Nickel markets and the year ahead

For nickel markets, there is one key fact you should consider for this year: China needs at least 45,000 of the 60,000 tonnes of additional primary nickel available to the world in 2005. Put another way, primary nickel demand growth in the rest of the world would be limited to less than 1% before all available nickel is consumed.

The reality in 2004 was that the price was high to make the deficit small, not that the price was high despite a small deficit. The temporary periods when the market felt well-supplied would not have happened in an environment of lower nickel prices.

Nickel prices had to rise to force demand in line with available supply. It took the highest annual nickel price ever — US$13,852 per tonne, or US$6.28 per lb. — to slow demand growth to a level that could be met. World stainless steel production rose 6.6%, owing to double-digit growth in stainless scrap availability and to greater production of ferritic and low-nickel-containing stainless grades.

In non-stainless markets, high-nickel alloys recovered sooner and stronger than expected, offsetting some substitution in decorative plating. Geographically, China took a short and temporary reprieve from the spotlight in 2004, while the U.S. and several European countries accounted for most of world demand growth.

At Inco, our outlook for this year is based on three factors: first, China’s resurgence; second, strong nickel alloy demand; and third, limited nickel supplies. Demand will exceed supply, and the balancing mechanism — the nickel price on the London Metal Exchange (LME) — will adjust to the situation.

In 2004, Chinese nickel consumption rose by more than 20%, as it had in the past five years. This occurred despite government moves to cool the economy, despite a slower-than-expected ramp-up at Baosteel despite substitution in plating, and despite higher local 200 series stainless steel production.

This consumption growth of more than 20% was not recognized, as nickel stock movements created visible demand growth of just 6%. In 2005, there will be no hidden demand, inventories are low, and de-stocking cannot recur. We should remember that consumption growth has exceeded 20% in each of the past five years, even when industrial production growth rates were lower than they are now.

In fact, 2004 ended with four months of growth and fourth-quarter nickel demand was up 36%, year over year, signalling the end of de-stocking. More than 70% of the demand increase in the fourth quarter went directly into Baosteel’s furnaces, showing that stocks are not being rebuilt.

In 2005, Baosteel’s expansions are expected to continue to drive Chinese demand. With phase one running at full capacity and phase two ramping up later this year, Chinese stainless production is projected to increase at least 800,000 tonnes in 2005, and account for at least 35,000-40,000 tonnes of additional nickel consumption.

Demand growth for stainless steel in China remains strong, and domestic production will be required to expand for many years to come to meet demand.

Chinese non-stainless nickel demand is also rebounding sharply; growth in plating, alloys and batteries, combined with low inventory levels, means a tight market. Inco’s sales to China continue to show strong growth, and the fourth quarter was the company’s best ever. Many customers are asking for more nickel, and Inco is taking all possible steps to provide it.

The next reason to be excited about 2005 is the great recovery in the global market for high nickel alloys — not only in the U.S., but increasingly in Europe and Japan as well. Many of Inco’s customers report that business is up 10-15% and that their order books are full for months.

This recovery in aerospace is gaining momentum and should push demand for high nickel alloys to record levels. Global passenger traffic now exceeds pre-9/11 levels, and business jet orders are up 10%.

Aerospace companies see strong growth ahead, and we are well-positioned to participate in this. By 2008, Boeing and Airbus build-schedules will be 38% above the 2004 level. The alloys needed to meet these schedules are being melted this year, creating real demand for high-purity nickel that only a few producers, including Inco, can provide. The new Airbus A380 super-jumbo jet’s engine showcases a 60% nickel content alloy, which accounts for 40% of its total weight.

The energy market will also drive non-stainless growth. Chinese energy investments will be over and above global growth in liquid natural gas and land-based gas turbines.

Inco is seeing strong growth in hybrid-electric vehicles, cordless power tools, and other applications driving increased demand for nickel-based batteries. The company anticipates a great year for its nickel powders, foams and other specialty products. World stainless steel production is expected to rise more than 5%, largely driven by China, as well as by higher utilization of European facilities. We will see the austenitic ratio fall slightly, and a small increase in the scrap ratio; both are necessary for production growth to occur.

