S&P Global Ratings updated its metal price assumptions, as most prices settle in at an elevated level for a second consecutive year. Potential scarcity and higher production costs for several metals are feeding into expectations of high prices in 2022 and 2023, even if last year's price spikes moderate. We are moving our assumptions for most metals in 2022 and 2023 about 5%-10% higher. Most notably, we have not revised any price assumptions down for the next few years, mostly because forward-price expectations remain above our current base-case assumptions. Our coal price assumptions in 2022 and 2023 are up about 40% since our last review in 2021, highlighting the effects of production constraints and trade friction. Also, higher electricity prices around the world could limit output growth for power-intensive aluminum, which stands in stark contrast with previous cycles when rising production and inventories sometimes drove prices below many smelters' cash production costs.

Many issuers stand on the cusp of significant changes, as cyclically strong cash flow and five years of financial discipline translate into corporate development opportunities like greenfield capital expenditures or acquisitions, as well as potential returns to shareholders or even higher credit ratings. Metals producers have generally benefited from inflation, as revenue growth well outstrips higher input costs, many of which are fixed, as well as rising capital spending in tight market conditions (see "Economic Outlook Q1 2022: Rising Inflation Fears Overshadow A Robust Rebound," published Nov. 30, 2021). Price spikes, like the trough in 2020, are often fleeting, so our longer-term price assumptions moderate toward the cash costs for most metals because high prices inevitably encourage marginal production. And even if high prices last a while, corporate development and equity returns can outrank the permanent debt reduction that could underpin sustained credit improvement.

Aluminum

Aluminum prices have reached levels not seen since 2008, underpinned by robust recovery in demand and constraints to supply.   Environmental factors, particularly fuel sources for electricity inputs and carbon anodes for aluminum smelting, are driving a shift in global production for this electricity-intensive but highly recyclable metal. Demand appears to be outpacing supply, particularly as output in China shifts from coal-fired electricity to renewable sources. Moreover, regional supply disruptions are contributing to record-high regional premiums.

Our outlook for aluminum prices has improved with the market currently in a deficit. Industrial and consumer demand is strong and increasing investment in the energy transition, such as renewables and electric vehicle (EV) batteries, will support demand growth. At the same time, record high energy prices in Europe and energy shortages in China are disrupting supply. Furthermore, supply is slow to respond as capacity restarts can take up to a year and Chinese supply response will be muted because local governments enacted stricter rules to restrict carbon-intensive capacity growth.

The fundamentals for aluminum appear to be stronger and persistently declining stocks may indicate better potential for equilibrium. However, we assume prices will moderate as supply constraints eventually ease and some marginal capacity returns. In addition, China's announced a production limit of 45 million tons and industry transformation could cap supply and support aluminum prices over the long term (see "The Future Of China Aluminum Production: Leaner, Cleaner, Greener," published Sept. 5, 2021).

Copper

Copper continues to be the bellwether for economic megatrends, as demand shifts to global electrification from China's rapid industrialization and urbanization.   Our price assumptions for copper are persistently high, because it appears that copper demand will sustain despite our views on slower growth in China and rising interest rates globally. We estimate that incremental demand from the nascent EV industry and the global need to accelerate the buildup of electric infrastructure from renewable sources, especially but not exclusively in China, could drive global copper demand in the next few years. We believe the industry could face deficits of around 100,000 tons to 200,000 tons per year for the next three to four years. Moreover, suppliers may face incremental levies on their exports in countries like Chile and Peru, which at this point we don't see as playing a significant role but they might de-incentivize expansions at least until clarified.

Nickel

Nickel prices hit their highest levels since 2011 due to the ongoing reduction in inventories, as demand from restocking stainless steel manufacturers and the EV industry in China have outpaced supply growth.   Recently announced fiscal stimulus in China could also support the prices in the near term. Still, we expect demand to moderate in the coming months as stainless steel plants are going on maintenance while supply continues to expand, primarily thanks to capacity additions in Indonesia. This could result in overall surplus in the market this year, which should support lower prices.

Our long-term prices are a bit higher, but these will continue to be sensitive to Indonesian policies towards further capacity increases, as well as the dynamics of EV industry. We believe the market could be in surplus in 2022-2023 thanks to a healthy pipeline in projects in Indonesia. In particular, Tsingshan Holding Group has started processing nickel pig iron into high-grade nickel matte in Indonesia, which can later be converted to battery-grade nickel sulfate. Future nickel demand can be shaped by the type of chemistry battery producers adopt, as some of the formulations do not include nickel, such as lithium iron phosphate (LFP), to which Tesla is switching its standard range cars globally.

Zinc

We revised our price assumption for 2022-2024 up by about 10%, reflecting the change in the forecasted refined zinc supply/demand balance to a deficit in both years, from previously a slight surplus globally.   On the supply-side, refined zinc production in China should remain constrained by power limitations and emissions targets, while in Europe sky-rocketing energy prices led several refiners to curtail production. On the demand-side, forecasts for global refined zinc consumption have come down slightly compared to September but remain well supported, particularly in the context of some COVID (omicron variant) risks lingering into 2022. The supply/demand deficit should tighten to close to balance in 2024 and move to a surplus in 2025, so that we remain cautious with our medium-term zinc price assumption.

Gold

We are maintaining our gold price assumptions following a year of notable strength in 2021 that included an average gold price of about US$1,800 per ounce (oz).   We continue to believe gold prices could ease this year, and we believe our longer-term assumption of $1,400/oz is consistent with many gold producers' assumptions for corporate development. Since our last review, there have been limited changes to S&P Global economists' macroeconomic forecasts that we incorporate in our price assumptions, although gold prices are being pulled around by expectations for rising U.S. interest rates against a backdrop of global security concerns.

