Commodity supply disruptions in today’s volatile market
Supply-demand fundamentals have been a key theme since the last quarter of 2016 when Chinese constriction of coal supply saw coal prices sky rocket, followed closely by many other commodity prices, e.g., aluminium, copper and iron ore. Interruption to supply is a re-occurring challenge for the industry. Disruptions have spanned commodities and geographies and impacted the sector in a variety of ways, but the result is usually the same: significant price volatility.
Regulatory policy is unbalancing the nickel market
The nickel market is experiencing supply side disruption from two contrasting events. On the bullish side, we have the threat of a large number of mine closures in the Philippines. On the bearish side is the potential return of Indonesian nickel pig iron to the global market.
In the Philippines, 23 nickel mines were ordered closure and 75 mining permits were cancelled in February 2017. While the Government has permitted eight companies to resume exports, the ruling could impact around 175kt of nickel or 40% of total mine output. The outcome of the order is still not clear as miners have the right to appeal; however coupled with other ongoing political issues in Philippines, an impact to supply must be factored in. In contrast, Indonesia’s plan to permit the export of low-grade ore may balance out the reduced supply from the Philippines and have a positive effect on prices. However, only one miner, PT Antam, has applied for the permit to export 6mt of nickel ore, of which the Government approved shipment capacity of 2.7mt so the impact may be minimal.
Industrial action takes its toll on copper
The impact of disruptions in the copper market are less ambiguous and have been significant so far. The 44-day strike at Escondida is one of the largest disruptions we have seen this year and the longest ever in Chile. It is estimated to have resulted in over US$1b in lost revenue and 220,000-230,000t in lost production.1 Strikes in the first quarter of 2017 as a whole have taken an estimated 425,000t copper out of production, and there are more than 10 more mines in Chile due to renegotiate their collective bargaining agreements this year. In Indonesia, supply was disrupted as ongoing negotiations with the Government halted concentrate shipments from Freeport-McMoRan’s Grasberg mine for about 12 weeks and resulted in an estimated US$1b of lost revenues.2 CRU estimates that disruptions could reach in the range of 1.3mt of copper this year, or around 6% of total production.3
Coal supply disturbed by Cyclone Debbie
Cyclone Debbie has been the most significant disruption to the global coal sector. It caused significant damage to coal mines and logistics infrastructure as it hit the Queensland coast in Australia. Queensland mines produced an estimated 221mt of metallurgical coal last year, and its exports account for 58% of the global seaborne market.4 It is still not clear what the five weeks of interruption will mean for the market overall, but it will impact around 15-20mt of coal and US$3.2b in exports.5 Coal prices have already doubled to reach over US$300/t in April 2017 for some cargos contracted by Japan, so the question now is how this will affect the supply/demand dynamic going forward as prices fall back down.
This supply and resultant price volatility creates and environment of instability, a difficult environment for miners to operate and plan in.
See EY’s Navigating volatility: Do you change your business or the way your business works? The key to success is agility and getting into shape to deal with volatility. This report focuses on six areas that will lead to more effective cash management.
1 “Strike-related losses at BHP Billiton's Escondida mine could reach over US$1B,” SNL Metals & Mining, 4 April 2017.
2 “Freeport awaits permit to end costly Indonesia export ban: executives,” Reuters News, 4 April 2017.
“Indonesia allows exports from Freeport Mine in Stop-gap deal”, Bloomberg.com, 4 April 2017.
3 “Copper market to strengthen: CRU,” Mining Journal, 4 April 2017.
4 “With Australian supply disrupted, coking coal buyers race to secure needs,” Reuters News, 6 April 2017; “Met Coal Surges Past $300 Toward Record on Australia Outages,” Bloomberg.com, 10 April 2017.
5 “Debbie disrupts $US3.2bn of coal exports,” The Australian, 4 April 2017.
Does cutting debt have to mean reducing your ambitions?