Demand for nickel is so strong that some substitution must occur. There was growth in 200 series stainless steel for certain uses in China in 2004. However, some of this was used where higher-grade steel was really needed, and the Chinese government is now reviewing controls on 200 series imports and applications. We’ve recently seen imports of 200 series drop sharply, and growth rates should slow in 2005, leading to more appropriate use and less substitution.

In 2005, nickel supply will not keep pace with demand growth. Primary production, secondary stainless scrap, and nickel inventories will all be limited by real physical constraints and be unable to provide the nickel required for underlying global demand.

Primary nickel production will rise in 2005, as almost all producers strive to operate at capacity and three brownfield expansions ramp up. We forecast record nickel output from nearly every major producer, on average at 107% of historical highs. There is clearly risk in such an aggressive forecast; the risk of production losses that cannot be made up later in the year, resulting in an even tighter market.

With the industry at capacity, growth reliant on expansions, and labour negotiations overhanging 10% of world supply, we expect any 2005 production surprises to be negative.

Meanwhile, stocks began 2005 at low levels and have since declined. LME warehouse stocks have already declined significantly, and withdrawals should continue in the short term. LME and reported producer stocks represent just over four weeks of demand — lower than in 1988-1989. Justifying the prices of the past 18 months and indicating their direction when inventories are drawn down further. Inventory releases will not help forecasts based on a large amount of off-market material — it simply doesn’t exist on that scale.

The third source of nickel supply to come up short in 2005 is scrap. Last year’s growth rates will not be repeated. Nickel-containing stainless steel scrap availability is finite, and supply is responsive to price. High nickel prices drove unsustainable growth in scrap collection and consumption last year. We conservatively forecast 5% growth in scrap, but availability may even decline.

Scrap availability has spiked sharply four times in the past 15 years. Each occurrence was followed by a decline the next year. If scrap rises at all in 2005, it will be the first time availability has grown in four consecutive years.

And availability is slowing. The U.S., Russia and Ukraine export most of the world’s scrap. Their exports began rising early in 2003 when nickel prices hit US$9,000 per tonne, or US$4 per lb., and reached peak growth rates late that year and in early 2004. Since then, growth has slowed significantly, though prices have stayed well above their long-term average.

Higher nickel production, combined with available LME stocks, is expected to result in only 55,000-60
,000 tonnes of primary nickel available for growth in 2005.

We see available supply capping world demand growth at 4.1%. Yes, this is above long-term demand growth rates, but let me restate the first point made here — that China needs 75% of the increased nickel availability. This leaves just 10,000-15,000 tonnes for growth in aerospace, energy, electronics, stainless, hybrid vehicles, and all other applications combined. This means that world nickel demand growth, excluding China, would be capped at just 0.6%.

Leading economic indicators suggest growth will be at a slower but still-healthy pace in 2005. Western World industrial-production growth forecasts of about 4% this year exceed the maximum allowable nickel-demand growth of less than 1%.

Bear in mind that Western World nickel demand and industrial production have a 94% correlation over the past 40-plus years. Even if there is slowing economic growth, so long as nickel-demand growth in the West is just 1%, China will do the rest, leading the market into deficit. And of course, the deficit’s size will be limited by supply.

Actual nickel deficits will be small this year. The only available stocks left are on the LME, and they won’t fall to zero. Strong underlying nickel demand — coupled with low inventories, tighter scrap conditions and limited production growth — will create a large buffer of unmet demand, which will be able to absorb even the largest upside supply surprise, or downside demand surprise, without affecting the fundamentals.

Several new projects will come on-stream before the decade’s end, but remember, a new Goro is needed every year just to match long-term demand growth. The capital cost increases and delays at some greenfield projects show that bringing on new supply is difficult and time-consuming. The market will not see much higher nickel production for several years. That said, deficits will not last forever; market forces will bring about a balance. Meanwhile, prices will be as high as necessary to force the necessary substitution. This will be hard on our customers. Inco will spend more than US$2.5 billion in the next four years to raise production and ensure the long-term health of markets for nickel and austenitic stainless steel.

I want to emphasize one more point. In 2005, we expect to see levels of tightness that are not yet fully understood by the nickel market. The underlying tightness of 2004 was softened by a large increase in scrap availability and by significant drawdowns of inventory, especially in China. We do not think this relief is possible again in 2005.

— The preceding is an edited version of a speech given to the investment community in Toronto in February. Peter Goudie is the executive vice-president of marketing for Inco, the world’s second-largest nickel producer.