UNDERSTANDING THE MINERAL RESOURCES SECTOR ON MINES, MARGINS AND MARKETS

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2 2 THE WAY FORWARD UNDERSTANDING THE MINERAL RESOURCES SECTOR ON MINES, MARGINS AND MARKETS DR ALLAN TRENCH PROFESSOR OF MINERAL & ENERGY ECONOMICS

3 3 THE WAY FORWARD Commodity market changes akin to aftershave advertising Mineral Demand Macroeconomic drivers Microeconomic drivers Mineral Supply The geography of supply Technology impacts Understanding the Commodity Cycle Revenues, Costs Forecasting Prices CRU Commodity Price Outlook to 2018 Subtle.yet Striking!!

4 4 THE WAY FORWARD UNDERSTANDING THE MINERAL RESOURCES SECTOR ON MINES, MARGINS AND MARKETS Mineral Demand

5 5 THE WAY FORWARD WE HAVE COME A LONG WAY IN DEMANDING MORE FROM OUR MINERALS... From This..To This Too...but cool mobile devices aside, most mineral production still goes into heavy industry...

6 6 THE WAY FORWARD LOOKING BACK OVER THE LAST DECADE WHAT WAS OUR INDUSTRY LIKE BACK IN 2003/4...? Xstrata bids for MIM The bid for MIM is high-risk but is a potentially transforming transaction for Xstrata April 8, 2003 Mining industry is worth* over $150 billion...and China was starting to get hungry Data: CRU * Value of sales for Fe, Cu, Au, HCC, Zn, Ni, Pb, Pt

7 7 THE WAY FORWARD CHINA HAS SINCE CONSUMED PLENTY China consumption growth as a percentage of total growth in global consumption ( ) 250% 200% 150% 100% 50% 0% Nickel Mo FeCr Zinc Copper Lead Fe Ore Met Coal SiMn Data: CRU

8 GDP growth yoy - % 8 THE WAY FORWARD GOING FORWARD SEES A DIVERGING ECONOMIC OUTLOOK China India Other Emergers investment led slowdown amid reforms and debt concerns economy stabilised election uncertainty means less consensus a mixed bag... recovery... 2 Advanced Economies 1 0 World Global GDP reflects developed economies Average E 2015E Data: CRU

9 9 THE WAY FORWARD 2014: CHINA SLOWER GROWTH STEADY REFORMS UNDER-APPRECIATED BY THE MARKET Slowdown in growth rate since 2011: more structural than cyclical Slow and steady demand growth with limited price volatility (the investors are playing somewhere else...) Prices stable or declining slightly as construction frenzy dissipates Underappreciated structural shift - no pain, no gain reform Some hot spots do exist (demand-side and supply-side) and the market will always reward a good project... Our industry is significantly larger than it was 10 years ago, over US$600 billion

10 10 THE WAY FORWARD AND THE NEW CHINA COULD BE...CENTRAL & WESTERN CHINA! Percent of population living in urban areas Chinese population by region East: 624M C & W: 724M Central & Western China s share of national output, % Central & Western China East China OECD Industrial production Construction Data: CRU

11 11 THE WAY FORWARD METAL INTENSIVE INDUSTRIAL PRODUCTION TELLS US MORE China IP growth yoy - % India Other Emergers Advanced Economies World Average E 2015E...and, we are still talking about GROWTH Data: CRU Data: CRU

12 12 THE WAY FORWARD SLOWER MINERALS/METALS DEMAND GROWTH IN CHINA China Demand Growth CAGR CAGR Index % Steel Sheet Aluminium Copper Iron Ore Alumina Phosphate Rock Steel Sheet 7% 4% 14% 12% Iron Ore 4% 3% 10% Aluminium 7% 6% 8% 6% Copper 4% 4% 4% 2% Phosphate Rock 2% 0% 0% -2% -4% Data: CRU

13 13 THE WAY FORWARD ELSEWHERE GROWTH RETURNS Aftershocks of GFC are easing & fundamentals become more influential World (ex-china) Demand Growth CAGR CAGR Index % Steel Sheet Aluminium Copper Iron Ore Alumina Phosphate Rock Steel Sheet 1% 2% 6% Iron Ore 0% 3% 4% Aluminium 1% 2% 2% Copper 0% 2% Phosphate Rock -1% 3% 0% -2% -4% 13 Data: CRU

14 14 THE WAY FORWARD HEADWINDS TO GROWTH TO DISSIPATE Steady global growth over the forecast period World Demand Growth CAGR CAGR Index % Steel Sheet Aluminium Copper Iron Ore Alumina Phosphate Rock Steel Sheet 3% 3% 7% 6% Iron Ore 2% 3% 5% Aluminium 4% 4% 4% 3% Copper 2% 3% 2% Phosphate Rock 1% 2% 1% 0% Data: CRU