As we approach the half way point of 2017, the much-needed pricing recovery seems to be holding up. The sector continues to remain in good health, relative at least to early 2016. As many of the miners have been at pains to tell us during results announcements, there remains a firm focus on capital discipline and operational excellence.
In the first of a two-part series focused on the mining industry’s capital agenda, we look at debt levels across the sector and how leverage has been brought back under control. Using the top 50 global miners as a gauge on the industry’s health, we illustrate in this report with the following details that the sector is in far better health than perhaps investors give it credit:
- Debt has fallen by almost 25% from peak levels, with the associated leverage down by 8 percentage points, back to 2013 levels.
- Cost of debt has increased, but balance sheet flexibility is much improved and miners continue to focus on retiring higher-cost, unsecured facilities, in order to bring debt costs down.
- Earnings momentum is strong, with the pricing environment much improved from 2016, which increasingly looks to be remembered as “bottom of the cycle.”
Read more in EY’s report: Does cutting debt have to mean reducing your ambitions?
In the first four months of 2017 aluminium prices have rallied 22.5% y-o-y to US$1,868/t1supported by Chinese supply side reforms, disrupted production and strong global demand.
- The outlook for aluminium is stronger than expected due to Chinese reforms and robust global demand.
- New Chinese Government policies have been introduced to limit the construction of new capacity and restrict how much aluminium can be produced during winter.
- China has also issued an official notice on illegal aluminium capacity inspection built after May 2013. This could result in 1mtpa production loss on top of the winter supply cuts.2 The sustainability of these measures is in question, however, given the high costs associated with smelter shutdowns and restarts.
- Global demand is expected to grow by 4.3% y-o-y to 61mt driven by strong automotive and construction demand from the US, China and India.3 The potential increase in trade measures if the US investigation finds that aluminium imports are a threat to US national security may impact the global market.
- Higher aluminium prices have also resulted in producers planning to raise capital through IPOs. EN+ Group, which owns 48% stake in UC Rusal, and Emirates Global Aluminium have indicated plans to conduct IPOs later in 2017.4
1 Thomson DataStream
2 “Potential inspection on China’s illegal aluminium capacity- Commodities Comment,” Macquarie Research, 19 April 2017 via ThomsonOne
3 “The Price deck – 2Q 2017,” Morgan Stanley, 13 March 2017 via ThomsoneOne
4 “Billionaire Deripaska’s En+ Group Said to Plan an IPO in 2017,” Bloomberg.Com, https://www.bloomberg.com/news/articles/2016-12-22/billionaire-deripaska-s-en-group-said-to-plan-an-ipo-in-2017, accessed 9th May 2017; “Emirates Global Aluminium mandates U.S. banks for IPO,” Reuters.com, http://www.reuters.com/article/us-emirates-global-aluminium-ipo-mandate-idUSKBN16Y24E, accessed 9th May 2017
After a weak first quarter, Cyclone Debbie severely disrupted Australian supply in April leading to a rally in coking coal prices and a smaller surge in thermal coal prices. Ongoing significant volatility in coal prices and delays in industry reference pricing, is building uncertainty in the market.
