CEIC News@lert: CEIC Thematic Analysis: Low Oil Prices Prolonging Supply-Demand Imbalance in Metal Mining Sector?
CEIC News@lert: Sector Database - June 12, 2015 The recent decline in commodity prices – both for energy and metals – has occurred for a variety of reasons and in conjunction is a mixed blessing for the Metal Mining sector. On the one hand, lower oil prices have been a boon to metal mining. As an energy-intensive industry, oil is among the major fuels used in production. While energy use may vary depending on the commodity and the extraction techniques involved, oil costs can range from 20% to 40% of total costs within the sector. The decline in oil prices effectively relieves the cost pressure for many of these companies. On the other hand, the benefits must be weighed against the relatively weak performance of metal prices. The coincident decline in metal prices places a damper on the industry’s revenue stream and is made worse if the downturn is prolonged – a likely scenario as lower oil prices delays the exodus of weaker companies. THE COMMODITY PRICE TUMBLE Oil prices fell below the USD100/barrel mark after peaking in the second quarter of 2014 and continued falling below the USD50/barrel mark during early 2015, reaching the lowest point in January. While crude oil prices have since rebounded slightly above the USD60/barrel mark as of the second quarter of 2015, oil prices are expected to remain substantially below their pre-crisis levels of USD100/barrel. Metal prices took a similar path, albeit with a less dramatic downturn relative to oil prices (see chart). The Commodity Research Bureau (CRB) Index of metal spot prices plunged below 900 points (1967=100) and hovered just above 700 points during early 2015, before subsequently stabilising around the 750 point mark. Weak metal prices coincided and indeed reflected weakness in the global economy. In particular, slowing growth in China – one of the largest consumers of many metal commodities – has resulted in a significant reduction in demand for metals and other related commodities, creating a supply-demand imbalance. Although the CRB metal index provides a ‘birds-eye’ view of metal prices, the individual movements in metal prices varies substantially across the different commodities (given the breadth of the index). Indeed, some metal prices have remained somewhat stable despite fluctuations in the metals commodity market. METAL OVER-SUPPLY AND LOW PRICES For many metal extraction industries, lower metal prices (caused in part by slumping demand) have been exacerbated by over-supply in the industry. Global production of iron, for instance, increased by 3.5% during 2014 despite weaker demand. This corresponded to a difficult year for iron ore producers, with prices falling from approximately USD128/metric ton in January 2014 to USD67/metric ton by January 2015. The converse was true with nickel. Nickel production declined by 8.7% in 2014, in part due to an export ban in Indonesia, one of the world’s major producers. This occurred as the Philippines likewise mulled over a similar ban during September 2014 (affecting the market despite not actually being implemented). Falling production saw nickel prices rise from USD14,101/metric ton in January 2014 to a high of USD19,118/metric ton during July 2014, although they gradually receded by succumbing to weaknesses in demand. However, rising production need not necessarily spell a decline in prices. Aluminium prices, in particular, actually rose despite a hefty 3.6% increase in production during 2014. Aluminium prices rose to USD2,030/metric ton in August 2014 from USD1,727/metric ton in January 2014. However, demand and supply factors combined with market speculation eventually cause aluminium prices to fall below USD1,820/metric ton from January 2015 to April 2015. Price pressures and weaker demand have seen the exodus or, at least, scale-backs in the metals mining sector. Allied Nevada Gold Corporation (which is US-based), Atlas Iron (Australia) and Dannemora Mineral AB (Sweden) have decided to cease production, or have declared bankruptcy because of liquidity problems. IMPACT ON THE FIRMS AND THEIR RESPONSE The interaction of low oil and metal prices has had a mixed impact. Some metal industry players, including BHP Billiton Group (BHP) and Teck Resources Limited (TCK), have hailed lower oil prices for leading to cost savings and, by extension, improved earnings before interest and tax (EBIT) amounting to hundreds of millions of dollars in 2014. However, despite enjoying lower costs, these savings were offset and indeed, outstripped by the lower revenue stream from low metal prices. Indeed, many industry players saw a decline in their net income, if not outright losses. BHP’s and TCK’s net income was reduced by half in the second half of 2014. Notwithstanding weaker profitability, many of these mining companies are not planning to reduce output substantially to help support prices. Companies enjoying lower cost structures – such as the Rio Tinto Group (RIO) – believe that sustained low metal prices will naturally balance market demand and supply following an exodus of higher-cost rivals. This has resulted in the counter-intuitive move of maintaining or even raising output to place further pressures on their competitors. RIO increased its production for many of its principal commodities during the first quarter of 2015 when iron ore production was ramped up by 14% year-on-year despite lower iron prices. While the company saw reduced copper production, this was largely attributed to the lower grade of ore mined rather than a deliberate decision to reduce output. Notwithstanding its strategy, RIO continued to maintain stable net income during the commodity price declines, outperforming its competitors. This is not to say that firms are not cutting costs in response to the crisis. To maintain competitiveness in the period of low metal prices, companies are switching their focus from project development and mine expansion to cost savings and improving margins. Companies are reducing their exploration and capital expenses to retain more cash on hand for daily operations and to improve liquidity, as less cash is generated from operations due to lower sales revenue. Capital expenditures are being further lowered as no further cash investments are required on completed mine construction. BHP, RIO and TCK are all examples of this cost-cutting approach, having reduced their capital expenditure in 2014 by 30-40%. Despite the industry’s war of attrition against high-cost producers, ironically lower oil prices – which were previously hailed for relieving cost pressures on firms – may threaten to prolong the weak metal price trend. Low oil prices served as a useful lifeline for some of these high-cost producers, allowing them to reduce their operating costs to lessen the impact on revenue from tougher competition. This, in turn, delays (or averts) the exodus of these companies, arguably delaying industry consolidation and prolonging these supply-demand imbalances. CONCLUSION The oil crisis, coupled with cost-cutting strategies, has lowered operating costs for commodity mining companies, enabling them to cope with falling metals prices without necessarily exiting the market. The presence of higher cost companies still active in the market producing raw mineral ores is only likely to delay the recovery in metals prices, which have been weakened by a combination of over-supply and reduced demand from China’s slowing economy. Many companies wish to wait out the price falls in the hope that a near-term recovery ensues. In any event, variations typically exist depending on the individual commodity concerned, which can be affected by specific factors, such as the nickel export ban in Indonesia. By the Sector Database Team Discuss this post and many other topics in our LinkedIn Group (you must be a LinkedIn member to participate). Request a Free Trial Subscription. Back to Blog