15 15 THE WAY FORWARD MOVING OUT OF A PERIOD OF EXTREME PRICE VOLATILITY Prices have come down from cyclical peaks. We are now looking at a flatter period for prices. Price change by commodity group Ave y-o-y % chg 200% 150% 100% 50% 0% -50% -100% Aluminium Base Metals Steel Raw Materials Fertilizer Precious Data: CRU

16 16 THE WAY FORWARD SO ~3% (NORMAL) GROWTH LIES AHEAD FOR MINERAL DEMAND Lets be honest even those who saw China coming under-estimated the size of the demand growth Could it happen again? Technology influences demand both positively and negatively: New products from plentiful commodities Substitution of scarce commodities Electrification will permeate in the long term

17 17 THE WAY FORWARD GOLD CHINA S APPETITE FOR GOLD CONTINUES tonnes Consumption of Gold China net gold imports * yoy change (t) yoy change % % 24% 21% 18% 15% 12% 9% 6% 3% 0% -3% tonnes $10bn CRU calculated value of Chinese gold imports in Chinese spot prices for gold (SHFE), RMB/g 21.9% Chinese gold consumption as a proportion of global consumption in * Note: without any published data on gold imports in China, we estimate net gold balance from supply minus demand

18 18 THE WAY FORWARD UNDERSTANDING THE MINERAL RESOURCES SECTOR ON MINES, MARGINS AND MARKETS Mineral Supply

19 19 THE WAY FORWARD MINERAL SUPPLY DOESN T CHANGE FAST...BUT IT DOES CHANGE Kalgoorlie; ca Super-Pit, KCGM We think first of price as a key element in supply - But there are also two intangibles that impact supply: 1. Technology 2. Political will (interference)

20 20 THE WAY FORWARD LOOKING AT NICKEL SHOWS THINGS CAN CHANGE. (Selected country mined nickel production, ktpa, 2003 / 13) Russia Australia Canada New Caledonia Indonesia Philippines Data: CRU

21 21 THE WAY FORWARD..AND FORECASTING? (Selected country mined nickel production, ktpa, 2003 / 13 / 18) Russia Australia Canada New Caledonia Indonesia Philippines Data: CRU

22 22 THE WAY FORWARD THE LONG TERM NICKEL PRICE WILL BE DICTATED BY SUPPLY, WHICH WILL BE DICTATED BY TECHNOLOGY.. Ni units Sulphide Laterite Scrap Processing HPAL FeNi Ni NPI NPI Technology: [RKEF] [EAF] [BF] Different types of NPI process. What will be built in Indonesia? Indonesia Policy Grades FeNi Ramp-up delays? HPAL Technological development? Have mistakes been made here? Is HPAL now delivering on its potential? Data: CRU

23 23 THE WAY FORWARD THIS IS NOT NEW: TECHNOLOGY REDUCES COSTS. Are we due a game changer? Historical copper price in 2012$/tonne 10,000 8,000 Froth flotation SX-EW Equipment scaling???? 6,000 4,000 Consensus LT price of ~$3/lb 2, Data: CRU

24 24 THE WAY FORWARD SOME THINGS ARE FORCEAST NOT TO CHANGE QUICKLY Mo and Mn will see more dirt from the same place... Molybdenum: Production is China / USA / Chile / Peru = 84-88% of total 100% 80% 60% 40% 20% 0% Manganese ore Example (Market share by country) ROW Gabon Brazil Australia South Africa China Data: CRU

25 25 THE WAY FORWARD CHANGES IN IRON ORE HAVE BEEN SUBTLE AND INVOLVE POLITICAL WILL & TECHNOLOGY Market share by country, % 90% 80% ROW 70% 60% 50% 40% 30% 20% 10% Africa Other Asia North America China CIS Oceania C.& S. America 0% Data: CRU

26 26 THE WAY FORWARD INDIA S EXPORTS WERE FLYING UNTIL POLITICS GOT INVOLVED... Indian contribution to seaborne market, mt ( ) Australia were happy fill the gap +18% Exports in % Exports in 2014f Data: CRU

27 27 THE WAY FORWARD AUSTRALIA HAS TAKEN ADVANTAGE BIG-TIME Australian iron ore exports (mt) Exports 3 month average 40 = Australian iron ore miners $$$$$! Data: CRU, GTIS

28 28 THE WAY FORWARD THERE IS NO SCARCITY OF IRON ORE AND THE MAJORS CONTINUE TO WALK THE TALK ON PRODUCTION GAINS. China s dependency on iron ore will increase and iron ore prices will fall % Chinese iron ore apparent production of fines, lump and pellets, Mt Production Import dependency 90% 85% 80% 75% 70% Chinese import dependency (1), % % Data: CRU, company reports. Note: (1) Iron ore imports as a proportion of iron ore consumption.

