants are expected to commission new capacity amounting to 375 kt/y from 2013, with Rusal’s 600 kt/y Boguchanskoye and 750 kt/y Taishet plants offsetting planned closures elsewhere and no doubt reducing overall costs.

Improved technical performances at Rio Tinto’s Alma plant in Canada and BHP Billiton’s Hillside plant in South Africa amounting to more than 350 kt of extra aluminium in 2013.

Press Metals has also commenced production at its new smelter in Malaysia (Samaluju) at a rate of 300 kt/y.

Exhibit 173: Although profits are lean, premiums are sparing most smelters from major losses

Exhibit 174: Chinese smelters have the added benefit of higher domestic aluminium prices

Cash costs of smelter production, excluding China, US$/t Cash costs of smelter production in China, US$/t

1,000

1,500

2,000

2,500

3,000

Current LME 3M: $1,785 57%

$260/t Premium Added 89%

1,000

1,500

2,000

2,500

3,000

Current China Spot: $2346 (incl. VAT) 89%

Source: Credit Suisse, Wood Mackenzie Source: Credit Suisse, Wood Mackenzie

China too has undertaken measures to remove higher-cost outmoded capacity. This is part of a long-standing program focused on energy efficiency and environmental performance. Further measures were recently introduced (right down to energy use per tonne of ingot) but China was producing barely 5 Mt/y of the metal ten years ago, compared to a landmark 25 Mt this year. In other words, most of the country’s plants are young and modern and likely to comply with stricter regulations.

The new rules also extend to an insistence that new plants are integrated with dedicated power or coal sources, but this is not new. China’s aluminium smelting sector is characterized by deep vertical integration, from coal in many instances to downstream fabrication and manufacturing. The “business model” that brought forth aluminium production centers in the east of China has merely relocated to the interior to exploit cheap power and undeveloped coal resources in the north and north-west of the country, or to harness low-cost hydro power in southwestern China.

China’s cuts

swamped by new

capacity …

03 October 2013


Exhibit 175: New smelter capacity totaling 3.7 Mt/y is being added in 2013 in China Aluminium capacity in kt/y

Company Location Capacity Addition Start-up StatusXinjiang Jiarun Resources Holding Co. NW 0 50 Jan In operationShandong Weiqiao Group E 2100 300 Feb In operationXinjiang Jiarun Resources Holding Co. NW 50 100 Mar In operationYunnan Aluminium SW 670 150 Apr In operationShaanxi Nonferrous Metals NW 50 200 May In operationChongqing Tiantai Aluminium SW 55 100 Jun In operationShandong Weiqiao Group E 2400 120 Jun In operationChongqing Energy Banner Co. SW 0 300 Jul Ready for startXinjiang Xinfa NW 800 500 Aug Ready for startYunnan Aluminium SW 820 150 Aug Ready for startXinjiang Jiarun Resources Holding Co. NW 150 150 Sep Ready for startJiuquan Iron & Steel Group NW 450 150 Sep Ready for startXinjiang Qiya NW 100 100 Sep Ready for startHenan Shenhuo Group NW 130 130 Sep Under constructionInner Mongolia Jinlian NW 0 100 Oct Under constructionTianshan Aluminium NW 500 350 Oct Under constructionQinghai West Hydroelectric Aluminium NW 150 150 Oct Under constructionQinghai Xinheng Aluminium NW 620 230 Nov Under constructionHuomei Hongjun Aluminium N 740 60 Nov Under constructionBaotou Aluminium N 450 140 Dec Under constructionXinjiang East Hope Aluminium N 450 150 Dec Under constructionTotal 3680

Source: SMM, Credit Suisse

Exhibit 176: China’s cuts in smelter production are modest compared to new additions in 2013 Aluminium capacity affected in 2013, kt/y

Company Cuts CommentsZhengzhou Longxiang Aluminium 50 Closed in 1QHenan Xinwang Aluminium 45 Shut in Jan due to unpaid power billsDanjiangkou Aluminium 50 Cut in early 2QJiangsu Datun Aluminium 56 Shut in Jan due to lossesDongyuan Qujing Aluminium 150 2Q closure due to lossesBaise Yinhai Aluminium 180 Cut in 1Q but local gov subsidy allows restartBaise Yinhai Aluminium 100 Cut in 1Q due to losses. Now restartedShaanxi Tongchuan Aluminium 100 Closed in 2Q due to lossesHenan Linfeng Aluminium 60 Pots offline due to losses in 1QShenhuo Group 100 2Q halt at Yongcheng and ShangqiuZhejiang Huadong 90 Suspended in June. 50 kt/y remainsChalco (Shandong) 45 Cuts began AugustChalco Guizhou) 160 Accident forced closure in August

1186

Source: SMM, Credit Suisse

These plants are located in less well-developed areas where new industrial activity has strong local and (for now) central support. Interestingly, Beijing appears to have reversed its thrust of recent years which removed aluminium from the “preferred” industry list and steadily cranked up power tariffs. These impositions have been eased as economic growth slowed – the imperative of creating catalyst industrial development in regions yet to experience the boom of the eastern provinces means that China is likely to retain an aluminium smelting industry at least sufficient to cater to its needs for the metal for some years to come, even if the pace of expansion slows.

03 October 2013


The decision to cut back on aluminium supply is therefore tied to the economic and socio-political features of more than just stand-alone smelting. In any case, China’s plants effectively benefit from a VAT-driven price 17% higher than LME. Producers are no doubt finding profits lean, but it is not especially surprising to find that cutbacks as of now amount to a paltry 1.2 Mt/y.

China’s smelting capacity is set to surpass 30 Mt/y by the end of this year, an increase of more than 7 Mt/y since the start of 2012.

Depletion of domestic bauxite resources does not seem to pose a barrier either, at least for the next few years, with a new large discovery being reported in Henan which accounts for almost one-quarter of China’s alumina supply. SMM’s surveys list 8 Mt/y of new alumina refining capacity under construction in 2013-2014 in China.

Exhibit 177: LME stocks tied up in inconvenient locations

Exhibit 178: High regional premiums have helped prop up supply

LME stocks by warehouse location, kt US$/t

0

1000

2000

3000

4000

5000

6000

2008 2009 2010 2011 2012 2013

Other Vlissingen Detroit

0

50

100

150

200

250

300

350

2007 2008 2009 2010 2011 2012 2013

US Europe Singapore


Reasons to be cheerful? Part two: Stocks are tied up … or are they?

That aluminium prices have not fallen much further in 2013 owes much to the fact that acres of inventories held in LME warehouses are painfully slow to access for consumers. Most of these tonnages are also located in the wrong places, far from where they will eventually be used.

Total inventories amassed as a result of years of supply surpluses amount to more than 15 Mt, equivalent to almost four months of demand.

At some point the influences of cash-and-carry warehouse financing and delays caused by long load-out queues will erode the price buffer created by artificially high regional premiums and quite possibly base prices. However, this may not happen imminently.

As we highlighted in What Lies in Store? rule changes proposed by the LME and potential regulatory intervention could dislodge some of the log-jammed stocks held tightly in LME warehouses. Consumers continue to argue they are bearing the brunt of bloated and volatile premiums (which they cannot hedge), exacerbated by severe delays in accessing metal from storage. Although these changes may not take effect immediately, the days of very high physical premiums for aluminium would appear to be limited. However, the full impact on prices remains uncertain:

We agree with many that looming rule changes stand to lead to downward corrections to premiums but not necessarily back to “normal” levels in a great hurry.

03 October 2013


The impact on “base” prices is more difficult to discern but we believe aluminium is at greater risk of an initial severe correction to underlying prices as well as easing of premiums. A harsh scenario sits outside our base-case forecast, but risks have grown for 2014; the threat of a more rapid decay in premiums cannot be ruled out.

Ultimately, money-market dynamics will likely stifle the attraction of carry trade, though this could still lie a year or two away; rule changes (e.g., in the US) may supersede the effects of these “natural” forces.

Reasons to be cheerful? Part three: Demand is growing strongly …

China’s – indeed, the world’s – appetite for aluminium in broad-ranging applications is one of the commodity’s great success stories of the past few years. Growth rates eclipsing other industrial commodities have come about largely because of the metal’s affordability. For example, the price ratio to copper is almost 4:1 and it is no surprise that aluminium is gaining market share at the expense of more expensive commodities and products.

Exhibit 179: Aluminum prices slipping… Exhibit 180: … but it has become more affordable US$/t, 3-month contract Aluminium to copper price ratio

1000

1500

2000

2500

3000

3500

2003 2005 2007 2009 2011 2013

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60

0.65

2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

However, while global demand growth is likely to remain at or slightly above a healthy 6% pa in 2013-2015, we worry that China’s recent demand boost will prove highly seasonal or prone to lulls in investment activity. China is responsible for about 46% of global primary aluminium use; hence, more muted growth there will weigh heavily on the overall balance.

For example, operating rates at plate/sheet and strip fabricators were just 61% in August, almost on par with July. Orders from can-stock, construction and the auto sectors were mixed.

Liquidity tightness and modest order books are pointing to a disappointing autumn seasonal “peak.”

End users are reported to be cautious on the outlook for the final quarter of the year.

Higher-than-expected production (despite modest utilization rates) in the normally low season summer months has kept up stocks of finished products – fabricators are likely to destock further in 4Q to limit working capital costs.

The wire and cable sector was slow to gear up after the Chinese New Year, with March operating rates just 56% at larger manufacturers exposed more heavily to power grid investment. However, the summer saw stronger levels of activity.

03 October 2013


The power sector accounts for more than 20% of aluminium demand in China and is expected to be its strongest performing use in terms of growth this year. However, activity here is almost certain to be patchy, with periods of accelerated demand growth, followed by flatter off-take.

Much is made of brighter prospects for the developed economies, but the reality is North America, Western Europe and Japan make up less than 28% of primary aluminium consumption and a miniscule portion of incremental demand compared to emerging markets. Core manufacturing sectors in the US may prove broadly supportive, but we have a lower regard for prospects in Europe and Japan’s off-take is arguably at a permanent standstill.

Smaller emerging markets have also provided mixed blessings in 2013, although herein lie the prospects for better progress in 2014 as the cycle gradually turns.

Nevertheless, at 5%-6% pa, world primary aluminium demand is a notch ahead of most of its LME peers. We have revised upward our demand forecasts for China in 2013-2014 and have taken into account prospects for broader gentle improvement next year and beyond.

And now for the good news – the surpluses will get smaller

The light metal appears at risk of slipping into a new, lower trading range in the weeks ahead and we feel that at the very least sustained price flatness is a necessary ingredient for staving growth in supply.

We believe that underlying prices will need to fall further to trigger tangible smelter responses and bring about more rapid price recovery.

Meaningful price recovery looks unlikely in 2013-2014, if not longer.

However, it is demand that might eventually come to the rescue. Our revisions mean that market surpluses are likely to dip below the 1 Mt mark for the first time since 2007 – this is a feature we think has taken place in 2013 and we have reduced our projected annual surpluses progressively in 2014 and 2015, by which time the market may even be approaching some semblance of annual statistical balance.

Exhibit 181: Aluminium’s global annual market surpluses are receding Supply-demand surplus/deficit, kt primary aluminium

‐1,500

‐1,000

‐500

0

500

1,000

1,500

2,000

2,500


Developed world is

far less important

than EMs

03 October 2013


That might be construed as a touch optimistic but it would be borne out of a further year of prices below US$1,900/t, along with ebbing premiums.

Even then, the prospects of a more adventurous running up of prices will be hampered by the gravitational pull of stocks – in theory those will still be able to service four months of use.

Exhibit 182: Aluminium forecast comparison Exhibit 183: Aluminium historical price and forecastUS$ per metric tonne US$ per metric tonne

$1,600

$1,650

$1,700

$1,750

$1,800

$1,850

$1,900

$1,950

$2,000

$2,050

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$1,200

$1,700

$2,200

$2,700

$3,200

$3,700

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Aluminium 3M Quarterly Avg Forecast


Exhibit 184: Forecast aluminium prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

1Q-13 2Q-13 3Q-12 4Q-13f 2013f 1Q-14f 2Q-13f 3Q-13f 4Q-14f 2014f 2015f 2016f LT

LME aluminium 3M New US$/t 2,040 1,875 1,825 1,900 1,910 1,800 1,850 1,900 1,900 1863 2,000 2,100 2,250

New US¢/lb 95 85 85 85 85 80 85 85 85 85 90 95 100

Old US$/t 2,040 1,875 1,800 1,750 1,866 1,800 1,850 1,900 1,900 1,863 2,000 2,100 2,250 Source: Credit Suisse Commodities Research

03 October 2013


Alumina: From bad to worse We have been pessimistic about alumina since April, but were not bearish enough. The alumina price has collapsed to a lowly $313/t and with no relief on the horizon. Bauxite supply to China is booming, presumably with stockpiles being erected, China’s domestic alumina output is operating at a solid surplus, and Australian alumina imports have slumped. Downstream, the aluminium price is becoming increasingly grim, and as premiums drift lower with warehouse queues, Western aluminium smelters are staring down the barrel of forced cuts and closures, not helpful for alumina producers.

Indonesia's raw material ban due to start in January might have lifted alumina prices by cutting China's bauxite supply and crimping its alumina output, but Indonesia is suffering a hefty trade deficit and the government is anxious to increase exports, not chop them off. Raw necessity has rolled over value-adding dreams. The ban is a Parliamentary law and cannot be over-turned by ministerial authority alone, but Reuters reports that the Energy and Mineral Resources Ministry has initiated talks with lawmakers to circumvent the effects by delaying the ban or allowing exports by companies with agreements to process ore domestically. We place no hope in the ban lifting the price near term.

Near-term alumina dampening on aluminium price capitulation

With demand weakening as China produces ample alumina itself, the spot price has recently stepped down again. There was probably also a contribution by aluminium price capitulation. Given that a significant portion of the alumina supply remains priced by linkage, the aluminium price continues to influence the spot alumina price. The only positive factor we can see is that the spot price is not hitting the lows that a 15.5% linkage to the aluminium price would suggest, and China pricing is stable.

Exhibit 185: Spot prices for Australian Chinese and Chalco alumina

260

280

300

320

340

360

380

400

420

Jul-1

0A

ug-

10S

ep-

10O

ct-1

0N

ov-1

0D

ec-1

0Ja

n-1

1F

eb-1

1M

ar-1

1A

pr-

11M

ay-1

1Ju

n-1

1Ju

l-11

Au

g-11

Se

p-11

Oct

-11

Nov

-11

Dec

-11

Jan

-12

Feb

-12

Mar

-12

Ap

r-12

May

-12

Jun

-12

Jul-1

2A

ug-

12S

ep-

12O

ct-1

2N

ov-1

2D

ec-1

2Ja

n-1

3F

eb-1

3M

ar-1

3A

pr-

13M

ay-1

3Ju

n-1

3Ju

l-13

Au

g-13

Se

p-13

US

$/t

FOB Australia spot price Other China spot SGA less VAT

Chalco spot SGA less VAT 15.5% of spot aluminium

Source: Metal Bulletin, Chalco, Credit Suisse Commodities Research

Forecast pricing

We have slashed our spot alumina prices to reflect the more bearish tone of the market. Also, we have lowered our prices across the mid-term and now forecast a price of only $325/t and $330/t in 2014 and 2015. Our LT price remains $400/t, being the price needed to justify building an alumina refinery.

03 October 2013


Exhibit 186: Alumina spot price forecast

Source: Company data, Credit Suisse Commodities Research

In the Western World, the major developments recently surround aluminium warehouses. Pressure has mounted on warehouse operators to cut queues and this now appears to be under way, slowly. Likewise, the premium, representing the difficulty in obtaining physical metal is heading back to lower levels. The elevated premium was an important source of revenue for aluminium smelters, given the extraordinarily low metal price, so with it sliding we expect pressure on aluminium smelters to idle may increase, cutting alumina demand.

To that bleak assessment of the West, we have alumina demand also falling in China as bauxite supply has poured in, allowing Shandong smelter output to grow.

With the situation appearing bleak for alumina producers in both East and West, it appears to us that demand for alumina from Australia is likely to be reduced for the next couple of years. Given alumina cannot easily be stored, refineries will need to cut production. There seems no reason to expect prices to head significantly higher for the next couple of years.

Other new developments

The Gove Refinery in Australia's NT is looking a little uncertain again, but this has not had the same price effect as it did at the start of the year. Rio Tinto is again threatening that the refinery may be closed if it is unable to obtain sufficient gas to cut the energy bill. In March, the NT Government offered Rio 300PJ of its supply, but has now clipped its offer to 175PJ as it determined the original offer put NT residents at risk of gas shortages. However, the incoming Federal Resources Minister has pushed back on Rio. His comment is that Rio needs to commit to the refinery before the government will commit time and effort assisting with an energy solution. It remains uncertain how this will play out.

Bauxite prices remain firm, but interest seems to be diminishing from the major players. Both Rio Tinto and Chalco pulled out of the bidding for the Arukun bauxite deposit adjacent to Weipa in northern Queensland. Only Glencore and an indigenous miner submitted bids by the deadline of 13 September.

Indonesian bauxite exports back to their highs

All restrictions on bauxite imports from Indonesia appear to have evaporated. China's bauxite imports from Indonesia have maintained a hefty +4Mt/y since April. The abundant imports are probably being used to build stockpiles in China as a buffer against export policy confusion in Indonesia.

Combined with supply from Australia, India, Fiji and other localities, the monthly supply is at new highs of an annualized 70-80 Mt/y sufficient for over 30 Mt/y of alumina production. The refineries in Shandong have total capacity of 14.4 Mt/y, according to Wood Mackenzie, suggesting they will be adequately supplied by these imports.

03 October 2013


Exhibit 187: China monthly imports of bauxite Mt/m

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auxi

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tpm

)

Australian bauxite Indonesian bauxite other

Source: China customs, Credit Suisse estimates

China’s alumina output climbing

After falling steadily since the middle of 2012, daily alumina production in China has lifted once again to hit new highs. Aluminium production has broadly steadied, since mid-2012 so, according to our calculation, China became self-sufficient in alumina from March and has produced surpluses since then. We suspect Shandong refineries picked up output given abundant imported bauxite feed.

Exhibit 188: China smelter grade alumina output and domestic surplus/(deficit) kt/d

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0102030405060708090

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Alumina surplus/(shortfall) (kt) China alumina output

Source: NBS, Credit Suisse estimates

03 October 2013


Alumina imports falling – a negative read for pricing

Predictably, with surplus alumina production, China’s appetite for alumina imports has fallen away. The Pacific market has slackened. We have lowered our spot alumina price forecasts for 2H from $350/t to $340/t.

We may now have to wait for global demand for alumina to outpace supply and a deficit in refining capacity to develop before alumina is priced at a more commercial rate. We don't know when that will occur and push it out to LT in our numbers. In the next couple of years we expect the industry to be stressed with low prices.

Exhibit 189: China monthly alumina imports kt/m

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Alumina imports from Australia Other net imports

Source: China customs, Credit Suisse estimates

Bauxite price steady

The landed Indonesian price jumped after the imposition of Indonesia’s 20% export tax, but fell sharply in February. We suspect that may have reflected a supply of poor quality material, given the price has subsequently recovered.

Indonesian exports and why they matter

While China is by far the largest aluminium producer, it is deficient in quality bauxite in its supply chain. Accordingly, China will need to import either bauxite or alumina to feed its smelters. If sufficient bauxite is available, it can cheaply expand refineries in Shandong Province and supply its own industry.

If bauxite is in short supply, China will import alumina, lifting prices. Indonesia is the largest source of bauxite feed to China and the key to its imports. We now believe that bauxite exports will continue into 2014 and beyond at sufficient rates to feed Shandong’s current refining capacity and expansions. This means reduced demand for alumina imports in China.

03 October 2013


Exhibit 190: Landed price of bauxite in China US$/t

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US$/t

Australian bauxite Indonesian bauxite

Source: China Customs, Credit Suisse

Longer-term view – +$400/t price needed for commercial return to refineries

Our estimates suggest that new start global refineries with integrated bauxite mines need an alumina price of +$400/t to gain a commercial IRR. At the current spot price, the IRR of all refinery builds – irrespective of their position on the cost curve – is skinny. Around the world, including in China, when integrated bauxite mines are included in the development, the capital intensity is greater than $1000/t. At this investment level, the alumina price needs to be higher than $400/t to gain an IRR of 15%, even with the newest cheapest refineries such as Hindalco’s Utkal.

This view is supported by commentary from Rio Tinto in March: According to Metal Bulletin (18 March 2013), at a bauxite and alumina conference, Rio Tinto’s General Manager of Commercial Bauxite and Alumina said that there is almost no reason for Western companies to invest in new alumina capacity due to low prices and high costs. “Prices have been lackluster for 12 months and are stuck in the uncomfortable zone where they are neither low enough to see capacity fall, nor high enough to invest in new greenfields. Considering the cost-curve, most producers are around break-even. It’s not enough to incentivize Western producers to expands or invest in new projects.”

Only Shandong refineries using imported bauxite have a stronger IRR

Our view on the necessary alumina price differs only for non-integrated refineries, without accompanying bauxite mines. We estimate that the Nanshan refinery, operating in China’s Shandong Province using imported Indonesian and Australian bauxite, can gain a commercial IRR at $350/t and above. The key control on the IRR is not the operating cost but the capital intensity of the refinery. The cost of expanding Shandong refineries is low because only the refinery infrastructure is needed, and the refineries can be built to use the low-temperature Bayer process unlike other Chinese refineries that use China’s domestic low quality bauxite. Building cheaply is China’s strength, in our view.

03 October 2013


Exhibit 191: Estimated IRRs for alumina refineries at various alumina prices US$/t

Source: Wood Mackenzie, Credit Suisse estimates

Exhibit 192: Position of tested alumina refineries on the global cost curve US$/t

Source: Wood Mackenzie, Credit Suisse estimates

03 October 2013


Key control on Pacific alumina price is supply of bauxite to Shandong Province

With this backdrop, expansion of coastal refineries using imported bauxite would seem to be the most commercially sensible strategy for China and indeed in recent years the capacity of Shandong refineries did increase more rapidly than China overall. We consider these cheap expansions have capped the global alumina price.

Chinese refineries outside Shandong Province, with integrated bauxite mines and roasters to allow use of poor quality Chinese bauxite, need a strong alumina price, as evident in the Chalco alumina price. Ex 17% VAT, Chalco’s ex-works price is nudging $400/t, whereas the Shandong price is sub-$360/t. Given the coastal location, Shandong refineries are direct competitors to Australian alumina imports. If Shandong refineries have sufficient bauxite to expand readily, then tightness in the Pacific price cannot be maintained.

Therefore, the key issue in predicting the spot alumina price, in our view, is whether China’s Shandong refineries have sufficient bauxite imports to operate at full capacity.

Indonesian bauxite remains the key source for China

Despite commentary about China developing alternative bauxite sources, Indonesia remains the mainstay. Australian supply has barely increased and other overseas feed sources remain piece-meal – a few hundred thousand tonnes from India, a small mine in Fiji, and wherever else a shipload of bauxite can be sourced. The dominant and critical bauxite source remains Indonesia, so we maintain our focus on its supply.