- Premium Australian hard coking coal prices receded 35% q-o-q, to an average US$172.01/t in the first quarter after the Chinese Government relaxed restrictions on domestic coal production.5
- In April, however, metallurgical coal prices surged to over US$300mt as Cyclone Debbie disrupted supply of around 21mt of coal from Queensland mines.6 However, as operations resumed, prices dropped again to US$220/t.7
- Metallurgical coal prices will also be affected by China’s steel demand, which is forecast to remain flat in 2017 and decline by 2% in 2018 as the government tries to tighten its real estate policies.8
- Newcastle thermal coal prices averaged ~US$81.1/t, in first quarter on strong Chinese supply as the caps on the number of working days were removed. Resulting higher domestic output will put a pressure on China’s seaborne thermal coal demand, which is forecast to decline 5% y-o-y in 2017.9
- China maintains its target of cutting 150mt coal capacity in 2017. The size and timing of the cuts to be decided by local governments when prices remain stable. Cuts will not be large scale if prices remain in the reasonable range, within 6% basis on Yuan535/mt FOB.10
5 Thomson Datastream, EY Analysis
6 Coking coal price correction turns into crash, Mining.com, 21 April 2017
7 Aurizon says Goonyella coal line restarts after cyclone damage, Reuters, 26 April 2017; Thomson datastream
8 Steel recovery strengthens, but geopolitical uncertainty clouds outlook, World Steel, 21 April 2017
9 Metals Quarterly, HSBC, 19 April 2017, via Thomson One
10 No large-scale cuts from Chinese coal mines in 2017: NDRC, Platts, 07 March 2017
LME copper prices increased by 10.3% to average US$5,825/t in 1Q17, driven by disrupted supply and steady demand
- In 2017 it is estimated that disruptions will result in lost production of 1.3mt, ~6% of total output. Much of this will be as a result of upcoming labor negotiations in Chile.11 Strikes and disruptions at Escondida, Cerro Verde and Grasberg have already resulted in 425,000t of lost copper production in 1Q17.
- In Indonesia, regime risk is a factor as Freeport-McMoRan is negotiating with the Indonesian Government to obtain a special mining license. This reduced the operating capacity at the Grasberg mine to 40%.12
- Price-related production cuts (around 700,000-800,000t) over the last 18 months have already pushed the market from oversupply into balance in 2016 and will possibly move the market into deficit in 2017, as mine supply drops 3.5%.13
- No new copper mines are expected online in 2017 and only 8 projects with a capacity of over 100,000tpa are scheduled till 2021.14 For miners to increase capital spending on Greenfield projects, copper prices need to rise to US$6,700/t, which is unlikely until 2019.15
- This combined with a decline in ore quality, particularly in Chile and end of life closures over the next few years, will result in overall mine supply plateauing by 2020.
China’s demand also remained strong in 1Q17, with concentrate imports rising 8.5% to 4.31mt, as a part of its efforts to build-out refining capacity and reduce refined imports. In addition, its plans to add 3.5mt of smelter capacity over the next four years will tighten the concentrate market further.16
11 Copper market to strengthen: CRU, Mining Journal, 4 April 2017
12 Indonesia allows exports from Freeport mine in stop-gap deal, Bloomberg.com, 4 April 2017
13 Rio Tinto's copper boss sees small market deficit this year, Reuters News, 2 April 2017
14 Copper market to strengthen: CRU, Mining Journal, 4 April 2017
15 Copper Price Forecast: New Mine Opening Just in Time, Metal Miner, 13 March 2017
16 RPT-COLUMN-China still hungry for copper, but not in refined form: Andy Home, Reuters, 27 April 2017
Gold prices are up 5.7% from early May at US$1,284/oz due to recent geopolitical tensions and weak US jobs data. Prices had reached a low of US$1,220/oz in early May as a result of centrist Macron’s victory in the French elections and the expectation that the Federal Reserve will increase interest rates in its June meeting. This price volatility impacts margins of gold miners and in turn their ability to allocate capital effectively.
- Uncertainty in Europe is positive for gold prices but Macron’s recent victory in France removed a significant risk on the future of the EU and the Euro and led to a fall in gold prices.
- There is an inverse relationship between increases in the Federal Reserve interest rates and gold prices. As such gold prices are currently subdued on the expectation of two interest rate increases in 2017 with the next one in June.17
- Gold demand from exchange traded funds (ETFs) was down 68% y-o-y in 1Q17. However, the current weakness in gold prices may trigger increased inflows into ETFs.
- Major gold miners are expanding their portfolios and replenishing their reserves through investments in junior gold miners. For example, Goldcorp bought Exeter Resource Corp and Newmont invested in Goldstrike Resources.18
17,18 “North American gold leaders get busy,” Mining Journal, 5 May 2017.
- Iron ore prices peaked at US$94.50/t on 21 February 2017 before retreating steadily to US$55.90 on 5 June. The decline in prices, although largely expected, is a return to a more realistic market, and a come down from the overly optimistic and speculative activity that characterized the second half of 2016.
