Returning to growth and preparing for future demand
Solid economic performance in a number of regions is proving to be positive news for the mining and metals sector. Global growth will reach 2.8% this year and is forecast at 3% in 2018. Both the US and Eurozone are growing steadily at around 2.1% in 2017 and this is expected to continue in the EU in 2018. US economic growth may be stronger in 2018 at around 2.4% on the back of stimulus plans.
Chinese growth has surprised on the upside this year at 6.8% and has boosted demand for commodities and pushed up prices. Many commodity prices are hitting new highs, such as zinc is trading over US$3,000/t for the first time in a decade and aluminium at over US$2,000/t for the first time since 2014.
It is therefore unsurprising that mid-year results have been largely positive. Nineteen of the top 25 mining companies beat consensus earnings estimates. With additional cash, miners are focusing on returns to shareholders, including debt buybacks. In addition, development pipelines are also being re-examined. There have already been some significant new capex announcements e.g., BHP approved capex of US$2.46b to expand its Spence copper mine’s life by over 50 years in Chile1 and Chalco plans to invest US$500m in a Guinea bauxite project in 2018.2
The future of demand
In 2018 while global economic growth is expected to remain fairly robust, miners will still be watching China closely, particularly on a lower growth forecast of 6.2% (see chart above). Understanding future demand will be important, particularly as innovation in other sectors increases.
The shift to clean energy, for example, is already affecting the mining and metals sector in a number of ways, including:
- Changing demand dynamics: Batteries for electric vehicles will require increased volumes of copper, cobalt and lithium. Some analysts predict a ~1,000% increase in lithium demand. The shift to clean energy will also result in increasing demand for renewables and natural gas. Coal demand growth is expected to slow as a result.
- New portfolio decisions: Should companies divest their coal assets? Is it the right time to invest in lithium assets? Should miners increase their interests in copper?
- Increased scrutiny over the supply chain for electric vehicles: The green credentials of electric vehicles is likely to result in increased focus on miners’ environmental standards and energy efficient production methods.
It seems unlikely that any sector will be unaffected by the rate of disruption in today’s world. Keeping abreast of macroeconomic conditions and changing demand will be imperative for the mining and metals sector to continue on its growth trajectory.
1 “BHP to spend $2.5bn to extend life of Spence copper mine in Chile”, Financial Times, 17 August 2017
2 China's Chalco plans $500 mln investment in Guinea bauxite project”, Reuters, 17 August 2017
Digital mining: the evolution
Digital mining is not new; it has been with us for over half a century. Over the last few decades, the mining sector has embraced the introduction of new technologies which have resulted in significant productivity benefits.
However you can only you can only truly achieve a sustainable productivity improvement by adopting an integrated end-to-end business approach from market to mine.
One of the key steps that can significantly reduce the integration gap is to adopt digital strategies to reduce variability in the organization, enhance an end-to-end approach and improve decision-making.
In the mining and metals sector, there is the gap between the potential from digital transformation and the poor track record for successful implementations. This exists, not because of a lack of engagement from the sector, but because of a range of practical issues that continue to challenge the industry.
We explore the common pitfalls, which include lack of practical pathways to an aligned vision, unclear accountabilities and poorly defined digital business models. Understanding these pitfalls will help answer the question: “With so much opportunity, why is the road to digital transformation littered with stalled or failed endeavors?”
Read more in EY’s digital mine reports, watch the videos and listen to the on-demand webcast here: ey.com/digitalmine
After correcting in June, aluminium prices have traded above US$2,000/t for the first time in almost three years as several countries impose trade measures and China cuts production to curb pollution and remove illegal capacity.3
- The US Department of Commerce made a preliminary decision that Chinese aluminium producers are receiving government subsidies and it will therefore impose anti-dumping duties ranging from 16.56% to 80.97% on imports of aluminium foil from China.4
- Aluminium may be in short supply in China as Shandong province plans to cut production by about 30% to curb pollution and 3.21mt of illegal smelting capacity.5 China Hongqiao has closed 2.68mt of illegal capacity on orders of the Shandong provincial government.6
- Growth in aluminium demand is accelerating in China, US and Japan as a result of increased consumer demand for beverage cans, appliances and automotive.
