A
factor that we underestimated was the hedge funds'
aggressiveness in pushing prices ahead of the fundamentals:
leading to higher prices coming earlier; a quicker
scrap response; and more rapid destocking than we
anticipated.
The combination of the hedge funds' aggressiveness
and a relatively illiquid LME market resulted in
substantial price volatility. The market does work:
a shortage of supply leads to higher prices, which
generates the necessary demand substitution, which
returns the market to balance. Unfortunately, the
pricing mechanism is a very blunt way of allocating
the final few thousand tonnes of supply in a million-plus
tonne market. As long as prices remain high, while
LME stocks and liquidity remain low, price volatility
will be an unfortunate part of the nickel market.
The impact of high and volatile nickel prices has
created misunderstandings about underlying market
conditions in 2004 and the outlook for next year.
One of my goals in today's presentation is to provide
more insight into the issues we believe that truly
drove the market this year and those that will drive
it during 2005.
Based
on the comments I read after our third quarter conference
call, it appears that I contributed to some misconceptions
of Inco's view of the market. Everyone heard the
same words, but came up with vastly different interpretations
of my view. Some thought I was bullish, some neutral,
and others downright bearish.
Let
me be even clearer. Since 2002, I have been saying:
"The current nickel cycle will require prices
to rise to force demand in line with available supply."
Our market perspective has never wavered. Moreover,
2005 will be yet another year when we believe underlying
demand will exceed supply. This will require prices
to rise further from this year's levels to bring
demand in line with supply. I don't know how I can
be more emphatic about our view of the underlying
strength of the nickel market.
There
is a misconception by some observers that demand
has not been strong this year. While realized demand
growth was limited, underlying demand
growth remained very strong. Nickel demand is driven
by increases in industrial production. Since 1960,
demand has risen in lock-step with growth in industrial
production. Projected G7 plus Asia industrial production
growth of 6.9% in 2004 generated underlying demand
growth of about 7%, but there was only enough primary
nickel available to meet 2% of this demand. The
remaining 5% - or 50,000-to-60,000 tonnes - was
'unmet demand'.
In
fact, non-stainless demand has been surprisingly
strong this year as high nickel alloys recovered
more quickly than we expected and several other
segments and areas of the world did not experience
as much substitution as we thought would occur.
The market has had to move nickel between segments,
and countries, and there are timing issues on these
adjustments.
I
want to reiterate that Inco has been committed for
more than a century to the long-term growth and
development of nickel and nickel-containing stainless.
We are spending more than $2.5 billion over the
next four years to ensure that we provide as much
nickel as possible to the market.
At
this point in the presentation, I would like to
talk about some of the underlying issues in the
market.
With
Christmas less than two weeks away, I thought I
would go through Santa's nickel market list of who
has been 'naughty' or 'nice', based on their contributions
to the long-term health of the nickel market.
First
on the list of 'presents' is global industrial production.
Our measure of G7 plus Asia industrial production
projected growth for 2004 of 6.9% is the highest
annual increase in a decade and among the best in
the last 30 years. This synchronized recovery has
provided a strong base for global nickel demand
growth. Please remember that there is an almost
perfect correlation between G7 plus Asia industrial
production growth and nickel demand.
Next
on Santa's 'present' list is the U.S. market, where
the exceptional recovery has led to double-digit
demand growth this year. The recovery has been strong
across all sectors - stainless, alloy steel, high
nickel alloys, and plating - and this momentum is
set to continue in 2005.
Based
on this year's nickel market, Santa's final 'present'
goes to stainless steel scrap, which thankfully
appears to be growing close to our forecast of 12%.
This increase in scrap accounted for more than half
of the effective increase in nickel units available
to consumers, allowing stainless mills to continue
producing austenitic stainless and to utilize a
higher percentage of their newly expanded capacity.
Scrap supply growth was so strong in late 2003/early
2004 that most stainless mills were able to build
all of the inventory they wanted by mid-year.
Now,
unfortunately, it's time for the naughty list -
those who get lumps of coal in their stockings this
year. And top of the list is China. It gets two
lumps: one for its poor nickel demand growth - which
will only be about 5% this year, the slowest of
all of the base metals - and one for its poor stainless
demand growth in 2004. Both nickel and stainless
growth in 2004 were much lower than industrial production
growth of 16% and historic trend growth rates. Baosteel
experienced difficulties this year in ramping up
its capacity, removing close to 10,000 tonnes of
nickel demand from the market in the fourth quarter.
This would pretty much have eliminated the late
build-up we have seen in LME stocks.
If
we factor in destocklng in China of only 10,000
tonnes of nickel and 300,000 tonnes of stainless
steel this year, underlying consumption is much
closer to trend growth rates of 20%. The good news
for the market, and the reason to be optimistic
about next year, is that the two reasons for 2004's
low demand growth rate - a slower than expected
ramp-up of stainless steel capacity, and destocking
- will be positive for 2005 growth. This has significant
implications for Chinese demand growth in the coming
year - but more on that later
The
next big lump of coal goes to nickel producers.
The overall supply response to higher prices has
been lower than trend demand growth, as we expected.
We were one of the few producers to increase production
this year. The high grading and use of excess capacity
that some commentators speculated would be brought
to market has NOT occurred. The market needs more
nickel and it is our obligation as a nickel producer
to do everything we can to make this happen. But
forgive us, this is not easy to do and it takes
considerable time.