The assumed drop in average prices in 2022 is material but relatively modest compared to past periods of price volatility. In our view, S&P Global forecasts and consensus market expectations for several interest rate increases--which increase the opportunity cost of holding gold--this year primarily underpin our lower assumption for 2022. We assume prices will stabilize below this level in 2023 and 2024, closer to the average price utilized by most gold companies for long-term planning purposes. Our conservatism also reflects the potential for downside price shocks like in 2013, given relatively recent peak gold prices and the potential for market sentiment to change.

The strength and stability in prices over the past year was somewhat surprising. Factors historically negatively correlated with gold had little influence, including relative U.S. dollar strength, market expectation for higher interest rates, strong oil prices, and solid overall performance of the broader equities market. Alternatively, lack of price spike from higher inflation is difficult to explain in the context of the historically held view of gold as a safehaven asset.

Iron ore

We have modestly raised our price assumptions for 2022 and 2023, but our long-term price assumption remains the same for 2024 and beyond.   China's crude steel output fell 3% year on year to 1.033 billion mt in 2021, National Bureau of Statistics data released showed, posting the first year-on-year decline since 2016. After seeing an historic price spike in 2021 to $233 per dry metric ton (dmt), iron ore plunged to below $100/dmt by September 2021, after China clamped down to limit steel output to meet its carbon neutrality target. China's steel industry accounts for around 15% of the country's carbon emissions. Prices have since rallied above $140/dmt, supported by seasonal restocking for Chinese New Year and temporary supply disruptions after Vale S.A. was forced to halt some mines due to heavy rains.

Moreover, we believe the Chinese government is unlikely to loosen the control on steel production in 2022. Given that China's goal of peak carbon emission by 2030, China's crude steel production is likely to gradually fall. The world's largest steel company, China Baowu Steel Group Corp. Ltd., targets peak carbon emission by 2023. We believe this signals a potential step-change and believe China's decarbonization drive will keep steel production output flat year on year compared with 2020, as its government policy targets reducing steel sector carbon emissions. Chinese steelmakers will likely be required to further cut production to meet the nation's carbon neutrality goal by 2060. Still, a high proportion of high-cost, fourth-quartile producers with cash costs of close to $100/dmt remain profitable. Over the long term, we maintain the view that high-cost marginal producers will likely be forced out of the market as Vale S.A.'s disrupted supply gradually returns, which will drop prices toward the marginal cost of supply.

Metallurgical Coal

We raised our met coal price assumption for 2022 by about 40%, and we maintain our downward price trend for the next two years albeit at about 20% higher levels.   This primarily reflects our expectation that China's crude steel production will continue to gradually fall despite the commitment of peak carbon emission by 2030. We also expect the supply constraints to ease in the coming months.

The seaborne met coal price has stayed strong despite a temporary retreat to US$300 per ton when China's crude steel production fell to a four-year low of 69 million tons (mmt) in November. China's steel output in December rebounded to 86 mmt, supporting met coal prices, while other major steel producing countries in the region, including India, Japan, and Korea, increased their steel output late in November to further offset the decline in China.

The impact of weather and restocking demand are also support met coal prices. Queensland has been experiencing wetter-than-average weather due to a La Nina event, spurring supply disruptions and logistics issues. Restocking demand from Indian, Japanese, and Korean steel mills is robust as their inventory remains low, partly because of tight supplies, and Chinese steel mills have been restocking ahead of the Winter Olympics and the Lunar Near Year.

Finally, in applying these assumptions in our financial forecasts, we will take into account underlying pricing mechanisms, contract structures, and other factors that affect issuers' realized coal prices.

Thermal Coal

The seaborne thermal coal price is higher despite China's efforts to stimulate domestic production since October 2021.   Current prices are more than 2.5 times compared to $85/ton a year ago. This comes amid persistent tight supply, initially fueled by Indonesia's month-long export ban, and now Russian-Ukraine tensions threatening gas supplies, as well as wet weather conditions and Omicron spread resulting in logistical bottlenecks at Australia's ports. Nonetheless, even with a higher near-term price, we believe that prices could ease from its current peak once supply chains stabilize. China's thermal coal inventory at key power plants was at a record high in mid-January after the country ramped up production in October last year to end a serious power shortage. However, coal prices may stay above our assumption for the rest of the year, especially if China pulls back on domestic production, tensions between Russia and Ukraine continues, or demand picks up faster than expected.

We assume thermal coal prices will moderate toward their 10-year average next year as economic growth and supply rebalances and normalizes. Our expectation is that carbon policies will continue to gain greater traction within the next two to three years. New commitments during the 2021 U.N. Climate Change Conference, more commonly referred to as COP26to accelerate the transition from unabated coal power generation, place additional pressure on coal and more countries in Asia-Pacific have joined the net zero race with more aggressive 2030 emission targets. As such, our long-term price reflects our more bearish view on thermal coal as countries reduce carbon intensity.

Related Research

• Economic Outlook Q1 2022: Rising Inflation Fears Overshadow A Robust Rebound, Nov. 30, 2021
• Coal Crunch Won't Leave China's Power Firms In The Cold, Oct. 5, 2021
• Credit FAQ: How Decarbonization Will Affect China's Steel And Aluminum Producers, Sept. 20, 2021
• Steely Resolve: Why Green Mandates May Finally Stop China's Steel Expansion, Aug. 11, 2021
• How S&P Global Ratings Formulates, Uses, And Reviews Commodity Price Assumptions, Sept. 28, 2018.