- Green aluminium, produced using renewable energy sources, is beginning to attract a premium as industrial customers face pressure to reduce their own carbon footprints.
3 “Aluminium trades above $2,000 a tonne for first time in nearly three years,” Financial Times, https://www.ft.com/content/6483b9c7-832c-3432-abaa-0b9d334761cb, accessed 21 August 2018
4 “China's aluminium output falls in July from June record,” Reuters, https://www.reuters.com/article/china-economy-output-aluminium-idUSL4N1L01IU, accessed 18 August 2017
5 “Chinese aluminum stocks rise as Shandong province prepares to cut output by 30%,” SNL Mining & Metals, https://www.snl.com/InteractiveX/article.aspx?ID=41536498&KPLT=2, accessed 18 August 2017
6 “China Hongqiao confirms 2.68 MT aluminium capacity closure,” Reuters, https://af.reuters.com/article/africaTech/idAFL4N1L025B, accessed 18 August 2017
Volatility has remained the key theme to coal markets in 2017 with supply shocks causing uncertainty, despite this thermal coal has been trading in a narrower band in 2017.
- There is a structural change in how China is producing and consuming its thermal coal. It is streamlining its mines to be more productive and cutting excess capacity.
- These efficiency and profitability targets have cut significant production boosting imports
- China has been forced to increase coal consumption this year as, insufficient hydropower production and increased power demand resulted in thermal power generation growing 7.8% in the first seven months of 2017.7
Despite China’s policies targeting thermal coal through the restriction of production metallurgical coal has benefited significantly. This combined with recent price hikes has stimulated new production which could result in oversupply.
- Recent volatility has pushed metallurgical coal pricing from quarterly contracts to a system closer to a daily market price.
- US production will increase by 10% in 2017. Mines in Mongolia, Mozambique and China have also increased production.8
- In the wake of the Australian supply disruptions, steelmakers are seeking to diversify their sources of metallurgical coal supply. For example India is increasing supply contracts with Canada to diversify away from Australia.
7 Coal price surge justified by China's dynamics, for now: Russell, Reuters News, 21 August 2017
8 METALLURGICAL COAL- US Resurgence, AME Group, July 2017
Copper prices were particularly volatile in the first seven months on changing regulations, improving macroeconomics and supply disruptions. A future market deficit remains a possibility, but overall copper fundamentals are poised for growth.
- Prices hit a two year high of US$6,430/t in July 2017 as the Chinese Government proposed a ban on copper scrap imports from 2018.9
- An improving global macro-economic outlook, weaker US dollar and improved Chinese industrial growth have also strengthened copper prices. The IMF raised its projections for Chinese and Eurozone GDP to 6.7% and 1.9% respectively for 2017.10
- Copper price forecasts for 2017 have increased to an average of US$5,820/t on rising Chinese demand.11
- A 15kt surplus was reported in the first five months of 2017 but this is likely to be reduced by supply disruptions, e.g., industrial action at Freeport’s Grasberg mine and interrupted power supply to mines in Zambia. So far many operations in Latin America have narrowly avoided strikes.
9 “China's threatened scrap import ban jolts copper into life: Andy Home,’ Reuters, 31 July 2017
10 “IMF maintains global growth forecasts; China, euro zone revised higher,” Reuters, 24 July 2017
11 “Chile seen producing 5.6m tonnes of copper in 2017 – agency,” Mining Weekly, 28 July 2017
Gold prices increased to an 11 month high of over US$1,330/oz in late August from about US$1,200/oz in early July. This was largely due to geopolitical and economic events such as the North Korea missile launch and lower investor confidence in the US economic recovery. This has led to a weaker dollar and bearish sentiment on US equities resulting in investments flowing back into gold.
- Many gold miners such as Centamin, Harmony, St. Barbara, Evolution and Newcrest reported higher profits and declared dividends in June quarter. Kinross, on the other hand, does not plan to distribute dividends in the near term but plans to invest back in business.
- Gold prices have largely remained range bound (US$1,200/oz – US$1,300/oz) during the year but have often moved between the two ends of the range. Increased price volatility impacts gold miners’ ability to allocate capital effectively, especially for long term projects.