03

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inding Road

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Exhibit 193: Global aluminium and alumina supply and demand estimates Millions of metric tonnes (Mt)

World Alumina and Aluminium Supply & Demand Balance2008 2009 2010 2011 2012 2013f 2014f 2015f 2008 2009 2010 2011 2012 2013f 2014f 2015f

ALUMINA PRODUCTION STOCKS North America 6.16 4.28 5.34 5.72 6.06 6.52 6.38 6.52 LME + COMEX Stocks 2.37 4.63 4.28 4.97 5.21 Western Europe 6.95 4.66 5.64 5.85 5.79 5.82 5.73 5.75 SHFE Stocks 0.20 0.30 0.44 0.21 0.44 Eastern Europe 5.63 4.75 5.38 5.56 5.03 5.22 5.47 5.64 IAI Stocks 2.96 2.23 2.52 2.39 2.28 China 25.37 23.85 31.00 39.20 43.00 46.50 50.60 54.20 Japanese Port Stocks 0.32 0.18 0.22 0.25 0.28 Kazakhstan & Azerbaijan 2.05 1.74 1.64 1.67 1.83 2.06 2.13 2.13 Estimated Unreported Stocks 1.40 2.19 3.74 5.14 6.03 India 3.63 3.69 3.61 3.91 3.79 4.08 5.97 6.98 Total stocks 7.25 9.53 11.20 12.96 14.24 15.10 15.66 15.92 Other Asia 1.00 1.00 1.22 1.12 1.23 1.35 1.73 3.14 Weeks Consumption 9.9 14.1 14.3 15.2 15.8 15.7 15.4 14.7 Australia 19.73 20.26 20.12 19.64 21.56 21.85 23.63 23.80 Al Price (US$/t) 2,567 1,665 2,173 2,398 2,027 1,866 1,863 2,000 Africa 0.59 0.53 0.60 0.57 0.15 - - 0.43 Alumina Linkage 13.5% 14.5% 15.3% 15.8% 15.7% 18.6% 18.8% 18.0% Jamaica 4.16 1.77 1.78 2.01 1.77 1.85 1.95 2.12 Alumina Price (US$/t) 341 230 332 378 319 348 350 360 Brazil 7.86 8.65 9.52 10.40 10.26 9.69 10.06 10.52 ALUMINIUM CONSUMPTION BY COUNTRY Other Latin America 3.75 2.85 2.51 2.67 2.03 1.78 1.85 2.10 North America 6.27 4.72 5.29 5.64 6.10 6.32 6.61 6.83Highly Probable Grow th - 0.32 0.32 Western Europe 6.59 5.27 5.88 5.97 5.84 5.85 6.01 6.19Disruption Allowance - (2.8) (2.9) Eastern Europe 2.14 1.55 1.77 2.01 2.06 2.13 2.24 2.36Required Cuts - - (1.5) China 12.56 13.88 16.47 19.17 21.04 22.90 24.73 26.46World Alumina Production 86.9 78.0 88.4 98.3 102.5 106.7 113.0 119.2 India 1.28 1.48 1.72 1.84 1.91 2.04 2.19 2.36 % Change 7.6% -10.2% 13.2% 11.3% 4.3% 4.1% 5.9% 5.5% Japan 2.25 1.71 1.79 1.79 1.80 1.78 1.83 1.87Capacity Utilisation (%) 89.5% 77.7% 82.8% 84.0% 82.7% 80.5% 80.4% 81.4% Other Asia 3.99 3.97 4.74 4.88 4.96 5.43 5.75 6.54NMA Consumption 5.62 4.74 5.98 6.48 6.67 7.01 7.36 7.73 Oceania 0.46 0.45 0.48 0.46 0.48 0.49 0.52 0.53 % Change 1.4% -15.6% 26.2% 8.3% 3.0% 5.0% 5.0% 5.0% Africa 0.47 0.42 0.53 0.54 0.57 0.60 0.64 0.68SGA Av ailable 81.26 73.30 82.38 91.84 95.82 99.70 105.62 111.49 Latin America (inc Mex ico) 1.87 1.75 1.92 2.08 2.21 2.32 2.45 2.58SGA Requirement 77.45 73.89 83.28 90.97 95.11 99.95 105.50 111.65 World Consumption 37.9 35.2 40.6 44.4 47.0 49.9 53.0 56.4SURPLUS/(DEFICIT) SGA 3.80 (0.59) (0.90) 0.86 0.71 (0.25) 0.13 (0.16) % Change (World) -1.3% -7.1% 15.3% 9.4% 5.8% 6.1% 6.2% 6.5%

% Change (China) 1.7% 10.5% 18.7% 16.4% 9.8% 8.8% 8.0% 7.0%ALUMINIUM PRODUCTION ALUMINIUM CONSUMPTION BY SECTOR North America 5.79 4.759 4.69 4.97 4.85 4.90 4.90 4.95 Building & Construction 9.91 9.87 11.59 13.25 14.24 15.17 16.12 17.03 Western Europe 4.63 3.722 3.80 4.03 3.61 3.55 3.55 3.65 % Change -0.1% -0.4% 17.4% 14.4% 7.4% 6.6% 6.2% 5.6% Eastern Europe 5.13 4.422 4.58 4.65 4.65 4.40 4.50 4.70 Transport 9.70 8.38 10.67 11.17 11.82 12.62 13.63 14.81 China 13.60 13.500 17.30 19.80 22.40 25.00 27.50 28.80 % Change -6.5% -13.6% 27.3% 4.7% 5.8% 6.7% 8.0% 8.6% Other Asia & Oceania 6.53 6.91 7.86 8.75 8.91 9.31 10.41 11.71 Electrical 4.85 5.15 5.51 6.02 6.36 6.74 7.14 7.60 Africa 1.71 1.682 1.75 1.80 1.82 1.91 1.95 2.05 % Change 19.5% 6.3% 6.9% 9.3% 5.6% 5.9% 6.0% 6.4% Latin America (inc Mex ico) 2.66 2.508 2.31 2.19 2.05 1.97 2.08 2.22 Packaging 5.84 5.14 5.34 5.54 5.79 6.01 6.28 6.59Highly Probable Grow th - - - - - - - - % Change 2.2% -12.0% 3.8% 3.9% 4.5% 3.8% 4.5% 5.0%Disruption Allowance - - - - - (0.30) (1.33) (1.40) Consumer Goods 2.70 2.51 3.03 3.42 3.59 3.90 4.13 4.41Required Cuts - - - - - - - - % Change 0.1% -7.3% 21.0% 12.9% 5.0% 8.6% 5.9% 6.7%World Production 40.0 37.5 42.3 46.2 48.3 50.7 53.6 56.7 Machinery & Equipment 3.06 2.63 2.84 3.24 3.35 3.51 3.68 3.86 % Change 5.0% -6.3% 12.7% 9.2% 4.6% 5.1% 5.5% 5.8% % Change -18.8% -14.1% 8.1% 13.9% 3.5% 4.9% 4.6% 5.1%Capacity Utilisation (%) 87.5% 76.0% 84.2% 87.1% 86.9% 86.2% 82.5% 82.9% Other 1.83 1.54 1.63 1.76 1.85 1.92 2.01 2.12World Consumption 37.9 35.2 40.6 44.4 47.0 49.9 53.0 56.4 % Change -2.1% -15.8% 6.1% 7.8% 4.8% 4.3% 4.6% 5.1%SURPLUS/(DEFICIT) ALUMINIUM 2.14 2.28 1.67 1.77 1.28 0.86 0.56 0.26 Total 37.9 35.2 40.6 44.4 47.0 49.9 53.0 56.4


03 October 2013


Nickel: Saddled by supply (with a caveat) Of all the LME metals, nickel would appear to have the poorest nearer-term fundamentals, with one caveat – uncertainties about Indonesia’s pending ban on nickel ore exports, which could support prices for a while longer. As we explain later, we are not of the view this is going to turn out to be a bullish feature, but it does present a binary upside price risk.

Otherwise, we have substantially revised our price forecasts downward on the belief that Indonesia’s restrictions will turn out to be lukewarm.

With surpluses higher again in 2013, prices need to remain depressed to trigger any semblance of aggregate producer restraint.

We are of the opinion nickel will not step sustainably above US$15,000/t until 2015. Even then, these flat prices are probably only enough to bite into annual surpluses rather than fully remove them in 2014-2016.

Nickel supply surges ahead

Production of nickel is rising at an unprecedented rate of knots. This is a manifestation of a raft of new refineries and processing plants outside China that are struggling to ramp up to targets but that are collectively bumping up the supply of the metal.

Exhibit 194: Recently commissioned nickel projects outside China make slow progress in ramping up, but collectively these programs will add too much nickel supply for the market to absorb in the short to medium term

Project Country Operator TypeCapacity

(kt) Start-up Comments

Barro Alto Brazil Anglo American FeNi 40 Mar-2011 Design problems necessitate furnace reconstruction that will hold back output below rated capacity until June 2016. Production of 20-25 kt expected this year.

Onca Puma Brazil Vale FeNi 53 Mar-2011 Production halted as one furnace is being rebuilt. Restart is expected by end of 2013. Highest achieved production was 4 kt in Q1 2012.

Tagaung Myanmar Tagaung Taung Nickel (MCC)

FeNi 22 Apr-2011 Produced first NPI pellets in March after first basic NPI produced in October 2012. First furnace aims to ramp-up to 85 kt/y of crude NPI

Ravensthorpe Australia First Quantum HPAL 39 Oct-2011 31-35 kt expected in 2013 after 32.9 kt produced in 2012.

Ramu Papua New Guinea

MCC HPAL 31 2Q 2012 Ramp-up expected to progress at a slow but steady pace with full operation unlikely before 2015. Currently running at 35-40% of nameplate capacity.

VNC (Goro) New Caledonia Vale HPAL 60 4Q 2010 Persistent technical problems hamper achievement of high production levels. Operation produced 8.5kt of Ni in products in 1H 2013.

Ambatovy Madagascar Sherritt HPAL 60 May 2012 Steady ramp-up continues but CY2013 guidance reduced 15% to 6 kt contained Ni.

Koniambo New Caledonia Xstrata FeNi 60 Sep 2013 Line 1 production started in April with 2nd line on stream in November. Firs commercial production likely this month. Guidance at 4 kt for 2013, 34 kt for 2014 and 55 kt for 2015.

Long Harbour Canada Vale Hydromet 50 4Q 2013 Refinery close to commissioning based on matte feed from PT Vale in Indonesia and concentrate from Voisey's Bay.

Taganito Philippines Sumitomo HPAL 30 3Q 2013 Mixed sulphides production commenced for shipment to SMM's Niihima refinery in Japan. We expect 15-20 kt in 2014.

Source: Company reports, Credit Suisse

Our forecasts take into account persistent technical and operational hitches at these facilities and we consider we have been conservative in our supply projections. Others will have to cut back to avoid deeper price slumps than we have portrayed in our base case – to date such curtailments have not materialized and this poses significant downside price risks to our forecast for 2014.

03 October 2013


Meanwhile, in China the production of nickel pig iron (NPI) has posted new records. NPI is now the preferred source of feed for the country’s rapidly expanding stainless steel plants. Consequently, nickel produced elsewhere is being increasingly marginalized.

Demand is not to blame

This means that, globally, a bigger surplus than in 2012 is almost certain to weigh on the market this year and the only reason it is not considerably greater is because demand has held up reasonably well. Indeed, prospects for stainless steel production remain solid, albeit overcapacity is a feature as Chinese operators aggressively seek to gain market share in global markets. Inevitably, this will lead to casualties, but this may take time. Europe and Japan are probably going to bear the brunt of China’s grab for market territory.

Worldwide, stainless steel production is approaching 37 Mt this year and nickel-bearing grades have contributed more to this growth than last year. China’s output is in double-digit realms, although rising exports are accompanying the boom. Unfortunately, pronounced restocking, and now destocking, cycles are characterizing the market but prospects for 2014 are positive (for instance, we hear that inventories are being reduced in Wuxi, China’s principal stainless steel trading hub).

Another strong year in China may also be accompanied by a rebound more broadly, a feature typical of the stainless steel production cycle. Such a bounce may provide a rare opportunity for the nickel market to readjust supply and shed overhanging stocks – beyond 2014-2015, we foresee a return to growth closer to trend pace and with it a greater shift in the axis of production to China and possibly other emerging markets.

Exhibit 195: Stainless steel production rising in China Exhibit 196: Stainless steel exports climbing too Monthly, kt, sa Flat rolled products, monthly, kt, sa

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2006 2007 2008 2009 2010 2011 2012 2013 Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

The nickel pig iron story continues

China’s NPI producers may turn increasingly toward the Philippines to mitigate risks, and higher costs, of sourcing laterite ore from Indonesia next year. Concern continues on the possibility that Indonesia’s ore ban will turn out to be a half-hearted one but that cannot be guaranteed. It is also possible duties on volumes permitted to leave could be raised over and above the 20% currently levied.

The Philippines presently supplies around one-half of China’s imports, though a greater proportion of these volumes are lower- and medium-grade ore. Shipments from the country in August are thought to have fallen back to 2.4 Mt from almost 4 Mt in July. This compares to 2.6 Mt from Indonesia in August, a similar rate to July. Typhoon season hampers Philippines shipping in the peak summer months.

03 October 2013


We are led to believe that NPI plants could treat greater volumes of ore averaging 1.6% Ni from the Philippines to compensate for losses of higher-grade ore from Indonesia if higher taxes eventuate. This would lend further weight to suggestions NPI operators are looking at ways to “sweeten” nickel grades at the front end of their processes where higher-grade NPI is needed. However, increased volumes from the Philippines would also work to lift ore prices.

Although RKEF facilities boast costs of production below present price levels, SMM estimates that a “typical” EAF-based producer in Jiangsu province, representative of higher-cost NPI plants, would have average costs of production of around US$14,900/t of NPI (about US$1,070/mtu compared to a price of US$1,000/mtu), assuming a 20% tax on imports.

An increase in the tariff to 50% would lift these costs by almost US$3,000/t, providing a clear incentive for alternative sources of ore. Despite poor profitability of highest-cost NPI operators, costs for marginal production have come down from around US$20,000/t since 2011.

Meanwhile, NPI production in August rose by 8.8% in China, on track for a record year of production close to 425 kt of nickel content.

Will the ban take place?

Under the conditions of the 2009 Mineral and Coal Mining Law, holders of rights to extract minerals, rock, and coal were required to commence domestic processing and refining of raw resources by January 2014. The logic behind the move was to extract greater value from Indonesia’s minerals endowment through a mix of higher prices, employment, and expansion of services associated with mineral processing.

The obligation was subsequently outlined in much greater detail in the 2010 Mining Minerals Activities Regulation (Articles 93-96). Further tailoring took place in 2012 when coal was excluded from the regulation and the government sought extension of the edict to Contract of Work (CoW) holders.

Too little, too late? No flurry of downstream investment

In February the government issued a Presidential Instruction prompting key ministers, and regional governors and officials, to take necessary steps to accelerate making processing and refining a reality by January 2014.

However, with less than three months remaining before the law is introduced, placing a ban on exports of unprocessed minerals (except coal), the list of investments in new downstream plants intended to come on stream by next year is noticeably short. Metal miners in particular have been vociferous in their protests that it is not economically feasible for them to carry out domestic processing and refining, a conclusion also reached in a comprehensive USAID study earlier this year, which highlighted the poor investment returns in downstream activities for metals, such as nickel and aluminium, blighted by global overcapacity and weak economic rent.

Is the government back-tracking?

Events took another twist last month with the announcement of targets to raise revenue from the minerals sector by 18% for the 2014 budget to boost the country’s softening economy. This comes against a background of commodity prices under downward pressure and would require a substantial boost in exports, precisely at the time when “raw” ore shipments – and prices – may have been heading the other way.

As a tardy stimulus, the government has relaxed some quota restrictions – in effect, the extension of the quota approval time frame from 3 months to 12 months means that it will be easier to push up exports through the second half of this year before the ban on shipments of unprocessed ore takes effect next January. A sharp recovery in exports of nickel ore and bauxite is likely in the remaining months of 2013.

03 October 2013


Soft ban looks more likely

The ban is poised to take place, but we believe this will not be a full one. There is scope to repeal the ruling, but not immediately, to avoid substantial embarrassment. We contemplate the most likely compromise as retention of the quota system, with the 20% tax on exports and additional royalty (5%), a situation favoring those producers that have processing projects under way.

This is where the clarity ends; it would be relatively easy to defer construction of new plants while still benefitting from quotas to export ore. A number of projects “under way” may merely have entailed token breaking of ground. Indeed, indications that incentives will be put in place, as well as confused signals from the media, will have caused project owners to hold their activities back to see what emerges.

Faith that nickel ore shipments will continue to flow would seem to be shared by Japan’s nickel processors – the country relies heavily on high-grade laterites for nickel and ferronickel production. When the 2009 law was introduced, Japan challenged its legitimacy with the WTO, but more recently there has been little outward sign of protestation.

Flexibility in interpreting “processing” may be the key

Beyond potential stalling or deferring of actual construction and completion of planned plants, guidelines on what constitutes “processing” are not crystal clear. For instance, one possible permutation that makes sense at first glance would be attempts to reduce the very high capital costs of constructing fully vertically integrated facilities in Indonesia by constructing kiln- or sinter-based processing, essentially the “front end” of existing NPI configurations in China.

China still affords superior competitiveness on many fronts in installing rotary kiln-electric furnaces (RKEFs), especially lower-cost power and the benefits of closer integration with stainless steel production. Further, we doubt that a lengthy list of players will wish to tackle the potentially greater risks of high capital expenditure and operational difficulties in Indonesia.

Moreover, production of a sintered or agglomerated product opens up opportunities to improve on freight efficiencies (potentially shipping a product with <10% moisture instead of as much as 25% to 30%) and possibly also improving safety. “Wet” laterite ore is notoriously difficult to transport due to the high risks of liquefaction while at sea – this was the cause attributed to the capsizing of four vessels in 2011, another in 2012, and several other narrow misses, with costly and tragic consequences.

Of all the projects on the drawing board, Tsingshan Iron & Steel, which has built some of the largest NPI plants in China, appears the most willing to commit to adding NPI capacity in the country, with construction of a new RKEF and stainless plant in Sulawesi aimed to produce 300 kt/y of high-grade NPI by the end of 2014 at a cost of more than US$1 billion (this is still a modest sum compared to a number of ferronickel and acid leach projects currently under commissioning and ramp-up elsewhere). A second phase of investment is intended to lift output to 500 kt/y of NPI (about 60 kt/y nickel).

Tsingshan is also committed to expanding NPI and stainless steel production in China and continues to test new innovations in its nickel processing.

03 October 2013


Exhibit 197: China’s NPI production advanced almost 9% in August, heading for 425 kt (contained nickel) for the year

Ni Content (tonnes) Jan Feb Mar Apr May Jun Jul Aug YTD % of total

By Region:

Shandong 5,800 5,000 6,200 5,200 4,400 4,200 4,700 5,500 41,000 14.5

Inner Mongolia 8,100 7,600 8,500 8,300 6,500 6,500 7,100 8,200 60,800 21.4

Jiangsu 6,900 6,300 8,200 7,900 7,300 7,000 8,000 9,000 60,600 21.4

Fujian 4,600 4,400 5,100 5,000 5,000 5,000 5,000 5,000 39,100 13.8

Other 11,200 11,000 11,500 11,200 9,300 9,300 9,200 9,300 82,000 28.9

By Grade:

High Grade NPI 30,400 28,400 33,600 32,600 27,900 27,400 29,700 33,100 243,100 85.7

‐ of which: RKEF 13,100 12,100 14,000 14,000 12,000 11,000 14,000 15,600 105,800 37.3

Medium Grade NPI 2,400 2,200 2,200 1,300 1,100 1,100 1,100 1,600 13,000 4.6

Low Grade NPI 3,800 3,700 3,700 3,700 3,500 3,500 3,200 2,300 27,400 9.7

TOTAL 36,600 34,300 39,500 37,600 32,500 32,000 34,000 37,000 283,500 100.0

% Change mom ‐6.3% 15.2% ‐4.8% ‐13.6% ‐1.5% 6.3% 8.8% Source: SMM, Credit Suisse

Exhibit 198: Nickel supply and demand in China Tonnes, nickel content

2012 Jan/Feb Mar Apr May Jun H1 2013

Domestic Refined Nickel 205,391 37,173 18,240 18,150 19,200 18,950 111,713

Nickel Salts 8,400 1,400 700 700 700 700 4,200

NPI 360,057 70,900 39,500 37,600 32,500 32,000 212,500

Total Primary Ni 573,848 109,473 58,440 56,450 52,150 51,650 328,163

Imports Refined Nickel 159,303 34,946 13,877 14,825 11,138 10,423 85,209

Ferronickel 72,332 10,049 2,528 3,744 3,611 2,366 22,298

Total Imports 231,635 44,995 16,405 18,569 14,749 12,789 107,507

Exports Refined Nickel 35,334 4,241 3,162 2,624 5,844 6,699 22,570

Ferronickel 1,847 0 0 0 0 0 0

Total Exports 37,181 4,241 3,162 2,624 5,844 6,699 22,570

Apparent Cons'n 768,356 150,227 71,683 72,395 61,055 57,740 413,100 Source: SMM, Credit Suisse

Will rising ore costs pressure NPI producers to cut?

Ore prices now appear to be rising off their mid-year lows; nickel ore grading 1.8%-1.9% Ni is trading this week at about RMB360-410/wmt (US$59-67/wmt), CFR China, on a par with April’s levels prior to 2Q’s declines.

An RKEF producer well-positioned in coastal Fujian, southern China, recovering NPI at grades of 10%-15% Ni would currently be incurring costs of about RMB835/mtu (i.e., per percentage point) of Ni. This compares to a price for NPI of around RMB1,000/mtu, providing a 15% profit margin. However, margin pressure is being felt by EAF-based NPI producers (running with sinter plants) and this explains the stronger growth in expansion of RKEF facilities.

RKEF units now account for more than 40% of nickel contained in NPI in China. More than half the costs of production are for ore procurement and delivery.

Reductions in costs of coal/coke have helped, as have favorable electricity tariffs in some locations; plants in Inner Mongolia, for example, leverage low-cost power and access to regional coal/coke supplies, although freight costs of delivering raw materials are higher.

03 October 2013


By way of example, Dingxin’s new 300 kt/y NPI plant (12% Ni) at Fuan in Fujian is estimated by Wood Mackenzie to incur cash costs of around US$12,200/t of nickel (we think these costs will have come down since this analysis). Of these, 33% are for ore purchases and 24% for ore delivery costs. Total energy costs (electricity and coke/coal) account for 32% and other direct overheads for the remaining 11%.

This plant arguably lies in the more competitive part of the NPI supply curve, but it should be remembered that differences in product prices because of iron credits make this comparison complicated.

Moreover, as an integral part of the stainless steel production process, many NPI plants are now capturing the benefits of operational synergies with production closely tied to stainless steel production plans.

Exhibit 199: Chinese nickel ore imports from Indonesia appear to have stabilized after 1H’s declines – we expect reasonable recovery in 4Q

Exhibit 200: Japan is heavily reliant on imported laterite, mostly from Indonesia. However, supplies from the Philippines could also rise

Monthly, kt, gross tonnage, sa Monthly, kt, gross tonnage

0

1

2

3

4

5

6

7

8

2008 2009 2010 2011 2012 2013

Indonesia Phillipines Other

Source: Customs data, Credit Suisse Source: Customs data, Credit Suisse

Don’t forget the iron credits!

For Chinese stainless steel producers, NPI is a preferred source of nickel supply over imported ferronickel and especially refined nickel. Presently, high-grade NPI nickel units are trading at a discount of RMB20-40/mtu to refined nickel.

The value of iron units is often under-estimated, as are the requirements for yielding different stainless steel products. For example, low nickel content NPI (1.6-1.7% Ni) – prices are presently around RMB2,700/t (US$440/t) – is inaccurately thought of merely as the highest-cost and most vulnerable swing supply to the Chinese stainless industry. However, this material, usually recovered in blast furnaces, is a strong source of base-load iron units in a country short of stainless steel scrap.

Low-grade NPI is mainly sought by stainless steel mills producing lower nickel-bearing 200-series products. Lower grade ore from the Philippines is the mainstay of this NPI production – prices of this ore are less well correlated to LME nickel prices, reflecting the subordinate role in supplying nickel units.

High-grade NPI is more closely tied to producing higher nickel stainless products in the 300-series spectrum. This is where higher-grade saprolite ore becomes more important, with Fe:Ni ratios broadly required to be less than 10:1 to achieve higher NPI grades. However, NPI producers are believed to be looking at fresh ways to boost nickel grades within their RKEF systems to mitigate heavy reliance on high-grade ore.

03 October 2013


NPI production will continue to rise …

Stacking up NPI producers on global nickel supply cost curves provides a misleading sense of price support. NPI production is an integral part of stainless steel production in China. NPI is competitive with most imported forms of nickel units, with refined nickel, in particular, largely relegated to the role of a “sweetener” or for non-stainless applications (even so, Jan-Jul 2013 net imports still rose 10% year-on-year to 72 kt).

Expansions of NPI, therefore, come at the expense of competing nickel products. Further, domestic supplies of refined nickel, mainly from Jinchuan, provide about one-third of China’s overall nickel needs. We have substantially increased our projections for NPI production, expecting an increase from this year’s 425 tonnes of contained nickel to more than 500 t/y nickel in NPI by 2015, supplying 55%-60% of China’s total nickel needs.

The good news that nickel-bearing stainless steel grades are once again gaining the most ground for China’s producers is therefore heavily tempered by the apparent squeezing of LME-registered products into a proportionally smaller, segmented market that looks likely to be over-supplied, possibly for a number of years to come.

This is not a recipe for sustained price rises. With LME stocks already pointing to surpluses in excess of the 50 kt we had postulated for CY2013, it is hard to have any confidence that nickel prices will rise far anytime soon…unless Indonesia plays hard ball.

Exhibit 201: Deep cuts to planned production are needed to shrink surpluses

Exhibit 202: LME stocks are on the rise, reflecting acute oversupply

kt nickel kt

‐80

‐60

‐40

‐20

0

20

40

60

80

100

120

0

50

100

150

200

250

2005 2007 2009 2011 2013

Source: Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

03 October 2013


Exhibit 203: Nickel forecast comparison Exhibit 204: Nickel historical price and forecast US$ per metric tonne US$ per metric tonne

$12,000

$12,500

$13,000

$13,500

$14,000

$14,500

$15,000

$15,500

$16,000

$16,500

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

$45,000

$50,000

$55,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Nickel 3M Quarterly Avg Forecast


Exhibit 205: Forecast nickel prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05


LME nickel 3M New US$/t 17,376 15,250 14,000 13,750 15,094 14,250 14,500 14,500 14,500 14,438 15,000 16,000 20,000 New US$/lb 7.90 6.90 6.35 6.25 6.85 6.45 6.60 6.60 6.60 7.00 7.00 7.00 9.05


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Exhibit 206: Global nickel supply and demand estimates Millions of metric tonnes (Mt)

World Nickel Supply and Demand Balance (kt Ni)2008 2009 2010 2011 2012 2013F 2014F 2015F 2008 2009 2010 2011 2012 2013F 2014F 2015F

Mine Production 1,600 1,451 1,658 1,995 2,181 2,306 2,379 2,464 Stainless production by Country (kt stainless steel)Disruption allow ance (115) (119) (123) Europe 8,079 6,064 7,558 7,659 7,559 7,219 7,780 7,700 Mine Output 1,600 1,451 1,658 1,995 2,181 2,190 2,260 2,341 % change -4% -25% 25% 1% -1% -4% 8% -1%REFINED Ni AND FeNi PRODUCTION China 7,200 9,400 12,600 14,500 15,500 17,600 19,712 21,289

Canada 164 117 107 148 152 157 149 152 % change -8% 31% 34% 15% 7% 14% 12% 8%Western Europe 234 188 222 246 239 237 242 244 Japan 3,566 2,607 3,427 3,256 3,132 3,135 3,173 3,236 CIS 280 269 281 280 277 264 262 264 % change -8% -27% 31% -5% -4% 0% 1% 2%Japan 157 144 166 157 170 174 192 202 South Korea 1,743 1,644 2,022 2,116 2,131 2,000 2,200 2,266 China 215 256 347 454 513 650 704 741 % change -21% -6% 23% 5% 1% -7% 10% 3%Australia 109 131 101 110 129 140 130 128 Taiw an 1,313 1,468 1,523 1,203 1,106 1,051 1,156 1,190 Other 231 234 239 258 268 303 371 439 % change -12% 12% 4% -21% -8% -5% 10% 3%Highly Probable Grow th 1 5 8 India 1,550 1,690 2,170 2,105 2,450 2,695 2,911 3,114 Disruption Allowance (96) (103) (109) % change -13% 9% 28% -3% 16% 10% 8% 7%Required Adjustment (30) (80) USA 1,925 1,618 2,201 2,074 1,978 1,938 2,229 2,408

Total Production 1,390 1,339 1,463 1,653 1,748 1,830 1,922 1,989 % change -11% -16% 36% -6% -5% -2% 15% 8%% change -1.7% -3.7% 9.3% 12.9% 5.8% 4.7% 5.1% 3.5% Brazil 450 375 466 432 421 450 491 506 Capacity Utilisation % 73% 66% 66% 62% 59% 59% 61% 63% % change -8% -17% 24% -7% -3% 7% 9% 3%NPI 87 102 180 267 307 425 460 480 Other 809 633 702 642 693 811 849 891 CONSUMPTION Total World 26,635 25,499 32,669 33,987 34,970 36,900 40,500 42,600 Nth America 132 109 132 135 141 146 155 161 % change -8% -4% 28% 4% 3% 6% 10% 5% Europe 422 361 408 414 414 406 429 431 Austenitic ratio 70.7% 72.5% 71.6% 71.1% 72.8% 73.3% 73.5% 73.6% China 298 443 541 666 705 753 834 896 Scrap ratio 46.1% 40.3% 40.9% 37.6% 38.1% 38.5% 38.8% 38.9% Japan 176 154 170 167 167 171 173 176 India 34 42 50 50 57 64 69 75 Other Asia 142 142 155 137 138 132 142 146 Other World 86 63 69 52 74 77 81 84 Total consumption 1,289 1,325 1,529 1,623 1,696 1,749 1,883 1,968 % change -6.1% 2.8% 15.4% 6.1% 4.5% 3.1% 7.7% 4.5%For Stainless 779 834 1,010 1,103 1,134 1,163 1,274 1,336 % change -10.6% 7.2% 21.0% 9.2% 2.8% 2.6% 9.5% 4.9%For Non-Stainless 511 491 519 541 562 586 609 632 % change 1.7% -4.0% 5.8% 4.3% 3.8% 4.2% 4.0% 3.8%Restocking - - - - - - - SURPLUS/(DEFICIT) 101 14 (66) 30 52 81 39 21LME stocks 79 158 136 90 140 250Producer Stocks 103 89 91 98 128 198Estimated Total Stocks 389 402 325 324 368 449 488 509Weeks Consumption 15.7 15.8 11.1 10.4 11.3 13.3 13.5 13.5Price (US$/t) 21,204 14,651 21,806 22,843 17,536 15,094 14,438 15,000Price (US$/lb) 9.62 6.65 9.89 10.36 7.95 6.85 6.55 6.80

-

500

1,000

1,500

2,000

2008 2009 2010 2011 2012 2013F

Nickel Production (bars) versus Consumption (kt Ni)

Nth America Europe Chin a Japan In dia Other Asia Othe r World

Can ada We stern Europe CIS Japan China Austra lia Other


03 October 2013


Zinc: Light at the end of the tunnel? Becoming optimistic about zinc is fraught with danger. The metal has suffered at the hands of years of very large supply excesses and prices have worn themselves steadily lower since 2011. However, our stance is changing; we believe that the market could remain in annual supply/demand shortfall throughout 2013-2016. The themes are familiar to those looking for prices to move out of the doldrums.