Before
I give my predictions for the naughty and nice Christmas
list for 2005, I would like to address one more
misconception: that we are experiencing the highest
nickel prices in history. It is true that average
prices year to date of $6.27 per pound are the highest
on record. However, because the current period of
market tightness has been well signaled, the level
of prices and volatility are much less severe than
in 1988 and 1989. In Euros, nickel prices are actually
below the last peak in 2000. And in real dollars,
nickel is nowhere near its 1988-to-1989 peaks. In
2004 dollar terms, nickel prices in 1988 and 1989
averaged over $21,000 per tonne or $9.50 per pound,
which had a far greater impact on consumers and
the industry.
Now
let's discuss our views on 2005.
We
expect that it will be another year in which underlying
demand exceeds supply. Even with a slowdown in G7
plus Asia industrial production growth to a range
of 5-to-6%, underlying demand growth will be several
percentage points greater than supply growth. As
a result, nickel prices in 2005 will have to rise
even further to keep demand in line with available
supply. Keep in mind that actual deficits will be
small next year, as the only remaining available
stocks are on the LME and they will not go to zero.
The unmet demand that is generated, above and beyond
2004's level, will create a significant buffer,
able to absorb even the largest upside supply surprise
or downside demand surprise without impacting the
fundamentals.
The
biggest presents on the 2005 Christmas list will
likely be for China. The Chinese will receive three
big ones, in fact - one for stainless demand, one
for stainless production, and one for nickel demand.
We are expecting a sharp rebound in stainless demand
for 300 series in the first quarter of 2005, due
to a few factors: the end of several months of destocking;
a shortage of hot rolled coil in the Asian market,
resulting from a slower than anticipated Baosteel
ramp-up; and a slowdown in 200 series demand, as
misrepresented sales and inappropriate use of 200
series in place of 300 series is drawing attention
from the market, and even the government. The impact
of this shift away from 200 series will be felt
in other countries, as several of the largest Asian
producers will actually cut production of 200 series
and increase 300 series production in the first
quarter of 2005.
We
believe that Chinese stainless production will ramp
up sharply and increase by a minimum of 800,000
tonnes, as the first phase of the Baosleel expansion
reaches design capacity and its second phase begins
commissioning later in 2005.
Nickel
demand will also rebound sharply, due to increased
stainless production; continuing growth in non-stainless
demand for plating, alloys, and batteries: and very
low inventory levels. However, this rise in nickel
demand may not translate into substantial growth
in unwrought nickel imports, as Jinchuan production
will increase by 15,000-to-20,000 tonnes and much
of the increase in imports may be in the form of
intermediate products plus ferronickel and other
stainless steel feed materials.
The
impact of all of this demand growth is that China
may account for at least 40,000 tonnes of the approximately
50,000 tonnes of additional supply available for
demand growth next year. This is not fully understood
by the market, so let me say it another way: there
will likely be less than 10,000 tonnes of primary
nickel available to satisfy additional demand growth
outside of China.
The
next big present on the list for 2005 will go to
the high nickel alloys sector - not only in the
U.S., but increasingly in Europe and Japan. We expect
demand growth of about 10,000 tonnes next year,
which is essentially equal to the remaining available
supply for 2005.
The
recovery in aerospace is gaining momentum. Global
passenger traffic is above pre-9/11 levels for the
first time ever. Business jet orders are up 10%
and fractional jet ownership programs are generating
additional delivery backlogs. Several aerospace
industry participants have expressed their optimism
about strong growth in the years ahead, and we are
well positioned to participate in the industry's
recovery. Boeing and Airbus build schedules for
the next five years have increased since the start
of 2004; by 2008 they will be 38% higher than this
year's level. Please keep in mind that the nickel-based
alloys required to meet these aggressive build schedules
are needed now, creating real demand for nickel.
The
energy market is also recovering as LNG continues
to grow and China invests heavily in energy generation.
GE indicated in a recent presentation that demand
from China is expected to represent one-third of
global power generation orders over the next three
years
I
can see two lumps of coal on my naughty list for
next Christmas. The first lump will be for scrap.
Scrap availability is not infinite, and supply is
quite responsive to price. Unless prices rise sharply,
there will not be a surprise increase in scrap supply
in 2005. There is evidence to suggest that scrap
availability may even decline. In 1989,
obsolete scrap generation in the U.S. market actually
fell, despite a second year of high nickel prices.
Scrap
availability appears to be slowing. The U.S., Russia,
and Ukraine account for the bulk of net stainless
scrap exports, which began accelerating early in
2003 when nickel prices reached $4 per pound. Year-over-year
growth rates peaked during the latter part of 2003
and in early 2004. Since then, year-over-year growth
has slowed substantially, even though nickel prices
throughout 2004 remained well above their long-term
average.
We
have seen sharp spikes in scrap availability four
times in the last 15 years: in 1992, 1995, 1997
and 2000. Each was followed by an absolute decline
in the subsequent year. If we see any increase
in scrap in 2005, it will be an exception to this
pattern and the first time scrap has grown for four
consecutive years. Lower scrap availability means
stainless mills need more primary nickel.
The
second lump is for nickel producers, including Inco,
who again will have little ability to squeeze out
additional production beyond the long-planned expansions
at Eramet, Jinchuan, and Falconbridge. Most producers
will be operating at effective capacity, creating
the potential for downside surprises. Unfortunately,
production increases at Inca in 2005 will be challenging.
We are facing a furnace maintenance shutdown in
Sudbury. We must cope with low water levels in Indonesia,
where rainfall has been below normal.
As
I said earlier, Inco's view of the nickel market
has remained fundamentally unchanged over the last
three years. The story has unfolded largely as we
expected and shapes our thoughts on the future:
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