- Fears of rising port stock in China (particularly low grade) and stock piles at steel mills sparked the most recent decline in prices. Concerns too that marginal mid-tier miners, Chinese domestic supply and minor producing countries such as India and Iran would be incentivized to return to the market on higher prices exacerbated the retreat.
- With the top four producers now commanding roughly 76% of the seaborne market, there is a question whether their moderated production in the last 18 months may return to a more aggressive approach as prices start falling again. Prices need to stay closer to US$50-$55/t for a prolonged period to force marginal producers out once and for all.
- Pressure on Chinese steel mills to maximize efficiency did improve demand for high grade iron ore, improving margins in comparison to lower grade ore. However, Chinese steel demand is still expected to weaken in the second half, resulting in obvious market normalization and a further decline in prices.
Nickel prices have fallen from US$10,005/t at the beginning of the year to US$8,805/t at the end of May, primarily as a result of policy changes in the Philippines and Indonesia and reduced Chinese imports. Prices are forecast to remain weak in the short- to medium-term, which is likely to result in companies returning their focus to core operations, production cuts and cost cutting.
- Combined nickel production from the Philippines and Indonesia is expected to increase by around 6% to 754.5kt in 2017.
- In the Philippines it is expected that exports will increase as the new environment minister plans to balance conservation and mining interests. Nickel exports from the Philippines were down 47% to 23,004mt in the first quarter due to the environmental suspensions but also due to intermittent rains and maintenance issues. Only 7 of the 28 nickel mines reported production in the first quarter.19
- In Indonesia exports have slowly been returning to the market since export ban was reversed in January 2017 also resulted in increased global supply.20
- Chinese imports declined 60% y-o-y in 1Q17 as domestic production of nickel pig iron increased in 2016 on improved profit margins.21
- The outlook for the sector remains weak due to lack of demand drivers, supply side risks and significant inventories.
19 “Nickel miners expect rebound with Lopez ‘out of the picture’, Business Mirror via Factiva, 15 May 2017
20 “Commodities Quarterly,” Deutsche Bank, Via Thomson One, 16 March 2017
21 “China demand concern push nickel lower,” Reuters, 27 April 2017
Trade protectionist activity continues to increase with the US launching a wide-ranging investigation into steel imports. If the report concludes that steel imports will threaten US national security, the administration can take several actions including the imposition of tariffs to limit steel imports into the US.22
- Despite strong policies to limit output, China’s steel production grew by 4.6% y-o-y to 201mt during 1Q 2017, following firm steel prices. However, trade protectionist measures in a number of countries and stronger Chinese demand have resulted in a 25% y-o-y decline in Chinese steel exports in the first quarter. Higher production and lower exports has led to a significant increase in Chinese steel inventories, accelerating the risk of further pricing pressure in near future.
- Firm domestic demand coupled with strong protectionist measures have kept US and European steel prices elevated, leading to widening spread between US-China and EU-China prices which now stands at US$280/t and US$157/t against the historic average of US$140/t and US$50/t respectively. This increases the vulnerability of these markets to higher exports from China as imports will inevitably become very competitive despite all restrictions.24
- World steel demand is expected to increase by 1.3% in 2017. Stronger economic growth outside of China, particularly in India and the United States, will drive growing demand in 2017-18. As China continues its economic transformation, demand is forecast to be steady in 2017 but is likely to decline in 2018 as the Government tightens its real estate policies. In 2018 global steel demand excluding China will increase by 3.1% while Chinese demand is expected to decline by 2%. WorldSteel estimates that Indian steel demand will be higher at 6.1% in 2017 on increased infrastructure spending.25
22 “U.S to probe steel imports,” The Wall Street Journal via Factiva, 21st April 2017
23 “China crude steel output up 4.6% in Q1,” China Daily,”26th April 2017
24,25 “Materials (Steel)- Looking for logic behind the volatility,” Jefferies via ThomsonOne, 13th April 2017
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