World mine supply growth has shown constraints as a result of low prices, rising treatment charges (i.e., costs) – there is very little incentive to invest in new production capacity and 2014 looks like a slothful year of mine expansion.

Chinese supply growth appears to have moderated, although we are wary that this is truly “structural.” China continues to be an enigma with a mix of new mines…and old.

Demand is showing signs of decent recovery after 2012’s sluggishness, heavily influenced by addition of new galvanizing capacity in China (compromising growth elsewhere, it has to be said).

These factors add up to deficits in statistical supply/demand balances, an aspect that has eluded zinc since 2007. The problem is, even with growing shortages on this measure, the overhang of inventories accumulated in the wake of the collapse of Lehman could defer the point at which prices crank up with more conviction.

Nevertheless, we are cautiously optimistic that zinc prices may have found a base. Further, a slow and orderly release of warehoused volumes (as opposed to a flood) could both prop up regional premiums and encourage base prices to start to climb in 2014. After all, markets are forward looking.

Rising TCs not a sign of fundamental supply/demand weakness

For zinc miners, higher treatment charges (TCs) and stagnant LME prices have punched into profit margins. Higher TCs on first appearances would appear to be good for beleaguered smelters but they too are struggling to maintain profitability as zinc prices languish below US$1,900/t.

Poor profitability has prompted withdrawal of capital from mine and project development; the list of casualties is growing and looks set to outweigh modest mine expansions. Producers are in survival, not expansion, mode.

China’s small-scale mining sector, important for making up the tonnage, is suffering heavily with the latest rises in TCs; although volatile, Chinese mine supply growth seems to have lost momentum.

Concentrate shipments to China should creep up again but smelters are also likely to keep a check on refined production in the absence of a sharper metal price recovery in 4Q. We are trimming our refined production growth rate for China sharply this year, perhaps by as much as 400-500 kt.

Demand providing sound support

Meanwhile, as with a number of other industrial commodities, we have adjusted upward our demand assumptions for CY2013, although we are circumspect on predicting this carrying forward with quite as much strength. China’s “stabilization” indicates consumption growth rates are likely to end the year a couple of percentage points higher than we forecast before. We have consequently increased our Chinese zinc consumption to 8% from our previous projection of 5.8%, equivalent to an extra 100-150 kt of zinc use.

Galvanized sheet production in the country topped 24 Mt in January-July, 11% higher than in the same period of 2012. This is consistent with an almost 12% jump in auto production in 1H. However, we watch for flatter momentum as showroom stocks of vehicles are worked off. Operating rates at galvanizers seem to have dipped in August.

03 October 2013


The picture is more mixed elsewhere. Japanese and US galvanized output slipped in 1H 2013 but emerging markets showed pockets of strength.

Overall, even with some drags, world zinc consumption should eclipse the modest 3.6% increase we forecast in our June forecast update, possibly coming in at 5% pa, in 2014-2015.

As a counter, there seem to be inconsistencies in sector demand growth and patchier galvanized shipments in some regions, especially the US. There are other areas for prudence too. For example – auto production momentum in China, the key growth market, may fade as showroom destocking takes place. Growth in construction activity could also ebb in coming months.

Will cuts turn fortunes around for zinc prices?

From a supply perspective, zinc’s day in the sun has generally been seen as a distant prospect. One of the keys to a scenario of higher prices is the terminal decline in production at a number of larger mines, not least of which is closure of MMG’s Century mine, with the loss of 480-490 kt/y contained zinc on today’s production levels by 2016 when open-pit operations are halted.

In the interim, the mine is attempting to combat declines in grades and explore options beyond the open-pit life (average mining grade in the first half of 2013 was 8.2% zinc compared to 11.9% in 1H 2012). This implies a steady decline in output as open-pit mining draws to a close. Ambitions to counter the losses from Century also seem to have taken a knock with geological problems at the Dugald River prospect, which was intended to enter production in 2016 at a rate of about 200 kt/y of zinc. The mine is subject to an investment review by the end of the year, but halting of development activity and announcements of termination of the EPC do not augur well for the project’s future.

Other mines coming off line include: Lisheen in Ireland (145 kt this year, closing in 2014); Brunswick in Canada (173 kt last year, closed in 2013); and Perseverance in Canada (125 kt last year and closed this year).

In recent weeks nine mine expansion projects have been pulled or deferred due to financing constraints. Miners are in survival mode and struggling to maintain basic cash flows, which means trimming all but essential capital expenditure. Junior companies face severe cash crises.

New mines are planned – for example Trevali Mining’s 24 kt/y Santander mine in Peru is in commissioning phase, as is Tahoe Resources' Escobal mine in Guatemala (15 kt/y zinc.

In Australia, the planned full purchase of Perilya by Chinese zinc/lead miner and smelter, Zhongjin Lingnan, is likely to extend activity at the 80 kt/y Broken Hill operations. (CBH has shed one-third of its labor force at the nearby Rasp mine this month to stem losses.)

Of greater significance, the world’s largest zinc miner, Glencore, not surprisingly, is upbeat about zinc’s prospects, with plans on track to lift group zinc output from 1.43 Mt to 1.82 Mt/y by 2016, mainly through ongoing expansions at the McArthur River, George Fisher and Lady Loretta mines in Australia.

However, elsewhere the list of companies expanding zinc mine supply has shortened and time frames for commissioning new operations are at risk of slipping. These extend to Yukon Zinc’s 50 kt/y Wolverine, commissioned this year and now cutting output 40% to preserve cash; and Hudson Bay’s Lalor Lake, deferring US$325 million, to cap output for now at 70-80 kt/y zinc.

03 October 2013


Outside China, we now expect mine-through-refined supply to grow by less than 2% pa in 2013-2014, with downside risks to this forecast in the months ahead if prices do not move up.

China’s supply growth slows

Moreover, growth momentum in China appears to have eased, although problems with reported data mask the extent of this slowing and whether it is transient (we believe official data overstate production). In large part this reflects the struggles faced by small-scale, private mines facing weak zinc prices and also under increasing scrutiny for environmental and safety performance. Smaller mines are very sensitive to prices and have flexibility to withdraw production quickly if prices weaken and vice versa.

With the latest increase in treatment charges – base TCs in term contracts look likely to near US$235, US$44 above 2012 levels – mines are feeling even greater pressure on margins and production may well stagnate for the balance of the year.

Smelters too have taken their foot off the throttle, undertaking longer maintenance activity to hold supplies back. Operating rates are thought to be no higher than 70%, although improving TCs are likely to see concentrate imports creeping up in 4Q. These should accelerate again to above the 200 kt/m mark as concentrate stocks in the West flow into the country.

However, we believe that to a degree China’s slowdown in mine-through-refined zinc supply growth is structural; of ten0 smelter expansions on the drawing board for 2013, just one, Yunnan Chihong’s 320 kt/y plant, has been completed. Projects planned to add almost 700 kt/y of new capacity have been deferred or suspended altogether.

Refined production may struggle to reach 5.5 Mt from last year’s 4.8 Mt and we have factored in a plausible “loss” of around 200 kt of refined zinc on our 2013 regional totals.

This compares to our previous expectation of about 5.7 Mt of refined zinc production. China’s slower pace of supply growth alone explains the greater-than-expected supply/demand tightness for global zinc markets this year.

Exhibit 207: Imports of zinc concentrate may begin to rise again

Exhibit 208: Imports of zinc metal are steady at around 40-50 kt/m

0

50

100

150

200

250

300

350

400

450

500

0

20

40

60

80

100

120

140

Source: Customs data, Credit Suisse Source: Customs data, Credit Suisse

03 October 2013


Exhibit 209: Chinese refined zinc supply – growth has slowed; smelter utilization rates have fallen and plants are scheduling maintenance programs

Exhibit 210: Growth in Chinese mine supply of zinc also appears to have stalled; small mines are under intense margin pressure

Monthly, kt, zinc Monthly, kt, zinc

200

250

300

350

400

450

500

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

200

250

300

350

400

450

500

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013


Revised supply/demand balance points to annual shortfall in 2013

In summary, revisions to our forecasts for Chinese mine-through-refined supply, coupled with slightly stronger demand than we had anticipated suggest that the zinc market is going to remain in mild deficit. Our latest assessment is less downbeat for zinc prices ahead – support around US$1,800 may have a strengthening fundamental, as well as technical, basis.

Stocks have resumed their steady decline on the LME and SHFE; these movements point to a modest deficit globally, although commercial inventories remain at very high levels.

Although warehouse stock financing has prevented a further price rout in recent times, premiums may begin to ease from historical highs in 2014; this could offset some of the gains in base prices and keep pressure on mines to hold supply back.

The projection of a surplus of 350-400 kt in our S&D modeling last June lies behind our view that zinc would experience a period of further weakness in the remainder of 2013, an aspect that would persist through to 2014 before deeper supply cuts pushed the market toward greater shortfall. Indeed, that was the price signal we felt was required to prompt producer action. Now, elevated TCs seem to have had the same effect at a higher base price.

any event, an improved demand picture and signs that poor profitability have taken a toll on suppliers look to have brought about the potential for an earlier rebalancing act.

Tentatively, we are of the view that zinc prices may have found their floor, unless a washout of LME inventories sets prices back as cash-and-carry trade unwinds. If this material is released in orderly fashion, there could well be a light at the end of a long, dark tunnel for the zinc.

03 October 2013


Exhibit 211: Zinc prices may have found a floor a close to US$1,900/t

Exhibit 212: LME zinc stocks are in slow decline from lofty peaks

LME 3-month zinc prices, US$/t Kt (lhs), Yield (rhs)

1000

1500

2000

2500

3000

3500

4000

4500

5000

2005 2006 2007 2008 2009 2010 2011 2012 2013

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0

200

400

600

800

1,000

1,200

1,400

1980 1985 1990 1995 2000 2005 2010

Total LME Zinc Inventory US 2yr (rhs)

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Exhibit 213: SHFE volumes also easing Exhibit 214: SHFE/LME import arb remains positive, albeit volatile

Kt, monthly, SA US$/t

50

100

150

200

250

300

350

400

450

2008 2009 2010 2011 2012 2013

-150

-100

-50

0

50

100

150

200

250

300

350

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13

LME Cheap

LME Expensive

Source: Credit Suisse, Customs Data Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

03 October 2013


Exhibit 215: Zinc forecast comparison Exhibit 216: Zinc historical price and forecast US$ per metric tonne US$ per metric tonne

$1,600

$1,650

$1,700

$1,750

$1,800

$1,850

$1,900

$1,950

$2,000

$2,050

$2,100

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$800

$1,300

$1,800

$2,300

$2,800

$3,300

$3,800

$4,300

$4,800

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Zinc 3M Quarterly Avg Forecast


Exhibit 217: Forecast zinc prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05


LME zinc 3M New US$/t 2,054 1,850 1,880 1950 1,934 1,900 1,950 2,000 2,050 1,975 2,250 2,500 1,900 New US¢/lb 95 85 85 90 90 85 90 90 95 90 100 115 85


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Exhibit 218: Global zinc supply and demand estimates In thousands of metric tonnes (kt)

World Zinc Supply & Demand Balance (kt Zn)2008 2009 2010 2011 2012 2013f 2014f 2015f 2008 2009 2010 2011 2012 2013f 2014f 2015f

MINED ZINC SUPPLY STOCKS North America (inc Mex ico) 1,927 1,869 1,883 1,985 1,968 1,883 1,959 2,065 LME 253 457 701 822 1,221 C & S America (ex cl. Peru) 614 696 698 716 637 645 678 656 SHFE Stocks 63 172 311 364 311 Europe 927 876 907 916 936 966 940 989 Weeks Cons. (Exch. Stks) 1.5 3.1 4.4 4.8 6.2 CIS 661 616 667 626 659 730 852 872 Producer Stocks 365 317 313 366 315 China 3,160 3,198 3,703 4,307 4,734 4,850 4,950 5,000 Consumer Stocks 128 105 97 204 126 India 626 688 719 745 741 873 886 904 Merchant & US strategic 25 21 19 42 21 Other Asia 317 315 346 373 390 394 396 424 Reported stocks 834 1,072 1,441 1,798 1,994 Australia 1,508 1,316 1,481 1,483 1,477 1,494 1,623 1,690 Weeks Consumption 3.9 5.2 6.3 7.3 8.1 Africa 286 292 304 322 306 347 410 442 Price (US$/t) 1,874 1,543 2,094 2,193 1,952 1,915 1,975 2,250 Peru 1,550 1,430 1,403 1,185 1,187 1,315 1,296 1,429 Price (US$/lb) 0.85 0.70 0.95 0.99 0.89 0.87 0.90 1.02Highly Probable Projects - - - - - - - - Probable Projects - - - - - - 26 83 REGIONAL ZINC CONSUMPTIONDisruption Allowance & Market Adj - - - - - (280) (434) North America 1,181 1,246 1,320 1,402 1,461 1,498 1,527 1,575 World Mined Zinc Production 11,576 11,296 12,111 12,658 13,035 13,497 13,737 14,120 % Change -10.7% -11.6% 5.5% 5.9% 6.2% 4.2% 2.5% 2.0% % Change 5.9% -2.4% 7.2% 4.5% 3.0% 3.5% 1.8% 2.8% South & Central America 466 374 429 444 454 466 485 509 REFINED ZINC SUPPLY % Change 2.8% -19.7% 14.7% 3.5% 2.3% 2.6% 4.0% 5.0% North America (inc Mex ico) 1,334 1,224 1,266 1,236 1,231 1,258 1,284 1,284 Europe 2,758 2,076 2,500 2,678 2,511 2,508 2,546 2,609 C & S America 470 417 536 633 599 644 663 672 % Change -8.7% -24.7% 20.4% 7.1% -6.2% -0.1% 1.5% 2.5% Europe 2,197 1,810 2,093 2,166 2,094 2,097 2,155 2,190 Asia ex China 2,379 2,042 2,439 2,499 2,544 2,627 2,811 2,951 CIS 655 543 600 620 670 675 675 695 % Change -3.4% -14.2% 19.4% 2.5% 1.8% 3.3% 7.0% 5.0% China 3,905 4,246 5,100 5,109 4,817 5,500 6,100 6,500 China 3,795 4,100 4,705 5,257 5,606 6,077 6,502 6,893 India 595 646 727 821 741 829 878 878 % Change 7.5% 8.0% 14.8% 11.7% 6.6% 8.4% 7.0% 6.0% Japan 622 541 593 546 551 611 625 635 Australasia 284 217 223 224 149 176 181 189 South Korea 738 722 779 859 915 900 940 1,010 % Change 0.0% -23.6% 2.8% 0.4% -33.5% 18.1% 3.0% 4.0% Other Asia 195 209 216 247 261 262 283 283 Africa 186 154 173 186 148 151 157 164 Oceania 498 525 499 517 498 502 524 534 % Change -6.5% -17.2% 12.3% 7.5% -20.4% 2.0% 4.0% 4.5% Africa 268 279 275 256 170 180 185 185 China SRB & Prov inces - 494 (50) 100 - - - - Highly Probable Grow th - - - - - - - - Restocking - - 200 50 - - - - Disruption Allowance - - - - - (159) (485) (496) World Consumption 11,204 10,144 11,715 12,608 12,814 13,466 14,179 14,842Adjustments to refined zinc - - - - - - - - % Change -2.1% -5.1% 11.5% 7.5% 0.4% 5.1% 5.3% 4.7%World Refined Production 11,476 11,163 12,684 13,009 12,547 13,299 13,827 14,370 World Refining Capacity 14,278 15,153 15,331 15,592 15,907 16,154 16,544 16,544 % Change 2.8% -2.7% 13.6% 2.6% -3.6% 6.0% 4.0% 3.9% Capacity Utilisation (%) 80.4% 73.7% 82.7% 83.4% 78.9% 82.3% 83.6% 86.9%Incl. Scrap/secondary 888 773 925 956 976 1,026 1,076 1,126 World Galv. Capacity (Mt) 149.3 157.4 166.9 173.1 180.2 183.5 185.6 185.6Process losses/pipeline stocks 647 637 705 711 678 718 747 776 % Increase 6.3% 5.4% 6.0% 3.7% 4.1% 1.8% 1.1% 0.0%Required mined zinc 11,236 11,027 12,464 12,764 12,248 12,991 13,498 14,020 Europe (ex cl. Russia) 37.0 38.6 40.3 42.6 43.2 43.2 43.2 43.2Concentrate Balance 340 269 (353) (106) 787 236 239 100 USA 25.5 26.1 25.4 25.4 28.2 27.4 27.4 27.4World Consumption 11,204 10,144 11,715 12,608 12,814 13,466 14,179 14,842 Japan 17.5 17.5 17.5 17.5 17.5 17.5 17.5 17.5REFINED SURPLUS/(DEFICIT) 272 1,019 969 401 (267) (167) (352) (473) China 26.9 30.9 37.2 38.7 40.4 41.6 41.9 41.9


03 October 2013


Lead: Turning point ahead? Lead stocks continue to draw down and, despite a skewed distribution of the metal within LME warehouses, we are of the view that these movements to a great extent reflect a market in relatively tight balance. However, over the course of the calendar year, we are cautious that the metal has recorded a deficit – stocks outside exchange warehouses are hard to tally.

Consumption is poised to retain its growth rate in the vicinity of 5% pa, globally, with China once again leading the charge. In contrast, mine supply will struggle to surpass 4% pa in the next 2-3 years. Meanwhile, the poor economics of secondary supply, coupled with perpetual environmental constraints, mean that most growth in refined supply for this year has stemmed from primary sources.

At the mine level, what new programs there are in train are likely to be heavily offset by the effects of natural depletion at existing mines. Indeed, if anything we feel we have been generous with our mine supply projections for all regions outside China. In China too, while we expect further growth, we believe production figures are greatly overstated. Although gauging China’s likely mine production is problematic, new mines are once again being countered in part by losses in the smaller-scale, informal sector, which is under increased scrutiny on the grounds of poor environmental performance.

The same is true of the smelting/refining industry. Again, we have moderated our projections to take into account the effects of tightened rules and more intensive plant inspections. Surviving plants are scaling up and facing enforced capital spending to meet higher standards of hygiene; unfettered growth is less probable in the years ahead.

Market surplus or deficit? Difficult to tell …

Determining if these reductions in stocks reflect a shift into deficit is more problematic to determine. Traders we have spoken to insist that US stocks movements represent a firm flow into the hands of consumers, manifested in high levels of cancelled warrants in recent weeks. These represent virtually all of the US LME stocks and more than one-half of global LME warehouse tonnage.

Others are less convinced that the lead market has quite such robust fundamentals. For example, consultant group CHR questions International Lead Zinc Study Group (ILZSG) statistics that indicate a 37 kt shortfall in world refined lead supplies in January-May, believing that ILZSG data overstate US consumption on the one hand and miss figures for Peruvian production on the other; these center on the initial volumes coming from La Oroya, which restarted zinc and lead production late last year after almost three years of halts.

At its peak, Peru’s sole lead refinery produced 120 kt/y refined lead, but operations at the zinc-lead-copper complex were suspended in 2009 due to bankruptcy.

Creditors allowed the restart of the zinc and lead circuits in late 2012, but the copper smelter remained offline due to SO2 emission levels. The operation is on target to produce around 60 kt of refined metal this year and potentially 100 kt/y lead from 2014.

We are skeptical that operations will be sustained wholly uninterrupted in 2014-2015 but accept that is a possibility.

03 October 2013


Exhibit 219: LME 3-month lead prices have channeled broadly sideways to higher since the start of 2Q

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013


We think the LME stock falls also underplay the effects of a surge in US imports of both refined lead and alloys since late last year, which CHR argues added 326 kt in November 2012 through to 2Q 2013 and remain mostly in off-exchange warehouses. Taking these into account (and an off-LME stock increase of more than 140 kt, matched against LME draws) suggests a growth rate of 3.7% in apparent consumption in the first five months of this year, compared to ILZSG’s estimate of a rise of 11% in apparent consumption in the period (which in turn does not factor in the fall in LME inventories).

The US picture has been clouded by the closure of a number of secondary lead plants operated by Exide, which has fallen into Chapter 11 bankruptcy protection. Exide’s 100 kt/y Vernon secondary smelter in California was suspended in April on environmental grounds but a court approval has granted reopening of the facility pending further hearings. Severe pressure on refined lead production in the US explains the jump in imports and these could continue to rise with the expected closure of Doe Run’s Herculaneum operation in Missouri later this year.

Herculaneum produces about 120 kt/y of refined lead but the facility is running short of domestic feedstock and has been the subject of deep environmental scrutiny and lawsuits.

We believe closure by the end of this year is the precursor to a broader sweep of terminations at global lead mines, including Brunswick in Canada (50-70 kt/y from this year), Lisheen in Ireland (20 kt/y from 2014) and Century in Australia (40 kt/y from 2016).

MMG’s efforts to offset the effects of depletion at its Australian zinc-lead operations also face potential delays, or worse, due to technical hitches at Dugald River.

Closures, even measured against stretching out possible survival for La Oroya, signal a lead market that can be expected to move into more pronounced tightness from 2014.

Recharging the batteries – demand prospects positive

The lead industry continues to work aggressively to promote advanced battery technologies that offer cheaper alternatives than lithium ion, and other rivals, although there are signs of substitution pressures in some uses better suited to lighter-weight batteries. The Advanced Lead-Acid Battery Consortium (ALABC) claims that newly

03 October 2013


developed lead-carbon batteries are one-quarter to one-third the cost per kWh of lithium ion or nickel metal hydride variants; these applications could provide a meaningful extension to lead’s dominance.

The more immediate outlook for demand is dictated by auto production and demand for original equipment (OE) batteries – replacement batteries are an important source of end use but, obviously, most scrapped batteries are recycled and lead returned to the supply chain (as much as 98% in developed economies).

In North America, a repeat of 2012’s boost of 17%-18% in auto production (this was mainly recovery from 2008-2009’s trough) is unlikely, but we continue to expect light vehicle output to grow by 5% to 14.5 million units in 2013, keeping OE starting-lighting-ignition (SLI) battery demand on the rise. However, a milder summer and a higher scrapping rate of light commercial vehicles may mean that the replacement battery market in the winter is relatively sluggish (battery life is adversely impacted by extreme temperatures).

The rapid expansion of Chinese auto production has been a strong driver of lead demand growth. Further, China’s emergence as a major exporter of lead-acid batteries has also been a powerful influence in the past, though now eclipsed by growing domestic off-take. There are a couple of points of caution, however: although production and sales of new vehicles are generating robust demand for new lead, and current hot weather may be a boost for replacement demand in 2H, export activity in battery markets is relatively flat. In addition, the support from growth in China’s electric bicycle market may have passed its peak.

The all-important replacement battery season has yet to show signs of moving into higher gear toward the winter months. August has been especially quiet in European markets.

China’s traditionally strong seasonal peak for e-bike battery demand has been disappointing.

The effects of China’s soft domestic battery markets were exacerbated by a 15% fall in lead-acid battery exports in 1H.

A consequent building up of battery stocks would explain weak utilization rates at battery plants in 2013.

China’s secondary lead smelters continued to experience low operating rates at 37%-38% last month, though this was a little higher than July’s 35%. Primary smelters held rates steady at 56%-57%.

03 October 2013


Exhibit 220: Battery use in vehicles continues to drive lead demand – industrial battery use is also growing steadily from a lower base

Exhibit 221: Auto sales in major global markets – positive trends in China and North America

World refined lead demand by use, kt Million vehicles, monthly, sa

0

2000

4000

6000

8000

10000

12000

2008 2009 2010 2011 2012 2013

Non‐Battery Uses

Industrial ‐ Stationary

Industrial ‐ Traction

SLI Original Equipment

SLI Replacement

0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2005 2006 2007 2008 2009 2010 2011 2012 2013

EU North America China

Source: Wood Mackenzie, Credit Suisse the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Exhibit 222: US light vehicle production, and OE battery off-take, is dominated by conventional autos

Exhibit 223: China’s auto production has more than doubled since 2008

0

2

4

6

8

10

12

14

16

18

20 Electric Hybrid GasolineHybrid Diesel Combustion Gasoline

0

2

4

6

8

10

12

14

16

18

20 ElectricHybrid GasolineHybrid DieselCombustion GasolineCombustion Diesel

Source: PWC Autofacts, HIS Global Insight, Credit Suisse Source: PWC Autofacts, HIS Global Insight, Credit Suisse

Vehicle production the main driver …

China’s auto production (passenger cars and light commercial vehicles) reached 10.75 million units in 1H 2013, a year-on-year increase of almost 13%. This is running ahead of our forecast of 18.5 million units for the full year, even allowing for an 2H moderation of the pace.

Assuming an OE battery has an average lead content of about 11 kg (this varies widely depending on vehicle type and size), China’s production of light vehicles this year of more than 18 million units would represent an increase in “new” lead of around 200 kt. In all likelihood, the amount will be higher, reflecting growth in hybrids and EVs, even taking into account potential substitution.

Worldwide, light duty vehicles account for more than 900 kt of lead in OE SLI batteries, about 40% of OE SLI totals.

