Commodities Comment. Assessing the risks to nickel in 2017 GLOBAL. Feature article. Latest news

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1 GLOBAL LME cash price % change US$/tonne day on day Aluminium 1, Copper 5, Lead 2, Nickel 10, Tin 19, Zinc 2, Cobalt 50, Molybdenum 14, Other prices % change day on day Gold (US$/oz) 1, Silver (US$/oz) Platinum (US$/oz) Palladium (US$/oz) Oil WTI USD:EUR exchange rate AUD:USD exchange rate LME/COMEX stocks Tonnes Change Aluminium 2,117,875-23,650 LME copper 261,975 26,725 Comex copper 116, Lead 189,725 0 Nickel 381,096 3,816 Tin 5, Zinc 386, Source: LME, Comex, Nymex, SHFE, Metal Bulletin, Reuters, LBMA, Macquarie Research, March March 2017 Assessing the risks to nickel in 2017 Feature article In the second half of 2016, nickel prices appeared to be headed higher. Demand was booming and grew almost 8% YoY in 2016, the highest rate of any of the base metals. Supply was waning, driven by large closures of supply in 2015/16 due to low nickel prices and also the forced closure of some mine supply in the Philippines for environmental reasons. The global nickel market moved into deficit in 2016 for the first time since For 2017, key to the global market is supply of nickel ore from Indonesia and the Philippines, which is in a state of flux in both cases. Based on our assessment of the current situation and canvassing of the main players, we have summarised the range of possible outcomes in this report. The results of this analysis are indeed distressing for those seeking clarity, as the range of possible outcomes for 2017 supply remains large. The high case implies 155kt of extra NPI supply in 2017 from our base case, while the low case implies 145kt less NPI supply. Latest news Tuesday was another tough day for LME metals, with falls across the board. Nickel led the way, down 4.1%, while LME copper stocks rose once more. As was widely expected, Malaysia s environment minister has stated plans to recommend a further three-month extension to the moratorium on bauxite mining in the country, a situation which has been in place since early It is fair to say the bauxite market has adapted well to this absence, most notably Chinese importers who took 24mt from Malaysia in The almost tripling of Chinese imports from the Atlantic Basin, mostly Guinea, has certainly helped, while the bauxite price is essentially unchanged from when the Malaysian ban was announced. Our Australian resources analyst, Hayden Bairstow, has initiated coverage on one of the few cobalt-rich equity exposures globally, Clean TeQ Holdings. The company s Syerston project in Australia is targeting 19ktpa of nickel and 3ktpa of cobalt in sulphate from Our oil economist, Vikas Dwivedi, has noted that leading indicators of loadings and crude spreads continue to signal OPEC compliance, and we are looking for these cuts to start impacting global crude inventory levels, confirming tighter S/D balances. Beyond the near term, crude oil bulls must be cognisant of the risks posed by record net length, healthy US production growth and the risk of OPEC compliance slippage in 3Q and 4Q17. Macquarie invites you to save the date for two forthcoming conferences. Our annual Global Metals, Mining and Materials Conference is being held on June 27 28, 2017, at the Sheraton Times Square in New York. This will be Macquarie s 12 th year hosting this event, which will feature senior management from up to 40 world-class metals, mining and basic materials companies as well as commodity-related keynote presenters from around the world. Meanwhile, we will be hosting our third-annual Global Gemstones Conference in our London office on April 27. This will include participation of senior executives from all segments of the diamond industry and will provide key insights for this year and beyond. Please refer to page 7 for important disclosures and analyst certification, or on our website

