Energy market turbulence, geopolitics and stocks to watch this reporting season

While significant uncertainty hangs over the outlook for coal market due to energy market turbulence and slowing economic growth, the global consumption is set to rise in 2022, taking it to the record level it reached nearly a decade ago, according to the International Energy Agency (IEA).

The IEA’s July 2022 Coal Market Update report highlights the significant turmoil in coal markets in recent months, “which has important implications for many countries where coal remains a key fuel for electricity generation and a range of industrial processes. At the same time, the world’s continued burning of large amounts of coal is heightening climate concerns, as coal is the largest single source of energy-related CO2 emissions.”

 “As soaring natural gas prices have made coal more competitive in many markets, international coal prices have risen in turn, hitting three all-time peaks between October 2021 and May 2022. Sanctions and bans on Russian coal following Russia’s invasion of Ukraine have disrupted markets, and issues in other major exporters have contributed to supply shortages. With other coal producers facing constraints in replacing Russian output, prices on coal futures markets indicate that tight market conditions are expected to continue well into next year and beyond,” according to the IEA.

Closer to home, BHP recently announced record dividend payment of US $1.75 per share, after a surge in coal prices driven by geopolitical conflict.

In this article, Perennial’s Director Portfolio Management, Stephen Bruce shares his thoughts on market outlook and stocks to watch this reporting season.

Commodities outlook

BHP delivered record earnings and free cash flow driven by underlying commodity price strength particularly in metallurgical and thermal coal. As a result, the balance sheet is in excellent shape and was able to support a record dividend payout while also leaving them well positioned to pursue growth whether that be via M&A or brownfield expansion of their existing assets.

Clearly inflation had and will continue to have an impact but it was pleasing to see BHP exercise discipline around costs and we expect them to solidify their position as a best in class operator in the face of a challenging environment. Looking forward we believe that BHP’s focus on high quality metallurgical coal will prove to be a prudent decision as countries like India rapidly industrialise, consuming more steel and increasing demand for coal.   

Stocks to watch

Woodside – Their upcoming result will be closely watched by the market, being the first post the merger with BHP’s Petroleum division. This has transformed them into a top ten global oil & gas producer and as the beneficiary of high prices they should deliver a strong result. On top of this, although oil has cooled, 20-25% of their LNG production (pre BHP Petroleum merger) is exposed to spot LNG prices which have remained elevated due to a tight market and increased demand from European and Asian buyers.

S32 – Due to the diversity of its portfolio, S32 is an excellent proxy for the resources sector and in particular base metals. Earnings are expected to be bolstered by the strength of aluminium and metallurgical coal and we would expect them to continue their impressive track record of returning capital to shareholders. As a result of their broad geographical and industrial footprint the market will be keeping a close eye on production and cost guidance for 2023 and 2024 and how they are seeing demand.  

Where’s the upside?

Undoubtedly the resources sector is currently under pressure as concerns of a global recession weigh on demand and prices. However, we believe this negative sentiment should be short lived if central banks are able to get inflation under control within the next year or so and ultimately physical markets remain tight for many commodities due to chronic underinvestment.

With China expected to start stimulating their economy towards the end of the year and the ongoing global push for decarbonisation, it is not hard to see resources entering a decade long bull market. In the near term we see the most upside in aluminium and LNG due to supply tightness and over the medium to long term copper remains the preferred pick due to its ubiquity across industrial sectors and importance to the green energy transition. 

Top two investment tips

• Focus on companies that have strong balance sheets and sustainable cash flows to weather the volatility. In uncertain times it is imperative that companies exercise capital discipline, around both costs and capital expenditure, to ensure their financial strength
• Although the iron ore price has declined the large cap Australian miners remain the lowest cost producers and therefore can maintain a healthy balance sheet while continuing to pay dividends.