Mining needs US$150bn to survive, Wood Mac says

Ongoing weak markets and commodity price pressures may mean the industry’s focus on the now rather than the future could damage it ahead.

According to a recent presentation by Wood Mackenzie vice chairman of metals and mining research, Julian Kettle, if the mining industry focusses too heavily on cost cutting now and fails to invest the US$150 billion required to meet future supply needs, supply shortages will erupt.

“Across base metals, iron ore and steel Chinese consumption growth rates are set to fall dramatically in the next five years, compared with the previous half decade. However, we caution against this being interpreted as a bleak outlook – Chinese consumption hasn't hit a great wall,” Kettle said.

“The scale effect, i.e. the sheer volume, still translates into significant incremental demand and good growth in tonnage terms. China will account for between 58-69% of global total demand growth for base metals over the next decade."

This renewed focus on future supply comes as the market and governments tout the bottom of the decline.

Bankers are seeing mining returning to form in late 2016/17, with predictions of commodity prices rising by a fifth.

Morgan Stanley is bullish on mining again, after earlier putting an ‘attractive’ tag on the sector, stating the industry is at an historically attractive level.

The bank lifted its recommendations for the majors, moving Rio Tinto and BHP from ‘overweight’ to ‘equal weight’, and Anglo American from ‘equal weight’ to ‘underweight’.

According to the bank they expect commodity prices to rise approximately 19 per cent by 2017, carrying out “a sharp reversal from the experience in the last 18 months”.

“Emerging markets and China in particular remain key to commodities demand. In the next few months we expect the perception around this demand to improve. In particular the acceleration of financial and administrative stimulus policies in China in recent weeks should start to feed through in both actual activity levels and equity market expectations,” Morgan Stanley analysts stated.

 Australia’s chief economist also pegged the bottom of the mining downturn.

In its report it outlined positive guidance.

“Over the medium term, the outlook for the Australian resources sector is largely positive,” the report said.

“The prices of several commodities, in particular iron ore and coal, are projected to increase moderately towards the end of the outlook period. In addition, production and export volumes are projected to increase as the recent investment in the sector contributes to increased output.”

According to Wood Mac, however, this recovery can’t happen unless the industry begins to invest US$150 billion to meet the medium to long term supply.

"This need for investment is becoming desperate in zinc and lead and will become an issue in copper in the next few years. Unfortunately there is little appetite to invest with prices cutting into the cost curve, low free cash-flow, surpluses building, difficulty in financing and shareholders demanding dividends."

The group’s analyses showed that further reductions in base metals are needed to keep the sector viable.

"In copper, prices are hovering around the 90th percentile price plus sustaining capex – a measure we use to assess where production sits on the cost curve. We're expecting a further 400-500 thousand tonnes (kt) of cuts to offset the ramp up of projects and to prevent surpluses building significantly. If more curtailments are not forthcoming, prices will test marginal (90th percentile) costs of $2/lb.

"In nickel, we conclude that 55% of the industry is loss making on a cash basis at current price levels, but there appears to be little appetite to cut with just 30kt of production cutbacks so far.  The market is focusing on the slow pace of Indonesian nickel pig iron development and nickel stock drawdown over the next 3-4 years rather than high above ground stocks unavailable to the market.

"In zinc, prices had held up much better with only a very low percentage (around 10-15% of zinc miners are losing cash at current price levels) losing money on a cash basis at current prices. Prices would have to be much lower to precipitate more cuts yet the market is relatively balanced and trending to deficits until 2019 so one questions the need for cuts from a fundamental perspective."

In regards to zinc, Glencore took major actions earlier this month to raise the price after it viewed the metal as undervalued.

It announced it will slash it zinc output, suspending operations at Lady Loretta and reducing output at Macarthur River and George Fisher, as well as cutting more than 500 jobs.

"Glencore believes that current prices do not correctly value the scarcity of our zinc resources; our finite resources are valuable and reducing production, in response to current prices, preserves value," it said in a company statement.

According to a source close to the company, it believes it is more valuable to reduce production and keep the asset in the ground until prices rise, and sees the lack of a strong zinc pipeline ahead as a welcoming omen for potentially raising output in the future.

However Wood Mac wasn’t entirely negative on the sector, stating that for those who work against the trends there will be significant upsides.

“As we've witnessed in our cyclical industry, we believe that the winners will be those producers who invest counter-cyclically. The industry needs to sow the seeds for its future – without investment a critical shortage will follow," Kettle said.


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