2 Jan 16 Feb 16 Mar 16 Apr 16 May 16 Jun 16 Jul 16 Aug 16 Sep 16 Oct 16 Nov 16 Dec 16 Jan 17 Feb 17 Mar 17 Index: Jan 1, 2016 = 100 Does politics in the Philippines and Indonesia make nickel too hard to call in 2017? In the second half of 2016, nickel prices appeared to be headed higher. Demand was booming and grew almost 8% YoY in 2016, the highest rate of any of the base metals. Supply was waning, driven by large closures of supply in 2015/16 due to low nickel prices and also the forced closure of some mine supply in the Philippines for environmental reasons. The global nickel market moved into deficit in 2016 for the first time since LME prices peaked in mid-november at $11,735/t, up 52% from the early-2016 low of $7,710/t. In December and January prices crashed, falling 20% from their November peak. In December, all prices fell, in part due to year-end profit-taking by funds, but nickel fell by more than the wider base metals complex (Fig 1) and kept falling in January as other base metals rallied. The main reason for this fall was the mid-january announcement by the Indonesian government of a partial relaxation of its nickel ore export ban. There were significant conditions applied to the granting of export licences (regarding grades, construction of domestic processing facilities and use of lower-grade ore in domestic production, etc), but this still came as a negative shock to the nickel bulls, causing prices to crash temporarily. Fig 1 Daily LME cash nickel and LMEX index prices since January LMEX Nickel Source: LME, Macquarie Research, March 2017 The price crash was short-lived following another surprise, this time from the Philippines in early- February. Against analyst consensus, the Mines Minister, Gina Lopez, announced the closure of 23 of the country s 41 mines and suspended 5 others to protect the watershed. For nickel, the mines announced to be closed and suspended produced 124kt of nickel in ore in 2016 and 183kt of nickel in ore in 2015; at face value a considerable potential reduction in exports of nickel ore from the Philippines in 2017, given that total exports in 2016 were estimated to have been around 330kt Ni (down from 395kt Ni in 2015). Prices subsequently rallied strongly towards ±$11,000/t based on a growing conviction that Lopez will at least partly succeed in reducing supply (after the appeals process is completed). Meanwhile, there has been little concrete information emerging from Indonesia since January, with unconfirmed speculation that exports may be capped at 5M wet tonnes of ore (just below 50kt of recoverable nickel). At the time of writing, no export licences have been issued, and it remains unclear how much can be exported, with some believing the floodgates could open later this year. In the Philippines, the mine closures are inextricably linked to one person, Gina Lopez. She has the strong backing of the president of the Philippines, Rodrigo Duterte, but following strong lobbying by the mining industry (and commencement of legal actions) some doubts have begun to emerge about whether her hard line will be maintained through the appeals process, especially if the Philippine Senate does not confirm her appointment. President Duterte was quoted this week as saying that he hoped that there would be a happy compromise reached between mining and the environment. 7 March

3 In summary, the likely level of exports of nickel ore from the Philippines and Indonesia remains as clear as mud! Based on our assessment of the current situation and canvassing of the main players, we have summarised the potential range of possible outcomes in Fig 2. The vast bulk of ore exports from the Philippines and Indonesia will go to feed the Chinese nickel pig iron (NPI) industry, so we have excluded flows of ore elsewhere to ferronickel production in Europe, Japan and Korea. Apart from nickel ore, the Chinese NPI industry (led by Tsingshan) has also started using other feed sources (such as nickel sulphide ore and concentrate, mixed hydroxides and nickel metal). The high case assumes 100kt of nickel in ore is exported from Indonesia this year and that most of the mines in the Philippines slated for closure do not close. The low case assumes significant delays in issuing export licences in Indonesia and that most of the mines in the Philippines slated for closure do in fact close. Our base case is, in our view, the most likely outcome, but we would not entirely rule out something approaching the high- or low-case scenarios. In Fig 2, we have also estimated the level of domestic Indonesian nickel pig iron production. There is also considerable uncertainty surrounding 2017 production levels of NPI in part due to the uncertainties of ore export policy but also due to commissioning delays of some potential producers. Fig 2 Supplies of raw materials to Chinese nickel pig iron and NPI production ( 000t recoverable Ni) Actual Actual t Ni Base Low High High minus Low minus base base Philippines Indonesia New Caledonia Guatemala Non-ore feed Total ore feed Total feed for NPI Estimated Chinese NPI production Estimated Indonesian NPI production Total NPI production Source: Trade data, Antaike, Macquarie Research, March 2017 The results of this analysis are indeed distressing for seekers after clarity. The range of possible outcomes for 2017 supply remain large (see Fig 2). The high case implies 155kt of extra NPI supply in 2017 from our base case, while the low case implies 145kt less NPI supply. Fig 3 Scenarios on Indonesian and Philippines ore exports to China ( 000t Ni) Philippines exports: Scenario Low Base High Outcome Indonesia exports: Scenario Outcome Low Base High Source: Trade data, Antaike, Macquarie Research, March 2017 Fig 3 focuses just on ore supply to the Chinese NPI market, and there are nine possible outcomes assuming different combinations of the base-, low- and high-case scenarios for each country. Given such a large range of outcomes, we have attempted to assess the impact on pricing outcomes based on potential deviations from our base-case global supply/demand balance (Fig 4). In our base case, assuming global nickel use falls from 7.8% growth in 2016 to only 2.2% growth this year, we are projecting a similar market deficit to last year of 50kt. 7 March