03 October 2013


About 60% of the weight of an average automotive SLI lead-acid battery (11-12 kg of an 18 kg battery) is lead or comprises internal parts made of lead. The remainder comprises electrolyte, separators, and the casing.

Trucks and buses are equipped with heavier batteries and hence contain more lead, typically more than 15 kg and in some instances far higher, especially where multiple units are installed.

China’s rapidly growing electric bicycle population accounts for around 300 kt/y of lead demand in new batteries, although growth rates appear to be slowing as the market matures.

… But battery manufacturers face immense pressures

Paradoxically, China’s battery plant run-rates paint a picture of a troubled industry. Operating rates are reported to have declined to 57% in June from May’s 62% in the SLI sector and held flat at 48% in motive battery manufacture (fork lift trucks etc.). Stationary battery production rates edged up moderately to 66%. June’s lull in auto production (at 1.67 million vehicles, the second lowest month this year) was mainly to blame, as was stagnant monthly motorcycle output (1.9-2.0 million units) but the weak run-rates principally highlight major overcapacity in a highly fragmented sector that has yet to consolidate fully.

Lead-acid battery production: Output has recovered from the effect of environmentally driven plant closures in 2011. However, momentum subsequently stalled, largely because of a slowdown in exports (Exhibits 224 and 225).

E-bike use uncertain, but some growth should persist: Despite encouraging OE SLI battery off-take in auto production (21% of total lead demand), demand from the important electric bicycle sector (responsible for about 37% of China’s lead demand in 2012) dominates but faces some uncertainty.

In part this simply reflects over-production ahead of the traditionally peak summer season and a consequent need to reduce battery stocks, but it also reflects underlying moves to control e-bike use in major cities blighted by poor safety records and congestion.

These controls extend to tighter licensing rules and speed restrictions. However, the eventual outcome of these moves is not clear. For now, operating rates at major e-bike manufacturers have fallen sharply.

Some manufacturers are also keen to use lithium ion batteries, which are lighter, though far more expensive.

Stationary battery use facing possible growth slowdown: After a spurt in growth since 2011, the pace of growth in demand for batteries in stationary applications (mainly in back-up power, representing 8% of China’s lead use) appears to have hit a lull.

This may be temporary, however – installations to support renewable power are expected to continue growing strongly and are set to benefit from the government’s renewable energy targets and improvements to rural power distribution.

There are concerns earlier orders have catered to the largest increases in the mobile telecom network sector and that a slowdown will follow as battery stocks are worked off. Again though, this may simply reflect “lumpy” investment activity.

The Ministry of Industry & Information Technology (MIIT) last month announced the first wave of closures of outmoded battery production plants. The move is an extension of long-lasting inspections on emission and hygiene standards, which virtually brought the industry to a stand-still in 2011.

03 October 2013


The latest measures list 44 lead-acid battery producers representing 7.8 million kVAh in battery assembly and 8.17 million kVAh in polar plate capacity. Five producers account for 45% of production earmarked for removal but the list does not include the two largest manufacturers, Chaowei Power and Tianneng Power. China’s lead-acid battery production last year amounted to more than 16 million kVAh monthly, so the closures represent modest proportions and are likely to be offset by expansions.

The elimination of inefficient capacity in 2011’s purge halved the number of China’s lead-acid battery producers but expansions kept overall capacity on a sharp expansion track. The number of lead-acid battery producers fell from more than 2,000 in 2011 to about 400 currently following the massive industrial consolidation. Severe overcapacity has led to fierce price wars and it is by no means certain that an orderly industry will emerge soon, perpetuating production and price volatility as profits pinch and swell.

Exhibit 226: Chinese lead-acid battery manufacture has been affected by environmental scrutiny

Exhibit 227: … and flat demand from external markets

kVAh, thousands, monthly (with six-month moving average) Lead-acid battery exports, million units, monthly

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

20000 Environmental inspections and closures

0

2

4

6

8

10

12

14

16

18


China’s lead supply dynamics perplex

Meanwhile, lack of transparency in China’s lead production sector does not help in getting a firm gauge on price prospects for 2H 2013.

First-half data point to mine supply running ahead of our forecast rate of 2.75 Mt for the full year; however, at this juncture we are reluctant to predict the maintenance of this pace throughout the second half and believe supply is over-reported, possibly because of errors on lead content and gross tonnages.

A further doubt on the figures comes from recorded production of refined lead. Primary refined output also stood at 1.65 Mt in 1H, up by just 4.1% on year-ago levels, according to the NBS. Operating rates, however, dipped below 55%-56% as a number of plants undertook maintenance work, complaining of poor availability of domestic feed and an unfavorable SHFE/LME price arbitrage, discouraging concentrate imports. It is our understanding that a number of planned expansion programs have recently been deferred but this too is unclear.

Secondary producers have also struggled as weak prices and scrap shortages in 2Q wiped out profits – utilization rates are well below 50% overall. Secondary producers are generally more sensitive to price swings and prone to switching off supply rapidly when losing money.

03 October 2013


The Chinese lead smelting industry has undergone two substantial periods of consolidation since 2008, firstly with the primary sector and more recently with secondary plants. The main influence has been environmental performance and tougher rules. Meanwhile, the primary sector has rapidly adopted SKS smelting technology now accounting for more than one-half of China’s primary lead output.

This technology brings greater flexibility in raw material feed, boosting the amount of scrap that can be treated in primary facilities, without the need for batch processing concentrate and scrap feed.

Primary smelters are competing with secondary plants for scrap supplies – the lead in spent batteries is ideal as a feedstock for the SKS process.

Secondary producers are also facing stricter regulations regarding the size of new and expanded operations, as well as the type of technology used (blast furnaces will be phased out). Existing secondary smelters had to exceed 10 kt/y, upgrades over 20 kt/y and new smelters more than 50 kt/y, as is the case with new primary smelters. The proposed objective is to close all operations with a rating of less than 30 kt/y lead output before the end of 2013.

All-in-all, recent developments point to China’s refined lead production falling short of 5 Mt for CY2013. Although this is the single-most important variable in the equation, the signs are there that China’s lead production growth momentum has slowed and with it the market is looking potentially a lot healthier than in the recent past.

Exhibit 228: Growth in refined lead production in China may have stalled in 2013

Exhibit 229: Exports of refined lead have fallen back sharply since 2007

kt, monthly kt, monthly

0

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100

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500

0

10

20

30

40

50

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70Lead Alloys

Refined Lead


03 October 2013


Exhibit 230: Monthly lead concentrate imports to China are highly seasonal but still below par

Exhibit 231: The SHFE/LME lead price arb has been out of favor in 1H 2013

kt, gross weight, monthly US$/t

0

50

100

150

200

250

-550

-450

-350

-250

-150

-50

50

150

250

350

Jul-11 Jan-12 Jul-12 Jan-13 Jul-13

LME Cheap

LME Expensive

Source: CEIC, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

Exhibit 232: Lead forecast comparison Exhibit 233: Lead historical price and forecast US$ per metric tonne US$ per metric tonne

$1,600

$1,700

$1,800

$1,900

$2,000

$2,100

$2,200

$2,300

$2,400

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Lead 3M Quarterly Avg Forecast


Exhibit 234: Forecast lead prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

1Q-13 2Q-13 3Q-13 4Q-13f 2013 1Q-14f 2Q-14f 3Q-14f 4Q-14f 2014f 2015f 2016f LT

LME lead 3M New US$/t 2,307 2,050 2,100 2,150 2,152 2,200 2,250 2,300 2,350 2,275 2,400 2,500 2000 New US¢/lb 105 95 95 100 100 100 100 105 105 105 110 115 90


03

Octo

ber 2

013

Com

modities F


inding Road

129

Exhibit 235: Global lead supply and demand estimates In thousands of metric tonnes (kt)

World Lead Supply & Demand Balance2008 2009 2010 2011 2012 2013f 2014f 2015f 2008 2009 2010 2011 2012 2013f 2014f 2015f

MINED LEAD SUPPLY STOCKS North America (inc Mex ico) 588 562 553 568 566 558 599 619 LME 45 147 209 353 320 C & S America 132 129 119 137 120 127 139 136 SHFE 31 75 Peru 320 270 235 208 222 243 256 266 Days Cons. (Exch. Stks) 6.8 7.7 7.3 8.3 8.8 Europe 257 252 239 256 283 283 280 289 Producer Stocks 146 135 129 142 131 Russia + Caspian 91 111 140 186 230 245 228 235 Consumer Stocks 114 106 111 95 104 China 1,221 1,405 1,857 2,358 2,650 2,750 2,850 2,900 Merchant & US strategic 1 1 1 1 1 Other Asia 121 145 141 166 163 200 218 232 Reported Stocks 306 389 450 622 631 Australia 605 544 648 574 572 680 725 730 Days Consumption 12.6 15.7 16.9 22.3 21.6 Africa 102 104 114 92 92 94 98 97 Price (US$/t) 2,067 1,719 2,151 2,397 2,064 2,139 2,275 2,400Probable Projects - 4 18 Price (US$/lb)Disruption & Market Adjustment (52) (162) (166) LEAD CONSUMPTION BY COUNTRY 11190World Mined Lead Production 3,437 3,522 4,046 4,545 4,898 5,128 5,235 5,356 USA 1,560 1,390 1,405 1,489 1,514 1,536 1,507 1,522 % Change 2.9% 2.5% 14.9% 12.3% 7.8% 4.7% 2.1% 2.3% Other North America 285 273 270 239 246 253 268 272REFINED LEAD SUPPLY C & S America 365 366 388 387 387 391 403 418 North America (inc Mex ico) 1,798 1,761 1,844 1,930 1,929 1,925 1,808 1,808 Europe 1,801 1,522 1,635 1,640 1,624 1,730 1,675 1,697 C & S America 391 318 312 322 334 382 445 455 China 3,081 3,709 4,102 4,352 4,714 5,101 5,541 5,975 Europe 1,713 1,558 1,604 1,632 1,683 1,689 1,748 1,768 India 375 483 545 606 696 745 798 851 Russia + Caspian 189 176 225 221 203 261 286 321 Japan 211 153 190 195 207 209 198 197 China 3,206 3,740 4,097 4,420 4,685 4,930 5,500 5,850 South Korea 318 328 385 420 417 421 430 440 Japan 225 191 219 213 221 200 200 200 Other Asia 521 537 554 596 593 682 643 663 South Korea 276 327 320 423 460 440 440 440 Oceania 26 22 30 26 19 20 24 25 Other Asia 523 614 688 791 883 964 1,022 1,067 Africa 108 95 80 99 99 102 101 100 Australia 289 277 226 237 196 200 240 240 World Consumption 8,853 9,030 9,743 10,196 10,671 11,190 11,747 12,293 Africa 111 119 107 118 96 80 125 125 % Change 5.4% 2.0% 7.9% 4.6% 4.7% 4.9% 5.0% 4.6%Prim. ref. Pb adjustment required - - (62)Sec. ref. Pb adjustment required - - - Highly Probable Grow th - - - Disruption Allowance - (269) (218)World Refined Production 8,861 9,216 9,777 10,455 10,837 11,223 11,696 12,146 % Change 5.3% 4.0% 6.1% 6.9% 3.7% 3.6% 4.2% 3.9%World Secondary Ref. Production 4,340 4,618 5,115 5,267 5,587 5,623 5,888 6,067 World Production Primary Ref. 4,521 4,598 4,662 5,188 5,250 5,600 5,807 6,079 Residues scrap available 1,305 1,325 1,001 1,046 945 1,008 1,045 1,094 Metallurgical losses 261 261 266 294 315 336 348 365 Required mined lead 3,476 3,534 3,927 4,436 4,620 4,928 5,111 5,350 Concentrate Balance (39) (12) 119 109 278 200 124 6 World Consumption 8,853 9,030 9,743 10,196 10,671 11,190 11,747 12,293DLA Stock Sales - - - - - - - - SURPLUS/(DEFICIT) LEAD 8 186 34 259 166 33 (51) (146)

0

2,000

4,000

6,000

8,000

10,000

12,000

2008 2009 2010 2011 2012 2013f 2014f 2015f

China

USA

Other N.AmericaC&S America

India

Japan

S. Korea

Other Asia

Oceania

Africa


03 October 2013


Tin: Managing supply in a constrained world Tin stands out among the LME metals. After dipping to levels below US$20,000 in July, the LME three-month price has bounced back to stand above US$23,000/t at the end of September.

The reason is simple, in a market already in tight supply/demand balance, the Indonesian government has intervened. Rule changes were introduced in August restricting trade in refined metal to transactions using domestic bourses. The move is aimed at tightening trade flows, propping up prices and creating a more orderly domestic supply industry. However, many buyers are yet to register with the local exchanges and PT Timah faced little choice but to declare force majeure on shipments this month. Solder is currently exempt from the new ruling but is expected to be added to the regulations later.

Exports have fallen to around 3,000 t/m of tin and are unlikely to rise quickly in 4Q. All in all, even if the measures create a temporary bottleneck in supplies, we consider that Indonesian production of the metal has probably reached a peak and that much more emphasis will be placed on managing supply in order to keep prices elevated close to US$25,000. This appears to be Jakarta’s target as does controlling mining on Bangka island where disputes over contracts of work have held mining activity back.

Exhibit 236: Tin prices have been lifted by Indonesia’s export restrictions, but resumption of trading may result in reversals in 1H 2014 LME 3-month tin prices, US$/t

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013


More broadly, supply growth is generally constrained, with modest expansions under way in several domains, including Peru and Myanmar, but these are modest in scale. China remains the largest mine-through-refined producer but the country’s production appears to be struggling to maintain upward momentum. In part this may also reflect increased scrutiny of environmental performance at small-scale mines. Yunnan Tin, the largest operator is also relocating a tin smelter to its larger base metals complex, temporarily slowing refined output.

However, imports of metal have also fallen back (offset in small part by increases in concentrates from Myanmar) and this suggests that demand activity is subdued. We suspect that underlying growth in use of tin, mainly in electrical solders, is being tempered by the effects of downsizing and “thrifting,” despite boosts to the tin component of solders (at the expense of lead).

Indonesia puts a

check on refined

exports

Supply growth

constrained

elsewhere

03 October 2013


Although new uses are being explored by market development agencies, demand prospects remain very much dominated by consumer electronics markets, and overwhelmingly by China from a manufacturing point of view.

Exhibit 237: China’s tin production is struggling to grow

Exhibit 238: China’s imports of unwrought tin have eased since 2011-2012

Tonnes/month kt

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Source: CEIC, Credit Suisse Source: Customs data, Credit Suisse

Exhibit 239: China’s manufacture of semiconductors – a proxy for growing use of electronics solders

Exhibit 240: LME refined tin inventories look poised to fall, but stocks may accumulate at Indonesian producers

Millions/month kt

0

5,000

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15,000

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25,000

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35,000

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50,000

0

5

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30

2005 2007 2009 2011 2013

Source: Credit Suisse, CEIC the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

For next year, the portents are more favorable, with developed economies likely to be more supportive after several years of softness and demand in emerging markets possibly showing stronger traction.

However, our revised forecasts for tin – entailing a steady progression towards US$25,000 by 2015-2016 – also feature a temporary retreat in prices in 1H 2014 as Indonesia’s export curtailments are superseded by renewed shipments, out of stockpiles.

03 October 2013


This correction may be mild and any further supply bottlenecks provide upside risks. Tin’s fairly violent price swings of the past are worth remembering – if supply hits a roadblock again very sharp increases are more than possible.

Exhibit 241: Tin forecast comparison Exhibit 242: Tin historical price and forecast US$ per metric tonne US$ per metric tonne

$18,000

$19,000

$20,000

$21,000

$22,000

$23,000

$24,000

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Tin 3M Quarterly Avg Forecast


Exhibit 243: Forecast tin prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05

1Q-13 2Q-13f 3Q-13f 4Q-13f 2013 1Q-14f 2Q-14f 3Q-14f 4Q-14f 2014f 2015f 2016f LT

LME Tin 3M New US$/t 23,230 20,500 21,150 23,500 22,095 21,000 21,500 22,000 22,500 21,750 23,000 25,000 20,000 New US$/lb 10.55 9.30 9.60 10.65 10.00 9.55 9.75 10.00 10.20 9.85 10.45 10.50 9.00


03

Octo

ber 2

013

Com

modities F


inding Road

133

Exhibit 244: Global tin supply and demand estimates In thousands of metric tonnes (kt)

World Tin Supply & Demand Balancekt 2008 2009 2010 2011 2012f 2013f 2014f 2015f 2008 2009 2010 2011 2012f 2013f 2014f 2015fMINE PRODUCTION STOCKS June

China 121 128 130 127 116 127 135 142 LME 8 27 16 11 12 14 Indonesia 96 84 84 78 78 80 82 82 Producer Stock 12 8 7 7 7 6 Asia ex China, Indonesia 10 9 10 11 11 11 11 12 Consumer/Others 13 12 11 11 11 11 Boliv ia 17 20 20 20 19 20 20 21 Total Reported Stock 32 46 34 18 14 16 5 (13) Brazil 14 10 10 11 11 11 11 11 Weeks Consumption 4.76 7.35 4.84 2.40 2.05 2.16 0.72 (1.66) Peru 39 37 34 29 26 28 29 30 LME Price (US/t) 18,457 13,599 20,441 25,958 21,085 20,308 19,250 23,000 ROW 18 29 31 25 21 29 31 35 KLTM Price (US$/t) 18,511 13,502 20,351 25,955 21,075

World Mine Production 316 316 319 301 281 307 320 333 TIN CONSUMPTION BY COUNTRYDisruption Allow ance - - - - - (9) (10) (10) China 145 149 153 181 176 185 194 204 Required Adjustment - - - - - 5 - - Japan 32 23 36 27 28 28 28 29 World Mined Tin 316 316 319 301 281 302 310 323 Asia ex China, Japan 66 59 67 59 58 60 62 64

% Change -8.1% 0.0% 1.0% -5.5% -6.8% 7.6% 2.6% 4.2% U.S.A 26 27 32 32 31 31 32 33 Conc avail after direct use 316 316 319 301 281 302 310 323 Germany 21 14 17 20 18 18 18 18 Primary Smelter Production 296 289 298 303 290 301 300 303 Other Europe 46 38 42 46 36 37 37 37 Smelter Loss 7 7 7 8 7 7 7 7 ROW 19 16 22 21 16 16 17 17 Primary feed required 304 297 305 311 297 308 307 310 World Tin Consumption 355 326 370 387 363 375 388 402 SURPLUS/(DEFICIT) CONC. 12 19 14 (9) (16) (6) 3 13 % Change -1.0% -8.0% 13.3% 4.6% -6.2% 3.4% 3.5% 3.7%

TIN CONSUMPTION BY USAGEREFINED TIN PRODUCTION Solder 182 172 194 201 192 202 213 225

China 140 140 149 156 148 154 158 162 % of total 51.4% 52.7% 52.6% 52.0% 53.0% 54.0% 55.0% 56.0%Indonesia 70 65 64 73 78 76 73 71 Tinplate 57 54 59 65 61 63 65 67 Malay sia 32 36 39 40 38 40 42 43 % of total 16.1% 16.5% 15.9% 16.7% 16.7% 16.7% 16.7% 16.7%Thailand 22 19 24 24 22 24 24 25 Chemicals 48 43 51 54 51 52 54 56 Other Asia 8 7 7 9 10 10 10 10 % of total 13.5% 13.0% 13.8% 14.0% 14.0% 14.0% 14.0% 14.0%Boliv ia 12 15 15 15 14 15 16 17 Brass & Bronze 20 18 20 19 18 19 19 20 Peru 38 34 36 30 25 28 30 30 % of total 5.7% 5.6% 5.3% 5.0% 5.0% 5.0% 5.0% 5.0%Europe 11 10 13 12 14 14 14 14 Float Glass 7 8 7 8 7 7 8 8 ROW 12 9 10 10 10 11 11 11 % of total 1.8% 2.3% 1.9% 2.0% 2.0% 2.0% 2.0% 2.0%

World Refined Production 344 336 357 370 359 371 378 384 Others 41 32 39 40 34 31 28 25 Primary Production 296 289 298 303 290 301 300 303 % of total 11.5% 9.9% 10.6% 10.3% 9.3% 8.3% 7.3% 6.3%Secondary Production 47 46 60 67 70 75 78 82 Total 355 326 370 387 363 375 388 402

Required Adjustment - - - - - 5 - - Required Demand Destruction - - - - - - - - World Refined Tin 344 336 357 370 359 376 378 384 Final Tin Consumption 355 326 370 387 363 375 388 402

% Change -2.0% -2.3% 6.5% 3.5% -2.9% 4.7% 0.4% 1.7% % Change -1.0% -8.0% 13.3% 4.6% -6.2% 3.4% 3.5% 3.7%DLA Sales 4 - - - - - - - SURPLUS/(DEFICIT) (7) 9 (12) (17) (3) 1 (10) (18)


03 October 2013


Gold & Silver: Gold: Downward pressure likely to resume soon For gold, the main premise of our bearish outlook hasn’t changed:

A slow improvement in global growth.

The ongoing gradual normalization of real interest rates.

A lack of inflationary pressure in developed markets.

Less investor demand for tail-risk protection in the form of zero-yielding gold.

What has shifted, thanks to a run of softer US economic data, postponement of “the taper,” and the fiscal debate in the US is the degree of certainty about the timing of the next major move down in price. The balance of probability suggests that the timing of the first reduction in the rate of stimulus in the US may have shifted into late 4Q or early 1Q 2014 but the market's expectation apparently changes with each new statement from a member of a Federal Reserve bank. In addition, dealers are having to navigate the intra-day volatility generated by the political arguments in the US regarding the federal budget and debt ceiling.

On balance, the fiscal headlines may provide a modicum of support to gold above the key resistance level of $1,270 a little while longer. However, we do still expect the Fed to begin withdrawing stimulus in the not-too-distant future, while key budget decisions are likely to be deferred until after US mid-term elections in 4Q 2014. There is, of course, a tail risk that the political divide in Washington becomes so great that Congress fails to raise the debt ceiling in time. That would be disastrous for asset prices of all kinds in our view and we are not convinced that gold would necessarily do well in the mass liquidation/margin call panic that would probably ensue.

In summary, with physical demand out of Asia having moderated from the 1H surge and the Indian market still struggling to get to grips with new import restrictions, we are comfortable in retaining our bearish forward price deck, expecting the metal to average $1,150 in 12 months’ time. Of course there will be rallies within the downward trend but we continue to believe the correct strategy is to sell those rather than buy dips.

Indian market stress looks set to continue for now

Since late July Indian gold demand has been stressed by a sharp slide in the rupee, domestic economic weakness, and an unprecedented regulatory initiative to cut the rate of gold imports. After an almost complete hiatus in imports in August, trade was still more or less on hold by late September as uncertainty of the implementation of new rules by customs officials deterred fresh shipments. We do expect that impasse to be resolved soon but it seems improbable that imports will recover to pre-regulation levels (imports averaged >100 tonne/month in 2Q) and will not come close matching last year’s 4Q total of 255 tonnes.

Illicit trade in gold into India has almost certainly increased, incentivized by a 10% import duty and strong local premiums, but not to the extent that it will make up the difference. In the local market, record high prices plus a squeeze on family budgets is resulting in more scrap coming back to market.

RESEARCH ANALYSTS

Commodities Research Tom Kendall




analysts above.


03 October 2013


Exhibit 245: Rupee and gold trends have deterred Indian buyers, incentivized scrap sales

Exhibit 246: India’s 3Q gold imports likely to be lowest for four years, quick rebound not expected

40

45

50

55

60

65

70

75

Rs15

Rs20

Rs25

Rs30

Rs35


Th

ou

san

ds

Gold, Rs/10g

INR Curncy (rhs)

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Q1

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3e

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U IN

R,

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usan

ds

net

gold

impo

rts,

tonn

es

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, World Gold Council Source: Credit Suisse estimates, World Gold Council

Scrap flows down then up

To dip into sporting cliché – it has been a year of two halves as far as gold scrap flows are concerned. Scrap returns all but dried up in western markets and fell heavily in many developing markets during the first half of the year as the USD price slumped and sellers held back waiting for a recovery. However, that recovery, coupled with the slide in the Indian rupee and other EM currencies in 3Q spurred a sharp upturn in scrap flows. Over the year as a whole we forecast a near 20% reduction in scrap returns but that shift was very much concentrated into the first six months of the year.

A great deal resting on the Chinese appetite

Chinese gold demand remains robust – there is no doubt that this will be a record year for Chinese imports and physical volumes traded on the Shanghai Gold Exchange (Exhibit 247). Both jewelry and investment products (bars, coins and collectables) have done very well indeed – we forecast jewelry demand globally will exceed 2,100 tonnes this year for the first time since 2008, driven in large part by China. However, demand there, although still solid, has cooled since 2Q as the price has risen. Premiums in Hong Kong have fallen to around $2/oz for kilobars compared to $5/oz in 2Q, and the unusual backwardation at the front of the forward curve has reverted to contango as the availability of refined metal in small bar sizes has recovered.

The Shanghai/London arbitrage, while still favorable for Chinese banks, has also narrowed. We detected reluctance amongst Chinese buyers to chase the price above $1,400 in August (Exhibit 248).

03 October 2013


Exhibit 247: Trading of gold on the SGE is running well ahead of 2012 …

Exhibit 248: Though much of the surge in volumes occurred in 1H

0

20

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1 5 9 13 17 21 25 29 33 37 41 45 49

Mill

ion

s o

z 2008 2009

2010 2011

2012 2013

week

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1.0

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1.4

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1.8

200

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Mill

ions

oz

SGE volume, oz

SGE price, RMB/g (LHS)

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: Credit Suisse

September and October should be reasonable months either side of the Golden Week holiday but unless there is a sharp rise in Chinese inflation (which we consider unlikely) we doubt that the pace of imports will climb back to April/May levels.

Exhibit 249: Chinese inflation has been well-contained this year, and real rates have held above zero

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

'00 '02 '04 '06 '08 '10 '12

%China real rate, 1 year China CPI, yoy


Western investor disinterest

ETF liquidation came to a halt in August after falling by 22 million oz (684 tonnes) between January and the end of July. We have no means of quantitatively predicting ETF flows but do expect further moderate investor selling basis our (Credit Suisse economists/strategists) constructive economic and USD outlook. Certainly forward inflation expectations appear to be low and stable.

03 October 2013


Exhibit 250: US inflation expectations remain very stable and no boost to gold

1

2

3

4

5

6

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

%

Univ. Michigan 1 year ahead

Fed 5yr Fwd Breakeven rate


The pace of direct investment in physical bullion has weakened since 2Q (which saw sizable “bargain hunting” from private investors). Sales of American Eagles slowed to a crawl in August. Coin premiums elsewhere have eased lower. Activity in the US market is likely to get a boost from the headlines that will be generated around the forthcoming debt ceiling and budget discussions but we think that will be transient and small in scale. We did see some pick-up in European and Middle Eastern investor buying during the second half of August as the Syria crisis deepened but that tailed off in September as the prospects of direct US intervention have receded.

