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Metals Outlook 2006

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Most unusually, major mining companies like BHP Billiton and Rio Tinto are investing heavily at what many analysts consider the top of the minerals cycle in commodities like iron ore, coal, nickel and mineral sands.

In the past such investment has been usually undertaken at the bottom of the cycle when the cost of everything from skilled labour to design and construct, and the actual steelwork and mining equipment and consumables is depressed.

But the China story seems to have convinced some players in the minerals industry worldwide that this time is different: that there will be a super cycle lasting a decade long in which China, and possibly India, will suck in our resources long term.

The government department, DFAT, is clearly in this camp, forecasting that China’s gross domestic product will overtake that of Germany by 2010 and of Japan by 2030. Chinese imports of minerals and energy, claims DFAT, will grow by 13.5% a year until 2010.

Not all agree. Many of the international analysts believe that the present situation, where demand clearly outstrips supply, will not last beyond 2006-2008.

They say that suppliers in iron ore and coal may gain further monopoly rents in 2006 but, after that, the rapid expansion worldwide of supply in many minerals will see a winding back of prices, often substantially.

Analysts say it will be a brave company that invests in new projects or major expansion based on present prices. The essential need is to factor in historic price levels, adjusted for inflation, into any feasibility studies rather than current super cycle prices.

Among local forecasters to “poop” on the super cycle theory are the federal government’s ABARE and leading economic consultancy, Access Economics.

For example, the latest Access Economics Minerals Monitor report (contact 02 62731 222) admits that iron ore suppliers, despite the bleating of the Chinese and Japanese steel mills, will gain a further increase in current negotiations for 2006. They predict the price for lump iron ore will rise to US$85.14/t next year.

But then the price will then fall successively over the two next years to US$77.68/t by 2008. Iron ore fines will suffer a similar percentage drop.

Among other commodities that will suffer a double digit drop by 2008 will be silver, hard coking coal, nickel and copper (this last, says Access Economics, by a massive 37.9% in US terms).

All these forecasts of course hinge on the crucial US$ versus A$ exchange rate as most minerals prices are denominated in US$ terms in real life, even where they are trade on the London Metals Exchange (LME).

Below we report on the forecasts for 2006 from major forecasters for minerals demand, supply and prices for six crucial minerals: iron ore, coking coal, steaming coal, nickel, copper and gold.

IRON ORE

Of all the minerals that Australia exports, iron ore has seen the most dramatic 12-months with a massive 71.5% price hike last year gained by BHP Billiton and Rio Tinto on the back of the rise gained with Japanese customers by the world's third player in sea traded iron ore, CVRD of Brazil.

The Japanese were obviously intent on sewing up supply against the burgeoning Chinese demand. The Chinese have naturally called foul but they do not have the experience of negotiating in a free capitalist market and their hopes of winding back the price this year are doomed.

Instead, analysts believe that another rise of 10-20% is possible for next year, especially for the Australian producers who have a freight rate advantage against the Brazilians that is not reflected in landed prices in China.

It is rumoured that the Chinese will follow the Japanese line, by presenting a unified negotiating face against the three big iron ore suppliers.

That worked when supply was fragmented but now that, for example, Rio Tinto has absorbed North Ltd, this will not work today.

Neither will the former Japanese strategy of directly investing in projects. This enabled them, at board meeting, to request the finest financial detail so that they could know exactly the margins the miner was making.

So what do the analysts say? ABARE, in its most recently released report, says that sea borne trade in iron ore is forecast to rise by over 7% in 2006 to 699Mt.

Australian exports are expected to rise by 35Mt to 280Mt in 2006, and then there is the $3000m investment now committed by both BHP Billiton and Rio Tinto for mine development, rail capacity increases and port development which will give even further export capacity, if is needed (China now has a policy of rolling back many of its huge number of smaller steel producers).

Another forecaster, AME Mineral Economics, reflects on the new iron ore mining projects being undertaken in countries as diverse as Brazil, India, and even Sweden, with “niche” players like Australia’s Portman Mining, able to strike deals with steel makers wanting to undermine the dominance of the Big Three.

AME is forecasting that by 2010 world iron ore consumption will reach 1,760,000Mtpa, growing at a compound rate of 4.5%.

It is not releasing publicly its pricing forecasts, but Access Economics is prepared to do so. It says lump iron ore will fall from an increased US$85.14/t next year to US$77.68/t in 2008. It says Iron ore fines will rise from US$62.62/t this year and fall to US$60.57/t in 2008.

METALLURGICAL COAL

Almost hand-in-hand with demand for iron ore is that for metallurgical, or coking, coal which is essential for most steel blast furnaces.

So it was not surprising that, last year, coal suppliers gained major price increases. Indeed, some of them expect a further rise in the next set of negotiations in line with any iron ore price rise.

But the joker in the pack could be the rapid expansion of production worldwide, especially in Australia and Canada but also including Indonesia, which could undermine the long-term price stability.