29 29 THE WAY FORWARD LAST WORD ON IRON ORE AFRICA HOLDS THE KEY TO THE LONG-RUN PRICE... Project cost curve, opex and capital charge Simandou will it, won t it? X Potential production (mt) Data: CRU Iron Ore Cost Model

30 30 THE WAY FORWARD WHERE CHINA CAN MAKE A DIFFERENCE TO SUPPLY IT HAS Production and market share Mined Production Zinc 1.9mt (20%) 4.1mt (33%) Lead 0.98mt (31%) 2.6mt (52%) Copper 0.66mt (5%) 1.7mt (10%) Refined Production Zinc 2.3mt (23%) 4.6mt* (37%) Lead 1.7mt (24%) 4.8mt (44%) Copper 1.9mt (12%) 5.7mt (29%) Aluminium 5.5mt (19%) 24.4mt (49%) Data: CRU (*2012 data)

31 31 THE WAY FORWARD KAZAKHSTAN IS ANOTHER COUNTRY THAT HAS STOLEN THE #1 PRODUCER CROWN IN URANIUM Selected country mined uranium production, tpa, 2003 / 13) 30,000 25,000 20,000 15,000 10,000 5,000-3, Canada Australia Russia Kazakhstan Namibia Data: CRU

32 32 THE WAY FORWARD THE CHANGING FACE OF MINE SUPPLY It is changing ALL the time mind you don t miss the structural shifts! Both Nickel and Uranium had massive price spikes: both have had new supply entrants There are two intangibles in determining future winners in supply: Technology Political will I believe technology will surprise us this decade if only I knew how!

33 33 THE WAY FORWARD UNDERSTANDING THE MINERAL RESOURCES SECTOR ON MINES, MARGINS AND MARKETS Margins & Commodity Markets

34 34 THE WAY FORWARD DAWN DAWN Commodity amongst those viewed as the next big thing. Price at around long-run marginal cost (equilibrium level). Solid producer margins attracts interest. Strong and easily understood demand story. Eg Chinese growth, technology led demand, light-weighting. Supply concerns on tightening market. Market opportunity for early movers.

35 35 THE WAY FORWARD NOON NOON Commodity considered Hot. Price above the cost curve. Record producer margins (price-driven) in the 1 st & 2 nd Quartile. Producers focus on volume growth over cost control. Consumers respond via substitution and economisation. Reliability of supply an industry issue. New production technologies, low grades, tailings rework all considered viable. A market optimism that proclaims market conditions as the new normal.

36 36 THE WAY FORWARD EVENING Commodity still in favour but doubters emerge. EVENING Prices gradually eroding. Strong margins (volume-driven). Demand growth solid but not spectacular. Supply growth rates meet and exceed demand expectations. As short term signals weaken optimists have to rely on mediumterm fundamentals to maintain optimism.

37 37 THE WAY FORWARD TWILIGHT Commodity out of favour. TWILIGHT Prices well down into the cost curve, 3rd & 4 th Quartile assets fight for survival with state owned protected assets. Margins squeezed across the industry. Producers sacrifice volume for cost reductions. Demand-side, even if healthy, fails to influence price. Supply growth and future expectations far higher than demand growth. Supply (and stocks) overhang. A market pessimism that proclaims market conditions as the new normal.

38 38 THE WAY FORWARD A BAROMETER APPROACH LOOKS AT PAST PRICES Dry (25% above 5-year average) Fair (10% above 5-year average) Changeable (Between +10% and -10% of the 5-year average) Rainy (10% below 5-year average) Stormy (25% below 5-year average) Rising (Year-on-Year average increase) n/a Indium & Palladium Iron Ore, Lead & Tin Tantalum Falling (Year-on-Year average increase) n/a Tungsten Antimony, Bismuth, Copper, Gold & Zinc Nickel, Platinum, Silver Cobalt, Gallium, Molybdenum, Rhodium & Uranium Source: Sykes (2014) Copyright: Greenfields Research