Exhibit 251: The overhang of ETF holdings is still big; we expect further liquidation in 4Q and 2014

Exhibit 252: Comex futures positioning has been cut but a break of $1270 could entice more shorts

Million oz , US$/oz Million oz

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

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Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Mill

ions

oz

Physical ETF/ETC gold heldGold price (RHS)

-15-10-505

101520253035

Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13

Mill

ions

oz

Non-comm long Non-comm short

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: Credit Suisse

Central bank activity steady, not spectacular

Central banks remain quiet (other than the buying that we assume is taking place within China by the PBoC/SAFE). According to IMF data, central banks bought 71 tonnes in 2Q, a notable slowdown from the >110 tonnes per quarter run-rate seen from 3Q 2011 onward. We do not agree with those who argue that central bank reserve managers will come back to the market in large size at current price levels. We assume those reserve managers are as rational as any other portfolio manager; those who bought between 2011 and 2013 will be reluctant to add to out of the money positions and few will be willing to call a bottom of the market.

03 October 2013


That said, there will be ongoing net buying in our view, primarily from central banks that can accumulate reserves from domestic mine production (e.g., Russia), and perhaps some modest rebalancing of FX allocations. We factor in a rate of purchasing of 65-85 tonnes/quarter going forward – constructive perhaps, but certainly not sufficient to drive price higher.

Exhibit 253: The slide in the gold price has not incentivized central banks to add to reserves, in fact the reverse has happened with Russia the only major buyer

-20

0

20

40

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80

100

120

Jan Feb Mar Apr May June Jul Aug Sept Oct Nov Dec

ton

ne

s2011

2012

2013

Source: Credit Suisse, International Monetary Fund, World Gold Council

Miners to remain under pressure, hedging a possible cap to price rallies

Mine supply is likely to grow marginally this year as the legacy of already sunk expansion capex outweighs closures. We forecast mine production of 2,890 tonnes for 2013, a 1% year-over-year increase, before output starts to shrink next year. A turn lower in primary supply, however, is unlikely to translate into price support for at least another 12 months – after all this is a market buffered by more than 30 years’ worth of above ground inventory.

Producer hedging is not, at present, a force pressing down on the gold price. A return to fixed price forward hedging is highly improbable we think, given that it is not long since major gold producers spent billions of dollars unwinding their legacy hedges from the 1990s and early 2000s. However, we have seen sporadic project hedging and some opportunistic by-product hedging by multi-metal mining companies. That activity could increase if, as we expect, price begins trending lower again and has the potential to act as a more powerful cap to rallies in future.

03 October 2013


Exhibit 254: Gold supply/demand summary – above ground stocks set to grow ever bigger tonnes 2006 2007 2008 2009 2010 2011 2012 2013f 2014f 2015f 2016f

Supply

Mine Supply 2,486 2,476 2,416 2,589 2,709 2,812 2,861 2,890 2,855 2,780 2,655

Old Scrap Supply 1,126 977 1,215 1,549 1,695 1,610 1,616 1,285 1,240 1,100 975

Prim ary Supply 3,612 3,453 3,631 4,138 4,404 4,422 4,477 4,175 4,095 3,880 3,630

Mine Supply, yoy -2.51% -0.40% -2.42% 7.16% 4.63% 3.80% 1.74% 1.01% -1.21% -2.63% -4.50%

Primary Supply, yoy 5.12% -4.40% 5.15% 13.96% 6.43% 0.41% 1.24% -20.48% -1.92% -5.25% -6.44%

Dem and

Jew ellery 2,284 2,401 2,186 1,813 1,990 1,980 1,893 2,125 2,160 2,275 2,400

Other:Industrial/dental 459 462 436 410 450 445 405 370 390 410 425

Total Fabrication 2,743 2,863 2,622 2,223 2,440 2,425 2,298 2,495 2,550 2,685 2,825

Annual Total Fabrication growth -12.62% 4.37% -8.42% -15.22% 9.76% -0.61% -5.24% 8.57% 2.20% 5.29% 5.21%

Bar Hoarding/Coins/Medals 402 400 838 676 879 1,194 980 1,400 750 520 400

Exchange Traded Funds 260 251 321 647 363 174 290 -840 -200 -125 40

Prim ary Dem and 3,405 3,514 3,781 3,546 3,682 3,793 3,568 3,055 3,100 3,080 3,265

Annual Growth Primary Demand -8.74% 3.20% 7.60% -6.22% 3.84% 3.01% -5.93% -14.38% 1.47% -0.65% 6.01%

Prim ary Surplus /(Deficit) 207 -61 -150 592 722 629 909 1,120 995 800 365

Total Of f icial Sector Supply/(Demand) 355 396 -103 -276 -235 -628 -718 -720 -650 -610 -590

Net hedging/de-hedging -410 -446 -358 -236 -108 -50 -30 -20 0 15 15

Net Surplus /(Deficit) 152 -111 -611 80 379 -49 161 380 345 205 -210 Source: Credit Suisse, International Monetary Fund, World Gold Council, WBMS, Thomson Reuters GFMS

03 October 2013


Silver: equilibrium looks achievable if investors stay long Our economists expect global IP to resume above-trend growth next year (5.0%) after two years of below-trend expansion in 2012 and 2013. That is in line with their somewhat cheerier global growth outlook for 2014: they forecast 3.8% global GDP growth for next year, which would be a significant improvement from this year’s rather disappointing 3.0% expected rate (see Forecasting the Elusive Speed-Up for 2014). Taken in isolation, that should spell good news for silver demand and potentially prices.

However, the silver market is awash with inventory and price gains depend primarily on the metal being able to attract continued investor flows. ETF holders and the retail segment of the market are still net buyers but institutions have been much less active on the buy side via Comex futures since April.

Net/net we expect the effect of a lower gold price but more positive global outlook and improving rate of industrial demand growth to be broadly neutral for silver over the next 12 months. In addition, producer hedging, including hedging of by-product silver output by lead/zinc producers, is likely to act as natural cap to any rallies toward $25.00 in our view. Consequently we have kept our 4Q 2014 average unchanged at $21.30.

Exhibit 255: Despite a reduced rate of scrap returns, the silver market still requires investors to absorb an excess of supply, though the gap is narrowing

500

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2009 2010 2011 2012 2013 2014 2015 2016

mill

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Total supply

Total fabrication demand


Investor flows

As noted above, Comex long positioning from the fund community has not changed significantly since the price bottomed in April. The turn in price, and the net position of futures bounced primarily due to investor short positions being covered, not due to new inflows (Exhibits 256 and 257).


03 October 2013


Exhibit 256: Not much fund enthusiasm to get long silver again after the March/April slump

Exhibit 257: Price recovery and rise in Comex net position has been more about short covering

0

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Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

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%

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Non-comm shorts, % of totalopen interest

Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse Source: Credit Suisse

Greater recovery of long positions has been seen in the ETF world, with a rapid rise in the shares outstanding of the main physically backed fund, SLV, through July and August. The fund is now almost back at its mid-March record high of 357 million shares issued, equivalent to around 342 million oz of silver (10,630 tonnes).

Total ETF holdings of the metal, meanwhile have already reached a new record high at 645 million oz (more than 20,000 tonnes!). That’s great news for the custodians who receive the vault fees but in our opinion does not support a compelling investment case for the metal.

Exhibit 258: SLV shares outstanding recovering Exhibit 259: Total ETF silver at new highs – no shortage of metal here

Shares issued Million oz

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iShares SLVZKB ZSIL

Swiss GlobalOthers


03 October 2013


The robustness of ETF holdings of silver is mirrored by ongoing retail level demand for silver coins and other investable products in the North American market. US Mint sales of American Eagle silver bullion coins being indicative of the strength of the market as a whole, which stands in stark contrast to the pattern of sales of American Eagle gold coins (Exhibits 260 and 261).

In Europe, however, investor buying of silver coins and small bars has slowed, both in reaction to earlier price moves and volatility but also as the economic situation has stabilized and the outlook improved.

Exhibit 260: The appetite for silver bullion coins has held up remarkably well in the USA

Exhibit 261: Unlike that for gold coins, which has crashed back down to earth

American Eagle silver coin sales, monthly, September 2013 = three weeks’ data American Eagle gold coin sales, monthly, September 2013 = three weeks’ data

0

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3 month moving av.

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an

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Actual, oz

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Source: the BLOOMBERG PROFESSIONAL™ service, US Mint, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, US Mint, Credit Suisse

China flows – imports have been sluggish

As with many other commodities, China exerts a disproportionately large influence on silver supply, demand and trade. The country shifted from net exporter to net importer several years back following changes to the duty/tax rebate system. The last year has been rather disappointing in terms of China’s call on the international silver market (Exhibit 262). We think a combination of factors is responsible:

Lower investment demand.

An inventory overhang.

The consequences of thrifting of silver in electronic applications.

A pause in the pace of solar power installations as the industry goes through a period of deep restructuring.

Possibly greater imports of raw silver via copper concentrates.

03 October 2013


Exhibit 262: Chinese net trade in silver Tonnes, monthly

-600

-400

-200

0

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05 06 07 08 09 10 11 12 13

tonn

es Net imports

Net exports

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse, CEIC

The rate of imports did pick up in August and with the IP cycle on the up, there is some cause for optimism that could herald a moderately stronger period of demand through the back end of this year and in 2014.

Exhibit 263: Silver supply/demand balance – better than it was but still needs investor support Million oz

2009 2010 2011 2012 2013 2014 2015 2016SupplyMine production 710 750 758 785 801 817 830 846 Net official sector sales 14 45 13 9 9 7 6 6 Silver scrap 166 225 254 215 185 175 168 166 Producer hedging - 61 35 25 10 5 5 5 Total supply 889 1,081 1,061 1,034 1,005 1,004 1,008 1,023

Demand Industrial applications 352 487 498 513 531 557 582 609 Photography 83 73 68 63 60 59 57 55 Jewelry & silverware 216 217 208 210 214 220 227 231 Coins & medals 79 101 122 97 92 90 88 89 Total fabrication demand 730 879 895 883 897 926 954 984 Net official sector purchases - - - - - - - - Producer de-hedging 22 - - - - - - - Implied net investment (ETF's+OTC) 137 178 166 151 108 78 54 39 Total consumption 889 1,057 1,061 1,034 1,005 1,004 1,008 1,023

Source: Credit Suisse, Thomson Reuters GFMS, WBMS, the BLOOMBERG PROFESSIONAL™ service

03 October 2013


Forecasts:

Exhibit 264: Gold forecast comparison Exhibit 265: Gold historical price and forecast US$/oz US$/oz

$1,000

$1,100

$1,200

$1,300

$1,400

$1,500

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$300

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$1,700

$1,900

$2,100

05 06 07 08 09 10 11 12 13 14

Gold (Spot)

Quarterly Avg Forecast


Exhibit 266: Silver forecast comparison Exhibit 267: Silver historical price comparison US$/oz US$/oz

$20

$21

$22

$23

$24

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$5

$15

$25

$35

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$55

05 06 07 08 09 10 11 12 13 14

Silver (Spot) Quarterly Avg Forecast


Exhibit 268: Forecast Gold & Silver prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05


Gold New US$/oz 1630 1410 1310 1250 1400 1220 1190 1150 1150 1180 1200 1250 1300

Silver New US$/oz 30.10 23.40 22.20 21.20 24.20 21.40 21.60 20.90 21.30 21.30 22.60 23.10 22.80


03 October 2013


PGMs: Addressing the inventory concerns For both platinum and palladium the demand outlook in their key autocatalyst markets is favorable. Platinum should benefit from a recovery in the European vehicle market and the ongoing spread of tighter emissions regulation to heavy duty vehicles (both off and on-road); palladium from a combination of global light vehicle growth, the ongoing tightening of emissions limits in emerging markets, and some further substitution of platinum.

For both metals, however, the premise that constrained supply coupled with rising demand would tighten the markets and support higher prices faces challenges. Scrap supply should continue to grow, the South African PGM mining industry is restructuring only very slowly, and the idea that Russian state-owned stocks of palladium will no longer be an influence has been thrown into question by the release of sizeable volumes of metal from Swiss bonded vaults and by activity in the options market.

That uncertainty has got some questioning whether prices can appreciate, given that above-ground inventories of both metals are in excess of 1-year’s production. Or to put it another way, is the supply/demand outlook compelling enough to make existing holders of stock retain their long positions and to draw in fresh investor buying? In the case of platinum we think the answer is “probably” and “yes” for palladium.

For platinum we believe the turn in sentiment toward Europe is likely to be followed by a clearer upturn in activity and both consumer and corporate spending in 2014. That should feed through to growth in the light vehicle market for the first time in three years. Although the incremental growth in terms of ounces of platinum is likely to be small (we estimate just 35k to 50k oz basis our conservative vehicle production increase of 3.3% yoy) the shift from contraction to expansion is likely to generate some additional investor appetite for platinum.

The case for palladium continues to rest on growth in developing market light vehicle sales and emission regulation trends. Both should continue to be positive in 2014. Palladium should also continue to gain some market share from platinum, though the easy substitution has largely already occurred. One cloud shading the sunny scenario is the fact that Russian entities (we believe the Ministry of Finance via Gokhran, the State Precious Metals and Gems Repository) apparently released 435 koz of the metal from bonded vaults earlier this year. That metal we think was shipped from Russia some time ago, so does not contradict statements made by various officials in the past that domestic inventories were close to zero. It does, however, throw another element of doubt into the picture.

Exhibit 269: Russian palladium flows to Zurich – not massive but not zero eitherkg

0

10,000

20,000

30,000

40,000

50,000

'02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

kg

Source: Global Trade Atlas, Credit Suisse

RESEARCH ANALYSTS




Liam Fitzpatrick [email protected]

+44 20 7883 8351



analysts above.



03 October 2013


Perhaps of more concern to long-standing bulls should be the presence of regular and fairly sizable selling of short tenor palladium calls by Russian names. That has been a feature of the market on and off for several weeks now. Our understanding is that the calls are covered by physical inventory, and we think the most likely owner of that inventory is the Russian Central Bank. The history of the Russian Central Bank’s ownership of palladium is convoluted and somewhat obscure to those outside the organization. Significant exports were made in the late 1990s and early 2000s we think, some of which ended up as loan collateral, so estimating the size of the inventory the bank holds and how much, if any, of that metal it is willing to be called away on is in the first instance not easy and the second close to impossible (assuming that is where the call selling is emanating from). Our view on the first question is perhaps 1 million oz, we have no insight into the latter question.

On balance though, we think further solid growth in global vehicle production combined with possible supply losses from South Africa is likely to see the above ground inventories of palladium slowly being drawn down, and consequently keep the investment community at large on-board with the bullish palladium narrative.

A key risk to that view is that a macroeconomic event triggers widespread liquidation by longs. In that event, as has been shown on a number of occasions in the past, the exit doors may prove to be rather narrow.

Platinum: a long road uphill In summary, we think this is a metal that is more likely to grind its way steadily higher over the next several years than surge upwards in a repeat of 2008. The sector needs to see more mining capacity taken off-line in South Africa and a clear turn in European economic activity to become a more compellingly bullish story – both may happen in 2H 2014. In the interim we still think it is worth building a core position when the metal is trading at or below $1,400. At those levels there is substantially more upside than down for patient longs in our view.

Supply

Restructuring of platinum supply is proving exceptionally difficult despite the persistent low-USD price and low operating margin environment. That is a reflection of numerous factors, the primary one being the dominance of South Africa in mine supply and the strong influence of both government and labor organizations on the industry. In addition, the rand/USD exchange rate is the largest single influence on margins for the South African pgm mines, and the exchange rate is itself influenced by the country’s commodity exports. The slide in ZAR from around 8.5 at the start of the year to 10.5 in August helped ease some of the immediate burden on the platinum mines. That was helpful to the mining companies but not to the price as it meant less pressure to close sub-economic operations.

In our assessment many shafts or sections of shafts are still uneconomic at today’s prices and exchange rates. How long they can be subsidized by other operations is hard to call as it depends on politics, black economic empowerment considerations and exchange rates, as well as simple cost of production economics. But given the difficulties that Anglo American Platinum is facing to implement what we (and many others outside the country) would regard as very modest restructuring plan, it seems unlikely that the industry will change much ahead of the South African parliamentary and presidential elections next year; the former are scheduled for April, the latter is likely to be held shortly thereafter.

So although we think further shaft closures over the medium term are inevitable – particularly as wage inflation seems set to continue at 8% to 11% per annum – it is hard to forecast with much certainty which ones and when. And consequently, how quickly the global supply/demand balance will genuinely begin to tighten. In our view operations on the northern section of the Eastern Limb of the Bushveld complex and at on the

03 October 2013


southeastern end of the Western Limb are probably most at risk due to less favorable geology and prill splits (the ratio of different pgms in the ore). Those include Impala’s Marula operation (circa 70k oz/year platinum), Atlatsa’s Bokoni mine (50k to 60k oz/yr Pt), and the Eland mine owned by Glencore Xstrata (in ramp up at present, circa 50k oz/yr Pt). The closure of all three would go some way toward helping to tighten the market but that does not appear to be an imminent prospect.

Autocatalyst demand

Although less dominant than in the past, European autocatalyst demand still accounts for close to 20% of annual platinum usage. The outlook for the industry is better than it has been for some time but we are yet to see evidence that suggests the improvement will be anything more substantial than a few percent year-over-year growth from a fairly depressed 2013. We currently base our 2014 pgm demand forecast on 3.3% light vehicle growth in western Europe, roughly equivalent to an additional 500,000 vehicles. We do not expect any material shift in the gasoline/diesel market share. That magnitude of growth is likely to deliver just 25k oz of additional platinum demand in cars, with a similar incremental growth in demand from the commercial vehicle sector.

The EU is in the process of phasing in Euro 6 emissions regulations for heavy duty diesel vehicles. It appears, however, that in the majority of cases, improvements to engine technology and the use of integrated oxidation catalyst, particulate filter and selective catalytic reduction (SCR) emissions systems will mean there will be no step change higher in platinum use per vehicle. In fact it seems that many emissions systems will use the same amount if not less pgm than under Euro 5.

The ongoing fitment of platinum containing catalysts to non-road diesel vehicles is, however, expected to continue to drive some growth in platinum demand in both the US and EU.

Elsewhere, the Indian vehicle market – the second largest for diesel cars behind Europe – is on course for a weak 2013, following a disappointing 2012, thanks to rising fuel prices, a weak currency importing inflation and fragile consumer confidence. The market share of diesel cars has slipped below 50% as price controls have been steadily removed from diesel fuel and consumers shift to cheaper gasoline variants.

Scrap recovery

Recycling companies have started to see heavily loaded platinum catalysts from diesel vehicles dating from the early 2000s enter the recycling stream in increasing numbers in Europe. Platinum began to be used in diesel autocatalysts around 2000/2001 following the introduction of Euro 3 emission regulations. About that time there was also a shift (back) to platinum-based catalysts in gasoline vehicles as well, following the now infamous spike in the price of the metal to >$1,000/oz in 1999/2000.

The average age of replacement has crept higher over the last five years and is now as high as 12 years in some countries. If the economic environment in the EU really does improve sustainably that figure should fall, generating a greater flow of obsolete vehicle into the scrap chain. The net effect is that we project a resumption in the growth of platinum recovered from autocatalyst scrap between now and 2016.

Jewelry

It appears that 2013 will have been a reasonably strong year for platinum jewelry demand in China. Year-to-date imports into Hong Kong and China are marginally up year to date on what was a good prior year, while turnover of platinum on the Shanghai Gold Exchange is running more like 35% ahead of 2012. While neither figure is directly representative of jewelry demand for the metal, the data in aggregate do reflect the fact that the appeal of platinum in the Chinese market has not been damaged by a lower price environment

03 October 2013


(partly because increasingly the price of individual jewelry pieces are diverging from the value of the metal content). Platinum demand has expanded both as retail sales have risen (supported by a strong brand image and nationwide marketing campaigns) and the ongoing expansion of mid- to high-end jewelry stores north and westwards.

Exhibit 270: Chinese platinum imports Exhibit 271: Platinum volume traded on the SGE kg 000 oz

0

2,000

4,000

6,000

8,000

10,000

12,000


kgSponge and ingot semi fabricated

0

200

400

600

800

1,000

1,200

1 6 11 16 21 26 31 36 41 46 51T

ho

us

an

ds

oz 2008 2009

2010 2011

2012 2013

week


Platinum is also slowly gaining ground (albeit still a very small market share) in India. A multi-year marketing and retailer/consumer education campaign appears to be bearing fruit at the upper end of the jewelry market. Depending on the local economic situation demand from Indian jewelry fabricators for platinum could get close to 100k oz in 2014.

We also expect demand for the metal to hold more or less steady in Europe and North America but proposed sales tax could be a barrier to any meaningful growth in Japan.

Investment

The physical investment side of the platinum market has been dominated this year by the introduction of a South African domiciled physically backed ETF. Launched in April, the fund accumulated more than 300k oz within the first month and its holdings now stand at just under 630k oz. That is impressive we think, and is a testament to the local demand to either hedge equity holdings in platinum miners with a position in the underlying commodity, or to own the metal outright.

However, the 630k oz is probably not all new investment in our view (some would argue that the majority of it is not) – we think at least some of it represents metal previously held as investment outside SA and now held locally to avoid having to deal with regulations around foreign exchange. The fact that the fund is denominated in rand has undoubtedly added to its local appeal.

It is striking though that the accumulation of more than one-tenth of annual mine supply in an exchange-traded fund in less than six months failed to move the price much at all. That supports the idea that the growth in the ABSA-managed fund represents the transfer of market stocks from one location to another rather than a call on current production.

03 October 2013


Exhibit 272: Platinum ETF flows dominated by South African fund this year 000 oz

$1,000

$1,250

$1,500

$1,750

$2,000

$2,250

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

Oct

-09

Jan

-10

Apr

-10

Jul-

10

Oct

-10

Jan

-11

Apr

-11

Jul-

11

Oct

-11

Jan

-12

Apr

-12

Jul-

12

Oct

-12

Jan

-13

Apr

-13

Jul-

13

Th

ou

san

ds

oz

Plat. Ldn Bskt Ldn Plat. ZKB

Pt other Plat. US Plat. Swiss

ABSA Plat, spot


Palladium: hold on tight to your dreams Are investors who are long palladium playing a risky game of “the greater fool” – hoping that the supply of fresh investment money is not yet exhausted on the back of flawed supply/demand analysis? It is a question some in the market have begun to ask. We do not subscribe to the view common among a number of industry observers that the palladium market is and has been running 1 million oz per year plus deficits. We also recognize that there are substantial and in some cases rather opaque above-ground inventories of metal. But we do think there are grounds to believe the metal can get back to the 2011 highs around $850 over the next 18 months to 2 years.

That said, that positive outlook depends on a benign growth outlook for the global automotive industry, and Chinese car sales in particular, and so we repeat our earlier caveat: an unforeseen macro shock (such as a China credit event) would likely see a rush to the exits. If that were to happen, today’s level of implied volatility (circa 27%) would look like very good value indeed.

03 October 2013


Autocatalyst

Although subject to its fair share of month to month volatility, trend growth in Chinese car sales has been remarkably resilient for the last four years. That has been achieved despite various slow-down and speed-up scares, limitations on new car registrations in some of the most congested cities, rising fuel prices, and most recently the SHIBOR shock of June.

Exhibit 273: China passenger vehicle sales Millions of new registrations per month

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2005 2006 2007 2008 2009 2010 2011 2012 2013

mill

ions

per

mon

thSeasonally adjusted Raw data


That growth in the world’s largest single vehicle market should have been very positive for palladium demand – and it has. Use of the metal in autocatalysts in China is likely to exceed 1.4 million oz this year, up from around 1 million oz in 2010. However, the impact has not been as deeply felt on the wider palladium market (and the price) as one might have expected for reasons we discussed in the Commodities Advantage of 10 September (see Commodities Advantage: Light at the End of the Tunnel?). In essence, while Chinese autocatalyst demand has grown, jewelry demand has shrunk, palladium has faced substitution by nickel in capacitors, use of the metal in dental alloys has continued to dwindle, and inventories accumulated in 2008 have been fed into the market.

All that has tempered China's call on the international palladium market over the past four years. However, we think there is reason to believe that the relationship between Chinese auto production and palladium imports may strengthen from 2014 onward. The contraction in jewelry demand does not have much further to go and nickel for palladium substitution in electronics has also largely run its course in our assessment.

Autocatalyst recycling is growing quickly within China but from a small base. So if the Chinese car market continues to expand at close to current rates, the impact should be felt more clearly on the global palladium market (and, all else being equal, price) in 2014-2015.

Outside of China palladium demand is continuing to benefit from the robust recovery in the US automotive industry (though followers of the monthly data should be aware that September sales are likely to come in well below consensus due to a peculiarity of seasonality – Labor Day fell into August rather than September). The metal also continues to gain some additional share from platinum in diesel after treatment systems, though much of the easy gains have already been made.

https://plus.credit-suisse.com/r/Kd5AcF

03 October 2013


Stocks and flows

Those who question the bullish palladium argument point to the fact that there is by most estimates above-ground refined inventory equivalent to at least one year’s worth of demand (~9 million oz), held directly by investors, backing ETFs, in the form of producer and refiner stocks, auto industry inventories, stocks in CME approved vaults, near-market scrap, held by government agencies/sovereign wealth funds, etc. We would put the figure around the 12 million oz mark, others would say even that is too conservative.

However, the fact that there is sizeable inventory of refined metal is not new, and was not a barrier to the price climbing from less than $200 in 2008 to $850 in 2011. What has changed is that more of it is visible, partly in the form of ETF metal (a bit over 2.1 million oz). More of it has come to light as metal has flowed from Zurich vaults to secure storage in London, attracted by zero cost loco swaps and low vaulting fees offered by the owners of new vault space in and around the UK capital and who back London as a clearing center.

Swiss trade statistics show palladium exports to the UK have totaled a cumulative 165 tonnes, or 5.3 million oz, since 2008. Close to 1.5 million oz of that is ETF metal by our estimation, so shouldn’t be double counted, and some of the remainder is likely to have been used by UK based refiner and fabricator Johnson Matthey in industrial applications but that still leaves a sizeable remainder.

Exhibit 274: Inventory on the move – Swiss exports of palladium to the UK kg

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000


Monthly shipmentsCumulative total (rhs)


Further inventory has suggested itself to industry watchers this year as Swiss trade statistics have shown metal of Russian origin being customs cleared into Zurich, and as the call selling we commented on earlier has emerged.