According to ABARE, the world seaborne trade in metallurgical coal will be up 4% this year to 216Mt and then on again to 227Mt in 2006.

Australian exports are expected to lift by 8.7% to 133.6MT next year. Apart from expansion of existing mines, there is a range of greenfields sites in NSW (Dendrobium) and Queensland (Excel Mooranbah, Minerva, Broadmeadows, Curragh North).

There is anecdotal evidence that, given the constraints in the rail and port systems in Queensland and NSW, that some existing coal miners are forsaking production of the less lucrative steaming coal and instead switching available transport and infrastructure capacity to coking coal.

In fact, by 2006, despite a rapid ramping up of Canadian coking coal production, Australia is expected to account for some 59% of worldwide seaborne metallurgical coal trade, according to ABARE.

China is not the major customer for this coal, being a relatively small importer at just under 4.7% of worldwide demand. The bulk of imports are made by Japan, the European Union, South Korea, India and Brazil.

For the future, the large expansion in capacity looks set to undermine the present contract prices. AME Mineral Economics points to the self-inflicted wounds caused to miners by optimistic capacity expansion in the uncertain steel markets of the 1990s and queries whether this will be repeated.

Analysts at Goldman Sachs JBWere have recently cut their forecasts for future coking coal prices. Thus hard coking coal, at a present US$125/t is expected to fall to US$115/t in the 2006-7 year and as low as US$80/t in 2008-9.

Similarly semi-soft coking coal, they forecast, will fall from the present US$85/t to US$55/t in 2006 and then US$45/t in 2008-9.

Access Economics is also forecasting price drops for hard coking coal in its latest Minerals Monitor, although nowhere as sever as Goldman Sachs JBWere.

From the present US$125/t, it is suggesting a price of US$119.3/t for 2006 and a fall to US$101.78/t by 2008, or a decline of 18.6%.

Access Economics comments that hard coking coal “continues to be seen as the most overvalued (of minerals) compared to its ‘sustainable’ price, with a fall of over 50% expected in the long term”.

THERMAL COAL

ABARE says a slowing world economy next year will lead to a lower growth in demand for electricity, and hence for thermal coal for power stations.

Coupled with this is the move to alternative sources of energy in some countries. Although not in themselves of major significance, the move to hydroelectric, solar and wind power will have a cumulative effect on demand for steaming coal.

The rebirth of the nuclear power station industry will also be a determinant. It has been a little reported fact, revealed by ABARE in its latest quarterly report, that two Japanese power companies have restarted 27 of the 28 nuclear reactors shut down in 2003 and 2004. A further 3,000MW of nuclear power is expected on stream in that country by the end of 2006.

Australia has lost its mantle as the world’s largest export of thermal coal: that crown now belongs to Indonesia.

But nevertheless, ABARE forecasts Australia will still export 110.5Mt in 2006, an increase of 3.2% (Indonesia: 114.5Mt). Other major exporters are China, South Africa (where the main coal port of Richards Bay is being massively expanded) and that almost unknown competitor, Colombia.

The growing world supply and a probable lessening of demand is unlikely to see present prices sustainable in 2006. Indeed ABARE is forecasting a major drop, with spot prices likely to fall further in 2006.

In 2005, spot prices were already well below the levels at the time the annual contract prices were settled for the current Japanese financial year (April-March).

While ABARE is not prepared to forecast where prices may head, Goldman Sachs JBWere is.

It suggests that the present US$52.52/t prices will fall back to US$44/t next year and as low as US$40/t by 2008-9.

Access Economics survey of leading forecasters also suggests a similar picture of higher volumes but lower prices for Australian miners, if they can get the coal out of the ports.

The present contract prices of US$52.52/t, it forecasts, will fall to US$48.45/t next year and then to US$43.14/t by 2008.

AME Mineral Economics also identifies another trend: the consolidation of production of seaborne thermal coal production by the major companies. It says that the top ten countries will control 47% of international thermal coal supply this year.

While BHP Billiton and Rio Tinto are obviously in the Top 10, number three is actually the almost unknown (outside of Hong Kong) China Shenhua Energy Corporation.

NICKEL

The main use of nickel is for stainless steel production, and the huge ramp up in Chinese production in recent years with more anticipated in future years has supported the price at high levels.

The failure of the three Australian laterite nickel projects (Murrin Murrin, Cawse and Bulong) to perform as originally designed has been part of a major worldwide constraint on nickel availability.

In consequence, according to ABARE, for most of this year prices have average US$15,600/t, or 13% higher than a year previously.

But this is all about to change. Production next year is forecast by ABARE to exceed consumption even though the Chinese are drawing down on stocks caused by previous over-ordering.

As a result the forecast from ABARE, at least, is that prices will fall to US$13,880/t next year, down 7.8%.

World nickel production will reach 1.35Mt in 2006, of which Australia will contribute 212,000t, a rise of 7% over this year.

