METALS INSIDER: Will nickel pay the price for past excess?

* Stainless steel production slumps in Q4 08

* No evidence of imminent turnaround

* Drift away from nickel-intensive stainless

* Danger of structural overcapacity in nickel supply

By Andy Home

LONDON, March 18 (Reuters) - Stainless steel production fell off a cliff in the fourth quarter of last year and with it went a sector that accounts for around two-thirds of global nickel demand.

The result has been a ballooning nickel market surplus, surging LME warehouse stocks and a price collapse that has forced multiple production cutbacks.

A revival of nickel's fortunes will be first and foremost dependent on a recovery in the key stainless steel sector but nickel's previous price exuberance may come back to haunt it both in terms of excess production capacity and structural changes in its demand profile.

SLUMP!

The International Stainless Steel Forum (ISSF) has just released preliminary global stainless steel production figures for the fourth quarter of 2008.

They are breathtakingly awful, showing stainless output slumping by 30 percent year-on-year to 4.84 million tonnes.

The super-fast transmission of financial crisis in the third quarter of 2008 to real-economy crisis in the fourth quarter sent global stainless production tumbling to its lowest quarterly level since the second quarter of 2004.

The late-year slump nullified a cyclical improvement in stainless output in the third quarter, meaning global production fell by 6.9 percent to 25.91 million tonnes over the whole of last year.

Critically, the year-on-year slide encompassed all the major geographical regions, including China. The previous driver of rising global stainless production experienced a 3.6 percent fall in output in 2008.

There is no tangible evidence of any improvement in the current quarter. Stainless mills continue to operate at sub-capacity levels and all the big players have warned of very low visibility in terms of future prospects.

The most optimistic have suggested some stabilisation of stainless demand at the current depressed levels. Others are less sure. Finnish producer Outokumpu warns in its annual report, released last week, that "it seems likely that markets will remain difficult in both the short and medium term."

Still, recovery will at some stage come, even if no-one is yet sure of the timing. The conventional thinking is that the speed of nickel supply response to the collapse in demand will leave it well positioned to benefit from any recovery in the stainless sector.

LME stocks may be high at just over 100,000 tonnes but they are lower than the 1994 peak of over 150,000 tonnes.

Moreover, when the upturn does come, restocking along the stainless supply chain will accentuate the pick-up in nickel demand due to actual improved stainless consumption.

AND RECOVERY?

There are, though, going to be two major constraints on any bounce-back in nickel prices and they both relate to the market's previous bout of exuberance in 2007, when LME prices surged to over $50,000 before deflating just as rapidly.

Even by the volatile standards of the nickel market, 2007 was an extraordinary example of the boom-and-bust commodities template.

And it changed consumption patterns in nickel's key end-use sector, stainless steel.

Production of 300-series stainless steel, that with the highest nickel component, slumped to 53 percent of total output in the third quarter of 2007, immediately after the peak in LME nickel prices, according to data from the ISSF.

The ratio has recovered a bit since then. It averaged 60.5 percent last year but that's still a long way short of the 70 percent plus levels seen prior to 2004. Nor did lower prices over the back end of last year translate into a reversal of this trend. The ISSF's preliminary take on Q4 2008 is that 300-series represented 58 percent of total stainless output.

The message seems to be that there has been a tectonic shift by stainless producers away from nickel-intensive steel to 200-series and 400-series stainless with higher chrome and manganese but lower nickel inputs.

This shift is currently being masked by the catastrophic collapse in total stainless production but the trend is clear and it will act as a future brake on nickel consumption growth.

That's significant because the second consequence of runaway nickel prices in 2007 is a production project pipeline that still looks plentiful even with recent suspensions and deferrals.

While BHP Billiton's giant 50,000-tonne per year Ravensthorpe mine in Australia has been suspended indefinitely, Vale's similar-sized Goro project in New Caledonia has only been slowed down. Indeed, the most recent guidance from the company, albeit dating from late last year, was that first production would be scheduled for April 2009.

Waiting in the sidelines are other huge projects such as Vale's Onca Puma, which with capacity of 58,000 tonnes per year of nickel in ferronickel is even bigger than Goro, Votorantim's Niquelandia and Anglo American's Alto Barro.

Even allowing for further push-backs, the question remains as to whether nickel producers invested in so much new production at the 2006/2007 price peak that they have planted the seeds for a period of structural overcapacity.

That could potentially be bad news for producers but good news for nickel consumers, although whether stainless mills will forget the volatility of 2007 and reverse the drift away from nickel-intensive stainless is quite another matter. For an analysis on the nickel market outlook, click on [ID:nL3406122]