So it is clear to us that there is currently no “shortage” of palladium, a fact evidenced by the lack of tightness in forward rates and the continued discount of sponge to ingot.

Ultimately though, we think there will be sufficient “good news” to keep investors on-side for the foreseeable future. The majority of those long positions, while arguably stale, are well in the money at current prices we think and their owners are prepared to hold out for prices at least 15%-20% above current levels.

03 October 2013


Exhibit 275: Summary PGM supply /demand forecasts ‘000 oz

PLATINUM 2009 2010 2011 2012 2013f 2014f 2015f 2016fSupplyMine supply 6,051 6,040 6,379 5,631 5,689 5,843 5,930 5,997Autocat recycling 882 1,090 1,179 1,105 1,183 1,296 1,347 1,355Total supply 6,933 7,130 7,558 6,736 6,872 7,139 7,277 7,352YoY, % -2.3% 2.8% 6.0% -10.9% 2.0% 3.9% 1.9% 1.0%

DemandAutocat 2,255 2,934 3,012 3,175 3,071 3,165 3,278 3,388Autocat off-road 0 22 56 98 140 181 190 210Industrial 965 1,312 1,507 1,183 1,262 1,346 1,437 1,485Jewellery 2,000 1,700 1,675 1,826 1,970 1,895 1,890 1,840Other 366 398 411 419 453 467 487 511Demand, ex-investment 5,586 6,366 6,662 6,702 6,895 7,054 7,281 7,433YoY, % -19.7% 14.0% 4.6% 0.6% 2.9% 2.3% 3.2% 2.1%

Running balance 1,347 764 896 34 -23 85 -5 -81Investment 827 765 198 348 875 426 282 240Total Demand 6,413 7,131 6,860 7,050 7,770 7,480 7,563 7,673

Final balance 520 -1 698 -314 -898 -341 -287 -321

PALLADIUM 2009 2010 2011 2012 2013f 2014f 2015f 2016fSupplyMine supply 6,232 6,292 6,578 6,285 6,446 6,577 6,602 6,616State stock sales 850 650 400 250 475 150 60 0Autocat recycling 1,000 1,310 1,605 1,556 1,858 2,118 2,240 2,315Total supply 8,082 8,252 8,583 8,091 8,779 8,845 8,902 8,931YoY, % -4.6% 2.1% 4.0% -5.7% 8.5% 0.8% 0.6% 0.3%

DemandAutocat 4,085 5,529 5,931 6,531 6,923 7,220 7,510 7,734Autocat off-road 0 6 14 24 35 45 47 53Industrial 1,169 1,188 1,226 1,283 1,201 1,175 1,154 1,114Jewellery 715 568 340 300 305 285 272 275Dental 597 570 526 468 407 373 338 317Other 83 92 90 95 102 106 108 116Demand, ex-investment 6,649 7,952 8,127 8,702 8,973 9,204 9,430 9,610YoY, % -9.2% 19.6% 2.2% 7.1% 3.1% 2.6% 2.5% 1.9%

Running balance 1,433 300 456 -610 -194 -359 -527 -679Investment 700 1,145 -505 455 140 263 -50 -120Total Demand 7,349 9,097 7,622 9,157 9,113 9,467 9,380 9,490

Final balance 733 -845 961 -1,065 -334 -622 -477 -559 Source: Credit Suisse

03 October 2013


Forecasts:

Exhibit 276: Palladium forecast comparison Exhibit 277: Palladium historical price and forecast US$/oz US$/oz

$600

$650

$700

$750

$800

$850

$900

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$100

$300

$500

$700

$900

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Palladium (Spot) Quarterly Avg Forecast


Exhibit 278: Platinum forecast comparison Exhibit 279: Platinum historical price comparison US$/oz US$/oz

$1,400

$1,450

$1,500

$1,550

$1,600

$1,650

$1,700

$1,750

Q4 13 Q1 14 Q2 14 Q3 14 Q4 14


$500

$750

$1,000

$1,250

$1,500

$1,750

$2,000

$2,250

$2,500

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Platinum (Spot) Quarterly Avg Forecast


Exhibit 280: Forecast platinum and palladium prices US$ per metric tonne, long-term prices based on 2011 real prices, conversion to US¢/lb rounded to nearest 0.05


Platinum New US$/oz 1630 1490 1500 1480 1525 1550 1580 1580 1630 1585 1660 1750 1800

Palladium New US$/oz 745 730 720 750 740 760 780 780 820 790 850 870 850


03 October 2013


Mineral Sands Both zircon and TiO2 feedstocks to strengthen in 2014 Zircon demand has proven to be firm this year, but producers have been slow to raise pricing. We remain confident that prices will rise in 2014, but not to the peaks that we previously forecast.

On the other hand, demand for high-grade TiO2 feedstock remains extremely weak and is probably 12 months behind zircon on the recovery trail. Demand may begin to increase in 4Q, but we don't expect a price response until 2014. While pigment demand is improving, and producer destocking is near complete, there will be a further delay for pigment plants to lift capacity utilization and wind down feedstock inventories until they need to buy.

Exhibit 281: Mineral sands price forecasts

1Q-13 2Q-13 3Q-13 4Q-13 2013E 1Q-14 2Q-14 3Q-14 4Q-14 2014E 2015E 2016E 2017E LT real

Zircon bulk New US$/t 1,230 1,250 1,300 1,350 1,283 1,400 1,600 1,600 1,600 1,550 1,650 1,650 1,625 1,500

Old US$/t 1,230 1,250 1,500 1,500 1,370 1,700 1,700 1,700 1,700 1,700 1,650 1,650 1,625 1,500

Chg % 0% 0% -13% -10% -6% -18% -6% -6% -6% -9% 0% 0% 0% 0%

Rutile bulk New US$/t 1,350 1,250 1,250 1,250 1,275 1,350 1,450 1,450 1,450 1,425 1,300 1,100 1,075 1,000

Old US$/t 1,450 1,450 1,450 1,500 1,463 1,550 1,550 1,350 1,350 1,450 1,175 1,100 1,075 1,000

Chg % -7% -14% -14% -17% -13% -13% -6% 7% 7% -2% 11% 0% 0% 0%

Synthetic Rutile

New US$/t 1,250 1,200 1,150 1,150 1,188 1,250 1,350 1,300 1,300 1,300 1,200 1,000 975 890

Old US$/t 1,300 1,300 1,300 1,350 1,313 1,450 1,450 1,250 1,250 1,350 1,075 1,000 975 890

Chg % -4% -8% -12% -15% -10% -14% -7% 4% 4% -4% 12% 0% 0% 0%

Ilmenite New US$/t 255 230 200 200 221 250 250 250 250 250 225 225 225 200

(sulphate 54%)

Old US$/t 285 275 225 250 259 250 250 250 250 250 225 225 225 200

Chg % -11% -16% -11% -20% -15% 0% 0% 0% 0% 0% 0% 0% 0% 0%

Titanium slag

New US$/t 1,050 1,050 1,000 1,000 1,025 1,050 1,150 1,150 1,150 1,125 1,000 850 825 760

(SA Chlor 86%)

Old US$/t 1,150 1,150 1,150 1,200 1,163 1,300 1,300 1,100 1,100 1,200 925 850 825 760

Chg % -9% -9% -13% -17% -12% -19% -12% 5% 5% -6% 8% 0% 0% 0%

Titanium slag

New US$/t 850 800 800 800 813 850 850 900 900 875 825 750 725 650

(Sulphate 80%)

Old US$/t 850 850 850 850 850 950 950 950 950 950 825 750 725 650

Chg % 0% -6% -6% -6% -4% -11% -11% -5% -5% -8% 0% 0% 0% 0%

Titanium slag

New US$/t 1,300 0 0 0 1,300 0 1,400 1,400 1,400 1,400 1,250 1,050 1,025 960

(UGS 95%) Old US$/t 1,400 0 0 0 1,400 1,300 1,300 1,300 1,300 1,300 1,125 1,050 1,025 960

Chg % -7% -7% -100% 8% 8% 8% 8% 11% 0% 0% 0%

MINERAL SANDS


China Pricing

The pricing in China is meaningful for zircon, but not so important for chloride feedstocks. China is the only major player in the zircon market given that Europe remains out of action. However, for TiO2 feedstocks, differences in pigment production processes and feedstock preferences between China and ROW means that China pricing may not reflect ROW prices for anything other than ilmenite.

High grade TiO2 feedstocks Recovery in the high grade TiO2 feedstocks market is lagging twelve months behind zircon. The weakness has been pigment, which was over-produced in the front end of 2012. Pigment demand is well down the path for recovery, but given we are entering a seasonal slow period, and feedstocks are further up the supply chain and will take longer to feel the demand pull, we are looking at early 2014 to see solid demand pull on feedstocks and a pricing response.

RESEARCH ANALYSTS

Equity Research Matthew Hope


Paul McTaggart [email protected]

+61 2 8205 4698





analysts above.




03 October 2013


The genesis of the poor market

The difficult conditions now being experienced in the pigment market were initiated in 2011 when the pigment market was tight and prices were rising substantially every quarter. Customers became anxious about obtaining sufficient supply and ever-rising prices so they over-ordered, accentuating the tightness of the market even further.

Chloride pigment producers rolled into 2012 with plants operating at stretch capacity to meet excessive demand, and paying premium prices for high-grade rutile to squeeze higher production from their plants. By 2Q the painting season should have started, but demand did not pick up. Global macro weakness in every region had struck, IP fell away so finished goods were not painted, and discretionary re-painting of houses was delayed.

Pigment consumers had sufficient supply in a weak demand environment, having over-stocked in 2011. They did not buy from pigment-makers, hence the latter’s inventories blew out to as much as 120 days before the capacity utilization of plants was slashed.

Consequently, at the top of the supply chain, demand for TiO2 feedstocks died in 2H 2012, particularly for the premium high-grade products of rutile and synthetic rutile. Pigment makers wanted to cut production and did not need premium grade products at premium prices.

2012 Pigment demand

We believe that pigment consumption dropped by 16% in 2012 (Exhibit 282). This was not purely due to a demand slow-down on weak construction and sluggish economic activity globally. It also reflected destocking by pigment consumers through the year.

Four stages of pigment market recovery

Tronox has mapped out the four stages of recovery in the pigment market:

Sales volume increases and customer destocking ceases; prices continue to soften as demand is met with producer inventory.

Pigment prices stabilize as producer inventory reaches normal levels of around 50 days’ supply.

Plant utilization rate increase as excess inventory is sold out and margins benefit on lower unit costs.

Prices recover after inventories normalize and utilization rates increase.

Our estimate is that the pigment industry is at stage 2 and probably entering stage 3. Producers have wound back capacity utilization to about 70% across the Western industry. Finished inventories are normalized for DuPont, and Huntsman, but still high at 60 days for Tronox. However, in August Tronox noted demand in 2Q had returned to normalized levels. If it had run its plants to match demand it would have been at 89% capacity utilization. However, it was reducing inventory instead.

Although Tronox suggested prices would only increase in stage of recovery, as capacity utilization picks up, Dupont, Tronox, Kronos, Cristal Global and Huntsman all have announced price increases of $175-$200/t to take effect in 2H. However, we doubt any of these increases fully took hold.

Not expecting feedstock demand pull until DecQ 2013.

We expect stage 3 has begun, with plant utilization levels lifting and pigment prices perhaps beginning to pick up, but it will be DecQ before the feedstock market feels any demand pull. Huntsman in particular noted that it had sufficient slag inventory left from a legacy contract to avoid buying any feedstock until SepQ.

03 October 2013


High grade products are taking the brunt

Given that capacity utilization is low to minimize production while producers destock, pigment-makers are still not interested in buying premium grade natural rutile or synthetic rutile. Iluka's reported sales totaling 76kt of rutile and syn-rutile for JunH versus 250kt in normal periods.

Longer term we remain cautious and do not forecast a climb back to the LT trend

Over the long term, pigment demand growth has matched global GDP. Going forward it’s a little difficult to know what global GDP growth rate will be. If the LT trend through the 1990s and 2000s apparent in Exhibit 282 continued, we would be looking pigment demand to reach 6Mt by 2016. However, we are more cautious and our pigment consumption does not match the boom year of 2011 (which now appears to have included stocking-piling) until 2015. By 2016, we remain 300kt below the 6Mt implied by the LT trend.

Exhibit 282: Global pigment demand (actual and forecast)

0

1000

2000

3000

4000

5000

6000

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

f

2014

f

2015

f

2016

f

Glo

bal p

igm

ent d

eman

d (k

t)

Source: TZMI, Credit Suisse

Real pigment consumption trends

In terms of real pigment consumption, some signs are improving in 2013, although growth is patchy. In the US, housing sales have picked up, which is a key driver for repainting houses, the major use of architectural paint in developed economies.

Europe is looking a little better than previously, but we expect discretionary spending, such as repainting, will remain curtailed for an extended period.

In China, new housing construction is a larger demand sector than repainting. Strong residential price increases in Tier 1 & 2 cities have occurred, but the news from the pigment sector has remained gloomy throughout the year.

High grade TiO2 feedstocks Balance

Looking at balances in the high grade market, despite the production cuts implemented by Iluka and RBM, we still expect a surplus of 200kt will be generated through 2013. There is little more that Iluka can do so we expect that surplus will be picked up as an inventory build by a producer, and most likely in the chloride slag segment of the market.

03 October 2013


Balances in 2014 onward remain hard to read because it depends very much on which projects are restarted as prices improve. If Iluka’s projects resume, we consider there would be a 480ktpa surplus in 2014 and 325kt in 2015. We doubt projects will restart if this is the likely result, but nevertheless the potential for overhang remains significant Which we expect will mute the expected feedstock price increase in 2014.

However, our forecast is based on a cautious view of future pigment demand. With the break down in long term contracts, demand and pricing are both becoming exceedingly volatile and it is entirely plausible that we may instead see an acceleration in demand and a restocking cycle that would draw down inventories and wipe out surpluses.

Exhibit 283: High-grade TiO2 feedstock production (actual and forecast)

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3,500

4,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f 2014f 2015f

TiO

2 un

its

Iluka Rio Tinto Tronox (Exxarro) ROW

Source: Company data, Credit Suisse

Sulfate slag balance

We expect 25% growth in sulfate slag output in 2013, due largely to Rio Tinto’s reduction in UGS output in favor of Sorel sulfate slag. Hopes of Western slag makers to sell excess product into China appear to be diminishing. In the year to June, only 14kt of slag had been imported to China, although that was more than double 2012. We expect a surplus of about 80kt in 2013.

Beyond 2013, we continue to see tight market conditions and a potential 130kt deficit for non-China sulfate slag provided Rio Tinto restarts UGS production. If it does not, and continues elevated output of Sorel sulfate slag, the market may become slack and continued hefty exports to China may be needed to balance the market.

The Chinese slag producer output appears to be slowing output because the Chinese titanium metal producers, the main slag users in China, are facing weak demand. We note that Chinese slag prices have been falling since November (Exhibit 284 – but no update on 90% slag prices since June). Production of titanium metal early in 2013 has been weak in China due to a large inventory build in 2012 caused by delayed aircraft build programs and slowing desalination projects.

03 October 2013


Exhibit 284: China TiO2 slag prices (ex VAT) Exhibit 285: China ilmenite prices (ex VAT)

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China TiO2 slag 92% China TiO2 slag 90%

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China Ilmenite price (50%) China Ilmenite price (46%)

Source: Metal Pages, Credit Suisse Commodities Research Source: Metal Pages, Credit Suisse Commodities Research

Chinese ilmenite market The improving trend seen for pigments is not reflected in China at this stage. According to Metal Pages reports, pigment demand has weakened and producers are ceasing production on low prices and demand. Metal Pages reported a producer in Guanxi saying 60%-70% of producers have stopped production, while a producer source in Sichuan noted that most producers are cutting production to stabilize prices and that the market may improve in September and October, which is the peak season for decorating houses.

Given pigment plants are idling, prices for ilmenite feedstock are also sliding in China. Prices for domestic 46% TiO2 ilmenite are down $90/t from the start of the year to reach the lowest point in the past couple of years (Exhibit 286). Metal Pages reported a source saying capacity utilization of mines in Sichuan Province was lower than 30% with trade sparse. Sichuan is the main source of Chinese ilmenite, from the giant hard rock deposit at Panzihua.

There will be further pressure on pigment producers because the Vietnamese Government planned to lift its export tariff for ilmenite to 40% from 30% on 19 June, pushing up ilmenite prices. Vietnamese 50% TiO2 ilmenite is already trading at $80/t premium to domestic 46% ilmenite ex-VAT, so we expect that in the short-term Vietnamese imports may ease. Domestic 46% ilmenite accounts for 86% of ilmenite use in China and its share may rise further .

On an Ex VAT basis, 50% ilmenite prices from Vietnam have fallen to $212/t from $285/t at the start of the year. We have lowered our 3Q price to $200/t to account for current weakness before lifting it back to $250/t in 2014.

Zircon demand steadying at normalized level Tronox and Iluka report strong demand

Producer reports indicate that demand for zircon has picked up strongly in 2013. Iluka sold 211kt of zircon in JunH, almost equal to the entire year's sales in 2012. Tronox only reports percentage increases, but indicated that 2Q sales rose 80% qoq following a 47% lift in 1Q and 93% in 4Q 2012. Demand remains concentrated into China, but the ROW is starting to exhibit some recovery. The strong China sales are in line with the firm property construction and sales that has been evident in China this year.

03 October 2013


But China tile growth looking flat

Interestingly, China's tile statistics, as reported by NBS, don't exhibit a strong lift year-over-year, but do show see improvement within this year. Tile production at the start of the year was weak, and output was down 17% yoy by the end of MarQ. However, production picked up in 2Q and made up the gap so that production was only down 1% yoy by the end of the JunQ. Our China economists expect construction to remain firm this year and into next, so we expect tile production to maintain pace and end the year up 2% yoy, only a small increase, but a good result from where the year started.

Exhibit 286: China tile production historical and 2013 actual to July + forecast

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Chi

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2013F 2012 2011 2010 2009


With only a 2% annual increase, we would expect flat zircon consumption, but zircon sales have picked up solidly on last year. One obvious explanation is that destocking within the sector took place last year, but has now ended. However, we suspect that much of the change is actual a structural change from imports dominated by concentrate from Indonesia to dominantly zircon sand imports from mainstream producers:

To June, China's cumulative zircon sand imports were up 37% (67kt), whereas concentrate imports were down 39% (100kt). This appears to reflect the Indonesian situation where supply has been sporadic due to export licensing issues. Sand producers such as Tronox and Iluka may be benefiting on the Indonesian outage.

No price increases – not producer destocking so market management?

The improvement in demand has not been met with price increases. The only price increase we have seen since the start of the year was $50/t in May. The zircon price in China is sitting stable at around $1300-$1350/t. The lack of producer response is a little perplexing. We don't believe it can be explained as producers concentrating on reducing inventories – Tronox said in its 2Q report that its inventories were back at normalized levels. And Iluka has restarted shipping HMC from its Jacinth Ambrosia zircon mine to the mineral separation plant, so further destocking will be difficult as production should now equal sales after being 90kt short in JunH.

If producers are not destocking and demand is solid, then the best explanation we can arrive at is that producers are engaging in market management. The sharp and erratic price increases and then decreases in 2012 caught some consumers out as they were left

03 October 2013


holding expensive inventory when the market undercut their last purchase. We understand this was damaging for the zircon industry as a whole and probably destroyed some demand. We suspect that producers have decided that an extended period of stable pricing is necessary to soothe consumer fears. However, prices cannot remain flat forever and must ultimately respond to demand. We expect that zircon producer will lift prices, but follow this with a long steady period.

Zircon pricing

We continue to forecast that 2014 will see substantially higher prices reaching $1600/t and then subside towards our LT rate of $1500/t in future years as production and consumption readjust and match.

Normalized zircon sales volumes Globally, we expect zircon demand in 2013 will reflect recovery of 13% on the exceptionally depressed demand of 2012. We are gradually finding out what normalized zircon sales are post the Global Financial Crisis of 2008-2009, the following Chinese stimulus, and the European recession.

2010 and 2011 sales volumes were abnormally high on stimulus

With the benefit of hindsight, we can now see that China’s zircon consumption in 2010 and 2011 was excessively high (Exhibits 287 and 288), driven by the massive infrastructure stimulus and a consequent surge in tile demand and production. After enjoying 2010 and 2011 with +30% pa tile volume growth rates, China’s tile producers were caught out when demand gave way and growth rolled over to 1%, under the influence of Beijing’s clamp down on property investment and funding in 2012 (Exhibit 287). Excessive inventory of zircon and tiles needed to be worked off over the course of 2012, a process that now appears to be complete. Tile production has restarted but as we have noted above is flat on the 2012.

Simultaneously in 2012, Europe’s recession began to bite and the zircon demand by the tile manufacturers in Italy and Spain fell away to levels less than the global financial crisis of 2009 (Exhibit 288).

Exhibit 287: China zircon consumption by sector actual and forecast

Exhibit 288: Global zircon demand actual and forecast

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China Europe Other Asia PacificJapan Other North America

Source: Company data, Credit Suisse Source: Credit Suisse, TZMI

03 October 2013


Assessing normalized sales volumes

Midway through 2013, global zircon demand had not yet returned to a normalized level. Europe remained depressed, although China has picked up and appears to be strong.

To assess the new normal, we also need to be aware of structural changes:

Structural demand decrease

As best we know, there has been a reduction in zircon intensity in China’s tiles, which in our estimate will exceed natural growth in non-ceramic applications. We expect China’s 2013 zircon demand to be 60kt below 2011 levels.

The structural changes occurred as China’s tile manufacturers caught up with European technology and progressively altered porcelain tile manufacturing from full body (zircon though the entire tile thickness) to double-charging that puts zircon in the top layer only. We examined the issue in our sector note of 18 December 2012 Mineral Sands Sector – Quantifying the zircon demand gap and estimated that the reduction in zircon intensity reduced China’s zircon demand by 130kt in 2012 or 20% of 2011 levels.

Chinese demand

We build up our forecast Chinese demand by market segments (Exhibit 287), starting with a tile estimate (Exhibit 289) and the structural change to reduced zircon intensity of use in porcelain tiles through double charging. We expect 535kt of zircon demand by China in 2013, up only 2.5% from 2012, and below 2010 at 578kt (Exhibit 295).

Exhibit 289: China monthly tile output actual and Credit Suisse forecasts

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China Tile Manufacturing (million sq m)

6 per. Mov. Avg. (China Tile Manufacturing (million sq m))

Source: NBS, Credit Suisse

03 October 2013


Exhibit 290: Zircon imports Exhibit 291: Zircon imports in China

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China Other Asia W Europe N America Other Europe

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Tho

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2008 2009 20102011 2012

Source: TZMI, Credit Suisse estimates Source: TZMI, Credit Suisse estimates

European demand

China remains the main source of zircon demand but, there are incipient signs of life in Europe, detected by Iluka. Europe returning to the zircon market would derisk it from complete reliance on China. Judging from zircon imports, Europe must be heavily destocked, so we expect a 33% demand recovery in 2013, although that still remains 30% lower than demand in 2011. We do not look for a resumption of even 2009’s production given that a resurgence of building in the Mediterranean sun-belt seems distant.

Exhibit 292: Zircon imports to Europe Exhibit 293: Zircon exports

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Australia South Africa Indonesia Ukraine Vietnam Other

Source: TZMI, Credit Suisse estimates Source: TZMI, Credit Suisse estimates

Zircon supply

The weak demand experienced in the zircon market for the past 18 months, saw producers take action to cut zircon output. However, now its producers are gradually winding production back up.