4 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 $/tonne CFR $/tonne LME equivalent Fig 4 Global supply/demand balance base case ( 000t Ni) `000t f Total SS production % Change 8.7% -1.7% 8.3% 2.6% 300-series SS prod % Change 7.2% 1.4% 7.1% 3.3% Primary nickel consumption % Change 4.7% -0.6% 7.8% 2.2% Nickel Supply % Change 1.5% -0.8% 0.1% 2.0% (of which NPI) (483) (428) (471) (555) World Market Balance Estimated total stocks Weeks' world demand Source: INSG, Macquarie Research, March 2017 The size of the projected 2017 deficit has been lowered slightly from our previous estimates, based on the assumption of higher NPI production in both China and Indonesia this year than our previous forecast. The ongoing market deficit in 2017 suggests that prices should be higher in 2017 than in As we have previously noted, an important element of the level of price is the cost of making nickel pig iron in China via the RKEF (rotary kiln/electric furnace process). These costs are driven mainly by the cost of nickel ore (just more than 50% of total cash costs) and the energy inputs (coal, coke and electricity around one-third of total cash costs). Chinese government policy appears to be to support profitability in the coal industry (in part to reduce bad debts by coal producers and also to help them finance expected redundancies in the coal mining industry), so we expect little downside to energy costs this year and probably some small upside. Fig 5 Chinese import price for mid-grade nickel ore Fig 6 Close relationship between cash costs of Chinese RKEF and LME price Source: Metal Bulletin, Macquarie Research, March 2017 Source: LME, Mysteel, Macquarie Research, March 2017 The price of nickel ore seems well supported near current levels unless ore supply rises above our base-case scenario towards the high case. Conversely, lower ore supplies, especially with Chinese ore stocks approaching critically low levels, would imply significant upside to nickel ore prices, raising cash costs for making nickel pig iron and supporting LME prices. As a rule of thumb, every $10/t of ore costs raises the cash costs of making NPI by around $1,000/t. 7 March

5 LME price Fig 7 applies the range of outcomes listed in Fig 3 to expected price outcomes (as annual average for 2017). Our base case is based on a Chinese NPI breakeven price of $11,250/tonne. The extreme tails of the pricing outcomes are $15,000/t and $9,000/t. In our view, prices below $10,000/t would cause extreme pain in the industry generally and induce more widespread production cuts. Prices above $14,000/t, conversely, would induce reopening of some capacity closed in 2015/16. Fig 7 Range of outcomes for nickel market balance and LME price average in Market balance Source: LME, Macquarie Research, March March

6 Tuesday 07 March 2017 Prices Closing price * Closing price * 07-Mar Mar Mar Mar-17 % ch. day 2017 YTD Ave 2016 US$/tonne US /lb US$/tonne US /lb on day US$/tonne US$/tonne LME Cash Aluminium 1, , ,428 1,605 Aluminium Alloy 1, , ,259 1,555 NAASAC 1, , ,420 1,704 Copper 5, , ,558 4,863 Lead 2, , ,774 1,872 Nickel 10, , ,079 9,609 Tin 19, , ,632 18,006 Zinc 2, , ,168 2,095 Cobalt 50,750 2,302 50,850 2, ,433 25,655 Molybdenum 14, , ,890 14,453 LME 3 Month Aluminium 1, , ,430 1,610 Aluminium Alloy 1, , ,269 1,577 NAASAC 1, , ,435 1,725 Copper 5, , ,570 4,867 Lead 2, , ,775 1,878 Nickel 10, , ,123 9,657 Tin 19, , ,626 17,912 Zinc 2, , ,174 2,102 Cobalt 50,750 2,302 50,850 2, ,446 25,758 Molybdenum 15, , ,890 14,472 * LME 2nd ring price hrs London time. Year-to-date averages calculated from official fixes. Gold - LBMA Gold Price (US$/oz) Silver - LBMA Silver Price (US$/oz) Platinum - London 3pm price (US$/oz) Palladium - London 3pm price (US$/oz) Oil WTI - NYMEX latest (US$/bbl) EUR : USD exchange rate - latest AUD : USD exchange rate - latest 1,217 1, , Exchange Stocks Change since last report Cancelled End-16 Ch. since (tonnes) 07-Mar Mar-17 Volume Percent warrants stocks end-16 LME Aluminium 2,117,875 2,141,525-23, % 819,050 2,202,175-84,300 Shanghai Aluminium 221, , % 0 100, ,336 Total Aluminium 2,338,933 2,362,583-23, % 819,050 2,302,897 36,036 LME Copper 261, ,250 26, % 107, ,825-49,850 Comex Copper 116, , % - 80,112 36,292 Shanghai Copper 313, , % - 146, ,275 Total Copper 692, ,113 27, % 107, , ,717 LME Zinc 386, , % 177, ,850-41,825 Shanghai Zinc 199, , % - 152,824 46,209 Total Zinc 585, , % 177, ,674 4,384 LME Lead 189, , % 69, ,900-5,175 Shanghai Lead 68,419 68, % - 28,726 39,693 Total Lead 258, , % 69, ,626 34,518 Aluminium Alloy 13,280 13, % , NASAAC 119, , % ,380 22,380 Nickel 381, ,280 3, % 108, ,066 9,030 Tin 5,320 5, % 1,410 3,750 1,570 Source: CME, LBMA, LME, Reuters, SHFE, Macquarie Research 7 March

7 This publication was disseminated on 07 March 2017 at 19:31 UTC. 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