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COLUMN-An ugly start to what may be a brutal year for nickel producers: Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters.)

LONDON, Jan 14 (Reuters) - If the first two weeks are anything to go by, this is going to be an ugly year for nickel producers.

Canada’s Sherritt International and Japan’s Sumitomo Corp have just announced massive write-downs against their Ambatovy nickel assets in Madagascar.

The total impairment will be $2.4 billion on a 100 percent basis, according to Sherritt, based on a long-term nickel price of $8.50 per lb, or around $18,400 per tonne.

It’s a hugely disappointing outcome for both companies and their shareholders given the $5.5 billion Ambatovy project is only now approaching nameplate capacity after a lengthy three-year ramp-up.

Moreover, that long-term price of $18,400 looks like a pipe-dream. Three-month nickel is currently trading on the London Metal Exchange (LME) at $8,400 per tonne after hitting a 12-year low of $8,100 this week.

These two facts are not unrelated.

Nickel has fallen harder and further than any other major base metal because the supply side has failed to respond to the demand shock rippling out of China.

The continued ramp-up of new projects such as Ambatovy is part of a broader problem of inelastic supply.

The global nickel market is still generating surplus units, adding to what are already mountainous stocks of the stuff.

Barring some sort of miraculous recovery in the stainless steel market, the key end-use sector for nickel, the outlook for producers is for a brutal battle for survival.

MORE NICKEL ANYONE?

Ambatovy produced 13,000 tonnes of refined nickel in the third quarter of last year, a new record for the operation and close to nameplate capacity of 60,000 tonnes per year.

It’s taken over three years to get there. The long ramp-up time is typical of the new generation of nickel projects using the operationally temperamental high-pressure-acid-leach (HPAL) technology.

Brazil’s Vale has been struggling to master its Goro HPAL project in New Caledonia for five years. It too posted an operational record in the third quarter of 2015 but at 7,300 tonnes of finished nickel products, it’s still some way from nameplate capacity of 58,000 tonnes per year.

The company remains committed to lifting production, unsurprisingly given the amount of money already sunk into the Goro.

Ramu in Papua New Guinea is another HPAL project, albeit one that produces an intermediate nickel product rather than refined metal. As with Ambatovy, it has been ramping up for over three years and is only now approaching its annual 31,150-tonne capacity run rate.

Glencore’s Koniambo project in New Caledonia doesn’t use HPAL technology but is still enduring a painful birthing process.

Cumulative production in the first nine months of last year was just 7,700 tonnes of nickel in ferronickel, meaning there’s plenty more work to be done before Koniambo hits its 60,000-tonne per year capacity target.

All these mega projects were conceived in the middle of the last decade, when the LME nickel price soared above $50,000. Years of permitting, planning, construction and often problematic commissioning mean they are still chasing full run-rates at a time when the market simply doesn’t need any more nickel.

STANDING PAT

Owners of projects like Ambatovy have no option but to continue to increase output. Construction loans have to repaid and higher rates of production mean lower costs and improved cash flow.

But what of the rest of the world’s producers?

Why is no one cutting production in response to the continuing price implosion?

As with metal producers of any kind, the answer is partly because shuttering capacity is never a cost-free option in either financial or social terms.

But what singles nickel out is a collective conviction that Chinese nickel pig iron (NPI) producers will close before anyone else.

This is partly down to the constraints on the supply of nickel ore after Indonesia’s export ban at the start of 2014 and partly down to the perception that NPI producers sit at the top of the global cost curve.

The only problem is that China’s NPI producers have proven themselves adept both at cost-cutting and mingling their stockpiled Indonesian ore with material from other sources, mainly the Philippines.

It wasn’t so long ago that NPI costs were thought to be above $20,000 per tonne. The very fact that so many are still operating says much about Chinese ingenuity.

True, NPI production has been falling. It was down 18 percent in the first 10 months of last year, according to Antaike figures cited by analysts at Citi.

But it’s falling from a high base and not nearly as fast as consensus expectations.

In the interim every other major nickel producer is standing pat.

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Graphic on nickel market balance: tmsnrt.rs/1mY0IgH

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SURPLUS IS STILL A SURPLUS

The net result is that the global refined nickel market is still in supply surplus to the tune of almost 52,000 tonnes in the first 10 months of last year, according to the International Nickel Study Group.

The scale of surplus has been declining but a surplus is still a surplus.

And that’s a big problem given the already huge weight of stocks’ overhang in the nickel market.

LME stocks rose by over 26,000 tonnes last year, which doesn’t sound so bad until you factor in the 50,000 tonnes that have found their way into Shanghai Futures Exchange (SHFE) warehouses since the SHFE launched its own nickel contract in April last year.

Combined visible exchange stocks stand at a record high of around 490,000 tonnes and even that may be only the tip of the iceberg.

That Citi report (“Nickel; New Year, No Cheer”, Jan. 5, 2016) cites figures from research house Wood Mackenzie suggesting that total refined nickel stocks, both visible and non-visible, may be as high as 1.13 million tonnes, equivalent to 219 days of global consumption.

BATTLE FOR SURVIVAL

With stocks still rising and production costs still sliding, thanks in large part to plummeting oil prices, the inference is that the price must go lower still if the market is going to rebalance.

Citi, by the way, is citing $8,000 per tonne as “the next key target level.”

Everything looks set for a long attritional battle for survival, both in China and everywhere else.

There is an obvious comparison with iron ore, another commodity where pricing has now fallen below the troughs of 2008-2009 due to chronic overproduction in the face of falling demand.

Forget about costs, the real determinant of who will survive will be balance sheet strength.

And if that sounds a bit overdramatic, it’s not just me saying so.

Speaking at a Bloomberg seminar during last October’s LME Week in London, Anton Berlin, strategic marketing director at Russia’s Norilsk Nickel, warned about the consequences of inelastic supply.

“If prices stay at these levels, there will be cutbacks from producers who run out of cash. That’s as positive as we can be in terms of light at the end of the tunnel.”

When he spoke, the LME nickel price was still above $10,000, a level that looks a long way away right now.

The Ambatovy write-downs are just the start. (Editing by Susan Fenton)

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