03 October 2013


Global output run-rate 31% below 2011

Our present estimate is that global finished zircon production for 2013 will total 1100ktpa, 31% down on the peak output of 1600kt in 2011. This is ahead of our estimate of 890kt in our last quarterly as Iluka has announced a restart of production at Jacinth Ambrosia, and Rio Tinto is undertaking some limited separation of zircon at Richards Bay Minerals

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Exhibit 294: TiO2 feedstocks supply & demand Thousands of metric tonnes (kt)

kt 2008 2009 2010 2011 2012 2013F 2014F 2015F 2016F kt 2008 2009 2010 2011 2012 2013F 2014F 2015fTiO2 UNITS SUPPLY TiO2 CONSUMPTION BY SECTOR

Australia 1,583 1,168 1,223 1,205 1,298 1,136 1,283 1,383 1,389 Pigments 5,374 4,732 5,785 6,185 5,620 4,980 5,870 6,335 South Africa 1,090 854 1,126 1,141 1,033 1,018 1,094 1,144 1,139 Titanium sponge 360 260 290 423 479 479 494 548 Other Africa 248 340 463 437 418 575 1,126 1,367 1,405 Other (Welding rods) 177 208 280 310 330 365 410 460 Canada 896 696 905 956 1,056 900 1,109 1,109 1,129 TOTAL TiO2 demand 5,912 5,200 6,355 6,918 6,429 5,824 6,774 7,343 China 597 550 730 979 1,037 892 1,051 1,110 1,142 TiO2 for Pigments 91% 91% 91% 89% 87% 86% 87% 86%Other Europe 758 737 747 610 694 760 812 873 852 TiO2 for Titanium sponge 6% 5% 5% 6% 7% 8% 7% 7%US 187 151 194 217 164 158 154 99 99 Other 3% 4% 4% 4% 5% 6% 6% 6%ROW 690 903 912 900 823 831 839 891 907 PIGMENT BALANCETotal TiO2 units 6,050 5,400 6,300 6,504 6,580 6,330 7,527 8,043 8,163 PIGMENT PRODUCTION 4,950 4,370 5,330 5,695 5,180 4,590 5,410 5,840 Disruption Allowance - - - - - 317- 376- 402- 408- % Chg y-o-y -3.5% -11.7% 22.0% 6.9% -9.1% -11.4% 17.9% 7.9%

Total Production 6,050 5,400 6,300 6,504 6,580 6,014 7,151 7,641 7,755 PIGMENT CONSUMPTION 4,974 4,340 5,332 5,585 4,690 5,110 5,370 5,560 % change -6.7% -10.7% 16.7% 3.2% 1.2% -8.6% 18.9% 6.8% 1.5% % Chg y-o-y -3.3% -12.7% 22.9% 4.7% -16.0% 9.0% 5.0% 3.5%CONSUMPTION PIGMENT BALANCE 24- 30 2- 110 490 520- 40 280 Total TiO2 consumption 5,906 5,200 6,355 6,918 6,429 5,824 6,774 7,343 7,590 TiO2 FEEDSTOCK BALANCES (TiO2 units kt)

% Chg y-o-y -3.2% -12.0% 22.2% 8.9% -7.1% -9.4% 16.3% 8.4% 3.4% Chloride ilmenite supply 636 458 421 420 444 586 745 572 SURPLUS/(DEFICIT) 144 200 -55 -414 152 189 377 298 165 Disruption allowance - - - - - 12- 37- 29-

Estimated Total Stocks 194 394 339 -75 76 266 643 940 1105 Chloride ilmenite demand 761 697 911 924 751 693 826 872 weeks Consumption 1.7 3.9 2.8 -0.6 0.6 2.4 4.9 6.7 7.6 CHLOR. ILMEN. TiO2 BALANCE - - - - - - - -

FEEDSTOCK SUPPLY High grade supply 2,701 2,293 2,950 3,022 3,004 2,425 3,115 3,462 Ilmenite (Sulphate) 4,102 4,219 4,747 4,793 4,892 4,914 5,894 6,272 6,157 Disruption allowance - - - - - 48- 156- 173- Ilmenite (Chloride) 1,053 757 685 681 730 971 1,235 948 1,016 High grade demand 2,573 2,246 2,965 2,977 2,436 2,167 2,476 2,962 Rutile 621 552 761 810 799 621 909 1,005 1,039 HIGH GRADE TiO2 BALANCE 128 47 -15 45 568 209 483 327Leucoxene 181 168 188 159 205 175 253 285 290 Sulfate slag supply (ex China) 649 428 457 518 571 630 571 685 Synthetic rutile 767 671 635 614 585 396 447 702 657 Disruption allowance - - - - - 14- 31- 36- Slag (Chloride) 1,430 1,149 1,692 1,769 1,756 1,560 1,905 1,945 1,985 Sulfate slag demand (ex China) 675 544 628 709 628 618 675 724 Slag (sulphate) 1,023 830 860 940 1,012 1,113 1,072 1,247 1,372 SULFATE SLAG BALANCE 26- 116- 171- 192- 57- 2- 135- 75-

TiO2 SUPPLY BY FEEDSTOCK PRODUCT Global sulfate ilmenite TiO2 1,888 1,972 2,229 2,318 2,373 2,452 2,860 3,064 Ilmenite (sulphate) TiO2 1,888 1,972 2,229 2,318 2,373 2,452 2,860 3,064 3,138 Disruption allowance - - - - - 242- 153- 165- Ilmenite (Chloride) TiO2 636 458 421 420 444 586 745 572 612 Global sulfate ilmenite demand 1,917 1,824 2,178 2,537 2,596 2,130 2,548 2,682 High grade TiO2 1,442 1,278 1,455 1,460 1,449 1,063 1,428 1,742 1,612 SULFATE ILMENITE BALANCE -29 148 51 -219 -223 80 159 217Chloride slag TiO2 1,260 1,016 1,494 1,562 1,556 1,362 1,686 1,721 1,755 Sulphate slag TiO2 825 677 700 744 759 867 808 944 1,045 PRICES(US$/t)

Sulfate supply TiO2 units 45% 49% 46% 47% 48% 52% 49% 50% 51% Rutile - Bulk Aust FOB 509 537 550 1,055 2,405 1,275 1,425 1,300 Chloride supply TiO2 units 55% 51% 54% 53% 52% 48% 51% 50% 49% Synthetic rutile - Aust FOB 429 424 443 858 1,707 1,188 1,300 1,200 TiO2 PIGMENT SUPPLY BY PROCESS Ilmenite (sulfate) 119 74 84 209 313 221 250 225

Chloride Pigment Supply 2,602 2,243 2,795 2,854 2,351 2,203 2,590 2,855 2,985 Slag (Chloride SA 86%) 449 426 431 490 1,688 1,025 1,125 1,000 Sulfate Pigment (ex-China) 1,438 1,097 1,332 1,306 1,129 1,087 1,220 1,285 1,305 Slag (Sulphate 80%) 356 294 322 415 1,500 813 875 825 China Pigment Supply 900 1,047 1,200 1,545 1,700 1,300 1,600 1,700 1,700 Slag (UGS 95%) - - 524 996 2,350 325 1,050 1,250

Source: TZMI, Company data, Credit Suisse estimates

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Exhibit 295: Zircon supply & demand summary kt 2008 2009 2010 2011 2012 2013F 2014F 2015F 2016F kt 2008 2009F 2010 2011 2012 2013F 2014F 2015FMINED ZIRCON PRODUCTION CONSUMPTION SECTOR USE

Australia 500 415 530 722 478 467 549 595 591 Ceramics 628 543 780 795 600 - - - South Africa 398 352 381 395 410 185 390 390 440 Refractories 144 113 160 165 140 - - - Other Africa 8 27 54 72 77 70 145 207 219 Foundry 133 109 140 145 120 - - - China 50 40 30 25 40 40 40 40 40 TV glass 35 27 21 15 10 - - - India 29 28 35 40 43 53 53 53 53 Zirconia & chemicals 200 176 245 260 260 - - - Ukraine 24 27 24 24 28 25 25 25 25 Other 21 19 25 20 20 - - - United States 124 57 88 85 74 67 69 49 49 Total 1,161 987 1,371 1,400 1,150 - - - Other 161 161 145 233 241 200 195 185 185 Mkt shareHighly Probable Growth - - - - - - - - - Ceramics 54% 55% 57% 57% 52% - - - Disruption Allowance - - - - - -11 -59 -62 -64 Refractories 12% 11% 12% 12% 12% - - -

Total Production 1,294 1,107 1,288 1,596 1,392 1,096 1,407 1,482 1,538 Foundry 11% 11% 10% 10% 10% - - - % change -10.0% -14.5% 16.4% 24.0% -12.8% -21.3% 28.4% 5.3% 3.7% TV glass 3% 3% 2% 1% 1% - - -

Zirconia & chemicals 17% 18% 18% 19% 23% - - - ZIRCON CONSUMPTION Other 2% 2% 2% 1% 2% - - - Nth America 121 86 113 120 130 140 150 155 160 Total 100% 100% 100% 100% 100% - - - % change -17.7% -28.9% 31.4% 6.2% 8.3% 7.7% 7.1% 3.3% 3.2% Europe 300 229 328 290 150 200 230 270 290 % change -21.3% -23.7% 43.2% -11.6% -48.3% 33.3% 15.0% 17.4% 7.4% China 421 398 578 625 522 535 574 620 659 % change 7.7% -5.5% 45.2% 8.1% -16.5% 2.5% 7.4% 8.0% 6.3% Japan 45 37 45 45 40 50 50 50 50 % change -21.1% -17.8% 21.6% 0.0% -11.1% 25.0% 0.0% 0.0% 0.0% Other Asia 163 140 196 195 130 170 190 200 210 % change -13.8% -14.1% 40.0% -0.5% -33.3% 30.8% 11.8% 5.3% 5.0% Other World 111 97 111 110 100 115 120 125 130 % change 23.3% -12.6% 14.4% -0.9% -9.1% 15.0% 4.3% 4.2% 4.0%Total consumption 1,161 987 1,371 1,385 1,072 1,210 1,314 1,420 1,499 % change -7% -15% 39% 1% -23% 13% 9% 8% 6%Restocking - - 25 - -40 - - - - SURPLUS/(DEFICIT) 133 120 -83 211 320 -114 93 62 38Estimated Total Stocks 81 150 42 253 613 499 592 654 692weeks Consumption 3.6 7.9 1.6 9.5 29.7 21.4 23.4 23.9 24.0

Price (US$/t)Bulk from Australia 765 858 875 1,875 2,173 1,283 1,550 1,650 1,650

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Zircon Production (bars) v Consumption (kt) & price (line) US$/t RHS

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Other World Australia South Africa Other Africa China

India Ukraine United States Other Bulk from Australia

Source: TZMI, Company Data, Credit Suisse

03 October 2013


Uranium: Spot-Term Price Dichotomy Reflects Inventory-Driven Factors Uranium price forecasts

We are lowering our spot uranium price forecast by 12% to $38.50/lb in 2013 and by 20% to $43/lb in 2014. We are also reducing our term price forecast by 6% to $56/lb in 2013 and by 10% to $56/lb in 2014. Our long-term forecast of $65/lb remains unchanged. The lack of pricing support at the $40/lb level is reflective, in our view, of a number factors including: (i) a general lack of producer cutbacks and the expectation that smaller-scale US ISR production will go ahead despite the negative market sentiment; and (ii) the knock-on effects of producers that have historically been short of material now finding themselves long as a result of Japanese deferrals. We do continue to expect a rising price profile over the next three to five years, albeit from currently depressed levels, and we now forecast a peak uranium price of $70/lb in 2017 (previous 2016).

Exhibit 296: Uranium price forecast

2011E 2012E 1Q13A 2Q13A 3Q13E 4Q13E 2013E 2014E 2015E 2016E 2017E LT Uranium (spot) New (US$/lb) 56.75 48.75 42.75 40.25 35.00 36.00 38.50 43.13 55.00 60.00 70.00 65.00

Previous (US$/lb) 42.50 45.00 43.75 53.88 65.00 70.00 65.00 65.00 change (%) -18% -20% -12% -20% -15% -14% 8% 0%

2011E 2012E 1Q12E 2Q12E 3Q12E 4Q12E 2013E 2014E 2015E 2016E 2017E LT Uranium (LT) New (US$/lb) 67.50 59.25 56.00 57.00 55.00 55.00 55.75 56.25 60.00 65.00 65.00 65.00

Previous (US$/lb) 58.00 60.00 59.00 62.50 65.00 65.00 65.00 65.00 change (%) -5% -8% -6% -10% -8% 0% 0% 0%


In our view, positive uranium price momentum will be driven by stronger evidence of the following key factors over the next 12 months: (i) clarity surrounding the nuclear outlook for Japan; (ii) resumption of approvals for new nuclear reactors in China; (iii) clarity over Russian supplies post expiry of the HEU supply agreement in 2013; (iv) producer/supply discipline at uranium spot prices below the marginal cost of production; and (v) lower expected uranium production growth rates in Kazakhstan.

Supply

From 2013-2022 (ten-year view), we estimate total uranium supply of 2.347bn lbs U3O8, including 2.021bn lbs of primary mine supply and 0.326bn lbs of secondary sources. The key change to our forecast from previous involves Cameco's identification of additional work at Cigar Lake that will delay jet boring in ore and now expects first ore production in 1Q 2014 (previous mid-2013). Cameco has withdrawn its 2013 production guidance and expects to provide a revised five-year production plan as part of its annual reporting for 2013 (in early 2014).

Demand

From 2013-2022, we estimate total uranium demand of 2.424bn lbs U3O8. Our demand forecasts take into account assumptions for Japanese restarts (20 reactors in operation by the end of 2016) and full decommissioning in Germany. In summary, we forecast a net addition of 81 reactors to the current global fleet of 434 in operation by 2021 (including Japan restarts).

In our view, the social and political tolerance for new nuclear build initiatives remains dynamic and because of the unique technological and environmental challenges facing uranium/nuclear, industry sentiment continues to be subject to public opinion risks. We remain constructive on the outlook for new reactor build in China, Russia, and India, where we forecast 47GWe of new nuclear capacity over the next five years (2013-2017) out of total global new capacity of 57GWe, accounting for 83% of our growth forecast.

RESEARCH ANALYSTS

Equity Research Ralph Profiti






analysts above.



03 October 2013


Exhibit 297: Reactor expansions and uranium required URANIUM REQUIRED

URANIUM REQUIRED

KWh (Billion) % # MWe # MWe # MWe # MWe tonnes U M'lbs U3O8Argentina 5.9 4.7 2 935 1 745 1 33 2 1,400 213 0.554 Armenia 2.1 26.6 1 376 - - 1 1,060 64 0.166 Bangladesh - - - - - - - - 2 2,000 - - Belarus - - - - - - 2 2,400 2 2,400 - - Belgium 38.5 51.0 7 5,943 - - - - - - 995 2.587 Brazil 15.2 3.1 2 1,901 1 1,405 - - 4 4,000 995 2.587 Bulgaria 14.9 31.6 2 1,906 - - 1 950 - - 317 0.824 Canada 89.1 15.3 19 13,553 - - 2 1,500 3 3,800 1,906 4.956 Chile - - - - - - - - 4 4,400 - - China 92.7 2.0 17 13,842 28 30,550 49 56,020 120 123,000 5,999 15.597 Czech Republic 28.6 35.3 6 3,766 - - 2 2,400 1 1,200 577 1.500 Egypt - - - - - - 1 1,000 1 1,000 - - Finland 22.1 32.6 4 2,741 1 1,700 - - 2 3,000 728 1.893 France 407.4 74.8 58 63,130 1 1,720 1 1,720 1 1,100 9,254 24.060 Germany 94.1 16.1 9 12,003 - - - - - - 1,934 5.028 Hungary 14.8 45.9 4 1,880 - - - - 2 2,200 331 0.861 India 29.7 3.6 20 4,385 7 5,300 18 15,100 39 45,000 1,261 3.279 Indonesia - - - - - - 2 2,000 4 4,000 - - Iran 1.3 0.6 1 915 - - 1 1,000 1 300 172 0.447 Israel - - - - - - - - 1 1,200 - - Italy - - - - - - - - 10 17,000 - - Japan 17.2 2.1 50 44,396 3 3,036 9 12,947 3 4,145 4,425 11.505 Jordan - - - - - - 1 1,000 - Kazakhstan - - - - - - 2 600 2 600 - - North Korea - - - - - - - - 1 950 - - Korea RO (South) 143.5 30.4 23 20,787 4 5,415 6 8,730 - - 3,769 9.799 Lithuania 10.0 76.2 - - - - - - 1 1,350 - - Malaysia - - - - - - - - 2 2,000 - Mexico 8.4 4.7 2 1,600 - - - - 2 2,000 279 0.725 Netherlands 3.7 4.4 1 485 - - - - 1 1,000 102 0.265 Pakistan 5.3 5.3 3 725 2 680 - - 2 2,000 117 0.304 Poland - - - - - - 6 6,000 - - - - Romania 10.6 19.4 2 1,310 - - 2 1,310 1 655 177 0.460 Russia 166.3 17.8 33 24,164 10 9,160 24 24,180 20 20,000 5,073 13.190 Slovakia 14.4 53.8 4 1,816 2 880 - - 1 1,200 305 0.793 Slovenia 5.2 53.8 1 696 - - - - 1 1,000 137 0.356 South Africa 12.4 5.1 2 1,800 - - - - 6 9,600 304 0.790 Spain 58.7 20.5 7 7,002 - - - - - - 1,355 3.523 Sweden 61.5 38.1 10 9,388 - - - - - - 1,469 3.819 Switzerland 24.4 35.9 5 3,252 - - - - 3 4,000 527 1.370 Thailand - - - - - - - - 5 5,000 - - Turkey - - - - - - 4 4,800 4 4,500 - - Ukraine 84.9 46.2 15 13,168 - - 2 1,900 11 12,000 2,356 6.126 UAE - - - - - - 2 2,800 2 2,800 - - United Kingdom 64.0 18.1 16 10,038 - - 4 6,680 9 12,000 1,775 4.615 USA 770.7 19.0 102 101,060 3 3,618 9 10,860 15 24,000 18,983 49.356 Vietnam - - - - - - 4 4,000 6 6,700 - - WORLD** 2,346.0 13.5 434 373,892 67 69,709 159 174,340 318 359,750 66,512 171.337

NUCLEAR ELECTRICITY GENERATION 2012

REACTORS NOW OPERATING

REACTORS PROPOSEDREACTORS UNDER CONSTRUCTION

REACTORS CURRENTLY PLANNED


Under Construction = first concrete for reactor poured, or major refurbishment under way; Planned = Approvals, funding or major commitment in place, mostly expected in operation within 8-10 years; Proposed = Specific program or site proposals, expected operation mostly within 15 years. Source: World Nuclear Association, Credit Suisse estimates

Market balance

Our supply-demand forecasts remain largely unchanged from our last update. In total, from 2013-2022, we estimate the global uranium market will be in a deficit of 77mn lbs, with deficits occurring in 2014 and 2015, followed by a balanced market until 2020, and then more significant deficits growing thereafter.

03 October 2013


Exhibit 298: UxC Summer Uranium survey

Source: US Weekly (UxC) September 9, 2013

Recent price leakage resulting from limited demand interest has caused spot prices to dip below the $40/lb barrier for the first time since March 2006. Over the medium and long term, we believe the uranium price will stage a steady recovery to a level that reflects the incentive price for production expansion and exploration, averaging between $65-70/lb over the next five years.

Exhibit 299: Uranium price history, forecasts and NYMEX futures curve

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20

40

60

80

100

120

140

UxC Month-end U3O8 spot price (US$/lb) Credit Suisse spot forecast (US$/lb)

NYMEX-UxC Futures (US$/lb) UxC Month-end U3O8 LT price (US$/lb)

Historical Forecast


Uranium supply: Supply growth fueled by Kazakhstan and Cigar Lake

Current low uranium price relative to the marginal cost of production and availability of both inventory and secondary sources of fuel supply translates into a riskier environment for mine supply, in our view. As such, we believe future mine supply trends will focus on uranium deposits of the highest quality in terms of tonnage, grade, cost, and ability to finance. Prior to the events of Fukushima, questions facing the uranium market centered on security of supply, and although we believe this to still be the case, addressing future supply concerns will now have to be made in a period of lower prices and sentiment.

03 October 2013


Exhibit 300: Uranium supply forecasts all figures in Mln lbs U3O8, unless noted 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Uranium mine productionNorth America 29.8 29.4 27.3 25.9 25.5 26.4 28.0 35.8 41.6 47.8 52.7 53.4 South America 0.9 0.4 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 - Western Europe - - - - - - - - - - - - Eastern Europe 0.7 0.7 0.6 0.7 0.7 0.7 0.7 0.7 0.0 0.0 0.0 0.0 Kazakhstan 36.5 46.3 50.6 54.3 55.9 58.5 58.5 61.1 59.5 55.9 56.4 56.4 Russia & Other FSU 19.6 22.2 22.5 22.8 23.1 23.8 24.6 25.5 26.5 26.6 26.7 26.8 Africa 19.6 23.0 26.6 33.4 37.2 40.7 44.9 56.4 56.4 58.3 60.2 62.8 Asia & Oceana 27.7 25.9 21.0 20.3 22.6 21.5 21.5 21.0 20.4 19.8 23.1 23.3 Other (adjustments) - - - - - - - - - - - - Mine production 134.8 147.8 149.2 158.1 165.6 172.2 178.9 201.1 205.1 209.0 219.8 222.8

growth rate 16.3% 9.7% 0.9% 5.9% 4.8% 4.0% 3.9% 12.4% 2.0% 1.9% 5.2% 1.4%Secondary supply 45.5 48.2 47.1 50.3 54.2 27.0 29.5 29.5 32.0 32.0 32.0 32.0 Total supply 180.3 196.0 196.3 208.4 219.8 199.2 208.4 230.6 237.1 241.0 251.8 254.8

growth rate 7.6% 8.7% 0.2% 6.2% 5.5% -9.4% 4.6% 10.7% 2.8% 1.6% 4.5% 1.2%


Kazakhstan production increased 7.5% yoy in 2012 to 54.3mn lbs U3O8. We estimate further growth to ~60mn lbs by 2016; however, resources could be depleted at a faster rate than anticipated, with some high-grading occurring at the expense of future production, leaving future production more dependent on higher market prices. We estimate production peaking in 2016 at an annual rate of 60mn lbs/year, with expansion to 60+mn lbs/yr requiring a price above $80/lb.

Cameco has identified additional work at Cigar Lake that will delay jet boring in ore and now expects first ore production in 1Q 2014 (previous mid-2013). Additionally, AREVA will need more time to modify the McLean Lake mill and will not be ready to process Cigar Lake ore until 2Q 2014. We effectively view the news as a six- to nine-month delay in Cigar Lake achieving first uranium deliveries. We await further clarity on whether the additional work needed around underground ore handling involves dealing with increased water risks, ground stability, or other adverse geologic conditions, which would further impact our production estimates.

Although secondary sources of nuclear fuel supply are finite and the HEU agreement governing the sale of decommissioned Russian warheads is due to expire in 2013, we believe other fuel sources, such as quantities delivered under the US-Russia Suspension Agreement (enrichment), tails re-enrichment, reprocessing, and US DOE stockpiles, are all likely sources that will greatly mitigate the impact of lower supplies under HEU and when combined with relatively light volumes of uncovered requirements, should results in commercial markets able to access required quantities over the next three to five years.

Nuclear regulations in Japan a positive step toward plant restarts

We see a generally supportive scenario for restarts in Japan over the next three years, and compared to the 50 reactors currently operable, we forecast a total of a total of six reactors in operation by end-2014, a total of 12 by end-2015, and a total of 20 by end-2016, which equates to 40% of current operable capacity.

We believe the largest hurdle to these forecasts remains general public opposition to nuclear and the final outcome of regulatory reforms under the new Nuclear Regulation Authority (NRA). The NRA is an independent organization established under the National Government Organization Act, Article 3, and its decisions are protected in principle from interference by the government.

03 October 2013


Exhibit 301: Nuclear output of Japan and China (TWh)

Source: Nuclear Power Authority, Credit Suisse - Japan Market Strategy (Shinichi Ichikawa; April 2013)

The NRA has stipulated requirements at nuclear reactors in Japan to include markedly higher and tighter enforcement of countermeasures against earthquakes and tsunamis, and design standards to prevent major accidents, as well as countermeasures to deal with major accidents. The timing of implementation is divided into measures that must be in operation when the plants are restarted and backup measures to increase reliability that must be in place within five years of restart. According to Credit Suisse’s Japan Marketing Strategy Team (Shinichi Ichikawa), the new regulations should allow electric power companies to restart their nuclear plants at a relatively early stage, such as the five-year grace period granted for establishing a second control room to deal with severe accidents. Once the new regulations are approved (expected mid-July) the application and approval process should begin at nuclear plants where conditions are already in order.

China at 60GWe by 2020 still a realistic goal

Nuclear power currently provides about 13.5% of the world's electricity, comprised of roughly 24% share of electricity in OECD countries and a much lower share in developing economies. According to WNA estimates, 218 nuclear reactors were started up during the 1980s (an average of one every 17 days), including 47 in the US, 42 in France and 18 in Japan, so there is a strong precedent for rapid building and commissioning phases for nuclear power. Our current ten-year forecast (2012-2021) incorporates a more modest 112 nuclear reactors, or one every 33 days.

China’s Nuclear Power Mid/Long Term Development Plan issued in 2007, China planned to have 40GWe of installed nuclear capacity by 2020. The number was subsequently talked up to 80GWe by 2020; however, the Fukushima nuclear event has created waves for the development strategy of nuclear power, in our view, particularly plans for inland nuclear plants where closer scrutiny based on seismic sensitivity has put approximately 20GWe of growth at risk of delay. Our estimate calls for 60Gwe of installed capacity by 2020. Domestically, China currently produces about 2-3mn lbs of uranium annually (vs. 15-20mn lbs currently required). The remaining requirements have been imported or purchased in the open market, and strategically stockpiled for future use.

03 October 2013


Exhibit 302: Uranium supply/demand model

all figures in Mln lbs U3O8, unless noted 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Uranium mine productionNorth America 29.8 29.4 27.3 25.9 25.5 26.4 28.0 35.8 41.6 47.8 52.7 53.4 South America 0.9 0.4 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 - Western Europe - - - - - - - - - - - - Eastern Europe 0.7 0.7 0.6 0.7 0.7 0.7 0.7 0.7 0.0 0.0 0.0 0.0 Kazakhstan 36.5 46.3 50.6 54.3 55.9 58.5 58.5 61.1 59.5 55.9 56.4 56.4 Russia & Other FSU 19.6 22.2 22.5 22.8 23.1 23.8 24.6 25.5 26.5 26.6 26.7 26.8 Africa 19.6 23.0 26.6 33.4 37.2 40.7 44.9 56.4 56.4 58.3 60.2 62.8 Asia & Oceana 27.7 25.9 21.0 20.3 22.6 21.5 21.5 21.0 20.4 19.8 23.1 23.3 Other (adjustments) - - - - - - - - - - - - Mine production 134.8 147.8 149.2 158.1 165.6 172.2 178.9 201.1 205.1 209.0 219.8 222.8

growth rate 16.3% 9.7% 0.9% 5.9% 4.8% 4.0% 3.9% 12.4% 2.0% 1.9% 5.2% 1.4%Secondary supply 45.5 48.2 47.1 50.3 54.2 27.0 29.5 29.5 32.0 32.0 32.0 32.0 Total supply 180.3 196.0 196.3 208.4 219.8 199.2 208.4 230.6 237.1 241.0 251.8 254.8

growth rate 7.6% 8.7% 0.2% 6.2% 5.5% -9.4% 4.6% 10.7% 2.8% 1.6% 4.5% 1.2%

Nuclear power plant (NPP) forecasts (units)China 11.0 11.0 15.0 15.0 18.0 26.0 35.0 40.0 44.0 48.0 52.0 56.0 India 17.0 17.0 20.0 20.0 18.0 18.0 19.0 21.0 22.0 22.0 23.0 24.0 Japan 53.0 53.0 - 2.0 6.0 12.0 18.0 18.0 18.0 18.0 18.0 18.0 Russia 31.0 31.0 32.0 33.0 32.0 34.0 35.0 37.0 40.0 42.0 43.0 45.0 U.S.A. 104.0 104.0 104.0 104.0 104.0 104.0 104.0 104.0 104.0 105.0 105.0 106.0 Other 225.0 225.0 262.0 262.0 270.0 269.0 264.0 264.0 265.0 265.0 265.0 266.0 Total 441.0 441.0 433.0 436.0 448.0 463.0 475.0 484.0 493.0 500.0 506.0 515.0

growth rate 0.0% 0.0% -1.8% 0.7% 2.8% 3.3% 2.6% 1.9% 1.9% 1.4% 1.2% 1.8%

Uranium demand analysisExisting NPP capacity 175.4 178.2 175.1 178.2 177.8 180.3 183.6 187.7 188.5 189.2 190.0 190.7 New NPP capacity - - - - 23.9 27.5 34.3 36.4 39.9 48.4 51.7 62.8 Strategic inventory build - - - - 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 Total demand 175.4 178.2 175.1 178.2 211.0 217.0 226.7 232.9 237.3 246.4 250.6 262.4

growth rate 0.6% 1.6% -1.8% 1.8% 18.4% 2.9% 4.5% 2.8% 1.8% 3.9% 1.7% 4.7%

Market surplus (deficit)Based on total supply 5 18 21 30 9 (18) (18) (2) (0) (5) 1 (8)

Surplus (deficit) as % of global demand 3% 10% 12% 17% 4% -8% -8% -1% 0% -2% 0% -3%

Excl Russia/supplier inventories 5 18 21 30 9 (23) (26) (10) (10) (15) (9) (18)

Surplus (deficit) as % of global demand 3% 10% 12% 17% 4% -11% -11% -4% -4% -6% -4% -7%

Excluding secondary sources (41) (30) (26) (20) (45) (45) (48) (32) (32) (37) (31) (40)

Surplus (deficit) as % of global demand -23% -17% -15% -11% -22% -21% -21% -14% -14% -15% -12% -15% Source: Company data, Credit Suisse estimates

03 October 2013


Financial Flows 3Q 2013 summary of commodity-linked flows Investments into commodity-linked indices and exchange-traded funds fell in the third quarter of 2013, with commodity-linked index assets under management (AUM) decreasing by 5.8% to average $192.9 billion (Exhibit 303). Additionally, we note that average total contracts held by indices fell by 1.1%.