39 39 THE WAY FORWARD MINING MARGINS DRIVEN BY LAG BETWEEN COMMODITY PRICE & INPUT COST CYCLES Price Peak Cost Peak

40 The 2006 tin cost curve is an example of the first stage of the commodity price cycle (low prices & low costs) 20, , ITRI Net of By-Product Cash Cost (US$/tonne) 15,000 Uneconomic Producers Cost (US$/t) 10,000 5,000 Thin margin Annual Average Tin Price (US$8,763) ,000-10,000 % of cumulative production CRU STRATEGIES Data: ITRI & Greenfields Research (2014); Copyright: ITRI

41 The 2007 tin cost curve is an example of the second stage of the commodity price cycle (high prices & low costs) 20,000 15, , ITRI Net of By-Product Cash Cost (US$/tonne) Annual Average Tin Price (US$14,543) Fewer uneconomic producers Cost (US$/t) 10,000 5,000 0 Substantial margin ,000-10,000 % of cumulative production CRU STRATEGIES Data: ITRI & Greenfields Research (2014); Copyright: ITRI

42 The 2008 tin cost curve is an example of the third stage of the commodity price cycle (high prices & high costs) Cost (US$/t) 20,000 15,000 10,000 5, , ITRI Net of By-Product Cash Cost (US$/tonne) Substantial margin, but it remains the same despite price increase Annual Average Tin Price (US$18,533) Virtually no uneconomic producers ,000-10,000 % of cumulative production CRU STRATEGIES Data: ITRI & Greenfields Research (2014); Copyright: ITRI

43 The 2009 tin cost curve is an example of the final stage of the commodity price cycle (low prices & high costs) Cost (US$/t) 20,000 15,000 10,000 5, , ITRI Net of By-Product Cash Cost (US$/tonne) Thinned margin, costs remain high despite price decrease Annual Average Tin Price (US$13,592) More uneconomic producers again ,000-10,000 % of cumulative production CRU STRATEGIES Data: ITRI & Greenfields Research (2014); Copyright: ITRI

44 MINING MARGINS HIGH PRICES BUT HIGH COSTS ARE EQUIVALENT TO LOW PRICES AND LOW COSTS PRICES High Prices & Low Costs (Positive) Low Prices & Low Costs (Neutral) High Prices & High Costs (Neutral) Low Prices & High Costs (Negative) COSTS Source: Trench & Sykes (2014)

45 IT IS NOT JUST ECONOMICS THAT DRIVE COMMODITY PRICES BUT FINANCIAL FACTORS TOO LME Copper Cash Price Constituent Analysis 2013 Example Copper Fundamentals $6,075/t Investment Factors $1,625/t 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Stocks/ Demand Relationship Currency Energy China Balance Physical ETFs Short term Investors Hedge Funds Index Funds Total Price CRU STRATEGIES Source: CRU (2013)

46 46 THE WAY FORWARD UNDERSTANDING THE MINERAL RESOURCES SECTOR ON MINES, MARGINS AND MARKETS Forecast Prices

47 Short term price recovery on hold for % price decline expected on average over 2013 actual prices Hot > 15% Warm 5% to 15% Mild 0% to 5% Cool 0% to -5% Cold -5% to 15% Freezin g < -15% Tin Palladium Ferrochrome, Platinum, Zinc, Alumina, Met Coke, Manganese, Lead, Nickel, Molybdenum, Gold, Copper, Aluminium, Cobalt, Met Coal, Urea, Sulphur, Ammonia, Iron Ore Potash, Phosphate Rock, Silver * 2014 annual average price forecast (nominal $ or benchmark) versus 2013 average actual prices CRU STRATEGIES

48 Medium term prices recover where supply is constrained 14% price increase by 2018 over 2013 average actual price 48 Hot > 15% Warm 5% to 15% Mild 0% to 5% Cool 0% to -5% Cold -5% to 15% Freezing < -15% Zinc, Palladium, Nickel, Tin, Hard Coking Coal, Cobalt, Platinum, Aluminium, Met Coke, Alumina, Molybdenum, Lead, Manganese, Urea, Potash, Copper, Phosphate Rock, Gold, Ammonia, Sulphur, Iron ore Silver, Ferrochrome * 2014 annual average price forecast (nominal $ or benchmark) versus 2013 average actual prices CRU STRATEGIES

49 49 THE WAY FORWARD Thank you for your attention! Professor Allan Trench Curtin University of Technology Associate Consultant CRU Consulting Thank you to Phil Newman CRU International Ltd. Chancery House Chancery Lane London WC2A 1QS With Special Thanks to John Sykes Centre for Exploration Targeting (CET) Dept of Mineral & Energy Economics Curtin University of Technology Also at Greenfields Research Previously CRU Group Consider the Joint Masters Program in Mineral and Energy Economics and Curtin MBA