- Global gold demand fell by 10% y-o-y to 953.4t in 2Q2017 primarily due to weak demand from ETFs (down 76% y-o-y to 56t).12 ETF demand is an important price driver for gold. Higher gold prices would lead to higher revenues and higher cash flows for gold miners.
- Gold production fell 2% y-o-y in the first five months of 2017 with adverse government policies being one of the reasons impacting continuity of gold mining projects.13 More recently, Tanzania’s changes in its mining law will curtail gold production of Acacia and South Africa’s revision of the mining charter has created uncertainty for domestic gold miners.
- To address falling gold production, many miners such as Harmony Gold continue to look for acquisitions that would help raise its gold production.14
12 “Gold demand trends Q2 2017,” World Gold Council, 3 August 2017.
13 “Gold mining output at its lowest level since the financial crisis, says ANZ,” CNBC, 17 August 2017.
14 “Harmony books dividend lift, but side steps AngloGold rumour,” Miningmx, 17 August 2017.
Iron ore prices have trended upwards from lows reached in mid-June, with benchmark 62% Fe ore hitting a four month high of $77.94/t on 18 August 2017.
- Increased steel production and improved steel margins have helped balance the iron ore market. Demand has kept up with anticipated new supply, giving support to iron ore prices.
- Positive forecasts for steel production is driving speculative activity in Chinese commodity futures which is also keeping iron ore prices buoyant.
- While port stockpiles of iron ore are historically high, imports continue to be strong. Much of the landed stocks are lower grade ore, so continuing imports is reflective of a preference for higher grade material. This is also evidenced in the historically wide spread between 58% and 62% Fe prices.
- First half production results from the major iron ore producers were mixed, although there was an increase in supply overall for the period. This has mostly been absorbed by increased demand.
- Prices are expected to average US$67/t for 2017, but still anticipated to trend lower to between US$50-US$53/t for 2018 and 2019.
Nickel prices recovered from US$8,680/t in mid-June to US$10,835/t in August due to a weakening US dollar and robust Chinese stainless steel production. A long period of depressed prices means high-cost miners remain cautious and are either reviewing or closing down operations. In addition, the nickel prices are expected to remain volatile on large inventory stockpiles and excess supply.
- Stainless steel production increased 5.36% y-o-y to 23.42mt in the first half of 2017.15
- First Quantum will close Ravensthorpe mine directly impacting close to 500 jobs in Australia.16 Vale has also put its New Caledonia operations under review.17
- The Indonesian Government granted export licenses to five companies with a combined nickel ore export quota of 8.14mt.
- President Duterte in the Philippines has launched a review of local mining laws to come up with an improved tax and revenue sharing system through the Mining Industry Coordinating Council. The council will also assess mining operations affected by previous environmental decrees. This may result in higher taxes, particularly on companies that are not compliant.18
15 “Metals Quarterly Q3 2017,” HSBC Global Research, 11 July 2017
16 “WA nickel mine to close, putting 500 jobs on the line” The West Australian, 9 August, 2017
17 “Vale says loss-making New Caledonia nickel operations under review,” Reuters, 4 July 2017
18 “MICC to review mining tax regime,” Philstar.com, 31 July 2017
The removal of Chinese long steel capacity, rising steel demand, trade protectionist measures and higher steel prices have resulted in stronger financial performance by most steel players during 1H2017. However, rising prices is incentivizing increased global steel production and this may impact steel companies’ performance in the second half.
- The closure of Chinese long steel capacity, largely induction furnaces, has pushed up Chinese steel prices. The spread between the US and Chinese steel prices has narrowed from US$210/t in April to around US$100/t in August 2017.
- China has removed more than 42 million tonnes of steel production capacity. This is in addition to 65 million tonnes eliminated in 2016. China has achieved almost all of its 5-year capacity reduction target in the first two years. However, cuts as of now has more been towards long products production capacity.
- Restrictive import duties or anti-dumping duties imposed by many countries has led to a sharp decline in Chinese exports, down 28% y-o-y to 41 million tonnes in the first half.
- Stronger Chinese steel demand from real estate and machinery has underpinned better supply and demand fundamentals in China.
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