Among exchange-traded products, physical commodity-linked exchange-traded product (ETP) AUM fell by about 15% to average $105.3 billion for 3Q 2013. Non-physical commodity ETP AUM decreased by 3% to $31.3 billion over the same period.

Together, total commodity investment AUM during 3Q averaged an estimated $329.5 billion, approximately 9% lower than total average AUM for 2Q 2013 ($361.4 billion). Most recent data indicate current total commodity AUM has retreated further to 323.6 billion, below most recent 3Q 2012 averages.

Exhibit 303: Commodity-linked index AUM fell in 3Q 2013 Estimated billions of US$, 2010 onwards

125

135

145

155

165

175

185

195

205

215

225

235

245

255

265

(10)

(5)

0

5

10

24-Sep-1321-May-1315-Jan-1311-Sep-128-May-123-Jan-1230-Aug-11

Flows (left axis) Index-linked AUM (right axis)2013 Q3:

AUM: ‐5.8%Contracts: ‐1.1%

Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse

Exhibit 304: Physical ETF AUM in 2Q 2013 Exhibit 305: Non-physical ETF AUM in 2Q 2013 Estimated billions of US$, 2012 onwards, 99.98% in precious metals Estimated billions of US$, 2012 onwards, tracks indexes and futures

90

100

110

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190

(4.00)

(3.00)

(2.00)

(1.00)

0.00

1.00

2.00

3.00

6-Jan-12 22-Jun-12 7-Dec-12 24-May-13

Flow (lhs) Physical ETP AUM (rhs)

2013 Q3:AUM: ‐15%

29

31

33

35

37

39

(0.60)

(0.40)

(0.20)

0.00

0.20

0.40

0.60

0.80

1.00

1.20

6-Jan-12 22-Jun-12 7-Dec-12 24-May-13

Flow (lhs) Non-physical ETP AUM (rhs)

2013 Q3:AUM: ‐3%


RESEARCH ANALYSTS

Commodities Research Stefan Revielle



03 October 2013


Index investments

While the average value of commodity-linked index investments fell by 9% in 3Q 2013, indices ended 8.1% lower. The sum of all index flows so far in 2013 continues to be near zero (Exhibit 306), while total contracts held has fallen by 7.3% qoq.

We further note that all commodity baskets displayed outflows over the quarter while only base and precious metals displaying yoy AUM growth. Exhibits 307 and 308 summarize key changes in commodity AUM and contracts. In 3Q 2013 we note:

Energy commodities saw net outflows, with AUM falling by 4.7% and contracts held decreased by 8.3% qoq.

Base metals saw net outflows with AUM falling 8.0% and contracts decreasing 10.8% qoq.

Precious metals saw net outflows with total contracts held decreasing by 10.5% and AUM falling by 6.2%.

Agriculture saw net outflows as total contracts held decreasing by 4.8% while AUM fell by 15.3%.

Livestock saw net outflows, with total contracts held falling by 8.8% and AUM falling by 8.4% qoq.

Exhibit 307: Commodity index investments AUM Exhibit 308: Commodity index investment contractsUS$ billion (end of quarters) Thousands of contract (end of quarters)

Q3-2013 Q2-2013 Q1-2013 Q4-2012 Q3-2012 YoY QoQCrude Oil (WTI) 29.2 29.2 31.8 42.3 49.9 -41.5% -0.1%Crude Oil (Brent) 19.9 20.1 24.7 26.6 30.7 -35.0% -1.0%Heating Oil 8.3 8.8 9.4 8.9 10.0 -16.2% -5.2%Gasoil 4.4 4.4 6.5 10.2 12.8 -65.7% 0.2%Gasoline 7.8 8.7 10.0 8.4 9.4 -17.4% -10.8%Natural Gas 17.9 20.7 18.4 11.8 8.8 103.0% -13.2%

Energy 87.6 91.9 100.7 108.2 121.6 -28.0% -4.7%Copper (LME) 1.6 1.6 2.5 4.3 5.2 -69.6% 0.9%Copper (Comex) 9.5 10.1 8.7 5.5 4.0 138.8% -5.8%Zinc 3.7 4.1 3.4 3.3 2.7 35.9% -9.9%Aluminum 7.2 8.0 7.3 7.2 6.3 13.9% -10.2%Nickel 2.9 3.3 3.2 2.5 2.2 29.8% -11.8%Lead 0.2 0.2 0.3 0.6 0.7 -68.0% -3.1%

Base Metals 25.0 27.2 14.3 23.4 21.1 18.7% -8.0%Gold 14.0 15.1 15.7 11.6 10.5 33.8% -7.5%Silver 4.3 4.4 5.1 3.0 2.5 71.5% -1.5%

Precious Metals 18.3 19.5 20.8 14.6 13.0 41.1% -6.2%Wheat (Chicago) 6.1 6.9 6.9 9.4 9.5 -36.5% -12.8%Wheat (Kansas) 2.0 2.3 2.2 1.4 1.7 22.1% -10.9%Corn 8.5 12.1 13.7 12.2 12.1 -29.5% -29.7%Soybeans 9.0 9.7 9.5 10.0 9.7 -7.0% -7.6%Cotton 3.5 3.9 3.5 2.4 2.2 57.9% -10.5%Cocoa 0.1 0.1 0.2 0.3 0.4 -63.7% 17.3%Sugar 6.2 6.7 5.8 4.3 4.3 43.0% -7.2%Coffee 3.1 3.5 3.3 2.1 2.2 43.0% -12.5%Soybean Oil 3.4 4.2 3.6 2.4 1.8 87.4% -18.5%

Agriculture 41.8 49.4 48.7 44.5 43.8 -4.4% -15.3%Lean Hogs 3.7 4.5 3.9 3.5 3.0 24.8% -18.4%Live Cattle 6.3 6.4 5.9 6.7 6.2 0.9% -1.9%Feeder Cattle 0.3 0.3 0.4 0.6 0.7 -57.9% 6.5%

Livestock 10.3 11.2 10.1 10.8 9.9 3.7% -8.4%TOTAL 183.0 199.3 194.7 201.5 209.3 -12.6% -8.1%

Q3-2013 Q2-2013 Q1-2013 Q4-2012 Q3-2012 YoY QoQCrude Oil (WTI) 283.0 306.5 329.8 493.5 546.4 -48.2% -7.7%Crude Oil (Brent) 183.5 198.9 226.0 246.6 277.5 -33.9% -7.8%Heating Oil 67.1 73.3 77.3 72.7 76.3 -12.0% -8.5%Gasoil 38.3 38.3 50.4 88.0 110.7 -65.4% 0.2%Gasoline 69.6 75.8 76.6 76.3 75.5 -7.9% -8.2%Natural Gas 513.9 567.1 463.2 345.8 302.4 69.9% -9.4%

Energy 1155.5 1259.9 1223.3 1,322.9 1,388.7 -16.8% -8.3%Copper (LME) 8.9 9.3 13.1 21.4 25.2 -64.6% -4.0%Copper (Comex) 116.1 131.0 101.7 60.2 42.1 175.9% -11.4%Zinc 79.8 89.7 81.5 63.3 51.3 55.7% -11.0%Aluminum 163.9 183.7 169.8 135.7 121.7 34.7% -10.8%Nickel 35.0 39.1 35.7 23.8 20.1 74.1% -10.6%Lead 4.2 4.3 5.2 10.0 11.5 -63.7% -2.8%

Base Metals 407.9 457.1 407.0 314.4 271.8 50.1% -10.8%Gold 106.3 118.7 98.5 68.1 59.3 79.4% -10.4%Silver 39.9 44.7 35.7 18.3 14.8 169.8% -10.7%

Precious Metals 146.2 163.4 134.2 86.3 74.1 97.4% -10.5%Wheat (Chicago) 183.9 205.4 189.9 233.7 215.2 -14.5% -10.5%Wheat (Kansas) 58.0 65.2 56.3 31.7 36.8 57.8% -11.0%Corn 378.9 368.3 375.8 337.3 324.1 16.9% 2.9%Soybeans 136.9 127.5 131.6 136.4 119.9 14.2% 7.4%Cotton 82.7 90.7 79.2 63.8 61.7 34.0% -8.7%Cocoa 5.2 5.3 7.8 12.4 15.0 -65.3% -1.2%Sugar 317.8 349.3 292.1 201.1 195.0 63.0% -9.0%Coffee 69.6 77.9 64.1 39.1 33.0 110.7% -10.7%Soybean Oil 135.4 147.5 117.2 81.2 56.9 137.8% -8.2%

Agriculture 1368.4 1437.1 1314.0 1,136.7 1,057.5 29.4% -4.8%Lean Hogs 100.0 113.2 121.4 105.1 97.2 2.9% -11.7%Live Cattle 123.1 131.8 116.6 132.5 126.5 -2.7% -6.7%Feeder Cattle 3.9 3.9 5.8 8.5 10.2 -61.8% -0.3%

Livestock 226.9 248.9 243.8 246.0 233.9 -3.0% -8.8%TOTAL 3305.0 3566.4 3322.3 3,106.3 3,026.0 9.2% -7.3%

Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, CFTC, Credit Suisse

Exhibit 306: Cumulative index flows per year: 2010-2013 US$ billions

(40)

(30)

(20)

(10)

-

10

20

30

Jan Apr Jul Oct

2013 2012 2011 2010


03 October 2013


Exchange-traded products (ETP)

Through 3Q, we estimate total commodity ETP AUM increased by 6.7% qoq to $136.7 billion from $128.1 billion last quarter. The ratio AUM held in non-physical ETPs to physical ETPs saw a small 1% decrease qoq, but increased 10% yoy.

Examining cumulative ETP flows for 2013 YTD, we note that they remain significantly lower than the same period over the previous three years (Exhibit 310).

Increases in AUM were seen in broad based, energy, precious metals, agriculture and livestock while base metals displayed the only decrease. Exhibit 311 summarizes recent changes to ETP AUM.

Exhibit 309: Commodity ETP AUM and ratio – physical and non-physical

Exhibit 310: Cumulative ETP flows per year – 2010, 2011, 2012 and 2013

US$ billion (end of quarters) US$ billions

178.7 170.6155.4

97.8 104.9

36.435.7

34.8

30.331.7

0.20

0.22

0.24

0.26

0.28

0.30

0.32

0.34

0.0

50.0

100.0

150.0

200.0

250.0

300.0

Q3-2012 Q4-2012 Q1-2013 Q2-2013 Q3- 2013

Non-physical

Physical

Ratio Commodity ETP AUM and ratio physical and non-physical

-40

-30

-20

-10

0

10

20

30


2013 2012 2011 2010


Exhibit 311: Commodity ETP AUM Summary US$ billion (end of quarters)

Total Physical Index FuturesNon-

physicalBroad Energy

Precious Metals

Base Metals

Agriculture Livestock

Q3-2012 215.1 178.7 32.9 3.5 36.4 17.9 8.1 181.7 2.3 4.8 0.3

Q4-2012 206.3 170.6 32.1 3.6 35.7 17.5 8.4 173.5 2.5 4.2 0.3

Q1-2013 190.1 155.4 31.6 3.2 34.8 17.7 7.5 157.9 2.6 4.2 0.3

Q2-2013 128.1 97.8 27.4 2.9 30.3 15.5 6.8 1.9 2.2 3.8 0.2

Q3- 2013 136.7 104.9 28.9 2.9 31.7 16.6 7.1 2.0 2.0 3.9 0.2

YoY change -36.5% -41.3% -12.3% -16.7% -12.8% -7.3% -12.3% -98.9% -12.5% -19.1% -28.4%

QoQ change 6.7% 7.3% 5.2% -0.3% 4.7% 7.0% 4.9% 7.6% -9.4% 1.7% 6.1% Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse

03 October 2013


Technical Analysis Precious metals stay bearish Gold’s recovery from June through August this year was capped off at the initial retracement of the 2012/13 fall (38.2%) at $1415 and well ahead of the 200-day average now at $1460. The rebound has not damaged the ongoing down trend and the reversal lower from here begins to see the bear trend resume. Immediate support is placed at $1277/70 and while we allow for an initial bounce here, look for an eventual break below it to trigger a move down to the year’s low at $1180. We would expect a bounce here, but beneath it would look to our longstanding core target at $1157/54 – the 61.8% retracement of the 2008/11 rally and the July 2010 low. Capitulation through here is needed to aim at topping targets at $1122, which if moved would look to extended levels at half the 1999/2011 bull run at $1087. Above $1434 is needed for the recovery to resume for $1460/88.

Silver has also similarly been capped beneath topping resistance at $24.80/$26.11 and stays bearish for a test of $18.23/19. Below here would aim at our core target at $17.30/030 – the 78.6% retracement of the 2008/11 rally. We would look for a basing effort here, but if removed would look to trendline support at $15.29, then $14.75/70. Above $24.80/$26.11 is needed for a base for $26.65/79.

In PGMs Platinum has been notably weaker then Palladium. The capitulation beneath $1425 has confirmed a bearish “head & shoulders” continuation pattern and targets $1350/30 next with more solid levels seen at $1300/1295. We would look for a basing effort here and an attempt to turn higher again. Above $1555 is required to look back to the top of the range. Palladium has been more resilient, which is clear from the Palladium/Platinum ratio, which has moved back up to 0.5271 July high. We would look for a move through here to see further outperformance to 0.6145/.6357. Outright Palladium near term stays biased lower in the broader converging range to the $632/30, where we look for renewed basing effort. Below finds solid range support at $588/85.

Exhibit 312: Gold – Weekly

Source: Updata, Credit Suisse

Commodities Research

David Sneddon [email protected]

+44 20 7888 7173

Christopher Hine [email protected]

+1 212 538 5727



03 October 2013


Base Metals remain range bound Copper has since holding key support at $6505 – half the 2008/11 rally – settled into a broad sideways range. Topside a break above the May 2013 high at $7534 is needed for a base for $7645 to then target the 38.2% retracement of the entire 2011/13 fall. Extension through here is required for a push up to $8346/8422. Key support stays at $6505 and its removal is needed to set a bigger top for $6038, then $5635.

Elsewhere in the group Aluminium is also currently range bound, but while capped beneath $1919/49 medium-term downside pressures remain in place. Above $1949/81 is needed for a better base for $2032. Removal of $1758/38 would get the downtrend back on track for $1605.

Nickel remains the laggard of the group and moribund at the year’s lows at $13205. Should this level be removed this would see further downside to $12978, then $10750. Above $14405 is needed to look to $150001 and only through here would set a base for $15600.

Lead and Zinc continue to lead the group relatively. The former is locked in a broader converging range. Above $2257/59 would target the range highs at $2361. Extension through here is needed to resolve the range higher for $2483/99, above which would aim at $2779. Removal of $1182 is needed for a deeper sell-off to $1742. Zinc is holding well above the range lows at $1812/$1794 and we look for a reversal up through the $1935 to test $2009. Extension through here would set a bigger base and a more durable recovery to $2203.

Exhibit 313: Copper – Weekly

Source: Updata, Credit Suisse

03 October 2013


Energy stays within broad multi-year ranges Brent Crude Oil’s rally in August was capped off ahead of the February 2013 peak at $119.17 and the snap lower from here leaves prices under pressure in the broader range. Support shows first at $105.85/73 and beneath here is required for a deeper setback to trendline support at $101.50, where we would look for a rebound. Only below $99.67 would see a deeper setback to the April low at $96.75. Above $113.05 is needed to retest the $117.34 peak. We would expect selling here and only through it would allow a push to the top of the range at $119.17, which we would look to provide a ceiling.

WTI Crude Oil’s rally was capped at the top end of the broader two-year range marked by the 2011 peak at $114.83. The break beneath $102.22 sees the broader range maintained and the focus on support next at $98.93/97.81 – 38.2% retracement support and the 200-day average. We would expect better support here. Beneath $97.81 is needed for a deeper setback in the range for $92.67 with trendline support from the June 2012 low at $90.85. Only below $85.61 signals a deeper sell-off. Above $109.00 is needed to retest the $112.24 peak. The major barrier remains at $114.83 and only above here would turn the range higher for $122.69.

In products Gasoline is into its seasonally weak period and is now reverting to the low end of the multi-year range at the 38.2% retracement of the 2008/11 rally at 255.24/244.40. We look for a base to be found here and to see a turn higher. Only a decisive break and hold beneath 244.40 would signal a bigger top for 234.14, then 213.25. Above 290.00 is required for a base for 310.95. Only above 316.32 sees a better recovery to 326.72.

Heating Oil is entering its traditionally a firmer seasonal period. Near term, though, it is under pressure to trendline support at 285.50, where we would look for buying interest to resurface. Only below 276.40/272.55 would see a deeper sell-off to 251.00/248.31. Above 306.35 is needed for a revisit to the 2013 peak at 322.54 where we would expect selling. Above here is needed to aim at 326.68, with the major test at the 2011/12 highs at 331.76/33.00.

Exhibit 314: Brent Crude Oil – Weekly Exhibit 315: WTI Crude Oil – Weekly

Source: CQG, Credit Suisse Source: Credit Suisse, CQG

03 October 2013


Contributors Commodities Research Ric Deverell +44 20 7883 2523 [email protected] Global Commodities London Marcus Garvey +44 20 7883 4787 [email protected] Global Commodities London Tom Kendall +44 20 7883 2432 [email protected] Global Commodities London Stefan Revielle +1 212 538 6802 [email protected] Global Commodities New York Bhaveer Shah +44 20 7883 1449 [email protected] Global Commodities London Andrew Shaw +65 6212 4244 [email protected] Global Commodities Singapore Jan Stuart +1 212 325 1013 [email protected] Global Commodities New York Johannes Van Der Tuin +1 212 325 4556 [email protected] Global Commodities New York Equity Research – Metals and Mining Paul McTaggart +61 2 8205 4698 [email protected] Metals and Mining Sydney Matt Hope +61 2 8205 4669 [email protected] Metals and Mining Sydney Martin Kronborg +61 2 8205 4369 [email protected] Metals and Mining Sydney Michael Slifirski +61 3 9280 1845 [email protected] Metals and Mining Melbourne Sam Webb +61 3 9280 1716 [email protected] Metals and Mining Melbourne Trina Chen +852 2101 7031 [email protected] Metals and Mining Hong Kong Frankie Zhu +852 2101 7426 [email protected] Metals and Mining Hong Kong Owen Liang +852 2101 6093 [email protected] Metals and Mining Hong Kong Shinya Yamada +81 3 4550 9910 [email protected] Metals and Mining Tokyo Jun Yamaguchi +81 3 4550 9789 [email protected] Metals and Mining Tokyo Paworamon (Poom) Suvarnatemee +66 2 614 6210 [email protected] Metals and Mining Bangkok Minseok Sinn +82 2 3707 8898 [email protected] Metals and Mining Seoul Hayoung Chung +82 2 3707 3795 [email protected] Metals and Mining Seoul Neelkanth Mishra +91 22 6777 3716 [email protected] Metals and Mining Mumbai Anubhav Aggarwal +91 22 6777 3808 [email protected] Metals and Mining Mumbai Ishan Mahajan +91 22 6777 3894 [email protected] Metals and Mining Mumbai Neelkanth Mishra +91 22 6777 3716 [email protected] Metals and Mining Mumbai Michael Shillaker +44 20 7888 1344 [email protected] Metals and Mining London Liam Fitzpatrick +44 20 7883 8350 [email protected] Metals and Mining London James Gurry +44 20 7883 7083 [email protected] Metals and Mining London Conor Rowley +44 20 7883 9156 [email protected] Metals and Mining London James Hanford +44 20 7883 1551 [email protected] Metals and Mining London Semyon Mironov +7 495 662 8510 [email protected] Metals and Mining Moscow Mikhail Priklonsky +7 495 662 8511 [email protected] Metals and Mining Moscow Ralph Profiti +1 416 352 4563 [email protected] Metals and Mining Toronto Anita Soni +1 416 352 4587 [email protected] Metals and Mining Toronto Robert Reynolds +1 416 352 4516 [email protected] Metals and Mining Toronto Yan Truong +1 416 352 4584 [email protected] Metals and Mining Toronto Nathan Littlewood +1 416 352 4563 [email protected] Metals and Mining New York Hubert Dagbo +1 212 325 4739 [email protected] Metals and Mining New York Ivano Westin +55 11 3701 6318 [email protected] Metals and Mining Sao Paulo Viccenzo Paternostro +55 11 3701 6043 [email protected] Metals and Mining Sao Paulo Marina Melemendjian +55 11 3701 6341 [email protected] Metals and Mining Sao Paulo Vanessa Quiroga +52 55 5283 8939 [email protected] Metals and Mining Mexico City Santiago Perez Teuffer +52 55 5283 8901 [email protected] Metals and Mining Mexico City Equity Research – Agriculture Christopher Parkinson +1 212 538 6286 [email protected] Agriculture New York Thomas Ackerman +1 212 325 4793 [email protected] Agriculture New York Lars Kjellberg +44 20 7888 4811 [email protected] Agriculture London Robert Moskow +1 212 538 3095 [email protected] Agriculture New York Equity Research – Energy Edward Westlake +1 212 325 6751 [email protected] Global Energy New York David Hewitt +65 6212 3064 [email protected] Global Energy Singapore Rakesh Advani +1 212 538 5084 [email protected] Global Energy New York Scott Willis +1 212 325 2664 [email protected] Global Energy New York Arun Jayaram +1 212 538 8428 [email protected] Global Energy New York Helen Xu +1 212 325 4750 [email protected] Global Energy New York Mark Lear +1 212 538 0239 [email protected] Global Energy New York




































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03 October 2013


David Lee +1 212 325 6693 [email protected] Global Energy New York Sanya Thapa +1 212 325 4763 [email protected] Global Energy New York James Wicklund +1 214 979 4111 [email protected] Global Energy Dallas Jonathan Sisto +1 212-325-1292 [email protected] Global Energy New York Brittany Commins +1 212 325 7128 [email protected] Global Energy New York Pooja Shakya +1 212 535 2827 [email protected] Global Energy New York Dan Eggers +1 212 538 8430 [email protected] Global Energy New York Kevin Cole +1 212 538 8422 [email protected] Global Energy New York Matt Davis +1 212 325 2573 [email protected] Global Energy New York Thomas Murray +1 212 325 6924 [email protected] Global Energy New York Patrick Jobin +1 212 325 0843 [email protected] Global Energy New York Brandon Heiken +1 415 249 7930 [email protected] Global Energy San Francisco Maheep Mandloi +1 212 325 2345 [email protected] Global Energy New York Greg Lewis +1 212 325 6418 [email protected] Global Energy New York Anthony Sibilia +1 212 325 9507 [email protected] Global Energy New York John Edwards +1 713 890 1594 [email protected] Global Energy Houston Abhiram Rajendran +1 212 538 9038 [email protected] Global Energy New York Bhavesh Lodaya +1 212 325 2337 [email protected] Global Energy New York Paul Jacob +1 713 890 1596 [email protected] Global Energy Houston Andrew Kuske +1 416 352 4561 [email protected] Global Energy Toronto Paul Tan +1 416 352 4593 [email protected] Global Energy Toronto Jason Frew +1 403 476 6022 [email protected] Global Energy Calgary Terence Chung +1 403 476 6024 [email protected] Global Energy Calgary David Phung +1 403 476 6023 [email protected] Global Energy Calgary Robert Loebach +1 403 476 6021 [email protected] Global Energy Calgary Onur Muminoglu +90 212 349 0454 [email protected] Global Energy Istanbul Thomas Adolff +44 20 7888 9114 [email protected] Global Energy London David Thomas +44 20 7888 0277 [email protected] Global Energy London Charlotte Elliott +44 20 7888 9484 [email protected] Global Energy London Rob Mundy +44 20 7888 6091 [email protected] Global Energy London Ilkin Karimli +44 20 7883 0303 [email protected] Global Energy London Andrey Aleev +44 20 7888 9368 [email protected] Global Energy London Vincent Gilles +44 20 7888 1926 [email protected] Global Energy London Mark Freshney +44 20 7888 0887 [email protected] Global Energy London Stefano Bezzato +44 20 7883 8062 [email protected] Global Energy London Michel Debs +44 20 7883 9952 [email protected] Global Energy London Zoltan Fekete +44 20 7888 0285 [email protected] Global Energy London Guy MacKenzie +44 20 7883 9534 [email protected] Global Energy London Emerson Leite +55 11 3841 6290 [email protected] Global Energy Sao Paolo Andre Sobreira +55 11 3841 6299 [email protected] Global Energy Sao Paolo Vinicius Canheu +55 11 3841 6310 [email protected] Global Energy Sao Paolo Viccenzo Paternostro +55 11 3841 6043 [email protected] Global Energy Sao Paolo Paul McTaggart +61 2 8205 4698 [email protected] Global Energy Sydney James Redfern +61 2 8205 4779 [email protected] Global Energy Sydney Mark Samter +61 2 82054537 [email protected] Global Energy Sydney Thomas Wong +852 2101 6738 [email protected] Global Energy Hong Kong Horace Tse +852 2101 7379 [email protected] Global Energy Hong Kong Kelly Chen +852 2101 7079 [email protected] Global Energy Hong Kong Kenneth Whee +852 2101 7319 [email protected] Global Energy Hong Kong Edwin Pang +852 2101 6406 [email protected] Global Energy Hong Kong Yang Song +852 2101 6550 Yang.song@credit-suisse,com Global Energy Hong Kong Sanjay Mookim +65 6212 3017 [email protected] Global Energy Singapore Gerald Wong +65 6212 3037 [email protected] Global Energy Singapore Poom Suvarnatemee + 66 2 614 6210 [email protected] Global Energy Bangkok Wattana Punyawattanakul +66 2 614 6215 [email protected] Global Energy Bangkok Annuar Aziz +603 2723 2085 [email protected] Global Energy Kuala Lumpur Ji Hong Choi +82 2 3707 3796 [email protected] Global Energy Seoul Jeremy Chen +8862 2715 6368 [email protected] Global Energy Taiwan Badrinath Srinivasan +91 22 6777 3698 [email protected] Global Energy India


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Commodities Forecasts: The Long and Winding Road