While these numbers may seen benign the fact is that next year there will only be 4.6 weeks of supply available to the world at any one time. Any disruption to production, failure of new plants to meet production targets or indeed failure to meet construction deadlines could impact adversely on supply, and hence drive prices higher again.

While Australia’s nickel miners, many of them “tiddlers” able to successfully revitalise moribund ex-WMC mines, are doing well, the nickel smelting industry worldwide is operating at close to capacity.

New refining plants will come on stream in China, the Philippines, and New Caledonia, but will be offset by shut downs in Canada and Finland.

This will create problems for new nickel miners, most notably the long-anticipated Inco Voiseys Bay nickel mine in Canada which finally seems to being developed, although the Canadian winter means that it will be a seasonal supplier to world markets.

Other new mines include BHP Billiton’s Ravensthorpe laterite nickel mine in WA and the Goro mine in Indonesia.

Outside of ABARE, Access Economics has its own predictions. It says that the present nickel price of US$14,596/t may drop to US$13,124/t next year and to US$9,868/t by 2008, a fall of over 32%. It says nickel prices “remain the most stretched”.

GOLD

Gold is the most enigmatic of all metal commodities. Geo-political events almost anywhere around the world can impact on its price in a rapid time span.

Even something seemingly non-associated like the oil price can have a correlation with the gold price, with the two moving closely in tandem.

Apart from its value as a safe haven in times of stress there is also the physical gold demand caused by increasing affluence in those nations that place great store on possessing good jewellery such as India and China.

And then there is the important nexus between the value of the US$, the Euro and the gold price. According to ABARE, between mid 2001 and mid 2005, a 45% increased in the gold price was accompanied by a 40% depreciation of the US$ against the Euro, although of more recent times the situation appears to have reversed.

ABARE in its most recent report says that the growing demand for physical gold for jewellery and other applications is expected to more than offset the downward pressure on prices from expected expansion in gold mining worldwide and higher central bank sales of the metal (forecast to reach 550t in 20005-6).

For next year, forecasts ABARE, an increase in mine production, along with less de-hedging, is expected to lead to a 4% fall in the gold price to average US$414/oz from its forecast of an average US$430/oz this year.

The US$/A$ rate will determine how profitable the local producers will be, but ABARE is positing an A$ price of 571/oz in 2006 against an average forecast for this year of A$562/oz.

Not all analysts are agreed on 2006 and beyond regarding gold production worldwide.

ABARE is confident that world production will rise 2.2% next year to 2560t, with Australian mine production lifting to 275t, or 3.8% over 2005.

Increased production in Australia, Indonesia, China, the US and South America is expected to offset lower production in South Africa, which has been hit by mine closures and industrial action.

But the latest quarterly report by Melbourne gold analysts Surbiton Associates paints a less optimistic picture. It points to a drop in Australian gold production in the June 2005 quarter bringing local gold production for the 2004-5 financial year to 3% less than the 273t produced in the 2003-4 year.

Surbiton Associates has warned that continued lower production could mean Australia could lose its status as the world’s second largest gold producer behind South Africa.

Delays in recent start ups, combined with closure of exhausted mines, is putting the pressure on existing operations to reach their full potential. Newcrest’s Telfer operation is a case in point.

COPPER

Copper has recently reached record prices, with the financial markets apparently betting against a Chinese government gamble on the metal’s price that went wrong.

The fundamentals of copper have pointed for some time to high prices. Low stocks in LME and Comex warehouses, huge demand from China for everything from cars to domestic appliances and telecommunications, have pointed to a supply shortage.

According to AME Mineral Economics, in the last six years, China’s compound annual growth in copper demand has been 14.5%. Although AME says that this cannot be sustained, the longer-term growth rate is still expected to be more than 5-6%.

But copper mining and refining is being swiftly ramped up to meet world demand following several years of industrial disputes, riots and natural disasters at several mine sites and refineries in third world countries. This will significantly reduce the current supply deficit over the next decade.

AME Mineral Economics says that copper is one of the most over valued metals. Indeed Access Economics, in its latest Minerals Monitor report, forecasts that copper price will drop from US$3746.77/t in September this year to US$2841.29/t by this time next year and US$2327.54/t by March 2008. That is a starling fall of nearly 38%.

For the record, forecasts included in the survey range from a March 2008 price of US$1,873/t from ABN Amro to US$2,718/t from Deutsche Bank.

Perhaps, more importantly, ABARE provides a forecast too. It says that with increased stocks and lower demand as the world economy slows, copper prices are likely to fall by 19% in 2006 to average around US$2,770/t.

It suggests world production will lift 4.9% in 2006 to 17.63Mt, which will only provide the world with 4.3 weeks average consumption.

In Australia, mine output is expected in 2006 to rise to 942,000t, up 3.4%, and refined output to 486,000t, the balance of export being concentrates for refining elsewhere.

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